CenterPoint Energy, Inc. (CNP) Q1 2011 Earnings Report, Transcript and Summary

Good morning, and welcome to CenterPoint Energy's First Quarter 2011 Earnings Conference Call with senior management. [Operator Instructions] I will now turn the call over to Marianne Paulsen, Director of Investor Relations. Ms. Paulsen?

Thank you very much, Thea. Good morning, everyone. This is Marianne Paulsen, Director of Investor Relations for CenterPoint Energy. I'd like to welcome you to our first quarter 2011 earnings conference call. Thank you for joining us today. David McClanahan, President and CEO; and Gary Whitlock, Executive Vice President and Chief Financial Officer, will discuss our first quarter 2011 results and will also provide highlights of the key activities. In addition to Mr. McClanahan and Mr. Whitlock, we have other members of management with us who may assist in answering questions following their prepared remarks. Our earnings press release and Form 10-Q filed earlier today are posted on our website, which is www.centerpointenergy.com, under the Investors Section. I would like to 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 Mr. McClanahan begins, I would like to mention that a replay of this call will be available until 6:00 p.m. Central Time to Thursday, May 12, 2011. To access the replay, please call 1 (800) 642-1687 or (706) 645-9291 and enter the conference ID number 52480366. You can also listen to an online replay of the call through the website that I just mentioned. We will archive the call on CenterPoint Energy's website for at least one year. And with that, I will now turn the call over to David McClanahan.

