Integrys Energy Group CEO Discusses Q4 2010 - Earnings Call Transcript

Feb.24.11 | About: Integrys Energy (TEG)

Integrys Energy Group Inc. (NYSE:TEG)

Q4 2010 Earnings Call

February 24, 2011 9:00 am ET

Executives

Charlie Schrock – Chairman, President, Chief Executive Officer

Joe O’Leary – Senior Vice President, Chief Financial Officer

Steve Eschbach – Vice President, Investor Relations

Analysts

Ted Heyn – Catapult Capital

John Ali – Decade Capital

Operator

Welcome to the Fourth Quarter 2010 Earnings conference call for Integrys Energy Group Incorporated. All lines will remain on listen-only until the question and answer session. At that time, instructions will be given should you wish to participate. 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 of Integrys Energy Group. Sir, you may now begin.

Steve Eschbach

Thank you and good morning everyone. Welcome to Integrys Energy Group’s Fourth Quarter 2010 Earnings conference call. Delivering formal remarks with me today are Charlie Schrock, our Chairman, President and Chief Executive Officer; and Joe O’Leary, our Senior Vice President and Chief Financial Officer. Other executives, including Larry Borgard, our President and Chief Operating Officer, Utilities; Mark Radtke, Executive Vice President and Chief Strategy Officer of Integrys Energy Group and Chairman of our non-regulated subsidiary, Integrys Energy Services; 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 slide supporting today’s presentation and an associated data package are located on our website at www.integrysgroup.com, select Investor, select Presentation, and then today’s presentation.

Before I begin, I will advise everyone that this call is being recorded and will be available for replay through May 3, 2011. I need to direct you to Slides 3 and 4 of our presentation and to point out that this presentation contains forward-looking statements within the definition of the 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 the ability of Integrys Energy Group to control and, in many cases, Integrys Energy Group cannot predict what factors would cause actual results to differ materially from those indicated by forward-looking statement. I’d also refer you to the forward-looking statement section of yesterday’s news release for further information. Except as may be required by federal securities laws, Integrys Energy Group and its subsidiaries undertakes no obligation to publicly update or revise any forward-looking statements contained in this presentation, whether the result of new information, future events or otherwise.

Slide 5 indicates that today’s presentation includes non-GAAP financial information related to diluted earnings per share adjusted and adjusted earnings or loss. We believe that these are useful 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 in the slide regarding non-GAAP financial information.

I will now turn this call over to Charlie Schrock. Charlie?

Charlie Schrock

Thanks, Steve. Good morning everyone and thanks for joining us on the call today. Before we move on with our conference call today, you will note that Steve mentioned both Mark Radtke and Dan Verbanac will be available during our question and answer session after our formal remarks are completed. Mark has recently accepted the position of Executive Vice President and Chief Strategy Officer for Integrys Energy Group and he remains Chair of our non-regulated subsidiary, Integrys Energy Services. Dan is President of Integrys Energy Services and is directly responsible for the day-to-day leadership and oversight of our non-regulated operations. In the future, I expect you will be seeing more of Dan at our investor relations forums.

Moving on to today’s presentation, I will begin by providing a high-level overview of our 2010 fourth quarter and full year financial and operating results. Joe O’Leary will then discuss our financial results for 2010 in greater detail, in addition to providing insights regarding our investment and financing plans for 2011 and reviewing our guidance for 2011. We will conclude with a question and answer session.

Turning to Slide 6, I am pleased to report that our fourth quarter and full-year 2010 diluted earnings per share adjusted on a consolidated basis were stronger than the same periods a year ago. As a reminder, diluted earnings per share adjusted is how we internally evaluate our financial performance as it eliminates the effect of certain items that are not comparable from one period to the next.

Our positive financial results reflect the effective execution of our business plan. The benefits of cost control efforts across all of Integrys Energy Group’s subsidiaries are now being seen. Reductions in workforce at our regulated utilities, Integrys Energy Services, and our business support subsidiary along with furloughs throughout Integrys Energy Group, were key drivers of labor savings. Our employees have been focused on minimizing non-labor costs without sacrificing safety or reliability, and this has helped drive improved financial performance.

The solid operating performance of our electric generating fleet resulted in lower fuel and purchase power costs than were authorized to be recovered in rates and increased opportunity sales throughout our system. Our 2010 financial results also reflect the retail rate increases for our regulated utilities that were implemented in 2010 across our various jurisdictions. And finally, the improved realized unit margins and lower operating expenses at Integrys Energy Services enabled us to achieve our projected financial results for our non-regulated subsidiary.

