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Integrys Energy Group (NYSE:TEG)

Q2 2013 Earnings Call

August 06, 2013 9:00 am ET

Executives

Steven P. Eschbach - Vice President of Investor Relations

Charles A. Schrock - Chairman, Chief Executive Officer and President

James F. Schott - Chief Financial Officer and Vice President

Daniel J. Verbanac - President of Integrys Energy Services

Lawrence T. Borgard - President of Utilities and Chief Operating Officer of Utilities

Analysts

Ashar Khan

Ali Agha - SunTrust Robinson Humphrey, Inc., Research Division

Charles J. Fishman - Morningstar Inc., Research Division

Operator

Welcome to the Second Quarter 2013 Earnings Conference Call for Integrys Energy Group, Inc. [Operator Instructions] At the request of Integrys Energy Group, today’s call will be recorded for instant replay. I would now like to introduce today's host, Mr. Steve Eschbach, Vice President of Investor Relations at Integrys Energy Group. Sir, you may now begin.

Steven P. Eschbach

Thank you very much. Good morning, everyone, and happy Integrys Energy Group Analyst Day in New York eve. Welcome to the Integrys Energy Group's Second Quarter 2013 Earnings Conference Call. Delivering formal remarks with me today are Charlie Schrock, our Chairman, President and Chief Executive Officer; and Jim Schott, our Vice President and Chief Financial Officer. Other executives, including Larry Borgard, our President and Chief Operating Officer, Utilities; Mark Radtke, Executive Vice President, Shared Services and Chief Strategy Officer; and Dan Verbanac, President of Integrys Energy Services, are also available for the question-and-answer session at the conclusion of our formal remarks.

The slides supporting today’s presentation and an associated data package are located on our website at www.integrysgroup.com, select Investors, select Presentations, and then today’s presentation. Before we begin, I will advise everyone that this call is being recorded and will be available for audio replay through November 5, 2013.

Now I need to direct you to Slide 3 and to point out that this presentation contains forward-looking statements within the definition of the United States Securities and Exchange Commission’s Safe Harbor rules, including projected results for Integrys Energy Group and its subsidiaries.

Forward-looking statements contain factors that are beyond our ability to control, and in many cases, we cannot predict what factors would cause actual results to differ materially from those indicated by forward-looking statements. Except as may be required by federal securities laws, we undertake no obligation to publicly update or revise any forward-looking statement contained in this presentation, whether the result of new information, future events or otherwise.

This slide is a condensed commentary on forward-looking statements, and you are encouraged to read and understand the more specific language that is contained in our filings with the SEC, including the quarterly report on Form 10-Q we plan to file later today and Forward-Looking Statements section of yesterday's news release and Slide 51 in the appendix of the slide deck.

Slide 4 indicates that today’s presentation includes the non-GAAP financial information related to diluted EPS adjusted and adjusted earnings. We believe that these are useful financial measures for providing investors with additional insight into our operating performance because they eliminate the effects of certain items that are not comparable from one period to the next. Please review the text of this slide for more information regarding these non-GAAP financial measures.

I will now turn this call over to Charlie Schrock.

Charles A. Schrock

Thanks, Steve. Good morning, everyone, and thanks for joining us on the call today. I'll provide an overview of our second quarter and our year-to-date financial results, some recent operational highlights and our expectations for the balance of 2013. Jim Schott will discuss our financial results in more detail, and he will provide more information regarding our financial outlook. And as usual, we will conclude with the question-and-answer session.

Turning to Slide 5. Diluted EPS adjusted was up in 2013 compared with 2012 for both the quarter and the first half of the year. This is shown on the table at the bottom of this slide. Given our performance so far this year and the results of the Peoples Gas and North Shore Gas rate cases, we are narrowing our 2013 guidance for diluted EPS adjusted to a range between $3.35 and $3.60 on a consolidated basis. This is an upward revision to the lower end of the guidance range of $3.25 that we presented in May. Jim will have more details on this during his formal remarks.

