10-Q 1 ctws10qq22017.htm CTWS FORM 10-Q JUNE 30, 2017 Document


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 JUNE 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
11,575,400
Number of shares of common stock outstanding, July 1, 2017
(Includes 224,770 common stock equivalent shares awarded under the Performance Stock Programs)



CONNECTICUT WATER SERVICE, INC. AND SUBSIDIARIES

Financial Report
June 30, 2017

TABLE OF CONTENTS

Part I, Item 1:  Financial Statements (Unaudited)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Exhibit 31.1
Exhibit 31.2
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
 
June 30, 2017
 
December 31, 2016
Utility Plant
 
$
859,295

 
$
777,860

Construction Work in Progress
 
12,321

 
33,748

 
 
871,616

 
811,608

Accumulated Provision for Depreciation
 
(223,928
)
 
(210,212
)
Net Utility Plant
 
647,688

 
601,396

Other Property and Investments
 
9,894

 
9,071

Cash and Cash Equivalents
 
2,694

 
1,564

Accounts Receivable (Less Allowance, 2017 - $1,161; 2016 - $1,100)
 
12,875

 
13,024

Accrued Unbilled Revenues
 
9,153

 
8,171

Materials and Supplies, at Average Cost
 
1,768

 
1,536

Prepayments and Other Current Assets
 
6,743

 
5,069

Total Current Assets
 
33,233

 
29,364

Unrecovered Income Taxes - Regulatory Asset
 
98,453

 
93,264

Pension Benefits - Regulatory Asset
 
11,439

 
12,266

Post-Retirement Benefits Other Than Pension - Regulatory Asset
 
146

 
265

Goodwill
 
43,045

 
30,427

Deferred Charges and Other Costs
 
11,118

 
8,449

Total Regulatory and Other Long-Term Assets
 
164,201

 
144,671

Total Assets
 
$
855,016

 
$
784,502

CAPITALIZATION AND LIABILITIES
 
 

 
 

Common Stockholders’ Equity:
 
 

 
 

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

 
 

     Issued and Outstanding: 2017 - 11,575,400; 2016 - 11,248,458
 
$
163,808

 
$
145,739

Retained Earnings
 
96,975

 
91,213

Accumulated Other Comprehensive (Loss)
 
(735
)
 
(924
)
Common Stockholders’ Equity
 
260,048

 
236,028

Preferred Stock
 
772

 
772

Long-Term Debt
 
205,351

 
197,047

Total Capitalization
 
466,171

 
433,847

Current Portion of Long-Term Debt
 
5,196

 
4,859

Interim Bank Loans Payable
 
43,632

 
32,953

Accounts Payable and Accrued Expenses
 
9,640

 
13,116

Accrued Interest
 
1,045

 
1,012

Current Portion of Refund to Customers - Regulatory Liability
 
239

 
855

Other Current Liabilities
 
2,856

 
2,330

Total Current Liabilities
 
62,608

 
55,125

Advances for Construction
 
21,433

 
19,127

Deferred Federal and State Income Taxes
 
51,838

 
50,558

Unfunded Future Income Taxes
 
96,524

 
90,977

Long-Term Compensation Arrangements
 
34,686

 
33,540

Unamortized Investment Tax Credits
 
1,151

 
1,189

Refund to Customers - Regulatory Liability
 

 
108

Other Long-Term Liabilities
 
4,647

 
5,074

Total Long-Term Liabilities
 
210,279

 
200,573

Contributions in Aid of Construction
 
115,958

 
94,957

Commitments and Contingencies
 

 

Total Capitalization and Liabilities
 
$
855,016

 
$
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 June 30, 2017 and 2016
(Unaudited)
(In thousands, except per share amounts)
 
2017
 
2016
Operating Revenues
$
27,902

 
$
26,055

Operating Expenses
 
 
 
Operation and Maintenance
11,626

 
8,840

Depreciation
3,984

 
3,359

Income Tax (Benefit) Expense
(624
)
 
589

Taxes Other Than Income Taxes
2,477

 
2,238

Total Operating Expenses
17,463

 
15,026

Net Operating Revenues
10,439

 
11,029

Other Utility Income, Net of Taxes
190

 
188

Total Utility Operating Income
10,629

 
11,217

Other (Deductions) Income, Net of Taxes
 
 
 
Non-Water Sales Earnings
332

 
406

Allowance for Funds Used During Construction
231

 
289

Other
(744
)
 
(283
)
Total Other (Deductions) Income, Net of Taxes
(181
)
 
412

Interest and Debt Expense
 
 
 
Interest on Long-Term Debt
2,106

 
1,830

Other Interest Income, Net
(111
)
 
(174
)
Amortization of Debt Expense and Premium, Net
35

 
30

Total Interest and Debt Expense
2,030

 
1,686

Net Income
8,418

 
9,943

Preferred Stock Dividend Requirement
10

 
10

Net Income Applicable to Common Stock
$
8,408

 
$
9,933

Weighted Average Common Shares Outstanding:
 
 
 
Basic
11,344

 
11,004

Diluted
11,568

 
11,223

Earnings Per Common Share:
 
 
 
Basic
$
0.75

 
$
0.90

Diluted
$
0.73

 
$
0.89

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 Six Months Ended June 30, 2017 and 2016
(Unaudited)
(In thousands, except per share amounts)
 
2017
 
2016
Operating Revenues
$
50,365

 
$
47,607

Operating Expenses
 

 
 

Operation and Maintenance
22,862

 
20,129

Depreciation
7,676

 
6,757

Income Tax (Benefit) Expense
(814
)
 
982

Taxes Other Than Income Taxes
5,082

 
4,687

Total Operating Expenses
34,806

 
32,555

Net Operating Revenues
15,559

 
15,052

Other Utility Income, Net of Taxes
355

 
343

Total Utility Operating Income
15,914

 
15,395

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

 

Non-Water Sales Earnings
590

 
801

Allowance for Funds Used During Construction
567

 
521

Other
(753
)
 
