10-K 1 ctws_form10-k.htm CONNECTICUT WATER SERVICE, INC. FORM 10-K 12-31-2011 ctws_form10-k.htm
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D. C. 20549

Form 10-K

x
Annual Report pursuant to section 13 or 15(d) of the Securities Exchange Act of 1934 for the fiscal year ended December 31, 2011 or

o
Transition report pursuant to section 13 or 15(d) of the Securities Exchange Act of 1934 for the transition period from
to

Commission File Number 0-8084

Connecticut Water Service, Inc.
(Exact name of registrant as specified in its charter)

Connecticut
(State or other jurisdiction of
incorporation or organization)
06-0739839
(I.R.S. Employer Identification No.)
   
93 West Main Street, Clinton, CT
(Address of principal executive office)
06413
(Zip Code)

Registrant's telephone number, including area code (860) 669-8636
Registrant’s website:  www.ctwater.com

Securities registered pursuant to Section 12 (b) of the Act:

Title of each Class
Common Stock, without par value
Name of each exchange on which registered
The Nasdaq Stock Market, Inc.

Securities registered pursuant to Section 12 (g) of the Act:
None

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.  Yes o  No x

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Exchange Act.  Yes o  No x

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934 during the preceding twelve (12) months (or for such shorter period that the registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days.  Yes x  No o

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (Section 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes o  No o

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K, (Section 229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer, or a smaller reporting company.  See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.  (Check one):

Large Accelerated Filer o
Accelerated Filer x
Non-Accelerated Filer o
Smaller Reporting Company o
(Do not check if smaller reporting company)

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes o  No x

As of June 30, 2011, the aggregate market value of the registrant's voting Common Stock held by non-affiliates of the registrant was $214,731,952 based on the closing sale price on such date as reported on the NASDAQ.

Number of shares of Common Stock, no par value, outstanding as of March 1, 2012 was 8,785,832, including 136,157 common stock equivalent shares.

DOCUMENTS INCORPORATED BY REFERENCE

Document
 
Part of Form 10-K Into Which Document is Incorporated
     
Definitive Proxy Statement, to be filed on or about March 23, 2012, for Annual Meeting of Shareholders to be held on May 10, 2012.
 
Part III
 
 
 

 

   
For the Year Ended December 31, 2011
   
       
Page Number
     
Part I
       
   
   
   
   
   
   
         
Part II
       
   
 
Selected Financial Data
 
   
   
   
   
   
   
         
Part III
       
   
   
   
   
   
         
Part IV
       
   
     
 



Certain statements in this Annual Report on Form 10-K (“10-K”), or incorporated by reference into this 10-K, are forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934 (“Exchange Act”) that are made based upon, among other things, our current assumptions, expectations and beliefs concerning future developments and their potential effect on Connecticut Water Service, Inc. (referred to as “the Company”, “we”, “us”, or “our”).  These forward-looking statements involve risks, uncertainties and other factors, many of which are outside our control, which may cause our actual results, performance or achievements to be materially different from any future results, performance or achievements expressed or implied by these forward-looking statements.  In some cases you can identify forward-looking statements where statements are preceded by, followed by or include the words “believes,” “expects,” “anticipates,” “plans,” “future,” “potential,” “probably,” “predictions,” “continue” or the negative of such terms or similar expressions.  Forward-looking statements included in this 10-K, or incorporated by reference into this 10-K, include, but are not limited to, statements regarding:

·  
projected capital expenditures and related funding requirements;
·  
the availability and cost of capital;
·  
developments, trends and consolidation in the water and wastewater utility industries;
·  
dividend payment projections;
·  
our ability to successfully acquire and integrate regulated water and wastewater systems, as well as unregulated businesses, that are complementary to our operations and the growth of our business;
·  
the capacity of our water supplies, water facilities and wastewater facilities;
·  
the impact of limited geographic diversity on our exposure to unusual weather;
·  
the impact of conservation awareness of customers and more efficient plumbing fixtures and appliances on water usage per customer;
·  
our capability to pursue timely rate increase requests;
·  
our authority to carry on our business without unduly burdensome restrictions;
·  
our ability to maintain our operating costs at the lowest possible level, while providing good quality water service;
·  
our ability to obtain fair market value for condemned assets;
·  
the impact of fines and penalties;
·  
changes in laws, governmental regulations and policies, including environmental, health and water quality and public utility regulations and policies;
·  
the decisions of governmental and regulatory bodies, including decisions to raise or lower rates;
·  
our ability to successfully extend and expand our service contract work within our Service and Rentals Segment in both Connecticut and Maine;
·  
the development of new services and technologies by us or our competitors;
·  
the availability of qualified personnel;
·  
the condition of our assets;
·  
the impact of legal proceedings;
·  
general economic conditions;
·  
the profitability of our Real Estate Segment, which is subject to the amount of land we have available for sale and/or donation, the demand for any available land, the continuation of the current state tax benefits relating to the donation of land for open space purposes and regulatory approval for land dispositions; and
·  
acquisition-related costs and synergies.

Because forward-looking statements involve risks and uncertainties, there are important factors that could cause actual results to differ materially from those expressed or implied by these forward-looking statements, including but not limited to:

·  
changes in general economic, business, credit and financial market conditions;
·  
changes in environmental conditions, including those that result in water use restrictions;
·  
abnormal weather conditions;
·  
increases in energy and fuel costs;
·  
unfavorable changes to the federal and/or state tax codes;
·  
significant changes in, or unanticipated, capital requirements;
·  
significant changes in our credit rating or the market price of our common stock;
·  
our ability to integrate businesses, technologies or services which we may acquire, including the acquisition of The Maine Water Company in January 2012;
·  
our ability to manage the expansion of our business;
·  
the extent to which we are able to develop and market new and improved services;
·  
the continued demand by telecommunication companies for antenna site leases on our property;
·  
the effect of the loss of major customers;
·  
our ability to retain the services of key personnel and to hire qualified personnel as we expand;
·  
labor disputes;
·  
increasing difficulties in obtaining insurance and increased cost of insurance;
·  
cost overruns relating to improvements or the expansion of our operations;
·  
increases in the costs of goods and services;
·  
civil disturbance or terroristic threats or acts; and
·  
changes in accounting pronouncements.

Given these uncertainties, you should not place undue reliance on these forward-looking statements.  You should read this 10-K and the documents that we incorporate by reference into this 10-K completely and with the understanding that our actual future results, performance and achievements may be materially different from what we expect.  These forward-looking statements represent our assumptions, expectations and beliefs only as of the date of this 10-K.  Except for our ongoing obligations to disclose certain information under the federal securities laws, we are not obligated, and assume no obligation, to update these forward-looking statements, even though our situation may change in the future.  For further information or other factors which could affect our financial results and such forward-looking statements, see Part I, Item 1A “Risk Factors.”  We qualify all of our forward-looking statements by these cautionary statements.

 
PART I


The Company

The Registrant, Connecticut Water Service, Inc. (referred to as “the Company”, “we”, “us”, or “our”) was incorporated in 1974, with The Connecticut Water Company (Connecticut Water) as its largest subsidiary which was organized in 1956.  Connecticut Water Service, Inc. is a non-operating holding company, whose income is derived from the earnings of its four wholly-owned subsidiary companies as of December 31, 2011.  In 2011, approximately 90% of the Company’s net income was attributable to water activities carried out within its regulated water company, Connecticut Water.  As of December 31, 2011, Connecticut Water supplied water to 90,023 customers, representing a population of over 300,000, in 55 towns throughout Connecticut.  As a regulated water company, Connecticut Water is subject to state regulation regarding financial issues, rates, and operating issues, and to various other state and federal regulatory agencies concerning water quality and environmental standards.

In addition to its regulated utility, the Company owns two active unregulated companies as of December 31, 2011.  In 2011, these unregulated companies, together with real estate transactions within Connecticut Water, contributed the remaining 10% of the Company’s net income through real estate transactions as well as services and rentals.  The two active companies are Chester Realty, Inc., a real estate company in Connecticut; and New England Water Utility Services, Inc. (NEWUS), which provides contract water and sewer operations and other water related services.

On July 27, 2011, the Company announced that it had entered into an agreement on July 26, 2011 with Aqua America, Inc. (“AA”) to purchase all of the outstanding shares of Aqua Maine, Inc. (“AM”), a wholly-owned subsidiary of AA, for approximately $35.8 million (subject to certain adjustments at closing), including approximately $17.7 million of long-term debt as of December 31, 2010, reflecting a total enterprise value of approximately $53.5 million.  AM is a public water utility regulated by the Maine Public Utilities Commission (“MPUC”) that serves approximately 16,000 customers in 11 water systems in the State of Maine.  The acquisition is consistent with the Company’s growth strategy and will make the Company the largest U.S. based publicly-traded water utility company in New England.  The acquisition expanded the Company’s footprint into another New England state, providing some diversity with respect to weather and regulatory climate and ratemaking.  The Company will account for the acquisition in accordance with Accounting Standards Codification (ASC) 805 “Business Combinations”.  On November 22, 2011, the MPUC issued an Order approving a Settlement Agreement that gave regulatory approval for the acquisition by the Company.  Effective January 1, 2012, the Company completed the acquisition of AM from AA for a total cash purchase price, adjusted at closing, of $35.8 million.  Subsequent to the closing, the name of AM was changed to The Maine Water Company (“Maine Water”).  The Company is still in the process of completing the purchase price allocation as required by ASC 805.

Our mission is to provide high quality water service to our customers at a fair return to our shareholders while maintaining a work environment that attracts, retains and motivates our employees to achieve a high level of performance.

Our corporate headquarters are located at 93 West Main Street, Clinton, Connecticut 06413.  Our telephone number is (860) 669-8636, and our internet address is www.ctwater.com.  The references to our Web site and the SEC’s Web site are intended to be inactive textual references only, and the contents of those Web sites are not incorporated by reference herein and should not be considered part of this or any other report that we file with or furnish to the SEC.

The Company’s annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, proxy statements and all amendments to these documents will be made available free of charge through the “INVESTORS” menu of the Company’s internet website (http://www.ctwater.com) as soon as practicable after such material is electronically filed with, or furnished to, the Securities and Exchange Commission (SEC). The following documents are also available through the “CORPORATE GOVERNANCE” section of our website:

·  
Employee Code of Conduct
·  
Audit Committee Charter
·  
Board of Directors Code of Conduct
·  
Compensation Committee Charter
·  
Corporate Finance and Investment Charter
·  
Corporate Governance Committee Charter
·  
Bylaws of Connecticut Water Service, Inc.

Additionally, information concerning the Company’s 2012 Annual Meeting Materials (2011 Annual Report and 2012 Proxy Statement) can be found under the “INVESTORS” menu, under the “Annual Reports” tab.

Copies of each of the Company’s SEC filings (without exhibits) and corporate governance documents mentioned above will also be mailed to investors, upon request, by contacting the Company’s Corporate Secretary, Kristen A. Johnson, at Connecticut Water, 93 West Main Street, Clinton, CT 06413.

Our Regulated Businesses

Our regulated businesses are subject to seasonal fluctuations and weather variations.  The demand for water is generally greater during the warmer months than the cooler months due to customers’ incremental water consumption related to cooling systems and various outdoor uses such as private and public swimming pools and lawn sprinklers.  Demand will vary with rainfall and temperature levels from year to year and season to season, particularly during the warmer months.

In general, the profitability of the water utility industry is largely dependent on the timeliness and adequacy of rates allowed by utility regulatory commissions. In addition, profitability is affected by numerous factors over which we have little or no control, such as costs to comply with security, environmental, and water quality regulations. Inflation and other factors also impact costs for construction, materials and personnel related expenses.

Costs to comply with environmental and water quality regulations are substantial.  Since the 1974 enactment of the Safe Drinking Water Act, we have spent approximately $61.4 million in constructing facilities and conducting aquifer mapping necessary to comply with the requirements of the Safe Drinking Water Act, and other federal and state regulations, of which $7.7 million was expended in the last five years.  The Company expects to spend approximately $1.2 million in 2012 on Safe Drinking Water Act projects in Connecticut, primarily to bring newly acquired systems up to the Company’s standards.  The Company believes that we are presently in compliance with current regulations, but the regulations are subject to change at any time.  The costs to comply with future changes in state or federal regulations, which could require us to modify existing filtration facilities and/or construct new ones, or to replace any reduction of the safe yield from any of our current sources of supply, could be substantial.
 
 
Connecticut Water’s Operations

Connecticut Water derives its rights and franchises to operate from special Connecticut acts that are subject to alteration, amendment or repeal and do not grant us exclusive rights to our service areas. Our franchises are free from burdensome restrictions, are unlimited as to time, and authorize us to sell potable water in all the towns we now serve.  There is the possibility that the State of Connecticut could attempt to revoke our franchises and allow a governmental entity to take over some or all of our systems.  While we would vigorously oppose any such attempts, from time to time such legislation is contemplated.
 
The rates we charge Connecticut our water customers are established under the jurisdiction of and are approved by the Connecticut Public Utilities Regulatory Authority (PURA), formerly the Connecticut Department of Public Utility Control.  It is our policy to seek rate relief as necessary to enable us to achieve an adequate rate of return.  Connecticut Water’s allowed return on equity and return on rate base, effective as of July 14, 2010 are 9.75% and 7.32%, respectively.  Prior to July 14, 2010, Connecticut Water’s allowed return on equity and return on rate base were 10.125% and 8.07%, respectively.

On July 14, 2010, the PURA issued its Final Decision in a rate case filed by the Connecticut Water on January 6, 2010, granting an increase in revenues of $8.0 million, or approximately 13%, over pro forma test year revenues.  The PURA approved a return on equity of 9.75%.  The new rates became effective for services rendered on or after July 14, 2010, at which point all previously approved Water Infrastructure Conservation Act (“WICA”) surcharges were folded into customers’ base charges.  Connecticut Water is not precluded from seeking increased rates for future years as part of a new general rate filing should it choose to do so.

