Vectren's (VVC) CEO Carl Chapman on Q2 2016 Results - Earnings Call Transcript

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Vectren Corporation (NYSE:VVC) Q2 2016 Earnings Conference Call August 4, 2016 2:00 PM ET

Executives

Naveed Mughal - Treasurer and VP, IR

Carl Chapman - Chairman, President and CEO

Susan Hardwick - SVP and CFO

Analysts

Matt Tucker - KeyBanc Capital Markets

Paul Patterson - Glenrock Associates

Joe Zoo - Avon Capital Advisors

Operator

Good afternoon and welcome to the Vectren Second Quarter Earnings Call and Webcast. All participants will be in listen-only mode. [Operator Instructions] After today’s presentation, there will be an opportunity to ask questions. [Operator Instructions] Please note this event is being recorded.

I would now like to turn the conference over to Naveed Mughal, Vice President of Investor Relations. Please go ahead.

Naveed Mughal

Thank you, operator. Good afternoon and thank you for joining us on today’s call to review Vectren’s 2016 second quarter results. This call is being webcast and shortly following its conclusion, a replay will be available on our website at www.vectren.com under the Investors link at the top of the page. Yesterday, we released our second quarter results and this morning we filed our Form 10-Q with the SEC. Under the Investors link on our website, you can also find copies of the earnings release, today’s slide presentation and the 10-Q.

As further described on slide 3, I would like to remind you that many of the statements we’ll make on this call are over-looking statements. Actual results may differ materially from those discussed in this presentation.

Also you will find the reconciliation of GAAP to non-GAAP measures at the end of the event. Carl Chapman, Vectren’s Chairman, President and CEO, will provide opening comments on the quarter’s financial results and our 2016 earnings guidance. He will then turn it over to Susan Hardwick, Executive Vice President and CFO, who will discuss in more detail our utility and non-utility results, and provide closing remarks. Also joining us on today’s call is Ron Christian, Executive Vice President and Chief Legal and External Affairs Officer and Rick Shaw, Executive Vice President and Chief Operating Officer. Following our prepared remarks, we will be glad to answer questions you may have.

With that, I’ll turn it over to Carl.

Carl Chapman

Thank you, Naveed. And thanks for joining us on our call today and we appreciate your continued interest in Vectren. Before we discuss results for the quarter I should note that we again had severe weather hit our service territory in mid July. The second time in the very short period. At the pick of the we had over 30,000 customers without power summer conditions. I would like to once again thank our nearly 300 Vectren employees and 150 contractors who performed above and beyond in a hot wet working environment to restore power to all affected customers within 72 hours. They are commitment to our customers.

Let’s turn to slide four for a review of our 2016 second quarter results. For 2016, consolidated net income was $32.3 million or $0.39 per share compared to net income of $35.8 million or $0.43 per share in the second quarter of 2016. While overall results for the quarter were slightly lower, our utility operations VESCO and VISCO distribution operations continued to perform very well through the first half of 2016. For the quarter utility results were $0.03 per share higher than 2015 primarily driven by the execution on our gas infrastructure programs to enhance system safety and reliability which is the cornerstone of our consistent earnings and dividend growth strategy.

In our non-utility group VESCO produced strong revenues and margins in both the quarter and year-to-date periods which position the business for a strong year results in 2016. Performance at our VESCO distribution business year-to-date is comparable of the very strong first half in 2015. This good start to the year for VISCO distribution keeps it on track and aggressive growth plan in 2016. VISCO's transmission business continues to work through tough market conditions where margins remain compressed on the work secured. Despite a difficult current environment VISCO's transmission business continues to be prudent in its bidding and is poised to take advantage of strong medium to long term demand as it materializes.

