ARTESIAN RESOURCES CORP - Annual Report: 1999 (Form 10-K)

FORM 10-K

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

X ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES

EXCHANGE

ACT OF 1934

For the fiscal year ended December 31, 1999

Commission file number 0-18516

ARTESIAN RESOURCES CORPORATION

(Exact name of registrant as specified in its charter)

State or other jurisdiction of incorporation or organization: Delaware

I.R.S. Employer Identification No.: 51-0002090

Address of principal executive offices: 664 Churchmans Road, Newark, Delaware, Zip Code: 19702

Registrant's telephone number, including area code: 302-453-6900

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

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

Class A Non-Voting Common Stock

(Title of class)

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 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. X Yes _ No

Indicate by check mark if the disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of the 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. X Yes _ No

The aggregate market value of the non-voting and voting stock held by non-affiliates of the registrant at March 1, 2000 was $36,652,896 and $3,647,417, respectively.

As of March 1, 2000, 1,609,474 shares and 391,824 shares of Class A Non-Voting Common Stock and Class B Common Stock, respectively, were outstanding.

PART I

Item 1. - Business.

          Artesian Resources Corporation ("Artesian Resources" or the "Company") operates as the parent holding company of Artesian Water Company, Inc. ("Artesian Water"), our principal subsidiary and a regulated public water utility, and several non-regulated subsidiaries. Artesian Water Company was organized in 1927 as the successor to the Richardson Park Water Company, founded in 1905. In 1984, the name of Artesian Water Company was changed to Artesian Resources Corporation and the utility assets were contributed to a newly formed subsidiary, Artesian Water. In this Annual Report on Form 10-K, we frequently use the terms "we" and "our" to refer to Artesian Resources and its subsidiaries, including Artesian Water.

          We distribute and sell water to residential, commercial, industrial, governmental, municipal and utility customers throughout the State of Delaware. As of December 31, 1999, we had approximately 62,600 metered customers and served a population of approximately 200,000, representing approximately 27% of Delaware's total population. We also provide water for public and private fire protection to customers in our service territories. Our gross water sales revenue for 1999 was approximately $26.3 million, and our percentages of gross water sales revenue by major customer classifications were 61.4% for residential, 29.0% for commercial, industrial, governmental, municipal and utility, and 9.6% for fire protection and other. These percentages have remained fairly constant for the past three years.

          Our current market area is the State of Delaware, which had a population of approximately 744,000 at December 31, 1999. According to the Delaware Economic Development Office, Delaware's population has increased by approximately 5.7% over the six-year period ended December 31, 1999. Most of our existing exclusive franchised service areas and customers are in New Castle County in northern Delaware. Although New Castle is the most populous of Delaware's three counties, Sussex County, in southern Delaware, has experienced the most significant growth with a population increase of approximately 15% over the last six years. The largest project we are currently undertaking with continued investment in 2000 is the expansion of our system in Sussex County, Delaware, which included enhancement of supply capabilities and installation of new transmission and distribution facilities with a total cost of $4.6 million. Substantial portions of Delaware, particularly outside of New Castle County, are not served by a public water system and represent potential new exclusive franchised service areas for Artesian Water. We continue to focus resources on developing and serving existing service territories and obtaining new territories throughout the state.

          In Delaware, a Certificate of Public Convenience and Necessity issued by the Delaware Department of Natural Resources and Environmental Control grants a water company the exclusive right to serve all existing and new customers within a designated area. In this Annual Report on Form 10-K, we refer to these Certificates as "CPCNs" or "franchises." We hold CPCNs for approximately 142 square miles of exclusive service territory, which is segmented into a number of service areas. Our largest connected regional water system, consisting of approximately 101 square miles and 61,000 customers, is located in northern Delaware. A significant portion of our exclusive service territory remains undeveloped, and if and when development occurs and there is population growth in these areas, we will increase our customer base by providing water service to the newly developed areas and new customers. The total number of customers we serve has grown at an average annual rate of approximately 2.6% for the last five years. Within our existing service territory, we hold CPCNs for over 4,000 acres zoned for industrial and manufacturing development. Nearly 2,000 of these acres have been targeted for development by the Delaware Economic Development Office, a state agency whose primary objective is to attract business and industry to Delaware, and we are partnering with the state to market these sites for industrial and manufacturing development.

          Since 1993, we have been significantly expanding our service territory by acquiring new exclusive service areas in Delaware through grants of CPCNs. This expansion, which has occurred in southern New Castle, Kent and Sussex Counties, has increased our exclusive service area in Delaware by approximately 40% since 1993. The pursuit of new service territory in the State of Delaware by water companies is competitive.

          We acquired the rights to provide water to two municipalities and neighboring developments in Sussex County providing us the opportunity to serve approximately 10,000 new customers. We began construction in December 1998 of a fully integrated water system to serve both municipalities and we expect to add these new customers over the next two years. We also entered into agreements in 1998 to supply water to two municipalities in New Castle County.

          We have identified sufficient sources of groundwater supply to serve our expanding customer base for the foreseeable future. Our self-supply has increased from 63% of our total water supply in 1992 to approximately 81% in 1999. Since 1992, we have increased our sources of groundwater supply from our own wells by 50%, or nearly nine million gallons per day, and plan to continue development of new sources of groundwater supplies previously identified.

          Our primary sources of water are our wells that pump groundwater from aquifers and other formations. To supplement our groundwater supply, we purchase surface water through interconnections only in the northern service area of our New Castle County system. The purchased surface water is blended with our groundwater supply for distribution to our customers. Nearly 81% of the overall 6.8 billion gallons of water we distributed in all our systems during 1999 came from our groundwater wells, while the remaining 19% came from interconnections with other utilities and municipalities. During 1999, our average rate of water pumped was approximately 16.2 million gallons per day ("mgd") from our groundwater wells and approximately 2.3 mgd was supplied from interconnections. Our peak water supply capacity currently is approximately 48.0 mgd. Our peak water demand in 1999 was approximately 28.5 mgd. We believe that we have in place sufficient capacity to provide water service for the foreseeable future to all existing and new customers in all of our service territories.

          We have 72 operating and 46 monitoring wells in our systems. Our northern New Castle County system is interconnected. In the remainder of the state, we have several satellite systems which have not yet been connected by transmission and distribution facilities. We intend to join these systems into larger integrated regional systems through the construction of a transmission and distribution network as development continues and our expansion efforts provide us with contiguous exclusive service territories.

          We have 14 interconnections with four neighboring water utilities and four municipalities which provide us with the ability to purchase or sell water. Interconnection agreements with Chester Water Authority and one municipality have "take or pay" clauses requiring us to take, as of December 31, 1999, minimum draws totaling 1.3 billion gallons annually. We presently use the minimum draws under these agreements. The Chester Water Authority agreement, which expires in 2021, provides for a renewal period of an additional 25 years at our option, subject to the approval of the Susquehanna River Basin Commission. We decided not to renew one interconnection agreement with the municipality, which reduced our overall take or pay requirement by 100 million gallons annually. Our remaining take or pay agreement with that municipality expires and is renewable in December 2001. All of the interconnections provide Artesian Water the ability to sell water to neighboring water utilities or municipalities.

