TXNM Energy Inc (TXNM) 2004 Q3 法說會逐字稿

Good morning and thanks for joining us. I'm Jeff Sterba, Chairman, President and CEO of PNM Resources. Let me introduce the folks from our Company that are with us today.

John Loyack our Chief Financial Officer, whom many of you know. Lisa Rister, who is head of our Investor Relations department. Lisa Eden who is standing in the back, who works with Lisa. So we call them the Lisa squared. They will provide you with the information that you count on. And David Harkness who is standing back next to Lisa Eden who in his day job runs our IT side for Customer Solutions, and the rest of the time he is serving as my aide for the next five months. I appreciate you all joining us.

If you all would do me a favor, -- I think you each have the presentation. If you would turn to the Safe Harbor and titillate your literary senses by reading it, that way I don't have to read it to you, I would appreciate it. Done? [ laughter ]

It's a real pleasure to join you all today. I know that you are being inundated with information from a number of companies over the course of three days. It's always information through a fire hose. I believe most of you know our story and know about our Company, so we'll hit some high points, then talk about elements that are current to us.

But one of the things as you know we've been doing over the last set of -- about four or five years is really focusing on creating the foundation for our growth. We're a Company that has really focused on four corner stones of our strategy that we believe have helped us generate a 20% per year compounded total shareholder return over the last 5 years or 4 and 3/4 years since the start of the century.

Most corner stones for us really start with the notions for reliability. We have been rated #1, 2 or 3 on system reliability since the year 2002. One of the reasons that's important for us is that it drives a lot of our customer satisfaction. And most of our industrial growth that has occurred is high-tech. Intel has its largest value added fab facility in the world in our service territory, and they are a very high demander of high quality service. So reliability has been a major corner stone that I think has helped cement strong customer satisfaction ratings.

For the last set of years, any company that makes a presentation that doesn't talk about integrity is probably missing something. The problem is, in most instances, it's talk. I'm not going to talk about integrity. I would just invite to you come visit our Company and visit our employees because to me, it's not measures whether it's ISS or corporate library or anybody else that rates your corporate governance. It's the depth and the degree to which integrity is built into your culture. How do you make decisions and how are decisions made at the lowest level of an organization and do they reflect integrity? And I can't talk about that. I just invite you to come experience it with us.

The third piece which has been very important to us is the area of innovation. And it's innovation in three arenas. It's in products, it's in process and it's in market positioning. We talked a lot in the past about how we have positioned within our markets, particularly in our wholesale markets, to do something different than just a marketer trader. We focus on niches. We focus on customers who need something more than the kilowatt hour.

So the innovation that we've demonstrated, I think, in our wholesale marketing area, has been one of the things that has allowed us to grow that business in a significant way, through ups and downs in the western power market cycle. In process, as I'll talk about a little bit, this is how we have really driven down our costs per unit in a significant way. Process quality is something we teach every one of our employees. And we challenge our process continually. I won't talk about it in great detail but you will see the results of what we've done in process quality.

The items that are mentioned here really focus on the third element, which is products. I won't go into detail on these Phase ID and MIB are things that have come out of our technology set. Phase ID is a device, a free standing device that allows people in the field without having to make -- having a reference point back to a command center. Allows them to determine what phase are they working on in the distribution line. So load balancing is one of the critical things you have to do in a distribution operation. Most companies can't do it very well, because when you are out in the field, you have no idea what phase you are working on unless it's labeled. And labeling is not very good. And when you go through things like hurricanes, you really mess up the spaghetti and have no idea what phase is connected.

So this is a tool that we developed for our own use. We're now taking it out into the marketplace because it has worked so well. MIB of something similar, it's a Mutual Inductance Bridge technology that allows us to detect wall thinning inside boilers. And as you may know, in particularly coal-fired boilers, steam tube leaks is the biggest cause of forced outages. So we're able to scan a boiler and determine where are thinning patterns in it -- using a technology that hasn't before been applied. Both of these are now patented. Innovation is something we as a Company focus on.

