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Executives

Beth W. Cooper - Chief Financial Officer, Principal Accounting Officer, Senior Vice President and Corporate Secretary

Michael P. McMasters - Chief Executive Officer, President and Director

Analysts

Spencer E. Joyce - Hilliard Lyons, Research Division

Chesapeake Utilities (CPK) Q3 2013 Earnings Call November 8, 2013 10:30 AM ET

Operator

Good morning. My name is Shannon, and I will be your conference operator today. At this time, I would like to welcome everyone to the Chesapeake Utilities Third Quarter Earnings Call. [Operator Instructions] I would now like to turn the call over to Ms. Beth Cooper, Senior Vice President and Chief Financial Officer. Ms. Cooper, you may begin.

Beth W. Cooper

Thank you, Shannon. Good morning, everyone, and welcome to the Chesapeake Utilities Corporation Third Quarter 2013 Earnings Conference Call. We have prepared a presentation to accompany our discussion today. This presentation can be accessed on our website under the Investors section and the Events & Webcasts subsection.

Moving to Slide 2. Today's conference call may include forward-looking statements that involve risks and uncertainties. Actual results may differ materially from those in the forward-looking statements. Please refer to the Safe Harbor for forward-looking statements in the company's most recent annual report on Form 10-K.

Yesterday, we announced results for the third quarter and first 9 months of 2013. Continued growth in the Natural Gas Distribution and Transmission businesses, as well as contributions from the acquisitions we have completed earlier in the year, were the key drivers of gross margin growth during the quarter. The pipeline extensions we completed in recent years, as well as earlier this year, generated increased results for the quarter and provide opportunities for continued growth.

The company's third quarter 2013 net income was $3.9 million or $0.40 per share, which is highlighted on Slide 3. This represents an increase over third quarter 2012 net income, which was $3.2 million or $0.33 per share.

During the third quarter of 2013, the company recorded a onetime reduction in operating expenses of $1.9 million related to the establishment of a regulatory asset for previously incurred litigation costs associated with the Marianna, Florida electric franchise dispute. Late last month, the Florida Public Service Commission approved recovery of the litigation costs. Partially offsetting the impact of this recovery on third quarter results was a $698,000 contingency for taxes other than income.

I will highlight the key accomplishments and results for the business segments during the third quarter of 2013. Detailed discussions of the changes in gross margin and operating expenses by business segment for the quarter and 9 months ended September 30, 2013, are provided in our press release and Form 10-Q, which were issued yesterday.

As shown on Slide 4, Chesapeake's Regulated Energy segment, which includes our Natural Gas Transmission and Distribution and Electric Distribution businesses, generated operating income of $10.2 million in the third quarter of 2013, up $2.4 million from 2012. Growth in the Regulated Energy segment remains strong, with $3 million in additional gross margin from natural gas expansion and customer additions, including the Eastern Shore Gas customers acquired in May, which are now being served by Sandpiper Energy.

The increase in gross margin was partially offset by $600,000 in operating expenses. The increase in operating expenses resulted from $1.3 million in additional expenses associated with Sandpiper's operation, as well as $1 million in increased costs from higher depreciation, administrative costs and additional investments in corporate resources to capitalize on future growth opportunities. These increases were partially offset by the $1.9 million reduction in operations expense associated with the Marianna litigation costs recovery, which was mentioned earlier.

Turning to Slide 5. Our Unregulated Energy segment reported an operating loss of $1.8 million for the third quarter of 2013, compared to an operating loss of $709,000 for the third quarter of 2012. Lower gross margin for Xeron of approximately $517,000 and the recordation of the non-income tax contingency of $698,000, mentioned earlier, were the driving factors of the $1.1 million decline in operating income. Lower volatility in wholesale propane prices resulted in lower profit on trading activity. Finally, the unregulated acquisitions that we completed earlier in the year had an impact on both margins and costs, generating slight earnings accretion for the quarter.

The Other segment is principally BravePoint, our Advanced Information Services business. For the third quarter of 2013, BravePoint reported operating income of $280,000, as detailed on Slide 6, down from $425,000 in operating income in the third quarter of 2012. A $286,000 increase in expenses was partially offset by $141,000 increase in gross margin.

Slide 7 highlights the key variances between 2013 and 2012 third quarter results. Unusual items accounted for $711,000 in higher net income, or $0.07 per share, due to the impact of the Marianna litigation costs recovery and the additional contingency for taxes other than income. Growth in the natural gas businesses and additional gross margin from acquisitions were the most significant positive factors during the period and more than offset the decline in margin from Xeron. These key increases in gross margin increased net income by $1.9 million or $0.18 per share.

Higher operating expenses reduced net income by $1.6 million or $0.15 per share. We incurred additional operating expenses as a result of the acquisitions, increased administrative staffing costs to support the growth in the company and additional investments in corporate resources to capitalize on future growth opportunities. Other changes reduced net income by $362,000 or $0.03 per share.

