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Piedmont Natural Gas (NYSE:PNY)

2013 Earnings Call

January 03, 2014 10:00 am ET

Executives

Nicholas Giaimo

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

Karl W. Newlin - Chief Financial Officer and Senior Vice President

Victor M. Gaglio - Chief Utility Operations Officer and Senior Vice President

Franklin H. Yoho - Chief Commercial Operations Officer and Senior Vice President

Analysts

Sarah Akers - Wells Fargo Securities, LLC, Research Division

Daniel M. Fidell - U.S. Capital Advisors LLC, Research Division

Spencer E. Joyce - Hilliard Lyons, Research Division

Travis Miller - Morningstar Inc., Research Division

Operator

Good day, and welcome to the Piedmont Natural Gas Year End 2013 Earnings Conference Call. Today's conference is being recorded. At this time, I would like to turn the conference over to Mr. Nick Giaimo. Please go ahead, sir.

Nicholas Giaimo

Thank you, Shannon. Good morning, everyone, and thank you for joining the Piedmont Natural Gas Year End 2013 Earnings Conference Call. This call is open to the general public and is being webcast live over the Internet. If you would like to access the webcast of this call or view the slides of the accompanying presentation, please visit our website at piedmontng.com and choose the For Investors link. On the right hand side of that page, you will find the appropriate link.

On the call today presenting prepared remarks, we have Tom Skains, President, Chairman and Chief Executive Officer; and Karl Newlin, Senior Vice President and Chief Financial Officer. Other officers of the company are also in attendance to take your questions.

Finally, this call may include forward-looking statements, and our actual results may materially differ from those statements. More information about the risks and uncertainties relating to these forward-looking statements may be found in Piedmont's 2013 Form 10-K filed Monday, December 23, with the SEC.

And with that, I will turn the call over to Tom.

Thomas E. Skains

Thanks, Nick. Good morning, everybody, and thank you for joining us for our year end 2013 earnings conference call. I know many of you are just getting back to the office after the holidays, and we appreciate you taking the time to be with us today.

As you know, we filed our 2013 10-K and issued our year-end earnings release on December 23. This morning, I'm going to talk about our 2013 accomplishments and provide you with a general update on the company. And then I'll turn the call over to Karl Newlin to give you a more detailed discussion of our 2013 financial results and our 2014 earnings guidance.

Let's begin on Slide 2, since Nick has already covered Slide 1. I'm extremely proud of what our team accomplished in 2013. We generated net income of $134 million and diluted earnings per share of $1.78. This was 12% and 7% higher, respectively, than 2012 results and at the upper end of our guidance range. 2013 was also a strong year for customer growth. We added more than 14,000 new customers to our system, the strongest year of customer growth since 2008.

We executed our regulatory strategy, with general rate relief in North Carolina and the approval of Integrity Management Riders, or IMRs, in both North Carolina and Tennessee to reduce the regulatory lag on the recovery of our system integrity capital expenditures. In North Carolina, our general rate case was approved effective January 1, and the new IMR will allow us to earn a recovery of and a return on our system integrity investments outside of general rate cases effective February 1 of each year. We were granted a similar IMR mechanism in Tennessee with the first annual margin adjustment of $13 million effective January 1 of this year. The driving force behind our pursuit of IMRs in North Carolina and Tennessee was our increased level of annual capital expenditures to enhance the safety, integrity and reliability of our pipeline systems.

In 2013, we completed the largest capital expenditure program in the company's history, which included the Sutton power generation delivery project for Duke Energy. We also achieved growth in our joint venture portfolio in 2013. This includes our 24% equity participation in the Constitution Pipeline project, a 5% ownership increase in Pine Needle LNG to 45%, as well as in the expansion of SouthStar into Illinois markets and our 15% equity ownership level.

During the year, we took advantage of the favorable interest rate environment and issued $300 million, a 30-year debt at a coupon rate of 4.65%. We also issued 4.6 million common shares in 2013 and early fiscal 2014 that provided proceeds of about $130 million. And finally, our board once again demonstrated its confidence in the company's strategic growth plan by raising our dividend in 2013 for the 35th consecutive year.

