# Essential Utilities, Inc. (WTRG) FY 2023 MD&A

Verbatim Item 7 Management's Discussion and Analysis from Essential Utilities, Inc.'s 10-K for fiscal year 2023.

SEC filing source: https://www.sec.gov/Archives/edgar/data/78128/000156276224000047/wtrg-20231231x10k.htm
Accession: 0001562762-24-000047
Filing date: 2024-02-29
Report date: 2023-12-31
Extracted structurally from real Item 7 body heading to real Item 7A/8 boundary.
Confidence: high

Company profile: /company/WTRG/
All MD&A years: /company/WTRG/mda/
Previous year: /company/WTRG/mda/fy2022/ (FY 2022)
Next year: /company/WTRG/mda/fy2024/ (FY 2024)

Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations

OVERVIEW

The following discussion and analysis of our financial condition and results of operations should be read together with our Consolidated Financial Statements and accompanying Notes included in this Annual Report. This discussion contains forward-looking statements that are based on management’s current expectations, estimates, and projections about our business, operations, and financial performance. All dollar amounts are in thousands of dollars, except per share amounts.

The Company

Essential Utilities, Inc., (Essential Utilities, the Company, we, us, or our), a Pennsylvania corporation, is the holding company for regulated utilities providing water, wastewater, or natural gas services to an estimated 5.5 million people in Pennsylvania, Ohio, Texas, Illinois, North Carolina, New Jersey, Indiana, Virginia, and Kentucky under the Aqua and Peoples brands. One of our largest operating subsidiaries, Aqua Pennsylvania, Inc. (Aqua Pennsylvania), provides water or wastewater services to approximately one-half of the total number of water or wastewater customers we serve. These customers are located in the suburban areas in counties north and west of the City of Philadelphia and in 27 other counties in Pennsylvania. Our other regulated water or wastewater utility subsidiaries provide similar services in seven additional states. Our Peoples subsidiaries provide natural gas service to approximately 744,000 customers in western Pennsylvania and Kentucky. Approximately 95% of the total number of natural gas utility customers we serve are in western Pennsylvania. Lastly, the Company’s market-based activities are conducted through Aqua Resources, Inc. and certain other non-regulated subsidiaries of Peoples. Aqua Resources offers, through a third-party, water and sewer service line protection solutions and repair services to households. Other non-regulated subsidiaries of Peoples provide utility service line protection services to households and operate gas marketing and production businesses.

In December 2022, the Company signed an agreement to sell its regulated natural gas utility assets in West Virginia, which represented approximately two percent of the Company’s regulated natural gas customers. The sale closed on October 1, 2023 for an estimated purchase price of $39,965, subject to working capital and other adjustments. The sale concluded the Company’s regulated utility operations in West Virginia. In October 2023, the Company entered into an agreement to sell its interest in three non-utility local microgrid and distributed energy projects for $165,000. The sale was completed in January 2024. These transactions are consistent with the Company’s long-term strategy of focusing on its core business and will allow the Company to prioritize the growth of its utilities in states where it has scale. The Company intends to use the proceeds from these transactions to finance its capital expenditures and water and wastewater acquisitions, in place of external funding from equity and debt issuances. See Note 3 – Assets Held for Sale and Dispositions in the Notes to Consolidated Financial Statements for additional information.

Recent Developments

National Primary Drinking Water Regulation

On March 14, 2023, the U.S. Environmental Protection Agency (“EPA”) announced the proposed National Primary Drinking Water Regulation (“NPDWR”) for the treatment of six per- and polyfluoroalkyl substances or compounds (“PFAS”), which would establish legally enforceable levels for PFAS in drinking water. It is expected that the EPA will finalize the regulation in 2024. The Company will be provided a three-year window to comply with the NPDWR, and the Safe Drinking Water Act allows for an additional potential for a two-year extension at the state level (the “Compliance Period”). We expect that the regulation, once finalized, will result in changes to or addition of certain treatment processes that will require increased capital expenditures and operating expenses. The Company performed its initial analysis of the NPDWR and estimates an investment of at least $450,000 of capital expenditures to install additional treatment facilities over the Compliance Period in order to comply with the proposed NPDWR. This figure could increase as plans for construction execution are refined or if additional sites require treatment in the future. Additionally, the Company estimates annual operating expenses of approximately five percent of the installed capital expenditures, in today’s dollars, related to testing, treatment, and disposal. These are preliminary estimates and actual capital expenditures and expenses may differ based upon a variety of factors, including supply chain issues and site-by-site requirements. The Company continues to advocate for actions to hold polluters accountable and is part of the Multi-District Litigation and other legal

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actions against multiple PFAS manufacturers and polluters to attempt to ensure that the ultimate responsibility for the cleanup of these contaminants is attributed to the polluters and is seeking damages and other costs to address the contamination of its public water supply systems by PFAS. Capital expenditures and operating costs required as a result of water quality standards have been traditionally recognized by state utility commissions as appropriate for inclusion in establishing rates; however, we are also actively applying for grants and low interest loans, whenever possible, to reduce the overall cost to customers. The Company is also monitoring ongoing litigation and settlement activity with manufacturers of PFAS in these proceedings. For more information, see Part I, Item 3—Legal Proceedings in our Annual Report on Form 10-K for the year ended December 31, 2023.

Lead and Copper Rule Revisions and Improvements

On January 15, 2021, the EPA published the Lead and Copper Rule Revisions (LCRR) which details additional measures to better protect communities from exposure to lead in drinking water. Under the LCRR and subsequent rulings, water utilities are required to submit a lead service line inventory and a lead service line replacement plan to the respective states or agencies by October 16, 2024.  We are continuing to enhance our lead service line inventory and refine our lead service line replacement plans, which we expect to complete by the deadline. On November 30, 2023, the EPA announced a proposed Lead and Copper Rule Improvements (LCRI) to further strengthen the key elements of the LCRR. The proposed LCRI includes, among others, a requirement to replace lead service lines within 10 years, lower lead action levels, changes to tap sampling protocol, and enhancements to public notification and customer communication. We are still in the process of reviewing the overall impact of the proposed LCRI. Capital expenditures and operating costs associated with compliance with any of these rule revisions will be determined once the EPA finalizes the rule. 

Economic Regulation

Most of our utility operations are subject to regulation by their respective state utility commissions, which have broad administrative power and authority to regulate billing rates, determine franchise areas and conditions of service, approve acquisitions, and authorize the issuance of securities. The utility commissions also generally establish uniform systems of accounts and approve the terms of contracts with affiliates and customers, business combinations with other utility systems, and loans and other financings. The policies of the utility commissions often differ from state to state and may change over time. A small number of our operations are subject to rate regulation by county or city government. Over time, the regulatory party in a particular state may change. The profitability of our utility operations is influenced to a great extent by the timeliness and adequacy of rate allowances in the various states in which we operate. One consideration we may undertake in evaluating on which states to focus our growth and investment strategy is whether a state provides for consolidated rates, a surcharge for replacing and rehabilitating infrastructure, fair value treatment of acquired utility systems, and other regulatory policies that promote infrastructure investment and efficiency in processing rate cases.

Rate Case Management Capability – The mission of the regulated utility industry is to provide quality and reliable utility service at reasonable rates to customers, while earning a fair return for shareholders. We strive to achieve the industry’s mission by effective planning, efficient investments, and productive use of our resources. We maintain a rate case management capability to pursue timely and adequate returns on the capital investments that we make in improving our distribution system, treatment plants, information technology systems, and other infrastructure. This capital investment creates assets that are used and useful in providing utility service and is commonly referred to as rate base. Timely and adequate rate relief is important to our continued profitability and in providing a fair return to our shareholders; thus, providing access to capital markets to help fund these investments. In pursuing our rate case strategy, we consider the amount of net utility plant additions and replacements made since the previous rate decision, the changes in the cost of capital, changes in our capital structure, and changes in operating and other costs. Based on these assessments, our utility operations periodically file rate increase requests with their respective state utility commissions or local regulatory authorities. In general, as a regulated enterprise, our utility rates are established to provide full recovery of utility operating costs, taxes, interest on debt used to finance capital investments, and a return on equity used to finance capital investments. Our ability to recover our expenses in a timely manner and earn a return on equity employed in the business helps determine the profitability of the Company.

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As of December 31, 2023, the Company’s rate base is estimated to be $10,400,000, which is comprised of:

$6,900,000 in the Regulated Water segment; and

$3,500,000 in the Regulated Natural Gas segment.

As of December 31, 2023, the regulatory status of the Company’s rate base is estimated to be as follows:

$8,200,000 filed with respective state utility commissions or local regulatory authorities; and

$2,200,000 not yet filed with respective state utility commissions or local regulatory authorities.

Our water and wastewater operations are composed of 57 rate divisions, and our natural gas operations are comprised of four rate divisions. Each of our utility rate divisions require a separate rate filing for the evaluation of the cost of service and recovery of investments in connection with the establishment of tariff rates for that rate division. When feasible and beneficial to our utility customers, we have sought approval from the applicable state utility commission to consolidate rate divisions to achieve a more even distribution of costs over a larger customer base. All of the eight states in which we operate water and wastewater utilities currently permit us to file a revenue requirement using some form of consolidated rates for some or all of the rate divisions in that state.

Our operating subsidiaries received rate increases representing estimated annualized revenues of $28,426 in 2023 resulting from seven base rate decisions, $81,610 in 2022 resulting from seven base rate decisions, and $3,390 in 2021 resulting from six base rate decisions. Annualized revenues in aggregate from all of the rate increases realized in the year of grant were $10,109 in 2023, $51,163 in 2022, and $2,995 in 2021.

