Forward-looking Statements
Certain statements contained in this report on Form 10-Q constitute "forward-looking statements" within the meaning of Section 21E of the Securities Exchange Act of 1934 and Section 27A of the Securities Act of 1933. Words such as "may," "should," "believe," "anticipate," "estimate," "expect," "intend," "plan" and similar expressions are intended to identify forward-looking statements. These forward-looking statements include certain information relating to the Company's business strategy; statements including, but not limited to:
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the amount and timing of rate increases and other regulatory matters including the recovery of costs recorded as regulatory assets;
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expected profitability and results of operations;
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trends;
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goals, priorities and plans for, and cost of, growth and expansion;
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strategic initiatives;
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availability of water supply;
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water usage by customers; and
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the ability to pay dividends on common stock and the rate of those dividends.
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The forward-looking statements in this report reflect what the Company currently anticipates will happen. What actually happens could differ materially from what it currently anticipates will happen. The Company does not intend to make a public announcement when forward-looking statements in this report are no longer accurate, whether as a result of new information, what actually happens in the future or for any other reason. Important matters that may affect what will actually happen include, but are not limited to:
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changes in weather, including drought conditions or extended periods of heavy rainfall;
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levels of rate relief granted;
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the level of commercial and industrial business activity within the Company's service territory;
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construction of new housing within the Company's service territory and increases in population;
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changes in government policies or regulations, including the tax code;
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the ability to obtain permits for expansion projects;
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material changes in demand from customers, including the impact of conservation efforts which may impact the demand of customers for water;
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changes in economic and business conditions, including interest rates, which are less favorable than expected;
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loss of customers;
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changes in, or unanticipated, capital requirements;
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the impact of acquisitions;
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changes in accounting pronouncements;
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changes in the Company's credit rating or the market price of its common stock;
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the ability to obtain financing; and
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other matters set forth in Item 1A, "Risk Factors" of the Company's Annual Report on Form 10-K for the year ended December 31, 2015.
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General Information
The primary business of the Company is to impound, purify to meet or exceed safe drinking water standards and distribute water. The Company also owns and operates two wastewater collection and treatment systems. The Company operates within its franchised water territory, which covers 39 municipalities within York County, Pennsylvania and nine municipalities within Adams County, Pennsylvania. The Company's wastewater operations include portions of three municipalities in York County, Pennsylvania. The Company is regulated by the Pennsylvania Public Utility Commission, or PPUC, in the areas of billing, payment procedures, dispute processing, terminations, service territory, debt and equity financing and rate setting. The Company must obtain PPUC approval before changing any practices associated with the aforementioned areas.
Water service is supplied through the Company's own distribution system. The Company obtains the bulk of its water supply from both the South Branch and East Branch of the Codorus Creek, which together have an average daily flow of 73.0 million gallons. This combined watershed area is approximately 117 square miles. The Company has two reservoirs, Lake Williams and Lake Redman, which together hold up to approximately 2.2 billion gallons of water. The Company has a 15-mile pipeline from the Susquehanna River to Lake Redman which provides access to an additional supply of 12.0 million gallons of untreated water per day. The Company also owns seven wells which are capable of providing a safe yield of approximately 366,000 gallons per day to supply water to its customers in Carroll Valley Borough and Cumberland Township, Adams County. As of March 31, 2016, the Company's average daily availability was 35.4 million gallons, and average daily consumption was approximately 17.8 million gallons. The Company's service territory had an estimated population of 194,000 as of December 31, 2015. Industry within the Company's service territory is diversified, manufacturing such items as fixtures and furniture, electrical machinery, food products, paper, ordnance units, textile products, injectable drug delivery systems, air conditioning systems, laundry detergent, barbells and motorcycles.
The Company's water business is somewhat dependent on weather conditions, particularly the amount and timing of rainfall. Revenues are particularly vulnerable to weather conditions in the summer months. Prolonged periods of hot and dry weather generally cause increased water usage for watering lawns, washing cars, and keeping golf courses and sports fields irrigated. Conversely, prolonged periods of dry weather could lead to drought restrictions from governmental authorities. Despite the Company's adequate water supply, customers may be required to cut back water usage under such drought restrictions which would negatively impact revenues. The Company has addressed some of this vulnerability by instituting minimum customer charges which are intended to cover fixed costs of operations under all likely weather conditions.
