Integrys Energy Group's CEO Discusses Q4 2011 Results - Earnings Call Transcript

Feb.29.12 | About: Integrys Energy (TEG)

Integrys Energy Group, Inc. (NYSE:TEG)

Q4 2011 Earnings Call

February 29, 2012 9:00 am ET

Executives

Steve Eschbach - VP, IR

Charlie Schrock - Chairman, President and CEO

Joe O'Leary - SVP and CFO

Larry Borgard - President and COO, Utilities

Mark Radtke - EVP and CSO

Dan Verbanac - President, Integrys Energy Services

Analysts

Ashar Khan - Visium Asset Management

Mike Bates - D.A. Davidson

Amit Marwaha - Citigroup

Maury May - Power Insights

Operator

Welcome to the fourth quarter 2011 earnings conference call for Integrys Energy Group, Incorporated. (Operator Instructions) I would now like to introduce today's host Mr. Steve Eschbach, Vice President of Investor Relations at Integrys Energy Group.

Steve Eschbach

Thank you. Good morning. Welcome to the Integrys Energy Group's fourth quarter 2011 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 Dan Verbanac, President of Integrys Energy Services, are available for the question-and-answer session that will follow our formal remarks.

The slides supporting today's presentation and an associated data package are located on our website at www.integrysgroup.com. Select Investors, select Presentations, and then today's presentation. Before we begin, I will advise everyone that this call is being recorded and will be available for audio replay through May 1, 2012.

I need to direct you to Slide 3 of our presentation and to point out that this presentation contains forward-looking statements within the definition of the United States 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 our ability to control and, in many cases, we cannot predict what factors would cause actual results to differ materially from those indicated by forward-looking statements. Except as may be required by federal securities laws, we undertake no obligation to publicly update or revise any forward-looking statement contained in this presentation, whether the result of new information, future events, or otherwise. This slide is a condensed summary on forward-looking statements, and you are encouraged to read and understand the more specific language that is contained in our filings with the Securities and Exchange Commission, including the Annual Report on Form 10-K we filed last night, the forward-looking statements section of yesterday's news release, and Slide 48 in this appendix.

Slide 4 indicate that today's presentation includes non-GAAP financial information related to diluted earnings per share adjusted and adjusted earnings and/or loss. We believe that these are useful financial 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 other. Please review the text of this slide for more information regarding these non-GAAP financial measures.

I will now turn this call over to Charlie Schrock.

Charlie Schrock

Thanks Steve. Good morning everyone, and thanks for joining us on the call today.

I'll begin by providing a high level overview of our 2011 financial results and operating highlights. Joe O'Leary will then discuss our financial results in more detail and provide a summary of our financing outlook for 2012. And as usual, we will conclude with a question-and-answer session.

Turning to Slide 5, I am pleased to report improved earnings for both the fourth quarter and full year 2011. In the fourth quarter of 2011, we posted a 23% increase in diluted earnings per share adjusted over the same period in 2010. And for the full year, we posted about an 8% increase over the full year 2010. These favorable results are from the solid execution of our business plan.

As for 2012, we are introducing guidance for diluted earnings per share of $3.35 to $3.55 with a midpoint of $3.45. Joe will have more to say on that in just a few moments.

Slide 6 provides a brief operational update on our regulated utilities. Our utilities finished the year strong. As shown on Slide 19 in the appendix, the actual returns on equity for our natural gas and electric utilities were about 8% and 11% respectively in 2011. We expect some slight improvement in 2012, as our returns on equity for our utilities are projected to be in the range of 9% to 10%.

In terms of net income the shortfall of our actual utility earnings to authorized level was about $15.4 million in 2011, which is much better than $37 million that we had estimated at this time last year. The progress we made in 2011 places us within a range of what we can reasonably expect on a continuing basis.

From a rate perspective we reached resolutions on four of the five rate cases that were pending in 2011. This included rate cases for Peoples Gas, North Shore Gas and Upper Peninsula Power as well as the Wisconsin Public Service limited reopener case. The loan case that did not come to a final decision in 2011 was Minnesota Energy Resources, but interim rates were granted in February of 2011. The key details for each rate case are summarized in appendix Slides 22 to 26.