          Under state laws and regulations, we are required to file applications with the Delaware Department of Natural Resources and Environmental Control for water allocation permits for each of our production wells pumping quantities of water above certain levels. Presently, we have permits for 59 wells, permit applications pending for 12 wells and 9 wells not requiring a permit. Our access to aquifers within our service territory is not exclusive. Water allocation permits control the amount of water which can be drawn from water resources and are granted with specific restrictions on water level draw down limits, annual, monthly and daily pumpage limits, and well field allocation pumpage limits. Our ability to supply the demands of our customers has not been affected by private usage of the aquifers by landowners or the limits imposed by the state. Because of the extensive regulatory requirements relating to the withdrawal of any significant amounts of water from the aquifers, we believe that third party usage of the aquifers within our service territory will not interfere with our ability to meet the present and future demands of our customers.

          At the end of 1999, we were serving customers through 842 miles of transmission and distribution mains. Mains range in diameter from two inches to twenty-four inches, and most of the mains are made of ductile iron, cast iron or transite pipe. Ductile iron is more durable than plastic and we install ductile iron pipes wherever possible. We are installing a more durable type of plastic pipe only near ocean front property in southern Delaware where corrosive conditions of the surrounding ground affect the longevity of ductile iron pipe. We also supply public fire protection service through 3,178 hydrants installed throughout our service territories.

          We have 25 storage tanks, most of which are elevated, providing total system storage of 36.5 million gallons. We also are developing and using an aquifer storage and recovery system. At some locations, we rely on hydro pneumatic tanks to maintain adequate system pressures. Where possible, we will combine our smaller satellite systems with systems having elevated storage facilities. In 1999, we completed a 500,000 gallon elevated storage facility to serve our newest service territory in the resort communities in Sussex County.

          We pump all of our water with electric power purchased from major electric utilities. We also have diesel and propane powered generating equipment at selected treatment and elevated storage facilities for the provision of basic water service during possible electrical outages.

          We derive about 90% of our self-supplied groundwater from wells located in the Coastal Plain. The remaining 10% comes from wells in the Piedmont area. We use a variety of treatment methods, including aeration, pH adjustment, chlorination, fluoridation and iron removal, to meet state and federal water quality standards. Additionally, a corrosion inhibitor is added to all of our self-supplied groundwater and most of the supply from interconnections. We have 34 different water treatment facilities. All water supplies that we purchase from neighboring utilities are potable. We believe the costs of treating groundwater are significantly lower than those of treating surface water.

          We are subject to regulation by federal, state and local agencies with respect to, among other things, rates charged for water service, awards of new service territory, water allocation rights, water quality and environmental matters.

          Artesian Water, as a public utility, is regulated by the Public Service Commission with respect to rates and charges for service, the sale and issuance of securities, mergers and other matters. We periodically seek rate increases to cover the cost of increased operating expenses, increased financing expenses due to additional investments in utility plant and other costs of doing business.

          We filed for a rate increase in April 1999, but we cannot predict whether the Public Service Commission will approve the requested increase, approve a smaller increase or deny any such request. We currently derive our water service revenues from water consumption upon which base rates are applied, which were last increased as of July 1, 1999 to reflect a temporary increase of approximately 9.7% which Artesian Water is permitted to collect by law, under bond, until a final rate determination is made by the Public Service Commission. The previous increase was placed in effect May 13, 1998, which authorized a return on equity rate of 10.85%, with an overall rate of return on rate base of 9.51%.

          A public water utility operating in Delaware must obtain a Certificate of Public Convenience and Necessity for a service territory to begin or expand its operations, which is granted by the Delaware Department of Natural Resources and Environmental Control. We refer to the Department in this discussion of regulations as "DNREC." DNREC grants a CPCN under circumstances where there has been a determination that the water in the proposed service area does not meet the regulations governing drinking water standards of the State Board of Health for human consumption, where the supply is insufficient to meet the projected demand, or where the applicant is in possession of one of the following: (i) a signed service agreement with the developer of a proposed subdivision or development, which subdivision or development has been duly approved by the respective county government; (ii) a petition requesting such service signed by a majority of the landowners of the proposed territory to be served; or (iii) a duly certified copy of a resolution from the governing body of a county or municipality requesting the applicant to provide service to the proposed territory to be served. CPCNs are not transferable, and a water utility must obtain the approval of the Public Service Commission to abandon a service territory once granted.

          The United States Environmental Protection Agency (the "EPA"), DNREC and the Delaware Division of Public Health regulate the water quality of our treatment and distribution systems. We believe that we are in material compliance with all current federal and state water quality standards, including regulations under the federal Safe Drinking Water Act. Chester Water Authority, which supplies water to Artesian Water through interconnections in northern New Castle County, is regulated by the Pennsylvania Department of Environmental Protection as well as the EPA.

          As required by the Safe Drinking Water Act, the EPA has established maximum contaminant levels for various substances found in drinking water. The Division of Public Health has set maximum contaminant levels for certain substances which are more restrictive than the maximum contaminant levels set by the EPA. The Division of Public Health is the EPA's agent for enforcing the Safe Drinking Water Act in Delaware and, in that capacity, monitors the activities of Artesian Water and reviews the results of water quality tests performed by Artesian Water for adherence to applicable regulations. Artesian Water is also subject to other laws regulating substances and contaminants in water, including the Lead and Copper Rule, rules for volatile organic compounds and the Total Coliform Rule. Because we have no surface water sources of supply which we treat for consumption, the Surface Water Treatment Rule generally does not apply to us.

          Delaware enacted legislation in 1998 requiring water utilities to meet secondary water quality standards which include limitations on iron content, odor and other water quality-related issues which are not proven health risks but may be objectionable for consumption. We believe our current treatment systems and facilities as designed meet or exceed these secondary standards and that the new standards should not impose a significant financial burden on Artesian Water.

          As a normal by-product of iron removal, our treatment facility at Old County Road generates iron removed from untreated groundwater plus residue from chemicals used in the treatment process. We have contracted with a licensed third party vendor to dispose of the solids produced at the facility. Our other iron removal facilities rely on disposal through county-approved wastewater facilities. Management believes that compliance with existing federal, state or local laws and regulations regulating the discharge of materials into the environment, or otherwise relating to the protection of the environment, has no material effect upon the business and affairs of Artesian Resources.

          On December 19, 1996, Artesian Wastewater Management, Inc. ("Artesian Wastewater") was created as a non-regulated subsidiary of Artesian Resources. Artesian Wastewater provides wastewater treatment services in Delaware. In 1999, Artesian Wastewater began operating a wastewater facility for the town of Middletown in southern New Castle County. This subsidiary did not engage in any business activity in 1998 or 1997. On March 12, 1997, Artesian Wastewater became a one-third participant, along with heavy-construction contractor George and Lynch and engineering firm Woodward-Clyde International-Americas (a subsidiary of URS Greiner), in a limited liability company called AquaStructure Delaware, L.L.C., which intends to develop and market various proposals to provide wastewater treatment services.

          The business of Artesian Water is subject to seasonal fluctuations. The demand for water during the warmer months is generally greater than during cooler months due primarily to additional requirements for water in connection with cooling systems, private and public swimming pools and lawn sprinklers. Throughout the year, and particularly during warmer months, demand will vary with rainfall and temperature levels.