On October 29, 2010, Connecticut Water filed a WICA application with the PURA requesting a 1.58% surcharge to customer bills representing investments of approximately $9.4 million in WICA related projects.  On December 28, 2010, the PURA approved the 1.58% surcharge effective for all bills issued after January 1, 2011.  Additionally, due to under-collection of previously approved WICA surcharges during 2010, Connecticut Water was granted a 0.11% additional surcharge on bills issued after April 1, 2011 to make up the short fall.  It should be noted if the Company were to over-collect on WICA surcharges, the Company would be required to include a surcredit on customer bills.

On July 28, 2011, Connecticut Water filed a WICA application with the PURA requesting an additional 1.42% surcharge to customer bills representing approximately $7.7 million in WICA related projects.  On September 21, 2011, the PURA approved a 1.40% increase to customers’ bills effective October 1, 2011, for a cumulative 3.09% WICA surcharge.  The surcharge was effective for bills rendered on or after October 1, 2011.

On January 26, 2012, Connecticut Water filed a WICA application with the PURA requesting an additional 1.17% surcharge to customer bills, related to approximately $7.0 million spending on WICA projects.  This application also reduced the surcharge by 0.11% for the prior year reconciliation adjustment which expires April 1, 2012.  If approved, the total cumulative surcharge on customer bills will be 4.15%, beginning April 1, 2012.  On January 30, Connecticut Water filed for a 0.09% reconciliation adjustment for the 2011 shortfall in WICA, to become effective April 1, 2012.  If approved, the cumulative surcharge for all WICA applications will be 4.24%.

Our Connecticut Water Systems

As of December 31, 2011, our water infrastructure consists of 63 noncontiguous water systems in the State of Connecticut.  Our system, in total, consists of approximately 1,600 miles of water main and reservoir storage capacity of 7.0 billion gallons.  The safe, dependable yield from our 219 active wells and 18 reservoirs is approximately 54 million gallons per day.  Water sources vary among the individual systems, but overall approximately 34% of the total dependable yield comes from reservoirs and 66% from wells.

For the year-ended December 31, 2011, Connecticut Water’s 90,023 customers consumed approximately 6.6 billion gallons of water generating $69,402,000 in revenue.  We supply water, and in most cases, fire protection to all or portions of 55 towns in Connecticut.

The following table breaks down the above total figures by customer class as of December 31, 2011, 2010, and 2009:

   
2011
   
2010
   
2009
 
Customers:
                 
Residential
    80,256       79,604       78,820  
Commercial
    5,679       5,692       5,690  
Industrial
    425       422       425  
Public Authority
    600       609       608  
Fire Protection
    1,746       1,724       1,705  
Other (including non-metered accounts)
    1,317       1,351       1,286  
Total
    90,023       89,402       88,534  
                         
Water Revenues (in thousands):
                       
Residential
  $ 43,656     $ 42,103     $ 36,471  
Commercial
    8,621       7,725       6,729  
Industrial
    1,817       1,755       1,459  
Public Authority
    2,253       2,280       1,926  
Fire Protection
    11,890       11,430       10,958  
Other (including non-metered accounts)
    1,165       1,115       1,848  
Total
  $ 69,402     $ 66,408     $ 59,391  
                         
Customer Water Consumption (millions of gallons):
                       
Residential
    4,821       5,124       4,737  
Commercial
    1,133       1,151       1,078  
Industrial
    339       335       306  
Public Authority
    323       348       351  
Total
    6,616       6,958       6,472  
 
Connecticut Water owns various small, discrete parcels of land that are no longer required for water supply purposes.  At December 31, 2011, this land totaled approximately 490 acres.  Over the past several years, we have been disposing of these land parcels. For more information, please refer to Segments of Our Business below.

Additional information on land dispositions can be found in Item 7 – Management’s Discussion and Analysis of Financial Conditions and Results of Operations – Commitments and Contingencies.

Competition

Connecticut Water faces competition from a few small privately-owned water systems operating within, or adjacent to, our franchise areas and from municipal and public authority systems whose service areas in some cases overlap portions of our franchise areas.

Employees

As of December 31, 2011, we employed a total of 198 persons.  Our employees are not covered by collective bargaining agreements.

Organizational Review

As part of a broader organizational review, beginning in July 2010, the Company examined both its Connecticut regulated and unregulated operations to ensure that it is maximizing the Company’s financial results while maintaining the high quality water and service our customers have come to expect.  During the third quarter of 2010, the Company determined that a targeted reduction in workforce was appropriate.  The Company eliminated approximately 15 positions that centered on traditional managerial, officer and overhead positions.  The Company did not eliminate positions in direct service of its customers.  The Company recorded a one-time charge of approximately $786,000 related to this organizational review.  This charge represents the aggregate severance benefit provided to the employees leaving the Company and other costs associated with the review.

Executive Officers of the Registrant

The following is a list of the executive officers of the Company as of March 15, 2012:

Name
 
Age in 2012*
 
Office
 
Period Held or Prior Position
 
Term of Office Expires
E. W. Thornburg
 
51
 
Chairman, President, and Chief Executive Officer
 
 
Held position since March 2006
 
 
2012 Annual Meeting
D. C. Benoit
 
55
 
Vice President – Finance, Chief Financial Officer and Treasurer
 
Held current position or other executive position with the Company since April 1996
 
 
2012 Annual Meeting
T. P. O’Neill
 
57
 
Vice President – Service Delivery
 
 
Held current position or other engineering position with the Company since February 1980
 
 
2012 Annual Meeting
M. P. Westbrook
 
53
 
Vice President – Customer and Regulatory Affairs
 
Held current position or other management position with the Company since September 1988
 
 
2012 Annual Meeting
K. A. Johnson
 
45
 
Vice President –  Human Resources and Corporate Secretary
 
Held current position or other human resources position with the Company since May 2007.  Ms. Johnson previously served as the senior vice president, Human Resources and Organizational Development Officer for Rockville Bank.
 
2012 Annual Meeting
J. E. Wallingford
 
55
 
Division President – The Maine Water Company
 
President of The Maine Water Company (and its predecessor companies) since 1993
 
2012 Annual Meeting

* - Age shown is as of filing date of March 15, 2012.

For further information regarding the executive officers see the Company’s Proxy Statement to be filed on or about March 23, 2012.

Segments of Our Business

For management and financial reporting purposes we divide our business into three segments: Water Activities (our regulated companies), Real Estate Transactions (through either our regulated or unregulated companies), and Services and Rentals (our unregulated companies).

Water Activities – The Water Activities segment is comprised of our core regulated water activities to supply public drinking water to our customers.  This segment encompasses all transactions of our regulated water companies with the exception of certain real estate transactions.

Real Estate Transactions – Our Real Estate Transactions segment involves the sale or donation for income tax benefits of our real estate holdings.  These transactions can be effected by any of our subsidiary companies.  Through land donations and sales in previous years, the Company earned tax credits to use in future years.  The Company is limited by time and the amount of taxable income when using these credits.  During 2009, the Company completed the sale of a conservation easement of approximately 200 acres to the Town of Windsor Locks, CT.  Additionally, the Company made adjustments to tax valuation allowances associated with land donations made in previous years.  Finally, Chester Realty sold a non-regulated rental property in Killingly, CT for a small profit.  During 2010 and 2011, the Company did not make any land sales or donations; however, it did adjust its valuation allowances.  The Company is finalizing a land sale with the Town of Plymouth, Connecticut to sell approximately 175 acres of land for open space and recreational purposes, pending the approval of a Conservation Easement by the State of Connecticut Attorney General’s Office.  The Company and Town have agreed on a sale price of $1.45 million for the parcel that is valued at $1.615 million.  The Company expects the transaction to be completed in 2012.
 
A breakdown of the net income of this segment between our regulated and unregulated companies for the past three years is as follows:

   
Income (Loss) from Real Estate Transactions from Continuing Operations
 
   
Regulated
   
Unregulated
   
Total
 
                   
2011
  $ --     $ 176,000     $ 176,000  
2010
  $ (7,000 )   $ 237,000     $ 230,000  
2009
  $ 1,427,000     $ 22,000     $ 1,449,000  

Services and Rentals – Our Services and Rentals segment provides contracted services to water and wastewater utilities and other clients and also leases certain of our properties to third parties through our unregulated companies.  The types of services provided include contract operations of water and wastewater facilities; Linebacker®, our service line protection plan for public drinking water customers; and providing bulk deliveries of emergency drinking water to businesses and residences via tanker truck.  Our lease and rental income comes primarily from the renting of residential and commercial property.

Linebacker® is an optional service line protection program offered by the Company to eligible residential customers through NEWUS covering the cost of repairs for leaking or broken water service lines which provide drinking water to a customer’s home.  For customers who enroll in this program, the Company will repair or replace a leaking or broken water service line, curb box, curb box cover, meter pit, meter pit cover, meter pit valve plus in-home water main shut off valve before the meter.  Beginning in January 2010 with the acquisition of certain assets from Home Service USA, NEWUS expanded its coverage offerings to Connecticut Water customers for failure of in-home plumbing and sewer and septic drainage lines.  In 2011 the Company launched a successful marketing campaign prompting over 1,000 existing Linebacker® customers to upgrade to one of the expanded offerings.  As of December 31, 2011, the Company had 21,207 customers enrolled in its Linebacker® protection program.  Of these, 4,827 were enrolled in one of the expanded plans.

Some of the services listed above, including the service line protection plan, have little or no competition.  But there can be considerable competition for contract operations of large water and wastewater facilities and systems.  However, we have sought to develop a niche market by seeking to serve smaller facilities and systems in our service areas where there is less competition.  The Services and Rentals segment, while still a relatively small portion of our overall business, has grown over the past five years and has provided approximately 9% of our overall net income in 2011, 2010 and 2009, respectively.  Net income generated by this segment of our business was $1,001,000, $899,000 and $929,000 for the years 2011, 2010 and 2009, respectively.


Our business, financial condition, operating results and cash flows can be impacted by a number of factors, including, but not limited to, those set forth below, any one of which could cause our actual results to vary materially from recent results or anticipated future results. For a discussion identifying additional risk factors and important factors that could cause actual results to differ materially from those anticipated, see the discussion in “Forward Looking Information” in Item 7 below – “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and “Notes to Consolidated Financial Statements.”

Because we incur significant capital expenditures annually, we depend on the rates we charge our customers, which are subject to regulation.

The water utility business is capital intensive. On an annual basis, we spend significant sums for additions to or replacement of property, plant and equipment. Our ability to maintain and meet our financial objectives is dependent upon the rates we charge our customers. These rates are subject to approval by the PURA in Connecticut and the MPUC in Maine.  The Company is entitled to file rate increase requests, from time to time, to recover our investments in utility plant and expenses. Once a rate increase petition is filed with the respective agency, the ensuing administrative and hearing process may be lengthy and costly.  We can provide no assurances that any future rate increase requests will be approved by each agency; and, if approved, we cannot guarantee that any such rate increase requests will be granted in a timely or sufficient manner to cover the investments and expenses for which we initially sought the rate increase.  Additionally, a regulatory agency may rule that a company must reduce its rates.

Under a 2007 Connecticut law, the PURA may authorize regulated water companies to use a rate adjustment mechanism, known as a Water Infrastructure and Conservation Adjustment (WICA), for eligible projects completed and in service for the benefit of the customers.  For more information related to WICA, please refer to the “Executive Overview” found in Item 7 of this Form 10-K.

If we are unable to pay the principal and interest on our indebtedness as it comes due, or we default under certain other provisions of our loan documents, our indebtedness could be accelerated and our results of operations and financial condition could be adversely affected.

As of December 31, 2011, we had $135.3 million in long-term debt outstanding and $21.4 million in bank loans payable.  Our ability to pay the principal and interest on our indebtedness as it comes due will depend upon our current and future performance.  Our performance is affected by many factors, some of which are beyond our control.  We believe that our cash generated from operations, and, if necessary, borrowing under our existing and planned credit facilities, will be sufficient to enable us to make our debt payments as they become due.  If, however, we do not generate sufficient cash, we may be required to refinance our obligations or sell additional equity, which may be on terms that are not favorable to the Company as current terms.

No assurance can be given that any refinancing or sale of equity will be possible when needed or that we will be able to negotiate acceptable terms.  In addition, our failure to comply with certain provisions contained in our trust indentures and loan agreements relating to our outstanding indebtedness could lead to a default on these documents, which could result in an acceleration of our indebtedness.

Credit market volatility may affect our ability to refinance our existing debt, borrow funds under our existing lines of credit or incur additional debt.

During certain periods of the Unites States credit and liquidity crisis of 2008-2009, the volatility and disruption in the credit and banking markets reached unprecedented levels.  In many cases, the markets contained limited credit capacity for certain issuers, and lenders had requested shorter terms.  The market for new debt financing was limited and in some cases not available at all.  In addition, the markets had increased the uncertainty that lenders will be able to comply with their previous commitments.  The Company noted improvements beginning during the second half of 2009 and continuing through 2011.  If market disruption and volatility return, the Company may not be able to refinance our existing debt when it comes due, draw upon our existing lines of credit or incur additional debt, which may require us to seek other funding sources to meet our liquidity needs or to fund our capital expenditures budget.  We cannot assure you that we will be able to obtain debt or other financing on reasonable terms, or at all.
 
Failure to maintain our existing credit ratings could affect our cost of funds and related margins and liquidity position.

Since 2003, Standard & Poor's Ratings Services has rated our outstanding debt and has given credit ratings to us and our subsidiary The Connecticut Water Company.  Their evaluations are based on a number of factors, which include financial strength as well as transparency with rating agencies and timeliness of financial reporting.  On October 28, 2011, Standard & Poor's Ratings Services (S&P) affirmed its 'A' corporate credit rating on the Company, however, S&P revised the Company’s ratings outlook from stable to negative.  The negative outlook reflected S&P’s expectation of weaker credit metrics as a result of the debt the Company planned to incur to complete the acquisition of AM as well as additional near-term debt funding of the Company’s capital expenditure program.  S&P also indicated that if the Company were to issue a material amount of common equity in the future, this step could lead S&P to revise the outlook to stable.

