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

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

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The following discussion should be read together with the consolidated financial statements and the notes thereto included elsewhere in this Form 10-K. This discussion contains forward-looking statements that are based on management’s current expectations, estimates and projections about our business, operations and financial performance. The cautionary statements made in this Form 10-K should be read as applying to all related forward-looking statements whenever they appear in this Form 10-K. Our actual results may differ materially from those currently anticipated and expressed in such forward-looking statements as a result of a number of factors, including those we discuss under “Forward-Looking Statements,” Item 1A—Risk Factors and elsewhere in this Form 10-K.

Executive Overview

Through its subsidiaries, American Water is the largest and most geographically diverse investor-owned publicly-traded water and wastewater utility company in the United States, as measured by both operating revenues and population served. We employ approximately 6,800 professionals who provide drinking water, wastewater and other related services to an estimated 15 million people in 47 states, the District of Columbia and Ontario, Canada. Our primary business involves the ownership of utilities that provide water and wastewater services to residential, commercial, industrial and other customers, including sale for resale and public authority customers. Our Regulated Businesses that provide these services are generally subject to economic regulation by certain state utility commissions or other entities engaged in utility regulation. Certain federal and state governments also regulate environmental, health and safety, and water quality matters. Our Regulated Businesses provide services in 16 states and serve approximately 3.3 million customers based on the number of active service connections to our water and wastewater networks. We also operate several businesses that provide a broad range of related and complementary water and wastewater services in four operating segments that individually do not meet the criteria of a reportable segment in accordance with GAAP. These four non-reportable operating segments are collectively presented as our Market-Based Businesses, which is consistent with how management assesses the results of these businesses.

2016 Strategic Focus & Achievements

For 2016, our focus was anchored on five central strategic themes:

•Customer – One of our core values is putting our customers at the center of everything we do.
•In 2016, we achieved a customer satisfaction rating in the top quartile among our water industry peers and achieved a service quality rating of 85%, which also placed us in the top quartile compared to our water industry peers;
•We launched a comprehensive customer experience initiative designed to enhance our quality of service and make it easier for customers to do business with us;
•We continued to make needed infrastructure investment while implementing operational efficiency improvements to keep customer rates affordable; and
•Our drinking water system quality was 21 times better than the industry average.
•Safety – The health and safety of our employees, customers and the public is both a strategy and a value.
•In 2016, our focus continued on putting safety first. We finished 2016 with fewer employee injuries than in the prior year, we enhanced accident prevention and risk mitigation through our “near miss” reporting program and we achieved a stronger safety culture as measured by employee responses in the Company’s culture survey. Our safety council, consisting of management and labor employees from across the Company, continued their mission of developing and implementing recommendations to reinforce the Company’s commitment to safety. In addition, we hold our vendors accountable to the same safety standards as our Company.
•People – Our employees and culture are paramount to our success.
•In 2016, we continued to demonstrate our commitment to employees by providing safety and technical training throughout the Company and expanding training and development offerings for supervisors and individual employees. We enhanced and developed robust succession plans for key leadership roles across the company and we continued to provide competitive compensation and benefits to retain and attract a highly skilled and diverse workforce.
•Growth – We invested $1.5 billion in 2016; a record level of annual investment since the Company went public in 2008 including:
•$1.3 billion of which the majority was in our Regulated Businesses primarily to improve infrastructure; and
•$199 million for completed regulated acquisitions, adding approximately 42,000 water and wastewater customers. Included was the purchase of substantially all of the wastewater collection and treatment assets of the Sewer Authority of the City of Scranton by Pennsylvania-American Water Company (“PAWC”) on December 29, 2016. This acquisition alone added approximately 31,000 wastewater customers in the City of Scranton and Dunmore Borough, Pennsylvania.
•In addition to the acquisitions that closed in 2016 adding approximately 42,000 water and wastewater customers discussed above, we also entered into a number of agreements for which the closing of the transactions remain pending. These pending transactions represent the potential addition of approximately 40,000 new water and wastewater customers. The largest of the pending acquisitions include:
▪Shorelands Water Company, New Jersey: Shorelands currently provides water service to approximately 11,000 customers in Monmouth County, New Jersey. On August 2, 2016, we agreed to acquire all of the capital stock of Shorelands Water Company (“Shorelands”) in exchange for an equivalent value of our common stock. The maximum number of shares of our common stock to be exchanged upon closing of this acquisition will be less than 500,000 and will be based upon the average price of our common stock. The closing of this acquisition is subject to the satisfaction of various conditions and compliance by the parties with certain covenants, including obtaining the approval of the New Jersey Board of Public Utilities. The Company is seeking to close the acquisition in the first half of 2017.
▪Municipal Authority of the City of McKeesport, Pennsylvania: The system currently represents approximately 22,000 wastewater customers. On September 9, 2016, PAWC signed an asset purchase agreement to acquire substantially all of the wastewater collection and treatment system assets of the Municipal Authority of the City of McKeesport, Pennsylvania for approximately $156 million, subject to certain adjustments provided in the agreement. In connection with the execution of this agreement, a $5 million non-escrowed deposit was also paid. The closing of this acquisition is subject to the satisfaction of various conditions and covenants, including obtaining the approval of the Pennsylvania Public Utility Commission. We are seeking to close this acquisition in the second half of 2017.
•Technology and Operational Efficiency – We drove continued cost savings into our businesses.
•Our Regulated Businesses achieved an adjusted O&M efficiency ratio (a non-GAAP measure) of 34.9% in 2016;

Our adjusted O&M efficiency ratio for the year ended December 31, 2016 was 34.9%, compared to 35.9% and 36.7% for the years ended December 31, 2015 and 2014, respectively. The improvement in the 2016 adjusted O&M efficiency ratio over the 2015 ratio was primarily attributable to an increase in revenue. The improvement in the 2015 adjusted O&M efficiency ratio over the 2014 ratio was attributable to both an increase in revenue and decreases in O&M expenses.

Our adjusted O&M efficiency ratio is defined as our regulated O&M expenses divided by regulated operating revenues, where both O&M expenses and operating revenues were adjusted to eliminate purchased water expense. Additionally, from the O&M expenses, we excluded the allocable portion of non-O&M support services cost, mainly depreciation and general taxes that are reflected in the Regulated Businesses segment as O&M expenses but for consolidated financial reporting purposes are categorized within other line items in the accompanying Consolidated Statements of Operations. In addition to the standard adjustments to the O&M efficiency ratio for the year ended December 31, 2016, we have also excluded from operating revenues and O&M expenses the impact from the binding global agreement in principle related to the Freedom Industries chemical spill in West Virginia. Also, for the year ended December 31, 2014, we have also excluded from operating revenues and O&M expenses the estimated impact to revenue and O&M attributable to changes in consumption as a result of abnormal weather and the costs associated with the Freedom Industries chemical spill, as applicable. We excluded all the above items from the calculation as we believe such items are not reflective of management’s ability to increase efficiency of the Company’s regulated operations.

We evaluate our operating performance using this measure because management believes it is a direct measure of the improvement to the efficiency of our Regulated Businesses’ operations. This information is intended to enhance an investor’s overall understanding of our operating performance. The O&M efficiency ratio is not a GAAP financial measure and may not be comparable to other companies’ operating measures and should not be used in place of the GAAP information provided elsewhere in this report.

The following table provides the calculation and reconciliation that compares O&M expenses and operating revenues, as determined in accordance with GAAP, to those amounts utilized in the calculation of our adjusted O&M efficiency ratio for the years ended December 31:

201620152014
(in millions)
Total operation and maintenance expenses$1,504$1,404$1,350
Less:
Operation and maintenance expenses—Market-Based Businesses372358289
Operation and maintenance expenses—Other(44)(49)(51)
Total regulated operation and maintenance expenses1,1761,0951,112
Less:
Regulated purchased water expenses122117122
Allocation of non-operation and maintenance expenses303539
Impact of Freedom Industries chemical spill in West Virginia——10
Impact of binding global agreement in principle65——
Estimated impact of weather——(2)
Adjusted regulated operation and maintenance expenses (a)$959$943$943
Total operating revenues$3,302$3,159$3,011
Less:
Operating revenues—Market-Based Businesses451434355
Operating revenues—Other(20)(18)(18)
Total regulated operating revenues2,8712,7432,674
Less:
Regulated purchased water revenues*122117122
Add:
Impact of Freedom Industries chemical spill in West Virginia——1
Estimated impact of weather——17
Adjusted regulated operating revenues (b)$2,749$2,626$2,570
Adjusted O&M efficiency ratio (a)/(b)34.9%35.9%36.7%
*Note calculation assumes purchased water revenues approximate purchased water expenses.
•We implemented an enterprise resource planning system in our Market-Based Businesses to integrate and enhance operations, customer service and support services; and
•We initiated a strategic technology program designed to leverage technological advancements to enhance customer experience, drive operational efficiency, provide data integration and analytics, and enhance security. In addition, we implemented improved technology tools to enhance communication, collaboration and mobility, including a new comprehensive technology roadmap that will help our operations and support employees in providing even better customer experiences in the future.

2016 Financial Results

Highlights of our diluted earnings per share and adjusted diluted earnings per share for the years ended December 31, 2016, 2015 and 2014 are as follows:

201620152014
Income from continuing operations$2.62$2.64$2.39
Loss from discontinued operations, net of tax (a)——(0.04)
Diluted earnings per share$2.62$2.64$2.35
Add back: Non-GAAP adjustment:
Impact of the binding global agreement in principle (b)0.36——
Tax impact(0.14)——
Non-GAAP adjustment impact on diluted earnings per share0.22——
Adjusted diluted earnings per share$2.84$2.64$2.35
(a)Discontinued operations represents the 2014 sale of our Terratec line of business, which was part of our Market-Based Businesses. The loss from discontinued operations, net of tax, reflected in the 2014 financial results includes the loss on the sale, an income tax valuation allowance and the 2014 operating results of the entity prior to the sale. See Note 3—Acquisitions and Divestitures in the Notes to Consolidated Financial Statements for further details on our discontinued operations.
(b)See Item 3—Legal Proceedings and Note 15—Commitments and Contingencies in the Notes to Consolidated Financial Statements included in Item 8—Consolidated Financial Statements in this Form 10-K.

Income from continuing operations decreased 2 cents per diluted share, or 0.8%, for the year ended December 31, 2016 compared to the prior year. Included in the 2016 amount was the after-tax charge of $39 million, or $0.22 per diluted share, resulting from the binding global agreement in principle related to the Freedom Industries chemical spill. Excluding this charge, income from continuing operations increased $0.20 per diluted share, or approximately 7.6%. This increase was mainly due to continued strong growth in our Regulated Businesses. For further detailed discussion of the consolidated results of operations, as well as the financial results of our business segments, see “Comparison of Consolidated Results of Operations” and “Segment Results of Operations”.

