Chesapeake Utilities Corp (CPK) 2011 Q4 法說會逐字稿

Good morning. My name is Matthew, and I will be your conference operator today. At this time, I'd like to welcome everyone to the Chesapeake Utilities Corporation 2011 year-end earnings 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. Beth Cooper, you may begin your conference.

Thank you, Matt. Good morning, everyone, and welcome to the Chesapeake Utilities fourth quarter 2011 earnings conference call. Joining me on the call today is Mike McMasters, President and Chief Executive Officer. On today's call we are going to discuss the results of the fourth quarter and the year ended December 31, 2011. We encourage you to read our earnings release issued yesterday and our Form 10-K filed earlier today for more details. Matters discussed in this conference call made include forward-looking statements that involve risks and uncertainties. Actual results may differ materially from those described in the forward-looking statements. Please refer to the Safe Harbor for forward-looking statements and the Company's Form 10-K or further information on the risks and uncertainties related to the Company's forward-looking statements. Now, I'll turn the call over to Mike for an overview of the fourth quarter and year-to-date results.

Thanks, Beth, and good morning, everyone. We are pleased to announce that Chesapeake Utilities reported net income of $27.6 million and earnings per share of $2.87 for the year ended December 31, 2011. These represent increases of $1.566 million and $0.14 per share over last year. This is the fifth consecutive year of record earnings for the Company. The key factors, contributing to the year-over-year increases were the growth and expansion of our natural gas distribution and transmission operations was significant enough to overcome the $5.2 million negative impact that warmer weather had on margins. Improved margins in the propane distribution and wholesale marketing operations also contributed to the improved earnings and finally, a net gain from several unusual items also contributed 2011 results.

For the fourth quarter of 2011, net income was $8 million, or $0.83 per share, an increase of $844,000, or $0.09 per share over the fourth quarter of last year. After I highlight some of the key opportunities that we see for the Company going forward, Beth will provide a more detailed discussion of the financial results. We continue to aggressively promote the economic and environmental advantage of natural gas and to identify, and then to develop opportunities for growth in both the gas transmission and distribution businesses. Our gas transmission distribution operations are working together to capitalize on these opportunities.

In January of this year, Eastern Shore completed an eight-mile extension and interconnect with Texas Eastern's transmission pipeline system. This strategic extension provides access to new sources of natural gas, including shale gas production areas in Pennsylvania and Ohio. New transportation services of 20,000 dekatherms per day associated with this extension commenced in January 2011. This is service generated gross margin of $2 million in 2011 and is expected to generate $1.9 million in 2012 and $2.1 million annually thereafter.

One of the factors contributing to growth in the transmission business over the years has been our Delmarva natural gas distribution business growth. During the third quarter, Eastern Shore began construction of new facilities to extend natural gas service further into southern Delaware and ultimately into Worcester County, Maryland. The expansions are primarily for our Delaware and Maryland divisions. As a result of changes in market conditions over the last couple of years, we adjusted our growth strategy to focus on large commercial and industrial customer conversions in areas where natural gas was previously not available. 20 new commercial industrial customers have been added since June 2010. Service to these customers generated $1.2 million of additional gross margin in 2011 and is expected to generate gross margin of $2.1 million in 2012. In addition, the mainline extensions necessary to serve these customers provide future opportunities to convert smaller commercial businesses and homes from higher cost energy sources to natural gas.

Included in the 20 customers above are two customers located in Lewes, Delaware that were connected in December of this past year. These two customers will add margin equivalent to 1,000 residential customers. Not included in the group of customers mentioned earlier is another existing customer that have signed new agreements for natural gas service at two of its facilities located in southern Delaware. These new services are expected to begin the fourth quarter of 2012 and will generate annual gross margin equivalent to 415 residential customers.

