Chesapeake Utilities Corp (CPK) 2010 Q3 法說會逐字稿

Good morning. My name is Tracy and I will be your conference operator today. At this time, I would like to welcome everyone to the Chesapeake Utilities' third-quarter 2010 earnings conference call. All lines have been placed on mute to prevent any background noise.

After the speaker's remarks, there will be a question-and-answer session. (Operator Instructions). Thank you. I would now like to introduce Senior Vice President, Chief Financial Officer, Ms. Beth Cooper. You may begin your conference.

Thank you, Tracy. Good morning, everybody, and welcome to the Chesapeake Utilities' third-quarter 2010 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 report on Form 10-Q 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 Operating Officer.

Thanks, Beth, and good morning, everyone. As you can see from the results announced in our press release issued Thursday evening, third-quarter financial results were very strong and reflect the increased margins from our Delmarva natural gas distribution and transmission businesses as a result of continued residential, commercial, and industrial growth; the rate increase for our Florida division, effective in January 2010; strong earnings generated by FPU; the successful efforts of our management team in integrating Chesapeake's and FPU's Florida operations; and the success of the actions we took to improve the results from our advanced information services businesses.

In just a few minutes, I will discuss the operational details, but first I'd like to highlight some of the key strategic issues and opportunities that we see for the Company going forward.

First, despite the impact of current economic conditions in Florida and on the Delmarva Peninsula, we continue to grow our natural gas distribution businesses. While a decline in housing starts has reduced the rate of residential customer growth, we have successfully added new commercial and industrial customers with larger incremental margins to offset that lower growth.

The substantial growth in our Delmarva distribution operations is being made possible due to the expansion of our natural gas transmission business, Eastern Shore Natural Gas Company. Likewise, the growth in the distribution business is creating increased demand for pipeline capacity at Eastern Shore.

In the propane business, we are enhancing current growth through our community gas systems strategy. Community gas systems are essentially piped propane systems, similar to natural gas distribution systems for communities not served by natural gas pipelines. Once our natural gas service is extended out to these community gas systems, and if it makes economic sense, we can convert the systems to natural gas. So this initiative not only generates growth in our propane business, but also creates an opportunity to add these customers to our natural gas distribution system as we expand our natural gas footprint.

Second, successful integration of the merger between Chesapeake and FPU continued during the quarter. We are proud of the work that our team is doing -- has done in managing the integration of Florida Pub into the Chesapeake family.

When we announced the merger approximately one year ago, we expected it to have a neutral to slightly accretive impact on earnings for 2010. As a result of the integration efforts of the FPU and Chesapeake teams, we were able to raise our expectations for the merger on 2010 earnings to be accretive earlier this year.

As the results from the quarter and nine months ended September 30, 2010 demonstrate, the merger has been accretive. The speed at which our team has integrated the operations has surpassed our expectations. We remain optimistic about achieving and exceeding our goal of accretion in 2010.

Over the next few months, we will be seeking Public Service Commission approval for recovery of the acquisition premium in rates. You will hear more about this moving forward.

We are also very excited about the future growth opportunities across our lines of business. The outlook for our Company is very encouraging. We expect continued growth and merger integration to produce further improved financial results, and we remain committed to providing excellent service to our customers and superior returns to our shareholders.

Now, I would like to talk a few minutes about the operational details. I'm pleased to announce increased financial results for both the quarter and nine months ended September 30, 2010. The earnings per share results are stated on a diluted basis.

For the nine months ended September 30, 2010, the Company recognized net income of $18.9 million, or $1.98 per share. This represents an increase of $9.2 million or $0.58 per share, which represents 41% percent growth over the nine months ended September 30, EPS of $1.40 per share.

Chesapeake's legacy businesses generated $0.24 per share, representing approximately 17% growth. These results reflect the strong performance of the Delmarva regulated energy business and improved results for the advanced information services business.

FPU also generated $7.3 million of net income, or $0.34 per share of the $0.58 per share increase. The $0.34 per-share increase represents 24% growth over the 2009 diluted earnings per share of $1.40 for the nine months ended September 30, 2009.

While it is sometimes difficult to draw conclusions about the Company's performance when reviewing our results for the third quarter, it was nonetheless an excellent one for the Company.

Net income for the quarter ended September 30, was $1.6 million or $0.17 per share, an increase of $1.3 million, or $0.13 per share. This compares to $308,000 or $0.04 per share for the quarter ended December (sic -- see press release) 30, 2009.

