YORK WATER CO 10-Q

Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations. (In thousands of dollars, except per share amounts) Forward-looking Statements Certain statements contained in this report on Form 10-Q constitute “forward-looking statements” within the meaning of Section 21E of the Securities Exchange Act of 1934 and Section 27A of the Securities Act of 1933. Words such as "may," "should," "believe," "anticipate," "estimate," "expect," "intend," "plan" and similar expressions are intended to identify forward-looking statements. These forward-looking statements include certain information relating to the Company’s business strategy; statements including, but not limited to: • the amount and timing of rate changes and other regulatory matters including the recovery of costs recorded as regulatory assets; • expected profitability and results of operations; • trends; • goals, priorities and plans for, and cost of, growth and expansion; • strategic initiatives; • availability of water supply; • water usage by customers; and • the ability to pay dividends on common stock and the rate of those dividends. The forward-looking statements in this report reflect what the Company currently anticipates will happen. What actually happens could differ materially from what it currently anticipates will happen. The Company does not intend to make a public announcement when forward-looking statements in this report are no longer accurate, whether as a result of new information, what actually happens in the future or for any other reason. Important matters that may affect what will actually happen include, but are not limited to: • changes in weather, including drought conditions or extended periods of heavy rainfall; • natural disasters, including pandemics such as the current outbreak of the novel strain of coronavirus known as “COVID-19” and the effectiveness of the Company’s pandemic plans; • levels of rate relief granted; • the level of commercial and industrial business activity within the Company's service territory; • construction of new housing within the Company's service territory and increases in population; • changes in government policies or regulations, including the tax code; • the ability to obtain permits for expansion projects; • material changes in demand from customers, including the impact of conservation efforts which may reduce the demand of customers for water; • changes in economic and business conditions, including interest rates; • loss of customers; • changes in, or unanticipated, capital requirements; • the impact of acquisitions; • changes in accounting pronouncements; • changes in the Company’s credit rating or the market price of its common stock; and • the ability to obtain financing. Page 16 Table of Contents General Information The primary business of the Company is to impound, purify to meet or exceed safe drinking water standards and distribute water. The Company also owns and operates two wastewater collection systems and five wastewater collection and treatment systems. The Company operates within its franchised water and wastewater territory, which covers portions of 51 municipalities within three counties in south-central Pennsylvania. The Company is regulated by the Pennsylvania Public Utility Commission, or PPUC, for both water and wastewater in the areas of billing, payment procedures, dispute processing, terminations, service territory, debt and equity financing and rate setting. The Company must obtain PPUC approval before changing any practices associated with the aforementioned areas. Water service is supplied through the Company's own distribution system. The Company obtains the bulk of its water supply from both the South Branch and East Branch of the Codorus Creek, which together have an average daily flow of 73.0 million gallons. This combined watershed area is approximately 117 square miles. The Company has two reservoirs, Lake Williams and Lake Redman, which together hold up to approximately 2.2 billion gallons of water. The Company supplements its reservoirs with a 15-mile pipeline from the Susquehanna River to Lake Redman which provides access to an additional supply of 12.0 million gallons of untreated water per day. The Company also owns nine wells which are capable of providing a safe yield of approximately 597,000 gallons per day to supply water to the customers of its satellite systems in Adams County. As of September 30, 2021, the Company's average daily availability was 35.6 million gallons, and average daily consumption was approximately 20.3 million gallons. The Company's service territory had an estimated population of 202,000 as of December 31, 2020. Industry within the Company's service territory is diversified, manufacturing such items as fixtures and furniture, electrical machinery, food products, paper, ordnance units, textile products, air conditioning systems, laundry detergent, barbells, and motorcycles. The Company's water business is somewhat dependent on weather conditions, particularly the amount and timing of rainfall. Revenues are particularly