ITEM 1. BUSINESS
THE COMPANY
Overview
Delmarva Power & Light Company (the Company) was incorporated in Delaware in 1909 and in Virginia in 1979. The Company's primary businesses include producing, purchasing, delivering, and selling electricity; purchasing, transporting, and selling natural gas; and providing other services which are primarily energy-related. In 1997, the Company's revenues were earned from the following sources: 77% from electricity sales and delivery; 14% from the sale and transportation of natural gas; and 9% from other services.
The Company provides regulated electric service (supply and delivery) to approximately 448,300 customers located on the Delmarva Peninsula and also sells electricity off-system in markets which are not subject to price regulation. The Company's traditional electric service territory on the Delmarva Peninsula, which includes Delaware, ten primarily Eastern Shore counties in Maryland, and the Eastern Shore of Virginia, encompasses an area consisting of about 6,000 square miles with a population of approximately 1.2 million. The Company provides regulated gas service (supply and/or delivery) to approximately 103,200 customers located in an area consisting of about 275 square miles with a population of approximately 480,000 in northern Delaware, including the City of Wilmington. The Company also sells gas off-system in markets which are not subject to price regulation.
In addition to selling competitive electricity and natural gas, the Company also sells other non-regulated/nonutility products and services which include the following: local and long-distance telephone service; heating, ventilation, and air-conditioning (HVAC) products, installation and services; power plant operating services; and certain other services. For additional information on nonutility businesses, see "Business Plans" on page I-2 and "Nonutility Businesses" on page I-13.
For information concerning the Company's business segments, see Note 21 to the Company's 1997 Consolidated Financial Statements included in Item 8 of Part II.
Atlantic Merger
On August 12, 1996, the Company announced plans for a merger with Atlantic Energy, Inc. (Atlantic), an investor-owned holding company located in southern New Jersey, which owned Atlantic City Electric Company (ACE) and nonutility subsidiaries. The final required regulatory merger approval was received from the Securities and Exchange Commission (SEC) on February 27, 1998. On March 1, 1998, a series of merger transactions were consummated. These merger transactions (the Merger) formed Conectiv, a new holding company, and merged Atlantic out of existence. As a result of the Merger, Conectiv owns the Company, the Company's subsidiaries, ACE, and the nonutility subsidiaries formerly held by Atlantic. ACE serves approximately 481,000 customers in a 2,700 square mile area in southern New Jersey. Atlantic's 1997 operating revenues and net income were $1,102.4 million and $74.4 million, respectively, and its total assets were $2,723.9 million as of December 31, 1997.
Conectiv is a registered holding company under the Public Utility Holding Company Act of 1935, as amended (1935 Act). The 1935 Act imposes certain restrictions on the operations of registered holding company systems. In particular, new lines of businesses not otherwise approved under generally applicable regulations cannot be undertaken without prior approval from the SEC.
For additional information about the Merger, refer to Management's Discussion and Analysis of Financial Condition and Results of Operations (MD&A) in Item 7 of Part II, Note 4 to the Company's 1997 Consolidated Financial Statements included in Item 8 of Part II, and the registration statement on Form S-4 dated December 26, 1996.
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Utility Regulation and Industry Restructuring
To date, the Company's regulated electric and gas public utility operations have provided the predominant share of the Company's net earnings. Delaware, Maryland, and Virginia regulate the Company's retail electric sales within areas for which the Company holds retail franchises (see "Retail Franchises" on page I-18). Delaware also regulates the Company's retail gas sales within the State. The Federal Energy Regulatory Commission (FERC) regulates the transmission of electricity, the wholesale sale of electricity, and interchange and other purchases and sales of electricity involving other utilities.
Prices charged to electric utility customers have historically been a "bundled" price which includes the electricity production (supply) cost and the delivery cost (transmission and distribution). State regulatory commissions and legislatures throughout the country are considering or have approved changes to laws and regulations governing the sale and pricing of electricity. Generally, the supply component of the price charged to a customer for electricity would be deregulated, and electric suppliers would compete to supply electricity to customers. Competition is expected to reduce gross margins earned from the supply of electricity. Customers would continue to pay the local utility a regulated price for the delivery of the electricity over the transmission and distribution system.
In Delaware, the Delaware Public Service Commission (DPSC) submitted a report to the Delaware House of Representatives on January 27, 1998, recommending that Delaware customers be able to choose their electricity supplier beginning twelve months after restructuring legislation is enacted. On March 13, 1998, the DPSC sent draft legislation to the Delaware legislature which would provide all Delaware electric retail customers the ability to choose their electric supplier beginning on August 1, 1999. The draft legislation also includes a provision that would allow the DPSC to delay the start date of electric retail competition by up to 12 months. In Maryland, the Maryland Public Service Commission (MPSC) issued an order on December 31, 1997, providing for the phase-in of electric retail competition over a three- year period beginning July 1, 2000.
In Virginia, the Virginia State Corporation Commission (VSCC) Staff advised lawmakers that electric competition should be studied and tested over a five- year period before deciding if retail competition should be implemented. Under restructuring plans in New Jersey and Pennsylvania, all retail customers in those states will be able to choose their electric suppliers by July 1, 2000 and January 1, 2001, respectively. See the MD&A in Item 7 of Part II for additional information about the status of deregulation of the electric utility industry in Delaware, Maryland, Virginia, New Jersey (which regulates ACE's retail electric utility business), and Pennsylvania.
The electric resale (wholesale) market is highly competitive due to federal legislation enacted in 1992 which provided electric resale customers with a choice of electric suppliers and gave the FERC the authority to order local utilities to provide transmission service to other resale electricity suppliers. In 1996, the FERC issued Order No. 888 which required electric utilities to provide open access to their transmission systems under non- discriminatory tariffs available to all wholesale sellers and buyers of electricity. For information on the Company's resale business, refer to the MD&A in Item 7 of Part II.
For a discussion of deregulation of the Company's gas business, refer to "Gas Business" on page I-10.
Business Plans
As deregulation of the electric utility industry continues to unfold, the Company is moving ahead with its plan to become a prominent regional player by being first into new markets that complement its utility business and by enhancing its ability to serve additional customers outside of its traditional borders. The Company is growing its businesses by building long-term customer relationships, establishing the Conectiv brand name, marketing products and services that complement the Company's core energy business, and serving more customers in a larger geographic area. To accomplish these goals, the Company has increased investments in marketing/branding programs, new businesses, and infrastructure systems.
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On June 30, 1997, the Company launched a campaign to introduce the new Conectiv brand and Conectiv's products and services. The campaign explained that Conectiv is offering energy, telecommunications, heating and cooling, and related services for homes and businesses. Customer response to the new Conectiv brand name has been positive, as evidenced by name recognition and the Company's success in gaining new customers in retail energy pilot programs. The Company is marketing an array of products and services--energy, local and long-distance telephone service, HVAC services, and other services-- under the Conectiv name. The Company plans to continue its advertising campaigns and other support of the Conectiv brand name.
Over the next year or two, the Company's earnings are expected to be constrained by on-going start-up costs for new businesses, including telecommunications and HVAC. After this start-up period, these investments are expected to contribute to long-term consolidated earnings growth exceeding the utility industry average.
Conectiv's business plans will be carried out by its three business groups; Conectiv Energy Delivery, Conectiv Energy Supply, and Conectiv Enterprises. The business groups are aligned with customers' needs, markets, and the future structure of the utility industry. The business groups are discussed below.
Conectiv Energy Delivery
Conectiv Energy Delivery will deliver electricity and gas to retail and wholesale customers within its service territory. These delivery services are structured into various forms of price-regulated offers, some including energy supply, so that customers may choose the combination that provides the best value. Customer satisfaction and loyalty is expected to remain high due to the Company's reliable delivery systems, superior customer service, and competitive cost and pricing structures.
Conectiv Energy Supply
Conectiv Energy Supply will manage the generating assets, bulk energy marketing and trading activities, and the transition of those assets and activities from a regulated to a competitive environment. Its principal products are electric power and natural gas, supplemented by other fuels and related energy management services. Its customers are bulk energy users and retail aggregators in the region stretching from the Delmarva peninsula north through New England and west to Ohio.
Conectiv Enterprises
Conectiv Enterprises is comprised of the following five start-up businesses: Conectiv Communications, Inc. (CCI)--provides local and long distance telephone services; Conectiv Energy--primarily sells energy in competitive retail markets; Conectiv Services, Inc. (CSI)--provides a full range of HVAC services; Conectiv Solutions LLC--provides customized solutions to customers' energy needs; and Conectiv Thermal Systems, Inc. (currently Atlantic Thermal Systems, Inc.)--provides custom thermal heating and cooling systems. These businesses provide an opportunity to grow Conectiv's customer base throughout the Mid-Atlantic region and strengthen its relationship with customers in its traditional service territory. Conectiv Enterprises expects to incur operating losses for the first year or two after the Merger due to start-up costs.
For more detailed information about Conectiv Enterprises' businesses and other nonutility businesses, refer to "Nonutility Businesses" on page I-13.
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ELECTRIC BUSINESS
Installed Capacity
The megawatts (MW) of net installed summer electric generating capacity available to the Company to serve its peak load as of December 31, 1997 is presented below.
The net generating capacity available for operations at any time may be less than the total net installed generating capacity due to generating units being temporarily out of service for inspection, maintenance, repairs, or unforeseen circumstances. See "Item 2
ITEM 2. PROPERTIES
Substantially all utility plants and properties of the Company are subject to the lien of the Mortgage under which the Company's First Mortgage Bonds are issued.
The Company's electric properties are located in Delaware, Maryland, Virginia, Pennsylvania, and New Jersey. The following table sets forth the net installed summer electric generating capacity available to the Company to serve its peak load as of December 31, 1997.
- -------- (A) Company portion of jointly-owned plants. (B) Represents capacity owned by a refinery customer which is available to the Company to serve its peak load.
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The Company's electric transmission and distribution system includes 1,391 transmission poleline miles of overhead lines, 5 transmission cable miles of underground cables, 6,931 distribution poleline miles of overhead lines, and 5,540 distribution cable miles of underground cables.
The Company has a liquefied natural gas plant located in Wilmington, Delaware with a storage capacity of 3.045 million gallons and an emergency sendout capability of 45,000 Mcf per day.
The Company also owns four natural gas city gate stations at various locations in its gas service territory. These stations have a total sendout capacity of 125,000 Mcf per day.
The following table sets forth the Company's gas pipeline miles:
-------- * Includes 11 miles of joint-use gas pipeline that is used 10% for gas and 90% for electric.
As of December 31, 1997, CCI, the Company's telecommunications subsidiary, owned the assets listed and described below.
"Central office equipment" consists of switching equipment, transmission equipment and related facilities. "Cable, wiring and conduit" consists primarily of aerial cable, underground cable, conduit and wiring. "Other equipment" consists of circuit equipment and radio systems.
The Company owns and occupies office buildings in Wilmington and Christiana, Delaware and Salisbury, Maryland, and also owns elsewhere in its service area a number of properties that are used for office, service, and other purposes.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
On February 6, 1997, a major customer of the Company filed a lawsuit in the Delaware Superior Court alleging negligence and breach of contract against the Company in relation to the electric system outages that occurred on March 28, 1996, and May 14, 1996. The complaint asked for actual damages in excess of $41 million and for special and punitive damages in unspecified amounts. This lawsuit was settled before trial. The result of the settlement was not material to the Company's financial position or results of operations.
See Note 18 to the Company's 1997 Consolidated Financial Statements included in Part II, Item 8 for information concerning the Company's lawsuit against Westinghouse Electric Corporation, the designer and manufacturer of the Salem steam generators.
In March 1996, the Company and PECO filed a complaint in the United States District Court for the Eastern District of Pennsylvania against Public Service Enterprise Group, Inc. (Enterprise) and PSE&G seeking damages for breach of contract and negligence concerning Salem operations. The suit asked for compensatory damages for breach of contract and negligence and unspecified punitive damages. On May 12, 1997, it was announced that PSE&G settled the suit with the Company and PECO. Under the settlement, PSE&G paid the Company approximately $12 million on December 31, 1997, in settlement of all claims related to the lawsuit.
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The parties to the settlement also agreed to operating performance standards through December 31, 2011 for Salem, and similar standards through December 31, 2007 for the Peach Bottom Atomic Power Station operated by PECO. Under these standards, the Company is entitled to receive payments from the nuclear plant operator as follows: (a) if the three-year capacity factor determined annually falls below 40 percent but is equal to or above 20 percent, the operator will pay the Company $1.5 million for each year that the historical capacity factor is below 40 percent; and (b) if the historical capacity factor is below 20 percent, the operator will pay the Company $3.7 to $3.8 million for each such year. The initial three-year period will begin on the date Unit 1 returns to service, which is expected to be in the second quarter of 1998.
The parties have further agreed to forego litigation in the future, except for very limited cases in which the operator would be responsible for no more than $5 million per year.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matter was submitted during the fourth quarter of the fiscal year covered by this report to a vote of security holders, through the solicitation of proxies or otherwise.
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PART II
ITEM 5.
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The Company's common stock was listed on the New York and Philadelphia Stock Exchanges and had unlisted trading privileges on the Cincinnati, Midwest, and Pacific Stock Exchanges and had the following dividends declared and high/low prices by quarter for the years 1997 and 1996.
The Company had 47,187 registered holders of common stock as of December 31, 1997.
For information concerning common dividends, see the MD&A in Item 7
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
MERGER WITH ATLANTIC
Effective March 1, 1998, Delmarva Power & Light Company (the Company) and Atlantic Energy, Inc. (Atlantic) consummated merger transactions (the Merger) which formed a new company named Conectiv and merged Atlantic out of existence. Additional information about the Merger is included in Note 4 to the Consolidated Financial Statements and in the registration statement on Form S-4 dated December 26, 1996.
Prior to the Merger, Atlantic owned Atlantic City Electric Company (ACE), an electric utility, and subsidiaries engaged in nonutility businesses. As a result of the Merger, Conectiv owns ACE, nonutility subsidiaries formerly held by Atlantic, the Company, and the Company's subsidiaries. ACE serves approximately 481,000 customers in a 2,700 square mile area in southern New Jersey. Atlantic's 1997 operating revenues and net income were $1,102.4 million and $74.4 million, respectively, and its total assets were $2,723.9 million as of December 31, 1997.
The benefits expected from the Merger include increased scale, cost savings, competitive prices and services, a more balanced customer base, and increased financial flexibility. The companies expect cost savings from Merger synergies of approximately $500 million over 10 years.
Approximately 50% to 75% of estimated cost savings from the Merger with Atlantic will serve to reduce customers' rates and the balance of the cost savings realized will benefit Conectiv stockholders. Pursuant to settlement agreements approving the Merger, the Company will decrease retail customer non-fuel (base) rates by an aggregate total of $13 million in Delaware, Maryland, and Virginia. In New Jersey, ACE will share approximately 75% of the Merger savings with its customers through a $15.75 million electric rate reduction.
Concurrent with the Merger, the Company and Atlantic plan to achieve workforce reductions through enhanced retirement offers (ERO) and other employee separation programs. The cost of the Company's employee separation programs and other Merger related costs are currently estimated to be $55 million to $60 million before income taxes ($33 million to $36 million after income taxes).
Each outstanding share of the Company's common stock, par value $2.25 per share, is being exchanged for one share of Conectiv's common stock, par value $0.01 per share. Each share of Atlantic's common stock, no par value per share, is being exchanged for 0.75 of one share of Conectiv's common stock and 0.125 of one share of Conectiv's Class A common stock, par value $0.01 per share. Class A common stock gives holders of Atlantic common stock a proportionately greater opportunity to share in the growth prospects of, and a proportionately greater exposure to the uncertainties associated with the electric utility business of ACE. Earnings applicable to Class A common stock will be equal to 30% of the net of (1) earnings attributable to ACE's regulated electric utility business, as the business existed on August 9, 1996, less (2) $40 million per year. Earnings applicable to Conectiv common stock will be the consolidated earnings of Conectiv less earnings applicable to Class A common stock.
