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

Good day, ladies and gentlemen, and welcome to the PNM Resources First Quarter Conference Call. [Operator Instructions] As a reminder, this conference is being recorded. I would now like to introduce your host for today's conference, Gina Jacobi. You may begin.

Thank you, everyone for joining us this morning for a discussion of the company's First Quarter 2010 Earnings. Please note that the presentation and accompanying materials for this conference call and supporting documents are available on the PNM Resources website at www.pnmresources.com. Joining me today are PNM Resources' CEO, Pat Collawn; and Chuck Eldred, our Chief Financial Officer; as well as several members of our executive management team. Before I turn the call over to Pat, I need to remind you that some of the information provided this morning should be considered forward-looking statements pursuant to the Private Securities Litigation Reform Act of 1995. We caution you that all of the forward-looking statements are based on current expectations and estimates, and that PNM Resources assumes no obligation to update the information. For a detailed discussion of factors affecting PNM Resources' results, please refer to our current and future annual reports on Form 10-K and the quarterly reports on Form 10-Q, as well as other current and future reports on Form 8-K filed with SEC. And with that, I'll turn the call over to Pat.

Thank you, Gina, and good morning, everyone. This morning, we released our first quarter results and reported ongoing earnings of $0.04 per diluted share, which is below our 2010 performance of $0.06. As we noted in our news release, quarterly results were driven by performance from TNMP and First Choice Power. While we expected First Choice Power to be down compared to last year, we are very pleased with their performance as they continued to demonstrate good results. As Chuck will discuss in more detail, TNMP had strong performance, up $0.03 quarter-over-quarter primarily as a result of rate relief. TNMP implemented new transmission costs of service rates last May and also benefited from new retail rates that went into effect on February 1. As expected, First Choice Power was down this quarter compared to the same period last year as we continue to see margins compressed due to lower consumer pricing. For PNM, we remain focused on strengthening the regulatory framework for PNM with the ultimate goal of improving credit metrics and shareholder returns. If you turn to Slide 5, I will go into some detail on our ongoing regulatory matters. As I'm sure you're all aware, the hearing on PNM stipulation begins this coming Monday in Santa Fe. The hearing is scheduled for 8 days of testimony. Opposition testimony has been filed and PNM has also filed its rebuttal testimony. We believe the hearing examiner will issue her recommended decision in June and the commission has indicated they could render a final order in July. PNM's FERC case is still moving forward and we plan to implement new transmission rates on June 1 subject to refund. As a reminder, the new FERC rates will increase annual revenues by $11.1 million and the filing is based on the return of equity -- on equity of 12.25%. Another open docket is the case involving the Advanced Metering System Rider for TNMP. There is a hearing set for this case for May 18 through 20 and we could see resolution of that case by the end of July. If you turn to Slide 6, we'll have a brief discussion of economic conditions and load in the regulated businesses. When we first provided 2011 guidance in February, we said that we anticipated the Texas economy would rebound quicker than New Mexico's. Initial unemployment figures, however, paint a little bit of a different picture and have New Mexico keeping pace with Texas. And I say initial results because when you look at the March New Mexico unemployment rate of 8.1%, that is a significant drop from the reported 8.7% unemployment rate in February. When the U.S. Labor Department announced that 8.1% rate, there was some immediate skepticism by our local economists. If that 8.1% holds up, that would say New Mexico's unemployment rate improved faster than any other state's rate between February and March. We could see that 8.1% figure change and tick upward in the coming months, but for now that is our official figure in New Mexico. Texas' unemployment rate seems to be in line with what we have seen recently and continues to make modest improvement. In addition, the Texas leading indicators index continues to grow and it's currently at its highest point since August of 2008. Overall unemployment figures there have shown positive growth for more than a year now. If you look at regulated load growth, both PNM and TNMP had good growth for the quarter. PNM's load growth was 2.2% and TNMP's was 2% and these are both weather-adjusted. While customer growth remains modest, we are seeing higher use per customer in both Texas and New Mexico. PNM residential use per customer was up 1.6%, and in Texas, the commercial use for per customer was up 1.8%. I want to turn to Slide 7 for a minute and discuss the proposed impact of some environmental regulations. Many of you have asked us about the financial impact of pending environmental regulation. We've put this slide together to help you would assess that impact. As you can see, the EPA's pending determination regarding BART at San Juan is the largest impact. If we are required to implement the federal implementation plan to address regional haze, the defense have already adopted, then PNM will be required to install selective catalytic reduction technology that would cost PNM rate payers up to $460 million. Plant-wide, that's almost a billion dollars. If the State implementation plan is adopted, however, which recommends SNCR, those costs for PNM customers are estimated at about $36 million. PNM supports the New Mexico Environment Department proposal, which filed on April 4, for that SNCR Technology at San Juan that addresses regional haze and, we think, minimizes costs for customers. We'll know by August 5 when the EPA issued its final determination. The original plan was for the EPA to rule in June, but the state received an extension and the EPA will use that time to review the state's plan. Regarding our Mercury Rules, our plants are well positioned and will require minimal capital spending. Specifically, San Juan will not need new additional equipment; they are already capturing Mercury removal in excess of 90%. Four Corners may need some additional equipment and you know we own about 13% of units 4 and 5 which is currently equipped with fabric filters and dry line scrubbers and can also achieve 90%-plus mercury control efficiency. In Texas, Twin Oaks will likely be slightly impacted by the new Mercury Rule and we expect the upgrades to cost between $1 million and $2 million. We turn to Slide 8. We'll talk briefly about the competitive businesses. Starting with First Choice Power, at the beginning of the year, we stated that one of First Choice's goals was to continue to grow its commercial customer sales, and boy, have they grown customer commercial sales. For the first quarter, commercial sales were up 32% compared with Q1 of 2010. That's a significant jump and commercial sales during the first quarter accounted for about 40% of First Choice Power volume. In addition, First Choice continues to build upon its sales and distribution channels and is developing stronger relationships and partners to strategically expand its customer portfolio. First Choice is also seeing strong and positive customer satisfaction trends as they continue to deliver on their new First brand proposition. Loyalty scores are strong and their Q1 customer satisfaction score was about 80% for the second consecutive quarter. In this very, very competitive arena, satisfaction scores are key in order to maintain and attract customers. We look at Optim as we discussed in the news release, we saw the natural hedge between First Choice Power and Optim Energy demonstrate its value during that cold snap in February. As we've said many times, Optim is in cost control mode as we await an improved power market in Texas. This concludes my update and I will turn it over to Chuck for a more detailed discussion of our financial results.

