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TECO Energy, Inc. (NYSE:TE)

Q2 2014 Results Earnings Conference Call

July 31, 2014, 09:00 AM ET

Executives

Mark Kane - Director of IR

Sandra Callahan - CFO

John Ramil - CEO

Analysts

Michael Weinstein - UBS

Ali Agha - SunTrust Robinson Humphrey

Andrew Weisel - Macquarie Capital Securities

Andy Bischof - Morningstar Research

Chris Shelton - Millennium Partners

Operator

Good day. My name is Bettina and I will be your conference operator today. At this time, I would like to welcome everyone to TECO Energy's Second Quarter Results and 2014 Outlook Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session. (Operator Instructions)

Thank you. Mr. Kane, you may begin your conference.

Mark Kane

Thank you, Bettina. Good morning, everyone and welcome to the TECO Energy's second quarter 2014 results conference call. Our earnings, along with un-audited financial statements, were released and filed with the SEC earlier this morning. 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 two 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 2014 and beyond, and our New Mexico Gas Company acquisition. There are a number of factors that could cause actual results to differ materially from those 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 31st, 2013, and as updated in subsequent filings with the SEC.

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.

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, to assist in answering your questions.

Now, I will turn it over to Sandy.

Sandra Callahan

Thank you, Mark. Good morning, everyone, and thank you for joining us. Today, I will cover our financial results, the local economy, our 2014 guidance, which now includes the New Mexico Gas acquisition, our longer term outlook and our progress on the acquisition.

In the course of my remarks today, I will be using non-GAAP results. And there is a reconciliation to the nearest GAAP measure in the appendix. There are also some graphs on the Florida economy contained in the appendix. And you will also see that we're now including for New Mexico some of the same economic metrics that we track in Florida.

In the second quarter, net income was $58.4 million or $0.27 a share compared with $51.4 million or $0.24 in 2013. Those results include $2.7 million of charges related to the acquisition of New Mexico Gas. Excluding those, non-GAAP results were $0.28 per share compared with $0.25 last year.

For the year-to-date period, net income was $108.5 million or $0.50 a share compared with $92.9 million or $0.43 in 2013. Year-to-date results include in continuing operations $4.8 million of charges related to the acquisition and in discontinued operations, a first quarter benefit of $3.1 million related to the resolution of a TECO Guatemala tax matter. Excluding those items, non-GAAP results were $0.51 per share compared with $0.44 last year.

Tampa Electric recorded higher net income in the quarter, reflecting the rate settlement that became effective November 1 of last year. This added about $15 million to pretax base revenue in the quarter. The settlement also extended the amortization life for software, which reduced depreciation and amortization expense on those assets, thus, offsetting some of the depreciation associated with normal additions to facilities.

It also discontinued accruals to the storm damage reserve, which were $2 million per quarter. And this, as well as lower pension expense, offset higher generation and employee related costs, resulting in lower O&M year-over-year.

The number of customers was up 1.7% this quarter, which is higher than our full year estimates. And energy sales were also up, reflecting less rain late in the quarter when temperatures are warmer. The combination of growth and favorable weather pattern resulted in retail net energy per load in the second quarter 8% higher than last year, despite total degree days 4% below normal and 6% below last year.

AFUDC increased this quarter with higher investment balances in the Polk conversion project and our related water project. The return on investments recovered through the environmental cost recovery clause was lower in 2014, reflecting that 10.25% ROE authorized in Tampa Electric's rate case settlement, and the 2013 Florida Commission Rule that requires annual revision of the return rate to reflect actual capital structure and actual capital cost for sources other than equity.

Peoples Gas experienced customer growth of 1.8% in the quarter, which like Tampa Electric, was higher than our full year estimate. While therm sales to residential customers were lower due to very mild late winter and early spring weather and sales to power generation customers were lower because two customers didn't operate in the quarter. Overall, retail based revenues were largely unchanged from last year. And on the expense side, both O&M and depreciation were up slightly in 2014.

TECO Coal recorded second quarter net income of $800,000, similar to last year. These results reflect a $6 per ton reduction in costs compared to last year, despite costs in the quarter being negatively impacted $0.30 per ton by higher transportation costs because of the April fire in the railroad tunnel serving the Premier Elkhorn facility.