vulnerable to weather conditions in the summer months. Prolonged periods of hot and dry weather generally cause increased water usage for watering lawns, washing cars, and keeping golf courses and sports fields irrigated. Conversely, prolonged periods of dry weather could lead to drought restrictions from governmental authorities. Despite the Company’s adequate water supply, customers may be required to cut back water usage under such drought restrictions which would negatively impact revenues. The Company has addressed some of this vulnerability by instituting minimum customer charges which are intended to cover fixed costs of operations under all likely weather conditions. The Company’s business does not require large amounts of working capital and is not dependent on any single customer or a very few customers for a material portion of its business. Increases in revenues are generally dependent on the Company’s ability to obtain rate increases from the PPUC in a timely manner and in adequate amounts and to increase volumes of water sold through increased consumption and increases in the number of customers served. The Company continuously looks for water and wastewater acquisition and expansion opportunities both within and outside its current service territory as well as additional opportunities to enter into bulk water contracts with municipalities and other entities to supply water. The Company has agreements with several municipalities to provide sewer billing and collection services. The Company also has a service line protection program on a targeted basis in order to further diversify its business. Under this optional program, customers pay a fixed monthly fee, and the Company will repair or replace damaged customer service lines, as needed, subject to an annual maximum dollar amount. The Company continues to review and consider opportunities to expand both initiatives. Page 17 Table of Contents Impact of COVID-19 In December 2019, an outbreak of a novel strain of coronavirus (“COVID-19”) was reported. On March 11, 2020, the World Health Organization characterized COVID-19 as a pandemic. On March 6, 2020, Governor Tom Wolf signed an emergency disaster declaration for the Commonwealth of Pennsylvania which was extended for an additional ninety days five times, most recently on May 19, 2021. This emergency declaration was ended on June 16, 2021, by joint resolution of the Pennsylvania legislature. However, developments in this area continue at the local, state, and national levels and the Company continues to stay abreast of these developments. The Company has taken steps, consistent with directions from local, state, and federal authorities, to mitigate known risks with the health and safety of its employees and customers as its first priority. The Company is an essential, life-sustaining business and has continued normal operations. The Company continues to monitor guidance from state and local authorities and, although most restrictions have been lifted, has made some modifications to its operations in order to comply with Pennsylvania’s guidelines. This includes implementing enhanced safety procedures in its lobby and other measures such as holding virtual meetings and maintaining social distancing practices, when appropriate. These restrictions are not expected to materially impede the Company’s ability to complete its planned capital expenditures or acquisitions. The Company has not experienced any material supply chain disruptions. The Company has been informed of longer lead times for some items, although this does not impact daily operating supplies. The Company maintains an adequate inventory of critical repair parts which are available as needed. The Company continues to maintain relationships with its vendors to identify issues in a timely manner while also seeking out additional vendor relationships to diversify its supply chain. The Company has addressed the longer lead times by placing orders proactively with its vendors to align with current lead times. If the delays increase materially or if certain materials and supplies become unavailable, the Company may re-prioritize some of its capital projects or experience higher operating expenses or capital costs. The Company believes it has sufficient liquidity and access to the capital markets if needed. As a water and wastewater utility, it is the Company’s mission to provide uninterrupted water and wastewater service. Due to the effect of COVID-19 on the general public, in compliance with an order from the PPUC, the Company paused shut-off procedures for delinquent customers on March 13, 2020. In addition, the Company stopped billing late payment charges. These customers were billed at normal tariff rates for the water they used, and wastewater service provided. As allowed by the PPUC, the Company resumed normal shut-off procedures and began billing late payment charges for most customers in January 2021. Most remaining PPUC required customer protections specific to the COVID-19 pandemic fully expired on April 1, 2021 with the exception of the