EARNINGS RESULTS SUMMARY
The Company's earnings per share for 1997 were $1.66 compared to $1.77 for 1996. Earnings from the Company's traditional, regulated utility operations were relatively flat, and the $0.11 per share earnings decrease was primarily attributed to expenses of non-regulated activities, as discussed below. For the utility business, the positive effects of higher net electric revenues and lower outage expenses for the Salem nuclear generating units were offset by anticipated higher capital costs. Net electric revenues grew despite milder weather due to customer growth and a strong economy.
The earnings decrease from non-regulated activities resulted from planned cost increases associated with investments in new businesses, branding, and other expenditures which are positioning the Company to compete in deregulated energy markets. Part of the Company's strategy for competition (in deregulated markets) involves
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the divestiture of non-strategic assets. A $0.22 per share gain from the Company's sale of Pine Grove, Inc., which owned a landfill and related waste- hauling company, mitigated the earnings decrease. This sale freed up capital invested in a non-strategic asset and enabled the Company to absorb additional investments to grow new businesses.
Earnings per share for 1996 were $1.77, a $0.02 decrease from 1995. Excluding the adverse impact of the Salem outages, earnings rose $0.08 per share in 1996, primarily due to additional revenues from customer growth, partly offset by higher depreciation and other expenses, including marketing expenses for new value-added (energy-related) services.
DIVIDENDS
On December 11, 1997, the Board of Directors declared a dividend on common stock of $0.38 1/2 per share for the fourth quarter or $1.54 on an annualized basis. The Company's growth strategy will require increased reinvestment of earnings into new businesses. The business growth from these investments and the payment of dividends on common stock are expected to maximize stockholder value on a long-term basis. Following the Merger, dividends on Conectiv common stock are expected to be paid at the rate of $1.54 per year, subject to periodic evaluation of Conectiv's results of operations, financial condition, capital requirements and other relevant considerations. Dividends on Class A common stock are expected to be paid at the rate of $3.20 per share for three years following the Merger subject to periodic evaluation of Conectiv's results of operations, financial condition, capital requirements and other relevant considerations. After the three-year period, dividends on Class A common stock are expected to be equal to approximately 90% of earnings available for Class A common stock. However, if dividends on Class A common stock exceed earnings available for Class A common stock during the three year period, that may influence the Board's determination of the amount of Class A common stock dividends to be paid after the three-year period.
ELECTRIC UTILITY INDUSTRY RESTRUCTURING
Prices charged to electric utility customers have historically been a "bundled" price which includes the electricity production (supply) cost and the delivery cost (transmission and distribution). State regulatory commissions and legislatures throughout the country are considering or have approved changes to laws and regulations governing the sale and pricing of electricity. Generally, the supply component of the price charged to a customer for electricity would be deregulated, and electric suppliers would compete to supply electricity to customers. Competition is expected to reduce gross margins earned from the supply of electricity. Customers would continue to pay the local utility a regulated price for the delivery of the electricity over the transmission and distribution system. Discussed below are proposals concerning deregulation of the electric utility industry in Delaware, Maryland, and Virginia (which have jurisdiction over the Company's retail electric utility business), New Jersey (which regulates ACE's retail electric utility business), and Pennsylvania.
DELAWARE
In response to a request from the Delaware House of Representatives, on January 27, 1998, the Delaware Public Service Commission (DPSC) submitted its report on electric utility industry restructuring to the Delaware General Assembly. The report included the following recommendations:
. All customers in Delaware would be able to choose their electricity supplier beginning twelve months after the restructuring legislation is signed into law.
. The incumbent utility would serve as the default electricity supplier during a DPSC-determined transition period. During this period, the retail generation rates for default customers would be market-based, but would continue to be regulated.
. Each utility would have an opportunity to recover all DPSC-approved non- mitigated stranded costs (or costs which would not be recovered under competitive pricing). Stranded cost recovery would occur through a separate, non-bypassable charge, which would be applied to all transmission and distribution
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customers. A "true-up" process would be established to adjust for fluctuations in stranded cost recovery due to sales volumes.
. Utilities would file their estimates of potential, non-mitigated stranded costs with the DPSC approximately three months after the restructuring was enacted. The estimates would be reviewed in a proceeding before the DPSC to determine the level of stranded cost recovery.
. A legal divestiture of generation assets would not be required; however, the generation business would have to be functionally separated from the remaining regulated utility business.
. The distribution and transmission services provided to retail customers by utilities, as well as some customer service functions, would continue to be regulated by the DPSC. Distribution services would continue to be priced based on cost-of-service. The DPSC also recommends that it oversee pricing of retail transmission services for some period; however, the Federal Regulatory Energy Commission (FERC) has indicated that it has jurisdiction over pricing of such transmission services.
. The DPSC recognized that alternative plans should be considered without necessitating changes to the restructuring legislation. Accordingly, the DPSC recommended that it be authorized to consider such alternatives and implement them, if they achieve the same customer choice goals and are in the public interest.
On March 13, 1998, the DPSC sent draft legislation to the Delaware legislature which would provide all Delaware electric retail customers the ability to choose their electric supplier beginning on August 1, 1999. The draft legislation also includes a provision that would allow the DPSC to delay the start date of electric retail competition by up to 12 months. Restructuring legislation may be considered by the Delaware legislature during this session, which ends on June 30, 1998.
MARYLAND
On December 3, 1997, the Maryland Public Service Commission (MPSC) issued an order concluding that retail electric competition is in the public interest and should be phased-in over a three-year period, one-third of the customers per year, beginning April 1, 1999. The order established a schedule for filing of additional information, roundtables, and proceedings. Enabling legislation and resolution of complex issues such as stranded costs and utility taxation will be necessary for implementation of retail electric competition in Maryland.
On December 31, 1997, the MPSC ordered a delay in the start of the three- year phase in period from April 1, 1999 to July 1, 2000 and also suspended all mandated filing dates. The MPSC subsequently adopted a revised schedule for this proceeding. The Company and other Maryland utilities supported the adoption of this schedule.
Certain key provisions of the MPSC's order are as follows:
. A price cap would be in effect during the three-year phase-in period.
. Utilities would be given the opportunity to recover their verifiable and prudently incurred stranded costs subject to full mitigation. Securitization of stranded costs would be permitted. Utilities are to file with the MPSC their estimates of stranded costs and proposed recovery mechanisms.
. Cost-of-service regulation of electric generation would be discontinued at the end of the three-year period, while distribution service would remain subject to cost-of-service regulation.
. The local utility will supply customers who do not select alternate suppliers during the three-year period.
. Reciprocity from out-of-state suppliers will not be required.
Restructuring legislation is being considered by the Maryland legislature.
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VIRGINIA
On November 7, 1997, the Virginia State Corporation Commission (VSCC) Staff report recommended that electric competition should be studied and tested over a five-year period before determining if retail competition should be implemented.
Restructuring legislation is being considered by the Virginia legislature.
NEW JERSEY
In New Jersey, the Board of Public Utilities (BPU) has recommended that retail choice begin with 10% of customers on October 1, 1998 and be available to 100% of the customers by July 1, 2000. New Jersey electric utilities, as directed by the BPU, have filed complete restructuring plans, stranded cost estimates and unbundled rates. Proceedings are currently underway to address restructuring issues.
PENNSYLVANIA
In December 1996, the Pennsylvania legislature enacted the Pennsylvania Electricity Generation Customer Choice and Competition Act (Competition Act) which provides for the restructuring of the electric industry in Pennsylvania, including retail competition beginning in 1999. The Competition Act requires that all customers be allowed to choose their suppliers by January 1, 2001. In accordance with the Competition Act, pilot programs, open to 5% of each customer class, began on November 1, 1997. The Company is currently selling electricity under the Conectiv Energy brand name in the pilot programs and has acquired approximately 32,200 new customers. The Company plans to continue to evaluate market opportunities in Pennsylvania.
In December 1997, the Pennsylvania Public Utility Commission approved a restructuring plan for PECO Energy Company (PECO) under which two-thirds of PECO's customers can choose their energy supplier on January 2, 1999, and the remaining PECO customers can choose as of January 1, 2000. Starting in 1999, PECO's residential customers who purchase electricity from another supplier will receive a credit of 5.2 cents per kilowatt hour. This credit will allow electricity suppliers, such as the Company, a better opportunity than under previous terms to earn a profit from electricity sales to PECO's existing customers.
STRANDED COSTS
The transition to a competitive market could result in "stranded costs" for a utility. Stranded costs are generally costs which may not be recoverable in a competitive market due to market-based pricing or customers choosing different energy suppliers. Potential stranded costs could include (i) above- market costs associated with generation facilities or long-term power purchase agreements and (ii) regulatory assets (see Note 9 to the Consolidated Financial Statements) if cost recovery does not continue under a transition plan.
Authoritative accounting guidance issued in 1997 prescribes that a utility should cease to apply Statement of Financial Accounting Standards (SFAS) No. 71, "Accounting for the Effects of Certain Types of Regulation," for any separable portion of the business, such as the electricity production (supply) portion of its business, no later than the date that a specific deregulation plan is finalized. Stranded costs and regulatory assets attributed to electricity supply would continue to be recognized to the extent that a transition plan provides for their recovery through cash flows from the regulated transmission and distribution business.
As previously discussed, proposals concerning deregulation of the electric utility industry are being considered in Delaware, Maryland, and Virginia, but no deregulation plan has yet been finalized. Due to the uncertainty surrounding the outcome of the restructuring plans, the Company cannot currently predict if or when it would cease applying SFAS No. 71. To the extent stranded cost recovery is not provided for, the Company would be required to write down asset values, and such write-downs could be material.
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BUSINESS PLANS
As deregulation of the electric utility industry continues to unfold, the Company is moving ahead with its plan to become a prominent regional player by being first into new markets that complement its utility business and by enhancing its ability to serve additional customers outside of its traditional borders. The Company is growing its businesses by building long-term customer relationships, establishing the Conectiv brand name, marketing products and services that complement the Company's core energy business, and serving more customers in a larger geographic area. To accomplish these goals, the Company has increased investments in marketing/branding programs, new businesses, and infrastructure systems.
On June 30, 1997, the Company launched a campaign to introduce the new Conectiv brand and Conectiv's products and services. The campaign explained that Conectiv is offering energy, telecommunications, heating and cooling, and related services for homes and businesses. Customer response to the new Conectiv brand name has been positive, as evidenced by name recognition and the Company's success in gaining new customers in retail energy pilot programs. The Company is marketing an array of products and services--energy, local and long-distance telephone service, heating, ventilation, and cooling (HVAC) services, and other services--under the Conectiv name. The Company plans to continue its advertising campaigns and other support of the Conectiv brand name.
Over the next year or two, the Company's earnings are expected to be constrained by on-going start-up costs for new businesses, including telecommunications and HVAC. After this start-up period, these investments are expected to contribute to long-term consolidated earnings growth which exceeds the utility industry average.
Conectiv's business plans will be carried out by its three business groups: Conectiv Energy Delivery; Conectiv Energy Supply; and Conectiv Enterprises. The business groups are aligned with customers' needs, markets, and the future structure of the utility industry. The business groups are discussed below. For financial information concerning the Company's business segments and the expected impact of SFAS No. 131, "Disclosure About Segments of an Enterprise and Related Information", see Note 21 to the Consolidated Financial Statements.
CONECTIV ENERGY DELIVERY
Conectiv Energy Delivery will deliver electricity and gas to retail and wholesale customers within its service territory. These delivery services are structured into various forms of price-regulated offers, some including energy supply, so that customers may choose the combination that provides the best value. Customer satisfaction and loyalty is expected to remain high due to the Company's reliable delivery systems, superior customer service, and competitive cost and pricing structures.
CONECTIV ENERGY SUPPLY
Conectiv Energy Supply will manage the generating assets, bulk energy marketing and trading activities, and the transition of those assets and activities from a regulated to a competitive environment. Its principal products are electric power and natural gas, supplemented by other fuels and related energy management services. Its customers are bulk energy users and retail aggregators in the region stretching from the Delmarva peninsula north through New England and west to Ohio.
CONECTIV ENTERPRISES
Conectiv Enterprises is comprised of the following five start-up businesses: Conectiv Communications, Inc. (CCI)--provides local and long distance telephone services; Conectiv Energy--primarily sells energy in competitive retail markets; Conectiv Services, Inc. (CSI)--provides a full range of HVAC services; Conectiv Solutions LLC--provides customized solutions to customers' energy needs, and Conectiv Thermal Systems, Inc. (currently Atlantic Thermal Systems, Inc.)--provides custom thermal heating and cooling systems. These businesses provide an opportunity to grow Conectiv's customer base throughout the Mid-Atlantic region and
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strengthen its relationship with customers in its traditional service territory. Conectiv Enterprises expects to incur operating losses for the first year or two after the Merger due to start-up costs.
Conectiv Communications, Inc.
CCI is a full range facilities based telecommunications company initially operating in the region that includes Delaware, Southeastern Pennsylvania, Southern New Jersey, and Eastern Maryland. CCI's product and service offerings include all local and long distance services as well as carrier, network, and data services. CCI is marketing its products and services to business, residential, and carrier customers. CCI will focus on providing a facilities- based solution to its customers, and will also resell Bell Atlantic service. This strategy requires capital expenditures for further expansion of CCI's existing fiber optic network over the next several years. CCI currently operates in a duopoly local service environment with Bell Atlantic. Competition may increase from other telecommunications companies seeking to establish a local service presence in the region.
Conectiv Energy
Conectiv Energy currently sells competitive natural gas, electricity, and energy related products and services to residential and commercial customers in the Mid-Atlantic region. Retail customers' favorable response to the Conectiv brand has been a key to acquiring new retail customers in competitive markets. In 1997, Conectiv Energy obtained approximately 7,700 gas customers and 32,200 electric customers. The costs associated with acquiring new customers, timing of market entry, gross margins on sales, and regulations governing the transition to competition are factors critical to this business.
Conectiv Services, Inc.
CSI is a full-service HVAC business operating in the Mid-Atlantic region. CSI provides commercial customers with mechanical HVAC/piping construction and installation, design services, sheet metal fabrication, preventative maintenance and repair services. Residential offerings include HVAC installation, maintenance, repair and related plumbing services. The regional HVAC and plumbing industry is highly competitive, fragmented, and rapidly consolidating. The sales and earnings of HVAC businesses are affected by weather conditions. CSI originated through acquisitions of established businesses, and its future growth will be impacted by the availability of acquisition candidates and any regulatory limits imposed on market access.
Conectiv Solutions LLC
Conectiv Solutions LLC (Conectiv Solutions) is building close customer relationships by understanding individual customers' energy-related needs, and meeting those needs with customized, turnkey solutions. Conectiv Solutions provides large commercial and industrial customers, primarily within the Delaware Valley region, with energy and energy-related products and services. These products and services are built around occupant comfort, reliability of systems, and cost containment and reduction. Conectiv Solutions provides energy efficiency services, power systems consulting, custom on-site energy systems' services and construction, telecommunication services, and energy procurement. In addition, Conectiv Solutions offers the HVAC and telecommunications services provided by CSI and CCI.
Conectiv Thermal Systems, Inc.
Atlantic Thermal Systems, Inc. (ATS), owned by Atlantic prior to the Merger, will become Conectiv Thermal Systems, Inc. (CTS) shortly after the Merger. CTS will provide products and services offered by ATS prior to the Merger, including heating, cooling and related energy services to large commercial and industrial customers. In conjunction with these services, ATS develops, finances, constructs, owns and operates thermal energy production and distribution plants. Targeted customer groups include gaming/hotel resort complexes, colleges and universities, health care facilities and industrial complexes. ATS offers a highly customized service
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tailored to meet each customer's specific energy needs. Through ATS' energy outsourcing programs, customers are able to reduce their capital expenditures on non-strategic assets, realize energy cost savings, and free themselves from energy matters, which are incidental to their principal business activities.
PRICE REGULATION OF ENERGY REVENUES
Through 1997, customer rates for non-fuel costs represented a "bundled" price, including production costs and delivery costs, and have been set in past base rate proceedings before utility regulatory commissions. Changes in non-fuel (or base rate) revenues due to volume, or rate changes, generally affect the earnings of the Company.
