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Executives

Robert Goocher – VP, Investor Relations

Carl Chapman – President, CEO

Jerry Benkert – EVP, CFO

Analysts

Steven Wang – Carlson Capitals

Andrew Philips – RGO Capital

Vectren Corporation (VVC) Q3 2011 Earnings Call November 4, 2011 10:00 AM ET

Operator

Good morning. My name is Melinda and I’ll be your conference operator today. At this time, I would like to welcome everyone to the Vectren Corporation Third Quarter Earnings Conference Call. (Operator Instructions) Thank you. Robert Goocher, Treasurer and VP of Investor Relations, you may begin your conference.

Robert Goocher

Thank you, Operator. Good morning and thanks to all of you for joining us on the call to review our 2011 third quarter and year-to-date results. This call is being webcast, and shortly following its conclusion a replay will be available on our website at vectren.com in the Investor Relations section.

This morning we released our third quarter earnings and also filed our 10-Q for the quarter. Copies of our earnings release, today’s slide presentation and the 10-Q could all be found on our website.

As further described in slide two I would like to remind you that many of the statements made on this call will be forward-looking statements. Actual results may differ materially from those discussed in this presentation.

Jerry Benkert, Executive Vice President and CFO will kick off today’s discussion by providing a few comments on Vectren’s third quarter and year-to-date results. He will then provide an update of our 2011 earnings guidance and insights into our utility results. Then, Carl Chapman, Vectren's Chairman, President and CEO, will provide his thoughts on the performance of our non-utility businesses including our recent acquisition of Minnesota Limited and then finish with a few summary remarks. Following Carl’s comments, we’ll be happy to take your questions. Also joining us on today's call is Ron Christian, Executive Vice President and Chief Legal and External Affairs Officer.

With that, I'll turn it over to Jerry.

Jerry Benkert

Thanks, Robert. I would like to welcome everyone to today's call. As always, we really appreciate you joining us. Overall, we are pleased with our 2011 year-to-date results. Looking at slides three and four, our utility operations continue to provide a solid contribution earnings leading the way year-to-date.

Our non-utility portfolio other than ProLiance also has performed very well in 2011. Highlighted by the increased earnings we are seeing year-to-date and particularly in the third quarter from infrastructure services and coal mining. ProLiance on the other hand continues to struggle on the ongoing weak natural gas market facing gas marketers. Carl will comment further on these market conditions and the significant progress that ProLiance has made to improve future performance.

I will discuss where we did stand on our 2011 earnings guidance here in a few minutes, but first I want to touch up on a few recent highlights listed on slide three.

I am pleased to report that on Wednesday our Board declared a 1.4% dividend increase bringing Vectren’s quarterly dividend to $0.35 per share or $1.40 per share annualized effective December 01, 2011. This marks the 52nd consecutive year that annual dividends have increased. A record we are proud to maintain because of the contribution our dividend adds to total shareholder return for our investors. In addition we believe our current yield of approximately 5% remains very attractive.

On the financing front, in October, we successfully priced $100 million of utility related long term debt and interest rate at 5%. With this, later this month, we will be able to call at par $96 million of 5.95% long term debt. As you recall back in March we priced $150 million of utility long term debt at a weighted average interest rate of 5.12% and with a delayed draw feature in order to receive the proceeds at the end of this month which coincides with a $250 million 6.58 (ph) debt maturity on December 1st.

Given the very low levels of short term debt currently outstanding supporting our utility operations we plan to refinance the remaining $100 million with short term debt. In total, the net impact of these financing actions will achieve annualized savings of nearly $9 million in 2012 and beyond, which will help our utility businesses offset rising costs expected in other areas of their operations such as depreciation and chemical cost for example.

Finally, on the state regulatory front we are pleased to receive Indiana Commission approval for extension of decoupling and energy efficiency programs for our natural gas customers through December 2015. In August we also received commission approval to implement additional electric customer and energy efficiency programs as well, as related to margin stabilization. Both actions by the Indiana Commission in the quarter demonstrate a regulatory environment that remains constructive for us.

Turning to slide five our consolidated guidance for 2011 including the results of ProLiance is nearer to a range of $1.60 to a $1.80 per share. We are lowering the top end of our range by $0.05 per share to reflect the larger expected loss at ProLiance though it was substantially offset by the higher expected contribution from our infrastructure services business.

