Sandy Callahan – VP, Finance & Accounting and CFO
John Ramil -- President and COO
TECO Energy Inc. (TE) EEI Financial Conference Transcript November 3, 2009 11:15 AM ET
Good morning everyone and thank you for joining us for this update on TECO Energy. I know that we are at the tail end of a long morning of presentation, so we will do our best to keep our remarks focused. I am Sandy Callahan; and today I will cover our third quarter results and business drivers and then John Ramil will discuss our initial thoughts on business drivers for 2010, and what we are seeing in the Florida and local economies.
With us today are Sherrill Hudson, TECO Energy’s CEO; Kim Caruso, our Treasurer; Nadia Yazback, Manager of Investor Relations; and Mark Kane, our Director of Investor Relations.
I need to caution you that in the course of our remarks today, we will be making forward-looking statements regarding our financial outlook and plans for 2009 and beyond. There are number of factors that could cause our actual results to differ materially from those that we’ll discuss as our outlook and expectations today.
For a more complete discussion of these factors, we refer you to the discussion of risk factors in our Annual Report on Form 10-K for the period ended December 31, 2008, and as updated in subsequent SEC filings. Also today, we’ll be using non-GAAP measures in the course of our presentation. There are reconciliations to the nearest GAAP measure that are contained in the appendix to today’s presentation.
In the third quarter, our GAAP net income was $64.8 million compared to $58.2 million in 2008. Earnings per share were $0.30 in the third quarter compared to $0.28 in 2008. Net income included $20.8 million of charges in the third quarter. Excluding these charges, non-GAAP results were 47% higher than last year at $85.6 million or $0.40 on a per share basis. The charges in the quarter included $15.4 million of restructuring charges, primarily at Tampa Electric and Peoples Gas. The restructuring charge is related to the management changes that we announced at the end of July to combine the operations of Tampa Electric and Peoples Gas under a single management structure. These changes are designed to create a leaner, more nimble organization and encompass the integration of certain operating and support functions at the utilities.
In connection with the restructuring, we implemented a reduction in force of approximately 225 positions and eliminated an additional 15 unfilled position. The pretax charge this quarter was $25 million and we expect the final amount to be $27 million. We also recognized a $5.2 million charge to write off project development costs, primarily related to the base load IGCC unit that we planned at the Polk Power Station. The reason for the write-off at this time is that the lower customer energy sales and demand growth that we are now forecasting have extended the need for base load generation beyond the point that these initial costs would continue to have value.
For the year-to-date period, GAAP net income was $160.4 million compared to $140.4 million in 2008. Non-GAAP results for the period, excluding charges and gains, were 25% higher at $176.1 million compared to $141 million last year. On a per-share basis, our year-to-date non-GAAP results were $0.83 a share compared to $0.67 last year.
Charges and gains for the year-to-date period included the third quarter charges, as well as the valuation adjustment to student loan securities and a gain on the sale of Guatemala telecommunications provider, Navega; both of those having been recorded in the first quarter.
We’ve discussed the drivers for the quarter extensively and the year-to-date period in our earnings release on Friday, so I will just cover the highlights here today. Tampa Electric reported quarter end, year-to-date results that were substantially above last year, although GAAP results were affected by the third quarter charges. New base rates, which were effective for Tampa Electric in May and the motion for reconsideration which was effective in August added about $33 million to base revenues in the quarter and $47 million in the year-to-date period. The benefit from higher base rates was partially offset by lower retail electric sales in the quarter, reflecting a slight decline in the number of customers and the overall economic conditions. While commercial and non-phosphate industrial sales were down due to the economy, residential volumes were higher.
Total degree days were above normal and above last year’s third quarter, which drove higher sales to the more weather-sensitive residential sector. Also contributing to higher earnings at Tampa Electric this year has been the elimination of the waterborne transportation disallowance which, as you will recall, had reduced Tampa Electric's net income by about $10 million annually over the last five years.
Non-fuel operations and maintenance expenses were slightly higher this quarter, and depreciation expense increased from normal additions to facilities to serve customers. Of the total restructuring charge that I described, $11.1 million after-tax related to restructuring at Tampa Electric.
