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Northwest Natural Gas Company (NYSE:NWN)

Q4 2013 Earnings Conference Call

February 28, 2014 11:00 AM ET

Executives

Bob Hess - Director of IR

Gregg Kantor - President and CEO

Steve Feltz - SVP and CFO

Analysts

Operator

Good morning and welcome to the Northwest Natural 2013 Results Conference Call and Webcast. All participants will be in listen only mode. (Operator Instructions) After today’s presentation there will be an opportunity to ask questions. (Operator Instructions) Please note this event is being recorded. I would now like to turn the conference over to Mr. Bob Hess, Director of Investor Relations, please go ahead.

Bob Hess

Thank you, Gary. Good morning everybody and welcome to our 2013 year-end and fourth quarter earnings call. As a reminder, some of the things that will be said this morning contain forward-looking statements. They are based on management’s assumptions, which may or may not come true, and you should refer to the language at the end of our news release for the appropriate cautionary statements and also to our SEC filings for additional information. We expect to file our 10-K later today.

As previously mentioned this teleconference is being recorded and will be available on our website approximately an hour following the call. Please that these conference calls are designed for the financial community. If you are an individual investor and have questions please contact me directly at area code 503-220-2388, media may contact Kim Heiting directly at 503-220-2366.

Speaking this morning are Gregg Kantor, President and Chief Executive Officer, and Steve Feltz, Senior Vice President and Chief Financial Officer. Gregg and Steve have some opening remarks and then will be available to answer your questions.

Also, joining us today are other members of our executive team who can help to answer those questions. With that it’s my pleasure to turn it over to Gregg.

Gregg Kantor

Good morning everyone, and welcome to our fourth quarter and year-end review. I’ll begin today with an overview of 2013 and then turn it over to Steve to provide the financial details for the quarter and the year. I’ll wrap up the call with a look forward.

2013 marked the first full year following the conclusion of our Oregon general rate case and while not all of the issues from the case are completed, I’m pleased to report we posted earnings per share $2.24.

As I’ve mentioned before there were a number of rate case issues pushed into new proceedings last year. The Oregon commission opened four new dockets, one to resolve implementation issues related to our new environmental coast recovery mechanism, a second to determine whether working gas inventory balances should be added to rate base. Another to review the current revenue sharing agreement for interstate storage and optimization services. And the fourth to determine whether prepaid pension assets should be added to rate base.

Last fall we received OPUC approval to add 39.5 million of working gas inventory to rate base, closing out that docket. The associated carrying cost replaced in to rates with the purchase gas adjustment filing on November 1.

Last fall we also announced an all-party settlement that addressed several implementation issues related to our new environmental cost recovery mechanism. As you may recall, this mechanism is designed to address cost recovery for clean-up of our legacy manufacturing gas plant operations.

In reviewing the settlement, the commission indicated they would be supportive of certain aspects of the agreement but also cited a desire to reassess how an earnings test should be applied. As a result, the OPUC directed that the parties continue to work through the proceeding this year.

The OPUC did rule on one aspect of the environmental docket allowing 19 million of construction cost for a water treatment plant completed last year to be placed in to rates in November.

In a related matter, we made significant progress on a lawsuit that company had filed against several insurance carriers to address the environmental clean-up effort. By the end of last year we have settlements or agreements in principle with all but three of the insurers in the litigation and in January we concluded the litigation effort with signed settlements from those three remaining insurers.

We’re pleased with this outcome. Including all settlements to date, we now have approximately 150 million for investigation and remediation of environmental sites, while avoiding the significant costs associated with trials and the potential for years of appeals.

In 2014, we will continue to work through the remaining regulatory issues from our 2012 rate case, the environmental earnings test, the prepaid pension issue and the interstate storage revenue sharing dockets. We expect these proceedings to be resolved this year. While our regulatory agenda was a key priority last year, we also made great progress on a number of operational issues.