Carl will have more to say on that topic in a few minutes, but suffice it to say that we are very pleased with the 2011 year-to-date results from infrastructure services including the positive contribution being made by Minnesota Limited that we acquired on March 31st. We’re now projecting a $0.25 to $0.35 per share loss for ProLiance based upon the year-to-date results and the assumption that current difficult market conditions will persist for the fourth quarter.

With the strong performance of our infrastructure services group in the third quarter we have raised our expectations for the non-utility group excluding ProLiance by $0.08 per share to a range of $0.40 to $0.50 per share.

And finally, we continue to expect the earnings from our utility group to be within a range of $1.52 to a $1.58 per share which at midpoint would represent approximately 5% growth over 2002 on the weather normalized basis.

On slide six, you will see year-to-date utility group results were $92.8 million versus $90.3 million in 2010 and results for the third quarter were $27.9 million compared to $18.7 million in 2010. Both year-to-date and third quarter results reflect increased margins from new electric rates that were implemented in May 2011. Improved year-to-date results are somewhat tempered by the higher operating expenses due to planned maintenance of electric generating units in the first part of 2011 and milder summer cooling weather compared to what we saw in 2010.

As we’ve discussed in previous calls, a review by the Indiana Commission is underway for our procurement process for future coal purchases by our electric utility not our existing contracts. The sub-docket was established and the procedural schedule continues with hearings before the commission scheduled for December.

As we reported in our second quarter call, our electric utility conducted an RFP process for additional coal needs in 2012 and beyond and submitted documentation to the commission in August for its review as part of the sub-docket process.

In October the Consumer Counselor’s office filed its testimony and while they offered suggestions on how to improve the process in the future they do not challenge the results of the RFP or the resulting new contracts with Vectren Fuels.

Additionally, at the end of October we have an agreement in principle and are nearing a final signed contract with the other successful bidder in the RFP process. Finally, as I mentioned earlier, we were pleased to be able to take advantage of lower long-term interest rates and execute another successful pricing of utility related long term debt in October.

With that I will turn it over to Carl for more comments on the non-utility group, year-to-date results and for the quarter.

Carl Chapman

Thanks Jerry. Turning to slide seven, third quarter 2011 coal mining earnings were $5.8 million compared to $2.5 million in 2010. The sizeable increase was a result of increased production and sales of approximately 300,000 tons and 400,000 tons respectively in the quarter versus 2010. Based upon year-to-date results coal mining remains on track to produce and sell at least 5 million tons in 2011.

The higher cost of sales per ton in the quarter was primarily due to somewhat unfavorable mining conditions at our Prosperity mine. In underground mining, the geological conditions vary somewhat as you mine through different sections of the mine such as the thickness of the coal seam, the amount of water seepage experienced, the stability of the roof, and so on. Adapting to these various mining conditions impact productivity and obviously cost per ton mine. Mining conditions in the second quarter were more favorable than those experienced in the third quarter particularly at our Prosperity Mine, but as we move into the fourth quarter so far the mining conditions are somewhat better than those experienced last quarter.

In contrast to Prosperity cost per ton at our Oaktown mine in the third quarter and year-to-date have been much lower compared to the prior year. Further we are pleased that the Oaktown costs in the quarter were in line with the cost in the first half of the year and in line with our plan. Bottom-line, the mine is performing as expected.

Looking ahead, approximately 70% and 40% respectively of 2012 and 2013 expected production has already been subscribed. We currently anticipate the opening of Oaktown mine number two to occur mid-year 2012 or later. As always, the date of opening will be dependent upon demand for the additional coal and our success at securing contracts for 2012 sales.

Vectren feels it’s currently in negotiations with a number of customers regarding sales in 2012 and beyond. While the sales cycle is more extended than we prefer we believe many utilities are simply making coal contracting decisions later in the year.

One final note related to coal mining. As we told you in our call last quarter, based on recently executed contract amendments Vectren Fuels expect to provide about 1.5 million tons of coal to Vectren South in 2012 and 2.3 million tons in both ’13 and ’14.

Our guidance for 2012 generally and for coal operation specifically will be provided in February of 2012. At that time we will have further detail on coal cost and prices as well as our expected increase to tonnage. But given the updated utility pricing and new third party sales to current market and current estimates around tonnage and cost, at this time we expect 2012 coal margins to be reduced to an estimated $5 to $6 per ton.

Moving on to our energy services business, earnings for the third quarter of Energy Systems Group were $2.3 million in 2011, compared to $2.8 million in 2010, which reflects the increased cost associated with our planned growth in the sales force in 2011 and furtherance of our plans to invest to accelerate the growth of our performance contracting in renewable businesses.