Energy costs, including fuel and purchased energy, are currently billed to customers located within the Company's service territory under regulated fuel adjustment clause rates. These rates are adjusted periodically for cost changes and are subject to review by utility regulatory commissions. "Fuel revenues", or energy costs billed to customers, do not generally affect net income, because the amount of under- or over-recovered fuel costs is generally deferred until it is subsequently recovered from or returned to utility customers.
As the utility industry is restructured, fuel adjustment clauses are expected to be eliminated, and any differences between energy costs and related revenues will impact future earnings. The Company is currently managing the price risk associated with its unregulated, off-system energy sales through commodity hedging activities as discussed in Note 6 to the Consolidated Financial Statements. When energy sales are deregulated in the Company's service territory, price risk is expected to be managed similarly for these sales.
Electric revenues also include interchange delivery revenues, which result primarily from the sale of electricity to other electricity suppliers in the Pennsylvania-New Jersey-Maryland (PJM) Interconnection, which is an electric power pool. Interchange delivery revenues are currently reflected in the calculation of rates charged to customers under fuel adjustment clauses and, thus, do not affect net income. The future deregulation of the generation function will cause the margins from interchange delivery revenues to impact earnings.
Merchant revenues result from off-system energy sales in competitive markets outside the Company's traditional service territory. These sales are not subject to price regulation and include retail competition pilot programs and bulk commodity sales.
ELECTRIC REVENUES AND SALES
The Company's sources of electric revenues as a percentage of total electric revenues are shown below.
Electric retail revenues provide the highest gross margin (revenues less fuel and purchased energy costs) of the revenue categories shown above and are currently subject to price regulation. The electric resale and electric merchant businesses' gross margins, as a percent of revenue, are lower due to product differences, greater volume per customer, and competitive/unregulated pricing. However, the Company's new electric merchant business contributed an incremental amount of gross margin in 1997, which enhanced the Company's overall profitability.
In 1997, the percentage of electric retail revenues contributed by the various retail customer classes were as follows: residential--42.6%; commercial--33.9%; industrial--19.6%; and other--3.9%.
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Details of the changes in the various components of electric revenues are shown below.
COMPARATIVE INCREASE (DECREASE) FROM PRIOR YEAR IN ELECTRIC REVENUES
For 1997 compared to 1996, electric non-fuel revenues increased $8.9 million mainly due to a 2.6% increase in total retail kilowatt-hour (kWh) sales. The sales increase was due to a 1.4% increase in the number of regulated retail customers and favorable economic conditions, partly offset by milder weather's unfavorable effect on sales. For 1996 compared to 1995, electric non-fuel revenues increased $27.2 million due to a 4.5% increase in total retail kWh sales which was attributed primarily to a full year of Conowingo District sales in 1996 versus a half year in 1995. As discussed in Note 4 to the Consolidated Financial Statements, the Company acquired Conowingo Power Company (COPCO) in June 1995.
In 1997 and 1996, electric fuel revenues increased $32.7 million and $26.8 million, respectively, due to higher average fuel rates and increased kWh sales.
In 1997, more output was sold off-system through the Company's merchant program (discussed below), reducing kWh deliveries to and revenues from the PJM Interconnection. In 1996, interchange delivery revenues increased $28.0 million principally due to increased energy purchases which enabled the Company to sell more of its higher-cost peaking unit output to utilities in the PJM Interconnection.
Electric merchant revenues, which are not subject to price regulation, increased $102.4 million due to the start-up of the Company's new merchant group which sells power in competitive markets outside the Company's traditional service territory.
ELECTRIC RESALE BUSINESS
With electric resale customers free to choose their electric supplier, the electric resale business continues to be highly competitive. If a supplier other than the local utility is selected, then the local utility receives a fee for delivering the electricity to the resale customer. The status of the Company's contract with its largest electric resale customer, Old Dominion Electric Cooperative (ODEC), is discussed below. Other electric resale customers of the Company have electricity supply contracts with the Company which expire in 2001 to 2004.
Under notice provisions in its electricity supply contract, ODEC informed the Company in August 1996 that it will reduce its load of approximately 200 megawatts (MW) by 60 MW on September 1, 1998, and will further reduce its load to zero on September 1, 2001. The Company and ODEC have signed a new contract under which the Company will supply part of the 60 MW. Due to lower pricing and capacity supplied under this new contract beginning September 1, 1998, annualized earnings per share will decrease by $0.04 to $0.05 based on historical common shares outstanding, which equates to about $0.03 based on pro forma Conectiv common shares outstanding. If ODEC further reduces its load to zero on September 1, 2001, then annualized earnings per share would decrease by an additional $0.04 to $0.05 based on historical common shares outstanding, or about $0.03 to $0.04 based on pro forma Conectiv common shares outstanding. These projected earnings decreases are net of the expected savings from avoided capacity costs, which are expected to rise in price substantially during 1998-2000.
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GAS REVENUES, SALES AND TRANSPORTATION
The Company earns gas revenues from gas sales on-system and off-system (merchant sales) and from the transportation of gas for customers. Transportation customers may purchase gas from the Company or other suppliers.
Details of the changes in the various components of gas revenues are shown below.
COMPARATIVE INCREASE (DECREASE) FROM PRIOR YEAR IN GAS REVENUES
The total number of on-system gas customers served by the Company increased by 2.3% in 1997 and 2.5% in 1996.
Gas non-fuel revenues decreased $1.2 million in 1997 principally due to a 9.8% decline in residential gas sales from milder winter weather, partly offset by sales to new customers. In 1996, gas non-fuel revenues increased $3.7 million mainly due to customer growth and a colder heating season.
Gas fuel revenues increased $8.8 million in 1997 primarily due to higher fuel rates. In 1996, gas fuel revenues increased $10.5 million due to a prior year refund of over-recovered fuel costs, higher sales, and higher average rates.
The Company launched its gas merchant business in 1996 and ramped-up operations in 1997. Gas merchant revenues increased $82.2 million in 1997 primarily due to higher off-system gas sales. Similar to electric merchant revenues, the margin provided by gas merchant revenues in excess of related purchased gas costs is relatively small due to the competitive nature of bulk commodity sales.
OTHER SERVICES REVENUES
Other service revenues were comprised of the following:
- -------- (1) Primarily the Company's operation of the Delaware City power plant which supplies power to Star Enterprises' oil refinery. (2) Other includes real estate activities, value-added (energy-related) services, leveraged leasing, telecommunications and other miscellaneous services.
HVAC revenues increased $55.7 million and $7.1 million in 1997 and 1996, respectively, due to acquisitions by CSI of companies which provide HVAC and plumbing services. (For information concerning CSI, see "Business Plans.") Revenues classified above as "Landfill and waste hauling" were earned by Pine
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Grove, Inc. which was sold in the fourth quarter of 1997, as discussed in Note 5, to the Consolidated Financial Statements. In 1996, "Other" revenues increased $16.4 million due to increased revenues from real estate activities and value-added (energy-related) services.
ELECTRIC FUEL AND PURCHASED ENERGY EXPENSES
In 1997, electric fuel and purchased energy expenses increased $89.2 million compared to 1996 primarily due to greater volumes of energy sold and lower amounts of energy expenses deferred under fuel adjustment clauses.
In 1996, electric fuel and purchased energy expenses increased $59.6 million mainly due to higher kWh sales and interchange deliveries, and higher fuel and purchased energy prices. Lower energy expense recognition due to higher amounts deferred under fuel adjustment clauses mitigated the increase.
For information concerning the Salem outage's impact on electric fuel and purchased energy expenses, see Note 18 to the Consolidated Financial Statements.
The kWh output required to serve load within the Company's service territory is substantially equivalent to total output less interchange deliveries and off-system sales. In 1997, the Company's output for load within its service territory was provided by 35% coal generation, 35% net purchased power, 20% oil and gas generation, and 10% nuclear generation.
GAS PURCHASED
In 1997, gas purchased increased $91.8 million due primarily to larger volumes of gas purchased for resale off-system. In 1996, gas purchased increased $12.6 million principally due to higher prices for purchased gas and less purchased gas costs deferred under the fuel adjustment clause.
OTHER SERVICES' COST OF SALES
Other services' cost of sales increased to $85.2 million in 1997 from $55.3 million in 1996 due to acquisitions of HVAC service companies, partly offset by decreased volume in real estate activities and landfill/ waste hauling operations. In 1996, other services' cost of sales increased by $16.3 million primarily due to acquisitions of HVAC service companies and higher volume of real estate activities and value-added (energy-related) services.
OPERATION AND MAINTENANCE EXPENSES
Operation and maintenance expenses increased to $331.8 million in 1997 from $277.9 million in 1996. The $53.9 million increase was mainly due to the start-up of the HVAC, telecommunications, retail energy, and merchant businesses, and costs associated with establishing the Conectiv brand name and gaining new customers. Lower pension cost and Salem outage expenses partly reduced the total increase in operation and maintenance expenses.
In 1996, operation and maintenance expenses increased $12.5 million primarily due to marketing expenses for value-added (energy-related) services, increased costs associated with the Salem outages, and a full year's operation of the Conowingo District.
YEAR 2000
A Conectiv project team has been formed to address the issue of computer programs not properly recognizing the Year 2000. The project team is identifying, analyzing, correcting and reporting on all systems, equipment, and processes suspected of putting Conectiv's businesses or customers at risk. The Year 2000 project team has developed a detailed plan to address the problem. The project team's goal is to resolve Year 2000
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related problems associated with all core systems by the close of 1998. The recent implementation of a new management information system has resolved a substantial portion of the "Year 2000" problem. The Company has also contacted major vendors to review remediation of their Year 2000 issues. The Company believes it will successfully resolve its Year 2000 issues in a timely manner and does not expect related costs to be material to the Company's results of operations or financial position.
DEPRECIATION EXPENSE
Depreciation expense increased $7.8 million in 1997 due to completion of on- going construction projects and installation of new systems. Depreciation expense increased $9.2 million in 1996 due to the completion of on-going construction projects and the acquisition of COPCO in mid-1995.
OTHER INCOME
In 1997, other income increased to $28.2 million from $7.6 million in 1996 primarily due to a $22.9 million pre-tax gain on the sale of the Pine Grove landfill and waste-hauling operations. On an after-tax basis, the gain was $13.7 million or $0.22 per common share.
FINANCING COSTS
Financing costs reflected in the consolidated income statement include interest charges, allowance for funds used during construction (AFUDC), dividends on preferred securities of a subsidiary trust, and dividends on preferred stock. In 1997, financing costs increased $9.9 million primarily due to higher interest charges from the issuance of $124.2 million of Medium-Term Notes in February 1997 and $42.0 million of Medium-Term Notes in the fourth quarter of 1997, partly offset by savings from the refinancing of $78.4 million of preferred stock in the fourth quarter of 1996. In 1996, financing costs increased $3.2 million primarily due to debt issued in mid-1995 to finance the acquisition of COPCO.
LIQUIDITY AND CAPITAL RESOURCES
The Company's primary capital resources are internally generated funds (net cash provided by operating activities less common and preferred dividends) and external financings. These resources provide capital for utility construction expenditures, expansion of new business lines and other capital requirements, such as repayment of maturing debt and capital lease obligations. Utility construction expenditures are the Company's largest on-going capital requirement and are affected by many factors including growth in demand for electricity. In the foreseeable future, the Company expects that incremental demand for electricity will be supplied with purchased power. This expectation, and the Company's strategy to grow new businesses, has shifted a larger proportion of the Company's capital resources into new businesses.
Capital expenditures increased $4.0 million in 1997 and $26.2 million in 1996. The 1997 increase was principally due to $35 million of capital expenditures to expand CCI's fiber optic network, partially offset by a $30 million decrease in utility construction expenditures, including deferred Merger-related costs. In 1996, capital expenditures increased $26.2 million primarily due to higher utility construction.
The Company's cash expenditures for business acquisitions of $17.6 million and $4.9 million in 1997 and 1996, respectively, were due to CSI's acquisition of HVAC and related businesses. In 1995, the Company acquired COPCO for $157.0 million, net of cash acquired, with $125.8 million of long-term debt and the balance with short-term debt.
Operating activities provided net cash inflows of $221.3 million in 1997, $222.7 million in 1996, and $239.4 million in 1995. In 1997, increased cash flows from higher regulated fuel revenues, net of amounts paid for fuel and purchased energy, were offset by planned cost increases associated with investments in new businesses. In 1996, net cash flow from operating activities decreased $16.7 million due to lower electric fuel revenues, net of amounts paid for electric fuel and purchased energy.
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After deducting common and preferred dividend payments of $98.0 million in 1997, $102.4 million in 1996, and $102.0 million in 1995, internally generated funds were $123.2 million in 1997, $120.3 million in 1996, and $137.4 million in 1995. Internally generated funds provided 110%, 79%, and 101% of the cash required for utility construction in 1997, 1996, and 1995, respectively.
"Sales of nonutility assets" under cash flows from investing activities includes $33.4 million of pre-tax proceeds from the 1997 sale of Pine Grove Inc.'s landfill and waste-hauling operations. The principal effects of the sale on the consolidated balance sheet were a $23.7 million decrease in nonutility property and an $11.7 million decrease in variable rate demand bonds.
Long-term financings during 1995-1997, net of long-term refinancings and redemptions, raised $292.8 million of net capital. Sources of cash from long- term financings, net of refinancings and redemptions, included the following: $28.9 million of common stock; $260.6 million of long-term debt; $11.7 million of variable rate demand bonds; and $70.0 million of Company obligated mandatorily redeemable preferred securities issued by the Company's subsidiary trust (as discussed below). Preferred stock outstanding was reduced by $78.4 million during this period.
Depending on its financing needs, the Company periodically raises cash by issuing common stock through its Dividend Reinvestment and Common Share Purchase Plan (DRIP). Alternatively, the Company at times provides DRIP shares to investing stockholders by purchasing its common shares in the open market.
In February 1997, the Company issued $124.2 million of unsecured Medium-Term Notes with maturities of 10 to 30 years and interest rates of 7.06% to 7.72%. The proceeds were used to repay short-term debt. On the consolidated balance sheet as of December 31, 1996, $77.0 million of short-term debt was reclassified to long-term debt to recognize the amount of short-term debt refinanced with the Medium-Term Notes.
In September 1997, $25.0 million of 6 3/8% First Mortgage Bonds were redeemed at maturity. In June 1998, $25 million of 5.69%, Medium-Term Notes are scheduled to mature.
In the fourth quarter of 1997, the Company repaid short-term debt with proceeds from the issuance of $42 million of unsecured Medium-Term Notes with maturities of 5 to 9 years and interest rates of 6.6% to 6.8%.
In January 1998, the Company issued $33.0 million of 6.81% Medium-Term Notes, which mature in 20 years, and used $25.4 million of the proceeds to repay short-term debt. In recognition of this refinancing, $25.4 million of short-term debt was reclassified to long-term debt on the consolidated balance sheet as of December 31, 1997.
In October 1996, a subsidiary trust of the Company issued $70 million of 8.125% Company obligated mandatorily redeemable preferred securities and loaned the proceeds to the Company. On a consolidated basis, this financing vehicle results in a tax benefit which is equivalent to the tax effect of a deduction for distributions on the preferred securities. The proceeds from the issuance of the preferred securities and additional short-term debt were used to retire $78.4 million of the Company's preferred stock, which had an average dividend rate of 6.9%. On an after-tax basis, the refinancing lowers financing costs by approximately $1.5 million annually.
The Company's capital structure as of December 31, 1997 and 1996, expressed as a percentage of total capitalization, is shown below.
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Presented below are Conectiv's estimated capital requirements, including anticipated expenditures for business acquisitions.
Over the five-year forecast period, Conectiv's capital requirements, exclusive of maturing debt, are expected to be funded by internally generated funds. External financing, during the five-year period, is anticipated only for the refunding of maturing debt.
NONUTILITY SUBSIDIARIES
For summarized financial information on the Company's nonutility subsidiaries, please refer to Note 20 to the Consolidated Financial Statements.