Moving to Slide 8. The company's net income for the first 9 months of 2013 was $23.1 million or $2.39 per share, compared to net income of $19 million or $1.97 per share for the first 9 months of 2012. The increase in net income for the first 9 months was largely a result of growth in the natural gas businesses, colder weather in the first quarter, strong retail propane margins per gallon and the impact of acquisitions, all of which combined to generate a $14.7 million increase in total gross margins.

Operating expenses increased $8.4 million year-to-date, as increases in costs associated with growth to serve new customers acquired organically as well as through acquisitions, were partially offset by a $1.5 million reduction of expenses from the recovery of the Marianna litigation costs.

Reconciling 9-month earnings for 2013 to 2012 on Slide 9, you can see that unusual items added a net of $2.4 million in net income, or $0.24 per share. More normal, colder weather during the first quarter of 2013 compared to 2012 was the primary component of the change from unusual items, as the recovery of Marianna litigation costs was offset by tax expenses associated with acquisitions and an accrual for additional non-income-related taxes.

Higher gross margin generated from the natural gas and propane businesses added a total of $5.7 million or $0.59 per share to 2013 year-to-date earnings. Growth in the Natural Gas Distribution businesses and higher retail propane margins, supplemented by new gross margin from the acquisitions completed earlier in the year, offset a decline in Xeron's performance on a year-to-date basis as a result of lower volatility in wholesale propane prices.

Operating expenses increased by $3.7 million or $0.38 per share for the first 9 months of 2013, compared to 2012, due principally to expenses associated with the acquisitions, increased incentive compensation as a result of year-to-date performance, higher administrative costs to support recent growth and additional investments in corporate resources to capitalize on future growth opportunities. Finally, net other changes, which primarily reflected the results of BravePoint, accounted for a $271,000 or $0.03 per share decrease in earnings for the first 9 months.

As you can see from our year-to-date results, we continue to benefit from successful execution of our growth strategy. The results also show that we are experiencing some increased costs which are required to support this growth and to capitalize on future growth. We will continue to invest in our capacity to serve our existing customers and to position ourselves to take advantage of future growth opportunities in our ongoing effort to produce dependable, growing returns to our shareholders.

Moving to Slide 10. Slide 10 shows that our capital expenditures for 2013 are expected to total $127 million, with year-to-date capital expenditures totaling $88 million. We expect the timing of completing some of these capital projects to extend into 2014.

Slide 11 shows that during the fourth quarter of 2013, we expect to complete 2 projects: the NRG Energy Center expansion and the Delaware City Refinery expansion, which combined, are expected to generate between $2.9 million and $3.3 million in incremental annual margin. Calpine is currently constructing a new natural-gas-powered electric generation plant in Dover. Chesapeake has entered into a precedent agreement with Calpine for this project and plans to enter into a firm transportation agreement once certain conditions have been satisfied. Once in service, the plant will generate an additional $1.2 million to $1.8 million in margin beginning in 2015.

We also have developed some major projects in Florida. In April 2012, we completed a transmission expansion in Nassau County that added $1.3 million in incremental annual gross margin. More recently, in August 2013, we began serving an unaffiliated utility in Florida, which will generate incremental annual gross margin of $840,000. In addition, we are aggressively pursuing several other natural gas opportunities that may translate into new expansions for the company in 2014 and beyond.

In the propane business, we acquired Glades Gas in February of 2013, and that acquisition contributed year-to-date gross margin of $831,000. Our Delmarva and Florida natural gas distribution, transmission and propane operations are strong and well-positioned going forward. Delivering clean, reliable energy throughout our territories will ensure that we can continue to deliver superior value to our shareholders.

Now, I'll turn the call over to Mike McMasters, President and Chief Executive Officer.

Michael P. McMasters

Thanks, Beth. Before I talk about our growth strategy, I want to take a step back to reinforce what I think has been a key to our success over the years: the underlying foundation to our success that has not and will not change; our continued commitment to our core values; care for our customers, communities, employees and our shareholders; our relentless financial discipline; and our profound aspiration to be better at what we do.

With this as a foundation, our employees are dedicated to providing safe, environmentally friendly service to our customers in a manner that represents value to them. Our drive to grow the company by extending service to new communities is generating significant savings for our customers and growth in earnings and shareholder value for our investors.

Whether it's a pipeline expansion to serve a new community, a regulatory strategy for large information technology implementation or favorably resolving a complex lawsuit, such as the Marianna case, our employees will continue to drive to achieve results that benefit our customers, the communities we serve and our investors.

As Beth mentioned earlier, our business units are continuing to generate growth, and we are continuing to see opportunities for growth looking forward. In that regard, I want to spend a little bit of time today talking about growth, opportunity and investment, both past and future.

