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EX-32 - SOX CERTIFICATION - CONNECTICUT WATER SERVICE INC / CTexhibit32q32017.htm
EX-31 - CEO CERTIFICATION - CONNECTICUT WATER SERVICE INC / CTexhibit31q32017.htm
EX-10.5 - MWC CMLT AMENDMENTS - CONNECTICUT WATER SERVICE INC / CTexhibit105-mwccmltamendmen.htm


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

FORM 10-Q

(Mark One)
x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2017 or

¨ TRANSITION REPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM ___________ TO ___________


Commission File Number: 0-8084
cwclogocolora01.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 offices)
 
06413
(Zip Code)

(860) 669-8636
(Registrant’s telephone number, including area code)

Not Applicable
(Former name, former address and former fiscal year, if changed since last report)

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 12 months (or 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 x        No ¨

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 x        No ¨

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

Large accelerated filer o
 
Accelerated filer x
Non-accelerated filer o
(Do not check if a smaller reporting company)
 
Smaller reporting company o
Emerging growth company o
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. o

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

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date
12,068,299
Number of shares of common stock outstanding, October 1, 2017
(Includes 225,864 common stock equivalent shares awarded under the Performance Stock Programs)



CONNECTICUT WATER SERVICE, INC. AND SUBSIDIARIES

Financial Report
September 30, 2017

TABLE OF CONTENTS

Part I, Item 1:  Financial Statements (Unaudited)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Exhibit 31
Exhibit 32
Exhibit 101.INS
Exhibit 101.SCH
Exhibit 101.CAL
Exhibit 101.DEF
Exhibit 101.LAB
Exhibit 101.PRE



CONNECTICUT WATER SERVICE, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(Unaudited)
(In thousands, except share data)
ASSETS
 
September 30, 2017
 
December 31, 2016
Utility Plant
 
$
905,437

 
$
777,860

Construction Work in Progress
 
15,882

 
33,748

 
 
921,319

 
811,608

Accumulated Provision for Depreciation
 
(237,581
)
 
(210,212
)
Net Utility Plant
 
683,738

 
601,396

Other Property and Investments
 
10,324

 
9,071

Cash and Cash Equivalents
 
8,274

 
1,564

Accounts Receivable (Less Allowance, 2017 - $1,223; 2016 - $1,100)
 
15,642

 
13,024

Accrued Unbilled Revenues
 
9,906

 
8,171

Materials and Supplies, at Average Cost
 
1,842

 
1,536

Prepayments and Other Current Assets
 
11,485

 
5,069

Total Current Assets
 
47,149

 
29,364

Unrecovered Income Taxes - Regulatory Asset
 
107,911

 
93,264

Pension Benefits - Regulatory Asset
 
11,025

 
12,266

Post-Retirement Benefits Other Than Pension - Regulatory Asset
 
86

 
265

Goodwill
 
66,979

 
30,427

Deferred Charges and Other Costs
 
12,164

 
8,449

Total Regulatory and Other Long-Term Assets
 
198,165

 
144,671

Total Assets
 
$
939,376

 
$
784,502

CAPITALIZATION AND LIABILITIES
 
 

 
 

Common Stockholders’ Equity:
 
 

 
 

Common Stock Without Par Value: Authorized - 25,000,000 Shares
 
 

 
 

     Issued and Outstanding: 2017 - 12,068,299; 2016 - 11,248,458
 
$
190,975

 
$
145,739

Retained Earnings
 
104,091

 
91,213

Accumulated Other Comprehensive (Loss)
 
(661
)
 
(924
)
Common Stockholders’ Equity
 
294,405

 
236,028

Preferred Stock
 
772

 
772

Long-Term Debt
 
255,193

 
197,047

Total Capitalization
 
550,370

 
433,847

Current Portion of Long-Term Debt
 
7,950

 
4,859

Interim Bank Loans Payable
 
18,547

 
32,953

Accounts Payable and Accrued Expenses
 
8,585

 
13,116

Accrued Interest
 
1,564

 
1,012

Current Portion of Refund to Customers - Regulatory Liability
 
145

 
855

Other Current Liabilities
 
3,044

 
2,330

Total Current Liabilities
 
39,835

 
55,125

Advances for Construction
 
20,783

 
19,127

Deferred Federal and State Income Taxes
 
54,081

 
50,558

Unfunded Future Income Taxes
 
106,160

 
90,977

Long-Term Compensation Arrangements
 
32,343

 
33,540

Unamortized Investment Tax Credits
 
1,153

 
1,189

Refund to Customers - Regulatory Liability
 

 
108

Other Long-Term Liabilities
 
4,704

 
5,074

Total Long-Term Liabilities
 
219,224

 
200,573

Contributions in Aid of Construction
 
129,947

 
94,957

Commitments and Contingencies
 

 

Total Capitalization and Liabilities
 
$
939,376

 
$
784,502


The accompanying footnotes are an integral part of these condensed consolidated financial statements.

3


CONNECTICUT WATER SERVICE, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
For the Three Months Ended September 30, 2017 and 2016
(Unaudited)
(In thousands, except per share amounts)
 
2017
 
2016
Operating Revenues
$
31,797

 
$
29,477

Operating Expenses
 
 
 
Operation and Maintenance
12,133

 
11,495

Depreciation
4,283

 
3,449

Income Tax Expense
235

 
1,219

Taxes Other Than Income Taxes
2,822

 
2,535

Total Operating Expenses
19,473

 
18,698

Net Operating Revenues
12,324

 
10,779

Other Utility Income, Net of Taxes
264

 
160

Total Utility Operating Income
12,588

 
10,939

Other (Deductions) Income, Net of Taxes
 
 
 
Gain on Real Estate Transactions

 
2

Non-Water Sales Earnings
252

 
181

Allowance for Funds Used During Construction
101

 
330

Other
187

 
(136
)
Total Other Income, Net of Taxes
540

 
377

Interest and Debt Expense
 
 
 
Interest on Long-Term Debt
2,230

 
2,064

Other Interest Income, Net
150

 
(315
)
Amortization of Debt Expense and Premium, Net
32

 
32

Total Interest and Debt Expense
2,412

 
1,781

Net Income
10,716

 
9,535

Preferred Stock Dividend Requirement
10

 
10

Net Income Applicable to Common Stock
$
10,706

 
$
9,525

Weighted Average Common Shares Outstanding:
 
 
 
Basic
11,817

 
11,014

Diluted
12,041

 
11,233

Earnings Per Common Share:
 
 
 
Basic
$
0.92

 
$
0.86

Diluted
$
0.90

 
$
0.84

Dividends Per Common Share
$
0.2975

 
$
0.2825


The accompanying footnotes are an integral part of these condensed consolidated financial statements.


4


CONNECTICUT WATER SERVICE, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
For the Nine Months Ended September 30, 2017 and 2016
(Unaudited)
(In thousands, except per share amounts)
 
2017
 
2016
Operating Revenues
$
82,162

 
$
77,084

Operating Expenses
 

 
 

Operation and Maintenance
34,995

 
31,624

Depreciation
11,959

 
10,206

Income Tax (Benefit) Expense
(579
)
 
2,201

Taxes Other Than Income Taxes
7,904

 
7,222

Total Operating Expenses
54,279

 
51,253

Net Operating Revenues
27,883

 
25,831

Other Utility Income, Net of Taxes
619

 
503

Total Utility Operating Income
28,502

 
26,334

Other Income (Deductions), Net of Taxes
 
 
 
Gain on Real Estate Transactions
33

 
2

Non-Water Sales Earnings
842

 
982

Allowance for Funds Used During Construction
668

 
851

Other
(566
)
 
(451
)
Total Other Income, Net of Taxes
977

 
1,384

Interest and Debt Expense
 
 
 
Interest on Long-Term Debt
6,397

 
5,630

Other Interest Income, Net
(221
)
 
(631
)
Amortization of Debt Expense and Premium, Net
101

 
93

Total Interest and Debt Expense
6,277

 
5,092

Net Income
23,202

 
22,626

Preferred Stock Dividend Requirement
29

 
29

Net Income Applicable to Common Stock
$
23,173

 
$
22,597

Weighted Average Common Shares Outstanding:
 
 
 
Basic
11,436

 
11,004

Diluted
11,661

 
11,223

Earnings Per Common Share:
 
 
 
Basic
$
2.03

 
$
2.05

Diluted
$
1.99

 
$
2.01

Dividends Per Common Share
$
0.8775

 
$
0.8325


The accompanying footnotes are an integral part of these condensed consolidated financial statements.


5


CONNECTICUT WATER SERVICE, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
For the Three Months Ended September 30, 2017 and 2016
(Unaudited)
(In thousands)

 
2017
 
2016
Net Income
$
10,716

 
$
9,535

Other Comprehensive Income, net of tax
 

 
 

Reclassification to Pension and Post-Retirement Benefits Other than Pension, net of tax (expense) of $(30) and $(25) in 2017 and 2016
48

 
39

Unrealized gain on investments, net of tax (expense) of $(17) and $(29) in 2017 and 2016
26

 
46

Other Comprehensive Income, net of tax
74

 
85

Comprehensive Income
$
10,790

 
$
9,620





CONNECTICUT WATER SERVICE, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
For the Nine Months September 30, 2017 and 2016
(Unaudited)
(In thousands)

 
2017
 
2016
Net Income
$
23,202

 
$
22,626

Other Comprehensive Income, net of tax
 

 
 

Reclassification to Pension and Post-Retirement Benefits Other than Pension, net of tax (expense) of $(91) and $(75) in 2017 and 2016
144

 
117

Unrealized gain on investments, net of tax (expense) of $(76) and $(21) in 2017 and 2016
119

 
33

Other Comprehensive Income, net of tax
263

 
150

Comprehensive Income
$
23,465

 
$
22,776





The accompanying footnotes are an integral part of these condensed consolidated financial statements. 