Chesapeake's legacy businesses continued to generate strong earnings growth, reporting an increase of EPS of $0.04 per share, or 100% growth as compared to the third quarter of 2009. Chesapeake's legacy business results reflect the impact of the rate increases for the Company's Central [Florida] Gas division; strong natural gas distribution in residential, commercial, and industrial customer growth on the Delmarva Peninsula; additional margin from the continued expansion of natural gas transportation services; and, improved performance from the advanced information services business.

The improved results for the third quarter also included $1.1 million or $0.09 per share of net income contributed from Florida Public Utilities. With the addition of Florida Public Utilities, the Company's earnings have become less sensitive to the seasonal lull that Chesapeake has historically experienced in the third quarter.

Some of the key developments and highlights for the quarter were --

Chesapeake's natural gas distribution operations in Florida, generated additional gross margin of $554,000 as a result of a rate increase. The increase which amounts to $2.5 million annually was approved in December 2009 and became effective in January 2010. The increase is expected to generate higher earnings in the fourth quarter of 2010 also.

Eastern Shore generated additional gross margin of $390,000 from new transportation services from expansion facilities.

Growth in residential, commercial, and industrial customers for the Delmarva natural gas distribution operations contributed to a period-over-period increase in gross margin of $138,000.

The Company's advanced information services subsidiary, BravePoint, generated operating income of $258,000 in the third quarter of 2010. This compares to an operating loss of $103,000 in the same period in 2009. The increase was due to increased billable consulting hours and lower operating costs.

FPU reported $2.4 million of operating income and $1.1 million of net income in the third quarter of 2010. FPU's results for the quarter include approximately $49,000 in gross margin generated from approximately two months of operations of the Indiantown Gas Company. The acquisition of Indiantown occurred in August and added approximately 700 customers including two large industrial customers.

Xeron, the Company's propane wholesale marketing company, experienced a $328,000 decrease in gross margin for the [third] quarter of 2010 as a result of a 13% decrease in trading volume.

The Delmarva propane distribution operation recorded lower retail margins on a per-gallon basis during the third quarter of 2010 compared to the same period in 2009, reducing gross margin by $138,000.

There are two developments that have not yet fully impacted 2010 results, but will begin to produce benefits in the fourth quarter and 2011.

First, the Delmarva natural gas distribution operations entered into agreements to provide natural gas service to two industrial customers located in southern Delaware. The anticipated annual margin from these services equates to approximately 1,575 residential heating customers. One of the customers began receiving service in the third quarter, with the other customer expected to take service in late 2010 or 2011.

Second, our Delmarva natural gas distribution operation entered into a Precedent Agreement with Texas Eastern Transmission to secure firm transportation service of 40,000 dekatherms per day in conjunction with their new expansion project. Texas Eastern's expansion project is projected to be completed in 2012.

In conjunction with this agreement, Eastern Shore will build and operate an eight-mile mainline extension from Texas Eastern's pipeline to Eastern Shore's existing facilities.

The Precedent Agreement allows for a three-year phase-in from 20,000 dekatherms per day in the first year of service to 40,000 dekatherms per day by the third year of service at Eastern Shore's current tariff rate. Estimated annual margin for this project is $2.2 million based on 20,000 dekatherms per day and $4.3 million based on 40,000 dekatherms per day.

Eastern Shore's received approval from the FERC for this expansion and has initiated construction. Eastern Shore's service under this project is expected to begin no later than January 2011.

As you can see Chesapeake is taking advantage of the opportunities across our business segments, and we continue to seek and find new opportunities to grow our business and create value for our shareholders.

Now, I'll turn the call over to Beth Cooper, Senior Vice President and Chief Financial Officer to provide additional details on the financial performance for the quarter.

Thanks, Mike. As Mike indicated, third quarter and year-to-date financial results for Chesapeake were very strong. For the quarter, consolidated operating income increased by $2.3 million or 103% to $4.6 million. The greatest factors underlying the improvement are continued growth in our legacy utility operations as well as the results of our newest subsidiary, FPU.

Operating income for the regulated energy segment for the third quarter of 2010 was $6.5 million, an increase of $3.6 million or 120% compared to the same period in 2009. The improvement resulted from the rate increase for Chesapeake's Florida division, new transportation services for Eastern Shore and continued customer growth in the Delmarva service territory. FPU generated the remaining $3 million of operating income.

An increase in gross margin of $13.2 million for the regulated segment was partially offset by an increase in operating expenses of $9.6 million.