Slide 3 shows our 2013 net income of $134 million, which was 12% higher than 2012. Higher top line margin growth from utility operations and increased earnings contributions from joint ventures more than offset the increased O&M, depreciation and the interest expense to support that growth. I'll let Karl speak to these income statement items in more detail in just a moment.

On Slide 4, we've highlighted our gross customer additions for the year. As you can see, customer gains of 14,274 were 8% better than last year and produced a growth customer growth rate of 1.4%, above our initial forecast for the year. Notably, residential new construction and customer additions were 30% higher than last year, reflecting an improved housing market across our 3-state service territory. We expect this momentum to continue, which is why we're forecasting a gross customer addition growth rate of 1.5% in 2014.

At the end of May, we filed our first general rate case in North Carolina since 2008. In October, we reached a comprehensive settlement with the North Carolina public staff that was approved by the North Carolina Utilities Commission, or NCUC, last month. Under the approved settlement, we were granted rate relief of $30.7 million, which translates into $24.2 million of pretax income after depreciation changes and regulatory amortization adjustment. Our approved return on equity is 10% based on an equity capital structure of 50.7%. New rates under the settlement went into effect January 1.

As I mentioned earlier, the NCUC also approved an IMR that allows us to recover costs associated with our capital investments to comply with federal safety and integrity regulations. Following the close of each fiscal year, we will make annual IMR filings with the NCUC for updated rates the following February.

Last month, we made our first NC IMR filing proposing a $1 million annual increase in rates to be effective next month. Although not shown on this slide, our first Tennessee IMR filing was approved last month by the Tennessee Regulatory Authority, with a $13 million annual increase in rates effective January 1.

Moving to Slide 6. In 2013, we invested over $670 million in support of customer growth, power generation delivery projects, system integrity programs and joint venture opportunities, the largest capital expansion program in company history. Capital expenditures related to customer growth and system integrity are shown in the blue and red bars. The green bar represents expenditures to complete the Sutton power generation delivery project, which we put into service in June. With the completion of this project, we've now invested more than $500 million to provide service to 5 new gas-fired power plants in North Carolina since 2010.

The purple bar represents contributions made to our joint ventures, which, in 2013, included the investments in SouthStar, Pine Needle and the Constitution Pipeline project. In 2014 and 2015, our forecasted joint venture contributions are related to the Constitution Pipeline. As you can see, with the utility capital expenditure and joint venture contribution program totaling more than $500 million in both 2014 and 2015, we are continuing to make significant investments in the growth of our company.

Slide 7 provides more details on our joint venture investments. As you know, last November, we announced our 24% ownership stake in Constitution Pipeline, an interstate transmission pipeline proposed to transport Marcellus gas to Northeast markets. Last summer, Constitution filed its 7(c) certificate application with the Federal Energy Regulatory Commission, or FERC. And in December, the FERC announced its review schedule, targeting June 2014 for its final environmental impact statement in September 2014 as the federal authorization decision deadline for the project.

Our Constitution management team is currently assessing the impact of this review schedule on our targeted in-service date of March 2015. Our 24% portion of this estimated $680 million project would be approximately $163 million, $146 million of which we plan to contribute over fiscal years 2014 and 2015.

Last July, we increased our ownership percentage in Pine Needle LNG by 5%. We acquired the additional 5% ownership from Hess Corporation for $2.9 million after their announcement of their intent to divest non-E&P assets. This transaction increased our ownership percentage in Pine Needle from 40% to 45%.

Finally, effective September 1, we and AGL Resources agreed to expand SouthStar Energy into the Illinois unregulated retail natural gas markets. AGLR contributed 108,000 Illinois customers and related assets, and we contributed $22.5 million to equalize to our 15% ownership level.

In conclusion, 2013 was a very good year for our company. We invested in and delivered substantial earnings growth for our shareholders, executed our regulatory strategy to achieve a fair return on invested capital and reduce regulatory lag and pursued both the utility and complementary joint venture opportunities. I'm extremely proud of our 1,800 dedicated and talented employees and want to take this opportunity to thank all of them for their very good work.

And with that, I will turn the call over to our Senior Vice President and Chief Financial Officer, Karl Newlin.

Karl W. Newlin

Thank you, Tom, and good morning, everyone. As Tom mentioned, we had an excellent year in 2013, with net income of $134 million and diluted earnings per share of $1.78.

