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Unitil Corporation (NYSE:UTL)

Q4 2012 Earnings Call

January 30, 2013 03:30 PM ET

Executives

David Chong - Director, Finance

Bob Schoenberger - President and CEO

Tom Meissner - SVP and COO

Mark Collin - SVP and CFO

Analysts

Liam Burke - Jenny Capital Markets

Shelby Tucker - RBC Capital Markets

Operator

Good day ladies and gentlemen and welcome to the Q4 2012 Unitil Earnings Conference call. My name is Jason and I'll be your operator for today. At this time all participants are in a listen only mode. Later we will conduct a question and answer session. (Operator Instructions). As a reminder this conference is being recorded for replay purposes,

I would now like to turn the conference over to your host for today, Mr. David Chong, Director of Finance. Please proceed, sir.

David Chong

Good afternoon and thank you for joining us to discuss Unitil Corporation's fourth quarter 2012 financial results. With me today are Bob Schoenberger, Chairman, President and Chief Executive Officer, Tom Meissner, Senior Vice President, Chief Operating Officer, Mark Collin, Senior Vice President, Chief Financial Officer and Treasurer and Larry Bach, Chief Accounting Officer and Controller.

We will discuss financial and other information about our fourth quarter and year end results on this call. As we mentioned in the press release announcing the call, we've posted that information including a presentation to the investor section of our website at www.unitil.com. We will refer to that information during this call.

Before we start please note that comments made on this conference call may contain statements that are commonly referred to as forward looking statements, which are mainly pursuant to the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995. These forward looking statements include statements regarding the company's financial condition, results of operations, outlook, expenditures and other expenses, regulatory environment and strategy, market opportunities and other plans and objectives.

In some cases forward looking statements can be identified by terminology such as may, will, should, estimate, expect or belief, the negative of such terms or other comparable terminology. These forward looking statements are neither promises nor guarantees but involve risk and uncertainties and the company's actual results could differ materially.

Those risks and uncertainties including those listed or referred to on slide 1 of the presentation and those detailed in the Company's filings with the Securities and Exchange Commission including the Company's Form 10-K for the year ended December 31, 2012. Forward looking statements speak only of the date they are made. The company undertakes no obligation to update any forward looking statements.

That said I'll now turn the call over to Bob.

Bob Schoenberger

Thanks David. I'll begin by discussing the highlights of our financial performance in 2012. If you turn to slide 4 of our presentation today we announced net income of $18.1 million for 2012, an increase of $1.8 million or 11% over the $16.3 million we reported in 2011.

Earnings per share were a $1.43 for 2012, compared to $1.50 per share in 2011. Earnings per share in 2012 reflect a higher number of average shares outstanding year-over-year from a $70 million common stock offering we completed in May 2012.

Our 2012 results reflect the highest net income in our history. The strong annual growth reflects significant new customer additions, as well as higher natural gas and electric sales margins due to higher distribution rates from our recently completed rate cases, despite extremely mild winter weather in 2012 which was the warmest year on record.

We estimate that the mild weather in 2012 negatively impacted earnings by $1.7 million or $0.14 per share compared to normal. Mark will provide some additional details on our financial results in just a few minutes.

We believe that our key strategic initiatives over the past few years, including our emphasis on customer service and satisfaction, our regulatory agenda that we set base distribution rates across our operating utilities, our focus on natural gas customer growth and the expansion of our non-regulated energy brokering business have all been key contributors to our growth.

We turn to slide 5; we focus on our non-regulated energy brokering subsidiary, Usource. Usource continues to execute on its strategic growth plan. Usource recorded revenues of $5.5 million in 2012, on par with 2011.

Furthermore, Usource has a forward book of $8.2 million, which represents an estimate of revenues already under contract to be recognized in future periods. Usource currently manages over $660 million annually in energy contracts for over 1200 customers, with the customer retention rate exceeding 90%.

We recently expanded Usource’s operations and sales force in Central and Western New York and are rapidly adding new customers in this important medium. We expect this most recent expansion initiative, coupled with our continued focus on our existing core markets will result in a growing contribution from Usource to our consolidated financial results.

On slide 6; over the past few years we’ve demonstrated a strong track record of success in achieving base rate relief across all of our jurisdictions with an increase to our natural gas and electric sales margin of over 30%. We plan to file new rate cases in 2013, recover investments we’ve made in our distribution system.

These rate cases will also reflect a substantially improved equity capitalization ratio, resulting from our comment equity offering in May of last year, which we invested directly into our utility businesses. Mark will review our rate case plans in little bit more detail in just a few minutes.

