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Just Energy Group’s (JE) CEO James Lewis on Q4 2016 Results – Earnings Call Transcript

Just Energy Group, Inc. (NYSE: JE ) Q4 2016 Earnings Conference Call May 19, 2016 10:00 AM ET Executives Rebecca MacDonald – Executive Chair James Lewis – President and Co-Chief Executive Officer Just Energy Pat McCullough – Chief Financial Officer Analysts Nelson Ng – RBC Capital Market Carter Driscoll – FBR Damir Gunja – TD Securities Sameer Joshi – Rodman & Renshaw Operator Good morning, ladies and gentlemen. Welcome to the Just Energy Group Inc. Conference Call to discuss the Fourth Quarter 2016 Results for the period ended March 31, 2016. At the end of today’s presentation, there will be a formal Q&A session. [Operator Instructions] I would now like to turn the meeting over to Ms. Rebecca MacDonald. Go ahead Ms. MacDonald. Rebecca MacDonald Good morning. Thank you for joining us thing morning for our fiscal 2016 fourth quarter earnings conference. I’m Rebecca MacDonald, Executive Chair, Just Energy. And are here with me this morning, Co-CEO James Lewis and CFO Pat McCullough. Unfortunately, we will not be joined by Co-CEO, Deb Merril, as she is attending funeral services for a family member. Before we begin, let me preface the call by telling you that our earnings release and potentially our answers to questions will contain forward-looking financial information. This information may eventually prove to be inaccurate, so please read the disclaimer regarding such information at the bottom of our press release. Fiscal 2016 was tremendous year or Just Energy from a financial, operational and strategic positioning perspective. Our business continues to perform very well, delivering strong top and bottom line results, while generating meaningful cash flow. In parallel, with delivering strong results we were able to take strategic measures to position the company for continued long-term success in this exciting changing industry. On behalf of the board, I want to extend our appreciation to Deb, Jay, Pat and the entire team for their focus and commitment to driving meaningful change throughout the organization. As I look back over the past three years, essentially the time strains can put this new leadership team together, this is clearly a developing track record of delivering on our promises to our shareholders, customers and all of our stakeholders. In fiscal 2016, we exceeded our own guidance and overcame a very tough comparison to the strong fourth quarter of 2015. Given our world class risk management and our hedging strategy, we were able to drive strong performance in recently completed winter quarter, despite a relatively warm weather. As you’d recall, the winter weather of last year provided a windfall across much of the industry. The recent winter was about 15% milder than normal across Just Energy customer base in North America. Delivering such a strong result is testament to our hedging philosophy and commitment to establishing a stable and predictable earning profile. We feel strongly that our demonstrated ability to consistently deliver performance driven results in our any environment is now the new norm at Just Energy, as a result of our strengthened financial position and improved profitability profile. As you’ve heard us talk about all year long, we’ve taken action to change the business foundation and reposition the company to capture more accretive, profit and cash flow by not allowing our team to chase market share at the expense of margin due to our refusal to engage in risky pricing tactics that would ultimately damage our improved profitability profile. While this strategy will result in a decline in next customer additions from time to time, we feel strongly that our margin for customer improvement initiative is working. The progress is evident in improved scale and leverage in our model that is allowing us to take 5% topline sales growth for the year and deliver 17% gross margin and 15% Base EBITDA growth, while driving a 62% increase in cash flow. Let me be very clear, we are managing this business for the long-term, if that yield shorter negative additions for the sake of long-term accretive profit and cash flow, we will do it every single quarter. Let me also be clear, that we are planning for and we are well positioned for significant growth. We see tremendous opportunities to achieve our goals through the addition of product, markets and partnerships that will deliver value to our customers and growth for our business. Today, we are operating from greatly improved financial position. And our strategy is proving our ability to consistently deliver throughout any cycle. Our financial flexibility combined with the commitment to maintain a capital like model supports our ability to pursue a growth strategy centered on geographic expansion, structuring superior product value proposition and enhancing the portfolio of energy management offering. We feel confident, our strategy will continue to deliver in fiscal 2017 and beyond. With that I will pause, and ask Pat to provide some additional color on the quarter and years financial results. Pat. Pat McCullough Thank you, Rebecca. Overall, it was an outstanding year in terms of both profitability and cash. We’re very pleased with the financial results we’re generating as a results of the actions we’ve taken to reposition the company. The business is performing exceptionally well, and we’re seeing a consistency in our ability to take strong topline performance and deliver even more impressive bottom-line results. Let me cover some of the recent highlights for the fourth quarter and full year, then I’ll add more added color in specific focus areas and provide our outlook for fiscal 2017. In the fourth quarter, sales were $1,075.9 million, a decrease of 11% over the very strong quarter of fiscal 2015. The quarterly decline was a mix of lower commodity prices, lower volume due to warm weather and lower net additions from the year ago period in the consumer division, combined with lower sales prices for variable products in the commercial division. The effect of these items combined with the lower customer base more than offset the positive foreign exchange impact. For the full year, sales were up 5% to $4,105.9 million. The increase is primarily a result of the currency impact of converting US dollar denominated sales into Canadian dollars. Gross margin increased 5% to $204.3 million during the quarter, this is a continuation of the same positive foreign exchange impact and ongoing success of our margin improvement strategies that led to a full year gross margin increase of 17% to $702.3 million over last year. This quarter’s gross margin did not feel the impact of the warm weather that Rebecca mentioned due to our superior weather hedging program. Let me step back to add some color on how far we’ve come along this profitability for customer initiative. Today, we’re signing consumer customers at $207 of gross margin for our RCE, which compares to $191, just one year ago and $166 two years back. Additionally, commercial margins are being added now at $84 for RCE, up from $79 just one year ago, and $67 two years ago. So that’s a 25% improvement in both consumer and commercial over the two year period. We were able to drive these improvements in margin because our new innovative products are gaining more appeal and presenting more value for our customers. This is allowing us to price our energy management solutions competitively without sacrificing customer satisfaction. This satisfaction is evident in the attrition rate remaining flat year-over-year in what we consider a highly competitive market. The improvement in our operating results is also reflected in our cash flow performance. We ended the quarter with $127.6 million on cash and cash equivalents, up 62% from $78.8 million at the end of fiscal 2015. In addition, base funds from operations increased 37% from the same quarter last year and increased 49% year-over-year to $138.2 million. You’ve heard us talk a lot about the changes and repositioning this company has undergone, and this is another great example of delivering on promised change. Today, we’re happy to be able to say that the payout ratio on base funds is 54% for the full year, down from 94% in fiscal 2015 and down from 139% in fiscal 2014. Given the growth we’re projecting moving forward, I’m confident this achievement is sustainable. We’ve also remained committed to reducing debt. At year-end, long-term debt was $660.5 million, a decrease of 2% year-over-year. Despite the higher value of the US denominated debt due to foreign exchange, we successfully reduced debt during the year by $7 million through our normal course issuer bid program and an additional $25 million through repayment of our unsecured senior notes. As a result, book value net debt was 2.6 times the trailing 12 month Base EBITDA, significantly improved from 3.3 times just one year ago and approximately 6 times two years ago. We remain focused on further improvements to our debt position going forward. We were also successful in controlling overhead cost. Administrative expenses for the year increased by 10% to $170.3 million, however this was entirely driven by higher costs required to support customer growth in the UK, as well as the impact of the exchange rate on the US dollar denominated administrative cost. Selling and marketing expenses for the year increased 14% to $257.3 million, due to the impact of foreign exchange on the US base commission and overhead expenses. The start-up cost associated with the residential solar division, as well as the expenses becoming more directly co-related to the growing portion of the customer base for which selling cost are recorded over the life of a contract. In fact, the majority of the year-over-year increase was driven by prepaid commercial commissions. I’d also like to point out that during the recent quarter, we made four strategic sales in energy management solutions hires, whom we’re very excited to have on-board. These new members of the team provide us increased confidence in our ability to execute our growth strategy around solar and broader energy management solutions that will drive future customer growth within existing and new channels. To wrap up the year, the sum of all these activities and results led to strong bottom line results that exceeded even our aggressive expectations. Base EBITDA increased by 10% to $74.7 million this quarter, excluding the additional prepaid commission expense item. It’s important to remember that our reported Base EBITDA in the fourth quarter of this year included $7.4 million of prepaid commission expense, reflecting the change in classification of prepaid commissions to a current asset effective April 1, 2016. Base EBITDA was $67.3 million in the quarter, a 1% decrease from last year when we fully reflect this change in the current period. For the full year, Base EBITDA increased by 25% to $225.5 million in comparison to the fiscal 2015 excluding the additional prepaid commission expense. In fiscal 2016, we incurred $17.9 million of prepaid commission expense. When you include the prepaid commission expense item, reported Base EBITDA was $207.6 million, an increase of 15% over the prior year. While we did benefit nearly $21 million from foreign currency impact on the translation of our US operations, it was still a very impressive year as we posted performance based improvements of $24.5 million for the year. Now let me turn to the outlook for 2017. The improvements we’ve made to the business are here to stay. To reflect the progress in repositioning the business and to build off of our strong 2016, we believe we will achieve fiscal 2017 Base EBITDA in the range of $223 million to $233 million, reflecting continued double-digit percentage year-over-year growth. Fiscal 2017 guidance includes deductions to Base EBITDA of approximately $40 million for prepaid commercial commissions, which were previously have been included in amortization within selling and marketing expenses. This represents a $22 million year-over-year increase in this expense versus 2016, and represents a go forward run rate for this incremental deduction in future years. As you saw this year, we expect to offset this headwind with continued strong gross margin performance and foreign exchange benefit. If you consider the 20% EBITDA growth that we recorded this year, prepaid commission adjusted and on top of that another 25% for next year, this is a very compelling fees. In addition, Just Energy’s solar program continues to show promise, based on the success of the pilot launch in Southern California, operations will continue to grow with further expansion in California and in Northeast United States. In fiscal 2017, our solar and renewables business is expected to contribute $10 million towards the double digit percentage Base EBITDA targets. With that, I’ll turn it over to Rebecca for some concluding remarks. Rebecca MacDonald Thanks Pat. We enter fiscal 2017 well positioned to participate in the significant growth opportunity that exists in our changing industry. The energy management solution industry is in the midst of significant transformation as customers demand value added product that address the changing manner in which energy will be consumed. We embrace this change and feel we are uniquely capable of transforming our vision and insights into action, by delivering effective strategies and compelling product that capitalize on change and deliver real value. Our growth plan is centered on continued geographic expansion, structuring superior product value proposition and enhancing the portfolio of energy management offerings. Geographically, our expansion plan are focused in Europe, where we are actively evaluating new markets. Our UK business is striving and we are successfully adding consumer and commercial customers in a profitable manner. We believe this early success validates our ability to compete outside of North America and we plan to take this experience and expand into two new European nations this year. A large part of our ongoing success is also being driven by our ability to provide innovative product that take advantage of technological advantage and offer a superior value proposition to our customers. New products like our unlimited plan, our bundled product offering, our JustGreen offering, smart stat, thermostat and JustSolar to name just a few exciting opportunities. During the year, we also started [indiscernible] energy efficient LED lightbulbs without commodity product, and we added air filters to our suite of options. Each of those initiative –innovative product gaining more appeal and delivering more values to customer, which in turn is allowing us to price our solutions at premium, while retaining customers for long duration. In summary, this has been an incredible year for our company, and one we feel places us [indiscernible] on the best path of becoming the premium world-class provider of energy management solution. Our business is healthy and growing even stronger. We are committed to delivering another year of double-digits earnings growth, maintain our stable dividend, pursuing prudent geographic expansion and further strengthening the company’s financial and strategic position in the coming year. We would like to thank the employees of Just Energy, for making these results possible. As