6


CONNECTICUT WATER SERVICE, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF RETAINED EARNINGS
For the Three Months Ended September 30, 2017 and 2016
(Unaudited)
(In thousands, except per share amounts)

 
2017
 
2016
Balance at Beginning of Period
$
96,975

 
$
87,284

Net Income
10,716

 
9,535

 
107,691

 
96,819

Dividends Declared:
 

 
 

Cumulative Preferred, Class A, $0.20 per share
3

 
3

Cumulative Preferred, Series $0.90, $0.225 per share
7

 
7

Common Stock - 2017 $0.2975 per share; 2016 $0.2825 per share
3,590

 
3,173

 
3,600

 
3,183

Balance at End of Period
$
104,091

 
$
93,636





CONNECTICUT WATER SERVICE, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF RETAINED EARNINGS
For the Nine Months September 30, 2017 and 2016
(Unaudited)
(In thousands, except per share amounts)

 
2017
 
2016
Balance at Beginning of Period
$
91,213

 
$
80,378

Net Income
23,202

 
22,626

 
114,415

 
103,004

Dividends Declared:
 

 
 

Cumulative Preferred, Class A, $0.60 per share
9

 
9

Cumulative Preferred, Series $0.90, $0.675 per share
20

 
20

Common Stock - 2017 $0.8775 per share; 2016 $0.8325 per share
10,295

 
9,339

 
10,324

 
9,368

Balance at End of Period
$
104,091

 
$
93,636





The accompanying footnotes are an integral part of these condensed consolidated financial statements.


7


CONNECTICUT WATER SERVICE, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
For the Nine Months Ended September 30, 2017 and 2016
(Unaudited)
(In thousands)
 
2017
 
2016
Operating Activities:
 
 
 
Net Income
$
23,202

 
$
22,626

Adjustments to Reconcile Net Income to Net Cash and Cash Equivalents Provided by
 
 
 
Operating Activities:
 
 
 
Deferred Revenues
(5,283
)
 
(2,688
)
Provision for Deferred Income Taxes and Investment Tax Credits, Net
406

 
3,244

Allowance for Funds Used During Construction
(668
)
 
(851
)
Depreciation and Amortization (including $593 and $744 in 2017 and 2016, respectively, charged to other accounts)
12,552

 
10,950

Gain on Real Estate Transactions
(33
)
 
(2
)
Change in Assets and Liabilities:
 
 
 
Increase in Accounts Receivable and Accrued Unbilled Revenues
(3,155
)
 
(4,699
)
Increase in Prepaid Income Taxes and Prepayments and Other Current Assets
(6,038
)
 
(4,270
)
(Increase) Decrease in Other Non-Current Items
1,675

 
(2,908
)
Decrease in Accounts Payable, Accrued Expenses and Other Current Liabilities
(2,760
)
 
(511
)
Total Adjustments
(3,304
)
 
(1,735
)
Net Cash and Cash Equivalents Provided by Operating Activities
19,898

 
20,891

Investing Activities:
 

 
 

Net Additions to Utility Plant Used
(36,986
)
 
(47,470
)
Cash portion of The Avon Water Company Acquisition
(6,134
)
 

Proceeds from the Sale of Land
212

 
9

Cash Acquired
1,791

 

Release of Restricted Cash

 
846

Net Cash and Cash Equivalents Used in Investing Activities
(41,117
)
 
(46,615
)
Financing Activities:
 
 
 
Net Proceeds from Interim Bank Loans
16,047

 
21,837

Net Repayment of Interim Bank Loans
(32,953
)
 
(16,085
)
Proceeds from the Issuance of Long-Term Debt
55,000

 
49,930

Costs to Issue Long-Term Debt and Common Stock
(2
)
 
(88
)
Proceeds from Issuance of Common Stock
1,044

 
1,232

Repayment of Long-Term Debt Including Current Portion
(1,866
)
 
(21,608
)
Advances from Others for Construction
983

 
301

Cash Dividends Paid
(10,324
)
 
(9,368
)
Net Cash and Cash Equivalents Provided by Financing Activities
27,929

 
26,151

Net Increase in Cash and Cash Equivalents
6,710

 
427

Cash and Cash Equivalents at Beginning of Period
1,564

 
731

Cash and Cash Equivalents at End of Period
$
8,274

 
$
1,158

Non-Cash Investing and Financing Activities:
 

 
 

Stock-for-stock acquisition of The Heritage Village Water Company
$
16,903

 
$

Stock-for-stock acquisition of The Avon Water Company
$
26,949

 
$

Non-Cash Contributed Utility Plant
$
2,349

 
$
1,045

Supplemental Disclosures of Cash Flow Information:
 
 
 
Cash Paid for:
 
 
 
Interest
$
5,669

 
$
4,410

State and Federal Income Taxes
$
392

 
$
295


The accompanying footnotes are an integral part of these condensed consolidated financial statements.

8


NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

1.
Basis of Preparation of Financials

The condensed consolidated financial statements included herein have been prepared by Connecticut Water Service, Inc. (“CTWS” or the “Company”) and its wholly-owned subsidiaries, pursuant to the rules and regulations of the Securities and Exchange Commission and reflect all adjustments that are of a normal recurring nature which are, in the opinion of management, necessary to a fair statement of the results for interim periods.  Certain information and footnote disclosures have been omitted pursuant to such rules and regulations, although the Company believes that the disclosures are adequate to make the information presented not misleading.  The Company’s primary operating subsidiaries are: The Connecticut Water Company (“Connecticut Water”), The Heritage Village Water Company (“HVWC”) and The Avon Water Company (“Avon Water”) in the State of Connecticut and The Maine Water Company (“Maine Water”) in the State of Maine. The Condensed Consolidated Balance Sheet at December 31, 2016 has been derived from the audited financial statements at that date but does not include all of the information and footnotes required by accounting principles generally accepted in the United States of America for complete financial statements.  It is suggested that these condensed consolidated financial statements be read in conjunction with the financial statements and the notes thereto included in the Company’s latest Annual Report on Form 10-K for the fiscal year ended December 31, 2016 (the “10-K”) and as updated in the Company’s Quarterly Report on Forms 10-Q for the periods ending March 31, 2017 and June 30, 2017.

The results for interim periods are not necessarily indicative of results to be expected for the year since the consolidated earnings are subject to seasonal factors.  Effective February 27, 2017 and July 1, 2017, the Company acquired HVWC and Avon Water, respectively, discussed further in Note 11 below.  As a result, the Company’s Condensed Consolidated Balance Sheet at December 31, 2016, the Condensed Consolidated Statements of Net Income, Condensed Consolidated Statements of Comprehensive Income, Condensed Consolidated Statements of Retained Earnings for the three and nine months ended September 30, 2016 and Condensed Consolidated Statements of Cash Flows for the nine months ended September 30, 2016 do not include HVWC or Avon Water.  The Condensed Consolidated Statements of Net Income, Condensed Consolidated Statements of Comprehensive Income, Condensed Consolidated Statements Retained Earnings for the three months ended September 30, 2017 and the Condensed Consolidated Statements of Net Income, Condensed Consolidated Statements of Comprehensive Income, Condensed Consolidated Statements of Retained Earnings and the Condensed Consolidated Statements of Cash Flows for the nine months ended September 30, 2017 do include HVWC’s and Avon Water’s results for the periods the Company owned HVWC and Avon Water. HVWC’s and Avon Water’s assets and liabilities are included in the Condensed Consolidated Balance Sheet as of September 30, 2017.

As noted in Note 11 below, 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. The results of the wastewater line of business are included in the Company’s Water Operations segment. Additionally, as noted in Note 11, Avon Water serves approximately 4,800 water customers in the Towns of Avon, Farmington, and Simsbury, Connecticut.

During the preparation of the Condensed Consolidated Financial Statements for the quarter ended June 30, 2016, the Company identified two errors related to the accounting treatment of stock based performance awards granted to officers of the Company. First, the Company had mistakenly classified all stock based performance awards as equity awards and, secondly, incorrectly marked those awards to the market price of the Company’s common stock price at the end of each reporting period. A portion of these awards should have been classified as liability awards and only those awards should have been marked-to-market based on the Company’s common stock price. During the second quarter of 2016, the Company reversed all of the incorrectly recorded mark-to-market expense as a cumulative out-of-period adjustment resulting in a one-time benefit of approximately $2.6 million on the Operation and Maintenance line item on its Condensed Consolidated Statements of Income for the three months ended June 30, 2016. Approximately $1.6 million of the out of period adjustment pertained to years prior to 2016, with the remaining $1.0 million related to the first quarter of 2016. Additionally, the Company decreased its Common Stock Without Par Value and increased its Long-Term Compensation Arrangement line items on the Condensed Consolidated Balance Sheet as of June 30, 2016 by approximately $0.6 million to reflect both the awards that should have been classified as liability awards and their corresponding mark-to-market adjustments.