The highlight for our natural gas utility segment was our accelerated main replacement program in Chicago. In 2011, we began the field work for this program and installed 154 miles of new pipe, which is more than a threefold increase over what we have typically done in the past. I congratulate the project team, our employees and our contractors for a successful first year of this project.

Most of you are probably aware of the Court of Appeals ruling which found at the Illinois Commerce Commission did not have the authority to approve Rider ICR for our accelerated main replacement project at Peoples Gas. The Illinois Supreme Court recently denied our petition to hear an appeal of the ruling, which ended our options to the change the appellate court decision. We expect the appellate court to remand this back to ICC for further actions.

In the near term, we plan to continue with the Accelerated Main Replacement Project in Chicago and we'll seek recovery of our projected cost for the next year through the traditional ratemaking process. Beyond 2013, we will seek appropriate legislative or regulatory solutions to achieve timely recovery of the cost associated with the Accelerated Main Replacement Program.

For our regulated electric utility segment, environmental projects are of priority. We are proceeding with an environmental retrofit at the Columbia plant that was approved by the Public Service Commission of Wisconsin in 2011. And we plan to file a certificate of authority with the PSCW later this year for installation of environmental control equipment on our Weston 3 plant. We expect approval in 2013.

Turning to Slide 7, 2011 was the first year of Integrys Energy Services operating in its fully restructured environment. We saw improved unit margins in both, retail, natural gas and retail electric as we continue to provide value-added services to Integrys Energy Services customers. This is clearly evident from the information shown on slide 30 in the appendix.

Our customer retention continues to strong, nearly 90% of our commercial and industrial customers will retain in 2011. In addition, we grew by expanding our presence in existing geographical markets. For example, we participate in retail customer aggregation in Illinois that resulted in over 44,000 new electric customers. Last year, we also began offering electric products directly to small commercial and residential customers in Illinois and have added over 33,000 new customers through those offerings.

As announced in our news release in early February, we are now preparing to offer natural gas products and services to commercial and industrial customers in Washington D.C., Maryland and Virginia.

At December 31, 2011, our contracted retail natural gas and retail electric volumes for 2012 were both up by more than 4% in our retail markets as compared to the contracted volumes on December 31 of 2010.

So all told, Integrys Energy Services first full year of operation in its restructured environment was impressive as it more than doubled its contribution to adjusted earnings in 2011 compared to 2010, thus providing a nice complementary earning stream to our utility operations which as I mentioned earlier also had a very good year.

I'll now turn in the call over to Joe O'Leary.

Joe O'Leary

Thanks Charlie. I'll cover our financial results for the fourth quarter 2011 and discuss our guidance for 2012 diluted earnings per share beginning with Slide 8. During the fourth quarter of 2011, in accordance with generally accepted accounting principles, or GAAP, we recognized diluted earnings per share of $0.49 for the quarter ended December 31, 2011 compared with $0.91 for the same quarter in 2010. This slide also sets forth the additions and subtractions we have made to arrive at diluted earning per share adjusted for the fourth quarter of 2011.

Our diluted earnings per share adjusted for the fourth quarter 2011 was $1.01 versus $0.82 in the same period in 2010. More information on the comparative fourth quarters of 2011 and 2010, adjusted earnings, and diluted earnings per share adjusted is reported by segment on Slides 31 and 32 in the appendix. You will also find the full year 2011 and 2010 comparative data for adjusted earnings and diluted earnings per share adjusted on Slides 38 and 39 in the appendix.

On Slide 9, we present the changes in adjusted earnings by segment for the fourth quarter of 2011 compared with the fourth quarter of 2010. The improved quarter-over-quarter adjusted earnings were primarily driven by favorable results in our regulated electric utility segment and Integrys Energy Services. These more than offset the lower sales volumes at the natural gas utility segment due to warmer weather for those customer groups that are not covered under decoupling mechanisms. Additional detail on the key variance drivers for each segment can be found in the appendix on Slides 33 through 37.

