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Unitil Corp  (NYSE:UTL)
Q4 2018 Earnings Conference Call
Jan. 31, 2019, 2:00 p.m. ET


Prepared Remarks:


Good day, ladies and gentlemen, and welcome to the Q4 2018 Unitil Earnings Conference Call. (Operator Instructions) As a reminder, today's conference is being recorded. I would now like to turn the call over to Todd Diggins, Director of Finance. Sir, please begin.

Todd Diggins -- Director, Finance

Good afternoon and thank you for joining us to discuss Unitil Corporation's fourth quarter 2018 financial results. With me today are Tom Meissner, Chairman, President and Chief Executive Officer; Mark Collin, Senior Vice President, Chief Financial Officer and Treasurer; Christine Vaughan, Senior Vice President of Financial and Regulatory Services, Larry Brock, Chief Accounting Officer and Controller and Todd Black, Senior Vice President, External Affairs and Customer Relations.

We will discuss financial and other information about our fourth quarter and year-to-date results on this call. As we mentioned in the press release announcing the call, we have posted that information including a presentation to the Investors section of our website at www.unitil.com. We will refer to that information during this call.

Before we start, as you see on Slide two, the comments made today about future operating results or future events are forward-looking statements under the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995. Forward-looking statements inherently involve risks and uncertainties that could cause our actual results to differ materially from those predicted.

Statements made on this call should be considered together with cautionary statements and other information contained in our most recent annual report on Form 10-K and other documents we have filed with or furnished to the Securities and Exchange Commission. Forward-looking statements speak only as of today, and we assume no duty to update them.

With that said, I'll now turn the call over to Tom.

Thomas P. Meissner -- Chairman, President & Chief Executive Officer

Thank you, Todd. And thanks everyone for joining us. Before I go over the results for the year, I want to take a moment to thank Mark Collin for his dedication and service to our Company over the past 30 years. Earlier this month, Mark formally announce his retirement effective May 1st 2019 Mark's leadership has helped transform Unitil into the successful Company that it is today. And while Mark will be greatly missed. I'm pleased that he is joining the Board, where he will continue to contribute to the success of our Company.

At the same time, I'm pleased to introduce the newest member of our executive team and planned successor to Mark as Chief Financial Officer and Treasurer, Christine Vaughan. Christine recently served as Vice President, Rates & Regulatory and Treasurer for Eversource Energy in Massachusetts, where she had been since 2004. in order to assure a smooth transition in this important role, Christine and Mark will work closely together over the next few months.

We're all excited to have Christine joining our team and we wish Mark all the best in his retirement.

Now I'll turn to our 2018 results beginning on Slide four. Today, we announced net income of $33 million or $2.23 per share for 2018. This represents an increase of $4 million or $0.17 per share compared to 2017. We had another solid year in 2018 as earnings per share increased over 8%. This increase in earnings was driven by higher sales margins reflecting customer growth favorable impacts of weather and new distribution rates.

Turning to Slide five, we've highlighted some of our recent successes. We are currently generating record earnings and in the past five years have outpaced both the broader market and our utility peers. In addition to strong financial results, we continue to focus on superior customer service and operational performance to ensure the safe and reliable delivery of natural gas and electricity.

Slide six highlights the substantial growth we've experienced in our service territories as well as future growth opportunities. In 2018, our natural gas customer base grew by 1.8%. We've been the fastest growing publicly traded investor-owned natural gas utility in New England over the past five years.

Our service areas continue to benefit from robust customer growth, with over $6.8 billion of new construction planned or under way in the next decade. This robust economic growth will generate significant growth opportunities for the Company in the years ahead.

Turning to Slide seven, we've provided a look at our historical and future capital spending program. In the next three years, the Company has abundant investment opportunities and will have notably higher capital expenditures than in the prior three years. Our capital budget for 2019 is projected to be $125 million, which is an increase of 22% compared to 2018.

Moving to Slide eight, I will focus on some of the investment opportunities we have in our service territories. On the gas side of the business, we have been actively investing in system expansion projects that have added approximately 110 miles of new distribution mains since 2013. In addition to expansion projects, we have a relatively low customer penetration of approximately 62% along our existing mains, which provides an opportunity for thousands of low cost customer conversions over time.

These customers are incentivized to convert to natural gas due to the significant price advantage and corresponding cost savings relative to higher cost fuel oil. As highlighted earlier, we also continue to see robust development activity in our service territories, which will translate into new customers for years to come as those projects are completed.

In New Hampshire, we recently received approval to expand our service area to the towns of Atkinson and Kingston. We are currently completing main extensions to reach anchor customers in those communities, plus, we expect to pick up additional customers along the route of those mains. A similar request is currently pending for Epping, New Hampshire and we expect to receive approval in the first half of 2019.

All of this is part of our ongoing growth plan sustained by strong customer demand to expand our footprint within and contiguous to our current service areas. In Maine, we completed our final year of the Saco Targeted Area Buildout or TAB program and to date have exceeded our initial target for new customer additions.

