ARTESIAN RESOURCES CORP - Annual Report: 2002 (Form 10-K)

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.

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.

Indicate by check mark whether the registrant is an accelerated filer (as defined in Exchange Act Rule 12b-2)

The aggregate market value of the non-voting and voting stock held by non-affiliates of the registrant at March 3, 2003 was $66,743,840 and $3,773,790, respectively.

As of March 3, 2003, 2,185,880 shares and 391,824 shares of Class A Non-Voting Common Stock and Class B Common Stock, respectively, were outstanding.

PART I

Artesian Resources Corporation ("Artesian Resources" or the "Company") operates as the parent holding company of Artesian Water Company, Inc. ("Artesian Water"), our principal subsidiary, Artesian Water Pennsylvania, Inc. and two 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 the newly formed subsidiary, Artesian Water. In this Annual Report on Form 10-K, we frequently use the terms "we," "our" and the "Company" 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, 2002, we had 68,000 metered customers and served a population of approximately 226,000 (including contract services), 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 2002 was approximately $33.6 million, and our percentages of gross water sales revenue by major customer classifications were 60% for residential, 32% for commercial, industrial, governmental, municipal and utility, and 8% for fire protection and other. These percentages have remained fairly constant for the past three years. We have received recognition of Artesian Water Pennsylvania, Inc. as a regulated public water utility by the Pennsylvania Public Utility Commission in 2002. We are now serving a community in Pennsylvania of 39 customers.

Our current market area is the State of Delaware, which had a population of approximately 800,000 at December 31, 2002. According to the US Census Bureau, Delaware's population has increased 17.6% over the last 10 years, the 14th largest percentage increase among the states. 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 38.3% over the last ten years. The largest project, which was completed in 2002, is the Bayville Iron Removal Facilities project in Sussex County, Delaware, with a total cost of $4.17 million. Substantial portions of Delaware, particularly outside of New Castle County, are not served by a public water system and represent potential opportunities for Artesian Water to obtain 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 ("CPCN") grants a water company the exclusive right to serve all existing and new customers within a designated area. Effective July 1, 2001, the authority to issue CPCNs was transferred to the Delaware Public Service Commission ("PSC") from the Delaware Department of Natural Resources and Environmental Control ("DNREC"). In this Annual Report on Form 10-K, we refer to these Certificates as "CPCNs" or "franchises." We hold CPCNs for approximately 140 square miles of exclusive service territory, which is segmented into a number of service areas. Our largest connected regional water system, consisting of approximately 98.6 square miles and 64,300 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 2.7% for the last ten years. Within our existing service territory, we hold CPCNs for nearly 5,000 acres zoned for industrial and manufacturing development.

Since 1993, we have significantly expanded 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 30% since 1993. The pursuit of new service territory in the State of Delaware by water companies is competitive.

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 82% in 2002. Since 1992, we have increased our sources of groundwater supply from our own wells by 50%, or nearly nine million gallons per day. We 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 82% of the overall 7.2 billion gallons of water we distributed in all our systems during 2002 came from our groundwater wells, while the remaining 18% came from interconnections with other utilities and municipalities. During 2002, our average rate of water pumped was approximately 16.4 million gallons per day ("mgd") from our groundwater wells and approximately 3.3 mgd was supplied from interconnections. Our peak water supply capacity currently is approximately 45.5 mgd. Our peak water demand in 2002 was approximately 29.3 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 94 operating and 52 monitoring wells in our systems. Our northern New Castle County system is interconnected. In the remainder of the state, we have several satellite systems that 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 17 interconnections with four neighboring water utilities and six municipalities that provide us with the ability to purchase or sell water. Interconnection agreements with the Chester Water Authority and the City of Wilmington have "take or pay" clauses requiring us to take, as of December 31, 2002, minimum draws totaling 864,000,000 gallons annually. Because of the drought, the Chester Water Authority reduced their minimum draw for 2002 only. 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. Our remaining take or pay agreement with that municipality was renewed in December 2001 for a period of five years. 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 DNREC for water allocation permits for each of our production wells pumping quantities of water above certain levels. Presently, we have permits for 69 wells, permit applications pending for 14 wells and 11 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 2002, we were serving customers through approximately 915 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 approximately 3,600 hydrants installed throughout our service territories.

We have 30 storage tanks, most of which are elevated, providing total system storage of 38.0 million gallons. We also are developing and using an aquifer storage and recovery system. At some locations, we rely on hydropneumatic tanks to maintain adequate system pressures. Where possible, we will combine our smaller satellite systems with systems having elevated storage facilities.

