密歇根天然氣 (DTE) 2003 Q3 法說會逐字稿

Welcome to the DTE Energy third quarter earnings release conference call.

All lines will remain in a listen-only mode during the presentation. After the broadcast, questions will be accepted. If you would like to ask a question, please press star and then the number 1 on your telephone key pad.

Today's speaker will be Dave Meador, Senior Vice President and Chief Financial Officer.

I will now like to turn the call over to Mr. David Meador. Please go ahead, sir.

Thank you, Tracy, and good morning.

On Page 2 of our presentation which is on the web is the standard Safe Harbor statement that you can read. And if you get a chance, you can look on that.

This morning with me I have Dan Brudzynski, our Vice President and Controller, Nick Khouri our Vice President and Treasurer, Peter Pintar, our Director of Investor Relations, and to help us with regulatory and legislative questions, Mike Champley, our Senior Vice President of Regulatory Affairs is with us.

The outline of our presentation this morning is on Page 4, we're going to cover the third quarter, give you a 2003 update and then we're going to talk about the business outlook.

Let me start on Page 5 by making a few summary comments.

As we have mentioned, this is one of those years where many external factors have lined up against us. Althought we've created a culture within the company that rallies to offset unexpected bad news, the order of magnitude this year in the category of bad news is greater than we really can offset. You've heard about many of these issues as we've talked to you during the year. Examples like the Customer Choice Program (and we'll talk about that this morning), weather, the economy, employee-related costs, they've impacted us all year long and some of these will continue right up till year-end. An example of one of these external events would be, for example, storm.

Our year-to-date storm net of insurance this year has been $64 million. Now, if you add the blackout to that, which is another (inaudible) external event, another $39 to $44 million. So you put those together, and just that weather-related and blackout-related category, this year's been over $100 million, net of insurance. And this is an example of something that's impacted not only earnings, but has impacted cash. Although many of these factors are external and difficult to control, we're going to continue to drive cost reductions to offset some portion of these, and we're going to continue on that front.

On the extremely positive side, to shift over, is the recent announcement we have received on synfuels. The IRS has formally resolved the suspension of private letter rulings which was put in place in the spring. And as suspected, and as we have suggested a number of times, the resolution of the significant chemical change issue turned on technical arguments and expert testimony. In the end, the industry experts were able to show test procedures buy independent labs are supportable.

As a result of this recent action, the IRS has resumed issuing private letter rulings. Yesterday we received private letter rulings on the two remaining facilities so now we have private letter rulings on all nine machines. The two we received yesterday were for our Red Mountain facility in Birmingham, Alabama, and the Utah synfuel facility in Utah. So we're completely covered on the private letter ruling front now.

We also expect the IRS to begin issuing confirming private letter rulings, which are required for us as we sell down our interest in these facilities. So with this behind us now, it's going to enable us to move forward in our efforts to sell down the machines.

We are in discussions with serious counterparties to sell interests in several of the machines. One deal that's currently being negotiated is in late stages for two machines. And we expect to close that transaction later this month. Our forecast also is to close on several more deals in early 2004.

Now, given the third quarter results, shifting a little bit, the low end of our guidance is still achievable, and we'll talk about the year in a little bit but I wanted to comment on that as we look towards the lower end of the guidance, $3.10, it's going to require significant effort on our part and several things have to line up for us to be able to accomplish that. In the meantime, we continue to focus on operational performance but the key focus or the management team is on several fronts. One is fixing the Customer Choice Program, and we'll talk more about that, resolving regulatory proceedings and then the third key focus for us is selling down the synfuel machines.

Another positive for us in an area of strength has been our balance sheet through this whole period of transition, including our liquidity position. And the renewal of our corporate credit revolver. Another positive is the elements in the proposed energy bill that we're encouraged about, and we'll take you through some of the potential benefits to DTE.

Also, we continue to pursue growth in nonregulated side of the business in areas like on-site energy, waste coal recovery, and coalbed methane all of which require modest up-front capital. So that sets the stage.

Let me turn it over to Dan, he'll take you through some of the third quarter numbers.

Thanks, Dave, and good morning.

