Attached files

file filename
EX-10.8 - EXHIBIT 10.8 - FORM OF RESTRICTED STOCK AWARD AGREEMENT - CONNECTICUT WATER SERVICE INC / CTexhibit108-formofrestricte.htm
EX-32.2 - CFO SOX CERTIFICATION - CONNECTICUT WATER SERVICE INC / CTexhibit322-2016cfosoxcerti.htm
EX-32.1 - CEO SOX CERTIFICATION - CONNECTICUT WATER SERVICE INC / CTexhibit321-2016ceosoxcerti.htm
EX-31.2 - CFO CERTIFICATION - CONNECTICUT WATER SERVICE INC / CTexhibit312-2016cfocertific.htm
EX-31.1 - CEO CERTIFICATION - CONNECTICUT WATER SERVICE INC / CTexhibit311-2016ceocertific.htm
EX-23.1 - CONSENT OF BAKER TILLY - CONNECTICUT WATER SERVICE INC / CTexhibit231-2016consentofin.htm
EX-21 - 2016 SUBSIDIARY LISTING - CONNECTICUT WATER SERVICE INC / CTexhibit21-2016subsidiaryli.htm
EX-10.10 - EXHIBIT 10.10 - PSU AWARD AGREEMENT - LONG TERM - CONNECTICUT WATER SERVICE INC / CTexhibit1010-psuawardagreem.htm
EX-10.9 - EXHIBIT 10.9 - PSU AWARD AGREEMENT - SHORT TERM - CONNECTICUT WATER SERVICE INC / CTexhibit109-psuawardagreeme.htm



UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D. C. 20549

Form 10-K
ý
Annual Report pursuant to section 13 or 15(d) of the Securities Exchange Act of 1934 for the fiscal year ended December 31, 2016 or

o
Transition report pursuant to section 13 or 15(d) of the Securities Exchange Act of 1934 for the transition period to from

Commission File Number 0-8084
cwclogocolor-sizeda02.jpg
Connecticut Water Service, Inc.
(Exact name of registrant as specified in its charter)

Connecticut
(State or other jurisdiction of
incorporation or organization)
06-0739839
(I.R.S. Employer Identification No.)
 
 
93 West Main Street, Clinton, CT
(Address of principal executive office)
06413
(Zip Code)

Registrant’s telephone number, including area code (860) 669-8636
Registrant’s website:  www.ctwater.com

Securities registered pursuant to Section 12 (b) of the Act:

Title of each Class
Common Stock, without par value
Name of each exchange on which registered
The Nasdaq Stock Market, LLC

Securities registered pursuant to Section 12 (g) of the Act:
None

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.  Yes o  No ý

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Exchange Act.  Yes o  No ý

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934 during the preceding twelve (12) months (or for such shorter period that the registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days.  Yes ý  No o

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (Section 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes ý  No o






Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (Section 229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  ý

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer, or a smaller reporting company.  See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act:

Large Accelerated Filer o
Accelerated Filer x
Non-Accelerated Filer o
Smaller Reporting Company o

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes o  No ý

As of June 30, 2016, the aggregate market value of the registrant’s voting Common Stock held by non-affiliates of the registrant was $619,633,255 based on the closing sale price on such date as reported on the NASDAQ.

Number of shares of Common Stock, no par value, outstanding as of February 1, 2017 was 11,258,790, including 227,673 common stock equivalent shares.

DOCUMENTS INCORPORATED BY REFERENCE

Document
 
Part of Form 10-K Into Which Document is Incorporated
 
 
 
Definitive Proxy Statement, to be filed on or about March 30, 2017, for Annual Meeting of Shareholders to be held on May 11, 2017.
 
Part III





 
INDEX TO ANNUAL REPORT ON FORM 10-K
For the Year Ended December 31, 2016
 
 
 
 
 
Page Number
 
 
Part I
 
 
 
Item 1.
 
Item 1A.
 
Item 1B.
 
Item 2.
 
Item 3.
 
Item 4.
 
 
 
 
 
Part II
 
 
 
Item 5.
 
Item 6.
 
Item 7.
 
Item 7A.
 
Item 8.
 
Item 9.
 
Item 9A.
 
Item 9B.
 
 
 
 
 
Part III
 
 
 
Item 10.
 
Item 11.
 
Item 12.
 
Item 13.
 
Item 14.
 
 
 
 
 
Part IV
 
 
 
Item 15.
 
Item 16.
 
 
 





SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS

Certain statements in this Annual Report on Form 10-K (“10-K”), or incorporated by reference into this 10-K, are forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934 (“Exchange Act”) that are made based upon, among other things, our current assumptions, expectations and beliefs concerning future developments and their potential effect on Connecticut Water Service, Inc. (referred to as “the Company”, “we”, “us”, or “our”).  These forward-looking statements involve risks, uncertainties and other factors, many of which are outside our control, which may cause our actual results, performance or achievements to be materially different from any future results, performance or achievements expressed or implied by these forward-looking statements.  In some cases you can identify forward-looking statements where statements are preceded by, followed by or include the words “believes,” “expects,” “anticipates,” “plans,” “future,” “potential,” “probably,” “predictions,” “continue” or the negative of such terms or similar expressions.  Forward-looking statements included in this 10-K, or incorporated by reference into this 10-K, include, but are not limited to, statements regarding:

projected capital expenditures and related funding requirements;
the availability and cost of capital;
developments, trends and consolidation in the water and wastewater utility industries;
dividend payment projections;
our ability to successfully acquire and integrate regulated water and wastewater systems, as well as unregulated businesses, that are complementary to our operations and the growth of our business;
the capacity of our water supplies, water facilities and wastewater facilities;
the impact of limited geographic diversity on our exposure to unusual weather;
the impact of conservation awareness of customers and more efficient plumbing fixtures and appliances on water usage per customer;
our capability to pursue timely rate increase requests;
our authority to carry on our business without unduly burdensome restrictions;
our ability to maintain our operating costs at the lowest possible level, while providing good quality water service;
our ability to obtain fair market value for condemned assets;
the impact of fines and penalties;
changes in laws, governmental regulations and policies, including environmental, health and water quality and public utility regulations and policies;
the decisions of governmental and regulatory bodies, including decisions to raise or lower rates;
our ability to successfully extend and expand our service contract work within our Service and Rentals Segment in both Connecticut and Maine;
the development of new services and technologies by us or our competitors;
the availability of qualified personnel;
the condition of our assets;
the impact of legal proceedings;
general economic conditions;
the profitability of our Real Estate Segment, which is subject to the amount of land we have available for sale and/or donation, the demand for any available land, the continuation of the current state tax benefits relating to the donation of land for open space purposes and regulatory approval for land dispositions;
the amount of repair tax deductions and the Internal Revenue Service’s ultimate acceptance of the deduction methodology;
delays in completing the merger with The Avon Water Company, or difficulties in achieving anticipated benefits or cost savings from the merger; and
acquisition-related costs and synergies.

Because forward-looking statements involve risks and uncertainties, there are important factors that could cause actual results to differ materially from those expressed or implied by these forward-looking statements, including but not limited to:

changes in public utility regulations and policies;
changes in general economic, business, credit and financial market conditions;
changes in environmental conditions, including those that result in water use restrictions;
the determination of what qualifies for a repair expense tax deduction;
abnormal weather conditions;
increases in energy and fuel costs;
unfavorable changes to the federal and/or state tax codes;
significant changes in, or unanticipated, capital requirements;

4



significant changes in our credit rating or the market price of our common stock;
our ability to integrate businesses, technologies or services which we may acquire;
our ability to manage the expansion of our business;
the continuous and reliable operation of our information technology systems, including the impact of cyber security attacks or other cyber-related events;
the extent to which we are able to develop and market new and improved services;
the continued demand by telecommunication companies for antenna site leases on our property;
the effect of the loss of major customers;
our ability to retain the services of key personnel and to hire qualified personnel as we expand;
labor disputes;
increasing difficulties in obtaining insurance and increased cost of insurance;
cost overruns relating to improvements or the expansion of our operations;
increases in the costs of goods and services;
civil disturbance or terroristic threats or acts; and
changes in accounting pronouncements.

Given these uncertainties, you should not place undue reliance on these forward-looking statements.  You should read this 10-K and the documents that we incorporate by reference into this 10-K completely and with the understanding that our actual future results, performance and achievements may be materially different from what we expect.  These forward-looking statements represent our assumptions, expectations and beliefs only as of the date of this 10-K.  Except for our ongoing obligations to disclose certain information under the federal securities laws, we are not obligated, and assume no obligation, to update these forward-looking statements, even though our situation may change in the future.  For further information or other factors which could affect our financial results and such forward-looking statements, see Part I, Item 1A “Risk Factors.”  We qualify all of our forward-looking statements by these cautionary statements.

5



PART I

ITEM 1.  BUSINESS

The Company

The Registrant, Connecticut Water Service, Inc. (referred to as “the Company”, “we”, “us”, or “our”) was incorporated in 1974, with The Connecticut Water Company (“Connecticut Water”) as its largest subsidiary which was organized in 1956. Connecticut Water Service, Inc. is a non-operating holding company, whose income is derived from the earnings of its five wholly-owned subsidiary companies as of December 31, 2016.  In 2016, approximately 95% of the Company’s net income was attributable to water operations carried out within its regulated water companies, Connecticut Water and The Maine Water Company (“Maine Water”), together the “Regulated Companies”.  As of December 31, 2016, the Regulated Companies supplied water to 124,968 customers, representing a population of approximately 400,000, in 77 municipalities throughout Connecticut and Maine.  The Regulated Companies are subject to state regulation regarding financial issues, rates, and operating issues, and to various other state and federal regulatory agencies concerning water quality and environmental standards.

In addition to its Regulated Companies, the Company owns two active unregulated companies.  In 2016, these unregulated companies, together with real estate transactions within Connecticut Water, contributed the remaining 5% of the Company’s net income through real estate transactions as well as services and rentals.  The two active unregulated companies are Chester Realty, Inc., a real estate company in Connecticut; and New England Water Utility Services, Inc. (“NEWUS”), which provides contract water and sewer operations and other water related services.

Our mission is to provide high quality water service to families and communities at a fair return to our shareholders while maintaining a work environment that attracts, retains and motivates our employees to achieve a high level of performance.

Our corporate headquarters are located at 93 West Main Street, Clinton, Connecticut 06413.  Our telephone number is (860) 669-8636, and our Internet address is www.ctwater.com.  The references to our Web site and the Securities and Exchange Commission’s (“SEC”) website are intended to be inactive textual references only, and the contents of those Web sites are not incorporated by reference herein and should not be considered part of this or any other report that we file with or furnish to the SEC.

The Company’s annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, proxy statements and all amendments to these documents will be made available free of charge through the “INVESTORS” section of the Company’s Internet website (www.ctwater.com) as soon as practicable after such material is electronically filed with, or furnished to, the SEC. The following documents are also available through the “INVESTORS” section of our website, under the “Corporate Governance” tab:

Board of Directors Code of Conduct
Compensation Committee Charter
Corporate Finance and Investments Committee Charter
Corporate Governance Committee Charter
Bylaws of Connecticut Water Service, Inc.
Employee Code of Conduct
Audit Committee Charter

Additionally, information concerning the Company’s 2017 Annual Meeting Materials (2016 Annual Report and 2017 Proxy Statement) can be found under the “INVESTORS” menu, under the “Investor Resources” tab when the Annual Meeting Materials are filed with the SEC on or about March 30, 2017.

Copies of each of the Company’s SEC filings (without exhibits) and corporate governance documents mentioned above will also be mailed to investors, upon request, by contacting the Company’s Corporate Secretary, Kristen A. Johnson, at Connecticut Water, 93 West Main Street, Clinton, CT 06413.


6



Our Regulated Companies

Our Regulated Companies are subject to seasonal fluctuations and weather variations.  The demand for water is generally greater during the warmer months than the cooler months due to customers’ incremental water consumption related to cooling systems and various outdoor uses such as private and public swimming pools and lawn sprinklers.  Demand will vary with rainfall and temperature levels from year to year and season to season, particularly during the warmer months. The financial risk associated with changes in demand was mitigated in the State of Connecticut due to the adoption of the Water Revenue Adjustment (“WRA”) by Connecticut Water in 2013.

In general, the profitability of the water utility industry is largely dependent on the timeliness and adequacy of rates allowed by utility regulatory commissions. In addition, profitability is affected by numerous factors over which we have little or no control, such as costs to comply with security, environmental, and water quality regulations. Inflation and other factors also impact costs for construction, materials and personnel related expenses.

The Company believes that we are presently in compliance with current environmental and water quality regulations, but the regulations are subject to change at any time.  The costs to comply with future changes in state or federal regulations, which could require us to modify existing filtration facilities and/or construct new ones, or to replace any reduction of the safe yield from any of our current sources of supply, could be substantial.

Regulatory Matters

The rates we charge our water customers in Connecticut and Maine are established under the jurisdiction of and are approved by the Connecticut Public Utilities Regulatory Authority (“PURA”) and the Maine Public Utilities Commission (“MPUC”), respectively.  It is our policy to seek rate relief as necessary to enable us to achieve an adequate rate of return.  Connecticut Water’s allowed return on equity and return on rate base, effective as of December 31, 2016 were 9.75% and 7.32%, respectively. Maine Water’s average allowed return on equity and return on rate base, as of December 31, 2016 were 9.50% and 7.96%, respectively. The PURA establishes rates in Connecticut on a company-wide basis while the MPUC approves Maine Water’s rates on a division-by-division basis. Both Connecticut Water and Maine Water are permitted to add surcharges to customers’ bills in order to recover certain approved capital projects in between full rate cases, as well as approved surcharges for Water Revenue Adjustments in Connecticut, as discussed in more detail below.

Heritage Village Water Company Acquisition
On May 10, 2016, the Company announced that it had reached an agreement to acquire The Heritage Village Water Company ("HVWC"), pending a vote of HVWC shareholders, approval by PURA and MPUC and the satisfaction of other various closing conditions, pursuant to the terms of that certain Agreement and Plan of Merger dated May 10, 2016 between and among HVWC, the Company, and HAC, Inc., the Company’s wholly-owned Maine subsidiary (the “Merger Agreement”). HVWC serves approximately 4,700 water customers in the Towns of Southbury, Middlebury, and Oxford, Connecticut and approximately 3,000 wastewater customers in the Town of Southbury, Connecticut.

Under the Merger Agreement, the acquisition was agreed to be executed through a stock-for-stock merger transaction valued at approximately $16.1 million. Holders of HVWC common stock will receive shares of the Company’s common stock in a tax-free exchange. In addition the transaction reflects a total enterprise value of HVWC of approximately $20.7 million.

The Company received regulatory approval from MPUC on September 28, 2016 and from PURA on December 5, 2016, to proceed with the transaction. The shareholders of HVWC voted to approve the acquisition at a special meeting of HVWC’s shareholders held on February 27, 2017.

On February 27, 2017, the Company completed the acquisition of HVWC by completing the merger of Connecticut Water’s wholly-owned subsidiary HAC, Inc. with and into HVWC, with HVWC as the surviving corporation, pursuant to the terms of the Merger Agreement and Connecticut corporate law. Upon the effective time of the Merger, the holders of HVWC’s 1,620 issued and outstanding shares of common stock became entitled to receive an aggregate of 300,445 shares of the Company’s common stock in a tax-free exchange, which exchange was commenced by the issuance of a letter of transmittal and related materials by Connecticut Water’s exchange agent.

Avon Water Company Acquisition
On October 11, 2016, the Company entered into an Agreement and Plan of Merger (the “Avon Agreement”) with The Avon Water Company, a specially-chartered Connecticut corporation (“Avon Water”). Founded in 1911, Avon Water serves about 4,800 customers in the Farmington Valley communities of Avon, Farmington, and Simsbury, Connecticut, and is located near Connecticut Water’s existing operations in Avon and Farmington.

7




The Boards of Directors of the Company and Avon Water have each unanimously approved the Avon Agreement and the transactions contemplated thereby. Consummation of the merger is subject to regulatory, Avon Water shareholder and other specified approvals described below and is expected to be consummated by the end of the third quarter of 2017.

Under the terms of the Avon Agreement, each of the 121,989 Avon Water common stock shares outstanding at the time of the closing of the merger will be exchanged and converted into the right to receive the following merger consideration: (i) a cash payment of $50.37; and (ii) a stock consideration component, consisting of 4.38 shares of Company Common Stock, provided that the Company’s Share Price (as defined below) over a specified period prior to the closing date of the merger is equal to or greater than $45.00 but less than or equal to $52.00. If the Company’s Share Price is less than $45.00 as of the closing date, each share of Avon Water common stock issued and outstanding at the time of the closing of the merger will be exchanged and converted into the right to receive that number of shares of Company Common Stock equal to 197.10 divided by the Company’s Share Price, rounded to the nearest hundredth. If the Company’s Share Price is more than $52.00 as of the closing date, each share of Avon Water common stock issued and outstanding at the time of the closing of the merger will be exchanged and converted into the right to receive that number of shares of Company Common Stock equal to 227.76 divided by the Company’s Share Price, rounded to the nearest hundredth. The “Company’s Share Price” is determined by calculating an average of the closing prices for shares of the Company’s Common Stock on the Nasdaq Stock Market, LLC for the twenty trading days immediately preceding the third business day prior to the closing of the Merger. Holders of Avon Water common stock prior to the Merger will receive cash in lieu of fractional shares of Company Common Stock.