Slide 5 breaks down our 2016 consolidated EPS guidance range which we are affirming today at 245 to 255. As you can see we are adjusting our expectations for the utility with the higher EPS range now at 205 to 210. this includes the roughly break even impact of expected weather for the year compared to normal as the hot summer has nearly offset the warm winter that primarily impacted our electric utility results in the first quarter. The increase at the utility offsets the downward adjustments in our line utility and corporate other EPS range to $0.40 to $0.45. The utility story remains much the same growth driven by continued successful execution on gas utility investment plans in both Indiana and Ohio and a continuous focus on cost control. They are along with our expectation as weather will now be normal for the year has allowed us to increase our utility projection for 2016. In addition VESCO remains on track for a solid year as does VISCO distribution business. As VISCO transmission continues to be pressured by tight pipeline construction market a solid performance on the other parts of the overall business is key to being able to achieve our consistent consolidated earnings growth again in 2016. Before I turn it over to Susan who will provide more detail on our utility non-utility results for the quarter I would like to congratulate both Rick and her on their recent promotion to Executive Vice President. Susan and I look forward to introducing Rick to many of you over the coming months. Susan?

Susan Hardwick

Thanks, Carl. Let’s turn first to slide number six. As Carl mentioned earlier, the utility operations had a seldom quarter where results were $0.32 per share up $0.03 per share from 2015 primarily on returns for our gas infrastructure program. This growth is also present in year-to-date results shown in by approximately $0.04 of unfavorable weather in the year over year comparison for the first half of the year. As Carl mentioned we look at over the rest of the year we expect weather to be about normal for the year as a whole. As we look to invest more than $2 million over the next five years primarily in our gas operations I think it is important to reiterate that the utility performance plays the key role in producing consistent earnings growth at the Vectren level. And for us to continue to earn overall leverage return of the utility it is crucial that we continue to manage our gas infrastructure investments and our cost across the entire utility operations. As we show in the chart at the bottom of the slide we continue to expect 2016 to be a milestone year as the contribution from gas becomes more than half of our utility earnings and based on our outlook today we expect our utility earnings to be over 60% gas in the future.

Let’s turn to slide number seven for regulatory updates. At the end of June, the Indiana Commission approved our fourth semi-annual filing related to our gas infrastructure investment plan and included rates, investment covering the last six months of 2015. We continue to have appeal on file related to our previous filing for recovery related to our belief the legislation intended to allow utilities to updates and said plan overtime based upon continuous modeling based on risk. The largest project related to our field totaled approximately $65 million for a lateral project that will bring Marcellus Utica gas to our Indiana North system. While we do not expect the outcome of our appeal until 2017 we would remind you that the commission did pre-approve this project for inclusion in rate base in our next case in our appeal being successful.

In May we filed our annual updates the distribution replacement in Ohio and based on the commission staff report we do not expect any significant issues and we except and order from the Ohio commission by September of this year. Now related to the electric business in June the Indiana commission issued an order for running the certificate of public convenience and necessity for the approximately $40 million of equipment we installed related to EPAs 2011 notice violation. Recently the appellant to the original order appeals the new order, appeal will be filed later in this year that we believe the commission decision is well founded and should ultimately be upheld.

As I mentioned last quarter in the Indiana commission has approved Vectren's 2016 and 2017 electric interview efficiency programs include in the order is a loss margin recovery mechanism how it now limits recovery related to new program to the shorter of 4 years for the life of installed energy efficiency measure. While we remain committed to these and future energies efficiency programs we do not think the legislation allowing for these incentives contemplate such a limitation and have appeal that four year cap. However, if the commission upholds the order it would not affect electric utility results until the year 2020.

Moving on to slide number 8, few weeks ago we held our second public stakeholder meeting related to our Indiana Integrated Resource plan or IRP. In addition to our explanation of process and key assumptions this meeting along with the first meeting in April offered stakeholders an opportunity to voice their thoughts on the future of our electric generation. As you may recall, each Indiana electric utility periodically submits an IRP to the Indiana commission which reviews the IRP with the purpose of addressing long term electric system liability throughout the state. We believe the first two stakeholder meetings were productive and look forward to the final meeting in early November prior to our expected filing of the IRP in late 2016.

As we updated several times there are many complexities and uncertainties related to the significant yet to be finalized relations related to water, ash and carbon. We continue to believe that in the mid to long term there will likely be substantial capital expenditures in the electric operations to address some or all of these issues. And we would however expect to recovery any required investments to the existing mechanism such as 251 and 29. Recall that we had a philosophy of relatively flat electric ring base growth for some time, so any expenditures that it requires resulted the IRP will of course add to rate base.