Revenue Surcharges – Each of our states in which we operate water, wastewater, and natural gas utilities, permit us to add an infrastructure rehabilitation surcharge to their respective bills to offset the additional depreciation and capital costs associated with capital expenditures related to replacing and rehabilitating infrastructure systems. Prior to allowing for such surcharges, utilities absorbed all of the depreciation and capital costs of these projects between base rate increases without the benefit of additional revenues. The gap between the time that a capital project is completed and the recovery of its costs in rates is known as regulatory lag. This surcharge is intended to substantially reduce regulatory lag, which could act as a disincentive for utilities to rehabilitate their infrastructure. In addition, some states permit our subsidiaries to use a surcharge or credit on their bills to reflect allowable changes in costs, such as changes in state tax rates, other taxes and purchased water costs, until such time as the new costs are fully incorporated in base rates. Additional information regarding revenue surcharges is provided in Note 17 – Rate Activity in this Annual Report.

Inflation and Operating Costs – Most elements of operating costs are subject to the effects of inflation and changes in the number of customers served. Several elements are subject to the effects of changes in water or gas consumption, weather conditions, and the degree of water treatment required due to variations in the quality of the raw water. The principal elements of operating costs are purchased gas, labor and employee benefits, electricity, chemicals, transportation, maintenance expenses, insurance and claims costs, and costs to comply with environmental regulations. Electricity and chemical expenses vary in relationship to water or gas consumption, raw water quality, wastewater volumes, and price changes. Maintenance expenses are sensitive to extremely cold weather, which can cause utility mains to rupture and natural gas service lines to freeze, resulting in additional costs to repair the affected mains. Higher operating costs and capital requirements may also require us to increase borrowings under our credit facilities, resulting in higher interest expense.

Inflation, higher interest rates, higher insurance costs due to market conditions, and supply chain pressures resulted in an increase in our operating and capital spending requirements in 2022 and 2023, which we expect to continue through 2024. Recovery of the effects of increased cost of providing services and infrastructure improvements through higher customer rates is dependent upon receiving adequate and timely rate increases. However, rate increases are not retroactive and often lag increases in costs. On occasion, our regulated utility companies may enter into rate settlement agreements, which require us to wait for a period of time to file the next base rate increase request. These agreements may result in regulatory lag whereby inflationary increases in expenses may not be reflected in rates, and may not yet be requested, or a gap may exist between when a capital project is completed and the start of its recovery in rates. Even during periods of moderate inflation, the effects of inflation can have a negative impact on our operating results. We continue to pursue

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enhancements to our regulatory practices to facilitate the efficient recovery of the increased cost of providing services and infrastructure improvements in our rates and mitigate the inherent regulatory lag associated with traditional rate making processes.

Our natural gas distribution operations are also affected by the cost of natural gas. We are able to generally pass the cost of gas to our customers without markup under purchase gas cost adjustment mechanisms; therefore, increases in the cost of gas are offset by a corresponding increase in revenues. However, higher gas costs may adversely impact our accounts receivable collections, resulting in higher bad debt expense. This risk is currently mitigated by rate design that allows us to collect from our customers a portion of our bad debt expense. A typical residential natural gas bill includes charges for the cost of gas, delivery, and other charges. As of January 1, 2024, the annual portion of a typical Peoples Natural Gas residential bill related to gas costs is approximately 41%. In periods when we experience market increases in natural gas costs, such as in 2022, customer affordability and usage may be reduced. Customer conservation measures may occur that can reduce natural gas revenues, either temporarily or over time.

Income Tax Accounting Method Change - In March 2020 and in June 2022, the Company changed the method of tax accounting for certain qualifying infrastructure investments at its Peoples Natural Gas and Peoples Gas Company subsidiaries, respectively. In December 2022, the Company made a similar change for its Aqua New Jersey subsidiary. These changes resulted in a tax deduction for qualifying utility asset improvement costs that were formerly capitalized for tax purposes. The Company is utilizing the flow-through method to account for these timing differences. For Peoples Natural Gas, the Company calculated the income tax benefits for qualifying capital expenditures made prior to March 16, 2020 (catch-up adjustment) and recorded a regulatory liability for $160,655 for these income tax benefits. In May 2021, the Pennsylvania Public Utility Commission approved a settlement petition that allows Peoples Natural Gas to continue to use flow-through accounting for the current tax repair benefit and allows for the catch-up adjustment be given to its customers. These benefits are being provided back to customers over a five-year period through a credit on customer bills which commenced in August 2021. In addition, the settlement petition required the contribution of $500 to a customer-bill payment assistance program, completed in July 2021, and $5,000 in relief to past-due accounts for natural gas customers impacted by the COVID-19 pandemic, completed in December 2021. For Peoples Gas, the Company calculated the catch-up adjustment for periods prior to the 2021 tax year and recognized a regulatory liability of $13,808 for these income tax benefits.

In April 2023, the Internal Revenue Service issued Revenue Procedure 2023-15 which provides a safe harbor method of accounting that taxpayers can adopt to determine whether expenses to repair, maintain, replace, or improve natural gas transmission and distribution property must be capitalized for tax purposes. The Company evaluated the safe harbor and intends to adopt the methodology on its 2023 tax return. Upon completion of its 2023 tax return analyses, the Company will update the regulatory liabilities recorded with the recalculated amounts for the catch-up periods for its Peoples Natural Gas and Peoples Gas subsidiaries, and file a petition to update its Tax Repair Surcredit rider to address the benefits due to customers.

In the second quarter of 2023, based on the tax legislative guidance that was issued, the Company reevaluated the uncertain tax positions related to the Regulated Water Segment and ultimately released a portion of its historical income tax reserves. Concurrently, the Company deferred this tax benefit from the reserve release as a regulatory liability, as the accounting treatment is expected to be determined in a subsequent regulatory proceeding.

Growth-Through-Acquisition Strategy

Part of our strategy to meet the industry challenges is to actively explore opportunities to expand our utility operations through acquisitions of water, wastewater, and other utilities either in areas adjacent to our existing service areas or in new service areas, and to explore acquiring market-based businesses that are complementary to our regulated utility operations. To complement our growth strategy, we routinely evaluate the operating performance of our individual utility systems, and in instances where limited economic growth opportunities exist or where we are unable to achieve favorable operating results or a return on equity that we consider acceptable, we will seek to sell the utility system and reinvest the proceeds in other utility systems. Consistent with this strategy, we are focusing our acquisitions and resources in states where we have critical mass of operations in an effort to achieve economies of scale and increased efficiency. Our growth-through-acquisition strategy allows us to operate more efficiently by sharing operating expenses over more utility customers and

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provides new locations for future earnings growth through capital investment. Another element of our growth strategy is the consideration of opportunities to expand by acquiring other utilities, including those that may be in a new state if they provide promising economic growth opportunities and a return on equity that we consider acceptable. Our ability to successfully execute this strategy historically and to meet the industry challenges has largely been due to our core competencies, financial position, and our qualified and trained workforce, which we strive to retain by treating employees fairly and providing our employees with development and growth opportunities.

During 2023, we completed seven acquisitions of water and wastewater systems, which along with the organic growth in our existing systems, represents 19,659 new customers. During 2022, we completed three acquisitions of water and wastewater systems, which along with the organic growth in our existing systems, represents 31,537 new customers. During 2021 we completed two acquisitions of water and wastewater systems, which along with the organic growth in our existing systems, represents 21,364 new customers.

The Company currently has six signed purchase agreements for additional water and wastewater systems that are expected to serve approximately 215,000 equivalent retail customers or equivalent dwelling units and total approximately $380,000 in purchase price in two of our existing states. This includes the Company’s agreement to acquire the Delaware County Regional Water Quality Control Authority (DELCORA) for $276,500. DELCORA, a Pennsylvania sewer authority, serves approximately 198,000 equivalent dwelling units in the Philadelphia suburbs. Refer to Note 2 – Acquisitions in this Annual Report for further discussion.

As of December 31, 2023, the pipeline of potential water and wastewater municipal acquisitions the company is actively pursuing represents approximately 400,000 total customers or equivalent dwelling units. The Company remains on track to, on average, annually increase customers between 2% and 3% through acquisitions and organic customer growth.

Performance Measures Considered by Management

We consider the following financial measures (and the period to period changes in these financial measures) to be the fundamental basis by which we evaluate our operating results:

earnings per share;

water and wastewater operating revenues;

gas operating revenues, net of purchased gas costs;

operations and maintenance expenses;

earnings before interest, taxes, and depreciation (EBITD);

earnings before income taxes;

net income; and

the dividend rate on common stock.

In addition, we consider other key measures in evaluating our utility business performance within our Regulated Water and Regulated Natural Gas segments:

our number of utility customers;

the ratio of operations and maintenance expense compared to operating revenues (this percentage is termed “operating expense ratio”);

return on revenues (net income divided by operating revenues);

rate base growth;

return on equity (net income divided by stockholders’ equity); and

the ratio of capital expenditures to depreciation expense.

Some of these measures, like EBITD and gas operating revenues, net of purchased gas costs, are non-GAAP financial measures. The Company believes that the non-GAAP financial measures provide management the ability to measure the Company’s financial operating performance across periods and are more comparable to measures reported by other companies. We believe EBITD is a relevant and useful indicator of operating performance, as we measure it for

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management purposes because it provides a better understanding of our results of operations by highlighting our operations and the underlying profitability of our core businesses.

We review these measurements regularly and compare them to historical periods, to our operating budget as approved by our Board of Directors, and to other publicly-traded utilities. Additionally, our Regulated Natural Gas segment is affected by the cost of natural gas, which is passed through to customers using a purchased gas adjustment mechanism and includes commodity price, transportation and storage costs. These costs are reflected in the consolidated statement of operations and comprehensive income as purchased gas expenses. Therefore, fluctuations in the cost of purchased gas impact operating revenues on dollar-for-dollar basis. Management uses gas operating revenues, net of purchased gas costs, a non-GAAP financial measure, to analyze the financial performance of our Regulated Natural Gas segment. Management believes this measure provides a meaningful basis for evaluating our natural gas utility operations since purchased gas expenses are included in operating revenues and passed through to customers.