(315
)
Total Other Income, Net of Taxes
437

 
1,007

Interest and Debt Expense
 
 
 
Interest on Long-Term Debt
4,167

 
3,566

Other Interest Income, Net
(371
)
 
(316
)
Amortization of Debt Expense and Premium, Net
69

 
61

Total Interest and Debt Expense
3,865

 
3,311

Net Income
12,486

 
13,091

Preferred Stock Dividend Requirement
19

 
19

Net Income Applicable to Common Stock
$
12,467

 
$
13,072

Weighted Average Common Shares Outstanding:
 
 
 
Basic
11,242

 
10,998

Diluted
11,467

 
11,217

Earnings Per Common Share:
 
 
 
Basic
$
1.11

 
$
1.19

Diluted
$
1.09

 
$
1.17

Dividends Per Common Share
$
0.5800

 
$
0.5500


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 June 30, 2017 and 2016
(Unaudited)
(In thousands)

 
2017
 
2016
Net Income
$
8,418

 
$
9,943

Other Comprehensive Income/(Loss), net of tax
 

 
 

Reclassification to Pension and Post-Retirement Benefits Other than Pension, net of tax (expense) of $(36) and $(27) in 2017 and 2016
57

 
43

Unrealized gain on investments, net of tax (expense) of $(18) and $(2) in 2017 and 2016
29

 
2

Other Comprehensive Income, net of tax
86

 
45

Comprehensive Income
$
8,504

 
$
9,988





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

 
2017
 
2016
Net Income
$
12,486

 
$
13,091

Other Comprehensive Income/(Loss), net of tax
 

 
 

Reclassification to Pension and Post-Retirement Benefits Other than Pension, net of tax (expense) of $(61) and $(49) in 2017 and 2016
96

 
78

Unrealized gain (loss) on investments, net of tax (expense) benefit of $(59) and $8 in 2017 and 2016
93

 
(13
)
Other Comprehensive Income, net of tax
189

 
65

Comprehensive Income
$
12,675

 
$
13,156





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 June 30, 2017 and 2016
(Unaudited)
(In thousands, except per share amounts)

 
2017
 
2016
Balance at Beginning of Period
$
92,007

 
$
80,521

Net Income
8,418

 
9,943

 
100,425

 
90,464

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
3,440

 
3,170

 
3,450

 
3,180

Balance at End of Period
$
96,975

 
$
87,284





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

 
2017
 
2016
Balance at Beginning of Period
$
91,213

 
$
80,378

Net Income
12,486

 
13,091

 
103,699

 
93,469

Dividends Declared:
 

 
 

Cumulative Preferred, Class A, $0.40 per share
6

 
6

Cumulative Preferred, Series $0.90, $0.45 per share
13

 
13

Common Stock - 2017 $0.5800 per share; 2016 $0.5500 per share
6,705

 
6,166

 
6,724

 
6,185

Balance at End of Period
$
96,975

 
$
87,284





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 Six Months Ended June 30, 2017 and 2016
(Unaudited)
(In thousands)
 
2017
 
2016
Operating Activities:
 
 
 
Net Income
$
12,486

 
$
13,091

Adjustments to Reconcile Net Income to Net Cash and Cash Equivalents Provided by
 
 
 
Operating Activities:
 
 
 
Deferred Revenues
(3,421
)
 
(2,667
)
Provision for Deferred Income Taxes and Investment Tax Credits, Net
(617
)
 
2,125

Allowance for Funds Used During Construction
(566
)
 
(521
)
Depreciation and Amortization (including $351 and $571 in 2017 and 2016, respectively, charged to other accounts)
8,027

 
7,328

Gain on Real Estate Transactions
(33
)
 

Change in Assets and Liabilities:
 
 
 
Decrease in Accounts Receivable and Accrued Unbilled Revenues
(488
)
 
(1,376
)
Increase in Prepaid Income Taxes and Prepayments and Other Current Assets
(1,070
)
 
(1,854
)
(Increase) Decrease in Other Non-Current Items
2,369

 
(5,049
)
Decrease in Accounts Payable, Accrued Expenses and Other Current Liabilities
(2,027
)
 
(1,613
)
Total Adjustments
2,174

 
(3,627
)
Net Cash and Cash Equivalents Provided by Operating Activities
14,660

 
9,464

Investing Activities:
 

 
 

Net Additions to Utility Plant Used
(24,438
)
 
(28,627
)
Proceeds from the Sale of Land
212

 

Cash Acquired
1,336

 

Release of Restricted Cash

 
649

Net Cash and Cash Equivalents Used in Investing Activities
(22,890
)
 
(27,978
)
Financing Activities:
 
 
 
Net Proceeds from Interim Bank Loans
43,632

 
11,200

Net Repayment of Interim Bank Loans
(32,953
)
 
(16,085
)
Proceeds from the Issuance of Long-Term Debt
5,000

 
30,000

Costs to Issue Long-Term Debt and Common Stock
(2
)
 
(27
)
Proceeds from Issuance of Common Stock
692

 
852

Repayment of Long-Term Debt Including Current Portion
(1,104
)
 
(1,021
)
Advances (to) from Others for Construction
819

 
192

Cash Dividends Paid
(6,724
)
 
(6,185
)
Net Cash and Cash Equivalents Provided by Financing Activities
9,360

 
18,926

Net Increase in Cash and Cash Equivalents
1,130

 
412

Cash and Cash Equivalents at Beginning of Period
1,564

 
731

Cash and Cash Equivalents at End of Period
$
2,694

 
$
1,143

Non-Cash Investing and Financing Activities:
 

 
 

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

 
$

Non-Cash Contributed Utility Plant
$
2,278

 
$
558

Supplemental Disclosures of Cash Flow Information:
 
 
 
Cash Paid for:
 
 
 
Interest
$
3,825

 
$
3,208

State and Federal Income Taxes
$
362

 
$
255


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. (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”) and as updated in the Company’s Quarterly Report on Form 10-Q for the period ending March 31, 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, the Company acquired HVWC, 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 six months ended June 30, 2016 and Condensed Consolidated Statements of Cash Flows for the six months ended June 30, 2016 do not include HVWC.  The Condensed Consolidated Statements of Net Income, Condensed Consolidated Statements of Comprehensive Income, Condensed Consolidated Statements Retained Earnings for the three months ended June 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 six months ended June 30, 2017 do include HVWC’s results for the approximate four months the Company owned HVWC during the period. HVWC’s assets and liabilities are included in the Condensed Consolidated Balance Sheet as of June 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.

