Annual Report

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-K

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

THE SECURITIES EXCHANGE ACT OF 1934

For the Fiscal Year Ended: December 31, 2005 Commission File Number: 001-11590

Chesapeake Utilities Corporation

(Exact name of registrant as specified in its charter)

State of Delaware	51-0064146
(State or other jurisdiction of	(I.R.S. Employer
incorporation or organization)	Identification No.)

909 Silver Lake Boulevard, Dover, Delaware 19904

(Address of principal executive offices, including zip code)

302-734-6799

(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
Common Stock - par value per share $.4867	New York Stock Exchange, Inc.

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

8.25% Convertible Debentures Due 2014

(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 Section 15(d) of the Act. Yes [ ]. No [X].

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 [X]. 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 registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendments to this Form 10-K. [X]

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. (Check one):

Large accelerated filer [ ] Accelerated filer [X] 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 [X].

The aggregate market value of the common shares held by non-affiliates of Chesapeake Utilities Corporation as of June 30, 2005, the last business day of its most recently completed second fiscal quarter, based on the last trade price on that date, as reported by the New York Stock Exchange, was approximately $170 million.

As of March 2, 2006, 5,925,945 shares of common stock were outstanding.

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the Proxy Statement for the 2006 Annual Meeting of Stockholders are incorporated by reference in Part III.

Chesapeake Utilities Corporation

Form 10-K

YEAR ENDED DECEMBER 31, 2005

TABLE OF CONTENTS

	Page
Part I	1
Item 1. Business	1
Item 1A. Risk Factors	8
Item 1B. Unresolved Staff Comments	11
Item 2. Proprties	11
Item 3. Legal Proceedings	11
Item 4. Submission of Matters to a Vote of Security Holders	11
Part II	12
Item 5. Market for the Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities	12
Item 6. Selected Financial Data	14
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations	18
Item 7A. Quantitative and Qualitative Disclosures About Market Risk	36
Item 8. Financial Statements and Supplemental Data	36
Item 9. Changes In and Disagreements With Accountants on Accounting and Financial Disclosure	67
Item 9A. Controls and Procedures	67
Item 9B. Other Information	67
Part III	68
Item 10. Directors and Executive Officers of the Registrant	68
Item 11. Executive Compensation	68
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters	68
Item 13. Certain Relationships and Related Transactions	69
Item 14. Principal Accounting Fees and Services	69
Part IV	70
Item 15. Exhibits, Financial Statement Schedules	70
Signatures	73

Part I

Safe Harbor for Forward-Looking Statements

References in this document to “Chesapeake,” “the Company,” “we,” “us” and “our” mean Chesapeake Utilities Corporation and/or its wholly owned subsidiaries, as appropriate. Chesapeake Utilities Corporation has made statements in this Form 10-K that are considered to be forward-looking statements. These statements are not matters of historical fact. Sometimes they contain words such as “believes,” “expects,” “intends,” “plans,” “will” or “may,” and other similar words of a predictive nature. These statements relate to matters such as customer growth, changes in revenues or gross margins, capital expenditures, environmental remediation costs, regulatory approvals, market risks associated with our propane operations, the competitive position of the Company and other matters. It is important to understand that these forward-looking statements are not guarantees, but are subject to certain risks and uncertainties and other important factors that could cause actual results to differ materially from those in the forward-looking statements.

Item 1. Business.

(a)

General Development of Business

Chesapeake is a diversified utility company engaged directly or through subsidiaries in natural gas distribution, transmission and marketing, propane distribution and wholesale marketing, advanced information services and other related businesses. Chesapeake is a Delaware corporation that was formed in 1947.

Chesapeake’s three natural gas distribution divisions serve approximately 54,800 residential, commercial and industrial customers in central and southern Delaware, Maryland’s Eastern Shore and parts of Florida. The Company’s natural gas transmission subsidiary, Eastern Shore Natural Gas Company (“Eastern Shore” or “ESNG”), operates a 331-mile interstate pipeline system that transports gas from various points in Pennsylvania to the Company’s Delaware and Maryland distribution divisions, as well as to other utilities and industrial customers in southern Pennsylvania, Delaware and on the Eastern Shore of Maryland. Our propane distribution operation serves approximately 32,900 customers in central and southern Delaware, the Eastern Shore of Maryland and Virginia, southeastern Pennsylvania, and parts of Florida. The advanced information services segment provides domestic and international clients with information technology related business services and solutions for both enterprise and e-business applications.

(b)

Financial Information about Industry Segments

Financial information by business segment is included in Item 8 under the heading “Notes to Consolidated Financial Statements — Note C.”

(c)

Narrative Description of Business

Chesapeake is engaged in three primary business activities: natural gas distribution and transmission, propane distribution and wholesale marketing and advanced information services. In addition to the primary groups, Chesapeake has subsidiaries in other related businesses.

(i) (a) Natural Gas Distribution and Transmission

General

Chesapeake distributes natural gas to residential, commercial and industrial customers in central and southern Delaware, the Salisbury and Cambridge, Maryland areas on Maryland’s Eastern Shore and parts of Florida. These activities are conducted through three utility divisions, one division in Delaware, another in Maryland and a third division in Florida. The Company also offers natural gas supply and supply management services in the state of Florida through its subsidiary, Peninsula Energy Services Company, Inc. (“PESCO”).

Delaware and Maryland . Chesapeake’s Delaware and Maryland utility divisions serve approximately 42,000 customers, of which approximately 41,800 are residential and commercial customers purchasing gas primarily for heating purposes. The remainder are industrial customers. For the year 2005, residential and commercial customers accounted for approximately 75% of the volume delivered by the divisions and 68% of the divisions’ revenue.

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Florida . The Florida division distributes natural gas to approximately 13,100 residential and commercial and 100 industrial customers in Polk, Osceola, Hillsborough, Gadsden, Gilchrist, Union, Holmes, Jackson, Desoto, Suwannee, Liberty and Citrus Counties. Currently the industrial customers, which purchase and transport gas on a firm basis, account for approximately 90% of the volume delivered by the Florida division and 45% of the revenues. These customers are primarily engaged in the citrus and phosphate industries and in electric cogeneration. PESCO provides natural gas supply management services to 285 customers on the Company’s Florida division, which operates as Central Florida Gas and an additional 424 customers on the Peoples Gas system, a subsidiary of TECO Energy, headquartered in Tampa, Florida. During 2005, Chesapeake formed a new wholly owned subsidiary, Peninsula Pipeline Company, Inc. to deliver natural gas to industrial customers by an intra-state pipeline.

Eastern Shore. The Company’s wholly owned transmission subsidiary, Eastern Shore, owns and operates an interstate natural gas pipeline and provides open access transportation services for affiliated and non-affiliated companies through an integrated gas pipeline extending from southeastern Pennsylvania through Delaware to its terminus on the Eastern Shore of Maryland. Eastern Shore also provides swing transportation service and contract storage services. Eastern Shore’s rates and services are subject to regulation by the Federal Energy Regulatory Commission (“FERC”).

Adequacy of Resources

General . The Delaware and Maryland divisions have both firm and interruptible contracts with four interstate “open access” pipelines including Eastern Shore. The divisions are directly interconnected with Eastern Shore and services upstream of Eastern Shore are contracted with Transcontinental Gas Pipeline Corporation (“Transco”), Columbia Gas Transmission Corporation (“Columbia”) and Columbia Gulf Transmission Company (“Gulf”), none of which are affiliates of the Company. The divisions use their firm transportation supply resources to meet a significant percentage of their projected demand requirements. In order to meet the difference between firm supply and firm demand, the divisions purchase natural gas supply on the spot market from various suppliers. This gas is transported by the upstream pipelines and delivered to the divisions’ interconnects with Eastern Shore. The divisions also have the capability to use propane-air peak-shaving to supplement or displace the spot market purchases. The Company believes that the availability of gas supply and transportation to the Delaware and Maryland divisions is adequate under existing arrangements to meet the anticipated needs of their customers.

Delaware . The Delaware division’s contracts with Transco include: (a) firm transportation capacity of 9,029 dekatherms (“Dt”) per day, with provisions to continue from year to year, subject to six (6) months notice for termination; (b) firm transportation capacity of 311 Dt per day for December through February, expiring in 2006; (c) firm transportation capacity of 174 Dt per day, which expires in 2008; (d) firm transportation capacity of 1,842 Dt, currently released from Eastern Shore, which expires in 2006; (e) firm storage service, providing a total capacity of 142,830 Dt, with provisions to continue from year to year, subject to six (6) months notice for termination; and (f) firm storage service, providing a total capacity of 17,967 Dt, currently released from Eastern Shore, which expires in 2006.

The Delaware division’s contracts with Columbia include: (a) firm transportation capacity of 880 Dt per day, which expires in 2014; (b) firm transportation capacity of 1,132 Dt per day, which expires in 2017; (c) firm transportation capacity of 549 Dt per day, which expires in 2018; (d) firm transportation capacity of 899 per day, which expires in 2019; (e) firm storage service providing a peak day entitlement of 6,193 Dt and a total capacity of 298,195 Dt, which expires in 2015; (f) firm storage service, providing a peak day entitlement of 635 Dt and a total capacity of 57,139 Dt, which expires in 2018; (g) firm storage service providing a peak day entitlement of 583 Dt and a total capacity of 52,460 Dt, which expires in 2019; (h) firm storage service providing a peak day entitlement of 583 Dt and a total capacity of 52,460 Dt, which expires in 2020; (i) firm storage service providing a peak day entitlement of 15 Dt and a total capacity of 1,350 Dt, which expires in 2018; and (j) firm storage service providing a peak day entitlement of 215 Dt and a total capacity of 10,646 Dt, which expires in 2010. Delaware’s contracts with Columbia for storage-related transportation provide quantities that are equivalent to the peak day entitlement for the period of October through March and are equivalent to fifty percent (50%) of the peak day entitlement for the period of April through September. The terms of the storage-related transportation contracts mirror the storage services that they support.

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The Delaware division’s contract with Gulf, which expires in 2009, provides firm transportation capacity of 880 Dt per day for the period November through March and 809 Dt per day for the period April through October.

The Delaware division’s contracts with Eastern Shore include: (a) firm transportation capacity of 43,787 Dt per day for the period December through February, 42,565 Dt per day for the months of November, March and April, and 33,489 Dt per day for the period May through October, with various expiration dates ranging from 2005 to 2017; (b) firm storage capacity providing a peak day entitlement of 2,655 Dt and a total capacity of 131,370 Dt, which expires in 2013; (c) firm storage capacity providing a peak day entitlement of 580 Dt and a total capacity of 29,000 Dt, which expires in 2013; (d) firm storage capacity providing a peak day entitlement of 911 Dt and a total capacity of 5,708 Dt, which expires in 2006.

The Delaware division currently has contracts for the purchase of firm natural gas supply with several suppliers. These supply contracts provide the availability of a maximum firm daily entitlement of 29,700 Dt and delivered on Transco, Columbia, and/or Gulf systems to Eastern Shore for redelivery under firm transportation contracts. The gas purchase contracts have various expiration dates and daily quantities may vary from day to day and month to month.