Our operating expense ratio is one measure that we use to evaluate our operating efficiency and management effectiveness of our regulated operations. Our operating expense ratio is affected by a number of factors, including the following:

Regulatory lag – Our rate filings are designed to provide for the recovery of increases in costs of operations (primarily labor and employee benefits, electricity, chemicals, transportation, maintenance expenses, insurance and claim costs, and costs to comply with environmental regulations), capital, and taxes. The revenue portion of the operating expense ratio can be impacted by the timeliness of recovery of, and the return on capital investments. The operating expense ratio is further influenced by regulatory lag (increases in operations and maintenance expenses not yet recovered in rates or a gap between the time that a capital project is completed and the start of its cost recovery in rates). The operating expense ratio is also influenced by decreases in operating revenues without a commensurate decrease in operations and maintenance expense, such as changes in customer usage as impacted by adverse weather conditions, or conservation trends. During periods of inflation, our operations and maintenance expenses may increase, impacting the operating expense ratio, as a result of regulatory lag, since our rate cases may not be filed timely and are not retroactive.

Acquisitions – In general, acquisitions of smaller undercapitalized utility systems in some areas may initially increase our operating expense ratio if the operating revenues generated by these operations do not reflect the true cost of service and are accompanied by a higher ratio of operations and maintenance expenses as compared to other operational areas of the company that are more densely populated and have integrated operations. In these cases, the acquired operations are characterized as having relatively higher operating costs to fixed capital costs, in contrast to the majority of our operations, which generally consist of larger, interconnected systems, with higher fixed capital costs (utility plant investment) and lower operating costs per customer. For larger acquisitions, we may incur significant transaction expenses, which increase operations and maintenance expenses in periods prior to and in the period of the closing of the acquisition. In addition, we operate market-based subsidiary companies consisting of our non-regulated natural gas operations and Aqua Resources. The cost-structure of these market-based companies differs from our utility companies in that, although they may generate free cash flow, these companies may at times have a higher ratio of operations and maintenance expenses to operating revenues and a lower capital investment and, consequently, a lower ratio of fixed capital costs versus operating revenues in contrast to our regulated operations. As a result, the operating expense ratio is not comparable between the businesses. These market-based subsidiary companies are not a component of our Regulated Water or Regulated Natural Gas segments.

We continue to evaluate initiatives to help control operating costs and improve efficiencies.

Other Operational Measures Considered by Management

Sendout - Sendout represents the quantity of treated water delivered to our distribution systems. We use sendout as an indicator of customer demand. Weather conditions tend to impact water consumption, particularly during the late spring, summer, and early fall when discretionary and recreational use of water is at its highest. Consequently, a higher proportion of annual Regulated Water segment operating revenues are realized in the second and third quarters. In general, during this period, an extended period of hot and dry weather increases water consumption, while above-average

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rainfall and cool weather decreases water consumption. Conservation efforts, construction codes that require the use of low-flow plumbing fixtures, as well as mandated water use restrictions in response to drought conditions can reduce water consumption. We believe an increase in conservation awareness by our customers, including the increased use of more efficient plumbing fixtures and appliances, may continue to result in a long-term structural trend of declining water usage per customer. These gradual long-term changes are normally taken into account by the utility commissions in setting rates, whereas significant short-term changes in water usage, resulting from drought warnings, water use restrictions, or extreme weather conditions, may not be fully reflected in the rates we charge between rate proceedings. In Illinois, our operating subsidiary has a revenue stability mechanism which allows us to recognize state PUC-authorized revenue for a period which is not based upon the volume of water sold during that period, and effectively lessens the impact of weather and consumption variability.

On occasion, drought warnings and water use restrictions are issued by governmental authorities for portions of our service territories in response to extended periods of dry weather conditions, regardless of our ability to meet unrestricted customer water demands. The timing and duration of the warnings and restrictions can have an impact on our water revenues and net income. In general, water consumption in the summer months is affected by drought warnings and restrictions to a higher degree because discretionary and recreational use of water is highest during the summer months, particularly in our northern service territories. At other times of the year, warnings and restrictions generally have less of an effect on water consumption. Drought warnings and watches result in the public being asked to voluntarily reduce water consumption.

The geographic diversity of our utility customer base reduces the effect of our exposure to extreme or unusual weather conditions in any one area of the country. During the year ended December 31, 2023, our operating revenues for our Regulated Water segment were derived principally from the following states: approximately 56% in Pennsylvania, 11% in Ohio, 8% in Illinois, 9% in Texas, and 7% in North Carolina.

Heating Degree Days – The regulated natural gas utility business is subject to seasonal fluctuations with the peak usage period occurring in the heating season which generally runs from October to March. A heating degree day (HDD) is each degree that the average of the high and the low temperatures for a day is below 65 degrees Fahrenheit in a specific geographic location. Particularly during the heating season, this measure is used to reflect the demand for natural gas needed for heating based on the extent to which the average temperature falls below a reference temperature for which no heating is required (65 degrees Fahrenheit). HDDs are used in the natural gas industry to measure the relative coldness of weather and to estimate the demand for natural gas. Normal temperatures are based on a historical twenty-year average heating degree days, as calculated from data provided by the National Weather Service for the same geographic location. During the year ended December 31, 2023, we experienced actual HDDs of 4,558 days, which was warmer by 16.0% than the average or normal HDDs for Pittsburgh, Pennsylvania, which we use as a proxy for our western Pennsylvania service territory.

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RESULTS OF OPERATIONS

Consolidated financial and operational highlights for the years ended December 31, 2023, 2022, and 2021 are presented below. For discussion of our results of operations and cash flows for 2022 compared with 2021, refer to Part II, Item 7 “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in our Annual Report on Form 10-K for our fiscal year ended December 31, 2022, filed with the SEC on March 1, 2023.

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Consolidated Results of Operations Comparison for 2023 and 2022

Operating revenues - Operating revenues decreased by $234,208 or 10.2% for the year ended December 31, 2023 compared to the year ended December 31, 2022. Revenues from our Regulated Water segment increased by $70,404, Regulated Natural Gas segment revenues decreased by $279,603 and Other business segment revenues decreased by $25,009. A detailed discussion of the factors contributing to the changes in segment net revenue is included below under the section, Segment Results of Operations.

Our Other business segment revenues consist of market-based revenues at Aqua Resources and our non-regulated natural gas operations amounting to $36,689 in 2023, $61,698 in 2022, and $38,435 in 2021. The decrease in Other business segment revenues is primarily due to lower revenues from our non-regulated natural gas operations as a result of lower average gas prices and lower gas usage in the current period as compared to the prior period.

Operating expenses - Operations and maintenance expenses decreased in 2023, as compared to 2022, by $38,131 or 6.2%, primarily due to:

decrease in customer assistance surcharge costs of $18,710 in our Regulated Natural Gas segment, which has an equivalent offsetting amount in revenues;

decrease in employee related costs of $5,381, primarily due to lower post-retirement benefit costs, higher capitalization in 2023 due to greater capital expenditures, and a one-time compensation payment for non-officer level employees in 2022;

decrease in charitable contributions to the Essential Foundation and other organizations of $15,360;

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decrease in bad debt expense of $4,422;  

decrease in outside services, maintenance expenses, and other operating expenses of $7,707, primarily due to lower water main break activity and higher capitalization as a result of greater capital expenditures during the period in our Regulated Water segment;

insurance recovery of $2,448 associated with clean-up and additional expenses incurred during Hurricane Ida;

an asset impairment charge recognized in the first quarter of 2022 of $1,801 to write down a portion of the right of use asset of our Regulated Natural Gas segment’s office space to fair value; offset by

an increase in production costs for water and wastewater operations of $12,208, primarily due to higher chemical prices and an increase in wholesale purchased water costs;

additional operating costs associated with acquired and pending acquisitions of water and wastewater utility systems and higher customer base of $5,767;

increase in insurance expense of $1,741 due to higher reserve for claims and insurance premiums in 2023;   

increase in legal expenses of $2,427;

lower operation and maintenance expense of $837 as a result of the sale and cessation of our regulated natural gas operations in West Virginia in October 2023; and

lower operating expenses driven by various cost-saving measures.

Purchased gas decreased by $249,689 or 41.5% in 2023 compared to 2022. Purchased gas represents the cost of gas sold by Peoples for the regulated and non-regulated gas business and has a corresponding offset in revenue. This expense decreased for the regulated natural gas business and non-regulated business by $223,461 and $26,228, respectively. The decrease in 2023 is the result of the impact of lower cost of gas of $128,997 and, lower gas usage of $120,692 due to warmer weather conditions as compared with 2022.

Depreciation and amortization expense increased by $22,518 or 7.0%, in 2023 over 2022, principally due to continued capital expenditures to expand and improve our utility facilities, upgrade our information systems, our acquisitions of new utility systems, and additional rate case filings. Expenses associated with filing rate cases are deferred and amortized over periods that generally range from one to three years.

Taxes other than income taxes totaled $90,208 in 2023 and $90,024 in 2022, and has increased by $184 or 0.2% in 2023 as compared to 2022.

Other expense, net - Interest expense, net was $279,961 in 2023 and $234,441 in 2022. Interest expense increased in 2023 primarily due to an increase in average borrowings, and an increase in average interest rates. The weighted average cost of fixed rate long-term debt was 3.86% at December 31, 2023 and 3.78% at December 31, 2022. The weighted average cost of fixed and variable rate long-term debt was 4.14% at December 31, 2023 and 3.94% at December 31, 2022.

Allowance for funds used during construction (AFUDC) was $16,967 in 2023 and $23,665 in 2022, and varies as a result of changes in the average balance of utility plant construction work in progress, to which AFUDC is applied, changes in the AFUDC rate which is based predominantly on short-term interest rates, changes in the balance of short term-debt, and changes in the amount of AFUDC related to equity. The decrease in 2023 is primarily due to a decrease in the average balance of utility plant construction work in progress, to which AFUDC is applied. The amount of AFUDC related to equity was $11,726 in 2023 and $17,618 in 2022.