Adjusted diluted earnings per share represents a non-GAAP financial measure and excludes the impact of the Settlement. We believe that this non-GAAP measure provides useful information by excluding such matters that may not be indicative of our on-going operating results. We believe this non-GAAP measure will allow for better evaluation of the operating performance of the business and facilitate a meaningful comparison of our results in the current year to those in prior years. The non-GAAP financial information should be considered in addition to, not as a substitute for, measures of financial performance prepared in accordance with U.S. GAAP. In addition, our non-GAAP measure may not be comparable to similarly titled non-GAAP measures of other companies.

Regulatory Matters

The table below provides rate authorizations effective from 2014 through 2016. The table depicts annualized incremental revenues assuming a constant water sales volume:

For the Years Ended December 31,
201620152014
(In millions)
General rate cases by state
Indiana (a)$2$5$—
West Virginia (b)18——
Missouri (c)5——
Kentucky (d)7——
New Jersey (e)—22—
California (f)252
Iowa (g)——4
Other—1—
Total General rate cases$34$33$6
(a)New rates effective January 29 of each year.
(b)New rates effective February 25, 2016.
(c)New rates effective July 20 and 22, 2016.
(d)New rates effective August 28, 2016.
(e)New rates effective September 21, 2015.
(f)Step rates for 2016 and 2015 effective January 1. The 2014 increase is from step rate and attrition year filing with rates effective on April 1, 2014.
(g)New rates effective April 18, 2014, including $3 million of interim rates effective May 10, 2013.

On December 13, 2016 we received a decision on our general rate case in Illinois authorizing additional annualized revenues of $26 million effective on January 1, 2017.

On February 1, 2016, Cal Am received approval from the CPUC to extend its cost of capital proceeding for an additional year. Subsequently, Cal Am has requested to extend its current authorized cost of capital which is scheduled to expire on December 31, 2017 for an additional year. If no extension is received by March 31, 2017, Cal Am will file its cost of capital application as scheduled.

During the first quarter of 2017, Cal Am received approval from the CPUC for step rates authorizing additional annualized revenues of $5 million effective on various dates between January 13, 2017 and February 2, 2017.

A number of states have authorized the use of regulatory mechanisms that permit rates to be adjusted outside of a general rate case for certain costs and investments, such as infrastructure surcharge mechanisms that permit recovery of capital investments to replace aging infrastructure. The following table details additional annualized revenues authorized through infrastructure surcharge mechanisms that were effective from 2014 through 2016:

For the Years Ended December 31,
201620152014
(In millions)
Infrastructure charges by state
Pennsylvania (a)$28$14$—
New Jersey (b)19917
Missouri (c)—213
Indiana (d)3——
Illinois (e)762
New York (f)—12
Tennessee (g)221
Total Infrastructure charges$59$34$35
(a)Quarterly filings in 2016 for $11 million, $2 million, $6 million and $9 million effective the first day of the calendar quarter for January, April, July and October, respectively. For 2015, $2 million, $4 million and $8 million effective April 1, July 1 and October 1, 2015, respectively. No infrastructure charges in 2014 as the general rate case effective January 1, 2014, included a forecasted test year.
(b)Semi-annual filings in 2016, $9 million effective June 1, 2016 and $10 million effective December 1, 2016. For 2015, $9 million effective January 1, 2015. For 2014, $7 million and $10 million effective July 1, 2014 and January 1, 2014.
(c)2015 effective date was June 27, 2015. For 2014, $9 million and $4 million effective December 31, 2014 and May 30, 2014.
(d)Effective May 4, 2016.
(e)For 2016, $1 million effective January 1 and $6 million effective August 1. For 2015, $1 million and $5 million effective February 1 and January 1. For 2014, $2 million effective January 1.
(f)For 2015, effective date is December 1. For 2014, $1 million effective January 1 and March 3.
(g)Effective dates of March 15, 2016, June 29, 2015 and April 15, 2014.

On December 2, 2016, infrastructure charges amounting to additional annualized revenues of $2 million was approved for our West Virginia subsidiary and became effective on January 1, 2017. Also, on January 1, 2017, $1 million of additional annualized revenues from infrastructure charges for our Pennsylvania subsidiary were authorized and became effective.

2016 Pending Rate Cases and Infrastructure Charges

On April 1, 2016, $9 million in annualized revenues, which was requested in our Virginia general rate case that was filed on October 30, 2015, was put into effect as interim rates under bond and subject to refund.

On April 29, 2016, our New York subsidiary filed a general rate case requesting $9 million in additional annualized water revenues. Also on April 29, 2016, our Iowa subsidiary filed a general rate case requesting $5 million in additional annualized revenue. On May 9, 2016, $2 million in additional annualized revenues of the $5 million requested in our Iowa rate case were put into effect as interim rates under bond and subject to refund.

On July 1, 2016, our California subsidiary filed a general rate case requesting to increase revenues over three years. This increase includes a request of $35 million of additional annualized revenue, which is expected to become effective on January 1, 2018 as well as a step rate and attrition rate increase of $8 million in both 2019 and 2020.

On November 4, 2016, our Tennessee subsidiary filed for an infrastructure surcharge requesting additional revenues of $2 million. On January 16, 2017, our Indiana subsidiary filed for an infrastructure surcharge requesting additional revenues of $8 million.

There is no assurance that all or any portion of these requests will be granted.

Other Regulatory Matters

On December 8, 2016, the CPUC issued a final decision in regard to the application filed by Cal Am in July 2015 which requested changes to the then present rate design and the emergency conservation and rationing plan for water customers in certain areas within its Monterey County service district. The final decision allowed for: (i) recovery of existing undercollections of the net water revenue adjustment mechanism/modified cost balancing account (“WRAM/MCBA”) balance amounting to approximately $32 million at December 31, 2016, over 5 years earning interest at the 90-day commercial paper rate; and (ii) modification of existing conservation and rationing plans.

2017 and Beyond

We believe our success in the future will be driven by engaged employees, smart investments and safe, efficient operations leading to highly satisfied customers, which in turn will lead to constructive regulatory outcomes and sustainable financial performance. Our future results will continue to be anchored on our five central themes with customers at the center of all we do. These five central themes are our focus over the next five years:

•Customers. Our focus continues on our customers by achieving customer satisfaction and service quality targets in the top quartile of our industry. Our comprehensive customer experience initiative is designed to make it easier for customers to do business with us. Our focus on water quality continues to converge people, technology and innovation to deliver industry leading water quality. We intend to continue to make needed infrastructure investments while implementing operational efficiency improvements to help keep customer rates affordable.
•Safety. Our focus continues to put safety first in everything that we do. Our safety focus includes the safety and health of our employees, our customers and the public. We measure our success through water quality, OSHA recordable incident and DART rates (“days away, restricted or transferred”), where we strive to achieve industry leading performance.
•People. Our focus on our employees and culture is paramount to our success going forward. We intend to continue our focus on ensuring we have strong relationships with our union employees, effective training and development plans for all employees and a diverse workforce.
•Growth. We expect to invest $6.7 to $7.3 billion over the next five years, with $1.5 billion in 2017, as follows:
▪Capital investment to improve infrastructure in our Regulated Businesses segment of $5.9 billion, with $1.25 billion expected in 2017;
▪Growth from acquisitions in our Regulated Businesses segment of $600 million to $1.2 billion to expand our water and wastewater customer base with $120 million to 240 million expected in 2017; and
▪Strategic capital investments of about $200 million for the next five years with approximately $100 million expected in 2017, which includes investments related growth in our Market-Based Businesses as we expand markets and new offerings, and evaluate potential opportunities to assist the natural gas exploration and production industry in the delivery of water to support their processes. Also, we are building a new corporate headquarters in Camden, New Jersey, which is expected to be complete in 2018. This project is eligible for up to $164 million in tax credits from New Jersey’s Economic Development Authority.

The chart below presents our estimated percentage of projected capital expenditures over the period of 2017 to 2021 for improving infrastructure in our Regulated Businesses segment by purpose:

•Technology and Operational Efficiency. We intend to continue our commitment to operational efficiency, technology, innovation and environmental leadership. We plan to continue to modernize our infrastructure and leverage technological advancements to enhance customer experience, drive operation efficiency, provide data integration and analytics and enhance security. We have set a goal to achieve an adjusted O&M efficiency ratio (a non-GAAP measure, see below for additional information) equal to or below 32.5% by 2021. We are committed to environmental leadership while providing safe, reliable and cost effective water and water-related services to our customers.

With respect to our adjusted O&M efficiency ratio goal for 2021, we are unable to provide without unreasonable efforts a quantitative reconciliation of each component of this ratio to the most comparable financial measure calculated in accordance with GAAP. In calculating the components of the ratio, certain items that may ultimately be excluded would be reflective of events that cannot be reasonably predicted at this time. The unavailable information would include, among other things, the impact of items currently excluded from the calculation of the components, adjustments for weather conditions that exceed a certain threshold of variability and adjustments for events or circumstances that may not be reflective of ongoing operating results. The probable significance of these items is also presently unknown and cannot be reasonably estimated.

Consolidated Results of Operations

The following table presents our consolidated results of operations for the years ended December 31:

Increase (Decrease)Increase (Decrease)
2016201520142016 vs. 20152015 vs. 2014
(In millions)%%
Operating revenues$3,302$3,159$3,011$1434.5$1484.9
Operating expenses:
Operation and maintenance1,5041,4041,3501007.1544.0
Depreciation and amortization470440424306.8163.8
General taxes258243236156.273.0
(Gain) loss on asset dispositions and purchases(10)(3)(2)(7)233.3(1)50.0
Total operating expenses, net2,2222,0842,0081386.6763.8
Operating income1,0801,0751,00350.5727.2
Other income (expenses):
Interest, net(325)(308)(299)(17)5.5(9)3.0
Other, net15156——9150.0
Total other income (expenses)(310)(293)(293)(17)5.8——
Income from continuing operations before income taxes770782710(12)(1.5)7210.1
Provision for income taxes302306280(4)(1.3)269.3
Income from continuing operations468476430(8)(1.7)4610.7
Loss from discontinued operations, net of tax——(7)——7(100.0)
Net income attributable to common stockholders$468$476$423$(8)(1.7)$5312.5

Comparison of Consolidated Results of Operations

Operating revenues. In 2016, operating revenues increased $143 million, or 4.5%, primarily due to a:

•$128 million increase in our Regulated Businesses segment primarily due to authorized rate increases to fund infrastructure investment growth, acquisitions, organic growth and incremental revenues from surcharges and balancing accounts; and
•$17 million increase in our Market-Based Businesses primarily attributable to our acquisition of Keystone in the third quarter of 2015, and incremental revenues from our Homeowner Services and Contract Operations Groups; partially offset by a decrease in our Military Services Group revenues.

In 2015, operating revenues increased $148 million, or 4.9%, primarily due to an:

•$69 million increase in our Regulated Businesses segment primarily due to rate increases, infrastructure charges and increased demand, partially offset by decreased surcharges and balancing accounts in 2015;
•$53 million increase in our Market-Based Businesses primarily due to incremental revenue from increased construction project activity in our Military Services Group and contract growth in our Homeowners Services Group; and
•$26 million increase attributable to our Keystone acquisition, which is included in our Market-Based Businesses.

