Mdu Resources Group Inc Q3 FY2023 Earnings Call

Hello. My name is Cynthia, and I will be your conference facilitator. At this time, I would like to welcome everyone to the MDU Resources Group 2023 Third Quarter Conference Call. All lines have been placed on mute to prevent background noise. After the speakers' remarks, there will be a question and answer period. The webcast can be accessed at www.mdu.com under the Investor Relations heading. Select Events and Presentations and click Q3 2023 Earnings Conference Call. After the conclusion of the webcast, a replay will be available at the same location. I would now like to turn the conference over to Jason Vollmer, Vice President, Chief Financial Officer and Treasurer of MDU Resources Group. Thank you. Mr. Vollmer, you may begin your conference.

Thank you, Cynthia, and welcome, everyone, to our third quarter 2023 earnings conference call. You can find our earnings release and supplemental materials for this call on our website at www.mdu.com under the Investor Relations tab. Leading today's discussion along with me will be Dave Goodin, President and CEO of MDU Resources. Also with us today to answer questions following our prepared remarks are Stephanie Barth, Vice President, Chief Accounting Officer and Controller of MDU Resources; Nicole Kivisto, President and CEO of our Utility Group; Rob Johnson, President of WBI Energy; and Jeff Thiede, President and CEO of MDU Construction Services Group. During our call, we will make certain forward-looking statements within the meaning of Section 21E of the Securities Exchange Act of 1934. Although the company believes that its expectations and beliefs are based on reasonable assumptions, actual results may differ materially. For more information about the risks and uncertainties that could cause our results to vary from any forward-looking statements, please refer to our most recent SEC filings. We may also refer to certain non-GAAP information. For a reconciliation of any non-GAAP information to the appropriate GAAP measure, please reference our earnings news release. Along with our earnings release this morning, we announced in a separate news release that our Board of Directors approved a plan to spin off our Construction Services business to the shareholders of MDU Resources, which will result in two independent publicly traded companies. The spin-off is expected to be tax-free to MDU Resources and its shareholders and be completed in late 2024. You can also find this release on our website at www.mdu.com. Dave will provide additional information on the spin-off later during the call. Prior to handing the call over to Dave for his formal comments and his forward look, I will provide consolidated financial results for the third quarter. This morning, we announced third quarter earnings of $74.9 million or $0.37 per share on a GAAP basis compared to third quarter 2022 GAAP earnings of $147.9 million or $0.73 per share. Third quarter income from continuing operations was $78.2 million or $0.38 per share compared to $42.3 million or $0.21 per share in 2022. It's important to note that with the spinoff of Knife River being completed, Knife River's results and other related impacts are reported as discontinued operations in our GAAP-based results for the current and prior year. As such, with the completion of the Knife River spin-off and work continuing on the Construction Services spin-off, we are also reporting adjusted income from continuing operations to provide financial results that more closely correlate to and better outline the strength of our ongoing business operations. These adjustments reflect the May 31 spin-off of approximately 90% of the outstanding shares of Knife River Corporation including the unrealized gain on the retained shares as well as other items related to our strategic initiatives. For more information on these adjustments, please see the table provided on Page 7 of our earnings news release. We experienced very strong results from all of our businesses in the third quarter with adjusted income from continuing operations of $58.6 million or $0.29 per share compared to third quarter 2022 adjusted income from continuing operations of $42.3 million or $0.21 per share. Turning to our individual businesses. Our combined Utility business reported earnings of $3.2 million for the quarter compared to earnings of $3.5 million in the third quarter of 2022. The Electric Utility segment reported third quarter earnings of $20.9 million compared to $21.6 million for the same period in 2022. The decrease was largely a result of lower residential volumes due to cooler weather and higher operation and maintenance expense, primarily payroll-related costs. Partially offsetting the decrease were higher retail sales revenue due to rate relief in North Dakota and Montana and an electric service agreement to provide power to a data center near Ellendale, North Dakota, and also higher transmission revenue. Our Natural Gas utility reported a seasonal loss of $17.7 million in the third quarter compared to a loss of $18.1 million in the third quarter of 2022. Earnings increased due to short-term debt interest recovery in Idaho, rate relief in Idaho and Washington, which were partially offset by higher operation and maintenance expense, primarily payroll-related costs. The business also experienced a 9.3% decrease in retail sales volumes to all customer classes due to seasonal weather patterns, which was partially offset by our weather normalization and decoupling mechanisms. The pipeline business earned record third quarter earnings of $11.9 million compared to $9.8 million in the third quarter last year. The earnings increase was driven by higher transportation revenue primarily the result of increased contracted volume commitments from the North Bakken Expansion project as well as higher storage-related revenue and new transportation and storage service settlement rates that were effective August 1. The increase was offset in part by higher operation and maintenance expense, primarily payroll-related costs. Interest expense also increased as a result of higher rates and higher debt balances. Construction services reported record third quarter earnings of $36 million compared to earnings of $28 million for the same period in 2022. EBITDA for the quarter increased $14.1 million compared to the prior year to a third quarter record of $58 million. Gross profit increased due to project mix in the commercial, renewable, institutional and utility markets, offset in part by lower industrial gross profit. This business also had higher selling, general and administrative costs, largely higher payroll-related expenses and higher interest expense from increased working capital needs and higher interest rates. That summarizes the financial highlights for the quarter. And now I'd like to turn the call over to Dave for his formal remarks.