Maryland . The Maryland division’s contracts with Transco include: (a) firm transportation capacity of 4,738 Dt per day, with provisions to continue from year to year, subject to six (6) months notice for termination; (b) firm transportation capacity of 155 Dt per day for December through February, expiring in 2006; (c) firm transportation capacity of 973 Dt, currently released from Eastern Shore, which expires in 2006; (d) firm storage service providing a total capacity of 33,120 Dt, with provisions to continue from year to year, subject to six months notice for termination ; and (e) firm storage service, providing a total capacity of 5,489 Dt, currently released from Eastern Shore, which expires in 2006.

The Maryland division’s contracts with Columbia include: (a) firm transportation capacity of 442 Dt per day, which expires in 2014; (b) firm transportation capacity of 908 Dt per day, which expires in 2017; (c) firm transportation capacity of 350 Dt per day, which expires in 2018; (d) firm storage service providing a peak day entitlement of 3,142 Dt and a total capacity of 154,756 Dt, which expires in 2015; and (e) firm storage service providing a peak day entitlement of 521 Dt and a total capacity of 46,881 Dt, which expires in 2018. The Maryland division’s contracts with Columbia for storage-related transportation provide quantities that are equivalent to the peak day entitlement for the period October through March and are equivalent to fifty percent (50%) of the peak day entitlement for the period April through September. The terms of the storage-related transportation contracts mirror the storage services that they support.

The Maryland division’s contract with Gulf, which expires in 2009, provides firm transportation capacity of 590 Dt per day for the period November through March and 543 Dt per day for the period April through October.

The Maryland division’s contracts with Eastern Shore include: (a) firm transportation capacity of 16,278 Dt per day for the period December through February, 15,554 Dt per day for the months of November, March and April and 10,993 Dt per day for the period May through October, with various expiration dates ranging from 2006 to 2015; (b) firm storage capacity providing a peak day entitlement of 1,428 Dt and a total capacity of 70,665 Dt, which expires in 2013; (c) firm storage capacity providing a peak day entitlement of 309 Dt and a total capacity of 15,500 Dt, which expires in 2013; and (d) firm storage capacity providing a peak day entitlement of 569 Dt and a total capacity of 3,560 Dt, which expires in 2006.

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The Maryland division currently has contracts for the purchase of firm natural gas supply with several suppliers. These supply contracts provide the availability of a maximum firm daily entitlement of 7,500 Dt delivered on Transco, Columbia, and/or Gulf systems to Eastern Shore for redelivery under the Maryland division’s transportation contracts. The gas purchase contracts have various expiration dates and daily quantities may vary from day to day and month to month.

Florida . The Florida division receives transportation service from Florida Gas Transmission Company (“FGT”), a major interstate pipeline. Chesapeake has contracts with FGT for: (a) daily firm transportation capacity of 27,579 Dt in November through April; 21,123 Dt in May through September, and 27,105 Dt in October, which expires in 2010; and (b) daily firm transportation capacity of 1,000 Dt daily, which expires in 2015.

The Florida division also began receiving transportation service from Gulfstream Natural Gas System (“Gulfstream”), beginning in June 2002. Chesapeake has a contract with Gulfstream for daily firm transportation capacity of 10,000 Dt daily. The contract with Gulfstream expires May 31, 2022.

PESCO currently has a contract with Eagle Energy Partners for the purchase of firm natural gas supply. This contract provides the availability of a maximum firm daily entitlement of 7,500 MMBtus. The gas purchase contract expires in April 2006.

Eastern Shore . Eastern Shore has 2,720 thousand cubic feet (“Mcf”) of firm transportation capacity under contract with Transco, which expires in 2008. Eastern Shore also has contracts with Transco for: (a) 5,406 Mcf of firm peak day entitlements and total storage capacity of 267,981 Mcf, which expires in 2013; and (b) 1,640 Mcf of firm peak day entitlements and total storage capacity of 10,283 Mcf, which expires in 2006.

Eastern Shore has retained the firm transportation capacity and firm storage services described above in order to provide swing transportation service and storage service to those customers that requested such service.

Competition

See discussion on competition in Item 7 under the heading “Management’s Discussion and Analysis — Competition.”

Rates and Regulation

General . Chesapeake’s natural gas distribution divisions are subject to regulation by the Delaware, Maryland and Florida Public Service Commissions with respect to various aspects of the business, including the rates for sales and transportation to all customers in each respective jurisdiction. All of Chesapeake’s firm distribution sales rates are subject to gas cost recovery mechanisms, which match revenues with gas costs and normally allow eventual full recovery of gas costs. Adjustments under these mechanisms, which are limited to gas costs, require periodic filings and hearings with the relevant regulatory authority.

Eastern Shore is subject to regulation by the FERC as an interstate pipeline. The FERC regulates the provision of service, terms and conditions of service, and the rates Eastern Shore can charge for its transportation and storage services.

Management monitors the achieved rate of return in each jurisdiction in order to ensure the timely filing of rate cases.

Regulatory Proceedings

See discussion of regulatory activities in Item 7 under the heading “Management’s Discussion and Analysis — Regulatory Activities.”

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(i) (b) Propane Distribution and Wholesale Marketing

General

Chesapeake’s propane distribution group consists of (1) Sharp Energy, Inc. (“Sharp Energy”), a wholly owned subsidiary of Chesapeake, (2) Sharpgas, Inc. (“Sharpgas”), a wholly owned subsidiary of Sharp Energy, and (3) Tri-County Gas Co., Incorporated (“Tri-County”), a wholly owned subsidiary of Sharp Energy. The propane wholesale marketing group consists of Xeron, Inc. (“Xeron”), a wholly owned subsidiary of Chesapeake.

Propane is a form of liquefied petroleum gas, which is typically extracted from natural gas or separated during the crude oil refining process. Although propane is a gas at normal pressure, it is easily compressed into liquid form for storage and transportation. Propane is a clean-burning fuel, gaining increased recognition for its environmental superiority, safety, efficiency, transportability and ease of use relative to alternative forms of energy. Propane is sold primarily in suburban and rural areas, which are not served by natural gas distributors. Demand is typically much higher in the winter months and is significantly affected by seasonal variations, particularly the relative severity of winter temperatures, because of its use in residential and commercial heating.

During 2005, our propane distribution operations served approximately 32,900 propane customers on the Delmarva Peninsula, southeastern Pennsylvania and in Florida and delivered approximately 26 million retail and wholesale gallons of propane.

In May 1998, Chesapeake acquired Xeron, a natural gas liquids trading company located in Houston, Texas. Xeron markets propane to large independent and petrochemical companies, resellers and southeastern retail propane companies in the United States. Additional information on Xeron’s trading and wholesale marketing activities, market risks and the controls that limit and monitor the risks are included in Item 7 under the heading “Management’s Discussion and Analysis — Market Risk.”

The propane distribution business is affected by many factors, such as seasonality, the absence of price regulation, and competition among local providers. The propane wholesale marketing business is affected by wholesale price volatility and the supply and demand for propane at a wholesale level.

Adequacy of Resources

The Company’s propane distribution operations purchase propane primarily from suppliers, including major domestic oil companies and independent producers of gas liquids and oil. Supplies of propane from these and other sources are readily available for purchase by the Company. Supply contracts generally include minimum (not subject to take-or-pay premiums) and maximum purchase provisions.

The Company’s propane distribution operations use trucks and railroad cars to transport propane from refineries, natural gas processing plants or pipeline terminals to its bulk storage facilities. From these facilities, propane is delivered in portable cylinders or by “bobtail” trucks, owned and operated by the Company, to tanks located at the customer’s premises.

Xeron does not own physical storage facilities or equipment to transport propane; however, it contracts for storage and pipeline capacity to facilitate the sale of propane on a wholesale basis.

Competition

See discussion on competition in Item 7 under the heading “Management’s Discussion and Analysis — Competition.”

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Rates and Regulation

The propane distribution and wholesale marketing activities are not subject to any federal or state pricing regulation. Transport operations are subject to regulations concerning the transportation of hazardous materials promulgated under the Federal Motor Carrier Safety Act, which is administered by the United States Department of Transportation and enforced by the various states in which such operations take place. Propane distribution operations are also subject to state safety regulations relating to “hook-up” and placement of propane tanks.

The Company’s propane operations are subject to all operating hazards normally associated with the handling, storage and transportation of combustible liquids, such as the risk of personal injury and property damage caused by fire. The Company carries general liability insurance in the amount of $35 million, but there is no assurance that such insurance will be adequate.

(i) (c) Advanced Information Services

General

Chesapeake’s advanced information services segment consists of BravePoint, Inc. (“BravePoint”), a wholly owned subsidiary of the Company. BravePoint, headquartered in Norcross, Georgia, provides domestic and international clients with information technology related business services and solutions for both enterprise and e-business applications.

Competition

See discussion on competition in Item 7 under the heading “Management’s Discussion and Analysis — Competition.”

(i) (d) Other Subsidiaries

Skipjack, Inc. (“Skipjack”), Eastern Shore Real Estate, Inc. and Chesapeake Investment Company are wholly owned subsidiaries of Chesapeake Service Company. Skipjack and Eastern Shore Real Estate, Inc. own and lease office buildings in Delaware and Maryland to affiliates of Chesapeake. Chesapeake Investment Company is a Delaware affiliated investment company. During 2004, Chesapeake formed a new wholly owned subsidiary, OnSight Energy, LLC (“OnSight”), to provide distributed energy solutions to customers requiring reliable, uninterrupted energy sources and/or those wishing to reduce energy costs.

(ii) Seasonal Nature of Business

Revenues from the Company’s residential and commercial natural gas sales and from its propane distribution activities are affected by seasonal variations, since the majority of these sales are to customers using the fuels for heating purposes. Revenues from these customers are accordingly affected by the mildness or severity of the heating season.

(iii) Capital Budget

A discussion of capital expenditures by business segment and capital expenditures for environmental control facilities are included in Item 7 under the heading “Management Discussion and Analysis — Liquidity and Capital Resources.”

(iv) Employees

As of December 31, 2005, Chesapeake had 423 employees, including 185 in natural gas, 140 in propane and 60 in advanced information services. The remaining 38 employees are considered general and administrative and include officers of the Company, treasury, accounting, internal audit, information technology, human resources and other administrative personnel.

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(v) Executive Officers of the Registrant

Information pertaining to the executive officers of the Company is as follows:

John R. Schimkaitis (age 58) Mr. Schimkaitis is President and Chief Executive Officer of Chesapeake and its subsidiaries. Mr. Schimkaitis assumed the role of Chief Executive Officer on January 1, 1999. He has served as President since 1997. Prior to this, Mr. Schimkaitis served as President and Chief Operating Officer, Executive Vice President, Senior Vice President, Chief Financial Officer, Vice President, Treasurer, Assistant Treasurer and Assistant Secretary of Chesapeake.