Gain on sale of other assets totaled $65 in 2023 and $991 in 2022, and consists of the sales of property, plant and equipment.

Other (income) expense totaled $(2,613) in 2023 and $494 in 2022, and largely consists of the non-service cost component of our net benefit cost for post-retirement benefits and unrealized gains and losses on investments associated with our non-qualified pension plan. In 2023, the fair values of our investments associated with our non-qualified plan increased, and we recognized a gain of $582 in 2023 compared to a loss of $895 in 2022. Additionally, the non-service cost component of the net benefit cost for post-retirement benefits in our Regulated Gas segment was lower in 2023.

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Income tax benefit - Our effective income tax rate was a benefit of 15.4% in 2023 and 3.2% in 2022. The Company’s provision for income taxes represents an income tax benefit due to the effects of tax deductions recognized for certain qualifying infrastructure investments. The decrease in the effective tax rate is primarily attributed to the increase in our income tax benefit associated with the tax deduction for qualifying infrastructure investments in our Regulated Natural Gas segment.

Net income -

[[GREPCENT_TABLE]]
[["","Years ended December 31,"],["","2023","2022","2021"],["Operating income","$","692,097","$","661,187","$","602,709"],["Net income","","498,226","","465,237","","431,612"],["Diluted net income per share","","1.86","","1.77","","1.67"]]
[[/GREPCENT_TABLE]]

The changes in diluted net income per share in 2023 over the previous year were due to the aforementioned changes.

Although we have experienced increased income in the recent past, continued adequate rate increases reflecting increased operating costs and new capital improvements are important to the future realization of improved profitability.

Segment Results of Operations Comparison for 2023 and 2022

We have identified eleven operating segments, and we have two reportable segments based on the following:

Eight segments are composed of our water and wastewater regulated utility operations in the eight states where we provide these services. These operating segments are aggregated into one reportable segment, Regulated Water, since each of these operating segments has the following similarities: economic characteristics, nature of services, production processes, customers, water distribution and/or wastewater collection methods, and the nature of the regulatory environment.

Our Regulated Natural Gas segment is composed of natural gas utility companies in three states acquired in the Peoples Gas Acquisition. These utilities provide natural gas distribution services, and their operating results subsequent to the March 16, 2020 acquisition date are reported in the Regulated Natural Gas segment. In October 2023, the Company sold its regulated natural gas utility assets in West Virginia, which represented approximately two percent of the Company’s regulated natural gas customers. The sale concluded the Company’s regulated utility operations in West Virginia.

Two segments are not quantitatively significant to be reportable and are composed of our non-regulated natural gas operations and Aqua Resources. These segments are included as a component of “Other,” in addition to corporate costs that have not been allocated to the Regulated Water and Regulated Natural Gas segments, because they would not be recoverable as a cost of utility service, and intersegment eliminations. Corporate costs include general and administrative expenses, and interest expense.

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(In thousands of dollars, except per share amounts)

Regulated Water Segment

The following tables present the selected operating results and customers served for our Regulated Water segment, for and as of the year ended December 31:

[[GREPCENT_TABLE]]
[["","","2023","","2022","","2021","","2023 vs. 2022","","2022 vs. 2021"],["Sendout (in millions of gallons)"],["Pennsylvania","","42,525","","42,666","","42,198","","(141)","","468"],["Ohio","","13,560","","14,604","","13,971","","(1,044)","","633"],["Illinois","","8,421","","8,784","","8,764","","(363)","","20"],["Texas","","8,703","","8,606","","7,212","","97","","1,394"],["North Carolina","","5,824","","5,934","","5,984","","(110)","","(50)"],["Other states","","6,526","","6,272","","6,191","","254","","81"],["Subtotal","","85,559","","86,866","","84,320","","(1,307)","","2,546"],["Elimination","","(122)","","(141)","","(154)","","19","","13"],["Total sendout by state","","85,437","","86,725","","84,166","","(1,288)","","2,559"],["Utility customers:"],["Residential water","","859,331","","850,673","","842,200","","8,658","","8,473"],["Commercial water","","43,853","","43,119","","42,864","","734","","255"],["Industrial water","","1,283","","1,286","","1,331","","(3)","","(45)"],["Other water","","19,123","","18,446","","17,932","","677","","514"],["Wastewater","","190,119","","181,721","","162,478","","8,398","","19,243"],["Total water and wastewater utility customers","","1,113,709","","1,095,245","","1,066,805","","18,464","","28,440"],["Operating revenues:"],["Residential water","$","641,351","$","607,473","$","561,996","$","33,878","$","45,477"],["Commercial water","","180,731","","168,460","","151,071","","12,271","","17,389"],["Industrial water","","33,949","","32,581","","30,230","","1,368","","2,351"],["Other water","","92,784","","94,359","","89,472","","(1,575)","","4,887"],["Wastewater","","187,462","","165,312","","132,316","","22,150","","32,996"],["Other utility","","17,099","","14,787","","15,118","","2,312","","(331)"],["Total operating revenues","$","1,153,376","$","1,082,972","$","980,203","$","70,404","$","102,769"],["Operating expenses:"],["Operations and maintenance expense","$","368,843","$","370,850","$","332,598","$","(2,007)","$","38,252"],["Depreciation and amortization","$","217,593","$","201,392","$","182,074","$","16,201","$","19,318"],["Taxes other than income taxes","$","62,759","$","64,472","$","63,264","$","(1,713)","$","1,208"],["Other expense, net","$","105,674","$","84,396","$","81,931","$","21,278","$","2,465"],["Provision for income taxes","$","57,546","$","47,510","$","26,633","$","10,036","$","20,877"],["Segment net income","$","340,961","$","314,352","$","293,703","$","26,609","$","20,649"]]
[[/GREPCENT_TABLE]]

Operating revenues - The growth in our Regulated Water segment’s revenues over the past three years is primarily a result of increases in our water and wastewater rates and our customer base. Water and wastewater rate increases, including infrastructure rehabilitation surcharges, implemented during the past three years have provided additional operating revenues of $57,924 in 2023, $63,367 in 2022, and $27,421 in 2021. The number of customers increased at an annual compound rate of 2.1% over the past three years due to acquisitions and organic growth, adjusted to exclude customers associated with utility system dispositions. Acquisitions in our Regulated Water segment have provided additional water and wastewater revenues of $9,646 in 2023, $16,145 in 2022, and $6,750 in 2021.

Our Regulated Water segment also includes operating revenues of $14,863 in 2023, $11,477 in 2022 and $13,358 in 2021, associated with revenues earned primarily from fees received from telecommunication operators that have put cellular antennas on our water towers, fees earned from municipalities for our operation of their water or wastewater treatment services or to perform billing services, and fees earned from developers for accessing our water mains.

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Operating expenses - Operations and maintenance expense for the year ended December 31, 2023 was $368,843 compared to $370,850 in the prior period. The decrease of $2,007 or 0.5% was primarily due to the following:

increase in production costs for water and wastewater operations of $12,208;

additional operating costs resulting from acquired water and wastewater utility systems and higher customer base of $5,767; offset by

decrease in employee related costs of $8,379 primarily due to lower post-retirement benefit costs, higher capitalization in 2023 due to greater capital expenditures, and a one-time compensation payment for non-officer level employees in 2022;

decrease in bad debt expense of $902;

insurance recovery of $2,448 associated with clean-up costs and other expenses incurred during Hurricane Ida; and,

lower outside services, maintenance expenses and other operating expenses of $7,707 primarily due to lower water main break activity and higher capitalization as a result of greater capital expenditures during the period.

Depreciation and amortization increased by $16,201 or 8.0% primarily due to continued capital investment to expand and improve our utility facilities and our acquisitions of new utility systems.

Other expense, net – Interest expense, net, increased by $12,742 or 11.4% primarily due to the increase in average borrowings and increased borrowing costs.

AFUDC decreased by $6,164 or 29.4% due to the decrease in the average balance of utility plant construction work in progress, to which AFUDC is applied.

Other income, inclusive of loss/gain on sale of other assets, totaled $4,220 in 2023 and $6,592 in 2022. The decrease in other income is largely due to the increase in the non-service cost component of post-retirement benefits in our Regulated Water segment in 2023.

Provision for income tax – The effective income tax rate for our Regulated Water segment was an expense of 14.4% in 2023, compared to an expense of 13.1% in 2022. The change in the effective tax rate is primarily due to a decrease in the amortization of certain regulatory liabilities associated with deferred taxes.

