Northwest Natural Company - Earnings Call - Q3 2020

Transcript

Operator (participant)

Good morning and welcome to the NW Natural Third Quarter 2020 Earnings Conference Call. All participants are in listen-only mode. Should you need assistance, please signal a conference specialist by pressing the star key followed by zero. After today's presentation, there will be an opportunity to ask questions. Please note this event is being recorded. I would now like to turn the conference over to Nikki Sparley. Please go ahead.

Nikki Sparley (Director of Investor Relations)

Thank you, Emily. Good morning and welcome to our third quarter 2020 earnings call. As a reminder, some of the things that will be said this morning contain forward-looking statements. They're based on management's assumptions, which may or may not occur. In addition, some of our comments today reference non-GAAP adjusted measures. For a complete reconciliation of these measures and other cautionary statements, please refer to the language and reconciliation at the end of our press release. We expect to file our 10-Q later today. As mentioned, this teleconference is being recorded and will be available on our website following the call. Please note these calls are designed for the financial community. If you are an investor and have additional questions after the call, you may contact me directly at 503-721-2530. News media may contact Melissa Moore at 503-220-2436.

Speaking this morning are David Anderson, President and Chief Executive Officer, and Frank Burkhartsmeyer, Senior Vice President and Chief Financial Officer. David and Frank have prepared remarks and then will be available along with other members of our executive team to answer your questions. With that, I will turn it over to David.

David Anderson (President and CEO)

Thanks, Nikki, and good morning and welcome. I hope this call finds you safe and well. Like all of you, we continue to navigate these unusual times. In addition to COVID, in September, Oregon dealt with wildfires. Our gas system was resilient and minimally impacted, but as with any event, we took proactive steps to ensure the safety of our customers and coordinated closely with fire commanders. I personally want to thank all of our employees for their hard work here and, of course, the first responders for all of their efforts during those unusual times. Moving to a few economic updates, it is important to remember where we stood in February before the pandemic started. At that time, we had a fundamentally sound, sustainable, growing economy with record-low unemployment, both nationally and in our service territories.

As discussed in previous earnings calls, COVID impacts affected the Northwest like the rest of the country, but we've seen some economic improvement in recent months. For example, Oregon's unemployment rate was 8% in September, essentially matching the national rate. That's down from a 14.9% high in April. Job growth in Oregon bounced back to positive territory in the second quarter of this year and has sustained an upward climb through September. In the Portland metro region, year-to-date closed home sales were up 3.1% from 2019, with stronger year-over-year price growth of about 10%. New single-family permits issued this year are close to where we were in 2019. That's much better than what was generally expected this spring. As a result, we have connected over 13,800 meters during the last 12 months ended September 30th, and that's 300 more meters than we added this time last year.

Our overall customer growth rate is 1.9% for the 12 months ended September and reflects a lower level of customers disconnecting from our system during the pandemic. As we resume normal disconnection practices, we will likely see this growth rate decrease a little bit. Despite the positive trends, we know these are difficult times for some customers. That's why we voluntarily suspended normal collection processes and disconnections in March. Since the pandemic began, we've been working with the commissions, staff, and stakeholders in all of our states to determine the best way to return to more normal operating practices. The last couple of months, commissions in all of our states have finalized their timelines that allow utilities to resume normal operations. Additionally, the Oregon, Texas, and Idaho commissions have approved deferral applications.

On the regulatory front, an order was issued in our Oregon general rate case in October approving our previously disclosed all-party settlement. The order includes a $45.1 million increase in our revenues requirement based on the 50/50 cap structure, a return of equity of 9.4%, and a cost of capital just under 7%. In addition, the order reflects average rate base of $1.44 billion for an increase of $242 million compared to the last rate case. Somebody's on the phone needs to mute, please. New rates took effect November 1st and were largely offset by reduced gas costs from our PGA filing. In Oregon, the combined effect of the rate case and annual purchase gas adjustment resulted in a $2 increase to a residential customer's monthly bill. Overall, gas bills continue to remain low.