As for the details of the income statement, let's start with Slide 8. Margin of $621 million was 8% higher than in 2012. Half of the increase was due to increased transportation services under new power generation contracts placed into service. The remainder was attributable to customer growth, the full year impact of new rates for residential and commercial customers in Tennessee and overall colder weather.

On the expense side, Slide 9, O&M of $253 million was 4% higher than last year due to increased contract labor for pipeline integrity, maintenance and safety programs, incentive compensation accruals and bad debt accruals related to higher customer bills. However, despite the increase in O&M, we performed better than expected as our original guidance forecasted an expense increase of 5% from 2012. The O&M savings were due to expense discipline by our employees across the company.

Slide 10 shows depreciation expense of $112 million, which was 8% higher than last year and general taxes of $35 million, which were in line with 2012 levels. The increase in depreciation was due to increased plant service, related mostly to power generation delivery projects and investments in system integrity programs.

On Slide 11, income from joint ventures was $26 million in 2013, 9% higher than last year. The growth was due to increased contributions from SouthStar, primarily due to higher customer usage as a result of colder weather, a 2012 lower cost for market gas price and inventory adjustment and the new Illinois customers. In addition, AFUDC from Constitution Pipeline also added to joint venture contributions.

Turning to Slide 12. Interest expense of $25 million was 24% higher than in 2012. This was a result of higher long-term debt interest expense from new issuances in 2012 and 2013, partially offset by higher AFUDC interest income, as well as lower commercial paper balances at a lower average rate.

Finally, on Slide 13, we began to outline the assumptions underlying the 2014 earnings guidance of $1.73 to $1.83 per diluted share that we issued in November and reaffirmed in our December 23 earnings release. Our margin assumptions include customer growth of approximately 1.5%, the settlement of the North Carolina rate case with rates effective January 1, or roughly 75% of our fiscal year; the implementation of Integrity Management Riders in North Carolina and Tennessee, also for partial fiscal year impact; and a full year impact of the Sutton power generation delivery project, which was placed into service June 2013.

We expect to increase joint venture contributions in 2014 due to the SouthStar expansion, AFUDC at Constitution Pipeline and higher contributions from Pine Needle LNG due to our increased ownership. Guidance also assumes $12 million in income from AFUDC, increased depreciation and a 3% increase in O&M expense compared to the 4% increase in 2013.

And as Tom mentioned, utility capital expenditures are estimated to be approximately $450 million in fiscal 2014, including $250 million for system integrity spend. On the financing side, we anticipate higher interest expense mostly due to the issuance of $300 million of long-term debt in 2013. Our share count will also grow to include the issuance in December, under the forward settlement agreement, of 1.6 million additional shares. Issuances of long-term debt and equity in 2014 and 2015 will be timed to meet our needs for capital under our capital expenditure program and shaped to maintain our targeted capital ratios.

Thank you. I will now turn the call back over to Nick to take your questions.

Nicholas Giaimo

Thank you, Karl. Shannon, we're now ready to open the call for questions.

Question-and-Answer Session

Operator

[Operator Instructions] And we'll take our first question from Sarah Akers with Wells Fargo.

Sarah Akers - Wells Fargo Securities, LLC, Research Division

Just had a follow-up on the Constitution timeline. I think previously, construction was slated to begin in April. With the new schedule, does that have to be delayed until September?

Thomas E. Skains

Yes. I'm going to let Victor Gaglio kind of give you a further briefing on Constitution. Victor serves on the board of that company. Victor?

Victor M. Gaglio

Thanks, Tom. As Tom mentioned in his comments, on December 13, Constitution received notice from FERC that the final environmental impact statement would be complete on June 13 of 2014. And with that information, the project team's in the process of reviewing the schedule based on the notice we got from FERC. We're expecting to have an updated schedule by the end of January, and we'll be able to tell you more about when construction will start at that point in time.

Sarah Akers - Wells Fargo Securities, LLC, Research Division

Great. And then just one on O&M, are the operating costs associated with the integrity programs recovered vis-à-vis IMRs, or would that O&M piece require a rate case for recovery?

Karl W. Newlin

Yes. It's Karl. The Integrity Management Riders are for capital investments only. The O&M is separate.

