ITC Holdings Corporation Q1 2009 Earnings Call Transcript

Executives

Pat Wenzel – Director of Investor Relations

Joseph L. Welch – President, Chief Executive Officer & Treasurer

Cameron M. Bready – Senior Vice President, Treasurer & Chief Financial Officer

Edward M. Rahill – President of ITC Grid Development, LLC

Analysts

Dan Eggers – Credit Suisse

Leon Dubov – Catapult Capital

Neil Kalton – Wachovia

Yiktat Fung – Zimmer Lucas Partners

ITC Holdings Corporation (ITC) Q1 2009 Earnings Call April 30, 2009 11:00 AM ET

Operator

Good day and welcome everyone to the ITC Holdings Corp. first quarter 2009 conference call. Today's call is being recorded. For opening remarks and introductions, I’d like to turn the call over to Pat Wenzel. Please go ahead.

Pat Wenzel

Good morning and thank you for joining us for ITC's 2009 first quarter earnings conference call. Joining me on today’s call are Joseph Welch, Chairman, President and CEO of ITC; Edward Rahill, our former CFO, who was recently appointed President of ITC Grid Development; and Cameron Bready, our new Senior Vice President, Treasurer and CFO. Last night, we issued a press release summarizing our first quarter 2009 results. We expect to file our Form 10-Q with the Securities and Exchange Commission today.

Before we begin, I would like to remind everyone of the cautionary language contained in the following Safe Harbor statement. Certain statements made during today’s call that are not historical facts, such as, those regarding our future plans, objectives, and expected performance are forward-looking statements as defined by the Private Securities Litigation Reform Act of 1995. These forward-looking statements represent our outlook only as of today.

While we believe that these statements and their underlying assumptions are reasonable, investors should know that actual results may differ from our projections and expectations because they are based on current facts and are subject to risks and uncertainties. A discussion of the risks inherent in our business that could cause these differences may be found in certain documents filed with the SEC such as, our Form 10-Q expected to be filed today; our other periodic reports filed on Forms 10-Q and 10-K as well as our other SEC filings. You should consider these risk factors when evaluating our forward-looking statements. We disclaim any obligations to update or alter our forward-looking statements except as required by law.

At this time, I’d like to turn the call over to Joe Welch.

Joseph L. Welch

Thanks, Pat. We are obviously pleased with our 2009 first quarter financial results. In spite of the difficult economic environment in which we are operating ITC continues to deliver value for our shareholders. Our performance through these challenging times serves as the testament to the resilience of our business model. In the first quarter of 2009, ITC experienced increased earnings compared to the first quarter of 2008. Importantly, ITC is generating quality income and results and our liquidity and ability to finance is strong. Cameron will discuss this in more detail following my remarks. As I've noted many times before ITC is committed to operational excellence and continues to work towards its goal of best-in-class operations.

Based on the 2008 SGC Statistical Services Transmission Reliability Benchmark Study, our Michigan systems achieved top decile performance for sustained outages, and ITCTransmission was top decile in momentary outages, while METC was top quartile. The 2009 study is not yet complete, but based on our continued improvement in reliability, we expect to remain a top performer and for ITCTransmission to be one of the best performers in the study. This is a direct result of the investments we've made in the system over the last six years and correlates strongly with the length of time we have operated these systems.

ITC's Midwest system, which ITC began operating and maintaining in December 2008 has a history of poor outage performance, third quartile or worse. ITC is focusing on system improvements and maintaining activities or maintenance activities in order to reduce the number of outages and improve reliability. Over the next several years ITC will strive to improve the Midwest system performance to be a top performer like it is in the Michigan system.

At this time, when critical infrastructure security is a national priority, ITC has been recently recognized for its efforts to safeguard the reliability of the high-voltage electric system in Michigan. The North American Electric Reliability Corporation or NERC, an international regulatory authority for the reliability of the bulk power system in North America cited ITC's system security operations as an example of excellence as the part of its reliability readiness evaluation and improvement program.

