National Fuel Gas Company — Q2 FY2018 10-Q
Reporting period: Fiscal quarter and six months ended March 31, 2018; comparisons are with the periods ended March 31, 2017. The company operates five segments: Exploration and Production, Pipeline and Storage, Gathering, Utility, and Energy Marketing.
Financial performance
| Metric | Three months | Six months |
|---|---|---|
| Revenue | $540.9 million, up 3.6% | $960.6 million, up 1.7% |
| Operating income | $156.7 million, down from $170.0 million | $298.7 million, down from $342.1 million |
| Net income | $91.8 million, up from $89.3 million | $290.5 million, up from $178.2 million |
| Diluted EPS | $1.06, versus $1.04 | $3.37, versus $2.07 |
| Operating cash flow | Not presented for the quarter | $286.8 million, down from $351.9 million |
The six-month net income increase was principally tax-driven: the 2017 Tax Reform Act produced a $107.0 million reduction in income tax expense from remeasurement of deferred taxes, as well as benefits from the lower tax rate. The six-month effective tax rate was negative 17.4%, versus 38.0% a year earlier. The quarter’s effective rate was 29.4%, versus 37.2%.
- Segment earnings, six months: Exploration and Production $133.2 million (up $64.4 million); Pipeline and Storage $61.2 million (up $22.6 million); Gathering $57.2 million (up $35.9 million); Utility $54.4 million (up $7.6 million); Energy Marketing $1.6 million (down $1.1 million).
- Margins and drivers: Consolidated operating income fell despite modest revenue growth as operating expenses rose. Exploration and Production faced lower hedged gas prices and lower production; Utility benefited from colder weather and higher rates. The filing does not present a headline margin metric.
- Capital spending and cash: Capital expenditures were $261.7 million; operating cash flow was $286.8 million. Investing activities used $239.1 million and financing activities used $375.2 million, including $307.0 million to redeem notes. Cash declined to $228.0 million from $555.5 million at September 30, 2017.
- Debt and liquidity: Long-term debt, net, was $2.085 billion, with no current maturities or short-term debt at March 31. The $300 million of 6.50% notes due in 2018 were redeemed in October 2017 and replaced with $300 million of 3.95% notes due 2027. The company had a $750 million revolving credit facility, no borrowings under it, and a $500 million commercial paper program. Its facility debt-to-capitalization ratio was 0.52 against a 0.65 limit.
- Dividends: Declared dividends were $0.415 per share for the quarter and $0.830 for six months, versus $0.405 and $0.810, respectively, in 2017.
Material changes, outlook, and risks
- Management expects Exploration and Production capital expenditures of approximately $360 million for FY2018 and planned to add a third Appalachian drilling rig in Q3, primarily for Utica development.
- Pipeline and Storage transportation revenue may decline by up to approximately $14 million in FY2019 when an Empire system contract terminates in December 2018; management does not expect to renew it at existing rates.
- The Northern Access 2016 pipeline project remains subject to New York permitting disputes and related litigation. Approximately $75.1 million had been spent; no impairment was recorded, but an unfavorable resolution could impair a significant portion of project costs. No target in-service date had been set.
- State and federal regulators are reviewing the tax-law changes and their effect on utility and pipeline rates. Pennsylvania utility rates were made temporary for six months, potentially extendable by another six months; refunds or rate adjustments may follow. The company recorded $365.1 million of taxes refundable to customers, including $271.0 million associated with regulated deferred-tax reductions.
- Tax-reform amounts remain provisional pending further regulatory guidance and other analysis. The company estimated $89.6 million of alternative minimum tax credit carryovers to be used or refunded in FY2019–FY2022 and recorded a $4.0 million estimate for possible sequestration of refunds.
- Oil and gas prices, production, reserve estimates, and full-cost ceiling-test changes could affect results. At March 31, the ceiling exceeded oil and gas property book value by $502.8 million; the filing’s specified price sensitivities still showed a cushion, but do not account for other changes in reserves or costs.
- Estimated remaining cleanup costs for former manufactured gas plant sites were $7.1 million, expected to be recovered through rates over about four years. Other routine litigation and regulatory matters could affect earnings or cash flows; management could not estimate possible losses.
Important facts for investors to verify
- How much of reported earnings growth is repeatable after separating the $107.0 million deferred-tax remeasurement and other tax-reform effects.
- Final regulatory treatment of tax savings, including the timing and amount of utility customer refunds or rate reductions.
- Permitting and litigation developments, project economics, and potential impairment exposure for Northern Access 2016.
- Whether FY2018 capital spending and the additional drilling rig can be funded from operating cash and available credit while maintaining leverage and liquidity.
- Actual FY2019 revenue impact from the expiring Empire transportation contract and the trajectory of commodity prices, production, and gathering volumes.