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CMS Energy Corporation. (NYSE:CMS)

Q2 FY08 Earnings Call

August 5, 2008, 09:00 AM ET

Executives

Laura L. Mountcastle - VP of IR and Treasurer

David W. Joos - President and CEO of CMS Energy Corporation and CEO of Consumers Energy Company

Thomas J. Webb - EVP and CFO of CMS Energy Corporation and Consumers Energy Company

Analysts

Daniel Eggers - Credit Suisse

Brian Russo - Ladenburg Thalmann

Paul Ridzon - KeyBanc Capital Markets

Operator

Good morning everyone and welcome to the CMS Energy 2008 Second Quarter 2008 Results and Outlook Call. This call is being recorded. Just a reminder, there will be a rebroadcast of this conference call today beginning at 11 AM Eastern Time, running through August 12. This presentation is also being webcast and is available on CMS Energy's website in the Investor Relations section

At this time I would now like to turn the call over to Ms. Laura Mountcastle, Vice President and Treasurer, please go ahead.

Laura L. Mountcastle - Vice President of Investor Relations and Treasurer

Thank you. Good morning and thank you for joining us for our second quarter earnings presentation. With me today are Dave Joos, President and CEO, and Tom Webb, Executive Vice President and CFO.

Our earnings press release issued earlier today and the presentation used in this webcast are available on our website at cmsenergy.com. This presentation contains forward-looking statements. These statements are subject to risks and uncertainties and should be read in conjunction with our Form 10-K and 10-Q. The forward-looking statements and information and risk factor section discuss important factors that could cause results to differ materially from those anticipated in such statements. This presentation also includes non-GAAP measures when describing the company's results of operations and financial performance.

A reconciliation of each of these measures, the most directly comparable GAAP measure is included in the appendix and posted in the Investor section of our website. We expect 2008 reported earnings to be about the same as adjusted earnings. Reported earnings could vary because of gain per charges relating to previously sold assets and business operations or other factors. We are not providing reported earnings guidance reconciliations because of the uncertainties associated with those factors.

Now I will turn the call over to Dave.

David W. Joos - President and Chief Executive Officer of CMS Energy Corporation and Chief Executive Officer of Consumers Energy Company

Thanks, Laura, and good morning ladies and gentlemen, thanks for joining us for our second quarter earnings call. As is our usual practice I will start the presentation with a brief update on the business and then I will turn the call over to Tom for more detailed discussion on the financial results and outlook, and then we will close with questions-and-answers.

Solid operating results for the second quarter 2008 reflect the successful efforts over the past few years to restructure the company. Our second quarter non-GAAP adjusted earnings were $0.19 a share up from $0.08 a year ago. Core utility earnings are up as a result of the investments made to improve the capital restructure and grow the rate base. Enterprises impaired earnings were up slightly as reduced overhead and lower interest expense more than offset lost earnings from asset sold last year.

Year-to-date earnings are on plan and our full year guidance for adjusted earnings remains unchanged from the target set over a year ago over $1.20 a share. Tom will get into more detail on both the second quarter results and our year-end forecast in a minute.

There has been lot of activity on the legislative and regulatory front in Michigan and I want to update you on the progress in these areas. But before I do, I want to mention how pleased I am to say that as of July 1st, we have made the transition to our new SAP-based enterprise software system, replacing more than 100 legacy systems that manage all major business processes, implementation is going well. We expect both operating efficiencies and customer service improvements to result from this investment overtime.

Turning now to legislation; the State House and Senate have been working on the details of the legislative energy reform package we've discussed in the past. House Bill 5524 rewrites the state's electric deregulation law and updates electric utility regulatory policies. Both the House and Senate version set a cap of 10% for the customer load that can be served by alternative electric suppliers. While, there are differences in the deskewing provisions of the House and Senate versions, remember deskewing is the inter-class subsidies that we're trying to address.