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 Atlantic Coastal Plain. The remaining 10% come from wells in the Piedmont Province. We use a variety of treatment methods, including aeration, pH adjustment, chlorination, fluoridation and iron removal, to meet federal, state and local 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 42 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 PSC 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 2002, but we cannot predict whether the PSC 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 December 3, 2002. This reflects a temporary increase of approximately 11.4%, which Artesian Water is permitted to collect by law, under bond, until the PSC makes a final rate determination. On June 1, 2002, we placed temporary rates into effect, up to the statutory limit of $2.5 million on an annualized basis, under bond. The previous increase was placed in effect July 1, 2001, which authorized a return on equity rate of 10.5%, with an overall rate of return on rate base of 8.99%.

A public water utility operating in Delaware must obtain a CPCN for a service territory to begin or expand its operations, which is granted by the PSC. Currently the PSC 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 PSC to abandon a service territory once granted.

The United States Environmental Protection Agency (the "EPA"), DNREC, and the Delaware Division of Public Health ("DPH") and regulate the water quality of our treatment and distribution systems. We believe that we are in material compliance with all current federal, state and local 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. DPH has set maximum contaminant levels for certain substances that are more restrictive than the maximum contaminant levels set by the EPA. The DPH 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 that 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 that include limitations on iron content, odor and other water quality-related issues that are not proven health risks but may be objectionable for consumption. We believe our current treatment systems and facilities meet or exceed these secondary standards.

As a normal by-product of iron removal, our treatment facility at Old County Road in New Castle County and our treatment facility in South Bethany in Sussex County generate 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 these facilities. 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. 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. ("AquaStructure").

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.

The Company has no collective bargaining agreements with any of its employees, and its work force is not union organized or union represented. As of December 31, 2002, we employed 178 full-time and six part-time employees, all of whom were non-unionized. Of this number, 24 were officers and managers; 98 were employed as operations personnel, including engineers, technicians, draftsman, maintenance and repair persons, meter readers and utility personnel; and 46 were employed in the accounting, budgeting, information systems, human resources, customer relations, public relations and conservation departments. The remaining ten employees were administrative personnel. We believe that our employee relations are good.

The corporate headquarters of Artesian Resources, Artesian Water and its other non-regulated subsidiaries are located at 664 Churchmans Road, Newark, Delaware. The property is leased from White Clay Realty by Artesian Water through December 31, 2002. Artesian Water, in December of 2002, filed a condemnation action in the Delaware Superior Court, seeking to acquire title to the office and shop complex currently leased by Artesian, known as 664 Churchmans Road, Newark, Delaware (the "Property"). Artesian Water filed this action under its statutory power of eminent domain against the owner of the Property, White Clay Realty, a Delaware Limited Partnership, and each of the limited partners. White Clay Realty has no general partner and the Superior Court has ruled that the partnership is dissolved and all of the former partners now own the Property jointly as tenants in common. Certain of the officers and directors of Artesian Resource are tenants in common or the beneficiary of a tenant in common. A special committee of the Board of Directors, composed entirely of outside directors who have no ownership interest in the Property, made the determination to purchase the Property through the condemnation procedures. Under this procedure, if the acquisition of the Property is approved by the court, the fair market value of the Property will be determined by a panel of commissioners after an evidentiary hearing. Artesian Water's independent appraiser has valued the Property to be worth $3,800,000. Until a final determination of the condemnation, the parties have agreed that Artesian Water may continue to occupy the Property under the terms of the lease with a quarterly rental payment of $43,361. See Item 13, Transactions with Management and Affiliated Interests, for further disclosures.

Of the 694 acres we own, Artesian Development owns approximately eleven-acres zoned for office buildings located immediately adjacent to our corporate headquarters. ADC has no present plans to purchase new land or develop the acreage it owns.

All of our existing facilities adequately meet current necessary production capacities and current levels of utilization.

Item 3. - Legal Proceedings.

On April 2, 2002, Artesian Water filed a petition with the PSC seeking to raise rates for water service by 23.12%, or $7.5 million. As is permitted by law, we placed a 7.71% rate increase into effect under bond beginning June 1, 2002. On June 17, 2002, we filed a supplemental application reducing the requested increase to 19%, or $6.4 million. Hearings regarding the rate increase were held on October 30 and 31, 2002. During these hearings, we reduced our requested rate increase to 14.2%, or $4.8 million. Beginning December 3, 2002, as is permitted by law, we placed an additional 3.69% of the proposed rates into effect. These rates represent an increase in water consumption charges, customer charges and fire hydrant ready to serve charges necessary to generate an increase in operating revenues of approximately $3.9 million.. On March 18, 2003 the PSC approved an increase in rates for Artesian Water. Based on the decisions made during the Commission hearings the company has calculated the increase to be approximately $3.3 million, this calculation has been reviewed by PSC staff. Pending review of the final order by the PSC, which has not been issued, the final amount and impact of the new rate on customer bills will be determined. Any revenues that have been deferred and are subsequently approved for recovery will be recorded as revenue in 2003.

