CenterPoint Energy, Inc. (CNP) Q2 2013 Earnings Report, Transcript and Summary

Good morning, and welcome to CenterPoint Energy's Second Quarter 2013 Earnings Conference Call with senior management. [Operator Instructions] I will now turn the call over to Carla Kneipp, Vice President of Investor Relations. Ms. Kneipp?

Thank you very much, Sarah. Good morning, everyone. Welcome to our second quarter 2013 earnings conference call. Thank you for joining us today. David McClanahan, President and CEO; Scott Prochazka, Executive Vice President and Chief Operating Officer; and Gary Whitlock, Executive Vice President and CFO, will discuss our second quarter 2013 results and provide highlights on other key activities. We also have other members of management who may assist in answering questions following the prepared remarks. Our earnings press release and Form 10-Q are posted on our website, centerpointenergy.com, under the Investors section. I remind you that any projections or forward-looking statements made during this call are subject to the cautionary statements on forward-looking information in the company's filings with the SEC. Before David begins, I'd like to mention that a replay of this call will be available on CenterPoint Energy's Investor website and will be archived for at least 1 year. And with that, I will turn the call over to David.

Thank you, Carla. Good morning, ladies and gentlemen. Thank you for joining us today and thank you for your interest in CenterPoint Energy. This morning marks the first quarter we are reporting the results of our new midstream partnership with OGE Energy. This partnership is an exciting opportunity for CenterPoint, and has the potential for substantial long-term shareholder value creation. We will provide a status update on the partnership's progress, as well as second quarter performance later in the call. Earlier this morning, we reported a second quarter net loss of $100 million or $0.23 per diluted share. Second quarter results included 2 unusual items resulting from the formation of the midstream partnership. The first, related to a $225 million non-cash deferred tax charge, which Gary will speak to later on the call. The second, related to $10 million of expenses that the company incurred in the formation of the midstream partnership. Excluding these 2 unusual items, the second quarter net income would've been $131 million or $0.30 per diluted share, compared to net income of $126 million or $0.29 per diluted share for the same period of 2012. This quarter's performance continues to demonstrate the benefit of CenterPoint's balanced and diversified energy delivery portfolio. Our regulated natural gas distribution unit reported a strong quarter, offsetting the impacts of milder weather on our electric unit. As anticipated, the financial performance of our midstream investments fell below last year's results. Scott is going to speak to the performance of each of our business segments following my remarks. Let me speak to the progress being made at the midstream partnership. Earlier this week, we announced the name of the new partnership, Enable Midstream Partners. This name captures the rich heritage of both CenterPoint and OGE, reinforces our focus on enabling our customer success and reflects our employees' mindset and expertise. Yesterday, we also announced our senior operations leadership team. Up until now, we have continued to operate the former CenterPoint and Enogex businesses as 2 separate businesses within the partnership. We have had a number of teams working diligently on integration efforts, and we now believe it is important that we operate as a single integrated and united company. Keith Mitchell, the former President of Enogex, was named Chief Operating Officer of the midstream partnership. Keith is a very capable and experienced executive and will do a fine job in this role. We also named 8 additional senior officers of the partnership, all are very seasoned and knowledgeable midstream executives. Our search for a chief executive officer is continuing. The most important decision that Pete and I have is this one, and it has our undivided attention. As you know, it is very important to select the right person for the long-term success of the partnership. I'm confident we'll find the right candidate for this role. We have also identified a number of projects that will help us obtain the $50 million of estimated synergies over the next 2 years, as we have previously discussed. A number of these are related to our field operations and are in the process of being implemented. While it will take some time to realize the full potential of this partnership, I'm pleased with our progress to date and the attitude and commitment of our employees to make this partnership successful. Gary will update you on the progress the partnership has made in preparation for its initial public offering. Scott will now update you on the business performance of each unit for the second quarter of 2013.

