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spectra energy _1Q07Transcript


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spectra energy _1Q07Transcript

  1. 1. Spectra Energy Conference Call May 8, 2007 Page 1 of 13 Spectra Energy Conference Call May 8, 2007 John Arensdorf: Good morning, and welcome to Spectra Energy’s first quarter 2007 earnings review. Thank you for joining us today on this our first ever quarterly conference call as Spectra Energy. Leading our discussion today are Fred Fowler, our president and chief executive officer, and Greg Ebel, our chief financial officer. Also available to take your questions at the end of the call are Martha Wyrsch, president and CEO of Spectra Energy Transmission, and Sabra Harrington, our vice president and controller. Fred will begin our discussion today by providing his perspective on our results for first quarter. Greg will then provide more detail and context around our company’s results, and those of each of our business segments. Fred will close with a discussion of some of our key capital projects. Following our prepared remarks we will open the lines for your questions. Before we begin, let me take a moment to remind you that some of the things we will discuss today concern future company performance and include forward looking statements within the meanings of the securities laws. Actual results may materially differ from those discussed in these forward looking statements, and you should refer to the additional information contained in Spectra Energy’s form 10K, filed with the SEC on April 2, and our other SEC filings concerning factors that could cause these results to be different than contemplated in today’s discussion. In addition, today’s discussion includes certain non-gap financial measures as defined by the SEC regulation G. A reconciliation of those measures to the most directly comparable gap measures is available on our investor relations web site, at
  2. 2. Spectra Energy Conference Call May 8, 2007 Page 2 of 13 And finally, I want to remind you that Spectra Energy Partners filed an S1 on March 30 to IPO a portion of our newly formed MLP. As such, regulatory requirements do not permit us to comment on the MLP beyond our prepared remarks. You may access Spectra Energy Partners filings on the SEC website. With that, I will turn the call over to Fred. Fred: Thanks, John, and good morning everyone. Our first year is off to a good start, and I am very pleased with our accomplishments over the last four months. Since January 1, we have put in place the infrastructure needed to stand alone, but I think more importantly, to boldly move forward. I am pleased with our first quarter operating results which you will hear more about shortly. Our U.S. Transmission and our distribution segments each contributed solid financial results this quarter. One challenge we did encounter this quarter was the severity of this winter’s impact on operations in our Field Services business. While you might normally think of cold weather as being good for volumes, the severity of the weather caused problems with well freeze-offs, as well as other operational difficulties, which did reduce the volumes that we processed. The good news is that operations were closer to normal by the end of the first quarter. While commodity prices are typically weaker in the first quarter, that weakness was a little more pronounced this year than in recent years. The average oil price of $58 for the first quarter was about $10 below our forecast for the year. Fortunately, commodity prices have strengthened, and the 12-month strip for oil is now in the mid $60’s again. If today’s forward strip and the improved correlations between natural gas liquids and crude are realized for the rest of the year, we should be very close to the EBIT numbers that we gave you last fall for DCP Midstream. Our solid first quarter operating results overall put us on firm footing to achieve our goals. We are well on track to meet our three-year, $3 billion capital expansion plans, which will drive our stated goal of five to seven percent compound annual EPS growth for the period 2007 through 2009. I will update you on the progress that we are making on several of our more significant projects a little later in the call. Let me reiterate our dedication to delivering solid, sustainable shareholder value. We have targeted a dividend payout ratio of approximately 60 percent, with an annual dividend of $0.88 per share. We paid our first quarterly dividend of $0.22
  3. 3. Spectra Energy Conference Call May 8, 2007 Page 3 of 13 per share on March 15, and we declared our second quarter dividend on April 4. And as our earnings grow, we would expect our dividend to grow as well. With just four months under our belt, Spectra Energy has distinguished itself as one of the premier pure-play midstream natural gas companies in North America. I am very proud of the efforts of my leadership team and everyone at Spectra Energy in executing a successful spin-off while staying firmly focused on delivering long-term value to our shareholders. I know that you are all anxious to hear about the numbers, so let me turn things over to Greg who will discuss our quarterly performance in more detail. Greg: Thanks, Fred. Earlier this morning, Spectra Energy reported first quarter 2007 earnings of $236 million, or $0.37 per diluted share, compared with earnings of $222 million in the first quarter of 2006. This quarter’s results included the negative impact of special items of $4 million related to the Spectra Energy spinoff, compared to a net $3 million positive impact for discontinued operations and special items in the prior year quarter. Ongoing earnings were up 10 percent over first quarter 2006, reflecting strong operational