FORWARD-LOOKING STATEMENTS
The Private Securities Litigation Reform Act of 1995 (Litigation Reform Act) provides a "safe harbor" for forward-looking statements to encourage such disclosures without the threat of litigation, provided those statements are identified as forward-looking and are accompanied by meaningful, cautionary statements identifying important factors that could cause the actual results to differ materially from those projected in the statement. Forward-looking statements have been made in this report. Such statements are based on management's beliefs as well as assumptions made by and information currently available to management. When used herein, the words "will," "anticipate," "estimate," "expect," "objective," and similar expressions are intended to identify forward-looking statements. In addition to any assumptions and other factors referred to specifically in connection with such forward-looking statements, factors that could cause actual results to differ materially from those contemplated in any forward-looking statements include, among others, the following: deregulation and the unbundling of energy supplies and services; an increasingly competitive energy marketplace; sales retention and growth; federal and state regulatory actions; future litigation results; costs of construction; operating restrictions; increased costs and construction delays attributable to environmental regulations; nuclear decommissioning and the availability of reprocessing and storage facilities for spent nuclear fuel; and credit market concerns. The Company undertakes no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise. The foregoing review of factors pursuant to the Litigation Reform Act should not be construed as exhaustive or as any admission regarding the adequacy of disclosures made by the Company prior to the effective date of the Litigation Reform Act.
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ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
REPORT OF MANAGEMENT
Management is responsible for the information and representations contained in the Company's financial statements. Our financial statements have been prepared in conformity with generally accepted accounting principles, based upon currently available facts and circumstances and management's best estimates and judgments of the expected effects of events and transactions.
Delmarva Power & Light Company maintains a system of internal controls designed to provide reasonable, but not absolute, assurance of the reliability of the financial records and the protection of assets. The internal control system is supported by written administrative policies, a program of internal audits, and procedures to assure the selection and training of qualified personnel.
Coopers & Lybrand L.L.P., independent accountants, are engaged to audit the financial statements and express their opinion thereon. Their audits are conducted in accordance with generally accepted auditing standards which include a review of selected internal controls to determine the nature, timing, and extent of audit tests to be applied.
The Audit Committee of the Board of Directors, composed of outside directors only, meets with management, internal auditors, and independent accountants to review accounting, auditing, and financial reporting matters. The independent accountants are appointed by the Board on recommendation of the Audit Committee, subject to stockholder approval.
/s/ Howard E. Cosgrove /s/ Barbara S. Graham - ------------------------------------- ------------------------------------- Howard E. Cosgrove Barbara S. Graham Chairman of the Board, President Senior Vice President and Chief Executive Officer and Chief Financial Officer
March 1, 1998
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REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and Stockholders Delmarva Power & Light Company Wilmington, Delaware
We have audited the accompanying consolidated balance sheets of Delmarva Power & Light Company and Subsidiary Companies as of December 31, 1997 and 1996, and the related consolidated statements of income, changes in common stockholders' equity, and cash flows for each of the three years in the period ended December 31, 1997. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Delmarva Power & Light Company and Subsidiary Companies as of December 31, 1997 and 1996, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 1997, in conformity with generally accepted accounting principles.
/s/ Coopers & Lybrand L.L.P. - ------------------------------------- Coopers & Lybrand L.L.P. 2400 Eleven Penn Center Philadelphia, Pennsylvania February 6, 1998, except as to the information presented in Note 4 under Merger with Atlantic Energy, Inc., for which the effective date of the merger is March 1, 1998
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DELMARVA POWER & LIGHT COMPANY
CONSOLIDATED STATEMENTS OF INCOME
See accompanying Notes to Consolidated Financial Statements.
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DELMARVA POWER & LIGHT COMPANY
CONSOLIDATED BALANCE SHEETS
See accompanying Notes to Consolidated Financial Statements.
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DELMARVA POWER & LIGHT COMPANY
CONSOLIDATED BALANCE SHEETS
See accompanying Notes to Consolidated Financial Statements.
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DELMARVA POWER & LIGHT COMPANY
CONSOLIDATED STATEMENTS OF CASH FLOWS
- -------- (1) Other than debt and deferred income taxes classified as current. (2) Excluding net change in term loan. (3) Company obligated mandatorily redeemable preferred securities of subsidiary trust holding solely Company debentures. (4) As of December 31, 1994, the Company had a $45.0 million term loan which was classified as long-term debt.
See accompanying Notes to Consolidated Financial Statements.
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DELMARVA POWER & LIGHT COMPANY CONSOLIDATED STATEMENTS OF CHANGES IN COMMON STOCKHOLDERS' EQUITY
- -------- (1) The Company's common stock has a par value of $2.25 per share and 90,000,000 shares are authorized. (2) Dividend Reinvestment and Common Share Purchase Plan (DRIP)--As of December 31, 1997, 3,742,677 shares remained available under the Company's registration statement filed with the Securities and Exchange Commission for issuance of shares through the DRIP. (3) Shares of restricted common stock granted under the Company's Long-Term Incentive Plan.
See accompanying Notes to Consolidated Financial Statements.
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DELMARVA POWER & LIGHT COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. SIGNIFICANT ACCOUNTING POLICIES
NATURE OF BUSINESS
As discussed in Note 4 to the Consolidated Financial Statements, effective March 1, 1998, Delmarva Power & Light Company (the Company) and Atlantic Energy, Inc. (Atlantic) consummated a series of merger transactions (the Merger) which formed a new company named Conectiv, and merged Atlantic out of existence.
In 1997, the Company's revenues were earned from the following sources: 77% from the sale and delivery of electricity, 14% from the sale and transportation of gas, and 9% from other services.
The Company provides regulated electric service (supply and delivery) to approximately 448,300 customers located on the Delmarva Peninsula and also sells electricity off-system in markets which are not subject to price regulation. The Company's traditional electric service territory on the Delmarva Peninsula, which includes Delaware, ten primarily Eastern Shore counties in Maryland, and the Eastern Shore of Virginia, encompasses an area consisting of about 6,000 square miles with a population of approximately 1.2 million.
The Company provides regulated gas service (supply and/or transportation) to approximately 103,200 customers located in an area consisting of about 275 square miles with a population of approximately 480,000 in northern Delaware, including the City of Wilmington. The Company also sells gas off-system in markets which are not subject to price regulation.
"Other services," which are not subject to utility regulation, are sold by the Company and its wholly owned subsidiaries. As of December 31, 1997, other services' business activities were conducted primarily by three subsidiaries: Conectiv Services, Inc., which provides heating, ventilation, and air- conditioning (HVAC) sales, installation and services; Conectiv Communications, Inc., which provides local and long-distance phone service; and Delmarva Capital Investments, Inc., which is involved in power plant operating services, real estate activities, and leveraged equipment leases. Delmarva Capital Investments, Inc. sold its landfill and waste-hauling operations in 1997 as discussed in Note 5 to the Consolidated Financial Statements.
REGULATION OF UTILITY OPERATIONS
The Company is subject to regulation with respect to its retail utility sales by the Delaware and Maryland Public Service Commissions (DPSC and MPSC, respectively) and the Virginia State Corporation Commission (VSCC), which have powers over rate matters, accounting, and terms of service. Gas sales are subject to regulation by the DPSC. The Federal Energy Regulatory Commission (FERC) exercises jurisdiction with respect to the Company's accounting systems and policies, the transmission of electricity, the wholesale sale of electricity, and interchange and other purchases and sales of electricity involving other utilities. The FERC also regulates the price and other terms of transportation of natural gas purchased by the Company. Excluding off- system sales not subject to price regulation, the percentage of electric and gas utility operating revenues regulated by each Commission for the year ended December 31, 1997, was as follows: DPSC, 64.0%; MPSC, 27.0%; VSCC, 2.7%; and FERC, 6.3%.
Refer to Note 9 to the Consolidated Financial Statements for a discussion of regulatory assets arising from the financial effects of rate regulation.
CONSOLIDATION POLICY
The consolidated financial statements include the accounts of the Company's wholly owned subsidiaries. All significant intercompany accounts and transactions are eliminated in consolidation. Certain reclassifications, not affecting net income, have been made to conform amounts previously reported to the current presentation.
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DELMARVA POWER & LIGHT COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
Primarily, the operating results of nonutility subsidiaries were reclassified from "Other income" into other classifications within the income statement.
USE OF ESTIMATES
The preparation of financial statements in conformity with generally accepted accounting principles requires management to make certain estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
UTILITY REVENUES
At the end of each month, there is an amount of electric and gas service rendered from the last meter reading to the month-end which has not yet been billed to customers. The non-fuel (base rate) revenues associated with such unbilled services are accrued by the Company.
When interim rates are placed in effect subject to refund, the Company recognizes revenues based on expected final rates.
FUEL EXPENSE
Fuel costs charged to the Company's results of operations generally are adjusted to match fuel costs included in customer billings (fuel revenues). The difference between fuel revenues and actual fuel costs incurred is reported on the Consolidated Balance Sheets as "Deferred energy costs." The deferred balance is subsequently recovered from or returned to utility customers.
The Company's share of nuclear fuel at the Peach Bottom Atomic Power Station (Peach Bottom) and the Salem Nuclear Generating Station (Salem) is financed through a contract which is accounted for as a capital lease. Nuclear fuel costs, including a provision for the future disposal of spent nuclear fuel, are charged to fuel expense on a unit-of-production basis.
FINANCIAL INSTRUMENTS
The Company's Energy Supply business group (currently known as Conectiv Energy Supply) uses futures, options and swap agreements to hedge firm commitments or anticipated transactions of commodities associated with the energy sector (natural gas and electricity). In order to qualify for hedge accounting a derivative, at its inception and on an ongoing basis, must be expected to substantially offset adverse price movements in the firm commitment or anticipated transaction that it is hedging. Gains and losses related to qualifying hedges are deferred and are recognized in income when the underlying transaction occurs. If subsequent to being hedged, underlying transactions are no longer likely to occur or the hedge is no longer effective, the related derivatives gains or losses are recognized currently in income. Gains and losses on derivatives that do not qualify as hedges are recognized currently in revenues. Premiums paid for options are included as current assets in the consolidated balance sheet until they are exercised or expire. Margin requirements for futures contracts are also recorded as current assets. Unrealized gains and losses on all futures contracts are deferred on the consolidated balance sheet as either current assets or deferred credits. The cash flows from derivatives are included in the cash flows from operations section of the cash flow statement.
DEPRECIATION EXPENSE
The annual provision for depreciation on utility property is computed on the straight-line basis using composite rates by classes of depreciable property. The relationship of the annual provision for depreciation for
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DELMARVA POWER & LIGHT COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
financial accounting purposes to average depreciable property was 3.7% for 1997 and 3.6% for 1996 and 1995. Depreciation expense includes a provision for the Company's share of the estimated cost of decommissioning nuclear power plant reactors based on amounts billed to customers for such costs. Refer to Note 7 to the Consolidated Financial Statements for additional information on nuclear decommissioning.
INCOME TAXES
Refer to Note 3, for the Company's accounting policy on income taxes and investment tax credits.
DEBT REFINANCING COSTS
Costs of refinancing debt are deferred and amortized over the period during which the refinancing costs are recovered in utility rates.
INTEREST EXPENSE
The amortization of debt discount, premium, and expense, including refinancing expenses, is included in interest expense.
ALLOWANCE FOR FUNDS USED DURING CONSTRUCTION
Allowance for Funds Used During Construction (AFUDC) is included in the cost of utility plant and represents the cost of borrowed and equity funds used to finance construction of new utility facilities. In the Consolidated Statements of Income, the borrowed funds component of AFUDC is reported as a reduction of interest expense and the equity funds component of AFUDC is reported as other income. AFUDC was capitalized on utility plant construction at the rates of 7.5% in 1997, 6.7% in 1996, and 7.1% in 1995.
STOCK-BASED EMPLOYEE COMPENSATION
Refer to Note 10 to the Consolidated Financial Statements for the Company's accounting policy on stock-based employee compensation.
GOODWILL
The Company amortizes goodwill arising from business acquisitions over the shorter of the estimated useful life or 40 years.
LEVERAGED LEASES
As of December 31, 1997, the Company's portfolio of leveraged leases, held by a nonutility subsidiary, consisted of five aircraft leased to three separate airlines. The Company's investment in leveraged leases includes the aggregate of rentals receivable (net of principal and interest on nonrecourse indebtedness) and estimated residual values of the leased equipment less unearned and deferred income (including investment tax credits). Unearned and deferred income is recognized at a level rate of return during the periods in which the net investment is positive.
FUNDS HELD BY TRUSTEE
Funds held by trustee are stated at fair market value and generally include deposits in the Company's external nuclear decommissioning trusts and unexpended, restricted, tax-exempt bond proceeds.
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DELMARVA POWER & LIGHT COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
EARNINGS PER SHARE
Earnings per share has been computed in accordance with Statement of Financial Accounting Standards (SFAS) No. 128, "Earnings Per Share." Under SFAS No. 128, basic earnings per share is computed based on earnings applicable to common stock (net income less preferred dividends) divided by the weighted average number of common shares outstanding for the period. Diluted earnings per share is computed based on earnings applicable to common stock divided by the weighted average number of shares of common stock outstanding during the period after giving effect to securities considered to be dilutive common stock equivalents. The effect of dilutive common stock equivalents was not significant, consequently for 1997, 1996, and 1995, the Company's basic and diluted earnings per share were the same amounts.
CASH EQUIVALENTS
In the consolidated financial statements, the Company considers highly liquid marketable securities and debt instruments purchased with a maturity of three months or less to be cash equivalents.
2. SUPPLEMENTAL CASH FLOW INFORMATION
CASH PAID DURING THE YEAR
3. INCOME TAXES
The Company files a consolidated federal income tax return which includes its wholly owned subsidiaries. Income taxes are allocated to the Company's subsidiaries based upon the taxable income or loss of each subsidiary.
Deferred income tax assets and liabilities represent the tax effects of temporary differences between the financial statement and tax bases of existing assets and liabilities and are measured using presently enacted tax rates. The portion of the Company's deferred tax liability applicable to utility operations that has not been reflected in current customer rates represents income taxes recoverable through future rates and is reflected on the Consolidated Balance Sheets as "Deferred recoverable income taxes." Deferred recoverable income taxes were $88.7 million and $90.3 million as of December 31, 1997 and 1996, respectively.
Deferred income tax expense represents the net change during the reporting period in the net deferred tax liability and deferred recoverable income taxes.
Investment tax credits (ITC) from regulated operations are being amortized over the useful lives of the related utility plant. ITC associated with leveraged leases are being amortized over the lives of the related leases during the periods in which the net investment is positive.
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DELMARVA POWER & LIGHT COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
COMPONENTS OF CONSOLIDATED INCOME TAX EXPENSE
RECONCILIATION OF EFFECTIVE INCOME TAX RATE
The amount computed by multiplying income before tax by the federal statutory rate is reconciled below to the total income tax expense.
COMPONENTS OF DEFERRED INCOME TAXES
The tax effect of temporary differences that give rise to the Company's net deferred tax liability are shown below.
Valuation allowances for deferred tax assets were not material as of December 31, 1997 and 1996.
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DELMARVA POWER & LIGHT COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
4. MERGERS AND ACQUISITIONS
MERGER WITH ATLANTIC ENERGY, INC.
On August 12, 1996, the Company announced plans to merge with Atlantic Energy, Inc. (Atlantic). On March 1, 1998, the two companies consummated merger transactions (the Merger) which formed a new company named Conectiv, and merged Atlantic out of existence. Prior to the Merger, Atlantic owned Atlantic City Electric Company (ACE), an electric utility, and subsidiaries engaged in nonutility businesses. ACE serves approximately 481,000 customers in a 2,700 square mile area in southern New Jersey. For financial information about Atlantic and ACE, see the tables presented at the end of this note.
Under the Merger approval settlement agreements with the DPSC, MPSC, and VSCC, the Company will reduce retail base rates in order to share with utility customers a portion (ranging from approximately 50% to 60%) of the net cost savings expected to result from the Merger. The annualized amounts of the retail base rate decreases are as follows:
Under the Merger order of the Board of Public Utilities (BPU) in New Jersey, ACE will share approximately 75% of the estimated Merger savings with its customers through a $15.75 million (on an annualized basis) electric rate reduction.
