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Chesapeake Utilities (NYSE:CPK)

Q3 2012 Earnings Call

November 08, 2012 10:30 am ET

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

Michael E. Gaugler - Brean Murray, Carret & Co., LLC, Research Division

John Hanson

Operator

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

Beth W. Cooper

Thank you. Good morning, and welcome to the Chesapeake Utilities' third quarter 2012 Earnings Conference Call. Before we begin, let me 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 and Form 10-K for further information on the risks and uncertainties related to the company's forward-looking statements.

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

Michael P. McMasters

Thanks, Beth, and good morning, everyone. Yesterday, we announced a 32% increase in diluted earnings per share for the third quarter of 2012. Our results from the third quarter of 2012 included net income of $3.2 million and earnings per share of $0.33. These strong results represent an increase of $822,000 in net income and $0.08 in earnings per share over the third quarter 2011. The increased financial results reflect higher profitability in all segments of the company. These results continue to show the strong growth in our core businesses and the success of our employees in transforming opportunities into growth that generates value for our shareholders and customers. Beth will provide a more detailed discussion on the financial results after I highlight the results in each of our segments.

The regulated energy segment continues to take a long term strategic approach toward extending our natural gas systems to customers and communities. We have been successfully adding new commercial and industrial customers that have significant energy requirements that can be served with natural gas. This has been done by extending our distribution and transmission services to areas where natural gas was previously not available.

Since November of 2011, we have extended service to the different parts of Sussex County, Delaware, Worcester County, Maryland and Nassau County, Florida. These expansions accounted for $1 million of additional gross margin during the third quarter of 2012.

For the year-to-date, gross margin from these expansions has totaled $2.4 million, with another $1.1 million expected in the fourth quarter. Going forward, these expansions are expected to generate annual margin of $4.4 million. Offsetting this $4.4 million is $800,000 of costs we will start incurring once the joint pipeline being constructed to permanently serve Fernandina Beach is completed and in service.

In addition, during the third quarter of 2012, we generated additional $719,000 of gross margin from new natural gas distribution customers and new transmission services from growth not related to the expansions mentioned above.

We are continuously working with large energy consumers outside of our service territory in an effort to identify ways to make mainline extensions to serve them economic. It's not unusual for us to have to aggregate several customers to make the project economic for all parties.

Once we identify a solution and enter into acceptable contractual arrangements, we extend our facilities. We then increase our efforts to serve customers in a relatively close proximity to the new facilities. The lower the customer's energy requirements, the more difficult it is to make a project economic for both parties. To help overcome this obstacle, in June of this year, we filed an application with the Delaware Public Service Commission to increase and modify our service offerings. Because the cost of constructing facilities in areas that have already been developed is more costly than in construction in new developments, we have proposed an additional fixed monthly fee. This additional charge only applies in a defined expansion area. We are also offering a service to assist a customer in the process of converting their home to natural gas. We expect the Delaware PSC to rule on this filing sometime in 2013.

Also in June, we entered into an agreement to purchase the assets of Eastern Shore Gas and its affiliates. Currently, Eastern Shore Gas provides propane service to approximately 11,000 customers in Worcester County, Maryland, primarily through underground distribution systems. We are evaluating the potential conversion of these underground propane distribution systems to natural gas to determine where it is economical.

In August 2012, we filed an application with the Maryland Public Service Commission for approval of this transaction, a gas tariff to provide service and new rates, and several other matters. We expect the Maryland PSC to rule on this application sometime in 2013.

Looking forward, we expect to begin service to Cecil County, Maryland later this month. Eastern Shore Natural Gas Company is working on a mainline expansion that would generate an estimated $147,000 of margin in the fourth quarter and annual margin of $882,000. Again, we will be aggressively pursuing additional customers to add in this area.

We signed a Precedent Agreement with NRG Energy Center Dover late last year to provide transportation to NRG's generating facility in Dover, Delaware. Eastern Shore Natural Gas Company will construct additional facilities at an estimated cost of $12.5 million to $15 million to serve this plant. Upon meeting certain conditions, Eastern Shore Natural Gas Company and NRG will sign a 15-year firm transportation agreement. We expect to initiate service in May 2013. Estimated annual margin from this project is between $2.4 million and $2.8 million. We are currently seeking the necessary approvals to move this project forward.

We also recently signed a Precedent Agreement with a refinery in Delaware city for a larger contract based on the expansion of their facility. The new contract is for 15,000 dekatherms a day, an increase from 9,514 dekatherms per day and is expected to generate additional margin of $600,000 annually beginning in November of 2013.

Our natural gas distribution transmission operations are strong and are well positioned for growth going forward. Our unregulated energy operation showed increased results during the third quarter also. This segment typically reports our loss during the third quarter. This year, the loss was reduced by $683,000, primarily due to the improvement in Florida propane margins and better results from our wholesale and marketing operation Xeron.