requirement to offer extended term payment agreements to certain “protected customers” as defined by PPUC order which expired on September 30, 2021. Certain customers are eligible to receive utility assistance made available through federal relief funds through organizations not related to the Company. The Company has begun to see demand by customer class revert back to close to pre-pandemic levels. However, the Company may continue to experience changes in demand as the response to this pandemic continues. The duration and magnitude of these changes is currently unknown and difficult to predict. To date, there has been no material impact on the Company’s workforce, operations, financial performance, liquidity, or supply chain as a result of COVID-19. However, the ultimate duration and severity of the pandemic or its effects on the economy, the capital and credit markets, or the Company’s workforce, customers, and suppliers, as well as governmental and regulatory responses, are uncertain. Results of Operations Three Months Ended September 30, 2021 Compared With Three Months Ended September 30, 2020 Net income for the third quarter of 2021 was $4,794, an increase of $90, or 1.9%, from net income of $4,704 for the same period of 2020. The primary contributing factors to the increase were lower income taxes and higher operating revenues which were partially offset by higher expenses. Page 18 Table of Contents Operating revenues for the third quarter of 2021 increased $246, or 1.7%, from $14,257 for the three months ended September 30, 2020 to $14,503 for the corresponding 2021 period. The increase was primarily due to revenues from the distribution system improvement charge, or DSIC, allowed by the PPUC of $255. The DSIC allows the Company to add a charge to customers’ water bills for qualified replacement costs of certain infrastructure without submitting a rate filing. Growth in the customer base also added to revenues. The average number of water customers served in 2021 increased as compared to 2020 by 760 customers, from 68,996 to 69,756 customers. The average number of wastewater customers served in 2021 increased as compared to 2020 by 256 customers, from 3,077 to 3,333 customers, due to acquisitions during 2020. Total per capita consumption for the third quarter of 2021 was approximately 1.8% lower than the same period of last year. Operating expenses for the third quarter of 2021 increased $583, or 8.1%, from $7,236 for the third quarter of 2020 to $7,819 for the corresponding 2021 period. The increase was primarily due to higher expenses of approximately $221 for wages, $177 for depreciation, $80 for wastewater treatment, $72 for outside services, $60 for water treatment and distribution system maintenance, and $49 for insurance. The increased expenses were partially offset by reduced expenses of $44 for a lower provision for uncollectible accounts. Other expenses decreased by a net of $32. Interest on debt for the third quarter of 2021 increased $85, or 7.4%, from $1,152 for the third quarter of 2020 to $1,237 for the corresponding 2021 period. The increase was primarily due to an increase in long-term debt outstanding. The average debt outstanding under the lines of credit was $12,911 for the third quarter of 2021 and $10,595 for the third quarter of 2020. The weighted average interest rate on the lines of credit was 1.30% for the quarter ended September 30, 2021 and 1.41% for the quarter ended September 30, 2020. Allowance for funds used during construction increased $195, from $115 in the third quarter of 2020 to $310 in the corresponding 2021 period due to a higher volume of eligible construction. Other income (expenses), net for the third quarter of 2021 reflects decreased expenses of $7 as compared to the same period of 2020. Higher earnings on life insurance policies of approximately $11 were the primary reasons for the decrease. Other expenses increased by a net of $4. Income taxes for the third quarter of 2021 decreased $273, or 30.4%, compared to the same period of 2020 primarily due to higher deductions from the Internal Revenue Service, or IRS, tangible property regulations, or TPR. The Company’s effective tax rate was 11.5% for the third quarter of 2021 and 16.0% for the third quarter of 2020. Nine Months Ended September 30, 2021 Compared With Nine Months Ended September 30, 2020 Net income for the first nine months of 2021 was $12,983, an increase of $95, or 0.7%, from net income of $12,888 for the same period of 2020. The primary contributing factors to the increase were lower income taxes and higher operating revenues which were partially offset by higher expenses and a prior year gain on life insurance, not repeated this year. Operating revenues for the first nine months of 2021 increased $931, or 2.3%, from $40,454 for the nine months ended September 30, 2020 to $41,385 for the corresponding 2021 period. The increase was primarily due to growth in the customer base and revenues from the DSIC of $280. The average number of water customers served in 2021 increased as compared to 2020 by 775 customers, from 