On June 26, 1997, the Company and Atlantic announced that enhanced retirement offers (ERO) and other employee separation programs were expected to be utilized to achieve workforce reductions concurrent with the Merger of the two companies. As of December 31, 1997, the ERO and other employee separation programs were contingent on consummation of the Merger. Employee separation costs and other Merger costs related to Delmarva will be expensed and are estimated to be approximately $55 million to $60 million before taxes ($33 million to $36 million after taxes).
Conectiv, a corporation formed to accomplish the Merger, holds the common stock of the Company and ACE and is a registered holding company under the Public Utility Holding Company Act of 1935. Each outstanding share of the Company's common stock, par value $2.25 per share, is being exchanged for one share of Conectiv's common stock, par value $0.01 per share. Each share of Atlantic's common stock, no par value per share, is being exchanged for 0.75 of one share of Conectiv's common stock and 0.125 of one share of Conectiv's Class A common stock, par value $0.01 per share. Class A common stock gives holders of Atlantic common stock a proportionately greater opportunity to share in the growth prospects of, and a proportionately greater exposure to the uncertainties associated with the electric utility business of ACE. Earnings applicable to Class A common stock will be equal to 30% of the net of (1) earnings attributable to ACE's regulated electric utility business, as the business existed on August 9, 1996, less (2) $40 million per year. Earnings applicable to Conectiv common stock will be the consolidated earnings of Conectiv less earnings applicable to Class A common stock.
The Merger is being accounted for under the purchase method of accounting, with the Company as the acquirer. The total consideration to be paid to Atlantic's common stockholders, measured by the average daily
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DELMARVA POWER & LIGHT COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
closing market price of Atlantic's common stock for the three trading days immediately preceding and the three trading days immediately following the public announcement of the Merger, is $921.0 million. The consideration paid plus estimated acquisition costs and liabilities assumed in connection with the Merger are expected to exceed the net book value of Atlantic's net assets by approximately $200.5 million, which will be recorded as goodwill. The actual amount of goodwill recorded will be based on Atlantic's net assets as of the Merger date and, accordingly, will vary from the preceding estimate which is based on Atlantic's net assets as of December 31, 1997. The goodwill will be amortized over 40 years.
Pro forma unaudited financial information for Conectiv on a consolidated basis, giving effect to the Merger as if it had occurred on January 1, 1997, and actual reported financial information for Atlantic and ACE is presented below. The pro forma information excludes expected one-time charges related to the Merger such as the ERO and other employee separation costs. The pro forma information is not necessarily indicative of the results that would have occurred in 1997, or that will occur in the future.
SUMMARIZED INCOME STATEMENT INFORMATION (UNAUDITED)
- -------- (1) The calculation of pro forma 1997 earnings applicable to Class A common stock is shown below.
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DELMARVA POWER & LIGHT COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
SUMMARIZED BALANCE SHEET INFORMATION (UNAUDITED)
ACQUISITION OF CONOWINGO POWER COMPANY
On June 19, 1995, the Company acquired Conowingo Power Company (COPCO), the Maryland retail electric subsidiary of PECO Energy Company (PECO), for $158.2 million ($157.0 million net of cash acquired). The Company financed the acquisition with $125.8 million of long-term debt and the balance with short- term debt. COPCO was merged into the Company and is operated as the Conowingo District. Approximately 37,500 electric retail customers were added to the Company's customer base. The acquisition was accounted for as a purchase and, accordingly, the operating results of the Conowingo District since June 19, 1995 are included in the Consolidated Statements of Income. The purchase price included $76 million of goodwill which is being amortized on a straight-line basis over 40 years.
Assuming that the COPCO acquisition had occurred at the beginning of 1995, the Company's pro forma operating results for 1995 would not have been materially different from the operating results reported.
ACQUISITION OF OTHER SERVICE COMPANIES
The Company's expenditures for HVAC and other service companies acquired in 1997 and 1996 were $17.6 million and $9.3 million (including non-cash consideration), respectively.
5. SALE OF PINE GROVE LANDFILL AND WASTE HAULING COMPANIES
In the fourth quarter 1997, a subsidiary of the Company sold the Pine Grove Landfill and its related waste-hauling company. The subsidiaries which were sold had a net book value of approximately $11.3 million and reported revenues in 1997 of approximately $12.7 million. Pre-tax proceeds received from the sale were $34.2 million ($33.4 million net of cash sold), resulting in a pre- tax gain of $22.9 million ($13.7 million after income taxes) or $0.22 per common share.
6. COMMODITY HEDGING ACTIVITIES
The Company's Energy Supply business group (currently known as Conectiv Energy Supply) engages in commodity hedging activities to minimize the risk of market fluctuations associated with the purchase and sale of energy commodities (natural gas and electricity). Some hedging activities are conducted using energy derivatives. Most of the Company's hedging activity is conducted by backing physical transactions with offsetting physical positions. Currently, commodity hedging activities using derivatives are only conducted in
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DELMARVA POWER & LIGHT COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
conjunction with transactions that are not subject to price regulation. The hedging objectives include the assurance of stable and known minimum cash flows and the fixing of favorable prices and margins when they become available. Under internal guidelines, risk exposure is mitigated to acceptable risk tolerance levels.
Energy Supply utilizes futures, options and swap agreements to manage risk. Futures help manage commodity price risk by fixing purchase or sales prices. Options provide a floor or ceiling on future purchases or sales prices while allowing the Company to benefit from favorable price movements. Swaps are structured to provide the same risk protection as futures and options. Basis swaps are used to manage risk by fixing the basis differential that exists between a delivery location index and the commodity futures price.
At December 31, 1997, there were 220 open futures contracts and 30 open options contracts to purchase natural gas, representing a notional quantity of 2.5 billion cubic feet (Bcf) through October of 1999, at an average price of $2.35 per thousand cubic feet (Mcf), and 60 open options contracts, to sell natural gas, representing a notional quantity of 0.6 Bcf through July of 1998 at an average price of $2.38 per Mcf. At December 31, 1997, there was 1 swap contract to sell electricity, representing a notional quantity of 68,000 megawatt-hours (MWh), through August of 1998 at an average price of $31.91 per MWh. These open contracts were entered into to hedge the gas and electric marketing activities of the Energy Supply business group through October 1999. A total of $0.3 million of unrealized losses were deferred on the consolidated balance sheet as of December 31, 1997.
The Company is exposed to credit losses in the event of nonperformance by counterparties to its various hedging contracts. Management has evaluated and implemented policies and procedures to monitor such risk and believes that the overall business risk is minimized as a result.
7. NUCLEAR DECOMMISSIONING
The Company records a liability for its share of the estimated cost of decommissioning the Peach Bottom and Salem nuclear reactors over the remaining lives of the plants based on amounts collected in rates charged to electric customers. For utility rate-setting purposes, the Company estimates its share of future nuclear decommissioning costs based on Nuclear Regulatory Commission (NRC) regulations concerning the minimum financial assurance amount for nuclear decommissioning. The Company is presently recovering, through electric rates in the Delaware and Virginia jurisdictions, nuclear decommissioning costs based on the current NRC minimum financial assurance amount of approximately $130 million. In the Maryland and FERC jurisdictions, the Company is presently recovering nuclear decommissioning costs based on the 1990 NRC minimum financial assurance amount of approximately $50 million.
The Company's accrued nuclear decommissioning liability, which is reflected in the accumulated reserve for depreciation, was $48.8 million as of December 31, 1997. The provision reflected in depreciation expense for nuclear decommissioning was $4.2 million in 1997, $4.2 million in 1996, and $3.6 million in 1995. External trust funds established by the Company for the purpose of funding nuclear decommissioning costs had an aggregate book balance of $46.5 as of December 31, 1997. Earnings on the trust funds are recorded as an increase to the accrued nuclear decommissioning liability, which, in effect, reduces the expense recorded for nuclear decommissioning.
The ultimate cost of nuclear decommissioning for the Peach Bottom and Salem reactors may exceed the NRC minimum financial assurance amount, which is updated annually under a NRC prescribed formula.
The staff of the Securities and Exchange Commission has questioned certain of the current accounting practices of the electric utility industry, including the Company, regarding the recognition, measurement and classification of decommissioning costs for nuclear generating stations in the financial statements of electric utilities. In February 1996, the Financial Accounting Standards Board (FASB) issued the Exposure Draft,
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DELMARVA POWER & LIGHT COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
"Accounting for Certain Liabilities Related to Closure or Removal of Long- Lived Assets," which proposed changes in the accounting for closure and removal costs of long-lived assets, including the recognition, measurement, and classification of decommissioning costs for nuclear generating stations. If the proposed changes were adopted: (1) annual provisions for decommissioning would increase, (2) the estimated cost for decommissioning would be recorded as a liability rather than as accumulated depreciation, and (3) trust fund income from the external decommissioning trusts would be reported as investment income rather than as a reduction of decommissioning expense. The FASB is uncertain when it will issue a final Statement or a revised Exposure Draft.
8. JOINTLY OWNED PLANT
The Company's Consolidated Balance Sheets include its proportionate share of assets and liabilities related to jointly owned plant. The Company's share of operating and maintenance expenses of the jointly owned plant is included in the corresponding expenses in the Consolidated Statements of Income. The Company is responsible for providing its share of financing for the jointly owned facilities. Information with respect to the Company's share of jointly owned plant as of December 31, 1997 was as follows:
9. REGULATORY ASSETS
In conformity with generally accepted accounting principles, the Company's accounting policies reflect the financial effects of rate regulation and decisions issued by regulatory commissions having jurisdiction over the Company's utility business. In accordance with the provisions of SFAS No. 71, "Accounting for the Effects of Certain Types of Regulation," the Company defers expense recognition of certain costs and records an asset, a result of the effects of rate regulation. Except for deferred energy costs, which are classified as a current asset, these "regulatory assets" are included on the Company's Consolidated Balance Sheets under "Deferred Charges and Other Assets." As of December 31, 1997, the Company had $156.5 million of regulatory assets, which included the following: deferred energy costs--$18.0 million; deferred debt refinancing costs--$18.8 million; deferred recoverable income taxes--$88.7 million (refer to Note 3, to the Consolidated Financial Statements); deferred recoverable plant costs--$7.8 million; deferred costs for decontamination and decommissioning of United States Department of Energy gaseous diffusion enrichment facilities--$6.3 million; deferred demand-side management costs--$6.2 million; and other regulatory assets--$10.7 million. The costs of these assets are either being recovered or are probable of being recovered through customer rates. Generally, the costs of these assets are recognized in operating expenses over the period the cost is recovered from customers.
Prices charged to electric utility customers have historically been a "bundled" price which includes the electricity production (supply) cost and the delivery cost (transmission and distribution). Various state regulatory
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DELMARVA POWER & LIGHT COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
commissions and legislatures, as well as federal legislators, are considering or have approved changes to laws and regulations governing the pricing of electricity. These changes would generally deregulate the supply component of the price charged to a customer for electricity. Under existing plans, the transmission and distribution of electricity would continue to be regulated. Authoritative accounting guidance issued in 1997 prescribes that a utility should cease to apply SFAS No. 71 for any separable portion of the business, such as the electricity supply portion of the business no later than the date that a specific deregulation plan is finalized. Stranded costs and regulatory assets attributed to electricity supply would continue to be recognized to the extent that a transition plan provides for their recovery through cash flows from the regulated transmission and distribution business.
Proposals concerning deregulation of the electric utility industry are being considered in Delaware, Maryland, and Virginia (the states which have jurisdiction over the Company's retail electric utility business), but no deregulation plan has yet been finalized. Thus, at this time, the Company cannot predict if or when it would cease applying SFAS No. 71, and the related financial impacts of discontinuing SFAS No. 71.
10. COMMON STOCK
For information concerning issuances and redemptions of common stock during 1995-1997, please refer to the Consolidated Statements of Changes in Common Stockholders' Equity.
Through the effective date of the Company's Merger with Atlantic (March 1, 1998), the Company's Long-Term Incentive Plan (LTIP) provided long-term incentives to key employees through contingent awards of performance-based restricted stock. The restricted stock is earned over a four-year period to the extent that performance targets are satisfied. Restrictions on shares contingently granted in 1994-1996 will lapse upon the earlier of March 1, 1998 or the end of the four-year vesting period. Restrictions on shares contingently granted in 1997 do not lapse on March 1, 1998. During 1997, 1996, and 1995, the number of restricted shares contingently granted and their fair values as of grant date was as follows: 1997--110,670 shares, $19 1/8 per share fair value; 1996--48,750 shares, $22 3/4 per share fair value; 1995-- 62,050 shares, $18 9/64 per share fair value.
Changes in stock options granted under the LTIP are summarized below.
For options outstanding as of December 31, 1997, the range of exercise prices was $17.50 to $21.25 and the weighted average remaining contractual life was 2.8 years.
The Company recognizes compensation costs for its stock-based employee compensation plans based on the accounting prescribed by Accounting Principles Board (APB) Opinion No. 25, "Accounting for Stock Issued to Employees." Stock- based employee compensation costs charged to expense were $2.2 million in 1997, $0.3 million in 1996, and $1.3 million in 1995. Pro forma net income, based on the application of SFAS No. 123, "Accounting for Stock-Based Compensation," would have changed by $0.5 million or less in 1997, 1996, and 1995, and earnings per share would have changed by less than $0.01 per share in each year.
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DELMARVA POWER & LIGHT COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
11. COMPANY OBLIGATED MANDATORILY REDEEMABLE PREFERRED SECURITIES OF SUBSIDIARY TRUST HOLDING SOLELY COMPANY DEBENTURES
A wholly owned subsidiary trust (Delmarva Power Financing I) was established in 1996 as a financing subsidiary of the Company for the purposes of issuing common and preferred trust securities and holding 8.125% Junior Subordinated Debentures (the Debentures). The Debentures held by the trust are its only assets. The trust uses interest payments received on the Debentures it holds to make cash distributions on the trust securities.
The combination of the obligations of the Company pursuant to the Debentures, agreements to pay the expenses of the trust and the Company's guarantee of distributions with respect to trust securities, to the extent the trust has funds available therefor, constitute a full and unconditional guarantee by the Company of the obligations of the trust under the trust securities the trust has issued. The Company is the owner of all of the common securities of the trust, which constitute approximately 3% of the liquidation amount of all of the trust securities issued by the trust.
In October 1996, the trust issued $70 million in aggregate liquidation amount of 8.125% Cumulative Trust Preferred Capital Securities (representing 2,800,000 preferred securities at $25 per security). At the same time, $72,165,000 in aggregate principal amount of 8.125% Junior Subordinated Debentures, Series I, due 2036 were issued to the trust. For consolidated financial reporting purposes, the Debentures are eliminated in consolidation against the trust's investment in the Debentures. The preferred trust securities are subject to mandatory redemption upon payment of the Debentures at maturity or upon redemption. The Debentures are subject to redemption, in whole or in part at the option of the Company, at 100% of their principal amount plus accrued interest, after an initial period during which they may not be redeemed and at any time upon the occurrence of certain events.
In October 1996, the Company used part of the proceeds received from the trust to purchase and retire $32,087,500 of its $25 par value, 7.75% series preferred stock, and $31,295,200 of various series of its $100 par value preferred stock which had an average dividend rate of 5.68%. In December 1996, the Company used the balance of the proceeds and cash from short-term debt to fund the redemption of its entire 7.52% preferred stock series which had a total par value of $15,000,000.
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DELMARVA POWER & LIGHT COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
12. CUMULATIVE PREFERRED STOCK
The Company has $1, $25, and $100 par value per share preferred stock for which 10,000,000; 3,000,000; and 1,800,000 shares are authorized, respectively. No shares of the $1 par value per share preferred stock are outstanding. Shares outstanding for each series of the $25 and $100 par value per share preferred stock are listed below. Redemptions of preferred stock in 1996 are discussed in Note 11 to the Consolidated Financial Statements.
- -------- (1) Redeemable beginning September 30, 2002, at $25 per share. (2) Redeemable beginning November 1, 2003, at $100 per share. (3) Average rates were 5.5% during 1997 and 1996. (4) Average rates were 4.1% during 1997 and 1996.