The document highlights ITC's efforts to implement physical protection, stating ITC operates an intensive physical security program comprised of many sophisticated security systems, which provides an extremely effective system of protection for its physical access. ITC takes seriously its commitment to grid security, and we are quite pleased that NERC has recognized our efforts in this example of excellence.

Protecting geographically disbursed assets in a mix of urban and rural settings require substantial thought, planning and effort to develop integrated systems that provide effective protection. I would like to also note that on April 16 at its regularly scheduled meeting the Federal Energy Regulatory Commission, or FERC issued an order denying the complaint filed by Interstate Power & Light Company, or IPL under Section 206 of the Federal Power Act. IPL's complaint filed in November of last year had asked that FERC investigate ITC's Midwest implementation of its rate is potentially unjust and unreasonable.

This action by the FERC dismisses the complaint. We are pleased that FERC acted in a timely manner to address the complaint and we are committed to continuing to operate the ITC Midwest system and making the needed investments to ensure that the system operates in a safe, reliable, and efficient manner. To bolster our strategic vision and development efforts ITC recently announced new management positions.

First, we appointed former Chief Financial Officer, Ed Rahill to President of ITC Grid Development and named Cameron Bready to succeed Ed as Senior Vice President and CFO of ITC Holdings Corp. Ed's dedication, focus, and efforts while CFO helped ITC achieve remarkable financial and industry success. Focusing his leadership and insight on ITC Grid Development will be invaluable as ITC continues to aggressively pursue regional transmission projects in the Great Plains and upper Midwest states.

As Senior Vice President, Treasurer, and CFO, Cameron brings a wealth of financial and accounting experience to the company. Cameron is responsible for the company's accounting, finance, treasury, investor relations, and other related financial functions. We are pleased to welcome Cameron to ITC. His skills, leadership, and experience in the utility industry will position ITC for continued financial performance and as a recognized leader in the electric transmission industry.

In addition, Terry Harvill has joined the company as Vice President of Energy Policy. The newly created position is aligned with ITC's strategy to become a more active leader in policy issues related to the transmission industry. We are committed to moving forward with our development projects, and we have made some significant progress in the first quarter.

In February, ITC unveiled plans for the Green Power Express, a 3000-mile, 765kV, high-voltage backbone transmission system that would facilitate the movement of 12,000 megawatts of power from the wind-abundant areas in the Dakotas, Minnesota and Iowa to Midwest load center, such as, Chicago, Southeastern Wisconsin, Minneapolis, and other states that demand clean renewable energy.

On April 10, the FERC approved Green Power Express' request for favorable transmission investment incentives. It also authorized the establishment of a regulatory asset for development and pre-construction costs. These approvals are a first step that will enable the partnership to pursue the development of its proposed multi-state Green Power Express project.

Specifically, the FERC order authorized the establishment of a regulatory asset for development and pre-construction cost. An incentive return on common equity of 12.38% including incentive adders for independents, RTO membership and risk; the deferral of recovery for start-up, development, and pre-construction costs through the creation of a regulatory asset; inclusion of 100% of construction work in progress in rate base abandoned plant treatment, and use of a hypothetical capital structure comprised of 60% equity and 40% debt, until any portion of Green Power Express project is placed in service.

An important next step is for MISO, the Midwest Independent Transmission System Operator to complete its study of the benefits of the Green Power Express. We expect that MISO will conclude, as our consultants did that the project has significant benefits, their work will help shape how the regional cost allocation will play out. The next key step would be for MISO and ITC to begin working with the FERC by the end of the third quarter to develop appropriate original cost allocation based on where the benefits are distributed. Ongoing work to identify partners or additional equity owners will continue concurrently with these steps.

