EQT Corp (EQT) 2004 Q4 法說會逐字稿

Good morning, ladies and gentlemen.

Welcome to your Equitable Resources year-end 2004 earnings conference call.

At this time, all lines have been placed on a listen-only mode and the floor will be open for questions following the presentation.

It is now my pleasure to turn the floor over to your host, Mr. Pat Kane.

Sir, you may begin.

Thanks, Ian.

Good morning, everyone.

And thank you for participating in Equitable's year-end 2004 earnings conference call.

With me today are Murry Gerber, Chairman, President, and Chief Executive Officer and Dave Porges, Vice Chairman and Executive Vice President, Finance and Administration.

In just a moment, Murry will briefly discuss the recent management changes.

Then Dave will review the 2004 financial results that we released this morning.

Following Dave's remarks, we'll open the phone lines up for questions.

But first, I'd like to remind you that today's call may contain forward-looking statements related to such matters as the anticipated earnings per share; the targeted growth of earnings per share; forecasted capital expenditures; the Company's approach to compensation, including in particular long-term comp and defined benefit obligations; estimated 2005 compensation costs; staffing matters; and operational matters.

It should be noted that a variety of factors could cause the Company's actual results to differ materially from the anticipated results or other expectations expressed in these forward-looking statements.

These factors are listed in today's earnings release, the MD&A section of the Company's 2004 Form-10K, the 2004 first, second, and third quarter 10Qs as well as on our website.

I'd now like to turn the call over to Murry Gerber.

Thanks Pat.

Good morning everybody.

My comments will be a little brief this morning.

There are a number of specific items in the release that bear some explanation that Dave will give.

First of all, I'd like to report the Equitable is reiterating previous earnings guidance for 2005 at $3.45 to $3.50 per share.

Second, I want to assure you that we are charging full-steam ahead on our accelerated plan for growth in the supply business.

Things look very good there.

Lastly, I'd like to explain a little bit of the rationale for the management changes we recently announced.

To reiterate, Dave is being elevated to the position of Vice Chairman of Equitable Resources.

With that promotion, he is taking on responsibility for all the Company's administrative functions including finance, legal, information technology, human resources, purchasing, and our shared services.

As such his titled position will be Executive Vice-President of Finance and Administration.

Phil Conti, whom you all know, I think, is being promoted to the position of Chief Financial Officer, though he will retain the title and responsibilities of Treasurer of the Corporation.

Dave Porges will remain our principle financial officer.

There are several tangible reasons we are making this change right now.

First and foremost Dave is a fine executive.

This title change explicitly formalizes his role as the number two executive officer here at Equitable Resources.

Second, given our desire to continue to grow the Company, it is imperative that our administrative functions are working at maximum effectiveness and minimum cost.

Dave is stepping up to the challenge to review this in 2005 to make sure that all of our administrative functions are spending money wisely.

It's been a few years since we have undertaken such a review.

It's timely to do another one in 2005.

Third, with Dave leading our administration, my direct reports aside from David will include the business unit Presidents Diane Prier in Supply;

Randy Crawford in Utility; and Ted O'Brien in NORESCO.

As you know, Ted is also responsible for facilities construction and supply.

He has also picked up corporate-wide compliance, safety, and environmental responsibility.

Similar to what I mentioned for Dave, given my experience in the supply group last year, it again is, I think, important that I take an active role in reviewing all of our operating value drivers throughout the Company this year.

So I'll be spending a lot more time in the field in boots and a pickup, which I like to do anyway.

I am, in summary, very confident in the opportunities we still have at Equitable Resources to increase shareholder value.

We, as usual, will continue to invest capital at returns higher that our cost of capital in order to grow.

We hope that growth – we expect that growth in earnings to be at higher levels than our competitors'.

That is what we do here at Equitable.

We will continue to do that in the future.

Now I'll turn the discussion over to Dave with public congratulations on his new position.

Dave.

Thanks Murry.

Equitable Resources today announced record 2004 annual earnings per diluted share or EPS of $4.44.

This compares with an EPS of $2.68 in 2003.

For the fourth quarter 2004 the Company reported EPS of $0.69 compared to fourth quarter 2003 EPS of $0.78.

Several non-operational factors impacted fourth quarter and full-year results.