Operation and maintenance. In 2016, operation and maintenance expense increased $100 million, or 7.1%, primarily due to a:

•$65 million charge in our Regulated Businesses attributable to the binding global agreement in principle to settle claims arising out of the Freedom Industries chemical spill in West Virginia;
•$16 million increase in our Regulated Businesses operations and maintenance expenses principally due to higher employee-related costs and litigation expenses, partially offset by lower insurance claims and uncollectible accounts expense; and
•$14 million increase in our Market-Based Businesses with $11 million attributable to Keystone and the remaining $3 million primarily due to incremental costs associated with growth in our Homeowner Services Group and Contract Operations Group.

In 2015, operation and maintenance expense increased $54 million, or 4.0%, primarily due to a:

•$45 million increase in our Market-Based Businesses primarily due to incremental costs in our Military Services Group and Homeowner Services Group corresponding with the increases in operating revenues discussed above;
•$24 million increase attributable to our Keystone acquisition; partially offset by a
•$17 million decrease in our Regulated Businesses segment primarily due to lower production costs, contract services and transportation costs, partially offset by higher casualty insurance costs.

Depreciation and amortization. In 2016 and 2015, depreciation and amortization expense increased $30 million and $16 million, or 6.8% and 3.8%, respectively. The increase for both periods was primarily due to additional utility plant placed in service. Also included in 2016 is incremental depreciation and amortization expense resulting from the acquisition of Keystone in the third quarter of 2015.

General Taxes. In 2016, general taxes increased $15 million, or 6.2%, due to higher gross receipt taxes and higher property taxes in our Regulated Businesses segment.

Other income (expenses). In 2016, other expenses increased by $17 million, or 5.8%, principally due to an increase in interest expense from the issuance of incremental long-term debt, as well as, an increase in short-term interest expense mainly due to higher levels of short-term borrowings during 2016 coupled with an increase in the average short-term borrowing rates in 2016 compared to 2015.

Provision for income taxes. In 2016, our provision for income taxes decreased by $4 million, or 1.3%, due primarily to the decrease in pre-tax income. In 2015, our provision for income taxes increased $26 million, or 9.3%, due primarily to the increase in pre-tax income. The effective tax rates were 39.2%, 39.1% and 39.4% for the years ended December 31, 2016, 2015 and 2014, respectively.

In December 2015, the accelerated tax benefit for bonus depreciation was legislatively extended through 2019. Bonus depreciation applies to certain qualified capital investments placed into service and allows for a bonus depreciation provision of 50% for both 2016 and 2017, 40% in 2018 and 30% in 2019. We have federal NOL carryforwards of $1.2 billion as of December 31, 2016. As such, the election of bonus depreciation will be annually determined on a state-by-state basis and will include, among other items, an evaluation of our ability to utilize our federal NOL carryforwards, charitable contribution carryforwards, and state regulatory practices. If we elect bonus depreciation for all years, we would not expect to pay federal income taxes until 2021 under current Internal Revenue Service regulations.

Loss from discontinued operations, net of tax. As previously noted, the financial results of our Terratec line of business within our Market-Based Businesses was classified as discontinued operations for all periods presented. The sale of Terratec was completed in 2014. The 2014 loss from discontinued operations, net of tax includes the loss on sale, a tax valuation allowance and operating results.

Segment Results of Operations

Our segments are determined based on how we assess performance and allocate resources. We evaluate the performance of our segments and allocate resources based on several factors, with the primary measure being income from continuing operations.

We conduct our business primarily through one reportable segment, our Regulated Businesses segment. We also operate businesses that provide a broad range of related and complementary water and wastewater services, which includes four operating segments that individually do not meet the criteria of a reportable segment. These four non-reportable segments have been combined and are presented as Market-Based Businesses, which is consistent with how management assesses the results of our businesses.

Regulated Businesses Segment

The following table summarizes certain financial information for our Regulated Businesses segment:

For the Years Ended December 31,
(Dollars in millions)201620152014
Operating revenues$2,871$2,743$2,674
Operation and maintenance1,1761,0951,112
Operating expenses, net1,8521,7321,726
Net income attributable to common stockholders472473434

Operating revenues. The following tables and discussions provide explanation of the variances related to the three components of operating revenues––water revenues, wastewater revenues and other revenues:

For the Years Ended December 31,Increase (Decrease)Increase (Decrease)
2016201520142016 vs. 20152015 vs. 2014
(Dollars in millions)Operating Revenues%%
Water service:
Residential$1,592$1,536$1,515$563.6$211.4
Commercial580559550213.891.6
Industrial13413013243.1(2)(1.5)
Public and other33833133372.1(2)(0.6)
Other water revenues5339261435.91350.0
Billed water services2,6972,5952,5561023.9391.5
Unbilled water services13(3)(25)16(533.3)22(88.0)
Total water revenues2,7102,5922,5311184.6612.4
Wastewater revenues11297931515.544.3
Other revenues495450(5)(9.3)48.0
Total operating revenues$2,871$2,743$2,674$1284.7$692.6
For the Years Ended December 31,Increase (Decrease)Increase (Decrease)
2016201520142016 vs. 20152015 vs. 2014
(Gallons in millions)Billed Water Sales Volume%%
Water service
Residential174,599175,653176,975(1,054)(0.6)(1,322)(0.7)
Commercial82,48981,77281,5647170.92080.3
Industrial38,46538,99139,833(526)(1.3)(842)(2.1)
Public and other50,67851,32452,710(646)(1.3)(1,386)(2.6)
Billed water services346,231347,740351,082(1,509)(0.4)(3,342)(1.0)

Note: The correlation between water service revenues and billed water sales volumes shown above is impacted by the California drought. In 2015 and to a lesser extent in 2016 California experienced a severe drought. In April 2015, the Governor mandated water usage restrictions to reduce overall water usage by 25% in the state compared to 2013 levels. Revenue in California is decoupled from sales volume through the Water Revenue Adjustment Mechanism and the Modified Cost Balancing Account, aligning our water conservation goals with those of the state and our customers and therefore usage reductions do not impact earnings.

In 2016, operating revenues increased $128 million, or 4.7%, primarily due to a:

•$92 million increase from authorized rate increases, including infrastructure surcharges, primarily to fund investment growth in various states;
•$23 million increase resulting from water and wastewater acquisitions as well as organic growth in existing systems;
•$13 million net increase principally due to revenues from balancing accounts, with the majority associated with our California subsidiary, surcharges and other adjustments.

In 2015, operating revenues increased $69 million, or 2.6%, primarily due to a:

•$45 million increase from rate increases and infrastructure charges;
•$24 million increase from higher demand, mainly due to milder weather in 2014;
•$6 million increase attributable to recent water and wastewater acquisitions coupled with organic growth in existing systems;
•$5 million incremental revenues for late payments and reconnection fees; partially offset by a
•$21 million decrease in surcharges and balancing accounts in our California subsidiary primarily related to the drought and the $5 million charge associated with the July 2015 application filed with CPUC.

Operation and maintenance. The following table and discussions provide a detailed explanation of the variances related to the major components of operation and maintenance.

For the Years Ended December 31,Increase (Decrease)Increase (Decrease)
2016201520142016 vs. 20152015 vs. 2014
(Dollars in millions)%%
Production costs$288$282$289$62.1$(7)(2.4)
Employee-related costs443430430133.0——
Operating supplies and services212194217189.3(23)(10.6)
Maintenance materials and supplies73706834.322.9
Customer billing and accounting546361(9)(14.3)23.3
Other10656475089.3919.1
Total$1,176$1,095$1,112$817.4$(17)(1.5)

Production costs

For the Years Ended December 31,Increase (Decrease)Increase (Decrease)
2016201520142016 vs. 20152015 vs. 2014
(Dollars in millions)%%
Purchased water$122$117$121$54.3$(4)(3.3)
Fuel and power878992(2)(2.2)(3)(3.3)
Chemicals474846(1)(2.1)24.3
Waste disposal322830414.3(2)(6.7)
Total$288$282$289$62.1$(7)(2.4)

In 2016, production costs increased $6 million, or 2.1%, primarily due to a:

•$3 million increase in purchased water attributable to price increases in our California subsidiary;
•$4 million increase in waste disposal cost mainly attributable to higher sludge removal costs; partially offset by a
•$2 million decrease in fuel and power primarily due to a price decrease in our New Jersey subsidiary.

In 2015, production costs decreased $7 million, or 2.4%, primarily due to a:

•$9 million decrease primarily due to lower usage in our California subsidiary as a result of statewide conservation initiatives, including decreases of $8 million in purchased water and $1 million in fuel and power; partially offset by a
•$4 million increase in purchased water primarily due to price increases in our Illinois and New Jersey subsidiaries.

Employee-related costs

For the Years Ended December 31,Increase (Decrease)Increase (Decrease)
2016201520142016 vs. 20152015 vs. 2014
(Dollars in millions)%%
Salaries and wages$336$321$328$154.7$(7)(2.1)
Pensions283027(2)(6.7)311.1
Group insurance586055(2)(3.3)59.1
Other benefits211920210.5(1)(5.0)
Total$443$430$430$133.0$——

In 2016, employee-related costs increased $13 million, or 3.0%, primarily due to a:

•$19 million increase in compensation in support of the growth of the business;
•$9 million increase in medical and prescription drug group insurance costs, offset by a
•$10 million decrease in other postretirement benefit plan expenses as a result of plan amendments in the third quarter of 2016; and
•$6 million decrease in costs due to an increase in capitalized labor attributable to an increase in capital investments.

In 2015, employee-related costs remained consistent primarily due to a:

•$14 million reduction largely attributable to fewer employees and an increase in capital projects, which in turn resulted in higher capitalization rates; partially offset by a
•$14 million increase in pension costs and postretirement benefits costs, which is included in the group insurance line above, primarily due to the adoption of new mortality assumptions and a decrease in the discount rate resulting in increased plan obligations.

Operating supplies and services

For the Years Ended December 31,Increase (Decrease)Increase (Decrease)
2016201520142016 vs. 20152015 vs. 2014
(Dollars in millions)%%
Contracted services$84$81$88$33.7$(7)(8.0)
Office supplies and services45444512.3(1)(2.2)
Transportation131620(3)(18.8)(4)(20.0)
Rents141415——(1)(6.7)
Other5639491743.6(10)(20.3)
Total$212$194$217$189.3$(23)(10.6)

In 2016, operating supplies and services increased $18 million, or 9.3%, primarily due to:

•$8 million attributable to a judgment in litigation and related legal costs associated with a contract dispute;
•$5 million write-off related to timekeeping system costs that were capitalized under construction work in process; and
•$3 million adjustment in 2015 attributable to the recognition of a regulatory asset for previously expensed business transformation costs as a result of the finalization of our California rate case.

In 2015, operating supplies and services decreased $23 million, or 10.6%, primarily due to a:

•$5 million decrease in condemnation and conservation costs primarily due to initiatives in 2014 incurred by our California subsidiary;
•$3 million decrease in legal services;
•$3 million incremental costs in 2014 associated with the Freedom Industries chemical spill in West Virginia;
•$3 million adjustment attributable to the recognition of a regulatory asset for previously expensed business transformation costs as a result of the finalization of our California rate case; and
•$3 million decrease in transportation costs primarily due to lower fuel prices.