Slide 10 presents the changes in adjusted earnings by segment for the full year 2011 compared with the same period in 2010. The only segment that was down in 2011 was the regulated electric utility, which was primarily driven by decreased margins related to rate order differences affected decoupling at Wisconsin public service. Additional detail on the key variance drivers for each segment can be found in the appendix on Slides 41 through 44.

Moving to Slide 11, we have provided our capital expenditure plans for 20112 through 2014, the key segment drivers remain the same with environment retrofits at Wisconsin Public Service for the electric utilities and the accelerated main replacement program at Peoples Gas in Chicago for the natural gas utilities.

Slide 12 sets forth our expected depreciation expense at the regulated utilities for 2012 through 2014. You may recall from our former remarks during our quarterly earnings conference calls last year but due to the accumulated differed income taxes resulting from bonus tax depreciation capital expenditures less depreciation is not a good proxy for rate base growth in the near term. Our projected rate base chart for 2012 through 2014 appears at Slide 45 in the appendix.

Moving to Slide 13, you will see our financing summary for 2012. At January 24, 2012 Standard & Poor's upgraded the corporate credit rating for Integrys Energy Group to A- from BBB+. Similar action was taken for Peoples Gas and North Shore Gas. Standard & Poor's also reaffirmed the corporate credit rating for Wisconsin Public Service with a stable outlook. In this report Standard & Poor's attributed their reaction to our improved business risk profile due to restructuring and reducing the size of our non-utility business and continuing to effectively managed regulatory risk.

Long term borrowings expected in 2012 include about $250 million to $300 million for Wisconsin Public Service, about $75 million for Peoples Gas and about $30 million for North Shore Gas. We do not plan to issue any new common stock in 2012.

Turning to Slide 14, our guidance for 2012 diluted earnings per share on a consolidated basis is in the range of $3.35 and $3.55. And we have provided the details by segment. At this time, we are not projecting any special items such as non-cash mark-to-market gain or losses or any other items such as we have projected in the past. As such that the diluted earning per share adjusted numbers are the same as the GAAP numbers at this time. When we report future quarterly results we'll detail any special items that occur and provide you with diluted earnings per share adjusted.

Moving to Slide 15, we have provided you with the waterfall graph that starts with our 2011 adjusted earnings and shows the changes by reporting segment to get you to the midpoint of our 2012 guidance.

In 2012, we expect the earnings contribution for the Regulated Natural Gas Utility, Electric Transmission Investment, Holding Company and Other and Integrys Energy Services segments to improve over 2011. We expect the earnings contribution from our regulated electric utility segment to decline during 2012. Part of this has to do with items that occurred in 2011 that we don't expect to repeat in 2012 and part of it has to do with expense items that we plan to address with Wisconsin Public Services next rate filing for new rates to be effective in 2013.

For example, there was a $3 million after-tax benefit of lowered fuel cost that because they remained within the 2% band established by regulators, we were able to retain. We are not projection that to repeat in 2012 at this point.

In addition, the emission costs were lowered by $3 million after-tax. For 2012, the emission costs are part of the fuel window calculation and we aren't projecting emission cost be lowered in 2012.

In 2012, we are projecting certain expense items to increase relative to what they were in 2011 and we expect these items to be addressed in our next rate case filing in April, 2012 for new rates to be effective in 2013.

On an after-tax basis some examples include $6 million for increased transmission costs, $5 million for increased employee benefit costs and $5 million for reduced margins due to actual customer accounts differences and the loss of a wholesale customer.

We are projecting Integrys Energy Services earnings contribution 2012 to be up marginally from its strong performance in 2011. Integrys Energy Services contribution from energy marketing is expected to increase by about $7 million in 2012 which would be more than a 20% increase over 2011. This is somewhat offset by an expected decrease in adjusted earnings resulting from the expiration of certain capacity contracts associated we legacy generation assets.

The legacy generation assets contributed about $3 million in adjusted earnings in 2011 but we're projecting a loss of about $2 million in 2012 which represents a decline of about $5 million.

