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Vectren (NYSE:VVC)

Q1 2012 Earnings Call

May 03, 2012 9:30 am ET

Executives

Robert L. Goocher - Vice President of Investor Relations and Treasurer

Carl L. Chapman - Chairman, Chief Executive Officer and President

Jerome A. Benkert - Chief Financial Officer, Executive Vice President, President of Vectren Shared Services and Director of VUHI

Analysts

Sarah Akers - Wells Fargo Securities, LLC, Research Division

Steven E. Lessans - Luminus Management, LLC

Operator

Good morning, ladies and gentlemen. My name is Martina, and I will be your conference operator today. At this time, I would like to welcome everyone to the Vectren First Quarter 2012 Earnings Call. [Operator Instructions]

I would now like to turn the call over to Robert Goocher, Treasurer and Vice President, Investor Relations. You may begin your conference.

Robert L. Goocher

Thank you, operator. Good morning, and thank all of you for joining us on the call to review our 2012 first quarter 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. Yesterday, we released our quarterly earnings, and this morning we filed our first quarter 10-Q. Copies of our earnings release, today's slide presentation and the 10-Q can all be found on our website.

As further described on Slide 2, I would like to remind you that many of the statements made on this call today will be forward-looking statements. Actual results may differ materially from those discussed in this presentation. Carl Chapman, Vectren's Chairman, President and CEO, will provide comments on the quarter and review our 2012 earnings guidance before opening it up for questions. Also joining us on today's call are Jerry Benkert, Executive Vice President and CFO; and Ron Christian, Executive Vice President and Chief Legal and External Affairs Officer. With that, I'll turn it over to Carl.

Carl L. Chapman

Thanks, Robert. I'd also like to welcome everyone to today's call. As always, we really appreciate you joining us.

Turning to Slides 3 and 4, the key message here is that overall, first quarter consolidated results continued to meet our expectations and support our 2012 consolidated guidance of $1.75 to $1.95 per share, which we affirmed in our earnings release last night. Reported consolidated net income for the first quarter was $51.3 million, or $0.63 per share, compared to net income of $44.6 million, or $0.55 per share, in 2011.

Our Utility earnings were the remain contributor to the successful quarter and we're driven by higher electric margins, primarily related to new rates implemented in May 2011, and lower operating expenses and interest expense. Increased margins were partially offset by weather impacts from the extremely mild winter, which primarily impacted our electric utility. Weather impacts on our gas utilities were minimal due to rate design and other regulatory mechanisms.

As we review comparative quarter-over-quarter earnings for our Nonutility group, let me remind you that results for the first quarter of 2011 include earnings from Vectren Source, our former retail gas marketing affiliate, which was sold at the end of December 2011. Seasonal earnings from Source in the first quarter of 2011 were $7.1 million, although full year results for Source were $2.8 million.

Setting aside Source's earnings in 2011, Vectren's 2012 Nonutility results for the first quarter increased compared to the first quarter of 2011, reflecting a very strong contribution from our Infrastructure Services group, partially offset by lower contributions from our Coal Mining group, which I'll describe further in a few minutes.

On Slide 5, Utility earnings were $56.0 million, or $0.69 per share, in 2012 compared to $48.6 million, or $0.59 per share, in 2011. Retail electric margins across all customer classes increased $6.5 million, and primarily reflected an increase from new base rates effective May 3, 2011. These increases were partially offset by the impacts to the unusually mild winter weather, which reduced electric margins from small customers by about $3.4 million year-over-year.

On the gas side of the business, the mild heating season caused a decrease in gas volumes, but I'm pleased to report that the rate design in regulatory mechanisms we worked hard to implement in our Indiana and Ohio service territories did a nice job of minimizing bottom line impacts for our gas businesses.

As we expect to see throughout 2012, utility interest expense for the quarter was down significantly from the prior year, decreasing by $2.7 million, mostly due to the long-term debt refinancing that took place in 2011. Given the nice start in 2012 for our Utility businesses, we expect our 2012 Utility results to continue to be in line with our 2012 Utility EPS guidance of $1.60 to $1.70 per share.

Turning to Slide 6, where we begin a review of our Nonutility businesses, we are affirming 2012 EPS guidance of $0.30 to $0.40 per share for our Nonutility group, excluding ProLiance. Note, however, that our expectations regarding the mix of businesses' earnings contributions for the year have changed. This change in the mix of expected earnings is due in part to the significantly differing impacts of the extremely mild weather in the first quarter on our Infrastructure Services and Coal Mining businesses, which I'll discuss in more detail later.