The Avon Agreement contains customary representations and warranties regarding, on the one hand, Avon Water, its business and operations and related matters, and, on the other hand, the Company, made by the parties as of specified dates, and customary affirmative and negative covenants with respect to the conduct of Avon Water’s business prior to the closing. In the Avon Agreement, Avon Water has agreed that its Board of Directors will, subject to certain exceptions, recommend adoption of the Avon Agreement by Avon Water shareholders and the transactions contemplated by the Avon Agreement. Avon Water has also agreed: (i) to cause a special meeting of shareholders of Avon Water to be held to consider the approval and adoption of the Agreement and the transactions contemplated thereby; and (ii) not to solicit proposals relating to alternative business combination transactions or, subject to certain exceptions, enter into discussions concerning confidential information in connection with alternative business combination transactions.

The obligation of the parties to complete the merger is subject to the satisfaction or waiver on or prior to the closing date of certain specified conditions, including the following: (i) receipt of final and non-appealable orders from each of PURA and the MPUC approving the merger in form and substance reasonably acceptable to the parties; (ii) approval of the merger by the affirmative vote of the holders of not less than two-thirds (66 2/3rd %) Avon Water’s issued and outstanding shares of common stock as required under the Connecticut Business Corporation Act; (iii) the receipt of all other necessary consents or approvals to the merger; (iv) approval for listing of the Company Common Stock to be issued in the merger on the Nasdaq Stock Market, LLC; (v) the absence of laws, orders, judgments and injunctions that restrain, enjoin or otherwise prohibit consummation of the Merger; (vi) effectiveness under the Securities Act of the Company’s registration statement on Form S-4 relating to the issuance of the Company Common Stock in the merger and absence of any stop order in respect thereof or proceedings by the SEC for that purpose; (vii) the receipt of a legal opinion from counsel to Avon Water regarding certain corporate law matters; (viii) the receipt of a customary tax opinion from counsel to the Company that will state that the merger will qualify as a tax-free reorganization within the meaning of Section 368(a) of the Internal Revenue Code of 1986; (ix) the accuracy of representations and warranties with respect to the businesses of Avon Water and the Company and compliance by Avon Water and the Company with their respective covenants contained in the Avon Agreement; (xi) no event(s) occurring that could reasonably be expected to result in either a “Company Material Adverse Effect” or a “CWS Material Adverse Effect” (each, as defined in the Avon Agreement) and (xii) holders of no more than 5% of Avon Water’s common stock have exercised appraisal rights under Connecticut law.

The Avon Agreement contains certain termination rights for both the Company and Avon Water and further provides that, in connection with the termination of the Avon Agreement under specified circumstances, Avon Water may be required to pay to the Company, or the Company may be required to pay to Avon Water, a termination fee of $200,000 in cash, as liquidated damages.

During the fourth quarter of 2016, Connecticut Water filed an application with PURA seeking approval of the transaction, which the Company expects to receive in April 2017.


8



Connecticut Rates
In Connecticut, the Water Infrastructure Conservation Adjustment (“WICA”) was 7.13%, 4.19% and 1.59% above base rates at December 31, 2016, 2015, and 2014, respectively. On January 26, 2017, Connecticut Water filed a WICA application with the PURA requesting a 1.09% surcharge to customers’ bills, representing approximately $8.5 million in WICA related projects. Additionally, on February 9, 2017, Connecticut Water filed its annual WICA reconciliation which requested a 0.06% surcharge, which would replace the 0.03% reconciliation adjustment filed in January 2016. If approved as filed, Connecticut Water’s cumulative WICA surcharge, effective April 1, 2017, will be 8.25%.

Since 2013, Connecticut law has authorized a Water Revenue Adjustment (“WRA”) to reconcile actual water demands with the demands projected in the last general rate case and allows companies to adjust rates as necessary to recover the revenues approved by PURA in the last general rate case. The WRA removes the financial disincentive for water utilities to develop and implement effective water conservation programs. The WRA allows water companies to defer on the balance sheet, as a regulatory asset or liability, for later collection from or crediting to customers the amount by which actual revenues deviate from the revenues allowed in the most recent general rate proceedings, including WICA proceedings. Additionally, projects eligible for WICA surcharges were expanded to include energy conservation projects, improvements required to comply with streamflow regulations, and improvements to acquired systems.

Connecticut Water’s allowed revenues for the year ended December 31, 2016, as approved by PURA during our 2010 general rate case and including subsequently approved WICA surcharges, were approximately $76.7 million. Through normal billing for the year ended December 31, 2016 operating revenue for Connecticut Water would have been approximately $75.6 million had the WRA not been implemented. As a result of the implementation of the WRA, Connecticut Water recorded $1.1 million in additional revenue for the year ended December 31, 2016. During the years ended December 31, 2015 and 2014, Connecticut Water recorded $1.6 million and $3.7 million, respectively, in additional revenue related to the WRA.

Maine Rates
In Maine, the overall, approved cumulative Water Infrastructure Charge (“WISC”) for all divisions was 4.7%, 1.6% and 2.0% above base rates as of December 31, 2016, 2015 and 2014, respectively. Two pending WISC filings as of December 31, 2016 have since been approved in the first quarter of 2017, bringing the total to 6.5%.

In 2014 and 2015, Maine Water petitioned the MPUC for approval of accounting orders that would address (1) the return to its customers a federal income tax refund stemming from the adoption of the Internal Revenue Service (“IRS”) Revenue Procedure 2012-19 (“Repair Regulations”), and (2) the treatment of any benefit resulting from the elimination of deferred tax liabilities previously recorded on these qualifying fixed assets that are now deducted under the Repair Regulations.

On February 26, 2015, the MPUC approved a stipulation between Maine Water and the Office of the Public Advocate that refunds $2.9 million to the customers of the eight divisions over a two-year period starting no later than July 1, 2015, and allows the flow-through treatment of the repair deduction as of January 1, 2014. In addition, Maine Water agreed not to file a general rate case during the two-year refund period in any of the eight divisions that were allowed the refund.

On June 22, 2015, the MPUC approved a settlement agreement between Maine Water and the Office of the Public Advocate that allowed for the amortization of the deferred tax liabilities over a one to nine year period, depending on the division. Maine Water commenced amortization per the agreed upon schedule.

With the completion of these two dockets, Maine Water recorded in the quarter ended June 30, 2015 the retroactive benefit associated with the flow-through of the Repair Regulations from January 1, 2014. The 2014 benefit, reflected in the second quarter of 2015, was approximately $931,000, or $0.09 per basic share outstanding.

A newly passed water revenue adjustment mechanism law in Maine became available to regulated water utilities in Maine on October 15, 2015. Maine Water is currently precluded from seeking new rates in certain divisions due to various agreements with the MPUC, but is evaluating how and when this new mechanism can be implemented.

Our Water Systems

As of December 31, 2016, our water infrastructure consisted of 75 noncontiguous water systems in the States of Connecticut and Maine.  Our system, in total, consists of approximately 2,100 miles of water main and reservoir storage capacity of 9.4 billion gallons.  The safe, dependable yield from our 236 active wells and 25 surface water supplies is approximately 176 million gallons per day.  Water sources vary among the individual systems, but overall approximately 80% of the total dependable yield comes from surface water supplies and 20% from wells.


9



For the year-ended December 31, 2016, our Regulated Companies’ 124,968 customers consumed approximately 9.8 billion gallons of water, generating $98,667,000 in operating revenues.  We supply water, and in most cases, fire protection to all or portions of 77 towns throughout Connecticut and Maine.

The following table breaks down the above total figures by customer class as of December 31, 2016, 2015, and 2014:

 
2016
 
2015
 
2014
Customers:
 
 
 
 
 
Residential
111,494

 
110,254

 
109,662

Commercial
8,626

 
8,569

 
8,586

Industrial
479

 
478

 
484

Public Authority
948

 
964

 
943

Fire Protection
2,876

 
2,815

 
2,834

Other (including non-metered accounts)
545

 
553

 
562

Total
124,968

 
123,633

 
123,071

Water Revenues (in thousands):
 

 
 

 
 

Residential
$
59,884

 
$
58,439

 
$
57,095

Commercial
12,250

 
11,816

 
11,473

Industrial
3,176

 
3,229

 
2,984

Public Authority
3,510

 
3,193

 
3,215

Fire Protection
18,486

 
18,016

 
17,757

Other (including non-metered accounts)
1,361

 
1,348

 
1,496

Total
$
98,667

 
$
96,041

 
$
94,020

Customer Water Consumption (millions of gallons):
 

 
 

 
 

Residential
6,583

 
6,551

 
6,341

Commercial
1,954

 
1,941

 
1,865

Industrial
724

 
777

 
739

Public Authority
539

 
503

 
483

Total
9,800

 
9,772

 
9,428


The Regulated Companies own various small, discrete parcels of land that are no longer required for water supply purposes.  At December 31, 2016, this land totaled over 600 acres.  Over the past several years, we have been disposing of these land parcels through sales and/or donations, primarily to towns and municipalities. For more information, please refer to Segments of Our Business below.

Additional information on land dispositions can be found in Item 7 – “Management’s Discussion and Analysis of Financial Conditions and Results of Operations – Commitments and Contingencies”.

University of Connecticut Agreement
Connecticut Water and the University of Connecticut (“UCONN”) negotiated a definitive agreement for Connecticut Water to provide a long-term supply of potable water for UCONN’s Storrs campus facilities which was approved by the Board of Trustees at their December 11, 2013 meeting and executed on December 18, 2013. The definitive agreement is consistent with the requirements of the project’s Environmental Impact Evaluation (“EIE”) and record of decision, as approved by the Office of Policy and Management, an agency of the State of Connecticut, that identified the Company as the preferred option to supply UCONN and the Town of Mansfield, Connecticut with up to 2.2 million gallons of water per day over the next 47 years.  Connecticut Water funded a 5-mile pipeline from Tolland and other necessary infrastructure improvements at no cost to UCONN, the Town or the state’s taxpayers to serve the area. The Company was responsible for obtaining any required regulatory permits, licenses and approvals to implement the water supply solution, including but not limited to those from PURA, the Connecticut Department of Energy and Environmental Protection (“DEEP”) and the Connecticut Department of Public Health (“DPH”). The capital improvements were completed on time and the pipeline was connected to the UCONN campus in December 2016, which was within the agreed upon timeframe.


10



Town of Mansfield Agreement
Connecticut Water and the Town of Mansfield entered into an agreement for Connecticut Water to serve the Town of Mansfield community. On January 13, 2014, the Mansfield Town Council voted to authorize the Town Manager to execute the agreement with Connecticut Water and it was signed by the parties on January 21, 2014.

The key provisions of the agreement with the Town of Mansfield are as follows:
Current off-campus customers of UCONN will become customers of Connecticut Water at UCONN’s water rates in effect at that time (subject to any state-approved surcharges);
Future water customers in the Town of Mansfield will be served by Connecticut Water at the rates authorized by the PURA;
Connecticut Water will assume responsibility for maintaining, repairing and replacing the off-campus water system serving the Town of Mansfield;
Connecticut Water will make any source or system improvements to meet current and future water supply needs of the area; and
Pursuant to the Agreement, a Water System Advisory Committee (“WSAC”) was created with representatives of the Town of Mansfield, UCONN, regional representatives and other key stakeholders to advise Connecticut Water regarding water service and the system’s operations, expansion or integration as well as recommended best management practices, including water conservation programs.  The WSAC meets quarterly.

The former off-campus customers of UCONN in the Town of Mansfield became customers of Connecticut Water in December 2016.

Competition

Our Regulated Companies face competition from a few small privately-owned water systems operating within, or adjacent to, our franchise areas and from municipal and public authority systems whose service areas in some cases overlap portions of our franchise areas.

Employees

As of December 31, 2016, we employed a total of 266 people.  Our employees are not covered by collective bargaining agreements.


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Executive Officers of the Registrant

The following is a list of the executive officers of the Company as of March 13, 2017:

Name
 
Age in 2017*
 
Offices
 
Period Held or Prior Position
 
Term of Office Expires
E. W. Thornburg
 
56
 
Chairman, President, and Chief Executive Officer
 
 
Held positions since March 2006

 
2017 Annual Meeting
D. C. Benoit
 
60
 
Senior Vice President – Finance, Chief Financial Officer and Treasurer
 
Held current position or other executive position with the Company since April 1996
 
2017 Annual Meeting
C. J. Patla
 
50
 
Vice President – Service Delivery
 
 
Held current position or other engineering position with the Company since June 1990
 
2017 Annual Meeting
M. P. Westbrook
 
58
 
Vice President – Customer and Regulatory Affairs
 
Held current position or other management position with the Company since September 1988
 
2017 Annual Meeting
K. A. Johnson
 
50
 
Vice President –  Human Resources and Corporate Secretary
 
Held current position or other human resources position with the Company since May 2007
 
2017 Annual Meeting
J. E. Wallingford
 
60
 
Division President – The Maine Water Company
 
President of The Maine Water Company (and its predecessor companies) since 1993
 
Retiring effective March 31, 2017

* - Age shown is as of filing date of March 13, 2017.

For further information regarding the executive officers see the Company’s Proxy Statement to be filed on or about March 30, 2017.

Segments of Our Business

For management and financial reporting purposes we divide our business into three segments: Water Operations (our Regulated Companies), Real Estate Transactions (through either our regulated or unregulated companies), and Services and Rentals (our unregulated companies and certain unregulated transactions within Maine Water).

Water Operations – The Water Operations segment is comprised of our core regulated water operations to supply public drinking water to our customers.  This segment encompasses all transactions of our Regulated Companies with the exception of certain real estate transactions. More detailed information, including revenues, costs and income taxes associated with the segment can be found in Note 14, “Segment Reporting” in the Company’s “Notes to the Consolidated Financial Statements”.

Real Estate Transactions – Our Real Estate Transactions segment involves the sale or donation for income tax benefits of our real estate holdings.  These transactions can be effected by any of our subsidiary companies.  Through land donations and sales in previous years, the Company earned tax credits to use in future years.  The Company is limited by time and the amount of taxable income when using these credits.  In the year ended December 31, 2014, the Company sold two small parcels of real estate, resulting in net income of $50,000. During 2015, the Company donated land associated with a previously sold land conservation easement in Connecticut and the sale of three small parcels of land in Maine. These transactions generated $349,000 in net income in the Real Estate segment. For the year ended December 31, 2016, the Company sold a small parcel of land and adjusted previously adjusted tax reserves related to previously completed land sales/donations resulting in a loss of $54,000. Net income from the Real Estate Transactions segment is shown net in the “Other Income (Deductions), Net of Taxes” portion of the Company’s Consolidated Statements of Income. More detailed information, including revenues, costs and income taxes associated with the segment can be found in Note 14, “Segment Reporting” in the Company’s “Notes to the Consolidated Financial Statements”.


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A breakdown of the net income of this segment between our regulated and unregulated companies for the past three years is as follows:

 
(Loss) Income from Real Estate Transactions
 
Regulated
 
Unregulated
 
Total
2016
$
(54,000
)
 
$

 
$
(54,000
)
2015
$
349,000

 
$

 
$
349,000

2014
$
4,000

 
$
46,000

 
$
50,000


Services and Rentals – Our Services and Rentals segment provides contracted services to water and wastewater utilities and other clients and also leases certain of our properties to third parties through our unregulated companies in the State of Connecticut and through Maine Water in the State of Maine.  The types of services provided include contract operations of water and wastewater facilities; Linebacker®, our service line protection plan for public drinking water customers; and providing bulk deliveries of emergency drinking water to businesses and residences via tanker truck.  Our lease and rental income comes primarily from the renting of residential and commercial property. Net income from the Services and Rentals segment is shown net in the “Other Income (Deductions), Net of Taxes” portion of the Company’s “Consolidated Statements of Income”. More detailed information, including revenues, costs and income taxes associated with the segment can be found in Note 14, “Segment Reporting” in the Company’s “Notes to the Consolidated Financial Statements”.

Linebacker is an optional service line protection program offered by the Company to eligible residential customers through NEWUS in Connecticut and Maine Water in Maine covering the cost of repairs for leaking or broken water service lines which provide drinking water to a customer’s home.  For customers who enroll in this program, the Company will repair or replace a leaking or broken water service line, curb box, curb box cover, meter pit, meter pit cover, meter pit valve plus in-home water main shut off valve before the meter.  This was the fifth year that NEWUS has successfully offered expanded coverage to Connecticut Water customers for failure of in-home plumbing, sewer and septic drainage lines and implemented modified terms and conditions with limitations on certain coverages. As of December 31, 2016, NEWUS had approximately 20,000 customers enrolled in its Linebacker protection program and over 35% were enrolled in one of our expanded coverage plans. Depending on the coverage selected, Linebacker prices range between $85 and $185 per year for residential customers. Maine Water offers basic service line protection under Linebacker to its customers at a rate of $85. As of December 31, 2016, Maine Water had approximately 2,500 customers enrolled in Linebacker. During 2015, NEWUS began expanding its Linebacker offering in towns in the State of Connecticut not currently served by Connecticut Water.