Consequently, as we resolved these issues with the regulated electric utility segment and Integrys Energy Services legacy generation assets, we believe we can remain on track to achieve our 4% to 6% long term growth objective in diluted earnings per share and adjusted on an average annualized basis from 2011 through 2015 as previously stated.

Now I'll turn the call back over to Charlie.

Charlie Schrock

Thanks Joe. Before taking your questions I'll summarize the highlights of our call this morning as shown on Slide 16. First, we continued the execution of our business plans through our operational excellence initiatives, cost control efforts and the timely filing of rate cases. On an adjusted basis our quarter end year-to-date performance improved over the same period last year.

Our 34% ownership in American Transmission Company contributed to earnings as expected. And our nonregulated operations saw a meaningful growth in earnings and forward contracted retail volumes.

Our portfolio of businesses, regulated natural gas and electric utilities operating in the Midwest, retail nonregulated energy services operations in the northeast quadrants of United States and our equity investments in the American Transmission Company, enabled us to meet our financial objective on a consolidated basis.

Our guidance for 2012, diluted earnings per share on a consolidated basis is between $3.35 and $3.55. And finally, as Joe mentioned, we continue to expect growth in diluted earnings per share adjusted of 4% to 6% on an average annualized basis with 2011 as the base year through 2015.

We'll now open the call for your questions.

Question-and-Answer Session

Operator

(Operator Instructions) The first question is from Ashar Khan.

Ashar Khan - Visium Asset Management

This is Ashar. Joe, I just wanted to go over the Slide 19, what I heard on the comments, if I heard them correctly. Are you saying that the regulatory lag that you have now of about like $7 million as it's shown. Is that what we should expect that to continue that is that you kind of narrowed it to this level and it's harder to narrow further, is that what you're saying? I'm just wondering?

Joe O'Leary

On that page that you referred to, Page 19, that's using the midpoint of our earnings per share guidance range for 2012. And as you can see it does come down to $7.4 million. And as Charlie mentioned, that's true. We kind of expect that to kind of where we will be on a go forward basis, because of some regulatory lag.

Charlie Schrock

There's going to be some variability around that and it's not going to be exactly the same every year, it will be within a range, give or take some. But fundamentally we're at a point where we wouldn't expect that to improve on a consistent basis year-over-year.

Ashar Khan - Visium Asset Management

And then can I just go back to Slide 16, your last bullet point you're saying, as we resolve issues related to the regulated electric utility segment and the Integrys Energy Services. I guess the regulated electric utility segment you referred to will be addressed in the next rate case, if I heard it correctly. Could you just amplify what you mean by the services' legacy generation assets?

Charlie Schrock

Well, as you know, we have a small number of, what we call our legacy generation assets that we had procured years ago. They operate in Pennsylvania and New York and Wisconsin. There is a one there as well. We did have a contract terminated at the end of last year for one of those assets. So with a loss of that contract, we're seeing a decrease in the revenues from there. Going forward, we'll manage those as best we can and that will be part of the things that we need to resolve going forward. But I'm sure we will.

On the electric utility side, what we're seeing are some one-time things that helped us last year like the fuel window thing that Joe mentioned. But going forward we'll just have to go in for rate cases to readjust our revenues as appropriate and makeup for what we're seeing in terms of our increased costs and other changes that we're sitting in that segment. And that's what we mean by as we resolve those issues through rate cases and other things going forward.

Ashar Khan - Visium Asset Management

Could you just tell me, are the two assets, when do their contracts expire?

Dan Verbanac

Sure. Those facilities don't have long-term contracts. We dispatch them into the market today. So primarily all of them now are merchant plants and being dispatched directly into the market.

Operator

Michael Bates from D.A. Davidson, you may ask your question.

Mike Bates - D.A. Davidson

I was looking at Slide 11, and I noticed that your CapEx forecast for Wisconsin Public Service moved up by about $40 million in 2013. Is that the impact of the Weston 3 CapEx or is that something else?

Charlie Schrock

Mike, I'll have Larry address that, but basically, you're right.