The average selling price for the quarter of $80 per ton was more than $5 below last year, reflecting the weak market, and the all-in cost of sales was also $80 per ton. Tax benefits of $700,000 included $800,000 associated with tax percentage depletion.

The Florida economy continued to be a good story. Statewide, unemployment at the end of the second quarter was 6.2%, an improvement of 1.2% from a year ago. At the same time, the state has added more than 237,000 new jobs over the past year, with the largest growth occurring in trade transport and utilities, followed by business services and by construction. On a percentage gain basis, construction, which was the hardest hit sector in the downturn, was once again the biggest gainer with an increase of more than 10%.

Hillsborough County, which is Tampa Electric's primary service territory, also continues to do well, with the unemployment rate also at 6.2%, down 1.3% from a year ago. It is up slightly from the end of the first quarter, which is a seasonal pattern every summer while the schools are out.

Over the past year, the Tampa, St. Petersburg area added more than 25,000 jobs, with the largest gains in business services, followed by trade transport and utilities. The housing market also continues to look good, with more than 4,600 new single-family building permits issued in Tampa Electric's service territory for the 12 months ended in May and a continued strong pace of home re-sales. The July Case-Shiller Report showed that selling prices in the Tampa market increased more than 10% year-over-year, slightly better than the national average.

Despite higher selling prices, sales of existing homes have remained strong. And the housing inventory is at a healthy level of four months. We are in a pretty balanced housing market now, with the all cash investors largely out of the market.

Another strong indicator of the resilience of the Florida economy is taxable sales. Through April, the last month's data is available, year-over-year sales were up almost 7% statewide and up more than 6% at the local level. While we always quote year-over-year statistics, I wanted to note that these economic and housing metrics have showed consistently positive trends for about four years now.

We are maintaining our 2014 guidance for our Florida operations, net of parent, in a range between $1 and $1.05. We expect that the combined earnings growth of our Florida utilities will exceed 13% in 2014, driven by higher electric base revenues as a result of the 2013 rate settlement, gas and electric customer growth, and higher AFUDC earnings. All things considered, we expect Tampa Electric to earn at or above its allowed 10.25% midpoint return, and Peoples Gas to earn above its 10.75% midpoint return.

We anticipate that the net cost in parent and other in 2014 will be slightly higher than last year because of less favorable tax consolidation impacts and lower results from unregulated gas marketing, both of which are reported in this segment, along with TECO finance interest expense and TECO's pipeline results. We are also maintaining our full year consolidated guidance of $0.95 to $1.05. That guidance now includes the New Mexico Gas acquisition and related financing activities.

The fourth quarter is typically a strong quarter for New Mexico Gas and if we see the normal cold weather there, we expect the acquisition to be mildly accretive this year. That won't be the case in the third quarter though, as we will have a full quarter effect of the new shares, but results that reflect the mild shoulder month of September, which like many LDCs, typically produces a small loss.

The consolidated guidance range still has $0.05 of downside allowance for TECO Coal in it. Although, we expect TECO Coal results to be about breakeven in 2014, and that's consistent with what we've actually experienced through the first half, the weak market does present an element of risk to that. At this point in the year though, there are less than 450,000 tons of TECO Coal's expected sales volume that are exposed to the quarterly Asian benchmark pricing. Everything else is contracted and priced so the downside risk on selling price is limited to those tons.

Looking beyond this year, we have a strong growth profile at both Florida utilities. Tampa Electric's $700 million investment in the Polk plant conversion on top of annual capital investment averaging about $330 million, results in a compound average annual growth and rate base of almost 7% through 2017.

And remember that our 2013 rate case settlement includes a $110 million base rate increase starting January 1 of 2017, which provides regulatory certainty for cost recovery for the Polk plant.

Peoples Gas expects to invest about $100 million annually, which results in about 6% annual rate base growth. About two-thirds of that is revenue-producing capital to support customer growth and conversion of large customers and vehicle fleets to natural gas, while about one-third is capital to maintain the system. Included in the annual total is about $10 million per year that we recover through a rider for bare steel and cast iron pipe replacement.

As we've said recently, we are very focused on opportunities to sell TECO Coal. While we have been in discussions with several potential buyers, there is no agreement in place at this time. Not surprisingly, in the current weak coal market, a sale above the $200 million book value is not likely.