You are by now familiar with the myriad second quarter items of this ilk that, taken together, increased earnings substantially.

A fourth quarter item that reduced earnings was our decision to settle that portion of the Company's defined pension benefit plan that was provided to several hundred non-represented employees in the form of a cash balance plan.

The cost of this item in the fourth quarter was $13.4 million, which more than fully explains the decrease versus the prior year.

I will discuss that topic and several others after briefly reviewing full-year results for our three business segments.

First, Equitable Utilities.

The transmission and distribution segment had operating income of $108.1 million for 2004, compared with $109.9 million for 2003, a 2 percent decrease.

This decrease was more-than-explained by warmer weather.

Heating degree-days totaled 5,360 for 2004, or 6 percent warmer than the 5,695 degree-days recorded in 2003 and 8 percent warmer than the 30-year normal of 5,829 degree-days.

We estimate that the warmer weather reduced operating income by $4.6 million versus the priory year.

Other factors of note affecting the year-to-year comparison were the $2-million decrease in depreciation expense as a result of a determination that our remaining pipes have longer lives than previously estimated; a previously much-discussed overrun in costs totaling $1.7 million due to a new customer information system that was brought live early in 2004; and a $2.2 million improvement in earnings from our storage and commercial activities.

Equitable Supply.

The production and gathering segment recorded operating income of $227.4 million in 2004, which is 16 percent higher than the $195.8 million earned in 2003.

We estimate that this was largely due to the 14 percent increase in effective wellhead price that we experienced.

There are clearly judgment calls involved in determining which categories to use in comparing 2004 results to 2003 results, especially with prices and volumes both increasing.

The way we look at it, price improvements increased operating income by $32.5 million versus the prior year, while the 5 percent increase in sales volumes increased operating income by $12.9 million.

Virtually offsetting these increases were increases in operating expenses of $11.3 million and depreciation, depletion, and amortization expenses of $5.3 million.

The net of all other items, such as an increase in gathering rates, account for the rest of the variance versus 2003.

The way we calculate these numbers, costs that are directly related to the price increase, such as severance taxes or directly related to the volume increases, such as unit operating expenses and unit depletion expenses, are already captured in the variances provided for price and volume respectively.

However, the sharp increases in both prices and volumes surely had some effect on the increases in unit operating expenses and unit depletion and depreciation expenses as general oil field inflation has made everything cost more.

However, both of these expenses were also driven up by our recent initiatives to improve compression, gathering, metering, and other infrastructure integrity and effectiveness.

As mentioned in the press release, some of these expenses were also incurred to prepared the Company for ramped up activity in the Appalachian basin.

The Company plans to drill 440 wells in 2005 compared with the 314 wells drilled in 2004.

NORESCO.

The energy services segment posted 2004 operating income of $14.9 million, compared with $16.9 million earned in 2003.

The external construction backlog was $83.5 million at year-end, down from $134.2 million at the end of 2003.

These reductions versus 2003 were mainly due to the lapsing in September 2003 of the enabling legislation for the performance contracting work that NORESCO performs for the federal government.

The federal government passed new enabling legislation in October 2004, providing NORESCO with the opportunity to resume contracting this work.

We previously disclosed that in the second quarter 2004, NORESCO recognized an impairment of $40.3 million pre-tax, essentially the cost of its entire international investment and the related cost of exiting these investments.

In January 2005, NORESCO sold its minority interest in a Costa Rican electric generation plant to a third-party purchaser and recorded a slight gain on the sale.

This was one of four international facilities owned by NORESCO.

A second facility in Panama is being dismantled.

We continue to make progress towards resolution regarding the other two facilities, the larger Panama plant and a plant in Jamaica.

There are several other topics that we would like to cover, including some reminders of why earnings were particularly high in 2004.

First, a brief reminder on previously discussed unusual gains and charges in 2004.

Equitable recognized a capital gain of $217 million pre-tax on the exchange of Westport shares for Kerr-McGee shares on the closing of the merger between Westport Resources Corp and Kerr-McGee Corp on June 25, 2004.

Also during the second quarter Equitable sold 800,000 Kerr-McGee shares after the merger was completed.

The sale resulted in a pre-tax capital gain of $3 million.

