CHESAPEAKE UTILITIES CORP quarterly report, Q2 FY2013

Business Context and Reporting Period

Chesapeake Utilities Corporation filed this unaudited Form 10-Q for the quarter and six months ended June 30, 2013. The company operates regulated natural gas distribution, electric distribution and natural gas transmission businesses; unregulated natural gas marketing, propane distribution and propane wholesale marketing businesses; and an advanced information services business. Results are seasonal, with higher energy consumption and earnings typically occurring in the first and fourth quarters.

Financial Results and Key Metrics

Metric	Three Months 2013	Three Months 2012	Six Months 2013	Six Months 2012
Operating revenues	$94.1 million	$83.9 million	$234.9 million	$204.8 million
Operating income	$9.2 million	$10.5 million	$35.7 million	$30.5 million
Income before taxes	$7.2 million	$8.4 million	$31.9 million	$26.3 million
Net income	$4.4 million	$5.1 million	$19.2 million	$15.8 million
Diluted EPS	$0.45	$0.52	$1.99	$1.63
Dividends declared per share	$0.385	$0.365	$0.750	$0.710

Second-quarter revenue increased 12.2%, while operating income declined 12.5% and net income declined 13.9%. Six-month revenue increased 14.7%, operating income increased 17.0% and net income increased 21.8%. Total operating margin, calculated as operating income divided by revenue, was approximately 9.7% for the quarter and 15.2% for the first six months, compared with 12.5% and 14.9%, respectively, in the prior-year periods.

Regulated energy operating income was $8.6 million in the quarter, down $1.9 million, and $25.9 million year to date, up $0.6 million.
Unregulated energy operating income was $0.4 million in the quarter, compared with a $0.4 million loss, and $9.8 million year to date, up $5.1 million.
Six-month regulated energy gross margin, a non-GAAP measure, increased 6% to $73.1 million. Unregulated energy gross margin increased 37% to $25.3 million.
The effective income tax rate was 39.2% in the quarter and 39.8% year to date.

Cash Flow, Balance Sheet and Liquidity

Six-month cash provided by operating activities was $54.1 million, down from $60.8 million in 2012.
Capital expenditures were $41.2 million, compared with $34.4 million. Cash paid for acquisitions was $19.5 million.
Investing cash flow was negative $60.9 million, and financing cash flow was positive $5.7 million, primarily reflecting $15.5 million of net borrowing under credit lines.
Cash and cash equivalents were $2.2 million at June 30, 2013, compared with $3.4 million at December 31, 2012.
Total long-term debt, including current maturities and a $7.1 million capital lease obligation, was $115.7 million. Short-term borrowings were $75.5 million, up from $61.2 million at year-end.
Stockholders’ equity was $269.3 million, and total capitalization including short-term debt was $460.5 million.
The company had $125.0 million of unsecured bank lines, including $85.0 million of committed capacity, and was authorized to borrow up to $140.0 million from those lines.

Material Changes Versus the Prior Comparable Period

Six-month earnings benefited from more normal weather, with heating degree-days up 26% on the Delmarva Peninsula and 40% in Florida versus 2012. Management attributed approximately $3.7 million of additional gross margin to weather.
Natural gas customer growth and transmission expansions increased six-month gross margin by approximately $2.7 million. New short-term services to the NRG Dover plant and PBF Energy refinery generated $474,000 of second-quarter gross margin.
Retail propane margins benefited from lower wholesale propane costs, adding $1.2 million of second-quarter gross margin and $3.3 million for the first six months.
Xeron’s propane wholesale marketing margin declined by $770,000 in the quarter and $936,000 year to date because lower price volatility reduced trading activity and profitability.
Operating expenses increased due to higher incentive compensation, administrative costs, growth investments and expenses associated with new acquisitions.
Interest expense decreased 10% in both the quarter and six-month period, primarily from scheduled debt repayments and lower interest on customer deposits.

Guidance, Outlook, Commentary and Unusual Items

Management increased its 2013 capital expenditure projection from $112.3 million to $123.5 million, including approximately $16.5 million for the Eastern Shore Gas acquisition. Funding is expected from operating cash flow, short-term borrowings and other sources.
The May 2013 acquisition of Eastern Shore Gas operating assets added approximately 11,000 underground propane distribution customers and 500 bulk delivery customers. The transaction is expected to be accretive to earnings per share in the first full year of operations.
Management expects the NRG and PBF expansion facilities to be completed in late 2013. The NRG long-term service is expected to produce annual gross margin of $2.4 million to $2.8 million, while the PBF expansion is expected to produce approximately $1.6 million annually.
Additional contracted opportunities include approximately $840,000 of annual gross margin from a Florida utility service expected to begin in the third quarter of 2013 and $1.2 million to $1.8 million from a proposed Calpine Dover lateral, subject to regulatory approval and construction.
Second-quarter results included a $759,000 one-time sales tax expense related to the Eastern Shore Gas acquisition. Second-quarter 2012 included a $568,000 non-recurring accrued-revenue adjustment. Excluding these items, management stated that second-quarter 2013 net income would have increased by approximately $99,000.
The Delaware PSC was expected to decide by September 2013 on proposed natural gas expansion offerings. The Maryland PSC approved the Eastern Shore Gas acquisition and related rate framework, subject to future depreciation and rate-case filings.
The Marianna, Florida dispute was resolved: voters rejected the proposed municipal purchase of Florida Public Utilities’ facilities, the litigation was dismissed with prejudice, and the franchise was extended by 10 years.
Environmental liabilities were approximately $10.5 million at June 30, 2013, excluding potential unrecorded exposure for certain matters. Management expects environmental costs to be recoverable through rates or contributions from other responsible parties.

Principal Risks and Contingencies

Results depend on weather, customer consumption, commodity prices, propane margins, wholesale market volatility and competitive conditions.
Regulatory approvals and rate recovery remain important for capital projects, environmental costs, acquisition accounting and extraordinary litigation expenses.
The company had $31.1 million of corporate guarantees for subsidiary commodity purchases, plus letters of credit including $2.3 million for TETLP, $1.0 million for electric transmission services and $400,000 for insurance obligations.
Environmental matters include former manufactured gas plant sites. The company has not recorded a liability for potential sediment remediation at the Winter Haven site, where possible costs were estimated at up to $1.0 million and the outcome was not predictable.
Propane wholesale marketing activities carry commodity-price and counterparty risk. Outstanding Xeron forward contracts covered 2.1 million gallons of sales and 2.1 million gallons of purchases, with contracts expiring by the end of 2013.
Management identified risks related to financing availability, interest rates, pension funding, regulatory and legal outcomes, construction costs, acquisitions and integration, environmental laws and competition.

Investor Verification Checklist

Verify whether the planned $123.5 million 2013 capital program and related short-term borrowing remain consistent with operating cash generation.
Monitor completion, regulatory approval and contracted margins for the NRG, PBF Energy, Florida utility and Calpine expansion projects.
Assess the earnings contribution and integration costs of Eastern Shore Gas, Glades Gas and Austin Cox acquisitions.
Separate recurring operating performance from the $759,000 acquisition-related sales tax charge and the prior-year accrued-revenue adjustment.
Track propane wholesale volatility and retail margins, which materially affected period-over-period results.
Review environmental remediation estimates, rate-recovery proceedings, corporate guarantees and upcoming credit-facility maturities.