Paul M. Barbas (age 49) Mr. Barbas is Chief Operating Officer of Chesapeake Utilities Corporation. He was appointed to his current position effective January 1, 2006. He previously served as Executive Vice President and President of Chesapeake Service Company. He was appointed Executive Vice President in 2004 and served as Vice President and President of Chesapeake Service Company since joining the company in 2003. Prior to joining Chesapeake, Mr. Barbas was Executive Vice President of Allegheny Power. Mr. Barbas joined Allegheny Energy as President of Allegheny Ventures in 1999 and was appointed Executive Vice President of Allegheny Power in 2001. Prior to 1999 Mr. Barbas held a variety of executive positions within G.E. Capital.

Michael P. McMasters (age 47) Mr. McMasters is Senior Vice President and Chief Financial Officer of Chesapeake Utilities Corporation. He was appointed Senior Vice President in 2004 and has served as Chief Financial Officer since December 1996. He has previously held the positions of Vice President, Treasurer, Director of Accounting and Rates, and Controller. From 1992 to May 1994, Mr. McMasters was employed as Director of Operations Planning for Equitable Gas Company.

Stephen C. Thompson (age 45) Mr. Thompson is President of Eastern Shore Natural Gas Company and Senior Vice President of Chesapeake Utilities Corporation. Prior to becoming Senior Vice President in 2004, he served as Vice President of Chesapeake since May 1997. He has also served as Vice President, Director of Gas Supply and Marketing, Superintendent of Eastern Shore and Regional Manager for the Florida distribution operations.

Beth W. Cooper (age 39) Ms. Cooper is Vice President, Treasurer and Corporate Secretary of Chesapeake Utilities Corporation. Ms. Cooper has served as Corporate Secretary since July 2005. She previously served as Assistant Treasurer and Assistant Secretary, Director of Internal Audit, Director of Strategic Planning, Planning Consultant, Accounting Manager for Non-regulated Operations and Treasury Analyst. Prior to joining Chesapeake, she was employed as an auditor with Ernst & Young’s Entrepreneurial Services Group.

S. Robert Zola (age 53) Mr. Zola joined Sharp Energy in August of 2002 as President. Prior to joining Sharp Energy, Mr. Zola most recently served as Northeast Regional Manager of Synergy Gas, now Cornerstone MLP, in Philadelphia, PA. During his 25-year career in the propane industry, Mr. Zola also started Bluestreak Propane in Phoenix, AZ, which after successfully developing the business, was sold to Ferrell Gas.

(vi) Financial Information about Geographic Areas

All of the Company’s material operations, customers, and assets occur and are located in the United States.

(d)

Available Information

As a public company, Chesapeake files annual, quarterly and other reports, as well as its annual proxy statement and other information, with the Securities and Exchange Commission (“the SEC”). The public may read and copy any materials that the Company files with the SEC at the SEC’s Public Reference Room at 100 F Street, N.E.

Washington, DC 20549-5546; and the public may obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. The SEC also maintains an Internet site that contains reports, proxy and information statements and other information regarding the Company. The address of the SEC’s Internet website is www.sec.gov. Chesapeake makes available, free of charge, on its Internet website its Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and amendments to those reports, as soon as reasonably practicable after such reports are electronically filed with or furnished to the SEC. The address of Chesapeake’s Internet website is www.chpk.com. The content of this website is not part of this report.

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Chesapeake has a Business Code of Ethics and Conduct applicable to all employees, officers and directors and a Code of Ethics for Financial Officers. Copies of the Business Code of Ethics and Conduct and the Financial Officer Code of Ethics are available on its website. Chesapeake also adopted Corporate Governance Guidelines and Charters for the Audit Committee, Compensation Committee, and Governance Committee of the Board of Directors, each of which satisfies the regulatory requirements established by the Securities and Exchange Commission and the New York Stock Exchange (“NYSE”). The Board of Directors has also adopted “Corporate Governance Guidelines on Director Independence,” which conform to the NYSE listing standards on director independence. Each of these documents also is available on Chesapeake’s Internet website or may be obtained by writing to: Corporate Secretary; c/o Chesapeake Utilities Corporation; 909 Silver Lake Blvd.; Dover, DE 19904.

If Chesapeake makes any amendment to, or grants a waiver of, any provision of the Business Code of Ethics and Conduct or the Financial Officer Code of Ethics applicable to its principal executive officer, principal financial officer, principal accounting officer or controller, the amendment or waiver will be disclosed within five business days on the Company’s Internet website.

Item 1A. Risk Factors.

The following is a discussion of the primary factors that may affect the operations and/or financial performance of the regulated and unregulated businesses of Chesapeake. Refer to the section entitled “Management’s Discussion and Analysis of Financial Condition and Results of Operations” under Item 7 of this report for an additional discussion of these and other related factors that affect the Company’s operations and/or financial performance. The principal business, economic and other factors that affect the operations and/or financial performance of the Company include:

Fluctuations in weather have the potential to adversely affect the company’s results of operations, cash flows and financial condition.

The Company’s regulated utility and propane distribution operations are weather sensitive, with a significant portion of its revenues derived from the delivery of natural gas and propane to residential and commercial heating customers during the winter season. Generally, weather conditions directly influence the volume of natural gas and propane delivered by the regulated utility and propane distribution operations.

Regulation of Chesapeake, including changes in the regulatory environment in general, may adversely affect the company’s results of operations, cash flows and financial condition.

The state Public Service Commissions of Delaware, Maryland and Florida regulate the natural gas distribution operations . The Company’s natural gas transmission operation is regulated by the FERC. These regulatory commissions set the rates in their respective jurisdictions that the Company can charge customers for its rate-regulated services. Changes in these rates, as ordered by regulatory commissions, affect the Company’s financial performance.

The Company expects that regulatory commissions will continue to set the prices for delivery service that give it an opportunity to earn a just and reasonable rate of return on the capital invested in its distribution system and to recover reasonable operating expenses.

The amount and availability of natural gas and propane supplies are difficult to predict, which may reduce our earnings.

Natural gas and propane production can be impacted by factors outside of the Company’s control, such as weather and refinery closings. The Company believes it has adequate resources to meet its customer’s needs. See discussion on adequacy of resources in Item 1 under the heading “Business — Narrative Description of Business.”

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Chesapeake relies on direct connections to interstate pipelines and storage capacity. If these pipelines or storage facilities were unable to deliver for any reason it could impair Chesapeake’s ability to meet its customers’ full requirements.

Chesapeake is responsible for acquiring both sufficient natural gas supplies and interstate pipeline and storage capacity to meet customer requirements. As such, Chesapeake must contract for reliable and adequate delivery capacity to its distribution system, while considering the dynamics of the interstate pipeline and storage capacity market, its own on-system peak-shaving facilities, as well as the characteristics of its customer base.

Local distribution companies, including Chesapeake, along with other participants in the energy industry, have raised concerns regarding the gradual depletion in the availability of additional upstream interstate pipeline and storage capacity. Diminishing pipeline and storage capacity is a business issue that must be managed by the Company, whose customer base has grown at an annual rate between seven and nine percent. This rate of growth is expected to continue. To help maintain the adequacy of pipeline and storage capacity for its growing customer base, the Company has contracted with various interstate pipeline and storage companies for the acquisition of additional existing capacity, as well as, the construction of new capacity by ESNG. The Company will continue to monitor other opportunities to acquire or participate in obtaining additional pipeline and storage capacity that will improve or maintain the high level of service expected by its customer base.

Natural gas and propane commodity price changes may affect the operating costs and competitive positions of the company’s natural gas and propane distribution operations, which could adversely affect its results of operations, cash flows and financial condition.

Natural Gas

Increased prices of natural gas are being driven by increased demand that is exceeding the growth in available supply. As discussed above, the fall 2005 hurricane season significantly reduced the current and anticipated availability of natural gas supply from the Gulf Coast region, causing a dramatic rise in natural gas prices during the fourth quarter of fiscal year 2005. The higher natural gas prices resulted in significant increases in the cost of gas billed to customers during the upcoming 2005-2006 winter heating season. Under its regulated gas cost recovery mechanisms, Chesapeake records cost of gas expense equal to the cost of gas recovered in revenues from customers. Accordingly, an increase in the cost of gas due to an increase in the purchase price of the natural gas commodity generally has no direct effect on the regulated utility’s net revenues and net income. However, net income may be reduced due to higher expenses that may be incurred for uncollectible customer accounts, as well as lower volumes of natural gas deliveries to firm customers that may result due to lower natural gas consumption caused by customer conservation. Increases in the price of natural gas also can affect the Company’s operating cash flows, as well as the competitiveness of natural gas as an energy source.

Propane

The level of profitability in the retail propane business is largely dependent on the difference between retail sales price and product cost. The unit cost of propane is subject to volatile changes as a result of product supply or other market conditions, including, but not limited to, economic and political factors impacting crude oil and natural gas supply or pricing. Product cost changes can occur rapidly over a short period of time and can impact profitability. There is no assurance that the Company will be able to pass on product cost increases fully or immediately, particularly when product costs increase or decrease rapidly. Therefore, average retail sales prices can vary significantly from year to year as product costs fluctuate with propane, fuel oil, crude oil and natural gas commodity market conditions. In addition, in periods of sustained higher commodity prices, as was experienced in fiscal 2005, retail sales volumes may be negatively impacted by customer conservation efforts and increased amounts of uncollected accounts.

The replacement of less efficient gas appliances with more energy efficient appliances will result in a decline of consumption per customer, which will lead to reduced revenues.

Natural gas and propane supply requirements may be affected by changes in natural gas and propane consumption by end-use customers. Natural gas and propane usage per customer will decline as customers replace older, less efficient gas appliances with more efficient appliances. In addition, homebuilders in each of the growth areas are installing the newer, more efficient appliances in the homes they build.

- Page 9 -

Each of Chesapeake’s segments competes in a competitive environment and may be faced with losing customers to a competitor.

See discussion on competition in Item 7 under the heading “Management’s Discussion and Analysis — Competition.”

A change in Chesapeake’s approved rate mechanisms for recovery of environmental remediation costs at former manufacturer gas sites could adversely affect the company’s results of operations, cash flows and financial condition.

The Company and its subsidiaries are subject to federal, state and local laws and regulations related to environmental matters. These evolving laws and regulations may require expenditures over a long time frame to control environmental effects. Refer to Note M of the Notes to Consolidated Financial Statements for a further discussion of these matters.

A change in the economic conditions and interest rates could adversely affect the company’s results of operations and cash flows.

The Company and its subsidiaries operate in one of the fastest growing regions in the nation. The continued prosperity of this region, supported by a relatively low interest-rate environment, has allowed our regulated utility to expand its delivery services to its customer base at a rate of growth approximately twice the national industry average during the past five years. A downturn in the economy of the region in which we operate, or a significant increase in interest rates, which cannot be predicted with accuracy, might adversely affect the Company’s ability to grow its regulated utility customer base and other businesses at the same rate they have grown in the recent past.