We maintained our quarterly dividend at $0.68 per share. With continued earnings growth, we expect our dividend payout ratio to decrease over time to a level that will be comparable to our utility peer group.

To complete our high level financial overview, our guidance for 2011 diluted earnings per share adjusted on a consolidated basis remains between $3.24 and $3.57, although there are some changes within our five reporting segments that Joe will discuss later.

Slide 7 provides a brief overview of the operational activities for our regulated utilities. We completed rate cases for Upper Peninsula Power at year-end 2010 and Wisconsin Public Service in early 2011. Our rate case for Michigan Gas Utilities was completed earlier in 2010 and subsequent to that, our appeal on the conservation decoupling mechanism in the case was successful in moving the original effective date of September 1, 2010 to a retroactive date of January 1, 2010.

We also filed for a retail rate increase for Minnesota Energy Resources on November 30, 2010. It was accepted as complete by the state regulatory commission and interim rates went into effect on February 1, 2011. And we announced a little more than a week ago that we filed retail natural gas rate cases for Peoples Gas and North Shore Gas, requesting rate increases to be effective in the first quarter of 2012. Further details regarding these rate cases can be found in the appendix of our slide deck, Slides 25 through 28.

Our customers and shareholders alike benefited from the performance of our generation fleet. Our Weston 4 plant performed well throughout the year and our operations group took steps to ensure that our entire fleet was available when needed the most, when prices when high in the Midwest independent system operator market. As a result, our fuel and purchase power costs were less than what was in rates, resulting in customer refunds and additional earnings.

Our employees responded to external events in their usual efficient manner. Last fall, we had what some called the Storm of the Century, a windstorm that caused more than 70,000 of our regulated electric customers in Wisconsin to be without power. Focused and safe efforts by our employees kept the length of those power outages to a minimum, which resulted in only a modest $3 million cost impact for restoring power to our customers and zero complaints filed with the Public Service Commission of Wisconsin. Our stringent cost control efforts in this endeavor and elsewhere throughout our regulated electric utilities and our lower fuel and purchase power costs enabled our regulated electric utility segment to exceed its authorized return on equity for 2010.

In January 2010, we received Illinois Commerce Commission approval for our accelerated cast iron main replacement rider for Peoples Gas in the city of Chicago, and that project is now underway. We are applying the same project management skills to this project that we used to construct Weston 4 power plant on time and under budget. When completed in 2030, the main replacement project will be the largest construction project in our Company’s history.

I’m sure many of you are wondering how we have done in closing the shortfall between our actual adjusted earnings at the regulated utilities versus where we could be if all of our utilities were earning their respective authorized returns on equity. Turning to Slide 8, there is very good news on this front as we narrowed the shortfall from a $56.8 million shortfall in 2009 to a $20.4 million in 2010. Our February 2010 estimated target was a $37 million shortfall for 2010. The regulated natural gas and electric segments had more adjusted earnings attributed to common shareholders in 2010 than they did in 2009.

In February 2010, we also estimated an adjusted earnings shortfall of $34 million for 2011, but we are now estimating this shortfall to grow slightly to a $37 million adjusted earnings shortfall. As Joe will explain during his formal remarks, our guidance for 2011 diluted earnings per share adjusted for the regulated utilities is down slightly from what we gave you last November, which translates into this slight increase for the estimated shortfall compared to what we presented a year ago. Just as we did in 2010, we intend to narrow the 2011 shortfall with continued emphasis on cost controls and the timely filing of rate cases where necessary. It is unlikely that this adjusted earnings shortfall will reach zero, but we will continue our efforts to reduce it as much as possible.

Turning to Slide 9, let me recap the accomplishments related to our non-regulated operations at Integrys Energy Services. Our strategy change is essentially complete. Our recovered invested capital target of $700 million related to the sale of non-core businesses at Integrys Energy Services was achieved in April 2010, and our collateral support requirement target of $500 million related to our retail energy marketing business was achieved at year-end 2010. That leaves us with a non-regulated energy services subsidiary company that has a reduced scope and scale and a significantly lower risk profile, leading to controlled growth. Integrys Energy Services is now focused on retail natural gas and electric marketing in the northeast quadrant of the United States as well as solar and other renewal energy projects within selected markets in the United States.

With that, I will now turn this call over to Joe O’Leary. Joe?

