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Vectren Corporation (NYSE:VVC)

Q1 FY08 Earnings Call

May 01, 2008, 02:00 PM ET

Executives

Steven M. Schein - VP, IR

Jerome A. Benkert, Jr. - EVP and CFO

Carl L. Chapman - President and COO

Niel C. Ellerbrook - Chairman and CEO

Analysts

Paul Patterson - Glenrock Associates

Barry Klein - Citigroup

Brooke Glenn Mullin - J.P. Morgan

Operator

Good afternoon. My name is Sheila, and I'll be your conference operator today. At this time, I would like to welcome everyone to the Vectren's First Quarter 2008 Earnings Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session. [Operator Instructions].

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

Steven M. Schein - Vice President, Investor Relations

Thank you, and good afternoon to everyone. On behalf of Vectren, we welcome you to our first quarter 2008 earnings call. This call is being webcast and accompanying slides are available on our website at vectren.com.

We would like to remind you that certain statements made on this call will be forward-looking statements. They are subject to risks and uncertainties that could cause actual results to differ materially from those discussed in this presentation. I would encourage you to refer to our Form 10-K filed on February and also to forward-looking statements we have in our news release.

Members of our senior management team present today include Niel Ellerbrook, our Chairman and CEO; Carl Chapman our CEO; Jerry Benkert, our CFO; and Ron Christian, General Counsel and Secretary. We’d welcome questions at the end of our prepared comments.

With that, I will turn it over to Jerry to begin.

Jerome A. Benkert, Jr. - Executive Vice President and Chief Financial Officer

Thanks, Steve. Good afternoon and welcome. We have only a few slides to cover today, and then we’d be happy to take questions. And for a number of you on the call, we will probably see you shortly at AGA beginning this weekend. I'm planning on covering only overall results briefly beginning with slide number three.

We were very pleased with utility results overall at $58 million and a $0.09 per share increase over last year. Since the first quarter of 2007, we've completed three rate cases in four of our jurisdictions and those rate cases have all contributed too and helped our results. The most recent case was the Vectren North order at our largest gas territory where our settlement was approved unchanged by the Indiana Commission on February 13. This order positions us to better earn our authorized return to pursue a multi-year bare steel/cast iron replacement program and to continue to promote conservation and efficiency programs. With our strong first quarter results, including great results on Wholesale Power Marketing sales and with this last rate case determined now, we find that we're able to raise our Utility guidance on the year by about $0.10. Niel will speak through guidance in just a few moments.

On the Nonutility side, operations contributed $6.3 million to the quarter. The year-over-year decline of our Nonutility results was driven largely by lower storage optimization of ProLiance, given less volatility in the gas markets recently. While I think the news on lower recent volatility has been out and discussed somewhat including by others with gas marketing operations, the recent and somewhat unusual market out of high gas cost and lower volatility has been challenging for ProLiance.

Coal Mining results also declined quarter-over-quarter and while we have in place higher pricing this year in our 2008 contracts, changing safety guidelines have impacted cost and production unfavorably as well as other cost increases such as diesel fuel. I don't think our mining operations are alone here either like across industry both cost and pricing are on the rise. Carl will cover the quarter and the outlook for each of these businesses in more detail.

So for 2008, we have not… have lowered Nonutility guidance by about $0.20 and as an assumption underlying that, we have based the guidance on lower volatility for ProLiance and higher costs for Coal Mining continuing in 2008. And while we may not cover it in any great detail, Vectren Source, our retail marketer had a nice quarter and we continue to expect a substantial contribution to Nonutility earnings from our infrastructure businesses.

Please turn to slide four. You see on this table, which reconciles Utility results EPS for the quarter, that weather was a small increase, roughly $0.01, driven by electric and Ohio. And weather is not going to be all that significant for us since 75% of our gas margins are weather normalized. Wholesale Power Marketing, which I mentioned earlier, was up $0.02 and the really significant item was coming from those regulatory strategies. Both the rate cases and decoupling contributed $0.08 net of the cost increases that were anticipated in the rate cases. So those were the significant drivers on the Utility side. I’d also note that O&M costs did increase by about $6.8 million. $2.1 million of that reflects items that are directly passed through and tracked, and the other $5 million or so including some rate case related spending and amortization were contemplated in the rate cases.

We've got last note on this slide just about the second quarter, and I would make a comment or two about guidance just for a moment on the Utility side. We really did have great results in the quarter and quarter-on-quarter on the Utility business. In this case, no… none of these rate cases were in place same quarter a year ago. And we have raised our projection on the year. But having said that, we are continuing to ramp up to some extent our spending on maintenance and reliability programs and the second quarter itself is not a large revenue quarter for the Utility business. So putting those pieces together, I guess what I’d say is we would expect the second quarter to be relatively similar to the same quarter a year ago on the Utility side.