The Company has been operating in a relatively low interest-rate environment in the recent past as it relates to long-term debt financings. Short-term interest rates had been relatively low in relation to historical levels; however, actions and communications by the Federal Reserve in the past year have resulted in increases in short-term interest rates. A rise in interest rates without the recovery of the higher cost of debt in the sales and/or transportation rates the Company charges its utility customers could adversely affect future earnings. A rise in short-term interest rates would negatively affect the results of operations, which depend on short-term debt to finance accounts receivable and storage gas inventories.

Inflation / Deflation conditions may impact Chesapeake’s results of operations, cash flows, and financial position.

See discussion on competition in Item 7 under the heading “Management’s Discussion and Analysis — Inflation.”

Changes in technology could adversely affect the Company’s advanced information services segment’s results of operations, cash flows, and financial condition.

The advanced information services segment participates in a market that is characterized by rapidly changing technology and accelerating product introduction cycles. The success of our advanced information services segment depends upon our ability to address the rapidly changing needs of our customers by developing and supplying high-quality, cost-effective products, product enhancements and services on a timely basis, and by keeping pace with technological developments and emerging industry standards.

The Company’s propane wholesale and marketing operation has credit risk that could adversely affect the Company’s results of operations, cash flows, and financial condition.

The propane wholesale and marketing operation extends credit to its counter-parties. Despite prudent credit policies, the Company is exposed to the risk that it may not be able to collect amounts owed to it. If the counter-party to such a transaction fails to perform and any collateral the Company has secured is inadequate, the Company could experience financial losses.

Chesapeake’s use of derivative instruments could adversely affect the company’s results of operations.

The Company’s propane distribution operation uses derivative instruments, including forwards, swaps, and puts, to hedge propane price risk. Fluctuating propane prices cause earnings and financing costs of Chesapeake to be impacted. The use of derivative instruments that are not perfectly matched to the exposure could adversely affect the Company’s results of operations, cash flows, and financial conditions.

- Page 10 -

Item 1B. Unresolved Staff Comments.

None.

Item 2. Properties

(a)

General

The Company owns offices and operates facilities in the following locations: Pocomoke, Salisbury, Cambridge and Princess Anne, Maryland; Dover, Seaford, Laurel and Georgetown, Delaware; and Winter Haven, Florida. Chesapeake rents office space in Dover and Ocean View, Delaware; Jupiter and Lecanto, Florida; Chincoteague and Belle Haven, Virginia; Easton, and Salisbury, Maryland; Honey Brook and Allentown, Pennsylvania; Houston, Texas; and Atlanta, Georgia. In general, the Company believes that its properties are adequate for the uses for which they are employed. Capacity and utilization of the Company’s facilities can vary significantly due to the seasonal nature of the natural gas and propane distribution businesses.

(b)

Natural Gas Distribution

Chesapeake owns over 880 miles of natural gas distribution mains (together with related service lines, meters and regulators) located in its Delaware and Maryland service areas and 695 miles of natural gas distribution mains (and related equipment) in its central Florida service areas. Chesapeake also owns facilities in Delaware and Maryland for propane-air injection during periods of peak demand.

(c)

Natural Gas Transmission

Eastern Shore owns and operates approximately 331 miles of transmission pipelines extending from supply interconnects at Parkesburg, Pennsylvania; Daleville, Pennsylvania and Hockessin, Delaware to approximately 75 delivery points in southeastern Pennsylvania, Delaware and the eastern shore of Maryland.

(d)

Propane Distribution and Wholesale Marketing

The company’s Delmarva-based propane distribution operation owns bulk propane storage facilities with an aggregate capacity of approximately 2.0 million gallons at 42 plant facilities in Delaware, Maryland and Virginia, located on real estate that is either owned or leased. The Company’s Florida-based propane distribution operation owns three bulk propane storage facilities with a total capacity of 66,000 gallons. Xeron does not own physical storage facilities or equipment to transport propane; however, it leases propane storage capacity and pipeline capacity.

Item 3. Legal Proceedings

(a)

General

The Company and its subsidiaries are involved in various legal actions and claims arising in the normal course of business. The Company is also involved in certain legal and administrative proceedings before various governmental agencies concerning rates. In the opinion of management, the ultimate disposition of these proceedings will not have a material effect on our consolidated financial position.

(b)

Environmental

See discussion of environmental commitments and contingencies in Item 8 under the heading “Notes to Consolidated Financial Statements — Note M.”

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

None

- Page 11 -

Part II

Item 5. Market for the Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.

(a)

Common Stock Price Ranges, Common Stock Dividends and Shareholder Information:

The Company’s Common Stock is listed on the New York Stock Exchange under the symbol “CPK.” The high, low and closing prices of Chesapeake’s Common Stock and dividends declared per share for each calendar quarter during the years 2005 and 2004 were as follows:

Quarter Ended	High		Low		Close		Dividends Declared Per Share
2005
March 31	$	27.5900	$	25.8300	$	26.6000	$	0.2800
June 30		30.9500		23.6000		30.5800		0.2850
September 30		35.6000		59.5000		35.1620		0.2850
December 31		35.7799		30.3227		30.8000		0.2850

2004
March 31	$	26.5100	$	24.3000	$	25.6200	$	0.2750
June 30		26.2000		20.4200		22.7000		0.2800
September 30		25.4000		22.1000		25.1000		0.2800
December 31		27.5500		24.5000		26.7000		0.2800

Dividend payments are payable at the discretion of our Board of Directors. Future payment of dividends, and the amount of these dividends, will depend on our financial condition, results of operations, capital requirements, and other factors. We sold no securities during the year 2005 that were not registered under the Securities Act of 1933, as amended.

Indentures to the long-term debt of the Company contain various restrictions. The most stringent restrictions state that the Company must maintain equity of at least 40 percent of total capitalization and the pro-forma fixed charge coverage ratio must be at least 1.5 times.

At December 31, 2005, there were approximately 2,026 shareholders of record of the Common Stock.

- Page 12 -

(b)

Purchases of Equity Securities by the Issuer

The following table sets forth information on purchases by or on behalf of Chesapeake of shares of its Common Stock during the quarter ended December 31, 2005.

Period	Total Number of Shares Purchased		Average Price Paid per Share		Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs ⁽²⁾		Maximum Number of Shares That May Yet Be Purchased Under the Plans or Programs ⁽²⁾
October 1, 2005 through October 31, 2005 ⁽¹⁾		295	$	36.00		0		0
November 1, 2005 through November 30, 2005		0	$	0.00		0		0
December 1, 2005 through December 31, 2005		0	$	0.00		0		0
Total		295	$	36.00		0		0

⁽¹⁾ Chesapeake purchased shares of stock on the open market to add to shares held in a Rabbi Trust to adjust the balance to the contractual value. 295 shares were purchased through executive dividend deferrals.
⁽²⁾ Chesapeake has no publicly announced plans or programs to repurchase its shares.

See discussion on compensation plans of Chesapeake and its subsidiaries under which shares of Chesapeake common stock are authorized for issuance in Item 12 under the heading “Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters.

- Page 13 -

Item 6. Selected Financial Data

For the Years Ended December 31,	2005			2004			2003			2002 ⁽¹⁾			2001 ⁽¹⁾
Operating *(in thousands of dollars)* ⁽³⁾
Revenues
Natural gas distribution and transmission	$	166,582		$	124,246		$	110,247		$	93,588		$	107,418
Propane		48,976			41,500			41,029			29,238			35,742
Advanced informations systems		14,140			12,427			12,578			12,764			14,104
Other and eliminations		(68	)		(218	)		(286	)		(334	)		(113	)
Total revenues	$	229,630		$	177,955		$	163,568		$	135,256		$	157,151

Operating income
Natural gas distribution and transmission	$	17,236		$	17,091		$	16,653		$	14,973		$	14,405
Propane		3,209			2,364			3,875			1,052			913
Advanced informations systems		1,197			387			692			343			517
Other and eliminations		(112	)		128			359			237			386
Total operating income	$	21,530		$	19,970		$	21,579		$	16,605		$	16,221

Net income from continuing operations	$	10,468		$	9,550		$	10,079		$	7,535		$	7,341


Assets *(in thousands of dollars)*
Gross property, plant and equipment	$	280,345		$	250,267		$	234,919		$	229,128		$	216,903
Net property, plant and equipment ⁽⁴⁾	$	201,504		$	177,053		$	167,872		$	166,846		$	161,014
Total assets ⁽⁴⁾	$	295,980		$	241,938		$	222,058		$	223,721		$	222,229
Capital expenditures ⁽³⁾	$	33,423		$	17,830		$	11,822		$	13,836		$	26,293


Capitalization *(in thousands of dollars)*
Stockholders' equity	$	84,757		$	77,962		$	72,939		$	67,350		$	67,517
Long-term debt, net of current maturities		58,991			66,190			69,416			73,408			48,409
Total capitalization	$	143,748		$	144,152		$	142,355		$	140,758		$	115,926

Current portion of long-term debt	$	4,929		$	2,909		$	3,665		$	3,938		$	2,686
Short-term debt		35,482			5,002			3,515			10,900			42,100
Total capitalization and short-term financing	$	184,159		$	152,063		$	149,535		$	155,596		$	160,712



⁽¹⁾ The years 2002, 2001, 2000 and 1999 have been restated in order to reflect the Company’s Delaware and Maryland natural gas divisions on the “ accrual” rather than the “as billed” revenue recognition method.
⁽²⁾ The years 1998, 1997, and 1996 have not been restated to reflect the “accrual” revenue recognition method due to the immateriality of the impact on the Company’s financial results.
⁽³⁾ These amounts exclude the results of water services due to their reclassification to discontinued operations. The assets of all of the water businesses were sold in 2004 and 2003.
⁽⁴⁾ The years 2005, 2004, 2003, 2002 and 2001 reflect the results of adopting SFAS 143.

