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Chesapeake Utilities Corporation (NYSE:CPK)

Q4 2013 Earnings Conference Call

March 7, 2014 10:30 AM ET

Executives

Beth Cooper - SVP, CFO & Corporate Secretary

Michael McMasters - President and CEO

Analysts

Spencer Joyce - Hilliard Lyons

Michael Gaugler - Brean Capital

Operator

Good morning. My name is Sun Xie, and I will be your conference operator today. At this time, I would like to welcome everyone to the Chesapeake Utilities 2013 Year End Earnings Call. [Operator Instructions].

Thank you. Ms. Beth Cooper, Senior Vice President and Chief Financial Officer, you may begin your conference.

Beth Cooper

Good morning and welcome to the Chesapeake Utilities year end 2013 earnings conference call. Turning to Slide 2, before we begin, I would like to remind you that matters discussed in this 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. This section provides information on the risks and uncertainties related to the company's forward-looking statements.

As shown on Slide 3, yesterday morning, we announced our results for 2013, record net income of $32.8 million or $3.39 per share. 2013 earnings per share were 13.4% higher than 2012 earnings per share of $2.99. Further, compound annual earnings growth for the five years ended December 31, 2013, exceeded 11%. This consistent level of superior earnings growth also supported growth in the dividend. Our most recent dividend increase in May of 2013, represented growth in the annualized dividend of 5.5% or dividend payout ratio of approximately 45%.

Growth in our earnings has facilitated growth in our dividend, and has also enabled us to retain earnings, to make additional investments to generate continued earnings growth in the future.

The significant growth in 2013 earnings over 2012 reflected positive contributions from recent acquisitions, continued strong growth in the natural gas distribution and transmission businesses, from new service expansions and new customer growth. A return to more normal weather on the Delmarva Peninsula and higher retail propane margins.

While these factors were instrumental in driving our higher performance in 2013, the acquisitions, pipeline and distribution system expansions and customer additions, also provide opportunities for continued margin growth in the future.

I will next highlight the key accomplishments and results for the company's business segments during 2013. Detailed discussions of the changes in gross margin and operating expense by segment for the quarter and year ended December 31, 2013 are provided in our press release and annual report on Form 10-K which were issued yesterday.

Turning to Slide 4; Chesapeake's regulated energy segment, which includes our natural gas transmission and distribution, and electric distribution operations, generated operating income of $50 million in 2013, compared to $47 million in 2012. Overall, the regulated energy segment generated approximately 80% of the company's total operating income for 2013.

Growth in the regulated energy segment generated $11 million in additional margin in 2013, as compared to 2012, primarily from natural gas expansions and customer additions, as well as the acquisition of Sandpiper. The increase in margin was partially offset by an increase in other operating expenses of $7.9 million. The increase in other operating expenses reflected expenses as a result of the addition of Sandpiper, including sales taxes recorded at the time of the transaction, higher payroll benefits and incentive bonuses due to broader participation and our growth and performance in 2013, and higher depreciation asset removal costs and property taxes, associated with capital expenditures related to growth and system integrity.

Reducing the increase in other operating expenses from $9.4 million to $7.9 million, the company recorded a $1.5 million credit to expenses, resulting from the recovery of litigation costs related to the successful resolution of the City of Marianna franchise dispute.

Looking at Slide 5; you can see that our unregulated energy segment generated an increase in operating income of $4 million to $12.4 million in 2013, reflecting normal weather on the Delmarva Peninsula, higher retail propane margins, and the impact of several recent acquisitions. Gross margin for the segment increased by $9.5 million in 2013, as a result of these factors, which more than offset lower margins from our wholesale propane marketing operation.

The higher retail propane margins generated $0.20 of incremental earnings per share in 2013 and drove our ROE or return on equity from 11.6% in 2012, to 12.2% in 2013. Mike will highlight our ROE results later in the presentation, although I would like to comment, that the level of retail propane margins sustained during 2013, is not typical, and therefore is not included in the company's long term financial plans or forecasts.

Other operating expenses increased by $5.5 million due to the addition of costs to operate several new businesses acquired during the year, increased other non-income taxes, as well as higher incentive bonuses due to strong financial performance.

The Other segment is principally BravePoint, our Advanced Information Services business. As you can see on Slide 6 for 2013, this segment reported operating income of $297,000, down from $1.3 million in 2012. The decline in BravePoint's operating income for the year, reflected stable margins but with higher payroll related expenses. In 2014, we are committed to increasing profitability at BravePoint.

