AGL Resources Management Discusses Q3 2013 Results - Earnings Call Transcript

| About: AGL Resources (GAS)

AGL Resources (NYSE:GAS)

Q3 2013 Earnings Call

October 30, 2013 9:00 am ET


Sarah M. Stashak - Director of Investor Relations

Andrew W. Evans - Chief Financial Officer and Executive Vice President

John W. Somerhalder - Chairman, Chief Executive Officer, President, Member of Executive Committee and Member of Finance & Risk Management Committee

Scott Carter - Chief Regulatory Officer and Senior Vice President of Commercial Operations

Peter I. Tumminello - Executive Vice President of Wholesale Services and President of Sequent Energy Management


Mark Barnett - Morningstar Inc., Research Division


Good day, ladies and gentlemen, and welcome to the Third Quarter 2013 AGL Resources Earnings Conference Call. My name is Tehisha [ph], and I will be your coordinator for today's call. As a reminder, this conference is being recorded for replay purposes. [Operator Instructions] I would now like to turn the presentation over to Ms. Stashak, Director of Investor Relations. Please proceed.

Sarah M. Stashak

Good morning. Thank you, and thanks, everyone, for joining us today to review our third quarter 2013 results. Joining me on the call today are John Somerhalder, our Chairman, President and CEO; and Drew Evans, our Executive Vice President and CFO. We also have several members of our management team available to answer your questions following our prepared remarks. Our earnings release, earnings presentation and our Form 10-Q are available on our website. To access these materials, please visit

Let me remind you today that we will be making forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Forward-looking statements involve matters that are not historical facts, and our forward-looking statements and projections could differ materially from our actual results. The factors that could cause such material differences are included in our earnings release and more fully described in today's 10-Q filing. We also describe our business using some non-GAAP measures, such as EBIT, operating margin, adjusted net income, adjusted EPS and EPS excluding our wholesale services segment. A reconciliation of those measures to the GAAP financials is available in the appendix of our presentation, as well as on our website. We'll begin the call with some prepared remarks before taking your questions.

Drew, I'll turn it over to you to begin.

Andrew W. Evans

Thanks, Sarah, and good morning, everyone. I will begin today with a recap of our financial results for the quarter and year-to-date, and then I'll turn it over to John for some additional remarks. Our solid third quarter results are additive to our very strong performance year-to-date. We continue to track ahead of expectations in nearly all segments, and as a result, we're raising our full year 2013 earnings per diluted share outlook to between $2.75 and $2.85 on a consolidated basis. Guidance excluding wholesale services has risen to between $2.55 and $2.65. John will provide more information on our upward revision in a few minutes.

Looking specifically at the quarter, starting on Slide 3, we reported third quarter 2013 earnings of $0.24 per diluted share, an increase of $0.15 compared to the third quarter of last year, excluding the Nicor merger expenses. The principal variance in the quarter relates to strong commercial activity in our wholesale services segment despite being muted by hedge losses.

Excluding wholesale services, EPS was $0.24 for the quarter, compared to $0.21 last year, due to year-over-year improvements at distribution operations, retail operations and cargo shipping. In addition to achieving strong financial results, we received approvals on several important regulatory and legislative initiatives during the quarter, which John will speak to in greater detail.

On Slide 4, you will see our year-to-date results through September. Diluted EPS was $1.96, an increase of $0.40 from last year, excluding the Nicor merger expenses. Excluding wholesale services, EPS was $1.85 for the first 9 months, up $0.22 year-over-year. The variance year-over-year through September is mainly due to: colder weather and usage compared to the same periods that were historically warm last year in distribution and retail; higher revenues from regulatory infrastructure programs; higher commercial activity in the wholesale services segment; and the gain on the sale of Compass, offset by higher compensation expense accruals related to above-target performance for the full year. Through the first 9 months, our distribution segment contributed 78% of operating EBIT and our retail businesses contributed 17%.

Taking a closer look at each segment, a snapshot of third quarter EBIT for our distribution business is on Slide 5. EBIT was up $6 million compared to the third quarter of 2012. This is mainly due to increased margin from our infrastructure replacement programs and increased customer growth and usage. Through the first 9 months, the main drivers of the $39 million year-over-year EBIT improvement were slightly-colder-than-normal weather during the first quarter that was 34% colder than the record warm weather we experienced in the first quarter of 2012; and higher revenues from our infrastructure investment programs.