68,790 to 69,565 customers. The average number of wastewater customers served in 2021 increased as compared to 2020 by 298 customers, from 3,018 to 3,316 customers, due to acquisitions during 2020. Total per capita consumption for the first nine months of 2021 was approximately 1.1% higher than the same period of last year, but residential demand decreased. Additional billing and revenue collection services also added to revenues. For the remainder of the year, the Company expects revenues to show a modest increase due to the revenues from the DSIC. An increase in the number of water and wastewater customers from acquisitions and growth within the Company’s service territory are also expected to add to revenues. The duration and severity of the COVID-19 pandemic including any resulting economic slowdown or changes in consumption patterns could impact results. Other regulatory actions and weather patterns could also impact results. Page 19 Table of Contents Operating expenses for the first nine months of 2021 increased $1,921, or 8.9%, from $21,524 for the first nine months of 2020 to $23,445 for the corresponding 2021 period. The increase was primarily due to higher expenses of approximately $482 for depreciation, $375 for wages, $365 for wastewater treatment, $283 for insurance, $277 for water treatment and distribution system maintenance, and $126 for outside services. Other expenses increased by a net of $161. The increased expenses were partially offset by reduced expenses of $92 for purchased power and $56 for a lower provision for uncollectible accounts. For the remainder of the year, the Company expects depreciation expense to continue to rise due to additional investment in utility plant, and other expenses to increase at a moderate rate as costs to treat water and wastewater, and to maintain and extend the distribution system, continue to rise. Interest on debt for the first nine months of 2021 increased $170 or 4.9%, from $3,503 for the first nine months of 2020 to $3,673 for the corresponding 2021 period. The increase was primarily due to an increase in long-term debt outstanding. The average debt outstanding under the lines of credit was $9,405 for both the first nine months of 2021 and the first nine months of 2020. The weighted average interest rate on the lines of credit was 1.30% for the nine months ended September 30, 2021 and 1.99% for the nine months ended September 30, 2020. Interest expense for the remainder of the year is expected to be slightly higher due to continued borrowings under the line of credit. Allowance for funds used during construction increased $553, from $330 in the first nine months of 2020 to $883 in the corresponding 2021 period due to a higher volume of eligible construction. Allowance for funds used during construction for the remainder of the year is expected to increase based on a projected increase in the amount of eligible construction. A non-recurring gain on life insurance of $515 was recorded in the first nine months of 2020 as a result of a death benefit from a life insurance policy. No similar gains are anticipated at this time. Other income (expenses), net for the first nine months of 2021 reflects decreased expenses of $108 as compared to the same period of 2020. Higher earnings on life insurance policies of approximately $71 and lower charitable contributions of $34 were the primary reasons for the decrease. Other expenses decreased by a net of $3. For the remainder of the year, other income (expenses) will be largely determined by the change in market returns and discount rates for retirement programs and related assets. Income taxes for the first nine months of 2021 decreased $998, or 48.1%, compared to the same period of 2020 primarily due to higher deductions from the IRS TPR. The Company’s effective tax rate was 7.7% for the first nine months of 2021 and 13.9% for the first nine months of 2020. The Company's effective tax rate for the remainder of 2021 will largely be determined by the level of eligible asset improvements expensed for tax purposes under TPR each period. Rate Matters See Note 9 to the financial statements included herein for a discussion of rate matters. Effective October 1, 2021, the Company's tariff included a distribution system improvement charge on revenues of 2.60%. The Company does not expect to file a rate increase request in 2021. Page 20 Table of Contents Acquisitions and Growth On July 30, 2021, the Company signed an agreement to purchase the water assets of Scott Water Company in Greene Township, Franklin County, Pennsylvania. Completion of the acquisition is contingent upon receiving approval from all required regulatory authorities. Closing is expected in the third quarter of 2022 at which time the Company will add approximately 25 water customers. On April 22, 2021, the Company signed an agreement to purchase the water assets and wastewater collection and treatment assets jointly owned by Letterkenny Industrial Development Authority and Franklin County General Authority in Letterkenny and Greene Townships, Franklin