But first, I'll provide a brief update on our operational activities. Let's take a look, starting on Slide #6. The key development for our natural gas utility segment is that Illinois has adopted legislation for recovery of certain rate base investments, the most notable, of course, is our Accelerated Main Replacement Program, which we call AMRP. That legislation received strong support in both the Illinois House and Senate. On July 5, Governor Quinn signed into law what is now known as the Natural Gas Consumer Safety & Reliability Act. This law becomes effective on January 1, 2014, and we've included some of the key provisions on this slide. This law is important to Chicago, and on behalf of the company, I extend our thanks to the bill sponsors, legislative leadership, labor unions, our employees and other stakeholders for their support and efforts to enact this legislation.

And while we were working on this legislation, we continued to work on our main replacement project. We installed about 36 miles of main in Chicago during the second quarter and are on track to complete about 90 miles of main installation during 2013.

Turning to Slide 7. The major item of note for the electric utility segment is related to our Fox Energy Center ownership. The second quarter was the first for WPS as owner and operator. Integration into our system has been smooth, and operations are proceeding as expected. Recall that all ownership costs in excess of our previous power purchase agreement expenses are being deferred, including the equity return on investment for recovery in a subsequent rate case.

With receipt of approval from the Public Service Commission of Wisconsin to install multi-pollutant control technology called ReACT on our Weston 3 plant, we are moving forward with the project. Construction will begin in the third quarter starting with site preparation. We expect the product to be in service in early 2016.

Another positive development for our electric utility segment during the quarter was the PSCW approval to move forward with our system modernization and reliability project, which will improve electric reliability for our customers in Wisconsin. This 5-year $220 million project will convert more than 1,000 miles of overhead electric distribution lines to underground. It also includes the installation of automation equipment on an additional 400 miles of line. Construction will begin next year, and we have included this project in our 2014 Wisconsin Public Service rate case.

Slide 8 summarizes key developments regarding our rate case activity. We received a final order in our Peoples Gas and North Shore Gas rate cases on June 18, and new rates became effective on June 27. A summary of our initial filing and final outcome can be found in the appendix on Slides 22 and 23. Our other rate cases are also proceeding as expected.

Turning to Slide 9 for our nonregulated operations. We're continuing to make solid progress on growing our market share as both delivered and forward volumes are up versus the same period a year ago. Unit margin compression continues, which is having a dampening effect on Integrys Energy Services results. However, returns in the business continued to stay strong.

I'll now turn the call over to Jim Schott. Jim?

James F. Schott

Thank you, Charlie, and good morning, everyone. I'll cover our financial results for the second quarter and year-to-date 2013 in a little more detail and discuss our financial expectations for the rest of 2013.

Let's begin with the financial review by turning to Slide 10. In the second quarter of 2013, we posted diluted EPS adjusted of $0.45 per share, up from $0.27 per share from the same period a year ago. For the year-to-date comparison, we posted diluted EPS adjusted of $2.20 in 2013 versus $1.83 in 2012. Taking into account -- taking into consideration the weather and decoupling reserve adjustments in the 3-month and 6-month periods for each year, the second quarter results were $0.05 per share better in 2013 than the same period a year ago and the year-to-date results in 2013 were $0.08 lower than the comparable period in 2012. For the year-to-date results, this is due to the regulatory lag for Peoples Gas and North Shore Gas. Costs increased in the first half of the year, including for our AMRP investment, but new rates did not go into effect until the end of June.

On Slide 11, we showed the changes in diluted EPS adjusted by segment and key variances for the 3-month and 6-month periods in 2013 compared with the same periods in 2012. The 3-month and 6-month financial results for 2013 are better than the same period a year ago for our regulated utilities. Unit margin compression at Integrys Energy Services continues to impact period-over-period results.

On Slide 12, we've updated our capital expenditure projections. Of note, we have increased the Peoples Gas spend given the new Illinois law allowing current recovery of our AMRP costs. Changes at our other utilities are not material. Reductions and/or shifts in expenditures in Integrys Energy Services, Integrys Transportation Fuels and American Transmission Company reflect changes in near-term project opportunities.

Slide 13 shows our estimated utility depreciation for 2013 through 2015. And Slide 14 shows our updated projected rate base growth through 2015. This chart continues to show the strong growth in rate base over the next couple of years.