results in our U.S. Transmission and our Distribution segments. We also benefited from a lower net effective tax rate. Those increases were partially offset by lower processing revenues in western Canada and the impact of weather- related challenges, and lower commodity prices at our Field Services segment, which Fred mentioned earlier. As a reminder, prior year results are those of Spectra Energy Capital, previously known as Duke Capital. Also, you will note that we have no EPS data for 2006 since, as you know, we had no shares outstanding prior to January 2, 2007. I will now discuss each business segment in a little more detail. U.S. Transmission U.S. Transmission reported first quarter 2007 EBIT, of $220 million, compared with $235 million in first quarter 2006. The decrease is primarily due to a favorable special item in last year’s results of $24 million, related to the settlement of a customer transportation contract. Absent that special item, ongoing EBIT from first quarter 2007 was $220 million, compared with $211 million in the previous year’s quarter. The increase is
  4. 4. Spectra Energy Conference Call May 8, 2007 Page 4 of 13 primarily due to a combination of lower operating expenses, and higher revenues from improved storage prices and expansion projects, partially offset by lower natural gas processing revenues associated with pipeline operations. The key item contributing to lower operating expenses this quarter was the capitalization of expansion project development costs incurred in prior years. As we’ve previously discussed with you, when we start projects, we expense the costs until we are comfortable that the project will move forward to successful completion. At that time we reverse the expenses and capitalize those development costs. All in all, it was a good solid quarter for our U.S. Transmission business. Gas Distribution Gas Distribution reported strong first quarter 2007 EBIT of $144 million, compared with $118 million in the first quarter of 2006, or a 22 percent increase. This increase primarily reflects the return to more normal weather, the increase in distribution rates, and higher storage revenues. First quarter 2007 natural gas usage at Union Gas increased as a result of weather, which was closer to normal this year and nearly 12 percent colder than last year. Distribution margins also benefited as a result in an increase in our 2007 cost of service rates. Storage results were also higher this quarter, reflecting strong storage values. Also contributing to the improvement this quarter was the additional capacity on the Dawn Trafalgar pipeline. Phase 1 of our three-phase project was commissioned at the end of fourth quarter 2006. Now let’s move to western Canada. Western Canada Transmission & Processing Western Canada Transmission and Processing reported first quarter 2007 EBIT of $74 million, compared to $82 million in the first quarter 2006. The decrease was primarily a result of lower processing revenues in field service operations due to reduced producer activity in the Fort Nelson area of northeast British Columbia, and higher overall operating costs. These reductions were partially offset by higher NGL results at our Empress facility. During the quarter, the Empress frac spread averaged $4.20, compared to about $3.80 for the same quarter last year. Field Services
  5. 5. Spectra Energy Conference Call May 8, 2007 Page 5 of 13 The Field Services segment, which represents Spectra Energy’s 50 percent interest in DCP Midstream, reported first quarter 2007 EBIT of $82 million, compared with $144 million in the first quarter of 2006. 2007 EBIT includes special items of $3 million in costs resulting from the partnership initiative to create stand-alone corporate functions. 2006 earnings included a gain on sale of assets of $14 million. So, first quarter 2007 ongoing EBIT was $85 million, compared with $130 million in the prior year’s first quarter. Lower ongoing results were primarily due to lower volumes in operating efficiencies at various facilities, as a result of extreme winter storms. As Fred said earlier, the DCP system experienced a large number of well freeze- offs this winter. That, coupled with the inability to access facilities to service them, caused volume reductions in the first quarter 2007. We did see a return to more normal volume and activities at these facilities by the end of the quarter. Lower commodity prices during the first quarter of 2007, compared to 2006, also reduced margins. Crude oil prices averaged slightly above $58 a barrel for the quarter, compared to about $63 a barrel in 2006. They have recovered significantly over the past several weeks, and the strip for the remainder of 2007 is in the mid $60 range. We did see improved NGL to crude correlations during the quarter, which helped somewhat to mitigate the affect of lower crude prices on Field Services earnings. It is worth noting that significant basis differentials existed in the first quarter of 2006 following the 2005 hurricane season. These differentials boosted gas marketing margins in the first quarter of 2006. Let me turn now to “Other,” which are primarily our corporate costs and the operation of Spectra Energy’s wholly owned captive insurance subsidiary. Other “Other” reported net costs of $15 million in first quarter 2007, compared with net costs of $49 million in the first quarter of 2006. The 2007 period includes separation costs of $3 million. The ongoing EBIT costs of $12 million in 2007 compares favorably with the ongoing EBIT costs in 2006 of $49 million. While not considered a special item in 2006, prior year results included mark-to- market losses of $24 million related to corporate hedges associated with Field Services’ earnings. Those hedges expired at the end of 2006.
