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Niska Gas Storage Partners LLC (NYSE:NKA)

F2Q14 Earnings Call

October 31, 2013 9:00 AM ET

Executives

Simon Dupéré – President and CEO

Jason Dubchak – VP, General Counsel and Corporate Secretary

Rick Staples – EVP

Vance Powers – CFO

Analysts

Shneur Gershuni – UBS

Michael Blum – Wells Fargo Securities

David Neuhauser – Livermore Partners, Inc.

Tom Nowak – Advent Capital

Operator

Good day, ladies and gentlemen, and welcome to the Quarter Two 2014 Niska Gas Storage Partners LLC Earnings Conference Call. My name is Carol, and I will be your operator for today. At this time, all participants are in a listen-only mode. We will conduct a question-and-answer session towards the end of this conference. (Operator Instructions). As a reminder, this call is being recorded for replay purposes.

And I’d now like to turn the call over to Simon Dupere, President and CEO. Please proceed, sir.

Simon Dupéré

Thank you, Carol, and thanks, everyone, for joining us this morning. On our call today, we will discuss our results for the first six months and quarter ended September 30th, 2013. And provide an update on our operations and our market outlook.

Speaking on the call with me will be Rick Staples, our Executive Vice President, who will provide a market update, and Vance Powers, our Chief Financial Officer, who will provide financial details. Following our prepared remarks, we will open the call to questions.

But first, Jason Dubchak, our Vice President, General Counsel, and Corporate Secretary, will read the customary cautionary statements.

Jason Dubchak

Thank you, Simon. Before we begin, I would like to advise everyone that we may make statements on the call that could be considered forward-looking statements, as defined by the SEC. Future financial performance and operational results are subject to numerous contingencies, many of which are beyond our control.

Any forward-looking statements we make are qualified by the risk factors and other information set forth in our Form 10-K filed in June and the Form 10-Q, which we will file shortly with the SEC.

Additionally, in discussing our results, we will refer to the financial measures adjusted EBITDA and cash available for distribution, which are non-GAAP measures. A reconciliation of these measures to the most directly comparable GAAP measure, net earnings, is included in the press release we issued this morning and is available on our website at www.niskapartners.com.

With that, I’ll hand things back to Simon.

Simon Dupéré

Thanks, Jason. As you saw in our press release earlier this morning, our adjusted EBITDA for the quarter ended September 30th, 2013, was $32.1 million and cash available for distribution was $15.7 million, compared to $36.3 million and $19.6 million, respectively, for the prior year’s comparable period.

On a year-to-date basis, adjusted EBITDA was $47.4 million and cash available for distribution was $15.2 million, compared to $89.1 million and $56.9 million, respectively, in the prior year. These results are in line with our expectations.

During the latter part of the quarter, we experienced short-term opportunities in our Canadian-based AECO market region, which helped to offset continued challenges in our US storage markets. Accordingly, we are reaffirming our previous guidance of adjusted EBITDA in the range of $125 million to $135 million and cash available for distribution in the range of $60 million to $70 million.

As of today, I am pleased to report that we have locked in almost 90% and to be exactly perfect, it’s 89% of the revenues required to meet the midpoint of our guidance range.

Also this morning, we declared a quarterly distribution of $0.35 to unitholders of record on November 13, 2013. The distribution remains unchanged from previous quarter and will be payable on November 21 of this year to unitholders of record as of November 13, 2013.

As you may remember, last quarter we implemented a distribution reinvestment plan, or the DRIP program, and I am pleased to announce that the Carlyle/Riverstone Equity and Power Fund II and Carlyle/Riverstone Equity and Power Fund III, which collectively own about 49% of the outstanding common units, I have indicated that again we intend to reinvest all proceeds from this quarter distribution in the DRIP program.

