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CPK > SEC Filings for CPK > Form 10-Q on 9-Aug-2013All Recent SEC Filings

Show all filings for CHESAPEAKE UTILITIES CORP

Form 10-Q for CHESAPEAKE UTILITIES CORP


9-Aug-2013

Quarterly Report


Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
Management's Discussion and Analysis of Financial Condition and Results of Operations is designed to provide a reader of the financial statements with a narrative report on our financial condition, results of operations and liquidity. This discussion and analysis should be read in conjunction with the attached unaudited condensed consolidated financial statements and notes thereto and our Annual Report on Form 10-K for the year ended December 31, 2012, including the audited consolidated financial statements and notes thereto. Safe Harbor for Forward-Looking Statements We make statements in this Quarterly Report on Form 10-Q that do not directly or exclusively relate to historical facts. Such statements are "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995. One can typically identify forward-looking statements by the use of forward-looking words, such as "project," "believe," "expect," "anticipate," "intend," "plan," "estimate," "continue," "potential," "forecast" or other similar words, or future or conditional verbs such as "may," "will," "should," "would" or "could." These statements represent our intentions, plans, expectations, assumptions and beliefs about future financial performance, business strategy, projected plans and objectives of the Company. These statements are subject to many risks, uncertainties and other important factors that could cause actual results to differ materially from those expressed in the forward-looking statements. Such factors include, but are not limited to:

            state and federal legislative and regulatory initiatives that affect
             cost and investment recovery, have an impact on rate structures, and
             affect the speed at and degree to which competition enters the
             electric and natural gas industries (including deregulation);


            the outcomes of regulatory, tax, environmental and legal matters,
             including whether pending matters are resolved within current
             estimates and whether the costs associated with such matters are
             adequately covered by insurance or recovered in rates;


            the loss of customers due to a government-mandated sale of our
             utility distribution facilities;


            industrial, commercial and residential growth or contraction in our
             markets or service territories;


            the weather and other natural phenomena, including the economic,
             operational and other effects of hurricanes, ice storms and other
             damaging weather events;

the timing and extent of changes in commodity prices and interest rates;

            general economic conditions, including any potential effects arising
             from terrorist attacks and any consequential hostilities or other
             hostilities or other external factors over which we have no control;


            changes in environmental and other laws and regulations to which we
             are subject and environmental conditions of property that we now or
             may in the future own or operate;


            the results of financing efforts, including our ability to obtain
             financing on favorable terms, which can be affected by various
             factors, including credit ratings and general economic conditions;


            declines in the value of the pension plan assets and resultant cash
             funding requirements for our defined benefit pension plans;


            the creditworthiness of counterparties with which we are engaged in
             transactions;


            the extent of success in connecting natural gas and electric
             supplies to transmission systems and in expanding natural gas and
             electric markets;


            the effect of accounting pronouncements issued periodically by
             accounting standard-setting bodies;


            conditions of the capital markets and equity markets during the
             periods covered by the forward-looking statements;


            the ability to successfully execute, manage and integrate merger,
             acquisition or divestiture plans, regulatory or other limitations
             imposed as a result of a merger, acquisition or divestiture, and the
             success of the business following a merger, acquisition or
             divestiture;

the ability to establish and maintain new key supply sources;

the effect of spot, forward and future market prices on our distribution, wholesale marketing and energy trading businesses;

the effect of competition on our businesses;

the ability to construct facilities at or below estimated costs; and

changes in technology affecting our advanced information services business.