Joe O’Leary

Thanks, Charlie. I’ll cover our financial results for the fourth quarter and full year 2010 and briefly review our guidance for 2011 diluted earnings per share adjusted. But before I do, I need to summarize an accounting policy change we made in the fourth quarter of 2010 and provide a brief commentary on bonus tax depreciation.

For our non-regulated renewable energy and solar business, we changed our method of accounting for investment tax credits, also referred to as ITC. In the fourth quarter of 2010, we changed from the flow-through method to the deferral method which provides better matching of the benefit of these credits with the cost of the related investment. Under the deferral method, we defer ITC in the year the credit is received and reduce the provision for income taxes over the useful life of the related property.

Our financial statements for 2009 and 2008 were retrospectively adjusted to reflect this accounting policy change. The impact of the policy change on net income attributed to common shareholders in 2008 was an after-tax reduction of $9.9 million in 2008, all in the fourth quarter, and an increase in subsequent years on a quarterly basis. The annual impact on net income attributed to common shareholders in 2009 was an after-tax increase of $1.3 million. Our 2010 full-year reported net income attributed to common shareholders includes a $900,000 positive after-tax impact as a result of this policy change.

Income attributed to common shareholders in subsequent years will be positively impacted by this accounting policy change by approximately $7.7 million after taxes over the next 13 years for renewable projects at December 31, 2010. For additional information, see Note 1(d), Change in Accounting Policy, on Page 73 of our Form 10-K.

The tax relief, unemployment insurance reauthorization, and Job Creation Act of 2010 included the extension of cash grants related to renewable energy projects and bonus tax depreciation. We will certainly take advantage of both of these provisions, which will improve our cash flows beginning this year. We are currently reviewing our options regarding these matters and taking into consideration what is best for our customers and shareholders. We will most likely further fund our employee benefit plans, defer some future planned equity issuances, and increase capital expenditures as appropriate. These potential adjustments to our operating plan are not reflected in Slides 13 through 16 that I will discuss later on.

Now let’s move to the financial overview. Beginning with Slide 10, during the fourth quarter of 2010 in accordance with Generally Accepted Accounting Principles, or GAAP, we recognized diluted earnings per share of $0.91 for the quarter ended December 31, 2010 compared with $0.30 for the same quarter in 2009. For the full year 2010 and again in accordance with GAAP, we recognized diluted earnings per share of $2.83 versus a net loss per share of $0.91 for the same period in 2009.

This slide sets forth the additions and subtractions we have made to arrive at diluted earnings per share adjusted for the fourth quarter and full year 2010 that Charlie commented on during his opening remarks. I won’t go through each line item here, but I will gladly answer any questions you may have during our question and answer session at the completion of our formal remarks. The key takeaway is that for 2010, consolidated fourth quarter and full year results show strong improvement over the comparable periods in 2009, and our full year 2010 diluted earnings per share adjusted at $3.13 came in at the higher end of the guidance we provided you in November 2010. For more information on the comparative fourth quarters of 2010 and 2009, adjusted earnings and diluted earnings per share adjusted are reported by segment on Slides 33 and 34 in the Appendix; and the comparative full year 2010 and 2009 adjusted earnings and diluted earnings per share adjusted results by segment can be found on Slides 40 and 41, also in the Appendix.

On Slide 11, we present the changes in adjusted earnings by segment for the fourth quarter of 2010 compared with the fourth quarter of 2009, and Slide 12 is a similar exhibit for the full year 2010 compared with the full year 2009. The related key drivers for each segment can be found in the Appendix on Slides 35 through 39 for the quarter, and on Slides 42 through 46 for the full year. I will not go through the key drivers here, but again I will answer any questions you may have on the key drivers during our question and answer session.

Moving to Slide 13, we have provided an update on our capital expenditure plans for all of our subsidiaries. The key drivers remain the same as we have discussed recently; that is, the environmental retrofits for our regulated electric utility segment, the cast iron main replacement program for our regulated natural gas segment in Chicago, and renewable energy project investments, predominantly solar, for Integrys Energy Services.

At Integrys Business support, we will continue to invest in infrastructure projects that support the corporate services we provide to our subsidiaries, and we will continue to invest in American Transmission Company through their annual equity calls, although these are expected to continue declining as American Transmission Company increases its self-funding of transmission projects.