Overall, Niska had a solid quarter. We focused much of our efforts on taking advantage of the short-term favorable spread environment in Alberta, as well as growing and diversifying our asset base. We’ve completed our expansion at Wild Goose, adding 25 Bcf of working capacity. We now have a total of 75 working gas capacity now fully operational at Wild Goose.

We continued to make good progress at Starks, our proposed NGL storage facility in Louisiana. Currently, we are working on the requisite regulatory permits and we continue to work with potential customers to market liquid storage capacity in the region. We believe that our efforts to grow and diversify the business through projects like Starks and potentially acquisitions are the keys to growing unitholders’ value in this challenging storage market environment.

With that, I will turn the call over to Rick to discuss our commercial environment.

Rick Staples

Thank you, Simon, and good morning, everyone. We experienced some significant regional diversity between storage markets over the past quarter. You may recall that the United States entered this past summer with about 0.8 trillion cubic feet less natural gas in inventory than the previous year. The requirement to refill depleted storage inventories during the injection season, along with other factors, provided support for cash prices for most of the summer.

With relatively strong pricing at the front of the curve, we encountered very challenging conditions in the US-based markets where we operate. Near-term storage spreads remained extremely weak, and at times we even saw summer cash prices trade above winter. Despite these pricing challenges, the natural gas market maintained a strong pace of storage injections, nearly eliminating the year-over-year inventory deficit.

Natural gas inventories in the lower 48 states have already returned to robust levels of more than 3.7 trillion cubic feet with two weeks remaining to be reported in the traditional injection season. We believe that this powerful recovery in storage inventories underscores the market’s deep dependence on natural gas storage.

The Western Canadian natural gas market, where we have our AECO storage hub, experienced an entirely different set of market fundamentals than the US this past summer. To begin with, storage inventories in western Canada did not draw down as deeply as the United States this past winter.

In addition, on July 1, TransCanada Pipeline significantly amended the short-term toll structure on its mainline system that moves gas out of Alberta to serve eastern Canadian and US markets. The higher tolls had the effect of trapping natural gas production in Alberta, depressing near-term prices and significantly widening seasonal spreads in the region.

Cash to winter spreads in Alberta widened to more than $1.50 through the latter half of summer. We were able to participate in this market improvement through our optimization strategy. Toward the end of the season, TransCanada again amended its pipeline tolls, this time encouraging more flow to, gas to flow to eastern markets and alleviating the congestion in western Canada.

The favorable storage markets we encountered in Alberta served to offset weaker spreads at our US-based assets. This underscores the strength of Niska’s regional portfolio of assets. At this point, we have locked in nearly 90% of the revenues needed to meet the midpoint of our guidance range and are maintaining our guidance of $125 million to $135 million for the year.

At a more macro level, we continue to see growth in US-based natural gas supply, as well as near-term increases in residential, commercial, and industrial demand. In the long term, the market continues to develop demand-side infrastructure, such as gas-fired power generation and petrochemical projects, and we continue to see announcements of new LNG developments, both in the US Gulf Coast, as well as on Canada’s West

Coast.

While we continue to see market challenges in the near term, we remain well positioned to capitalize on market shifts when they arise and are confident in our ability to provide valuable service to a growing natural gas industry into North America over the long term.

I will now turn the call over to Vance to review our financial results.

Vance Powers

Thank you, Rick, and good morning, everyone. As Simon mentioned, our adjusted EBITDA for the quarter and six months ended September 30 was $32.1 million and $47.4 million, compared to $36.3 million and $89.1 million in the same periods last year. Cash available for distribution was $15.7 million and $15.2 million for the three- and six-month periods ended September 30, 2013, compared to last year’s results of $19.6 million and $56.9 million. I would note that last year’s three- and six-month results included benefits of $5.1 million and $6.4 million, respectively, from inventory write-downs recorded in the three months ended June 30 and March 31, 2012.

