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,
2007 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, a non-accelerated filer, or a smaller reporting
company. See the definitions of “accelerated filer,” “large
accelerated filer” and “smaller reporting company in Rule 12b-2 of the Exchange
Act. (Check one):
Large
accelerated filer
[ ] Accelerated
filer [X] Non-accelerated
filer [ ] Smaller
Reporting Company [ ]
Indicate
by a 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, 2007, 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 $230.9
million.
As of
February
29, 2008, 6,806,487
shares of common stock were
outstanding.
DOCUMENTS
INCORPORATED BY REFERENCE
Portions
of the Proxy Statement for the 2008 Annual Meeting of Stockholders are
incorporated by reference in Part III.
Chesapeake
Utilities Corporation
Form
10-K
YEAR
ENDED DECEMBER 31, 2007
TABLE
OF CONTENTS
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Page
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Part
I
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1
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Item
1. Business.
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5
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Item
1A. Risk Factors.
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7
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Item
1B. Unresolved Staff Comments.
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7
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Item
2. Properties
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7
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Item
3. Legal Proceedings
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7
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Item
4. Submission of Matters to a Vote of Security Holders.
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7
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Item
4A. Executive Officers of the Registrant.
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8
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Part
II
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8
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Item
5. Market for the Registrant’s Common Equity, Related Stockholder Matters
and Issuer Purchases of Equity Securities.
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8
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Item
6. Selected Financial Data
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11
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Item
7. Management’s Discussion and Analysis of Financial Condition and Results
of Operations
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15
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Item
7A. Quantitative and Qualitative Disclosures About Market
Risk.
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32
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Item
8. Financial Statements and Supplementary Data.
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32
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Item
9. Changes In and Disagreements With Accountants on Accounting and
Financial Disclosure.
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54
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Item
9A. Controls and Procedures.
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54
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Item
9B. Other Information.
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57
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Part
III
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57
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Item
10. Directors, Executive Officers of the Registrant and Corporate
Governance.
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57
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Item
11. Executive Compensation.
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57
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Item
12. Security Ownership of Certain Beneficial Owners and Management and
Related Stockholder Matters.
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57
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Item
13. Certain Relationships and Related Transactions, and Director
Independence.
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57
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Item
14. Principal Accounting Fees and Services.
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58
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Part
IV
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58
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Item
15. Exhibits, Financial Statement Schedules.
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58
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Signatures
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60
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References
in this document to “Chesapeake,” “the Company,” “we,” “us” and “our” mean
Chesapeake Utilities Corporation and/or its wholly owned subsidiaries, as
appropriate.
Safe
Harbor for Forward-Looking Statements
Chesapeake
Utilities Corporation has made statements in this Form 10-K that are considered
to be “forward-looking statements” within the meaning of the Private Securities
Litigation Reform Act of 1995. These statements are not matters of historical
fact and are typically identified by words such as, but not limited to,
“believes,” “expects,” “intends,” “plans,” and similar expressions, or future or
conditional verbs such as “may,” “will,” “should,” “would,” and “could.” These
statements relate to matters such as customer growth, changes in revenues or
gross margins, capital expenditures, environmental remediation costs, regulatory
trends and decisions, 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. The factors that could cause actual results to
differ materially from the Company’s expectations include, but are not limited
to those discussed in Item 1A, “Risk Factors.”
Item
1. Business.
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(a)
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General
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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
is composed of four operating segments:
|
·
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Natural
Gas.
The natural gas segment includes regulated natural
gas distribution and transmission operations and also a non-regulated
natural gas marketing operation.
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·
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Propane.
The
propane segment includes non-regulated propane distribution and wholesale
marketing operations.
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|
·
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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.
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|
·
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Other.
The
other segment consists primarily of non-regulated operations that own real
estate leased to other Company
subsidiaries.
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(b)
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Financial
Information About Business Segments
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Our
natural gas segment accounts for approximately 80 percent of Chesapeake’s
consolidated operating income and approximately 86 percent of the
consolidated net property plant and equipment. The following table shows the
size of each of our operating segments based on operating income and net
property, plant and equipment.
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|
Net
Property, Plant
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|||||||||||||||
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(Thousands)
|
Operating
Income
|
&
Equipment
|
||||||||||||||
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Natural
Gas
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$ | 22,485 | 80 | % | $ | 224,661 | 86 | % | ||||||||
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Propane
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4,498 | 16 | % | 29,363 | 11 | % | ||||||||||
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Advanced
information systems
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836 | 3 | % | 419 | < 1 | % | ||||||||||
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Other
& eliminations
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295 | 1 | % | 5,980 | 2 | % | ||||||||||
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Total
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$ | 28,114 | 100 | % | $ | 260,423 | 100 | % | ||||||||
Additional financial information by business segment is included in Item 8 under the heading “Notes to Consolidated Financial Statements — Note C.”
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(c)
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Narrative
Description of the Business
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(i)(a)
Natural Gas
Chesapeake’s
natural gas segment performs natural gas distribution, transmission and
marketing services for its customers. Chesapeake operates its natural gas
distribution services as three divisions: Delaware, Maryland, and Florida, which
are based in their respective service territories. These three
divisions serve approximately 62,900 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 370-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. The Company, through its subsidiary, Peninsula Energy
Services Company, Inc. (“PESCO”), also provides natural gas supply and supply
management services in the State of Florida.
Natural Gas
Distribution
Chesapeake
distributes natural gas to residential, commercial and industrial customers in
central and southern Delaware, the Salisbury and Cambridge areas on Maryland’s
Eastern Shore, and parts of Florida. These activities are conducted through
three utility divisions, one in Delaware, another in Maryland and a third in
Florida.
Delaware
and Maryland
. Chesapeake’s Delaware and Maryland distribution divisions
serve approximately 48,490 customers, of which approximately 48,290 are
residential and commercial customers purchasing gas primarily for heating and
cooking use. The remaining 200 customers are industrial. For the year 2007,
operating revenues and deliveries by customer class were as follow:
|
Operating
Revenues
|
Deliveries
|
|||||||||||||||
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(Thousands)
|
(MMcf's)
|
|||||||||||||||
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Residential
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$ | 49,858 | 47 | % | 2,586,517 | 35 | % | |||||||||
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Commercial
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29,430 | 28 | % | 2,047,112 | 28 | % | ||||||||||
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Industrial
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1,597 | 2 | % | 612,631 | 8 | % | ||||||||||
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Subtotal
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$ | 80,885 | 77 | % | 5,246,260 | 71 | % | |||||||||
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Interruptible
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7,989 | 7 | % | 1,023,866 | 14 | % | ||||||||||
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Off-system
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16,819 | 16 | % | 1,129,137 | 15 | % | ||||||||||
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Total
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$ | 105,693 | 100 | % | 7,399,263 | 100 | % | |||||||||
Florida
.
The Florida division
distributes natural gas to approximately 14,250 residential and commercial and
100 industrial customers in the 13 Counties of Polk, Osceola, Hillsborough,
Gadsden, Gilchrist, Union, Holmes, Jackson, Desoto, Suwannee, Liberty,
Washington and Citrus. For the year 2007, operating revenues and
deliveries by firm transportation customer class were as follow:
|
Operating
Revenues
|
Deliveries
|
|||||||||||||||
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(Thousands)
|
(MMcf's)
|
|||||||||||||||
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Residential
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$ | 3,612 | 32 | % | 307,779 | 5 | % | |||||||||
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Commercial
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2,929 | 26 | % | 1,067,539 | 18 | % | ||||||||||
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Industrial
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4,744 | 42 | % | 4,478,921 | 77 | % | ||||||||||
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Total
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$ | 11,285 | 100 | % | 5,854,239 | 100 | % | |||||||||
Natural Gas
Transmission
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 local distribution companies through
an integrated gas pipeline system 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. For the year 2007, operating revenues and deliveries by
customer class were as follow:
|
Operating
Revenues
|
Deliveries
|
|||||||||||||||
|
(Thousands)
|
(MMcf's)
|
|||||||||||||||
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Local
Distribution Companies
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$ | 19,354 | 83 | % | 10,011,290 | 52 | % | |||||||||
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Industrial
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3,076 | 13 | % | 7,793,128 | 40 | % | ||||||||||
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Commercial
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856 | 4 | % | 1,542,061 | 8 | % | ||||||||||
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Total
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$ | 23,286 | 100 | % | 19,346,479 | 100 | % | |||||||||
During
2005, Chesapeake formed a wholly-owned subsidiary, Peninsula Pipeline Company,
Inc. (“PIPECO”), to provide industrial customers in the State of Florida natural
gas transportation service as an intrastate pipeline. PIPECO did not have any
activity in 2005 and 2006. On August 27, 2007, PIPECO filed with the
Florida PSC its petition for approval of a natural gas transmission pipeline
tariff in order to establish its operating rules and regulations. The
Florida PSC approved the petition at its December 4, 2007 agenda conference.
PIPECO will begin marketing its services to potential industrial customers in
2008.
Natural Gas
Marketing
PESCO, a wholly-owned
subsidiary, competes with regulated utilities and other unregulated third-party
marketers to sell natural gas supplies directly to commercial and industrial
customers in the State of Florida with the objective of earning a profit
through competitively-priced contracts. PESCO does not own or operate any
natural gas transmission or distribution assets. The gas that PESCO sells is
delivered to retail customers through assets owned by the Company’s regulated
Florida distribution system and intrastate pipeline and four other regulated
utilities’ local distribution systems. PESCO bills its customers
through the billing services of the regulated utilities that deliver the gas, or
directly, through its own billing capabilities.
