Beth Cooper - SVP and CFO Mike McMasters - President and CEO.

Spencer Joyce - Hilliard Lyons Sarah Akers - Wells Fargo Securities.

Good morning. My name is Andres, and I will be your conference operator today. At this time, I would like to welcome everyone to the Chesapeake Utilities' Second Quarter 2017 Earnings 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. I would now like to turn the conference over to Beth Cooper. Please go ahead..

Good morning, everyone, and welcome to our second quarter earnings conference call. We're hosting today's conference call live from Wesley College here in Dover, Delaware, where our corporate headquarters is located. And I'd like to just say a special thanks to Dr. Gibson and Dr.

Jacobs, who are here in the room with us, for enabling us to hold our conference call here today. In the room with us are several members of our management team as well as several of our key employees, some of which are alumni of Wesley College. Turning to slide two.

Before we begin, all of you know that this presentation may include forward-looking information.

We will ask that you take a look at our SEC reports, including our Form 10-Q that we filed yesterday, as well as our Annual Report on Form 10-K that we filed in February, where we discussed those factors and those risks that could cause our actual results to differ from the forward-looking information. Turning to slide three.

This is a summary for the quarter. Really just three things on here that we wanted to highlight.

First, just overall from a top level, we continue to have strong gross margin growth in the second quarter, operating expenses did overshadow that gross margin growth and I'll talk about in just a minute, but still as strong quarter overall in terms of gross margin growth.

Secondly, just a high level from an EPS standpoint, we'll talk in a little more detail later on in the presentation, you will see that the letter and also the wind down of Xeron represented a reduction in earnings per share of about $0.04, you'll see that gross margin from our [Indiscernible], including Eight Flags and some of the areas where we had growth, also basically added about $0.01 per share for the quarter, including overcoming operating expenses for those operations.

Higher depreciation represented about the $0.05 per share. The equity issuance and our refinancing of about $70 million of short-term debt to long-term debt, basically represented another $0.04, and then lastly, some other expenses change of tax rate, those kinds of things, represented $0.03 per share.

During to the quarter, there were several significant events that occurred. First, I want to talk about two significant Eastern Shore projects were completed. Those were the [Indiscernible] projects and also the System Reliability project.

And then in addition to that we also just after the second quarter, we announced an acquisition of a small natural gas marketing company that will compliment [Indiscernible] growth strategy.

In addition, we were well underway on our Eastern Shore rate case within our rates going into effect earlier this week on August the 1st and our construction continues, and we're expecting, and we'll talk about later on to that project to be in service in the second quarter of next year.

Speaking into the number a little bit more, turning to slide four, you will see that for the quarter, we reported EPS of $0.37 per share that compares to last year's second quarter of $0.52 per share.

Operating income overall declined by $2.1 million, basically that was a result of -- I mentioned we had gross margin growth -- very strong gross margin growth coming from Eight Flags, coming from our natural gas service expansion, coming from our Brit [ph], coming from our organic customer growth and also from our long-term supply agreements that were the pricing in those agreements have been amended [Indiscernible].

Very strong gross margin growth on the expense side. We saw an increase of $4.7 million.

When you do look at operating expense growth, what you find is about 85% of that operating expense growth came as a result of depreciation because of the capital that we've invested as a result of Eastern Shore and the growth that it had and has projected to experience and then lastly, because of the Eight Flags.

We also took a look at a states going back and looking at every time the expense that ramp-up that we've seen and we saw that ramp start to decline in the second quarter, which shows that as we're moving forward to some of these future projects coming along, that our margins and our expense growth are converging and this is becoming more of an alignment.

Year-to-date, when you take a look at those result, you'll seen that we were down by $0.31, half of it from the second quarter, half of it from the first quarter. Weather on a normalized basis which represented about $0.16 per share in terms of the lower results that we achieved for the year.

In addition, the financing with the stock issuance is another $0.10, and the write-down and wind down of Xeron business represented another $0.03.

Taking a look at a little more detailed level from an EPS standpoint, you will see that the unusual items once again were $0.04; Eight Flags, when you look at the expenses as well as the margin growth, added $0.03; margin of our other businesses was $0.04; and then our other expenses or the other operating expenses were $0.06, depreciation $0.05, and then I mentioned the other two earlier the $0.04 and the $0.03 from the financing and then the other items.

