NiSource Inc (NI) 2006 Q3 法說會逐字稿

Good morning. My name is Courtney and I will be your conference operator today. At this time, I would like to welcome everyone to the NiSource third quarter financial results and business updates conference call.

All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question and answer session. [OPERATOR INSTRUCTIONS] Thank you.

I would now like to turn the call over to Mr. Glen Kettering, Senior Vice President, Corporate Affairs. Mr. Kettering, you may now begin your conference.

Thank you, Courtney. Good morning to everyone. On behalf of NiSource, I would like to welcome you to our quarterly analyst call. We appreciate the opportunity to be with you today and thank you for taking the time to join us.

Joining me this morning are Bob Skaggs, President and Chief Executive Officer; Mike O'Donnell, Executive Vice President and Chief Financial Officer; and Randy Hullen, Director of Investor Relations.

As you know, the focus of today's call is to review our third quarter 2006 financial performance and to provide an update on progress on our four-point business plan. We will then open the call to your questions.

I would like to remind all of you that some of the statements made on this conference call will be forward-looking statements within the meaning of the Safe Harbor provisions of the U.S. federal security laws.

These forward-looking statements are subject to risks and uncertainties that could cause actual results to differ materially from those expressed in the forward-looking statements. Information concerning factors that could cause actual results to differ materially is included in the management's discussion and analysis section of our form 10-Q quarterly report for the second quarter, which was filed August 3, 2006, with the SEC. We will be updating the risk factors in the third quarter 10-Q, which we plan to file later today.

And now I would like to turn the call over to Bob Skaggs.

Thank you, Glen. Good morning.

As you can see from this morning's news release, NiSource's net operating earnings increased for both the three-month and nine-month periods. We continue to make good progress across our four-point business plan for long-firm sustainable growth. We're also very pleased to report significant progress on negotiations with B.P. regarding Whiting Clean Energy.

The improved third quarter performance was driven by strong results in our Electric business, improvement in gas distribution, and a significant decrease in interest expense due to the refinancing of $2.4 billion in long-term debt during 2005. I would also note that our Gas Transmission and Storage team continued to deliver the revenue growth projected for the year.

Having said all that, we remain intensely focused on reduced customer usage and increasing attrition that has been affecting our Gas Distribution segment as well as gas utilities across the country.

Our current view on customer usage and attrition through the balance of the year remains consistent with the outlook we provided after the second quarter. The recent decline in natural gas prices is certainly welcome news for NiSource and our customers. However, it remains to be seen whether we will experience moderation in the negative usage trends and attrition that have occurred over the last two years. Therefore, we're not adjusting our full-year usage and attrition outlook that we provided after the second quarter. And we won't be reforecasting 2006 earnings.

Before turning to our financial update and operating segment discussion, I'd like to report on the Whiting Clean Energy situation, which you know has been a financial drain and a distraction for NiSource for some time now. The very encouraging news is that Whiting Clean Energy and B.P. have reached a memorandum of understanding, which, subject to the execution of a definitive agreement, would redefine terms under which Whiting would provide steam to B.P. A key component of that arrangement is that B.P. intends to develop alternative solutions to meet the refinery steam needs by the end of 2009.

Also notable is that Whiting and B.P. have outlined a restructured steam pricing approach for operating the Whiting facility in the interim. Because the new arrangement with B.P. is subject to the finalization of a definitive agreement, we're not at liberty to go into further detail at this time. I can say, however, that this is an important milestone towards improving the financial performance of Whiting Clean Energy.

I can't leave this subject without acknowledging how highly we value our business relationship with B. P. Throughout the process, B.P., which recently announced a major investment in its Whiting refinery, has demonstrated its commitment to working with us to develop a solution to the Whiting operations that will be beneficial to both parties.

Moving on to a broader discussion of our financial highlights, on a nonGAAP basis, net operating earnings for the quarter ended September 30, 2006 were $29.5 million or $0.11 per share. This is an increase from $16.4 million or $0.06 per share for the third quarter of 2005.

Operating earnings were $142.8 million for the third quarter of 2006, up from $128 million for the same period in 2005.

