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Northwest Natural Holding Co (NYSE:NWN)
Q3 2019 Earnings Call
Nov 5, 2019, 11:00 a.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Good day, and welcome to the Northwest Natural Holding Company's Third Quarter 2019 Conference Call and Webcast. [Operator instructions] After today's presentation, there will be an opportunity to ask questions. [Operator Instructions]

I would now like to turn the conference over to Nikki Sparley, Director of Investor Relations. Please go ahead.

Nikki Sparley -- Director, Investor Relations

Thank you, Ben. Good morning, everyone, and welcome to our third quarter 2019 earnings call.

As a reminder, some of the things that will be said this morning contain forward-looking statements. They are 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, 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, please 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'll turn it over to David.

David H. Anderson -- President and Chief Executive Officer

Thanks, Nikki, and good morning, everyone.

The year continues to progress nicely, both in terms of financial results and in the execution of our long-term strategy. Our year-to-date results are strong, and position us nicely for a strong full-year financial results.

For the first nine months of the year, net income was $0.91 per share compared to $1.06 per share for the same period in 2018. As previously discussed, our first quarter results included a one-time regulatory pension disallowance of $0.22 per share related to an Oregon commission order. Excluding that disallowance, on an adjusted basis, net income increased $0.07 per share or $3 million to $33.6 million or $1.13 per share for the first nine months in 2019. These results reflect new rates in Oregon, North Mist storage project, again gas storage services, and customer growth.

Our gas utility continues to grow and that coincides with the momentum in the local job market and housing sector. Oregon's unemployment rate maintain a record low at 4.1% with the Portland area have seen unemployment at 3.9%.

Single-family housing permits in the Portland metro area were up 8.4% year-to-date, compared to the same period last year, and multi-family permits increased 10.4%. These factors translating -- translated into connecting more than 12,000 new customers over the last year, resulting in an annual growth rate of 1.6%.

On the regulatory front, I'm pleased to report that after 10 months of review with stakeholders, an order was issued in our Washington general rate case. Our Washington state service territory covers about 11% of our overall customers, and represents approximately 10% of overall revenues. The order provides for a $5.1 million increase in revenues from previous rates, based on an ROE of 9.4%, and a cost of capital of 7.2%, which represents a capital structure of 49% equity, 50% long-term debt, and 1% short-term debt. Rate base in the case increased $46 million to approximately $174 million.

In addition, an environmental recovery mechanism was approved, allowing recovery of costs associated with remediating historical manufactured gas sites. These rates were effective November 1. Adding to the good news, customers ranked Northwest Natural first in the country and the West, among large utilities in the J.D. Power's Residential Customer Satisfaction survey. These results are a testament to our customer-centric culture, and I'm proud of all of our employees, who make this happen every day.

We also continue to make progress on the sale of the Gill Ranch Storage facility in California. We heard late last week that the administrative law judge recommended the California Public Utility Commission approved the sale. CPUC approval is the last regulatory step in completing the sale. We do not have a revised schedule from the CPC -- CPUC yet, but I am hopeful it can be addressed before year-end. If approved, I would expect to close this transaction late this year or early 2020.

And finally, this morning, I'm pleased to report that in the fourth quarter, the Board approved a dividend increase making this 64th consecutive year of annual dividend increases. Our annual indicated dividend amount is now $1.91 per share. We are proud to be one of only three companies on the NYSE with this growth record.

With that, let me turn it over to Frank to cover some of the financial results. Frank?

Frank Burkhartsmeyer -- Senior Vice President and Chief Financial Officer

Thank you, David, and good morning everyone. I'll begin with a summary of our third quarter and year-to-date reported financials, and then discuss our cash flows and guidance for the year. I'll describe earnings drivers on an after-tax basis, using the statutory rate. Note that our effective rate was 19% for the third quarter, compared to our statutory rate of 26.5%. The main difference is a result of returning excess deferred income taxes, related to tax reform to our Oregon customers. We expect the lower effective rate to persist, as we continue to provide these benefits to customers. 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 $18.5 million or $0.61 per share, compared to a loss of $11.1 million or $0.39 per share for the same period in 2018. The $0.22 per share difference, largely reflects three timing issues, all of which are offset across 2019.