Northwest Natural customers are paying about 30% or, excuse me, 40% less today for their bills than they did 15 years ago. In addition, in June, we passed back a record $17 million in storage bill credits to Oregon gas customers. I'm proud to report that continuing our legacy of service, customers ranked Northwest Natural second in the West among large utilities in the 2020 J.D. Power residential customer satisfaction study. These results are a testament to our customer-centric culture, and it's especially gratifying to see customers recognize our employees and company during this challenging year. Finally, this morning, I'm pleased to report that in the fourth quarter, the board approved the dividend increase, making this the 65th consecutive year of annual dividend increases. Our annual dividend amount is now $1.92 per share.

We're proud to be one of the only three companies on the New York Stock Exchange with this long record. With that, let me turn it over to Frank to get a little bit more details of the financials. Frank?

Frank Burkhartsmeyer (Senior VP and CFO)

Thank you, David, and good morning, everyone. I will begin by discussing the financial impacts of COVID-19 and the highlights of the third quarter and year-to-date results and conclude with guidance for 2020. As David noted, the Oregon commission recently approved a COVID-19 term sheet that outlines the types of revenues and costs that may be recovered. These include PPE, bad debt expense, financing costs associated with additional liquidity, and certain lost revenues. Direct expense reductions, such as lower travel and meals and entertainment, are to be netted against the deferral. Prudency review and recovery of the deferral accounts will be determined in a future proceeding. While our business model is resilient, we are experiencing some financial impacts related to the pandemic. Through September 30th, we have incurred an estimated $7 million of incremental costs and lower revenue.

In the third quarter, we recognize a $3.1 million regulatory asset for Oregon costs incurred to date. Utilities are also allowed to recover late fee revenue that has not been charged to customers since the suspension of normal collection processes. However, this revenue will be recognized in a future period when we begin to recover the foregone fees through rates. At the end of September, this revenue totaled approximately $1 million. In summary, of the $7 million of total financial impact as of September 30th, we expect to recover $4.4 million through rates under these orders, with $3.1 million deferred in the third quarter. In addition to these deferrals, in order to further mitigate the financial effects of the pandemic, we initiated temporary cost savings measures, which provided approximately $2 million of savings for the third quarter and year-to-date.

Switching now to our detailed financial results, I'll describe earnings drivers on an after-tax basis using the statutory tax rate of 26.5%. The return of excess deferred income taxes to our Oregon customers resulted in an effective tax rate of 22.3%. Also note that year-to-date earnings per share comparisons were impacted by the issuance of $1.4 million shares in June 2019 as we raised equity to fund investment in our gas utility. As a reminder, Northwest Natural's earnings are seasonal, with a majority of revenues generated in the first and fourth quarters during the winter heating season. For the quarter, we reported a net loss from continuing operations of $18.7 million or $0.61 per share, compared to a net loss of $18.5 million or $0.61 per share for the same period in 2019.

The gas utility posted a decline of $0.08 per share related to higher depreciation and general tax expense, partially offset by the recognition of the regulatory deferral asset for COVID-19, which I discussed earlier. This decline in the gas utility was offset by an increased contribution from our water business as we acquired assets in Washington and Texas and lower expenses at the holding company. In the gas distribution segment, utility margin declined $300,000, as the benefit of customer growth and higher rates in Washington was slightly more than offset by a decrease in revenues from late charges and reconnection fees and slightly lower usage from the industrial and large commercial customers that are not decoupled. Utility O&M increased $700,000 in the quarter as we incurred higher compensation and non-payroll expenses, partially offset by the cost savings measures and deferral of expenses related to COVID-19.

Depreciation expense and general taxes increased $2.4 million related to ongoing investment in our system. Finally, interest expense for the quarter decreased $1.2 million as we deferred interest incurred to increase cash balances in March. For the first nine months of 2020, we reported net income from continuing operations of $24.5 million or $0.80 per share, compared to net income of $27 million or $0.91 per share for the same period last year. Last year's results included a regulatory disallowance of $0.22 per share related to an Oregon commission order. Excluding that disallowance, on an adjusted non-GAAP basis, earnings per share from continuing operations was $1.13 for 2019. The $0.33 per share decline is largely due to year-over-year growth in expenses and the effects of COVID. In the gas distribution segment, utility margin declined $100,000.