Niska’s net loss during the quarter ended September 30, 2013, was $7.8 million, compared to a net loss of $15.4 million in the same period last year. For the six months ended September 30, 2013, Niska’s net earnings were $0.1 million, compared to a net loss of $52.7 million for the six months ended September 30, 2012. Earnings per common unit were a loss of $0.22 and flat for the three and six months ended September 30, 2013, compared to losses per common and subordinated unit of $0.22 and $0.76 per unit, respectively, through the three and six months ended September 30, 2012.

Remember that earnings per unit in this year’s three- and six-month periods include 34.5 million common units, whereas these amounts in the respective periods last year include 68.3 million common and subordinated units. The subordinated units were eliminated in our equity restructuring effective April 2, 2013.

Fee-based revenues for the three months ended September 30, 2013, were $33.2 million, compared to $41 million in the same period last year. Year to date, fee-based revenues were $64.7 million, compared to $78.1 million in fiscal 2013. The decrease in fee-based revenues resulted from lower rates and a narrower spread environment, coupled with reduced capacity utilized for fee-based services in the current quarter and six-month periods. These results were in line with expectations.

Realized optimization revenues for the quarter and six months ended September 30, 2013, were $17.3 million and $22.9 million, compared to $12.2 million and $45.9 million last year. The increase quarter over quarter principally resulted from the realization of the near-term opportunities at AECO that Rick discussed.

The decrease on a year-to-date basis reflected substantial realizations from financial hedges in the prior year that caused optimization revenues to be shifted towards the first six months in our last fiscal year. Net optimization revenues, which include unrealized mark-to-market gains and losses, for the three months ended September 30, 2013, were $3.7 million and $29.4 million, compared to negative $16.5 million and negative $56.9 million in the comparable prior-year periods.

Operating expenses in the current quarter were $8.9 million, about flat with $8.8 million last year. Year to date, operating expenses were $19.3 million versus $16.9 million last year. Fuel and electricity costs incurred in our fiscal first quarter, which resulted from increased cycling and higher power prices in Alberta, drove the increase in year-to-date operating costs.

General and administrative costs for the three and six months ended September 30, 2013, were $9.5 million and $20.8 million, respectively, compared to $8.1 million and $17.9 million in the respective prior-year periods. Incentive compensation accruals, primarily related to long-term incentive plans, caused most of the increase. Interest costs for the quarter and six months ended September 30 were $16.4 million and $32.6 million, compared to $16.7 million and $33.2 million last year. The reduction in interest resulted from lower revolver utilization and lower rates, partially offset by the absence of capitalized interest in the current year.

Turning to the balance sheet, we maintained our strong liquidity position with $8.2 million of cash on hand and $60.5 million drawn on the revolver. Last year at this time, we had $165 million drawn on the revolver, which principally fund our optimization strategy. At September 30 this year, we had about 55 Bcf of proprietary gas inventory, compared to approximately 70 Bcf at this time last year.

As of today, we have $82 million drawn on the revolver and $58.3 million in letters of credit outstanding, so we currently have $259.7 million available on the revolver. Our fixed-charge coverage ratio was 2.1 to 1.

As Simon mentioned earlier, we are pleased that the Carlyle/Riverstone Funds have again committed to reinvesting the full amount of their quarterly distribution, signaling continued strong support from our parent. This second consecutive reinvestment injects approximately $6 million back into the business.

With that, I will turn it back to Simon.

Simon Dupéré

Thank you, Vance. Our second quarter has been a busy one with the completion of our expansion at Wild Goose with 25 Bcf and the continued execution of our commercial plan, particularly at AECO. Once again our strong geographical diversification has been beneficial for our operation. In addition, we continue to strengthen our balance sheet and position ourselves for future growth.

With that, I will turn the call over to the operator for questions. Operator are you there?

Question-and-Answer Session

Operator

(Operator Instructions). The first question comes from Shneur Gershuni from UBS. Please proceed.

Shneur Gershuni – UBS

Good morning guys.