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(In thousands of dollars, except per share amounts)

Regulated Natural Gas Segment

The following tables present the selected operating results and customers served for our Regulated Natural Gas segment for and as of the year ended December 31:

[[GREPCENT_TABLE]]
[["","","2023","2022","","2021","","2023 vs. 2022","","2022 vs. 2021"],["Gas utility customers:"],["Residential gas","","683,811","","695,198","","692,174","","(11,387)","","3,024"],["Commercial gas","","59,384","","59,684","","59,595","","(300)","","89"],["Industrial gas","","551","","1,459","","1,475","","(908)","","(16)"],["Total gas utility customers","","743,746","","756,341","","753,244","","(12,595)","","3,097"],["Delivered volumes (thousand cubic feet)"],["Residential gas","","51,698,440","","61,093,372","","56,542,038","","(9,394,932)","","4,551,334"],["Commercial gas","","33,151,308","","37,240,382","","33,403,899","","(4,089,074)","","3,836,483"],["Industrial gas","","48,323,846","","49,017,036","","49,726,237","","(693,190)","","(709,201)"],["Total delivered volumes","","133,173,594","","147,350,790","","139,672,174","","(14,177,196)","","7,678,616"],["Heating Degree Days (a)","","4,558","","5,648","","5,139","","(1,090)","","509"],["Average Heating Degree Days (b)","","5,427","","5,438","","5,466","","(11)","","(28)"],["","","2023","","2022","","2021","","2023 vs. 2022","","2022 vs. 2021"],["Operating revenues:"],["Residential gas","$","519,406","$","720,490","$","530,338","$","(201,084)","$","190,152"],["Commercial gas","","111,272","","149,653","","99,596","","(38,381)","","50,057"],["Industrial gas","","3,232","","5,636","","3,427","","(2,404)","","2,209"],["Gas transportation","","184,598","","205,825","","198,195","","(21,227)","","7,630"],["Customer rate credits","","-","","-","","(5,000)","","-","","5,000"],["Other utility","","45,251","","61,758","","33,346","","(16,507)","","28,412"],["Total operating revenues","$","863,759","$","1,143,362","$","859,902","$","(279,603)","$","283,460"],["Operating expenses:"],["Operations and maintenance expense","$","209,073","$","239,506","$","226,194","$","(30,433)","$","13,312"],["Purchased gas","$","327,548","$","551,009","$","313,390","$","(223,461)","$","237,619"],["Depreciation and amortization","$","125,263","$","118,955","$","113,238","$","6,308","$","5,717"],["Taxes other than income taxes","$","23,846","$","22,642","$","20,801","$","1,204","$","1,841"],["Other expense, net","$","90,819","$","87,916","$","78,099","$","2,903","$","9,817"],["Income tax benefit","$","(113,353)","$","(61,942)","$","(40,013)","$","(51,411)","$","(21,929)"],["Segment net income","$","200,563","$","185,276","$","148,193","$","15,287","$","37,083"]]
[[/GREPCENT_TABLE]]

(a) Unit of measure reflecting temperature-sensitive natural gas consumption, calculated by subtracting the average of a day’s high and low temperatures from 65 degrees Fahrenheit; measured at Pittsburgh, PA.

(b) Based on historical twenty-year average heating degree days, as calculated from data provided by the National Weather Service for the same geographic location.

Operating revenues – Operating revenues from the Regulated Natural Gas segment decreased by $279,603 or 24.5% due to:

impact of lower gas cost of $223,461 in 2023 as compared to 2022;

lower gas usage of $53,122 due to warmer weather conditions in 2023;

decrease in customer assistance surcharge of $18,710, which has an equivalent offsetting amount in operations and maintenance expense; offset by

an increase of $11,141 due to higher rates and other surcharges.

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Operating expenses – Operations and maintenance expense for the year ended December 31, 2023 decreased by $30,433 or 12.7% primarily due to the following:

decrease in customer assistance surcharge costs of $18,710, which has an equivalent offsetting amount in revenues;

lower charitable contributions to the Essential Foundation and other organizations of $13,360;

an asset impairment charge recognized in the first quarter of 2022 of $1,801 to write down a portion of the right of use asset to fair value;

lower operations and maintenance expense of $837 as a result of the sale and cessation of our regulated natural gas operations in West Virginia in October 2023;

decrease in bad debt of $3,520; offset by

an increase in legal fees of $1,892; and

an increase in materials and supplies of $2,121.

Our Regulated Natural Gas segment is affected by the cost of natural gas, which is passed through to customers using a purchased gas adjustment clause and includes commodity price, transportation and storage costs. These costs are reflected in the consolidated statement of operations and comprehensive income as purchased gas expenses. Therefore, fluctuations in the cost of purchased gas impact operating revenues on dollar-for-dollar basis. Purchased gas decreased by $223,461 or 40.6% in 2023 compared to 2022. The decrease is the result of the impact of lower cost of gas and lower gas usage which amounted to $118,371 and $105,090, respectively, in 2023 as compared with the prior year.

Depreciation and amortization increased by $6,308 or 5.3% primarily due to continued capital investment in pipe replacement.

Taxes other than income taxes increased by $1,204 or 5.3% mainly due to higher gross receipts tax and public utility commission assessments in 2023 as compared with the prior year.

Other expense, net – Interest expense, net, increased by $5,134 or 5.9% for 2023 compared to 2022 due to additional borrowings and a higher interest rate on our revolving line of credit in 2023.

AFUDC decreased by $534 or 19.7% due to the decrease in the average balance of utility plant construction work in progress, to which AFUDC is applied.

Other expense, inclusive of loss/gain on sale of other assets, totaled $680 in 2023 and $3,445 in 2022. The decrease in other expense is driven by a lower non-service cost component of our net benefit cost for post-retirement benefits in our Regulated Gas segment in 2023.

Income tax benefit – The effective income tax rate was a benefit of 130.0% in 2023, compared to a benefit of 50.2% in 2022. The change in the effective tax rate is primarily attributed to an increase in the income tax benefit associated with the tax deduction for qualifying infrastructure investments.

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LIQUIDITY AND CAPITAL RESOURCES

Consolidated Cash Flow and Capital Expenditures

Net operating cash flows, dividends paid on common stock, capital expenditures, including allowances for funds used during construction, and expenditures for acquiring utility systems were as follows for the years ended December 31:

[[GREPCENT_TABLE]]
[["","Net Operating Cash Flows","Dividends","Capital Expenditures","Acquisitions"],["2021","$","644,679","$","258,650","$","1,020,519","$","36,326"],["2022","","600,306","","288,632","","1,062,763","","116,891"],["2023","","933,587","","316,806","","1,199,103","","45,303"],["","$","2,178,572","$","864,088","$","3,282,385","$","198,520"]]
[[/GREPCENT_TABLE]]

Net cash flows from operating activities increased from 2022 to 2023 largely due to the decrease in accounts receivable, unbilled revenues and inventory - gas stored. Average cost of gas stored in inventories and associated recoveries of gas costs from customers was lower in 2023 than in 2022.

Included in capital expenditures for the three year period are: expenditures for the rehabilitation of existing utility systems, the expansion of our utility systems, modernization and replacement of existing treatment facilities, meters, office facilities, information technology, vehicles, and equipment. During this three year period, we received $50,960 of customer advances and contributions in aid of construction to finance new utility mains and related facilities that are not included in the capital expenditures presented in the above table. In addition, during this period, we have made repayments of debt, which includes the net effect of borrowings and repayments under our long-term revolving credit facility of $1,441,098 and have refunded $21,202 of customers’ advances for construction. Dividends increased during the past three years as a result of annual increases in the dividends declared and paid and increases in the number of shares outstanding.

Our planned 2024 capital program, excluding the costs of new mains financed by advances and contributions in aid of construction is estimated to be approximately $1,365,000 in infrastructure improvements for the communities we serve. The 2024 capital program is expected to include approximately $935,000 for infrastructure rehabilitation surcharge qualified projects. Our planned 2024 capital program in Pennsylvania for our water and natural gas utilities is estimated to be approximately $915,000, a portion of which is expected to be eligible as a deduction for qualifying utility asset improvements for Federal income tax purposes. Our overall 2024 capital program along with $67,415 of debt repayments and $322,176 of other contractual cash obligations, as reported in the section captioned “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Contractual Obligations”, has been, or is expected to be, financed through internally-generated funds, our revolving credit facilities, and the issuance of long-term debt and equity.

Future utility construction in the period 2025 through 2026, including recurring programs, such as the ongoing replacement or rehabilitation of utility meters and mains, water treatment plant upgrades, storage facility renovations, pipes, service lines, and additional transmission mains to meet customer demands, excluding the costs of new mains financed by advances and contributions in aid of construction, is estimated to require aggregate expenditures of approximately $2,769,000. We anticipate that more than one half of these expenditures will require external financing. We expect to refinance $168,875 of long-term debt during this period as it becomes due with funds from new issues of long-term debt, issuances of equity, internally-generated funds, and our revolving credit facilities. The estimates discussed above do not include any amounts for possible future acquisitions of utility systems or the financing necessary to support them.

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Our primary sources of liquidity are cash flows from operations (including the allowed deferral of Federal income tax payments), borrowings under various short-term lines of credit and other credit facilities, and customer advances and contributions in aid of construction. Our cash flow from operations, or internally-generated funds, is impacted by the timing of rate relief, utility operating revenues, and changes in Federal tax laws, and accelerated tax depreciation or deductions for utility construction projects. We fund our capital and typical acquisitions through internally-generated funds, supplemented by short-term lines of credit. Over time, we partially repay or pay-down our short-term lines of credit with long-term debt. The ability to finance our future construction programs, as well as our acquisition activities, depends on our ability to attract the necessary external debt and equity financing and maintain internally-generated funds. Timely rate orders permitting compensatory rates of return on invested capital will be required by our operating subsidiaries to achieve an adequate level of earnings and cash flow to enable them to secure the capital they will need to operate and to maintain satisfactory debt coverage ratios.

Acquisitions

As part of the Company’s growth-through-acquisition strategy, as of December 31, 2023, the Company has entered into purchase agreements to acquire the water or wastewater utility system assets of five municipalities and a private company for a total combined purchase price in cash of approximately $380,000.  The purchase price for these pending acquisitions is subject to certain adjustments at closing, and the pending acquisitions are subject to regulatory approvals, including the final determination of the fair value of the rate base acquired.  Closings for these acquisitions are expected to occur in 2024 or 2025, which is subject to the timing of the various regulatory approval processes.  These acquisitions are expected to add approximately 215,000 equivalent retail customers in two of the states in which the Company operates.



In July 2023, the Company completed the following water utility asset acquisitions: Shenandoah Borough, Pennsylvania, which serves approximately 2,900 customers for $12,291; La Rue, an Ohio municipality, which serves approximately 300 customers for $2,253; and, Southern Oaks Water System, which serves approximately 800 customers in Texas for $3,321. In July 2023, the Company completed their acquisition of a portion of the water and wastewater utility assets of the Village of Frankfort, an Illinois municipality, which serves approximately 1,500 customers for $1,424. In June 2023, the Company acquired the wastewater utility assets of Union Rome, Ohio, which serves approximately 4,300 customers for a cash purchase price of $25,547. Additionally, in March 2023, the Company acquired the North Heidelberg Sewer Company in Berks County, Pennsylvania, which serves approximately 300 customer connections for a cash purchase price of $136.

