FINANCIAL CONDITION
Executive Overview

The Company is a non-operating holding company, whose income is derived from the earnings of its four wholly-owned subsidiary companies: The Connecticut Water Company (Connecticut Water), New England Water Utility Services, Inc. (NEWUS), Chester Realty Company (Chester Realty), and Barnstable Holding Company (Barnstable Holding).

In 2008, approximately 93% of the Company earnings from continuing operations were attributable to the water activities of its largest subsidiary, Connecticut Water, a regulated water utility with 87,361 customers throughout 54 Connecticut towns, as of December 31, 2008. The rates charged for service by Connecticut Water are subject to review and approval by the Connecticut Department of Public Utility Control (DPUC).

In the mid 1990's, Connecticut Water made a conscious decision to minimize its reliance on rate increase requests to drive its financial performance. Instead, it relied upon unregulated operations and cost containment to grow the earnings of the Company without seeking higher rates. After a successful extended period of meeting these objectives, it became clear in 2006 that a rate increase was needed to continue to provide shareholder value through increased earnings. The Company decided to return to the more traditional model of recurring rate increase filings to efficiently collect its cost of both annual expenses and its investment in the infrastructure of the regulated business. In 2006, the Connecticut Water communicated to its customers, regulators and shareholders that it expected to seek rate relief on a more recurring basis for amounts less than the 30% that was requested in the 2006 filing. Currently, the Company is precluded from increasing its customers' base rates prior to January 1, 2010. The Company has not determined when it will file for its next general rate increase.

Over the next twenty years, the Environmental Protection Agency expects water companies to spend over $275 billion in infrastructure costs nationwide to ensure compliance with existing and future water regulations. Recognizing the importance of timely infrastructure replacement and improvement, the Company, along with other investor-owned regulated water companies in the state, campaigned for the passage of the Water Infrastructure and Conservation Adjustment (WICA) Act in the Connecticut General Assembly in 2007. WICA allows the Company to add a surcharge to customers' bills, subject to an expedited review and approval by the DPUC and no more than twice a year, to reflect the replacement of certain types of aging utility plant; principally water mains, meters, service lines and water conservation related investments. The Company, however, does not expect to be able to file for a surcharge under the WICA mechanism until the second quarter of 2009.

The passage of the WICA legislation will help augment the Company's current strategy of seeking to collect its costs of operating the regulated utility on a timely basis through a mechanism even more efficient than a general rate filing with the DPUC. The use of WICA will help to eliminate the regulatory lag from the time the Company invests in infrastructure replacement, or certain qualified new, plant and when it can begin to recover that investment in the rates charged to customers. In October 2008, the Company filed with the DPUC its Infrastructure Assessment Report (IAR) required under the WICA legislation. The purpose of the IAR is to clearly define the criteria for determining the priority of future replacement projects. The first public hearing on the Company's IAR was held on January 16, 2008. The Company expects a ruling on its IAR from the DPUC in the first quarter of 2009, after which the Company would be eligible to file for its first surcharge under WICA. Approximately 90 days after the surcharge filing, customers would begin to see an increase in their bills.

The Company has and will continue to focus on minimizing operating costs that are passed along to its customers without sacrificing the quality service it values and the customers demand. At the same time, the Company will continue to employ its current strategy of timely collection of appropriate costs and a fair rate of return for its shareholders through appropriate rates for its regulated water service.

Following our successful acquisition and integration of the water utility assets of Eastern Connecticut Regional Water Company (Eastern), which added over 2,300 customers, the Company announced on July 23, 2008 that it had reached a definitive purchase agreement with Ellington Acres Company (Ellington Acres) to purchase all of Ellington Acres' outstanding stock for approximately $1.5 million. Ellington Acres is a regulated water company serving approximately 750 customers in Ellington and Somers, Connecticut, situated between two systems in the Company's Northern Region that the Company had planned to interconnect. The Company will be able to interconnect the two systems in the Northern Region with Ellington Acres, saving ratepayers of both Connecticut Water and Ellington Acres significant capital expenditures. The DPUC approved the acquisition in December 2008 and the Company completed the transaction on January 16, 2009.

In 2009 and beyond, the Company will continue to look for acquisition candidates that we would easily be able to "tuck-in" to existing service territories, as well as possible acquisitions outside of our service territories, including outside the State of Connecticut. Additionally, the Company plans to continue its efforts to tie-in private well owners whose homes are in close proximity to our mains. In 2008, Connecticut Water added 89 private well owners in our existing service territories. Lastly, the Company will continue to work with developers to encourage public water use for new residential construction within Connecticut Water's service areas.

