道明尼資源 (D) 2003 Q2 法說會逐字稿

Good morning.

My name is Letishia and I'll be your conference facilitator today.

At this time I'd like to welcome everyone to the Dominion second quarter earnings conference call.

Leading the call will be Thomas Chewning Dominion's Chief Financial Officer.

All lines have been placed on mute to prevent any background noise.

After the speakers' remarks, there will be a question and answer period.

If you would like to ask a question during this time simply press '*' then the number one on your telephone keypad.

If you would like to withdraw your question, press the pound key.

Thank you, Mr. Chewning, you may begin your conference.

Good morning.

Thank you for joining us for our second quarter 2003 earnings conference call.

Joining me on the call are Steve Rogers, Vice President and Controller, and Thomas (inaudible) Director of Investor Relations.

In addition, other members of management will be available for the Q&A portion of the call.

Earnings release and other matters that may be discussed in the call today contains forward-looking statements and estimates that are subject to various risks and uncertainties.

Please refer to our SEC filings including our most recent annual reports on form 2-K and quarterly reports on form 10-Q for a discussion of factors that may cause results to differ from management projections, forecasts, and expectations.

Also on this call we will discuss the measures about our company's performance that differ from those recognized by generally accepted accounting principals or GAAP.

You can find a reconciliation of these non-GAAP measures to GAAP on our investors relations website at www.dom.com/investors under GAAP reconciliation.

Dominion posted operating earnings of 84 cents per diluted share in the second quarter of 2003 as compared to 97 cents per diluted share earned in the second quarter last year.

Earnings prepared in accordance with generally accepted accounting principals or reported earnings for the second quarter of 2003 were 76 cents per diluted share.

Excluded from the calculation of second quarter 2003 operating earnings is a $25 million after tax impact or eight cents per share from an impairment of certain assets held for sale.

These assets include a small generation facility located in KUWA, Hawaii and our interest in epic energy a pipeline business in Australia.

This charge is reported in the corporate and other segment for reporting purposes.

We acquired these assets as a part of the C and G merger and we plan to sell them over the next year.

The impairment charge lowers book value to our estimate of net realizable value.

In total the book value of the two assets after impairment is about $114 million.

There were no adjustments to second quarter 2002 operating earnings, so reported earnings of 97 cents per share were the same as operating earnings.

Dominion utilizes operating earnings as the primary earnings performance measurement for external communications with Steven L. Fleishman's and investors.

We define operating earnings as reported earnings adjusted to remove the impact of certain items, for example, severance costs, cumulative effects of changes in accounting rules or, in this case, the impairment of assets.

We do this because we believe operating earnings provide a more meaningful representation of the Company's fundamental earnings power.

We also use operating earnings for budgeting and reporting to the Dominion board of directors as well as for the Company's profit sharing plan.

Second quarter 2003 results were strong, especially considering the mild weather which reduced earnings about eight cents per share compared to normal.

Adjusting for that impact, and a slightly positive mark-to-market timing impact from the corporate hedge, operating earnings for the second quarter would have been about 91 cents per share, above the top end of our original guidance of 80 to 90 cents per share.

Second quarter net cash flow from operations was also strong, at about $600 million compared to $420 million last year.

Year-to-date 2003 operating earnings were $2.35 per share, or about nine percent ahead of operating earnings per share for the same period last year, and above the top end of our guidance for the first half of the year.

Year-to-date, weather positively contributed about three cents a share to earnings as compared to normal and the mark-to-market impact of the corporate hedge reduced earnings by about the same amount.

Net cash flow from operations was about $1.5 billion year-to-date, compared to $832 million for the same period last year.

We are on target to generate about $3 billion in operating cash flow for the full year 2003 compared to $2.4 billion in 2002.

Dominion ended the second quarter with a debt to capitalization ratio of about 55 percent, compared to about 57 percent at the end of the first quarter.

Debt to capital on both the GAAP and adjusted basis are roughly equal.

The SFO to interest ratio for the 12 months ended June 30, 2003 was strong at 4.7 times.

So far this year gas and oil production is coming in slightly below our previous guidance, but that's been more than offset by strong prices and other factors.

Year-to-date, total equivalent natural gas production was about 225 BCF equivalent.

Due to some drilling programs underway, we expect the second half of 2003 production to be in line with the second half of 2002, or about 235 billion cubic feet equivalent.

Therefore, we are now giving revised 2003 production guidance of around 460 BCFE compared to prior guidance of 470 to 475 BCFE.

This implies roughly flat production to 2002.

The reduced production outlook has two primary causes.

First, we have sold or planned to sell several non-core and relatively high lifting cost properties with approximately 7 BCFE of 2003-planned production.

Due to the high cost nature of these properties, these divestitures will have a neutral impact on earnings.

Second, when Devil's Tower was delayed from the fourth quarter of 2003 into the first quarter of 2004, the impact on this year's production was about 7 BCFE reductions.