leadership team, we are very fortunate to have a group of employees who deliver results and believe in the future of Just Energy. Thank you for all you do for the business we operate, the customers we service, and the communities which we live in. With that I would like to open it up for questions. Question-and-Answer Session Operator Thank you. [Operator Instructions] We have a question from Nelson Ng from RBC Capital Market. Nelson Ng Great, thanks. Congratulations on a good quarter. Rebecca MacDonald Thank you very much. Pat McCullough Thank you, Nelson. Nelson Ng My first question relates to the customer margins, in terms of additions and the attrition, so I’m not sure if my math is right, but are the margins for the consumer customers lost higher than the margins for the consumer customers added in Q4? Pat McCullough The margin for… Nelson Ng For the customers lost, for Q4 specifically and not for the year, was it higher than the margins for the customers added? James Lewis No, the margin for the customer for Q4 and full year had [indiscernible]. Now, if we continue to look at those customers the mass markets are – has been added, as Rebecca talked about the bundles there, so that would be the case. Nelson Ng Okay. Pat McCullough So Nelson, we can help you with this offline. I know we put this full year fiscals in our MD&A, but we can pull apart the fourth quarter for you. Nelson Ng Okay, that’s great. And then, just in terms of the fiscal 2017 guidance, like once you back out solar and you kind of back out the – or adjust for the commercial commission prepayments, it implies like a growth rate of above 15% EBITDA for the base energy retail business. I guess, like what’s your expectations in terms of the customer level going forward for the year, compared to I guess the growth in margins? James Lewis Nelson, when you – if you look at it, I think – we’re looking at this from an overall cost perspective, we’re getting more value add, the customers were singing up, or cost selling, up selling investing customers with the filters, with the deck, with the LED lights, so we expect more value under the existing customers. As we bring on new customers, our expectation is that from next year, we’re mostly in the range of 300,000 customers to add. As you go – brings the guidance, typically, and now we didn’t have the other original value in gross margins a little bit. Nelson Ng So you expect modest customer growth than most of the EBITDA growth will come from higher margins per customer? James Lewis Yes. But we are expecting, as Rebecca said to add more customers this year. Rebecca MacDonald I think in the last couple of years, Nelson, what you’ve seen is a, cleaning up our customer base that grew over time with number of unprofitable customers and this theme of change is focused on financial metrics, way more than on actual absolute number of customers. And one thing that we have proven to ourselves is that the margin for customer with the bundled product that is growing, and we don’t expect any change there. Now, would we like to add more customers? Absolutely. But, we have created enormous amounts of discipline around the margin that we will accept for each customer. And if we are not able to get it, we are happy to walk away from it. So what Jay is saying, look at the bundle and look at additions. And, we want to add as many profitable customers as we possibly can. But the key is profitable. Nelson Ng I see. But I guess in terms of your revenue guidance, you’re assuming like a modest customer growth, plus stronger margins per customer to drive growth, right? Pat McCullough Yeah, this is Pat, Nelson. If you go back to our growth strategy, we’re expecting both customer top line and bottom line growth through three main initiatives, geographic expansion, product enhancements to both bundling, but also bringing superior product structures like flat bill products to markets, when volatility returns, we think those are going to exciting products, and then the enhancement of more things sold through the customer at higher value. Nelson Ng I see, okay. And then just kind of moving on to the balance sheet, so you have a $128 million of cash at the end of the quarter, like I presume you’ll allocate some of that to reduce debt, as you’ve done in the last quarter. Can you talk about your – I guess your uses of cash in the next year in terms of what you intend to do with that and also, are there any updates in terms of I guess refinancing or addressing the 2017 maturity? Pat McCullough That was more than one question. Sure, let me start at the top. So, we’re very proud of this quarter based on the cash generated. Not only did we report, as we mentioned a $128 million of cash, we actually paid down $25 million of principal on the high yields senior note. And yes, that remains the priority. As we generate cash and [indiscernible] the dry powder on our balance sheet, we support the restructuring efforts of the business, which we’re very pleased, are right on track and we’re very confident that we’re going to be able to restructure the long-term converts and debt on our balance sheet in a shareholder efficient manner. Nelson Ng And do you have any, I guess updated timing on the solution? Pat McCullough We’re consistent with what we’ve said in the past, we see this getting done this year, this calendar year. We won’t be spilling into the fiscal 2017 calendar year, or the calendar year 2017. Nelson Ng Okay. Thanks Pat. I will get back in the queue. Pat McCullough Thanks, Nelson. Operator Our next question comes from Carter Driscoll from FBR. Carter Driscoll Good morning. So, can you talk maybe just about the competitive situation and maybe in conjunction with some of the changing regulatory in particular, obviously your state had a bit of a hick-up in terms of its curves to the energy retailing market most recently. How do you kind of deal with that from a high level? And then I’ve a couple of follow-up. James Lewis Yes, Carter. We believe the [indiscernible] that’s what they were looking at, whatever the drivers is. And if you look at, historically, when we have those competition, it will drive long-term value. So what we’re doing is we’re working with industry groups, and all the other markets to make sure they have the right market structure in place, that can deliver those types of value. What you’ve seen in place, where you have open access to the bill and you have policy going, you can offer customer innovative products, such as bundle that depends on what you do when you have markets when we only have aligned among the customer bill. Rebecca MacDonald I’m so sorry, I’d like to add to this, management of Just Energy is confident that we would be able to maneuver to any regulatory changes that might show through the year. Being in this for 25 years, I have seen so many different regulatory changes over time, pendulum goes left to the right and back, and our approach by large is conversation with the local environment about moderation, everything has to be balanced. Governments do want to protect the customers, but responsible players want to protect the customers as well. And we see the best protection customer guest is a strong consumer protection act and a very good value proposition to that customer. If you don’t try to drive value then in our opinion you are not going to survive in the business. Pat McCullough And Carter, this is Pat. One of the other enticing things about our strategy is as we move to more off grid or let’s say grid unconnected products, we’ve come a lot less attendant on regulation versus deregulation trends, where some of our competitors are pretty concentrated selling commodity only in deregulated markets. We’re really moving away from that to a broader or more diverse portfolio of products. And if you think about some of the new companies that are selling solar energy storage, they are not constrained by deregulation versus regulated space. Carter Driscoll And to that point Pat, can you talk maybe about your tax rate for some of the new bundled product, maybe quantify a little bit, so we get a sense of how that translate from just commodity offerings? Pat McCullough Sorry, I didn’t understand the beginning of your question Carter. Carter Driscoll I was just saying, can you talk about the attach rates for some of the bundled services, relative to your existing RCE base and how that’s trended over the past few quarters, so we get a sense, or try to quantify going forward as we try to apply some level run rate to, you’re kind of decoupling from the largely dependents on the commodity markets. Pat McCullough Yeah, that’s right. And as we were talking about earlier, and as Jay alluded to. Number of customers versus RCEs, which are commodity equivalent and the products per customer are going to be major drivers of improvement for us in the future. And as we create more of these bundled attach solutions, we’re really piloting first and then scaling into solutions that provide better conversion upfront and then less attrition and longer lifecycles with customers. So if you can get a – obviously stickier, more profitable customer you’re really going to be working both the front end and the back end of those income and cash cycles. And we see evidence of that as we bring differentiated value propositions to our customers. And we’re excited because we’re really starting to get to the point where we can take some of these high levels like LEDs, smart thermostats and solar from tens of thousands of customers to more. Carter Driscoll But quantifying it, is that possible at this point, can you just talk about your tax rate, as from some period, or over a longer period of time, is it 5%, is it 10%? James Lewis I think earlier on, Carter, I think we see in the market where we’re able to deal with and attrition rate, we see attrition, say about 5 percentage points and some like is 10%. What you’ll see in those markets, where you have a control of the bill and you choose the right customer, we’re getting a much this year value composition in those markets. As we look and figure out the ways to deliver this and constrain markets where we don’t have that sort of bill, the stickiness isn’t that strong because the utility determined to win the dropped customers in those markets. So [indiscernible] strong, but in other markets it’s extremely strong. Pat McCullough And Carter, the direct answer to your question is no, we’re not presenting a tax rate at this point in time, but obviously as we move to a broader portfolio RCEs don’t really represent, the strategy what the business will be doing. So you will see us begin to report in a different way in the future where we’re really talking about number of customers and products per customer, so that we can directly to the answer to your question. Carter Driscoll Alright. And then, just maybe a couple of quick ones. On the national side, you talked about kind of the margin expectations as you penetrate and the time to reach maybe kind of, what you’ve earned domestically, and then is there any incremental spend for those two target markets, you’re looking to expand internationally, is that already baked into your EBITDA guidance for the year? Pat McCullough Yes, it is. We’re really looking to address two markets as Deb mentioned on the last call. We’ve put some investor materials out on our investor website, which showed the P&L and the cash over the last four years for our UK organic business development. We’re assuming a similar business case as we enter markets in Continental Europe. Now the difference in Continental Europe and the UK is, UK and Germany are the largest markets by far. So other markets that Deb spoke about, Netherlands, Austria, Ireland are smaller markets. But we do expect to see similar sized customers as the UK, those customers end up being much smaller than North American users of energy, but they end up being much more profitable on a common energy unit basis, meaning gross margin for RCE for example on commodity. So we’re believing, as we’ve said in the past that single-digit millions of dollars to penetrate two new markets, we don’t want to take more than that on in the year, but we expect to have breakeven just after about a year’s time and get a cash on cash return in less than two years, that’s what we experienced in the UK, that’s what we think we can do in the other Continental European markets. Carter Driscoll It’s very helpful. Then just lastly, I’ll sneak one in, on the Resi Solar side, what do you see in terms of pricing, obviously there has been some comments about slowdown in market, I think it’s more unrealistic expectations entering the year, but any kind of feedback you can give, what you’ve learned, whether you can hold EBITDA margins that you thought you would get from those markets and kind of the uptake, I know you reiterated the same contribution you did last quarter, but any incremental color would be helpful? Pat McCullough Yeah, I think we all know with SolarCity and SunEdison that the solar industry is taking some loss. It is impacting the cost of capital of our counterparties, and it’s impacting the cost of capital of financing solar across the industry. So yes, is the answer to your question that there is going to be pressure on our origination income and other parts of the value chain like installation and panels, which we do not participate in. But we really do believe we can hold higher origination income to the industry, but we’re obviously going to feel the same pressure that the industry feels. Rebecca MacDonald And just to add, we have already looked at solar and part of our bundle, because of diversified offerings we have to our customer base, we don’t want to hang our hat on any – not totally on solar and not totally on commodity, and that’s what does give us a real competitive edge. I would definitely, I don’t think this management team would want to be in 100% solar business today, and that’s not the space we would enjoy very much. Carter Driscoll Okay. I appreciate all your responses. I’ll go back in the queue. Thank you. Rebecca MacDonald You’re welcome. Operator We have a question from Damir Gunja from TD Securities. Damir Gunja Thanks good morning. Rebecca MacDonald Good morning. Damir Gunja Maybe can you just confirm the exact level of FX that you’re assuming in your forward guidance? Pat McCullough Yeah, Damir, we’re assuming 1.25 US deal saving. Damir Gunja Okay, that’s great. Thanks. And, I guess just a second one since everything was asked, I just want to confirm you quoted 300,000 customer adds for the coming year, that’s on a net basis? Pat McCullough Yes, Damir. And I think, the way we’re thinking about this, is it comes from geographic expansion, continued improvement in the UK, but also those non-RCE type customers. And I think solar being our energy storage pilot that we talked about in our outlook as well. Damir Gunja Okay. Got it. Okay, thank you. Operator We have a question from Sameer Joshi from Rodman & Renshaw. Sameer Joshi Hey, Pat, good morning. Pat McCullough Good morning. Sameer Joshi Just a quick question on – follow-up on Carter, line of questioning about the solar, is the outlook phase $10 million contribution to Base EBITDA from the solar business, should we expect the top line to be sort of in the same proportion as the $223 million to $223 million would reflect on the top line? Pat McCullough Relative to solar sales? Sameer Joshi Yeah. Pat