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

 

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of Registrants' knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  o

 

GLOSSARY OF TERMS

The following is a glossary of frequently used abbreviations or acronyms used herein.

 

 

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TABLE OF CONTENTS

(iii)

PART I

FILING FORMAT

This 10-K Annual Report for the fiscal year ended December 31, 2012, is a combined report being filed by two different Registrants: CH Energy Group and Central Hudson.  Any references in this 10-K Annual Report to CH Energy Group include all subsidiaries of CH Energy Group, including Central Hudson, except where the context clearly indicates otherwise.  Central Hudson makes no representation as to the information contained in this 10-K Annual Report in relation to CH Energy Group and its subsidiaries other than Central Hudson.  When this 10-K Annual Report is incorporated by reference into any filing with the SEC made by Central Hudson, the portions of this 10-K Annual Report that relate to CH Energy Group and its subsidiaries, other than Central Hudson, are not incorporated by reference therein.

CH Energy Group's wholly owned subsidiaries include Central Hudson and CHEC.  For additional information, see the sub-caption "CHEC and Its Subsidiaries and Investments" in Item 1 - "Business" under the caption "Subsidiaries of CH Energy Group."

FORWARD-LOOKING STATEMENTS

Statements included in this Annual Report on Form 10-K and any documents incorporated by reference which are not historical in nature are intended to be, and are hereby identified as, "forward-looking statements" for purposes of the safe harbor provided by Section 21E of the Exchange Act. Forward-looking statements may be identified by words including "anticipates," "intends," "estimates," "believes," "projects," "expects," "plans," "assumes," "seeks," and similar expressions.  Forward-looking statements including, without limitation, those relating to CH Energy Group's and Central Hudson's future business prospects, revenues, proceeds, working capital, investment valuations, liquidity, income, and margins, as well as the acquisition by a subsidiary of Fortis Inc. and the expected timing of the transaction, are subject to certain risks and uncertainties that could cause actual results to differ materially from those indicated in the forward-looking statements, due to several important factors, including those identified from time to time in the forward-looking statements. Those factors include, but are not limited to: the possibility that various conditions precedent to the consummation of the proposed Fortis transaction will not be satisfied or waived, including regulatory approvals of the proposed Fortis transaction and the timing and terms thereof; the impact of delay or failure to complete the proposed Fortis transaction on CH Energy Group's stock price; the costs associated with the proposed Fortis transaction; deviations from normal seasonal weather and storm activity; fuel prices; energy supply and demand; potential future acquisitions; legislative, regulatory, and competitive developments; interest rates; access to capital; market risks; electric and natural gas industry restructuring and cost recovery; the ability to obtain adequate and timely rate relief; changes in fuel supply or costs including future market prices for energy, capacity, and ancillary services; the success of strategies to satisfy electricity, natural gas, fuel oil, and propane requirements; the outcome of pending litigation and certain environmental matters, particularly the status of inactive hazardous waste disposal sites and waste site remediation requirements; and certain presently unknown or unforeseen factors, including, but not limited to, acts of terrorism.  CH Energy Group and Central Hudson undertake no obligation to update publicly any forward-looking statements, whether as a result of new information, future events, or otherwise.  Given these uncertainties, undue reliance should not be placed on the forward-looking statements.

 

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Additional Information about the Fortis Transaction and Where to Find It

In connection with the proposed acquisition of CH Energy Group by Fortis, CH Energy Group filed a definitive proxy statement with the SEC on May 9, 2012, and has filed other relevant materials with the SEC as well.  Investors and stockholders of CH Energy Group are urged to read the proxy statement and other relevant materials filed with the SEC because they contain important information about the proposed acquisition and related matters.  Investors and stockholders may obtain a free copy of the proxy statement and other documents filed by CH Energy Group, at the SEC's Web site, www.sec.gov.  These documents can also be obtained by investors and stockholders free of charge from CH Energy Group at CH Energy Group's website at www.chenergygroup.com, or by contacting CH Energy Group's Shareholder Relations Department at (845) 486-5204.

ITEM 1 - Business

CORPORATE STRUCTURE

CH Energy Group is the holding company parent corporation of two principal, wholly owned subsidiaries, Central Hudson and CHEC.  Central Hudson is a regulated electric and natural gas subsidiary.  CHEC, the parent company of CH Energy Group's unregulated businesses and investments, has one wholly owned subsidiary, Griffith Energy Services, Inc. ("Griffith").  CHEC also has ownership interests in certain subsidiaries that are less than 100% owned.  For more information, see sub-caption "Other Subsidiaries and Investments" under caption "CHEC and Its Subsidiaries and Investments." For information concerning revenues, certain expenses, earnings per share, and information regarding assets of Central Hudson's regulated electric and regulated natural gas segments and of Griffith, see Note 13 - "Segments and Related Information."

HOLDING COMPANY REGULATION

CH Energy Group is a "holding company" under Public Utility Holding Company Act of 2005 ("PUHCA 2005") because of its ownership interests in Central Hudson and CHEC.  CH Energy Group, however, is exempt from regulation as a holding company under PUHCA 2005, because it derives substantially all of its public utility company revenues from business conducted within a single state, the State of New York.  At the present time, CH Energy Group cannot predict whether and when its circumstances may change such that it no longer qualifies for exemption from PUHCA 2005.