Thank you, Marianne. Good morning, ladies and gentlemen. Thank you for joining us today and thank you for your interest in CenterPoint Energy. This morning, I will talk about a significant development that occurred during the first quarter, then describe our first quarter financial results and provide the operating results for each of our business segments. Let me begin with the discussion of our true-up appeal. As most of you probably know, the 1999 law, which restructured the electric industry in Texas, allowed electric utilities to recover stranded costs and certain other transition expenses in what is known as a "true-up proceeding." In 2005, the Texas PUC issued a decision that failed to allow us to recover some of the costs to which we believe we were entitled. As a result, we took a $947 million after-tax extraordinary loss, and appealed the PUC decision. The appeal was heard in the district court, followed by the Court of Appeals and finally the Texas Supreme Court. On March 18, the Supreme Court issued its decision in our true-up appeal. The court reversed the PUC on a number of points and remanded the case back to the commission for implementation. As a result of the decision of the Supreme Court and of the earlier decision by the Court of Appeals, we will be able to seek in the remand proceeding recovery of the following: $210 million of excess mitigation credits paid to retail electric providers; $146 million of deferred federal income taxes that had reduced stranded costs; $378 million in depreciation; and $440 million from the capacity auction true-up. The Supreme Court also determined that the PUC should have valued our generation assets for stranded cost purposes by using the subsequent sales price of those assets. This decision reduced the amount we can seek to recover by $252 million. The net result of the court's decision is approximately $922 million in additional stranded costs and transition expenses. A number of parties have asked for a rehearing of the Supreme Court's decision. The court has 180 days to act on those motions, or they are denied. Based on the court's decision, we believe we are entitled to seek recovery of approximately $1.85 billion in the remand proceedings. We conclude the calculation of interest through the third quarter of this year. We will also seek a financing order from the PUC to allow us to issue transition bonds to recover the allowed amounts. While there is no statutory deadline for the PUC to act on the remand, interest on the unrecovered true-up balance will continue to accrue at a rate of about 8% until the transition bonds are issued. In his remarks, Gary will discuss the expected accounting treatment and cash flow impacts of the true-up decision. Now let me review the company's overall results for the first quarter. This morning, we reported net income of $148 million or $0.35 per diluted share. This compares to net income of $114 million or $0.29 per diluted share for the first quarter of 2010. Operating income for the first quarter was $364 million, compared to $357 million last year. We also reported lower interest expense and federal income taxes this year compared to the first quarter of 2010. Houston Electric had a solid quarter, reporting operating income of $68 million, about $3 million below the first quarter of 2010. Operating income benefited from growth of more than 29,000 customers since the first quarter of last year. This represents a growth rate of about 1.4%, and is an indication that our service territory continues to rebound. Offsetting the benefit of customer growth were higher operating expenses, due primarily to system reliability programs. The first quarter results do not reflect the impact of our recent Houston Electric rate case. The Texas PUC approved the final order at its open meeting last week, but the signed order has yet to be issued. We do not expect new tariffs to be implemented before the third quarter. As I indicated earlier this year, the cash flow impact from this case should be minimal, but we anticipate Houston Electric's operating income will be negatively impacted by approximately $30 million on an annualized basis. Our Natural Gas Distribution business had another good quarter, reporting operating income of $142 million or about $3 million above the first quarter of last year. This increase resulted primarily from lower bad debt expense, partially offset by increases in other operating expenses. Last month, the Texas Railroad Commission approved a rate settlement that is expected to result in increased annual revenues of approximately $4.6 million in our South Texas service territory. We had requested an increase of a little over $6 million. The new rates were implemented this month. We are progressing well in the implementation of advanced metering technology in both our Electric and Natural Gas Distribution utilities in Houston. Houston Electric is now a little over halfway through the deployment of its advanced metering system, having installed approximately 1.2 million smart meters. We expect this deployment to be completed in the middle of 2012. Earlier this year, we began installing remote electronic transmitters on the 1.2 million natural gas meters in and around our Houston service territory and expect to be completed in the first half of 2013. This new technology is expected to enhance the information available to our customers and significantly improve the operating efficiency of these business units. Our Competitive Natural Gas Sales and Services business reported operating income of $10 million compared to $15 million for the first quarter of 2010. After adjusting from mark-to-market accounting for derivatives, both quarters' operating income would have been approximately $12 million. Our Retail division had a good quarter, experiencing increases in both the number of customers it serves and sales volumes. Although our Wholesale division continues to face a challenging business environment, we expect to see some improvement over last year. Now let me turn to our midstream businesses, Interstate Pipelines and Field Services. Both of these units reported results ahead of last year. Our Interstate Pipelines recorded operating income of $76 million compared to $72 million for the first quarter of 2010. Our core business continues to perform well with increased margin from our Carthage to Perryville pipeline, as well as increased revenues related to several new firm contracts to serve the power generation facilities on our system. Ancillary services revenues, however, were below levels of last year. Operating expenses were lower than the first quarter of last year, principally the result of an insurance settlement recorded in the first quarter of this year. Equity income from SESH, our joint venture with Spectra, was $4 million compared to $3 million in the first quarter of 2010. Our Field Services unit reported operating income of $36 million compared to $23 million for the first quarter of 2010. The increase in operating income was primarily the result of the long-term agreements with subsidiaries of Shell and Encana. In addition to operating income, we also recorded equity income of $2 million for both the first quarter of 2011 and 2010 from our jointly owned Waskom facilities. Our gathering volumes were up significantly this quarter. Average gathering volumes were a little over 2 billion cubic feet per day, an increase of about 43% from the first quarter of last year. Gathering volumes related to shale reserves accounted for about 60% of our total volume this year, compared to 32% last year. Gathering volumes from our traditional basins were down about 15% from the first quarter of last year, and about 5% from the most recent quarter. Drilling activity in these areas continues to be modest. The few major systems to gather and treat production in the Haynesville shale continue to progress well. The first 700 million cubic feet per day phase of the Magnolia System is now complete, except for well connects. In the first quarter of this year, we substantially completed construction of the 600 million cubic feet per day Olympia System, and the 200 million cubic feet per day expansion of the Magnolia System, both on schedule and on budget. There are still several pipeline interconnections and additional well connects remaining to be completed. During the first quarter, throughput on the Magnolia System averaged approximately 550 million cubic feet per day, and the Olympia System averaged over 300 million cubic feet per day. We expect throughput on these 2 systems to increase over the course of the year and be at system capacity by early 2012. As you may recall, the Shell and Encana contracts provide for a step-up of annual throughput guarantees as certain milestones are reached. Various milestones are expected to be achieved during 2011, and by early next year, the annual throughput guarantees will be at the contracted capacities. For planning purposes, we are assuming that about half of the remaining 1.3 billion cubic feet per day in expansion rights will be elected over the next 5 years. In addition to the Haynesville shale area, we also realized throughput growth of about 34% in the areas that include the Fayetteville and Woodford shales, driven principally by projects we are developing for XTO Energy, a subsidiary of Exxon Mobil. Over the last 3 years, we have deployed over $140 million for scalable projects in the Woodford and Fayetteville shales, and are positioned to build additional facilities over time to meet our customers' needs. Overall, I believe our company performed well this quarter. In his remarks, Gary will discuss our earnings guidance for 2011. In closing, I'd like to remind you of the $19.75 per share quarterly dividend declared by our Board of Directors on April 21. We believe our dividend actions continue to demonstrate a strong commitment to our shareholders and the confidence the Board of Directors has in our ability to deliver sustainable earnings and cash flow. With that, I will now turn the call over to Gary.