- 31


Table of Contents

Introduction
We are a diversified utility company engaged, directly or through subsidiaries,
in regulated energy businesses, unregulated energy businesses, and other
unregulated businesses, including advanced information services.
Our strategy is focused on growing earnings from a stable utility foundation and
investing in related businesses and services that provide opportunities for
returns greater than traditional utility returns. The key elements of this
strategy include:

           executing a capital investment program in pursuit of organic growth
            opportunities that generate returns equal to or greater than our cost
            of capital;


           expanding the regulated energy distribution and transmission
            businesses into new geographic areas;


           providing additional services in our current and new service
            territories, including conversion opportunities;


           expanding the propane distribution business in existing and new
            markets through leveraging our community gas system services and our
            bulk delivery capabilities;


           expanding both our regulated energy and unregulated energy businesses
            through strategic acquisitions;


           utilizing our expertise across our various businesses to improve
            overall performance;


           pursuing and executing new unregulated energy opportunities that will
            complement our existing strategy and operating units;

enhancing marketing channels to attract new customers;

           providing reliable and responsive customer service to existing
            customers so they become our best promoters;


           empowering and energizing our employees at all levels to work in
            unison to achieve our strategy;


           engaging our local communities and government in a cooperative and
            mutually beneficial way;

maintaining a capital structure that enables us to access capital as needed;

maintaining a consistent and competitive dividend for shareholders; and

creating and maintaining a diversified customer base, energy portfolio and utility foundation.

Due to the seasonality of our business, results for interim periods are not necessarily indicative of results for the entire fiscal year. Revenue and earnings are typically greater during the first and fourth quarters, when consumption of energy is normally highest due to colder temperatures. The following discussions, and those elsewhere in the document, on operating income and segment results include the use of the term "gross margin." Gross margin is determined by deducting the cost of sales from operating revenue. Cost of sales includes the purchased cost of natural gas, electricity and propane and the cost of labor spent on direct revenue-producing activities. Gross margin should not be considered an alternative to operating income or net income, which are determined in accordance with GAAP. We believe that gross margin, although a non-GAAP measure, is useful and meaningful to investors as a basis for making investment decisions. It provides investors with information that demonstrates the profitability achieved by the Company under its allowed rates for regulated energy operations and under its competitive pricing structure for unregulated natural gas marketing and propane distribution operations. Our management uses gross margin in measuring our business units' performance and has historically analyzed and reported gross margin information publicly. Other companies may calculate gross margin in a different manner.

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Table of Contents

Results of Operations for the Three and Six Months Ended June 30, 2013
Overview and Highlights
Our net income for the quarter ended June 30, 2013 was $4.4 million, or $0.45
per share (diluted). This represents a decrease of $704,000, or $0.07 per share
(diluted), compared to net income of $5.1 million, or $0.52 per share (diluted),
as reported for the same quarter in 2012.

                                                                Increase
For the Three Months Ended June 30,     2013        2012       (decrease)
(in thousands except per share)
Business Segment:
Regulated Energy                      $ 8,619    $ 10,505     $    (1,886 )
Unregulated Energy                        447        (401 )           848
Other                                      86         351            (265 )
Operating Income                        9,152      10,455          (1,303 )
Other Income                               24         153            (129 )
Interest Charges                        2,016       2,241            (225 )
Income Taxes                            2,804       3,307            (503 )
Net Income                            $ 4,356    $  5,060     $      (704 )
Earnings Per Share of Common Stock
Basic                                 $  0.45    $   0.53     $     (0.08 )
Diluted                               $  0.45    $   0.52     $     (0.07 )



Key variances included:
                                                            Pre-tax       Net       Earnings
(in thousands, except per share)                            Income      Income      Per Share
Second Quarter of 2012 Reported Results                    $ 8,367     $ 5,060     $    0.52
Adjusting for unusual items:
Contribution from New Acquisitions                             150          90          0.01
Non-recurring adjustment to accrued revenues in 2012          (568 )      (344 )       (0.03 )
One-time sales tax expense associated with the ESG
acquisition                                                   (759 )      (459 )       (0.05 )
Weather impact                                                 547         330          0.03
                                                              (630 )      (383 )       (0.04 )
Increased (Decreased) Gross Margins:
Natural gas growth                                           1,149         693          0.07
Higher propane retail margins per gallon                     1,154         698          0.07
    Propane wholesale marketing                               (770 )      (466 )       (0.05 )
                                                             1,533         925          0.09
Increased Other Operating Expenses:
Larger accrual for incentive bonuses                          (699 )      (423 )       (0.04 )
Increased administrative costs (accounting, information
technology and insurance)                                     (421 )      (255 )       (0.03 )
Additional investments in corporate resources to
capitalize on future growth opportunities                     (263 )      (159 )       (0.02 )
                                                            (1,383 )      (837 )       (0.09 )
Net Other Changes                                             (727 )      (409 )       (0.03 )
Second Quarter of 2013 Reported Results                    $ 7,160     $ 4,356     $    0.45