Slide 7 highlights our storm preparedness and commitment to provide reliable electric service. In October of last year, Hurricane Sandy struck the eastern seaboard with flooding rain and damaging winds. During the storm 69,000 outages were reported across our customer base, representing about 70% of our electric customers.

A customer service responded to 40,000 plus calls during the event and 99% of those calls were picked up in 20 seconds or less. In the end, we had power restored to our customers within 48 hours of Sandy’s peak.

Sandy came on the heels of two other major storms, Hurricane Irene and the October Nor'easter in 2011. In those storms Unitil restored power to all of our customers in 36 and 72 hours respectively. In its review of the October Nor'easter, the New Hampshire Public Utilities Commission referred to our restoration efforts as a model for other utilities to follow.

In recognition of our restoration efforts following Hurricane Sandy, Unitil was awarded the 2012 Emergency Recovery Award from the Edison Electric Institute. This award recognizes extraordinary efforts undertaken to restore electric service following severe weather conditions or natural events.

In addition to the emergency recovery awards, we received recognition from senior executives of other utilities in neighboring states for our mutual aid assistance following Sandy, where we provided 45 gas and electric utility employees to other utilities to aid in restoration. We will continue to work as a leader in storm preparedness and providing exceptional service to our customers.

On slide eight, we are experiencing an unparalleled demand for natural gas service within our gas service areas. Changing natural gas fundamentals have created significant opportunities for growth within our industry.

The abundance of natural gas supply has caused prices to be near historic lows. Natural gas also has significant environmental benefits and can reduce Co2 and other greenhouse gases by over 40% compared to coal generation.

With these benefits of natural gas, customer demand is at an all-time high. We expect to have 4,000 customer additions and conversions in 2013, which is double what we added at last year. And 2012 was 50% ahead of 2011.

Currently, there are 55,000 potential on-the-main customers on our distribution system that are not using natural gas. With such a high number of new customer prospects, we plan to continue to execute an aggressive gas growth program, that will ramp up to a target level of 5,000 gas customer additions per year, which will result in the doubling of our total investment in our gas business over the next four years.

On slide 9 the price of amateur natural gas versus other competing fuel choices such as home heating oil, natural gas continues to be near historic lows, largely driven by availability of shale gas plays across the U.S.

We estimate that by switching to natural gas from fuel oil, our customers here in New England can reduce their cost by about half or $1,500 annually. On a larger scale this means that for every 1000 customers that we convert, we are providing $1.5 million of annual savings which can be used by our customers for other purposes and ploughed right back into the local economy.

Slide 10 shows our market potential and the current on-the-main penetration rates of gas service areas. Currently Unitil has 74,000 gas customers with a combined gas service area penetration rate of only 57%.

If we look at penetration rates within our individual service areas, we see that the majority of the opportunity is in Maine and New Hampshire where we serve the most popular cities in these states including Portland, Maine, which is the largest city in north of New England and the Greater Dover Portsmouth Seacoast area in New Hampshire, a growing center of economic activity in the region.

We have a growth plan to target to serve a total of 92,000 customers by 2016, which would reflect a customer growth rate of 5% annually and an overall penetration rate of 71%.

Now I will turn the call over to Tom to discuss further details of our gas growth plan and our capital budget for 2013.

Tom Meissner

Thank Bob. I would like to pick up where Bob left off; starting on slide 11 by discussing significant growth in our gas business in terms of customer additions. Since acquiring Northern Utilities in December of 2008, we’ve added and converted nearly 6000 natural gas customers, which is an increase of about 10% over the 2008 customer base.

In 2012 we added and converted over 2000 gas customers, which was up 50% from the prior year and as Bob indicated we plan to double our level of activity in 2013, with 4000 customer additions and conversions.

In terms of the impact on our operations, we are essentially doubling our gas construction activity heading into 2013 from what it was just a year or two ago, which requires a proportionate increase in construction resources. We expect to add additional construction resources next year as we head into 2014 in order to ramp up to a target of 5000 customer additions per year.

Slide 12 reflects the financial impacts of our growth program as well as other strategic initiatives. Our gas rate base has grown at an annual rate of 9%, driven by customer editions as well as cast iron and bare steel replacement programs across all of our gas service areas.

This growth in rate base combined with recent rate cases at all three of our natural gas utility subsidiaries has led to natural gas margin growth of 12% annually. Looking forward, we expect growth in customer addition and utility plan to accelerate in the few years resulting in a doubling of our 2008 rate base by 2016.