Thank you, David, and good morning to everyone. Today I would like to discuss the accounting treatment and cash flow impacts of the Supreme Court's decision in our true-up case, recent credit rating agency actions, and our earnings guidance. As David mentioned in his remarks, on the basis of the Supreme Court's March 18 decision, we plan to seek to recover approximately $1.85 billion through the sale of non-recourse securitization bonds. The $1.85 billion includes interest through September 30, certain costs associated with the sale of our generation assets, and an adjustment associated with the benefit of deferred taxes. This entire amount will be subject to federal and state income taxes at a rate of approximately 36%. Although we will receive the cash when the securitization bonds are issued, these taxes will be paid over the life of the bonds as we collect this amount from customers. As you know, we cannot be certain when the Supreme Court will dispose of the motions for rehearing, or when the PUC will issue its order on remand and the necessary financing order. However, for purposes of this discussion, I have assumed that $1.85 billion of bonds are issued on September 30. If the bonds are issued later than September 30, interest will continue to accrue at approximately 8%. Let me explain how the $1.85 billion would be recorded. Assuming a 36% tax rate, we expect to recognize just under $1.2 billion in after-tax earnings. This amount will be recognized in 2 different time frames. Once the decision is finalized, the company would immediately recognize after-tax earnings of approximately $830 million to reflect the recovery of additional stranded costs and transition expenses, plus the debt component of the interest amount, offset by the benefit of deferred taxes. The equity component of the interest amount, which we estimate to be approximately $365 million after taxes, would not be recognized upfront, but will be recognized over the life of the securitization bonds. Regarding the use of the proceeds from the sale of the securitization bonds, our fundamental objectives have not changed. We will continue to seek opportunities to invest in accretive projects and to strengthen the balance sheet. Depending upon the timing and availability of these opportunities, we may also consider a modest stock buyback. Now let me address 2 recent positive credit rating developments. Following the Texas Supreme Court's decision in our true-up case, Moody's placed under review for possible upgrade the ratings of CenterPoint Energy and our subsidiaries CE and CERC. Moody's said that during the course of this review over the next few months, it will assess the financial impact from the Supreme Court ruling, including our plans for the securitization proceeds. Last month, S&P announced that it has affirmed CenterPoint's corporate credit rating at BBB, but also revised the ratings outlook on CenterPoint Energy, CE and CERC to positive from stable. In the release accompanying the announcement, S&P said that the rating action results from improvements in CenterPoint's business and financial risk profile that may support a higher rating, and reflects S&P's expectations that CenterPoint will prudently utilize the proceeds expected to result from the Texas Supreme Court's decision in the true-up case. Finally, let me discuss our earnings guidance. We were pleased with our overall business performance in the first quarter, and this morning, we reaffirmed our 2011 earnings guidance in the range of $1.04 to $1.14 per diluted share. This guidance does not include the earnings impact of the Texas Supreme Court's decision in our true-up case which I described earlier. In providing earnings guidance, we have taken into consideration our year-to-date performance, as well as various economic, operational and regulatory assumptions. As the year progresses, we will keep you updated on our earnings expectations. Now, I'd like to turn the call back to Marianne.