Maintenance materials and supplies

In 2016, maintenance materials and supplies increased $3 million, or 4.3%, primarily due to a:

•$10 million increase in tank painting; partially offset by a
•$ 5 million decrease in main breaks maintenance cost as a result of milder winter weather in 2016.

In 2015, maintenance materials and supplies increased $2 million, or 2.9%, primarily due to an increase in tank painting costs.

Customer billing and accounting

Customer billing and accounting expenses decreased $9 million, or 14.3%, in 2016 compared to 2015 primarily due to a decrease in uncollectible accounts expense primarily attributable to focused collection efforts.

Other

In 2016, other operation and maintenance expenses increased $50 million, or 89.3%, primarily due to a:

•$65 million charge resulting from the binding global agreement in principle to settle claims associated with the Freedom Industries chemical spill in West Virginia; partially offset by a
•$15 million decrease in casualty insurance costs attributable to a decrease in historical claims experience.

In 2015, other operation and maintenance expenses increased $9 million, or 19.1%, primarily due to an increase in casualty insurance costs as a result of an increase in historical claims experience resulting in premium adjustments.

Operating expenses, net. For the year ended December 31, 2016, operating expenses, net increased $120 million, or 6.9% compared to same period in prior year, primarily due to:

•$81 million increase in operation and maintenance expense as explained above;
•$30 million increase in depreciation and amortization expense attributable to additional utility plant placed in service; and
•$14 million increase in general tax expense most of which is associated with incremental property and gross receipt taxes.

Market-Based Businesses

The following table summarizes certain financial information for our Market-Based Businesses:

For the Years Ended December 31,
(Dollars in millions)201620152014
Operating revenues$451$434$355
Operation and maintenance372358289
Operating expenses, net391370300
Net income attributable to common stockholders394233

Operating revenues. In 2016, operating revenues increased $17 million, or 3.9%, primarily due to a:

•$15 million increase resulting from Keystone, which was acquired in the third quarter of 2015;
•$11 million increase in our Homeowner Services Group revenues primarily due to contract growth, as well as expansion into new geographic areas and price increases for certain existing customers; and
•$11 million increase in our Contract Operations Group revenues primarily due to contract growth, mostly associated with our contract in Camden, New Jersey; partially offset by a
•$21 million decrease in our Military Services Group revenues primarily due to lower capital upgrades in 2016 attributable to higher project activity in 2015 partially offset by incremental revenues due to the addition of Vandenberg Air Force Base in 2016.

In 2015, operating revenues increased $79 million, or 22.3%, primarily due to a:

•$41 million increase in our Military Services Group revenues primarily due to additional construction project activities and the addition of two military contracts, Hill Air Force Base and Picatinny Arsenal, in the second half of 2015;
•$15 million increase in our Homeowner Services Group revenues primarily due to contract growth, mainly in New York City, and the expansion into other geographic areas; and
•$26 million increase resulting from Keystone; partially offset by a
•$3 million decrease in our Contract Operations Group revenues primarily attributable to the termination of certain municipal and industrial operations and maintenance contracts.

Operation and maintenance. The following table provides information regarding components of operation and maintenance:

For the Years Ended December 31,Increase (Decrease)Increase (Decrease)
2016201520142016 vs. 20152015 vs. 2014
(Dollars in millions)%%
Production costs$35$36$35$(1)(2.8%)$12.9%
Employee-related costs9476621823.7%1422.6%
Operating supplies and services165182138(17)(9.3%)4431.9%
Maintenance materials and supplies6857471119.3%1021.3%
Other1077342.9%——
Total$372$358$289$143.9%$6923.9%

In 2016, operation and maintenance expense increased $14 million, or 3.9%, primarily due to a:

•$11 million increase resulting from Keystone, including $8 million in employee-related costs, $1 million in operating supplies and services and $1 million in other;
•$11 million increase in maintenance materials and supplies primarily due to contract growth in our Homeowner Services and Contract Operations Groups, as well as higher claims, marketing expenses, and costs associated with our investment in a new customer information system in our Homeowner Services Group; and
•$10 million increase in employee-related costs primarily due to the addition of the Vandenberg Air Force Base contract, as well as increased headcount resulting from contract growth in our Homeowner Services and Contract Operations Groups; partially offset by a
•$18 million decrease in operating supplies and services primarily due to lower capital upgrades in our Military Services Group, as discussed above.

In 2015, operation and maintenance expense increased $69 million, or 23.9%, primarily due to a:

•$30 million increase in our Military Services Group operating supplies and services primarily due to increased construction project activities and the addition of two military contracts;
•$24 million increase resulting from Keystone, including $9 million in employee-related costs, $14 million in operating supplies and services and $1 million in maintenance, materials and supplies;
•$7 million increase in our Homeowner Services Group maintenance and supplies primarily due to higher repair costs incurred, which was attributable to the increase in the number of contracts; and
•$5 million increase in our Military Services Group and Homeowners Services Group employee-related costs, which was attributable to the addition of two military contracts and increase in headcount.

Liquidity and Capital Resources

We regularly evaluate and monitor our cash requirements for capital investments, acquisitions, operations, commitments, debt maturities, interest and dividends. Our business is capital intensive, with a majority of this capital funded by cash flows from operations. When necessary, we also obtain funds from external sources, primarily in the debt markets and through short-term commercial paper borrowings. We also have access to equity capital markets, if needed. Our access to external financing on reasonable terms depends on our credit ratings and current business conditions, including that of the utility and water utility industries in general, as well as conditions in the debt or equity capital markets and the national and international economic and geopolitical arenas. If these business, market, financial and other conditions deteriorate to the extent that we no longer are able to access the capital markets on reasonable terms, we have access to an unsecured revolving credit facility with aggregate bank commitments of $1.75 billion, with an expiration date of June 2020 (subject to extension by us for up to two one-year periods). We rely on this revolving credit facility and the capital markets to fulfill our short-term liquidity needs, to issue letters of credit and to support our commercial paper program. Disruptions in the credit markets may discourage lenders from extending the terms of such commitments or agreeing to new commitments. Market disruptions may also limit our ability to issue debt and equity securities in the capital markets. See “Credit Facility and Short-Term Debt” below for further discussion. In order to meet our short-term liquidity needs, we, through AWCC, our wholly owned financing subsidiary, issue commercial paper, which is supported by the revolving credit facility. AWCC had no outstanding borrowings and $88 million of outstanding letters of credit under its credit facility as of December 31, 2016. As of December 31, 2016, AWCC had $1.75 billion available under the credit facility that we could use to fulfill our short-term liquidity needs and to issue letters of credit, which supported our $849 million outstanding commercial paper. We believe that our ability to access the capital markets, our revolving credit facility and our cash flows from operations will generate sufficient cash to fund our short-term requirements. We have no plans to issue equity under normal operating conditions in the foreseeable future with the limited exception of privately or investor-owned tuck-in acquisitions whose sellers require equity as necessary to complete the acquisition. We believe we have sufficient liquidity and ability to manage our expenditures should there be a disruption of the capital and credit markets. However, there can be no assurances that our lenders will meet their existing commitments or that we will be able to access the commercial paper or loan markets in the future on terms acceptable to us or at all.

In addition, our regulated subsidiaries receive advances and contributions from customers, home builders and real estate developers to fund construction necessary to extend service to new areas. Advances for construction are refundable for limited periods, which vary according to state regulations, as new customers begin to receive service or other contractual obligations are fulfilled. Amounts which are no longer refundable are reclassified to contributions in aid of construction. Utility plant funded by advances and contributions is excluded from our Regulated Businesses rate base. Generally, we depreciate contributed property and amortize contributions in aid of construction at the composite rate of the related property. Some of our subsidiaries do not depreciate contributed property, based on regulatory guidelines.

We use our capital resources, including cash, primarily to; (i) fund operating and capital requirements; (ii) pay interest and meet debt maturities; (iii) pay dividends; (iv) fund acquisitions; and (v) fund pension and postretirement benefit obligations. We invest a significant amount of cash on regulated capital projects where we expect to earn a long-term return on investment. Additionally, we operate in rate-regulated environments in which the amount of new investment recovery may be limited, and where such recovery generally takes place over an extended period of time, and certain capital recovery is also subject to regulatory lag. See Item 1—Business—Operating Segments—Regulated Businesses—Economic Regulation and Rate Making Process. We expect to fund future maturities of long-term debt through a combination of external debt and, to the extent available, cash flows from operations. Since we expect our capital investments over the next few years to be greater than or equal to our cash flows from operating activities, we have no plans to reduce debt significantly.

If necessary, the Company may delay certain capital investments or other funding requirements or pursue financing from other sources to preserve liquidity, if necessary. In this event, we believe we can rely upon cash flows from operations to meet our obligations and fund our minimum required capital investments for an extended period of time.

Cash Flows Provided by Operating Activities

Cash flows provided by operating activities primarily result from the sale of water and wastewater services and, due to the seasonality of demand, are generally greater during the third quarter of each fiscal year. Our future cash flows provided by operating activities will be affected by, among other things, economic utility regulation; inflation; compliance with environmental, health and safety standards; production costs; customer growth; declining customer usage of water; employee-related costs, including pension funding; weather and seasonality; taxes; and overall economic conditions.

Cash flows provided by operating activities have been a reliable, steady source of funding, sufficient to meet operating requirements, make our dividend payments and fund a portion of our capital expenditure requirements. We expect to seek access to debt capital markets to meet the balance of our capital expenditure requirements as needed. We also have access to equity capital markets, if needed. Operating cash flows can be negatively affected by changes in our rate regulated environments or changes in our customers’ economic outlook and ability to pay for service in a timely manner. As such, our working capital needs are primarily limited to funding increases in customer accounts receivable and unbilled revenues mainly associated with revenue increases in our Regulated Businesses. We can provide no assurance that our customers’ historical payment pattern will continue in the future. Sometimes our current liabilities exceed current assets because of the Company’s debt due within one year and the periodic use of short-term debt as a funding source primarily to meet scheduled maturities of long-term debt, as well as cash needs which can fluctuate significantly due to the seasonality of the business, stage of our acquisitions and construction projects. We address cash timing differences through the aforementioned liquidity funding mechanisms.

The following table provides a summary of the major items affecting our cash flows provided by operating activities:

For the For the Years Ended December 31,
201620152014
(In millions)
Net income$468$476$423
Add (subtract):
Non-cash activities (a)787773723
Impact of binding global agreement in principle65——
Changes in working capital (b)9(13)3
Pension and postretirement benefit contributions(53)(57)(52)
Net cash flows provided by operating activities$1,276$1,179$1,097
(a)Includes depreciation and amortization, provision for deferred income taxes and amortization of investment tax credits, provision for losses on accounts receivable, (gain) loss on asset dispositions and purchases, pension and non-pension postretirement benefits, and other non-cash items. Details of each component can be found in the Consolidated Statements of Cash Flows.
(b)Changes in working capital include changes to receivables and unbilled revenues, accounts payable and accrued liabilities, and other current assets and liabilities.