Both should result in elimination of skewing over five years for consumers energy. Senate Bill 213 set a combined renewable energy and energy efficiency portfolio standard at 7% by 2015. The House version approved a 10% RPS standard and a separate energy efficiency standard. The Senate has a broader definition of renewable energy as well. The bills were sent to conference committees in late July to resolve the differences in those committees are beginning their work. This could lead to a vote when both sides meet again in August. We expect most of the effort in the coming weeks to be focused on reaching a compromise on the energy efficiency and RPS differences.

There has been broad support for energy reform by the Michigan Chamber of Commerce, The Michigan Manufacturers Association as well as many individual businesses, labor unions, the Michigan Public Service Commission and the Governor. We continue to be optimistic.

Turning now to regulatory; this summer we received an electric rate order and reached a settlement that resolves issues related to the MCV power purchase agreement. The rate order was sufficient to support our plan while the MCV order resolved longstanding risks associated with the contract. In February, we filed a new gas rate case requesting a $91 million increase based on a 2009 test year. We also requested revenue decoupling mechanism for residential customers that would eliminate the impact of planned energy efficiency and conservation programs. Staff testimony is scheduled to be filed August 25th. Later this month we plan to file a new electric rate case reflecting increased investment at the utility to improve customer service and system reliability. This case will also be based on a 2009 test year.

Now let me turn the call over to Tom for more detail.

Thomas J. Webb - Executive Vice President and Chief Financial Officer of CMS Energy Corporation and Consumers Energy Company

Thank you, Dave, and thanks everybody for joining us on this busy earnings call day. For the quarter reported and adjusted earnings were $0.19 a share. Without restructuring and other legacy costs adjusted earnings were up $0.11 from a year ago. Unique events during the quarter included some unusually severe storms and some gain changers included the launch of the new SAP-based system that Dave talked about, resolution of MCV exposure and progress on Michigan Energy Legislation. I would talk a little bit more about some of these in just a moment.

The $0.11 earnings increase from last year includes an improvement at the utility of $0.07 and enterprise and the parent of $0.04. Despite, softer than planned sales, then an extraordinary strong system we continue to manage our business and our cost to achieve our earnings target. In enterprises and the parent results of restructuring are flowing through to the bottom-line. These include big benefits from the sale of international businesses and unlocking value at DIG.

At the utility, earnings improvement flow through from restructuring the MCV contract in accomplishing a good electric rate order. The order reflects major investments made possible, the rate order by proceeds that come from international sales last year very pleased with that. Now, these results reinforced the decision several years ago to sell higher risk non-regulated asset and redeploy the proceeds from that to improve our balance sheet, and invest in the utility. We are delighted to deliver these results to you.

Now it's true that the Michigan economy is weak, but not all locations are impacted equally. The big three auto companies are struggling. The auto sector represents 5% of our customer revenues, but only 3% of our gross margins. Provisions in the new Michigan Energy Legislation are designed to help our big customers from the skewing tests, economical new generation. We work every day to serve all of our customers better. They are bright spots in our service territory and one example is Hemlock Semiconductor, they are world's leading producer of polycrystalline silicon, a substance used in solar panels and other electronics.

They approved a $500 million expansion in 2005, and a $1 billion upgrade last year. This created 500 jobs and likely provides a boost in sales in the second half of this year. Michigan's on the short list of sites for another major expansion and that should be announced soon. Now, other examples of growth include Kaiser Aluminum Corporation, a leading producer of lightweight fabricated aluminum products for aerospace and engineering applications. They are planning to locate a new $80 million research facility in Kalamazoo. And MTI Research, a provider of comprehensive preclinical research and development services is planning a $330 million expansion in Kalamazoo. These two Kalamazoo expansions alone are expected to create nearly 4000 new jobs and those are in our service territory.

Other business expansions have been announced this year creating several thousand new jobs in Michigan. Over the last ten years our total electric demand has increased at a rate of about 1% annually. This year we expect to be down due to weather and up slightly on a weather adjusted basis. For the period 2009 to 2013, we base our plans on an annual growth rate of about 1%. Our full year guidance, as Dave mentioned, at $1.20 is unchanged, that's up 43% from 2007.

The darker green and red portions of the bars shown on this wonderful chart illustrates what's behind us in the first half. The lighter portion shows what's left to go. Even here much of the work is done.

