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TECO Energy (NYSE:TE)

Q3 2013 Earnings Call

October 31, 2013 9:00 am 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

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

Andrew M. Weisel - Macquarie Research

Andrew Bischof - Morningstar Inc., Research Division

Julien Dumoulin-Smith - UBS Investment Bank, Research Division

Jonathan P. Arnold - Deutsche Bank AG, Research Division

Operator

Good morning. My name is Jannica, and I will be your conference operator today. At this time, I would like to welcome everyone to TECO Energy's Third Quarter Results Conference Call. [Operator Instructions] Thank you. Mr. Kane, you may begin your conference.

Mark M. Kane

Thank you, Jannica. Good morning, everyone, and welcome to TECO Energy's Third Quarter 2013 Results Conference Call. Our earnings, along with unaudited financial statements, were released and filed with the SEC earlier this morning. This presentation is being webcast, and our earnings release, financial statements and the 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 expectations for the remainder of 2013 and our New Mexico Gas Company acquisition. 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 ended December 31, 2012, and as updated in our subsequent SEC filings.

In the course of today's presentation, we will be using non-GAAP results. There is a reconciliation between these non-GAAP measures and the closest GAAP measure in the Appendix to today's presentation. There are also graphs depicting some of the financial trends and indicators for the economic recovery in the Tampa area in the Appendix.

The host for our call today is Sandy Callahan, TECO Energy's Chief Financial Officer. Also with us today is John Ramil, TECO Energy's CEO, who will assist in answering your questions. Now, I'll turn it over to Sandy.

Sandra W. Callahan

Thank you, Mark. Good morning, everyone. Happy Halloween, and thank you for joining us. I understand that there are many companies releasing today in the normal pre-EEI rush, so I promise to be concise.

I'll cover third quarter results and update on the local economy, guidance and our progress in the New Mexico Gas Company acquisition. We will be providing our preliminary outlook for next year at EEI in just 10 days.

An additional comment to what Mark said about what's in the Appendix, I wanted to point out that the graphs on the Florida economy are current as of the most recent data available, but due to the government shutdown certain data wasn't available yet. And so a few of the graphs are a month behind what we would normally show.

In the third quarter, net income was $62.8 million or $0.29 a share, compared with $44 million or $0.20 in 2012. Net income from continuing operations was $62.9 million, compared to $90.2 million last year. Discontinued operations in 2012 reflected results from TECO Guatemala, which we sold late last year.

Non-GAAP results in 2013, which exclude $2.1 million of charges related to the acquisition of New Mexico Gas, were $0.30 per share compared to $0.42 last year. Year-to-date, net income was $155.7 million or $0.72 per share, compared with $167.6 million or $0.78 in 2012, which of course, included the discontinued operations and sale of TECO Guatemala.

Net income from continuing operations in 2013 was also $155.7 million, which compares to $200.4 million last year. Non-GAAP results in 2013, which exclude charges related to the New Mexico Gas acquisition, were $0.74 per share compared to $0.93 in 2012.

The most significant factor impacting the year-over-year comparisons in both the quarter and 9 months was the effect of the coal price environment on margins at TECO Coal.

Tampa Electric reported slightly lower net income in the quarter. The number of customers was up 1.6% this quarter, while energy sales were lower, reflecting the summer's significantly above normal rainfall.

Higher O&M and expenses associated with the growing rate base were offset in part by lower interest expense. A lower return on investments recovered through the Environmental Cost Recovery Clause, which impacted net income about $1 million in the quarter, reflects the commission rule effective the 1st of this year that requires annual revision of the return rate to reflect the actual capital structure and capital cost for sources other than equity. In Tampa Electric's case, this included a lower cost per debt and customer deposits and a higher proportion of deferred taxes due to bonus depreciation.

Retail net energy per load in the third quarter was 0.8% lower than last year. Total degree days were 1% below normal and unchanged from last year. Sales to residential customers increased, reflecting customer growth, and sales to commercial customers were lower due to the reclassification of certain large commercial customers to the industrial class as well as improved energy efficiency.

Sales to phosphate customers were lower as expected as self-generation capacity additions came online. Peoples Gas experienced customer growth of 1.3% in the third quarter and higher firm sales in every retail segment, residential, commercial and industrial as the Florida economy continues to improve but saw lower volumes from the lower margin power generation and off [ph] system sales customers. Compared to 2012, Peoples had higher O&M in the quarter, which resulted in lower net income.

TECO Coal recorded a loss for the quarter on margin significantly below last year due to the weak global coal market. The average selling price for the quarter at $82 per ton was $14 below last year. The third quarter selling price was below our full-year expectation as we expected to sell higher-priced met coals in the second half of the year. And while we've sold the volume, the prices were lower.