You'll notice that O&M expense is up 4% year-to-date, this is due largely to increased accruals for incentive compensation related to performance above targeted levels. Excluding this factor, our expense control has been excellent this year, which is consistent with our shared services model. With regard to customer growth, we have had a modest increase in our total utility customer account this year as compared to 2012.

Before leaving this slide, I also want to remind you of the weather hedge that we have in place related to Nicor Gas for the fourth quarter. It is designed largely to mitigate our downside weather risk in Illinois in the event of significantly warmer-than-normal weather, while retaining upside potential should the fourth quarter be colder than normal. This affords additional protection for our shareholders, and we will continue to evaluate options for mitigating our Illinois-weather risk in future periods.

Turning to the retail segment on Slide 6. We reported EBIT for the third quarter of $8 million, an increase of $3 million compared to the third quarter of 2012. For the first 9 months of the year, EBIT for the segment increased $11 million year-over-year. The primary driver of the third quarter improvement is the acquisition of 500,000 retail service contracts in January for this year. For the year through September, the increase is a result of colder-than-normal weather in the first half of the year, as well as the acquisition of the retail services customers.

In Georgia, we retained our leading market share position in our retail services business. The number of warranty contracts we are serving is up substantially year-over-year due to the acquisition I just mentioned. At the end of the second quarter of this year, we completed the acquisition of approximately 33,000 residential commercial customer relationships in Illinois. Integration of that acquisition went as planned and is largely complete.

You'll find third quarter 2013 results for our wholesale services segment on Slide 7. The EBIT loss of $2 million for the quarter is an improvement from the $23 million loss in the third quarter of 2012. The $21 million improvement is driven by strong commercial activity, offset by net hedge losses.

Through September, EBIT at the wholesale segment has improved by $37 million year-over-year, primarily driven by commercial activity that is $62 million, offset by net hedge losses in 2013 versus net hedge gains in 2012 and the $11 million gain on the sale of Compass in the second quarter of 2013. Through September, we recorded net hedge losses of $27 million, compared to net hedge gains of $8 million for the same period in 2012. The substantial improvement in commercial activity is related to improved monetization of our diverse asset portfolio. The storage rollout schedule at the end of September was $23 million, compared to $65 million at the end of the same period in 2012. The $42 million year-over-year reduction is reflective of the monetization of many of our storage positions as we withdrew natural gas from storage in the first half of this year.

Now let's move to Slide 8. The midstream segment decline year-over-year is due largely to the roll off of legacy contracts that were above current market rates, as well as higher depreciation, property tax and other storage-related expenses due to the additional facilities in service when compared to last year. Market fundamentals continue to be challenging for this business segment due to low natural gas price volatility, abundant market supplies and associated low seasonal storage spreads. As a result, we have entered into shorter-term contracts at lower rates, reflective of the current market, and in some cases have further optimized the value of the assets through short-duration transactions.

Briefly, you can see the results for the cargo shipping segment on Slide 9. Third quarter results were $3 million higher than in the prior year's third quarter, and through September, the segment is up about $4 million compared to last year. As a reminder, the fourth quarter is when substantially all of this segments' operating income is anticipated due to the seasonal nature of the business. We are seeing continued improvement in market conditions, and our volume is higher by 10% year-over-year through September. While the rate per 20-foot equivalent unit, or TEU, has fallen slightly on average due to pricing action taken last summer, rates for the third quarter were above last year's levels.

Some balance sheet highlights are noted on Slide 10. Our debt-to-capitalization improved modestly for the -- from quarter-to-quarter and stands at 55% at the end of September. We noted in our 10-Q that we have exercised an option under our 2 existing credit facilities to extend their duration by an additional year. We are awaiting lender approval on the request, but we do not anticipate any problems in extending the maturities. When approved, both facilities would mature at the end of 2017.