At the Utility, we have $0.24 to go, the bulk of which is attributable to electric and gas rate orders in place and the MCV regulatory out accomplished last September. Most of our large uncertainties are resolved, but we still need to manage the business to address normal issues, whether there is storm or adverse weather or whatever may occur.

At Enterprises and the parent, in 2007 we had some one-time tax and other gains that don't repeat in 2008. Overhead and interest savings pretty much are in place.

Bottom line, our results are on track to meet full year guidance of $1.20 a share for this year. Let's switch over to cash flow. Many of you appreciate having this view of our cash flow. Except for gas prices up about $2, these data are similar to what we showed you in our last call. Growth-oriented investment of $860 million at the Utilities is funded with earnings and appropriate debt. Parent cash flow was healthy with dividends from Consumers and Enterprises more than ample to service debt overhead and the growing dividend.

Gas prices have been volatile. In this forecast, we have included prices at $11.44, up from 9.43 last quarter. As you know, that's conservative with prices recently falling below $10. If this holds for the rest of the year, our cash flow will improve from what's shown here by more than $100 million. Even so, to provide additional cushion against the risk of rising working capital requirements caused by higher commodity prices, especially gas, we are planning to add a new 364-day 150 million bank facility, increasing Utilities revolver capacity to $650 million. With more than $400 million projected as available at year-end, this short-term capacity with help to ensure strong liquidity.

Also I know many of you like to keep track of our NOLs and our AMT credit status. These should be worth over $600 million at year-end.

And here is another slide that many of you like to see. With it, we provide earnings and cash flow sensitivities. They are not a lot of different from what we showed you in our last call.

Utilities across the country are suffering from rising customer uncollectibles. We forecast $32 million of bad debt this year and that's the total for gas and electric, it's about the same as last year. Most of this is provided for in our rates today.

As a percent of revenues, this is about 0.5% similar to the levels of the last two years. Now, our weakness is in communities near Detroit and Flint. Exposure is lower in the mid and western portions of the state where most of our service territory exists. If, however, our uncollectibles rise another 10% or about $3 million, we'd still be just below our peers.

Looking further into the future, we expect to invest over $6 billion during the next five years, providing rate-based growth of about 7% a year and our EPS growth projected at about 6 to 8%. The pending energy legislation that Dave discussed earlier would mandate part of it and facilitate a lot of the rest. Our balanced energy initiative approach supports the state's energy efficiency and renewable priorities, and the desire for added green coal generation to provide cost-efficient energy.

Meaningful coal plant investment begins about 2011. As shown on the right, other important investments opportunities exist if for any reason the plant is delayed.

Alternative investments include extending the life of existing coal generation plants, converting simple cycle to combined cycle gas generation, and reliability improvements. We simply do not lag for attractive investment opportunities. We prefer our base plan as the most cost-efficient for our customers and the most balanced approach that minimizes risk to... by providing fuel diversity and flexibility.

Now here is one example of one those new investments that will lead to improvements in reliability and cost efficiencies.

As Dave mentioned, we launched the comprehensive SAP-based system on July 1. This replaced over 100 legacy systems, including customer billing, supply chain, payroll, asset management, customer management, and a suite of financial management systems. Many of these legacy systems were well beyond a decade old and some went back more than 30 years.

Maintaining these systems was becoming costly and cumbersome and candidly, our reliability was not what it should have been. We have got a good start, thanks to the super work of our employees. Still we got a lot of work to do and it will take several months to fully integrate and fine-tune.

We invested $174 million and expect this investment to pay for itself in efficiencies and, importantly, provide for better service to our customers.

Recapping our progress this year, we are on track to meet each of the financial targets on our score card with one exception. Our cash flow is still short of target, reflecting the impact of higher than planned gas prices on working capital. If gas prices continue to pull back, we may end up a little closer to our target, but we will see. Capital structure and earnings at $1.20 a share continue right on plan.

Now we'd like to open up the call for you questions, if you could help us, operator.