In November 2022, the Company acquired the water system of Oak Brook, DuPage County, Illinois, which serves 2,037 customers, for a cash purchase price of $12,500. In August 2022, the Company acquired the municipal wastewater assets of East Whiteland Township, Chester County, Pennsylvania, which serves 4,018 customers, for a cash purchase price of $54,374. In March 2022, the Company acquired the wastewater system of Lower Makefield Township, which serves 11,323 customer connections in Lower Makefield, Falls, and Middletown townships, and Yardley Borough, Bucks County, Pennsylvania, for a cash purchase price of $53,000.

Subsequent to the August 2022 closing on the acquisition of the municipal wastewater assets of East Whiteland Township, a party filed an appeal to the Pennsylvania Public Utility Commission’s order of approval. On July 31, 2023, a decision was issued by the Pennsylvania Commonwealth Court that agreed with the party’s appeal and reversed the order which approved the acquisition. In an effort to resolve the matter, the Company pursued and is continuing to pursue certain legal actions. Management believes the final resolution of this matter is not expected to have a material adverse effect on the Company’s financial position, results of operations or cash flows. Refer to Note 2 – Acquisitions in this Annual Report for additional information.

In August 2021, the Company acquired the water utility system assets of The Commons Water Supply, Inc., which serves 992 customers in Harris County, Texas, and the wastewater utility system assets of the Village of Bourbonnais, which serves approximately 6,500 customers in Kankakee County, Illinois. The total cash purchase prices for these utility systems were $4,000 and $32,100, respectively.

During the past three years, we have expended cash of $198,520 related to the acquisition of both water and wastewater utility systems. We continue to pursue the acquisition of water and wastewater utility systems and explore other utility

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acquisitions that may be in a new state. Our typical acquisitions are expected to be financed with short-term debt with subsequent repayment from the proceeds of long-term debt, retained earnings, or equity issuances.

Assets Held for Sale and Dispositions

We routinely review and evaluate areas of our business and operating divisions and, over time, may sell utility systems or portions of systems. In December 2022, the Company signed an agreement to sell its regulated natural gas utility assets in West Virginia, which represented approximately two percent of the Company’s regulated natural gas customers. The sale closed on October 1, 2023 for an estimated purchase price of $39,965, subject to working capital and other adjustments. The sale concluded the Company’s regulated utility operations in West Virginia. In October 2023, the Company entered into an agreement to sell its interest in three non-utility local microgrid and distributed energy projects for $165,000. The sale was completed in January 2024. These transactions are consistent with the Company’s long-term strategy of focusing on its core business and will allow the Company to prioritize the growth of its utilities in states where it has scale. The Company intends to use the proceeds from these transactions to finance its capital expenditures and water and wastewater acquisitions, in place of external funding from equity and debt issuances. Refer to Note 3 – Asset Held for Sale and Dispositions in this Annual Report for additional information.

Sources of Capital

Since net operating cash flow plus advances and contributions in aid of construction have not been sufficient to fully fund our cash requirements including capital expenditures and our growth through acquisitions program, we issued $2,786,632 of long-term debt, and obtained other short-term borrowings during the past three years. At December 31, 2023, we have a $1,000,000 unsecured long-term revolving credit facility that expires in December 2027, of which $16,838 was designated for letter of credit usage, $263,162 was available for borrowing, and $720,000 of borrowings were outstanding at December 31, 2023. This credit facility was established in December 2022, replacing a similar facility, and was used to repay all indebtedness and fees under our prior unsecured revolving credit facility, and for other general corporate purposes. In addition, we have short-term lines of credit of $435,500 of which $275,377 was available as of December 31, 2023. Included in the short-term lines of credit is an Aqua Pennsylvania $100,000 364-day unsecured revolving credit facility and a Peoples Natural Gas $300,000 364-day unsecured revolving credit facility. These short-term lines of credit are subject to renewal on an annual basis. Although we believe we will be able to renew these facilities, there is no assurance that they will be renewed, or what the terms of any such renewal will be.

On January 8, 2024, the Company issued $500,000 of long-term debt (the “2024 Senior Notes”), less expenses of $4,610, due in 2034 with an interest rate of 5.375%. The Company used the net proceeds from the issuance of 2024 Senior Notes (1) to repay a portion of the borrowings under the Company’s existing five year unsecured revolving credit facility, and (2) for general corporate purposes.

In August 2023, the Company’s subsidiary, Aqua Pennsylvania, issued $225,000 in aggregate principal amount of first mortgage bonds. The bonds consisted of $175,000 of 5.48% first mortgage bonds due in 2053; and $50,000 of 5.56% first mortgage bonds due in 2061. In January 2023 and October 2022, Aqua Pennsylvania issued $75,000 and $125,000 of first mortgage bonds, due in 2043 and 2052, and with interest rates of 5.60% and 4.50%, respectively. The proceeds from these bonds were used to repay existing indebtedness and for general corporate purposes.

On October 14, 2022, the Company entered into at-the market sales agreements (“ATM”) with third-party sales agents, under which the Company may offer and sell shares of its common stock, from time to time, at its option, having an aggregate gross offering price of up to $500,000 pursuant to the Company’s effective shelf registration statement on Form S-3 (File No. 333-255235). The Company intends to use the net proceeds from the sales of shares through the ATM for working capital, capital expenditures, water and wastewater utility acquisitions and repaying outstanding indebtedness. As of December 31, 2022, the Company has issued 1,321,994 shares for net proceeds of $63,040 under the ATM. During the year ended December 31, 2023, the Company sold 8,938,839 shares of common stock, in exchange for net proceeds of $322,983 under the ATM. As of December 31, 2023, approximately $110,000 remained available for sale under the ATM.

On June 29, 2023, Aqua Pennsylvania and Peoples Natural Gas Companies amended the terms of their respective $100,000 and $300,000, 364-day revolving credit agreements, as follows: (1) extended the maturity dates to June 27, 2024; and (2) updated the adjustment on the Bloomberg Short-Term Bank Yield Index (BSBY) Rate.

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(In thousands of dollars, except per share amounts)

On May 20, 2022, the Company issued $500,000 of long-term debt (the “Senior Notes”), less expenses of $5,815, due in 2052 with an interest rate of 5.30%. The Company used the net proceeds from the issuance of Senior Notes to (1) to repay $49,700 of borrowings under Aqua Pennsylvania’s 364-day revolving credit facility and $410,000 of borrowings under the Company’s existing five year unsecured revolving credit facility, and (2) for general corporate purposes.

On April 15, 2021, our operating subsidiary, Aqua Ohio, Inc., issued $100,000 of first mortgage bonds, of which $50,000 is due in 2031 and $50,000 is due in 2051, with interest rates of 2.37% and 3.35%, respectively. The proceeds from these bonds were used for general corporate purposes and to repay existing indebtedness. Further, on April 19, 2021, the Company issued $400,000 of long-term debt, with expenses of $4,010, which is due in 2031 with an interest rate of 2.40%. The Company used the proceeds from this issuance to repay $50,000 of borrowings under the Aqua Pennsylvania revolving credit facility, and the balance was used to repay in full the borrowings under its existing five-year unsecured revolving credit agreement.

In August 2020, we entered into a forward equity sale agreement for 6,700,000 shares of common stock with a third party (the “forward purchaser”). In connection with the forward equity sale agreement, the forward purchaser borrowed an equal number of shares of our common stock from stock lenders and sold the borrowed shares to the public. We did not receive any proceeds from the sale of our common stock by the forward purchaser until settlement of the forward equity sale agreement. On August 9, 2021, the Company settled the forward equity sale agreement in full by physical share settlement. The Company issued 6,700,000 shares and received cash proceeds of $299,739 at a forward price of $44.74 per share. Pursuant to the agreement, the forward price was computed based upon the initial forward price of $46.00 per share, adjusted for a floating interest rate factor equal to a specified daily rate less a spread and scheduled dividends during the term of the agreement. The Company used the proceeds received upon settlement of the forward equity sale agreement to fund general corporate purposes, including for water and wastewater acquisitions, working capital and capital expenditures. The forward equity sale agreement has now been completely settled, and there are no additional shares subject to the forward equity sale agreement.

Our consolidated balance sheet historically has had a negative working capital position, whereby routinely our current liabilities exceed our current assets. Management believes that internally-generated funds along with existing credit facilities and the proceeds from the issuance of long-term debt and common equity will be adequate to provide sufficient working capital to maintain normal operations and to meet our financing requirements for at least the next twelve months.

Our loan and debt agreements require us to comply with certain financial covenants, which among other things, subject to specific exceptions, limit the Company’s ratio of consolidated total indebtedness to consolidated total capitalization, and require a minimum level of earnings coverage over interest expense. During 2023, we were in compliance with our debt covenants under our credit facilities. Failure to comply with our debt covenants could result in an event of default, which could result in us being required to repay or refinance our borrowings before their due date, possibly limiting our future borrowings, and increasing our borrowing costs.

In April 2021, the Company filed a universal shelf registration statement through a filing with the SEC to allow for the potential future offer and sale by the Company, from time to time, in one or more public offerings, of an indeterminate amount of our common stock, preferred stock, debt securities, and other securities specified therein at indeterminate prices. During the past three years, we issued common stock, including common stock in connection with a forward equity sale agreement, and long-term debt in offerings under this shelf registration statement. Refer to Note 11 – Long-term Debt and Loans Payable and Note 13 – Stockholders’ Equity in this Annual Report for further information regarding these financings.

In addition, we have an acquisition shelf registration statement, which was filed with the SEC on February 27, 2015, to permit the offering from time to time of an aggregate of $500,000 of our common stock and shares of preferred stock in connection with acquisitions. The balance remaining available for use under the acquisition shelf registration as of December 31, 2023 is $487,155.

We will determine the form and terms of any further securities issued under the universal shelf registration statement and the acquisition shelf registration statement at the time of issuance.