If issues of cost allocation and sighting are addressed in a meaningful way through pending energy legislation, the Green Power Express may be able to move forward more quickly. The project will be completed in phases. We have also moved a step closer to building critical transmission infrastructure improvements in Kansas with the ruling in March from FERC that approved a forward-looking formula rate and certain transmission incentives for ITC Great Plains Transmission facilities in Kansas and elsewhere in the Southwest Power Pool, or SPP region as well as the favorable decision this week by the SPP Board on the balanced portfolio of projects that included the KETA project.

Over 2.5 years ago, we began studying this marketplace and recognized that the need for regional transmission to improve electrical reliability and to tap into the tremendous potential for renewable energy. We announced the formation of two subsidiaries, ITC Grid Development and its subsidiary ITC Great Plains and geared our efforts towards becoming a regional transmission company.

At that time we told you that it would take about three years to develop this opportunity and to create a company that was nearly the size of ITCTransmission. With these two recent approvals, we are right on track with my prediction when we first announced these efforts. The order received from FERC in March approved rate incentives for the two principal Kansas projects, the V-Plan and the KETA project, as well as base rate for the transmission assets owned or build by ITC Great Plains in SPP.

The incentives are similar to the incentives we received for the Green Power Express project such as inclusion of 100% of CWIP in rate base, use of capital structure targeting 60% equity, 40% debt, abandoned plant treatment and the establishment of regulatory assets to recover startup and development cost. FERC approved an incentive ROE for ITC Great Plains of 2.16%, which includes incentive adders for independence in RTO membership. Just this week, the SPP Board of Directors' approved the first balance portfolio of economic projects, which includes a 345kV transmission line from Spearville, Kansas to Axtell, Nebraska including an interconnect at the Knoll substation near Hays, Kansas.

ITC Great Plains committed to build this project in July 2007 and has commonly referred to it as the KETA project. As a reminder the balanced portfolio is a group of projects that produces net positive benefits to all zones in the entire SPP regions, when compared to the cost of the balance portfolio projects.

Approval of the balance portfolio is a key step because it identifies those projects, which will qualify for regional cost sharing. Cost allocation through the SPP tariff, ITC Great Plains has already received certification approval by the Kansas Corporation Commission, KCC to construct the KETA product. On March 13, ITC Great Plains filed the sighting application at the KCC for the 89-mile potion of the KETA project from Spearville substation to Knoll substation. Another important event occurred in the first quarter regarding the V-Plan project. In the Certificate proceeding before the Kansas Corporation Commission, ITC Great Plains and the other party submitted a stipulation with the KCC to settle what is called Phase I of that case.

In the stipulation the parties agreed that ITC Great Plains as well as Prairie Wind Transmission posses necessary qualifications to construct and operate the V-Plan project including at 765kV. Further proceedings remain pending at the KCC or ITC Great Plains is seeking the issuance of a certificate to construct facilities that were part of the V-Plan.

This is important as the first public acknowledgment that ITC is qualified to build the 765kV transmission lines. As you may recall in September of last year, ITC Great Plains received approval from the Oklahoma Corporation Commission to operate as the transmission utility in the state in order to construct own, operate, and maintain electric transmission lines and we are beginning to see the results of our efforts here.

On April 7, 2009 Western Farmers Electric Cooperative in Oklahoma agreed to assign ITC Great Plains the rights to construct the Hugo to Valiant transmission line. The 19-mile, 345kV project, which also includes the installation of a new 138 to 345kV autotransformer, has estimated cost of $30 million and an expected in service date of April 1, 2012.

On April 28, the SPP Board approved the destination agreement that allows ITC to build the project, certain regulatory milestone are still necessary before ITC Great Plains may begin construction. After ever recession in the U.S. there has been a driver that helps to restore growth and prosper to the U.S. economy. Our view is that one of the key drivers for ending this recession is a massive coordinated stimulus effort of which energy infrastructure investment is a significant and critical component. As the country's only independent transmission company, ITC is well positioned to take advantage of this opportunity and be an instrumental player in the build-out of the regional transmission grid.

