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Operator
Hello everyone and welcome to the NW Natural Holdings Company Q2 2022 earnings call. My name is Seb and I will be the operator for your call today. There will be an opportunity to ask questions at the Q&A session. You can register a question at any time by pressing star 1 on your telephone keypad or press star 2 if you need to withdraw your question. If you need assistance at any time, please press star 0 to flag an operator. I will now hand the floor over to Nikki Sparley to begin. Please go ahead.
Seb
Thank you, Seb. Good morning and welcome to our second quarter 2022 earnings call. As a reminder, some things that will be said this morning contain forward-looking statements. They are based on management's assumptions, which may or may not occur. For a complete list of cautionary statements, please refer to the language at the end of our press release. We expect to file our 10Q later today. As mentioned, this teleconference is being recorded and will be available on our website following the call. Please note these calls are designed for the financial community. If you are an investor and have additional questions after the call, please contact me directly at 503-721-2530. News media may contact David Roy at 503-610-7157. Speaking this morning are David Anderson, President and Chief Executive Officer, and Frank Burkhartsmeyer, Senior Vice President and Chief Financial Officer. David and Frank have prepared remarks and then will be available, along with other members of our executive team, to answer your questions. With that, I will turn it over to David.
David Roy
Thanks, Nikki. Good morning and welcome, everybody. We continue to see strong financial results that are in line with our expectations and the guidance that we provided earlier this year. Frank will go through more of the details here in a moment. This morning, I'll walk through some economic indicators for Oregon and Washington and provide an update on our Oregon general rate case. I'll wrap up with some exciting efforts related to hydrogen and gas utility and an update on our water and competitive renewables business. Turning to a few comments on the economy, in our service territory, we continue to experience growth despite a dynamic macroeconomic backdrop. Reports in the first quarter of 2022 rank Oregon in the top 10 states for the change, positive change in GDP. That outperformance is based on stronger than average growth in real estate and the healthcare industries as the Oregon economy continues to rebound after COVID. So the labor market also remains robust with low unemployment and strong employment gains. In Oregon, unemployment was 3.6% in June 2022. That's nearly as low as the pre-pandemic levels of 3.4% in February of 2020. Single-family housing activity remains solid. The median sales price of a home in our area was up 9.4% for the second quarter of 2022 compared to last year. And the inventory of homes for sale in the Portland metro area remains low at 1.4 months of supply. Overall customer growth is in line with our expectations with a dip in mixed-use multifamily construction that we knew was coming. Single-family ads continue to be strong, driving the addition of nearly 10,200 new customers during the last 12 months, which equates to a growth rate of 1.3%. Our water and wastewater utilities also continue to grow. Strong residential housing construction primarily in Texas, where our water and wastewater utility posted nearly 11% organic growth. And Idaho, where our Falls Water Company posted 4% organic growth. boosted us to a consolidated 3% customer growth from organic customer growth over the last 12 months. The combination of this organic growth and acquisitions resulted in a 27% increase in our water and wastewater utility connections. Moving to an update on our Oregon general rate case. As you know, 2021 and 2022 have CapEx plans related to spend for safety and reliability, technology system upgrades, and cybersecurity investments. So to recover those costs, we filed an mortgage and rent case in December of last year. The original request included a revenue requirement increase of $73.5 million that's based on a 50-50 cash structure, a return on equity of 9.4%, and a cost of capital of about 6.9%. In May 2022, we filed a settlement with the main parties in the case related to the majority of the revenue requirement items. That included a revenue requirement increase of $62.7 million, Also on a 50-50 cash structure, an ROE of 9.4% and an overall cost of capital of 6.8%. It also included a rate-based increase of $337 million since the last rate case for a total rate base of $1.77 billion. In June, we reached the second multi-party settlement related to a number of smaller items, including recovery of our COVID deferral. We expect an order from the Commission on the full rate case this fall with rates effective November 1st. With that, let me turn it over to Frank to cover more of the details of the quarter. Frank?