One other note about the business. We have observed a slowdown recently in the performance contracting business as many of our typical customers are facing budget constraints elsewhere thereby limiting their eagerness to pursue these types of projects even when financing can be provided.

However, we expect this to be a near term issue because longer term with rising power prices and a national focus on energy efficiency performance contracting just makes sense.

In addition to pursuing performance contracting work, ESG also continues to compete for additional renewable energy projects including making direct investments in certain strategic renewable projects. The projects committed so far in 2011 have been primarily landfill gas projects and anaerobic digester projects. For example, just days ago ESG broke ground on two customer-owned projects; a landfill gas to recycle natural gas processing facility for DeKalb County Georgia where they’ll use that gas for compressed natural gas in their garbage trucks and a landfill gas to power project for the Town of Munster, Indiana. In addition, construction is underway in Wisconsin on three ESG-owned anaerobic digester projects.

On slide eight, ProLiance’s third quarter loss of $8.6 million compares to a loss of $6.9 million in the third quarter in 2010. Low stable prices are great news from the perspective of our gas utility customers, however, from the gas marketer perspective current market conditions have deteriorated further in quarter three or further compression of seasonal and basis spreads. There continues to be an abundance of supply, less than robust demand and therefore low price volatility and low spreads.

Despite the tough environment ProLiance has made great strides and is ahead of schedule in its efforts to reduce its firm transportation and storage demand cost which began the year totaling approximately $80 million annually. To-date approximately $25 million of annualized fixed demand cost have been eliminated for 2012.

Looking forward, ProLiance is continuing to pursue the renegotiation of contracts of which $18 million of these contracts will expire by the end of 2015. Faster than expected results of restructuring and dropping contracts will help to offset the impact of spread that continue to be weaker than expected.

It’s not listed on the slide, but we should also remind you that ProLiance has continued to pursue other profit improvement initiatives this year. Annualized G&A cost have been reduced to-date by over $4 million which will be fully reflected in 2012 results, also customer growth has been a focus in 2011. ProLiance's overall number of customers has increased approximately 13% year-over-year from roughly 1700 to just over 1900. That should add approximately $2 million in margins in 2011 over 2010. And finally, new trading strategies employed in 2011 within existing borrow limits have delivered approximately $3 million of margin benefit year-to-date.

It’s also worth noting that as of September 30th ProLiance's balance sheet still includes over a $140 million of equity, no long term debt and only minimal short term seasonal borrowings outstanding. We obviously continue to be disappointed with the ongoing quarterly losses being experienced by ProLiance as a result of the unfavorable market conditions which don’t seem to be improving yet. ProLiance is not unique in that most gas marketers are experiencing significantly depressed earnings as a result of the current market environment. However, ProLiance's management team is successful in managing what is in their control and the results I outlined earlier demonstrate that.

Though we can make no promises based on forward price curves related to basis and seasonal spreads that we’ve seen recently along with the results achieved related to profitability improvements initiatives that are ongoing at ProLiance, we believe ProLiance's results in 2012 will be markedly improved over 2011 results.

At the bottom of slide 8, you’ll also note Vectren Source has earned $1 million year-to-date which compares favorably to the $800,000 of earnings through September of ’10. Given this performance year-to-date and the seasonal nature of its retail gas marketing business we continue to expect that Source will meet its 2011 earnings target of approximately $4 million.

Turning to slide 9, our infrastructure services group had a great third quarter which drove year-to-date earnings up to $11.1 million compared to $2.2 million year-to-date in 2010. Minnesota Limited which we acquired on March 31st has now contributed $6.3 million earnings year-to-date or about $0.08 per share.

Demand for transmission pipeline repair work in the third quarter was very high and much higher than we had anticipated and was obviously helped by favorable weather for construction activity. Though we’re not sure yet if a quarter this large can be duplicated in the near future we’re pleased the business took advantage of the opportunity. We continue to see demand remaining strong but the typical negative impacts which reduced construction activity from winter weather is also worth noting for the fourth quarter.

Switching to Miller pipeline, the cost Miller incurred in the second quarter to add and train additional work crews paid off in the third quarter, as strong demand for construction work related to bare steel cast iron projects contributed to a good quarter. Looking ahead to the fourth quarter, we expect favorable results for infrastructure services compared to the $900,000 of earnings in the fourth quarter of 2010 though with winter weather approaching we certainly don’t anticipate a repeat of the third quarter’s results.