Our inability to comply with debt covenants under our credit facilities could result in prepayment obligations.

We are obligated to comply with debt covenants under our loan and debt agreements.  Failure to comply with covenants under our credit facilities could result in an event of default, which if not timely cured or waived, could result in us being required to repay or finance these borrowings before their due date, could limit future borrowings, and result in cross default issues and increase borrowing costs.  The covenants are normal and customary in bank and loan agreements.  The Company was in compliance with all covenants at December 31, 2011.

Market conditions may unfavorably impact the value of our benefit plan assets and liabilities which then could require significant additional funding.

The performance of the capital markets affects the values of the assets that are held in trust to satisfy future obligations under the Company’s pension and postretirement benefit plans and could significantly impact our results of operations and financial position.  As detailed in the Notes to Consolidated Financial Statements, the Company has significant obligations in these areas and the Company holds significant assets in these trusts.  These assets are subject to market fluctuations, which may affect investment returns, which may fall below the Company’s projected return rates.  A decline in the market value of the pension and postretirement benefit plan assets will increase the funding requirements under the Company’s pension and postretirement benefit plans if the actual asset returns do not recover these declines in value.  Additionally, the Company’s pension and postretirement benefit plan liabilities are sensitive to changes in interest rates.  As interest rates decrease, the liabilities increase, potentially increasing benefit expense and funding requirements.  Further, changes in demographics, including increased numbers of retirements or changes in life expectancy assumptions may also increase the funding requirements of the obligations related to the pension and other postretirement benefit plans.  Also, future increases in pension and other postretirement costs as a result of reduced plan assets may not be fully recoverable from our customers, and the results of operations and financial position of the Company could be negatively affected.

Our operating costs could be significantly increased because of state and federal environmental and health and safety laws and regulations.

Our water and wastewater operations are governed by extensive federal and state environmental protection and health and safety laws and regulations, including the federal Safe Drinking Water Act, the Clean Water Act and similar state laws, and federal and state regulations issued under these laws by the U.S. Environmental Protection Agency and state environmental regulatory agencies.  These laws and regulations establish, among other things, criteria and standards for drinking water and for discharges into the waters of the United States, the State of Connecticut and/or the State of Maine. Pursuant to these laws, we are required to obtain various environmental permits from environmental regulatory agencies for our operations.  We cannot assure that we have been or will be at all times in full compliance with these laws, regulations and permits. If we violate or fail to comply with these laws, regulations or permits, we could be fined or otherwise sanctioned by regulators.

Environmental laws and regulations are complex and change frequently.  These laws, and the enforcement thereof, have tended to become more stringent over time.  While we have budgeted for future capital and operating expenditures to maintain compliance with these laws and our permits, it is possible that new or stricter standards could be imposed that will raise our operating costs.  Although these costs may be recovered in the form of higher rates, there can be no assurance that either the PURA or the MPUC would approve rate increases to enable us to fully recover such costs.  In summary, we cannot be assured that our costs of complying with, or discharging liabilities under, current and future environmental and health and safety laws will not adversely affect our business, results of operations or financial condition.

Climate change laws and regulations may be adopted that could require compliance with greenhouse gas emissions standards and other climate change initiatives. Additional capital expenditures could be required and our operating costs could be increased in order to comply with new regulatory standards imposed by federal and state environmental agencies.

Climate change is receiving ever increasing attention worldwide.  Many scientists, legislators, and others attribute global warming to increased levels of greenhouse gases, including carbon dioxide, which has led to significant legislative and regulatory efforts to limit greenhouse gas emissions.  Possible new climate change laws and regulations, if enacted, may require us to monitor and/or change our utility operations.  It is possible that new standards could be imposed that will require additional capital expenditures or raise our operating costs.  Because it is uncertain what laws will be enacted, we cannot predict the potential impact of such laws on our future consolidated financial condition, results of operations, or cash flows.  Although these expenditures and costs may be recovered in the form of higher rates, there can be no assurance that either the PURA or the MPUC or other regulatory bodies that govern our business would permit us to recover such expenditures and costs.  We cannot assure you that our costs of complying with new standards or laws will not adversely affect our business, results of operations or financial condition.

New Streamflow Regulations could potentially impact our ability to serve our customers.

In December 2011, new regulations concerning the flow of water in Connecticut’s rivers and streams became law.  These regulations were initially proposed by the Department of Energy and Environmental Protection (DEEP) in 2009, and were twice rejected by the State Legislature’s Regulations Review Committee.  Following the last rejection, DEEP worked closely with stakeholders to develop regulations that were not opposed by the regulated community.  As promulgated, the regulations will require that certain downstream releases be made from seven of the Company's eighteen active reservoirs no later than ten years following the adoption of stream classifications, which has yet to occur.  Currently, releases are made at two locations.  No groundwater supply wells are affected by the regulations.

Although significantly and favorably modified from prior versions, the regulations still have the potential to lower our safe yield, raise our capital and operating expenses and adversely affect our revenues and earnings.  Because they affect only a subset of the Company's supplies and allow for releases to be scaled back in response to drought events, however, the overall impact is anticipated to be manageable.  Costs associated with the regulations may be recovered in the form of higher rates, although there can be no assurance the PURA would approve rate increases to enable us to recover such costs.  The DEEP has recently proposed legislation that would expand the current WICA mechanism to allow for customer surcharges to recover the costs associated with the capital improvements necessary to achieve compliance with the streamflow regulations.

 
Our business is subject to seasonal fluctuations which could adversely affect demand for our water services and our revenues.

Demand for our water during the warmer months is generally greater than during cooler months due primarily to additional requirements for water in connection with irrigation systems, swimming pools, cooling systems and other outside water use. Throughout the year, and particularly during typically warmer months, demand will vary with temperature and rainfall levels. In the event that temperatures during the typically warmer months are cooler than normal, or if there is more rainfall than normal, the demand for our water may decrease and adversely affect our revenues.

Declining per customer residential water usage may reduce our revenues, financial condition and results of operations in future years.

A trend of declining per customer residential water usage in Connecticut and Maine has been observed for the last several years, which we would attribute to increased water conservation, including the use of more efficient household fixtures and appliances among residential users.  Our regulated business is heavily dependent on revenue generated from rates we charge to our residential customers for the volume of water they use.  The rate we charge for our water is regulated by the PURA in Connecticut and the MPUC in Maine and we may not unilaterally adjust our rates to reflect changes in demand.  Declining volume of residential water usage may have a negative impact on our operating revenues in the future if regulators do not reflect any usage declines in the rate setting design process.

Potential regulatory changes or drought conditions may impact our ability to serve our current and future customers’ demand for water and our financial results.

We depend on an adequate water supply to meet the present and future demands of our customers.  Changes in regulatory requirements could affect our ability to utilize existing supplies and/or secure new sources, as required.  Insufficient supplies or an interruption in our water supply could have a material adverse effect on our financial condition and results of operations.  Although not occurring in 2011, drought conditions could interfere with our sources of water supply and could adversely affect our ability to supply water in sufficient quantities to our existing and future customers. An interruption in our water supply could have a material adverse effect on our financial condition and results of operations.  Moreover, governmental restrictions on water usage during drought conditions may result in a decreased demand for our water, even if our water reserves are sufficient to serve our customers during these drought conditions, which may adversely affect our revenues and earnings.

We are increasingly dependent on the continuous and reliable operation of our information technology systems.

We rely on our information technology systems in connection with the operation of our business, especially with respect to customer service and billing, accounting and, in some cases, the monitoring and operation of our treatment, storage and pumping facilities.  A loss of these systems or major problems with the operation of these systems could affect our operations and have a significant material adverse effect on our results of operations.

With the 2010 implementation of the Company’s new Enterprise Resource Planning (ERP) system, the Company delayed customer billings in order to verify the integrity of the system and the accuracy of those bills prior to mailing.  As a result, some billings and consequently, cash receipts were delayed.  The Company has increased its utilization of its lines of credit during this period.  Its operations, including plans to continue investment in new infrastructure, are not impacted.

During 2011, the Company has seen progress towards resolving the collection issues, primarily through the ability to charge interest and shut off customers for non-payment and expects continued improvement throughout 2012.  The Company fully anticipates that the reserve will return to more historical levels during 2012.

The failure of, or the requirement to repair, upgrade or dismantle, any of our dams may adversely affect our financial condition and results of operations.

We own and operate numerous dams throughout the States of Connecticut and Maine.  While the Company maintains robust dam maintenance and inspection programs, a failure of any of those dams could result in injuries and damage to residential and/or commercial property downstream for which we may be responsible, in whole or in part.  The failure of a dam could also adversely affect our ability to supply water in sufficient quantities to our customers and could adversely affect our financial condition and results of operations.  Any losses or liabilities incurred due to the failure of one of our dams might not be covered by insurance policies or be recoverable in rates, and such losses may make it difficult for us to secure insurance in the future at acceptable rates.

Any failure of our reservoirs, storage tanks, mains or distribution networks could result in losses and damages that may affect our financial condition and reputation.

Connecticut Water and Maine Water distribute water through an extensive network of mains and stores water in reservoirs and storage tanks located across Connecticut and Maine.  A failure of major mains, reservoirs, or tanks could result in injuries and damage to residential and/or commercial property for which we may be responsible, in whole or in part.  The failure of major mains, reservoirs or tanks may also result in the need to shut down some facilities or parts of our water distribution network in order to conduct repairs.  Such failures and shutdowns may limit our ability to supply water in sufficient quantities to our customers and to meet the water delivery requirements prescribed by governmental regulators, including the PURA and the MPUC, and adversely affect our financial condition, results of operations, cash flow, liquidity and reputation.  Any business interruption or other losses might not be covered by insurance policies or be recoverable in rates, and such losses may make it difficult for us to secure insurance in the future at acceptable rates.

Any future acquisitions we may undertake may involve risks and uncertainties.

An important element of our growth strategy is the acquisition and integration of water systems in order to move into new service areas and to broaden our current service areas.  As of the date of this filing, Connecticut Water now serves more than 90,000 customers, or a population of over 300,000 people, in 55 Connecticut towns and an additional 16,000 customers, representing over 48,000 people, in 20 towns in the state of Maine served by Maine Water.  We will be unable to acquire other businesses if we cannot identify suitable acquisition opportunities or reach mutually agreeable terms with acquisition candidates.  It is our intent, when practical, to integrate any businesses we acquire with our existing operations.  The negotiation of potential acquisitions as well as the integration of acquired businesses, including Maine Water, could require us to incur significant costs and cause diversion of our management's time and resources.  Future acquisitions by us could result in:

·  
dilutive issuances of our equity securities;
·  
incurrence of debt and contingent liabilities;
·  
failure to have effective internal control over financial reporting;
·  
fluctuations in quarterly results; and
·  
other acquisition-related expenses.
 
 
Some or all of these items could have a material adverse effect on our business as well as our ability to finance our business and comply with regulatory requirements.  The businesses we acquire in the future may not achieve sales and profitability that would justify our investment and any difficulties we encounter in the integration process, including the integration of controls necessary for internal control and financial reporting, could interfere with our operations, reduce our operating margins and adversely affect our internal controls.  In addition, as consolidation becomes more prevalent in the water and wastewater industries, the prices for suitable acquisition candidates may increase to unacceptable levels and limit our ability to grow through acquisitions.

Water supply contamination may adversely affect our business.

Our water supplies are subject to possible contamination, including contamination from the development of naturally-occurring compounds, chemicals in groundwater systems, pollution resulting from man-made sources, such as Methyl Tertiary Butyl Ether (MTBE), and possible terrorist attacks. In the event that our water supply is contaminated, we may have to interrupt the use of that water supply until we are able to substitute the flow of water from an uncontaminated water source or provide additional treatment.  We may incur significant costs in order to treat the contaminated source through expansion of our current treatment facilities, or development of new treatment methods.  If we are unable to substitute water supply from an uncontaminated water source, or to adequately treat the contaminated water source in a cost-effective manner, there may be an adverse effect on our revenues, operating results and financial condition.  The costs we incur to decontaminate a water source or an underground water system could be significant and could adversely affect our business, operating results and financial condition and may not be recoverable in rates.  We could also be held liable for consequences arising out of human exposure to hazardous substances in our water supplies or other environmental damage.  For example, private plaintiffs have the right to bring personal injury or other toxic tort claims arising from the presence of hazardous substances in our drinking water supplies.  Our insurance policies may not be sufficient to cover the costs of these claims.

On January 6, 2012, Connecticut Water issued a “Do Not Drink Advisory” to 181 year round customers in the Amston Lake water system when elevated levels of copper were detected in samples from some customers’ homes.  While there was not a violation of any state or federal water quality standard, copper levels in samples from some customers’ homes were found above the Environmental Protection Agency (EPA) action level of 1.3 mg/L.  The "Do Not Drink Advisory" was lifted on January 18, 2012.  The Company is following an action plan approved by the Department of Public Health.  The resulting copper levels have been below the EPA Action Level.

Increased security measures may continue to increase our operating costs.

In addition to the potential pollution of our water supply as described above, we have taken steps to increase security measures at our facilities and heighten employee awareness of threats to our water supply.  We have also tightened our security measures regarding the delivery and handling of certain chemicals used in our business.  We have and will continue to bear increased costs for security precautions to protect our facilities, operations and supplies. These costs may be significant.  We are currently not aware of any specific threats to our facilities, operations or supplies; however, it is possible that we would not be in a position to control the outcome of terrorist events should they occur.

The accuracy of our judgments and estimates about financial and accounting matters will impact our operating results and financial condition.

We make certain estimates and judgments in preparing our financial statements regarding, among others:
·  
the number of years to depreciate certain assets;
·  
amounts to set aside for uncollectible accounts receivable and uninsured losses;
·  
our legal exposure and the appropriate accrual for claims, including medical and workers’ compensation claims;
·  
future costs for pensions and other post-retirement benefit obligations; and
·  
possible tax allowances.

