Nicor Inc. Q1 2008 Earnings Call Transcript

Nicor Inc. (GAS)

Q1 2008 Earnings Call Transcript

May 1, 2008 9:30 am ET

Executives

Russ Strobel – Chairman, President and CEO

Mark Knox – Director, IR

Rick Hawley – EVP and CFO

Analysts

Daniel Fidell – Brean Murray

Erica Liu – JPMorgan

Michael Gresens – Robert W. Baird

Greg McGowan [ph] – Sidoti & Co.

Operator

Good day ladies and gentlemen and welcome to the Nicor first quarter 2008 earnings conference call. My name is Stacey and I'll be your moderator for today. At this time, all participants are in a listen-only mode. We will be facilitating a question-and-answer session towards the end of the conference. (Operator instructions)

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

Russ Strobel

Stacy, thanks. Good morning everyone and thank you for joining us. With me this morning are Rick Hawley, our CFO; and Mark Knox, our Director of Investor Relations. We're going to discuss our 2008 first quarter financial results and our annual outlook for 2008 earnings. 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 everyone. First, I would 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, the three months ended March 31, 2008 diluted earnings per share were $0.91 compared to $1.04 per share for the same period in 2007. 2007's three months ended 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 that commenced in 2000. If you remove the effects of these items for comparison purposes, it gives you 2007 first quarter earnings of about $0.93 per share compared to $0.91 per share that we reported for 2008.

Let me now turn things over to Rick for a discussion of our 2008 results and our outlook for the remainder of the year.

Rick Hawley

Thanks, Mark. Good morning everyone. As Mark mentioned, absent the impact of noteworthy items, 2008 diluted earnings per share were $0.91 compared to $0.93 per share in 2007. These results reflect lower operating results in our gas distribution and shipping businesses and lower corporate operating income, offset in part by improved operating results in our other energy ventures and lower interest costs. These results on a consolidated basis are in line with our earlier expectations.

Nicor Gas's results excluding noteworthy items compared to last year were negatively impacted by higher operating and maintenance costs due primarily to increased bad debt expense and higher depreciation expense. Offsetting these factors were the impact of colder weather in 2008 and the impact of customer interest.

Nicor Gas's outlook for 2008 operating results remains unchanged from our earlier expectations, which as we indicated in our February call we expect to be significantly below last year's levels. We did benefit at the gas company level from colder than normal weather in the first quarter, but expect that increases in costs projected for the year including those impacted by high and increasing natural gas costs will offset much of that benefit. As a result of our projections for higher operating costs, we have filed for rate relief with the Illinois Commerce Commission. I will discuss this filing in more detail shortly.

Moving to our shipping segment, for the first quarter, shipping operating results were down due to decreased revenue caused by lower volumes shipped, partially offset by higher overall rates, and higher operating costs. Increased operating costs for 2008 compared to 2007 were due primarily to higher fuel costs.

In February's call, we indicated Tropical's results were expected to be down from the record levels of 2007, but still strong by historical standards. Tropical's quarterly results did come in less than anticipated. While management has been working to mitigate the margin impact of lower volumes, quarterly results were negatively impacted by lagging recovery of increasing fuel costs.

Management at Tropical continues to take steps to recover from this shortfall. For example, Tropical recently completed an acquisition for the assets of Caribtrans, Inc., a provider of less-than-container load and full-container load consolidation services from the United States to the Caribbean and Central America. While this acquisition is relatively small to Tropical's total volumes, adding about 4% to expected revenue, this is an exceptional strategic fit for us that increases our less-than-container load business into markets that are important to our long-term success. As you remember, expansion of this less-than-container load business is a key element of our business plan going forward.

Our other energy ventures operating results were up compared to last year, due to improved results at our retail products and services business, offset in part by lower results at our wholesale natural gas marketing business. For the quarter, overall other energy venture results were consistent with our earlier expectations. Although Enerchange's quarterly GAAP results were less than expected, our retail platform's first quarter results were better than expected and made up much of that difference. For the full year, we continue to expect that our other energy ventures will be down from the record levels of 2007, but still very strong compared to historical levels.

