- 10-K 1 cng10k.htm CORNING NATURAL GAS INC 10K 

UNITED STATES 

SECURITIES AND EXCHANGE COMMISSION 

Washington, D.C. 20549 

FORM 10-K 

[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF 

THE SECURITIES EXCHANGE ACT OF 1934 

For the fiscal year ended September 30, 2011

OR 

[ _] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF 

THE SECURITIES EXCHANGE ACT OF 1934 

Commission file number: 0-643 

Corning Natural Gas Corporation 

(Exact name of registrant as specified in its charter) 

**New York
**16-0397420**(State or other jurisdiction of 

incorporation or organization) 
**(I.R.S. employer 

Identification no.) 
**330 W. William St. 

Corning, New York 14830 

(Address of principal executive offices, including zip code) 

(607) 936-3755 

(Registrant's telephone number, including area code) 

Securities registered pursuant to Section12(b) of the Act: 

None 

Securities registered pursuant to Section12(g) of the Act: 

Common Stock, par value $5.00 per share 

(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 [X]
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Exchange Act. YES [ ] NO [X]
Indicate by check mark whether the registrant (1)has filed all reports required to be filed by Section13 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 [X] NO [ ]

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

Indicate by check mark if disclosure of delinquent filers pursuant to Item405 of Regulation S-K is not contained herein and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [ ]

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

Large accelerated Filer [ ] Accelerated Filer [ ] Non-Accelerated Filer [ ] Smaller Reporting Company [X]
Indicate by check mark whether the registrant is a shell company. YES [ ] NO [X]
The aggregate market value of the 1,106,068 shares of the Common Stock held by non-affiliates of the Registrant at the $14.83 average of bid and asked prices as of the last business day of registrant's most recently completed second fiscal quarter, March 31, 2011, was $16,358,498.

Number of shares of Common Stock outstanding as of the close of business on December 1, 2011: 1,823,967

DOCUMENTS INCORPORATED BY REFERENCE

Portions of Registrant's definitive proxy statement relating to the 2012 annual meeting of shareholders are incorporated by reference into Part III hereof.

Information contained in this Form 10-K and the Annual Report to shareholders for fiscal 2011 period which is incorporated by reference contains certain forward looking comments which may be impacted by factors beyond the control of the Company, including but not limited to natural gas supplies, regulatory actions and customer demand. As a result, actual conditions and results may differ from present expectations. See "Cautionary Statement Regarding Forward-Looking Statements" below.
**Page 1****Table of Contents
For the Fiscal Year Ended September 30, 2011
**Contents

Part I

Item 1

Business

Item 1A

Risk Factors

Item 2

Properties

Item 3

Legal Proceedings

Item 4

Removed and Reserved
**Part II
- Item 5

Market for the Registrant's Common Equity, Related

Stockholder Matters and Issuer Purchases of Equity Securities

Item 6

Selected Financial Data

Item 7

Management's Discussion and Analysis of Financial Condition

and Results of Operations

Item 7A

Quantitative and Qualitative Disclosures about Market Risk

Item 8

Financial Statements and Supplementary Data

Item 9

Changes In and Disagreements with Accountants on

Accounting and Financial Disclosure

Item 9A

Controls and Procedures

Item 9B

Other Information
**Part III

Item 10

Directors, Executive Officers and Corporate Governance

Item 11

Executive Compensation

Item 12

Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

Item 13

Certain Relationships and Related Transactions, and Director Independence

Item 14

Principal Accounting Fees and Services
**Part IV

Item 15

Exhibits and Financial Statement Schedules
- Signatures
**Page 2 

PART I**
ITEM 1 - BUSINESS

Corning Natural Gas Corporation (the "Company," "we" or "our"), incorporated in 1904, is a natural gas utility. We distribute natural gas through our distribution and transmission network to residential, commercial, industrial and municipal customers in the Corning, Hammondsport and Virgil, New York, areas and to two other gas utilities which service the Elmira and Bath, New York, areas. We are franchised to supply gas service in all of the political subdivisions in which we operate. We are under the jurisdiction of the Public Service Commission of New York State which oversees and sets rates for New York gas distribution companies.
**Gas Supply**
We have contracted with various sources to provide natural gas to our distribution system. We contract for pipeline capacity, as well as storage capacity of approximately 736,000 dekatherms ("Dth"). We had a contract with Atmos Energy Marketing, LLC to manage our transportation and storage assets from 2008 through March 2011. Since April 1, 2011, our asset manager is ConocoPhillips. This contract expires on March 31, 2013.

We have secured the New York Public Service Commission ("NYPSC") required fixed price and storage gas supply for the 2011-2012 winter season and are managing our storage and gas supply contracts to assure that we follow our gas supply and acquisition plan. Assuming no extraordinary conditions for the winter season, gas supply, flowing and storage will be adequate to serve our approximately 14,700 customers.

