Beth Cooper - Senior Vice President, Chief Financial Officer & Assistant Secretary Michael McMasters - President & Chief Executive Officer.

Insoo Kim - RBC capital Markets Tate Sullivan - Sidoti & Company.

Good morning. My name is Nicola, and I will be your conference operator today. At this time, I would like to welcome everyone to the First Quarter Earnings Chesapeake Utilities Corporation 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. Beth Cooper, you may begin your call..

Good morning, everyone. And once again, as Nicola mentioned, we’d like to welcome you to the first quarter earnings conference call. We appreciate you joining us today. On the call with me today will be Mike McMasters, President and CEO. We also have other members of our team joining us in the room today.

And today’s call is being hosted from Dover, Delaware, live from the company’s corporate office. Turning to Slide 2, before we begin, I would like to remind everyone on the call that today’s call will include a discussion of some forward-looking information.

Please refer to our 2017 Annual Report on Form 10-K for discussion of risk factors that could cause our results to actually differ from this forward-looking information. You will note in the presentation today that our discussion includes certain non-GAAP measures including, but not limited to, gross margin and adjusted EPS.

We have described on Slide 2 why these and other non-GAAP items are meaningful from our perspective as we review and discuss our performance. Now I would like to turn the call over to Mike McMasters, President and CEO, and he’ll briefly talk about the first quarter highlights..

Thanks, Beth. This first quarter highlights our adjusted GAAP earnings per share of $1.64 for the first quarter of 2018, compared to $1.17 for the first quarter of 2017. It’s a 40% increase in the first quarter earnings, the most profitable quarter in the company’s history.

We achieved growth across the business units led by Propane, Eastern Shore Natural Gas, Natural Gas and Electric Distribution, and Aspire Energy. The Board of Directors declared a 13.8% dividend increase, reflecting strong growth and lower income tax rate.

Regulated business units served $3.2 million in estimated, excuse me, reserved, $3.2 million in estimated refunds for customers due to lower tax rates. Eastern Shore and Florida expansion major projects are under construction.

Regulated Distribution and Transmission growth and Eastern Shore rate settlement generated $0.15 and $0.13, $0.15 for growth and $0.13 for the settled rates. In Propane and Aspire Energy, growth of $0.07, net impact of lower rates of $0.10, generated $0.17 increase in earnings per share.

Colder weather, although still warmer than normal by $1.7 million, or $0.07 a share, generated $0.17. Lower contribution from PESCO, negative $0.10 and higher depreciation operating expenses and interest to support growth, negative $0.09. I’ll turn it back to Beth..

$0.10 is generated from our Unregulated Energy segment; and $0.14, which has an offset as shown on the slide in conjunction with that estimated reserve for customer refunds to our regulated customers.

Moving on to Slide 6, we’ve provided a reconciliation in terms of our reported GAAP EPS and what we refer to as our adjusted non-GAAP earnings per share.

The adjusted non-GAAP earnings per share includes a $0.24 per share mark-to-market adjustment associated with the unrealized loss that we recognized in the fourth quarter of 2017 and a large portion of which was the exception of $300,000 we saw reverse in the first quarter of this year.

With the results that we’ve seen coming out of the first quarter, we continue to affirm our previous year-end guidance in regards to our expectations for 2018 earnings per share, and we basically affirmed a 17% plus EPS growth over the 2017 adjusted EPS of $2.89 per share.

Moving on to Slide 7, it’s been important to us as a company to continue to have the balance sheet that will support our future growth in terms of new incremental investments. At the end of March, you will see that our balance sheet included total capitalization of just under $1 billion at $966 million.

In terms of the equity to capitalization -- in terms of total capitalization, equity to total capitalization represented approximately 52% and equity to permanent capitalization represented 69.5%. During the month of May, we’re undertaking our first of two long-term debt placements that we will fund this year.

That $50 million will increase the amount of long-term debt we have outstanding by reducing the amount of short-term debt currently on our books, and therefore increase our equity to permanent capitalization to 62.6% on a pro forma basis. Overall, as a company, we continue to target an equity to total capitalization ratio of 50% to 60%.

