CHESAPEAKE UTILITIES CORP annual report, FY2015

Chesapeake Utilities Corporation — FY2015 Form 10-K Summary

Business context and reporting period

Chesapeake Utilities Corporation is a diversified energy company operating primarily in Delaware, Maryland, Florida, Pennsylvania and Ohio. Its businesses are organized into Regulated Energy, including natural gas distribution and transmission and electric distribution, and Unregulated Energy, including propane distribution and marketing, natural gas marketing, and Ohio gathering, processing and supply services. The filing covers the fiscal year ended December 31, 2015; quarterly data identifies the fourth quarter as the period ended December 31, 2015.

The company completed the Gatherco acquisition on April 1, 2015, with the acquired Ohio operations conducted through Aspire Energy. The company had 832 employees and 15.27 million common shares outstanding at year-end.

Financial performance and key metrics

Metric	2015	2014	Change
Operating revenue	$459.2 million	$498.8 million	(7.9%)
Operating income	$77.8 million	$62.3 million	+$15.5 million
Net income	$41.1 million	$36.1 million	+$5.0 million
Diluted EPS	$2.72	$2.47	+$0.25
Operating cash flow	$105.1 million	$79.3 million	+$25.8 million
Capital expenditures, excluding acquisition	$142.7 million	$98.1 million	+$44.7 million
Capital expenditures including acquisitions	$195.2 million	$98.1 million	+$97.1 million

Regulated Energy revenue was $301.9 million and operating income was $61.0 million, compared with $50.5 million of operating income in 2014. Unregulated Energy revenue declined to $162.1 million from $185.0 million, while operating income increased to $16.4 million from $11.7 million.

Consolidated gross margin increased to $239.4 million from $213.8 million, based on segment gross margins of $179.1 million for Regulated Energy and $60.3 million for Unregulated Energy. The filing does not present a single consolidated GAAP operating margin, but operating income represented approximately 16.9% of revenue in 2015 versus approximately 12.5% in 2014.

Income before taxes was $68.0 million, interest expense was $10.0 million and income tax expense was $26.9 million. The effective tax rate was 39.5%, compared with 39.9% in 2014. Cash dividends declared totaled $1.1325 per share, and the company reported 55 consecutive years of cash dividend payments.

Liquidity, debt and capital resources

Cash and cash equivalents were $2.9 million at December 31, 2015, compared with $4.6 million at year-end 2014.
Short-term borrowings increased to $173.4 million from $88.2 million, including $35.0 million drawn under a new five-year $150.0 million revolving credit facility.
Long-term debt, including current maturities, was $158.5 million; long-term debt net of current maturities was $149.3 million.
Total capitalization including short-term borrowings was $690.0 million, with stockholders’ equity of $358.1 million, or 51.9% of total capitalization.
The company entered into a $150.0 million private Shelf Agreement for potential fixed-rate senior notes over three years. The filing states that the purchasers are not obligated to buy the notes.
Net cash used in investing activities was $165.6 million, primarily reflecting capital expenditures, the Gatherco acquisition and environmental expenditures. Financing activities provided $58.7 million.
The company reported compliance with its debt covenants. Revolving credit facilities require, among other conditions, a funded indebtedness ratio no greater than 65% and fixed-charge coverage of at least 1.20 times.

Material changes versus the prior comparable period

Net income increased 14.0%, and diluted EPS increased 10.1%, despite lower revenue.
Regulated Energy operating income rose $10.5 million, driven by service expansions, Florida GRIP infrastructure recovery, customer growth and the Florida electric rate increase.
Unregulated Energy operating income rose $4.6 million, primarily from stronger retail propane margins and the contribution from Aspire Energy.
2015 benefited from the absence of 2014 impairment charges totaling approximately $6.9 million and from a $1.5 million gain related to a customer billing-system settlement.
The company recorded no business-sale gains in 2015; 2014 included approximately $7.1 million of gains, principally from the sale of BravePoint.
Warmer weather reduced 2015 gross margin by approximately $4.4 million compared with 2014. Delmarva and Florida heating degree-days were below normal.
Capital investment increased materially, including $32.8 million of Florida GRIP investment, $24.7 million related to the Eight Flags combined heat and power project, and the $52.5 million net Gatherco acquisition.
Shares issued in the Gatherco acquisition increased common shares outstanding by 592,970 shares and contributed to the increase in equity.

