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TECO Energy (NYSE:TE)

Q1 2013 Earnings Call

April 30, 2013 5:00 pm ET

Executives

Mark M. Kane - Director of Investor Relations

Sandra W. Callahan - Chief Financial Officer, Chief Accounting Officer and Senior Vice President of Finance & Accounting

John B. Ramil - Chief Executive Officer, President, Director and Member of Finance Committee

Analysts

Julien Dumoulin-Smith - UBS Investment Bank, Research Division

Kevin Cole - Crédit Suisse AG, Research Division

Paul T. Ridzon - KeyBanc Capital Markets Inc., Research Division

Andrew Bischof - Morningstar Inc., Research Division

Operator

Good afternoon. My name is Tiffany, and I will be your conference operator today. At this time, I would like to welcome everyone to the TECO Energy's First Quarter Results and 2013 Outlook Conference Call. [Operator Instructions] I would now like to turn the call over to Mr. Mark Kane, Director of Investor Relations. Sir, you may begin.

Mark M. Kane

Thank you, Tiffany. Good afternoon, everyone, and welcome to the TECO Energy's first quarter call. Our earnings, along with unaudited financial statements, were released and filed with the SEC after the close today. This presentation is being webcast and our earnings release, financial statements and slides for this presentation are available on our website at tecoenergy.com.

The presentation will be available for replay through the website approximately 2 hours after the conclusion of our presentation and will be available for 30 days.

In the course of our remarks today, we will be making forward-looking statements about our plans and expectations for the remainder of 2013 and Tampa Electric's base rate proceeding.

There are a number of factors that could cause actual results to differ materially from those that we'll discuss today. For a more complete discussion of these factors, we refer you to the risk factor discussion in our Annual Report on Form 10-K for the period 12/31/12, as filed with the SEC. With us today is Sandy Callahan, TECO Energy's Chief Financial Officer, who will be our main presenter. Also with us today to help address your questions is John Ramil, TECO Energy's Chief Executive Officer. With that, let me turn it over to Sandy.

Sandra W. Callahan

Thank you, Mark. Good afternoon, everyone, and thank you for joining us late in the day like this. Today, I will cover our first quarter results, summarize what we're seeing in the local and state economies, update our 2013 guidance and discuss Tampa Electric's base rate case filing.

In the first quarter, net income from continuing operations was $41.2 million or $0.19 a share compared with $44.6 million or $0.21 in 2012. The small net benefit in discontinued operations this quarter was related to last year's sale of TECO Guatemala.

I'll touch briefly on the 2013 business drivers that were covered in detail in the earnings release.

Tampa Electric reported slightly higher net income in the quarter as a result of good customer growth, but milder weather than last year.

Since customer growth began to recover at the end of 2009, it has been on a steady trend up, and for the first quarter of this year was 1.4%, which is close to what we expect to be the new normal for long-term customer growth.

Retail net energy for load in the first quarter was 3.7% lower than last year and base revenues declined about $4 million. This may look a little inconsistent with the degree days in the quarter, which were 9% below normal and 16% below last year, including both heating and cooling degree days. We actually had a higher number of heating degree days in the first quarter, but most of them came in March, and so they barely moved the needle. In Florida, you have to consider cooling degree days even in the first quarter, and the real weather impact that you're seeing here was the absence of cooling degree days this March. In 2012, we had a much warmer March, which generated higher energy sales to commercial customers, who are more sensitive to air-conditioning load than residential customers.

Tampa Electric had lower interest expense, higher depreciation expense, due to normal additions to facilities, and higher operations and maintenance expense.

Peoples Gas reported higher first quarter results from customer growth that reached 1.3%, and higher therm sales to all customer classes. Despite another mild start to the winter, we saw therm sales increase in every retail segment, Residential, Commercial & Industrial.

Cooler than normal weather in March helped, as did improvements in the housing market and continued economic recovery. And Peoples had lower O&M in the quarter as compared with 2012.

