Ronald Jibson - Chief Executive Officer, President, Director, Chief Executive Officer of Questar Gas Company and President of Questar Gas Company
Kevin Hadlock - Chief Financial Officer, Principal Accounting Officer and Executive Vice President
Carl Kirst - BMO Capital Markets U.S.
Questar (STR) Q2 2011 Earnings Call July 28, 2011 9:30 AM ET
Good morning. My name is Chris, and I will be your conference operator today. At this time, I would like to welcome everyone to the Second Quarter 2011 Earnings Release Conference Call. [Operator Instructions] Mr. Hadlock, you may begin your conference.
Thank you, operator. Good morning, everyone, and thank you for joining us for Questar's Second Quarter 2011 Earnings Conference Call. I am Kevin Hadlock, Questar's Chief Financial Officer. With me today are Ron Jibson, President and CEO of Questar Corporation; Jim Livsey, Executive Vice President of Wexpro; Allan Bradley, CEO of Questar Pipeline; and Craig Wagstaff, Senior Vice President of Questar Gas. This quarter, we have provided a slide presentation that reviews our results for the second quarter. We encourage you to visit our website at www.questar.com to obtain a copy of the presentation.
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 describe in our SEC filings. Also, this call may reference non-GAAP financial measures. Our slides in the Appendix of the presentation provide reconciliations to these measures.
Let's begin on Slide 4. Yesterday, we reported second quarter net income of $40.3 million or $0.22 per diluted share. This compares to income from continuing operations of $35.8 million or $0.20 per diluted share in the second quarter of 2010. Operating cash flow has been strong in the first half of 2011, totaling $257 million, up 29% versus the first half of 2010. We also affirmed our 2011 earnings guidance range of $1.07 to $1.11 per diluted share. In addition to releasing our earnings results, we announced that Questar's Board of Directors approved a $100 million share repurchase program to manage our share count back to a pre-spin level of approximately 175 million shares. This program will be effective through 2012.
Turning to Slide 5. All 3 business units showed earnings improvement in the second quarter versus the prior year. Corporate was slightly lower due to higher interest expense from the $250 million of debt issued in December of 2010. Overall, net income in the second quarter of 2011 increased by $4.5 million or $0.02 per diluted share over income from continuing operations in the same period last year.
Moving to Slide 6. Wexpro, our cost of service natural gas development company, grew EBITDA to $52.2 million, up $3.4 million or 7% versus the same period last year. Net income was up $1.7 million to $23.7 million, an increase of 8% from the second quarter of 2010. These results were driven largely by a higher average investment base, which saw a year-over-year increase of $19 million or about 4.5%. Given the successful execution of our drilling plan which Ron will discuss in a few minutes, Wexpro is on pace to spend at least $108 million of capital this year. Overall, Wexpro delivered strong results in the second quarter and earned an attractive return on equity, which was 20.4% for the 12 months ended June 30.
Turning to Slide 7. Questar Pipeline, our interstate natural gas pipeline and storage business, had a strong second quarter. Revenue was up $2.5 million or 4% driven primarily by additional transportation revenues from the recently completed Overthrust Loop Expansion. These results were partially offset by lower revenues from natural gas liquids sales. Net income was $16.6 million, an increase of $700,000 or 4% compared to last year's second quarter, due in part to lower interest expense. With the completion of several key projects last year, capital spending was down versus last year. Overall, Questar Pipeline earned an 11.3% return on average equity for the 12 months ended June 30.
Moving to Slide 8. Questar Gas, our retail gas distribution utility, saw an increased gross margin of $3 million or 6% due to continued customer growth, higher rates following our 2010 general rate case settlement and recovery of feeder-line replacement costs. On a net income basis, Questar Gas showed positive net income in a quarter where it would generally record a modest loss. This success was due in part to a reduction in operating costs of $1.6 million versus the second quarter of 2010, as we increased focus on post-spin process improvements and cost containment initiatives. Overall, Questar Gas earned an 11% return on average equity for the 12 months ended June 30.