In terms of the gross margin increase, a $2.5 million annual rate increase for Chesapeake's Florida natural gas distribution division, which became effective in January of 2010, provided $554,000 in incremental gross margin for the quarter.

Our natural gas distribution operations in Delaware and Maryland experienced growth in residential, commercial, and industrial customers in the third quarter of 2010 which contributed an additional $138,000 to gross margin.

While residential growth has slowed, we are still seeing customer additions in our Delmarva operations, and adding industrial customers, such as the two new Southern Delaware Industrial companies previously mentioned, will offset some of the impact of the economy on residential growth, as well as open up new areas for service which should create additional future opportunities for growth.

Eastern Shore generated additional gross margin of $254,000 from transmission services on expansion facilities placed in service in November of 2009, and $76,000 from transportation service that was commenced for an industrial customer also in that same month.

A new expansion project completed in May 2010 also generated additional gross margin of $60,000 for the quarter and is expected to generate annualized gross margin of $343,000.

FPU's natural gas and electric distribution operations accounted for $7.1 million and $4.9 million in additional gross margin, and $5.7 million and $3.3 million in additional operating expenses respectively for the period.

We recognized a seasonal operating loss for the unregulated energy segment for the third quarter of 2010 of $2.2 million, approximately $876,000 higher than the operating loss we reported for the same period in 2009.

The addition of FPU's propane distribution business has increased the seasonal loss experienced by the unregulated energy segment during the third quarter, generating an operating loss of $606,000.

The other factor contributing to the higher loss was a $328,000 decrease in gross margin for Xeron during the third quarter as a result of a decline in trading activity. The decline in gross margin reflects lower volumes and volatility in the wholesale propane markets.

Additionally, in the third quarter 2009, our Sharp Delmarva operation recorded a non-recurring propane physical inventory adjustment of $118,000, which increased gross margin for that quarter.

In 2010, retail margins per gallon have returned to more normal levels, resulting in decreased gross margin of $138,000 as compared to the third quarter of 2009.

During the quarter, although not contributing to our results, we initiated a propane start-up in a new territory in Maryland. We are very excited about expanding our propane service footprint.

The Company's natural gas marketing subsidiary, Peninsula Energy Services Company or PESCO, reported a $109,000 increase in gross margin, due primarily to increased spot sales of natural gas. Spot sales are not predictable, and therefore are not included in the Company's long-term financial plans or forecasts.

Operating income for the other segment for the third quarter of 2010 was $284,000, compared to operating income of $647,000 for the same period in 2009.

Operating expenses increased by $744,000 due primarily to the deferral of certain previously expensed merger-related costs in the third quarter of 2009, which resulted in a net credit of $675,000 for that quarter in 2009.

BravePoint reported a fourth straight profitable quarter with an increase in gross margin of $374,000 while operating expenses increased by only $13,000. These results demonstrate the effectiveness of our plan to control costs at BravePoint and enhance its contributions to earnings.

Gross margins for BravePoint increased as a result of an 8% increase in the number of billable consulting hours, and an increase in revenue and gross margin from its professional database monitoring and support solution services.

The Company originally budgeted capital expenditures of approximately $55 million for 2010. [As] the result of the continued growth and expansion opportunities that Mike and I have talked about, we believe this budget is still appropriate. However, some of the actual expenditures may be delayed into the first quarter of 2011.

Our forecast calls for these expenditures are to be covered initially by cash flow [and] short-term borrowings, later followed by a long-term debt financing. We believe we have access to competitively-priced capital to refinance these expenditures over the long term.

Interest expense increased by approximately $716,000 or 47% in the third quarter '10 compared to the third quarter of 2009, because of the addition of FPU's debt. The components of this increase are as follows --

First, interest on long-term debt for FPU increased long-term interest expense by $456,000.

Second, short-term interest expense increased by approximately $140,000, as $29.1 million of FPU long-term debt was redeemed and temporarily refinanced with short-term debt.

We redeemed two series of FPU bonds -- the 6.85% and 4.9% series of FPU's secured first mortgage bonds in January 2010 for $29.1 million prior to their respective maturities, using a new short-term loan facility that will mature later this year. For the third quarter, refinancing of these bonds generated approximately $285,000 in interest expense savings.

On June 29, 2010, the Company entered into an agreement with an existing lender to refinance this short-term loan facility prior to 2012 as well as $7 million of other FPU long-term debt prior to May 2013.

Finally, in terms of the interest expense increase, we recorded additional interest expense of $184,000 on deposits from FPU customers.