Just taking a step back for a moment we want to share just a few early thoughts on the Minnesota Limited acquisition that we announced back in late March. First, at a very high level the acquisition was in line with the gross strategy we laid out in February for our infrastructure service group. When we announced the Minnesota acquisition, we told you it was based upon the expectation of increasing demand for repair and replacement of pipe given the heightened concerns about the safety of our country’s aging natural gas infrastructure particularly with the incidents in California and elsewhere.

We also told you we believe new shale gas and oil infrastructure needs would drive demand for businesses like infrastructure services. What we didn’t anticipate earlier this year is how quickly the demand would increase particularly for Minnesota Limited which was running full out this past quarter. I might note that the shale related opportunities are still being pursued and developed, but to-date we’ve not seen shale driving a meaningful contribution to earnings since crews and equipment have generally been fully utilized on pipeline repairs.

Although we’re certainly encouraged about the results we are seeing in the business early on, we’ve been in the pipeline construction business long enough with Miller Pipeline to understand that business has seasonality and at times it’s also cyclical.

Having said that, based upon what we’ve seen recently we expect construction activity for the remainder of 2011 and into 2012 will remain rather strong, and we see the opportunity for this favorable construction cycle to be quite extended.

So, in summary, on slide 10, we’ve had a strong financial performance thus far in 2011 and expect to finish the year equally well including nice overall contributions from coal mining and our infrastructure services business including Minnesota Limited.

As Jerry mentioned earlier, the regulatory and legislative environments remain encouraging in our utility service territories which coupled with rate relief in our recent utility debt deals positions us well heading into 2012. And finally, Vectren’s Board and we as management clearly understand the value of the dividends to our investors and its importance as a key component of shareholder return and are pleased to provide yet another increase in our dividend level.

Operator that concludes our prepared remarks and we’re now ready for questions.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question comes from the line of Steven Wang from Carlson Capital. Your line is open.

Steven Wang – Carlson Capitals

Hi good morning guys. I guess I have a question first to start off with ProLiance. Congratulations on gaining from the renegotiation of the contracts that’s going to help going forward. Although I think you did make a comment that the spread margins are continually compressing this year, when we look into 2012 how should we think about the spread compression impacting the 2012 results. So we talked a lot about the benefits, what about the continued spread margin impact?

Carl Chapman

Yeah. For 2012 what we actually said is that we have anticipated that those margins are similar to about where they are right now. We have not seen improvements. But we still believe because of not only the pipeline reductions which is the largest part, but also some of the other cuts and activities we have made in adding margin that we will see marked improvement in ProLiance’s earnings in 2012.

Steven Wang – Carlson Capitals

Okay, but just on the spread portion itself, you don’t anticipate it to be any worse than ’11?

Carl Chapman

Well, we can't guarantee that it won't be worse. We certainly don’t expect that. Obviously the seasonal spreads are very low as well as the spreads between some of the pipes. So of course they could go down we don’t anticipate that given where they are as low as they are right now.

Steven Wang – Carlson Capitals

And then, moving on to the coal mining operations, you guys indicated that you have 1.5 million tons hedged with the – or sold to the utility. I guess you guys filed the 8-K a while ago, and when I add it all up the firm commitment, I only got up to 830,000 tons. Are you doing some sort of probability weigh on the Culley and the Brown 1 contract? Because right now technically I guess Brown 1 and Culley don’t have to take any coal from you. And what I have is Warrick 4 it’s 500,000 and Brown 2 is 350,000. When we add it together that’s like, you know, 850,000

Carl Chapman

Yeah, I'm not exactly sure what you are commenting on in terms of the exact comments in the 8-K. But I will tell you that we are very comfortable in what the utility’s needs are and what those contracts call for them to take from Vectren fuels. Maybe five ought to be a very good estimate.

Steven Wang – Carlson Capitals

Okay. And then on the 70% hedged for ’12, what type of assumed production are you guys assuming for ’12, and are you including anything from Oaktown 2?

Carl Chapman

Well, we are allowed that production in the February 2012 as we have commented, of course we expect that to be middle of ’12 or later, but we are not going to give guidance on the exact tonnage. Until then I will just say that we do expect a nice increase in tonnage from 2011.

Steven Wang – Carlson Capitals

Well, then can you remind us what the Oaktown 2 production level was supposed to be?

Carl Chapman

Yeah, I believe that we have described that in the past as roughly one point – in an annual full production year as I believe 1.8 to 2.