On December 22, 2011, Eastern Shore entered into a precedent agreement with NRG Energy Center Dover LLC to provide firm natural gas transportation service to NRG's electric power generation plant in Dover. Eastern Shore has previously provided interruptible service to the NRG at this plant. To provide firm service, Eastern Shore will construct new facilities at an estimated cost of $12.5 million to $15 million. The precedent agreement provides that upon satisfying certain conditions, Eastern Shore and NRG will sign at 15 year firm transportation service agreement for maximum daily quality of 13,440 dekatherms per day. This service is projected to commence in May 2013 and expected to generate an estimated annual gross margin of $2.4 million to $2.8 million.

Residential customer growth in the Delmarva natural gas distribution business was about 2% in 2011. Absent any significant changes in economic conditions, we expect this level of growth to be sustained. To facilitate growth in the residential market, we're in a process of finalizing a proposal we're filing with the Delaware PSC to add new services and a change in our rate design. The new services are designed to assist potential natural gas customers in converting to natural gas. It will take several months before we know how the Public Service Commission will react to our proposal. Given natural gas's current value proposition and the environmental and energy efficiency benefits that natural gas service provides, we are cautiously optimistic that the Commission may view a substantial portion of the proposal favorably.

Our Florida Natural gas distribution operations are also contributing to our growth. Our service territories are spread out across the state of Florida. This provides numerous opportunities for us to identify new commercial industrial customers for possible conversion to natural gas. In many cases, this will require new mainline extensions that could in turn provide additional opportunities for growth down the road. During 2011, we have seen commercial customer growth of approximately 2%, which generated additional margin of $771,000. As it relates to residential growth in Florida, we do not expect to see a significant increase until economic conditions improve.

In January 2012, initial pipeline executed an agreement with TECO Peoples Gas for the joint construction, ownership and operation of a 16-mile pipeline from the Duval/Nassau county line to Amelia Island in Nassau County, Florida. Under the terms of the agreement, Peninsula Pipeline will own approximately 45% of the 16-mile pipeline. Peninsula Pipeline's portion of the estimated project cost is $3.3 million. Peninsula contracted Peoples Gas for capacity from Peoples interconnect with an unaffiliated upstream interstate pipeline across its distribution system to this jointly owned pipeline. Peninsula Pipeline will then provide transportation service to FPU for the natural gas distribution system it is constructing in Nassau County. The completion of this jointly owned pipeline is expected to be in the second half of 2012.

On the regulatory side, Eastern Shore filed a request for base rate increase with the FERC in December 2010. On January 24, 2012, the FERC approved a rate case settlement. The settlement provides for annual rate increase of approximately $805,000, effective July 29, 2011. It also included in the settlement a rate adjustment effective November 1, 2011 associated with the phase-in of additional transportation services on Eastern Shore's eight-mile extension to Texas Eastern's pipeline system. This rate adjustment reduces the rate per dekatherm of the service on this extension by reflecting the increased service of 15,000 dekatherms per day.

In 2011, we recorded $409,000 in additional gross margin as a result of implementing the new rates pursuant to this settlement. In January, 2012 the Florida Public Service Commission approved the Company's request for approval for the recovery of the $34.2 million acquisition adjustment and $2.2 million of merger related costs in connection with the Company's acquisition of FPU in 2009. In its order, of the Florida Public Service commission also determined that no refund should be made to customers as a result of the 2010 earnings of FPU's natural gas distribution operations. Absent approval for the recovery of the acquisition adjustment, FPU would have earned 21.87% ROE and could have been required to reduce its rates. The commission's order found that FPU had a revenue excess of approximately $5.2 million excluding the acquisition adjustment, and a revenue deficiency of $1.9 million including the acquisition adjustment.