County, Pennsylvania. Completion of the acquisition is contingent upon receiving approval from all required regulatory authorities. Closing is expected in the second quarter of 2022 at which time the Company will add approximately 90 water and wastewater customers. On May 27, 2020, the Company signed an agreement to purchase the water assets and wastewater collection and treatment assets of Country View Manor Community, LLC in Washington Township, York County, Pennsylvania. Completion of the acquisition is contingent upon receiving approval from all required regulatory authorities. Closing is expected in the second quarter of 2022 at which time the Company will add approximately 50 water and wastewater customers. On March 4, 2019, the Company signed an agreement to purchase the wastewater collection assets of West Manheim Township in York County, Pennsylvania. Completion of the acquisition is contingent upon receiving approval from all required regulatory authorities. Closing is expected in 2021 at which time the Company will add approximately 1,800 wastewater customers. These wastewater customers are currently water customers of the Company. On October 8, 2013, the Company signed an agreement to purchase the wastewater collection and treatment assets of SYC WWTP, L.P. in Shrewsbury and Springfield Townships, York County, Pennsylvania. On July 1, 2020, the Company signed an agreement to purchase the Albright Trailer Park water assets and wastewater collection assets of R.T. Barclay, Inc. in Springfield Township, York County, Pennsylvania. Completion of the acquisitions is contingent upon receiving approval from all required regulatory authorities. Closing is expected in the second quarter of 2022, at which time the Company will add approximately 90 combined wastewater customers and approximately 60 water customers t hrough an interconnection with its current water distribution system. The wastewater customers of the Albright Trailer Park are currently served by SYC WWTP, L.P. and the water customers are currently served by the Company, each through a single customer connection to the park. In total, these acquisitions are expected to be immaterial to Company results. The Company is also pursuing other bulk water contracts and acquisitions in and around its service territory to help offset any further declines in per capita water consumption and to grow its business. On May 10, 2017, the Company signed an emergency interconnect agreement with Dallastown-Yoe Water Authority. The effectiveness of this agreement is contingent upon receiving approval from all required regulatory authorities. Approval is expected to be granted in 2022 at which time the Company will begin construction of a water main extension to a single point of interconnection and either supply a minimum agreed upon amount of water to the authority, receive a payment in lieu of water, or provide water during an emergency, at current tariff rates. Capital Expenditures For the nine months ended September 30, 2021, the Company invested $27,434 in construction expenditures for routine items and an upgrade to the enterprise software system as well as various replacements and improvements to infrastructure. The Company was able to fund construction expenditures using internally-generated funds, line of credit borrowings, proceeds from its stock purchase plans and customer advances and contributions from developers, municipalities, customers, or builders. Page 21 Table of Contents The Company anticipates construction expenditures for the remainder of 2021 of approximately $7,600 exclusive of any potential acquisitions not yet approved. In addition to routine transmission and distribution projects, a portion of the anticipated expenditures will be for additional main extensions, an elevated water tank, completion of a wastewater treatment plant, and various replacements and improvements to infrastructure. The Company intends to use primarily internally-generated funds for its anticipated construction and fund the remainder through cash, line of credit borrowings, proceeds from its stock purchase plans and customer advances and contributions. Customer advances and contributions are expected to account for between 5% and 10% of funding requirements during the remainder of 2021. The Company believes it will have adequate credit facilities and access to the capital markets, if necessary, to meet its anticipated capital needs in the remainder of 2021 and 2022. Liquidity and Capital Resources Cash The Company manages its cash through a cash management account that is directly connected to its line of credit. Excess cash generated automatically pays down outstanding borrowings under the line of credit arrangement. If there are no outstanding borrowings, the cash is used as an earnings credit to reduce banking fees. Likewise, if additional funds are needed beyond what is generated internally for payroll, to pay suppliers, to fund capital expenditures, or to pay debt service, funds are automatically borrowed under the line of credit. As of September 30, 2021, the Company borrowed $15,192 on its line of credit and incurred a cash overdraft on its cash management account of $1,277. The cash and the cash management facility connected to the line of credit are expected to provide the necessary liquidity and funding for the Company's operations, capital expenditures, acquisitions, and potential buybacks of stock for the foreseeable future. Accounts Receivable The accounts receivable balance tends to follow the change in revenues but is also affected by the timeliness of payments by customers and the level of the reserve for doubtful accounts. For the three months ended September 30, 2021, a strengthening in the timeliness of payments, compared to the end of 2020, resulted in a decrease in accounts receivable – customers. A reserve is maintained at a level considered adequate to provide for losses that can be reasonably anticipated based on inactive accounts with outstanding balances. Management periodically evaluates the adequacy of the reserve based on past experience, agings of the receivables, adverse situations that may affect a customer’s ability to pay, current economic conditions, and other relevant factors. During 2021, management’s assessment included consideration of the COVID-19 pandemic along with past trends during times of economic instability and regulations from the PPUC regarding customer turn-offs and collections and determined its allowance for doubtful accounts should remain elevated compared to historical norms. If the status of these factors deteriorates, the Company may incur additional expenses for uncollectible accounts and experience a reduction in its internally-generated funds. Internally-generated Funds The amount of internally-generated funds available for operations and construction depends on the Company’s ability to obtain timely and adequate rate relief, changes in regulations including taxes, customers’ water usage, weather conditions, customer growth and controlled expenses. During the first nine months of 2021, the Company generated $18,476 internally from operations as compared to the $16,306 it generated during the first nine months of 2020, primarily due to lower income taxes paid and a decrease in accounts receivable – customers due to a strengthening in the timeliness of payments. Credit Lines Historically, the Company has borrowed $15,000 to $20,000 under its lines of credit before refinancing with long-term debt or equity capital. As of September 30, 2021, the Company maintained an unsecured line of credit in the amount of $50,000 at an interest rate of LIBOR plus 1.05% with an unused commitment fee and an interest rate floor. The Company had $15,192 in outstanding borrowings under its line of credit as of September 30, 2021. The interest rate on the line of credit borrowings as of September 30, 2021 was 1.30%. In the third quarter, the Company renewed its committed line of credit and extended the maturity date to September 2023. Page 22 Table of Contents The Company has taken steps to manage the risk of reduced credit availability. It has established a committed line of credit with an increase in the total amount available and a 2-year revolving maturity that cannot be called on demand. There is no guarantee that the Company will be able to obtain sufficient lines of credit with favorable terms in the future. If the Company is unable to obtain sufficient lines of credit or to refinance its line of credit borrowings with long-term debt or equity when necessary, it may have to eliminate or postpone capital expenditures. Management believes the Company will have adequate capacity under its current lines of credit to meet anticipated financing needs throughout 2021 and 2022. Long-term Debt The Company’s loan agreements contain various covenants and restrictions. Management believes it is currently in compliance with all of these restrictions. See Note 6 to the financial statements included in the Company's Annual Report on Form 10-K for the year ended December 31, 2020 for additional information regarding these restrictions. The Company’s total long-term debt as a percentage of the total capitalization, defined as total common stockholders’ equity plus total long-term debt, was 47.3% as of September 30, 2021, compared with 46.9% as of December 31, 2020. The Company expects to allow the debt percentage to trend upward until it approaches fifty percent before considering additional equity. A debt to total capitalization ratio between forty-six and fifty percent has historically been acceptable to the PPUC in rate filings. Due to its ability to generate more cash internally, the Company has been able to keep its ratio below fifty percent. The variable rate line of credit and the interest rate swap of the Company use the LIBOR as a benchmark for establishing the rates. The United Kingdom’s Financial Conduct Authority, which regulates LIBOR, has announced that it intends to stop encouraging or compelling banks to submit rates for the calculation of LIBOR rates. For most LIBOR rates, the cessation date is expected to be June 30, 2023. The Company’s line of credit