What's been important for us over time as we have been growing, many of you know, is to have a strong balance sheet and that continue to be the case this quarter. We entered the quarter with book capitalization about $820 million. In terms of equity as a percentage of total capitalization, very strong at 56%.

When you look at equity as a percentage of permanent capitalization, at about 70%, just shy of that. In terms of being able to support our future growth, we've got a strong capital budget of this year and we've got some dollars that are actually rolling into next year.

We have short-term capacity available, including a revolver, that's $150 million totaling $330 million. Similarly, we also have Shell facilities now in place for another $330 million, where we can place some of that short-term debt long-term as we seem or deem appropriate.

On the CapEx side, earlier this year, we talked about our budget and capital was right around $260 million.

We expect about half of the project cost associated with our Eastern Shore project of 2017 expansion to roll into next year and that's basically resulting in our $0.04 docking to about $209 million versus the $260 million that we started the year. But still a very strong, very high capital budget.

And if you'll recall, I mentioned our book capitalization is about $820 million. This is about 25% of our book capitalization today. So, a lot of growth that's going on with the company. And now I'll turn it over to Mike, and he's going to touch on the growth projects underway..

Thanks Beth. I guess so let me move forward to the next slide on slide eight. What we're highlighting here on slide eight are basic five major projects that were currently underway, will be initiated in 2018 and 2019.

Basically the Eastern Shore Natural Gas Expansion, that major project almost $100 million of capital investment expected to generating $9.3 million in 2018 and $15.8 million in 2019. The project is expected to go to service the second quarter of 2018.

If you look next, FPU Gas Reliability Infrastructure program, I think everyone probably knows that's a program to replace old aging pipe that needs to be replaced, so there's an automatic mechanism to recover cost associated with that. As you can see, that's expected to generate $14.4 million in 2018 and $15.1 million 2019.

Eight Flags Combined Heat and Power Plant, that project went into service in June of last year. This year -- well next year is expected to earn $8.7 million, and slightly higher in 2019, there's some automatic pricing adjustments compared to that project.

The FPU Northwest Florida Expansion that's going into service we expect probably in the second quarter of next year, as well in 2018, $4 million, and then in 2019, $5.1 million.

And then Eastern Shore Natural Gas System Reliability project, that also is a reliability project, it's little bit different that the GRIP, but that, you may recall, there's a forward vortex we had several years ago, and when that occur, what we saw gas price coming into our system from Southeastern PA.

It had declined pretty significantly, had an impact on our system. So, we're beefing up our system, so you bet that occurs again, won't have a lot reliability challenges [Indiscernible] what happens in the north.

But in any event, $4.5 million in 2018 and the same thing in 2019, now that number is really rough estimate of the revenue requirement on the investment in that facility. These towers what we hear is expected to clearly be included or they are included in our rate case filings, so we'll do the final estimate [ph] there later on this year.

Next slide, this is also has a lot of the growth initiatives we just talked about. However, the key point of this slide is really at the bottom of the slide, where we've got a triangle, that's $9.443 million, $13.440 et cetera, that's showing the difference from year-over-year.

So, it includes a lot of different projects here just so we can capture that total difference. Now what's interesting also, this is focused on major initiatives. Since 2013, I guess beginning of 2013, our gross margin has grown $20 million every year or approximately $20 million every year and we're looking at the same thing in 2017.

So, what you're seeing here as a subset of our overall growth and just for comparison purposes, obviously, pretty close to about half of that, so there's lot of other stuff going on. We're not pulling out these projects. I'll talk little bit about the Eastern Shore project.

As I mentioned earlier, $98.6 million in investment, generating $15.8 million of margin in the first full year. The project right now have filing on with the FERC. We're waiting I guess for [Indiscernible] FERC's doing without form for some times, so not been able to approve the project, or lot of other projects.

They did get the form filled, I think, yesterday and so there's going to be a lot of work done by the FERC Commissioners over the next few months trying to deal with the backlog, but we expect -- well, we hope to get that pretty quickly.

There's not only issues with our filing, staff has looked at it, and it's pretty clean stuff, so we should get approved fairly quickly. In any event, so if you get all that done, we'll start in the third quarter of 2017 and for services hopefully in the first quarter or second quarter of 2018.

Projects about 23 miles of pipeline, starting in Pennsylvania into Maryland and Delaware, upgrades to our TETCO interconnect that enables us to get access cheaper gas for the Marcellus. 17 model remain line extensions, upgrade 3,750 horsepower compression and then two new pressure control stations help us. Capacity increase of 61,162 [Indiscernible].

They are translated to a residential customer on a peak day, that's equivalent about to 61,000 customers. The Florida Natural Gas project, Northwest Florida Expansion. This project is kind of hard to tell from the graph, from the table, I guess. But it's just about the Northwest corner of Florida, in the Panhandle, the Central Time Zone.

Where we initiated this project is just barely inside the rig zone of Florida for the gas transmission that is cheaper than the rig zone that provide gas from in the rest of the Florida projects. So, it actually enables us to get lower cost gas into this area.

It’s a $36 million project as you can see we expected to generate $5.1 million in the first full year of operation. Construction has already started; again, expect to go service in second quarter 33 miles transmission pipe. Now we've done anchor customer, obviously, that are going to start paying for the service as soon as we can deliver them.

There's also a lot of other opportunities that present themselves from the [Indiscernible] pipeline in Northwest Florida, Florida. A little difficulty from slide here. Okay, turning to slide 11 -- turning to slide 11, we just completed third year of operation of our Combined Heat and Power Plant down in Florida. Capital investments $40 million.

$40 million gross margin, $9.4 million in the first full year of operation and $5 million were generated in first half in 2017. This is a pretty significant project for us as a company. It was our first power plant that we've ever constructed and owned and operated. We've got several orders from this power plant, Southeastern Electric Exchange Inc.

recognized Eight Flags as a plant as a 2017 Industry Excellence Award in the production category. Southeast Gas Association recognized Eight Flags plant as the first place Engineering Award and Power Engineering recognized the plant as the best CHP Project 2016. So, a lot of great -- happened here with this project, very profitable.

Also saving customers $3 million to $4 million a year on the [Indiscernible] they are getting power and an increase in steel production for [Indiscernible].

PESCO Energy overview, Peninsula Energy Services Company, a company we've had since filing it back in the 1980s, so we've got some quite time where we've been growing it pretty rapidly here in the last few years once we hired -- once we acquired [Indiscernible] in Ohio.

Little bit about the service, the first service that will service demand origination. Now demand origination remains, we're finding customers that need gas that are generally speaking, connected to pipeline and were moving gas on. And so we're looking for new customers there to deliver gas. And we have supply aggregation.

We also need to find the gas, the additional gas to service customers and we make money growing that well. And the optimization, whenever you're doing -- moving natural gas from one place to another, the demand -- actually demand is also a little bit different than what everybody schedules. So, that creates challenges and opportunities.

And so the optimization enables for us to do things with our capacity, either sell our capacity short-term or deliver more gas other places to make additional money. And so those three categories are basically what's driving.

As you can see, our territorial right inside the market area starting off Delmarva at Florida, the first things we started, then we Spark Energy acquisition in Ohio, it expands our footprint to the White Oak and the dark [Indiscernible].

I think that Beth mentioned a little bit earlier the acquisition Pittsburgh, just a quick summary of that on slide 14, acquisition of ARM Energy Management; we closed that on August 1st.

It's first, I guess, we think about this we're in Ohio with Spark Energy, we're in Pennsylvania with our interstate pipeline and are also our [Indiscernible] market company and also our propane operations.

And so this in Pittsburgh kind of just as between those two, it gives us -- deepens our footprint and our commercial rate relationships in the area. It complements our existing portfolio and also provides customer opportunities to aggregate supply, provide services [Indiscernible]. Major projects and initiatives.

As you can see, let's start with 2019, we started with -- let's go back 2014, 2014 was $7 million that has specific projects that have some growth thereafter, so we started with the foundation of 2014 then have shown the changes going to 2019. So, what you'll see in 2014 to 2015 is $18 million growth from these major projects.

You could see going from 2015 to 2016, $22 million, from 2016 to 2017, slightly less than $10 million, and then up $14 million in 2018 and then another $8 million or so in 2019 and we still got more to build on 2019 and we'll report in 2020 to get our 10-year growth rate in order member of $20 million a year pretty much since 2013.

Project graph on slide 16, we show this every time we talk to anybody. We're looking at quick way to measure how effective we're being and how profitable we are.

We're looking at -- building to achieve rates of return on equity that are higher than our cost of capital and higher from the medians -- appropriate medians and we've been able to achieve that. The second thing is that we've been able to deploy a lot of capital. Beth mentioned 25% of our current book capitalization.

We're going to visit our current budget estimates. So, we are able to invest [Indiscernible] capital and maintain these solid returns, we would expect that our growth rate would be higher than the peers. These are three areas on slide 16. Slide 17 just shows our performance at the NYSE.

You could see most of these peers about 85% to 95% performance and then one year of 51 % and then average shareholder returns, you can see that on the right hand side, again, 15% this year, 8% last year.

So, we got us plenty high performance on the shareholder return, that's obviously driven by earnings per share growth and the ability to indemnify our opportunities out of the marketplace executing on these opportunities. Our disciplined approach reaching new heights slide 18, the key here is the start of the foundation at the bottom.

All this stuff that we're doing, we have a highly engaged fully base that thoroughly enjoys the work that we're doing. I hear it all the time from employees about how much they love company and a lot of that has to do with opportunity to give back to the communities that we're serving.

And just that enjoyment of helping individual people whether food bank stuff, whole series of things, -- all these different programs that are invest in people trying to help the community. And that's really lifted up more our engagement. It also includes safety and reliability.

Now, if we get the foundation, right -- the engagement strategies right, and our employees, what they need to really enjoy what they're doing, [Indiscernible] and they will just move up to the next level which is developing new business opportunities.

If we're not doing a good job on the foundation, then we have to spend more time working on the foundation as supposed to working on growing the company. And so I think that's been a critical component of us -- our growth and you can see the results, a lot of different awards.

Continue to build for the future, we're looking at this all the time, every year, we update our five-year strategic plan and the key thing there is to have aggressive -- to identify growth opportunities. So, we look at this, the left hand side strategic growth expand existing pipelines because of the low cost supplies.

So, [Indiscernible] people, we have every day we're getting support of our group. What that does, provides customers access to lower -- to lowest cost supplies and ensures liability. Next line down, leverage pipeline expertise preferred owner/operator pipeline systems, certain high growth and new markets.

You can see that, especially, when you're looking at what we've done thus far in Ohio, what you're seeing there with Western Florida, what you've seen on [Indiscernible] pipeline expansion you're seeing there. We're continuing to look for different places -- pipelines.

Expand market share, there are three targeted growth markets to profitable organic growth.

Essentially, once we've planned a foot -- put a footprint somewhere, we just look for opportunities around that footprint to continue to expand and I mentioned Northwest Florida, that's a good example where we know there's opportunities on that pipeline -- or just off that pipeline that we'll be developing over the years.

You get the pipeline in place, provide service initially and then you have all these opportunities that exist to grow. Same thing in Spark Energy, Ohio, same types of opportunities exist and so, obviously, we've got a pretty good footprint here and the same thing there. Chesapeake is a full service energy supplier for providing customer-centric model.

Essentially, what we're trying to do there, we have a propane company here on the [Indiscernible] natural gas company and customers, obviously, is looking for the lowest cost energy supply. And so we're trying to be flexible with those customers.

And for a propane company, finds an opportunity to service serve someone, they're hesitating because they're waiting for natural gas service. Propane company is just front -- you need natural gas, it's available and we'll work with you on getting that taken care of.

And that actually helped us get to Lewes, Delaware couple of years ago with a customer there. With that, I will open it up to questions..

[Operator Instructions] And your first question is from Spencer Joyce..

Hi, Beth, good morning..

Good morning Spencer..

Good morning..

Just a few quick ones from me. First I want to talk about the ARM Energy Management purchase that was just announced this week. I know you gave some color on the operations there and some of the rationale.

But Beth, perhaps from a financial standpoint, can you just shed a little might maybe on the purchase consideration there? Or just maybe in very rough terms, what kind of margin or operating impact we might expect to see, just incremental work in that acquisition announced?.

Spencer, this particular acquisition, as I mentioned in the beginning is rather small. But it also really complement what PESCO does. The base purchase price of this business was just a little bit over $10 million..

Okay. Perfect. Also kind of sticking to the financing side, am I correct the full short-term availability to Chesapeake is just the $330 million.

Is that, right?.

That's right. We have $330 million and of that $330 million, $150 million is the revolver, and then the balance price are lines of credit that we have with the financial institutions..

Okay, great.

Then finally just kind of broadly, could either of you all discuss kind of how the first half of the year has stacked up versus your initial internal expectations? I know the EPS was a little light versus kind of what we're looking for here on The Street, not that that's your problem necessary, but I'm just wondering kind of some of the puts and takes.

I know it's been a pretty good, exciting first half of the year.

But you just kind of open-ended there, how is the first half of the year gone versus how you had hoped or expected?.

We sort of in the first half of the year, we did have the warm weather that came into play. And also we've been ramping up some our cost structure. And I think the combination of that warm weather and the cost structure ramp up, obviously, disappointed us.

But its -- we've stayed with the plan to maintain our growth and [Indiscernible] accelerate that growth. And I guess that's a lot of detailed knowledge obviously I can talk about. But I think when you look at overall, we've had 10 years in a row of record earnings, and so we like that to be 11 and we haven't given up on that.

But we've had 10 years of record earnings. So, we're sitting here half of this year, nothing higher than last year, anytime that happens, we're going to be in a place where we're going to be pushing things very hard to see what we can do to make any adjustments necessary to continue that record. So, I guess that [Indiscernible]..

Sure. I would say one of the things, Spencer that I've alluded to earlier, last year we did the equity issuance, and we did it at a time not knowing what the market expectations for this year around the political election and also at that time with the different expectations in terms of the timing of the 2017 expansion project.

So, those two things we were [Indiscernible] and I think we -- it was a great issuance and it was right thing to do. But I would say it was probably a little bit in advance of where the ultimate 2017 expansion project will come in.

Having said that, though, as Mike pointed to, we have had the cost ramp, we've had tremendous growth going on with Eight Flags with Eastern Shore doing two projects this year.

But in the middle of our rate case and then also the 2017 expansion project on the heels [ph] of that and so there's been in my mind, that you're going to start to see us, as I mentioned, the margin growth and the expense growth, I would say, the expense declining as the margin growth begins accelerating, and completely come out of the third and into the fourth quarter, that's the expectation.

And then you have the bigger ramp as our slides show, as you have the 2017 system expansion next year. That alone adding just to almost $9 million in one year from that one project is significant. And had it occur this year, it would be -- as Mike mentioned, we would be in a slightly different place.

But we're committed to, as Mike mentioned, trying to look and hopefully accomplish our 11th year of record earnings and we're focused on our margin growth across the company..

Okay. So, I mean, just kind of setting the EPS here year-to-date aside. I mean it's fair to say that, operationally, the progress that you've made is sufficient to support kind of how you see in the company in, say, 2019 and 2020 and kind of the multi-year planning horizon? I mean the first half has been adequately constructive, if you will..

Yes, for 2019 and 2020, I think we're in a very good shape..

Okay. Sounds good. That's all I had. Thanks for taking the call..

Thanks Spencer..

[Operator Instructions] And our next question is from Sarah Akers..

One level of intern rate increase that you were implementing at Eastern Shore relative to that $18.9 million requests?.

We are -- Sarah, that's something that we're still discussing at this time again. We'll have more information certainly as we come through the third quarter. But we, as a team, are looking at that. And as we mentioned in our disclosures, we're in the midst of a settlement discussions right now..

Okay, got it. And then just to clarify your comments on O&M.

So, should we model O&M increases in the second half of the year similar to the 15% increase in the first half? Or would you expect that to materially come down in terms of the second half O&M growth?.

Based on with those products coming on and we have had coming from the first quarter into the second quarter, you saw a decline as we came out of first and as we came into the second and our goal, as I mentioned, hopefully those two start to converge and align more so that cash should continue Sarah..

Okay.

And then lastly, Beth, should we take your comments on the balance sheet to mean that you won't need equity to fund next year's capital budget?.

We're doing right now, Sarah. We -- also those were in our annual budget process and I would tell you that in our last year's budget process, it was basically borderline, probably looked at ask whether or not we needed any additional equity capital.

At this time, we're updating those numbers and those budgets, but if there's big projects that come down the pipe, certainly we would access the markets necessary what Tom and I need to take a look at those and we do have operating cash flows today that's anywhere between $90 million and $100 million of operating cash flow that's going to come in and be available.

So, that's going to fund the first $100 million or so of capital and then depending on the level, we'll go out in the permanent market if that's necessary. Right now, what I know is from last year and what I'm hearing, I would not expect us to be accessing those equity markets at this time, but we'll let you know once we get through that process..

Great. Thanks a lot..

Thanks Sarah..

Thank you..

[Operator Instructions] And now we will pass this conference over to Mike McMasters..

Thank you. I want to thank everyone for your continued interest and support of the company. We are not leaving and our efforts to grow our company and also to drive the shareholder value. Thank you very much..

And this does conclude our today's conference. You may now disconnect..