National Fuel Gas Company — FY2018 Form 10-K
Reporting period: Fiscal year ended September 30, 2018. The filing also provides unaudited fourth-quarter results for the three months ended September 30, 2018; it is an annual report, not a standalone quarterly filing. National Fuel is an integrated energy company operating five segments: Exploration and Production, Pipeline and Storage, Gathering, Utility, and Energy Marketing.
Financial performance
| Metric | FY2018 | FY2017 |
|---|---|---|
| Operating revenue | $1.593 billion | $1.580 billion |
| Operating income | $487.1 million | $552.8 million |
| Net income available to common stock | $391.5 million | $283.5 million |
| Basic / diluted EPS | $4.56 / $4.53 | $3.32 / $3.30 |
| Cash from operating activities | $613.6 million | $684.3 million |
| Cash capital expenditures | $584.0 million | $450.3 million |
| Dividends paid | $143.3 million | $139.1 million |
Revenue increased about 0.8%, while operating income declined about 11.9%. Net income rose about 38.1%, substantially reflecting tax reform rather than stronger operating income. Operating margin was approximately 30.6% (35.0% in FY2017); net margin was approximately 24.6% (17.9% in FY2017), with the FY2018 figure materially affected by the tax benefit.
FY2018 earnings included a $103.5 million reduction in income tax expense from remeasurement of deferred taxes on non-regulated activities and the lower blended federal tax rate. The effective tax rate was negative 2.0%. Tax accounting estimates remained provisional pending additional federal, state and regulatory guidance.
FY2018 fourth quarter: Revenue was $289.2 million, operating income $80.6 million, net income $38.0 million, and basic and diluted EPS $0.44. The quarter included a $3.5 million increase in income tax expense related to deferred-tax remeasurement.
Segment earnings and operating drivers
- Exploration and Production earned $180.6 million versus $129.3 million. Higher production and oil prices, lower costs and tax benefits more than offset lower gas prices after hedging. Gas production increased to 162.9 Bcf from 157.1 Bcf; weighted average gas sales price after hedging fell to $2.52/Mcf from $2.95/Mcf.
- Pipeline and Storage earned $97.2 million versus $68.4 million, benefiting principally from tax reform and higher transportation and storage revenues.
- Gathering earned $83.5 million versus $40.4 million, primarily due to tax benefits. Gathered volume rose to 198.4 Bcf from 194.9 Bcf, while reported revenue was broadly flat.
- Utility earned $51.2 million versus $46.9 million, supported by colder weather and rate-order effects, partly offset by customer tax refunds and operating costs.
- Energy Marketing earned $0.4 million versus $1.5 million; lower margins, including pressure from local gas prices relative to NYMEX-linked sales, hurt results.
Cash flow, debt and liquidity
- Operating cash flow fell $70.7 million year over year, primarily from lower Exploration and Production cash receipts as realized gas prices declined. Cash capital expenditures increased to $584.0 million; operating cash flow less cash capital expenditures was approximately $29.6 million, a simple non-GAAP calculation.
- Cash and temporary investments were $229.6 million at year-end, down from $555.5 million. Long-term debt, net of discount and issuance costs, was $2.131 billion; total shareholders’ equity was $1.937 billion. No short-term borrowings or current long-term debt were outstanding at September 30, 2018.
- The company issued $300 million of 4.75% notes due 2028 and redeemed $250 million of 8.75% notes due 2019. Its embedded cost of long-term debt declined to 4.69% from 5.34%. Facility-defined debt-to-capitalization was 0.52, against a 0.65 limit.
- After year-end, the company entered into a $750 million revolving credit facility through October 2023; its commercial-paper program has a $500 million capacity. Management stated that liquidity was adequate for known needs. Fiscal 2019 capital expenditures were estimated at $770 million; management expected to use cash on hand and operating cash flow first and may issue debt as needed.
Material changes, outlook and risks
- Production and reserves: Proved reserves increased 17% to 2,523 Bcfe. Seneca moved from two to three Pennsylvania drilling rigs; management expected meaningful production and reserve growth in FY2019. Planned E&P capital spending was $480 million in FY2019. Commodity prices, basis differentials, production performance and hedging can materially affect results.
- Pipeline projects: Northern Access remained subject to litigation and permitting disputes after New York denied permits. FERC found the state had waived its opportunity to act on the federal water certification, but rehearing requests were filed. The project’s target in-service date was no earlier than the first half of FY2022; $76.2 million had been incurred, and further adverse developments could lead to impairment. Empire North was projected for the second half of FY2020 at an estimated $145 million; FM100 was targeted for late calendar 2021 at a preliminary $280 million.
- Revenue and rate exposure: Pipeline and Storage expected up to approximately $14 million of lower FY2019 transportation revenue when an Empire contract terminated in December 2018; management did not expect renewal at existing rates. Utility customers began receiving tax-related sur-credits under New York and Pennsylvania orders. Supply Corporation was required to address FERC tax-reform requirements by December 6, 2018; Empire’s rate case remained pending, with proposed increases subject to refund.
- Other risks and contingencies: Key exposures include environmental and pipeline-safety regulation, project approvals and construction delays, oil and gas price volatility, reserve-estimation and full-cost ceiling-test risk, counterparty/credit risk, cybersecurity, pension costs and regulatory recovery. The oil-and-gas ceiling exceeded book value by $569.1 million at year-end, but could narrow with lower prices or reserve changes. Estimated remaining cleanup costs for former manufactured-gas sites were $7.6 million, expected to be recovered through rates over about four years. A disputed Pennsylvania environmental penalty was described as not material.
- The company reported effective disclosure controls and internal control over financial reporting; the auditor gave an unqualified opinion on the financial statements and internal controls.
Most important facts for investors to verify
- How much of FY2018’s earnings increase came from the one-time deferred-tax remeasurement and lower tax rate, and what earnings level is sustainable without those benefits.
- FY2019 production, realized gas prices and basis differentials, hedging settlements, and execution of the increased drilling program.
- Resolution, timing, remaining costs and potential impairment exposure for Northern Access, and progress and contracted economics for Empire North and FM100.
- Whether the Empire contract termination and pending FERC/state rate proceedings reduce regulated or contracted earnings beyond the disclosed estimates.
- Funding of the $770 million FY2019 capital plan, resulting borrowing needs, debt covenants and liquidity after dividends and project spending.