Operator

And we'll take our next question from Dan Fidell with U.S. Capital Advisors.

Daniel M. Fidell - U.S. Capital Advisors LLC, Research Division

Just a quick question for me on -- maybe if you could give us a little bit more color on the IMR spending. You gave us kind of the total, but can you break that out a little bit in terms of your expectations for North Carolina relative to Tennessee, and then how we might think about your annual spend going forward?

Karl W. Newlin

Yes. We haven't broken out by state what the integrity spend will be. The guidance that I would give is if you look at the system integrity spend of $250 million in 2014, over each year, that's roughly going to correspond with our mix of business across our 3 states, so it's going to be a little lumpy year-over-year. For example, we've had a larger project in Nashville of late, and we probably would have going forward. But I think as a general modeling exercise would be kind of -- 70% plus of our business is in state of North Carolina and roughly 70% plus of the integrity spend. And in -- generally, every year, would accrue in North Carolina and then about 15% or so to Tennessee and then the remainder in South Carolina. In South Carolina, we have the RSA mechanism, which essentially is a miniature rate case each and every year that allows recovery even though we don't have a separate IMR mechanism in that state. So without giving exact details around the capital spend in each state, I think that's a pretty good modeling exercise to get you hopefully to where you need to be.

Thomas E. Skains

And to add just a little bit more color -- this is Tom -- as we mentioned in our presentation, the impact of fiscal '14 from the IMRs has already been established in Tennessee with that $13 million annual increase. That is effective January 1. In North Carolina, the largest impact from our integrity spend came from the approval of the rate case settlement itself for fiscal '14, which goes into effect January 1 for a partial year effect. And then the IMR filing in North Carolina essentially only picks up another month with a small adjustment that we proposed to be effective February 1 of '14. So absent this additional $1 million filing we made in North Carolina, the incremental impact of the IMRs over and above what we've already discussed are going to take place in January of '15 and February of '15 based upon our capital expenditures essentially through October of 2014.

Operator

And we'll take our next question from Spence Joyce with Hilliard Lyons.

Spencer E. Joyce - Hilliard Lyons, Research Division

My question is similar to Dan's. Can you help us understand how much of the $13 million in Tennessee might be catch up? And I'm just trying to establish what might be a good run rate for that figure going forward.

Karl W. Newlin

The $13 million from the Tennessee IMR, first of all, let me say that, that's captured in our guidance range for 2014 and clearly, it's a partial year, given the implementation date of the IMR there. We've had a fairly large capital expenditure program in Nashville over the past 18 months or so to replace a fairly -- a decent-sized pipeline near the Radnor Lake Area in Nashville. And so I think our expenditures has been a little higher over there than it will be going forward, but -- so it's a bit of a one-time catch-up, I'd say, right now. If you look, going forward, again, using the system integrity, I think a good allocation is probably to allocate 70% plus of that system integrity spend in North Carolina, but it will be a little lumpy going forward. It won't be exactly the percentages I laid out in the answer to Dan.

Thomas E. Skains

Yes. This is Tom. Just for frame of reference again, if you look at Slide 6 in our presentation, the Tennessee IMR adjustment that went into effect January 1 was that the Tennessee portion of that $273 million of integrity spend that we spent in 2013 on that bar chart. So it is a lag effect as you might expect. What we spend in one fiscal year is going to impact the next.

Spencer E. Joyce - Hilliard Lyons, Research Division

Okay, fair enough there. Stepping back a little bit from a broad sense, I know the guidance came out before we got the December rulings in both Carolina and Tennessee. And it seems to me like the bottom end of guidance might be a little on the conservative side. Can you speak any bit to that, or did the -- both those rate activities come in about where you expected a little better in places or worse? Just anything you can give us on that front.