We do not expect a shortage of natural gas to impact our business over the next five to ten years. Natural gas drilling activity over the last several years has been robust, and domestic reserves and production have increased. This is especially true in proximity to our distribution network. We likewise anticipate no shortages of the necessary pipes and valves for safe distribution of natural gas, and continue to receive material inventory from various reliable sources.
**Seasonality**
Because our business is highly seasonal in nature, sales for each quarter of the year vary and are not comparable. Sales vary depending on seasonal variations in temperature, although the Company's weather normalization and revenue decoupling clauses in our latest NYPSC rate order serve to stabilize net revenue from the effects of unusual temperature variations and conservation. The weather normalization and revenue decoupling clauses allow us to adjust customer billings to compensate for changes in net revenue.
**Significant Customers**
We have four major customers, Corning Incorporated, New York State Electric & Gas, Bath Electric, Gas & Water Systems, and Talisman Energy USA Incorporated. The loss of any of these customers would have an impact on our financial results. Additional information is provided in Note 2 to the Notes to Consolidated Financial Statements.
**Employees**
We had 52 employees as of September 30, 2011, and 50 as of September 30, 2010. Of this total, 46% are union labor working under an agreement effective until April 2, 2012. Negotiations for the new contract have not yet started. The Company anticipates that negotiations will begin in the second fiscal quarter of 2012.
**Competition**
Historically, the competition in our residential market has been primarily from electricity for cooking, water heating and clothes drying, and to a small degree, electricity, fuel oil and propane for heating. The price of gas remains low in comparison to that of alternative fuels in our service territory and our competitive position in the residential and commercial market continues to be very strong. Over 90 percent of our residential customers heat with gas. When we expand our distribution system to attract new customers, our principal competition is oil and propane. Natural gas enjoys a price advantage over these fuels today. 

We face limited competition from oil in the commercial and industrial market. We have been able to compete successfully through several mechanisms, including providing customers the option of transporting their own gas. We are able to maintain our profit margin in these situations because our transportation rate is equal to the lowest unit rate of the appropriate rate classification, exclusive of gas costs.
**Environmental Regulation**
We believe we are in compliance with present federal, state and local provisions relating to the protection of the environment. We do not expect that continued compliance with these requirements will have any material adverse effect on our capital expenditures, earnings and financial position. The Company has no former manufactured gas plant sites (MGP) and is not a party to any environmental proceedings, litigation or complaints.
**Page 3**
ITEM 1A. RISK FACTORS.
***Our operations could be adversely affected by fluctuations in the price of natural gas.*
Prices for natural gas are subject to volatile fluctuations in response to changes in supply and other market conditions. While these costs are usually passed on to customers pursuant to natural gas adjustment clauses and therefore do not pose a direct risk to earnings, we are unable to predict what effect a sharp increase in natural gas prices may have on our customers' energy consumption or ability to pay. Higher prices to customers can lead to higher bad debt expense and customer conservation. Higher prices may also have an adverse effect on our cash flow as typically we are required to pay for our natural gas prior to receiving payments for the natural gas from our customers.
***Operational issues beyond our control could have an adverse effect on our business.*
Our ability to provide natural gas depends both on our own operations and facilities and that of third parties, including local gas producers and natural gas pipeline operators from whom we receive our natural gas supply. The loss of use or destruction of our facilities or the facilities of third parties due to extreme weather conditions, breakdowns, war, acts of terrorism or other occurrences could greatly reduce potential earnings and cash flows and increase our costs of repairs and replacement of assets. Although we carry property insurance to protect our assets and have regulatory agreements that provide for the recovery of losses for such incidents (under our rate order we can defer extraordinary expenses for future recovery), our losses may not be fully recoverable through insurance or customer rates. 
***Significantly warmer than normal weather conditions may affect the sale of natural gas and adversely impact our financial position and the results of our operations.*
The demand for natural gas is directly affected by weather conditions. Significantly warmer than normal weather conditions in our service areas could reduce our earnings and cash flows as a result of lower gas sales. We mitigate the risk of warmer winter weather through the weather normalization and revenue decoupling clauses in our tariffs. These clauses allow the Company to surcharge customers for under recovery of revenue.
***There are inherent risks associated with storing and transporting natural gas, which could cause us to incur significant financial losses.*
There are inherent hazards and operation risks in gas distribution activities, such as leaks, accidental explosions and mechanical problems that could cause substantial financial losses. These risks could, if they occur, result in the loss of human life, significant damage to property, environmental pollution, impairment of operations and substantial losses. The location of pipelines and storage facilities near populated areas, including residential areas, commercial business centers and industrial sites, could increase the level of damages resulting from these risks. These activities may subject us to litigation and administrative proceedings that could result in substantial monetary judgments, fines or penalties. To the extent that the occurrence of any of these events is not fully covered by insurance, they could adversely affect our financial position and results of operations. 
***Changes in regional economic conditions could reduce the demand for natural gas.*
Our business follows the economic cycle of the customers in our service regions: Corning, Bath, Virgil, and Hammondsport, New York. A falling, slow or sluggish economy that would reduce the demand for natural gas in the areas in which we are doing business by forcing temporary plant shutdowns, closing operations or slow economic growth would reduce our earnings potential.

Many of our commercial and industrial customers use natural gas in the production of their products. During economic downturns, these customers may see a decrease in demand for their products, which in turn may lead to a decrease in the amount of natural gas they require for production.