9

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

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 September 30, 2017, were 9.75% and 7.32%, respectively. HVWC’s blended water and wastewater allowed return on equity and return on rate base, effective September 30, 2017, were 10.10% and 7.19%, respectively. Avon Water’s allowed return on equity and return on rate base, effective September 30, 2017, were 10.00% and 7.79%, respectively. Maine Water’s average allowed return on equity and return on rate base, effective September 30, 2017, 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. Each of Connecticut Water, HVWC, Avon Water and Maine Water are allowed to add surcharges to customers’ bills in order to recover certain costs associated with 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. HVWC has not added surcharges to customers’ bills in order to recover certain approved capital projects as of September 30, 2017, however, HVWC, as authorized by PURA, began to utilize Water Revenue Adjustments as of March 31, 2017.

Maine Water Land Sale
On March 11, 2016, Maine Water entered into a purchase and sale agreement with the Coastal Mountains Land Trust, a Maine nonprofit corporation (the “Land Trust”) pursuant to which Maine Water agreed to sell two conservation easements to the Land Trust on approximately 1,300 acres of land located in the towns of Rockport, Camden and Hope, in Knox County, Maine valued in the aggregate at $3.1 million.  The land had a book value of approximately $600,000 at September 30, 2017 and December 31, 2016 and is included in “Utility Plant” on the Company’s “Condensed Consolidated Balance Sheets”. The easements and purchase prices are as follows:

1.Ragged Mountain Mirror Lake Conservation Easement: $1,875,000; and
2.Grassy Pond Conservation Easement: $600,000.

On October 13, 2017, an amendment to the agreement was made to extend closing of the first transaction to June 30, 2018, from December 31, 2017. This is also expected to extend the second closing into 2020.  Maine Water will make a $200,000 contribution to the Land Trust upon completion of the closing of the first easement sale.  Maine Water also expects to claim a charitable deduction for the $600,000 in excess of the fair market value of the second easement over the $600,000 sale price.

Connecticut Rates
Connecticut Water’s Water Infrastructure Conservation Adjustment (“WICA”) was 8.25% and 3.04% at September 30, 2017 and 2016, respectively. On July 26, 2017, Connecticut Water filed a WICA application with the PURA requesting a 1.56% surcharge to customers’ bills, representing approximately $8.2 million in WICA related projects. On September 20, 2017, PURA approved the Company’s filing. Effective October 1, 2017, Connecticut Water’s cumulative WICA surcharge was 9.81%. As of September 30, 2017, Avon Water’s WICA surcharge was 8.09%. As of September 30, 2017, HVWC has not filed for a WICA surcharge.

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 and HVWC’s allowed revenues for the nine months ended September 30, 2017, as approved by PURA during each company’s most recent general rate case and including subsequently approved WICA surcharges, are approximately $62.3 million. Through normal billing for the nine months ended September 30, 2017, revenue for Connecticut Water and HVWC would have been approximately $56.8 million had the WRA not been implemented. As a result of the implementation of the WRA, Connecticut Water and HVWC recorded $5.5 million in additional revenue for the nine months ended September 30, 2017. Avon Water does not currently use the WRA mechanism.


10

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

Maine Rates
In Maine, the overall, cumulative Water Infrastructure Charge (“WISC”) for all divisions was 6.47% and 4.08% as of September 30, 2017 and 2016, respectively.

On June 29, 2017, Maine Water filed for a rate increase in its Biddeford and Saco division. The rate request is for an approximate $1.6 million, or 25.1%, increase in revenues. The rate request is to recover higher operating expenses, depreciation and property taxes since Biddeford and Saco’s last rate increase in 2015. The Company expects a final decision to be issued by the MPUC in the fourth quarter of 2017 with new rates to be effective as of December 1, 2017.

A 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 outside of the Biddeford and Saco division due to various agreements with the MPUC, but is evaluating how and when this new mechanism can be implemented in the future.

2.
Pension and Other Post-Retirement Benefits

The following tables set forth the components of pension and other post-retirement benefit costs for the three and nine months ended September 30, 2017 and 2016.

Pension Benefits
Components of Net Periodic Cost (in thousands):
 
Three Months
 
Nine Months
Period ended September 30,
2017
 
2016
 
2017
 
2016
Service Cost
$
482

 
$
474

 
$
1,446

 
$
1,421

Interest Cost
800

 
803

 
2,400

 
2,409

Expected Return on Plan Assets
(1,073
)
 
(1,020
)
 
(3,218
)
 
(3,060
)
Amortization of:
 

 
 

 
 
 
 
Prior Service Cost
4

 
4

 
12

 
12

Net Recognized Loss
517

 
512

 
1,548

 
1,537

Net Periodic Benefit Cost
$
730

 
$
773

 
$
2,188

 
$
2,319


The Company made a total contribution of approximately $2,971,000 in 2017 for the 2016 plan year during the nine months ended September 30, 2017.

Post-Retirement Benefits Other Than Pension (PBOP)
Components of Net Periodic Cost (in thousands):
 
Three Months
 
Nine Months
Period ended September 30,
2017
 
2016
 
2017
 
2016
Service Cost
$
85

 
$
94

 
$
252

 
$
282

Interest Cost
128

 
135

 
384

 
406

Expected Return on Plan Assets
(89
)
 
(86
)
 
(266
)
 
(256
)
Other
57

 
57

 
169

 
169

Amortization of:
 

 
 

 
 
 
 
Prior Service Credit
(46
)
 
(100
)
 
(136
)
 
(300
)
Recognized Net (Gain) Loss
(20
)
 
8

 
(60
)
 
27

Net Periodic Benefit Cost
$
115

 
$
108

 
$
343

 
$
328



11

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

3.
Earnings per Share

Earnings per weighted average common share are calculated by dividing net income applicable to common stock by the weighted average number of shares of common stock outstanding during the respective periods as detailed below (diluted shares include the effect of stock awards):

Three months ended September 30,
2017
 
2016
Common Shares Outstanding End of Period
12,068,299

 
11,240,417

Weighted Average Shares Outstanding (Days Outstanding Basis):
 

 
 

Basic
11,816,553

 
11,014,002

Diluted
12,041,432

 
11,233,375

 
 
 
 
Basic Earnings per Share
$
0.92

 
$
0.86

Dilutive Effect of Stock Awards
(0.02
)
 
(0.02
)
Diluted Earnings per Share
$
0.90

 
$
0.84

 
 
 
 
Nine months ended September 30,
 
 
 
Weighted Average Shares Outstanding (Days Outstanding Basis):
 
 
 
Basic
11,435,545

 
11,003,644

Diluted
11,660,674

 
11,222,588

 
 
 
 
Basic Earnings per Share
$
2.03

 
$
2.05

Dilutive Effect of Stock Awards
(0.04
)
 
(0.04
)
Diluted Earnings per Share
$
1.99

 
$
2.01


Total unrecognized compensation expense for all stock awards was approximately $0.2 million as of September 30, 2017 and will be recognized over a weighted average period of 1.3 years.


12

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

4.
Recently Adopted and New Accounting Pronouncements

In May 2014, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2014-09, “Revenue from Contracts with Customers,” (“No. 2014-09”) which amends its guidance related to revenue recognition. ASU No. 2014-09 requires an entity to recognize revenue as performance obligations are met, in order to reflect the transfer of promised goods or services to customers in an amount that reflects the consideration the entity is entitled to receive for those goods or services. The following steps are applied in the updated guidance: (1) identify the contract(s) with a customer; (2) identify the performance obligations in the contract; (3) determine the transaction price; (4) allocate the transaction price to the performance obligations in the contract; and (5) recognize revenue when, or as, the entity satisfies a performance obligation. ASU No. 2014-09 is effective for public companies for fiscal years, and interim periods within those years, beginning after December 15, 2016, and can be adopted either retrospectively to each prior reporting period presented or as a cumulative-effect adjustment as of the date of adoption, however early adoption is not permitted. On April 1, 2015, the FASB voted for a one-year deferral of the effective date of ASU No. 2014-09, making ASU No. 2014-09 effective for public companies for fiscal years, and interim periods within those years, beginning after December 15, 2017. The Company has been engaged in a project to analyze the impact that adoption of this standard will have on our consolidated financial statements, disclosures, and internal controls. The project includes identification of the Company’s revenue streams, creation of an inventory of its contracts with customers, evaluation of a representative sample of these contracts with respect to the new guidance and documentation of any required changes in reporting. The Company derives more than 90% of its revenue from regulated delivery of water to its retail customers. The majority of the remainder of the Company’s revenue is derived from contract operations and unregulated revenues generated from its Linebacker program. Certain of the identified revenue streams are judgmental in nature. The Company has determined that revenue generated from the attachment of telecommunications equipment to its facilities through leases with third parties is outside the scope of the new guidance. In 2017, the American Institute of Certified Public Accountants (AICPA) power and utility entities revenue recognition task force has determined that contributions in aid of construction are not in the scope of the new standard, and submitted its determination to the AICPA’s revenue recognition working group for approval. The Company does not believe that the impact of adoption of the new guidance will result in a material change in the measurement and timing of recognition of its revenues based on our current interpretations of the new guidance. The Company’s assessments are preliminary and subject to change pending completion of its review of the guidance and its impact on the Company’s contracts with customers. The Company has not made a final decision on the transition method, but currently anticipates using the modified retrospective approach when it implements the new guidance on January 1, 2018.