The last piece is stability. We do operate in a competitive wholesale market that has demonstrated volatility but through both, what we've done on our retail end of the business in terms of rate freezes and rate increases, what we've done on the wholesale end of the business in terms of locking up 70 to 80% of our margins under long-term contracts-- we've brought stability to those revenue streams, which has enabled a second credit rating upgrade earlier this year.

So these four corner stones have helped fuel fundamental, solid operations that use a somewhat unique business model, what we call the Merchant Utility Model. As most of you know, we operate in a realm in which we take our regulated and our unregulated generation. We treat our retail load as a wholesale customer if you will, and we're able to treat those resources as an entire system, that gives us a great deal amount of flexibility in terms of what we can offer into the wholesale markets. And allows to us appeal to these customers who need something more than the kilowatt hour.

With these four corner stones, as you were probably are aware of, we're targeting 5 to 6% long-term growth and the question is, well how are we going to reach that? The first piece I'd like to touch on is our organic growth, which is really just doing our core business and doing it better. That starts with that Merchant Utility Model that I talked about. That brings a strong regulated base, where in our electric business we have a rate freeze that's in place that goes through the year 2007. So we have good, solid known stream of revenue coming from it. A gas business that just received a rate increase earlier this year. And then balancing that is our unregulated growth, which has contributed 15% of margin, 23% of earnings year-to-date, and generates about 40% of our corporate revenue.

One of the keys for us is maintaining a balance between the regulated revenue streams and unregulated revenue streams. For me, that balance is to keep the earnings power of our unregulated business in the 30 to 40%(no higher than 35 or 40%) of our total earnings power. We want to keep that in balance. As we target 35% or so, out of our unregulated business, our wholesale business, while it is unregulated, it is largely locked up through long-term contracts as we'll talk about in a moment. So it has much less risk than many revenue streams associated with pure marketing.

As we look at revenue, one, what are the keys for us that drive our intrinsic growth, you know, in the top line. One of the first is the way in which we're able to operate our power plants. San Juan, which is our largest coal unit coal facility, last year suffered a little bit but you can see this year it has returned to top quartile performance-- where we're committed to maintaining that facility. One of the reasons is that the coal contract that we have, once we go above a certain level, we get incremental pricing out of the coal resource that effectively make that coal unit about the same incremental cost as nuclear fuel. So it makes it very, very competitive in any marketplace. So the difference between operating at an 85% capacity factor and a 92% capacity factor, is a heck of a lot in today's markets of the bottom line.

One of the things about our service territory that's always been good, is that we have consistently and historically had 2% or so greater growth than the national average. In fact, more recently, it's been greater than that. We don't experience the explosive growth that say, as Las Vegas has had, which sometimes challenges your ability to keep up with it and certainly on the capital side. But we have never had a decline in our retail load. It has always increased even through every -- recession we have had since the early 80's. So we maintain a good, healthy retail growth rate.

As I talked about earlier, long-term contracts has been a steady goal for us, and we have increased the amount of contracts that we have under – the number of megawatts that we have under contract, and the average duration at these contracts is just under 7 years at this stage. In terms of our generation facilities, we sell about 2 megawatt hours for every megawatt we generate. That's what we call velocity. Just slightly under 2 times churn. And we are at a point, as we talked about before, where we need to add generation resources. We added about 210 megawatts of gas in 2002, we added 205 megawatts of wind this year, which has been operating, well, really end of last year, has been operating very, very well. And over the next 10 to 14 months, you will see additional resources that will be added, and I think you'll be, at least our intention is that you will be favorably disposed in terms of the pricing that we acquire those resources at. That's the top line side.

But obviously another key part is helping you control expenses. 65% of our energy comes from coal. So how we're able to manage our coal expenses is very important. Particularly if you look at 2002 thru 2004, for most companies, this arrow is going the wrong direction because they have experienced coal price increases particularly those who don't have long-term contracts.

We have a very different arrangement in that for our largest facility, San Juan, it's a captive mine and a captive generating unit. A few years ago, early in 2000, we entered into an agreement to change that operation and move to a below the ground long wall mine operation. You can see the results. We've dramatically reduced the costs of the coal. We don't have the kind of exposure to increases particularly market-based increases that many other players have. I don't expect to see this continue to decline but it does give us a much lower cost of average fuel from which we will proceed with it -- I think a nice level coal price.