At
December 31, 2007, PESCO served approximately 1,500 commercial and industrial
natural gas customers, and as of January 2008, PESCO began offering similar
services to customers in the State of Delaware.
Gas Supplies, Firm
Transportation and Storage Capacity
The
Company believes that the availability of gas supply and transportation to its
Delaware, Maryland and Florida divisions is adequate under existing arrangements
to meet the anticipated needs of their customers. The following discussion
provides a summary of the gas supplies and pipeline transportation and storage
capacities, stated in dekatherms (“Dts”), available to each of the Company’s
natural gas operations.
The
Delaware and Maryland divisions have both firm and interruptible transportation
service contracts with four interstate “open access” pipelines, including
Eastern Shore, a wholly-owned subsidiary. The divisions are directly
interconnected with Eastern Shore, and are contracted with interstate pipelines
upstream of Eastern Shore. These interstate pipelines include
Transcontinental Gas Pipe Line Corporation (“Transco”), Columbia Gas
Transmission Corporation (“Columbia”) and Columbia Gulf Transmission Company
(“Gulf”). None of the upstream service providers is an affiliate 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 supplies on the spot market from various suppliers. This gas is
transported by the upstream pipelines and delivered to the divisions’
interconnections with Eastern Shore. The divisions also have the capability to
use propane-air peak-shaving to supplement or displace the spot market
purchases.
Delaware
.
|
Pipeline
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Firm
transportation capacity maximum peak-day daily deliverability
(Dts)
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Firm
storage capacity maximum peak-day daily withdrawal (Dts)
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Expiration
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Transco
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11,356
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6,407
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Various
dates between 2008 and 2013
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Columbia
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3,460
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8,224
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Various
dates between 2010 and 2020
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Gulf
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880
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-
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Expries
in 2009
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Eastern
Shore
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57,639
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4,146
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Various
dates between 2008 and 2022
|
The
Delaware division currently has contracts with several suppliers for the
purchase of firm natural gas supply in the amount of its capacity on the Transco
and Columbia pipelines. The Delaware division also has contracts for
firm peaking gas supplies to be delivered to its system in order to meet the
differential between the Delaware division’s capacity on Eastern Shore and
capacity on pipelines upstream of Eastern Shore. These supply
contracts provide a maximum firm daily entitlement of 44,566 Dts, delivered on
the Transco, Columbia, and/or Gulf systems to Eastern Shore for redelivery to
the division under firm transportation contracts. These gas supply contracts
have various expiration dates, and quantities may vary from day-to-day and
month-to-month.
Maryland
.
|
Pipeline
|
Firm
transportation capacity maximum peak-day daily deliverability
(Dts)
|
Firm
storage capacity maximum peak-day daily withdrawal (Dts)
|
Expiration
|
|
Trancso
|
5,866 | 2,456 |
Various
dates between 2012 and 2013
|
|
Columbia
|
1,700 | 3,663 |
Various
dates between 2014 and 2018
|
|
Gulf
|
590 | - |
Expires
in 2009
|
|
Eastern
Shore
|
19,428 | 2,306 |
Various
dates between 2008 and 2022
|
The
Maryland division currently has contracts with several suppliers for the
purchase of firm natural gas supply in the amount of its capacity on the Transco
and Columbia pipelines. The Maryland division also has contracts for
firm peaking gas supplies to be delivered to its system in order to meet the
differential between the Maryland division’s capacity on Eastern Shore and
capacity on pipelines upstream of Eastern Shore. These supply
contracts provide a maximum firm daily entitlement of 12,816 Dts, delivered on
the Transco, Columbia, and/or Gulf systems to Eastern Shore for redelivery to
the division under firm transportation contracts. These gas supply contracts
have various expiration dates, and quantities may vary from day-to-day and
month-to-month.
Florida
Division
The
Florida division has firm transportation service contracts with Florida Gas
Transmission Company (“FGT”) and Gulfstream Natural Gas System (“Gulfstream”).
Pursuant to a program approved by the Florida Public Service Commission
(“Florida PSC”), all of the capacity under these agreements has been released to
various third parties, including PESCO. Under terms of these capacity release
agreements, Chesapeake is contingently liable to FGT and Gulfstream should any
party that acquired the capacity through release fail to pay for the
service.
Chesapeake’s
contracts with FGT include: (a) a contract, which expires in 2010, for daily
firm transportation capacity of 23,519 Dts for the months of November through
April, capacity of 20,123 Dts for the months of May through September, and
capacity of 22,105 Dts for October; and (b) a contract for daily firm
transportation capacity of 1,000 Dts daily, which expires in 2015. Chesapeake’s
contract with Gulfstream is for daily firm transportation capacity of 10,000 Dts
and expires in 2022.
Eastern
Shore
Eastern
Shore has three contracts with Transco for a total of 7,292 Dts of firm peak day
storage entitlements and total storage capacity of 288,003 Dts, which expire in
2013. Eastern Shore has retained these firm storage services in order
to provide swing transportation service and firm storage service to those
customers that have requested such service.
PESCO
PESCO
currently has contracts with ConocoPhillips and British Petroleum (“BP”) for the
purchase of firm natural gas supplies. The ConocoPhillips contract, which
provides a maximum firm daily entitlement of 15,000 MMBtus, and the BP contract,
which provides a maximum firm daily entitlement of 10,000 MMBtus, expires in May
2008. PESCO is currently in the process of obtaining and reviewing
supply proposals from suppliers and anticipates executing agreements prior to
the expiration of the existing contracts.
The
Company believes that the availability of gas supply and transportation to its
operations is adequate under existing arrangements to meet the anticipated needs
of its customers.
Competition
See
discussion on competition in Item 7 under the heading “Management’s Discussion
and Analysis — Competition.”
Rates and
Regulation
Chesapeake’s
natural gas distribution divisions are subject to regulation by the Delaware,
Maryland and Florida Public Service Commissions (“PSCs”) with respect to various
aspects of their 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 supply and transportation costs and normally allow full
recovery of such costs. Adjustments under these mechanisms, which are limited to
such costs, require periodic filings and hearings with the state regulatory
authority having jurisdiction.
Eastern
Shore is subject to regulation by the Federal Energy Regulatory Commission
(“FERC”) as an interstate pipeline. The FERC regulates the 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 of its distribution divisions and Eastern
Shore in order to ensure 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.”
Seasonality of Natural Gas
Revenues
Revenues
from the Company’s residential and commercial natural gas distribution
activities are affected by seasonal variations in weather
conditions. Weather conditions directly influence the volume of
natural gas sold and delivered. Specifically, customer demand substantially
increases during the winter months, when natural gas is used for heating.
Accordingly, the volumes sold for this purpose are directly affected by the
severity of winter weather and can vary substantially from year to year.
Sustained warmer-than-normal temperatures will tend to result in reduced use of
natural gas, while sustained colder-than-normal temperatures will tend to result
in greater use. The Company measures the relative impact of weather by
using an accepted degree-day methodology. Degree-day data is used to estimate
amounts of energy required to maintain comfortable indoor temperature levels
based on each day’s average temperature. A degree-day is the measure of the
variation in the weather based on the extent to which the average daily
temperature (from 10:00 am to 10:00 am) falls below 65 degrees Fahrenheit. Each
degree of temperature below 65 degrees Fahrenheit is counted as one heating
degree-day. Normal heating degree-days are based on the most recent 10-year
average.
In
efforts to stabilize the level of net revenues collected from customers, the
Company has begun to request Weather Normalization Adjustments (“WNA”) in its
rate filings with the Maryland and Delaware PSCs.
A WNA mechanism
is a billing adjustment mechanism that is designed to eliminate the effect of
deviations from average seasonal temperatures on utility net revenues. On
September 26, 2006, the Maryland PSC approved the Company’s proposal to
implement a revenue normalization mechanism for its residential heating and
smaller commercial heating customers. The Company also has a pending
rate case application filed with the Delaware PSC, requesting among other
things, to implement a WNA billing mechanism. For further discussion of these
matters, refer to the discussion of regulatory activities in Item 7 under the
heading “Management’s Discussion and Analysis — Regulatory
Activities.”
(i)(b)
Propane
Chesapeake’s
retail 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., Inc. (“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 fossil fuels. Propane is sold primarily
in suburban and rural areas, which are not served by natural gas
distributors.
|
|
Propane
Distribution
|
During
2007, our propane distribution operations served approximately 34,100 propane
customers in central and southern Delaware, the Eastern Shore of Maryland and
Virginia, southeastern Pennsylvania and parts of Florida and delivered
approximately 29.8 million retail and wholesale gallons of
propane. The propane distribution business is affected by many
factors, such as seasonality, the absence of price regulation, and competition
among local providers.
For the
year 2007, operating revenues and number of customers for our Delmarva and
Florida propane distribution operations were as follow:
Propane Wholesale
Marketing
In May
1998, Chesapeake acquired Xeron, a natural gas liquids trading company located
in Houston, Texas. Xeron markets propane to large, independent petrochemical
companies, resellers and retail propane companies in the southeastern United
States. The propane wholesale marketing business is affected by wholesale price
volatility and supply levels. Additional information on Xeron’s
trading and wholesale marketing activities, market risks and the controls that
limit and monitor Xeron’s risks is included in Item 7 under the heading
“Management’s Discussion and Analysis — Market Risk.”