Turning to slide five then for the Nonutility operations, I'll make quick comments here because Carl is going to going to be go into more depth for… on Energy Marketing and Coal Mining, but you can see the reductions there at $0.09 and $0.03. Relative to the Energy Infrastructure Services business, while it shows down $0.02 quarter-over-quarter, I think we view that more than anything as timing as contracts that have been awarded, but not yet released are very strong and so we think there is a good pipeline for the remainder of the year.

And then lastly, just a quick comment around guidance for the Nonutility business also. As we look forward to the second quarter, I would add that… no first I’d make a comment, we have lowered guidance on the year. So that's into projection. The second quarter itself though, we had some visibility, not all, but some visibility around ProLiance earnings. And I guess I would make the comment that quarter-over-quarter we'd expect some of that reduction in guidance to indeed land in the second quarter itself.

With that, Carl?

Carl L. Chapman - President and Chief Operating Officer

Thanks, Jerry. And on the next two slides, as Jerry mentioned, we'll discuss the revised guidance for both Energy Marketing Services and Coal Mining and as well as the reasons why those revisions are necessary, and more importantly perhaps our thoughts on longer-term earnings drivers. The detailed metrics are also provided again this quarter, and for all of Nonutility those are on slides 11 to 12 in the appendix for your reference.

Turning to slide six, we now expect Energy Marketing and Services net income in the range of $12.5 million to $17.5 million. And with 80% plus of ProLiance earnings coming from asset optimization opportunities, particularly storage, lower volatility drove both last summer to winter and cash to NYMEX spreads. And although prices are high, which would normally cause greater volatility, some key issues like the highest storage withdrawals in the last five years with resulting limited gas from gas competition, very low LNG shipments and overall industry trading apparently being driven more by oil prices than the fundamentals of the North American gas market have caused these lesser optimization opportunities. However, longer-term we continue to believe gas storage will have strong optimization opportunities. [inaudible] concerns will result in new power sector demand. LNG, which is more volatile than the North American market typically, should grow and cause greater volatility. And fundamentals suggest higher prices, which as I said early would generally result in greater volatility.

Further, specifically for ProLiance, additional storage contracts including 7 bcf by the end of the year should continue to provide nice opportunity. Our transport contracts allow arbitrage across multiple basins, which give us again additional opportunities. And we're also… we think we’re positioned well with flexible assets to take advantage of what the market provides in the next few months. And while much of 2008 still remains, given current market conditions we decided to lower guidance for ProLiance, but we’re still hopeful there will be some upside opportunities, particularly in the fourth quarter.

Turning to slide seven, as we look at Coal Mining, we think that those earnings now should be in the range of $2 million to $4 million, and again some detailed metrics provided for you on the makeup of that in the appendix. The first quarter results, as Jerry mentioned, were a loss primarily due to the changing MSHA guidelines related to roof control at our underground mine, Prosperity, and the higher diesel fuel cost at our surface mine, Cypress Creek. We've taken significant actions at Prosperity to increase productivity, and the productivity itself was greatly affected by roof guidelines as well as cost, and again this productivity should help us to lower our unit cost.

I'm happy to say that the April tonnage has increased 55,000 tons from the March tonnage of 160,000, and we think another 20,000 plus tons per month should be achievable. We will accomplish that because we’ve now completed the moving of the one working section and another move of another working section is yet to come into better conditions, and we think that has and will continue to provide increased productivity. We've installed new technology to improve the efficiency on two of the sections and we have another two additional installations yet to come. Again, both of these… the first two working well and the next two we would think and work similarly to help us with that productivity. In addition, lower cost roof plans and we’ve developed those with industry experts, frankly worldwide industry experts, have now been presented to [inaudible] and we're very hopeful of approval shortly.

Longer-term, 2009 Illinois Basin, market prices have increased substantially and the key to that is really the less than 20% of our planned production for 2009 is currently priced. That production does include about 1.5 million tons from Oaktown in 2009, as that first mine ramps up through ten and of course the second mine added shortly there after. And work on Oaktown, I'm happy to say, is progressing well with first production still scheduled for late Q1 '09.

And with that, I think Neil will summarize and have some closing comments.