ITC continues to excel operationally, financially, and strategically. ITC’s operational efforts and system reliability continues to improve and the quality of our earnings is intact. Our liquidity and ability to finance our growth are strong and we will continue to focus and move forward on our development and growth efforts through the reminder of 2009, which also served to diversify our future revenue base.

At this time I’ll turn the call over to Cameron to discuss our financial results, quality of earnings, and liquidity.

Cameron M. Bready

Thanks Joe and good morning. Let me first note how pleased I’m to have joined the ITC team. I look forward to contributing to the ongoing success of the company and continuing to work closely with the investment community going forward.

In the first quarter of 2009, ITC reported net income of $28.7 million or $0.57 per diluted share. This compares with net income of $27.5 million or $0.52 per diluted share in the first quarter of 2008. The key drivers that contributed to the $3.2 million or $0.05 per diluted share increase in first quarter earnings, compared to 2008 include an increase in net income due to higher rate base at ITCTransmission, METC, and ITC Midwest, partially offset by lower AFUDC earnings.

Total capital investments for the quarter were $85.2 million, which includes $20.4 million, $31.0 million, and $33.8 million for ITCTransmission, METC, and ITC Midwest respectively. Net income also benefited in 2009 due to the lower interest expense at ITC Holdings. The first quarter of 2008 had higher interest expense as a result of the $765 million bridge facility that was outstanding most of January associated with the ITC Midwest acquisition.

On January 24, 2008 we repaid the full amount outstanding under the bridge facility using the proceeds of ITC Holdings 385 million senior notes, the ITC Midwest 175 million first mortgage bonds, and the issuance of 6.4 million shares of common equity. These increases in net income in 2009 were partially offset by higher non-recoverable G&A expenses including development expenses at ITC Great Plains, ITC Grid Development, and ITC Green Power Express.

Diluted earnings per share increased due to the higher net income partially offset by the impact of higher weighted-average shares outstanding as a result of the equity issuance I just mentioned. I would note that during 2009, ITC adopted Financial Accounting Standards Board's staff position number EITF 03-6-1, which modified the calculation of basic and diluted earnings per share including the treatment of restricted stock in such calculations.

This pronouncement required retroactive application, which resulted in a decrease to both basic and diluted earnings per common share of $0.01 per share for the first quarter of 2008, as compared to the previously reported amounts for that period. Please refer to our 10-Q, expected to be filed later today that contains the full disclosure of the effects of the new accounting pronouncement.

As Joe noted we continue to operate in a very difficult economic environment. Although, economic struggles are widespread, Michigan's are particularly acute given the state of the U.S. auto sector. The struggles in Michigan have manifested themselves in a variety of ways including a precipitous drop in electric load, even relative to levels we forecasted in establishing our network rates last fall. Given the attachment of rate making model, all else being equal, these lower than anticipated loads would result in current revenues collected in cash being lower than forecasted and the creation of a true-up receivable to be recovered in future periods.

Notwithstanding, the financial health of ITC, we are very mindful of the impacts at our operations and expenditures have on our customers and the difficult choices that companies are forced to make during these challenging times. In light of the current economic environment and in particular reduced network load we continue to be engaged in efforts to mitigate both operations and maintenance and general, administrative expenses at ITC. It should be noted that we are being very cautious with our cost mitigation efforts to ensure that we are continuing to meet our high standards for the safe and reliable operation of our system and are not jeopardizing our ability to continue to pursue our growth strategies.

Our cost mitigation efforts seek to minimize the impacts of lower than forecasted loads in 2009. By doing so, we will help to ensure that our earnings are quality earnings and that we are collecting cash in a manner that more closely corresponds with the revenues that we are recording and not deferring such collection of cash to later periods. This will also benefit our customers by reducing the risk of future rate impacts associated with historical activities. During the first quarter of 2009, we also undertook a review of our process for capitalizing certain expenses, including compensation and benefits and general and business expenses given our continued focus on investing capital at our operating subsidiaries and the ongoing cost to support these activities.