The
Company’s propane distribution operations purchase propane primarily from
suppliers, including major oil companies, independent producers of natural gas
liquids and from Xeron. Supplies of propane from these and other sources are
readily available for purchase by the Company.
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. The Company’s Delmarva-based propane
distribution operation owns bulk propane storage facilities with an aggregate
capacity of approximately 2.4 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. From these storage facilities, propane is delivered
primarily by “bobtail” trucks, owned and operated by the Company, to tanks
located at the customers’ 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.”
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 by
the Federal Motor Carrier Safety Administration within 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 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.
Seasonality of Propane
Revenues
Revenues
from the Company’s propane distribution sales activities are affected by
seasonal variations in weather conditions. Weather conditions
directly influence the volume of propane sold and delivered to customers;
specifically, customers’ demand substantially increases during the winter months
when propane is used for heating. Accordingly, the propane
volumes sold for this purpose are directly affected by the severity of winter
weather and can vary substantially from year to year. Sustained
warmer-than-normal temperatures will tend to result in reduced propane use,
while sustained colder-than-normal temperatures will tend to result in greater
use.
(i)(c)
Advanced Information Services
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, which is a
wholly-owned subsidiary of Chesapeake. Skipjack and Eastern Shore Real Estate,
Inc. own and lease office buildings in Delaware and Maryland to affiliates of
Chesapeake. Chesapeake Investment Company is an affiliated investment company
registered in Delaware. During the quarter ended September 30, 2007,
Chesapeake decided to close its distributed energy services subsidiary,
Chesapeake OnSight Services, LLC.
(ii)
Capital Budget
A
discussion of capital expenditures by business segment and capital expenditures
for environmental remediation facilities is included in Item 7 under the heading
“Management’s Discussion and Analysis — Liquidity and Capital
Resources.”
(iii)
Employees
As of
December 31, 2007, Chesapeake had 445 employees, including 185 in natural gas,
134 in propane and 85 in advanced information services. The remaining 41
employees are considered general and administrative and include officers of the
Company, treasury, accounting, internal audit, information technology, human
resources and other administrative personnel.
(iv)
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 (“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
the Company’s 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.
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 internet 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 SEC 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
financial, operational, regulatory and legal, and environmental factors that
affect the operations and/or financial performance of the Company
include:
Financial
Risks
Inability
to access capital markets may impair our future growth.
We rely
on access to both short-term and longer-term capital markets as a significant
source of liquidity for capital requirements not satisfied by the cash flow from
our operations. Currently, $65 million of the total $90 million of short-term
lines of credit utilized to satisfy our short-term financing requirements are
discretionary, uncommitted lines of credit. We utilize discretionary lines of
credit to reduce the cost associated with these short-term financing
requirements. We are committed to maintaining a sound capital structure and
strong credit ratings to provide the financial flexibility needed to access the
capital markets when required. However, if we are not able to access capital at
competitive rates, our ability to implement our strategic plan, undertake
improvements and make other investments required for our future growth may be
limited.
A
downgrade in our credit rating could adversely affect our access to capital
markets.
Our
ability to obtain adequate and cost effective capital depends on our credit
ratings, which are greatly affected by our subsidiaries’ financial performance
and the liquidity of financial markets. A downgrade in our current
credit ratings could adversely affect our access to capital markets, as well as
our cost of capital.
Debt
covenants may impact financial condition if triggered.
Our
long-term debt obligations contain financial covenants related to
debt-to-capital ratios and interest-coverage ratios. Failure to comply with any
of these covenants could result in an event of default which, if not cured or
waived, could result in the acceleration of outstanding debt obligations or the
inability to borrow under certain credit agreements. Any such acceleration would
cause a material adverse change in Chesapeake’s financial
condition.
A
change in economic conditions and interest rates may adversely affect our
results of operations and cash flows.
A
downturn in the economies of the regions in which we operate, which we cannot
accurately predict, might adversely affect our ability to increase our customer
bases and cash flows at the same rates by which they have grown in the recent
past. Further, an increase in interest rates, without the recovery of the higher
cost of debt in the sales and/or transportation rates we charge our utility
customers, could adversely affect future earnings. An increase in short-term
interest rates would negatively affect our results of operations, which depend
on short-term borrowing to finance accounts receivable and storage gas
inventories, and to temporarily finance capital expenditures.
Inflation
may impact our results of operations, cash flows and financial
position.
Inflation
affects the cost of supply, labor, products and services required for
operations, maintenance and capital improvements. While the impact of inflation
has remained low in recent years, natural gas and propane prices are subject to
rapid fluctuations. To help cope with the effects of inflation on our capital
investments and returns, we seek rate relief from regulatory commissions for
regulated operations and closely monitor the returns of our unregulated business
operations. There can be no assurance that we will be able to obtain adequate
and timely rate relief to offset the effects of inflation. To compensate for
fluctuations in propane gas prices, we adjust our propane selling prices to the
extent allowed by the market. However, there can be no assurance that we will be
able to increase propane sales prices sufficiently to compensate fully for such
fluctuations in the cost of propane gas to us.
Operational
Risks
Fluctuations
in weather may adversely affect our results of operations, cash flows and
financial condition.
Our
utility and propane distribution operations are sensitive to fluctuations in
weather, and weather conditions directly influence the volume of natural gas and
propane sold and delivered by our utility and propane distribution operations. A
significant portion of our utility and propane distribution operation revenues
is derived from the sale and delivery of natural gas and propane to residential
and commercial heating customers during the five-month peak heating season
(November through March). If the weather is warmer than normal, we sell and
deliver less natural gas and propane to customers, and earn less revenue. In
addition, hurricanes or other extreme weather conditions could damage production
or transportation facilities, which could result in decreased supplies of
natural gas and propane, increased supply costs and higher prices for
customers.
The
amount and availability of natural gas and propane supplies are difficult to
predict; a substantial reduction in available supplies could reduce our earnings
in those segments.
Natural
gas and propane production can be affected by factors outside of our control,
such as weather and refinery closings. If we are unable to obtain sufficient
natural gas and propane supplies to meet demand, results in those segments may
be adversely affected.
We
rely on having access to interstate natural gas pipelines’ transportation and
storage capacity; a substantial disruption or lack of growth in these services
may impair our ability to meet customers’ existing and future
requirements.
In order
to meet existing and future customer demands for natural gas, we must acquire
both sufficient natural gas supplies and interstate pipeline and storage
capacity to serve such requirements. We must contract for reliable and adequate
delivery capacity for our distribution systems while considering the dynamics of
the interstate pipeline and storage capacity market, our own on-system
resources, as well as the characteristics of our markets. Chesapeake, along with
other local natural gas distribution companies and other participants in the
industry, have raised concerns regarding the future availability of additional
upstream interstate pipeline and storage capacity. This is a business issue
which we must continue to manage as our customer base grows.
Natural
gas and propane commodity price changes may affect the operating costs and
competitive positions of our natural gas and propane distribution operations,
which may adversely affect our results of operations, cash flows and financial
condition.
Natural Gas.
Over the
last four years, natural gas costs have increased significantly, due to
increased demand, and have become more volatile, due to events such as the
hurricane activity in 2005, which reduced the natural gas available from the
Gulf Coast region and caused a spike in natural gas prices. Higher natural gas
prices can result in significant increases in the cost of gas billed to
customers. Under our regulated gas cost recovery mechanisms, an increase in the
cost of gas due to an increase in the price of the natural gas commodity
generally has no immediate effect on our revenues and net income. Our net
income, however, may be reduced by higher expenses that we may incur for
uncollectable customer accounts and by lower volumes of natural gas deliveries
as a result of customers reducing their consumption. Therefore, increases in the
price of natural gas can affect our operating cash flows and the competitiveness
of natural gas as an energy source.
Propane
. Propane
costs are subject to volatile changes as a result of product supply or other
market conditions, including economic and political factors affecting crude oil
and natural gas supply or pricing. Such cost changes can occur rapidly and can
affect profitability. There is no assurance that we will be able to pass on
propane cost increases fully or immediately, particularly when propane costs
increase rapidly. Therefore, average retail sales prices can vary significantly
from year to year as product costs fluctuate in response to propane, fuel oil,
crude oil and natural gas commodity market conditions. In addition, in periods
of sustained higher commodity prices, declines in retail sales volumes, because
of reduced consumption and increased amounts of uncollectible accounts may
adversely affect net income.
Operating
even
ts affect
ing
public safety and the reliability of
Chesapeake
’s
natural gas distribution system
could adversely affect
the
results of operations, financial
condition and cash flows.
Chesapeake’s
business is exposed to operational events, such as major leaks, mechanical
problems and accidents, that could affect the public safety and reliability of
its natural gas distribution systems, significantly increase costs and
cause loss of customer confidence. The occurrence of any such operational events
could adversely affect the results of operations, financial condition and cash
flows. If Chesapeake is unable to recover from customers, through the regulatory
process, all or some of these costs and its authorized rate of return on these
costs, this also could adversely affect the results of operations, financial
condition and cash flows.
Because
we operate in a competitive environment, we may lose customers to
competitors.
In our
natural gas marketing business, we compete with third-party suppliers to sell
gas to commercial and industrial customers. In our gas transportation and
distribution operations, our competitors include interstate pipelines, when
distribution customers are located close enough to the transmission company’s
pipeline to make direct connections economically feasible.
