Northwestern Energy Group Inc (NWE) Q4 2011 Earnings Report, Transcript and Summary

Good morning, and welcome to the Northwest Natural Gas Fourth Quarter and 2011 Financial Results Conference Call. [Operator Instructions] Please note, this event is being recorded. I would now like to turn the conference over to Bob Hess. Please go ahead, sir.

Thank you, Laura. Good morning, and welcome to our full year and fourth quarter earnings call for 2011. As a reminder, some of the things that will be said this morning contain forward-looking statements. They are based on management's assumptions, which may or may not come true, and you should refer to the language at the end of our press release for the appropriate cautionary statements and also our SEC filings for additional information. We expect to file our 10-K later today. This teleconference is being recorded and will be available on our website following the call as mentioned. Please note that these conference calls are designed for the financial community. If you are an individual investor and have questions, please contact me directly at 1(800)422-4012, extension 2388. Speaking this morning are Gregg Kantor, President and Chief Executive Officer; and David Anderson, Senior Vice President and Chief Financial Officer. Gregg and David have some opening remarks and then will be available to answer your questions. With that brief introduction, let me turn you over to Gregg.

Thanks, Bob. Good morning, everyone, and welcome. Thanks for joining us for our fourth quarter and year-end review. I'll begin today by providing an overview of 2011, and then turn it over to David to provide the financial details for the period and the year. And then, finally, I'll wrap it up with a look forward. Last year, we made progress on many fronts, from safety and service to the Encana gas reserves purchase. Our company finished the year stronger than it started. In one area, however, the news wasn't as good. In the second quarter, we announced a onetime after-tax charge of $4.4 million related to a retroactive change in Oregon's utility tax law. Including that charge, the company posted earnings of $2.39 per share. While the earnings impact of this repeal was disappointing, we believe the elimination of Senate Bill 408 is in the best interest of our customers and the company over the long run. The new law reverts back to having utility income taxes considered by state regulators in each rate case, a practice consistent with other utilities across the country. Last year was a good reminder of what this company does well. We manage through unexpected challenges while finding added value for customers and shareholders. It wasn't a perfect year, but I'm pleased with all that was accomplished. For example, in 2011, we were able to lower customer rates for the third consecutive year due to lower gas prices, resulting in about a 20% rate decrease in Oregon and about a 26% decrease in Washington over the last 3 years. Customer growth came in at just under 1% despite challenging housing market conditions, and we continue to post industry-leading customer satisfaction ratings. In fact, for the fifth consecutive year, Northwest Natural scored among the top 2 in the nation in the J.D. Power & Associates Gas Utility Residential Customer Satisfaction Study. Hand in hand with providing superior service is ensuring a safe, reliable system. In 2011, we built on our proactive approach to pipeline and system safety by expanding the number of our employee first responders. Today, I'm pleased to report that we have essentially 100% of our field service and construction employees trained and able to respond to emergency situations. In the year when new pipeline safety legislation was passed at the federal level, we feel good about the safety investments we've made in our system over many decades. As you may know, in 2000, we became one of the first gas utilities in the nation to replace all the cast iron pipe in our system. While many gas utilities across the country have thousands of miles of bare steel main, we have less than 26 miles left in our system and expect to eliminate it completely over the next few years. The progress we've made because of our pipe replacement program is a testament to positive outcomes that can be achieved when you work with regulators and customer advocates to find opportunities that benefit both customers and shareholders. Another example of this came in the form of a groundbreaking agreement we entered into with Encana Oil & Gas that enables us to acquire long-term gas supplies on behalf of our Oregon customers. Under the agreement we announced last year, Northwest Natural will invest between $45 million and $55 million a year for 5 years, for a total investment of about $250 million. The agreement is designed to provide supplies over a 30-year period for customers in a rate-based investment, with a utility risk profile for shareholders. And in 2011, our gas reserve investment reached about $52 million. And to date, we are pleased with how things are progressing. Last year, 20 wells were drilled, and we are on schedule to drill an additional 24 wells in 2012. We view our gas reserve investment as a great example of a win-win opportunity for customers and shareholders. And in 2012, we intend to actively search for other innovations that meet that same criteria. In December, we completed 1 additional critical task to close out the year. We filed our first general rate case since 2002. Timing of our filing was influenced by a number of factors, after approving the gas reserve investment that commissioned one of the opportunity to review our rates. Also, our decoupling, weather normalization and system integrity mechanisms were due to expire and needed to be renewed. And finally, after 9 years without a rate case, our cost had increased. We're proud to have managed our business effectively so that we could avoid an increase on our rates for that long. But after 9 years, it was simply time to have that across-the-board discussion with the commission and the customer advocates that can only come in the context of a rate case. The $44 million revenue request will help us ensure we continue to meet customer expectations for a safe, reliable system and quality service, while providing a fair return for our shareholders. Separate from the revenue request, we are also proposing a mechanism to recover cost of cleanup expenses related to our legacy manufactured gas plants. The proposal would collect in rates only those costs that insurance does not cover and would do so over many years to lessen the impact on customer bills. This mechanism could result in an additional 1% to 3% rate increase depending on insurance recovery collections and cleanup costs that occurred between now and the date that the new rates take effect. Employees from across the company spent countless hours last year preparing for our rate case filing, but the work is really just beginning. And I'll talk more about the rate case schedule before I wrap up today. Finally, let me touch on 1 more 2011 accomplishment, important to shareholders, and that's delivering the 56th consecutive year of increasing dividends paid. The record we know sets us apart from other companies, and it's a legacy we're very proud of. With that, I'll turn it over to David to cover the financial details.

Thanks, Gregg, and good morning, everybody. Let me start with full-year results for the period ended December 31. Net income was approximately $64 million or $2.39 per share. This compares to net income of $73 million or $2.73 per share in 2010. Our utility operations contributed $61 million of net income compared to $66 million in 2010. The major factor contributing to this decline was a $50 million reduction in utility net operating revenues or what many people call utility margin from utility tax legislation, which includes a $7.4 million of charge taken in the second quarter of 2011, plus the $7.7 million getting recognized in 2010. Senate Bill 408 was the Oregon utility tax legislation which was repealed in 2011 with a retroactive impact that affected amounts earned in 2010. This utility margin loss was partially offset by an $11 million margin gain from residential and commercial customers, driven by colder weather and customer growth. Gas storage contributed net income of $4 million in 2011 compared to $6 million in 2010, and that decline is due primarily to lower storage values. Operating results from our non-utility investments and activities in 2011 resulted in a net loss of $0.02 per share compared to net income of $0.01 per share in 2010. The difference primarily reflects a pre-tax charge of $1.3 million related to a partial write-down of the company's investment in the Palomar pipeline project. As mentioned before, Oregon's gas utilities, including Northwest Natural, are subject to an annual earnings review to determine if the utility is earning above its allowed return on equity. In our case, if utility earnings exceed the ROE threshold from the last rate case, the company is required to defer 33% of the amount above that level for refund to customers in the following year. For 2011, the company has estimated a refund of approximately $1.5 million to Oregon customers in next year's rates. Turning to operating results. Total gas deliveries in 2011 were 1.15 billion therms compared to 1.06 billion therms in 2010. The 9% increase over last year was due mainly to weather that was 9% colder than average and 12% colder than a year ago. Sales of gas for residential and commercial customers were 685 million therms in 2011, a 14% increase over 2010's 599 million therms. The increased consumption was due to colder weather and customer growth, including the effects from the company's Oregon rate mechanisms for weather and decoupling. Utility margin from residential and commercial customers was $316 million in 2011 compared to $304 million in 2010. Our weather normalization mechanisms in Oregon adjusted margin down by $13 million in 2011 based on weather that was 9% colder than average. This compared to a margin adjustment increase of $14 million in 2010 based on weather that was 2% warmer than average. The Oregon conservation decoupling mechanism adjusted margins up by $19 million in 2011 compared to a margin adjustment upward of $15 million in 2010. Gas deliveries to industrial customers were 468 million therms in 2011 compared to 463 million therms in 2010, with margin increasing $200,000 or 1%, which we believe reflects continued improvement in economic conditions. 2011 results from the company's regulatory incentive sharing mechanism in Oregon were higher in 2011 than in 2009, contributing $2.1 million margin in 2011 compared to a $1.6 million contribution in 2010. In Washington, 100% of higher or lower gas costs are passed through to customers. As reported in the second quarter, we reported a onetime charge of $7.4 million or $4.4 million after-tax or $0.17 per share when Senate Bill 967 was signed into law, which repealed 2005's Senate Bill 408 utility tax legislation. Operations and maintenance costs for 2011 were 4% higher than 2010 at $125 million compared to $121 million last year. The primary reason for the increase was the first full year of expenses at our Gill Ranch storage facility. Excluding Gill Ranch, utility O&M expenses increased approximately 1% from a year ago. 2010 also benefited from an after-tax gain of approximately $3.6 million or $0.14 per share for the refund of property taxes from an Oregon tax appeal ruling. Cash provided by operations in 2011 was $233 million compared to $126 million in 2010. The increase was mainly due to gas cost savings, income tax benefits from bonus depreciation and insurance recoveries related to environmental cleanup costs. Cash requirements for investing activities in 2011 were $153 million compared to $213 million in 2010, with most of the decrease related to developmental costs at Gill Ranch in 2010. After capital expenditures and dividends, the company generated free cash flow of around $34 million in 2011. During 2011, Northwest Natural's utilities successfully refinanced long-term debt at historically low rates, funded capital expenditure requirements and successfully financed a portion of the Gill Ranch storage facility with long-term debt. Now let me briefly review fourth quarter results. For the fourth quarter, net income was approximately $29 million versus approximately $30 million in 2010. The slightly lower results were driven by higher O&M, the Palomar impairment charge and the Oregon earnings adjustment, somewhat offset by higher sales from colder weather and customer growth. Weather for the quarter was 4% colder than average and 7% colder than last year. Utility operations contributed net income of approximately $29 million compared to $30 million in 2010. Gas storage operations contributed net income of around $1 million compared to $300,000 loss in 2010. Total gas sales and transportation deliveries in the fourth quarter, excluding gas stored for others, increased 5% to 350 million therms compared to 333 million therms in 2010. The increase was due primarily to weather that was colder than last year. Margin from utility operations was approximately $113 million compared to $112 million in 2010. Residential and commercial sales from the fourth quarter were 226 million therms or 7% higher than 210 million therms a year ago. Our weather normalization mechanism in Oregon adjusted margin down by $2.5 million in the quarter based on weather that was 4% colder than average. This compared to a margin increase of $2.4 million in the fourth quarter of 2010 when weather was 2% warmer than average. In addition, the decoupling mechanism in Oregon adjusted margin up by $8.5 million in 2011 compared to a margin increase of $7.5 million in 2010. Industrial sales and transportation deliveries in the fourth quarter of 2011 were 125 million therms, up 2% from 123 million therms in 2010. O&M expenses for the 2011 quarter were 1% higher than in 2010. On December 30, we filed an Oregon general rate case with the Oregon PUC. As reported, we are proposing a rate increase of $43.7 million, which results in an increase of approximately 6% over current customer rates. This includes $15 million already in customer's current rates as a temporary rate adjustment for the decoupling mechanism. The overall rate increase is calculated on a total revenue requirement of $743 million, assuming a net rate base of approximately $984 million. Our proposed return on equity is 10.3% and an overall rate of return of 8.28%. This is based on a 50-50 equity debt structure. The test here in Oregon is November 2012 through October 2013. Key items in our requested revenue increase are $14 million for safety and customer service, as well as $7.2 million for pension recovery and $7.7 million for other O&M and cost of capital increases. Separate from the revenue increase request, the company is also proposing a mechanism to address environmental cleanup expenses related to legacy manufactured gas plant operations. The proposal would be to collect in rates only those costs that insurance does not recover over a multiyear period to lessen the impact on customers. This mechanism could result in an additional 1% to 3% rate increase depending on insurance recovery and cleanup project cost that occur between now and September 30, 2012. Turning to our 2012 earnings guidance. We initiated guidance today to be in the range of $2.35 per share to $2.55 per share. This guidance assumes a continued weak economic recovery, customer growth and normal weather conditions, ongoing benefits from improvements to our cost structure and no further significant changes in prevailing legislative and regulatory policies or outcomes. With that, I'll turn it back over to Gregg to wrap things up.

Thanks, David. Given what we've covered this morning, I think it's fair to characterize the landscape we've been operating in. It's a unique mixture of challenges and opportunities. Abundant natural gas supplies and lower prices have been good for utility customers and, frankly, for the company's satisfaction ratings. But lower and less volatile prices have driven storage values down, creating a challenging environment for our storage business. On the positive side, we've been pleased with the performance of our Gill Ranch facility in its first full year of operation, and we remain on track to reach our share of the design capacity of about 15 Bcf by the end of this year. Today, we are meeting our contracting plan for this year at Gill Ranch. In fact our capacity is almost all contracted out. And I would also say that the team has done a very good job of managing the facility's operating cost. Certainly, storage values today aren't where we'd like to see them, but given the projected demand for gas to serve electric generation in the West, we believe in our strategy and the value of storage over the long term. Looking forward into 2012, our focus on the storage business will remain consistent, execute on our operating plans and identify new commercial opportunities that take advantage of the growing reliance on natural gas, also this increasing dependency on gas for power generation in the Northwest that continues to drive the need for the Palomar pipeline. Last year, the Palomar team withdrew its FERC application, and at the same time, we announced plans to file a new application reflecting changes to the project. This year, our goal is to continue to work with Northwest utility to consolidate the region's effort around a single integrated solution using a shorter route, one that reduces the number of miles the pipeline crosses the Mt. Hood National Forest. We are also assessing the timing of an open season aimed at identifying enough shipper support to proceed with permitting process. With coal plants in Boardman, Oregon and Centralia, Washington beginning to shut down as soon as 2020, additional natural gas pipeline infrastructure to support base load electric facilities and to back up solar and wind generation is essential. The fact remains that today, during peak demand periods, the existing interstate pipeline serving the Northwest is at maximum capacity. We, along with many electric providers in the region, recognize that it's not a question of if additional pipeline capacities needed to serve the Northwest, but when. Looking ahead at our priorities for 2012, topping the list will be a successful outcome to our rate case. We now in May will be focused on responding to data request from the Oregon Public Utility Commission staff and working through initial settlement conferences with all the parties. By early May, we expect staff and interveners in the case to file their opening testimony. In summer, we'll entail our rebuttal for that testimony and more settlement discussions. If the case goes all the way, we'll be in front of the commissioners by early fall, with new rates effective no later than November 1. I know a number of you want to know how well I think we'll do in the case. Unfortunately, it's very early in the process, and it's impossible to predict the outcome. But I can tell you, I am extremely proud of how this company has performed since our last rate case. We streamlined operations and effectively managed our way through one of the worst economic recessions in American history, and at the same time, we actually increased customer satisfaction and improved on the safety of our system. And we did all this while keeping increases in our cost to serve customers below the rate of inflation. The bottom line is, we've managed our business well and done all we can to keep rates as low as possible. In fact, because of our cost control efforts and lower natural gas prices, even with this rate increase, our customers will be paying less for gas service than they did in 2005. As I said, I feel good about the way we've lived up to our commitments and how well we've performed in the midst of very difficult conditions. And I look forward to making our case to the commission and to the customer advocates. Thanks again for joining us today. And with that, I'll open it up for questions.

[Operator instructions] And our first question is from Dan Fidell of U.S. Capital Advisors.

Just a question, I guess, in terms of the fiscal '12 guidance number. Can you maybe just talk a little bit about the deltas you see for both the low end and the high end of the guidance range?

Yes, Dan. This is David. Obviously, probably the -- I would put it in 3 buckets. One would be the amount of gas cost savings or cost that we have right now. It does look like we are in the saving method, with gas prices being lower than we have set in our last PGA. The second piece of that would be storage values overall and how that plays out through the period of time. And then the third item would be the outcome of the rate case. The right case, I think Gregg mentioned in his remarks, should be done in rates in place November 1. And what we have -- obviously, that's only 2 months of revenue, but assuming what the outcome of that could have an impact either plus or minus on that guidance range or in that guidance range, the $0.20 guidance range.

Okay, great. And just for clarification, you are or you're not including any assumption for the outcome of the rate case for the 2012 guide?

The 2012 guidance, since it has a fairly -- so there's only 2 months in there, Dan. We're basically just assuming no impact from the rate case from the guidance.

Okay, great. And then in terms of the storage as we look into 2012, is there an assumption there for continuing falloff of kind of the initial startup cost, I guess, improvement on cost into '12?

Yes, that's correct. And we saw that in the fourth quarter. If you look at the fourth quarter numbers period-to-period, the O&M costs from the Gill Ranch facility are down, and there's really no different assumption on the storage pricing going forward other than a minor increase overall. So if the economics are better or storage pricing is better, that would be upside. Or if it's the other side, it would be a little bit of a downside.

Okay, great. Maybe just a final question from me switching topics just to the Encana and a potential layer on with commodity prices very cheap here. I was just wondering if and how that affects your potential timing to maybe go for a second round, maybe another 10% layer into the overall supply picture.

Dan, this is Gregg. Well, our first mission is to make sure that the current deal is working well, and so far, it has been. But we feel like we've got to put some time between the beginning of this first layer and the possibility of a second layer. You also need to have a tax appetite, which is important for the benefits of customers in the next deal. But I will tell you, we are -- we continue to look at it. I wouldn't expect anything this year, though, in the way of another layer. But we are continuing to look at it. And as you point out, gas prices are down. And if they continue to stay there, we will continue to look at layering in some -- an additional layer of gas reserves.

Yes, Dan, the tax appetite is an important comment because a lot of the economics or the IDCs and things like that, we get to take advantage of on the drilling side. And the real unknown right now, well, if the current administration is going to have another level of bonus depreciation. And as you know, utilities have been taken advantage of bonus depreciation for a while here. And I think most utilities would say we don't want anymore, and this utility would be in that camp. So that's one of the unknowns out there right now, because we couldn't take advantage of all the tax appetite that another transaction could bring because of our NOL situation. But we can probably in another year, depending on whether bonus depreciation goes forward or not.

Sure. Very last question. Just do you have a number for CapEx guide for '12?

We're probably a little over $100 million, rough number for us. I mean, obviously, the major capital expenditures are done with the Gill Ranch facility. So we're back into a little bit more of a normal mode. We do have some CapEx related to some investments we're making for some pipe and things like that. But we're a little bit over $100 million in a general sense.

[Operator Instructions]

It looks like we have James Bellessa.

This is actually Mike here with Jim. I have a couple of questions for you. I noticed that you're expecting Gill Ranch to be operating at or near its full capacity about a year earlier than anticipated. Can you give us any color as to where operations were in 2011?

Well, I've got Dave Weber here who is operating the facility. You don't get the full capacity of the storage reservoir that first year of operations. As you're injecting and pulling out, you're continuing to push the water out of the reservoir. So I've forgotten right now what -- we started the facility at in a way of Bcf capacity.

We went from 9 to 13, and now we're at 15.

Yes, we went from 9 to 13, and now we're headed towards 15.

All right. Great. I also wanted to ask you, in terms of pension expense, what are your expectations going into 2012 compared to last year?

Yes. First thing I will say is pension expenses are going up. This is Steve Feltz, sorry. But we do have a pension balancing account. So what you won't see is the increase in pension expenses in the O&M cost because we actually defer that into a regulatory account for future recovery. The balancing account works where what's included in the rates will be above or below that. And eventually, it will balance out, we expect, in 6 to 7 years.

So, I mean, to be more specific here, from an income statement perspective, Michael, you're really not going to see much difference because of this balancing account. We will be making contributions to the plan to bring it up, which we're looking at around $30 million of contributions. So the balancing account protects the income statement. We still have contributions we need to make to the plan from a cash flow perspective.

We show no further questions at this time. I'll turn the conference back over to management for closing remarks.

Okay. Well, thank you, all. I know this was a busy morning for other companies reporting, so we really appreciate you spending the time with us. And we'll be seeing you in a month ahead. Thanks for tuning in. Bye.

The conference is now concluded. Thank you for attending today's presentation. You may now disconnect.