Beginning with the third quarter performance, DTE had reported net income of $176 million or $1.04 per diluted share. Operating earnings for the quarter, which includes operating earnings from continuing operations but excludes the impact of the quarterly effective tax rate adjustment, earnings from discontinued operations (which was our transmission business), and the nonrecurring impact of the August blackout effects on operating costs, was 67 cents per diluted share.

As shown on Slide 6, there you will see a breakdown by legal entity of third quarter results. Regulated electric contributed 67 cents per share, nonregulated, 31 cents per share, and regulated gas had a loss of 27 cents per share reflecting the seasonality of the gas business. At a high level, some of the key issues that affected performance include continued marginal (inaudible) due to the migration of electric customers to Choice.

Through year-to-date 2003 approximately 11% of Detroit Edison's retail sales have left Detroit reflecting a collective negative impact to gross margins of approximately $70 million through September.

Another key impact within the quarter was weather, which was driven by cooling demand the during the peak summer months. Cooling degree days in 2003 were up slightly about 2% from weather normal levels. Lower power supply costs were another key driver for the quarter.

Our mix of internal versus external supply improved, coupled with lower locked-in prices over the summer months, an exception to this was the period of time following the August blackout where supply to our customers was primarily externally sourced, as we worked to restart our generating units. This impact coupled with O&M operating costs directly related to the blackout have been excluded from operating earnings for the quarter and I'll go through this in a little more detail. The company has initiated the regulatory practices to seek deferral and recovery of these costs.

Within the third quarter, there was also a negative margin impact of the blackout due to foregone sales of approximately 200 gigawatts. These lost sales are not included in the adjustment to arrive at third quarter operating earnings, and we are not seeking recovery of these foregone sales.

Also, within the quarter, higher regulatory deferrals provided support to the regulated electric performance for environmental costs and served to partially offset some of the negative impact of Choice. Within the regulated business, cost pressures continued with higher pension and benefit costs and increased uncollectible expenses due to the weak economy and a higher gas commodity prices.

Nonregulated results were slightly up in the third quarter driven by gains within our coenergy portfolio, related to mark-to-market favorability on storage and transportation contracts, partially offset by the impact of inventory evaluation adjustments. Coal-based fuel performance down from 2002 levels but was at our targeted synfuel production.

Moving on to Slide 7, in the third quarter view by business unit.

Primary contribution in the quarter were 73 cents per diluted share within the energy resources portfolio businesses, but the details show in between the regulated and nonregulated companies. Nineteen cents within energy distribution and a $0.20 share loss within energy gas, again reflecting the seasonality of the gas business.

Continuing on to Slide 8, and summary of changes from third quarter 2002.

Beginning at the top with reported earnings of 96 cents per share, then adjusting for the effective tax rate adjustment in 2002 of 11 cents, and discontinued operations of 13 cents, you arrive at a comparable third quarter 2002 earnings of 72 cents per diluted share. Regulated electric results were impacted by the following: Gross margins were off 24 cents per share, driven by decreased cooling demand due to the mild weather.

While 2003 was slightly above weather normal, it was approximately 30% below 2002 demand levels which were well above weather normal. An indicator of this drop-off shows an up in residential sales for the quarter, which were down 13% primarily due to this decreased cooling demand. Incremental sales lost to Choice and foregone sales related to the August blackout also affected 2003's margins.

Offsetting some of these deteriorations, as I mentioned, were improvements in power supply costs due to lower locked-in prices and overall incremental territory sales growth. O&M was improved over 2002 levels due to weather-related restoration costs last year as a result of the high temperature-related outage we experienced that were not present in 2003. We also had a small (inaudible) billing adjustment contained within the recent FERC order and on the down side we continued to experience higher pension and benefit costs, similar to patterns throughout the remainder of 2003.

Offsetting some of these costs was time-related favorability within our power generation group due to outages costs within the quarter last year that were not present in 2003. If you remember earlier in the year, we talked about planned outages that were sequenced early in the year versus 2002. In addition, as Dave has mentioned, as a means to mitigate some of these increases in our base business costs, we are pursuing reductions in deferral actions to help address the increases we are experiencing in our base cost structure, and are also seeking rate relief to help address these factors on a going-forward basis.