 

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SUBSIDIARIES OF CH ENERGY GROUP

Central Hudson

Central Hudson is a New York State natural gas and electric corporation formed in 1926.  Central Hudson purchases, sells at wholesale and retail, and distributes electricity and natural gas at retail in portions of New York State.  Central Hudson also generates a small portion of its electricity requirements.

Central Hudson serves a territory comprising approximately 2,600 square miles in the Hudson Valley, with a population estimated at 681,000.  Electric service is available throughout the territory, and natural gas service is provided in and about the cities of Poughkeepsie, Beacon, Newburgh, and Kingston, New York, and in certain outlying and intervening territories.  The number of Central Hudson employees at December 31, 2012, was 869.

Central Hudson's territory reflects a diversified economy, including manufacturing industries, governmental agencies, public and private institutions, wholesale and retail trade operations, research firms, farms and resorts.

Seasonality and Other Weather Impacts

Central Hudson's delivery revenues have historically varied seasonally in response to weather.  Sales of electricity are highest during the summer months, primarily due to the use of air-conditioning and other cooling equipment.  Sales of natural gas are highest during the winter months, primarily due to space heating usage.  Central Hudson's rates are developed based on forecasts of annual sales volumes.  Effective July 1, 2009 and continuing in the 2010 Rate Order through June 30, 2013, Central Hudson's delivery rate structure includes RDMs, which provide the ability to record revenues equal to those forecasted in the development of current rates for most of Central Hudson's customers.  As a result, fluctuations in actual sales volumes as a result of weather or other factors as compared to those forecasted in rate proceedings no longer have a significant impact on earnings.  However, variations between actual expenses incurred due to storm activity and the amount set in rates may impact Central Hudson's earnings.  Central Hudson has the ability to request regulatory recovery of significant incremental costs incurred if certain criteria are met as defined by the PSC and, as such, any adverse impact on earnings for higher storm expenses should be limited to non-material amounts, as long as the other criteria for deferral accounting are met.

 

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Competition

Central Hudson is a regulated utility with a legal obligation to deliver electricity and natural gas within its PSC-approved franchise territory.  Central Hudson has no direct competitors in its electricity distribution business; indirect competitors include distributed generation systems, including net metered systems.  Central Hudson's natural gas business competes with other fuels, especially fuel oil and propane.  The competitive marketplace continues to develop for electric and natural gas supply markets, and Central Hudson's electric and natural gas customers may purchase energy and related services from other providers.  Central Hudson's rate making structure neutralizes any earnings impact of customers' decisions to purchase electricity and natural gas from other providers.

Regulation

Central Hudson is subject to regulation by the PSC regarding, among other things, services rendered (including the rates charged), major transmission facility siting, accounting treatment of certain items, and issuance of securities.  For certain restrictions imposed by the Settlement Agreement, see Note 2 - "Regulatory Matters."

Certain activities of Central Hudson, including accounting and the acquisition and disposition of property, are subject to regulation by FERC under the Federal Power Act.

Central Hudson is not subject to the provisions of the Natural Gas Act.  Central Hudson's hydroelectric facilities are not required to be licensed under the Federal Power Act but are regulated by the DEC.

Central Hudson is subject to regulation by the North American Electric Reliability Corporation regarding its ownership, operation and use of a bulk power system.

Rates

General: The electric and natural gas rates charged by Central Hudson applicable to service supplied to retail customers within New York State are regulated by the PSC.  Costs of service, both for electric and gas delivery service and for electric and gas supply costs, are recovered from customers through PSC approved tariffs, subject to a standard of prudency.  Both transmission rates and rates for electricity sold for resale which involve interstate commerce are regulated by FERC.

Since July 2009, Central Hudson's rates have included RDMs which are intended to minimize the earnings impact resulting from reduced energy consumption as energy efficiency programs are implemented by breaking the link between energy sales and utility revenues and profits.  Central Hudson's RDMs allow the Company to recognize electric delivery revenues and gas sales per customer at the levels approved in rates for most of Central Hudson's electric and gas customer classes.

 

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Central Hudson's retail electricity rate structure consists of various service classifications covering delivery service and full service (which includes electricity supply) for residential, commercial, and industrial customers.  Retail rates for delivery and supply are shown separately on retail bills to allow customers to see the costs associated with their commodity supply, and thus facilitate retail competition.  During 2012, the average price of electricity for full service customers was 14.85 cents per kWh as compared to an average of 14.48 cents per kWh in 2011.  The PSC has authorized Central Hudson to recover the costs of the electric commodity from customers, without earning a profit on the commodity costs.  The average delivery price in 2012 was 6.24 cents per kWh and 5.60 cents per kWh in 2011.  The increase in delivery price was primarily due to the implementation of new rates as part of the 2010 Rate Order.  The average delivery prices in 2012 and 2011 also include a surcharge resulting from the Electric RDM.

Central Hudson's retail natural gas rate structure consists of various service classifications covering transport, retail access service, and full service (which includes natural gas supply) for residential, commercial, and industrial customers.  During 2012, the average price of natural gas for full-service customers was $13.81 per Mcf as compared to an average of $15.50 per Mcf in 2011.  The PSC has authorized Central Hudson to recover the costs of the gas commodity from customers, without earning a profit on the commodity costs.  The average delivery price for natural gas for retail and full service in 2012 was $7.52 per Mcf and $6.94 per Mcf in 2011.  The increase in delivery price was primarily due to the implementation of new rates as part of the 2010 Rate Order and the result of fixed revenue spread over lower sales due to milder weather conditions.  The average delivery price in 2012 includes a refund resulting from the Gas RDM, whereas the average delivery price in 2011 includes a surcharge resulting from the Gas RDM.