The quality and accuracy of those estimates and judgments will have an impact on our operating results and financial condition.

In addition, we must estimate unbilled revenues and costs at the end of each accounting period.  If our estimates are not accurate, we will be required to make an adjustment in a future period.

Key employee turnover may adversely affect our operating results.

Our success depends significantly on the continued individual and collective contributions of our management team. The loss of the services of any member of our senior management team or the inability to hire and retain experienced management personnel could harm our operating results.


None


At December 31, 2011, the properties of our regulated water company consisted of land, easements, rights (including water rights), buildings, reservoirs, standpipes, dams, wells, supply lines, treatment plants, pumping plants, transmission and distribution mains and conduits, mains and other facilities and equipment used for the collection, purification, storage and distribution of water.  In certain cases, Connecticut Water is or may be a party to limited contractual arrangements for the provision of water supply from neighboring utilities.  We believe that our properties are in good operating condition.  Water mains are located, for the most part, in public streets and, in a few instances, are located on land that we own in fee simple and/or land utilized pursuant to easement right, most of which are perpetual and adequate for the purpose for which they are held.

The net utility plant of the Company at December 31, 2011 was solely owned by Connecticut Water.  Connecticut Water’s Net Utility Plant balance as of December 31, 2011 was $360,027,000, approximately $16 million more than the balance of net utility plant as of December 31, 2010, due primarily to normal plant additions and construction spending related to infrastructure improvements.

 
Sources of water supply owned, maintained, and operated by Connecticut Water include eighteen reservoirs and ninety-one well fields, as of December 31, 2011.  In addition, Connecticut Water has agreements with various neighboring water utilities to provide water, at negotiated rates, to our water systems.  Collectively, these sources have the capacity to deliver approximately fifty-two million gallons of potable water daily to the thirteen major operating systems in the following table. In addition to the principal systems identified, Connecticut Water owns, maintains, and operates fifty small, non-interconnected satellite and consecutive water systems that, combined, have the ability to deliver about two million gallons of additional water per day to their respective systems. For some small consecutive water systems, purchased water may comprise substantially all of the total available supply of the system.

As of December 31, 2011, Connecticut Water owns and operates 22 water filtration facilities, having a combined treatment capacity of approximately 29.55 million gallons per day.

The Company’s estimated available water supply, including purchased water agreements, but excluding non-principal systems, at December 31, 2011 is as follows:

System
 
Estimated Available Supply
(million gallons per day)
 
Chester System
    1.69  
Collinsville System
    1.65  
Danielson System
    3.76  
Gallup System
    0.60  
Guilford System
    10.10  
Naugatuck System
    7.07  
Northern Western System
    16.53  
Plainfield System
    1.01  
Stafford System
    1.00  
Terryville System
    0.91  
Thomaston System
    1.73  
Thompson System
    0.29  
Unionville System
    6.02  
Total
    52.36  

As of December 31, 2011, the transmission and distribution systems of Connecticut Water consisted of approximately 1,600 miles of main.  On that date, approximately 78 percent of our mains were eight-inch diameter or larger.  Substantially all new main installations are cement-lined ductile iron pipe of eight-inch diameter or larger.

We believe that our properties are maintained in good condition and in accordance with current regulations and standards of good waterworks industry practice.


We are involved in various legal proceedings from time to time. Although the results of legal proceedings cannot be predicted with certainty, there are no pending legal proceedings to which we, or any of our subsidiaries are a party, or to which any of our properties is subject, that presents a reasonable likelihood of a material adverse impact on the Company’s financial condition, results of operations or cash flows.


Not Applicable

PART II


Our Common Stock is traded on the NASDAQ Global Select Market under the symbol “CTWS”.  Our quarterly high and low stock prices as reported by NASDAQ and the cash dividends we paid during 2011 and 2010 are listed as follows:

   
Price
   
Dividends
 
Period
 
High
   
Low
   
Paid
 
2011
                 
First Quarter
  $ 28.27     $ 23.27     $ .2325  
Second Quarter
    26.64       24.01       .2325  
Third Quarter
    28.15       24.77       .2375  
Fourth Quarter
    29.10       24.76       .2375  
                         
2010
                       
First Quarter
  $ 25.12     $ 21.57     $ .2275  
Second Quarter
    24.28       20.00       .2275  
Third Quarter
    24.15       20.80       .2325  
Fourth Quarter
    27.90       23.60       .2325  

As of March 1, 2012, there were approximately 3,600 holders of record of our common stock.

We presently intend to pay quarterly cash dividends in 2012 on March 15, June 15, September 17 and December 17, subject to our earnings and financial condition, regulatory requirements and other factors our Board of Directors may deem relevant.

The Company’s Annual Meeting of Shareholders is scheduled for May 10, 2012 in Westbrook, Connecticut.

Purchases of Equity Securities by the Company – In May 2005, the Company adopted a common stock repurchase program (Share Repurchase Program).  The Share Repurchase Program allows the Company to repurchase up to 10% of its outstanding common stock, at a price or prices that are deemed appropriate.  As of December 31, 2011, no shares have been repurchased.  Currently, the Company has no plans to repurchase shares under the Share Repurchase Program.

Performance Graph – Set forth below is a line graph comparing the cumulative total shareholder return for each of the years 2007 – 2011 on the Company’s Common Stock, based on the market price of the Common Stock and assuming reinvestment of dividends, with the cumulative total shareholder return of companies in the Standard & Poor’s 500 Index and the Standard and Poor’s 500 Utility Index.
 


                         
                               
SUPPLEMENTAL INFORMATION (Unaudited)
                             
                               
SELECTED FINANCIAL DATA
                             
                               
Years Ended December 31, (thousands of dollars except per share
                             
amounts and where otherwise indicated)
 
2011
   
2010
   
2009
   
2008
   
2007
 
CONSOLIDATED STATEMENTS OF INCOME
                             
Continuing Operations
                             
Operating Revenues
  $ 69,402     $ 66,408     $ 59,391     $ 61,270     $ 59,026  
Operating Expenses
  $ 53,842     $ 52,573     $ 47,003     $ 47,874     $ 46,324  
Other Utility Income, Net of Taxes
  $ 847     $ 742     $ 704     $ 579     $ 552  
Total Utility Operating Income
  $ 16,407     $ 14,577     $ 13,092     $ 13,975     $ 13,254  
Interest and Debt Expense
  $ 5,674     $ 5,853     $ 4,744     $ 5,198     $ 4,411  
Net Income
  $ 11,300     $ 9,798     $ 10,209     $ 9,424     $ 8,781  
Cash Common Stock Dividends Paid
  $ 8,196     $ 7,942     $ 7,671     $ 7,373     $ 7,146  
Dividend Payout Ratio from Continuing Operations
    73 %     81 %     75 %     78 %     81 %
Weighted Average Common Shares Outstanding
    8,610,070       8,531,741       8,447,950       8,377,428       8,270,494  
Basic Earnings Per Common Share from Continuing Operations
  $ 1.31     $ 1.14     $ 1.20     $ 1.12     $ 1.06  
Number of Shares Outstanding at Year End
    8,755,398       8,676,849       8,573,744       8,463,269       8,376,842  
ROE on Year End Common Equity
    9.6 %     8.7 %     9.4 %     9.1 %     8.8 %
Declared Common Dividends Per Share
  $ 0.940     $ 0.920     $ 0.900     $ 0.880     $ 0.865  
                                         
                                         
CONSOLIDATED BALANCE SHEET
                                       
Common Stockholders' Equity
  $ 118,189     $ 113,191     $ 108,569     $ 103,476     $ 100,098  
Long-Term Debt (Consolidated, Excluding Current Maturities)
    135,256       111,675       111,955       92,227       92,285  
Preferred Stock
    772       772       772       772       772  
Total Capitalization
  $ 254,217     $ 225,638     $ 221,296     $ 196,475     $ 193,155  
Stockholders' Equity (Includes Preferred Stock)
    47 %     51 %     49 %     53 %     52 %
Long-Term Debt
    53 %     49 %     51 %     47 %     48 %
Net Utility Plant
  $ 360,027     $ 344,219     $ 325,202     $ 299,233     $ 277,662  
Total Assets
  $ 464,831     $ 424,199     $ 415,276     $ 372,431     $ 360,813  
Book Value - Per Common Share
  $ 13.50     $ 13.05     $ 12.66     $ 12.23     $ 11.95  
                                         
OPERATING REVENUES BY
                                       
REVENUE CLASS
                                       
Residential
  $ 43,656     $ 42,103     $ 36,471     $ 37,963     $ 38,354  
Commercial
    8,621       7,725       6,729       7,150       6,762  
Industrial
    1,817       1,755       1,459       1,822       1,764  
Public Authority
    2,253       2,280       1,926       2,027       1,924  
Fire Protection
    11,890       11,430       10,958       10,606       9,482  
Other (Including Non-Metered Accounts)
    1,165       1,115       1,848       1,702       740  
Total Operating Revenues
  $ 69,402     $ 66,408     $ 59,391     $ 61,270     $ 59,026  
                                         
Number of Customers (Average)
    89,812       88,895       88,390       87,028       84,023  
Billed Consumption (Millions of Gallons)
    6,616       6,958       6,472       6,895       7,257  
Number of Employees
    198       204       225       226       206  




FINANCIAL CONDITION
Executive Overview

The Company is a non-operating holding company, whose income is derived from the earnings of its three active wholly-owned subsidiary companies, as of December 31, 2011: The Connecticut Water Company (Connecticut Water), New England Water Utility Services, Inc. (NEWUS), and Chester Realty Company (Chester Realty).  Additionally, on January 1, 2012, the Company completed the acquisition of Aqua Maine from Aqua America.  Upon completion of the acquisition, Aqua Maine renamed The Maine Water Company (Maine Water).

On July 27, 2011, the Company announced that it had entered into an agreement on July 26, 2011 with Aqua America, Inc. (“AA”) to purchase all of the outstanding shares of Aqua Maine, Inc. (“AM”), a wholly-owned subsidiary of AA, for approximately $35.8 million (subject to certain adjustments at closing), including approximately $17.7 million of long-term debt as of December 31, 2010, reflecting a total enterprise value of approximately $53.5 million.  AM is a public water utility regulated by the Maine Public Utilities Commission (“MPUC”) that serves approximately 16,000 customers in 11 water systems in the State of Maine.  The acquisition is consistent with the Company’s growth strategy and will make the Company the largest U.S. based publicly-traded water utility company in New England.  The acquisition expanded the Company’s footprint into another New England state, providing some diversity with respect to weather and regulatory climate and ratemaking.  The Company will account for the acquisition in accordance with Accounting Standards Codification (ASC) 805 “Business Combinations”.  On November 22, 2011, the MPUC issued an Order approving a Settlement Agreement that gave regulatory approval for the acquisition by the Company.  Effective January 1, 2012, the Company completed the acquisition of AM from AA for a total cash purchase price, adjusted at closing, of $35.8 million.  Subsequent to the closing, the name of AM was changed to The Maine Water Company (“Maine Water”).  The Company is still in the process of completing the purchase price allocation as required by ASC 805.

In 2011, approximately 90% of the Company’s net income was attributable to the water activities of its largest subsidiary, Connecticut Water, a regulated water utility with 90,023 customers throughout 55 Connecticut towns, as of December 31, 2011.  The rates charged for service by Connecticut Water are subject to review and approval by the Connecticut Public Utilities Regulatory Authority (PURA), formerly the Connecticut Department of Public Utility Control.

In the mid 1990s, Connecticut Water made a conscious decision to minimize its reliance on rate increase requests to drive its financial performance.  Instead, it relied upon unregulated operations and cost containment to grow the earnings of the Company without seeking higher rates.  After a successful extended period of meeting these objectives, it became clear in 2006 that a rate increase was needed to continue to provide shareholder value through increased earnings.  The Company decided to return to the more traditional model of recurring rate increase filings to efficiently collect its cost of both annual expenses and its investment in the infrastructure of the regulated business.  In 2006, Connecticut Water communicated to its customers, regulators and shareholders that it expected to seek rate relief on a more recurring basis.

Recognizing the importance of timely infrastructure replacement and improvement, the Company, along with other investor-owned regulated water companies in the state, campaigned for the passage of the Water Infrastructure and Conservation Adjustment (WICA) Act in the Connecticut General Assembly, which was adopted in 2007.  WICA allows Connecticut Water to add a surcharge to customers’ bills, subject to an expedited review and approval by the PURA and no more than twice a year, to reflect the replacement of certain types of aging utility plant; principally water mains, meters, service lines and water conservation related investments.

On July 14, 2010, the PURA issued its Final Decision in a rate case filed by Connecticut Water on January 6, 2010, granting an increase in revenues of $8.0 million, or approximately 13%, over pro forma test year revenues.  The PURA approved a return on equity of 9.75%.  The new rates became effective for services rendered on or after July 14, 2010, at which point all previously approved WICA surcharges were folded into customers’ base charges.  Connecticut Water is not precluded from seeking increased rates for future years as part of a new general rate filing should it choose to do so.

On October 29, 2010, Connecticut Water filed a WICA application with the PURA requesting a 1.58% surcharge to customer bills representing investments of approximately $9.4 million in WICA related projects.  On December 28, 2010, the PURA approved the 1.58% surcharge effective for all bills issued after January 1, 2011.  Additionally, due to under-collection of previously approved WICA surcharges during 2010, Connecticut Water was granted a 0.11% additional surcharge on bills issued after April 1, 2011 to make up the short fall.  This surcharge will expire on March 31, 2012.  It should be noted if Connecticut Water were to over-collect on WICA surcharges, we would be required to include a surcredit on customer bills.

On July 28, 2011, Connecticut Water filed a WICA application with the PURA requesting an additional 1.42% surcharge to customer bills representing approximately $7.7 million in WICA related projects.  On September 21, 2011, the PURA approved a 1.40% increase to customers’ bills effective October 1, 2011, for a cumulative 3.09% WICA surcharge.  The surcharge was effective for bills rendered on or after October 1, 2011.