          As of December 31, 1999, we employed 151 full-time and 7 part-time employees, all of whom were non-unionized. Of this number, 16 were officers and managers; 93 were employed as operations personnel, including engineers, technicians, draftsman, maintenance and repair persons, meter readers and utility personnel; and 45 were employed in the accounting, budgeting, information systems, human resources, customer relations, public relations and conservation departments. The remaining four employees were administrative personnel. We believe that our employee relations are good.

Item 2. - Properties.

          The corporate headquarters of Artesian Resources and Artesian Water are located at 664 Churchmans Road, Newark, Delaware. The property is leased from White Clay Realty by Artesian Water through December 31, 2002. See Item 13, Certain Relationships and Related Transactions, for further disclosures. The lease may be extended at the Company's option for two consecutive five-year renewal terms subject to the terms set forth in the lease.

          Artesian Resources and Artesian Development own various parcels of land in New Castle County, Delaware. Artesian Water owns land, transmission and distribution mains, pump facilities, treatment plants, storage tanks and related facilities within New Castle, Kent and Sussex Counties, Delaware. The acreage owned by the Company, not including rights-of-way and easements, totals approximately 674. Of this amount, approximately 500 acres are located directly adjacent to the corporate headquarters of the Company. Approximately one-half of the 500-acre tract has been the subject of an Environmental Impact Study being performed by the United States Army Corps of Engineers relating to the identification of a potential reservoir site and the environmental impact to the natural area at the prospective site; however, several other locations also are being evaluated for the site of a new reservoir in New Castle County. A current reassessment of future demands on water supply is under way and must be completed before the Environmental Impact Study is concluded. At this date, it is not known whether any site will be designated as needed for a reservoir. Substantially all of Artesian Water's utility plant, except utility plant within the town of Townsend, Delaware, is pledged as security for First Mortgage Bonds.

          We also own approximately 52 acres of land which will be the site of a future well field and iron removal facility in northern New Castle County. Artesian Development owns approximately 12 acres zoned for light manufacturing located immediately adjacent to our corporate headquarters. Artesian Development has no present plans to purchase new land or develop the acres it owns.

          All of Artesian Water's existing facilities adequately meet current necessary productive capacities and current levels of utilization.

Item 3. - Legal Proceedings.

          On April 30, 1999, Artesian Water filed a petition with the PSC to implement new rates to meet an increased revenue requirement of approximately 10.35%, or $2.7 million on an annualized basis. On September 30, 1999, Artesian Water filed a supplemental rate increase request which reduced the Company's increase from $2.7 million to approximately $2.5 million. Artesian is permitted to collect a temporary increase not in excess of $2.5 million on an annualized basis, under bond, until permanent rates are approved by the PSC. Artesian Water has deferred approximately 56%, or $720,000, of the temporary increase placed into effect which represents the difference between our requested increase and the PSC staff's filed position with regard to our rate increase. Such temporary rates became effective July 1, 1999. We expect a final decision on this matter in the first six months of 2000. Any revenues which have been deferred and are subsequently approved for recovery will be recorded as revenue in 2000.

          There are no other material legal proceedings pending at this date.

Item 4. - Submission of Matters to a Vote of Security Holders.

          None.

PART II

Item 5. - Market for Company's Common Equity and Related Stockholder Matters.

          Artesian Resources' Class A Non-Voting Common Stock ("Class A Stock") is listed on the Nasdaq National Market and trades under the symbol "ARTNA." On March 1, 2000, there were 659 holders of record of the Class A Stock. The following table sets forth, for the periods indicated, the high and low closing sale prices for the Class A Stock on the Nasdaq National Market and the cash dividends declared per share:

          The closing sale prices shown above reflect prices between dealers and do not include retail markups or markdowns or commissions and may not necessarily represent actual transactions.

          Our Class B Voting Stock ("Class B Stock") is quoted on the OTC Bulletin Board under the symbol "ARTNB". There has been a limited and sporadic public trading market for the Class B Voting Common Stock. As of March 1, 2000, the last reported trade of the Class B Voting Common Stock on the OTC Bulletin Board was at a price of $29.00 per share on February 11, 2000. As of March 1, 2000, we had 239 holders of record of the Class B Voting Common Stock.

          We file annual, quarterly and special reports and other information with the Securities and Exchange Commission (the "SEC"). You may read and copy any of the reports and other information we file at the SEC's public reference facilities located in Washington at Judiciary Plaza, Room 1024, 450 Fifth Street, N.W., Washington, D.C. 20549, in New York at 7 World Trade Center, Suite 1300, New York, New York 10048, and in Chicago at Northwest Atrium Center, 500 West Madison Street, Suite 1400, Chicago, Illinois 60661. You may call the SEC at 1-800-SEC-0330 for further information about the public reference rooms. Copies of such material can also be obtained from the Public Reference Room of the SEC at 450 Fifth Street, N.W., Washington, D.C. 20549, at prescribed rates. Our SEC filings are also available to the public over the Internet at the SEC's web site which is located at the following address: http://www.sec.gov.

          You may request a free copy of our Annual Report on Form 10-K for the year ended December 31, 1999, other than exhibits, by writing or telephoning us at: Artesian Resources Corporation, 664 Churchmans Road, Newark, Delaware 19702, Attention: Joseph A. DiNunzio, Vice President and Secretary [telephone (302) 453-6900].

Item 6 - Selected Financial Data.

(1) For the year ended December 31, 1995, includes a write-down of $784 in connection with our sale of an office building and a $128 loss on our disposal of Artesian Laboratories, Inc.

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

Results of Operations

Overview

          Artesian Water, our principal subsidiary, is the oldest and largest public water utility in the State of Delaware and has been providing water service within the state since 1905. We distribute and sell water to residential, commercial, industrial, governmental, municipal and utility customers throughout Delaware. As of December 31, 1999, we had approximately 62,600 metered customers and served a population of approximately 200,000, representing approximately 27% of Delaware's total population.

          The Delaware Public Service Commission regulates Artesian Water's rates charged for water service, the sale and issuance of securities, mergers and other matters. We periodically seek rate increases to cover the cost of increased operating expenses, increased financing expenses due to additional investments in utility plant and other costs of doing business. Increases in customers served by Artesian Water also contribute to increases in our operating revenues. We continue our efforts to contain expenses and improve efficiencies which contribute to increases in our operating income. Our business is also subject to seasonal fluctuations and the effects of weather.

1999 Compared to 1998

Operating Revenues

          We realized 98.3% of our total revenue in 1999 from the sale of water. Water sales revenue increased $1,214,000, or 4.8%, for the year ended December 31, 1999 compared to 1998. The increase was primarily due to a temporary rate increase placed in effect on July 1, 1999, and to a 3.2% increase in the number of customers served. In Delaware, utilities are permitted to place rates into effect on a temporary basis pending completion of a rate increase application. Specific statutes permit the recovery of appropriate increases under certain terms and conditions including the provision that, if such rates are found to be in excess of rates which the Commission finds to be appropriate, the utility must refund the portion found in excess to customers with interest. In addition to the revenues reported as operating revenues, we have deferred approximately 56%, or $720,000, of the temporary increase placed into effect which represents the difference between our requested increase and the Public Service Commission staff's filed position with regard to our rate increase. We expect a final decision on this matter in the first six months of 2000. Any revenues which have been deferred and are subsequently approved for recovery will be recorded as revenue in 2000.