  6. 6. Spectra Energy Conference Call May 8, 2007 Page 6 of 13 The remaining improvement over the prior year quarter resulted primarily from lower corporate costs, as well as the favorable resolution of a legal matter. Let me now turn to ongoing EBITDA. Ongoing EBITDA As we mentioned in our December 2006 road show, we believe investors’ views of our EBITDA are an important valuation metric, so we are reporting that to you here today. We have attempted to make our EBITDA calculation all-encompassing, and as such have adjusted for interest, taxes and depreciation for our unconsolidated businesses – Gulfstream and DCP Midstream. Interest Expenses With respect to interest and taxes, interest expense for the quarter was $155 million, compared with $143 million for the first quarter 2006. The increase is largely the result of interest costs capitalized in the prior period for capital projects of businesses transferred to Duke Energy. Income Taxes First quarter 2007 income tax expenses from continuing operations were $119 million, compared with $148 million for the first quarter 2006. This quarter, our effective tax rate was 34 percent, an improvement from the prior year’s rate of 38 percent, which is largely due to the fact that as a stand-alone entity in 2007, we enjoyed tax benefits on certain debt and corporate costs that had previously gone to Duke corporate. Other Items A couple of final items of note: The Canadian currency net income impact for the quarter was unfavorable by $1.2 million, when compared with the first quarter 2006. Debt to total capitalization as of March 31, 2007 was 59 percent. However, we had almost $600 million of cash on our balance sheet at March 31, so net debt to total capitalization was approximately 57.5 percent.
  7. 7. Spectra Energy Conference Call May 8, 2007 Page 7 of 13 Later this month we expect to enter into a new Spectra Energy credit facility with a total capacity of approximately $1.5 billion, which will replace our existing $950 million U.S. facility. Now let me turn things back over to Fred, who will update you on several of the more significant projects in our capex plan. Fred: I want just to finish up today’s call by giving you an in-depth update on a few of our key growth projects – projects which will make our earnings growth in the future a reality. As you know, we have earmarked more than $1 billion for expansion this year to grow our business both organically and through Greenfield project development. While our total capital expenditures for the first quarter were around $175 million, the lion’s share of our construction activity will take place between now and the end of the year, so we fully expect to deploy over $1 billion of growth capital this year. I do want to walk you through where we are on one of our larger organic growth projects and a couple of our large Greenfield projects. Maritimes Phase IV Expansion Our Maritimes Phase IV project is an expansion of the capacity on the U.S. leg of our Maritimes & Northeast pipeline to connect the Canaport LNG terminal in New Brunswick. This terminal is being developed jointly by Repsol and Irving Oil, and is expected to be on-stream by November of 2008, with a send out capacity of 1 Bcf per day. We are doubling the capacity of the U.S. piece of Maritimes & Northeast to over 830 million cubic feet per day to accommodate this new LNG. This is mainly a compression project, involving the re-piping of two of our existing stations, building five new stations, and constructing less than two miles of new pipe. We are making great progress on this expansion: • Repsol has signed a firm 25-year contract for 730 million cubic feet per day on the Maritime system for delivery into the Northeast market. • We have our FERC approval in hand, and are in the process of finalizing our remaining state permits. • We have ordered more than 60 percent of the project materials and equipment, completed the majority of the design work, and selected contractors for the station construction.
  8. 8. Spectra Energy Conference Call May 8, 2007 Page 8 of 13 • We are going to build the project over two construction seasons, beginning this year, which will allow us to spread the work over a very doable schedule and utilize several different contractors. • We expect to spend about $320 million on this project, and we anticipate completing its construction to meet the commencement of service from the Canaport LNG terminal in November of 2008. Northeast Gateway A good example of a significant Greenfield project is Northeast Gateway, which remains on track for a December 2007 in-service date. Northeast Gateway will be a 16-mile, 24-inch offshore pipeline in Massachusetts Bay that will connect Excelerate Energy’s deep water LNG port to our Algonquin Hubline system. The new lateral is designed to transport 800 million cubic feet per day of supply into the Algonquin system. We have achieved several key project milestones: • We received our FERC certificate in March. • We ordered the pipe for this project last year, and entered into a comprehensive construction contract with an offshore contractor. • The offshore lay barge is making its way up from Columbia as we speak, and it will be in Boston in the next few weeks. As we secure our final permits for the project, we will be in position to begin construction at the end of May, which will allow us to place the project in-service by late this year. • We have entered into a 25 year contract with Excelerate Energy for all 800 million cubic feet per day of the capacity for this pipeline. • The $240 million that we expect to spend on this project will start generating returns later in the year. Southeast Supply Header Our Southeast Supply Header is another good example of a Greenfield project. It involves the construction of about 270 miles of new pipeline from the Perryville hub in northern Louisiana to our Gulfstream Natural Gas System near Mobile, Alabama. With our partner, CenterPoint Energy, we have made our filing with FERC. We expect to receive certification later this year and begin construction shortly thereafter. This project will link the onshore natural gas supply basins of East Texas and North Louisiana to the Southeast markets, which are now predominantly served by offshore natural gas supplies from the Gulf of Mexico.