In July 2015, the FASB issued ASU 2015-11, “Inventory (Topic 330): Simplifying the Measurement of Inventory,” (“ASU No. 2015-11”) which applies to inventory that is measured using first-in, first-out (“FIFO”) or average cost. Under the updated guidance, an entity should measure inventory that is within scope at the lower of cost or net realizable value, which is the estimated selling price in the ordinary course of business, less reasonably predictable costs of completion, disposal and transportation. Subsequent measurement is unchanged under the updated guidance for inventory that is measured using last-in, last-out (“LIFO”). This ASU is effective for annual and interim periods beginning after December 15, 2016, and should be applied prospectively with early adoption permitted at the beginning of an interim or annual reporting period. The Company uses average cost to value its inventory and, therefore, ASU No. 2015-11 did not have an impact on the Company.

In February 2016, the FASB issued ASU No. 2016-02, “Leases (Topic 842)”, (“ASU No. 2016-02”), which will require lessees to recognize the following for all leases at the commencement date of a lease: a) a lease liability, which is a lessee’s obligation to make lease payments arising from a lease, measured on a discounted basis; and b) a right-of-use asset, which is an asset that represents the lessee’s right to use, or control the use of, a specified asset for the lease term. Public business entities should apply the amendments in ASU No. 2016-02 for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. Early application is permitted for all public business entities and all nonpublic business entities upon issuance. Lessees (for capital and operating leases) and lessors (for sales-type, direct financing, and operating leases) must apply a modified retrospective transition approach for leases existing at, or entered into after, the beginning of the earliest comparative period presented in the financial statements. The modified retrospective approach would not require any transition accounting for leases that expired before the earliest comparative period presented. Lessees and lessors may not apply a full retrospective transition approach. The Company is currently assessing the impact of this standard on its consolidated financial statements and footnote disclosures, but does not expect that the adoption of this guidance will materially impact our consolidated financial position.

In August 2016, the FASB issued ASU No. 2016-15, “Classification of Certain Cash Receipts and Cash Payments” (“ASU No. 2016-15”). The amendments ASU No. 2016-15 clarify the classification for eight different types of activities, including debt prepayment and extinguishment costs, proceeds from insurance claims and distributions from equity method investees. For public business entities, ASU No. 2016-15 is effective for financial statements issued for fiscal years beginning after December 15, 2017. The Company is currently assessing the impact of this standard on its Consolidated Statements of Cash Flows, but

13

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

does not expect that the adoption of this guidance will materially impact our consolidated financial position or results of operation.

In March 2017, the FASB issued ASU 2017-07, "Compensation - Retirement Benefits (Topic 715): Improving the Presentation of Net Periodic Pension Cost and Net Periodic Postretirement Benefit Cost," (“ASU 2017-07”) which amends the requirements related to the income statement presentation of the components of net periodic benefit cost for employer sponsored defined benefit pension and other postretirement benefit plans. Under ASU 2017-07, an entity must disaggregate and present the service cost component of net periodic benefit cost in the same income statement line item as other employee compensation costs arising from services rendered during the period, and only the service cost component will be eligible for capitalization. Other components of net periodic benefit cost will be presented separately from the line item that includes the service cost. The new standard is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2017. Early adoption is permitted at the beginning of an annual period in which the financial statements have not been issued. Entities must use a retrospective transition method to adopt the requirement for separate presentation of the income statement service cost and other components, and a prospective transition method to adopt the requirement to limit the capitalization of benefit cost to the service component. The Company is currently evaluating the impact of adopting this guidance.


14

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

5.
Accumulated Other Comprehensive Income

The changes in Accumulated Other Comprehensive Income (Loss) (“AOCI”) by component, net of tax, for the three months ended September 30, 2017 and 2016 are as follows (in thousands):
Three months ended September 30, 2017
 
Unrealized Gains on Investments
 
Defined Benefit Items
 
Total
Beginning Balance (a)
 
$
328

 
$
(1,063
)
 
$
(735
)
Other Comprehensive Income Before Reclassification
 
(2
)
 

 
(2
)
Amounts Reclassified from AOCI
 
28

 
48

 
76

Net current-period Other Comprehensive Income
 
26

 
48

 
74

Ending Balance
 
$
354

 
$
(1,015
)
 
$
(661
)
 
 
 
 
 
 
 
Three months ended September 30, 2016
 
Unrealized Gains on Investments
 
Defined Benefit Items
 
Total
Beginning Balance (a)
 
$
187

 
$
(1,057
)
 
$
(870
)
Other Comprehensive (Loss) Income Before Reclassification
 
46

 

 
46

Amounts Reclassified from AOCI
 

 
39

 
39

Net current-period Other Comprehensive (Loss) Income
 
46

 
39

 
85

Ending Balance
 
$
233

 
$
(1,018
)
 
$
(785
)
 
 
 
 
 
 
 
Nine months ended September 30, 2017
 
Unrealized Gains on Investments
 
Defined Benefit Items
 
Total
Beginning Balance (a)
 
$
235

 
$
(1,159
)
 
$
(924
)
Other Comprehensive Income Before Reclassification
 
83

 

 
83

Amounts Reclassified from AOCI
 
36

 
144

 
180

Net current-period Other Comprehensive Income
 
119

 
144

 
263

Ending Balance
 
$
354

 
$
(1,015
)
 
$
(661
)
 
 
 
 
 
 
 
Nine months ended September 30, 2016
 
Unrealized Gains on Investments
 
Defined Benefit Items
 
Total
Beginning Balance (a)
 
$
200

 
$
(1,135
)
 
$
(935
)
Other Comprehensive (Loss) Income Before Reclassification
 
23

 

 
23

Amounts Reclassified from AOCI
 
10

 
117

 
127

Net current-period Other Comprehensive (Loss) Income
 
33

 
117

 
150

Ending Balance
 
$
233

 
$
(1,018
)
 
$
(785
)
 
 
 
 
 
 
 
(a) All amounts shown are net of tax. Amounts in parentheses indicate loss.


15

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

The following table sets forth the amounts reclassified from AOCI by component and the affected line item on the Condensed Consolidated Statements of Income for the three months ended September 30, 2017 and 2016 (in thousands):
Details about Other AOCI Components
 
Amounts Reclassified from AOCI Three Months Ended September 30, 2017(a)
 
Amounts Reclassified from AOCI Three Months Ended September 30, 2016(a)
 
Affected Line Items on Income Statement
Realized Gains on Investments
 
$
47

 
$

 
Other Income
Tax expense
 
(19
)
 

 
Other Income
 
 
28

 

 
 
 
 
 
 
 
 
 
Amortization of Recognized Net Gain from Defined Benefit Items
 
78

 
64

 
Other Income (b)
Tax expense
 
(30
)
 
(25
)
 
Other Income
 
 
48

 
39

 
 
 
 
 
 
 
 
 
Total Reclassifications for the period, net of tax
 
$
76

 
$
39

 
 
 
 
 
 
 
 
 
Details about Other AOCI Components
 
Amounts Reclassified from AOCI Nine Months Ended September 30, 2017(a)
 
Amounts Reclassified from AOCI Nine Months Ended September 30, 2016(a)
 
Affected Line Items on Income Statement
Realized Gains on Investments
 
$
60

 
$
17

 
Other Income
Tax expense
 
(24
)
 
(7
)
 
Other Income
 
 
36

 
10

 
 
 
 
 
 
 
 
 
Amortization of Recognized Net Gain from Defined Benefit Items
 
235

 
192

 
Other Income (b)
Tax expense
 
(91
)
 
(75
)
 
Other Income
 
 
144

 
117

 
 
 
 
 
 
 
 
 
Total Reclassifications for the period, net of tax
 
$
180

 
$
127

 
 
 
 
 
 
 
 
 
(a) Amounts in parentheses indicate loss/expense.
(b) Included in computation of net periodic pension cost (see Note 2 for additional details).


16

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

6.
Long-Term Debt

Long-Term Debt at September 30, 2017 and December 31, 2016 consisted of the following (in thousands):
 
2017
 
2016
4.09%
 
CTWS
Term Loan Note
$
12,632

 
$
13,437

4.15%
 
CTWS
CoBank Term Note Payable, Due 2037
15,000

 

Total CTWS
27,632

 
13,437

Var.
 
Connecticut Water
2004 Series Variable Rate, Due 2029
12,500

 
12,500

Var.
 
Connecticut Water
2004 Series A, Due 2028
5,000

 
5,000

Var.
 
Connecticut Water
2004 Series B, Due 2028
4,550

 
4,550

5.00%
 
Connecticut Water
2011 A Series, Due 2021
22,969

 
23,115

3.16%
 
Connecticut Water
CoBank Note Payable, Due 2020
8,000

 
8,000

3.51%
 
Connecticut Water
CoBank Note Payable, Due 2022
14,795

 
14,795

4.29%
 
Connecticut Water
CoBank Note Payable, Due 2028
17,020

 
17,020

4.72%
 
Connecticut Water
CoBank Note Payable, Due 2032
14,795

 
14,795

4.75%
 
Connecticut Water
CoBank Note Payable, Due 2033
14,550

 
14,550

4.36%
 
Connecticut Water
CoBank Note Payable, Due May 2036
30,000

 
30,000

4.04%
 
Connecticut Water
CoBank Note Payable, Due July 2036
19,930

 
19,930

3.53%
 
Connecticut Water
NY Life Senior Note, Due September 2037
35,000

 

Total Connecticut Water
199,109

 
164,255

4.75%
 
HVWC
2011 Farmington Bank Loan, Due 2034
4,504

 

3.05%
 
Avon Water
Mortgage Note Payable, due 2033
3,343

 

