Northwest Natural Gas' (NWN) CEO David Anderson on Q2 2016 Results - Earnings Call Transcript

| About: Northwest Natural (NWN)

Northwest Natural Gas Company (NYSE:NWN)

Q2 2016 Earnings Conference Call

August 2, 2016 11:00 AM ET

Executives

Nikki Sparley - Manager-Investor Relations

David Anderson - President and Chief Executive Officer

Gregory Hazelton - Senior Vice President, Chief Financial Officer and Treasurer

Analysts

Gabe Moreen - Bank of America Merrill Lynch

Tate Sullivan - Sidoti & Company, LLC

Operator

Good morning, and welcome to the Northwest Natural Gas Company’s Second Quarter 2016 Results Conference Call. All participants will be in a 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’d now like to turn the conference over to Nikki Sparley. Please go ahead.

Nikki Sparley

Thank you, Zelda. Good morning, everyone, and welcome to our second quarter 2016 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 occur. In addition, some of our comments today reference non-GAAP measures. For a complete reconciliation of these measures and other cautionary statements, you should refer to the language at the end of our press release and also our SEC filings for additional information. We expect to file our 10-Q later today.

As mentioned, this teleconference is being recorded and will be available on our website following the call. Please note these conference calls are designed for the financial community. If you are an investor and have questions, please contact me directly at 503-721-2530. Media may contact, Melissa Moore at 503-220-2436.

Speaking this morning are David Anderson, President and Chief Executive Officer; and Greg Hazelton, Senior Vice President, Chief Financial Officer and Treasurer. Mr. Anderson and Mr. Hazelton have some prepared remarks and then will be available to answer your questions. Also joining us today are other members of our executive team, who are available to help answer any questions that you may have.

With that, I will turn it over to David for his opening remarks.

David Anderson

Thanks, Nikki, and good morning, everyone, and welcome to our second quarter earnings call and my first call in my new role. It is an honor to be speaking to you this morning as Northwest Natural’s CEO, and I’m pleased and humbled to be the 12th CEO appointed by the Board.

I would like to take a moment and personally thank Gregg Kantor for his nearly 20 years of service, and especially his leadership over the past 7.5 years as CEO. He has been a great mentor, partner, and friend during this transition. We all wish him the best in his well-deserved retirement.

Turning to the quarter, I’ll start with some highlights, then Gregory Hazelton, our CFO will cover the financials. And finally, I’ll close with an update on our North Mist project. Financial performance this quarter was steady with earnings per share at $0.07. An uptick in our gas gas storage revenues and strong customer growth nearly offset the impact of extremely warm weather in the second quarter. In fact, this quarter was our second warmest on record.

On a year-to-date basis, earnings per share was $1.40 per share, that’s up $0.28 over last year. The major piece of this story was our environmental regulatory proceeding and the non-cash charges incurred in both the first quarter of 2015 and 2016. While these charges were disappointing, we have begun collections from customers and believe the environmental mechanism provides a good path forward for all stakeholders.

This is even more critical as the EPA moves towards likely in an environmental cleanup plan for the Portland Harbor. Currently, the EPA. is targeting the decision by January next year. Outside of the environmental charges, our year-to-date results reflect strong customer growth, cost of gas incentive gains, and higher gas storage results.

Now moving to the economic indicators for our region. Oregon continues to add jobs as the labor force froze. In June, the labor force did an all-time high of around 2.1 million workers. The state has reached a milestone in terms of recovery and expansion. In fact, Oregon has added enough jobs to regain all the losses during the great recession. This was no small task.

In 2010, at the higher recession, the gap between potential employees and available jobs hit 170,000 individuals, or 10% of the workforce. Today, not only have we regained those jobs, but more importantly, our job growth is in pace with our strong population growth. Our service territory in Southwest Washington has also experienced a strong recovery.

As you know, job growth coupled with a strong housing market continues to signal a robust economy here. Single-family construction permits rose sharply over the past 12 months with a 21% increase in Oregon statewide permits and a 22% increase in the Portland and Vancouver metro area. These were the highest increases in single-family building permits, since June of 2007.