An additional 357,000 Kerr-McGee shares were committed to Equitable Resources Foundation, Inc. in the second quarter.

The Foundation supports development programs in the communities where the Company conducts business.

The contribution resulted in a $18.2 million pre-tax charge.

We also recorded various transaction-related charges during the course of 2004.

On a related note in 2004, we recorded long-term compensation expenses of $30 million and short-term compensation expenses of $15.8 million compared with 2003 figures of $17.6 million for long-term compensation and $10.5 million in short-term incentive compensation.

Much of the $17.7-million increase from 2003 to 2004 was due directly and indirectly, to the crystallization of the Westport transaction.

For reference, had all aspects of the plans been held constant except that the Equitable stock price remained the same at the end of 2004 as it was at the beginning of 2004, those aforementioned 2004 long-term compensation expenses would have been reduced by $13 million, making them slightly lower than the 2003 long-term compensation expense.

The long-term compensation expenses are primarily associated with executive performance incentive plans that were instituted starting in 2002 as a replacement for the issuance of stock options.

Philosophically we wanted to implement an incentive compensation approach that would closely align management's incentives with shareholder rewards than was the case with traditional stock options.

We have long utilized time-restricted stock in our compensation plans, but only began issuing performance-restricted units in 2002.

We have now fully transitioned to a long-term incentive approach that is limited to performance-restricted stock or units and time-restricted stock, but no stock options.

Unlike the case with stock options, the cost of all of these plans are fully expensed.

They do not have the long-term dilutive effective on shareholders that is true of stock options.

And, unlike the way that option expensing will occur in the future, the performance-restricted compensation expenses will vary with stock price and relative performance.

By the way, the total incentive compensation expense of $45.8 million in 2004 and $28 million in 2003 compares with $21.2 million in 2002.

We have also tracked the amount of option expense that would have been recorded had the Company elected to expense options.

Adding that figure, the 2004 total for all incentive compensation would have been $52 million versus $37 million in 2003 and $34 million in 2002.

Our current estimate for 2005 assumes total incentive compensation expense of just under $34 million.

Expensing options would have increased that total so slightly, that the total would still round to $34 million.

To be perhaps clearer, we are currently expecting that the total cost of incentive compensation in 2005 will be in the same range as that of 2002 and 2003.

But the 2005 total will essentially all be expensed on the income statement while this was not true in 2002 and 2003.

Incidentally, we recognize that the increased volatility in costs reflected on the income statement directionally means that our expenses will grow in periods in which our stock price increases and decline in periods in which our stock price declines.

This may prove somewhat confusing.

We do believe this is the correct way to present this information since the true economic cost to shareholders of most long-term compensation plans does move with such variables as stock price.

It is therefore, our intent prospectively, to provide more comprehensive information on incentive compensation expenses so that investors can make their own determinations about the appropriateness of the compensation, the significance of the volatility of these items as well as on the health of the underlying pre-compensation earnings.

We are also happy to provide the information I have reeled off above in tabular form in our filings if it is of interest.

Please let our Director of Investor Relations, Pat Kane, know if this is the case.

Separately, and as mentioned at the outset of my comments, during the fourth quarter of 2004 the Company irrevocably committed to settle the cash balance portion of the defined benefit pension plan.

This decision resulted in the Company incurring a charge of $13.4 million.

The cash balance portion of the pension plan provided future benefits for certain salaried employees of the Company's utilities segment.

We had previously frozen future participation in this cash balance plan such that contributions prospectively went into a defined contribution plan, but the Company continued to have a defined benefit obligation relating to the balances in the plan at that time.

We have now taken the additional step of moving those obligations into a defined contribution style approach.

We have long discussed our philosophical opposition to holding the shareholders responsible for investment returns of employees.

The practical reality is more complicated.

We continue to make progress on this topic incrementally.

This is the last increment pertaining to active non-represented employees.

We continue to have defined benefit pension obligations to various represented employees.

We will endeavor to insulate shareholders from undefined obligations arising from these remaining plans to the extent possible.

Since the Company has few unilateral actions available to it, we cannot provide any guidance on timing of any possible future moves on this front.

On a more strategic front, the Company made a determination in 2004 that we wished to sell certain non-core natural gas production assets in an effort to focus our activities more intensely on our core areas and on our future investment program.

However, we eventually concluded that the optimal high-grading plan involved assets that were owned by Eastern Seven Partners, L.P., of which the Company owned a small piece and for which the Company provided well and related operations.

Therefore, in January 2005 Equitable purchased the remaining 99 percent limited partnership interest in Eastern Seven Partners, L.P. for cash of $57.5 million and assumed liabilities of $47.3 million.

The purchase added approximately 30 Bcfe of reserves.

The purchase price reflects a high per Bcf price because the reserves are all developed and have a very short reserve life.

Equitable now intends to sell some non-core producing wells during the first half of 2005.

The net result of the purchase and sales is expected to increase the sales volume and supply to about 73 Bcfe in 2005.

The expected increase in revenues will be partially offset by lower revenues from fees formerly paid by the partnership for marketing and operating services and an increase in the depletion rate versus what it would have been had the acquisition not occurred.

Again the purpose of the recently completed acquisition and the intended sale is to further our strategic interests rather than to achieve a short-term financial effect.

On a related topic, 2004 capital expenditures totaled $202 million.

This included $142 million for Equitable Supply, $56 million for Equitable Utilities, and $4 million for headquarters and NORESCO.

For 2005, Equitable forecasts $293 million of capital expenditures.

This forecast includes $219 million for Equitable Supply, excluding the aforementioned acquisition, $61 million for Equitable Utilities, and $13 million for headquarters and NORESCO.

The latter figure is due to the upcoming consolidation of Pittsburgh-based office workers into a single building.

The move to this building is intended to begin in late March and largely be completed by memorial day.

Finally, I wish to update you on the Company's stock repurchases.

During the fourth quarter, Equitable repurchased 500,000 shares of EQT stock bringing total 2004 repurchases to 2,350,000 shares for the year.

The number of shares repurchased since October 1998 is approximately 19.0 million out of 21.8 million currently authorized for repurchase.

With that I will turn the call back over to Pat Kane.

Thank you Dave.

That concludes the comments portion of the call.

Ian, can we please now open the call to questions.

Thank you. (OPERATOR INSTRUCTIONS) Anatol Feygin.

Good morning.

Thanks for the time.

Two questions.

Can you give us a sense for what the volumes are out of Eastern Seven?

The Eastern Seven volumes for 2005, you mean?

Or what they were on a 100 percent basis in 2004.

That number is about 7 or 8 Bcf per year.

Okay.

The other question, on the executive comp plans, there were two big ones, right?

The '02 plan and the '03 plan.

The '02 plan has now been settled.

I am assuming that it was based on the year-end stock price that the expense was calculated on.

My question is really about the '03 plan and how that plays out in 2005.

Presumably, the estimated stock price was somewhat higher than where the '02 plan was expensed.

Right?

So I guess I'm trying to figure out if the stock doesn't go much above the $64-level, does that mean that the '03 plan has basically been fully expensed up until that point?

Actually, the '05 estimate that I gave you included an estimate of about $12 million for that '03 plan of additional accrual.

That amount is included in the numbers that I gave you for 2005.

Yes, we've assumed a slight price increase over the year.

Just as importantly, since these are performance shares, is the issue of relative ranking.

So, compared to the current stock price, we've got a little over a 10 percent increase, or thereabouts – or maybe a little less than 5 percent increase versus the year-end price baked in there.

But the current accrual also includes a relative ranking that was about what it was at year-end.

Frankly, that means it's a little better than what that relative ranking is right now.

So both of those factors weigh into coming up with that $12 million accrual.

You mean relative to the benchmark of the 30 companies----

Yes.

We use a 30 – to remind you.

There is a group of 30 companies.

The way we treat this is that the awards are made at par.

So you have a certain number of units.

The relative ranking could affect whether you got a multiple of from zero times that number of units, zero units, to a peak of two times.

If you were a median performer, you got a median—you got the par number of units.

To get more specific, the way we treated it within that group of 30 is if it were in the bottom four, then it is a zero multiplier.

In the top four, it is a two-times multiplier.

Then it is a straight-line between those two groups of eight with the median going through 1.0 times multiplier.

Got it.

Then it's about the – the stated amount of shares is 440,000.

Right?

Yes.

And at the end of the year we would have assumed that we were ranked about seventh.

We're a little below that now.

Got it.

Great.

Thanks very much.

(OPERATOR INSTRUCTIONS) Yves Siegel.

Good morning gentlemen.

Can you discuss expectations for the gathering.

You had an operating loss in the fourth quarter.

How do you see that segment performing going forward?

Some of this has to do with how we're treating the gathering segment.

If you wouldn't mind just a minute or so to try to give you some background.

In years gone by, Equitable viewed the gathering segment as part and parcel to the overall producing operations so that the wells and the gathering system we all tied together.

Since Dave and I have gotten here, we have increasingly tried to separate those two as business units.

The effective of that separation is starting to become – well, it's becoming more and more clear.

It is providing us with the following kind of business model so that you can get in our heads on what we're trying to do.

For the wells, we expect them to perform and make their cost of capital based on how much production is extracted from the wells and based on the costs.

So as we drill new wells, we expect those wells to go in at higher than the cost of capital, as a straight, unregulated business model.

For the gathering system, however, we're increasingly detaching it from the wells.

We're moving towards a more utility-like model for that system.

The costs that we put into the business, not only operating but capital, will be recovered in rates associated with transporting the gas in the gathering system.

So what we are endeavoring to do right now, more explicitly, is to assure that all the costs – both capital and operating – are captured properly and then working with various either regulated entities or other entities – to assure that the rates that we're getting earn a proper return for that gathering asset.

So I think – that's a little bit long-winded.

But you can see where we're headed.

Unfortunately, at this moment, although I gave a little preview of that in my December analyst meeting, I really don't have a lot more to say on that.

We are moving in that direction.

It's probably going to be a year or two process before we get some of those rates sorted out.

You can see where we're headed on that.

Is that helpful to you?

Yes.

In terms of the capital budget, how much of the supply is going towards gathering versus production?

We don't normally give that number out.

But we could certainly do that.

What we can do is make that more explicit, unless Pat has the number here.

Because I would rather not do something – I don't have the sheet in front of me is the problem. (multiple speakers) Yes, we have a number that is approximate here.

It's about $80 million or so.

That includes new compressors, which is about 50 or so—50 million or 55 million of that.

It includes metering, which is 5, 6, 7 million of that.

But it does include about $20 million in various compliance activities on the pipelines.

Then there is some other miscellaneous capital.

Is that about the same as it was a year before (multiple speakers)

No.

It's higher.

It's higher by about $20 million.

Basically on the compliance or----?

It's about flat on the compliance level.

The real increase from year-to-year is in more compression, more pipelines that can reduce the surface pressure for the gathering system.

Okay.

So the way that we should think about it is that this is a nice opportunity for you going forward in terms of generating incremental profits?

I believe that's true.

You have to make this – you have to consider this.

As we more clearly define the gathering system and we raise the rates – because that's the real key here – is raising the rates, those increased gathering rates will apply to all producers that use that gathering system.

Of course, we are a producer.

So you need to keep that in mind.

Our gathering rates will go up, which will be beneficial to the gathering business.

The gathering rates will go up that will not be beneficial to the producing part of the business.

Keep that in mind as you're doing your arithmetic.

Last two questions.

Related to what you just said, how much of it is your own gas that you're gathering?

About two-thirds or so.

Maybe a little more than that.

Okay.

Then on the housekeeping side, anything going on with the tax rate?

It looks a little bit low for the fourth quarter.

It's just normal tax planning.

As you are aware, tax rates move around some as different activities make more money or different tax planning activities are implemented or roll off.

I view it as being in the normal – I view the 2004 rate – because we really look at it on an annual basis.

As you get through the year, you need to adjust the quarterly ones to make sure that the full year numbers are correct.

So I wouldn't focus ever very much on a quarter's effective tax rate.

I'd only focus on the full-year effective tax rate.

The effective tax rate in 2004 of about 34 percent is pretty much in the range of what we expect for 2005 as well.

Though it is certainly subject to change depending on activities and tax planning—the implementation of tax planning projects.

Got it.

Alright.

Thank you very much.

(OPERATOR INSTRUCTIONS) Peter Hark. (ph)

Good morning everybody.

A couple of quick questions.

First on the eventual disposition of Kerr-McGee shares.

What are the plans for that?

Have you built in any of the use of the proceeds into the earnings guidance you've given out here for '05?

The answer to the second question is no.

The answer to the first question is we've talked about it quite a bit.

Just to reiterate briefly.

We did not at the time of the sale have a particular use of proceeds for that money.

We also are endeavoring and continue to endeavor to make sure that those proceeds receive the most favorable tax treatment that is available to us.

So we really don't have any plans to use — so we structured it—structured the holding such that we're able to borrow money from that if we wish to and otherwise preserve it for what we may need money to spend on in the future.

There is nothing unusual that we're planning at this point in time for the use of those proceeds.

Okay.

What are the tax-efficient options available?

There are a lot of things we're thinking about, talking about, people are talking to us about.

There is nothing that has crystallized.

Okay.

Secondly, on the acquisition of Eastern Seven Partners, I am trying to understand the valuation.

It looks like something around $3 in M. (ph) But I'm sure that can't be right.

Can you run through the valuation of that for us.

Actually that is about right.

Remember, these are – as an answer to an earlier question, you can do the math yourself.

It's very short reserve lives.

That is really the difference.

Most of this stuff is going to play out over the next few years.

You look at incremental cost structures.

The cost structure in that business is about $1.

The DD&A is about $1 or so.

In this case it will be about 3 or so when you put it all together against the current and hedge-able stock price and gas price—I mean gas price.

It's a very profitable thing to do.

Normally, when we do our economics on gas reserves, we're playing out over 40 (ph) years or so.

This is just a very unusual short reserve life piece.

Do bear in mind when you look at our effective wellhead price, that that is heavily influenced by the hedges that we've put in place in years past.

The wellhead price for these sales would, of course – you'd have to apply the market price to get to where Murry is talking about.

A lot of this stuff we are planning on packaging up and turning around and selling as part of a non-core divesture program.

That's perfect.

Thank you for that explanation.

What are now the sensitivities to commodity prices?

I know you have spelled out a 5.50 NYMEX price.

To the extent that we hold 6.50 here, where are the earnings sensitivities for '05 and going forward?

We're still at about one cent per 10-cent change in the natural gas price – $0.01 in EPS.

Okay, great.

Thanks.

When you made your presentation in December, you laid out a reserve profile that totaled to about 3.7T.

Didn't know if the makeup of that reserve basis changed materially at all.

No.

It hasn't changed yet.

Of course, we'll be filing with the 10-K the updated reserve report for the year-end of 2004.

I just don't have that before me right at this moment.

But nothing has changed since my December presentation.

Okay, perfect.

Thank you.

Sam Brothwell.

Good morning.

Murry, you are doing a pretty-good size ramp-up in your drilling program in the coming year.

Forgive me if you've already addressed this, can you give us some kind of idea what of timing and impact on production that would lead to.

Good question.

The ramp-up in production, of course, is delayed from the actual ramp-up in drilling.

In other words, it takes some time for the gas to come on.

Everything that I mentioned in the December 3 meeting that we talked about in terms of production reserve growth is exactly the same.

We haven't changed it at all.

As you are looking at 2005 volumes, which we put in here at 73 Bcf, certainly that number is positively affected by the ESP. (ph) But it is also somewhat negatively impacted by the fact that we didn't drill at a maintenance level last year, a maintenance level being defined as the number of wells we need to drill to keep production flat.

So those two pieces are offsetting one another somewhat.

Rest assured that this level that we're shooting for this year, the 440 wells – which will be a record year for us.

We've only drilled – I guess 401 was our biggest year.

This is designed to show, as I showed in December, ramping-up—a ramped-up production in the future – '06, '07, '08.

Okay, thanks.

There appear to be no further questions at this time.

I'd like to turn it back over to the management team for any closing remarks.

That concludes today's call.

This call will be replayed for a seven-day period beginning at approximately 1:30 today.

The phone number for the replay is 973/341-3080.

A confirmation code 440-3608 is needed for the replay.

The call will also be replayed for seven days on our website.

Thanks everybody for participating.

Thank you.

This does conclude this morning's presentation.

Please disconnect your lines at this time.

Have a great day.