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ALLETE’s (ALE) CEO Alan Hodnik on Q1 2016 Results – Earnings Call Transcript

ALLETE, Inc. (NYSE: ALE ) Q1 2016 Earnings Conference Call May 3, 2016 10:00 AM ET Executives Alan Hodnik – Chairman, President and Chief Executive Officer Steven DeVinck – Senior Vice President and Chief Financial Officer Analysts Paul Ridzon – KeyBanc Capital Markets Brian Russo – Ladenburg Thalmann & Company Inc. Christopher Ellinghaus – The Williams Capital Group, L.P. Sarah Akers – Wells Fargo Securities, LLC Joe Zhou – Avon Capital Advisors Operator Good day, ladies and gentlemen, and welcome to the ALLETE Conference Call announcing the First Quarter 2016 Financial Results. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session and instructions will be given at that time. [Operator Instructions] As a reminder, this conference is being recorded. I would now like to turn the call over to Mr. Al Hodnik, Chief Executive Officer. Sir, you may begin. Alan Hodnik Well, thank you for joining us this morning. With me is ALLETE’s Chief Financial Officer, Steve DeVinck. This morning we reported our first quarter financial results that delivered earnings per share of $0.93 on revenue that was up almost 6% over last year. I am pleased with our financial performance for the quarter and believe ALLETE is well-positioned to deliver sustainable value to our shareholders. These financial results demonstrate the synergies of ALLETE’s businesses in challenging times and the strength of our strategic direction. We started this year facing headwinds similar to those in 2015 the most notable coming from a decline in power demand for Minnesota Power’s taconite customers. Our regulated businesses continue to manage costs as they have always done getting through these down cycles without compromising customer service or reliability. Additionally, our emerging and complementary Energy Infrastructure and Related Services companies posted financial results in line with our expectations and we expect further growth as they execute against their strategies. ALLETE Clean Energy and U.S. Water Services strategies are designed to capitalize on the countries desire for cleaner energy sources and conservation. This to meet changing societal expectation, regulation, and resource scarcity, additions of new wind generation facilities in Southern Minnesota and Pennsylvania last year significantly contributed to strong financial performance at ALLETE Clean Energy. ACE currently owns and operates about 537 megawatts of fully contracted wind generating capability and is well-positioned to meet the nation’s call for more renewable energy. We remain excited about the prospects for U.S. Water Services our newest member to the ALLETE family of businesses. U.S. Water experienced impressive revenue growth in the first quarter. Earnings for the Company reflect results from selling certain products, which are seasonal in nature with higher demand typically realize in warmer months. Attention to the water and energy nexus continues to increase and we believe changing regulation and societal expectations will drive growth and improved profitability for this business. Similar to ALLETE Clean Energy, U.S. Water will further balance and complement our core regulated businesses while providing long-term earnings growth. We are seeing encouraging signs relative to the steel dumping that is negatively impacted taconite production on Minnesota’s iron range. The United States Department of Commerce has made preliminary affirmative determinations in its duty and antidumping investigation; final determinations are expected in 2016. According to the U.S. Census Bureau, February 2016 year-to-date imports for consumption of steel products are down approximately 40% compared to February of 2015. Consequently, we are pleased that the import share of the domestic market has fallen from a peak of 34% in March of last year to roughly 24% of this year. Auto production in the United States remains very strong, all of this reminder that there is no lack of domestic steel demand. In addition, Cliffs Natural Resources recently reported stronger than anticipated Q1 financial results and affirmed that it will be restarting its previously idled Northshore mine in May of this year. Cliffs’ CEO, Lourenco Goncalves announced on a recent earnings call that they fully expect United Taconite to restart later this year. While NorthShore mining is not a large power customer of Minnesota Power, we are nonetheless pleased with these developments. Given nominations as we know them however in the near-term, we believe our full-year earnings will likely be in the lower half of our earnings guidance range of $3.10 to $3.40 per share. Again this expectation reflects our current view of industrial sales at Minnesota Power. The midpoint of our original earnings guidance reflected production levels in Minnesota Power’s taconite customers of approximately 35 million tons in 2016. We now estimate 2016 taconite production to be between 30 million and 32 million tons. We are preparing for our next general rate case at Minnesota Power and will be able to file later this year. Some factors affecting rate case timing decisions includes current depreciation dockets and approval of our integrated resource plan currently be for regulators and the outlook for industrial sales. We expect to have more specific information when we release the second quarter financial results. We remain committed to maintaining reasonable and competitive rates for our customers while providing a fair rate of return to our investors. I am pleased with ALLETE’s financial results for the quarter and I am confident in our ability to deliver sustainable shareholder value. I will make some additional comments after Steve takes you through the quarterly financial results. Steve? Steven DeVinck Thanks, Al and good morning everyone. Before I begin, I encourage you to refer to the 10-Q we filed earlier today for more details on the quarter. For the first quarter of 2016, ALLETE reported earnings of $0.93 per share on net income of $45.9 million and operating revenue of $333.8 million. This compares with $0.85 per share on net income of $39.9 million and operating revenue of $320 million in 2015. Earnings in 2015 included $3 million or $0.06 per share of acquisition costs related to our acquisition of U.S. Water Services in February of last year. Earnings from ALLETE’s regulated operations segment, which includes Minnesota Power, Superior Water Light and Power and our investment in the American Transmission Company were $42.4 million compared with $41 million in 2015. This year’s results reflect higher cost recovery rider revenue and lower operating and maintenance expenses mostly offset by a decrease in kilowatt hour sales and higher depreciation and property tax expenses. Our equity earnings in ATC increased $600,000 after-tax due to period-over-period changes in ATC’s estimate of a refund liability related to MISO return on equity compliance. Operating revenue from the Regulated Operation segment decreased $10.5 million or 4% from 2015, primarily due to lower kilowatt-hour sales, field adjustment cost recoveries and gas sales, partially offset by higher cost recovery rider revenue and FERC formula based rates. Revenue decreased $8.1 million due to a 5% decrease in kilowatt-hour sales. Sales to our residential, commercial, and municipal customers were lower due to warmer average temperatures this year. Heating degree days were approximately 8% lower in 2016. Sales to our industrial customers decreased 18% primarily due to reduced taconite production in 2016. Sales to other power suppliers increased 27% mostly due to more energy available for sale resulting primarily from the reduced demand from our taconite customers. Fuel cost recoveries decreased $5.5 million due to lower fuel and purchase power cost attributable to our retail and municipal customers. Revenue from gas sales at Superior Water Light and Power decreased $1.8 million as a result of warmer temperatures in 2016. Cost recovery rider revenue increased $4.7 million primarily due to the completion of our Boswell Unit 4 environmental upgrade. Revenue from our wholesale FERC regulated customers increased $1.7 million primarily due to additional environmental upgrades and other investments. On the expense side, fuel and purchase power expense decreased $9.1 million or 11% from 2015 primarily due to lower purchase power prices in kilowatt-hour sales this year compared to last year. Transmission services expense increased $1.9 million for the quarter or 13% primarily due to higher MISO related expenses. Cost of sales decreased $1.5 million or 33% from last year due to the previously mentioned lower gas sales at Superior Water, Light and Power. Operating and maintenance expense decreased $8.1 million or 14% primarily due to a sales tax refund received this year and lower salary and benefit expenses. In addition, conservation improvement program expenditures were less than the first quarter of 2015. Conservation improvement program expenses are recovered from certain retail customers resulting in a corresponding reduction in revenue. We remain committed to cost containment at Minnesota Power to reduce rate increases per customers, improve our return on equity over time, and mitigate some of the impacts of cyclicality facing our customers in taconite mining. Our 2016 earnings guidance reflected lower operating and maintenance expense due to cost control initiatives with the expectation that 2016 amounts would be 5% to 10% lower than 2014 actual amounts. We are on track to meet those expectations. Depreciation and amortization expense increased $6.2 million or 19% from 2015 primarily due to additional property, plant and equipment and service. Equity earnings in ATC increased $900,000 or 23% from last year due mostly to period-over-period changes in ATC’s estimate of a refund liability related to MISO return on equity compliance. Net income at ALLETE Clean Energy increased $3.6 million and revenue increased $11.2 million over the last year primarily due to Wind Energy facilities required in April and July of last year. U.S. Water acquired in February of last year is a leader in integrated water management to a growing number of industrial and commercial customers throughout the United States. Revenue at U.S. Water Services increased $16.9 million compared to the period from February 10, 2015 to March 31, 2015. The net loss at U.S. Water was in line with expectations and was $400,000 higher than the first quarter of 2015 which did not reflect the full quarter. The Company sells certain products which are seasonal in nature with higher demand typically realized after the first quarter. The first quarter net loss also included $300,000 of after tax expense related to purchase accounting for inventories and sales backlog. As we have discussed in previous quarters this purchase accounting adjustment has now been fully recognized. The corporate