In 2016, cash flows provided by operations increased $97 million primarily due to an increase in net income after non-cash adjustments and the impact of the binding global agreement in principle which is not expected to be paid until late 2017 or early 2018 and an increase in cash flows from working capital. The main factors contributing to net income increase are described in this section under “Comparison of Consolidated Results of Operations” and included higher operating revenue partially offset by higher operation and maintenance expense. The increase in non-cash activities was mainly the result of an increase in depreciation and amortization attributable to infrastructure investment projects placed into service. The change in working capital was primarily the result of the following: (1) a change in accounts receivable and unbilled revenues resulting from continuous improvement in our Regulated Businesses’ collection efforts, as well as a decrease in unbilled revenues in our Military Services Group attributable to lower capital upgrades in 2016 as compared to the same period in 2015; (2) timing of accounts payable and accrued liabilities; and (3) change in other current assets and liabilities.

In 2015, cash flows provided by operations increased $82 million primarily due to higher net income mainly as a result of improved operating performance. The main factors of this increase are described in this section under “Comparison of Consolidated Results of Operations” and included higher operating revenue partially offset by higher operation and maintenance expense. The increase in non-cash activities were mainly the result of an increase in pensions/post-retirement benefit expense and higher deferred taxes. Pension/postretirement benefit expense increased in 2015 due to changes in actuarial assumptions, including the adoption of new mortality tables. The increase in deferred taxes was due to accelerated tax depreciation related to infrastructure investments. Offsetting these increases was a decrease in working capital which was principally driven by an increase in receivables and unbilled revenues due to higher customer rates; an increase in accounts payable and accrued liabilities, most of which was associated with the timing of payments and increase in accrued insurance; and a decrease in other current assets and liabilities, net which is the result of an increase in the book overdraft liability in 2014 for which there was no comparable change in 2015.

The Company expects to make pension and postretirement contributions to the plan trusts of $46 million in 2017, of which $11 million was already made in 2017. In addition, we estimate that contributions will amount to $43 million in 2018, $38 million in both 2019 and 2020 and $42 million in 2021. Actual amounts contributed could change materially from these estimates as a result of changes in assumptions and actual investment returns, among other factors.

Cash Flows Used in Investing Activities

Cash flows used in investing activities were as follows:

For the For the Years Ended December 31,
201620152014
(In millions)
Net capital expenditures$(1,311)$(1,160)$(956)
Proceeds from sale of assets and securities9514
Acquisitions(204)(197)(9)
Other investing activities, net (a)(81)(113)(63)
Net cash flows used in investing activities$(1,587)$(1,465)$(1,014)
(a)Includes removal costs from property, plant and equipment retirements, net and net funds released.

In 2016 and 2015, cash flows used in investing activities increased primarily due to an increase in our regulated capital expenditures, principally from incremental investments associated with the replacement and renewal of our transmission and distribution infrastructure.

Our infrastructure investment plan consists of both infrastructure renewal programs, where we replace infrastructure, as needed, and major capital investment projects, where we construct new water and wastewater treatment and delivery facilities to meet new customer growth and water quality regulations. Our projected capital expenditures and other investments are subject to periodic review and revision to reflect changes in economic conditions and other factors.

The following table provides a summary of our historical capital expenditures related to upgrading our infrastructure and systems:

For the Years Ended December 31,
201620152014
(In millions)
Transmission and distribution$568$527$463
Treatment and pumping15113697
Services, meter and fire hydrants297214170
General structure and equipment202174142
Business transformation project——8
Sources of supply595331
Wastewater345645
Total capital expenditures$1,311$1,160$956

In 2016, capital expenditures increased $151 million, or 13.0%, primarily due to the continued investment across the majority of our infrastructure categories.

In 2015, capital expenditures increased $204 million, or 21.3%, primarily due to continued investment across all infrastructure categories, mainly replacement and renewal of transmission and distribution infrastructure.

We also grow our business through acquisitions of water and wastewater systems, as well as other water-related services. These acquisitions are complementary to our existing business and support continued geographical diversification and growth of our operations. Generally, acquisitions are funded initially with short-term debt and later refinanced with the proceeds from long-term debt.

The following provides a summary of the acquisitions and dispositions affecting our cash flows from investing activities:

2016:

•Paid $199 million for 15 water and wastewater systems representing approximately 42,000 customers.
•Made a non-escrowed deposit of $5 million related to the pending McKeesport acquisition.
•Received $9 million for the sale of assets and securities.

2015:

•Paid $133 million for the acquisition of our ninety-five percent interest in Water Solutions Holdings, LLC, the parent company of Keystone.
•Paid $64 million for 14 water and wastewater systems representing approximately 24,000 customers.
•Received $5 million for the sale of assets and securities.

2014:

•Paid $9 million for 13 water and wastewater systems representing approximately 4,500 customers.
•Received $14 million for the sale of assets and securities.

As previously noted, we expect to invest in the range of $6.7 to $7.3 billion from 2017 through 2021. In 2017, we estimate that our total capital expenditures will be $1.5 billion, with $1.25 billion allocated to improving infrastructure in our Regulated Businesses segment and $220 million to $340 million for acquisitions and strategic capital investments, including construction of our corporate headquarters building as discussed below.

We are moving forward with our plan to construct a new corporate headquarters to consolidate our support services and certain of our employees in our Market-Based Businesses within a single location. On December 2, 2016, we closed on the acquisition of the land on Camden, New Jersey’s waterfront and began construction. The cost of construction is currently estimated to be up to $165 million and exclusive of any tax incentives that the Company may receive.

Cash Flows from Financing Activities

Our financing activities, primarily focused on funding infrastructure construction expenditures, include the issuance of long-term and short-term debt, primarily through AWCC. In addition, new infrastructure may be funded with customer advances and contributions in aid of construction (net of refunds), which amounted to $16 million for the year ended December 31, 2016 and $26 million for the years ended December 31, 2015 and 2014. Based on the needs of our regulated subsidiaries and the Company, AWCC may borrow funds or issue its debt in the capital markets and then, through intercompany loans, provides those borrowings to the regulated subsidiaries and the Company. The regulated subsidiaries and the Company are obligated to pay their portion of the respective principal and interest to AWCC in the amount necessary to enable AWCC to meet its debt service obligations. Because the Company’s borrowings are not a source of capital for the regulated subsidiaries, the Company is not able to recover the interest charges on the Company’s debt through regulated water and wastewater rates. As of December 31, 2016, AWCC has made long-term fixed rate loans and commercial paper loans to our Regulated Businesses amounting to $3.6 billion and $600 million, respectively. Additionally, as of December 31, 2016, AWCC has made long-term fixed rate loans and commercial paper loans to the Company totaling $1.4 billion and $249 million, respectively.

On March 24, 2016, we entered into three forward starting swap agreements with an aggregate notional amount of $225 million to reduce interest rate exposure for a portion of the expected refinancing of our 6.085% fixed-rate long-term debt maturing in 2017. These forward starting swap agreements terminate in December 2017 and have an average fixed interest rate of 2.29%. On July 1, 2016, we entered into another forward starting swap agreement with a notional amount of $75 million at a 30-year fixed rate of 1.92% to reduce the average 30-year fixed rate on the total hedged notional amount of $300 million to 2.20%. On February 8, 2017, we entered into a forward starting swap agreement with a notional amount of $100 million to reduce interest rate exposure for a portion of the expected refinancing of our 5.62% fixed-rate long-term debt maturing in December 2018. This forward starting swap agreement terminates in November 2018 and has a fixed rate of 2.67%. Changes in the fair value of the forward starting swaps will be recognized in accumulated other comprehensive income (loss) until the agreement’s termination date.

In May, 2015, the Company and AWCC filed with the SEC a universal shelf registration statement that enables us to meet our capital needs through the offer and sale to the public from time to time of an unlimited amount of various types of securities, including American Water common stock, preferred stock and other equity securities, and AWCC debt types of securities, all subject to market conditions and demand, general economic conditions, and as applicable, rating status. The shelf registration will expire in May 2018. During 2016, 2015 and 2014, $550 million, $550 million and $500 million, respectively, of debt securities were issued pursuant to this and predecessor registration statements.

The following long-term debt was issued in 2016:

CompanyTypeRateMaturityAmount
American Water Capital Corp. (a)Senior notes—fixed rate3.00%-4.00%2026-2046$550
Other American Water subsidiariesPrivate activity bonds and government funded debt—fixed rate1.00%-1.36%2026-20373
Total issuances$553
(a)On November 17, 2016, AWCC completed an offering of its senior fixed rate notes. Proceeds from this offering were used to lend funds to the Company and its regulated utilities, to repay its commercial paper borrowings and for general corporate purposes.

In addition to the above issuances, we also assumed $6 million of debt as a result of an acquisition in 2016, which had a fixed interest rate of 1.00% and matures in 2037.

The following long-term debt was retired through optional redemption or payment at maturity during 2016:

CompanyTypeRateMaturityAmount
American Water Capital Corp.Senior notes—fixed rate5.52%2016$37
American Water Capital Corp.Private activity bonds and government funded debt—fixed rate1.79%-2.90%2021-20311
Other American Water subsidiariesPrivate activity bonds and government funded debt—fixed rate0.00%-5.30%2016-2041104
Other American Water subsidiariesMandatorily redeemable preferred stock8.49%-9.18%2031-20362
Total retirements and redemptions$144

The following long-term debt was issued in 2015:

CompanyTypeRateMaturityAmount
AWCC (a)Senior notes—fixed rate3.40%-4.30%2025-2045$550
Other American Water subsidiariesPrivate activity bonds and government funded debt—fixed rate1.00%-1.56%203215
Total issuances$565
(a)On August 13, 2015, AWCC completed an offering of its senior fixed rate notes. Proceeds from this offering were used to lend funds to the Company and its regulated utilities, to refinance commercial paper borrowings and to finance redemptions of long-term debt.

In addition to the above issuances, we also assumed $1 million of debt as a result of an acquisition in 2015, which has a fixed interest rate of 1.00% and matures in 2040.

The following long-term debt was retired through optional redemption or payment at maturity during 2015:

CompanyTypeRateMaturityAmount
AWCCPrivate activity bonds and government funded debt—fixed rate1.79%-5.25%2015-2031$36
AWCCSenior notes—fixed rate6.00%201530
Other American Water subsidiaries (a)Private activity bonds and government funded debt—fixed rate0.00%-5.40%2015-204161
Other American Water subsidiariesMandatorily redeemable preferred stock8.49%-9.18%2031-20364
Total retirements and redemptions$131
(a)Includes $2 million of non-cash redemptions resulting from the use of restricted funds.