We had planned to make this up with other drilling activities, but we now expect only to make up about half of this.

As always our focus is on profit, not production.

We hedged more than 80 percent of 2003 gas and oil production with virtually all of the second half hedged.

We've hedged 65% of expected 2004 production and 45% of expected 2005 production.

On the merchant power side of the business, we've hedged about 80 percent of the portfolio in 2003, 60% in 2004, and 50% in 2005.

When the franchise hedge associated with generation that serves our Virginia and North Carolina franchise cusThomas ers is included, the hedge percentages on the total Dominion Energy generation portfolio, are about 95% in 2003, 90% in 2004, and 85% in 2005.

We expect operating earnings of about $1.30 to $1.40 per share in the third quarter of 2003.

And we are reaffirming our full year 2003 operating earnings guidance of $4.60 to $4.80 per share and 5% to 7% average annual growth after 2003.

In providing quarterly and full year 2003 operating earnings per share guidance, Dominion management is aware of potential differences going forward between reported and operated earnings due to changes resulting from the implementation of recently issued accounting standards.

At this time Dominion management is still reviewing the effect of these recently issued accounting standards and has not fully determined the impact on its financial statements.

Therefore is not able at this time Dominion to provide a corresponding GAAP equivalent for 2003 earnings guidance figures.

Immediately following the call we will post on Dominion's investor relations web site located at www.dom.com/investors, statistical and financial data that we hope you will find helpful in understanding Dominion's strategy and business model and also in doing financial modeling.

Before moving on to earnings reconciliation, we would like to comment on one issue that has been of great interest to investors recently.

Dividends.

With the recent tax law change, we've received a lot of questions from investors on the likelihood and timing of a dividend increase by Dominion.

We're glad to see investors have returned to the basics of cash flow, balance sheet and dividends.

And we hope this new discipline is here to stay.

The timing and amount of potential dividend increase is a matter for the Dominion board of directors to decide.

Management's goal is to advice the board.

One thing we can assure you is that as holders of over two million shares of common stock, Dominion management will act in the best long-term interest of shareholders in this regard.

In general, our advice to the board would be to consider a dividend increase when Dominion has further strengthened the credit metrics underlying our current investment grade credit rating.

We believe that we have very strong momentum in this regard.

In addition, before recommending an increase, we wanted to be confident that Dominion is in a position to produce sustainable free cash flow excluding acquisition related capital expenditures.

A management recommendation to the board to increase the dividend could possibly come at any time in which in management's judgment this defined set of conditions has been met.

Now, let me turn the call over to Steve Rogers to review the 2003 earnings results.

Thanks, Thomas .

The following variance reconciliation of second quarter 2003 versus second quarter 2002 operating earnings per share will be available immediately after the call on Dominion's investor home page at www.dom.com/investors.

Supporting operational statistics, such as retail gas and electric sales (inaudible) Day information, gas and oil production and averaged realized prices are also located on our web site. 2002 segment results have been restated to reflect the transfer of the electric transmission operations from Dominion Delivery to Dominion Energy.

All variances are stated as second quarter 2003 actual results as compared to the second quarter of 2002.

We will start with Dominion Energy.

Dominion Energy manages the company's electric generation and transmission business, natural gas pipeline and storage business, the Dominion Energy Clearinghouse and Dominion Retail.

Dominion Energy earned 56 cents per share in the second quarter of 2003, compared to 67 cents per share in the second quarter of 2002.

CusThomas er growth in both the electric franchise service area and the areas served by Dominion Retail increased earnings three cents per share.

Weather in the electric franchise service area reduced earnings 10 cents per share.

A change in the allocation of electric base revenues from energy to delivery reduced energy's earnings by four cents per share.

Net losses related to corporate hedges of natural gas production as compared to net gains during the second quarter of 2002 reduced earnings by two cents per share.

Millstone's contribution increased earnings three cents per share and other factors, including share dilution decreased earnings one cent per share.

Moving on to Dominion Delivery.

Dominion Delivery is the company's electric and gas distribution and cusThomas er service business.

Delivery also manages the company's telecommunications joint venture.

Dominion Delivery posted earnings of 17 cents per share in the second quarter of 2003, as compared to 19 cents per share in the second quarter of 2002.

CusThomas er growth in our electric and gas franchise service areas increased earnings one cent per share.

Weather in the electric franchise service area reduced earnings four cents per share.

Weather in the gas franchise service area reduced earnings one cent per share.

A change in the allocation of electric base revenues from energy to delivery increased delivery's earnings by four cents per share.

And other factors including share dilution, decreased earnings two cents per share.

Moving to Dominion Exploration and Production.

Dominion E&P is the company's gas and oil exploration and production business.

Dominion Exploration and Production's earnings were 30 cents per share in the second quarter of 2003, compared to 33 cents per share in the second quarter of 2002.

Higher average realized gas and oil prices increased earnings 15 cents per share.