In 2013 we made significant investments in the safety and reliability of our system, we completed several major system reinforcement projects and we continued our aggressive pipe replacement efforts. In fact we were one of the first utilities in the country to have replaced all of the cast iron in our system. We will soon complete the removal of all bare steel as well. Currently we have about 10 miles of bare steel pipe left in our system and we expect to eliminate it by the end of 2015.

Our pipeline investments paid off; during the cold weather we experienced in the fourth quarter and again in February when we set a record send out volume of 9 million tons. In both cases I’m pleased to report, our system performed very well.

But ensuring a reliable and safe system doesn’t end with pipe replacement. We also advanced many of our other safety initiatives including a completion of our new operations and training center in Sherwood, Oregon.

Last year hundreds of company field employees and several municipal fire departments participated in hands-on scenario based safety training at our new facility, and we’re proud to say that our commitment to safety and service continues to be recognized by our customer.

For the third time in six years, Northwest Natural ranked first in the west among large utilities and posted the highest score in the nation in the J.D. Power and Associates Gas Utility Residential Customer Satisfaction Study.

On the growth front, we continue to see steady positive improvement in the local economy. The Portland Metro area's employment rate dropped to a five-year low of 6.6% with the labour market expanding by 1.6% over 12 months. That positive momentum has also reflected in the housing sector numbers.

By December, home sales were up 14% and average home prices rose by 30%, and with more movement of exiting housing stock, new construction activity also rebounded. Housing permits in 2013 were up 46% compared to 2012. These gains supported an uptick in our customer growth rate which reached about 1.3% last year.

To better position us for the housing recovery, we’ve been developing new tools to more aggressively compete in the market. Last fall, we launched a web-based portal that provides a very unique online resource for conversion customers. Now with a few clicks potential customers can quick check from a computer, smartphone phone or tablet to learn if they can get natural gas to their home. They can also find everything needed to connect to gas in one section of our website with special offers on equipment, contractor information and a tool to compare the cost of natural gas to oil and electricity.

In return, Northwest Natural is collecting data from web analytics to see where demand for gas service goes beyond our existing system. We can use this information to more effectively plan for future main extensions.

In 2014, we plan to expand the portal to better serve our trade allies through a secured, personalized account builders, and HVAC contractors who will be to order service, track progress of their orders and manage multiple projects. With as much as a 60% price advantage in our service territory, we see a lot of potential for adding customers and we intend to leverage this advantage by using these industry leading tools to make sure getting gas service is convenient and easy.

Overall, we’re pleased with our performance in 2013. We continue to execute effectively throughout our operations. We made progress on several regulatory items and for the 58th consecutive year, we increased dividends paid to shareholders. There is increasing recognition by the public and policy leaders of the advantages that clean affordable natural gas provides and that recognition that embracing of natural gas is creating new opportunities for growth.

After Steve’s report, I’ll talk more about those opportunities and our priorities for 2014. Steve?

Steve Feltz

Thank you, Gregg and good morning everyone. As Gregg noted, we made significant progress on a number of operational, regulatory and growth initiatives in 2013. As a result, earnings for the quarter were up $0.03 a share and for the year were up $0.06 a share compared to the prior the year. Net income was $61 million or $2.24 a share for 2013 versus net income of 59 million or $2.18 a share for 2012.

The improvements over 2012 were largely driven by an increase in utility margin and an increase in net income from gas storage operations. In addition, results for 2012 were lower because of a onetime income tax charge which aided the 2013 year-over-year increase. These increases were partly offset by higher operating expenses.

Let me pause a moment and comment on how results for the year compared to our 2013 earning guidance. As you may recall, the Oregon Commission approved in principal the recovery of environmental expenditures in our 2012 rate case. Upon conclusion of the case, we began working with all parties to determine how cost and associated insurance proceeds would be handled. That work resulted in an all-party settlement that was announced in the second quarter of 2013. Part of that settlement proposal was an agreement on our part to forgo recovery of $7 million pre-tax which resulted in us revising guidance down by $0.13 in anticipation of the charge to a revised guidance range of $2.02 to $2.22 per share.