Operating Expenses

          Operating expenses increased $417,000, or 2.9%, primarily due to increased payroll and related expenses and increased regulatory expenses, including rate case related expenditures. The ratio of operating expense to total revenue was 54.9% for the year ended December 31, 1999, compared to 56.0% for the year ended December 31, 1998. Payroll and related expenses increased $538,000, or 8.3%, primarily due to the addition of new employees and increases in annual merit and incentive compensation and the results of a 17% increase in medical insurance premiums. Rate case expenses increased approximately $105,000, or 29.0%, due to the write-off of $165,000 in unrecoverable rate case expenses from our 1997 rate increase request. Power expense increased $58,000 due to the addition of new wells and treatment facilities. Expense related to the write-off of uncollectible accounts increased approximately $52,000 primarily due to increases in rates and growth in customer base. Purchased water expense decreased approximately $176,000 primarily due to mandatory drought restrictions placed in effect in August 1999 which led to a reduced purchase water requirement from our supply from Chester Water Authority. In addition, our expense for painting tanks decreased $263,000, as we could not take any of our tanks out of service during 1999 to paint while our service area was experiencing a severe drought. Our legal expense increased $64,000 primarily due real estate and other general corporate governance matters.

          Depreciation and amortization expense increased $234,000, or 10.7%, due to increases in our utility plant in service. Income tax expense increased $152,000, or 8.4%, due to increased profitability in 1999. Our total effective income tax rate for 1999 was 39.8% compared to 39.9% for 1998.

Interest Charges

          Interest charges increased approximately $136,000, or 4.3%, primarily due to the $111,000 in interest expense related to the $4.5 million note issued to Ellis and Helena Taylor in exchange for the purchase of 24,165 shares of Class A Non-Voting Common Stock and 126,353 shares of Class B Common Stock.

Net Income

          For the year ended December 31, 1999, our net income applicable to common stock increased by $271,000, or 10.3%, compared to the same period in 1998. The increase in net income was primarily due to a temporary rate increase placed in effect in July 1999 and the addition of new customers. Reductions in purchased water and tank painting expenses also contributed to the increase in net income for the year.

1998 Compared to 1997

Operating Revenues

          We realized 98.5% of our total revenue in 1998 from the sale of water. Water sales revenue increased $3,093,000, or 14.1%, for the year ended December 31, 1998, compared to 1997. The increase was primarily due to rate increases placed in effect in late 1997 and in 1998, and to a 2.5% increase in the number of customers served, which was slightly offset by a decrease in usage per customer.

Operating Expenses

          Operating and maintenance expenses increased $1,498,000, or 11.7%, primarily due to increased payroll and related expenses and increased regulatory expenses, including rate case amortization. The ratio of operating and maintenance expense to total revenue was 56.0% for the year ended December 31, 1998, compared to 57.2% for the same period in 1997. Payroll and related expenses increased $517,000, or 8.7%, primarily due to the addition of new employees and increases in annual merit and incentive compensation. Rate case amortization expense increased $249,000, or 223.0%, due to the use of a two-year amortization period for a portion of deferred rate case costs. Rent expense increased $193,000, or 271.8%, due to the renewal of the office building lease with White Clay Realty, which was reclassified as an operating lease effective January 1, 1998. Repair and maintenance expense increased $251,000, or 41.0%, due to the timing of storage tank maintenance.

          Depreciation and amortization expense decreased $258,000, or 10.6%, due to the expiration of the White Clay Realty lease, described previously, and lower book depreciation rates approved in our last rate case. Income tax expense increased $530,000, or 41.5%, reflecting our increased profitability in 1998. Our total effective income tax rate for 1998 was 39.9% compared to 39.7% for 1997.

Interest Charges

          Interest charges increased $582,000, or 22.6%, primarily due to a higher average level of debt outstanding, which was partially offset by a slightly lower average interest rate for 1998. The increase in the average debt outstanding was partly attributable to our issuance of $10 million of Series M and $5 million of Series N First Mortgage Bonds in June and September 1997, respectively.

Net Income

          For the year ended December 31, 1998, our net income applicable to common stock increased by $746,000, or 39.4%, compared to the same period in 1997. The increase in net income was primarily due to rate increases placed in effect in late 1997 and in 1998, and to the addition of new customers, which was slightly offset by a decrease in usage per customer.

Liquidity & Capital Resources

Overview

          Our primary sources of liquidity for 1999 were $8.0 million from the net proceeds from the issuance of Class A Non-Voting Common Stock and $7.5 million provided by cash flow from operating activities. Cash flow from operating activities was primarily provided by our utility operations, and is impacted by operating and maintenance expenses, the timeliness and adequacy of rate increases and weather conditions.

          We rely on our sources of liquidity for investments in our utility plant and systems and to meet our various payment obligations. We currently estimate that our aggregate investments in our utility plant and systems in 2000 will be approximately $15.6 million. Our total obligations related to dividend and sinking fund payments on preferred stock, interest and principal payments on indebtedness, rental payments and water service interconnection agreements for 2000 are anticipated to be approximately $4.1 million.

Investment in Utility Plant and Systems

          Capital expenditures increased by approximately $1.0 million for the year ended December 31, 1999, or approximately 7.1%, from $14.3 million in 1998 to $15.3 million in 1999. Investment in utility plant, excluding amounts contributed by real estate developers, increased by $800,000, or 6.4%, from $12.5 million in 1998 to $13.3 million recorded in 1999. In addition, developers financed $2.4 million for the installation of water mains and hydrants serving their developments, compared to $1.8 million financed by developers in 1998. We invested over $5.2 million in Sussex County on the first section of our single largest project in 1999 which included a new transmission main, a treatment facility and an elevated storage tank. We invested nearly $4.1 million in our continuing efforts to increase our sources of supply by constructing new wells and associated equipment, new treatment facilities, rehabilitating our current facilities and improving our Aquifer Storage and Recovery system. We invested $1.8 million as part of our replacement and renewal program, and our installation of new services. We also invested $1.6 million in leasehold improvements, generators, general plant and equipment. In addition, we invested $580,000 for the relocation of existing mains as a result of government-mandated roadway construction.

          We have planned to invest approximately $15.6 million in utility plant in 2000. Developers are expected to finance an additional $3.4 million in utility plant construction. The largest project we are currently undertaking with continued investment in 2000 is the expansion of our system in Sussex County Delaware which includes enhancement of supply capabilities and installation of new transmission and distribution facilities with a total cost of approximately $4.6 million. We intend to invest approximately $1.7 million in other new sources of water supply, new treatment facilities and the rehabilitation of current facilities. In order to continue to provide superior quality water service, we plan to invest approximately $2.1 million in our transmission and distribution system for replacements and renewals, hydraulic improvements, maintenance of water storage facilities and new services. In addition, we have projected an investment of $3.2 million in other general plant and facilities.

          The remaining $4.0 million of anticipated investments is for projects for which the timing of initiation and completion are directly influenced by the needs of developers or governmental agencies. The largest portion of this projected investment is directly related to the relocation of existing mains as a result of government-mandated roadway construction totaling approximately $3.0 million. In addition, we expect to invest $1.0 million in projects for prospective developments in southern New Castle and Sussex Counties, which include the installation of new wells, treatment facilities and transmission mains. We may exercise some discretion in the exact timing of projects for prospective developments.