Moving on to the non-utility review on slide number 9, we will start with energy services. We saw earnings per share up $0.03 over 2015 on strong revenues and gross margins. As a reminder you can find quarterly and year-to-date metrics for both of our non-utility businesses in the company appendix. Energy system group capitalize on two significant opportunities in the quarter. First, EST secured $66 million ten year extension of the agreement to offering and maintain customer utility plan. This is the great win for the team as it presents our largest OEM contract and is another example of EST continued success of maintaining the existing business and winning additional business by building upon the debt fraction of existing customers.

Also in the second quarter EST signed first project in the state of New York, a $12 million contract to upgrade [indiscernible] the scope of the project includes approving to the energy efficiency of city building for new equipment, boilers and lighting retrofits, street and traffic light improvements, and implementation of advanced meter against structure system to the city water utility which will include [indiscernible].

As you are likely aware the state is in the process of a significant overhaul the utility regulatory structure with the reforming the energy vision strategy. This project is an important first step in securing additional work in the rapidly evolving efficiency and distributed energy markets in New York. The strength of the public sectors over the last few years has allowed Vectren to fail and backlog as shown at the bottom of the slide to continue to grow and provide a positive outlook for earnings growth in 2016 and beyond. VISCO strong performance over the first half of 2016 has been very encouraging and we expect that to continue throughout the remainder of 2016 as we look to have a very strong second half of the year for new orders. Once contracts are signed the key focus become project execution where ESG has consistently excelled through its 24 plus year history.

Now moving to slide number ten on our infrastructure services distribution business where year-to-date revenues were up 13% year-over-year and earnings are on track to meet our plan growth in 2016. As of June 30, this portion of the pipeline construction business had roughly 2800 employees a record number for that point in the construction season. The distribution business continues to expand its footprint with proved now deployed in the Missouri, Camden and California. We anticipate continuing to grow into the third quarter and picking record levels for employee and crude counts.

Overall, long term growth in this portion of the pipeline construction business is strongly tied to the ever growing gas infrastructure program that utilities that most states have pursued, because of our over 60 year history of serving this market very effectively with a strong customer service approach we expect strong earnings growth to continue into the future.

Turning now to slide number 11 in VISCO transmission construction business. Surely the highlight of the quarter has been awarded roughly $70 million Michigan pipeline project that we expect will be substantially completed by the end of 2016. The transmission business also won $40 million station project in the second quarter about half of which we expect to be completed in 2016. These are works which have helped backlog grow in the quarter exemplified this continued effort to bill on work in this challenging market were numerous projects have been delayed due to environmental and regulatory reviews and in some cases -- unfortunately we witnessed some of these delays and cancellation first hand approximately $30 million of worth that we had expected to complete in the second quarter was delayed into the second half of 2016 causing lower than planned second quarter results.

We had thought at Q1 that given the faster distribution business we would be closer break even by now for all VISCO. But the transmission project delays noted here and adjustment in the timing of work with some of our distribution customers after that fast start were key factors in VISCO year-to-date losses. And then just this week we learned that a significant oil pipeline project has a higher risk of being canceled. As of June 30, VISCO had roughly $50 million of work related to this project in the backlog. It is too early to draw any conclusions on whether or not any of these work will be performed it is currently at high risk of being eliminated. However, since most of our work related for this project was scheduled for 2017 we have more than enough time to seek other work to replace if this does go away.

So while project delays and even some cancellations are the reality in the current environment and will competition for projects as desired margins remains very difficult we continue to actively bid on projects that align with our profitability targets and the test of our bidding process that we have had in place for many years. With that said we now expect the market to be challenging throughout the remainder of 2016 and into 2017 particularly as it relates pressure on margins. Despite these near term pressures we continue to believe the outlook for construction activity in the transmission business remain very strong. There are approximately 13000 miles of pipeline projects across the US that are announced and are still being expected to be completed generally by 2018, which should ease the competition for transmission maintenance work.

We remain focus on the long cycle of maintenance and integrity work that is expected as pipeline companies continue to invest and safety related work driven by federal regulation including the proposed entry rule for transmission pipes that was published and made available for coming back in March. They are expected to leave significant additional – lead to significant additional opportunities.