All of the local and state economic trends we've been showing you over time continue to be positive. In March, the unemployment rate in Hillsborough County, Tampa Electric's primary service area, dropped to 6.6%, which is now well below the state and national levels.

In the past 12 months, the Tampa St. Petersburg metropolitan area had the largest job gains in the state, adding almost 36,000 jobs, primarily in professional and business services, education and health services and the trade, transportation and utilities sector.

The housing market also continued to show strength, with more than 4,800 single-family building permits issued in Tampa Electric's service area over the last 12 months. Existing home resales remained strong and have brought the inventory down to a new low, representing under 3 months of sales. And resale prices posted an 8.9% year-over-year increase according to the most recent Case-Shiller report.

Growth in taxable sales has also continued this trend over the last few years, with a 4.8% year-over-year increase.

We're encouraged by the trends we've seen in the state and local economies and housing markets, and assume that these trends continue in 2013 at a modest pace.

As expected, TECO Coal recorded much lower margins on coal sales this quarter and volumes that were lower than last year. The average selling price for the quarter declined to almost $90 per ton, from $96 in 2012. The first quarter average price is slightly higher than our full-year expectation, due to some higher priced carryover tons from 2012. The all-in cost in the quarter was almost $88 per ton, which was driven by shipping some higher cost coal in January and February out of December inventory. That included costs associated with idling certain mines and personnel reductions.

I want to point out though, that the cost of sales in March was in line with our full year cost guidance, which we're maintaining in a range between $81 and $85 per ton.

We're maintaining our 2013 earnings per share guidance in a range between $0.90 and $1. The major drivers of the 2013 guidance are shown here. We anticipate that Tampa Electric's full year, 13-month average ROE will be less than 9% this year, that Peoples Gas will earn above the middle of its allowed ROE range of 9.75% to 11.75% and that TECO Coal is positioned to achieve net income in the neighborhood of $12 million in a very weak coal market.

At Tampa Electric, we expect full year customer growth to reflect trends similar to those that we experienced in 2012.

Consistent with the longer-term forecast we have described before, we anticipate that retail electric sales growth will be about 0.5% below the expected customer growth. In the Residential and Commercial customer classes, that expectation reflects the impact of new lighting efficiency standards and increased appliance efficiencies. For Residential customers, it also reflects smaller and more energy-efficient houses and more multifamily units.

Sales to phosphate customers were strong in 2012, reflecting outages on some of their self-generating units, and the relocation of mining equipment to Tampa Electric's system. So we expect reduced sales to this sector in 2013, as self generation at those customers increases during the year.

Tampa Electric will also experience earnings pressure from higher O&M and depreciation in 2013. And Peoples Gas expects to benefit from continued customer growth, more compressed natural gas vehicle conversions and from industrial customers converting from petroleum or propane to natural gas, due to the positive economics.

TECO Coal expects 2013 sales to be in a range between 5.2 and 5.7 million tons, and about 95% of the expected volume is now contracted. All of the 2.7 million tons of steam coal included in that total is contracted at prices that range from $75 to $82 per ton.

At this point, TECO Coal has also contracted and priced 2.7 million tons of net PCIM stoker coal. The remaining unsold tons are primarily our high-vol A product, which we do expect to sell later this year.

The average selling price for all 2013 tons is expected to be about $86 per ton, and the average cost for the full year is still expected to be in a range between $81 and $85 per ton, despite the higher first quarter cost.

At the middle of the volume and cost ranges, we expect TECO Coal to produce about $12 million of net income this year.

On these next 3 slides, I'm going to summarize Tampa Electric's rate case filing, the drivers for that filing and the tentative schedule for the case.

On April 5, we filed our full case, using a 2014 projected test year for new rates effective in early January of 2014. The base rate request is just under $135 million. We think that our current allowed ROE range, with a midpoint of 11.25%, remains appropriate, with a major generating unit construction program just getting started.

