Seeking Alpha
We cover over 5K calls/quarter
Profile| Send Message|
( followers)  

Nicor Inc. (NYSE:GAS)

Q4 2007 Earnings Call

February 22, 2008 9:30 am ET

Executives

Russ Strobel - Chairman, President and CEO

Rick Hawley - EVP and CFO

Mark Knox - Director of IR

Analysts

Brooke Glenn Mullin - JP Morgan

David Grumhaus - Copia Capital

Dan Fidell - Brean Murray, Carret

Dave Parker - Robert W Baird.

Chris Muir - Standard & Poor's

James Heckler - Levin Capital

Operator

Good day, ladies and gentlemen, and welcome to Nicor's 2007 earnings call. My name is Mary and I will be your coordinator for today. At this time, all participants are in listen-only mode. We will be facilitating a question-and-answer session toward the end of this conference (Operator Instructions)

I would now like to turn the presentation over to today's host Mr. Russ Strobel, Chairman, President, and CEO. Please proceed, sir.

Russ Strobel

Thanks, Merry. Good morning, everybody and thanks for joining for us. With me today are Rick Hawley, our CFO, and Mark Knox, our Director of Investor Relations. We're going cover our 2007 full year financial results and our 2007 earnings outlook this morning. And then when we have completed our remarks, we will be happy to take your questions. Let me now turn things over to Mark.

Mark Knox

Thanks, Russ, and good morning. First, I'd like to remind you that this call will include certain forward-looking statements about the operations and expectations of our company, subsidiaries and affiliates. Although, we believe our representations are based on reasonable assumptions, actual results may vary materially from stated expectations.

Information concerning the factors that could cause materially different results can be found in our periodic filings with the Securities and Exchange Commission and in this morning's press release.

As we reported in our press release this morning, preliminary twelve month ended 2007 diluted earnings per share were $2.99 compared to $2.87 per share for the same period in 2006.

Both periods were impacted by noteworthy items. 2007's twelve nine month results included the positive effect of a reserve adjustment and cost recoveries of approximately $0.11 per share after-tax, related to our Mercury Inspection and Repair Program.

Financial results for the 2006, twelve-month-period included the effects of a cost recovery of approximately $0.5 per share after- tax, associated with the Mercury inspection and repairs program and a second quarter charge associated with an SEC inquiry of $0.02 per share after-tax.

Removing the effects of these items for comparison purposes gives you 2007 twelve-month-ended earnings of about $2.88 per share compared to $3.04 per share in 2006.

With that let me now turn things over to Rick for the discussion of our 2007 results and our outlook for 2008.

Rick Hawley

Thanks Mark. Good morning, everyone. Thanks for joining us. Today, I am going to focus my remarks on annual results for 2007 and our outlook for 2008. 2007 resulted in another year of good performance for Nicor.

Nicor Gas, our primary business performed well in 2007 despite a challenging business environment. Tropical Shipping posted the best year in its history from a net income perspective and our other energy ventures also had their best year ever. We ended the year a little better than the upper end of our earlier earnings guidance as all our business units performed better than expected in the fourth quarter of 2007.

Compared to 2006, absent the impact of noteworthy items, 2007 full year earnings per share reflect higher operating results in our gas distribution business and other energy-related ventures, offset by lower operating results in our shipping business, lower corporate income, and lower income from equity investments. Full year comparisons were also impacted by lower interest expense and higher average common shares outstanding in 2007.

Nicor Gas’s full year results compared to last year were positively impacted by increased natural gas deliveries related to weather, partially offsetting this positive factor with the impact of lower average distribution rates, the impact of customer interest, higher operating and maintenance expenses, lower properties sales gains and higher depreciation expense.

Higher operating cost were due to increased bad debt due largely to the impact of a sluggish economy and high gas cost, partially offset by decreased storage related natural gas cost and natural gas and fuel cost to operate company equipment and facilities.