Some of the services listed above have limited competition. However, the Company has seen competitors in the service line protection business begin to market to Connecticut Water and Maine Water customers. Additionally, there can be considerable competition for contract operations of large water and wastewater facilities and systems. The Company sought to develop a niche market by attaching our name to service line protection plans and by seeking to serve smaller facilities and systems in our service areas where there is less competition.  The Services and Rentals segment has provided between 5-8% of our overall net income in 2016, 2015, and 2014.  Net income generated by this segment of our business was $1,219,000, $1,394,000 and $1,471,000 for the years 2016, 2015, and 2014, respectively.

ITEM 1A.  RISK FACTORS

Our business, financial condition, operating results and cash flows can be impacted by a number of factors, including, but not limited to, those set forth below, any one of which could cause our actual results to vary materially from recent results or anticipated future results. For a discussion identifying additional risk factors and important factors that could cause actual results to differ materially from those anticipated, see the discussion in “Special Note Regarding Forward-Looking Information”, in Item 7 below – “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and “Notes to Consolidated Financial Statements.”


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Because we incur significant capital expenditures annually, we depend on the rates we charge our customers, which are subject to regulation.

The water utility business is capital intensive. On an annual basis, we spend significant amounts of capital for additions to or replacement of property, plant and equipment. Our ability to maintain and meet our financial objectives is dependent upon the rates we charge our customers. These rates are subject to approval by the PURA in Connecticut and the MPUC in Maine.  Our Regulated Companies are entitled to file rate increase requests, from time to time, to recover our investments in utility plant and expenses. Once a rate increase petition is filed with the respective agency, the ensuing administrative and hearing process may be lengthy and costly.  We can provide no assurances that any future rate increase requests will be approved by each agency; and, if approved, we cannot guarantee that any such rate increase requests will be granted in a timely or sufficient manner to cover the investments and expenses for which we initially sought the rate increase.  Additionally, a regulatory agency may rule that a company must reduce its rates.

Under a 2007 Connecticut law, the PURA authorizes regulated water companies to use a rate adjustment mechanism, known as WICA, for eligible projects completed and in service for the benefit of the customers.  During 2013, the Maine Legislature enacted a law that will allow Maine Water for expedited recovery of investments in water systems infrastructure replacement, both treatment and distribution, through WISC, similar to WICA in Connecticut. Maine Water began to use the WISC during 2014.

If we are unable to pay the principal and interest on our indebtedness as it comes due, or we default under certain other provisions of our loan documents, our indebtedness could be accelerated and our results of operations and financial condition could be adversely affected.

As of December 31, 2016, we had approximately $197.0 million in long-term debt outstanding.  Our ability to pay the principal and interest on our indebtedness as it comes due will depend upon our current and future performance.  Our performance is affected by many factors, some of which are beyond our control.  We believe that our cash generated from operations, and, if necessary, borrowing under our existing and planned credit facilities, will be sufficient to enable us to make our debt payments as they become due.  If, however, we do not generate sufficient cash, we may be required to refinance our obligations or sell additional equity, which may be on terms that are not as favorable to the Company as current terms.

No assurance can be given that any debt refinancing or sale of equity will be possible when needed or that we will be able to negotiate acceptable terms.  In addition, our failure to comply with certain provisions contained in our trust indentures and loan agreements relating to our outstanding indebtedness could lead to a default on these documents, which could result in an acceleration of our indebtedness.

Credit market volatility may affect our ability to refinance our existing debt, borrow funds under our existing lines of credit or incur additional debt.

During certain periods of the Unites States credit and liquidity crisis of 2008-2009, the volatility and disruption in the credit and banking markets reached unprecedented levels.  In many cases, the markets contained limited credit capacity for certain issuers, and lenders had requested shorter terms.  The market for new debt financing was limited and in some cases not available at all.  In addition, the markets had increased the uncertainty that lenders will be able to comply with their previous commitments.  The Company noted improvements during the second half of 2009 and continuing through 2016.  If significant market disruption and volatility return, the Company may not be able to refinance our existing debt when it comes due, draw upon our existing lines of credit or incur additional debt, which may require us to seek other funding sources to meet our liquidity needs or to fund our capital expenditures budget.  We cannot assure you that we will be able to obtain debt or other financing on reasonable terms, or at all.

Failure to maintain our existing credit ratings could affect our cost of funds and related margins and liquidity position.

Since 2003, Standard & Poor’s Ratings Services (“S&P”) has rated our outstanding debt and has given credit ratings to us and our subsidiary The Connecticut Water Company.  Their evaluations are based on a number of factors, which include financial strength as well as transparency with rating agencies and timeliness of financial reporting.  In March 2017, S&P affirmed its ‘A’ corporate credit rating on the Company. Additionally, S&P also affirmed the Company’s ratings outlook as stable.


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We may sustain losses that exceed or are excluded from our insurance coverage or for which we are not insured.

We maintain insurance coverage as part of our overall legal and risk management strategy to minimize our potential liabilities. Our insurance programs have varying coverage limits, exclusions and maximums, and insurance companies may seek to deny claims we might make. Generally, our insurance policies cover property damage, worker’s compensation, employer’s liability, general liability and automobile liability. Each policy includes deductibles or self-insured retentions and policy limits for covered claims. As a result, we may sustain losses that exceed or that are excluded from our insurance coverage or for which we are not insured.

Although in the past we have been generally able to cover our insurance needs, there can be no assurances that we can secure all necessary or appropriate insurance in the future, or that such insurance can be economically secured. For example, catastrophic events can result in decreased coverage limits, more limited coverage, increased premium costs or deductibles.

We are subject to adverse publicity and reputational risks, which make us vulnerable to negative customer perception and could lead to increased regulatory oversight or other sanctions.

Water utilities, including our Regulated Companies, have a large consumer customer base and as a result are exposed to public criticism regarding, among other things, the reliability of their water services, the quality of water provided, and the timeliness and accuracy of bills that are provided for such services. Adverse publicity and negative consumer sentiment may render legislatures and other governing bodies, the MPUC, PURA and other regulatory authorities, and government officials less likely to view companies such the Company and its Regulated Companies in a favorable light, and may cause the Company and its Regulated Companies to be susceptible to less favorable legislative and regulatory outcomes, as well as increased regulatory oversight and more stringent regulatory requirements. Unfavorable regulatory outcomes may include the enactment of more stringent laws and regulations governing our operations, as well as fines, penalties or other sanctions or requirements. The imposition of any of the foregoing could have a material negative impact on the Company and each of our regulated compaies’ business, financial condition, results of operations and cash flows.

Our inability to comply with debt covenants under our credit facilities could result in prepayment obligations.

We are obligated to comply with debt covenants under our loan and debt agreements.  Failure to comply with covenants under our credit facilities could result in an event of default, which if not timely cured or waived, could result in us being required to repay or finance these borrowings before their due date, could limit future borrowings, and result in cross default issues and increase our borrowing costs.  The covenants are normal and customary in bank and loan agreements.  The Company and its subsidiaries were in compliance with all covenants at December 31, 2016.

Market conditions, interest rate changes or changes in demographics may unfavorably impact the value of our benefit plan assets and liabilities which then could require significant additional funding.

The performance of the capital markets affects the values of the assets that are held in trust to satisfy future obligations under the Company’s pension and post-retirement benefit plans and could significantly impact our results of operations and financial position.  As detailed in the “Notes to Consolidated Financial Statements”, the Company has significant obligations in these areas and the Company holds significant assets in these trusts.  These assets are subject to market fluctuations, which may affect investment returns, which may fall below the Company’s projected return rates.  A decline in the market value of the pension and post-retirement benefit plan assets will increase the funding requirements under the Company’s pension and post-retirement benefit plans if the actual asset returns do not recover these declines in value.  Additionally, the Company’s pension and post-retirement benefit plan liabilities are sensitive to changes in interest rates.  As interest rates decrease, the liabilities increase, potentially increasing benefit expense and funding requirements.  Further, changes in demographics, including increased numbers of retirements or changes in life expectancy assumptions may also increase the funding requirements of the obligations related to the pension and other post-retirement benefit plans.  Also, future increases in pension and other post-retirement costs as a result of reduced plan assets may not be fully recoverable from our customers, and the results of operations and financial position of the Company could be negatively affected.


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Our operating costs could be significantly increased because of state and federal environmental and health and safety laws and regulations.

Our water operations are governed by extensive federal and state environmental protection and health and safety laws and regulations, including the federal Safe Drinking Water Act, the Clean Water Act and similar state laws, and federal and state regulations issued under these laws by the U.S. Environmental Protection Agency and state environmental regulatory agencies.  These laws and regulations establish, among other things, criteria and standards for drinking water and for discharges into the waters of the United States, the State of Connecticut or the State of Maine. Pursuant to these laws, we are required to obtain various environmental permits from environmental regulatory agencies for our operations.  We cannot assure that we have been or will be at all times in full compliance with these laws, regulations and permits. If we violate or fail to comply with these laws, regulations or permits, we could be fined or otherwise sanctioned by regulators.

Environmental laws and regulations are complex and change frequently.  These laws, and the enforcement thereof, have tended to become more stringent over time.  For example, Connecticut is in the process of adopting a revision to its Water Diversion Regulations.  The proposed revision would restrict the current exemption from Water Diversion permitting for certain expansions of service beyond Exclusive Service Areas identified as of October 2016.  If this regulatory change is approved by the General Assembly’s Legislative Regulation Review Committee, Water Diversion permits will be required for more service area expansions. While we have budgeted for future capital and operating expenditures to maintain compliance with these laws and our permits, it is possible that new or stricter standards could be imposed that will raise our operating costs.  Although these costs may be recovered in the form of higher rates, there can be no assurance that either the PURA or the MPUC would approve rate increases to enable us to fully recover such costs.  In summary, we cannot be assured that our costs of complying with, or discharging liabilities under, current and future environmental and health and safety laws will not adversely affect our business, results of operations or financial condition.

Our business has inherently dangerous workplaces. If we fail to maintain safe work sites, we can be exposed to not only people impacts but also to financial losses such as penalties and other liabilities.

Our safety record is critical to our reputation. We maintain health and safety standards to protect our employees, customers, vendors and the public. Although we intend to adhere to such health and safety standards and aim for zero injuries, it is extremely difficult to avoid accidents at all times.

Our business sites, including construction and maintenance sites, often put our employees and others in close proximity with large pieces of equipment, moving vehicles, pressurized water, underground trenches and vaults, chemicals and other regulated materials. On many sites we are responsible for safety and, accordingly, must implement safety procedures. If we fail to implement such procedures or if the procedures we implement are ineffective or are not followed by our employees or others, our employees and others may be injured or die. Unsafe work sites also have the potential to increase employee turnover and raise our operating costs. Any of the foregoing could result in financial losses, which could have a material adverse impact on our business, financial condition, results of operations and cash flows.

In addition, our operations can involve the handling and storage of hazardous chemicals, which, if improperly handled, stored or disposed of, could subject us to penalties or other liabilities. We are also subject to regulations dealing with occupational health and safety. Although we maintain functional employee groups whose primary purpose is to ensure we implement effective health, safety, and environmental work procedures throughout our organization, including construction sites and maintenance sites, the failure to comply with such regulations or procedures could subject us to liability.

Climate change laws and regulations may be adopted that could require compliance with greenhouse gas emissions standards and other climate change initiatives. Additional capital expenditures could be required and our operating costs could be increased in order to comply with new regulatory standards imposed by federal and state environmental agencies.

Climate change has been receiving ever increasing attention worldwide in the past decade.  Many scientists, legislators, and others attribute global warming to increased levels of greenhouse gases, including carbon dioxide, which has led to significant legislative and regulatory efforts to limit greenhouse gas emissions.  Possible new climate change laws and regulations, if enacted, may require us to monitor and/or change our utility operations.  It is possible that new standards could be imposed that will require additional capital expenditures or raise our operating costs.  Because it is uncertain what laws will be enacted, we cannot predict the potential impact of such laws on our future consolidated financial condition, results of operations, or cash flows.  Although these expenditures and costs may be recovered in the form of higher rates, there can be no assurance that either the PURA or the MPUC or other regulatory bodies that govern our business would permit us to recover such expenditures and costs.  We cannot assure you that our costs of complying with new standards or laws will not adversely affect our business, results of operations or financial condition.

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Streamflow Regulations in Connecticut could potentially impact our ability to serve our customers.

In December 2011, regulations concerning the flow of water in Connecticut’s rivers and streams were adopted.  As promulgated, the regulations require that certain downstream releases be made from seven of Connecticut Waters’s eighteen active reservoirs no later than ten years following the adoption of stream classifications by the Department of Energy and Environmental Protection (“DEEP”).  Currently, downstream releases are made at two locations.  No groundwater supply wells are affected by the regulations.

DEEP has finalized stream classifications in two areas of the state where Connecticut Water maintains and operates sources of supply.  Other areas of the state, including areas where Connecticut Water operates, remain to be classified.  The Company remains engaged in the process in order to minimize impact to our available water supply.  Although significantly and favorably modified from prior versions, the regulations still have the potential to lower our safe yield, raise our capital and operating expenses and adversely affect our revenues and earnings.  Because they affect only a subset of the Company’s supplies and allow for releases to be scaled back in response to drought events, the overall impact is anticipated to be manageable.  Costs associated with the regulations may be recovered in the form of higher rates.  Although there can be no assurance the PURA would approve rate increases to enable us to recover all such costs, legislation passed in 2013 allows for a WICA surcharge to recover capital improvement costs necessary to achieve compliance with the regulations.

The State of Maine also has regulations that govern the flow of water in rivers and streams and also govern lake levels on great ponds.  Code of Maine Rules Chapter 587 (“Chapter 587”) regulates any activity that alters the flow or level of classified state waters after August 2007.  Maine Water operates five water systems that use surface waters governed by this chapter.  Maine Water has operated in full compliance with the chapter since its effective date and fully expects continued compliance.  For public water systems, Chapter 587 allows the Maine Department of Environmental Protection (“MDEP”) to impose site specific conditions in locations where Maine’s water quality classifications are not being met.  Any conditions proposed on a water withdrawal by a public water system must consider the provisions of any legislative charter, the watershed protection benefits provided by the utility and the financial viability of the utility.  Further, any conditions imposed must be accommodated by the existing MPUC approved rate schedule for the utility and may not, in and of themselves, cause a utility to request a rate increase from their customers.  To date, the MDEP has not imposed any withdrawal conditions on any public water system in Maine.

Maine Water’s business is subject to seasonal fluctuations which could adversely affect demand for its water services and its revenues.

Demand for our water during the warmer months is generally greater than during cooler months due primarily to additional requirements for water in connection with irrigation systems, swimming pools, cooling systems and other outside water use. Throughout the year, and particularly during typically warmer months, demand will vary with temperature and rainfall levels. In the event that temperatures during the typically warmer months are cooler than normal, or if there is more rainfall than normal, the demand for our water may decrease and adversely affect our revenues. As Maine Water becomes eligible to use the recently passed water revenue adjustment mechanism upon the expiration of the agreed upon stay out period, this risk will be mitigated.

Declining per customer residential water usage in the State of Maine may reduce our revenues, financial condition and results of operations in future years.

A trend of declining per customer residential water usage has been observed for the last several years, which we attribute to increased water conservation, including the use of more efficient household fixtures and appliances among residential users.  Our regulated business in Maine is heavily dependent on revenue generated from rates we charge to our residential customers for the volume of water they use.  The rate we charge for our water is regulated by the MPUC in Maine and we may not unilaterally adjust our rates to reflect changes in demand.  Declining volume of residential water usage may have a negative impact on our operating revenues in the future if regulators do not reflect any usage declines in the rate setting design process. As Maine Water becomes eligible to use the recently passed water revenue adjustment mechanism upon the expiration of the agreed upon stay out periods, this risk will be mitigated.


17



Potential regulatory changes or drought conditions may impact our ability to serve our current and future customers’ demand for water and our financial results.

We depend on an adequate water supply to meet the present and future demands of our customers.  Changes in regulatory requirements could affect our ability to utilize existing supplies and/or secure new sources, as required.  Insufficient supplies or an interruption in our water supply could have a material adverse effect on our financial condition and results of operations.  Drought conditions could interfere with our sources of water supply and could adversely affect our ability to supply water in sufficient quantities to our existing and future customers. An interruption in our water supply could have a material adverse effect on our financial condition and results of operations.  Moreover, governmental restrictions on water usage during drought conditions may result in a decreased demand for our water, even if our water reserves are sufficient to serve our customers during these drought conditions, which may adversely affect our revenues and earnings. Persistent dry weather and continued drought conditions in 2016 in the State of Connecticut prompted Connecticut Water to join other major water utilities in the state and request that all customers voluntarily reduce their water usage by 10% in July in an effort to extend the availability of existing supplies and to support the rivers and streams in the state. While supplies in our reservoirs are lower than normal, Connecticut Water also has groundwater sources in nearly all of its water systems that provide operational flexibility so we are not solely dependent on our reservoirs for water supply. Connecticut Water continues to encourage all customers to reduce their water usage by 10% and, in October, began asking customers in the shoreline communities of Guilford, Madison, Clinton, Westbrook and Old Saybrook to reduce their water usage by 15%. Connecticut Water will continue to monitor precipitation rates, reservoir levels, and water demands and will modify its request for water conservation measures accordingly.

Wastewater operations entail significant risks and may impose significant costs.