Larry Borgard

Yes, the two biggest CapEx components for Wisconsin Public Service are the Columbia environmental retrofits, in addition to the beginning of the spend for the Weston 3 environmental retrofits.

Mike Bates - D.A. Davidson

Have there been any changes to your assumptions as to the size of the Columbia project?

Larry Borgard

No. It's as approved by the Commission.

Mike Bates - D.A. Davidson

I also see CapEx spiking for Integrys Business Support in 2014. Can you talk about that a little bit?

Charlie Schrock

Just a second, Mike, I want to look at that number. I think that has to do with computer systems that we're looking at installing. And Larry might have a little more detail on that.

Larry Borgard

So our Integrys Business Support supports all of our utilities in part of our nonregulated business as well. So to the extent that we look at things like consolidation of customer information systems, that would be the spend associated with the increase that you're seeing on the CapEx line.

Mike Bates - D.A. Davidson

So with that supporting not just the utilities, but the Energy Services segment and what not as well, we should look for only a portion of that to eventually be moved into rate base. Is that a fair assumption?

Larry Borgard

The specific example I gave you with respect to the customer information systems is only for the regulated utilities and not for the non-reg. So that specific example we would expect a full rate recovery of.

Operator

The next question is from Faisel Khan from Citigroup.

Amit Marwaha - Citigroup

This is actually Amit, I'm calling on Faisel's behalf. Just a quick question on Slide 43. Just want to get a bit more color into what exactly is going on behind, I guess, that $6.5 million increase with respect to the retail margin business. Do you guys expect in terms of the nonregulated business next year in terms of expansion plans and so on?

Charlie Schrock

I could not quite hear the end of your question. Could you repeat that again please?

Amit Marwaha - Citigroup

Sure. On Page 43, I just wanted to get more color on Item A as well as the plans for the nonregulated side of the business in terms of expansion plans, if it's just a continuation of the expansion into the local market that you guys are engaged in?

Charlie Schrock

I'll have Dan address that. But Dan did have a good year last year as we mentioned earlier.

Dan Verbanac

As far as Slide 43, that $6.5 million is primarily made up of improved margins on the retail, electric, C&I side. From the documents that we put out there, both unit margin improvements on gas and power side, and going forward our plan is to continue to grow in that regions that we're in today, so more organic growth. There is significant opportunities in Illinois today. As Charlie mentioned in his comments, we participated in the aggregation programs in 2011 and look to continue to do that in 2012.

Amit Marwaha - Citigroup

Is it primarily Illinois now? Is your focus and how many customers do you think you can get potentially in the next couple of years?

Dan Verbanac

We look to grow organically in all the regions we're in, which is particularly the northeast quadrant of the U.S. on the C&I side of the business. Our focus in Illinois in 2012 has been more on the small customer segment, which has really opened up here in the last year. And we think that there is significant opportunity there in 2011. There was 20 communities that approved aggregation. And 2012, there is over 250 that have it on the ballot in March. And we plan to do that with the same risk profile and focus that we've done to date in our retail owned business.

Operator

The next question is from Maury May from Power Insights.

Maury May - Power Insights

Got a few questions this morning. First of all, you're projecting 4% to 6% earnings growth based upon 2011 results for the period 2013 to 2015. So if you take the midpoint of your 2012 guidance that indicates only a 3% increase year-over-year. So you're saying that the growth is going to be kind of back-end loaded in that period in the '13 to '15 period, I guess. Is that correct?

Charlie Schrock

Maury, that's a fair characterization. It really depends on the timing of rate cases and things like that. So it's going to be somewhat lumpy, but over the next few years, we'll be continuing with our rate case strategy.

Maury May - Power Insights

So where do you expect the growth to come from, the stronger growth in the '13 to '15 timeframe?

Charlie Schrock

There is a handful of components that contribute to it, Maury. For starters, with the rate cases and the continued capital investment, both in environmental projects and AMRP, that's going to drive up our utility earnings. Then, our retail operations at Integrys Energy Services is expected to continue to grow as well. So when you put it all together, we are estimating that by 2015, we'll have that 4% to 6% annual average.