Thank you, David, and good morning to everyone. Houston Electric's second quarter 2013 core operating income was $131 million, compared to $153 million in the prior year. Base revenues were down approximately $21 million due to weather, compared to last year. When compared to normal weather, base revenues were down about $4 million. In addition, economic growth in our service territory and higher net transmission revenues offset increases in O&M, depreciation and lower right-of-way revenues. Overall, this business continues to perform well. Despite the milder-than-normal spring weather, we remain encouraged by the economic activity around the Houston area. We have added over 43,000 customers since the second quarter of 2012, and continue to expect a 2% growth rate, which equates to $25 million of new revenues annually. Our transmission rights-of-way continue to be an attractive route for third-party pipelines to move their commodities to the Houston ship channel. Year-to-date, right-of-way revenue is around $7 million compared to about $19 million last year. By yearend, we anticipate being at about $20 million, well above our normal run rate of $2 million to $3 million per year but below last year's total of $27 million. Houston Electric's capital plan reflects the infrastructure investment needed to support service area growth and system reliability. Through June of 2013, Houston Electric has spent $325 million of capital and expects to deploy approximately $700 million of capital by yearend, of which roughly half is for transmission assets. Our planned 5-year capital investment program of approximately $3 billion results in a compound annual rate base growth of 5%. We continue to be asked how Houston Electric's investments correlates to its earnings growth. We recently filed our 2012 earnings monitoring report, which reflects that we earned, on a weather-normalized basis, above our allowed return, due in part to increased right of way revenues, reduced interest expense and the benefit of bonus depreciation. Our infrastructure recovery mechanisms are designed to ensure timely recovery of our capital investments. In 2013, we do not expect to file for additional rate increases utilizing these mechanisms. Our natural gas distribution unit had an excellent quarter, earning $25 million of operating income compared to $9 million the prior year. Base revenues, net of various weather normalization mechanisms were up $10 million due to weather compared to last year and up about $5 million when compared to normal weather. Timely rate recovery mechanisms along with customer growth and increased throughput resulted in an additional $8 million. These positive contributions were partially offset by increases of $3 million in depreciation, and $2 million in property taxes. Gas operations continues to focus on providing safe and reliable system operations, as well as continued expense management. Pipeline integrity continues to drive a sizable and growing portion of our total capital expenditures and serves to provide a safe and reliable system, as well as reduced operating expenses over time. Excluding the expenses associated with energy efficiency programs, for which we received offsetting revenue, operating expenses remained flat year-over-year, for the quarter and year-to-date. Additionally, our ongoing effective management of credit and collections has enabled us to contain bad debt expenses. Write-offs as a percentage of revenues are at historic lows. We continue to see growth across our service territories, with the addition of about 32,000 gas customers since June of 2012, and forecast growth to continue at a rate of approximately 1% annually. Our capital investment through the second quarter of 2013 was almost $190 million, and we are on track to invest in excess of $420 million by yearend. This level of investment is needed to support increased pipeline integrity requirements and growth from commercial and residential customer classes in our service territories. Our planned 5-year capital investment program of approximately $2 billion results in a compound annual rate base growth of 7%. Competitive natural gas sales and services performed as expected this quarter. Operating income was $3 million compared to an operating loss of $4 million during the same period last year, driven primarily by mark-to-market accounting. This business is now on solid footing, having eliminated most of the uneconomic transportation and storage agreements. Now let me report on our midstream investment. First, I'll remind you that under SEC regulations, we are limited in what we can say about the financial and strategic details of the partnership until we file the S-1 registration statement for the IPO. In April, CenterPoint Energy's Interstate Pipelines and Field Services segments contributed $40 million of operating income. Additionally, in the second quarter, we recognized $37 million of equity income, of which $33 million is from our investment in the midstream partnership and $4 million is from our investment in SESH, our partnership with Spectra. Last year, we owned 100% of CenterPoint's midstream assets, plus a 50% interest in SESH. This year, we are reporting 1 month ownership interest from that same structure, plus 58% of the new partnership for May and June, as well as the 25% ownership we retained in SESH. CenterPoint Energy's earnings contributions from our midstream investment is down by approximately $22 million versus the second quarter of 2012, excluding the impact of any step up in basis of the partnership's assets. Over half of the decline in earnings is driven by changes in market conditions. While natural gas prices and processing volumes are up from last year, gathering volumes in primarily dry gas basins and basis differentials have not recovered. Additionally, liquids pricing and the demand for ancillary services are below last year's levels. These conditions were largely anticipated, and the midstream partnership's results are essentially in line with our expectations. As Gary will describe in more detail, we had a reduction of our state tax liability associated with the formation of the partnership, which more than offset the earnings contribution decline this quarter. Let me update you on a couple items we have discussed in the past. Earlier this month, the partnership received clearance from the Bureau of Land Management for construction of the Bakken crude oil gathering project. The partnership has completed the applicable right of way activity and construction is well underway. You may recall that in August of 2012, the MRT pipeline filed for an approximate $43 million cost of service increase. The partnership is very pleased to have reached the settlement in this rate proceeding and is currently seeking FERC approval. The settlement provides for a $27 million cost of service increase. Overall, despite some challenges, we had a good quarter. Our regulated businesses complemented each other well, and the fundamentals exist for a strong second half of the year. Our midstream investment performed in line with our expectation and continues to pursue value creation through synergy opportunities and growth. I will now turn the call over to Gary.