Moving to Slide 9. With regard to costs, Questar's general and administrative expense in the second quarter totaled $26.2 million. While this was up a modest $1.2 million from the second quarter of 2010, we saw a reduction of $6.8 million from the first quarter of 2011. Our second quarter results demonstrate that our cost reduction initiatives are beginning to take effect. Consolidated operating and maintenance expense was up $500,000, consistent with the growth in the overall business activity. Production and other taxes were flat compared to the prior year. Depreciation grew $1.5 million due to the higher levels of year-over-year capital investment. Consolidated interest expense was $800,000 higher as a result of the $250 million of parent company debt issued in December of 2010. This interest expense includes $700,000 of pretax benefit from the fixed to floating interest rate swap we executed in April of this year.
Turning to Slide 10. The company continues to generate strong cash flow. For the first half of 2011, cash flow from continuing operations before working capital changes totaled about $257 million, a 29% increase over the first half of 2010. This strong cash flow will allow us to continue raising the dividend and will provide an opportunity to manage the share count back to pre-spin levels through the $100 million share repurchase program. Cash used in continuing operations for the first half of 2011 was about $22 million, which included a reduction in commercial paper outstanding of $105 million versus year-end 2010. Currently, Questar's credit lines totaled $350 million, which support our seasonal working capital requirements. At the end of the second quarter, Questar had net liquidity of $213 million with $137 million of commercial paper outstanding, which we used to retire $100 million of Questar Pipeline debt that matured in the second quarter. We expect to refinance this amount, as well as Questar Pipeline's additional $80 million debt maturity in the second half of this year.
With that, let me turn the time over to Questar's President and CEO, Ron Jibson, to discuss operations and Questar's outlook.
Good morning, everyone. And thanks, Kevin, for that summary. We do appreciate all of you joining us today. I'll comment briefly on our second quarter results and update our outlook for the remainder of 2011 beginning on Slide 12.
With the end of the second quarter, we celebrated the first year of the new Questar. We are pleased with the progress we have made across all 3 of our business units: Wexpro, Questar Pipeline and Questar Gas. Overall, capital spending programs are on track and operating performance is in line with our 2011 plan. Accordingly, we remain confident in our earlier guidance range for 2011 of $1.07 to $1.11 per diluted share.
On a consolidated basis, we expect to generate $192 million to $200 million of net income this year. We anticipate strong cash flow, primarily from Wexpro and Questar Pipeline, of between $520 million and $535 million. Returns are also remaining strong as we expect to earn a consolidated return on average equity of between 17% and 18%.
As Kevin mentioned in his remarks, the Questar Board of Directors approved a $100 million share repurchase program. This program will help us manage our share count to Questar's pre-spin level of approximately 175 million common shares. We plan to make opportunistic open market purchases through 2012 to reach this goal. Given our strong earnings and cash flow forecast, we do not expect that this share repurchase program will affect our plans to continue growing the dividend 5% to 10% annually.
Let's review business unit results starting on Slide 13. Wexpro is a key differentiator for Questar because of its unique cost recovery model and industry-leading returns. The company develops natural gas and oil on a defined set of producing properties in the Rockies and earns an approximate 20% after-tax unlevered return on its net investment base. The natural gas produced from these properties is delivered to our utility, Questar Gas, at a cost of service that includes the 20% return. So while Wexpro's operations are similar to those of the natural gas exploration and production company, its economic model is much like that of a regulated utility, noted for its stable and predictable earnings and cash flow, but without commodity price exposure or the need for periodic rate cases.
Wexpro's development program continues to deliver low-cost production, largely due to increasing drilling efficiencies, particularly in the shallow formations of the Vermillion Basin. Drilling performance in this location continues to exceed expectations with drilling times as short as 7 days and reserve estimates of 2.5 to 3.5 Bcfe per well. This has resulted in an average finding cost of less than $1 per Mcfe for recently completed wells that Wexpro operates in this area. For the second quarter, cost of service gas from new wells was competitive with the forward price curve.
Wexpro continues to be on track to spend at least $108 million of capital during 2011. Wexpro's average investment base for 2011 is currently forecast to be about $458 million compared to $444 million in 2010. The growth of Wexpro's investment base will be impacted by 100% bonus depreciation, which increases deferred taxes used in the calculation of the investment base. While bonus depreciation slows the growth of Wexpro's investment base, it helps lower the price of cost of service gas.