A one Bcfe decline in equivalent gas and oil production reduced earnings by one cent per share.

A change in the DD&A rate reduced earnings by three cents per share.

Increased expenses reduced earnings four cents per share.

Exploration of section 29 production tax credits reduced earnings three cents per share.

Other income reduced earnings three cents per share, and share dilution reduced earnings by four cents per share.

Corporate, Dominion capital and other.

The Corporate Cost Center consists primarily of interest expense on corporate level debt and certain unallocated general and administrative corporate costs.

It also includes Dominion capital results reflecting the performance of its remaining assets.

The Corporate and other segment contributed net expenses of 19 cents per share to second quarter 2003 operating earnings as compared to net expenses of 22 cents per share in the second quarter of 2002.

Lower expenses and share dilution increased earnings five cents per share.

Dominion capital earnings were lower by two cents per share.

We should also note that in the second quarter of 2003, the corporate and other segment contributed net expenses of 27 cents per share to reported earnings.

The reason for the eight cents per share difference between operating and reported earnings was a $25 million after tax impairment of assets held for sale.

There were no differences between operating and reported earnings in the second quarter of 2002.

This concludes our earnings reconciliation and we'll now open the call for your questions.

At this time I would like to remind everyone that in order to ask a question, please press "*" then the "1" on your telephone keypad.

We'll pause for just a moment to compile the Q&A roster.

Your first question comes from Dan Eggers with CSFB.

Good morning.

Good morning Dan.

First question on the hedging levels.

Looks like you guys added a bit on the E&P side this quarter.

How far or how much hedging are you guys willing or capable to do on the E&P side for '04, '05 before you start getting into a new corporate hedge position?

Well, that's a question that doesn't really have an absolute answer.

In the past we've tried to hedge about as much as we could allowing for production problems such as hurricanes in the Gulf.

We do look at it each year with a fresh look.

We are developing more internal hedges than we used to have.

So the answer is we would not hedge probably more than 80 percent as we've done this year.

And it just depends on our forward look and on the cost of hedging, what we can get.

We look at this regularly and probably formally at least every quarter.

We don't have any set goal.

It's a matter of taking a lot of different factors into consideration, including what our forecast is for prices.

In general, we try to lock in prices that will ensure as budgeted forecasted of commodity prices.

So as we move later in the year, that number tends to rise.

We did, as you notice, increase a slight amount since our last meeting.

But I can't predict an exact percentage for our next meeting or if there will be any movement at all.

OK, Thank you.

I guess I'll extend this.

But on the corporate hedge side, when would you guys feel comfortable putting on a position I know you guys tend to wait until the beginning of the year to do so, is that the way we should think about it for this year as well?

Well, in the past I think we've been a little intimidated by having hedges that crossed over years, year-ends, but I think the marketplace would accept good judgment in December as well as it would in January the next year.

So I think we're not bounded by that end of the year.

It's just been more or less an appropriate time for us to look at a corporate hedge after we've take a look at budgets and seen which way we think the markets have turned.

It's possible we could do a corporate hedge if we wanted to late this year, as well as early next year.

Great.

Thank you.

And now just one more.

With the UI contract rowing over at the end of the year, I was wondering if you guys give any color on progress on signing up contracts to fill that capacity for next year?

I'm going to turn that over to Thomas Farrell, COO of Dominion Energy.

We've been continuing to sell capacity out of [inaudible] for next year and I believe the number we're presently, for '04 is about 80% of [inaudible] hedged for.

Great.

Thank you, guys.

Thanks, Dan.

Your next question comes from Kit Konolige with Morgan Stanley.

Good morning.

Hey, really kind of pair of related questions.

First of all, I was wondering if you have any updates for us on a story in which Mr. Capps was quoted as saying that he was interested in buying generation from Ala gainey (ph) and then more broadly I wonder if you could discuss the relative merits of a dividend increase versus acquisitions of assets or other properties how, if any, has your thinking changed with the dividend tax law.

I'll answer the second part and then I might turn it over to someone you named earlier for the first part.

In terms of looking financially at whether you pay a dividend or make an acquisition, the hurdle rate for an acquisition to compare favorably with the dividend increase has certainly grown because of the effective tax rate individuals now pay on dividends.

So Kit, I can only say that, we will continue to evaluate as any company should whether or not we pay a greater dividend or we go after potential growth in capital expenditures, whether it's things that we're building or drilling or things that are out there in the marketplace.

But I do think that, obviously the hurdle rates are a little higher now, as the alternative value to our shareholders has grown with the dividend, with the dividend tax change.

But it's temporary at this point.

So, we'd like to see that more permanent before we take that as a final conclusion.

Now, you mentioned Thomas Capps, and he happens to be with us this morning.

So I'm going to turn that first part over to him.

Kit.

You were right I would say we'd like to have Ala gainey's (ph) generating units but as I understand it now, they've taken them off the market and they're no longer for sale.