Thanks, Pat, and good morning. As Pat reported, we are in the $0.04, down $0.02 from last year. The breakdown of our earnings by segment shows that earnings at our regulated businesses are beginning to improve, particularly in Texas. In total regulated earnings were up $0.02 from last year, reflecting improved load growth in Texas and New Mexico as well as our continued focus to earn our allowed return. On the other hand, you'll see our competitive businesses show a decline in earnings. This trend has been fully expected given the low power price in Texas and the expiration of the Twin Oaks contract, both of which have been factored into the guidance we issued earlier this year. And turning now to the individual business units on Slide 11 that provides a breakdown of the major earnings drivers for our regulated businesses, PNM Electric and TNMP. Let's start with PNM. This year, the New Mexico utility's ongoing earnings were down $0.01 from last year. The decline reflects the expiration of the Palo Verde 3 toll agreement, which had been expected and reduced earnings by $0.06. Lower outage costs, improving load growth and some rate relief helped to offset the impact of the toll's expiration. Outage costs were down $0.04 from last year reflecting a reduction on a number of plant outages. Last year, 2 units at San Juan and one unit at Four Corners were down for maintenance while this year, only one unit at San Juan was down for plant maintenance. Weather-normalized load growth of 2.2% added $0.02 of earnings. An implementation of the second base of 2008's rate increase added another $0.02 to PNM's earnings. If you recall, the second phase went into effect April 1 of 2010. Other negative factors affecting PNM's performance this year included milder weather, which reduced earnings by about $0.015, and increased depreciation which roughly cost utility another $0.01. At TNMP, earnings were up $0.03, the implementation of new transition rates last year along with new retail rates that were put in place in February of this year added $0.03 to earnings. Weather-normalized load growth of 2% contributed an additional $0.01 to earnings. Today, we are very pleased with TNMP's performance and still expect to earn close to our allowed return this year at our Texas utility. And I say close, because implementation of the new rates went into effect on February 1, not at the beginning of the year. Now turning into the competitive businesses, as I mentioned earlier, earnings at our competitive businesses were lower than last year but the decline had been fully expected. Starting with First Choice Power, although First Choice EBITDA was down quarter-over-quarter, we are nevertheless pleased with their performance, the company's sales trends, particularly on the commercial side, is moving in the right direction, bad debt continues to decline as a percent of sales and their marketing efforts of paying off. The company earned about $12 million of EBITDA, down almost $5 million from last year and as expected, a reduction in margins accounted for most of the decline. As we have mentioned during our last call, unit margins declined about 10% in 2010, and we project a similar decline in 2011. During the first quarter, total unit margins for the quarter ended at 18% below last year. However, the decline was skewed by the impact of the extreme weather and rolling outages that hit Texas in early February. While First Choice Power was adversely impacted by the extreme weather, the company's portfolio and risk management approaches helped mitigate some of the exposure. Additionally, the negative impact associated with the weather event was almost completely offset by a corresponding increase in margins in Optim Energy, reflecting a natural hedge between these 2 businesses. A 32% increase in commercial sales volume also helped First Choice Power offset the negative impact of lower unit margins. This growth rate, however, had been anticipated and has been factored into First Choice's commercial sales guidance assumptions. The company still expects its annual commercial sales to increase 15% to 20% over last year. Bad debt at First Choice was also down, reflecting a 15% drop in customer departures and lower average final bills. For the year, First Choice still anticipates bad debt to come in between 4% and 5% of revenue for the year. And moving on to Optim Energy. Optim Energy generated about $7 million of EBITDA in the first quarter, which was down $3 million from last year. And as I mentioned before, we had been expecting a decline in earnings due to the exploration of the power sales contract at Twin Oaks. In the quarter, the roll off of the contract reduced Optim's earnings about $14 million. However, the company was able to partially offset the impact of the contract’s expiration by continuing to focus on cost control and selling excess emission credits of about $4 million. Another favorable earnings driver was associated with the cold snap that had adversely impacted First Choice Power. While the extreme weather and volatile prices reduced First Choice's EBITDA by $3 million, we estimate that the cold snap added about $5.4 million to Optim's EBITDA. So clearly, the natural hedge between First Choice and Optim Energy demonstrated its value to the first quarter and helped mitigate our competitive earnings volatility. And now moving on to guidance. Despite the delay and expected rate relief at PNM, we remain confident in our ability to deliver earnings within our original guidance range and are affirming our earnings of the unregulated EBITDA and cash earnings guidance. One caveat, though, is this assumes new rates are implemented by August 1 and there's more information of the financial impact of this delay if you look at this appendix on Slide A7. We still expect consolidated earnings to range between $0.80 to $0.92 per share, with our regulated earnings coming in between $0.89 and $0.96 and our Unregulated business is contributing between $0.06 and $0.16. Despite the delay in the rate case, PNM's electric guidance range of $0.62 and $0.67 is unchanged from our original guidance as we continue to focus on managing our costs. I do want to caution you, however, that the utility could come at the low end of our range depending on the rate case outcome. Our unregulated EBITDA guidance range is also unchanged from last quarter, as is our outlook for cash earnings. And that -- with that, I'll turn it back over to Pat for her concluding remarks.