On the O&M cost side, this is where process quality has really had an impact. We really do focus on process quality in every aspect of the business. There are a few we still have to tackle, procurement being one. But we've seen good results in driving costs out of our operating the business, such that we can serve more and more customers at lower per unit costs.

One of the things that John and his team has been very successful on, is reducing our financing costs which I think is one of the themes that has come out to varying degrees from many companies. I’m particularly proud of the success we've had. We've refinanced about 60% of our debt over the last couple of years, and we've done this in a way in which we had very little exposure to variable interest rate, short-term interest rate changes. Less than about 15% or so of our debt is variable rate debt. And we have reduced the costs to a point that it's at or about 14 cents so far this year, 14 cents a share.

One other thing I'd like to touch on because it's important to me personally, it's important to our Company and very important in the state of New Mexico. We have a made a commitment, and this is something you will see us invest in, that's the commitment to environmental sustainability. For many, that's an interesting buzz word. But for us it translates into specific measurable goals. How we use water, the emissions that we put into the air and the waste streams that we generate. We have specific measurable goals across all three of those venues over the next five years. One of the things that we've done is we've worked over the last 3 to 4 years with a lot of environmentalists, who had a tendancy in the past to be foes, and we have built alliances with them. And I got to tell you the power of those alliances can't be underestimated. It's one thing if a legislator wants to come after a utility for something, but when the first line of defense is the environmentalist,and this has now happened a series of times over the last 18 months, it changes the dynamics enormously. I'm very pleased with the progress we've made and I'm also very committed.

You will see us expend capital but I think it's going to be capital that will earn well and do well for our customers and our constituencies. These things in terms of our baseline business have led to improved earnings and cash flows. If you look over the last, since 2002, if we take the midpoint of the range that we narrowed for earnings guidance for this year, we had a range of $1.30 to $1.45 in our Friday release of earnings. We narrowed that range to $1.35 to $1.45. If you take the midpoint of that, our earnings growth will be in excess of 7.5%. If you take the low end of that guidance at $1.35, it's 5.6%. So still within what we targeted our long-term growth rate of 5 to 6% and, in fact, we continue to perform better than that. One of the things that has always been a stronghold for our Company, is our cash flow and we're continuing to show strong cash flow from operations, and free cash flow after dividends and construction in the $100 million a year range.

Organic growth in our existing resources and existing markets will only take us so far. So we spend a fair amount of time obviously focusing on strategic growth. And by strategic growth, it's not just our desire to be bigger. In fact, I don't really care about being bigger. It is a matter of being better. So the transactions that we have pursued are really focused on the right transactions that are right priced.

The first of those as you know is our acquisition of TNP Enterprises. This transaction we announced at the end of July and frankly things are moving quite well as we'll touch on in a few ways. We announced at that time that this transaction will be at least 10% of accretive to earnings and 20% to cash flow. Everything that we have seen and the work we have done so far says it will absolutely be at least that.

One of the strategic values that this transaction provides us is diversity. It puts us into a new marketplace so we are not just at risk relative to the movements in market in the western United States, it puts us into a completely different marketplace, the ERCOT market. That has a lot of value to us because it allows us to think about how we deploy capital and allowed us to have some diversity in the things that affect markets whether it be weather, market dynamics or the like.

It's a well-run distribution business. They have-- frankly do a very good job of running a distribution utilities. The other piece of their business, which is the REP, retail electric affiliate, retail electric provider, First Choice, is where we see a lot of opportunity. So again, we've added to our stable revenue base by the addition TNP distribution business, and have added to the unregulated base in a new way by moving into the competitive aspect of the retail model. I'll talk a little about that in a moment.

Just as a quick overview of the transaction, I won't go into any details, you remember that the enterprise value is a little over $1 billion. Purchase price of $189 million subject to adjustment. One of the main drivers of value is our ability to refinance and eliminate about $600 million of debt and PIK preferred at the holding company and will not come into issue as we go forward through the regulatory proceedings. Because it's financial instruments that have never been in rates. They sit at the holding company side.

