Chesapeake Utilities Corporation — 2018 Q2 Form 10-Q
Business context and reporting period
Chesapeake Utilities is a diversified energy company with regulated natural gas and electric distribution and transmission operations, plus unregulated natural gas services, propane delivery, energy generation and related services. The filing covers the three and six months ended June 30, 2018, with comparisons to the corresponding 2017 periods. Results are seasonal, with higher energy consumption and earnings generally occurring in the first and fourth quarters.
Financial performance and key metrics
| Metric | Three months ended June 30 | Six months ended June 30 |
|---|---|---|
| Operating revenue | $136.7 million, versus $125.1 million | $376.0 million, versus $310.2 million |
| Operating income | $13.2 million, versus $14.1 million | $53.7 million, versus $49.2 million |
| Income before taxes | $9.1 million, versus $10.0 million | $45.9 million, versus $41.6 million |
| Net income | $6.4 million, versus $6.0 million | $33.2 million, versus $25.2 million |
| Diluted EPS | $0.39, versus $0.37 | $2.03, versus $1.54 |
| Dividends declared per share | $0.3700, versus $0.3250 | $0.6950, versus $0.6300 |
- Second-quarter revenue increased approximately 9.2%, while net income increased approximately 5.6%. Six-month revenue increased approximately 21.2%, and net income increased approximately 32.0%.
- Six-month gross margin increased $14.0 million, or 9.7%, and operating income increased $4.5 million. Management reported that, excluding estimated TCJA-related customer refunds and reserves, six-month gross margin increased $19.4 million, or 13.4%, and operating income increased $9.9 million, or 20.2%.
- Second-quarter operating income declined $0.8 million despite a $6.9 million increase in gross margin, primarily because of higher operating costs, depreciation, property taxes and other expenses.
- Regulated Energy operating income was $14.3 million in the second quarter and $41.0 million for the first six months, compared with $14.1 million and $37.5 million, respectively, in 2017.
- Unregulated Energy operating income was $0.5 million in the second quarter and $14.2 million for the first six months, compared with approximately breakeven and $11.6 million, respectively, in 2017. PESCO had a six-month operating loss of $76,000 after higher infrastructure, staffing and risk-management costs and unusual margin items.
- Effective income tax rates decreased to 29.9% from 39.5% in the second quarter and to 27.6% from 39.5% for the first six months, primarily because of the Tax Cuts and Jobs Act.
- At June 30, 2018, total assets were $1.46 billion and stockholders’ equity was $508.0 million. Cash and cash equivalents were $4.5 million, compared with $5.6 million at December 31, 2017.
Cash flow, debt and liquidity
- For the first six months, operating cash flow was $108.4 million, compared with $96.4 million in 2017. Investing cash flow was negative $126.7 million, principally due to $126.8 million of capital expenditures.
- Financing activities provided $17.2 million, compared with cash used of $9.6 million in the prior-year period. Ending cash decreased $1.1 million to $4.5 million.
- Capital expenditures were $134.7 million through June 30. Management increased its projected 2018 capital expenditures from an original $181.6 million budget to approximately $216.4 million, including $185.3 million for Regulated Energy.
- Short-term borrowings were $235.3 million at a weighted-average interest rate of 2.98%, compared with $251.0 million at December 31, 2017. The company had $220.0 million of unsecured bank credit facilities and a $150.0 million Revolver available through October 2020.
- Long-term debt, including current maturities, was $251.6 million, compared with $206.8 million at year-end. The increase included issuance of $50.0 million of 3.48% Series A notes in May 2018. A further $50.0 million of Series B notes was scheduled to be issued on or before November 20, 2018.
- Additional potential borrowing capacity under the Prudential and MetLife shelf agreements was $230.0 million at June 30, 2018; the NYL shelf agreement was fully utilized.
Material changes versus the prior comparable period
- Growth reflected Eastern Shore settled rates, natural gas customer and consumption growth, service expansions, more favorable weather, Florida reliability and modernization rates, Florida GRIP investment recovery, and growth in propane operations.
- The 2017 Eastern Shore system expansion had an estimated cost of $117.0 million. Chesapeake had invested $89.6 million through June 30, 2018, with remaining facilities expected to enter service during the second half of 2018.
- The Northwest Florida expansion entered service in May 2018 and generated approximately $0.9 million of incremental gross margin during the quarter and first half; expected annual gross margin is approximately $6.5 million.
- PESCO’s results included nonrecurring margin benefits in the second quarter but adverse items in the first quarter, including unusual costs from the January 2018 Bomb Cyclone, pipeline capacity constraints and warm February weather.
- Operating expenses increased because of additional staffing, infrastructure and risk-management investment, facilities maintenance, incentive compensation, depreciation and property taxes. Second-quarter 2018 also included $1.5 million of pre-tax separation expenses related to a former executive.
- The company adopted ASC 606 on January 1, 2018. The adoption reduced first-half net income by approximately $145,000 and reduced retained earnings by approximately $1.6 million at June 30, 2018. Management expects no material ongoing impact on net income.
- Quarterly dividends declared increased to $0.37 per share from $0.325 per share.
Guidance, outlook, risks and unusual items
- Management did not provide formal earnings guidance in the filing. It projected approximately $216.4 million of 2018 capital expenditures and estimated 2018 gross margin from listed projects and initiatives of $39.3 million, increasing to $50.6 million in 2019.
- TCJA-related rate reductions, refunds and reserves reduced regulated gross margin by approximately $2.3 million in the second quarter and $5.4 million in the first six months. The company stated that the reductions were generally offset by lower federal income taxes and were not expected to materially affect regulated after-tax earnings.
- Regulatory matters include pending Delaware approval concerning conversion of Consumer Gas Cooperative propane assets to natural gas, Florida recovery of hurricane-related electric restoration costs, and ongoing proceedings concerning the effect of the TCJA on rates.
- Environmental liabilities related to former manufactured gas plant sites were approximately $9.5 million at June 30, 2018. Estimated West Palm Beach cleanup costs ranged from $4.5 million to $15.4 million; Cambridge, Maryland costs could not be estimated.
- Corporate guarantees, primarily for PESCO commodity purchases, totaled approximately $72.5 million and expire on various dates through June 2019. Letters of credit totaled approximately $5.0 million, with no draws reported.
- Commodity, weather, interest-rate, counterparty credit, regulatory, environmental, construction, cybersecurity and financing risks remain material. The company also noted exposure to hurricane and other severe-weather events and to PESCO trading and risk-management activities.
- FPU was in compliance with the financial requirements of its electric fuel supply contracts at June 30, 2018.
Most important facts for investors to verify
- Whether the planned $216.4 million 2018 capital program and Eastern Shore expansion remain on schedule and within cost estimates.
- The timing and final treatment of TCJA-related rate reductions, refunds and regulatory liabilities across Delaware, Maryland, Florida and FERC-regulated operations.
- Whether PESCO’s operating performance improves after the 2018 unusual costs and increased investments in staffing, infrastructure and risk controls.
- The company’s ability to fund capital expenditures while maintaining short-term borrowing capacity, complying with debt covenants and issuing the scheduled Series B notes.
- Actual weather, customer growth and commodity-price results, particularly because reported earnings and margins are seasonal and weather-sensitive.
- The ultimate cost and recoverability of environmental remediation liabilities and the outcome of pending regulatory and storm-recovery proceedings.