Chesapeake Utilities Corp (CPK) 2011 Q2 法說會逐字稿

Please stand by for realtime transcript. Good morning. My name is Danny and I will be conference operator today. At this time I would like to welcome everyone to the Chesapeake Utilities Corp second-quarter 2011 earnings conference call. All lines have been placed on mute to prevent any background noise. After the speakers remarks there will be a question and answer session. (Operator Instructions) Thank you. Ms Beth Cooper, you may begin your conference.

Good morning and welcome to the Chesapeake Utilities Corp second-quarter 2011 earnings conference call. Before you 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 and the Company's 2010 Form 10-K and most recent quarterly report on Form 10-Q for further information on the risks and uncertainties related to the Company's forward-looking statements. Now I will turn the call over to Mike McMasters, President and Chief Executive Officer.

Thanks, Beth. And good morning everyone. As detailed in our press release issued yesterday, Chesapeake Utilities Corp reported net income of $3.5 million and diluted earnings per share of $0.37 for the second quarter of 2011. This represents an increase of $200,000 over 2010 second-quarter net income and an increase of $0.02 in per diluted earnings per share.

There were several key factors generating this increased performance quarter-over-quarter. First, continued growth in our natural gas distribution businesses, expansion of our natural gas transmission system, and improved margins in the propane distribution and wholesale marketing operations.

The impact of these factors more than offset the one-time charges associated with the Florida voluntary workforce reduction and the costs related to the rollout and initial implementations of a new product -- ProfitZoom by the Company's advanced information service subsidiary, BravePoint. The $549,000 in one-time charges in May 2011 associated with the voluntary workforce reduction is expected to generate approximately $500,000 in cost savings in 2011 and $800,000 savings thereafter.

The cost incurred in the second quarter related to the rollout and initial implementations of ProfitZoom enabled BravePoint to complete its first implementation of the product in July. There are 2 other customers that are currently in the process of converting their systems to ProfitZoom.

To briefly highlight the Company's year-to-date performance, for the first 6 months of 2011, net income was $17.3 million or $1.79 per diluted share. This compares to $17.3 million or $1.82 per diluted share for the first 6 months of 2010. Earnings per share declined by $0.03 as a result of additional shares issued and outstanding in 2011. Year-to-date results reflect the factors mentioned for the second quarter, as well as warmer weather during the first quarter of 2011 when compared to last year.

Before I turn the call over to Beth to go into more detail on the financial performance, I would like to highlight some of the key growth opportunities that we see for the Company going forward. The Company's continued extension of our natural gas systems to serve new customers and communities has led to continued growth and positioned us well for the future.

We continue to seek out further opportunities for growth in our Delmarva natural gas transmission and distribution operations and are excited about the extension of service to Southern Delaware and Cecil and Worcester counties in Maryland. We are also pursuing multiple growth opportunities throughout our Florida operations. We are working diligently to transform these opportunities into value-added services.

During the second quarter of 2011, Eastern Shore generated $542,000 of higher gross margin from new transportation services that commenced in January. These new services are expected to generate gross margin of $2.4 million in 2011, $3.9 million in 2012 and $4.3 million annually thereafter.

Additionally during the quarter, Eastern Shore entered into 2 new transportation service agreements with an existing customer. This generated an additional gross margin of $61,000 in the second quarter of 2011. These additional services are expected to generate gross margin of $356,000 in the remainder of 2011, $1.2 million in 2012, and $369,000 annually thereafter.

In our Delmarva natural gas distribution business, we have successfully added new commercial industrial customers with larger incremental margins to offset slower residential and small commercial customer growth. The addition of 14 new commercial industrial customers in 2010 generated $261,000 of incremental gross margin in the second quarter of 2011. For the 2011 calendar year, these new commercial industrial customers are expected to generate $1.1 million in margin compared to $196,000 in 2010.

On our last quarterly conference call with discussed our expansion to Lewes, Delaware, and the service agreements with 2 large customers in that area. These 2 customers will generate estimated gross margin equal to 1,000 residential heating customers. We expect the service to 1 of the customers to commence in the fourth quarter of 2011 and service to the second in early 2012.