Thank you, Jason, and thank you, everyone, for joining us today and for your ongoing interest in MDU Resources. Today marks an exciting moment for our company as we reveal our plan to spin off the Construction Services business from MDU Resources. On November 3 of last year, we initiated a strategic review of this business, which culminated in our announcement on July 10 this year about pursuing a tax-advantaged separation. At that point, we aimed to establish the best method and timeline for the separation, which we are thrilled to share today. We anticipate that this spin-off will greatly enhance the value within our businesses and help us achieve our goal of transforming MDU Resources into a pure-play regulated energy delivery company. I will begin by discussing our third-quarter results and outlook for each of our businesses before giving an overview of the spin-off announcement. Our strong third-quarter results continue the impressive performance we have seen throughout 2023 across all of our companies. We faced an active regulatory schedule in 2023 for our regulated energy delivery sectors and are benefiting from new rate implementations in our Electric, Natural Gas, and Pipeline divisions. Our Construction Services business is also achieving record results and has a robust backlog as we approach the year's end, with all of our divisions presenting promising opportunities for growth. In our Utility business, electric retail sales volumes for the third quarter rose by 36.6% compared to last year, while year-to-date figures are 23% higher than in 2022. This rise primarily reflects our service to a data center customer that came online in the second quarter of '23. We have also submitted a request to the North Dakota Public Service Commission to serve another data center that is expected to launch in 2024. We anticipate that Heskett Unit IV will be operational before the year ends, as construction on the 88-megawatt natural gas-fired electric generating facility near Mandan, North Dakota is nearly complete and currently undergoing testing. We expect to see a growth rate of 6% to 7% compounded annually in our electric and gas business over the next five years, fueled by investments in system upgrades and replacements to safely meet customer demand. In August, we received approval for a settlement in our Montana electric case, with rates taking effect on October 1. That same month, we filed for electric and natural gas rate cases in South Dakota, followed by a natural gas rate case in North Dakota on November 1. Our Utility continues to strive for timely regulatory recovery for investments that support safe and reliable electric and natural gas services to our expanding customer base, including a multiyear case that we plan to file in the first quarter of 2024 in Washington. In our Pipeline sector, we achieved record earnings for the quarter and year-to-date, with earnings 19% higher than in the same period last year. This division also reported another record quarter in Natural Gas transportation volumes due to increased contracted commitments for our North Bakken expansion project. In August, we settled our rate case with customers and FERC staff, and the new rates, pending final approval from FERC, took effect on August 1, expected to yield a 7% revenue increase, approximately $10 million annually. We commenced construction in Q2 on three natural gas Pipeline Expansion projects, with two recently placed into service, adding 119 million cubic feet per day of transportation capacity. The third project is expected to be completed in early 2024, contributing an additional capacity of 175 million cubic feet per day. On October 19, WBI received FERC approval for its Wahpeton Expansion project slated for Eastern North Dakota, adding another 20 million cubic feet per day of capacity. This project, supported by long-term customer commitments, is expected to cost around $75 million and be operational by late 2024. Given our strong start in our regulated energy delivery sectors, we are increasing our earnings guidance for these businesses to a range of $155 million to $165 million, up $5 million from our previous projections of $150 million to $160 million. As highlighted earlier, our Construction Services business continues to see