QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended: September 30, 2020
OR
☐
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from to
Commission File Number: 001-11590
CHESAPEAKE UTILITIES CORPORATION
(Exact name of registrant as specified in its charter)
Delaware
51-0064146
(State or other jurisdiction of incorporation or organization)
(I.R.S. Employer Identification No.)
909 Silver Lake Boulevard, Dover, Delaware19904
(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
Trading Symbol(s)
Name of each exchange on which registered
Common Stock - par value per share $0.4867
CPK
New York Stock Exchange, Inc.
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☒ No ☐
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes☒ No ☐
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and "emerging growth company" in Rule 12b-2 of the Exchange Act.
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.
☐
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ☐ No ☒
Common Stock, par value $0.4867 — 17,460,906 shares outstanding as of October 30, 2020.
ASC: Accounting Standards Codification issued by the FASB
Aspire Energy: Aspire Energy of Ohio, LLC
Aspire Energy Express: Aspire Energy Express, LLC
ASU: Accounting Standards Update issued by the FASB
ATM: At-the-market
Boulden: Boulden, Inc., an entity from whom we acquired certain propane operating assets
CARES Act: Coronavirus Aid, Relief, and Economic Security Act
CDC: U.S. Centers for Disease Control and Prevention
CDD: Cooling Degree-Day
CGS: Community Gas Systems
Chesapeake or Chesapeake Utilities: Chesapeake Utilities Corporation, and its direct and indirect subsidiaries, as appropriate in the context of the disclosure
CHP: Combined heat and power plant
Company: Chesapeake Utilities Corporation, and its direct and indirect subsidiaries, as appropriate in the context of the disclosure
COVID-19: An infectious disease caused by a newly discovered coronavirus
CNG: Compressed natural gas
Degree-Day: 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 above (CDD) or below (HDD) 65 degrees Fahrenheit
Delmarva Peninsula: A peninsula on the east coast of the U.S. occupied by Delaware and portions of Maryland and Virginia
DRIP: Dividend Reinvestment and Direct Stock Purchase Plan
Dt(s): Dekatherm(s), which is a natural gas unit of measurement that includes a standard measure for heating value
Dts/d: Dekatherms per day
Eastern Shore: Eastern Shore Natural Gas Company, a wholly-owned subsidiary of Chesapeake Utilities
Eight Flags: Eight Flags Energy, LLC, a subsidiary of Chesapeake OnSight Services, LLC
Elkton Gas: Elkton Gas Company, a wholly-owned subsidiary of Chesapeake Utilities
FASB: Financial Accounting Standards Board
FERC: Federal Energy Regulatory Commission
FPU: Florida Public Utilities Company, a wholly-owned subsidiary of Chesapeake Utilities
GAAP: Accounting principles generally accepted in the United States of America
GRIP: Gas Reliability Infrastructure Program
Gross Margin: A non-GAAP measure defined as operating revenues less the cost of sales. The Company's cost of sales includes purchased fuel cost for natural gas, electricity and propane and the cost of labor spent on direct revenue-producing activities and excludes depreciation, amortization and accretion
Marlin Gas Services: Marlin Gas Services, LLC, a wholly-owned subsidiary of Chesapeake Utilities that acquired certain operating assets of Marlin Gas Transport, Inc.
MetLife: MetLife Investment Advisors, an institutional debt investment management firm, with which we have previously issued Senior Notes and which is a party to the current MetLife Shelf Agreement, as amended
MGP: Manufactured gas plant, which is a site where coal was previously used to manufacture gaseous fuel for industrial, commercial and residential use
NYL: New York Life Investors LLC, an institutional debt investment management firm, with which Chesapeake Utilities entered into a Shelf Agreement and issued Shelf Notes
Peninsula Pipeline: Peninsula Pipeline Company, Inc., a wholly-owned subsidiary of Chesapeake Utilities
Peoples Gas: Peoples Gas System division of Tampa Electric Company
PESCO: Peninsula Energy Services Company, Inc., an inactive wholly-owned subsidiary of Chesapeake Utilities
Prudential: Prudential Investment Management Inc., an institutional investment management firm, with which Chesapeake Utilities entered into a previous Shelf Agreement, which has been subsequently amended, and issued Shelf Notes
PSC: Public Service Commission, which is the state agency that regulates utility rates and/or services in certain of our jurisdictions
Revolver: Our new $375 million unsecured revolving credit facility with certain lenders
Sandpiper Energy: Sandpiper Energy, Inc., a wholly-owned subsidiary of Chesapeake Utilities
SEC: U.S. Securities and Exchange Commission
Sharp: Sharp Energy, Inc., a wholly-owned subsidiary of Chesapeake Utilities
Shelf Agreement: An agreement entered into by Chesapeake Utilities and a counterparty pursuant to which Chesapeake Utilities may request that the counterparty purchase our unsecured senior debt with a fixed interest rate and a maturity date not to exceed 20 years from the date of issuance
Shelf Notes: Unsecured senior promissory notes issuable under the Shelf Agreement executed with various counterparties
SICP: 2013 Stock and Incentive Compensation Plan
SJI: South Jersey Industries, Inc.
TCJA: Tax Cuts and Jobs Act enacted on December 22, 2017
TETLP: Texas Eastern Transmission, LP, an interstate pipeline interconnected with Eastern Shore's pipeline
Uncollateralized Senior Notes: Our unsecured long-term debt issued primarily to insurance companies on various dates
Condensed Consolidated Statements of Stockholders’ Equity (Unaudited)
Common Stock (1)
(in thousands, except shares and pershare data)
Number of
Shares(2)
Par Value
Additional Paid-In Capital
Retained Earnings
Accumulated Other Comprehensive Loss
Deferred Compensation
Treasury Stock
Total
Balance at June 30, 2019
16,403,776
$
7,984
$
256,385
$
285,762
$
(5,747)
$
4,694
$
(4,694)
$
544,384
Net income
—
—
—
5,621
—
—
—
5,621
Other comprehensive loss
—
—
—
—
344
—
—
344
Dividend declared ($0.4050 per share)
—
—
—
(6,689)
—
—
—
(6,689)
Dividend reinvestment plan
—
—
(1)
—
—
—
—
(1)
Share-based compensation and tax benefit (3)(4)
—
—
1,052
—
—
—
—
1,052
Treasury stock activities
—
—
—
—
—
(189)
189
—
Balance at September 30, 2019
16,403,776
$
7,984
$
257,436
$
284,694
$
(5,403)
$
4,505
$
(4,505)
$
544,711
Balance at December 31, 2018
16,378,545
$
7,971
$
255,651
$
261,530
$
(6,713)
$
3,854
$
(3,854)
$
518,439
Net income
—
—
—
42,589
—
—
—
42,589
Prior period reclassification
—
—
—
115
(115)
—
—
—
Other comprehensive income
—
—
—
—
1,425
—
—
1,425
Dividend declared ($1.1800 per share)
—
—
—
(19,540)
—
—
—
(19,540)
Dividend reinvestment plan
—
—
(3)
—
—
—
—
(3)
Share-based compensation and tax benefit (3)(4)
25,231
13
1,788
—
—
—
—
1,801
Treasury stock activities
—
—
—
—
—
651
(651)
—
Balance at September 30, 2019
16,403,776
$
7,984
$
257,436
$
284,694
$
(5,403)
$
4,505
$
(4,505)
$
544,711
Balance at June 30, 2020
16,463,808
$
8,013
$
263,272
$
326,454
$
(4,462)
$
5,659
$
(5,659)
$
593,277
Net income
—
—
—
9,261
—
—
—
9,261
Other comprehensive income
—
—
—
—
833
—
—
833
Dividend declared ($0.440 per share)
—
—
—
(7,358)
—
—
—
(7,358)
Equity issuances under various plans (5)
232,684
113
19,420
—
—
—
—
19,533
Share-based compensation and tax benefit (3)(4)
1,144
—
—
—
—
1,144
Treasury stock activities
—
—
—
—
—
(25)
25
—
Balance at September 30, 2020
16,696,492
$
8,126
$
283,836
$
328,357
$
(3,629)
$
5,634
$
(5,634)
$
616,690
Balance at December 31, 2019
16,403,776
$
7,984
$
259,253
$
300,607
$
(6,267)
$
4,543
$
(4,543)
$
561,577
Net income
—
—
—
49,146
—
—
—
49,146
Other comprehensive income
—
—
—
—
2,638
—
—
2,638
Dividend declared ($1.285 per share)
—
—
—
(21,366)
—
—
—
(21,366)
Equity issuances under various plans (5)
258,260
126
21,693
—
—
—
—
21,819
Share-based compensation and tax benefit (3)(4)
34,456
16
2,890
—
—
—
—
2,906
Treasury stock activities
—
—
—
—
—
1,091
(1,091)
—
Cumulative effect of the adoption of ASU 2016-13
—
—
—
(30)
—
—
—
(30)
Balance at September 30, 2020
16,696,492
$
8,126
$
283,836
$
328,357
$
(3,629)
$
5,634
$
(5,634)
$
616,690
(1)2,000,000 shares of preferred stock at $0.01 par value have been authorized. No shares have been issued or are outstanding; accordingly, no information has been included in the statements of stockholders’ equity.
(2)Includes 104,119 shares at September 30, 2020, 95,329 shares at December 31, 2019, 94,923 shares at September 30, 2019 and 97,053 shares at December 31, 2018, respectively, held in a Rabbi Trust related to our Non-Qualified Deferred Compensation Plan.
(3)Includes amounts for shares issued for directors’ compensation.
(4)The shares issued under the SICP are net of shares withheld for employee taxes. For the nine months ended September 30, 2020 and 2019, we withheld 10,319 and 7,635 shares, respectively, for employee taxes.
(5)Includes the Retirement Savings Plan, DRIP and ATM equity issuances.
The accompanying notes are an integral part of these financial statements.
References in this document to the “Company,” “Chesapeake Utilities,” “we,” “us” and “our” are intended to mean Chesapeake Utilities Corporation, its divisions and/or its subsidiaries, as appropriate in the context of the disclosure.
The accompanying unaudited condensed consolidated financial statements have been prepared in compliance with the rules and regulations of the SEC and GAAP. In accordance with these rules and regulations, certain information and disclosures normally required for audited financial statements have been condensed or omitted. These financial statements should be read in conjunction with the consolidated financial statements and notes thereto, included in our latest Annual Report on Form 10-K for the year ended December 31, 2019. In the opinion of management, these financial statements reflect all adjustments that are necessary for a fair presentation of our results of operations, financial position and cash flows for the interim periods presented.
Where necessary to improve comparability, prior period amounts have been changed to conform to current period presentation.
Due to the seasonality of our business, results for interim periods are not necessarily indicative of results for the entire fiscal year. Revenue and earnings are typically greater during the first and fourth quarters, when consumption of energy is highest due to colder temperatures.
Beginning in the third quarter of 2019, our management began executing a strategy to sell the operating assets of PESCO. In the fourth quarter of 2019, we closed on four separate transactions to sell PESCO's assets and contracts. As a result of these sales, we have fully exited the natural gas marketing business, which provided natural gas management and supply services to commercial and industrial customers in Florida, Delaware, Maryland, Pennsylvania, Ohio and other states. Accordingly, PESCO’s historical financial results are reflected in our condensed consolidated financial statements as discontinued operations, which required retrospective application to financial information for all periods presented. Refer to Note 3, Acquisitions and Divestitures, for further information
Effects of COVID-19
On March 13, 2020, the CDC declared a national emergency due to the rapidly growing outbreak of COVID-19. In response to this declaration and the rapid spread of COVID-19 within the United States, federal, state and local governments throughout the country imposed varying degrees of restrictions on social and commercial activity to promote social distancing in an effort to slow the spread of the illness. These restrictions have continued to significantly impact economic conditions in the United States. We are considered an “essential business,” which allows us to continue our operational activities and construction projects while the social distancing restrictions remain in place. In response to the COVID-19 pandemic and related restrictions, we implemented our pandemic response plan, which includes having all employees who can work remotely do so in order to promote social distancing and providing personal protective equipment to field employees to reduce the spread of COVID-19. Impacts from the restrictions imposed in our service territories and the implementation of our pandemic response plan, included reduced consumption of energy largely in the commercial and industrial sectors, higher bad debt expenses and incremental expenses associated with COVID-19, including personal protective equipment and premium pay for field personnel. The additional operating expenses we incurred support the ongoing delivery of our essential services during these unprecedented times. As the COVID-19 pandemic is still ongoing, we are continuing to assess recoverability and to date, have not established regulatory assets associated with the incremental net expense impacts, as currently authorized by the Delaware, Maryland and Florida PSCs. We are committed to communicating timely updates and will continue to monitor developments affecting our employees, customers, suppliers, and stockholders and take additional precautions as warranted to operate safely and to comply with the CDC, Occupational Safety and Health Administration, state and local requirements in order to protect our employees, customers and the communities we serve, and update and communicate the ongoing financial impact on our results once determined. Refer to Note 5, Rates and Other Regulatory Activities, for further information on the potential deferral of incremental expenses associated with COVID-19.
FASB Statements and Other Authoritative Pronouncements
Recently Adopted Accounting Standards
Financial Instruments - Credit Losses (ASC 326) - In June 2016, the FASB issued ASU 2016-13, Measurement of Credit Losses on Financial Instruments, which changes how entities account for credit losses for most financial assets and certain
other instruments, and subsequent guidance which served to clarify or amend the original standard. ASU 2016-13 and the related amendments require entities to estimate lifetime expected credit losses for trade receivables and to provide additional disclosure related to credit losses. We adopted ASU 2016-13 on January 1, 2020 and recorded an immaterial cumulative effect in retained earnings as of that date. As a result, prior period financial information has not been recast and continues to be reported under the accounting guidance that was effective during those periods.
Our estimate for expected credit losses has been developed by analyzing our portfolio of financial assets that present potential credit exposure risk. These assets consist solely of our trade receivables from customers and contract assets. The estimate is based on five years of historical collections experience, a review of current economic and operating conditions in our service territories, and an examination of economic indicators which provide a reasonable and supportable basis of potential future activity. Those indicators include metrics which we believe provide insight into the future collectability of our trade receivables such as unemployment rates and economic growth statistics in our service territories.
When determining estimated credit losses, we analyzed the balance of our trade receivables based on the underlying service line they pertain to. This resulted in an examination of trade receivables from our energy distribution, energy transmission, energy delivery services and propane operations service lines. Our energy distribution service line consists of all our regulated distribution utility operations on the Delmarva Peninsula and throughout Florida. These business units have the ability to recover their costs through the rate making process, which can include consideration for amounts historically written off as a component of their rate base. Therefore, they possess a mechanism to recover credit losses which we believe reduces their exposure to credit risk. Our energy transmission and energy delivery services business units consist of our natural gas pipelines and our mobile compressed natural gas ("CNG") delivery operations. The majority of the customer base these business units serve are regulated distribution utilities who also have the ability to recover their costs. We believe this cost recovery mechanism significantly reduces the amount of credit risk they present. Our propane operations are unregulated and do not have the same ability to recover their costs as our regulated operations. However, historically our propane operations have not had material write offs relative to the amounts of revenues earned.
Our estimate of expected credit losses reflects our anticipated losses associated with our trade receivables as a result of non-payment from our customers beginning the day the trade receivable is established. We believe the risk of loss associated with trade receivables classified as current presents the least amount of credit exposure risk and therefore, we assign a lower estimate to our current trade receivables. As our trade receivables age outside of their expected due date, our estimate increases. Our allowance for credit losses relative to the balance of our trade receivables has historically been immaterial as a result of on time payment activity from our customers.
During the first quarter of 2020, COVID-19 began to rapidly spread within the United States. Federal, state and local governments throughout the country imposed restrictions to promote social distancing to slow the spread of the virus, which has also had the effect of limiting commercial activity. These measures have resulted in significant job losses and a slowing of economic activity across the United States and in the areas that we serve. We have been identified as an “essential business,” which allowed us to continue operational activity and construction projects with social distancing restrictions in place. We have considered the impact of COVID-19 for the nine months ended September 30, 2020, monitored developments that impact our customers’ ability to pay and have revised our estimates of expected credit losses.
Our prior estimates for expected credit losses had not included an evaluation of current conditions or forward-looking economic indicators as we were not required to consider those factors under the previous incurred loss accounting guidance. The below table provides a reconciliation of our allowance for credit losses at September 30, 2020:
(in thousands)
Balance at December 31, 2019
$
1,337
Additions:
Provision for credit losses
2,810
Recoveries
577
Deductions:
Write offs
(594)
Balance at September 30, 2020
$
4,130
Fair Value Measurement (ASC 820) - In August 2018, the FASB issued ASU 2018-13, Disclosure Framework - Changes to the Disclosure Requirements for Fair Value Measurement, which removes, modifies and adds certain disclosure requirements on fair value measurements in ASC 820. We adopted ASU 2018-13 beginning January 1, 2020 and, since the changes only impacted disclosures, its adoption did not have a material impact on our financial position or results of operations.
Intangibles - Goodwill (ASC 350) - In January 2017, the FASB issued ASU 2017-04, Simplifying the Test for Goodwill Impairment, which simplifies how an entity is required to test goodwill for impairment by eliminating Step 2 from the goodwill impairment test. ASU 2017-04 was effective beginning January 1, 2020. The amendments included in this ASU are to be applied prospectively, and are not expected to have a material impact on our financial position or results of operations.
2. Calculation of Earnings Per Share
Three Months Ended
Nine Months Ended
September 30,
September 30,
2020
2019
2020
2019
(in thousands, except shares and per share data)
Calculation of Basic Earnings Per Share:
Income from Continuing Operations
$
9,280
$
6,251
$
48,981
$
43,977
Income (Loss) from Discontinued Operations
(19)
(630)
165
(1,388)
Net Income
$
9,261
$
5,621
$
49,146
$
42,589
Weighted average shares outstanding
16,533,748
16,403,776
16,466,106
16,396,646
Basic Earnings Per Share from Continuing Operations
$
0.56
$
0.38
$
2.97
$
2.68
Basic Earnings (Loss) Per Share from Discontinued Operations
—
(0.04)
0.01
(0.08)
Basic Earnings Per Share
$
0.56
$
0.34
$
2.98
$
2.60
Calculation of Diluted Earnings Per Share:
Reconciliation of Denominator:
Weighted shares outstanding—Basic
16,533,748
16,403,776
16,466,106
16,396,646
Effect of dilutive securities—Share-based compensation
59,094
50,091
57,094
47,585
Adjusted denominator—Diluted
16,592,842
16,453,867
16,523,200
16,444,231
Diluted Earnings Per Share from Continuing Operations
$
0.56
$
0.38
$
2.96
$
2.67
Diluted Earnings (Loss) Per Share from Discontinued Operations
—
(0.04)
0.01
(0.08)
Diluted Earnings Per Share
$
0.56
$
0.34
$
2.97
$
2.59
3. Acquisitions and Divestitures
Acquisition of Western Natural Gas Company
In October 2020, Sharp acquired certain propane operating assets of Western Natural Gas Company, which provides propane distribution service throughout Jacksonville, Florida and the surrounding communities, for approximately $6.7 million, net of cash acquired. The acquisition will be accounted for as a business combination within our Unregulated Energy Segment beginning in the fourth quarter of 2020. There are multiple strategic benefits to this acquisition including it: (i) expands our propane territory serviced in Florida; (ii) includes an established customer base with opportunities for future growth; and (iii) provides opportunities to market additional services and pricing programs to these customers.