While the Company plans to file timely rate cases, continue to make acquisitions and, in the future, utilize the WICA adjustment to increase its earnings through its regulated subsidiary, it will also look to NEWUS to increase its earnings in the unregulated business. As part of the Company's January 2008 acquisition of Eastern, NEWUS acquired the operation and maintenance contracts of Birmingham H2O Services Inc., an unregulated business of Birmingham that has nearly 50 contracts for unregulated water systems in eastern Connecticut, totaling approximately $500,000 in annual revenues. The Company will continue to seek out maintenance and service contracts with new customers and renew existing contracts that have proven to be beneficial to the Company, as well as to continue the expansion of the Linebacker® program.

In 2008, the Company entered into negotiations with the town of Windsor Locks, Connecticut to sell a conservation easement on a well field property no longer needed as a source of supply for $2.16 million. Windsor Locks was awarded a grant from the Connecticut Department of Environmental Protection to assist in purchasing the conservation easement in order to permanently protect the approximate 200-acre property from development and guarantee public access to the land for passive recreation. The Purchase and Sale Agreement between the Company and the Town has not been executed as of the date of this filing. The Company expects to file an application with the DPUC and will submit the draft agreement and the form of Conservation Easement to the DPUC in March 2009. DPUC approval is expected in the second half of 2009. Subject to successful receipt of DPUC approval, and of final authorization for the town to proceed with the transaction, the Company expects the transaction to be completed in 2009. If the transaction closes, the Company estimates that it will generate approximately $1.0 million in net income in the Real Estate segment. The Company currently has no other specific plans for land transactions in 2009 and beyond.

Regulatory Matters and Inflation

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

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

Connecticut Water is also subject to environmental and water quality regulations, which are continually modified and refined to ensure the safety of the Company's water sources and, ultimately, the public's health. Costs to comply with environmental and water quality regulations are substantial. The costs to comply with future changes in state or federal regulations, which could require us to modify current filtration facilities and/or construct new ones, or to replace any reduction of the safe yield from any of our current sources of supply, could be substantial. While there can be no guarantee that all expenditures related to increased regulation will be recoverable in rate proceedings, the Company believes that the regulatory environment in Connecticut would allow prudent expenditures to be recovered in rates. To date, the Company has never had any costs associated with water quality and environmental spending refused in a general rate proceeding. The Company believes that it is in compliance with current regulations, but the regulations are subject to change at any time. During 2008, the Company incurred approximately $0.6 million in capital expenditures on Safe Drinking Water Act projects. The Company expects to spend approximately $1.2 million on Safe Water Drinking Act projects in 2009, primarily to bring newly acquired systems up to the Company's standards.

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

Public Utility Regulation - Statement of Financial Accounting Standards No. 71, "Accounting for the Effects of Certain Types of Regulation" (SFAS 71), requires cost-based, rate-regulated enterprises such as Connecticut Water to reflect the impact of regulatory decisions in their financial statements. The state regulators, through the rate regulation process, can create regulatory assets that result when costs are allowed for ratemaking purposes in a period after the period in which costs would be charged to expense by an unregulated enterprise. The balance sheet includes regulatory assets and liabilities as appropriate, primarily related to income taxes and post-retirement benefit costs. The Company believes, based on current regulatory circumstances, that the regulatory assets recorded are likely to be recovered and that its use of regulatory accounting is appropriate and in accordance with the provisions of SFAS 71. Material regulatory assets, other than deferred revenue, are earning a return.

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

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

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

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

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

The discount rate assumption we use to value our pension and postretirement benefit obligations has a material impact on the amount of expense we record in a given period. Our 2008 and 2007 pension and postretirement expense was calculated using assumed discount rates of 6.30% and 5.75%, respectively. In 2009, our pension and postretirement expense will be calculated using an assumed discount rate of 6.25% and 6.20%, respectively. The following table shows how much a one percent change in our assumed discount rate would have changed our reported 2008 pension and postretirement expense:

                                                                  Increase
                                                               (Decrease) in      Increase (Decrease)
                                                                  Pension          in Postretirement
                                                                  Expense               Expense
1% Increase in the discount rate                               $     (317,000 )   $          (210,000 )
1% Decrease in the discount rate                               $      366,000     $           254,000

Outlook

The Company's earnings and profitability are primarily dependent upon the sale and distribution of water, the amount of which is dependent on seasonal weather fluctuations, particularly during the summer months when water demand will vary with rainfall and temperature levels. The Company's earnings and profitability in future years will also depend upon a number of other factors, such as the ability to maintain our operating costs at current or lower levels, customer growth in the Company's core regulated water utility business, growth in revenues attributable to non-water sales operations, and the timing and adequacy of rate relief when requested, from time to time, by our regulated water company.