Now turning to the final slide, slide number 12, I wanted to conclude with our view that we are positioned Vectren well for continued consistent earnings and dividend growth. We will continue to invest in and manage our utility operations with the focus on remaining safe, reliable and cost effective while delivering consistent earnings growth. At VESCO we will continue to focus on providing solutions to our customers that meet their ever increasing efficiency and security as well as clean energy needs. And at VISCO well we recognized the transmission maintenance business and facing difficult market headwinds over the next several months we will continue to perceive both distribution and transmission projects that allow us to demonstrative our construction expertise and competitive advantage in this highly attractive market. Recent awards in both parts of the construction business represent positive and encouraging trends and with that operator we are now ready for questions.

Question-and-Answer Session

Operator

[Operator Instructions] Our first question comes from Matt Tucker with KeyBanc Capital Markets. Please go ahead.

Matt Tucker

Good afternoon. Thanks for taking my questions. I wanted to ask first about the increase in utility guidance. I guess I wanted you to comment on how the first half performance compared to your expectations and then really what’s changed in terms of driving the guidance higher is it primarily the warm weather you have seen so far this summer are there any other drivers to play there?

Susan Hardwick

Yes I think Matt really the answer to that is it is weather. That's really the driver behind our expectations for the year and the first quarter we had a pretty warm winter. And so in the guidance that we established at that time recall we adjust our guidance with the first quarter we had included in the utility guidance at that point roughly a portion hit because of weather. We now see that reverse this hot summer has really helped overcome that and our outlook even into July certainly would indicate lot more weather to be included in our results. So I say weather is the primary driver. We continue to stay focus on cost. We continue to work with our customers, large customers seem to perform well so I think all those things together and with the weather being sort of the largest piece in the latitude to raise full guidance.

Matt Tucker

Great. Thanks Susan and then shifting to VISCO the guidance still implies a pretty significant ramp in the second half versus both the first half and then nice growth versus the second half of last year, given the first half so far has been really tracking below last year. I guess can you comment on in the visibility you have on achieving the second half ramp and I know you mentioned some of the discrete maybe projects that are contributing to that but if you could just talk about in general where you see that growth coming from?

Carl Chapman

Yes, Matt it really is the visibility is all tied to the backlog and you can see year-over-year a nice pick up in the backlog. And that's what’s it's tied to as you mentioned there are some bid projects for sure obviously we are estimating the work that will done under blankets but based on conversation with our customers we feel good about what we have estimated there. So the visibility is pretty good. We obviously, to say there is always the issue of the possibility or some delays we have not seen a lot of cancellation. Susan mentioned the one. We have not seen a lot of that but there are some delays here and there but in terms of our expectations we feel pretty good about them.

Matt Tucker

Thanks Karl and then in terms of the competitor pressure on the transmission side it sounds like you are still expecting to see that start to obey going forward as activity throughout the industry starts to ramp up. Have you have started to see that it all was it fair to say that maybe happening slower than you had expected?

Carl Chapman

It's probably happening little slower than we expected simply because of delays again and having said that we have seen some nice things happen to two projects that Susan mentioned. There are obviously some really good news and there are projects that I think are either have been released or about to be released. That should be helpful again not so much our work but others. So, I think we are seeing some positive sign but we have not counted on any change in the margin situation for the rest of '16 in our guidance.

Matt Tucker

Thanks. And just last question from me. You guys are in a very unique situation as both the owner and operator pipelines and also the contractor that does that maintenance work. So, I'd like to hear you explain a little bit more and how you see the PHMSA rules effecting the business. We've seen a pretty light discrepancy between the government estimates which suggest that maybe not a lot of additional spending will be required. But then industry estimates suggesting pretty massive numbers in terms of what the rules means. So, just interested in your thoughts on that.

Carl Chapman

Well, you're exactly right and I would say that's kind of typically the case when you have gone to a rule that for comments, there's going to be a wide range there. But what we would tell you is the best way for us to think on the operator side and even though we would be a very small player on the transmission aspect of the operator side. We are seeing that there will be substantial cost added. And so, our expectation is it's once the particularly the big pike's get through really looking at where those rules come out and obviously we don’t know for sure whether it's going to come out. But I think fence is pretty strong in what they want.