Acquisition of Elkton Gas
In July 2020, we closed on the acquisition of Elkton Gas, which provides natural gas distribution service to approximately 7,000 residential and commercial customers within a franchised area of Cecil County, Maryland for approximately, $15.6 million, net of cash acquired. Additionally, the purchase price included $0.6 million of working
capital. Elkton Gas’ territory is contiguous to our franchised service territory in Cecil County, Maryland. Elkton Gas continues to operate out of its existing office with the same local personnel who are now also serving our existing franchised service territory in Cecil County.
In connection with this acquisition, we recorded $15.9 million in property, plant and equipment, $0.6 million in accounts receivable, $2.6 million in other liabilities, $2.6 million in regulatory liabilities and $4.3 million in goodwill, all of which is deductible for income tax purposes. All of the assets and liabilities are recorded in the Regulated Energy segment. The amounts recorded in conjunction with the acquisition are preliminary, and subject to adjustment based on contractual provisions. The purchase price allocation will be finalized in the third quarter of 2021. For the three and nine months ended September 30, 2020, Elkton Gas generated operating revenue of $0.6 million and an operating loss of less than $0.1 million, respectively. The immaterial operating loss is reflective of less than a full quarter of results; in addition, the third quarter is typically the warmest quarter of the year.
Acquisition of Boulden
In December 2019, Sharp acquired certain propane operating assets of Boulden, which provides propane distribution service to approximately 5,200 customers in Delaware, Maryland and Pennsylvania, for approximately $24.6 million, net of cash acquired. Additionally, the purchase price included $0.2 million of working capital. We recorded contingent consideration of $0.6 million related to the seller's adherence to various provisions contained in the contract through the first anniversary of the transaction closing. We accounted for the purchase of the operating assets of Boulden as a business combination and integrated the business into our Sharp operation. There are multiple strategic benefits to this acquisition including it: (i) overlays with the Elkton Gas acquisition to establish an integrated energy delivery platform in Cecil County, Maryland; (ii) includes an established customer base with opportunities for future growth; (iii) enables operational synergies, including supply, for the northern Delmarva Peninsula; and (iv) provides opportunities to market additional services and pricing programs to these customers.
In connection with this acquisition, we recorded $8.3 million in property, plant and equipment, $5.1 million in intangible assets associated with customer relationships and non-compete agreements and $11.2 million in goodwill, all of which is deductible for income tax purposes. The amounts recorded in conjunction with the acquisition are preliminary, and subject to adjustment based on contractual provisions and will be finalized in the fourth quarter of 2020. For the three months ended September 30, 2020, Boulden generated operating revenue of $0.4 million and an operating loss of $0.2 million, respectively. For the nine months ended September 30, 2020, Boulden generated operating revenue and income of $4.1 million and $1.2 million, respectively. The third quarter is typically the warmest quarter of the year, with the smallest amount of gallons being delivered during that quarter.
Divestiture of PESCO
During the fourth quarter of 2019, we sold PESCO's assets and contracts in four separate transactions and exited the natural gas marketing business. As a result of the sales agreements, we began to report PESCO as discontinued operations during the third quarter of 2019, excluded PESCO's performance from continuing operations for all periods presented and classified its assets and liabilities as held for sale where applicable. We received a total of $23.1 million in cash consideration from the buyers, inclusive of working capital of $8.0 million and recognized total pre-tax gain of $7.5 million ($5.4 million after tax) in connection with these transactions of which, $7.3 million of this gain was recognized in the fourth quarter of 2019.
Operating revenues and costs of sales from the previous reporting periods, which were previously eliminated in consolidation, have been grossed up and are now reflected as a component of operating revenues and costs of sales for the three and nine months ended September 30, 2019. We recast these amounts because, upon completion of the sales transactions, we continued to provide and receive services from the buyers through the remainder of the contractual terms.
A summary of discontinued operations presented in the condensed consolidated statements of income includes the following:
Three Months Ended
Nine Months Ended
September 30,
September 30,
(in thousands)
2020
2019 (1)
2020
2019 (1)
Operating revenues(1)
$
3
$
34,271
$
26
$
152,573
Cost of sales(1)
(40)
33,763
(39)
149,464
Other operating expenses
75
1,360
272
4,819
Operating loss
(32)
(852)
(207)
(1,710)
Interest and other expense
6
(74)
(23)
(242)
Loss from Discontinued Operations before income taxes
(26)
(926)
(230)
(1,952)
Gain on sale of Discontinued Operations
—
—
200
—
Income tax benefit
(7)
(296)
(195)
(564)
Gain (Loss) from Discontinued Operations, Net of Tax
$
(19)
$
(630)
$
165
$
(1,388)
(1) Included in operating revenues and cost of sales for the three and nine months ended September 30, 2019, is $4.3 million and $19.1 million, respectively, representing amounts which had been previously eliminated in consolidation related to intercompany activity that continued with the buyers after the disposition of the assets of PESCO.
Since the disposition of the assets and contracts of PESCO was completed in the fourth quarter of 2019, there were no assets or liabilities classified as held for sale at September 30, 2020 and December 31, 2019.
We have elected not to separately disclose discontinued operations on the condensed consolidated statements of cash flows. The following table summarizes significant statements of cash flows data related to the discontinued operations of PESCO:
Nine Months Ended September 30, 2019
In thousands
Depreciation and amortization
$
437
Deferred income taxes
$
513
Realized gain on commodity contracts
$
(623)
Our Delmarva Peninsula natural gas distribution operations had asset management agreements with PESCO to manage their natural gas transportation and storage capacity. The agreements were effective as of April 1, 2017, and expired on March 31, 2020. As a result of the sale of the assets of PESCO, effective October 1, 2019, these agreements were managed by New Jersey Resource Energy Services Company through the remainder of the contract term. In March 2020, our Delmarva Peninsula natural gas distribution operations entered into asset management agreements with a third party to manage their natural gas transportation and storage capacity. The agreements were effective as of April 1, 2020, and expire on March 31, 2023. In addition to the asset management agreements, Eastern Shore had several firm transportation and capacity arrangements with PESCO, which were included in the assets sold to United Energy Trading, LLC. Eastern Shore will continue to fulfill these arrangements throughout the remainder of their contractual term. These agreements currently have expiration dates of November 30, 2021.
4. Revenue Recognition
We recognize revenue when our performance obligations under contracts with customers have been satisfied, which generally occurs when our businesses have delivered or transported natural gas, electricity or propane to customers. We exclude sales taxes and other similar taxes from the transaction price. Typically, our customers pay for the goods and/or services we provide in the month following the satisfaction of our performance obligation. The revenues in the following tables exclude operating revenues from PESCO that are reflected as discontinued operations. The following table displays our revenue from continuing operations by major source based on product and service type for the three months ended September 30, 2020 and 2019:
(1)Total operating revenues for the three months ended September 30, 2020, include other revenue (revenues from sources other than contracts with customers) of $0.2 million and $0.05 million for our Regulated and Unregulated Energy segments, respectively, and $0.1 million and $0.1 million for our Regulated and Unregulated Energy segments, respectively, for the three months ended September 30, 2019. The sources of other revenues include revenue from alternative revenue programs related to revenue normalization for the Maryland division and Sandpiper and late fees.
The following table displays our revenue from continuing operations by major source based on product and service type for the nine months ended September 30, 2020 and 2019:
Nine months ended September 30, 2020
Nine months ended September 30, 2019
(in thousands)
Regulated Energy
Unregulated Energy
Other and Eliminations
Total
Regulated Energy
Unregulated Energy
Other and Eliminations
Total
Energy distribution
Delaware natural gas division
$
45,568
$
—
$
—
$
45,568
$
42,758
$
—
$
—
$
42,758
Florida natural gas division
23,018
—
—
23,018
21,625
—
—
21,625
FPU electric distribution
58,972
—
—
58,972
59,016
—
—
59,016
FPU natural gas distribution
64,877
—
—
64,877
60,357
—
—
60,357
Maryland natural gas division
15,941
—
—
15,941
15,867
—
—
15,867
Sandpiper natural gas/propane operations
12,440
—
—
12,440
14,237
—
—
14,237
Elkton Gas
623
—
—
623
—
—
—
—
Total energy distribution
221,439
—
—
221,439
213,860
—
—
213,860
Energy transmission
Aspire Energy
—
17,784
—
17,784
—
23,139
—
23,139
Eastern Shore
55,944
—
—
55,944
54,368
—
—
54,368
Peninsula Pipeline
16,618
—
—
16,618
11,573
—
—
11,573
Total energy transmission
72,562
17,784
—
90,346
65,941
23,139
—
89,080
Energy generation
Eight Flags
—
11,898
—
11,898
—
12,405
—
12,405
Propane operations
Propane delivery operations
—
69,593
—
69,593
—
78,217
—
78,217
Energy delivery services
Marlin Gas Services
—
5,266
—
5,266
—
4,601
—
4,601
Other and eliminations
Eliminations
(34,766)
(75)
(12,937)
(47,778)
(28,200)
(9,377)
(13,351)
(50,928)
Other
—
—
396
396
—
—
395
395
Total other and eliminations
(34,766)
(75)
(12,541)
(47,382)
(28,200)
(9,377)
(12,956)
(50,533)
Total operating revenues (1)
$
259,235
$
104,466
$
(12,541)
$
351,160
$
251,601
$
108,985
$
(12,956)
$
347,630
(1)Total operating revenues for the nine months ended September 30, 2020, include other revenue (revenues from sources other than contracts with customers) of $1.0 million and $0.2 million for our Regulated and Unregulated Energy segments, respectively, and $(0.1) million and $0.3 million for our Regulated and Unregulated Energy segments, respectively, for the nine months ended September 30, 2019. The sources of other revenues include revenue from alternative revenue programs related to revenue normalization for the Maryland division and Sandpiper and late fees.
The timing of revenue recognition, customer billings and cash collections results in trade receivables, unbilled receivables (contract assets), and customer advances (contract liabilities) in our condensed consolidated balance sheets. The balances of our trade receivables, contract assets, and contract liabilities as of September 30, 2020 and December 31, 2019 were as follows:
Trade Receivables
Contract Assets (Current)
Contract Assets (Non-current)
Contract Liabilities (Current)
(in thousands)
Balance at 12/31/2019
$
47,430
$
18
$
3,465
$
589
Balance at 9/30/2020
37,190
18
4,537
971
Increase (decrease)
$
(10,240)
$
—
$
1,072
$
382
Our trade receivables are included in trade and other receivables in the condensed consolidated balance sheets. Our current contract assets are included in other current assets in the condensed consolidated balance sheet. Our non-current contract assets are included in other assets in the condensed consolidated balance sheet and primarily relate to operations and maintenance costs incurred by Eight Flags that have not yet been recovered through rates for the sale of electricity to our electric distribution operation pursuant to a long-term service agreement.
At times, we receive advances or deposits from our customers before we satisfy our performance obligation, resulting in contract liabilities. Contract liabilities are included in other accrued liabilities in the condensed consolidated balance sheets and relate to non-refundable prepaid fixed fees for our Mid-Atlantic propane delivery operation's retail offerings. Our performance obligation is satisfied over the term of the respective retail offering plan on a ratable basis. For each of the three months ended September 30, 2020 and 2019, we recognized revenue of $0.2 million. For the nine months ended September 30, 2020 and 2019, we recognized revenue of $0.8 million and $0.7 million, respectively.
Remaining performance obligations
Our businesses have long-term fixed fee contracts with customers in which revenues are recognized when performance obligations are satisfied over the contract term. Revenue for these businesses for the remaining performance obligations, at September 30, 2020, are expected to be recognized as follows:
(in thousands)
2020
2021
2022
2023
2024
2025
2026 and thereafter
Eastern Shore and Peninsula Pipeline
$
9,115
$
34,541
$
27,047
$
21,664
$
19,587
$
18,736
$
174,774
Natural gas distribution operations
970
4,351
5,394
4,937
4,705
4,172
32,996
FPU electric distribution
141
566
566
566
566
275
825
Total revenue contracts with remaining performance obligations
$
10,226
$
39,458
$
33,007
$
27,167
$
24,858
$
23,183
$
208,595
5. Rates and Other Regulatory Activities
Our natural gas and electric distribution operations in Delaware, Maryland and Florida are subject to regulation by their respective PSC; Eastern Shore, our natural gas transmission subsidiary, is subject to regulation by the FERC; and Peninsula Pipeline, our intrastate pipeline subsidiary, is subject to regulation (excluding cost of service) by the Florida PSC.
Delaware
CGS: InAugust 2019, we filed with the Delaware PSC an application seeking an order that will establish the regulatory accounting treatment and valuation methodology for the acquisition of propane CGS owned by our affiliate, Sharp and the conversion of the CGS to natural gas service. We proposed to acquire each CGS one at a time and to pay replacement cost for each CGS system. In addition, we requested authorization to pay for and capitalize the CGS residents’ behind-the-meter conversion costs. Our existing natural gas customers will be protected against subsidizing
the acquisitions and conversions of the CGS systems because we will complete only those systems that meet our economic test. The application was reviewed by the Delaware PSC, who approved and issued a final order in June 2020.
Maryland
Approval of the Elkton Gas Acquisition:In December 2019, we entered into an agreement with SJI to acquire its subsidiary, Elkton Gas, which provides natural gas distribution service to approximately 7,000 residential and commercial customers within a franchised area of Cecil County, Maryland. Elkton Gas territory is contiguous to our franchised service territory in Cecil County, Maryland. On June 29, 2020, the Maryland PSC issued a final order approving the settlement agreement, therefore, enabling the transaction to move forward.In July 2020, the transaction closed and we acquired Elkton Gas as our wholly-owned subsidiary.
Application for Authority to Exercise a Franchise: In March 2020, we filed with the Maryland PSC an application seeking approval to exercise a franchise granted to us by the Board of County Commissioners of Somerset County, Maryland in December 2019. The application was approved in June 2020.
Florida
Hurricane Michael: In October 2018, Hurricane Michael passed through FPU's electric distribution operation's service territory in Northwest Florida and caused widespread and severe damage to FPU's infrastructure resulting in the loss of electric service to 100 percent of its customers in the Northwest Florida service territory. FPU, after exerting extraordinary hurricane restoration efforts, restored service to those customers who were able to accept it. FPU expended more than $65.0 million to restore service, which was recorded as new plant and equipment, charged against FPU’s accumulated depreciation or charged against FPU’s storm reserve. Additionally, amounts undergoing review by the Florida PSC for regulatory asset treatment were recorded as receivables and other deferred charges.
In August 2019, FPU filed a limited proceeding requesting recovery of storm-related costs associated with Hurricane Michael (capital and expenses) through a change in base rates. FPU also requested treatment and recovery of certain storm-related costs as regulatory assets for items currently not allowed to be recovered through the storm reserve as well as the recovery of capital replaced as a result of the storm. Recovery of these costs includes a component of an overall return on capital additions and regulatory assets. In March 2020, we filed an update to our original filing to account for actual charges incurred through December 2019, revised the amortization period of the storm-related costs from 30 years as originally requested to 10 years, and included costs related to Hurricane Dorian of approximately $1.2 million in this filing.
In late 2019, the Florida PSC approved an interim rate increase, subject to refund, effective January 1, 2020, associated with the restoration effort following Hurricane Michael. We fully reserved these interim rates, pending a final resolution and settlement of the limited proceeding.In September 2020, the Florida PSC approved a settlement agreement between FPU and the Office of the Public Counsel regarding final cost recovery and rates associated with Hurricane Michael. The settlement agreement allowed us to: (a) record regulatory assets for storm costs in the amount of $45.8 million including interest which will be amortized over six years; (b) recover these storm costs through a surcharge for a total of $7.7 million annually; and (c) collect an annual increase in revenue of $3.3 million to recover capital costs associated with new plant and a regulatory asset for cost of removal and undepreciated plant. The new base rates and storm surcharge were effective on November 1, 2020.
Electric Depreciation Study: In September 2019, FPU filed a petition, with the Florida PSC, for approval of its consolidated electric depreciation rates. The petition was joined to the Hurricane Michael docket, and was approved at the Florida PSC Agenda in September 2020. The approved rates were retroactively applied effective January 1, 2020.
West Palm Beach Expansion Project: In June 2019, Peninsula Pipeline filed with the Florida PSC for approval of its Transportation Service Agreement with FPU. Peninsula Pipeline will construct several new interconnection points and pipeline expansions in Palm Beach County, Florida, which will enable FPU to serve an industrial research park and several new residential developments. Peninsula Pipeline will provide transportation service to FPU, increasing reliability, system pressure as well as introducing diversity in fuel source for natural gas to serve the increased demand in these areas. The petition was approved by the Florida PSC at the August 6, 2019 Agenda. Interim services began in the fourth quarter of 2019. We expect to complete the remainder of the project in phases through the second quarter of 2021.
Callahan Pipeline, Nassau County: In the second quarter of 2020, Peninsula Pipeline and Seacoast Gas Transmission completed construction of a jointly owned 26-mile, 16-inch steel pipeline that interconnects to the Cypress Pipeline
interstate system in western Nassau County in order to serve growing demand in both Nassau and Duval counties, Florida. The Callahan pipeline terminates into the existing Peninsula Pipeline-Peoples Gas jointly owned pipeline, which serves Amelia Island and the Peoples Gas distribution system. The Callahan Pipeline has enhanced FPU’s ability to expand service into Nassau County and has enabled Peoples Gas to enhance its system pressure and the reliability of its service in Duval County.
Eastern Shore
Del-Mar Energy Pathway Project: In December 2019, the FERC issued an order approving the construction of the Del-Mar Energy Pathway project. The order, which was applied for in September 2018 by Eastern Shore, approved the construction and operation of new facilities that will provide an additional 14,300 Dts/d of firm service to four customers. Facilities to be constructed include six miles of pipeline looping in Delaware; 13 miles of new mainline extension in Sussex County, Delaware and Wicomico and Somerset Counties in Maryland; and new pressure control and delivery stations in these counties. The benefits of this project include: (i) additional natural gas transmission pipeline infrastructure in eastern Sussex County, Delaware, and (ii) extension of Eastern Shore’s pipeline system, for the first time, into Somerset County, Maryland. Construction on the project began in January 2020, and Eastern Shore anticipates that this project will be fully in-service by the beginning of the fourth quarter of 2021.
Capital Cost Surcharge: In December 2019, the FERC approved Eastern Shore’s proposed capital cost surcharge to become effective January 1, 2020. The surcharge, an approved item in the settlement of Eastern Shore’s last general rate case, allows Eastern Shore to recover capital costs associated with mandated highway or railroad relocation projects that required the replacement of existing Eastern Shore facilities. Eastern Shore expects to recover $0.5 million in capital cost surcharges on an annual basis. As Eastern Shore continues to relocate its pipeline and incur capital expenditures, we will continue to utilize the surcharge to seek recovery of its costs.
Renewable Natural Gas Tariff: In October 2019, Eastern Shore filed an application with the FERC to include renewable natural gas (biogas) utilization and standards in its tariff. Eastern Shore had proposed changes to its gas quality specifications that would enable it to accommodate renewable natural gas at various receipt points on its system. Changes to the gas quality specifications would ensure interchangeability of renewable natural gas with the natural gas currently delivered to Eastern Shore. The tariffs became effective in November 2019.
Ohio
Aspire Energy Express: In October 2020, the Public Utilities Commission of Ohio approved the request by Aspire Energy Express for authority to operate as an intrastate pipeline company in Ohio and also approved the submitted tariff. Aspire Energy Express will utilize the pipeline to provide natural gas transportation service in Ohio, including delivery to the Guernsey Power Station and other potential customers elsewhere in Ohio. Aspire Energy Express has entered into agreements with the Guernsey Power Station to construct the pipeline and provide natural gas transportation service to the facility pending approval of the application. Aspire Energy Express intends to own and operate the proposed intrastate pipeline facilities that will interconnect with the Rockies Express Pipeline and other potential points of receipt. The pipeline facilities that will be initially constructed are near the Guernsey Power Station. Aspire Energy Express will be subject to ongoing jurisdiction and supervision of the Public Utilities Commission of Ohio with respect to the gas pipeline safety standards and requirements.
