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Piedmont Natural Gas Company Inc. (NYSE: PNY ) Q4 2014 Results Earnings Conference Call January 05, 2015, 10:00 AM ET Executives Nick Giaimo – IR Tom Skains – Chairman, President & Chief Executive Officer Karl Newlin – Senior Vice President and Chief Financial Officer Franklin Yoho – Senior Vice President and Chief Commercial Officer Analysts Chris Turnure – JPMorgan Andy Levi – Avon Capital Advisors Spencer Joyce – Hilliard Lyons Operator Good day, and welcome to the Piedmont Natural Gas Year End 2014 Earnings Call. Today’s conference is being recorded. At this time, I would like to turn the call over to Mr. Nick Giaimo. Please go ahead. Nick Giaimo Thank you, Jamie. Good morning, everyone, and thanks for joining the Piedmont Natural Gas year end 2014 earnings conference call. This call is open to the general public and is being webcast live over the Internet. If you would like to access the webcast of this call or view the slides of the accompanying presentation, please visit our website at PiedmontNG.com and choose the For Investors link. On the right hand side of that page, you will find the appropriate links. On the call today presenting prepared remarks, we have Tom Skains, President, Chairman, and Chief Executive Officer, and Karl Newlin, Senior Vice President and Chief Financial Officer. Other officers of the company are also in attendance to take your questions. Finally, this call may include forward-looking statements, and our actual results may materially differ from those statements. More information about the risks and uncertainties relating to these forward-looking statements may be found in Piedmont’s 2014 Form 10-K, filed on December 23rd with the SEC. And with that, I will turn the call over to Tom. Tom Skains Thanks, Nick, and good morning, everybody. And thank you for joining us for our year end 2014 earnings conference call. I know many of you are just getting back into the office after the holidays, and we really appreciate you taking the time to be with us today. As you know, we filed our 2014 10-K and issued our year end earnings release on December 23. This morning, I am going to talk about our 2014 accomplishments and provide you with a general update on the company. Then I’ll turn it over to Karl to give you a more detailed discussion of our 2014 financial results and our 2015 earnings guidance. Let’s begin on slide 2, since Nick has already covered slide 1. I’m extremely proud of what our team accomplished in 2014. We generated net income of $144 million and diluted earnings per share of $1.84. This was 7% and 3% higher respectively than 2013 results. 2014 was also a good year for customer growth. We added more than 16,000 new customers to our system, the strongest year of customer growth since 2008. We executed our regulatory strategy with general base rate relief in North Carolina and successfully completed the first year of Integrity Management Riders or IMRs in both North Carolina and Tennessee. We also outlined future growth in our joint venture portfolio with the announcement of our 10% equity participation in the Atlantic Coast Pipeline project. As Karl will discuss in a moment, we completed the $515 million utility capital expenditure and joint venture contribution program for 2014. Over half of our 2014 capital spend was dedicated to integrity management. And as I just mentioned, we have IMRs in place to recoup that spend in a more timely and efficient manner. Part of our future capital expenditures will be to continue to serve new natural gas power generation facilities in our region. In June, we announced a new power generation delivery project for Duke Energy to serve their planned W.S. Lee facility in Anderson, South Carolina. During the year, we took advantage of the favorable interest rate environment and issued $250 million of 20 year debt at a coupon rate of 4.1%. And finally, our Board once again demonstrated its confidence in the company’s strategic growth plan by raising our dividend in 2014 for the 36th consecutive year. Slide 3 shows our 2014 net income of $144 million, which was 7% higher than 2013. Higher top line margin growth and increased earnings contributions from joint ventures more than offset increased O&M depreciation and interest expense to support that growth. On slide 4, we highlighted our gross customer additions for the year. As you can see, customer gains of 16,251 in 2014 were 14% better than last year’s growth and produced a gross customer growth rate of 1.6% above our initial forecast for the year. Notably, customer additions in all categories reflect good economic growth across our three state service territory. We expect this momentum to continue, which is why we are again forecasting a growth rate of 1.6% in 2015. Slide 5 is an overview of our constructive regulatory environment. In North Carolina, we settled a general rate case and new rates went into effect in January 2014. The settlement includes a 10% return on equity with a 50.7% equity capital component. We also have implemented an IMR in North Carolina to allow us to earn a recovery of and a return on our system integrity investments outside of general rate cases on an annual