Our
propane distribution operations compete with several other propane distributors,
primarily on the basis of service and price, emphasizing reliability of service
and responsiveness. Some of our competitors have significantly greater
resources. The retail propane industry is mature, and we foresee modest growth
in total demand. Given this limited growth, we expect that year-to-year industry
volumes will be principally affected by weather patterns. Therefore, our ability
to grow the propane distribution business is contingent upon execution of our
community gas systems strategy to capture additional market share and to employ
service pricing programs that retain and grow our customer base. Any failure to
retain and grow our customer base would have an adverse effect on our
results.
The
propane wholesale marketing operation competes against various marketers, many
of which have significantly greater resources and are able to obtain price or
volumetric advantages.
The
advanced information services business faces significant competition from a
number of larger competitors having substantially greater resources available to
them to compete on the basis of technological expertise, reputation and
price.
Changes
in technology may adversely affect our advanced information services segment’s
results of operations, cash flows and financial condition.
Our
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. There is no
assurance that we will be able to keep up with technological advancements
necessary to keep our products and services competitive.
Our
energy marketing subsidiaries have credit risk and credit requirements that may
adversely affect our results of operations, cash flows and financial
condition.
Xeron,
our propane wholesale and marketing subsidiary, and PESCO, our natural gas
marketing subsidiary, extend credit to counter-parties. While we believe Xeron
and PESCO utilize prudent credit policies, each of these subsidiaries 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 underlying
collateral is inadequate, we could experience financial losses.
Xeron and
PESCO are also dependent upon the availability of credit to buy propane and
natural gas for resale or to trade. If financial market conditions decline
generally, or the financial condition of these subsidiaries or of the Company,
declines, then the cost of credit available to these subsidiaries could
increase. If credit is not available, or if credit is more costly, our results
of operations, cash flows and financial condition may be adversely
affected.
Our
use of derivative instruments may adversely affect our results of
operations.
Fluctuating
commodity prices may affect our earnings and financing costs. Our propane
distribution and wholesale marketing segments use derivative instruments,
including forwards, swaps and puts, to hedge price risk. In addition, we have
utilized in the past, and may decide, after further evaluation, to continue to
utilize derivative instruments to hedge price risk for our Delaware and Maryland
divisions, as well as PESCO. While we have a risk management policy and
operating procedures in place to control our exposure to risk, if we purchase
derivative instruments that are not properly matched to our exposure, our
results of operations, cash flows, and financial conditions may be adversely
affected.
Changes
in customer growth may affect earnings and cash flows.
Chesapeake’s
ability to increase its gross margins in its regulated and propane businesses is
dependent upon the new construction housing market, adding new industrial
customers and conversion of customers to natural gas or propane from other fuel
sources. Slowdowns in these markets could adversely affect the Company’s gross
margin in its regulated or propane businesses, its earnings and cash
flows.
Chesapeake’s
businesses are capital intensive, and the costs of capital projects may be
significant.
Chesapeake’s
businesses are capital intensive and require significant investments in internal
infrastructure projects. Our results of operations and financial condition could
be adversely affected if we are unable to manage such capital projects
effectively or if we do not receive full recovery of such capital costs in
future regulatory proceedings.
Regulatory
and Legal Risks
Regulation
of the Company, including changes in the regulatory environment, may adversely
affect our results of operations, cash flows and financial
condition.
The
Delaware, Maryland and Florida PSCs regulate our natural gas distribution
operations; Eastern Shore, our natural gas transmission subsidiary, is regulated
by the FERC. These commissions set the rates that we can charge customers for
services subject to their regulatory jurisdiction. Our ability to obtain timely
future rate increases and rate supplements to maintain current rates of return
depends on regulatory approvals, and there can be no assurance that our
divisions and Eastern Shore will be able to obtain such approvals or maintain
currently authorized rates of return.
We
are dependent upon construction of new facilities to support future growth in
earnings in our natural gas distribution and interstate pipeline
operations.
Construction
of new facilities required to support future growth is subject to
various regulatory and developmental risks, including but not limited to:
(a) our ability to obtain necessary approvals and permits by regulatory
agencies on a timely basis and on terms that are acceptable to us; (b) potential
changes in federal, state and local statutes and regulations, including
environmental requirements, that prevent a project from proceeding or increase
the anticipated cost of the project; (c) inability to acquire rights-of-way or
land rights on a timely basis on terms that are acceptable to us; (d) lack of
anticipated future growth in available natural gas supply; and (e) insufficient
customer throughput commitments.
We
are subject to operating and litigation risks that may not be fully covered by
insurance.
Our
operations are subject to the operating hazards and risks normally incidental to
handling, storing, transporting and delivering natural gas and propane to end
users. As a result, we are sometimes a defendant in legal proceedings arising in
the ordinary course of business. We maintain insurance policies with insurers in
such amounts and with such coverages and deductibles as we believe are
reasonable and prudent. There can be no assurance, however, that such insurance
will be adequate to protect us from all material expenses related to potential
future claims for personal injury and property damage or that such levels of
insurance will be available in the future at economical prices.
Environmental
Risks
Costs of compliance with
environmental laws may be significant
.
We are
subject to federal, state and local laws and regulations governing environmental
quality and pollution control. These evolving laws and regulations may require
expenditures over a long period of time to control environmental effects at
current and former operating sites, including former manufactured gas plant
sites that we have acquired from third parties. Compliance with these legal
obligations requires us to commit capital. If we fail to comply with
environmental laws and regulations, even if such failure is caused by factors
beyond our control, we may be assessed civil or criminal penalties and
fines.
To date,
we have been able to recover, through regulatory rate mechanisms, the costs
associated with the remediation of former manufactured gas plant sites. However,
there is no guarantee that we will be able to recover future remediation costs
in the same manner or at all. A change in our approved rate mechanisms for
recovery of environmental remediation costs at former manufactured gas plant
sites could adversely affect our results of operations, cash flows and financial
condition.
Further,
existing environmental laws and regulations may be revised, or new laws and
regulations seeking to protect the environment may be adopted and be applicable
to us. Revised or additional laws and regulations could result in additional
operating restrictions on our facilities or increased compliance costs, which
may not be fully recoverable.
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 Norcross, Georgia. In
general, the Company believes that its properties are adequate for the uses for
which they are employed.
|
(b)
|
Natural
Gas Distribution
|
Chesapeake
owns over 1,033 miles of natural gas distribution mains (together with related
service lines, meters and regulators) located in its Delaware and Maryland
service areas and 741 miles of natural gas distribution mains (and related
equipment) in its central Florida service areas. Chesapeake also owns facilities
in Delaware and Maryland, which it uses for propane-air injection during periods
of peak demand.
|
(c)
|
Natural
Gas Transmission
|
Eastern
Shore owns and operates approximately 370 miles of transmission pipelines,
extending from supply interconnects at Parkesburg, Pennsylvania; Daleville,
Pennsylvania; and Hockessin, Delaware, to approximately 78 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 2.4 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 currently involved in various legal actions and
claims arising in the normal course of business. The Company is also involved in
certain administrative proceedings before various governmental agencies
concerning rates. In the opinion of management, the ultimate disposition of
these current 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
Item
4A. Executive Officers of the Registrant.
Set forth
below are the names, ages, and positions of executive officers of the registrant
at December 31, 2007, with their recent business experience. The age
of each officer is as of the date of filing this report.
John R. Schimkaitis
(age 60) 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. Mr.
Schimkaitis previously 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.
Michael P. McMasters
(age 49) 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 47) 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. 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
41) 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
55) Mr. Zola joined Sharp Energy in August 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 27-year career
in the propane industry, Mr. Zola also started and successfully developed
Bluestreak Propane, in Phoenix, AZ, which was ultimately sold to Ferrell
Gas.
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 (“NYSE”) 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 2007
and 2006 were as follows:
|
Dividends
|
|||||||||||||
|
Declared
|
|||||||||||||
|
Quarter
Ended
|
High
|
Low
|
Close
|
Per
Share
|
|||||||||
|
2007
|
|||||||||||||
|
March
31
|
$ 31.10 | $ 28.85 | $ 30.94 | $ 0.290 | |||||||||
|
June
30
|
35.58 | 29.92 | 34.24 | 0.295 | |||||||||
|
September
30
|
37.25 | 28.00 | 33.94 | 0.295 | |||||||||
|
December
31
|
36.38 | 29.59 | 31.85 | 0.295 | |||||||||
|
2006
|
|||||||||||||
|
March
31
|
$ 32.47 | $ 29.97 | $ 31.24 | $ 0.285 | |||||||||
|
June
30
|
31.20 | 27.90 | 30.08 | 0.290 | |||||||||
|
September
30
|
35.65 | 29.51 | 30.05 | 0.290 | |||||||||
|
December
31
|
31.31 | 29.10 | 30.65 | 0.290 | |||||||||
Dividends
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 2007 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. The Company was in compliance with these
restrictions and other debt covenants during 2007.
At
December 31, 2007, there were 1,920 shareholders of record of the Common
Stock.
|
(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,
2007.
Discussion
of compensation plans of Chesapeake and its subsidiaries, for which shares of
Chesapeake common stock are authorized for issuance, included in the portion of
the Proxy Statement captioned “Equity Compensation Plan Information” to be filed
not later than March 31, 2008, in connection with the Company’s Annual Meeting
to be held on May 1, 2008, is incorporated herein by reference.