As we begin to think about the fourth quarter, it is appropriate to revisit our performance in the fourth quarter of 2009. We reported diluted earnings per share of $0.71 for the quarter, which excluded one month, October, of FPU's results and not a full quarter's impact of the shares issued in the merger.

Several of the opportunities that we have discussed in this call will positively impact our fourth quarter 2010 performance.

First, Eastern Shore's expansion that was completed in May 2010 and the expansion completed earlier this week will generate additional annual margin. Additionally, both Eastern Shore's Texas Eastern and natural gas distribution service to a second large industrial customer are scheduled to begin service in late 2010 or early 2011.

In summary, Chesapeake reported another strong quarter of financial results and is well positioned for future growth based on the fundamentals of our operating segments and our strong financial position.

Now I'll turn the call back over to Mike for closing remarks.

Thanks, Beth. As you've heard, we are well positioned to provide stable returns to our shareholders based on the opportunities within our service territories and our management team's ability to profitably manage growth, effectively manage regulation and execute on opportunities such as the FPU merger, transmission system expansions, new commercial and industrial growth opportunities, and our community gas system initiative.

We believe natural gas is the cleanest, most abundant, and lowest cost energy option available for meeting the nation's energy needs for tomorrow and the years to come.

We see continued opportunities for profitable growth ahead for the Company and remain committed to producing solid returns for our shareholders.

We would be pleased to answer any questions you may have at this time.

(Operator Instructions). Dan Fidell, Brean Murray.

Good morning.

Good morning, Dan.

Hi, Dan.

First, congratulations on a nice quarter and special congratulations to you, Mike, on the new title.

Well, thank you, sir. It's a pretty exciting times here at Chesapeake.

Absolutely. Just a few housekeeping questions on my side. First, can you give us maybe an update on what you're expecting for effective tax rate for 2010? Or what we should be using it is a better way of putting it.

That would be approximately 39, Dan.

Okay, great. And then have you given any kind of guidance or I guess can you give us some guidance in terms of what you expect on O&M trend-wise into 2011 and maybe a refresh on CapEx for 2011?

Not at this time. Typically in the 10-K, we will lay out what we expect our capital expenditures to be. We've not disclosed that at this time.

In terms of the operating expenses, we are continuing, as Mike talked about, trying to look at what opportunities that we have as a result of the merger. And I think in looking back with some of our historical numbers would have been for the fourth quarter, that would be a good place to start for 2009.

Okay, great. Thank you. That's helpful. And then maybe just a last question. If you can give us maybe just kind of the regulatory calendar as we go forward into the next quarter or two. I know you talked about Florida filing an acquisition premium. I think you've also said in your last call talking about a FERC filing for Eastern Shore may be coming up. Can you just sort of lay out for us how the next several months will go on the regulatory side?

Yes. Eastern Shore first. Eastern Shore will be filing -- making a rate filing with the FERC around January 1, it's going to be prior to January 1, 2011. At this time, it's just too early to tell what that filing is going to look like. Eastern Shore's earnings have been pretty strong.

As it relates to the Florida come-back filing, we are required to make that filing around April, and so we will be looking to address that issue at that time. And as things evolve between now and April, there could be some conversation about that prior or likely to be conversation about that prior to April. So that's quickly approaching us and there's been some preliminary conversations around that issue with the OPC and staff as you would expect.

Any kind of color you can give us on those initial conversations in terms of their position?

Yes, there's a lot of policy in Florida and I guess you can call it a policy to grant rate recovery of acquisition adjustments if you can prove that there's no negative impact on the customers, in fact, a positive impact on the customer from the acquisition.

So we've been having some conversations, and as you would expect, really ongoing starting with probably even before we closed the transaction, and we have been continuing those -- with the strength of our earnings, and the cold weather that we've had in Florida enhancing margins, we have been continuing these conversations.

Okay, thanks very much.

Thank you, Dan.

David Parker, Robert W. Baird & Company.

Hi, good morning, and congrats. I always hate to follow Dan because he asks all the good questions, but there's only a couple that are left, I think, to ask, Dan, thanks.

First off, just the transition. I know John had been pretty instrumental or definitely very helpful in the success of integrating FPU, and I don't know if -- is John going to continue to stay on despite his retirement on a retainer or consulting fee? Or Mike do you feel comfortable that the team in Florida that you've been building up is capable of carrying on the good work?

I think both are true, Dave. I mean, John is continuing on on our Board of Directors. He is Vice Chairman and so I expect to be able to talk to John anytime I want. And he's not a shy guy, and so he will certainly be involved and he will have certainly a lot of guidance to give us during that continued process of integrating Florida Pub.