The Company's business does not require large amounts of working capital and is not dependent on any single customer or a very few customers for a material portion of its business. Increases in revenues are generally dependent on the Company's ability to obtain rate increases from the PPUC in a timely manner and in adequate amounts and to increase volumes of water sold through increased consumption and increases in the number of customers served. The Company continuously looks for water and wastewater acquisition and expansion opportunities both within and outside its current service territory as well as additional opportunities to enter into bulk water contracts with municipalities and other entities to supply water.
The Company has agreements with several municipalities to provide sewer billing and collection services. The Company also has a service line protection program on a targeted basis in order to further diversify its business. Under this optional program, customers pay a fixed monthly fee, and the Company will repair or replace damaged customer service lines, as needed, subject to an annual maximum dollar amount. Opportunities to expand both initiatives are being pursued.
Results of Operations
Three Months Ended March 31, 2016 Compared
With Three Months Ended March 31, 2015
Net income for the first quarter of 2016 was $2,486, a decrease of $42, or 1.7%, from net income of $2,528 for the same period of 2015. The primary contributing factors to the decrease were higher depreciation expense and income taxes which were partially offset by lower operation and maintenance expenses and higher operating revenues.
Operating revenues for the three months ended March 31, 2016 increased $69, or 0.6%, from $11,209 for the three months ended March 31, 2015 to $11,278 for the corresponding 2016 period. The primary reasons for the increase were an increase in customers and higher sewer billing and collection service revenue. The average number of customers served in the 2016 period increased as compared to the 2015 period by 1,018 customers, from 65,233 to 66,251 customers. Total per capita consumption for the first quarter of 2016 was 2.3% lower than the same period of last year. For the remainder of the year, the Company expects revenues to increase slightly due to higher summer demand and an increase in the number of water and wastewater customers due to acquisitions and growth within the Company's service territory. Other regulatory actions and weather patterns could impact results.
Operating expenses for the first quarter of 2016 decreased $11, or 0.2%, from $6,075 for the first quarter of 2015 to $6,064 for the corresponding 2016 period. The decrease was primarily due to lower expenses of approximately $57 for health insurance, $33 for higher capitalized overhead, and $32 for reduced maintenance. Other expenses decreased by a net of $20. The decrease was partially offset by increased expenses of approximately $78 for depreciation and $53 for wages. For the remainder of the year, the Company expects depreciation expense to continue to rise due to additional investment in utility plant, and other expenses to increase at a moderate rate as costs to maintain and extend the distribution system continue to rise and as additional water and wastewater systems are acquired.
Interest on debt for the first quarter of 2016 increased $21, or 1.6%, from $1,284 for the first quarter of 2015 to $1,305 for the corresponding 2016 period. The increase was due to an increase in long-term debt outstanding resulting from the bond issuance in July 2015. Interest expense for the remainder of the year is expected to remain consistent, but could be higher with possible line of credit borrowings.
Allowance for funds used during construction decreased $2, from $55 in the first quarter of 2015 to $53 in the 2016 period, due to a lower volume of eligible construction. Allowance for funds used during construction for the remainder of the year is expected to increase based on a projected increase in the amount of eligible construction.
Other income (expenses), net for the first quarter of 2016 reflects increased expenses of $22 as compared to the same period of 2015. Outside services of approximately $20 and lower earnings on life insurance policies of $15 were the primary reasons for the increase. Other expenses of approximately $4 increased as compared to the same period of 2015. The increased expenses were partially offset by lower charitable contributions of approximately $17. For the remainder of the year, other income (expenses) will be largely determined by the change in market returns and discount rates for retirement programs and related assets.