Karl W. Newlin

Yes, it's Karl. The -- most of that did come in about where we expected as we're going through our budgeting process and putting out guidance internally. Both the North Carolina and the Tennessee processes were underway, but did it come out about where we had expected. I would just make a couple of comments around the guidance range that we've provided. And this is our best look as we look into the crystal ball for the next year and provide the range. There's really kind of few things happening. Number one is our capital investments shift from what it's been, power generation delivery projects to the system integrity, the flavor of those to the way we were covering marginals projects is a little different. So for example, in the power generation delivery projects like the Wayne and the Sutton projects, those are the crude AFUDC while they're in construction. And then the day after they go into service, we start billing the customer and collecting margin on those investments, as well as booking depreciation expense. So when we go to the system integrity projects, the difference is once those projects go into service, we'll start booking depreciation expense, but there may very well be a lag up to 12 months before we get margin recovery on those investments. So for example, in North Carolina, let's say, a project goes into service March 1, we need to start booking depreciation expense on that when it goes into service, but it won't be captured on the IMR until the following fiscal year beginning February 1. So there could be an 11-month lag in that example before we start getting margin recovery on that. As we transition right now from these one set of projects to the other, you're going to see that lag effect occur, especially in the first year, as these IMR mechanisms begin to kick in. That's one thing you're seeing on the guidance. The second thing that you're seeing is, frankly, just -- is just financing expense. As we've made substantial investments on our system for the safety and integrity and the growth of the system, we need to finance it with long-term capital. And we've done that prudently, I believe, with long-term debt, as well as with equity. And you can just see that impact on the income statement if the AFUDC is dropped from the difficult nature of the projects, higher interest expense, a higher share count is really the outcome of all that.

Spencer E. Joyce - Hilliard Lyons, Research Division

Okay. So '14 could be sort of our lag year here, plus, obviously, we have the equity dilution, plus a little bit of debt expense.

Karl W. Newlin

We've given guidance for '14 that we think is appropriate at this time and we'll update that in future quarters as necessary.

Operator

We'll go next to Travis Miller with Morningstar.

Travis Miller - Morningstar Inc., Research Division

I just wondered if you could characterize the customer conversion rate, the kind of the environment there and how that might play into your numbers for the 2014 growth rate.

Franklin H. Yoho

Travis, this is Frank Yoho. We're seeing the conversion rate steady as we continue to attack the propane and oil markets. Where we're really seeing the opportunity as the economy recovers is in the residential new construction. So while we continue to see steady opportunities with conversion, given the advantage price natural gas has on basically all of its competitors, the real growth we're seeing continue to trend upward is in the residential new construction.

Travis Miller - Morningstar Inc., Research Division

Okay, great. Now one more...

Thomas E. Skains

This is Tom Skains. I'll just add briefly to see -- the conversion numbers, if -- when you look at those year-to-year -- and I think in our 10-K, we indicated that there was a large multi-unit conversion project in 2012, which provided a somewhat anomalous comparison when you look at that level of conversion activity to 2013. So the conversion market has been steady. But every once in a while, we have a large multi-unit conversion project, which may pick up several hundred conversions as a part of one single project that may impact the numbers.

Travis Miller - Morningstar Inc., Research Division

Okay, that's helpful. And then, one more. If we step back, you've obviously made some significant investments in retail, LNG, the Constitution Pipeline. Could you talk strategically about how you see perhaps the entire natural gas environment shaping up, what the opportunities are there and how we look out 3 to 5 years about the investment plans?

Thomas E. Skains

Excellent question. Thank you for that. This is Tom again. As you would expect, Travis, we're constantly evaluating all opportunities for growth at our company that are aligned with our core competencies and our corporate strategies. We prioritize our investments based on quality returns, with a bias on the natural gas infrastructure business in our Southeast markets that complement our core business operations. So as you'd expect, we focus first on core growth, on our natural gas distribution systems that we currently operate. We also have and will continue to look at investments in upstream infrastructure and pipelines and storage that we think may be strategic to our supply portfolio, are more complementary to our supply portfolio. And we're also looking, frankly, constantly at other local distribution company assets that we think may be strategic and synergistic with our company. Can't comment on any specific project or opportunity we may be evaluating along the way until we're ready to make an announcement on some investment initiative, but this process is constant. We do prioritize them based upon our core competencies, our corporate strategies and -- which -- frankly, which investment opportunities give us the best quality return on investment.

Operator

And we have no further questions in the queue at this time. I'll turn the call back to Mr. Giaimo for any closing remarks.

Nicholas Giaimo

Okay. Thank you, Shannon. This concludes our year end 2013 earnings conference call. Thank you all for joining us this morning, and happy new year.

Operator

That does conclude today's conference. Thank you for your participation.

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