agreement explicitly states that another index may be used if LIBOR is discontinued or otherwise unavailable. The Company believes that it is implicit in its other agreements that a successor rate to LIBOR may be used. The Company is not yet aware what successor rate will be used and therefore cannot estimate the impact to the Company’s financial position, results of operations and cash flows, but it could include an increase in the cost of the variable rate indebtedness. Income Taxes, Deferred Income Taxes and Uncertain Tax Positions The Company filed for a change in accounting method under the IRS TPR effective in 2014. Under the change in accounting method, the Company is permitted to deduct the costs of certain asset improvements that were previously being capitalized and depreciated for tax purposes as an expense on its income tax return. This ongoing deduction results in a reduction in the effective income tax rate, a net reduction in income tax expense, and a reduction in the amount of income taxes currently payable. It also results in increases to deferred tax liabilities and regulatory assets representing the appropriate book and tax basis difference on capital additions. The Company expects to continue to expense these asset improvements in the future. The Company’s effective tax rate will largely be determined by the level of eligible asset improvements expensed for tax purposes that would have been capitalized for tax purposes prior to the implementation of TPR. The Company has a substantial deferred income tax asset primarily due to the excess accumulated deferred income taxes on accelerated depreciation from the 2017 Tax Act and the differences between the book and tax balances of the customers’ advances for construction and contributions in aid of construction and deferred compensation plans. The Company does not believe a valuation allowance is required due to the expected generation of future taxable income during the periods in which those temporary differences become deductible. The Company has seen an increase in its deferred income tax liability amounts primarily as a result of the accelerated depreciation deduction available for federal tax purposes which creates differences between book and tax depreciation expense. The Company expects this trend to continue as it makes significant investments in capital expenditures subject to accelerated depreciation or TPR. The Company has determined there are no uncertain tax positions that require recognition as of September 30, 2021. Page 23 Table of Contents Common Stock Common stockholders’ equity as a percent of the total capitalization was 52.7% as of September 30, 2021, compared with 53.1% as of December 31, 2020. The volume of share repurchases and higher debt from capital expenditures, among other things, could reduce this percentage in the future. It is the Company’s general intent to target a ratio between fifty and fifty-four percent. The Company has an effective “shelf” Registration Statement on Form S-3 on file with the Securities and Exchange Commission, pursuant to which the Company may offer an aggregate remaining amount of up to $50,000 of its common stock or debt securities subject to market conditions at the time of any such offering. Credit Rating On October 8, 2021, Standard & Poor’s affirmed the Company’s credit rating at A-, with a stable outlook and adequate liquidity. The Company’s ability to maintain its credit rating depends, among other things, on adequate and timely rate relief, which it has been successful in obtaining, its ability to fund capital expenditures in a balanced manner using both debt and equity and its ability to generate cash flow. The Company’s objectives are to continue to maximize its funds provided by operations and maintain a strong capital structure in order to be able to attract capital. Physical and Cyber Security The Company maintains security measures at its facilities, and collaborates with federal, state, and local authorities and industry trade associations regarding information on possible threats and security measures for water and wastewater utility operations. The costs incurred are expected to be recoverable in water and wastewater rates and are not expected to have a material impact on its business, financial condition, or results of operations. The Company relies on information technology systems in connection with the operation of the business, especially with respect to customer service, billing, accounting, and in some cases, the monitoring and operation of treatment, storage, and pumping facilities. In addition, the Company relies on these systems to track utility assets and to manage maintenance and construction projects, materials and supplies, and human resource functions. The information technology systems may be vulnerable to damage or interruption from cyber security attacks or other cyber-related events, including, but not limited to, power loss, computer systems failures, internet, telecommunications or data network failures, physical and electronic loss of data, computer viruses, intentional