Moving on to Slide 15. Let me review our financing plan for 2013 as some activity has occurred here. As we discussed during our March call, we returned to issuing new shares of stock to meet the needs of our stock investment plan and other stock-based benefit plans, such as stock option exercise activity. We have raised about $55 million under this program through June 30, with another $20 million expected to be raised for the balance of the year, plus any equity issuances for stock option exercise activity that may occur.

Turning to our long-term debt. Transactions for Peoples Gas and North Shore Gas are now behind us. Still up on the horizon is $450 million of long-term debt issuance for Wisconsin Public Service. In addition, up to $400 million of hybrid debt security issuance for Integrys Energy Group. Both issuances are planned to take place between now and year end. At this time, we are planning the hybrid security issue earlier rather than later in the period. Our financing plans for Integrys Energy Group are expected to continue to support our current credit ratings.

Turning to Slide 16. As Charlie indicated, our guidance for 2013 diluted EPS adjusted is now in the range of $3.35 to $3.60 with the midpoint of $3.47. The slide also shows how our revised guidance improved by comparing it to what we presented to you in May. The change is reflected in 2 of our segments. For the regulated natural gas utility segment, we have increased and narrowed our guidance range to $1.36 to $1.44. This change was primarily driven by the final rate case outcomes for Peoples Gas and North Shore Gas. For the Holding Company and Other segment, we are reducing our guidance range to a loss of $0.15 to $0.09. This reflects the potential acceleration of the hybrid debt from later in the period to earlier in the period, as well as the increase in interest rates.

Now I will turn the call back over to Charlie. Charlie?

Charles A. Schrock

Thanks, Jim. Before taking your questions, I'll summarize our key investment highlights shown on Slide 17. As you can see, the execution of our business plan for the regulated utilities remains on track. We continue to make prudent investments in our utilities to provide safe, reliable and affordable service for our customers.

Our 34% ownership in the American Transmission Company continues to contribute to earnings as expected. Our long-term plan is for our regulated businesses to contribute about 85% to 90% of our consolidated net income and our nonregulated businesses to contribute the remaining 10% to 15%. Our business risk profile today is commensurate with this mix of regulated and nonregulated businesses.

Our guidance for 2013 diluted EPS adjusted on a consolidated basis is in the range of $3.35 to $3.60. Our portfolio of regulated and nonregulated businesses, operational excellence initiatives and cost control efforts will enable us to meet our 2013 consolidated financial objectives.

Given the investments in our portfolio of businesses and assuming continued reasonable rate treatment, we expect average annualized growth and diluted EPS adjusted to be between 4% and 6% on an average annualized basis through 2015, with 2011 as the base year. And given our solid long-term business plan and portfolio of businesses, our current dividend is sustainable and our dividend payout ratio will decline to utility industry norms as our earnings grow over time.

Finally, as a reminder, we will conduct Analyst Day in New York tomorrow morning and invite you to listen in to the live webcast. You'll find a link to the webcast on our website.

We will now open the call for your questions related to today's earnings and the 2013 financial summary.

Question-and-Answer Session

Operator

[Operator Instructions] The first question today is from Ashar Khan with Visium Asset Management.

Ashar Khan

Can I just go and check, I guess, going back to the growth rate that you had from '11 going onwards? Does that suggest that we should have some meaningful growth next year from this year's base to achieve that line through 2015?

Charles A. Schrock

Ashar, thanks for joining us this morning and thanks for the question. I guess the simple answer to the question is yes, and it's based on the rate base investment that we've been making and the rate cases that we will be implementing over the next couple of years. Jim, do you have any additional comments on that?

James F. Schott

Yes. I think, one, be sure to come by tomorrow where we'll have more detail on this. But the 2 big items, I think, affecting 2014 over 2013 is, first of all, you'll have a full year of the Illinois rate case. We just got a $63 million rate increase in Illinois. Yes, but as a matter of fact on, like, June 27. So you get a full year of that. You only have a half year in 2013. So you have a full year in 2014. The second piece is the Fox Energy Center, $440 million of rate base. Because of GAAP, while we're able to defer the equity return on that, we can't recognize that in 2013. So that's not in the $3 -- in the range of $3.35 to $3.60. So in 2014, we'll have an increase on a rate base of $440 million for Fox Energy Center. Those are 2 of the bigger items. And then I think some of the smaller pieces are the continued AMRP investment, et cetera.