Steven Wang – Carlson Capitals

Okay. And my last question is you guys indicated that margins coming down to $5 to $6 a ton. Can you just give a little bit more granularity as to why that’s coming down to $5 to $6?

Carl Chapman

Yeah, that really is nothing more than where market is today. Some of those contracts were entered into in 2008 when prices were higher. And so we are just moving contracts as they are reopeners or as we have the additional tonnage just moving it to market and that’s causing the drop. Oaktown 1 still would be a cheaper, much cheaper buying than Prosperity but that’s really not driven out of the cost side, it’s driven on the revenue side.

Steven Wang – Carlson Capitals

And then this year’s guidance what are you assuming the margins for the coal that has been sold?

Carl Chapman

Well, we had given that guidance at the start of the year, and as we said we still believe that Vectren fuel should be generally on track for its – with the estimates we provided on earnings at the start of the year.

Steven Wang – Carlson Capitals

Okay, do you know those numbers off the top of your head?

Carl Chapman

I believe that that was seven at the start of the year.

Analyst

Seven, great. Thank you very much.

Carl Chapman

And by the way you can get what it is year-to-date from our metrics in the appendix of the (inaudible).

Steven Wang – Carlson Capitals

Thank you.

Operator

(Operator Instructions) Your next question comes from Andrew Philips of RGO Capital.

Andrew Philips – RGO Capital

Hi, how are you?

Carl Chapman

Good morning.

Andrew Philips – RGO Capital

A question on ProLiance again. The basis location spreads you mentioned, the pipeline spreads that are weak, can you give an example of some of those that ProLiance currently has exposure to?

Carl Chapman

Well, what we primarily talked about in the past and why we have seen a bit of a larger hit than some of the other markers is that we have very large positions on Panhandle, and Panhandle in particular, and when we say a basis spread primarily would be Panhandle to the Henry Hub or to the NYMEX. So that’s really where we are seeing the biggest part of compression. ProLiance does have positions on other pipes, but the biggest issue for us has been Panhandle just because of the size of our position and also the amount of the drop there over the last few years.

Andrew Philips – RGO Capital

You mentioned in the prior questions that some pipeline reductions had affected the location spreads, I was assuming in your favor the way you answered it, I am not sure. But, what pipeline reductions were you referring to?

Carl Chapman

Yeah, it’s actually not a change in the spread. What it is, is that we had disclosed earlier this year that ProLiance had $80 million of annual demand charges from the pipeline transportation and storage contracts. And through renegotiations and the drop in some cases we now have that down for 2012 to – we dropped that by $25 million annually starting in 2012. We would be able to achieve that amount in 2012.

Andrew Philips – RGO Capital

Okay. I understand. The $25 million, is that – should I think about it in effect buying back futures exposure, something equivalent at – will there be a charge related to that annualized $25 million taken in the quarter or is there no – have you already realized that cost or?

Carl Chapman

Actually there is no charge, that’s just either the contracts we’re expiring or we were able to negotiate a different price. So there's no charge it’s simply that there’ll be a reduced cost to ProLiance at the ProLiance level of $25 million in 2012.

Andrew Philips – RGO Capital

Okay.

Carl Chapman

And on, it continues on obviously, it’s not just a one year.

Andrew Philips – RGO Capital

Okay. And lastly, Minnesota Limited, you mentioned very strong demand there for infrastructure services. Can you talk to where that demand might be regionally? Is it associated with – I have to go back to the slide, but I mean Western North Dakota, is it – you know, can you give a little bit more color?

Carl Chapman

Actually that demand – I’ll talk about Minnesota particularly in a second. That demand is really nationwide. All of the pipelines having to do lots of repair work as they respond to evaluation of safety concerns. But Minnesota Limited’s territory is in that central part of the country although it’s driven by customer, and so if a customer happens to have positions both in, let’s say in Minnesota and New York, we’ll obviously go to where the customer wants us to be. So it’s not so much that it’s a region although it has been strong where Minnesota has been strong which has been the central part of the country, but we also are in the eastern part of country doing that work.

Andrew Philips – RGO Capital

Okay, thank you.

Operator

We have no further questions in the queue at this time.

Robert Goocher

Thank you, Operator. We would like to thank everyone for joining us on our call today and also for those that will be obtaining the EEI Financial Conference next week. We will be there and we look forward to seeing you there.

On behalf of our entire team we appreciate your continued interest in Vectren and invite you to please contact us if you have any follow-up questions. With that we’ll conclude our call for today. Thanks to all of you for your participation.

Operator

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

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