The financing for this as you probably know, we've been going through a layering of approaches. And our overall plan is to issue $215 million of common, $200 million of equity linked and $100 million of debt. Just to give you a brief update on where we stand on that. Of the $250 million of common, $95 million will go as consideration in the purchase price, because half of the purchase price will be paid in stock. So that's taken care of. That leaves us with $155 million to go.

There are a number of ways in which you can take that forward. We can use a superdrip program. We could look at a -- retail offering because we would like to look at building our retail share holders. We could look at a private placement. We have not found problems in getting that equity out. It's just a question of when and how.

On the equity linked issuance of $200 million, as you probably know, we have already placed $100 million of it shortly after we entered the transaction with Cascade. And we've got $100 million more to do. Again, there are a number of ways and a number of interested parties as to how we put that out into the market. The terms under which we issued the $100 million with Cascade out of 6.625 coupon, which is below what we assumed at the time we announced this transaction at 7.5%.

On the debt side, the $100 million of debt, it's really an interim notion because we generated enough cash -- free cash to not really have to consider it real long-term debt. It's moderate-term debt. We're looking at the 5 year range or so. We have now really already locked that in. We're in the process of syndicating the $400 million revolver at the parent level that will provide the liquidity because it's dropped -- we can drop it down to any of the entities, will provide the liquidity to the entity that we're acquiring through TNP. $100 million of that $400 million, through a forward swap we have already locked into full pricing on at 4.97%. So again we had assumed 7.5% and we've gotten that piece of the financing done at under 5%.

From a regulatory perspective, things are going along quite well. Texas has set a schedule that we are very pleased with. Even if it is fully litigated we would have a decision in April. And certainly we are interested in pursuing settlement negotiations so it doesn't go through litigation. On the New Mexico side, it's a little slower but I fully anticipate that there will be settlement negotiations. And a good chance that creating a settlement that would certainly allow this transaction to close in the second quarter of next year. You will see us making the FERC filing in the next 30 to 60 days. So far the regulatory pieces are going reasonably well. Obviously, we know there are people that want something out of the transaction for them as a constituency they represent.

From an integration process, we have got teams formed. They have started to meet between the two companies. We delayed getting that started because we really wanted to focus on the broad-based architecture. It's not a merger. It is an acquisition and it's pretty clear to the company that's being acquired where the decision-making rests, but we want them engaged because we're very committed to the best of the best process. We are focused on first making sure that we get the best processes in place. Second, the best systems and architecture that will stand behind those processes. And third the organizational structures that go along with that filling in the boxes and getting into the issues most people really want to know,who’s names go where.

The biggest issue and the biggest upside in this transaction for us which we did not build in, really has to do with the power supply sourcing. As you probably know, TNP was in a position where it has effectively outsourced the power supply sourcing under a contract we discussed, many different elements in it because they didn't have credit to secure their own resources, they did not have the risk management systems to manage the risk associated with that, and so a number of the things that they are having to procure today, frankly, we don't need.

Certainly on the credit side, and on the risk management side, we're very comfortable with the way we run that business. And obviously one of our real goals, was to be able to take what we've learned in operating in the western wholesale market, bring it to bear on the supply sourcing side of Texas.

We did not make assumptions about what can we do to make TNP or First Choice more competitive in its market, when we did our analysis, so we believe there is upside relative to that. The last piece I want to touch on, is asset acquisition, I have heard some people raise the question of 'Well, since you're doing the TNP transaction, I guess that means you're out of the business of acquiring other assets for a while?' The answer is no, we're going to continue what I consider a conservative, smart approach to the addition of other assets. The only difference is now we look at 2 markets. We look at the Western market and we look at ERCOT market for potential resource addition. And we are finding assets that are of interest to us, although we don't have anything to tell you at this stage of the transaction, but I think you will see something in the not too distant future.

One of the good things, I think about our resource mix is that we can add depth today without distorting our profile, because we are only using even on our merchant side, only about 7% of the portfolio comes from gas. If we look at our entire system it's about 3%. So we can afford to have more gas risk and still have a fairly stable platform. This just represents one scenario where we would add gas in the intermediate term and then coal in the later term, and maintain a well-balanced portfolio that if necessary could be carved out and separated from the main utility.