13. DEBT
Substantially all utility plant of the Company is subject to the lien of the Mortgage and Deed of Trust collateralizing the Company's First Mortgage Bonds.
As of December 31, 1997, the Company had $200 million of bank lines of credit available for borrowing except for amounts supporting outstanding short-term debt. Two separate revolving credit facilities aggregating to $500 million have been arranged for Conectiv effective on March 1, 1998. The Conectiv credit facilities are comprised of a $300 million credit facility which expires five years after becoming effective and a $200 million credit facility which expires one year after becoming effective. The Conectiv revolving credit facilities will replace the Company's and Atlantic's credit lines and certain other short-term credit facilities which existed as of December 31, 1997.
The weighted average interest rates on short-term debt outstanding as of December 31, 1997 and 1996 were 6.6% and 5.6%, respectively.
Maturities of long-term debt and sinking fund requirements during the next five years are as follows: 1998--$33.3 million; 1999--$35.7 million; 2000-- $2.7 million; 2001--$3.6 million; 2002--$49.2 million.
In February 1997, the Company issued $124.2 million of unsecured Medium-Term Notes with maturities of 10 to 30 years and interest rates of 7.06% to 7.72%. The proceeds were used to refinance short-term debt. On the consolidated balance sheet as of December 31, 1996, $77.0 million of short-term debt was reclassified to long-term debt in order to recognize the amount of short-term debt which had been refinanced with Medium-Term Notes.
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DELMARVA POWER & LIGHT COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
In September 1997, the Company redeemed $25 million of 6 3/8% First Mortgage Bonds at maturity through the issuance of short-term debt.
In October 1997, the Company initiated a public offering of up to $75 million of unsecured Medium-Term Notes. Through December 31, 1997, the Company had issued $42 million of unsecured Medium-Term Notes with maturities of 5 to 9 years and interest rates of 6.6% to 6.8%. The proceeds were used to refinance short-term debt.
In January 1998, the Company issued $33.0 million of 6.81% unsecured Medium- Term Notes which mature in 20 years. The Company used $25.4 million of the proceeds to refinance short-term debt. In recognition of this refinancing $25.4 million of short-term debt has been reclassified to long-term debt on the consolidated balance sheet as of December 31, 1997.
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DELMARVA POWER & LIGHT COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
LONG-TERM DEBT OUTSTANDING AS OF DECEMBER 31, 1997 AND 1996 IS PRESENTED BELOW:
- -------- (1) Repaid through monthly payments of principal and interest using a 15-year principal amortization, with the unpaid balance due in September 1999. (2) Repaid through monthly payments of principal and interest over 15 years ending November 2002. (3) The Company's debt obligations included Variable Rate Demand Bonds (VRDB) in the amounts of $71.5 million as of December 31, 1997 and $85.0 million as of December 31, 1996. The VRDB are classified as current liabilities because the VRDB are due on demand by the bondholder. However, bonds submitted to the Company for purchase are remarketed by a remarketing agent on a best efforts basis. The Company expects that bonds submitted for purchase will continue to be remarketed successfully due to the Company's credit worthiness and the bonds' interest rates being set at market. The Company also may utilize one of the fixed rate/fixed term conversion options of the bonds. Thus, the Company considers the VRDB to be a source of long-term financing. The $71.5 million balance of VRDB outstanding as of December 31, 1997, matures in 2017 ($26 million), 2028 ($15.5 million), and 2029 ($30 million). Average annual interest rates on the VRDB were 3.8% in 1997 and 3.6% in 1996.
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DELMARVA POWER & LIGHT COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
14. FAIR VALUE OF FINANCIAL INSTRUMENTS
The year-end fair values of certain financial instruments are listed below. The fair values were based on quoted market prices of the Company's securities or securities with similar characteristics.
15. COMMITMENTS
The Company's expected capital and acquisition expenditures are estimated to be approximately $187 million in 1998.
The Company has a 26-year agreement with Star Enterprise effective through May 2018, to purchase 48 MW of capacity supplied by the Delaware City Power Plant. By mutual agreement, the capacity portion of the contract has been suspended from October 1, 1996 until June 1, 2000. In conjunction with the COPCO acquisition, the Company agreed to purchase capacity and energy from PECO effective June 19, 1995, through May 31, 2006. The base amount of the capacity purchase, which is subject to certain possible adjustments, started at 205 MW, is currently 212 MW, and increases annually to 279 MW in 2006. The Company also has a contract with Electric Clearinghouse to purchase 100 MW of energy from January 1, 1998 to December 31, 2005. Under the terms of these agreements, the Company's expected commitments for capacity and energy charges are as follows: 1998--$79.5 million; 1999--$87.4 million; 2000--$95.7 million; 2001--$99.2 million; 2002--$103.1 million; after 2002--$410.3 million; total-- $875.2 million.
The Company's share of nuclear fuel at Peach Bottom and Salem is financed through a nuclear fuel energy contract, which is accounted for as a capital lease. Payments under the contract are based on the quantity of nuclear fuel burned by the plants. The Company's obligation under the contract is generally the net book value of the nuclear fuel financed, which was $31.0 million as of December 31, 1997.
The Company leases an 11.9% interest in the Merrill Creek Reservoir. The lease is considered an operating lease and payments over the remaining lease term, which ends in 2032, are $150.5 million in aggregate. The Company also has long-term leases for certain other facilities and equipment. Minimum commitments as of December 31, 1997 under the Merrill Creek Reservoir lease and all other noncancelable lease agreements (excluding payments under the nuclear fuel energy contract which cannot be reasonably estimated) are as follows: 1998--$6.7 million; 1999--$6.6 million; 2000--$5.4 million; 2001-- $5.3 million; 2002--$4.6 million; after 2002--$133.9 million; total--$162.5 million. Approximately 93% of the minimum lease commitments shown above are payments due under the Merrill Creek Reservoir lease.
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DELMARVA POWER & LIGHT COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
RENTALS CHARGED TO OPERATING EXPENSES
The following amounts were charged to operating expenses for rental payments under both capital and operating leases.
16. PENSION PLAN
The Company currently has a defined benefit pension plan covering all regular employees. The benefits are based on years of service and the employee's compensation. The Company's funding policy is to contribute each year the net periodic pension cost for that year; however, contributions have not been necessary during 1995-1997 due to the pension expense credit and the plans' funding status.
Based on fair values as of December 31, 1997, pension plan assets were comprised of the following: publicly traded equity securities ($466.5 million or 60%), U.S. government obligations ($121.5 million or 16%), and primarily investment grade corporate and other fixed income obligations ($183.3 million or 24%).
The following schedules show the funded status of the plan, the components of pension cost, and assumptions.
RECONCILIATION OF FUNDED STATUS OF THE PLAN
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DELMARVA POWER & LIGHT COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
COMPONENTS OF NET PENSION COST
The Company maintains a 401(k) savings plan for its employees. The plan provides for employee contributions up to 15% of pay and for $0.50 in matching contributions by the Company for each dollar contributed up to 5% of employee pay. The Company's matching contributions charged to expense were $3.0 million in 1997, $2.4 million in 1996, and $2.3 million in 1995.
17. POSTRETIREMENT BENEFITS OTHER THAN PENSIONS
The Company provides health-care and life insurance benefits to its retired employees and substantially all of the Company's employees may become eligible for these benefits upon retirement. The Company's policy is to fund its obligation to the extent that costs are reflected in customer rates, including amounts which are capitalized. Based on fair values as of December 31, 1997, the plan's assets consisted of $35.7 million (73%) of equity securities, including mutual funds and directly owned publicly traded securities, and $12.9 million (27%) of intermediate term investment grade bond mutual funds.
The following schedules show the funded status of the plan, the components of the cost of postretirement benefits other than pensions, and assumptions.
RECONCILIATION OF FUNDED STATUS OF THE PLAN
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DELMARVA POWER & LIGHT COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
ANNUAL COST OF POSTRETIREMENT BENEFITS OTHER THAN PENSIONS
The health-care cost trend rate, or the expected rate of increase in health- care costs, is assumed to decrease to 7.0% in 1998 and gradually decrease to 5.4% by 2002. Increasing the health-care cost trend rates of future years by one percentage point would increase the accumulated postretirement benefit obligation by $5.1 million and would increase annual aggregate service and interest costs by $0.5 million.
18. SALEM NUCLEAR GENERATING STATION
The Company owns 7.41% of the Salem Nuclear Generating Station (Salem), which consists of two pressurized water nuclear reactors operated by Public Service Electric & Gas Company (PSE&G). Salem Units 1 and 2 were removed from operation by PSE&G in the second quarter of 1995 due to operational problems, and maintenance and safety concerns. After receiving NRC authorization, PSE&G returned Unit 2 to service on August 30, 1997. Due to degradation of a significant number of tubes in the Unit 1 steam generators, PSE&G replaced the Unit 1 steam generators. The Company has been informed by PSE&G that the NRC's Readiness Assessment Team has concluded that Unit 1 is ready to return to operation. PSE&G expects Unit 1 will return to service in the second quarter of 1998, subject to final NRC approval.
In May 1997, the Company settled its lawsuit against PSE&G concerning Salem operations. Under the settlement's primary provision, PSE&G paid the Company $12 million in settlement of all claims related to the lawsuit. In August 1997, the DPSC approved a settlement regarding the ratemaking treatment of the PSE&G settlement payment and the replacement power costs attributable to the Salem outages. The DPSC settlement provided for recovery of approximately one- half of the replacement power costs from electric customers and retention of two-thirds of the PSE&G settlement payment by the Company's stockholders. Based on expected similar ratemaking treatment in other regulatory jurisdictions and the terms of these settlements, the Company charged $3.1 million, net of the stockholder portion of the PSE&G settlement payment, to fuel expenses in 1997. In 1996 and 1995, approximately $10.1 million and $4.1 million, respectively, were charged to fuel expenses for replacement power costs and capacity deficiency charges owed to the Pennsylvania-New Jersey- Maryland (PJM) Interconnection. (Utilities which are parties to the PJM Interconnection agreement are required to pay capacity deficiency charges if capacity levels are lower than the level committed to by the PJM utility.) The aforementioned fuel-related expenses decreased earnings for 1997, 1996, and 1995 because these amounts were not expected to be recovered through customers' fuel rates. The Company also estimates that operation and maintenance costs were higher than normal by $4 million, $9 million, and $5 million in 1997, 1996, and 1995, respectively, because of the Salem outages.
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DELMARVA POWER & LIGHT COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
As previously reported, on February 27, 1996, the co-owners of Salem, including the Company, filed a complaint in the United States District Court for New Jersey against Westinghouse Electric Corporation (Westinghouse), the designer and manufacturer of the Salem steam generators. The complaint, which seeks to recover from Westinghouse the costs associated with and resulting from the cracks discovered in Salem's steam generators and with replacing such steam generators, alleges violations of federal and New Jersey Racketeer Influenced and Corrupt Organizations Acts, fraud, negligent misrepresentation and breach of contract. The estimated replacement cost of such generators is between $150 million and $170 million. On October 1, 1997, Westinghouse filed a motion for summary judgment. The parties argued the summary judgment motion and a decision on the motion is expected after March 1, 1998. No trial date has been set. The Company cannot predict the outcome of this lawsuit.
19. CONTINGENCIES
ENVIRONMENTAL MATTERS
The Company is subject to regulation with respect to the environmental effects of its operations, including air and water quality control, solid and hazardous waste disposal, and limitation on land use by various federal, regional, state, and local authorities. The disposal of Company-generated hazardous substances can result in costs to clean up facilities found to be contaminated due to past disposal practices. Federal and state statutes authorize governmental agencies to compel responsible parties to clean up certain abandoned or uncontrolled hazardous waste sites. The Company is currently a potentially responsible party (PRP) at three federal superfund sites and is alleged to be a third-party contributor at three other federal superfund sites. The Company also has two former coal gasification sites in Delaware and one former coal gasification site in Maryland, each of which is a state superfund site. The Company's current liabilities included $2 million as of December 31, 1997 and 1996, respectively, for clean-up and other potential costs related to the federal and state superfund sites. The Company does not expect such future costs to have a material effect on the Company's financial position or results of operations.
NUCLEAR INSURANCE
In the event of an incident at any commercial nuclear power plant in the United States, the Company could be assessed for a portion of any third-party claims associated with the incident. Under the provisions of the Price Anderson Act, if third-party claims relating to such an incident exceed $200 million (the amount of primary insurance), the Company could be assessed up to $23.7 million for such third-party claims. In addition, Congress could impose a revenue-raising measure on the nuclear industry to pay such claims.
The co-owners of Peach Bottom and Salem maintain property insurance coverage in the aggregate amount of $2.8 billion for each unit for loss or damage to the units, including coverage for decontamination expense and premature decommissioning. The Company is self-insured, to the extent of its ownership interest, for its share of property losses in excess of insurance coverages. Under the terms of the various insurance agreements, the Company could be assessed up to $3.2 million in any policy year for losses incurred at nuclear plants insured by the insurance companies.
The Company is a member of an industry mutual insurance company, which provides replacement power cost coverage in the event of a major accidental outage at a nuclear power plant. The premium for this coverage is subject to retrospective assessment for adverse loss experience. The Company's present maximum share of any assessment is $1.3 million per year.
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DELMARVA POWER & LIGHT COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
20. NONUTILITY SUBSIDIARIES
The following presents summarized financial information about the Company's nonutility wholly owned subsidiaries. Common general and administrative costs are allocated to the Company's nonutility subsidiaries on the basis of cost causative factors. The Company's management believes the cost allocations are reasonable.
Excluding non-regulated energy sales conducted by operating divisions of the Company, as of December 31, 1997, the following three subsidiaries conducted substantially all of the Company's nonutility business: Conectiv Services, Inc., which provides HVAC sales, installation and services; Conectiv Communications, Inc., which provides local and long-distance phone service; and Delmarva Capital Investments, Inc. (DCI), which is involved in power plant operating services, real estate activities, and leveraged equipment leases. Delmarva Capital Investments, Inc. sold its landfill and waste-hauling operations in 1997 as discussed in Note 5 to the Consolidated Financial Statements.
DCI's net income was $6.3 million in 1996 and $4.1 million in 1995. DCI's total assets were $101.1 million and $117.1 million at December 31, 1996 and 1995, respectively. Conectiv Services, Inc. and Conectiv Communications, Inc. started operations in late 1996.
21. SEGMENT INFORMATION
In 1997, the FASB issued SFAS No. 131, "Disclosure About Segments of an Enterprise and Related Information." SFAS No. 131 will supersede SFAS No. 14, "Financial Reporting for Segments of a Business Enterprise," and become effective for the Company's annual financial statements in 1998. Under SFAS No. 131, operating segments will be based on the manner in which management operates the business. The Company expects that its operating segments will be Conectiv Energy Delivery, Conectiv Energy Supply, and Conectiv Enterprises, as described in Management's Discussion and Analysis of Financial Condition and Results of Operations. In brief, the businesses of these operating segments are as follows: Conectiv Energy Supply--produces and purchases energy, and sells bulk energy in competitive markets; Conectiv Energy Delivery--delivers energy to customers at regulated prices over transmission and distribution systems; Conectiv Enterprises--sells retail energy, HVAC services, local and long distance telephone service, and other services in competitive markets.
The operating segments presented below are based on the criteria of SFAS No. 14. For a description of the Electric, Gas, and Other Services' businesses, refer to Note 1 to the Consolidated Financial Statements. Under SFAS No. 131, the energy and delivery businesses embedded within both the Electric and Gas businesses will be unbundled and reported under Conectiv Energy Supply and Conectiv Energy Delivery, respectively. Unregulated retail electric and gas sales will be reported within Conectiv Enterprises. The businesses in Other Services will primarily be included in Conectiv Enterprises.
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DELMARVA POWER & LIGHT COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
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DELMARVA POWER & LIGHT COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
22. QUARTERLY FINANCIAL INFORMATION (UNAUDITED)
The quarterly data presented below reflect all adjustments necessary in the opinion of the Company for a fair presentation of the interim results. Quarterly data normally vary seasonally because of temperature variations, differences between summer and winter rates, the timing of rate orders, and the scheduled downtime and maintenance of electric generating units.