In the fourth quarter of 2011, as a result of the order, the Company reversed a $750,000 reserve established in 2010. The reserve was accrued in the third and fourth quarter of 2010 based on the regulatory risks associated with the Florida Natural gas earnings merger savings and recovered the acquisition adjustment. The inclusion of the acquisition adjustment and merger related costs in the Company's rate base and the recovery of these assets from amortization expense will increase the Company's earnings and cash flows above what it would have otherwise been able to achieve. The acquisition adjustment merger costs will be amortized over 30 years and 5 years respectively, beginning in November 2009. Based upon the effective date of the outcome of the order, amortization will reflected as an expense in the Company's income statement beginning in 2012. The Company will record $2.4 million and amortization expense relates to these assets in 2012, 2013; $2.3 million in 2014; and $1.8 million annually thereafter until 2039.

The results from our nonregulated energy businesses have improved for the year ended December 31 compared to 2010 also. The results from our propane distribution business were positively impacted by improvements in margins per gallon. The price differential between propane wholesale prices and the average cost of inventory and market conditions all contributed to the increase. Results for the propane wholesale marketing operation also improved due to increased trading activities.

On December 12, 2011 Flow Gas Corporation, the propane distribution subsidiary of Florida Public Utilities, purchased the operating assets of Crescent Propane Inc. These assets are used to provide propane distribution services to approximally 800 customers in North Central Florida. Our propane distribution business is well positioned and is providing excellent returns to our shareholders and has been a strong source of cash flow. Additionally, providing propane service in the areas around our natural gas service territories provides us with market intelligence and supports our strategy of expanding natural gas service into our surrounding communities.

Finally, 2011 results for BravePoint, our information services business, are lower due to product development and release cost incurred to launch ProfitZoom. BravePoint has successfully implemented ProfitZoom for three customers, and two additional customers have executed contracts to implement it in early 2012. In addition, BravePoint is utilizing a component of ProfitZoom, Application Evolution, to provide services to new and existing customers. Application Evolution is currently being used to provide services to seven customers, and BravePoint as contracts to serve four additional customers in 2012. BravePoint recorded $572,000 in revenue in 2011 for ProfitZoom and Evolution. Several other sales proposals are under consideration by current and other potential customers.

The 2011 results reflect the strength of our businesses which overcame significantly warmer weather to generate the fifth consecutive year of record earnings. Our strategic focus on growth and continued pursuit of operational excellence, coupled with financial discipline, are generating results. We will continue our pursuit of profitable new opportunities, both in and beyond the traditional markets, to generate value for our customers and shareholders. Now, I'll turn the call over to Beth to provide additional details of our financial performance.

Thanks, Mike. As Mike indicated, 2011 was a record year for Chesapeake. These results were achieved despite warmer than normal temperatures. Earnings growth has been led by continued growth in our regulated operations and improved margins from our propane businesses. In 2011, operating income increased by $1.8 million to $53.7 million, up from $51.9 million in 2010. Gross margin increased by $4.9 million, or 3% over 2010. The increase in gross margin was achieved despite 13% and 50% warmer temperatures on the Delmarva Peninsula and in Florida, respectively. These warmer temperatures reduced margin by $5.2 million in 2011.

Overcoming the weather impact was over a $9 million increase in gross margin due to $3 million of new transportation services provided by Eastern Shore, $2.7 million from natural gas distribution customer growth on both the Delmarva Peninsula and in Florida, $2.2 million in higher retail margins per gallon for our propane distribution operations, and $1.5 million associated with the reversal of the regulatory reserve related to the comeback filing. This increase in gross margin was offset in part by $3.1 million and higher operating expenses for nonrecurring severance and pension settlement charges and additional costs incurred in connection with the launch of BravePoint's new product, ProfitZoom. We are pleased with the results to date as they demonstrate the strong fundamentals of our regulated and unregulated energy businesses.

Chesapeake's regulated energy businesses, which include our natural gas distribution and transmission and electric distribution operations, generated operating income of $44.2 million for 2011 compared to $43.5 million for 2010. Increased margins from customer growth in distribution services, new Eastern Shore transportation services, and the benefits from the successful outcome of our comeback filing related to the FPU acquisition more than offset the effects of warmer weather. These factors on a combined basis generated a net increase in margins of $3.9 million.