Income taxes for the first quarter of 2016 increased $77, or 6.2%, compared to the same period of 2015 due to higher taxable income and a lower volume of asset improvements eligible for the tax benefit of the Internal Revenue Service, or IRS, tangible property regulations, or TPR. The Company's effective tax rate was 34.6% for the first quarter of 2016 and 32.8% the first quarter of 2015. The Company expects the effective tax rate to fall to approximately 28% to 32% for 2016 due to the continued expensing of asset improvements that would have been capitalized for tax purposes prior to the implementation of the TPR. The Company's effective tax rate will vary depending on the level of eligible assets improvements that are placed in service each period.
Rate Matters
See Note 11 to the financial statements included herein for a discussion of rate matters.
The benefit from the implementation of the IRS TPR impacts the rate matters of the Company. E
arnings in excess of the regulatory benchmark prevent the collection of a distribution system improvement charge, which is likely to remain throughout 2016. It may also lengthen the amount of time until filing the next rate increase request. As a result, the Company does not expect to file a rate increase request in 2016.
When the Company does file for its next rate increase, the PPUC will take into account the lower income taxes which resulted from the implementation of the IRS TPR, effectively reducing the amount of revenue required in future years and lowering the Company's rate increase request.
Acquisitions
See Note 9 to the financial statements included herein for a discussion of completed acquisitions included in financial results.
On October 8, 2013, the Company signed an agreement to purchase the wastewater assets of SYC WWTP, L.P. in Shrewsbury and Springfield Townships,
York County, Pennsylvania. Completion of the acquisition is contingent upon receiving approval from all required regulatory authorities. Closing is expected in the fourth quarter of 2016 at which time the Company will add approximately 30 commercial and industrial wastewater customers.
On July 20, 2015, the Company signed an agreement to purchase the water assets of the Westwood Mobile Home Park in York County, Pennsylvania. Completion of this acquisition is contingent upon receiving approval from all required regulatory authorities. The Company expects to begin serving approximately 200 new customers through an interconnection with its current distribution system in the second quarter of 2016. These customers are currently served through a single customer connection to the park.
On January 18, 2016, the Company signed an agreement to purchase the wastewater collection assets of West York Borough in York County, Pennsylvania. Completion of the acquisition is contingent upon receiving approval from all required regulatory authorities. Closing is expected in the fourth quarter of 2016 at which time the Company will add approximately 1,700 wastewater customers.
In total, these acquisitions are expected to be immaterial to Company results. The Company is also pursuing other bulk water contracts and acquisitions in and around its service territory to help offset any further declines in per capita water consumption and to grow its business.
Capital Expenditures
For the three months ended March 31, 2016, the Company invested $1,921 in construction expenditures for routine items, further upgrades to water treatment facilities and information technology upgrades, as well as various replacements of infrastructure. In addition, the Company invested $5 in the acquisition of water systems. The Company was able to fund construction expenditures using internally-generated funds and proceeds from its stock purchase plans.
The Company anticipates construction expenditures for the remainder of 2016 of approximately $15,300 exclusive of any potential acquisitions not yet approved. In addition to routine transmission and distribution projects, a portion of the anticipated expenditures will be for additional main extensions, further upgrades to water and wastewater treatment facilities, an additional raw water pumping station and force main, and various replacements and improvements to infrastructure. The Company intends to use primarily internally-generated funds for its anticipated construction and fund the remainder through line of credit borrowings, proceeds from its stock purchase plans and customer advances and contributions. Customer advances and contributions are expected to account for less than 5% of funding requirements in the remainder of 2016. The Company believes it will have adequate credit facilities and access to the capital markets, if necessary, to meet its anticipated capital needs in 2016.
Liquidity and Capital Resources
Cash
The Company manages its cash through a cash management account that is directly connected to a line of credit. Excess cash generated automatically pays down outstanding borrowings under the line of credit arrangement. If there are no outstanding borrowings, the cash is used as an earnings credit to reduce banking fees. Likewise, if additional funds are needed beyond what is generated internally for payroll, to pay suppliers, to fund capital expenditures, or to pay debt service, funds are automatically borrowed under the line of credit. The Company utilized a portion of its cash on hand in January for significant cash outflows, specifically a $2,300 contribution to its pension trusts and a dividend payment, but did not use its lines of credit during the first three months of 2016. The Company has rebuilt its cash through internally-generated funds, accumulating a cash balance of $3,217 as of March 31, 2016. The Company expects the cash balance to be fully utilized in 2016, after which the cash management facility is expected to provide the necessary liquidity and funding for the Company's operations, capital expenditures, acquisitions and potential buybacks of stock.