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We offer a Dividend Reinvestment and Direct Stock Purchase Plan (the Plan) that provides a convenient and economical way to purchase shares of the Company. Under the direct stock purchase portion of the Plan, shares are issued throughout the year. The dividend reinvestment portion of the Plan offers a five percent discount on the purchase of shares of common stock with reinvested dividends. As of the December 2023 dividend payment, holders of 4.3% of the common shares outstanding participated in the dividend reinvestment portion of the Plan. The shares issued under the Plan are either original issue shares or shares purchased by the Company’s transfer agent in the open-market. During the past three years, we have sold 1,173,589 original issue shares of common stock for net proceeds of $49,423 through the dividend reinvestment portion of the Plan, and we used the proceeds to invest in our operating subsidiaries, to repay short-term debt, and for general corporate purposes. In 2023, 2022 and 2021, we sold 430,487, 368,278, and 374,824 original issues shares of common stock for net proceeds of $16,005, $16,619, and $16,799, respectively, through the dividend reinvestment portion of the plan.

Credit Risk

As of December 31, 2023, our credit ratings remained at investment grade levels. On July 12, 2023, S&P affirmed an A issuer credit rating for the Company, Aqua Pennsylvania and Peoples Natural Gas Companies, and revised its outlook from stable to negative for the companies, citing weakening financial measures as a result of inflationary pressures and our significant capital spending. However, as can be noted in their report, S&P continues to assess our business risk profile as excellent, considering our low-risk and rate-regulated water and gas distribution operations in credit-supportive regulatory environments, our geographic and regulatory diversity, our large and stable residential and commercial customer base, and our solid and reliable operations.  On August 29, 2023, Moody’s Investors Service (“Moody’s”) affirmed the Company’s senior unsecured notes rating of Baa2 and stable outlook; and, affirmed Peoples Natural Gas Companies’ senior secured notes rating of Baa1 and revised its outlook from stable to negative. The Company’s ability to maintain its credit rating depends, among other things, on adequate and timely rate relief, its ability to fund capital expenditures in a balanced manner using both debt and equity, and its ability to generate cash flow.  A material downgrade of our credit rating may result in the imposition of additional financial and/or other covenants, impact the market prices of equity and debt securities, increase our borrowing costs, and adversely affect our liquidity, among other things. Management continues to enhance our regulatory practices to address regulatory lag and recover capital project costs and increases in operating costs efficiently and timely through various rate-making mechanisms.

Off-Balance Sheet Financing Arrangements

We do not engage in any off-balance sheet financing arrangements. We do not have any interest in entities referred to as variable interest entities, which includes special purpose entities and other structured finance entities.

Contractual Obligations

The following table summarizes our contractual cash obligations as of December 31, 2023:

[[GREPCENT_TABLE]]
[["","","","Payments Due by Period"],["","Total","Less than 1 year","1 - 3 years","3 - 5 years","More than 5 years"],["Long-term debt","$","6,938,008","$","67,415","$","168,875","$","964,760","$","5,736,958"],["Interest on fixed-rate, long-term debt (1)","","286,799","","2,660","","8,599","","56,123","","219,417"],["Operating leases (2)","","53,038","","9,037","","16,166","","13,933","","13,902"],["Unconditional purchase obligations (3)","","18,067","","5,990","","7,961","","3,035","","1,081"],["Gas purchase obligations (4)","","2,519,459","","206,378","","471,836","","485,586","","1,355,659"],["Other purchase obligations (5)","","87,187","","87,187","","-","","-","","-"],["Pension plan obligations (6)","","9,393","","9,393","","-","","-","","-"],["Other obligations (7)","","8,428","","1,531","","2,499","","2,659","","1,739"],["Total","$","9,920,379","$","389,591","$","675,936","$","1,526,096","$","7,328,756"]]
[[/GREPCENT_TABLE]]

(1)Represents interest payable on fixed rate, long-term debt. Amounts reported may differ from actual due to future refinancing of debt.

(2)Represents minimum lease payments for long-term operating leases of land, office facilities, office equipment, and vehicles.

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(3)Represents our commitment to purchase minimum quantities of water as stipulated in agreements with other water purveyors. We use purchased water to supplement our water supply, particularly during periods of peak customer demand. Our actual purchases may exceed the minimum required levels.

(4)Represents our commitment to purchase minimum quantities of natural gas stipulated in agreements with various producers of natural gas to meet regulated customers’ natural gas requirements.

(5)Represents an approximation of the open purchase orders for goods and services purchased in the ordinary course of business.

(6)Represents contributions to be made to the Company’s retirement plans.

(7)Represents expenditures estimated to be required under legal and binding contractual obligations.

In addition to the contractual obligations table above, we have the following obligations:

Refunds of customer’s advances for construction – We pay refunds on customers’ advances for construction over a specific period of time based on operating revenues related to developer-installed utility mains or as new customers are connected to and take service from such mains. After all refunds are paid, any remaining balance is transferred to contributions in aid of construction. The refund amounts are not included in the above table because the refund amounts and timing are dependent upon several variables, including new customer connections, customer consumption levels and future rate increases, which cannot be accurately estimated. Portions of these refund amounts are payable annually through 2033 and amounts not paid by the contract expiration dates become non-refundable.

Asset Retirement Obligations – We recognize asset retirement obligations associated with retirements of production, storage wells and other pipeline components at fair value, as incurred, or when sufficient information becomes available to determine a reasonable estimate of the fair value of the retirement activities to be performed. Expected obligations are not included in the above table because the amounts and timing are dependent upon several variables, which cannot be accurately estimated.

Uncertain tax positions – We have uncertain tax positions of $7,898. Although we believe our tax positions comply with applicable law, we have made judgments as to the sustainability of each uncertain tax position based on its technical merits. Due to the uncertainty of future cash outflows, if any, associated with our uncertain tax positions, we are unable to make a reasonable estimate of the timing or amounts that may be paid. See Note 7 – Income Taxes in this Annual Report for further information on our uncertain tax positions.

We will fund these contractual obligations with cash flows from operations and liquidity sources held by or available to us.

The Company is routinely involved in legal matters, including both asserted and unasserted legal claims, during the ordinary course of business. See Note 9 – Commitments and Contingencies in this Annual Report for a discussion of the Company’s legal matters. It is not always possible for management to make a meaningful estimate of the potential loss or range of loss associated with such litigation. Also, unanticipated changes in circumstances and/or revisions to the assessed probability of the outcomes of legal matters could result in expenses being incurred in future periods as well as an increase in actual cash required to resolve the legal matter.

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(In thousands of dollars, except per share amounts)

Capitalization

The following table summarizes our capitalization as of December 31, 2023 and 2022:

[[GREPCENT_TABLE]]
[["December 31,","2023","2022"],["Long-term debt (1)","54.1%","55.2%"],["Essential Utilities stockholders' equity","45.9%","44.8%"],["","100.0%","100.0%"]]
[[/GREPCENT_TABLE]]

(1)Includes current portion, as well as our borrowings under a variable rate revolving credit agreement of $720,000 at December 31, 2023, and $490,000 at December 31, 2022.

Over the past two years, the changes in the capitalization ratios primarily resulted from the issuance of debt to finance our acquisitions and capital program, changes in net income, the issuance of common stock, and the declaration of dividends.

CRITICAL ACCOUNTING POLICIES AND ESTIMATES

Our financial condition and results of operations are impacted by the methods, assumptions, and estimates used in the application of critical accounting policies. The following accounting policies are particularly important to our financial condition or results of operations and require estimates or other judgments of matters of uncertainty. Changes in the estimates or other judgments included within these accounting policies could result in a significant change to the financial statements. We believe our most critical accounting policies include the use of regulatory assets and liabilities, revenue recognition, the valuation of our long-lived assets (which consist primarily of utility plant in service, regulatory assets, and goodwill), our accounting for post-retirement benefits, and our accounting for income taxes. We have discussed the selection and development of our critical accounting policies and estimates with the Audit Committee of the Board of Directors.

Regulatory Assets and Liabilities ─ We defer costs and credits on the balance sheet as regulatory assets and liabilities when it is probable that these costs and credits will be recognized in the rate-making process in a period different from when the costs and credits were incurred. These deferred amounts, both assets and liabilities, are then recognized in the consolidated statement of operations in the same period that they are reflected in our rates charged for utility service. We make significant judgments and estimates to record regulatory assets and liabilities, such as for amounts related to income taxes, pension and postretirement benefits, acquisitions and capital projects. For each regulatory jurisdiction with regulated operations, we evaluate at the end of each reporting period, whether the regulatory assets and liabilities continue to meet the probable criteria for future recovery or refund. The evaluation considers factors such as regulatory orders or guidelines, in the same regulatory jurisdiction, of a specific matter or a similar matter, as provided to us in the past or to other regulated utilities. In addition, the evaluation may be impacted by changes in the regulatory environment and pending or new legislation that could impact the ability to recover costs through regulated rates. There may be multiple participants to rate or transactional regulatory proceedings who might offer different views on various aspects of such proceedings, and in these instances may challenge our prudence of business policies and practices, seek cost disallowances or request other relief.

In the event that our assessment as to the probability of the inclusion in the rate-making process is incorrect, the associated regulatory asset or liability would be adjusted to reflect the change in our assessment or change in regulatory approval.

Revenue Recognition ─ Our utility revenues recognized in an accounting period include amounts billed to customers on a cycle basis and unbilled amounts based on estimated usage from the last billing to the end of the accounting period. The estimated usage is based on our judgment and assumptions; our actual results could differ from these estimates, which would result in operating revenues being adjusted in the period that the revision to our estimates is determined.

In Virginia, North Carolina, and Kentucky, we may bill our utility customers, in certain circumstances, in accordance with a rate filing that is pending before the respective regulatory commission, which would allow interim rates before the final commission rate order is issued. The revenue recognized reflects an estimate based on our judgment of the final outcome of the commission’s ruling. We monitor the applicable facts and circumstances regularly and revise the estimate as required. The revenue billed and collected prior to the final ruling is subject to refund based on the commission’s final ruling.