The Gas Company reported higher results for both the quarter and year-to-date periods. Peoples Gas results also benefited from higher base rates that became effective for them, June 18. Peoples Gas had fewer average customers this quarter when compared to last year at this time, but benefited during the quarter from higher therm sales to commercial customers. These were former propane gas users that converted over to natural gas.
O&M expense increased primarily from higher pipeline integrity costs and higher depreciation expense reflected routine capital additions to our pipeline system, and the restructuring charge at Peoples Gas was $2.8 million during the quarter.
For the unregulated companies; TECO Coal's results were well above last year reflecting higher selling prices across all product lines. Coal sales were slightly higher at 2.3 million tons compared to 2.2 million tons last year in the third quarter when mining conditions impacted production. The average selling price for the quarter increased almost 20% over last year to more than $73 a ton, and that's due to the higher prices for met coal.
Production costs increased almost 9%, driven primarily by higher labor costs as expected and also by costs associated with the mine closures. Although TECO Coal's effective income tax rate varies quarter to quarter due to the mine-specific effects of percentage depletion, our normal expectation is about 25%, and that's about where they were this quarter.
Results at TECO Guatemala were lower than last year as expected for both the quarter and year-to-date period. The San José Power Station was returned to service in early July after experiencing extended unplanned outages during the first six months of the year. The capacity payments for San Jose are calculated on a rolling 12-month availability factor. If the units fall below the 85% availability defined in the contract, then the capacity payments are reduced. So results for the quarter reflect the impact that the outages had on the calculation of these capacity payments.
Results for the DECA II Companies, which include the regulated distribution utility, EEGSA, and its unregulated affiliates were lower due to the unfavorable rate decision that occurred in August of last year. This was partially offset by energy sales growth and by cost control efforts to mitigate the rate reduction. And in March, DECA II completed the sale of the telecommunications provider Navega; and Navega had contributed about $3 million of annual net income in 2008.
Based on our year-to-date results and our outlook for the fourth quarter, we are maintaining our guidance of $1.00 to $1.15 for the year, excluding charges and gains. The utilities will continue to benefit from the higher base rates, but don't expect customer growth for the year. In the fourth quarter, Tampa Electric does expect to have a higher O&M spending due to the timing of some regularly scheduled maintenance on generating units.
And at TECO Coal, we expect the deferral of contracted tons to be toward the upper end of the 200,000 tons to 700,000 tons that we estimated in July, resulting in total expected volumes for the year of under 9 million tons. The average per ton selling price for the year is expected to be $1 to $2 below the previous forecast of $73 a ton and the all-in cost of production is expected to remain at the higher end of the $63 to $66 per ton guidance range.
One of the factors driving the $71 to $72 selling price forecast is the mix of met and steam coal. For the full year, we expect our product mix to be about 25% met and specialty coal compared to the historical one-third that that type of coal typically makes up in the mix. And to round out the math here, TECO Coal's effective tax rate should be about 20% for the full year.
At TECO Guatemala, we expect energy sales from the San José Power Station to be higher than previously forecasted. This is the combined result of higher fuel prices for competing generating resources and diminished production from hydro units due to low rain fall levels. And the low VAD rate at the distribution utility was in effect during the fourth quarter of 2008, so the earnings comparisons for EEGSA in the fourth quarter will reflect the positive impact this year of energy sales growth and the cost mitigation efforts.
And now I will turn it over to John to preview next year and discuss what we are seeing in the Florida economy. John?
Thank you Sandy and good morning everybody. I would like to welcome everyone to our natural gas service territory. If you had a hot shower or a hot breakfast this morning, it was made possible in part by TECO Peoples Gas. So we hope you enjoy that. I want to also take the opportunity to, first time, publicly congratulate Sandy on being promoted to CFO at TECO Energy, and Kim Caruso in being appointed our Treasurer; and Sandy, great job picking the timing for a good quarter to become the CFO. Today we will discuss the factors that we’d see driving our 2010 results at the utility businesses, and we will also provide you an update in the state and local economies in which we operate, and then discuss the factors that we see driving our 2010 results for TECO Coal and for TECO Guatemala.