and other segment, which includes result from BNI Energy, ALLETE Properties, and other miscellaneous corporate income and expenses, reported a $2.1 million net loss this quarter compared to a net loss of $3.5 million for the same quarter in 2015. Earnings in 2015 included the $3 million or $0.06 per share of acquisition costs related to the acquisition of U.S. Water Services. ALLETE’s effective tax rate in the first quarter of this year was approximately 17% compared to about 13% in 2015. We anticipate the effective tax rate for 2016 will be approximately 17%; this could vary slightly if earnings expectations change. ALLETE’s financial position continues to be solid. Cash from operating activities increased $21.4 million for the quarter driven primarily by higher net income and non-cash expense. Our debt-to-capital ratio at quarter end was 46%. Al. Alan Hodnik Thank you for the financial update, Steve. I have a few more comments to make before Steve and I take your questions. Regarding Minnesota Power’s Energy forward initiatives we recently shared good news on Minnesota Power’s proposed great Northern transmission line. This proposed 220 mile, 500 kV line will deliver hydro generated electricity from Manitoba to Minnesota Power. In an order dated April 11, 2016 the Minnesota Public Utilities Commission approved the route permit which largely follows Minnesota Power’s preferred route including the international border crossing. The project has garnered considerable support and a final decision on the Presidential permit by the United States Department of Energy is expected in the second quarter of 2016. Minnesota Power expects to begin construction on the transmission line in 2017 and this project will provide investment and growth opportunities to the end of the decade. With respect to a natural gas generation addition Minnesota Power continues to advance the need within its resource plan currently before regulators and with other strategic partners who share a similar interest. I would like to remind everyone that these initiatives are the latest step and how Minnesota Power is advancing its energy forward strategy and the balancing of its energy supply towards one-third renewable, one-third natural gas and one-third coal by the early 2020. Regarding new industrial load in our region, I have constructive news for PolyMet’s proposed copper, nickel, and precious metal mining operation in Northeast Minnesota. The Minnesota Department of Natural Resources issued its record of decision on March 3 of this year finding the final EIS adequate. The time to appeal that adequate EIS adequacy determination has expired and on April 19 the Department of Natural Resources initiated their required free application, public information hearing near the mine site. With this required step complete formal submission of permit applications by PolyMet can now occur. Once records of decisions by the federal and state agencies on the necessary permits are received PolyMet could move forward with its plans to construct and operate the mine. Minnesota Power could begin to supply between 45 and 50 megawatts of new load to a 10-year power supply contract that would begin upon start up of the mining operations. Essar is again in the midst of seeking financing to complete their Minnesota project. As you will recall the Essar facility will result in approximately 110 megawatts of new load in Minnesota Power’s fulfill municipal segment once it reaches full production levels and by taking service from the City of Nashwauk. Given the quality of the ore body and the billion plus dollars investment made to date we maintain a view that it is not a matter of if but when the Essar project moves to commercial operations. Further just last week Cliffs Natural Resources publicly shared a view that the Essar site is favorable for a direct reduced iron facility, which is an enhanced product suitable for use in electric arc furnaces. Regarding our complementary Energy Infrastructure and Related Services businesses, ALLETE Clean Energy is positioned for earnings growth in 2016 as a result of the wind energy facilities it acquired during 2015. Opportunities within the renewable space remain very strong and ACE will continue to target acquisitions of existing facilities which have long-term power sales agreements in place. U.S. Water Services will further complement our core regulated operations, balance our exposure to business cycle and changing demand and provide earnings growth over the long-term. The Company will continue to look for strategic tuck-in acquisitions which expand its geographic reach, add new technology or deepen its capabilities to service expanding customer base. All of us at ALLETE are excited about our prospects and the opportunities to create shareholder value. Thank you for your continued confidence and your investment with us. At this time, I’ll ask the operator to open up the line for your questions. Question-and-Answer Session Operator [Operator Instructions] And our first question comes from the line of Paul Ridzon with KeyBanc. Your line is now open. Paul Ridzon Good morning. Alan Hodnik Good morning, Paul. Paul Ridzon What’s the status of – you had talked about special rates for energy intensive customers. Is that still a viable option? Alan Hodnik It still is. The Minnesota Public Utilities Commission took up the docket initially here in the first quarter of the year and ultimately determined that they did not have enough information and Utility Kilowatt rejected it without sort of discrimination against it in that sense. And so we’re positioned right now and working with our customers to resubmit the EITE where that’s known here in Minnesota to our regulators and would hope to get that to the regulators again sometime in the early spring or mid spring here as we go off into the summer. Paul Ridzon And Al, I think I heard you say you will be filing a rate cases here, is that correct? Alan Hodnik We will be able to file a rate case later this year, yep. Paul Ridzon And how does that targeting with the energy intensive customers, there just be two separate processes? Alan Hodnik While the EITE was a piece of special legislation that was passed by the Minnesota Legislature of course and signed by Governor Dayton into law to help paper customers and taconite customers with their competitiveness challenges that they’re facing. And so that has its own docket if you will or its own pathway with the regulators. It could ultimately get a part of the conversation inside of a rate case because after all it is a rate design question, but the EITE is on its pathway and it’s collateral to or connected to any rate case that we might file later this year. Paul Ridzon So you’re still not committing to file a rate case, you are still prepared to file one if need to be? Alan Hodnik We are going to be able and ready to file a rate case and as we said timing around that really is stemming from sort of more clarity on filings that we have before our regulators in the moment. We have depreciation filings before our regulators right now that are very important to the Company, of course we have our integrated resource plan before the commission at this point in time. We expect to hear on that shortly. And then as I say, we have this industrial loan growth and demand situation here in the region that we continue to manage, but also we’re going to be able and ready to file a rate case in the fall if we need to. We’ll have more clarity on that after our second quarter earnings call. Paul Ridzon Understood. Thanks for clearing that up. What was your previous expectation for tonnage of taconite? Steven DeVinck Our original guidance – Paul this is Steve, good morning. Our original guidance, the midpoint had approximately 35 million tons. Paul Ridzon Okay. Thank you very much. Alan Hodnik Thanks, Paul. Operator Thank you. And our next question comes from the line of Brian Russo with Ladenburg Thalmann. Your line is now open. Brian Russo Hi, good morning. Alan Hodnik Good morning, Brian. Brian Russo How does the 30 million to 35 million tons of taconite production assumption – how does that correlate with the present nominations which I believe are set at 80% for the next few months? Steven DeVinck So our updated information this morning were we expect taconite production to be in the 30 million to 32 million ton range would generally correlate with that 80% of total production number that you’ve seen from us here in the last quarter or two. Brian Russo So then what’s changed because I believe the last time you reaffirm to guidance we were at 80% as well? Is it just fine tuning the sensitivity? Steven DeVinck Well, the last time we talked that 80% was for the first four months of the year. We have a better insight into the remaining eight months of the year or an insight or expectation as to what that maybe, so with that insight into the later – in the left eight months of the year we now think taconite production will be reduced from 35 million tons at original expectations to 30 million to 32 million. Brian Russo Okay, got it. And just is there any update on the Boswell depreciation study when might we expect an outcome? Steven DeVinck Yes, as you know in conjunction with Minnesota Power’s Energy forward plan and the related extensive environmental upgrades completed at our Boswell generating facility, we filed for depreciation use of life extensions earlier this year. The requested useful life extension would decrease annual depreciation expense by approximately $20 million and have a rate increase mitigating effects for our customers both immediate and longer-term. We are proposed to provide immediate customer benefit for approximately one-third of the annual expense reduction through our environmental cost recovery rider. The remainder will help mitigate future rate increase needs. The Minnesota Department of Commerce requested and was granted a postponement of the proceeding until August. Brian Russo And did they give a reason why? Steven DeVinck No, we are not certain, but we think it just might be the status of other workload initiatives in front of them. Brian Russo Okay, great. And has there been any change to the property net book value relative to your 10-K? Steven DeVinck No. Brian Russo Okay. And then lastly could you elaborate a little bit more on the ALLETE Clean Energy project pipeline? Alan Hodnik Well, this is Al. Brian, the pipeline remains strong both on the wind and solar side existing assets are positioned for sale or original developers want to move on. So I’m not going to get specific this morning about projects that we are looking at or locations that we are looking at, but I would say again that the pipeline remains very, very strong both on the solar and on the wind side. The ACE has plenty of opportunities before it and right now the team over there is parsing the opportunities that they have in the past and fully expect to have more opportunities later this year for us to assess at the ALLETE corporate level and