As calculated from investor sources, our filing reflects the same proportion of equity in the capital structure, 54%, that we presently have. When calculated from all sources included in the regulatory capital structure, it is 42%, which is lower than in our 2008 filing due to the higher level of deferred taxes as a result of bonus depreciation and repairs treatment.

The adjusted jurisdictional rate base included in our filing is $4.3 billion. Tampa Electric's total rate base of $5 billion includes items that do not affect base rates because they earn a return elsewhere. The major differences between these 2 amounts are the assets that we earn on through the environmental cost recovery clause and CWIP that's eligible for AFUDC.

This describes some of the major factors underlying Tampa Electric's need to file for new rates in 2014. As you know, we had hoped to avoid seeking rate relief for as long as possible, and we've done everything we could to try to achieve that outcome. But without base rate relief, Tampa Electric's projected ROE for 2014 is 6.74%, which is well below the allowed range.

What is driving this is that, since the last base rate case, jurisdictional rate base has increased more than $770 million from investments made to safely, reliably and cost-effectively serve customers. At the same time, the revenues contemplated in the previous rate decision didn't materialize. The recession and subsequent slow economic recovery caused energy sales to be much lower than the forecast on which base rates were set in the last case.

The comparison shown here is telling. Actual base revenue in 2012 was $897 million. Compare that with the $969 million base revenue that was used to set rates in 2009.

In response to the revenue shortfall, we have aggressively managed O&M, and very successfully. In 2012, Tampa Electric's O&M was essentially the same level as 2007. That's not sustainable, and we saw that start to really pressure us in 2012.

Tampa Electric has the second lowest rates among the IOUs in Florida, and we expect to maintain that position, even with higher base rates in 2014.

The current rate case schedule has intervenor and staff testimony due 2 weeks apart in July. The hearings are scheduled for the middle of September, followed by a staff recommendation at the end of October. And the commission would make its revenue requirements ruling at the special agenda conference scheduled for November 13. The schedule, of course, is tentative and could change as the case proceeds. I'll close with our upcoming investor communication activities. We will file our 10-Q later this week. We will be at the AGA conference in Naples next week, and the EEI Financial Conference in New York in late May. June will also be busy with investor conferences, with the Baird and Williams conferences in Boston and the BCG conference in New York. And now, I will turn it over to the operator to open the lines for your questions.

Question-and-Answer Session

Operator

[Operator Instructions] And your first question will come from the line of Julien Dumoulin-Smith of UBS.

Julien Dumoulin-Smith - UBS Investment Bank, Research Division

I wanted to ask here about the tax rate in the quarter here on coal. Just to what extent do you expect that to continue into other quarters? Or is it strictly limited to the first quarter here on your tons?

Sandra W. Callahan

Well, it will change every quarter. And as you know, percentage depletion is calculated on a by-mine basis, and so I think the effective tax rate for the full year, which we had originally estimated would be 25%, will be less than 25% overall, because of the 0 tax rate in the first quarter, but it's hard to tell at this point what the second, third and fourth quarters will be.

Julien Dumoulin-Smith - UBS Investment Bank, Research Division

Got you, but there seems like there could be some tax benefit?

Sandra W. Callahan

There could be.

Julien Dumoulin-Smith - UBS Investment Bank, Research Division

And then in terms of the coal business overall, how do you feel today, looking beyond, I suppose the '13 parameters to '14 and beyond, keeping it net income or free cash flow positive, if you will?

John B. Ramil

This is John Ramil. Right now, we're looking at '14, maybe being about like '13, maybe a little bit better. We still have a lot of unknowns. We do have about 1.2 million of steam coal already contracted at high $70s to low $80s pricing. So that's a pretty good start on the year. But we remain feeling good that we will be able to stay earnings positive and cash flow positive in '14.

Julien Dumoulin-Smith - UBS Investment Bank, Research Division

And if you were to piece apart the revision in the Tampa Electric ROE comment on the guidance, what drives it far and away, just to be very clear about this?

