National Fuel Gas Company — Form 10-Q Summary
Reporting period: Fiscal first quarter ended December 31, 2010; comparisons are with the three months ended December 31, 2009 unless otherwise noted. The filing is unaudited. The company operates Utility, Pipeline and Storage, Exploration and Production, and Energy Marketing segments.
Financial performance and liquidity
| Metric | Q1 FY2011 | Q1 FY2010 | Change |
|---|---|---|---|
| Operating revenue | $450.9 million | $454.1 million | Down 0.7% |
| Operating income | $117.4 million | $125.6 million | Down 6.5% |
| Income from continuing operations | $58.5 million | $64.2 million | Down 8.8% |
| Net income available to common shareholders | $58.5 million | $64.5 million | Down 9.2% |
| Diluted EPS | $0.70 | $0.78 | Down 10.3% |
| Cash from operating activities | $87.5 million | $68.3 million | Up $19.2 million |
Operating margin was approximately 26.0%, versus 27.7% a year earlier; net margin was approximately 13.0%, versus 14.2% (calculated from reported figures). The company paid common dividends of $28.3 million, or $0.345 per share.
Capital expenditures were $192.1 million in cash-flow reporting; total expenditures for long-lived assets were $200.9 million, including accrued items and an investment in a subsidiary. Investing cash outflow was $192.1 million and financing cash outflow was $210.9 million, including repayment of $200 million of maturing notes. Cash declined $315.5 million during the quarter to $79.6 million.
At December 31, 2010, total assets were $5.0 billion. Long-term debt, including its current portion, was $1.049 billion; short-term bank notes were $20.5 million. The company reported a debt-to-capitalization ratio of 0.38 under its credit facility. It had a $300 million committed credit facility, undrawn at quarter-end, and $405 million of revocable uncommitted credit lines. The $150 million of current long-term debt matures in November 2011.
Material changes and operating drivers
- Consolidated earnings fell $6.0 million. Exploration and Production earnings declined $2.4 million, Pipeline and Storage declined $1.8 million, and All Other declined $1.5 million. Utility earnings were essentially flat; Energy Marketing earnings decreased $0.2 million.
- Exploration and Production revenue rose $13.8 million as Appalachian gas production increased, including Marcellus growth. Total gas production increased to 11.0 Bcf from 6.5 Bcf, while the weighted-average gas price after hedging fell to $5.26/Mcf from $6.30/Mcf. Segment earnings were pressured by lower gas prices, higher depletion and operating costs, and lower oil production.
- Pipeline and Storage revenue decreased $1.4 million and earnings fell $1.8 million. Lower firm transportation revenue reflected shippers’ preference for lower-priced supply and routes; higher pension and personnel costs also weighed on earnings.
- Utility revenue increased $10.5 million, mainly from off-system sales and transportation. These revenue gains had limited margin impact, and Utility earnings remained about $23.0 million.
- Energy Marketing revenue declined $18.1 million, largely because of lower sales volumes, including fewer low-margin wholesale transactions; earnings decreased modestly.
- Prior-year comparison includes $0.3 million of income from discontinued landfill-gas operations. Those operations were sold in September 2010. The company also sold its sawmill and related timber assets in September 2010, reducing current-period timber margins.
Outlook, projects, risks and unusual items
- Management raised FY2011 Exploration and Production capital-spending expectations to $531 million from $455 million, including $490 million for Appalachia. The estimate of 100–130 gross Marcellus wells for FY2011 was unchanged. Management expects to fund investment primarily from operating cash, with short-term borrowing as needed and possible long-term financing later in FY2011 or in FY2012.
- The company controls approximately 745,000 net Marcellus acres and spent $173 million on Marcellus development in the quarter. It acquired additional Tioga County properties for $24.1 million; management anticipated approximately 42 Bcf of proved gas reserves from the acquisition.
- Management is exploring a Marcellus joint venture to accelerate development and shift some early drilling costs to a partner, but said it would proceed only if the terms enhance shareholder value. A proposed sale of the company’s 50% interests in Seneca Energy and Model City was expected to close in the quarter ended March 31, 2011, with an estimated gain of approximately $28 million.
- Pipeline projects include Northern Access (estimated cost $62 million; planned service in late 2012), Line N expansion ($23 million; targeted for September 2011), Line N Phase II (approximately $40 million; targeted for November 2012), Lamont Phase II (approximately $7 million; service beginning in 2011), W2E Overbeck to Leidy ($260 million; initial facilities expected in 2013), and Tioga County Extension ($46 million; anticipated service September 2011). Project approvals, customer commitments, schedules, and costs remain important dependencies.
- The quarterly results should not be viewed as a full-year forecast: Utility and Energy Marketing operations are seasonal, and winter normally contributes substantially to their annual earnings. No company-wide earnings guidance is provided in the filing.
- The oil-and-gas full-cost ceiling exceeded the carrying value by approximately $232 million at quarter-end, so no impairment was required. The filing’s sensitivity analysis showed the cushion falling to about $8 million if both test gas and oil prices were lower by $1/MMBtu and $5/Bbl, respectively.
- Environmental remediation liabilities were estimated at $17.2–$21.4 million; $17.2 million was accrued, and the company expects recovery through rates. The company is disputing an IRS proposed disallowance of a prior accounting-method change for certain utility capitalized costs. Other routine litigation and regulatory matters could affect earnings or cash flows when resolved, although management did not expect them to materially impair financial condition or liquidity.
- Risks include commodity-price and price-differential exposure, pipeline capacity renewals, project execution and permitting, environmental and greenhouse-gas requirements, and potential additional hydraulic-fracturing regulation. The New York moratorium on hydraulic fracturing of new horizontal Marcellus wells was not expected by management to materially affect its plans, given its limited New York acreage.
- Derivative positions require monitoring: the company had $31.4 million of hedging collateral deposits at quarter-end, including $24.8 million for over-the-counter crude-oil swaps. A substantial portion of oil-swap liabilities used Level 3, unobservable valuation inputs; the filing reported $37.4 million of Level 3 net derivative liabilities.
Important facts for investors to verify
- Whether Marcellus production growth and realized prices support the increased FY2011 capital budget and targeted well program.
- Progress on pipeline project approvals, firm shipper commitments, construction costs, and in-service dates—particularly Line N, Tioga County Extension, and Northern Access.
- Funding needs and liquidity as capital spending continues, including refinancing of the $150 million November 2011 maturity and any later long-term debt issuance.
- Commodity-price sensitivity, hedge collateral requirements, counterparty exposure, and the valuation assumptions behind Level 3 crude-oil swaps and the full-cost ceiling cushion.
- Completion and proceeds of the Seneca Energy and Model City sale, and whether the anticipated approximately $28 million gain is realized.
- Developments in the IRS dispute, environmental remediation recovery, and regulatory changes affecting hydraulic fracturing, pipeline operations, and emissions.