The all-in cost of sales was $84 per ton, which is backed within the full-year cost guidance range. And the September cost of sales was actually below our full-year cost guidance.

Due to the effects of tax percentage depletion, TECO Coal recognized a tax benefit of $1.2 million in the third quarter that partially offset the operating loss.

The Florida economy has continued to show strength. Statewide, unemployment fell in the third quarter to 7% through August, the last month that data is available, and that was an improvement of 1.6% from a year ago. At the same time, the state has added more than 131,000 new jobs. The unemployment rate for Hillsborough County, Tampa Electric's primary service territory, dropped to 6.7%, as the normal summer seasonal increase reversed.

Over the past year, the Tampa/St. Petersburg Metropolitan area added almost 42,000 jobs, the most of any metro area in the state. These jobs were in many fields. But the biggest gainer was construction, where employment grew more than 7% over the past 12 months, followed by professional services and education and health services, each with gains of more than 5%.

The housing market also continued its pattern of strength. For the 12 months ended in August, more than 5,300 new single-family building permits were issued in the areas served by Tampa Electric, representing an almost 40% increase over the prior 12-month period. We follow building permits closely because they're a good indicator of future customer growth. Typically, 6 months after a building permit is issued, it becomes a new customer.

Sales of existing homes have also been robust, up more than 18% for the 12 months ended September 2013. And although inventories have picked up, as potential sellers respond to higher prices and strong demand, they remain low with about 4 months of existing homes in inventory as of September. And the September Case-Shiller report showed selling prices in the Tampa housing market increasing more than 12% year-over-year. An interesting thing we've seen this year in the housing market is a large increase in all-cash transaction, both in Tampa and statewide, reportedly by investors buying as rentals for the attractive returns on these investments.

We're encouraged by the consistency of the positive economic trends over the past few years and believe they will continue into 2014. We are maintaining our earnings per share guidance for the year in a range between $0.90 and $1, excluding non-GAAP charges or gain. The major drivers of the guidance are shown here. Tampa Electric will benefit from the rate settlement this year with 2 months of additional revenues and certain expense adjustments. As a result, combined with a lower base revenues experienced today, we expect that the 13-month average ROE will be above 9% for the year. We expect that Peoples Gas will earn above the middle of its allowed ROE range of 9.75% to 11.75%.

We still expect that TECO Coal will achieve positive results but in a coal market that is weaker than we expected earlier in the year and has yielded selling prices on the unpriced tons below our earlier expectations. Fortunately, tax benefits will partially offset some of that weakness.

I'd like to briefly recap Tampa Electric's rate case settlement approved by the Florida Public Service Commission in September. As you know, Tampa Electric filed for new rates in April, driven primarily by rate-based growth since 2009. At that time, we also expected that we would need to file another rate case in 2016 for rates to support the Polk expansion project in 2017. The settlement, which was agreed to by public counsel and all intervenors, resolves all of the issues in the 2013 case; and by also including the rate requirements associated with the Polk in service in 2017, it eliminates the need for a case in 2016. The settlement provides that Tampa Electric's base rate will increase $57.5 million starting November 1 this year, an additional $7.5 million in November 2014 and then $5 million in November 2015. On January 1, 2017, or when the Polk project goes into service, whichever is later, Tampa Electric will receive an additional $110 million of base revenues.

Reference in the settlement is an authorized ROE midpoint of 10.25% with a typical 100 basis point range. The indicated ROE would be used for clauses, AFUDC and for surveillance purposes and can increase for these purposes to 10.5%, if the 30-year Treasury bond yield rises 75 basis points for 6 months. The settlement authorizes a 54% equity layer from investor sources in the capital structure. And Tampa Electric cannot file for new rates to be effective before January 1, 2018, unless its actual earned return falls below the bottom of the allowed range. And while that provision is an important protection in a long-term settlement, it clearly will be our objective to earn our allowed return during this period.

This slide is a graphic depiction of rate base and base revenue growth and illustrates that with the settlement revenues are now reasonably aligned with expected rate-base growth through 2017. Including the addition of the Polk unit in 2017, our expected rate base addition represents a compound average growth of more than 6% over the period.

This is a brief recap of the status of closing our New Mexico Gas Company acquisition. The Hart-Scott-Rodino antitrust waiting period expired with no comments and is considered complete. We filed for approval with the New Mexico Commission in July. And we are currently working through the discovery process with staff and with intervenors. We've established integration teams made up of TECO and New Mexico Gas employees, and they are already making excellent progress toward evaluating the current state and future state post-closing to ensure successful integration.

