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Piedmont Natural Gas Company, Inc. (NYSE:PNY)

F4Q08 Earnings Call

January 5, 2009 2:30 pm ET

Executives

John Sutphin - Manager of Finance and Investor Relations

Thomas E. Skains - Chairman, President, Chief Executive Officer

David J. Dzuricky - Chief Financial Officer, Senior Vice President

Michael H. Yount - Senior Vice President - Utility Operations

Franklin H. Yoho - Senior Vice President - Commercial Operations

Analysts

Dan Fidell - Brean Murray, Caret & Co.

Greg McGowan – Sidoti & Co.

Dave Parker – Robert W. Baird

Operator

Welcome to the Piedmont Natural Gas year-end 2008 earnings conference call. (Operator Instructions) I would now like to turn the conference over to John Sutphin. Please go ahead Sir.

John Sutphin

Good afternoon everyone and thank you for joining our 2008 year-end earnings conference call. This call is open to the general public and is being web cast live over the Internet. If you would like to access the web cast of this call, please visit our website at www.piedmontng.com and choose the Investors link. On the right-hand side of that page you will find a link to the web cast.

On the call today presenting prepared remarks we have Tom Skains, President, Chairman and Chief Executive Officer and Dave Dzuricky, Senior Vice President and Chief Financial Officer. Other members of our executive management team are also in attendance. At the conclusion of the prepared remarks we will open the discussion to questions.

Finally, this call may include forward-looking statements within the meaning of the Securities laws. Actual results may materially differ from those discussed in the forward-looking statements. More information about the risks and uncertainties related to these forward-looking statements may be found in Piedmont’s latest Form 10K which is available on the SEC’s website at www.sec.gov.

With that I will turn the call over to Tom.

Thomas Skains

Thanks John. Good afternoon everybody and thank you for joining us for our 2008 year-end conference call. We know many of you are just getting back from your holiday break and we appreciate your time with us today. As you already know we filed our 10K and issued our year-end earnings release last Monday. I’m going to walk through some of our highlights for 2008, talk about the year ahead in 2009 and then I’ll pass the call over to Dave for a more detailed discussion of our financial results.

2008 was another excellent year for Piedmont with record net income of $110 million compared to $104.3 million in 2007. That translates to EPS growth of more than 6% as we grew diluted earnings per share from $1.40 in 2007 to a record level of $1.49 in 2008. In addition to EPS growth we increased the quarterly dividend in 2008 for the 30th straight year and provided shareholders with a 34% total return for the fiscal year in a difficult and uncertain economic climate.

During our last conference call we guided you to the upper end of our original $1.45 to $1.55 earnings guidance range for 2008. We fell a little short of that projection largely because of the decline in the wholesale natural gas prices and the increase in our stock price after the date of our guidance. The subsequent decline in natural gas commodity prices led to a greater gas storage valuation write down than we expected at SouthStar and the subsequent stock price appreciation led to greater stock based incentive plan accruals than we expected. Dave will give you more details on those two items in just a moment.

Overall, 2008 was still an outstanding year characterized by solid margin growth and lower O&M expenses. Margin grew 5% in 2008. We added 20,500 new customers to our distribution system in 2008, a gross customer growth rate of 2% and we remain one of the fastest growing natural gas utilities in the nation.

For the year we added 16,280 residential new construction customers; 2,360 new commercial customers and 1,860 new residential conversion customers. Our conversion market was actually up 17% from 2007 due to the hard work and persistence of our sales and marketing team.

O&M expenses were down 2% from 2007 as a result of our continued focus on cost control and business process improvement primarily due to lower pension expenses from the company’s restructuring of its defined benefit and pension program. In 2009 we will continue to look for ways to more efficiently operate our system and to keep expenses down without sacrificing quality customer service, safety or reliability.

As to our joint venture performance we benefited from the first full year of service at Hardy Storage and from ongoing business operations at Cardinal Pipeline and Pine Needle LNG. SouthStar turned in lower performance in 2008 than 2007 for a variety of reasons that Dave will discuss in a moment including the fourth quarter lower cost of markets storage inventory write down I mentioned just a few moments earlier.