First, the Oregon rate case resulted in both an increase in customer rates and the recognition of greater pension expense. While the higher expense is matched by the rate increase over the year, there are quarterly timing differences. Whereas pension expenses recognized evenly through the year, it is recovered through rates on a volumetric basis. As a result of this difference, third quarter 2019 O&M and other expense increased $1 million over 2018.

The second timing matter is also the result of the Oregon rate case. Beginning this year, we began returning tax reform benefits to customers on a volumetric basis. However, the Company realizes the benefits in alignment with pre-tax income. As a result of this timing difference, tax benefits declined $2 million in the quarter, compared to prior period.

Finally, our third quarter 2018 margin benefited from a $2.8 million adjustment to our tax reform deferral estimate, that adjustment was not repeated in 2019. In summary, for the calendar year, these timing matters essentially offset. I'm very pleased with our strong financial performance to-date.

On a consolidated basis, year-to-date net income from continuing operations was $27 million or $0.91 per year -- per share, compared to $30.5 million or $1.06 per share for the same period in 2018. Excluding the $6.6 million pension disallowance, adjusted year-to-date net income from continuing operations was $1.13 per share or an increase of $0.07 over 2018. The $0.07 per share increase is a result of a $0.13 per share increase in the Gas Distribution segment, partially offset by a $0.06 per share decline from lower asset management revenues and expenses associated with the water business.

In the Gas Distribution segment utility margin increased $23.6 million, as higher Oregon rates and customer growth added $5.3 million, and colder weather along with higher fee revenue from interruptible customers contributed $3.3 million. We also had our first full quarter of gas storage revenues from the North Mist expansion, which provided an additional $5.3 million. Finally, as we've discussed in previous quarters, the Oregon order resulted in a $10.6 million increase in utility margin, with no significant effect on net income, as offsetting adjustments were recognized through expenses and income taxes.

Utility O&M and other expenses increased $23.8 million, with the majority related to the Oregon rate case. $6.3 million is related to collecting our pension expense through rates, and is offset with higher revenues from customer rates. $7.7 million is the pension disallowance recorded in the first quarter of 2019. And $9.2 million of the increase was due to day one impacts of implementing the March Oregon order, which also were offset by benefits in revenues and tax expense. Underlying O&M is essentially flat for these adjustments.

Depreciation and interest expense increased $5.7 million from additional investment in our system, and higher long-term debt balances. Tax expense reflected a $3.7 million benefit related to implementing the March order. However, as this offset higher expense, there was no significant resulting effect on net income.

As a result of the Oregon general rate case and tax reform, there are lots of moving pieces in the financials, but the underlying drivers are straightforward. We have new rates in Oregon, customer growth, and North Mist is online.

A few notes on cash flow. For the first nine months of 2019, the Company generated $155 million in operating cash flow. We invested $225 million into the business with $161 million used for gas utility capital expenditures, and $56 million for water acquisitions. We continue to expect capital expenditures this year to be in the range of $230 million to $270 million. Our balance sheet remains strong with ample liquidity.

Moving on to 2019 financial guidance. As you may recall from our first quarter earnings release, GAAP earnings guidance from continuing operations for 2019 is expected to range from $2.02 to $2.22 per share. Excluding the $0.22 per share disallowance, we remain on track with our adjusted earnings guidance from continuing operations in the range of $2.25 to $2.45 per share.

Guidance assumes continued customer growth, average weather conditions, and no significant changes in prevailing regulatory policies mechanisms or outcomes or significant laws or regulations.

Finally, this guidance excludes any gain related to the sale of Gill Ranch storage facility and associated operating results, which are reported in discontinued operations.

