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Chesapeake Utilities Corp. (NYSE: CPK ) Q2 2015 Earnings Conference Call August 7, 2015 10:30 ET Executives Mike McMasters – President and Chief Executive Officer Beth Cooper – Senior Vice President and Chief Financial Officer Analysts Michael Gaugler – Janney Montgomery Roger Liddell – Clear Harbor Asset Management John Hanson – Praesidis Operator Good morning. My name is Mariana and I will be your conference operator today. At this time, I would like to welcome everyone to the Chesapeake Utilities Second Quarter Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks, there will be a question-and-answer session. [Operator Instructions] Thank you. Senior Vice President and Chief Financial Officer, Beth Cooper, you may begin your conference. Beth Cooper Thank you and good morning, everyone. We appreciate you joining us this morning to review our second quarter and year-to-date 2015 results. Joining me on the call today with prepared remarks is Mike McMasters, President and CEO. We also have several additional members of our management team here with us today to answer questions following prepared remarks. The presentation to accompany our discussion today can be accessed on our website at www.chpk.com under the Investor section and Events and Webcast subsection or via our IR app. Moving to Slide 2, before we begin, let me remind you that matters discussed in this conference call may include forward-looking statements that involve risks and uncertainties. Forward-looking statements and projections could differ materially from our actual results. The Safe Harbor for forward-looking statements section of the company’s 2014 Annual Report on Form 10-K, provides further information on the factors that could cause such statements to differ from our actual results. Finally, please note that earnings per share data, is shown on a fully diluted basis and reflects the company’s 3-for-2 stock split effective September 8, 2014. While second quarter results are typically lower due to the seasonality of our regulated and unregulated energy business segments, we are pleased to report quarter-over-quarter increases in net income and earnings per share driven by continued strong growth in our regulated energy distribution and natural gas transmission businesses. We also continue to execute on our strategic growth plans. On April 1, we closed on the acquisition of Gatherco. During the quarter, we made significant progress in our integration of Gatherco, which we have re-branded as Aspire Energy of Ohio. We are also continuing to develop and cultivate profitable growth opportunities in our natural gas and propane businesses across Delmarva and in Florida. Our Florida Gas Reliability Infrastructure Program, or GRIP, as we commonly refer to it, is generating increased earnings as we make natural gas infrastructure investments to further enhance the safety and reliability for our systems. Finally, the outcome of the Florida electric base rate case supplemented our earnings for the quarter. As shown on Slide 3, on Thursday, we announced second quarter 2015 net income of $6.3 million, or $0.41 per share, an increase of $1.2 million, or $0.06 per share compared to the same quarter in 2014. Second quarter 2015 results reflect the continued successful execution of our strategy to generate profitable growth from service expansions, acquisitions, major projects, continued investment in the GRIP program and the electric rate case in Florida. The growth in our Regulated Energy segment generated increased operating income that offset the weather-sensitive unregulated energy businesses. The second quarter’s results also included $900,000 after-tax gain or $0.06 per share from a settlement with a vendor related to a customer billing system implementation. As we look out over the rest of the year, we believe we are well-positioned to build on our successful track record given the Gatherco acquisition, several major projects currently in progress, and other key strategic actions we are undertaking. Mike will elaborate on these later in the call. I will now highlight the accomplishments and results for the two business segments during the second quarter. Detailed discussions of the changes in gross margin and other operating expenses by business segment for the quarter and six months ended June 30, 2015 are provided in our press release and quarterly report on Form 10-Q, both of which were filed on Thursday. Turning to Slide 4, Chesapeake’s Regulated Energy businesses, which include our natural gas transmission and distribution and electric distribution operations generated operating income of $13.6 million in the second quarter of 2015 compared to $10.7 million for the same quarter in 2014. The increase in Regulated Energy operating income reflected $4 million in additional gross margin from customer growth, the GRIP service expansions and the electric rate case. Other operating expenses increased by $1.1 million, which included a $1.5 million credit offset to expenses associated with the settlement for billing system implementation, which was mentioned earlier. Absent the offset, other operating expenses increased by $2.6 million. The increase in other operating expenses reflected