COVID-19 Impact
We are monitoring the global outbreak of COVID-19 and taking steps to mitigate the potential risks posed by its spread. We provide an “essential service” to our customers, which means that it is paramount that we keep our employees who operate our business safe and informed. We have taken and are continuously monitoring and updating precautions and protocols to ensure the safety of our employees and customers. As an “essential business” we are allowed to continue operational activity and construction projects with appropriate safety precautions, personal protective equipment and social distancing restrictions in place. We have taken steps to assure our customers that disconnections for non-payment will be temporarily suspended. We are also working with our suppliers to understand the potential impacts to our supply chain; if material negative impacts are identified, we will work to mitigate them. This is a rapidly evolving situation, and could lead to extended disruption of economic activity in our markets. We will continue to monitor developments affecting our employees, customers, suppliers and shareholders, and will take additional precautions as warranted to comply with the CDC, state and local requirements and recommendations to protect our employees, customers and the communities we serve.
As a result of these measures, we are incurring costs associated with crisis management and the pandemic response including restrictions put in place by the state PSCs on utility disconnects for non-payment, technology costs incurred to expand work from home capabilities, additional sanitation and cleaning costs and costs of acquiring personal protective equipment as well as other expenses. We are tracking and analyzing whether these costs qualify for cost recovery and could be classified as regulatory assets.
In April 2020, the Maryland PSC issued an order that authorized utilities to establish a regulatory asset to record prudently incurred incremental costs related to COVID-19, beginning on March 16, 2020. The Maryland PSC found that the creation of a regulatory asset for COVID-19 related expenses will facilitate the recovery of those costs prudently incurred to serve customers during this period, and that the deferral of such costs is appropriate because the current catastrophic health emergency is outside the control of the utility and is a non-recurring event.
In May 2020, the Delaware PSC issued an order that authorized Delaware utilities to establish a regulatory asset to record COVID-19 related incremental costs incurred to ensure customers have essential utility services, for the period beginning on March 24, 2020 and ending 30 days after the state of emergency ends. The creation of the regulatory asset for COVID-19 related costs offers utilities the ability to seek recovery of those costs.
In October 2020, the Florida PSC approved a joint petition of our natural gas and electric distribution utilities in Florida to establish regulatory asset to record incremental expenses incurred due to COVID-19. This regulatory asset will allow us to seek recovery of these costs in our next base rate proceeding.
As the COVID-19 pandemic is still ongoing, to date we have not established regulatory assets associated with the incremental expense impacts, as currently authorized by the Delaware, Maryland and Florida PSCs.
The following table summarizes the TCJA impact on our regulated businesses:
Regulatory Liabilities related to Accumulated Deferred Income Taxes ("ADIT")
Operation and Regulatory Jurisdiction
Amount (in thousands)
Status
Status of Customer Rate impact related to lower federal corporate income tax rate
Eastern Shore (FERC)
$34,190
Will be addressed in Eastern Shore's next rate case filing.
Implemented one-time bill credit (totaling $0.9 million) in April 2018. Customer rates were adjusted in April 2018.
Delaware Division (Delaware PSC)
$12,758
PSC approved amortization of ADIT in January 2019.
Implemented one-time bill credit (totaling $1.5 million) in April 2019. Customer rates were adjusted in March 2019.
Maryland Division (Maryland PSC)
$4,000
PSC approved amortization of ADIT in May 2018.
Implemented one-time bill credit (totaling $0.4 million) in July 2018. Customer rates were adjusted in May 2018.
Sandpiper Energy (Maryland PSC)
$3,726
PSC approved amortization of ADIT in May 2018.
Implemented one-time bill credit (totaling $0.6 million) in July 2018. Customer rates were adjusted in May 2018.
Chesapeake Florida Gas Division/Central Florida Gas (Florida PSC)
$8,214
PSC issued order authorizing amortization and retention of net ADIT liability by the Company in February 2019.
Florida PSC's final order was issued in February 2019. Excluding GRIP, tax savings arising from the TCJA rate reduction will be retained by the Company.
GRIP: Tax savings for 2018 will be refunded to customers in 2020 through the annual GRIP cost recovery mechanism. Future customer GRIP surcharges will be adjusted to reflect tax savings associated with TCJA.
FPU Natural Gas (excludes Fort Meade and Indiantown) (Florida PSC)
$19,192
Same treatment on a net basis as Chesapeake Florida Gas Division (above).
Same treatment on a net basis as Chesapeake Florida Gas Division (above).
FPU Fort Meade and Indiantown Divisions
$309
Same treatment on a net basis as Chesapeake Florida Gas Division (above).
Tax rate reduction: The impact was immaterial for the divisions.
GRIP (Applicable to Fort Meade division only): Same treatment as Chesapeake Florida Gas Division (above).
FPU Electric (Florida PSC)
$6,758
In January 2019, PSC issued order approving amortization of ADIT through purchased power cost recovery, storm reserve and rates.
TCJA benefit is provided to customers through a combination of reductions to the fuel cost recovery rate, base rates, as well as application to the storm reserve over the next several years.
Elkton Gas (Maryland PSC)
$1,124
PSC approved amortization of ADIT in March 2018.
Implemented one-time bill credit (totaling less than $0.1 million) in May 2020.Customer rates were adjusted in April 2020.
6. Environmental Commitments and Contingencies
We are subject to federal, state and local laws and regulations governing environmental quality and pollution control. These laws and regulations require us to remove or remediate, at current and former operating sites, the effect on the environment of the disposal or release of specified substances.
MGP Sites
We have participated in the investigation, assessment or remediation of, and have exposures at, seven former MGP sites. We have received approval for recovery of clean-up costs in rates for sites located in Salisbury, Maryland; Seaford, Delaware; and Winter Haven, Key West, Pensacola, Sanford and West Palm Beach, Florida.
As of September 30, 2020 and December 31, 2019, we had approximately $6.2 million and $8.0 million, respectively, in environmental liabilities related to FPU’s MGP sites in Key West, Pensacola, Sanford and West Palm Beach. FPU has approval to recover, from insurance and through customer rates, up to $14.0 million of its environmental costs related to its MGP sites. As of September 30, 2020 and December 31, 2019, we had recovered approximately $12.3 million and $11.9 million, respectively, leaving approximately $1.7 million and $2.1 million, respectively, in regulatory assets for future recovery of environmental costs from FPU’s customers.
Environmental liabilities for our MGP sites are recorded on an undiscounted basis based on the estimate of future costs provided by independent consultants. We continue to expect that all costs related to environmental remediation and related activities, including any potential future remediation costs for which we do not currently have approval for regulatory recovery, will be recoverable from customers through rates.
The following is a summary of our remediation status and estimated costs to implement clean-up of our key MGP sites:
MGP Site (Jurisdiction)
Status
Estimated Clean Up Costs
West Palm Beach (Florida)
Remedial actions approved by the Florida Department of Environmental Protection have been implemented on the east parcel of the site. Similar remedial actions have been initiated on the site's west parcel, and construction of active remedial systems are expected be completed in 2021.
Between $3.3 million to $14.2 million, including costs associated with the relocation of FPU’s operations at this site, and any potential costs associated with future redevelopment of the properties.
Sanford (Florida)
In March 2018, the United States Environmental Protection Agency ("EPA") approved a "site-wide ready for anticipated use" status, which is the final step before delisting a site. Construction has been completed and restrictive covenants are in place to ensure protection of human health. The only remaining activity is long-term groundwater monitoring.
FPU's remaining remediation expenses, including attorneys' fees and costs, are anticipated to be immaterial.
Winter Haven (Florida)
Remediation is ongoing.
Not expected to exceed $0.4 million.
Seaford (Delaware)
Conducted investigations of on-site and off-site impacts in the vicinity of the site, from 2014 through 2018, and submitted the findings to Delaware Department of Natural Resources and Environmental Control ("DNREC") in a March 2019 report. An interim action involving air-sparging/vapor extraction is being implemented, in accordance with the DNREC-approved Work Plan.
In March 2020, our Delmarva Peninsula natural gas distribution operations entered into asset management agreements with a third party to manage their natural gas transportation and storage capacity. The agreements were effective as of April 1, 2020 and expire on March 31, 2023. Previously, our Delmarva Peninsula natural gas distribution operations had asset management agreements with PESCO to manage their natural gas transportation and storage capacity. See Note 3, Acquisitions and Divestitures, for additional details regarding the sale of PESCO's assets and contracts.
In May 2019, FPU natural gas distribution operations and Eight Flags entered into separate asset management agreements with Emera Energy Services, Inc. to manage their natural gas transportation capacity. The parties also entered into long-term agreements for a 10-year term that commenced in July 2020.
Chesapeake Utilities' Florida Division has firm transportation service contracts with Florida Gas Transmission Company ("FGT") and Gulfstream Natural Gas System, LLC ("Gulfstream"). Pursuant to a capacity release program approved by the Florida PSC, all of the capacity under these agreements has been released to various third parties. Under the terms of these capacity release agreements, Chesapeake Utilities is contingently liable to FGT and Gulfstream should any party, that acquired the capacity through release, fail to pay the capacity charge. To date, Chesapeake Utilities has not been required to make a payment resulting from this contingency.
FPU’s electric supply contracts require FPU to maintain an acceptable standard of creditworthiness based on specific financial ratios. FPU’s agreement with Florida Power & Light Company requires FPU to meet or exceed a debt service coverage ratio of 1.25 times based on the results of the prior 12 months. If FPU fails to meet this ratio, it must provide an irrevocable letter of credit or pay all amounts outstanding under the agreement within five business days. FPU’s electric supply agreement with Gulf Power requires FPU to meet the following ratios based on the average of the prior six quarters: (a) funds from operations interest coverage ratio (minimum of two times), and (b) total debt to total capital (maximum of 65 percent). If FPU fails to meet the requirements, it has to provide the supplier a written explanation of actions taken, or proposed to be taken, to become compliant. Failure to comply with the ratios specified in the Gulf Power agreement could also result in FPU having to provide an irrevocable letter of credit. As of September 30, 2020, FPU was in compliance with all of the requirements of its fuel supply contracts.
Eight Flags provides electricity and steam generation services through its CHP plant located on Amelia Island, Florida. In June 2016, Eight Flags began selling power generated from the CHP plant to FPU pursuant to a 20-year power purchase agreement for distribution to our electric customers. In July 2016, Eight Flags also started selling steam, pursuant to a separate 20-year contract, to the landowner on which the CHP plant is located. The CHP plant is powered by natural gas transported by FPU through its distribution system and Peninsula Pipeline through its intrastate pipeline.
Corporate Guarantees
The Board of Directors has authorized us to issue corporate guarantees securing obligations of our subsidiaries and to obtain letters of credit securing our subsidiaries' obligations. The maximum authorized liability under such guarantees and letters of credit as of September 30, 2020 was $20.0 million. The aggregate amount guaranteed at September 30, 2020 was approximately $7.9 million with the guarantees expiring on various dates through September 24, 2021. The amounts related to PESCO were immaterial and were fully terminated in October 2020. See Note 3, Acquisitions and Divestitures, for additional details on the sale of assets and contracts for PESCO.
Chesapeake Utilities also guarantees the payment of FPU’s first mortgage bonds. The maximum exposure under this guarantee is the outstanding principal plus accrued interest balances. The outstanding principal balances of FPU’s first mortgage bonds approximate their carrying values. See Note 15, Long-Term Debt, for further details.
As of September 30, 2020, we have issued letters of credit totaling approximately $4.8 million related to the electric transmission services for FPU's electric division, the firm transportation service agreement between TETLP and our Delaware and Maryland divisions and our current and previous primary insurance carriers. These letters of credit have various expiration dates through October 5, 2021. There have been no drawings on these letters of credit as of September 30, 2020. We do not anticipate that the counterparties will draw upon these letters of credit, and we expect that they will be renewed to the extent necessary in the future. At September 30, 2020, letters of credit associated with PESCO were fully terminated.
We use the management approach to identify operating segments. We organize our business around differences in regulatory environment and the operating results of each segment are regularly reviewed by the chief operating decision maker (our Chief Executive Officer) in order to make decisions about resources and to assess performance.
Our operations are entirely domestic and are comprised of two reportable segments:
•Regulated Energy. Includes energy distribution and transmission services (natural gas distribution, natural gas transmission and electric distribution operations). All operations in this segment are regulated, as to their rates and services, by the PSC having jurisdiction in each operating territory or by the FERC in the case of Eastern Shore.
•Unregulated Energy. Includes energy transmission, energy generation (the operations of our Eight Flags' CHP plant), propane operations, and the new mobile compressed natural gas distribution and pipeline solutions subsidiary. Also included in this segment are other unregulated energy services, such as energy-related merchandise sales and heating, ventilation and air conditioning, plumbing and electrical services. These operations are unregulated as to their rates and services. Effective in the third quarter of 2019, the natural gas marketing and related services subsidiary (PESCO), previously reported in the Unregulated Energy segment, was reflected in discontinued operations. See Note 3, Acquisitions and Divestitures for additional details of the sale of PESCO.
The remainder of our operations are presented as “Other businesses and eliminations,” which consists of unregulated subsidiaries that own real estate leased to Chesapeake Utilities, as well as certain corporate costs not allocated to other operations. The following table presents financial information about our reportable segments:
Three Months Ended
Nine Months Ended
September 30,
September 30,
2020
2019
2020
2019
(in thousands)
Operating Revenues, Unaffiliated Customers
Regulated Energy
$
82,297
$
74,027
$
257,810
$
249,978
Unregulated Energy
19,122
18,599
93,350
97,652
Total operating revenues, unaffiliated customers
$
101,419
$
92,626
$
351,160
$
347,630
Intersegment Revenues (1)
Regulated Energy
$
465
$
553
$
1,425
$
1,623
Unregulated Energy
3,592
3,681
11,116
11,333
Other businesses
131
133
396
395
Total intersegment revenues
$
4,188
$
4,367
$
12,937
$
13,351
Operating Income
Regulated Energy
$
20,482
$
17,540
$
66,376
$
65,310
Unregulated Energy
(3,092)
(3,169)
11,050
11,317
Other businesses and eliminations
16
(14)
92
18
Operating income
17,406
14,357
77,518
76,645
Other income (expense), net
(40)
(351)
2,997
(731)
Interest charges
4,584
5,403
15,452
16,583
Income from Continuing Operations before Income Taxes
12,782
8,603
65,063
59,331
Income Taxes on Continuing Operations
3,502
2,352
16,082
15,354
Income from Continuing Operations
9,280
6,251
48,981
43,977
Income (loss) from Discontinued Operations, Net of Tax
(19)
(630)
165
(1,388)
Net Income
$
9,261
$
5,621
$
49,146
$
42,589
(1)All significant intersegment revenues are billed at market rates and have been eliminated from consolidated operating revenues.
On June 30, 2020, we filed a shelf registration statement with the SEC to facilitate the issuance of our common stock from time to time. On August 17, 2020, we filed a prospectus supplement under the shelf registration statement for an ATM equity program under which we may issue and sell shares of our common stock up to an aggregate offering price of $75.0 million. In September 2020, we issued 0.1 million shares of common stock at price per share of $83.21 and received net proceeds of approximately $10.2 million, after deducting commissions and other fees of $0.4 million. In October 2020, we issued an additional 0.6 million shares at price per share of $82.88 and received approximately $50.8 million in net proceeds, after deducting commissions and other fees of $1.1 million.
We maintain an effective shelf registration statement with the SEC for the issuance of shares under our DRIP. Depending on our capital needs and subject to market conditions, in addition to other possible debt and equity offerings, we may consider issuing additional shares under the direct stock purchase component of the DRIP. In the third quarter of 2020, we issued 0.1 million shares at price per share of $84.90 and received net proceeds of $9.0 million under the DRIP. In October 2020, we issued an additional 0.1 million shares at price per share of $86.99 and received approximately $13.0 million in net proceeds.
We intend to use the net proceeds from the ATM equity program and the DRIP, after deducting the commissions or other fees and related offering expenses payable by us, for general corporate purposes, including, but not limited to, financing of capital expenditures, repayment of short-term debt, financing acquisitions, investing in subsidiaries, and general working capital purposes.
Accumulated Other Comprehensive Loss
Defined benefit pension and postretirement plan items, unrealized gains (losses) of our propane swap agreements and natural gas swaps and futures contracts, designated as commodity contracts cash flow hedges, and the unrealized gains (losses) of our interest rate swap agreements designated as cash flow hedges are the components of our accumulated other comprehensive loss. The following tables present the changes in the balance of accumulated other comprehensive (loss)/income as of September 30, 2020 and 2019. All amounts except the stranded tax reclassification are presented net of tax.
Defined Benefit
Commodity
Interest Rate
Pension and
Contracts
Swap
Postretirement
Cash Flow
Cash Flow
Plan Items
Hedges
Hedges
Total
(in thousands)
As of December 31, 2019
$
(4,933)
$
(1,334)
$
—
$
(6,267)
Other comprehensive income before reclassifications
—
3,594
23
3,617
Amounts reclassified from accumulated other comprehensive income (loss)
Other comprehensive income (loss) before reclassifications
(80)
1,780
—
1,700
Amounts reclassified from accumulated other comprehensive income/(loss)
312
(587)
—
(275)
Net prior-period other comprehensive income
232
1,193
—
1,425
Prior-year reclassification
—
(115)
—
(115)
As of September 30, 2019
$
(5,696)
$
293
$
—
$
(5,403)
The following table presents amounts reclassified out of accumulated other comprehensive loss for the three and nine months ended September 30, 2020 and 2019. Deferred gains or losses for our commodity contracts and interest rate swap cash flow hedges are recognized in earnings upon settlement.
Three Months Ended
Nine Months Ended
September 30,
September 30,
2020
2019
2020
2019
(in thousands)
Amortization of defined benefit pension and postretirement plan items:
Prior service credit (1)
$
19
$
19
$
57
$
58
Net loss(1)
(108)
(44)
(323)
(370)
Total before income taxes
(89)
(25)
(266)
(312)
Income tax benefit
23
5
68
80
Net of tax
(66)
(20)
(198)
(232)
Gains and losses on commodity contracts cash flow hedges:
Propane swap agreements (2)
116
290
1,581
1,148
Natural gas swaps (2)(3)
—
(4)
—
7
Natural gas futures (2)(3)
—
348
—
(350)
Total before income taxes
116
634
1,581
805
Income tax expense
(32)
(179)
(437)
(218)
Net of tax
84
455
1,144
587
Gains on interest rate swap cash flow hedges:
Interest rate swap agreements
34
—
45
—
Total before income taxes
34
—
45
—
Income tax expense
(9)
—
(12)
—
Net of tax
25
—
33
—
Total reclassifications for the period
$
43
$
435
$
979
$
355
(1)These amounts are included in the computation of net periodic costs (benefits). See Note 10, Employee Benefit Plans, for additional details.
(2)These amounts are included in the effects of gains and losses from derivative instruments. See Note 13, Derivative Instruments, for additional details.
(3)PESCO's results are reflected as discontinued operations in our condensed consolidated statements of income.