Thank you, Scott, and good morning to everyone. Let me address some items associated with the partnership's formation before discussing the CenterPoint Energy update. First, I would like to discuss an item that impacts our effective tax rate for the second quarter. The May formation of the partnership required us to record a non-cash deferred tax liability of $225 million or $0.52 per diluted share. This non-cash deferred tax liability is related to the nondeductible goodwill contributed by CenterPoint to the midstream partnership. You may recall that CenterPoint Energy maintained $628 million of goodwill associated with the midstream assets from the original 1997 acquisition of NorAm Energy. In connection with the formation of the partnership on May 1, CenterPoint Energy contributed to goodwill associated with its midstream assets to the partnership. The triggering events that required us to record this onetime non-cash deferred tax liability relates to the deconsolidation from CenterPoint and the recording of our portion of the midstream partnership using the equity method of accounting. In addition, our effective tax rate in the second quarter was favorably impacted by $29 million or approximately $0.07 per diluted share. This tax benefit results from the formation of the midstream partnership and will ultimately result in lower future state tax payments. Next, I would like to discuss the accounting for the midstream partnership. We mentioned on our last earnings call that we did not expect the partnership to record a step up of book basis to fair value in connection with its formation. However, after consultation with the SEC, it has been determined that the partnership will revalue to fair value the net assets of Enogex. There is no cash impact to the midstream partnership or CenterPoint Energy in doing so. As you know, the partnership is planning to conduct an initial public offering as a master limited partnership, and we have been working diligently to do so. We expect the additional valuation work to determine fair value for the net assets of Enogex, and the related audit requirements will extend the timeline for this effort. However, the goal remains to complete the IPO in either the fourth quarter of this year or the first quarter of 2014. Next, I'm going to address some other items related to CenterPoint Energy. First, let me update you on our liability management activity following the receipt of $1.05 billion from the midstream partnership. As I mentioned last quarter, our objective is to use the initial cash received from the midstream partnership to achieve an appropriate capital structure with SERC. During the quarter, we reduced our debt by approximately $525 million, which will result in approximately $38 million of annual interest savings. By yearend, we expect to have reduced consolidated debt by more than $1.1 billion, which will result in an annual interest savings of more than $70 million. Although not impacting our earnings, I would also note that we expect to pay off our first transition securitization bonds later this year, which will lower the charges we bill to retail electric providers in our electric service territory. We received a number of questions regarding our dividend policy, both the timing of the decision to change the policy and the expected amount. As we mentioned in our last earnings call, the additional cash flow generated by the partnership will provide flexibility and allow us to reevaluate future dividend levels and other capital allocation decisions. We will provide an update on our dividend policy early next year. Now let me discuss our earnings -- our 2013 earnings guidance. This morning, we reaffirmed our estimate for earnings on a guidance basis in the range of $1.17 to $1.25 per diluted share. Our guidance excludes the effects of the 2 unusual items resulting from the formation of the midstream partnership. In addition to our normal guidance exclusions described in our press release, this range takes into consideration the closing of the midstream partnership on May 1, the performance to date of our businesses, as well as an estimate of our portion of the partnership's earnings for the balance of 2013. The actual earnings of the partnership will be dependent on a number of variables, the most significant being commodity pricing, volume throughput, ancillary services and the net synergies realized as the partnership's operations are integrated. In addition to the impact of our midstream partnership earnings, we continue to provide earnings guidance in the form of a range to reflect a number of other economic and operational variables such as weather, regulatory proceeding, effective tax rates and financing activities. As the year progresses, we will keep you updated on our earnings expectations. In closing, I'd like to remind you of the $0.2075 per share quarterly dividend declared by our Board of Directors on July 25. We believe our dividend actions continue to demonstrate a strong commitment to our shareholders and confidence of management and the Board of Directors in our ability to deliver sustainable earnings and cash flow. Thank you for your continued interest in CenterPoint Energy, and I will turn the call back over to the Carla.