8.95%
 
Maine Water
1994 Series G, Due 2024
7,200

 
7,200

2.68%
 
Maine Water
1999 Series J, Due 2019
170

 
254

0.00%
 
Maine Water
2001 Series K, Due 2031
574

 
615

2.58%
 
Maine Water
2002 Series L, Due 2022
60

 
67

1.53%
 
Maine Water
2003 Series M, Due 2023
321

 
341

1.73%
 
Maine Water
2004 Series N, Due 2024
341

 
371

0.00%
 
Maine Water
2004 Series O, Due 2034
113

 
120

1.76%
 
Maine Water
2006 Series P, Due 2026
361

 
391

1.57%
 
Maine Water
2009 Series R, Due 2029
207

 
217

0.00%
 
Maine Water
2009 Series S, Due 2029
538

 
583

0.00%
 
Maine Water
2009 Series T, Due 2029
1,509

 
1,634

0.00%
 
Maine Water
2012 Series U, Due 2042
148

 
154

1.00%
 
Maine Water
2013 Series V, Due 2033
1,310

 
1,335

2.52%
 
Maine Water
CoBank Note Payable, Due 2017
1,965

 
1,965

4.24%
 
Maine Water
CoBank Note Payable, Due 2024
4,500

 
4,500

4.18%
 
Maine Water
CoBank Note Payable, Due 2026
5,000

 

7.72%
 
Maine Water
Series L, Due 2018
2,250

 
2,250

2.40%
 
Maine Water
Series N, Due 2022
1,026

 
1,101

1.86%
 
Maine Water
Series O, Due 2025
750

 
790

2.23%
 
Maine Water
Series P, Due 2028
1,264

 
1,294

0.01%
 
Maine Water
Series Q, Due 2035
1,678

 
1,771

1.00%
 
Maine Water
Series R, Due 2025
2,010

 
2,250

Various
 
Maine Water
Various Capital Leases
3

 
8

Total Maine Water
33,298

 
29,211

Add: Acquisition Fair Value Adjustment
196

 
321

Less: Current Portion
(7,950
)
 
(4,859
)
Less: Unamortized Debt Issuance Expense
(4,939
)
 
(5,318
)
Total Long-Term Debt
$
255,193

 
$
197,047


There are no mandatory sinking fund payments required on Connecticut Water’s outstanding bonds.  However, certain fixed rate Unsecured Water Facilities Revenue Refinancing Bonds provide for an estate redemption right whereby the estate of

17

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

deceased bondholders or surviving joint owners may submit bonds to the trustee for redemption at par, subject to a $25,000 per individual holder and a 3% annual aggregate limitation.

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 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.

On August 28, 2017, the Company executed and delivered to CoBank a new Promissory Note and Supplement (2017 Single Advance Term Loan) (the “2017 Promissory Note”). On the terms and subject to the conditions set forth in the 2017 Promissory Note issued pursuant to the Company’s Master Loan Agreement, CoBank agreed to make a term loan (the “Loan”) to the Company in the principal amount of $15,000,000. Under the 2017 Promissory Note, the Company will pay interest on the Loan at a fixed rate of 4.15% per year through August 20, 2037, the maturity date of the Loan.

On September 28, 2017, Connecticut Water completed the issuance of $35,000,000 aggregate principal amount of its 3.53% unsecured Senior Notes due September 25, 2037 (the “Senior Notes”). The Senior Notes were issued pursuant to the Note Purchase Agreement dated as of September 28, 2017 (the “Purchase Agreement”) between and among Connecticut Water, NYL Investors, LLC (“NY Life”), as agent, and the Purchasers listed in the Purchaser Schedule attached to the Purchase Agreement, in a private placement financing exempt from registration pursuant to Section 4(a)(2) of the Securities Act of 1933, as amended. The proceeds of the sale of the Senior Notes will be used by Connecticut Water to repay loans from the Company the proceeds of which were used for capital expenditure projects by Connecticut Water. The Senior Notes bear interest at the rate of 3.53% per annum, payable semi-annually on March 27 and September 27 of each year commencing on March 27, 2018. The principal amount of the Senior Notes, if not previously paid, shall be due on September 25, 2037. The Senior Notes are callable in whole or in part, subject to a make-whole amount.

During the first nine months of 2017, the Company paid approximately $805,000 related to Connecticut Water Service’s Term Note Payable issued as part of the 2012 acquisition of Maine Water, approximately $913,000 in sinking funds related to Maine Water’s outstanding bonds, approximately $95,000 in sinking funds related to HVWC’s bank loan and $53,000 related to Avon Water’s mortgage note payable.

Financial Covenants – The Company and its subsidiaries are required to comply with certain covenants in connection with various long term loan agreements.  The most restrictive of these covenants is to maintain a consolidated debt to capitalization ratio of not more than 60%. Additionally, Maine Water has restrictions on cash dividends paid based on restricted net assets. The Company and its subsidiaries were in compliance with all covenants at September 30, 2017.

7.
Fair Value Disclosures

FASB Accounting Standards Codification (“ASC”) 820, Fair Value Measurements and Disclosures (“FASB ASC 820”) provides enhanced guidance for using fair value to measure assets and liabilities and expands disclosure with respect to fair value measurements.

FASB ASC 820 establishes a fair value hierarchy that distinguishes between assumptions based on market data (observable inputs) and the Company’s assumptions (unobservable inputs).  The hierarchy consists of three broad levels, as follows:

Level 1 – Quoted market prices in active markets for identical assets or liabilities.
Level 2 – Inputs other than Level 1 that are either directly or indirectly observable.

18

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

Level 3 – Unobservable inputs developed using the Company’s estimates and assumptions, which reflect those that the Company believes market participants would use.

The following table summarizes our financial instruments measured at fair value on a recurring basis within the fair value hierarchy as of September 30, 2017 (in thousands):
 
Level 1
 
Level 2
 
Level 3
 
Total
Asset Type:
 
 
 
 
 
 
 
Money Market Fund
$
69

 
$

 
$

 
$
69

Mutual Funds:
 

 
 

 
 

 
 

Equity Funds (1)
1,991

 

 

 
1,991

Fixed Income Funds (2)
642

 

 

 
642

Total
$
2,702

 
$

 
$

 
$
2,702


The following table summarizes our financial instruments measured at fair value on a recurring basis within the fair value hierarchy as of December 31, 2016 (in thousands):
 
Level 1
 
Level 2
 
Level 3
 
Total
Asset Type:
 
 
 
 
 
 
 
Money Market Fund
$
122

 
$

 
$

 
$
122

Mutual Funds:
 

 
 

 
 

 
 

Equity Funds (1)
1,662

 

 

 
1,662

Fixed Income Funds (2)
534

 

 

 
534

Total
$
2,318

 
$

 
$

 
$
2,318

(1)
Mutual funds consist primarily of equity securities and are presented on the Other Property and Investments line item of the Company’s Condensed Consolidated Balance Sheets.
(2)
Mutual funds consist primarily of fixed income securities and are presented on the Other Property and Investments line item of the Company’s Condensed Consolidated Balance Sheets.

The following methods and assumptions were used to estimate the fair value of each of the following financial instruments, which are not recorded at fair value on the financial statements.

Cash and cash equivalents – Cash equivalents consist of highly liquid instruments with original maturities at the time of purchase of three months or less.  The carrying amount approximates fair value.  Under the fair value hierarchy the fair value of cash and cash equivalents is classified as a Level 1 measurement.

Company Owned Life Insurance – The fair value of Company Owned Life Insurance is based on the cash surrender value of the contracts. These contracts are based principally on a referenced pool of investment funds that actively redeem shares and are observable and measurable and are presented on the “Other Property and Investments” line item of the Company’s Consolidated Balance Sheets. The value of Company Owned Life Insurance at September 30, 2017 and December 31, 2016 was $3,351,000 and $3,075,000, respectively.

Long-Term Debt – The fair value of the Company’s fixed rate long-term debt is based upon borrowing rates currently available to the Company.  As of September 30, 2017 and December 31, 2016, the estimated fair value of the Company’s long-term debt was $276,706,000 and $210,463,000, respectively, as compared to the carrying amounts of $260,132,000 and $202,365,000, respectively. The estimated fair value of long term debt was calculated using a discounted cash flow model that uses comparable interest rates and yield curve data based on the A-rated MMD (Municipal Market Data) Index which is a benchmark of current municipal bond yields. Under the fair value hierarchy, the fair value of long term debt is classified as a Level 2 measurement.

Advances for Construction – Customer advances for construction had a carrying amount of $20,783,000 and $19,127,000 at September 30, 2017 and December 31, 2016, respectively. Their relative fair values cannot be accurately estimated since future refund payments depend on several variables, including new customer connections, customer consumption levels and future rate increases.

The fair values shown above have been reported to meet the disclosure requirements of FASB ASC 825, “Financial Instruments” (“FASB ASC 825”) and do not purport to represent the amounts at which those obligations would be settled.