Accounts Receivable
The accounts receivable balance tends to follow the change in revenues which was true for the period ended March 31, 2016. At times, it is also affected by the timeliness of payments by customers and the level of the reserve for doubtful accounts. A reserve is maintained at a level considered adequate to provide for losses that can be reasonably anticipated based on inactive accounts with outstanding balances. Management periodically evaluates the adequacy of the reserve based on past experience, agings of the receivables, adverse situations that may affect a customer's ability to pay, current economic conditions, and other relevant factors. If the status of these factors deteriorates, the Company may incur additional expenses for uncollectible accounts and experience a reduction in its internally-generated funds.
Internally-generated Funds
The amount of internally-generated funds available for operations and construction depends on the Company's ability to obtain timely and adequate rate relief, changes in regulations, customers' water usage, weather conditions, customer growth and controlled expenses. In the first three months of 2016, the Company generated $3,324 internally from operations, consistent with the $3,232 it generated in the first three months of 2015.
Credit Lines
Historically, the Company has borrowed $15,000 to $20,000 under its lines of credit before refinancing with long-term debt or equity capital. As of March 31, 2016, the Company maintained unsecured lines of credit aggregating $29,000 with three banks at interest rates ranging from LIBOR plus 1.20% to LIBOR plus 1.50%. The Company had no outstanding borrowings under any of its lines of credit as of March 31, 2016.
The Company plans to renew its $5,000 committed line of credit that expires in June 2016 for an additional year, as well as extend the maturity of its $13,000 and $11,000 committed lines of credit into 2018, under similar terms and conditions.
The Company has taken steps to manage the risk of reduced credit availability by maintaining committed lines of credit that cannot be called on demand and obtaining a 2-year revolving maturity on its larger facilities. There is no guarantee that the Company will be able to obtain sufficient lines of credit with favorable terms in the future. In addition, if the Company is unable to refinance its line of credit borrowings with long-term debt or equity when necessary, it may have to eliminate or postpone capital expenditures. Management believes the Company will have adequate capacity under its current lines of credit to meet anticipated financing needs throughout 2016.
Long-term Debt
The Company's loan agreements contain various covenants and restrictions. Management believes it is currently in compliance with all of these restrictions. See Note 4 to the Company's Annual Report on Form 10-K for the year ended December 31, 2015 for additional information regarding these restrictions.
The Company's total long-term debt as a percentage of the total capitalization, defined as total common stockholders' equity plus total long-term debt, was 44.2% as of March 31, 2016, compared with 44.5% as of December 31, 2015. The Company expects to allow the debt percentage to trend upward until it approaches fifty percent before considering additional equity. A debt to total capitalization ratio between forty-six and fifty percent has historically been acceptable to the PPUC in rate filings. Due to its recent ability to generate and retain cash internally, the Company has been able to keep its ratio below fifty percent.
Income Taxes, Deferred Income Taxes and Uncertain Tax Positions
The Company has a substantial deferred income tax asset primarily due to the differences between the book and tax balances of the pension and deferred compensation plans. The Company does not believe a valuation allowance is required due to the expected generation of future taxable income during the periods in which those temporary differences become deductible.
The Company has seen an increase in its deferred income tax liability amounts as a result of the accelerated and bonus depreciation deduction available for federal tax purposes which creates differences between book and tax depreciation expense. The Company expects this trend to continue as it makes significant investments in capital expenditures subject to accelerated and bonus depreciation or TPR.
The Company filed for a change in accounting method under the IRS TPR effective beginning in 2014. Under the change in accounting method, the Company is permitted to deduct the costs of certain asset improvements that were previously being capitalized and depreciated for tax purposes as an expense on its income tax return. This ongoing deduction results in a reduction in the effective income tax rate, a net reduction in income tax expense, and a reduction in the amount of income taxes currently payable. It also results in increases to deferred tax liabilities and regulatory assets representing the appropriate book and tax basis difference on capital additions. The Company expects an effective tax rate of 28% to 32% each year based on current asset improvement estimates. The effective tax rate will vary depending on the level of eligible assets improvements that are placed in service each period.