Thank you, Gary. As a reminder, since the midstream partnership plans to pursue an IPO, we are restricted by SEC regulations [indiscernible]. We will now open the call to questions. [Operator Instructions] Sarah?

[Operator Instructions] Our first question is from Matt Tucker with KeyBanc Capital Markets.

First question, you indicated that the midstream results were in line with your internal expectations, also that the 2 businesses have been kind of operated independently today. Is that -- is it true that both businesses performed in line with expectations? Or could you talk a little bit about individually how they compared to what you were expecting?

Matt, this is David. No, we were talking about the total partnership. Each business was really pretty close to plan. We expected liquids prices to drop and they did. We expected that ancillary services were going to be challenging and they were. So I think that both businesses operated pretty close to the plans we put together earlier this year.

Okay. And on the ongoing search for a CEO for the business, could you give us a little flavor for what type of qualities or background you're looking for? And do you have any kind of timeline that you can share with us at this point?

Well, we clearly want a seasoned executive that it can come in and help integrate and unite these 2 companies. We're looking for a seasoned executive in the midstream business who knows the energy business and that is a leader. And so we have lots of candidates we've been talking to, including some internal candidates. Lots of interest in this position, as you would expect. But this is a really important decision for us because we're going to operate this thing for the long term, not the short term. And so we're looking for a leader that's really going to help us get and create long-term value for both -- all the owners of the partnership. So timeline, we're going at this as fast as we can, but we're not going to make a decision just to make it. We're going to make it when we believe we have the right person to run the partnership.

And just one quick follow-up and sorry if I missed this. Was there an update on the expected timing of the S-1 filing?

This is Gary. We expect, again, that we would file the S-1 in the fourth quarter -- hopefully, in the fourth quarter, late third quarter or the fourth quarter. In terms of the timing of the IPO, again, that depends on the review process of the SEC.

Your next question comes from the line of Andrew Weisel with Macquarie Capital.

My first question is kind of following up on the timing. If I heard you correctly, you said that early next year, you'll talk about the CenterPoint dividend policy. Can you maybe elaborate would the magnitude of the increase depend on whether or not the IPO has been completed?

This is Gary. Look, the way we're thinking about this is that we want to file the S-1. We want to obviously file the S-1, really understand the cash flows that we'll have from the joint venture. Also this fall, as you would expect, we go through our normal process of looking at the capital that we'll allocate to our businesses, both the electric and the gas utilities. So it's really understanding our capital allocation opportunities, the dividend policy is part of that. And of course, historically, we've been allocating capital to the midstream business in the future subsequent to the IPO or even before the IPO, ultimately, we'll receive cash from the joint venture. So we're taking all of that, Andrew, into consideration in determining the dividend level. We think the appropriate time to do that is really after the first few years. I said, we hope to do the IPO as soon as possible. Again, we'll file the S-1 as soon as possible and hope to have a review of that and go to market as soon as possible. We hope that's going to be this year, if not in the first quarter of next year. I think having clarity around those items will be important in terms of making the dividend decisions, which is part of our capital allocation. So I think that's the color around it, Andrew.

Okay. Now if the IPO isn't done by the time you make your dividend decision, which you typically announce in mid-January, would it be possible to have a 2-step increase in the dividend during the next calendar year? Or will it be a decision in January, then the following decision wouldn't be until 12 months later?

I'm not going to get in front of the board on that. I think that certainly, the IPO is important. But again, the JV in terms of the cash flows we'll have on the JV is really the clarity around their capital plan and with their investment plan. So I won't speak to whether it's going to be 1-step or 2-step, but clearly, we have the flexibility to rewrite the dividend, and again, that's going to be a part of a holistic decision around our capital allocation opportunities.