OK.

There are other things out there, however, that we're kicking the tires on.

Can you give us any sense of what kinds of things?

Well, we'd like base-load generation in the Northeast.

Very good.

That is accretive, immediately accretive to earnings.

Great.

Thank you.

Thank you, Kit.

Your next question comes from Jeff Dietert with Simmons.

Good morning.

I was wondering if you could update us on the contributions from the Clearinghouse during the second quarter and how that compared to the second quarter of last year.

Good question.

I'm going to ask Thomas to answer that question.

The Clearinghouse, the non-corporate hedged piece, the contribution was $2.2 million second quarter of this year, versus 1.7.

So it's basically flat.

Second quarter is a shoulder quarter for Clearinghouse.

The first and the third quarter is really limited to when we make money.

Very good.

On a second topic, with some of the recent softness in natural gas prices, I wondered what influence that has on your drilling plans and if there's a natural gas price that if we follow low enough would force you to adjust capital spending for the year.

I'll ask Duane Radtke, CEO of E&P to answer that.

Thomas , first of all, even though gas prices have softened, they're still at a very high forward curve in support the entire program.

The other thing I would remind you, with our hedging program the benefits that we have going forward, it stabilizes our cash flow going forward.

So, Right now we have no changes or no plans to change anything in the program.

Very good.

Thank you.

Your next question comes from Thomas Hamlin with Wachovia Securities.

Good Morning.

Good morning Thomas .

The question has to do with assets held for sale.

Can you tell us how much they earned or lost, let's say in the past year or two, and in what business segment would we have found that?

That would have been the Australian assets would have been in corporate and other, and it was very, I mean, I could even tell you the numbers, very insignificant.

The KUAI plant just recently finished construction, so didn't have a contribution over the last couple of years.

I would say the botThomas line answer is that note impact on earnings, positive or negative, when we sell it.

It will be a cash flow positive, obviously to us to sell those assets.

As you know they're non core.

And so it's always their our objective to try to sell the non core assets to the highest possible price.

Thanks.

My second question had to do with your reserve replacement.

You talked about you were at 265 percent on gas, given how expensive gas has been lately, has that come at a high cost to your overall average?

Thomas , I'll take care of that again.

No, we're still saying and that we can find and develop gas for the $40 to $50 range on a full cycle and our current results support that.

OK.

Thank you.

Thanks, Thomas .

Your next question comes from James Yannello with UBS.

Good morning.

Was there any movement in the Millstone decommissioning trust during the quarter Or is that just the first quarter of that?

There was some movement, minor movement in the second quarter, which was positive, not to the same degree that the first quarter was negative.

There were a few realized gains, a few million dollars, I believe.

OK.

And just a little flavor on what's going on with storage, since you have such a big capacity position.

We've seen some large injections recently.

Are you seeing any behavior changes this year versus in the past, less marketers, more marketers, just any kind of insights what's going on with storage right now would be helpful.

Thanks.

Thomas Pearl will answer that one and Kevin Howell.

Our storage levels we've seen are about what we would have expected for people in our region.

I think there are fewer marketers.

There are more LDCs gone ahead and not in the past as the prices have leveled they tended to worry about being second guessed, putting gas into storage at this level.

They don't seem to be worried about that too much.

As you can see from the storage injections so, I think that behavior is different than we've seen in the past.

Kevin, do you want to say anything.

Yes.

If you look at it from a fundamental standpoint, particularly with market area storage.

Market area storage is not a price tool it's a deliverability tool.

Pipeline capacity in the U.S. cannot meet peak day demand in the market area.

You need that storage to be full.

So, I guess it's always been our view that storage will get fuel irrespective of price.

I think the other perhaps behavioral change you may see come in as Thomas was referencing the price considerations even some of the state corporation commissions in the market area are now starting to come in and try to encourage the LCDs to use financial hedges to protect them from any second guessing around any storage fills.

OK.

Thank you.

Thanks, Jay.

Your next question comes from Steven L. Fleishman with Merrill Lynch

Hi Steve.

Hi Thomas .

Thank you.

First with the detailed questions, can you just go through the cost line items in the E&P business and explain some of the cost increases that -- we had similar in the first quarter and I assume they're the same reasons, but if you can go through the DD&A rate increase, the higher O&M expense and the other income being down?

Scott Hertzer what do you -

We're both here.

Thomas .

I'll take most of that.

Scott Hertzer can add some things.

When you take a look at the change that we had, the DD&A rate of course is really the pressure that we're seeing on the cost structure.

Although our DD&A rate is still I think our guidance was $1.15 to $1.20.

We have internally forecast full cycle at $1.40 to $1.50 for new reserves.

So, as we put that blend into the mix of what we have, you're going to see pressure on the DD&A rate going up.

Likewise on O&M expenses, with gas in particular being high, our severance costs are up, our property taxes are up.

Our fuel costs are up that we have pass-throughs on.