The following long-term debt was issued in 2014:

CompanyTypeRateMaturityAmount
AWCC (a)Senior notes—fixed rate3.40%-4.30%2025-2042$500
Other subsidiaries (b)Private activity bonds and government funded debt—fixed rate0.00%-5.00%2031-203310
Total issuances$510
(a)On August 14, 2014, AWCC completed an offering of its senior fixed rate notes. Proceeds from this offering were used to lend funds to the Company and its regulated utilities, to refinance commercial paper borrowings and to finance redemptions of long-term debt.
(b)Proceeds from the above issuance were received in 2014 and have been utilized to fund certain specific projects. $10.0 million of these proceeds are held in trust pending our certification that we have incurred qualifying capital expenditures. These issuances have been presented as non-cash on the Consolidated Statements of Cash Flows. Subsequent releases of all or a lesser portion of the funds by the trust are reflected as the release of restricted funds and are included in the investing activities in the Consolidated Statements of Cash Flows.

In addition to the above issuances, we also assumed $2 million of debt as a result of acquisitions in 2014.

The following long-term debt was retired through optional redemption or payment at maturity during 2014:

CompanyTypeRateMaturityAmount
American Water Capital Corp.Private activity bonds and government funded debt—fixed rate6.00%-6.75%2018-2032$101
American Water Capital Corp.Senior notes—fixed rate6.00%203959
Other American Water subsidiaries (a)Private activity bonds and government funded debt—fixed rate0.00%-5.25%2014-204179
Other American Water subsidiariesMandatorily redeemable preferred stock8.49%-9.18%2031-20362
Total retirements and redemptions$241
(a)Includes $1.0 million of non-cash redemptions resulting from the use of restricted funds.

From time to time and as market conditions warrant, we may engage in long-term debt retirements via tender offers, open market repurchases or other viable alternatives to strengthen our balance sheets.

In February 2015, our Board of Directors authorized an anti-dilutive common stock repurchase program to mitigate the effect of shares issued through our dividend reinvestment, employee stock purchase and executive compensation activities. The program allows the Company to purchase up to 10 million shares of its outstanding common stock over an unrestricted period of time in the open market or through privately negotiated transactions. The program is conducted in accordance with Rule 10b-18 of the Exchange Act, and to facilitate the repurchases, the Company has also entered into a Rule 10b5-1 share repurchase plans with a third-party broker, which allows us to repurchase shares at times when we may otherwise be prevented from doing so under insider trading laws or because of self-imposed trading blackout periods. Subject to applicable regulations, the Company may elect to amend or cancel this repurchase program or the share repurchase parameters at its discretion. As of December 31, 2016, we have repurchased an aggregate of approximately 3.3 million shares of common stock under this program.

Credit Facility and Short-Term Debt

We have an unsecured revolving credit facility of $1.75 billion through June 2020. In March 2016, and under the terms of the revolving credit agreement dated June 30, 2015, AWCC exercised its right to increase its borrowing capacity available under our revolving credit facility from the aggregate maximum of $1.25 billion to $1.75 billion. All other terms, conditions and covenants with respect to the existing facility remained unchanged. On June 30, 2015, AWCC and its lenders extended the termination date of the revolving credit facility from October 2018 to June 2020. This amended and restated agreement also allowed AWCC to request to extend further the term of the credit facility for up to two one-year periods. An extension request must satisfy certain conditions and receive approval of the lenders, as set forth in the agreement.

Interest rates on advances under the facility are based on a credit spread to the Eurodollar rate or base rate in accordance with AWCC then-applicable Moody Investors Service or Standard & Poor’s Ratings Services credit rating. At current ratings that spread would be 0.90%. The facility is used principally to support AWCC’s commercial paper program and to provide up to $150 million in letters of credit. Indebtedness under the facility is considered “debt” for purposes of a support agreement between American Water and AWCC, which serves as a functional equivalent of a guarantee by American Water of AWCC’s payment obligations under the credit facility.

AWCC also has an outstanding commercial paper program that is backed by the revolving credit facility, the maximum aggregate amount of which on March 22, 2016 was increased from $1.0 billion to $1.6 billion.

Keystone has its own line of credit facility with a maximum availability of up to $16 million dependent on a collateral base calculation. Borrowings under this facility are payable upon demand with interest being paid monthly. Interest accrues each day at a rate per annum equal to 2.75% above the greater of the one month or one day LIBOR. The borrowing base under the facility allows for financing up to the greater of the note or 80% of eligible accounts receivable. Based on the collateral assets at December 31, 2016, $6 million was available to borrow. At December 31, 2016, there were no outstanding borrowings.

The following table summarizes information regarding the Company’s aggregate credit facility commitments, letter of credit sub-limits and available funds under those revolving credit facilities, as well as outstanding amounts of commercial paper and outstanding borrowings under the respective facilities as of December 31, 2016 and 2015:

Credit FacilityAvailable CreditLetter of CreditAvailable Letter ofCommercialAvailable Commercial
CommitmentFacility CapacitySublimitCredit CapacityPaper LimitPaper Capacity
(In millions)
December 31, 2016$1,766$1,668$150$62$1,600$751
December 31, 20151,2661,182150681,000374

The weighted-average interest rate on AWCC short-term borrowings for the years ended December 31, 2016 and 2015 was approximately 0.78% and 0.49%, respectively.

Capital Structure

The following table indicates the percentage of our capitalization represented by the components of our capital structure as of December 31:

201620152014
Total common stockholders' equity42.1%43.5%45.2%
Long-term debt and redeemable preferred stock at redemption value46.4%50.6%50.1%
Short-term debt and current portion of long-term debt11.5%5.9%4.7%
Total100%100%100%

The changes in the capital structure between periods were mainly attributable to an increase in the current portion of long-term debt.

Debt Covenants

Our debt agreements contain financial and non-financial covenants. To the extent that we are not in compliance with these covenants, an event of default may occur under one or more debt agreements and we or our subsidiaries may be restricted in our ability to pay dividends, issue new debt or access our revolving credit facility. Our long-term debt indentures contain a number of covenants that, among other things, prohibit or restrict the Company from issuing debt secured by the Company’s assets, subject to certain exceptions. Our failure to comply with any of these covenants could accelerate repayment obligations.

Covenants in certain long-term notes and the revolving credit facility require us to maintain a ratio of consolidated debt to consolidated capitalization (as defined in the relevant documents) of not more than 0.70 to 1.00. On December 31, 2016, our ratio was 0.58 to 1.00 and therefore we were in compliance with the covenants.

Security Ratings

Our access to the capital markets, including the commercial paper market, and respective financing costs in those markets, may be directly affected by our securities ratings. We primarily access the debt capital markets, including the commercial paper market, through AWCC. However, we have also issued debt through our regulated subsidiaries, primarily in the form of tax exempt securities or borrowings under state revolving funds, to lower our overall cost of debt.

Our long-term and short-term credit rating and rating outlook as of December 31, 2016 are as follows:

Moody's InvestorsStandard & Poor's
SecuritiesServiceRatings Service
Rating OutlookStableStable
Senior unsecured debtA3A
Commercial paperP2A-1

A security rating is not a recommendation to buy, sell or hold securities and may be subject to revision or withdrawal at any time by the assigning rating agency, and each rating should be evaluated independently of any other rating. Security ratings are highly dependent upon our ability to generate cash flows in an amount sufficient to service our debt and meet our investment plans. We can provide no assurances that our ability to generate cash flows is sufficient to maintain our existing ratings. None of our borrowings are subject to default or prepayment as a result of the downgrading of these security ratings, although such a downgrading could increase fees and interest charges under our credit facility.

As part of the normal course of business, we routinely enter into contracts for the purchase and sale of water, energy, chemicals and other services. These contracts either contain express provisions or otherwise permit us and our counterparties to demand adequate assurance of future performance when there are reasonable grounds for doing so. In accordance with the contracts and applicable contract law, if we are downgraded by a credit rating agency, especially if such downgrade is to a level below investment grade, it is possible that a counterparty would attempt to rely on such a downgrade as a basis for making a demand for adequate assurance of future performance, which could include a demand that we provide collateral to secure our obligations. We do not expect to post any collateral which will have a material adverse impact on the Company’s results of operations, financial position or cash flows.

Dividends

Our Board of Directors authorizes the payment of dividends. Our ability to pay dividends on our common stock is subject to having access to sufficient sources of liquidity, the net income and cash flows of our subsidiaries, the receipt of dividends and repayments of indebtedness from our subsidiaries, compliance with Delaware corporate and other laws, compliance with the contractual provisions of debt and other agreements, and other factors. The Company’s dividend rate on its common stock is determined by the Board of Directors on a quarterly basis and takes into consideration, among other factors, current and possible future developments that may affect the Company’s income and cash flows. Historically, dividends have been paid quarterly to holders of record approximately 15 days prior to the distribution date. Since the dividends on our common stock are not cumulative, only declared dividends are paid.

During 2016, 2015 and 2014, we paid $261 million, $239 million and $216 million in cash dividends, respectively. The following table summarizes the per share cash dividends paid for the years ended December 31, 2016, 2015 and 2014:

201620152014
December$0.375$0.34$0.31
September$0.375$0.34$0.31
June$0.375$0.34$0.31
March$0.34$0.31$0.28

On December 9, 2016, our Board of Directors declared a quarterly cash dividend payment of $0.375 per share payable on March 1, 2017 to stockholders of record as of February 7, 2017.

Regulatory Restrictions

The issuance by the Company or AWCC of long-term debt or equity securities does not require authorization of any state PUC if no guarantee or pledge of the regulated subsidiaries is utilized. However, state PUC authorization is required to issue long-term debt at most of our regulated subsidiaries. Our regulated subsidiaries normally obtain the required approvals on a periodic basis to cover their anticipated financing needs for a period of time or in connection with a specific financing.

Under applicable law, our subsidiaries can pay dividends only from retained, undistributed or current earnings. A significant loss recorded at a subsidiary may limit the dividends that the subsidiary can distribute to us. Furthermore, the ability of our subsidiaries to pay upstream dividends or repay indebtedness to American Water is subject to compliance with applicable regulatory restrictions and financial obligations, including, for example, debt service and preferred and preference stock dividends, as well as

applicable corporate, tax and other laws and regulations, and other agreements or covenants made or entered into by American Water and its subsidiaries.

Insurance Coverage

We carry various property, casualty and financial insurance policies with limits, deductibles and exclusions that we believe are consistent with industry standards. However, insurance coverage may not be adequate or available to cover unanticipated losses or claims. Additionally, annual policy renewals can be impacted by claims experience which in turn can impact coverage terms and conditions on a going forward basis. We are self-insured to the extent that losses are within the policy deductible or exceed the amount of insurance maintained. Such losses could have a material adverse effect on our short-term and long-term financial condition and our results of operations and cash flows.

Contractual Obligations and Commitments

We enter into contractual obligations with third parties in the ordinary course of business. Information related to our contractual obligations as of December 31, 2016 is summarized in the table below:

Contractual obligationTotal1 year or Less2-3 Years4-5 yearsMore Than 5 years
(In millions)
Long-term debt obligations (a)$6,312$572$620$498$4,622
Interest on long-term debt (b)4,4023325605212,989
Operating lease obligations (c)12214231570
Purchase water obligations (d)1,04256122129735
Other purchase obligations (e)142142———
Postretirement benefit plans' obligations (f)66———
Pension plan obligations (f)195407580—
Preferred stocks with mandatory redemption requirements122334
Interest on preferred stock with mandatory redemption requirements61113
Other obligations (g)1,102337302101362
Total$13,341$1,502$1,706$1,348$8,785

Note: The above table reflects only financial obligations and commitments. Therefore, performance obligations associated with our Market-Based Businesses are not included in the above amounts. Also, uncertain tax positions of $169 million are not reflected in this table as we cannot predict when open tax years will close with completed examinations. See Note 13—Income Taxes in the Notes to the Consolidated Financial Statements.