Slide 13 highlights some of the large industrial customers that we recently added or converted to natural gas in just the last few years. Some of these customers required an extension of our existing mains in order to deliver natural gas to their location. This not only added a large customer to our system but also allowed for other customers to connect to the newly extended gas mains at a lower cost.

In addition, thanks in part to the price advantage of natural gas discussed earlier, we are also seeing an increase in conversion projects involving existing customers, in which heating or process equipment is converted over to natural gas from other fuel types. This results a newer added load without the capital investment and resource commitment of a main extension or new service connection.

Turning to slide 14, we have provided a more detailed look at next year’s capital budget on the gas side of the business. We plan to spend about $49 million on gas construction projects in 2013 which represents an increase of about 13% over 2012.

Spending on new customer additions will be a significant component of this budget. In 2013 we plan to spend about $23 million or 47% of our capital budget on expansion of our natural gas delivery system, targeting new customers and increased gas sales.

Another major category of spending is infrastructure replacement, consisting of cast iron and bare steel replacement programs in all three of our state jurisdictions. We plan to spend about $11 million or 22% of our natural gas capital budget on infrastructure replacement.

I’ll also point out that this contributes to customer growth, since we target new customers when we are in the street, making for easier and less expensive customer conversions.

Finally, we will be investing in several major system upgrades, including two pipeline upgrade and replacement projects for interstate gas transmission, our interstate transmission pipeline.

Spending on these projects is expected to be about $6 million in 2013 with additional spending of about $2 million annually over the next couple of years. Under a rate settlement approved by the Federal Energy Regulatory Commission in 2011, the cost of these projects will be included in rate base and recovered through rate mechanisms without the need to file a for rate case.

Slide 15 highlights spending in our Electric division, where we have provided a summary of our capital budget for 2013. Total expending for the electric division is expected to be $26 million, which is about 27% higher than 2012.

Capital expenditures for new customer additions and related upgrades comprise $11 million or 40% of our electric budget. The remainder of the budget consists of system upgrades and reliability enhancement projects.

As a reminder in our Electric division we have capital trackers to provide substantial annual recovery of our plant investments. For example in New Hampshire, we budget capital spending of $18 million and we have a rate mechanism that will allow us to recover about 80% of the change in net plant through annual step adjustments, without the need to file a for rate case.

In addition to capital spending at our gas and electric subsidiaries, we will also be spending about $8 million to improve our utility business and information systems. A majority of this will be spent on a new customer information system, replacing an existing system that has been in service for over 15 years and allowing us to maintain and improve our high customer service standards.

In total, we have a capital budget of $83 million for 2013, with $49 million or 60% of that being spent on gas operations, $26 million or 30% on electric operations, and the remaining $8 million or 10% on other common additions and improvements.

Now, I will turn the call over to Mark Collin, who will further discuss our financial results for the quarter and our upcoming rate basis.

Mark Collin

Thanks Tom. Good afternoon everyone. As Bob stated earlier, earnings increased by $1.8 million or 11% for this past year ended 31 December 2012, the highest net income in our history. Results were positively affected by higher natural gas and electric sales margins, due to higher distribution rates and new customer growth but were negatively impacted by extremely mild winter weather in 2012. We estimate that compared to normal, the mild weather in 2012 negatively impacted earnings by about $1.7 million or $0.14 per share.

Now turning to slide 16, natural gas sales margins were $76.2 million in 2012, an increase of $8.3 million compared to 2011, reflecting higher distribution rates and new customer growth, but again relatively impacted by the low gas therm sales due to mild winter weather early in the year.

Also gas margins in 2011 include a onetime recovery of $4.5 million in purchased gas costs that had been charged off in a prior period. Based on weather data collected in the company’s service areas, there were 16% fewer heating degree days in 2012 compared to normal, where the normalized gas therm sales in 2012 are estimated to be approximately 5% and 3% higher compared to 2011 in the fourth quarter and full year respectively. Strong growth in our weather normalized sales reflects the significant number of customer additions we're making across our gas territories.

Turning to slide 17 we highlight our electric division sales and margin. Electric sales margins were $71.9 million in 2012, an increase of $4.3 million compared to 2011, reflecting higher electric distribution rates and new customer growth, but again negatively impacted by lower sales due to the mild winter weather we saw early in 2012, where the normalized electric kilo/hour sales in 2012 are estimated to be approximately the same or on par with 2011.

Turning to slide 18, Usource the Company's non-regulated energy brokering business recorded revenues of $5.5 million in 2012, on par with 2011. Usource's revenues are primarily derived from fees and charges billed to suppliers as customers take delivery of energy from these suppliers under term contracts brokered by Usource.