Turning to Slide 12. Over the past several years, one of the major things that differentiates Chesapeake from other utility investments is our ability to identify and develop significant growth opportunities, while maintaining consistently high returns on equity. The combination of earning higher returns, while investing higher levels of capital, has been generating higher earnings growth.

Turning to Slide 13, you can see more clearly the comparative rate of capital investments that Chesapeake and our peer group have made over the 3 years ended June 2013. As indicated, we ranked third in our peer group, annually investing on average approximately 18% of our total capitalization. These investments, when made with discipline, provide the fuel for earnings growth.

On Slide 14, you can see that our 11.6% average ROE also ranks us third when compared to our peer group. As an aside, the 2 companies that are higher than us on return on equity are lower than us when it comes to investing capital.

Turning to Slide 15. The combination of the amount of capital we have invested and the attractive returns on capital that we have generated has enabled us to produce compound annual growth and earnings per share of 11.6% in the past 3 years and an excess of 9% over the past 5. Updating that for the 3 years ended June of 2013, our earnings per share growth rate is 6.7%, which ranks us fourth when compared to our peer group. See Slide 16.

We are committed to profitable growth and creating tangible value for our shareholders. This can come from acquisitions such as FPU or Sandpiper Energy, or it can come from service expansions or the addition of large industrial customers. This growth will create increased demand for capacity on our pipelines and new opportunities to add commercial and residential customers as we expand our infrastructure to serve both Delmarva and Florida.

As indicated on Slide 17, our dividend growth rate over the 3 years ended June 2013 is 4.9%, slightly lower than our earnings growth rate. You also may recall that on an annualized basis, we raised our dividend by $0.08 per share or 5.5% in 2013.

Turning to Slide 18. In this presentation, earnings retention rate is simply earnings per share, less dividends per share, divided by book value per share. As a result of our business units driving earnings growth faster than the rate of our dividend growth, our earnings retention rate has also increased to 6% of equity, making it the second highest in the peer group. The significance of the earnings retention rate is that this relatively high rate positions us to generate relatively high earnings and dividend growth looking forward.

Turning to Slide 19. Over the 3-year period ended October 31, 2013, Chesapeake has produced a cumulative return to shareholders of 63%. This ranks third among our peer group of 11 companies and is 50% higher than the peer group median. As we look forward, the growth potential that we have, our strong balance sheet and our disciplined approach to making investments, retaining earnings and the potential for dividend growth, position us to continue to produce superior returns.

Turning to Slide 20. Looking forward, natural gas is expected to have a sustained price advantage relative to other traditional energy sources. Certainly, the improved technology for extracting natural gas has created new sources of supply that have increased our nation's energy security and created new jobs, while providing economic, home-grown source of low-cost energy. We believe that the cleanliness and the low cost of natural gas will create additional opportunities for us to grow. We are planning and positioning the company to take advantage of these opportunities.

In this regard, we are taking steps to add resources in our business units to support current and future growth; we're expanding our capacity to support growth by adding resources in accounting, human resources and information technology; we're expanding our capabilities and capacity to identify, evaluate and develop traditional and evolving opportunities. We will also continue to make strategic acquisitions that generate value. We think that this is the time to make these investments.

As summarized on Slide 21, we will continue to seek opportunities to add large commercial and industrial customers. We have outlined the large ongoing and near-term projects in Delmarva and Florida to grow our Natural Gas Distribution and Transmission businesses. In addition, we believe there are significant opportunities to add customers in areas where service has recently been expanded and to provide new services to existing customers.

We have been successful in growing our unregulated earnings by making strategic acquisitions such as the Glades Gas acquisition in Florida. We will continue to seek these opportunities, as well as to continue growing through our Community Gas System strategy. We believe that there will also be opportunities to grow through new startups in Pennsylvania and Cecil County, Maryland and through small propane acquisitions that expand our footprint.

Given the advantages of natural gas, we believe that there will be new opportunities for the use of natural gas, such as just natural gas vehicles, which we will look at carefully. We also see opportunities for natural gas pipeline expansions to meet electric generation demand and to serve combined heat and power projects. As always, we will keep our focus on profitable growth and managing risk.

In closing, Chesapeake remains fundamentally strong, and growth in our regulated and nonregulated earnings capacity continues. Our financial position remains strong, and we believe the outlook for shareholder returns remains bright given our current dividend and the outlook for future growth in the dividend, all supported by our earnings growth.

Now, Beth and I will be happy to answer your questions.

Question-and-Answer Session

Operator

[Operator Instructions] Your first question comes from the line of Spencer Joyce of Hilliard Lyons.