There are a number of ways in which we can add those resources. They're of -- there's nothing unique in them. We're looking at all of them, whether it's individual asset acquisitions. I will tell you this and you probably know this. The one thing you will not see us do, is go buy a single asset in the marketplace that we don't have a presence That just is not our strategy. We're a system player. We focus on systems and we focus on making sure that we have load that stands behind, before we secure the resources. Because we want to keep a minimum of 65%, today we're in excess of 85%, of our resources committed either under retail load or long-term contracts.

So then if we look at what -- when we take strategic growth and the core growth, what's happening in terms of our business? Well, I can't -- I won't just look at financial numbers. We've got to start with customers. And because customers have the ability to limit your freedom of action when they are in a regulated environment.

One of the things that I'm very proud of about this Company is what we've been able to do in changing our profile in terms of prices to customers. Our retail rates have been going down while everyone else's has gone up. In the last ten years, we've reduced our retail rates in excess of 15% in nominal terms. In excess of 40% in real terms. We are about 20%, 18% below regional averages. And that is a good thing. Because it gives us more freedom to move as we go forward.

From a shareholder value perspective, we're pleased but not satisfied. Since the year 2000, we've generated just shy of a 20% compound annual growth in total shareholder returns, driven by a 4.5% annualized growth in our dividends and improvement in our share price. And we've gone from being -- having a below averageP/E. to having a slightly premium in our P/E. We're proud of that but obviously we think we still have value to go. The TNP transaction, the continued focus on our resource mix provides those opportunities.

And just as I -- concluding before I turn it over to John to go over our third quarter results, I think, what I hope you take away is that the strategy that we laid out over the last four years we've executed. We've consistently tried to find those things that will add value. We will continue to apply conservative principles to the growth opportunities that we uncover. And we will make sure that we maintain stability and balance, particularly as it comes to our balance sheet. With that, I'm going to ask John to touch on the third quarter.

Thanks, Jeff and good morning. I'll start with some third quarter highlights. (inaudible) For the quarter, we have 45 cents of EPS on fully diluted basis both for GAAP and ongoing -- basis.

Key factors for the quarter were lower operating costs, lower interest costs as Jeff mentioned earlier, improved operations in San Juan, and lower coal costs. Which is countered a bit by a pretty mild season in the southwest from a cooling perspective. And we will get into cooling degree days and you'll get a good sense for that. If we look at EPS on an ongoing basis quarter-over-quarter EPS is up 2.3% to 45 cents on an ongoing basis year-to-date, $1.13 versus $1.09, or up about 3.7%.

In 2004, we have no one-time nonrecurring items but we did have a handful of them in 2003 if you remember, we had the transition costs write-off associated with deregulation going away in New Mexico in the first quarter, as well as the adoption of FAS 143 in the first quarter. And then in the third quarter, we had some early retirement cost on some debt that was retired, that was also part of our one time items. Why don't we take a minute and walk through the quarter and give you the highlights of what the critical changes were.

Operating costs were down 8 cents, lower depreciation, lower healthcare and lower pension costs. Refinancing saved us about 5 cents in the quarter. That was our senior unsecured notes that we refinanced about a year ago. As well as tax exempt debt. We also short-term borrowings were down $100 million year-over-year. They look really good -- free cash flow generation. So we've been using that to pay down short-term debt.

Long-term margin is up because of new contracts. The electric retail growth although it was hampered by weather, which I'll talk about in a minute. On a weather-adjusted basis for the quarter was up 4%. Certainly in the high end of our range forecast that also added to margin. And we saw San Juan plant performing both coal and availability in the quarter, also, helped us out.

On the downside, weather cost us about 6 cents in a couple of different ways. Cooling degree days were down 28% quarter-over-quarter. So you can see the impact of the mild weather.

Market prices were down on the wholesale business on a short-term basis about 3.5%. We also sold a little bit less transmission in the wholesale market because of the milder weather and just less demand.

The electric rate decrease in the quarter cost us 6 cents. This is the last component of the first tier of rate reduction from the global settlement, so that's fully behind us.

We had an energy imbalance settlement with one of our transmission providers where they actually provided us some generation on their transmission that we needed to reimburse for the cost. That's really a one-time settlement item that won't reoccur. That really takes you through the quarter.