Niel C. Ellerbrook - Chairman and Chief Executive Officer

Page eight summarizes the guidance that Jerry and Carl have described, Utility up a dime and the Nonutility group down 20, primarily Energy Marketing and Services, but also some decline in coal. Let me also reemphasize what Jerry talked about. In the second quarter, the utility we would expect to be roughly in the same range we were in '07 in the second quarter, as increased maintenance and reliability expenditures are likely to offset the increased revenues that the rate cases will produce. We expect lesser ProLiance earnings for the reasons already described, lower market volatility. So, all in all, the second quarter is probably likely to look somewhat like it did a year ago.

Let's move on to the final slide for some wrap-up comments. We remain very optimistic about the business overall. The South Electric and Gas rates implemented in August of 2007 and the new North Gas rates implemented in February of 2008 provide increased and more secure revenues. And at the same time, they allowed us to implement some processes and programs that provide better bill management for our customers. The decoupled tariffs and the trackers, particularly the uncollectible trackers that we’re going to have now in the gas business in both Indiana and Ohio, have helped us stabilize earnings and I think put us in pretty good shape as the entire industry is steering at much higher commodity cost this coming winter.

This last Wednesday, the Public Utilities Commission of Ohio approved an order that provides the first steps for us to exit the merchant function in Ohio. We think this is important. Certainly, it's another step in the process of trying to de-risk the utility business overall and certainly we’ll do so in Ohio. And at the same time, I think it's a surprise. This will ultimately result in more choices for customers in Ohio. So we think that customers are going to benefit as well.

We remain very confident and optimistic about our Nonutility portfolio, all of the three major segments; Energy Marketing and Services, Coal and Infrastructure remained fundamentally sound and we think we have continuing opportunities in all three. Coal production up, expense is starting to come under control, price increases as Carl described. We still have a strong balance sheet and we think that that's particularly important in these times as working capital requirement is almost certain to increase in the wake of the higher commodity prices.

And as a reminder, we continue to be very proud of our superior record of dividend growth, 48 consecutive years. Our yield of 4.6% compares very favorably to the peer group we watch, which is about 4.3% and the gas-only group of about 4.0%. So things are still looking very good for us and we are optimistic as we continue through the year.

With that, let me stop and we'd be happy to respond to any the questions.

Question and Answer

Operator

[Operator Instructions]. Your first question comes from the line of Paul Patterson of Glenrock Associates.

Paul Patterson - Glenrock Associates

Good afternoon.

Niel C. Ellerbrook - Chairman and Chief Executive Officer

Good afternoon, Paul.

Paul Patterson - Glenrock Associates

A couple of things. With respect to the Energy Marketing and Services, the market conditions that you're talking about, when do you expect them to change? I mean I see difference in the quarter, but it looks like… I guess that you guys are expecting still some of the... these market conditions to continue into the second quarter, is that right?

Niel C. Ellerbrook - Chairman and Chief Executive Officer

Yes, Carl, why don't you pick on it.

Carl L. Chapman - President and Chief Operating Officer

Yes. Paul, Of course, for all practical purposes other than some June… April and May, of course April is done but May was set up some time ago and so we did see these conditions continue in April and then for May and June as well. Having said that, there still may well be cash to NYMEX opportunities open up. We have not counted on very much, but there isn't any reason why that could not occur. So we anticipate this point that it stays where it is and we will just see how that unfolds.

Paul Patterson - Glenrock Associates

Okay. You say LNG summer deliveries are expected to grow to meet rising gas demand and creating storage opportunities. What kind of expectation do you have in terms of what LNG is going to do during the summer?

Carl L. Chapman - President and Chief Operating Officer

Well, for this summer again, we have not contemplated very much. Again we think LNG, the way we see it’s still likely to be lower, but longer-term we still believe LNG is part of the solution to gas supply for the U.S. and I think that in the summer we're still likely to be a place that gas has dropped off with more storage opportunities in the U.S. than in Europe or Asia. So, we continue to think longer-term that's the way that will work. We have not counted on very much LNG at all for 2008.

Paul Patterson - Glenrock Associates

Okay, got you. Then the MSHA, the guidelines of the Coal Mining business, when was the notification in terms of these guidelines, when did that first come out?

Carl L. Chapman - President and Chief Operating Officer

Well, of course last year we shared with you that there was a focus on seals and that happened mid to late... or mid to… well, I’ll just say mid-year last year. The roof issues really started occurring well into the first quarter. And so, as an example what we've been… described to us is a much different tolerant situation for what might be described as more typical in the Illinois Basin, so typical roof falls have really taken a very different view of that and requiring more and more roofing cost to be incurred. And that's when we've then went added… hired some outside expertise to help us identify roofing plans that can meet their requirements of MSHA, but hopefully at a lesser cost than we are experiencing right now.