Financing

          We have several sources of liquidity to finance our investment in utility plant and other fixed assets. Developer advances and contributions in aid of construction are used for the installation of mains and hydrants in new developments. We estimate that approximately $15.6 million of our capital expenditures will be financed by our operations and external sources, including a combination of capital investment, long-term debt financing and short-term borrowings under our revolving credit agreements discussed below. The remaining $3.4 million of capital expenditures will be financed by developers.

          At December 31, 1999, we had a working capital deficit of $10.5 million mainly due to borrowings on our lines of credit of $7.6 million, a $1.1 million increase in the current portion of long-term debt, an $810,000 increase in accounts payable and $720,000 deferred revenue which has been held in reserve until the rate proceeding is completed. The $1.1 million increase in the current portion of long-term debt is related to a portion of the amount due to Ellis and Helena Taylor under the terms of the stock purchase agreement which we discuss below.

          On April 13, 1999, Artesian Resources issued 325,000 shares of Class A Non-Voting Common Stock at $25.00 per share in an underwritten public offering, and the net proceeds of approximately $7.5 million were used to reduce Artesian Water's borrowing on the lines of credit incurred to finance investment in utility plant.

          On May 4, 1999, we purchased from Ellis and Helena Taylor 24,165 shares of Class A Non-Voting Common Stock for $604,125 and 126,353 shares of Class B Common Stock for $3,845,875, subject to certain upward adjustments based upon increases in our book value per common share, payable in equal quarterly installments over a four year period and bearing interest at a rate equal to the amount that the sellers would have received in dividends on the shares as to which the principal amount has not yet been paid. We anticipate that this obligation will be funded by our cash flow from operations and external sources.

          At December 31, 1999, Artesian Water had lines of credit with three separate financial institutions totaling $35.0 million to meet its temporary cash requirements. These revolving credit facilities are unsecured. As of December 31, 1999, we had $27.4 million of available funds under these lines. The interest rate for borrowings under each of these lines is the London Interbank Offering Rate plus 1.0% or the bank's federal funds rate plus 1.0%, at our discretion. All the facilities are reviewed annually by each bank for renewal.

          We may from time to time sell securities to meet capital requirements. The amount and timing of future sales of our securities will depend upon market conditions and our specific needs.

Impact of Recent Accounting Pronouncements

          In June 1998, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards No. 133, "Accounting for Derivative Instruments and Hedging Activities," which established accounting and reporting standards for derivative instruments and hedging activities. In June 1999, FASB issued Statement of Financial Accounting Standards No. 137, "Accounting for Derivative Instruments and Hedging Activities-Deferral of the Effective Date of FASB Statement No. 133-an amendment of FASB Statement 133," which deferred the effective date of this standard to financial years beginning after June 15, 2000. We plan to adopt this statement effective January 1, 2001. Our adoption of this statement will not have a material impact on our financial condition or results of operations.

Year 2000 Compliance

          In 1999, our management completed an assessment of all our information and non-information technology systems and implemented a company-wide program which was designed to assure Year 2000 compliance. Since then, there have been no identified problems related to recognition of the Year 2000. We do not anticipate any problems related to the Year 2000 issue, however, we continue to monitor all our systems to assure continued uninterrupted operations.

Cautionary Statement

          Statements in this Annual Report which express our "belief," "anticipation" or " expectation," as well as other statements which are not historical fact, are forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 and involve risks and uncertainties that could cause actual results to differ materially from those projected. Certain factors, such as competitive market pressures, material changes in demand from larger customers, changes in weather, availability of labor, changes in government policies, levels of rate relief granted and changes in economic conditions, could cause results to differ materially from those in the forward-looking statements.

Item 7a - Quantitative and Qualitative Disclosures about Market Risk.

          None.

Item 8 - Financial Statements and Supplementary Data

The notes and schedules are an integral part of the consolidated financial statements.

The notes and schedules are an integral part of the consolidated financial statements.

During 1999 24,165 shares of class A stock and 126,353 shares of class B stock were reacquired in exchange for a note in the amount of $4,450,000 which is discusses under Note 6.

The notes and schedules are an integral part of the consolidated financial statements.

(1) At December 31, 1999, 1998 and 1997, Class A Non-Voting Common Stock had 3,500,000 shares authorized.

(2) At December 31, 1999, 1998 and 1997, Class B Common Stock had 1,040,000 shares authorized.

(3) Artesian Resources Corporation issued 325,000 shares of Class A Non-Voting Common Stock on April 13, 1999.

(4) Artesian Resources registered 200,000 shares of Class A Non-Voting Common Stock available for purchase through the Artesian Retirement Plan and the Artesian Supplemental Retirement Plan.

The notes and schedules are an integral part of the consolidated financial statements.

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

NOTE 1

SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Principles of Consolidation-- The consolidated financial statements include the accounts of Artesian Resources Corporation and its wholly-owned subsidiaries ("Artesian Resources" or the "Company"), including its principal operating company, Artesian Water Company, Inc. ("Artesian Water"). Appropriate eliminations have been made for all material intercompany transactions and account balances.

Utility Subsidiary Accounting-- The accounting records of Artesian Water are maintained in accordance with the uniform system of accounts as prescribed by the Delaware Public Service Commission ("PSC"). Artesian Water follows the provisions of Statement of Financial Accounting Standards No. 71, "Accounting for the Effects of Certain Types of Regulation," which provides guidance for companies in regulated industries.

Utility Plant and Capitalized Leases-- All additions to plant are recorded at cost. Cost includes direct labor, materials, and indirect charges for such items as transportation, supervision, pension, and other fringe benefits related to employees engaged in construction activities. When depreciable units of utility plant are retired, the cost of retired property, together with any cost associated with retirement and less any salvage value or proceeds received, is charged to accumulated depreciation. Maintenance, repairs, and replacement of minor items of plant are charged to expense as incurred.

          In accordance with a rate order issued by the PSC, Artesian Water accrues an Allowance for Funds Used During Construction ("AFUDC"). AFUDC, which represents the cost of funds devoted to construction projects through the date the project is placed in service, is capitalized as part of construction work in progress. The rate used for the AFUDC calculation is based on Artesian Water's weighted average cost of debt and the rate of return on equity authorized by the PSC. The rate used to capitalize AFUDC in 1999, 1998 and 1997 was 9.4%, 9.5%, and 9.7%, respectively.

Utility plant comprised:

Depreciation and Amortization-- For financial reporting purposes, depreciation is provided using the straight-line method at rates based on estimated economic useful lives which range from 5 to 85 years. Composite depreciation rates for utility plant were 2.15%, 2.11% and 2.38%, for the years ended December 31, 1999, 1998, and 1997, respectively. In a rate order issued by the PSC, the Company was directed effective January 1, 1998 to begin using revised depreciation rates for utility plant. In rate orders issued by the PSC, Artesian Water was directed effective May 28, 1991, and August 25, 1992, to offset depreciation on utility property funded by Contributions in Aid of Construction ("CIAC") and Advances for Construction ("Advances"), respectively, against CIAC and Advances. Other deferred assets are amortized using the straight-line method over applicable lives which range from 2 to 10 years.