higher payroll costs to support growth and as a result of increased quarterly results, other transaction cost, costs associated with system integrity and facility improvements as well as depreciation and other related costs because of increased investments. As shown on Slide 5, the Unregulated Energy segment reported a second quarter 2015 operating loss of $540,000 compared to an operating loss of $43,000 for the same period in 2014. A $2.1 million increase in gross margin for this segment was offset by a $2.6 million increase in other operating expenses. The Unregulated Energy segment has typically reported an operating loss or very modest earnings during the second quarter due to the seasonal nature of the propane distribution operations. Slide 6 highlights the key variances between second quarter net income and earnings per share results for 2015 and 2014. As mentioned earlier, earnings per share was $0.41, an increase of $0.06, or 17% quarter-over-quarter. First, there were several unusual items that in total resulted in a $0.05 increase in 2015 second quarter earnings per share. As previously mentioned, a settlement with a vendor on the implementation of a customer billing system contributed $0.06 per share. Also of a non-recurring nature, the sale of our Florida fuel line maintenance contracts to third-party during the second quarter of 2014 offset by the absence of BravePoint, which was sold in 2014 resulted in $0.01 lower earnings per share in the second quarter of 2015. In our Regulated Energy segment, increased gross margin of $0.17 per share was generated from the key growth drivers previously highlighted. In the Unregulated Energy segment, margins generated by Aspire Energy of Ohio, as well as higher retail propane margins accounted for an increase of $0.10 per share. The expenses associated with operating Aspire Energy of Ohio as well as higher operating expenses largely driven by our continued growth, increased transaction cost as well as cost associated with system integrity and facility improvements offset this additional gross margin by $0.19 per share. Finally, interest and other net changes reduced quarter-over-quarter earnings per share by $0.06, including a $0.02 per share impact of dilution from the issuance of shares for Gatherco. Slide 7 highlights the financial results for the first six months of 2015 and 2014. We are pleased to report that the first six months have been very strong. The company reported diluted earnings per share of $1.83 for the first six months of 2015, up $0.26 or 17% over the same period in 2014. Increased operating income from the Regulated and Unregulated Energy segments contributed almost equally to the higher earnings for the first six months, which was supplemented by the absence of an operating loss in 2015 from BravePoint. Slide 8 highlights the key variances in terms of net income and earnings per share contribution between the results for the first six months of 2015 and 2014. Unusual items resulted in an $0.08 increase in earnings per share for the first six months of 2015. In our Regulated Energy segment increased gross margin of $0.34 per share was generated from natural gas customer growth, service expansions in the natural gas transmission businesses, the GRIP program in Florida and the electric rate case. In the Unregulated Energy segment, margins generated by Aspire Energy of Ohio, higher retail propane margins, and increased customer consumption which were partially offset by lower wholesale propane volatility opportunities for Xeron accounted for an increase of $0.28 per share. Higher operating expenses associated with the addition of Aspire Energy of Ohio, the cost of serving growth and expansions as well as increased results year-to-date, other transaction costs and system reliability and facility improvement costs partially offset this additional gross margin by $0.34 per share. Interest charges and other changes reduced year-to-date earnings per share by $0.10, including a $0.04 per share impact of dilution from the issuance of shares for Gatherco. Slide 9 highlights the company’s commitment to maintaining a strong balance sheet, which should facilitate access to competitively priced capital to fund our growth initiatives. Our equity to permanent capitalization was 69.2% and equity to total capitalization was 57.5% at the end of June 2015. We target to maintain a ratio of equity to total capitalization of 50% to 60% and will access longer term capital as necessary to meet our financing needs. Our financial success has been a result of our ability to identify significant opportunities to invest in growth, while maintaining our disciplined capital allocation process. We set targets for new investments and pursue profitable growth opportunities that meet our investment objectives, while achieving target returns. The level and impact of the capital investments we have made has continued to fall through the earnings and dividend growth and ultimately the shareholder return that have consistently set us apart over the last eight years. The current forecast for 2015 capital expenditures is $160 million to $190 million as shown on Slide 10. This does not include the $52.5 million acquisition of Gatherco, net of the cash acquired in the