- Page 14 -

Item 6. Selected Financial Data

For the Years Ended December 31,	2000 ⁽¹⁾			1999 ⁽¹⁾			1998 ⁽²⁾			1997 ⁽²⁾			1996 ⁽²⁾
Operating *(in thousands of dollars)* ⁽³⁾
Revenues
Natural gas distribution and transmission	$	101,138		$	75,637		$	68,770		$	88,108		$	90,044
Propane		31,780			25,199			23,377			28,614			36,727
Advanced informations systems		12,390			13,531			10,331			7,786			7,230
Other and eliminations		(131	)		(14	)		(15	)		(182	)		(243	)
Total revenues	$	145,177		$	114,353		$	102,463		$	124,326		$	133,758

Operating income
Natural gas distribution and transmission	$	12,798		$	10,388		$	8,820		$	9,240		$	9,627
Propane		2,135			2,622			965			1,137			2,668
Advanced informations systems		336			1,470			1,316			1,046			1,056
Other and eliminations		816			495			485			558			560
Total operating income	$	16,085		$	14,975		$	11,586		$	11,981		$	13,911

Net income from continuing operations	$	7,665		$	8,372		$	5,329		$	5,812		$	7,764


Assets *(in thousands of dollars)*
Gross property, plant and equipment	$	192,925		$	172,068		$	152,991		$	144,251		$	134,001
Net property, plant and equipment ⁽⁴⁾	$	131,466		$	117,663		$	104,266		$	99,879		$	94,014
Total assets ⁽⁴⁾	$	211,764		$	166,958		$	145,029		$	145,719		$	155,786
Capital expenditures ⁽³⁾	$	22,057		$	21,365		$	12,516		$	13,471		$	15,399


Capitalization *(in thousands of dollars)*
Stockholders' equity	$	64,669		$	60,714		$	56,356		$	53,656		$	50,700
Long-term debt, net of current maturities		50,921			33,777			37,597			38,226			28,984
Total capitalization	$	115,590		$	94,491		$	93,953		$	91,882		$	79,684

Current portion of long-term debt	$	2,665		$	2,665		$	520		$	1,051		$	3,526
Short-term debt		25,400			23,000			11,600			7,600			12,735
Total capitalization and short-term financing	$	143,655		$	120,156		$	106,073		$	100,533		$	95,945



⁽¹⁾ The years 2002, 2001, 2000 and 1999 have been restated in order to reflect the Company’s Delaware and Maryland natural gas divisions on the “accrual” rather than the “as billed” revenue recognition method.
⁽²⁾ The years 1998, 1997, and 1996 have not been restated to reflect the “accrual” revenue recognition method due to the immateriality of the impact on the Company’s financial results.
⁽³⁾ These amounts exclude the results of water services due to their reclassification to discontinued operations. The assets of all of the water businesses were sold in 2004 and 2003.
⁽⁴⁾ The years 2005, 2004, 2003, 2002 and 2001 reflect the results of adopting SFAS 143.

- Page 15 -

Item 6. Selected Financial Data

For the Years Ended December 31,	2005			2004			2003			2002 ⁽¹⁾			2001 ⁽¹⁾
Common Stock Data and Ratios
Basic earnings per share from continuing operations ⁽³⁾	$	1.79		$	1.66		$	1.80		$	1.37		$	1.37
Diluted earnings per share from continuing operations ⁽³⁾	$	1.77		$	1.64		$	1.76		$	1.37		$	1.35

Return on average equity from continuing operations ⁽³⁾		12.9	%		12.7	%		14.4	%		11.2	%		11.1	%

Common equity / total capitalization		59.0	%		54.1	%		51.2	%		47.8	%		58.2	%
Common equity / total capitalization and short-term financing		46.0	%		51.3	%		48.8	%		43.3	%		42.0	%

Book value per share	$	14.41		$	13.49		$	12.89		$	12.16		$	12.45


Market price:
High	$	35.780		$	27.550		$	26.700		$	21.990		$	19.900
Low	$	23.600		$	20.420		$	18.400		$	16.500		$	17.375
Close	$	30.800		$	26.700		$	26.050		$	18.300		$	19.800


Average number of shares outstanding		5,836,463			5,735,405			5,610,592			5,489,424			5,367,433
Shares outstanding at year-end		5,845,571			5,730,801			5,612,935			5,500,357			5,394,516
Registered common shareholders		2,026			2,026			2,069			2,130			2,171

Cash dividends declared per share	$	1.14		$	1.12		$	1.10		$	1.10		$	1.10
Dividend yield (annualized) ⁽⁴⁾		3.7	%		4.2	%		4.2	%		6.0	%		5.6	%
Payout ratio from continuing operations ^(3) (5)		63.7	%		67.5	%		61.1	%		80.3	%		80.3	%


Additional Data
Customers
Natural gas distribution and transmission		54,786			50,878			47,649			45,133			42,741
Propane distribution		35,367			34,888			34,894			34,566			35,530


Volumes
Natural gas deliveries (in MMCF)		34,981			31,430			29,375			27,935			27,264
Propane distribution (in thousands of gallons)		26,178			24,979			25,147			21,185			23,080


Heating degree-days (Delmarva Peninsula)		4,792			4,553			4,715			4,161			4,368

Propane bulk storage capacity (in thousands of gallons)		2,315			2,045			2,195			2,151			1,958

Total employees ⁽³⁾		423			426			439			455			458



⁽¹⁾ The years 2002, 2001, 2000 and 1999 have been restated in order to reflect the Company’s Delaware and Maryland natural gas divisions on the “accrual” rather than the “as billed” revenue recognition method.
⁽²⁾ The years 1998, 1997, and 1996 have not been restated to reflect the “accrual” revenue recognition method due to the immateriality of the impact on the Company’s financial results.
⁽³⁾ These amounts exclude the results of water services due to their reclassification to discontinued operations. The assets of all of the water businesses were sold in 2004 and 2003.
⁽⁴⁾ Dividend yield (annualized) is calculated by multiplying the fourth quarter dividend declared by four (4), then dividing that amount by the closing common stock price at December 31.
⁽⁵⁾ The payout ratio from continuing operations is calculated by dividing cash dividends declared per share (for the year) by basic earnings per share from continuing operations.

- Page 16 -

Item 6. Selected Financial Data

For the Years Ended December 31,	2000 ⁽¹⁾			1999 ⁽¹⁾			1998 ⁽²⁾			1997 ⁽²⁾			1996 ⁽²⁾
Common Stock Data and Ratios
Basic earnings per share from continuing operations ⁽³⁾	$	1.46		$	1.63		$	1.05		$	1.17		$	1.58
Diluted earnings per share from continuing operations ⁽³⁾	$	1.43		$	1.59		$	1.04		$	1.15		$	1.54

Return on average equity from continuing operations ⁽³⁾		12.2	%		14.3	%		9.7	%		11.1	%		16.1	%

Common equity / total capitalization		55.9	%		64.3	%		60.0	%		58.4	%		63.6	%
Common equity / total capitalization and short-term financing		45.0	%		50.5	%		53.1	%		53.4	%		52.8	%

Book value per share	$	12.21		$	11.71		$	11.06		$	10.72		$	10.26


Market price:
High	$	18.875		$	19.813		$	20.500		$	21.750		$	18.000
Low	$	16.250		$	14.875		$	16.500		$	16.250		$	15.125
Close	$	18.625		$	18.375		$	18.313		$	20.500		$	16.875


Average number of shares outstanding		5,249,439			5,144,449			5,060,328			4,972,086			4,912,136
Shares outstanding at year-end		5,290,001			5,186,546			5,093,788			5,004,078			4,939,515
Registered common shareholders		2,166			2,212			2,271			2,178			2,213

Cash dividends declared per share	$	1.07		$	1.03		$	1.00		$	0.97		$	0.93
Dividend yield (annualized) ⁽⁴⁾		5.8	%		5.7	%		5.5	%		4.7	%		5.5	%
Payout ratio from continuing operations ^(3) (5)		73.3	%		63.2	%		95.2	%		82.9	%		58.9	%


Additional Data
Customers
Natural gas distribution and transmission		40,854			39,029			37,128			35,797			34,713
Propane distribution		35,563			35,267			34,113			33,123			31,961


Volumes
Natural gas deliveries (in MMCF)		30,830			27,383			21,400			23,297			24,835
Propane distribution (in thousands of gallons)		28,469			27,788			25,979			26,682			29,975


Heating degree-days (Delmarva Peninsula)		4,730			4,082			3,704			4,430			4,717

Propane bulk storage capacity (in thousands of gallons)		1,928			1,926			1,890			1,866			1,860

Total employees ⁽³⁾		471			466			431			397			338



⁽¹⁾ The years 2002, 2001, 2000 and 1999 have been restated in order to reflect the Company’s Delaware and Maryland natural gas divisions on the “accrual” rather than the “as billed” revenue recognition method.
⁽²⁾ The years 1998, 1997, and 1996 have not been restated to reflect the “accrual” revenue recognition method due to the immateriality of the impact on the Company ’ s financial results.
⁽³⁾ These amounts exclude the results of water services due to their reclassification to discontinued operations. The assets of all of the water businesses were sold in 2004 and 2003.
⁽⁴⁾ Dividend yield (annualized) is calculated by multiplying the fourth quarter dividend declared by four (4), then dividing that amount by the closing common stock price at December 31.
⁽⁵⁾ The payout ratio from continuing operations is calculated by dividing cash dividends declared per share (for the year) by basic earnings per share from continuing operations.

- Page 17 -

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

Business Description

Chesapeake Utilities Corporation (“Chesapeake” or “the Company”) is a diversified utility company engaged in natural gas distribution, transmission and marketing, propane distribution and wholesale marketing, advanced information services and other related businesses.

Critical Accounting Policies

Chesapeake’s reported financial condition and results of operations are affected by the accounting methods, assumptions and estimates that are used in the preparation of the Company’s financial statements. Because most of Chesapeake’s businesses are regulated, the accounting methods used by Chesapeake must comply with the requirements of the regulatory bodies; therefore, the choices available are limited by these regulatory requirements. Management believes that the following policies require significant estimates or other judgments of matters that are inherently uncertain. These policies and their application have been discussed with Chesapeake’s Audit Committee.

Regulatory Assets and Liabilities

Chesapeake records certain assets and liabilities in accordance with Statement of Financial Accounting Standards (“SFAS”) No. 71 “Accounting for the Effects of Certain Types of Regulation.” Costs are deferred when there is a probable expectation that they will be recovered in future revenues as a result of the regulatory process. At December 31, 2005, Chesapeake had recorded regulatory assets of $5.6 million, including $4.0 million for under-recovered purchased gas costs, $712,000 for tax-related regulatory assets, and $304,000 for conservation cost recovery. The Company has recorded regulatory liabilities totaling $19.3 million, including $16.7 million for accrued asset removal cost, $1.4 million for self-insurance, $483,000 for cash in/cash out, and $328,000 for tax-related regulatory assets at December 31, 2005. If the Company were required to terminate application of SFAS No. 71, it would be required to recognize all such deferred amounts as a charge to earnings, net of applicable income taxes. Such a charge could have a material adverse effect on the Company’s results of operations.

Valuation of Environmental Assets and Liabilities

As more fully described in Note M to the Financial Statements, Chesapeake has completed its responsibilities related to one environmental site and is currently participating in the investigation, assessment or remediation of three other former gas manufacturing plant sites. Amounts have been recorded as environmental liabilities and associated environmental regulatory assets based on estimates of future costs provided by independent consultants. There is uncertainty in these amounts because the Environmental Protection Agency (“EPA”) or state authority may not have selected the final remediation methods. Additionally, there is uncertainty due to the outcome of legal remedies sought from other potentially responsible parties. At December 31, 2005, Chesapeake had recorded environmental regulatory assets of $195,000 and a regulatory liability of $298,000 for over-collections and an additional liability of $353,000 for environmental costs.

Propane Wholesale Marketing Contracts

Chesapeake’s propane wholesale marketing operation enters into forward and futures contracts that are considered derivatives under SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities.” In accordance with the pronouncement, open positions are marked to market prices at the end of each reporting period and unrealized gains or losses are recorded in the Consolidated Statement of Income as revenue. The contracts all mature within one year, and are almost exclusively for propane commodities with delivery points of Mt. Belvieu, Texas, Conway, Kansas and Hattiesburg, Mississippi. Management estimates the market valuation based on references to exchange-traded futures prices, historical differentials and actual trading activity at the end of the reporting period. At December 31, 2005, these contracts had net unrealized gains of $46,000 that was recorded in the financial statements. At December 31, 2004, these contracts had net unrealized losses of $182,000 that were recorded in the financial statements.