Frank
Thank you, David, and good morning, everyone. I will begin by discussing the highlights of the quarter and year-to-date results and conclude with guidance for the year. I'll describe earnings drivers on an after-tax basis using the statutory tax rate of 26.5%. As a reminder, Northwest Naturals earnings are seasonal, with a majority of revenues and earnings generated in the first and fourth quarters during the winter heating months. For the second quarter, we reported net income of $1.7 million, or 5 cents per share, compared to a net loss of $700,000, or 2 cents per share for the same period in 2021, an increase of 7 cents per share. The improvement over last year was driven by our gas utility, which posted an increase of 5 cents per share. Higher earnings at the gas utility were primarily related to higher margin and lower pension expense. Utility margin in the gas distribution segment increased $2.3 million as a result of customer growth and new rates, which collectively contributed $1.7 million. Utility O&M increased $3 million, reflecting higher contractor costs for safety and reliability projects, professional services, and information technology costs. Other income increased $2.1 million, primarily from lower pension expense, reflecting higher returns and lower interest costs. Net income from our other businesses increased $900,000 for the second quarter of 2022 due to higher asset management revenues and lower business development costs. For the first six months of 2022, we reported net income of $58 million or $1.77 per share, compared to net income of $58.8 million or $1.92 for the same period in 2021. The $0.15 decrease in earnings per share is largely the result of the issuance of 2.9 million shares of common stock on April 1st. The $800,000 decline in net income for the six-month period reflects an improvement in gas utility net income of $3 million, while the results from our other businesses declined $3.8 million, as the prior period benefited from the higher asset management revenues related to the February 2021 cold weather event. Higher earnings at the gas utility were primarily related to customer growth, new rates in Washington, and colder weather in 2022. As a result of these factors, utility margin increased $6.1 million. Utility O&M increased $6.5 million, reflecting higher levels of contractor and professional services and information technology upgrades. Utility depreciation and general taxes increased $800,000 due to higher property plant equipment as we continue to invest in our system. Other income increased $3.9 million, driven by lower pension costs. For 2022, cash provided by operating activities was $197 million, in line with the prior year. We invested $170 million into the business, most of which was for the gas utility capital expenditures. Related to our financing cash flows, we had two successful transactions. On April 1st, we completed an equity offering with approximately $140 million of proceeds to support our growing businesses. In July, we executed a private placement bond agreement for the gas utility. We plan to close the $140 million transaction and take the proceeds on September 30th. I'm pleased with our ability to access the markets and take this financing risk off the table. Last quarter, Moody's and S&P both reviewed the gas utility and reaffirmed ratings and stable outlook. That includes Northwest Natural's senior secured long-term debt rating of AA- for S&P and A2 for Moody's. Our objective remains to keep our balance sheet strong with ample liquidity. Moving on to financial guidance, the company reaffirmed 2022 earnings per share guidance for net income in the range of $2.45 to $2.65 per share. Guidance assumes continued customer growth, average weather conditions, and no significant changes in prevailing regulatory policies, mechanisms, or outcomes, or significant changes in laws, legislation, or regulations. We continue to target a long-term earnings per share growth rate of 4% to 6%. With that, I'll turn the call back over to David.
David Roy
Well, thanks, Frank. We continue to focus on the future, making sound investments today that will support sustainable growth for tomorrow. As we shared before, over the last few years, our engineering team has conducted 5% hydrogen blend tests at one of our service centers, our Sherwood Operations and Training Center, with a goal to increase our blending and increment In parallel with these efforts, we've continued to work collaboratively with Eugene Water and Electric Board and Bonneville Environmental Foundation on the scoping of a one megawatt power-to-gas facility. This project has been designed to blend 5% clean hydrogen into a dedicated section of our Eugene distribution system serving about 2,500 customers. But the benefits go well beyond our Eugene customers. This partnership with EWEB will provide hands-on experience independent gas and electric grids. Interdependent, excuse me. We've already begun preliminary outreach with various stakeholder groups representing the local community, regulatory staff, elected officials, industry groups, and customer advocates. In July, we filed a request to open a document with the Public Utility Commission of Oregon to recover the cost of the project under Senate Bill 844. This law is innovative and unique to Oregon supporting gas utility projects that are designed to reduce greenhouse gas emissions. If approved, this Eugene project could be Oregon's first clean hydrogen production facility, serving to demonstrate the applications of this versatile energy source and the important role it will play in decarbonizing both the gas and electric systems. In July, we also announced that Northwest Natural is partnering with Modern Electron on an exciting turquoise hydrogen pilot project to turn methane clean hydrogen and solid carbon. We'll be testing this groundbreaking technology at our Portland Operations Facility. The innovative process is designed to produce hydrogen and solid carbon using only natural gas and air as inputs and to not use any electricity, water, or consumable catalysts. It's an incredibly sustainable and flexible way of producing hydrogen and is scalable as a potential to allow us to produce clean hydrogen whenever and whenever needed to decarbonize our system, at potentially a very low cost. It also produces valuable byproducts that can be used to make tires and dye, among other things. This project is in partnership with Modern Electron, a Seattle-based sustainable heat and power technology company that has funding support from Microsoft's founder, Bill Gates. We expect the project to go live in early 2023. We believe that clean hydrogen, along with renewable natural gas, energy efficiency, and equipment innovation are critical to achieving our goals of greenhouse gas emissions reductions. And we're committed to preparing our system and employees for any changes in equipment, operations, and training that working with a blended gas might require. Moving now to an update on our competitive renewable natural gas business that we launched late last year. As you know, we focused on providing cost-effective solutions using existing waste streams and renewable energy resources. Our first project with EDL includes an investment in two renewable natural gas facilities and a 20-year RNG supply agreement. Construction is ongoing at both RNG facilities, and we expect them to be placed into service in early 2023. The team is fully engaged, pursuing incremental opportunities and putting the final touches on the business plan, which we will share in more detail later this year. Turning to our water and wastewater utility businesses, as previously mentioned, in December 2021, we signed our largest acquisition today to acquire our wastewater and wastewater utilities in Yuma, Arizona, a fast-growing region which currently serves approximately 25,000 customers. In March, we submitted the application for approval of the transaction with the Arizona Commission. In June, Arizona staff recommended the Commission approve the acquisition. early September, and subject to its approval, expect to close the transaction as soon thereafter as we can. We expect the transaction to be agreed to earnings per share after its first full year of operations. We remain excited about the investment potential for this business and look forward to more announcements soon. So in conclusion, we're off to a good start for the year with continued customer growth at the gas utility, water, and wastewater utilities. Thanks for joining us this morning. With that, we'll open it up to questions. Seth?