Amortization of defined benefit pension and postretirement plan items is included in other expense, net gains and losses on propane swap agreements, natural gas swaps, and natural gas futures contracts are included in cost of sales, the realized gain or loss on interest rate swap agreements is recognized as a component of interest charges in the accompanying condensed consolidated statements of income. The income tax benefit is included in income tax expense in the accompanying condensed consolidated statements of income.
Net periodic benefit costs for our pension and post-retirement benefits plans for the three and nine months ended September 30, 2020 and 2019 are set forth in the following tables:
Chesapeake Pension Plan
FPU Pension Plan
Chesapeake SERP
Chesapeake Postretirement Plan
FPU Medical Plan
For the Three Months Ended September 30,
2020
2019
2020
2019
2020
2019
2020
2019
2020
2019
(in thousands)
Interest cost
$
46
$
104
$
518
$
614
$
16
$
16
$
8
$
10
$
10
$
12
Expected return on plan assets
(42)
(127)
(745)
(693)
—
—
—
—
—
—
Amortization of prior service credit
—
—
—
—
—
—
(19)
(19)
—
—
Amortization of net loss
65
101
135
128
5
17
12
11
—
—
Net periodic cost (benefit)
69
78
(92)
49
21
33
1
2
10
12
Settlement expense
—
—
—
—
—
58
—
—
—
—
Amortization of pre-merger regulatory asset
—
—
—
162
—
—
—
—
2
2
Total periodic cost
$
69
$
78
$
(92)
$
211
$
21
$
91
$
1
$
2
$
12
$
14
Chesapeake Pension Plan
FPU Pension Plan
Chesapeake SERP
Chesapeake Postretirement Plan
FPU Medical Plan
For the Nine Months Ended September 30,
2020
2019
2020
2019
2020
2019
2020
2019
2020
2019
(in thousands)
Interest cost
$
138
$
314
$
1,554
$
1,844
$
48
$
58
$
24
$
29
$
30
$
36
Expected return on plan assets
(126)
(381)
(2,235)
(2,079)
—
—
—
—
—
—
Amortization of prior service credit
—
—
—
—
—
—
(57)
(58)
—
—
Amortization of net loss
195
304
405
386
15
68
36
35
—
—
Net periodic cost (benefit)
207
237
(276)
151
63
126
3
6
30
36
Settlement expense
—
—
—
—
—
58
—
—
—
—
Amortization of pre-merger regulatory asset
—
—
—
543
—
—
—
—
6
6
Total periodic cost
$
207
$
237
$
(276)
$
694
$
63
$
184
$
3
$
6
$
36
$
42
We expect to record immaterial pension and post-retirement benefit costs for 2020. The components of our net periodic costs have been recorded or reclassified to other expense, net in the condensed consolidated statements of income. Pursuant to a Florida PSC order, FPU continues to record, as a regulatory asset, a portion of the unrecognized postretirement benefit costs related to its regulated operations after the FPU merger. The portion of the unrecognized pension and postretirement benefit costs related to FPU’s unregulated operations and Chesapeake Utilities' operations is recorded to accumulated other comprehensive loss.
The following tables present the amounts included in the regulatory asset and accumulated other comprehensive loss that were recognized as components of net periodic benefit cost during the three and nine months ended September 30, 2020 and 2019:
For the Three Months Ended September 30, 2020
Chesapeake Pension Plan
FPU Pension Plan
Chesapeake SERP
Chesapeake Postretirement Plan
FPU Medical Plan
Total
(in thousands)
Prior service credit
$
—
$
—
$
—
$
(19)
$
—
$
(19)
Net loss
65
135
5
12
—
217
Total recognized in net periodic benefit cost
65
135
5
(7)
—
198
Recognized from accumulated other comprehensive loss/(gain) (1)
65
26
5
(7)
—
89
Recognized from regulatory asset
—
109
—
—
—
109
Total
$
65
$
135
$
5
$
(7)
$
—
$
198
For the Three Months Ended September 30, 2019
Chesapeake Pension Plan
FPU Pension Plan
Chesapeake SERP
Chesapeake Postretirement Plan
FPU Medical Plan
Total
(in thousands)
Prior service credit
$
—
$
—
$
—
$
(19)
$
—
$
(19)
Net loss
101
128
17
11
—
257
Total recognized in net periodic benefit cost
101
128
17
(8)
—
238
Recognized from accumulated other comprehensive loss/(gain) (1)
101
24
(93)
(8)
—
24
Recognized from regulatory asset
—
104
—
—
—
104
Total
$
101
$
128
$
(93)
$
(8)
$
—
$
128
For the Nine Months Ended September 30, 2020
Chesapeake Pension Plan
FPU Pension Plan
Chesapeake SERP
Chesapeake Postretirement Plan
FPU Medical Plan
Total
(in thousands)
Prior service credit
$
—
$
—
$
—
$
(57)
$
—
$
(57)
Net loss
195
405
15
36
—
651
Total recognized in net periodic benefit cost
195
405
15
(21)
—
594
Recognized from accumulated other comprehensive loss/(gain) (1)
195
78
15
(21)
—
267
Recognized from regulatory asset
—
327
—
—
—
327
Total
$
195
$
405
$
15
$
(21)
$
—
$
594
For the Nine Months Ended September 30, 2019
Chesapeake Pension Plan
FPU Pension Plan
Chesapeake SERP
Chesapeake Postretirement Plan
FPU Medical Plan
Total
(in thousands)
Prior service credit
$
—
$
—
$
—
$
(58)
$
—
$
(58)
Net loss
304
386
(42)
35
—
683
Total recognized in net periodic benefit cost
304
386
(42)
(23)
—
625
Recognized from accumulated other comprehensive loss/(gain) (1)
During the three and nine months ended September 30, 2020, we contributed approximately $0.1 million and $0.3 million, respectively, to the Chesapeake Pension Plan and approximately $0.5 million and $2.6 million, respectively, to the FPU Pension Plan. We expect to contribute approximately$0.3 million and $3.2 million, respectively, to the Chesapeake Pension Plan and FPU Pension Plans during 2020, which represents the minimum annual contribution payments required. A provision in the CARES Act, which was passed by Congress and signed into law by President Trump in March 2020, authorized the deferral of 2020 pension contributions to January 1, 2021. Despite this authorization, we have not deferred, and do not expect to defer, any of our 2020 pension plan contributions to 2021.
The Chesapeake SERP, the Chesapeake Postretirement Plan and the FPU Medical Plan are unfunded and are expected to be paid out of our general funds. Cash benefits paid under the Chesapeake SERP for the three and nine months ended September 30, 2020 were immaterial and $0.1 million, respectively. We expect to pay total cash benefits of approximately $0.2 million under the Chesapeake SERP in 2020. Cash benefits paid under the Chesapeake Postretirement Plan, primarily for medical claims for the three and nine months ended September 30, 2020 were immaterial. We estimate that approximately $0.1 million will be paid for such benefits under the Chesapeake Postretirement Plan in 2020. Cash benefits paid under the FPU Medical Plan, primarily for medical claims for the three and nine months ended September 30, 2020, were immaterial. We estimate that approximately $0.1 million will be paid for such benefits under the FPU Medical Plan in 2020.
11. Investments
The investment balances at September 30, 2020 and December 31, 2019, consisted of the following:
(in thousands)
September 30, 2020
December 31, 2019
Rabbi trust (associated with the Non-Qualified Deferred Compensation Plan)
$
9,663
$
9,202
Investments in equity securities
17
27
Total
$
9,680
$
9,229
We classify these investments as trading securities and report them at their fair value. For the three months ended September 30, 2020 and 2019, we recorded a net unrealized gain of approximately $0.6 million and a net unrealized loss of approximately $0.1 million, respectively, in other expense, net in the condensed consolidated statements of income related to these investments. For the nine months ended September 30, 2020 and 2019, we recorded a net unrealized gain of approximately $0.4 million and $1.0 million, respectively, in other expense, net in the condensed consolidated statements of income related to these investments. For the investment in the Rabbi Trust, we also have recorded an associated liability, which is included in other pension and benefit costs in the condensed consolidated balance sheets and is adjusted each period for the gains and losses incurred by the investments in the Rabbi Trust.
12. Share-Based Compensation
Our non-employee directors and key employees are granted share-based awards through our SICP. We record these share-based awards as compensation costs over the respective service period for which services are received in exchange for an award of equity or equity-based compensation. The compensation cost is based primarily on the fair value of the shares awarded, using the estimated fair value of each share on the date it was granted and the number of shares to be issued at the end of the service period.
The table below presents the amounts included in net income related to share-based compensation expense for the three and nine months ended September 30, 2020 and 2019:
Share-based compensation amounts included in net income
$
984
$
895
$
2,699
$
1,705
Non-employee Directors
Shares granted to non-employee directors are issued in advance of the directors’ service periods and are fully vested as of the date of the grant. We record a deferred expense equal to the fair value of the shares issued and amortize the expense equally over a service period of one year. In May 2020, after the most recent election of directors, each of our non-employee directors received an annual retainer of 887 shares of common stock under the SICP for service as a director through the 2021 Annual Meeting of Stockholders; accordingly, 8,870 shares, with a weighted average fair value of $84.47 per share, were issued and vested in 2020. At September 30, 2020, there was approximately$0.4 million of unrecognized compensation expense related to shares granted to non-employee directors. This expense will be recognized over the remaining service period ending on the date of the 2021 Annual Meeting of Stockholders.
In January 2020, a newly appointed member of the Board of Directors received a pro-rated retainer of 254shares of common stock under the SICP to serve as a non-employee director through the 2020 Annual Meeting of Stockholders. The shares awarded to the non-employee director immediately vested upon issuance in January 2020, had a weighted average fair value of $95.83 per share, and the expense was recognized over the remaining service period ending on the date of the 2020 Annual Meeting of Stockholders.
Key Employees
The table below presents the summary of the stock activity for awards to key employees for the nine months ended September 30, 2020:
Number of Shares
Weighted Average Fair Value
Outstanding—December 31, 2019
157,817
$
80.28
Granted
69,345
$
92.78
Vested
(35,651)
$
66.48
Expired
(5,302)
$
65.32
Outstanding—September 30, 2020
186,209
$
86.98
In February 2020, our Board of Directors granted awards of 69,345 shares of common stock to key employees under the SICP. The shares granted are multi-year awards that will vest at the end of the three-year service period ending December 31, 2022. All of these stock awards are earned based upon the successful achievement of long-term financial results, which comprise market-based and performance-based conditions or targets. The fair value of each performance-based condition or target is equal to the market price of our common stock on the grant date of each award. For the market-based conditions, we used the Monte Carlo valuation to estimate the fair value of each market-based award granted.
In March 2020, upon the appointment of certain of our executive officers, we withheld shares with a value at least equivalent to each such executive officer’s minimum statutory obligation for applicable income and other employment taxes related to shares that we awarded in February 2020 for the performance period ended December 31, 2019, remitted the cash to the appropriate taxing authorities, and paid the balance of such awarded shares to each such executive officer. We withheld 10,319 shares, based on the value of the shares on their award date. Total combined payments for the employees’ tax obligations to the taxing authorities were approximately $1.0 million.
At September 30, 2020, the aggregate intrinsic value of the SICP awards granted to key employees was approximately $15.7 million. At September 30, 2020, there was approximately $4.9 million of unrecognized compensation cost related to these awards, which is expected to be recognized as expense for the remainder of 2020 through 2022.
There were no stock options outstanding or issued during the nine months ended September 30, 2020 and 2019.
13. Derivative Instruments
We use derivative and non-derivative contracts to manage risks related to obtaining adequate supplies and the price fluctuations of natural gas, electricity and propane and to mitigate interest rate risk. Our natural gas, electric and propane distribution operations have entered into agreements with suppliers to purchase natural gas, electricity and propane for resale to our customers. Our natural gas gathering and transmission company has entered into contracts with producers to secure natural gas to meet its obligations. Purchases under these contracts typically either do not meet the definition of derivatives or are considered “normal purchases and normal sales” and are accounted for on an accrual basis. Our propane distribution operations may also enter into fair value hedges of their inventory or cash flow hedges of their future purchase commitments in order to mitigate the impact of wholesale price fluctuations. Occasionally, we may enter into interest rate swap agreements to mitigate risk associated with changes in short-term borrowing rates. As of September 30, 2020, our natural gas and electric distribution operations did not have any outstanding derivative contracts.
PESCO's Derivative Instruments
As discussed in Note 3, Acquisitions and Divestitures, during the fourth quarter of 2019, we sold PESCO's assets and contracts and, therefore, no longer have natural gas futures and contracts recorded in our condensed consolidated financial statements.
Commodity Derivative Activities
As of September 30, 2020, the volume of our commodity derivative contracts were as follows:
Business unit
Commodity
Quantity hedged (in millions)
Designation
Longest Expiration date of hedge
Sharp
Propane (gallons)
21.7
Cash flows hedges
May 2023
Sharp entered into futures and swap agreements to mitigate the risk of fluctuations in wholesale propane index prices associated with the propane volumes expected to be purchased during the heating season. Under the futures and swap agreements, Sharp will receive the difference between: (i) the index prices (Mont Belvieu prices for September 2020 through May 2023), and (ii) the per gallon propane swap prices, to the extent the index prices exceed the contracted prices. If the index prices are lower than the swap prices, Sharp will pay the difference. We designated and accounted for propane swaps as cash flows hedges. The change in the fair value of the swap agreements is recorded as unrealized gain (loss) in other comprehensive income (loss) and later recognized in the statement of income in the same period and in the same line item as the hedged transaction. We expect to reclassify approximately $1.0 million from accumulated other comprehensive income (loss) to earnings during the next 12-month period ended September 30, 2021.
Interest Rate Swap Activities
We manage interest rate risk by entering into derivative contracts to hedge the variability in cash flows attributable to changes in the short-term borrowing rates. In the second quarter of 2020, we entered into interest rate swaps with notional amounts totaling $100.0 million associated with three of our short-term lines of credit through October 2020. The interest rate swaps were entered to hedge the variability in cash flows attributable to changes in the short-term borrowing rates during this period. Pricing on the interest rate swaps range between 0.2615 and 0.3875 percent for the period. Our short-term borrowing is based on the 30-day LIBOR rate. The interest rate swaps are cash settled monthly as the counter-party pays us the 30-day LIBOR rate less the fixed rate.
We designated and accounted for interest rate swaps as cash flows hedges. Accordingly, unrealized gains and losses associated with the interest rate swaps are recorded as a component of accumulated other comprehensive income (loss). When the interest rate swaps settle, the realized gain or loss will be recorded in the income statement and recognized as a component of interest charges. We expect to reclassify less than $0.1 million from accumulated other comprehensive income (loss) to earnings during the next 12-month period ended September 30, 2021.
Futures exchanges have contract specific margin requirements that require the posting of cash or cash equivalents relating to traded contracts. Margin requirements consist of initial margin that is posted upon the initiation of a position, maintenance margin that is usually expressed as a percent of initial margin, and variation margin that fluctuates based on the daily mark-to-market relative to maintenance margin requirements. We currently maintain a broker margin account for Sharp, with the balance related to the account is as follows:
(in thousands)
Balance Sheet Location
September 30, 2020
December 31, 2019
Sharp
Other Current Assets
$
177
$
2,317
Financial Statements Presentation
The following tables present information about the fair value and related gains and losses of our derivative contracts. We did not have any derivative contracts with a credit-risk-related contingency.
As of September 30, 2020 and December 31, 2019, we did not have material fair value hedges. The fair values of the derivative contracts recorded in the condensed consolidated balance sheets as of September 30, 2020 and December 31, 2019, are as follows:
GAAP establishes a fair value hierarchy that prioritizes the inputs to valuation methods used to measure fair value. The three levels of the fair value hierarchy are the following:
Fair Value Hierarchy
Description of Fair Value Level
Fair Value Technique Utilized
Level 1
Unadjusted quoted prices in active markets that are accessible at the measurement date for identical, unrestricted assets or liabilities
Investments - equity securities - The fair values of these trading securities are recorded at fair value based on unadjusted quoted prices in active markets for identical securities.
Investments - mutual funds and other - The fair values of these investments, comprised of money market and mutual funds, are recorded at fair value based on quoted net asset values of the shares.
Level 2
Quoted prices in markets that are not active, or inputs which are observable, either directly or indirectly, for substantially the full term of the asset or liability
Derivative assets and liabilities - The fair value of the propane put/call options and swap agreements are measured using market transactions for similar assets and liabilities in either the listed or over-the-counter markets.
Level 3
Prices or valuation techniques requiring inputs that are both significant to the fair value measurement and unobservable (i.e. supported by little or no market activity)
Investments - guaranteed income fund - The fair values of these investments are recorded at the contract value, which approximates their fair value.
Financial Assets and Liabilities Measured at Fair Value
The following tables summarize our financial assets and liabilities that are measured at fair value on a recurring basis and the fair value measurements, by level, within the fair value hierarchy as of September 30, 2020 and December 31, 2019:
The following table sets forth the summary of the changes in the fair value of Level 3 investments for the nine months ended September 30, 2020 and 2019:
Nine months ended September 30,
2020
2019
(in thousands)
Beginning Balance
$
803
$
686
Purchases and adjustments
243
123
Transfers
1,579
—
Distribution
(514)
(14)
Investment income
18
11
Ending Balance
$
2,129
$
806
Investment income from the Level 3 investments is reflected in other expense, (net) in the condensed consolidated statements of income.
At September 30, 2020, there were no non-financial assets or liabilities required to be reported at fair value. We review our non-financial assets for impairment at least on an annual basis, as required.
Other Financial Assets and Liabilities
Financial assets with carrying values approximating fair value include cash and cash equivalents and accounts receivable. Financial liabilities with carrying values approximating fair value include accounts payable and other accrued liabilities and short-term debt. The fair value of cash and cash equivalents is measured using the comparable value in the active market and approximates its carrying value (Level 1 measurement). The fair value of short-term debt approximates the carrying value due to its near-term maturities and because interest rates approximate current market rates (Level 3 measurement).
At September 30, 2020, long-term debt, which includes current maturities but excludes debt issuance costs, had a carrying value of approximately $536.5 million, compared to the estimated fair value of $567.0 million. At December 31, 2019, long-term debt, which includes the current maturities but excludes debt issuance costs, had a carrying value of approximately $486.6 million, compared to a fair value of approximately $505.0 million. The fair value was calculated using a discounted cash flow methodology that incorporates a market interest rate based on published corporate borrowing rates for debt instruments with similar terms and average maturities, and with adjustments for duration, optionality, and risk profile. The valuation technique used to estimate the fair value of long-term debt would be considered a Level 3 measurement.
(1)FPU secured first mortgage bonds are guaranteed by Chesapeake Utilities.
Term Notes
In January 2019, we issued a $30 million unsecured term note through Branch Banking and Trust Company, with a maturity date of February 28, 2020. This note was paid in full in February 2020 utilizing our short-term borrowing facilities.
Shelf Agreements
We have entered into Shelf Agreements with Prudential, MetLife and NYL, whom are under no obligation to purchase any unsecured debt. The following table summarizes our Shelf Agreements at September 30, 2020:
(1) In January 2020, we requested and Prudential accepted our request to purchase $50.0 million of our unsecured debt. We issued the Shelf Notes in July 2020 at the rate of 3.00 percent per annum.
(2) In April 2020, the Prudential Shelf Agreement was amended to increase the available borrowing capacity to $150.0 million. The Shelf Agreement expires in April 2023.
(3) In May 2020, we reached into an agreement with MetLife to provide a new $150.0 million MetLife Shelf Agreement for a three-year term ending May 2023.
(4) In February 2020, we requested and NYL accepted our request to purchase $40.0 million of our unsecured debt. The Shelf Notes were issued in August 2020 at the rate of 2.96 percent per annum. The Shelf Agreement expires in November 2021.