In addition to these 2 large customers, the expansion of the distribution system will enable us to serve additional residential commercial customers that are in close proximity to the system and interested in converting to natural gas.

Additionally, we are actively engaged in negotiations with several large commercial industrial customers in both Worcester and Cecil counties in Maryland. We expect service to be established in these new areas in 2012. As we expand our natural gas distribution and transmission systems south of Worcester County, we have also identified opportunities to serve industrial customers in Southern Delaware which will generate additional gross margin starting in late 2011.

Residential customer growth in the Delmarva natural gas distribution business was about 3% during the second quarter. This contributed approximately $105,000 additional gross margin for the 3 months. In addition, all of these expansions position our Delmarva natural gas distribution business for continued future growth.

1% residential growth and 3% commercial growth in the Florida gas distribution business generated incremental margin of $376,000 during the second quarter. Customers added as a result of the acquisition of Indiantown Gas Company in August 2010 generated another $142,000 during the quarter.

On the regulatory side, Eastern Shore filed a base rate case with the FERC in December and expects the case to be resolved before year end. In Florida, on April 29, 2011, the Company submitted its comeback filing with the Public Service Commission. This filing explains the known benefits, cost savings and increases resulting from the merger with FPU.

As we have previously indicated, our integration efforts to date have gone well. We are also proud of the fact that we produced significant accretion in 2010, the first full year after the merger. In our filing, we have requested recovery of approximately $34.2 million in purchase premium and $2.2 million in merger-related costs.

If the Florida PSE allows the recovery of the premium and merger-related costs, we will begin amortizing the premium which will reduce the operating income by $1.6 million annually until 2040 and $1.1 million thereafter. However, the inclusion of the premium and the Company's rate base and recovery of the premium and merger related costs or amortization expense will increase the Company's earnings and cash flows above those levels that would have otherwise been achievable.

If the PSE does not allow recovery of the purchase premium, the Company's earnings could be negatively impacted. The decision on the Company's request to recover the acquisition adjustment and merger-related costs is expected in the fourth quarter of 2011.

The Company has accrued $750,000 based on Management's assessment of FPU's earnings and the regulatory risk associated with those earnings since the merger. We will provide more details about the progress of this filing as the process moves forward.

Our propane business is also well-positioned for growth. We have a strong reputation in the markets we serve and access to the capital necessary to grow the business.

Over the last year we have consolidated the supply purchasing functions of our Delmarva and Florida propane distribution operations, thereby lowering our costs. To facilitate growth in customer retention, we offer our customers several different pricing programs to empower them to tailor their service based upon their personal preferences. Additionally, our Cecil County Maryland start up and our community gas systems are continuing to grow.

Finally, the results for BravePoint, our advanced information services subsidiary, were lower during the quarter due to the rollout and implementation costs associated with launching ProfitZoom. BravePoint has been developing ProfitZoom since 2009 and we are excited about the potential for this new product.

Results for the second quarter, and the opportunities we see going forward for our Company are very encouraging. We expect continued growth to produce further improved financial results and we remain committed to providing excellent service to our customers and superior returns to our shareholders. I will turn the call over to Beth to provide additional details on the financial performance for the quarter and year-to-date.

Operating fundamentals for the Company's energy distribution and natural gas transmission operations remains strong. Growth from these operations and improved margins from our propane wholesale and natural gas marketing subsidiary offset one-time charges associated with the voluntary workforce reduction in Florida and the ProfitZoom roll-out and initial implementation costs incurred by BravePoint.

For the quarter, consolidated operating income was unchanged at $7.8 million, as a $2.5 million increase in gross margin was offset by higher operating expenses. These higher operating expenses included $549,000 of workforce reduction charges and $341,000 in additional costs related to the launch of ProfitZoom.