During any economic slowdown there is typically an increase in individual and corporate customer bankruptcies. An increase in customer bankruptcies would increase our bad debt expenses and reduce our cash flows.
***Our earnings may decrease in the event of adverse regulatory actions.*
Our operations are subject to the jurisdiction of the NYPSC. The NYPSC approves the rates that we may charge to our customers. If we are required in a rate proceeding to reduce the rates we charge our customers, or if we are unable to obtain approval for rate relief from the NYPSC, particularly when necessary to cover increased costs, including costs that may be incurred in connection with mandated infrastructure improvements, our earnings would decrease. 
***Our success depends in large part upon the continued services of a number of significant employees, the loss of which could adversely affect our business, financial condition and results of operation.*
Our success depends in large part upon the continued services of our senior executives and other key employees. Although we have entered into an employment agreement with Michael I. German, our president and chief executive officer, he can terminate his agreement on ninety days notice. Other significant employees, who have not entered into employment agreements, may terminate their employment at any time. The loss of the services of any significant employee could have a material adverse effect on our business. 
**Page 4
*Concentration of share ownership among our largest shareholders may prevent other shareholders from influencing significant corporate decisions.*
The five largest holders of our common stock own over 63% of the company. As a result, if any chose to act together, they would have the ability to exert substantial influence over all matters requiring approval by our shareholders, including the election and removal of directors and any proposed merger, consolidation or sale of all or substantially all of our assets and other corporate transactions. This concentration of ownership could be disadvantageous to other shareholders with differing interests from these shareholders. 
***Our cash flows from operations will not be sufficient to fund our extraordinary capital expenditures.*
We may not generate sufficient cash flows from operations to meet all of our cash needs. As part of our 2009 rate order set by the NYPSC, we are required to make substantial capital expenditures to upgrade our distribution system. We also continue to have debt retirement obligations of approximately $1.5 million per year. In addition, we have made contractual and regulatory commitments for additional capital expenditures related to system reliability and other commitments.
***We may require additional financing.*
In order to fund our extraordinary capital expenditures we may need to obtain additional equity or debt financing.The sale of additional equity securities could result in dilution to our shareholders. The incurrence of debt would result in increased debt service obligations and could result in operating and financing covenants that would restrict our operations. Additional financing may have unacceptable terms or may not be available at all for various reasons including:

* limits placed on us by our current lenders in our loan agreements,
***
our future results of operations, financial condition and cash flows, ***
our inability to meet our business plan, ***
lenders' or investors' perception of, and demand for, securities of natural gas utilities, and ***
conditions of the capital markets in which we may seek to raise funds.
If we cannot raise additional capital on acceptable terms, we may not be able to finance the expansion and mandated upgrading of our distribution system, take advantage of future opportunities or respond to competitive pressures or unanticipated capital requirements.
***The Company's profitability may be adversely affected by increased competition.*
We are in a geographical area with a number of interstate pipelines and local production sources. If a major customer decided to connect directly to either an interstate pipeline or a local producer, our earnings and revenues would decrease.

ITEM 2 - PROPERTIES

The Company's headquarters are located at 330 West William Street, Corning, New York. This structure is physically connected to the operations center.

The Company's pipeline system is surveyed each year as required for compliance with federal and state regulations. Any deficiencies found are corrected as mandated. Approximately 400 miles of distribution main, 15,000 services, and 86 regulating stations, along with various other properties are owned by the Company, except for one section of 10" gas main that is under long term lease and is used primarily to serve Corning Incorporated. All of the property owned by the Company is adequately insured and is subject to the lien of the Company's first mortgage indenture. 
**Page 5**
ITEM 3 - LEGAL PROCEEDINGS 

The Company is party to two lawsuits filed by a former Chairman of the Company in the U.S. District Court for the Western District of New York. In the first lawsuit, filed August 9, 2007, the Chairman, Thomas Barry, seeks damages arising out of the Company's refusal to transfer to the former Chairman a key-man life insurance policy that the Company had surrendered. The former Chairman has prevailed in his motion for summary judgment with the Court and the Company filed an appeal in the Second Circuit Court of Appeals.

The second lawsuit filed on December 16, 2010, by Mr. Barry, challenges the Company's termination in 2007 of certain payments to him provided for under an Amended and Restated Survivor Benefit Deferred Compensation Agreement ("Deferred Compensation Agreement"). The complaint alleges that the Company's termination of benefits breached the Deferred Compensation Agreement because, according to the Chairman, the Company did not have good cause to terminate those benefits and that the Company failed to follow the procedures set forth in the Deferred Compensation Agreement for the termination of benefits. The complaint asserts four causes of action under ERISA section 1332, and seeks the recovery of deferred compensation payments accrued through the date of judgment, a declaration that he is entitled to future payment of the deferred benefits, and attorney fees. 

On December 6, 2011, the Company and Mr. Barry signed an initial settlement agreement that terminated the two lawsuits. The Company views the outcome as favorable because it will allow the Company to reduce certain reserves and liabilities and it will end an expensive and distracting litigation. The Company anticipates a positive impact to net income during the first quarter of fiscal 2012 but does not have the necessary actuary data and other information at this time to know the exact effect.