transaction. The current forecast is less than our original budget of $223 million. The change in our forecast represents a shift in the timing of the spending on some items from 2015 to 2016 and does not reflect a reduction in our planned investments for future growth. Of the forecasted expenditures for 2015, $115 million to $145 million are expected to be invested in our regulated energy operations. In terms of the large projects, we have previously disclosed the associated 2015 capital expenditures include $27.7 million for the Eight Flags combined heat and power plant and related facilities; $12.7 million for the Calpine mainline expansion; and our projected spend of approximately $29 million for GRIP. Our team works closely with our customers to develop and deliver customized solutions that fulfill their energy needs and also achieve the financial objectives of both parties. The projects we are undertaking today are much more diverse and larger in terms of their magnitude. In addition, it is important to note that there is a lag between the finalization of a budget estimate for a project and inclusion in our capital budget when we are positioned to announce the project and then ultimately when it is placed into service. The permitting and regulatory processes have become much longer and have expanded the overall timeline of the projects. As we have mentioned previously, we have historically spent 82% to 88% of the original capital budget that we announced at the beginning of the respective years. We are committed to making future investments in our businesses in a disciplined manner that represents valued, customized energy solutions for our customers at attractive returns for our shareholders. Now, I will turn the call over to Mike. Mike McMasters Thank you, Beth. Good morning, everyone. As we have previously discussed, we update our strategic plan every year. We ask our business unit leaders to engage our employees to figure out ways to go at rates faster than they could if they simply continued to do what they are doing today. As reflected on Slide 11, we are continuing to the implementation of our aggressive growth strategy. This slide summarizes the largest projects and acquisitions that are contributing to our growth in 2015. The recent Gatherco acquisition, now Aspire Energy, contributed approximately $1.6 million in margin during the second quarter, as expected to contribute approximately $8.8 million in 2015. The expansions to provide new services to transmission customers in New Castle and Kent Counties, Delaware and Polk County, Florida added $919,000 in gross margin during the second quarter of 2015 and $2.4 million of gross margin during the first six months of 2015. For the full year of 2015, these expansions are expected to generate gross margin of $5.3 million, an excess of the margins that they generated last year. We expect to spend about $29 million on the GRIP safety program during 2015. The increase in margin contribution from the GRIP program for the second quarter and first six months of 2015 were $1.1 million and $1.8 million, respectively. Turning to Slide 12, on April 1, 2015 we completed the acquisition of Gatherco and merged the company into our newly formed subsidiary, Aspire Energy of Ohio, LLC. The enterprise value net of cash acquired was $52.8 million. Aspire operates 16 gathering systems and over 2,400 miles of pipeline in the areas in and around the Utica Shale in Eastern and Central Ohio. The company serves more than 300 producers with gathering and liquids processing services and also delivers natural gas to two local distribution companies that serve approximately 30,000 customers. We believe that there are significant growth opportunities period to add both production and distribution customers to the system. Aspire also owns variable rights of way that could present additional opportunities for growth as shale development continues in Ohio. We are making good progress in the integration of Gatherco into the Chesapeake family. As we indicated, we announced the transaction we have rebranded Gatherco as Aspire Energy. We recently announced that Doug Ward joined our team as Business Unit Leader and Vice President of Aspire Energy. Doug has 25 years of leadership experience in the natural gas industry. We have moved some administrative functions to Chesapeake’s headquarters and have began the implementation of our safety, environmental compliance and other programs. We have completed the management transition and have been successful in our employee and customer retention efforts and are in the process of filling the positions to support our growth plans for this business. We believe that Aspire Energy of Ohio will be accretive to earnings in its first full year of operations. Approximately 92% of the margins from natural gas services to producers and deliveries to the commercial and residential markets, which are tracking as expected. As anticipated, the current reduction in natural gas versus natural gas liquids spread has reduced margins for processing. Approximately 8% of the margin is from two processing facilities on the system. As a part of Chesapeake, Aspire Energy now has the resources to accelerate their growth in accordance with our strategic plan. We