Thank you, Chuck. We will finish today's presentation with our checklist. This is a brief reminder of the strategic goals we continue to work on in our efforts to ultimately return our subsidiaries and PNM Resources back to investment-grade status. This was an unusual quarter in that we do not have any milestone as our previous earnings call. Although we do have a lot in progress, by the time we talk to you again to report our second quarter results on August 5, we should have a significant updates for you. By then, we'll have a clearer picture on the PNM rate case and the TNMP AMF docket, and we'll have an idea of how that Texas power market fared during this summer. With that, I will turn the call back over to our operator to start the question-and-answer portion.

[Operator Instructions] Our first question comes from Paul Fremont from Jefferies. Paul Fremont - Jefferies & Company, Inc.: I guess my first question relates to First Choice. With the growing level of C&I contribution there, is the margin on C&I different than the margin on the residential and can you give us sort of numbers that we should think about in terms of like a range?

Paul, it's Pat, and Brian Hayduk who's the head of First Choice Power is here with us this morning and I'm going to ask him to give you some color on that.

Sure. Paul, it's Brian. Certainly, the commercial margins are lower than residential -- and I don't I'll give specific guidance of that, but I will say as Chuck mentioned, we were down in the neighborhood of 10% for the year on margin last year. We expect to be in similar trends this year, and that is inclusive of what we are forecasting from a commercial standpoint. So we are not at this point, really, looking to have the commercial growth dramatically impact our forecasted margin. Paul Fremont - Jefferies & Company, Inc.: So is it fair then to think about the 10% decline in '11 as being primarily driven by the change in mix in your customer base?

No, I think it's a combination. It's the combination of compression certainly on the residential side. I think most suppliers have mentioned the compression in margin and the competitive nature of Texas. I think you have that as well as the change in mix and in our case, it's probably more the compression on the residential side than a dramatic material change in mix at this point.