For further information regarding the terms of the 2009 Rate Order and 2010 Rate Order under which Central Hudson operated during the current reporting period, see Note 2 - "Regulatory Matters" under the caption "2009 and 2010 Rate Orders."

Cost Adjustment Clauses and RDMs:  For information regarding Central Hudson's electric and natural gas cost adjustment clauses and RDMs, see Note 1 - "Summary of Significant Accounting Policies" under the caption "Rates, Revenues and Cost Adjustment Clauses."

Capital Expenditures and Financing

For estimates of future capital expenditures for Central Hudson, see the sub-caption "Anticipated Sources and Uses of Cash" in Item 7 - "Management's Discussion and Analysis of Financial Condition and Results of Operations" of this 10-K Annual Report under the caption "Capital Resources and Liquidity."

Central Hudson's Certificate of Incorporation and its various debt instruments do not contain any limitations upon the issuance of authorized, but unissued, Preferred Stock or unsecured short-term debt.

 

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Central Hudson has in place certain credit facilities with financial covenants that limit the amount of indebtedness Central Hudson may incur.  Additionally, Central Hudson's ability to issue debt securities is limited by authority granted by the PSC.  Central Hudson believes these limitations will not impair its ability to issue any or all of the debt described under the sub-caption "Financing Program" in Item 7 - "Management's Discussion and Analysis of Financial Condition and Results of Operations" of this 10-K Annual Report under the caption "Capital Resources and Liquidity."

 

Research and Development

Central Hudson is engaged in the conduct and support of research and development ("R&D") activities, which are focused on the improvement of existing energy technologies and the development of new technologies for the delivery and customer use of energy.  Central Hudson's R&D expenditures were $4.0 million in 2012, $2.1 million in 2011 and $3.1 million in 2010.  These expenditures were for internal research programs and for contributions to research administered by New York State Energy Research and Development Authority ("NYSERDA"), the Electric Power Research Institute, and other industry organizations.  The decrease in total R&D expenditures in 2011 as compared to the other periods presented is a result of a PSC Order to cease the collection from customers and payment to NYSERDA of certain energy efficiency research funds in 2011.  There was no impact on earnings related to this change and the collections and payments resumed in 2012.  R&D expenditures are provided for in Central Hudson's rates charged to customers for electric and natural gas delivery service, with any differences between R&D expense and the rate allowances deferred for future recovery from or return to customers.

Other Central Hudson Matters

Labor Relations:  Central Hudson has an agreement with Local 320 of the International Brotherhood of Electrical Workers for its 526 unionized employees, representing construction and maintenance employees, customer service representatives, service workers, and clerical employees (excluding persons in managerial, professional, or supervisory positions).  This agreement became effective on May 1, 2011, and remains effective through April 30, 2016.

 

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CHEC and Its Subsidiaries and Investments

CHEC, a New York corporation, is a wholly owned subsidiary of CH Energy Group.  CHEC's wholly owned subsidiary is Griffith.  For further discussion of certain energy-related projects within other subsidiaries and investments, see Note 5 - "Acquisitions, Divestitures and Investments."

Griffith

Griffith is an energy services company engaged in fuel distribution, including heating oil, gasoline, diesel fuel, kerosene, and propane, and the installation and maintenance of heating, ventilating, and air conditioning equipment.  The number of Griffith employees at December 31, 2012 was 366.

Seasonality

A substantial portion of CHEC's revenues vary seasonally, as Griffith's fuel oil deliveries are directly related to use for space heating and are highest during the winter months.  Griffith entered into a weather swap for the period beginning November 1, 2012 through March 31, 2013. The hedge is designed to minimize the impact on earnings of variations from normal temperatures on the sale of products and services whose use is weather sensitive. These products and services include the sale of heating oil, propane, HVAC equipment, and billable service on HVAC equipment. In prior years, Griffith had entered into weather collars which reduced, but did not eliminate, the impact of weather on earnings.  Management believes that the weather swap will more effectively mitigate the impact of weather on earnings volatility.

Competition

Griffith participates in a competitive fuel distribution industry that is subject to different risks than those found in the businesses of the regulated utility, Central Hudson.  Griffith faces competition from other fuel distribution companies and from companies supplying other sources for heating, such as electricity, natural gas, propane and heat pumps.  For a discussion of Griffith's operating revenues and operating income, see the caption "Results of Operations" in Item 7 - "Management's Discussion and Analysis of Financial Condition and Results of Operations" of this 10-K Annual Report.

 

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ENVIRONMENTAL QUALITY REGULATION

Central Hudson and Griffith are subject to regulation by federal, state, and local authorities with respect to the environmental effects of their operations. Environmental matters may expose Central Hudson and Griffith to potential liability, which, in certain instances, may be imposed without regard to fault or may be premised on historical activities that were lawful at the time they occurred.

Central Hudson and Griffith each monitor their activities in order to determine their impact on the environment and to comply with applicable environmental laws and regulations.

The principal environmental areas relevant to these companies (air, water and industrial and hazardous wastes, other) are described below. Unless otherwise noted, all required permits and certifications have been obtained by the applicable company. Management believes that each company was in material compliance with these permits and certifications during 2012, except as noted in Note 12 – "Commitments and Contingencies" under the caption "Environmental Matters" of this 10-K Annual Report.