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Operating Revenues

Revenues for the natural gas distribution operations of the Company are based on rates approved by the public service commissions of the jurisdictions in which we operate. The natural gas transmission operation’s revenues are based on rates approved by the Federal Energy Regulatory Commission (“FERC”). Customers’ base rates may not be changed without formal approval by these commissions. However, the regulatory authorities have granted the Company’s regulated natural gas distribution operations the ability to negotiate rates with customers that have competitive alternatives using approved methodologies. In addition, the natural gas transmission operation can negotiate rates above or below the FERC approved tariff rates.

Chesapeake’s natural gas distribution operations in Delaware and Maryland each have a gas cost recovery mechanism that provides for the adjustment of rates charged to customers as gas costs fluctuate. These amounts are collected or refunded through adjustments to rates in subsequent periods.

The Company charges flexible rates to the natural gas distribution’s industrial interruptible customers to make them competitive with alternative types of fuel. Based on pricing, these customers can choose natural gas or alternative types of supply. Neither the Company nor the interruptible customer is contractually obligated to deliver or receive natural gas.

The propane wholesale marketing operation records trading activity, on a net mark-to-market basis in the Company’s income statement, for open contracts. The natural gas segment recognizes revenue on an accrual basis. The propane distribution, advanced information services and other segments record revenue in the period the products are delivered and/or services are rendered.

Goodwill Impairment

In accordance with SFAS No. 142, “Goodwill and Other Intangible Assets,” Chesapeake no longer amortizes goodwill. Instead, goodwill is tested for impairment at least annually. In addition, goodwill of a reporting unit is tested for impairment between annual tests if an event occurs or circumstances change that would more likely than not reduce the fair value of a reporting unit below its carrying value.

The initial test was performed upon adoption of SFAS No. 142 on January 1, 2002, and again at the end of each subsequent year. These tests were based on subjective measurements, including discounted cash flows of expected future operating results and market valuations of similar businesses. The propane unit had $674,000 in goodwill at both December 31, 2005 and 2004. Testing for 2005 and 2004 has indicated that no impairment has occurred.

Results of Operations

Net Income & Diluted Earnings Per Share Summary

For the Years Ended December 31,	2005		2004			Increase (decrease)		2004			2003			Increase (decrease)
Net Income *
Continuing operations	$	10,468	$	9,550		$	918	$	9,550		$	10,080			($530	)
Discontinued operations		-		(121	)		121		(121	)		(788	)		667
Total Net Income	$	10,468	$	9,429		$	1,039	$	9,429		$	9,292		$	137

Diluted Earnings Per Share
Continuing operations	$	1.77	$	1.64		$	0.13	$	1.64		$	1.76			($0.12	)
Discontinued operations		-		(0.02	)		0.02		(0.02	)		(0.13	)		0.11
Total Earnings Per Share	$	1.77	$	1.62		$	0.15	$	1.62		$	1.63			($0.01	)

* Dollars in thousands.

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The Company’s net income from continuing operations increased $918,000, or 10 percent, in 2005 compared to 2004. Net income from continuing operations was $10.5 million, or $1.77 per share (diluted), compared to a net income from continuing operations of $9.6 million, or $1.64 per share (diluted) for 2004.

Net income from continuing operations for 2004 was $9.6 million, or $1.64 per share (diluted), a decline of $530,000 compared to net income from continuing operations of $10.1 million, or $1.76 per share (diluted), for 2003.

During 2003, Chesapeake decided to exit the water services business and had sold the assets of six of seven dealerships by December 31, 2003. The remaining operation was sold in 2004. The results of water services were classified as discontinued operations for years 2004 and 2003. Discontinued operations experienced losses of $0.02 and $0.13 per share (diluted) for 2004 and 2003, respectively.

Operating Income Summary (in thousands)

For the Years Ended December 31,	2005			2004		Increase (decrease)			2004		2003		Increase (decrease)
Business Segment:
Natural gas distribution & transmission	$	17,236		$	17,091	$	145		$	17,091	$	16,653	$	438
Propane		3,209			2,364		845			2,364		3,875		(1,511	)
Advanced information services		1,197			387		810			387		692		(305	)
Other & eliminations		(112	)		128		(240	)		128		359		(231	)
Total Operating Income	$	21,530		$	19,970	$	1,560		$	19,970	$	21,579		($1,609	)

The improvement in results for 2005 was primarily driven by:

The Lightweight Association Management Processing Systems (“LAMPS™”) product, including the sale of its property rights, contributed $622,000 to operating income in 2005 for the Company’s advanced information services segment. The LAMPS product was an internally developed software that was developed and marketed specifically for REALTOR® Associations.

·	The Delmarva and Florida natural gas distribution operations experienced strong residential customer growth of 8.7 percent and 7.4 percent, respectively, in 2005.

·	Temperatures on the Delmarva Peninsula were 5 percent colder than 2004, which led to increased contributions from the Company’s natural gas and propane distribution operations. This increase was offset by conservation efforts by customers.

·	The natural gas transmission operation achieved gross margin growth of 9 percent due to additional transportation capacity contracts that went into effect in November 2004.

·	A 100 percent increase of the number of customers for the Company’s natural gas marketing operation.

·	An increase of 1.1 million gallons sold by the Delmarva propane distribution operation.

Improvement in Chesapeake’s 2005 overall results compared to 2004 was primarily related to a $924,000 pre-tax gain on the sale of its LAMPS™ by the Company’s advanced information service operation, continued strong customer growth, and colder weather, which led to increased contributions from the Company’s natural gas and propane operations. The Company’s natural gas operations experienced an increase of 7.9 percent in residential customers. Weather, measured in heating degree-days, was 5 percent colder than 2004. The gross margin increases from growth and weather was partially offset by energy conservation efforts by customers in light of increased natural gas and propane costs and also, an increase in operating expenses.

Chesapeake’s 2004 results reflected strong customer growth, warmer weather as compared to 2003, customers’ energy conservation and costs incurred to comply with Sarbanes-Oxley. Weather, measured in heating degree-days, was 4 percent warmer than 2003. Management estimates that warmer weather negatively impacted gross margin by $566,000. The natural gas segment was able to offset the impact of warmer weather through customer growth of 7 percent. Additionally, the Company incurred approximately $600,000 of expenses through December 31, 2004 related to compliance with Section 404 of Sarbanes-Oxley. These costs include incremental audit fees, expansion of the Internal Audit Department and the temporary hiring of an outside consultant. The increase in operating income from the Company’s natural gas operations was more than offset by decreases in the propane and advanced information services businesses.

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The following discussions of segment results include use of the term “gross margin.” Gross margin is determined by deducting the cost of sales from operating revenue. Cost of sales includes the purchased gas cost for natural gas and propane and the cost of labor spent on direct revenue-producing activities. Gross margin should not be considered an alternative to operating income or net income, which are determined in accordance with Generally Accepted Accounting Principles (“GAAP”). Chesapeake believes that gross margin, although a non-GAAP measure, is useful and meaningful to investors as a basis for making investment decisions. It provides investors with information that demonstrates the profitability achieved by the Company under its allowed rates for regulated operations and under its competitive pricing structure for non-regulated segments. Chesapeake’s management uses gross margin in measuring its business units’ performance and has historically analyzed and reported gross margin information publicly. Other companies may calculate gross margin in a different manner.

Natural Gas Distribution and Transmission

The natural gas distribution and transmission segment earned operating income of $17.2 million for 2005, $17.1 million for 2004, and $16.7 million for 2003, resulting in increases of $145,000 for 2005 and $438,000 for 2004.

Natural Gas Distribution and Transmission (in thousands)

For the Years Ended December 31,	2005		2004		Increase (decrease)		2004		2003		Increase (decrease)
Revenue	$	166,582	$	124,246	$	42,336	$	124,246	$	110,247	$	13,999
Cost of gas		116,178		77,456		38,722		77,456		65,495		11,961
Gross margin		50,404		46,790		3,614		46,790		44,752		2,038

Operations & maintenance		23,874		21,129		2,745		21,129		19,893		1,236
Depreciation & amortization		5,682		5,418		264		5,418		5,188		230
Other taxes		3,612		3,152		460		3,152		3,018		134
Other operating expenses		33,168		29,699		3,469		29,699		28,099		1,600

Total Operating Income	$	17,236	$	17,091	$	145	$	17,091	$	16,653	$	438

Natural Gas Heating Degree-Day (HDD) and Customer Analysis

For the Years Ended December 31,	2005		2004		Increase (decrease)		2004		2003		Increase (decrease)
Heating degree-day data — Delmarva
Actual HDD		4,792		4,553		239		4,553		4,715		(162	)
10-year average HDD		4,436		4,383		53		4,383		4,409		(26	)

Estimated gross margin per HDD	$	2,234	$	1,800	$	434	$	1,800	$	1,680	$	120

Estimated dollars per residential customer added:
Gross margin	$	372	$	372	$	0	$	372	$	360	$	12
Other operating expenses	$	106	$	104	$	2	$	104	$	100	$	4

Average number of residential customers
Delmarva		37,346		34,352		2,994		34,352		31,996		2,356
Florida		11,717		10,910		807		10,910		10,189		721
Total		49,063		45,262		3,801		45,262		42,185		3,077

2005 Compared to 2004

Revenue and cost of gas increased in 2005 compared to 2004, primarily due to changes in natural gas commodity prices. Increased prices of natural gas costs are being driven by increased demand that is exceeding the growth of available supply. The fall 2005 hurricane season significantly reduced the current and anticipated availability of natural gas supply from the Gulf Coast region, causing a dramatic rise in natural gas prices during the fourth quarter of 2005. Commodity cost changes are passed on to the ratepayers through a gas cost recovery or purchased gas cost adjustment in all jurisdictions; therefore, they have limited impact on the Company’s profitability. However, higher commodity prices may cause customers to reduce their energy consumption through conservation efforts and may cause the Company to have higher uncollectible accounts.

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Natural gas gross margin increased $3.6 million, or 7.7 percent, for 2005 compared to 2004. The natural gas transmission operation achieved gross margin growth of $1.4 million, or 9 percent, primarily due to additional contracts signed in November 2004 for transportation capacity provided to its firm customers. In addition, the Company’s capital investments enabled the natural gas transmission operations to execute additional transportation capacity contracts in November 2005. These additional contracts will contribute approximately $53,000 monthly to gross margins. An increase of $980,000 in other operating expenses partially offset the increased gross margin. The factors contributing to the increase in expenses are associated with higher customer counts caused by continued economic growth, as well as higher depreciation and property taxes due to an increase in the level of capital investments.