As discussed in Note 5 to the Consolidated Financial Statements, in the fourth quarter of 1997, net income was increased by $13.7 million ($0.22 per average common share) due to the sale of the Pine Grove Landfill and its related waste-hauling company.
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None.
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PART III
ITEM 10.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
DIRECTORS
The following were the Directors of the Company on February 28, 1998, prior to consummation of the Merger:
CLASS I DIRECTORS WITH TERMS EXPIRING IN 2000--
R. FRANKLIN BALOTTI, age 55. Director since 1995. Member of the law firm of Richards Layton & Finger, Wilmington, Delaware. Mr. Balotti is a past President of the Delaware Bar Association and serves as a member of the Board of Overseers of Widener University School of Law.
MICHAEL B. EMERY, age 59. Director since 1994. Retired, Former Senior Vice President of E.I. duPont deNemours & Company (a diversified chemical, energy, and specialty products company), Wilmington, Delaware. Mr. Emery serves as Chairperson of the Development Council of Delaware Technical and Community College.
SARAH I. GORE, age 62. Director since 1990. Human Resources Associate, W. L. Gore & Associates, Inc. (a high technology manufacturing company), Newark, Delaware. Member of the Delaware Advisory Board of CoreStates Bank, Wilmington, Delaware. Mrs. Gore and her family created the I Have a Dream Foundation of Delaware for which she serves as a director.
CLASS II DIRECTORS WITH TERMS EXPIRING IN 1998--
HOWARD E. COSGROVE, age 54. Director since 1986. Chairman, President and Chief Executive Officer of the Company. Mr. Cosgrove also is a director of the Federal Reserve Bank of Philadelphia and is a Trustee of The University of Delaware.
AUDREY K. DOBERSTEIN, age 65. Director since 1992. President of Wilmington College, New Castle, Delaware. Director of Mellon Bank Delaware (N.A.), Wilmington, Delaware. Dr. Doberstein also serves as a member of the Board of Directors of Blue Cross/Blue Shield of Delaware.
JAMES C. JOHNSON, age 62. Director since 1992. Retired, Former President and Chief Executive Officer of Loyola Federal Savings Bank, Baltimore, Maryland. Mr. Johnson is a member of the Board of Directors of the Chesapeake Bay Trust.
WESTON E. NELLIUS, age 61. Director since 1995. President, Nellius Management Associates, Inc. (an information technology, financial, management and government relations consulting firm), Dover, Delaware. Director of Nations Bank of Delaware (N.A.), Dover, Delaware. Mr. Nellius also serves as a member of the Board of Directors of The Delaware Family Foundation and the Board of the Delaware Region of the National Conference of Christians and Jews.
CLASS III DIRECTORS WITH TERMS EXPIRING IN 1999--
MICHAEL G. ABERCROMBIE, age 58. Director since 1993. President of Cato, Inc. (a petroleum distributorship), Salisbury, Maryland. Mr. Abercrombie is a past President of The Community Foundation of the Eastern Shore and is a past Chairman of the Greater Salisbury Committee.
ROBERT D. BURRIS, age 53. Director since 1993. President of Burris Foods, Inc. (a refrigerated food distribution company), Milford, Delaware. Mr. Burris also is a director of the Federal Reserve Bank of Philadelphia and is a member of the Board of BayHealth, Inc.
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EXECUTIVES
Information about the executive officers of the registrant is included under Item 1.
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION
The summary compensation table below (along with important explanatory notes on the next page) provides information about salary and other compensation. Following the summary compensation table are tables about long-term incentive plan awards and pension benefits, a performance graph that compares the Company's common stockholder return to both the S&P 500 Index and the Dow Jones Electric Utilities Index, and a report by the Compensation Committee about executive compensation.
SUMMARY COMPENSATION TABLE
- -------- # Number of units $--Dollar amounts (1) Dividends on shares of performance-based restricted stock are accrued at the same rate as that paid to all holders of Common Stock. Restricted stock awards are reported in the Long-Term Incentive Plan Table on page III-4. As of December 31, 1997: Mr. Cosgrove held 62,750 shares of restricted stock with a value of $1,275,606.25 (6,070, 11,570, 9,590, and 35,520 shares with a grant-date market price of $22.00, $19.50, $22.875, and $19.625 per share respectively); Mr. Shaw held 14,810 shares of restricted stock with a value of $301,878.75 (1,350, 2,870, 2,580, and 8,010 shares with a grant-date market price of $22.00, $19.50, $22.875, and $19.625 per share respectively); Mrs. Graham held 14,530 shares of restricted stock with a value of $295,718.75 (1,070, 2,870, 2,580, and 8,010 with a grant-date market price of $22.00, $19.50, $22.875, and $19.625 respectively); Mr. Ford held 13,460 shares of restricted stock with a value of $272,178.75 (2,870, 2,580 and 8,010 shares with a grant- date market price of $19.50, $22.785, and $19.625 per share respectively); and Mr. Klesius held 14,070 shares of restricted stock with a value of $287,356.25 (1,350, 2,870, 2,580, and 7,270 shares with a grant-date market price of $22.00, $19.50, $22.875, and $19.625 per share respectively). During 1997, all the shares granted in 1993 were forfeited because the Company's Total Stockholder Return was 65th out of 87 companies in its Peer Group over the four-year performance period. (2) The amounts of All Other Compensation for each of the named executive officers for fiscal year 1997 include the following: for Mr. Cosgrove, $2,083 in Company matching contributions to the Company's Savings & Thrift Plan, and $16,688 in Company matching contributions under the Company's Deferred Compensation Plan Thrift Fund; for Mr. Shaw, $2,458 in Company matching contributions to the Company's Savings & Thrift Plan, and $3,895 in Company matching contributions under the Company's Deferred Compensation Plan Thrift Fund; for Mrs. Graham, $2,483 in Company matching contributions to the Company's Savings & Thrift Plan, and $697 in Company matching contributions under the Company's Deferred Compensation Plan Thrift Fund; for Mr. Ford, $3,750 in Company matching contributions to the Company's Savings & Thrift Plan; and for Mr. Klesius, $2,444 in Company matching contributions to the Company's Savings & Thrift Plan, and $2,138 in Company matching contributions under the Company's Deferred Compensation Plan Thrift Fund. In addition, the amounts of All Other Compensation for each of the five named executive officers includes $210 in term life insurance premiums paid by the Company on such officer's behalf (which insurance is provided on an equal basis to all employees of the Company). (3) Mr. Ford joined the Company on March 13, 1995.
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OPTION EXERCISES DURING 1997 AND YEAR-END OPTION VALUES
The following table provides information related to options held by the named executive officers at fiscal year-end 1997. The Board of Directors, at its January 1993 meeting, approved an amendment to the Company's Long-Term Incentive Plan eliminating awards of Common Stock options and dividend rights effective fiscal year 1993. The Company does not grant stock appreciation rights.
AGGREGATED OPTION EXERCISES IN LAST FISCAL YEAR AND FY-END OPTION VALUES
- -------- (*) The closing price for the Company's Common Stock as reported by the New York Stock Exchange on December 31, 1997, was $23.0625. The value is calculated on the basis of the difference between the exercise price of the options and $23.0625, which difference is multiplied by the number of options. For Mr. Cosgrove, 8,500 of the exercisable options have an exercise price of $21.25, and 5,900 have an exercise price of $20.50. For Mr. Klesius, 3,100 of the exercisable options have an exercise price of $21.25, and 1,300 have an exercise price of $20.50. The options all are exercisable currently. No options were exercised in 1997 by the named executive officers.
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PERFORMANCE-BASED RESTRICTED STOCK GRANTS CHART
The following table shows the number of shares of performance-based restricted stock that were granted to the named executive officers as part of the Company's Long-Term Incentive Plan in 1997. It also shows the number of shares of Common Stock that would be awarded if the threshold, target or maximum performance is achieved at the end of the four-year performance period.
LONG-TERM INCENTIVE PLANS AWARDS IN LAST FISCAL YEAR
- -------- (*) Shares of performance-based restricted stock were granted as a part of the Company's Long-Term Incentive Plan. Actual awards are made after the end of a four-year performance cycle and are based on a comparison of the combination of the Company's performance prior to the Merger, and Conectiv's performance after the Merger, as measured by Total Stockholder Return (stock appreciation and dividends paid), to the Peer Group. The target number of shares (100% of the shares originally granted) will be awarded if the Total Stockholder Return (four year cumulative as compared to the Peer Group) is in the 55th percentile (up to 149.9% to be awarded for Total Stockholder Return up to the 84.9th percentile). The threshold number of shares (25% of the shares originally granted) will be awarded if the Total Stockholder Return (four year cumulative as compared to the Peer Group) is in the 40th percentile (up to 99.9% to be awarded for Total Stockholder Return up to the 54.9th percentile). The maximum number of shares (150% of the shares originally granted) will be awarded if the Total Stockholder Return (four year cumulative as compared to the Peer Group) is in the 85th percentile or greater. The actual percentage of the originally granted shares to be awarded will be determined by interpolation of a straight line within the percentile ranges.
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RETIREMENT PLAN
PENSION PLAN TABLE
ANNUAL RETIREMENT BENEFITS TO PERSONS IN SPECIFIED REMUNERATION AND YEARS OF SERVICE CLASSIFICATIONS
- -------- (1) Represents reduced early retirement benefit payable at age 55. (2) Effective January 1, 1998, annual compensation recognized in computing Average Annual Earnings under the Retirement Plan may not exceed $160,000 as limited by Section 401(a)(17) of the Internal Revenue Code of 1986, as amended (the "Internal Revenue Code"). With the exception of this limitation, and the exclusion of compensation paid under the Company's Long-Term Incentive Plan and Company contributions under the Savings & Thrift Plan and Supplemental Executive Retirement Plan ("SERP"), Average Annual Earnings include substantially all cash compensation shown in the Summary Compensation Table on page III-2. Compensation in excess of the limitation of Section 401(a)(17) is recognized in computing the benefit payable under the SERP. (3) For 1998, the limit on annual benefits payable under qualified, defined benefit plans is $130,000. The amount in excess of $130,000 in the above table would be payable under the Company's SERP.
The Company has a trusteed, noncontributory Retirement Plan covering all regular employees. Directors who are not employees of the Company do not participate in the Plan. Subject to the maximum limitation on benefits imposed by Section 415(b) of the Internal Revenue Code, the Retirement Plan provides management employees, including all officers, a retirement income equal to years of service times the sum of (1) plus (2) where (1) is 1.30% of the Average Annual Earnings (for the five consecutive years of earnings that result in the highest annual average) up to the Average Social Security Earnings Base ($31,128 in 1998), and where (2) is 1.60% of such Average Annual Earnings above the Average Social Security Earnings Base. Effective January 1, 1996, a second formula was added (i.e., 1.50% of Average Annual Earnings times years of service). Management employees will receive a pension computed under this second formula if it results in a greater pension amount. Normal retirement is age 65; however, employees may retire as early as age 55 with an actuarial reduction in benefits and also at age 60 without such reduction, provided they have completed the requisite number of years of service with the Company. Aside from the integration feature of the above-described benefit formula, retirement benefits are not subject to any reduction for Social Security benefits or other offset amounts.
Annual benefits payable upon retirement will be in the form of a joint and 50% survivor annuity for married individuals and a straight life annuity for single individuals. Both the straight life and joint and survivor forms are paid to management employees in specified remuneration and years of service classifications, as illustrated in the Pension Plan Table.
Mr. Cosgrove, Mrs. Graham, and Messrs. Shaw, Ford and Klesius have, respectively, 31, 14, 26, 3 and 32 credited years of service under the Company's Retirement Plan.
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In the event of a change in control of the Company, as defined in the Retirement Plan, the Plan's surplus assets are to be allocated to the extent available to (1) satisfy all Plan liabilities, (2) fund certain post- retirement medical benefits and death benefits and (3) subject to certain limitations, increase the benefits payable to employees who were active participants on the date of such change in control by crediting each such participant with an additional five years of deemed credited service and five years of deemed salary increases at 5% per year. If the Plan is terminated or merged or benefits are reduced within five years of such change in control, any remaining surplus assets would be allocated to the extent available to (1) provide a 2% cost of living increase for retirees for each year of retirement and (2) subject to certain limitations, increase the benefits payable to employees who were active participants on the date of such termination, merger or benefit curtailment by crediting each such participant with additional years of deemed credited service for the ten-year period following such change in control together with salary increases at 5% per year for such period. The Retirement Plan requires that the obligations described above that are assumed following such a change in control must be funded by the purchase of a guaranteed annuity contract.
DIRECTORS' COMPENSATION
Directors who are not officers of the Company receive an annual retainer of $12,000, plus $700 for each Board meeting attended and $600 for each Committee of the Board meeting attended. Chairpersons of the Audit, Compensation, and Nuclear Oversight Committees receive an additional annual retainer of $1,000. There have been no changes in the amounts of Directors' compensation since May 1, 1992. Beginning on June 1, 1997, the $12,000 annual retainer paid to each Director and the $1,000 annual retainer paid to Chairpersons of the Committees previously mentioned were paid in Common Stock of the Company.
SEVERANCE AGREEMENTS AND OTHER PROVISIONS RELATING TO POSSIBLE CHANGE OF CONTROL
The Company has entered into severance agreements with each of the five named executive officers. The severance agreements are intended to encourage the continued dedication of members of the Company's management. These agreements provide potential benefits for such persons upon actual or constructive termination of employment (other than for cause) following a change of control of the Company, as defined in such agreements. Each affected employee would receive a severance payment equal to 2.99 times base salary (as defined in Section 280G of the Internal Revenue Code), and entitlement to Company-paid life, disability, medical and dental benefits for 24 months following termination, as well as an amount in cash equal to the actuarial equivalent value of accrued retirement pension credits equal to 24 months following termination; provided, however, that if any payments under such agreements would not be deductible by the Company as a result of Section 280G of the Internal Revenue Code, the amounts payable under such agreements will be reduced until the entire payment is deductible. The Merger comes within the definition of "change of control" under the severance agreements. Mr. Ford has terminated employment in connection with the Merger, and has received the severance payment and will receive the other benefits under the severance agreement. Although Mr. Klesius will remain with Conectiv for a transition period, he also has terminated employment in connection with the Merger, and will receive both the severance payment and the other benefits under the severance agreement.
The Company has the following additional benefit plans containing "change in control" provisions. These plans, for which the five named executive officers are eligible, were established by the Board of Directors. In the event of a change in control: The SERP provides for the Company to satisfy the liabilities accrued under the SERP through the purchase of fully-paid annuity or life insurance contracts; the Company's Management Incentive Compensation Plan provides that, at the option of the participant, the Company will pay all Incentive Awards earned but not distributed; the Company's Management Life Insurance Plan provides for the Company to prepay all premiums to any life insurance policy under this Insurance Plan; and the Company's Long-Term Incentive Plan provides that all restrictions on shares of performance-based restricted stock will lapse immediately, without regard to performance criterion, and shares will be issued to all participants, and all dividends in each Dividend Rights Account will be paid or, at the employee's option, the ongoing obligation to make such payments will continue. Mr. Ford has terminated employment in connection with the Merger, and has received the severance payment. He also will receive the other benefits under his severance agreement and the
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benefit plans described above. Although Mr. Klesius will remain with Conectiv for a transition period, he also has terminated employment in connection with the Merger, and will receive the severance payment, the other benefits under his severance agreement and the benefit plans mentioned above.
BOARD COMPENSATION COMMITTEE REPORT
DELMARVA POWER & LIGHT COMPANY BOARD COMPENSATION COMMITTEE REPORT
PRINCIPLES OF EXECUTIVE COMPENSATION PROGRAM
OVERALL OBJECTIVES
This will be the last Board Compensation Committee Report for the Company. Effective March 1, 1998, a series of merger transactions were consummated, involving the Company and Atlantic Energy, Inc. (the "Merger"). A new holding company, named Conectiv, was formed as a result of the Merger, and the shares of the Company's Common Stock were exchanged for shares of Conectiv common stock. The next Compensation Committee Report will be contained in the 1999 proxy statement for Conectiv.