The office building and shop complex utilized by Artesian Water are leased at an average annual rental of $175,000 from a partnership, White Clay Realty, in which certain of Artesian Resources' officers and directors are a partner or the beneficiary of a partner (Dian C. Taylor and John R. Eisenbrey, Jr.). The current rental of $175,000 is below market. Artesian Water, in December 2002, filed a condemnation action in the Delaware Superior Court, seeking to acquire title to the office and shop complex currently leased by Artesian, known as 664 Churchmans Road, Newark, Delaware (the "Property"). Artesian Water filed this action under its statutory power of eminent domain against the owner of the Property, White Clay Realty, a Delaware Limited Partnership, and each of the limited partners. White Clay Realty has no general partner and the Superior Court has ruled that the partnership is dissolved and all of the former partners now own the Property jointly as tenants in common. A special committee of the Board of Directors, composed entirely of outside directors who have no ownership interest in the Property, made the determination to purchase the Property through the condemnation procedures. Under this procedure, if the acquisition of the Property is approved by the court, the fair market value of the Property will be determined by a panel of commissioners after an evidentiary hearing. Artesian Water's independent appraiser has valued the Property to be worth $3,800,000. In December 2002, Artesian Water issued a payment to the Prothonotary for the State of Delaware for $3,800,000. As the court has delayed payment until the matter is decided, the amount is to be refunded to Artesian and is recorded as a receivable at December 31, 2002. Until a final determination of the condemnation, the parties have agreed that Artesian Water may continue to occupy the Property under the terms of the lease with a quarterly rental payment of $43,361.

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

There were no matters submitted to a vote of security holders during the fourth quarter of 2002.

PART II

Artesian Resources' Class A Non-Voting Common Stock ("Class A Stock") is listed on the Nasqad National Market and trades under the symbol "ARTNA." On March 3, 2003, there were 795 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 Nasqad National Market and the cash dividends declared per share:

CLASS A NON-VOTING COMMON STOCK

Upon recognition from the Pennsylvania Public Utility Commission as a regulated utility, our other water utility subsidiary, Artesian Water Pennsylvania, Inc., began operations in 2002, providing water service to a residential community, consisting of 41 homes, in Chester County. Our other subsidiaries, neither of which is regulated, are Artesian Wastewater Management, Inc., which provides wastewater services in Delaware, and Artesian Development Corporation, whose sole activity has been ownership of an eleven-acre parcel of land.

Our profitability is primarily attributable to the sale of water by Artesian Water, the amount of which is dependent on seasonal fluctuations in weather, particularly during the summer months when water demand may vary with rainfall and temperature.

While customer growth in our utility subsidiary will continue to be a major focus in 2003, we are aggressively seeking opportunities that produce revenue streams that are unrelated to weather. These opportunities include our wastewater management subsidiary's operation of a new spray irrigation wastewater treatment facility with a capacity of 2.5 million-gallons-per-day for the town of Middletown, Delaware, which began in the third quarter of 2002. In addition, we will continue to focus attention on expanding our contract operations opportunities with municipalities and private water providers in Delaware and surrounding areas.

Ensuring our customers have a dependable supply of safe, high-quality water has been, and will continue to be, a high priority. We expect to make investments in 2003 that will increase our sources of water and enhance our ability to deliver supply from our Aquifer Storage and Recovery Program. We are the first and only water utility in Delaware to utilize this technology that capitalizes on Delaware's unique geology to provide storage capacity for water to be used during periods of peak water demand.

As of December 31, 2002, we had approximately 68,000 metered customers and serviced a population of approximately 226,000, representing approximately 27% of Delaware's total population. The Delaware Public Service Commission ("PSC") regulates Artesian Water's rates charged for water service, the sale and issuance of our securities 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. In Delaware, utilities are permitted to place rates into effect on a temporary basis pending completion of a rate increase proceeding. Increases in the number of customers served by Artesian Water also contribute to increases in our operating revenues.