Corporate operating results were negatively impacted by the effects of our weather offset associated with our utility bill management products. As we previously discussed, certain of those products provide a natural and partial offset to the weather risk of the gas distribution business.

In the first quarter 2008, we recorded an approximate $3.8 million cost associated with this hedge due to the impact of colder than normal weather. This compares to a cost of $600,000 in the first quarter of 2007 when we had near normal weather. The amount of the offset will vary depending on a number of factors, but it generally ranges from around 30% to 50% of our gas company's weather impact. Under terms of a corporate swap agreement, benefit or cost resulting from variances in normal weather related to these products are recorded primarily in corporate operating results.

Turning to our outlook for 2008, taking into consideration all of the pieces I just discussed, our 2008 diluted earnings per share estimate is in the range of $2.20 to $2.40, unchanged from the guidance we provided in our year-end earnings call on February 22, 2008. Our outlook assumes normal weather for the remainder of the year, but excludes among other things any future impacts associated with the ICC's PBR plan and PGA reviews, other contingencies, and changes in tax laws. Our estimate also does not reflect the variability to earnings due to fair value accounting adjustments and other impacts that could occur because of future volatility in the natural gas markets. As a reminder, updates to our annual earnings outlook will only be provided as part of our quarterly and annual earnings releases.

Let me now move and spend a few minutes discussing the regulatory filing made earlier this week by our gas distribution business. I don't intend to get into all of the specific details of the filing, which are available on the Web site referred to in our Tuesday press release about the rate case, but I'll spend some time discussing our rationale for filing and our proposed changes in rate design.

Nicor Gas is proposing an overall increase in business and residential rates of about $140 million. Despite one of the nation's best records for efficiencies and our continuing efforts to control costs, Nicor Gas's costs have gone up significantly while revenues have not kept pace, resulting in a decline of our earnings and our return on rate base. We have discussed this matter in a number of our previous calls. We are requesting an increase in base rates to recover the rising cost of operating our distribution system and increased capital investments made by us.

Our proposed rates are based on our projected 2009 test year, which we believe reasonably reflects the conditions and costs of Nicor for the period during which the rates will become effective. We are proposing a return on rate base of 9.21%, including a return on equity of 11.05% as compared to an 8.85% return on rate base which included a 10.51% return on equity approved in our 2005 rate order. Our projected rate base in the filing is $1.5 billion. Our capital structure is consistent with that approved in our last order and our actual capital structure.

We are also proposing to continue using a ten-year average for calculating normal weather. This change would result in a reduction in our normal degree days from 5,830 to 5,600.

Finally, we are also proposing certain changes in rate design, the most significant of which are riders for a volumetric balancing adjustment, the recovery of cost of natural gas to operate company owned equipment and facilities, our uncollectible expense, to effect energy efficiency programs and put in place a qualifying infrastructure cost recovery program.

It's important to keep our request in context. Allowing us to recover the reasonable costs of providing safe, reliable service if granted in full would increase an average residential customer bill by less than $5.00 per month and result in an average residential customer's delivery bill that is still almost 40% less than it would be if our customers paid the weighted average delivery cost of other utilities in Illinois. These rates, which are low in absolute terms, result from our cost metrics that are among the best in the country.

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

Russ Strobel

Thank you, Rick. I want to close by emphasizing several points. First, as Rick mentioned, our first quarter financial results are generally in line with our earlier expectations. However, Nicor Gas results continue to be pressured by higher operating costs. This ongoing trend, combined with the continued pressure on demand, has led to our decision to file for rate relief with the Illinois Commerce Commission.

