AGL Resources, Inc. Q1 2008 Earnings Call Transcript

May. 1.08 | About: AGL Resources (ATG)

AGL Resources Inc. (ATG) Q1 FY08 Earnings Call May 1, 2008 8:30 AM ET

Executives

Steve Cave - Managing Director, IR

John W. Somerhalder II - Chairman, President and CEO

Andrew W. Evans - EVP and CFO

Hank Linginfelter - EVP, Utility Operations

Douglas N. Schantz - President, Sequent Energy Management

Analysts

Gordon Howald - Calyon Securities

Elvira Scotto - Banc of America Securities

- - -

Operator

Good day, ladies and gentlemen, and welcome to the First Quarter 2008 AGL Resources Earnings Conference Call. My name is Lauren, and I will be your operator for today. At this time, all participants are in listen-only mode. We will conduct a question-and-answer session towards the end of this conference. [Operator Instructions].

I'd now like to turn the presentation over to your host for today's call, Mr. Steve Cave, Managing Director of Investor Relations.

Steve Cave - Managing Director, Investor Relations

Thank you, and good morning everyone. Thank you for joining us today to review our first quarter 2008 earnings results. The speakers on the call today will be John Somerhalder, our Chairman, President and CEO and Drew Evans, our Executive Vice President and CFO. We also have several other members of our management team here with us to answer questions following the prepared remarks.

As you know, we issued our earnings release yesterday. We also filed our Form 10-Q this morning. If you don't have those already, you can find copies of those documents on our website. We also have a slide presentation at the company's webcast just to provide a summary of some of the key highlights for the quarter.

Moving now onto the prepared remarks, let me just remind you that our discussion today may contain forward-looking statements and that our actual results could differ materially from those projected in those forward-looking statements. The various factors that could cause that material difference are included in our press release and our 10-Q and are more fully described in our most recent 10-K filings. We also use some non-GAAP measures in describing our business, and reconciliation of those measures to the GAAP financial measures is available in our earnings release and SEC filings as well as our website.

We will begin today's call with some prepared remarks and then we will open up the lines to take your questions. And with that let me turn it over to John.

John W. Somerhalder II - Chairman, President and Chief Executive Officer

Thanks, Steve, and good morning everyone. We had the chance to see a number of you at our analyst conference in early April and look forward to seeing many of you at the upcoming AGA Financial Forum this weekend. So Drew and I will keep our comments brief today and just hit the highlights for the quarter and briefly describe our outlook for the year. Yesterday, we reported earnings of $1.17 per basic share, which is more consistent with the results you would expect given the current set of economic and market conditions that we discussed with you at the analyst conference. Further, as discussed during the analyst conference, these results for first quarter 2008 were in line with Drew's comment that we were expecting that current year first quarter to be roughly $0.15 below last year's reported first quarter. Adjusting for changes in the value of our hedge positions at Sequent, which resulted in current period unrealized losses of $15 million or approximately $0.12 impact to earnings per share. Our reported results would have been in the range of $1.29 per share.

Drew will walk through those changes in more detail in a minute, but I think it's important to note that Sequent had a strong quarter in terms of generating significant economic value and the majority of that value was not realized in the first quarter but is expected to be realized later in the year.

On the retail side, SouthStar's performance for the first quarter of 2008 was not as strong as it was during last year's first quarter. SouthStar's lower results were mainly driven by the increase in commodity prices throughout the first quarter and lower opportunities to optimize storage and transportation assets relative to last year. Given last year's very strong conditions and performance in the first quarter, we had expected lower earnings from SouthStar in the first quarter of this year and had already projected a majority of the lower earnings that we actually experienced when we established guidance for 2008.

Our utility business results were flat year-over-year. We continue to make progress in reducing our customer attrition levels, but were challenged on the growth side by the slowdown of the economy and turbulent real estate market that lowered our customer growth rate below our expectations. The good news is we were able to hold our expenses flat to the business as compared to the prior-year period.

As I mentioned earlier, Sequent is off to a good start from an economic value standpoint, and we believe that business is well positioned to capitalize on market opportunities throughout the year in addition to realizing in future periods the economic value that has already been generated during the first quarter. Also, we continue to see strong contributions from our energy investment segment, including better results from the Jefferson Island Storage facility as well as from AGL Networks. And finally, we continue to focus on actively managing our interest rate exposure and building on our long history of reducing costs in each of our businesses. We have actively managing both interest and O&M cost throughout our businesses and see upside in both of those areas.