And over the last year, home sales were up about a 11% in the Portland area, with average home prices increasing by about 9%. We are seeing similar permit trends in our Washington service territory, where about a 11% of our customers are located. The expansion of the economy coupled with a very competitive price position drove customer growth.

In the past year, we have added over 10,500 new customers, which equates to a 1.5% growth rate. The majority of this growth stems from new single-family construction, as well as the steady stream of conversions. We now are honor to serve over 718,000 customers.

Combined with this healthy economy, there’s a strong preference for natural gas. In fact, a recent Market Strategies International Survey found in our market, 9 out of 10 homebuyers would pay $50,000 more for a home equipped with a natural gas heating and appliances, an amazing statistic, frankly. A similar multifamily study showed 80% of Portland area renters paying average rent prices were above. Also, for amenities, such as cook tops, water heating, and of course, fireplaces, whether renting or buying, consumers prefer natural gas versus affordability performance and efficiency.

In fact, our customers are paying less for their natural gas now than they did 15 years ago, another amazing statistic. And recently, these low gas prices coupled with the benefits from our asset management activities, allowed us to refund nearly $30 million to customers this summer.

With that, let me turn it over to Greg to cover the financial details for the quarter. Greg?

Gregory Hazelton

Thank you, David, and good morning, everyone. Starting with consolidated results for the second quarter of 2016, we reported consolidated net income of $0.07 per share, or $2 million, compared to $0.08 per share, or $2.2 million for the same period last year. The quarters results reflected the utility customer growth and higher gas storage revenues, offset by an increase in O&M expenses and a net decrease in the utility margin from significantly warmer and warmer weather in the prior year.

For the first six months of 2016, we reported consolidated net income of $1.40 per share, or $38.7 million, compared to $1.12 per share, or $30.7 million for the same period last year. Year-to-date, results were largely driven by non-cash regulatory environmental charges.

As David mentioned, we worked through our environmental docket in 2015 and early 2016, which resulted in a mechanism that allows us to recover prudently incurred environmental cleanup costs allocated to Oregon for our legacy manufactured gas plant. Although virtually all the environmental costs were deemed to be prudent, the commission disallowed $9.1 million of after-tax costs in 2015, due to over earning in years past, an additional $2 million after-tax in the first quarter of 2016 was also disallowed primarily related to crude interest on the original disallowance.

Excluding these charges on a non-GAAP basis, net income was $1.47 per share, or $40.7 million for the first six months of 2016, compared to $1.45 per share, or $39.8 million for the same period last year. This $0.02 EPS increase is the result of some larger offsetting drivers.

First, strong Utility margin contributed $0.10 and our Gas Storage segment added $0.08 in net income. These gains were almost entirely offset by a significant decrease in other income related to the 2016 environmental disallowance and equity earnings recognized in 2015 – in the first quarter of 2015, but did not recur in 2016.

Shifting to our segment results, for the second quarter, the Utility segment net income decreased $1.7 million. Based on a $1.3 million decrease in Utility margin, a $900,000 increase in O&M expense, and a $700,000 decrease in the other income. The decrease in the utility margin was driven by significantly warmer weather than last year offset by customer growth and rate-based returns on certain track investments. Total utility volumes delivered this quarter decreased 7% over the second quarter of 2015 due to the impact of 21% warmer weather in the prior year.

The utility margins are largely, but not entirely protected from the impact of weather to the company’s weather normalization mechanism in Oregon, we saw the benefits of this mechanism for the second year in a row, as the region experienced 42% warmer than average weather in the second quarter of 2016.

Utility O&M for the quarter increased $900,000, primarily reflecting higher contract and professional service costs. Utility other income decreased $700,000 as a result of lower interest earned on regulatory assets.

For the first six months in 2016, Utility segment net income increased $5.8 million based on higher utility margins of $4.7 million, and O&M expense decreasing $13.8 million. These positive drivers were offset by other income decreasing by $8.5 million.