Let me now turn to some general comments about our fiscal year ahead in 2009. While we experienced 2% growth in gross customer additions in 2008 our fourth quarter 2008 growth figure came in slightly lower at an annualized rate of about 1.9%. This paper growth and the state of our national and regional economy suggest the possibility that our customer growth in 2009 will be lower than previously forecasted.

We will be closely monitoring our rate of customer growth over the 2008/2009 winter period and we will be prepared to give you a further update at our first quarter 2009 conference call in March. Of course slower growth and new customer additions would reduce our capital requirements and our depreciation expense.

In that regard, one of our power generation customers has delayed the development of one of its new gas fired power generation projects in North Carolina. Their revised development schedule will reduce our capital requirements in 2009 for related pipeline infrastructure by about $20 million. In addition, as you know wholesale commodity prices and short term interest rates have both declined since we first provided our 2009 guidance in early November.

All that being said we are still comfortable with and have reaffirmed our previously issued 2009 guidance range of $1.55 to $1.65 per share even in light of these fluctuations and economic and market conditions.

In short, our projection for 2009’s earnings per share remains unchanged even though the factors and related assumptions to achieving that level of performance are fluctuating relative to our initial expectations.

Finally, I’d like to provide you with an update on the status of our Robeson LNG project. The project remains slightly ahead of schedule and on budget. After successfully rezoning the project site we closed on the purchase of the land in November and we continue to enjoy a positive relationship with the county and the local community.

We are in the project design and engineering phase and continue to work with our consultants and the contractor on the project scope and cost. Although we are still working towards a 2012 in-service date, as we monitor our systems design performance and our customer growth rate this winter we will again review our project timeline and development schedule and we anticipate making an assessment towards the end of our first quarter 2009.

With that let me turn the call over to our Senior Vice President and Chief Financial Officer, Dave Dzuricky.

David Dzuricky

Thank you Tom. Good afternoon everyone. I hope all of you had a great holiday season. First, I’d like to point out those items that led us to earning slightly lower than the upper end of the guidance range we pointed to last quarter. Then, as Tom mentioned, I will walk through the income statement and finally give an update on the general state of our liquidity.

The first item Tom touched upon was the $4.5 million lower cost of market accounting adjustment recognized by SouthStar. Essentially when this adjustment was made storage was revalued at the end of the fiscal period price and if that re-pricing yields a lower inventory than is on the books a write down is required. In effect, we are recognizing a non-cash charge to earnings in advance of our normal storage withdrawal schedule.

The total earnings per share reduction associated with the lower cost or market accounting adjustment was $0.04 but we had anticipated taking a $0.02 write down last quarter when we updated guidance. The addition of $0.02 came as a result of gas prices falling below our original forecast.

The second unexpected item was higher accruals for our stock based incentive plans during the year. From the time before we updated guidance to the end of the quarter Piedmont stock rose almost $5 per share or an 18% increase. As a result, our incentive accruals needed to be about $2.3 million higher than expected which translates into another $0.02 in earnings per share. Taking those two together, the $1.49 could have been $1.53 which was at the higher end of our range.

Now let me turn to the income statement.

Margin in 2008 grew $28.8 million or 5.5% to $553 million. This was due to 2% customer growth for the year as well as some positive regulatory accounting adjustments related to gas spots.

At the same time O&M expense decreased $3.7 million or 1.7% in 2008 due primarily to reductions in pension expense accruals from our re-structuring of the pension program. This was offset somewhat by higher incentive accruals that I just mentioned as well as an increase in our contract labor.

As expected, depreciation expense increased $4.5 million during the year or year-over-year due to continued capital expenditures for our utility operations.

Our joint venture income decreased $9.4 million in 2008 to $27.7 million. This was almost exclusively due to the lower income from SouthStar in addition to the $4.5 million write down from lower cost or market accounting adjustments. SouthStar’s income was down due to lower contributions from the management of storage and transportation assets, a slight loss on weather derivatives and a Georgia Public Service Commission consent agreement.

However, remember this compares to an extremely strong performance by SouthStar in 2007. The weaker performance in 2008 was partially offset by higher income from Hardy Storage since it was in its first full year of operations.

Finally, utility interest expense increased $2 million in 2008. This was primarily due to higher regulatory interest expense resulting from annual year-end true ups we recognized in the fourth quarter. Otherwise interest expense was lower than in 2007.