Since our last earnings call, we've made significant progress on the New Mexico Gas acquisition and the finish line is in sight. In May, we reached a settlement with a major party to the case and the New Mexico staff agreed that it would not oppose the settlement.

At the end of June, the hearing examiner issued her recommendation that the settlement be approved. The recommendation is in the hands of the Commission's Office of General Counsel to develop this recommendation and propose a final Order for the Commission to vote upon, which we expect soon.

We completed the permanent financing for the transaction in a very attractive market. This includes the early July equity offering and the signing of definitive agreements for private placement debt at both New Mexico Gas Company and New Mexico Gas Intermediate. We continue to anticipate that the acquisition will close in the third quarter following the required regulatory approval.

Our 11 functional integration team, with members from both Florida and New Mexico, have developed detailed integration plans to bring the two organizations together efficiently and cost-effectively. We are positioned to begin putting these plans in place immediately after we close.

Based on now having the permanent financing completed, and completed on favorable terms, and based on the excellent work by our integration team, we are now optimistic that the acquisition will be accretive in 2015.

I'll close with our upcoming investor communications schedule. We will be doing a non-deal road show in the Northeast in August and will be at the Wolfe Conference in September. Our third quarter is a little lighter than normal due to the expected acquisition closing and some conference schedule issues. But we expect activity to be much more normal later in the year.

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 question comes from the line of Michael Weinstein with UBS.

Michael Weinstein - UBS

Hi, guys. How are you doing?

John Ramil

Good morning.

Michael Weinstein - UBS

Good morning. Hey, I was wondering if you could talk a little bit more about customer usage growth, the conservation issues in Florida and how you are seeing that effect going forward.

Sandra Callahan

Our expectation is still that the change in customer usage near term is about a half a percent a year that offsets customer growth, and that longer term, that's more like two-tenths or three-tenths of a percent.

And it's interesting, when we look back over the last couple of years, we've seen customer usage normalize, and so some of the larger decreases that we've seen and have been factoring in seem to be largely captured. A lot of that was probably lighting-related because that's pretty significant.

Michael Weinstein - UBS

Have you talked at all about synergies that you expect to receive or lead from the merger at all?

John Ramil

Yeah. Michael, this is John Ramil. We have, on a limited basis. We do expect significant synergies from combining all the back office and support operations in New Mexico with what we already have going on at the headquarters here in Florida.

The specific synergy we've talked about is in terms of fewer jobs in New Mexico. The amount associated with that is about twice the rate reduction that we've agreed to as part of the regulatory process. And that's the only one that we focused on. All the other synergies we've identified and will contribute to the accretion that Sandy talked about.

Michael Weinstein - UBS

All right. Would it be fair to say that your economic growth in the Southwest is a major impetus to the merger?

John Ramil

The areas that we would be interested in acquiring utilities would be the areas that we would expect to grow at better than the national average, and yes, we think that's going to happen there. But also, particularly with the gas utility, and the popularity and the positive economics of more and more gas use, we think that there's opportunities for growth beyond just what regular population growth would give you.

Michael Weinstein - UBS

Thank you very much.

Operator

Your next question comes from the line of Ali Agha with SunTrust.

Ali Agha - SunTrust Robinson Humphrey

Hi, there. Good morning.

John Ramil

Good morning.

Sandra W. Callahan

Good morning.

Ali Agha - SunTrust Robinson Humphrey

Sandy, with regards to the potential sale of the coal business, given where you are in the process, can you give us some sense, do you see that closing before the end of this year or is it still not that early to lock that down?

John Ramil

Ali, this is John. Thanks for the question. I anticipated that would come probably from you first on this call. You're very consistent. It's been a slow process dictated by the soft market and I don't think that's a surprise to anybody. We'd love to get it done and closed this year, but it's really, really hard to predict that.

Ali Agha - SunTrust Robinson Humphrey

Okay. Then secondly, on the permanent financings for the New Mexico acquisition, can you remind us on the debt side, what was the total amount of debt that has been issued? And what was the interest rate on those private placements?