potentially make investment in. Brian Russo Okay, great. Thank you. Alan Hodnik Thank you. Operator Thank you. And our next question comes from the line of Chris Ellinghaus with Williams Capital. Your line is now open. Christopher Ellinghaus Hey, guys. How are you? Steven DeVinck Hi, Chris. Alan Hodnik Good morning. Christopher Ellinghaus Couple of questions, have you got any updates on activity with the ALLETE properties? Steven DeVinck No, nothing really new to report. We continue to see about the same level of activity that we saw in 2015, so we’ll see how the year progresses. Christopher Ellinghaus Okay. And given the acquisition costs that were incorporated another in the first quarter last year; it looks like there was a material decline in adjusted earnings. Can you give us some color on that? Steven DeVinck So the acquisition costs were about $0.06 per share, our earnings per share this year were $0.93 versus $0.85 last year. So if we adjusted for that $0.06 I guess it would be $0.93 versus $0.91 last year. Christopher Ellinghaus No, I meant just in the corporate and another segment, if you take out the $3 million from last year’s first quarter it would’ve been a loss of more like $0.5 million. So there was some significant decline there versus last year adjusted so maybe 2.1 versus minus 0.5 last year. So what was the delta there? Steven DeVinck Yes, I see. So you’re correct, the acquisitions cost of $3 million were in there last year, this year we have just more general corporate interests and taxes, so we have higher interest expense of rate around $0.5 million. We also I’m going to get into ALLETE’s here a little bit but if you look at some of our disclosures we have a contingent purchase obligation for U.S. Water that is discounted and then accreted over time through 2019 when that buyout happens. So there’s accretion expense of about 600,000 related to that that is more than last year. And we have some period to period income tax allocations of probably another $0.5 million or so. So it’s miscellaneous things like that. Christopher Ellinghaus Okay great. And as far as the guidance on taconite production can we infer that a significant portion of your decline in expectations is just related to the timing of United Tac coming back? Steven DeVinck Yes. Christopher Ellinghaus Okay. Great. Thanks for the color. Alan Hodnik Thanks Chris. Operator Thank you. And our next question comes from the line of Sarah Akers with Wells Fargo. Your line is now open. Sarah Akers Hey, good morning. Alan Hodnik Good morning, Sarah. Sarah Akers With the latest news on PolyMet and Essar can you update us on the current expectation for the in-service dates there? Alan Hodnik Well, it’s a little difficult with both these to do that I guess Sarah the PolyMet process we’re very encouraged about at the moment. The fact that the EIS adequacy determination and decision by the agencies was not litigated in any way is very good news for PolyMet and somewhat unprecedented to in terms of mining in Minnesota at least with regards to that. On the permit processes themselves have a bit more of a defined timeline both from the Federal Government side and also the state, so unlike the EIS which had a much more sort of expansive process if you will in an undefined timeline, the permit processes are tighter of course it was financing that the Company needs to obtain as well. And so I don’t know that I can give you anything more than what PolyMet expressed already that you know they would hope to be moving forward of permitting in the later part of 2016 here and into 2017 and then hopefully with construction and the timing of finance and all the rest would be operating sometime in 2018 would be kind of I’d think there are commentary or what I’d see basically on their webpage with respect to their latest observations. Essar, of course is about 1 billion plus ton and Essar continues to try to work on it’s financing if you will to put the rest of the project together. We are certainly not expecting any production from Essar in the kind of early 2017 timeframe as they put their financing togetherness construction is played out up there. So that’s the best I can offer with respect to PolyMet and Essar. Sarah Akers Got it. Thank you. And then on the upcoming rate filing should we expect a multi-year rate plan with step-ups in years two and three or will this just be a one-year filing? Steven DeVinck So we are working through that rate now. I have nothing really to announce on the specifics here today. As Al mentioned, when we announce second quarter results, we will have more specifics on the timing amount and some of the other factors in a rate case. So we’re still working through that. Sarah Akers Got it. And then one more, can you just remind us of ALLETE’s deferred tax position and whether you are a cash taxpayer now and if not how many years you expect to be a non-cash taxpayer with bonus and renewable credits? Steven DeVinck Yes, so we are not a cash taxpayer right now because of all the factors you just indicated. I believe our current projections are that we will run through those net operating loss carry-forwards in 2018 or 2019. Sarah Akers Great. Thank you. Steven DeVinck Thank you. Alan Hodnik Thanks, Sarah. Operator Thank you. [Operator Instructions] And our next question comes from the line of Joe Zhou with Avon Capital. Your line is now open. Joe Zhou Hi, how are you? Good morning. Alan Hodnik Hi, Joe. Steven DeVinck Good morning. Joe Zhou Good morning. So I just want to make sure my model is correct. Is that – so now the taconite production is reduced to 30 million to 32 million tons for the year? So is that still a rule of thumb that reduced $0.03 per million tons for taconite production on your [earnings per] share? Alan Hodnik Yes, that rule of thumb generally still holds. Joe Zhou Okay. So your original guidance was like $3.10 to $3.40 and with – and the original taconite production was 35 million and now reduced to a midpoint of 31, so there is 3 million tons. So that should reduce your regional guidance by roughly $0.12 for the rate should be roughly $2.98 to $3.28 so that’s my calculation. And now you say that the earning will be in the bottom half of the guidance, so there is $3.10 to $3.25 so I assume that the lower end lift by $0.10 is that because of the rate case? Steven DeVinck No I don’t think your math is quite accurate. So our original guidance contemplated, the midpoint contemplated taconite production of approximately 35 million tons, so the midpoint would’ve been $3.25. Joe Zhou Okay. Steven DeVinck So that was the midpoint, so now we are expecting taconite production to be $0.30 to $0.32 so you got to subtract that delta from that midpoint. Joe Zhou Okay, okay. Steven DeVinck That’s how we get in the lower… Joe Zhou It’s not the linier relationship that can now do that back-of-the-envelope calculation I guess. Okay, so and on the timing for the rate case can you remind us that you said you would be able to file later this year. Are you talking about the second half of this year or like towards the end the year? Steven DeVinck We don’t have the specific month yet that we’re ready to disclose at this time, some of the factors affecting rate case timing include decisions on our open depreciation docket, approval of our integrated resource plan which is expected in June and really the outlook for industrial sales, but we do expect to have more specific information when we release second quarter financial results. Joe Zhou Okay, great. Thank you very much. Steven DeVinck Thank you. Alan Hodnik Thank you. Operator Thank you. And our next question comes from the line of Brian Russo with Ladenburg Thalmann. Your line is now open. Brian Russo Yes, just curious are you able to file for interim rates in the Minnesota rate cases? Steven DeVinck Hi, Brian, yes. So the way it works in Minnesota is once the filing is being complete 60 days later interim rates would go into effect of course subject to refund. Brian Russo Okay, so they automatically going to effect is not like you have to request interim rates? Steven DeVinck Well, we will certainly request and they will automatically going to effect. Brian Russo Okay, got it. And then just within the guidance range might be at the lower end of the range, is there any assumption made on the outcome of the Boswell extension wise study? Steven DeVinck No, we are assuming nothing for that. Brian Russo Okay, great. Thank you very much. Steven DeVinck Thank you. Alan Hodnik Thanks Brian. End of Q&A Operator Thank you. And I am showing no further questions at this time. I would now like to turn the call back to Mr. Al Hodnik for closing remarks. Alan Hodnik Well, Steve and I thank you again for being with us this morning and we certainly thank you for your investment and interest in ALLETE. We hope to see some or all of you on our travel throughout the summer. Thank you very much. Steven DeVinck Thank you. Operator Ladies and gentlemen, thank you for participating in today’s conference. This does conclude the program and you may all disconnect. Everyone have a great day. Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited. 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NiSource (NI) Joseph J. Hamrock on Q1 2016 Results – Earnings Call Transcript

NiSource, Inc. (NYSE: NI ) Q1 2016 Earnings Call May 03, 2016 9:00 am ET Executives Randy G. Hulen – Vice President-Investor Relations Joseph J. Hamrock – President, Chief Executive Officer & Director Donald E. Brown – Executive Vice President, Chief Financial Officer & Treasurer Analysts Greg Gordon – Evercore Group LLC Charles Fishman – Morningstar Research Paul T. Ridzon – KeyBanc Capital Markets, Inc. Operator Good day, ladies and gentlemen, and welcome to the First Quarter 2016 NiSource Earnings Conference Call. At this time, all participants are in a listen-only mode. As a reminder, this conference is being recorded. I would now like to introduce your host for today’s conference, Mr. Randy Hulen. Sir, you may begin. Randy G. Hulen – Vice President-Investor Relations Thank you, and good morning. On behalf of everyone at NiSource, I’d like welcome you to our quarterly analyst call. Joining me this morning are Joe Hamrock, Chief Executive Officer; and Donald Brown, Chief Financial Officer. The purpose of today’s call is to review the NiSource financial performance for the first quarter of 2016, as well as provide an overall business update on our utility operations and growth drivers. We’ll then open up the call to your questions. Just as a reminder, we will be referring to supplemental earnings slides that are available on our website. Before turning the call over to Joe, just a quick reminder that some statements made on this conference call will be forward-looking. These statements are subject to risks and uncertainties that could cause actual results to differ materially from those expressed in the statements. Information concerning such risks and uncertainties is included in the MD&A and Risk Factors