In 2010, we expect substantially improved results at both Tampa Electric and Peoples Gas and those would be driven by the full-year effect of our new base rates at those two utilities. The new rates at Tampa Electric were effective in early May, and at Peoples Gas they were effective in mid-June. So we are going to have, for the balance of this year, a little bit more than half a year’s benefit at each company; and we will be able to catch the higher use winter season, the heating season, for Peoples Gas. And even though it might be hard to believe with the weather outside, we will have a heating season here in Florida. Tampa Electric will also have the benefit of the step increase that will take effect in January of 2010. This step increase is associated with five CTs that are already in service in the railroad [ph] moving facilities at Big Bend that will be in service in early December of this year. These assets are subject to a Florida Public Service Commissions’ staff audit and a review for their final cost; and those things have been completed. And they also have to verify that those facilities are in service and are needed by customers.
The CTs and its service at various times this year between April and late August and were used to meet the summer of loads of our customers -- those units with a very attractive future rates and the low cost of natural gas that we had during this past summer operated at very, very high capacity factors right around 20%, which is really the upper end for peaking units in the summertime. So they were used quite a bit for capacity and because they are so efficient they also saved customers’ money on their fuel goal. In addition, two of those CTs provide the Black Star capability at two of our power plants that are required by the new NERC requirements. The rail facilities are being installed to comply with the PSC staffs’ recommendations over time that we have dual solid fuel delivery capabilities at our Big Bend stations, so that is going to happen.
As we move through this process, the staff recommendations are due on November 17, and the commission is scheduled to decide on these new facilities on December 1. As previously noted, the interveners in our base rate increase have notified us of their intent to appeal the 2010 step increase to the Florida Supreme Court. Their appeal is only related to the step increase and not the entire decision. What will happen once they do file, and right now we expect them to file sometime in 2010, we will file a counter appeal and then the court will decide if they want to even hear the matter at all. There is no set schedule for the timing and for the court to make such a decision. In 2010, we expect the utilities to realize the benefits of the restructuring activities that Sandy talked about just a few minutes ago through lower operating and maintenance expenses. These reductions are the major component of our efforts to offset about $40 million of revenue shortfalls that we have seen from our flat customer growth versus the projections that we used in our rate case.
With a very modest expected economic recovery in 2010 and a focus on managing our utility businesses effectively, we expect those companies to earn the newly authorized returns on equity in 2010. The overall economic conditions in Florida and in the Tampa area remains weak, though we see signs of improvement. For the state its 11% unemployment rate is higher than the national level, but we are seeing signs that it appears to be leveling off. And in the Tampa area, unemployment is even a little bit higher than the state, but it also appears to be leveling off as well. During this downturn, the most significant job losses that we saw were in the construction sector. And there is some positives there. There is an indicator that in the last few months we have seen the numbers show that there has been increase in construction employment in the area. We’ve seen another positive sign with respect to economic activity in the area, and that's the passenger traffic at Tampa International Airport in September showed positive growth for the first time in 18 months; we hadn't seen that in quite a long time. And we think this is especially a good sign because September is typically not a heavy tourist month.
Even with the positive signs that we are seeing, we expect the recovery to be slow and even a little bit slower than we have been thinking over the last few months. We have been expecting very modest, about 0.10% customer growth at Tampa Electric this year with some economic recovery possibly boosting that at the end of the year. But now, as Sandy mentioned, we are expecting our customer growth to be flat for the year. Based on several economic advisers that we have talked to and we have seen their forecast, we expect from these early signs that we are seeing that that is going to translate to an improving economy in areas in which we operate about the middle of 2010. And with that we've adjusted our expectations for customer growth to be a little bit less than 5%, a little bit weaker than what we have been talking about at the end of the second quarter – I’m sorry, less than 0.5% than we have been talking about in the last quarter.
The next few slides that you're going to see shows some of the trends -- I talked about a few data points a minute ago, but we are seeing some trends that lead us to believe that the economy and the housing markets have bottomed out in the Tampa Bay area. The graph that you're looking at, the graph on the left shows the sequential customer additions at Tampa Electric. You can clearly see the seasonal drop in customers when our winter residence returned to their northern homes at the end of springtime. When we’re adding about 5,000 customers a year, a dip for a couple of months in April and May was not very noticeable. Now that season dip is enough to take the customer additions in that period of time negative. The important point here though as you look at the slide is that that we are seeing a rebound and we are adding new customers on a monthly basis.