Air Quality

The Clean Air Act Amendments of 1990 address attainment and maintenance of national air quality standards and impact Central Hudson electric generating facilities in South Cairo and Coxsackie, NY.  See Note 12 − "Commitments and Contingencies" under the caption "Environmental Matters" regarding the investigation by the EPA into the compliance of a former major Central Hudson generating asset.

Water Quality

The Clean Water Act established the basic framework for federal and state regulation of water pollution control and requires facilities that discharge waste or storm water into the waters of the United States to obtain permits. Central Hudson and Griffith have permits regulating pollutant discharges for relevant locations.

Industrial & Hazardous Substances and Wastes

Central Hudson and Griffith are subject to federal, state and local laws and regulations relating to the use, handling, storage, treatment, transportation, and disposal of industrial, hazardous, and toxic wastes. Currently, there are no permit or certification requirements for Griffith. See Note 12 − "Commitments and Contingencies" under the caption "Environmental Matters" for additional discussion regarding, among other things, Central Hudson's former MGP facilities and Little Britain Road.

 

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Environmental Expenditures

2012 actual and 2013 estimated expenditures attributable in whole or in substantial part to environmental considerations are detailed in the table below (In Millions):

The increase in 2013 estimated expenditures relates to MGP remediation activities at the Catskill site, which commenced in September 2012.  For further discussion of these activities, see Note 12 – "Commitments and Contingencies" under caption "Former Manufactured Gas Plant Facilities".

Central Hudson and Griffith are also subject to regulation with respect to other environmental matters, such as noise levels, protection of vegetation and wildlife, and limitations on land use, and are in compliance with regulations in these areas.

Regarding environmental matters, except as described in Note 12 - "Commitments and Contingencies" under the caption "Environmental Matters," neither CH Energy Group, Central Hudson nor Griffith are involved as defendants in any material litigation, administrative proceeding, or investigation and, to the best of their knowledge, no such matters are threatened against any of them.

AVAILABLE INFORMATION

CH Energy Group and Central Hudson file annual, quarterly, and current reports and other information with the SEC.  CH Energy Group also files proxy statements.  The public may read and copy any of the documents each company files at the SEC's Public Reference Room at 100 F Street N.E., Room 1580, Washington, D.C. 20549.  The public may obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330.  SEC filings are also available to the public from the SEC's Internet website at www.sec.gov.

CH Energy Group and Central Hudson make available free of charge at www.CHEnergyGroup.com their annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Exchange Act, as soon as reasonably practicable after it electronically files such material with, or furnishes it to, the SEC.  CH Energy Group's proxy statements, governance guidelines, Code of Business Conduct and Ethics, and the charters of its Audit, Compensation, Governance and Nominating, and Strategy and Finance Committees are also available at www.CHEnergyGroup.com.  The governance guidelines, the Code of Business Conduct and Ethics, and the charters may also be obtained by writing to the Corporate Secretary, CH Energy Group, Inc., 284 South Avenue, Poughkeepsie, New York 12601-4839.

 

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FIVE-YEAR SUMMARY OF CONSOLIDATED OPERATIONS AND SELECTED FINANCIAL DATA⁽¹⁾ (CH ENERGY GROUP)

(In Thousands, except per share data)

 

		2012				2011				2010				2009				2008
Operating Revenues:
Electric - Delivery		$	336,360			$	332,388			$	317,023			$	275,167			$	242,334
Electric - Supply			175,721				206,160				246,116				261,003				365,827
Natural Gas - Delivery			83,158				85,196				81,606				66,916				59,897
Natural Gas - Supply			49,276				76,778				75,189				107,221				129,649
Competitive business subsidiaries			280,204				284,998				240,174				211,250				330,254
Total			924,719				985,520				960,108				921,557				1,127,961
Operating Income			91,318				99,589				99,303				81,585				70,701
Income from continuing operations			39,847				43,184				40,330				33,597				30,968
Income (loss) from discontinued operations, net of tax			-				3,126				(1,128	)			10,681				5,186
Preferred Stock redemption premium			342				-				-				-				-
Dividends declared on Preferred Stock of subsidiary			624				970				970				970				970
Net Income attributable to CH Energy Group			38,881				45,340				38,504				43,484				35,081
Dividends Declared on Common Stock			33,169				33,291				34,161				34,119				34,086
Change in Retained Earnings			5,712				12,049				4,343				9,365				995
Retained Earnings - beginning of year			242,391				230,342				225,999				216,634				215,639
Retained Earnings - end of year		$	248,103			$	242,391			$	230,342			$	225,999			$	216,634
Common Share Data:
Average shares outstanding - basic			14,909				15,278				15,785				15,775				15,768
Income from continuing operations - basic		$	2.61			$	2.77			$	2.51			$	2.08			$	1.89
Income (loss) from discontinued operations - basic		$	-			$	0.20			$	(0.07	)		$	0.68			$	0.33
Net Income attributable to CH Energy Group - basic		$	2.61			$	2.97			$	2.44			$	2.76			$	2.22
Average shares outstanding - diluted			15,099				15,481				15,952				15,881				15,805
Income from continuing operations - diluted		$	2.58			$	2.73			$	2.48			$	2.07			$	1.89
Income (loss) from discontinued operations - diluted		$	-			$	0.20			$	(0.07	)		$	0.68			$	0.33
Net Income attributable to CH Energy Group - diluted		$	2.58			$	2.93			$	2.41			$	2.74			$	2.22
Dividends declared per share		$	2.22			$	2.19			$	2.16			$	2.16			$	2.16
Book value per share (at year-end)		$	34.05			$	33.72			$	34.03			$	33.76			$	33.17
Total Assets (at year-end)		$	1,784,949			$	1,720,234			$	1,729,275			$	1,697,883			$	1,730,183
Long-term Debt (at year-end)(2)		$	486,926			$	446,003			$	502,959			$	463,897			$	413,894
Cumulative Preferred Stock (at year-end)		$	9,027			$	21,027			$	21,027			$	21,027			$	21,027
Total CH Energy Group Common Shareholders' Equity (at year-end)		$	509,290			$	502,248			$	537,804			$	553,502			$	523,534