Rick Staples

Good morning.

Shneur Gershuni – UBS

First question that I had, the opportunity in the quarter was, it sounds like it was created by a rate structure change with respect to TransCanada, and then at the end of the quarter, they changed it again. So effectively, is it fair to say that opportunity doesn’t effectively repeated itself kind of on a go-forward basis? Is that a fair point?

Rick Staples

I wouldn’t necessarily, it’s Rick here, by the way. I wouldn’t necessarily say that. We really don’t know what TransCanada’s future plans are for its short-term toll structure. What we do know is that they adjusted it to some pretty significant high levels mid-summer and that they reduced it in the fall, and, in fact, have been discounting more recently. So what we do know is that any shifts in that particular toll structure have the potential to add volatility to the AECO market, and our storage facilities are well positioned to take value from any volatility in the market.

Shneur Gershuni – UBS

Okay. And my second question is kind of more of a longer-term major type question. So for this year at this point, right now, you have got your guidance on the board. You have locked in 90% of the revenue. It looks like execution is all you really need to effectively hit it and so forth. When we think about the following year, what would you describe as the recipe or market environment that’s necessary to effectively achieve the same numbers and possibly higher numbers, absent expansions and so forth, just kind of on the base business that exists today?

Rick Staples

It’s a good question. At this point in time, our focus continues to be on, in delivering the results that we have committed to the market for this year. We’ve only just begun our contracting for next year, so really it’s very early days, and at this point in time, we’re really not in a position to provide guidance for next year.

Shneur Gershuni – UBS

Right, I’m not necessarily looking for a dollar guidance, per se, but would you prefer a heavy draw the winter? How should we think about the storage market and the movements in flow of natural gas over the course of the next six to nine months that will set up the next year in your favor or not in your favor?

Rick Staples

When we look at next year, I think that a couple things to consider. There’s sort of three market conditions you could encounter through the coming winter. You could encounter a warmer-than-normal winter. It could be just an average winter or a cooler-than-normal winter. If we see some significant draw downs, there’s the potential that the spread for next year could narrow somewhat.

However, in the other two scenarios, we believe that there’s potential that the spread could actually widen, and so if you have warmer-than-normal winter, natural gas basically stays in the ground. The more gas stays in the ground, we could see a softening of prices at the front of the curve and you could see the spreads widen.

We actually see the potential for that to occur even if you encounter a normal winter, and the rationale for that is that we have more production today than we did a year ago and we’re still coming into the year with robust levels of storage inventory.

Shneur Gershuni – UBS

Okay, great. Thank you very much, guys.

Rick Staples

Thank you.

Operator

Thank you the next question comes from Michael Blum from Wells Fargo. Please proceed.

Michael Blum – Wells Fargo Securities

Thanks very good morning.

Rick Staples

Morning Michael.

Michael Blum – Wells Fargo Securities

Just a couple questions, I guess. One, you mentioned in the press release and a little bit in your prepared remarks about a weakness in your US gas storage assets. Can you just expand a little bit there and maybe talk a bit about the contract portfolio and when you see additional contracts rolling over?

Vance Powers

Sure. Michael, first off, with respect to the US storage markets, as we mentioned, this past year there was a fairly deep drawdown in storage inventory, especially at the end of the winter, and that had the effect of driving prices up at the front of the curve.

The market has been running very hard to refill that storage, and as a result, what we are seeing is cash prices, the short-term prices, have been very strong. And of course, the market’s also had to cope with whatever the short-term heating requirements are in place in the meantime.

So what we’ve found is that with the strength at the front of the curve, the spreads certainly did compress, and we were susceptible to that in the regions where we operate, Wild Goose and Salt Plains. The other, with respect to the contracts, we just have our typical portfolio contracts.

As you recall, we like to contract our capacity over a variety of terms, and so we had some contracts rolling off this past year that we re-contracted and we will have some rolling off again as we roll into next year, and our team has just started focusing on re-contracting that capacity.