Unfortunately, the settlement was not approved by the commissioners and thus we did not take the charge in 2013. As a result, the reported earnings of $2.24 per share was within the guidance range without the charge.

Turning now to a more complete discussion of full year results, our utility generated net income of $55 million for the year compared to $54 million a year ago. Year-over-year, the results include a net $9 million increase in margin and a $2.7 million benefit in income tax expense from a onetime charge taken in 2012.

These favourable impacts were partially offset by increases in operating expense in 2013. With respect to the margin increase, we saw positive contributions from growth and residential and commercial customers, from rate base returns on gas reserves, pipeline integrity and other tracked in investments and from revenue timing differences stemming from the 2012 rate case.

We also saw margin decreases year-over-year from our gas cost incentive sharing mechanism and from the annualized impact of lower revenue requirements from the 2012 rate case.

For 2013, utility gas deliveries were up 3% over last year with sales to residential and commercial customers up 5% on weather that was 5% colder than a year ago and 3% colder than average. A key factor for the year was our customer growth rate which rose 1.3% to 695,000 customers at yearend. That’s compared to an annual growth rate of less than 1% for the past four years. We are seeing an uptick in customer growth in our service territory due to an improving housing market and the price advantage in environmental benefits of natural gas. We expect these growth trends to continue in 2014.

With regards to our gas storage segment, net income for the year was $5.6 million compared to $4.5 million a year ago with the increase primarily reflecting higher revenues from asset management services and lower operating costs at both our Mist and Goran storage facilities.

The market outlook for gas storage in 2014 remains challenging. In recent month the country has seen significant storage withdrawals and gas price volatility due to the extremely cold weather nationally while current storage values have been negatively impact by the increase in spring and summer prices this year in anticipation of storage refill. The lack of summer winter spreads has had a direct impact on what parties are willing to pay for storage. Increased volatility helps but currently we anticipate contracting at lower market prices than in previous years, especially at our California facility where some multiyear contracts are expiring.

Consolidated operating expenses excluding the cost of gas were $9 million higher in 2013 driven mainly by O&M cost that were $7 million or 6% higher than last year and depreciation expenses that were $3 million or 4% higher. The O&M increase was primarily due to utility payroll increases driven by new positions for safety and customer service programs as well as incentive compensation and by increased system maintenance cost. These cost increases were largely covered in our most recent rate case.

Cash flow from operating activities in 2013 was $176 million compared to $169 million in 2012. The increase reflected higher net income, positive changes in working capital and lower pension contribution. Cash used in investing activities was about the same as a year ago with a net $182 million spent in 2013 versus $185 million in 2012. Looking ahead to 2014, we expect investments to be about the same or slightly lower than the last two years with utility CapEx and gas reserves totalling between $165 million to $185 million.

Now let me briefly cover fourth quarter results. For the quarter earnings were up $0.03 a share on net income of $29 million in 2013 compared to $28 million in 2012. Overall trends for the quarter are very similar to the full year. Accordingly, the increase in earnings was mainly due to the higher utility margin partially offset by increased utility operating expenses.

The utility contributed net income of $28 million in the quarter, up from $27 million a year ago. This uptick was due to margin increase of $7 million, offset in part by $4 million of higher operating and maintenance cost and depreciation expenses.

Both increases are closely related to the full year factors described previously. Utility volume in the fourth quarter increased 15% or 49 million [indiscernible] as a result of weather that was 25% colder than last year’s fourth quarter and 12% colder than normal.

As Gregg mentioned earlier, the company reached settlements with the remaining insurance companies on environmental damage claims. As a result, we anticipate receiving insurance proceeds of $102 million in the first half of 2014 bringing the total insurance recoveries to approximately $150 million. We expect these proceeds to be applied to past and future environmental expenditures as part of our SRRM mechanism.