Utility margins for the year-to-date period reflected strong customer growth and rate-based returns on certain tracked investments, as well as an increase in gains from gas cost incentive sharing, as the company and customers benefited from lower actual gas costs than prices set in the PGA.

Although weather for the six months ended June 2016 was comparable to the prior year, with only five fewer heating degree days, deliveries increased 5% due to the comparatively colder weather in the first quarter 2016 during our peak heating season. The utility O&M for the first six months decreased $13.8 million, primarily reflecting the previously mentioned $15 million environmental disallowance, offset by an increase in contractor and professional service costs.

In the second-half of 2015, management instituted a number of temporary cost saving measures through these targeted efforts we’ve reduced budgeted O&M levels by approximately $5 million, or $0.11 per share last year. We have been gradually resuming normal operating expense levels in the first-half of the year, we expect to fully reach our footprints in terms of headcount in non-payroll costs by year end.

As mentioned, utility other income decreased $8.5 million in the first six months, as a result of $2.8 million 2016 environmental disallowance along with $5.3 million of equity earnings recognized in 2015 when we received the original order.

For the quarter, our Gas Storage segment net income increased $1.5 million, reflecting higher asset management in firm revenues, at both our Gill Ranch and Mist storage facility. Gill Ranch also had lower operating expenses as a result of lower power cost and managing the business to a lower cost structure at the end of 2015.

We also saved $400,000 in interest expense by redeeming the Gill Ranch note in the fourth quarter of 2015. For the first six months, gas storage net income was $2.2 million, compared to just $28,000 for the prior year. We saw improvements in operating revenues at both facilities and a reduction in operating expenses at Gill Ranch.

Cash provided by operating activities increased $32 million compared to last year, primarily due to inflows from net deferred taxes, reflecting the extensions of bonus depreciation and beginning cash collections under the environmental mechanism. Cash used in financing activities increased $27 million, as we leveraged our strong operating cash flows to reduce short-term financing by over a $117 million in 2016, compared to a reduction in short and long-term debt of $84 million in the prior year.

Finally, the company reaffirms 2016 earnings guidance today in the range of $1.98 to $2.18 per share, which includes the $3.3 million pre-tax, or $0.07 per share after-tax charge from the January 2016 order. Excluding the charge, on a non-GAAP basis, our guidance range is $2.05 to $2.25 per share.

With that, I’ll turn the call back over to David for his concluding remarks.

David Anderson

Thanks, Greg and I’d like to close with a brief update on our North Mist storage expansion projects. As you may remember, this project is an expansion of our Mist storage facility in Oregon and we’ll provide storage services to PGEs generating plants at Port Westward. The project includes new reservoir providing at 2.5 billion cubic feet in available storage and additional compressor station and a new pipeline.

You may recall in April, we received approval for the amendment to the Mist site certificate from the Oregon Energy Facility Siting Council better known as EFSC, which was a critical permit needed to move forward on the project. In May, we launched an RFP to capture best terms and pricing for the engineering, procurement, and construction portion of the project. We received final bids in June and are working closely with PGE to evaluate proposals and select a preferred vendor. We hope to finalize that selection soon.

At the same time, we are competing – completing a full project estimate including an updated EPC contract, well drilling, and financing cost and obtaining a few final permits. We continue to work closely with PGE to obtain a note proceed and anticipate a notice this fall after receipt of additional permits.

Achieving that milestone will allow the project remain on track for an in-service date during the winter of 2018/2010. And finally this morning, I would like to say it’s a privilege to lead this 157 year old company. Like those before me, I’m deeply committed to operating the safe and reliable system in an environmentally responsible manner and providing exceptional service to our customers.

I am also dedicated to partnering with regulators to productively meet the energy needs of our communities, while creating solid value for our investors. I believe we are well positioned for the future and could not be more proud of our employees. Their service ethic and unwavering commitment to the safe and reliable delivery of natural gas is second to none.

Thanks again for taking the time this morning to join us. And with that, Gilda I’ll open it up to questions.