The chief
executive officer’s annual certification regarding the Company’s compliance with
the NYSE’s corporate governance listing standards was submitted to the NYSE on
May 29, 2007.
|
(c)
|
Chesapeake
Utilities Corporation Common Stock Performance
Graph
|
The
following stock Performance Graph compares cumulative total shareholder return
on a hypothetical investment in the Company’s common stock during the five
fiscal years ended December 31, 2007, with the cumulative total shareholder
return on a hypothetical investment in both (i) the S&P 500 Index and
(ii) an industry index consisting of 14 companies in the Edward Jones
Natural Gas Distribution Group, a published listing of selected gas distribution
utilities’ results. The Company’s Performance Graph for the previous
year included all but one of these same companies in addition to seventeen other
companies. The Company chose to use the Edward Jones Natural Gas
Distribution Group as its peer group this year for performance metrics
comparison to coincide with the Compensation Committee’s decision to use this
index of companies to evaluate the Company’s results in connection with issuing
long-term awards to executive officers under the new long-term performance
plan.
The
fourteen companies in the Edward Jones Natural Gas Distribution Group industry
index include: AGL Resources, Inc., Atmos Energy Corporation,
Chesapeake Utilities Corporation, Corning Natural Gas Corporation, Delta Natural
Gas Company, Inc., Energy West, Inc., EnergySouth. Inc., The Laclede Group,
Inc., New Jersey Resources Corporation, Northwest Natural Gas Company, Piedmont
Natural Gas Co., Inc., RGC Resources, Inc., South Jersey Industries, Inc, and
WGL Holdings, Inc. The Company excluded SEMCO Energy, Inc. from its
comparison due to its recent acquisition by Cap Rock Holding
Corporation.
The
comparison assumes $100 was invested on December 31, 2002 in the Company’s
common stock and in each of the foregoing indices and assumes reinvested
dividends. The comparisons in the graph below are based on historical
data and are not intended to forecast the possible future performance of the
Company’s Common Stock.
|
2002
|
2003
|
2004
|
2005
|
2006
|
2007
|
||
|
Chesapeake
|
$ 100 | $ 148 | $ 158 | $ 189 | $ 196 | $ 211 | |
|
Industry
Index
|
$ 100 | $ 120 | $ 141 | $ 152 | $ 180 | $ 202 | |
|
S&P
500
|
$ 100 | $ 128 | $ 142 | $ 149 | $ 172 | $ 182 |
Item
6. Selected Financial Data
Item
7. Management’s Discussion and Analysis of Financial Condition and Results of
Operations
INTRODUCTION
This
section provides management’s discussion of Chesapeake Utilities Corporation and
its consolidated subsidiaries, with specific information on results of
operations and liquidity and capital resources. It includes management’s
interpretation of our financial results, the factors affecting these results,
the major factors expected to affect future operating results and future
investment and financing plans. This discussion should be read in conjunction
with our consolidated financial statements and notes thereto.
Several
factors exist that could influence our future financial performance, some of
which are described in Item 1A above, “Risk Factors.” They should be
considered in connection with evaluating forward-looking statements contained in
this report, or otherwise made by or on behalf of us since these factors could
cause actual results and conditions to differ materially from those set out in
such forward-looking statements.
EXECUTIVE
OVERVIEW
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.
The
Company’s strategy is focused on growing earnings from a stable utility
foundation and investing in related businesses and services that provide
opportunities for returns greater than traditional utility returns. The key
elements of this strategy include:
|
·
|
executing
a capital investment program in pursuit of organic growth opportunities
that generate returns equal to or greater than our cost of
capital;
|
|
·
|
expanding
the natural gas distribution and transmission business through expansion
into new geographic areas in our current service
territories;
|
|
·
|
expanding
the propane distribution business in existing and new markets through
leveraging our community gas system services and our bulk delivery
capabilities;
|
|
·
|
utilizing
the Company’s expertise across our various businesses to improve overall
performance;
|
|
·
|
enhancing
marketing channels to attract new
customers;
|
|
·
|
providing
reliable and responsive customer service to retain existing
customers;
|
|
·
|
maintaining
a capital structure that enables the Company to access capital as needed;
and
|
|
·
|
maintaining
a consistent and competitive dividend for
shareholders.
|
In 2007,
net income increased 26 percent as the Company earned $13.2 million in net
income, or $1.94 per share (diluted), when compared to the net income of
$10.5 million, or $1.72 per share (diluted), earned in
2006. Overall, operating income in 2007 increased $4.8 million, or 20
percent, from 2006. The increase in operating income was partially offset by an
increase of $816,000, or 14 percent, in interest expense and higher income taxes
of $1.6 million, or 23 percent.
The
following discussions and those later in the document on operating income and
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.
Operating
Income
A strong
year-over-year increase in operating income for 2007 was attained from the
Company’s natural gas, propane, and advanced information services business
segments.
|
Percentage
|
|||||||
|
(In
thousands)
|
2007
|
2006
|
Change
|
Change
|
|||
|
Natural
gas
|
$
22,485
|
$
19,733
|
$
2,752
|
14
%
|
|||
|
Propane
|
4,498
|
2,534
|
1,964
|
78
%
|
|||
|
Advanced
information services
|
836
|
767
|
69
|
9
%
|
|||
|
Other
& eliminations
|
295
|
298
|
(3)
|
-1
%
|
|||
|
Total
operating income
|
$
28,114
|
$
23,332
|
$
4,782
|
100%
|
|||
The
natural gas segment benefited from the additional transportation capacity
contracts implemented by Eastern Shore, continued customer growth from the
distribution operations, rate increases, and the impact of colder temperatures
on the Delmarva Peninsula that were 15 percent colder in 2007 than in
2006. The propane segment benefited from the colder temperatures on
the Delmarva Peninsula and also from the volatility in wholesale propane prices
experienced in 2007.
Key
financial and operational highlights for fiscal year 2007 include the
following:
|
·
|
New
transportation capacity contracts implemented by Eastern Shore in November
2006 provided for 26,200 Dts of firm transportation capacity per day and
contributed $3.1 million of additional gross margin in
2007.
|
|
·
|
On
August 11, 2007, Eastern Shore received authorization from the FERC to
commence construction of a portion of the Phase II facilities
(approximately 4 miles) of the 2006-2008 Expansion
Project. These additional facilities, which were completed and
placed in service on November 1, 2007 provide for 8,300 Dts of additional
firm capacity per day generating annualized gross margin of $1.2
million.
|
|
·
|
The
base rate increase that the Company received from the Maryland PSC on
September 26, 2006, for our Maryland natural gas operations, contributed
$693,000 of additional gross margin in
2007.
|
|
·
|
Effective
September 1, 2007, the FERC authorized Eastern Shore to commence the
billing of increased rates agreed to in a settlement with its customers,
which the FERC formally approved in January 2008. These
increased rates provided for an additional $563,000 of gross margin in
2007.
|
|
·
|
On
August 21, 2007, the Delaware PSC authorized the Company to implement
temporary rates with its customers, subject to refund, pending the
completion of full evidentiary hearings and a final decision by the
Delaware PSC.
|
|
·
|
Customer
growth in the natural gas and propane businesses remained strong, with the
Delmarva and Florida natural gas distribution operations registering seven
and five percent increases in residential customers, respectively, and the
Delmarva Community Gas Systems (“CGS”) generating a 22 percent increase in
propane distribution customers.
|
|
·
|
For
the year ended December 31, 2007, the Company generated
$25.7 million in operating cash attributed to net income of $13.2
million and $12.5 million in net cash from other operating activities,
which includes $9.1 million in depreciation and
amortization.
|
|
·
|
The
Company continued to invest in property, plant and equipment to support
current and future growth opportunities and utilized $31.3 million of cash
in 2007 for such expenditures.
|
The
Company’s financial performance is discussed in greater detail below in Results
of Operations.
Critical
Accounting Policies
Chesapeake
prepares its financial statements in accordance with accounting principles
generally accepted in the United States of America
(“GAAP”). Application of these accounting principles requires the use
of estimates and assumptions that affect the reported amounts of assets,
liabilities, revenues and expenses, and related disclosures of contingencies
during the reporting period. Chesapeake bases its estimates on
historical experience and on various other assumptions that are believed to be
reasonable under the circumstances, the results of which form the basis for
making judgments about the carrying value of assets and liabilities that are not
readily apparent from other sources. Most of Chesapeake’s businesses
are regulated, accordingly, the accounting methods used by these businesses must
comply with the requirements of the regulatory bodies; therefore, the choices
available are limited by these regulatory requirements. In the
normal course of business, estimated amounts are subsequently adjusted to actual
results that may differ from estimates. 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
As a
result of the ratemaking process, 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,” and
consequently, the accounting principles applied by our regulated utilities
differ in certain respects from those applied by the unregulated businesses.
Costs are deferred when there is a probable expectation that they will be
recovered in future revenues as a result of the regulatory process. As more
fully described in Note A to the Consolidated Financial Statements, Chesapeake
had recorded regulatory assets of $4.1 million and regulatory liabilities of
$27.7 million, at December 31, 2007. 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 or a credit to earnings, net of applicable income taxes.
Such an adjustment 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 manufactured gas 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 applicable state
environmental authority may not have selected the final remediation methods. In
addition, there is uncertainty with regard to amounts that may be recovered from
other potentially responsible parties.