Depreciation and amortization expense down over 2002 levels primarily due to increased regulatory deferrals for a portion of the Choice impact and environmental costs. Regulated gas is down in 2003, primarily due to cost pressures in the gas operations, higher employee benefit costs, customer service costs, and uncollectible expenses. Michcon also had a lower effective tax rate applied to those operating losses during the quarter as compared to 2002 levels.

Nonregulated performance was up in 2003, primarily due to gains on positions within the coenergy portfolio, a small incremental gain on the distribution of our Portland pipeline asset in the DTE Energy gas group, offset by lower coal base fuel earnings due to synfuel production and coke [inaudible] credits that expired in 2002. We also had lower merchant energy earnings due to lower summer volumes and wholesale prices.

For DTE overall, operating earnings 67 cents per diluted share, down 5 cents per share from the comparable 2002 period. You can see at the bottom of the slide, adjustments to these operating earnings levels to derive reported earnings were nonrecurring direct costs related to the blackout impact of 10 cents per share, the quarterly effective tax rate adjustment of 49 cents per share, (remember, this is the normalizing adjustment within the quarters and has no flow-through impact for the year over all).

In addition, there was a small 2 cents per share adjustment to the discontinued operations line item, netting to $1.04 per share of reported earnings.

Moving on to Slide 9, a summary of the blackout impact, overall the estimated impact is in the $39 to $44 million range, made up of lost margins, as I mentioned, and the direct related operating costs such as replacement power, and higher restoration costs. We started the regulatory process, as I mentioned, through a filing seeking recovery of this direct portion and anticipate direction on the deferral before year-end, but this will be dependent as always on the timing of the outcome of the regulatory process, and could stretch into first quarter 2004.

Now transitioning to 2003 overall, Slide 11 lays out some of our views for the remainder of 2003.

As has been a common theme to the year overall, the remainder of 2003, as Dave has mentioned, is expected to be every bit as challenging, but we still feel the low end of guidance appears achievable.

Contained within this outlook is a continued accelerated movement to Choice. Clearly the Michigan model needs to be addressed, but regulatory deferral of stranded costs of approximately $40 million, targeted synfuel production of 12.4 million tons with net income of $177 million, consistent with prior guidance, and normal weather for sales and restoration costs.

Further illustrating some of the challenges that we've experienced through the third quarter 2003, on Slide 12 we take a look at the Detroit Edison's performance over 2002 levels.

Year-to-date operating earnings are down 34% from comparable 2002 levels. Primary drivers include weather-driven sales last year in 2002, new incremental margin losses, as I mentioned, due to Customer Choice, offsetting some of these deteriorations were regulatory deferrals for the impact of Choice, and environmental cost. We've also experienced typical sales growth within our territory. And on the O & M front, increased costs for pensions and benefits and higher power generation maintenance and outage costs.

Now, looking at the choice impact over a longer period of time, you see on Slide 13, which details the migration of sales to Choice and the related margin impact. The graph on the left details sales penetration, and you can see that the trend is indicating a doubling effect with each passing year. With the impact in 2004 of upwards of 11,000 gigawatts migrating to Choice. The related margin impact is on a similar trajectory where the margin loss is upwards of 200 million potentially by 2004.

A similar look for Michcon on Slide 14 details a 29% deterioration in operating earnings due to increased pensions and benefits and uncollectible expenses as 2003 has been buoyed primarily by weather-related volumes. Considering Slides 12, 13 and 14 within our regulated businesses you can see clearly rate relief is needed for these businesses with the choice issues resolved on a going-forward basis.

Another key part of 2003 is our synfuel business. Some of the assumptions are summarized on Slide 15. The graph on the left details our targeted production by quarter, fourth quarter production will be down from 2002 levels, and the related net income from this business is expected to be down also in the fourth quarter.

Now, pulling up to a DTE level for 2003, lets move on to Slide 16. The low end of our guidance, as I mentioned, still appears achievable but will be dependent on factors that we can control as David mentioned, like cost containment, and pushing for a greater nonregulated growth, while others are outside of our control for the remainder of 2003, such as things like the weather, the economy, and continued Choice migration. Based on third quarter results, we've taken the opportunity to remix the components, lowering our expectations on the regulated parts of our business.