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 and six 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 June 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 June 30, 2017, were 10.10% and 7.19%, respectively. Maine Water’s average allowed return on equity and return on rate base, effective June 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 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.

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 June 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.

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 8.25% and 3.04% at June 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. If approved as filed, Connecticut Water’s cumulative WICA surcharge will be 9.81%, effective October 1, 2017. As of June 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 six months ended June 30, 2017, as approved by PURA during each company’s most recent general rate case and including subsequently approved WICA surcharges, are approximately $38.9 million. Through normal billing for the six months ended June 30, 2017, revenue for Connecticut Water and HVWC would have been approximately $35.3 million had the WRA not been implemented. As a result of the implementation of the WRA, Connecticut Water and HVWC recorded $3.6 million in additional revenue for the six months ended June 30, 2017.

Maine Rates
In Maine, the overall, cumulative Water Infrastructure Charge (“WISC”) for all divisions was 5.66% and 4.08% as of June 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,

10

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

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 January 1, 2018.

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.

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 six months ended June 30, 2017 and 2016.

Pension Benefits
Components of Net Periodic Cost (in thousands):
 
Three Months
 
Six Months
Period ended June 30,
2017
 
2016
 
2017
 
2016
Service Cost
$
450

 
$
426

 
$
964

 
$
947

Interest Cost
806

 
812

 
1,600

 
1,606

Expected Return on Plan Assets
(1,044
)
 
(1,061
)
 
(2,145
)
 
(2,040
)
Amortization of:
 

 
 

 
 
 
 
Prior Service Cost
4

 
4

 
8

 
8

Net Recognized Loss
486

 
514

 
1,031

 
1,025

Net Periodic Benefit Cost
$
702

 
$
695

 
$
1,458

 
$
1,546


The Company anticipates making a total contribution of approximately $2,971,000 in 2017 for the 2016 plan year by September 30, 2017.

Post-Retirement Benefits Other Than Pension (PBOP)
Components of Net Periodic Cost (in thousands):
 
Three Months
 
Six Months
Period ended June 30,
2017
 
2016
 
2017
 
2016
Service Cost
$
74

 
$
85

 
$
167

 
$
188

Interest Cost
123

 
135

 
256

 
271

Expected Return on Plan Assets
(89
)
 
(85
)
 
(177
)
 
(170
)
Other
56

 
56

 
112

 
112

Amortization of:
 

 
 

 
 
 
 
Prior Service Credit
(45
)
 
(100
)
 
(90
)
 
(200
)
Recognized Net Loss
(31
)
 
11

 
(40
)
 
19

Net Periodic Benefit Cost
$
88

 
$
102

 
$
228

 
$
220



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 June 30,
2017
 
2016
Common Shares Outstanding End of Period
11,575,400

 
11,231,037

Weighted Average Shares Outstanding (Days Outstanding Basis):
 

 
 

Basic
11,343,528

 
11,004,331

Diluted
11,568,278

 
11,222,989

 
 
 
 
Basic Earnings per Share
$
0.75

 
$
0.90

Dilutive Effect of Stock Awards
(0.02
)
 
(0.01
)
Diluted Earnings per Share
$
0.73

 
$
0.89

 
 
 
 
Six months ended June 30,
 
 
 
Weighted Average Shares Outstanding (Days Outstanding Basis):
 
 
 
Basic
11,241,884

 
10,998,408

Diluted
11,467,141

 
11,217,136

 
 
 
 
Basic Earnings per Share
$
1.11

 
$
1.19

Dilutive Effect of Stock Awards
(0.02
)
 
(0.02
)
Diluted Earnings per Share
$
1.09

 
$
1.17


Total unrecognized compensation expense for all stock awards was approximately $0.6 million as of June 30, 2017 and will be recognized over a weighted average period of 1.4 years.

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 continues to assess all potential impacts of adopting ASU No. 2014-09, however it does not believe the new standard will have an impact on the Company’s revenues from water and wastewater customers. In instances where operating contracts contain more than one distinct good or service, as defined by ASU No. 2014-09, the new standard may affect the timing of when the Company recognizes the related revenue. The Company additionally continues to assess the impact ASU No. 2014-09 will have on the Company’s accounting surrounding Contributions in Aid of Construction. The Company will complete its assessment of the expected impact of adoption, including selecting a transition method for adoption, in 2017, and continue to evaluate ASU No. 2014-09 through the date of adoption.

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,

12

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

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 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.