Interest expense was down by $2 million for both the quarter and the year compared to the same periods in 2012. 2013 interest expense reflects a $4 million reduction due to a third quarter correction of interest expense amortization related to prior periods.

Through September, we remain on track for a very strong year. Importantly, we were driving improvements in nearly every business segment through a combination of margin growth and ongoing expense discipline. As we enter the fourth quarter and the winter heating season, we are well-positioned to exceed the objectives we set forth at the beginning of the year.

Thanks for your time today. Now, I'll turn the call over to John.

John W. Somerhalder

Thanks, Drew, and good morning, everyone. I would like to spend a few minutes this morning discussing some of the strategic steps we have taken that have led to the year-over-year improvements Drew described and ultimately drove our decision to raise our guidance for this year. Clearly, as Drew pointed out, we have benefited from slightly-colder-than-normal weather this year, which is one significant driver of our year-over-year margin improvements. However, there are several strategic initiatives we have undertaken this year that have resulted in strong performance and we want to highlight these for you in a bit more detail.

In our distribution business, our infrastructure investment programs have resulted in enhanced safety and pipeline integrity for our customers while generating additional revenues for our shareholders. In addition, our non-payroll expense discipline is among the best in our sector due to our shared services model and our ability to generate efficiencies while spreading costs over a larger customer base.

Further our regulatory and legislative affairs teams have worked hard to obtain approvals for key programs across our footprint, specifically in Illinois, Georgia and New Jersey. Our strategic initiatives related to our non-utility businesses also are bearing fruit. We made some targeted acquisitions in our retail business earlier this year, both of which are already generating enhanced returns.

In our wholesale services business, we scaled back our cost structure to withstand a low-volatility environment and our team in Houston has done a remarkable job of retaining customers, bringing in new business and positioning our storage and transportation portfolios to take advantage of market dislocations that are occurring as a result of a shale gas revolution. And our cargo shipping business volumes have improved meaningfully year-over-year due to improving market fundamentals and a highly focused management team.

As Drew described, we are raising full year 2013 earnings per diluted share outlook to between $2.75 and $2.85 on a consolidated basis, up from $2.50 to $2.70. Guidance excluding wholesale services has risen to between $2.55 and $2.65, up from $2.40 to $2.50. The increase in our guidance range reflects very good success on many of the initiatives I just mentioned, which position us well for a strong finish to this year and for growth over the next few years.

Let me summarize the main EPS drivers of the increase, which you will find on Slide 11. Slightly-colder-than-normal weather across our distribution and retail businesses through June resulted in favorability to expectations of $0.05. As mentioned, last week we received approval to lower our depreciation rate in Illinois by approximately 100 basis points, which will reduce depreciation expense for the remainder of the year by $17 million or $0.08 per share, which will be recognized in the fourth quarter. We announced earlier this year that we recorded a $0.04 gain on the sale of Compass during the second quarter. In addition, the acquisition at the end of the second quarter of additional retail customers in Illinois is expected to add about $0.02 this year, and lower interest expense versus expectations should add $0.04. Importantly, underlying all of this is, is our ongoing focus on controlling expenses, which has resulted in additional favorability to our initial forecast. As a partial offset to these increases, we expect that variable compensation expense will increase relative to our original expectation, due to our strong year-to-date performance and expectations for the fourth quarter. And I'll just remind you that mark-to-market accounting related to storage and transportation hedge movements can have a meaningful impact on our wholesale business and our consolidated results. For that reason, and consistent with our past practices, our consolidated EPS guidance excludes the impact of any mark-to-market accounting movements.

Before I take your questions, I will briefly highlight some legislative and regulatory developments during the quarter, starting on Slide 12. We filed a depreciation study on behalf of Nicor Gas with Illinois Commerce Commission on August 30, recommending a revised composite depreciation rate of 3.07%, compared to the long-standing rate of 4.1%. The ICC approved the new rate on October 23 and it is effective as of August 30. As I noted earlier, this is expected to result in lower depreciation expense of $17 million this year and $50 million on an annualized basis. Importantly, this change does not impact the rates Nicor customers pay for service and it provides good incentives for Nicor Gas to increase its capital expenditures.