On January 26, 2012, Connecticut Water filed a WICA application with the PURA requesting an additional 1.17% surcharge to customer bills, related to approximately $7.0 million spending on WICA projects.  This application also reduced the surcharge by 0.11% for the prior year reconciliation adjustment which expires April 1, 2012.  If approved, the total cumulative surcharge on customer bills will be 4.15%, beginning April 1, 2012.  On January 30, Connecticut Water filed for a 0.09% reconciliation adjustment for the 2011 shortfall in WICA, to become effective April 1, 2012.  If approved, the cumulative surcharge for all WICA applications will be 4.24%.

The Company has and will continue to focus on minimizing operating costs that are passed along to its customers without sacrificing the quality service it values and the customers demand.  At the same time, the Company will continue to employ its current strategy of timely collection of appropriate costs and a fair rate of return for its shareholders through appropriate rates for its regulated water service.  As part of a broader organizational review, beginning in July 2010, the Company examined both its regulated and unregulated operations in Connecticut to ensure that it is maximizing the Company’s financial results while maintaining the high quality water and service our customers have come to expect.  During the third quarter of 2010, the Company conducted a targeted reduction in workforce that eliminated approximately 15 positions that centered on traditional managerial, officer and overhead positions.  The Company did not eliminate positions in direct service of its customers.  The Company recorded a one-time pre-tax charge of approximately $786,000 related to this organizational review in 2010.  This charge represents the aggregate severance benefit provided to the employees leaving the Company, legal costs associated with the review and out placement services provided to the effected employees.  The Company will continue to evaluate all segments of its business and will make additional changes if warranted.

Connecticut Water has previously announced that it had reached an agreement to acquire a water system in Old Lyme, Connecticut for $216,000.  This acquisition added approximately 100 customers and additional water supply to Connecticut Water.  The PURA issued a final decision approving the acquisition on July 21, 2011.  Connecticut Water completed the acquisition on August 18, 2011.  Additionally, during the first quarter of 2011, Connecticut Water completed the acquisition of a water company serving approximately 25 customers in the Town of Madison, Connecticut for a nominal amount.

 
In 2011, Connecticut Water added 54 private well owners in our existing service territories.  In 2012 and beyond, the Company will continue its efforts to tie-in private well owners whose homes are in close proximity to our mains.  Additionally, the Company will continue to work with developers to encourage public water use for new residential construction within Connecticut Water and Maine Water’s service areas.

While the Company plans to file timely rate cases, continue to make acquisitions and, in the future, utilize the WICA adjustment to allow for more timely recovery of investment in utility plant, it will also look to NEWUS and its new subsidiary Maine Water to increase its earnings in the unregulated business.  The Company will continue to seek out maintenance and service contracts with new customers and renew existing contracts that have proven to be beneficial to the Company, as well as to continue the expansion of the Linebacker® program.  In January 2010, NEWUS acquired the assets of Home Service USA.  Prior to the acquisition, Home Service USA offered Connecticut Water customers coverage for failure of home plumbing and septic drainage lines.  NEWUS agreed to purchase the right to provide the service to Connecticut Water customers and began offering its own comparable coverage.  As part of the agreement, Home Service USA will not offer its products to Connecticut Water customers for a period of ten years.  The new products offered by NEWUS have been integrated into the Linebacker® program.

During 2010, the Company entered into discussions to sell approximately 175 acres of land to the Town of Plymouth, CT for open space purposes.  The Town was awarded a Watershed and Open Space Grant from the Connecticut Department of Environmental Protection to assist in purchasing the land.  This transaction will allow the Company to receive financial benefit by disposing of property that is no longer needed for public water supply purposes while at the same time supporting environmental stewardship by ensuring the property is permanently maintained as open space.  The Company is finalizing a land sale with the Town of Plymouth, Connecticut to sell approximately 175 acres of land for open space and recreational purposes, pending the approval of a Conservation Easement by the State of Connecticut Attorney General Office.  The Company and Town have agreed on a sale price of $1.45 million for the parcel that is valued at $1.615 million.  If approved, the Company expects the transaction to be completed in 2012.

Regulatory Matters and Inflation

The Company, like all other businesses, is affected by inflation, most notably by the continually increasing costs required to maintain, improve, and expand its service capabilities.  The cumulative effect of inflation over time results in significantly higher operating costs and facility replacement costs, which must be recovered from future cash flows.

Our regulated water companies’ ability to recover its increased expenses and/or investment in utility plant is dependent on the rates we charge our customers.  Changes to these rates must be approved by the appropriate regulatory agency through formal rate proceedings.  Due to the subjectivity of certain items involved in the process of establishing rates such as customer usage, future customer growth, inflation, and allowed return on investment, we have no assurance that we will be able to raise our rates to a level we consider appropriate, or to raise rates at all, through any future rate proceeding.

Our regulated water utilities are also subject to environmental and water quality regulations, which are continually modified and refined to ensure the safety of the Company’s water sources and, ultimately, the public’s health.  Costs to comply with environmental and water quality regulations are substantial.  The costs to comply with future changes in state or federal regulations, which could require us to modify current filtration facilities and/or construct new ones, or to replace any reduction of the safe yield from any of our current sources of supply, could be substantial.  While there can be no guarantee that all expenditures related to increased regulation will be recoverable in rate proceedings, the Company believes that the regulatory environment in Connecticut and Maine would allow prudent expenditures to be recovered in rates.  To date, the Company has never had any costs associated with water quality and environmental spending refused in a general rate proceeding.  The Company believes that it is in compliance with current regulations, but the regulations are subject to change at any time.  During 2011, the Company incurred approximately $1.7 million in capital expenditures on Safe Drinking Water Act projects.  The Company expects to spend approximately $1.2 million on Safe Drinking Water Act projects in 2012, primarily to bring newly acquired systems up to the Company’s standards.

Critical Accounting Policies and Estimates

The Company’s consolidated financial statements are prepared in conformity with accounting principles generally accepted in the United States of America (GAAP) and as directed by the regulatory commissions to which the Company’s subsidiaries are subject.  (See Note 1 to the Consolidated Financial Statements for a discussion of our significant accounting policies).  The Company believes the following policies and estimates are critical to the presentation of its consolidated financial statements.

Public Utility Regulation – Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) 980 “Regulated Operations” (“FASB ASC 980”), requires cost-based, rate-regulated enterprises such as Connecticut Water and Maine Water to reflect the impact of regulatory decisions in their financial statements.  The state regulators, through the rate regulation process, can create regulatory assets that result when costs are allowed for ratemaking purposes in a period after the period in which costs would be charged to expense by an unregulated enterprise.  The balance sheet includes regulatory assets and liabilities as appropriate, primarily related to income taxes and post-retirement benefit costs.  The Company believes, based on current regulatory circumstances, that the regulatory assets recorded are likely to be recovered and that its use of regulatory accounting is appropriate and in accordance with the provisions of FASB ASC 980.

Revenue Recognition – The Company’s accounting policies regarding revenue recognition by segment are as follows:

Water Activities – Most of our water customers are billed quarterly, with the exception of larger commercial and industrial customers, as well as public and private fire protection customers who are billed monthly.  Most customers, except fire protection customers, are metered.  Revenues from metered customers are based on their water usage multiplied by approved, regulated rates and are earned when water is delivered.  Public fire protection revenues are based on the length of the water main, and number of hydrants in service and are earned on a monthly basis.  Private fire protection charges are based on the diameter of the connection to the water main.  The Company accrues an estimate for metered customers for the amount of revenues earned relating to water delivered but unbilled at the end of each quarter.

Real Estate Transactions – Revenues are recorded when a sale or other transaction has been completed and title to the real estate has been transferred.

Services and Rentals – Revenues are recorded when the Company has delivered the services called for by contractual obligation.

Employee Benefit Plan Accounting – Management evaluates the appropriateness of the discount rate through the modeling of a bond portfolio which approximates the pension and postretirement plan liabilities.  Management further considers rates of high quality corporate bonds of approximate maturities as published by nationally recognized rating agencies consistent with the duration of the Company’s pension and postretirement plans.

 
The discount rate assumption we use to value our pension and postretirement benefit obligations has a material impact on the amount of expense we record in a given period.  Our 2011 and 2010 pension expense was calculated using assumed discount rates of 5.50% and 5.95%, respectively. Our 2011 and 2010 post-retirement welfare expense was calculated using assumed discount rates of 5.35% and 5.80%, respectively.  In 2012, our pension and postretirement welfare expense will be calculated using assumed discount rates of 4.60% and 4.40%, respectively.  The following table shows how much a one percent change in our assumed discount rate would have changed our reported 2011 pension and postretirement expense:

   
Increase (Decrease) in Pension Expense
   
Increase (Decrease) in Postretirement Expense
 
1% Increase in the discount rate
  $ (370,000 )   $ (187,000 )
1% Decrease in the discount rate
  $ 430,000     $ 223,000  

Other assumptions that affect the costs associated with our benefit plans include the assumed rate of return on plan assets and the expected rate of compensation increase.  The Company has assumed an 7.25% and 8.00% return on plan investments for 2011 and 2010, respectively, and a 3.5% rate of compensation increase for our pension and post-retirement welfare plans, in 2011 and 2010.  The assumed health care trend rate was 10% at December 31, 2011 and 2010, respectively.

Outlook

The Company’s earnings and profitability are primarily dependent upon the sale and distribution of water, the amount of which is dependent on seasonal weather fluctuations, particularly during the summer months when water demand will vary with rainfall and temperature levels.  The Company’s earnings and profitability in future years will also depend upon a number of other factors, such as the ability to maintain our operating costs at current or lower levels, customer growth in the Company’s core regulated water utility businesses, growth in revenues attributable to non-water sales operations, availability and desirability of land no longer needed for water delivery for land sales, and the timing and adequacy of rate relief when requested, from time to time, by our regulated water companies.

The Company believes that the factors described above and those described in detail below under the heading “Commitments and Contingencies” may have significant impact, either alone or in the aggregate, on the Company’s earnings and profitability in fiscal years 2012 and beyond.  Please also review carefully the risks and uncertainties described in Item 1A – Risk Factors and those described above under the heading “Special Note Regarding Forward Looking Statements”.

The Company expects Net Income from its Water Activities and Real Estate segments to increase in 2012 over 2011 levels, based on the acquisition of Maine Water and the completion of the land sale with the Town of Plymouth, Connecticut, along with modest growth in its Services and Rentals segment.  During 2012 and subsequent years, the ability of the Company to maintain and increase its Net Income will principally depend upon the effect on the Company of the factors described above in this “Outlook” section, those factors described in the section entitled “Commitments and Contingencies” and the risks and uncertainties described in the “Special Note Regarding Forward-Looking Statements” and Item 1A “Risk Factors”.

FINANCIAL CONDITION
Liquidity and Capital Resources

The Company is not aware of any demands, events, or uncertainties that will result in a decrease of liquidity or a material change in the mix or relative cost of its capital resources, other than those outlined below.

Borrowing Facilities

In November 2008, the Company was authorized by its Board of Directors to increase the available lines of credit from $21 million to $40 million.  On June 30, 2009, the Company let expire one line of credit totaling $6 million and entered into a new $15 million line of credit agreement with CoBank, ACB, which was amended in May 2010 and July 2011 and is currently scheduled to mature on June 25, 2013.  On August 12, 2009, the Company replaced an existing $3 million line of credit with a $10 million line of credit, which expires on August 10, 2013.  Finally, on September 15, 2009, the Company increased a third line of credit from $12 million to $15 million, with an expiration date of June 1, 2013.  On December 30, 2011, the Company terminated its $10 million line of credit.  The Company expects to maintain the two remaining lines of credit totaling $30 million and to renew the lines of credit annually, with a rolling two year expiration date.  Interim Bank Loans Payable at December 31, 2011 and 2010 was approximately $21.4 million and $26.3 million, respectively, and represents the outstanding aggregate balance on these lines of credit.  As of December 31, 2011, the Company had $8.6 million in unused lines of credit.  Interest expense charged on interim bank loans will fluctuate based on market interest rates.

At December 31, 2011 and 2010, the weighted average interest rates on these short-term borrowings outstanding were 2.19% and 2.33%, respectively.

On January 1, 2012, the Company and CoBank entered into an amendment to the CoBank Agreement (the “Amendment”) and two additional Promissory Note and Single Advance Term Loan Supplements providing for two additional Term Loans to the Company (the “Term Loan Notes and Supplements”).  Under the terms of the Amendment and the Term Loan Notes and Supplements, on January 3, 2012 the Company borrowed from CoBank, in the aggregate, an additional $36.1 million of an available $40 million to be applied to the Company’s acquisition of the issued and outstanding capital stock of Aqua Maine, Inc. from Aqua America, Inc., as more fully described in Item 1 and the executive summary of this Item 7 above.

Under the CoBank Agreement, as amended, the Company is required to maintain together with its consolidated subsidiaries at all times a ratio of Total Debt to Capitalization (as defined in the Agreement) of not more than .65 to 1.00.  In addition to the foregoing, the two regulated water subsidiaries, Connecticut Water and Maine Water are each required to maintain at all times a ratio of Total Debt to Capitalization of not more than .60 to 1.00.

Under one Term Loan Note and Supplement, CoBank loaned the Company $18.0 million, which Term Loan shall be repaid by the Company in 60 equal quarterly installments of principal and interest over a 15-year amortizing term, with the first installment due on April 20, 2012 and the last installment due on January 20, 2027.  Under the other Term Loan Note and Supplement, CoBank loaned the Company $18.1, which Term Loan shall be repaid by the Company in quarterly interest payments and repayment of the principal balance in full on the earlier of July 30, 2013 or upon the Company raising equity capital, in the aggregate, up to the outstanding amount owed under the second Term Note and Supplement.