As far as the team, we're very pleased with the team that we've got in Florida. As you know we've added two new players, Tom is -- going back before the Florida Pub acquisition, Tom Geoffroy was running Central Florida Gas; and Jeff Sylvester was down there also in Florida, very strong individual contributor to the Company. And looking forward we've added Jeff Householder and also Kevin Webber to the team and [ever] before we feel like it's very strong.

Good. And as you answered Dan's question on the regulatory activity, I think we've also talked or we talked in the past quarterly call about sort of an update on the strategic outlook for the Florida Pub. Is that still expected in the near term? Or with regulatory activity, does that sort of slides to the back burner?

We've had our first year actually of completion of the strategic planning process in the Florida Pub, Chesapeake's chief planning process, and so that, I guess, helped us get some arms around it. But as we're integrating and as we're working on this regulatory project or opportunity, I guess we are not really moving aggressive -- I want to say, let me back up, [that's not] aggressive, we're not going to be coming out with a statement on strategy.

I will say this. If you look at some of the public things on the public domain we have -- are evaluating a project of extending a gas line to Fernandina Beach and we are looking for the commercial industrial opportunities that exist in the State of Florida, as we are here on Delmarva. So you're going to see those things happening and you are going to see us moving forward on the regulatory side, and then you'll see some more coming out as we make progress on the strategic front.

There's also a lot of effort being put into improving our customer service or customer care if you will. We have converted our billing system, Central Florida's billing system to the same system Florida Public Utilities has been using, and we are at the early stages of beginning to upgrade that system to a new version and so we are through our reorganization making improvements there and in the customer service.

We feel like we'll be making improvements in the sales and marketing side with the addition of Kevin Webber. We're working on making improvements on the operations side as well, and so we've got all of those things that we're putting under the integration umbrella as opposed to maybe strategic although they are strategic initiatives.

Do you plan, Mike, on issuing like any kind of longer-term CapEx forecast for the electric operations in Florida eventually or is that something you haven't thought through yet?

I have to say, Dave, we have not really thought that through at this point in time. As you know, we don't generate power in Florida so there's really -- CapEx there is not as significant as it might be for some other electric companies that have generation.

But yes, you have a purchased power agreement that is coming up or is going to expire here relatively soon. Is that correct, Mike?

I think it's several years out, I think more than five anyway.

Okay, all right. In utility years, that's nothing right, utility time frame? (Inaudible). Well, congratulations on a great quarter and [seeing] with the operations, I appreciate it.

Okay, thanks, Dave.

John Hanson, Praesidis Asset.

Good morning.

Good morning.

Good morning.

You've come up with some good projects and particularly the short-term pipeline project. Anything else out there like that in terms of pipeline or other related kind of projects that you see out there in the coming years?

Well, there's the things that are out there right now, the TETCO project that is on Eastern Shore's system is probably the single largest, and then you know we're looking in Florida -- continuously looking in Florida as we have been for a lot of years -- for opportunities down there.

As far as anything signed, contracts signed, or projects approved by the FERC, we don't have others but we are, again, continuously working on those and as those come to fruition, we'll issue releases. And we've been, I guess through our strategic planning process, we're looking five years out for opportunities and I guess our Management team is looking for ways to grow beyond what our current footprint would allow us to and so there is a lot of work going into this effort to build, if you will, a pipeline of projects and we're in a pretty good shape there, so it's just a matter of trying to bring those to fruition.

Okay, good. So longer-term there may be some other larger projects that might be out there. Near-term though in terms of cash flows and financing for your projects, are you pretty comfortable about living within the current financial situations you have or are you going to need some more financing?

We, you know, as Mike mentioned, we do look out approximately five years and so, John, right now we have budgets prepared that enable us to try to get a feel for both, you know, what type of long-term financing we're going to need.

And so we are continually looking at that and to the extent that we can continue to capitalize on some of these growth opportunities that we've talked about. And there are -- we believe opportunities to continue to try to grow our distribution system specifically on the natural gas distribution side. We will be looking to access the capital market.

Okay, good, thanks.

And that will be primarily debt. It really takes a lot of capital expenditures to get to the equity market side.

Very good.

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

I'd like to thank everyone for taking the time to listen to us this morning and for the good questions. And we are excited about how things are going here at Chesapeake, and look forward to hearing from you again. Thank you.

Thank you.

This will conclude today's conference call. You may now disconnect.