The Company's executive compensation program was designed to motivate its senior executives to achieve the Company's goals of providing the Company's stockholders with a competitive return on their investment and its customers with high quality service at a competitive price.
Toward that end, the Company's program was designed to provide total compensation that emphasizes long-term performance which increases stockholder value and reflects market conditions for executive talent. This program has included the following elements:
.Long-term incentive compensation based on long-term performance which increases stockholder value;
.Annual incentive compensation that varies based on corporate and individual performance; and
.Base salary levels related to position and individual performance.
In its role as administrator of the executive compensation program, the Compensation Committee has placed particular emphasis on long-term compensation as a critical element of total compensation. The Compensation Committee's objective has always been to provide incentives which have a direct link to increased stockholder value.
TOTAL COMPENSATION
Total compensation (base salary, annual incentive, and long-term incentive) opportunities were developed for Company executives utilizing the Edison Electric Institute ("EEI") Executive Compensation Survey Report and other general competitive industry surveys, as well as counsel with the Company's outside consulting firm, Towers Perrin. In general, the total compensation structure for executives was targeted to the median of a blend of utility and general competitive industry peers contained in the EEI Executive Compensation Survey Report (the "Peer Group")/1/ and other general competitive industry surveys with individual reward levels varying based on contribution and performance. The targets for each component of the executive compensation program have been reviewed on an annual basis to ensure alignment with the Company's compensation philosophy and to ensure a proper balance between short- and long-term objectives. Annual base salary increases reflect the individual's performance and contribution over several years in addition to the results for a single year. Year-to-year changes in annual incentive awards have varied with the performance results of the individual as well as - -------- /1/ The compensation Peer Group includes some, but not all, of the same companies as the published industry index in the Comparison of Five Year Cumulative Total Return graph included in this Proxy Statement.
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the Company. The Company's base salary level for the five named executive officers as a group was below the median of the salary levels defined by the Peer Group.
The Company has examined the IRS regulation pertaining to the $1,000,000 compensation deductibility cap for each of the five named executive officers and has determined that the regulation is not applicable to the Company, since the total compensation for any one individual is significantly below the cap.
ANNUAL INCENTIVE COMPENSATION
The Company's Management Incentive Compensation Plan was designed to motivate participants to accomplish stretch financial and individual goals. The corporate financial goals relate to both customer and stockholder measurements. Two criteria must be met before there were any awards under this plan: (1) at least half of specified corporate goals must have been met; and (2) actual earnings per share ("EPS") for the year must have met or exceeded 95% of the Company's EPS goal.
The awards, upon satisfaction of these criteria, contained two components: corporate performance and individual performance. For the senior executives, award targets for both performance components were set annually by the Compensation Committee and have varied among individuals. Approximately 75% of the maximum incentive opportunity for the Company's senior executives, including those named in the compensation tables in this Proxy Statement, arose out of corporate performance, which was measured by (1) the Company's EPS as compared with the Company's EPS goal, and (2) the Company's net change in electric rates per kilowatt hour as compared against the net change in the electric rates of the average of a regional survey/2/ over a three-year period. Generally, the payout in connection with corporate performance was determined in the following manner. The base multiplier of 1.00 was adjusted at year-end based upon corporate performance. This adjustment could not exceed 150% and was based upon the EPS and Rates performance at the corporate level. EPS Adjustment: If actual EPS was higher than the goal, the multiplier was increased by 5% for each 1% above the goal. If actual EPS was lower than the goal, the multiplier was decreased by 20% for each 1% below the goal. Rates Adjustment: If the Company's rates decreased more, or increased less, than the regional survey average, the multiplier was increased by 5% for each 1% positive deviation. If the Company's rates increased more, or decreased less, than the regional survey average, the decrease was 2% for each 1% negative deviation.
The remaining approximately 25% of the maximum incentive opportunity for senior executives arose out of individual performance, with a particular focus on achievement of individual goals, as evaluated at each year-end merit review.
LONG-TERM INCENTIVE COMPENSATION
The Company's Long-Term Incentive Plan has reinforced the importance of providing investors with a competitive return on their investment. Awards granted under this Plan in 1997 consisted entirely of shares of performance- based restricted stock. Participants in the Plan were granted shares of the Company's stock, subject to forfeiture if performance criteria are not met over a four-year performance period. After the end of the four-year performance cycle, a combination of the Company's performance prior to the Merger, and Conectiv's performance after the Merger, as measured by Total Stockholder Return (stock appreciation and dividends paid), will be compared to the Peer Group to determine the number of shares of unrestricted Conectiv common stock to be paid out to participants. Upon consummation of the Merger, the restricted Common Stock of the Company held in the Long-Term Incentive Plan were converted to shares of Conectiv common stock, as required by the merger agreement. For grants made under the Plan in prior years, for which the performance cycle had not yet run (1995 and 1996 grants), 100% of the shares originally granted were awarded as unrestricted shares of Company Common Stock upon consummation of the Merger, pursuant to the "change in control provisions" - -------- /2/ The regional survey includes some, but not all, of the same companies as the Peer Group and the published industry index in the Comparison of Five Year Cumulative Total Return graph included in this Proxy Statement.
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contained in the Plan. The grants made in 1993 and 1994 did not meet the performance criteria and were forfeited.
For the 1997 grants, the following amounts of shares of Conectiv common stock will be awarded at the end of the four-year performance cycle if the combination of the Total Stockholder Return for the Company prior to the Merger, and Conectiv after the Merger, over the four-year cycle as compared to the Peer Group falls in the following percentile ranges: no award for Total Stockholder Return less than the 40th percentile; 25%--99.9% of the shares originally granted for Total Stockholder Return in the 40th percentile to the 54.9th percentile; 100%--149.9% of the shares originally granted for Total Stockholder Return in the 55th percentile to the 84.9th percentile; and 150% of the shares originally granted for Total Stockholder Return in the 85th percentile or greater. The actual percentage of the originally granted shares to be awarded will be determined by interpolation of a straight line within the percentile ranges.
SUMMARY OF ACTIONS TAKEN BY THE COMPENSATION COMMITTEE
The Compensation Committee of the Company, which has consisted entirely of outside directors, has reviewed and approved each of the transactions with the Company's officers under the Company's executive compensation plans, and has assessed the effectiveness of the program as a whole. This included activities such as reviewing the design of the Company's various incentive plans and assessing the reasonableness of the overall executive compensation program.
In addition, the Committee has administered key aspects of the Company's salary program and incentive plans, such as approving the annual salary increase budget, setting the targets used in the annual incentive plan, approving the size of the annual incentive pool and approving the grants under the annual and long-term incentive plans. With respect to the annual incentive pool, individual awards were not limited by the size of the total pool, but were limited to maximum amounts annually determined by the Compensation Committee. For 1997 performance, within the senior executive group, these maximum amounts have varied among individuals.
Finally, the Committee has implemented the Company's executive compensation program, which includes the Chief Executive Officer and the Company's four other most highly-compensated executives--i.e., the five "named executive officers."
Significant actions by the Committee for fiscal year 1997 included setting salaries and reviewing criteria for and approving the grants of annual incentive awards and long-term incentive opportunities. For 1997, total compensation opportunities for the named executive officers were consistent with the compensation levels in the evolving utility and general industry markets for executive talent. The Committee believes these compensation levels to be appropriate, since having the ability to attract and retain high-quality executives from both within and outside the utility industry is increasingly important in an environment where competition is increasing and predicted to become more intense. In 1997, the Compensation Committee made its senior management team's compensation opportunities more sensitive to the long-term performance of the Company (and Conectiv, after the Merger) and increased value to the Company's and Conectiv's stockholders. The Committee's purpose in doing so was to keep management interests in line with the long-term stockholder interests. Accordingly, more of the total compensation of the Company's management team was granted in the form of incentive awards tied to long-term corporate performance. The targets to achieve those incentives were also set at higher levels than in the past./3/ Thus, the potential for reward at the end of the four-year performance cycle is greater, but higher levels of performance, measured based on the Company's performance prior to the Merger, and Conectiv's performance - -------- /3/ The only exception is that the target for the maximum level was decreased from 90% to 85%. The 90% target had proven unrealistic based on an evaluation of the companies that have achieved this level of performance. Most of these companies have had an extraordinary event over the performance cycle which enabled them to reach the maximum target level. The 85% level still represents a significant challenge but has the potential to be achieved, while ensuring that management's interests continue to be aligned with stockholders.
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thereafter, will be required to achieve that potential. Consistent with the intention to tie more compensation opportunity to long-term corporate performance, the base salaries for the senior management team were increased slightly, with lower annual incentive awards than in the past.
CHIEF EXECUTIVE OFFICER COMPENSATION
SALARY ACTION
Chief Executive Officer, Howard E. Cosgrove's salary remained the same as in 1996, at $400,000. This salary placed Mr. Cosgrove at approximately 97% of the median for Chief Executive Officers in comparably-sized utilities.
Consistent with the Compensation Committee's goal to tie more of its executives' total compensation opportunity to corporate performance, the Compensation Committee decided to freeze Mr. Cosgrove's base salary for the 1997 fiscal year and not to grant any annual incentive award. This decision was not intended as a negative reflection on Mr. Cosgrove's performance. On the contrary, the Committee commends Mr. Cosgrove's leadership and supports the direction the Company is taking in this increasingly competitive and uncertain environment. As an expression of confidence in Mr. Cosgrove's ability to drive the Company's, and now Conectiv's, success in the long term, increases in Mr. Cosgrove's total compensation will be earned in long-term incentives which are tied to the Company's and Conectiv's long-term performance.
ANNUAL INCENTIVE AWARD
In lieu of an annual incentive award, a greater long-term incentive opportunity was granted to Mr. Cosgrove in 1997 than otherwise would have been granted, to allow Mr. Cosgrove to share in corporate success if stockholder value is increased through better long-term corporate performance.
LONG-TERM INCENTIVE PLAN
Long-term incentive grants represent an increasingly important component of the compensation opportunity for the Chief Executive Officer. Consistent with the Company's Long-Term Incentive Plan, the Committee determined the 1997 grants of performance-based restricted stock (reflected in the compensation tables contained in this Proxy Statement) made to Mr. Cosgrove. The initial award of performance-based restricted stock is targeted at providing total compensation, including a long-term opportunity, consistent with similar awards made to other executives from the Peer Group. The number of shares actually earned, if any, will be awarded in the year 2001 based on a comparison of the combination of the Company's performance prior to the Merger, and Conectiv's performance thereafter, as measured by Total Stockholder Return compared to the Peer Group over the four-year period 1997- 2000, as discussed under "Long-Term Incentive Compensation" on page III-8. As discussed above, Mr. Cosgrove's 1997 base salary was not increased and he received no annual incentive award; instead, all of Mr. Cosgrove's opportunity to increase his total compensation in 1997 was in the form of long-term incentives tied to corporate performance over the four-year period.
COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION
The Compensation Committee is comprised solely of non-officer directors. There are no Compensation Committee interlocks.
COMPENSATION COMMITTEE
S. I. Gore, Chairperson M. B. Emery J. C. Johnson
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COMPARISON OF FIVE YEAR TOTAL RETURN* AMONG DELMARVA POWER & LIGHT COMPANY, THE S&P INDEX AND THE DOW JONES ELECTRIC UTILITIES INDEX [graph appears here--plot points are listed below] Dow Jones Electric Utility Year Company Index S&P 500 ---- ------- ---------------- ------- 1992 100 100 100 1993 108 112 110 1994 90 98 112 1995 122 129 153 1996 117 130 189 1997 144 165 252 * $100 invested on 12/31/92 in stock or index including reinvestment of dividends. Fiscal year ending December 31.
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ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Security Ownership of Directors and Executive Officers as of December 31, 1997:
As of December 31, 1997, all current executive officers and directors as a group (14 persons) owned beneficially 168,805 shares of Common Stock, representing 0.27% of the shares of Common Stock outstanding.
(1) Each of the individuals listed beneficially owned less than 1% of the Company's outstanding common stock.
(2) Includes shares owned beneficially by Mr. Cosgrove and Other Executive Officers of the Company pursuant to the Company's Savings & Thrift Plan, Payroll-Based Employee Stock Ownership Plan, and Deferred Compensation Plan Thrift Fund.
(3) Includes 62,750, 14,530, 14,810, 13,460, and 14,070 shares, of performance-based restricted stock for Mr. Cosgrove, Mrs. Graham, and Messrs. Shaw, Ford and Klesius respectively, which were granted as a part of the Company's Long-Term Incentive Plan. The number of shares actually earned will depend on the Company's performance, as measured by Total Stockholder Return (stock appreciation and dividends paid), relative to the Peer Group at the end of a four-year period.
(4) Does not include 14,400 and 4,400 shares of Common Stock which Messrs. Cosgrove and Klesius respectively, are deemed to have beneficial ownership. These shares may be acquired upon the exercise of stock options granted under the Company's Long-Term Incentive Plan.
(5) Does not include 300 shares of Common Stock owned by Mr. Abercrombie's wife, beneficial ownership of which he disclaims.
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SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS
The following table provides information with respect to the only person who is known to Delmarva Power & Light Company to be the beneficial owner of more than 5% of the outstanding shares of Common Stock of the Company.
- -------- (1) The share ownership shown above is based on Amendment No. 5 to a Form 13G, dated January 16, 1998 filed with the Securities and Exchange Commission.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
None.
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PART IV
ITEM 14.
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a) The following documents are filed as part of this report:
1. Financial Statements--The following financial statements are contained in Item 8 of Part II.
2. Financial Statement Schedules--No financial statement schedules have been filed since the required information is not present in amounts sufficient to require submission of the schedule or because the information required is included in the respective financial statements or the notes thereto.
3. Schedule of Operating Statistics for the three years ended December 31, 1997 can be found on page IV-4 of this report.
4. Exhibits
IV-1
IV-2
(b) Reports on Form 8-K:
On October 27, 1997, the Company filed a Form 8-K which reported an agreement for the sale of a landfill and waste-hauling company owned by a subsidiary of the Company.
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DELMARVA POWER & LIGHT COMPANY
SCHEDULE OF OPERATING STATISTICS FOR THE THREE YEARS ENDED DECEMBER 31, 1997
The table below sets forth selected financial and operating statistics for the Company's electric and gas businesses for the three years ended December 31, 1997.
(Table continued on next page)
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DELMARVA POWER & LIGHT COMPANY
SCHEDULE OF OPERATING STATISTICS--(CONTINUED) FOR THE THREE YEARS ENDED DECEMBER 31, 1997
- -------- (1) Includes unbilled sales. (2) Offsystem, competitive sales and other services. (3) Includes unbilled revenues and other miscellaneous revenues. (4) Service territory only.
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SIGNATURES
PURSUANT TO THE REQUIREMENTS OF SECTION 13 OR 15(D) 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, ON MARCH 27, 1998.
Delmarva Power & Light Company (Registrant)
/s/ Barbara S. Graham By __________________________________ (Barbara S. Graham, Senior Vice President and Chief Financial Officer)
PURSUANT TO THE REQUIREMENTS OF THE SECURITIES EXCHANGE ACT OF 1934, THIS REPORT HAS BEEN SIGNED BELOW BY THE FOLLOWING PERSONS ON BEHALF OF THE REGISTRANT AND IN THE CAPACITIES, ON MARCH 27, 1998.
SIGNATURE TITLE
/s/ Howard E. Cosgrove Chairman of the Board, ..................................... Chief Executive (Howard E. Cosgrove) Officer and Director
/s/ Barbara S. Graham Senior Vice President, ..................................... Chief Financial (Barbara S. Graham) Officer and Director
/s/ James P. Lavin Controller and Chief ..................................... Accounting Officer (James P. Lavin)
/s/ Meredith I. Harlacher, Jr. Director ..................................... (Meredith I. Harlacher, Jr.)
/s/ Thomas S. Shaw Director ..................................... (Thomas S. Shaw)
/s/ Barry R. Elson Director ..................................... (Barry R. Elson)
/s/ Audrey K. Doberstein Director ..................................... (Audrey K. Doberstein)
/s/ Jerrold L. Jacobs Director ..................................... (Jerrold L. Jacobs)
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