The Uncollateralized Senior Notes, Shelf Agreements or Shelf Notes set forth certain business covenants to which we are subject when any note is outstanding, including covenants that limit or restrict our ability, and the ability of our subsidiaries, to incur indebtedness, or place or permit liens and encumbrances on any of our property or the property of our subsidiaries.
16. Short-Term Borrowings
At September 30, 2020 and December 31, 2019, we had $216.4 million and $247.4 million, respectively, of short-term borrowings outstanding at weighted average interest rates of 1.28 percent and 2.62 percent, respectively. Our short-term borrowings balance at September 30, 2020 and December 31, 2019, included book overdrafts of $0.9 million and $3.2 million, respectively. Included in the September 30, 2020 balance, is $100.0 million in short-term debt for which we have entered into interest rate swap agreements.
In the second quarter of 2020, we entered into interest rate swaps with notional amounts totaling $100.0 million associated with three of our short-term lines of credit through October 2020. The interest rate swaps were entered to hedge the variability in cash flows attributable to changes in the short-term borrowing rates during this period. The fixed swap rates will range between 0.2615 and 0.3875 percent for the period. Our short-term borrowing is based on the 30-day LIBOR rate. The interest swap is cash settled monthly as the counter-party pays us the 30-day LIBOR rate less the fixed rate.
In September 2020, we entered into a new $375.0 million syndicated Revolver with six participating lenders. The Revolver expires on September 29, 2021 and has a commitment fee of 0.175 percent and an interest rate of 1.125 percent over LIBOR. As a result of entering into the Revolver, in September 2020, we terminated and paid outstanding balances for all of our previously existing bilateral lines of credit and the previous revolving credit facility. Our available credit under the new Revolver at September 30, 2020 was $154.7 million.
The availability of funds under the Revolver is subject to conditions specified in the credit agreement, all of which we currently satisfy. These conditions include our compliance with financial covenants and the continued accuracy of representations and warranties contained in the agreement. We are required by the financial covenants our Revolver to maintain, at the end of each fiscal year, a funded indebtedness ratio of no greater than 65 percent. As of September 30, 2020, we are in compliance with all of our debt covenants.
17. Leases
We have entered into lease arrangements for office space, land, equipment, pipeline facilities and warehouses. These lease arrangements enable us to better conduct business operations in the regions in which we operate. Office space is leased to provide adequate workspace for all our employees in several locations throughout the Mid-Atlantic, Mid-West and in Florida. We lease land at various locations throughout our service territories to enable us to inject natural gas into underground storage and distribution systems, for bulk storage capacity, for our propane operations and for storage of equipment used in repairs and maintenance of our infrastructure. We lease natural gas compressors to ensure timely and reliable transportation of natural gas to our customers. Additionally, we lease a pipeline to deliver natural gas to an industrial customer in Polk County, Florida. We also lease warehouses to store equipment and materials used in repairs and maintenance for our businesses.
Some of our leases are subject to annual changes in the Consumer Price Index (“CPI”). While lease liabilities are not re-measured as a result of changes to the CPI, changes to the CPI are treated as variable lease payments and recognized in the period in which the obligation for those payments was incurred. A 100-basis-point increase in CPI would have resulted in immaterial additional annual lease costs. Most of our leases include options to renew, with renewal terms that can extend the lease term from one to 25 years or more. The exercise of lease renewal options is at our sole discretion. The amounts disclosed in our condensed consolidated balance sheet at September 30, 2020 pertaining to the right-of-use assets and lease liabilities, are measured based on our current expectations of exercising our available renewal options. Our existing leases are not subject to any restrictions or covenants which would preclude our ability
to pay dividends, obtain financing or enter into additional leases. As of September 30, 2020, we have not entered into any leases, which have not yet commenced, that would entitle us to significant rights or create additional obligations. The following table presents information related to our total lease cost included in our condensed consolidated statements of income:
Three Months Ended
Nine Months Ended
September 30,
September 30,
( in thousands)
Classification
2020
2019
2020
2019
Operating lease cost (1)
Operations expense
$
627
$
638
$
1,882
$
1,926
Finance lease cost:
Amortization of lease assets
Depreciation and amortization
—
—
—
650
Interest on lease liabilities
Interest expense
—
—
—
5
Net lease cost
$
627
$
638
$
1,882
$
2,581
(1) Includes short-term leases and variable lease costs, which are immaterial.
The following table presents the balance and classifications of our right of use assets and lease liabilities included in our condensed consolidated balance sheet at September 30, 2020 and December 31, 2019:
(in thousands)
Balance sheet classification
September 30, 2020
December 31, 2019
Assets
Operating lease assets
Operating lease right-of-use assets
$
11,077
$
11,563
Total lease assets
$
11,077
$
11,563
Liabilities
Current
Operating lease liabilities
Other accrued liabilities
$
1,733
$
1,705
Noncurrent
Operating lease liabilities
Operating lease - liabilities
9,681
9,896
Total lease liabilities
$
11,414
$
11,601
The following table presents our weighted-average remaining lease terms and weighted-average discount rates for our operating and financing leases at September 30, 2020 and December 31, 2019:
September 30, 2020
December 31, 2019
Weighted-average remaining lease term (in years)
Operating leases
8.5
8.88
Weighted-average discount rate
Operating leases
3.8
%
3.8
%
The following table presents additional information related to cash paid for amounts included in the measurement of lease liabilities included in our condensed consolidated statements of cash flows as of September 30, 2020 and 2019:
The following table presents the future undiscounted maturities of our operating and financing leases at September 30, 2020 and for each of the next five years and thereafter:
(in thousands)
Operating
Leases (1)
Remainder of 2020
$
602
2021
1,984
2022
1,939
2023
1,874
2024
1,619
2025
1,383
Thereafter
3,876
Total lease payments
$
13,277
Less: Interest
1,863
Present value of lease liabilities
$
11,414
(1) Operating lease payments include $3.9 million related to options to extend lease terms that are reasonably certain of being exercised.
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Management’s Discussion and Analysis of Financial Condition and Results of Operations is designed to provide a reader of the financial statements with a narrative report on our financial condition, results of operations and liquidity. This discussion and analysis should be read in conjunction with the attached unaudited condensed consolidated financial statements and notes thereto and our Annual Report on Form 10-K for the year ended December 31, 2019, including the audited consolidated financial statements and notes thereto.
We make statements in this Quarterly Report on Form 10-Q that do not directly or exclusively relate to historical facts. Such statements are “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. One can typically identify forward-looking statements by the use of forward-looking words, such as “project,” “believe,” “expect,” “anticipate,” “intend,” “plan,” “estimate,” “continue,” “potential,” “forecast” or other similar words, or future or conditional verbs such as “may,” “will,” “should,” “would” or “could.” These statements represent our intentions, plans, expectations, assumptions and beliefs about future financial performance, business strategy, projected plans and objectives of the Company. Forward-looking statements speak only as of the date they are made or as of the date indicated and we do not undertake any obligation to update forward-looking statements as a result of new information, future events or otherwise. These statements are subject to many risks, uncertainties and other important factors that could cause actual future results to differ materially from those expressed in the forward-looking statements. In addition to the risk factors described under Item 1A, Risk Factors in our 2019 Annual Report on Form 10-K, and Item 1A, Risk Factors, in the Quarterly Report on Form 10-Q for the quarter ended March 31, 2020, such factors include, but are not limited to:
•state and federal legislative and regulatory initiatives that affect cost and investment recovery, have an impact on rate structures, and affect the speed and the degree to which competition enters the electric and natural gas industries;
•the outcomes of regulatory, environmental and legal matters, including whether pending matters are resolved within current estimates and whether the related costs are adequately covered by insurance or recoverable in rates;
•the impact of climate change, including the impact of greenhouse gas emissions or other legislation or regulations intended to address climate change;
•the impact of significant changes to current tax regulations and rates;
•the timing of certification authorizations associated with new capital projects and the ability to construct facilities at or below estimated costs;
•changes in environmental and other laws and regulations to which we are subject and environmental conditions of property that we now, or may in the future, own or operate;
•possible increased federal, state and local regulation of the safety of our operations;
•the inherent hazards and risks involved in transporting and distributing natural gas and electricity;
•the economy in our service territories or markets, the nation, and worldwide, including the impact of economic conditions (which we do not control ) on demand for electricity, natural gas, propane or other fuels;
•risks related to cyber-attacks or cyber-terrorism that could disrupt our business operations or result in failure of information technology systems or result in the loss or exposure of confidential or sensitive customer, employee or Company information;
•adverse weather conditions, including the effects of hurricanes, ice storms and other damaging weather events;
•customers' preferred energy sources;
•industrial, commercial and residential growth or contraction in our markets or service territories;
•the effect of competition on our businesses from other energy suppliers and alternative forms of energy;
•the timing and extent of changes in commodity prices and interest rates;
•the effect of spot, forward and future market prices on our various energy businesses;
•the extent of our success in connecting natural gas and electric supplies to transmission systems, establishing and maintaining key supply sources; and expanding natural gas and electric markets;
•the creditworthiness of counterparties with which we are engaged in transactions;
•the capital-intensive nature of our regulated energy businesses;
•our ability to access the credit and capital markets to execute our business strategy, including our ability to obtain financing on favorable terms, which can be affected by various factors, including credit ratings and general economic conditions;
•the ability to successfully execute, manage and integrate a merger, acquisition or divestiture of assets or businesses and the related regulatory or other conditions associated with the merger, acquisition or divestiture;
•the impact on our costs and funding obligations, under our pension and other post-retirement benefit plans, of potential downturns in the financial markets, lower discount rates, and costs associated with health care legislation and regulation;
•the ability to continue to hire, train and retain appropriately qualified personnel;
•the effect of accounting pronouncements issued periodically by accounting standard-setting bodies; and
•risks related to the outbreak of a pandemic, including the duration and scope of the pandemic and the corresponding impact on our supply chains, our personnel, our contract counterparties, general economic conditions and growth, and the financial markets.
We are an energy delivery company engaged in the distribution of natural gas, propane and electricity; the transmission of natural gas; the generation of electricity and steam, and in providing related services to our customers.
Our 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. We are focused on identifying and developing opportunities across the energy value chain, with emphasis on midstream and downstream investments that are accretive to earnings per share and consistent with our long-term growth strategy.
Our strategy is to consistently produce industry-leading total shareholder return by profitably investing capital into opportunities that leverage our skills and expertise in energy distribution and transmission to achieve high levels of service and growth. The key elements of our strategy include:
•capital investment in growth opportunities that generate our target returns;
•expanding our energy delivery businesses within our existing service areas as well as into new geographic areas;
•providing new services in our current service areas;
•expanding our footprint in potential growth markets through strategic acquisitions that complement our businesses;
•entering new energy markets and businesses that complement our existing operations and growth strategy; and
•operating as a customer-centric full-service energy supplier/partner/provider, while providing safe and reliable service.
Our employees strive to build meaningful connections that generate opportunities to grow our businesses, develop new markets, and enrich the communities in which we live, work and serve.
Due to the seasonality of our business, results for interim periods are not necessarily indicative of results for the entire fiscal year. Revenue and earnings are typically greater during the first and fourth quarters, when consumption of energy is normally highest due to colder temperatures.
The following discussions and those later in the document on operating income and segment results include the use of the term “gross margin," which is determined by deducting the cost of sales from operating revenue. Cost of sales includes the purchased cost of natural gas, electricity and propane and the cost of labor spent on direct revenue-producing activities, and excludes depreciation, amortization and accretion. Gross margin should not be considered an alternative to operating income or net income, which are determined in accordance with GAAP. We believe 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 us under our allowed rates for regulated energy operations and under our competitive pricing structures for unregulated energy operations. Our management uses gross margin in measuring our business units’ performance and has historically analyzed and reported gross margin information publicly. Other companies may calculate gross margin in a different manner.
Earnings per share information is presented for continuing operations on a diluted basis, unless otherwise noted.
Results of Operations for the Three and Nine Ended September 30, 2020
Overview
Chesapeake Utilities is a Delaware corporation formed in 1947. We are a diversified energy company engaged, through our operating divisions and subsidiaries, in regulated energy, unregulated energy and other businesses. We operate primarily on the Delmarva Peninsula and in Florida, Pennsylvania and Ohio and provide natural gas distribution and transmission; electric distribution and generation; propane gas distribution; mobile compressed natural gas services; steam generation; and other energy-related services.
In the fourth quarter of 2019, we completed the sale of the assets and contracts of PESCO. As a result, PESCO’s results for all periods presented have been separately reported as discontinued operations.
In March 2020, the CDC declared a national emergency due to the rapidly growing outbreak of COVID-19. In response to this declaration and the rapid spread of COVID-19 within the United States, federal, state and local governments throughout the country imposed varying degrees of restrictions on social and commercial activity to promote social distancing in an effort to slow the spread of the illness. These restrictions have continued to significantly impact economic conditions in the United States. Chesapeake Utilities is considered an “essential business,” which allows us to continue its operational activities and construction projects while the social distancing restrictions remain in place. In response to the COVID-19 pandemic and related restrictions, we implemented our pandemic response plan, which includes having all employees who can work remotely do so in order to promote social distancing and providing personal protective equipment to field employees to reduce the spread of COVID-19. For the three and nine months ended September 30, 2020, the estimated impacts that COVID-19 had on our earnings were approximately $0.7 million and $1.9 million, respectively, primarily driven by reduced consumption of energy largely in the commercial and industrial sectors, higher bad debt expenses and incremental expenses associated with COVID-19, including protective personal equipment and premium pay for field personnel. The additional operating expenses we incurred support the ongoing delivery of our essential services during these unprecedented times. As the COVID-19 pandemic is still ongoing, we are continuing to assess recoverability and to date, have not established regulatory assets associated with the incremental expense impacts, as currently authorized by the Delaware, Maryland and Florida PSCs. We are committed to communicating timely updates and will continue to monitor developments affecting our employees, customers, suppliers, stockholders and take additional precautions as warranted to operate safely and to comply with the CDC, Occupational Safety and Health Administration, state and local requirements in order to protect its employees, customers and the communities. Refer to Note 5, Rates and Other Regulatory Activities, for further information on the potential deferral of incremental expenses associated with COVID-19.
Operational Highlights
Our net income for the three months ended September 30, 2020 was $9.3 million, or $0.56 per share, compared to $5.6 million, or $0.34 per share, for the same quarter of 2019. Our income from continuing operations for the three months ended September 30, 2020 was $9.3 million, or $0.56 per share, compared to $6.3 million, or $0.38 per share for the same quarter of 2019. Operating income for the three months ended September 30, 2020 increased by $3.0 million, or 21.2 percent, compared to the same period in 2019. The increase in operating income was largely driven by the settlement of the Hurricane Michael regulatory proceeding which improved operating income by $2.9 million, including $1.9 million in operating income that was previously billed under interim rates during the first half of 2020. Operating income for the quarter was reduced by an estimated $1.9 million due to unfavorable impacts of COVID-19. For additional details on the Hurricane Michael regulatory proceeding, see the Major Projects and Initiatives discussion below.
Further contributing to the improved performance for the quarter was margin growth from our organic growth projects, increased margins from investments in Florida GRIP and increased demand for Marlin Gas Services' CNG transportation services. These increases were partially offset by higher operating expenses related to growth initiatives.
Key variances in continuing operations, between the third quarter of 2020 and the third quarter of 2019, included:
(in thousands, except per share data)
Pre-tax Income
Net Income
Earnings Per Share
Third Quarter of 2019 Reported Results from Continuing Operations
$
8,603
$
6,251
$
0.38
Adjusting for Unusual Items:
Hurricane Michael (net impact of the first and second quarter of 2020)(1)
2,705
1,964
0.12
Unfavorable COVID-19 impacts
(1,023)
(742)
(0.04)
Decreased customer consumption - primarily weather related
(1,005)
(729)
(0.05)
677
493
0.03
Increased (Decreased) Gross Margins:
Margin contribution from the Hurricane Michael regulatory proceeding settlement*
2,754
1,999
0.12
Eastern Shore and Peninsula Pipeline service expansions*
2,677
1,943
0.12
Natural gas growth (excluding service expansions)
797
578
0.03
Florida GRIP*
685
498
0.03
Margin contributions from Boulden and Elkton Gas acquisitions (completed July 2020 and December 2019, respectively)*
684
496
0.03
Increased demand for CNG services for Marlin Gas Services*
599
435
0.03
8,196
5,949
0.36
(Increased) Decreased Operating Expenses (Excluding Cost of Sales):
Depreciation and amortization associated with Hurricane Michael regulatory proceeding settlement
(1,781)
(1,293)
(0.08)
Depreciation, amortization and property tax costs due to new capital investments
(1,312)
(952)
(0.06)
Operating expenses from Elkton Gas and Boulden acquisitions (completed July 2020 and December 2019, respectively)
(867)
(630)
(0.04)
Facilities, maintenance and outside services costs
(414)
(301)
(0.02)
Insurance expense (non-health) - both insured and self-insured
(323)
(234)
(0.01)
(4,697)
(3,410)
(0.21)
Interest charges
(841)
(611)
(0.04)
Lower pension expense
388
282
0.02
Net other changes
456
326
0.02
3
(3)
—
Third Quarter of 2020 Reported Results from Continuing Operations
$
12,782
$
9,280
$
0.56
*See the Major Projects and Initiatives table.
(1) Includes amortization of regulatory liability associated with interest expense of $0.8 million related to the Hurricane Michael regulatory proceeding settlement.
Our net income for the nine months ended September 30, 2020 was $49.1 million, or $2.97 per share, compared to $42.6 million, or $2.59 per share for the same period of 2019. Our net income from continuing operations for the nine months ended September 30, 2020 was $49.0 million, or $2.96 per share compared to $44.0 million, or $2.67 per share, for the same period of 2019. Operating income for the nine months ended September 30, 2020 increased by $0.9 million compared to the same period in 2019. Operating income for the period was reduced by an estimated $6.7 million due to unfavorable impacts of COVID-19, inclusive of an increase in bad debt expense of $1.9 million compared to the same period in 2019. Excluding this impact, operating income for the quarter increased by $7.6 million which included operating income of $2.9 million from the settlement of the Hurricane Michael regulatory proceeding, higher operating income from organic growth projects, gross margin contributions from the Boulden and Elkton Gas asset acquisitions completed in December 2019 and July 2020,
respectively, and higher retail propane margins per gallon, partially offset by decreased margin from customer consumption associated with milder weather during 2020.