Gross margin for the natural gas marketing operation increased $506,000, or 39 percent, for 2005 compared to 2004 as the number of customers to which it provides supply management services increased 100 percent. The increase in the number of customers is attributed to the additional customers that are on the Peoples Gas system for which the Company provides services. The increase in gross margin was partially offset by an increase of $352,000 in other operating expenses due to higher levels of staff and other operating costs necessary to support the increase in business.

Gross margin for the Delaware and Maryland distribution divisions increased $1.2 million, as temperatures in 2005 were 5 percent colder and the number of residential customers increased 8.7 percent. An increase in gross margin from the colder weather of $534,000 was offset by a decrease of $651,000 in gas deliveries to customers as a result of conservation efforts in response to the higher gas prices . Gross margin for the Florida distribution operations increased $579,000, primarily due to changes in the customer rate design and a 7.4 percent increase in the number of residential customers served. The Company estimates the rate design changes contributed $322,000 in additional gross margin and resulted in the Florida division collecting a greater percentage of revenues from fixed charges, rather than variable charges based upon consumption. Other operating expense for the natural gas distribution operations increased $2.1 million in 2005. Some of the key components of the increase in other operating expenses in 2005, compared to 2004, include the following:

·	The incremental operating and maintenance cost of supporting the residential customers added by the Delmarva and Florida distribution operations was approximately $403,000.

·	In response to higher natural gas prices, the Company increased its allowance for uncollectible accounts by $98,000.

·	The cost of providing health care for our employees increased $180,000.

·	Costs of line location activities increased $177,000.

·	With the additional capital investments, depreciation expense, asset removal cost, and property taxes increased $225,000, $130,000, and $319,000, respectively.

2004 Compared to 2003

Gross margin grew by $2.0 million in 2004 compared to 2003. The Company estimates that warmer weather reduced gross margin by $292,000. After adjusting for the effect of weather, gross margin would have increased 5.3 percent. The Company estimates that residential and commercial growth for the distribution operations generated $1.1 million of gross margin increase. The Company added 3,077 residential customers, an increase of 7 percent, in 2004. This growth was net of lower consumption per customer, which reflects customer conservation efforts in light of higher energy costs and a higher mix of apartments rather than single family homes in the customer additions for some divisions. Additionally, the natural gas supply and management services operation increased gross margin by $565,000, primarily through industrial customer growth and resale of seasonal excess capacity on upstream pipelines. The natural gas transmission operation also achieved gross margin growth of $716,000, due to additional transportation services provided to its firm customers.

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Higher other operating expenses partially offset the gross margin increase. Operating expenses increased $1.6 million, or 5.7 percent, which includes $382,000 of expenses related to Sarbanes-Oxley Section 404 compliance implementation. The higher other operating expenses reflect the costs to support customer growth.

Propane

During 2005, the propane segment increased operating income by $845,000, or 36 percent, over 2004. In addition, gross margin increased $2.6 million, which more than offset the increase of $1.7 million of operating expenses. During 2004, the propane segment experienced a decrease of $1.5 million in operating income compared to 2003, reflecting a gross margin decrease of $1.9 million, partially offset by a decrease in operating expenses of $411,000.

Propane (in thousands)

For the Years Ended December 31,	2005		2004		Increase (decrease)		2004		2003		Increase (decrease)
Revenue	$	48,976	$	41,500	$	7,476	$	41,500	$	41,029	$	471
Cost of sales		30,041		25,155		4,886		25,155		22,762		2,393
Gross margin		18,935		16,345		2,590		16,345		18,267		(1,922	)

Operations & maintenance		13,355		11,718		1,637		11,718		12,053		(335	)
Depreciation & amortization		1,574		1,524		50		1,524		1,506		18
Other taxes		797		739		58		739		833		(94	)
Other operating expenses		15,726		13,981		1,745		13,981		14,392		(411	)

Total Operating Income	$	3,209	$	2,364	$	845	$	2,364	$	3,875		($1,511	)

Propane Heating Degree-Day (HDD) Analysis — Delmarva

For the Years Ended December 31,	2005		2004		Increase (decrease)		2004		2003		Increase (decrease)
Heating degree-days
Actual		4,792		4,553		239		4,553		4,715		(162	)
10-year average		4,436		4,383		53		4,383		4,409		(26	)

Estimated gross margin per HDD	$	1,743	$	1,691	$	52	$	1,691	$	1,670	$	21

2005 Compared to 2004

The increases in revenues and cost of sales in 2005 compared to 2004 were caused both by increases in volumes and by increases in the commodity prices of propane. Commodity price changes are passed on to the customer, subject to competitive market conditions.

The gross margin increase for the propane segment was due primarily to an increase of $1.8 million for the Delmarva distribution operations. Volumes sold in 2005 increased 1.1 million gallons or 5 percent. Temperatures in 2005 were 5 percent colder than 2004, causing an estimated gross margin increase of $417,000. Additionally, the gross margin per retail gallon improved by $0.0342 in 2005 compared to 2004. Gross margin per gallon increased as a result of market prices rising greater than the Company’s inventory price per gallon. This trend will reverse when market prices decrease and move closer to the Company’s inventory price per gallon. The gross margin increase was partially offset by increased other operating expenses of $1.5 million. The higher other operating costs are attributable to the Pennsylvania start-up costs and expenses related to higher earnings, such as incentive compensation and other taxes, employee benefits, insurance, vehicle fuel and maintenance expenses, and a non-recurring credit of $100,000 for vehicle insurance audits in 2004. The start-up costs accounted for $722,000, or approximately 49 percent, of the increase in operating expenses.

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Gross margin for the Florida propane distribution operations increased $385,000, or 45 percent, in 2005 compared to 2004. The increase in gross margin was attained from an increase of 27% in the average number of customers, which contributed to the $267,000 in propane sales gross margin, and an increase of $118,000 in house-piping sales. Florida propane also experienced an increase in other operating expenses. The higher expenses of $147,000 were attributed to business growth, such as payroll, vehicle fuel and maintenance, insurance, and depreciation expense.

The Company’s propane wholesale marketing operation experienced an increase in gross margin of $445,000 and an increase of $121,000 in other operating expenses, leading to an improvement of $323,000 in operating income over 2004. Wholesale price volatility created trading opportunities during the third and fourth quarters of the year; however, these were partially offset by reduced trading activities particularly in the first half of the year when the wholesale marketing operation followed a conservative marketing strategy, which lowered risk and earnings, in light of continued high wholesale price levels.

2004 Compared to 2003

Increases in revenues and cost of sales in 2004 were caused by an increase in the commodity prices of propane, partially offset by lower sales volumes due to warmer weather. Commodity price changes are generally passed on to the customer, subject to competitive market conditions. High commodity prices may cause customers to reduce their energy consumption through conservation efforts and may cause higher bad debt expense.

Propane distribution gross margin declined $1.2 million and propane wholesale marketing gross margin fell by $710,000. The Company estimates that warmer weather negatively impacted gross margin by $274,000. After adjusting for the impact of weather, gross margin decreased 9 percent. Lower retail gross margin per gallon in the distribution business reduced gross margin by approximately $493,000. In addition, lower sales volumes, not attributable to the weather, reduced gross margin by approximately $197,000, including $172,000 related to customers in the poultry industry. The closing of a poultry processing plant in the fourth quarter of 2003 is estimated to have reduced gross margin by $129,000. The plant is not expected to reopen. An outbreak of avian influenza on the Delmarva Peninsula in the first quarter of 2004 also contributed to the lower sales volumes. The influenza outbreak was contained. Volumes were also down partially due to customers conserving energy in light of higher energy costs. Finally, gross margin earned from a non-recurring service project in 2003 contributed $192,000 to the decline in gross margin.

The Company’s propane wholesale marketing operation contributed $373,000 to operating income; however, this was a decrease of $533,000 compared to 2003. This reflects a conservative strategy taken in the wholesale marketing operation, due to the high level of energy prices.

Other operating expenses decreased $411,000 despite additional costs of $142,000 associated with the implementation of Sarbanes-Oxley Section 404 compliance procedures. The decrease included reductions in incentive compensation, revenue-related taxes and lower delivery costs.

Advanced Information Services

The advanced information services segment provides domestic and international clients with information technology related business services and solutions for both enterprise and e-business applications. The advanced information services business contributed operating income of $1.2 million for 2005, $387,000 for 2004, and $692,000 for 2003.

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Advanced Information Services (in thousands)

For the Years Ended December 31,	2005		2004		Increase (decrease)			2004		2003		Increase (decrease)
Revenue	$	14,140	$	12,427	$	1,713		$	12,427	$	12,578		($151	)
Cost of sales		7,181		7,015		166			7,015		7,018		(3	)
Gross margin		6,959		5,412		1,547			5,412		5,560		(148	)

Operations & maintenance		5,129		4,405		724			4,405		4,196		209
Depreciation & amortization		123		138		(15	)		138		191		(53	)
Other taxes		510		482		28			482		481		1
Other operating expenses		5,762		5,025		737			5,025		4,868		157

Total Operating Income	$	1,197	$	387	$	810		$	387	$	692		($305	)

2005 Compared to 2004

The advanced information services segment had operating income of $1.2 million and $387,000 for years 2005 and 2004, respectively. The results for 2005 and 2004 include revenues and costs related to the LAMPS ^TM product that was sold in October 2005. The sale resulted in a $924,000 pre-tax gain.

Revenues for 2005 increased $1.7 million to $14.1 million compared to revenues of $12.4 million for 2004. The 2005 and 2004 revenue figures include $2.4 million and $149,000 of revenue relating to the LAMPS ^TM product for those respective years. Decreases in consulting revenues for the eBusiness group of $793,000 and lower sales of Progress software licenses of $285,000 account for the decrease in revenue when compared to 2004. This decrease is partially offset by the performance revenue of $238,000 received in the third quarter 2005 and an increase of $317,000 in consulting revenues for the Enterprise Solutions group. The performance revenue is related to the sale of the webproEX software to QAD that took place in 2003. As part of the sale agreement, Chesapeake receives a percentage of revenues after certain annual revenue and performance targets have been reached by QAD.

Cost of sales for 2005 increased $165,000 to $7.2 million, compared to $7.0 million for 2004. The increase in cost of sales is attributed to the LAMPS ^TM product. The 2005 and 2004 cost of sales figures includes $511,000 and $345,000 of cost for the LAMPS ^TM product. Other operating expenses increased $738,000 in 2005 to $5.8 million, compared to $5.0 million in 2004. The increase in other operating cost is attributed to the increase of costs relating to the LAMPS ^TM product. The costs associated with the LAMPS ^TM product for 2005 and 2004 are $1.2 million and $575,000 respectively. The remaining increase is primarily due to health care claims and office rent, which were offset by cost containment measures implemented in the second quarter of 2005 to reduce operating expenses.

2004 compared to 2003

The decrease in gross margin and operating income in 2004 was due to the non-recurring revenue recorded in 2003 on the sale of some rights to one of the Company’s internally-developed software products to a third party software provider. Absent the sale, gross margin would have increased by $351,000; however, the increase was partially offset by higher costs associated with continued investment in the Company’s LAMPS™ product and Sarbanes-Oxley compliance costs of $60,000.