expect growth to come from additional sales to local distribution companies that we serve and additional gathering systems – gathering services to producers. Turning to Slide 13, in November of last year, we implemented a $3.8 million rate increase in our Florida electric distribution system. This increase generated $731,000 and $1.5 million in additional margin during the second quarter and first six months of 2015, respectively. We are also in the process of preparing a rate case for our Sandpiper Energy operation in Maryland. This filing is required to support the original rates that the Maryland PSC approved and we filed for approval of the acquisition and our original tariff. Finally, as a part of a settlement in Eastern Shore Natural Gas Company’s most recent rate increase, we are required to file a rate case with the FERC that will establish new rates effective February 1, 2017. Slide 14 summarizes two large projects that are currently under construction that are expected to be completed and contribute to earnings in 2016 and Eastern Shore’s system reliability project proposal filed with the FERC this year. In total, the two projects under development are expected to produce approximately $13.1 million in gross margin annually. In addition, at these projects we are continuing to work with our customers to develop projects and services that are responsive to their needs that are also expected to generate growth. Slide 15 describes in further detail the pipeline expansion to serve Calpine Energy Services’ Garrison Energy Center power plan. The project currently under construction will generate significant additional margins beginning in 2016. Eastern Shore Natural Gas will invest approximately $30 million to build facilities to serve Calpine Energy’s Garrison Energy Center in Kent County. Eastern Shore provided Calpine with firm service during the non-heating months from May to October and provided interruptible service from November to April. This project is expected to go into service during the first half of 2016 and should provide an additional $5.8 million of annual margins. Turning to Slide 16, as a part of our ongoing efforts to maintain the quality of our service to our customers, we continuously monitor our systems to ensure that they are operating as designed or expected. During the polar vortex, in the first quarter of 2014 we experience sort of challenges. Accordingly, we reevaluated or system and concluded that we should invest in more facilities to maintain the reliability of our system and provide more operating flexibility to address future unforeseen circumstances. The project is estimated to cost $32.1 million and involves the installation of one compressor and 10.1 miles of 16-inch pipeline. The Federal Energy Regulatory Commission or FERC has accepted and publicly noticed Eastern Shore application. Eastern Shore has requested FERC issue an order granting the certificate for the project by December 2015. The targeted in-service date for this project is the third quarter of 2016. Slide 17 describes in further detail the second major project under construction, Eight Flags Energy. Eight Flags Energy is constructing a combined heat and power plant that will be located on Amelia Island, Florida at the Rayonier Advanced Materials paper mill. The plant will have 19 megawatts – 20 megawatts of generation capacity and all electricity generated will be sold to our electric distribution system in Florida. Steam from the plant will be sold to Rayonier Advanced Materials and a contract for these sales has been executed. The combined heat and power plant and the related facilities will cost approximately $40 million to construct. Site construction has started on July 13, 2015. In addition to generating approximately $7.3 million in incremental annual gross margin, the electric output from the plant is expected to reduce our purchased electric costs thus saving our electric customers approximately $3 million to $4 million annually. The project is expected to be online in the third quarter of 2016. Turning to Slide 18, the environmental and economic advantages of natural gas continued to provide opportunities for the expansion of its use in our service territory and across the United States. Natural gas is an abundant, clean and affordable fuel and the significant reserves that we have here in the United States continued to provide security of supply and price. This is reflected in the comparison of energy prices on the Slide 18. As indicated, even with the falling price of oil last year, natural gas still enjoys a price advantage compared to oil and is expected to maintain this advantage for the foreseeable future. This natural gas price advantage coupled with our other competitive advantages creates the opportunities for continued growth. Turning to Slide 19, we see attractive opportunities for growth across our energy businesses. As in the past, we will continue to look for profitable opportunities in natural gas distribution and transmission businesses. As a result of past expansions, we continued to be positioned to provide service to many new customers where service was not previously available. To maximize this opportunity, we have implemented conversion programs to make it easy