On April 15, 2011, the Company received a copy of a complaint filed by Richard M. Osborne and Gas Natural, Inc. in the U.S. District Court for the Northern District of Ohio against four of the Company's directors and, nominally, against the Company (collectively "Defendants"). *Richard M. Osborne and Gas Natural Inc. v. Michael I. German, Henry B. Cook, Ted W. Gibson, George J. Welch and Corning Natural Gas Corporation*, Civ. Action No. 1:11-CV-744-CAB, N.D. Ohio (the "Action"). The plaintiffs claim that the directors breached their fiduciary duties to shareholders of the Company by (i) allegedly failing to maximize shareholder value in connection with the Company's responses to non-binding cash and stock offers to acquire the Company made by Gas Natural, Inc., which the Company did not accept: and (ii) allegedly diluting the holdings of Osborne and Gas Natural, Inc. by conducting a rights offering in July and August of 2010. The complaint also alleges, in the alternative, a derivative claim against the named directors for the same conduct. The complaint seeks to recover compensatory damages in an unspecified amount in excess of $75,000 and to rescind the rights offering, as well as payment of costs and interest. On May 27, 2011 the defendants moved to dismiss the Action on the grounds that (i) the court lacked personal jurisdiction over the defendants; (ii) venue does not properly lie in the Northern District of Ohio, (iii) the plaintiffs failed to state claims upon which relief can be granted, and (iv) to the extent that the claims are derivative and not direct, the plaintiffs failed to make a demand on the board as required by law before commencing the Action. Alternatively, defendants requested transfer of the Action to the United States District Court for the Western District of New York. Plaintiffs filed opposition papers on July 15, 2011 and defendants' reply papers were filed on July 28, 2011. The Court stayed discovery in the Action until it rules on defendants' motion, and the ruling is anticipated before year-end 2011. If the Court dismisses the Action for lack of personal jurisdiction or improper venue, the plaintiffs may attempt to recommence the Action elsewhere, including in the United States District Court for the Western District of New York. In the event the Action survives defendants' motion or is successfully recommenced elsewhere, defendants intend to defend all of the claims vigorously. Pursuant to the Company's by-laws, the named directors are entitled to advancement of the expenses of their defense of the litigation, and indemnification of any liability, subject to each director's undertaking to repay such advances in the event it is determined that they are not entitled to indemnification under applicable New York law. In addition, Gas Natural has also sued in New York State Court in Steuben County as a shareholder, seeking books and records related to the 2010 rights offering. A hearing is scheduled for February 15, 2012.

ITEM 4 - REMOVED AND RESERVED
**PART II**
ITEM 5 - MARKET FOR THE REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

The principal market on which the Company's common stock is traded is the Over-the-Counter Bulletin Board, or OTCBB, under the symbol "CNIG". Trading in the common stock is limited and sporadic. The following table sets forth the high and low closing sale prices as reported on the OTCBB for the Company's common stock for each quarter within the Company's last two fiscal years. Because the Company's stock is traded on the OTCBB, these quotations reflect inter-dealer prices, without retail markup, markdown or commission and may not represent actual transactions. The market prices have been adjusted retroactively to reflect the stock dividend in April 2011 (see "Dividends" for more information). The number of shareholders of record of the Company's common stock was 272 at September 30, 2011. 

MARKET PRICE - (OTC)
Quarter Ended
High
Low
December 31, 2009
12.53
10.33
March 31, 2010
16.67
11.50
June 30, 2010
16.00
13.50
September 30, 2010
15.67
11.77
December 31, 2010
14.33
12.33
March 31, 2011
16.00
13.83
June 30, 2011
23.33
11.11
September 30, 2011
20.00
16.50
DIVIDENDS

On March 13, 2009, the NYPSC in Case 07-G-0772 lifted the prohibition on the payment of dividends on the Company's common stock but limited pay outs to a percentage of earnings tied to the Company's debt/equity ratio. At its regular meeting on December 15, 2009, the Board of Directors approved an increase from $.12 a share to $.13 a share for shareholders of record on December 31, 2009, payable on January 15, 2010. At its regular meeting on February 5, 2010, the Board of Directors approved an increase in the quarterly dividend from $.13 a share to $.15 a share. After adjusting for the stock dividend paid in April 2011 (see third paragraph in this section below for additional information), dividends paid to shareholders of record were $.24 a share in 2009 and $.39 a share in 2009. At its regular meeting on December 14, 2010, the Board of Directors approved an increase in the quarterly dividend from $.15 a share to $.1725 a share and was paid on January 15, 2011 to shareholders of record as of December 31, 2010, and on April 15, 2011 for shareholders of record on March 31, 2011. The dividend rate of $.1725 reflects the pre-stock dividend rate (see third paragraph). The Board of Directors reviewed the quarterly dividend rate at its next regularly scheduled meeting on June 14, 2011 and adjusted the dividend rate to $.115. This dividend was paid on July 15, 2011 to shareholders of record on June 30, 2011 and on October 15, 2011 to shareholders of record on September 30, 2011.

On May 28, 2009, the Company registered 100,000 shares of common stock with a par value of $5 per share for a dividend reinvestment program. As part of this program 761 shares were issued in 2009, 2,319 shares in 2010 and 3,975 shares in 2011. A total of 7,055 shares have been issued since the program started.

On March 21, 2011, the Company set April 1, 2011 as the record date for a one for two stock dividend on its outstanding common stock as authorized by the NYPSC in an order in Case 10-G-0647 dated March 17, 2011. Each shareholder of record as of close of business on the record date was paid one share of common stock for each two shares held by such holder on April 20, 2011. Due to this stock dividend, all computations of number of shares and earnings per share have been adjusted retroactively for prior periods to reflect the change in capital structure.