Wastewater collection and treatment and septage pumping and sludge hauling involve various unique risks.  If collection or treatment systems fail or do not operate properly, or if there is a spill, untreated or partially treated wastewater could discharge onto property or into nearby streams and rivers, causing various damages and injuries, including environmental damage.  These risks are most acute during periods of substantial rainfall or flooding, which are the main causes of wastewater overflow and system failure.  Liabilities resulting from such damages and injuries could harm our business, financial condition, and results of operations.

We are increasingly dependent on the continuous and reliable operation of our information technology systems, and a disruption of these systems, resulting from cyber security attacks or other events, could adversely affect our business.

We rely on our information technology systems in connection with the operation of our business, especially with respect to customer service and billing, accounting and, in some cases, the monitoring and operation of our treatment, storage and pumping facilities. In addition, we rely on our systems to track our utility assets and to manage maintenance and construction projects, materials and supplies, and our human resource functions. A loss of these systems, or major problems with the operation of these systems, could adversely affect our operations and have a material adverse effect on our business, financial condition, and results of operations. Our information technology systems may be vulnerable to damage or interruption from the following types of cyber security attacks or other events:
power loss, computer systems failures, and internet, telecommunications or data network failures;
operator negligence or improper operation by, or supervision of, employees;
physical and electronic loss of data;
computer viruses, cyber security attacks, intentional security breaches, hacking, denial of service actions, misappropriation of data and similar events;
difficulties in the implementation of upgrades or modification to our information technology systems; and
hurricanes, fires, floods, earthquakes and other natural disasters.

Recognizing the increasing importance of managing and protecting electronic data, the Company, beginning in 2014, partnered with a consulting firm to evaluate the Company's cyber security strengths and vulnerabilities and to help in creating an evaluation of the Company's current information technology (“IT”) structure within the organization.  In April 2014, a cyber security assessment analysis identified and prioritized steps that the Company should take to enhance its security surrounding cyber security.  In September 2014, the consultant delivered a report related to the IT structure which contained recommendations aimed at strengthening the IT organization.  The Company has implemented the recommendations contained in the cyber security assessment and will continue to monitor developments across the cyber security environment.

Although we do not believe that our systems are at a materially greater risk of cyber security attacks than other similar organizations, our information technology systems may be vulnerable to damage or interruption from the types of cyber security attacks or other events listed above or other similar actions, and such incidents or other events may go undetected for a

18



period of time. Such cyber security attacks or other events may result in: the loss or compromise of customer, financial or operational data; disruption of billing, collections or normal field service activities; disruption of electronic monitoring and control of operational systems; and delays in financial reporting and other normal management functions. Possible impacts associated with a cyber security attack or other events may include remediation costs related to lost, stolen, or compromised data, repairs to data processing systems, increased cyber security protection costs, adverse effects on our compliance with regulatory and environmental laws and regulation, including standards for drinking water, litigation and reputational damage.

The failure of, or the requirement to repair, upgrade or dismantle, any of our dams may adversely affect our financial condition and results of operations.

We own and operate numerous dams throughout the States of Connecticut and Maine.  While the Company maintains robust dam maintenance and inspection programs, a failure of any of those dams could result in injuries and damage to residential and/or commercial property downstream for which we may be responsible, in whole or in part.  The failure of a dam could also adversely affect our ability to supply water in sufficient quantities to our customers and could adversely affect our financial condition and results of operations.  Any losses or liabilities incurred due to the failure of one of our dams might not be covered by insurance policies or be recoverable in rates, and such losses may make it difficult for us to secure insurance in the future at acceptable rates.

Any failure of our reservoirs, storage tanks, mains or distribution networks could result in losses and damages that may affect our financial condition and reputation.

Connecticut Water and Maine Water distribute water through an extensive network of mains and stores water in reservoirs and storage tanks located across Connecticut and Maine.  A failure of major mains, reservoirs, or tanks could result in injuries and damage to residential and/or commercial property for which we may be responsible, in whole or in part.  The failure of major mains, reservoirs or tanks may also result in the need to shut down some facilities or parts of our water distribution network in order to conduct repairs.  Such failures and shutdowns may limit our ability to supply water in sufficient quantities to our customers and to meet the water delivery requirements prescribed by governmental regulators, including the PURA and the MPUC, and adversely affect our financial condition, results of operations, cash flow, liquidity and reputation.  Any business interruption or other losses might not be covered by insurance policies or be recoverable in rates, and such losses may make it difficult for us to secure insurance in the future at acceptable rates.

Any future acquisitions we may undertake may involve risks and uncertainties.

An important element of our growth strategy is the acquisition and integration of water systems in order to move into new service areas and to broaden our current service areas.  As of December 31, 2016, our Regulated Companies serve 124,968 customers, or a population of approximately 400,000 people, in 77 municipalities throughout Connecticut and Maine.  We will be unable to acquire other businesses if we cannot identify suitable acquisition opportunities or reach mutually agreeable terms with acquisition candidates.  It is our intent, when practical, to integrate any businesses we acquire with our existing operations.  The negotiation of potential acquisitions as well as the integration of acquired businesses could require us to incur significant costs and cause diversion of our management’s time and resources.  Future acquisitions by us could result in:
dilutive issuances of our equity securities;
incurrence of debt and contingent liabilities;
failure to have effective internal control over financial reporting;
fluctuations in quarterly results; and
other acquisition-related expenses.

Some or all of these items could have a material adverse effect on our business as well as our ability to finance our business and comply with regulatory requirements.  The businesses we acquire, including HVWC and Avon Water, may not achieve sales and profitability that would justify our investment and any difficulties we encounter in the integration process, including the integration of controls necessary for internal control and financial reporting, could interfere with our operations, reduce our operating margins and adversely affect our internal controls.  In addition, as consolidation becomes more prevalent in the water and wastewater industries, the prices for suitable acquisition candidates may increase to unacceptable levels and limit our ability to grow through acquisitions.


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The failure to consummate the pending acquisition of The Avon Water Company could adversely affect our business.

We recently entered into an acquisition agreement to acquire Avon Water.  The transaction is subject to regulatory and other specified approvals, including a final order of the PURA approving the transaction and the effectiveness under the Securities Act of 1933 (the “Securities Act”) of the Company’s registration statement on Form S-4 which is expected to be filed in the second quarter of 2017.

The completion of this transaction is subject to risks and uncertainties.  First, if the required conditions and regulatory approvals are not satisfied or waived, then the acquisition likely would not be completed.  Second, if the closing of the acquisition is substantially delayed or the closing does not occur at all, or if the terms of the acquisition are required to be modified substantially due to regulatory concerns, we may not be able to realize the anticipated benefits of the acquisition fully or at all.  Third, under certain circumstances specified in the purchase agreement, we may be required to pay a termination fee if the agreement is terminated under specified circumstances.  Fourth, the failure to consummate the pending acquisition may result in negative publicity and a negative impression of us in the investment community.  There can be no assurance that our business, the price of our common stock or our financial condition will not be adversely affected, as compared to the condition prior to the announcement of the acquisition, if the acquisition is not consummated.

Water supply contamination may adversely affect our business.

Our water supplies are subject to possible contamination, including contamination from the development of naturally-occurring compounds, chemicals in groundwater systems, pollution resulting from man-made sources, and possible terrorist attacks. In the event that our water supply is contaminated, we may have to interrupt the use of that water supply until we are able to substitute the flow of water from an uncontaminated water source or provide additional treatment.  We may incur significant costs in order to treat the contaminated source through expansion of our current treatment facilities, or development of new treatment methods.  If we are unable to substitute water supply from an uncontaminated water source, or to adequately treat the contaminated water source in a cost-effective manner, there may be an adverse effect on our revenues, operating results and financial condition.  The costs we incur to decontaminate a water source or an underground water system could be significant and could adversely affect our business, operating results and financial condition and may not be recoverable in rates.  We could also be held liable for consequences arising out of human exposure to hazardous substances in our water supplies or other environmental damage.  For example, private plaintiffs have the right to bring personal injury or other toxic tort claims arising from the presence of hazardous substances in our drinking water supplies.  Our insurance policies may not be sufficient to cover the costs of these claims.

We operate a number of water and wastewater systems under Operation and Maintenance (“O&M”) contracts and face the risk that the owners of those systems may fail to provide capital to properly maintain those systems, which may negatively affect us as the operators of the systems.

We operate a number of water and wastewater systems under O&M contracts. Pursuant to these contracts, we operate the system according to the standards set forth in the applicable contract, and it is generally the responsibility of the owner of the system to undertake capital improvements. In some cases, we may not be able to convince the owner to make needed improvements in order to maintain compliance with applicable regulations. Although violations and fines incurred by water and wastewater systems may be the responsibility of the owner of the system under these contracts, those non-compliance events may reflect poorly on us as the operator of the system and damage our reputation, and in some cases, may result in liability to the same extent as if we were the owner. Effective February 27, 2017, the only wastewater O&M contract customer served by the Company was acquired as part of the Heritage Village acquisition.

Increased security measures may continue to increase our operating costs.

In addition to the potential pollution of our water supply as described above, we have taken steps to increase security measures at our facilities and heighten employee awareness of threats to our water supply.  We have also tightened our security measures regarding the delivery and handling of certain chemicals used in our business.  We have and will continue to bear increased costs for security precautions to protect our facilities, operations and supplies. These costs may be significant.  We are currently not aware of any specific threats to our facilities, operations or supplies; however, it is possible that we would not be in a position to control the outcome of terrorist events should they occur.


20



The accuracy of our judgments and estimates about financial and accounting matters will impact our operating results and financial condition.

We make certain estimates and judgments in preparing our financial statements regarding, among others:
the number of years to depreciate certain assets;
amounts to set aside for uncollectible accounts receivable and uninsured losses;
our legal exposure and the appropriate accrual for claims, including medical and workers’ compensation claims;
future costs for pensions and other post-retirement benefit obligations; and
possible tax allowances.

The quality and accuracy of those estimates and judgments will have an impact on our operating results and financial condition.

In addition, we must estimate unbilled revenues and costs at the end of each accounting period.  If our estimates are not accurate, we will be required to make an adjustment in a future period.

The final determination of our income tax liability may be materially different from our income tax provision.

Significant judgment is required in determining our provision for income taxes. Our calculation of the provision for income taxes is subject to our interpretation of applicable business tax laws in the jurisdictions in which we file. In addition, our income tax returns are subject to periodic examination by the Internal Revenue Service and other taxing authorities. During 2013 and 2014, Connecticut Water and Maine Water, respectively, changed their tax method of accounting to permit the expensing of qualifying utility asset costs that were previously being capitalized and depreciated for tax purposes. Our determination of what qualifies as a capital cost versus a repair expense tax deduction is subject to subsequent adjustment and may impact the income tax benefits that have been recognized. Although we believe our income tax estimates, including any tax reserves or valuation allowances we have recorded or may record, are appropriate, there is no assurance that the final determination of our income tax liability will not be materially different; either higher or lower, from what is reflected in our income tax provision. In the event we are assessed additional income taxes, our business, financial condition, and results of operations could be adversely affected.

Key employee turnover may adversely affect our operating results.

Our success depends significantly on the continued individual and collective contributions of our management team. The loss of the services of any member or our senior management team or the inability to hire and retain experienced management personnel could harm our operating results.

We must continue to attract and retain qualified technical and managerial personnel in order to succeed.

Our future success will also depend largely upon our ability to attract and retain highly skilled technical, operational and financial managers. There is significant competition for such personnel in our industry. We try to ensure that we offer competitive compensation and benefits as well as opportunities for continued development, and we continually strive to recruit and train qualified personnel and retain key employees. There can be no assurance, however, that we will continue to be successful in attracting and retaining the personnel we require to grow and operate profitably.

ITEM 1B.  UNRESOLVED STAFF COMMENTS

None

ITEM 2.  PROPERTIES

At December 31, 2016, the properties of our Regulated Companies consisted of land, easements, rights (including water rights), buildings, reservoirs, standpipes, dams, wells, supply lines, treatment plants, pumping plants, transmission and distribution mains and conduits, mains and other facilities and equipment used for the collection, purification, storage and distribution of water.  In certain cases, Connecticut Water and Maine Water are or may be a party to limited contractual arrangements for the provision of water supply from neighboring utilities.  Water mains are located, for the most part, in public streets and, in a few instances, are located on land that we own in fee simple and/or land utilized pursuant to easement right, most of which are perpetual and adequate for the purpose for which they are held. Substantially all of our treatment, storage, and distribution properties are owned by our subsidiaries, Connecticut Water and Maine Water. A substantial portion of such properties owned by Maine Water are subject to liens of mortgage or indentures that secure bonds, notes and other evidences of long-term indebtedness.

21




The net utility plant of the Company at December 31, 2016 was solely owned by the Regulated Companies.  The “Net Utility Plant” balance as of December 31, 2016 was $601,396,000, approximately $55.1 million more than the balance of “Net Utility Plant” as of December 31, 2015, due primarily to normal plant additions and construction spending related to infrastructure improvements.

Sources of water supply owned, maintained, and operated by our Regulated Companies include 25 surface water supplies and 99 well fields, as of December 31, 2016.  In addition, Connecticut Water and Maine Water have agreements with various neighboring water utilities to provide water, at negotiated rates, to our water systems.  Collectively, these sources have the capacity to deliver approximately 75 million gallons of potable water daily to the 25 major operating systems. The Regulated Companies own, maintain, and operate 50 small, non-interconnected satellite and consecutive water systems that, combined, have the ability to deliver about 3.5 million gallons of additional water per day to their respective systems. For some small consecutive water systems, purchased water may comprise substantially all of the total available supply of the system.

As of December 31, 2016, the Regulated Companies own and operate 30 water filtration facilities, having a combined treatment capacity of approximately 52 million gallons per day.

As of December 31, 2016, the transmission and distribution systems of the Regulated Companies consisted of approximately 2,100 miles of main.  On that date, approximately 75% of our mains were 8 inch diameter or larger.  Substantially all new main installations are cement-lined ductile iron pipe of 8 inch diameter or larger.

We believe that our properties are maintained in good condition and in accordance with current regulations and standards of good waterworks industry practice.

ITEM 3.  LEGAL PROCEEDINGS

We are involved in various legal proceedings from time to time. Although the results of legal proceedings cannot be predicted with certainty, there are no pending legal proceedings to which we, or any of our subsidiaries are a party, or to which any of our properties is subject, that presents a reasonable likelihood of a material adverse impact on the Company’s financial condition, results of operations or cash flows.

ITEM 4.  MINE SAFETY DISCLOSURES

Not Applicable

22



PART II

ITEM 5.  MARKET FOR THE REGISTRANTS’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

Our Common Stock is traded on the NASDAQ Global Select Market under the symbol “CTWS”.  Our quarterly high and low stock prices as reported by NASDAQ and the cash dividends we paid during 2016 and 2015 for our Common Stock are listed as follows:

 
Price
 
Dividends
Period
High
 
Low
 
Paid
2016
 
 
 
 
 
First Quarter
$
45.66

 
$
37.48

 
$
0.2675

Second Quarter
56.27

 
43.16

 
0.2825

Third Quarter
56.62

 
45.13

 
0.2825

Fourth Quarter
58.32

 
48.00

 
0.2825

2015
 
 
 
 
 
First Quarter
$
38.55

 
$
35.07

 
$
0.2575

Second Quarter
37.99

 
33.20

 
0.2575

Third Quarter
36.58

 
33.15

 
0.2675

Fourth Quarter
39.93

 
34.15

 
0.2675


As of February 1, 2017, there were approximately 3,000 holders of record of our common stock.

We presently intend to pay quarterly cash dividends in 2017 on March 15, June 15, September 15 and December 15, subject to our earnings and financial condition, regulatory requirements and other factors our Board of Directors may deem relevant.

The Company’s Annual Meeting of Shareholders is scheduled for May 11, 2017 in Madison, Connecticut.

Purchases of Equity Securities by the Company – In May 2005, the Company adopted a common stock repurchase program (“Share Repurchase Program”).  The Share Repurchase Program allows the Company to repurchase up to 10% of its outstanding common stock, at a price or prices that are deemed appropriate.  As of December 31, 2016, no shares have been repurchased. Currently, the Company has no plans to repurchase shares under the Share Repurchase Program.