Sandra W. Callahan

When you're talking about revision, you're talking about our expectation that Tampa Electric's ROE will be below 9% versus --

Julien Dumoulin-Smith - UBS Investment Bank, Research Division

Right, versus your 4Q commentary. Just the magnitude of each of those pieces.

Sandra W. Callahan

Yes, I think what's driving it is really the continued investment in rate base that we've been making, which drives the capital structure. It drives depreciation. It drives ad valorem taxes. And then on top of that, we are continuing to see some pressure on O&M, which we have kept a lid on for a long time, but some of that's been deferral.

Mark M. Kane

Julian, just to be clear, we said on our fourth quarter call that we expected the ROE to be below the bottom of the range. As we've developed all the detail around the rate case filing, in the filing we do have a ROE less than 9%.

Operator

And your next question comes from the line of Dan Eggers with Crédit Suisse.

Kevin Cole - Crédit Suisse AG, Research Division

This is actually Kevin Cole. I guess, like on the regulatory mechanism side, I guess now, since you're entering a new regulatory cycle, do you see the opportunity to address new rate mechanisms to help account for the impacts of energy efficiency that are weighing on your natural demand growth that you had once realized, and to help facilitate, I guess, utility-directed energy efficiency?

John B. Ramil

Yes, Kevin, I think when we look at what we filed, it's kind of a pretty traditional a rate case. We do have some things we've done in certain rate classes to address how their patterns have changed, but really, it's kind of catching up with some of what you just talked about, why we're going in now. And we got of our last rate case, we envisioned that we'd be able to stay out longer, but because of many factors that we've talked about, including those that you mentioned, we're having to go in now. In addition to things that Sandy mentioned, that are putting pressure on us from a cost side, recognize that the total revenue that our rates were based on in our test year, when our rates were last set, what we're expecting this year is about $72 million less than that. So we're going to catch up and make for that -- make up for that in this filing.

Kevin Cole - Crédit Suisse AG, Research Division

Okay, so I guess in this filing, will you be requesting like a lost fixed cost recovery, or any mechanism, any nontraditional mechanism to help account for energy efficiency?

John B. Ramil

No, just -- we'll just lay it out, what our costs to serve are, and setting the rates properly by customer class.

Kevin Cole - Crédit Suisse AG, Research Division

Okay, and then can you remind me what your medium term, like 2014, 2015 customer growth targets are? And does that 50 basis point less load growth assumptions apply to that number as well?

Sandra W. Callahan

Yes, actually the longer-term outlook is about 1.5% customer growth, and the energy sales growth is expected to be about 0.3% below that. The 0.5% is really 2013, '14 and that is a little higher than the longer-term outlook, primarily because of the lighting efficiency standards coming into effect in that time frame.

Kevin Cole - Crédit Suisse AG, Research Division

How much housing inventory, I guess, slack do you have in the system today to support the demand growth, like when will you start needing new homes built?

John B. Ramil

They're -- we're seeing the numbers on new, single-family home permits ramping up pretty quickly in our service territory. Our last number, I think, Sandy, you had it in your numbers, about 4,800 permits over the last 12 months. That's almost double what it was a couple of years ago, if my memory serves me right. And a little less than half of where it was at the peak. So it's coming back pretty strongly. Sales have increased and the inventory's been consumed.

Mark M. Kane

Existing home inventory is less than 3 month -- pre-existing home inventory for resale is less than 3 months, so that's starting to impact new home demand. And to pick up on John's thought, I actually annualized first quarter building permits. Admittedly first quarter's always a little heavier on building permits, but that would be approaching 5,500 new home building permits in 2013, if it holds at that annual rate.

Kevin Cole - Crédit Suisse AG, Research Division

Okay. That's great, and then last question. How vulnerable is, I guess, the Polk CCGT to a year or 2 delay if demand growth doesn't quite come back as expected?

John B. Ramil

Kevin, it's mostly driven by the need to replace purchased power contracts that are expiring. So it's pretty locked in when we need it in 2017.

Operator

And your next question will come from the line of Paul Ridzon with KeyBanc.