sections of our periodic SEC filings. With all that covered, I’d like to now turn the call over to Joe. Joseph J. Hamrock – President, Chief Executive Officer & Director Thanks, Randy. Good morning, everyone, and thanks for joining us. As we’ll detail on today’s call, NiSource is off to a great start in 2016. Our first quarter results reflect the strength of our regulated business strategy and sustained track record of delivering improved service for our customers through our utility investment programs. We continue to execute on our infrastructure investment strategy, which is designed to improve safety, reliability and environmental performance for our customers and communities. NiSource also made significant progress on several regulatory initiatives supporting these investments, as well as enhanced employee training and customer programs. Today, we’ll briefly cover our first quarter 2016 results before discussing specific operational and regulatory highlights. We’ll also touch on how we’re positioning NiSource for continued growth before opening the call for your questions. Turning to slide three of our supplemental deck, let’s now highlight a few key takeaways for the quarter. The NiSource team delivered non-GAAP net operating earnings of $0.60 per share in the first quarter compared to $0.57 in the same period in 2015. We are well positioned to deliver non-GAAP net operating earnings within our 2016 guidance range of $1 to $1.10 per share. And with a strong start to the construction season, we’re on track to execute on more than $1.4 billion in utility infrastructure investments planned for the year. Violet Sistovaris and our NIPSCO team reached settlement agreements with key stakeholders in both its electric base rate case, and its long-term electric infrastructure modernization plan. And our Columbia Gas teams led by Carl Levander filed base rate cases in Maryland, Pennsylvania and Virginia. And we received regulatory approval of gas system modernization plan updates in Indiana, Massachusetts and Ohio. On the organizational front, we announced changes aimed at further advancing our growth plan and enhancing performance. Pablo Vegas joined NiSource today as President of our Columbia Gas group. He will oversee the six Columbia Gas companies, including leadership of state regulatory, customer, and stakeholder performance, as well as customer service, billing and new business platforms for all seven NiSource companies. Pablo most recently served as President and Chief Operating Officer of AEP Ohio. With Pablo’s appointment and the planned retirement of our Human Resources Leader, Rob Campbell, Chief Regulatory Officer, Carl Levander, assumes the role of Executive Vice President, Regulatory Policy and Corporate Affairs, which includes responsibility for Policy, Corporate Communications, Federal Government Affairs, Regulatory Strategy and Human Resources at NiSource. I’ll talk more about the significant progress across all our businesses later in the call, but first I’d like to turn the call over to Donald to review our financial results in more detail, which are highlighted on page four of our supplemental slides. Donald? Donald E. Brown – Executive Vice President, Chief Financial Officer & Treasurer Thanks, Joe. And good morning, everyone. As Joe mentioned, we delivered non-GAAP net operating earnings of about $191 million or $0.60 per share in the quarter compared with about $179 million or $0.57 per share in the first quarter of 2015. On an operating earnings basis, NiSource reported about $399 million for the quarter, which is an increase of about $35 million over the first quarter of 2015. On a GAAP basis, our income from continuing operations was about $180 million for the quarter versus about $193 million in the first quarter of 2015. Now, let’s take a closer look at the operating earnings performance of our two utility business segments for the first quarter of 2016. Our gas distribution operation segment delivered about $330 million compared with about $306 million in 2015. Net revenues excluding the impact of trackers were up by nearly $35 million, primarily attributable to increases in regulatory and service program, including the impact of new rates in Massachusetts and Pennsylvania, as well as the implementation of new rates under Columbia Gas of Ohio’s approved infrastructure replacement program. Operating expenses excluding the impact of trackers increased by $10.3 million, primarily due to increased outside service costs and higher depreciation. Our electric operations reported about $72 million compared with about $67 million for 2015. Net revenues excluding the impact of trackers were essentially flat. Operating expenses excluding the impact of trackers were essentially flat. Operating expenses excluding the impact of trackers decreased by $4.8 million, primarily due to lower generation expenses, decreased employee and administrative costs and lower environmental expenses. These decreases were partially offset by higher outside service costs. As Joe mentioned, our first quarter results position NiSource well to deliver net operating earnings within our guidance range of $1 to $1.10 per share for the year. Full details of our results are available in our earnings release issued and posted online this morning. Now turning to slide five, I’d like to briefly touch on our debt and credit profile. Our debt level as of March 31 was about $7 billion, with a weighted average maturity on long-term debt of approximately 14 years and a weighted average interest rate of approximately 5.72%, down from 5.88% at the end of 2015. On March 31, we executed a three-year, $500 million term loan agreement with pricing of LIBOR plus 95 basis points. In utilizing the delay draw feature, we have until the end of September to borrow the full $500 million. At the end of the first quarter, we maintained net available liquidity of more than $1 billion, consisting of cash and available capacity under our credit facilities. And our credit ratings at the three major agencies remained solidly investment grade, something we remain committed to as we continue to execute on our $30 billion and 100% regulated infrastructure investment opportunities. Going forward, our financial foundation is strong employees for continued execution and growth. Now, I’ll turn the call back to Joe to discuss a few customer, infrastructure and regulatory highlights across our utilities. Joseph J. Hamrock – President, Chief Executive Officer & Director Thanks, Donald. We began 2016 by building upon the positive momentum that we’ve gained in recent years in maintaining our sharp focus on serving our customers and communities. For instance, in March, we became a founding member of the U.S. EPA’s Natural Gas STAR Methane Challenge Program. Through our five-year program commitment, NiSource will continue to replace cast iron and bare steel pipelines remaining in our natural gas system. Since 2005, we’ve reduced our greenhouse gas emissions by 23%. As part of our planned investments, we expect to further reduce methane emissions by more than 300 million cubic feet, a reduction of 10% compared to 2015. In addition to helping reduce emissions, our well-established infrastructure modernization programs are producing other meaningful benefits and adding value for our customers. For example, we have reduced gas leaks on our mains by 9%, and by 14% on our service lines over the past five years. This builds on the safety and reliability of our system. And we have continued to receive recognition for doing business the right way. In March, NiSource was named for the fifth consecutive year as one of the World’s Most Ethical Companies by the Ethisphere institute. Ethisphere honors companies for leading and promoting ethical business standards in key categories, which include ethics and compliance programs. This designation demonstrates our commitment to serving our customers with integrity and the highest of ethical business standards. Now, let’s turn to a few recent highlights in our gas operations on slide six. On March 18, Columbia Gas of Pennsylvania filed a request with the Pennsylvania Public Utility Commission to adjust its base rates in support of the company’s continued upgrades and replacement of infrastructure, and other programs to enhance pipeline safety. If approved as filed, the case would result in $55 million annual revenue increase. An order is expected by the end of 2016. On April 20, the Public Utilities Commission of Ohio approved Columbia Gas of Ohio’s annual infrastructure replacement rider. The rider provides for continued support of the company’s well-established pipeline replacement program investments. This order authorizes an increase of about $21 million in annual revenue related to 2015 infrastructure investments of about $185 million. At NIPSCO gas, the team continues to execute on its seven-year, approximately $800 million long-term gas system modernization program to further improve system reliability and safety. On March 30th, the Indiana utility regulatory commission or IURC approved the semi-annual tracker update that was filed in August 2015 with additional revenues of $7.6 million, which covered approximately $74 million of investments through mid-2015. NIPSCO filed its latest semi-annual tracker update on February 29th, which remains pending with the IURC. On April 29, Columbia Gas of Virginia filed a request with the Virginia State Corporation Commission to adjust its base rates to recover investments and other costs associated with the company’s ongoing initiatives to improve the overall safety and reliability of its distribution system and to accommodate increasing demand for service. If approved as filed, the case would result in an annual revenue increase of $37 million. A commission decision is expected by early 2017. A decision on Columbia Gas of Massachusetts’ 2016 Gas System Enhancement Plan was issued by the Massachusetts’ Department of Public Utilities on April 29th. This approval allows for a recovery of investments through 2016 and will increase annual revenues by approximately $8.2 million beginning May 1st. On April 15th, Columbia Gas of Maryland filed a request with the Maryland Public Service Commission to adjust its base rates so it can support the continued replacement of aging pipe, as well as adopt pipeline safety upgrades. If approved as filed, the case would result in an annual revenue increase of approximately $6.5 million. A commission order is expected by the end of 2016. And finally, Columbia Gas of Kentucky, on April 27th, filed notice with the Kentucky Public Service Commission that it intends to file a request to adjust its base rates to support continued infrastructure investments. Now, let’s turn to our electric operations on slide seven. On March 24th, NIPSCO reached a settlement agreement with the Indiana Office of Utility Consumer Counselor, industrial customers, the La Porte County Board of Commissioners and the Indiana Municipal Utility Group on the company’s seven-year