Now, continuing on to Slide 17 and cash flow, I'd like to turn the discussion over to Nick Khouri.

Thank you, Dan, and good morning.

Cash flow and balance sheet strength remained a key priority for management and the Board of Directors. Page 17 summarizes DTE cash flow for 2002 and the forecast for 2003. Cash from operations is projected to reach approximately $950 million this year. About on par with the $974 million in 2002.

The current 2003 estimate is below original projection due to our unusually weak earnings at the two utilities, as Dave mentioned, the cash cost for the storms and the August blackout, and the delay in the sale of synfuel interests. However, when measuring cash from operations this year, it is important to remember that we made a $222 million contribution to the pension fund in late February, which is recorded as a reduction in cash from operations.

Compared to 2002, capital spending is approximately $144 million lower this year, led in large part by a reduction in required environmental spending. This year, we expect to reach about $700 million in net asset sales. This number is made up of two major components.

First is the sale in February of DTE's transmission system for approximately $600 million. The second major component of 2003 asset sales reflects the way we account for synfuel sale. We sold partial interest in two synfuel facilities in 2002, these should be thought of as installment sales with little up-front cash, but instead receiving cash each year synfuels are produced.

Unfortunately, the ongoing revenue stream is accounted for as asset sales, not cash from operations. This year, that number will total approximately $90 million but will rise to $200 to $300 million each year as we sell additional synfuel interests.

In other words, annual asset sales higher and cash from operations lower because of this accounting treatment, as a result in the future, we will show both reported cash from operations and cash adjusted for synfuel sales.

In total, even after the $350 million dividend, we will generate net cash this year of $460 million. Looking towards 2004, cash from operations will improve significantly as more synfuel facilities are sold and interim rate relief supports the two utilities.

Finally, it is likely that DTE will make $170 million contribution to the pension fund next year. One option we are exploring is to meet that requirement directly with company stock. This translates into roughly 4 1/2 million new shares. The earnings impact, however, is small, probably 1 to 2 cents dilutive.

Page 18 shows DTE's balance sheet. 2003 should end with leverage towards the bottom of our 50 to 55% range. In addition, liquidity remains strong, last month we successfully completed the renewal of a 1.3 billion credit facility giving us over 900 million of excess liquidity.

Now let me turn it back to Dave.

Thanks, Nick.

And I am going to shift to Page 20.

Looking forward to 2004, we have several moving pieces that I want to talk through. Detroit Edison's net income, as you know, is highly dependent on the timing and amount of rate relief also the implementation of power supply cost recovery mechanism, the PSCR as we refer to it, and the fixing of the electric Customer Choice program. Michcon's net income is the dependant on the timing and the amount of rate relief also.

On the nonregulated side, net income will be driven by the timing of synfuel sales and also production levels. With the two PLRs being issued to us yesterday and assuming we close the deal for the two machines later this month, we’re off to a very positive start on that front. We'll continue to pursue growth as we mentioned [inaudible] energy. Another positive variable for the company will be the manner and the timing of the energy bill that is currently being proposed. Given the current state of events on all the pieces I've just mentioned we will provide guidance early next year when there's more clarity on each of these issues and also on the opportunities that are coming our way.

Let me go through a regulatory update on Page 21.

As we've discussed, at EEI will provide a regular update for you offer key dates or milestones throughout this process over the next six to nine months. First, on the PSCR reinstatement, briefs were filed on October 17th and reply briefs on the 31st. We anticipate an order from the NPSE before year-end on the PSCR.

Regarding blackout recovery we've filed our application on October 24 for authority to defer the cost as Dan mentioned, and we hope to get it resolved before we close the books at the end of the year.

On the elimination of the credit for Choice, we filed our application to eliminate the subsidies currently provided to Choice customers and have asked to use those funds for low income customers and we expect a decision on that in December.

On the rate cases, first with Detroit Edison, we expect the NPSE staff report on the interim rate relief on December 12th. That's a key milestone for us. And on the NPSE decision we expect sometime after we file our briefs on February 10 of next year. For Michcon, a prehearing conference is scheduled on December 10 and this is the meeting where the schedule will be set for that rate case, and regarding the Michcon GCR for the 2002 calendar year, the hearings been set later this month with an order anticipated in mid-2004 on that process.