With regard to our liquidity I am pleased to report Piedmont remains in a stable position despite volatile commodity prices and tight credit markets. Like the rest of the industry we experienced a steep run up in commodity prices in the summer and then saw prices decline during our fourth quarter.

This combination of events ultimately led to a need for additional short-term debt capacity on a seasonal basis. Interestingly, we had already started work on this well in advance of the credit crisis thinking at the time the sustained high commodity prices may stress our short-term debt capacity. Even at the height of the crisis, credit markets remained open to Piedmont due to our ability to maintain investment grade ratings and strong long-term relationships with our banking partners.

Suffice it to say we are very comfortable with our liquidity position at this point in time.

With that I’ll turn it over to John Sutphin.

John Sutphin

Thank you Dave. This concludes our prepared remarks. We now welcome your questions.

Question-and-answer Session

Operator

(Operator Instructions) The first question comes from the line Dan Fidell - Brean Murray, Caret & Co.

Dan Fidell - Brean Murray, Caret & Co.

First, I am wondering if you can talk about some of the assumptions that are in your 2009 guidance for cost trend lines for O&M and bad debt. I know bad debt has been trending around 0.3% of operating revenue. I’m just wondering have you notched that number up at all after all the cost savings on the O&M side in recent periods. Should we be looking for some small increase or something along those ranges in 2009?

Thomas Skains

I’m going to ask Dave to address our trend on bad debt, particularly bad debt as a percentage of revenue and then I’m going to ask Michael to address some of the activities we are working on terms of further process improvements in our field operations. As you know, the last several years we have worked hard to focus on our cost structures and business processes while at the same time actually improving the services we provide our customers and the quality of our services.

As you know we have over the last three years worked on our management structure. We have deployed automated meter reading across the company. We have consolidated some of our call centers and back office operations and more recently we re-structured and reorganized the activities in our front office operation.

The process now on the O&M side is to really look at how we can better provide services to our customers in the most efficient way possible. Deploying new technology and deploying the organization of our field staff in a way that transcends traditional district lines and looking at our assets more holistically.

Before I ask Michael to talk about what we are going to be working on in 2009 and beyond I’m going to ask Dave to address where we were with bad debt experiences in 2008 compared to previous years.

David Dzuricky

Let me just give you a little bit of perspective on where we have been regarding our bad debt expense as a ratio to our revenues. In 2007, as you properly note we were about 3/10 of 1% of revenue and in 2008 we were down to about 0.25% as a percent of revenue. Even though our revenue was up our bad debt expense in dollars was down compared to the prior year ever so slightly.

Part of that is due to the fact, as Tom mentioned before, we have been fine tuning processes all around the organization and one of those areas is the way we manage our uncollectible expense or bad debt expense and how we proactively work with our customers in order to avoid having to write off some of our accounts receivable. June Moore and her folks and Michael Yount and his folks have been doing the work in this regard.

As a result, you will know in our November 3 release with guidance we didn’t mention uncollectible expense as any significant factor in the overall determination of our guidance and that is why. We did not consider it to be a major element affecting one way or the other our guidance for 2009.

Unless you have any other questions let me kick it over to Michael as Tom suggested.

Michael Yount

Tom touched on two of the aspects we are working on particularly in the operations area. One is deploying our work force; the term he used is holistically, outside of our traditional and historic district lines. We find we are able to move folks around and essentially meet our customer service needs more quickly than perhaps we have been able to in the past by sticking strictly within those district lines.

More broadly in a variety of areas we have an internal program called Optic and what that is allowing us to do is to take a look at a variety of the work processes we use in the operations area and really see if we can’t bring technology as well as improved processes to bear to be more efficient in the way we go about doing the work that we do.

In the technology arena that may mean a work management system; it can mean an upgrade to our GIS system which impacts a lot of different things we do. It is broad. It cuts all the way across the operations area and it is continuous. We will be at it in 2009, 2010 and 2011. We want to always look at how can we deliver good, solid customer service that exceeds our customer expectations and consistently try to do it for less.

As usual any benefits we gain from that are built into the guidance.