From a cash flow perspective, the insurance proceeds will improve our liquidity position significantly in 2014 thus allowing us to reduce short term borrowings and redeem the $50 million of medium term notes due in July 2014 without any need for reissuance.

Finally, we initiated earnings guidance for 2014 today in the range of $2.15 to $2.35 per share. This guidance assumes a continued economic recovery, customer growth from our utility gas segment, average weather conditions, current market conditions for gas storage pricing and no significant changes in prevailing legislative and regulatory policies or outcomes.

With that, I will turn it back over to Gregg for his concluding remarks.

Gregg Kantor

Thanks Steve. As we move into 2014 without a question abundant domestic supplies of natural gas are creating new avenues for growth, avenues that wouldn’t have seemed viable just a few years ago. Great example is the opportunity we now have in the transportation sector. Today like never before we have the ability to reduce our dependence on foreign oil and lower our environmental impact by moving fleet vehicles to compressed natural gas. By switching to CNG fleet operators can cut their fuel costs in half and reduce their emissions. Unfortunately there is little refueling infrastructure readily available that would allow fleet owners to make that -- the change.

To bridge that gap last fall we filed a new tariff with the Oregon commission to provide high pressure natural gas service to business customers interested in moving their fleet to CNG. There were a number of organizations interested in the service that provided support through the regulatory review process. In the coming months we’ll be working with them on the details of our service and to determine whether we can serve them.

We’ll also be working toward a decision on a potential expansion at our Mist underground storage facility in Oregon and continue to work with Portland General Electric to explore how a Mist expansion could provide a flexible on-demand fuel source for their gas plants at Fort Westward, plants designed to integrate wind resources into their system supply.

In 2013 we worked through many of the engineering details for the project and in 2014 we’ll be working with PGE to refine cost and determine whether the expansion will move forward. While the North West storage situation continues to offer near term potential, storage values in many parts of the country remain low, despite these conditions we continue to work hard to find added value opportunities at our Gill Ranch facility in California.

We believe California’s renewable portfolio standard [Audio Gap] of 33% by 2020 will mean more volatility on the electric grid increasing the need for the kind of flexible resource that gas storage can provide. Overall we continue to believe that as the nation moves increasingly to natural gas for power, transportation and industrial processes, storage will provide long term value.

And whether it’s through storage and vehicles are at the burner tip, the environmental and economic advantages natural gas provides has caught the interest of policy makers. Last year Oregon’s governor and one of the state’s commissioners led the effort to get Senate bill 844 passed. The bill allows the OPUC to establish a voluntary greenhouse gas reduction program to incent natural utilities to investment projects that reduce emissions. We believe this unique legislation provides a new proactive way for Northwest Natural to earn on investments that have quantifiable environmental benefits for customers. Projects that otherwise would not have moved forward.

The bill took effect in January this year and we’re making effort to establish project and investment criteria is just beginning at the PUC. We’re pleased to have this framework in place and we look forward to finding those untapped opportunities where natural gas can provide significant environmental benefits for Oregon.

There’s no doubt that the shale gas revolution has been a transformational change for our country, one that offers great opportunities, now it’s our job to make sure Northwest Natural is positioned to thrive in this new environment and to deliver those opportunities to the consumers and communities we serve as well as to our shareholders. That will remain our focus in 2014.

Thanks again for joining us this morning and with that I’ll open it up for questions.

Question-and-Answer Session

Operator

We will now begin the question and answer session, (Operator Instructions).

Gregg Kantor

Well doesn’t look like anyone had a question, we must have been very good at explaining everything, take that as a compliment, I guess. Thank you all once again for joining us and hope to see you all down the road someplace. And with that, I guess we’ll slide on.

Operator

The conference is now concluded. Thank you for attending today’s presentation. You may now disconnect.

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