 
Under the initial Promissory Note and each of the Term Loan Notes and Supplements, the Company will pay interest on any Loans made by CoBank in accordance with one of more of the following interest rate options, as selected periodically by the Company: (1) at a weekly quoted variable rate, a rate per annum equal to the rate of interest established by CoBank on the first business day of each week; (2) at a fixed rate per annum to be quoted by CoBank in its sole discretion in each instance for periods of 180 days or more; or (3) at a fixed rate per annum equal to LIBOR plus 1.75% for 1, 2, 3, 6, 9 or 12 month interest periods.  Interest shall be calculated on the actual number of days each Loan is outstanding on the basis of a year consisting of 360 days.

Capital Budget

In 2011, the Company spent $22.9 million on capital projects.  The Company used a combination of its internally generated funds, borrowing under its available lines of credit, and a long term debt issuance to fund this construction budget.  On December 20, 2011, Connecticut Water completed the issuance of $22,050,000 aggregate principal amount of 5.00% fixed rate Water Facilities Revenue Bonds – Series 2011A with a maturity date of December 1, 2021 (the “Bonds”).  The Bonds are tax-exempt notes and were issued by the Connecticut Development Authority (the “Authority”).  The proceeds of issuance were loaned to Connecticut Water to be used by Connecticut Water to fund various water facilities projects.  The Bonds were issued under a Bond Purchase Agreement, a Loan Agreement and an Indenture.  Both of the Loan Agreement and the Indenture for the Bonds contain provisions that provide for the acceleration of the indebtedness upon the occurrence of an event of default (as defined in the Loan Agreement).  The Company received approximately $24,000,000 in cash in exchange for the issuance of bonds with an aggregate principal amount of $22,050,000 for a 10-year term and a 5% coupon.

Future Plans

The Company expects to issue equity at some point between the fourth quarter of 2012 and the third quarter of 2013, depending on market conditions and other Company activities.  The Company has a target capital structure that is equally balanced with equity and debt.  As noted above, the interim financing utilized in completing the acquisition of Maine Water included two similar sized debt facilities – an $18 million fifteen-year fixed loan with an interest rate of 4.09% and a variable rate debt facility with a borrowing of $18.1 million and an initial interest rate of 2.06%.  The latter facility is expected to be paid off with the proceeds of the equity issuance.  The Company has not determined the specific structure nor the specific amount of equity that it will seek to raise.  It currently estimates raising equity of between $35.0 and $45.0 million depending on the Board’s determination of the Company’s needs and market conditions.

The following table shows the total construction expenditures excluding non-cash contributed utility plant for each of the last three years and what we expect to invest on construction projects in 2012.

   
Gross Construction Expenditures
   
Construction Funded by Developers & Others
   
Construction Funded by Company
 
2011
  $ 24,012,000     $ 1,154,000     $ 22,858,000  
2010
  $ 26,692,000     $ 452,000     $ 26,240,000  
2009
  $ 28,349,000     $ 751,000     $ 27,598,000  
                         
2012 (Projected)
  $ 25,100,000       **     $ 25,100,000  

** – The Company cannot predict the amount of construction funded by others.

Credit Rating

On October 28, 2011, Standard & Poor's Ratings Services (S&P) affirmed its 'A' corporate credit rating on the Company, however, S&P revised the Company’s ratings outlook from stable to negative.  The negative outlook reflects S&P’s expectation of weaker credit metrics as a result of the debt the Company planned to incur to complete the acquisition of AM as well as additional near-term debt funding of the Company’s capital expenditure program.  S&P also indicated that if the Company were to issue a material amount of common equity in the future, this step could lead S&P to revise the outlook to stable.

Stock Plans

The Company offers a dividend reinvestment plan (DRIP) to all registered shareholders, whereby shareholders can elect to have cash dividends directly reinvested into additional shares of the Company’s common stock.  During the years ended December 31, 2011 and 2010, shareholders reinvested $1,346,000 and $1,358,000, respectively, as part of the DRIP.

From 1999 through 2003, the Company issued stock options to certain employees of the Company.  No stock options have been issued by the Company since 2003.  During the year ended December 31, 2011, 5,671 options were exercised resulting in approximately $146,000 in proceeds to the Company.  During the year ended December 31, 2010, 14,074 options were exercised resulting in approximately $287,000 in proceeds to the Company.  For the same period in 2009, 17,498 options were exercised resulting in approximately $390,000 in proceeds to the Company.

Enterprise Resource Planning Implementation

With the implementation of the Company’s new Enterprise Resource Planning (ERP) system, the Company delayed customer billings in order to verify the integrity of the system and the accuracy of those bills prior to mailing.  As a result, some billings and consequently, cash receipts were delayed.  The Company has increased its utilization of its lines of credit during this period.  Its operations, including plans to continue investment in new infrastructure, are not impacted.

The Company has returned to normal billing and collection processes and does not anticipate delays in billing or collection in subsequent periods.  The delay in billing contributed to the increase in the Company’s bad debt expense for the year due to the reserve policy based upon aging of the receivables.  During 2011, the Company has seen progress towards resolving the collection issues, primarily through the ability to charge interest and shut off customers for non-payment and expects continued improvement throughout 2012.  The Company fully anticipates that the reserve will return to more historical levels during 2012.

During 2011, the Company incurred approximately $24.0 million of construction expenditures, including approximately $1,154,000 funded by developers and others.  The Company financed the expenditures through internally generated funds, long-term debt issuances, proceeds from its dividend reinvestment plan, customers’ advances, contributions in aid of construction and short-term borrowings.

 
Our Board of Directors has approved a $25.1 million construction budget for 2012, net of amounts to be financed by customer advances and contributions in aid of construction.  The Company will use a combination of its internally generated funds and borrowing under its available lines of credit.

As the Company looks forward to 2012 and 2013, it anticipates continued reinvestment to replace aging infrastructure and to seek recovery through periodic WICA applications.  The total cost of that investment is expected to exceed the amount of internally generated funds.  The Company expects that it will require external financing over the next two years.  In order to maintain a balanced capital structure, we expect to consider both debt and equity issuances.  As the capital investment planning process is completed in the coming periods, the Company expects to provide a reasonable range of these potential financings.

Off-Balance Sheet Arrangements and Contractual Obligations

We do not use off-balance sheet arrangements such as securitization of receivables with any unconsolidated entities or other parties. The Company does not engage in trading or risk management activities and does not have material transactions involving related persons.

The following table summarizes the Company’s future contractual cash obligations as of December 31, 2011:

Payments due by Periods
 
(in thousands)
 
 
 
Contractual Obligations
 
 
Total
   
Less
than 1
year
   
Years
2 and 3
   
Years
4 and 5
   
More
than 5
years
 
Long-Term Debt (LTD)
  $ 135,256     $ --     $ --     $ --     $ 135,256  
Interest on LTD
    107,002       5,942       11,884       11,884       77,292  
Operating Lease Obligations
    264       229       35       --       --  
Purchase Obligations (1) (2)
    95,906       1,070       2,127       2,291       90,418  
Long-Term Compensation Agreement(3)
    38,885       304       5,581       4,258       28,742  
Total (4) (5)
  $ 377,313     $ 7,545     $ 19,627     $ 18,433     $ 331,708  

(1) Connecticut Water has an agreement with the South Central Connecticut Regional Water Authority (RWA) to purchase water from RWA.  The agreement was signed on April 24, 2006 and will remain in effect for a minimum of fifty (50) years from that date.  Connecticut Water has agreed to purchase a maximum of one million (1,000,000) gallons of water per day from RWA.  The Company is required to pay $75,000 per year for access to this water.
(2) Connecticut Water has an agreement with The Metropolitan District (MDC) to purchase water from MDC.  The agreement became effective on October 6, 2000 for a term of fifty (50) years beginning May 19, 2003, the date the water supply facilities related to the agreement were placed in service.
(3) Pension and post retirement contributions cannot be reasonably estimated beyond 2012 and may be impacted by such factors as return on pension assets, changes in the number of plan participants and future salary increases.  The amounts included for pension and post retirement contributions are management’s best estimate.
(4) We pay refunds on Advances for Construction over a specific period of time based on operating revenues related to developer-installed water 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 2020 and amounts not paid by the contract expiration dates become non-refundable.
(5) We intend to fund these contractual obligations with cash flows from operations and liquidity sources held by or available to us.


RESULTS OF OPERATIONS

Overview of 2011 Results from Operations

Net Income for 2011 was $11,300,000, or $1.31 basic earnings per share, an increase of $1,502,000, or $0.17 basic earnings per share, compared to 2010.  The increase in earnings was principally due to higher net income in our Water Activities and Services and Rentals segments partially offset by lower net income in our Real Estate segment.  Changes in net income for our segments were as follows:

Business Segment
 
2011 Net Income
   
2010 Net Income
   
Increase (Decrease)
 
Water Activities
  $ 10,123,000     $ 8,669,000     $ 1,454,000  
Real Estate
    176,000       230,000       (54,000 )
Services and Rentals
    1,001,000       899,000       102,000  
Total
  $ 11,300,000     $ 9,798,000     $ 1,502,000  

Water Activities

The increase in net income from Water Activities for 2011 over 2010 was $1,454,000 or 16.8%.  A breakdown of the components of this increase was as follows:

   
2011
   
2010
   
Increase (Decrease)
 
Operating Revenues
  $ 69,402,000     $ 66,408,000     $ 2,994,000  
Operation and Maintenance
    32,662,000       33,105,000       (443,000 )
Depreciation
    7,773,000       7,088,000       685,000  
Income Taxes
    6,966,000       5,323,000       1,643,000  
Taxes Other than Income Taxes
    6,441,000       6,271,000       170,000  
Organizational Review Charge
    --       786,000       (786,000 )
Other Utility Income
    847,000       742,000       105,000  
Other Deductions
    (798,000 )     (226,000 )     (572,000 )
Interest and Debt Expense (net of AFUDC)
    5,486,000       5,682,000       (196,000 )
Total Income from Water Activities
  $ 10,123,000     $ 8,669,000     $ 1,454,000  

Revenue from our water customers increased by $2,994,000, or 4.5%, to $69,402,000 for the year ended December 31, 2011 when compared to the same period in 2010.  The primary reasons for the increase in revenues were an approximate 13% increase in rates as approved by the PURA in July 2010 (which folded in previously approved WICA surcharges of 2.1%) and various WICA surcharges not in effect during 2010, which totaled 3.09% beginning in the fourth quarter of 2011.  Offsetting these increases, the Company saw a decrease of approximately 4.9% in the amount of water produced at its treatment plants and pump stations.  The reduction in water production was attributable to the wet weather experienced in the second and third quarters of 2011.  During the second and third quarters of 2011, there was a nearly 150% increase in rainfall while the average temperature was 2 degrees cooler in the Town of Windsor Locks, CT, which is located in our largest service area, when compared to the same periods in 2010.  The second and third quarters are typically the period during which there is the most fluctuation in water usage due to changes in weather.

The factors detailed above led to a net increase in revenue from residential customers of $1,553,000 or 3.7%.  Residential customers represent our largest customer class and the group whose usage is most dependent on favorable weather.

Operation and Maintenance (O&M) expense decreased in 2011 by $443,000 due to the following changes in expenses:

Components of O&M
 
2011
   
2010
   
Increase (Decrease)
 
Maintenance
  $ 2,185,000     $ 1,783,000     $ 402,000  
Other employee benefit costs
    645,000       351,000       294,000  
Medical expense
    1,964,000       1,714,000       250,000  
Vehicle
    1,636,000       1,481,000       155,000  
Post-retirement medical costs
    1,128,000       983,000       145,000  
Investor relations
    555,000       475,000       80,000  
Customer
    1,154,000       1,075,000       79,000  
Regulatory commission expense
    232,000       301,000       (69,000 )
Property & liability insurance
    978,000       1,071,000       (93,000 )
Water treatment (including chemicals)
    2,389,000       2,553,000       (164,000 )
Utility costs
    3,269,000       3,527,000       (258,000 )
Outside services
    1,028,000       1,404,000       (376,000 )
Labor
    11,187,000       12,093,000       (906,000 )
Other
    4,312,000       4,294,000       18,000  
Total O&M Expense
  $ 32,662,000     $ 33,105,000     $ (443,000 )

Operation and Maintenance costs for the year ended December 31, 2011 saw a decrease of 1.3%, primarily due to the Company’s continued focus on cost containment.  The following items contributed to the decrease in O&M expense as a result of that focus:
-  
Labor costs decreased in 2011 primarily due to the workforce reduction as part of the Organizational Review conducted in the third quarter of 2010.  The Company’s headcount decreased by approximately 25 people as compared to the beginning of 2010;
-  
Outside services decreased by $376,000 during 2011 due primarily to a reduction in consulting and legal fees.  The reduction in consulting costs was primarily due to training services provided prior to the launch of the Company’s Enterprise Resource Planning (ERP) system in early 2010;
-  
Utility costs decreased by approximately 7% when compared to 2010 due to reduced electrical costs.  In December 2010, the Company received lower rates on its electricity through new suppliers and improved efficiency at many of our facilities through the completion of energy audits; and
-  
Property and liability insurance expense decreased by $93,000 due to cost reductions in our package and workers’ compensation policies.  Workers’ compensation decreased primarily due to the Organizational Review and the corresponding headcount reduction.
 
 
Non-cost containment O&M decreases consisted of the following:
-  
Water treatment costs decreased by 6% primarily due to a decrease in water production in 2011 when compared to 2010; and
-  
Regulatory commission expense decreased by $69,000 due to the deferral of costs associated with a PURA docket examining the feasibility of uniform methodology for determining return on equity for water companies.