Slide 7 highlights the key variances between 2013 and 2012 results. In terms of adjusting items, these items generated an additional $0.20 for the year, including a return to more normal weather conditions, which accounted for $2 million or $0.21 per share in additional earnings in 2013. Weather returned to more normal levels from historically warm weather in 2012 on the Delmarva Peninsula. Temperatures were 702 degree days colder than 2012, which resulted in approximately $4 million of additional margin in 2013, or $2.4 million on a net income basis.

Partially offsetting the weather impact on the Delmarva Peninsula, 121 fewer cooling degree days in Florida reduced gross margin from 2012's results by approximately $650,000 or $400,000 on a net income basis.

Finally, in terms of non-recurring items, a gain from the recovery of litigation expenses incurred to resolve a franchise dispute in Marianna, was primarily offset by taxes paid on acquisitions, as well as higher non-income related taxes.

Moving to gross margin; growth in the natural gas business combined with contributions from recent acquisitions and higher retail propane margins, more than offset lower results from the wholesale propane marketing operation, and accounted for $8.4 million in higher net income or $0.86 per share in 2013. These results demonstrate the future growth potential of the areas we serve, and the successful efforts of our team, in seeking out, creating and cultivating profitable growth.

Partially offsetting the higher gross margin, higher operating expenses reduced net income by approximately $6.8 million. The increase in expenses was largely driven by our success and growth, as we added additional expenses to operate the new acquisitions that were consummated during the year; accrued higher incentive bonuses, as a result of broader participation to cover substantially all employees, as well as our increased performance; recorded higher depreciation asset removal and property taxes because of our increased capital investments; and added additional human resources to support the growth in the company's energy businesses, and to increase our capacity for future growth, company-wide.

As you can see on Slide 8; as we have made significant investments over the last five years, we have maintained a strong balance sheet to facilitate future growth. Chesapeake's equity-to-total-capitalization was 54% at December 31, 2013. We have a commitment in place to fund $50 million of long term debt in May 2014, at 3.88% for 15 years. We believe our strong balance sheet will enable us to attract additional capital as necessary to fund future growth.

We are fortunate to have a team of employees and management that have successfully identified and developed an increasing amount of opportunities to invest capital that meet our strict criteria. As shown on Slide 9, capital expenditures for 2013 totaled $108 million. We expect 2014 capital expenditures to be approximately $111 million, nearly four times the level of expenditures five years earlier.

As Mike will explain, our financial success has been a result of our capital investment discipline. The level and efficiency of the capital we have invested, have allowed us to deliver the earnings and dividend growth, and ultimately, the shareholder return that have set us apart from our peers.

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

Michael McMasters

Thank you, Beth, and good morning everyone. As Beth has highlighted, in 2013 we increased earnings per share by $0.40 or 13% and had another record year. I couldn't be prouder of our team's efforts over the last several years. A lot has been done, but there are still more to be accomplished.

Having said that, we as a country are very fortunate. We have an abundance of clean burning, low cost natural gas, that provides an opportunity for us to lower energy bills and improve our competitive position worldwide.

At Chesapeake, we are working tirelessly to identify opportunities to deliver this clean fuel, to as many residential, commercial and industrial consumers as possible. Our efforts are saving our customers and the communities we serve money and improving their local economies. We are reducing our emissions, while creating jobs. Finally, our efforts are also generating value for our shareholders.

While I am proud of what our team has accomplished to-date, we know that we always have to look ahead. We are continuing to invest in our distribution-transmission systems for all the reasons described above, including generating earnings. We are continuing our efforts to identify opportunities to expand our service offerings and our transmission and distribution systems. We are making important investments to expand our capabilities and bandwidth to serve the significant growth that we are already serving, and to increase our ability to identify and develop the significant growth potential we see ahead.

Before I move on, let me talk about the shareholder value we are creating, and some of the types of opportunities we are seeing, and how we plan to continue to producing superior returns and growth.

As you can see on Slide 10, total shareholder return for 2013 exceeded 35%. In addition, our average annual shareholder returns have exceeded 12% over three years, five years, 10 years, and 20 years, and ranks Chesapeake in the top quartile of our peer group. As an [indiscernible], Beth has told me that I have to tell you that past performance is not necessarily an indicator of future performance.