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

David H. Anderson -- President and Chief Executive Officer

Thanks, Frank. As we discussed last quarter, we're very pleased to be taken a significant step forward in our energy transition with the passage of Oregon bill -- Senate Bill 98, the most aggressive renewable natural gas law in the country. This groundbreaking legislation was signed into law by Oregon Governor Kate Brown this summer, after months of collaboration with Oregon Senators, Michael Dembrow and Lee Beyer, and other influential environmental leaders across the state. The bill creates a path for renewable natural gas to become an increasing part of the state's energy supply. We know, putting renewable natural gas on our system is one of the most effective ways to reduce emissions.

In August, the Oregon commission opened a docket to begin rulemaking on this law. They laid out an expedited process that is scheduled to conclude by July of 2020. We are in the early stages of these initiatives, and I look forward to a growing portion of supply coming from renewables and moving quickly on the opportunities in this market. We are later focused on providing our customers with innovative solutions that drive climate betterments at a reasonable cost, and do not negatively impact reliability of the overall energy system.

Turning now to the water side of the business. I'm very pleased with the success of our water strategy. We initiated the strategy two years ago, with small transactions, close to our natural gas service territory here in the Northwest, and have grown to operate nine utility serving customers in the three state Northwest area. Our disciplined approach has worked well. We began with solid transactions that were financially manageable, ensuring good execution, confirming our understanding of the regulatory process, and allowing our team to gain experience.

Our acquisition strategy in the Pacific Northwest continues. In October, we signed an agreement to purchase Suncadia's Water and Wastewater Utilities in Washington state. This high-end resort community attracts residents from Seattle, and serves about 2,800 connections. We are happy that -- happy to add another resort community to our water family.

As I've grown confident in our team's abilities, we broadened our focus to include opportunities west of the Mississippi. Our first opportunity is in Texas for our water utility serving about 3,500 connections in Conroe, Texas. This community is part of the larger Houston metropolitan area, which is vibrant and historically has posted one of the highest growth rates in the country.

Texas is a key growth area in the United States. Its economy, business environment and growth, make it an attractive region. The core population centers in Austin, Dallas and Houston continue to post some of the highest population, and housing growth rates in the United States. With a strong business culture and constructive regulatory environment, and numerous privately owned water companies we believe Texas is the right place to continue growing our water business.

We also continue talking in utilities around our existing footprint. Our other pending acquisitions are examples of this roll-up strategy. Last quarter we highlighted our first municipal transaction Taylor Mountain Water and Sewer District near Idaho Falls.

We also closed on two privately owned water utilities in the Coeur d'Alene territory earlier this month, and have two more utilities pending in that area. We will continue to target other utilities adjacent or near our footprint. Obviously, this now includes Texas, which greatly increases our pool of opportunities. Acquisitions are projected to be accretive in the first full year of operations.

Altogether, we've now committed nearly $110 million of investment into the water sector. Once we close these outstanding transactions, we'll serve approximately 62,000 people through nearly 25,000 connections. I remain excited by the growth potential of this business. We continue to find good opportunities to add additional assets to this platform through acquisition. But we're also finding good organic investment opportunities to put capital to work in our current portfolio.

I'm very pleased with the strong results posted year-to-date, our best-in-class customer satisfaction results, and our continued progress on our strategic plan, especially as it relates to our water platform. I look forward to a strong fourth quarter, and continue to execute on these opportunities for the years to come.

Thanks, again, for taking time to join us this morning. With that, Ben, I think we're ready to open it up to questions.

Questions and Answers:

Operator

Thank you. We will now begin the question-and-answer session. [Operator Instructions]

Our first question comes from Chris Ellinghaus with Siebert Williams Shank. Please go ahead.

Chris Ellinghaus -- Siebert Williams Shank -- Analyst

Hey, guys, how are you?

David H. Anderson -- President and Chief Executive Officer

We are good.

Chris Ellinghaus -- Siebert Williams Shank -- Analyst

Can I ask you, David, to talk a little bit high level about the renewable side? Once the implementation dockets sort of work it's way through, what's your sort of thought process in terms of the time frame that you might start to see investment opportunities? And would you be interested in things as far down the chain as supply or electrolysis for hydrogen that sort of thing? Or you're just thinking more pipes?