 

(1)	This summary should be read in conjunction with the Consolidated Financial Statements and Notes thereto included in Item 8 - "Financial Statements and Supplementary Data" of this 10-K Annual Report.
(2)	Net of current maturities of long-term debt.

For additional information related to the impact of acquisitions and dispositions on the above, this summary should be read in conjunction with Item 7 - "Management Discussion and Analysis of Financial Condition and Results of Operations" of this 10-K Annual Report and Note 5 - "Acquisitions, Divestitures and Investments" of Item 8 - "Financial Statements and Supplementary Data" of this 10-K Annual Report.

 

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ITEM 7 - Management's Discussion and Analysis of Financial Condition and Results of Operations

 

INTRODUCTION

The following Management's Discussion and Analysis of Financial Condition and Results of Operations are intended to help the reader understand CH Energy Group and Central Hudson.

Please note that the Executive Summary (below) is provided as a supplement to, and should be read together with, the remainder of this Item 7 - "Management's Discussion and Analysis of Financial Condition and Results of Operations," the Consolidated Financial Statements, including the Notes thereto, and the other information included in this 10-K Annual Report.

EXECUTIVE SUMMARY

Business Overview

CH Energy Group's objective is to deliver value to its shareholders through current income, in the form of quarterly dividend payments, and through share appreciation that is expected to result from earnings and dividend growth over the long term.

CH Energy Group is a holding company with four business units:

 

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CH Energy Group's asset allocation between Central Hudson, Griffith and Other Businesses and Investments were unchanged from December 31, 2011 to December 31, 2012.  The allocation for both periods is as follows:

 

Information Regarding the Fortis Transaction

 

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Mission and Strategy

CH Energy Group's mission is to provide electricity, natural gas, petroleum and related services to an expanding customer base in a safe, reliable, courteous and affordable manner; to produce growing financial returns for shareholders; to foster a culture that encourages employees to reach their full potential; and to be a good corporate citizen.

CH Energy Group endeavors to fulfill its mission, providing an attractive risk adjusted return to CH Energy Group shareholders, by executing our plan to:

 

·	Concentrate on energy distribution through Central Hudson in the Mid-Hudson Valley and through Griffith in the Mid-Atlantic region

·	Invest primarily in utility electric and natural gas transmission and distribution

·	Focus on risk management

-	Limit commodity exposure

-	Manage regulatory affairs effectively

-	Maintain a financial profile that supports a credit rating in the "A" category

-	Limit the impact of weather on Griffith's earnings

·	Target stable and predictable earnings, with growth trend expectations of 5% or more per year

·	Provide an annualized dividend that is approximately 65% to 70% of annual earnings

 

Strategy Execution

Based on the current investment and capital structure, CH Energy Group's management believes that it is well positioned to achieve its earnings growth and annualized dividend goals.

Management continues to focus on Central Hudson's electric and natural gas infrastructure as the core growth drivers of CH Energy Group.  Central Hudson's capital expenditure program is on course to achieve its targets under its three year rate plan.  Central Hudson invested approximately $100 million in 2012 and the five year forecast includes increasing annual capital investments.  The capital program provides for continued strengthening of electric and gas infrastructure, as well as prudent investment in technology that will improve reliability and customer satisfaction.  Central Hudson has effectively managed its operational challenges, including significant weather events in the past few years and the impact of a significant recession on its customers' ability to pay bills, and has achieved a return approximately equal to its allowed return in 2012.

Griffith's financial results in 2012 were impacted by extremely mild winter weather in the first quarter and escalating wholesale prices, which further dampened demand for its products.  Griffith continued its focus on cost management in an effort to reduce the impact of the lower volumes and higher commodity costs on its cost of doing business. Additionally, Griffith's high quality service and brand recognition enabled management to continue its history of increasing margins in an environment of contracting customer demand for petroleum products.  Griffith also successfully acquired and tucked-in five companies in 2012, all of which are expected to be accretive in 2013.

 

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The following information outlines the strategies for each of CH Energy Group's business units, including a description of the business core competencies, investment opportunities, potential risks, and notable activity during 2012.  Business unit contributions to operating revenues and net income for years ended December 31, 2012 and 2011 are discussed in more detail in the Results of Operations section of this Management's Discussion and Analysis.