Just a footnote, we focus on net operating earnings and operating earnings, both nonGAAP measures, because we believe these measures better represent the fundamental earning strength and performance of the Company. Net operating earnings and operating earnings do normalize for weather as well as for other items such as restructuring charges related to the implementation of our outsourcing agreement with IBM, significant reserve changes, and tax adjustments.

For a reconciliation of net operating earnings and operating earnings to GAAP, please see schedules one and two of our news release, available at www.nisource.com.

As I mentioned earlier, our financial results for the quarter and year-to-date reflect ongoing progress on the Company's four-point plan for long-term sustainable growth. Just a reminder, this balanced plan centers on NiSource's portfolio of regulated assets and includes: commercial growth and expansion of the gas transmission and storage business; commercial and regulatory initiative at our utilities; management of our balance sheet; and process and expense management.

Now, let's turn to an overview of third quarter operating earnings for each of our core business segments, including a discussion of gas usage and attrition.

In our Gas Distribution business, we reported an operating earnings loss of $30.8 million compared to an operating earnings loss of $44 million during the same quarter last year. The improvement was due primarily to lower operating expenses from decreased employee and administrative costs and lower property tax accruals.

Another positive is that our Distribution gas supply team continues to capitalize on short-term revenue-generating market opportunities. Using our Distribution's business's extensive supply and storage portfolio, the team has done a great job of increasing our stream of revenues that are shared with customers under various regulatory mechanisms.

Fundamentally, conservation customer attrition remained the most pressing issues for gas distribution companies. We must address these issues aggressively but in a balanced and thoughtful fashion. To that end, NiSource is developing and pursuing regulatory initiatives throughout its gas distribution markets.

In Indiana, for example, Northern Indiana Public Service Company, NIPSCO, continues to work with its regulatory stakeholders on a filing made earlier this year to simplify its residential rate structure. And in Pennsylvania, the company is encouraged by the recent action of the Pennsylvania Public Utility Commission to establish a working group to address a variety of issues relating to residential customer demand, including potential changes in rate design. Columbia Gas of Pennsylvania's regulatory team will participate actively in that process.

Although these are tangible examples of how we are addressing customer conservation and attrition issues, they are by no means intended to represent an exhaustive list. Our companies will continue working with all regulatory stakeholders to develop and pursue additional regulatory purchase over the next few years as we engage in more formal rate proceedings. The goal of these initiatives will be to address customer usage and attrition as well as to support profitable customer growth and infrastructure investments.

I can assure you that our team remains tightly focused on our broad regulatory objectives and I'm convinced that over a reasonable period, our team will fix these problems and reshape our regulatory constructs.

Moving to our Gas Transmission and Storage Operations segment. Operating earnings were $69.4 million, which was essentially flat with the operating earnings of $69.8 million during the third quarter of last year. Net revenues increased by $12.5 million, primarily due to sales of shorter term transportation and storage services, which is a continuation of the successful optimization efforts we told you about on our first and second quarter conference calls.

However, expenses also increased this quarter, mainly due to higher property insurance premiums, the building of our commercial effort, and costs to settle legacy litigation. Just to note, the higher property insurance premiums relate to facilities in or near the Gulf of Mexico and primarily stem from the industry's unprecedented losses from Hurricanes Ivan, Katrina, and Rita.

Our commercial team, which we continue to build, is doing an excellent job of optimizing opportunities based on our market-leading storage and pipeline platform. During 2006, this team has signed new agreements that are expected to result in more than $40 million in revenue for the year. About 12.5 million of that revenue was recorded during the third quarter. A total of $31.7 million was recorded through the first nine months of the year.

I'd also note that the Gas Transmission and Storage segment continues to make solid progress on asset expansion projects that are driven by both the market and producers. A few examples:

Construction continues on the Hardy storage project in West Virginia, with service scheduled to begin in April 2007. As you know, the project is a joint venture between NiSource's Columbia Gas Transmission and a subsidiary of Piedmont Natural Gas Company.

Likewise, progress continues on Columbia Gas Transmission's eastern market expansion, so-called E.M.E. project, which as I mentioned last quarter is underpinned with binding customer commitments. Certificate application for E.M.E. is expected to be filed with the Federal Energy Regulatory Commission during the first half of 2007. Service is on target to begin in the second quarter of 2009.