Our guidance range for the year remains at $2.75 to $2.85 per share. Longer-term we have described for you what we think is a very good set of opportunities to develop storage and pipeline infrastructure and we have made significant progress related to these growth projects. With respect to the Golden Triangle Storage project in Texas, we will hold the groundbreaking ceremonies next week to begin construction on this important project. This is the first of several key milestones during the construction phase of this $265 million project. The project is on schedule and on budget.

We also will be breaking ground on the Hampton Roads Crossing project, the HRX project, in Virginia later in the month. This project… it will help with supply diversity for natural gas in Virginia and it also will provide important service for two anchor third-party utilities and will generate solid returns for us. We continue to move forward on the Magnolia project and that will help us move additional volumes from Elba Island into the metro Atlanta area. We expect FERC action on that project any day now.

We’ve spoken with most of you about Jefferson Island and the lawsuits we have filed there. The only thing I would add at this time is that we continue to believe the environment is right there for some type of settlement and those discussions continue to occur. We remain optimistic that we can get the project back on track and we will certainly let you know of any new developments over the next several months.

With that, I will turn it to Drew for the financial discussion.

Andrew W. Evans - Executive Vice President and Chief Financial Officer

Thanks, John, and good morning everybody. I think John covered the basis pretty well on distribution in terms of the largest drivers, which are customer growth and attrition and the continued focus on managing expenses. I won't walk through all the distinct offsetting factors that get you to the flat year-over-year results, but you can certainly call Steve and walk through those if you like.

Before I talk about SouthStar and Sequent, you should understand one macro economic factor that has a significant impact on reported earnings. Unique to the last three years, gas prices rose steadily throughout the quarter in 2008. In SouthStar, this produced some lost opportunity relative to previous years. In Sequent, it will affect only the reporting of the value of our hedges, but has no impact on our reported inventory valuations. Despite these accounting changes, the underlying economic margin expected from the initial injections remains unchanged. Continued increases in prices as we have experienced since the end of the first quarter will continue this impact, but could just as easily reverse itself. On a net basis, Sequent is carrying roughly 11 bcf of storage. So $1 change in NYMEX could affect reported earnings by as much as $11 million.

At SouthStar, John talked about how the cost of gas and rising commodity prices were the major drivers there. And the overall impact of that issue led to a $16 million decline in operating margin for the first quarter relative to last year. The remaining $5 million decline in operating margin was a result of two items, lower margins in Ohio and Florida markets of about $2 million and a settlement of $2.5 million we consented to during the first quarter this year with the Georgia Public Service Commission to settle an issue related to retail pricing in Georgia. Please remember that SouthStar had earnings that were $9 million in 2007 than in the previous year. Operating expenses at SouthStar were up a couple of million dollars due to slightly higher bad debt expense and increased marketing and direct sales costs. As John pointed out, Sequent had a stronger year-over-year commercial activity, stronger by about $5 million. That positions the business very well going into the remainder of the year.

What you see in our reported GAAP results reflects the accounting impacts of the increase in forward NYMEX gas prices and the widening of future locational spreads, as these changes affect the underlying value of our storage and transportation hedges. But in reference to the former, we make no adjustments to the inventory that backstops the NYMEX hedges.

Last year in the first quarter, we had GAAP reported storage hedge losses of $6 million and recorded no significant losses on transportation hedges. This year, we reported losses of $11 million on storage hedges and $4 million on transportation hedges. So we reported an additional $9 million in hedge losses as compared to last year, resulting in a reduction in reported operating margin of $4 million year-over-year when combined with the $5 million increase in underlying commercial activity.

Sequent's operating expenses were up $4 million for the quarter and that was mainly due to higher payroll and other operating costs as we continued to expand the business model including our acquisition of Compass Energy, a commercial industrial marker, which was completed in 2007.

The inventory rollout schedule on page 22 of the 10-Q gives you a good view of our expected timing for realization of future economic value of Sequent's portfolio that has not yet been realized in reported results. You can see we anticipate about $18 million in operating revenues to be realized over the next three quarters compared to about $15 million last year at this time. Although it’s [inaudible] change with changes in forward prices and Sequent's response to capture additional market opportunities, I think it demonstrate the longer-term value generation potential of this business. It's also important to note that Sequent's sales volumes in the first quarter of 2008 were up 12% over the prior-year period, again reinforcing the significant growth we have seen in that business.

Turning to energy investments, we had good results in this segment with operating margins up $2 million due to higher interruptible and firm revenues at Jefferson Island storage facility and higher revenues from AGL Networks… the AGL Networks business due to network expansion projects. Operating expenses declined $1 million because of lower business development expense and that's because we are capitalizing our cost for the Golden Triangle project after receiving the FERC permit at the end of the year. That covers the highlights of the operating segments.

And with that, we can take your questions.

Question and Answer

Operator

[Operator Instructions]. And your first question comes from the line of Gordon Howald with Calyon.

Gordon Howald - Calyon Securities

Hi, guys. Good morning. I apologize if you’re asked this because I got interrupted a couple of times during the conference call, but at retail, I understand that you set your… the retail tariff at the beginning of each month. Now gas prices rise, you utilize storage gas to meet your customer need. Isn't there a way to hedge that exposure that you have on a monthly basis rather than subject shareholders and subject to yourself to the changes, the swings on a monthly basis in natural gas prices? Am I missing something or am I looking at this properly? How do you go about hedging that?

Andrew W. Evans - Executive Vice President and Chief Financial Officer

You're looking at it properly, Gordon. There are sort of two issues there. You can have rising prices during the period and you can have volumetric change due to weather. Weather was an item this year that we hedged pretty heavily, and… but unfortunately it was colder than normal. So, we had $7 million benefit from increased volumetric flow, but we had a $7 million offsetting loss from the hedges that we put in place. That was to protect us from volume changing due to weather. On the price side, what happens in a rising price environment is that a greater percentage of the total gas that's being delivered comes out of storage as opposed to just coming from flowing gas. And I'd say that we had a history of two years where we had pretty natural declines from first of month throughout those months. And to some degree we… you factor that in when considering what you should actually hedge in those months and we hedged it to a lesser degree in the first quarter of this year.

John W. Somerhalder II - Chairman, President and Chief Executive Officer

And I would add to that a little bit that one of the difficulties as Drew talked is, you can hedge to some extent but the volumes that actually flow out depend on the weather, which makes it difficult to completely protect yourself. But there are some ways through inventory that you can protect yourself. Most of what you have seen year-over-year was the difference between the benefits we’ve received in past time periods where we actually had a positive benefit by being able to use inventory to make additional. This year was more return to a level where we were protected, but we didn't have that upside. But we do attempt to establish a position that best protects us under these type of circumstances, but still gives us the opportunity in past periods and that's more what the variance is than any other factor.

Gordon Howald - Calyon Securities

Okay, I see. That's real helpful. And I apologize, what did you peg the normalized EPS number at for the quarter excluding mark-to-markets?

John W. Somerhalder II - Chairman, President and Chief Executive Officer

Right. You take $1.17, well, $15 million of the 998… what we call 998 [ph], that's $0.12 a share, so it will be $1.29.

Gordon Howald - Calyon Securities

$1.29, that’s what I was looking for. Thanks, guys. I appreciate it. See you in a couple of days.

John W. Somerhalder II - Chairman, President and Chief Executive Officer

Thanks, Gordon.

Operator

And your next question comes from the line of Elvira Scotto with Banc of America Securities.

Elvira Scotto - Banc of America Securities

Hi, good morning. Can you give us a sense for bad debt expenses at the distribution operations as well as SouthStar, kind of what you are seeing relative to your expectations and maybe versus last year?

Andrew W. Evans - Executive Vice President and Chief Financial Officer

I am trying to think of what we've got for accrual exactly. Brian [ph], you want to give that one.

Unidentified Company Representative

Bad debt expense is running probably roughly about 1% of operating revenues. As Drew mentioned, you’ll see at the retail side that bad debt is actually up a little bit on a year-over-year basis, but it is not really as a result of change in the underlying demographics of our customer base or what we think about what customers are going to do about payment. It is really being driven by the higher operating revenues and that’s largely being driven by the higher gas price. So, that’s really what you're seeing from a bad debt perspective. I don't think we've seen any change necessarily at this point on the distribution side or on the retail side. I guess that's [inaudible] feeling or expectation that we have a change in kind of what our standard process is around recognizing bad debt.

Elvira Scotto - Banc of America Securities

Okay. And then just on customer growth, I think this quarter was up 0.3%. Any change to outlook for the full-year growth expectation I think, which was up 0.5%?

John W. Somerhalder II - Chairman, President and Chief Executive Officer

Elvira, you're right. After this quarter, we did see not as much on the attrition side, but a little bit more on the growth side. We did see growth slow down more than what we had anticipated. We still believe that we've a chance to bring growth in at around 0.5%. It is more challenged though with the continued slowdown of the housing market and the economy. So, that is a little more challenged, but we do believe… and we've got a number of programs to address that, programs that have been successful in the past. And so, we still are targeting the 0.5%.

Hank Linginfelter - Executive Vice President, Utility Operations

That's right. This is Hank Linginfelter. We also have seen a little bit of improvement nationally in the housing market. The census has updated January's numbers and December's numbers slightly upward, and we think that that will indicate some additional strength in the market than what was anticipated earlier in the year. So, it really depends on what happens in the economy, but we think the 0.5% or there… is still fair enough.

John W. Somerhalder II - Chairman, President and Chief Executive Officer

Also, I’d point out that when we look at these statistics year-over-year, different whether patterns cause customers to turn on and turn off at different times coming into seasons and out of seasons. So, sometime a single data point or even a single quarter-over-quarter comparison may make the situation look better or worse, and we tend to normalize that out. And that's what also gives us some level of comfort that we have a chance to make that 0.5%.

Elvira Scotto - Banc of America Securities

All right, that's helpful. Thank you.

Operator

And your next question comes from the line of Pat Durban [ph] with Goldman Sachs.

Unidentified Analyst - Goldman Sachs

Hi guys. A question for the outlook for the wholesale segment, given that you had a $5 million increase in commercial activity is that in line with sort of what you're budgeting towards your guidance of $40 million for that segment for EBIT or are you sort running ahead of your plan for that?

Andrew W. Evans - Executive Vice President and Chief Financial Officer

I think the increase in total for the year is probably pretty consistent with our plan. I think it occurred a bit earlier in the year than we would have anticipated when we budgeted.

Unidentified Analyst - Goldman Sachs

Okay great.

John W. Somerhalder II - Chairman, President and Chief Executive Officer

I think that's pretty good way of saying that as we expected growth year-over-year, the good news is we had a good first quarter. That gives us quite a bit of confidence. We still have the opportunity as we move through the summer… again, this depends on the conditions we see in the summer, but what we've been able to execute around in past, we still have upside potential, but you're right, what we've experienced so far gives us confidence around the $40 million level at this point of the year.

Unidentified Analyst - Goldman Sachs

Okay. And the outlook now, given where you're seeing the spreads, same thing, you’re sort of still on track?

Douglas N. Schantz - President, Sequent Energy Management

This is Doug Schantz, and clearly we see, just like within any portfolio, ups and downs in the portfolio. Single cycle storage [inaudible] tighter, but we have seen a lot of action on deal flow and transportation activities. So it is always a mix and match for a situation, but we are still confident we will come in at least where we are projected.

John W. Somerhalder II - Chairman, President and Chief Executive Officer

Again single cycle spreads are important and that driver is a negative indicator, but a lot of value that we achieve are through the high deliverability storage and that depends a lot on the volatility and what happens in the summer with hot weather or hurricane or other activities. So for the reasons Doug mentioned, though one indicator is negative other factors appear to be positioned well for the summer at the early stage.

Unidentified Analyst - Goldman Sachs

Okay. And then can you talk a little bit about the Magnolia project and how exactly you are planning to recover the costs of the, what kind of returns you expecting to see and the timing and things like that?

John W. Somerhalder II - Chairman, President and Chief Executive Officer

Yes. The project, I believe in service was late 2010... in 2010. The way that we received approval for that project was as part of our Capacity Supply Plan in Georgia, we received approval for that capacity to be part of the capacity that the utility would contract for and that capacity is allocated month-to-month to our marketers for them to use, but then those costs in the Capacity Supply Plan had been approved. So we will get recovery in that way from a state standpoint. However, the pipeline will be FERC regulated pipeline and the rate will charge and return we’ll achieve on this will be a FERC regulated return. So we expect returns… and it’s about $45 million investment. The returns on that $45 million investment will be consistent with what are being achieved at the FERC level with FERC regulated pipeline.

Unidentified Analyst - Goldman Sachs

Do you have a range in terms of what those returns are?

John W. Somerhalder II - Chairman, President and Chief Executive Officer

We would hope to be in the 13% to 14% range return on equity.

Unidentified Analyst - Goldman Sachs

Return on equity. Okay, great. That's all my questions, thanks.

Operator

[Operator Instructions]. And your next question comes from the line of Mike Himes [ph] with Sawtooth Investment Management.

Unidentified Analyst - Sawtooth Investment Management

Thanks. Hi. How are you doing? I was going to ask about your comments about economic value creation in Sequent in light of weaker summer, winter spreads and I think you kind of addressed that a couple of questions ago. So I’m good.

John W. Somerhalder II - Chairman, President and Chief Executive Officer

Good to hear your voice.

Unidentified Analyst - Sawtooth Investment Management

Thanks.

Operator

And there are currently no further questions.

Steve Cave - Managing Director, Investor Relations

Okay. Well, thanks for joining us today, and we hope to see some of you down in Miami over the weekend. Have a good day.

Operator

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

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