electric infrastructure modernization plan. This plan includes more than $1.2 billion of transmission and distribution investments designed to improve system safety and reliability. An IURC order on the settlement is anticipated in the third quarter of 2016. NIPSCO also reached an agreement in its electric base rate case currently pending before the IURC. The February 19 settlement provides a platform for NIPSCO’s continued investments in service improvements for customers. The proposed settlement agreement would increase annual revenues by $72.5 million. An IURC order is anticipated early in the third quarter of 2016. NIPSCO’s two major electric transmission projects remain on schedule with anticipated in-service dates in the second half of 2018. The 100-mile 345KV and 65-mile 765KV projects are designed to enhance region-wide system flexibility and reliability. Right-of-way acquisition, permitting and engineering are well underway on both projects. NIPSCO expects to provide updated project cost estimates prior to the commencement of line construction later this year. Before opening the call to your questions, I’d like to touch on our financial and growth commitments as well as how we’re positioning NiSource for continued growth. NiSource remains on track for sustained execution on the more than $30 billion of long-term regulated utility investments the company outlined in 2014. As we’ve outlined previously, we expect to deliver net operating earnings per share of $1 to $1.10, and to make more than $1.4 billion in planned infrastructure investments in 2016. This 2016 earnings and investment guidance provides the starting point for NiSource’s long-term annual earnings per share and dividend growth projections of 4 to 6%, which we first announced a year ago in anticipation of the separation of Columbia Pipeline Group. As we execute on our well established plans, we’re aligning our organization to capitalize on all of our strategic opportunities, including our infrastructure investment plans, while at the same time looking at enhancements to our plan such as growing our customer base, improving service to our customers and driving enhanced performance through the increased use of common platforms. These emerging elements of our plan are expected to enhance our existing best-in-class risk-adjusted total return proposition. Thank you all for participating today and for your ongoing interest and support of NiSource. We look forward to sharing continued updates on our progress. Now let’s open the call to your questions. Skyler? Question-and-Answer Session Operator Thank you. And our first question comes from the line of Greg Gordon from Evercore. Your line is now open. Greg Gordon – Evercore Group LLC Thank you. Joseph J. Hamrock – President, Chief Executive Officer & Director Good morning, Greg. Greg Gordon – Evercore Group LLC Yeah. Good morning, guys. Happy to finally be covering the stock. Joseph J. Hamrock – President, Chief Executive Officer & Director Yeah. Welcome to the fold. Greg Gordon – Evercore Group LLC I wish I had been quicker on the uptake and got all the outperformance the last couple of years, but so be it. So I’ve asked you this question before and I just wanted to ask it again. Obviously, the performance in the quarter was great and you’ve got $1.4 billion in capital still in the budget – vast majority of it covered by riders. And you’ve got this sort of 4% to 6% long-term earnings guidance drive out there, but the rate base growth guidance range is 6% to 8%. Obviously, that’s very enticing because there seems like there’s a lot of cushion in there. But you first gave that well before the bonus depreciation rules were extended for five years, so can you tell us about how that may have moved things around inside the guidance range? It still seems like you’re well positioned to, at the minimum, hit the high end of the earnings guidance range. But maybe the rate base growth is less robust because of bonus D (18:59) and what you might do to offset that? Joseph J. Hamrock – President, Chief Executive Officer & Director Yeah. Thanks, Greg. And it’s a fairly common question, as you noted. I’ll ask Donald to touch on the bonus and the relative impact on rate base and how we’re navigating through that. But let me take this, sort of, the higher level question about the relationship between our outlook, our guidance and our business plan. We think and firmly believe that one of the strengths of the NiSource story is the long-term visibility, the sustained investment platform we have that we outlined as we noted a couple of years ago with the $30 billion in investment. As we look through the future and the strong support we have across all seven states for those kind of investments, that’s a great engine for driving growth, the visibility. And I wanted to be sure that we’ve put out a fairly long-term look at earnings guidance in that 4% to 6% annual growth range. We remain committed to that. As we’ve noted before, the relationship between investments in rate base that are tracked, the ongoing support for those investments, is offset in some ways and a couple of ways by regulatory lag, continued O&M growth that gets picked up in rate cases that don’t have quite the same effect as the trackers have. A bit of conservatism in our outlook. And then over the long-term, the need to finance that in a balanced way. That story remains the same today. I will ask Donald to touch on the effect of bonus. As we’ve noted, our guidance remains the same for the year, and our growth guidance remains the same. A little bit of insight about the relationship of bonus depreciation would be helpful. Donald E. Brown – Executive Vice President, Chief Financial Officer & Treasurer Yeah. And so think about the bonus depreciation on our rate base. It certainly has a detrimental impact over our plan years, and we typically look out four to five years. And so what we’ve done to offset that is to increase our capital spend a little bit over the next couple of years to offset the impact of the rate base. But then when you look at it over a four- or five-year period, we actually do have positive cash flows through the period. If you’ll remember, we’ve got NOLs that before this extension of bonus depreciation went out through 2018. With this extension of bonus depreciation, our NOL will now go out to the end of 2022. So from a cash standpoint is the detriment early with the bonus depreciation because of the NOL position. But on the back end of the years, we do have a cash pickup. And so with the cash, we’ll spend in the next couple of years to offset the rate base degradation, we’ll come out slightly ahead over kind of a five- or six-year period. So I think all in all, we’re looking at staying within that range. It doesn’t challenge our earnings growth story. And at the same time, I think as Joe talked a little bit about conservatism, we understand we’re in multiple rate cases at any time. There’s certainly some risk from amount realized, as well as just the timing of when rates go into effect. And so trying to balance out the understanding of the risks of both the kind of regulatory mechanisms, as well as kind of O&M, which doesn’t go into the trackers. We feel confident we’ll certainly be in the range, but obviously have some opportunities, if everything goes the right way to be at the higher end of the range. Greg Gordon – Evercore Group LLC Fantastic. Thanks, guys. Take care. Joseph J. Hamrock – President, Chief Executive Officer & Director Thanks, Greg. Operator Our next question comes from the line of Larry Louie (23:15) from JPMorgan. Your line is now open. Unknown Speaker Hey, good morning, guys. Thanks for taking my question. I just wanted to walk through the decision process on the term loan. Was it more economically driven or was it more so of a flexibility decision when it comes to kind of call provisions on term loans? Joseph J. Hamrock – President, Chief Executive Officer & Director I’d say it’s both. When we’re looking at the need for this year and looking at what are our different options, really did want to take advantage of the low interest rate environment and the interest savings that provided, as well as making sure we’ve got kind of a full toolkit for financing our company going forward. So I’d say it’s a little bit of both. And I think, going forward, we’ll look at both the bond market, as well as taking advantage of the bank market in term loans. Unknown Speaker Got you. And can you just remind us what are your financing needs? I know I think you paid down the rest of your 10% handle that remained outstanding. Joseph J. Hamrock – President, Chief Executive Officer & Director Yeah. So this year I would expect that we wouldn’t have any significant financing needs. This term loan, which we took out. We haven’t actually tapped into yet and won’t tap into until later this year. But I don’t expect anything significant this year. But certainly, we’re always looking at our portfolio. We do have some higher cost debt in the portfolio and still looking for opportunities to bring down our overall cost of debt. If the market and the timing makes sense, we would do that as well. Okay, thank you. Joseph J. Hamrock – President, Chief Executive Officer & Director Thanks, Larry. Operator Our next question comes from the line of Charles Fishman from Morningstar. Your line is now open. Charles Fishman – Morningstar Research Thank you. Just to follow up on that bonus depreciation question. I noticed, Joe, in your introductory comments, I believe you said CapEx for 2016 more than $1.4 billion, where I believe last quarter it was approximately $1.4 billion. Is that consistent with Donald’s comments about the accelerating CapEx because of the cash flow benefit from bonus depreciation? Joseph J. Hamrock – President, Chief Executive Officer & Director Yeah. Thanks, Charles, and good morning. That’s very perceptive. It’s entirely consistent. There’s not a big shift in the 2016 – Donald’s comments related to the near-term years of the plan to offset the NOL issues and to help with the outer years of the plan on an earnings standpoint. But it’s all around the $1.4 billion, as we’ve navigated through the 2016 planning cycle. Charles Fishman – Morningstar Research Okay. And then my next question is on the case or the settlement on the electric modernization program. Does that – are we done? Does that pretty much eliminate any of the excitement that we’ve seen – regulatory and legal? I mean, are you pretty confident we’re on the… Joseph J. Hamrock – President, Chief Executive Officer & Director We’re confident that – yes, I’m sorry. I like your term excitement. But we’re confident that we’ve got a framework vis-à-vis the settlement that we’ve filed. We are still in the regulatory process. So we still have the remaining steps through the regulatory process that we would expect to resolve early in the third quarter this year, but feel very good about the position we’re in and we’ve remained committed to making those investments. So that’s