McCullough Yeah, so I will refresh everyone’s memory on accounting for solar sales given we’re in origination business model. We’ll be experiencing the normal size installation that the industry sees, so I think 5, 6 kilowatts, we’ll be reporting revenue on the basis of the origination income that were paid. There is no cost of goods sold on our transactions, so gross margin will be equal to revenue. And then we’ll be recognizing our direct sales cost, our marketing efforts, our overheads between the gross margin and EBITDA lines. So that’s where you’ll see the fallout. We’ve talked publicly that we know third-parties are paying as much as $1 per watt, excuse me in Southern California, lower amounts closer to $0.50 in the Northeast, but we know that third-parties can hold as much as $1,500 US per transaction. We’re hoping to hold something in that range, but as I mentioned with Carter, there is quite a bit of pressure on those margins and with the heavy margins on the origination side of the business, we don’t think those will be sustainable for the long-term, but in the short-term we hope to experience those type of industry norms. Sameer Joshi Okay. That is helpful. And just two part question. Where there any installations in the – this quarter, in the last quarter, and going forward, are you giving any outlook in terms of solar installations, should we expect total installed base to be in the 5,000 to 7,000 range, and that 5 to 6 kilowatt per residence? Pat McCullough Yeah, if you use the industry norms, that’s the math that you would get to based on our guidance for fiscal 2017. And to answer your question that were limited installations done in fiscal 2016, they’ll become material to us in the coming year, so we’ll start to segment and show the details as to what we’re signing, what we’re recognizing as revenue gross margin needed up. Sameer Joshi Great. Thanks a lot, and good luck. Pat McCullough Thank you. Rebecca MacDonald Thank you. Well, if there are no more questions, I would like to thank you very much for joining us on this call. As management team, we really really appreciate your support, and if there are any other additional questions, all of us are available, you can call us directly. And look forward to talking to you in August when we report our first quarter. Pat McCullough Thank you. Rebecca MacDonald Thanks. James Lewis Thanks. Operator Thank you. Ladies and gentlemen, this concludes today’s conference. 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Chesapeake Utilities’ (CPK) CEO Mike McMasters on Q1 2016 Results – Earnings Call Transcript

Chesapeake Utilities Corporation (NYSE: CPK ) Q1 2016 Earnings Conference Call May 6, 2016 10:30 am ET Executives Beth Cooper – SVP and CFO Mike McMasters – President and CEO Analysts Nathan Martin – BB&T Capital Markets Operator Good morning. My name is Chrystal and I will be your conference operator today. At this time, I would like to welcome everyone to the Chesapeake Utilities first quarter financial results conference 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. I would now like to hand the conference over to Beth Cooper. Please go ahead ma’am. Beth Cooper Thank you, and good morning, everybody. I’d like to welcome you to our first quarter 2016 earnings conference call. Joining me today is Mike McMasters, President and CEO. And in addition to Mike, we’re joined by other members of our management team. For those on the phone today, we’re actually hosting today’s call live from Salisbury University in Salisbury, Maryland. The call is being held within the Perdue School of Business, so as Mike and I are alumni of that school, and we owe special thanks to Dr. William [ph] for enabling us to have the call here today, and included within our meeting we have members of the local financial community here in Salisbury. We have a board member. We have distinguished faculty and also many students here in the room. We are very happy here as I said. As usual today, presentation can be found on our website under the Investors section, the Events and Webcasts subsection or you can access our presentation via our IR app. One of the things I maybe like to point out on Page 1 of presentation, when trying to think about the themes and typically at the beginning of each year, we try to look at what are themes going to be for this as presentation. I pulled something from actually Mike’s President Letter in the annual report and basically within his letter he talks about that we’re driving growth by focusing on long-term sustainable growth opportunities. And hopefully today you will see that that’s really been the case our past – in terms of our past success, as well as what we think in terms of our future opportunities for continued earnings and dividend growth. Turning to Slide 2, this is the typical forward looking and other disclosures section. This presentation today will include forward-looking information. I encourage everyone to take a look at our Form 10-K, there is a section called Safe Harbor for forward looking information. Because some of the information that we talk about may actually differ from our actual results, and we discuss those factors that could cause our forward looking information to differ from the actual results. Turning to Slide 3, I’m now going to begin to touch on the first quarter results. And so what you’ll see is for the first quarter, we reported net income of $20.4 million as compared to last year of $21.1 million, a slight decline of about $740,000 over the prior quarter of last year. On the surface, earnings are down, yes, but certainly it’s driven by the weather. Weather represented for us about $0.27 in terms of decline in earnings per share for the quarter. Our growth that we experienced across – a good part of our businesses helped offset the weather impact and ultimately resulted in net income only being down by about 3.5% for the quarter — pretty remarkable. And that’s really been driven by – and we’ll talk about it a little bit later on — growth in our natural gas businesses, service expansions and customer growth and also the contribution of a new acquisition that we did last year. I’m next going to touch on our results by our segments. And included in our press release that we filed on Wednesday, as well as in our Form 10-Q that we filed yesterday, we provide detailed information about the accomplishments and results for our segments. And so I encourage you to take a look at that for more detailed information. In terms of our regulated energy segment, you will see that we generated an increase in gross margin growth of about $1.9 million. That $1.9 million of gross margin growth actually made its way to the bottom line to generate $2.1 million in terms of increased operating income. Overall, we saw an increase of $4.3 million in gross margin, that was driven by $1.9 million related to natural gas service expansions, our Florida Gas Reliability Infrastructure Program which we refer to as GRIP, generated an additional $1.1 million of margins, and natural gas customer growth, driven basically about half on the Delmarva Peninsula and half in Florida, contributed to an additional $745,000. The gross margin was up about $4.3 million, weather that was much warmer than the prior year offset that by about $2.4 million, resulting in that $1.9 million of margin increase that we saw. You will see expenses were pretty flat year over year, actually a slight decline which resulted in a $2.1 million increase in our regulated businesses, that once again helped to offset that significant weather impact in the first quarter. Turning to our unregulated businesses, which are certainly more weather sensitive, and you will see that here in the results. Our gross margin was down by $2.2 million. That was comprised of basically lower volumes of propane gallon sold which represented about $4.3 million. Our margins per gallon – we were anticipating that those would begin to return to more normal levels and we saw that start to happen. That represented about $1.8 million. And then weather basically — the combination of those two, when you think about, first, the $4.3 million and then the lower margins per gallon, that’s about $6.1 million. That was partially offset, as I mentioned, with the inclusion of Aspire Energy’s results in the first quarter. We acquired that last year on April 1, April Fool’s Day. And so we didn’t have them in our results for last year and they added about $4.2 million. So ultimately ending in the $2.2 million decline that you see here. Additionally we had about $1 million of higher expenses. Those were the result of Aspire being part of our operations. So overall this business was down about $3.3 million in operating income for the quarter, but all driven by the weather and then the lower retail margins which we had anticipated. The next page is actually a summary of a chart that we include within our 10-Q and also within our press release, looking at the factors from an earnings per share standpoint. And you will see, once again, I started off by saying that earnings last year for the quarter were $1.44. Weather contributed basically to a decline of $0.27. But you will see that growth in our regulated businesses added back $0.15 and the Aspire which is basically $0.06 also added to our earnings. So really a $0.27 per share decline was offset with the exception of $0.11. This is another chart – turning to Slide 7 – that actually shows the weather impact. And on this chart, we actually show a comparison relative to normal weather. Because it’s one thing to show a comparison relative to the prior year but compared to normal, what you will see is that we were down in Delmarva by 13% and down in Ohio by 10%. So we talked a little bit about the growth that we’ve experienced as a company. Strong growth in our natural gas businesses, I know this year, is somewhat offset in the first quarter by weather. But that growth has really been driven by the capital expenditures that we as a company have made, those investments have been made to earn either our target returns or greater than our target returns, and the dollars that we have invested have been very substantial. If you look at last year, we invested approximately $195 million in capital expenditures, $52.5 million of which was related to the Aspire Energy of Ohio acquisition. This year we’re projected to invest another $179 million. And when you look at that just a couple of key points relative to benchmark about those numbers. First, $179 million this year represents just under 30% of our total book capitalization. Our equity long term debt and short term debt are very substantial. When you look at this over the five year period, you will see that we’ve invested — will have invested $679 million. Our total book capitalization today once again is about $700 million. So huge investment that has happened over the last five years and are continuing this year. Our projects this year are comprised of about 82% regulated investments in our natural gas and electric businesses and the key projects that are underway include our Eight Flags combined heat and power plant that we expect to complete mid-year this year. Also, we’re expanding facilities to serve Calpine power plant in Dover, Delaware. We have a reliability project that’s underway and our Gas Reliability Infrastructure Program which replaces qualifying pipes and mains in Florida is another large component of our capital expenditure budget this year. So a very substantial project, the largest of which is our CHP plant, that’s about $40 million. And there are other projects that we’re constantly looking at to hopefully add to our pipeline to add further earnings growth as we move from this point forward. Some of those projects we know will not necessarily be incurred this year but may be incurred next year and we’re constantly looking for new opportunities. So while we have all these capital expenditures, it’s very important for us to have a balance sheet that supports those levels of expenditures. And so as you look at our balance sheet, as I mentioned we’re sitting with about $700 million in total book capitalization at the end of March. Breaking that down, when you look at it from a permanent capital perspective, our equity represents about 71% of that balance. When you look at it from a total capitalization, we’re capitalized about 53% equity and our target is 50% to 60% equity to total capitalization. Wanting to have that strong balance sheet, so we can make the investments that we need for continued future earnings growth. Last year we put into place several facilities with the amount of capital that we’ve expanded. We want to try to align as much as possible of the financing with those projects and those projects coming online. We executed a $150 million revolver agreement with five different banks. Currently at the end of March, we borrowed $40 million under that $150 million revolver. But it’s very important as we’re expanding the levels of capital that we have that short term debt capacity available. We’d also entered into a $150 million private placement shelf agreement with Prudential. And that enables us to basically take that shorter term debt and as those projects are placed into service, we can then finance the long term. And we will seek to utilize those mechanisms, those particular options that we have as well as access the equity markets as needed to always ensure that we’re looking towards that target capital structure that I mentioned. Given the growth opportunities we have, we talked a little bit about on past conference calls and a little bit earlier here in the room, that we recognized last year our ninth consecutive year of record earnings for the company. And we’re hopefully going to continue that trend. But looking at what we’ve accomplished and always trying to align our dividend growth, so it is supported by earnings growth. Earlier this week, our board increased our dividend by $0.07 which represented a 6.1% increase in our dividends, moving it from $1.15 to $1.22. What’s important also to note is that this was a 13 th consecutive year of dividend increases upon the prior year. So it’s not that we’re just increasing our dividend at the prior year’s amount, we’re actually stepping it up beyond that. We paid a consistent dividend for over 55 years. For the last 13, we’ve been constantly increasing each year. And as I mentioned, our focus is on dividend growth that’s supported by earnings growth and we expect a significant growth potential that we see in our businesses to continue to provide the opportunity for superior dividend growth in the future, just as it has in the past. Just a little bit of information, turning to Slide 11 in regards to our gross margin, I talked a little bit about our growth. You will see that last year in the middle of the chart, basically we recognized about $25 million from projects that we had placed into service in 2014 and thereafter. Those projects coupled with new projects that are coming online are expected to result in gross margin this year of about $44 million. So we’ve identified $19 million of margin increase that we’re expecting this year and those same projects are going to add an additional $7 million beyond that next year. So where is some of that gross margin growth coming from? I talked a little bit about the Aspire Energy transaction that we did, and you will see on here that basically that added — third column – that added about $4.2 million of gross margin for the quarter. Serving the Calpine power plant in Dover is at a considerable margin. They’re operating right now under our short term service agreement and ultimately when we place additional services into place next year at the beginning of the year, they’ll be under a long term contract for approximately 20 years. That added additional margin for us. And then last, the Gas Reliability Infrastructure Program added $1.1 million that I talked about earlier. So you will see from projects that have really already been done or set into motion, $15 million. We have two additional projects that are underway, that are going to add some incremental margin, the Eight Flags project, combined heat and power plant, that’s going to add $3.7 million and then next year will add $7.3 million dollars on a fully annualized basis. So a lot of growth that’s happened in the last several years. A lot of growth that we see happening from here on out in terms of projects that we’ve identified, and there are also many other projects on the drawing board. As always, thank you for your support and interest in our growing company. I believe this continues to be very exciting time for Chesapeake, as exemplified by our strong financial results. And certainly the weather was a downer in the first quarter but the amount of growth that the company experienced was able to match a large part of that weather impact. Now I will turn the call over to Mike who will expand on our strategic growth initiatives, our long term performance results and our commitment to continued growth for our shareholders. Mike McMasters Thanks, Beth. I guess I want to turn to Slide 13, 14 I guess – Slide 14, I am going to start talking about our strategic platform for growth. This is a pretty important slide for us as a company. We actually show this to our employees quite a bit, in addition to our board of directors and investors. We start at the bottom and work our way up engagement strategies, basically what we are trying to do is to get our employees more engaged in the company’s efforts. And we do that by allowing them, I guess, the opportunity to get more engaged in the communities that we’re serving. And so what we’re finding. I guess, with our efforts to do that is that we’re getting — I’m going to say — improved community relations. We’re getting improved productivity and therefore improved growth. And one of the key things that we have to do as a company, I guess, the first job really is safety. And so if we can maintain a safe system, we can maintain a reliable system, we take care of our customers and the communities, then we’re positioned for growth. Without those strategic ingredients, growth becomes more difficult. It’s fairly easy to sell services when they look at your track record and see that you’re doing – you’re in a very good development. The next step in the process, moving up the triangle, is developing new business lines and executing existing business unit growth. You think about a utility — as the utility matures, it becomes more and more difficult to grow, and you will see that a lot in the electric industry today. And so what we’re having to do is, so let’s think about things differently. Let’s not just stick to the same services we’re providing, now let’s expand the services that we can provide. In addition, let’s look beyond our current service territories and see if we could grow outside of our territories to help increase our growth, and that’s how you get numbers like the $100 million worth of CapEx et cetera. And then finally, all that shows up in results. And you can see safety awards, community service awards, achieving top quartile growth in earnings, achieving top quartile growth in shareholder return. Turning to Slide 15, there are several things here, and just in a moment ago, I want to point to the last bullet on the slide. This is the fourth consecutive year for the Chesapeake, it was recognized as the Top Workplace. Well the significance of that just says, the engagement strategies are working. It is allowing employees that participate in community service activities. Our executives generally, I want to say almost every time, are also participating whether it’s the Food Bank, Steve is on a couple of different boards, at the time the humanity, for building homes, also and the Food Bank, Steve joined that network as well, these different services. So there is also of different things that our executives are doing and our employees are doing and that’s driving team work and engagement. Turning to Slide 16, I guess to the community side, we get a lot of stuff here but one of the things I will point out here. There are several awards here that were very important to us. The second bullet — Central Delaware Chamber of Commerce Excellence in Business Award for Corporation of The Year. Again, that was based on our community contributions, and the last bullet, just last few months, we got an award — Jefferson Awards in Delaware for Outstanding Service by a Major Company. And so it’s these types of awards that are telling us that we are accomplishing something that our employees –our employees are doing great things and the communities are recognizing what we’re doing. Strategic planning and thinking is one of the key processes that we have for growth. The way we attack I guess strategic planning and thinking is that we set very high growth targets in our strategic planning process – targets that really we could not hit if we kept doing the same thing. So it forces us every year to help — what are we going to do differently tomorrow to help accelerate our growth. We involve every business unit. Just about every employee in the company, at some point of time is involved in the strategic planning process. Every business unit is very much involved in the strategic planning and process. If you roll the clock back probably 10 years, maybe 15, I don’t know how far back it was, we used to do the strategic planning in the corner office. And so the slower speed we’re getting — we would talk about all this stuff and we would write this plan out and we’d put it on the shelf. And next year we go pull it off the shelf. Do it again and nothing ever really happened. So we changed the whole way we approached that and said, okay, let’s get the business units in here. Let’s ask them, what do they see happening in their markets and how can we grow the company, and through that change in the process it took two or three years. But we all of a sudden started getting great ideas coming in the door and the business units were engaged and empowered to execute those plans. That’s a significant change for us. We monitor the conditions that we’ve –or the assumptions that we had in the strategic plan. Constantly, we update the board on that constantly. And we make changes to the plan if necessary when circumstances dictate. Turning to Slide 18, this is another part of the process — part of our growth process. We formed a Growth Council several years ago. The Growth Council — same type of approach. We want to get all the business units involved in the growth council. What the council does is it evaluates the strategic objectives or plans, or actually initiatives that we’re working on, if you bring in specific projects, they’re involved with challenging, the business unit leader that brought the project in, asking good questions, forcing a real thorough evaluation of the project. In that council we had legal counsel, we’ve got engineers, accountants, every business – just operations people, a whole variety of people that you look at the same thing from a variety of perspectives. And that actually is part of our key to sustaining our growth as well. If we’re making good investments we’re going to get returns. We’re going to be able to continue to attract capital. And obviously you can’t grow if you’re not getting the capital. I guess a follow-on here, to give you an idea of how we look at these things – this is a form of illustration but you can see, start with information gathering, identifying opportunities. About 50% of the projects that we’re looking at are in that category. We weed out some of those, we get down to feasibility analysis. About 20% of the project would be expected to be in that category. And then proposal development, offer negotiation, and execution, as you can see, we’re weeding projects out of the opportunities that we see as we work our way down. It was probably a year ago, I think Beth and I were in Boston and somebody asked me, if we ever rejected a project. And I was sitting there, I was actually stumped for a minute, and I think, we reject almost all the projects. And then I’ve been thinking about it, after it occurred to me that, I guess that would be a question if you’re doing a lot of – making a lot of capital investments, the expectation might be from the other side as well. You guys are just doing everything that you come across the table and we do have a strategic set of criteria on these projects as well. So we’re not just doing anything that looks like to be profitable or making sure we’re sticking to things that we understand and that’s what we know how to do with this with our strategic plans. Turning to Slide 19, it’s something about — looking around what are the results of all the stuff. Beth gave you a pretty good picture of that. But this is just something that we look at all the time. So you’re looking at the ROE which is the vertical axis and you’ve got the capital expenditures force horizontally. And you’ll see Chesapeake in the top right hand quadrant, which simply means that we are above the 50% in both ROE and also CapEx, so we’re deploying a tremendous amount of capital. And we’re maintaining returns and that’s a pretty big challenge. You can see how few companies are over there near us and when you do that you’re going to drive EPS growth. All these other dots are just a variety of companies. It’s the electric and combination companies, it’s also an industry index for people that we use in our index for marketing our performance and then Chesapeake. So it’s not cherry picking of the peer group, it’s actually a broad range of companies. So then what happens – Beth talked about nine years of record earnings, so if you look at the blue line, I am on Slide 20, look at the blue line. Record earnings per share, the blue line climbing from roughly, you can see that $1.20 up to almost $2.80. Over this time period, ROEs maintained, actually climbing a little bit which is pretty hard to do in that kind of environment, up to little over 12. So it’s been a very successful process that we’ve been implementing and it requires a lot of discipline. So also shareholder returns, so what happens with this. We’ve looked at broader comparisons. This was something Beth was just I guess thinking about one day and did a lot of work to come up with some numbers. And when we looked at and we thought these numbers were little scary, little high. It was, what we can — nobody’s going to believe us. So we asked one of our investment bankers to tell us – help us with the analysis and they put together their own and so we use theirs. The numbers are consistent. But as you can see 84 th percentile in five years and then after that you get 86 th percentile for one year, 80 th percentile for three and then 89 th , 10. So substantial I guess [indiscernible] measure there. With an annual large shareholder returns, you see the median — we joke around about this too. Utility business sometimes is pretty tough to grow as you get bigger. So you will see a negative 5.1% could be weather related, could be pricing relate type of thing. And you can see Chesapeake over the 75 th percentile in all four periods. Once again we go to the S&P 500 — maybe the NYSEs big in our peer group. If you go the S&P 500 similar type results for 73th percentile in five years and then up over 75 in the other two periods. So it’s just I guess a measurement of our discipline. This is a table that we use periodically on Slide 23. The lightly shaded blue or those metrics where we didn’t hit to 75 th percentile, all the others we were at 75 th percentile. We have another table that shares — we have basically, 18 out of 20 times was 75 th percentile. So again things that we’re very proud of, and again you can go back to the processes that we talked about earlier, that are responsible for that, obviously the people that are executing on those processes. So now what are we doing tomorrow? We talked about what we did yesterday. One of our key I guess brand values is simply that we don’t rest on our laurels and so we like to celebrate the victories but we know that really it’s about what we do today and tomorrow, that’s going to count. And so here’s a few of the projects that we actually mentioned these. You can see we’ve got three projects here on Delmarva, the White Oak expansion, Beth talked a little bit about the impact of that on earnings. That’s just obviously a significant project for us. We’ll be constructing that soon. I guess we’re still working with FERC to get approval to do that. The TETCO capacity expansion in the second row is an interesting opportunity that comes and goes really. With the TETCO, it’s obviously connected to TETCO, Texas Eastern. And there’s lower cost of gas on Texas Eastern than there are on other pipelines that are nearby. And so what happens is customers may not have subscribed to move gas on that pipe, that section of the pipe, but when those prices change and TETCO become significantly cheaper than the other place, all the companies or the major companies are interested in trying to get more gas off of TETCO, that are subscribed to use long term capacity or just to use short term interruptible capacity to do that, so we get some earnings supplements from that line. The next box down, Eastern Shore Natural Gas System Reliability, going back to the polar vortex that showed some weaknesses and some upstream systems, and that’s flowed through to us. We also learned things about our system so we’ve done – we’re working on a distribution system to improve that. We also have a filing with the FERC to improve our transmission systems and we have to be ready for low gas pressures coming into our system lower than we historically had seen in the past. So it’s an important thing and reliability is obviously a critical issue for us. Florida and Ohio. Florida Public Utilities has a Gas Reliability Infrastructure Program, Beth talked about that. Once again that’s about safety and reliability. It was a very little to natural gas prices now. It was an opportune time to look at and is strengthening your system, so we’re doing that. Eight Flags, Beth talked a little about that as well. That project is expected to come online in June or July of this year, so it’s I think over 90% complete, was the last number we heard, just as strong as we get actually. Aspire Energy of Ohio, that was the acquisition we did last year. So all of these things, if you look at these Eight Flags, it’s a completely new service we never provided. Aspire Energy of Ohio, completely new service territory. We weren’t serving — and the services are slightly different than what we provided. So you’re getting two out of the six big projects are either new service or new territories. And it’s a picture of Eight Flags, it’s actually – the picture was taken with them celebrating the safety. I