Nine Months Ended
September 30,
Increase
2020
2019
(decrease)
(in thousands except per share)
Gross Margin
Regulated Energy segment
$
191,745
$
177,149
$
14,596
Unregulated Energy segment
61,883
59,340
2,543
Other businesses and eliminations
(210)
(286)
76
Total Gross Margin
$
253,418
$
236,203
$
17,215
Operating Income
Regulated Energy segment
$
66,376
$
65,310
$
1,066
Unregulated Energy segment
11,050
11,317
(267)
Other businesses and eliminations
92
18
74
Total Operating Income
77,518
76,645
873
Other income (expense), net
2,997
(731)
3,728
Interest charges
15,452
16,583
(1,131)
Income from Continuing Operations Before Income Taxes
Key variances in continuing operations, between the nine months ended 2020 and the nine months ended 2019, included:
(in thousands, except per share data)
Pre-tax Income
Net Income
Earnings Per Share
Nine Months Ended September 30, 2019 Reported Results from Continuing Operations:
$
59,331
$
43,977
$
2.67
Adjusting for Unusual Items:
Unfavorable COVID-19 impacts
(4,933)
(3,587)
(0.22)
Decreased customer consumption - primarily weather related
(3,090)
(2,247)
(0.14)
Absence of Florida tax savings (net of GRIP refunds) recorded in first quarter of 2019 for 2018
(910)
(667)
(0.04)
Gains from sales of assets
3,162
2,317
0.14
Favorable income tax impact associated with net operating loss carryback
—
1,669
0.10
(5,771)
(2,515)
(0.16)
Increased (Decreased) Gross Margins:
Margin contribution from the Hurricane Michael regulatory proceeding settlement*
8,261
6,007
0.36
Eastern Shore and Peninsula Pipeline service expansions*
5,485
3,988
0.24
Margin contribution from Elkton Gas and Boulden acquisitions (completed July 2020 and December 2019, respectively)*
3,120
2,269
0.14
Natural gas growth (excluding service expansions)
2,497
1,816
0.11
Increased retail propane margins per gallon
1,892
1,375
0.08
Eastern Shore margin from capital improvements and non-service expansion projects
793
576
0.04
Increased demand for CNG services for Marlin Gas Services*
694
505
0.03
Florida GRIP*
678
493
0.03
Aspire Energy rate increases
443
322
0.02
23,863
17,351
1.05
(Increased) Decreased Operating Expenses (Excluding Cost of Sales):
Depreciation and amortization associated with Hurricane Michael regulatory proceeding settlement
(5,355)
(3,894)
(0.24)
Depreciation, amortization and property tax costs due to new capital investments
(3,732)
(2,714)
(0.16)
Insurance expense (non-health) - both insured and self-insured
(1,900)
(1,382)
(0.08)
Operating expenses from Elkton Gas and Boulden acquisitions (completed July 2020 and December 2019, respectively)
(1,900)
(1,382)
(0.08)
Facilities maintenance and outside services costs
(1,294)
(941)
(0.06)
(14,181)
(10,313)
(0.62)
Other income tax effects
—
(914)
(0.06)
Interest charges (1)
(852)
(620)
(0.04)
Lower pension expense
1,131
822
0.05
Net other changes
1,542
1,193
0.07
1,821
481
0.02
Nine Months Ended September 30, 2020 Reported Results from Continuing Operations
$
65,063
$
48,981
$
2.96
*See the Major Projects and Initiatives table.
(1) Interest charges includes amortization of a regulatory liability of $1.1 million related to the Hurricane Michael regulatory proceeding settlement.
Recently Completed and Ongoing Major Projects and Initiatives
We constantly pursue and develop additional projects and initiatives to serve existing and new customers, and to further grow our businesses and earnings, with the intention to increase shareholder value. The following represent the major projects/initiatives recently completed and currently underway. Major projects and initiatives that have generated consistent year-over-year margin contributions are removed from the table. In the future, we will add new projects and initiatives to this table once negotiations are substantially final and the associated earnings can be estimated.
Gross Margin for the Period
Three Months Ended
Nine Months Ended
Year Ended
Estimate for
September 30,
September 30,
December 31,
Fiscal
in thousands
2020
2019
2020
2019
2019
2020
2021
Pipeline Expansions:
Regulated Energy
West Palm Beach County, Florida Expansion(1)
$
1,020
$
745
$
2,988
$
1,068
$
2,139
$
4,076
$
4,984
Del-Mar Energy Pathway(1)
925
189
1,565
542
731
2,398
4,100
Auburndale
170
113
509
113
283
679
679
Callahan Intrastate Pipeline (including related natural gas distribution services)
1,609
—
2,146
—
—
4,039
6,437
Guernsey Power Station
—
—
—
—
—
—
514
Total Pipeline Expansions
3,724
1,047
7,208
1,723
3,153
11,192
16,714
Virtual Pipeline Growth:
Compressed Natural Gas Transportation
1,592
993
5,047
4,353
5,410
7,000
8,000
Renewable Natural Gas Transportation
—
—
—
—
—
—
1,000
Total Virtual Pipeline Growth
1,592
993
5,047
4,353
5,410
7,000
9,000
Acquisitions:
Boulden Propane
327
—
2,763
—
329
4,000
4,200
Elkton Gas
357
—
357
—
—
1,365
3,992
Western Natural Gas Company
—
—
—
—
—
250
1,800
Total Acquisitions
684
—
3,120
—
329
5,615
9,992
Regulatory Initiatives:
Florida GRIP
3,831
3,146
11,135
10,457
13,939
14,976
16,739
Hurricane Michael regulatory proceeding(2)
8,261
—
8,261
—
—
11,014
11,014
Total Regulatory Initiatives
12,092
3,146
19,396
10,457
13,939
25,990
27,753
Total
$
18,092
$
5,186
$
34,771
$
16,533
$
22,831
$
49,797
$
63,459
(1) Includes margin generated from interim services.
(2)This amount includes $5.5 million of gross margin previously invoiced under interim rates that was not recognized in revenue during the first and second quarters of 2020.
Detailed Discussion of Major Projects and Initiatives
Pipeline Expansions - Regulated Energy
West Palm Beach County, Florida Expansion
Peninsula Pipeline is constructing four transmission lines to bring additional natural gas to our distribution system in West Palm Beach, Florida. The first phase of this project was placed into service in December 2018 and generated $0.3 million and $1.9 million in additional gross margin for the three and nine months ended September 30, 2020 compared to 2019,
respectively. We expect to complete the remainder of the project in phases through the second quarter of 2021, and estimate that the project will generate gross margin of $4.1 million in 2020 and $5.0 million annually thereafter.
Del-Mar Energy Pathway
In December 2019, the FERC issued an order approving the construction of the Del-Mar Energy Pathway project. Eastern Shore anticipates that this project will be fully in-service by the beginning of the fourth quarter of 2021. The new facilities will: (i) ensure an additional 14,300 Dts/d of firm service to four customers, (ii) provide additional natural gas transmission pipeline infrastructure in eastern Sussex County, Delaware, and (iii) represent the first extension of Eastern Shore’s pipeline system into Somerset County, Maryland. Construction of the project began in January 2020, and interim services in advance of this project generated $0.9 million and $1.6 million for the three and nine months ended September 30, 2020, respectively. The estimated gross margin from this project is approximately $2.4 million in 2020, $4.1 million in 2021 and $5.1 million annually thereafter.
Auburndale
In August 2019, the Florida PSC approved Peninsula Pipeline's Transportation Service Agreement with the Florida Division of Chesapeake Utilities. Peninsula Pipeline purchased an existing pipeline owned by the Florida Division of Chesapeake Utilities and Calpine, and has completed the construction of pipeline facilities in Polk County, Florida. Peninsula Pipeline provides transportation service to the Florida Division of Chesapeake Utilities increasing both delivery capacity and downstream pressure as well as introducing a secondary source of natural gas for the Florida Division of Chesapeake Utilities' distribution system. Peninsula Pipeline generated additional gross margin from this project of $0.2 million and $0.5 million for the three and nine months ended September 30, 2020, respectively, and expects to generate annual gross margin of $0.7 million in 2020 and beyond.
Callahan Intrastate Pipeline
In May 2018, Peninsula Pipeline announced a plan to construct a jointly owned intrastate transmission pipeline with Seacoast GasTransmission in Nassau County, Florida. The 26-mile pipeline will serve growing demand in both Nassau and Duval Counties. This project was placed in service in June 2020, one month earlier than initially forecasted, and generated $1.6 million and $2.1 million in additional gross for the three and nine months ended September 30, 2020, respectively. Peninsula Pipeline expects to generate gross margin of $4.0 million in 2020 and $6.4 million annually thereafter.
Pipeline Expansions - Unregulated Energy
Guernsey Power Station
Guernsey Power Station, LLC ("Guernsey Power Station") and our affiliate, Aspire Energy Express, entered into a precedent firm transportation capacity agreement whereby Guernsey Power Station will construct a power generation facility and Aspire Energy Express will provide firm natural gas transportation service to this facility. Guernsey Power Station commenced construction of the project in October 2019. Aspire Energy Express is expected to commence construction of the gas transmission facilities to provide the firm transportation service to the power generation facility in the fourth quarter of 2021. This project is expected to produce gross margin of approximately $0.5 million in 2021 and $1.5 million in 2022 and beyond.
Virtual Pipeline Growth
CNG Transportation
Marlin Gas Services provides CNG temporary hold services, contracted pipeline integrity services, emergency services for damaged pipelines and specialized gas services for customers who have unique requirements. For the three and nine months ended September 30, 2020, Marlin Gas Services generated additional gross margin of $0.6 million and $0.7 million, respectively. We estimate that Marlin Gas Services will generate annual gross margin of approximately $7.0 million in 2020 and $8.0 million in 2021, with potential for additional growth in future years. Marlin Gas Services continues to actively expand the territories it serves, as well as leverage its patented technology to serve other markets, including pursuing liquefied natural gas transportation opportunities and most recently, announcing its expansion into the transportation of renewable natural gas from diverse supply sources to various pipeline interconnection points, as further outlined below.
Renewable Natural Gas Transportation
Bioenergy Devco
In June 2020, our Delmarva natural gas operations and Bioenergy Devco (“BDC”), a developer of anaerobic digestion facilities that create renewable energy and healthy soil products from organic material, entered into an agreement related to a project to remove excess organics from poultry waste and convert it into renewable natural gas. BDC and our affiliates are
collaborating on this project in addition to several other project sites where organic waste can be converted into a carbon-negative energy source. This project provides us the opportunity to maintain the green attributes of renewable natural gas as the gas is distributed to natural gas distribution customers.
The resources generated from organic material at BDC's anaerobic digestion facilities in Delaware, will be processed by our Delmarva natural gas operations and Eastern Shore, and Marlin Gas Services will facilitate the transportation and receipt of renewable natural gas for multiple suppliers through its interconnect facility and equipment. Marlin Gas Services will transport the sustainable fuel to Eastern Shore, where it will be introduced to our distribution system and ultimately distributed to our natural gas customers.
CleanBay Project
In July 2020, our Delmarva natural gas operations and CleanBay Renewables Inc. ("CleanBay") announced a new partnership to bring renewable natural gas to our operations. As part of this partnership, we will transport the renewable natural gas produced at CleanBay's planned Westover, Maryland bio-refinery, to our natural gas infrastructure in the Delmarva Peninsula region. Eastern Shore and Marlin Gas Services, will transport the renewable natural gas from CleanBay to our Delmarva natural gas distribution system where it is ultimately delivered to the Delmarva natural gas distribution end use customers.
At the present time, we have disclosed that we expect to generate $1.0 million in 2021 in incremental margin from renewable natural gas transportation beginning in 2021. We continue to finalize contract terms associated with some of these projects. Additional information will be provided regarding incremental margin on these projects at a future time, as contracts are finalized.
Acquisitions
Boulden Propane
In December 2019, Sharp acquired certain propane customers and operating assets of Boulden, which provides propane distribution service to approximately 5,200 customers in Delaware, Maryland and Pennsylvania. The customers and assets acquired from Boulden have been assimilated into Sharp. The operations acquired from Boulden generated $0.3 million and $2.8 million of incremental gross margin for the three and nine months ended September 30, 2020, respectively. We estimate that this acquisition will generate annual gross margin of approximately $4.0 million in 2020, and $4.2 million in 2021, with the potential for additional growth in future years.
Elkton Gas
In July 2020, we closed on the acquisition of Elkton Gas, which provides natural gas distribution service to approximately 7,000 residential and commercial customers within a franchised area of Cecil County, Maryland. The purchase price is approximately $15.6 million, which included $0.6 million of working capital. Elkton Gas’ territory is contiguous to our franchised service territory in Cecil County, Maryland. We generated $0.4 million in additional gross margin from Elkton Gas and estimate that this acquisition will generate gross margin of approximately $1.4 million in 2020 and $4.0 million in 2021.
Western Natural Gas Company
In October 2020, Sharp acquired certain propane operating assets of Western Natural Gas Company, which provides propane distribution service throughout Jacksonville, Florida and the surrounding communities, for approximately $6.7 million, net of cash acquired. The acquisition will be accounted for as a business combination within our Unregulated Energy Segment beginning in the fourth quarter of 2020. We estimate that this acquisition will generate gross margin of approximately of $0.3 million in 2020 and $1.8 million in 2021.
Regulatory Initiatives
Florida GRIP
Florida GRIP is a natural gas pipe replacement program approved by the Florida PSC that allows automatic recovery, through rates, of costs associated with the replacement of mains and services. Since the program's inception in August 2012, we have invested $160.1 million of capital expenditures to replace 322 miles of qualifying distribution mains, including $16.1 million of new pipes during the first nine months of 2020. We expect to generate annual gross margin of approximately $15.0 million in 2020, and $16.7 million in 2021.
Hurricane Michael
In October 2018, Hurricane Michael passed through FPU's electric distribution operation's service territory in Northwest Florida and caused widespread and severe damage to FPU's infrastructure resulting in 100 percent of its customers in the Northwest Florida service territory losing electrical service.
In August 2019, FPU filed a limited proceeding requesting recovery of storm-related costs associated with Hurricane Michael (capital and expenses) through a change in base rates. FPU also requested treatment and recovery of certain storm-related costs as regulatory assets for items currently not allowed to be recovered through the storm reserve as well as the recovery of capital replaced as a result of the storm. Recovery of these costs included a component of an overall return on capital additions and regulatory assets. In March 2020, we filed an update to our original filing to account for actual charges incurred through December 2019, revised the amortization period of the storm-related costs from 30 years as originally requested to 10 years, and included costs related to Hurricane Dorian of approximately $1.2 million in this filing.
In September 2019, FPU filed a petition, with the Florida PSC, for approval of its consolidated electric depreciation rates. The petition was joined to the Hurricane Michael docket, and was approved at the Florida PSC Agenda on September 21, 2020. The approved rates were retroactively effective January 1, 2020.
In September 2020, the Florida PSC approved a settlement agreement between FPU and the Office of the Public Counsel regarding final cost recovery and rates associated with Hurricane Michael. Previously, the Florida PSC approved an interim rate increase, subject to refund, effective January 1, 2020, associated with the restoration effort following Hurricane Michael. We fully reserved these interim rates, pending a final resolution and settlement of the limited proceeding.The settlement agreement allowed us to: (a) record regulatory assets for storm costs in the amount of $45.8 million including interest which will be amortized over six years; (b) recover these storm costs through a surcharge for a total of $7.7 million annually; (c) collect an annual increase in revenue of $3.3 million to recover capital costs associated with new plant and regulatory asset for cost of removal and undepreciated plant. The new base rates and storm surcharge were effective on November 1, 2020. The following table summarizes the impact of Hurricane Michael regulatory proceeding for the three and nine months ended September 30, 2020:
Three Months Ended
Nine Months Ended
(in thousands)
September 30, 2020(1)
September 30, 2020
Gross Margin
$
2,754
$
8,261
Depreciation
(298)
(883)
Amortization of regulatory assets
2,079
6,238
Operating income
973
2,906
Amortization of liability associated with interest expense
(360)
(1,132)
Pre-tax income
1,333
4,038
Income tax expense
365
1,106
Net income
$
968
$
2,932
(1) The Hurricane Michael impact for three months ended September 30, 2020, is presented for comparison purposes.
Other major factors influencing gross margin
Weather and Consumption
Weather conditions accounted for a $1.0 million decrease in gross margin during the third quarter of 2020, compared to the same period in 2019, due to a 17 percent decrease in CDDs in Florida that resulted in reduced customer consumption for our electric operations. Compared to normal temperatures, as detailed below, gross margin was lower by $0.5 million. For the nine-month period, overall milder temperatures decreased gross margin by $3.1 million compared to the same period in 2019 and $3.2 million compared to normal temperatures. The following table summarizes HDD and CDD variances from the 10-year average HDD/CDD ("Normal") for the three and nine months ended September 30, 2020 and 2019.
The following table summarizes HDD and CDD variances from the 10-year average HDD/CDD ("Normal") for the three and nine months ended September 30, 2020 and 2019.
Three Months Ended
Nine Months Ended
September 30,
September 30,
2020
2019
Variance
2020
2019
Variance
Delmarva
Actual HDD
43
7
36
2,416
2,576
(160)
10-Year Average HDD ("Normal")
48
61
(13)
2,797
2,846
(49)
Variance from Normal
(5)
(54)
(381)
(270)
Florida
Actual HDD
—
—
—
343
379
(36)
10-Year Average HDD ("Normal")
—
—
—
508
532
(24)
Variance from Normal
—
—
(165)
(153)
Ohio
Actual HDD
86
2
84
3,383
3,533
(150)
10-Year Average HDD ("Normal")
79
90
(11)
3,691
3,742
(51)
Variance from Normal
7
(88)
(308)
(209)
Florida
Actual CDD
1,337
1,620
(283)
2,412
2,840
(428)
10-Year Average CDD ("Normal")
1,573
1,553
20
2,666
2,625
41
Variance from Normal
(236)
67
(254)
215
Natural Gas Distribution Margin Growth
Customer growth for our natural gas distribution operations, as a result of the addition of new customers and the conversion of customers from alternative fuel sources to natural gas service, generated $0.8 million and $2.5 million of the three and nine months ended September 30, 2020, respectively. The average number of residential customers served on the Delmarva Peninsula and in Florida increased by 4.9 percent and 3.9 percent, respectively, during the third quarter of 2020 and 4.0 percent and 3.8 percent, respectively, for the nine months ended September 30, 2020. On the Delmarva Peninsula, a larger percentage of the margin growth is generated from residential growth given the expansion of gas into new communities and conversions to natural gas as our distribution infrastructure continues to build out, while in Florida, as gas heating is not a significant portion of residential use, a greater portion of the margin growth occurred in the commercial and industrial sectors. The details for the three and nine months ended September 30, 2020 are provided in the following table:
For the quarter ended September 30, 2020, compared to the quarter ended September 30, 2019:
Three Months Ended
September 30,
Increase
2020
2019
(decrease)
(in thousands)
Revenue
$
82,762
$
74,580
$
8,182
Cost of sales
16,271
19,619
(3,348)
Gross margin
66,491
54,961
11,530
Operations & maintenance
26,364
24,374
1,990
Depreciation & amortization
15,314
8,684
6,630
Other taxes
4,331
4,363
(32)
Total operating expenses
46,009
37,421
8,588
Operating income
$
20,482
$
17,540
$
2,942
Operating income for the Regulated Energy segment increased by $2.9 million for the three months ended September 30, 2020 compared to 2019, or 16.8 percent. Higher operating income was a result of the settlement of the Hurricane Michael regulatory proceeding, which included recognizing the first and second quarter rate impacts associated with the settlement, expansion projects completed and underway by Eastern Shore and Peninsula Pipeline, organic growth in our natural gas distribution businesses, margin from increased investments in Florida GRIP and the gross margin generated from the acquisition of Elkton Gas. These increases were partially offset by higher depreciation, amortization and property taxes including amortization of the regulatory asset associated with the Hurricane Michael regulatory proceeding settlement and higher other operating expenses. Operating income for the quarter was reduced by an estimated $1.5 million due to unfavorable impacts of COVID-19, which included an increase in bad debt expense of $1.3 million compared to the third quarter 2019.
Items contributing to the quarter-over-quarter increase in gross margin are listed in the following table:
(in thousands)
Margin contribution from Hurricane Michael regulatory proceeding settlement (1)
$
8,261
Eastern Shore and Peninsula Pipeline service expansions
2,677
Natural gas growth (excluding service expansions)
797
Florida GRIP
685
Margin contribution from Elkton Gas (acquisition completed in July 2020)
357
Decreased customer consumption - weather related
(1,013)
Other variances
(234)
Quarter-over-quarter increase in gross margin
$
11,530
(1)This amount includes $5.5 million of gross margin previously invoiced under interim rates that was not recognized in revenue during the first and second quarter of 2020.