Ashar Khan

And then if I heard you correct, you mentioned that the hybrid sale, you forwarded it, so I'm assuming it's going to be a hybrid, right? So it should have no dilutive effect, is that correct, for '14? Is that the way to look at it?

James F. Schott

There's no additional shares issued. So it's not dilutive in that way. But obviously, the interest expense will affect net income.

Ashar Khan

I understand that. I understand that. But it says, right, there'll be no shares issued, so it should not impact high shares outstanding for '14?

James F. Schott

Correct, correct. But if you're looking at our cap structure, S&P treats that as 50/50 debt equity. So even though shares aren't issued, we get credit for having the equity in our cap structure.

Ashar Khan

Okay. And you said the timing is earlier, so the timing is, what, in the fall, September, October timeframe or what?

James F. Schott

I'd say earlier rather than later, I think. We can't pin down an exact date yet. We're watching the markets carefully, and we'll take our opportunities when we can. But again, sooner rather than later.

Operator

The next question is from Ali Agha with SunTrust.

Ali Agha - SunTrust Robinson Humphrey, Inc., Research Division

A couple of quick questions. One, just on the quarter itself, perhaps for you, Jim, the delta that you laid out for the regulated businesses, this other utility margins that went up significantly year-over-year, can you remind us what was driving those numbers?

James F. Schott

Okay. You're back in the additional pages?

Ali Agha - SunTrust Robinson Humphrey, Inc., Research Division

Yes. I'm looking at the delta that you show us for the regulated going from Q2 last year to Q2 this year.

James F. Schott

Yes. And if you go to Slide 37, I think it has the detail that you're referring to, and there's a $14.1 million of other utility -- other utility margin impacts.

Ali Agha - SunTrust Robinson Humphrey, Inc., Research Division

Yes. What is that?

James F. Schott

$7 million of that is pass-through costs related to manufactured gas plant and energy efficiency costs. So that's really offset in that $12.8 million of operating expense increase. So you can net $7 million out of both of those numbers. The other $7 million is, frankly, non-weather-related margin increases. Now I would caution you, this is year-over-year and 2012 was a very warm year, so we had an unusually warm year. Shoulder months are notoriously hard to weather normalize. So I think those factors -- how much of that other margin really belongs in the weather, I think, is an issue. But we did have $7 million of other margin increases.

Ali Agha - SunTrust Robinson Humphrey, Inc., Research Division

And similarly on the electric side, then roughly $9 million or $8.9 million, what was that?

James F. Schott

Yes. The biggest piece there, Ali, is $6 million for Fox capacity payments. When we bought Fox capacity payment -- when we bought Fox, we no longer have the capacity payments, so that will be a reduction in our fuel costs -- show up in the reduction in fuel and purchased power costs. Again, though, all of that is deferred, and so -- but the deferral, which show up in the O&M column, which is Column E. So those 2 offset similar to the rider's effect, so those 2 offset. So there's $6 million of savings in the $8.9 million and the $6 million offset in Column E.

Ali Agha - SunTrust Robinson Humphrey, Inc., Research Division

Okay. Separate question. On the Energy Services front, your margins, as you pointed out, Charlie, have been coming down. I think year to date, electric is about $5.50, gas is about $0.28. Can you just remind us how we should think about them on a full year basis and what we should think about as the new contracts are coming in and old ones are rolling off? What is the correct margin that we should be thinking about?

Charles A. Schrock

Yes, Ali. For starters, if you look at the guidance range that we have, that really is indicative of where we expect Energy Services to come in. We are seeing the continuing pressure on unit margins. And as I noted, volumes continue to grow, so that's one way to offset those margins. But that's about where we're at. And Dan, any additional comments on that?

Daniel J. Verbanac

Just one additional comment, Charlie. When we think about unit margins, 2013 has business that was put on in 2011, 2012. A lot of that business now is rolling off the book. So the way to think about unit margins going forward, I think, is similar to the unit margin changes we saw between 2011 and 2012. You can think about similar type changes between 2012 and 2013, Ali. And I think year to date, that's in line with that.