Dan Fidell - Brean Murray, Caret & Co.

In terms of Robeson can you tell us the next steps in 2009 specifically we should be looking for? I understand the D&E is going on now and you haven’t made any specific comments on mid-2012 in-service date at this point. What would be the next hurdle we would be looking for in the next 12 months?

Thomas Skains

I addressed this in my prepared remarks and I will reiterate what I said earlier and that is again we are on budget and ahead of schedule to date. Things are going very well in terms of the re-zoning process which has been completed and the purchase of the land site and working with the local community. We are in the process now of finalizing project scope and costs and working with our consultants and our contractor. Really the thing to do at this point for us is to finalize that body of work and as I mentioned earlier, review again our customer growth rate this winter along with our system design and operations performance this winter to make another assessment of the project timeline and development schedule. This will address the 2012 in-service date question.

That assessment we think will be made in the next couple of months by the end of our first quarter 2009. Once that assessment is made then we’ll be in a position to discuss that more.

Operator

The next question comes from Greg McGowan – Sidoti & Co.

Greg McGowan – Sidoti & Co.

Can you refresh my memory here? I think you budgeted capEx for about $245 million for fiscal 2009. I guess we should just reduce that by $20 million?

David Dzuricky

That’s correct.

Greg McGowan – Sidoti & Co.

In the past I think you said your objective was to keep debt to capital about 45-50%. Is 50% a hard sailing or is that more of a goal?

David Dzuricky

If you will refer to our 10K we target our long-term debt to total capital at 45-50%. Anything relating to capital structure is a longer term goal rather than an instantaneous goal. If we got to debt of 50.1% would we issue equity? No we wouldn’t. It is a policy guide for us and the capital structure and the way we finance is kind of an ongoing process. As you will notice if you look back across our history we have been very good at keeping ourselves within that 45-50% of total cap ratio relative to our long-term debt.

Greg McGowan – Sidoti & Co.

You finished with the North Carolina rate case. Maybe you could talk about what comes next on the regulatory front?

Franklin Yoho

On the regulatory front, as you mentioned we finished our North Carolina rate case and an order is out on that. In South Carolina we have an RSA and that updates our rates on an annual basis so that continues. Thirdly we have not been in a rate case in Tennessee for a number of years and in that respect we continue to evaluate the need as to when we do go in for a rate case in Tennessee. From our three regulatory perspectives that is where we stand today.

Greg McGowan – Sidoti & Co.

Are you achieving your allowed rate of returns in Tennessee right now?

Franklin Yoho

From a historical perspective we have been doing pretty good in Tennessee and once again we update that and continue to evaluate that on an ongoing basis but from historically looking backwards we have been fairly close to our allowed rate of return.

Operator

The next question comes from Dave Parker – Robert W. Baird.

Dave Parker – Robert W. Baird

Pension expense, given the change in the financial markets, maybe you could walk through what your expectations are for 2009 and maybe what was baked into what your initial guidance was and if things had to change there?

David Dzuricky

There has been a lot of turmoil in the markets hasn’t there? How is that for a non-answer? Let me try to collect my thoughts here for a minute and say to you of course pension expense is actually an equation where we are taking a look at both assets and liability. Certainly with the changes in how we calculate our liabilities where we are no longer using government securities but now are using high quality A and AA rated corporate and with spreads where they are over Treasuries that has had a significant downward impact on the liabilities that we have calculated under FAS 87.

So even though our assets have dwindled fairly appreciably our liabilities also have as well. Where we try to focus is where we are in terms of having assets surplus to the liabilities of the fund. We are very comfortable there and all of that was built into the guidance.

Dave Parker – Robert W. Baird

As far as resetting those estimates is that an annual or quarterly look? Refresh my memory how that works.

David Dzuricky

It is an annual look. Then we kind of true it up at the end of the year.

Operator

There are no further questions in the queue at this time. Please continue.

John Sutphin

As always we thank you for your interest in Piedmont Natural Gas and for taking time to be with us today. If you have further questions pertaining to our 2008 results please contact our Investor Relations Department. This concludes our 2008 year-end earnings call.

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Source: Piedmont Natural Gas Company Inc. F4Q08 (Qtr End 10/31/08) Earnings Call Transcript
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