The following is a narrative discussion of the significant items in the foregoing table, which we believe is necessary to understand the information disclosed in the table.
Margin Contribution from Hurricane Michael Regulatory Proceeding Settlement
We generated $8.3 million in additional gross margin in the third quarter of 2020 as a result of the settlement of the Hurricane Michael regulatory proceeding which included $5.5 million of gross margin previously invoiced under interim rates that were not recognized in revenue during the first and second quarters.Refer to Note 5, Rates and Other Regulatory Activities,in the condensed consolidated financial statements for additional information.
Eastern Shore and Peninsula Pipeline Service Expansions
We generated additional gross margin of $1.9 million from Peninsula Pipeline's Western Palm Beach County, Auburndale and Callahan projects and $0.7 million from Eastern Shore's Del-Mar Energy Pathway project.
Natural Gas Distribution Customer Growth
We generated additional gross margin of $0.8 million from natural gas customer growth. Gross margin increased by $0.4 million in Florida and $0.4 million on the Delmarva Peninsula for the three months ended September 30, 2020, as compared to the same period in 2019, due primarily to residential customer growth of 4.9 percent and 3.9 percent on the Delmarva Peninsula
and in Florida, respectively. On the Delmarva Peninsula, a larger percentage of the margin growth was generated from residential growth given the expansion of gas into new communities and conversions, while in Florida, as gas heating is not a significant portion of residential use, a greater portion of the margin growth occurred in the commercial and industrial sectors.
Florida GRIP
Continued investment in the Florida GRIP generated additional gross margin of $0.7 million in 2020 compared to 2019.
Elkton Gas
Gross margin increased by $0.4 million due to the margin generated by Elkton Gas which was acquired in July 2020.
Decreased Customer Consumption - Weather Related
Gross margin decreased by $1.0 million for the for the three months ended September 30, 2020, compared to the same period in 2019, primarily due to a 17 percent decrease in CDDs in Florida that resulted in reduced customer consumption for our electric operations.
Other Operating Expenses
Items contributing to the quarter-over-quarter increase in other operating expenses are listed in the following table:
(in thousands)
Hurricane Michael regulatory proceeding settlement - depreciation and amortization impact(1)
$
5,355
Unfavorable COVID-19 impacts (primarily bad debt expense)
1,334
Depreciation, asset removal and property tax costs due to new capital investments
1,187
Payroll, Benefits and other employee-related expenses
447
Operating expenses from Elkton Gas acquisition (completed July 2020)
276
Other variances
(11)
Quarter-over-quarter increase in other operating expenses
$
8,588
(1)This amount includes $3.6 million of depreciation and amortization for the first and second quarter of 2020.
For the nine months ended September 30, 2020, compared to the nine months ended September 30, 2019:
Nine Months Ended
September 30,
Increase
2020
2019
(decrease)
(in thousands)
Revenue
$
259,235
$
251,601
$
7,634
Cost of sales
67,490
74,452
(6,962)
Gross margin
191,745
177,149
14,596
Operations & maintenance
78,062
73,071
4,991
Depreciation & amortization
33,979
26,099
7,880
Other taxes
13,328
12,669
659
Total operating expenses
125,369
111,839
13,530
Operating income
$
66,376
$
65,310
$
1,066
Operating income for the Regulated Energy segment for the nine months ended September 30, 2020 was $66.4 million, an increase of $1.1 million, compared to the same period in 2019. Excluding the estimated unfavorable COVID-19 impacts of $4.8 million, which included an increase in bad debt expense of $1.9 million, operating income increased $5.9 million as a result of the Hurricane Michael regulatory proceeding settlement, higher gross margin from expansion projects completed by Eastern Shore and Peninsula Pipeline and organic growth in our natural gas distribution businesses. These increases were offset by higher depreciation, amortization and property taxes, including amortization of the regulatory asset associated with the Hurricane Michael regulatory proceeding settlement and higher other operating expenses.
Gross Margin
Items contributing to the period-over-period increase in gross margin are listed in the following table:
Margin Contribution from Hurricane Michael regulatory proceeding settlement
$
8,261
Eastern Shore and Peninsula Pipeline service expansions
5,485
Natural gas distribution - customer growth (excluding service expansions)
2,497
Eastern Shore margin from capital improvements and non-service expansion projects
793
Florida GRIP
678
Margin contribution from Elkton Gas acquisition (completed July 2020)
357
Unfavorable COVID-19 impacts on gross margin
(2,634)
Absence of Florida tax savings (net of GRIP refunds) recorded in the first quarter of 2019 for 2018
(910)
Decreased customer consumption - weather related
(863)
Other variances
932
Period-over-period increase in gross margin
$
14,596
The following is a narrative discussion of the significant items in the foregoing table, which we believe is necessary to understand the information disclosed in the table.
Margin Contribution from Hurricane Michael Regulatory Proceeding Settlement
We generated $8.3 million in additional gross margin related as a result of the settlement of the Hurricane Michael regulatory proceeding. Refer to Note 5, Rates and Other Regulatory Activities,in the condensed consolidated financial statements for additional information.
Eastern Shore and Peninsula Pipeline Service Expansions
We generated additional gross margin of $4.5 million from Peninsula Pipeline's Western Palm Beach County, Auburndale and Callahan projects and $1.0 million from Eastern Shore's Del-Mar Energy Pathway project.
Natural Gas Distribution Customer Growth
We generated additional gross margin of $2.5 million from natural gas customer growth. Gross margin increased by $1.1 million in Florida and $1.4 million on the Delmarva Peninsula for the nine months ended September 30, 2020, as compared to the same period in 2019, due primarily to residential customer growth of 4.0 percent on the Delmarva Peninsula and 3.8 percent in Florida. On the Delmarva Peninsula, a larger percentage of the margin growth was generated from residential growth given the expansion of gas into new communities and conversions, while in Florida, as gas heating is not a significant portion of residential use, a greater portion of the margin growth occurred in the commercial and industrial sectors.
Eastern Shore margin from capital improvements and non-service expansion projects
We generated additional gross margin of $0.8 million from Eastern Shore's surcharge on capital spent on several relocation projects and non-service expansion projects.
Florida GRIP
Continued investment in the Florida GRIP generated additional gross margin of $0.7 million in 2020 compared to 2019.
Elkton Gas
Gross margin increased by $0.4 million due to the margin generated by Elkton Gas which we acquired in July 2020.
Unfavorable COVID-19 Impacts
Gross margin decreased by $2.6 million for the nine months ended September 30, 2020, as compared to the same period in 2019, as a result of the lower customer consumption, which was caused by the slowing of economic activities in our service territories as a result of restrictions imposed to promote social distancing and slow down the spread of COVID-19.
Absence of Florida Tax Savings Recorded in the First Quarter of 2019
Gross margin decreased by $0.9 million for the nine months ended September 30, 2020, as compared to the same period in 2019, due primarily to the absence of TCJA related tax savings from 2018 that the Florida PSC allowed us to retain during the first quarter of 2019. In February 2019, the Florida PSC issued a final order regarding the treatment of the TCJA impact, allowing us to retain the savings associated with lower federal tax rates for certain of our natural gas distribution operations. As a result, refunds to GRIP customers and reserves for customer refunds, recorded in 2018 were reversed in the first quarter of 2019.
Gross margin decreased by $0.9 million due to weather and other consumption on the Delmarva Peninsula and in Florida during the first nine months of 2020 compared to the same period in 2019.
Other Operating Expenses
Items contributing to the period-over-period increase in other operating expenses are listed in the following table:
(in thousands)
Hurricane Michael settlement agreement - depreciation and amortization impact
$
5,355
Depreciation, asset removal and property tax costs due to new capital investments
3,095
Unfavorable COVID-19 impacts (largely higher bad debt expense)
2,194
Insurance expense (non-health) - both insured and self-insured
1,377
Payroll, benefits and other employee-related expenses
1,029
Facilities maintenance and outside services costs
777
Operating expenses from Elkton acquisition (completed July 2020)
276
Other variances
(573)
Period-over-period increase in other operating expenses
$
13,530
.
Unregulated Energy Segment
For the quarter ended September 30, 2020, compared to the quarter ended September 30, 2019:
Three Months Ended
September 30,
Increase
2020
2019
(decrease)
(in thousands)
Revenue
$
22,714
$
22,280
$
434
Cost of sales
9,646
9,862
(216)
Gross margin
13,068
12,418
650
Operations & maintenance
12,412
12,262
150
Depreciation & amortization
2,968
2,519
449
Other taxes
780
806
(26)
Total operating expenses
16,160
15,587
573
Operating loss
$
(3,092)
$
(3,169)
$
77
Operating results for the Unregulated Energy segment increased by $0.1 million for the third quarter, as compared to the third quarter of 2019. Excluding the estimated COVID-19 impacts of $0.3 million, operating income increased $0.4 million driven by margin growth from Marlin Gas Services and incremental margin from the Boulden assets. These increases were partially offset by higher depreciation, amortization and property taxes and higher other operating expenses.
Items contributing to the quarter-over-quarter increase in gross margin are listed in the following table:
(in thousands)
Margin Impact
Marlin Gas Services - increased gross margin from demand for CNG transportation services
$
599
Boulden acquisition (assets acquired in December 2019)
327
Unfavorable COVID-19 impacts on gross margin
(399)
Other variances
123
Quarter-over-quarter increase in gross margin
$
650
The following is a narrative discussion of the significant items in the foregoing table, which we believe is necessary to understand the information disclosed in the table.
Marlin Gas Services
•Gross margin increased by $0.6 million in the third quarter of 2020, as compared to the same period in the prior year due to higher demand for compressed natural gas hold services.
Boulden acquisition
•Gross margin increased by $0.3 million due to the margin generated from Boulden, which was acquired by Sharp in December 2019.
Unfavorable COVID-19 Impacts
•Gross margin decreased by $0.4 million as a result of the lower customer consumption, which was caused by the slowing of economic activities in our service territories as a result of restrictions imposed to promote social distancing and slow down the spread of COVID-19.
Other Operating Expenses
Items contributing to the quarter-over-quarter increase in other operating expenses are listed in the following table:
(in thousands)
Depreciation, amortization and property tax costs due to new capital investments
$
425
Operating expenses from Boulden acquisition (completed December 2019)
290
Payroll, Benefits and other employee-related expenses
(202)
Other variances
60
Quarter-over-quarter increase in other operating expenses
$
573
For the nine months ended September 30, 2020, compared to the nine months ended September 30, 2019:
Nine Months Ended
September 30,
Increase
2020
2019
(decrease)
(in thousands)
Revenue
$
104,466
$
108,985
$
(4,519)
Cost of sales
42,583
49,645
(7,062)
Gross margin
61,883
59,340
2,543
Operations & maintenance
39,408
37,965
1,443
Depreciation & amortization
8,774
7,462
1,312
Other taxes
2,651
2,596
55
Total operating expenses
50,833
48,023
2,810
Operating income
$
11,050
$
11,317
$
(267)
Operating income for the Unregulated Energy segment decreased by $0.3 million for the nine months ended September 30, 2020, compared to the same period in 2019. Excluding the estimated COVID-19 impacts of $1.6 million, operating income
increased $1.3 million as a result of incremental gross margin from the acquisition of the Boulden propane assets, higher retail propane margins per gallon and increased demand for Marlin Gas Services' CNG transportation services. These increases were partially offset by reduced gross margins from overall warmer temperatures, expenses associated with recent acquisitions, and increased insurance expense.
Gross Margin
Items contributing to the period-over-period increase in gross margin are listed in the following table:
(in thousands)
Propane Operations
Boulden acquisition (assets acquired in December 2019)
$
2,763
Increased retail propane margins per gallon driven by favorable market conditions and supply management
1,892
Decreased customer consumption - primarily weather related
(1,540)
Marlin Gas Services
Increased demand for CNG services
694
Aspire Energy
Decreased customer consumption - primarily weather related
(687)
Higher margins from negotiated rate increases
443
Unfavorable COVID-19 impacts on gross margin
(1,145)
Other variances
123
Period-over-period increase in gross margin
$
2,543
The following is a narrative discussion of the significant items in the foregoing table, which we believe is necessary to understand the information disclosed in the table.
Propane Operations
•Propane Operations - Boulden - Gross margin increased by $2.8 million due to the margin generated from Boulden, which was acquired by Sharp in December 2019.
•Increased Retail Propane Margins - Gross margin increased by $1.9 million, for the nine months ended September 30, 2020 as compared to the same period in the prior year, due to lower propane inventory costs and favorable market conditions. These market conditions, which include market pricing and competition with other propane suppliers, as well as the availability and price of alternative energy sources, may fluctuate based on changes in demand, supply and other energy commodity prices.
•Decreased Customer Consumption Primarily Driven by Weather - Gross margin decreased by $1.5 million primarily from the Mid-Atlantic propane operations as weather on the Delmarva Peninsula was 6 percent warmer for the nine months ended September 30, 2020 compared to the same period in 2019.
Marlin Gas Services
•Gross margin increased by $0.7 million for the nine months ended September 30, 2020, as compared to the same period in the prior year due to higher demand for compressed natural gas hold services.
Aspire Energy
•Decreased Customer Consumption Primarily Driven by Weather - Gross margin decreased by $0.7 million due to lower consumption as weather in Ohio was approximately 4 percent warmer for the nine months ended September 30, 2020 compared to the same period in 2019.
•Increased Margin Driven by Changes in Rates - Gross margin increased by $0.4 million in 2020, as compared to the prior year, due primarily to higher margins from negotiated rate increases.
Unfavorable COVID-19 Impacts
•Gross margin decreased by $1.1 million as a result of lower customer consumption, which was caused by the slowing of economic activities in our service territories as a result of restrictions imposed to promote social distancing and to slow down the spread of COVID-19.
Items contributing to the period-over-period increase in other operating expenses are listed in the following table:
(in thousands)
Depreciation, amortization and property tax costs due to new capital investments
$
1,326
Operating expenses from Boulden acquisition (completed in December 2019)
939
Insurance expense (non-health) - both insured and self-insured
523
Unfavorable COVID-19 impacts (higher operating and bad debt expenses)
417
Other variances
(395)
Period-over-period increase in other operating expenses
$
2,810
Divestiture of PESCO
As discussed in Note 3, Acquisitions and Divestitures, during the fourth quarter of 2019, we sold PESCO's assets and contracts and accordingly have exited the natural gas marketing business. This was done in an effort to enable us to focus on the strategies that support our core energy delivery business. As a result, we began to report PESCO as discontinued operations during the third quarter of 2019 and excluded PESCO's performance from continuing operations for all periods presented and classified its assets and liabilities as held for sale, where applicable.
OTHER EXPENSE, NET
For the quarter ended September 30, 2020 compared to the quarter ended September 30, 2019
Other expense, net, which includes non-operating investment income (expense), interest income, late fees charged to customers, gains or losses from the sale of assets and pension and other benefits expense, increased by $0.3 million in the third quarter of 2020, compared to the same period in 2019. The increase was primarily due to lower pension expense.
For the nine months ended September 30, 2020 compared to for the nine months ended September 30, 2019
Other expense, net, which includes non-operating investment income (expense), interest income, late fees charged to customers, gains or losses from the sale of assets and pension and other benefits expense, increased by $3.7 million for the first nine months of 2020, compared to the same period in 2019. The increase was primarily due to gains from the sale of two properties as well as lower pension expense. The property sales were made possible due to changes in the consolidation of certain operations.
INTEREST CHARGES
For the quarter ended September 30, 2020 compared to the quarter ended September 30, 2019
Interest charges for the quarter ended September 30, 2020 decreased by $0.8 million, compared to the same period in 2019, attributable primarily to $1.1 million in amortization expense associated with a regulatory liability that was established in connection with the Hurricane Michael regulatory proceeding settlement offset by $0.2 million in lower capitalized interest associated with growth projects. Higher interest expense from long-term debt offset the decreased interest from short-term borrowings as we consummated several refinancing of short-term debt to long-term debt in mid-2019 and earlier this year.
For the nine months ended September 30, 2020 compared to for the nine months ended September 30, 2019
Interest charges for the nine months ended September 30, 2020 decreased by $1.1 million, compared to the same period in 2019, attributable primarily to a decrease of $3.6 million in interest expense primarily on lower levels outstanding under our revolving credit facilities and lower interest rates on short-term borrowings, $1.1 million in amortization expense associated with a regulatory liability that was established in connection with the Hurricane Michael regulatory proceeding settlement, and $0.3 million in higher capitalized interest associated with growth projects. This decrease was offset by an increase of $3.9 million in interest expense on long-term debt as a result of several long-term debt placements in 2019 and 2020.
INCOME TAXES
For the quarter ended September 30, 2020 compared to the quarter ended September 30, 2019
Income tax expense was $3.5 million for the quarter ended September 30, 2020, compared to $2.4 million for the quarter ended September 30, 2019. Our effective income tax rate was 27.4 percent and 27.3 percent, for the three months ended September 30, 2020 and 2019, respectively.
For the nine months ended September 30, 2020 compared to for the nine months ended September 30, 2019
Income tax expense was $16.1 million for the nine months ended September 30, 2020, compared to $15.4 million in the same period in 2019. Our effective income tax rate was 24.7 percent and 25.9 percent for the nine months ended September 30, 2020
and 2019, respectively. During the nine months ended September 30, 2020, we implemented certain provisions of the CARES Act that allowed us to carryback net operating losses from 2018 and 2019 into prior year periods where the federal income tax rate was higher. As a result, we recognized a $1.7 million reduction in tax expense for the nine months ended September 30, 2020. Excluding this impact of the CARES Act, our effective tax rate for the nine months ended September 30, 2020 was 27.3 percent.
FINANCIAL POSITION, LIQUIDITYAND CAPITAL RESOURCES
Our capital requirements reflect the capital-intensive and seasonal nature of our business and are principally attributable to investment in new plant and equipment, retirement of outstanding debt and seasonal variability in working capital. We rely on cash generated from operations, short-term borrowings, and other sources to meet normal working capital requirements and to temporarily finance capital expenditures. We may also issue long-term debt and equity to fund capital expenditures and to more closely align our capital structure with our target capital structure. We maintain an effective shelf registration statement with the SEC for the issuance of shares of common stock in various types of equity offerings, including shares of common stock under our ATM equity program, as well as an effective registration statement with respect to the DRIP. Depending on our capital needs and subject to market conditions, in addition to other possible debt and equity offerings, we may consider issuing additional shares under the direct share purchase component of the DRIP and/or under the ATM equity program. Beginning in the third quarter of 2020, we issued shares of common stock under both the DRIP and the ATM equity program.
Our energy businesses are weather-sensitive and seasonal. We normally generate a large portion of our annual net income and subsequent increases in our accounts receivable in the first and fourth quarters of each year due to significant volumes of natural gas, electricity, and propane delivered by our distribution operations, and our natural gas transmission operations to customers during the peak heating season. In addition, our natural gas and propane inventories, which usually peak in the fall months, are largely drawn down in the heating season and provide a source of cash as the inventory is used to satisfy winter sales demand.