Turning to Slide 11; we will continue our relentless growth efforts. We have been and will continue to be focused on natural gas transmission and distribution expansions to provide service to large commercial industrial customers, serving residential and commercial growth as it develops in the markets we serve, and facilitating conversion to natural gas, by providing new services to help current and prospective customers. Convert their appliances and fuel lines to enable them to use low cost, clean burning natural gas in their homes and businesses. As a result of significant expansions that we have made in the past few years, these services are in demand more than ever.

In the unregulated energy business, we are continuing to leverage our community gas systems strategy, evaluate new startups and new territories, and look for new acquisitions. All this is being done in the pursuit of growth. We are also looking at compressed natural gas opportunities for temporary and long term service, and for vehicle use. We are also looking at opportunities to displace gasoline with propane for vehicles. Finally, we are looking at combined heat and power opportunities.

Slide 12 highlights the major opportunities that we have initiated and that are currently driving our growth. This table is limited to those opportunities that we have already placed in service. As indicated, we expect the listed opportunities to generate margin growth, in excess of $10 million in 2014.

In addition, on Slide 13, we have highlighted two opportunities currently under contract, that will contribute additional growth in 2014 and 2015. Once again, we are working very hard to continue to transform the opportunities that we see into additional growth generating services.

Turning to Slide 14, in 2013, we received approval from the Florida Public Service Commission to implement a gas reliability and infrastructure program. The program includes a plan to invest $75 million over 10 years and to replace older pipe in our service areas. It also includes a recovery mechanism to reduce the regulatory lag, normally associated with maintenance type capital expenditures.

We exceeded our operational targets in 2013 and invested $16.5 million. In 2014, we are targeting to spend another $8.3 million replacing older pipe and service lines. We expect that the 2013 and 2014 investments to generate $1.5 million in additional margin in 2014.

Turning to Slide 15; rate of return regulation effectively limits the Utilities' growth by limiting the rate of return it can achieve on its invested capital. Therefore, fundamentally, the Utilities' growth is dependent upon its ability to identify and develop opportunity to translate into value creating investments. One reason that we have been able to outpace our peers in earnings and dividend growth, has been that we have invested considerably more in our business than our peers, while maintaining relatively high levels of return on capital.

As shown on Slide 15, over the past five years, we ranked second among our peers in terms of capital spending as a percent of total capitalization, and at an average spend of 23% of total capitalization per year, we have invested 1.7 times the median rate of 13.7%.

Turning to Slide 16; while the amount of capital invested is important, it is only beneficial to shareholders, if the returns generated exceeds the cost of capital. As indicated on the chart, the company ranks third in our peer group, in return-on-equity for the five years ended September 2013. We are also 1.2 times the median return of 9.75%. What is not obvious from the graph, is that over the past five years, we have invested $432 million or approximately 80% of our total capitalization at December 31. All of this has been done, while maintaining our ROE over 11%.

The chart on Slide 17 illustrates two key performance measurements for Chesapeake Utilities. It is the balance of investing relatively larger amounts of capital at higher returns, that underlies our success in 2013, and over the longer term. This graphic contrasts capital spendings' return on equity for 39 gas distribution, electric and combination utility companies.

As you can see, Chesapeake is one of the few companies in the upper right hand high return, high investment quadrant. We believe that this has driven our past success, and we will continue to execute our strategic plan with the goal of maintaining this position.

Slide 18 shows that for the past five years ended September 2013, Chesapeake has produced compound growth and earnings, more than double the rate of its peers. We think that the formula for success is clear.

Turning to Slide 19; the growth in earnings generated through the execution of our strategic plan has enabled us to increase our dividend on average, by 4.8% over the last five years, and more than 5.5% in the last two years. Our growth rate over the five year period is 1.5 times the median, while our payout ratio is well below the average than most of our peers. Our lower payout ratio reflects the above average EPS growth, supports our relatively high capital investment program, and our expectation that we will be able to continue to find and develop investment opportunities going forward.

Finally, the lower payout ratio also means that future growth in earnings per share should translate into growth in dividends, and our goal is for both to exceed our peer group and industry averages.

We understand how important dividends are to investors, particularly, given expectations for bull [ph] market returns. We also believe that superior earnings and dividend growth will enhance shareholder value going forward. We are committed to dividend growth, supported by earnings growth.

Turning to Slide 20; 2013 was another outstanding year for Chesapeake Utilities and our shareholders. We achieved earnings per share of $3.39, marked the seventh consecutive year of record earnings, and more than doubling earnings per share compared to 2004. Our return on equity was 12.2% this year, compared to the average for the last five years ended 2012 of 11.4%.