  9. 9. Spectra Energy Conference Call May 8, 2007 Page 9 of 13 The pipeline will give customers an important alternative to offshore supply, which as we have learned over the past couple of years, can be very vulnerable to weather- related service disruptions. We expect that natural gas transported by the Southeast Supply Header will probably end up being used in the Northeast during the winter months, and then it will supply Florida and other Southeastern markets during the summer. 95 percent of the capacity has been subscribed under long-term agreements. The pipe on this project has been ordered and is scheduled for delivery, and all the prime contractors have been retained, which will allow us to start construction later this year. Our half of the construction costs of this project will be $400 billion, and we expect an in-service date in the summer of 2008. These three projects alone will account for almost $1 billion of the $3 billion in capex that we expect to spend over the next three years. They are real projects that are moving toward completion. I hope this gives you a comfort that we are well on our way toward deploying $3 billion over the 2007 to 2009 timeframe in growth capex projects, which will serve as the catalyst for our earnings growth. Let me finish up by reminding you why we believe that Spectra Energy has the best midstream assets and opportunities for growth in North America. That growth is being driven by: • Changing dynamics around gas supply and the need for new midstream infrastructure. • Our position of serving the fastest growing gas demand markets. • A stable of homegrown expansion projects equaling more than $3 billion in investment opportunities • A management team with a proven record in operations, delivering results and earnings growth. • And the financial flexibility to handle virtually any opportunities that arise in this sector. We’ve just wrapped up our first quarter as a publicly traded entity. We have delivered strong core results, even in the face of a challenging commodity environment. We are on-plan to achieve our goals. And we are optimistic about the growth opportunities that lay ahead for Spectra Energy and our investors. With that, let’s open up the lines for your questions.
  10. 10. Spectra Energy Conference Call May 8, 2007 Page 10 of 13 Operator Instructions Ramzi Faris with Fidelity Investments: Just wondering what your plan was for funding the $800 million cash flow deficit for this year. Greg: We will do that with debt. The intention was not to actually issue any equity over the next three years, but we have some room on our balance sheet that we will use. And it will be a combination of short term and long term debt. Karen Taylor with BMO Capital Markets: Can you just perhaps run through some of these items that maybe contributed to the quarter in not normalized form, but we need to know how much they are. The ad valorem tax issues that were resolved, how much EBIT did that contribute, or how much was that? Greg: That is approximately $8 million, Karen. Karen: 8 million? Greg: Yes. Karen: The tax issues, or legal issues that were resolved in the other segment, how much were those? Greg: Similar number. Approximately $8 million. Karen: Okay. And the costs that were capitalized that were basically expensed in prior periods, how much was that? Greg: The difference year-over-year was about $22 million. Karen: I just want to make sure – those were costs that were incurred on projects that are now definitive, so you have capitalized them in this quarter and then reduced what would normalize – normally be a higher run rate on cost in that segment. Greg: Correct. We take the expenses, we build the project up, and so you do not have big write offs if a project does not go forward, and then we capitalize that. Fred: But Karen -- this is Fred -- I would tell you at the level of project development that we are at, we have a lot of new expenses that hit this current quarter as well. Karen: Okay, how much were those?