23



Performance Graph – Set forth below is a line graph comparing the cumulative total shareholder return for each of the years 20122016 on the Company’s Common Stock, based on the market price of the Common Stock and assuming reinvestment of dividends, with the cumulative total shareholder return of companies in the S&P’s 500 Index and the S&P’s 500 Utility Index.

ctws2016for_chart-20954.jpg


24



ITEM 6.  SELECTED FINANCIAL INFORMATION

SUPPLEMENTAL INFORMATION (Unaudited)
SELECTED FINANCIAL DATA
 
 
 
 
 
 
 
 
 
Years Ended December 31, (thousands of dollars except per share amounts and where otherwise indicated)
 
 
 
 
 
 
 
 
 
 
2016
 
2015
 
2014
 
2013
 
2012
CONSOLIDATED STATEMENTS OF INCOME
 
 
 
 
 
 
 
 
 
Operating Revenues
$
98,667

 
$
96,041

 
$
94,020

 
$
91,481

 
$
83,838

Operating Expenses
$
70,462

 
$
69,399

 
$
68,856

 
$
69,488

 
$
64,229

Other Utility Income, Net of Taxes
$
744

 
$
797

 
$
833

 
$
856

 
$
812

Total Utility Operating Income
$
28,949

 
$
27,439

 
$
25,997

 
$
22,849

 
$
20,421

Interest and Debt Expense
$
6,916

 
$
6,737

 
$
6,515

 
$
6,130

 
$
8,581

Net Income
$
23,387

 
$
22,761

 
$
21,319

 
$
18,269

 
$
13,640

Cash Common Stock Dividends Paid
$
12,514

 
$
11,715

 
$
11,188

 
$
10,758

 
$
8,467

Dividend Payout Ratio
54
%
 
51
%
 
52
%
 
59
%
 
62
%
Weighted Average Common Shares Outstanding
11,008,565

 
10,958,499

 
10,892,986

 
10,827,220

 
8,763,418

Basic Earnings Per Common Share from Continuing Operations
$
2.12

 
$
2.07

 
$
1.95

 
$
1.68

 
$
1.55

Number of Shares Outstanding at Year End
11,248,458

 
11,192,882

 
11,124,630

 
11,038,232

 
10,939,486

ROE on Year End Common Equity
9.9
%
 
10.2
%
 
10.2
%
 
9.2
%
 
7.4
%
Declared Common Dividends Per Share
$
1.115

 
$
1.05

 
$
1.01

 
$
0.98

 
$
0.96

CONSOLIDATED BALANCE SHEET
 
 
 
 
 
 
 
 
 
Common Stockholders’ Equity
$
236,028

 
$
223,977

 
$
209,451

 
$
197,753

 
$
185,349

Long-Term Debt (Consolidated, Excluding Current Maturities)
197,047

 
171,868

 
170,309

 
168,201

 
171,064

Preferred Stock
772

 
772

 
772

 
772

 
772

Total Capitalization
$
433,847

 
$
396,617

 
$
380,532

 
$
366,726

 
$
357,185

Stockholders’ Equity (Includes Preferred Stock)
55
%
 
57
%
 
55
%
 
54
%
 
52
%
Long-Term Debt
45
%
 
43
%
 
45
%
 
46
%
 
48
%
Net Utility Plant
$
601,396

 
$
546,284

 
$
506,939

 
$
471,876

 
$
447,911

Total Assets
$
784,502

 
$
710,715

 
$
664,897

 
$
623,970

 
$
571,564

Book Value - Per Common Share
$
20.98

 
$
20.01

 
$
18.83

 
$
17.91

 
$
16.94

OPERATING REVENUES BY REVENUE CLASS
 
 
 
 
 
 
 
 
Residential
$
59,884

 
$
58,439

 
$
57,095

 
$
55,403

 
$
50,783

Commercial
12,250

 
11,816

 
11,473

 
11,238

 
10,138

Industrial
3,176

 
3,229

 
2,984

 
3,120

 
3,080

Public Authority
3,510

 
3,193

 
3,215

 
2,967

 
2,675

Fire Protection
18,486

 
18,016

 
17,757

 
17,337

 
15,592

Other (Including Non-Metered Accounts)
1,361

 
1,348

 
1,496

 
1,416

 
1,570

Total Operating Revenues
$
98,667

 
$
96,041

 
$
94,020

 
$
91,481

 
$
83,838

Number of Customers (End of Year)
124,968

 
123,633

 
123,071

 
121,768

 
121,791

Billed Consumption (Millions of Gallons)
9,800

 
9,772

 
9,428

 
9,277

 
8,332

Number of Employees
266

 
266

 
265

 
259

 
259



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ITEM 7.  MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

FINANCIAL CONDITION
Executive Overview

Connecticut Water Service, Inc. (the “Company”) is a non-operating holding company, whose income is derived from the earnings of its four active wholly-owned subsidiary companies, as of December 31, 2016: The Connecticut Water Company (“Connecticut Water”), The Maine Water Company (“Maine Water”), New England Water Utility Services, Inc. (“NEWUS”), and Chester Realty Company (“Chester Realty”). Connecticut Water and Maine Water are our regulated water companies (together, the “Regulated Companies”).

In 2016, approximately 95% of the Company’s net income was attributable to the water operations of the Regulated Companies, which combined had 124,968 customers throughout 77 municipalities in Connecticut and Maine, as of December 31, 2016.  The rates charged for service by Connecticut Water are subject to review and approval by the Connecticut Public Utilities Regulatory Authority (“PURA”). The rates charged for service by Maine Water are subject to review and approval by the Maine Public Utilities Commission (“MPUC”).

In 2007, the Connecticut General Assembly passed the Water Infrastructure and Conservation Adjustment (“WICA”) Act.  WICA allows Connecticut Water to add a surcharge to customers’ bills, subject to an expedited review and approval by the PURA and no more than twice a year, to reflect the replacement of certain types of aging utility plant; principally water mains, meters, service lines and water conservation related investments. Connecticut Water has been using the WICA surcharge since 2009. Similarly, beginning in June 2013, a Water Infrastructure Charge (“WISC”) became available in Maine that allows for expedited recovery of investment in water system infrastructure replacement, both treatment and distribution. Maine Water implemented the WISC mechanism in all of their systems in 2014.

Since 2013, Connecticut law has authorized a Water Revenue Adjustment (“WRA”) to reconcile actual water demands with the demands projected in the last general rate case and allows companies to adjust rates as necessary to recover the revenues approved by PURA in the last general rate case. The WRA removes the financial disincentive for water utilities to develop and implement effective water conservation programs. The WRA allows water companies to defer on the balance sheet, as a regulatory asset or liability, for later collection from or crediting to customers the amount by which actual revenues deviate from the revenues allowed in the most recent general rate proceedings, including WICA proceedings. Additionally, the cap for WICA charges has been raised to 10%, from 7.5%, between general rate cases and expands the eligible projects to include energy conservation projects, improvements required to comply with streamflow regulations, and improvements to acquired systems.

On June 28, 2013, Connecticut Water entered into a settlement agreement with the Office of Consumer Council (“OCC”) and the Office of the Attorney General for the State of Connecticut (the “Settlement Agreement”), whereby Connecticut Water adjusted the water rates charged to its customers effective April 1, 2014 in accordance with the elements of the Settlement Agreement (the “Connecticut Water Rate Reduction Plan”). On July 1, 2013, Connecticut Water submitted an application to the PURA seeking formal approval of the Settlement Agreement.

The Settlement Agreement contemplated that Connecticut Water would adopt regulations issued by the Internal Revenue Service (“IRS”) that allowed the Company to adopt an alternative method for determining how expenditures related to tangible property can be treated for federal tax purposes for tax years beginning on or after January 1, 2012.  This tax accounting method change treated certain expenditures that the Company historically capitalized for tax purposes, as a deductible repair expense on its tax return.  The adoption of the tax accounting method change allowed Connecticut Water to record a favorable “catch up adjustment” on the Company's consolidated 2012 federal tax return which was filed in September 2013. The Company filed with the IRS a tax refund of approximately $13.6 million by carrying back the net operating loss generated from this adjustment.

The Settlement Agreement includes, as a result of negotiated compromise of the parties' respective positions, the following key elements related to the Connecticut Water Rate Reduction Plan:

1)    Connecticut Water crediting its water customers with the amount of the catch up adjustment plus the amount by which 2012 federal income taxes are reduced by the repair deduction (the deduction amount filed on the Company's 2012 federal tax return was approximately $45 million) that would be offset in whole or in part by an anticipated rate increase arising from the WRA authorized by the State of Connecticut in Public Act No. 13-78 with any associated net change in rates reflected on Connecticut Water customers' bills as of April 1, 2014;

26




2)    Resetting Connecticut Water's adjustment under Connecticut's WICA mechanism to zero by integrating the present WICA surcharge of 7.89% into Connecticut Water's base rates; and

3)    Connecticut Water agreeing not to file for a general rate increase (except under extraordinary circumstances outside Connecticut Water's control) for new rates to be effective any sooner than October 1, 2015.

In the Settlement Agreement, the parties also requested that PURA approve an accounting treatment for Connecticut Water to: 1) allow for the deferral of the tax refund described above and a credit of the tax benefit to customers over a proposed two-year period through a credit on water bills issued which started on April 1, 2014 and 2) as discussed above, use the WRA to defer on the balance sheet as a regulatory asset or liability, for later collection from or crediting to customers of the amount by which actual revenues deviate from the revenues allowed in Connecticut Water's most recent general rate proceedings, including WICA proceedings.

On August 30, 2013, the PURA issued a final decision approving the Settlement Agreement. Connecticut Water began to issue a credit on customers' bills of approximately 8.5% on April 1, 2014, related to the repair deduction. Additionally, Connecticut Water began adding an approximate 4.5% surcharge to customer bills related to the WRA for a net surcredit of approximately 4.0%. Effective April 1, 2015, the 4.5% surcharge to customers was replaced by a 5.07% surcharge based on the WRA revenues recorded during 2014, leaving an approximate 3.4% net surcredit on customer bills.

Connecticut Water’s allowed revenues for the year ended December 31, 2016, as approved by PURA during our 2010 general rate case and including subsequently approved WICA surcharges, were approximately $76.7 million. Through normal billing for the year ended December 31, 2016 operating revenue for Connecticut Water would have been approximately $75.6 million had the WRA not been implemented. As a result of the implementation of the WRA, Connecticut Water recorded $1.1 million in additional revenue for the year ended December 31, 2016. During the year ended December 31, 2015 and 2014, Connecticut Water recorded $1.6 million and $3.7 million, respectively, in additional revenue related to the WRA.

The Company has and will continue to focus on minimizing operating costs that are passed along to its customers without sacrificing the quality service it values and the customers demand.  At the same time, the Company will continue to employ its current strategy of timely collection of appropriate costs and a fair rate of return for its shareholders through appropriate rates for its regulated water service while looking to expand through targeted acquisitions.

University of Connecticut Agreement
Connecticut Water and the University of Connecticut (“UCONN”) negotiated a definitive agreement for Connecticut Water to provide a long-term supply of potable water for UCONN’s Storrs campus facilities which was approved by the Board of Trustees at their December 11, 2013 meeting and executed on December 18, 2013. The definitive agreement is consistent with the requirements of the project’s Environmental Impact Evaluation (“EIE”) and record of decision, as approved by the Office of Policy and Management, an agency of the State of Connecticut, that identified the Company as the preferred option to supply UCONN and the Town of Mansfield, Connecticut with up to 2.2 million gallons of water per day over the next 47 years.  Connecticut Water funded a 5-mile pipeline from Tolland and other necessary infrastructure improvements at no cost to UCONN, the Town or the state’s taxpayers to serve the area. The Company was responsible for obtaining any required regulatory permits, licenses and approvals to implement the water supply solution, including but not limited to those from PURA, the Connecticut Department of Energy and Environmental Protection (“DEEP”) and the Connecticut Department of Public Health (“DPH”). The capital improvements were completed on time and the pipeline was connected to the UCONN campus in December 2016, which was within the agreed upon timeframe.

Town of Mansfield Agreement
Connecticut Water and the Town of Mansfield entered into an agreement for Connecticut Water to serve the Town of Mansfield community. On January 13, 2014, the Mansfield Town Council voted to authorize the Town Manager to execute the agreement with Connecticut Water and it was signed by the parties on January 21, 2014.

The key provisions of the agreement with the Town of Mansfield are as follows:
Current off-campus customers of UCONN will become customers of Connecticut Water at UCONN’s water rates in effect at that time (subject to any state-approved surcharges);
Future water customers in the Town of Mansfield will be served by Connecticut Water at the rates authorized by the PURA;
Connecticut Water will assume responsibility for maintaining, repairing and replacing the off-campus water system serving the Town of Mansfield;

27



Connecticut Water will make any source or system improvements to meet current and future water supply needs of the area; and
Pursuant to the Agreement, a Water System Advisory Committee (“WSAC”) was created with representatives of the Town of Mansfield, UCONN, regional representatives and other key stakeholders to advise Connecticut Water regarding water service and the system’s operations, expansion or integration as well as recommended best management practices, including water conservation programs.  The WSAC meets quarterly.

The former off-campus customers of UCONN in the Town of Mansfield became customers of Connecticut Water in October 2016.

While the Company plans to file timely rate cases, continue to make acquisitions, similar to the recently completed HVWC acquisition and the announced Avon Water acquisition, and, in the future, utilize the WICA and WISC adjustments to allow for more timely recovery of investment in utility plant, it will also look to NEWUS and Maine Water to increase its earnings in unregulated businesses.  The Company will continue to seek out maintenance and service contracts with new customers and renew existing contracts that have proven to be beneficial to the Company, as well as to continue the expansion of the Linebacker® program. As part of the Maine Water Stipulation Agreement, Maine Water is precluded from filing for a general rate increase that would be effective prior to July 1, 2017 in most of its divisions.

Regulatory Matters and Inflation

The Company, like all other businesses, is affected by inflation, most notably by the continually increasing costs required to maintain, improve, and expand its service capabilities.  The cumulative effect of inflation over time results in significantly higher operating costs and facility replacement costs, which must be recovered from future cash flows.

Our regulated water companies’ ability to recover its increased expenses and/or investment in utility plant is dependent on the rates we charge our customers.  Changes to these rates must be approved by the PURA and MPUC through formal rate proceedings.  Due to the subjectivity of certain items involved in the process of establishing rates such as customer usage, future customer growth, inflation, and allowed return on investment, we have no assurance that we will be able to raise our rates to a level we consider appropriate, or to raise rates at all, through any future rate proceeding.

Our regulated water utilities are also subject to environmental and water quality regulations, which are continually modified and refined to ensure the safety of the Company’s water sources and, ultimately, the public’s health.  Costs to comply with environmental and water quality regulations are substantial.  The costs to comply with future changes in state or federal regulations, which could require us to modify current filtration facilities and/or construct new ones, or to replace any reduction of the safe yield from any of our current sources of supply, could be substantial.  While there can be no guarantee that all expenditures related to increased regulation will be recoverable in rate proceedings, the Company believes that the regulatory environment in Connecticut and Maine would allow prudent expenditures to be recovered in rates.  To date, the Company has never had any costs associated with water quality and environmental spending refused in a general rate proceeding.  The Company believes that it is in compliance with current regulations, but the regulations are subject to change at any time.

Recognizing the increasing importance of managing and protecting electronic data, the Company, beginning in 2014, partnered with a consulting firm to evaluate the Company's cyber security strengths and vulnerabilities and to help in creating an evaluation of the Company's current information technology (“IT”) structure within the organization.  In April 2014, a cyber security assessment analysis identified and prioritized steps that the Company should take to enhance its security surrounding cyber security.  In September 2014, the consultant delivered a report related to the IT structure which contained recommendations aimed at strengthening the IT organization.  The Company has implemented the recommendations contained in the cyber security assessment and will continue to monitor developments across the cyber security environment.

Critical Accounting Policies and Estimates

The Company’s Consolidated Financial Statements are prepared in conformity with accounting principles generally accepted in the United States of America (“GAAP”) and as directed by the regulatory commissions to which the Company’s Regulated Companies are subject.  (See Note 1 to the Consolidated Financial Statements for a discussion of our significant accounting policies).  The Company believes the following policies and estimates are critical to the presentation of its Consolidated Financial Statements.

Public Utility Regulation – Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) 980 “Regulated Operations” (“FASB ASC 980”), requires cost-based, rate-regulated enterprises such as Connecticut Water and Maine Water to reflect the impact of regulatory decisions in their financial statements.  The state regulators, through the rate

28



regulation process, can create regulatory assets that result when costs are allowed for ratemaking purposes in a period after the period in which costs would be charged to expense by an unregulated enterprise.  The balance sheet includes regulatory assets and liabilities as appropriate, primarily related to income taxes, post-retirement benefit costs and deferred revenues associated with the WRA.  The Company believes, based on current regulatory circumstances, that the regulatory assets recorded are probable to be recovered and that its use of regulatory accounting is appropriate and in accordance with the provisions of FASB ASC 980.

Revenue Recognition – The Company’s accounting policies regarding revenue recognition by segment are as follows:

Water Operations – Most of our water customers are billed quarterly, with the exception of larger commercial and industrial customers, as well as certain public and private fire protection customers who are billed monthly.  Most customers, except fire protection customers, are metered.  Revenues from metered customers are based on their water usage multiplied by approved, regulated rates and are earned when water is delivered.  Public fire protection revenues are based on the length of the water main, and number of hydrants in service and are earned on a monthly basis.  Private fire protection charges are based on the diameter of the connection to the water main.  Our Regulated Companies accrue an estimate for metered customers for the amount of revenues earned relating to water delivered but unbilled at the end of each quarter, which is reflected as “Accrued Unbilled Revenues” in the accompanying balance sheets. Beginning in 2013, Connecticut Water began to record deferred revenue to represent under collection from customers based upon allowed revenues as approved by PURA. More detailed information, including revenues, costs and income taxes associated with the segment can be found in Note 14, “Segment Reporting” in the Company’s “Notes to the Consolidated Financial Statements”.

Real Estate Transactions – Revenues are recorded when a sale or other transaction has been completed and title to the real estate has been transferred. Net income from the Real Estate Transactions segment is shown net in the “Other Income (Deductions), Net of Taxes” portion of the Company’s Consolidated Statements of Net Income. More detailed information, including revenues, costs and income taxes associated with the segment can be found in Note 14, “Segment Reporting” in the Company’s “Notes to the Consolidated Financial Statements”.