Operation and maintenance expenses increased $5.5 million in 2012, compared to 2011. The change O&M expenses reflects higher utility operating costs of $3.7 million, higher employee compensation and benefit cost of $0.5 million, and higher professional fees up about $0.3 million.

The increase in utility operating costs in 2012, compared to 2011 includes an increase of $2.6 million in new spending on vegetation management and electric reliability enhancement programs, of which approximately $1.8 million of these expenditures are recovered through cost tracker mechanisms that result in a corresponding and offsetting increase in revenue.

The increase in O&M costs in 2012 over the prior period also reflects lower O&M expenses recorded in the first quarter of 2011, due to a receipt of a non-re-occurring insurance payment of $1 million.

Depreciation and amortization expense increased $5.8 million in 2012, compared to 2011 principally reflecting normal utility plan additions, amortization of storm recovery costs and recovery of other regulatory assets.

Local property and other taxes increased $1 million in 2012, compared to 2011 reflecting higher local property taxes on higher levels of utility plant and service.

Net interest expense decreased $2.3 million in 2012, compared to 2011, primarily reflecting lower interest rates and lower borrowing balances as a result of the equity offering in mid-2012; as well as the recognition of non-re- occurring pretax charge in 2011 against interest income of $1.8 million charge off previously accrued carrying tasks that were disallowed for rate recovery.

Now turning to slide 19, we have provided an update of our financial results at the utility operating company level. The chart shows that the last authorized return on equity compared with the earn return on equity. The chart reflects year end equity balances and includes the equity contributions to our utility subsidiaries, with the proceeds from the common equity offering completed last May. In addition, the results shown on this chart have not been weather normalized and reflect the mild winter weather we had this past year.

As we’ve indicated in the past, we have long term capital cost trackers in place to recover a significant portion of current and future capital spending. In May of this year, Unitil Energy, our New Hampshire subsidiary will begin recovering approximately 80% of its 2012 change in net plan in the form of a rate adjustment.

Similarly, as Tom described earlier, Granite State our FERC regulated gas pipeline has an annual rate adjustment to recover capital spending on several pipeline upgrade and replacement projects.

Turning to slide 20, as Bob mentioned earlier, we will be filing base rate cases in both jurisdictions of Northern Utilities, our gas utility in Maine and New Hampshire and for our Electric corporations in Massachusetts to recover investments in our utility infrastructure and to bridge the gap between our allowed and earn returns.

At Northern Utilities we will file gas base rate cases in the second quarter of 2013. Under the regulatory construct in each state, we expect new gas rates to be effective in Maine early first quarter of 2014 or next year and the initial temporary rates in New Hampshire to be effective earlier, in the third quarter of 2013. The final gas rates in New Hampshire will be effective by the second quarter of 2014 which will be trued up to the temporary rates at that time.

In both states, we will be seeking to put in place a capital tracker mechanism that will allow us to recover additions to our growing rate base in future years without the need and cost of filing a full rate case. We also plan to assess rate mechanisms to help mitigate the sensitivity of our gas business to weather.

In Massachusetts, we will also file a base rate case for Fitchburg’s electric division in the second quarter of 2013. Recent legislation in Massachusetts has changed from a six month process to a 10 month process to result in some additional regulatory lag and new rates effective in the second quarter of 2014. The recovery of deferred storm costs of approximately $5.4 million related to major storms in 2011 and 2012 will also be included in this filing.

Now, this concludes our summary of our financial performance for the period. I will turn the call over to the operator who will coordinate questions from the audience.

Question-and-Answer Session

Operator

(Operator Instructions). Our first question comes from the line of Liam Burke - Jenny Capital Markets. Please proceed.

Liam Burke - Jenny Capital Markets

One of the gaining factors in the build-out has been crew availability and you mentioned you showed the crew sizes in one of the slides, A: have you been able to alleviate that shortage and B: how have you have been able to do it?

Tom Meissner

We were able to get crews, as long as we plan in advance and when we issued our contracts for next year, we were able to get sufficient resources for the built-out that we have planned. Where we tend to run into problems is if we discover that or determine that we’re running ahead of the forecast by say August, it becomes difficult at that time to acquire additional resources because the contractors have already committed their resources to other utilities within the region.

Liam Burke - Jenny Capital Markets

On the capital budget, I guess you came up with $83 million. You had a capital budget this year of roughly $70, when you are about cash flow breakeven. What are you anticipating in terms of cash needs over and above your CapEx next year?