On Page 22, you know, in addition to the synfuel resolution, the two PLR's that have come out, as I mentioned, another very positive possibility for DTE is the pending energy bill. If enacted there's a potential extension of tax credits, for (inaudible) interim shale and landfill gas. These are all businesses that we are in and have been successful at.

For example, if the coke battery credits are extended, it can provide an additional 10 cents per share in 2004 and 2005. They're currently considering a two-year extension on those credits. And if that happens, that would provide a benefit to the company which coincides with the transition years for the two utilities. So it's something we're watching closely.

There are also potential tax credits proposed for the production of refined coal, if certain emission credits are met and our [inaudible] process, our waste coal process might qualify for those credits.

And last, there might be credit for fuel cell development and distributed generation technology. We're very encouraged by the opportunities and we will track this bill as it moves forward, but the impact on 2004 depends on the final provisions of the bill.

Let me wrap up and then we'll open up for questions.

Although there are challenges this year, it's still possible, as we've mentioned, to hit the low end of our guidance but it will take some work on our part. Regarding Customer Choice, Choice has to be restructured in line with the original intent. The rate cases need to be resolved in a timely fashion. And, until then, the utilities will continue to be stressed.

Nonregulated earnings and cash flows are expected to grow now that the PLR's are being reissued and with new investments we're making in waste coal and coalbed methane we'll continue to see growth on that side of the business. The energy bill (inaudible) has a potential upside for (inaudible) that could come as early as next year. And as we said, our balance sheet remains sound during this transition period.

We're really pleased that the synfuel PLR issue has been resolved, and that's behind us and we will work with the NPSE for timely and fair resolution on all our proceedings. We continue to believe the overhang on our stock that started back when the synfuel issue came up in April and the regulatory issues make DTE undervalued and very attractive at today's prices.

With that, at this time I am pleased to take your questions. So Tracy, if you could open it up for questions, I'd appreciate it.

If you wish to ask a question please press star then the number 1 on your touch tone phone. Your questions will be answered in the order received.

Your first question comes from Carrie Stevens with Morgan Stanley.

Hi, good morning.

Good morning, Carrie.

I was wondering if you could maybe clarify how much regulatory deferrals were booked in the quarter?

Carrie, this is Peter. In the quarter, we had $8 million of choice-related regulatory deferrals.

What about the environmental?

Carrie, this is Dan, about 30 on the environmental.

Okay.

I didn't remember you that guys would be booking deferrals for the environmental costs, maybe you could go over the thinking behind that? How is that expected to be [inaudible]? Because I knew you would be booking deferrals for Choice but I'm not sure about the environmental.

What's the kind of thinking, like how's that going to be addressed and the upcoming rate filings?

The -- this is going back to the reduction expenditures primarily in the power plants and the coal plants. We have been constructing those facilities and spending money, and have included them in the rate case. And also, have indicated that after the rate case, electric rate case is closed, we also are leaving open the option to securitize those costs because it's something that we want to look at closely.

So as you know, on the securitization front, initially we were going to pursue securitization and in parallel with the electric rate case. We actually had included it with the rate case and we agreed with the NPSE to tentatively set aside our securitization process and just leave the environmental costs in the rate case for now.

So that's not anticipated to be a real near-term resolution on treatment of those costs?

Mike, do you want to comment on that?

Yes. This is Mike Champley.

The regulatory assets and all the environmental costs are part of the rate case and we would expect they would be addressed both as part of the interim rate relief as well as the file rate relief.

So I guess for the year, it looks like you guys are talking about 17 cents in your 310 will be based on regulatory deferrals, is that accurate?

I believe the 17 is only just the --

Carrie, this is Dan again. I believe the 17 is related only to the $40 million? Is that how you're getting the 17?

I'm just looking at one of your pages for drivers for the utility, it said $29 million in operating earnings, I think it was page -- sorry --

Carrie, that's a delta year-over-year.

Oh, that's a delta year-over-year.

Right, right.

So the $40 million, is that Customer Choice and environmental total?

No, that's just the Choice impact of stranded cost deferral.

So you guys will b having $70 million pretax of regulatory deferrals this year?