Accordingly, you'll see in the appendix that we have provided updated expected 2012 results and metrics for Infrastructure Services, Energy Services and our Coal Mining businesses.

Starting with our Infrastructure Services segment. First quarter earnings were $3.0 million, compared to a 2011 loss of $2.9 million. First quarter losses in the Infrastructure businesses are common given the impact of typical winter weather. However, the $5.9 million turnaround this quarter is partially attributable to the favorable construction environment created by the mild winter weather. The weather allowed cruise to begin projects 1 to 2 months earlier than normal and customers were willing to take advantage of the opportunity to get started early.

Also contributing to the strong quarter is the March 31, 2011 acquisition of Minnesota Limited. Looking ahead to the remainder of 2012, we expect the year to be very strong as utilities and pipeline operators continued to allocate dollars to construction work. As a result, we now expect our Infrastructure Services segment to contribute approximately $20 million to earnings in 2012, which if achieved would represent an increase of $5 million over a very strong earnings level in 2011 and a nearly $17 million increase from the results just 2 years ago in calendar 2010.

Moving to Slide 7. First quarter results from Vectren Energy Services, our performance contracting and renewable energy services business, totaled a loss of $1.7 million, compared to a $1.4 million loss in 2011. The greater loss is attributable to the continued strategy of investing in additional personnel to help facilitate what we believe will be very strong long-term earnings growth.

For full year 2012, we now expect Energy Services to contribute approximately $3 million to earnings as the timing of recognizing certain renewable energy projects, tax credits and earnings has changed, and due to a slowdown that the industry is seeing in new performance contracting projects. Although the industry slow down and our hiring plans for key personnel through 2014 will temper results in the near term, long term we remain confident in the growth opportunities for this business. We believe that in the future, energy efficiency and response to rising electric prices and focused renewable energy markets will provide excellent growth opportunities.

Moving on to Slide 8, our Coal Mining operations saw a first quarter loss of $300,000, compared to earnings of $1.6 million in 2011's first quarter. The quarter was impacted by the widespread mild winter weather, which hurt sales. As a result, utility customers' coal burn fell, inventories grew, and they deferred to reduce takes within contract limits, as well as delayed decision making on term contracts. Opportunities for spot sales were also reduced.

In addition, our total cost per ton was higher than expected in the first quarter. At Prosperity, thin coal seams and additional roof bolting caused to increase cost per ton well above plan in prior year. However, we did see continued strong operational performance at our Oaktown 1 mine, with cost per ton at plan and substantially better than first quarter 2011.

Overall, cost per ton at both mines would have been even better had we not slowed production to better match the current market demand. As a result of first quarter results and current demand uncertainty, we are lowering our midpoint of expected 2012 Coal Mining earnings to approximately $6 million. We now expect to produce and sell 5.6 million tons in 2012 at a margin of approximately $3.50 per ton.

Our margin per ton estimate assumes a full-year cost per ton of approximately $43.50, which we believe can be achieved through cost improvement initiatives at our Prosperity mine and even better productivity at our Oaktown 1 mine. For example, we're in the process of switching to lower-profile mining equipment in our Prosperity mine in order to reduce the amount of rock mined along with coal, which should increase mining efficiency. We're also working with MSHA and other roof control specialists to modify the roof control plan, which, if approved, will help lower future cost associated with roof bolting while maintaining our high safety standards.

Additionally, our revised estimate of coal earnings assumed taxes at near 0 based on the lower sales margin levels and tax depletion. Looking forward, we currently have 70% of our expected 2012 production and 40% of 2013 production sold, and we now anticipate opening our second Oaktown mine in the fourth quarter of 2012. While we had liked this commitments to be higher, we also continue to be confident in the long-term demand outlook for Illinois Basin coal and believe the delays in committing to future coal purchases are directly related to the current high inventory levels of customers and prospective customers.

As Central Appalachian coal production continues to decline and as scrubbers continue to be installed, we believe our Indiana coal mines are well positioned to capture additional sales as market demand recovers.

On Slide 9, you'll see the ProLiance first quarter results were a loss of $5.9 million versus a loss of $7.5 million over the same period in 2011. As expected, the improvement is primarily the result of approximately $4 million of lower fixed-demand costs in the first quarter of 2012 compared to 2011. Also, ProLiance has seen seasonal spreads improve somewhat since the beginning of the year, and in some cases has executed hedges to lock in spread opportunities.