Central Hudson

Business Description and Strategy

Central Hudson's earnings are derived primarily from the revenue it generates from delivering energy to approximately 300,000 electric customers and 80,000 natural gas customers.  The delivery rates Central Hudson charges its customers are set by the PSC and are designed to recover the cost of providing safe and reliable service to Central Hudson's customers while providing the opportunity to earn a fair and reasonable return on the capital invested by shareholders.

Central Hudson's strategy is to provide exceptional value to its customers by:

·	practicing continuous improvement in everything we do;

·	investing in transmission and infrastructure to enhance reliability, improve customer satisfaction and reduce risk;

·	moderating cost pressures that increase customer bill levels and variability; and

·	advocating on behalf of customers and other stakeholders.

Central Hudson believes that it has strong competencies in safe and efficient utility operations, financial management, risk management and regulatory affairs which will facilitate the achievement of its strategy.  Central Hudson's strategic and business planning processes provides goal alignment throughout all levels of the organization in an effort to meet or exceed the expectations of its key stakeholders.

Opportunities and Risks

Earnings growth is primarily expected to come from increases in net utility plant.  Central Hudson invests significant capital on an annual basis to strengthen its distribution system by replacing aging infrastructure and to attach new customers to the system.  Central Hudson's investments enhance safety and reliability through cost-beneficial solutions, which improve customer satisfaction and reduce risk.  Opportunities to enhance transmission and distribution systems and information systems technologies are evaluated and prioritized based on their designed benefits, projected costs and estimated risks.  Management continually monitors and evaluates its capital expenditure forecasts and project priorities, which include certain long-term investment opportunities in the system's distribution infrastructure and potentially in gas and electric transmission.

 

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Future legislative or political actions could result in additional opportunities for infrastructure enhancement.  Following Superstorm Sandy, Governor Cuomo formed the Moreland Commission to investigate utility storm preparedness and response.  The ultimate recommendations of this Commission, if adopted, could result in increased investment with the goal of reducing damage from storms in the future.

Central Hudson also believes there is an opportunity related to the expansion of its current natural gas customer base.  Development of the Marcellus Shale formation and other shale formations has dramatically increased the domestic supply of natural gas and its price has fallen significantly.  As a result, natural gas enjoys a significant price advantage over alternative fuels and management believes this will make it more attractive to customers.  Central Hudson is surveying its service territory to identify the most cost-effective areas in which to expand its gas distribution system and attach new customers.

Central Hudson continues to advance its cost management efforts and seek opportunities to improve existing business processes utilizing Lean Six Sigma techniques.  Lean Six Sigma is a data driven approach to develop processes that are faster, higher quality and less costly.  Our incremental process improvements focus on producing more revenue, providing cost savings and creating quality improvements, thereby providing benefits for both CH Energy Group shareholders and Central Hudson customers.  Central Hudson also recognizes the importance of innovation and encourages employees to create new value and opportunities to reduce costs and improve quality through the application of technology in new ways and creative problem solving.

The key risks management sees in achieving this strategy are the regulatory environment, cost pressures and the economy in Central Hudson's service territory.

Central Hudson's ability to meet its financial objectives is largely dependent on supportive ratemaking practices by the PSC.  Risks related to these practices include reduced allowed returns on equity and/or reduced probabilities of achieving allowed returns, an inability to recover the full costs of doing business, declining support for strong capital structures and credit ratings, changes in deferral accounting that increase volatility of earnings and/or defer cash recovery of our costs, elimination of RDMs and changes in the mechanisms currently in place for recovery of our commodity purchases.  Falling interest rates since our last rate case decision could lead to a decrease in the authorized ROE in a future rate proceeding.  Management believes Central Hudson's commitments to providing safe and reliable service, customer satisfaction, operational excellence and promoting positive customer and regulatory relations are important for supportive regulatory relationships and obtaining full cost recovery and competitive returns for shareholders.

 

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The current three-year rate plan, which commenced on July 1, 2010 and will continue until new rates are reset, reduces uncertainty and risk and supports investment in Central Hudson's infrastructure to improve the quality of service to customers.  The key provisions of the rate plan include an authorized regulatory return on equity of 10.0% and a 48% regulatory equity ratio; the continuation of a RDM; full recovery and deferral provisions for purchased electric and gas, MGP site remediation, pension and OPEB expenses.  The rate plan also contains a number of service quality thresholds; performance below these thresholds entails financial penalties.  Additionally, PSC staff approved and incorporated in the development of rates, the revenue requirements associated with Central Hudson's capital expenditure budget for the term of the three-year rate plan, subject to the achievement of certain defined Net Plant targets.  The PSC's regulations also provide an opportunity to recover certain extraordinary expenditures that are not reflected in rates.  However, the 3-pronged test criteria required for approval may limit Central Hudson from recovering some or all of such costs, reducing earnings for shareholders.  Management believes the current rate plan and other regulatory orders under which Central Hudson operates demonstrate a constructive relationship with New York State regulators and the willingness of regulators to enable Central Hudson to earn stable, predictable returns while providing reliable, high quality service and fulfilling New York State energy policy objectives.