Since the
Company’s management believes that recovery of these expenditures, including any
litigation costs, is probable through the regulatory process, the Company has
recorded, in accordance with SFAS 71, a regulatory asset and corresponding
regulatory liability. At December 31, 2007, Chesapeake had
recorded an environmental regulatory asset of $851,000 and a regulatory
liability of $227,000 for over-collections and an additional liability of
$835,000 for environmental costs.
Derivatives
Chesapeake
may use derivative instruments to manage the price risk of its natural gas and
propane purchasing activities. The use of these instruments is subject to the
Company’s risk management policies, which are continually monitored for
compliance. Derivative instruments utilized in connection with these activities
and services are accounted in accordance with SFAS 133,
Accounting for Derivative
Instruments and Hedging Activities
, under which Chesapeake either records
the fair value of derivatives held as assets and liabilities. If the
derivative contracts meets the “normal purchase and normal sale” scope exception
of SFAS 133, the related activities and services are accounted on an accrual
basis of accounting.
The
following is a review of Chesapeake’s derivative activity at December 31, 2007
and 2006:
|
·
|
The
natural gas distribution and marketing operations entered into physical
contracts for the purchase and sale of natural gas. These physical
contracts qualify for the “normal purchases and normal sales” scope
exception under SFAS 133 at December 31, 2007 and 2006 in that they
provide for the purchase or sale of natural gas that will be delivered in
quantities expected to be used or sold by the Company over a reasonable
period of time in the normal course of business. Accordingly, they
are not subject to the accounting requirements of
SFAS No. 133.
|
|
·
|
During
2007 and 2006, Chesapeake’s propane distribution operations entered into
physical contracts to buy propane supplies. These contracts qualify for
the “normal purchases and normal sales” scope exception under SFAS
133 in that they provide for the purchase or sale of propane that will be
delivered in quantities expected to be used or sold by the Company over a
reasonable period of time in the normal course of business. Accordingly,
the related liabilities incurred and assets acquired under these contracts
are recorded when title to the underlying commodity
passes.
|
During
2006, the propane distribution operation had entered into a swap agreement to
protect the Company from the impact of price increases on our price-cap plan
that we offer to customers. The Company considered this agreement to be an
economic hedge that did not qualify for hedge accounting as described in SFAS
133. At the end of the period, the market price of propane dropped below the
unit price within the swap agreement. As a result of the price drop, the Company
marked the agreement to market, which resulted in an unrealized loss in 2006 of
$84,000. The Company did not enter into a similar swap agreement in
2007.
|
·
|
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
that 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, 2007,
these contracts had net unrealized gains of $179,000 that were recorded in
the financial statements. At December 31, 2006, these contracts had net
unrealized gains of $8,500 that were recorded in the financial
statements. Commodity price volatility may have a significant
impact on the gain or loss in any given
period.
|
Operating
Revenues
Revenues
for the natural gas distribution operations of the Company are based on rates
approved by the PSCs of the jurisdictions in which we operate. The natural gas
transmission operation’s revenues are based on rates approved by the 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,
based on approved methodologies, with customers that have competitive
alternatives. In addition, the natural gas transmission operation can negotiate
rates above or below the FERC-approved tariff rates.
For
regulated deliveries of natural gas, Chesapeake reads meters and bills customers
on monthly cycles that do not coincide with the accounting periods used for
financial reporting purposes. Chesapeake accrues unbilled revenues for gas that
has been delivered, but not yet billed at the end of an accounting period to the
extent that they do not coincide. In connection with this accrual,
Chesapeake must estimate the amount of gas that has not been accounted for
on its delivery system and must estimate the amount of the unbilled revenue by
jurisdiction and customer class. A similar computation is made to accrue
unbilled revenues for propane customers with meters, such as community gas
system customers.
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
propane distribution, advanced information services and other segments record
revenue in the period the products are delivered and/or services are
rendered.
Chesapeake’s
natural gas distribution operations in Delaware and Maryland each have a
purchased gas cost recovery mechanism. This mechanism provides the
Company with a method of
adjusting the billing rates with its
customers for changes in the cost of purchased gas included in base rates. The
difference between the current cost of gas purchased and the cost of gas
recovered in billed rates is deferred and accounted for as either unrecovered
purchased gas costs or amounts payable to customers. Generally, these deferred
amounts are recovered or refunded within one year.
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 fuels.
Neither the Company nor the interruptible customer is contractually obligated to
deliver or receive natural gas.
Allowance for Doubtful
Accounts
An
allowance for doubtful accounts is recorded against amounts due to reduce the
net receivable balance to the amount we reasonably expect to collect based upon
our collections experiences and our assessment of our customers’ inability or
reluctance to pay. If circumstances change, however, our estimate of the
recoverability of accounts receivable may also change. Circumstances which could
affect our estimates include, but are not limited to, customer credit issues,
the level of natural gas prices and general economic conditions. Accounts are
written off once they are deemed to be uncollectible.
Results
of Operations
The
Company’s net income from continuing operations increased $2.5 million in 2007
when compared to 2006. Net income from continuing operations was $13.22 million,
or $1.94 per share (diluted), for 2007, compared to a net income from continuing
operations of $10.75 million, or $1.76 per share (diluted) in 2006.
The
Company’s net income from continuing operations increased $49,000 in 2006 when
compared to 2005. Net income from continuing operations was $10.75 million, or
$1.76 per share (diluted), for 2006, compared to a net income from continuing
operations of $10.70 million, or $1.81 per share (diluted) in 2005.
During
2007, Chesapeake decided to close its distributed energy services company,
Chesapkeake OnSight Services, LLC (“OnSight”), which consistently experienced
operating losses since 2004. At December 31, 2007, the results of
operations for OnSight have been reclassified to discontinued operations and
shown net of tax for all periods presented. For 2007, the
discontinued operations experienced a net loss of $20,000 compared to a net loss
of $241,000, or $0.04 per share (diluted), for 2006 and a net loss of $231,000,
or $0.04 per share (diluted), for 2005.
|
Operating
Income Summary (in thousands)
|
||||||||||||||||||||||||
|
Increase
|
Increase
|
|||||||||||||||||||||||
|
For
the Years Ended December 31,
|
2007
|
2006
|
(decrease)
|
2006
|
2005
|
(decrease)
|
||||||||||||||||||
|
Business
Segment:
|
||||||||||||||||||||||||
|
Natural
gas
|
$ | 22,485 | $ | 19,733 | $ | 2,752 | $ | 19,733 | $ | 17,236 | $ | 2,497 | ||||||||||||
|
Propane
|
4,498 | 2,534 | 1,964 | 2,534 | 3,209 | (675 | ) | |||||||||||||||||
|
Advanced
information services
|
836 | 767 | 69 | 767 | 1,197 | (430 | ) | |||||||||||||||||
|
Other
& eliminations
|
295 | 298 | (3 | ) | 298 | 279 | 19 | |||||||||||||||||
|
Operating
Income
|
$ | 28,114 | $ | 23,332 | $ | 4,782 | $ | 23,332 | $ | 21,921 | $ | 1,411 | ||||||||||||
|
Other
Income
|
291 | 189 | 102 | 189 | 383 | (194 | ) | |||||||||||||||||
|
Interest
Charges
|
6,590 | 5,774 | 816 | 5,774 | 5,132 | 642 | ||||||||||||||||||
|
Income
Taxes
|
8,597 | 6,999 | 1,598 | 6,999 | 6,472 | 527 | ||||||||||||||||||
|
Net
Income from Continuing Operations
|
$ | 13,218 | $ | 10,748 | $ | 2,470 | $ | 10,748 | $ | 10,700 | $ | 48 | ||||||||||||
2007 Compared to
2006
Compared
to 2006, operating income in 2007 increased by $4.8 million, or 20
percent. Factors affecting this improvement included the
following:
|
·
|
New
transportation capacity contracts implemented for the natural gas
transmission operation in November 2006 and November 2007 provided for
$3.3 million of additional gross margin in
2007.
|
|
·
|
Weather
on the Delmarva Peninsula was 15 percent colder in 2007 than 2006, which
the Company estimates contributed approximately $2.0 million in additional
gross margin for its Delmarva natural gas and propane distribution
operations. This amount differs from the $2.2 million of
additional gross margin that the Company had expected the colder weather
to contribute. The variance occurred as a result of the season
or month that the heating degree day variance
occurred.
|
|
·
|
Rate
increases to customers of the natural gas transmission and distribution
operations in Delaware and Maryland added $1.4 million to gross margin in
2007.
|
|
·
|
Strong
period-over-period residential customer growth of seven percent and five
percent, respectively, for the Delmarva and Florida natural gas
distribution operations in 2007.
|
|
·
|
The
average gross margin per retail gallon sold to customers increased $0.05
in 2007 for the Delmarva propane distribution operations, which
contributed $1.1 million to gross
margins.
|
|
·
|
The
Delmarva Community Gas Systems continued to experience strong customer
growth as the number of customers increased 22 percent in 2007 compared to
2006.
|
2006 Compared to
2005
Operating
income in 2006 increased $1.4 million, or 6.5 percent, compared to 2005, despite
significantly warmer weather in 2006. The improvement in 2006 results of
operations compared to 2005 was affected by the following factors:
|
·
|
Weather
on the Delmarva Peninsula was 18 percent warmer in 2006 than in 2005; as a
result, the Company estimates that 2006 gross margin for its Delmarva
natural gas and propane distribution operations was approximately $3.4
million less than in 2005.