Question And Answer

Operator

Thank you very much, Mr. Webb. The question and answer will be conducted electronically. [Operator Instructions]. Our first question comes from the line of Dan Eggers from Credit Suisse. You may proceed.

Daniel Eggers - Credit Suisse

Hi, good morning. On the Michigan legislation, where are you guys seeing the sticking points between House and Senate right now? Any thoughts on when we should expect this to get finalized if you guys have a feeling for that at point in time and then just the Governor's comfort with the renewable standard and some of the policies relative to what she had laid from an expectation perspective?

David W. Joos - President and Chief Executive Officer of CMS Energy Corporation and Chief Executive Officer of Consumers Energy Company

Good morning, Dan. Some of this is hard to predict. There is really two major groups of issues here. One is the reform to the regulatory policies, including a limitation on alternative energy suppliers providing service to customers in the States. And frankly, there are not a lot differences in the two House and Senate versions of those bills. So that's not where most of the attention will be over the coming weeks. It's really the... the major differences will be Senate provided an overall 7% standard, which included both renewable portfolio standard investments as well as energy efficiency, while the House version had 10% for RPS alone, plus energy efficiency requirements. And I think that's where the discussions and the negotiation between the contraries [ph] and frankly, the administration on those issues is probably where most of the attention is going to take place.

Those discussions are ongoing right now. We continue to be optimistic that a reasonable compromise on those issues can be reached. The next opportunity for the two chambers to be in session at the same time and vote on the issues would be the 13of August. It's difficult to predict whether or not a full compromise on those issues can be reached between now and then, but it's possible. And if not, we are still optimistic that that's going to get done yet in the third quarter.

Daniel Eggers - Credit Suisse

Okay. Thank you. And on... just kind of given the running coal prices in the quarter, can you remind us where you're guys are hedged and kind of the nature of your hedging for the existing fleet and then may be any impact on the economics of the new coal plants given the big movement in coal costs?

David W. Joos - President and Chief Executive Officer of CMS Energy Corporation and Chief Executive Officer of Consumers Energy Company

Yes, I will just remind you, and then maybe Tom has some more details. I'll just remind you that we shifted predominantly to western coal and despite the fact that eastern coal prices have been up dramatically this year, western coal prices have been relatively well behaved. And the new coal plant we would expect to be western coal oriented as well.

Our cost estimates for the new coal facility are up. We haven't talked about specifics, but as you know, commodity prices are up: steel, labor and everything else. So, those are probably going to continue to change and we'll present a forecast to the Public Service Commission as the actual cost when we make a filing associated with that plant probably some time next year, by the time that all gets done. But in terms of the coal supply for this year, we really had a 100% of our estimated coal supply already under contract and about 84% for 2009. We also have a multi-year transportation contracts in place. So we are in pretty good shape with regard to hedging our fuel.

Daniel Eggers - Credit Suisse

Great, thank you guys.

Operator

Your next question comes from the line Brian Russo from Ladenburg Thalmann. You may proceed.

Brian Russo - Ladenburg Thalmann

Good morning.

David W. Joos - President and Chief Executive Officer of CMS Energy Corporation and Chief Executive Officer of Consumers Energy Company

Good morning, Brian.

Brian Russo - Ladenburg Thalmann

It looks like you guys had a very good first half in terms of reducing overhead and it looks like to meet your guidance of a $1.20, you only need $0.03 [ph] in the second half. And I am just wondering why isn't it more evenly spread? Or why can't you repeat the first half cost cuts in the second half?

Thomas J. Webb - Executive Vice President and Chief Financial Officer of CMS Energy Corporation and Consumers Energy Company

Yes, you need to remember that some of things we did was little bit one time in nature because our overhead levels have come down to about where we need then to be on the enterprise and parent side, and you are going to see that pretty smooth as you then go off into the future. But there is a couple of little one time things that go the other way in these numbers in the second half. So the key message here is right on target down where need to be, interest income falls off just a little bit because we had a little more cash sitting around earlier than we will have in the second half.

Brian Russo - Ladenburg Thalmann

Okay and you also mentioned benefits in savings with the new SAP-based system launch that was launched I think, I heard you say early July do that lead to incremental reductions in overhead?

