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CPK > SEC Filings for CPK > Form 10-Q on 6-May-2014All Recent SEC Filings

Show all filings for CHESAPEAKE UTILITIES CORP

Form 10-Q for CHESAPEAKE UTILITIES CORP


6-May-2014

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, 2013, 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 (including
             deregulation) 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;


            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 changes in 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;


            the impact to the asset values and resulting higher costs and
             funding obligations of the Company's pension and other
             postretirement benefit plans as a result of potential downturns in
             the financial markets, lower discount rates or impacts associated
             with the Patient Protection and Affordable Care Act;


            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;

risks related to cyber-attack or failure of information technology systems; and

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Table of Contents

changes in technology affecting our advanced information services business.

Introduction
We are a diversified energy company engaged, directly or through our operating
divisions and 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 and providing new services in
            our current service territories;


           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 entering new unregulated energy markets and business
            lines 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;

engaging our customers through a distinctive service excellence initiative;

developing and retaining a high-performing team that advances our goals;

           empowering and engaging our employees at all levels to live our brand
            and vision;


           demonstrating community leadership and engaging our local communities
            and governments 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 us under our allowed rates for regulated energy operations and under our competitive pricing structure for non-regulated segments. 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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Results of Operations For Three Months Ended March 31, 2014
Overview and Highlights
Our net income for the three months ended March 31, 2014 was $17.7 million, or
$1.82 per share (diluted). This represents an increase of $2.8 million, or $0.28
per share (diluted), compared to net income of $14.9 million, or $1.54 per share
(diluted), as reported for the same quarter in 2013.

                                        Three Months Ended
                                            March 31,             Increase
                                        2014          2013       (decrease)
(in thousands except per share)
Business Segment:
Regulated Energy                     $  21,091     $ 17,306     $     3,785
Unregulated Energy                      10,858        9,369           1,489
Other                                     (326 )       (125 )          (201 )
Operating Income                        31,623       26,550           5,073
Other Income                                 6          289            (283 )
Interest Charges                         2,155        2,072              83
Income Taxes                            11,793        9,898           1,895
Net Income                           $  17,681     $ 14,869     $     2,812
Earnings Per Share of Common Stock
Basic                                $    1.83     $   1.55     $      0.28
Diluted                              $    1.82     $   1.54     $      0.28

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Key variances included:
                                                           Pre-tax        Net        Earnings
(in thousands, except per share)                            Income       Income      Per Share
First Quarter of 2013 Reported Results                    $ 24,767     $ 14,869     $    1.54
Adjusting for unusual items:
Weather impact (due primarily to colder temperatures in
2014)                                                        2,711        1,628          0.17
                                                             2,711        1,628          0.17
Increased (Decreased) Gross Margins:
Major Projects (See Major Projects Highlights table)
Contribution from Sandpiper                                  4,289        2,575          0.27
Service expansions                                           1,423          855          0.08
Increased wholesale propane sales                            1,032          620          0.06
Propane wholesale marketing                                    889          534          0.06
GRIP                                                           724          435          0.04
Lower retail propane margins                                  (516 )       (310 )       (0.03 )
Contribution from other acquisitions                           502          302          0.03
                                                             8,343        5,011          0.51
Increased Other Operating Expenses:
Expenses from acquisitions                                  (2,117 )     (1,271 )       (0.14 )
Higher payroll costs                                        (1,161 )       (697 )       (0.07 )
Increased accruals for incentive compensation                 (980 )       (589 )       (0.06 )
Higher depreciation, asset removal and property tax
costs due to new capital investments                          (726 )       (436 )       (0.04 )
Higher benefits costs                                         (674 )       (405 )       (0.04 )
                                                            (5,658 )     (3,398 )       (0.35 )
Net Other Changes                                             (689 )       (429 )       (0.05 )
First Quarter of 2014 Reported Results                    $ 29,474     $ 17,681     $    1.82

Summary of Key Factors
The following information highlights certain key factors contributing to our results for the quarter ended March 31, 2014.

Major Projects
Acquisition
In May 2013, we completed the purchase of the operating assets of ESG. Approximately 11,000 residential and commercial underground propane distribution system customers acquired in this transaction are now being served by Sandpiper under the tariff approved by the Maryland PSC. We are evaluating the potential conversion of some of these systems to natural gas. This acquisition is expected to be accretive to earnings per share in the first full year of operations. We generated $4.3 million in additional gross margin from Sandpiper and incurred $1.4 million in other operating expenses for the three months ended March 31, 2014.

Service Expansions
During 2013, Eastern Shore, our interstate natural gas transmission subsidiary, commenced new transmission services to local distribution utilities and industrial customers in Delaware and Maryland. These new services generated additional gross margin of $1.2 million in the first quarter of 2014 over the same quarter in 2013.

In August 2013, Peninsula Pipeline, our intrastate natural gas transmission subsidiary, commenced a new firm transportation service in Florida with an unaffiliated utility. This new service generated $210,000 in gross margin for the three months ended March 31, 2014.

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The following Major Project Highlights table summarizes our major projects initiated in 2011, 2012 and 2013 (dollars in thousands):

                                                                      Gross Margin
                                                                 Q1 2014        2014 (1)
Acquisition:
ESG acquisition being served by Sandpiper in Worcester
County, Maryland (2)                                           $    4,289     $    9,817
Service Expansions
Natural Gas Distribution:
Long-term
Sussex County, Delaware (3)                                    $      204     $      694
Natural Gas Transmission:
Short-term
New Castle County, Delaware (4) (5)                            $        -     $    1,862
Total Short-term                                               $        -     $    1,862
Long-term
Sussex County, Delaware (6)                                    $      431     $    1,725
New Castle County, Delaware (6) (7)                                   741          2,964
Nassau County, Florida (6)                                            327          1,300
Worcester County, Maryland (6)                                        137            547
Cecil County, Maryland (6)                                            287          1,147
Indian River County, Florida                                          210            840
Kent County, Delaware                                                 665          2,660
Total Long-term                                                $    2,798     $   11,183

Total Service Expansions                                       $    3,002     $   13,739

Total Major Projects                                           $    7,291     $   23,556

Less: 2013 Margin                                              $    1,579     $   13,176
Incremental Margin in 2014 over 2013                           $    5,712     $   10,380

(1) The figures provided represent the estimated annual gross margin.
(2) During the quarter ended March 31, 2014, we incurred $1.4 million in other operating expenses related to Sandpiper's operation. We expect to incur $6.3 million in other operating expenses for the entire 2014.
(3) These services generated $201,000 in gross margin in the first quarter of 2013.
(4) Expected gross margin in 2014 includes $1.9 million from a new short-term contract for 50,000 Dts/d for one year, which began in April 2014.
(5) During the first quarter of 2013 we provided short-term service and generated $40,000 in gross margin. The short-term service was displaced by the new long-term service in November 2013.
(6) Gross margin generated by these services in the first quarter of 2013 was $345,000 for Sussex County, Delaware; $343,000 for New Castle County, Delaware; $332,000 for Nassau County, Florida; $98,000 for Worcester County Maryland and $220,000 for Cecil County, Maryland.
(7) Gross margin generated from this service expansion replaces the 10,000 Dts/d contract, which expired in November 2012. This expired contract had annualized gross margin of $1.1 million.

Future System Expansions and New Services In June 2013, Eastern Shore filed an application with the FERC, seeking approval to construct a pipeline lateral to an industrial customer facility under construction in Kent County, Delaware. Upon completion of construction of the required facilities, this new service is expected to generate annual gross margin of approximately $1.2 million to $1.8 million. The new facilities include approximately 5.5 miles of lateral pipeline and metering facilities and extend from Eastern Shore's mainline to the new industrial customer facility. The construction of this lateral will not increase the overall capacity of Eastern Shore's mainline system. Service is projected to commence in January 2015.

Eastern Shore also executed a one-year contract with another industrial customer to provide an additional 50,000 Dts/d of service from April 2014 to April 2015. This short-term contract is expected to generate $1.9 million and $767,000 of gross margin in 2014 and 2015, respectively.

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GRIP
The Florida PSC approved the GRIP, which is designed to recover capital and other program-related-costs, inclusive of a return on investment, to replace older pipes in our Florida service territories. We received approval to invest $75 million to replace qualifying distribution mains and services (any material other than coated steel or plastic). Since the beginning of 2013, $21.4 million has been invested, $4.6 million of which is in 2014. These investments generated additional gross margin of $724,000 for the three months ended March 31, 2014 over the same quarter in 2013.

Investing in Growth
We continue to expand our resources and capabilities to support growth. Our Delmarva natural gas distribution operation is in the early stages of natural gas distribution expansions in Sussex County, Delaware, and Worcester and Cecil Counties, Maryland. These expansions will require not only the construction or conversion of distribution facilities, but also the conversion of residential customers' appliances or equipment. We have begun the process of reorganizing our Delmarva natural gas distribution operation and expect to increase staffing to support future expansions. Eastern Shore expects to increase its staffing to support recent and future expansions of its facilities and services. Finally, to increase our overall capabilities to support sustained future growth, resources have been added in our corporate shared services departments. For the three months ended March 31, 2014, payroll expenses for our Regulated Energy segment increased by $616,000, compared to the same quarter in 2013, as a result of the increased resources. We expect to make additional investments in human resources, as needed, to further develop our capability to capitalize on future growth opportunities.
Weather and Consumption

Temperatures on the Delmarva Peninsula and in Florida during the first three months of 2014 were significantly colder than the first quarter of 2013. The following tables highlight the HDD and CDD information for the quarter ended March 31, 2014 and 2013 and the gross margin variance resulting from the weather fluctuation in those periods.

HDD and CDD Information
                                 Three Months Ended
                                      March 31,
                                  2014         2013      Variance
Delmarva
Actual HDD                       2,717         2,407        310
10-Year Average HDD ("Normal")   2,361         2,377        (16 )
Variance from Normal               356            30

Florida
Actual HDD                         557           468         89
10-Year Average HDD ("Normal")     529           541        (12 )
Variance from Normal                28           (73 )

Florida
Actual CDD                          42            81        (39 )
10-Year Average CDD ("Normal")      74            75         (1 )
Variance from Normal               (32 )           6

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Gross Margin Variance attributed to Weather

(in thousands)      2014 vs. 2013      2014 vs. Normal
Delmarva
Regulated Energy   $           511    $           617
Unregulated Energy           1,827              1,096
Florida
Regulated Energy               325               (207 )
Unregulated Energy              48                 81
Total              $         2,711    $         1,587

Propane Prices

Our retail propane margins began to revert to more normal levels during the first quarter of 2014 as a significant increase in wholesale prices in late 2013 and early 2014 increased our average propane inventory cost. The decline in retail propane margins reduced gross margin by $516,000 during the first quarter of 2014, compared to the same quarter in 2013.

The increase in wholesale propane sales generated additional gross margin of $1.0 million due primarily to the wholesale propane supply agreements entered into in May 2013 with an affiliate of ESG.
Xeron, which benefits from price volatility in the propane wholesale market by entering into trading transactions, generated an increase in gross margin of $889,000 during the first quarter of 2014. Higher propane wholesale price volatility during the current quarter resulted in higher profits on executed trades.

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Regulated Energy

                                 Three Months Ended
                                     March 31,             Increase
                                  2014         2013       (decrease)
(in thousands)
Revenue                       $   102,166    $ 81,566    $     20,600
Cost of sales                      54,307      41,615          12,692
Gross margin                       47,859      39,951           7,908
Operations & maintenance           18,402      15,468           2,934
Depreciation & amortization         5,527       4,809             718
Other taxes                         2,839       2,368             471
Other operating expenses           26,768      22,645           4,123
Operating Income              $    21,091    $ 17,306    $      3,785

Operating income for the Regulated Energy segment for the quarter ended March 31, 2014 was $21.1 million, an increase of $3.8 million, or 22 percent. An increase in gross margin of $7.9 million was partially offset by an increase in other operating expenses of $4.1 million. Gross Margin
Items contributing to the quarter-over-quarter increase of $7.9 million, or 20 percent, in gross margin are listed in the following table:

(in thousands)
Gross margin for the three months ended March 31, 2013                 $   39,951
Factors contributing to the gross margin increase for the three months
ended March 31, 2014:
Contributions from acquisitions                                             4,351
Service expansions                                                          1,423
Increased customer consumption - weather and other                            726
Additional revenue for GRIP in Florida                                        724
Other natural gas growth                                                      496
Other                                                                         188
Gross margin for the three months ended March 31, 2014                 $   47,859

Contributions from Acquisitions
In late May 2013, upon completion of the purchase of the ESG operating assets, Sandpiper began providing services to approximately 11,000 propane underground distribution system customers in Worcester County, Maryland under a tariff approved by the Maryland PSC. Sandpiper generated $4.3 million of gross margin in the first quarter of 2014. Also, the acquisition of operating assets of Fort Meade, Florida in December 2013 generated $62,000 of additional gross margin during the first quarter of 2014.
Service Expansions
Increased gross margin from service expansions was due primarily to the following:
$400,000 from expansions completed in 2013 that facilitated new natural gas transmission and distribution services in Sussex County, Delaware; Worcester and Cecil Counties, Maryland; and Nassau and Indian River Counties, Florida.

$1.1 million from long-term transmission services commenced in November 2013, when Eastern Shore began providing long-term transmission services to industrial customers, located in New Castle and Kent Counties, Delaware. These long-term transmission services, which displaced short-term services that Eastern Shore provided to these customers from May through October 2013, are expected to generate $4.3 million of annual gross margin. They also displace annualized gross margin of $1.1 million from an older contract, which expired in November 2012.

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Increased Customer Consumption-Weather and Other Higher customer consumption due to colder temperatures on the Delmarva Peninsula and in Florida during the first quarter of 2014 generated increased gross margin of approximately $511,000 and $325,000, respectively. Additional Revenue for GRIP in Florida
In August 2012, the Florida PSC approved the GRIP for FPU and Chesapeake's . . .

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