security breaches, hacking, denial of service actions, misappropriation of data, and similar events. In some cases, administration of certain functions may be outsourced to third-party service providers that could also be targets of cyber security attacks. A loss of these systems, or major problems with the operation of these systems, could harm the business, financial condition, and results of operations of the Company through the loss or compromise of customer, financial, employee, or operational data, disruption of billing, collections or normal field service activities, disruption of electronic monitoring and control of operational systems, and delays in financial reporting and other normal management functions. Possible impacts associated with a cyber security attack or other events may include remediation costs related to lost, stolen, or compromised data, repairs to data processing systems, increased cyber security protection costs, adverse effects on our compliance with regulatory and environmental laws and regulation, including standards for drinking water, litigation, and reputational damage. The Company has implemented processes, procedures, and controls to prevent or limit the effect of these possible events, and maintains insurance to help defray costs associated with cyber security attacks. The Company has not experienced a material impact on business or operations from these attacks. Although the Company does not believe its systems are at a materially greater risk of cyber security attacks than other similar organizations and despite the implementation of robust security measures, the Company cannot provide assurance that the insurance will fully cover the costs of a cyber security event, and its robust security measures do not guarantee that reputation and financial results will not be adversely affected by such an incident. Page 24 Table of Contents Environmental Matters The Company entered into a consent order agreement with the Pennsylvania Department of Environmental Protection in December 2016 after the Company determined it exceeded the action level for lead as established by the Lead and Copper Rule, or LCR, issued by the U.S. Environmental Protection Agency. The Company did not have an exceedance in any subsequent compliance test. Under the agreement, the Company successfully completed its commitment to exceed the LCR replacement schedule by replacing all the known company-owned lead service lines within four years from the agreement. Any additional company-owned lead service lines that are discovered will be replaced and included in utility plant but are not expected to have a material impact on the financial position of the Company. The Company was granted approval by the PPUC to modify its tariff to include the cost of the annual replacement of up to 400 lead customer-owned service lines over nine years from the agreement. The tariff modification allows the Company to replace customer-owned service lines at its own initial cost. The Company will record the costs as a regulatory asset to be recovered in future base rates to customers, over a four-year period. The cost for the customer-owned lead service line replacements was approximately $1,307 and $1,204 through September 30, 2021 and December 31, 2020, respectively, and is included as a regulatory asset. Based on its experience, the Company estimates that lead customer-owned service lines replacements will cost $1,500. This estimate is subject to adjustment as more facts become available. Critical Accounting Estimates The methods, estimates, and judgments the Company used in applying its accounting policies have a significant impact on the results reported in its financial statements. The Company’s accounting policies require management to make subjective judgments because of the need to make estimates of matters that are inherently uncertain. The Company’s most critical accounting estimates include regulatory assets and liabilities, revenue recognition, accounting for its pension plans, and income taxes. There has been no significant change in accounting estimates or the method of estimation during the quarter ended September 30, 2021. Off-Balance Sheet Arrangements The Company does not use off-balance sheet transactions, arrangements or obligations that may have a material current or future effect on financial condition, results of operations, liquidity, capital expenditures, capital resources or significant components of revenues or expenses. The Company does not use securitization of receivables or unconsolidated entities. For risk management purposes, the Company uses a derivative financial instrument, an interest rate swap agreement discussed in Note 5 to the financial statements included herein. The Company does not engage in trading or other risk management activities, does not use other derivative financial instruments for any purpose, has no guarantees and does not have material transactions involving related parties. Page 25 Table of Contents Item 3. Quantitative and Qualitative Disclosures About Market Risk. Not applicable.