So, we are full expectation that there will be substantial expenditures there. I don’t think we can confirm necessarily the high side of what's with the different estimates out there because there's so many. But I would tell you that as we looked at it for ourselves, we see a substantial increase and we don’t think there's anything unique about our transmission system.

Matt Tucker

Thanks a lot, Carl. I appreciate the color.

Carl Chapman

Thank you…

Operator

The next question is from Paul Patterson with Glenrock Associates. Please go ahead.

Paul Patterson

Good afternoon.

Carl Chapman

Yes.

Paul Patterson

I wanted to ask you about whether versus normal. If you have it from the beginning of the year to July. How we should think about it?

Susan Hardwick

Carl, you go ahead and comment, I've got some data here.

Carl Chapman

Yes, Susan gives specific data. But we basically and of course we have a far in August, we basically are suggesting we'll write it normal, is really what we would say for a year. Susan mentioned that it was where we had to hit in the first quarter due to it not being as cold and now it's been warmer in the second quarter and those have basically offset each other for our purposes.

Susan Hardwick

And Paul, I might just point you to the financial report that goes with the press release.

Paul Patterson

Okay.

Susan Hardwick

At the bottom of them, each of those pages we give a separate page on gas, statistics, and electric and at the bottom of those pages we provide the percentage to normal. So, for example for the six months ended June for the gas business, feeling that three days 98% normal this year compared to 106% a normal last year.

Paul Patterson

Okay.

Susan Hardwick

This is an example, these day on the electric side you could see again is not quite as hot this year and what's left through June. But again, we've seen some ramp-up in that heat latter part of the quarter and then certainly well into July.

Paul Patterson

Okay. So, your guidance basically it seems normal weather now, is that how we should think about it?

Susan Hardwick

That’s right, yes.

Carl Chapman

That's right.

Paul Patterson

Okay. And with respect to the VISCO transmission delays and what have you. Is there any particular issue that's come up that's cause these to be taking longer than what you had thought, or is this just a confluence of separate individual events? If you could just talk to a little bit more towards that?

Carl Chapman

Well, I would say the biggest thing that we have seen from the company looking to build these pipelines, the single biggest is clearly been environmental type delays. I think we shared last quarter, we can never guarantee that a sponsor who might have had some struggles with the financial results earlier in the year, we can say that they may not have had some delay but they actually were happy to see. We're not aware of that, the ones that we're aware of though clearly have been environmental driven.

Paul Patterson

Okay, blame me. So, the environment, so, if I could -- if you just elaborate a little bit further on that. I guess, I'm trying to well I'm wondering here is, so if it's environmentally what's causing the projects to be delayed, is that something that requires a reassessment of your pipeline in terms of obviously you've done that right now. But I'm just saying going forward, is that something in which you might be taking additional contingency into account with respect to what these guys are telling you in terms of their anticipated schedule

Carl Chapman

Well, actually we use a number of different sources on that. And so, we try to take a very hard look at the dates and all of those things are factored in, there's no guarantee as to when environmental approvals will occur. But I will say that there have been a couple of project recently, and I think who have got some pretty good name in the environmental realm. There obviously are some who haven’t too. But I think there been some good news and so I think we're starting to see happening what we thought would happen, which is taking longer to move these through the environmental process.

Paul Patterson

Okay. Now, we'll see my other question which is basically you -- is a pretty much there's a timing delay as you see it. You don’t see anything that is showing up on the horizon which actually might mean that it would be more difficult for such projects to actually start taking place. This is just sort of the ins and outs of the business to a certain degree and as opposed to something that's developing here that might lead to more project cancellation other than the one that you mentioned, I think the $50 million item that you talked about other than that. Is that the way to think of it?

Carl Chapman

Yes. I think that's exactly the way to think of it. And the course, we can't guarantee where projects are going to come out and remember of course we're monitoring projects in many cases we're not doing work on. But we're still monitoring closely, we can't guarantee where they'll come out but based on what we're seeing, I think there are both positives and negatives but on balance. We see these as timing delays and when we have a different point-of-view on one of them or frankly when our experts do that monitor this for us, we'll take them out and describe them to you just as we did on this one this quarter. Even though it's not final, we're just wanting to give the warning that it has the potential to not come together.