The Company has determined there are no uncertain tax positions that require recognition as of March 31, 2016.
Common Stock
Common stockholders' equity as a percent of the total capitalization was 55.8% as of March 31, 2016, compared with 55.5% as of December 31, 2015. The volume of share repurchases and line of credit borrowings, among other things, could reduce this percentage in the future. It is the Company's intent to target a ratio between fifty and fifty-four percent.
Credit Rating
On March 30, 2016, Standard & Poor's affirmed the Company's credit rating at A-, with a stable outlook and adequate liquidity. The Company's ability to maintain its credit rating depends, among other things, on adequate and timely rate relief, which it has been successful in obtaining, its ability to fund capital expenditures in a balanced manner using both debt and equity and its ability to generate cash flow. The Company's objectives are to continue to maximize its funds provided by operations and maintain a strong capital structure in order to be able to attract capital.
Critical Accounting Estimates
The methods, estimates and judgments the Company used in applying its accounting policies have a significant impact on the results reported in its financial statements. The Company's accounting policies require management to make subjective judgments because of the need to make estimates of matters that are inherently uncertain. The Company's most critical accounting estimates include regulatory assets and liabilities, revenue recognition and accounting for its pension plans. There has been no significant change in accounting estimates or the method of estimation during the quarter ended March 31, 2016.
Off-Balance Sheet Arrangements
The Company does not use off-balance sheet transactions, arrangements or obligations that may have a material current or future effect on financial condition, results of operations, liquidity, capital expenditures, capital resources or significant components of revenues or expenses. The Company does not use securitization of receivables or unconsolidated entities. The Company uses a derivative financial instrument, an interest rate swap agreement discussed in Note 6 to the financial statements included herein, for risk management purposes. The Company does not engage in trading or other risk management activities, does not use other derivative financial instruments for any purpose, has no material lease obligations, no guarantees and does not have material transactions involving related parties.
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Quantitative and Qualitative Disclosures About Market Risk
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The Company's operations are exposed to market risks primarily as a result of changes in interest rates under its lines of credit. The Company has unsecured lines of credit with three banks having a combined maximum availability of $29,000. The first line of credit, in the amount of $13,000, is a committed line of credit with a revolving 2-year maturity (currently May 2017), and carries an interest rate of LIBOR plus 1.20%. The second line of credit, in the amount of $11,000, is a committed line of credit, which currently matures in May 2017 and carries an interest rate of LIBOR plus 1.25%. The third line of credit, in the amount of $5,000, is a committed line of credit, which matures in June 2016 and carries an interest rate of LIBOR plus 1.50%. The Company had no outstanding borrowings under any of its lines of credit as of March 31, 2016. Other than lines of credit, the Company has long-term fixed rate debt obligations that are not subject to interest rate risk as shown in Note 5 to the financial statements included herein, and a variable rate PEDFA loan agreement, which is subject to minimal market risk, described below.
In May 2008, the PEDFA issued $12,000 aggregate principal amount of PEDFA Exempt Facilities Revenue Bonds, Series A (the "2008 Bonds"). The proceeds of this bond issue were used to refund the $12,000 PEDFA Exempt Facilities Revenue Bonds, Series B of 2004 which were refunded due to bond insurer downgrading issues. The PEDFA then loaned the proceeds to the Company pursuant to a variable interest rate loan agreement with a maturity date of October 1, 2029. The interest rate under this loan agreement averaged 0.07% during the three months ended March 31, 2016. In connection with the loan agreement, the Company retained its interest rate swap agreement whereby the Company exchanged its floating rate obligation for a fixed rate obligation. The purpose of the interest rate swap is to manage the Company's exposure to fluctuations in the interest rate. If the interest rate swap agreement works as intended, the receive rate on the swap should approximate the variable rate the Company pays on the PEDFA Series A 2008 Bond Issue, thereby minimizing its risk. See Note 6 to the financial statements included herein for additional information regarding the interest rate swap.
