Q3 2013 Earnings Call
October 31, 2013 9:30 am ET
Kevin W. Hadlock - Chief Financial Officer, Principal Accounting Officer and Executive Vice President
Ronald W. Jibson - Chairman, Chief Executive Officer, President, Chief Executive Officer of Questar Gas Company, Chief Executive Officer of Wexpro, President of Questar Gas Company and President of Wexpro
R. Allan Bradley - Executive Vice President, Chief Executive Officer Questar Pipeline and President of Questar Pipeline
James R. Livsey - Executive Vice President and Chief Operating Officer of Wexpro
Good morning. My name is Nishay, and I will be your conference operator today. At this time I would like to welcome everyone to the Questar Third Quarter 2013 Earnings Release Conference call. [Operator Instructions]
Mr. Kevin Hadlock, you may begin your conference.
Kevin W. Hadlock
Thank you Nishay. Good morning, everyone, and thank you for joining us for Questar's Third Quarter 2013 Earnings Conference Call.
I am Kevin Hadlock, Questar's Chief Financial Officer. With me today are Ron Jibson, Chairman, President and CEO of Questar Corporation; Jim Livsey, Executive Vice President and COO of Wexpro; Allan Bradley, President and CEO of Questar Pipeline; and Craig Wagstaff, Executive Vice President and COO of Questar Gas.
During this call, we'll be referencing our third quarter earnings presentation that can be found on our website at www.questar.com.
Let's move to Slide 2. Before we begin, let me remind you that we will be making forward-looking statements during our call today and actual results could differ from our estimates for a variety of reasons that we described in our SEC filings. Also, this call references non-GAAP financial measures. Our slides in the appendix of the presentation provide reconciliations to these measures.
So let's begin our review of the third quarter on Slide 4. Yesterday, we reported third quarter 2013 adjusted earnings of $33.2 million, or $0.19 per diluted share, slightly below last year's third quarter net income of $33.8 million. Third quarter 2013 adjusted earnings excludes the impact of a $52.4 million noncash after-tax impairment for the eastern segment of Southern Trails Pipeline. Including this impairment charge, we reported a net loss of $19.2 million, or $0.11 per diluted share, for the third quarter of 2013.
Adjusted EBITDA was strong in the third quarter, totaling $112.6 million, an increase of about 3% compared to last year's third quarter. Despite inflationary cost pressures, combined OEM, and G&A expense was down $5 million or 8% compared to the third quarter of 2012. Capital investment for the first 9 months of 2013 was $394.1 million, including $106.7 million Wexpro acquisition in the Vermillion Basin.
Turning to Slide 5. All business units performed as expected in the third quarter of 2013. Consolidated adjusted earnings were down slightly, with adjusted earnings per share equal to last year's third quarter. Including the impairment for this eastern segment of Southern Trails, we reported a consolidated loss of $0.11 per diluted share compared to earnings of $0.19 per diluted share in the third quarter of 2012.
Let's go to Slide 6. Questar Gas, our local gas distribution utility, showed a $1.2 million increase in gross margin during the third quarter to $39.5 million. Adjusted EBITDA was higher by $400,000. Questar Gas recognized a seasonal net loss of $9 million, which improved by $300,000 compared to the same period last year. This improvement was due to higher recovery of infrastructure replacement investment and customer growth. Questar Gas' capital investment in the third quarter was $45.2 million, an increase of $10.3 million compared to the third quarter of 2012.
Moving to Slide 7. Wexpro, our national gas development and production company, grew adjusted EBITDA to $62.2 million, up $900,000 or about 1% compared to the same period last year. Net income was up $1.1 million to $27.5 million, an increase of 4% over the third quarter of 2012.
These results were driven largely by a higher 12-month average investment base, which increased $33.9 million, and higher oil revenues. Wexpro invested capital of $128.4 million in the third quarter, which includes Wexpro's acquisition in the Vermillion Basin.