Thank you, Gary. And with that, we will now open the call to questions. In the interest of time, I would ask you to please limit yourself to one question and a follow-up. Thea, would you please give the instructions on how to ask a question?

[Operator Instructions] The first question will come from Carl Kirst with BMO Capital.

Gary, can I just ask a clarifying question here? So the accounting aside, and I appreciate that color, you're saying that we're going to be paying out the income taxes on the new securitized bonds over the life of those bonds? That means we're actually going to be getting something close to $1.85 billion -- I mean, if it all went well, we'll be getting $1.85 billion of cash on hand and then we'll just see, like a $20 million to $25 million bleed out per year? Is that how we should think of it?

Yes, I would think of it when -- the first part of that is correct. We will sell securitization bonds, in this example, $1.85 billion that we would receive. The tax then will be paid out at approximately 36%, and you can think about that when you see the term of those bonds. So in an assumption that you have 14-year bonds, you would pay the income tax over the 14 years as you collect the money from the customers.

Okay, appreciate that. And just on a related question, and understanding you guys don't necessarily know the minds of the PUC, but do you get the sense that they are working in parallel with respect to the TSC [Texas Supreme Court], i.e. that they're working on the remand order as we speak, or is this something where it's going to be very, very linear and we have to have the Supreme Court either issue their ruling or wait 180 days before the PUC will even start working on this?

Scott, why don't you address that.

Carl, my expectation is that the commission has reviewed the Supreme Court's order as it exists so far. We'll review the motions for rehearing that people have filed, including the PUC itself, that they will do some preliminary work to understand how that process will play out, potentially looking at prior financing orders and the models that we used to plug in the inputs from the Supreme Court's ultimate decision, so that we will be in a position to move fairly quickly after the Supreme Court rules on the motions for rehearings. But in terms of taking any formal steps, I think the PUC will wait until after the Supreme Court has disposed of the motions for rehearing.

Understood. That's very helpful. And then lastly, if I could, just any investment update, if you will, as far as the status of either the Eagle Ford or the Haynesville -- and with the Haynesville, I'm not necessarily talking about the Encana shale, but there at one point was sort of the intimation that maybe some other types of facilities, support facilities, water, et cetera, might be out there. I didn't know if you could touch on either of those.

I'll get Greg to answer that for you, Carl.

We continue to work on several items in the Haynesville relative to our contracts with Shell and Encana, and those are -- would evolve around water systems or other services as well. Nothing to report at this point in time. We continue to exchange proposals, and it's really up to our customers to dictate the time frame there, but we feel pretty good that we'll -- eventually something's going to happen. At Eagle Ford, we continue to press forward on opportunities in Eagle Ford. One of our largest customers had a request for proposals come out and we've responded to that, and we'll continue to respond to those.

[Operator Instructions] The next question will come from Ali Agha with SunTrust.

Gary, also I want to comment on a related question. In terms of how you're going to recognize the earnings from this decision, it appears to me that the $830 million that you would recognize upfront, was an obligation [ph] recognized as a one-time item gain. The $365 million that gets recognized over the life of the bonds, would you consider that as ongoing earnings, or would you look at that separate from your, when you're talking about ongoing earnings with us?

No, I would look at that as ongoing earnings.

Okay. Second question. With regards to the use of proceeds, as you mentioned, investments and potentially a modest share buyback, should we assume that discussions with regards to setting up an MLP are no longer on your radar screen, or is that still under consideration?