The real issue is the margin increase.

And that continues to expand.

Obviously we lost section 29 tax credits last year and we had some share dilution.

I think under the other income, Scott Hertzer, there was a lot 3 cents.

That's correct.

And we actually had a reclassification that impacted other income this year, which is really explaining the variance from the second quarter of last year.

The reclassification picked up a full six months, so I think when you view other income it's better to view it year-to-date versus quarter-to-quarter, compared to last year.

But again it's driven by the higher priced environment.

It also flows through some other income items.

So that is an ongoing factor, inter-periods too?

In this price environment, I would say the year-to-date other would be something that is it's representative of the current price environment compared to

With a slight I believe currency cost to us on our Canadian production where we had hedged the Canadian dollar.

Right, we did lose some on the Canadian dollar with it strengthening.

OK.

Another question.

I know, Thomas , your comments on the kind of guidance operating versus GAAP that you need to provide with the new rules allow more comment on GAAP.

But just your comments on these recent accounting standards, which accounting standards are you referring to?

Steve Rogers has got all that.

There's three new standards that have recently, standards or interpretations that have come out.

The first one is called FIN 46 and it concerns variable interest entities, which is really the whole off balance sheet SPE standard that came out.

The second one there was an amendment to FAS 133, which is referred to as FAS 149.

And thirdly there was an interpretation of FAS 133 FAS referred to it big interpretation C 20.

And those three items we're looking at what they say, what potential impacts are and what interpretations and implementation guidance we'll receive both from our internal experts and from our external auditors over the next few months and then we will record what we need to record in the third quarter.

OK.

But to clarify by saying it the way you did you said these might affect reported GAAP earnings but not our operating earnings guidance.

Primarily they will be reported GAAP earnings impacts, that's correct to cumulative effect adjustments.

OK.

And then -- I'm sorry.

We don't know enough quite yet to give you any guidance.

You'd have to, some of these interpretations still move around.

And so you get a FASB interpretation or a directive and then the accountants sit around and talk with each other how they're going to interpret it.

They try to get a consensus among the big accounting firms so that there's not a discrepancy in practice, and then they get to us.

So, we often have one idea upfront, and by the time it gets done it reverses.

So, we're still holding on.

The only thing I would add to that is on the FIN 46, we will be consolidating some of our off balance sheet plants as a result of FIN 46.

And we expected that that would happen.

So, the ongoing impact of that is baked into our forecast that we have already put out with you folks.

OK, so that I know you were looking at other structure there.

I assume that means you're going to consolidate them, though?

Some of them will be consolidated.

One of them will stay off and that is consistent with how we expected it would occur.

It's (inaudible) That's a [inaudible] Project.

It's rating neutral, those that had already been included in debt to capital (inaudible).

OK, just quickly to finish up on Devil's Tower timing.

Any change there?

We're still saying the first quarter.

We have the hole, the botThomas half of the spar on location right now.

We have eight of the nine suction piles in place.

We hope to basically have it tied to the sea botThomas here in the next couple of weeks.

And we would expect to bring the top sides in, in early fourth quarter.

So, we're still saying first quarter depending -- obviously weather could impact that by a few weeks one way or another.

OK.

And Steve, this is Scott Hertzer.

I want to clarify a little bit.

The going forward impact of other, just to get that clear.

The largest piece of that actually is what Thomas Chewning referred to which is a currency exchange impact, which the treasury group has actually hedged.

It really accounts for last year's second quarter.

So, the largest part of that pre-severance is not going to continue forward because we've actually hedged it away.

OK.

One final question -- just on Devil's Tower again.

So, you're still saying first quarter.

What would your conviction be on that?

Predictions are pretty high.

I mean again when we put the top sides on, it depends whether it's October 1st or November 1st, obviously, but we feel very good about it coming on stream in the first quarter.

I just can't tell you what day.

Finally, you filed a fuel rate case in Virginia.

Can you update us on the process for that and is there going to be any opposition you expect?

I'll answer that.

We filed it.

They've changed the rules here.

It used to do a one-year look back and a one-year look forward.

They've changed it to an 18 month look back and 18 month look forward which gives it an order of magnitude, obviously one-third higher than it otherwise would have been.

It's been scheduled for hearing in October.

They generally come out with rulings shortly after they have the hearings.

There's always opposition in the fuel case.

There will be opposition in this fuel case, but we feel very confident that we've put on -- that the increases we've asked for are completely justified.

OK.

Thanks for the update on everything, guys.

Thanks, Steve

Your next question comes from Michael Worms with Harrison Nesbith.

Thank you and good morning everybody.

I believe Mr.Capps said indicated at one time that there was a desire to monetize swap trade whatever, some offshore properties for onshore or some other items.

Can you just kind of, is that still a part of the strategy and if so what kind of timing, what might we see on this?

Duane, would you like to cover that?

Sure, we're always looking at what creates more value for Dominion.