13

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 June 30, 2017 and 2016 are as follows (in thousands):
Three months ended June 30, 2017
 
Unrealized Gains on Investments
 
Defined Benefit Items
 
Total
Beginning Balance (a)
 
$
299

 
$
(1,120
)
 
$
(821
)
Other Comprehensive Income Before Reclassification
 
21

 

 
21

Amounts Reclassified from AOCI
 
8

 
57

 
65

Net current-period Other Comprehensive Income
 
29

 
57

 
86

Ending Balance
 
$
328

 
$
(1,063
)
 
$
(735
)
 
 
 
 
 
 
 
Three months ended June 30, 2016
 
Unrealized Gains on Investments
 
Defined Benefit Items
 
Total
Beginning Balance (a)
 
$
185

 
$
(1,100
)
 
$
(915
)
Other Comprehensive (Loss) Income Before Reclassification
 
(8
)
 

 
(8
)
Amounts Reclassified from AOCI
 
10

 
43

 
53

Net current-period Other Comprehensive (Loss) Income
 
2

 
43

 
45

Ending Balance
 
$
187

 
$
(1,057
)
 
$
(870
)
 
 
 
 
 
 
 
Six months ended June 30, 2017
 
Unrealized Gains on Investments
 
Defined Benefit Items
 
Total
Beginning Balance (a)
 
$
235

 
$
(1,159
)
 
$
(924
)
Other Comprehensive Income Before Reclassification
 
85

 

 
85

Amounts Reclassified from AOCI
 
8

 
96

 
104

Net current-period Other Comprehensive Income
 
93

 
96

 
189

Ending Balance
 
$
328

 
$
(1,063
)
 
$
(735
)
 
 
 
 
 
 
 
Six months ended June 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

 
78

 
88

Net current-period Other Comprehensive (Loss) Income
 
(13
)
 
78

 
65

Ending Balance
 
$
187

 
$
(1,057
)
 
$
(870
)
 
 
 
 
 
 
 
(a) All amounts shown are net of tax. Amounts in parentheses indicate loss.


14

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 June 30, 2017 and 2016 (in thousands):
Details about Other AOCI Components
 
Amounts Reclassified from AOCI Three Months Ended June 30, 2017(a)
 
Amounts Reclassified from AOCI Three Months Ended June 30, 2016(a)
 
Affected Line Items on Income Statement
Realized Gains on Investments
 
$
13

 
$
17

 
Other Income
Tax expense
 
(5
)
 
(7
)
 
Other Income
 
 
8

 
10

 
 
 
 
 
 
 
 
 
Amortization of Recognized Net Gain from Defined Benefit Items
 
93

 
71

 
Other Income (b)
Tax expense
 
(36
)
 
(28
)
 
Other Income
 
 
57

 
43

 
 
 
 
 
 
 
 
 
Total Reclassifications for the period, net of tax
 
$
65

 
$
53

 
 
 
 
 
 
 
 
 
Details about Other AOCI Components
 
Amounts Reclassified from AOCI Six Months Ended June 30, 2017(a)
 
Amounts Reclassified from AOCI Six Months Ended June 30, 2016(a)
 
Affected Line Items on Income Statement
Realized Gains on Investments
 
$
13

 
$
17

 
Other Income
Tax expense
 
(5
)
 
(7
)
 
Other Income
 
 
8

 
10

 
 
 
 
 
 
 
 
 
Amortization of Recognized Net Gain from Defined Benefit Items
 
157

 
128

 
Other Income (b)
Tax expense
 
(61
)
 
(50
)
 
Other Income
 
 
96

 
78

 
 
 
 
 
 
 
 
 
Total Reclassifications for the period, net of tax
 
$
104

 
$
88

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


15

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

6.
Long-Term Debt

Long-Term Debt at June 30, 2017 and December 31, 2016 consisted of the following (in thousands):
 
2017
 
2016
Connecticut Water Service, Inc.:
 
 
 
4.09%
 
Term Loan Note
$
12,903

 
$
13,437

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

 
12,500

Var.
 
2004 Series A, Due 2028
5,000

 
5,000

Var.
 
2004 Series B, Due 2028
4,550

 
4,550

5.00%
 
2011 A Series, Due 2021
23,051

 
23,115

3.16%
 
CoBank Note Payable, Due 2020
8,000

 
8,000

3.51%
 
CoBank Note Payable, Due 2022
14,795

 
14,795

4.29%
 
CoBank Note Payable, Due 2028
17,020

 
17,020

4.72%
 
CoBank Note Payable, Due 2032
14,795

 
14,795

4.75%
 
CoBank Note Payable, Due 2033
14,550

 
14,550

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

 
30,000

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

 
19,930

Total The Connecticut Water Company
164,191

 
164,255

The Heritage Village Water Company
 
 
 
4.75%
 
2011 Farmington Bank Loan, Due 2034
4,543

 

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

 
7,200

2.68%
 
1999 Series J, Due 2019
170

 
254

0.00%
 
2001 Series K, Due 2031
574

 
615

2.58%
 
2002 Series L, Due 2022
60

 
67

1.53%
 
2003 Series M, Due 2023
321

 
341

1.73%
 
2004 Series N, Due 2024
371

 
371

0.00%
 
2004 Series O, Due 2034
113

 
120

1.76%
 
2006 Series P, Due 2026
361

 
391

1.57%
 
2009 Series R, Due 2029
207

 
217

0.00%
 
2009 Series S, Due 2029
560

 
583

0.00%
 
2009 Series T, Due 2029
1,572

 
1,634

0.00%
 
2012 Series U, Due 2042
148

 
154

1.00%
 
2013 Series V, Due 2033
1,310

 
1,335

2.52%
 
CoBank Note Payable, Due 2017
1,965

 
1,965

4.24%
 
CoBank Note Payable, Due 2024
4,500

 
4,500

4.18%
 
CoBank Note Payable, Due 2026
5,000

 

7.72%
 
Series L, Due 2018
2,250

 
2,250

2.40%
 
Series N, Due 2022
1,026

 
1,101

1.86%
 
Series O, Due 2025
790

 
790

2.23%
 
Series P, Due 2028
1,264

 
1,294

0.01%
 
Series Q, Due 2035
1,678

 
1,771

1.00%
 
Series R, Due 2025
2,250

 
2,250

Various
 
Various Capital Leases
5

 
8

Total The Maine Water Company
33,695

 
29,211

Add: Acquisition Fair Value Adjustment
255

 
321

Less: Current Portion
(5,196
)
 
(4,859
)
Less: Unamortized Debt Issuance Expense
(5,040
)
 
(5,318
)
Total Long-Term Debt
$
205,351

 
$
197,047


16

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)


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 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 July 20, 2017, Connecticut Water filed an application with PURA to issue up to $35,000,000 in unsecured notes during the second half of 2017. Connecticut Water intends to use the $35,000,000 principal to repay amounts owed to the Company and to fund capital expenditures associated with the Connecticut Water’s ongoing construction program. The notes will be callable in whole or in part, subject to payment of a make-whole amount. The notes will have a bullet payment of the full principal amount due at maturity, unless they are prepaid in whole or in part prior to that maturity. Additionally, the notes will have fixed interest rates which will be based on current market rate at the time of the closing.