Also contributing to the increase in other operating expenses were increased regulatory, legal and other costs for the regulated energy businesses. These costs included $316,000 of costs associated with the electric franchise dispute in Marianna, Florida and $83,000 in costs with respect to the comeback filing in Florida and the Eastern Shore rate case proceedings. The Company expects both regulatory proceedings to be resolved in 2011.

For the 6 months ended June 2011, operating income decreased by $544,000 reflecting the factors mentioned in the second-quarter discussion, plus the impact of warmer temperatures on propane and natural gas distribution margins during the first quarter of 2011. Lower consumption due, largely to warmer weather, generated lower gross margins of $2.4 million during the first 6 months of 2011 when compared to the same period in 2010.

Chesapeake's regulated energy businesses generated operating income of $7.9 million for the second quarter of 2011, compared to $8.3 million for the second quarter of 2010.

As Mike indicated, growth in margins of $1.3 million from customer additions and new Eastern Shore transportation service contracts was offset by one-time costs related to the Florida voluntary workforce reduction. The workforce reduction is expected to produce future benefits through lower operating costs and a more streamlined operating organization in Florida.

Excluding the impact of the voluntary workforce reduction, operating expenses for the regulated energy segment increased by $1.3 million in the second quarter of 2011, largely due to higher regulatory, legal and other costs mentioned previously, higher depreciation expense from additional plant investments and increased pipeline integrity costs.

For the first 6 months of 2011, operating income for the regulated energy segment decreased by $1.7 million, reflecting the impacts detailed in the second-quarter discussion, as well as warmer weather, which was only partially offset by customer growth over the 6 months.

Operating income for the unregulated energy segment improved $795,000 to $4,000 [sic-see presentation] in the second quarter of 2011, compared to an operating loss of $791,000 for the second quarter of 2010. These results reflect margins per gallon returning to more normal levels on the Delmarva Peninsula.

The Company's marketing operations also recognized higher margin due to increases in trading activity and favorable imbalance resolutions with third-party interstate pipelines. Increased margin for the segment more than offset increase operating expenses of $501,000.

Operating income for the unregulated energy operations increased by $1.5 million during the 6 months ended June 2011, compared to the 6 months ended June 2010.

A $2 million increase in gross margin, principally as a result of the same factors that generated the strong second-quarter results, was offset by a decrease of $934,000 in propane gallons sold partially due to warmer weather and also increased operating expenses of $430,000. Unregulated energy operations also benefited from a $575,000 gain recognized from a litigation settlement during the first quarter of 2011.

Other operations reported a loss of $91,000 for the second quarter of 2011, compared to operating income of $244,000 during the second quarter of 2010. The decline reflects $418,000 in lower operating income from the ProfitZoom launch at BravePoint, which was partially offset by a $92,000 decrease in merger-related transition costs.

For the 6 months ended June 2011, the other segment reported a loss of $74,000, compared to operating income of $366,000 in the same period of 2010. The decrease in operating results reflects lower operating income of $548,000 from BravePoint, offset by $111,000 in lower merger-related transition costs. We have provided a detailed discussion of the factors contributing to the results for the quarter in our press release which was issued yesterday.

Capital expenditures for the first 6 months of 2011 totaled $21.2 million. For the year we expect to spend a total of $62.6 million. Based on our track record, our actual capital expenditures typically lag our forecast.

We expect to finance these capital expenditures initially on an interim basis with our short-term lines of credit and then as necessary with long-term debt financing. We believe we have access to competitively priced capital to refinance these expenditures over the long term.

Interest expense for the first 6 months of 2011 decreased by approximately $403,000, or 9%, compared to the first 6 months of 2010, due to a lower level of long-term debt and short-term borrowings.

On June 23, 2011, we issued $29 million of 5.68% unsecured senior notes to 2 institutions. We used the proceeds to permanently refinance the redemption of 2 series of FPU first mortgage bonds that had interest rates of 6.85% and 4.90%. These 2 first mortgage bonds had initially been refinanced using a short-term loan credit facility.

The refinancing will increase interest expense by $550,000 during the second half of the year over the cost of the short-term loan credit facility. With the refinancing of these 2 series of FPU first mortgage bonds, we have reduced the amount of secured long-term debt and relative to Chesapeake's other senior debt, obtained comparable financial covenants.