And if we had the right circumstances we would certainly look at that.

We're currently not looking to swap anything for onshore.

But we certainly look at anything that creates value.

OK.

With regards to the Six Sigma program, can you give us an update on that?

Yes, Six Sigma program has produced outstanding results about on an annualized basis this year about $38 million.

Cumulatively take us to close to 160.

Our goal is a little higher than that, but we would expect to pass this year's goal probably by the end of the third quarter.

And we have a lot of very prospective ideas and projects in the works.

So we continue to be excited about it.

I think one thing that is obviously is that it saves us money.

But I think beyond that it also creates better services for our cusThomas ers and a better working environment.

And we're absolutely thrilled with results and I think the first test was getting off the ground and it was a successful launch.

The second has been to follow that up with the same sort of intensity and quality we started with.

And we don't have any attitudinal problems here.

So we're already looking on to the next wave and next year with it.

Thank you.

One last question.

With regard to Merant, is there any exposure here?

Zero.

Thank you.

Thank you, Mike.

Your next question comes from James Dobson with Deutsche Banc.

Good morning, Thomas .

Hi, Jay.

Just three questions, if I can.

First on the reactor vessel head replacement, I know those cost should be capitalized but was there a material amount of replacement power of other costs that would flowed in that we should expect next year.

There were replacement power costs.

Those flow through the fuel cost.

Does that answer your question?

Yes.

Whatever increment over what you're collecting would have been deferred.

So the answer is no.

That's correct.

Great.

Thank you.

Also, tax rate, can we get an idea what that was in the second quarter versus a year ago?

Tax rate in the second quarter is around, effective tax rate is around 36 percent.

A year ago it was roughly 33 percent.

The biggest driver there has been section 29 tax credits no longer being available.

Great.

And then last question, Thomas , if you can just review those hedge numbers for the gas portfolio, I'd appreciate it, this year, next year, 2005.

OK.

For this year it's 80 percent.

But I would say that that was skewed towards the second half.

So that we basically have all of our production for the second half of this year hedged.

We have 65 percent of next year's productions and 45 percent of the expected 2005 production.

Thank you very much.

Thank you, Jay.

Your next question comes from Paul Patterson with Glenrock Associates.

Hai Paul.

Hai, how are you.

Very good, hope you are.

Yes.

I wanted to ask little bit about the operating cash flow.

Could you describe the, what actually impacted it so much again in the first half?

Is it working capital of timing issue or anything else?

The first half of the year really on a year-over-year basis the big drivers first was net income, which was up 155 for the six months.

Deferred taxes was about $130 million higher.

And then the sort of the net of accounts receivable and accounts payable was contributed about 230.

And then margin was 199 positive for six months this year versus six months last year.

So those were, if you add those up, that represents, that really is what drove the $650 million increase in cash flow.

And I think that just looking at the cash flow, the first half of this year was very strong.

The first half of last year was not, just because of timing differences and working capital, which is probably not representative, fully representative of the cash flow balance.

OK.

And then the second question I have is, what was the depreciation year to date on an operating basis, you know, normalized basis?

I think Thomas is looking that up.

OK.

And then finally in terms of 2004 and the hedged level of production, could you remind me what the -- what your expectation for production is in 2004?

We would have about a 10% to 15% increase of this year, but we're talking about around 490, I suppose. 490 Bs.

That's BOEs, right?

BCF equivalent.

Oh, BCF equivalent, fine, OK.

The depreciation expense year-to-date June is DD&A 616.

OK.

And then just back to the BCFE, how much again is the expectation for production of oil versus gas of that 490, roughly speaking?

It was a split, in other words?

We're going to be about 80% gas.

Great.

Thanks a lot, guys.

Thank you, Paul.

Your next question comes from Jeff Gildersleeve with Argus Research.

Hi, Jeff.

This has been very good.

But to just clarify, you mentioned merchant hedges in 2004.

How much was that on a percentage basis?

Jeff, the merchant fleet itself?

We have, the merchant fleet, we have 80% this year, 60% in 2004 and 50% in 2005.

When you add in the Virginia and North Carolina franchise, which we also have as a hedge, it's 95% this year, 90% next year and 85% in 2005.

OK, very good.

And in the past, you've made some assumptions about the peaking units coming into the third quarter.

I think you said 5% in the past.

What kind of assumptions are you looking for this year?

Run rate of the peaking units?

They're all based on performance, average between 5% and 10% run rate.

Great.

Thank you.

By the way, let me correct Paul Patterson.

Our 2004 production, we've estimated to be at 520.

So, that 60% is like 300 BCF equivalent.

We've already hedged.

Your next question comes from Paul Ritzlin (ph) with MidSouth Investments.

Good morning, can you hear me?

Yes, Paul.

Just, real quick question on E&P production, a little decline, is that just rounding errors or was there something material there?

And I guess, how much of capital is left and what are the plans.

And then, from a higher level you talked about potential for dividend increase.