Let's go to Slide 8. Revenue at Questar Pipeline, our interstate natural gas pipeline and storage business, was down $3.3 million in the third quarter, primarily due to lower revenues from natural gas liquids, lower transportation revenues on Southern Trails Pipeline and the impact of seasonal transportation contract revenues.
Questar Pipeline delivered adjusted earnings of $14.5 million, down $2.6 million versus the third quarter of 2012. Including the non-cash asset impairment on the eastern segment of Southern Trails Pipeline, Questar Pipeline reported a net loss of $37.9 million. Capital investment in the third quarter was $23.9 million, which was $7.6 million higher than the prior year.
Moving to Slide 9. With regard to costs, Questar's consolidated operating and maintenance costs in the third quarter were down $400,000 compared to the same period last year, due largely to lower employee-related expenses and lower demand-side management costs. General and administrative expenses were down $4.6 million, primarily due to lower employee-related costs. Production and other taxes were up $4.1 million, driven by higher gas prices at Wexpro and higher Questar Gas property taxes. Depreciation in the third quarter of 2013 was up $1.5 million, compared to the same period last year due to higher capital investment. Consolidated interest expense was down $600,000 due to the replacement of Questar Gas' debt at lower interest rates than in the third quarter of 2012.
Turning to Slide 10. The company continues to generate strong cash flow. For the first 9 months of 2013, operating cash flow before working capital changes totaled $369 million, an increase of about 3% compared to the first 9 months of 2012.
At the end of the quarter, Questar had net available liquidity of $395 million in unused commercial paper capacity. During the third quarter, Questar Gas priced a total of $150 million of 30-year and 35-year private placement notes. These notes will be issued on delayed draw basis in December of this year. The coupon rate for both tranches of debt averages 4.80%.
With that, let me turn the time over to Ron to discuss operations and Questar's outlook.
Ronald W. Jibson
Well thanks, Kevin, for that summary and good morning, everyone. I am pleased to report that Questar's adjusted quarterly and year-to-date earnings continue to be in line with our 2013 earnings guidance. Each of Questar's business units performed very well in the third quarter and consistent with our 2013 earnings guidance. I am very proud of the accomplishments of our employees and what they have achieved so far this year and their clear focus on controlling costs and delivering the results.
Let's resume -- review some of these accomplishments, beginning on Slide 12. Questar Gas continues to perform very well and is executing in line with our forecast. The infrastructure replacement program, which is currently focused on replacing a high-pressure, reconditioned pipe in our distribution system, increased gross margin by $500,000 in the third quarter. We are also seeing strong customer growth, which is currently running about 1.4%.
On July 1, Questar Gas filed a general rate case in Utah, requesting a $19 million revenue increase and continuation of the current 10.35% return on equity. A focus of this case is to review the infrastructure cost tracking mechanism. We expect the proceeding could take up to 240 days to complete, which means that any increase in revenue would primarily affect results beginning in 2014.
Wexpro continues to grow its investment base. Wexpro's ending investment base increased by $15.9 million or 3% over the past 12 months. Wexpro produced 13.7 Bcfe in the third quarter of 2013, a decrease of about 6% compared to the third quarter of last year.
In September -- in early September, Wexpro successfully completed its $106.7 million acquisition of an additional 42% working interest in the trail unit of Wyoming's Vermillion basin, which is our lowest-cost producing basin. Pursuant to the Wexpro II Agreement, which was signed earlier this year, we are in the process of filing with the Utah and Wyoming utility regulators to include the acquisition in the existing inventory of properties from which Wexpro develops and produces cost-of-service gas supplies for Questar Gas customers.
Questar Pipeline has done an exceptional job controlling costs, with combined operating and maintenance and general and administrative costs down by 7% compared to the third quarter of 2012. Also during the third quarter, Questar Pipeline completed and put into service its Uinta Basin expansion. The Lake Side 2 power generation project, which is currently being jointly developed with Questar Gas, remains on schedule and under budget. These 2 projects are important for Questar Pipeline's customers and to meet our strategic objectives.