Chesapeake reported another quarter of strong financial results. And is well-positioned for future growth based on the fundamentals of our businesses and our strong financial discipline and position. Now I will turn the call back over to Mike to my to discuss some of the key drivers for growth in 2011 and beyond.

We continue to see excellent opportunities for growth in our Delmarva natural gas distribution and transmission businesses. Wile residential customer business have declined, the opportunities to add large commercial industrial customers is still there. While the total number of customers added continued to be lower than we experienced several years ago, the incremental margin from new customers continues to grow at a healthy rate.

In addition, these large customer additions enable the Company to further extend the natural gas distribution and transmission infrastructure bringing safe, reliable, cost-effective and environmentally friendly natural gas to new areas on the Delmarva Peninsula. Our large commercial industrial additions during late 2010 and early 2011 are expected to generate annual margin of $1.1 million in 2011, compared to $196,000 in 2010.

We are also continuing to see growth in our transmission business and new transportation services we initiated last year and earlier this year will generate estimated annual margin of $3.4 million in 2011, $5.7 million in 2012 and $5.3 million annually thereafter.

In our Florida operations, we are working diligently to transform some of the opportunities we have identified into realized value-added benefits to the respective customers. Our unregulated energy businesses continue to execute upon their business plans and are generating positive results to the bottom line.

BravePoint has successfully launched ProfitZoom. Chesapeake has continued to take advantage of the opportunities available and we continue to seek out and find new opportunities to grow our businesses and create value for our shareholders.

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 for years to come. We believe that natural gas' competitive advantages will continue to create profitable opportunities for growth in the future. Operator, we are now ready for questions.

(Operator Instructions) Our first question comes from the line of Michael Gaugler from Brean Murray, Carret.

1 question surrounding future uses of cash flow. On a go-forward basis, is your focus more on reducing net debt or new investments in organic or inorganic growth?

Our focus is in finding new opportunities for organic growth.

We should expect net debt to ease up through the next couple of quarters?

Yes. As we talked a little bit earlier, we expect the capital expenditures that we will initially be able to finance those with short-term debt and cash flow that we have available from our existing operations, but with the level of capital expenditures that we are forecasting over the longer term, there would be increased long-term debt financing.

Okay and then I would assume as well with the new investments, you are expecting your D&A which has been relatively flat to start creeping up as well?

Actually, we saw that -- we talked a little bit about that in the call today where if you look at quarter-over-quarter, a little less than $500,000 of increased depreciation is coming from the additional investments that we have made.

Okay. That is all I had. Congrats on a nice quarter.

Thanks, Michael. We appreciate it.

Thanks.

(Operator Instructions) Our next question comes from the line of Dave Parker from Robert W Baird.

Thank you. Congratulations as well.

Thanks, Dave.

I know this is always tough to really forecast, Mike, but you have been successful with picking up or adding growth where it didn't exist in residential with the CNI customers and now you are in some new areas of the country. Can you give us some kind of color? Number 1, why you have been so successful in the last 12 months or so. Maybe where those growth opportunities may go, now that you are expanding your net into Maryland and other areas. Does that give you more opportunities there and, also, the same comments for the pipeline too.

Actually, Dave, I think the key -- probably the biggest single variable out there right now is this price differential between natural gas and oil. And some of that is a function of the shale gas availability, but with oil prices climbing and natural gas prices being relatively flat, it's increasing the incentive for industrial customers to convert from oil to natural gas. So, that coupled with the environmental benefits has probably been the biggest factor. We have also, in our territory, relatively low density of natural gas. So, there are opportunities out there that we have been able to identify and then solve the customers problems and give service to them.

The conditions in terms of the market conditions, oil versus natural gas, they may not be as extreme as they were a quarter ago but they are still very substantial today. And so, we see those opportunities continue. Now as we move further south on Delmarva, there'll be less and fewer industrial opportunities as we get south. That is partially why we felt it was important for us to go to Cecil County, Maryland, which is at the top of the Chesapeake Bay, and also part of the logic with the Florida Public Utilities merger a couple of years ago now. That basically Florida has also a low density of natural gas in the state and obviously a much bigger territory than the Delmarva Peninsula.