We are affected by inflation, most notably by the continually increasing costs required to maintain, improve and expand our service capability. The cumulative effect of inflation results in significantly higher facility costs, compared to investments made 20 to 40 years ago, which must be recovered from future cash flows.

In 2001, Delaware passed a statute permitting water utilities to put into effect, on a semi-annual basis, increases related to specific types of distribution system improvements through a Distribution System Improvement Charge (DSIC). This charge is available to water utilities to be implemented between general rate increase application that normally recognize changes in a water utility's overall financial position. The DSIC process significantly reduces expenses when compared to those typically associated with general rate increase requests. We requested on November 30, 2001, and subsequently implemented, a 0.53% overall surcharge for bills rendered subsequent to January 1, 2002. The first effective date for the implementation of DSIC was January 1, 2002. Revenues generated by this charge totaled $66,000 in 2002.

We record water service revenue, including 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. These estimates are made on an individual customer basis, based on the previous year's consumption in the same period, and are adjusted to reflect current changes in water demand on a system-wide basis. While actual usage for individual customers may differ materially from the estimate, we believe the overall total estimate of consumption and revenue for the fiscal period will not differ materially from actual billed consumption, as the overall estimate has been adjusted to reflect any change in overall demand on the system for the period.

Our regulated water utility records deferred regulatory assets under Statement of Financial Accounting Standards No. 71, "Accounting for the Effects of Certain Types of Regulation," which are expenses that may be recovered over various lengths of time as prescribed by the PSC. As the utility incurs certain expenses, such as expenses related to rate case applications, a deferred regulatory asset is created. Adjustments to these deferred regulatory assets are made when the PSC determines whether the expense is recoverable in rates, the length of time over which an expense is recoverable, or, because of changes in circumstances, whether a remaining balance of deferred expense is no longer recoverable in rates charged to customers. Adjustments to reflect changes in recoverability of certain deferred regulatory assets may have a material effect on our financial results.

Revenues totaled $34.6 million in 2002 and were 8.2% above revenues in 2001 of $32.0 million, reflecting an increase in water sales of 7.3% due to customer growth and rate increases approved by the PSC in 2002. We realized 97.2% of our total revenue in 2002 from the sale of water.

We filed an application with the PSC on April 2, 2002, to increase rates for water service for all of Artesian Water's customers. A temporary rate increase, calculated to increase annualized revenues $2.5 million was approved by the PSC and placed into effect on June 1, 2002. Beginning December 3, 2002, as is permitted by law, the Company placed an additional rate increase into effect, to generate an additional increase in annualized revenues of $1.4 million. The increase in revenues for the various customer classes will not consistently match changes in consumption levels for the class primarily due to our use of a multiple rate block structure. This structure charges different rates for different levels of consumption. In addition, rate increases are distributed among the rate blocks and service charges through a cost of service analysis and may not reflect, on an individual class or charge basis, the overall increase in rates approved by the PSC.

Residential water service revenues in 2002 amounted to $20.6 million, an increase of 6.9% over the $19.3 million recorded in 2001. The increase in 2002 follows an increase of 17.4% in 2001. The volume of water sold to residential customers, however, decreased by 5.0 % from 3,809 million gallons in 2001 to 3,627 million gallons in 2002, primarily as a result of drought water use restrictions. The number of residential customers served increased 2.8% in 2002.

Revenues from industrial customers in 2002 increased by 13.1% to $453,000, from $400,000 in 2001. The volume of water sold to industrial customers increased 33.8% from 165 million gallons in 2001 to 221 million gallons in 2002 primarily as a result of the addition of one new customer.

Government and other revenues in 2002 increased by 15.8% to $4.3 million, from $3.7 million in 2001. Revenues derived from fire protection services totaled $2.3 million in 2002, exceeding 2001 revenue by 22.9%. The remaining revenue increase was derived from the sale of water to neighboring utilities, government agencies, pools and other temporary and seasonal customers.

Other utility operating revenue, derived from contract operations, antenna leases on water tanks and finance charges increased 30.6% in 2002 to $666,000, from $509,000 in 2001. This is primarily a result of an increase in revenues for contract operation services.