As Kevin mentioned in his remarks, Questar Pipeline recognized an impairment charge for the eastern segment of Southern Trails. This impairment does not change our objective to realize the highest value from this pipeline. I will talk more about the impairment and the progress on the Southern Trails initiatives later in the presentation.
Let's turn to Slide 13. As I mentioned in the third quarter highlights, we are thrilled with the successful completion of the acquisition of an additional working interest in the Vermillion Basin, and at an attractive price. It adds significantly to our already strong position in one of our lowest cost and most successful development areas, with the potential to materially add to the long-term and low-cost gas supplies available to our Utah and Wyoming utility customers.
Wexpro now owns an 88% working interest in this low-cost field. We estimate proved plus probable and possible reserves attributable to the acquired properties to be 195 Bcfe. Finding costs in this field over the last 2 years have been below $1 per Mcfe. Under the terms of the original Wexpro agreement, Wexpro produces gas from certain properties at cost-of-service. The recently approved Wexpro II Agreement perpetuates that model. Wexpro II stipulates that all Wexpro acquisitions within the footprint of the 1981 agreement must be offered to the Public Service Commissions of Utah and Wyoming for inclusion of cost-of-service properties benefiting Questar's utility customers.
We are in the process of filing with the Utah and Wyoming regulators to have this acquisition included in the Wexpro II Agreement. The Wexpro II Agreement specifies that the regulators have 60 days from the date of filing to render a decision. If accepted, the initial acquisition cost of $106.7 million will earn a rate of return equal to Questar Gas' cost of capital, which is currently 8.4%, and in future development costs, which are in the higher Wexpro rate of return, currently at 20.2%.
Moving to slide 14. Last quarter, Questar Pipeline announced the completion of the second phase of the strategic review of the Southern Trails Pipeline, which is in -- which is a non-core asset. We are continuing to develop services for both the western and eastern segments of our Southern Trails Pipeline, seeking to obtain the greatest value from the non-core pipeline for shareholders. We are working closely with an affiliate, Spectra Energy Corp., to market the capacity of the recently named Inland California Express Pipeline. The project consists of recommissioning the existing 96-mile western segment of Southern Trails Pipeline to crude oil service and constructing a rail unloading facility. If market conditions and economics enable the project to move forward, it could be in service by late 2015.
As a result of this strategic review of Southern Trails Pipeline, we reassessed the outlook for the eastern segment. Current and projected market rates for natural gas transportation between the San Juan Basin and California markets do not cover increasing operating costs and expenses, including right-of-way and pipeline safety costs. As a consequence, we recorded a non-cash impairment of the entire investment in the eastern segment of Southern Trails Pipeline of $80.6 million or $52.4 million after income taxes. Discussions continue with potential developers to either purchase the eastern segment of Southern Trails Pipeline or to enter into a long-term contract for capacity on that segment. However, Questar pipeline was able to reach a definitive agreement.
Turning to Slide 15. Last year, we formed Questar Fueling to meet the needs of an expanding market for compressed natural gas for transportation. The market continues to develop and provide opportunities for us to invest in the growing demand for the low-cost transportation fuel. During the third quarter, Cummins-Westport launched production of the 12-liter natural gas engine. We are encouraged by the acceptance of the engine by trucking companies. Cummins has indicated that more than 90% of the engines emerging from the Cummins-Westport joint venture are sold for compressed natural gas applications, compared to less than 10% configured for liquefied natural gas. Questar Fueling is well positioned to take advantage of this growing market. Questar
Fueling opened its first 2 compressed natural gas fueling stations this month in Houston, Texas and Topeka, Kansas.
The Houston CNG station can fuel hundreds of vehicles daily, including 200 natural gas-powered trucks, operated by Swift Transportation and Central Freight Lines. This location includes 5 lanes of high-speed public access fueling along with 120 private time-fill spaces where parked trucks can fuel. Swift's and Central's 200 trucks are projected to use about 5 million diesel gallons equivalents of natural gas per year at the Houston facility, which is the largest CNG fueling facility in the United States.