Operating expenses for the regulated energy segment increased by $3.2 million in 2011 compared to 2010. The increase in operating expenses resulted from higher depreciation expense, nonrecurring charges related to severance and pension settlement charges, higher legal costs associated with an electric franchise dispute in Florida, as well as additional spending on pipeline integrity. We expect the operating cost to remain at these levels in 2012, with the exception of the nonrecurring severance and pension settlement charges. Depreciation expense will also increase further as a result of the additional capital expenditures we will incur to capitalize on the growth opportunities in our service territories.

Operating income for the unregulated energy segment increased by $1.4 million in 2011. This increase was the result of a $1.1 million increase in gross margin, coupled with the $361,000 decrease in operating expenses. An increase in retail margins per gallon from the propane distribution operations, higher margins from the propane wholesale marketing and natural gas marketing operations and a gain from the proceeds received from a litigation settlement with a propane supplier more than offset the impact of warmer temperatures and a decrease in propane deliveries to bulk customers. The $361,000 reduction in operating expenses for the unregulated segment during the year primarily related to the impact of the propane class action settlement in 2010.

The other segment reported operating income of the $175,000 in 2011 compared to $513,000 in 2010. The decrease in operating results was attributable to lower operating income of $1 million from BravePoint, partially offset by the absence of $660,000 in merger related costs in 2011. For the fourth quarter of 2011, consolidated operating income increased by $1.3 million from $14.2 million to $15.5 million. $1.8 million in lower operating expenses, offset by a $523,000 reduction in gross margin, generated this quarterly increase in operating income. Consumption declined due primarily to 26% and 61% warmer temperatures on the Delmarva Peninsula and in Florida, respectively. The impact of customer growth, system expansions, the reversal of a regulatory reserve, and rate changes were overshadowed by the significantly warmer temperatures. The decrease in operating expenses for the fourth quarter resulted from lower sales and gross receipts tax accruals, the absence of costs incurred in conjunction with the propane class action litigation settlement in Florida, as well as the lack of merger related costs.

Capital expenditures for 2011 totaled $44.4 million. We have budgeted $88.5 million for capital expenditures to be invested in 2012. Historically, our actual capital expenditures lagged behind our budgeted CapEx. This amount includes $75.9 million for the regulated energy segment, $3.1 million for the unregulated energy segment, and $9.5 million for the other segment. In the last two years, our cash flow from operations has exceeded $50 million, which has funded a large portion of the capital investments we have made. We believe we have access to competitively priced capital to finance as necessary these expenditures on both an interim basis and over the long-term. We have multiple short-term line of credit facilities and have access to additional short-term capacity as needed. Additionally, we have routine ongoing discussions with third parties about long-term financing and believe that we can quickly and competitively access these markets as well.

Total interest expense for 2011 decreased by $146,000 compared to 2010. The decrease in interest expense is attributable primarily to a decrease of $651,000 in other long-term interest expense as scheduled repayments decrease the outstanding principal balance. Offsetting this decrease was additional interest expense of $505,000 related to the $29 million long-term debt issuance of 5.68% unsecured senior notes in June 2011 to permanently finance the redemption of two series of FPU's first mortgage bond.

In summary, Chesapeake reported another quarter and year of record financial results. We have a very strong track record in terms of growth in earnings per share over the last five years. We have successfully acquired, integrated and operated FPU. We have achieved these record results despite significantly warmer temperatures in 2011. We are well positioned for future growth based on the fundamentals of our operating segments, our unwavering financial discipline and our continued focus on operational excellence. Now, Mike and I would happy to answer your questions.

(Operator Instructions) Your first question comes from the line of Nancy Doyle with MetLife. Your line is open.

Yes, thank you, and congratulations on a good year in the face of some very bad weather headwinds. Just a question for you on the resignation of Joe Cummiskey at the Xeron. Can you get into the circumstances around that and who is taking Joe's place?