In addition, the Millennium Pipeline Project received a favorable environmental impact statement from the FERC on October 13. And the FERC is expected to issue certificate approval by year end. The Millennium project team is focused on the completion of the FERC review process and finalizing the project's construction estimates. Also, the project team is in advanced discussions with local New York tax authorities concerning property tax abatements for Millennium.

In addition to these mature projects, the GT&S team is very actively engaged in the development of additional opportunities to expand our storage and pipeline assets, both in the supply and market areas. And I'm confident that we'll have a rich array of attractive investment opportunities that will drive the continued growth in this line of our business.

The Electric Operations segment had another strong quarter, reporting operating earnings of $113.1 million, up from $103.6 million from the year-ago period. Driving this improvement were lower unrecoverable costs from the Midwest Independent System Operator, MISO, as well as increased industrial sales and the timing of revenue credits. The improvement in MISO cost recovery resulted mainly from the Indiana commission second quarter ruling on the recoverability of certain MISO costs, as well as the deferral of another class of MISO costs that began on August 1, 2006.

As I suggested, steady growth in our northern Indiana market and continued strength in industrial sale volumes and margins provided ongoing lift for our Electric segment. Year-to-date, electric sales volumes to NIPSCO's largest electric customers are up by almost 10% over 2005.

Partially offsetting these increases were operating expenses which were up $5 million compared to last year due to higher electric generation and maintenance expenses.

Before leaving the Electric side of the business, we'd note that U.S. Steel has recently indicated it anticipates some softening in its business during the fourth quarter. We're actively monitoring this market and have ongoing discussions with all of our steel customers. At this point, we don't expect any material adverse impacts on our 2006 earnings, but obviously, we'll continue to monitor the situation closely.

Moving to the segment we refer to as Other operations, we reported an operating loss of $200,000 for the third quarter, compared with operating earnings of $2.1 million in the year-ago period. . The decrease was due primarily to increased losses at Whiting Clean Energy.

Now, to briefly touch on a few additional factors that affect our consolidated net operating earnings. Interest expense for the third quarter of 2006 decreased by $10.3 million compared to the third quarter of 2005, due to the refinancing of $2.4 billion in long-term debt at lower rates that we completed in 2005.

Net Other expense was $800,000 for the quarter compared to net Other income of $3.3 million in the previous year. The change was due primarily to lower interest income and higher fees due to increased interest costs related to the sale of accounts receivable.

Focusing now on liquidity. Net cash flow from continuing operations for nine months ended September 30 was over $860 million, an increase of more than $86 million from the first nine months of 2005. This increase was primarily due to a significant reduction in outstanding accounts receivable and the collection of under-recovered gas costs, partially offset by the impact in 2006 of reduced accounts payable balances.

We closed the quarter with short-term debt of $861 million and total debt of $6.5 billion. That equates to 57.5% debt to capitalization ratio.

To wrap up, NiSource's performance for the third quarter as well as through the first nine months of the year was solid. And the team has made notable progress in advancing our four-point plan for growth.

In closing, I'd like to briefly update you on the effort we launched earlier this year to unlock the underlying value of our asset base. We've been moving forward on the so-called financial and strategic study initiative. Clearly, our recent progress on Whiting is an important step forward in our comprehensive integrative process.

In addition, our Board of Directors is in the advanced stages of reviewing a variety of options developed during the analytical phase of our strategic review process.

As always, we remain committed to communicating with our investors and all stakeholders in a transparent and timely manner as soon as possible following decisions on these and other outlets. Ongoing updates will be provided through our analyst calls, through press releases that will be posted promptly on www.nisource.com.

Thank you for participating today and for your continued interest and support of NiSource. At this point we'll open the call to questions.

[OPERATOR INSTRUCTIONS] And your first question comes from the line of Josh Golden with J.P. Morgan.

Hi. Good morning.

Good morning, Josh.

A quick question. I just want to get some clarification around some of the strategic alternatives and what that may mean for the bond holders. You had made mention on the call today about balance sheet management and notably, you've refinanced 2.4 billion of debt last year. My question is this: are you committed to investment grade rating, particularly at the NiSource Finance subsidiary, or are you just committed to investment grade rating at the utility level?

Our long-term plan, Josh, is predicated on a commitment to long-term investment grade quality at the parent or the finance corp level.

So, would you be willing to sacrifice those ratings in the interim?

Again, it's an ongoing long-term commitment to that investment grade rating, so it would not contemplate sacrificing in the interim.

Okay. Thank you. That answers my question.

Your next question comes from the line of Carl Kirst with Credit Suisse.

Hey, good morning, everybody, and certainly congratulations on the MOU for Whiting.

Thank you.

Bob, just really quickly. On that -- I don't know if you can say anything to this respect, but am I right in assuming that when you said that B.P., when the 2009 event comes here, the long-term fix, is Whiting envisioned to then be separated from B.P. entirely? Is that the long-term fix? Or is that something that is actually still under negotiation?

Carl, again, I'll just repeat that we do need to reduce this MOU to a definitive agreement. Having said that, the contemplation is that Whiting Clean would not have a steam obligation to B.P. at the conclusion of 2009. At the end of 2009.

Okay. Now that's very helpful.

And is there -- is there a time frame? Obviously as soon as you can, but that you think that that may go to definitive agreement? Is that something that you hope can be in place by the end of the year or is that perhaps a little bit longer?

Just can't give you a definitive time line on that, Carl. But both parties -- and again, I have to recognize B.P. for their diligence. We're moving with all dispatch.

Fair enough.

If I could just turn to the Utility very quickly. One of the things, I guess, we were looking for with respect to the attrition side was, I guess, what is referred to as the light-up phase here, October, you know, here we are just kind of starting November. Is there anything that you can report on that front as far as perhaps people coming back on in October? I know you said that you're basically comfortable with the numbers you threw out as far as second quarter trends, but I didn't know if there was anything you could share with us over the last few weeks, perhaps?

Yes, Carl. As you would expect, we have been carefully monitoring our turn-on, re-light activity. And at this point, still somewhat early, it's going to really begin to accelerate now since we've hit the beginning of November. But to this point, we've not seen any notable indication that would alter our view on attrition. In other words, the turn-on activity is on pace, relatively speaking, to the shutoff that we did earlier in the year.

The turn-on is on pace with the shutoffs?

It's in a historic relationship with what we've seen. So the rates look about where we would expect them.

Fair enough. And then lastly, just to clarify this. With respect to the strategic effort -- and understand these are Board decisions -- I guess my last notes show that you guys were hopeful to have something to report by year end. Is that something that is still possible or are we now just kind of more -- we'll report once the Board makes a decision?

I think it's more the latter. I'll say this, Carl. I'll repeat, the Board management, advanced stages of reviewing the options. It's been a very collaborative effort. As you know, we've shied away from any definitive time line. I would say that we are on track. We're at an appropriate pace that's been aggressive but balanced. Clearly, the process could go into the first part of 2007.

I'll just renew the guiding principle that we've used throughout this study. We want to unlock value. We don't want to inadvertently destroy value and we're working to get the correct answer or answers.

I appreciate the clarification and good luck.

Your next question comes from the line of Andrew Levi with Bear Wagner.

Hi, guys. How are you doing?

Good morning.

You know, looking at the Duke Energy transaction, as far as them basically spinning off the gas business that they bought and looking at your transactions from several years ago, putting Columbia and NIPSCO, I guess, I don't know if they were NiSource or NIPSCO at the time. Whatever it was, anyway, together -- and obviously you're going through some strategic initiatives trying to figure out what you're going to do.

Do you see any strategic advantages that -- I don't want to say undoing the merger, but kind of breaking the two companies up again?

I'll just say this, that we've certainly looked at all of the alternatives. We've looked carefully at the Duke transaction and those notions as well as many, many other notions and alternatives are part of the array of things that we're looking at. We certainly understand the logic of the Duke transaction.

Great. Thank you very much.

Your next question comes from the line of Faisel Khan with Citigroup.

Hey, this is actually Barry.

Hi. Good morning.

How are you?

Good.

I saw in the earnings release, is there any -- you mentioned the Millennium Project. Is there any change in the expected in-service date?

No change to the expected in-service date. We're still looking at the latter part of 2009 -- 2008, I'm sorry. 2008.

Okay.

What about -- you mentioned also costs to settle litigation within the Gas Transmission and Storage operation. Is that a significant cost or -- how much was that?

It was south of $5 million. And it truly was a legacy issue that we wanted to clean up and put behind us.

Okay. And how about the insurance premiums relating to the Gulf hurricanes?

It's about $5 million on an annual run rate base. It's going to look like 10 million.

Okay. And you don't expect those to be ongoing?

Excuse me?

You don't expect those to be ongoing?

Well, the insurance premium is an increase stemming from the hurricane activity that we all went through last year, and it's certainly a function of the market and we expect it certainly to carry on into next year. We'll see what happens with the insurance markets after that point.

Okay.

And how about the -- anything new? I know you guys were sending divers down for the Columbia gas. Is that Gulf pipeline? Any update on that?

Really don't have any update. We have the divers in that area. We hope to have the line back in service a week, ten days.

Any significant impact on next quarter's earnings from that?

This is a relatively nominal amount of gas. It's about 15 million a day, which, in the big scheme of things is just not that notable.

Okay. That's it. Thanks a lot.

Your next question comes from the line of Scott Engstrom with Satellite Asset Management.

Good morning.

Good morning.

A question for you on the weather calculation you do and thinking about it relative to the uncertainty you've had regarding usage. Is the weather revenue calculation a sort of single variable regression revolving around degree days? And the reason I ask is I'm just wondering how do you -- with the uncertainty you've had around usage patterns, how do you kind of marry those two factors together and how confident are you, for example, if you do get to normal weather next year, that looking at the nine-month table here, whether at the LDCs, for example, has caused about a $53 million revenue hit? Any thoughts on those issues?

Scott this is Mike O'Donnell.

You're right. It is a single variable model, but we back test that with a considerable amount of history, so we're fairly confident that the weather portion of that is correct. One of the things that has accelerated over the last couple of years, as you know, is the increased decline in usage, and we continue to study that and wish we had more information than we do, but we're confident in the numbers and the split between weather and usage.

Okay. Great. Thanks.

Your next question comes from the line of [Shnur Gursahani], with UBS Securities.

Good morning, guys. Just had a couple of quick questions.

With respect to the Millennium Pipeline, I noticed you just mentioned to the previous caller that it was going to be in service as you expect at this point right now. Can we assume that basically any delays would be associated with the Islander East section? Or is there any other items that we should be looking for when we're thinking about the in-service date with Millennium?

No, I don't believe Islander East will have a negative impact or delay it. I would go back to the prepared comments. We're still working on cost estimates. We're still working with a handful of counties on tax abatements and obviously, we need to clear this last hurdle on FERC certification. So those are the most notable variables out there at this point.

Should we be -- but should we be paying attention to the dispute with the Attorney General of Connecticut with respect to Islander East?

Again, I don't believe that's going to pose a delay for go-forward for Millennium at this point. We feel that the court decision was favorable. We're hopeful Islander East will get resolved quickly, but we don't see that being a material problem or point of delay for our project.

Okay.

In the last quarter, you were pretty concerned about the potential for customer attrition and so forth. What are your views at this point right now? Is it a little less than what you'd expected, in line, or it's tough to say, just due to the seasonality of the earth?

We're staying with the outlook we provided at the end of the second quarter. We're hopeful lower gas prices will help, but we just don't have a basis to predict behavior that would suggest that we're going to see a notable change from the outlook we've already given you.

Okay.

And not to beat the dead horse on Whiting. Just one last question. So basically, if my understanding, if I was to think about this, you're in a memorandum of understanding. You're basically at a point of crossing the t's and dotting the i's in terms of resolving how you plan for this to work out and you'll basically report to us as soon as something is more concrete that you can say?

That's accurate.

Okay. Thank you very much, guys.

Thank you.

Your next question comes from the line of [Mark Ryder with Partner RE Asset Management].

Yes, hi.

You had about 330 million of bonds that came due yesterday. I was just wondering if you were planning on refinancing them with some longer-term debt, whether or not you think that you'll get a better rate if you wait until after the strategic review?

And then also I was just curious if you had any plans to call or refi the 450 million of floating rate notes that are callable later this month? Thanks.

Mark, this is Mike O'Donnell again. The same answer for both. We're going to refinance those temporarily with amounts under our bank facility and then look to refinance in longer term early next year. The spreads, as you pointed out, are pretty high right now, and we don't think the market is going to run away from us. So we're pretty confident taking that into next year and then refinancing it sometime in 2007.

Perfect. Thank you.

[OPERATOR INSTRUCTIONS] and your next question comes from the line of [Matthew Legus] with Copia Capital.

Hi, good morning.

Good morning.

I had a question about Whiting for you. I was wondering if you could help me kind of understand what earnings looked like in '05, this year, and maybe next year, if you have a sense of that. And also if you guys make this into a definitive agreement, would kind of the loss go away in 2010 after this obligation goes away?

I'm going to hand this over to Mark. But I would remind you and other folks on the call that Whiting had a, relatively speaking, good year in 2005, the market was favorable and Whiting consequently benefited from a good 2005.

With that, I'll turn it over to Mike.

That's right, Bob. We can give you the actuals. I think it wouldn't be right for to us comment on the change from the B.P. amendment until we have it definitive. But year-to-date, the operating income loss from Whiting is about $18 million. Last year, which, as Bob said, was a very good year because of some market conditions that were better last year than this year, the loss for the whole year on an operating income basis was about 25 million.

Okay. Thanks.

And I guess just looking at next quarter. If you could kind of give us the sense of what maybe some key drivers you think are going to be?

Well, what we've suggested consistently is that customer usage and attrition will be the primary factors in how that quarter looks.

Okay. Thanks.

And one final question is, in the Gas Distribution operation side, I was just wondering about this change in the reserve balance for leased office space, kind of what that was and if it was material or not?

It's not really material, but several years ago, our main facility in Columbus, Ohio, we abandoned a floor -- or several floors of an office building we have in that location. This year, we put that -- put a floor or two floors back into service. When we did that, we had to reverse the reserve of about $5 million.

Okay, great. Thank you.

Your next question comes from the line of Peter Hark with Talon Capital.

Yes, good morning. Thank you.

Good morning.

Just a quick question again on the Whiting situation. I know you can't disclose too much, but I think I heard Bob say that whatever it winds up, you might be relieved of the steam obligation at Whiting Clean Energy. But would that be through an ability to provide steam another way, through another forum?

The answer to that would be yes. That's the contemplation.

Okay. So you'd be able, through some other capital spending, be able to put in a boiler, let's say, to provide steam for B.P. and thereby be able to reconstruct the contract to allow Whiting to operate independently then from B.P. itself?

Just to be clear. The contemplation would be that NiSource would be out of the steam business. B.P. would deal with that through its own means. And to your concluding point, yes, the facility would not be burdened or would not have that steam obligation associated with that facility.

Okay. But then effectively, does Whiting then become a fully merchant/merchant plant, effectively, in Indiana?

That's exactly right.

Okay.

We would be.

Okay.

And then the second question is on the strategic review process. And I believe you probably addressed this in the past, but I don't understand if you've gone any further. You've got about $3.7 billion of good will on the balance sheet and was wondering how that might be reconciled in any type of separation or any type of strategic attempts in that -- is there an opportunity for you to, for instance, write up assets that may or may not eliminate good will and put true equity on the balance sheet. Or would there be contemplated, potentially, some good will write-downs if, in fact, you were to separate?

Maybe the basic question first is, how does that good will today break out between the various subsidiaries?

This is Mike O'Donnell again.

The good will at $3.7 billion is a practical matter. Most of it relates to the acquisition of Columbia energy group, and then it's split between the segments but we don't break it down beyond that.

The second part of your question, how the good will would be a factor in the strategic project, it's really too soon to tell that. We're looking at every alternative that there is, and the accounting issues, hopefully, won't be the important part of the ultimate outcome.

All right, Mike. Thanks very much.

Ladies and gentlemen, at this time, we have no further questions.

Once again, thank you so much for participating, and we will talk to you in the not-too-distant future. Good morning.

Ladies and gentlemen, this does conclude today's NiSource third quarter financial results and business update conference call. At this time, all parties may now disconnect.