I think certainly from a funding perspective, we're looking at that different because we certainly are looking at a significant amount of cash. I think the MLP though, perhaps has other benefits, and I think our position really remains the same. One, our guys are working diligently as you heard from Greg to originate new business in our midstream areas, so to the extent we got significant projects. We would look at an MLP because we'd think about the very long term, when's the best financing vehicle for the very long term. And so we're here to run this company for the longer term, not the near term. So I think an MLP certainly is not off the radar screen. I just think that the events that would be the catalyst for it really need to be significant projects in our midstream business. It's really not necessarily a near-term funding issue. And of course, there's been the qualitative aspects that you have to look at is the valuation for the total company in terms of some of the parts. We certainly continue to look at that with that structure being helpful in that regard, but I would not say it's off the radar screen. I think our screen though that we've put it through is a bit different now with the significant funding that we have coming from the securitization bonds.

Right. And last question, to clarify, what is share buyback -- when you think along those lines, you're thinking in the $50 million, $100 million range or how would you define modest?

Well, I'm really not prepared this morning to put a number on that. I think "modest" speaks for itself, and certainly we would not use the majority of these funds for a share buyback. What we're going to -- let me step back from that. What we want to do, of course, is invest these dollars in accretive projects. That's job number one. And our guys are continuing to work hard to find those very good opportunities. So that's job number one. To the extent, as I've mentioned, the timing of that is different, then we'll look at paying down debt, and we look at a share buyback as well. So don't try to pin me down on a number, but it would be modest because our goal really is to invest in this business. And that's best for our shareholders over the long term and it's best for our credits over the long term is to have really high-quality, accretive investments.

The next question will come from Steve Gambuzza with Longbow Capital.

Question for you on the numbers you put out regarding the volumes on Magnolia and Olympia, you said 550 on Magnolia and 350 on Olympia, is that correct?

300 on Olympia. 550 combined.

Okay. And is that -- just so I have this right. The Magnolia is about 900 capacity and the Olympia Phase I -- I'm sorry, the Magnolia and the Magnolia I expansion are, together, 900 of capacity and Olympia Phase I is 600 of capacity?

That's correct.

Okay. So you're roughly running kind of 55% or so capacity utilization in the first quarter and you'd expect to be running full when you exit 2011, is that right?

By 2012 -- early 2012 is when we expect to ramp up to the contracted quantities, yes.

Okay. And so, should we expect -- I mean we look at the operating profit that Field Services put out this quarter, would you expect kind of consistent sequential increases as we go through the year as the system continues to ramp up?

Well, I think we hope to see some fairly consistent improvements in profitability. The wildcard here, Steve, is our traditional basins, and they have flattened out some last year, they declined a little bit more in the first quarter of this year. But we had some unusual weather, we had, wellhead freeze offs and stuff like that, so we have to kind of look at it again in the second quarter. But I think we should see continued profitability from these investments we've made in Shell and Encana. And as we said, the Fayetteville, especially in southern Woodford, those volumes are picking up, too, more than offsetting the decline we're seeing in the traditional basins.

Great. And then just finally, it seems like O&M expense found a level versus last quarter after a couple of significant increases over the past couple of quarters. Is this a pretty good run rate to use for Field Services O&M expense going forward?

It's getting close to that. Most of the facilities are now in service and we have been putting new facility in service over the last 12 months, so once they're all in service, especially the AMI [ph] facilities, I think we'll have a good run rate. We're getting very close to that, I would think.

The next question will come from Debra Bromberg with Jefferies & Company. Debra Bromberg - Jefferies & Company, Inc.: I was just wondering if I could get clarity on something. The $365 million that you referred to earlier, was that the equity return?

Yes.

Yes, yes. Debra Bromberg - Jefferies & Company, Inc.: And are you securitizing that up front?

Yes, the entire $1.85 billion will be securitized. Debra Bromberg - Jefferies & Company, Inc.: Right, but the securitization proceeds, that includes both the debt and equity return?