The impacts of laws and regulations represent another risk to Central Hudson's strategy.  The Moreland Commission formed following Superstorm Sandy was tasked by Governor Cuomo to investigate utility storm preparedness and response.  The outcome of the Commission's investigation and recommendations may create potential opportunities, but may also create potential financial risks in terms of new or increased standards of performance, with associated penalties for failure to meet the standards.  Central Hudson responded timely to the two subpoenas it received during the Moreland Commission investigation requesting information regarding storm preparedness and restoration.  The Moreland Commission issued an Interim Report on January 7, 2013 making recommendations that, if adopted, may affect the regulation of future storm preparedness and response for all New York utilities, including Central Hudson.  Central Hudson believes its current storm preparedness and response is excellent, but opportunities for improvement are continuously pursued.  For example, Central Hudson's tree trimming program has proven to be a cost-effective measure to enhance reliability and reduce outages caused by falling branches, particularly in times of severe weather.  Central Hudson plans to invest in technology to automate the electric distribution system, which is expected to further reduce the frequency of outages.  Management believes these programs provide the type of cost-effective measures to improve resilience of the electric distribution system sought by state officials.  Furthermore, Central Hudson has been recognized nationally for its storm response by the Edison Electric Institute in each of the past three consecutive years, including its storm response and restoration efforts following Superstorm Sandy in 2012.  Central Hudson's dedicated and skilled workforce again demonstrated their ability to organize and execute high quality and efficient restoration for its customers, restoring power to 90% of its customers within four days following Superstorm Sandy.  Management does not believe it will be cited with any penalties related to prior storm restoration, however, continued regulatory support for recovery of the cost of these programs, along with recovery of incremental restoration costs will be necessary for Central Hudson to achieve stable and predictable earnings.

 

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In addition to the recovery of costs of operation, Central Hudson's current rate structure includes a return on its projected rate base.  Rate base represents Central Hudson's investment in its utility infrastructure, less depreciation, adjusted for certain required regulatory items.  Changes in tax legislation or regulatory accounting can reduce the amount of Central Hudson rate base, reducing Central Hudson's future rates and potential earnings.  For example, Central Hudson's election to utilize bonus depreciation as it has been made available in recent years has had just such an impact.  In addition, Central Hudson's change in accounting tax method related to costs to repair and maintain utility assets has resulted in an increase in its deferred tax liability and a corresponding decrease in its rate base.  For additional discussion of these tax items, see Note 4 – "Income Tax."

Another risk is the ability to effectively manage costs, which is a key component of Central Hudson's strategy.  The continued implementation of Lean Six Sigma techniques to streamline existing business processes and innovation to create new value will play critical roles in managing the costs of doing business in a sustainable manner as well as result in continuous improvement in services provided to customers.

The third risk, the economy in Central Hudson's service territory, affects the growth of utility rate base and earnings through a direct relationship to customer additions and peak demand growth as well as affecting our ability to collect receivables.  Management believes the economy in Central Hudson's service territory has good long-term growth prospects, but unexpected prolonged downturns could inhibit our ability to meet long-term business objectives.  Central Hudson has an economic development program intended to increase job growth and income in its service territory.

Griffith

Business Description and Strategy

Griffith provides fuel distribution products and services to approximately 55,000 customers in Delaware, Washington, D.C., Maryland, Pennsylvania, Virginia and West Virginia.  Griffith's revenues, cash flows and earnings are derived from the sale and delivery of heating oil, gasoline, diesel fuel, kerosene and propane and from the installation and maintenance of heating, ventilating and air conditioning ("HVAC") equipment.  For a breakdown of Griffith's gross profit by product and service line for the years ended December 31, 2012, 2011 and 2010, see the chart in the Results of Operations under the caption – "Griffith."

 

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Griffith's strategy is to provide premium service to customers and to increase its profitability and reduce earnings volatility by:

·	practicing continuous improvement in everything we do;

·	growing through selective "tuck-in" acquisitions;

·	managing the impacts of weather on earnings; and

·	expanding its service offerings.

Opportunities and Risks

Griffith has a strong regional brand that management believes stands for quality, reliability and value.  Griffith intends to continue its marketing efforts and focus on customer satisfaction, which management believes will help to minimize customer attrition.

Management also continues to focus on improving the profitability of operations and expanding products and services in the Mid-Atlantic region.  Griffith continues to seek selective oil and HVAC "tuck-in" acquisitions to be funded from internally generated cash.  This growth strategy focuses on acquiring and retaining customers in geographic areas that overlap Griffith's existing operations.  Griffith also expects to generate additional earnings and cash flow as a result of the organic expansion of its HVAC business.  These growth strategies are not expected to result in the growth of CH Energy Group's total invested capital in Griffith.

Management sees three key risks associated with this strategy.  The primary factor that could prevent Griffith from achieving earnings growth is a sustained, significant increase in wholesale oil prices, which could reduce residential sales volumes, put downward pressure on margins, increase operating costs and bad debt expense.  While management believes that margin expansion would still be possible in this environment as competitors would be forced to increase their prices to cover their increasing costs, management expects that this result would lag the increase in commodity prices.  Additionally, weakness in the economy of the Mid-Atlantic region could limit Griffith's ability to expand margins since customers' willingness and ability to pay are typically tied to income levels and unemployment rates.  The third risk relates to customer attrition which could be driven by increasing wholesale prices and margin expansion or as a result of the industry contracting due to conversions to alternative heating fuel sources or as a result of competitive pressures from within the industry.  Griffith seeks to eliminate the impact of weather on its business through the purchase of weather derivative instruments.

