CHESAPEAKE UTILITIES CORP annual report, FY2013

Business Context and Reporting Period

Chesapeake Utilities Corporation filed its Form 10-K for the fiscal year ended December 31, 2013. The company is a diversified energy business operating primarily on the Delmarva Peninsula and in Florida. Its segments are Regulated Energy, Unregulated Energy, and Other. Regulated operations include natural gas distribution and transmission and electric distribution; unregulated operations include propane distribution and marketing, natural gas marketing, and related services.

The filing reports full-year results; fourth-quarter unaudited results are also presented. The company completed the acquisition of Eastern Shore Gas Company’s operating assets on May 31, 2013, adding approximately 11,000 underground propane-system customers through Sandpiper and approximately 500 bulk propane customers through Sharp.

Financial Performance and Key Metrics

Metric	2013	2012	Change
Operating revenue	$444.3 million	$392.5 million	13%
Operating income	$62.7 million	$56.6 million	11%
Net income	$32.8 million	$28.9 million	14%
Diluted EPS	$3.39	$2.99	$0.40 increase
Operating cash flow	$72.9 million	$66.6 million	9%
Capital expenditures	$108.0 million	$78.2 million	38%
Cash and cash equivalents	$3.4 million	$3.4 million	Approximately unchanged

Regulated Energy revenue was $264.6 million and operating income was $50.1 million, representing approximately 80% of consolidated operating income.
Unregulated Energy revenue was $166.7 million and operating income was $12.4 million, up 48% from 2012.
Other segment operating income declined to $297,000 from $1.3 million, primarily because BravePoint reported a $154,000 operating loss versus $828,000 of operating income in 2012.
Consolidated gross margin, calculated as revenue less cost of sales, was approximately $199.5 million, or 44.9% of revenue. Operating margin was approximately 14.1% and net margin was approximately 7.4%.
Return on average equity from continuing operations was 12.2%, compared with 11.6% in 2012.
Cash dividends declared increased to $1.52 per share from $1.44 per share. The company reported 53 consecutive years of cash dividend payments.

Liquidity, Debt, and Capital Resources

Operating cash flow of $72.9 million funded only part of $108.0 million of capital expenditures and acquisition spending. Investing cash outflow was $114.8 million.
Short-term borrowings increased to $105.7 million from $61.2 million at year-end 2012. The weighted-average interest rate on short-term borrowings was approximately 1.25% at year-end.
Long-term debt, including current maturities, was $128.9 million, compared with $110.1 million in 2012. Total capitalization including short-term borrowings was $513.4 million, of which 54.3% was common equity.
The company issued $20.0 million of 3.73% unsecured senior notes in December 2013 and planned to issue an additional $50.0 million of 3.88% senior notes in May 2014. Proceeds were intended to reduce short-term borrowings and fund capital expenditures.
At December 31, 2013, the company had $165.0 million of short-term credit facilities, with approximately $62.4 million available based on reported facility balances, subject to facility terms and bank discretion for uncommitted lines.
Management reported compliance with all debt covenants. Contractual obligations totaled approximately $612.1 million, including debt, leases, transmission capacity, storage, commodities, electric supply, and employee benefits.

Material Changes Versus the Prior Comparable Period

Revenue and earnings growth reflected the Sandpiper acquisition, service expansions, higher natural gas customer activity, stronger propane margins, and more normal Delmarva weather compared with unusually warm conditions in 2012.
Regulated Energy operating income increased $3.1 million, or 7%. Gross margin increased $11.0 million, partly offset by $7.9 million of higher operating expenses.
Unregulated Energy operating income increased $4.0 million, or 48%. Gross margin increased $9.5 million, driven by weather-related consumption, propane margins, and acquisitions, partly offset by a $1.1 million decline in propane wholesale marketing margins.
The Sandpiper acquisition contributed $4.4 million of 2013 gross margin and $3.1 million of other operating expenses. A $726,000 acquisition-related sales tax was expensed.
Delmarva heating degree-days increased to 4,638 from 3,936 in 2012 and exceeded the 10-year normal of 4,454. Management estimated that weather increased 2013 gross margin by $3.4 million versus 2012, but reduced gross margin by $767,000 versus normal weather.
Capital expenditures increased substantially because of acquisitions, natural gas distribution and transmission expansions, Florida infrastructure replacement, and electric-system reliability projects.
Interest expense declined $513,000 to $8.2 million, despite higher short-term borrowings, primarily due to scheduled long-term debt repayments and lower interest on customer deposits.

Guidance, Outlook, Commentary, Risks, and Unusual Items

The 2014 capital expenditure budget was $110.9 million, including $85.0 million for Regulated Energy, $15.7 million for Unregulated Energy, and $10.2 million for Other.
Management expected Sandpiper to generate approximately $9.8 million of annual gross margin in 2014 and expected $6.3 million of related operating expenses.
Eastern Shore expected long-term transmission services to generate approximately $4.3 million of annual gross margin. A proposed Kent County lateral was expected to begin service in January 2015 and generate approximately $1.2 million to $1.8 million of annual gross margin. A separate one-year 50,000 Dts/day contract was expected to generate $1.9 million of 2014 gross margin.
Management cautioned that the strong 2013 retail propane margins were not typical and were not included in long-term plans or forecasts.
Key risks include weather variability, propane and other commodity-price volatility, counterparty credit exposure, reliance on energy suppliers and pipeline capacity, regulatory rate recovery, environmental remediation, pension funding, interest rates, capital-market access, cybersecurity, competition, construction costs, and the ability to renew municipal franchises.
Environmental liabilities totaled approximately $10.7 million in the business overview, with specific financial statement disclosures reporting approximately $10.2 million related to FPU sites and $488,000 related to Chesapeake sites. Remediation costs are generally expected to be recoverable through rates, but certain sites and potential future costs remain uncertain.
The former Marianna, Florida franchise dispute was resolved: voters rejected the proposed municipal purchase of FPU’s facilities, the litigation was dismissed with prejudice, and FPU’s franchise was extended by ten years. The company recorded regulatory recovery for substantially all related litigation costs.
The company’s independent auditor issued an unqualified opinion on the financial statements and internal control over financial reporting. Management and the auditor concluded that internal controls were effective as of December 31, 2013.

Important Facts for Investors to Verify

Whether the $110.9 million 2014 capital program and the planned $50.0 million senior-note issuance were completed as expected.
The sustainability of 2013 propane margins and the earnings contribution from Sandpiper after a full year of operations.
Progress, customer commitments, costs, and regulatory approvals for Eastern Shore expansion projects, including the White Oak lateral.
Short-term borrowing levels, available credit capacity, debt covenant compliance, and refinancing of near-term maturities.
Regulatory treatment and recovery of environmental remediation, pension, acquisition, and litigation-related costs.
Weather-normalized demand trends, customer growth, and the effect of commodity prices on unregulated earnings.
Potential exposure under $31.1 million of corporate guarantees, pipeline capacity-release arrangements, letters of credit, and other supply commitments.