And, Paul, I think the other thing to think about, when we talk about commercial customers, Brian is not talking about the real large folks that you tend to have really very small margins in. And this is more what we could consider smaller and medium-sized commercial customers. Paul Fremont - Jefferies & Company, Inc.: And then my other question is for Chuck. He mentioned that you might be at the low end of the guidance range on the New Mexico utility depending on the rate case outcome. Can you sort of clarify what that means -- are you assuming that the settlement is approved as submitted or is there something that I'm missing?

No, I think the key point, Paul, is we're making the assumption that rates would be implemented by August 1, which means that we would anticipate a decision out of the commission sometime in July. And so given that, obviously, if you go back and look at the full implementation of the stipulation, we would've gotten $0.23 this year, that drops it down to $0.16. And in the way in which we're managing that, and why I say at the lower end, it's because it's really trying to match up ways in which we can adjust O&M costs. And then also we're assuming in our guidance range, the upper end of the load growth of -- which is 1% to 2%, so the combination of those factors allow us to remain within the PNM guidance range. But I just want to caution you that based on what the ultimate outcome is, and given what that answer might be, then we would have to reevaluate based on what the decision is out of the Commission, but the key is the assumption that we're using now is August 1 with no change in the stipulation.

And Paul, we said that it was $0.02 to $0.03 a month impact to earnings if the stip was delayed as since these tend to be hot summer months, so if you end up moving to August 1, you'd lose some of the hot summer months.

Our next question comes from Bryan Russo from Ladenburg Thalmann. Brian Russo - Ladenburg Thalmann & Co. Inc.: Can you just talk a little bit more about kind of the Optim and First Choice Power dynamic. And correct me if I'm wrong, but Optim, or PNM -- I'm sorry, First Choice Power's load is significantly more than the capacity output of Optim? So I'm just trying to get a sense -- it's not kind of a perfect hedge because you're not selling from one to the other in purchase power, right?

Well, first of all -- I'm Brian, the load if compared to Optim Energy is 50%. So actually your long energy when you think Optim's supply versus what the load is on First Choice. And there's a pretty good match relative to the location of the generation assets and where that's in, in First Choice. It's not perfect but certainly not a bad match. But there is no benefit from integration of that, it's really how the 2 businesses perform during that cold snap. And that's our point, is that as you would expect, with the extreme increase in power prices in February because of that cold period, Optim and the plants performed well during that period. We were able to sell excess power and make money. On the other hand, Brian, it was in a situation where we had to deal with the swings and the usage and the impact of the cold snap, had to buy power, and that’s more costly. But net-net, the 2 businesses when you look at it in total really did come out as a net positive, and that is our point there, is the fact that the natural offset of how the businesses performed independently resulted in a net positive for the period of time that occurred in February. Brian Russo - Ladenburg Thalmann & Co. Inc.: And I have hadn't a chance to look at the PNM Electric subsidiary income statement. But I'm just wondering if you can discuss the trends that you're seeing in O&M maybe first quarter, '10 actual and then what you're seeing for the rest of the year, because I think that's kind of a big supporting factor in earning your allowed or a way over the next couple of years?.

Yes, we really haven't given direct information on the O&M cost costs but you can see the trends. But I think that the main message is that we continue to find ways to align the revenues and the costs certainly to reflect a more manageable outcome for the business to work towards earnings allowed returns. So we have internally tasked up programs and management does of ongoing process improvements and ways to tighten our belts to ensure that we create as much efficiency as we can. And so I think you will see over time that we'll continue -- it's just the nature of how we think of the business, is to find ways to control O&M costs and hopefully reduce and continue to reduce O&M costs.

Brian, if you look at the first quarter, for example, we did $0.04 better because of lower outage costs. As Chuck mentioned, we had significantly fewer outages. So we have some natural things in there that benefited us but we have plans in place to basically match our costs with our revenue. Brian Russo - Ladenburg Thalmann & Co. Inc.: My last question has to do with load growth. I think weather-normalized load growth at PNM Electric was 2% in the first quarter '11 versus first quarter '10.

Yes, 2.2%. Yes. Brian Russo - Ladenburg Thalmann & Co. Inc.: 2.2%, that seems quite high relative to what we're seeing in other parts of the country. I'm wondering if you could just maybe explain kind of the demographics or the dynamic that’s supporting that. And is that sustainable or is it just a function of the low sales base from a year ago?

No, I think it's the state of -- because the sales base of last year at 2010 was not that bad. 2009 was there real low sales year. And anecdotally, what we are seeing and hearing is people that have their jobs, they're are much more comfortable with their jobs. So they are either keeping the house a little cooler in the summer, maybe a little warmer in the winter and we’re all buying all these gadgets that just really kind of take a lot of energy. And so I think it's just more a psychological function of the fact that people are more comfortable using energy. And remember, we -- only 13% of our sales come from the Industrial segment, which was the one that I think experienced a large downturn. And our largest industrial customer happens to be Intel, and they're pretty steady. So we're just more of a steady commercial residential customer mix.

[Operator Instructions] Our next question comes from Ali Agha from SunTrust.

Chuck, can you remind us, embedded in your '11 guidance currently for PNM Electric? What is the implied ROE in there? And then, assuming the stipulation of the 71 days approved as planned, what should we be thinking about the ROE in '12, has it pretty much overcome the lag?

'11, we talked about 7% to 7.5% for the rate base return for PNM. In '12, we haven't really given out any guidance and information. I think that the clear message is based on the stipulation and the assumptions around the stipulation, it gives us a clear path towards earning our allowed return up through 2013. So I think at this point until we have more definite information as a result of this stipulation, we should probably just leave it at that. But definitely, if you look at 2010, or '09, '10 and '11, clearly you'd see us beginning to making significant improvements in our return on rate base and we just need a clear decision so we can begin to manage to earn that allowed return.

So should we not assume that you are only allowed return in '12 yet or assuming the stipulation goes through or did I not hear that correctly?

I think if you can take a look at the stipulation, it's in 3 pieces. It's this year, next year and then 2013 where you get that Capital Additions Rider. And in that Capital Additions Rider basically applies to any additions made to the capital from June 30 of 2010 which is the end of this case to December 31, 2012. So if you think about it, you really need to take another step until you get caught up on your capital.

Okay, that's understood. And then if you take -- and assuming that it goes out as planned and you now have 5-year CapEx numbers across the utilities, if you look at your growth rate and rate base of that, which I believe is about 6% a year, if my math is right, should we assume pretty much underlying EPS growth kind of follows that pattern? Or are there other pluses or minuses to think about assuming that 6% number sounds right to you?

I think there's 2 things to think about that are not in that capital that could happen. One is, as we discussed earlier, if the federal implementation plan for San Juan is implemented, that's about $460 million of capital that isn't in there. We would apply for rate recovery of that and we have an out in the stipulation to apply for rate recovery of that. The other question is if there would be any renewables above and beyond what currently is in the plan right now, but the rest of the capital that we have in here is really base O&M capital -- base capital would be covered in the Additions Rider.

Okay. And the last question, going back to Optim and First Energy, in the past you guys have talked about your goal obviously to run them in somewhat of integrated fashion. As you said, the location, it makes a lot of sense, et cetera. Any success there and linked to that, you've also said if that doesn't play out at some point, you're going to make a decision -- a strategic decision. Does it make sense to run them separately or to even own them-- can you just give us an update on your current thoughts on those non-reg businesses?

Ali, I think you just answered a question for us. You well stated our position and our view. We think the longer-term strategic direction would be a full integration of the business and certainly alternatives to achieve that are certainly things that we continue to review and think through. Meanwhile, our focus has been on stabilizing First Choice and having consistent and favorable results on that which we've proven out the last 2 years and continue to have a good feeling about that business this year. And Optim Energy itself has been able to manage through pretty difficult environment in Texas with low energy prices. So the businesses work well as they are but they are not fully benefiting from any synergies. And so we would continue to think through ways in which we would integrate it or make other decisions if we don't think that's achievable.

[indiscernible] on a number decision point or is that more on the 2012 kind of decision point?

You know, I wouldn't actually put a timetable on it at this point, Ali. I think we'll just leave it like it is. We'll let you know as soon as we have some better information.

Our next question comes from John Ali from Decade Capital.

A follow-up to Ali's question, if you were to drop First Choice into Optim, I'm assuming they pay off the cash for their portion of the – I mean, their portion of the JV, where are some potential uses for that cash?

You say if we pull cash out. Well, there's all sorts of ways at which you can look at it -- handling cash. If you were to pull cash out of it and use it to capitalize the new businesses you’re putting together. So whether you look at reducing debt to holding company, buy back stock, whatever typical things you might think about on use of cash, we would think through those alternatives as well.

Any preferences?

No comment.

I'm showing no further questions at this time, I would like to turn the call back to the CEO, Pat Collawn.

Okay, thank you, operator. With that, I think we'll end the call today and we appreciate everyone taking the time to participate in this call this morning. We look forward to talking with you all on the second quarter call, if we don't see you beforehand. Again, thank you all very much. Have a wonderful weekend.