Michael Blum – Wells Fargo Securities

Great, and then just in terms of organic capital spending, can you just give me your thoughts in terms of, we know what’s been announced at Wild Goose, but beyond that, is there any, are you looking and we know obviously, we know about the NGL storage opportunity, but on the natural gas storage side, is it your, would you expect you’ll continue to expand those assets or do you think you will probably hold it here at this level?

Simon Dupéré

I will take this one, Michael. As you mentioned, and you know Wild Goose, 25 Bcf this year expansion was extremely cheap for us because in the last few years, every time that we did expand Wild Goose, we were putting a little bit more money to grow the capacity and we were expecting to expand a little bit further.

Therefore, if you look at this year where our capital budget was, we are saying, about $10 million or less, this included capital maintenance of about $2 million, and I would say that all the remaining $8 million was to do the Wild Goose expansion, was to do some work at Starks, some work at Sundance as well, and basically I would say that at this point in time, we probably will not be spending that $10 million.

Therefore, if you do the math, it is probably going to be close to $5 million. If you do the math, Wild Goose expansion of 25 Bcf turned out to be probably $0.10 per Mcf, therefore, in the current spread environment, NYMEX of $0.30. Within four months, you have a nice payout, which has always been good for us in terms of organic growth.

To key in on your question, what’s next, we do have Starks that we were looking at and the timing is still the same thing.

We’re looking at some time in Q1 of 2015 calendar year; therefore, for Niska it is fiscal-year 2016. Therefore, as we go into next year, we will spend some money going forward, but most of the money will be spent probably when we do – if we go on construction for Starks.

We do have the Sundance project in Alberta, where we have mentioned that we do have all the permits. We’re waiting for the spread to improve, and we will wait and see. We are looking for a longer-term improvement in the spread. What would be nice would be to tie all this in when you do an LNG project coming in the 2017 timeframe.

Therefore, at this point in time, I would say for next year in terms of organic growth, we have done quite a bit. For next year, I would say there is not a lot, other than a bit on Starks. But as we mentioned as well, we see the growth for Niska. We have done a lot of organic growth, but the growth for us will be to still pursue those Starks, pursue those Sundance project, but we are looking for potential acquisition as well.

Michael Blum – Wells Fargo Securities

Great, and just last question on acquisitions. Can you talk about the type of assets you are looking at? Are you looking at additional gas storage assets or you are looking at other types of assets in the energy market?

Simon Dupéré

We still like the gas storage market at this point in time, even if it has been very, very challenging. We still like storage; therefore if there is opportunity, we’re always there and looking at them. But in terms of, we’d like to expand our fairway as well and be a little bit more of a midstream business; therefore, for example, gathering and processing would be something we would be looking at, could be looking at pipeline as well, and other businesses as well.

Michael Blum – Wells Fargo Securities

Great, thank you very much.

Simon Dupéré

Thank you Michael.

Operator

The next question comes from the line David Neuhauser from Livermore Partners. Please proceed.

David Neuhauser – Livermore Partners, Inc.

Most of the questions, I think, have been answered. It sounds like you are continuing to focus, obviously, on building out further organic projects, and also continuing to prosper, I guess, with the current AECO break in the basis. Looking forward, is it the goal that you are positioning the Company at this point for the future of gas demand and more normalized spreads over the next several years with LNG coming online? Is that the shorter to midterm plan at this point, and not necessarily looking at expanding growth much further?

Vance Powers

David, that’s a very open-ended question. I think that to go back to the things that we have said, we are positioning the Company to operate successfully in the storage environments that we working in. We are looking for, in the longer term, increased permanent gas demand that will benefit storage markets structurally. And we do have a portfolio of growth opportunities that we continue to pursue and evaluate, coupled with the potential for acquisitions, if we can do them and we can make them accretive to the business. So I think I will go back to those lines and say those are our strategy, and I think that fits with what you said.