ITEM 6 - SELECTED FINANCIAL DATA

2011
2010
2009
2008
2007
Total assets 
$45,005,488 
$41,491,639 
$39,274,790 
$33,786,320 
$30,295,666 
Long-term debt, less current installments 
$11,534,801 
$8,656,394 
$8,673,416 
$9,613,179 
$8,295,585 
Summary of earnings: 
Utility operating revenue 
$22,827,862 
$22,445,300 
$23,697,031 
$25,783,329 
$24,495,044 
Total operating expenses and taxes 
20,835,250
20,026,110
22,260,928
23,622,768
23,819,941
Net utility operating income 
1,992,612
2,419,190
1,436,103
2,160,561
478,473
Other income 
253,653
148,432
141,840
358,903
375,011
Interest expense-regulated 
897,437
925,999
905,658
1,513,115
790,569
Net income (loss)
$1,348,828 
$1,641,623 
$672,285 
$1,006,349 
$259,545 
Weighted average number of common shares outstanding 
1,746,198
1,562,576
1,280,285
1,221,825
798,206
Earnings per common share 
0.77
1.05
0.53
0.82
0.33
Dividends paid per common share 
$0.46 
$0.39 
$0.24 
$0.00 
$0.00 
Statistics (unaudited)-
Gas delivered (MMcf) 
Residential 
1,101
994
1,048
988
990
Commercial 
228
203
241
223
235
Other utilities 
300
287
317
305
291
Transportation deliveries 
8,072
7,621
6,311
7,072
7,478
Total deliveries 
9,701
9,105
7,917
8,588
8,994- Number of customers-end of period 

14,647
14,520
14,458
14,368
14,253
Average Mcf use per residential customer 
100
92
99
95
97
Average revenue per residential customer 
$1,193.17 
$1,188.07 
$1,268.27 
$1,377.99 
$1,345.60 
Number of degree days
8,136
7,429
8,139
7,436
7,212
Peak day deliveries (Mcf) 
56,302
49,005
56,218
53,532
55,442
Miles of mains 
418
414
413
410.6
406
Investment in gas plant (at cost) 
$47,490,565 
$43,767,615 
$39,257,065 
$34,395,538 
$30,323,764 
Stockholders' equity per share 
8.19
7.95
6.20
6.43
5.92**Page 6**
ITEM 7 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
**Management's Discussion and Analysis of Financial Condition and Results of Operations

Overview**
Our primary business is natural gas distribution. We serve approximately 14,700 customers through 400 miles of pipeline in the Corning, Hammondsport and Virgil, New York areas. The market for natural gas in our traditional service territory is relatively saturated with limited growth potential. However, growth opportunities do exist in extending our mains to areas adjacent or reasonably close to areas we currently serve. In addition, the Company continues to see expansion opportunities in the commercial and industrial markets. Two of our largest customers, Corning Incorporated and World Kitchen, added additional manufacturing capacity in our service area that is increasing our revenue and margins. We believe that our most promising growth opportunity for both revenues and margins is increasing connection with local gas production sources. We completed a new pipeline to Marcellus Shale gas in Pennsylvania in 2009 and we believe that pipeline could, depending on the volume of gas extracted and directed through the pipeline by the producer, significantly increase throughput on our system and have a significant impact on margins. In 2010 we upgraded portions of Lines 4, 7 and 13 to increase our capacity to transport local production gas. We have completed a compressor station that is working in conjunction with our pipeline upgrades to transport gas on our system and into the interstate pipeline system. In addition, we have formed a joint venture, Leatherstocking Gas Company, LLC, to pipe gas to areas of the northeast currently without gas service. We continue to focus on improving the efficiency of our operations and making capital investments to improve our infrastructure. 

Our key performance indicators are net income and shareholders' equity. 
**Year Ended September 30,**2011**2010**2009
Net income
$1,348,828 
$1,641,623 
$672,285 
Shareholders' equity
$14,646,582 
$13,676,797 
$9,396,862 
Shareholders' equity per weighted average share
$8.39 
$8.75 
$7.34 
In 2011, our consolidated net income was $1.3 million, a decrease of $292,795 from 2011 mainly because of an increase in property taxes and depreciation and unfavorable regulatory reconciliations.

In 2010, our consolidated net income was $1.6 million. Net income in 2010 was higher than 2009 mainly because of a full year under the rate increase that went into effect in September 2009, favorable Gas Adjustment Clause ("GAC") adjustments, the addition of large new customers and increased volumes used by existing major customers.

As a regulated utility company, shareholders' equity is an important performance indicator for us. The NYPSC allows us to earn a reasonable return on shareholders' equity. Shareholders' equity is therefore a precursor of future earnings potential. In 2011, shareholders' equity increased by $1 million due to exercise of stock options and warrants, raising $673,140. The equity per weighted average share ratio decreased for the period mainly due to the number of new shares issued with the stock dividend (see Note (k) Dividends). In 2010, shareholders' equity increased by $4.3 million due to a rights offering of our common stock, that raised $1.9 million in gross proceeds, favorable pension adjustments and positive earnings. In 2009, shareholders' equity increased by $1.8 million due to warrant holders exercising their rights and purchasing $2.8 million of common stock. Going forward, we continue to focus on rebuilding shareholders' equity. 