Joe O'Leary

Don't forget that we've got bonus tax depreciation will be expiring, and that helps us with regard to that rate base growth as we continue to make those capital expenditures on those programs.

Maury May - Power Insights

Second question has to do with the gas ROEs. You're projecting that they're going from the 8% range up to the 9% range in 2012. What's the reason for that? You might have covered that, I missed it.

Charlie Schrock

I'll have, Larry address that.

Larry Borgard

Maury, we've kind of been on a path for the last three to four years to improve the financial performance of our regulated natural gas utilities. I think if you look at Slide 19, you can see the success that we've had, and really it's just a continuation of that, although as both Joe and Charlie mentioned, the shortfall is narrowing substantially.

Maury May - Power Insights

But specifically on the gas side, what is it that's improving your results?

Larry Borgard

Our operational excellence initiatives at all of our utilities primarily, coupled with the rate filings that we've made.

Maury May - Power Insights

Next question, you have invested in CNG refueling stations, and I just wanted to get your expectations for this business going forward.

Charlie Schrock

We're kind of excited about this opportunity, Maury, and Mark is here to talk about that. We were thinking the question might come up. So, Mark?

Mark Radtke

As Charlie said, we're excited about the compressed natural gas business of the market, seems to be very excited about it, lot of customer interest. That said it's an early stage of business for us. We acquired the Pinnacle and Trillium companies, we're bringing those together with the organic business plan that we had developed at Integrys.

So that's reshaping those companies and focusing them on building out public access infrastructure. That build-out requires some time. So when you're making initial investments and patience, they're under scale in terms of their overall volume. So we don't see immediate near-term contributions that are significant. We see it a little bit later in the life cycle of that business, once the customer volumes grow and our individual stations get up to scale.

Maury May - Power Insights

What have you invested in the business so far, and when do you think it might become profitable?

Charlie Schrock

We have invested a little bit north of $40 million in the acquisition of those two companies and then we're in the process of building some stations. So as of the end of the year, it's really the acquisition investment that sits on the balance sheet. In terms of when we see it being profitable, the businesses that we acquired were profitable when we acquired them. We are, as I said, reshaping them, and that could cause the entities to go or the enterprise to go slightly negative in the very near term. I consider it kind of negligible drifting around zero for a couple of years here, Maury, and then perhaps the things beginning to take off.

Maury May - Power Insights

So then it might be a contributor to the accelerated earnings growth in 2014 and '15?

Charlie Schrock

It helps on the backend of that timeframe.

Maury May - Power Insights

Final question, really has to do with, you're re-growing the Integrys Energy Services energy marketing. I guess both Dan and Mark are there. Mark you have a lot of institutional memory on what happened in that business in 2008 when the prices collapsed essentially and you ended up with a collateral requirement of some $2.6 billion over that terrible winter of '08-'09. If you keep growing this business and you continue to have growth success, what prevents you from running into another collateral problem with market volatility?

Charlie Schrock

Maury, let me start that and I'll have Dan and Mark chime in if you need to, but fundamentally we're on a different trajectory here. We have exited wholesale trading and we don't do any of that and that was really driving a lot of the collateral and the collateral support requirements that we had. So we don't do that anymore.

We're talking strictly retail and we're also managing our liquidity with credit facilities for both short-term and long-term to make sure we always have met plenty of liquidity. Then the last thing I'd say is as you know we have deliberately kind of put a box around it. We in order to manage our overall corporate risk profile, we're sizing it in a way that won't negatively impact our ratings. So we're really looking at it in a different way and managing it in a much different and much tighter way at this point in time.

Operator

(Operator Instructions) I'd now like to turn the call back over to Mr. Steve Eschbach for closing comments.

Steve Eschbach

Thank you. And thank you very much for putting aside your 2012 leap day celebrations for the past three quarters of an hour and being a part of our fourth quarter earnings conference call. A replay of this conference call will be available until May 1, 2012 by dialing toll free, 866-499-8681.

The full transcript for today's conference call will be available on our website at www.integrysgroup.com before the end of day on Tuesday March 6th. Just select Investors 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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