basis. Our first annual North Carolina IMR adjustment of $0.8 [ph] million was effective in February 2014. We were granted a similar IMR mechanism in Tennessee with the first annual margin adjustment of $13 million effective in January 2014. Subsequently, we made additional IMR filings in both North Carolina and Tennessee. In North Carolina, we filed for an annual margin adjustment of $26.6 million to be effective February 2015. In Tennessee, we filed for an annual margin adjustment of $6.5 million to be effective January 2015. Both filings are before our state commissions and are pending regulatory approval. In South Carolina, we agreed under our last annual rate stabilization filing to an allowed ROE of 10.2% and to an equity capital component of 55%. The new or proposed rates in all three states are consistent with the margin assumptions we provided when we initiated fiscal year 2015 earnings guidance last November. Moving to slide 6, we show our two in-development joint ventures, Atlantic Coast Pipeline and Constitution Pipeline. We announced Atlantic Coast Pipeline or ACP in September 2014. ACP is an interstate pipeline that will run from West Virginia through Virginia and into eastern North Carolina and will have initial capacity of 1.5 billion cubic feet per day. The total project cost is estimated at $4.5 billion to $5 billion and our ownership percentage is 10%. Our other partners are Dominion Resources, who will construct and operate the pipeline, Duke Energy; and AGL Resources. In addition to our proportional cost of the project, we intend to make a $190 million utility capital investment in order to re-deliver ACP gas supplies to local North Carolina markets. ACP made its FERC pre-filing request in October 2014. Our targeted in-service date for ACP is November 2018. Constitution pipeline is an interstate natural gas pipeline that will connect natural gas supplies and gathering systems in Susquehanna County, Pennsylvania to the Iroquois Gas Transmission and Tennessee gas pipeline systems in New York. Williams is the project operator and is a joint venture partner, along with Cabot and WGL. We owned 24% of the pipeline, which is estimated in total to cost $730 million. We received the FERC 7(c) certificate for Constitution in early December 2014 and later in the month we received a notice of complete application from the New York Department of Environmental Conservation. Our targeted in-service date is late 2015 or 2016. In conclusion, 2014 was a very good year for our company. We invested in and delivered substantial earnings growth for our shareholders, executed our regulatory strategy to achieve a fair return on invested capital and reduce regulatory lag, and pursued both utility and complementary joint venture opportunities. I am extremely proud of our nearly 1,900 dedicated and talented employees and want to thank them all for their good work during the course of the year. And with that, I will turn the call over to our Senior Vice President and Chief Financial Officer, Karl Newlin. Karl Newlin Thank you, Tom, and good morning, everyone. As Tom mentioned, we had a good year in 2014, with net income of $144 million and diluted earnings per share of $1.84. Before we get into the details of the income statement, let me touch on our utility capital expenditures and joint venture contributions found on slide 7. In 2014, we invested $515 million in support of customer growth, system integrity programs, and joint venture opportunities. Capital expenditures related to customer growth and system integrity are shown in the blue and red bars respectively. The purple bar represents contributions made to our joint ventures, which in 2014 included investments for the Constitution Pipeline project. In 2015 and 2016, our forecasted joint venture contributions are for both the Constitution and the Atlantic Coast Pipeline projects. And in 2017, the forecasted contribution is only for the Atlantic Coast Pipeline project. As we noted in the 10-K, the partners of ACP intend to seek project financing for 70% of the construction cost and so the amounts shown here only represent our portion of the remaining 30%. We have added light blue bars in 2016 and 2017, which represent utility CapEx under our Atlantic Coast Pipeline redelivery contracts. These expenditures will be supported by long-term contracts and will not be subject to rate cases for recovery of and on these investments. Of the $190 million in utility capital expenditures we plan to invest associated with the redelivery of ACP volumes to North Carolina markets, $170 million will be supported by such contracts, the majority of which will be invested in 2018. Finally, during the second quarter we announced a new power generation delivery project for Duke Energy to serve the W.S. Lee facility in South Carolina, represented by the green bars, in 2015 and 2016. Our contract with Duke was approved by the Public Service Commission of South Carolina in June and we are targeting a May 2017 in-service state. As you can see, with the utility capital expenditure and joint venture contribution program totaling more than $600 million in 2015, 2016, and 2017, we are continuing to make significant investments in the growth of the