19

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)


8.
Segment Reporting

The Company operates principally in three business segments: Water Operations, Real Estate Transactions, and Services and Rentals. Financial data for the segments is as follows (in thousands):
Three months ended September 30, 2017
Segment
 
Revenues
 
Pre-Tax Income
 
Income Tax Expense (Benefit)
 
Net Income
Water Operations
 
$
32,252

 
$
10,500

 
$
36

 
$
10,464

Real Estate Transactions
 

 

 

 

Services and Rentals
 
1,256

 
465

 
213

 
252

Total
 
$
33,508

 
$
10,965

 
$
249

 
$
10,716

Three months ended September 30, 2016
Segment
 
Revenues
 
Pre-Tax Income
 
Income Tax Expense
 
Net Income
Water Operations
 
$
29,791

 
$
10,529

 
$
1,177

 
$
9,352

Real Estate Transactions
 
8

 
4

 
2

 
2

Services and Rentals
 
1,419

 
573

 
392

 
181

Total
 
$
31,218

 
$
11,106

 
$
1,571

 
$
9,535

Nine months ended September 30, 2017
Segment
 
Revenues
 
Pre-Tax Income
 
Income Tax Expense (Benefit)
 
Net Income
Water Operations
 
$
83,258

 
$
21,112

 
$
(1,215
)
 
$
22,327

Real Estate Transactions
 
212

 
55

 
22

 
33

Services and Rentals
 
3,745

 
1,461

 
619

 
842

Total
 
$
87,215

 
$
22,628

 
$
(574
)
 
$
23,202

Nine months ended September 30, 2016
Segment
 
Revenues
 
Pre-Tax Income
 
Income Tax Expense
 
Net Income
Water Operations
 
$
78,022

 
$
23,652

 
$
2,010

 
$
21,642

Real Estate Transactions
 
8

 
4

 
2

 
2

Services and Rentals
 
3,862

 
1,673

 
691

 
982

Total
 
$
81,892

 
$
25,329

 
$
2,703

 
$
22,626


The revenues shown in Water Operations above consisted of revenues from water customers of $31,199,000 and $29,477,000 for the three months ended September 30, 2017 and 2016, respectively, and wastewater revenues of $598,000 for the three months ended September 30, 2017. There were no wastewater revenues in 2016. Additionally, there were revenues associated with utility plant leased to others of $455,000 and $314,000 for the three months ended September 30, 2017 and 2016, respectively. The revenues from water and wastewater customers for the three months ended September 30, 2017 and 2016 include $1,989,000 and $81,000 in additional revenues related to the application of the WRA, respectively. The revenues shown in Water Operations above consisted of revenues from water customers of $80,843,000 and $77,084,000 for the nine months ended September 30, 2017 and 2016, respectively, and wastewater revenues of $1,319,000 for the nine months ended September 30, 2017. There were no wastewater revenues in 2016. Additionally, there were revenues associated with utility plant leased to others of $1,096,000 and $938,000 for the nine months ended September 30, 2017 and 2016, respectively. The revenues from water and wastewater customers for the nine months ended September 30, 2017 and 2016 include $5,542,000 and $2,867,000 in additional revenues related to the application of the WRA, respectively.

The Company owns various small, discrete parcels of land that are no longer required for water supply purposes.  From time to time, the Company may sell or donate these parcels, depending on various factors, including the current market for land, the amount of tax benefits received for donations and the Company’s ability to use any benefits received from donations.

20

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)


Assets by segment (in thousands):
 
September 30, 2017
 
December 31, 2016
Total Plant and Other Investments:
 
 
 
Water Operations
$
693,037

 
$
609,508

Non-Water
1,025

 
959

 
694,062

 
610,467

Other Assets:
 
 
 
Water Operations
237,224

 
171,674

Non-Water
8,090

 
2,361

 
245,314

 
174,035

Total Assets
$
939,376

 
$
784,502


9.
Income Taxes

FASB ASC 740 Income Taxes (“FASB ASC 740”) addresses the determination of how tax benefits claimed or expected to be claimed on a tax return should be recorded in the financial statements. Under FASB ASC 740, the Company must recognize the tax benefit from an uncertain tax position only if it is more likely than not that the tax position will be sustained on examination by the taxing authorities, based on the technical merits of the position. The tax benefits recognized in the financial statements from such a position are measured based on the largest benefit that has a greater than 50% likelihood of being realized upon ultimate resolution.

The Company adopted the Internal Revenue Service (“IRS”) temporary tangible property regulations on the Company’s 2012 Federal tax return. Since that time, the Company has been recording a provision for any possible disallowance of a portion of the repair deduction if the deductions were unable to be sustained on audit by the IRS. While the Company believes that the deductions taken on its tax returns are appropriate, the methodology for determining the deduction has not been agreed to by the taxing authorities.  During the Company’s review of the position through the quarter ended March 31, 2017, new information caused management to reassess the previously recorded provision. This reassessment resulted in the reversal of a portion of the provision related to the Maine subsidiary, in the amount of $1,164,000 in the first quarter of 2017. During the Company’s review of its position through the quarter ended June 30, 2017, the impact of new information on Connecticut Water caused management to reassess the previously recorded provision. The reassessment resulted in the reversal of a portion of the provision in the amount of $2,445,000. During the quarter ending September 30, 2017, the portion of the provision related to the tax year ending December 31, 2013, in the amount of $810,000, was reversed due to statute expiration. For the nine months ended September 30, 2017, the Company has recorded, as required by FASB ASC 740, a provision of $1,085,000 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 $9.4 million in the prior year for a cumulative total of $6.1 million.

From time to time, the Company may be assessed interest and penalties by taxing authorities.  In those cases, the charges would appear on the Other line item within the Other Income (Deductions), Net of Taxes section of the Company’s Condensed Consolidated Statements of Income.  There were no such charges for the nine months ended September 30, 2017 and 2016.  Additionally, there were no accruals relating to interest or penalties as of September 30, 2017 and December 31, 2016.  The Company remains subject to examination by federal tax authorities for the 2014 through 2016 tax years; the State of Maine’s tax authorities for the 2014 through 2016 tax years; and the State of Connecticut’s tax authorities for the 2014 through 2016 tax years. On April 26, 2017, Avon Water was notified by the IRS that its stand-alone Federal tax filing for 2015 was selected to be reviewed beginning in the second quarter of 2017.  The Company believes that the deductions taken on Avon Water’s tax return are appropriate, therefore no provision was recorded during the quarter ended September 30, 2017 as required by FASB ASC 740.

The Company is currently engaged in an analysis to determine the amount of expenditures related to tangible property that will be reflected on its 2017 Federal Tax Return to be filed in September 2018.  As a result, through the third quarter of 2017, the Company has estimated the portion of its infrastructure investment that will qualify as a repair deduction for 2017 and has reflected that deduction in its effective tax rate, net of any reserves.  Consistent with other differences between book and tax expenditures, the Company is required to use the flow-through method to account for any timing differences not required by the IRS to be normalized.


21

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

The Company’s effective income tax rate for the three months ended September 30, 2017 and 2016 was 2.3% and 14.1%, respectively. The Company’s effective tax rate, excluding discrete items recorded during the three months ended September 30, 2017 and 2016, was 0.1% and 7.0%, respectively. In 2017, these discrete items include adjustments related to uncertain tax positions for the repair deduction in Connecticut and a change in estimate of prior year tax expense. In 2016, these discrete items include adjustments related to uncertain tax positions for the repair deduction in both Connecticut and Maine and a change in estimate of prior year tax expense. Excluding discrete items, there was a decrease in the effective tax rate year over year for the three month period of approximately 7%. The decrease in the effective tax rate for this period can be attributed to a higher tax deductible pension contribution in 2017 than in 2016, offset partially by a lower estimated repair deduction in 2017 than in 2016. The blended Federal and State statutory income tax rates during each period were 41%. The Company’s effective income tax rate for the nine months ended September 30, 2017 and 2016 was (2.5)% and 10.7%, respectively. The Company’s effective tax rate, excluding discrete items recorded during the nine months ended September 30, 2017 and 2016, was 9.2% and 4.0%, respectively. In 2017, these discrete items include adjustments related to uncertain tax positions for the repair deduction in both Connecticut and Maine. In 2016, these discrete items include adjustments related to uncertain tax positions for the repair deduction in both Connecticut and Maine and a change in estimate of prior year tax expense. Excluding discrete items, there was an increase in the effective tax rate year over year for the nine month period of approximately 5%. The increase in the effective tax rate for this period can be attributed to a lower estimated repair deduction in 2017 than in 2016, offset partially by a higher tax deductible pension contribution in 2017 when compared to 2016. The blended Federal and State statutory income tax rates during each period were 41%. In determining its annual estimated effective tax rate for interim periods, the Company reflects its estimated permanent and flow-through tax differences for the taxable year, including the basis difference for the adoption of the tangible property regulations.

10.
Lines of Credit

As of September 30, 2017, the Company maintained a $15.0 million line of credit agreement with CoBank, that is currently scheduled to expire on July 1, 2020.  The Company maintained an additional line of credit of $45.0 million with Citizens Bank, N.A., with an expiration date of April 25, 2021.  Additionally, Avon Water maintains a $3.0 million line of credit with Northwest Community Bank, with an expiration date of September 30, 2018. As of September 30, 2017, the total lines of credit available to the Company were $63.0 million.  As of September 30, 2017 and December 31, 2016, the Company had $18.5 million and $33.0 million, respectively, of Interim Bank Loans Payable. As of September 30, 2017, the Company had $44.5 million in unused lines of credit.  Interest expense charged on lines of credit will fluctuate based on market interest rates.

11.    Acquisition

The Heritage Village Water Company Acquisition
As previously reported, on May 10, 2016, the Company announced that it had reached an agreement to acquire 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 Agreement and Plan of Merger dated May 10, 2016 between and among HVWC, the Company, and HAC, Inc., the Company’s wholly-owned Connecticut 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.

The acquisition was executed through a stock-for-stock merger transaction valued at approximately $16.9 million. Holders of HVWC common stock received shares of the Company’s common stock in a tax-free exchange. In addition, the transaction reflected a total enterprise value of HVWC of approximately $21.5 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 the Companys’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 promptly by the issuance of a letter of transmittal and related materials by Connecticut Water’s exchange agent.