Guidance, outlook, management commentary and unusual items

Management’s strategy is to grow earnings from a regulated utility foundation while expanding related unregulated businesses. The 2016 capital expenditure budget is $179.3 million, including $147.8 million for Regulated Energy and $24.6 million for Unregulated Energy. Management expects to use operating cash flow, short-term borrowings and potentially long-term debt or equity to fund the program; it cautions that the equity ratio may temporarily decline as projects are financed.

Management estimated 2016 gross margin from existing major projects and initiatives at $37.3 million and from future projects at $7.2 million, for total estimated project gross margin of $44.5 million.
Key projects include the White Oak Mainline Expansion, the Eastern Shore System Reliability Project, the TETLP capacity expansion and the Eight Flags combined heat and power plant.
Annualized gross margin estimates for these projects total approximately $20.4 million once fully operational, based on current tariff or negotiated rates.
Aspire Energy generated $6.3 million of gross margin and $16.7 million of revenue from April 1 through December 31, 2015, but contributed only $312,000 of net income. Management expected the acquisition to be accretive in its first full year, including the first quarter of 2016.
Management stated that 2015 retail propane margins were unusually favorable and were not included in long-term plans or forecasts.
Delaware and Sandpiper filed base-rate cases in December 2015. The Delaware application sought a $4.7 million increase, and Sandpiper sought a $950,000 increase. Decisions were expected in the third and second quarters of 2016, respectively.
Environmental liabilities associated with former manufactured gas plant sites totaled approximately $10.6 million. The West Palm Beach remediation estimate ranged from $4.5 million to $15.4 million.
The company had $45.6 million of corporate guarantees for subsidiary supplier obligations and $5.6 million of letters of credit at year-end. No letters of credit had been drawn.

Principal risks

Regulatory approval, rate recovery and potential changes to state, federal or FERC regulation.
Weather-driven volatility in natural gas, propane and electricity demand.
Commodity-price volatility, derivative valuation, inventory risk and counterparty credit risk in unregulated businesses.
Large capital requirements, construction delays, cost overruns and dependence on access to debt and equity markets.
Interest-rate exposure and the risk of covenant breaches or higher refinancing costs.
Environmental remediation costs and uncertainty regarding the timing and extent of regulatory recovery.
Pipeline, electric and propane supply interruptions; operational accidents; severe weather; terrorism; and cybersecurity events.
Execution and integration risk associated with Aspire Energy and other growth projects.
Unfunded pension and postretirement obligations, which may require additional contributions if asset returns or discount rates deteriorate.

Most important facts for investors to verify

Whether 2015 earnings growth remains after excluding the $1.5 million billing-system settlement, the absence of 2014 impairment charges and unusually favorable propane margins.
The timing, cost and regulatory authorization of the White Oak, System Reliability, TETLP and Eight Flags projects, and whether projected margins are achieved.
Progress on Delaware and Sandpiper rate cases, Florida GRIP recovery and the Eastern Shore 2017 rate proceeding.
Whether increased short-term borrowing is refinanced with long-term debt or equity without materially weakening capitalization or increasing interest expense.
Aspire Energy’s full-year contribution and integration results after inclusion of the winter heating season.
The ultimate cost and recoverability of former manufactured gas plant remediation, particularly the West Palm Beach and Sanford matters.
Exposure under supplier guarantees, capacity-release arrangements, purchase commitments and other contractual obligations totaling approximately $507.4 million.
The effect of warmer or colder weather, propane margins, commodity prices and customer consumption on future results.

The consolidated financial statements received an unqualified audit opinion, and management and the independent auditors concluded that internal control over financial reporting was effective as of December 31, 2015, although Aspire Energy’s non-integrated operations were excluded from management’s 2015 assessment.