Sandra W. Callahan

Yeah. On the total amount, Ali, it's pretty consistent with what we've been talking about in terms of what our expected size of permanent financing is, because remember, there was some debt that we needed to replace at the existing businesses, both the regulated company, New Mexico Gas Company, and the holding company there, New Mexico Gas Intermediate.

And so the size of the transactions would be $200 million at the intermediate company and $70 million at the regulated company. And a lot of that is just replacing existing debt that has to be repaid at closing.

And these are private placements. I'm not, at this point in time, disclosing any pricing on that because this is the New Mexico Gas Company and Intermediate. We don't own them yet. And so the debt won't actually transact until the closing takes place, although agreements with those companies have been signed.

John Ramil

I think it's fair to say that where we've come in in all our financing is consistent or better than our anticipated pro formas when we entered into the deal.

Ali Agha - SunTrust Robinson Humphrey

Okay. And just one clarification, how much of that debt, the $200 million and the $70 million, is new incremental debt versus the refinancing?

Sandra W. Callahan

About $50 million of it. All the rest of it is just refinancing existing debt that's out there.

Ali Agha - SunTrust Robinson Humphrey

Okay. My last question on Tampa Electric, can you remind us through the last 12 months, if I look at them on an LTM basis, what is the earned ROE at Tampa Electric?

Sandra W. Callahan

Their earned ROE is just slightly above the midpoint at this point in time, about where we expected them to be.

Ali Agha - SunTrust Robinson Humphrey

Okay. Thank you.

Operator

Your next question comes from line of Andrew Weisel with Macquarie Capital.

Andrew Weisel - Macquarie Capital Securities

Hi, good morning everyone.

Mark Kane

Good morning.

John Ramil

Good morning.

Andrew Weisel - Macquarie Capital Securities

First, a question on New Mexico Gas. You mentioned that it'll likely be a little bit accretive this year. Yet, guidance is unchanged. So should I think of that as being just a small contribution or were there some offsetting negatives that prevented you from raising the guidance?

Sandra W. Callahan

No, Andrew, we provide our guidance in $0.05 increments, and so we didn't move it because that would be a little too granular. But it's not offsetting anything negative, and I did say mildly accretive.

John Ramil

It was a little bit towards the upper end.

Sandra W. Callahan

Right.

Andrew Weisel - Macquarie Capital Securities

Okay. And then for 2015, how should we think about the accretion? I don't need you to get too specific, but would it be more like pennies or nickels?

Sandra W. Callahan

Previously, we had said that we expected it to begin to be accretive 12 months after the closing. And our current expectation is that we will see accretion from New Mexico Gas for the full year 2015. I'm not going to get real specific on that, but its moderate accretion at this point.

Andrew Weisel - Macquarie Capital Securities

Okay, moderate for next year versus modest for this year. That's helpful. Then just a quick one, at Peoples Gas, you mentioned that their two power generators went down affecting the quarter. How big was the impact and will those plants return or have they already?

John Ramil

Those were contracts that expired. They've been off the system all year, Andrew.

Andrew Weisel - Macquarie Capital Securities

Got it. Okay.

Sandra W. Callahan

And the margins on the power generation are very, very small and so that's why I made the point that even though, on a percentage basis, that it looks like a large percentage difference on firm and residential usage was down slightly because of the weather. Despite that revenues -- base revenues were largely unchanged. So those things did not have a material impact on Peoples Gas.

Andrew Weisel - Macquarie Capital Securities

Okay very good. Then lastly, if we can just return to the usage per account, it sounds like there's no change to your long-term view. Was there anything funny going on in the quarter? Because it was nearly 100-basis point drag in the second quarter.

Sandra W. Callahan

I wasn't following the question.

John Ramil

Do you mean the eight-tenths of a percent energy sales increase versus 1.8% customer growth?

Andrew Weisel - Macquarie Capital Securities

Exactly.

John Ramil

Don't forget, degree days were down significantly year-over-year. You had a lot of weather in that difference. And the fact that it was positive with that kind of a weather impact is a very good sign.

Andrew Weisel - Macquarie Capital Securities

You say in the press release that despite the total degree days, weather actually contributed to higher energy sales.

John Ramil

It was patterning that helped, but on an absolute basis -- it got hot and dry in late June, which is when it is normally hotter compared to the prior year. So the year-over-year comparison was driven primarily by rainfall and drier weather.