(a)Represents sinking fund obligations, debt maturities and capital lease obligations.
(b)Represents expected interest payments on outstanding long-term debt. Amounts reported may differ from actual due to future financing of debt.
(c)Represents future minimum payments under non-cancelable operating leases, primarily for the lease of motor vehicles, buildings, land and other equipment including water facilities and systems constructed by partners under the Public-Private Partnerships described below.
(d)Represents future payments under water purchase agreements for minimum quantities of water.
(e)Represents the open purchase orders as of December 31, 2016, for goods and services purchased in the ordinary course of business.
(f)Represents contributions expected to be made to pension and postretirement benefit plans for the years 2017 through 2021.
(g)Includes an estimate of advances for construction to be refunded, capital expenditures estimated to be required under legal and binding contractual obligations, contracts entered into for energy purchases, a liability associated with a conservation agreement and service agreements.

Public-Private Partnerships

WVAWC has entered into a series of agreements with various public entities, which we refer to as the Partners, to establish certain joint ventures, commonly referred to as “public-private partnerships.” Under the public-private partnerships, WVAWC constructed utility plant, financed by WVAWC, and the Partners constructed utility plant (connected to WVAWC’s property), financed by the Partners. WVAWC agreed to transfer and convey some of its real and personal property to the Partners in exchange for an equal principal amount of Industrial Development Bonds, commonly referred to as IDBs, issued by the Partners under a state Industrial Development Bond and Commercial Development Act. WVAWC leased back the total facilities, including portions funded by both WVAWC and the Partners, under leases for a period of 40 years.

The leases have payments that approximate the payments required by the terms of the IDBs. These payments are considered “PILOT payments” which represent payments in lieu of taxes and approximate what WVAWC otherwise would pay as property taxes

on the properties. We have presented the transaction on a net basis in the consolidated financial statements. The carrying value of the transferred facilities, which is presented in property, plant and equipment in the Consolidated Balance Sheets, was approximately $152 million as of December 31, 2016.

Performance Obligations

We have entered into agreements for the provision of services to water and wastewater facilities for the United States military, municipalities and other customers. These military services agreements expire between 2051 and 2065 and have remaining performance commitments as measured by estimated remaining contract revenues of $3.1 billion as of December 31, 2016. The operations and maintenance agreements with municipalities and other customers expire between 2015 and 2048 and have remaining performance commitments as measured by estimated remaining contract revenue of $794 million as of December 31, 2016. Some of the Company’s long-term contracts to operate and maintain a municipality’s, federal government’s or other party’s water or wastewater treatment and delivery facilities include responsibility for certain major maintenance for some of the facilities, in exchange for an annual fee.

Critical Accounting Policies and Estimates

The application of critical accounting policies is particularly important to our financial condition and results of operations and provides a framework for management to make significant estimates, assumptions and other judgments. Although our management believes that these estimates, assumptions and other judgments are appropriate, they relate to matters that are inherently uncertain. Accordingly, changes in the estimates, assumptions and other judgments applied to these accounting policies could have a significant impact on our financial condition and results of operations as reflected in our consolidated financial statements.

Our financial condition, results of operations and cash flows are impacted by the methods, assumptions and estimates used in the application of critical accounting policies. Management believes that the areas described below require significant judgment in the application of accounting policy or in making estimates and assumptions in matters that are inherently uncertain and that may change in subsequent periods. Judgments made include anticipated recovery of costs, especially through regulated operations, the likelihood of success of particular projects, possible legal and regulatory challenges, assumptions made in regards to pension and other benefit and forecast assumptions utilized in goodwill impairment testing. Our management has reviewed these critical accounting policies, and the estimates and assumptions regarding them, with our audit committee. In addition, our management has also reviewed the following disclosures regarding the application of these critical accounting policies with the audit committee.

For further information, see Note 2—Significant Accounting Policies in the Notes to the Consolidated Financial Statements.

Rate Regulation and Regulatory Accounting

Our regulated utility subsidiaries are subject to regulation by state PUCs and the local governments of the states in which they operate. As such, we follow the authoritative accounting principles required for rate regulated entities, which requires us to reflect the effects of rate regulation in our financial statements. Use of the authoritative guidance is applicable to utility operations that meet the following criteria: (i) third-party regulation of rates; (ii) cost-based rates; and (iii) a reasonable assumption that rates will be set to recover the estimated costs of providing service plus a return on net investment, or rate base. As of December 31, 2016, we concluded that the operations of our regulated subsidiaries met the criteria.

The application of the accounting principles has a further effect on the Company’s financial statements as a result of the estimates of allowable costs used in the ratemaking process. We make significant assumptions and estimates to quantify amounts recorded as regulatory assets and liabilities. Such judgements include but are not limited to assets and liabilities related to regulated acquisitions, pension and postretirement benefits, depreciation rates and taxes. Due to timing and other differences in the collection of revenue, these accounting principles allow a cost that would otherwise be charged as an expense by an unregulated entity to be capitalized as a regulatory asset if it is probable that such cost is recoverable through future rates; conversely, the principles allow creation of a regulatory liability for amounts collected in rates to recover costs expected to be incurred in the future or amounts collected in excess of costs incurred and are refundable to customers. Regulators may also impose certain fines or penalties.

As of December 31, 2016, we have recorded $1.3 billion of regulatory assets and $403 million of regulatory liabilities within our consolidated financial statements. See Note 6—Regulatory Assets and Liabilities in the Notes to Consolidated Financial Statements for further information regarding the significant regulatory assets and liabilities.

For each regulatory jurisdiction where we conduct business, we assess at the end of each reporting period whether the regulatory assets and liabilities continue to meet the criteria for probable future recovery or settlement. This assessment includes consideration of factors such as changes in applicable regulatory environments, recent rate orders on recovery of a specific or similar incurred cost to other regulated entities in the same jurisdiction, the status of any pending or potential legislation that could impact the ability to

recover costs through regulated rates. If subsequent events indicate that the regulatory assets or liabilities no longer meet the criteria for probable future recovery or settlement, our statement of operations and financial position could be materially affected. In addition, if we conclude in a future period that a separable portion of the business no longer meets the criteria, we are required to eliminate the financial statement effects of regulation for that part of the business, which would include the elimination of any or all regulatory assets and liabilities that had been recorded in the consolidated financial statements. Failure to meet the criteria of the authoritative guidance could materially impact our consolidated financial statements.

Goodwill

The Company has recorded $1.3 billion of goodwill at December 31, 2016 and 2015. The Company’s annual impairment test is performed as of November 30 of each year, in conjunction with the timing of the completion of the Company’s annual business plan. The Company also undertakes interim reviews when the Company determines that a triggering event that would more likely than not reduce the fair value of a reporting unit below its carrying value has occurred.

Entities assessing goodwill for impairment have the option of first performing a qualitative assessment to determine whether a quantitative assessment is necessary. In performing a qualitative assessment, the Company assess and makes judgments, among other things around, macroeconomic conditions, industry and market considerations, overall financial performance, cost factors and entity specific events. If an entity determines, on the basis of qualitative factors, that the fair value of the reporting unit is more likely than not greater than the carrying amount, no further testing is required. If the entity bypasses the qualitative assessment or performs the qualitative assessment, but determines that it is more likely than not that its fair value is less than its carrying amount, a quantitative two-step, fair value-based test is performed.

The first step compares the estimated fair value of the reporting unit to its respective net carrying values, including goodwill, on the measurement date. If the estimated fair value of any reporting unit is less than such reporting unit’s carrying value, then the second step is performed to measure the amount of the impairment loss (if any) for such reporting unit.

The second step requires an allocation of fair value to the individual assets and liabilities using purchase price allocation accounting guidance in order to determine the implied fair value of goodwill. If the implied fair value of goodwill is less than the carrying amount for the reporting unit, an impairment loss is recorded as a reduction to goodwill and a charge to operating expense. Application of the goodwill impairment test requires significant management judgment, including the identification of reporting units and determining the fair value of the reporting unit. Management estimates fair value using a combination of a discounted cash flow analysis and market multiples analysis. Significant assumptions used in these fair value analyses include, but are not limited to, discount and growth rates and projected terminal values.

For further information, see Note 7—Goodwill and Other Intangible Assets in the Notes to the Consolidated Financial Statements.

Impairment of Long-Lived Assets

Long-lived assets include land, buildings, equipment and long-term investments. Long-lived assets, other than investments and land, are depreciated over their estimated useful lives, and are reviewed for impairment whenever changes in circumstances indicate the carrying value of the asset may not be recoverable. Such circumstances would include items such as a significant decrease in the market value of a long-lived asset, a significant adverse change in the manner in which the asset is being used or planned to be used or in its physical condition, or a history of operating or cash flow losses associated with the use of the asset. In addition, changes in the expected useful life of these long-lived assets may also be an impairment indicator. When such events or changes occur, we estimate the fair value of the asset from future cash flows expected to result from the use and, if applicable, the eventual disposition of the assets, and compare that to the carrying value of the asset. If the carrying value is greater than the fair value, an impairment loss is recognized equal to the amount by which the asset’s carrying value exceeds its fair value. The key variables that must be estimated include assumptions regarding sales volume, rates, operating costs, labor and other benefit costs, capital additions, assumed discount rates and other economic factors. These variables require significant management judgment and include inherent uncertainties since they are forecasting future events. A variation in the assumptions used could lead to a different conclusion regarding the realizability of an asset and, thus, could have a significant effect on the consolidated financial statements.

The long-lived assets of the regulated utility subsidiaries are grouped on a separate entity basis for impairment testing as they are integrated state-wide operations that do not have the option to curtail service and generally have uniform tariffs. A regulatory asset is charged to earnings if and when future recovery in rates of that asset is no longer probable.

The fair values of long-term investments are dependent on the financial performance and solvency of the entities in which we invest, as well as volatility inherent in the external markets. In assessing potential impairment for these investments, we consider these

factors. If such assets are considered impaired, an impairment loss is recognized equal to the amount by which the asset’s carrying value exceeds its fair value.

Revenue Recognition

Revenues of the regulated utility subsidiaries are recognized as water and wastewater services are delivered to customers and include amounts billed to customers on a cycle basis and unbilled amounts based on estimated usage from the date of the meter reading associated with the latest customer bill to the end of the accounting period. Unbilled utility revenues as of December 31, 2016 and 2015 were $161 million and $144 million, respectively. Increases or decrease in volumes delivered to the utilities’ customers and rate mix due to changes in usage patterns in customer classes in the period could be significant to the calculation of unbilled revenue. Changes in the timing of meter reading schedules and the number and type of customers scheduled for each meter reading date would also have an effect on the estimated unbilled revenue.