Just for example, if you take a look at the winter/summer strip spreads at the end of March in 2011 versus 2012, they've increased from approximately $0.50 per decatherm to $0.80 per decatherm. So as the spreads widen a bit, ProLiance is focused on those opportunities in order to lock in value for its storage capacity for the year.

For 2012, though, the decrease in fixed-demand costs of approximately $18 million compared to 2011 remains the foundation for the expected year-over-year improvement, and we're maintaining our 2012 EPS guidance for ProLiance at a loss in the range of $0.10 to $0.20 per share.

Turning to Slide 10. As I mentioned earlier, we are affirming our 2012 earnings guidance of $1.75 to $1.95 per share. Excluding the expected ProLiance loss, our guidance midpoint remains at $2 per share for 2012. We continue to expect that utility operations will demonstrate strong earnings growth for the year, with earnings in a range of $1.60 to $1.70 per share. Our Nonutility portfolio, excluding the results from ProLiance, is still projected to contribute earnings in the range of $0.30 to $0.40 per share, led by continued strong results from Infrastructure Services.

With that, I'd like to close by saying that we look forward to seeing those of you who will be attending the AGA Financial Conference next week. Operator, that concludes our prepared remarks, and we are now ready for questions.

Question-and-Answer Session

Operator

[Operator Instructions] Your first question comes from the line of Sarah Akers from Wells Fargo.

Sarah Akers - Wells Fargo Securities, LLC, Research Division

You mentioned on the call that parties are kind of delaying the contract negotiations, but are you seeing anyone push back on the current contracts beyond just the flexibility that's built in? Is anyone kind of coming to the table wanting to renegotiate?

Jerome A. Benkert

Sarah, this is Jerry. It's a good question, but, no, we do not have that going on. So we have had some take advantage of the flexibility in the contracts, but, certainly, they've been standing behind the contracts and those continue forward this year.

Sarah Akers - Wells Fargo Securities, LLC, Research Division

Great. And then on Infrastructure Services, we know there is opportunities related to the shale basins. Can you comment on kind of where you are in that process? Do you expect in 2012 to be up and running in the shales? Or is there a ramp process where that represents kind of more future growth?

Carl L. Chapman

Sarah, we are pretty early in our opportunities on shale in the Marcellus because Miller was already active there. As we move the transmission of that over to Minnesota, we do have some contracts in the Marcellus. The Bakken is now just getting under way for us. So we see really nice opportunities in both of those going forward, but we don't have significant earnings in the first quarter related to the shale. But, again, those companies now are really starting to be much more aggressive in taking advantage of that. And, of course, Miller also will, with its exposure in the past, and now with that whole transmission operation under Minnesota, right there by Marcellus is now the Utica, that also should start to create opportunities fairly soon.

Operator

Your next question comes from the line of Steven Lessans from Luminus Management.

Steven E. Lessans - Luminus Management, LLC

With the Miller and the Minnesota Limited acquisition, how much of the strength in that business this quarter was weather related, and kind of how should we think about a run rate for that next year?

Carl L. Chapman

Well, I think it's fair to say that, as we described, a lot of it is weather related. Typically, we would expect that quarter would often have a loss, given where our territories are. So it is heavily impacted by weather. But on the other hand, we think the opportunities for the year are still very strong. So for the year, we're comfortable in raising our guidance on that part of the business or in that part of our guidance. But in terms of future years, we would expect that the first quarter is typically a loss quarter for that business.

Steven E. Lessans - Luminus Management, LLC

So if I were to think about kind of 2013 normalized, I mean, considering how much weather impacted the first quarter, how much lower would that be?

Carl L. Chapman

I don't think we're prepared to give it a number like that for '13 at this point, but what I would say is that even though we might see a drop in the first quarter in the future because of weather, we still have -- believe strongly that we'll have additional contracts. So, it's not so much that weather is going to certainly impact the quarter, but we also believe we'll see growth in the business. As we responded to Sarah earlier, there really isn't a lot of shale activity yet, an example, and of course, the rules related to San Bruno that came out from the federal government have not yet even fully interpreted. So we still think, very nice growth opportunities, but we're not prepared to give guidance for '13 at this point for that business.

Steven E. Lessans - Luminus Management, LLC

Okay. Then on the Energy Services side, maybe I missed this with the first question, but what's causing a weakness there?