Moving to our shipping segment. Although operating results were down a bit from last year, Tropical still posted the second best year of operating income in history and as I mentioned it's best year from a net income perspective. Full year shipping revenues were up due to higher volumes than last year. Offsetting this positive factor, were increased operating costs, due primarily to higher transportation related costs including fuel.

Moving to our other Energy ventures. Both our wholesale energy and our retail energy services business achieved record results in 2007, following up on a strong year in 2006.

Corporate operating results for the full year were impacted by the absence of an insurance recovery of about $5 million pretax recognized in 2006 related to previously incurred legal costs and also the effects of our weather offset associated with our utility bill management products.

As we have previously discussed, certain of those products offered through our retail service businesses provide a partial offset to the weather risk of our gas distribution business.

In 2007, we recorded an approximately $200,000 benefit, with respect to this offset, due to near normal weather compared to a benefit of approximately $10 million in 2006, due to substantially warmer weather than normal.

The amount of the offset will vary depending on a number of factors but it generally ranges from 30% to 50% of our gas companies weather impact. Under terms of a corporate swap agreement benefits are cost resulting from variances in normal weather are recorded primarily in corporate operating results.

Our overall financial results also reflected lower pre-tax equity income due primarily to the absence of a gain of $2.4 million pretax on a sale in 2006 of an investment interest and $1.4 of related pretax equity income recognized in 2006.

Now, let me talk briefly about the lower interest costs that we recognized in 2007. In the fourth quarter of 2007 we recorded the effects on interest expense of a settlement with the internal revenue service related to the timing of certain deductions taken as part of the change in accounting method on our 2002 tax return.

As a result of this settlement we reduced our reserve for interest payable by about $10 million pretax. About $3 million of that reversal, related to expense accruals made in 2007.

Moving on to our earnings guidance for 2008, we expect our 2008 diluted earnings per share estimate to be the in the range of $2.20 to $2.40 per share.

Our outlook assumes normal weather for the rest of the year, but excludes among other things any future impacts associated with the Illinois Commerce Commission's performance-based rate plan and their purchased gas adjustment reviews, other contingencies and other changes in tax laws.

Our estimate also does not reflect the additional variability in earnings due to fair value accounting adjustments and other impacts that could occur because of future volatility in the natural gas markets.

Looking at the composition of our 2008 guidance, we see the most significant decline reflected in our earnings outlook is projected at Nicor Gas, due to continued downward pressure on demand and the impact of higher operating and maintenance cost, most notably bad debt expense attributable again to higher gas prices and the economic slow down, higher deprecation expense and higher interest cost.

In addition to these factors increasing labor cost, investments in technology and gas delivery system improvements, are expected to adversely impact our operating results. Historically results are benefited significantly from the success of our cost control efforts, which continue. However, looking ahead those efforts will likely mitigate but not eliminate the upward pressure on cost.

As a result of all of these factors we are currently under recovering, our allowed cost of delivery service. The rate-relief Nicor Gas received in 2005 was a positive step towards rebuilding our earnings but is not sufficient in this environment.

We are evaluating our need for a general rate filing with the Illinois Commerce Commission. While a potential filing of such a case and timing and amount of same are still under consideration, a filing may be made in the first half of 2008.

Looking at tropical and other energy ventures, we expect 2008 net income to be down from the record levels of 2007, but still very robust compared to historical levels.

We also as I noted, expect higher interest expense due to the absence of the interest benefit related to the income tax matters recorded in 2007, that I discussed just a couple of minutes ago.

I do want to emphasize the importance we placed on being given the opportunity to earn a fair return at Nicor Gas and that we will not hesitate to seek relief in amounts sufficient to meet that objective. We have delivered and expect to continue to deliver significant benefits to our customers in the form of lower than average delivery rates and low natural gas cost and believe it, as reasonable to request returns that maintain the financial health and stability of the company.

As a reminder, updates to our annual earnings outlook will be provided only as part of our quarterly and annual earnings releases.