We think about in the neighborhood of 39 to 40 cents total in regulatory deferrals this year. As far as between the Public Act 141, the environmental-type costs in addition to the stranded cost.

Okay.

Do you know how much was in last year's number?

We're looking that up right now.

I just want to comment -- this is Dave -- that the nature of those two items are much different. You know, the environmental is more like plant in service with the option to securitize and as you know, the lost margin deferral is different in nature. And that will be resolved as customer choice gets resolved.

Carrie, this is Dan again.

Last year it was roughly about half that level. To give you a feel for year-over-year.

All right.

And then, two more quick questions: Do you have guidance now for '04 synfuel? I think before you were talking 180 to 200, does that seem reasonable still?

Yes.

Okay.

And then I saw that you gave segment, reupdated the segment net income. Were there any major shifts in how this is presented? I don't have last quarter's rate with me. Just so that I can be aware, or is it kind of consistent with where you were thinking before?

What segments in particular are you --

You're talking about for 2003?

Yeah, Page 16. (Inaudible). It's bucket change or mainly just the same?

The business is -- the businesses within those categories are the same as we've talked about before.

But regulated tire and maybe the regulated businesses are down, is that a fair statement?

Yeah, there's a -- relative to our guidance that we had in August, the Detroit Edison regulated electric piece has come down, energy gas has come down, and nonregulated has gone up. So there's been a shift relative to how those business segments break down relative to earlier in August.

All right.

That's mainly weather -- what's the main shifting factor?

For the -- for Detroit Edison, it's the continued impacts that we've seen year-to-date as illustrated in the year-to-date slide, likewise for Michcon. For nonregulated it's really a combination of variables.

But even since August, things have gotten incrementally worse than you thought?

What's that? On the regulated side, yes.

Okay. Thanks.

Your next question comes from Phyllis Gray with Dwight Asset Management.

Good morning.

Good morning.

I had a question about Slide 17.

Okay.

I was trying to reconcile your projection for the year with the cash flows through September provided on Page 5 of the supplemental information. I wondered if you could help me out with that?

Sure.

This is Nick Khouri.

I assume you're talking cash from operations?

Yes.

Year-to-date this year through the third quarter we have cash from operations of about $242 million as you see on the backup material. Last year it was about $500 million, slightly higher, $516 million.

There's a couple points I want to make. First, as I said in the prepared comments, that $242 million is reduced because of the pension contribution earlier in the year from $222 million. So that's the first thing we didn't have a pension contribution in '02.

More importantly, looking forward, we have a full-year forecast of 950, and year-to-date of 242. And there are two pieces as to how we get the additional money in the fourth quarter.

First, as we talked about before, we are a seasonal business as far as cash. Fourth quarter is the biggest quarter for us. For example, last year we had $457 million of cash from operations in the fourth quarter. So looking at the underlying factors, we think in the fourth quarter of this year, we'll have about $500 to $510 million of additional cash from operations from the base business. Again because of the seasonality.

In addition to that base cash before operations, we are, and have been, undertaking significant improvement in our underlying cash flow so we expect about $200 million of additional cash in the fourth quarter from these cash initiatives.

And just generally, these initiatives are things you would think about, managing our gas inventories effectively, managing our other fuel inventories effectively, working with receivables, so we think this additional $200 million of cash initiatives is a doable project in the fourth quarter.

So the 200 would be from working capital improvements?

The 200 would be from working capital improvements and then 500 from the base business.

And the 950 estimate is that net of the pension contribution or did you back that out?

950 is after the pension contribution.

Thank you very much.

You're welcome.

Thank you.

Your next question comes from Paul Ridzon with McDonald Investments.

I had a question on the gas storage mark-to-market, kind of what that looks like year-to-date, and kind of the duration of those contracts, when we would kind of see that reverse?

The mark-to-market on the -- is largely in the coenergy trading portfolio. It's the playing-out of the first quarter of write-down of the change in inventory accounting on the storage assets.

So in the quarter, the $23 million or so of earnings in coenergy and in energy trading, is about 70% due to that mark-to-market, and 30% due to realized earnings in the energy trading portfolio.

Paul, this is Dave.