The other graph, the one to your right, shows the data on the cumulative customer additions that we’ve had at the Electric Company. It shows, as we all know, a good steady growth through 2005, 2006, and in the first half of 2007 were it started to level off. And our customer count peaked in March of 2008, and it has actually declined a little bit overall since that time. And the most important point of this slide is the note on the graph, and that's the declining customers since that peak is less than 0.5%.
The next couple of slides that you see show existing home re-sales and the single-family building permits in the Tampa Bay area. And both are showing positive trends, especially since the beginning of this year. Re-sales have increased and prices on home sales appear to have stabilized. The Case Shiller index, which was reported last week, showed a second consecutive month of increased sale prices. And though the increases were slight, it is moving up for the first time in quite a while. Another positive point showing that retail activity is the slight decline in the number of foreclosed properties in our area. According to RealtyTrac, the number of homes in foreclosure in the Tampa area actually declined a little bit in late July and the inventory of homes available for sale has declined as well. The graph that you're seeing on the right is the single-family building permits in the Tampa area and that's been improving from a very low point in the fall of 2008 through the middle of this year; we are seeing a little bit of dip at the backend of that curve and we think that that's due to seasonal factors, you always see that in the late summertime. And perhaps a little bit of theory here is the expiration of the first-time home buyer tax credit. We know that's had an effect on activity as well.
Moving from the utilities and economy to our unregulated companies; at TECO Coal, we do expect improved results in 2010 over 2009. As we all know, the steam coal markets are driven by electricity demand and companies throughout the country, particularly those that we market to, have experienced lower commercial and industrial demands, have experienced quite a bit of competition from natural gas generation and low natural gas prices and mild weather this year. And that all has led to inventory builds and the conversations with customers on contract ton deferrals that we talked about at the end of the second quarter and that Sandy mentioned earlier. We've also seen signs of improvement in the met coal markets, driven by some improvement in the blast furnace utilization and stronger international met coal markets. Steel mill utilization rates here in the United States have recently been reported in about the 62% utilization rate and that compares to about the mid-30s, back in January of this year.
International market conditions, primarily in Asia, have also helped met coal prices and the demand for met coal in China has reportedly absorbed a lot of the Australian production capacity and that's caused spot prices to rise and is causing other countries to look to purchase met coal from those that might traditionally supply met coal to Europe. And although we don't sell right into the Asian market and we don't benefit directly from those things, all these dynamics, we are seeing some positive effect in our coal sales. As you see in the next graph we are going to show you it has allowed us to contract for met and for PCI coal with some of our 2010 customers already.
While the ultimate level of our sales in 2010 will be determined by the overall market conditions, we do have 7.8 million tons of our expected 2010 sales contracted and priced already at an average price of $74 per ton. Now that volume includes some of the carryover tonnage that we talked about and Sandy talked about being at the upper end of our estimated amount. Those tons are included, and now they are moving from 2009, they are helping out our year 2010.
We expect as we look at the cost side, we expect our all-in costs of production to decline next year primarily due to lower hedged diesel fuel prices, of course less cost pressure on the labor and on the contractor front and lower commodity prices. While we are still working on our business plans and we are not in a position to yet give you a cost guidance for full-year 2010, if we held everything confident with 2009 and just looked at diesel we see diesel prices that we hedged at versus 2009 given us the potential to reduce our operating costs $2 per ton.
The graphs you see before you now show the contracted and priced position on our sales for 2010 and 2011, and you can see we do have a good bit of our expected sales for 2010 contracted and priced. And about 45% of those sales contracted and priced for 2011. In 2010, the uncontracted and contracted but unpriced tons are a mix really of all of our products. We have some steam, met, PCI, and our specialty stoker coals included in that volume. In 2010, there is a small amount of met tons that are carryover tons from 2009 that we have moved out to 2011 included in the contracted and priced category, but otherwise our specialty coals position remains open for 2011.
We also, as we look ahead to next year, expect meaningfully improved results at TECO Guatemala. We expect normal operations at the San Jose plant next year compared to the outages that we experienced this year. In addition, with oil prices in the middle $70 per barrel range, we see the ability to increase our spot sales and potentially margins over 2009. The third quarter 2009 results that Sandy mentioned reflect a lower contract payments as a result of the outages, and those lower contract payments will continue for a little while but they will bottom out towards the end of this year and start to recover during the first half of 2010 as some of the poor availability months drop off and the better availability months kick in.