The bottom line is, you have been successful but there is still good opportunities out there.

Yes. Every time you grow, your platform is a little bigger which means you have to grow more. We're continuing to look pretty hard for those opportunities, Dave, and we are continuing to find them.

My last question, opportunities for pipeline expansion in the near term and the next few years?

Yes. All of this is on Delmarva, it is all related. As we go to Worcester County it is going to require pipeline expansion. As we go to Cecil County it is going to require pipeline. As we have these large commercial industrial, if we don't extend the transmission, we still have to increase the capacity of the transmission system. So, yes, there are transmission expansions in conjunction with that, and as we talked about in the past, we do have that [PESCO] which is Peninsula Interstate Pipeline in Florida. Which is a Florida PSE regulated pipeline that also we are looking to grow through that pipeline as well.

Okay. Great, thank you very much.

Thanks Dave.

Our next question comes from the line of Roger Lidell with Clear Harbor Asset Management.

Can you give me some information on the large commercial industrial loads? Is that thermal generation or is it on site electric generation? And is there a meaningful opportunity in distributed electric generation among those commercial industrial customers?

The customers that we have been adding so far have been primarily in 2 or 3 different fields, but 1 the poultry industry here on Delmarva was a pretty large industry. Secondly, we have been getting to hospitals in Southern Delaware and also are looking in other places to serve hospitals, and then, I think the most recent was a pharmaceutical company in Lewes, Delaware. And in terms of some of the on-site generation, those opportunities to some degree, some of our customers already have that capability and some of these customers have that capability. Our existing customer base is probably -- we've been working with for a couple of years on those opportunities and look forward to having some success there. So far, we have not had a lot of success, but that does represent an opportunity for us.

Similarly in Florida, as I recall, there are plans to build at least 4 nuclear units in the southern and western parts of the state. Even pre-Fukushima, the [busbar] costs for new capacity is arguably in the $0.10 or so, it could be higher than that, a kilowatt hour. In the deficit cutting mood in Congress, there could be steps to reduce some of the subsidies like Price-Anderson Act in place now, what 54 years and having outlived its usefulness. So, the question is, what about in Florida, are you assuming that there will be interesting distributed generation business there also?

Yes. We are working on opportunities as we speak and as you know, we have both the gas business and the electric business in Florida, and so where -- we think we can have a pretty good chance of some success there. We have some very good people working on this project, as well down in Florida.

Excellent. Thank you.

Our next question comes from the line of John Hanson from Praesidis.

Just a couple of follow-ups. Most of my questions were answered. On the expansion that you're getting for the large customers there in the Delmarva, are there particular industries or types of customers?

It has been primarily the poultry and secondarily hospitals, and then it is a mixed bag. The 1 pharmaceutical was important.

I thought I heard that. I wasn't sure if that pertained to some other part of the business or not. Thanks. The other question I have is, with regard to the Florida FPU case. Is there a possibility that things can be set up for some [kind of a settlement] somewhere in this process before it runs its full course?

I guess we had some earlier discussions about 6 months ago, and they were not -- they didn't seem to be moving very far along. So, I think what it will take is, after -- possibly after the Florida PSE staff gets its arms around our filing and starts to form an opinion, then that might create some opportunity to have some conversations about that. Right now we're still waiting for that progress to be made so we will know where their views are and then we can possibly start to try to figure out how to get that done, but it just hasn't been anything going on in that regard right now.

Thanks.

(Operator Instructions) Our next question comes from the line of [Peter Hark] from ZLP Partners.

A couple of housekeeping questions. First, the expenses for the workforce reduction and the costs for the franchise dispute and the come back filing in Florida, are those all pre-tax numbers? And will the franchise costs extend beyond here in the second quarter? And how much should we put into our models for that?