When you asked about the length of the contracts and how this plays out, these are long-term contracts, but the phenomena that we run into from an accounting standpoint is that the gas and inventory is accounted for on an average cost method, the forward sales mark-to-market. What you see is during the year the interplay of the two of those end up in a net unrealized gain or loss.

So earlier in the year, we had recorded a net unrealized loss and we said that we saw that in the gas cycle turning around during the year and it's primarily playing out. So what you're saying is a reversal of what we saw in the first six months of this year.

Thank you very much.

Okay.

Your next question comes from Paul Patterson with ABN Amro.

Hi, can you hear me?

Yes.

Hi.

First of all, you guys are still, just to sort of follow-up on Carrie's questions, is that $137 million of (inaudible). Is that what we're still looking at?

In 2003?

Yeah, I think that's what you guys had in -- yeah, in 2003.

Yeah, the 137 million, if you went back to the August slide, is from the two units that we sold down last year.

Okay.

In 2004 what are you guys expecting again?

Well, let me take you through that and kind of set some grounding on synfuels because we get a lot of questions.

This year our projections are to produce about 12.4 million tons, and that results in $177 million of net income. Now, if you go out past 2004, say 2005, 6, 7, synfuels can run at a maximum production of about 19.3 million tons, and will produce $220 million-plus in net income. Next year it's going to be somewhere in between the two, it's dependent on the timing of production and sell-downs of machines.

So the scenario that we provided in August was for roughly 16 to 17 million tons of production which equates to $170 million to $200 million of net income, and then cash improves year-over-year to the $200 to $300 million. So this year we're negative cash from synfuels and we'll go positive next year.

Okay.

And then --

But the next year our caution is, and this is where we're going to have to help people when we come to New York in early February to do our year-end earnings report, we're going to have to help people understand the monetization [inaudible] schedule because the production will depend on the sell-downs of the machines, and this could vary from these numbers that I'm giving you for next year. It gets easier to tell you what 2005 is than 2004 at this time.

You guys mentioned in your press release that DT Energy will assess the impact of the IRS announcement on current production levels of synthetic fuel?

Right.

Could you elaborate a little bit on that, is there any issue that's come up? Clearly you guys are pretty much sticking to the numbers you had before, but what does that sentence mean?

What it means is there's a potential positive for this year. In August, to take you through the numbers, we said there's $363 million in credits in total, the $137 is already monetized. There was $212 million of credits that we were booking to our count. What we're looking at right now is if -- there's a possibility of closing the sale of these two machines, in the next week, that we will assess taking production up this year. So it's -- what is meant there, is there's a positive.

My caution in saying that is around the guidance we're trying to provide for the year because we have several variables at play here that we've talked about: Electric load, customer choice, cost reduction. And then the potential for remaining mark-to-market changes of coenergy, and there's a possibility in all of that that we could upside the production in synfuels and have a benefit this year of 7 to 10 cents. But it's dependent on closing that transaction that I mentioned.

Okay, great.

Finally, on Page 22 you guys mentioned some benefits, potential benefits, that could happen of the proposed energy bill. I was wondering if you could give us a rough estimate as to what we might be seeing here, considering how complicated these things are in meeting legislation, what have you, in terms of the nonconventional, the three sectors you have here, refined coal, you know, just what -- what might be -- if you could elaborate a little bit more on what sort of numbers we might be talking about and when you might see them?

Well, it's a little bit difficult because the language in the bill, as you know, is moving. And the one that is easier for us and just clear is the coke battery extension, and that's why I provided the numbers, that if that's extended two years, there has been talk about extending it potentially four years. I can quantify that real clearly, and we have the ability to transact on that -- that provides 10 cents per share.

When you get into some of the other pieces, for example on the waste coal, they're looking at waste coal credits based on environmental remediation, which could be combinations of SO2 (inaudible) and mercury. The final language hasn't been resolved and we are doing tests on our waste coal process to understand the environmental remediation. So I don't know if the final language is, and I also don't know if our (inaudible) process will qualify so it's hard to know at this time.

Our (inaudible) business, as we said, is profitable without credits and it would provide upside for that business. When you look at biomass and the interim shales, we're currently assessing that, we'll have to come back to you with numbers on that.

Will we start seeing those in 2004, do you think?