Our current expectation is for a closing late first quarter or early second quarter in 2014. Our expectations for permanent financing of the acquisitions, summarized here, have not changed. The total purchase price of $950 million includes the assumption of $200 million of existing New Mexico Gas Company notes. These notes have a put option on a change of control, but with a 4.9% yield. We don't expect that the holders will exercise that option.

We expect to issue approximately $250 million of debt at the gas operating company and gas holding company level. We will also apply parent cash, and at quarter end, TECO energy parent had $135 million of cash available. This leaves TECO Energy equity needs in the range of $350 million to $400 million. We would expect to put the permanent financing in place in the first quarter of next year, depending on regulatory certainty and the timing of closing.

I'll close with our upcoming investor communication schedule. We expect to file our 10-Q tomorrow. And we hope to see many of you at EEI in Orlando in just 10 days, where we will be making our formal presentation, Tuesday at 9:00 a.m. The presentation will be webcast for those who are unable to attend. And finally, we will close our investor travel plans for the year with the BMO Conference in New York, the first week in December.

And now, I'll turn it over to the operator to open the lines for your questions.

Question-and-Answer Session

Operator

[Operator Instructions] Your first question comes from the line of Ali Agha of SunTrust.

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

Sandy or John, given the trends that you outlined for us on the call business, pricing trends that you're seeing, is it fair on our part to look at your '13 results and assume similar results for next year as well? Is that a fair way to think about it?

John B. Ramil

Ali, I think the way we're viewing the coal business right now is the soft markets that we're seeing are going to remain as we go into 2014. It's going to be continued tough sledding in that business. It's hard to tell you a whole lot more than that at this point because we're -- it's going to be driven by our met sales. And we're in the process of putting those together for next year right now. But I don't think there's a whole lot of reasons to be optimistic that it's going to be any better than what we actually do in 2013.

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

Okay. And secondly, John, remind us the book value for that business. And being-- related to that, you've talked about this being noncore. You'd like to monetize it if there's a right value. But conversely, at the trough of the market right now, it also leaves a much smaller hole for you to fill from the earnings perspective. And it's a distraction that you don't need to deal with in future calls, frankly. So can you just update us on your thinking on that business?

John B. Ramil

Yes, I'll let Sandy address the book value of coal. But I think you're right on your observations, and I think they're consistent with the message that we've been delivering on the coal business for quite a while. I mentioned in our last call that we have seen some expressions of interest in the business. I think folks are seeing that we may be at the bottom and coming off of the bottom of the met coal pricing cycle. And I will -- I can't tell you that, that has continued. We've continued to see that same pattern since our last call, but we are -- we're looking at that business as we always have. It's a value business, it's not core. And if we see the right transaction and the right opportunity, as we have with our other noncore businesses, we will take advantage of it.

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

And the book value is what?

Sandra W. Callahan

And Ali, as we've said before, the book value is in the neighborhood of $200 million.

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

My last question, for planning purposes, what kind of weather-normalized electric sales growth do you assume for TECO going forward?

John B. Ramil

Ali, we're assuming long-term customer growth of 1.5%. And we're very pleased that we're seeing that now in the electric business. Because of this kind of period of transition we've been in with new efficiency standards coming into effect right now, it's hard to tell exactly. But we think that sales lag that by about 0.5% short term. Longer term will lag that by about 0.3%. So if you see 1.5% customer growth over the longer term, sales growth more like about 1.2%.

Operator

And your next question comes from Andrew Weisel of Macquarie.

Andrew M. Weisel - Macquarie Research

My first question is at the electric utility. You gave some good descriptions as to the customer classes. But can you maybe describe what your expectations are going forward, in terms of -- sounds like some shift from commercial to industrial. And then some of the industrial self-generation that was delayed last quarter it seems like it's coming online now. So maybe if you could talk about, kind of elaborate on. And the last question, what those dynamics look like going forward?

Mark M. Kane

Yes, Andrew, this is Mark. The shift from commercial to industrial, those were customers who qualify based on energy usage to qualify for the lower rate. That was kind of a one-time deal. It actually occurred late last year. I think it was somewhere around 25 or 30 customers that we reclassified. You're correct in your observation on the phosphate customers. We had forecast early in the year that sales to phosphate customers would be down, but there were delays in them bringing some self-generation on. Over time, and this is a pattern we've expressed repeatedly, is phosphate sales are going to continue to decline as the mine reserves, the reserves in our area that they mine, are exhausted, and they continue to mine in areas outside where we serve. And there is in '14, there will probably be some additional self-generation coming on for certain phosphate customers. So phosphate sales will go down. Those are interruptible customers; they're low-margin customers. They take service at transmission voltage, and it's been expected for some time. We're actually fortunate that we didn't see the full impact this year in the first half of the year.