During the first six months of 2017, the Company paid approximately $534,000 related to Connecticut Water Service’s Term Note Payable issued as part of the 2012 acquisition of Maine Water, approximately $516,000 in sinking funds related to Maine Water’s outstanding bonds and approximately $54,000 in sinking funds related to HVWC’s bank loan.

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


17

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

The following table summarizes our financial instruments measured at fair value on a recurring basis within the fair value hierarchy as of June 30, 2017 (in thousands):
 
Level 1
 
Level 2
 
Level 3
 
Total
Asset Type:
 
 
 
 
 
 
 
Money Market Fund
$
35

 
$

 
$

 
$
35

Mutual Funds:
 

 
 

 
 

 
 

Equity Funds (1)
1,787

 

 

 
1,787

Fixed Income Funds (2)
550

 

 

 
550

Total
$
2,372

 
$

 
$

 
$
2,372


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 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 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 June 30, 2017 and December 31, 2016 was $3,259,000 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 June 30, 2017 and December 31, 2016, the estimated fair value of the Company’s long-term debt was $223,119,000 and $210,463,000, respectively, as compared to the carrying amounts of $210,391,000 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 $21,433,000 and $19,127,000 at June 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.


18

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

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.

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 June 30, 2017
Segment
 
Revenues
 
Pre-Tax Income
 
Income Tax Expense(Benefit)
 
Net Income
Water Operations
 
$
28,220

 
$
7,117

 
$
(969
)
 
$
8,086

Real Estate Transactions
 

 

 

 

Services and Rentals
 
1,279

 
505

 
173

 
332

Total
 
$
29,499

 
$
7,622

 
$
(796
)
 
$
8,418

Three months ended June 30, 2016
Segment
 
Revenues
 
Pre-Tax Income
 
Income Tax Expense
 
Net Income
Water Operations
 
$
26,376

 
$
10,173

 
$
636

 
$
9,537

Real Estate Transactions
 

 

 

 

Services and Rentals
 
1,212

 
563

 
157

 
406

Total
 
$
27,588

 
$
10,736

 
$
793

 
$
9,943

Six months ended June 30, 2017
Segment
 
Revenues
 
Pre-Tax Income
 
Income Tax Expense(Benefit)
 
Net Income
Water Operations
 
$
51,006

 
$
10,612

 
$
(1,251
)
 
$
11,863

Real Estate Transactions
 
212

 
55

 
22

 
33

Services and Rentals
 
2,489

 
996

 
406

 
590

Total
 
$
53,707

 
$
11,663

 
$
(823
)
 
$
12,486

Six months ended June 30, 2016
Segment
 
Revenues
 
Pre-Tax Income
 
Income Tax Expense
 
Net Income
Water Operations
 
$
48,231

 
$
13,123

 
$
833

 
$
12,290

Real Estate Transactions
 

 

 

 

Services and Rentals
 
2,443

 
1,100

 
299

 
801

Total
 
$
50,674

 
$
14,223

 
$
1,132

 
$
13,091


The revenues shown in Water Operations above consisted of revenues from water customers of $27,370,000 and $26,055,000 for the three months ended June 30, 2017 and 2016, respectively, and wastewater revenues of $532,000 for the three months ended June 30, 2017. There were no wastewater revenues in 2016. Additionally, there were revenues associated with utility plant leased to others of $318,000 and $321,000 for the three months ended June 30, 2017 and 2016, respectively. The revenues from water and wastewater customers for the three months ended June 30, 2017 and 2016 include $2,980,000 and $2,386,000 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 $49,644,000 and $47,607,000 for the six months ended June 30, 2017 and 2016, respectively, and wastewater revenues of $721,000 for the six months ended June 30, 2017. There were no wastewater revenues in 2016. Additionally, there were revenues associated with utility plant leased to others of $641,000 and $624,000 for the six months ended June 30, 2017 and 2016, respectively. The revenues from water and wastewater customers for the six months ended June 30, 2017 and 2016 include $3,553,000 and $2,786,000 in additional revenues related to the application of the WRA, respectively.


19

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

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.

Assets by segment (in thousands):
 
June 30, 2017
 
December 31, 2016
Total Plant and Other Investments:
 
 
 
Water Operations
$
656,556

 
$
609,508

Non-Water
1,026

 
959

 
657,582

 
610,467

Other Assets:
 
 
 
Water Operations
194,609

 
171,674

Non-Water
2,825

 
2,361

 
197,434

 
174,035

Total Assets
$
855,016

 
$
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. For the six months ended June 30, 2017, the Company has recorded, as required by FASB ASC 740, a provision of $725,000 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 $6.6 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 six months ended June 30, 2017 and 2016.  Additionally, there were no accruals relating to interest or penalties as of June 30, 2017 and December 31, 2016.  The Company remains subject to examination by federal tax authorities for the 2013 through 2015 tax years; the State of Maine’s tax authorities for the 2013 through 2015 tax years; and the State of Connecticut’s tax authorities for the 2014 and 2015 tax years.

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 second 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.