Other performance indicators that we track include leak repair, main and service replacements and customer service metrics. In 2011 we invested $3.7 million in system improvements and projects, repairing 216 leaks, and replacing 314 services and 4 miles of main. Because of weather related issues, some major projects started late in the fiscal year and will continue for the remainder of calendar 2011. During 2010 we invested $4.5 million in system improvements and projects, repairing 139 leaks, and replacing 358 services and 6.5 miles of gas main. In 2009 we invested $4.8 million in system improvements and projects, repairing 190 leaks, and replacing 459 services and 10.6 miles of gas main. 

Our customer service group has implemented several changes to positively impact our customers. Beginning in 2007, customers have the option of third party payment of their gas bill through their lending institution. We have also instituted online meter reading. Bill processing has been consolidated to shorten the time between meter readings and mailing, allowing a more direct link between the consumption of gas and the receipt by the customer of their bill. Our principal customer service metric is the number of customer complaints we receive. In 2011, the NYPSC reported 17 complaints against us. This compares to 20 in 2010 and 31 in 2009. 
**Earnings**
Earnings on a consolidated basis were as follows:
**Page 7****Net income
2011
2010
2009
Consolidated net income
$1,348,828 
$1,641,623 
$672,285 *2011 compared with 2010. We had a decrease in net income of $292,795 to $1.3 million or $.77 per share, mainly due to increased property taxes, depreciation and unfavorable regulatory reconciliations.
*2010 compared with 2009. We had an increase in net income of $969,338 to $1.6 million or $1.58 per share, from $672,285 or $0.79 per share because of a rate increase that went into effect in September 2009, favorable Gas Adjustment Clause ("GAC") adjustments, the addition of large new customers and increased volumes used by existing major customers.
**Utility Operating Revenue
2011
2010
2009
Retail Revenue:
Residential
$12,509,662 
$12,346,062 
$13,274,447 
Commercial
2,016,216
1,950,471
2,440,722
Industrial
59,733
59,732
76,612
Transportation
4,834,909
4,818,177
3,971,539
Total Retail Revenue
19,420,520
19,174,442
19,763,320
Wholesale
2,206,017
2,321,203
3,093,361
Local Production
1,055,565 
231,615 
367,753 
Other
145,760
718,040
472,597
Total Revenue
$22,827,862 
$22,445,300 
$23,697,031 
The following tables further summarize other income on the operating revenue table:

2011
2010
2009
Other gas revenues:
Customer discounts forfeited
$92,757 
$96,553 
$115,467 
Reconnect fees
3,620 
3,720 
5,020 
Gas revenues subject to refund
37,505 
604,850 
338,197 
Surcharges
11,878 
12,917 
13,913 
Total other gas revenues
$145,760 
$718,040 
$472,597 
2011
2010
2009
Gas revenues subject to refund:
Rate case amortizations
$20,363 
$20,363 
$1,697 
DRA carrying costs
17,019 
15,845 
315,924 
Estimated second stage rate increase accrual
216,604 
20,090 
- 
Monthly RDM amortizations
(111,282)
162,707 
20,576 
Capacity Release Income
51,690 
- 
- 
Annual RDM reconciliation
(156,889)
- 
- 
LAUF incentive benefit
- 
385,845 
- 
$37,505 
$604,850 
$338,197 *2011 compared with 2010. In 2011 our operating revenue increased $382,562, or 1.7%, primarily because of increased usage, local production revenues due to recognizing the revenue associated with offsetting our pipeline costs instead of offsetting plant (see Note (f) Depreciation) and the estimated second stage rate increase accrual that partially offset unfavorable regulatory amortizations and reconciliations.
*2010 compared with 2009. In 2010 our operating revenue decreased $1.25 million, or 5.3%, primarily because of lower gas costs partially offset by the rate increase that went into effect in September 2009.
**Margin
2011
2010
2009
Utility Operating Revenues
$22,827,862 
$22,445,300 
$23,697,031 
Natural Gas Purchased
9,714,941
9,647,495
13,034,734
Margin
13,112,921
12,797,805
10,662,297
57.44%
57.02%
44.99%
Our margin (the excess of utility operating revenues over the cost of natural gas purchased) increased $315,116 from 2010 to 2011 mainly due to increased usage, increased production revenues and accrual for the second stage rate increase granted as part of our last rate case partially offsetting unfavorable regulatory reconciliations.

Our margin increased $2.1 million from 2009 to 2010 primarily because of the rate increase in effect from September 2009 as well as higher throughput. The margin percentage increased 12.03% for the same reasons.

Looking forward, we anticipate additional margin growth due to our latest rate increase request effective in 2012. Our cost of gas should remain stable because of our access to local production and a favorable gas supply asset management agreement that we entered into with ConocoPhillips in 2011.
**Page 8 