22

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

The Avon Water Company Acquisition
As previously reported, on October 12, 2016, the Company announced that it had reached an agreement to acquire Avon Water, pending a vote of Avon Water shareholders, approval by PURA and the MPUC and the satisfaction of other various closing conditions, pursuant to the terms of that certain Agreement and Plan of Merger dated October 11, 2016 as amended on March 29, 2017 between and among Avon Water, the Company, and WC-A I, Inc., the Company’s wholly-owned Connecticut subsidiary (the “Merger Agreement”). Avon Water serves approximately 4,800 customers in the Farmington Valley communities of Avon, Farmington, and Simsbury, Connecticut.

On February 10, 2017, Connecticut Water received regulatory approval from MPUC and on April 12, 2017, Connecticut Water received regulatory approval from the PURA to proceed with the transaction. The shareholders of Avon Water voted to approve the acquisition at a special meeting of Avon Water’s shareholders held on June 16, 2017.

Effective July 1, 2017, the Company completed the acquisition of Avon Water by completing the merger of Connecticut Water’s wholly-owned subsidiary WC-A I, Inc. with and into Avon Water, with Avon Water 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 Avon Water’s 122,289 issued and outstanding shares of common stock became entitled to receive the following merger consideration for each share of Avon Water common stock held: (i) a cash payment of $50.11; and (ii) a stock consideration component, consisting of 3.97 shares of the Company’s common stock.

The transaction was completed through a stock-for-stock exchange where Avon Water shareholders received the Company’s common stock valued at approximately $26.9 million, in a tax-free exchange, and a cash payment of $6.1 million for a total payment to shareholders of $33.0 million. The transaction reflects a total enterprise value of approximately $39.1 million, with the $33.0 million paid to shareholders and the assumption by the Company of approximately $6.1 million of debt of Avon Water.

The Company is still in the process of finalizing the purchase price allocation of both HVWC and Avon Water as additional information becomes available. The following table summarizes the fair value of the HVWC assets acquired on February 27, 2017 and the Avon Water assets on July 1, 2017, the dates of the acquisitions (in thousands):

 
HVWC
 
Avon Water
Net Utility Plant
$
28,861

 
$
28,330

Cash and Cash Equivalents
1,336

 
455

Accounts Receivable, net
345

 
376

Prepayments and Other Current Assets
63

 
247

Accrued Unbilled Revenues

 
467

Materials and Supplies, at Average Cost
200

 
151

Goodwill
12,618

 
23,935

Unrecovered Income Taxes - Regulatory Asset

 
4,662

Deferred Charges and Other Costs
343

 
799

Total Assets Acquired
$
43,766

 
$
59,422

 
 
 
 
Long-Term Debt, including current portion
$
4,642

 
$
3,345

Accounts Payable and Accrued Expenses
21

 
581

Interim Bank Loans Payable

 
2,500

Other Current Liabilities
228

 
35

Advances for Construction
1,897

 
1,537

Deferred Federal and State Income Taxes
1,623

 
1,803

Unfunded Future Income Taxes

 
4,662

Other Long-Term Liabilities

 
315

Total Liabilities Assumed
$
8,411

 
$
14,778

 
 
 
 
Contributions in Aid of Construction
18,452

 
11,560

 
 
 
 
Net Assets Acquired
$
16,903

 
$
33,084



23

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

The estimated fair values of the assets acquired and the liabilities assumed were determined based on the accounting guidance for fair value measurement under GAAP, which defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. The fair value analysis assumes the highest and best use of the assets by market participants. The allocation of the purchase price includes an adjustment to fair value related to the fair value of HVWC’s and Avon Water’s long term debt. The excess of the purchase price paid over the estimated fair value of the assets acquired and the liabilities assumed was recognized as goodwill, none of which is deductible for tax purposes. Goodwill recognized as part of the acquisitions of HVWC and Avon Water are a part of the Company’s Water Operations segment.

The following unaudited pro forma summary for the three and nine months ended September 30, 2017 presents information as if HVWC and Avon Water had each been acquired on January 1, 2016 and assumes that there were no other changes in our operations.  The following pro forma information does not necessarily reflect the actual results that would have occurred had the Company operated the businesses since January 1, 2016, nor is it necessarily indicative of the future results of operations of the combined companies (in thousands):

Three months ended September 30,
2017
 
2016
Operating Revenues
$
31,797

 
$
32,058

Other Water Activities Revenues
455

 
356

Real Estate Revenues

 
8

Service and Rentals Revenues
1,256

 
1,435

Total Revenues
$
33,508

 
$
33,857

 
 
 
 
Net Income
$
10,716

 
$
10,333

 
 
 
 
Basic Earnings per Average Share Outstanding
$
0.92

 
$
0.88

Diluted Earnings per Average Share Outstanding
$
0.90

 
$
0.86

 
 
 
 
Nine months ended September 30,
2017
 
2016
Operating Revenues
$
84,823

 
$
83,490

Other Water Activities Revenues
1,179

 
1,060

Real Estate Revenues
212

 
8

Service and Rentals Revenues
3,754

 
3,912

Total Revenues
$
89,968

 
$
88,470

 
 
 
 
Net Income
$
23,188

 
$
23,888

 
 
 
 
Basic Earnings per Average Share Outstanding
$
1.96

 
$
2.03

Diluted Earnings per Average Share Outstanding
$
1.92

 
$
1.99



24

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

The following table summarizes the results of HVWC and Avon Water for the three months ended September 30, 2017 and from the dates of acquisition to September 30, 2017 (from February 27, 2017 for HVWC and July 1, 2017 for Avon Water) and is included in the Consolidated Statement of Income for the period (in thousands):

Three months ended September 30, 2017
 
Operating Revenues
$
2,368

Other Water Activities Revenues
42

Real Estate Revenues

Service and Rentals Revenues

Total Revenues
$
2,410

 
 

Net Income
$
476

 
 

Basic Earnings per Average Share Outstanding
$
0.04

Diluted Earnings per Average Share Outstanding
$
0.04

 
 
Period ending September 30, 2017
 
Operating Revenues
$
3,721

Other Water Activities Revenues
42

Real Estate Revenues

Service and Rentals Revenues

Total Revenues
$
3,763

 
 
Net Income
$
693

 
 
Basic Earnings per Average Share Outstanding
$
0.06

Diluted Earnings per Average Share Outstanding
$
0.06


Part I, Item 2: Management’s Discussion and Analysis of Financial Condition and Results of Operations

The following discussion should be read in conjunction with the accompanying unaudited financial statements and related notes thereto and the audited financial statements and the notes thereto contained in our Annual Report on Form 10-K for the year ended December 31, 2016.

General Information

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 2016 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 were 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 encouraged all customers to reduce their water usage by 10% and, in October 2016, began asking customers in the shoreline communities of Guilford, Madison, Clinton, Westbrook and Old Saybrook to reduce their water usage by 15%. On April 21, 2017, the Company announced that all of our reservoirs in the State of Connecticut had returned to full capacity and that the previously announced water supply advisory has been lifted.

Leadership Changes

On September 28, 2017, the Company announced that the Board of Directors accepted the resignation of Eric W. Thornburg, who has served as the Company’s President and Chief Executive Officer since early 2006 and as its Chairman since May 2007.

The Board of Directors unanimously appointed David C. Benoit, the Company’s Chief Financial Officer since 1996, to serve as the Interim President and CEO of the Company, its Connecticut operating subsidiaries and CEO of Maine Water. Richard Knowlton remains President of Maine Water. The Company is in the process of determining, and has therefore not yet finalized, the compensatory benefits to be provided to Mr. Benoit in connection with his service as Interim President and Chief Executive Officer.

25



The Board of Directors also elected Carol P. Wallace, the Company’s Lead Independent Director since 2013, to serve as Chairman of the Board of Directors of the Company.

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 September 30, 2017, were 9.75% and 7.32%, respectively. The Heritage Village Water Company’s (“HVWC”) blended water and wastewater allowed return on equity and return on rate base, effective September 30, 2017, were 10.10% and 7.19%, respectively. The Avon Water Company’s (“Avon Water”) allowed return on equity and return on rate base, effective September 30, 2017, were 10.00% and 7.79%, respectively. Maine Water’s average allowed return on equity and return on rate base, effective September 30, 2017, 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. Each of Connecticut Water, HVWC, Avon Water and Maine Water are allowed to add surcharges to customers’ bills in order to recover certain costs associated with 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. HVWC has not added surcharges to customers’ bills in order to recover certain approved capital projects as of September 30, 2017, however, HVWC, as authorized by PURA, began to utilize Water Revenue Adjustments as of March 31, 2017.

The Heritage Village Water Company Acquisition
As previously reported, on May 10, 2016, the Company announced that it had reached an agreement to acquire 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 Agreement and Plan of Merger dated May 10, 2016 between and among HVWC, the Company, and HAC, Inc., the Company’s wholly-owned Connecticut 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.

The acquisition was executed through a stock-for-stock merger transaction valued at approximately $16.9 million. Holders of HVWC common stock received shares of the Company’s common stock in a tax-free exchange. In addition, the transaction reflected a total enterprise value of HVWC of approximately $21.5 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 the Companys’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 promptly by the issuance of a letter of transmittal and related materials by Connecticut Water’s exchange agent.