Okay. Fair enough. I guess we have to be a little more patient. Then just 2 very quick ones on the electric utility. I believe you said you don't expect to file for a rate increase during '13. In the past, you said for the next few years or the foreseeable future, is that a change in your tone of when the next rate case may come?

Andrew, this is Scott, let me take that one. The statement I made was referencing the use of those mechanisms for asset recovery. I was not referencing a full-blown rate case. That's the distinction there. We just don't intend to use -- file this year for using those mechanisms. And the comment about a rate proceeding being a little further out is still very valid.

Okay. Then lastly, you mentioned 2% customer growth. What are the latest trends you're seeing in terms of usage per account or overall load growth?

Usage is holding about even. We've seen a little bit of decline in the past and then it seems to have leveled out here lately. So I'd say it's about flat to what we've -- and that's been our expectation and that's what we're actually experiencing.

Your next question comes from the line of Steven Fleishman with Wolfe Research.

A couple of things. First, just the state tax gain that you noted, is that something that was in the guidance plan from when you updated it on the transaction?

Yes. Certainly, our state taxes, Steve, are one of the items that we all call a variable that we outlined. And again, the background of this, when we formed the joint venture, as you know, we look at our state taxes, both current and deferred, each quarter, and we have to adjust for that. When we formed the joint venture, that allowed, if you will, looking at both the allocations and the construct of the determination of those rates, and that allowed us to adjust our deferred taxes related to then forming the joint venture. And again, those deferred taxes do result in cash-reduced state tax payments.

Okay. And then, also, just with the change in the step up accounting can -- does that have any implication for kind of the guidance you gave for the venture as well in terms of, I guess, equity earnings?

No, really the step up is not going to make any difference in terms of the way we're going to record earnings. I'd say the way -- the amount of equity earnings, it's either going to be additional depreciation coming from the joint venture or a change in the amortization that we have at the company. So there's really no cash impact or change.

Okay. But there could be some book impact or not that either?

I'd say potential book impact but I don't expect it to be material.

Okay. And then, is there any maybe possibility to update potential growth investment opportunities in the business right now, in terms of the midstream business?

Steven, we're a little bit hampered by what we can say because of the S-1 filing, which we hope to be doing here. I will say, just generally, there's lots of activity still in the wet basins that are in -- that the partnership both processes gas out of and gathers. So lots of activity. We're pursuing a lot of activity. But we can't give any specific details around any basin right now.

Your next question comes from the line of Carl Kirst with BMO Capital.

Actually, Steve just kind of touched on the question from a step up standpoint. But maybe one sort of associated question is will that allow you to basically have a higher deferral of the distributions you get? I just want to make sure I understand that there isn't any tax impact?

This is Gary, Carl. This is really not a tax -- this is really doing -- this is related to the book accounting for the joint venture. This is really around GAAP accounting for the joint venture. So it's not really going to have an impact on -- as I said, cash or economic impact up to the joint venture.

Your next question comes from the line of Charles Fishman with Morningstar.

Let me go about a question that was just asked with respect to the projects you're working on, realizing that you're restricted until the S-1 filing. But I suspect that losing the Florida pipeline RFP was, to the home team, was a disappointment, but not totally unexpected. Is there anything out there in the public domain that you can talk about on big RFPs like that, that you're thinking about working on, are working on?

Charles, that's probably the biggest one. Obviously that was a $3 billion pipeline. And you're right, we are very disappointed. We put a lot of work into that. But that's the way things go sometimes. But there's not anything comparable to that, that I'm aware of, on the pipeline side.

Okay. And then just to go back to the accounting, just to make sure I have this right. I realize these were non-cash charges, they're just GAAP. But as far as your expectations of the midstream transaction not being accretive to 2015, that doesn't change that at all, does it?

No, that doesn't change at all, Charles.

[Operator Instructions] Your next question comes from the line of Ali Agha with SunTrust.

Gary, I apologize, I got on the call late, so you may have addressed this. But if I look at your adjusted earnings, both for the quarter and the range -- guidance range for the year that you've kept. Can you remind us what is the effective tax rate that is associated with those on the adjusted basis?