Slide 14 sets forth our expected depreciation expense at the regulated utilities, and Slide 15 provides our expected net growth and regulated utility investment in property, plant and equipment - $708 million for the period 2011 through 2013. It should be noted, however, that the net growth in rate base investment may not match what we have on this slide. We have elected to use a revised tax strategy that may allow us to expense rather than capitalize certain costs. This has the benefit of increasing cash flow and deferred taxes; however, deferred taxes are an offset to rate base investment. For this reason and how we decide to apply the cash generated from bonus tax depreciation that I discussed earlier, our net growth in utility rate base investment may not be equal to what is depicted on Slide 15.

Moving to Slide 16, let me summarize the slight changes to our financing plan for 2011. The only long-term debt we currently plan to issue in 2011 is for Peoples Gas, and it could range between $50 million and $100 million. We also expect our stock investment plan, which includes our dividend reinvestment program, to remain on a new issue basis, and this is expected to generate $50 million of new equity during 2011.

Our financing plan for 2011 is designed to maintain our current credit ratings. For those who may have missed the news, Standard & Poor’s changed its outlook for Integrys Energy Group, Peoples Gas and North Shore Gas from stable to positive in January 2011. Please refer to Slide 47 for a complete listing of our credit ratings.

Turning to Slide 17, our guidance for 2011 diluted earnings per share adjusted on a consolidated basis is between $3.24 and $3.57. This slide depicts diluted earnings per share by segment as well as the removal of one special item – the net non-cash gains related to derivative and inventory activities at Integrys Energy Services - to arrive at diluted earnings per share adjusted. To provide a better perspective on this, I will compare this to 2010 actual results by segment and to the 2011 guidance we provided to you on our last earnings conference call on November 4, 2010 in the next two slides.

Turning to Slide 18, we have provided a waterfall chart that takes you from 2010 actual diluted earnings per share adjusted to our guidance for 2011 diluted earnings per share adjusted. The $3.41 indicated for 2011 is at the midpoint of our guidance range for Integrys Energy Group of $3.24 and $3.57. The chart sets forth the reasons for the change by segment.

Moving to Slide 19, we have provided our revised 2011 earnings per share guidance adjusted that we are presenting today side by side with what we presented to you on November 4, 2010. Consolidated Integrys Energy Group’s range doesn’t change. The only changes are between the segments themselves. The largest movement is for the regulated natural gas segment and the change is primarily related to the impact of the increased income taxes for the Illinois utilities and a rate reduction at Wisconsin Public service. The largest improvement comes from the holding company and other segment, and that is primarily due to expected lower net interest expense. The other segments have been adjusted slightly to reflect refinements based on our most recent forecasts.

Our ability to retain overall consolidated guidance within the same range as discussed last fall is due to our strategy and diversified business portfolio. Now I’ll turn the call back over to Charlie Schrock. Charlie?

Charlie Schrock

Thanks, Joe. Before we take your questions, I will conclude by briefly reviewing why Integrys remains well positioned for the future. Please turn to Slide 20.

First, the continued successful execution of our strategy is demonstrated by quarter-over-quarter and year-over-year increases in financial performance on an adjusted basis for our consolidated company. Our cost control efforts and the timely filing of rate cases are providing the desired results of improving our utilities’ return on equity. Our continued investment in American Transmission Company will continue to contribute to earnings. Additionally, the successful transition to a smaller, retail-focused non-regulated energy services company with a significantly lower risk profile has helped us to achieve our financial projections. Our guidance for 2011 diluted earnings per share adjusted on a consolidated basis remains between $3.24 and $3.57.

We look for 2011 to be a successful year for our Company, a continuation of what we accomplished in 2010. We have maintained our quarterly dividend rate at $0.68 per share, and we remain confident that our dividend payout ratio will become more comparable with our utility peer group over time. Finally, we continue to expect growth in diluted earnings per share adjusted of 4 to 6% on an average annualized diluted earnings per share adjusted basis with 2011 as the base year through 2015.

We will now open up the call for your questions.

Question and Answer Session

Operator

Thank you. At this time, if you would like to ask a question, please press star followed by one on your touchtone phone. You will be prompted to record your name. To withdraw your request, you may press star followed by two. Once again, that is star, one to ask a question, and one moment for the first question, please.

I’m currently showing no questions. I’d like to turn the call over to Mr. Steve Eschbach.

Steve Eschbach

Well, thank you very much for being part of our fourth quarter earnings conference call. Oh, I’m sorry—oh, we do have one. Wendy, if you would take the one person who has just signed on, please.

Operator

I do have a question from Ted Heyn with Catapult. Your line is now open.

Ted Heyn – Catapult Capital

Good morning.