Paul Patterson

Okay, great. Thanks a lot, guys.

Carl Chapman

Thank you.

Operator

[Operator Instructions] Our next question comes from Joe Zoo with Avon Capital Advisors. Please go ahead.

Joe Zoo

Good afternoon. And Congratulations on a solid utility performance.

Carl Chapman

Thanks, Joe.

Susan Hardwick

Thanks, Joe.

Joe Zoo

And just a quick question on the utility side, with this Indian IRP and other opportunities. Is there any upsides for like I will tell your CapEx, I'm talking about like 2019, 2020, and going forward?

Carl Chapman

Well, we're not really giving any timetable on exactly when it might be but what we've been talking about here for a couple of quarters is just to give an alert that as we work through the integrated resource plan, there is likely additional CapEx coming. And that's really just due to the rules that have continued to come out. We've shared consistently not so much on carbon, or there is an awful lot of uncertainty but more on ash and water as it impacts our plans and there is more certainty there of course. So, as those rules had come together as we try to make a better estimates and none of our estimates are final yet, we do believe there is the likelihood of additional CapEx in the electric generation space.

And what we've shared in that integrated resource plan, basically will be filed in the November and then sometimes in the next few months after that we'll pull together what our generation plan is and what kind of filings that will require with the commission.

Joe Zoo

Great, thank you. And my follow-up question with this is that I see on page eight, this closer there is a large customer's moving to self-generation and Alcoa as in the restructuring operations. Given this background, are you feel satisfied with your 1% customer growth going forward?

Carl Chapman

Yes, actually Alcoa self-generates. And so, while that has an impact on some integrate resource plan because we co-own a plant with them, it's called Warrick 4, it's 300 megawatts, its 50/50 and so it has an impact in our integrated resource plan depending on what Alcoa decides to do with their half could have an impact obviously on that plan. But it in terms of how it impacts volumes, we do not serve Alcoa.

Joe Zoo

I'm talking about if there is any lay off or on the just on the FX, yes.

Carl Chapman

Oh, on that FX. Yes. Actually the restructuring's already been announced and there was some layoff but there are many of the employees were able to get jobs elsewhere. So, there's some reduction here but I would say we don’t view it as significant. I mean, significant to those employees of course, then in terms of impact on our growth or our performance, we don’t see that obviously any job loss is a problem. But we're not seeing any big issues there.

Joe Zoo

Right. And one more my last question on the, I know you had decide, maybe my question is to Susan. I'm looking at your appendix, for your '16 guidance mid-points for VISCO and VESCO. So, on VISCO, the net income mid-point is 25 million and VESCO is 8 million. If I'd have to gather and divide it by your share count, that's only give me like $0.40, around $0.40. Does it mean that your know your sort of your guidance is trending to where your low end or how should I look at this, or how should I model this?

Susan Hardwick

Well, I think the mid-point of that that utility guidance is the right answer for the roughly $0.42 or $0.43 and recall in the remarks we said that it was non-utility and corporate now there. If we got a little bit of in comment that level that will sort of be included in that number as well. So, I think the mid-point of that 40, 45, is the right number for the total.

Joe Zoo

Okay. So, they've covered others embedded in that, so that if I had the net income that shows a lower number.

Susan Hardwick

That's right. That shows, yes the two non-utility company's want the little bit, the corporate, not that we just not disclose that number separate. It's just not really terribly material but the combination of all those will certainly get you into the mid-point of that range.

Joe Zoo

Okay. So, probably recovery in others roughly $0.02, $.0.025 cents something like that?

Susan Hardwick

Yes. I think if you do that math that way, again I would say our range is what's important, so that $0.40, $0.45, is the key. And I just would clarify again, it's so two individual companies along with the little bit of corporate and other. So, they'll all be -- they're all important in that range, that’s sort of how we look at it.

Joe Zoo

Excellent. Thank you, very much.

Operator

This concludes our question and answer session. I would like to turn the conference back over to Naveed Mughal for any closing remarks.

Naveed Mughal

I'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. With that, we'll conclude our call for today. Thanks again for you participation.

Operator

The conference is now concluded. Thank you for attending today's presentation. You may now disconnect.

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