Question-and-Answer Session

Operator

Thank you, sir. We’ll now begin the question-and-answer session [Operator Instructions]. Our first question comes from Gabe Moreen with Bank of America Merrill Lynch. Please go ahead.

David Anderson

Good morning, Gabe.

Gabe Moreen

Good morning, everyone. Hi Dave, how are you doing dude. The question on Gill Ranch actually for me, I know that there’s been a lot of California natural gas storage issues and not just maybe in the southern part of the state, but even in the northern part of the state.

Can you talk about I know you’re contracted for 2016 or 2017 or is any of that impacting potential demand for that facility and are you in discussions with any customers given some of that the liability issues some people maybe facing over there?

David Anderson

Yes, Gabe, we’re always in discussions with customers. And as you’ve indicated we’re fairly short in our contract book. So there’s an improvement in prices we will hope to capture that. As you saw spreads in the market as last year they did increase, some of that might have been driven a little bit by Aliso Canyon.

But a lot it was probably more driven by weather and a front end of the curve dropping to the full storage prices. Frankly, it’s starts to look like that’s setting up again of the coming year, but who knows, but we’re in contact with all of the individuals and nothing to report at this time in terms of additional contracts as a result of that.

Gabe Moreen

And can you just remind me how much you spent, I guess, capital wise on Gill Ranch back in the day?

David Anderson

Yes, our share was a little over $200 million. I’m looking at my control.

Gregory Hazelton

Sorry, you can’t hear him. That book is around $200 million right now, Gabe?

Gabe Moreen

Okay, got it great. And then on Mist just is everything spoken for general speaking for everything there or is there going to be some issue or going to be using or available for other third parties?

David Anderson

Yes, remember we have 16 Bcf up there and about five of that is for the interstate market. And so as we go forward there will be opportunities for other customers there, but related to the expansion 2.5 Bcf that that right now that is solely for PGE and there’s ability and if others want to kind of sign up for about at this juncture they’re the only customer that has signed up for it.

Gabe Moreen

Got it. Thanks very much.

David Anderson

You bet Gabe. Thank you.

Operator

The next question comes from Tate Sullivan with Sidoti. Please go ahead.

Tate Sullivan

Thank you and thank you for those comments and Mr. Anderson too. And I’m just diving into a little financials real quickly, environmental remediation charge in the quarter, if I’m reading it right, of $1.9 million. Can you just go over why that’s different in the quarter – in this quarter compared to 1Q?

Gregory Hazelton

Hey, good to speak to you this morning. Remediation charge, we didn’t have the environmental remediation is allowed that’s what you’re talking to.

Tate Sullivan

Okay.

Gregory Hazelton

That was recorded in the first quarter and was a gross of $3.3 million, $2.8 million impacted interest expense and roughly $0.5 million impacted our own end line and that was reflected in this quarter – first quarter of 2016 will receive the final order on our environmental remediation.

And correspondingly in the first quarter of 2015, we recognize that $15 million gross disallowance on environmental charges $9.1 million after-tax with the issuance of the order in Q1 2015. So we had Q1-to-Q1 at charges both in 2016 and 2015. Does that answer your question?

Tate Sullivan

And nothing in Q2, I mean that going forward will you accrue approved environmental remediation costs every quarter?

Gregory Hazelton

Yes, we continue to have environmental expenditures each quarter, which are put on to our balance sheet. And we’ve recognized interest or carrying cost on the balance sheet. In addition, we are collecting in rates currently charges environmental recoveries of our accrued balances of environmental each quarter and you see that for the full-year.

Tate Sullivan

Okay.

Gregory Hazelton

Tate, we been accruing every quarter when the liability moves…

Tate Sullivan

Okay.

Gregory Hazelton

So what was really even though we had to take some of the charges, as you pointed out, we now have a mechanism in place in Oregon, so basically for recovery of environmental cost. The exposure would have that that they’re not prudent, just be one that would be an issue that we would not – we would anticipate not having.