Ali Agha - SunTrust Robinson Humphrey, Inc., Research Division

Okay. So in '14, assuming all of this is flushed out by '14, should we see a similar decline, '14 versus '13, is that the way to think about it?

Daniel J. Verbanac

I think so, yes. And by the end of '14, most of those higher unit margin contracts will have rolled off by the end of '14 and will be contracted up in this new environment. But the offset to that, Ali, are our volumes are up considerably, as Charlie mentioned in his comments.

Ali Agha - SunTrust Robinson Humphrey, Inc., Research Division

Correct. And last question related to that, can you also remind us, the 4% to 6% EPS growth, '11 through '15, what does that assume for the growth in Energy Services? Is that comparable, higher, lower? How should we think about that?

Charles A. Schrock

Ali, we haven't given that specific sort of guidance out through 2015. We are assuming some growth in Energy Services. But on a consolidated basis, which is the way we're looking at the 4% to 6%, again, given appropriate rate treatment for the investments we're making, we do expect to be in that range. And we'll have some detail tomorrow at the Analyst Day.

Operator

[Operator Instructions] The next question is from John Ali [ph] with Integrys [ph].

Unknown Analyst

The question I have is kind of related to Ali's. But if I look at the 4% to 6% CAGR and then the target of 10% to 15% of consolidated for unregulated, does that 10% to 15% target work for 2015 as well?

Charles A. Schrock

Well, John [ph], as I was just commenting, we haven't really given that sort of detail around 2015 yet. While we do expect some growth in all of our segments, on a consolidated basis, we see ourselves getting there. And again, I think we'll have a lot more detail for you tomorrow.

Unknown Analyst

Right. No, my question was what percentage of your business do you expect to be unregulated, I guess, is the easier to put it.

Charles A. Schrock

Well, our intent is to keep it in that range of 10% to 15%.

Unknown Analyst

Got you, okay. So going from -- what is it in your guidance this year, is it something like $0.29, $0.30?

Charles A. Schrock

That's about right.

Unknown Analyst

Okay. And the 10% to 15% of whatever the 4% to 6% implies [ph] in 2015?

Charles A. Schrock

Yes, yes. We're following your math, and we're all shaking our heads, yes.

Operator

The next question is from Charles Fishman with MorningStar.

Charles J. Fishman - Morningstar Inc., Research Division

With the passage of the AMRP for Peoples Gas, just comparing the CapEx from last quarter, your plan, to this quarter. So 2013 does not change. And then it's materially higher in the next couple of years. But your second quarter CapEx spend was down. Is that -- is there anything to read into that? Were you waiting for the passage of the law? Or was it just more weather, timing, anything like that?

Charles A. Schrock

Yes. Charles, there's a few different factors there. But I'll say there's nothing to read into it. Let me have Larry Borgard comment on that for you.

Lawrence T. Borgard

Yes, I would agree. There's really nothing to read into the second quarter numbers. We're on track, as Charlie mentioned, for 90 miles this year. We were planning to dial back our AMRP spend if we did not receive the appropriate regulatory treatment and recovery of the costs. So that's why you see the '14 and '15 numbers jump up a little bit.

Charles J. Fishman - Morningstar Inc., Research Division

And that program would go well beyond '15, correct? It's just you only show another 3 years of CapEx?

Lawrence T. Borgard

That's correct. We're only showing you 3 years. The Legislation initially covers 10 years beginning in 2014.

Operator

And I'm showing no further questions. I will now turn the call back over to Steve Eschbach for closing remarks.

Steven P. Eschbach

Thank you. And thank you for being part of our second quarter earnings conference call. A replay of this conference call be available until November 5, 2013, by dialing toll-free (800) 308-7859. The full transcript for today's conference call will be available on our website at www.integrysgroup.com before the end of the day on Wednesday, August 14. Just select Investors and then Presentations. If you have any additional questions, please contact me directly at (312) 228-5408 or Donna Sheedy at (920) 433-1857. Thank you.

Operator

Thank you for participating in today's call. The conference has now ended. You may disconnect at this time.

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