Notable 2012 Activity

In 2012, Griffith continued its successful acquisition strategy by acquiring five fuel distribution and service businesses.  Two of the acquisitions were HVAC companies, which totaled approximately half of the acquisition dollars invested in 2012.  These strategic acquisitions have already begun contributing to Griffith's earnings and cash flows.  However, during 2012 Griffith's earnings were adversely impacted by both unusually warm winter weather and higher fuel prices, which resulted in reduced usage in 2012.  Griffith's weather hedging in place in early 2012 mitigated a portion of the weather impact on earnings, but did not provide full protection.  Currently, Griffith is invested in weather swaps which management believes will more effectively minimize the impacts of weather on earnings.  Griffith also experienced a decline in the number of service installations and repairs under its expanded HVAC program in 2012, which management believes resulted from warmer than normal winter weather.  Despite the unfavorable environment, management was successful in continuing its trend of increasing margins and reducing costs through effective cost management measures.  Management believes that the reduced level of HVAC installations is temporary and that the long-term outlook of the economy in Griffith's service territory continues to be strong with a stable pool of current and prospective customers that value quality service at a fair price.

 

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Other Businesses and Investments

As of December 31, 2012, CHEC's remaining investments are not considered a part of our core business.  These investments are immaterial at 0.1% of assets and no further capital investment in them is planned.  Management intends to retain these remaining investments, but will continue to monitor market conditions to evaluate the fair market value of these investments and consider whether the opportunity exists to create greater shareholder value through divestitures.  For further discussions relating to CHEC's renewable energy investments, see Note 5 – "Acquisitions, Divestitures and Investments."

 

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EARNINGS PER SHARE AND OVERVIEW OF YEAR-TO-DATE RESULTS

The following discussion and analyses include explanations of significant changes in revenues and expenses between the year ended December 31, 2012 and 2011 and the year ended December 31, 2011 and 2010 for Central Hudson's regulated electric and natural gas businesses, Griffith, and the Other Businesses and Investments.

The discussions and tables below present the change in earnings of CH Energy Group's business units in terms of earnings for each outstanding share of CH Energy Group's Common Stock.  Management believes that expressing the results in terms of the impact on shares of CH Energy Group is useful to investors because it shows the relative contribution of the various business units to CH Energy Group's earnings.  This information is considered a non-GAAP financial measure and not an alternative to earnings per share determined on a consolidated basis, which is the most directly comparable GAAP measure.  Additionally, management believes that the disclosure of Significant Events within each business unit provides investors with the context around the Company's results that is important in enabling them to ascertain the likelihood that past performance is indicative of future performance.  A reconciliation of each business unit's earnings per share to CH Energy Group's earnings per share, determined on a consolidated basis, is included in the table below.

Earnings

Earnings per share (basic and diluted) of CH Energy Group's Common Stock are computed on the basis of the average number of common shares outstanding (basic and diluted) during the subject year.  The number of average shares outstanding of CH Energy Group Common Stock, the earnings per share, and the rate of return earned on average common equity, which is net income as a percentage of a monthly average of common equity, are as follows (Shares In Thousands):

 

		2012				2011				2010
Average shares outstanding:
Basic			14,909				15,278				15,785
Diluted			15,099				15,481				15,952
Earnings per share from continuing operations:
Basic		$	2.61			$	2.77			$	2.51
Diluted		$	2.58			$	2.73			$	2.48
Earnings per share from discontinued operations:
Basic		$	-			$	0.20			$	(0.07	)
Diluted		$	-			$	0.20			$	(0.07	)
Earnings per share:
Basic		$	2.61			$	2.97			$	2.44
Diluted		$	2.58			$	2.93			$	2.41
Return earned on average common equity			7.6	%			8.7	%			7.4	%

 

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Earnings for CH Energy Group for the year ended December 31, 2012 compared to 2011 were negatively impacted by costs incurred in the current year associated with the pending Fortis acquisition and the impact of weather on Griffith's earnings. These impacts were only partially offset by earnings on increased capital investments at Central Hudson.

 

 

Earnings for CH Energy Group totaled $2.97 per share in 2011, an increase of $0.53 per share from the same period in 2010 when earnings had been negatively impacted by impairments on two of its non-utility assets.

Detail by business unit were as follows:

 

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Central Hudson

 

Earnings per Share (Basic)

 

		Year Ended December 31,
		2011				2010				Change
Central Hudson - Electric		$	2.22			$	2.10			$	0.12
Central Hudson - Natural Gas			0.66				0.76				(0.10	)
Total Central Hudson Earnings		$	2.88			$	2.86			$	0.02
Significant Events:
Uncollectible deferral in 2010		$	-			$	0.12			$	(0.12	)
Higher weather related restoration costs(1)			(0.31	)			-				(0.31	)
Energy efficiency incentives			0.10				-				0.10
Share accretion			0.09				-				0.09
Central Hudson Adjusted Earnings Per Share		$	3.00			$	2.74			$	0.26
										Change
Delivery revenue										$	0.42
Higher property and other taxes											(0.12	)
Higher depreciation											(0.11	)
Higher trimming costs											(0.02	)
Other											0.09
										$	0.26

Earnings from Central Hudson's electric and natural gas operations increased in the year ended December 31, 2011 compared to 2010.  After adjusting Central Hudson's earnings per share for the significant items displayed above, including incremental storm-related restoration costs, earnings were $0.26 per share higher year over year.  The single largest driver was an increase in delivery revenue resulting from mid-year delivery rate increases in both 2011 and 2010.  This additional revenue was needed to cover projected increases in operating costs such as those noted above and to cover revenue requirements associated with increases in rate base.

 

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