Okay. Yes. I think, the way to -- and you may have missed this early, but you need to exclude the $225 million deferred tax provision in terms of the effective tax rate for the quarter. So when you exclude that, that effective rate is 13%. Then that's lower than the statutory rate, of course, which is normally 36% to 37%. And the reason for that, we recorded in this quarter $29 million benefit related to lowered state deferred taxes. And those lower state deferred taxes again will ultimately -- those deferred taxes will ultimately result in lower payments, cash payments. So if you were to adjust both of those, it would be a 33% rate. For the balance of the year, our rate will return to more normal rate, I'm going to say circa 36% to 37%. So for the full year, you can expect a tax rate of about 32% to 33% for the full year. And again, I want to emphasize that the $29 million lower state deferred tax is a different item than the $225 million. The $225 million is the onetime non-cash deferred tax. The lower deferred taxes on the state taxes is the result of formation of the partnership, and again, will result in lower taxes going forward. And by the way, it could have gone the other way, depending on, again, on the construct of the way you calculate state taxes. We look at this each quarter.

Okay. Great. And then, secondly, I understand you guys have that -- and I heard your discussion on dividend and your plans post IPO, et cetera, to clarify. But conceptually -- historically, we've talked about a dividend on an earnings payout ratio. Conceptually, how should we be thinking of this dividend for the new CenterPoint going forward?

I'll take a shot at that because Gary and I talk about that a lot. And that is part of the regulated businesses, I think, still a dividend payout policy based on earnings is appropriate. But I think, for the cash flow we're going to get from our interest in the partnership, we have to think about that differently. Obviously, we need to look at how we can use that cash, whether it's investing in our core businesses or paying out dividends or buying back stock or something of that nature, we will. But I think, you do you need to look at the 2 pieces of our business different than we have in the past.

And Ali, this is Gary, just to continue on that vein. One of the earlier question was around the timing. And again, we really want to have this fall, as we go through our normal process of cap allocation understanding the opportunities we have to invest in our businesses, really understand that better and then have a real clear view, hopefully, again, as I mentioned earlier in the call, that we'll file the S-1 as early as this fall, and hopefully have the IPO done, but hopefully no later than the first quarter, we'd like as much clarity as possible as we make the decision on how much of our capital to allocate to the dividend, how much to allocate to direct share repurchases. But most importantly, we hope that we can invest -- continue to invest in our businesses. So that's the reason for the timing, if you will, on the dividend.

Understood. Makes sense. Last question if I could. Am I hearing you guys right that on the regulated businesses, both at the electric and gas LDCs, you're pretty much earning authorized returns, you're not seeing any lags in any of those businesses?

Ali, this is Scott. Yes, I think, your assumption there is pretty good. We are -- both of those businesses are earning right around their allowed return across the gas properties in aggregate, as well as in the electric area.

Your next question comes from the line of Sarah Akers with Wells Fargo.

As a follow-up to the capital deployment discussion. As you look out over the next few years, I know you've already ramped investment plans at the utility, I'm curious if you see any additional organic growth opportunities beyond the current CapEx guidance? And then, separately, how you're thinking about utility, M&A opportunities and the parameters that you use to evaluate acquisitions.

Scott, why don't you handle the organic question? And I'll take the M&A.

Okay. Sarah, we're in the process now of going through our next cycle of planning, where we look at capital requirements for the next 5-year period. But the growth that we've seen in Houston to date, it stays still very strong. It's possible, as we refresh these, that we may see opportunities for additional investment related to growth. One area that is a possibility that's not reflected in our plan is the potential for investment in some import capacity into the Houston area, where we've now -- where we're now working with ERCOT to complete the study about the need for that. And the timing for that particular opportunity would be towards the latter end of the next 5-year period. So it is possible there is additional opportunities for investment in that area.

And on the M&A front, Sarah, we continue to look at opportunities. We'd love to grow our regulated utilities, whether it's gas or electric. That's our core business and we like to grow it. Recognizing, as you do, that when you pay premiums for utilities, you have to make sure that it's accretive and value-accretive to your shareholder because you can't recover the premiums back through rights. So it's a little bit more difficult in a regulated business to do M&A because of the kind of the rate treatment, but we are active in doing that. As you know, we did acquire NorAm some years ago in a transaction and we continue to be interested in this space.

And with that, we do not have any additional questions, so we will end the call. Thank you very much for participating today. We appreciate your support and have a nice day.

This concludes CenterPoint Energy's Second Quarter 2013 Earnings Conference Call. Thank you for your participation.