On the next slide on the year-to-date basis, refinancing added 15 cents so far this year. Electric retail growth, again we are 4% for the full nine months on a load growth basis. That added about 12 cents. We've got 7 cents on gas margin, customer growth at 2% right at our targeted rate and that obviously has the impact of a rate increase on a commercial and industrial side that went into effect in January, and then in April for residential customers. Long-term margin is up 6 cents. That reflects the new contracts, and we saw the growth chart earlier. San Juan performance again, availability and coal price drives that improvement.

Some offsets to that, again, the electric rate reduction for the -- first eight months of the year were 16 cents, weather cooling degree days on a full year basis were down 21%. That captures that.

In the spring, we had an unscheduled outage Palo Verde if you remember. All three units went down for about a week. As a result, that cost us about 5 cents for replacement power and lost opportunity in the market. The transmission demands we talked about as well as the energy imbalance. I think the other thing to point out here is our operating costs for the nine months were up a penny year-over-year well below the rate of inflation.

If we do our platform look for the quarter, margin was down about $11 million for the quarter. Again, weather, that one-time imbalance settlement and lower power prices for the quarter were the key drivers there. On electric utilities was down just under 5 million and the rate reduction and weather were more than enough to offset some growth as well as better performance at San Juan.

On the gas side margins up 700,000 resulting in the rate case. Transmission down a bit, 2.5 million. Again that's the impact on the wholesale market on pricing. For our wholesale operations long-term, margin was up about 800,000 in new contracts. And forward and short term sales were down about 5 million. Again the impact of 3.5% drop in price. The contract settlement of 2 million is in that margin number. Again as we are seeing very strong growth on the retail side, there is a drag on resources where we have less available on the wholesale side because we have more resources serving the retail side. We're setting up the need for us to add assets to the fleet to continue growing our long-term contract business.

If we look at segment EPS for the quarter, utility EPS, the electric utility EPS was down 2 cents. Again weather and the rate decrease and that was offset by growth and some cost containment. Gas was up 5 cents, again the new gas rates were the critical factor there. Transmission was off 2 cents. Again we talked about lower demand. Wholesale down about 2 cents seeing the pricing impact for the quarter. And corporate it was 2 cents better and that's largely refinancing -- savings.

Liquidity and cash flow for the quarter very strong. Our operating cash flow was up 43 million or 27% to 204 million. Free cash flow, and that's after the dividend CapEx was up 21 million or 25%, to just a little over 100 million, and we also saw our construction expenditures continue to decline as our plant maintenance schedule year-over-year is much different. As we told you, CapEx would be down, it is, $35 million so far this year. As I mentioned earlier, we've taken that free cash flow and paid down short-term debt almost $100 million and it's just mentioned we we're in the process from a liquidity perspective of syndicating the $400 million revolver. That should be done in the next week or so.

Let me end with the revised earnings guidance again as Jeff mentioned, we did narrow the range. Good results through the first nine months and where we feel that we will come out in the fourth quarter allowed us to do that. I think we're really down to three critical factors for the quarter. As always, short-term pricing plant availability will be critical, and then the early part of the winter heating season and how that affects our gas business from the weather perspective will be the third issue that will drive -- that.

I didn't go over the year-to-date platform information. That, as well as full financials are out on the web. You can feel free to get those and at this point, we'd be glad to open it up for questions. The only thing would I ask because of the webcast that is going on, if you have a question, if you could go up to the microphone, that would be helpful to the folks on the webcast.

You know, going forward, it looks like you are going to be 50% short power in the western market, and 100% short power in the ERCOT market. Doesn't that argue for adding a plant in ERCOT?

We are looking at what is the best sourcing in the ERCOT market. Clearly you don't -- I don't believe you have to own resources but that's our tendency is to be a physical trader. So we are interested in looking at those resources, but we're not going to commit to resources in ERCOT, until we're very comfortable that the TNP transaction is going forward. Because we're not going to go long in a market we don't know.

Thank you.

And just to add -- because you mentioned the southwest market as well. Again, I think you'll see us act as an asset acquisition there as well.

Okay.

Well, thank you all very much.