Regulatory Assets-- Certain expenses, which are recoverable through rates, without a return on investment, as permitted by the PSC, are deferred and amortized during future periods using various methods. Expenses related to rate proceedings are amortized on a straight-line basis over a period of 2 to 5 years. The postretirement benefit obligation, which is being amortized over 20 years, is adjusted for the difference between the net periodic postretirement benefit costs and the cash payments. The deferred income taxes will be amortized over future years as the tax effects of temporary differences previously flowed through to the customers reverse.

Regulatory assets at December 31, net of amortization, comprised:

Other Deferred Assets-- Certain expenses are deferred and amortized using the straight-line method over various time periods ranging from 2 to 25 years. In 1992, Artesian Water entered a 10 year agreement for a water service interconnection with the Chester (Pennsylvania) Water Authority ("Chester"). The interconnection was placed in service during October 1992, at a total cost of $1.5 million and is being amortized over a 10 year period as approved by the PSC.

Other deferred assets at December 31, net of amortization, comprised:

Advances for Construction-- Water mains, services and hydrants or cash advances to reimburse Artesian Water its costs to construct water mains, services and hydrants, are contributed to Artesian Water by customers, real estate developers and builders in order to extend water service to their properties. The value of these contributions is recorded as Advances for Construction. Artesian Water makes refunds on these advances over a specific period of time based on operating revenues generated by the specific plant or as new customers are connected to the mains. After all refunds are made, any remaining balance is transferred to CIAC.

Contributions in Aid of Construction-- CIAC includes the non-refundable portion of advances for construction and direct contributions of water mains, services and hydrants or cash to reimburse Artesian Water its costs to construct water mains, services and hydrants by customers, real estate developers and builders in order to extend water service to their properties.

Income Taxes-- Deferred income taxes are provided in accordance with the provisions of Statement of Financial Accounting Standards No. 109, "Accounting for Income Taxes" on all differences between the tax basis of assets and liabilities and the amounts at which they are carried in the financial statements based on the enacted tax rates to be in effect when such temporary differences are expected to reverse.

          The Tax Reform Act of 1986 mandated that Advances and CIAC received subsequent to December 31, 1986, generally are taxable income to Artesian Water. For Advances, Artesian Water was directed by the PSC to pay the related taxes and collect amounts equal to the taxes paid from the developer. For CIAC, Artesian Water was directed to pay the taxes instead of the developer contributing the taxes. The 1996 Tax Act provides an exclusion from taxable income for CIAC and Advances received after June 12, 1996 by Artesian Water that are not included in rate base for rate-making purposes.

          Investment tax credits were deferred through 1986 and are recognized as a reduction of deferred income tax expense over the estimated economic useful lives of the related assets.

Net Income Per Common Share-- The Company adopted Statement of Financial Accounting Standards No. 128, "Earnings per Share" ("SFAS No. 128") in the fourth quarter of 1997. The adoption of this statement had no effect on the results of operations, financial conditions, or long-term liquidity.

Revenue Recognition and Unbilled Revenues- Water service revenue for financial statement purposes includes amounts billed to customers on a cycle basis and unbilled amounts based upon estimated usage from the date of the last meter reading to the end of the accounting period.

Cash and Cash Equivalents-- For purposes of the Consolidated Statement of Cash Flows, Artesian Resources considers all temporary cash investments with a maturity of three months or less to be cash equivalents. Artesian Water utilizes its bank's controlled disbursement service to reduce the use of its line of credit by funding checks as they are presented to the bank for payment rather than at issuance. If the checks currently outstanding but not yet funded exceed the cash balance on Artesian Water's books, the net liability is recorded as a current liability on the balance sheet in the Overdraft Payable account.

Use of Estimates in the Preparation of Consolidated Financial Statements-- The consolidated financial statements were prepared in conformity with generally accepted accounting principles, which require management to make estimates that affect the reported amounts of assets and liabilities and contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from management's estimate.

NOTE 2

FAIR VALUE OF FINANCIAL INSTRUMENTS

          The following methods and assumptions were used to estimate the fair value of each class of financial instruments for which it is practicable to estimate that value.

Current Assets and Liabilities-- For those current assets and liabilities that are considered financial instruments, the carrying amounts approximate fair value because of the short maturity of those instruments.

Long-term Financial Liabilities-- The fair value of Artesian Resources' long-term debt and mandatorily redeemable preferred stock as of December 31, 1999 and 1998, determined by discounting their future cash flows using current market interest rates on similar instruments with comparable maturities, are approximately as shown below.

Fair value of financial instruments at December 31, comprised:

          The fair value of Advances cannot be reasonably estimated due to the inability to accurately estimate future refunds expected to be paid over the life of the contracts. Refund payments are based on the water sales to new customers in the particular development constructed. Future refunds expected to be paid would have to be estimated on a per contract basis using the past history of refund payments. The fair value of Advances would be less than the carrying amount because these financial instruments are non-interest bearing.

NOTE 3

INCOME TAXES

          Deferred income taxes reflect temporary differences between the valuation of assets and liabilities for financial and tax reporting.

          At December 31, 1999, for state income tax purposes, Artesian Resources had recorded a deferred tax asset of $671,000 to reflect separate company net operating loss carryforwards aggregating approximately $7,707,000. These net operating loss carryforwards will expire if unused between 2000 and 2019. Artesian Resources has recorded a valuation allowance to reflect the estimated amount of deferred tax assets that may not be realized due to the expiration of the state net operating loss carryforwards. The valuation allowance increased from $665,000 in 1998 to $671,000 in 1999 as a result of additional net operating losses that are expected to expire unutilized.

          At December 31, 1997, for federal income tax purposes, there was a consolidated net operating loss carryforward of approximately $575,000, which was utilized in its entirety in 1998. At December 31, 1999, for federal income tax purposes, there were minimum tax credit carryforwards aggregating approximately $825,000 resulting from the payment of alternative minimum tax in current and prior years. These minimum tax credit carryforwards may be carried forward indefinitely to offset future regular federal income taxes. Artesian Resources has not recorded a valuation allowance for these federal tax carryforwards, because the Company believes it is more likely than not that such benefits will be realized.

Deferred income taxes at December 31, 1999, and 1998, were comprised of the following:

          Deferred taxes, which are classified into a net current and noncurrent balance, are presented in the balance sheet as follows:

NOTE 4

PREFERRED STOCK

          Artesian Resources has two classes of preferred stock outstanding. The 7% Prior Preferred stock (on which dividends are cumulative) is redeemable at Artesian Resources' option at $30.00 per share plus accrued dividends. The 9.96% Series Cumulative Prior Preferred Stock has annual mandatory redemption requirements and is redeemable at Artesian Resources' option at various declining prices ranging from $25.75 through January 31, 2000, to $25.00 after February 1, 2003. Under mandatory sinking fund provisions, redemptions will aggregate $100,000(4,000 shares) annually in 2000 through 2004. The Company also has 100,000 shares of $1.00 par value Series Preferred stock authorized but unissued. See the Consolidated Statements of Stockholders' Equity.