Higher customer rates in Washington, customer growth, and revenues from the North Mist Expansion Project contributed an additional $10.4 million. This was offset by lower entitlement and curtailment fees related to pipeline constraints in 2019 and warmer weather in the first quarter of 2020 compared to the prior year, which collectively reduced margin by $4.8 million. Utility margin also declined $1.1 million due to lower revenue from late and reconnection fees as we suspended normal collection processes. The remaining $5.2 million decline in utility margin is the result of the March 2019 Oregon order related to tax reform and pension expense. With the exception of the first quarter pension disallowance, this order has no impact on net income, as offsetting adjustments were recognized through expenses and income taxes, as I'll describe. Utility O&M and other expenses declined $6.4 million during the first nine months of 2020.

This decrease is associated with the Oregon order, which resulted in $14 million of additional expense in the first quarter of last year, as previously discussed. This was offset by a $6.4 million increase in underlying O&M related to higher compensation costs, contractor and professional service, as well as moving costs for our new headquarters and operations center. This was partially offset by cost savings measures, as I described earlier. Over the last several years, we have invested in our gas system at historically high levels, and we've placed the North Mist gas storage facility into service. As a result, depreciation expense and general taxes increased $7.3 million. Finally, utility segment tax expense in 2019 included a $5.9 million benefit related to the implementation of the March order, with no significant resulting effect on net income.

Net income from our other businesses increased $900,000 from higher earnings from our water and wastewater utilities and lower expenses at our holding company, partially offset by lower asset management revenues. A few notes on cash flow. For the first nine months of 2020, the company generated $149 million in operating cash flow. We invested $227 million into the business, with $193 million of primarily gas utility capital expenditures and $38 million for water acquisitions. We continue to expect capital expenditures this year to be in the range of $240 million-$280 million. Our balance sheet remains strong with ample liquidity. Now, regarding the ongoing financial effects of COVID-19, in summary, third quarter results are in line with our expectations, and we have clarity regarding the recovery of costs in Oregon and late fee revenues.

Going into the heating season, 96% of our commercial and industrial customers are current with their bills. Nonetheless, we know that some categories of commercial customers have been negatively impacted, and we continue to closely monitor usage levels and commercial customer losses. We will also continue to pursue the cost savings measures underway to mitigate these circumstances. Today, we reaffirm guidance for continuing operations in the range of $2.25-$2.45 per share and guided toward the lower end of the range due to the potential implications from COVID-19. Guidance also assumes continued customer growth, average weather conditions, and no significant changes in prevailing regulatory policies, mechanisms, or outcomes or significant laws, legislation, or regulations. Finally, this guidance excludes any gain related to the sale of Gill Ranch and associated operating results. These items are reported in discontinued operations.

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

David Anderson (President and CEO)

Thanks, Frank. While the year has held many challenges, we've persevered and accomplished many important things in terms of customer service, safety, and mitigating the pandemic effects. At the same time, we're also advancing key long-term objectives. That includes aggressively pursuing a renewable future and a carbon-neutral vision for our gas utility by 2050. Today, with no cast iron or bare steel, we have one of the tightest systems in the country. We use that tight system to deliver more energy in Oregon than any other utility each year. In fact, the existing gas system has provided nearly twice as much energy on a peak heating day as the electric system. Yet, the use of natural gas in our customers' homes and businesses accounts for just 6% of Oregon's greenhouse gas emissions annually. That's a very efficient delivery of a lot of energy.

We know we could do better, which is why we established a voluntary carbon savings goal of 30% by 2035 for emissions from our own operations and our sales customers' usage. Two years in, I'm pleased to report we're on track to meet or exceed this goal. In 2019, we achieved 21% of the savings needed to meet this goal. That's equivalent to removing over 60,000 cars from the road. So far, savings have come from three main areas. First, energy efficiency is the fastest and cheapest way to reduce emissions, and a long-standing priority for Northwest Natural. Back in 2002, we were one of the first gas utilities in the country to obtain a decoupling mechanism, which supports the energy efficiency move. Second, our carbon offset program also plays a vital role and was a strong contributor to the savings.

In 2007, Northwest Natural was the first standalone gas utility in the country to offer customers a voluntary program that allows them to offset some or all of their carbon emissions from natural gas use. Finally, we have also harvested carbon savings from implementing emission screening tools for our gas purchases. We believe we are the first gas utility to use EPA data to calculate the relative emissions intensity of gas producer operations. We use that information to prioritize purchases from the most responsible producers. Now, several years into our carbon goal, we see more ambitious savings are possible. We understand more about RNG and hydrogen today, and we now have policy support with the groundbreaking Senate Bill 98 in Oregon. We also have the advantage of seasonal storage with one of the only storage facilities in the Pacific Northwest.

Conventional natural gas storage is very valuable in our area, and it can be used for renewable molecules in the future. In fact, at 20 billion cu ft, our Mist underground storage facility is equivalent to about 6 million megawatt hours of electricity storage. That is about a $2 trillion battery at today's prices and many times larger than the biggest lithium battery in the world. What we in the industry need, however, now is continued policy support to help get these renewable solutions to scale. We are certainly not alone in our thinking about the future role of the gas system and how to leverage all of its advantages in new ways. We are having these discussions with peers here in the United States, and there is a much bigger focus on RNG and hydrogen coming out of Europe and Canada as well.

I'm excited about the recent steps Northwest Natural has already taken. We have several viable contracts we're pursuing as a result of the RFP we issued in July for renewable natural gas. In October, we signed an MOU to explore development of a renewable hydrogen facility. The collaborative includes an electric utility in our region and the Bonneville Environmental Foundation. Another long-term objective is growing our water and wastewater utility businesses. Although our acquisition pace is slow due to the pandemic, we continue to see good growth and investments in our existing platform. We continue making contacts in the industry and are working hard to expand our footprint. I remain excited about the investment potential for this business. None of this work is easy, and there are no shortcuts. Each year we set goals, we make strides, and we move closer to achieving our vision.

Again, thanks for joining us this morning. With that, Emily, we'll open it up for questions.

Operator (participant)

We will now begin the question and answer session. To ask a question, you may press star then one on your touch-tone phone. If you are using a speakerphone, please pick up your headset before pressing the keys. To withdraw your question, please press star then two. At this time, we will pause momentarily to assemble our roster. Our first question comes from Richard Selly at Bank of America. Please go ahead.

David Anderson (President and CEO)

Morning, Richard.

Hey, guys. This is actually Harry on for Richard. Thanks for taking our question. Starting off, you talked about higher earnings from your water utilities and 3Q contributing to the quarter, and your other segment increased by $0.08 year-over-year. Can you provide some more details around the earnings composition of that other segment and as it pertains to your water utilities? Over the longer term, do you think we could see the water utility potentially growing faster than the gas LDC business?

Frank Burkhartsmeyer (Senior VP and CFO)

Thanks, Richard.

Harry.

Harry, sorry, it's Frank here. Yeah, of course, we don't yet break out the water utility segment as a standalone, and you have some of the optimization and holding company costs in there. The primary driver quarter over quarter was the acquisition of the additional Washington and Texas assets that we announced earlier. That was the driver. I think that we haven't announced any more acquisitions from that point. What you're seeing there year to date is a pretty good representation of what's going on. Third quarter is a good quarter for the water business. It's a high usage period. The year-to-date number in there is representative, I think. There has been a little bit of softening year over year on some of the optimization as well.

Because business development costs kind of can go up and down depending on the level of activities, you'll see a little bit of volatility in there.

David Anderson (President and CEO)

Harry, the only thing I'll add to that is one of the things that the thesis on our water is proving out is that once we've acquired these assets, we are finding, number one, a lot of them do have good solid growth underlying it. Number two is we are seeing additional investment opportunity. We've kind of laid that out in our IR deck. The rate-based growth is proving to be beneficial. To your point about earnings growth going forward, we're seeing it be in a very nice match to our underlying gas utility that continues to have good investment opportunity overall. The thesis is playing out as we had hoped along that front.

Got it. That's nice to hear. I guess turning back to your gas utility, being about a month or so into 4Q, how are things trending into the peak winter heating season in the face of COVID here? It'll be a critical quarter for you guys, obviously, to execute guidance. Just any update on trends heading into winter heating season would be helpful.

Yeah. I mean, obviously, like all the country, we're experiencing the COVID effects. And so there are some businesses and customers that are having trouble. That's the good news of the commission working through the various term sheets on how we get back to normal over a period of time, which most of that will occur in the first quarter. We continue to watch things closely, but we are getting into the winter heating season for us, which is important. The good news is the rate case is done. Our PGA is done so that all of that is in place, which is a driver for some of those results. Of course, weather will be, even though we're weather normalized in most of our territory, there's still an impact from weather usage there. It seems to be, again, we've seen some impacts from COVID.

I think more we'll have to watch very carefully. It also, I think it's real critical to see what happens at the national level, whether we have a stimulus program that comes out of Congress like we did with the first one that greatly helped businesses and individuals. Harry, it's kind of going along to what we've seen on plan that we've seen some customers obviously having trouble. As we continue and we're still seeing the housing market being, frankly, fairly strong, it's just interesting. I don't know if that directly answers your question, but I think we're about as well prepared as we possibly can be.

Got it. Now, that makes sense. If I could sneak in one more, you touched on the RNG RFP that you issued. Just any update there on how discussions are trending. Does this relate to the renewable hydrogen project you talked about in the press release this morning?

Let me have Kim Heiting, one of our Senior VPs, tackle the hydrogen. Then Justin Palfreyman's on the phone. I'll have him give a little bit of an update on the RNG RFP. Kim?

Kim Heiting (Senior VP)

Yeah, good morning. Yeah. We recently announced our Eugene project with Eugene Water and Electric Board and Bonneville Environmental Foundation, as David mentioned. This is really an exciting demonstration project. We're hoping it can be up to a 10 MW project. The plan is to use excess renewables from EWEB's portfolio. Our portion of the project would be to use waste CO2 from some local industrials to methanate that renewable hydrogen and then flow it into our system. We're viewing this as an important part of our evolution around hydrogen. We're still seeking partners, but we have a site selected. We've put together a technical team. They're starting on their plan for the project. In parallel to that, we have a team out at our training center doing some pure hydrogen blending work, blending up to 5% into sort of an isolated system that we've created.

We're really pleased with the testing so far. Going into this year, we're going to be testing the 5% blend on some end-use equipment at that facility. Between the Eugene project and some of our own hydrogen blending testing, we're very excited about where all of this is evolving, and we're watching what's going on in Europe and Canada very closely. I'll turn it over to Justin to maybe touch on the status of the RFP.

Justin Palfreyman (Senior VP of Strategy and Business Development)

Yeah. Thanks, Harry. The RFP was we received a robust response to our RFP back in September. It's a little too early to announce exactly where that's going to head as we continue to conduct due diligence on some of the responses we receive and negotiate agreements. We do expect that it will result in some contracts that we execute for renewable natural gas. In parallel with that, we continue to evaluate investment opportunities through SB 98 to invest directly in renewable natural gas projects. We expect over time, we'll end up with a portfolio of some renewable gas purchase agreements and then some direct investments that we make into renewable natural gas. I think your question around whether or not the hydrogen project was separate or related to our RNG RFP, they are two separate projects.

They are related only in that they both will have a meaningful impact on our carbon savings goal. They are two separate projects and work streams within the company.

Got it. That's all I have. Thank you, guys.

David Anderson (President and CEO)

Thanks, Richard. It looks like there's no more questions in the queue, Emily. We'll go ahead and shut it down here. I know everybody's really busy and watching election results and getting ready for other conferences. Really want to thank you for joining us today. If you do have follow-up questions, please reach out to Nikki. As she indicated, she'll be happy to go into additional details to help you understand the quarter and the year to date. With that, Emily, we'll close the call down. Everybody, please be safe. Again, thank you for your time today.

Operator (participant)

This conference has now concluded. Thank you for attending today's presentation. You may now disconnect.