The decreases detailed above were offset by the following increases to O&M expense:
-  
Maintenance expense increased by $402,000 in 2011 when compared to 2010 primarily due to an increase in the cost to repair main breaks and increased computer maintenance costs, including the costs to maintain the ERP system implemented in 2010;
-  
Other employee benefit costs increased by $294,000 primarily due to the introduction of a non-officer incentive program offered to certain managers for enacting cost reducing measures that will return savings in future years.  Additionally, costs related to certain stock based compensation increased during 2011;
-  
The Company saw an increase in its Medical expense primarily as a result of an increase in the cost of claims and the administration of the plan, offset by a decrease in dental claims and administration;
-  
The $145,000 increase in Post-retirement medical costs from 2010 to 2011 was primarily due to a decrease in the discount rate used to determine the future liabilities of the plans and the decline in the market value of the plans’ assets in prior years.  During the second quarter of 2011, the Company made a change to its Post-retirement medical plan to limit the life-time benefits of the participants to $100,000;
-  
Investor relations costs increased by $80,000 primarily due to increases in directors’ fees and expenses and an increase in the cost to prepare and print the Company’s proxy statement; and
-  
Customer costs increased by 7% primarily due to an increase in uncollectible accounts.  During 2011, the Company has seen progress towards resolving the collection issues, primarily through the ability to charge interest and shut off customers for non-payment and expects continued improvement throughout 2012.

The Company’s Depreciation expense increased $685,000 or 9.7% from 2010 to 2011.  The primary driver of the increase in Depreciation expense is a higher Utility Plant balance in 2011.

The increase in Income Tax expense associated with the Water Activities segment of $1,643,000 was due primarily to higher pre-tax income and a higher effective income tax rate in 2011 when compared to 2010.  The drivers of the higher effective tax rate are attributable to a change in pension and post-retirement medical costs contribution assumptions along with the effect of incremental federal tax rates.  This increase is partially offset by a change in assumptions regarding the future utilization of our charitable contribution carryforwards.

As described above, the Company underwent an Organizational Review in July 2010.  The Company experienced a one-time charge associated with the Organizational Review of $786,000, in the third quarter of 2010.  The majority of that charge, approximately $583,000, related to severance packages offered to the employees affected by this review.  The remainder was split among fees related to legal and out-placement services and costs associated with the accelerated vesting of certain executive benefits.  As of December 31, 2010, all payments related to the Organizational Review had been made.

The increase in Other Deductions was primarily due to costs associated with the acquisition of Maine Water from Aqua America.  In accordance with accounting principles generally accepted in the United States, including Accounting Standards Codification (ASC) 805 “Business Combinations”, acquisition costs are expensed in the period incurred.

Real Estate

While the Company did not complete any land transactions during the year ending December 31, 2011, adjustments were made to valuation allowances recorded in earlier years which produced Net Income of $176,000 in 2011.  Through land donations and discount land sales in previous years, the Company earned tax credits to use in future years.  The Company is limited by time and the amount of taxable income when using these credits.  Each year, the Company assesses its ability to use these credits going forward and makes adjustments to its valuation allowances, accordingly.

Income from the Real Estate segment is largely dependent on the tax deductions received on donations and, or, sales of available land.  This typically occurs when utility-owned land is deemed to be unnecessary to protect water sources.  The Company plans to continue to utilize land donations and sales in 2012, and beyond, to generate income for this segment of our business, including the sale of land to the Town of Plymouth discussed above.

Services and Rentals

Net income generated from the Services and Rental segment increased in 2011 by $102,000, over 2010 levels.  The increased net income was primarily due to decreases in general and administrative expenses in 2011.

Overview of 2010 Results from Operations

Net Income for 2010 was $9,798,000, or $1.14 basic earnings per share, a decrease of $411,000, or $0.06 basic earnings per share, compared to 2009.  The decrease in earnings was principally due to lower net income in our Real Estate and Services and Rentals segments partially offset by higher net income in our Water Activities segment.  Changes in net income for our segments were as follows:

Business Segment
 
2010 Net Income
   
2009 Net Income
   
Increase (Decrease)
 
Water Activities
  $ 8,669,000     $ 7,831,000     $ 838,000  
Real Estate
    230,000       1,449,000       (1,219,000 )
Services and Rentals
    899,000       929,000       (30,000 )
Total
  $ 9,798,000     $ 10,209,000     $ (411,000 )
 
 
Water Activities

The increase in net income from Water Activities for 2010 over 2009 was $838,000 or 10.7%.  A breakdown of the components of this increase was as follows:

   
2010
   
2009
   
Increase (Decrease)
 
Operating Revenues
  $ 66,408,000     $ 59,391,000     $ 7,017,000  
Operation and Maintenance
    33,105,000       32,181,000       924,000  
Depreciation
    7,088,000       6,403,000       685,000  
Income Taxes
    5,323,000       2,466,000       2,857,000  
Taxes Other than Income Taxes
    6,271,000       5,953,000       318,000  
Organizational Review Charge
    786,000       --       786,000  
Other Utility Income
    742,000       704,000       38,000  
Other Deductions
    (226,000 )     (784,000 )     558,000  
Interest and Debt Expense (net of AFUDC)
    5,682,000       4,477,000       1,205,000  
Total Income from Water Activities
  $ 8,669,000     $ 7,831,000     $ 838,000  

Revenues from our water customers increased $7,017,000 or 11.8% to $66,408,000 for the year ended December 31, 2010 when compared to 2009.  The primary reasons for the increased revenues in 2010 were higher water production and consumption and rate increases approved by the PURA during 2010.
-  
Water production increased by 6.2% for the year ended December 31, 2010.  The increase in production was due to more favorable weather during the second and third quarters of 2010 when compared to the same periods of 2009.  During these two quarters, when the weather is warm and dry, residential customers are more likely to use more water.  During 2009, the Town of Windsor Locks, CT, part of our largest service area, saw 102 days of rain compared to 77 days in 2010.  During the six month period of April through September 2010, the Company’s water production increased by approximately 13%, when compared to the same six month period of 2009.
-  
During the first six months of 2010, customers were charged a 2.1% cumulative WICA surcharge that was not in effect during 2009.
-  
Effective July 14, 2010, the WICA surcharge was folded into the Company’s approximate 13% rate increase to customers.

The factors detailed above led to an increase in revenue from residential customers of $5,632,000 or 15.4%.  Residential customers represent our largest customer class and the group whose usage is most dependent on favorable weather.  For the year ended December 31, 2010, revenues from all other customer classes increased by approximately 10%.  Offsetting the increases described above was a decrease in revenues related to miscellaneous services, interest charged on late payments and turn-on/turn-off charges.

Operation and Maintenance (O&M) expense increased in 2010 by $924,000 due to the following changes in expenses:

Components of O&M
 
2010
   
2009
   
Increase (Decrease)
 
Labor
  $ 12,093,000     $ 11,637,000     $ 456,000  
Water treatment (including chemicals)
    2,553,000       2,253,000       300,000  
Pension costs
    2,010,000       1,718,000       292,000  
Post-retirement medical costs
    984,000       725,000       259,000  
Vehicle
    1,481,000       1,351,000       130,000  
Customer
    1,075,000       947,000       128,000  
Utility costs
    3,527,000       3,433,000       94,000  
Regulatory commission expense
    301,000       324,000       (23,000 )
Other employee benefit costs
    351,000       414,000       (63,000 )
Outside services
    1,404,000       1,590,000       (186,000 )
Medical expense
    1,714,000       2,220,000       (506,000 )
Other
    5,612,000       5,569,000       43,000  
Total O&M Expense
  $ 33,105,000     $ 32,181,000     $ 924,000  

Operation and Maintenance costs for the year ended December 31, 2010 saw an increase of 2.9%, primarily due to items as follows:
-  
Labor costs increased in 2010 primarily due to a larger component of 2009 labor costs being capitalized as part of the implementation of a new Enterprise Resource Planning (ERP) system;
-  
Water treatment costs increased due to higher costs associated with laboratory testing and waste disposal.  Additionally, the costs of chemicals increased when compared to 2009 due to higher prices and an increase in water production;
-  
Pension and post-retirement medical costs increased due primarily to a decrease in the discount rate used to determine the future liabilities of the plans and, partially, to a decline in the market value of the plans’ assets in prior periods; and
-  
Customer costs increased due to higher bad debt expense.  This was driven by a higher Accounts Receivable balance at December 31, 2010, when compared to 2009, due to higher consumption and higher rates in effect during the second half of 2010 and due to an increase in accounts receivable aged over 180 days, due in part to employees focusing on bill integrity with the implementation of the ERP system in the first quarter of 2010.  These increases to Customer costs were partially offset by a decrease in customer communication and postage costs.

The increases in O&M discussed above were partially offset by the following decreases:
-  
Outside services decreased due to a reduction in legal fees associated with the favorable resolution of an on-going legal matter in our Unionville decision during 2010 and a reduction in temporary labor used as part of cost containment; and
-  
Medical costs decreased 23% due to a reduction in claims and administrative expense as well as an increase in the amount contributed by employees through payroll deductions.  While the Company has taken steps to manage its medical costs by offering a wider variety of plans, including a high-deductible health plan, and passing some cost increases on to employees, it is difficult to project future costs as they are primarily dependant on claims made by employees in any given year.
 
 
The Company’s Depreciation expense increased $685,000 or 10.7% from 2009 to 2010.  The primary driver of the increase in Depreciation expense is a higher Utility Plant balance in 2010.  A portion of this higher Utility Plant balance is related to the implementation of the Company’s new ERP system that went into service in the first quarter of 2010 which is depreciated at a higher rate than our typical water delivery infrastructure.  The Company’s prior ERP system was fully depreciated prior to the implementation of the new system.

The increase in Income Tax expense associated with the Water Activities segment of $2,857,000 was due primarily to higher pre-tax income and a higher effective income tax rate in 2010 when compared to 2009.  The drivers of the higher effective tax rate are decreases to flow through timing differences, including planned pension contributions, and the utilization of state tax credits associated with infrastructure investment made by the Company.
 
The increase in Taxes Other Than Income Taxes was primarily due to both higher payroll tax and property taxes due to higher utility plant balances.

As described above, the Company underwent an Organizational Review in July 2010.  The Company experienced a one-time third quarter of 2010 charge associated with the Organizational Reviews of $786,000.  The majority of that charge, approximately $583,000, related to severance packages offered to the employees affected by this review.  The remainder was split among fees related to legal and out-placement services and costs associated with the accelerated vesting of certain executive benefits.  As of December 31, 2010, all payments related to the organizational review have been made.  The Company expects that the Organizational Review undertaken during 2010 will provide savings in future periods related to labor and employee benefit expenses.

The decrease in Other Deductions was primarily due to lower executive employee benefit costs in 2010 when compared to the same period in 2009.

Interest and Debt Expense increased primarily due to the issuance of $20 million of debt in December 2009.

Real Estate

While the Company did not complete any land transactions during the year ending December 31, 2010, adjustments were made to valuation allowances recorded in earlier years which produced Net Income of $230,000 in 2010.  Through land donations and discount land sales in previous years, the Company earned tax credits to use in future years.  The Company is limited by time and the amount of taxable income when using these credits.  Each year, the Company assesses its ability to use these credits going forward and makes adjustments to its valuation allowances, accordingly.

During 2009, the Company completed the sale of a conservation easement to the Town of Windsor Locks, CT for $2 million.  The transaction generated $1.2 million in net income for the Company.  The Company also adjusted tax valuation allowances associated with land donations made in previous years generating approximately $207,000 in net income in the Real Estate segment in 2009.  Additionally, Chester Realty, sold a rental property in Killingly, CT during the third quarter of 2009, generating a small profit.

Income from the Real Estate segment is largely dependent on the tax deductions received on donations and, or, sales of available land.  This typically occurs when utility-owned land is deemed to be unnecessary to protect water sources.  The Company plans to continue to utilize land donations and sales to generate income for this segment of our business, including the potential sale of land to the Town of Plymouth discussed above.

Services and Rentals

Net income generated from the Services and Rental segment decreased in 2010 by $30,000 over 2009 levels, while earnings per basic share remained flat.  The decreased net income was primarily due to increases in general and administrative expenses in 2010.

COMMITMENTS AND CONTINGENCIES

Security – Investment in security-related improvements is a continuing process and management believes that the costs associated with any such improvements will be eligible for recovery in future rate proceedings.

Reverse Privatization – Connecticut Water derives its rights and franchises to operate from state laws that are subject to alteration, amendment or repeal, and do not grant permanent exclusive rights to our service areas.  Our franchises are free from burdensome restrictions, are unlimited as to time, and authorize us to sell potable water in all towns we now serve.  There is the possibility that states could revoke our franchises and allow a governmental entity to take over some or all of our systems.  From time to time such legislation is contemplated.

Environmental and Water Quality Regulation – The Company is subject to environmental and water quality regulations.  Costs to comply with environmental and water quality regulations are substantial.  We are presently in compliance with current regulations, but the regulations are subject to change at any time.  The costs to comply with future changes in state or federal regulations, which could require us to modify current filtration facilities and/or construct new ones, or to replace any reduction of the safe yield from any of our current sources of supply, could be substantial.

On January 6, 2012, Connecticut Water issued a “Do Not Drink Advisory” to 181 year round customers in the Amston Lake water system when elevated levels of copper were detected in samples from some customers’ homes.  While there was not a violation of any state or federal water quality standard, copper levels in samples from some customers’ homes were found above the Environmental Protection Agency (EPA) action level of 1.3 mg/L.  The "Do Not Drink Advisory" was lifted on January 18, 2012.  The Company is following an action plan approved by the Department of Public Health.  The resulting copper levels have been below the EPA Action Level.

Rate Relief – Connecticut Water is a regulated public utility, which provides water services to its customers.  The rates that regulated companies charge their water customers are subject to the jurisdiction of the regulatory authority of the PURA.  Connecticut Water’s allowed rate of return on equity and return on rate base are currently 9.75% and 7.32%, respectively.

In 2007, the State of Connecticut adopted legislation which permits regulated water companies to recapture money spent on eligible infrastructure improvements without a full rate case proceeding.  The PURA may authorize regulated water companies to use a rate adjustment mechanism, such as a Water Infrastructure and Conservation Adjustment (WICA), for eligible projects completed and in service for the benefit of the customers.  Regulated water companies may only charge customers such an adjustment to the extent allowed by the PURA based on a water company’s infrastructure assessment report, as approved by the PURA and upon semiannual filings which reflect plant additions consistent with such report.

 
Land Dispositions – The Company and its subsidiaries own additional parcels of land in Connecticut, which may be suitable in the future for disposition, either by sale or by donation to municipalities, other local governments or private charitable entities.  These additional parcels would include certain Class I and II parcels previously identified for long term conservation by the Connecticut Department of Energy and Environmental Protection (DEEP), which have restrictions on development and resale based on provisions of the Connecticut General Statutes.

The Company is finalizing a land sale with the Town of Plymouth, Connecticut to sell approximately 175 acres of land for open space and recreational purposes, pending the approval of a Conservation Easement by the State of Connecticut Attorney General Office.  The Company and Town have agreed on a sale price of $1.45 million for the parcel that is valued at $1.615 million.  The Company expects the transaction to be completed in 2012.

Capital Expenditures – The Company has received approval from its Board of Directors to spend $25.1 million on capital expenditures in 2012, in part due to increased spending primarily for infrastructure improvements.


The primary market risk faced by the Company is interest rate risk.  As of December 31, 2011, the Company had no exposure to derivative financial instruments or financial instruments with significant credit risk or off-balance-sheet risks.  In addition, the Company is not subject in any material respect to any currency or other commodity risk.

The Company is subject to the risk of fluctuating interest rates in the normal course of business. The Company's exposure to interest fluctuations is managed at the Company and subsidiary operations levels through the use of a combination of fixed rate long-term debt (and variable rate borrowings) under financing arrangements entered into by the Company and its subsidiaries and the use of the interest rate swap agreement discussed below.  In November 2008, the Company was authorized by its Board of Directors to increase the available lines of credit from $21 million to $40 million.  On June 30, 2009, the Company let expire one line of credit totaling $6 million and entered into a new $15 million line of credit agreement, which was to expire on June 25, 2011 but was extended in late June 2011 until August 25, 2011.  On July 26, 2011, the Company extended the maturity date of this line to June 25, 2013.  On August 12, 2009, the Company replaced an existing $3 million line of credit with a $10 million line of credit, which expires on August 10, 2013.  Finally, on September 15, 2009, the Company increased a third line of credit from $12 million to $15 million, with an expiration date of June 1, 2013.  On December 30, 2011, the Company terminated its $10 million line of credit.  The Company expects to maintain the two remaining lines of credit totaling $30 million and to renew the lines of credit annually, with a rolling two year expiration date.  Interim Bank Loans Payable at December 31, 2011 and 2010 was approximately $21.4 million and $26.3 million, respectively, and represents the outstanding aggregate balance on these lines of credit.  As of December 31, 2011, the Company had $8.6 million in unused lines of credit.  Interest expense charged on interim bank loans will fluctuate based on market interest rates.

During the first quarter of 2004, Connecticut Water entered into a five-year interest rate swap transaction in connection with the refunding of its First Mortgage Bonds (Series V).   The swap agreement provides for Connecticut Water’s exchange of floating rate interest payment obligations for fixed rate interest payment obligations on a notional principal amount of $12,500,000.  The purpose of the interest rate swap was to manage the Company’s exposure to fluctuations in prevailing interest rates.  The interest rate swap expired on March 3, 2009.  The Company does not enter into derivative financial contracts for trading or speculative purposes and does not use leveraged instruments.


The Consolidated Financial Statements of Connecticut Water Service, Inc., and the Notes to Consolidated Financial Statements together with the report of PricewaterhouseCoopers LLP, independent registered public accounting firm are included herein on pages F-2 through F-25.


None


Disclosure Controls and Procedures – As of December 31, 2011, management, including the Company’s Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of the design and operation of the Company’s disclosure controls and procedures (as defined in Exchange Act Rule 13a-15(e)).  Based upon, and as of the date of that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that the Company’s disclosure controls and procedures were effective.

Management’s Report on Internal Control Over Financial Reporting – Internal control over financial reporting (as defined in Exchange Act Rule 13a-15(f)) is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with accounting principles generally accepted in the United States of America.

Management of the Company is responsible for establishing and maintaining adequate internal control over financial reporting.  We have used the criteria established in Internal Control – Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in conducting our evaluation of the effectiveness of the internal control over financial reporting.  Based on our evaluation, we concluded that the Company’s internal control over financial reporting was effective as of December 31, 2011.  The effectiveness of the Company’s internal control over financial reporting as of December 31, 2011 has been audited by PricewaterhouseCoopers LLP, an independent registered public accounting firm, as stated in their report which appears herein.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements.  Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

Changes in Internal Control Over Financial Reporting – There were no significant changes in the Company’s internal control over financial reporting that occurred during the Company’s most recent fiscal quarter that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.


On March 13, 2012, the Company reported its results of operations for the fiscal year and for the quarterly period ended December 31, 2011.  Details of this announcement are contained in the press release of the Company dated March 13, 2012, and furnished with this annual report on Form 10-K as Exhibit 99.1.

 
PART III

Pursuant to General Instruction G(3), the information called for by Items 10, 11, 12, 13 and 14 is hereby incorporated by reference to the Company’s definitive proxy statement to be filed in EDGAR on or about March 23, 2012.  Certain information concerning the executive officers of the Company is included in Item 1 of this report.













PART IV


(a)
    1.  
Financial Statements:
     
         
The report of independent registered public accounting firm and the Company’s Consolidated Financial Statements listed in the Index to Consolidated Financial Statements on page F-1 hereof are filed as part of this report, commencing on page F-2
 
             
Page
 
         
Index to Consolidated Financial Statements and Schedule
    F-1  
                   
         
Report of Independent Registered Pubic Accounting Firm
    F-2  
                   
         
Consolidated Statements of Income for the years ended December 31, 2011, 2010 and 2009
    F-3  
                   
         
Consolidated Statements of Comprehensive Income for the years ended December 31, 2011, 2010 and 2009
    F-3  
                   
         
Consolidated Balance Sheets at December 31, 2011 and 2010
    F-4  
                   
         
Consolidated Statements of Cash Flows for the years ended December 31, 2011, 2010 and 2009
    F-5  
                   
         
Notes to Consolidated Financial Statements
    F-6  
                   
      2.  
Financial Statement Schedule:
       
                   
         
The following schedule of the Company is included on the attached page as indicated
 
                   
         
Schedule II Valuation and Qualifying Accounts and Reserves for the years ended December 31, 2011, 2010 and 2009
    S-1  
                   
         
All other schedules provided for in the applicable regulations of the Securities and Exchange Commission have been omitted because of the absence of conditions under which they are required or because the required information is set forth in the financial statements or notes thereto.
       
                   
(b)
       
Exhibits
       
                   
         
Exhibits for Connecticut Water Service Inc., are in the Index to Exhibits
    E-1  
                   
         
Exhibits heretofore filed with the Securities and Exchange Commission as indicated below are incorporated herein by reference and made a part hereof as if filed herewith.  Exhibits marked by asterisk (* or **) are being filed or furnished herewith.
       




INDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND SCHEDULE

   
Page
 
Index to Consolidated Financial Statements and Schedule
    F-1  
         
Report of Independent Registered Pubic Accounting Firm
    F-2  
         
Consolidated Statements of Income for the years ended December 31, 2011, 2010 and 2009
    F-3  
         
Consolidated Statements of Comprehensive Income for the years ended December 31, 2011, 2010 and 2009
    F-3  
         
Consolidated Balance Sheets at December 31, 2011 and 2010
    F-4  
         
Consolidated Statements of Cash Flows for the years ended December 31, 2011, 2010 and 2009
    F-5  
         
Notes to Consolidated Financial Statements
    F-6  
         
Schedule II – Valuation Accounts
    S-1  


 
F-1


Report of Independent Registered Public Accounting Firm
 
 
To the Board of Directors and Stockholders of Connecticut Water Service, Inc.:
 
In our opinion, the accompanying consolidated balance sheets and the related consolidated statements of income, of cash flows and of comprehensive income present fairly, in all material respects, the financial position of Connecticut Water Service, Inc. and its subsidiaries (the “Company”) at December 31, 2011 and 2010, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2011 in conformity with accounting principles generally accepted in the United States of America.  In addition, in our opinion, the financial statement schedule listed in the accompanying index presents fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements.  Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2011, based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).  The Company's management is responsible for these financial statements and financial statement schedule, for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, appearing on Management’s Report on Internal Control over Financial Reporting under Item 9A.  Our responsibility is to express opinions on these financial statements, on the financial statement schedule, and on the Company's internal control over financial reporting based on our integrated audits.  We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States).  Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement and whether effective internal control over financial reporting was maintained in all material respects.  Our audits of the financial statements included examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation.  Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk.  Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions.
 
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles.  A company’s internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
 
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements.  Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
 
 
 
/s/ PricewaterhouseCoopers, LLP
 
Stamford, Connecticut
March 14, 2012
 
 
 
F-2

CONNECTICUT WATER SERVICE, INC.

                   
CONSOLIDATED STATEMENTS OF INCOME
                 
                   
For the Years Ended December 31, (in thousands, except per share data)
 
2011
   
2010
   
2009
 
                   
Operating Revenues
  $ 69,402     $ 66,408     $ 59,391  
                         
Operating Expenses
                       
   Operation and Maintenance
    32,662       33,105       32,181  
   Depreciation
    7,773       7,088       6,403  
   Income Taxes
    6,966       5,323       2,466  
   Taxes Other Than Income Taxes
    6,441       6,271       5,953  
   Organizational Review Charge
    --       786       --  
                         
       Total Operating Expenses
    53,842       52,573       47,003  
                         
Net Operating Revenues
    15,560       13,835       12,388  
                         
Other Utility Income, Net of Taxes
    847       742       704  
                         
Total Utility Operating Income
    16,407       14,577       13,092  
                         
Other Income (Deductions), Net of Taxes
                       
   Gain (Loss) on Real Estate Transactions
    176       230       1,449  
   Non-Water Sales Earnings
    1,001       899       929  
   Allowance for Funds Used During Construction
    188       171       267  
   Other
    (798 )     (226 )     (784 )
                         
       Total Other Income (Deductions), Net of Taxes
    567       1,074       1,861  
                         
Interest and Debt Expenses
                       
   Interest on Long-Term Debt
    4,602       4,628       3,937  
   Other Interest Charges
    651       784       393  
   Amortization of Debt Expense
    421       441       414  
                         
       Total Interest and Debt Expenses
    5,674       5,853       4,744  
                         
Net Income
    11,300       9,798       10,209  
                         
Preferred Stock Dividend Requirement
    38       38       38  
                         
Total Net Income Applicable to Common Stock
  $ 11,262     $ 9,760     $ 10,171  
                         
                         
Weighted Average Common Shares Outstanding:
                       
   Basic
    8,610       8,532       8,448  
   Diluted
    8,720       8,633       8,523  
                         
Earnings Per Common Share:
                       
   Basic
  $ 1.31     $ 1.14     $ 1.20  
   Diluted
  $ 1.29     $ 1.13     $ 1.19  
                         
                         
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
                       
                         
For the Years Ended December 31, (in thousands)
    2011       2010       2009  
                         
Net Income Applicable to Common Stock
  $ 11,262     $ 9,760     $ 10,171  
                         
Other Comprehensive Income, net of tax
                       
   Qualified cash flow hedging instrument net of tax (benefit) expense
                       
      of $(1), $(1), and $48 in 2011, 2010, and 2009, respectively
    3       3       4  
   Adjustment to post-retirement benefit plans, net of tax (benefit)
                       
      expense of $(231), $12 and $(49) in 2011, 2010 and 2009, respectively
    (361 )     16       (140 )
   Unrealized Investment loss, net of tax expense (benefit) of $31,
                       
      $30 and $(158) in 2011, 2010 and 2009, respectively
    (31 )     47       247  
                         
Comprehensive Income
  $ 10,873     $ 9,826     $ 10,282  
                         
The accompanying notes are an integral part of these consolidated financial statements.
                       

 
 
F-3

CONNECTICUT WATER SERVICE, INC.

               
CONSOLIDATED BALANCE SHEETS
             
               
               
December 31, (in thousands, except share amounts)
   
2011
   
2010
 
               
ASSETS
             
Utility Plant
    $ 487,540     $ 467,589  
Construction Work in Progress
      6,160       4,013  
        493,700       471,602  
Accumulated Provision for Depreciation
      (133,673 )     (127,383 )
Net Utility Plant
      360,027       344,219  
Other Property and Investments
      5,563       5,568  
Cash and Cash Equivalents
      1,012       952  
Accounts Receivable (Less Allowance, 2011 - $1,088; 2010 - $1,061)
    8,436       10,135  
Accrued Unbilled Revenues
      6,477       6,344  
Materials and Supplies, at Average Cost
      1,126       1,248  
Prepayments and Other Current Assets
      1,830       1,749  
Total Current Assets
      18,881       20,428  
Restricted Cash
      15,930       1,226  
Unamortized Debt Issuance Expense
      7,296       7,334  
Unrecovered Income Taxes - Regulatory Asset
      29,255       23,684  
Pension Benefits - Regulatory Asset
      13,862       6,296  
Post-Retirement Benefits Other Than Pension - Regulatory Asset
    3,967       5,451  
Goodwill
      3,608       3,608  
Deferred Charges and Other Costs
      6,442       6,385  
Total Regulatory and Other Long-Term Assets
      80,360       53,984  
Total Assets
    $ 464,831     $ 424,199  
                   
CAPITALIZATION AND LIABILITIES
                 
Common Stockholders' Equity:
                 
Common Stock Without Par Value:
                 
Authorized - 25,000,000 Shares - Issued and Outstanding:
       
  2011 - 8,755,398; 2010 - 8,676,849     $ 72,345     $ 70,024  
Retained Earnings
      46,669       43,603  
Accumulated Other Comprehensive Loss
      (825 )     (436 )
Common Stockholders' Equity
      118,189       113,191