company. Moving to slide 8, margin of $690 million in 2014 was 11% higher than in 2013. Nearly half of the increase was from customer growth, the full year impact of new rates for residential and commercial customers in North Carolina and Tennessee, and overall colder weather. The remainder was attributable to increased transportation services under new power generation contracts placed into service and secondary market activity. On the expense side, slide nine, O&M of $271 million was 7% higher than last year, primarily due to colder weather across our service territory. As a result of the colder weather, payroll, bad debt expense and contract labor were higher than both last year and our operating plan expectations. In addition, regulatory expenses increased due to amortization changes under the North Carolina rate case. Slide 10 shows depreciation expense of $119 million and general taxes of $37 million, which were 6% and 8% higher than last year respectively. The increase in depreciation was due to increased planned service and related mostly to power generation projects and investments in system integrity programs. Our general taxes were a result of increases in property and franchise taxes. On slide 11, income from joint ventures was $33 million in 2014, 26% higher than last year. So growth was due to increased contributions from SouthStar, primarily due to the new Illinois customer base, as well as higher customer usage as a result of colder weather. In addition, AFUDC from Constitution Pipeline also added to joint venture contributions. Turning to slide 12, interest expense of $55 million was 119% higher than in 2013. This was the result of lower AFUDC interest income, higher amounts due to customers, and higher long-term debt interest expense from new issuances in both 2013 and 2014. As I mentioned, full year diluted EPS came in at $1.84, which is below our revised 2014 guidance of a top half of $1.80 to $1.90. This was the result of three items that occurred during the fourth quarter. First, last year we filed with the TRA to recover $3.7 million in prior period uncollected gas costs. We ultimately settled with the TRA staff to recover $2 million of those costs and we wrote off the $1.7 million difference. Second, the year end stock price of $38 caused us to accrue additional incentive expense for future equity awards. And finally, AFUDC came in lower than projected for the fourth quarter. Lastly, on slide 13 we’ve outlined the assumptions underlying our 2015 earnings guidance of $1.82 to $1.92 per diluted share that we issued in November 2014 and reaffirmed in our December earnings release. Our margin assumptions include customer growth of approximately 1.6%, the expected impact of Integrity Management Riders in North Carolina and Tennessee, the full year impact of the 2013 North Carolina rate case that went into effect last January, lower wholesale secondary marketing margin due to normal weather, and a reduction in margin in South Carolina under the annual rate stabilization adjustments. We expect O&M to be up less than 2% from 2014 results. We expect to realize increased joint venture contributions due to AFUDC from the Constitution and the Atlantic Coast Pipeline projects and have higher interest expense due primarily to the $250 million in long-term debt we issued last September. The guidance also assumes higher depreciation due to additional planned service and approximately $13 million in utility AFUDC. On the financing side, we plan to issue both new long-term debt and equity in 2015 to maintain our targeted leverage ratio of 50% to 60%. As outlined in our 10-K, we intend to issue up to $170 million through an at the market equity program that will run through fiscal year end 2016. This program will supplement the other equity programs we already have in place. I thank you and we will now turn the call back over to Nick to take any questions. Nick Giaimo Thank you, Karl. Jamie, we are now ready to open the call for questions. Question-and-Answer Session Operator Thank you. [Operator Instructions] And we’ll now take our first question from Chris Turnure with JPMorgan. Please go ahead. Chris Turnure Good morning, guys. Tom Skains Good morning, Turnure… Chris Turnure Happy New Year. Can we get a little bit more color on the CapEx table in terms of JV contributions? Could you give us a breakout of how much is going to Constitution and how much is going to ACP in 2015 through 2016? Karl Newlin Yes. Chris, I don’t have that breakdown right in front of me, but I’ll tell you the bulk of that is going to be for Constitution. Given that they got their 2017 certificate and were waiting on some finalization of approval from New York. I would expect with the turning of dirt and construction beginning most of the expenditures are going to be for Constitution. ACP continues to go through its pre-filing process. And so, again, most of the dollars are going to go towards construction at Constitution. Chris Turnure Okay. And then, you said on the ACP utility CapEx, the balance, what’s not spent in 2016 and 2017, is probably all going to be spent in 2018? Tom Skains Yes, that’s right. So you are alluding to the $190 million of utility CapEx that goes to support three delivery contracts under ACP. That’s correct. And the bulk of that will be spent in 2018. Chris Turnure Okay. And then, is there any extra color that you could give us around the equity issuance that you announced in the 10-K? Will that be sufficient to cover your needs through 2016, at least? Tom Skains We anticipate that it will be sufficient to cover our needs through 2016. The at-the-market, or some people call them a dribble program, allows us that ability to issue into the market over the next two years and to be somewhat opportunistic with the timing and the price at which we issue the shares. In addition, I would remind people that we have a DRIP program, a dividend reinvestment program that adds about $27 million a year in equity as well. So that’s an additional $54 million over the next two years. So between that and the dribble or the at-the-market program, we do think that it’s sufficient. If we were to encounter a need for additional capital expenditures or additional opportunities, we could always avail ourselves of a regular marketed offering on top of that. But currently, the $170 million as outlined in the 10-K we deem to be sufficient. Chris Turnure Okay. And then switching gears to customer growth, it looks like you guys are anticipating a little bit of a higher rate than you originally anticipated last year. So the 2015 number is going to be higher than the original 2014 number. But kind of where is that coming from? Is there any change in the anticipated mix there? And then, specifically on residential conversions, are those people converting from oil or are they converting from some other source? Franklin Yoho Chris, this is Frank Yoho. We, like you said, continue to see pretty strong progress and mostly in the residential new construction market. And we’re seeing that across all three states, very consistent across all three states the growth there. And the big growing area is the residential new construction. Commercial is firming up. It continues to do well. And in the conversion market, you mostly see propane and fuel oil. You may see a little bit of electric here and there, but as the preponderance of it is fuel oil and propane. Chris Turnure Okay, great. That’s helpful. Thanks, guys. Operator We’ll take our next question from Joe Zoe with Avon Capital Advisors. Please go ahead. Andy Levi Hi. It’s Andy Levi. How are you? Tom Skains Good morning. Karl Newlin Good morning, Andy Andy Levi Happy New Year to you guys. Karl Newlin Happy New Year. Andy Levi Just a couple of quick questions. Is there like a weather versus normal for 2014 in earnings per share that you can give us? Karl Newlin It’s Karl. I won’t give an exact earnings per share. But you are right; we had a lot of things that happened because of the weather. So as you look to try and normalize it, I mean, there’s just a few things I would point out. To weather adjust, I don’t [ph] remove the incremental margin results that accrued from the wholesale marketing activity, and to normalize that, if you look just at our secondary market activity over and above the results from 2013, I would say those resulted from the weather. And also normalize SouthStar for weather, so to remove kind of the margin component of it. On the expense side, we had some higher O&M that would not have occurred without the weather, namely, over time, some higher bad debt accruals and specific contract labor in our call centers, as well as the incentive compensation accruals. And again, for normalization, I think you can look at prior year results for that. And then, in addition, we also had some one-time items on the expense side that affected the results that should not recur. We had a $2 million write-off of an investment we held at cost and then we also took the $1.7 million write-off for prior-year deferred gas costs in Tennessee that I mentioned in the prepared results. So netting all that out, removing some of the margin, adjusting the expenses, and adding back the one-time items, I would point back to our original earnings per share guidance range in 2014 of $1.73 to $1.83, again in 2014, and I think our results would have come in probably somewhere in the upper half of that range. Andy Levi Got it, okay. And then – so the $2 million and the $1.7 million, if you kind of strip that out, right, because you said that’s kind of one time, and then… Karl Newlin Yes, add it back. Andy Levi Right, right, and then you had higher – so that would be not including the $1.73 to $1.83, obviously. And then, O&M less the weather or whatever it is, I guess what you are saying is go to like the midpoint of the range or something like that and that would kind of give us our weather effect? Tom Skains Yes. I mean, our – at the time when we gave guidance for 2014, we gave a 3% increase in O&M. So that was our expectations going in. So you could take the 2012 number, add the 3% growth, and that would be kind of your normalized O&M for normal weather. Andy Levi Okay. And then on SouthStar, just remind me because I don’t know the answer. I probably should. But they don’t have any – there’s no volatility relative to commodity prices, right? It’s all just purely volume that you would benefit or not benefit from? Tom Skains Yes. They definitely benefit from colder weather. They can be exposed to the commodity, but they do a very nice job of locking in the contracts and trying to hedge against the weather as well. It’s mainly – it is, it’s a retail customer business and they would benefit from additional cold weather usage, as well as additional customer count. Andy Levi And they only deal in natural gas, right, not in any other… Tom Skains That’s correct. It’s only natural gas, and retail marketing. Andy Levi And how much – do you know how much was the incremental bad debt expense for 2014? I mean, I know that it was kind of part of the stuff that you were talking about as the pluses and minuses, but just on the bad debt, do you know how much – relative to normal, I guess? Karl Newlin It was about $2 million, and that’s pretty common for when you have a period of… Andy Levi Yes. Karl Newlin Colder than expected weather. Andy Levi Okay. And then the last question, just around the equity, is the $54 million which is your, I don’t know, DRIP or ESOP or your plans, whatever, is that a part of the 170 or is that incremental to the 170? Karl Newlin Incremental. Andy Levi And you don’t give a share count or anything, like what the average share count should be for… Tom Skains No, we don’t. But we give guidance on a diluted EPS range. So hopefully between our share count today, kind of the numbers we’ve been talking about and the equity issuance, you can back into what you think a fully diluted share count would be. Andy Levi And beyond the blackout periods for the dribble, which I guess are probably around earnings and things like that, are there any type of – like on a stock buyback, there’s a percent of the volume that you can do on a daily basis. Is there anything like that on the dribble? Karl Newlin Yes. There’s a number of limitations on an at-the-market program. You mentioned the blackout dates; as well, there’s volume considerations around it, so. Andy Levi Do you know what those volume considerations are? Karl Newlin I do not know what those are. But, again, we anticipate the $170 million to be adequate for what we’re looking to do over the next two years. Andy Levi Okay. And I guess, that we should kind of – just kind of evenly kind of spread it out, or do you think it’s more weighted towards 2015, the 170… Karl Newlin One of the nice advantages of that program is we can be opportunistic in the marketplace over the next couple of years with it. But from a modeling standpoint, I think it’s safe to assume you just take that and divide it by two. Andy Levi Got it. Okay. Thank you very, very much. Karl Newlin Sure. Operator [Operator Instructions] And we’ll take our next question from Spencer Joyce with Hilliard Lyons. Please go ahead. Spencer Joyce How are you guys? Happy New Year. Karl Newlin Happy New Year. Tom Skains Hi, Spencer. How are you? Spencer Joyce All right, doing well. Thanks for asking. Perhaps, Karl, just a quick one here. I wanted to go back to slide 6 where you all outlined the $26.6 million ask on the North Carolina IMR. And I know it’s tough to kind of project forward your regulatory proceedings. But just based on where the system integrity CapEx budget is, particularly for this year, I would assume our filing at this point next year would be somewhere similar to that number. Is that a pretty fair general assessment? Karl Newlin I think that’s a fair assessment. Spencer Joyce Okay. And then, perhaps secondarily, I’ve noticed a general upward trend in the utility CapEx budget just here over the past few quarters. Have you seen perhaps a more robust organic outlook for the utility, or is that really more of a natural function of just being a little closer to the timing of this trend and having a little better handle on where you may want to put some capital dollars? Tom Skains Yes. Well, two answers to that. I mean, as with any projections, you are closer to the actual spend date; your estimates are going to be more accurate. So you are right. As you look kind of two, three, four years out, the numbers are going to shift around a little bit just because it’s difficult to predict further into the future. And secondly, the increase in the utility CapEx is really driven around the two things that are highlighted in the two bars. I mean, it’s one; Frank Yoho outlined the customer growth expectations that we have. And as you have more customer growth, you necessarily will have more capital expenditures for the customer growth side. And on the system integrity, we continue to have a robust program to invest in the security and safety of our system, and that program continues. So I think you are seeing just those two trends continue in our CapEx projections. Spencer Joyce Fantastic. Thanks for the color. Karl Newlin Yes. Spencer Joyce That’s all I had. Nice year. Tom Skains Thank you. Operator And there are no further questions in queue at this time. I’d like to turn the conference back to our presenters for any additional or closing remarks. End of Q&A Nick Giaimo Thank you, Jamie. This concludes our year end 2014 earnings conference call. Thank you all for joining us this morning. Operator And that does conclude today’s conference. Thank you for your participation.