mean there was – I forgot the number of days now per hour – 60,000 hours of — without an injury, without an incident. So there’s safety, there is special celebration going on there. But the significance of Eight Flags, first, it’s a new service, we didn’t know how to do that. I want to go back even to the beginning. We got a phone call, that hey, we’re considering. This is Rayonier on – that we’re considering going off the grid, really electric utility on to the aisle. And so that means okay, we’re not going to use the electricity. And so we were looking at things, concerns about earnings deteriorating. So the team in Florida walked into the plant, just did a tour, brought some experts and got some experts involved to help us look at opportunities in the plant. And they came up with the idea, well, we could build a combined heat and power plant here and lower your steam costs. And we can scale it up on the electric generation side, because we’re the electric utility and we can buy the power cheaper from this facility than we can buy from on the grid — from the grid. So we turned what was a loss into a win. So as a result of this, Rayonier is saving money. They’re actually expanding their facility now. Two big wins are for Rayonier. For us, we have lower cost power coming into our electric system. So that’s going to help the customers on Amelia Island as millions of dollars of savings associated with that, and in early we had higher earnings. So it was a very big deal, very creative, it was a new service, a good job. And on top of all of that, we used a lot of our different capabilities. Obviously the electric utility was involved, had to build a pipeline, reinforced our pipeline there, we had a gas pipeline. So our gas, or distribution company – gas distribution companies involved and then also we have a company that’s marketing — natural gas marketer that was involved in solving the problem as well. So we took a variety of skills that we had across our entire company to help solve that problem. So that’s really talked about our strat plan and what we’re trying to do, be flexible, be able to do a lot of different things, solve customers’ problems has been a key factor in our success. So with that, I’ll turn it over to questions. Question-and-Answer Session Operator [Operator Instructions] Your first question comes from the line of Nathan Martin with BB&T Capital Markets. Nathan Martin Good morning everybody. Thanks for taking my questions. I guess, first just kind of given the current gas LDC M&A environment and obviously your clear goals to grow, would it be reasonable to assume you guys would execute possibly another deal or two by the end of this year? And kind of – if so, you mentioned you’re continuing to look at opportunities outside of your current territories. Are there any certain types of geographies you’re prioritizing, or would you basically consider anything if the returns and strategic fit are there? Mike McMasters I guess, let me do the first question first. When it comes to acquisitions, we are constantly looking for acquisitions. And you know how that works, you have a hard time, that you can look at it, 10, 100 — you look at a lot of acquisitions. And it’s very difficult to get anyone in particular to the finish line. And so forecasting out is just extremely difficult to do that. At least we just don’t do that but we are looking at several opportunities in that regard and we’re probably — always will be looking at several opportunities. You know that, funnel when you have that first – the top piece of the funnel, and you’ll have a lot of things in there that fully won’t come to fruition. Very few actually get through. So we can’t really forecast that. I’m trying to think the second question now. Nathan Martin Basically as far as geographies — you guys are continuing to look at opportunities outside of your current territory – Mike McMasters There’s maybe a natural tendency for us to be focusing on primarily the East Coast. We’ve been in Florida since the 80s, and so we are comfortable in Florida. And when we’re comfortable in Florida, that we’re going to be comfortable as we look to Georgia et cetera, in contiguous states. And we’ve got — I think primarily the focus is on the East Coast. If we saw something good that was East Coast – I am including Ohio in the East Coast, in that definition. As we get much further west of Ohio it maybe becomes – I don’t know, we’re having seen anything over there actually, so we don’t spend whole lot of time looking that far west. But that’s not to say that tomorrow if we don’t find something that’s attractive and strategic fit that we would look at it. Nathan Martin Thanks for that color. And then just in the same vein, I mean, looking at these opportunities, just trying to figure out where you lean more towards regulated, unregulated, or again is it just come down to strategic fit? Mike McMasters We are a different right — the regulated and unregulated. Aspire Energy of Ohio has basically gathering system delivering gas to either interstate pipelines or delivering gas to LDCs. And so we’re perfectly comfortable in that business. There is some commodity risk associated with that business. But we’re comfortable with that. So it is not whether it’s regulated or unregulated, it’s really what’s the opportunity and the strategic fit. End of &A Operator [Operator Instructions] There are no further questions at this time. I would like to turn the call back over to President and CEO Mike McMasters. Mike McMasters Thanks everyone for joining us on the call today and for your interest in Chesapeake Utilities. We’re here in Salisbury with members of local community at our meeting, and want to thank Salisbury University again for allowing us to use their facilities. We’re proud of what our team has accomplished for shareholders in the past and remain committed to working hard to deliver superior shareholder returns in the future. Thank you. Operator This does conclude today’s conference call. You may now disconnect. Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. 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Edison International (EIX) Theodore F. Craver, Jr. on Q1 2016 Results – Earnings Call Transcript

Edison International (NYSE: EIX ) Q1 2016 Earnings Call May 02, 2016 4:30 pm ET Executives Allison Bahen – Senior Manager-Investor Relations Theodore F. Craver, Jr. – Chairman, President & Chief Executive Officer Jim Scilacci – Chief Financial Officer & Executive Vice President Pedro J. Pizarro – President & Director, Southern California Edison Co. Adam S. Umanoff – Executive Vice President & General Counsel Maria C. Rigatti – Chief Financial Officer & Senior Vice President, Southern California Edison Co. Analysts Julien Dumoulin-Smith – UBS Securities LLC Greg Gordon – Evercore Group LLC Jonathan Philip Arnold – Deutsche Bank Securities, Inc. Praful Mehta – Citigroup Global Markets, Inc. (Broker) Steve Fleishman – Wolfe Research LLC Michael Lapides – Goldman Sachs & Co. Brian J. Chin – Bank of America Merrill Lynch Ali Agha – SunTrust Robinson Humphrey, Inc. Operator Good afternoon and welcome to the Edison International First Quarter 2016 Financial Teleconference. My name is Maddie, and I will be your operator today. Today’s call is being recorded. I would now like to turn the call over to Ms. Allison Bahen, Senior Manager of Investor Relations. Ms. Bahen, you may begin your conference. Allison Bahen – Senior Manager-Investor Relations Thanks, Maddie, and welcome, everyone. Our speakers today are Chairman and Chief Executive Officer, Ted Craver; and Executive Vice President and Chief Financial Officer, Jim Scilacci. Also here are other members of the management team. Scott Cunningham is not here today, as he is recovering from minor surgery and should be back in the office soon. Materials supporting today’s call are available at www.edisoninvestor.com. These include our Form 10-Q, Ted’s and Jim’s prepared remarks, and the presentation that accompanies Jim’s comments. Tomorrow afternoon, we will distribute our regular business update presentation. During this call, we will make forward-looking statements about the future outlook for Edison International and its subsidiaries. Actual results could differ materially from current expectation. Important factors that could cause different results are set forth in our SEC filings. Please read these carefully. The presentation includes certain outlook assumptions, as well as reconciliations of non-GAAP measures to the nearest GAAP measure. During Q&A, please limit yourself to one question and one follow-up. I will now turn the call over to Ted. Theodore F. Craver, Jr. – Chairman, President & Chief Executive Officer Thank you, Allie, and good afternoon, everyone. Our first quarter core earnings were $0.82 per share, $0.08 per share lower than last year’s first quarter. Most of this decline was due to timing differences at SCE during 2015, which were caused by the delay in receiving the 2015 to 2017 General Rate Case. The underlying earnings in the first quarter of 2016 are consistent with the profile we expect for the year. Therefore, today we are reaffirming our 2016 core earnings guidance of $3.81 to $4.01 per share. Jim will elaborate on all of this in his remarks. I will focus most of my comments today on SCE’s long-term growth potential. This is particularly relevant as we prepare for our 2018 to 2020 General Rate Case filing in September, and as the dialogue continues before the CPUC on the Distribution Resources Plan and related proceedings. We believe that there is good visibility to long-term sustained investment of at least $4 billion annually. They should in turn yield rate base growth of approximately $2 billion a year. We have confidence in these levels of investment for several complementary reasons. First, our strategy is very much aligned with California’s goals of creating a low carbon economy and providing customers with energy technology choices. Second, we see several different infrastructure areas that require years of continued investment, all of which can be expanded further from today’s levels and can be flexibly substituted for each other. Third, we have been steadily improving our ability to control overheads and fuel and purchased power costs in order to keep customer rate increases low, even with higher capital expenditures. And finally, as our rate base continues to grow, higher levels of investment can be more easily digested without stressing equity levels or our ability to execute the work. I will expand on each of these points further. As we look at the potential investments on the horizon, they support, and are supported by, several critical public policy initiatives. The overarching policy support comes from California’s desire to create a vibrant low carbon economy. This is not solely a goal of policymakers, but rooted in strong public support across income and ethnic divides. It is well understood that the state’s low carbon goals cannot be met without substantially greater electrification of stationary and mobile sources of energy use. Decarbonization is supported by California’s existing carbon cap-and-trade system, which does not rely on U.S. EPA’s new carbon rules to be implemented. There is also strong support for clean energy technology development in the state, driven in part by the importance of Silicon Valley to the state’s economy and its political influence. Importantly, Edison supplies the critical electric infrastructure investment needed to meet the state’s low carbon goals and facilitate customer choice of new clean energy technology. Let me discuss the areas of infrastructure investment needed to meet the goals of providing safe, reliable and low-emitting power to our customers. Starting with the basics, reliability of the core electric infrastructure requires routine replacement of ageing poles, transformers, underground cable and so on. Our system grew rapidly after World War II through the 1970s. Therefore, many components are reaching their mean time to failure and must be replaced. SCE’s infrastructure replacement program alone represents more than half of our total distribution system capital expenditures. To give you an idea of the size of this task, each year we replace on average 24,000 distribution poles, 4,000 transmission poles, 500 miles of underground cable, and 225 substation circuit breakers. Complementing basic infrastructure replacement is the need to adapt our power grid to changing customer preferences and to new technologies. This evolution to a technologically advanced electric delivery system was outlined in the Distribution Resources Plan, or DRP, that SCE filed last summer. Many of these potential investments are incremental to the investments that make up our current $4 billion annual CapEx. This vision for modernizing the grid will be an important principle as SCE develops its upcoming General Rate Case filing. The CPUC’s regulatory proceedings on distributed energy resources are still in the early stages. Initial insights from the proceeding appear to endorse some of the approaches we recommended in our DRP filing, while suggesting different approaches in other areas. SCE’s General Rate Case filing will be made well before the CPUC has made its full recommendations in the DRP and related proceedings. As a result, SCE will be making its best judgments on the scope and approach to grid modernization in its GRC filing. During the general rate case proceeding, SCE’s views will be synchronized with those of other stakeholders, informed by the discussions taking place in the CPUC’s broader Distribution Resources Plan proceedings. The GRC will be the cornerstone proceeding for determining SCE’s distribution system investment program. However, there are several complementary initiatives that represent additional investment in the power grid of the future, and that are not part of the current $4 billion annual CapEx. The first is electric vehicle charging. Last month, the CPUC officially authorized SCE to commence spending under the Charge Ready pilot program they previously approved. The pilot covers the first 1,500 stations of an eventual plan for 30,000 charging systems. The total program is estimated to provide roughly one-third of the charging infrastructure needed in SCE’s service territory for autos and light-duty vehicles at multi-family dwellings and public locations. While the rate base opportunity for the full program is approximately $225 million over several years, it is possible that the CPUC will consider higher levels of utility investment in charging infrastructure. Longer term, we think it is likely that additional opportunities for vehicle charging and other infrastructure may result from the transportation electrification initiative included in Senate Bill 350, signed into law last year. The bill is better known for establishing the mandate for electric utilities to deliver 50% of their customer load from renewable resources by 2030. But it also expanded the potential scope and scale of transportation electrification, which could support investments beyond SCE’s current Charge Ready light-duty vehicle initiative. The objective is to support California meeting its long-term carbon reduction targets and federal Clean Air Act standards. The electric sector in California, especially the three investor-owned utilities, have become very low carbon-emitting, while the transportation sector