  11. 11. Spectra Energy Conference Call May 8, 2007 Page 11 of 13 Greg: I cannot give that to you off the top of my head, but it is a pretty high level, just because of the level of activity. Karen: All right. And just lastly, the run rate for the other segment – we always talked about an EBIT loss of 100 million – you did quite a bit better than that in the first quarter – does that suggest that there might be some back-end loading to the other segment loss, or are we— Greg: I think that is a fair way to look at it. We are still comfortable with the approximately $100 million we talked about that for the year. Karen: Okay. Lastly, on the Union Gas, how much – you are 12% colder than last year. Last year was significantly warmer than normal – how much versus normal were we this year? Greg: In a dollar sense, as you know, there is a variety of factors that move up and down. Weather was about $6 million. Karen: So an adverse affect versus normal. Greg: Positive. Karen: Oh, positive. Okay. Thank you. Matthew Akman with CIBC World Market: Thanks guys. On the mid-stream business – the DEFS – what is the thought behind sort of maintaining guidance there, I guess despite some of the issue in the quarter, and your guidance set – it was based on $68 oil WTI going into the year. What has improved there that can offset some of these – some of the commodity price drag and operating issues in Q1? Greg: Well, Matt, the real issue there is that, you are right, we saw weaker prices in the first quarter. I will also say that, as you know, we talk about the average price for the year, so you are going to have quarterly differences there. And then you are seeing some improvement on the relationship between NGL and oil. So as NGL’s have a better relationship to oil, you can see an improvement there with your results, assuming NGL and oil are going the same way. Matt: Okay. All right. In terms-- My next question is around the western Canadian segment and Fred did not touch on any growth projects there, but I know Q1 was a low drilling quarter because of unusual weather factors, but there is a lot of activity there. Fred, is there anything on the horizon there that you guys can start to talk about in terms of growth in that part of your business?
  12. 12. Spectra Energy Conference Call May 8, 2007 Page 12 of 13 Fred: There’s really kind of two stories going on in western Canada. We do have areas that have growth in them, and they actually fit our system well because they are deeper gas and they are more sour. It is sour gas which we are very prepared to handle. At the same time, in the Fort Nelson area, we have seen a real drop off in drilling activity. We have not seen a big drop off in volumes yet, but at this low level of drilling activity, it is probably only a question of time. So I think probably overall, flat to down a little until we see drilling start back up. One of the big drivers that we have seen on the lack of drilling has just been the escalation in drilling costs. So it is a question, with this cut back, how quickly will that come back in line. Matt: Okay. Thanks. Those were my questions. Anna Agarwal with Jeffries: Actually I had one question: Based on your first quarter results, how comfortable are you with your annual EPS target of $1.40? Fred: Well number one, that $1.40 is an employee incentive target. We do not actually give guidance on EPS, and that will not change – that employee incentive target will not change regardless of how the rest of the year ends. I think, to me one of the key inputs into that incentive target was our commodity price assumption, and I think that after just one quarter, I think it is premature really to determine if our annual commodity assumptions are going to play out for the full year. Oil prices did start out the year weaker than we expected, but recovered nicely into the mid $60’s at this point, and as Greg said, NGL prices in relation to crude have improved. And then the other bright spot is frac spreads, although it is a much smaller determinant of our earnings. They have been in excess of our annual average to date. Anna: Okay, thank you. Faisel Khan with Citi: Actually, this is Barry Klein. I just had a quick question on the effective tax rate. You guys, I guess for the quarter, had a 34% rate. I think in one of the previous presentations you had mentioned 32% effective tax rate. What do you think we should be using going forward? Greg: I think 32 is the right number for the full year. As you know, we have got some quarter-over-quarter changes, so 32% for all of ’07 is the right number to be using. Barry: Okay. And then going forward into ’08, ’09? Greg: I think that 32-33% number is good going forward. Barry: Okay, great. Thanks a lot.
  13. 13. Spectra Energy Conference Call May 8, 2007 Page 13 of 13 Winfred Fruehauf with W. Fruehauf Consulting Ltd.: In terms of AFUDC, what were the amounts booked in the last quarter compared with a year ago? Greg: The delta was about $9 million. Winfred: In the last quarter? Greg: In the first quarter, correct. Winfred: I was not asking you for the delta. I was asking for the actual amounts in both quarters. Greg: Okay, let’s see if we can get that for you. Winfred, we can probably follow up with you and get you the AFUDC number. It was not a massive number. I want to say 3 or 4, but let me kind of get it for you. Because last year-- Yeah, the delta was 9, so this year was about $4 million and last year would have been approximately $12 million. Winfred: And what is the weighted average cost of capital you used to calculate the AFUDC in both quarters? Greg: I do not have that, but it will be a little big north of -- probably more like 8% kind of thing. Winfred: Thanks very much. Operator Instructions John: Okay, thank you Jennifer, and thank you everyone for joining us today. If there are no further questions – if you have additional questions, I would encourage you to give me a call later, or you may call Patti Fitzpatrick. So with that, thank you for joining us and we will look forward to speaking to you when we are in New York on next Tuesday, the 15 of May. Thank you.