We continue to expect that Wexpro will invest between $500 million and $700 million over the next 5 years in our low-cost, low-risk development drilling program. We estimate this investment will deliver between 4% and 8% compound annual growth in Wexpro's net income through 2015.
Before I leave Wexpro, I wanted to mention our recent dialogue with the Utah regulators to potentially expand the Wexpro agreement. Currently, the agreement does not permit us to add new properties. We believe that Questar Gas customers and company shareholders could benefit by expanding the Wexpro agreement to include some additional future assets. Let me emphasize that these discussions are very preliminary, and we will update you on any developments in the future.
Turning to Questar Pipeline on Slide 14. Questar Pipeline, our natural gas transportation and storage business, earned an 11.3% return on equity for the 12 months ended June 30. The completion of the Overthrust Loop Expansion increased Questar Pipeline's transportation revenue by $2.2 million in the second quarter compared to the same period last year. While processing activities continue to benefit from strong natural gas liquids pricing in the quarter, lower volumes reduced total NGL revenues by about $500,000. Overall, we saw an increase in revenue of about $2.5 million.
Operationally, Questar Pipeline performed very well in the second quarter. At June 30, 2011, Questar Pipeline held firm transportation contracts totaling about 5 million decatherms per day compared to about 4.7 million decatherms at June 30, an increase of 7%. From a cost perspective, combined O&M and G&A in the second quarter were $0.11 per decatherm, which was flat with the prior year. This focus on cost containment will help Questar Pipeline compete in a market of over capacity.
For 2011, Questar Pipeline's capital budget remains about $105 million. We expect the company to generate positive cash flows before dividends of about $50 million this year, and could generate cash flows in excess of capital requirements of about $350 million through 2015. These strong cash flows support internal financing of projects across the Questar family of companies, annual dividend growth and the share repurchase program.
Finally, turning to Questar Gas on Slide 15. For the 12 months ended June 30, 2011, Questar Gas earned an 11% return on average equity. Questar employees continue to provide outstanding customers service as survey results in the first half of 2011 are at an all-time high.
Questar Gas is benefiting from customer growth in our service area, albeit at a moderating pace. Over the past 12 months, Questar Gas added 8,000 customers, an increase of about 1%. In addition to customer growth, gross margin increased due to higher rates stemming from the general rate case settlement effective August of last year and recovery of feeder-line replacement costs.
Questar continues to be proactive on the issue of pipeline safety. We replaced cast iron pipe in the 1980s, bare steel pipe in the 1990s and are now upgrading our high-pressure pipe. The feeder-line replacement tracker allows us to earn on our current multi-year pipeline replacement program as we place the new facilities into service. This cost tracker is extremely important for Questar Gas, our customers and our shareholders. Everyone benefits as necessary improvements are made to the distribution system without costly and unnecessary rate proceedings.
Our efforts to reduce costs were evident in our second quarter results. Questar Gas's operating costs in the second quarter were $1.6 million lower than the same period last year, due to process improvements and cost containment initiatives. Increased margin from customer growth and our feeder-line replacement program combined with cost containment initiatives are expected to drive an 8% to 9% annual growth in Questar Gas's net income.
Our customer growth forecast is supported by the strong economic development activity in the State of Utah. In Forbes Magazine's annual rankings of the Best States for Business and Careers, Utah climbed to the top spot. Among the factors that placed Utah at the top are significant economic expansion, strong employment gains, a competitive corporate tax rate and low energy costs that are 35% below the national average. Fortune Magazine also highlighted the positive environment in Utah by naming Salt Lake City as one of the 15 best new cities for business in the world. The State of Utah has taken a strong stance on encouraging natural gas for transportation, and Questar is very active both in developing fueling facilities in Utah and Wyoming and on the national stage promoting the benefits of natural gas vehicles.