David H. Anderson -- President and Chief Executive Officer

Yes, and I appreciate the question, Chris. I think, for those of the phone, I think the first thing is to make sure everybody understand that when you look at our residential and sales customers they represent about 5% of the state's emissions in our -- in Oregon. And Oregon, in general, has very low emissions. But we do believe there are going to be opportunities to lower that even further, and to make sure that we do that. Along the line that you're talking about, the rulemaking is in process, right? So we don't really have all items that we need to kind of work through this. But the law clearly sets the ability for us to probably invest around -- in terms of revenue increases, around $30 million. It's about 5% of revenues is what the bill highlights. Now whether that ends up being straightforward purchases, Chris, or it results in revenue requirement from investment opportunities, that's yet to be determined.

From my perspective, strategically, I think it's important to get as much renewable natural gas on the system as quickly as possible. And that might start off with purchases. We will obviously work with the PUC not only through this rulemaking process, but in the futures to see if there's opportunities on the investment side. But the key for us is to get that renewable natural gas flowing. And renewable natural gas, as you mentioned, is numerous items. It's obviously gas from landfills, and wastewater facilities, like the one we did here with Portland, and dairies, but it also includes what I'm really excited about is the new technologies out there, that you mentioned, this power to gas. And that's using excess electricity generation, which we are abundant here at certain times of the year, because of our hydro situation and our wind generation to create hydrogen. And we can't put hydrogen on the system, and in fact, this is not really new technology. They've been doing in Europe for a period of time, and we look forward to trying to do that here. In fact we're working on a pilot project with the City of Eugene right now.

So all that, being in place, it's an exciting opportunity. I would love to have more investment opportunities. But strategically, the most important thing to us right now, is to get more decarbonized gas on the system, and then long-term, we'll see whether the investment opportunities play out or not. Hopefully, that makes sense.

Chris Ellinghaus -- Siebert Williams Shank -- Analyst

Sure. Would you imagine -- of course, this will go through the implementation docket. But when you imagine that if you were just to make a straight purchase of some renewable gas that that would be offset in the math that the legislature left you with in terms of the percentage of revenues?

David H. Anderson -- President and Chief Executive Officer

Yes. The legislature, the way they set it up is they allowed us to increase rates by 5% to get renewable natural gas on the system. That's either through purchase or through investment. So it's not -- I'm trying to make sure I understand your question. It's not really an offset. So if we bought $2 million of RNG on the open market, there would still be $30 million of revenue requirement that could be spent on something else, whether it's direct purchases or investment that translates back up to a revenue requirement. Is that makes sense?

Chris Ellinghaus -- Siebert Williams Shank -- Analyst

Yes. I was just thinking in terms of, if I bought $2 million with the renewable gas that replaces $2 million of other gas. So on a cost basis [Phonetic] I'm really net-net.

David H. Anderson -- President and Chief Executive Officer

That is -- yes, that is true, that it would replace the other gas. Sorry, I misunderstood your question.

Chris Ellinghaus -- Siebert Williams Shank -- Analyst

So can I also ask this Texas acquisitions sort of opens up a new horizon for the water acquisition strategy. Can you give us any sense of what you're seeing in other locations in terms of the opportunity set? Is it as robust as what you've seen so far in the Pacific Northwest?

David H. Anderson -- President and Chief Executive Officer

It's a great question. We are looking west of the Mississippi, as we've been articulating to you guys for a good nine months now. What was really attractive about Texas is, just the size of the population and how many private water companies there are there. So the opportunity set is very good. So that was -- that got our attention initially. And you can kind of see what we've been doing in the Northwest, is once we enter into a new area, I'd like to use the word that it's a beachhead for us, pardon the pun, but it allows us to do tuck-in acquisitions around that. So very similar to what we did in Idaho, both up in Coeur d'Alene and around Idaho Falls. And I suspect that most of our near-term efforts and attention will be focused on doing that in Texas. We continue to look at the other states right now. But I think, at this juncture, Chris, most of the focus is on taxes as we try to build out that platform.

Chris Ellinghaus -- Siebert Williams Shank -- Analyst

Okay. And you also have done your first municipal system. Are you seeing a lot of opportunities on the muni side?

David H. Anderson -- President and Chief Executive Officer

No. The muni side takes a little bit longer to work out. There is -- I will tell you the more near-term opportunities are on the private side. But I think once you start -- I think the nice thing that we've been able to accomplish in two years, is establish ourselves as a water player, and that's an important step to where -- when we come in now, we're not seen as a gas utility, we're a water utility, and that includes the regulator. The regulator clearly sees that we are a good long-term owner of these assets, and it's also been good for the sellers.

On the municipal side, that is something that we continue to work on, and have resources working on that. That just usually is a little bit longer lead time. And every city, every municipality has different issues that it's trying to solve. So the tailor situation that we had was one that was right next door. It was small, and they needed somebody like us to come in and takeover. We will be prepared to do that especially in the footprint that we have right now. But I do believe long-term, municipalities are a very important part of the long-term growth strategy, especially as you look at states that have fair value legislation. That'll be a dynamic, that we'll continue to push hard. But right now, most of the efforts on the private side, Chris.

Chris Ellinghaus -- Siebert Williams Shank -- Analyst

Are you seeing more -- as your name gets out there, more of the private side coming to you at this point?

David H. Anderson -- President and Chief Executive Officer

I think that's a fair thing to say. And I think the other side of this is when you have 160-year old utility that usually is number one, two or three in the country with customer satisfaction numbers, it's clear that we -- that the sellers appreciate selling to somebody that understands the business. And then I think we're also getting good feedback from the regulators in the three states, and I suspect Texas too, that they understand the value of the utility and utility owning these assets versus private individuals.

Chris Ellinghaus -- Siebert Williams Shank -- Analyst

Okay. One last question. I know it will be a while before water might potentially become a reportable segments. But as you get to the more critical mass in terms of dollars invested and having more and more acquisitions complete their first year, how do you envision sort of providing more benchmarks to us to sort of keep an eye on how the water business is progressing?

David H. Anderson -- President and Chief Executive Officer

Yes, it's a great question. And I think as we gain momentum and we gain size, I mean we do have $110 million invested. Of course, we're a $3 billion asset Company. So you'll -- in the future when we get the scale, you will see segment information. But we'll try to do more in our Investor Relations materials to make sure that you guys understand. But at this juncture, Chris, we're trying to build a business. And at this juncture, the most important thing is to get more assets under management.

And then for, Justin and Brody, which are the two that are running this Company, they are putting plans in place for additional capex, because each one of these have opportunities to expand their investment footprint. So I think we're in the early stages here. But I definitely hear your question and hopefully in the future, not so distant future, we'll be able to provide more guidance along this run.

Chris Ellinghaus -- Siebert Williams Shank -- Analyst

Great, I appreciate the color.

David H. Anderson -- President and Chief Executive Officer

Thanks, Chris.

Operator

Our next question comes from Aga Zmigrodzka with UBS. Please go ahead.

Aga Zmigrodzka -- UBS -- Analyst

Good morning.

David H. Anderson -- President and Chief Executive Officer

Good morning.

Aga Zmigrodzka -- UBS -- Analyst

Customer growth looks like it slowed modestly to 1.6% in 3Q. Could you please discuss what are your expectations for customer growth going forward? And do you think there is any impact of potential building electrification trend on the West Coast?

David H. Anderson -- President and Chief Executive Officer

Yes, on the trailing 12 month, I think the actual number is 1.62%. So it did drop a little bit on a trailing 12-month basis. We've been consistently seeing around that 1.6% or 1.7% for quite a bit of time here. And we have a lot of multi-family projects that will be coming on pretty soon. So I think it's kind of hard always to focus customer growth, because then you got to -- you have to ask, are we going to have a recession? Are we not going to have a recession? The great thing is, our product is very attractively priced and people want gas. So it's a high value-add products that they want to put in place. So I think a lot of those factors, including the economic information that we shared with you in the transcript in terms of how many new housing permits are and things like that bode well for continued good customer growth, whether that ends up being a 1.6% number or a little bit lower, a little bit higher. It's a little bit hard, Aga, to kind of a forecast that.

On the electrification, the discussion that you mentioned, obviously there is quite a bit of that discussion going on throughout the country. As you saw the activities down in California, one of the things that we've been trying to make sure that all of our local officials understand is the value of the natural gas system. And again, I think also -- I think gas systems are going to be a little bit different by what territory you are in. Obviously, we are -- we have long cold weathers. And if you really wanted to quote unquote electrify everything, you're actually going to increase the carbon footprint for many years to come. Because frankly, you're going to be using natural gas, no matter what. You're going to either use natural gas directly, which we believe is the right thing to do, especially as you add renewables, or you're going to use it in gas-fired generation, because the renewable portfolio can't handle the peak periods like it needs to.

So there is discussions everywhere, Aga, and we'll continue to be part of that. But it's our focus right now to make sure all of our elected officials, all the city councils, all of our jurisdictions, understand of why the gas system exist, what it's here for, and how we can achieve the climate change goals that our Governor and the state want to achieve.

Aga Zmigrodzka -- UBS -- Analyst

Thank you for taking my question.

Operator

Our next question comes from Sarah Akers with Wells Fargo. Please go ahead.

Sarah Akers -- Wells Fargo -- Analyst

Hey, good morning.

David H. Anderson -- President and Chief Executive Officer

Good morning, Sarah.

Sarah Akers -- Wells Fargo -- Analyst

Can you share your latest thoughts on the timing of the next Oregon rate case? And maybe talk through some of the key drivers of the need there?

David H. Anderson -- President and Chief Executive Officer

Yes, this is David. I'll start and then maybe I'll hand it over to Frank to cover some of the capex. Obviously, results year-to-date have been strong, as we indicated, and we're in a good position for strong results for the year. But with that said, we've also been making substantial investments in the system. And we are seriously contemplating right now, filing another Oregon rate case very soon. And it's really driven by that investment profile that we see. And Frank, you might just describe a little bit of that from a capex perspective.

Frank Burkhartsmeyer -- Senior Vice President and Chief Financial Officer

You bet. Sarah, our historic average capital expenditure was more in the range of $160 million. We were up a little bit last year. And then this year, we've got $230 million to $270 million as our guidance. So at this sustained level, of course, we'd be facing lag and we don't want to endure that for too long. A lot of this investment will come online, be in service here over this period. So it's really, as David said, it's looking like we'll need to consider rate case late this year or early next year.

David H. Anderson -- President and Chief Executive Officer

And Sarah, just a reminder, our practice in the past is, we really like to up -- to update rates at the same time that we do our PGAs, which for Oregon and Washington -- obviously, we're talking about Oregon here, since we just finished Washington. I don't want to infer that there's a Washington rate case right behind this. But it would still probably be the right thing to do is to update rates, at the same time as the PGA. If that's the fact that probably means, if we do decide to file a rate case, it will be late this year.

Sarah Akers -- Wells Fargo -- Analyst

All right, thank you.

Operator

Showing no further questions. We will conclude our question-and-answer session. I would like to turn the conference back over to Mr. David Anderson for any closing remarks.

David H. Anderson -- President and Chief Executive Officer

Ben, thank you. And thank you for everybody for participating on the call. Obviously, Nikki is available for questions. Just to kind of repeat where I started off. We've started the year really strong. You can see that in the year-to-date results, you can also see it in the trailing 12-month results, that we're in a good place where we need to be by year-end.

So, Ben, thank you. Everybody, if you have any questions, please call Nikki, and thanks for joining us today.

Operator

[Operator Closing Remarks]

Duration: 31 minutes

Call participants:

Nikki Sparley -- Director, Investor Relations

David H. Anderson -- President and Chief Executive Officer

Frank Burkhartsmeyer -- Senior Vice President and Chief Financial Officer

Chris Ellinghaus -- Siebert Williams Shank -- Analyst

Aga Zmigrodzka -- UBS -- Analyst

Sarah Akers -- Wells Fargo -- Analyst

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