Bob Schoenberger

Our operating cash flow we expect some improvement over this year. So as you pointed out, last year our operating cash flow was barely close to our total capital spending. So we expect to continue to finance most of our capital spending through operating cash flow. Any difference between that and our construction needs will be met with additional issuance of debt during the period to cover any kind of shortfall. But there is no, we don’t have any anticipated large or extraordinary cash expenditures, other than what shows up in our capital budget.

Operator

(Operator instructions). The next question comes from the line of Shelby Tucker with RBC Capital Markets. Please proceed.

Shelby Tucker - RBC Capital Markets

Just a few questions. When you follow up on the last one about the CapEx; what do you expect your run rate to be past 2013?

Mark Collin

Looking out, I think that it’s going to be closer to where we are this year, than we were a year prior, that given our ramp up and ramping up to -we talked about ramping up to 4000 additional gas customers this year. We are going to be ramping up to an additional 5000 the following year. We continue to expect to expect a follow through on the replacement programs on the gas side relative to cast iron replacement and bare steel replacement and then our electric reliability spending should trend similar to where we are this year.

So most of our spending, we are fairly consistent with this year. The change will be of course, that we will have completed or will be completing rate cases, particularly for the gas companies in Maine and New Hampshire to help support that capital spending and as I indicated, one of the key focus of those rate cases Shelby is that we get cost trackers that give us that ability to increase our revenues on a regular basis each year to further support the capital spending. And I would just point out that on the growth side, the way that we do that growth and the way that that growth is set up is that those expenditures are pretty much self-supporting, that the revenue we get from the growth, from the new customer supports that investment and allows us to bring in more and more investment and to cover that through our operating results.

Shelby Tucker - RBC Capital Markets

Okay and then the $8 million that was the third bucket in the CapEx program, that is still a rate base number?

Bob Schoenberger

Yes, it’s primarily related, as explained is related to our customer information system. There is a big project there. That’s a two year project. So we will spread that out over two years. It’s a very large project, as you can appreciate customer information system it’s at the center of just about everything we do.

So that’s the two year expenditure and that area is where we have the most discretion and moving things around and we may be able, as we get out and those expenditures may come down a little bit, but I think you’ll see our gas expenditures and electrical expenditures continuing to stay about where we are planning for this year.

Shelby Tucker - RBC Capital Markets

Okay and then on the rate cases, in most jurisdictions you have somewhere around low to mid 40% equity layer. Are you looking with these rate cases to maybe purpose a higher equity layer or is that something for a later date?

Mark Collin

Yes, definitely that’s a key component of the rate cases. We intend to reflect our actual equity investment in our subsidiaries, and as Bob mentioned when we issued the equity here midyear of last year, we took that equity and invested it directly into the utility subsidiaries. We invested in all of them and our equity ratio was significantly higher across all our utility subsidiaries than it was in the last rate cases. So we expect to get an uptick from that.

Shelby Tucker - RBC Capital Markets

And have you provided some details as to the level of equity you have? Well the parentage sorry, not the absolute number because I see it on the slide 19.

Bob Schoenberger

Yes, the percentage across the utilities is fairly close to the consolidated. So you can look at the consolidated and get a pretty, if anything they may be a tick higher, but they may be a little better. But they are right around the consolidated.

Shelby Tucker - RBC Capital Markets

Okay and then Bob you talked about Usource growing but as we look at the numbers, they really have not shown a lot of progress over last. We had a big bump I think in 2009 or 2010 if I remember correctly but after that it’s been kind if staying a steady level. Is it because you’re building up and therefore you are incurring higher expenses than usual has you build your portfolio? How should we be thinking about the realization of that growth?

Bob Schoenberger

Yes. It’s a good question Shelby. If you look at year-over-year, the total revenue for Usource were flat. There were really two major reasons for that. Just as Utilities experienced a warmer weather that impacts Usource’s revenues because obviously customers use less natural gas and electricity than otherwise would be in a normally use; so that was one impact.

The biggest impact during the year is we made a decision to in effect buy the sales force from a company that was exiting the marketplace in New York. That quite frankly progressed this year, but I expect that you will see a significant improvement year-over-year in 2013.

Shelby Tucker - RBC Capital Markets

And then last question I guess for Mark, any one time items that we should be aware of and so the numbers that you have posted today?

Mark Collin

Anything of that nature, particularly comparison year-over-year 2011-2012 comparison, I think we have done a fairly detailed job at highlighting that in both the earnings release as well as the 10-K. So there is some onetime adjustments in 2011 that you pick up on but we have nothing in 2012 of any material nature.

Operator

There are no further questions at this time. And ladies and gentleman that concludes today’s conference. Thank you for your participation. You may now disconnect and have a great day.

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