Jerome A. Benkert

Steven, on the Energy Services side, what we did there with that problem, which we talked about in the news release with some of their projects around the newer and actually some farms in Wisconsin, so they do have some renewable work going. On the performance contracting side, let's say, it's just an overall industry slowdown, we're seeing it, not just at ESG, but wider than that. And to some extent, though, they're projects, and when you think about the projects being driven by efficiencies, that will generate the savings that end up paying for the capital project, which helps, say, a school or university or otherwise make an investment. On the other hand, sort of politically, and the environment we're in currently, schools are cutting back on teachers and budgets are tight, and it's almost just sort of a political perception issue that makes it hard for contracts to be signed. So there's somewhat a slowdown that we don't think is long term in nature, but currently is apparent. That's going on as well as, as you know, because of our faith and confidence in sort of the long-term outlook for this business, we're continuing to invest in sales -- in the sales force and continuing to ramp up our efforts for future growth. So that has an additional cost that's an impact currently.

Steven E. Lessans - Luminus Management, LLC

Okay. Shifting if I may to the coal side of things. The fourth quarter call, you were thinking about 6 million tons this year of sales and you were 75% sold. And now we're talking about 5.6 million tons at 70%, so lower sales but also a lower contracted amount, what's happening there? And how should we think about 2013, considering that the contracted amount hasn't changed there?

Jerome A. Benkert

Yes, on the 75%, 70%, I just tend to say, we're at about the same level we were then. And as we sort of responded to the earlier calls so far this year, against the contracted sales that we would have spoke about last quarter, the only thing that's going on is the exercise of some flexibility within the contracts and that flexibility is fairly limited. But so, 2012 sales have come down some on contracts we are already added in place only because they're exercising some of that flexibility. As we look towards 2013, again, and the remainder of 2012, this is our conversation or the point that we're making was all around the extremely wild weather that took place, allowing some delay in signing contracts. And we just are not in a position where we're going to announce contracts that we think are close or negotiations and timing around negotiations. But I don't want you also to think that we aren't actively negotiating with multiple other parties on the outside because we are and we do have some faith sort of in the statement that we think there is a slowdown or delay in timing. So when we get this cut-off, this teleconference we just didn't have new announcements in regard to 2013.

Steven E. Lessans - Luminus Management, LLC

So those contracts had been flexed down to the minimums. Those are not being shifted into 2013, is that the right way to be looking at it?

Jerome A. Benkert

Well, I wouldn't -- I'd say we might have some flex down and some delay on take also. But it hasn't been -- in either case, it hasn't been all that significant.

Steven E. Lessans - Luminus Management, LLC

Just back to 2012, when you say 70% contracted, what is the pricing on that?

Jerome A. Benkert

We just haven't -- we have not given specific pricing. Now, we do have detail in the slides around the metrics. And so if you look deeper in the deck of slides, just sort of flipping back around Coal Mining itself, what we give are the estimates of the price per ton for the quarter at $50 and for the remainder of the year 2012 at a blended price of $47.

Steven E. Lessans - Luminus Management, LLC

Right, what I'm trying to figure out is if you're thinking $47 a ton for the year. When I look at the market out there for 2013, the high sulfur product on the river is trading low 40s right now. You're not at the river, so I'm trying to understand, I guess, where you're priced?

Carl L. Chapman

Well, what we had described in the past is that, of course, we did have some reopeners, so we have some coals still that has some reopeners on it and I would say also though that it's very difficult to determine what the price is right now. It really is down to a negotiation, because there isn't really much coal being contracted right now so when you see someone quoting a price on the river right at the moment, there really isn't much coal being contracted. The driver of the price for 2013, and we're just not prepared to give you prices today, but the driver of the pricing for 2013 is going to be heavily impacted, obviously, first by weather this summer, which will have a big impact on the coal piles at our customers, also by gas costs this year and then predictions in the next year. So I think we're not prepared to give those prices today and I would just say that, unfortunately, there are not a lot of great benchmarks -- public benchmarks right at the moment because of not a lot of coal being transacted. So we are in discussions with customers and as we know more, we'll obviously share that on future calls.

Operator

There are no further questions in queue. I'll turn the call back to the presenters for closing remarks.

Carl L. Chapman

Thank you, operator. We'd like to thank everyone for joining us on our call today. 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 the day. Thanks again for your participation.

Operator

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

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