Paul Patterson - Glenrock Associates

Okay. So then… I guess when we’re looking at the MSHA… I mean they can… in other words they just changed things in the first quarter and said you're going to have to… the issued guidelines is that basically you have to shore up the roof more? I mean is that basically… I mean they did that and then you have to respond… they don’t give you any lead-time at all on them?

Carl L. Chapman - President and Chief Operating Officer

That's really correct. You don’t get lead-time. Of course, what we were dealing with here and is completely understandable and on the part of the MSHA inspectors is given some of the situations that occurred in West Virginia and the Utah. I just think they were being much more cautious. And yes, it is up to them to interpret those guidelines. And so they certainly did change that well into the first quarter as I described, but again I think it's due to some of the conditions in the other mines that had happened.

Niel C. Ellerbrook - Chairman and Chief Executive Officer

Carl, you might talk a little bit just about what we normally see in terms of MSHA inspectors on site, just a little bit about that process.

Carl L. Chapman - President and Chief Operating Officer

Yes, I think historically if we would not have had much more than, say, an Inspector or maybe two at a time in the mine… we’ve had as many as eight or nine inspectors in our mine at a single time. Again, we don't expect that to occur for a very long time, but there is no question that diligence has been stepped up. And the one thing we’d want to say for sure is with or without MSHA inspectors we want a safe mine. So we intend to have a safe mine. It's just that as you described, they have changed some of the guidelines and the scrutiny is much more substantial right at this moment.

Paul Patterson - Glenrock Associates

Okay. Thanks a lot.

Carl L. Chapman - President and Chief Operating Officer

And also, I don't think that's unique to us in the Illinois Basin. We're well aware of other mines in the area that are experiencing some of the some inspections.

Paul Patterson - Glenrock Associates

Okay. I appreciate it.

Operator

[Operator Instructions]. Your next question comes from the line of Faisel Khan of Citigroup.

Barry Klein - Citigroup

It is actually Barry Klein at Citigroup. I was wondering about the year-on-year impact of consumption declines at the Utility?

Niel C. Ellerbrook - Chairman and Chief Executive Officer

Jerry, why don't you talk about that,

Jerome A. Benkert, Jr. - Executive Vice President and Chief Financial Officer

Actually, Barry, we’re… I think for the most part if you were just to ask questions around the economy or usage and sales and things like that, we are holding up pretty well. And so, we've built into the guidance a small decline in industrial sales, but as it relates specifically to consumption decline just generally in overall residential commercial, that's what Niel commented again, just sort of a reminder that we’ve got decoupling in each of our territories. So those gas consumption reductions to the extent they exist were covered for. And as we look out towards the next winter where we see higher gas prices for our utility and others, we think that will maybe even be more of a differentiating factor that we have less of that risk.

Barry Klein - Citigroup

So, if… based on our prices you shouldn't get... if prices rise, you shouldn't get hit too hard, and the… you still don't have the weather normalization in Ohio, correct?

Jerome A. Benkert, Jr. - Executive Vice President and Chief Financial Officer

That's right, yes. Just to confirm your first statement, as prices rise we should still recover them… the margins that we're seeing up in the last rate cases. And we do not have the weather norm... I'm sorry, temperature normalization in Ohio yet. That's part of that rate case, which we hope we'll have resolved towards fall of this year.

Niel C. Ellerbrook - Chairman and Chief Executive Officer

And in saying that you hope that in Ohio they do approve weather normalized tariffs.

Jerome A. Benkert, Jr. - Executive Vice President and Chief Financial Officer

That's right. Either that's approved as a mechanism or as part of decoupling or other rate design mechanics.

Barry Klein - Citigroup

Okay. You were talking about O&M increasing $7 million, $2 million of it being pass-through and $5 million of it being from rate case spending. So, without those two items, basically O&M was flat. Do you expect flat O&M going forward or… and do you expect to get the… that $7 million... should we be able to see a reduction of $7 million in O&M the following quarter or will it be followed up by some other additions?

Jerome A. Benkert, Jr. - Executive Vice President and Chief Financial Officer

It will probably continue to grow a bit because this is a new and continuing level of O&M spend if you will. In some cases, that may simply be amortization of a cost that was agreed to in the rate case. So that could be passed via [inaudible] dollars being passed through as an example or other cost, rate case expense spread over a number of years. But another example is… and what we’ve said over time is, we think we have been successful in building into these cases an adequate level of cost to run the business well and to step-up reliability and maintenance programs to the level where they need to be and also ageing workforce type programs. So many of these costs are built into the rate cases themselves. I suspect that outside of those cost for the reminder of the year that O&M increases will be very small as you suggest.

