CHESAPEAKE UTILITIES CORP quarterly report, Q2 FY2015

Business Context and Reporting Period

Chesapeake Utilities Corporation filed this unaudited Form 10-Q for the quarter and six months ended June 30, 2015. The company operates regulated natural gas distribution, transmission and electric businesses, as well as unregulated propane, natural gas marketing and midstream operations. Results are seasonal, with earnings generally higher in the first and fourth quarters.

Effective April 1, 2015, Chesapeake acquired Gatherco, which was merged into wholly owned Aspire Energy of Ohio. The acquisition added natural gas gathering, processing and supply operations in Ohio.

Financial Performance and Key Metrics

Metric	Three Months Ended June 30, 2015	Three Months Ended June 30, 2014	Six Months Ended June 30, 2015	Six Months Ended June 30, 2014
Operating revenue	$92.7 million	$100.5 million	$262.8 million	$286.8 million
Gross margin	$51.3 million	$47.4 million	$129.0 million	$118.1 million
Operating income	$13.2 million	$10.5 million	$50.7 million	$42.1 million
Net income	$6.3 million	$5.1 million	$27.4 million	$22.8 million
Diluted EPS	$0.41	$0.35	$1.83	$1.57
Cash dividends declared per share	$0.288	$0.270	$0.558	$0.527

Gross margin increased approximately 8.2% in the second quarter and 9.2% year to date. Operating margin was approximately 14.2% in the quarter versus 10.4% in the prior-year quarter, and approximately 19.3% year to date versus 14.7% in the prior-year period. The filing presents gross margin as a non-GAAP measure calculated as operating revenue less cost of sales.

Regulated Energy operating income increased 27.0% in the quarter to $13.6 million and 12.5% year to date to $35.8 million.
Unregulated Energy reported a second-quarter operating loss of $0.5 million, compared with a $0.04 million loss in the prior-year quarter, but year-to-date operating income increased 35.8% to $14.7 million.
Income taxes were $4.2 million in the quarter and $18.3 million year to date. Effective tax rates were approximately 40.1% and 40.0%, respectively.

Cash Flow, Debt and Liquidity

Six-month operating cash flow was $87.8 million, up from $58.6 million in 2014.
Investing cash flow was negative $85.7 million, including $64.7 million of property, plant and equipment expenditures and $20.9 million of net acquisition spending.
Financing cash flow was negative $4.6 million, including $7.5 million of common dividends and $3.9 million of long-term debt and capital lease repayments.
Cash and cash equivalents declined to $2.1 million at June 30, 2015, from $4.6 million at December 31, 2014.
Short-term borrowings were $94.7 million, compared with $88.2 million at year-end, at a weighted-average rate of 1.08%. The company reported $210.0 million of bank credit facilities and a $50.0 million short-term revolving credit note.
Long-term debt, including current maturities, was $165.4 million; stockholders’ equity was $351.2 million. Total capitalization including short-term debt was $611.3 million, with equity representing 58%.
Management expects to increase borrowing during 2015 to supplement operating cash flow for forecast capital expenditures of $160 million to $190 million, excluding the Gatherco acquisition. Potential equity issuance timing will depend on market conditions.

Material Changes Versus the Prior Comparable Period

Revenue declined primarily because lower commodity prices reduced reported propane and natural gas marketing revenue, although associated cost of sales also declined.
Net income increased $1.2 million, or $0.06 per diluted share, in the quarter and $4.6 million, or $0.26 per diluted share, year to date.
A $1.5 million pretax settlement gain, or approximately $0.9 million after tax, related to a customer billing system implementation benefited 2015 results. Chesapeake had recorded a $6.5 million pretax impairment loss related to the system in 2014.
The Gatherco acquisition contributed $5.2 million of revenue and a $0.2 million net loss during the second quarter and six-month period. It contributed $1.6 million of gross margin and $1.9 million of operating expenses during the quarter and year to date.
The acquisition was funded with $27.5 million of cash and 592,970 Chesapeake shares valued at $30.2 million. The transaction also included $1.7 million of assumed debt, which was repaid at closing, and up to $15.0 million of contingent consideration.
Regulated Energy benefited from customer growth, Florida GRIP infrastructure recovery, Florida electric base-rate increases and new transmission services.
Year-to-date retail propane margins benefited materially from lower inventory costs and favorable supply management and hedging. Management stated that the unusually strong first-half propane margins are not typical and are excluded from long-term plans and forecasts.
Xeron’s year-to-date gross margin declined $1.0 million because of lower wholesale price volatility and a 31% decrease in trading activity.
Interest expense increased $0.2 million in the quarter and $0.5 million year to date, primarily because of $50.0 million of notes issued in May 2014.

Guidance, Outlook, Risks and Unusual Items

Management expects the Gatherco acquisition to be accretive in its first full year of operations, including the winter first quarter of 2016, but expects minimal 2015 EPS impact because the transaction closed after the key winter period.
2015 capital expenditures are forecast at $160 million to $190 million, down from the original $223.4 million budget primarily because certain spending shifted to 2016.
Key planned projects include the Eight Flags combined heat and power plant, with estimated investment of approximately $40 million and projected annual gross margin of $7.3 million, and the Kent County, Delaware pipeline expansion, with estimated cost of approximately $30 million and projected annual gross margin of at least $5.8 million. Both projects depend on construction, regulatory and other conditions.
Eastern Shore expects fourth-quarter 2015 FERC approvals for the White Oak Mainline Expansion and System Reliability projects, with estimated costs of $29.8 million and $32.1 million, respectively.
Environmental liabilities totaled approximately $10.1 million for FPU Florida manufactured-gas-plant sites and $0.4 million for Chesapeake sites. Potential West Palm Beach remediation costs were estimated at $4.5 million to $15.4 million.
FPU may face additional exposure at the Sanford, Florida site. FPU has paid its stated $650,000 participation amount, but the filing says it cannot determine whether other parties will pursue claims for amounts above that contribution.
The company had $32.0 million of corporate guarantees, several letters of credit, and $54.4 million of commodity and forward contract obligations at June 30, 2015.
Risks include weather, commodity prices, regulatory and rate decisions, environmental remediation, financing availability, integration of acquisitions, construction costs and timing, counterparty credit, pension obligations, cybersecurity and general economic conditions.
Disclosure controls and procedures were evaluated as effective at June 30, 2015, and no material change in internal control over financial reporting was reported.

Important Facts for Investors to Verify

Whether elevated first-half propane margins normalize and how that affects future earnings.
The final purchase-price allocation, contingent consideration and environmental exposure associated with Aspire Energy of Ohio.
Progress, cost, regulatory approvals and in-service dates for the Eight Flags CHP plant and Eastern Shore expansion projects.
How the planned capital program will affect borrowing, equity issuance, leverage and liquidity.
The outcome and recoverability through customer rates of environmental remediation costs, particularly at West Palm Beach, Sanford and Seaford.
The sustainability of regulated earnings growth from GRIP, customer additions, rate increases and new transmission services.
Exposure from commodity purchase commitments, propane hedges, wholesale trading positions, guarantees and letters of credit.