record results and persistent demand. We achieved record earnings and EBITDA in the third quarter, with year-to-date earnings and EBITDA rising by 20% and 21% respectively compared to last year. Gross profit increased in both our E&M and T&D segments, and our backlog remains strong at $1.85 billion. We are positioned well to safely and efficiently complete our projects, supported by a skilled workforce of over 8,000 employees. We are reaffirming our 2023 revenue guidance to be between $2.8 billion and $3 billion, and we now expect higher margins compared to 2022. We are also refining our EBITDA guidance to a range of $210 million to $230 million, up from $200 million to $225 million. Looking ahead, our Construction Services division stands to gain from increased bidding opportunities due to funding from the Infrastructure Investment and Jobs Act and the Inflation Reduction Act, anticipating heightened demand through 2023 and beyond. Overall, as we look forward, we are optimistic about our growth opportunities in electric and natural gas utilities, a strong slate of pipeline expansion projects, and steady demand for our construction services. Now, concerning our earlier announcement about the spin-off of our wholly owned Construction Services business, MDU Construction Service Group will separate into two independent publicly traded companies. This separation will enable each company to focus strategically on their industry-specific opportunities and employ tailored equity to enhance acquisition programs and workforce retention. Both entities will benefit from distinct capital structures and financial policies aligned with their business profiles and needs, granting them greater flexibility to utilize capital for their specific growth opportunities through customized capital allocation strategies. We believe this separation will offer investors two attractive investment opportunities, allowing the investment community to evaluate each business more effectively based on their operational and financial characteristics. MDU Resources is dedicated to establishing robust capital allocation strategies for each business in line with their long-term goals. After the spin-off, MDU Resources plans to maintain a long-term dividend payout ratio target of 60% to 70% of regulated energy delivery earnings. The dividend policy for MDU Construction Services Group will be determined in the future following the company’s stated capital allocation strategies. More details regarding capital structure, governance, and other aspects of the spin-off will be provided later. Once the spin-off is finalized, MDU Resources shareholders will keep their current shares of MDU Resources and receive a pro rata distribution of shares of MDU Construction Service Group stock. We expect to complete the spin-off in late 2024, subject to certain conditions detailed in the news release. Further information on the transaction will follow as we work diligently toward completing the spin-off. In light of today's announcement and to provide a comprehensive update on the Construction Services spin-off, as well as our pure-play regulated energy delivery strategy, we are rescheduling our Investor Day to the first quarter of 2024. MDU Resources remains committed to operating with integrity and focusing on safety while delivering exceptional shareholder value, providing essential products and services to our customers and communities, and maintaining a safe and fulfilling work environment. Lastly, I want to mention my upcoming retirement as President and CEO, as noted in an earlier release, with Nicole Kivisto being named my successor. I have full confidence in Nicole's ability to excel in this role and lead MDU Resources moving forward. With our future as a pure-play regulated entity, her strategic insights and experience will benefit the company. Personally, it has been a privilege to be part of this organization for the past 40 years, and I am proud of our achievements together. I plan to stay on until January 5, and as this is my last quarterly earnings call before then, I want to express my gratitude to everyone I have had the pleasure to work with throughout my career. I appreciate your interest in and dedication to MDU Resources, and now we will open the line for questions.

Your first question comes from Dariusz Lozny with Bank of America. Please go ahead.

Dave, regarding the spin that was announced today, could you share more about the process you went through? I know you explored several tax-advantaged strategies before settling on this one. Were there any other options you considered? Additionally, if possible, can you discuss any potential challenges you foresee from the spin-off, such as increased public company costs for the smaller standalone CSG?

Yes, yes, certainly. So specific to the spend areas, certainly, this has been a strategic review focus of ours really for the last year, and as we updated the market back in mid-July as to our look to a tax-advantaged separation of the business. Clearly, today, we're more clearly defining that as a tax-free spin of the business. We have looked to effectuate by late 2024. And so I would say we looked at the broad range of possibilities there. Ultimately, along with our Board, we decided that we believe for the best method to optimize the value and likely create the most value for this business is to do what we just really did with Knife River. Essentially, we've created some institutional knowledge there as well. But ultimately, we do believe a tax-free separation via spin is looking to optimize the value of the business.

And I can jump in on the dissynergies question, Dariusz. This is Jason. As we look at this, you're correct. As we think about separating and standing up a separate public company here, there would be some additional public company costs. CSG pays a portion of those today as a segment of the MDU Resources companies here, but I will bear the full load of that, you could say on a stand-alone basis. What I would say is that we will provide more updates on that as we put together our Form-10 and get ready to show the pro forma financial information. But in addition, I think that was a piece of the decision-making process that we looked through here as well. And we really feel the benefits of a stand-alone business here and separating these businesses by far outweigh any dis-synergy type expenses that we would see in the valuation of the business.

Maybe just one more around that transaction. As far as RemainCo, MDU, I know you guys will give more fulsome updates in the future. But I mean, it'll probably look in terms of business mix, risk profile, probably similar to some publicly traded peers. Do you anticipate a similar capital structure and financing mix as some of your publicly traded mostly regulated peers?

Yes, Dariusz, this is Jason again. I think you're correct. We're looking at a pure-play regulated entity on a go-forward basis. And I think the capital structure and the financing, and as Dave mentioned, one of the benefits of these separations is as we look at separating the services business via spin-off to really give each of these companies a distinct capital structure that really makes them competitive within the industries that they participate.

I have one more question regarding the CSG results that were reported. It appears there has been a slight decline in the revenue and gross margin contribution from your industrial customers. I'm curious if this might be due to timing, a quirk of the backlog, or if you're noticing any kind of trend related to this.

Thanks for that question, Dariusz. Jeff's on the line, I'll have him dig into that detail.

You hit it right on the head, Dariusz with the semiconductor work that we have completed is going to be followed by additional work in this area. We've got great people and historical success with the relationship from several of our customers. We are in more geographic locations, not just in the Pacific Northwest, but also in the Southwest, and also in the Ohio area, where we expect continued workloads and available work packages, and we do have the resources to be able to accomplish that work and we'll look forward to rebuilding that. But yes, that was just a point in time.

Dariusz, if I could maybe just add a little bit. I think your point about one segment having a certain type of quarter, certainly offset by other segments in that business as we think kind of top line in that business at CSG, again, the record quarter, the record EBITDA and the year-to-date results, we feel very confident in that as we think about the rest of the year. Any other questions or follow-up, Dariusz?

No, not at this time. I'll let others in the queue ask. I'll just say congratulations to Dave and also to Nicole on the appointment. Thank you very much.

Thank you, Dariusz.

Your next question comes from the line of Chris Ellinghaus with Siebert Williams Shank.

Congratulations to Nicole and Dave, and thank you for all the great conversations over the years, Dave. I appreciate it. Can you discuss what led you to change the timing of your Analyst Day update?

Chris, appreciate the commentary earlier. I appreciate working with you over the years here as well. So we just felt given today's announcement and the timing of this clarity, if you will, on how we're looking to separate the Construction Services business and the timing of that slated for late 2024 that we just felt probably first quarter '24 would just be a more appropriate timing to give a more fulsome update into the marketplace, more kind of what the RemainCo story looks like and how that can kind of build on itself along with greater clarity on Construction Services. And there's a number of end markets there to be describing. And I think in our opinion, there'd be enhanced investor interest as knowing the separation being a separate publicly traded company, which is our target. We just thought there was probably a more appropriate timing.

When you get to that late first quarter meeting, do you anticipate having greater clarity on the form that the transaction might take?

That's certainly part of this as we work through this, and we would expect to have participants, all the principles of those business units, certainly Nicole leading the group, but the electric and gas business and the pipeline business is the RemainCo story. And then obviously, Jeff and his team are part of the CSG SpinCo story.

And one last question for Jeff. Jeff, has the sort of improvement in your outlook for margins this year, throughout the year, given you any insights into what your outlook for next year might look like?

I'm very confident in our ability to maintain strong performance, reaching record levels for our company. Part of our margin improvement comes from updating our Master Service Agreements and jobs in preconstruction, allowing us to adjust for labor, fuel, and equipment cost increases. Additionally, our execution in the field is vital to our business, and we've made significant progress through our prefabrication initiatives and improved planning. Our field personnel and management team have all stepped up, putting us in a strong position to move forward and continue delivering exceptional value to our shareholders.

Your next question comes from the line of Ryan Levine with Citi. Please go ahead.

I guess to start off, in terms of the timeline, so you highlighted that the intention to do the spin by the end of next year. What are the key milestones that really need to be achieved to hit that deadline? And in the disclosed material, there was a reference to private letter rulings and other contingent items. What's the challenge there? What's the confidence level that you're going to be able to achieve the targeted timeline?

Ryan, I'm going to ask Jason Vollmer to lead off there. Jason really led from an internal perspective, our Knife River spin and all the activities associated with that. And coincidentally, I've asked him to lead this effort. So I'll ask Jason because he can talk with detail there, but I think you're looking for the high-level work streams here.

Yes, absolutely. I can go into a few of those details. You're correct that there are significant items we need to address, such as the possibility of a private letter ruling, the Form-10 process, and navigating the SEC comment process. We aim to set this up by preparing financial statements and ensuring everything is audited and appropriately separated while developing our investor narrative and forecasts. The good news is that we have a lot of experience with these matters. We recently completed the Knife River transaction, which we believe we accomplished in a timely fashion, establishing a successful stand-alone company. We have applied many lessons learned from that process to the CSG task at hand, setting what we consider an ambitious yet achievable timeline to reach our objectives. We are very confident in our team's capacity to navigate this and finish it promptly. We believe this timeframe provides us with an excellent opportunity to perform the necessary due diligence on the project and position it as a very successful public company.

And I guess recognizing that some of the final capital structure is to be determined, but maybe moving to the fundamental business for CSG on a go-forward basis. Can you speak to where you think the backlog mix will be within the next year in terms of different customer types or industries that you're targeting?

Yes, Ryan, I'll ask Jeff Thiede to comment on kind of a future look at backlog and certainly split between T&D and E&M as we think about the major segments of that business. Jeff?

Our backlog has always been broad-based. You're currently building some of the most innovative and largest projects in multiple geographic regions and in the markets that we serve. And these projects include, but are really not limited to mission-critical data center work, semiconductor manufacturing, health care, renewables, and of course, hospitality gaming projects in the entertainment sector. There are more of these types of projects on our radar in the future. In our T&D sector, Transmission and Distribution work, including wildfire mitigation, traffic signal work are on our top 10 backlog list. And we are currently underway on two significant transportation projects in the Kansas City area in addition to our MSA and substation work for our utility customers. Again, this illustrates our diversification as a company and how we have the ability to capitalize on the current market and then, of course, pivot to expanding markets for continued success I see more of the same type of work. But as markets adjust, we will allocate those resources, and that will include, of course, capturing some more of the Infrastructure Investment and Jobs Act and the Inflation Reduction Act work. We have the experience in these areas and will continue to be positioned for those to be adding those projects and those opportunities in our backlog and executing successfully.

And then one follow-up. In terms of that mix, particularly on the renewable and utility work. Are you seeing any slippage in the timeline or delay in projects as you're looking out over the next 12 months?

We're not seeing any project delays over the next 12 months. So that's all positive. We are in preconstruction on more than several projects that are going to add to our backlog going forward. So looking forward to continuing that momentum and building upon our Q3 record performance.

Your next question comes from Brian Russo with Sidoti. Please go ahead.

Just a follow-up on the renewables. Just looking at the third quarter revenue, it looks like renewables were down on CSG, of course, was down quite significantly. And again, it was down for the 9 months ended September. While I see margins up, I just thought if you could just comment on the revenue trends there. If you're seeing any near-term slowdown or projects being pushed to the right.

Jeff?

We had a large project completed in Las Vegas. We've also picked up additional work in the renewable solar area in Ohio and in the Midwest. We do have several projects on our radar screen in the Midwest and are currently also looking for an increase of our backlog in the renewable solar market in the Las Vegas area going forward. We did complete two very significant projects in the Pacific Northwest, and those projects are completed. And I think that's what is affecting the numbers that we've reported out here. So we have the capabilities on the solar workforce also for the EVs, electrical vehicle, we've worked in manufacturing facilities. We've done quite a few of the charging stations. So we've got the experience. We see that this is a good opportunity going forward. We're positioned well for it, and we'll be able to build upon that as those opportunities come forward.

And then switching topics regarding rate cases and what has already been completed. The only remaining case is the Washington gas case, which I believe accounts for about 20% to 25% of your overall utility operations. Could you provide more details about the accumulating rate base or remind us when the test year of the last concluded rate case was?

I can go ahead and take that. Thanks for the question, Brian. So yes, I'm really proud of the team's work as we think about the overall regulatory activity that we have undertaken, obviously, a lot of that was highlighted in the news release. So you have seen what we've done historically, and certainly, that has added to our ability to improve our ROE over the last trailing 12 months. So really proud of the team's work there. In terms of your question on go ahead, what we're doing in the ensuing year. Yes, the one we've highlighted in the remarks is the Washington multiyear case. So this will be the first year that we'd be using the multiyear case in that state. We recently implemented rates in the state here last year and we'll be filing for the multiyear case here next year. In addition to Washington, though, I would comment that we are looking at three other states for filings later in the year next year. So most likely, we would be filing additional to Washington and three other gas jurisdictions. With respect to the overall percentage, you've got that approximately right. But keep in mind that we've got Washington and Oregon that operate under the Cascade brand. So Washington would be the larger state of those two. Did that answer your question?

Yes, it did. And just one quick follow-up. I think in Washington state, is it an 11-month statutory period to conclude rate cases you file in early '24, we can assume that you'll have full rates in effect in 2025.

You are correct. It's an 11-month statutory. So if we file in the first quarter, whatever date we filed, 11 months from there would be the assumed implementation date.

And then switching to the transmission. MISO Tranche 1 projects that you're working on. Any updates on the development there? Is everything on time and on schedule and aligned with your capital forecast?

We have been working with our partner and have hosted several open houses in some of the communities that would be in the line of sight in terms of that project. Everything right now, it's obviously early stages, but everything right now is on time, and we have not changed the overall budget. So as a reminder, a partner on that project. Total project costs are estimated at $440 million, our share of which would be $220 million, and that is included in our forecast and will continue to be included at that rate as we think about a new updated forecast that we would be bringing to the market here later in November.

And Dave, good luck in your future. Appreciate working with you.

Thank you very much, Brian.

Your next question comes from the line of Dariusz Lozny with Bank of America. Please go ahead.

Well, thank you all for taking the time to join us here on this third quarter earnings call. We are excited about today's announcement of the planned spin-off of MDU Construction Services Group. And look forward to keeping you updated as we progress through the separation process. We are optimistic about our growth opportunities and future regulated energy delivery projects and excited about the strong demand and performance of our construction service business. We thank you again and appreciate your continued interest in and support of MDU Resources. And with that, I'll turn it back to you, the operator, Cynthia. Thanks again.

This concludes today's MDU Resources Group conference call. Thank you for your participation. You may now disconnect.