The Company believes that the factors described above and those described in detail below under the heading "Commitments and Contingencies" may have significant impact, either alone or in the aggregate, on the Company's earnings and profitability in fiscal years 2009 and beyond. Please also review carefully the risks and uncertainties described in Item 1A - Risk Factors and those described below under the heading "Forward Looking Information".

Based on the Company's current projections, assuming normal weather patterns and appropriate regulatory treatment on recovery of infrastructure improvement, and the completion of the Windsor Locks land sale, the Company believes that its Net Income from Continuing Operations for the year 2009 will increase from the levels reported for 2008, primarily as a result of the second phase of the rate increase which was approved by the DPUC in March 2008. During 2009 and subsequent years, the ability of the Company to maintain and increase its Net Income from Continuing Operations will principally depend upon the effect on the Company of the factors described above in this "Outlook" section, those factors described in the section entitled "Commitments and Contingencies" and the risks and uncertainties described in "Forward Looking Information" and Item 1A - Risk Factors.

FINANCIAL CONDITION
Liquidity and Capital Resources

The Company has three variable rate bonds with principle values totaling $22.05 million. They are secured by irrevocable direct pay letters of credit issued by a financial institution. These bonds are currently remarketed on a weekly basis. On October 7, 2008, the Company was notified that there was a combined remarketing failure of $2.6 million on two of these bonds. We believe the increased volatility of the credit markets that began in September 2008 was the primary cause.

As a result of the remarketing failure, the remarketing agent drew upon the letters of credit issued by the financial institution in the amount of $2.6 million. These loan amounts were subject to interest rates at 5.09%, which were 100 basis points over the one month LIBOR rate. In addition, the letters of credit are reduced by the amounts of these loans, until such time as the bonds can be successfully remarketed. As of December 31, 2008 these bonds have been, and continue to be, successfully remarketed.

The Company currently maintains an aggregate of $21 million in lines of credit with three banks. During 2007, the Company increased these lines because of expected increased construction spending and recently completed acquisitions. The largest line, representing $12 million of our total available line of credit, was renewed and increased in the fourth quarter of 2007 and is due upon demand from the bank. The two other lines of credit, of which one renewed in the second quarter of 2008, the other in the third quarter of 2007, have terms of 12 and 24 months, respectively. Interim Bank Loans Payable at December 31, 2008 was approximately $12.1 million and represents the outstanding balance on these lines of credit. Interest expense charged on interim bank loans will fluctuate based on market interest rates. The weighted average interest rate on the $12.1 million aggregate balance outstanding at December 31, 2008 was 1.96%. After defining the Company's expected 2009 capital expenditures, discussed below, the Company determined that additional access to short term capital arrangements may be needed. In November 2008, the Company was authorized by the Board of Directors to increase the available lines of credit to $40 million. The Company expects to finalize the increased lines in the second quarter of 2009.

Standard and Poor's recently affirmed their 'A' corporate credit rating on the Company with a stable outlook. The affirmation of the corporate credit rating follows their annual review of the Company and incorporates their expectation of adequate and timely rate relief and maintenance of our current financial risk profile. The stable outlook reflects improving regulation and timely rate relief in Connecticut.

The Company offers a dividend reinvestment plan (DRIP) to all registered shareholders, whereby shareholders can elect to have cash dividends directly reinvested into additional shares of the Company's common stock. During the years ended December 31, 2008 and 2007, shareholders reinvested $1,281,000 and $1,313,000, respectively, as part of the DRIP.

From 1999 through 2003, the Company issued stock options to certain employees of the Company. No stock options have been issued by the Company since 2003. During the year ended December 31, 2008, 11,775 options were exercised resulting in approximately $218,000 in proceeds to the Company. For the same period in 2007, the Company received approximately $809,000 in proceeds from exercised stock options.

The following table shows the total construction expenditures excluding non-cash contributed utility plant for each of the last three years and what we expect to invest on construction projects in 2009.