Thomas J. Webb - Executive Vice President and Chief Financial Officer of CMS Energy Corporation and Consumers Energy Company

Yes, the way to think about that is don't look for overhead reductions this year for certain because this is the launch year that we just started this out on July 1, it will take several months to fine tune and get into good shape. Then we do expect to get some nice synergies out of this as we go through next year, in the next few years and what we will do is it will make it just that much easier to earn our authorized rate of return.

Brian Russo - Ladenburg Thalmann

Okay. And then just lastly, on the utility investment plan slide, could you quantify how much of that rate base investment is contingent on energy reform, and on the coal plant is anything else in there?

David W. Joos - President and Chief Executive Officer of CMS Energy Corporation and Chief Executive Officer of Consumers Energy Company

There is some additional items in there, when we talk about for example, the AMI system we think, AMI makes a lot of sense, but it is sort of tied to providing a lot of the energy efficiency benefits. And it maybe that if the legislation doesn't pass and the energy efficiency requirements are not in place, so, we may go a little bit slower on that. We don't expect that to be the case doesn't make sense either way. The other issue of course and probably the biggest one is renewable, because we have assumed in here investments and wind capacity and other renewables as part of meeting an RPS standard. We still think that the standards that are likely to come out of this legislation are going to justify that kind of investment or we certainly wouldn't go forward with that level until it was clear what the requirement were and if the commission is going to be supportive of those investments. Those are the two big ones.

Brian Russo - Ladenburg Thalmann

Okay great, thank you very much.

Operator

[Operator Instructions]. Your next question comes from the line of Paul Ridzon from KeyBanc. You may proceed.

David W. Joos - President and Chief Executive Officer of CMS Energy Corporation and Chief Executive Officer of Consumers Energy Company

Hey, Paul go ahead.

Paul Ridzon - KeyBanc Capital Markets

I am sorry I was muted. $0.07 of electric volume decline in fact $0.04 of that was weather, could you just elaborate little on the $0.03 and against that lower industrial sales and what's the opportunities or remark that as better margins?

Thomas J. Webb - Executive Vice President and Chief Financial Officer of CMS Energy Corporation and Consumers Energy Company

We remember a big of piece of that when you're looking at weather piece, is there was a hot June a year ago. Then when you look at weather adjusted kind of numbers, the best message to think about is that we've got a little bit of a kick up coming here in the second half from some of our new customers primarily, Hemlock Semiconductor. Remember we talked about their major investments that they are putting in place, that's going to translate into more business from them and maybe more jobs with more residential as well.

David W. Joos - President and Chief Executive Officer of CMS Energy Corporation and Chief Executive Officer of Consumers Energy Company

And I said Paul also in the first half of course, the auto sector has been down, but remember we all... and specifically there was an American axle strike that impacted the auto sector in general the first half of this year.

Paul Ridzon - KeyBanc Capital Markets

And did that hit your Detroit?

David W. Joos - President and Chief Executive Officer of CMS Energy Corporation and Chief Executive Officer of Consumers Energy Company

Yes, it probably hit them more than hit us, but it hit both.

Paul Ridzon - KeyBanc Capital Markets

Okay. Thank you.

Operator

[Operator Instructions]. We have no further questions at this time.

David W. Joos - President and Chief Executive Officer of CMS Energy Corporation and Chief Executive Officer of Consumers Energy Company

All right, well, that doesn't surprise me because things have been pretty straightforward, I think as we've indicated we are pretty much on plan for this year and a lot of the major issues have been resolved. As Tom indicated, we still have to manage cross our T's and dot our I's the rest of the year, but we feel pretty good about where we are and continuing to implement our plan, continue to be optimistic about the legislation, timing is difficult to predict as I indicated that there is good progress that's been made there and I think its priority for the state and every one and our leadership positions have indicated that.

So we are... we continue to optimistic and we look forward to talk with you in the future. Thanks very much for attending today.

Operator

This concludes today's conference. We thank you for your participation. Have a wonderful day.

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