all part of the framework that we’ve set up. Charles Fishman – Morningstar Research Okay, thank you. That was all I had. Joseph J. Hamrock – President, Chief Executive Officer & Director Thanks, Charles. Have a great day. Operator Our next question comes from the line of Paul Ridzon from KeyBanc. Your line is now open. Paul T. Ridzon – KeyBanc Capital Markets, Inc. Good morning. Congratulations on another solid quarter. Joseph J. Hamrock – President, Chief Executive Officer & Director Good morning, Paul. Thank you. Paul T. Ridzon – KeyBanc Capital Markets, Inc. Just with bonus depreciation, what’s your current view on when you may need to come back for some equity? Joseph J. Hamrock – President, Chief Executive Officer & Director We don’t see any real shift at this point in our outlook relative to bonus. We continue to not see a need for equity in the near term of the plan. And as you would guess with bonus, that didn’t change at all. We continue to look at our total plan, including CapEx, dividend policy and the ultimate need for equity. But at this point, not ready to change our outlook on any of those factors. Paul T. Ridzon – KeyBanc Capital Markets, Inc. And then strategically, it seems like a lot of large cap electrics kind of want to get some gas exposure. How are you thinking about the opportunity there? Joseph J. Hamrock – President, Chief Executive Officer & Director Well, we remain committed to our plan. As we’ve watched that play out, we look at our plan and don’t really need M&A to drive our opportunities going forward. Very focused on, as we’ve talked about at length today, the capital investments and the regulatory cadence that we’ve set up in our plan, and certainly don’t see M&A as a part of that strategy. That said, with anything that would be compelling being introduced into the mix, we’d certainly take a look at that. Paul T. Ridzon – KeyBanc Capital Markets, Inc. Certainly you don’t need the growth opportunity, but maybe there’s some players out there who could use your opportunities. Joseph J. Hamrock – President, Chief Executive Officer & Director I’m sure that’s fine. Paul T. Ridzon – KeyBanc Capital Markets, Inc. All right. Thank you very much. Joseph J. Hamrock – President, Chief Executive Officer & Director Thanks, Paul. Operator And our next question comes from the line of Greg Gordon from Evercore. Your line is now open. Greg Gordon – Evercore Group LLC Yeah, guys, I had a follow-up question. It’s on a completely different subject. I’m looking at the NEXUS pipeline project that’s being jointly built by Spectra and DTE. And in their first quarter slide deck, slide 25, they show the path of that pipeline going through your service territory in Ohio and sort of a massive amount of interest – interconnect agreements of up to 1.75 Bcf a day. And some of the names of your gas utilities are very prominent on that list. Can you talk about your needs for incremental gas supply and how likely it is that you’d be taking gas off the NEXUS pipeline and in what amounts? Joseph J. Hamrock – President, Chief Executive Officer & Director Yeah, Greg, that’s something we keep an eye on but not something that we’re actively interested in and involved in at this point, and a good position on capacity in the Midwest. More of our focus these days is in New England and Massachusetts. As you know, we have a position in the northeast direct pipeline project. So a lot of focus there on how to ensure that we have what we need up there. We, though, will continue to keep an eye on the Midwest. And if we see an opportunity, we’ll certainly participate. Greg Gordon – Evercore Group LLC Okay. So you’re definitely interested in capacity on the pipes going into New England. And this is more of a wait-and-see situation? Joseph J. Hamrock – President, Chief Executive Officer & Director Yeah, a more – that’s a good way to characterize it. Again, if we see an opportunity there that makes sense, we’ll certainly take advantage of that. Greg Gordon – Evercore Group LLC Okay. And what’s the time line that you would normally seriously consider a formal interconnect agreement on a new pipe? You would wait for that pipe to be sort of firmly under construction before you would have a serious conversation with them? I’m not that familiar with the process there. Joseph J. Hamrock – President, Chief Executive Officer & Director Yeah, typically there’s an open season upfront. We participate in that, express interest. That usually precedes any actual construction. So we’d be ahead of that curve to help underpin the fundamentals for the project itself. But that’s not always the case. Sometimes there’s opportunistic second pass, third pass opportunities to take advantage of a new project. So it really varies depending on our supply/demand balance, our existing contracts and the growth opportunities in that region. So I don’t think there’s a precise recipe that applies in all cases. Greg Gordon – Evercore Group LLC Well yeah, this would be a second or third pass-type deal because they did their open season, they’re 65%, 66% contracted, 50% with LDCs up a bit top end of the pipe, the other 50% of that is producers. And then they’ve been talking about the potential for incremental interconnect agreements along the length of the pipe. So am I right to say that that would be a second or third pass-type of deal? Joseph J. Hamrock – President, Chief Executive Officer & Director Yeah, I want to be careful that my general comment there is not characterizing a specific project or specific interest. This is an area we continue to look at. But on that specific project, I’m not providing any specific outlook on our participation at this point. Greg Gordon – Evercore Group LLC Okay, thanks. Joseph J. Hamrock – President, Chief Executive Officer & Director Thanks, Greg. Greg Gordon – Evercore Group LLC Can’t hurt to try. Thank you. Bye. Operator At this time, I’m showing no further questions. I would like to turn the call back over to Joe Hamrock for any closing remarks. Joseph J. Hamrock – President, Chief Executive Officer & Director Thank you, Skyler. And let me, again, express our appreciation for your participation and interest today, and ongoing interest in the NiSource story. Please have a great day. Thank you very much. Operator Ladies and gentlemen, thank you for your participation in today’s conference. This does conclude the program. You may now disconnect. Everyone have a great day. Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) 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Empire District Electric’s (EDE) CEO Brad Beecher on Q1 2016 Results – Earnings Call Transcript

Empire District Electric Co. (NYSE: EDE ) Q1 2016 Earnings Conference Call April 29, 2016, 1:00 pm ET Executives Dale Harrington – Secretary & Director, IR Brad Beecher – President & CEO Laurie Delano – VP, Finance & CFO Analysts Paul Ridzon – KeyBanc Brian Russo – Ladenburg Thalmann Michael Goldenberg – Luminus Management Operator Good day and welcome to the Empire District Electric Company First Quarter 2016 Earnings Conference Call and Webcast. All participants will be in a listen-only mode. [Operator Instructions]. After today’s presentation, there will be an opportunity to ask questions. [Operator Instructions]. Please note this event is being recorded. I would now like to turn the conference over to Mr. Dale Harrington, Secretary and Director of Investor Relations. Please go ahead. Dale Harrington Thank you, Emily, and good afternoon everyone and welcome to the Empire District Electric Company’s first quarter 2016 earnings conference call. Our Press Release announcing first quarter and 12-months ended March 31, 2016 results was issued yesterday morning. The Press Release and a live webcast of this call, including our accompanying slide presentation are available on our website at www.empiredistrict.com. And a replay of the call will be available on our website through July 29 of 2016. Joining me today are Brad Beecher, President and Chief Executive Officer and Laurie Delano, Vice President, Finance and Chief Financial Officer. In a few moments, Brad and Laurie will be providing an overview of our first quarter and 12-month ended results as well as some highlights on other key matters. But before we begin, I’ll remind you that our discussion today includes forward-looking statements and the use of non-GAAP financial measures. Slide 2 of our slide deck and the disclosure in our SEC filings present a list of some of the risks and other factors that could cause further results to differ materially from our expectations. So let me caution you though that these lists are not exhaustive and the statements made in our discussion today are subject to risks and uncertainties that are difficult to predict. Our SEC filings are available upon request or may be obtained from our website or from the SEC. I would also direct you to our earnings Press Release for further information on why we believe the presentation of estimated earnings per share impact of individual items and the presentation of gross margin, each of which are non-GAAP presentations, is beneficial for investors in understanding our financial results. And with that, I’ll now turn the call over to our CEO, Brad Beecher. Brad Beecher Thank you, Dale. Good afternoon, everyone and thank you for joining us. Today we will discuss matters from the Board of Directors and Annual Shareholders Meetings, as well as our financial results for the first quarter and 12-months ended period March 31, 2016. We will also provide an update on the proposed merger and other recent company activities. During our annual meeting of shareholders held yesterday, three directors were reelected to serve three-year terms, Ross Hartley, Herb Schmidt, and Jim Sullivan. And other business shareholders ratified the appointment of PricewaterhouseCoopers LLP as Empire’s independent registered public accounting firm for the fiscal year ending December 31, 2016. Shareholders also approved a non-binding advisor proposal regarding compensation of our named executive officers. During the meeting yesterday, the board declared a quarterly dividend of $0.26 per share payable June 15, 2016, for shareholders of record as of June 1. On Slide 3, of our presentation, we provided some highlights of the quarter and 12-months ended period; we will discuss these more throughout the call. Yesterday we reported first quarter 2016 earnings of $14 million or $0.32 per share inclusive of merger-related costs. This compares to the same period in 2015 when the earnings were $14.6 million or $0.34 per share. For the 12-month ending period March 31, 2016, earnings were $56 million or $1.28 per share inclusive of merger costs. This compares to 12-months earnings of $60.8 million or $1.40 per share for the same period last year. As you can see from the slide it’s been a mild quarter for weather. In terms of heating degree days the 2015/2016 winter season was the warmest in the past 30 years, the first quarter ranks as the sixth warmest in the last 