We're also pleased to report another quarter of improved results from BravePoint. BravePoint's current quarterly results reflect both increased margin from ProfitZoom and Application Evolution as well as higher consulting activity during the quarter. BravePoint has now successfully implemented or is implementing ProfitZoom for 8 customers. Application Evolution has been installed for 9 customers. We remain committed to providing excellent service to our customers. We expect continued growth to produce further improvements in the financial results, which will allow us to continue providing shareholders both superior growth in earnings per share and in dividends.

Finally, I'd like to make a few comments about the impact of Hurricane Sandy. While there were some impacts on coastal areas in Maryland and Delaware, we did not experience the same impact as those in New Jersey and New York. In addition, the storm did not do any significant harm to our system. To help those people in our region who have been affected by the storm, we have made a donation with the United Way of Delaware in partnership with the American Red Cross. To help our neighboring utilities, we deployed 11 of our electric employees in Florida to Long Island to assist in the restoration of electric service there. In addition, we have 6 natural gas employees working in New Jersey to help neighboring utilities restore natural gas service.

In closing, our hearts go out to those people affected by Hurricane Sandy. Now I'll turn the call back over to Beth to provide details on the financial performance for the quarter. Thank you.

Beth W. Cooper

Thanks, Mike. As Mike indicated, we were pleased to report strong results for the third quarter of 2012. For the quarter, consolidated operating income increased by $2 million to $7.6 million as each of the company's segments reported increased results. Detailed discussions of the changes in gross margin and operating expense by reporting segment for the quarter and 9 months ended September 30 of 2012 are provided in our press release and Form 10-Q, which were filed yesterday. However, I will highlight the key accomplishments and results for the business units during the third quarter of 2012.

Chesapeake's regulated energy businesses, which include our natural gas transmission and distribution and electric distribution operations, generated operating income of $7.8 million for the third quarter of 2012, up from $6.9 million in the same quarter of 2011. Additional gross margin generated by our natural gas expansion initiatives in Sussex County, Delaware; Worcester County, Maryland and Nassau County, Florida, increased gross margin by $1 million during the third quarter.

Gross margin from other new transmission services and distribution customer growth increased by $719,000 during the quarter. Increased consumption by existing customers also contributed $323,000 in additional margin during the third quarter of 2012. A rate increase at Eastern Shore Natural Gas Company accounted for the remainder of the increase in margin.

Operating expenses for our regulated energy segment increased by $1.4 million in the third quarter of 2012 due to amortization expense associated with the Florida Public Utilities acquisition adjustment, higher depreciation expense due to increased capital investment and higher costs associated with increasing our capacity to support future growth.

Mike highlighted our major expansion projects. Margin from these additions is expected to total approximately $3.5 million for 2012 and generate annualized margin of approximately $4.4 million going forward. Additionally, the company has executed contracts or Precedent Agreements for natural gas transmission service that could generate $4.8 million to $5.3 million in annualized margin, beginning primarily in mid to late 2013. As you can see, there is tremendous growth and growth opportunities from our natural gas business.

Our unregulated energy segment reported an operating loss of $709,000 during the third quarter of 2012, a 50% improvement from an operating loss of $1.4 million during the third quarter of 2011. The current quarter's results reflect a $1.1 million increase in additional gross margin, due primarily to higher retail propane margins per gallon in Florida and increased margin from Xeron, our wholesale propane marketing business. The higher margin was partially offset by a $444,000 increase in operating expenses. The higher expenses reflect increased payroll to support our growth initiatives in the propane distribution business.

For the quarter ended September 30, 2012, our other segment reported operating income of $425,000 compared to operating income of $43,000 in the same period of 2011. The increase in operating results reflects higher operating income from BravePoint. BravePoint reported operating income of $312,000 in the third quarter of 2012 compared to a loss of $74,000 in the third quarter of 2011. Again, I would remind you that we have provided a detailed discussion of the factors contributing to the results for the quarter and 9 months ended in our press release, which was issued yesterday.

Capital expenditures totaled $17 million for the third quarter of 2012 and $51 million year-to-date. We expect capital expenditures for the year to be approximately $90 million, although we recognize that actual capital expenditures typically lag our forecast. Capital expenditures for 2012 are being funded by cash flow from operations and the company's short-term lines of credit. In June, we executed a $1 million -- a 1-year, pardon me, $40 million incremental line of credit facility with an existing commercial lender to ensure financial flexibility over the next 12 months.

Earlier this week, the Board of Directors increased the short-term borrowing limit from $85 million to $100 million. We believe we have access to competitively priced capital to finance our capital expenditures over the long term.

Supported by the growth in our earnings and cash flows, we are providing superior dividend growth to our investors. Earlier this year in May, our Board of Directors increased our dividend by 5.6%. We announced the next quarterly dividend of $0.365 per share at the beginning of this week. Our goal is to continue to provide shareholders with strong dividend growth, supported by increased earnings from successful execution of profitable growth opportunities across our business segments. We believe that our prospects for earnings growth and dividend growth make our company stand out among utility stocks as an investment opportunity.