I'm wondering if there's any capital structure that would make you comfortable and offset you know the -- that the balance sheet was strong enough to support a dividend increase?

I'm going to answer the second part then I'll ask Duane Radtke to answer the first part of the question.

As far as the dividend is concerned, I don't think we're as concerned about debt to CAP as we are just making sure that we have good ample cash flow to maintain a higher FFO to interest coverage and to basically take care of all maintenance CAPEX, growth CAPEX, and our current dividend.

And as you probably remember, we've projected this year a deficit after dividend of between $100 million and $300 million.

We're still on that cliff, but for next year it reverses.

And we feel that we'll have that kind of excess and the following year we should be somewhere in the half a billion to $700 million excess of cash flow after dividend, our current dividend, growth CAPEX and maintenance CAPEX.

So, it's more of our comfort with the cash flow and how it relates to our CAPEX and current dividend than it is debt to CAP structure.

OK.

Thank you.

Thomas , I'll take the E&P side of it.

The drop that we had in the forecast and the production as Thomas said earlier, the majority of that was due to some dispositions that we've completed in the first half of the year and that we contemplate through the second half of the year.

Likewise, when we lost Devil's Tower or was delayed into the first quarter of next year, I think at the first quarter conference call we talked about losing seven to eight Bs, and we have been able to make up about half of that by reallocating our capital.

In other words by still staying within the billion dollar CAPEX program but just shifting some of the capital around.

But due to some delays in some of the other production that came on, we weren't able to make it all up.

So from our perspective we made up about half of it by reallocating our capital, in other words by still staying within the billion dollar CAPEX program but just shifting some of the capital around but due to some, delays in some of other production that came on, we weren't able to make it all up, so, from our perspective we made up half of it staying in the same capital, so we're quite happy with that.

How much more capital do you have left, more or less.

We spent about half through the first half of the year, and again we've had a very successful year, particularly in the onshore where we continue to expand the program, and in the west Cameroon area in the shallow waters of the Gulf of Mexico.

And we'll start seeing a lot of that production in the second half of the year.

I'm sorry, my question was how much of Dominion capital that the financial business remains and what's the outlook for --

OK, for the total company.

I'll give you that that one.

I don't think Duane should know that answer.

We have about a billion dollars worth of assets scattered over about 20 different categories, the largest part being collateralized loan obligations and residuals from tax and mortgage.

We are actively talking to various parties on all parts of that portfolio, we have no timing, as you know this year we were given an extension by the SEC of the time period which we had to divest those non-core assets, which gives us the freedom to actually not have to have these fire sales.

But we are actively working that portfolio.

Originally, it was about three billion, so in 19, in year 2000 when we merged, so it's down about two-thirds from its height.

I guess one last question, can you give us any color on the pricing of the second half hedge of the E and P?

We never give the -- we never give that.

We are always asked that.

We never reveal hedge.

I had to try.

That's good, though. .Laughter.

Yes, we're pleased with it.

Thank you very much.

Thank you very much

Your next question comes from Hugh Wynne with Sanford Bernstein.

Hello.

I just wanted to follow up if I could on the question that Steve Fleishmen asked, because I'm afraid I might have misunderstood the answer.

You all I believe indicated that part of the reason for the increase in the DD and A expense on the exploration and production side had to do with a change in the finding costs from, if I remember correctly.

And correct me if I'm wrong, 115 to 120 per BCF equivalent to 140 to 150.

And am I correct in understanding that this is adding to the base of capitalized costs, and therefore increasing the average at which you depreciate that base.

Thomas , this is Dwayne.

Our current DD and A is running a $15 to $20 which as a full cost company really is a strong proxy to our historic F and D costs but in our own forecasting as we go forward and we see the costs of the projects going forward, we project a higher DD and A rate going in.

In other words, as we continue to drill and explore and develop in some acquisitions, we built in a dollar $40 to $50 expectation.

And so year to year you're going to see some increase in DD and A in this cost structure.

OK.

Thank you.

And would that have applications for following years, would we expect the DD and A rating to trend upward.

One side of me would say I hope it does.

The reason would be is because pricing would stay up there.

Obviously we're very reactive to what pricing does.

If pricing goes down, you know you would expect the F and D costs full cycle to go down with it.

But if prices stay up in this environment, in excess of certainly $4 but 4.50 think you'd see upward movement over time on the DD and A rate that would be expected.

understood and OK.

All right.

Thank you very much.

One thing I wanted to.

The $45 , $50 has been in the capital budget.

That's what we put in our forecast.

Great.

Thank you.

Your next question comes from Margaret Jones with ABN AMRO.

I just wanted to ask how things stand with the rating agencies at this point, particularly with Moody's and how that may be influencing your dividend decision or your capital spending plans.

Our treasurer is here and he has responsibility in this group for relations with them.