Operating Expenses***2011 compared with 2010. Operating expenses increased to $7.2 million in 2011 from $6.9 million in 2010 mainly due to increased property taxes and increased pension expense as determined in our 2009 rate order. Depreciation and amortization increased by $765,887 from 2010 to 2011 because we are now recognizing the revenue associated with offsetting our pipeline costs and increasing accumulated depreciation and depreciation expense instead of offsetting plant (see Note (f) Depreciation). There has been a slight increase in purchase gas costs of $67,446 due to higher volumes purchased at a lower average price. 
*2010 compared with 2009. Operating expenses increased to $6.9 million in 2010 from $6.6 million in 2009 primarily because of increased administrative expense associated with pension costs. These pension costs were determined in our 2009 rate order. Depreciation and amortization decreased from $762,197 in 2009 to $713,066 in 2010 because of monthly amortization of excess depreciation based on the Company's last depreciation study per our last rate order. Our purchase gas costs have decreased $3.4 million from 2010 to 2009 mainly because of lower gas prices. 
**Investment Income***2011 compared with 2010. Investment income increased by $60,901 to $181,542 in 2011 due to realized gains and dividend and interest income.
*2010 compared with 2009. Investment income increased by $170,080 to a gain of $120,641 in 2010 from a loss of ($49,439) in 2009. This increase is the result of realized gains for the entire period as well as dividend and interest income.
**Effective Tax Rate**
Our effective tax rate for the period ending September 30, 2011 was 14.6% instead of the expected rate of 41.1% (34% federal provision and 7.1% New York State provision) due mainly to bonus depreciation on the Compressor Station, an asset not on the Company's Balance Sheet due to regulatory accounting (see Note (q) 311 Transportation Agreement/Compressor Station for more information). Our effective tax rate for the period ending September 30, 2010 was 37.2% instead of the expected rate of 41.1% (34% federal provision and 7.1% New York State provision) due to bonus depreciation and the adjustment back to a 34% federal provision for the prior fiscal year. Our effective tax rate for the period ending September 30, 2009 was 24.2% instead of the expected 42.1% (we were recognizing a 35% federal provision and 7.1% New York State provision) primarily due to bonus depreciation allowed this year. Taxes paid have also been affected by the amount of net operating loss (NOL) carryforward on both federal and state returns and have positively affected our effective tax rates. See also Note 6 to the Notes to Consolidated Financial Statements below.
**Liquidity and Capital Resources**
Internally generated cash from operating activities consists of net income, adjusted for non-cash expenses and changes in operating assets and liabilities. Non-cash items include depreciation and amortization, gain or loss on sale of securities and deferred income taxes. Over or under recovered gas costs significantly impact cash flow. In addition, there are significant year-to-year changes in regulatory assets that impact cash flow. Cash flows from investing activities consist primarily of capital expenditures. 

In October 2008, we obtained $1 million of financing in a form of Demand Note from M&T Bank to help with the cost of our new construction. Interest on this loan is payable on the monthly basis at the rate equal to 1% above the prime rate. The initial interest rate on this loan was 5.5% and was 4.25% at the end of September 2010. The Company repaid $500,000 in December 2009 and repaid the balance in December 2010.

In September 2010, we entered into an agreement with Five Star Bank to provide $750,000 to fund construction of an upgrade to existing natural gas piping to serve increased gas demands on one of our main supply lines, including at three Corning Incorporated plants. Interest is payable monthly at a fixed rate of 4.25% per annum and unless sooner accelerated or demanded, the note matured on September 25, 2011. This note was refinanced with Five Star Bank on September 1, 2011 with the same terms. The new maturity date is August 31, 2012 unless accelerated or demanded sooner.

In July 2010, the $1.9 million Community Bank Term Loan was repaid in full. On May 7, 2008, we entered into a credit agreement with M&T Bank to provide for a $6.0 million loan for the purpose of retiring a $3.1 million first mortgage and an unsecured senior note in the amount of $1.5 million. The remaining proceeds were used to fund construction projects related to furnishing natural gas within the Company's service area. This loan was converted to a long term loan on October 16, 2008, with an interest rate of 5.96%. Great West Life & Annuity Insurance Company, the holder of the Company's $4.7 million 7.9% Senior Notes dated as of September 1, 1997, expressed its belief that the refinancing with M&T Bank breached the negative covenants contained in the 1997 note agreement. An Intercreditor and Collateral Agency Agreement went into effect on December 1, 2009 between Great West and M&T Bank, as well as amendments to September 1997 Notes, resolving this issue and providing the Company more flexibility relative to future borrowings. On March 4, 2010, the $6 million loan agreement with M&T Bank was amended with the principal change being an increase in the interest rate to 6.5%. 

On May 7, 2010, the Company entered into a credit agreement with Community Bank N.A. for a $1.05 million promissory note at a fixed interest rate of 6.25% for the purpose of paying for the construction projects of our new franchise located in the town of Virgil. This agreement gives our lender security interest in all fixtures, equipment and inventory related to the Company's franchise in the town of Virgil as well as the Rabbi Trust account. The note also required an equity contribution of $350,000 which was accomplished by the exercise of 24,000 stock options by Michael I. German, President and CEO, at $15.00 per share or $360,000. The agreement included the following covenants to be measured at each fiscal year end starting with the September 30, 2009 financial statement: (i) maintain a tangible net worth of not less than $11.0 million, (ii) maintain a debt to tangible net worth of less than 3.0 to 1.0, and (iii) maintain a debt service coverage ratio of 1.10 to 1. 

On October 27, 2010, the Company entered into a Multiple Disbursement Term Note with Manufacturers and Traders Trust Company in the amount of $1,865,000 to refinance construction costs originally financed through internally generated funds. The interest rate of this note is 5.76% and is payable monthly for five years calculated on a ten year amortization schedule. A final payment will be due on the maturity date equal to the outstanding principal and interest. 