                                                                          Construction
                                                         Gross              Funded by          Construction
                                                      Construction        Developers &          Funded by
                                                      Expenditures           Others              Company
2008                                                 $   20,737,000     $         860,000     $   19,877,000
2007                                                 $   19,841,000     $       1,092,000     $   18,749,000
2006                                                 $   17,792,000     $       1,593,000     $   16,199,000

2009 (Projected)                                     $   31,400,000     $       5,000,000     $   26,400,000

During 2008, the Company incurred approximately $20.7 million of construction expenditures, including approximately $900,000 funded by developers and others. The Company financed the expenditures through internally generated funds, long-term debt issuances, proceeds from its dividend reinvestment plan, customers' advances, contributions in aid of construction and short-term borrowings.

In December 2007, Connecticut Water borrowed $15 million through the issuance of Water Facilities Revenue Bonds by the CDA sold in a single series with an interest rate of five percent maturing on December 1, 2037. The proceeds from the sale of the bonds have been used to finance construction and installation of various capital improvements to the Company's existing water system.

In connection with the 2004 issuance of the $12.5 million variable rate bonds, Connecticut Water entered into an interest rate swap transaction with a counterparty in the notional principal amount of $12,500,000. The interest rate swap agreement provides that, beginning in April 2004 and thereafter on a monthly basis, Connecticut Water paid J.P. Morgan, the counterparty, a fixed interest rate of 3.73% on the notional amount for a period of five years, which expired on March 3, 2009. In exchange, the counterparty began in April 2004 and thereafter on a monthly basis, paying Connecticut Water a floating interest rate (based on 105% of the U.S. Dollar one-month LIBOR rate) on the notional amount for a period of five years. The purpose of the interest rate swap was to manage the Company's exposure to fluctuations in prevailing interest rates. The Company notes that J.P. Morgan has maintained an investment grade rating by the three major credit rating agencies. We are evaluating whether or not to enter into a new interest rate swap agreement on our variable rate bonds.

Off-Balance Sheet Arrangements and Contractual Obligations

We do not use off-balance sheet arrangements such as securitization of receivables with any unconsolidated entities or other parties. The Company does not engage in trading or risk management activities (other than the interest rate swap agreement discussed above) and does not have material transactions involving related persons.

The following table summarizes the Company's future contractual cash obligations as of December 31, 2008:

                                                Payments due by Periods
                                                    (in thousands)

                                                    Less than 1                                             More than 5
Contractual Obligations                 Total          Year          Years 2 and 3       Years 4 and 5         years
Long-Term Debt (LTD)                  $  92,235     $         8     $            16     $            18     $    92,193
Interest on LTD                          96,633           4,182               8,362               8,361          75,728
Operating Lease Obligations                 731             309                 347                  75              --
Purchase Obligations (1) (2)            100,006           1,192               2,103               2,180          94,531
Long-Term Compensation Agreement(3)      47,735           4,461               6,685               6,690          29,899
Total (4) (5)                         $ 337,340     $    10,152     $        17,513     $        17,324     $   292,351

(1) Connecticut Water has an agreement with the South Central Connecticut Regional Water Authority (RWA) to purchase water from RWA. The agreement was signed on April 24, 2006 and will remain in effect for a minimum of fifty (50) years from that date. Connecticut Water has agreed to purchase a maximum of one million (1,000,000) gallons of water per day year from RWA. The Company is required to pay $75,000 per year for access to this water.
(2) Connecticut Water has an agreement with The Metropolitan District (MDC) to purchase water from MDC. The agreement became effective on October 6, 2000 for a term of fifty (50) years beginning May 19, 2003, the date the water supply facilities related to the agreement were placed in service.
(3) Pension and post retirement contributions cannot be reasonably estimated beyond 2009 and may be impacted by such factors as return on pension assets, changes in the number of plan participants and future salary increases. The amounts included for pension and post retirement contributions are management's best estimate.
(4) We pay refunds on Advances for Construction over a specific period of time based on operating revenues related to developer-installed water mains or as new customers are connected to and take service from such mains. After all refunds are paid, any remaining balance is transferred to Contributions in Aid of Construction. The refund amounts are not included in the above table because the refund amounts and timing are dependent upon several variables, including new customer connections, customer consumption levels and future rate increases, which cannot be accurately estimated. Portions of these refund amounts are payable annually through 2020 and amounts not paid by the contract expiration dates become non-refundable.
(5) We intend to fund these contractual obligations with cash flows from operations and liquidity sources held by or available to us.

RESULTS OF OPERATIONS

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