20

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

The Company’s effective income tax rate for the three months ended June 30, 2017 and 2016 was (10.5)% and 7.4%, respectively. The Company’s effective tax rate, excluding discrete items recorded during the three months ended June 30, 2017 and 2016, was 16.2% and 5.2%, respectively. In 2017, these discrete items include adjustments related to uncertain tax positions for the repair deduction in Connecticut. 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 is an increase in the effective tax rate year over year for the three month period of approximately 11%. The increase in the effective tax rate for this period can be attributed to a lower estimated repair deduction and a lower tax deductible pension contribution in 2017 than in 2016. The Company’s effective income tax rate for the six months ended June 30, 2017 and 2016 was (7.1)% and 8.0%, respectively. The Company’s effective tax rate, excluding discrete items recorded during the three months ended June 30, 2017 and 2016, was 17.7% and 3.4%, respectively. In 2017, these discrete items include adjustments related to uncertain tax positions for the repair deduction in both Connecticut and Maine. The blended Federal and State statutory income tax rates during each period were 41%. 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 is an increase in the effective tax rate year over year for the six month period of approximately 14%. The increase in the effective tax rate for this period can be attributed to a lower estimated repair deduction and a lower tax deductible pension contribution in 2017 than in 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 June 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.  As of June 30, 2017, the total lines of credit available to the Company were $60.0 million.  As of June 30, 2017 and December 31, 2016, the Company had $43.6 million and $33.0 million, respectively, of Interim Bank Loans Payable. As of June 30, 2017, the Company had $16.4 million in unused lines of credit.  Interest expense charged on lines of credit will fluctuate based on market interest rates.

11.    Acquisition

On May 10, 2016, the Company announced that it had reached an agreement to acquire The Heritage Village Water Company ("HVWC"), pending a vote of HVWC shareholders, approval by PURA and MPUC and the satisfaction of other various closing conditions, pursuant to the terms of that certain Agreement and Plan of Merger dated May 10, 2016 between and among HVWC, the Company, and HAC, Inc., the Company’s wholly-owned 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.

Under the Merger Agreement, the acquisition was agreed to be executed through a stock-for-stock merger transaction valued at approximately $16.9 million. Holders of HVWC common stock will receive shares of the Company’s common stock in a tax-free exchange. In addition, the transaction reflects a total enterprise value of HVWC of approximately $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 Company is still in the process of finalizing the purchase price allocation of HVWC as additional information becomes available. The following table summarizes the fair value of the net assets acquired, based on the best information available, on February 27, 2017, the date of the acquisition (in thousands):


21

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

Net Utility Plant
$
28,861

Cash and Cash Equivalents
1,336

Accounts Receivable, net
345

Prepayments and Other Current Assets
63

Materials and Supplies, at Average Cost
200

Goodwill
12,618

Deferred Charges and Other Costs
343

Total Assets Acquired
$
43,766

Advances for Construction
 
Long-Term Debt, including current portion
$
4,642

Accounts Payable and Accrued Expenses
21

Other Current Liabilities
228

Advances for Construction
1,897

Deferred Federal and State Income Taxes
1,623

Total Liabilities Assumed
$
8,411

 
 
Contributions in Aid of Construction
18,452

 
 
Net Assets Acquired
$
16,903


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 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 acquisition of HVWC is a part of the Company’s Water Operations segment.


22

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

The following unaudited pro forma summary for the three and six months ended June 30, 2017 presents information as if HVWC had 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 business since January 1, 2016, nor is it necessarily indicative of the future results of operations of the combined companies (in thousands):

Three months ended June 30,
2017
 
2016
Operating Revenues
$
27,902

 
$
27,039

Other Water Activities Revenues
318

 
320

Real Estate Revenues

 

Service and Rentals Revenues
1,279

 
1,212

Total Revenues
$
29,499

 
$
28,571

 
 
 
 
Net Income
$
8,418

 
$
9,950

 
 
 
 
Basic Earnings per Average Share Outstanding
$
0.75

 
$
0.89

Diluted Earnings per Average Share Outstanding
$
0.73

 
$
0.86

 
 
 
 
Six months ended June 30,
2017
 
2016
Operating Revenues
$
50,971

 
$
49,460

Other Water Activities Revenues
641

 
624

Real Estate Revenues
212

 

Service and Rentals Revenues
2,489

 
2,443

Total Revenues
$
54,313

 
$
52,527

 
 
 
 
Net Income
$
12,510

 
$
13,166

 
 
 
 
Basic Earnings per Average Share Outstanding
$
1.10

 
$
1.17

Diluted Earnings per Average Share Outstanding
$
1.08

 
$
1.14



23

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

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

Three months ended June 30, 2017
 
Operating Revenues
$
1,017

Other Water Activities Revenues

Real Estate Revenues

Service and Rentals Revenues

Total Revenues
$
1,017

 
 

Net Income
$
132

 
 

Basic Earnings per Average Share Outstanding
$
0.01

Diluted Earnings per Average Share Outstanding
$
0.01

 
 
Period ending June 30, 2017
 
Operating Revenues
$
1,353

Other Water Activities Revenues

Real Estate Revenues

Service and Rentals Revenues

Total Revenues
$
1,353

 
 
Net Income
$
217

 
 
Basic Earnings per Average Share Outstanding
$
0.02

Diluted Earnings per Average Share Outstanding
$
0.02


On July 1, 2017, the Company completed the previously announced acquisition of The Avon Water Company (“Avon Water”). As of the date of this filing, the initial accounting for this acquisition is incomplete and therefore the above tables for Avon Water are not available. For more information about the acquisition of Avon Water, see Note 12 Subsequent Events.

12.    Subsequent Events

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 $27.9 million, in a tax-free exchange, and a cash payment of $6.1 million for a total payment to shareholders of $34.0 million. The transaction reflects a total enterprise value of approximately $40.1 million, with

24

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

the $34.0 million paid to shareholders and the assumption by the Company of approximately $6.1 million of debt of Avon Water.

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.

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 June 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 June 30, 2017, were 10.10% and 7.19%, respectively. Maine Water’s average allowed return on equity and return on rate base, effective June 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 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.

Heritage Village Water Company Acquisition
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 that certain Agreement and Plan of Merger dated May 10, 2016 between and among HVWC, the Company, and HAC, Inc., the Company’s wholly-owned 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.