Services and Rentals – Revenues are recorded when the Company has delivered the services called for by contractual obligation. Net income from the Services and Rentals segment is shown net in the “Other Income (Deductions), Net of Taxes” portion of the Company’s Consolidated Statements of Income. More detailed information, including revenues, costs and income taxes associated with the segment can be found in Note 14, “Segment Reporting” in the Company’s “Notes to the Consolidated Financial Statements”.

Income Taxes – The Company provides income tax expense for its utility operations in accordance with the regulatory accounting policies of the applicable jurisdictions.  The Company’s income tax provision is calculated on a separate return basis. The Connecticut PURA requires the flow-through method of accounting for most state tax temporary differences as well as for certain federal temporary differences. The MPUC requires the flow-through method of accounting for most state temporary differences and normalized accounting for most federal temporary differences. However, in its approvals of the stipulation agreements between Maine Water and the Office of the Public Advocate, issued in 2015, the MPUC has allowed the flow-through method of accounting stemming from Maine Water’s adoption of the IRS’ Repair Regulations in all of its divisions.

The Company computes deferred tax liabilities for all temporary book-tax differences using the liability method prescribed in FASB ASC 740 “Income Taxes” (“FASB ASC 740”).  Under the liability method, deferred income taxes are recognized at currently enacted income tax rates to reflect the tax effect of temporary differences between the financial reporting and tax bases of assets and liabilities.  Such temporary differences are the result of provisions in the income tax law that either require or permit certain items to be reported on the income tax return in a different period than they are reported in the financial statements.  Deferred tax liabilities that have not been reflected in tax expense due to regulatory treatment are reflected as “Unfunded Future Income Taxes”, and are expected to be included in future years’ rates.

The Company believes that deferred income tax assets, net of provisions, will be realized in the future. The majority of Unfunded Future Income Taxes, prior to 2013, relate to deferred state income taxes regarding book to tax depreciation differences. Beginning in 2013, basis differences resulting from the repair tax deduction contributed to the change in unfunded income taxes.

Deferred Federal and State Income Taxes include amounts that have been provided for accelerated depreciation subsequent to 1981, as required by federal income tax regulations, as well as the basis differences associated with expenditures qualifying for repair tax deduction as clarified by the IRS in regulations issued in 2013. Deferred taxes have also been provided for

29



temporary differences in the recognition of certain expenses for tax and financial statement purposes as allowed by regulatory ratemaking policies.

Employee Benefit Plan Accounting – Management evaluates the appropriateness of the discount rate through the modeling of a bond portfolio which approximates the pension and post-retirement plan liabilities.  Management further considers rates of high quality corporate bonds of approximate maturities as published by nationally recognized rating agencies consistent with the duration of the Company’s pension and post-retirement plans.

The discount rate assumption we use to value our pension and post-retirement benefit obligations has a material impact on the amount of expense we record in a given period.  Our 2016 and 2015 pension expense was calculated using assumed discount rates of 4.30% and 3.95%, respectively. Our 2016 and 2015 post-retirement welfare expense was calculated using assumed discount rates of 4.15% and 3.80%, respectively.  In 2017, our pension and post-retirement welfare expense will be calculated using assumed discount rates of 4.10% and 3.95%, respectively.  The following table shows how much a one percent change in our assumed discount rate would have changed our reported 2016 pension and post-retirement expense:

 
Increase (Decrease) in Pension Expense
 
Increase (Decrease) in Post-retirement Expense
1% Increase in the discount rate
$
(1,421,000
)
 
$
(73,000
)
1% Decrease in the discount rate
$
1,720,000

 
$
92,000


Other assumptions that affect the costs associated with our benefit plans include the assumed rate of return on plan assets and the expected rate of compensation increase.  The Company has assumed an 7.25% return on plan investments for 2016 and 2015, and a 4.00% rate of compensation increase for our pension and post-retirement welfare plans, in 2016 and 2015.  The assumed health care trend rate was 8.25% and 8.5% at December 31, 2016 and 2015, respectively. RP 2016, issued by the Society of Actuaries in 2016, was used in determination of our pension and post-retirement benefit obligations as of December 31, 2016 and projected costs for 2017.

Goodwill – As part of the purchase of certain regulated water companies, the Company has recorded goodwill of $30.4 million as of December 31, 2016 representing the amount of the purchase price over net book value of the assets acquired.  The Company accounts for goodwill in accordance with Accounting Standards Codification 350 “Intangibles – Goodwill and Other” (“FASB ASC 350”). As a result of a rate order issued by the MPUC, the Company reduced its goodwill balance by $1.3 million in the year ended December 31, 2015.

As part of FASB ASC 350, the Company is required to perform an annual review of goodwill for any potential impairment, which we perform as of December 31 each year. We update the assessment between the annual testing if events or circumstances occur that would more likely than not reduce the fair value of a reporting unit below its carrying value. As allowed under FASB ASC 350, the Company performed a qualitative analysis of its goodwill for the year ended December 31, 2016. A qualitative analysis includes a review of internal and external factors that could have an impact on a reporting unit’s fair value when compared to its carrying amount. These factors included a review of macroeconomic conditions, industry and market considerations, cost factors, overall financial performance, company specific events, changes in reporting units and a review of the Company’s stock price.

The last quantitative analysis of impairment was performed as of December 31, 2015, which concluded that the estimated fair value of the Water Operations reporting unit, which has goodwill recorded, exceeded the reporting unit’s carrying amount by at least 71% as of December 31, 2015.  Additionally, the Company believes that no event has occurred which would trigger impairment since the last quantitative test performed.  Based on these factors and other factors considered in its qualitative analysis, the Company believes that it is more likely than not that the fair market value is more than the carrying value of the Water Operation Segment and therefore, no goodwill impairment was recognized in 2016 and 2015.

We may be required to recognize an impairment of goodwill in the future due to market conditions or other factors that are beyond our control and unrelated to our performance. Those market events could include a decline in the forecasted results in our business plan, significant adverse rate case results, changes in capital investment budgets or changes in interest rates that could permanently impair the fair value of a reporting unit. Recognition of impairments of a significant portion of goodwill would negatively impact our reported results of operation and total capitalization, the effects of which could be material and could make it more difficult to maintain our credit ratings, secure financing on favorable terms, maintain compliance with debt covenants and meet expectations of our regulators.

30




Outlook

The Company’s earnings and profitability are primarily dependent upon the sale and distribution of water. In the State of Maine, the amount of water sold and distributed is dependent on seasonal weather fluctuations, particularly during the summer months when water demand will vary with rainfall and temperature levels.  The Company’s earnings and profitability in future years will also depend upon a number of other factors, such as the ability to maintain our operating costs at current or lower levels, customer growth in the Company’s core regulated water utility businesses, growth in revenues attributable to non-water sales operations, availability and desirability of land no longer needed for water delivery for land sales, and the timing and adequacy of rate relief when requested, from time to time, by our Regulated Companies.

The Company believes that the factors described above and those described in detail below under the heading “Commitments and Contingencies” may have significant impact, either alone or in the aggregate, on the Company’s earnings and profitability in fiscal years 2017 and beyond.  Please also review carefully the risks and uncertainties described in Item 1A – Risk Factors and those described above under the heading “Special Note Regarding Forward Looking Statements”.

The Company expects Net Income from its Water Operations segment to increase in 2017 over 2016 levels, primarily due to revenue increases due to the utilization of WISC in Maine and WICA in Connecticut, continued cost containment efforts, modest growth in its Services and Rentals segment and the revenue growth resulting from the acquisitions of The Heritage Water Water Company and The Avon Water Company. During 2017 and subsequent years, the ability of the Company to maintain and increase its Net Income will principally depend upon the effect on the Company of the factors described above in this “Outlook” section, those factors described in the section entitled “Commitments and Contingencies” and the risks and uncertainties described in the “Special Note Regarding Forward-Looking Statements” and Item 1A “Risk Factors”.

FINANCIAL CONDITION
Liquidity and Capital Resources

The Company is not aware of any demands, events, or uncertainties that will result in a decrease of liquidity or a material change in the mix or relative cost of its capital resources, other than those outlined below.

Borrowing Facilities

The Company maintains a $15 million line of credit agreement with CoBank, ACB, that is currently scheduled to expire on July 1, 2020.  The Company maintains an additional line of credit of $45 million with RBS Citizens, N.A., with an expiration date of April 25, 2021.  As of December 31, 2016 the total lines of credit available to the Company were $60 million.  As of December 31, 2016 and 2015, the Company had $33.0 million and $16.1 million of “Interim Bank Loans Payable”, respectively.  As of December 31, 2016, the Company had $27.0 million in unused lines of credit.  Interest expense charged on interim bank loans will fluctuate based on market interest rates.

At December 31, 2016 and 2015, the weighted average interest rates on these short-term borrowings outstanding was 2.7% and 2.4%, respectively.

On March 17, 2015, Maine Water completed the issuance of $1,864,050 aggregate principal amount of its First Mortgage Bonds, Series Q, 0.01% due March 17, 2035 (the “Series Q Bonds”). The Series Q Bonds were issued by Maine Water to the Bank and the proceeds of the issuance were loaned (the “Series Q Loan”) by the Maine Municipal Bond Bank (the “Bank”) to Maine Water pursuant to a Loan Agreement by and between Maine Water and the Bank dated as of March 17, 2015. The proceeds of the Series Q Loan were used by Maine Water to fund various water facilities projects, including the replacement of a booster station and modifications to a treatment plant, each located in the City of Biddeford, Maine.

On November 25, 2015, Maine Water completed the issuance of $2,487,630 aggregate principal amount of its First Mortgage Bonds, Series R, 1.0% due November 25, 2025 (the “Series R Bonds”). The Series R Bonds were issued by Maine Water to the Bank and the proceeds of the issuance were loaned (the “Series R Loan”) by the Bank to Maine Water pursuant to a Loan Agreement by and between Maine Water and the Bank dated as of November 25, 2015. The proceeds of the Series R Loan were used by Maine Water to fund the construction of a 3 million gallon water storage tank, located in the City of Biddeford, Maine, which replaced an existing in-ground 7.5 million gallon reservoir.

In April 2016, Connecticut Water filed an application with PURA to issue promissory notes in the aggregate principal amount of up to $49,930,000 with CoBank, ACB (“CoBank”) under its existing Master Loan Agreement by and between Connecticut Water and CoBank dated October 29, 2012, in order for Connecticut Water to redeem its $19,930,000 2009A Series of

31



outstanding Water Facility Revenue Bonds previously issued by the Connecticut Development Authority (the “2009A Bonds”) and to provide $30,000,000 to partially fund its ongoing construction program. On June 1, 2016, Connecticut Water issued $30,000,000, at 4.36%, in debt under its existing Master Loan Agreement with CoBank, with a maturity date of May 20, 2036. On July 7, 2016, Connecticut Water issued $19,930,000, at 4.04%, in debt under its existing Master Loan Agreement with CoBank, with a maturity date of July 7, 2036. Connecticut Water used the proceeds to immediately pay off the $19,930,000 2009A Series of outstanding Water Facility Revenue Bonds.

On January 10, 2017, Maine Water executed and delivered to CoBank a new Promissory Note and Single Advance Term Loan Supplement, dated January 10, 2017 (the “Third Promissory Note”). On the terms and subject to the conditions set forth in the Third Promissory Note issued pursuant to the Agreement, CoBank agreed to make an unsecured loan (the “Loan”) to Maine Water in the principal amount of $5,000,000 at 4.18%, due December 30, 2026. The proceeds of the Loan will be used to finance new capital expenditures and refinance existing debt owed to the Company, incurred in connection with general water system improvements.

In addition to paying off the 2009 A Series, Due 2039 using the proceeds of the July CoBank issuance discussed above, during the year ending December 31, 2016, the Company paid approximately $1,035,000 related to Connecticut Water Service’s Term Note Payable issued as part of the 2012 acquisition of Maine Water and approximately $1,808,000 in sinking funds related to Maine Water’s outstanding bonds.

Capital Budget

In 2016, the Company spent $66.3 million on capital projects.  The Company used a combination of its internally generated funds, borrowings under its lines of credit, the June 2016 long term debt issuance by Connecticut Water, and the March and November 2015 long term debt issuances by Maine Water to fund this construction budget.

The following table shows the total construction expenditures excluding non-cash contributed utility plant for each of the last three years and what we expect to invest on construction projects in 2017.

 
Gross Construction Expenditures
 
Construction Funded by Developers & Others
 
Construction Funded by Company
2016
$
67,887,000

 
$
1,548,000

 
$
66,339,000

2015
$
48,555,000

 
$
781,000

 
$
47,774,000

2014
$
46,186,000

 
$
1,217,000

 
$
44,969,000

2017 (Projected)
$
55,400,000

 
**

 
$
55,400,000


** – The Company cannot predict the amount of construction funded by others.

Credit Rating

In March 2017, Standard & Poor’s Ratings Services (“S&P”) affirmed its ‘A’ corporate credit rating on the Company. Additionally, S&P also affirmed the Company’s ratings outlook as stable.

Stock Plans

The Company offers a dividend reinvestment and stock purchase plan (“DRIP”) to all registered shareholders, and to the customers and employees of our regulated water companies, whereby participants can opt to have cash dividends directly reinvested into additional shares of the Company. In August 2011, the Board of Directors approved amendments to the DRIP (effective as of January 1, 2012) that permit the Company to add, at the Company’s discretion, an “up to 5.00% purchase price discount” feature to the DRIP which is intended to encourage greater shareholder, customer and employee participation in the DRIP. In August 2014, the Board of Directors approved further amendments to the DRIP to reflect the Company's appointment of a new common stock transfer agent. During the years ended December 31, 2016 and 2015, participants reinvested $1,610,000 and $1,536,000, respectively, as part of the DRIP.


32



Construction Expenditures

During 2016, the Company incurred approximately $67.9 million of construction expenditures, including approximately $1,548,000 funded by developers and others.  The Company financed the expenditures through internally generated funds, long-term debt issuances, proceeds from its dividend reinvestment plan, customers’ advances, contributions in aid of construction and short-term borrowings.

Our Board of Directors has approved a $55.4 million construction budget for 2017, net of amounts to be financed by customer advances and contributions in aid of construction.  The Company will fund the capital budget through a combination of its internally generated funds, borrowing under its available lines of credit and a potential new debt issuance in 2017.

As the Company looks forward to 2017 and 2018, it anticipates continued reinvestment to replace aging infrastructure and to seek recovery of these costs through periodic WICA and WISC applications.  The total cost of that investment may exceed the amount of internally generated funds.  The Company expects to rely upon its internally generated funds and short-term borrowing facilities and new debt issuances over the next 12-24 months.

Off-Balance Sheet Arrangements and Contractual Obligations

We do not use off-balance sheet arrangements such as securitization of receivables with any unconsolidated entities or other parties. The Company does not engage in trading or risk management activities and does not have material transactions involving related persons.


33



The following table summarizes the Company’s future contractual cash obligations as of December 31, 2016:

Payments due by Periods
(in thousands)
 
 
Contractual Obligations
 
 
Total
 
Less
than 1
year
 
Years
2 and 3
 
Years
4 and 5
 
More
than 5
years
Long-Term Debt (LTD)
 
$
205,838

 
$
4,859

 
$
8,536

 
$
6,425

 
$
186,018

Interest on LTD
 
98,819

 
8,145

 
15,504

 
14,860

 
60,310

Operating Lease Obligations
 
209

 
91

 
117

 
1

 

Purchase Obligations (1) (2) (3) (4) (5)
 
81,437

 
1,562

 
3,244

 
3,147

 
73,484

Long-Term Compensation Agreements (6)
 
57,481

 
5,552

 
11,406

 
11,301

 
29,222

Total (7) (8)
 
$
443,784

 
$
20,209

 
$
38,807

 
$
35,734

 
$
349,034


1.
Connecticut Water has an agreement with the South Central Connecticut Regional Water Authority (“RWA”) to purchase water from RWA. The agreement was signed in April 2006 and became effective upon the receipt of all regulatory approvals in 2008 and will remain in effect for a minimum of fifty years upon becoming effective. Connecticut Water will pay RWA $75,000 per year as part of a capacity agreement, for a total of 14 years, starting on the effective date of the agreement. In addition, Connecticut Water is able, but under no obligation, to purchase up to one million gallons of water per day at the then current wholesale rates per the agreement.
2.
Connecticut Water has an agreement with The Metropolitan District (“MDC”) to purchase water from MDC to serve the Unionville system. The agreement became effective on October 6, 2000 and has a term of fifty years beginning May 19, 2003, the date the water supply facilities related to the agreement were placed in service. Connecticut Water agrees to purchase 283 million gallons of water annually from MDC.
3.
Connecticut Water has an agreement with Avon Water (“Avon”) to purchase water from Avon. The agreement became effective on October 3, 2008 and has a term of 10 years.
4.
Connecticut Water has a 99 year lease with 19 Perry Street to obtain well water for its public water supply system. The agreement became effective in 1975 and is based on current water rates in effect each year. There is no limitation on the amount of water that can be withdrawn from the leased property.
5.
Maine Water has an agreement with the Kenebec Water District for potable water service. The agreement was extended and became effective on November 7, 2015 for a new term of 5 years. Maine Water guarantees a minimum consumption of 63.5 million gallons of water annually. Water sales to Maine Water are billed at a flat rate per gallon plus the monthly minimum tariff rate for a 4-inch metered service.
6.
Pension and post retirement contributions cannot be reasonably estimated beyond 2017 and may be impacted by such factors as return on pension assets, changes in the number of plan participants and future salary increases.
7.
We pay refunds on Advances for Construction over a specific period of time based on operating revenues related to developer-installed water mains or as new customers are connected to and take service from such mains. After all refunds are paid, any remaining balance is transferred to Contributions in Aid of Construction. The refund amounts are not included in the above table because the refund amounts and timing are dependent upon several variables, including new customer connections, customer consumption levels and future rate increases, which cannot be accurately estimated. Portions of these refund amounts are payable annually through 2020 and amounts not paid by the contract expiration dates become non-refundable.
8.
We intend to fund these contractual obligations with cash flows from operations and liquidity sources held by or available to us.