In addition to the interest rate swap agreement, the Company entered into a Reimbursement, Credit and Security Agreement with PNC Bank, National Association ("the Bank"), dated as of May 1, 2008, in order to enhance the marketability of and to minimize the interest rate on the 2008 Bonds. This agreement provides for a direct pay letter of credit issued by the Bank to the trustee for the 2008 Bonds. The current expiration date of the letter of credit is June 30, 2017. It is reviewed annually for a potential extension of the expiration date. The Company's responsibility under this agreement is to reimburse the Bank on a timely basis for interest payments made to the bondholders and for any tendered bonds that could not be remarketed. The Company has fourteen months from the time bonds are tendered to reimburse the Bank. If the direct pay letter of credit is not renewed, the Company would be required to pay the Bank immediately for any tendered bonds and reclassify a portion of the bonds as current liabilities. In addition, the interest rate swap agreement would terminate causing a potential payment by the Company to the counterparty. Both the letter of credit and the swap agreement can potentially be transferred upon this type of event.
Evaluation of Disclosure Controls and Procedures
The Company's management, with the participation of the Company's President and Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of the Company's disclosure controls and procedures as of the end of the period covered by this report. Based upon this evaluation, the Company's President and Chief Executive Officer along with the Chief Financial Officer concluded that the Company's disclosure controls and procedures as of the end of the period covered by this report are effective such that the information required to be disclosed by the Company in reports filed under the Securities Exchange Act of 1934, as amended, is (i) recorded, processed, summarized and reported within the time periods specified in the SEC's rules and forms and (ii) accumulated and communicated to the Company's management, including the President and Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding disclosure. A controls system cannot provide absolute assurance, however, that the objectives of the controls system are met, and no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within a company have been detected.
No change in the Company's internal control over financial reporting occurred during the Company's most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, the Company's internal control over financial reporting.
Part II – OTHER INFORMATION
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Exhibits
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Exhibit No.
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Description
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3
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Amended and Restated Articles of Incorporation. Incorporated herein by reference to Exhibit 3.1 of the Company's Current Report on Form 8-K filed with the Securities and Exchange Commission on May 4, 2010.
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3.1
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Amended and Restated By-Laws. Incorporated herein by reference to Exhibit 3.1 of the Company's Current Report on Form 8-K filed with the Securities and Exchange Commission on January 26, 2012.
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101.INS
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XBRL Instance Document
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101.SCH
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XBRL Taxonomy Extension Schema
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101.CAL
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XBRL Taxonomy Extension Calculation Linkbase
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101.DEF
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XBRL Taxonomy Extension Definition Linkbase
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101.LAB
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XBRL Taxonomy Extension Label Linkbase
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101.PRE
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XBRL Taxonomy Extension Presentation Linkbase
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Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
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THE YORK WATER COMPANY
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/s/Jeffrey R. Hines
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Date: May 3, 2016
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Jeffrey R. Hines
Principal Executive Officer
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/s/Kathleen M. Miller
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Date: May 3, 2016
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Kathleen M. Miller
Principal Financial and Accounting Officer
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Exhibit No.
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Description
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3
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Amended and Restated Articles of Incorporation. Incorporated herein by reference to Exhibit 3.1 of the Company's Current Report on Form 8-K filed with the Securities and Exchange Commission on May 4, 2010.
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3.1
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Amended and Restated By-Laws. Incorporated herein by reference to Exhibit 3.1 of the Company's Current Report on Form 8-K filed with the Securities and Exchange Commission on January 26, 2012.
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101.INS
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XBRL Instance Document
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101.SCH
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XBRL Taxonomy Extension Schema
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101.CAL
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XBRL Taxonomy Extension Calculation Linkbase
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101.DEF
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XBRL Taxonomy Extension Definition Linkbase
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101.LAB
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XBRL Taxonomy Extension Label Linkbase
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101.PRE
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XBRL Taxonomy Extension Presentation Linkbase
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