Briefly before I turn things back Russ, I want to mention where we are on the PBR plan. As we've stated in previous calls, in April 2007, Nicor Gas submitted its direct testimony in compliance with the ICC scheduling order. Our new testimony resulted in a relatively modest change in our position of amounts due from customers. We cannot be sure when the proceedings will conclude or the issues will be resolved. No date has been set for evidentiary hearings on this matter. The next status hearing is now scheduled for April 17, 2008.

With that let me turn things back to Russ for a wrap up.

Russ Strobel

Thanks, Rick. In closing, I want to emphasize several points. First and most importantly, as Rick said, 2007 was another good year of performance for Nicor. Excluding noteworthy items, we posted the second best year of earnings per share in over a decade and our unregulated businesses including Tropical performed extremely well.

However, as Rick mentioned, despite our intense focus on cost management, earnings going forward will be negatively impacted by higher operating cost and downward pressure at Nicor Gas. Nicor Gas is simply not earning its allowed rate of return. Although we haven't reached a final conclusion on whether or when Nicor Gas might file for rate relief, we will not hesitate to seek relief in an amount fully sufficient to allow the company an opportunity to earn a fair rate of return. This kind of relief is essential, not only for our investors but also to enable Nicor Gas to continue to provide safe, reliable service to the 2.2 million homes and businesses that we serve.

While Nicor Gas will ask for all that it's entitled to, it bears emphasizing that any requested rate relief would not entail a significant cost increase for our customers. Nicor Gas residential customers benefit from the lowest delivery rates in Illinois, rates that are approximately 40% than the average Illinois delivery rates. Nicor Gas’s rates are also among the lowest rates in the entire nation. I want to emphasize that any rate relief we might seek will continue Nicor Gas’s longstanding tradition of being a low-cost, high value provider.

Turning to Tropical Shipping, this business continues to be post solid financial results. The economies where Tropical operates have been reasonably stable overall, but negative developments in the United States economy can spill over into those areas. And we also expect that the shipping environment will remain as it always has been, very competitive.

Growing Tropical’s volumes and controlling its costs will be important factors in improving results over the long-term. Management has always been effective in dealing with the competitive and cost pressures that have been presented, and we will expect that to continue into the future.

Looking ahead for our other energy-related ventures, we continue to be pleased with the performance of this growth platform. Our long-term earnings potential for wholesale energy services, hinges on our ability to continue optimizing the use of storage and transmission assets, as well as developing new assets, in conjunction with the growth of our customer base.

Long-term growth in our retail services business will depend on our efforts to expand the geographic scope of our offerings, while leveraging our call center capabilities, and capitalizing on investments that we have made in recent years, to develop new products and new marketing channels.

And with that ladies and gentlemen, we'll be happy to take your questions.

Question-and-Answer Session

Operator

(Operator Instructions)

Your first question comes from the line of Brooke Glenn Mullin. Please proceed.

Brooke Glenn Mullin - JP Morgan

Hi, this is Brooke Glenn Mullin. I just had few questions around the utility. Could you give us a sense of what return you earned in 2007 and what returns are embedded in guidance? And lastly if you could give us a sense of how large the rate base is utility at this point?

Rick Hawley

Couple of things as far as the return numbers as we've said on other calls, you obviously know what the equity of the gas company is just north of $650 million. So how we want to calculate the returns in normalized which items you want, we leave that to you to do, but we are under-earning and the project continues under-earn at that business. And I am sorry Brooke the second one was...

Brooke Glenn Mullin - JP Morgan

Just a sense of the rate base?

Rick Hawley

On rate base I apologize. If you look in the last case we filed and as we said we are currently evaluating the case, but if you look at the last case the Commerce Commission allowed us I think just south of a $1.3 billion in rate base, our requested rate base was a coupled hundred million higher than that. We've added and would project adding to that rate base overtime, but it will be a little bit north of those numbers. Our request -- our rate base if you look at our financial statements is probably $1.4 billion to $1.5 billion range.

Brooke Glenn Mullin - JP Morgan

Thank you.