Yes. Joe is actually -- was located here in Dover. He had the propane distribution operations, he had the trading and also Peninsula Energy Services all reporting to the unregulated energy components. And Joe just simply, he resigned to pursue, I think in his words, other challenges. And there's nothing more to it than that. There really aren't any issues that we have. I think the Business has been performing well. We expect that it will continue to.

In terms of replacing Joe, we are going to go look on the outside. We look at our propane distribution business, Bob Zola is there. He has been with the Company 10 years as president of Sharp Energy. We're comfortable with Bob; Bob's done a very good job. At Xeron, the team in Houston has stayed the same. There's no impact on the team in Houston. Rick Garcia, the president of Xeron, will report directly to me as will Bob Zola and then Peninsula Energy Services on an interim basis, and Peninsula Energy Services Company with Bill Hancock in Florida will report to Steve Thompson on an interim basis as well. And then Steve is over our natural gas regulated operations and electric regulated operations.

Well, thank you for that.

You're welcome, Nancy.

(Operator Instructions) Your next question comes from the line of John Hanson with Praesidis. Your line is open.

Good morning. Just a couple of items here. What I'm trying to do is to see - you've gone through a lot of the pluses and minuses here in what's happened in '11 and how they continue into '12. And I guess the overall question that I will ask is, I know we've got the amortization coming up on that piece here from Florida. And let me ask, first question is, is it looks like the software Company now is kind of doing okay, and that should be a net -- hopefully a net plus for '12 over '11 from the way things are looking now.

Yes, we do think that. It's got -- it's obviously got some work to do. It's -- they're rolling the product out, they're getting some traction, but they just need to continue to keep that momentum moving forward.

And that's a plus there. And if I look back, it looks like the $5.2 million on weather, that was margin, you said, or was that revenue?

That was (technical difficulty)

That was margin, okay. So, that was a hit in 2011. So, as we go into 2012, we hope to start at zero, but it looks like Q1 is not helping us out there, right? I guess my question is, is all the puts and takes and all, it looks like 2012 we ought to be able to do better than we did in 2011, except it's going to be tough to absorb that amortization. Is there anything that you can give us for comfort around that?

I guess maybe the first thing -- from a cash flow perspective, obviously, the amortization is not a cash charge. So from, again, a cash flow perspective, that will not impact us. On an earnings perspective, it will impact us, and I would say that one -- that is a little bit of a cloud, a little bit of a challenge. And I think the weather, coupled with the weather is going to be another challenge for us. But I think the first two months of this year, the third warmest in the last 20. And so we've got a challenge there as well.

So, It's not -- we're not unlike -- we're not sitting here today unlike we were last year, I think. The first couple of months, the first quarter of last year, we were down relative to the prior year relative to '10. And so we're -- with the weather that we've had, I think we're in a similar situation this year. We're likely to be there again, but anyway. So, we're going to have to dig out of it from here forward, and I don't know how it's going to turn out. There's a lot of work to be done, that's for sure.

Oh, good. That is kind of where I thought things were. On the big pipe project that is for NRG, and that goes in service you said in '13. The question I have is -- significant CapEx on that this year, or is that mostly kind of going to be back end loaded?

That will be back end loaded. There could be some stuff in the fourth quarter, but it's not going to be as significant this year.

And did we accrue something like AFUDC during the process on that, or is it strictly a contract where we are going to be eating some interest expense during the period, or not?

No, we would be accruing AFUDC.

Perfect, thanks. All right, good. Thanks, guys.

There are no further questions at this time. I'll turn the call back over to Mr. Michael McManus (sic).

I think actually, Matt, you meant to turn the call back over to the Company. If there are no further calls, Mike and I appreciate everybody listening in on today's calls. And if you have any follow-up questions, feel free to give us a call, and we look forward to talking to you at the end of the first quarter. Thank you.

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