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Valuation of Long-Lived Assets, Goodwill and Intangible Assets ─ We review our long-lived assets for impairment, including utility plant in service. We also review regulatory assets for the continued application of the FASB accounting guidance for regulated operations. Our review determines whether there have been changes in circumstances or events, such as regulatory disallowances, or abandonments, that have occurred that require adjustments to the carrying value of these assets. Adjustments to the carrying value of these assets would be made in instances where their inclusion in the rate-making process is unlikely. For utility plant in service, we would recognize an impairment loss for any amount disallowed by the respective utility commission.

Our long-lived assets, which consist primarily of utility plant in service, operating lease right-of-use assets and intangible assets, are reviewed for impairment when changes in circumstances or events occur. These circumstances or events could include a decline in the market value or physical condition of a long-lived asset, an adverse change in the manner in which long-lived assets are used or planned to be used, a change in historical trends, operating cash flows associated with the long-lived assets, changes in macroeconomic conditions, industry and market conditions, or overall financial performance. When these circumstances or events occur, we determine whether it is more likely than not that the fair value of those assets is less than their carrying amount. If we determine that it is more likely than not (that is, the likelihood of more than 50 percent), we would recognize an impairment charge if it is determined that the carrying amount of an asset exceeds the sum of the undiscounted estimated cash flows. In this circumstance, we would recognize an impairment charge equal to the difference between the carrying amount and the fair value of the asset. Fair value is estimated to be the present value of future net cash flows associated with the asset, discounted using a discount rate commensurate with the risk and remaining life of the asset. This assessment requires significant management judgment and estimates that are based on budgets, general strategic business plans, historical trends and other data and relevant factors. These estimates include significant inherent uncertainties, since they involve forecasting future events. If changes in circumstances or events occur, or estimates and assumptions that were used in this review are changed, we may be required to record an impairment charge on our long-lived assets. Refer to Note 1 – Summary of Significant Accounting Policies – Impairment of Long-Lived Assets in this Annual Report for additional information regarding the review of long-lived assets for impairment.

We test the goodwill attributable to each of our reporting units for impairment at least annually, or more often, if circumstances indicate a possible impairment may exist. When testing goodwill for impairment, we may assess qualitative factors, including macroeconomic conditions, industry and market considerations, changes to regulatory environment, recent regulatory and legislative proceedings, cost factors, overall financial performance, and entity specific events, for some or all of our reporting units to determine whether it’s more likely than not that the fair value of a reporting unit is less than its carrying amount. Based on our assessment of the qualitative factors previously noted, or at our discretion, we may perform a quantitative goodwill impairment test by determining the fair value of a reporting unit by weighting the results from the income approach and the market approach. These valuation approaches consider a number of factors that include, but are not limited to, prospective financial information (which includes projected operating income, expected future capital expenditures, and projected regulatory rate base, among others), growth rates, terminal value, discount rates, and comparable multiples from publicly traded companies in our industry and require us to make certain assumptions and estimates regarding industry economic factors and future profitability of our business. If we perform a quantitative test and determine that the fair value of a reporting unit is less than its carrying amount, we would record an impairment loss for the amount by which a reporting unit’s carrying amount exceeds its fair value, not to exceed the carrying amount of goodwill. The assessment requires significant management judgment and estimates that are based on budgets, general strategic business plans, historical trends and other data and relevant factors. If changes in circumstances or events occur, or estimates and assumptions that were used in our impairment test change, we may be required to record an impairment charge for goodwill. Refer to Note 1 – Summary of Significant Accounting Policies – Goodwill in this Annual Report for further information.

As part of the October 1, 2023 annual goodwill assessment, we elected to perform a quantitative goodwill impairment assessment on the goodwill attributable to our Regulated Natural Gas reporting unit and a qualitative assessment for our Regulated Water and Other reporting units. Additionally, the Company performed a market capitalization reconciliation to further support the Company’s estimated fair value and support the implied premium. Based on our analysis, we determined that none of the goodwill of our reporting units was impaired.

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We generally assumed operating margins in future years would increase as we continue to integrate and implement our rate base growth strategy. However, unforeseen events, such as adverse changes in market conditions and changes in the regulatory environment which could lead to disallowances of a portion of capital investments, may result in future non-cash impairment charges that could be material. If we were to assume changes in certain of our key assumptions used to determine the fair value of our Regulated Natural Gas reporting unit, the following would be the impact on the amount of headroom over the carrying value:

[[GREPCENT_TABLE]]
[["Sensitivity Analysis(1)","Percentage decrease in headroom of Regulated Natural Gas Reporting Unit"],["Increase in discount rate by 100 basis points","40%"],["Decrease in Market Multiples by 1x","46%"],["Reduction in terminal value EBITDA(2) by 10%","49%"]]
[[/GREPCENT_TABLE]]

(1) Each assumption used in the sensitivity analysis is independent of the other assumptions

(2) Defined as earnings before interest, taxes, depreciation and amortization

Accounting for Post-Retirement Benefits ─ We maintain a qualified and a non-qualified defined benefit pension plan and plans that provide for post-retirement benefits other than pensions. Accounting for pension and other post-retirement benefits requires an extensive use of assumptions including the discount rate, expected return on plan assets, the rate of future compensation increases received by our employees, mortality, turnover and medical costs. Each assumption is reviewed annually with assistance from our actuarial consultant, who provides guidance in establishing the assumptions. 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 post-retirement benefits expense that we recognize.

Our discount rate assumption, which is used to calculate the present value of the projected benefit payments of our post-retirement benefits, was determined by selecting a hypothetical portfolio of high quality corporate bonds appropriate to match the projected benefit payments of the plans. The selected bond portfolio was derived from a universe of Aa-graded corporate bonds. The discount rate was then developed as the rate that equates the market value of the bonds purchased to the discounted value of the projected benefit payments of the plans. A decrease in the discount rate would generally increase our post-retirement benefits expense and benefit obligation. After reviewing the hypothetical portfolio of bonds, we selected a discount rate of 5.17% for our pension plan, and 5.09% for our other post-retirement benefit plans as of December 31, 2023, which represent a 34 and 36 basis-point decrease as compared to the discount rates selected at December 31, 2022, respectively. Our post-retirement benefits expense under these plans is determined using the discount rate as of the beginning of the year, which was 5.51% for our pension plan and 5.45% for our other-postretirement benefit plan for 2023. In 2023, settlement accounting was triggered by the amount of lump-sum payments by our qualified pension plan to retirees and other separated employees exceeding the threshold of service and interest cost for the period. As a result, we remeasured our qualified pension plan assets and liabilities using a discount rate of 5.20%, and the remeasurement did not have a material impact to our consolidated financial statements.

Our expected return on plan assets is determined by evaluating the asset class return expectations with our advisors as well as actual, long-term, historical results of our asset returns. The Company’s market-related value of plan assets is equal to the fair value of the plans’ assets as of the last day of its fiscal year and is a determinant for the expected return on plan assets, which is a component of post-retirement benefits expense. The allocation of our plans’ assets impacts our expected return on plan assets. As of December 31, 2023, the expected return on plan assets is based on a targeted allocation of 20% to 40% return seeking assets and 30% to 70% liability hedging assets for our pension plan, and a targeted allocation of 50% to 70% return seeking assets and 30% to 50% liability hedging assets for our other post-retirement benefit plans. Our post-retirement benefits expense increases as the expected return on plan assets decreases. We believe that our actual long-term asset allocations on average will approximate our targeted allocations. Our targeted allocations are driven by our investment strategy to earn a reasonable rate of return while maintaining risk at acceptable levels through the diversification of investments across and within various asset categories. For 2023, we used a 6.8% expected return on plan assets assumption and are currently reviewing this assumption for 2024.

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Funding requirements for qualified defined benefit pension plans are determined by government regulations and not by accounting pronouncements. In accordance with funding rules and our funding policy, during 2024 our pension contribution is expected to be $9,393. Future years’ contributions will be subject to economic conditions, plan participant data and the funding rules in effect at such time as the funding calculations are performed, though we expect future changes in the amount of contributions and expense recognized to be generally included in customer rates.

Accounting for Income Taxes ─ We estimate the amount of income tax payable or refundable for the current year and the deferred income tax liabilities and assets that results from estimating temporary differences resulting from the treatment of specific items, such as depreciation, for tax and financial statement reporting. Generally, these differences result in the recognition of a deferred tax asset or liability on our consolidated balance sheet and require us to make judgments regarding the probability of the ultimate tax impact of the various transactions we enter into. Based on these judgments, we may record tax reserves or adjustments to valuation allowances on deferred tax assets to reflect the expected realization of future tax benefits. Actual income taxes could vary from these estimates and changes in these estimates can increase income tax expense in the period that these changes in estimates occur.

Our determination of what qualifies as a capital cost versus a tax deduction, for qualifying utility asset improvements, as it relates to our income tax accounting method, is subject to subsequent adjustment as well as IRS audits, changes in income tax laws, including regulations regarding tax-basis depreciation as it applies to our capital expenditures, or qualifying utility asset improvements, the expiration of a statute of limitations, or other unforeseen matters could impact the tax benefits that have already been recognized. We establish reserves for uncertain tax positions based upon management’s judgment as to the sustainability of these positions. These accounting estimates related to the uncertain tax position reserve require judgments to be made as to the sustainability of each uncertain tax position based on its technical merits. We believe our tax positions comply with applicable law and that we have adequately recorded reserves as required. However, to the extent the final tax outcome of these matters is different than our estimates recorded, we would then need to adjust our tax reserves which could result in additional income tax expense or benefits in the period that this information is known.

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IMPACT OF RECENT ACCOUNTING PRONOUNCEMENTS

We describe the impact of recent accounting pronouncements in Note 1 – Summary of Significant Accounting Policies in this Annual Report.