Under the Merger Agreement, the acquisition was agreed to be executed through a stock-for-stock merger transaction valued at approximately $16.9 million. Holders of HVWC common stock will receive shares of the Company’s common stock in a tax-free exchange. In addition the transaction reflects a total enterprise value of HVWC of approximately $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.


25


Avon Water Company Acquisition
As previously reported, on October 12, 2016, the Company announced that it had reached an agreement to acquire The Avon Water Company (“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 $27.9 million, in a tax-free exchange, and a cash payment of $6.1 million for a total payment to shareholders of $34.0 million. The transaction reflects a total enterprise value of approximately $40.1 million, with the $34.0 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 June 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.

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 8.25% and 3.04% at June 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. If approved as filed, Connecticut Water’s cumulative WICA surcharge will be 9.81%, effective October 1, 2017. As of June 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 six months ended June 30, 2017, as approved by PURA during each company’s most recent general rate case and including subsequently approved WICA surcharges, are approximately

26


$38.9 million. Through normal billing for the six months ended June 30, 2017, revenue for Connecticut Water and HVWC would have been approximately $35.3 million had the WRA not been implemented. As a result of the implementation of the WRA, Connecticut Water and HVWC recorded $3.6 million in additional revenue for the six months ended June 30, 2017.

Maine Rates
In Maine, the overall, cumulative Water Infrastructure Charge (“WISC”) for all divisions was 5.66% and 4.08% as of June 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 January 1, 2018.

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.

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 Connecticut Water and Maine Water, respectively, 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. 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. Additionally, Maine Water expects to complete the first portion of the previously announced sale of a conservation easement, which is expected to positively impact the Real Estate Transactions segment during the year ending December 31, 2017.

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

27


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 June 30
Net Income for the three months ended June 30, 2017 decreased from the same period in the prior year by $1,525,000 to $8,418,000. Earnings per basic average common share were $0.75 and $0.90 during the three months ended June 30, 2017 and 2016, respectively.

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

Business Segment
 
June 30, 2017
 
June 30, 2016
 
Increase/(Decrease)
Water Operations
 
$
8,086

 
$
9,537

 
$
(1,451
)
Real Estate Transactions
 

 

 

Services and Rentals
 
332

 
406

 
(74
)
Total
 
$
8,418

 
$
9,943

 
$
(1,525
)

The Net Income from Water Operations for the three months ended June 30, 2017 and 2016 were impacted positively by a partial reversal of previously established tax provisions and a non-recurring expense reduction, respectively. During the three months ended June 30, 2017, new information caused the Company to undertake a review of its provision recorded associated with the repair deduction. While the Company maintains the belief that the deduction taken on its tax return is appropriate, the methodology for determining the deduction has not been agreed to by the taxing authorities.  During the Company’s review of the position, new information caused management to reassess the previously recorded provision related to Connecticut Water. The reassessment resulted in the reversal of a portion of the provision in the amount of $2,445,000. In addition, during the three months ended June 30, 2016, the Company reversed incorrectly recorded mark-to-market expense as an out-of-period adjustment resulting in a one-time benefit (reduction) of approximately $2.6 million in Operation and Maintenance expense. 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.

Revenue

Revenue from our regulated customers increased by $1,847,000, or 7.1%, to $27,902,000 for the three months ended June 30, 2017 when compared to the same period in 2016.  Approximately $1,017,000 of the increase in revenues was related to the acquisition of HVWC on February 27, 2017. The primary driver for the remaining $830,000 increase was primarily due to the higher WISC and WICA surcharges in Maine and Connecticut, respectively, during the quarter ended June 30, 2017.


28


Operation and Maintenance Expense

Operation and Maintenance (“O&M”) expense increased by $2,786,000, or 31.5%, for the three months ended June 30, 2017 when compared to the same period of 2016, including O&M expense incurred after the acquisition of HVWC which contributed $447,000 of incremental O&M expense during the period. The following table presents the components of O&M expense for the three months ending June 30, 2017 and 2016, both including and excluding the impact of the HVWC acquisition (in thousands):

Expense Components
 
June 30, 2017
 
June 30, 2016
 
Increase / (Decrease)
 
HVWC O&M
 
Adjusted Increase/(Decrease)
Mark-to-market
 
$
(4
)
 
$
(2,389
)
 
$
2,385

 
$

 
$
2,385

Utility costs
 
1,006

 
914

 
92

 
56

 
36

Outside services
 
899

 
802

 
97

 
62

 
35

Investor relations
 
251

 
218

 
33

 

 
33

Purchased water
 
386

 
359

 
27

 
1

 
26

Property liability insurance
 
394

 
359

 
35

 
12

 
23

Vehicles
 
466

 
441

 
25

 
12

 
13

Pension
 
702

 
693

 
9

 

 
9

Payroll
 
4,104

 
3,947

 
157

 
154

 
3

Post-retirement medical
 
87

 
101

 
(14
)
 

 
(14
)
Medical
 
522

 
569

 
(47
)
 
6

 
(53
)
Water treatment (including chemicals)
 
633

 
668

 
(35
)
 
30

 
(65
)
Customer
 
386

 
508

 
(122
)
 
2

 
(124
)
Other benefits
 
454

 
692

 
(238
)
 