|
|
·
|
Strong
residential customer growth of nine percent and eight percent,
respectively, for the Delmarva and Florida natural gas distribution
operations in 2006.
|
|
·
|
The
natural gas transmission operation achieved gross margin growth of $1.8
million, or 11 percent, due to additional capacity contracts that went
into effect in November 2005 and November
2006.
|
|
·
|
A
67 percent increase in the number of customers for the Company’s natural
gas marketing operation.
|
|
·
|
Gross
margin for the Delmarva propane distribution operations decreased
$834,000, primarily, as a result of the warmer weather in
2006.
|
|
·
|
The
Delmarva Community Gas Systems continued to experience strong customer
growth increasing by 34 percent in 2006 compared to
2005.
|
|
·
|
Operating
income for the advanced information services segment decreased $430,000 in
2006. Although revenues from consulting increased $749,000 in 2006, the
2005 results contained $993,000 of operating income for the Lightweight
Association Management Processing Systems (“LAMPS
TM
”)
product,
which was sold in the fourth quarter 2005. The LAMPS
TM
product was an internally developed software that was developed and
marketed specifically for REALTOR
®
Associations.
|
Natural
Gas
The
natural gas segment earned operating income of $22.5 million for 2007, $19.7
million for 2006, and $17.2 million for 2005, resulting in increases of $2.8
million, or 13.9 percent for 2007, and $2.5 million, or 14.5 percent, for
2006.
|
Natural
Gas (in thousands)
|
||||||||||||||||||||||||
|
Increase
|
Increase
|
|||||||||||||||||||||||
|
For
the Years Ended December 31,
|
2007
|
2006
|
(decrease)
|
2006
|
2005
|
(decrease)
|
||||||||||||||||||
|
Revenue
|
$ | 181,202 | $ | 170,374 | $ | 10,828 | $ | 170,374 | $ | 166,582 | $ | 3,792 | ||||||||||||
|
Cost
of gas
|
121,550 | 117,948 | 3,602 | 117,948 | 116,178 | 1,770 | ||||||||||||||||||
|
Gross
margin
|
59,652 | 52,426 | 7,226 | 52,426 | 50,404 | 2,022 | ||||||||||||||||||
|
Operations
& maintenance
|
26,024 | 22,673 | 3,351 | 22,673 | 23,874 | (1,201 | ) | |||||||||||||||||
|
Depreciation
& amortization
|
6,918 | 6,312 | 606 | 6,312 | 5,682 | 630 | ||||||||||||||||||
|
Other
taxes
|
4,225 | 3,708 | 517 | 3,708 | 3,612 | 96 | ||||||||||||||||||
|
Other
operating expenses
|
37,167 | 32,693 | 4,474 | 32,693 | 33,168 | (475 | ) | |||||||||||||||||
|
Total
Operating Income
|
$ | 22,485 | $ | 19,733 | $ | 2,752 | $ | 19,733 | $ | 17,236 | $ | 2,497 | ||||||||||||
|
Heating
Degree-Day (HDD) and Customer Analysis
|
||||||||||||||||||||||||
|
Increase
|
Increase
|
|||||||||||||||||||||||
|
For
the Years Ended December 31,
|
2007
|
2006
|
(decrease)
|
2006
|
2005
|
(decrease)
|
||||||||||||||||||
|
Heating
degree-day data — Delmarva
|
||||||||||||||||||||||||
|
Actual
HDD
|
4,504 | 3,931 | 573 | 3,931 | 4,792 | (861 | ) | |||||||||||||||||
|
10-year
average HDD
|
4,376 | 4,372 | 4 | 4,372 | 4,436 | (64 | ) | |||||||||||||||||
|
Estimated
gross margin per HDD
|
$ | 1,937 | $ | 2,013 | $ | (76 | ) | $ | 2,013 | $ | 2,234 | $ | (221 | ) | ||||||||||
|
Estimated
dollars per residential customer added:
|
||||||||||||||||||||||||
|
Gross
margin
|
$ | 372 | $ | 372 | $ | 0 | $ | 372 | $ | 372 | $ | 0 | ||||||||||||
|
Other
operating expenses
|
$ | 106 | $ | 111 | $ | (5 | ) | $ | 111 | $ | 106 | $ | 5 | |||||||||||
|
Average
number of residential customers
|
||||||||||||||||||||||||
|
Delmarva
|
43,485 | 40,535 | 2,950 | 40,535 | 37,346 | 3,189 | ||||||||||||||||||
|
Florida
|
13,250 | 12,663 | 587 | 12,663 | 11,717 | 946 | ||||||||||||||||||
|
Total
|
56,735 | 53,198 | 3,537 | 53,198 | 49,063 | 4,135 | ||||||||||||||||||
2007 Compared to
2006
Gross
margin for the Company’s natural gas segment increased by $7.2 million, or 14
percent, and other operating expenses increased $4.5 million, or 14 percent, for
2007 compared to 2006. The gross margin increases of $3.9 million for the
natural gas transmission operation, $3.4 million for the Delmarva natural gas
distribution operations, and $88,000 for the Florida natural gas distribution
operation were partially offset by a lower gross margin of $207,000 for the
natural gas marketing operation, as further explained below.
Natural Gas
Transmission
The
natural gas transmission operation achieved gross margin growth of $3.9 million,
or 22 percent, in 2007 compared to 2006. Of the $3.9 million
increase, $3.3 million was attributable to new transportation capacity contracts
implemented in November 2006 and 2007. In 2008, the new transportation capacity
contracts implemented in November 2007 are expected to generate an additional
annual gross margin of $1.2 million above 2007 gross margins. In
addition, the implementation of rate case settlement rates, effective September
1, 2007, contributed an additional $563,000 to gross margins in
2007. A further discussion of the FERC rate proceeding is provided in
detail within the “Regulatory Activities” listed later in this
section. The remaining $43,000 increase to gross margin in 2007 is
attributable to other factors, such as higher interruptible sales. An
increase of $2.3 million in other operating expenses partially offset the
increased gross margin. The factors contributing to the increase in other
operating expenses are as follow:
|
·
|
Payroll
and benefit costs increased by $282,000 and $90,000, respectively, as the
operation increased its staffing levels to comply with new federal
pipeline integrity regulations and to serve the additional
growth. The new pipeline integrity regulations require the
Company to assess the integrity of each covered segment of its line
pipe. These regulations require the assessment of at least 50
percent of the covered segments by December 17, 2007 and completion of the
baseline assessment of all covered segments by December 17,
2012.
|
|
·
|
Eastern
Shore also incurred an additional $385,000 of third-party costs in 2007
compared to 2006 to comply with the new federal pipeline integrity
regulations previously discussed.
|
|
·
|
The
increased level of capital investment caused higher depreciation and asset
removal costs of $371,000 and increased property taxes of
$188,000.
|
|
·
|
Corporate
costs increased $568,000 as the Company updated its annual corporate cost
allocations based on a methodology accepted by the
FERC.
|
|
·
|
The
increase in operating expenses for 2007 is magnified by the FERC’s
authorization, in July 2006, to defer certain pre-service costs of Eastern
Shore’s E3 Project, allowing the Company to treat such costs as a
regulatory asset. The deferral of these costs resulted in the reduction of
$190,000 in other operating expenses in 2006 for expenses incurred in
2005. Please refer to the “Regulatory Activities” discussion below for
further information on the E3
Project.
|
|
·
|
Other
operating expenses relating to various items increased collectively by
approximately $226,000.
|
Natural Gas
Distribution
The
Delmarva distribution operations experienced an increase in gross margin of $3.4
million, or 16 percent. The significant items contributing to the increase in
gross margin include the following:
|
·
|
Continued
residential customer growth contributed to the increase in gross margin.
The average number of residential customers on the Delmarva Peninsula
increased by 2,950, or seven percent, for 2007 compared to 2006, and the
Company estimates that these additional residential customers contributed
approximately $1.2 million to gross margin. The Company does
not expect to maintain the growth rate of residential customers, which it
has experienced in the past few years. The Company has seen a
slow-down in the new housing market in 2007 as a result of unfavorable
market conditions in the housing industry, which include:
(a) increased new and resale home inventory levels,
(b) decreased homebuyer demand due to lower consumer confidence in
the overall housing market, (c) increased uncertainty in the overall
mortgage market, and (d) increased underwriting
standards.
|
|
·
|
Rate
increases for both the Delaware and Maryland divisions generated an
additional $848,000 in gross margin in 2007 compared to
2006. In October 2006, the Maryland PSC granted the Company a
base rate increase, which resulted in a $693,000 period-over-period
increase to gross margin in 2007. The Delaware Division
received approval from the Delaware PSC to implement temporary rates,
subject to refund, which contributed an additional $155,000 to gross
margin in 2007.
|
|
·
|
The
Company estimates that weather contributed $819,000 to gross margin in
2007 compared to 2006, as temperatures on the Delmarva Peninsula were 15
percent colder in 2007. This amount differs from the $1.1 million of
additional gross margin that the Company had expected the colder weather
to contribute. This variance occurred as a result of the season
or month that the heating degree day variance
occurred.
|
|
·
|
The
colder temperatures did not have a significant impact on the Maryland
distribution operation’s gross margin in 2007, because the operation’s
approved rate structure now includes a weather normalization adjustment
(“WNA”) mechanism, which was implemented in October 2006 and is designed
to protect a portion of the Company’s revenues against warmer-than-normal
weather, as deviations from normal weather can affect our financial
performance. The WNA also serves to offset the impact of
colder-than-normal weather on our customers by reducing the amounts the
Company can charge them during such
periods.
|
|
·
|
Growth
in commercial and industrial customers contributed $224,000 and $102,000,
respectively, to gross margin in 2007 compared to
2006.
|
|
·
|
Increased
sales volumes to interruptible customers contributed $224,000 to gross
margin in 2007 compared to 2006.
|
|
·
|
The
remaining $31,000 increase in gross margin can be attributed to various
other factors.
|
Gross
margin for the Florida distribution operation increased by $88,000, or one
percent, in 2007 compared to 2006. The higher gross margin, which resulted from
an increase in residential customers, was partially offset by lower volumes sold
to industrial customers. The operation experienced a five percent
growth in residential customers in 2007 compared to 2006, which provided for an
additional $142,000 in gross margin. The Florida distribution
operation also experienced a slowdown in the housing market in 2007 attributable
to the same unfavorable housing market conditions previously
discussed.