But between standard revenue require – a revenue condition each year and then also there is a balancing account in case that revenue per year is not enough. And so essentially, you get recovery fairly quick at the expenditures. So it’s overall positive for the company and credit positive for the company for us to be able to kind of to move forward on the environmental expenditures we have and then also have recovery of those move forward.

Tate Sullivan

Great, understood. Thank you. And then maybe I missed this on the gas storage segment and the swing on a year-over-year basis in net income to positive $1.4 million. What are temporary factors in the quarter that could cause that to go back down or could this be a sustainable level going forward?

Gregory Hazelton

I guess the fact is really are on re-contracting facility on Gill Ranch as well and is your question focused on Gill Ranch or a storage segment in total?

Tate Sullivan

But the storage segment in total, the net income reported this quarter of $1.4 million?

Gregory Hazelton

So as you know we have ongoing optimization activities in asset management activities that are five BCF of interstate storage of that missed. So those can fluctuate with market demand over time, but generally recognized pretty sustained demand pricing is tends to be very good there. We do have some long-term contracts there. So the Mist doesn’t tend to be volatile year-over-year or period-over-period.

Gill Ranch as we’ve mentioned, tends to operate under shorter-term seasonal contracts, which are renewed annually. We have some modest amount of multi-year or two year contracts. But we have – we end up re-contracting that regularly under shorter-term contracting, and that will be subject to the impacts of the California marketplace. David mentioned that Aliso Canyon may be impacting demand for storage as does weather as the need for storage either increases or is impacted by weather and seasonal demand.

Tate Sullivan

Okay, thank you. And then my last – you had a comment in there, I think about capturing some of the momentum from the recent economic strength in the actual press release. I mean is that referring to a delay that you’ll see in terms of the customers after you see those positive economic metrics?

Gregory Hazelton

Well, Tate, I think any time you’re a utility – you’re directly tied to the service area that you have the obligation and honor frankly to serve. And what I was trying to indicate is that the economic factors in the region are doing very well right now. And that tends to be a fairly decent predictor of whether they’re going to be building new houses, new multifamily type operations, whether new commercial type opportunities are coming, guarantees in life obviously, as we go through this, but they’re all positive indicators that typically means that the region is growing and therefore, that typically translates into customer growth.

Tate Sullivan

Thank you very much. I’ll get back in queue.

David Anderson

All right. Thank you, Tate.

Tate Sullivan

Thanks Dave.

Operator

[Operator Instructions] Yes. We have our follow-ups from Mr. Sullivan with Sidoti. Again Mr. Sullivan, go ahead.

Tate Sullivan

Oh, thank you. Yes, I just recall a follow-up on. I think it was a quarter ago that you talked about the different multi-story condo construction going on in your service territory too. I mean, has there been any progress in terms of how you may have new tariff agreements with those buildings? How is that effort going?

David Anderson

I would say, this is David. Nothing new on that front right now. I would tell you, we’re making very good progress there. I think Kim Heiting, our Chief Marketing Officer has done a fantastic job of just kind of identifying the opportunity here and working with the builders, getting awareness. We have seen some increase in those markets, haven’t done anything on the regulatory front right now. I think what’s most important for us is try to figure out, if we can do this outside the regulatory environment.

And then as we go forward, if we need to file a tariff to address some of the issues that we’ve talked about before we will. But right now, we’re just focused on seeing if we can work directly with builders and trying to capture as much as of that growth as we possibly can. That is an area that is very important to us, because what we’re seeing going forward especially with housing prices and rent prices. There’s probably pent-up demand for more multi-family. So I’m very excited that we’re addressing this market.

And I’m hopeful we can make it to say that getting a large market share that market too.

Tate Sullivan

Okay. Thank you very much.

Operator

This concludes our question-and-answer session. I would now like to turn the conference back over to Mr. David Anderson for any final remarks.

David Anderson

Well, thank you, Zelda. I appreciate everybody joining us this morning. If you have any questions, give Nikki a call. Otherwise we’ll talk to you soon. Have a great day.

Operator

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

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