Barry Klein - Citigroup

Got you. With regard to the Coal Mining division, how much of the safety cost… the additional safety regulation cost will go away? How much of the additional cost in the loss this quarter were from... how much was it from the loss of projection versus the safety cost… versus the additional moving [ph] and all the other stuff just from shutting down the mines, how much of that... how much was related to that?

Carl L. Chapman - President and Chief Operating Officer

Well, if you... first of all, in terms of continued cost, again what I described was we are in discussions or have presented to MSHA revised plan to lower some of that cost for going forward. We are also are in discussions with our customers on how much of those safety changes can be passed through. And just because we are in discussions, we are not really quoting $1 per ton per se until we really have further dialog with our customers. So we continue to try to recover some from them and also try to lower the cost themselves. In terms of productivity, if… in the metrics we show that we basically produced about 900,000 tons and I think we've lowered our production by about 200,000 tons. In our guidance… our midpoint guidance we’ve lowered it 200,000 tons to 300,000 tons for the year, I believe from our last guidance since that’ll give you some sense on the productivity.

Barry Klein - Citigroup

Got you. You were mentioned 20% of the… of your coal capacity for 2009 was sold. Was any sold for 2010 or 2011? And also, do you try to typically sell all the… all your capacity before the year starts or do you sell some on the spot or how does that work?

Carl L. Chapman - President and Chief Operating Officer

Recall, of course that the real linkage here is into our utility business and our own utility has about 3 million tons. So that's our starting point, but actually none of our coal... we have the same amount, 20%, for 2010 is priced… beyond 2010 we don't have any coal that's priced. But again, what we normally would like to do is by the end of the year we typically would like to be pretty well sold out. We don't see this as a merchant operation. We see it as providing coal to our utility and then to other utilities in the area and are not looking for a lot of merchant upside but more have a sense of what the coal price is going to be and know where we are. As we get a little further along with Oaktown, we will approach the Consumer Counselor and reach an agreement on the pricing of coal for our utility and then will continue discussions as we have them ongoing now with other utilities in the area for the rest of the coal.

Barry Klein - Citigroup

Okay, how long are the contracts typically?

Carl L. Chapman - President and Chief Operating Officer

I would say the typical contract is two to three years and then there may be a five-year or six-year contract that’ll have a price reopener either after two or three years.

Barry Klein - Citigroup

And the contracts with the utility are also in that two to three-year range or they’re renewed every year?

Carl L. Chapman - President and Chief Operating Officer

No, they have generally been in a two or three-year time frame, I would say, early on before cost escalations of... even overlook, let's say, the last three or four years, we might have gone with the longer contract to the utility, but we think it’s prudent at this point for the shorter period of time.

Barry Klein - Citigroup

Okay, thanks a lot.

Operator

[Operator Instructions]. Your next question comes from the line of Brooke Glenn Mullin of J.P. Morgan. Your line is open.

Niel C. Ellerbrook - Chairman and Chief Executive Officer

Good afternoon, Brooke.

Brooke Glenn Mullin - J.P. Morgan

Can you hear me now?

Niel C. Ellerbrook - Chairman and Chief Executive Officer

Yes, we can hear you now.

Brooke Glenn Mullin - J.P. Morgan

Great, thanks. Could you just quickly kind of walk through the consents of the utility, what the change in the assumptions are there? Is that a matter… is part of that just getting the rate case earlier than expected or if you could just kind of walk us through that that would be great?

Carl L. Chapman - President and Chief Operating Officer

The rate case, I think initially in guidance we might have expected at the end of the first quarter, that would have been more similar to 90-days period. So it's very helpful to us to pick it up earlier in that quarter as you suggested. And then, Wholesale Power Marketing, [inaudible] commented on for the additional $2 million there, and we may have higher sales there as the year goes on also. But timing did help us in the first quarter. I think the guidance piece also… I guess I would also say relative to the guidance that the outcome of the rate case we were pretty satisfied with, probably met our expectations, but guidance initially might have been just a little bit more conservative than that.

Brooke Glenn Mullin - J.P. Morgan

Okay. Great, thank you.

Operator

Mr. Schein, you have no further question. Do you have any closing remarks?

Steven M. Schein - Vice President, Investor Relations

Yes, thank you. First of all, I would like to thank you everybody for participating with us on the call today, and we look forward to talking to you in the future. For those of you heading down to AGA Financial Forum, have a safe trip and we hope to see you there. Operator, that does conclude our call.

Operator

Thank you for participating in today' s teleconference. You may now disconnect.

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