Operating expenses, excluding depreciation and taxes, increased approximately $715,000, or 4.1%, to $18.3 million in 2002. The increase in operating expenses resulted primarily from an increase in payroll and related expense of $731,000, or 8.2%, due to the addition of new employees and increases in annual merit compensation. Purchased water expenditure decreased $267,000 from 2001 levels due to Chester Water Authority removing minimum purchase requirements due to the drought conditions in the summer and fall of 2002 and our ability to rely on our less costly groundwater supply. Water treatment expense increased $68,000 primarily due to expanded testing of our sources of supply. Finally, our administrative expenses remained flat. This reflects the one-time $280,000 expense recognition in 2001 for legal costs associated with the suspended negotiations for the purchase of Tidewater Utilities, a subsidiary of Middlesex Water Company, offset by an increase in 2002 in consulting and temporary services of $323,000, which reflects the use of these services prior to filling positions with full-time employees. The ratio of operating expense, excluding depreciation and taxes, to total revenue was 53.0% for the year ended December 31, 2002, compared to 55.1% for the year ended December 31, 2001.

Depreciation and amortization expense increased $391,000, or 13.0%, due to increases in our utility plant in service. Income tax expense increased $641,000, or 29.3%, due to increased profitability in 2002. Our total effective income tax rate for 2002 and 2001 was 40.4% and 39.7%, respectively.

Interest charges decreased $149,000, or 3.3%, primarily due to a $208,000 decrease in interest associated with our short-term debt. Average outstanding lines of credit during 2002 of $16.5 million increased by $2.3 million, compared to the average outstanding lines of credit during 2001 of $14.2 million. The average interest rate applied to these balances decreased from 4.8% in 2001 to 2.7% in 2002.

For the year ended December 31, 2002, our net income applicable to common stock increased $855,000, or 26.1%, compared to in 2001. The increase in net income was primarily due to decreases in purchased water and legal expenses, lower interest rates on short-term lines of credit, continued customer growth, and rate increases authorized in 2001 and 2002.

Revenues totaled $32.0 million in 2001 and were 16.1% above revenues in 2000 of $27.6 million, reflecting an increase in water sales of 15.8% due to customer growth and rate increases approved by the PSC in 2001. We realized 98.0% of our total revenue in 2001 from the sale of water.

We filed an application with the PSC on December 5, 2000, to increase rates for water service for all of Artesian Water's customers. A temporary rate increase calculated to increase annualized revenue by $2.5 million was approved by the PSC and placed into effect on February 3, 2001. We received final approval, in PSC Docket 00-647 on June 19, 2001, to increase rates up to a total annualized increase in revenues of $3.7 million, or $1.2 million more than permitted under temporary rates. The approval was the result of a stipulated settlement reached with the PSC Staff and Division of Public Advocate. The increase in revenues for the various customer classes will not consistently match changes in consumption levels for the class primarily due to our use of a multiple rate block structure. This structure charges different rates for different levels of consumption. In addition, rate increases are distributed among the rate blocks and service charges through a cost of service analysis and may not reflect, on an individual class or charge basis, the overall increase in rates approved by the PSC.

Residential water service revenues in 2001 amounted to $19.3 million, an increase of 17.4% over the $16.4 million recorded in 2000. The increase in 2001 followed an increase of 1.4% in 2000. The volume of water sold to residential customers, however, decreased marginally from 3,817 million gallons in 2000 to 3,809 million gallons in 2001. The number of residential customers served increased 2.0% in 2001.

Revenues from commercial customers in 2001 increased by 12.1% to $7.9 million, from $7.1 million in 2000. The volume of water sold to commercial customers increased by 16.9% from 2,039 million gallons in 2000 to 2,384 million gallons in 2001. The number of commercial customers served increased 1.1% in 2001.

Revenues from industrial customers in 2001 increased by 93.9% to $400,000, from $207,000 in 2000. The volume of water sold to industrial customers increased 108.9% from 79 million gallons in 2000 to 165 million gallons in 2001, primarily as a result of the addition of one new customer.

Government and other revenues in 2001 increased by 10.9% to $3.7 million, from $3.4 million in 2000. Revenues derived from state, federal and local governmental agencies totaled $700,000 in 2001, exceeding 2000 revenue by 41.8%. The remaining revenue increase was derived from the sale of water to neighboring utilities, public fire protection service, pools and other temporary and seasonal customers.

Other utility operating revenue, derived from contract operations, antenna leases on water tanks and finance charges increased 21.8% in 2001 to $509,000, from $418,000 in 2000. The increase is primarily a result of a 28.3% increase in revenues for antenna leases and the addition of contract operation agreements.