We also completed the first year of the Sanford TAB and installed almost 7 miles of new mains in the downtown, of that city. We've invested almost $12 million on these two projects , which represents a market potential of approximately 3,000 customers.

Turning to Slide nine, we continue our work to implement policy driven initiatives related to natural gas infrastructure replacement programs as well as electric grid modernization. Our New Hampshire gas infrastructure replacement program was completed in 2017, which fully modernized our gas infrastructure in that state. In Maine, our gas infrastructure replacement program is on schedule to be completed by 2024 while our Massachusetts program is slightly further out with anticipated completion in approximately 15 years. All of these programs have been supported by our regulators and we have established capital tracker recovery mechanisms in each state.

Turning to electric, there are significant trends in the industry to modernize the electric grid. Our regulators in both Massachusetts and New Hampshire support grid modernization initiatives for new investment in the electric distribution system. To give an idea of the scope of this investment. The current 10-year preliminary planned spend is $24 million in Massachusetts.

While the New Hampshire Plan is still under development, we estimate that it could be approximately $60 million if sized comparably to Massachusetts. We will continue to participate in the proceedings in both states and look forward to providing our customers with more reliable and a more modern grid. In addition to the capital trackers that I just mentioned, the Company expects to file for cost recovery of 2018 capital spending at both of our gas and electric utilities in New Hampshire.

These filings will be made in the first quarter of 2019 with rates expected to be effective in the second quarter of 2019.

Now I'll turn the call over to Mark Collin, who will discuss our financial results for the year.

Mark Collin -- Senior Vice President, Chief Financial Officer, Treasurer

Thanks, Tom. Good afternoon, everyone. As Tom illustrated, we had another great year in 2018 as the Company experienced significant earnings growth and operating achievements. We turn to Slide 10.

Natural gas sales margin increased 7.2 million compared to 2017. Gas sales margin in 2018 was positively affected by higher natural gas distribution rates of $7.1 million, which was partially offset by the reduction in rates of $3.7 million due to the recognition of lower corporate income tax rate of 21% under the new tax law.

In addition, gas margin in 2018 reflects the positive effect of colder winter weather and customer growth on sales volume of $3.8 million. As a reminder, the reduction in revenues related to the tax law changes also reflects a correspondingly lower and offsetting provision for income taxes in the period. Natural gas therm sales increased 8.1% in 2018 compared to 2017. The increase in gas therm sales in the Company's service areas was driven by customer growth and colder winter weather in 2018.

Based on weather data collected in the Company's natural gas service areas, there were 12% more heating degree days in 2018 compared to the prior year. As of December 31, 2018, the number of natural gas customers served has increased by 1,450 over last year.

Next on Slide 11, electric sales margin decreased $0.3 million compared to 2017. Electric sales margin in 2018 was positively affected by higher electric distribution rates of $2.9 million, partially offset by the reduction in rates of $2.6 million in the year due to the recognition of lower corporate income tax rate of 21% under the new tax law.

Electric sales margin in the current period was also positively affected by warmer than average summer temperatures and customer growth of $0.8 million. These positive impacts on electric sales margin were offset by the absence in the current period of a one-year $1.4 million temporary rate reconciliation adjustment recognized in 2017 revenue by the Company's New Hampshire electric utility. Again, I would like to point out that the reduction in revenues related to the tax law changes also reflects a lower and offsetting provision for income taxes in the period.

Total electric kilowatt hour sales increased 3.2% in 2018 compared to 2017 reflecting customer growth and warmer than average summer temperatures in '18. Based on weather data collected in the Company's service areas, there were 42% more cooling degree days in 2018 compared to 2017. As of December 31st, 2018, the number of electric customers served has increased by 593 over last year.

Turning to Slide 12, operation and maintenance expenses increased $5 million in 2018 compared to 2017, the change in O&M expense reflects higher labor costs of $1.8 million and higher utility operating costs of $4 million, partially offset by lower professional fees of $0.8 million. The higher utility operating costs include a non-recurring temporary rate adjustment to recognize costs previously deferred in 2017 resulted in an increase in O&M of $1.2 million in the second quarter of 2018 compared to the same period in 2017, which was offset by a corresponding increase in gas revenue.

Excluding this non-recurring adjustment, O&M expense was up $3.8 million year-over-year or 5.9%. The remaining increases in utility operating cost is a result of higher than normal operating expenses in some areas, including higher bad debts and storm-related cost. Depreciation and amortization expense increased $3.5 million in 2018 compared to prior year. These increases reflect higher utility plant in service and higher amortization of information technology costs, partially offset by lower amortization of deferred major storm costs, which are being amortized over multiyear periods. Taxes other than income taxes increased $1.3 million in 2018, primarily reflecting higher local property taxes on higher levels of utility plant in service and higher payroll taxes.

Interest expense net increased $0.9 million in 2018 compared to 2017, reflecting interest on higher short-term debt rates and higher levels of long-term debt. Lastly, income taxes decreased $9.1 million in 2018 compared to the prior year, reflecting $6.3 million from the lower tax rate on pre-tax earnings in 2018 and a current tax benefit of $2.8 million of book/tax temporary differences turning at the lower income tax rate in 2018.

Slide 13 provides the trailing 12-month actual earn return on equity in each of our regulatory jurisdictions. Unitil on a consolidated basis earned a total return on equity of 9.6% in the last 12 months ended December 31 2018, which is in line with our authorized return terms ranging from 9.5% to 9.8% across our regulatory jurisdictions.

As we have discussed in the past, these results are not weather-normalized. We have a constructive regulatory environment that is supportive of growth initiatives and investments to provide our customers with safe and reliable service. In addition, we have long-term rate plans and cost trackers established across nearly all our utility subsidiaries and are prepared to update and extend these programs through rate cases in other proceedings as appropriate.

In 2019, we anticipate approximately 4.5 million of capital tracker revenue to be awarded on a conservative basis. Historically, up to 50% of our capital expenditures have been recoverable through annual cost trackers, while an additional third is related to the expansion of our gas and electric distribution systems to achieve new customer growth.

Our rate plans, capital trackers and sustained customer growth will help to maintain a relatively stable and consistent level of earnings and a return on equity across our utility subsidiaries.

Slide 14, provides an update on our capitalization and long-term financings. We have strong investment grade ratings and strive to achieve a balanced long-term capital structure with a strong equity capitalization that is approximately 50% equity and 50% long-term debt at the utility level. In November of this past year, our New Hampshire-based electric utility entered into an agreement to issue and sell $30 million of 4.18% first mortgage bonds through a private placement marketing process to institutional investors.

The net proceeds from this offering were used for the redemption of higher cost long-term debt and the repayment of short-term debt. We are well positioned to lower our weighted average cost of capital by refinancing higher cost long-term debt over the next 5 years, as we plan to refinance over $80 million of maturing long-term debt. Now, this concludes the summary of our financial performance for the period. I will turn the call over to the operator who will coordinate questions.

Thank you.

Questions and Answers:


(Operator Instructions) And our first question comes from the line of Shelby Tucker. Your line is now open.

Shelby Tucker -- RBC Capital Markets -- Analyst

Great. Good afternoon, congratulations on a great quarter -- sorry, great year I should say. A question about the dividend, with the $2.23 you delivered this year and the -- about 1.4% increase that you announced yesterday, you're now around 65% payout ratio. Wondering what your thoughts are about dividend policy, now that you're more or less in line with your utility peers.

Thomas P. Meissner -- Chairman, President & Chief Executive Officer

Given our investment program and the impact on cash flow from the TCJA last year, we're currently targeting a payout ratio in a range of 55% to 65% now.

And I think we'll consider raises to the dividend, when we are solidly in that range.

Shelby Tucker -- RBC Capital Markets -- Analyst

Great. Thanks, Tom. And then maybe a question for Mark. -- actually, sorry, no for Tom -- for the team, if I think through your rate case strategy going forward. You are now in a unusual time where you don't have any live rate cases. How should we be thinking about where you need to define rate cases over the next two years?

Mark Collin -- Senior Vice President, Chief Financial Officer, Treasurer

Yeah, I think, Shelby, as we explained, we have kind of an ongoing rate case pattern through our trackers and rate plan, so that we do have the ability to continue to adjust our rates through more streamlined proceedings before the commission. And those are very valuable to us. Outside of that, what we do look at is basically where each of the entities are on their earnings profile and make projections in terms of their cost structure and such and then we'll file rate cases if rate relief is determined to be needed. I think the best thing is to look at the ROE chart that we provide and the information in the presentation. And you can see some of the things we're looking at and considering as we look forward. And we haven't filed any general base rate case at this time. But there is still time to do it this year and we'll certainly be looking at that and whether it's advisable or not.

Shelby Tucker -- RBC Capital Markets -- Analyst

Got it. And then a question that I have for you Mark, I don't recall hearing if you provided what your number would have been this year normalized for weather?

Mark Collin -- Senior Vice President, Chief Financial Officer, Treasurer

It's about of $0.10 -- weather is about a $0.10 impact.

Shelby Tucker -- RBC Capital Markets -- Analyst

Got it. Okay.

Mark Collin -- Senior Vice President, Chief Financial Officer, Treasurer

A favorable impact, both the summer and some winter, yes.

Shelby Tucker -- RBC Capital Markets -- Analyst

Okay, great. That's all the questions I have. Thank you very much.

Thomas P. Meissner -- Chairman, President & Chief Executive Officer

Thanks, Shelby.


(Operator Instructions) I'm not showing any further questions at this time. Ladies and gentlemen, thank you for participating in today's conference. This does conclude the program and you may all disconnect. Everyone have a wonderful day.

Duration: 21 minutes

Call participants:

Todd Diggins -- Director, Finance

Thomas P. Meissner -- Chairman, President & Chief Executive Officer

Mark Collin -- Senior Vice President, Chief Financial Officer, Treasurer

Shelby Tucker -- RBC Capital Markets -- Analyst

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