The numbers that we discussed on the conference call are pre-tax numbers, Peter. In regards to the Marianna dispute -- the franchise dispute, those discussions are still under way and so, we have nothing more -- we don't have another estimate because it really depends on how long those negotiations go. We're actively trying to work on resolution of that dispute, but I can't tell you now how much or when it will be resolved.

The comeback filing, what are the next milestone events for that review in Florida?

It is set for commission agenda in October and I don't recall the hard date that the staff would file its position, but I think that is going to be sometime in October.

Thanks --. I'm sorry, Mike, go.

That would be 2 weeks before the agenda date, so I think it's probably early October and the agenda is probably third week of October. I have somebody here that is helping me with the answer. Thank you.

And they will vote on it at that agenda meeting, is that when they will decide?

Yes.

Alright, thank you. And just on propane margins, what exactly were the margins that you are seeing and maybe explain how they have been so strong given where natural gas prices have gone and the distribution side, certainly doing better off of -- better rates there? What is holding up the propane margins and can you be more explicit as to what they are?

We will hit you with a general answer first, but basically what happened in 2010, as you recall, the weather was extremely cold in '10 and we have a program with our customers where we will cap their price. So, we had a lot of customers -- we will go out and hedge those gallons, but we had a lot of customers that were signed up for this cap and cold weather hit which did 2 things. 1, it increased the price -- increased demand which means the customers needed more gas. And 2, because of the increased demand, the wholesale price went up. So, we can't perfectly hedge those gallons, there was some costs that we incurred for higher cost supply that we did not pass on to those customers. So, we had margin compression in 2010. So, what we are seeing in 2011, to a large degree, is the resumption of normal margins in our propane business. I do know if there is anything more, Beth, you would like to add to that.

I would just add also too, Peter, with that competitive environment, the retail prices, some of that is set based on, as well, what the competition is also charging and we monitor that as well. So, I think it is both of those coupled with, as Mike said, when you look back at last year and we had to go out and get additional gas and then, we are remaining competitive with the market in terms of the pricing and that is based upon the supply cost to the local competition as well.

Got you. What happens when the customers roll off of the cap program?

The cap program basically expires every year. It is a winter season option that we offer our customers so when they roll off, they are no longer under the capped program and then we will give them another opportunity to enroll the following summer.

Got you. You're seeking to realize the same type of margins on the new contracts, right? That is certainly the intention. I guess the question underlying this, can you maintain those margins?

We think the margins are about at the normal level and so absent something, some significant disruption to the market, we should be able to maintain these margins. But this is the energy business and it's not unusual to have significant changes in wholesale prices. You have to watch the inventory price risk too. If you are filling up inventory in high price periods and prices fall, then you're going to end up with some margin compression. The opposite is also true when prices are cheap and you are filling up inventory and then wholesale prices go up, you get some margin expansion. So, you get some volatility in earnings driven off of those impacts, but over time these margins are about what is normal.

Perfect, and you will be setting up hedges throughout [and before] the heating season starting this fall. Is that typically when these contracts roll away and you enlist new contracts coming up now?

Right.

Lastly, on Eastern Shore, factoring in the phase-in over the 2011 through 2013 period for the additional margins, is it fair to put in, almost, on a pro rata basis per quarter? Or is there a lumpiness to the margins from that?

There will be a slight increase as we come through the fourth quarter. I think when you look at the information that has been -- that we put in the press release, what you'll see is the sum of all those new services relative to what we are experiencing in 2011, Peter, it will increase by about $2.2 million. We're currently forecasted all those services at the end of the year and this was discussed in the press release to be about $3.4 million. For 2012 it will be approximately $5.7 million.

Okay.

Once a contract is in place, it is same margin per quarter. Once the contract is in place.

Okay, perfect. Thank you, Mike. Thanks Beth.

Thank you.

There are no further questions at this time. Ms Cooper, I turn the call back over to you.

Thank you. Mike and I would like to thank everyone for participating in the conference call and we look forward to talking with you again at the end of the third quarter.

Thank you.

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