
1.	Basis of Preparation of Financials

The condensed consolidated financial statements included herein have been prepared by Connecticut Water Service, Inc. (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”) and The Heritage Village Water Company (“HVWC”) 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”).

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, the Company acquired HVWC, discussed further in Note 11 below. As a result, the Company’s Condensed Consolidated Balance Sheet at December 31, 2016 and the Condensed Consolidated Statements of Net Income, Condensed Consolidated Statements of Comprehensive Income, Condensed Consolidated Statements Retained Earnings and Condensed Consolidated Statements of Cash Flows for the three months ended March 31, 2016 do not include HVWC. The Condensed Consolidated Statements of Net Income, Condensed Consolidated Statements of Comprehensive Income, Condensed Consolidated Statements Retained Earnings and Condensed Consolidated Statements of Cash Flows for the three months ended March 31, 2017 do include HVWC’s results for the approximate one month the Company owned HVWC during the period. HVWC’s assets and liabilities are included in the Condensed Consolidated Balance Sheet as of March 31, 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.

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 March 31, 2017, were 9.75% and 7.32%, respectively. HVWC’s blended waster and wastewater allowed returns on equity and returns on rate base, effective March 31, 2017, were 10.10% and 7.19%, respectively. Maine Water’s average allowed return on equity and return on rate base, effective March 31, 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. Both Connecticut Water and Maine Water are allowed to add surcharges to customers’ bills in order to recover certain approved capital projects in between full rate cases, as well as approved surcharges for Water Revenue Adjustments, as discussed in more detail below, in Connecticut. HVWC has not added surcharges to customers’ bills in order to recover certain approved capital projects as of March 31, 2017, however, HVWC has begun to utilize Water Revenue Adjustments as of March 31, 2017.

Avon Water Company Acquisition

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

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

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

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

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

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

On March 29, 2017, the parties amended the Avon Agreement to extend the End Date (as defined in the Avon Agreement) from March 31, 2017 to June 30, 2017. The Amendment also amends the Avon Agreement to permit Avon Water to pay additional cash dividends prior to June 30, 2017.

During the fourth quarter of 2016, Connecticut Water filed an application with PURA seeking approval of the transaction. On April 12, 2017, PURA approved the transaction.

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 March 31, 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.

The two easement sale and donation transactions are expected to close no later than December 31, 2017 and December 31, 2019, respectively. 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 7.13% and 4.19% at March 31, 2017 and 2016, respectively. On January 26, 2017, Connecticut Water filed a WICA application with the PURA requesting a 1.09% surcharge to customers’ bills, representing approximately $8.5 million in WICA related projects. Additionally, on February 9, 2017, Connecticut Water filed its annual WICA reconciliation which requested a 0.06% surcharge, which would replace the 0.03% reconciliation adjustment filed in January 2016. During March 2017, PURA approved both applications as filed, and, effective April 1, 2017, Connecticut Water’s cumulative WICA surcharge was 8.25%. As of March 31, 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 three months ended March 31, 2017, as approved by PURA during each company’s most recent general rate case and including subsequently approved WICA surcharges, are approximately $17.8 million. Through normal billing for the three months ended March 31, 2017, revenue for Connecticut Water and HVWC would have been approximately $17.2 million had the WRA not been implemented. As a result of the implementation of the WRA, Connecticut Water and HVWC recorded $0.6 million in additional revenue for the three months ended March 31, 2017.

Maine Rates

In Maine, the overall, cumulative Water Infrastructure Charge (“WISC”) for all divisions was 6.6% and 3.1% as of March 31, 2017 and 2016, respectively.

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 due to various agreements with the MPUC, but is evaluating how and when this new mechanism can be implemented.