Upon completion of this analysis, we updated our capitalization policies. For the quarter ended March 31, 2009, we capitalized $4.4 million of general and administrative expenses, which is $2.8 million higher than what was capitalized during the quarter ended March 2008. We expect that the amounts capitalized for the remainder of 2009 will continue to exceed the amounts capitalized during 2008 as a result of these updated policies. Please see our press release issued last night and our first quarter 10-Q expected to be filed later today for more details on the first quarter financial results.

Turning to the outlook for the remainder of the year, our earnings guidance for 2009 continues to be in the range of $2.20 to $2.30 per diluted share. I would note that in the FERC 2005 orders for both ITC Great Plains and Green Power Express, we received approval for regulatory asset treatment, which will allow us to create regulatory assets for development and startup cost associated with these projects. This guidance does not at this time assume any capitalization of these development expenses. With respective to ITC Great Plains, the total development expenses through March 31, 2009 that may be recoverable through regulatory assets or property, plant, and equipment were approximately $7.7 million, which been recorded to expense in the periods in which they were incurred.

Based on ITC Great Plains application and the FERC order, certain milestones must be met in order for us to recover these start-up development and pre-construction costs. In the period in which it becomes probable that future revenues will result from the authorization to recover these cost we will recognize the regulatory assets for financial reporting purposes and record a reduction to operating expense. At that time, we will also update our earnings guidance. For Green Power Express, the total development expense through March 31, 2009 that may be recoverable through regulatory assets is $1.3 million. Like ITC Great Plains in the period, in which it becomes probable that future revenues will result from its approval, we would record a reduction to operating expense and recognize the regulatory assets for financial reporting purposes. We do not expect that this will happen during 2009 for Green Power Express

In 2009, ITC still expects capital expenditures to be between $270 million and $325 million as we have previously disclosed. As I already mentioned, we do recognize that there is an decrease in load in Michigan resulting from the broader economic environment and that this may impact the timing and type of some expected future years capital expenditures included in our base CapEx plans. However, Michigan's efforts to diversify its economy and its various environmental initiatives designed to reduce carbon emissions and promote the development of new renewable generating resources may present investment opportunities that were not previously considered in our base CapEx plan.

To this end, the recently passed energy legislation of Michigan is expected to result in the need to connect new renewable generation to the transmission system. We expect to update long-term capital plans later this year to address all of these potential impacts. Lastly, I'd like to update you on our liquidity position and ability to finance our capital expenditures. ITC has revolving credit facilities at each of its operating companies and at ITC Holdings with total consolidated capacity of $340 million. As of March 31, we had undrawn capacity of a $167.8 million of which $49.7 million is held by Lehman Brothers. Given their recent bankruptcy filing, we do not expect any future draws on the outstanding Lehman commitment, which brings our undrawn capacity down to $118.1 million.

Additionally, as of March 31, we had $26.8 million of cash on hand bringing our total liquidity position to a $145 million. On April 29, 2009 ITC Holdings entered into a term loan agreement with a two-year maturity. The term loan agreement established as an unguaranteed, unsecured $100 million term facility. The proceeds of the term loan will initially be used to pay down the ITC Holdings revolver and will add a $100 million to ITC's liquidity position. All three of our operating subsidiaries are rated A3 with a positive outlook by Moody's and A-minus with a stable outlook by Standard & Poor's all solidly investment grade.

ITC Holdings maintains its investment grade of BAA3 with a positive outlook from Moody's and BBB minus with a stable outlook with S&P. With our available revolving credit facility capacity, internal cash flow generation and expected continue access to the credit markets and capital markets given our solid credit profile, we do not anticipate any difficulty funding, our capital expenditure plans going forward. At this time, I would like to open up the call to questions from the investment community. Operator?

Question-and-Answer Session

Operator

Thank you. (Operator Instructions). And we'll take our first question from Dan Eggers with Credit Suisse.