David Neuhauser – Livermore Partners, Inc.

Okay, yes, and what about in terms of, I think one question is, obviously, we have seen the units increase in value as people are starting to get a better understanding of your growth opportunities. The current markets, obviously, in Canada have been much more favorable, as well as looking out further again and things, sort of a bit of a structural change to storage. With that, what type of consistency do you think you need to see over time where you might gain some comfort and further cash flows to potentially increase distribution?

Vance Powers

As we said before, as distribution increases, our Board looks at it every quarter. I think you have hit the highlights of you have to have earnings that are there and sustainable. If you look towards an increase, the increase must be sustainable. I will say that the Board is sensitive to unitholder value, but they do consider it every quarter and they look at it. So, strong earnings that are sustainable into future periods, those are the conditions that drive distribution increases.

David Neuhauser – Livermore Partners, Inc.

Okay, that’s fair enough. I appreciate it, guys. Thank you.

Operator

(Operator Instructions). The next question comes from the line of Tom Nowak from Advent Capital. Please proceed.

Tom Nowak – Advent Capital

Hi good morning.

Vance Powers

Good morning Tom.

Tom Nowak – Advent Capital

Can you break your guidance in between, down to US and Canada? For EBITDA?

Vance Powers

We operate as one reportable segment and we don’t break our guidance down between geographic or on a facility-by-facility basis.

Tom Nowak – Advent Capital

Can you give us a sense of magnitude?

Vance Powers

No.

Tom Nowak – Advent Capital

Can you give us a sense of the year-over-year changes in the regions in terms of EBITDA generation?

Vance Powers

What we’ve told you already. Canadian operations are up and US operations are less robust than they were.

Tom Nowak – Advent Capital

Right. Okay, and just longer term, strategically, LNG does seem to be an opportunity, but can you make the case, it doesn’t seem like geographically you are necessarily in the right position. Does it make sense to ship gas from the Horn River down to AECO and then back out to BC? How does that, how do you see that playing out?

Rick Staples

There are a lot of irons in the fire when it comes to how the markets related to the LNG in western Canada are going to unfold, Tom. I think that the way to think about that is to view western Canada as one large market region, and we are aware that a number of the plans for connecting Horn River production or that sort of northeastern British Columbia production to markets, including the Asian markets, do have some link or connection with the TransCanada/Alberta system with NIT, the NOVA Inventory Transfer mechanism. And we’re obviously deeply connected to the NIT system. So our view is that there is a very good chance that any developments in northeastern British Columbia will have some direct impact on the Alberta markets, and we are positioned to participate in those upsides.

Tom Nowak – Advent Capital

Okay. And then, can you just update us on your thoughts on potentially making attempts to reduce the coupon on your high-yield bond through refinancing? The high-yield market is obviously very strong right now, so what are your thoughts there?

Vance Powers

That’s a great question. And as you know, Tom, the senior notes become first callable on March 15, 2014. I would say that the interest rate environment we’re in right now is very interesting. I think it is interesting for all US businesses, not just MLPs and not just MLPs that are situated the same as Niska. So I can say that we are very mindful that the first call date is in March, March 2014, that we are in a very, I will say, favorable interest-rate environment right now. As you know better than anybody, it is a little unsure as to how long that is going to continue, so we continue to consider and evaluate what the appropriate thing to do is.

Tom Nowak – Advent Capital

Okay, thanks.

Operator

Thank you. There are no further questions, so I would now like to turn the call over to Simon Dupere for closing remarks.

Simon Dupéré

Thank you, Carol, and I just want to thank everyone for joining us on the call this morning. We hope you enjoy the rest of the autumn season and have a great holiday season, a bit early, but we look forward to updating you in late January in the next year. Thank you very much.

Operator

Thank you for your participation in today’s conference. This concludes the presentation. You may now disconnect. Have a great day.

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