for these customers to convert to natural gas. As evidenced by the development of our Eight Flags’ CHP plant, we are also looking to provide new services to our existing customers. Finally, we expect to generate additional margins for initiatives such as the GRIP program, providing natural gas service to power generators and other applications for natural gas. In the unregulated business we will continue to pursue profitable opportunities both inside and outside of our current footprint. Increased housing activity will generate growth in our community gas system and startups initiatives. In the vehicular fuel market, we currently operate five public and six private propane fueling stations. We are currently negotiating with a number of companies and organizations to provide this service and expand our market in Florida, Maryland, Pennsylvania and Delaware. While this initiative is relatively small today, it is an example of a strategy that could supplement our growth down the road. Additionally, combined heat and power projects, compressed natural gas and midstream opportunities all represent potential avenues to supplement growth in this segment. Turning to Slide 20, we believe that the key to our success has been and will continue to be our ability to identify and develop opportunities to invest significant amounts of capital at returns to justify investment. As the chart on Slide 20 shows Chesapeake ranks near the top of 43 gas distribution, electric and combination companies in terms of capital invested and return on capital over the past 3 years. Our ability to achieve higher than industry average returns while investing higher than industry average levels of capital relative to our size is the cornerstone of our strong financial results. Slide 21 shows our continuous dividend growth. On May 6, 2015, the Board of Directors increased the company’s annualized dividend by $0.07 or 6.5%. Compound annual growth in the dividend over the past 5 years has been 5.5% and has been supported by earnings growth, as evidenced by an average payout ratio of 46% over the 5 years ended 2014. We understand how important dividends are to investors, particularly given the expectations for broad total market returns. We also believe that superior earnings and dividend growth will enhance shareholder value going forward. We are committed to dividend growth supported by earnings growth and believe that with the growth potential in and outside our service territories and our low payout, we are well-positioned to provide superior dividend growth in the future. As the shareholder return chart on Slide 22 shows, Chesapeake has produced top quartile total return to shareholders for the FERC 1, 3, 5, 10 and 20 years ended June 30, 2015. For each of the five periods shown said, Chesapeake shareholders have earned more than 14% returns on a compound annual basis. Slide 23 shows our financial performance over the past 1, 3 and 5 years. I am proud to say that our employees have delivered top quartile performance in 18 out of 20 categories. Further, our 10 year and 20 year compound annual total shareholder returns are 14% and 14.4% respectively, ranked the first amongst our peers. We will work hard to sustain our performance and track record going forward. Turning to slide 24, as we have said before our success starts with engaged, dedicated and capable employees that construct and operate safe, reliable energy delivery systems whether they are pipelines, wires or trucks. Our employees take care of our customers and the communities we serve. They also do a remarkable job of identifying, developing and transforming growth opportunities in a disciplined manner. We manage regulation to produce the free returns to shareholders. Our employees drive for growth, their determination and consistent performance enables us to deliver clean, reliable, low cost energy solutions to our customers, generate returns on capital that are above peer group medians and as a result access the capital necessary to sustain our growth. We will now be happy to take questions. Thank you. Question-and-Answer Session Operator [Operator Instructions] Your first question comes from the line of Michael Gaugler from Janney Montgomery. Your line is open. Michael Gaugler Good morning everyone. Mike McMasters Good morning Mike, how are you doing? Beth Cooper Good morning. Michael Gaugler Just one question Mike, on the White Oak mainline expansion project, the 7 miles or so, 16-inch pipe that’s going to loop in Chester County, does that actually in Chester County open up any other opportunities for further service expansions in the region perhaps maybe a little more in Pennsylvania versus Delaware or both? Mike McMasters Well, I guess every time – generically, I guess, Mike, every time we extend a pipeline facility somewhere there are some opportunities that get opened up. We haven’t identified as we speak here today any opportunities along that section of pipe. Michael Gaugler Okay. Just notice where that’s probably going to cross and figure there might be something else behind it in terms of expansions? Mike McMasters Yes. We do look for those, Mike, so… Michael Gaugler Okay, thanks. Operator Your next question comes from the line of Roger Liddell from Clear Harbor Asset Management. Your line is open. Roger Liddell Thank you and good morning. Mike McMasters Good morning, Roger. Roger Liddell I wanted to follow-up with a question on combined heat and power opportunities in Florida. And of course, Eight Flags looks to be a superb example of those opportunities. And I wanted to put it in the context of there is some nuclear construction underway in South Carolina and Georgia. And my recollection is that Turkey Point is still assumed to be built in Southern Florida. The most recent publicity I have seen on Georgia Power’s Plant Vogtle 3 and 4 is that the dates and budgets are almost unknowable. And assuming the last published figures on budget and on completion dates holds, which I think is highly unlikely. The present value of continuing the construction and benefit over the lifetime of Plant Vogtle versus just stopping now and going gas that benefit of continuing nuclear eroded at almost 40% in the last year. So, here it is close to Florida, what could be a startling example of the questions, the issues of pursuing nuclear, which takes us to Turkey Point and it maybe that those plants wind up being canceled out of common sense and prudence. So, I should think the opportunities in Florida for meaningful rollout of additional combined heat and power could be an even more attractive opportunity. Could you respond to that? Mike McMasters I would say, Roger, we agree with that. The opportunity on Amelia Island was one. There is multiple opportunities that we see in the southeastern part of the country and we are looking at those – and they are, as you know, very complex, at least from our perspective, they are complex to develop and to some degree, you have to be careful with what’s the economic situation given the replacement power cost, but we are optimistic about that and are looking at opportunities for combined heat and power more than one. So, this project actually has opened up, has caught some people’s attention. I think we are cautiously optimistic that we will be able to get something develop. It will take some time. I suspect this project in particular that we are doing took several years to come to a contractual agreement and then obviously some permitting etcetera and then finally construction. So, there will be a long lead time on these projects. Roger Liddell Well, fair enough. But if you think they are complex, how would you like to be building nuclear? Mike McMasters That would be, I would agree, multiple increased complexity. Roger Liddell Yes. Well, I understand your point of the lead times and the caution that you have demonstrated before you go after these opportunities. I appreciate that. I guess you are not in a position to throw goals or aspirations out there perhaps in the future call you would be able to do so but I remain optimistic on the opportunity for the company? Mike McMasters Yes. If we – as we move down this road, if there comes a point where we may, we have multiple opportunities that were close to and maybe able to put some sort of expectation out there. But right now, it’s we are talking about multiple opportunities, but we are not at a place where we are getting to a point where it’s even 50% probable, I would say. Roger Liddell Fair enough. Thank you. Mike McMasters You are welcome. Operator [Operator Instructions] Your next question comes from the line of John Hanson from Praesidis. Your line is open. John Hanson Good morning. Mike McMasters Good morning, John. Beth Cooper Good morning. John Hanson Just a quick question, you mentioned the CapEx was going to slide from ‘15 to ‘16, what kind of projects are we sliding? Beth Cooper In particular, John, some of those projects that we talked about, for example, the Eight Flags project in total, that’s a project. The capital cost is about $40 million. We expect to incur about $28 million of that this year, but there will be a chunk that moves into next year. And in our original capital budget, more of that was actually falling into the current year. Similarly, some of the other larger projects that we are looking at that necessarily, they haven’t been finalized. The timeline on some of those have also slipped. So, from our standpoint, its expansion projects that we are trying to look at, those that are both announced as well as those that are in the pipeline as well as – there maybe a few dollars as it relates to the Calpine project, those types of things that may move from year-to-year. Mike McMasters And some of that, John, is driven by permitting and regulatory timelines, expanding here more recently. John Hanson On the Eight Flags project, it is still targeting that in service July next year? Beth Cooper Yes. John Hanson Okay. Alright, thanks. Mike McMasters Yes. Operator There are no further questions at this time. I would like to turn the call back over to President and CEO, Mike McMasters. Mike McMasters Thank you everyone for joining us on our call today and for your interest in Chesapeake Utilities. We are proud of what our team has accomplished for shareholders in the past and we are committed to working hard to deliver superior shareholder results in the future. Thank you. Beth Cooper Thank you. Operator This concludes today’s conference call. You may now disconnect.