Dan Eggers – Credit Suisse

Hey good morning.

Cameron M. Bready

Good morning.

Joseph L. Welch

Good morning Dan.

Dan Eggers – Credit Suisse

Joe, can you just talk a little about of what you guys see, going on in Washington right now? I know that Bingaman's plan has been moving around a little bit as far as what he wants from transmission, which you guys have been involved in from a conversation perspective and what you think is most important to advancing kind of some of the big projects you are talking about?

Joseph L. Welch

Well I think there is two items that are floating around, and they both are going to have some form or another of implications as to how all the games or projects if you will, will play out in the future. But I truly believe that, I'll start with one that I think I have the best handle on. I hope it comes out this way now, but is that they are going to deal with the issue around sighting. I have heard a lot of issues back and forth on sighting, but I think the sighting issue will get dealt with I believe that they will have a role and involvement with the states, and the states will get the first bite of the apple if you will, to sight these major regional transmission projects. With then FERC getting real backstop sighting authority if the state fails to deliver within a prescribed timeframe. And I think that a state giving a no to sighting is not an issue that came up, will not be an acceptable outcome. I think everybody truly realizes that if we're going to change the energy climate in this country, we have absolutely got to get regional transmission built and it has to be sighted. The second thing is, they will deal with the cost allocation. And again, I think that they're going to make some positive step forward. I don’t think that we're going to get the position that we hold to be the one where everyone across the United States all pays for the transmission upgrades. I think they'll go to a more specific regional approach. I think ultimately we'll get to where we think it has to be, but we're probably ahead of the game on that one. I think they'll also deal with the coordination of planning, not putting in place a quote regional planner, but absolutely having the RTOs bring the plan up through the process and ultimately having FERC deal with them. So, I think we're going make good progress. I'm very optimistic.

Dan Eggers – Credit Suisse

Joe, what are you seeing as far as the willingness between the different ISOs to work together both by way of you kind of rate setting and sighting authority?

Joseph L. Welch

Well, I think the ISOs are in a position where they have to work together. Regardless of all of the politics that go on, I think that in the end the ISOs will have to ultimately come to FERC and it will be settled there. They are regulated by FERC, as we all know, and I think FERC will get that last vote. So, if there is any dissension or lack of coordination or cooperation across the RTO scenes, FERC will be in a position to settle that. And again, I think we'll get the right answers.

Dan Eggers – Credit Suisse

And I guess I might have just heard this wrong. But you said, I thought that you were waiting on MISO to say that Green Power Express was not economic so then you could go to FERC for a final decision. Did I hear that differently on the call today?

Joseph L. Welch

Well, I think that what we said and what I said is – I think you may have – I don't know exactly how I said it at the time. When we look at MISO, they have a protocol for regional cost sharing in their RECB 1 and 2 and we didn’t think that it would pass that test because that test is a very prescriptive test. Most of the things that Green Power Express does is not even permitted in the test. And not only that, then it has have a 3 to 1 benefit cost ratio and payback in three years. And so if you put all those test on anything it’s never going to pass you couldn’t build anything in this country with that cost benefit test. Green Power Express, as all of the other projects that we have put forth under the RTO guys, will have positive cost benefit, but not they don't pass that test.

Dan Eggers – Credit Suisse

So, then, or you wait for MISO to say, you don't pass the tes, and then you go to FERC, right?

Joseph L. Welch

Well I think what we’re really waiting for is that waiting for MISO to get done with their study to show that it has cost benefit and we will go to FERC. And I don’t view that that's going to be all that longer for process. I think that what people have to realize is that they’re literally thousands upon thousands of megawatts of high-quality, low-cost renewal energy to be developed in the Dakotas, and these people are wanting to move forward so I think there is a lot of pressure on everybody to get this thing done.

Dan Eggers – Credit Suisse

Okay. Thank you.

Operator

We’ll go next to Leon Dubov, Catapult Capital.