Business context and reporting period
National Fuel Gas Company is a diversified energy holding company with Utility, Pipeline and Storage, Exploration and Production, and Energy Marketing segments. This Form 10-Q covers the fiscal second quarter and six months ended March 31, 2011; comparisons are with the corresponding 2010 periods. The financial statements are unaudited.
Financial performance and position
- Quarter: Revenue was $660.9 million, down 1.1%; operating income was $153.8 million, up 1.4%. Net income was $115.6 million versus $80.4 million, and diluted EPS was $1.38 versus $0.97. Results included a $50.9 million pretax ($31.4 million after-tax) gain on the sale of equity-method investments.
- Six months: Revenue was $1.112 billion, down 0.9%; operating income was $271.2 million, down 2.2%. Net income was $174.2 million versus $144.9 million, and diluted EPS was $2.08 versus $1.76. The investment-sale gain also benefited this period.
- Margins: Operating margin was approximately 23.3% for the quarter versus 22.7% a year earlier, and 24.4% for six months versus 24.7%. Net margins were boosted by the sale gain.
- Cash flow: Six-month operating cash flow was $343.2 million, up from $279.3 million. Cash capital expenditures were $392.3 million; investing cash flow was negative $336.1 million, including $59.4 million of sale proceeds. Financing cash flow was negative $259.6 million, including $200 million of debt repayment and $56.7 million of dividends. Cash declined $252.4 million to $144.8 million.
- Debt and liquidity: Debt carrying value, including current maturities, was $1.049 billion at March 31, versus $1.249 billion at September 30, 2010. The $150 million current portion matures in November 2011. No short-term debt was outstanding at quarter-end; the company reported $300 million of committed credit capacity and $385 million of revocable bank lines. Its credit-facility debt-to-capitalization ratio was 0.37 against a 0.65 limit. Current assets were $620.1 million and current liabilities $603.6 million.
Material changes and management commentary
- The $31.4 million after-tax investment-sale gain was the principal reason consolidated earnings rose. Excluding segment effects of this gain, reportable segments were broadly stable: Exploration and Production earnings increased, while Pipeline and Storage earnings declined.
- Exploration and Production earnings rose to $33.3 million for the quarter and $60.7 million for six months. Marcellus production growth drove higher gas volumes, partly offset by lower gas prices after hedging and higher depletion and operating costs. Appalachian gas production for the quarter more than tripled year over year.
- Pipeline and Storage earnings fell to $11.0 million for the quarter and $19.5 million for six months, as lower transportation revenue and higher pension, personnel, tax, and depreciation costs outweighed increased throughput. Utility earnings were essentially flat; colder weather and higher usage supported volumes, while weather normalization and regulatory adjustments affected earnings. Energy Marketing earnings increased modestly despite lower sales volumes and revenue.
- Management is concentrating investment on Marcellus development and Appalachian pipeline infrastructure while divesting smaller or non-core assets. The company sold its Seneca Energy and Model City interests for $59.4 million. A separate Gulf of Mexico property sale closed in April 2011: total proceeds received were $61.8 million after an operating-cash-flow purchase-price adjustment; under full-cost accounting, proceeds reduced capitalized costs and no gain or loss was recorded.
Outlook, risks and unusual items
- Fiscal 2011 Exploration and Production capital spending was raised to $629 million from $531 million, including $588 million in Appalachia. The planned Marcellus drilling range was revised to 85–110 gross horizontal wells from 100–130 gross wells. Fiscal 2012 E&P spending was raised to $732 million, including $689 million in Appalachia; the planned Marcellus range was revised to 115–140 wells from 130–160.
- Management expects to fund investment primarily with operating cash and asset-sale proceeds, using short-term borrowing as needed; long-term financing may be needed later in fiscal 2011 or fiscal 2012. The filing does not provide consolidated earnings guidance.
- Major pipeline projects include the $62 million Northern Access expansion, the $20 million Line N expansion, the $7.6 million Lamont Phase II project, and the estimated $260 million W2E Overbeck-to-Leidy project. Timelines, regulatory approvals, customer commitments, construction costs, and demand remain relevant execution risks.
- At March 31, oil and gas properties were below the full-cost ceiling by approximately $230 million. Management’s stated price sensitivities show that simultaneous $1/MMBtu lower gas and $5/barrel lower oil assumptions would reduce that cushion to approximately $31 million; further price declines could increase impairment risk.
- Commodity derivatives create price, counterparty, hedge-effectiveness, and collateral risks. The company had $70.1 million of net derivative liabilities and $61.8 million of posted hedging collateral. Level 3 oil-swap net liabilities were $71.9 million. Dodd-Frank implementation could add hedging costs or requirements. Other risks include hydraulic-fracturing regulation, commodity-price and production variability, and pipeline project delays.
- Environmental cleanup costs were estimated at $17.1–$21.3 million; the $17.1 million minimum was accrued, and the company expects recovery through rates. The IRS is disputing the company’s accounting-method treatment of certain utility costs; the company filed a protest. Management said ordinary-course litigation and regulatory matters could affect period earnings but were not expected to materially impair liquidity or financial condition.
Important facts for investors to verify
- How much of earnings growth persists after removing the $31.4 million after-tax investment-sale gain?
- Whether Marcellus production growth and revised capital budgets deliver expected returns amid lower gas prices, rising well costs, and depletion expense.
- Progress, final costs, approvals, and contracted capacity for major pipeline projects, especially W2E and Northern Access.
- Cash needs and funding plans for the November 2011 debt maturity, capital spending, and required pension and post-retirement contributions.
- Changes in commodity prices, hedge positions, collateral requirements, ceiling-test headroom, and hydraulic-fracturing or derivatives regulation.