Also during the second quarter, Illinois Governor Quinn signed legislation that provides for infrastructure investment program for Illinois gas utilities, including Nicor Gas. A related rule making it is now before the ICC, and we are actively involved in that process. As a reminder, because Nicor Gas is under a base-rate freeze until December 2014 as part of the AGL-Nicor merger agreement, any new rates under this program could not take effect until January 2015.

Turning to Georgia and New Jersey on Slide 13, in Georgia, we received approval of our request to replace approximately 750 miles of vintage plastic pipeline over a 4-year period. This phase of the program is expected to cost approximately $275 million. As a continuation of our STRIDE program, we filed a new $260 million program in August that would be applied to system reinforcement and customer growth projects, carrying our schedule in November with the ruling anticipated in December of 2013. And in New Jersey, we received approval of our request for infrastructure investment under the AIR program. Under this program, we expect to spend $115 million over 4 years. In conjunction with this approval, we agreed to file a general rate case for Elizabethtown Gas by September 2016.

Again we are very pleased with our performance year-to-date and we are well-positioned for a strong finish to the year. Employees across our organization have worked diligently throughout the year, as they always do, to help us exceed our objectives thus far. As a management team, we cannot express enough appreciation for their efforts. And we thank our shareholders for your continued interest in and support of AGL.

Operator, I'll turn the call back over to you to begin the Q&A session.

Question-and-Answer Session


[Operator Instructions] Your first question comes from the line of Mark Barnett from Morningstar Equity Research.

Mark Barnett - Morningstar Inc., Research Division

Two quick questions, so I think you briefly touched on new Illinois filing mechanism here, but have you looked at the potential for filing under the Senate Bill 9 process for particular types of grid investments?

Scott Carter

Mark, I think that is -- this is Scott Carter. I think that's more focused at the electric side of the business. The opportunity that the gas utilities really saw in focusing on the infrastructure needs, we got through the legislation that was -- that John had mentioned. So then it becomes the right mechanism for us to move forward with meeting our needs in the State of Illinois.

Mark Barnett - Morningstar Inc., Research Division

Right. Yes, I know. I asked because I know that People's Gas had filed underneath or had attempted to file under that provision. And so I was just curious about the attractiveness -- potential attractiveness of that mechanism versus the alternatives.

John W. Somerhalder

Mark, it is -- I think it is an important point. We do believe that the legislation that Governor Quinn signed this year fits our needs very well, even though we will not be able to start putting new programs in place and having a surcharge before early 2015, that works very well with our planning cycle. It fits very well with the needs, we think, for increased capital on that system. So it does appear that, that is the right mechanism. It works well for us.

Mark Barnett - Morningstar Inc., Research Division

Okay. And a quick question on midstream. Looks like you didn't add much new contracts in the quarter. I'm curious, given where you see the rates today, when you're coming up for the 2014 expirations, do you expect -- there doesn't seem to be -- have been much movement in the market. Is there anything out there that you think might have a significant impact other than kind of unpredictable weather?

John W. Somerhalder

I think you've summarized it correctly. Our view is if you look several years out and you look at what's going on related to industrial demand growth and exports to Mexico and then LNG exports, there are drivers in those time periods. But that, as you know, that's closer to 2017. In the near term, we see very few drivers for changes in the storage rates other than what you mentioned. We've always seen in the past that weather events materially different than normal, on either side, have resulted in some dislocation and potential value in that market. But that's not our expectation, our expectation is that we'll be in this low-rate environment at that time period, and Pete can add to that.

Peter I. Tumminello

I think John's covered it well. I think we do see the next couple of years to be a continued challenge with the overhang of the supply and the abilities from gas-fired power generators to go back and forth between gas and coal, and in effect, have some surrogacy for storage. We do see, as John mentioned, longer-term, some recovery in those rates as those volatilities should increase with LNG exports and new loads, industrial and power-gen loads, increasing.


[Operator Instructions]

Sarah M. Stashak

Well, thank you, everyone, for joining us today. If you have follow-up questions later today, tomorrow, or over the next couple of weeks, feel free to give me a call. We will address it. Thank you.


Ladies and gentlemen, that concludes today's conference. Thank you for your participation. You may now disconnect. Have a great day.

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