In addition to the obligations disclosed in the contractual obligations table above, we have uncertain tax positions of $9.4 million.  Although we believe our tax positions comply with applicable law, we have made judgments as to the sustainability of each uncertain tax position based on its technical merits.  Due to the uncertainty of future cash outflows, if any, associated with our uncertain tax positions, we are unable to make a reasonable estimate of the timing or amounts that may be paid.


34



RESULTS OF OPERATIONS

Overview of 2016 Results from Operations

Net Income for 2016 was $23,387,000, or $2.12 basic earnings per share, an increase of $626,000, or $0.05 basic earnings per share, compared to 2015.  The increase in earnings was principally due to higher net income in our Water Operations segment due to ongoing investment in water infrastructure and the recovery of that investment through WICA and WISC. These investments drove both a revenue increase and lower current income tax expense as a result of the continued application of the Repair Regulations. Changes in net income for our segments were as follows (in thousands):

Business Segment
 
2016 Net Income
 
2015 Net Income
 
Increase (Decrease)
Water Operations
 
$
22,222

 
$
21,018

 
$
1,204

Real Estate
 
(54
)
 
349

 
(403
)
Services and Rentals
 
1,219

 
1,394

 
(175
)
Total
 
$
23,387

 
$
22,761

 
$
626


Water Operations

The increase in net income from Water Operations for 2016 compared to 2015 was $1,204,000, or 5.7%.  The Net Income from Water Operations for the years ended December 31, 2016 and 2015 were each impacted positively by non-recurring items. During the year ended December 31, 2016, the Company reversed incorrectly recorded mark-to-market expense as an out-of-period adjustment resulting in a one-time benefit (reduction) of approximately $1.6 million in Operation and Maintenance expense. During the twelve months ended December 31, 2015, the Company recorded an approximate $2.1 million reduction to Income Tax expense related to a June 2015 MPUC approval of a settlement agreement between Maine Water and the State of Maine’s Office of Public Advocate that in part allowed for the flow through benefit of Maine Water’s adoption of the IRS’s Repair Regulations and the reversal of previously established reserves after the completion of an IRS audit of the Company’s 2012 federal tax return. The items discussed in detail below reflect the approximate $1.1 million increase in Net Income related to Water Operations for the year ended December 31, 2016 after the impact of the above non-recurring items. A breakdown of the components of this increase was as follows (in thousands):

 
2016
 
2015
 
Increase (Decrease)
Operating Revenues
$
98,667

 
$
96,041

 
$
2,626

Operation and Maintenance
44,191

 
48,052

 
(3,861
)
Depreciation
13,905

 
12,871

 
1,034

Income Taxes
2,570

 
(818
)
 
3,388

Taxes Other than Income Taxes
9,796

 
9,294

 
502

Other Utility Income
744

 
797

 
(53
)
Other (Deductions) Income
(1,009
)
 
(214
)
 
(795
)
Interest and Debt Expense (net of AFUDC)
5,718

 
6,207

 
(489
)
Total Net Income from Water Operations
$
22,222

 
$
21,018

 
$
1,204


Revenue from our water customers increased by $2,626,000, or 2.7%, to $98,667,000 for the year ended December 31, 2016 when compared to the same period in 2015.  The primary drivers of higher revenues were the increased rates in 2016 associated with recurring WICA charges in Connecticut and WISC charges in Maine. In 2016, WRA revenues were $1,132,000 compared to $1,583,000 in 2015. The reduction in WRA revenues was due primarily to an increase in billed revenues in 2016 compared to 2015.


35



Operation and Maintenance (“O&M”) expense decreased by $3,861,000, or 8.0%, during the year ended December 31, 2016 when compared to the 2015 period, primarily due a decrease in expenses related to pension and post-retirement medical costs due to higher discount rates used to determine yearly expense and to the out-of-period adjustment related to stock-based compensation made during 2016. The following table presents the major components of O&M expense (in thousands):

Expense Components
 
2016
 
2015
 
Increase (Decrease)
Mark-to-market
 
$
(1,401
)
 
$
265

 
$
(1,666
)
Pension
 
3,096

 
4,392

 
(1,296
)
Outside services
 
3,284

 
4,224

 
(940
)
Payroll
 
15,812

 
16,110

 
(298
)
Post-retirement medical
 
440

 
729

 
(289
)
Maintenance
 
3,312

 
3,567

 
(255
)
Utility costs
 
3,899

 
4,126

 
(227
)
Water treatment (including chemicals)
 
2,702

 
2,740

 
(38
)
Property and liability insurance
 
1,542

 
1,530

 
12

Vehicles
 
1,793

 
1,666

 
127

Purchased water
 
1,675

 
1,423

 
252

Customer
 
1,829

 
1,494

 
335

Medical
 
2,597

 
2,126

 
471

Other benefits
 
1,945

 
1,211

 
734

Other
 
1,666

 
2,449

 
(783
)
Total
 
$
44,191

 
$
48,052

 
$
(3,861
)

The changes in individual items are described below:
The decrease in mark-to-market expense was related to an out-of-period adjustment made during the second quarter of 2016 related to stock-based performance awards previously granted to officers of the Company. The Company had mistakenly marked certain stock-based performance awards classified as equity awards to the market price of the Company’s common stock price at the end of each reporting period. During the second quarter of 2016, the Company reversed all of the incorrectly recorded mark-to-market expense resulting in a one-time benefit of $2.6 million, including a reversal of approximately $1.0 million in expense related to the first quarter of 2016 for a net out-of-period adjustment of $1.6 million;
Pension and post-retirement medical costs decreased primarily due to an increase in the discount rate used in determining 2016 expense compared to the discount rate used to determine the 2015 expense;
Outside services expenses decreased in 2016 primarily due to a reduction in costs associated with contractors and consultants. During 2015, the Company was involved in initiatives surrounding succession planning and risk management that were heavily reliant on consultants to assist with assessments prior to the Company implementing the assessments with internal labor;
Payroll costs decreased in 2016 when compared to 2015 primarily due to the amount of employee time charged to capital projects increasing in 2016 when compared to 2015; and
Utility costs decreased primarily due to decreased primarily due to a reduction in telephone related expenses, as well as a decrease in heating and electric costs.

The decreases detailed above were offset by the following increases to O&M expense:
Other benefits increased in 2016 when compared to 2015 primarily due to increased costs associated with a non-officer incentive plan and the Company’s performance stock plan offered to officers;
Medical costs in 2016 were higher than 2015 primarily due to an increase in medical claims made by employees and their families;
Customer related expenses increased from 2015 levels due to an increase in uncollectible accounts during 2016 and costs associated with a Company sponsored conservation drive that rewarded customers that were able to reduce their annual consumption by 10%; and
Purchased water costs increased primarily due to an increase in the amount of water purchased from neighboring utilities, particularly in the Company’s Shoreline Region in Connecticut which has experienced continuing drought conditions throughout 2016.


36



The Company’s Depreciation expense increased $1,034,000, or 8.0%, when comparing 2016 to 2015. The primary driver of the increase in Depreciation expense was a higher Utility Plant balance in 2016 due to normal plant additions.

Income Tax expense associated with Water Operations increased by $3,388,000 in the year ended December 31, 2016 when compared to the same period in 2015 due to a higher effective tax rate. The Company had a negative effective tax rate in 2015 primarily due to reversal of previously established provisions, the impact of returning of the repair tax benefit to customers in both Connecticut and Maine and the implementation of the MPUC order allowing flow through treatment of the repair deduction which was recorded in 2015.

Total Interest and Debt Expense, net of Allowance for Funds Used During Construction (“AFUDC”) decreased by $489,000 in the year ended December 31, 2016 when compared to the same period in 2015 due, primarily, to higher AFUDC earnings related to increased construction during 2016 when compared to 2015, partially offset by higher interest costs related to new debt issued by Connecticut Water in 2016 and full year’s worth of interest on Maine Water’s 2015 issuances.

Real Estate

Income from the Real Estate segment is largely dependent on the tax deductions received on donations and, or, sales of available land.  This typically occurs when utility-owned land is deemed to be unnecessary to protect water sources.  During 2016, the Company recorded a valuation allowance on a previously completed land donation and the sale of a small parcel of land in Connecticut. These transactions generated $54,000 in net loss in the Real Estate segment.

During 2015, the Company donated land associated with a previously sold land conservation easement in Connecticut and the sale of three small parcels of land in Maine. These transactions generated $349,000 in net income in the Real Estate segment.

Other

The increase in net loss seen in the year ended December 31, 2016 in “Other” under “Other Income (Deductions), Net of Taxes” was primarily due to costs due to the acquisitions of Heritage Village and Avon Water.

Overview of 2015 Results from Operations

Net Income for 2015 was $22,761,000, or $2.07 basic earnings per share, an increase of $1,442,000, or $0.12 basic earnings per share, compared to 2014.  The increase in earnings was principally due to higher net income in our Water Operations segment due to ongoing investment in water infrastructure and the recovery of that investment through WICA and WISC. These investments drove both a revenue increase and lower current income tax expense as a result of the continued application of the Repair Regulations. Changes in net income for our segments were as follows (in thousands):

Business Segment
 
2015 Net Income
 
2014 Net Income
 
Increase (Decrease)
Water Operations
 
$
21,018

 
$
19,798

 
$
1,220

Real Estate
 
349

 
50

 
299

Services and Rentals
 
1,394

 
1,471

 
(77
)
Total
 
$
22,761

 
$
21,319

 
$
1,442



37



Water Operations

The increase in net income from Water Operations for 2015 compared to 2014 was $1,220,000, or 6.2%.  A breakdown of the components of this increase was as follows (in thousands):

 
2015
 
2014
 
Increase (Decrease)
Operating Revenues
$
96,041

 
$
94,020

 
$
2,021

Operation and Maintenance
48,052

 
44,445

 
3,607

Depreciation
12,871

 
11,784

 
1,087

Income Taxes
(818
)
 
3,596

 
(4,414
)
Taxes Other than Income Taxes
9,294

 
9,031

 
263

Other Utility Income
797

 
833

 
(36
)
Other (Deductions) Income
(214
)
 
(202
)
 
(12
)
Interest and Debt Expense (net of AFUDC)
6,207

 
5,997

 
210

Total Net Income from Water Operations
$
21,018

 
$
19,798

 
$
1,220


Revenue from our water customers increased by $2,021,000, or 2.1%, to $96,041,000 for the year ended December 31, 2015 when compared to the same period in 2014.  The primary drivers of higher revenues were the increased rates in 2015 associated with recurring WICA charges and increased rates in almost all of Maine Water’s service areas due to both WISC filings and regular rate cases. In 2015, WRA revenues were $1,583,000 compared to $3,700,000 in 2014. The reduction in WRA revenues was due primarily to an increase in billed revenues in 2015 compared to 2014.

Operation and Maintenance (“O&M”) expense increased in 2015 by $3,607,000, or 8.1%, during the year ended December 31, 2015 when compared to the 2014 period primarily due to a increase in employee benefit costs and the use of outside services. The following table presents the major components of O&M expense (in thousands):

Expense Components
 
2015
 
2014
 
Increase (Decrease)
Pension
 
$
4,382

 
$
2,738

 
$
1,644

Outside services
 
4,224

 
2,594

 
1,630

Payroll
 
16,110

 
15,280

 
830

Utility costs
 
4,126

 
3,757

 
369

Maintenance
 
3,567

 
3,205

 
362

Post-retirement medical
 
729

 
575

 
154

Investor relations
 
770

 
631

 
139

Property and liability insurance
 
1,530

 
1,424

 
106

Vehicles
 
1,666

 
1,767

 
(101
)
Water treatment (including chemicals)
 
2,740

 
2,936

 
(196
)
Customer
 
1,494

 
1,719

 
(225
)
Medical
 
2,126

 
2,557

 
(431
)
Other benefits
 
1,211

 
1,809

 
(598
)
Other
 
3,377

 
3,453

 
(76
)
Total
 
$
48,052

 
$
44,445

 
$
3,607



38



The changes in individual items are described below:
Pension and post-retirement medical costs increased over the prior year primarily due to a decrease to the discount rate used in determining the 2015 expense. The discount rate selected to calculate the pension and post-retirement medical expenses for 2016 is higher than the rate used for 2015 which will likely cause 2016 pension and post-retirement medical expenses to be lower than 2015 expense;
Outside services expenses increased in 2015 primarily due to costs associated with Company initiatives surrounding succession planning and risk management and the use of consultants to assist for tax related matters and water quality compliance. Additionally, the Company saw continued costs associated with its ongoing cyber security improvements discussed above. These increases were partially offset by a reduction in legal costs throughout 2015;
Payroll costs increased in 2015 when compared to 2014 primarily due to regular wage increases;
Utility costs increased primarily due to increased electrical fees charged by our electric suppliers and higher phone costs in 2015. Theses increases were partially offset by lower costs associated with fuel oil;
Investor relation fees increased primarily as the result of increased efforts by senior leadership related to investor outreach throughout 2015 and higher expenses related to the Board of Directors; and
Property and liability insurance costs increased in 2015 due to higher premiums stemming from growth in insurable assets.

The increases detailed above were offset by the following decreases to O&M expense:
Other benefits decreased in 2015 when compared to 2014 primarily due to reduced costs associated with a non-officer incentive plan and the Company’s performance stock plan offered to officers;
Medical costs in 2015 were lower than 2014 primarily due to a reduction in medical claims made by employees and their families, partially offset by an increase in the administration of the Company’s medical plan;
Customer related expenses decreased from 2014 levels due to a reduction in uncollectible accounts during 2015, partially offset by higher customer communication costs; and
Water treatment costs decreased primarily due to a reduction in laboratory testing costs as a result of Connecticut Water now performing most test internally rather than through an outside vendor and lower costs associated with the disposal of certain treatment by-products. Maine Water has historically handled most of their testing in house.

The Company’s Depreciation expense increased $1,087,000, or 9.2%, when comparing 2015 to 2014. The primary driver of the increase in Depreciation expense was a higher Utility Plant balance in 2015 due to normal plant additions.

Income Tax expense associated with Water Operations decreased by $4,414,000 in the year ended December 31, 2015 when compared to the same period in 2014 due to a lower effective tax rate. The Company’s effective tax rate decreased in 2015 primarily due to reversal of previously established provisions, the impact of returning of the repair tax benefit to customers in both Connecticut and Maine and the implementation of the MPUC order allowing flow through treatment of the repair deduction which was recorded in 2015.

Total Interest and Debt Expense, net of Allowance for Funds Used During Construction (“AFUDC”) increased by $210,000 in the year ended December 31, 2015 when compared to the same period in 2014 due, primarily, to higher interest costs related to new debt issuances by Maine Water.

Real Estate

Income from the Real Estate segment is largely dependent on the tax deductions received on donations and, or, sales of available land.  This typically occurs when utility-owned land is deemed to be unnecessary to protect water sources.  During 2015, the Company donated land associated with a previously sold land conservation easement in Connecticut and the sale of three small parcels of land in Maine. These transactions generated $349,000 in net income in the Real Estate segment.

During 2014, the Company completed the sale of two small properties which generated $50,000 of net income in the Real Estate segment.


39



COMMITMENTS AND CONTINGENCIES

Water Supply – Connecticut Water has an agreement with the RWA to purchase water from RWA. The agreement was signed April 2006 and became effective upon the receipt of all regulatory approvals in 2008 and remains in effect for a minimum of fifty years upon the effective date. Connecticut Water will pay RWA $75,000 per year, for a total of 14 years, starting on the effective date of the agreement. In addition, Connecticut Water is able, but under no obligation, to purchase up to one million gallons of water per day at the then current wholesale rates per the agreement. Connecticut Water has an agreement with the MDC to purchase water from MDC to serve the Unionville system. The agreement became effective on October 6, 2000 and has a term of fifty years beginning May 19, 2003, the date the water supply facilities related to the agreement were placed in service. Connecticut Water agrees to purchase 283 million gallons of water annually from MDC. Connecticut Water has an agreement with Avon to purchase twelve million gallons per year from Avon. The agreement became effective on October 3, 2008 and has a term of 10 years. Connecticut Water has a 99 year lease with 19 Perry Street to obtain well water for its public water supply system. The agreement became effective in 1975 and is based on current water rates in effect each year. There is no limitation on the amount of water that can be withdrawn from the leased property. Maine Water has an agreement with the Kenebec Water District for potable water service. The agreement was extended and became effective on November 7, 2015 for a new term of 5 years. Water sales to Maine Water are billed at a flat rate per gallon plus the monthly minimum tariff rate for a 4-inch metered service. During 2016, 2015, and 2014, the Company spent $1,556,000, $1,112,000 and $3,700,000, respectively, on these agreements. The Company’s expected payments related to these agreements for the years 2017 through 2021 will be as follows:

(in thousands)
 
 
2017
 
$
1,562

2018
 
$
1,601

2019
 
$
1,643

2020
 
$
1,601

2021
 
$
1,546



Reviews by Taxing Authorities – On June 11, 2013, the Company was notified by the Connecticut Department of Revenue Services that its state tax filings for the years 2009 through 2011 would be reviewed beginning in the fourth quarter of 2013.  On March 24, 2015, the Company was notified by the Connecticut Department of Revenue Services that the audit was expanded to include the 2012 and 2013 tax years. The State focused its review on tax credits associated with fixed capital investment. The Company and the State came to an agreement (“Closing Agreement”) regarding investments eligible for the credit. The Closing Agreement was executed on May 4, 2015. The Company had previously recorded a provision for the possible disallowance of these credits and, therefore, there was minimal impact in 2015.