Steve Eschbach

Good morning, Ted.

Ted Heyn – Catapult Capital

Well, hopefully I’m not the only person listening!

Steve Eschbach

We’re sure you’re not.

Ted Heyn – Catapult Capital

Had just a quick question, I guess, a little in the weeds; but Joe, you talked about the potential benefit from financing and CAPEX from, I guess, the change in your tax strategy as well as bonus D&A. Could you give us just a little more color on, one, the change in the tax strategy, and then secondly, is there any kind of number you could put around the potential cash benefit from looking at these options?

Joe O’Leary

There’s a couple questions there, and let me see if I can handle those. I guess—we’d prefer not to go into great detail on tax strategy other than on a general sense. We’ve decided in terms of the level at which we capitalize versus expense, certain capital expenditures for tax purposes, we’ve raised that. That’s kind of in line with what a lot of others in the industry do, and we did that in part to ensure that we didn’t have regulators starting to impute that type of impact on us in future rate cases that may come up.

Ted Heyn – Catapult Capital

Okay, and that expense – that’s just on your tax books, right? So that’s not going to be an earnings impact for—

Joe O’Leary

That is correct.

Ted Heyn – Catapult Capital

Okay.

Joe O’Leary

That is correct. It does impact deferred taxes, however; and deferred taxes can have an impact on rate base.

Ted Heyn – Catapult Capital

Exactly.

Joe O’Leary

And so we’re looking at other things we can do to help mitigate some of the impacts of that and to make good use of the increased cash flows for the benefit of our customers and our shareholders. And we’re still in the process of sorting through some of those things, but I did mention a couple things that we’re considering is increasing the contributions to our benefit plans, the pension and the other post-retirement benefit plans. That is one piece of it; and then we’re also looking to see what types of capital projects would make sense for us to perhaps accelerate – move forward a little bit – that would benefit our customers at well and at the same time maybe mitigate some of the impacts on the earnings in future years of that other detrimental impact on rate base by virtue of having the deferred taxes increased.

Ted Heyn – Catapult Capital

Okay. And then is there any sense you can give us on the scope of how big that deferred tax impact is going to be relative to what you were thinking before? I mean, I guess what I’m trying to get at is what’s the earnings impact from bonus D&A and this other stuff – are we going to see a material reduction in your earnings power, or is the thought that some of those other things you mentioned like pension and additional CAPEX are going to offset the earnings power reduction from the deferred taxes?

Joe O’Leary

Well first of all, with regards to 2011 we’ve already factored that in there, and it’s a relatively insignificant impact on 2011. For 2012 and future years, we expect that the combination of those things that I mentioned will essentially mitigate all the impacts of that on earnings, and we don’t expect it to have a material impact on future earnings growth potential.

Ted Heyn – Catapult Capital

Okay, great. I appreciate it. Thanks a lot, guys.

Steve Eschbach

Thanks for the question.

Operator

Thank you. As a reminder, to ask a question please press star, one on your touchtone phone. Our next question is from John Ali with Decade Capital. Your line is now open.

John Ali – Decade Capital

Good morning.

Charlie Schrock

Good morning, John.

John Ali – Decade Capital

Just a quick question. I apologize – I joined the call late. What was your—during the script, your language around equity needs and financing needs?

Charlie Schrock

I’ll have Joe respond to that, John, okay?

John Ali – Decade Capital

Thank you.

Joe O’Leary

Our financing summary is actually on Slide 16, and based on that we talked about in 2011, we expect to do a long-term debt issuance for Peoples Gas between 50 and $100 million. Also in 2011, we expect to raise about $50 million of equity through our dividend reinvestment plan, and that’s pretty much it.

John Ali – Decade Capital

So no equity needs beyond the DRIP for the next few years?

Joe O’Leary

Yeah, with that bonus depreciation issue that I spoke of earlier, we’re looking to see—you know, that may defer future equity needs as well. So those are some of the things that we are sorting out.

John Ali – Decade Capital

Great. Thanks, guys.

Steve Eschbach

Thank you, John.

Operator

Thank you, and I currently show no further questions. I’d now like to turn the call back over to Mr. Steve Eschbach.

Steve Eschbach

Thank you. Thank you very much for being part of our fourth quarter earnings conference call. A replay of this conference call will be available until May 3, 2011 by dialing toll-free 866-489-8056. The text for today’s presentation is available on our website at www.integrysgroup.com. Just select Investor and then Presentations. If you have any additional questions, you may 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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