Operator

(Operator Instructions). Your next question comes from the line of the David Grumhaus from Copia Capital. Please proceed.

David Grumhaus - Copia Capital

Good morning guys.

Russ Strobel

Good morning.

Rick Hawley

Good morning.

David Grumhaus - Copia Capital

You said you haven't made a decision to file. Why wouldn’t you go file? What would cause you not to move forward especially in light of peoples getting the company mechanism?

Rick Hawley

Sure. And the people's mechanism is appears to be a positive development. We are looking and analyzing our going forward cost, trying to see what the factors in the people's case, how they impact us and what would be appropriate in our situation and I guess we have to whether we will or won't. So I guess it's more that we are looking at the numbers and seeing what makes sense.

David Grumhaus - Copia Capital

Okay. Next question, your balance sheet continues to be quite robust, your stock's trading at a three year low. You still have openings on your share repurchase but you haven’t done any as far as I know. Why not do some share buybacks at this point?

Rick Hawley

Well, you are right on every one of the facts you put out and we have, I think about $20 million or so left outstanding on the share buyback. As we've talked about, we look at the corporate uses, whether its dividends, buybacks, investments in the business and if we decided to do any of those things, we will let you know. We obviously haven’t decided to do that at this point in time and the reason up until now, we haven’t decided yet, because we didn’t think it was the best use of the capital of the business.

David Grumhaus - Copia Capital

Your cash flow for '08, what is that going to look like, your free cash flow?

Rick Hawley

I don’t have that number with me and we don’t give it out anyway, other than, as you can calculate it from our numbers. But it will be -- we are obviously projecting lower earnings. If you factor in that aspect of it, you can look at the '07 cash flow and have a pretty good idea. It's a pretty robust number as has been mentioned.

David Grumhaus - Copia Capital

Okay, thanks for the time.

Operator

Your next question comes from the line of Dan Fidell with Brean Murray, Carret. Please proceed, sir. Hello. Please proceed sir, your line is open.

Dan Fidell - Brean Murray, Carret

Sorry, can you hear me?

Operator

Go ahead, sir.

Dan Fidell - Brean Murray, Carret

Thank you. Just a couple of quick questions, first can you give us some indication of what you think CapEx will be like for 2008?

Rick Hawley

Sure. We actually see an increase coming from ‘07 and we're looking at combined among the businesses just about $250 million, $225 million of which is at the gas company.

Dan Fidell - Brean Murray, Carret

Okay and the reminder would be for shipping presumably?

Rick Hawley

Yes. Modest Dan, $20 million for Tropical Shipping and five in the other businesses.

Dan Fidell - Brean Murray, Carret

Okay. And then, in terms of, you had mentioned as part of your ‘08 guidance that cost….

Rick Hawley

Dan we lost you.

Dan Fidell - Brean Murray, Carret

-- having some issues here. Can you give us some specific on bad debt expense and where you think, maybe a little bit more specifically where that number is headed as a percentage of revenues perhaps in 2008?

Rick Hawley

Sure. If you look, we incurred about $52 million worth of bad debt, maybe $53 million worth of bad debt in ‘07, and see that number being up probably $5 million to $7 million in ‘08 based on revenue and...

Dan Fidell - Brean Murray, Carret

Okay. And then perhaps when do you think the 10-K might be filed?

Rick Hawley

I would expect it to see the -- for all of you, you’d see it the first of the week.

Dan Fidell - Brean Murray, Carret

All right. And then just a last question on follow-up to David’s question on decoupling. Obviously, this was a positive for the Entegris folks. Would it be fair to say that decoupling is something -- I know in the past you guys have talked about the importance of trying to take as much of the risk out of the utilities.

Rick Hawley

Dan we lost you again…

Dan Fidell - Brean Murray, Carret

I am sorry, should we….hopeful that you can hear. I…

Rick Hawley

You are breaking up Dan.

Dan Fidell - Brean Murray, Carret

Okay. I will follow up with you later, thank you.

Rick Hawley

Okay.

Operator

Our next question comes from the line of Dave Parker Robert W Baird. Please proceed sir.

Dave Parker - Robert W Baird.

Hi good morning may I'll follow up on that.

Rick Hawley

Hi Dave.

Dave Parker - Robert W Baird.

May be I'll follow up on Dan's question could you refresh my memory what bad debt expense is included in your last rate case?

Rick Hawley

Yes about $38 million.

Dave Parker - Robert W Baird.

And you ask for a bad debt record, did you not and that was disallowed or that was not approved?

Rick Hawley

You are absolutely right Dave.

Dave Parker - Robert W Baird.

All right and then any guess, I mean thanks for giving us sort of a sense in the fourth quarter. What declining customer usage sort of did for margins as well as what weather did? Do you have any kind of guess for the year with the declined customer usage, what that sort of did to your overall net income on margin?

Rick Hawley

Sure the when you look at the demand structure in the fourth quarter I should tell you Dave it was really the anomaly. I wouldn't project out the negative disclosure in the decisive number in the fourth quarter I wouldn't project that out to be continue. Actually 2006 was the anomaly that was a little high. When we look -- the number were losing on it, I would say losing on the demand side is in the low million. So that's not the big driver for what's going on. It's more an increase in cost.

The troublesome part about demand is, one, you would hope it would grow a little bit as you add customers and even though our customers growth is slowing temporarily with the economy the way it is, you would still expect some help in your earnings as you see demand growth year-over-year and we're not seeing that. It is actually going slightly lower and so it's the direction more than the dollar amount.

Dave Parker - Robert W Baird

Okay. That make sense. Then also may be to switch the shipping and looks as if rates were up nicely, your volumes down a little, any color you can provide us there? And obviously shipping has done very well and you expect it to be a little off from record levels, but may be just sort of what you are seeing there and the shipping climate, will be great?

Rick Hawley

Sure. And if you look at volumes, I actually think shipping volumes are probably up a little bit year-over-year when you look at it. You always get quarterly anomalies but the volumes are up year-over-year and rates flat if you go through. And that's pretty much the picture we see holding on to the rate levels. We have kind of ignoring what may happen because of fuel, but assuming rates will be reasonably flat and then looking to grow the volume in the business, although, not as robustly as we would have hoped to a couple of years ago, it's certainly true that there could be spill over from the US into the Caribbean markets.

Dave Parker - Robert W Baird

Okay. And have you had any problems recently passing through increased fuel expense or is that problem then taken care of?

Rick Hawley

No, I think everyone recognized that's reasonable cost of doing business and impacted by it and that has not been a major problem.

Dave Parker - Robert W Baird

All right. Great. Thank you very much.

Operator

(Operator Instructions). We have a question from Chris Muir from Standard & Poor's. Please proceed.

Chris Muir - Standard & Poor's

Hi, it's Chris Muir from Standard & Poor's Equity Research. In light of the lower utility earnings, is there any changes expected to your dividend policy going forward or you expect to keep that steady?

Russ Strobel

Chris, we don't have any expectations whatsoever by cutting the dividend. That's completely unnecessary given the exceptional financial condition of Nicor and its inherent earnings power. So that's a very emphatic, no.

Chris Muir - Standard & Poor's

Okay.

Operator

And we have a question from Mr. James Heckler from Levin Capital, Please proceed.

James Heckler - Levin Capital

Hi, good morning.

Russ Strobel

Good morning.

James Heckler - Levin Capital

Looking from 2007 to 2008, what you actually earned in 2007 versus what the guidance is in 2008. Just looking at it as a very rough number. I think the implication is that the ROE at the utility that's going to be earned in 07 versus 08 is going to be down by at least 200 basis points, maybe a little more. And I am wondering if I am on the right track and am I thinking about that correctly. Following up to that would be, is that all driven by these cost increases here, you are discussing, because it seems rather sudden?

Rick Hawley

Sure if you look at -- about our commenting on the specific numbers, you are looking at the right way. The issue and the earnings clearly, if you are looking at the earnings power of the business going forward, the issue is that the utility is under-earning it’s a allowed rate of return. Compared to 2007, just to give you, I guess a little more color, give everyone a little more color on the numbers , we are looking for Tropical to be down, about $3 million off of its record, the record kind of earnings that we have seen there.

So, very robust by any standards but down off the '07 results. If were to look at other energy-ventures, which performed very well in the fourth quarter, when you combine them with the rest of the year, we are looking for them again to return to the kind of earnings that we've seen in the last couple of years, which will put them down about $5 million and then the reminder is at the gas company.

And the gas company is, again, the demand portion decline is a modest portion of it and it is almost entirely -- it is entirely in the O&M depreciation and interest lines of the gas company and more specifically in the O&M and the depreciation lines.

As you are well aware the way our depreciation expense for example, works is, we add $200 million a year in gross plan, depreciation expense goes up $8 million just like clock work and there is no mechanism other than the rate case in order to adjust for that.

On the O&M side, it is payroll driven; we have union contracts that call for certain percentage increases. We see those, we've managed as you tell by our operating metrics of being the lowest in the country on the cost side is, we've managed to offset those over the years. But as I mentioned in my remarks, at best we will mitigate those kinds of cost increases going forward, not eliminate them.

And then, we've already talked about the substantial amount of increase in bad debt. Given what we're seeing in our service territory -- we have a good service territory our percentages are still lower than averages, I think for Illinois and around the country as percentages of revenue. But they are increasing on us and a number of the factors are heading the wrong way, whether it's a home foreclosures, when people are in the situation of losing their house, their gas bill is not their highest priority. The substantial portion of our bad debt is driven by final bills when people have moved. So you could understand why foreclosures would have a negative impact on us. And in all candor the climate of what we can do to collect our bad debt, is getting harder and not easier on us as various regulators look to help people who are having financial trouble.

So the combination of those is driving us, not up to the averages of other company but certainly in that direction. And so we're getting a double-whammy, revenues were up because gas costs are that we don't earn any profit on, they are up. So, even if you percentage stayed the same, you would see higher bad debt and then the percentage is working its way up. So that's the reason for the dramatic increase in the numbers that Dave Parker asked us about earlier.

James Heckler - Levin Capital

Okay. Taking the numbers that you just threw out, the Tropical being down $3 million, energy-ventures being down $5 million, just very roughly maybe that's like $0.17 year-over-year-year decline. And if I just look at the mid-point of your '07 guidance, it looks like just a reduction of roughly $0.30 or $0.40. I think that implies about $10 million less of earnings at the gas company next year.

And what did the gas company earn in 2007 from an earnings perspective, can you give -- that $10 million just seems like a large reduction year-over-year and that would imply just really enormous cost increases year-over-year?

Rick Hawley

I'm not going to comment at any of your math at all, I've tried to give you all the formulas. But the gas company's net income including Mercury I believe is $66 million let me see -- let me just check we've obviously disclosed operating income, but I will give you net income of gas. With the Mercury recoveries, the gas company’s net income is $66 million for 2007. There is $8 million pretax or call it $5 million after-tax of Mercury in there, so you got $61 million worth of income.

And then as we pointed out in the press release the gas, it was a gas company was benefited by the interest reduction in the year. So if you back that out, that's another $10 million pretax. So, I think you can take the numbers that we have given you and get to what the gas company earned and then again having given you two to three number, I will let you do the math on what the gas company is.

James Heckler - Levin Capital

That's great. I appreciate. Thanks for your time and the color.

Rick Hawley

No problem. Thanks for the questions.

Operator

And since there are no other questions I would like turn the call back over to Mr. Russ Strobel for closing remarks.

Russ Strobel

Thanks everybody. We appreciate your interest in Nicor and we will talk to you next quarter. Have a good day.

Operator

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

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!

Source: Nicor Inc. Q4 2007 Earnings Call Transcript
This Transcript
All Transcripts