Moving on to Slide 8, we have an update on this slide in regards to our tax reform discussions with our various regulatory authorities. And on the left-hand side, you will see that we basically laid out each of our regulatory jurisdictions.

And as of the end of March, the amount of dollars that we basically established as a reserve for refund to our customers. Beginning in Florida, our limited proceeding that was finalized at the end of 2017 actually includes provisions in it with regards to the amount and timing of the customer refunds, and those are to occur within 120 days.

On the natural gas side, dockets have been opened up by the PSC related to our gas operations, but no hearing dates have been set at this time. On the Delaware side, we have filed our preliminary estimated impact of the tax reform with the proposed rate schedules. At this point, no procedural schedule has been designated.

In Maryland, on April 25, the PSC actually issued an order and established that as of May 1, 2018, the new rates would go into effect, reflecting the tax reform. And that would also include basically a one-time credit associated with the months from January through April.

And lastly, in terms of our pipeline operations for Eastern Shore, the settlement rates that were established and negotiated and finalized reflects a change in the federal corporate income tax rate and as it relates to any deferred tax liabilities, those will be handled in our next rate case.

On Slide 9, we have forecasted this year that our CapEx will continue the patterns that we have seen over the last couple of years. We expect to spend approximately $182 million.

Through the first quarter if March, we have actually expended $63 million or about one-third of that total amount, so we still feel that this preliminary estimate is a very likely outcome for the year.

As you look at over the last six years, you will see at this company that we’ve expended close to $1 billion and actually as a result of those investments you’ve seen our total capitalizations doubled. Moving on to Slide 10, we provided an update in regards to the gross margin and our estimates of that impact from the investments that we’re making.

In the first quarter, these investments and these initiatives generated an incremental $5 million of margin, recall out of that $10 million of overall margin growth that we saw in the first quarter.

As we look at the year, our expectation is that these projects will add an incremental $21 million to 2017 and then 2018, as compared to 2019 there will an additional $11 million generated from these projects. The $32 million of incremental margin over the 2018 to 2019 time span from the investments that are already underway.

And now I’m going to turn it over to Mike who is going to talk in detail about some of these projects..

Thanks Beth. Turning to Slide 11, I’ll talk about Eastern Shore Natural Gas, as you know we’ve been working on system expansion project for quite some time. We expect this to go in service some time during this next year. It’s $117 million project, 60,000 dekatherms per day.

The project is approximately displays our total investment excuse me, in Eastern Shore about five times what it was back in 1998, some 20 years ago. It’s got 23 miles of pipeline looping, 17 miles of mainline extension, 3750 horsepower of new compression and 25% more capacity. Estimated annual gross margin is $15,800,000.

Turning to Slide 12, in Florida the Northwest Pipeline Expansion is now in service, it’s a $36 million capital investment, $6 million of estimated annual gross margin.

New Smyrna project, one slide below that or one layer below that, $9.1 million capital investment, $1.4 million of estimated annual gross margin, fully in service in September of 2018, 14 miles of transmitted pipeline.

Belvedere Pipeline Expansion is $3.8 million of capital expenditures, $1.1 million if estimated annual gross margin, expected to be in service end of the third quarter of 2018 and has 2 miles of pipeline. Moving to Slide 13, to talk about our propane operations a little bit.

Our propane delivery operations additional customer consumption related to weather increased gross margin by $1,956,000. The increased margin driven by growth and other factors $1,392,000; and the margin, propane margin and sales $379,000, all of this is based on the warmer weather as I mentioned earlier.

We continue to execute our multi-pronged growth strategy in the propane operations.

Organic growth, expanded growth in new territories, acquisition opportunities, targeted marketing to commercial and industrial customers to convert to propane, we’re targeting new community gas systems with high growth areas, the expansion of propane vehicular platform through Sharp AutoGas.

Our propane business units provide a higher return on capital than we can get on the regulated operations. We have approximately 54,500 customers. We have 800 independent customer vehicles at 42 field explorations in Delaware, Maryland, and Pennsylvania. Turning to Slide 14.

PESCO’s Natural Gas Marketing, just a real brief summary of what sort of last year with the weather or actually December and January with the weather. As indicated by the graph, if you look at the lowest line on the graph, that is basically the cost of capacity, our cost of gas from both Mount Belvieu and also M2 in Ohio.

The other lines on the graph are closer to southeastern Pennsylvania and you can see the dramatic increase that we saw in two days in the last month or in January. PESCO Natural Gas Marketing on Slide 15, PESCO first quarter of 2017 $3,467 top [ph], $3,467,000. The reversal at unrealized mark-to-market loss ticked up $5.7 million.

And then from supply agreement not renewed down $2.1 million; the impact of Mid Atlantic wholesale portfolio $3.3 million; and then a loss at Mid Atlantic retail portfolio by $2.3 million. Also resulting in an increase, or excuse me, in total margin of $1,175,000 for the first quarter.

We have taken some action to address some of the events that we’ve seen in the first quarter. We have reassessed our peak-day demand analysis and stress tested it under more extreme weather conditions. We’ve modified our capacity management and operational plans.

We secured firm transportation and/or delivered dekatherms to mitigate interstate pipeline operational constraints that we have experienced. Actions taken improved February and March results have better positioned us for the remainder of 2018. We’ve also enhancements our risk management policy.

Turning to Slide 16, Slide 16 recaps really some of the, I guess, the key indicators that can help determine the weather and how we are performing. When you look at this graph, you’ll see on the top right hand side Chesapeake Utilities.

If you look down, you’ll we are running at about 24.5%, 25% of investment in new capital relative to our total capitalization. And you can also see that we are running at 12% approximately ROE and both of those numbers are above median and contribute to our – that will explain our success in earnings per share growth. Shareholder return on Slide 17.

If you look at the left hand side, annualized total shareholder returns for performance peer group, you saw from of the right hand side of that a 14% 20-year number paying 14%, significantly higher than 75th percentile and higher than the median. The 10-year 17% total shareholder returns and 14% of 75th percentile still above that.

50-year the same results, 24% total shareholder return, 21% 75th percentile and then 19%, and 19% for the three year and the one year in terms of total shareholder return.

And you’ll see that over the time period as you get closer to this current year, you’ll see that the peers have increased their total shareholder return thus tightening that bandwidth. Dividend growth on Slide 18. You can see on the dividend growth starting in 2008 $0.81 a share, increasing to $1.48 a share in 2018, significant increases.

$1.48 annualized dividend per share in 2018 is a result of a positive energy of our teams track record in delivering superior earnings growth. This year’s annualized increase of $0.18 per share or a 13.8% also reflects the positive impact of the Tax Cuts and Job Act on earnings from our unregulated businesses.

Chesapeake’s five-year annualized dividend growth rate is 7.6%, in line with our five-year CAGR in adjusted earnings through 2017 of 7.7%. Our goal remains to provide above average growth in dividends, supported by our engaged team, continued disciplined approach to investment opportunities and the resulting strong earnings per share growth.

Turning to Slide 19. We are proud of our track record of identifying strategic opportunities and producing superior total returns driven by earnings and dividend growth. We are energized by our team, our strategy and execution, our financial operating performance and our future growth plans and objectives.

This is the result of our excellent team and culture that values both capital discipline and entrepreneurship. We’re driven to find innovative ways to serve our customers, while honoring our obligation to operate in a safe and environmentally responsible manner and to provide investors a competitive return on their investments with us.

With that, we’ll open it up for questions..

[Operator instructions]. Your first question comes from the line of Insoo Kim from RBC Capital Markets. Your line is open..

Hey, good morning, everyone..

Good morning..

Good morning..

Maybe just starting with the PESCO business. Understood – I understand, there were various moving parts, including significant weather that impacted the quarter on a year-over-year basis. But I know – I saw that you did have a negative impact from a supply contract that was not renewed.

Is this just part of the normal volatility of the business as contracts roll off and you sign huge contracts or is there something else that we should be aware of?.

No, it’s a normal part of the business. So we had a one-year contract and when we got – when we rebuild this year, we drew a line on the sand where we want to go and decided not to go any further than that, and so that was – that’s what’s happening there just basically having the discipline to walk away from the contract, it wasn’t the right price..

Understood. And then just looking at your CapEx, obviously, you guys mentioned how CapEx has been very robust, especially the past few years.

How much visibility do you see in the pipeline of projects in the next few years or so to give you any sense of whether that level should continue or if this has been more not an anomaly per se, but just a period of higher growth versus what you should – what we should see on a normal basis?.

Yes, I would say, Insoo, there – there’s multiple project opportunities that we’re looking at the present time. We haven’t formalized that number for 2019. But our goal was, hopefully, for it to be at a level that approximates that. But at this time, we – those projects are still coming to fruition.

I think, the important thing that we – that hopefully, we got across also is that, when you look at our margin table even for this first quarter, when you think about us as a company, there’s organic growth, there’s growth in the unregulated businesses, and there are lots of pieces that are seeding that gross margin growth that the company is achieving.

But certainly, a lot of projects in the pipeline, a lot of projects that we’re pursuing and hopefully, we’ll be providing some more information as those projects gets finalized..

Yes, this isn’t a really unusual for us. Every year, just about every quarter, just about – when you look at it, you will see a little fall off on the second year. And so it’s not unusual, it’s something we have to work on all the time..

Right, right. Yes, I understand. And then perhaps, lastly, I guess, in hindsight, it definitely makes sense, impressive dividend growth that you guys just announced at maybe close to 14% given the various items driving robust year-over-year growth in 2018, as expected.

Are you – but I guess, given this is kind of a jump in EPS unlike some of the other years we’ve seen, are you still sticking to – I believe it was the low 40s in terms of a payout ratio longer term, or are you thinking that maybe that could trend higher?.

Yes..

Well, I guess, we’re thinking somewhere between 45% and 50% payout. We typically have been growing at a rate higher than we expected, and so it’s been diluted down to the 40%. But we’re trying to get to the – we’re trying to be around the 45 to 50.

The key there is that at below 50% that we’re basically getting higher EPS growth than we’re in dividend growth. And so, as long as we can maintain that dividend, that EPS growth at rates that are that high, then we’ll be able to keep dividends fairly high. But again, it’s just something we look at every year.

We assess and spend a lot of time actually just going through this and studying whether we’ve got the right numbers and we feel good about where we are..

Got it. Thank you. That was it. Congratulations on a great quarter..

Thank you..

Thank you, Insoo..

Your next question comes from the line of Tate Sullivan from Sidoti. Your line is open..

Hi, thank you, thanks for taking my question. Beth, can we talk about the unregulated energy operating income result of $13.7 million in the first quarter. But then I think, it was – the previous quarter you backed out the mark-to-market change from that number….

Yes..

…in terms of PESCO.

Is that available, or did I miss that?.

No, you’re correct. In the fourth quarter, we actually – when we looked at adjusted earnings per share, we made an adjustment to look at our results and that’s where I spoke about the $2.89. That includes – basically, that include or excludes both the tax reform impact of last year as well as the unrealized loss.

And so then this year, what we did in – when we came out of the first quarter was we felt from a purpose – we needed to also remove that from the first quarter results, because it’s really just a timing issue between the fourth quarter and the first quarter..

Okay.

Do you have an -- adjusted for that mark-to-market, do you have an adjusted operating income margin for your Unregulated segment though? I think it was 10.5% in the first quarter?.

We have not looked at it like that, because when you think about that business as we talked about earlier. When Mike went through the results of that particular business, there are factors each year contracts that are and maybe not being renewed new ones that are being added.

But overall from this business standpoint, Tate, one of the things that Mike mentioned in his comments is that, when it comes to our unregulated businesses, our goal is to earn returns that are going to be above those that we can generate on the regulated side. And that continues to be the case across the portfolio of unregulated businesses..

Okay. Yes, I’ll have to take a better look at how I forecast the operating income margin for the unregulated energy piece. I’m just trying to get back out the mark-to-market and sort of see what is sustainable basis. Okay, thank you very much..

Thank you..

[Operator Instructions] There are no further questions at this time. I turn the call back over to the presenters..

Well, thank you very much, everyone. Thank you for your continued interest and support in our company. Our engaged employees are committed to providing safe realizable service and our continued growth. Thank you, again, and have a great weekend..

Thank you. Bye-bye..

This concludes today’s conference call. You may now disconnect..