Spencer E. Joyce - Hilliard Lyons, Research Division

Just from a high level, I want to make sure I'm thinking about this correctly. If we think ex items just in Q3, we're roughly flat from year ago on an EPS basis, with a little bit of upside from acquisitions in nat gas that would be offset by a little downside on the unregulated propane side. Is that a correct assumption?

Beth W. Cooper

Yes, that is, Spencer.

Spencer E. Joyce - Hilliard Lyons, Research Division

Okay. And then on a year-to-date basis, we had some headwind from the sales tax in Q2 and then some upside with the litigation this quarter. So sort of netting those items, we're flat roughly on a year-to-date basis, correct, too, as far special items go?

Beth W. Cooper

The special items on a year-to-date basis that you're referring to, yes, that would be correct.

Spencer E. Joyce - Hilliard Lyons, Research Division

Okay. Yes, the return to normal weather, I feel like we can kind of cross that out.

Beth W. Cooper

Right.

Spencer E. Joyce - Hilliard Lyons, Research Division

With respect to the CapEx line, you all are already above the spend for last year. Is there a sense of how close you're going to be to your budgeted amount this year? And is there any glimpse maybe into '14, what we could see budgeted?

Beth W. Cooper

Well, we've continued, and even in this Form 10-K, to put that our current forecast as $127 million. And with some of the projects that we talked about, we expect our expenditures to be high, as we have previously indicated, although we do recognize some of that will flow over into next year. I think, Spencer, as we get into next year, in our Form 10-K for 2013, we will definitely put what our budget is for next year. But we have those large expansions that are out there that we're going to be undertaking. We put some information out there in regards to the Calpine project. The filings are in with the FERC for the NRG project and the Delaware City project. So there's some information out there, but there are still several large projects that are out there. So on a looking back basis, the trend will be above several years ago, certainly. But I really can't comment beyond that at this time.

Michael P. McMasters

One thing you will see, Spencer, is that with the interstate pipeline expansions, there'll be -- obviously, notice will show up because we'll be making filings with the FERC to construct facilities. And also, we typically would do a press release once we have a contract or something significantly locked down. So you may have a hard time seeing '14 right now, but it'll evolve as we move down the road.

Spencer E. Joyce - Hilliard Lyons, Research Division

Okay. Fair enough there. The $757,000 of additional gross margin on the unregulated side, the bulk of that is from Glades, correct, or the acquisition amount, just in this quarter?

Beth W. Cooper

The bulk of that, yes, is from Glades, although there was some contribution as well by Austin Cox during the quarter.

Spencer E. Joyce - Hilliard Lyons, Research Division

Okay. Do you know what that would've been, up or down, on a pro forma basis?

Beth W. Cooper

I will have to get back to you on that, Spencer. I don't, right off the top.

Spencer E. Joyce - Hilliard Lyons, Research Division

Do you know just, I mean, would it have been down? I'm assuming with the rest of the segment down, it would have probably been down. Do you know?

Beth W. Cooper

A little bit -- for those 2 businesses, once we're in the third quarter, as with our legacy businesses, so when you look at their operations over the course of the year, you know, this is also for them probably what I would say more of the valley for them, just like it would be with Chesapeake's other legacy businesses. But they were accretive for the quarter, as we indicated. And on a year-to-date basis, along with Sandpiper, those acquisitions have been positive from an accretion standpoint.

Spencer E. Joyce - Hilliard Lyons, Research Division

Okay. Yes, speaking of Sandpiper, the $1.7 million in gross margin was just a great number compared to what we were looking for. Can you talk a little about the seasonality there? I mean, if we're seeing $1.7 million during the summer, can we think $3 million, $3.5 million during a winter quarter? Or is $1.7 million maybe a fair run rate there?

Beth W. Cooper

Well, they've only been part of us now for not even 1/2 a year yet. But certainly, there is seasonality to their business. And as we've started to look at it, some of it is a little different than Chesapeake's legacy businesses. And I think as we move forward, we'll be able, once again, to put more information out there. But I would think that you're going to expect the typical pattern that Chesapeake has with its existing propane businesses, where you're going to come into the fourth quarter, there will be the weather, the impact of that. It might be a little bit less than it would be in some of Chesapeake's other businesses, primarily because Eastern Shore Gas is operating in more of those resort areas. But there still will be that weather impact. You'll have it in the first quarter. And then once again, you'll start to have that valley in the second and the third quarters.

Spencer E. Joyce - Hilliard Lyons, Research Division

Okay. So there will be a little, at least a little bit of natural valley and this completed third quarter would be part of that valley?

Beth W. Cooper

Yes.

Operator

[Operator Instructions] There are no further questions on the phone lines at this time. I will turn the call back to the presenters.

Michael P. McMasters

Well, thanks, everyone, for joining us here this morning. I guess we'll be talking to you next quarter.

Beth W. Cooper

Thank you.

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