Revenue from Market-Based Businesses is recognized as services are rendered. Revenues from certain construction projects are recognized over the contract term based on the costs incurred to date during the period compared to the total estimated costs over the entire contract. Losses on contracts are recognized during the period in which the loss first becomes probable and estimable. Revenues recognized during the period in excess of billings on construction contracts are recorded as unbilled revenue. Unbilled market-based revenues as of December 31, 2016 and 2015 were $102 million and $123 million, respectively. Billings in excess of revenues recognized on construction contracts are recorded as other current liabilities on the balance sheet until the recognition criteria are met. Changes in contract performance and related estimated contract profitability may result in revisions to costs and revenues and are recognized in the period in which revisions are determined.

Accounting for Income Taxes

Significant management judgment is required in determining the provision for income taxes, primarily due to the uncertainty related to tax positions taken, as well as deferred tax assets and liabilities, valuation allowances and the utilization of net operating loss carryforwards.

In accordance with applicable authoritative guidance, we account for uncertain income tax positions using a benefit recognition model with a two-step approach, including a more-likely-than-not recognition threshold and a measurement approach based on the largest amount of tax benefit that is greater than 50% likely of being realized upon ultimate settlement. If it is not more-likely-than-not that the benefit of the tax position will be sustained on its technical merits, no benefit is recorded. Uncertain tax positions that relate only to timing of when an item is included on a tax return are considered to have met the recognition threshold. Management evaluates each position based solely on the technical merits and facts and circumstances of the position, assuming the position will be examined by a taxing authority having full knowledge of all relevant information. Significant judgment is required to determine whether the recognition threshold has been met and, if so, the appropriate amount of unrecognized tax benefit to be recorded in the consolidated financial statements.

We evaluate the probability of realizing deferred tax assets quarterly by reviewing a forecast of future taxable income and our intent and ability to implement tax planning strategies, if necessary, to realize deferred tax assets. We also assess our ability to utilize tax attributes, including those in the form of carryforwards, for which the benefits have already been reflected in the financial statements. We record valuation allowances for deferred tax assets when we conclude it is more-likely-than-not such benefit will not be realized in future periods.

Actual income taxes could vary from estimated amounts due to the future impacts of various items, including changes in income tax laws, our forecasted financial condition and results of operations, failure to successfully implement tax planning strategies, recovery of taxes through the regulatory process for our Regulated Businesses, as well as results of audits and examinations of filed tax returns by taxing authorities. While we believe the resulting tax balances as of December 31, 2016 and 2015 are appropriately accounted for in accordance with the applicable authoritative guidance, the ultimate outcome of tax matters could result in favorable or unfavorable adjustments to our consolidated financial statements and such adjustments could be material. See Note 13—Income Taxes in the Notes to Consolidated Financial Statements for additional information regarding income taxes.

Accounting for Pension and Postretirement Benefits

We maintain noncontributory defined benefit pension plans covering eligible employees of our regulated utility and shared service operations. Benefits under the plans are based on the employee’s years of service and compensation. The pension plans were closed for most employees hired on or after January 1, 2006. Union employees hired on or after January 1, 2001 had their accrued benefit frozen and will be able to receive this benefit as a lump sum upon termination or retirement. Union employees hired on or after January 1, 2001 and non-union employees hired on or after January 1, 2006 are provided with a 5.25% of base pay defined

contribution plan. We also maintain other postretirement benefit plans, which provide varying levels of medical and life insurance for eligible retirees. These retiree welfare plans are closed for union employees hired on or after January 1, 2006. The plans had previously closed for non-union employees hired on or after January 1, 2002. The Company also has several unfunded noncontributory supplemental non-qualified pension plans that provide additional retirement benefits to certain employees. The Company does not participate in a multiemployer plan. See Note 14—Employee Benefits in the Notes to Consolidated Financial Statements for further information regarding the accounting for the defined benefit pension plans and postretirement benefit plans. The Company’s pension and postretirement benefit costs are developed from actuarial valuations. Inherent in these valuations are key assumptions provided by the Company to its actuaries, including the discount rate and expected long-term rate of return on plan assets. Material changes in the Company’s pension and postretirement benefit costs may occur in the future due to changes in these assumptions as well as fluctuations in plan assets. The assumptions are selected to represent the average expected experience over time and may differ in any one year from actual experience due to changes in capital markets and the overall economy. These differences will impact the amount of pension and other postretirement benefit expense that the Company recognizes. The primary assumptions are:

•Discount Rate—The discount rate is used in calculating the present value of benefits, which are based on projections of benefit payments to be made in the future. The objective in selecting the discount rate is to measure the single amount that, if invested at the measurement date in a portfolio of high-quality debt instruments, would provide the necessary future cash flows to pay the accumulated benefits when due;
•Expected Return on Plan Assets (“EROA”)—Management projects the future return on plan assets considering prior performance, but primarily based upon the plans’ mix of assets and expectations for the long-term returns on those asset classes. These projected returns reduce the net benefit costs we record currently;
•Rate of Compensation Increase—Management projects employees’ pay increases, which are used to project employees’ pension benefits at retirement;
•Health Care Cost Trend Rate—Management projects the expected increases in the cost of health care; and
•Mortality—In 2014, management adopted a table based on the Society of Actuaries RP 2014 mortality table including a generational BB-2D projection scale.

The discount rate assumption, which is determined for the pension and postretirement benefit plans independently, is subject to change each year, consistent with changes in applicable high-quality, long-term corporate bond indices. We use an approach that approximates the process of settlement of obligations tailored to the plans’ expected cash flows by matching the plans’ cash flows to the coupons and expected maturity values of individually selected bonds. The yield curve was developed for a portfolio containing the majority of United States-issued AA-graded non-callable (or callable with make-whole provisions) corporate bonds. For each plan, the discount rate was developed as the level equivalent rate that would yield the same present value as using spot rates aligned with the projected benefit payments. The discount rate for determining pension benefit obligations was 4.28%, 4.66% and 4.24% at December 31, 2016, 2015 and 2014, respectively. The discount rate for determining other post-retirement benefit obligations was 4.26%, 4.67% and 4.24% at December 31, 2016, 2015 and 2014, respectively.

In selecting an expected return on plan assets, we considered tax implications, past performance and economic forecasts for the types of investments held by the plans. The long-term EROA assumption used in calculating pension cost was 7.02% for 2016, 6.91% for 2015, and 6.91% for 2014. The weighted average EROA assumption used in calculating other postretirement benefit costs was 5.37% for 2016, 4.92% for 2015 and 5.87% for 2014.

The asset allocations for the Company’s U.S. pension plan by asset category were as follows:

Target AllocationPercentage of Plan Assets as of December 31,
Asset Category201720162015
Equity securities52%49%50%
Fixed income40%42%41%
Real Estate6%7%7%
Real estate investment trusts (“REITs”)2%2%2%
Total100%100%100%

The investment policy guidelines of the pension plan require that the fixed income portfolio has an overall weighted average credit rating of AA or better by Standard & Poor’s and the minimum credit quality for fixed income securities must be BBB- or better. Up to 20% of the portfolio may be invested in collateralized mortgage obligations backed by the United States Government.

The Company’s other postretirement benefit plans are partially funded. The asset allocations for the Company’s other postretirement benefit plans by asset category were as follows:

Target AllocationPercentage of Plan Assets as of December 31,
Asset Category201720162015
Equity securities32%33%32%
Fixed income68%67%68%
REITs———
Total100%100%100%

The Company’s investment policy, and related target asset allocation, is evaluated periodically through asset liability studies. The studies consider projected cash flows of maturity liabilities, projected asset class return risk, and correlation and risk tolerance.

The pension and postretirement welfare plan trusts investments include debt and equity securities held either directly or through commingled funds. The trustee for the Company’s defined benefit pension and postretirement welfare plans uses independent valuation firms to calculate the fair value of plan assets. Additionally, the Company independently verifies the assets values. Approximately 44.8% of the assets are valued using the quoted market price for the assets in an active market at the measurement date, while 55.2% of the assets are valued using other inputs.

In selecting a rate of compensation increase, we consider past experience in light of movements in inflation rates. Our rate of compensation increase was 3.07% for 2016, 3.10% for 2015 and 3.12% for 2014.

In selecting health care cost trend rates, we consider past performance and forecasts of increases in health care costs. Our health care cost trend rate used to calculate the periodic cost was 6.50% in 2016 gradually declining to 5.00% in 2021 and thereafter.

Assumed health care cost trend rates have a significant effect on the amounts reported for the other postretirement benefit plans. The health care cost trend rate is based on historical rates and expected market conditions. A one-percentage-point change in assumed health care cost trend rates would have the following effects:

Change in Actuarial AssumptionImpact on Other Postretirement Benefit Obligation as of December 31, 2016Impact on 2016 Total Service and Interest Cost Components
(In millions)
Increase assumed health care cost trend by 1%$74$7
Decrease assumed health care cost trend by 1%$(61)$(6)

We will use a discount rate and EROA of 4.28% and 6.49%, respectively, for estimating our 2017 pension costs. Additionally, we will use a discount rate and expected blended return based on weighted assets of 4.26% and 5.09%, respectively, for estimating our 2017 other postretirement benefit costs. A decrease in the discount rate or the EROA would increase our pension expense. Our 2016 and 2015 pension and postretirement benefit costs were $54 million and $61 million, respectively. The Company expects to make pension and postretirement benefit contributions to the plan trusts of $39 million, $37 million, $38 million, $38 million and $42 million in 2017, 2018, 2019, 2020 and 2021, respectively. Actual amounts contributed could change significantly from these estimates. The assumptions are reviewed annually and at any interim re-measurement of the plan obligations. The impact of assumption changes is reflected in the recorded pension and postretirement benefit amounts as they occur, or over a period of time if allowed under applicable accounting standards. As these assumptions change from period to period, recorded pension and postretirement benefit amounts and funding requirements could also change.

Accounting for Contingencies

We record loss contingencies when management determines that the outcome of future events is probable of occurring and when the amount of the loss can be reasonably estimated. The determination of a loss contingency is based on management judgment and estimates about the likely outcome of the matter, which may include an analysis of different scenarios. Liabilities are recorded or adjusted when events or circumstances cause these judgments or estimates to change. In assessing whether a loss is reasonably possible, management considers many factors, which include, but are not limed to: the nature of the litigation, claim or assessment, available information, opinions or views of legal counsel and other advisors, and the experience gained from similar cases or situations. We provide disclosures for material contingencies when management deems there is a reasonable possibility that a loss or an additional loss may be incurred. We provide estimates of reasonably possible losses when such estimates may be reasonably determined, either as a single amount or within a reasonable range.

Actual amounts realized upon settlement of contingencies may be different than amounts recorded and disclosed and could have a significant impact on the liabilities, revenue and expenses recorded on the consolidated financial statements. For a discussion of contingencies, see Note 15—Commitments and Contingencies in the Notes to Consolidated Financial Statements.

New Accounting Standards

See Note 2—Significant Accounting Policies in the Notes to Consolidated Financial Statements for a description of recent accounting standards.

Previous: Item 6. SELECTED FINANCIAL DATA · Next: Item 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK