ONE Gas, Inc. Q3 FY2020 Earnings Call

Good morning. And thank you for joining us on our third quarter 2020 earnings conference call. This call is being webcast live and a replay will be made available later today. After our prepared remarks, we will be happy to take your questions. A reminder that these statements made during this call that might include ONE Gas expectations or predictions should be considered forward-looking statements and are covered under the Safe Harbor provision of the Securities Act of 1933 and 1934. Actual results could differ materially from those projected in any forward-looking statements and include, among others, statements about the length and severity of a pandemic or other health crises such as the outbreak of COVID-19. For a discussion of factors that could cause actual results to differ, please refer to our SEC filings. Joining us on the call this morning are Pierce Norton, President and Chief Executive Officer; Caron Lawhorn, Senior Vice President and Chief Financial Officer; Curtis Dinan, Senior Vice President and Chief Commercial Officer; and Sid McAnnally, Senior Vice President and Chief Operating Officer. And now, I will turn the call over to Caron.

Thanks, Brandon. Good morning, everyone. Yesterday, we announced that we updated our 2020 financial guidance, with net income and earnings per diluted share expected to be near the upper end of the ranges, which are $186 million to $198 million for net income and $3.44 to $3.68 for earnings per share. Our guidance for capital expenditures and asset removal costs remains $500 million to $525 million for the year. Turning to our actual results. Net income for the third quarter was $21.1 million or $0.39 per diluted share, compared with $17.5 million or $0.33 per diluted share in the same period of 2019. Our third quarter results reflect an increase in net margin of $5.2 million over the same period last year, which is primarily due to $3.7 million from new rates and $2.7 million in residential sales from net residential customer growth. Operating costs for the third quarter were $0.8 million higher compared to the same period last year. This includes an increase of $1.8 million in expenses related to our response to the COVID-19 pandemic and $1.5 million in employee-related costs. Offsetting a portion of those cost increases is a reduction in expenses for travel and employee training costs that have been impacted by the pandemic. We have not recorded any regulatory assets for financial accounting purposes pursuant to the accounting rules in all jurisdictions that allow us to defer for regulatory purposes certain net increases in expenses and lost revenues due to COVID-19. We continue to evaluate whether amounts expected to be recoverable under these accounting rules are both measurable and probable of recovery and we will record such amounts for financial accounting purposes when we meet that hurdle. Our guidance for 2020 does not assume that we will record any regulatory assets by the end of the year. Our capital expenditures and asset renewal cost decreased this quarter compared with the third quarter of last year simply due to timing. Yesterday, the ONE Gas board of directors declared a dividend of $0.54 per share and our authorized rate base reflecting our recent regulatory activity is approximately $3.71 billion as of September 30th. Authorized rate base is defined as the rate base reflected in completed regulatory proceedings including full rate cases and interim rate filings. We project that for 2020, our estimated average rate base, which is defined as authorized rate base plus additional investments in our system and other changes in the components of our rate base that are not yet reflected in approved regulatory filings will be approximately $3.91 billion with 42% of that in Oklahoma, 29% in Kansas, and 29% in Texas. We ended the quarter with adequate liquidity, which includes approximately $391 million of capacity in our commercial paper program and all of the capacity under our $250 million 364-day credit facility. Additionally, as of September 30, 2020, we have issued approximately $13 million of equity under the $250 million at-the-market equity program we put in place earlier this year. We have no plans to issue equity for the remainder of 2020. Now, I will turn it over to Curtis for a regulatory and commercial update.

Thank you, Caron, and good morning, everyone. First, I will provide an overview of recent regulatory activity and then provide an update on our commercial activities. Kansas Gas Service filed a Gas System Reliability Surcharge that seeks an increase in rate of approximately $7.5 million for capital expenditures incurred during the period covering July 2019 through June 2020. An order from the KCC is expected in December 2020 with new rates going into effect in January. Texas Gas Service filed a rate case in December 2019 for all customers in the Central Texas and Gulf Coast service areas seeking a rate increase and requesting to consolidate the two service areas. In August, the Railroad Commission approved all terms of a $10.3 million settlement, as well as consolidation of the Central Texas service area and the Gulf Coast service area into a new Central Gulf service area. This is a continuation of our strategy to consolidate jurisdictions which is a benefit to customers due primarily to a more efficient process. With this latest consolidation, we now have five jurisdictions in Texas, down from ten at the time of the spin-off in 2014. Moving on to our commercial activities. During our second quarter analyst call, I discussed the return to normal business levels for a couple of our large transport customers that had temporarily curtailed operations at the start of the pandemic and that we were not seeing any other significant disruptions with our transport customers. For the third quarter 2020, our transport revenues and volumes were above the same period of 2019. And on a year-to-date comparison between years, our transport revenues have erased the second quarter 2020 impact and are now flat year-over-year. We continue to see strong interest in natural gas from builders and developers. Capital spending to extend our service to reach new customers is the primary driver behind our increased capital expenditures guidance for 2020 as we described last quarter. Despite the pandemic, we are seeing positive economic signs across our footprint, particularly in Texas and Oklahoma. As an example, in the Austin area, there have been over 100 new business relocations or expansions announced thus far in 2020, which are expected to provide over 14,000 additional new jobs. This increase in economic activity across our territories has resulted in continued growth in our customer base. Year-to-date, we have averaged approximately 24,000 more sales customers than the same period last year. This increase includes the connection of 18,600 new customers, compared with 14,600 new customers in the same period last year or a 27% increase over last year’s pace. As I described during our last two quarterly analyst calls, the impact of the moratoriums on disconnects for non-payment by our customers, which expired in May in Oklahoma and Kansas, and early October in some areas of Texas has also impacted our average customer counts. And now, I will turn it over to Sid for an update on operations.

Thanks, Curtis. Our team in the field continues to adapt well to the current environment, with maintenance and compliance work on or ahead of schedule. Our supply chain remains uninterrupted and we see no forward constraints to our planned work. Thanks to steady performance by our resource management team related to materials and contractor resources. As Caron mentioned, while our capital spend was lower this quarter than the third quarter of last year, the issue is timing rather than performance. We have been pleased with the cadence of capital execution year-to-date with more consistent capital spend quarter-to-quarter than last year due to favorable weather and improved planning by our asset management, engineering, and field operations teams. We remain on track to meet our capital expenditure guidance as discussed earlier. And now, I will turn it over to Pierce.

Thank you, Caron, Curtis, and Sid. The pandemic has changed many things for many people. Our homes have become the place where we spend more and more time. Our customers take comfort in the warmth that our product provides, especially as we head into colder weather. As we are near the end of the year, it’s natural to reflect on how far we have come. For me, three things stand out: our resiliency, adaptability, and commitment to safety. Our performance this year demonstrates the resiliency of our business model and the continued value of natural gas as a preferred energy source for homes and businesses. This year we were able to grow our customer base, improve system integrity, and establish a remote workforce amidst great adversity. Despite the challenges brought on by the pandemic, our industry is accustomed to front-line response. Across our organization, we quickly implemented additional safety protocols and new processes designed to keep our employees and our customers safe during the pandemic. Thanks to the adaptability and diligence of each employee, we have continued providing service to our customers with minimal disruptions. Finally, in closing, I’d like to recognize the ONE Gas employees and give each of them a special thank you for their continued professionalism under stress, resolve when there is no clear end in sight, and poise in the face of uncertainty. We will get through this pandemic by relying on the values that we anchor our company to, as we address the challenges facing our business. Thank you all for joining us this morning. Operator, we are now ready for questions.

Hey. Good morning. Can you hear me okay?

We can. Good morning, Richard.

Hey. Thanks for taking my question. I was just curious how you guys are thinking about COVID into peak winter heating season here. And I realize OGS has a higher proportion of residential versus C&I transport customers. But how are you thinking about factoring the lingering impact especially with the resurgence of cases as you begin to look at your 2021 outlook and the moving pieces? And maybe just also comment on the equity means into next year as well.

Richard, let me start and throw to Curtis for the commercial part of that question and then Caron can come in in terms of the financing question. We have been preparing for winter since March. We understood that there was a high probability that we would see a second wave and that we would see some comingling of COVID and the flu. So our medical protocols were built with that in mind. We have not seen constraints in our service territories and our employees have done a remarkable job of proactively participating in our medical program to make sure that we could provide them with the best medical advice to keep them and their families and our customers safe, but also to allow us to tamp down any widespread unavailability of employees in any of our service territories. So we feel like we are well-prepared. We don’t say that spiking the ball on the 50. We recognize that there is a challenging time ahead of us, but we think we are as well prepared as we can be. So let me toss to Curtis to respond to the commercial question.

So, Richard, on the commercial side of things, as you know, we have a very high percent of our customer base being residential and then about 12% that’s our transport customers. So one of the things that I noted in my comments is that we are really not seeing an impact at this point from our transport customers, so we have seemed to have returned to a normal level of operations and have actually closed the gap with the activity we saw in the third quarter, closing the gap from what we saw during the second quarter of this year. On the residential side of things, I think we are well prepared in our customer call centers to handle the call volume that we typically run into this time of the year. One of the good things about the moratoriums being lifted when they were at the end of May for Oklahoma and Kansas, and a little bit later in Texas, is that, while those moratoriums were in place, the operations teams were able to divert those resources to handle a lot of our other normal annual activities and to get ahead of those activities such that when the moratoriums were lifted we were able to focus more of our resources on the disconnect process, which helped with our collections through that period. So several factors that we had to remain agile to handle during the year, but cooperation and the work between our commercial operations teams helped us work through that part of it to be ready when we could again resume disconnects and that’s helped our overall process. The last piece I would say is, as Caron talked about, we do have the regulatory accounting orders in each of our jurisdictions. We will continue to monitor the activities for increased expenses, as well as areas where we have been able to decrease expenses, so that we can continue to accumulate those until we are able to go through the regulatory process to begin the recovery of those.

I will pick up on the financing question. We have not updated our longer-term guidance for financing, which currently is that we anticipate $850 million to $900 million of net worth with about a quarter of that being equity. When we issue our guidance for 2021, which we expect to do probably sometime after the first of the year, we will provide a closer look on what 2021 looks like.

Okay. Got it. That’s very helpful. Appreciate all the color there. And maybe just switching gears here, obviously, with elections on top of mind, just curious how you are thinking about decarbonization goals and just given really some of the potential for electrification and buildings and some of the supply and cost constraints on the R&D side, I mean, is that really the solution or is the green hydrogen potentially a more likely candidate? Just maybe curious if you can provide some thoughts overall on the timing and when we can see more formal adoption of these technologies?

Thank you for the question, Richard. This is Curtis again. On the commercial side, I've previously mentioned our work on renewable natural gas. We are engaging with various projects and developers, some of which already capture RNG for alternative uses. Our goal is to enhance the commercial viability of that captured gas by integrating it into our system, allowing it to be used as a substitute for diesel or other products via compressed natural gas. We're actively exploring this, and I hope to see some of these projects advance in the coming year. We've demonstrated the commercial potential of these initiatives and established the necessary gas standards to incorporate this product into our system. Additionally, we are involved in a large-scale hydrogen project with the University of Texas and other partners, including the Department of Energy. This project focuses on producing hydrogen from both renewable energy sources and landfill gas, which we plan to use to power a computer center at the University of Texas and furnish fuel for hydrogen fuel cell vehicles. This initiative started in mid-2020 and is projected to last about three years, showing promising results so far. I will now hand over to Sid, who can provide more insights into our operations and what we are observing in that area.

Yeah. Richard, thank you for the question. As you know, there is a commercial component to this and R&D component, as you point out. But there are also some practical implications that companies need to consider as emergent opportunities like hydrogen start to be developed. We have two working groups in place currently. One is looking at technical issues including the engineering implications. There will be policies and procedures around hydrogen use. And there are also some system integrity implications to make sure that you can introduce hydrogen at the proper blending rate and handle that safely in terms of continuing to focus on safety of our system. The second is a really interesting working group that is looking at the gas supply implications. Hydrogen is a different material to compress and transport. And so the location and manufacturing facilities come into play. We are scoping all of that right now and excited about continuing the conversation.

All right. Thanks very much for all the color there. That’s all I have.

Good morning.

Good morning, Aga.

Could you give us an update on bad debt and how is it trending this year as we head into winter?

Sure. Good morning, Aga. This is Caron. We are still dealing with the impact of COVID, as Curtis mentioned regarding our collections activity. We currently have $8.8 million in bad debt expense for the first nine months, compared to $4.6 million last year, showing an increase of about $4 million year-over-year. We are closely monitoring the situation because there are still moratoriums in place in some service areas. Until we can return to normal collections activities for a sustained period, it will be challenging to fully assess the impact.

Okay. And how does the change in Kansas related to eliminating state income taxes from rates could impact ONE Gas’ cash flow going forward?

We don’t expect it to have a material impact in the scheme of things. It’s not a significant event in our overall tax picture. The elimination of the state income tax is not a large event.

Okay. And last question from me, to follow up on Richard’s question regarding decarbonization. Is there a regulatory framework in place to invest in RNG across your jurisdictions being a third established to potentially cover some additional costs related to investment in R&D and the quality outcome?

RNG is included in the tariffs in Texas and is considered a recoverable gas cost. Previously, it was part of the gas supply discussion. In Oklahoma, there was legislation introduced recently to require the commission to study RNG and explore ways to incorporate it into the state's gas supply. However, due to the pandemic, the bill wasn’t fully considered during the session. Additionally, the Oklahoma Corporation Commission has initiated a notice of inquiry on various energy issues, including renewable natural gas, to determine how the state and commission should approach it. There are movements in that direction at the state level, especially in Texas and Oklahoma, though there is less progress in Kansas at this time.

Thank you for the color and stay safe.

Thank you, Aga.

Thank you all again for your interest in ONE Gas. Our quiet period for the fourth quarter starts when we close our books in early January and extends until we release earnings in February. We will provide details on the conference call later dates. Have a great day.

This concludes today’s call. Thank you for your participation. You may now disconnect.