We have continuing dialog with the rating agencies and especially Moody's and quite interested in having them address that negative outlook and have been told that it will be sometime in the near future they will do so and we feel without giving any assurances of course which we feel we cannot do, we feel good about that.

And how close to the rating agency numbers is the 4.7 times FFO interest coverage that you mentioned for the last 12 months?

It would be a percent or two different, probably.

In terms of how far is that versus targets?

No, in terms of how they -

How they would calculate it?

Each rating agency makes its own adjustments, but that's S&P making the most.

So the 4.7 if you made all the adjustments that we see S&P making we'd take it down to 4.2 times, to put that in perspective, our target that they have given us is 4.2 times by the end of next year and four for this year.

So we are ahead of those targets.

OK.

And would you anticipate, and I'll work through the numbers myself, that given your suggestion for what would happen to next year's earnings that the actual that you've had of the 4.2 times would be higher next year?

I would expect it to trend up a little bit.

Not materially.

We are happy with the current levels and we'd be happy maintaining this.

It's likely what we have projected for next year that it will improve slightly.

Thank you very much.

Thank you, Margaret.

Your next question comes from Medela Marty (ph) with SAC capital.

Hi Medela.

Hi good morning, how are you?

Fine.

I am wondering can you tell us in the second quarter what the average realized price was per Mcf?

A little well over a $4, I believe. $4.05.

And in terms of your CAPEX, last numbers you given us was I think about 2.5 billion in '03 and 2.2 billion in '04.

Can you remind us how much is that is kind of considered maintenance CAPEX and how much is kind of like acquisition growth CAPEX that's built into that and whether when you are kind of looking forward to being able to fund everything in terms of both maintenance and your desired growth CAPEX.

What kind of is like the plug level for growth cap ex that we should be using?

The maintenance CAPEX is about a billion and a half, which is a little bit lower other than it is this year because the vessel heads will be done this year or substantially done.

And I think there is no (inaudible) with '05 but and then trends probably around 1.6 over the next couple of years so you can kind of take the differential there.

It's 6 to 700 million dollars of growth would be available for growth cap spending.

And that's for things like hooking up new cusThomas ers in the delivery business.

Growing E&P reserves as opposed to just replacing reserves, which is part of maintenance CAPEX.

And on the generation side growing, growing the generation really to just keep up with our cusThomas er growth.

Well, that 6 to 700 million, then sounds almost like that just given the business profile it's almost equivalent to maintenance CAPEX.

Is that frankly can't be avoided.

I mean territory growth you have to build up wires unless you are going to let assets issues deplete in the E&P basis, they have to be replaced, that kind of thing.

So what I'm trying to get at here is the idea in terms of new acquisitions or things that simply are not just maintenance, but sustenance of the current business, what kind of plug capital number should we be considering in the ballpark?

To do the least, we have no acquisitions ever built into any plans we have, any one year, three year, five-year plans.

We don't know when they will occur, what they will be, how much they would cost.

We couldn't possibly give you any guidance at all.

And I would say that I tend to agree with you that the growth CAPEX as you characterized it is what we should spend as a company that has a 5 to 7% growth rate.

By definition those growth CAPEX expenditures are accretive to us.

And they're very minimal when you compare to our total cash flow in the future.

This is the last year we expect to have any shortly fall between growth CAPEX, maintenance CAPEX and our current dividend.

And I think we're in pretty good shape on the balance sheet.

So I think we've got an awful lot of flexibility, as always.

If markets change, we won't spend the CAPEX if it doesn't return the right amount of return for our shareholders, if there are better alternatives.

Ok, and I guess in terms of your FFO and interest, you said you're 4.7 times right now, and you expect to see a slight improvement going forward.

And you indicated that's one of the critical variables you would like to have set in place at a certain level prior to considering a dividend increase.

Can you give us a sense as to where that would be?

Do you need to hit five times, 5.2, 4.8 roughly, I mean can you give us some sense there?

We're not going to give a formula out here.

We don't have one.

I think that if we felt comfortable that we had a 4.2 coverage, and that that was solid and that we had solid earnings and cash flow going forward, we wouldn't have a heartburn with the dividend increase.

That's a very strong coverage ratio, very, very strong.

Stronger if you look around, I think S&P recently did a study of the companies who remained investment grade.

Five of them.

We had the highest FFO to interest of any of them.

So, we don't have this magic we've got to get to five.

It's more of an art than just a pure science.

We don't want to give you the impression that we are worried about certain targeted ratios right now.

One last question, if I may.

You indicated, I think the second half production is going to be 235 Bcfe.

How does that compare to last year's second half production, will it be flat, will that be up slightly or how does that compare?

About even, about flat.

Ok.

Thank you very much.

Thanks to you.

Ladies and gentlemen, we have reached the end of the allotted time for questions and answers.

Mr. Chewning, do you have any closing remarks?

No ma'am.

Thanks for -- except thanks to everybody for being on the call this morning.

Thank you for participating in today's conference.

You may now disconnect.