Other
operating expense for the natural gas distribution operations increased by $2.0
million in 2007 compared 2006. Among the key components of the increase were the
following:
|
·
|
Payroll
costs increased by $110,000 as vacant positions in 2006 were filled in
2007 and additional positions were added to serve the growth experienced
by the operations.
|
|
·
|
Health
care costs increased by $177,000 as a result of the additional personnel
and a higher cost of claims in 2007 compared to
2006.
|
|
·
|
Incentive
compensation increased $229,000 in 2007 as the Delmarva operations
experienced improved earnings and increased staffing
levels.
|
|
·
|
Depreciation
and amortization expense, asset removal cost and property taxes increased
by $316,000, $121,000 and $156,000, respectively, as a result of the
Company’s continued capital
investments.
|
|
·
|
The
Florida distribution operation experienced an increased expense of
$227,000 in 2007 compared with 2006 to maintain compliance with the new
federal pipeline integrity
regulations.
|
|
·
|
Sales
and advertising costs increased $129,000 in 2007 compared to 2006,
primarily to promote energy conservation and customer awareness of the
availability of natural gas
service.
|
|
·
|
Regulatory
expenses increased $113,000 as the Delaware and Maryland operations began
expensing costs associated with their respective rate
cases.
|
|
·
|
The
allowance for uncollectible accounts increased $183,000 in 2007 compared
to 2006 due to increased revenues resulting from customer growth and
colder temperatures.
|
|
·
|
Merchant
payment fees decreased by $116,000 as the Company’s Delmarva operation
outsourced the processing of credit card payments in April
2007.
|
|
·
|
Other
operating expenses relating to various other items increased by
approximately $355,000.
|
Natural Gas
Marketing
Gross
margin for the natural gas marketing operation decreased by $207,000, or 11
percent, for 2007 compared to 2006. The decline in gross margin was primarily
the result of increases in natural gas supply costs that the Company was
contractually unable to pass through to its customers. In addition, a
shift in the market prevented the Company from selling as much of its available
capacity in 2007 as was sold during 2006. Other operating expenses
for the marketing operation increased by $258,000 primarily due to increases in
payroll and benefit costs, allowance for uncollectible accounts and corporate
overhead costs, which were partially offset by lower expenses for consulting
services.
2006 Compared to
2005
Gross
margin for the Company’s natural gas segment increased $2.0 million, or 4
percent, and other operating expenses decreased $475,000, or 1 percent, in 2006
compared to 2005. The gross margin increases of $1.8 million for the natural gas
transmission operation, $395,000 for the Florida natural gas distribution
operation and $75,000 for the natural gas marketing operation were partially
offset by a lower gross margin of $210,000 for the Delmarva natural gas
distribution operations.
Natural Gas
Transmission
The
natural gas transmission operation achieved gross margin growth of $1.8 million,
or 11 percent. Of the $1.8 million increase, $1.1 million was attributable to
new transportation capacity contracts implemented in November 2005 and $612,000
due to new transportation capacity contracts implemented in November
2006. An increase of $416,000 in other operating expenses partially
offset the increased gross margin. The factors contributing to the increased
expenses are as follow:
|
·
|
Payroll
costs and incentive compensation increased $108,000 to serve the
additional growth experienced by the
operation.
|
|
·
|
Depreciation
and asset removal costs increased by $558,000 and property taxes by
$109,000 due to an increase in the level of capital
investment.
|
|
·
|
As
a result of the operation receiving approval from the FERC to recover
certain pre-service costs associated with the E3 Project, the Company
deferred $188,000 of costs previously incurred and expensed in
2005. As a result of this deferral, the amounts recognized in
the Company’s income statement declined from 2005 by $376,000. Please
refer to the “Regulatory Activities” discussion for further information on
this expansion project.
|
|
·
|
Other
operating expenses relating to various other items increased by
approximately $17,000.
|
Natural Gas
Distribution
Gross
margin for the Florida distribution operation increased by $395,000 in 2006
compared to 2005. An eight percent growth in residential customers contributed
$230,000 of this increase in gross margin. In addition to residential customer
growth, new commercial and industrial customers contributed $91,000 to gross
margin in 2006. The remaining $74,000 increase in gross margin is attributed to
various factors, including turn-on revenue.
The
Delmarva distribution operations experienced a decrease of $210,000 in gross
margin. Weather significantly affected gross margin in 2006 compared to
2005. The Company estimates that the warmer temperatures in 2006,
which were 18 percent warmer than in 2005, led to a decrease in gross margin of
approximately $1.7 million when compared to 2005. This decrease was partially
offset by continued residential customer growth. The average number of
residential customers on the Delmarva Peninsula increased 3,189, or 9 percent,
for 2006 compared to 2005 and the Company estimates that additional residential
customers contributed approximately $1.2 million to gross margin. The remaining
$190,000 increase in gross margin can be attributed to various factors,
including an increase in the number of commercial customers and a decrease in
interruptible sales.
Other
operating expense for the natural gas distribution operations decreased $814,000
in 2006 compared to 2005. Some of the significant components of the decrease in
other operating expenses in 2006, compared to 2005, include the
following:
|
·
|
Health
care costs decreased by $313,000 as a result of the Company changing
health care service providers in November 2005 and experiencing lower
costs related to claims.
|
|
·
|
Allowance
for uncollectible accounts decreased by $289,000 in 2006 compared to 2005
due to increased collection efforts and lower revenues resulting from
lower prices and warmer
temperatures.
|
|
·
|
Incentive
compensation decreased by $177,000 in 2006, reflecting lower than expected
earnings.
|
|
·
|
Corporate
costs were reduced by $407,000 due to lower payroll and related
expenses.
|
|
·
|
Depreciation
and amortization expense and asset removal cost increased by $132,000 and
$186,000, respectively, as a result of the Company’s continued capital
investments.
|
|
·
|
Merchant
payment fees increased by $136,000 in 2006 compared to 2005 as the Company
experienced more customers making payments with the use of credit
cards.
|
|
·
|
In
addition, other operating expenses relating to various minor items
increased by approximately $55,000.
|
Natural Gas
Marketing
Gross
margin for the natural gas marketing operation increased by $75,000 for 2006
compared to 2005. The increase was due primarily to growth in the number of
customers to which the operation provided supply management services. Other
operating expenses decreased by $78,000 due to lower levels of consulting
services, partially offset by an increase in the allowance for uncollectible
accounts.
Propane
The
propane segment experienced an increase of $2.0 million, or 78 percent, in
operating income in 2007 compared to 2006. Gross margin increased
$4.0 million, which was partially offset by an increase in other operating
expenses of $2.0 million. During 2006, operating income for the
propane segment decreased by $675,000, or 21 percent, compared to 2005,
reflecting a gross margin decrease of $1.1 million, which was partially offset
by a decrease in operating expenses of $464,000.
|
Propane
(in thousands)
|
||||||||||||||||||||||||
|
Increase
|
Increase
|
|||||||||||||||||||||||
|
For
the Years Ended December 31,
|
2007
|
2006
|
(decrease)
|
2006
|
2005
|
(decrease)
|
||||||||||||||||||
|
Revenue
|
$ | 62,838 | $ | 48,576 | $ | 14,262 | $ | 48,576 | $ | 48,976 | $ | (400 | ) | |||||||||||
|
Cost
of sales
|
41,038 | 30,780 | 10,258 | 30,780 | 30,041 | 739 | ||||||||||||||||||
|
Gross
margin
|
21,800 | 17,796 | 4,004 | 17,796 | 18,935 | (1,139 | ) | |||||||||||||||||
|
Operations
& maintenance
|
14,594 | 12,823 | 1,771 | 12,823 | 13,355 | (532 | ) | |||||||||||||||||
|
Depreciation
& amortization
|
1,842 | 1,659 | 183 | 1,659 | 1,574 | 85 | ||||||||||||||||||
|
Other
taxes
|
866 | 780 | 86 | 780 | 797 | (17 | ) | |||||||||||||||||
|
Other
operating expenses
|
17,302 | 15,262 | 2,040 | 15,262 | 15,726 | (464 | ) | |||||||||||||||||
|
Total
Operating Income
|
$ | 4,498 | $ | 2,534 | $ | 1,964 | $ | 2,534 | $ | 3,209 | $ | (675 | ) | |||||||||||
|
Propane
Heating Degree-Day (HDD) Analysis — Delmarva
|
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|
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