Capital expenditures for investments in new or acquired plant and equipment are our largest capital requirements. Our capital expenditures were $143.9 million for the nine months ended September 30, 2020. The following table shows a range of the expected 2020 capital expenditures by segment and by business line:
2020
(dollars in thousands)
Low
High
Regulated Energy:
Natural gas distribution
$
77,000
$
85,000
Natural gas transmission
70,000
74,000
Electric distribution
3,000
5,000
Total Regulated Energy
150,000
164,000
Unregulated Energy:
Propane distribution
14,000
16,000
Energy transmission
17,000
18,000
Other unregulated energy
12,000
14,000
Total Unregulated Energy
43,000
48,000
Other:
Corporate and other businesses
2,000
3,000
Total Other
2,000
3,000
Total 2020 Expected Capital Expenditures
$
195,000
$
215,000
The 2020 budget includes: Eastern Shore's Del-Mar Energy Pathway, Florida's Callahan and West Palm Beach County Expansions and other potential pipeline projects, continued expenditures under Florida GRIP, further expansions of our natural gas distribution and transmission systems, continued natural gas infrastructure improvement activities, information technology systems, and other strategic initiatives and investments.
The capital expenditure projection is subject to continuous review and modification. Actual capital requirements may vary from the above estimates due to a number of factors, including changing economic conditions, capital delays because of COVID-19 that are greater than currently anticipated, customer growth in existing areas, regulation, new growth or acquisition opportunities and availability of capital. Historically, actual capital expenditures have typically lagged behind the budgeted amounts.
We are committed to maintaining a sound capital structure and strong credit ratings to provide the financial flexibility needed to access capital markets when required. This commitment, along with adequate and timely rate relief for our regulated energy operations, is intended to ensure our ability to attract capital from outside sources at a reasonable cost, which will benefit our customers, creditors, employees and stockholders.
The following table presents our capitalization, excluding and including short-term borrowings, as of September 30, 2020 and December 31, 2019:
September 30, 2020
December 31, 2019
(in thousands)
Long-term debt, net of current maturities
$
519,971
46
%
$
440,168
44
%
Stockholders’ equity
616,690
54
%
561,577
56
%
Total capitalization, excluding short-term debt
$
1,136,661
100
%
$
1,001,745
100
%
September 30, 2020
December 31, 2019
(in thousands)
Short-term debt
$
216,388
16
%
$
247,371
19
%
Long-term debt, including current maturities
535,571
39
%
485,768
38
%
Stockholders’ equity
616,690
45
%
561,577
43
%
Total capitalization, including short-term debt
$
1,368,649
100
%
$
1,294,716
100
%
Our target ratio of equity to total capitalization, including short-term borrowings, is between 50 and 60 percent. We seek to align permanent financing with the in-service dates of our capital projects. We may utilize more temporary short-term debt when the financing cost is attractive as a bridge to the permanent long-term financing or if the equity markets are volatile.
Our equity to total capitalization ratio, including short-term borrowings, was 45 percent as of September 30, 2020. As a result of issuing additional equity in October 2020, as described below, our equity to total capitalization ratio including short-term borrowings was approximately 50 percent at October 31, 2020.
In September 2020, we issued 0.2 million shares of common stock through our DRIP and the ATM programs and received net proceeds of approximately $19.2 million which were added to our general funds. In October 2020, we issued an additional 0.7 million shares of common stock through the same programs and received approximately $63.8 million in net proceeds, for the DRIP and ATM issuances. See Note 9, Stockholders’ Equity, in the condensed consolidated financial statements for additional information on commissions and fees paid in connection with these issuances.
Term Notes
In January 2019, we issued a $30.0 million unsecured term note through Branch Banking and Trust Company, with a maturity date of February 28, 2020. This note was paid in full in February 2020 utilizing our short-term borrowing facilities.
Shelf Agreements
We have entered into Shelf Agreements with Prudential, MetLife and NYL, whom are under no obligation to purchase any unsecured debt. The following table summarizes our Shelf Agreements at September 30, 2020:
(1) In January 2020, we requested and Prudential accepted our request to purchase $50.0 million of our unsecured debt. We issued the Shelf Notes in July 2020 at the rate of 3.00 percent per annum.
(2) In April 2020, the Prudential Shelf Agreement was amended to increase the available borrowing capacity to $150.0 million. The Shelf Agreement expires in April 2023.
(3) In May 2020, we reached into an agreement with MetLife to provide a new $150.0 million MetLife Shelf Agreement for a three-year term ending May 2023.
(4) In February 2020, we requested and NYL accepted our request to purchase $40.0 million of our unsecured debt. The Shelf Notes were issued in August 2020 at the rate of 2.96 percent per annum. The Shelf Agreement expires in November 2021.
The Uncollateralized Senior Notes, Shelf Agreements or Shelf Notes set forth certain business covenants to which we are subject when any note is outstanding, including covenants that limit or restrict our ability, and the ability of our subsidiaries, to incur indebtedness, or place or permit liens and encumbrances on any of our property or the property of our subsidiaries.
Short-term Borrowings
We are authorized by our Board of Directors to borrow up to $375.0 million of short-term debt, as required, from among our various short-term debt facilities. We utilize bank lines of credit to provide funds for our short-term cash needs to meet seasonal working capital requirements and to temporarily fund portions of the capital expenditure program.
In the second quarter of 2020, we entered into interest rate swaps with notional amounts totaling $100.0 million associated with three of our short-term lines of credit through October 2020. The interest rate swaps were entered to hedge the variability in cash flows attributable to changes in the short-term borrowing rates during this period. The fixed swap rates ranged between 0.2615 and 0.3875 percent for the period. Our short-term borrowing is based on the 30-day LIBOR rate. The interest swap is cash settled monthly as the counter-party pays us the 30-day LIBOR rate less the fixed rate.
In September 2020, we entered into a new $375.0 million syndicated revolving line of credit, the Revolver, with six participating lenders. The Revolver expires on September 29, 2021 and has a commitment fee of 0.175 percent and an interest rate of 1.125 percent over LIBOR. As a result of entering into the Revolver, in September 2020, we terminated and paid the outstanding balances for all of our previously existing bilateral lines of credit and the previous revolving credit facility. Our available credit under the new Revolver at September 30, 2020 was $154.7 million. Our book overdrafts were $0.9 million and $3.2 million at September 30, 2020 and December 31, 2019, respectively. If presented, the book overdrafts would be funded through the Revolver.
The availability of funds under the Revolver is subject to conditions specified in the credit agreement, all of which we currently satisfy. These conditions include our compliance with financial covenants and the continued accuracy of representations and warranties contained in the agreement. We are required by the financial covenants our Revolver to maintain, at the end of each fiscal year, a funded indebtedness ratio of no greater than 65 percent. As of September 30, 2020, we are in compliance with all of our debt covenants.
Cash Flows
The following table provides a summary of our operating, investing and financing cash flows for the nine months ended September 30, 2020 and 2019:
Changes in our cash flows from operating activities are attributable primarily to changes in net income, adjusted for non-cash items such as depreciation and changes in deferred income taxes, and working capital. Changes in working capital are determined by a variety of factors, including weather, the prices of natural gas, electricity and propane, the timing of customer collections, payments for purchases of natural gas, electricity and propane, and deferred fuel cost recoveries.
During the nine months ended September 30, 2020 and 2019, net cash provided by operating activities was $115.9 million and $103.9 million, respectively, resulting in an increase in cash flows of $12.0 million. Significant operating activities generating the cash flows change were as follows:
•Net income, adjusted for non-cash adjustments and reconciling activities, increased cash flows by $26.2 million, due primarily to deferred income taxes and depreciation and amortization, offset by realized gain on commodity contracts and sale of assets;
•Changes in net accounts receivable and accrued revenue and accounts payable and accrued liabilities increased cash flows by $8.9 million, due in part to the timing and receipt of payments and the absence of PESCO, whose assets and contracts were sold in the fourth quarter of 2019;
•Changes in net regulatory assets and liabilities increased cash flows by $4.9 million due primarily to the change in fuel costs collected through the various cost recovery mechanisms;
•Net cash flows from income taxes receivable decreased by $11.0 million due primarily to the implementation of the federal tax law associated with the CARES Act;
•Changes in net prepaid expenses and other current assets, customer deposits and refunds, accrued compensation and other net assets and liabilities, decreased cash flows by $11.8 million; and
•Net cash flows from changes in propane inventory, storage gas and other inventories decreased by approximately $5.2 million.
Cash Flows Used in Investing Activities
Net cash used in investing activities totaled $136.6 million and $139.9 million during the nine months ended September 30, 2020 and 2019, respectively, resulting in an increase in cash flows of $3.3 million. Cash paid for capital expenditures was $123.4 million for the first nine months of 2020, compared to $139.3 million for the same period in 2019, resulting in increased cash flows of $15.9 million, and was offset by cash paid for the acquisition of Elkton Gas of $15.6 million.
Cash Flows Provided by Financing Activities
Net cash used by financing activities totaled $16.7 million during the nine months ended September 30, 2020 compared to $34.2 million of net cash provided by financing activities during the prior year period resulting in a decrease in cash flows of $17.5 million. The decrease in net cash provided by financing activities resulted primarily from the following:
•Decreased cash flows of $40.0 million associated with issuance of long-term debt. For the nine months ended September 30, 2020, we received $89.8 million from the issuance of Prudential Shelf Notes in July 2020 and NYL Shelf Notes in August 2020. For the nine months ended September 30, 2019, we received $129.8 million from the issuance of the Prudential Shelf Notes in August 2019 and term notes in January 2019;
•Decreased cash flows of $33.7 million from repayments of long-term debt;
•Increased cash flows of $0.1 million as a result of changes in cash overdrafts in 2020;
•Cash dividends of $20.0 million paid during the nine months ended September 30, 2020, compared to $18.2 million for the nine months ended September 30, 2019;
•Increased cash flows from short-term borrowing of $37.9 million under our line of credit arrangements; and
•Increased cash flows of $20.3 million as a result of issuing stock under the DRIP and the ATM equity program.
Off-Balance Sheet Arrangements
We have issued corporate guarantees to certain vendors of our subsidiaries that provide for the payment of propane and natural gas purchases in the event of the subsidiary’s default. The liabilities for these purchases are recorded in our financial statements when incurred. The aggregate amount guaranteed at September 30, 2020 was $7.9 million, with the guarantees expiring on various dates through September 24, 2021. The amounts related to PESCO were immaterial and were fully terminated in October 2020. See Note 3, Acquisitions and Divestitures, in the condensed consolidated financial statements for additional details on the sale of assets and contracts for PESCO.
As of September 30, 2020, we have issued letters of credit totaling approximately $4.8 million related to the electric transmission services for FPU's electric division, the firm transportation service agreement between TETLP and our Delaware and Maryland divisions, to our current and previous primary insurance carriers. These letters of credit have various expiration dates through October 5, 2021. There have been no draws on these letters of credit as of September 30, 2020. We do not anticipate that the counterparties will draw upon these letters of credit, and we expect that they will be renewed to the extent necessary in the future. Additional information is presented inNote 7, Other Commitments and Contingencies, in the condensed consolidated financial statements. At September 30, 2020, letters of credit associated with PESCO were fully terminated. See Note 3, Acquisitions and Divestitures, in the condensed consolidated financial statements for additional details on the sale of PESCO.
Contractual Obligations
There has been no material change in the contractual obligations presented in our 2019 Annual Report on Form 10-K, except for commodity purchase obligations entered into in the ordinary course of our business. The following table summarizes commodity purchase contract obligations at September 30, 2020:
Payments Due by Period
Less than 1 year
1 - 3 years
3 - 5 years
More than 5 years
Total
(in thousands)
Purchase obligations - Commodity (1)
13,732
17,502
—
—
31,234
Total
$
13,732
$
17,502
$
—
$
—
$
31,234
(1) In addition to the obligations noted above, we have agreements with commodity suppliers that have provisions with no minimum purchase requirements. There are no monetary penalties for reducing the amounts purchased; however, the propane contracts allow the suppliers to reduce the amounts available in the winter season if we do not purchase specified amounts during the summer season. Under these contracts, the commodity prices will fluctuate as market prices fluctuate.
Rates and Regulatory Matters
Our natural gas distribution operations in Delaware, Maryland and Florida and electric distribution operation in Florida are subject to regulation by the respective state PSC; Eastern Shore is subject to regulation by the FERC; and Peninsula Pipeline is subject to regulation by the Florida PSC. At September 30, 2020, we were involved in regulatory matters in each of the jurisdictions in which we operate. Our significant regulatory matters are fully described in Note 5, Rates and Other Regulatory Activities, to the condensed consolidated financial statements in this Quarterly Report on Form 10-Q.
Recent Authoritative Pronouncements on Financial Reporting and Accounting
Recent accounting developments applicable to us and their impact on our financial position, results of operations and cash flows are described in Note 1,Summary of Accounting Policies, to the condensed consolidated financial statements in this Quarterly Report on Form 10-Q.
Item 3. Quantitative and Qualitative Disclosures about Market Risk
INTEREST RATE RISK
Long-term debt is subject to potential losses based on changes in interest rates. Our long-term debt at September 30, 2020, consists of fixed-rate Senior Notes and $8.0 million of fixed-rate secured debt. We evaluate whether to refinance existing debt or permanently refinance existing short-term borrowings based in part on the fluctuation in interest rates. The fluctuation in interest rates expose us to potential increased cost we could incur when we issue debt instruments or to provide financing and liquidity for our business activities. Occasionally, we utilize interest rate swap agreements to mitigate short-term borrowing rate risk. Additional information about our long-term debt and short-term borrowing is disclosed in Note 15, Long-Term Debt, and Note 16, Short-Term Borrowings, respectively,in the condensed consolidated financial statements.
COMMODITY PRICE RISK
Regulated Energy Segment
We have entered into agreements with various wholesale suppliers to purchase natural gas and electricity for resale to our customers. Our regulated energy distribution businesses that sell natural gas or electricity to end-use customers have fuel cost recovery mechanisms authorized by the PSCs that allow us to recover all of the costs prudently incurred in purchasing natural gas and electricity for our customers. Therefore, our regulated energy distribution operations have limited commodity price risk exposure.
Unregulated Energy Segment
Our propane operations are exposed to commodity price risk as a result of the competitive nature of retail pricing offered to our customers. In order to mitigate this risk, we utilize propane storage activities and forward contracts for supply.
We can store up to approximately 8.0 million gallons of propane (including leased storage and rail cars) during the winter season to meet our customers’ peak requirements and to serve metered customers. Decreases in the wholesale price of propane may cause the value of stored propane to decline, particularly if we utilize fixed price forward contracts for supply. To mitigate the risk of propane commodity price fluctuations on the inventory valuation, we have adopted a Risk Management Policy that allows our propane distribution operation to enter into fair value hedges, cash flow hedges or other economic hedges of our inventory.
Aspire Energy is exposed to commodity price risk, primarily during the winter season, to the extent we are not successful in balancing our natural gas purchases and sales and have to secure natural gas from alternative sources at higher spot prices. In order to mitigate this risk, we procure firm capacity that meets our estimated volume requirements and we continue to seek out new producers in order to fulfill our natural gas purchase requirements.
The following table reflects the changes in the fair market value of financial derivatives contracts related to propane purchases and sales from December 31, 2019 to September 30, 2020:
(in thousands)
Balance at December 31, 2019
Increase (Decrease) in Fair Market Value
Less Amounts Settled
Balance at September 30, 2020
Sharp
$
(1,844)
$
1,803
$
1,582
$
1,541
Total
$
(1,844)
$
1,803
$
1,582
$
1,541
There were no changes in methods of valuations during the nine months ended September 30, 2020.
The following is a summary of fair market value of financial derivatives as of September 30, 2020, by method of valuation and by maturity for each fiscal year period.
The Risk Management Committee reviews credit risks associated with counterparties to commodity derivative contracts prior to such contracts being approved.
Additional information about our derivative instruments is disclosed in Note 13, Derivative Instruments, in the condensed consolidated financial statements.
INFLATION
Inflation affects the cost of supply, labor, products and services required for operations, maintenance and capital improvements. To help cope with the effects of inflation on our capital investments and returns, we periodically seek rate increases from regulatory commissions for our regulated operations and closely monitor the returns of our unregulated energy business operations. To compensate for fluctuations in propane gas prices, we adjust propane sales prices to the extent allowed by the market.
Item 4. Controls and Procedures
Evaluation of Disclosure Controls and Procedures
The Chief Executive Officer and Chief Financial Officer of Chesapeake Utilities, with the participation of other Company officials, have evaluated our “disclosure controls and procedures” (as such term is defined under Rules 13a-15(e) and 15d-15(e), promulgated under the Securities Exchange Act of 1934, as amended) as of September 30, 2020. Based upon their evaluation, the Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective as of September 30, 2020.
Changes in Internal Control over Financial Reporting
In September 2020, we implemented a new fixed assets tracking system. Throughout this system implementation, we appropriately considered internal controls over financial reporting. Additionally, in response to the COVID-19 pandemic and the current social distancing restrictions that have been established in our service territories, we have implemented our pandemic response plan, which includes having office staff work remotely to promote social distancing in efforts to reduce the spread of COVID-19. During the quarter ended September 30, 2020, the implementation of the new fixed asset tracking system and our pandemic response plan did not result in a change in the design or operations of our internal controls over financial reporting that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
As disclosed in Note 7, Other Commitments and Contingencies, of the condensed consolidated financial statements in this Quarterly Report on Form 10-Q, we are involved in certain legal actions and claims arising in the normal course of business. We are also involved in certain legal and administrative proceedings before various governmental or regulatory agencies concerning rates and other regulatory actions. In the opinion of management, the ultimate disposition of these proceedings and claims will not have a material effect on our condensed consolidated financial position, results of operations or cash flows.
Item 1A. Risk Factors
Our business, operations, and financial condition are subject to various risks and uncertainties. The risk factors described in Part I, “Item 1A. Risk Factors” in our Annual Report on Form 10-K, for the year ended December 31, 2019, and Part II, "Item 1A. Risk Factors" in our Quarterly Report on Form 10-Q, for the quarter ended March 31, 2020, should be carefully considered, together with the other information contained or incorporated by reference in this Quarterly Report on Form 10-Q and in our other filings with the SEC in connection with evaluating Chesapeake Utilities, our business and the forward-looking statements contained in this Quarterly Report on Form 10-Q. Additional risks and uncertainties not known to us at present, or that we currently deem immaterial, also may affect Chesapeake Utilities. The occurrence of any of these known or unknown risks could have a material adverse impact on our business, financial condition and results of operations.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
Total Number of Shares
Average Price Paid
Total Number of Shares Purchased as Part of Publicly Announced Plans
Maximum Number of Shares That May Yet Be Purchased Under the Plans
Period
Purchased
per Share
or Programs (2)
or Programs (2)
July 1, 2020 through July 31, 2020 (1)
556
$
84.77
—
—
August 1, 2020 through August 31, 2020
—
—
—
—
September 1, 2020 through September 30, 2020
—
—
—
—
Total
556
$
84.77
—
—
(1) Chesapeake Utilities purchased shares of common stock on the open market for the purpose of reinvesting the dividend on shares held in the Rabbi Trust accounts for certain directors and senior executives under the Non-Qualified Deferred Compensation Plan. The Non-Qualified Deferred Compensation Plan is discussed in detail in Item 8 under the heading “Notes to the Consolidated Financial Statements—Note 9, Employee Benefit Plans,” in our latest Annual Report on Form 10-K for the year ended December 31, 2019. During the quarter ended September 30, 2020, 556 shares were purchased through the reinvestment of dividends on deferred stock units.
(2) Except for the purposes described in Footnote (1), Chesapeake Utilities has no publicly announced plans or programs to repurchase its shares.
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
CHESAPEAKE UTILITIES CORPORATION
/S/ BETH W. COOPER
Beth W. Cooper Executive Vice President, Chief Financial Officer, and Assistant Corporate Secretary