The PPA, the power purchase agreement, renewal for Alborada station comes up next September, and we have started negotiations with the regulators for extension of that agreement. The plant has been running regularly this summer. The country indeed needs the power. Load has been growing at the rate of about 5% a year there. And the proposed new base load coal plant for the country has been delayed appears indefinitely due to the financial market conditions. And if the contract is not renewed at fair capacity charges, we’d expect to operate the plant and bid into the market at spot prices. But the demand for power is growing and the supply is not expanding. And we feel we are in a pretty strong position in those negotiations.
Turning to the distribution utility, EEGSA and the VAD issue; there is no schedule for a decision to recalculate the VAD. A lower court has ruled favorably that the VAD needs to -- the process needs to go back and be done in accordance with Guatemalan law, a decision favorable to us. But as you might expect, that decision has been appealed and it now sits before the Guatemalan Supreme Court. Meanwhile, Iberdrola, our partner has filed for international arbitration under their bilateral trade agreement between Spain and Guatemala. And that process is underway and expected to take well over a year for conclusion. At the same time, we are preparing our cap [ph] to filing to follow suit.
In the meantime, with energy sales continue to grow at EEGSA and the good job as Sandy mentioned that we are doing on the cost side, there has been some mitigation of the VAD effects, and we expect for the EEGSA piece of Guatemala to see improved performance 2010 over 2009.
In conclusion, as we look ahead, we are on track to earn within our guidance range this year. And we expect, again, a meaningful earnings improvement overall at TECO Energy next year. With the earnings growth in utilities the percentage of earnings coming from the more stable utility earnings, that portion of our total EPS will increase as well. We expect, at this point, to follow our normal pattern of providing our 2010 guidance at the time of our fourth quarter earnings call, and that is scheduled to be in early February of next year. Looking beyond 2010, we see our company is well positioned to deal with the changes that are occurring in our industry. Our major environmental compliance spending program will be completed in early 2010. We have reduced SO2, NOx emissions 90%, mercury emissions 70%, and CO2 emissions in excess of 20%. So we are in good shape on the environmental front. And our base rate increases -- those whole cases are essentially complete and we don't expect to have any major regulatory activities in the foreseeable future.
We expected in time they are going to be new requirements in the utility industry for renewables and carbon capture and other things. And we think that these new initiatives may provide opportunities for continued investments and returns in our utilities. And while so far we have taken a measured approach to this point, there may be additional opportunities for investment in Smart Grid technologies at our utilities.
And with that summary, Sandy and I would be glad to entertain any questions you might have.
We will get all the questions out of the way in the one-on-ones. Here we go. Moray [ph]?
The TECO coal contract slide on page 15, there's obviously an assumption for production in those two years. Can you give us that assumption?
Moray, we are still working on that. As Sandy mentioned, in 2009, we think we are going to be about the 9 million ton market. As we read the market right now, our best guess is that we will be about that same figure in 2010.
Okay. So those are the numbers cranked into 2010 and 2011?
That 9 million ton production is what's cranked into 2010 and 2011?
No. My comments are restricted to 2010. 2011, I don't have a number for you, but would hope to move it higher.
And then a second question has to do on the appeal of the second step rate increase, I guess it's $34 million, an intervener has appealed that to the Florida Supreme Court. Can you give us some color on that --?
The interveners have appealed based on the question whether the interveners had due process to such a decision on a second step increase. We believe the positions for the commission to do what they did are strong. They had due process for those rates to be set in the first year. So certainly, they had due process for them to put it off a year. Other questions? Yes, sir.
(inaudible) yourself having to go back for any kind of rate cases in the next four years or as these new appointees are there.
Yes, our objective to the position the utilities to earn their ROE next and to continue doing that and to manage ourselves to live within our revenue growth. And look at rate increases as a last resort. So we expect to stay out. Last time it was 16 years between our rate cases, I don’t know if we will be able to stay out that long. But we would look to manage our business without going in.
It sounds like you had 25% of this year's production will be met coal versus steam coal. Is that going to be the same going forward for ‘10 and ’11?
No. We expect next year to move more towards our normal one-third, two-thirds, one-third met, PCT, specialty; two-thirds steam.
Okay. Thank you very much for joining us this morning. We appreciate it.
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