Operating expenses, excluding depreciation and taxes, increased approximately $2.2 million, or 14.4%, to $17.6 million in 2001. The increase in operating expenses resulted primarily from an increase in payroll and related expense of $1.2 million, or 15.7%, due to the addition of new employees and increases in annual merit compensation. Purchased water expenditures increased $201,000 over 2000 levels despite continuing to maintain minimum purchase requirements primarily due to the recognition of a credit in 2000 for water sold back to a provider in 2000. Repair and maintenance expenses increased as a result of an increase of $244,000 for tank painting expense, which reflects the first year of a five-year tank painting and maintenance agreement, which we entered into in 2000. Water treatment expense increased $86,000 reflecting the increased amount of chemicals used as a result of an increase in water pumped and a $42,000 increase related to the expanded testing of our sources of supply. Finally, our administrative expenses increased approximately $481,000, which primarily reflects the one-time $280,000 expense recognition for legal costs associated with the suspended negotiations for the purchase of Tidewater Utilities, a subsidiary of Middlesex Water Company. An additional $73,000 increase in our auditing and tax expense was recorded and reflects an increase in fees associated with the 2001 year end audit and additional fees related to our 2000 year end audit services. The remaining increase of $128,000 represents increases in a number of administrative expenses including bank fees, customer survey expense, regulatory commission expense and training expenses. The ratio of operating expense, excluding depreciation and taxes, to total revenue was 55.1% for the year ended December 31, 2001, compared to 55.9% for the year ended December 31, 2000.

Depreciation and amortization expense increased $295,000, or 10.9%, due to increases in our utility plant in service. Income tax expense increased $565,000, or 34.9%, due to increased profitability in 2001. Our total effective income tax rate for 2000 and 2001 was 39.8% and 39.7%, respectively.

Interest charges increased $482,000, or 11.9%, primarily due to an increase of $949,000 in interest related to long-term debt due to a full year recognition of interest on the Series O First Mortgage Bonds issued December 29, 2000, and the interest associated with the $4.3 million note issued by the Delaware Department of Health and Social Services on January 31, 2001. This increase is partially offset by a $353,000 decrease in interest associated with our short-term debt. The average outstanding lines of credit during 2001 of $14.2 million increased by $1.4 million, compared to the average outstanding lines of credit during 2000 of $12.8 million. However, the average interest rate applied to these balances decreased from 7.2% in 2000 to 4.8% in 2001. In addition, interest charges related to the early redemption of the Series K First Mortgage Bonds of $47,000 and $65,000 for refunds of revenues collected under bond which were in excess of the final rate increase award in 2000 were reflected in 2000 for which no similar entry was recorded in 2001.

For the year ended December 31, 2001, our net income applicable to common stock increased $880,000, or 36.8%, compared to the same period in 2000. The increase in net income was primarily due to rate increases authorized in 2000 and 2001, increases in consumption following a period of reduced consumption in 2000, a year with unusual frequency of summer rainfall, continued customer growth and lower interest rates on short-term lines of credit.

Our primary sources of liquidity for 2002 were $14.9 million in net proceeds from the issuance of Artesian Resources Class A Common Stock, $2.8 million provided by cash flow from operating activities and an increase of $2.5 million in contributions and advances. Cash flow from operating activities was primarily provided by our utility operations, and was impacted by the timeliness and adequacy of rate increases and reduced water usage as a result of the water restrictions and drought emergency in Delaware during 2002; this was offset by a change in receivable due to a pending refund related to the condemnation proceedings concerning our office building.

A significant part of our ability to maintain and meet our financial objectives is to assure our investments in utility plant are recovered in the rates charged to customers. As such, we file rate increase requests to recover increases in operating expenses and investments in utility plant, the timing of which is dependent upon the estimated cost of the administrative process in relation to the deficiency which is to be alleviated. We filed for a rate increase in April 2002, 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 December 3, 2002. This reflects a temporary increase of approximately 11.4%, which Artesian Water is permitted to collect by law, under bond, until the Public Service Commission makes a final rate determination. We expect a final decision on this matter in the first six months of 2003.

We rely on our sources of liquidity for investments in our utility plant and to meet our various payment obligations. We expect that our aggregate investments in our utility plant and systems in 2003 will be approximately $19.7 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 2003 are anticipated to be approximately $8.7 million. We expect that our available cash balances, our projected cash generated from operations and available bank credit lines will be sufficient to fund our activities for the next two years.

Capital expenditures decreased by approximately $2.9 million for the year ended December 31, 2002, or approximately 13.8%, from $21.3 million in 2001 to $18.4 million in 2002. Investment in utility plant, excluding advances and contributions in aid of construction received from real estate developers, decreased by $3.3 million, or 17.3%, from $19.2 million in 2001 to $15.9 million in 2002. Developers financed $2.3 million for the installation of water mains and hydrants serving their developments, compared to $2.1 million financed by developers in 2001.

We invested approximately $7.5 million in new transmission and distribution facilities, including refunds of advances for developer-financed infrastructure. We invested $5.4 million in new infrastructure to serve 1,837 new customers and $1.9 million in our rehabilitation program for transmission and distribution facilities, replacing aging or deteriorating mains.

Capital expenditures of $7.2 million were made to enhance or improve existing treatment facilities, rehabilitation of pumping equipment and installation of new wells to increase supply capabilities. We invested approximately $5.7 million for sources of supply to add new treatment processes and upgrade existing facilities and $1.5 million for new sources of supply throughout Delaware

The remaining $1.4 million of capital investment in 2002 was made for general plant, including fleet vehicles and computer equipment.

We have planned to invest approximately $19.7 million in utility plant in 2003. Developers are expected to finance an additional $4.3 million in utility plant construction. The largest portion of projected investment is primarily a result of our efforts to identify, develop, treat and protect sources of water supply to assure uninterrupted service to our customers. We expect to invest approximately $7.4 million in new treatment facilities, equipment and wells throughout Delaware.

As part of our total utility plant investment, we expect to invest over $11.8 million in transmission and distribution facilities. We project approximately $5.2 million will be invested in the relocations of facilities as a result of government mandates and renewals associated with the rehabilitation of aging infrastructure. We will also invest approximately $6.6 million in new transmission and distribution facilities to improve our system hydraulics and address service needs in growth areas of our service territory.

Approximately $5.7 million of expected utility plant investment represents expenditures for our general plant and equipment, such as fleet vehicles, computer equipment and tools. Of this expected investment, $3.8 million represents the purchase of Artesian Water's office and shop complex. Artesian Water, in December 2002, filed a condemnation action in the Delaware Superior Court, seeking to acquire title to the office and shop complex currently leased by Artesian, known as 664 Churchmans Road, Newark, Delaware (the "Property"). Artesian Water filed this action under its statutory power of eminent domain against the owner of the Property, White Clay Realty, a Delaware Limited Partnership, and each of the limited partners. White Clay Realty has no general partner and the Superior Court has ruled that the partnership is dissolved and all of the former partners now own the Property jointly as tenants in common. Certain of the officers and directors of Artesian Resources are tenants in common or the beneficiary of a tenant in common (Dian C. Taylor and John R. Eisenbrey, Jr.) A special committee of the Board of Directors, composed entirely of outside directors who have no ownership interest in the Property, made the determination to purchase the Property through the condemnation procedures. Under this procedure, if the acquisition of the Property is approved by the court, the fair market value of the Property will be determined by a panel of commissioners after an evidentiary hearing. Artesian Water's independent appraiser has valued the Property to be worth $3,800,000. In December 2002, Artesian Water issued a payment to the Prothonotary for the State of Delaware for $3,800,000. Until a final determination of the condemnation, the parties have agreed that Artesian Water may continue to occupy the Property under the terms of the lease with a quarterly rental payment of $43,361. As the court has delayed payment until the matter is decided, the amount is to be refunded to Artesian and is recorded as a receivable at December 31, 2002.

We have several sources of liquidity to finance our investment in utility plant and other fixed assets. We estimate that the projected investment of approximately $19.7 million will be financed by our operations and external sources, including a combination of capital investment and short-term borrowings under our revolving credit agreements discussed below. Developers are expected to finance, through advances and contributions in aid of construction, an additional $4.3 million of capital expenditures, which includes the installation of mains and hydrants in new developments.

Our cash flows from operations are primarily derived from water sales revenues and may be materially affected by changes in water sales due to weather and the timing and extent of increases in rates approved by the Delaware Public Service Commission`.

At December 31, 2002, 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, 2002, we had $17.2 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 banks' 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 our securities to meet capital requirements. The amount and timing of future sales of our securities will depend upon market conditions and our specific needs. Our trust indentures, which set certain criteria for the issuance of new long-term debt, limit long-term debt, including the short-term portion thereof, to 66 2/3% of total capitalization. Our debt to total capitalization, including the short-term portion thereof, was 48.93% at December 31, 2002.

In order to meet the expected level of investment in utility plant and retain future financing flexibility, we issued a $25 million Series P 6.58% First Mortgage Bond on January 31, 2003. With the proceeds we refinanced our Series L 8.03% First Mortgage Bond, which was due on February 1, 2003, along with $14.9 million of outstanding short-term debt under our lines of credit. Our debt to total capitalization, including the short-term portion thereof, was approximately 55.58% after this issuance.

On February 25, 2003, Artesian Water Company, Inc. (the "Company") entered into an agreement to borrow funds from the Delaware Drinking Water State Revolving Fund (the "Fund"). The Company previously received a binding commitment offer from the Fund for a loan in the amount of $2,900,285 for a term of twenty years at an interest rate of 3.57%. The loan will be used for costs associated with the installation of new public water systems for Keenwick West/Keenwick South and Route 54, Phase II projects in Sussex County, Delaware. The funds will be disbursed as construction is completed.

The 7% Preferred Stock was called on February 21, 2003. The total amount paid to shareholders was $30.00 per share or $326,040.

Long-term debt obligations reflect the maturities of certain series of our first mortgage bonds, which we intend to refinance when due. The state revolving fund loan obligation has an amortizing mortgage payment, payable over a 20-year period, and will be refinanced as future securities are issued. Both the long-term debt and the state revolving fund loan have certain provisions, which could result in default and subsequently require the obligation to be repaid, however, there are also specific cure provisions which allow us to avoid default of the obligation. We have not experienced conditions which would result in our default under these agreements, and we do not anticipate any such occurrence. Payments for unconditional purchase obligations reflect minimum water purchase obligations under our interconnection agreements with neighboring utilities.

In December 2002, the FASB issued Statement No. 148, "Accounting for Stock-Based Compensation-Transition and Disclosure." Statement No. 148 amends Statement No. 123, "Accounting for Stock-Based Compensation," by providing alternate methods of transitioning to fair value based accounting for Stock-Based compensation, for those who choose to change. It also amends disclosure requirements of SFAS No. 123 for both annual and interim financial statements. Certain of the disclosure modifications are required for fiscal years ending after December 15, 2002, and are included in the notes to these consolidated financial statements.

In June 2002, the FASB issued Statement No. 146, "Accounting for Costs Associated with Exit or Disposal Activities." This statement nullifies EITF 94-3, which addressed this subject. The statement requires recognition of a liability for a cost associated with an exit or disposal activity when the liability is incurred. Our adoption of this statement will not have a material impact on our financial condition or results of operation.

In April 2002, the FASB issued Statement No. 145, "Rescission of FASB Statements No. 4, 44 and 64, Amendment of FASB Statement No. 13 and Technical Corrections." Statement No. 145 eliminates accounting treatment described in Statements 4 and 64 related to Extinguishment of Debt and amends Statement 13 regarding the use of sale - lease back accounting. Our adoption of this statement will not have a material impact on our financial condition or results of operation.

In August 2001, the FASB issued Statement No. 143, "Accounting for Asset Retirement Obligations." Statement No. 143 addresses financial accounting and reporting for obligations associated with the retirement of tangible long-lived assets and the associated asset retirement costs. Statement No. 143 requires recognition of a liability at fair value and an increase to the carrying value of the related asset for any retirement obligation. This amount would then be amortized over the life of the asset. The liability would be adjusted at the end of each period to reflect the passage of time and changes in the estimated future cash flows. This statement is effective January 2003. Our adoption of this statement will not have a material impact on our financial condition or results of operations

In November 2002, the FASB issued Interpretation No. 45, "Guarantor's Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness to Others," an interpretation of FASB Statements No. 5, 57 and 107 and a rescission of FASB Interpretation No. 34. This Interpretation elaborates on the disclosures to be made by a guarantor in its interim and annual financial statements about its obligations under guarantees issued. The Interpretation also clarifies that a guarantor is required to recognize, at inception of a guarantee, a liability for the fair value of the obligation undertaken. The initial recognition and measurement provisions of the Interpretation are applicable to guarantees issued or modified after December 31, 2002 and are not expected to have a material effect on the Company's financial statements. The disclosure requirements are effective for financial statements of interim and annual periods ending after December 31, 2002.

Statements in this Annual Report which express our "belief," "anticipation," "projection" 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. These may include statements regarding our goals, priorities and growth and expansion plans, the timing and the amount of a final decision in our pending rate case, our investment in utility plant and systems in 2003, and our sources of financing. Also included is our anticipated payments due in 2003 and satisfaction of our debt covenants. Such statements involve risks and uncertainties that could cause actual results to differ materially from those projected, including 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 and the other risks set forth in our Registration Statement on Form S-2, Registration number 333-87864, under the caption "Risk Factors." All of the forward-looking statements made in this Annual Report are based on our current beliefs and we undertake no obligation to update any of these cautionary statements.