Andrew Weisel - Macquarie Capital Securities

So just to clarify, weather was a net negative for the quarter on usage?

John Ramil

Degree days were, yes; patterning, no. Don't forget, weather is a lot more than just absolute degree days. That's only one element in the whole weather discussion. It's the one that's most straightforward to measure. But it's only one element in energy usage. Wind gets into it, the number of days in a row of hot, dry weather or cold weather in the winter. There's a lot of elements in that whole weather equation that degree days don't actually capture.

Andrew Weisel - Macquarie Capital Securities

Sure, I understand that. But just to be clear here, net-net, did weather help or hurt?

Sandra W. Callahan

Net-net, it hurt slightly, but if you look at what you would expect the hurt to be based on degree days, it's very different from that and the reason for that is patterning.

John Ramil

If I could move discussion to a little higher macro level, we've seen now four or five, maybe more, quarters where customer growth has exceeded very consistently our expectations and we haven't changed our future expectations, but there seems to be a pretty strong pattern there.

In addition, we've talked about short term sales growth lagging customer growth by about half a percent, and then longer term, maybe three-tenths of a percent. Again, limited data, short period of time, but it looks like that spread is a little tighter than our expectations. So those are all positive signs, but again, a short period of data.

Operator

(Operator Instructions) Your next question comes from line of Andy Bischof with Morningstar Research.

Andy Bischof - Morningstar Research

Hi, good morning. I was wondering if you could provide a little more color on your long-term growth outlook for New Mexico Gas.

John Ramil

Yeah, I mean, they're seeing growth in the 1% range, where they recovered from the downturn in the economy. And we expect that to grow more towards a 1.5% over time.

Andy Bischof - Morningstar Research

And if you could comment on the drivers of the decline in all-in coal costs?

John Ramil

The -- you said all-in coal costs?

Mark Kane

Drivers, that we…

Andy Bischof - Morningstar Research

The drivers, yes.

John Ramil

Several things, Andy. First of all, just a super-focus by the team at Coal to drive down cost everyplace they can. And they've done an incredible job of it this year, effectively offsetting the decline in prices to get us to where we are. Right out of the chute, when prices go down, royalties go down, and roughly a $10 reduction in price takes you down a little bit more than $1 a ton.

We had moved a lot of our operations and surface mines to high-wall mining, which has been much more efficient for us. And it's allowed us to drop our operating costs quite a bit. With a softer market, labor costs are down from a contract miner standpoint, as well as a very, very sharp focus on how we're using people and minimizing overtime and things of that nature. So it's an all-of-the-above approach to get us to the success we've had.

Andy Bischof - Morningstar Research

Great. Thanks.

Operator

(Operator Instructions) And you do have a question from Eli Kraicer with Millennium.

Chris Shelton - Millennium Partners

Hey, good morning. It's Chris Shelton.

John Ramil

Hey Chris.

Chris Shelton - Millennium Partners

Good morning. Had a quick question just on the rate base growth for Tampa Electric. I remember you used to have a slide that pointed to -- had bar charts pointing to rate base in 2017 a little over $5 billion. Has that number changed measurably or is that how you're coming to the 7% now?

John Ramil

Yes, that's how we're getting to the 7%, Chris. Those numbers haven't changed. It's just a simplified presentation. The big incremental add in 2017 is Polk. Transmission will come in in 2016 and Polk will come in in 2017.

Chris Shelton - Millennium Partners

Right. So the target is still similar to what we used to see prior? There's no change in the rate base or the CapEx over years?

John Ramil

No, in the interim years, it's a slow, steady build with a normal annual cap ex of about $330 million with the Polk addition at the end and that 7% is a 2013 through 2017 number, Chris.

Chris Shelton - Millennium Partners

So 2013 as a base. Okay, got it. Okay. Great. Thanks for the clarification.

Operator

(Operator Instructions) At this time, I show no further questions. Are there any closing remarks?

John Ramil

I would like to thank everybody for joining us today. I know there are a number of other calls. So thank you for participating. We look forward to seeing you at various investor functions. Thank you, everyone. Goodbye.

Operator

And this does conclude today's conference call. You may now all disconnect.

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