Moving to Slide 16. In summary, we are off to a great start as we celebrate our first year as the new Questar. We are very pleased with our second quarter results, which demonstrate our employees resolve to execute on our business plan and reduce costs. Our business units are hitting on all cylinders and the outlook is bright. Questar Gas benefits from a very supportive regulatory environment and is expected to increase net income by 8% to 9% annually. Wexpro is on track to grow net income between 4% and 8% annually. We expect Questar Pipeline to deliver annual net income growth of 1% to 2% per year and generate cash flow in excess of $350 million through 2015.
These driving factors support our confidence in achieving earnings of $1.07 to $1.11 per share in 2011. We also remain confident in our ability to deliver 5% to 7% compound annual earnings growth over the next 5 years. We remain focused on increasing shareholder value and providing a competitive return. As mentioned before, the Questar board approved a $100 million share repurchase program, which will be effective through 2012 to manage the share count back to the pre-spin level. As we continue to expect -- and at the same time, we continue to expect our growth in the dividend between 5% and 10% annually.
With that, we'd be happy to take your questions at this time.
[Operator Instructions] Your first question comes from the line of Carl Kirst with BMO Capital.
Carl Kirst - BMO Capital Markets U.S.
Two questions, if I could. Maybe the first and -- just looking at the current results, also looking at the reiterated guidance of $1.07, $1.11, I can't help but notice that sort of on a trailing 12-month basis, we're already above that range. Here we are sort of second quarter kind of year-over-year getting a nice little bump. Is this something where, at this point, it just doesn't pay to get in front of your skis and so we're going to stay conservative? Or is there something you guys are specifically looking at, i.e., the NGL volumes in the pipeline, for instance? I mean, is there something specific we should be looking at saying, hey, this segment is definitely going to be weaker year-over-year as we go into the third and fourth quarter, for instance?
I think, Carl -- I appreciate the question, and I think part of your answer there was the reluctance to get too far over our skis. We are halfway through the year. Our 2011 performance year-to-date has been in line with our expectations and albeit near the top of that range. We're looking at -- we've been very involved, as we've mentioned last quarter, in cost containment initiatives. And we're starting to see the evidence of those when we look at our second quarter performance, but we're still early in this process. We're mindful that there's still 6 months remaining in the year and plenty of uncertainty regarding political, financial and commodity type issues. So I guess we're looking at it. We're very positive right now that we're meeting our expectations. And for the first half of the year, we'll certainly look going forward at that guidance, but just felt like it was a little too early to change that affirmation.
Carl Kirst - BMO Capital Markets U.S.
No, understood and very much appreciate the color. The second question is just more thinking about perhaps the decision process with the share buyback versus a more aggressive dividend increase. Is there something in particular, as far as, we talk about getting the share count back down to the pre-spin level? Or is there something where I guess as we get out a couple of years, we finish 2012 that -- if there is ongoing strong cash generation, that share buybacks might be a part of the ongoing process in addition to dividend growth? I'm just trying to think if I should think of this as a one-off or is this just one of the many arrows in your quiver, so to speak, as far as when you do have excess cash flow?
Yes, great question. It is one of the arrows in the quiver. Essentially, as you know, we're very committed to growing the dividend aggressively. We've shown that both last August and again this past February of the increases we've had at that time in our dividend, and we continue to feel very confident about being aggressive with the dividend growth. The share back is -- buyback is, as you've indicated, it's an opportunity for us to get back to those pre-spin numbers. Maybe I could ask Kevin if he wants to give a little more color on our thinking there from a financial standpoint.
As Ron pointed out, the share buyback really is going to be one tool we have to provide value to shareholders. If you do look over the last year, we've had a fair bit of dilution, and the program is really targeted to stop that dilution and to get us back to that pre-spin level. But given the strong cash flow situation for the company, we don't expect that, that will affect at all the plans to continue to aggressively raise the dividend.
[Operator Instructions] At this time, you have no further questions. I'll now turn the call back over to management for closing remarks.
Right. Thank you, operator. And again, thanks to all of you for being on the call this morning. Again, we feel very positive halfway through the year after our first year since the spinoff, and we look forward to meeting with many of you in the next 6 months and having some further discussions. Please call us if you have additional questions throughout the day. Thank you, again.
Ladies and gentlemen, this concludes today's conference call. You may now disconnect.