The Topeka location serves fleets for Frito-Lay and Dart Transit Company and will also be open to the public. At full capacity, the Topeka location can supply up to 3 million diesel-gallon equivalents of natural gas per year.
In 2014, Questar Fueling has plans to open additional facilities in several cities, including: Killingly, Connecticut; Dallas and Lancaster, Texas; Kansas City, Kansas; Phoenix, Arizona; and Salt Lake City, Utah.
Swift Transportation, Central Freight Lines and Frito-Lay are industry leaders in the adoption of compressed natural gas as a transportation fuel for the heavy duty market. I really want to commend them on their foresight in recognizing natural gas as a fuel that could transform the industry. With such abundant supplies of natural gas in America, it's only a matter of time before we see more trucking companies switching fuels to cut costs, increasing efficiencies and improving air quality.
Questar Fueling continues in discussions with many large national fleet operators regarding approximately 3 dozen potential anchored tenant sites. While not expected to make meaningful earnings or cash flow contributions in the early years, we are excited about Questar Fueling's long-term growth potential as the use of natural gas for transportation expands.
Let's move to Slide 16. Questar's return on equity continues to be industry-leading. For the 12 months ended September 30, 2013, we delivered an adjusted consolidated return on equity of 19.4%, excluding the impairment charge for the eastern segment of Southern Trails Pipeline. This superior return is supported by Wexpro, which provided an ROE of 20.3%. On a financial basis, Questar Gas delivered an ROE of 11%, and Questar pipeline's adjusted return on equity was 9.9%, excluding the impairment.
Moving to Slide 17. With 9 months of the year complete, we have raised the bottom of our guidance range by $0.04 per share. We now expect our 2013 adjusted earnings should be between $1.16 and $1.20 per diluted share. Wexpro continues to demonstrate an ability to grow its investment base, production and earnings. The completed acquisition of the new Vermillion Basin properties demonstrates the ability to execute on a long-term strategic plan.
At Questar Gas, strong customer growth and the infrastructure replacement program supports long-term earnings and rate-based growth.
Questar Pipeline continues to identify new long-term growth opportunities. Our commitment to customers and shareholders is to continue delivering superior service while profitably investing in and growing our businesses. These growth opportunities should help us maintain a compound annual earnings growth rate averaging 4% to 6% over the planning horizon. With the dividend increase earlier this year, we are near our target dividend payout of about 60%. We expect dividends will grow in line with earnings over the coming years.
Concluding on Slide 18. I want to emphasize Questar's unique strengths. Our integrated operations span the entire natural gas value chain from wellhead to burner tip. Our constructive regulatory relationships produce appropriate risk-adjusted returns. Questar has an attractive growth outlook, and we're excited about the new opportunities for Wexpro II, Questar Pipeline, and Questar Fueling.
Finally, our conservative balance sheet supports our earnings growth and long-term strategic plan. While we are pleased to be performing in line with our expectations and guidance, our goal is to consistently outperform. With the Wexpro acquisition, Southern Trails western segment development, Questar Fueling and other growth opportunities, we intend to do exactly that -- to outperform. Competitive and consistent growth in earnings, dividends and especially Questar's share price, will be the ultimate measure of our success.
And with that, we're happy to take your questions. I'll turn the time back to Nishay.
[Operator Instructions] And your first question comes from the line of Carl Kirst.
This is Danilo, filling in for Carl. Just a question on the Southern Trails. On the western leg side, do you guys still expect the timing of contracts sometime later this year or in early 2014?
Ronald W. Jibson
Yes. Let me ask Allan Bradley if he'll address that.