On the 2012 tax return, filed in September 2013, Connecticut Water filed a change in accounting method to adopt the IRS’s temporary tangible property regulations. On the 2013 Federal tax return, filed in September 2014, Maine Water filed the same change in accounting method. This method change allowed the Company to take a current year deduction for expenses that were previously capitalized for tax purposes. Since the filing of the 2012 tax return, the IRS has issued final regulations. On February 11, 2014, the Company was notified by the IRS that its Federal tax filing for 2012 would be reviewed. This review, which began in the first quarter of 2014 and was completed in the first quarter of 2015, resulted in no change to the tax liability. Since the Company had previously recorded a provision for the possible disallowance of the repair deduction in prior periods, the completion of the audit resulted in the reversal of the reserves in the amount of $1,185,000. While the Company maintains the belief that the deduction taken on its tax return is appropriate, the methodology for determining the deduction has not been agreed to by the taxing authorities.  Therefore, as required by FASB ASC 740, during the year ended December 31, 2016, the Company recorded a provision of $3.1 million for a portion of the benefit that is not being returned to customers resulting from any possible tax authority challenge. The Company had previously recorded a provision of $6.3 million in the prior year for a cumulative total of $9.4 million.

The Company remains subject to examination by federal tax authorities for the 2013 through 2015 tax years; the State of Maine’s tax authorities for the 2013 through 2015 tax years; and the State of Connecticut’s tax authorities for the 2014 and 2015 tax years.

Environmental and Water Quality Regulation – The Company is subject to environmental and water quality regulations.  Costs to comply with environmental and water quality regulations are substantial.  We are presently in compliance

40



with current regulations, but the regulations are subject to change at any time.  The costs to comply with future changes in state or federal regulations, which could require us to modify current filtration facilities and/or construct new ones, or to replace any reduction of the safe yield from any of our current sources of supply, could be substantial.

Legal Proceedings – We are involved in various legal proceedings from time to time. Although the results of legal proceedings cannot be predicted with certainty, there are no pending legal proceedings to which we, or any of our subsidiaries are a party, or to which any of our properties is subject, that presents a reasonable likelihood of a material adverse impact on the Company’s financial condition, results of operations or cash flows.

Rate Relief – Connecticut Water and Maine Water are regulated public utilities, which provide water services to their customers.  The rates that Regulated Companies charge their water customers are subject to the jurisdiction of the regulatory authority of the PURA in Connecticut and the MPUC in Maine.  Connecticut Water’s allowed rate of return on equity and return on rate base are currently 9.75% and 7.32%, respectively. Maine Water’s average allowed return on equity and return on rate base, as of December 31, 2016 were 9.50% and 7.96%, respectively.

Land Dispositions – The Company and its subsidiaries own additional parcels of land in Connecticut and Maine, which may be suitable in the future for disposition or for further protection through conservation easements, through sale or by donation to municipalities, other local governments or private charitable entities such as local land trusts.  In Connecticut, these additional parcels would include certain Class I and II parcels previously identified for long term conservation by the Connecticut DEEP, which have restrictions on development and resale based on provisions of the Connecticut General Statutes.  In Maine, these parcels include primarily company-owned land used for water supply protection, and a permanent conservation easement may be appropriate for some parcels to ensure the permanent protection of the watersheds, while balancing the appropriate community and recreational use of the land.

Capital Expenditures – The Company has received approval from its Board of Directors to spend $55.4 million on capital expenditures in 2017, in part to fund improvements to water treatment plants and increased spending related to infrastructure improvements.

ITEM 7A.  QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK

The primary market risk faced by the Company is interest rate risk.  As of December 31, 2016, the Company had no exposure to derivative financial instruments or financial instruments with significant credit risk or off-balance-sheet risks.  In addition, the Company is not subject in any material respect to any currency or other commodity risk.

The Company is subject to the risk of fluctuating interest rates in the normal course of business. The Company’s exposure to interest fluctuations is managed at the Company and subsidiary operations levels through the use of a combination of fixed rate long-term debt (and variable rate borrowings) under financing arrangements entered into by the Company and its subsidiaries.
The Company has entered into a $15 million line of credit agreement with CoBank, ACB, that is currently scheduled to expire on July 1, 2020.  The Company maintains an additional line of credit of $45 million with RBS Citizens, N.A., with an expiration date of April 25, 2021.  As of December 31, 2016 the total lines of credit available to the Company were $60 million.  As of December 31, 2016 and 2015, the Company had $33.0 million and $16.1 million of “Interim Bank Loans Payable”, respectively.  As of December 31, 2016, the Company had $27.0 million in unused lines of credit.  Interest expense charged on interim bank loans will fluctuate based on market interest rates.

ITEM 8.  FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

The “Consolidated Financial Statements” of Connecticut Water Service, Inc., and the “Notes to Consolidated Financial Statements”, together with the reports of Baker Tilly Virchow Krause, LLP independent registered public accounting firm, are included herein on pages 46 through 82.

ITEM 9.  CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE

None


41



ITEM 9A.  CONTROLS AND PROCEDURES

Disclosure Controls and Procedures – As of December 31, 2016, management, including the Company’s Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of the design and operation of the Company’s disclosure controls and procedures (as defined in Exchange Act Rule 13a-15(e)).  Based upon, and as of the date of that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that the Company’s disclosure controls and procedures were effective.

Management’s Report on Internal Control Over Financial Reporting – Internal control over financial reporting (as defined in Exchange Act Rule 13a-15(f)) is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with accounting principles generally accepted in the United States of America.

Management of the Company is responsible for establishing and maintaining adequate internal control over financial reporting.  We have used the criteria established in Internal Control – Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework) in conducting our evaluation of the effectiveness of the internal control over financial reporting. Based on our evaluation, we concluded that the Company’s internal control over financial reporting was effective as of December 31, 2016.  The effectiveness of the Company’s internal control over financial reporting as of December 31, 2016 has been audited by Baker Tilly Virchow Krause, LLP, an independent registered public accounting firm, as stated in their report which appears herein.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements.  Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

Changes in Internal Control Over Financial Reporting – There were no significant changes in the Company’s internal control over financial reporting that occurred during the Company’s most recent fiscal quarter that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.


42



Report of Independent Registered Public Accounting Firm


Board of Directors and Stockholders
Connecticut Water Service, Inc.

We have audited Connecticut Water Service, Inc.’s (the “Company”) internal control over financial reporting as of December 31, 2016, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework). Connecticut Water Service, Inc.’s management is responsible for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Report on Internal Control Over Financial Reporting. Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit.

We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audit also included performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.

An entity’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with accounting principles generally accepted in the United States of America. An entity’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the entity; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the entity are being made only in accordance with authorizations of management and directors of the entity; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the entity’s assets that could have a material effect on the financial statements.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

In our opinion, Connecticut Water Service, Inc. maintained, in all material respects, effective internal control over financial reporting as of December 31, 2016, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework).

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets and related consolidated statements of income, comprehensive income and cash flows of Connecticut Water Service, Inc., as well as the financial statement schedule listed in the accompanying index, and our report dated March 13, 2017 expressed an unqualified opinion.

/s/ Baker Tilly Virchow Krause, LLP

Philadelphia, Pennsylvania
March 13, 2017

43




ITEM 9B.  OTHER INFORMATION

None
PART III

Pursuant to General Instruction G(3), the information called for by Items 10, 11, 12, 13 and 14 is hereby incorporated by reference to the Company’s definitive proxy statement to be filed in EDGAR on or about March 30, 2017 in connection with the annual meeting to be held on May 11, 2017.  Certain information concerning the executive officers of the Company is included in Item 1 of this report.

ITEM 10.  DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE


ITEM 11.  EXECUTIVE COMPENSATION


ITEM 12.  SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS


ITEM 13.  CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE


ITEM 14.  PRINCIPAL ACCOUNTING FEES AND SERVICES


44



PART IV

ITEM 15.  EXHIBITS, FINANCIAL STATEMENT SCHEDULES

(a)
 
1

 
Financial Statements:
 
 
 
 
 

 
 
 
Page
 
 
 

 
Index to Consolidated Financial Statements and Schedule
 
46
 
 
 

 
Report of Independent Registered Public Accounting Firm
 
47
 
 
 

 
Consolidated Statements of Income for the years ended December 31, 2016, 2015 and 2014
 
48
 
 
 

 
Consolidated Statements of Comprehensive Income for the years ended December 31, 2016, 2015 and 2014
 
48
 
 
 

 
Consolidated Balance Sheets at December 31, 2016 and 2015
 
49
 
 
 

 
Consolidated Statements of Cash Flows for the years ended December 31, 2016, 2015 and 2014
 
50
 
 
 

 
Notes to Consolidated Financial Statements
 
51
 
 
2

 
Financial Statement Schedule:
 
 
 
 
 

 
The following schedule of the Company is included on the attached page as indicated
 
 
 

 
Schedule II Valuation and Qualifying Accounts and Reserves for the years ended December 31, 2016, 2015 and 2014
 
89
 
 
 

 
All other schedules provided for in the applicable regulations of the Securities and Exchange Commission have been omitted because of the absence of conditions under which they are required or because the required information is set forth in the financial statements or notes thereto.
 
 
(b)
 
 

 
Exhibits
 
 
 
 
 

 
Exhibits for Connecticut Water Service Inc., are in the Index to Exhibits
 
83
 
 
 

 
Exhibits heretofore filed with the Securities and Exchange Commission as indicated below are incorporated herein by reference and made a part hereof as if filed herewith.  Exhibits marked by asterisk (* or **) are being filed or furnished herewith.
 
 

45



INDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND SCHEDULE

 
 
Page
 
Index to Consolidated Financial Statements and Schedule
 
46
 
 
 
 
 
Report of Independent Registered Public Accounting Firm
 
47
 
 
 
 
 
Consolidated Statements of Income for the years ended December 31, 2016, 2015 and 2014
 
48
 
 
 
 
 
Consolidated Statements of Comprehensive Income for the years ended December 31, 2016, 2015 and 2014
 
48
 
 
 
 
 
Consolidated Balance Sheets at December 31, 2016 and 2015
 
49
 
 
 
 
 
Consolidated Statements of Cash Flows for the years ended December 31, 2016, 2015 and 2014
 
50
 
 
 
 
 
Notes to Consolidated Financial Statements
 
51
 
 
 
 
 
Schedule II Valuation and Qualifying Accounts and Reserves for the years ended December 31, 2016, 2015 and 2014
 
89
 


46



Report of Independent Registered Public Accounting Firm



Board of Directors and Stockholders
Connecticut Water Service, Inc.

We have audited the accompanying consolidated balance sheets of Connecticut Water Service, Inc. (the “Company”) as of December 31, 2016 and 2015, and the related consolidated statements of income, comprehensive income, and cash flows for each of the years in the three-year period ended December 31, 2016. In connection with our audits of the consolidated financial statements, we have also audited the financial statement schedule listed in the accompanying index. These consolidated financial statements and financial statement schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements and financial statement schedule based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Connecticut Water Service, Inc. as of December 31, 2016 and 2015, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2016, in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, the related financial statement schedule, when considered in relation to the basic financial statements taken as a whole, presents fairly, in all material respect, the information set forth therein.

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), Connecticut Water Service, Inc.’s internal control over financial reporting as of December 31, 2016, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework) and our report dated March 13, 2017 expressed an unqualified opinion.

/s/ Baker Tilly Virchow Krause, LLP

Philadelphia, Pennsylvania
March 13, 2017


47



CONNECTICUT WATER SERVICE, INC.

CONSOLIDATED STATEMENTS OF INCOME
 
 
 
 
 
 
For the Years Ended December 31, (in thousands, except per share data)
 
2016

 
2015

 
2014

Operating Revenues
 
$
98,667

 
$
96,041

 
$
94,020

Operating Expenses
 
 

 
 

 
 

Operation and Maintenance
 
44,191

 
48,052

 
44,445

Depreciation
 
13,905

 
12,871

 
11,784

Income Taxes
 
2,570

 
(818
)
 
3,596

Taxes Other Than Income Taxes
 
9,796

 
9,294

 
9,031

Total Operating Expenses
 
70,462

 
69,399

 
68,856

Net Operating Revenues
 
28,205

 
26,642

 
25,164

Other Utility Income, Net of Taxes
 
744

 
797

 
833

Total Utility Operating Income
 
28,949

 
27,439

 
25,997

Other Income (Deductions), Net of Taxes
 
 

 
 

 
 

(Loss) Gain on Real Estate Transactions
 
(54
)
 
349

 
50

Non-Water Sales Earnings
 
1,219

 
1,394

 
1,471

Allowance for Funds Used During Construction
 
1,198

 
530

 
518

Other
 
(1,009
)
 
(214
)
 
(202
)
Total Other Income, Net of Taxes
 
1,354

 
2,059

 
1,837

Interest and Debt Expenses
 
 

 
 

 
 

Interest on Long-Term Debt
 
7,714

 
7,087

 
7,023

Other Interest Income, Net
 
(922
)
 
(458
)
 
(573
)
Amortization of Debt Expense and Premium, Net
 
124

 
108

 
65

Total Interest and Debt Expenses
 
6,916

 
6,737

 
6,515

Net Income
 
23,387

 
22,761

 
21,319

Preferred Stock Dividend Requirement
 
38

 
38

 
38

Total Net Income Applicable to Common Stock
 
$
23,349

 
$
22,723

 
$
21,281

Weighted Average Common Shares Outstanding:
 
 

 
 

 
 

Basic
 
11,009

 
10,958

 
10,893

Diluted
 
11,228

 
11,164

 
11,091

Earnings Per Common Share:
 
 

 
 

 
 

Basic
 
$
2.12

 
$
2.07

 
$
1.95

Diluted
 
$
2.08

 
$
2.04

 
$
1.92

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
 
 

 
 

 
 

For the Years Ended December 31, (in thousands)
 
2016

 
2015

 
2014

 
 
 
 
 
 
 
Net Income
 
$
23,387

 
$
22,761

 
$
21,319

Other Comprehensive Income (Loss), net of tax
 
 

 
 

 
 

Adjustment to post-retirement benefit plans, net of tax benefit
 
 

 
 

 
 

(expense) of $15, $(505), and $735 in 2016, 2015, and 2014, respectively
 
(24
)
 
765

 
(1,527
)
Unrealized Investment gain (loss), net of tax (expense) benefit of $(22),
 
 

 
 

 
 

$62 and $(25), in 2016, 2015, and 2014, respectively
 
35

 
(97
)
 
39

Other Comprehensive Income (Loss), net of tax
 
$
11

 
$
668

 
$
(1,488
)
Comprehensive Income
 
$
23,398

 
$
23,429

 
$
19,831

 
 
 
 
 
 
 
The accompanying notes are an integral part of these Consolidated Financial Statements.

48



CONNECTICUT WATER SERVICE, INC.

CONSOLIDATED BALANCE SHEETS
 
 
 
 
December 31, (in thousands, except share amounts)
 
2016

 
2015

ASSETS
 
 
 
 
Utility Plant
 
$
777,860

 
$
722,447

Construction Work in Progress
 
33,748

 
23,298

 
 
811,608

 
745,745

Accumulated Provision for Depreciation
 
(210,212
)
 
(199,461
)
Net Utility Plant
 
601,396

 
546,284

Other Property and Investments
 
9,071

 
8,126

Cash and Cash Equivalents
 
1,564

 
731

Accounts Receivable (Less Allowance, 2016 - $1,100; 2015 - $947)
 
13,024

 
11,012

Accrued Unbilled Revenues
 
8,171

 
8,259

Materials and Supplies, at Average Cost
 
1,536

 
1,617

Prepayments and Other Current Assets
 
5,069

 
5,393

Total Current Assets
 
29,364

 
27,012

Restricted Cash
 

 
846

Unrecovered Income Taxes - Regulatory Asset
 
93,264

 
77,510

Pension Benefits - Regulatory Asset
 
12,266

 
12,414

Post-Retirement Benefits Other Than Pension - Regulatory Asset
 
265

 
468

Goodwill
 
30,427

 
30,427

Deferred Charges and Other Costs
 
8,449

 
7,628

Total Regulatory and Other Long-Term Assets
 
144,671

 
129,293

Total Assets
 
$
784,502

 
$
710,715

CAPITALIZATION AND LIABILITIES
 
 

 
 

Common Stockholders’ Equity: