EX-23.1
 


UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 10-K
 
(Mark One)
þ
 
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2006
 
OR
 
¨
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from _________________ to______________________
 
Commission File Number     0-422
 
MIDDLESEX WATER COMPANY
(Exact name of registrant as specified in its charter)
 
New Jersey
22-1114430
(State of Incorporation)
(IRS employer identification no.)
 
1500 Ronson Road, Iselin NJ 08830
(Address of principal executive offices, including zip code)
 
(732) 634-1500
(Registrant's telephone number, including area code)
 
Securities registered pursuant to Section 12(b) of the Act:
Title of Each Class:
Name of each exchange on which registered:
None
None
 
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, No par Value
(Title of Class)
 
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.   Yes ¨ No þ
 
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.  Yes þ No ¨

Indicate by check mark if 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.   þ
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act.   
Large accelerated filer ¨
Accelerated filer þ
Non-accelerated filer ¨
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).    Yes ¨ No þ
 
The aggregate market value of the voting stock held by non-affiliates of the registrant at June 30, 2006 was $210,829,136 based on the closing market price of $18.92 per share.
 
The number of shares outstanding for each of the registrant's classes of common stock, as of March 1, 2007:
 
Common Stock, No par Value 13,184,376 shares outstanding
 
Documents Incorporated by Reference
Proxy Statement to be filed in connection with the Registrant’s Annual Meeting of Shareholders to be held on May 23, 2007, which will be filed with the Securities and Exchange Commission within 120 days, is incorporated as to Part III.






MIDDLESEX WATER COMPANY
FORM 10-K

INDEX

 
 
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Forward-Looking Statements
 
Certain statements contained in this annual report and in the documents incorporated by reference constitute “forward-looking statements” within the meaning of Section 21E of the Securities Exchange Act of 1934 and Section 27A of the Securities Act of 1933. The Company intends that these statements be covered by the safe harbors created under those laws. These statements include, but are not limited to:
 
 
-
statements as to expected financial condition, performance, prospects and earnings of the Company;
 
-
statements regarding strategic plans for growth;
 
-
statements regarding the amount and timing of rate increases and other regulatory matters;
 
-
statements as to the Company’s expected liquidity needs during fiscal 2007 and beyond and statements as to the sources and availability of funds to meet its liquidity needs;
 
-
statements as to expected rates, consumption volumes, service fees, revenues, margins, expenses and operating results;
 
-
statements as to the Company’s compliance with environmental laws and regulations and estimations of the materiality of any related costs;
 
-
statements as to the safety and reliability of the Company’s equipment, facilities and operations;
 
-
statements as to financial projections;
 
-
statements as to the ability of the Company to pay dividends;
 
-
statements as to the Company’s plans to renew municipal franchises and consents in the territories it serves;
 
-
expectations as to the amount of cash contributions to fund the Company’s retirement benefit plans, including statements as to anticipated discount rates and rates of return on plan assets;
 
-
statements as to trends; and
 
-
statements regarding the availability and quality of our water supply.
 
These forward-looking statements are subject to risks, uncertainties and other factors that could cause actual results to differ materially from future results expressed or implied by the forward-looking statements. Important factors that could cause actual results to differ materially from anticipated results and outcomes include, but are not limited to:
 
 
-
the effects of general economic conditions;
 
-
increases in competition in the markets served by the Company;
 
-
the ability of the Company to control operating expenses and to achieve efficiencies in its operations;
 
-
the availability of adequate supplies of water;
 
-
actions taken by government regulators, including decisions on base rate increase requests;
 
-
new or additional water quality standards;
 
-
weather variations and other natural phenomena;
 
-
the existence of attractive acquisition candidates and the risks involved in pursuing those acquisitions;
 
-
acts of war or terrorism;
 
-
significant changes in the housing starts in Delaware;
 
-
the availability and cost of capital resources; and
 
-
other factors discussed elsewhere in this prospectus.
 
Many of these factors are beyond the Company’s ability to control or predict. Given these uncertainties, readers are cautioned not to place undue reliance on any forward-looking statements, which only speak to the Company’s understanding as of the date of this report. The Company does not undertake any obligation to release publicly any revisions to these forward-looking statements to reflect events or circumstances after the date of this prospectus or to reflect the occurrence of unanticipated events, except as may be required under applicable securities laws.
 
For an additional discussion of factors that may affect the Company’s business and results of operations, see Item 1A - Risk Factors.
 

1


PART I
 
Item 1. Business.
 
Overview

Middlesex Water Company (“Middlesex”) was incorporated as a water utility company in 1897 and owns and operates regulated water utility and wastewater systems in New Jersey and Delaware. The Company also operates water and wastewater systems under contract on behalf of municipal and private clients in New Jersey and Delaware.

The terms “the Company,” “we,” “our,” and “us” refer to Middlesex Water Company and its subsidiaries, including Tidewater Utilities, Inc. (Tidewater) and Tidewater’s wholly-owned subsidiaries, Southern Shores Water Company, LLC (Southern Shores) and White Marsh Environmental Systems, Inc. (White Marsh). The Company’s other subsidiaries are Pinelands Water Company (Pinelands Water) and Pinelands Wastewater Company (Pinelands Wastewater) (collectively, Pinelands), Utility Service Affiliates, Inc. (USA), Utility Service Affiliates (Perth Amboy) Inc., (USA-PA) and Tidewater Environmental Services, Inc. (TESI).

Middlesex principal executive offices are located at 1500 Ronson Road, Iselin, New Jersey 08830. Our telephone number is (732) 634-1500. Our internet website address is http://www.middlesexwater.com. We make available, free of charge through our internet website, reports and amendments filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, after such material is electronically filed with or furnished to the Securities and Exchange Commission (SEC).
 
Middlesex System
 
The Middlesex System in New Jersey provides water services to approximately 59,200 retail customers, primarily in eastern Middlesex County, New Jersey and provides water under wholesale contracts to the City of Rahway, Township of Edison, the Boroughs of Highland Park and Sayreville and both the Old Bridge and the Marlboro Township Municipal Utilities Authorities. The Middlesex System treats, stores and distributes water for residential, commercial, industrial and fire prevention purposes. The Middlesex System also provides water treatment and pumping services to the Township of East Brunswick under contract. The Middlesex System, through its retail and contract sales, produced approximately 67% of 2006 revenue.

The Middlesex System’s retail customers are located in an area of approximately 55 square miles in Woodbridge Township, the City of South Amboy, the Boroughs of Metuchen and Carteret, portions of the Township of Edison and the Borough of South Plainfield in Middlesex County and, to a minor extent, a portion of the Township of Clark in Union County. Retail customers include a mix of residential customers, large industrial concerns and commercial and light industrial facilities. These customers are located in generally well-developed areas of central New Jersey. The contract customers of the Middlesex System comprise an area of approximately 146 square miles with a population of approximately 303,000. Contract sales to Edison, Sayreville, Old Bridge, Marlboro and Rahway are supplemental to the existing water systems of these customers. The State of New Jersey in the mid-1980’s approved plans to increase available surface water supply to the South River Basin area of the state to facilitate a reduction in groundwater use in this area. The Middlesex System provides treated surface water under long-term agreements to East Brunswick, Marlboro, Old Bridge and Sayreville consistent with the state-approved plan.

Middlesex provides water service to approximately 300 customers in Cumberland County, New Jersey. This system is referred to as Bayview and is not physically interconnected with the Middlesex system. Bayview produced less than 1% of our total revenue in 2006. Bayview was legally merged into Middlesex effective January 1, 2006. 

2


Tidewater System
 
Tidewater, together with its wholly-owned subsidiary, Southern Shores, provides water services to approximately 30,100 retail customers for domestic, commercial and fire protection purposes in over 271 separate community water systems in New Castle, Kent and Sussex Counties, Delaware. An additional wholly-owned subsidiary, White Marsh, operates water and wastewater systems under contract for approximately 5,000 residential customers and also owns the office building that Tidewater uses as its business office. White Marsh’s rates for water and wastewater operations are not regulated by the Delaware Public Service Commission (PSC). The Tidewater System produced approximately 21% of total revenue in 2006.
 
Utility Service Affiliates-Perth Amboy
 
USA-PA operates the City of Perth Amboy, New Jersey’s water and wastewater systems under a 20-year agreement, which expires in 2018. USA-PA serves approximately 9,600 customers, most of whom are served by both systems. The agreement was effected under New Jersey’s Water Supply Public-Private Contracting Act and the New Jersey Wastewater Public/Private Contracting Act and requires USA-PA to lease from Perth Amboy all of its employees who currently work on the Perth Amboy water and wastewater systems. Under the agreement, USA-PA receives both fixed and variable fees. The variable position is based on customer billing. Fixed fee revenues were $7.6 million in 2006 and are to increase over the term of the 20-year contract to $10.2 million based upon a schedule of rates. USA-PA produced approximately 10% of total revenue in 2006.
 
In connection with the agreement, Middlesex guaranteed a series of Perth Amboy’s municipal bonds in the principal amount of approximately $26.3 million, of which approximately $23.4 million remains outstanding. In connection with the agreement with Perth Amboy, USA-PA entered into a 20-year subcontract with a wastewater operating company for the operation and maintenance of the Perth Amboy wastewater system. The subcontract provides for the sharing of certain fixed and variable fees and operating expenses.
 
Pinelands System
 
Pinelands Water provides water services to approximately 2,500 residential customers in Burlington County, New Jersey. Pinelands Water produced less than 1% of total revenue in 2006. Pinelands Water is not physically interconnected with the Middlesex System. 
 
Pinelands Wastewater provides wastewater services to approximately 2,500 primarily residential retail customers. Under contract, it also services one municipal wastewater system in Burlington County, New Jersey with about 200 residential customers. Pinelands Wastewater produced approximately 1% of total revenue in 2006.
 
Utility Service Affiliates, Inc.

USA provides residential customers a service line maintenance program called LineCareSM. LineCareSM is an affordable maintenance program that covers all parts, material and labor required to repair or replace specific elements of the customer’s water service line and customer shut-off valve in the event of a failure. USA produced less than 1% of total revenue in 2006.
 
TESI System

TESI, which was formed in 2005, provides wastewater services to approximately 115 residential retail customers in Delaware. TESI produced less than 1% of our total revenue in 2006.

3


Financial Information

Consolidated operating revenues and operating income are as follows:
 

   
(Thousands of Dollars)
Years Ended December 31,
 
   
2006
 
2005
 
2004
 
Operating Revenues
 
$
81,061
 
$
74,613
 
$
70,991
 
Operating Income
 
$
21,318
 
$
17,218
 
$
16,933
 
 
Operating revenues were earned from the following sources:
 
   
Years Ended December 31,
 
   
2006
 
2005
 
2004
 
               
Residential
   
42.6
%
 
41.9
%
 
39.9
%
Commercial
   
10.0
   
9.8
   
9.5
 
Industrial
   
10.7
   
11.0
   
10.9
 
Fire Protection
   
10.7
   
10.4
   
10.2
 
Contract Sales
   
12.3
   
13.4
   
12.8
 
Contract Operations
   
11.0
   
10.8
   
11.2
 
Other
   
2.7
   
2.7
   
5.5
 
                     
TOTAL
   
100.0
%
 
100.0
%
 
100.0
%
 
Water Supplies and Contracts
 
Our New Jersey and Delaware water supply systems are physically separate and are not interconnected. In New Jersey, the Pinelands System and Bayview System are not interconnected with the Middlesex System or each other. We believe that we have adequate sources of water supply to meet the current service requirements of our present customers in New Jersey and Delaware.

Middlesex System
 
Our Middlesex System, which produced approximately 17 billion gallons in 2006, obtains water from surface sources and wells, or groundwater sources. In 2006, surface sources of water provided approximately 71% of the Middlesex System’s water supply, groundwater sources provided approximately 23% from 31 wells and the balance was purchased from a non-affiliated water utility. Middlesex System’s distribution storage facilities are used to supply water to customers at times of peak demand, outages and emergencies. 

The principal source of surface water for the Middlesex System is the Delaware & Raritan Canal, which is owned by the State of New Jersey and operated as a water resource by the New Jersey Water Supply Authority. Middlesex is under contract with the New Jersey Water Supply Authority, which expires November 30, 2023. The contract provides for average purchases of 27 million gallons per day (mgd) of untreated water from the Delaware & Raritan Canal, augmented by the Round Valley/Spruce Run Reservoir System. Surface water is pumped to, and treated, at the Middlesex Carl J. Olsen (CJO) Plant. Middlesex also has an agreement with a non-affiliated regulated water utility for the purchase of treated water. This long-term agreement, which expires February 27, 2011, provides for minimum purchase of 3 mgd of treated water with provisions for additional purchases.

4


Tidewater System
 
Our Tidewater System, which produced approximately two billion gallons in 2006, obtains 100% of its supply from groundwater sources from 184 wells. In 2006, 19 new wells were placed into service. We deactivated, sealed and abandoned 10 wells for either water quality reasons or for the purpose of consolidating production facilities for more cost-efficient operation. Tidewater continues to submit applications to Delaware regulatory authorities for the approval of additional wells as growth, demand and water quality warrants. The Tidewater System does not have a central treatment facility but has several regional treatment plants. Several of its water systems in New Castle, Kent and Sussex Counties, Delaware have interconnected transmission systems.  

Pinelands System
 
Water supply to our Pinelands System is derived from groundwater sources from four wells which provided overall system delivery of 197 million gallons in 2006. The pumping capacity of the four wells is 2.2 million gallons per day.
 
Bayview System
 
Water supply to Bayview customers is derived from groundwater water sources from two wells, which delivered 7.7 million gallons in 2006.

Pinelands Wastewater System
 
The Pinelands Wastewater System discharges into the South Branch of the Rancocas Creek through a tertiary treatment plant that provides clarification, sedimentation, filtration and disinfection. The total capacity of the plant is 0.5 mgd, and the system provided overall treatment to 114 million gallons in 2006.

TESI System
 
The TESI System owns and operates five wastewater treatment systems in Southern Delaware. The treatment plants provide clarification, sedimentation, and disinfection. The combined total treatment capacity of the plants is 218,000 gallons per day. The treated effluent is disposed of through land application. Current average flow is approximately 12,000 gallons per day.

Employees
 
As of December 31, 2006, we had a total of 243 employees. In addition, we lease 19 full-time employees under the USA-PA contract with the City of Perth Amboy, New Jersey. No employees are represented by a union except the leased employees who are subject to a collective bargaining agreement with the City of Perth Amboy. We believe our employee relations are good. Wages and benefits, other than for leased employees, are reviewed annually and are considered competitive within both the industry and the regions where we operate.
 

5


Competition
 
Our business in our franchised service area is substantially free from direct competition with other public utilities, municipalities and other entities. However, our ability to provide contract water supply and wastewater services and operations and maintenance services is subject to competition from other public utilities, municipalities and other entities. Although Tidewater has been granted an exclusive franchise for each of its existing community water systems, its ability to expand service areas can be affected by the PSC awarding franchises to other regulated water utilities with whom we compete for such franchises and for projects.

Regulation
 
We are regulated as to rates charged to customers for water and wastewater services in New Jersey and Delaware, as to the quality of the services we provide and as to certain other matters. Our USA, USA-PA and White Marsh subsidiaries are not regulated utilities. We are subject to environmental and water quality regulation by the United States Environmental Protection Agency (EPA), and the New Jersey Department of Environmental Protection (DEP) with respect to operations in New Jersey and by Department of Natural Resources and Environmental Control (DNREC), the Delaware Department of Health and Social Services-Division of Public Health (DPH), and the Delaware River Basin Commission (DRBC) with respect to operations in Delaware. In addition, our issuances of securities are subject to the prior approval of the SEC and the New Jersey Board of Public Utilities (BPU) or the PSC.
 
Regulation of Rates and Services
 
New Jersey water and wastewater service operations (excluding the operations of USA and USA-PA) are subject to regulation by the BPU. Similarly, our Delaware water and wastewater operations (excluding the operations of White Marsh) are subject to regulation by the PSC. These regulatory authorities have jurisdiction with respect to rates, service, the issuance of securities and other matters of utility companies operating within the States of New Jersey and Delaware, respectively. For ratemaking purposes, we account separately for operations in New Jersey and Delaware to facilitate independent ratemaking by the BPU for New Jersey operations and the PSC for Delaware operations.
 
In determining our rates, the BPU and the PSC consider the income, expenses, rate base of property used and useful in providing service to the public and a fair rate of return on investments within their separate jurisdictions. Rate determinations by the BPU do not guarantee particular rates of return to us for our New Jersey operations nor do rate determinations by the PSC guarantee particular rates of return for our Delaware operations. Thus, we may not achieve the rates of return permitted by the BPU or the PSC.

On April 28, 2006, Tidewater filed for a $5.5 million, or 38.6%, base rate increase with the Delaware Public Service Commission (PSC). The request was intended to recover increased costs of operations, maintenance and taxes, as well as capital investment of approximately $23.8 million since rates were last established in March 2005. Since June 27, 2006, Tidewater has been billing and recognizing additional revenues through a 15% interim rate increase subject to refund as allowed under PSC regulations. A settlement was reached amongst the parties which concluded that a 26.9% overall increase in base rates would be implemented. The PSC approved the settlement and the remaining 11.9% increase was put into effect on February 28, 2007. The combined effect of the interim and final rate increases was $3.9 million in additional annual operating revenues.

Effective April 13, 2006, Pinelands Water and Pinelands Wastewater received approval from the New Jersey Board of Public Utilities (BPU) for base rate increases of 7.02% and 0.98%, respectively. These increases

6


represent a total base rate increase of approximately $0.1 million for Pinelands to offset increased costs associated with capital improvements and the operation and maintenance of their systems.

In accordance with the tariff established for Southern Shores, an annual rate increase of 3% was implemented on January 1, 2007. Under the terms of a contract with Southern Shores Homeowners Association, the increase cannot exceed the lesser of the regional Consumer Price Index or 3%.

There can be no assurance that any future rate increases will be granted or, if granted, that they will be in the amounts requested.

Water Quality and Environmental Regulations
 
Both the EPA and the DEP regulate our operations in New Jersey with respect to water supply, treatment and distribution systems and the quality of the water, as do the EPA, DNREC, DPH and DRBC with respect to operations in Delaware.
 
Federal, New Jersey and Delaware regulations adopted relating to water quality require us to perform expanded types of testing to ensure that our water meets state and federal water quality requirements. In addition, environmental regulatory agencies are reviewing current regulations governing the limits of certain organic compounds found in the water as byproducts of treatment. We participate in industry-related research to identify the various types of technology that might reduce the level of organic, inorganic and synthetic compounds found in the water. The cost to water companies of complying with the proposed water quality standards depends in part on the limits set in the regulations and on the method selected to implement such reduction. We believe the CJO Plant capabilities put us in a strong position to meet any such future standards with regard to our Middlesex System. We regularly test our water to determine compliance with existing federal, New Jersey and Delaware primary water quality standards.
 
Well water treatment in our Tidewater System is by chlorination for disinfection purposes and, in some cases, pH correction and filtration for nitrate and iron removal.

Well water treatment in the Pinelands and Bayview Systems (disinfection only) is done at individual well sites.

The DEP and the DPH monitor our activities and review the results of water quality tests that are performed for adherence to applicable regulations. Other regulations applicable to us include the Lead and Copper Rule, the maximum contaminant levels established for various volatile organic compounds, the Federal Surface Water Treatment Rule and the Total Coliform Rule.

Management 

This table lists information concerning our executive management team:

Name
 
Age
 
Principal Position(s)
Dennis W. Doll
 
48
 
President and Chief Executive Officer
A. Bruce O’Connor
  
48
  
Vice President and Chief Financial Officer
Ronald F. Williams
 
57
 
Vice President-Operations and Chief Operating Officer
Kenneth J. Quinn
 
59
 
Vice President-General Counsel, Secretary and Treasurer
James P. Garrett
  
60
  
Vice President-Human Resources
Richard M. Risoldi
  
50
  
Vice President-Subsidiary Operations
Gerard L. Esposito
  
55
  
President, Tidewater Utilities, Inc.


7


Dennis W. Doll - Mr. Doll, a Certified Public Accountant, joined the Company in November 2004 as Executive Vice President. He was elected President and Chief Executive Officer and became a Director of Middlesex effective January 1, 2006. Prior to joining the Company, Mr. Doll was employed by Elizabethtown Water Company since 1985, serving most recently as a member of the senior leadership team of the Northeast Region of American Water, which was comprised of Elizabethtown Water Company, New Jersey-American Water Company and Long Island Water Corporation and included other regulated and non-regulated subsidiaries. In this capacity, Mr. Doll most recently served as Vice President - Finance & Controller and served previously, as Vice President - Merger Integration. Prior to 2001, Mr. Doll served as Vice President & Controller of Elizabethtown, Elizabethtown’s parent company, E’town Corporation, and various other regulated and non-regulated subsidiaries, primarily engaged in the water and wastewater fields. Effective January 1, 2006, Mr. Doll became Chairman of the Board and Director of all Middlesex subsidiaries. Mr. Doll is a director of the New Jersey Utilities Association and the National Association of Water Companies effective January 1, 2006.

A. Bruce O’Connor - Mr. O’Connor, a Certified Public Accountant, joined the Company in 1990 as Assistant Controller and was elected Controller in 1992 and Vice President in 1995. He was elected Vice President and Chief Financial Officer in 1996. He is responsible for financial reporting, customer service, rate cases, cash management and financings. He is Treasurer and a Director of Tidewater Utilities, Inc., Tidewater Environmental Services, Inc., Utility Service Affiliates, Inc., and White Marsh Environmental Systems, Inc. He is Vice President, Treasurer and a Director of Utility Service Affiliates (Perth Amboy) Inc., Pinelands Water Company and Pinelands Wastewater Company.
 
Ronald F. Williams - Mr. Williams joined the Company in 1995 as Assistant Vice President-Operations, responsible for the Company’s Engineering and Distribution Departments. He was elected Vice President-Operations in October 1995. Mr. Williams was elected to the additional posts of Assistant Secretary and Assistant Treasurer for Middlesex in 2004. He was formerly employed by Garden State Water Company as President and Chief Executive Officer. He is a Director and President of Utility Service Affiliates (Perth Amboy) Inc., and Director of Utility Service Affiliates, Inc., Pinelands Water Company and Pinelands Wastewater Company.
 
Kenneth J. Quinn - Mr. Quinn joined the Company in 2002 as General Counsel and was elected Assistant Secretary in 2003. In 2004, Mr. Quinn was elected Vice President, Secretary and Treasurer for Middlesex and Secretary and Assistant Treasurer for all subsidiaries of Middlesex. Prior to joining the Company he had been employed in private law practice. Prior to that, Mr. Quinn spent 10 years as in-house counsel to two major banking institutions located in New Jersey. In May 2003, he was elected Assistant Secretary of Tidewater Utilities, Inc., Pinelands Water Company, Pinelands Wastewater Company, Utility Service Affiliates (Perth Amboy) Inc., and White Marsh Environmental Systems, Inc. He is a member of the New Jersey State Bar Association and is also a member of the Public Utility Law Section of the Bar.

James P. Garrett - Mr. Garrett joined the Company in 2003 as Assistant Vice President-Human Resources. In May 2004, he was elected Vice President- Human Resources. Prior to his hire, Mr. Garrett was employed by a national retail chain as Director of Organizational Development. 

Richard M. Risoldi - Mr. Risoldi joined the Company in 1989 as Director of Production, responsible for the operation and maintenance of the Company’s treatment and pumping facilities. He was appointed Assistant Vice President of Operations in 2003. He was elected Vice President in May 2004, responsible for regulated subsidiary operations and business development. He is a Director of Tidewater Utilities, Inc., Tidewater Environmental Services, Inc., White Marsh Environmental Systems Inc and USA-PA. He also serves as Director and President of Pinelands Water Company, Pinelands Wastewater Company and Utility Service Affiliates, Inc.

8


Gerard L. Esposito - Mr. Esposito joined Tidewater Utilities, Inc. in 1998 as Executive Vice President. He was elected President of Tidewater and White Marsh Environmental Systems, Inc. in 2003 and elected President of Tidewater Environmental Services, Inc. in January 2005. Prior to joining the Company he worked in various executive positions for Delaware environmental protection and water quality governmental agencies. He is a Director of Tidewater Utilities, Inc., Tidewater Environmental Services, Inc., and White Marsh Environmental Systems, Inc.


9


Item 1A.  Risk Factors.

 
Our revenue and earnings depend on the rates we charge our customers. We cannot raise utility rates in our regulated businesses without filing a petition with the appropriate governmental agency. If these agencies modify, delay, or deny our petition, our revenues will not increase and our earnings will decline unless we are able to reduce costs.

The BPU regulates our public utility companies in New Jersey with respect to rates and charges for service, classification of accounts, awards of new service territory, acquisitions, financings and other matters. That means, for example, that we cannot raise the utility rates we charge to our customers without first filing a petition with the BPU and going through a lengthy administrative process. In much the same way, the PSC regulates our public utility companies in Delaware. We cannot give assurance of when we will request approval for any such matter, nor can we predict whether the BPU or PSC will approve, deny or reduce the amount of such requests.

Certain costs of doing business are not completely within our control. The failure to obtain any rate increase would prevent us from increasing our revenues and, unless we are able to reduce costs, would result in reduced earnings.

We are subject to environmental laws and regulations, including water quality and wastewater effluent quality regulations, as well as other state and local regulations. Compliance with those laws and regulations requires us to incur costs and we are subject to fines or other sanctions for non-compliance.

The EPA and DEP regulate our operations in New Jersey with respect to water supply, treatment and distribution systems and the quality of the water. Our operations in Delaware are regulated by the EPA, DNREC, DPH, and DRBC with respect to water supply, treatment and distribution systems and the quality of water. Federal, New Jersey and Delaware regulations relating to water quality require us to perform expanded types of testing to ensure that our water meets state and federal water quality requirements. We are subject to EPA regulations under the Federal Safe Drinking Water Act, which include the Lead and Copper Rule, the maximum contaminant levels established for various volatile organic compounds, the Federal Surface Water Treatment Rule and the Total Coliform Rule. There are also similar state regulations by the DEP in New Jersey. The DEP and DPH monitor our activities and review the results of water quality tests that we perform for adherence to applicable regulations. In addition, environmental regulatory agencies are continually reviewing regulations governing the limits of certain organic compounds found in the water as byproducts of treatment.

We are also subject to regulations related to fire protection services. In Delaware, fire protection is regulated statewide by the Office of State Fire Marshal. In New Jersey there is no state-wide fire protection regulatory agency. However, state regulations exist as to the size of piping required regarding the provision of fire protection services.

The cost of compliance with the water and wastewater effluent quality standards depends in part on the limits set in the regulations and on the method selected to implement them. If new or more restrictive standards are imposed, the cost of compliance could be very high and have an adverse impact on our revenues and results of operations if we cannot recover those costs through our rates that we charge our customers. The cost of compliance with fire protection requirements could also be high and make us less profitable if we cannot recover those costs through our rates charged to our customers.

10


In addition, if we fail to comply with environmental or other laws and regulations to which our business is subject, we could be fined or subject to other sanctions, which could adversely impact our business or results of operations.
 
We are currently appealing a notice of violation and request for corrective action issued by the Delaware Fire Marshal regarding the alleged failure of one of the community water systems operated by Tidewater to meet Delaware fire protection requirements. If our appeal is unsuccessful, our operating results could be materially affected.

In July 2005, Tidewater received a notice of violation and request for corrective action issued by the Delaware Fire Marshal regarding the alleged failure of one of the community water systems operated by Tidewater to meet Delaware fire protection requirements. Tidewater appealed the Fire Marshal’s decision with the Delaware State Fire Prevention Commission (the “SFPC’) and, in November 2005, the SFPC denied Tidewater’s appeal. In December 2005, Tidewater filed an appeal of the SFPC’s decision with the Sussex County Superior Court in Delaware, which is still pending. There are approximately 67 of our other systems that may not meet the Delaware Fire Marshal’s recent interpretation of the fire protection requirements. If the Delaware Fire Marshal’s interpretation of the regulations is upheld upon appeal, we may be required to make corrections to the system at issue with an estimated cost of $1.6 million, and there is a possibility that the Delaware Fire Marshal could subsequently issue notices of violation and requests for corrective action for some or all of 67 of our other community systems. At this time, we cannot predict how many community water systems would ultimately require corrective action in that case, the time of the required corrective actions, or the costs we would incur to take the actions. We will apply to the PSC to increase base rates to recover the costs of any such corrective actions. However, if corrective actions need to be taken at several community water systems, our costs could be significant, and to the extent the PSC does not approve rate increases to offset these costs, or if there is a significant delay in receiving approval for such rate increases, such costs could have a material adverse effect on our operating results.

We depend upon our ability to raise money in the capital markets to finance some of the costs of complying with laws and regulations, including environmental laws and regulations or to pay for some of the costs of improvements to or the expansion of our utility system assets. Our regulated utility companies cannot issue debt or equity securities without regulatory approval.

We require financing to fund the ongoing capital program for the improvement of our utility system assets and for planned expansion of those systems. We expect to spend between $122 million and $194 million for capital projects through 2009. We must obtain regulatory approval to sell debt or equity securities to raise money for these projects. If sufficient capital is not available or the cost of capital is too high, or if the regulatory authorities deny a petition of ours to sell debt or equity securities, we may not be able to meet the costs of complying with environmental laws and regulations or the costs of improving and expanding our utility system assets to the level we believe necessary. This might result in the imposition of fines or restrictions on our operations and may curtail our ability to improve upon and expand our utility system assets.

Weather conditions and overuse of underground aquifers may interfere with our sources of water, demand for water services and our ability to supply water to customers.

Our ability to meet the existing and future water demands of our customers depends on an adequate supply of water. Unexpected conditions may interfere with our water supply sources. Drought and overuse of underground aquifers may limit the availability of ground and/or surface water. Freezing weather may also contribute to water transmission interruptions caused by pipe and/or main breakage. Any interruption in our water supply could cause a reduction in our revenue and profitability. These factors might adversely affect our ability to supply water in sufficient quantities to our customers. Governmental drought restrictions might result in decreased use of water services and can adversely affect our revenue and earnings.

11


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

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

Our water sources may become contaminated by naturally-occurring or man-made compounds and events. This may cause disruption in services and impose costs to restore the water to required levels of quality.

Our sources of water may become contaminated by naturally-occurring or man-made compounds and events. In the event that our water supply is contaminated, we may have to interrupt the use of that water supply until we are able to install treatment equipment or substitute the flow of water from an uncontaminated water source through our transmission and distribution systems. We may also incur significant costs in treating the contaminated water through the use of our current treatment facilities, or development of new treatment methods. Our inability to substitute water supply from an uncontaminated water source, or to adequately treat the contaminated water source in a cost-effective manner may reduce our revenues and make us less profitable.

We face competition from other water and wastewater utilities and service providers which might hinder our growth and reduce our profitability.

We face risks of competition from other utilities authorized by federal, state or local agencies. Once a state utility regulator grants a franchise to a utility to serve a specific territory, that utility has an exclusive right to service that territory. Although a new franchise offers some protection against competitors, the pursuit of franchises is competitive, especially in Delaware where new franchises may be awarded to utilities based upon competitive negotiation. Competing utilities have challenged, and may in the future challenge, our applications for new franchises. Also, third parties entering into long-term agreements to operate municipal systems might adversely affect us and our long-term agreements to supply water on a contract basis to municipalities, which adversely affect our operating results.

We have a long-term contractual obligation for water and wastewater system operation and maintenance under which we may incur costs in excess of payments received.

Middlesex Water Company and USA-PA operate and maintain the water and wastewater systems of the City of Perth Amboy, New Jersey under a 20-year contract expiring in 2018. This contract does not protect us against incurring costs in excess of revenues we earn pursuant to the contract. There can be no absolute assurance that we will not experience losses resulting from this contract. Losses under this contract or our failure or inability to perform may have a material adverse effect on our financial condition and results of operations. Also, in connection with the contract, Perth Amboy, through the Middlesex County Improvement Authority, issued approximately $68.0 million in three series of bonds. Middlesex guaranteed one of those series of bonds, designated the Series C Serial Bonds, in the principal amount of approximately $26.3 million. As of December 31, 2006, approximately $23.4 million of the Series C Serial Bonds remain outstanding. If Perth Amboy defaults on its obligations to pay the bonds we have guaranteed, we would have to raise funds to meet our obligations under that guarantee.

12



An important element of our growth strategy is the acquisition of water and wastewater assets, operations, contracts or companies. Any pending or future acquisitions we decide to undertake may involve risks.

The acquisition and/or operation of water and wastewater systems is an important element in our growth strategy. This strategy depends on identifying suitable opportunities and reaching mutually agreeable terms with acquisition candidates or contract partners. These negotiations, as well as the integration of acquired businesses, could require us to incur significant costs and cause diversion of our management’s time and resources. Further, acquisitions may result in dilution of our equity securities, incurrence of debt and contingent liabilities, fluctuations in quarterly results and other related expenses. In addition, the assets, operations, contracts or companies we acquire may not achieve the sales and profitability expected.


The current concentration of our business in central New Jersey and Delaware makes us susceptible to any adverse development in local regulatory, economic, demographic, competitive and weather conditions.

Our Middlesex System provides water services to retail customers who are located primarily in eastern Middlesex County, New Jersey and provides water under wholesale contracts to the Township of Edison, the Boroughs of Highland Park and Sayreville, and both the Old Bridge and the Marlboro Township Municipal Utilities Authorities, and the City of Rahway in Union County, New Jersey. Our Tidewater System provides water services to retail customers in the State of Delaware. Our revenues and operating results are therefore subject to local regulatory, economic, demographic, competitive and weather conditions in a relatively concentrated geographic area. A change in any of these conditions could make it more costly or difficult for us to conduct our business. In addition, any such change would have a disproportionate effect on us, compared to water utility companies that do not have such a geographic concentration.

The necessity for increased security has and may continue to result in increased operating costs.

Since the September 11, 2001 terrorist attacks and the continuing threats to the health and security of the United States of America, we have taken steps to increase security measures at our facilities and heighten employee awareness of threats to our water supply. We have tightened our security measures regarding the delivery and handling of certain chemicals used in our business. We are at risk for terrorist attacks and have incurred, and will continue to incur increased costs for security precautions to protect our facilities, operations and supplies from such risks.

Our ability to achieve growth in Delaware is somewhat dependent on the residential building market in the territories we serve. If housing starts decline significantly, our rate of growth may not meet our expectations.

We expect our revenues to increase from customer growth in Delaware for our regulated water operations and, to a lesser degree, our regulated wastewater operations as a result of the anticipated construction and sale of new housing units in the territories we serve. Although the residential building market in Delaware has experienced growth in recent years, this growth may not continue in the future. If housing starts in the Delaware territories we serve decline significantly as a result of economic conditions or otherwise, our revenue growth may not meet our expectations and our financial results could be negatively impacted.

 

13


We have restrictions on our dividends. There can also be no assurance that we will continue to pay dividends in the future or, if dividends are paid, that they will be in amounts similar to past dividends.

 
Our Restated Certificate of Incorporation and our Indenture of Mortgage dated as of April 1, 1927, as supplemented, impose conditions on our ability to pay dividends. We have paid dividends on our common stock each year since 1912 and have increased the amount of dividends paid each year since 1973.
 
Our earnings, financial condition, capital requirements, applicable regulations and other factors, including the timeliness and adequacy of rate increases, will determine both our ability to pay dividends on common stock and the amount of those dividends. There can be no assurance that we will continue to pay dividends in the future or, if dividends are paid, that they will be in amounts similar to past dividends.
 
If we are unable to pay the principal and interest on our indebtedness as it comes due or we default under certain other provisions of our loan documents, our indebtedness could be accelerated and our results of operations and financial condition could be adversely affected.

Our ability to pay the principal and interest on our indebtedness as it comes due will depend upon our current and future performance. Our performance is affected by many factors, some of which are beyond our control. We believe that our cash generated from operations, and, if necessary, borrowings under our existing credit facilities, will be sufficient to enable us to make our debt payments as they become due. If, however, we do not generate sufficient cash, we may be required to refinance our obligations or sell additional equity, which may be on terms that are not as favorable to us.

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

We depend significantly on the services of the members of our senior management team, and the departure of any of those persons could cause our operating results to suffer.

Our success depends significantly on the continued individual and collective contributions of our senior management team. If we lose the services of any member of our senior management or are unable to hire and retain experienced management personnel, it could affect our operating results.

We are subject to anti-takeover measures that may be used by existing management to discourage, delay or prevent changes of control that might benefit non-management shareholders.

Subsection 10A of the New Jersey Business Corporation Act, known as the Shareholder Protection Act, applies to us. The Shareholder Protection Act deters merger proposals, tender offers or other attempts to effect changes in our control that are not negotiated and approved by our Board of Directors. In addition, we have a classified Board of Directors, which means only one-third of the Directors are elected each year. A classified Board can make it harder for an acquirer to gain control by voting its candidates onto the Board of Directors and may also deter merger proposals and tender offers. Our Board of Directors also has the ability, subject to obtaining BPU approval, to issue one or more series of preferred stock having such number of shares, designation, preferences, voting rights, limitations and other rights as the Board of Directors may fix. This could be used by the Board of Directors to discourage, delay or prevent an acquisition that might benefit non-management shareholders.


 

14


 
Item 1B.  Unresolved Staff Comments.
 
None.
 
Item 2. Properties.

Utility Plant
 
The water utility plant in our systems consist of source of supply, pumping, water treatment, transmission and distribution, general facilities and all appurtenances, including all connecting pipes.
 
Middlesex System
 
The Middlesex System’s principal source of surface supply is the Delaware & Raritan Canal owned by the State of New Jersey and operated as a water resource by the New Jersey Water Supply Authority.
 
Water is withdrawn from the Delaware & Raritan Canal at New Brunswick, New Jersey through our intake and pumping station, located on state-owned land bordering the canal. Water is transported through two raw water pipelines for treatment and distribution at our CJO Plant in Edison, New Jersey.

The CJO Plant includes chemical storage and chemical feed equipment, two dual rapid mixing basins, four upflow clarifiers which are also called superpulsators, four underground reinforced chlorine contact tanks, twelve rapid filters containing gravel, sand and anthracite for water treatment and a steel washwater tank. The CJO Plant also includes a computerized Supervisory Control and Data Acquisitions system to monitor and control the CJO Plant and the water supply and distribution system in the Middlesex System. There is an on-site State certified laboratory capable of performing bacteriological, chemical, process control and advanced instrumental chemical sampling and analysis. The firm design capacity of the CJO Plant is 45 mgd (60 mgd maximum capacity). The main pumping station at the CJO Plant has a design capacity of 90 mgd. The four electric motor-driven, vertical turbine pumps presently installed have an aggregate capacity of 72 mgd.

In addition, there is a 15 mgd auxiliary pumping station located at the CJO Plant location. It has a dedicated substation and emergency power supply provided by a diesel-driven generator. It pumps from the 10 million gallon distribution storage reservoir directly into the distribution system.

The transmission and distribution system is comprised of 732 miles of mains and includes 23,200 feet of 48-inch reinforced concrete transmission main connecting the CJO Plant to our distribution pipe network and related storage facilities. Also included is a 58,600 foot transmission main and a 38,800 foot transmission main, augmented with a long-term, non-exclusive agreement with the East Brunswick system to transport water to several of our contract customers.

Middlesex System’s storage facilities consist of a 10 million gallon reservoir at the CJO Plant, 5 million gallon and 2 million gallon reservoirs in Edison (Grandview), a 5 million gallon reservoir in Carteret (Eborn) and a 2 million gallon reservoir at the Park Avenue Well Field.
 
In New Jersey, we own the properties on which Middlesex System’s 31 wells are located, the properties on which our storage tanks are located as well as the property where the CJO Plant is located. We also own our headquarters complex located at 1500 Ronson Road, Iselin, New Jersey, consisting of a 27,000 square foot office building and an adjacent 16,500 square foot maintenance facility.
 

15


Tidewater System
 
The Tidewater System is comprised of 87 production plants that vary in pumping capacity from 26,000 gallons per day to 2.0 mgd. Water is transported to our customers through 520 miles of transmission and distribution mains. Storage facilities include 45 tanks, with an aggregate capacity of 5.8 million gallons. Our Delaware operations are managed from Tidewater’s offices in Dover, Delaware and Millsboro, Delaware. Tidewater’s Dover, Delaware office property, located on property owned by White Marsh, consists of a 6,800 square foot office building situated on an eleven-acre lot.
 
Pinelands System
 
Pinelands Water owns well site and storage properties in Southampton Township, New Jersey. The Pinelands Water storage facility is a 1.2 million gallon standpipe. Water is transported to our customers through 18 miles of transmission and distribution mains.
 
Pinelands Wastewater System
 
Pinelands Wastewater owns a 12 acre site on which its 0.5 million gallons per day capacity tertiary treatment plant and connecting pipes are located. Its wastewater collection system is comprised of approximately 25 miles of main.
 
Bayview System
 
Bayview owns two well sites, which are located in Downe Township, Cumberland County, New Jersey. Water is transported to its customers through our 3.5 mile distribution system.

TESI System
 
The TESI System owns and operates five wastewater treatment systems in Southern Delaware. The treatment plants provide clarification, sedimentation, and disinfection. The combined total capacity of the plants is 218,000 gallons per day.

USA-PA, USA and White Marsh
 
Our non-regulated subsidiaries, namely USA-PA, USA and White Marsh, do not own utility plant property.

Item 3. Legal Proceedings.

In July 2005, Tidewater received a notice of violation and request for corrective action issued by the Delaware Fire Marshal regarding the alleged failure of one of the community water systems operated by Tidewater to meet Delaware fire protection requirements. Tidewater appealed the Fire Marshal’s decision with the Delaware State Fire Prevention Commission (the “SFPC”) and, in November 2005, the SFPC denied Tidewater’s appeal. In December 2005, Tidewater filed an appeal of the SFPC’s decision with the Sussex County Superior Court in Delaware, which is still pending. There are approximately 67 of our other systems that may not meet the Delaware Fire Marshal’s recent interpretation of the fire protection requirements. If the Delaware Fire Marshal’s interpretation of the regulations is upheld upon appeal, we may be required to make corrections to the system at issue and the Delaware Fire Marshal could issue notices of violation and requests for corrective action for some or all of the approximately 67 other community systems. At this time, we cannot predict how many community water systems would ultimately require corrective action if our appeal is unsuccessful nor can we predict the timing and the cost of any required corrective actions. We will apply to the PSC to increase base rates to recover the costs of any such corrective actions. However, if corrective actions need to be taken at several community water systems, our costs could be significant, and to the extent

16


the PSC does not approve rate increases to offset these costs, or if there is a significant delay in receiving approval for such rate increases, such costs could have a material adverse effect on our operating results.

The Court action is currently on hold while the parties, with the assistance of a mediator, have met in an attempt to resolve as many open issues as possible. If any significant issues remain open after these discussions, they will be referred back to the Court for ultimate decision.

The Company is a defendant in lawsuits in the normal course of business. We believe the resolution of pending claims and legal proceedings will not have a material adverse effect on the Company’s consolidated financial statements.
 
Item 4. Submission of Matters to a Vote of Security Holders.

None.

PART II

Item 5. Market for the Registrant's Common Equity and Related Stockholder Matters.

The Company’s common stock is traded on the NASDAQ Stock Market, under the symbol MSEX. The following table shows the range of high and low share prices per share for the common stock and the dividend paid to shareholders in such quarter. As of December 31, 2006, there were 2,032 holders of record.

2006
 
High
 
Low
 
Dividend
 
               
Fourth Quarter
 
$
19.50
 
$
17.96
 
$
0.1725
 
Third Quarter
   
20.50
   
17.58
   
0.1700
 
Second Quarter
   
19.34
   
16.50
   
0.1700
 
First Quarter
   
19.72
   
17.03
   
0.1700
 

2005
 
High
 
Low
 
Dividend
 
               
Fourth Quarter
 
$
23.34
 
$
17.31
 
$
0.1700
 
Third Quarter
   
23.47
   
19.05
   
0.1675
 
Second Quarter
   
20.00
   
17.07
   
0.1675
 
First Quarter
   
19.16
   
17.64
   
0.1675
 

The Company has paid dividends on its common stock each year since 1912. Although it is the present intention of the Board of Directors of the Company to continue to pay regular quarterly cash dividends on its common stock, the payment of future dividends is contingent upon the future earnings of the Company, its financial condition and other factors deemed relevant by the Board of Directors at its discretion.

 

17




If four or more quarterly dividends are in arrears, the preferred shareholders, as a class, are entitled to elect two members to the Board of Directors in addition to Directors elected by holders of the common stock. In the event dividends on the preferred stock are in arrears, no dividends may be declared or paid on the common stock of the Company. Substantially all of the Utility Plant of the Company is subject to the lien of its mortgage, which also includes certain restrictions as to cash dividend payments and other distributions on common stock.

The Company maintains a shareholder approved Restricted Stock Plan, under which 63,837 shares of the Company’s common stock are held in escrow by the Company for key employees. Such stock is subject to forfeiture by the employee in the event of termination of employment within five years of the grant other than as a result of retirement, death or disability. The maximum number of shares authorized for grant under this plan is 240,000 shares.

Set forth below is a line graph comparing the yearly change in the cumulative total return (which includes reinvestment of dividends) of a $100 investment for the Company’s common stock, a peer group of investor-owned water utilities, and the Dow Jones Wilshire 5000 Stock Index for the period of five years commencing December 31, 2001. The current peer group includes American States Water Company, Aqua America Inc., Artesian Resources Corp., California Water Service Company, Connecticut Water Service, Inc., Pennichuck Corp., SJW Corp., Southwest Water Company, York Water Company and the Company. The Dow Jones Wilshire 5000 Stock Index measures the performance of all U.S. headquartered equity securities with readily available price data.


 

Performance Graph
 
2001
2002
2003
2004
2005
2006
Middlesex Water Company
100.00
96.10
128.26
123.82
117.36
131.45
Dow Jones Wilshire 5000
100.00
79.14
104.18
117.33
124.75
144.56
Peer Group
100.00
95.60
122.38
141.20
184.94
185.41


18


Item 6. Selected Financial Data.



CONSOLIDATED SELECTED FINANCIAL DATA
                     
(In Thousands Except per Share Data)
                     
                       
   
2006
 
2005
 
2004
 
2003
 
2002
 
Operating Revenues
 
$
81,061
 
$
74,613
 
$
70,991
 
$
64,111
 
$
61,933
 
Operating Expenses:
                               
Operations and Maintenance
   
43,345
   
42,156
   
39,984
   
36,195
   
32,767
 
Depreciation
   
7,060
   
6,460
   
5,846
   
5,363
   
4,963
 
Other Taxes
   
9,338
   
8,779
   
8,228
   
7,816
   
7,737
 
Total Operating Expenses
   
59,743
   
57,395
   
54,058
   
49,374
   
45,467
 
Operating Income
   
21,318
   
17,218
   
16,933
   
14,737
   
16,466
 
Other Income, Net
   
774
   
740
   
795
   
358
   
442
 
Interest Charges
   
7,012
   
6,245
   
5,468
   
5,227
   
5,144
 
Income Taxes
   
5,041
   
3,237
   
3,814
   
3,237
   
3,999
 
Net Income
   
10,039
   
8,476
   
8,446
   
6,631
   
7,765
 
Preferred Stock Dividend
   
248
   
251
   
255
   
255
   
255
 
Earnings Applicable to Common Stock
 
$
9,791
 
$
8,225
 
$
8,191
 
$
6,376
 
$
7,510
 
Earnings per Share:
                               
Basic
 
$
0.83
 
$
0.72
 
$
0.74
 
$
0.61
 
$
0.73
 
Diluted
 
$
0.82
 
$
0.71
 
$
0.73
 
$
0.61
 
$
0.73
 
Average Shares Outstanding:
                               
Basic
   
11,844
   
11,445
   
11,080
   
10,475
   
10,280
 
Diluted
   
12,175
   
11,784
   
11,423
   
10,818
   
10,623
 
Dividends Declared and Paid
 
$
0.683
 
$
0.673
 
$
0.663
 
$
0.649
 
$
0.634
 
Total Assets
 
$
370,267
 
$
324,383
 
$
305,634
 
$
267,956
 
$
251,971
 
Convertible Preferred Stock
 
$
2,856
 
$
2,856
 
$
2,961
 
$
2,961
 
$
2,961
 
Long-term Debt
 
$
130,706
 
$
128,175
 
$
115,281
 
$
97,377
 
$
87,483
 


19



Management's Discussion and Analysis of Financial Condition and Results of Operation.

The following discussions of the Company’s historical results of operations and financial condition should be read in conjunction with the Company’s consolidated financial statements and related notes.

Overview

Middlesex Water Company has operated as a water utility in New Jersey since 1897, and in Delaware, through our wholly-owned subsidiary, Tidewater, since 1992. We are in the business of collecting, treating, distributing and selling water for domestic, commercial, municipal, industrial and fire protection purposes. We also operate a New Jersey municipal water and wastewater system under contract and provide wastewater services in New Jersey and Delaware through our subsidiaries. We are regulated as to rates charged to customers for water and wastewater services, as to the quality of water service we provide and as to certain other matters in New Jersey and in Delaware. Only our USA, USA-PA and White Marsh subsidiaries are not regulated utilities.

Our New Jersey water utility system (the Middlesex System) provides water services to approximately 59,200 retail customers, primarily in central New Jersey. The Middlesex System also provides water service under contract to municipalities in central New Jersey with a total population of approximately 303,000. In partnership with our subsidiary, USA-PA, we operate the water supply system and wastewater system for the City of Perth Amboy, New Jersey. Our other New Jersey subsidiaries, Pinelands Water and Pinelands Wastewater, provide water and wastewater services to residents in Southampton Township, New Jersey.
 
Our Delaware subsidiaries, Tidewater and Southern Shores, provide water services to approximately 30,100 retail customers in New Castle, Kent and Sussex Counties, Delaware. Our TESI subsidiary provides wastewater services to approximately 115 residential retail customers. Our other Delaware subsidiary, White Marsh, services an additional 5,000 customers in Kent and Sussex Counties through 41 operations and maintenance contracts.
 
The majority of our revenue is generated from retail and contract water services to customers in our service areas. We record water service revenue as such service is rendered and include estimates for amounts unbilled at the end of the period for services provided after the last billing cycle. Fixed service charges are billed in advance by our subsidiary, Tidewater, and are recognized in revenue as the service is provided.
 
We expect the growth of our regulated wastewater business in Delaware will eventually become a more significant component of our operations.

Our ability to increase operating income and net income is based significantly on four factors: weather, adequate and timely rate relief, effective cost management, and customer growth. These factors are evident in the discussions below which compare our results of operations from prior years.

Operating Results by Segment

The Company has two operating segments, Regulated and Non-Regulated. Our Regulated segment contributed 89% and 89% of total revenues, and 94% and 95% of net income for the years ended December 31, 2006 and 2005, respectively. The discussion of the Company’s results of operations is on a consolidated basis, and includes significant factors by subsidiary. The segments in the tables included below are comprised of the following companies: Regulated- Middlesex, Tidewater, Pinelands, Southern Shores, and TESI; Non-Regulated- USA, USA-PA, and White Marsh.

20


Results of Operations in 2006 Compared to 2005
 
   
(Millions of Dollars)
Fiscal Years ended December 31,
 
   
2006
 
2005
 
   
Regulated
 
Non-Regulated
 
 
Total
 
Regulated
 
Non-Regulated
 
Total 
 
Revenues
 
$
71.9
 
$
9.2
 
$
81.1
 
$
66.3
 
$
8.3
 
$
74.6
 
Operations and maintenance
   
35.7
   
7.7
   
43.4
   
35.0
   
7.2
   
42.2
 
Depreciation
   
7.0
   
0.1
   
7.1
   
6.3
   
0.1
   
6.4
 
Other taxes
   
9.1
   
0.2
   
9.3
   
8.6
   
0.2
   
8.8
 
Operating income
   
20.1
   
1.2
   
21.3
   
16.4
   
0.8
   
17.2
 
                                   
Other income (expense)
   
0.9
   
(0.1
)
 
0.8
   
0.7
   
0.0
   
0.7
 
Interest expense
   
7.0
   
-
   
7.0
   
6.2
   
-
   
6.2
 
Income taxes
   
4.6
   
0.5
   
5.1
   
2.9
   
0.3
   
3.2
 
Net income
 
$
9.4
 
$
0.6
 
$
10.0
 
$
8.0
 
$
0.5
 
$
8.5
 
 
Operating revenues for the year rose $6.5 million, or 8.7% over the same period in 2005. Water sales improved by $2.8 million in our Middlesex System, of which $4.1 million was a result of a base rate increase that was granted to Middlesex on December 8, 2005. This increase was somewhat offset by lower consumption revenues of $1.3 million due to unfavorable weather from mid-July through the late fall of 2006 as compared to the prior year. Customer growth of 7.07% in Delaware provided additional water consumption sales, facility charges and connection fees of $0.9 million, higher base rates provided $1.0 million, and increased consumption for existing customers provided an additional $0.6 million. New unregulated wastewater contracts in Delaware provided $0.4 million in additional revenues. Revenues from our operations and maintenance contract with the City of Perth Amboy increased by $0.4 million due to scheduled fixed fee adjustments under the agreement. USA had increased revenues for its LineCareSM maintenance program of $0.1 million. TESI revenues increased by $0.1 million, as we connected new customers to our wastewater systems in Delaware. All other operations contributed $0.2 million of additional revenues.

While we anticipate continued organic customer and consumption growth among our Delaware systems, such growth and increased consumption cannot be guaranteed. Our water systems are highly dependent on the effects of weather, which may adversely impact future consumption despite customer growth. Appreciable organic customer and consumption growth is less likely in our New Jersey systems due to the extent to which our service territory is developed.

Operation and maintenance expenses increased $1.2 million or 2.8% as compared to the same period in 2005. Continued growth of our Delaware water and wastewater operations led to higher costs of $1.1 million. Despite lower water production volume of 3.2% for our Middlesex System, costs increased by $0.3 million due to increased unit costs for electricity, chemicals and residuals removal. Costs for providing services under our contract with the City of Perth Amboy increased by $0.1 million and costs for providing services under our contracts in Delaware increased by $0.2 million. Audit fees declined by $0.3 million as the Company changed independent accounting firms beginning with the 2006 audit period. Labor and benefits expenses fell by $0.3 million due to vacant positions and improved performance on investments. All other operating costs increased by $0.1 million.

Electric generation costs for our Middlesex System will increase in 2007 due to the renewal of a contract for that service in late 2006. Total electric costs account for approximately 10% of our annual operations and maintenance expenses. Pension and postretirement costs increased $0.4 million during 2006 and we expect

21


these costs to continue to increase in 2007. In an effort to control the increasing cost of providing retirement benefits, we have instituted two changes for employees hired after March 31, 2007. Our company funded defined benefit pension plan and postretirement health and other benefit plans will not be available to employees hired after that date. A defined contribution plan is available for these future employees. Payroll and related employee benefit costs (excluding pension and postretirement expenses previously discussed) are also expected to be higher in 2007. These increasing costs, in addition to higher business insurances will require us to file a request for a rate increase with the BPU for Middlesex during 2007. We cannot predict whether the BPU will approve, deny or reduce the amount of our request. Our Tidewater system received approval by the PSC to increase its rates by an additional 11.9% effective February 28, 2007. As part of the same rate matter, the PSC had approved an interim rate increase of 15% back in June of 2006. The combined effect of the interim and final rate increases was $3.9 million in additional annual operating revenues.

Depreciation expense for 2006 increased by $0.7 million, or 10.9%, due to a higher level of utility plant in service. As our investments in utility plant and operating expenses increase, we continue to seek timely rate relief through base rate filings as discussed above.

Other taxes increased by $0.5 million generally reflecting additional taxes on higher taxable gross revenues, payroll and real estate.

Other income increased $0.1 million, primarily due to higher Allowance for Funds Used During Construction (AFUDC) as capital spending increased compared to the prior year.

Interest expense increased by $0.8 million, or 12.9%, as a result of a higher level of long-term debt, and higher average interest rates and increased weighted average short-term borrowings as compared to the prior year period.

Income tax expense based on our current year operating results was $5.1 million.

Net income increased to $10.0 million from $8.5 million in the prior year, and basic earnings per share increased from $0.72 to $0.83. Diluted earnings per share increased from $0.71 to $0.82.

Results of Operations in 2005 Compared to 2004

   
(Millions of Dollars)
Fiscal Years ended December 31,
 
   
2005
 
2004
 
   
Regulated
 
Non-Regulated
 
 
Total
 
Regulated
 
Non-Regulated
 
Total 
 
Revenues
 
$
66.3
 
$
8.3
 
$
74.6
 
$
60.8
 
$
10.2
 
$
71.0
 
Operations and maintenance
   
35.0
   
7.2
   
42.2
   
31.0
   
9.0
   
40.0
 
Depreciation
   
6.3
   
0.1
   
6.4
   
5.8
   
0.1
   
5.9
 
Other taxes
   
8.6
   
0.2
   
8.8
   
7.9
   
0.3
   
8.2
 
Operating income
   
16.4
   
0.8
   
17.2
   
16.1
   
0.8
   
16.9
 
                                   
Other income (expense)
   
0.7
   
0.0
   
0.7
   
0.8
   
0.0
   
0.8
 
Interest expense
   
6.2
   
--
   
6.2
   
5.4
   
0.1
   
5.5
 
Income taxes
   
2.9
   
0.3
   
3.2
   
3.5
   
0.3
   
3.8
 
Net income
 
$
8.0
 
$
0.5
 
$
8.5
 
$
8.0
 
$
0.4
 
$
8.4
 
 

22


Operating revenues for the year rose $3.6 million, or 5.1% over the same period in 2004. Water sales improved by $3.6 million in our Middlesex System, of which $1.8 million was a result of base rate increases that were granted to Middlesex on May 27, 2004 and December 8, 2005, and $1.8 million was due to increased consumption due to drier weather as compared to the prior year. Customer growth of 9.2% in Delaware provided additional water consumption sales, facility charges and connection fees of $0.9 million, and higher base rates provided $1.0 million. New unregulated wastewater contracts in Delaware provided $0.1 million in additional revenues. USA had reduced revenues of $2.2 million as compared to the prior year period, due to our meter services venture completing its original contracts during December 2004. This decrease was partially offset by increased revenues for USA’s LineCareSM maintenance program of $0.1 million. All other operations contributed $0.1 million of additional revenues.

Operation and maintenance expenses increased $2.2 million or 5.4% as compared to the same period in 2004. In New Jersey, payroll and employee benefits costs increased by $1.9 million. Water production costs for the Middlesex system increased by $0.7 million due to higher demand and increased unit costs for electricity, chemicals and residuals removal. Costs to operate the Tidewater system increased $0.2 million, and increases in our Delaware employee base, general wage increases and higher costs associated with employee medical and retirement benefits increased costs by $1.0 million. Costs for providing services under our contract with the City of Perth Amboy increased by $0.1 million. All other operating costs increased by $0.1 million. The costs of our meter services venture decreased $1.8 million due to the completion of the original projects during December 2004.

Depreciation expense for 2005 increased by $0.6 million, or 10.5%, due to a higher level of utility plant in service.

Other taxes increased by $0.6 million generally reflecting additional taxes on higher taxable gross revenues, payroll and real estate.

Other income decreased $0.1 million, primarily due to reduced AFUDC due to reduced capital spending as compared to the prior year.

Interest expense increased by $0.8 million, or 14.2%, as a result of a higher level of long-term debt, and higher average interest rates and increased weighted average short-term borrowings as compared to the prior year period.

Income tax expense based on our current year operating results was $3.8 million, which was partially offset by $0.6 million of tax benefits.

Net income increased to $8.5 million from $8.4 million in the prior year, however basic earnings per share decreased from $0.74 to $0.72. Diluted earnings per share decreased from $0.73 to $0.71. The earnings per share decrease was due to an increase in average shares outstanding as compared to the prior year period as a result of the sale of 700,000 shares of common stock on May 12, 2004, and shares issued under the Company’s Dividend Reinvestment Plan during 2005.  

Outlook

In addition to factors previously discussed under “Results of Operations in 2006 Compared to 2005,” our revenues are expected to increase in 2007 from anticipated customer growth in Delaware for our regulated water operations and, to a lesser degree, from growth in our regulated wastewater operations in Delaware. The recent settlement of our 2006 Tidewater rate case will allow rates to increase by another 11.9%, or $1.9

23


million in annual operating revenues, effective February 28, 2007. Earnings per share for 2007 will be fully impacted by the 1,495,000 shares of Common Stock issued in November 2006.

We expect to file for a base rate increase for Middlesex in 2007. Revenues and earnings for 2007 will be impacted by the ultimate timing and outcome of the anticipated filing. Revenues and earnings will also be influenced by weather. Changes in these factors, as well as increases in capital expenditures and operating costs are the primary factors that determine the need for rate increase filings.

We continue to explore viable plans to streamline operations and reduce costs in all aspects of our business.

TESI, our new regulated wastewater operation, commenced operations during fiscal 2005. Due to the start-up nature of this operation, we expect our expenses with respect to this subsidiary may marginally exceed its revenues in 2007.

We expect our interest expense to increase during 2007 as a result of higher expected average borrowings and interest rates on short-term credit facilities in order to finance a portion of our capital expenditures during the coming year (see Liquidity and Capital Resources).

Our strategy includes continued revenue growth through acquisitions, internal expansion, contract operations and when necessary, rate relief. We will continue to pursue opportunities in both the regulated and non-regulated sectors that are financially sound, complement existing operations and increase shareholder value.

Liquidity and Capital Resources
 
Cash flows from operations are largely based on three factors: weather, adequate and timely rate increases, and customer growth. The effect of those factors on net income is discussed in results of operations. For 2006, cash flows from operating activities increased $2.4 million to $15.9 million, as compared to the prior year. This increase was primarily attributable to higher net income, depreciation and the timing of collection of customer billings. The $15.9 million of net cash flow from operations enabled us to fund approximately 53% of our utility plant expenditures for the period internally, with the remainder funded with proceeds from equity issued under our Dividend Reinvestment Plan, long-term borrowings and short-term borrowings. In November 2006, we used proceeds from a common stock offering to repay all outstanding short-term debt.

For 2005, cash flows from operating activities decreased $2.1 million to $13.5 million, as compared to the prior year. This decrease was primarily attributable to the timing of collection of customer accounts and payments to vendors. These decreases in cash flows were partially offset by receipts of advance service fees and the timing of payments for interest and employee benefit plans. The $13.5 million of net cash flow from operations allowed us to fund approximately 53% of our utility plant expenditures for the period internally, with the remainder funded with proceeds from equity issued under our Dividend Reinvestment Plan and both short-term and long-term borrowings.

Increases in certain operating costs will impact our liquidity and capital resources. As described in our results of operations discussion, during 2006 we received rate relief for Tidewater and Pinelands. We also plan to file for a base rate increase for Middlesex in 2007 as a result of continued capital investment and increases in operating costs in New Jersey. There is no certainty, however, that the BPU or PSC will approve any or all of this or other future requested increases.

Sources of Liquidity

24


Short-term Debt. The Company has established revolving lines of credit aggregating $37.0 million. There were no outstanding borrowings under these credit lines as of December 31, 2006.

The weighted average daily amounts of borrowings outstanding under the Company’s credit lines and the weighted average interest rates on those amounts were $9.5 million and $9.2 million at 6.13% and 4.36% for the years ended December 31, 2006 and 2005, respectively.

Long-term Debt. Subject to regulatory approval, the Company periodically finances capital projects under State Revolving Fund (SRF) loan programs in New Jersey and Delaware. These government programs provide financing at interest rates that are typically below rates available in the financial markets. A portion of the borrowings under the New Jersey SRF is interest free. We participated in the Delaware and New Jersey SRF loan programs during 2006 and expect to participate in the 2007 New Jersey SRF program for up to $3.7 million.

During 2006, Middlesex closed on $3.7 million of first mortgage bonds through the New Jersey Environmental Infrastructure Trust (NJEIT) under the New Jersey SRF loan program in order to finance our 2007 RENEW program. The proceeds of these bonds and any interest earned are held by a trustee, and are classified as Restricted Cash on the Consolidated Balance Sheet.

During 2006, Tidewater closed on a $1.0 million loan with the Delaware SRF. The proceeds were used to fund the ongoing capital program in Delaware.

Substantially all of the Utility Plant of the Company is subject to the lien of its mortgage, which also includes debt service and capital ratio covenants, certain restrictions as to cash dividend payments and other distributions on common stock. The Company is in compliance with all of its mortgage covenants and restrictions.

Common Stock. The Company periodically issues shares of common stock in connection with its Dividend Reinvestment and Common Stock Purchase Plan. Periodically, the Company may issue additional equity to reduce short-term indebtedness and for other general corporate purposes.  The majority of the net proceeds of approximately $26.2 million from the November 2006 common stock offering of 1,495,000 shares were used to repay all of the Company’s short-term borrowings outstanding at that time. The Company also raised $1.3 million through the issuance of shares under its Dividend Reinvestment and Common Stock Purchase Plan (the Plan) during 2006. The Company issued shares under the Plan at a 5% discount for a six-month period during 2005. This allowed the Company to raise $3.7 million through the Plan during 2005.

Capital Expenditures and Commitments
 
Under our capital program for 2007, we plan to expend $19.7 million for additions and improvements for our Delaware water systems, which include the construction of several storage tanks and the creation of new wells and interconnections. We expect to spend approximately $20.9 million for system additions and acquisitions for our Delaware wastewater systems. We expect to spend $3.9 million for our RENEW program, which is our program to clean and cement line unlined mains in the Middlesex System. There remains a total of approximately 120 miles of unlined mains in the 732-mile Middlesex System. In 2006, nine miles of unlined mains were cleaned and cement lined. The capital program also includes $10.1 million for scheduled upgrades to our existing systems in New Jersey. The scheduled upgrades consist of $1.9 million for improvements to existing plant, $5.6 million for mains, $0.7 million for service lines, $0.4 million for meters, $0.5 million for hydrants, and $1.0 million for other infrastructure needs.
 

25


To pay for our capital program in 2007, we will utilize internally generated funds and funds available and held in trust under existing NJEIT loans (currently, $3.7 million) and Delaware SRF loans (currently, $2.5 million). The SRF programs provide low cost financing for projects that meet certain water quality and system improvement benchmarks. If necessary, we will also utilize short-term borrowings through $37.0 million of available lines of credit with several financial institutions. There were no outstanding borrowings under these credit lines as of December 31, 2006.
 
Going forward into 2008 through 2009, we currently project that we may be required to expend between $78.0 million and $140.0 million for capital projects. The exact amount is dependent on customer growth, residential housing sales and project scheduling. To the extent possible and because of favorable interest rates available to regulated water utilities, we expect to finance our capital expenditures under the SRF loan programs. We also expect to use internally generated funds and proceeds from the sale of common stock through the Dividend Reinvestment and Common Stock Purchase Plan. It may also be necessary to sell shares of our Common Stock through a public offering.

Tidewater is appealing a Notice of Violation regarding a plan of correction to a community water system to provide fire protection services. If we are unsuccessful in our defense, approximately 67 additional community water systems could be subject to similar corrective plans of action. While we are unable to estimate the potential capital investment costs for these additional community water systems at this time, Tidewater believes these expenditures would be subject to recovery in rates as set by the PSC. See Item 3. - Legal Proceedings for additional discussion of this matter.

Contractual Obligations

In the course of normal business activities, the Company enters into a variety of contractual obligations and commercial commitments. Some of these items result in direct obligations on the Company’s balance sheet while others are commitments, some firm and some based on uncertainties, which are disclosed in the Company’s underlying consolidated financial statements.

The table below presents our known contractual obligations for the periods specified as of December 31, 2006.
 
   
(Millions of Dollars)
Payment Due by Period
 
   
Total
 
Less
than
1 Year
 
1-3 Years
 
4-5
Years
 
More
than
5 Years
 
Long-term Debt
 
$
133.2
 
$
2.5
 
$
20.4
 
$
5.6
 
$
104.7
 
Notes Payable
   
---
   
---
   
---
   
---
   
---
 
Interest on Long-term Debt
   
104.8
   
6.6
   
12.0
   
10.5
   
75.7
 
Purchased Water Contracts
   
48.4
   
4.2
   
8.4
   
6.9
   
28.9
 
Wastewater Operations
   
55.7
   
4.0
   
8.3
   
8.7
   
34.7
 
Employee Retirement Plans (1)     3.5     3.5     ---     ---     ---  
Total
 
$
345.6
 
$
20.8
 
$
49.1
 
$
31.7
 
$
244.0
 
(1) Amount not determinable after year one.
 
Guarantees

USA-PA operates the City of Perth Amboy’s (Perth Amboy) water and wastewater systems under a service contract agreement through June 30, 2018. The agreement was effected under New Jersey’s Water Supply Public/Private Contracting Act and the New Jersey Wastewater Public/Private Contracting Act. Under the agreement, USA-PA receives a fixed fee and a variable fee based on increased system billing. Scheduled fixed

26


fee payments were $7.6 million in 2006 and will increase over the term of the contract to $10.2 million by the end of the contract.
 
In connection with the agreement, Perth Amboy, through the Middlesex County Improvement Authority, issued approximately $68.0 million in three series of bonds. Middlesex guaranteed one of those series of bonds, designated the Series C Serial Bonds, in the principal amount of approximately $26.3 million. Perth Amboy guaranteed the two other series of bonds. The Series C Serial Bonds have various maturity dates with the final maturity date on September 1, 2015. As of December 31, 2006, approximately $23.4 million of the Series C Serial Bonds remained outstanding.
 
We are obligated to perform under the guarantee in the event notice is received from the Series C Serial Bonds trustee of an impending debt service deficiency. If Middlesex funds any debt service obligations as guarantor, there is a provision in the agreement that requires Perth Amboy to reimburse us. There are other provisions in the agreement that we believe make it unlikely that we will be required to perform under the guarantee, such as scheduled annual rate increases for the water and wastewater services as well as rate increases due to unforeseen circumstances. In the event revenues from customers could not satisfy the reimbursement requirements, Perth Amboy has Ad Valorem taxing powers, which could be used to raise the needed amount. 

Critical Accounting Policies and Estimates
 
The application of accounting policies and standards often requires the use of estimates, assumptions and judgments. Changes in these variables may lead to significantly different financial statement results. Our critical accounting policies are set forth below.
 
Regulatory Accounting

We maintain our books and records in accordance with accounting principles generally accepted in the United States of America. Middlesex and certain of its subsidiaries, which account for 89% of Operating Revenues and 98% of Total Assets, are subject to regulation in the states in which they operate. Those companies are required to maintain their accounts in accordance with regulatory authorities’ rules and guidelines, which may differ from other authoritative accounting pronouncements. In those instances, the Company follows the guidance provided in the Financial Accounting Standards Board (FASB), Statement of Financial Accounting Standards (SFAS) No. 71, “Accounting For the Effects of Certain Types of Regulation” (SFAS 71).
 
In accordance with SFAS No. 71, costs and obligations are deferred if it is probable that these items will be recognized for rate-making purposes in future rates. Accordingly, we have recorded costs and obligations, which will be amortized over various future periods. Any change in the assessment of the probability of rate-making treatment will require us to change the accounting treatment of the deferred item. We have no reason to believe any of the deferred items that are recorded would be treated differently by the regulators in the future.

Revenues
 
Revenues from metered customers include amounts billed on a cycle basis and unbilled amounts estimated from the last meter reading date to the end of the accounting period. The estimated unbilled amounts are determined by utilizing factors which include historical consumption usage and current climate conditions. Differences between estimated revenues and actual billings are recorded in a subsequent period.
 
Revenues from unmetered customers are billed at a fixed tariff rate in advance at the beginning of each service period and are recognized in revenue ratably over the service period.

27


 
Revenues from the Perth Amboy management contract are comprised of fixed and variable fees. Fixed fees, which have been set for the life of the contract, are billed monthly and recorded as earned. Variable fees, which are based on billings and other factors and are not significant, are recorded upon approval of the amount by Perth Amboy.
 
Pension Plan
 
We maintain a noncontributory defined benefit pension plan which covers substantially all employees with more than 1,000 hours of service and who were hired prior to March 31, 2007.

The discount rate utilized for determining future pension obligations has decreased from 5.88% at December 31, 2004 to 5.52% at December 31, 2005 and increased to 5.89% at December 31, 2006. Lowering the discount rate by 0.5% would have increased the net periodic pension cost by $0.2 million in 2006. Lowering the expected long-term rate of return on the pension plans by 0.5% (from 8.0% to 7.5%) would have increased the net periodic pension cost in 2006 by approximately $0.1 million.
 
The discount rate for determining future pension obligations is determined based on market rates for long-term, high-quality corporate bonds at our December 31 measurement date. The expected long-term rate of return for pension assets is determined based on historical returns and our asset allocation.

Future pension expense will depend on future investment performance, changes in future discount rates and various other demographic factors related to the population participating in the pension plan.
 
Recent Accounting Standards
 
See Note 1(m) of the Notes to Consolidated Financial Statements for a discussion of recent accounting pronouncements.


28


Item 7A. Qualitative and Quantitative Disclosures About Market Risk.

The Company is subject to the risk of fluctuating interest rates in the normal course of business. Our policy is to manage interest rates through the use of fixed rate long-term debt and, to a lesser extent, short-term debt. The Company’s interest rate risk related to existing fixed rate, long-term debt is not material due to the term of the majority of our First Mortgage Bonds, which have final maturity dates ranging from 2009 to 2038. Over the next twelve months, approximately $2.5 million of the current portion of 16 existing long-term debt instruments will mature. Applying a hypothetical change in the rate of interest charged by 10% on those borrowings, would not have a material effect on our earnings.

Item 8. Financial Statements and Supplementary Data.

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
 
To the Board of Directors and Stockholders of Middlesex Water Company:
 
We have audited the accompanying consolidated balance sheet and consolidated statement of capital stock and long-term debt of Middlesex Water Company and subsidiaries (the Company) as of December 31, 2006, and the related consolidated statements of income, common stockholders’ equity and comprehensive income, and cash flows for the year then ended. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audit.
 
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion.
 
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of the Company as of December 31, 2006, and the results of their operations and their cash flows for the year then ended in conformity with accounting principles generally accepted in the United States of America.
 
As discussed in Note 1 to the consolidated financial statements, the Company changed its method of accounting for defined benefit pension and other postretirement plans in 2006.
 
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the effectiveness of Middlesex Water Company’s internal control over financial reporting as of December 31, 2006, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO), and our report dated March 13, 2007 expressed an unqualified opinion on management’s assessment of internal control over financial reporting and an unqualified opinion on the effectiveness of internal control over financial reporting.
 
/s/ Beard Miller Company LLP
Beard Miller Company LLP
Reading, Pennsylvania
March 13, 2007

29


REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
 
To the Board of Directors and Stockholders of Middlesex Water Company:
 
We have audited the accompanying consolidated balance sheet and consolidated statement of capital stock and long-term debt of Middlesex Water Company and subsidiaries (the Company) as of December 31, 2005, and the related consolidated statements of income, common stockholders’ equity and comprehensive income, and cash flows for each of the two years in the period ended December 31, 2005. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.
 
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States).  Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
 
In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 2005, and the results of its operations and its cash flows for each of the two years in the period ended December 31, 2005, in conformity with accounting principles generally accepted in the United States of America.
 
 
 
/s/ DELOITTE & TOUCHE LLP     
Parsippany, New Jersey
March 16, 2006





30


MIDDLESEX WATER COMPANY
 
CONSOLIDATED BALANCE SHEETS
 
               
           
 
 
       
December 31,
 
December 31,
 
ASSETS
     
2006
 
2005
 
UTILITY PLANT:
   
Water Production
 
$
95,323,657
 
$
91,403,549
 
 
   
Transmission and Distribution 
   
243,958,446
   
217,098,466
 
   
General 
   
25,153,277
   
23,292,087
 
 
   
Construction Work in Progress 
   
6,131,037
   
6,127,634
 
 
   
TOTAL 
   
370,566,417
   
337,921,736
 
 
   
Less Accumulated Depreciation 
   
59,693,678
   
54,960,290
 
 
   
UTILITY PLANT - NET 
   
310,872,739
   
282,961,446
 
                     
CURRENT ASSETS:
   
Cash and Cash Equivalents
   
5,826,012
   
2,983,762
 
 
   
Accounts Receivable, net 
   
8,538,302
   
8,074,929
 
 
   
Unbilled Revenues 
   
4,013,285
   
3,737,627
 
 
   
Materials and Supplies (at average cost) 
   
1,306,196
   
1,259,935
 
 
   
Prepayments  
   
1,228,620
   
927,254
 
 
   
TOTAL CURRENT ASSETS 
   
20,912,415
   
16,983,507
 
                     
DEFERRED CHARGES
   
Unamortized Debt Expense
   
3,014,005
   
3,164,043
 
AND OTHER ASSETS:
   
Preliminary Survey and Investigation Charges
   
3,436,124
   
1,774,817
 
 
   
Regulatory Assets 
   
18,341,766
   
7,469,190
 
 
   
Restricted Cash 
   
6,850,418
   
5,782,705
 
 
   
Non-utility Assets - Net 
   
6,254,895
   
5,727,806
 
 
   
Other 
   
584,652
   
519,610
 
 
   
TOTAL DEFERRED CHARGES AND OTHER ASSETS 
   
38,481,860
   
24,438,171
 
 
   
TOTAL ASSETS 
 
$
370,267,014
 
$
324,383,124
 
                   
CAPITALIZATION AND LIABILITIES
                   
CAPITALIZATION:
   
Common Stock, No Par Value
 
$
104,248,456
 
$
76,160,949
 
 
   
Retained Earnings 
   
25,001,295
   
23,638,301
 
 
   
Accumulated Other Comprehensive Income (Loss), net of tax 
   
94,255
   
(206,925
)
 
   
TOTAL COMMON EQUITY 
   
129,344,006
   
99,592,325
 
 
   
Preferred Stock 
   
3,958,062
   
3,958,062
 
 
   
Long-term Debt 
   
130,706,358
   
128,174,944
 
 
   
TOTAL CAPITALIZATION 
   
264,008,426
   
231,725,331
 
                     
CURRENT
   
Current Portion of Long-term Debt
   
2,500,537
   
1,930,617
 
LIABILITIES:
   
Notes Payable
   
-
   
4,000,000
 
 
   
Accounts Payable 
   
5,490,514
   
6,038,060
 
 
   
Accrued Taxes 
   
6,683,614
   
6,466,531
 
 
   
Accrued Interest 
   
1,879,731
   
1,868,962
 
 
   
Unearned Revenues and Advanced Service Fees 
   
600,626
   
473,627
 
   
Other 
   
984,476
   
707,446
 
 
   
TOTAL CURRENT LIABILITIES 
   
18,139,498
   
21,485,243
 
                     
COMMITMENTS AND CONTINGENT LIABILITIES (Note 4)
             
                     
DEFERRED CREDITS
   
Customer Advances for Construction
   
19,246,396
   
17,180,962
 
AND OTHER LIABILITIES:
   
Accumulated Deferred Investment Tax Credits
   
1,812,932
   
1,617,949
 
 
   
Accumulated Deferred Income Taxes 
   
15,779,440
   
14,296,620
 
 
   
Employee Benefit Plans 
   
16,387,754
   
6,650,724
 
 
   
Regulatory Liability - Cost of Utility Plant Removal 
   
6,200,302
   
5,647,757
 
 
   
Other 
   
526,345
   
793,857
 
 
   
TOTAL DEFERRED CREDITS AND OTHER LIABILITIES 
   
59,953,169
   
46,187,869
 
                     
CONTRIBUTIONS IN AID OF CONSTRUCTION
   
28,165,921
   
24,984,681
 
 
   
TOTAL CAPITALIZATION AND LIABILITIES 
 
$
370,267,014
 
$
324,383,124
 
                 
See Notes to Consolidated Financial Statements.
           

31

 
MIDDLESEX WATER COMPANY
CONSOLIDATED STATEMENTS OF INCOME
               
   
 Years Ended December 31,
 
   
2006
 
2005
 
2004
 
               
Operating Revenues
 
$
81,061,457
 
$
74,613,305
 
$
70,991,146
 
                   
Operating Expenses:
                   
Operations  
   
39,797,755
   
38,635,382
   
36,519,355
 
Maintenance 
   
3,546,677
   
3,519,914
   
3,464,036
 
Depreciation 
   
7,060,360
   
6,460,241
   
5,846,191
 
Other Taxes 
   
9,338,404
   
8,779,325
   
8,228,354
 
                     
Total Operating Expenses
   
59,743,196
   
57,394,862
   
54,057,936
 
                     
Operating Income
   
21,318,261
   
17,218,443
   
16,933,210
 
                     
Other Income (Expense):
                   
Allowance for Funds Used During Construction 
   
632,366
   
547,714
   
606,019
 
Other Income 
   
159,288
   
219,572
   
221,950
 
Other Expense 
   
(17,977
)
 
(27,593
)
 
(32,676
)
                     
Total Other Income, net
   
773,677
   
739,693
   
795,293
 
                     
Interest Charges
   
7,012,452
   
6,244,671
   
5,468,576
 
                     
Income before Income Taxes
   
15,079,486
   
11,713,465
   
12,259,927
 
                     
Income Taxes
   
5,040,591
   
3,237,324
   
3,814,418
 
                     
Net Income
   
10,038,895
   
8,476,141
   
8,445,509
 
                 
Preferred Stock Dividend Requirements
   
247,786
   
251,286
   
254,786
 
                   
Earnings Applicable to Common Stock
 
$
9,791,109
 
$
8,224,855
 
$
8,190,723
 
                     
Earnings per share of Common Stock:
                   
Basic 
 
$
0.83
 
$
0.72
 
$
0.74
 
Diluted 
 
$
0.82
 
$
0.71
 
$
0.73
 
                     
Average Number of
                   
Common Shares Outstanding : 
                   
Basic 
   
11,843,580
   
11,444,785
   
11,079,835
 
Diluted 
   
12,174,720
   
11,783,925
   
11,422,975
 
                     
Cash Dividends Paid per Common Share
 
$
0.683
 
$
0.673
 
$
0.663
 
                     
                     
                   
See Notes to Consolidated Financial Statements
                   
32


MIDDLESEX WATER COMPANY
CONSOLIDATED STATEMENTS OF CASH FLOWS
               
               
   
Twelve Months Ended December 31,
 
   
2006
 
2005
 
2004
 
CASH FLOWS FROM OPERATING ACTIVITIES:
                   
Net Income
 
$
10,038,895
 
$
8,476,141
 
$
8,445,509
 
Adjustments to Reconcile Net Income to
                   
Net Cash Provided by Operating Activities: 
                   
 Depreciation and Amortization
   
7,761,243
   
7,159,670
   
6,387,808
 
 Provision for Deferred Income Taxes and ITC
   
896,993
   
164,873
   
603,275
 
 Allowance for Funds Used During Construction
   
(632,366
)
 
(547,714
)
 
(606,019
)
Changes in Assets and Liabilities: 
                   
 Accounts Receivable
   
(463,373
)
 
(1,758,076
)
 
(634,245
)
 Unbilled Revenues
   
(275,658
)
 
(164,914
)
 
(337,925
)
 Materials & Supplies
   
(46,261
)
 
(56,029
)
 
215,236
 
 Prepayments
   
(301,366
)
 
(103,278
)
 
185,328
 
 Other Assets
   
(563,300
)
 
(151,166
)
 
(578,048
)
 Operations Contracts Receivable
   
78,161
   
-
   
14,207
 
 Accounts Payable
   
(538,220
)
 
(17,933
)
 
1,224,406
 
 Accrued Taxes
   
197,004
   
(323,227
)
 
528,715
 
 Accrued Interest
   
10,768
   
165,831
   
(107,508
)
 Employee Benefit Plans
   
(83,679
)
 
709,988
   
377,068
 
 Unearned Revenue & Advanced Service Fees
   
126,999
   
86,471
   
(215,698
)
 Other Liabilities
   
(298,779
)
 
(143,704
)
 
56,913
 
                     
NET CASH PROVIDED BY OPERATING ACTIVITIES
   
15,907,061
   
13,496,933
   
15,559,022
 
CASH FLOWS FROM INVESTING ACTIVITIES:
                   
Utility Plant Expenditures* 
   
(30,360,491
)
 
(25,287,735
)
 
(28,878,576
)
Cash Surrender Value & Other Investments 
   
(154,527
)
 
(294,372
)
 
(273,837
)
Restricted Cash 
   
(1,035,943
)
 
7,637,175
   
(9,431,686
)
Preliminary Survey & Investigation Charges 
   
(1,661,307
)
 
(742,635
)
 
348,589
 
                     
NET CASH USED IN INVESTING ACTIVITIES
   
(33,212,268
)
 
(18,687,567
)
 
(38,235,510
)
CASH FLOWS FROM FINANCING ACTIVITIES:
                   
Redemption of Long-term Debt 
   
(1,914,900
)
 
(1,214,521
)
 
(1,067,258
)
Proceeds from Issuance of Long-term Debt 
   
5,016,234
   
14,948,082
   
18,995,153
 
Net Short-term Bank Borrowings (Repayments) 
   
(4,000,000
)
 
(7,000,000
)
 
(1,500,000
)
Deferred Debt Issuance Expenses 
   
(27,858
)
 
(166,477
)
 
(65,219
)
Common Stock Issuance Expense 
   
(238,405
)
 
-
   
(379,534
)
Restricted Cash 
   
(31,770
)
 
(162,774
)
 
-
 
Proceeds from Issuance of Common Stock 
   
28,087,507
   
4,076,047
   
15,055,874
 
Payment of Common Dividends 
   
(8,189,710
)
 
(7,690,462
)
 
(7,375,629
)
Payment of Preferred Dividends 
   
(247,786
)
 
(251,286
)
 
(254,786
)
Construction Advances and Contributions-Net 
   
1,694,145
   
1,601,019
   
297,045
 
NET CASH PROVIDED BY FINANCING ACTIVITIES
   
20,147,457
   
4,139,628
   
23,705,646
 
NET CHANGES IN CASH AND CASH EQUIVALENTS
   
2,842,250
   
(1,051,006
)
 
1,029,158
 
CASH AND CASH EQUIVALENTS AT BEGINNING OF YEAR
   
2,983,762
   
4,034,768
   
3,005,610
 
CASH AND CASH EQUIVALENTS AT END OF YEAR
 
$
5,826,012
 
$
2,983,762
 
$
4,034,768
 
                     
*Excludes Allowance for Funds Used During Construction.
                   
                     
SUPPLEMENTAL DISCLOSURE OF NON-CASH ACTIVITY:
                   
Utility Plant received as Construction Advances and Contributions 
 
$
3,543,203
 
$
5,149,990
 
$
2,722,121
 
                     
SUPPLEMENTAL DISCLOSURE OF CASH FLOWS INFORMATION:
                   
Cash Paid During the Year for:
                   
Interest 
 
$
6,937,230
 
$
5,990,089
 
$
5,409,803
 
Interest Capitalized 
 
$
(632,366
)
$
(547,714
)
$
(606,019
)
Income Taxes 
 
$
4,351,550
 
$
3,792,000
 
$
3,074,513
 
                     
See Notes to Consolidated Financial Statements.
                   

33


MIDDLESEX WATER COMPANY
CONSOLIDATED STATEMENTS OF CAPITAL STOCK
AND LONG-TERM DEBT
           
           
 
 
December 31,
 
December 31,
 
   
2006
 
2005
 
Common Stock, No Par Value
             
Shares Authorized -  20,000,000 
             
Shares Outstanding -  2006 - 13,168,081 
 
$
104,248,456
 
$
76,160,949
 
2005 - 11,584,499 
             
               
Retained Earnings
   
25,001,295
   
23,638,301
 
Accumulated Other Comprehensive Income (Loss), net of tax
   
94,255
   
(206,925
)
 TOTAL COMMON EQUITY
 
$
129,344,006
 
$
99,592,325
 
               
Cumulative Preference Stock, No Par Value:
             
Shares Authorized - 100,000 
             
Shares Outstanding - None 
             
Cumulative Preferred Stock, No Par Value
             
Shares Authorized - 139,497 
             
Convertible:
             
Shares Outstanding, $7.00 Series - 13,881  
 
$
1,457,505
 
$
1,457,505
 
Shares Outstanding, $8.00 Series - 12,000 
   
1,398,857
   
1,398,857
 
Nonredeemable:
             
Shares Outstanding, $7.00 Series - 1,017  
   
101,700
   
101,700
 
Shares Outstanding, $4.75 Series - 10,000 
   
1,000,000
   
1,000,000
 
 TOTAL PREFERRED STOCK
 
$
3,958,062
 
$
3,958,062
 
               
Long-term Debt
             
8.05%, Amortizing Secured Note, due December 20, 2021
 
$
2,895,875
 
$
2,983,384
 
6.25%, Amortizing Secured Note, due May 22, 2028
   
8,995,000
   
9,415,000
 
6.44%, Amortizing Secured Note, due August 25, 2030
   
6,626,667
   
6,906,667
 
6.46%, Amortizing Secured Note, due September 19, 2031
   
6,906,667
   
7,000,000
 
4.22%, State Revolving Trust Note, due December 31, 2022
   
738,773
   
754,164
 
3.30% to 3.60%, State Revolving Trust Note, due May 1, 2025
   
3,099,950
   
3,018,254
 
3.49%, State Revolving Trust Note, due January 25, 2027
   
598,144
   
278,144
 
4.03%, State Revolving Trust Note, due December 1, 2026
   
914,537
   
-
 
4.00% to 5.00%, State Revolving Trust Bond, due September 1, 2021
   
730,000
   
760,000
 
0.00%, State Revolving Fund Bond, due September 1, 2021
   
577,222
   
614,436
 
First Mortgage Bonds:
             
5.20%, Series S, due October 1, 2022 
   
12,000,000
   
12,000,000
 
5.25%, Series T, due October 1, 2023 
   
6,500,000
   
6,500,000
 
6.40%, Series U, due February 1, 2009 
   
15,000,000
   
15,000,000
 
5.25%, Series V, due February 1, 2029 
   
10,000,000
   
10,000,000
 
5.35%, Series W, due February 1, 2038 
   
23,000,000
   
23,000,000
 
0.00%, Series X, due September 1, 2018 
   
646,897
   
700,280
 
4.25% to 4.63%, Series Y, due September 1, 2018 
   
820,000
   
870,000
 
0.00%, Series Z, due September 1, 2019 
   
1,454,749
   
1,567,367
 
5.25% to 5.75%, Series AA, due September 1, 2019 
   
1,890,000
   
1,990,000
 
0.00%, Series BB, due September 1, 2021 
   
1,804,982
   
1,926,956
 
4.00% to 5.00%, Series CC, due September 1, 2021 
   
2,090,000
   
2,185,000
 
5.10%, Series DD, due January 1, 2032 
   
6,000,000
   
6,000,000
 
0.00%, Series EE, due September 1, 2024 
   
7,482,432
   
7,715,909
 
3.00% to 5.50%, Series FF, due September 1, 2024 
   
8,735,000
   
8,920,000
 
0.00%, Series GG, due August 1, 2026 
   
1,750,000
   
-
 
4.00% to 5.00%, Series HH, due August 1, 2026 
   
1,950,000
   
-
 
 SUBTOTAL LONG-TERM DEBT
   
133,206,895
   
130,105,561
 
Less: Current Portion of Long-term Debt
   
(2,500,537
)
 
(1,930,617
)
TOTAL LONG-TERM DEBT
 
$
130,706,358
 
$
128,174,944
 
               
See Notes to Consolidated Financial Statements.
             

34






                       
 MIDDLESEX WATER COMPANY
CONSOLIDATED STATEMENTS OF COMMON STOCKHOLDERS' EQUITY AND COMPREHENSIVE
INCOME 
                       
                       
                       
                       
               
Accumulated
     
   
Common
 
Common
     
Other
     
   
Stock
 
Stock
 
Retained
 
Comprehensive
     
   
Shares
 
Amount
 
Earnings
 
Income (Loss)
 
Total
 
Balance at January 1, 2004
   
10,566,937
 
$
56,924,028
 
$
22,668,348
 
$
50,808
 
$
79,643,184