has not. The result is that today nearly 40% of total carbon emissions in the state comes from the transportation sector, compared to less than 20% for the electric sector. As part of the implementation of SB 350, this fall the CPUC is expected to order investor-owned electric power companies to submit proposals for investments and programs that will accelerate widespread adoption of transportation electrification. This would include potentially higher levels of light-duty vehicle charging infrastructure than SCE’s current target of providing 30,000 chargers. It could also include charging infrastructure for medium-duty and heavy-duty vehicles such as electric buses, trucks and tractors, which are especially important in meeting increasingly stringent air quality requirements in the LA Basin. These early concepts were part of the agenda at a CPUC workshop in San Francisco last Friday, hosted by assigned Commissioner Peterman. Another potential investment class not included in our $4 billion annual CapEx is the CPUC’s energy storage initiative. SCE has the opportunity to build half of its required 580 megawatts of energy storage and place it in its rate base by 2024. We have yet to attempt to estimate the potential capital spending, rate base or timing of this investment. However, storage is a mandated program and could be significant. The DRP process may spell out a greater role for storage solutions located in the distribution systems as the economics improve and the carbon-reduction attributes of storage relative to gas-fired generation become more apparent. Transmission investments remain an important complement to SCE’s distribution system investment program, though the planning process and scale are quite different. SCE continues to implement three major California ISO-approved investments. These projects are needed for transmission reliability and support the State’s renewable portfolio mandate. On April 11, SCE received a proposed decision to approve the $1.1 billion West of Devers project recommended by SCE and the California ISO. You may recall that we informed you last November of delays in the regulatory approvals of this project due to consideration of an alternative, staged-project. The proposed decision largely adopts the project as we originally proposed. It could be approved as early as May 12. Assuming the PD is adopted by the Commission, and once the required federal approvals are received, the project will be ready to begin construction. The West of Devers project will help California meet its 50% renewables portfolio standard. California ISO is in the early stages of planning for the transmission infrastructure to meet the expanded renewables requirement. This will be integrated with efforts underway to extend the span of the ISO to include adjacent electric power companies in other states. There is likely to be a continuing debate about whether the future resource mix should favor more utility-scale renewables with expanded transmission capacity or distributed resources enabled by an advanced distribution system. I expect it will be a mix of the two models. SCE is positioned to participate in both models. We expect either approach will expand the investment opportunity at SCE beyond the current $4 billion annual level. While it is difficult to predict the exact trajectory of investment levels required to support California’s policy objectives, our general belief is that investment levels could potentially grow beyond current CapEx levels. A critical objective that we and the CPUC share is to avoid causing customer rates from becoming unaffordable due to this expanded infrastructure investment. Our objective has been to keep customer rate increases at or below the rate of inflation in our service territory. To date, our record of accomplishing this goal is quite good. The compound annual growth rate of SCE’s System Average Rate has consistently stayed below that of the Consumer Price Index for our service territory. This is true, whether you look at the last five years, 10 years, 15 years or even the last 20 years. It is especially notable that this has occurred when kilowatt hour usage since 2007 has been flat to declining. Indeed, our System Average Rate in 2016 has dropped 8% from 2015 levels. Importantly, customers react mostly to their monthly bill, not kilowatt hour rates. And our average monthly residential electric bill last year was $94, meaningfully below the national average of $127 a month. We have accomplished this through a sharp focus on reducing overhead costs, creating efficiencies, and due to the benefits of the SONGS Settlement as well as declines in fuel costs. A concluding thought on keeping rates affordable longer term; I believe the growing percentage of the renewables in our generation mix is creating an excellent hedge against the potential future spikes in natural gas prices. Although I don’t expect much upward pressure on natural gas prices in the near to intermediate term, it is difficult to imagine much room for prices to go lower. SCE’s generation mix will move up from the current level of roughly 25% renewables to 50%. The cost of renewables new-build is increasingly becoming equal to or better than natural gas new-build. Also, since renewables have no fuel cost, customer rates are increasingly less exposed to future natural gas price spikes. All of this helps to keep our rate increases modest and electricity affordable, while we increase our investment in building an advanced electric delivery system. As I’ve discussed, SCE has several potential areas of incremental investment, which gives us flexibility to ramp up one program if another starts to lag. This, along with the steadily expanding rate base, earnings and cash flow, allows us to maintain a reasonable and growing total investment program without creating pressure to issue equity or having customer rates rise beyond inflation rates. A balanced program like this should also allow us to continue to provide higher-than-industry-average growth in earnings and dividends. I’d like to conclude with a brief discussion of power grid reliability this summer in the wake of the Aliso Canyon shutdown. SCE is working closely with California regulators and Sempra’s Southern California Gas Company on impacts from potential delays in returning the Aliso Canyon gas storage facility to use. Aliso Canyon provides pipeline pressure balancing to the Los Angeles Basin year-round. It also provides additional supplies in the winter when heating needs increase demand beyond the capability of interstate pipeline deliveries. SCE is one of SoCal Gas’ largest customers and very focused on this issue. Because of the shutdown, the risk to electric reliability has increased, which presents its own public safety implications. As we see it, the best scenario for electric reliability is to expeditiously complete inspections of a few of the more important wells to determine if they could be safely returned to service in time for summer peak power use. SCE is also working on contingency plans to reduce demand and maximize generation flexibility. At the CPUC’s direction, SCE has requested a memorandum account to track any unusual costs related to Aliso Canyon. These include costs related to demand response, energy efficiency, power contracts, et cetera. These costs are not expected to be sizeable. Any extra customer costs related to inefficient power plant dispatch will be captured as part of the ERRA balancing account mechanism. Although this situation shouldn’t create financial risks for SCE, it is a potential reliability issue for our customers. Okay. That’s it for me. I’ll now turn it over to Jim for his financial report. Jim Scilacci – Chief Financial Officer & Executive Vice President Okay. Thanks, Ted. Please turn to page two of the presentation. As Ted indicated, today we are reaffirming our core earnings guidance. I want to emphasize the quarterly earnings profile will be difficult to model given two primary factors; SCE’s delay in receiving its 2015 GRC decision and because revenues are generally weighted towards the third quarter of the year. As discussed when we introduced our 2016 earnings guidance, the simplified rate base approach is the best way to think about SCE’s earnings power on an annual basis. SCE’s rate base is growing, and this implies increasing earnings. However, anticipated revenue increases from both the CPUC and FERC were masked by the timing of revenues recognized in 2015. You will recall that until SCE received its 2015 GRC proposed decision, revenues were largely based on 2014 authorized levels. SCE recorded a significant year-to-date revenue adjustment in the third quarter of 2015 and a large regulatory asset write-off in the fourth quarter in connection with the final decision. With that in mind, let’s look at SCE’s earnings drivers. To simplify the earnings explanation, we removed the impact of San Onofre and tax repair and pole loading deductions. On a GAAP basis, as shown in the 10-Q, revenues are down $41 million, which is equivalent to $0.08 per share. As explained in footnote four, the 2016 revenue reduction relates to incremental tax repair and cost of removal deductions for the pole loading program in excess of levels authorized in the 2015 GRC. As we have previously explained, the GRC decision established balancing accounts to track forecast differences compared to actuals. Importantly, with these balancing accounts, there is no impact on earnings. Lastly, this is also the main driver for the low effective income tax rate for the quarter. After the adjustments, revenues are a net $0.04 per share positive contribution on a quarter-over-quarter basis. Breaking revenues down, there is an $0.08 per share GRC attrition mechanism increase. This mechanism provides for increases in revenues after the 2015 test year. Largely, offsetting this is a $0.06 per share timing issue on the GRC decision. As I mentioned earlier, reductions in authorized revenues from the GRC decisions are not reflected in the first quarter or second quarter 2015 results and were adjusted in the third quarter with the proposed decision and then again in the fourth quarter with the final GRC decision. Finish up on revenues, FERC revenues are $0.02 per share higher, largely for higher depreciation expense. This nets to a positive $0.04 per share earnings contribution from revenues. Moving to O&M, costs are $0.04 per share higher than last year. A significant factor in this was planned El Niño preparation costs, where SCE staged equipment such as portable generators in areas that could be sensitive to storm-related outages, as well as costs associated with responses to storms. While the Southern California El Niño phenomenon did not materialize at the level that had been predicted by many, we did see more significant storm activity than we experienced in 2015. Other important items include planned higher costs for distribution system inspections as well as higher severance costs resulting from ongoing efforts to drive increased productivity and efficiency. Higher depreciation of $0.02 per share reflects the normal trend supporting SCE’s wires-focused capital spending program. Income taxes, excluding the tax balancing account related items I’ve already discussed, are $0.02 per share higher than last year. The effective tax rate in the quarter is 14% compared to 24% last year. As I said previously, the lower rate largely reflects the incremental tax benefits above authorized levels. Excluding the $0.13 per share incremental tax benefits, the effective tax rate would have been 34%. Turning to Edison International earnings drivers, overall costs are higher by $0.03 per share. Holding company costs are comparable to last year. We had no affordable housing earnings this year, since the portfolio was sold last December, while in Q1 of 2015 we recorded $0.01 per share of earnings. Edison Energy’s net loss is $0.02 per share higher than last year. This reflects expected development and operating costs of Edison Energy’s businesses and timing of revenues from the newly acquired businesses. Revenues are $6 million in the first quarter of 2016. Our reported sales from last year were $3 million and only included SoCore Energy and not the recently acquired companies. I’d also like to remind investors that our financing strategy for SoCore Energy’s commercial solar program primarily uses third-party tax equity and project financing. As a result, a portion of project economics go to the tax equity investors. Holding company results on a core basis exclude earnings related to the hypothetical liquidation at book value accounting method for SoCore Energy’s tax equity financings. This is $0.01 per share this year versus $0.02 per share last year. So overall, Edison International core earnings are down $0.08 per share. Please turn to page three. SCE’s capital spending forecast is unchanged from our last call. First quarter and actual SCE’s spending of $1 billion is consistent with 2016 authorized levels. Keep in mind that this forecast does not include any DRP-related spending. SCE will continue to evaluate whether to pursue any early stage work this year. Page four shows SCE’s rate base forecast, which is also unchanged. Please turn to page five. The West of Devers project Ted mentioned is one of the two large transmission projects where most of the investment will be on the current rate base guidance period. Some of you may have followed this proceeding, and there’s one unique aspect to the project. Some of the West of Devers route transits the Morongo Indian reservation in the Coachella Valley. As discussed in our 10-K, a Morongo transmission entity has an option to invest $400 million or up to one half of the $1.1 billion project at commercial operation, which SCE expects to be in 2021. For internal planning purposes, SCE assumes that the option will be exercised. The 2018 GRC will include capital expenditures through 2020. With the option exercise date falling just outside of the period of time we will be providing more visibility on, we thought it was important to bring this option to the attention of investors and analysts. Please turn to page six. We have reaffirmed our core earnings guidance for the full year at $3.81 per share to $4.01 per share and updated our GAAP guidance for first-quarter non-core items. Our key assumptions are also unchanged. That’s it for me. Operator, let’s get started with the Q&A. Question-and-Answer Session Operator Thank you. Our first question is coming from Michael Weinstein of UBS. Your line is now open. Julien Dumoulin-Smith – UBS Securities LLC Hey, it’s Julien here. Jim Scilacci – Chief Financial Officer & Executive Vice President Hi, Julien. It’s Jim. Julien Dumoulin-Smith – UBS Securities LLC Hey, Jim. So, first question, you talked about SB 350 on the call just now. Can you elaborate how the regulatory schedule would jibe with what you’ve already underway on the 30,000 EV deployment? And kind of when you think about the scale of deployment contemplated and the ability to own it, I mean what kind of opportunity is that relative to even just the $225 million (30:37) elaborated? Jim Scilacci – Chief Financial Officer & Executive Vice President So, Julien, I’m going to turn that over to Pedro Pizarro. Pedro J. Pizarro – President & Director, Southern California Edison Co. Hi, there. So, starting with the charge rating piece, I think Jim and Ted had mentioned already