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Table of Contents

Our results in the second quarter of 2013 reflected a one-time sales tax expense of $759,000 related to the acquisition of the ESG assets. Our results in the second quarter of 2012 reflected a non-recurring increase in gross margin of $568,000 related to prior period accrued revenues. These two items resulted in a quarter-over-quarter decrease in pre-tax income of $1.3 million ($803,000 in net income, or $0.08 per share (diluted)). Absent these non-recurring adjustments, net income for the current quarter would have increased by $99,000. Our results also reflected additional gross margin generated by:
(a) new services and customer growth in our natural gas transmission and distribution operations as a result of major expansion initiatives completed in 2012 and 2013;
(b) new and additional transmission services to a Dover electric generation plant owned by NRG Energy Center Dover LLC ("NRG") and the PBF Energy Inc. ("PBF Energy") refinery in Delaware City, Delaware, which commenced in May 2013;
(c) residential, commercial and industrial natural gas distribution customer growth on the Delmarva Peninsula and in Florida;
(d) strong retail propane margins per gallon during the second quarter of 2013, as a significant decrease in the average wholesale market price of propane lowered our cost of propane sales (retail margins remained strong through the second quarter of 2013, as a decline in our propane costs from lower propane wholesale prices outpaced the decline in retail prices); and
(e) temperatures on the Delmarva Peninsula returning to more normal levels during the second quarter of 2013, compared to the same quarter in 2012, resulting in higher propane sales. These increases were offset by lower gross margin generated by Xeron, our propane wholesale marketing subsidiary, as lower volatility in wholesale propane prices resulted in fewer trading opportunities. Other operating expenses partially offset the gross margin increase as a result of:
(a) increased accruals for incentive bonuses due to the timing of bonus recognition, increased participation in the bonus program and our financial performance on a year-to-date basis;
(b) increased costs associated with administrative functions, such as accounting, information technology and insurance; and
(c) additional investments in corporate resources to further develop our capability to capitalize on future growth opportunities.

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Table of Contents

Our net income for the six months ended June 30, 2013 was $19.2 million or $1.99 per share (diluted). This represents an increase of $3.4 million, or $0.36 per share (diluted), compared to a net income of $15.8 million, or $1.63 per share (diluted), as reported for the same period in 2012.

                                                                Increase
For the Six Months Ended June 30,       2013        2012       (decrease)
(in thousands except per share)
Business Segment:
Regulated Energy                     $ 25,925     $ 25,303    $       622
Unregulated Energy                      9,816        4,753          5,063
Other                                     (39 )        472           (511 )
Operating Income                       35,702       30,528          5,174
Other Income                              312          349            (37 )
Interest Charges                        4,088        4,532           (444 )
Income Taxes                           12,701       10,558          2,143
Net Income                           $ 19,225     $ 15,787    $     3,438
Earnings Per Share of Common Stock
Basic                                $   2.00     $   1.65    $      0.35
Diluted                              $   1.99     $   1.63    $      0.36



Key variances included:

                                                            Pre-tax        Net        Earnings
(in thousands, except per share)                             Income       Income      Per Share
Six months ended June 30, 2012 Reported Results            $ 26,345     $ 15,787     $    1.63
Adjusting for unusual items:
Contribution from New Acquisitions                              216          129          0.01
Non-recurring adjustment to accrued revenues in 2012           (128 )        (77 )       (0.01 )
One-time sales tax expense associated with the ESG
acquisition                                                    (759 )       (455 )       (0.05 )
Weather impact (due primarily to significantly
warmer-than-normal weather in 2012)                           3,739        2,240          0.23
                                                              3,068        1,837          0.18
Increased (Decreased) Gross Margins:
Natural gas growth                                            2,725        1,632          0.18
Higher propane retail margins per gallon                      3,297        1,976          0.20
Propane wholesale marketing                                    (936 )       (561 )       (0.06 )
                                                              5,086        3,047          0.32
Increased Other Operating Expenses:
Larger accrual for incentive bonuses                         (1,430 )       (857 )       (0.09 )
Increased administrative costs (accounting, information
technology and insurance)                                      (582 )       (349 )       (0.04 )
Additional investments in corporate resources to
capitalize on future growth opportunities                      (712 )       (427 )       (0.04 )
                                                             (2,724 )     (1,633 )       (0.17 )
Net Other Changes                                               151          187          0.03
Six months ended June 30, 2013 Reported Results            $ 31,926     $ 19,225     $    1.99

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Table of Contents

Our results in the first six months of 2013 reflected additional gross margin generated by:
(a) temperatures on the Delmarva Peninsula returning to more normal levels during the first six months of 2013 (primarily during the heating season), compared to the same period in 2012;
(b) new services and customer growth in the natural gas transmission and distribution operations as a result of major expansion initiatives completed in 2012 and 2013;
(c) new and additional transmission services to the NRG Dover electric generation plant and the PBF Energy refinery in Delaware City, Delaware, which commenced in May 2013; and
(d) strong retail propane margins per gallon through the first six months of 2013 due to the significant decrease in the average wholesale market price of propane, which lowered our cost of propane sales. These increases in gross margin were partially offset by:
(a) decreased gross margins for our propane wholesale marketing subsidiary as lower price volatility during the current period resulted in lower-than-usual trading volume and profitability;
(b) increased accruals for incentive bonuses due to the timing of bonus recognition, increased participation in the bonus program and our financial performance on a year-to-date basis;
(c) a one-time sales tax expense related to the acquisition of the ESG assets in Maryland;
(d) increased costs associated with administrative functions, such as accounting, information technology and insurance; and
(e) additional investments in corporate resources to further develop our capability to capitalize on future growth opportunities.

Summary of Key factors
The following is a summary of key factors affecting our businesses and their impacts on our results during the current and future periods. Growth
New natural gas transmission services and growth in natural gas distribution customers generated $1.1 million and $2.7 million, respectively, in additional gross margin during the three and six months ended June 30, 2013. These growth initiatives are further explained in the following section.
We continue to see growth in our natural gas businesses as a result of our strategic initiatives over the past several years to expand our delivery of clean-burning, environmentally-friendly natural gas to customers on the Delmarva Peninsula and in Florida. In 2012 and 2013, we expanded natural gas transmission and distribution services in Sussex County, Delaware, Worcester County, Maryland, and Nassau County, Florida, where natural gas was not previously available. We also initiated natural gas transmission service in Cecil County, Maryland. We continue to pursue several opportunities on the Delmarva Peninsula to expand our transmission facilities to meet increased demand for natural gas by industrial customers, including electric power generation plants in Dover, Delaware and a refinery in Delaware City, Delaware.
Major Service Expansions and Customer Growth Reflected in Results Expansion of natural gas transmission and distribution services in Sussex County, Delaware, Cecil and Worcester Counties, Maryland, and Nassau County, Florida, which commenced during the period from March 2012 to January 2013, generated additional gross margin of $163,000 and $958,000 in the three and six months ended June 30, 2013, compared to the same periods in 2012, respectively. In May 2013, Eastern Shore commenced a new transmission service to the NRG Dover electric generation plant. This new service, which generated $386,000 in additional gross margin in the second quarter of 2013, is part of Eastern Shore's current system expansion to provide 13,440 Dts/d of firm transportation service to this plant. Eastern Shore and NRG entered into a precedent agreement in the first quarter of 2012, and Eastern Shore received necessary approval from the FERC in February 2013 to construct the new facilities required for this service. In advance of completion of the construction, which is anticipated in November 2013, Eastern Shore began providing the service using existing system capacity in May 2013 under a short-term contract. Once the facilities are constructed for the NRG plant, the long-term service contracts will replace the short-term contract and generate $2.4 million to $2.8 million of annual gross margin.

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Table of Contents

Also in May 2013, Eastern Shore commenced additional services to the PBF Energy refinery located in Delaware City, Delaware. These new services, which generated $88,000 in gross margin in the second quarter of 2013, are also part of Eastern Shore's current system expansion to provide 15,000 Dts/d of firm transportation service to this existing customer. Eastern Shore and PBF Energy entered into a precedent agreement in the first quarter of 2012, and Eastern Shore received necessary approval from the FERC in March 2013 to construct the new facilities required for this service. Once the additional facilities to serve the PBF Energy Delaware City refinery are constructed, the incremental service is expected to generate annual gross margin of $1.6 million. This long-term service contract with the PBF Energy will replace the 10,000 Dts/d contract that expired in November 2012. Eastern Shore provided additional interruptible service for the three and six months ended June 30, 2013, which generated $179,000 and $445,000, respectively, of additional gross margin. This interruptible service will be partially replaced by a short-term firm service contract for 5.000 Dts/d for the period from May to October 2013, which will generate $264,000 of gross margin, and ultimately by a new long-term firm service contract for 15,000 Dts/d, commencing in December 2013.
The following table summarizes our major service expansions initiated in 2012 and 2013 (dollars in thousands):

                                                         Q2 2013      YTD 2013          Estimated             Estimated
Project                           Date of New Service     Margin       Margin          2013 Margin        Annualized Margin
Sussex County, DE expansion
Transmission (for southeastern     Mar-12 to May-12     $    112     $     223     $              446     $           446
part) 1,550 Dts/d(1)
Distribution-Two facilities of
an existing customer in the        Mar-12 to Aug-12           48           101                    151                 154
southeastern part of Sussex
County (2)
                                                        $    160     $     324     $              597     $           600
Cecil County, MD expansion
Transmission - 4,070 Dts/d(3)           Nov-12          $    220     $     441     $              882     $           882
Worcester County, MD expansion
Transmission - 1,450 Dts/d(4)      Jun-12 to Jan-13     $     98     $     195     $              391     $           391
Nassau County, FL expansion
Transmission - A new fixed              Apr-12          $    333     $     665     $            1,300     $         1,300
annual rate service(5)
Service to NRG's Dover, DE
electric generation plant
Short-term contract - 13,440       May-13 to Oct-13     $    386     $     386     $            1,158     $             -
Dts/d(6)
Transmission - 13,440 Dts/d (7)                         $      -     $       -           $400 to $467           $2,400 to
                                  Starting in Nov-13                                                               $2,800
PBF Energy's Delaware City, DE
refinery expansion
Short-term contract - 5,000                             $     88     $      88     $              264     $             -
Dts/d(6)                           May-13 to Oct-13
Transmission - 15,000 Dts/d (6)                         $      -     $       -     $              133               1,600
(7) (8)                           Starting in Dec-13
                                                        $  1,285     $   2,099       $5,125 to $5,192           $7,173 to
                                                                                                                   $7,573

2012 margin                                             $    648     $     667     $            2,197
Incremental margin in 2013 over                         $    637     $   1,432       $2,928 to $2,995
2012

Total by Geographic Location of
the Project:
Delmarva Natural Gas                                    $     48     $     101     $              151     $           154
Distribution
Delmarva Natural Gas                                         904         1,333       $3,674 to $3,741           $5,719 to
Transmission                                                                                                       $6,119
Florida Natural Gas                                          333           665                  1,300               1,300
Transmission
                                                        $  1,285     $   2,099       $5,125 to $5,192           $7,173 to
                                                                                                                   $7,573

(1) These services generated $96,000 and $111,000 in gross margin for the three and six months ended June 30, 2012, respectively. These services also generated $334,000 in gross margin for the year ended December 31, 2012.
(2) These services generated $16,000 and $20,000 in gross margin for the three and six months ended June 30, 2012, respectively.These services also generated . . .

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