Thank you again for joining our call today, and for taking interest in or being a shareholder of Chesapeake Utilities. We are proud of what our team has accomplished for shareholders in the past and are committed to generating value going forward.

We will now be happy to take questions. Thank you.

Question-and-Answer Session

Operator

(Operator Instructions). And we do have a question from the line of Spencer Joyce with Hilliard Lyons. Your line is now open.

Spencer Joyce - Hilliard Lyons

Beth, Mike, good morning. Congrats on a really good year.

Michael McMasters

Thanks Spencer.

Beth Cooper

Thank you.

Spencer Joyce - Hilliard Lyons

Just one quick one for me here, maybe a little more over the weekend. But Beth, I may have asked you this before, but can you just refresh us on why we see the downtick in D&A in Q4, sequentially from Q3?

Beth Cooper

Sure. We actually had other post retirement benefit gain, that impacted quarter four. It represented about $510,000.

Spencer Joyce - Hilliard Lyons

That was through the depreciation line?

Beth Cooper

Yes. The amortization. Yes.

Spencer Joyce - Hilliard Lyons

Okay. Thanks. That all I had. Again, good year guys.

Beth Cooper

Thank you.

Michael McMasters

Thanks Spencer.

Operator

(Operator Instructions). Your next question comes from the line of Michael Gaugler with Brean Capital. Your line is now open.

Michael Gaugler - Brean Capital

Good morning everyone.

Beth Cooper

Good morning.

Michael McMasters

Good morning Michael.

One item I did notice in the slides, your CapEx by business segment in Slide 9, certainly a step-up in the CapEx on the electric side. I just was kind of wondering, what's driving that increased investment profile there?

Beth Cooper

On the electric side, there are some additional -- they have a replacement program, and so, some of the pull replacement and some of the other equipment that they have, the process of going through replacing that and upgrading that.

Michael Gaugler - Brean Capital

And then, would you anticipate that level of spend for a couple of years, or is 2014 just kind of a one-off?

Beth Cooper

I mean, they have had spend each year, related to those initiatives. I think there are some things that they are trying to actually pursue a little bit faster this year, to get in place, just to get the system where they would like it to be. So there is a little bit more this year. I wouldn't expect, that as we go out, you would tend to see that level reoccurring year-over-year. But there will be some each year.

Michael Gaugler - Brean Capital

Okay. That's all I had, and congrats on a nice quarter.

Beth Cooper

Thank you.

Michael McMasters

Thanks Michael.

Operator

(Operator Instructions). And we do have a question from the line of Spencer Joyce with Hilliard Lyons. Your line is now open.

Spencer Joyce - Hilliard Lyons

Hi. I remembered I did have one other one. In Q4, we saw pretty sharp increase in year-over-year O&M expense, about 17 percentage points there. And I know that something that you all have been talking to us for a while, that we may see a bit of growth in over the next year or two. I know you don't get too specific with line item guidance, but can you give us kind of a feel on what sort of growth we should we expecting out in 2014 there for the O&M?

Beth Cooper

Well, there is going to be a couple of things that are going to be impacting 2014, probably, one of the largest is going to be the fact that you are going to have five additional months of Sandpiper. So you are going to see a step-up in our expenses that come from that business, and the expenses that we incur basically from January to May; because they joined us in June of last year. So that in and of itself, Spencer will be a step-up that you'll see. Then above and beyond that, as we have been expanding into new areas, we have had increased business unit expenses, and we have also -- and we have had costs in our corporate area, both of which are to support the growth that we have seen, as well as the growth that we expect to continue to see, as we are building out in these areas, and as we are continuing to look at new investment opportunities.

So I think, if you take a look at the run rate of the fourth quarter of 2013, there were a couple of things that impacted that quarter, but I think that's a fairly good trend to build off of, as we are coming into 2014 and you will still continue to see a gradual increase there, compared to going back several years ago.

Michael Gaugler - Brean Capital

So a couple of special items here in Q4, but again, the trend should be up a little bit?

Beth Cooper

Yes.

Michael Gaugler - Brean Capital

Okay. Great color there. Thanks.

Operator

And there are no questions at this time. I'd turn the call back over to presenters.

Michael McMasters

Well thanks everyone for your interest in Chesapeake, and we appreciate all of your support, and have a nice weekend. Thank you.

Beth Cooper

Thank you.

Operator

This concludes today's conference call. You may now disconnect.

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