2

 
(240
)
Other
 
1,340

 
958

 
382

 
110

 
272

Total
 
$
11,626

 
$
8,840

 
$
2,786

 
$
447

 
$
2,339


The increase in O&M expenses excluding the incremental expense as a result of the acquisition of HVWC, was approximately $2,339,000, or approximately 26.5%, in the three months ended June 30, 2017 when compared to the same period in 2016.  The changes in individual items, excluding the impact of HVWC, are described below:
The increase in mark-to-market expense was related to an out-of-period adjustment made during the second quarter of 2016 related to stock-based performance awards previously granted to officers of the Company. Prior to the correction made in the second quarter of 2016, the Company had mistakenly marked certain stock-based performance awards classified as equity awards to the market price of the Company’s common stock price at the end of each reporting period, including in the first quarter of 2016;
Utility costs increased in the period primarily due to an increase in communication and electrical costs, partially offset by a decrease in fuel oil costs;
The increase in Outside services was primarily due to higher legal fees and higher usage of outside labor during the three months ended June 30, 2017 when compared to the same period in 2016, partially offset by a decrease in consulting services during the period;
Investor relations costs increased primarily due to an increase in fees associated with the Company’s transfer agent during the three months ended June 30, 2017;
Purchased water costs increased primarily due to an increase in the amount of water purchased from neighboring utilities, particularly in the Company’s Shoreline and Naugatuck Regions in Connecticut; and
Pension costs increased primarily due to a decrease in the discount rate used in determining 2017 expense compared to the discount rate used to determine the 2016 expense. This increase was partially offset by the plan’s 2016 asset returns which were higher than expected and the Company’s $5.5 million contribution to the pension plan in the first half of 2016.  The higher asset value led to a higher expected return component in the 2017 expense as well as a lower recognized gain/loss component.

The increases described above were partially offset by the following decreases to O&M expense:
Other benefits decreased primarily due to costs associated with the Company’s performance stock plans;
Customer costs decreased due to a reduction in uncollectible accounts during the three months ended June 30, 2017;
Water treatment costs due to a decrease in the cost of chemicals used in the treatment process; and

29


Medical costs decreased in the quarter ending June 30, 2017 compared to the same period in 2016 primarily due to a reduction in medical claims filed by the Company’s employees and their families.

The Company saw an approximate $625,000, or 18.6%, increase in its Depreciation expense for the three months ended June 30, 2017 compared to the same period in 2016.  Of this increase, approximately $174,000 was attributable to the acquisition of HVWC. The remaining increase was primarily due to higher Utility Plant in Service as of June 30, 2017 compared to June 30, 2016, driven by the completion of a large treatment plant in Connecticut in the second quarter of 2017, the completion of the pipeline that serves UConn in the fourth quarter of 2016 and spending on WICA and WISC projects in Connecticut and Maine, respectively.

The Company recorded an Income Tax benefit of $624,000 in the three months ended June 30, 2017 compared to $589,000 of expense in the same period of 2016. The primary reason for the change in the three months ended June 30, 2017 was the Company’s review of the provision recorded related to tangible property regulations through the quarter ended June 30, 2017. New information caused management to change its previously estimated reserve for uncertain tax positions related to the adoption of the tangible property regulation. This change in estimate resulted in the reversal of a portion of the provision in the amount of $2,445,000 in the three months ended June 30, 2017. Excluding discrete items in three months ended June 30, 2017 and 2016, there is an increase in the effective tax rate year over year for of approximately 11%. The increase in the effective tax rate for this period can be attributed to a lower estimated repair deduction and a lower tax deductible pension contribution in 2017 than in 2016. Partially offsetting this decrease was approximately $126,000 of Income Tax expense related to HVWC for the three months ended June 30, 2017.

Other Income (Deductions), Net of Taxes decreased for the three months ended June 30, 2017 by $593,000. The primary driver of this decrease was an increase in costs associated with corporate development and costs associated with the HVWC and Avon Water acquisitions. Additionally, the Company saw a decrease in net income from the Company’s Service and Rentals segment during the three months ended June 30, 2017.

Total Interest and Debt Expense increased by $344,000 in the three months ended June 30, 2017 when compared to the same period in 2016. Of this increase, approximately $38,000 was attributable to the acquisition of HVWC. The remaining increase was primarily due to higher debt balances outstanding at June 30, 2017 when compared to June 30, 2016.

Six months ended June 30
Net Income for the six months ended June 30, 2017 decreased from the same period in the prior year by $605,000 to $12,486,000. Earnings per basic average common share decreased by $0.08 to $1.11 during the six months ended June 30, 2017.

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

Business Segment
 
June 30, 2017
 
June 30, 2016
 
Increase/(Decrease)
Water Operations
 
$
11,863

 
$
12,290

 
$
(427
)
Real Estate Transactions
 
33

 

 
33

Services and Rentals
 
590

 
801

 
(211
)
Total
 
$
12,486

 
$
13,091

 
$
(605
)

The Net Income from Water Operations for the six months ended June 30, 2017 and 2016 were impacted positively by a partial reversal of previously established tax provisions and a non-recurring expense reduction, respectively. During the six months ended June 30, 2017, new information caused the Company to undertake a review of its provision recorded associated with the repair deduction. While the Company maintains the belief that the deduction taken on its tax return is appropriate, the methodology for determining the deduction has not been agreed to by the taxing authorities.  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 the 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, for a total reversal of $3,609,000 during the six months ended June 30, 2017. During the six months ended June 30, 2016, the Company reversed incorrectly recorded mark-to-market expense as an out-of-period adjustment resulting in a one-time benefit (reduction)

30


of approximately $2.6 million in Operation and Maintenance expense. 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.

Revenue

Revenue from our regulated customers increased by $2,758,000, or 5.8%, to $50,365,000 for the six months ended June 30, 2017 when compared to the same period in 2016. Approximately $1,354,000 of the increase in revenues was related to the acquisition of HVWC on February 27, 2017. The primary driver for the remaining $1,404,000 increase was due to the higher WISC and WICA surcharges in Maine and Connecticut, respectively, during the six months ended June 30, 2017.

Operation and Maintenance Expense

O&M expense increased by $2,733,000, or 13.6%, for the six months ended June 30, 2017 when compared to the same period of 2016, including O&M expense incurred after the acquisition of HVWC on February 27, 2017 which contributed $570,000 of incremental O&M expense during the period. The following table presents the components of O&M expense for the six months ended June 30, 2017 and 2016, both including and excluding the impact of the HVWC acquisition (in thousands):

Expense Components
 
June 30, 2017
 
June 30, 2016
 
Increase / (Decrease)