That includes the total amount, right, in that example I gave. Debra Bromberg - Jefferies & Company, Inc.: And the $365 million that you're recognizing over the life of the bonds, is that non-cash?

That would be non-cash, that's correct. Deferred taxes will be set up on all of this, and that would be non-cash, that's correct. Debra Bromberg - Jefferies & Company, Inc.: And one other question. Have you said what the deferred tax liability is?

Not specifically. We've estimated it at $1.85 [billion]...

About $600 million and that'll be kind of ratcheted off over the life of the securitization bond.

[indiscernible] Present value...

I'm sorry, Debbie -- Debra, what was your question again? I missed it. Andrew Smith - JP Morgan Chase & Co: The deferred tax liability, is that around $600 million?

Yes, that's correct. Debra Bromberg - Jefferies & Company, Inc.: Is that the present value?

No, no. That's just -- you set up that deferred tax when you set up the accounting for the proceeds, and you pay those -- are you referring to the deferred taxes that reduced the amount that we recovered through securitization? Debra Bromberg - Jefferies & Company, Inc.: Yes.

Yes. That's not that big, it's about $125 million or so that reduced the amount, essentially reduced the amount of interest we get to recover.

[Operator Instructions] The next question will come from Yves Siegel with Crédit Suisse. Yves Siegel - Crédit Suisse AG: I have 2 questions. Number one, could you describe the investment opportunity in the Eagle Ford in terms of the RFP that you received? And the second question is, could you describe how you view the acquisition landscape across the different businesses?

Greg, do you want to comment on that? This is a confidential kind of RFP and we can't provide very much color other than it's primarily directed at gas gathering and the liquids associated with that.

That's exactly right, David, it is under FCA [ph] right now, [indiscernible] but part of it is right in our [indiscernible], it's traditional gathering, and then the other part would be some higher pressure, can take away price, both gas and liquids. Yves Siegel - Crédit Suisse AG: And you wouldn't be looking at processing then?

Possibly.

And in terms of just the landscape of acquisitions, there's lots of activity going on in the electric space these days. A lot of that is not necessarily driven by pure regulated considerations, and of course, we look at things from a regulated standpoint. So I think there's more activity there now, so if that means anything, I guess only time will tell. Certainly on the midstream businesses, there's been activity there. They're fairly pricey as we see them. We would much rather be investing in organic growth as opposed to paying a high multiple, but we continue to look at those opportunities and I think there'll be some opportunities over time. Yves Siegel - Crédit Suisse AG: If I could just follow-up real quick. When we think about the Eagle Ford and your strategic advantage there, is it more so because of the customer connection as opposed to any synergies with existing assets?

Yes, I think that's right. I mean we obviously know the business well, but it is customer relationship. We do not have any assets today in the Eagle Ford. I would say definitely the relationship is very important.

Also I think just on our core business of gathering, I don't think there is a strategic advantage anybody would have over us just because they have existing facilities. And when you're talking about well connects and taking them to control points. So I think we're on an equal playing field on that type of relationship as well. Yves Siegel - Crédit Suisse AG: Last question, I promise. Just on the re-contracting, what's the situation there?

With the backhaul? Yves Siegel - Crédit Suisse AG: Yes.

We're making some progress on trying to get some dollars or some capacity re-contracted. I think we'll have some success there this year. We probably will not get the full $500 million a day re-contracted, and certainly what we do get re-contracted will be at a lower rate than we're being paid today. We still estimate, I think we said this last time, about a $20 million annual impact this year from the loss of that backhaul. That's including our estimate for offsetting with some re-contracting amounts.

At this time, there are no further questions. I will turn the conference back over to Ms. Paulsen for any closing remarks.

Thank you again, Thea. Since we do not have any further questions, we would like to end the call. Thank you very much for participating today, and we appreciate your support very much. Have a great day.

This concludes CenterPoint Energy's First Quarter 2011 Earnings Conference Call. Thank you for your participation.