          There are 80,000 authorized shares of the 9.96% Series Cumulative Prior Preferred Stock with a par value of $25 per share, of which 20,000 and 24,000 shares were outstanding as of December 31, 1999 and 1998, respectively. Cash dividends paid in 1999 and 1998 were $52,000 and $62,000, respectively.

NOTE 5

COMMON STOCK AND ADDITIONAL PAID-IN CAPITAL

          The Class A Non-Voting Common Stock ("Class A Stock") of Artesian Resources trades on the NASDAQ National Market under the symbol ARTNA. The Class B Common Stock of Artesian Resources trades on the NASDAQ Bulletin Board under the symbol ARTNB.

          In 1999, Artesian Resources issued 325,000 shares of Class A Stock at $25.00 per share. Net proceeds from the offering were used to reduce debt incurred to finance investment in utility plant.

          Contributions to the Tax Reduction Act Employees' Stock Ownership Plan (PAYSOP) by Artesian Resources for the purchase of its Class B Common stock on behalf of employees were limited to dividend reinvestments in 1997 and 1996. In 1997 the PAYSOP was merged into the Company's 401(k) plan. Under Artesian Resources' dividend reinvestment plan, stockholders were issued 12,560, 12,876 and 11,589 shares at fair market value for the reinvestment of $283,000, $242,000 and $204,000 of their cash dividends for the years 1999, 1998 and 1997, respectively.

NOTE 6

DEBT

          Artesian Water has available unsecured lines of credit, with no financial covenant restrictions, totaling $35.0 million at December 31, 1999, which are renewable annually at the banks' discretion. Borrowings under the lines of credit bear interest based on the London Interbank Offering Rate ("LIBOR") plus 1.0% for 30, 60, 90, or 180 days or the banks' Federal Funds Rate plus 1.0%, at the option of Artesian Water.

          At December 31, 1999, 1998, and 1997, Artesian Water had $7.6 million, $7.7 million and $1.2 million outstanding under these lines at weighted average interest rates of 6.3%, 6.0% and 7.6%, respectively. The maximum amount outstanding was $11.6 million, $9.1 million and $13.0 million in 1999, 1998, and 1997, respectively. The average amount outstanding was approximately $7.7 million, $4.4 million and $5.1 million, at weighted average annual interest rates of 6.0%, 6.0% and 6.5% in 1999, 1998, and 1997, respectively.

          On June 17, 1997, Artesian Water issued a $10.0 million, 7.84%, ten year Series M Mortgage Bond and borrowed $2.5 million against a $5.0 million, ten year Series N Mortgage Bond to repay the outstanding balance on the lines of credit. On September 18, 1997, Artesian Water borrowed the remaining $2.5 million on the Series N Mortgage Bond. The $5.0 million, ten year Series N First Mortgage Bond has a fixed interest rate of 7.56%. On February 1, 2003, the Series L Mortgage Bond matures. No other repayments or sinking fund deposits on first mortgage bonds are required over the next five years. As of December 31, 1999 and 1998, substantially all of Artesian Water's utility plant was pledged as security for the First Mortgage Bonds. In addition, the trust indentures contain covenants which limit long-term debt, including the current portion thereof, to 66 2/3% of total capitalization including the current portion of the long-term debt, and which, in certain circumstances, could restrict the payment of cash dividends. As of December 31, 1999, however, no dividend restrictions were imposed under these covenants.

          On May 4, 1999, Artesian repurchased 126,353 shares of Class B Common Stock and 24,165 shares of Class A Non-Voting Common Stock from Helena C. Taylor and Ellis D. Taylor in exchange for a promissory note (the "Note") in the principal amount of $4,450,000 representing the purchase price of the stock, with a discounted present value of $4,307,000. The Note is payable quarterly, on a calendar basis, over a four year period and in sixteen equal principal installments of $278,125 commencing on June 30, 1999. The outstanding balance on the Note bears interest in an amount computed based on the quarterly dividend the Taylors would have received on the Stock transferred to Artesian but not yet paid for by Artesian. In addition, the principal installment is adjusted on a quarterly basis to reflect changes in the book value per common share of the Company as reported in its most recent quarterly financial statement distributed to stockholders prior to the quarterly payment. Such amounts, if any, represent contingent purchase price of the stock and will be charged to retained earnings. At December 31, 1999, Artesian had $3,616,000 outstanding under this promissory note.

Long-term debt consisted of:

NOTE 7

NON-UTILITY OPERATING REVENUE AND EXPENSES

          On December 19, 1996, Artesian Wastewater Management, Inc. (Artesian Wastewater) was created as an additional non-regulated subsidiary of Artesian Resources. Artesian Wastewater plans to provide wastewater treatment services in Delaware. On March 12, 1997, Artesian Wastewater became a one-third owner in AquaStructure Delaware, L.L.C. which intends to develop and market various proposals to provide wastewater treatment services. No operations occurred under Artesian Wastewater for 1998 and 1997.

          Non-utility operating revenue consisted of $40,000 in income received by Artesian Wastewater Management, Inc. in 1999. No non-utility operating revenue was received in 1998 or 1997.

Non-utility operating expenses are as follows:

NOTE 8

RELATED PARTY TRANSACTIONS

          The office building and shop complex utilized by Artesian Water are leased at an average annual rental of $180,000 from a partnership, White Clay Realty, in which certain of Artesian Resources' officers and directors are partners. The lease expires in 2002, with provisions for renewals for two 5 year periods thereafter. Management believes that the payments made to White Clay Realty for the lease of its office building and shop complex are comparable to what Artesian Water would have to pay to unaffiliated parties for similar facilities (See Note 11).

          Artesian Water leased certain parcels of land for water production wells from Glendale Enterprises Limited, a company wholly-owned by Ellis D. Taylor, a former shareholder (see Note 6), at an annual rental of $44,000. Renewal of the lease has been automatic from year to year unless 60 days' written notice is given by either party before the end of the year's lease. Artesian Water has received notice that Glendale Enterprises Limited would like to discontinue the lease for the well sites. Artesian Water intends to negotiate the purchase of the land rights for the well sites associated with the Glendale lease.

Rental expense associated with related party transactions are as follows:

NOTE 9

STOCK COMPENSATION PLANS

          At December 31, 1999, the Company has two stock-based compensation plans, which are described below. The Company applies APB Opinion No. 25 and related interpretations in accounting for compensation expense under its plans. Accordingly, the compensation cost that has been charged against income for the two plans was $42,000, $44,000 and $48,000 for 1999, 1998, and 1997, respectively. Had compensation cost for the Company's two plans been determined based on the fair value at the grant dates for awards under those plans consistent with the method required by Statement of Financial Accounting Standards No. 123, "Accounting for Stock Based Compensation", the Company's net income and net income per common share would have been reduced to the pro-forma amounts indicated below:

          In 1998, the Company amended the 1992 Non-qualified Stock Option Plan (the "1992 Plan") increasing the number of shares of Class A Stock authorized for issuance from 100,000 to 250,000. Under the 1992 Plan (i) the maximum amount of shares of Class A Stock that may be granted to any individual during the term of the 1992 Plan is an amount equal to 50% of the number of shares of Class A Stock available for issuance under the 1992 Plan, (ii) the Company may require a participant to enter into a covenant not to compete and/or a confidentiality agreement as a condition of an option grant, (iii) provisions relating to grants to directors and officers of the Company were changed to add a prohibition on amending such provisions more than once in any six month period, to extend the exercise term from one to ten years and to eliminate the possibility of administrative discretion with respect to such grants, and (iv)the provision that limited to 34 the number of plan participants eligible to receive options under the 1992 Plan within any calendar year was removed. Options to purchase shares of Class A Stock may be granted to employees at prices not less than 85% of the fair market value on the date of grant. Employees who participate and who are not executive officers or directors of the Company may receive options to purchase up to 1,000 shares. Each director or officer who participates in any year may request an option to purchase 3,000 shares of stock. The option price for directors and officers of the Company is 90% of the fair market value on the date of grant. Options granted under this plan extend for a period of one year, are exercisable after six months of service from the date of initial grant, after one year of service to the Company, and are adjusted for stock dividends and splits.