we now have approval for the pilot phase, that’s the first 1,500 chargers’ worth. And as soon as we get to the pilot phase, we’ll go back to the PUC with a report and have that proceeded and seek authorization to take on the balance of the up to 30,000 chargers covered by the Charge Ready program. And I think we’ll have visibility into that, and in terms of the regulatory timeline for that, I think it’s envisioned that the pilot might take up to 12 months, we will go to the PUC as soon as we have enough data from the pilot. And tough to forecast how long it might take the PUC to provide approval for the balance of the Charge Ready Program, but we will be going back as soon as we have pilot data. Separate from that, in terms of additional opportunities, I think in Ted’s remarks he commented how it is possible that the PUC might envision a further role for us; I think, a couple directions for that. One could be that with the Charge Ready program, we’ve estimated those 30,000 chargers would cover about a third of the need for charging infrastructure to meet the state’s objectives for electric vehicle deployment. So one potential thrust would be whether the PUC might support us going even further than the Charge Ready program. They want to – don’t have any forecast or anything like that there but that is one potential direction. The other one is SB 350, there is talk about support for a broader utility role in transportation electrification and that could go beyond light-duty vehicles, that could go to other forms of transportation. Again tough to put our arms around what that could be, it will intersect with the integrated resource plan proceeding that’s also called for by SB 350 that’s just undergoing, scoping at the PUC now. So while we can’t point precisely to a specific program or specific number side of it, I think the theme is that there is a general recognition in the state that transportation electrification, whether light-duty vehicles or heavier transport, it’s going to be a big part of achieving greenhouse gas targets and it’s likely there’s some possibility for further utility roles there. Theodore F. Craver, Jr. – Chairman, President & Chief Executive Officer Julien, this is Ted, maybe just one other thing to add in there is as I mentioned, this fall, the PUC is expected order the investor-owned utilities to submit proposals for investments and programs related to the transportation electrification initiative in SB 350. So I think we’ll have a little bit more visibility late this year as to at least what the initial thinking is from the PUC. Jim Scilacci – Chief Financial Officer & Executive Vice President Hey, Julien, this is Jim. Just to finalize the point, when we file the General Rate Case later this year, we’ll include in our forecast of capital expenditures an estimate of spending for electric vehicles and we are developing that now based on what we are seeing in the pilot. We’ll have to come up with an estimate that covers beyond – through all the way through 2020. And we will include that as part of our normal expenditures. Julien Dumoulin-Smith – UBS Securities LLC Including the 350 piece, the SB 350 piece? Jim Scilacci – Chief Financial Officer & Executive Vice President Yes. Julien Dumoulin-Smith – UBS Securities LLC Got it. And then, Jim, just actually a quick subsequent follow-up from our prior conversations, MHI arbitration, just timing expectations, if you can just give us the latest. Jim Scilacci – Chief Financial Officer & Executive Vice President Well, we’ll let Adam Umanoff, our General Counsel, have that fun one. Adam S. Umanoff – Executive Vice President & General Counsel Thank you, Jim. As you know, we operate under a confidentiality order issued by the International Arbitration Tribunal. What we can tell you is that we’ve conducted a hearing, the hearing has ended at the end of last week, April 29, and we are expecting a ruling from the tribunal by the end of this year. It’s possible it could go over into early 2017, but our current expectation is by the end of this year. Julien Dumoulin-Smith – UBS Securities LLC Is there something beyond the current hearing that needs to happen and to get a ruling? Adam S. Umanoff – Executive Vice President & General Counsel There is the usual post-hearing exchange of briefs and then consideration by the tribunal. We’re not expecting any further testimony or any further proceedings in the hearing itself. Julien Dumoulin-Smith – UBS Securities LLC Great. Thank you, guys. Jim Scilacci – Chief Financial Officer & Executive Vice President Thanks, Julien. Operator Our next question is coming from Greg Gordon of Evercore ISI. Your line is now open. Greg Gordon – Evercore Group LLC Thanks, guys. Just a simple question. When you quote that $2 billion notional sort of rate base growth number, obviously that’s before some of the other things you discussed. Does that contemplate bonus depreciation, is that pre bonus deprecation? Is that sort of in the range of what you get with or without – can you be a little more specific? Jim Scilacci – Chief Financial Officer & Executive Vice President Greg, it’s Jim. I think it’s just meant to be a general guideline that, if you’re going to spend $4 billion in capital, the way our depreciation works and roughly the way the closings work out that you get to a rough order of magnitude of the $2 billion in growth in rate base a year. And if you look back in time, rate base, it bounces around from year to year, it could be – if you have a large transmission closing or something that can make that growth be somewhat different, but as we kind of look at the numbers and look at it over a period of time, it seems to work. Greg Gordon – Evercore Group LLC And you’ve had bonus depreciation in one form or another through most of that period, so… Jim Scilacci – Chief Financial Officer & Executive Vice President We have, we have. Greg Gordon – Evercore Group LLC So, that would presume that it’s kind of in there. Jim Scilacci – Chief Financial Officer & Executive Vice President Yeah. And again, it may change a little bit as we go forward in time, because bonus will start ramping down as we get beyond the next couple of years. Greg Gordon – Evercore Group LLC Well, supposedly. Jim Scilacci – Chief Financial Officer & Executive Vice President Yeah. Agreed. Greg Gordon – Evercore Group LLC Okay. Thank you, guys. Jim Scilacci – Chief Financial Officer & Executive Vice President Okay. Operator Our next question is coming from Jonathan Arnold of Deutsche Bank. Your line is now open. Jonathan Philip Arnold – Deutsche Bank Securities, Inc. Well, good afternoon, guys. Jim Scilacci – Chief Financial Officer & Executive Vice President Hi, Jonathan. Jonathan Philip Arnold – Deutsche Bank Securities, Inc. A quick question on the parent EIX level drag and the $0.06 in the quarter. I think some of your description as to variance versus last year was helpful, so thanks for that but is $0.06 kind of the current run rate, and if so how do we bridge to the $0.18 for the full year? Is there other things going on or is that just kind of ramp up of the revenues in some of the acquired businesses that get you there and some front ending of costs, so just curious. Jim Scilacci – Chief Financial Officer & Executive Vice President Yeah. So, John – and we’ve reaffirmed the annual guidance numbers. And so we’re going to stick with that, and you could see some variation quarter-to-quarter, it’s really hard to predict especially when you buy some new businesses and costs that float into the first quarter, but we’re going to hold on to what we’ve indicated the – in guidance, the full year impact’s going to be. Jonathan Philip Arnold – Deutsche Bank Securities, Inc. Okay. So, but those, you can’t kind of talk us through how you – how the $0.06 in the first quarter kind of becomes $0.18 for the year, or is that just seasonality? Jim Scilacci – Chief Financial Officer & Executive Vice President I think that’s our best plan right now from what we’re seeing. And I don’t have any further commentary in terms of how it’s going to change quarter-to-quarter, but we think the level we indicated at the beginning of the year was appropriate. Jonathan Philip Arnold – Deutsche Bank Securities, Inc. Great. Okay. And then just on the Morongo issue that you highlighted, Jim, can you explain the numbers, it’s a $1.1 billion project and you said that they could invest $400 million for up to half of it? Jim Scilacci – Chief Financial Officer & Executive Vice President Yes. Jonathan Philip Arnold – Deutsche Bank Securities, Inc. How does that make sense? Jim Scilacci – Chief Financial Officer & Executive Vice President Well, that’s the way the agreement reads. Jonathan Philip Arnold – Deutsche Bank Securities, Inc. Okay. Jim Scilacci – Chief Financial Officer & Executive Vice President So, I think it was – as over time the size of the project is going up, but that’s the way the agreement reads and we’ve assumed that they would exercise for the 50%, but that’s for planning purposes, that’s an option on their side. Jonathan Philip Arnold – Deutsche Bank Securities, Inc. They would end up with 50% of the project and you would receive $400 million, is that… Jim Scilacci – Chief Financial Officer & Executive Vice President No. No. So, if it’s $1 billion, say if it’s $1 billion and a 50% then they could take up to $0.5 billion. So if it’s $1.1 billion then you’ve got the $550 million. Jonathan Philip Arnold – Deutsche Bank Securities, Inc. Okay. So it’s the amount would be dependent on what the cost actually is? Jim Scilacci – Chief Financial Officer & Executive Vice President Yeah. So, they have the option. So that’s why we’re trying to describe the full amount. They may only take $400 million for whatever reason. But if it’s a good project, you would expect them to take more. Jonathan Philip Arnold – Deutsche Bank Securities, Inc. Okay. Great. Thank you. Jim Scilacci – Chief Financial Officer & Executive Vice President All right. Operator Our next question is coming from Praful Mehta of Citigroup. Your line is now open. Praful Mehta – Citigroup Global Markets, Inc. (Broker) Thank you. Hi, guys. Jim Scilacci – Chief Financial Officer & Executive Vice President Hi. Praful Mehta – Citigroup Global Markets, Inc. (Broker) Quick question on the vehicle charging. As that program gets built out, how do you see that impacting load and do you have resources right now or what kind of generation mix do you think kind of supports that build-out, given it’s going to be sizeable over time? Pedro J. Pizarro – President & Director, Southern California Edison Co. On electric vehicle charging. Jim Scilacci – Chief Financial Officer & Executive Vice President Okay, I missed the first part. Pedro J. Pizarro – President & Director, Southern California Edison Co. I can… Jim Scilacci – Chief Financial Officer & Executive Vice President Pedro, go right ahead. Pedro J. Pizarro – President & Director, Southern California Edison Co. Sure. I think if you look at electric vehicle charging, to date, it has – we’ve been able to accommodate the number of vehicles that have come on the grid without any undue impact on the system. I think this is one of these items where we’d expect to have planning visibility into what the needs are as the market continues to grow. So, I don’t think it’s one that lends itself to a dramatic spike. I’d also point out that from a system perspective, the Californian system overall still enjoys some pretty healthy resource margins. And then – so I’d expect that certainly over the next several years should be the ability to accommodate that. And then the final point I’d make is that, as the load from electric vehicles increases, that is happening in the context still of the net load for the system, which we continue to see moving in a generally flat to even potential decline as we have other offsetting factors, increased energy efficiency, increased demand response. So, we’ll have to continue to watch this from a planning perspective, as the market develops. But today we’re not seeing any undue impact that would be difficult to manage. Maybe one last little coda on that is that as we get more vehicles on the system, we’re going to be working with the regulators to have the right sort of signals and incentives to encourage charging when it helps from an overall system perspective. So, you guys are all pretty familiar with the concept of the duck curve, the fact that we have a lot more solar on the system today, and the ISO expects that to grow so the extent to which we can accommodate electric vehicles with current resources will be assisted by having charging align better with time periods during the day when we have more energy flowing out of solar panels. Praful Mehta – Citigroup Global Markets, Inc. (Broker) Okay. That’s very helpful. Thank you. And then finally just to link with that, the focus on keeping rates at inflation, going at inflation or below, how does this charging stations, where people are charging at homes, do you ever see that becoming a problem in terms of rate, especially if you say, bonus depreciation, reverses in stocks adding to rate base, start having these kind of charging stations at home as well. Do you ever see rates becoming a challenge, going out in the future? Jim Scilacci – Chief Financial Officer & Executive Vice President That’s always a – great question. There is a lot of factors that affect our rates and capital expenditures, we’re watching any number of items, you’re watching what’s happening with fuel and purchase power. I mean, we’re watching our sales, obviously that’s where you’re getting at, I mean obviously electric vehicle charging helps others detract from it. That would be solar roof panel for potentially energy efficiency. So, we’re trying to balance all those factors, and the goal is to try to keep that, the rates in or around the inflation level. And so, I think Ted’s points were real clear that over longer periods of time we’ve had acceleration in capital expenditures and we’ve had lower gas prices and all these different factors over quite a long period of time, and more importantly in the shorter term, the cost focus, the reduction in costs, because O&M obviously reduces rates dollar per dollar where capital is at a smaller percentage. So we’ll continue to monitor it; obviously from year to year you probably – we may exceed it or go underneath it, like this last year was 8% reduction. But over time, I think as the general trend we’d like to see it come in around that inflation level. Praful Mehta – Citigroup Global Markets, Inc. (Broker) Got you. Thanks so much, guys. Jim Scilacci – Chief Financial Officer & Executive Vice President Okay. Operator Our next question is coming from Steve Fleishman of Wolfe. Your line is now open. Steve Fleishman – Wolfe Research LLC Yeah, hi. Ted, can you hear me? Theodore F. Craver, Jr. – Chairman, President & Chief Executive Officer Yes, Steve. Steve Fleishman – Wolfe Research LLC All right. Just, I wanted to maybe just try and summarize your prepared remarks comments on the capital spending. So, you talk about the $4 billion a year of CapEx, and $2 billion of rate base growth, but then when you go through the different segments, a lot of them including some of that the DRP, electric vehicle storage could be kind of upside to that $4 billion a year. And then at the end you talk about maybe some programs could lag over time and the like. And so I’m just overall – are you kind of sending the message that we’re likely to see higher capital spend over this future period than we’ve had in the past, given these variety of new programs? Theodore F. Craver, Jr. – Chairman, President & Chief Executive Officer Yeah. Just, cutting right to the quick, the short answer is yes. Steve Fleishman – Wolfe Research LLC Okay. Theodore F. Craver, Jr. – Chairman, President & Chief Executive Officer So, the point we’re really trying to make is there are many levers. There is also a balancing act. So, under the many levers part of the equation, if for some reason one or more of these potential capital spends lags or we need to pull it back, there are substitute capital spending that can be pushed into its place. So I think we feel confident about the – certainly feel confident about the $4 billion and believe that there is upside. I’d say the second part is the balancing act element where – you’ve heard me on this a lot of times before – that if you get this thing growing too fast, you end up putting pressure first on customer rates and secondly on the ability of the underlying business to support the equity requirement of the new investment. So it’s a matter of trying to get it in the sweet spot where you’re getting kind of the maximum benefit from the growth but not so fast that it puts pressure on the need to issue equity or on customer rates. And that was the second kind of main point that I was trying to get across here is – as the rate base grows, earnings, cash grow along with it. We feel comfortable about being able to support a greater than $4 billion number without having to issue equity, and secondly, as we tried to spend quite a bit of time on here in the remarks, we actually have a really good track record of keeping customer rates below the rate of inflation in our service territory. And that coupled with the fact our average residential bill is considerably lower than the national average and that’s what customers really see, we feel we’ve kind of got the cost side under control and that it will support the ability to have this expanded investment opportunity. So those are kind of all the main points that I was really trying to make. Steve Fleishman – Wolfe Research LLC No, that’s helpful. And just in terms of the visibility on these longer-term numbers, I know we should hopefully get a lot of that with the GRC filing. And we’ll have the – the DRP spend will likely be within the GRC … Theodore F. Craver, Jr. – Chairman, President & Chief Executive Officer Yeah. Steve Fleishman – Wolfe Research LLC … filing. But things like the storage and the electric vehicles will kind of continue on their own pace separate from that? Theodore F. Craver, Jr. – Chairman, President & Chief Executive Officer Likely yes. Just a word on the General Rate Case and some of these other proceedings that will be going on at the same time. I think this one is going to be a little different for us in that what we put into the General Rate Case will try to anticipate, at least our best thinking on how we see some of this grid modernization activity taking place. Even though that will be in the process of being discussed coincident with the rate case filing, so that will be in the DRP proceedings. So this is going to be a little bit of – couple of things happening at the same time. We will do our best to articulate those in the General Rate Case. And there are other things, kind of the third point, there are other things above and beyond strictly what’s in the DRP or what you would find in the General Rate Case, and that’s what we are alluding to with some of the transportation electrification initiatives embedded in SB 350 and things of that sort. Storage and other pieces (48:54) would probably largely be outside of that. And of course, as more things develop with the transmission spending, as we look towards moving to 50% renewables and an expanded ISO, California ISO scope, there may very well be other investment opportunities embedded in that that also are not going to be in the GRC or some of these other proceedings. So, I think the general point here is there is, we feel, a robust opportunity, but of course, we want to make sure we’re doing that in a good, balanced way, so, it doesn’t put pressure on equity and doesn’t put pressure on customer rates. Steve Fleishman – Wolfe Research LLC Great. Thank you very much. Theodore F. Craver, Jr. – Chairman, President & Chief Executive Officer You’re welcome. Operator Our next question is coming from Michael Lapides of Goldman Sachs. Your line is now open. Michael Lapides – Goldman Sachs & Co. Hey guys. I’ll follow on to Steve’s question a little bit, but maybe a slightly different angle. Ted, it seems like you’re hinting that somewhere in the post 2017, you’re going to have CapEx above the $4 billion range. The when and where and how is still to be determined, but you seem pretty confident in that. I guess my question comes to the dividend, which is how are you thinking about the dividend growth trajectory, given the fact that kind of the risk reward to CapEx in the out years is higher rather than lower? Theodore F. Craver, Jr. – Chairman, President & Chief Executive Officer Well, I think that’s kind of embedded in our stated target, which is as you know, lower than what the industry average is. So, we have a 45% to 55% payout ratio target on SCE’s earnings. If I remember it right, the average utility payout ratio is somewhere between 60% and 65%, probably closer to 65%. So, and again, you’ve heard on me on this before, I believe given the growth prospects, the long-term growth prospects at SCE and Edison, that we probably should have a somewhat lower stated target. We’re mindful of the fact that that is lower than the industry average. I’ve probably used the phrase so many times, you guys are sick of hearing about it. But we still believe there is good room to come forward over the next few years here with dividend increases that are above the industry average, as we move up into this 45% to 55% payout ratio. There could potentially be opportunities above that, but we’ll worry about that when we get there. Michael Lapides – Goldman Sachs & Co. Got it. And one follow-up, unrelated, what’s the latest process or procedure wise, at the CPUC, when it comes to the request for re-hearing on the SONGS decisions? Adam S. Umanoff – Executive Vice President & General Counsel This is Adam Umanoff. There really is no additional news we have to share, the challenges to the SONGS OII settlement remain pending at the CPUC and we are awaiting a decision. Michael Lapides – Goldman Sachs & Co. And the CPUC can you just kind of rule any day TBD? Adam S. Umanoff – Executive Vice President & General Counsel Yeah, there is no fixed timeframe for them to rule. It could happen tomorrow, it could happen in six months. We don’t have any guarantees of timing. Michael Lapides – Goldman Sachs & Co. Got it. Thank you, Adam. Much appreciated. Theodore F. Craver, Jr. – Chairman, President & Chief Executive Officer Thanks, Michael. Operator Our next question is coming from Brian Chin of Bank of America. Your line is now open. Brian J. Chin – Bank of America Merrill Lynch Hi. Good morning. Can you hear me? Theodore F. Craver, Jr. – Chairman, President & Chief Executive Officer Hi, Brian. Brian J. Chin – Bank of America Merrill Lynch Hi. Just a general question about net metering policy in California. We’ve seen some interesting developments in New York and it seems like the tone in Arizona has marginally shifted towards a little bit more reconciliation, as opposed to outright conflict. Is there any sort of read-through to the different parties in California in terms of what’s going on in other states, as to how things might play out and might tip the scales in one direction or another in California, just more general thoughts there, if you would. Theodore F. Craver, Jr. – Chairman, President & Chief Executive Officer Want to take that, Pedro? Pedro J. Pizarro – President & Director, Southern California Edison Co. Yeah sure. Hey, Brian. It’s Pedro, how are you? Brian J. Chin – Bank of America Merrill Lynch Good, Pedro. Pedro J. Pizarro – President & Director, Southern California Edison Co. So yeah, we’ve seen with interest the agreement in New York among the utilities and some of the solar parties, and read about the Arizona piece as well. Just stay at a high level here and say that we’ve had constructive discussions with a number of the parties on all sides here in California as well. Obviously we proceeded through the NEM portion, NEM 2.0 proceeding here earlier this year. We did file a limited application for re-hearing on the topic, don’t have a timeline at this point in terms of when the PUC might consider that. But I think at the core – certainly from the utility perspective, we have a strong interest in seeing the market for solar be supported, and we’re doing our part, we want to make sure that our grid is getting continuously worked on to be a more and more of a two-way plug and play grid that can support solar resources. And we’ve done things like work on our own internal processes to shorten the timeframe for customers who want to interconnect on to our system. Used to take us about a month to process applications; we’ve got that down to a day and a half now. So, we’re doing a lot of things that we believe are constructive and supportive, bringing solar online. I think the NEM debate in California and other states has been more about what’s the cost responsibility and the level of subsidy. And so to the extent that parties can come together, and have creative approaches towards resolving some of those differences that’s great. I don’t think we’re there in California today, but we’ll continue to engage constructively with parties, and listen to ideas. Brian J. Chin – Bank of America Merrill Lynch Great. Thanks for the update, Pedro. That’s all I got. Operator Our next question is coming from Ali Agha of SunTrust. Your line is now open. Ali Agha – SunTrust Robinson Humphrey, Inc. Thank you. Ted or Jim, for the last several years now, you guys have done an excellent job of managing your costs and in fact that has allowed you to, in the off years, earn returns above your authorized levels as well. Just wondering how much more is left on that cost reduction side and when you benchmark yourself to where you need to be, are you halfway there, almost there just in the first quartile, can you give us some sense of where you are on that cost reduction plan? Jim Scilacci – Chief Financial Officer & Executive Vice President Hi, Ali, it’s Jim. I’ll straight it out and let Maria and Pedro chime in if I miss anything. There is more work to be done. We started this journey probably four years ago, and we saw at that point in time that, especially in our staffing, our A&G areas that we were considerably above benchmarks. And as you know, we benchmark our costs every single year and we break it down in significant detail in terms of some of the studies that we participate in, and there is more to be done. And it gets harder over time, as you take care of the things that we had -as I said the overstaffing areas that we were able to reduce and we’ve taken care of lot of that but there is more to be done. And for example, we revised our costs in our programs for our healthcare for the employees, and that takes it – over time, it builds up the advantage of that savings and it’s really a cost avoidance for customers, that will then reap that benefit over time. And there is a number of other initiatives there going on. I can’t peg, what you’re asking me, well, how far, you’re halfway, you’re a third of the way, you’ve got two-thirds to go, it’s really hard to say, because it’s really organization-by-organization that we’re looking at theses and some organizations may be in the first quartile, others may be in the fourth quartile. So, you really have to break it down and look at it that way. I’ll pause here and look if Pedro and Maria to add anything. Maria C. Rigatti – Chief Financial Officer & Senior Vice President, Southern California Edison Co. Yeah, we’re going to continue to look at also what our peer group does, because as they get better we’ll find ways to also trying keep pace with what they are doing. Ali Agha – SunTrust Robinson Humphrey, Inc. Okay. And then, second question, I wondered just kind of at your comments on the balancing act that you’re looking at, keeping customer rates at or below inflation. Within that context, equity issuance, just wanted to understand, are you adamant that you’re going to fund all your CapEx going forward, without needing to issue equity, if those – some of those new plans come in and the CapEx goes above $4 billion, but that requires equity issuance. Would you be open to that, or just wanted to understand, is no equity completely necessary for you, over the next several years? Theodore F. Craver, Jr. – Chairman, President & Chief Executive Officer Yeah. It’s – I mean it’s fair question, but I think without trying to be wibble wobbly about it, the way we see it is we have a significant investment opportunity, we actually think it’s an expanding investment opportunity. Because the rate base is expanding, which means cash production is expanding. But this, as we see it, allows us to keep the growth rate in balance with our retained earnings and existing equity so that we would not need to issue additional equity. Obviously, if the commission or somehow we’re ordered to do something really dramatic, we’re going to maintain our required equity ratio but I think that’s such a remote risk that I feel comfortable saying it the way we’ve said it, that the key here is to keep the growth rate in balance with keeping customer rate increases at or below the rate of inflation. And as we’ve evidenced here, we’ve done, I think, a really great job of that, and we intend to continue to do that. And such that we don’t have to issue equity and I think we can keep that balance. We’ve done it even when we had 12% annual rates of growth in CapEx and earnings; yet, we were able to – so pulling a lot of rabbits out of the hat, we were able to avoid any equity issuance and that was a very strong commitment that Jim and I had all through that period of time. So I feel comfortable making a statement, we’ll keep it in balance. Ali Agha – SunTrust Robinson Humphrey, Inc. And what is the regulatory equity ratio right now for you guys? Theodore F. Craver, Jr. – Chairman, President & Chief Executive Officer I missed that. What was the what? Ali Agha – SunTrust Robinson Humphrey, Inc. At the end of this quarter what is the equity ratio at the utility (1:00:15)? Jim Scilacci – Chief Financial Officer & Executive Vice President It’s 50.2%. Ali Agha – SunTrust Robinson Humphrey, Inc. Versus 48% authorized? Jim Scilacci – Chief Financial Officer & Executive Vice President Yes. Ali Agha – SunTrust Robinson Humphrey, Inc. Okay. Thank you. Theodore F. Craver, Jr. – Chairman, President & Chief Executive Officer You’re welcome. Operator That was the last question. I will now turn the call back to Ms. Bahen. Allison Bahen – Senior Manager-Investor Relations Thank you for joining us and please call if you have any follow-up questions. Thanks. Operator That concludes today’s conference. Thank you for your participation. You may disconnect at this time. Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) 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