Interest expense for the third quarter of 2012 decreased by approximately $263,000 compared to the same period in 2011. The lower interest expense reflects a decline in the total balance of outstanding debt and lower interest paid on customer deposits. Interest rates are projected to remain at current low levels through 2013, but there could be some upward pressure on rates should the economy reaccelerate.

In summary, Chesapeake remains fundamentally strong and growth in our regulated and non-regulated earnings capacity continues. We believe the outlook for our future remains bright given our most recently completed expansions, our 2013 expansion projects and customer conversion opportunities. Our growth track record and plan for continued earnings growth demonstrate our unwavering commitment to increase shareholder value.

Now, Mike and I would be happy to answer your questions.

Question-and-Answer Session

Operator

[Operator Instructions] Your first question comes from a participant whose information has not been captured.

Spencer E. Joyce - Hilliard Lyons, Research Division

It's Spencer at Hilliard Lyons. A couple of oddball questions here. First one on the unregulated energy side. If we look at the year-to-date through September, the gross margin there, we're down a few million from the prior year, which is pretty understandable with the weather. But my question is in sort of a base case scenario, I'm assuming that the prior year 2011 is probably a little bit closer to a normal year. Would that be a correct assessment there?

Beth W. Cooper

Yes. You're correct, Spencer.

Spencer E. Joyce - Hilliard Lyons, Research Division

Okay, good. Second question, Eastern Shore gas. Have you all disclosed any of the more granular financial details of that purchase, specifically a cost there or price tag?

Michael P. McMasters

There is a filing made with the Maryland Public Service Commission. It does have some of that information, Spencer. I, off the top of my head, don't recall the docket number but we can get you some information on the docket number and you can access that online.

Spencer E. Joyce - Hilliard Lyons, Research Division

Okay, yes. That would be great. And then a final question sort of pertaining to that Eastern Shore gas. We talked a time or two about the conservative debt position that you all are in. I guess, question would be, is there a certain cap on debt that you all would look to go to? Or, I don't want to ask outright, would you do equity for the Eastern Shore gas, but any sort of color on those point?

Michael P. McMasters

I think it's fair to say that we don't have an equity offerings in our forecast for the Eastern Shore Gas. I should mention we're very strong, Eastern Shore Gas -- I don't recall the number, exact number. Beth, you may recall it.

Beth W. Cooper

It's right about $16.5 million, $16 million to $16.5 million.

Michael P. McMasters

So it's not going to move that capital structure a lot.

Operator

Your next question comes from Michael Gaugler of Brean Capital.

Michael E. Gaugler - Brean Murray, Carret & Co., LLC, Research Division

I'm also kind of follow up to some of the questions you've already been asked. I'm taking a look specifically at the Commonwealth pipeline and how that's looking to tie into your system. I'm wondering if you can provide any color as to how you're thinking about that opportunity and where that project could eventually go longer-term?

Michael P. McMasters

Well, I guess, the Commonwealth pipeline is a project being developed, by my recollection, 3 different parties, and they continue to work on that project. And we have expressed an interest in becoming a customer and we have not, at this stage of the game, signed any firm commitments in that regard. So it's still in the process of evaluation on our part. And as you know, there are basically projects intending to move Marcellus Shale gas south from the production area, potentially down into the Baltimore, Washington area, et cetera. So that's, at this the stage, the only information that I have.

Michael E. Gaugler - Brean Murray, Carret & Co., LLC, Research Division

I was just wondering if there were any opportunities for you to perhaps tie in with that pipeline and perhaps actually even provide some transportation of that gas further south for them in lieu of them perhaps filling up the pipeline or taking it a different direction themselves.

Michael P. McMasters

That would obviously be something would be attractive to us. I think that their plans are to do that themselves, but obviously, that would be something that would be attractive to us. Our pipeline is already in existence. We're on the Eastern Shore Maryland and Delaware, so that would be effectively moving south but I think that's not really what you're talking about. But in any event -- but it would be obviously, for me, a great accomplishment to do that.

Operator

[Operator Instructions] Your next question comes from John Hanson of Praesidis.

John Hanson

Just a quick one on a minor item. You mentioned that on BravePoint that you were doing some investing or something along those lines. Can you talk a little bit about that, in just kind of order of magnitude as to what we're talking about there?

Beth W. Cooper

I think, actually, what we were talking about was in the case of BravePoint, they have this year been very, very successful in terms of, whether it would be ProfitZoom or Application Evolution, in the sales that they've accomplished there. And they're in the process of completing several more transactions by the end of the year. And I think that's really -- as they came across this investment, it's really that we're fulfilling the contracts and the commitments that we have out there.

Operator

There are no further questions queued up at this time. I will turn the call back over to presenters.

Michael P. McMasters

Thanks, everyone for joining in on the conference call this morning. And we look forward to talking to you next quarter. Thank you very much.

Beth W. Cooper

Thank you.

Michael P. McMasters

Bye.

Operator

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

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