          In 1996, the Company instituted the Incentive Stock Option Plan (the "ISO Plan"), under which the Company may grant options to its key employees and officers for up to 100,000 shares of Class A Stock. Options are granted at the fair market value on the date of grant. The option exercise period shall not exceed ten years from the date of grant and will be determined by the Company for each stock option granted. Options granted will vest in accordance with the terms and conditions determined by the Company and are adjusted for stock dividends and splits.

          The fair value of each option grant is estimated on the date of grant using the Black-Scholes option pricing model with the following weighted-average assumptions used for grants in 1999, 1998 and 1997, respectively: dividend yield of 4.2%, 4.7% and 5.1%; expected volatility of 0.31%, 0.30% and 0.33%; risk free interest rates of 5.08%, 4.96% and 5.63% for the employee options under the 1992 Plan, 5.58%, 5.57% and 6.65% for the director and officer options under the 1992 Plan and 5.58% for the 1999 ISO Plan options; and expected lives of one year for the employee options and five years for the director and officer options under the 1992 Plan for all years, five years for 1997 and 1996 and five years for the 1996 ISO Plan options. In 1998 and 1997, no ISO Plan options were granted. Shares of common stock have been reserved for future issuance under all of the foregoing options.

          The following summary reflects changes in the Class A shares under option:

The following tables summarize information about employee stock options outstanding at December 31, 1999:

NOTE 10

EMPLOYEE BENEFIT PLANS

401(k) Plan-- Artesian Resources has a defined contribution 401(k)Salary Reduction Plan (the "Plan") which covers substantially all employees. Under the terms of the Plan, Artesian Resources contributes 2% of eligible salaries and wages and matches employee contributions up to 6% of gross pay at a rate of 50%. Artesian Resources may, at its option, make additional contributions of up to 3% of eligible salaries and wages. No such additional contributions were made in 1999, 1998, and 1997. Plan expenses, which include Company contributions and administrative fees, for the years 1999, 1998, and 1997, were approximately $188,000, $210,000 and $255,000, respectively.

Postretirement Benefit Plan- Artesian Resources has a Postretirement Benefit Plan (the "Benefit Plan") which provides medical and life insurance benefits to certain retired employees. Prior to the amendment of the Benefit Plan, as described below, substantially all employees could become eligible for these benefits if they reached retirement age while still working for Artesian Resources.

Statement of Financial Accounting Standards No. 106, "Employers' Accounting for Postretirement Benefits Other Than Pensions" ("SFAS 106"), requires Artesian Resources to accrue the expected cost of providing postretirement health care and life insurance benefits as employees render the services necessary to earn the benefits. Artesian Resources elected to defer recognition and amortize its transition obligation over 20 years.

Artesian Resources recognized an offsetting regulatory asset with respect to the SFAS 106 liability. This asset is recorded based on the PSC order which permits Artesian Water to continue recovery of postretirement health care and life insurance expense on a pay-as-you-go basis for the remaining eligible employees. Artesian Water anticipates liquidating its SFAS 106 obligation and substantially recovering the expenses in rates over a period of approximately 20 years (based on the age and life expectancy of the remaining eligible participants). Further, expense recovery as a percentage of rates is expected to remain constant over the initial years, and then decline until the obligation is liquidated. Amounts charged to expense were $89,000, $78,000 and $70,000 for 1999, 1998, and 1997, respectively.

The following table sets forth the amount recognized in Artesian Resources' Consolidated Balance Sheet for the Benefit Plan as of December 31:

          For measurement purposes, an 8.5% annual rate of increase in per capita cost of covered health care benefits was assumed for 1999; the rate was assumed to decrease gradually to 5% through the year 2007 and remain at that level thereafter. The health care cost trend rate assumption has a significant effect on the amount of the obligation and periodic cost reported. An increase in the assumed health care cost trend rates by 1% in each year would increase the accumulated postretirement benefit obligation as of December 31, 1999, by $71,000 and the interest cost component of net periodic postretirement benefit cost for the year then ended by $4,000.

          The weighted-average discount rate used in determining the accumulated postretirement benefit obligation was 7.75% and 6.75% for the years ended December 31, 1999, and 1998, respectively.

Supplemental Pension Plan- Effective October 1, 1994, Artesian Water established a Supplemental Pension Plan (the "Supplemental Plan") to provide additional retirement benefits to full-time employees hired prior to April 26, 1994. The purpose of the Supplemental Plan is to help employees save for future retiree medical costs, which will be paid by employees. The Supplemental Plan accomplishes this objective by providing additional cash resources to employees upon a termination of employment or retirement, to meet the cost of future medical expenses. Artesian Water has established a contribution based upon each employee's years of service ranging from 2% to 6% of eligible salaries and wages. Artesian Water also provides additional benefits to individuals who were over age 50 as of January 1, 1994. These individuals are referred to as the "Transition Group." Effective November 1, 1994, individuals eligible for the Transition Group had the opportunity to defer compensation to the Supplemental Plan, and to receive a transition matching contribution for 5 years. Each one dollar of eligible salaries and wages deferred by the Transition Group is matched with three, four, or five dollars by Artesian Water based on the employee's years of service subject to certain limitations under the federal tax rules. Plan expenses, which include Company contributions and administrative fees, for the years 1999, 1998, and 1997 were approximately $267,000, $239,000, and $228,000, respectively.

NOTE 11

COMMITMENTS

          The office building and shop complex are leased at an average annual rental of $180,000 from a partnership, White Clay Realty (See Note 8). The original lease had been accounted for as a capital lease; accordingly, the present value of all future payments for the leased property at the inception of the lease ($1.9 million) was recorded in General Plant and in Capitalized Lease Obligations. At December 31, 1997, the fully amortized leased property was retired from General Plant and the five year lease renewal, which commenced January 1, 1998, is being accounted for as an operating lease.

          In 1995, Artesian Water entered into four 5-year leases for computer equipment and in 1997 Artesian Water entered a 10 year lease for a land easement which have been recorded as capital leases. Also in 1997, Artesian Water entered into a 33 year operating lease for a parcel of land with improvements located in South Bethany, a municipality in Sussex County, Delaware.

          During 1996, Artesian Water entered into a ten year lease commitment for office space. Rent expense for 1999, 1998, and 1997 for the office space was $66,000, $64,000, and $62,000, respectively.

         Future minimum annual rental payments under these lease obligations for the 5 years subsequent to 1999 are as follows: