Northwestern Energy Group Inc (NWE) Q3 2014 Earnings Report, Transcript and Summary

Good day, and welcome to the NorthWestern Corporation Third Quarter 2014 Financial Results Conference Call. Today’s conference is being recorded. At this time, I would like to turn the conference over to Mr. Travis Meyer. Please go ahead, sir.

Thank you, Shannon. Good afternoon and thank you for joining NorthWestern Corporation’s financial results conference call and webcast for the quarter ended September 30, 2014. NorthWestern’s results have been released and the release is available on our website at www.northwesternenergy.com. We also released our 10-Q pre-market this morning. Presenting today are Bob Rowe, President and Chief Executive Officer; and Brian Bird, Vice President and Chief Financial Officer. Also joining us around the table today we have several members of the executive team and they are available for questions as well as we go through this. Before I turn the call over for us to begin, please note that the Company’s press release, this presentation, comments by presenters and responses to your questions may contain forward-looking statements. As such, I need to remind you of our Safe Harbor language. During the course of this presentation, there will be forward-looking statements within the meaning of the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995. Forward-looking statements often address our expected future business and financial performance and often contains words such as expects, anticipates, intends, plans, believes, seeks or will. The information in this presentation is based upon our current expectations as of this date hereof unless otherwise noted. Our actual future business and financial performance may differ materially and adversely from our expectations expressed in any forward-looking statements. We undertake no obligation to revise or publicly update our forward-looking statements or this presentation for any reason. Although our expectations and beliefs are based upon reasonable assumptions, actual results may differ materially. The factors that may affect our results are listed in certain of our press releases and disclosed in our Company’s 10-Q, which we filed with the SEC this morning, and other public filings with the SEC. Following our presentation, those who are joining us by teleconference will be able to ask questions. The archived replay of today’s webcast will be available beginning at 6:00 PM Eastern Time today and can be found on our website at www.northwesternenergy.com under the Our Company, Investor Relations, Presentations and Webcasts link. To access the audio replay of the call, dial (888)-203-1112, then access code 2111100. Again, that’s (888)-203-1112, access code 2111100. I’ll now turn it over to our President and CEO, Bob Rowe.

Thank you very much. Obviously the biggest news for the quarter was Montana Public Service Commission’s historic approval of our application to dedicate hydroelectric facilities we are proposing to acquire to our Montana customers. I am tempted to stop right there, but I would also note that we achieved non-GAAP adjusted gross margin improvement of 2.1% for the third quarter as compared to 2013. Year-to-date non-GAAP adjusted gross margin was up 5.6%. We achieved improvement of net income of about 14.6 million as compared with the same period for 2013 and that was due primarily to the release of an unrecognized tax benefit and a tax method change resulting in an income tax benefit of 18.4 million in the third quarter of 2014. Our Board of Directors declared a quarterly stock dividend of $0.40 per share payable on December 31st of this year. Also notable, Public Utilities Fortnightly released its Fortnightly 40 and we moved up from 38th place to 36th. And as you all know, that’s notable because that’s based on multiple years of performance. So we’re very pleased to be included in the top 40 and certainly pleased with the movement as well. So, I’ll turn it over to Mr. Bird to walk through the financial results. Brian?

Thanks, Bob. On Page five we show summary financial results for both three months ending September 30 and nine months ended September 30. For the three months ended September 30, '14 versus '13, on net income we had 30.2 million of net income for the three months ended September 30, 2014 versus 15.6 million the prior year’s quarter. That was really [drived] (sic) by relatively flat gross margin on a year-over-year basis, flat operating expenses on a year-over-year basis, resulting of course in flat operating income. I’ll get into certainly more detail on each of these matters in a moment. Below operating though, we had increases in interest expense and reductions in other income that were more than offset by the improvement in income tax benefits that Bob just suggested, resulting in the benefit on a year-over-year basis in net income. On a EPS perspective, diluted earnings per share were $0.77 for the three months ended September 30, 2014 versus $0.40 from the prior year’s period. For the nine-month period ended September 30, 2014, net income of 83.5 million compared to 67.9 million from the prior year. Here I’ll start really talking about from an operating income perspective with the 127.4 million through the nine months this year versus 121.1 million through the nine months 2013. That’s primarily -- that improvement on a period-over-period is primarily due to the strong first quarter that we had. And I think people realize our first quarter is approximately 40% to 45% of our earnings for the year and a big driver was the strong first quarter that we had in those results. Below low operating income, we did have again higher interest expense. As I will point out in a minute, that higher interest expense is really associated with hydro bridge facility that…

Brian, everyone on this call has quit by now.

Moving to Page 8, operating income to net income. At the top of the page we note operating income of 31 million in three months ended September 30, 2014 versus the 31.4 million. Note the variance there. But below that, our interest expenses were up 1.7 million and interest expense quarter-over-quarter of about 1.9 million of that was associated with the expense from the bridge facility associated with the hydro transaction. So otherwise interest expense right in line with the year-over-year basis. And the other expense or other income component, our other income was down 3.5 million. Again, all of that was really attributed to the decrease associated with the 3.6 million reduction in the value of our deferred shares held in trust for non-employee directors deferred comp that is impacted by changes in our share price. And then lastly, from the income tax benefit, and I’ll go into more detail on this in a moment, but there was a $20.3 million improvement on a quarter-over-quarter in income taxes, 12.6 million of that associated with previously unrecognized tax benefits. The release have been 48 reserves. And then the other 4.3 million is the result of an election for the Safe Harbor method related to the deductibility of repair costs. Those are again the primary drivers. The other remaining components would be lower pre-tax income and any other adjustments. And associated with those adjustments, if you turn to Page 9 in the presentation, we lay out what those are for the quarter. We do highlight in yellow the two changes, again the 12.6 million. That release of FIN 48 reserves is associated with non-regulated losses that we had certainly many, many years ago in our business. The 4.3 million is the ability under the Safe Harbor method to elect that to…

Very well done, Brian. I’ll start with a little more information around the hydro project. As you know, we made a public announcement in September of 2013 the $900 million acquisition of 11 base load facilities representing a total of 633 megawatts in addition to one storage reservoir and that was an acquisition from PPL Montana. That was the combination of several years of very, very hard work. On September 26th of this year after a yearlong process, the contested case process, the Montana Public Service Commission issued a final order approving the application subject to certain conditions that they determined to be in the public interest and those conditions included the following: $870 million of the 900 million purchase price would be included in the Montana jurisdictional rate base with a 50-year asset life; the Kerr facility would be excluded and that was actually based on a recommendation that we made; return on equity of 9.8%, cost of debt of 4.25%, and a capital structure of 52%, net 48% equity and that would result in an associated first year annual retail revenue requirement of approximately $117 million. The commission authorized issuance in an aggregate of $900 million of securities necessary to complete the purchase with the debt portion of the financing to have a term of 30 years and not to exceed 4.25%. A final compliance filing that we do in December of 2015 to reflect post closing adjustments at the convenience of the Kerr project from NorthWestern to the Confederated Salish and Kootenai tribes and their energy keepers private corporation, there is to be no financial risk to customers associated with Kerr and then we would pay the actual property tax expenses for the hydroelectric facilities based on what PPL has paid from detracting of revenue credits on…

Thanks, Bob. With our reaffirmed 2014 non-GAAP adjusted EPS guidance range of $1.26 to $1.275 and using $2.68 as a starting point, we’ve provided 2015 preliminary EPS guidance range of $2.95 to $3.30 per diluted share and a 2013 preliminary EPS midpoint of $3.13 a share. I am not going to go through each of the primary drivers there that make up that change to come up with the guidance we have, but suffice it to say that a lion's share of the improvement is essentially with the hydro transaction. Taking $3.13 2015 preliminary EPS midpoint of the $2.95 to $3.30 preliminary EPS guidance range for 2015, if you take that range and apply a 60% targeted dividend payout range, our preliminary target dividend range of $1.77 to $1.98 with a midpoint of preliminary target dividend of $1.88 per share. I want to make sure people are aware of again our desire to continue to provide a 60% payout even with our increased earnings into 2015. I think assumptions are off to left there. They’re very similar to the assumptions that we have for our 2014 guidance other than the tax rate items of 15% to 19% of tax on a pretax income and then a diluted average shares of 49.1 million the low end of our guidance and 47.5 million in high end of our guidance. Speaking of that, one impact of our range here, the $0.73 to $0.68, certainly all of our sell side folks are very bright out there. One of them did put out a report today that pointed out that that range of $0.73 to $0.68 in terms of the diluted impact of the $400 million share issuance has an approximate range of a $40 to $50 share issuance price to get to our $3.13…

Just a couple of closing remarks before we open it up to questions and discussion. As you heard from both Brian and me, we’re in a very strong position to continue to invest in providing service to our customers and planning and executing long-term. We’re incredibly excited about assuming operation at the Montana hydro, dedicated and to serve our customers at prices based on cost and doing the work to analyze and ultimately optimize the entire Montana generation fleet for our customers. Although this is a finance call, earnings call, I think it’s important to close on more of a personal subject. The wisest public servant I have seen in a very long time is Chairman, Bill Gallagher. Many of you have had the privilege to meet him or listen to him. He’s leaving office, leaving public service at the end of this year. He guided this entire process for the last year and it was complicated and arduous to a good outcome. Lots of people talk about doing the right thing for future generations. That absolutely was the thing that was first and foremost in his mind. If you had the opportunity to watch any of the hearings, you remember seeing his grandson in the balcony of the Supreme Court chambers at one point. So I think all the work over the last year has led to a good outcome. And where we sit today is very much a part of Chairman, Bill Gallagher legacy to the citizens of Montana that he was so passionate to serve. So I hope you keep him in your thoughts as he continues his journey. And with that, we're open to questions.

Thank you. (Operator Instructions) And we’ll take our first question from Paul Ridzon with KeyBanc. Paul Ridzon – KeyBanc Capital Markets: In the past you have talked about exploring different options for Dave Gates, maybe dispatching it differently that might change the revenue stream. Do you need to exhaust the legal process before you consider that?

No, not necessarily. We’re obviously committed to pursuing the process in front of the FERC and if necessary, beyond the FERC. But the supply portfolio we have in Montana has changed fundamentally and fundamentally for the good since Dave Gates came online. So we’re excited about analyzing and optimizing all elements of the fleet to understand how they can work together. Paul Ridzon – KeyBanc Capital Markets: I think it was about a year ago you added more net gas and you have indicated you’re kicking tires. I mean where are we in the price deck and how economic does it look at this point?

The challenge we have there, certainly think there are acquisitions that would make tremendous long-term sense for our customers. Under the agreement that we have in place with the Montana Consumer Counsel, there is a forward price threshold. And given where the forward prices are right now, it would be challenging to, although again acquisitions make an awful lot of sense, kind of challenging to get those under the forward price threshold. So that’s something we have to spend time visiting with the commission and staff and consumer counsel about over the coming months. It would be a shame not to be able to execute on good opportunities when they are available. Paul Ridzon – KeyBanc Capital Markets: And then kind of in your slide deck, I saw a reference to up to 400 million and then on the formal guidance slide it says 400 million kind of firm. Is that how we should be thinking about it?

Brian?

I think up to is still guidance, Paul. But I think again, it’s also the layer of our capital structure, if you will. So obviously close to the 400 million, the better from our perspective. Paul, to be very clear, we’re going to be very close to 400 million of equity is our belief. Paul Ridzon – KeyBanc Capital Markets: And then lastly, Brian, when you went through some of the fourth quarter drivers, don’t you also have a DSM get back rolling off?

I don’t think we’re going to see much of an impact from a DSM perspective on a year-over-year basis, Paul. Paul Ridzon – KeyBanc Capital Markets: I thought the commission called some back in the fourth quarter.

We think that -- I would tell you that impact could be upwards of $1 million.

And we’ll take our next question from Andy Levi with Avon Capital.

Quite a run down, so I think you've answered most of my questions. Just one question kind of longer term just kind of thinking about – at some point is there some type of, I don’t know if you want to call it a cliff, but like some type of tax cliff where the rate goes up real quick? And then I have a follow up from that.

No, I think from our perspective, we’ve given pretty decent guidance at where we think our tax rate is going to go. And again, the tax repairs benefit continues to help us on a going forward basis. So I don’t see a cliff. I think the trajectory we've provided today is helpful guidance.

So, when you get to like 18, 19, or 20, there is no like big ramp up in taxes, tax rate?

I don’t anticipate a big ramp up in taxes. I do expect, Andy, that we continue to see upward movement, but I do not see big ramp ups.

And then does the play affect rate base at all, I mean when your taxes are so low, kind of like a deferred tax or not at all?

At the end of the day, the benefits of lower tax has to a great extent helped -- allowed us to stay out of rate cases. The lower taxes typically get passed on to the benefit of our customers. It does have an impact on rate base.

How does that work?

It can impact rate base from a deferred tax perspective is one aspect, but it's also repairs expense itself has an impact from a deduction standpoint. So those are various methods in terms of how it can impact customers.

How does the repair -- is it one for one on the repair tax or is there some type of….

We have what's called flow-through items, Andy. Those flow-through items are a dollar for dollar benefits to customers.

Okay, got it. And then…

Hey Andy, and then to put that out, those are captured in the next upcoming rate case, if you will.

Okay. And then on just the rate cases in general, just timing wise, obviously you've got the hydro plans in and there is a rate increase for that and then you’ve ramped up your CapEx. When should we expect you to file your next Montana rate case?

I think when we get very good guidance on what we’re doing in South Dakota in 2015 that we’ve been planning to do any rate case in Montana in 2015, we'd be telling you that today. Our expectation is each and every year we’ll look at our needs in terms of whether we need to go in for a rate case or not and we have no guidance today to tell you when our next rate case is. Having said that, as you've seen we have quite a bit of capital spend from both the DSIP and the TSIP in our plan. So there will be rate cases in the future. We certainly don’t want to give any thoughts on when that could be, because we don’t know at this point in time if that’s 2016, next year or '17, we don’t know that yet. And when we do know, we’ll certainly want to give the commission and investors an indication of that.

Typically we do an annual look across all jurisdiction with gas and electric and make a decision. And the focus for the coming few months will be the South Dakota application. Some of the benefits that you discussed with Brian actually have allowed us again to continue to invest in our system while keeping base rates to our customers very stable.

Just remind me again how long does it take from kind of filing to a final order for a Montana rate case?

It's typically a nine-month period for Montana.

Just again, credit to Chairman Gallagher and the commission, one of the biggest proceedings the commission has ever dealt with, they write to that nine-month clock and ran a very, very rigorous schedule and that's not an easy thing to do, says a lot for them.

And then my last question, you mentioned on the rate base of E&P and lower -- I guess perhaps the lower gas prices, is it lower oil and per se liquid prices that are affected by oil that changed the economics of the assets of what we’re thinking or there is something else in your comments?

But what we’re looking at is the attractive, very attractive low price of gas production assets right now, which suggests it's a great time to do those transactions on the one hand. On the other hand, the forward curve for gas purchased in the market is well enough that under the agreement we currently have in place of transactions that we think it might be quite sensible don’t pass that screen.

That’s because you can buy it cheaper, is that how works or?

Yes, it’s the shape of the curve.

And then like liquid prices and the price -- or that has nothing to do with the economic, does it?

Well, that’s not what we’re looking at now.

And we will take our next question from Brian Russo with Ladenburg Thalmann. Please go ahead. Brian Russo - Ladenburg Thalmann & Company: Just curious, it’s been a while since you've filed an electric case in Montana. But could you self-implement rates?

If I understand the context of the question, no. Brian Russo - Ladenburg Thalmann & Company: Okay. So whenever you get the final order, that’s when rates are adjusted?

We can request an interim rate increase, but we have to get approval of the commission of that interim rate request. Brian Russo - Ladenburg Thalmann & Company: Okay. Because I think you did the gas case a couple of years ago, correct?

Yes, we have. Brian Russo - Ladenburg Thalmann & Company: You have. Okay, good. Secondly, on the interest rate swaps, they’re quite a bit lower as indicated in the Q than the 4% to 5% cost of debt threshold. Do you retain the difference or does that kind of get trued up in that December '16 filing?

Everything gets trued up. And obviously when you say there's a big difference, but you have to add the credit spread, you have to add in the cost associated with fees associated with that. So, from our perspective, the four in a quarter that was in the final order from the commission, with where we locked in plus credit spreads and fees, we'll be we believe somewhere in the 4.20% to 4.25%. But things could happen in terms of spreads. And if we’re higher than 4.25%, we’re going to get 4.25%. If we’re less than 4.25%, we’re going to provide that benefit to customers. That’s based on our interpretation of the final order. Brian Russo - Ladenburg Thalmann & Company: Understood. And is there any like tracking mechanism recovery method for TSIP or DSIP or it all has to be rolled up into base rates in a general rate case?

No. In Montana there isn’t a specific tracking mechanism. What we did and we've discussed, this was obtaining an accounting order from Montana Commission for the first two for the expenses in the first two years of DSIPs and so that was primarily expensed and that would have been lost without the accounting order there. But actually quite a few states around the country have various kinds of specific infrastructure recovery trackers, writers for electric gas and even for water. We don’t have anything like that in Montana. Brian Russo - Ladenburg Thalmann & Company: And so would you file for an accounting order on the TSIP?

Certainly could. Again, it depends on whether the project has substantial expenses that might be out in the front of the capital. That’s not necessarily part of the plan though right now. Brian Russo - Ladenburg Thalmann & Company: And what if that’s over thresholds that you’ve agreed to with the MCC? And can – with your comments directly earlier, it seems like you guys can revisit that and look to adjust it down?

Yes, I'll you, by the time we're off the call, we can walk through, we can give you the specific threshold. Essentially the price is tied to – in fact I can give it to you right now. The price is tied to the years in which the transaction has to be positive. So if you look at that 20-year levelized unit revenue requirement dollars per MCF, that’s again 20-year levelized, less than $4 of the crossover has to be five years or less, between $4 and $5 for the 20 year levelized crossover has to be 40 there is less $5 to $6 three years or less. So as you see, the price per MCF levelized goes up, the benefit to customers has to be more imminent. And again, the unusual thing is the curve right now is kind of a roller coaster shape, which makes for a bit of a squeamish ride. But again, we are looking at the price of assets and think it’s going to be pretty compelling right now. Brian Russo - Ladenburg Thalmann & Company: And in terms of the 2015 implied dividend, will that take place at the February Board meeting and really just be one dividend increase or you're going to look to do multiple dividend increases throughout the year?

I’ll speak to that first and maybe hand it off to Brian. One of the policies we’re very clear about is our dividend range. We, as you know, we’ve tended to stay closer to the 60% to 70%. But the Board reviews and acts on the dividend on a quarterly basis. Brian?

I’d say and I totally agree with what Bob said, I think the thing that’s taken into consideration on a quarterly dividend perspective, it would be our expectation that we repay a 60% payout in February. And based upon our thoughts for our guidance for 2015 at the time we come to February. So I think on a quarterly basis, you’ll see that increase in quarterly dividend in February.

And we’ll take our next question from David Arcaro with Sidoti. David Arcaro – Sidoti & Company: Just a couple of quick questions. How can we think about TSIP, AFUDC versus going straight into service? Will it be similar to the DSIP program in that regard?

Should be very much the same, David. David Arcaro – Sidoti & Company: And can you remind me is that going to be across all states, all jurisdictions and then both gas and electric?

The overall infrastructure approach would be just both gas and electric and all jurisdictions. The DSIP focus was specifically in Montana because of [indiscernible] and complexity of the system and the level of need at that time. In terms of TSIP, most of our transmission assets are in Montana and the focus is there. We’re talking about T&D that also would remind folks that we have a substantial substation assets so they get as part of an overall utility approach to asset management substations and other assets will be very much a part. David Arcaro – Sidoti & Company: And then on the South Dakota rate case that you mentioned, when would you expect to get new rates implemented? And are those included in your 2015 outlook?

They are included in our South Dakota -- excuse me, they’re included in our 2015 guidance. We do have a half year benefit associated with that. And the assumption would be with a filing at the end of 2014, we would have the ability to have rates in effect for the third and fourth quarters of 2015. No, I won’t tell you how much I have in there associated with that rate base. David Arcaro – Sidoti & Company: And on that, do you expect to recover anything on Big Stone or would you have to get that into service before? Would you have to go back for another case later on to recover those costs?

Those types of costs typically that are known and measurable, David, we’re able to capture in the rate case. And so that's something that obviously we’ll be talking to staff about. But our expectation is that one of the reasons obviously going at this point in time too is our expectation is within 2015 we will be effectively done with Neal, but certainly with Big Stone as well.

And South Dakota does have an environmental rider that would be available for those expenses. We had been out for so long, I believe the appropriate thing was to file a general case. Obviously, we’ve been keeping the commission and staff informed of the Big Stone project from project conception right up to the present time. David Arcaro – Sidoti & Company: And one more quick question on the CapEx outlook. What caused such a big increase in the maintenance CapEx for 2016 through '18 versus your 2013 10-K outlook?

I think in addition we did talk about TSIP to a great degree, but there are some transmission projects included in our maintenance CapEx as well is a big driver, but that’s a big part of the driver. But I can’t give you a breakout of those on the call today. But I think about -- we’ve got various projects right now relatively large transmission projects in the queue right now that have an impact and that are not captured in TSIP. I think that’s the primary driver for the increase.

It’s worth noting with the transmission projects that these are jurisdictional projects to serve our existing customers. These are not merchant or speculative projects that are designed to meet current and future needs on our system.

And I'd just add to that, David, if we were to file our CapEx plan, if you will, if there was time to do our 10-K, I expect this to be very similar to what we’re going to file in our 10-K in terms of our plans. I don’t expect much changes between now and February in terms of our filings going forward.

And we’ll take our next question from Jonathan Reeder with Wells Fargo.

Most of my questions have been answered. But one question on the upcoming PSC elections in Montana. Any reason to expect a shift in the regulatory attitude in '15 particularly since Gallagher will no longer be serving?

As was clear from my comments, I think that Chairman Gallagher has been a tremendous public servant and it's just a great loss I think to the State of Montana. Whatever the makeup is of the commission, we intend to be as transparent as we can to try to inform, work with the commission and the staff on our plans to meet the needs of our customers and to be really kind of straight down the middle. So, we’re looking forward -- in fact honestly, the commissions and staff has been so focused, appropriately focused on the hydro project for the last year, we had an awful lot that we’re eager to go in and discuss in open meetings with the commission and staff over the coming months and that will be the same regardless. So again, Chairman Gallagher's departure is a real loss, but we look forward to working with whomever takes this place.

Is there any historical person on the district he represents? Does he always go Republican or is there any way to kind of speculate on that?

Not for me there isn’t.

Okay. And then last -- one project that you haven’t touched on in a while, didn't know if there was anything, any update on that would be the 500kv upgrade into the coal strip transition mine, where does that stand?

I’ll turn it over to Mike Cashell, our VP of Transmission. Mike?

Yeah. The one thing I would say about that is that there are no customers in our transmission queue that are waiting for that capacity. And in fact Bonneville recently announced that they had stopped their environmental assessment of that because of the transmission queue situation on their system. So, I would say that right now it's not moving forward.

And then I'd add to that, it is not included in our plans in the five years that we've just shown you, as a matter of fact, Mike's still busy working on other transmission projects. They work 40 million odd that we had is associated with our share of that 500kv upgrade. So, I hope that helped answer your question, Jon.

It does. Thank you very much.

(Operator Instructions) And there's no further questions in queue. I’ll turn the conference back over to management for any closing remarks.

Well, thank you all very much for a good discussion and for your interest. We’re eagerly looking forward to visiting with many of you at the EEI Financial Conference in Dallas and probably others of you in New York City at the end of the year. Hope to seeing you soon.

And ladies and gentlemen, that does conclude today’s conference. We do thank you for your participation. You may now disconnect. Have a great rest of your day.