The Avon Water Company Acquisition
As previously reported, on October 12, 2016, the Company announced that it had reached an agreement to acquire Avon Water (“Avon Water”), pending a vote of Avon Water shareholders, approval by PURA and the MPUC and the satisfaction of other various closing conditions, pursuant to the terms of that certain Agreement and Plan of Merger dated October 11, 2016 as amended on March 29, 2017 between and among Avon Water, the Company, and WC-A I, Inc., the Company’s wholly-owned Connecticut subsidiary (the “Merger Agreement”). Avon Water serves approximately 4,800 customers in the Farmington Valley communities of Avon, Farmington, and Simsbury, Connecticut.

On February 10, 2017, Connecticut Water received regulatory approval from MPUC and on April 12, 2017, Connecticut Water received regulatory approval from the PURA to proceed with the transaction. The shareholders of Avon Water voted to approve the acquisition at a special meeting of Avon Water’s shareholders held on June 16, 2017.

Effective July 1, 2017, the Company completed the acquisition of Avon Water by completing the merger of Connecticut Water’s wholly-owned subsidiary WC-A I, Inc. with and into Avon Water, with Avon Water as the surviving corporation, pursuant to the terms of the Merger Agreement and Connecticut corporate law. Upon the effective time of the Merger, the

26


holders of Avon Water’s 122,289 issued and outstanding shares of common stock became entitled to receive the following merger consideration for each share of Avon Water common stock held: (i) a cash payment of $50.11; and (ii) a stock consideration component, consisting of 3.97 shares of the Company’s common stock.

The transaction was completed through a stock-for-stock exchange where Avon Water shareholders received the Company’s common stock valued at approximately $26.9 million, in a tax-free exchange, and a cash payment of $6.1 million for a total payment to shareholders of $33.0 million. The transaction reflects a total enterprise value of approximately $39.1 million, with the $33.0 million paid to shareholders and the assumption by the Company of approximately $6.1 million of debt of Avon Water.

Maine Water Land Sale
On March 11, 2016, Maine Water entered into a purchase and sale agreement with the Coastal Mountains Land Trust, a Maine nonprofit corporation (the “Land Trust”) pursuant to which Maine Water agreed to sell two conservation easements to the Land Trust on approximately 1,300 acres of land located in the towns of Rockport, Camden and Hope, in Knox County, Maine valued in the aggregate at $3.1 million.  The land had a book value of approximately $600,000 at September 30, 2017 and December 31, 2016 and is included in “Utility Plant” on the Company’s “Condensed Consolidated Balance Sheets”. The easements and purchase prices are as follows:

1.Ragged Mountain Mirror Lake Conservation Easement: $1,875,000; and
2.Grassy Pond Conservation Easement: $600,000.

On October 13, 2017, an amendment to the agreement was made to extend closing of the first transaction to June 30, 2018, from December 31, 2017. This is also expected to extend the second closing into 2020.  Maine Water will make a $200,000 contribution to the Land Trust upon completion of the closing of the first easement sale.  Maine Water also expects to claim a charitable deduction for the $600,000 in excess of the fair market value of the second easement over the $600,000 sale price.

Connecticut Rates
Connecticut Water’s Water Infrastructure Conservation Adjustment (“WICA”) was 8.25% and 3.04% at September 30, 2017 and 2016, respectively. On July 26, 2017, Connecticut Water filed a WICA application with the PURA requesting a 1.56% surcharge to customers’ bills, representing approximately $8.2 million in WICA related projects. On September 20, 2017, PURA approved the Company’s filing. Effective October 1, 2017, Connecticut Water’s cumulative WICA surcharge was 9.81%. As of September 30, 2017, Avon Water’s WICA surcharge was 8.09%. As of September 30, 2017, HVWC has not filed for a WICA surcharge.

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 and HVWC’s allowed revenues for the nine months ended September 30, 2017, as approved by PURA during each company’s most recent general rate case and including subsequently approved WICA surcharges, are approximately $62.3 million. Through normal billing for the nine months ended September 30, 2017, revenue for Connecticut Water and HVWC would have been approximately $56.8 million had the WRA not been implemented. As a result of the implementation of the WRA, Connecticut Water and HVWC recorded $5.5 million in additional revenue for the nine months ended September 30, 2017. Avon Water does not currently use the WRA mechanism.

Maine Rates
In Maine, the overall, cumulative Water Infrastructure Charge (“WISC”) for all divisions was 6.47% and 4.08% as of September 30, 2017 and 2016, respectively.

On June 29, 2017, Maine Water filed for a rate increase in its Biddeford and Saco division. The rate request is for an approximate $1.6 million, or 25.1%, increase in revenues. The rate request is to recover higher operating expenses, depreciation and property taxes since Biddeford and Saco’s last rate increase in 2015. The Company expects a final decision to be issued by the MPUC in the fourth quarter of 2017 with new rates to be effective as of December 1, 2017.


27


A 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 outside of the Biddeford and Saco division due to various agreements with the MPUC, but is evaluating how and when this new mechanism can be implemented in the future.

Critical Accounting Policies and Estimates

The Company maintains its accounting records in accordance with accounting principles generally accepted in the United States of America and as directed by the PURA and the MPUC, to which the Company’s regulated water utility subsidiaries are subject.  Significant accounting policies employed by the Company, including the use of estimates, were presented in the Notes to Consolidated Financial Statements of the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2016.

Critical accounting policies are those that are the most important to the presentation of the Company’s financial condition and results of operations.  The application of such accounting policies requires management’s most difficult, subjective, and complex judgments and involves uncertainties and assumptions.  The Company’s most critical accounting policies pertain to public utility regulation related to ASC 980 “Regulated Operations”, revenue recognition (including the WRA), goodwill impairment, income taxes and accounting for pension and other post-retirement benefit plans.  Each of these accounting policies and the application of critical accounting policies and estimates were discussed in the Company’s Annual Report on Form 10-K for the year ended December 31, 2016.

Management must use informed judgments and best estimates to properly apply these critical accounting policies.  Because of the uncertainty in these estimates, actual results could differ from estimates used in applying the critical accounting policies.  The Company is not aware of any reasonably likely events or circumstances which would result in different amounts being reported that would materially affect its financial condition or results of operations.

Outlook

The following modifies and updates the “Outlook” section of the Company’s 2016 Annual Report on Form 10-K for the fiscal year ended December 31, 2016.

The Company’s earnings and profitability are primarily dependent upon the sale and distribution of water. In Maine, water revenues can be dependent on seasonal weather fluctuations, particularly during the summer months when water demand will vary with rainfall and temperature levels. This risk has been mitigated in Connecticut with the implementation of the WRA by Connecticut Water and HVWC. The Company’s earnings and profitability in future years will also depend upon a number of other factors, such as the ability to control our operating costs, 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 water companies.

The Company expects Net Income from its Water Operations segment to increase in 2017 over 2016 levels, primarily due to the accretive effects of the February 2017 HVWC acquisition and the Avon Water acquisition completed on July 1, 2017 and revenue increases resulting from increased surcharges related to WISC in Maine and WICA in Connecticut. As a result, the Company expects total Net Income and earnings per share to increase for the year-ended 2017 over 2016.

The Company believes that the factors described above and those described in detail under the heading “Commitments and Contingencies” below 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 the sections entitled Item 1A – Risk Factors, “Commitments and Contingencies” in Item 7 of the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2016 and the risks and uncertainties described in the “Forward-Looking Information” section below.

Results of Operations

Three months ended September 30
Net Income for the three months ended September 30, 2017 increased from the same period in the prior year by $1,181,000 to $10,716,000. Earnings per basic average common share were $0.92 and $0.86 during the three months ended September 30, 2017 and 2016, respectively.


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This increase in Net Income is broken down by business segment as follows (in thousands):

Business Segment
 
September 30, 2017
 
September 30, 2016
 
Increase/(Decrease)
Water Operations
 
$
10,464

 
$
9,352

 
$
1,112

Real Estate Transactions
 

 
2

 
(2
)
Services and Rentals
 
252

 
181

 
71

Total
 
$
10,716

 
$
9,535

 
$
1,181


Revenue

Revenue from our regulated customers increased by $2,320,000, or 7.9%, to $31,797,000 for the three months ended September 30, 2017 when compared to the same period in 2016.  Approximately $2,368,000 of the increase in revenues was related to the acquisitions of HVWC and Avon Water on February 27, 2017 and July 1, 2017, respectively.

Operation and Maintenance Expense

Operation and Maintenance (“O&M”) expense increased by $638,000, or 5.6%, for the three months ended September 30, 2017 when compared to the same period of 2016, including O&M expense incurred after the acquisitions of HVWC and Avon Water which together contributed $977,000 of incremental O&M expense during the period. The following table presents the components of O&M expense for the three months ending September 30, 2017 and 2016, both including and excluding the impact of the HVWC and Avon Water acquisitions (in thousands):

Expense Components
 
September 30, 2017
 
September 30, 2016
 
Increase / (Decrease)
 
HVWC and Avon Water O&M
 
Adjusted Increase/(Decrease)
Other benefits
 
$
70

 
$
640

 
$
(570
)
 
$
12

 
$
(582
)
Purchased water
 
490

 
616

 
(126
)
 
16

 
(142
)
Water treatment (including chemicals)
 
760

 
790

 
(30
)
 
80

 
(110
)
Pension
 
733

 
780

 
(47
)
 
2

 
(49
)
Utility costs
 
1,138

 
1,029

 
109

 
152

 
(43
)
Payroll
 
4,229

 
3,893

 
336

 
358

 
(22
)
Property and liability insurance
 
392

 
395

 
(3
)
 
16

 
(19
)
Customer
 
407

 
354

 
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