30 years, it was a great, it was great weather for enjoying the outdoors but not great for energy sales. During the quarter, we announced Empire had reached an agreement and planed a merger with Liberty Utilities, the U.S. subsidiary of Algonquin Power and Utilities Corporation. Algonquin Power and Utilities is a North American diversified generation transmission and distribution utility company, they are based in Oakville, Ontario, and their stock is traded on the Toronto Stock Exchange. Liberty Utilities is a growing utility operator that has been in business in the U.S. for over 15 years. They operate electric, natural gas, water, and waste water utilities across the broad geographic areas stretching from California to New Hampshire. Empire will be delivering Central’s region with Jolpin serving as the corporate headquarters. The Central region will include 340,000 customers in Missouri, Kansas, Arkansas, Oklahoma, Iowa, Illinois, and Texas. The transaction will provide greater scale, geographic diversity, and growth opportunities for both organizations. As a reminder, Empire shareholders will receive $34 for each share of stock owned at the close of the transaction. This represents a 50% premium over the unaffected price of $22.65 on December 10, 2015. On Slide 4, we provided a tentative timeline of the approval process and transaction closing. Merger applications were filed with state and federal regulatory agencies on March 16. We expect to receive an order from FERC approving the merger any day. In Oklahoma, the hearing was held on April 27 and Oklahoma Administrative Law Judge has recommended approval and order is expected within 60 days. Procedural schedules are being established in Missouri, Kansas, and Arkansas. We anticipate approvals in place for transaction close in the first quarter of 2017. Shareholder approval is also required for the transaction. We have set May 2, 2016, as the record date for determining eligibility to vote on their agreement and planned merger. We expect to hold a Special Shareholders Meeting on June 16, 2016, to conduct the vote. A final proxy and voting instructions will be mailed to shareholders next week. Last week, we began joint meetings at the senior management level to initiate the transition and integration planning process. As we work to fulfill the conditions to close the merger we remain focused on business as usual at Empire. Moving onto Slide 5, Riverton combined cycle is nearing completion of in-service testing. The project is on schedule and on budget. As of March 31, approximately $163.3 million has been spent on the project against a total budget of $165 million to $175 million. The Riverton project is the first large frame combined cycle generating unit in the State of Kansas and will be among the most efficient natural gas units in the country. This projects completes our multiyear compliance plan for the Mercury and air toxic standard. We continue to prosecute the Missouri rate case which is primarily related to the cost recovery of the Riverton project. Slide 6, is a reminder of the key aspects of this case filed October 16, 2015. The case seeks an increase in annual revenues of $33.4 million or about 7.3%. The procedural schedule provides for a true up of expenditures incurred through March 31, 2016, assuming a Riverton 12 combined cycle end service date of June 1, 2016. Evidentiary hearings are slated for May 31 in Jefferson City. As you can see from the projected timeline on Slide 7, we will experience a period of lag between the in-service state of the Riverton project and the time new customer rates are effective which we expect to be late September of this year. A corresponding rate filing has been made in our Oklahoma jurisdiction; we expect to file rate cases in Kansas by the end of the third quarter, and in Arkansas, no later than the end of the year. For 2016, we expect earnings to be within a weather-normalized range of a $1.26 to $1.44 including estimated merger transaction fees. We estimate total fees of $15 million to $17 million with approximately 50% of the fees payable in 2016 and included in the guidance range. As of April 1, 2016, we have received the applications for just over $10 million in rebates for private solar installations. As of the end of the quarter, we had processed 467 solar rebate applications and have recorded a regulatory asset of approximately $6.2 million on our books. These rebate costs will be collected from other Missouri electric customers and future charges. On the legislative front, we continue to support legislation in Missouri to update our century old regulatory framework. Senate Bill 1028 allows timely recovery of utilities prudently incurred operating cost while offering important consumer protection such as earnings caps, revenue caps, and performance standards. We believe that Senate Bill 1028 offers a balance long-term solution that will benefit both Empire customers and shareholders all while retaining the strong oversight of the Missouri Public Service Commission. We will continue to work to move this important legislation forward in the final two weeks of the Missouri legislative session. I will now turn the call to Laurie to provide additional details of our financials. Laurie Delano Thank you, Brad, and good afternoon everyone. As we review our first quarter 2016 earnings per share results, the financial affirmation I will discuss will supplement our press release that we issued yesterday, and as always our earnings per share numbers referenced throughout the call are provided on an after-tax estimated basis. As we noted in our press release yesterday the Missouri customer rate increase that went into effect in July 2015 was the primary driver of increased margin compared to the prior year quarter. The mild fourth quarter 2015 weather continued to spill over into the first quarter of 2016 driving the 7.5% decrease in our electric segment sales. This mild winter weather largely offset the impact of higher customer rates from an earnings per share standpoint. And as we also noted on our press release in the first quarter we paid approximately $4.2 million in merger-related costs which reduced earnings an estimated $0.06 per share minus the mild weather and the merger cost impacts, results were pretty much on track with our expectations. Slide 8, shows the detail of changes that impacted earnings per share quarter-over-quarter. Consolidated gross margin increased $1.8 million lifting earnings by $0.03 per share. Increased electric customer rates of about $7.7 million net of an estimated $1.9 million decrease in Missouri-based fuel recovery, increased revenue $5.8 million quarter-over-quarter this added an estimated $0.11 per share to margin. As mentioned previously, this increase was almost entirely offset by the impact of the mild winter weather and other volumetric factors which decreased revenue by about $10.5 million negatively impacting margin by about $0.10 per share when compared to the first quarter last year. Positive customer growth contributed about a penny to earnings per share and other items including the content and timing of our fuel deferral and recovery mechanisms combined to add another estimated $0.02 per share to margin when compared to the first quarter of 2015. Mild weather also impacted our gas segment retail sales quarter-over-quarter resulting in a decrease in gas segment margin of about a penny per share. We estimate the net impact of the mild winter weather reduced margin about $0.06 to $0.08 per share for the quarter when compared to normal weather. Continuing on with Slide 8, consolidated operating and maintenance expenses remained relatively flat compared to the 2015 quarter combining to raise earnings per share about a penny. And as mentioned previously, the most significant expense item during the period was the previously mentioned $4.2 million in merger cost which reduced earnings per share about $0.06. Exclusive of the $0.06 per share negative impact resulting from the merger cost, our first quarter earnings would have been $0.38 per share. Moving on to our 12-months ended results, Slide 9 provides a roll forward to our $1.28 per share earnings for the period ended March 2016. As Brad mentioned earlier, our net income decreased about $4.8 million or $0.12 per share compared to the year ago period. Slide 9 details the breakdown of the various components. Consolidated margin increased about $12.7 million or an estimated $0.18 per share when comparing the two periods. Electric rates were again the most significant positive margin driver during the period adding an estimated $0.26 per share. The impact of mild weather and other volumetric factors combined to reduce electric on-system sales about 2.7% decreasing margin an estimated $0.15 per share. Increases in customer growth added about $0.02 per share. Other items again including the content and timing of our various fuel deferral and recovery mechanism combined to add an estimated $0.08 per share to margin when compared to the 2015 period. The mild weather also continued to impact our gas segment reducing margin an estimated $0.03 per share period over period. Our total on-system electric sales for the 12-months ended March 2016 were 4.84 million megawatt hours versus 4.97 million megawatt hours in the 12-months period ending March 2015. This is near our weather-normalized annual expected sales level of approximately 5 million megawatt hours. Slide 9 also details the — shows the details of increases in operating and maintenance expense items which combined to decrease earnings per share by $0.05. A planned maintenance outage of our state line combined cycle plan, increases in production maintenance expense at a number of our other generation plants, and our previously discussed Riverton 12 maintenance contract which became effective January 1 of 2015, combined to decrease earnings around $0.05 per share. As you may recall, we did not begin recovering that Riverton maintenance contract and customer rates until our rate increase effective last year in July. Increased labor cost driven by increased executive stock-compensation valuations reduced earnings about $0.04 per share. Other smaller cost increases and decreases combined to add another $0.04 per share to earnings bringing the total O&M impact to the $0.05 per share reduction. Again the merger cost of approximately $4.5 million in that 12-month ending period reduced period over period earnings at an estimated $0.06. Increased depreciation and other taxes reduced earnings an estimated $0.08 and $0.03 per share respectively. Interest expense reduced earnings per share about $0.05 period over period due primarily to the $60 million privately placed first mortgage on financing that we did in August 2015. As Brad mentioned earlier, and as Slide 10 illustrates, our full-year 2016 weather-normalized earnings guidance range which we revised on February 2016 of this year remains unchanged at $1.26 to $1.44 per share. As a reminder, at the time we revised