Paul T. Ridzon - KeyBanc Capital Markets Inc., Research Division

I had a question on the interest expense at Tampa Electric, do we see that trend throughout the year or is there going to be new debt issues or are we going to lap that at some point?

Sandra W. Callahan

The -- what drove the improvement in interest expense this quarter was that we did some refinancing late in the year, and so you had the higher expense in the first quarter of last year. And also, during 2012, the commission changed the rate that utilities would pay on customer deposits. And so I think that came in about mid-year, last year and the refinancing took place in the fourth quarter?

John B. Ramil

I think some in the fourth quarter and some in the second quarter.

Sandra W. Callahan

So there'll be some work coming in the second quarter, but the second half of the year, it's probably a little closer year-over-year comparison.

Paul T. Ridzon - KeyBanc Capital Markets Inc., Research Division

And just back to the tax rate of coal, can you, just in a nutshell, explain the depletion accounting?

Sandra W. Callahan

Sure. On a per-mine basis, the depletion allowance for tax purposes is 80% of the lower of 10% of net revenues for that mine or 50% of earnings before interest and taxes. And you look at it on a per-mine basis. So you might have a mine that, on an individual basis, is in a loss position. It would not get any depletion. You might have a mine that, on an individual basis, is in a highly positive EBIT position, and then you would pick the lower of those 2 numbers and apply the 80% to it. That's how it works. Kind of hard to predict.

Paul T. Ridzon - KeyBanc Capital Markets Inc., Research Division

Why -- what would force it to change relative to 1Q results?

Sandra W. Callahan

Well, you might be taking more production or less out of 1 mine or another, and you might also have an instance where cost, for whatever reason, would be a little higher or a little lower in a specific mine in a given quarter. And because it's done on a per mine basis, that's what makes it very difficult to predict on a quarterly basis. Although all things being as expected, we can say it should be about a 25% effective tax rate for the year.

Paul T. Ridzon - KeyBanc Capital Markets Inc., Research Division

Is this something you proactively manage to optimize your tax position?

Sandra W. Callahan

Not really. We really manage production out of the mines more to optimize our response to the marketplace than we do to try to optimize taxes.

Operator

[Operator Instructions] And your next question comes from the line of Andy Bischof with Morningstar.

Andrew Bischof - Morningstar Inc., Research Division

I was hoping if you could provide a little more clarity between your $88 per cost ton in your coal segment, between January, February and March?

Mark M. Kane

Yes, Andy, this is Mark Kane. In December, we idled some mines, we laid off support people, we laid off miners, and we incurred those costs in December. And those went into the cost of production in December. December is a -- it's also a relevantly low production month. So we were spreading those costs over fewer tons. So what that meant was the tons in December, some of which we expected to ship, but didn't, wound up in inventory at a cost of production significantly above our average cost for both 2012 and our expected average cost for 2013. When we sell those tons, they come out of inventory at the same cost that they went in at. So the cost of sales in January and February reflected selling those costs at that cost of production.

Sandra W. Callahan

And March was back down to the normal level that we expect.

Operator

And you have a follow-up question from the line of Julien Dumoulin-Smith with UBS.

Julien Dumoulin-Smith - UBS Investment Bank, Research Division

Just going back to the '14 discussion on coal, just to be clear, it's that you feel good about the revenue number on the contracted tons thus far, rather than a further improvement on the cost side? Or just -- be curious on both sides of that equation?

John B. Ramil

I didn't mean to say that if I did. I think we're -- we feel good on margins, that we will remain profitable and cash positive in coal in '14.

Julien Dumoulin-Smith - UBS Investment Bank, Research Division

Right. And that's driven from both sides of that equation?

John B. Ramil

Correct.

Operator

And at this time, I'm showing no questions in the queue.

Mark M. Kane

With no further questions, we would like to thank you, all, for joining us this afternoon. I know we're right in the heart of utility earnings season. Thank you for joining us, and that concludes our call. Thank you, operator.

Operator

Thank you for participating in today's conference call. You may now disconnect.

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