R. Allan Bradley
Yes, Danilo, we're in the middle of our marketing phase, and as part of that effort, we're about halfway through initial discussions with the LA basin refiners. We do expect 2014 to be kind of the target we need to maintain that early 2016 or late 2015 in-service state. Feedback we're getting is that they like the rates. They like the design of Our terminal outside the LA Basin. Obviously, utilizing the 96 miles of Southern Trails west, takes trains off of a very congested part of the nation's railroad system. And it's up to us now to get the site selected. A lot of good competition between both Union Pacific and Burlington Northern, and we have a preferred site off each, and we'll have to make a decision here shortly so we can begin the permitting process. So things are moving in line or on track with our schedule. And I think 2014, early 2014, would be a good expectation for an initial foundation contract support.
Okay, great. And with respect to the services that you guys mentioned that you are developing for both the east and western segments, is that something that you can elaborate on?
R. Allan Bradley
Well, certainly on the west, it's pretty straightforward, as Ron said on his notes. Obviously, they're advantaged to having unloading facilities on the rail lines outside of the congested portion of their system. I think you're seeing some advancement in Bakersfield, the same concept using existing pipeline. We're doing the same thing, playing a little catch up ball on the permitting but very optimistic about the results there. On the eastern segment, as we indicated, we've completed our strategic review. We took what we thought was a very interesting proposal. We gave ourselves 90 days to convert that into a definitive agreement. And as we pushed forward, we just put a lot of energy into it. But we just weren't able to get that done in that 90-day window. At the same time we're developing our 5-year plan for Southern Trails. As you know, we're -- as an industry, we're very focused on our safety initiatives. we were seeing some rising O&M costs associated with the in-line inspection, class location and changes. We're also seeing some higher O&M around compressor maintenance. And we've looked at those costs relative to the basis differential between San Juan and the Cal border. We really -- we're in a sort of a squeeze, and as a result of that -- and this really has been about a year since we renegotiated the first contract that terminated. We had a 40,000, 30 [ph] day contract terminated. It rolled off from about a $0.35 rate to about an $0.18 rate. That was really all that basis differential would give us. As we looked out to 2015, when the other contracts were expiring, we just didn't see any change. And that really put us in the squeeze, so to speak, with O&M costs rising. We were seeing our revenues declining, and we applied sort of the accounting impairment rules. It really told us we need to take this noncash impairment. And I think, as Ron says, it might actually help us with some alternatives that we're pursuing around the sale or putting this pipeline back into a different transportation service. Because over time, we still think the best use of the pipeline is in crude service. The markets are not reflecting that right now, but we're still going to keep that on the drawing board. When the market conditions strengthened, we'll be ready to move on it.
Okay. Moving on to Wexpro, if I could, have you guys thought about possibly exporting that concept into other jurisdictions or is that still kind of early?
Ronald W. Jibson
That really does feed into our plans and our growth plans in Wexpro. And we're focused on that right now. We think it's a model that can be used elsewhere, and I think Wexpro II definitely opened up that opportunity. And I'd like maybe Jim could elaborate. Jim Livsey heads up Wexpro company. Ask Jim if he can elaborate a little bit on some of the discussions that we've been having there.
James R. Livsey
Sure. Yes. We've had a few discussions with other utilities as well as industrial end users. And we think that's a model as you mentioned, could be exported, and we're in the early stages of that. work. But we're cautiously optimistic that we might have some opportunities there.
So you guys did receive positive feedback even though you're at the early stages of this concept?
James R. Livsey
Yes we have.
Ronald W. Jibson
Yes, most definitely.
[Operator Instructions] And there are no questions from the phone line.
Ronald W. Jibson
Okay. Thank you very much. Again, let me just reiterate how much we appreciate all of you taking the time and making the decision to be with us this morning. We look forward to visiting with you. I know we've met with several of you in the last few weeks. And we look forward to our one-on-one meetings and calls in the future. We appreciate your support of Questar. And again, we're optimistic about the potential, and our objectives are to continue to execute and to outperform. And so again, thanks for taking the time this morning, and we'll talk to you all soon.
This concludes today's conference call. You may now disconnect.
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