On July 14, 2011, the Company entered into a Multiple Disbursement Term Note and Credit Agreement in the amount of $2 million with Manufacturers and Traders Trust Company to fund construction projects in our NYPSC-mandated repair/replacement program for calendar year 2011. Until October 31, 2011, the note was payable as interest only at a rate of the greater of 3.50% above 30-day LIBOR or 4.25%. On November 1, 2011 the note converted to a permanent loan payable monthly for five years calculated on a ten-year amortization schedule with a variable rate, adjusting daily, based on the greater of 3.25 basis points above 30-day LIBOR or 4.25%.

The Company believes it is in compliance with all of our loan covenants as of September 30, 2011.

Cash flows from financing activities consist of repayment of long-term debt and borrowings and repayments under our lines-of-credit. For our consolidated operations, during 2011, we had $7 million (as of the February 2011 credit agreement renewal) available through lines of credit at local banks, the terms of which are disclosed in Note 5 to the accompanying consolidated financial statements. The amount outstanding under these lines at September 30, 2011 was $4.2 million. The aggregate borrowings at any one time under the revolving line may not exceed the sum of 100% of all eligible accounts receivable plus 100% of all gas inventory plus 50% of miscellaneous eligible inventories (material and supplies on the balance sheet) plus 100% of the value of the Rabbi Trust investment account (a trust to fund a deferred compensation plan for certain officers-see Note 7 to the Notes to Consolidated Financial Statements) up to the $7 million limit. As security for our line of credit, collateral assignments have been executed which assign to the lender various rights in the investment trust account. In addition, our lender has a purchase money interest in all of our natural gas purchases utilizing funds advanced by the bank under the line-of-credit agreement and all proceeds of sale of the gas to customers and related accounts receivable. We rely heavily on our credit lines and large portions of them are utilized throughout the entire year. 

On September 30, 2011 we had $12.5 million in long term debt outstanding. We repaid $1.1 million during fiscal 2011 consistent with the requirements of our debt instruments and refinancing activities. 

On September 30, 2010 we had $9.6 million in long term debt outstanding. We repaid $1.1 million during fiscal 2010 consistent with the requirements of our debt instruments and refinancing activities. 

In 2008 we entered in to an agreement with Atmos Energy Marketing LLC until March 2011. ConocoPhillips became our asset manager in April 2011. As of September 30, 2011, we had 615,353 dekatherms at $2.8 million in storage. In 2010 we ended the year with 604,920 dekatherms at $2.7 million in storage. The higher inventory value in 2011 is directly related to higher volumes. As the result of these actions, we anticipate that we will have sufficient gas to supply our customers for the 2011-2012 winter heating season.
**Other Comprehensive Income**
Other comprehensive income ("OCI") is comprised of unrealized gains or losses on securities available for sale as required by FASB ASC 320 and pension liability adjustments as required by FASB ASC 715. A drop from 6.75 % to 5.50 % in the discount rate resulted in a $1.9 million pension liability adjustment and a related $1.9 million OCI loss in 2009. There was also a drop in the discounts rate from 5.5% to 5.25% in 2010. That drop was offset by changes in assumptions in the rate of compensation increase from 4.5% to 3% and fund performance that resulted in a $679,023 OCI gain for the period ending September 30, 2010 related to pension liability adjustments. For the period ending September 30, 2011, there was again a drop in the discount rate from 5.25% to 5% which contributed to an associated OCI loss of $321,993 for the period. For additional information, see Note 7 to the Notes to the Consolidated Financial Statements.
**Off Balance Sheet Arrangements**
We have no off balance sheet arrangements.
**Contractual Obligations**
Long-term Debt 

The fair market value of our long-term debt is estimated based on quoted market prices of similar issues having the same remaining maturities, redemption terms and credit ratings. Notes payable to banks are stated at cost, which approximates their value due to the short-term maturities of those financial instruments. Based on these criteria, the fair market value of long-term debt, including current portion, was as follows at September 30, 2011, 2010 and 2009:

2011
2010
2009
Unsecured senior note - 7.9%, due serially with annual payments of $355,000 beginning on September 1, 2006 through 2016 and $795,000 due in 2017
$2,570,000 
$2,925,000 
$3,280,000 
Term Loan - variable rate 1/2 point below prime, monthly
installments through August 2010
- 
- 
316,650
Note payable - 6.5% with monthly installments through 2013
5,050,408 
5,487,679 
5,821,654 
Note payable - variable rate with 4.5% floor with monthly 
installments through May 2015
928,249
1,018,363
-
M&T Bank - new truck loan
2,995 
9,786
16,122
M&T Bank - excavator & radio equipment
6,066
17,285
27,686
M&T Bank - backhoe & skidsteer loader
21,835
46,493
69,353
M&T Bank - used truck loan
- 
- 
4,499
Community Bank - used trucks (5) loan
- 
19,980
45,335
M&T Bank - used truck loan
6,854
8,902
10,813
M&T Bank - used truck loan
8,124
14,196
- 
M&T Bank - vehicles loan
54,220
80,127
- 
Note Payable - 5.76% with monthly installments through 
November 2015
1,747,565
-
-
M&T Bank - used truck loan
9,252
- 
- 
Note Payable - variable rate with 4.25% floor, monthly************************************************************************