Andrew M. Weisel - Macquarie Research

Okay, great. And then 2 quick ones on coal. You mentioned I believe in the press release that you expect to get a tax benefit in the fourth quarter. Should we think of that as roughly similar to what we saw in the third quarter?

Sandra W. Callahan

That's fair to say. Yes.

Andrew M. Weisel - Macquarie Research

Okay. And then, lastly what percentage of your met coal tons are annually contracted with domestic steel mills? And maybe any color on how those negotiations are progressing?

John B. Ramil

Well, we're in the middle of them right now, Andrew. But for the last few years, just about all of our met production has been domestic because they stepped up and took all of our quantities.

Mark M. Kane

That being said, Andrew, in the past, we have sold to European customers. There are reports, take them for what you will, that the European economy is improving. We would be very happy to see some European customers come back into the mix to create some demand tension.

John B. Ramil

And we're working that. We're not just looking domestically.

Operator

Your next question comes from the line of Andy Bischof of Morningstar.

Andrew Bischof - Morningstar Inc., Research Division

What was the earned ROE at Tampa Electric for the first 9 months with the understanding that you'll get released in November?

Sandra W. Callahan

We have not filed that surveillance yet, but for the first 9 months, I would -- remember, we were expecting it to be at 8.75% for the full year. And in our guidance, we talked about the fact that we expect that now with the additional revenues from the settlement and although we've had lower base revenues year-to-date thus far, we would expect to be above 9% now for the full year. So...

Operator

Your next question comes from the line of Michael Weinstein of UBS.

Julien Dumoulin-Smith - UBS Investment Bank, Research Division

It's Julien here. So first, just a quick question. I mean what kind of a swing factor are we talking about just beyond contracted coal here or for -- I suppose into the back end of the year here as far as full year results go?

John B. Ramil

We -- as we say -- as Sandy said in her remarks, we're selling the volumes that we thought we would sell in our guidance. It's just the prices are lower than we expected.

Julien Dumoulin-Smith - UBS Investment Bank, Research Division

Okay, all right. Sorry, about that. And then in terms of the transaction itself, I just be curious. I mean how kind of swings in interest rates changed expectations on, I suppose ability to place that, and how has that impacted the accretion of the transaction?

Sandra W. Callahan

Yes, I think, overall, although interest rates have gone up since that point in time within the scheme of what we're looking at, it doesn't change our outlook that we expect the transaction to be accretive in the first full year, which is 2015.

Julien Dumoulin-Smith - UBS Investment Bank, Research Division

Excellent. And then just going back to coal for a quick second. I mean if the prices -- if current prices and the current dynamic were to persist, just fall apart, how should we be thinking about just the composition of the coal business? Not asking for guidance per se, but just what kinds of tonnage would you expect or production would you expect going into next year, if you will?

John B. Ramil

Julien, with what we know right now, and as Mark said, this year we're going to sell all of our met products A and B. And we would expect the same thing for next year. We have 1.4 million tons of steam contracted and priced at very good $80-plus a ton pricing. Probably, the most at-risk tonnage is the balance of our steam tonnage for next year.

Julien Dumoulin-Smith - UBS Investment Bank, Research Division

Would it be fair to say that without pricing recovery that might be addressed?

John B. Ramil

Yes, I think that's fair to say. Because -- well, yes, it would be -- we're going to look at steam and that market and look at our cash cost of production and make our decisions there. So that's the -- that's really the component that's most at risk.

Mark M. Kane

One thing you have to remember, Julien, our cash cost is probably somewhere between $12 to $15 a ton, below the fully loaded cost that we provide in our guidance.

Operator

And your next question comes from the line of Jonathan Arnold of Deutsche Bank.

Jonathan P. Arnold - Deutsche Bank AG, Research Division

Just quickly on M&A [ph], we'll have to find a acceptable transaction for the coal business. I think in the past you've sort of talked that the primary use of proceeds would be delevering of parent. That'd still be the case? Or does adding another utility in another state change that calculus around your willingness to carry parent leverage?

John B. Ramil

Well, I think we've talked about -- if you put aside another -- an acquisition, we've talked about sale of coal company, we look both at debt and purchasing some stock back as a mix of those as we've gotten the parent debt much more well under control. If the timing was such that it could help with the New Mexico transaction, that would be[indiscernible].

Operator

[Operator Instructions] And at this time, sir, there are no further questions in the queue.

John B. Ramil

Okay, thank you, Jannica. Thank you, all, for joining us. I know it's a busy day, and there's lots of reports to be written. So thank you for joining us. This concludes TECO Energy's third quarter call. Goodbye, everyone.

Operator

This concludes today's conference call. You may now disconnect.

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