our guidance range we advised that we estimated full-year earnings to be $0.10 to $0.12 per share lower than our original full-year guidance range of $1.38 to $1.54 that we provided on February 4. We continue to expect to incur total merger costs of approximately $15 million to $17 million, half of which would be payable in ’16, with the other half in 2017, assuming a 2017 closing date. Now as I mentioned earlier we have already paid $4.2 million of those costs in 2016. On our balance sheet, we have $104 million in retained earnings and we had $19 million of short-term debt outstanding at the end of March. On Slide 11, we have updated our trailing 12-months return on equity charge. As you can see on the slide at the end of March our return on equity was approximately 6.9%. With that, I will now turn the call back over to Brad. Brad Beecher Thank you, Laurie. At Empire, we strive for continuous improvement and innovation, I’m proud to report our efforts were recently recognized by the Edison Electric Institute when they announced that we were among a small group of utilities chosen as the finalist for the Edison award. The award recognizes our work in developing an innovative modular transmission, structured design, and construction process. The design speeds construction, lowers cost, and reduces outage sign during coal replacement projects. With that, I will now turn the call back to the operator for your questions. Question-and-Answer Session Operator Thank you. We will now begin the question-and-answer session. [Operator Instructions]. Our first question is from Paul Ridzon of KeyBanc. Please go ahead. Paul Ridzon Good afternoon. How are you? Laurie Delano We’re fine Paul, thank you. How are you? Paul Ridzon Fine, thank you. Just hoping to get an update on where the proposed I think its Senate Bill 1028 stands? Brad Beecher Well that’s going to be the question of this day, Paul. There is only two weeks left in the session, but so we’ve got a lot of work to do and a short amount of time to do it. Senate Bill 1028 is currently on the informal Senate calendar which means it can be called up at any time. That said it’s going to be difficult for 1028 to move through the remaining process and house process in two weeks. So if Senate Bill 1028 is going to move forward or you will likely see it attach to another House Bill that might be moving through the Senate. As you probably heard we have had the third filibuster in the Senate here this week on voter ID and so it’s just going to be — so we are still working hard and we still think it’s got to shot but it’s going to be a difficult process. Paul Ridzon Thank you for that update. And Laurie, I had a question, when you talked about gross margin there was new rates net $5.8 million and then weather was $10.5 million headwind but net-net there was gross margin actually went up and you referenced in the release some fuel deferrals, is that where the delta is and is that a timing issue? Laurie Delano That’s where the delta is. So if you will recall in our last rate case fuel was rebased pretty significantly as part of the rate reduction and rates that were set. And so the way we think about that is our revenue reduction is net of that fuel rebate, but that fuel rebate doesn’t impact margin. So let me get to my notes here. So when we say that we had increased electric customer rates of $7.7 million for the quarter, net of the estimated $1.9 million decrease in Missouri-based fuel recovery that $1.9 million in Missouri-based fuel recovery is a loss to margin. So in our estimation the $7.7 million is really the impact of margins. Paul Ridzon Okay. Laurie Delano Does that make sense? Paul Ridzon So as we go through the year are there a few deferrals going to kind of reverse and may be make another quarter weaker? Laurie Delano No it’s a dollar for dollar increase in revenue and increase in fuel. So as we compare the two periods, period over period we’re identifying the new rates that came in at the gross amount which would be the $7.7 million and then we’re identifying how much of that fuel base recovery brought revenues and fuel both down together to get to our net revenue change. Paul Ridzon Of $5.8 million? Laurie Delano Yes, so again the $5.8 million reflects the increased cost less the fuel decrease. But that fuel decrease is not only decreasing revenues, it’s also decreasing fuel cost. Paul Ridzon Okay. Thank you very much. Laurie Delano Hope that made sense. Paul Ridzon Yes. Operator Our next question is from Brian Russo of Ladenburg Thalmann. Please go ahead. Brian Russo Yes hello. Laurie Delano Hi Brian. Brian Russo You mentioned the Missouri Legislature ends in two weeks, what’s the exact date that it concludes? Brad Beecher It’s Friday, May 13, I believe. Brian Russo Okay. And when does the legislature resume again I guess in 2017? Brad Beecher I don’t know that exact date but it’s again — it’s in 2017. Brian Russo Okay. And is there any sort of some statutory deadline in which Missouri would have to rule on the merger once procedural schedule is set? Brad Beecher We went through this a little bit Brian on our merger call. But the way it stands in Oklahoma once they have the hearing which they have, they have 60 days in order to issue an order, in Kansas they have 300 days from the time the merger application was filed, so 300 days from March 16, in Arkansas and Missouri, there is no prescribed statutory timeframe that they have to act. Brian Russo Okay, got it. And you mentioned that SB 1028 is on the informal calendar and it could be heard anytime. So if there is not, it’s not when it was put on the calendar prior along with a lot of other proposed legislation, so there is no particular order in which it will be heard, it can be heard at anytime? Brad Beecher As we said, right now, it can be heard at anytime. They have rolled — they have used the term roll to the calendar and anyway Senate Bill 1028 is on the informal calendar and either it or an energy-related House Bill could be that it’s passed through the House could be called up at anytime. Brian Russo Okay. And then I’m just curious the Riverton lag seems like it’s related to depreciation. Are there any O&M savings for the gas conversion that you guys will retain until you should include this rate case and new rates going to affect? Laurie Delano Nothing significant, Brian. Brian Russo Okay. Brad Beecher If we shift the coal units down really in ‘14 and ‘15 and so any reductions in O&M have already been in the rearview mirror. Operator Our next question is from Michael Goldenberg of Luminus Management. Please go ahead. Michael Goldenberg Hi I wanted to continue the discussion about the merger approvals. So as it stands right now which one do you think will be the most complicated or complex, which of the state will be the most involved? Brad Beecher As we said right now Missouri, Arkansas, and Kansas, are kind of all at the same stage we’re getting data request in all the states now, they all take you through a full process. So we have a few more interveners in Missouri than we do in the other states. If you think that’s going to add complexity but generally speaking all three of them are going to through the same type of process. Michael Goldenberg So you said Missouri, Kansas and I’m sorry. Brad Beecher Arkansas. Michael Goldenberg And what? Brad Beecher Arkansas were those three. Michael Goldenberg Arkansas, okay. Now in terms of in Kansas is the one with 300 days and Missouri has no statutory deadline right? Brad Beecher That is correct. Michael Goldenberg Do both Kansas and Missouri have a specific schedule of events posted somewhere? Brad Beecher So in Missouri we have field a proposed procedural schedule and Laurie can range you the dates here but the commission is not rolled on it. Laurie Delano So what the proposed schedule says is for technical conferences on May 16 and 17 and then June 1, with rebuttal testimony on July 6, serve rebuttal on July 22, and order witnesses, order cross examination on July 28, physician statements August 4, with the hearing occurring on August 15 to 17 and again that is just proposed that has not been approved yet. Michael Goldenberg But basically July, August will be the hard and heavy times of this, so to speak? Brad Beecher Right and I think that’s the way you need to think about Arkansas, Kansas and Missouri as we said here today it is the summer especially late summer is going to be full of hearings. And then hopefully that will give commissions about 90 days to make decisions and hopefully get us orders by December so that we can close in the first quarter. Michael Goldenberg When you think about interveners, is it the usual cash [indiscernible] consumer advocates comes out of that, oh, I want money, I want fixed rates stuff like that. Is it that kind of a millet that we see in every merger proceeding or is that something that we need? Brad Beecher So in Kansas and Arkansas the interveners are the typical AG consumer advocate or staff, in Missouri in addition to that we have some of our industrial consumers in the City of Jolpin which are typical interveners in our rate case and then we have a couple other folks that have groups that have intervened one of them being Empire’s retirees who have interest in retiree healthcare. Michael Goldenberg Okay. Is it too early to discuss strategy and kind of what you learned from recent merger proceedings? Brad Beecher We filed direct testimony, so a lot of the strategy is laid in that direct testimony. We filed joint testimony with Common Council with Liberty. And I think reflecting to 99 on why we didn’t get approval on 99 the big ticket items that have kind of been taken off the table as Algonquin is not asking for premium recovery, they are not asking for recovery of transition cost and they are not proposing any staff reductions and those are the big ticket items that have caused a lot of things in the past and so Algonquin took all of those off the table in their initial filings. Operator [Operator Instructions]. Showing no additional questions, this concludes our question-and-answer session. I would like to turn the conference back over to Brad Beecher for any closing remarks. Brad Beecher Thank you. Before we close, I will remind you that as we work diligently to achieve the conditions necessary to successfully close the merger with Liberty Utilities, our mantra will be business as usual. Rest assured we will continue to stay focused on the business at hand providing safe, reliable energy for our customers and attractive return for our shareholders and a rewarding environment for our employees. One last note, Laurie, Dale, and I will be at the AGA Financial Conference May 16 and 17 in Florida. We hope to see many of you there. Thank you for joining us today and have a great weekend. Operator The conference is now concluded. Thank you for attending today’s presentation. You may now disconnect. Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) 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