Operator
Thank you. As a reminder, to ask a question, please press star 1 on your telephone keypad. Our first question comes from Julian DeMolin-Smith from Bank of America. Please go ahead.
Julian DeMolin - Smith
Hey, it's Cody Clark on for Julian. Thanks for taking my question. You bet, Cody. So first, can you talk through the dynamics and expectations for pension expense in the next year? I know there's a lot of moving pieces that could change through the remainder of the year, but if we look at it today, what do you estimate the impact is for 2023? And you would have to go through a rate case for recovery of that, correct?
Frank
Hey, Cody, it's Frank. Yeah, great question. You know, we've seen about five cents per quarter benefit year over year. from a lower pension expense, and we expect that to continue through the year. We set the rates for the year, essentially. It's when you set the discount rate at 1231. That's pretty much the expense for the year, other than just a little bit of fine tuning. So we think this will continue through the year. It's driven. Interest rates are higher, so discount rates are higher. Asset performance was very good over the last couple of years, so we've got a better asset-funded position. Yes, that goes into rates, so that's forecasted to our test year for rates. So that will be in our Oregon case, and November 1st that will be reflected there. And we don't see a big change in that right now. It is just kind of reset. So as long as interest rates and asset performance are kind of in the same range, we don't expect big changes going forward here. It's been an improvement as both of those have improved.
Julian DeMolin - Smith
Right, but I'm thinking about 2023 and discount rates, yes, higher. Asset performance likely a lot lower. I guess just the net impact of that, you have a view on that into 2023?
Frank
Yeah, I mean, right now, and again, we'll have to set rates at the end of the year, so it'll depend upon where assets and discount rates are at the end of this year. But just when we look at it today, we're not seeing a lot of change net-net. You've seen interest rates go up since year-end last year, and you've seen assets come down. But net-net, we're in very much the same position. So if I had to do it today, if I had to make a guess today, I'd say I'm not expecting a lot of change.
Julian DeMolin - Smith
Okay, got it. And second, just wondering if you can talk through the latest trends you're seeing with inflation and the impact on the O&M budget and capital plan looking forward. Also, any mitigating measures or procurement strategies that you're implementing?
Frank
Yeah, another great question. From a supply chain standpoint, which is all kind of interrelated, we're not seeing a tremendous disruption there. It's a little bit slower delivery time on meters and some of the pipe and such, but we're not seeing a disruption to our business, to our projects. And we've been going through this. We're being more proactive. We're extending our orders out. extending or building up our inventories and such, as you might expect. We are seeing inflationary impacts on materials, but materials are actually a fairly small component of our cost structure. We're more labor-based, whether it's internal labor, third-party labor, other contracted costs. Most of our costs are under multi-year contracts, a lot of them with fixed escalators, but that's what we expect and what we build into rates and into our forecast. We're not seeing any tremendous disruptions at this point just from inflation. We will, you know, over time we will see more of that as our locate contracts and our labor agreements and all of those reprice over time. We will see some of that inflation come through. But I think it's over a manageable structure. Within the year, interest rates are definitely up. We've got some short-term debt at both the utility and the holding company. So we see that, some headwinds there. We saw that early in the year, and so we put in place some cost control measures that have allowed us to get a head start on that and not overreact. So we've got a pretty good beat on the year, and we're managing to our costs just based upon staffing levels, third-party costs, discretionary expenses, the sort of things that you would ordinarily manage, you know, a workflow, those sorts of things, or work mix. So we feel like we've got a really good project – program in place there to manage through this year on that coding.
Julian DeMolin - Smith
Great. And sorry, just one quick follow-up to that. As we're looking at 23, any large sort of renegotiations of contracts that we should be keeping an eye on?
Frank
No. Our big contract here is always going to be our union contract. I think that's got two years in it still, so we just renegotiated that. couple of years ago so that's a couple of years out and you know every year we've got you know it might be the paving contractor the locates etc come up but no one of them presents a particularly large change when we do our rate cases we look forward at as to what the major contracts will be so I think we're in good shape there got it thanks so much for the time I'll pass it up there thanks for the questions
Operator
As a reminder, for any further questions, please press star 1 on your telephone keypad. As we have no further questions at this time, I will hand the call back to David Anderson.
David Roy
Thank you, Seth. We know it's a busy day out there, everybody, and there's multiple calls going on. So for those of you listening to this and she will take care of you, as she always does. So thank you for joining us today, and look forward to seeing you soon. Take care, everybody.
Operator
This concludes today's conference call. Thank you all very much for joining. You may now disconnect your line.
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