Let me stress that in our filing, we are seeking an amount that we believe is sufficient to allow Nicor Gas an opportunity to meet its obligations to provide safe and reliable service and to recover its costs of service. I also want to emphasize that even with the requested new rates, Nicor Gas would still be the lowest natural gas provider among major Illinois utilities and among the lowest natural gas utilities in the entire nation. These low rates are a testament to our long history of being one of the most efficient natural gas utilities in the nation. Nicor Gas has consistently been a low cost, high-value provider, and our rate relief request will not change that.

Tropical Shipping is facing a challenging environment. Still we expect another solid year of performance in 2008. I've been pleased with Tropical's ability to cope with challenges in the past and I'm confident that our experienced management team will continue to do so in the future.

Looking ahead for our other energy-related ventures, we continue to be pleased with the performance of this growth platform. Businesses supporting this platform are expected to continue to make increasingly important contributions to Nicor's long-term earnings.

And with that, we'd be happy to take your questions.

Question-and-Answer Session

Operator

(Operator instructions) Your first question comes from the line of Daniel Fidell with Brean Murray. Please proceed.

Daniel Fidell – Brean Murray

Good morning.

Russ Strobel

Good morning, Dan.

Daniel Fidell – Brean Murray

Thanks for the call, as always. Just a couple of quick questions. First, were there any nonrecurring items in the quarter? Any real estate sales or anything like that?

Russ Strobel

No.

Daniel Fidell – Brean Murray

Okay, great. Next question, can you talk a little bit about – you talked about the rising operating costs, and I was wondering if you could just go into maybe some specifics in terms of what your bad debt expense has been for the second quarter and maybe year-to-date. And then maybe some – a little bit more color in terms of what operating costs specifically you feel challenged by as part of the rate case, the specific cost structures that you are really aiming at.

Rick Hawley

Sure. Bad debt for the first quarter compared to last year is up about $10 million. We've talked about in our rate case that went effective in 2005, we have about $38 million built in. By the time we get to the test year, you have got a number around $60 million. So that is one of the drivers. If you look at the drivers of the $140 million request, I can break it into four or five categories for you. Most of the money, $39 million of it comes from increases in cost that are driven by the cost of natural gas and that includes the gas that the company uses – what we refer to in our documents as company used gas, and the bad debt expense which to the extent we lose a percentage of revenue as gas costs go up, bad debt expense goes up as we're seeing in the quarter and in the projections. So that is about – the increase in those operating costs are about $39 million.

The departmental O&M costs, which are payroll, healthcare, payroll-related benefits, et cetera, those are up about $27 million in the test year, 2009. Rate-base additions in plant and the depreciation expense, and the biggest part of this is the depreciation expense that is not included in rates, is up $34 million. As you remember, we have a formula to calculate depreciation expense. So if you add, for example, $200 million in rate base, depreciation expense goes up about $8 million. So, the plant rate-base increase and the depreciation component increases are $34 million and then other rate-base additions are another $31 million, and that makes up the bulk of the $140 million request. Just I mentioned – I said the bad debt in the test year is around $60 million, it's actually $68 million in the test year, 2009.

Daniel Fidell – Brean Murray

Great, thank you for that color on that, very helpful. Maybe a last question and then I'll let someone else ask a question. Interested in your announcement on moving into the storage business, specifically in California. I was wondering if you could just sort of talk about the strategy, the overall strategic direction. Are you interested in moving more aggressively into the physical assets, like pipelines and storage, even as you are building Tropical?

Russ Strobel

We are interested in moving in that direction, Dan, but I don't think anyone should expect anything abrupt or sudden. Nicor has always been very disciplined, very systematic about how it approaches these areas, but we do think that storage in particular is going to be a big growth area in the future. Everybody knows that you have got a very tight supply-demand relationship. We've got unconventional sources coming online with low production rates. We've got LNG coming onshore. We've got a lot of volatility in the underlying prices of the commodity itself. And I view storage as a physical hedge where volatility can drive values, just the way it would drive values in a financial hedge. So it is an area that we're interested in, that we're looking at, but we're going to be disciplined, we're going to be systematic, we're not going to overpay. We like our ability to develop as opposed to purchase assets generally, because we think that it's a lower-cost entry point into the market. But it is something that we're going to be looking at.

Rick Hawley

And as you know, I mean, we're already in that – we have investment in Horizon Pipeline. That is a lot of what Enerchange already does, is bundling up storage assets with pipeline capacity and providing service to customers. So it's just a continued look in that area.

Russ Strobel

And just one more point on that, I think Rick makes an excellent point, at Nicor Gas, we operate one of the largest LDC owned storage systems in the nation. We have got 140 billion cubic feet of working gas in a whole series of aquifer storages. So it is a business that we know a lot about.

Daniel Fidell – Brean Murray

Right. I appreciate your comments today, especially on the rate case. Good luck to you as you go forward, we are big proponents of decoupling mechanisms, so very best of luck to you and we will see you down at the AGA.

Russ Strobel

Thanks, Dan, see you there.

Operator

Your next question comes from the line of Brooke Glenn Mullin with JPMorgan. Please proceed.

Erica Liu – JPMorgan

Hi, this is actually Erica Liu. A quick question on shipping. I was wondering if you could provide more color on the economic and competitive pressures on volumes shipped, is it falling tourism, new competitors, or other shippers lowering prices. And with 1Q '08 shipping earnings around $4 million, how should we think about the trends for the remainder of the year? I believe on the fourth quarter call, you guided that shipping would be down around $3 million from 2007 results.

Rick Hawley

Yes, let me start with that one. I think I said $3 million to $4 million; that is still our forecast for the year. On the volume side, I think you hit all the factors. There obviously is a spillover in certain of the economies down there from what's going on in the U.S. and the impacts of higher prices. So there is demand on – or pressure on demand. Our sense is that we're continuing to hold our share. So the pie is shrinking a little bit. That is where our volumes are going. So yes, there are competitors. Yes, some of them may make rational or irrational pricing decisions on a temporary basis that sometimes we respond to, sometimes we don't. But basically I think it's a contraction to some degree in the market.

It's not the end of the world, we're down about 5% versus last year on volumes, but it certainly puts pressure on it. The business down there has always been able to successfully manage around that by adjusting costs and seeking out (inaudible). Caribtrans is a good indicator of that. If you add about 4% of revenue, which is $15 million to $16 million worth of revenue of good volume, good margin business, that always helps make up some of the shortfall in other areas.

The wildcard now is a little bit on fuel cost. That is an impact that is probably a little greater than it's been. As I mentioned on calls, we do have a fuel – bunker surcharge that goes into play, but it is an averaging mechanism and you lag behind as prices go up. And then you get some of that back as prices go down. Unfortunately, as we all know, in the first quarter that has been a one-way street. And so, while we have recovered a substantial portion of the increases in fuel costs, there has been some lag. All we need them to do is flatten out, then that helps us. If they continue to just increasingly rise through the end of the year, that would put pressure on Tropical's earnings. But right now, as we forecast out, we are looking to be in the range of what we talked about before, and we will watch how the year develops.

Erica Liu – JPMorgan

Great, thank you.

Operator

Your next question comes from the line of Michael Gresens with Robert Baird. Please proceed.

Michael Gresens – Robert W. Baird

Good morning.

Rick Hawley

Good morning, Michael.

Michael Gresens – Robert W. Baird

One quick question just on the effective tax rate. Any expectations for the remainder of the year?

Rick Hawley

Yes, the rate for the quarter is approximately 25.3% and that should be the rate for the year if the forecast of the income stays. If it goes up, the effective rate will actually obviously move up a little bit. If, God forbid, it goes down a little bit, it will go down a little bit, but right around 25%, 26%.

Michael Gresens – Robert W. Baird

Okay. That's it, thanks.

Operator

(Operator instructions) Your next question comes from the line of Greg McGowan [ph] with Sidoti & Company. Please proceed.