Other Operations and Eliminations

Other operations and eliminating entries generated an operating loss of $112,000 for 2005 compared to income of $128,000 for 2004. Other operations consist primarily of subsidiaries that own real estate leased to other Company subsidiaries. In addition, in August 2004 the Company formed OnSight Energy, LLC (“OnSight”) to provide distributed energy services. The increase in revenues in 2005 is primarily attributed to OnSight completing its first contract in the second quarter of 2005. Other operating expenses increased in 2005 as a result of a full year of operation by OnSight, compared to a partial year in 2004. Eliminations are entries required to eliminate activities between business segments from the consolidated results.

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Other Operations & Eliminations (in thousands)

For the Years Ended December 31,	2005			2004		Increase (decrease)			2004		2003		Increase (decrease)
Revenue	$	763		$	647	$	116		$	647	$	702		($55	)
Cost of sales		116			-		116			-		-		-
Gross margin		647			647		-			647		702		(55	)

Operations & maintenance		472			279		193			279		79		200
Depreciation & amortization		220			210		10			210		238		(28	)
Other taxes		97			63		34			63		55		8
Other operating expenses		789			552		237			552		372		180

Operating Income — Other		($142	)	$	95		($237	)	$	95	$	330		($235	)
Operating Income — Eliminations	$	30		$	33		($3	)	$	33	$	29	$	4

Total Operating Income (Loss)		($112	)	$	128		($240	)	$	128	$	359		($231	)

Discontinued Operations

In 2003, Chesapeake decided to exit the water services business. Six of seven water dealerships were sold during 2003 and the remaining operation was sold in October 2004. The results of the water companies’ operations, for all periods presented in the consolidated income statements, have been reclassified to discontinued operations and shown net of tax. For 2004, the discontinued operations experienced a net loss of $121,000, compared to a net loss of $788,000 for 2003. The Company did not have any discontinued operations in 2005.

Income Taxes

Operating income taxes increased in 2005 compared to 2004, due to increased taxable income. Operating income taxes decreased in 2004 compared to 2003, due to decreased income. The effective current federal income tax rate for 2005 was 35%, whereas the rate for both 2004 and 2003 was 34%. During 2005, 2004 and 2003, the Company benefited of $223,000, $205,000, and 197,000, respectively, from a change in the tax law that allows tax deductions for dividends paid on Company stock held in Employee Stock Ownership Plans (“ESOP”).

Other Income

Other income was $383,000, $549,000 and $238,000 for the years 2005, 2004 and 2003, respectively. The other income amounts for the years 2005 and 2003 consist of interest income, compared to interest income and gains from the sale of assets for the year 2004.

Interest Expense

Total interest expense for 2005 decreased approximately $135,000, or 2.6 percent, compared to 2004. The decrease reflects the decrease in the average long-term debt balance. The average long-term debt balance during 2005 was $67.4 million with a weighted average interest rate of 7.2 percent, compared to $71.3 million with a weighted average interest rate of 7.2 percent in 2004. The average short-term borrowing balance in 2005 was $5.7 million, an increase from $870,000 in 2004. The weighted average interest rate for short-term borrowing increased from 3.7 percent for 2004 to 4.6 percent for 2005.

Total interest expense for 2004 decreased approximately $438,000, or 8 percent, compared to 2003. The decrease reflects the decrease in the average long-term debt balance. The average long-term debt balance during 2004 was $71.3 million with a weighted average interest rate of 7.2 percent, compared to $75.4 million with a weighted average interest rate of 7.2 percent in 2003. The average short-term borrowing balance in 2004 was $870,000, a decrease from $3.5 million in 2003. The weighted average interest rate for short-term borrowing increased from 2.4 percent for 2003 to 3.7 percent for 2004.

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Liquidity and Capital Resources

Chesapeake’s capital requirements reflect the capital-intensive nature of its business and are principally attributable to its investment in new plant and equipment and the retirement of outstanding debt. The Company relies on cash generated from operations and short-term borrowing to meet normal working capital requirements and to temporarily finance capital expenditures. During 2005, net cash provided by operating activities was $13.3 million, cash used by investing activities was $32.8 million and cash provided by financing activities was $20.4 million.

During 2004, net cash provided by operating activities was $23.4 million, cash used by investing activities was $16.9 million and cash used by financing activities was $8.0 million.

As of December 31, 2005, the Board of Directors has authorized the Company to borrow up to $50.0 million of short-term debt from various banks and trust companies. On December 31, 2005, Chesapeake had five unsecured bank lines of credit with three financial institutions, totaling $65.0 million. These bank lines provide funds for the Company’s short-term cash needs to meet seasonal working capital requirements and to temporarily fund portions of its capital expenditures. Two of the bank lines, totaling $15.0 million, are committed. The other three lines are subject to the banks’ availability of funds. The outstanding balances of short-term borrowing at December 31, 2005 and 2004 were $35.5 million and $5.0 million, respectively. In 2005 and 2004, Chesapeake used funds provided by operations and financing to fund net investing.

Chesapeake has budgeted $54.4 million for capital expenditures during 2006. This amount includes $20.8 million for natural gas distribution, $26.7 million for natural gas transmission, $5.7 million for propane distribution and wholesale marketing, $178,000 for advanced information services and $1.0 million for other operations. The natural gas distribution and transmission expenditures are for expansion and improvement of facilities. The propane expenditures are to support customer growth and for the replacement of equipment. The advanced information services expenditures are for computer hardware, software and related equipment. The other category includes general plant, computer software and hardware. Financing for the 2006 capital expenditure program is expected from short-term borrowing, cash provided by operating activities, and other sources. The capital expenditure program is subject to continuous review and modification. Actual capital requirements may vary from the above estimates due to a number of factors, including acquisition opportunities, changing economic conditions, customer growth in existing areas, regulation, new growth opportunities and availability of capital.

Chesapeake expects to incur approximately $300,000 in 2006 and $25,000 in 2007 for environmental-related expenditures. Additional expenditures may be required in future years (see Note M to the Consolidated Financial Statements). Management does not expect financing of future environmental-related expenditures to have a material adverse effect on the financial position or capital resources of the Company.

Capital Structure

As of December 31, 2005, common equity represented 59.0 percent of total capitalization, compared to 54.1 percent in 2004. If short-term borrowing and the current portion of long-term debt were included in total capitalization, the equity component of the Company’s capitalization would have been 46.0 percent and 51.3 percent, respectively. Chesapeake remains committed to maintaining a sound capital structure and strong credit ratings to provide the financial flexibility needed to access the capital markets when required. This commitment, along with adequate and timely rate relief for the Company’s regulated operations, is intended to ensure that Chesapeake will be able to attract capital from outside sources at a reasonable cost. The Company believes that the achievement of these objectives will provide benefits to customers and creditors, as well as to the Company’s investors.

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Cash Flows from Operating Activities

The primary drivers for the Company’s operating cash flows are cash payments received from gas customers, offset by payments made by the Company for gas costs, operation and maintenance expenses, taxes and interest costs.

Net cash provided by operating activities totaled $13.3 million, $23.4 million and $23.0 million for fiscal years 2005, 2004 and 2003, respectively. A description of certain material changes in working capital from December 31, 2004 to December 31, 2005 is listed below:

·	Accounts receivable and accrued revenue increased $16.8 million. The increase in receivables is attributed to higher gas and propane sale invoices in response to the higher natural gas and propane prices.

·	Propane inventory, storage gas and other inventory increased $5.7 million, primarily due to higher propane and natural gas prices.

·	The Company used $1.2 million of cash to purchase investments for the Rabbi Trust associated with the Company’s Supplemental Executive Retirement Savings Plan. See Note E on Investments in Item 8 under the heading “Financial Statements and Supplemental Data”.

·	Accounts payable and other accrued liabilities increased $15.3 million largely to fund the higher natural gas and propane purchases due mostly to higher prices.

During 2004, propane inventory, storage gas, and other inventory rose $1.7 million due to higher natural gas costs and increased storage capacity. During 2004 and 2003, Accounts receivable and accrued revenue increased $11.7 million and $3.6 million, respectively, primarily in response to higher gas and propane sale invoices in response to the higher natural gas and propane prices. Accounts payable and other accrued liabilities increased $11.1 million and $564,000, respectively, in 2004 and 2003 due to higher natural gas and propane purchases.

Cash Flows Used in Financing Activities

Cash flows received from financing totaled $20.4 million for 2005 and the cash used in financing activities totaled $8.0 million and $16.4 million for fiscal years 2004 and 2003, respectively. During fiscal year 2005, the Company increased the net amount of cash borrowed under its short-term lines of credits by $29.6 million. Additionally, the Company paid common stock dividends totaling $5.8 million and reduced its outstanding long-term notes payable balance by $4.8 million.

Cash flows used in financing activities during year 2004 reflected a $3.7 million repayment of long-term notes payable, coupled with common stock dividend payments totaling $5.6 million. Additionally during year 2004, the Company increased the net amount of cash borrowed from its short-term lines of credits by $1.2 million. During year 2003, cash flows used in financing activities reflected a $3.9 million repayment of long-term notes payable, a $7.4 million net repayment of short-term lines of credit, and payment of common stock dividends totaling $5.4 million.

On June 29, 2005, the Company entered into an agreement in principle with Prudential Investment Management Inc. Subsequently, the Company executed a Note Agreement, dated October 18, 2005, with three institutional investors (The Prudential Insurance Company of America, Prudential Retirement Insurance and Annuity Company and United Omaha Life Insurance Company), pursuant to which the investors agreed, subject to certain conditions, to purchase from the Company $20 million in principal of 5.5 percent Senior Notes (the “Notes”) issued by the Company; provided, that the Company elects to effect the sale of the Notes at any time prior to January 15, 2007. The terms of the Notes will require annual principal repayments of $2 million beginning on the fifth anniversary of the issuance of the Notes.

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Cash Flows Used in Investing Activities

Net cash flows used in investing activities totaled $32.8 million, $16.9 million and $5.9 million during fiscal years 2005, 2004 and 2003, respectively. In fiscal years 2005, 2004 and 2003, $33.0 million, $17.8 million and $11.8 million, respectively, of cash was utilized for capital expenditures. Additions to property, plant and equipment in 2005 were primarily for natural gas transmission ($15.0 million), natural gas distribution ($13.3 million) and propane distribution ($3.8 million). In both 2005 and 2004, the natural gas distribution expenditures were used primarily to fund expansion and facilities improvements. Natural gas transmission capital expenditures related primarily to expanding the Company’s transmission system. Additionally, cash of $240,000, $370,000 and $2.2 million was received in years 2005, 2004, and 2003, respectively, for the recovery of environmental costs through rates charged to customers. The year 2003 included cash proceeds of $3.7 million received from the sale of discontinued operations.

Contractual Obligations

We have the following contractual obligations and other commercial commitments as of December 31, 2005:

	Payments Due by Period
Contractual Obligations	Less than 1 year		1 - 3 years		3 - 5 years		More than 5 years	Total
Long-term debt ⁽¹⁾	$	4,929,091	$	15,312,727	$	13,312,727