Yes.

Thank you very much.

Your next question comes from Zachery Schreiber with DuPayne Capital Management.

Hi, Dave. It's Zach Schreiber with DuPayne.

Morning, Zach.

Just following up on Paul's question, when we met at AEI, we had spoken about this waste recovery coal. With the tax credits still be around the $26 per ton?

It's really difficult to tell at this point in time. You know, that is a possibility but it's just something that we're going to have to monitor.

There's a lot of variables in here, as I mentioned, you know, including is it two out of three requirements on the environmental, is it three out of three and does our process qualify? And then the other variable will be in-service dates on the machines which we think could be 2007 which would give us an opportunity to build up that business. Because we are the only one that we're aware of that has this process right now. We have one machine in operation and so there's a lot of variables at play.

So my thinking right now is let the energy bill play itself out and we'll get clarity on that, and be able to come back to you in early February with some guidance on this.

Got it.

Now, if I recall, though, you had met the SOC and N0x but you hasn't -- you met socks but hadn't met knocks and mercury and you weren't sure what the standard was going to be?

Yeah, Zack, this is Peter.

The three effluents are noxious 02 and mercury. We're in the process of testing, the pep tech process and remediation abilities against those three effluents so we don't know what levels of remediation across those three substances we're going to achieve. Nor do we know how the language will be written, either in terms of the levels of remediation required as well as which of the two or three are needed.

So we're going to monitor the energy bill as well as continue the testing on our facilities, and as we know more, we'll let you know. But at this point there's too much variables to start to handicap where that's going to end up.

Last question on this issue: When will you have definitive, or more definitive, results on the testing?

I can't give you a date on that either. We've just, you know, we've just started to take that first facility and move it from a pilot to a commercial facility, and you know, as you know, the testing process is incremental. I can't give you a date when we feel we're going to be comfortable with the testing results. On all of those.

But when we get to the point that we have clarity on whether or not we do meet the energy bill requirements, whatever they end up, we'll let you know how the economics might play out relative to the baseline earnings power of that business.

Okay.

And I was wondering if you can update us as to where we are legislatively, where we are in sort of garnering the political support to make some of these proposed modifications to the original deregulation or reregulation legislation in the state? We've got a new Governor in the state, she's a Democrat, she used to be the Attorney General. Has she made any comments where she's going to come out on these issues?

And from a timeline, what should we be watching the legislature convene and do you have the key support to accomplish this tweaking that you say you that need?

Mike?

This is Mike Champley.

We're actively pursuing the legislative strategy right now. A bill has been drafted.

We're in the process of getting the sponsors. We have them lined up, we're getting more cosponsors and we continue to meet with just about anybody and everybody in the state that's important to this process. And we continue to do that. As we do that, we're pleasantly surprised at the level of support. We will continue to assess the situation in terms of the -- in terms of the exact timing of the introduction of that legislation.

Is there any expectations as to when? How -- I don't think the legislature reconvenes officially until January or is it sooner?

The legislature is in session now, and obviously will come back after the first of the year. We're weighing our options in terms of what would be the optimal timing.

Got it.

And David or Mike, I was wondering if you can update us on the schedule for the interim rate relief request? If I recall, there was about a six-week differential in the bid/ask spread in terms of this procedural schedule and I'm not sure if it’s changed or not.

As a matter of fact, earlier this week the commission issued an order that addressed the schedule in the rate case and they moved forward. That is, they accelerated the filing of briefs and reply briefs as part of the interim request and moved that forward in a positive way by two weeks. And so we've made some progress on the schedule.

So I think we had in the pact that by February 10th all of the briefs will be filed with respect to the interim increase and from that point on, this issue then is ripe for a commission order.

Got it. Okay. That's helpful.

Thank you.

Your next question comes from David Frank with Zimmer Lucas Partners.

Hi. Good morning.

Good morning, David.

I was just wondering, could you remind us again of the, in aggregate, what you expect to spend on environmental this year? Both what you would expense, what you would capitalize, what you would spend or capitalize next year, and then what's the total amount you’re going to seek recovery of?

We're double-checking our numbers.

As far as capital spending, Dan will look into the treatment of it, as far as capital spending, we spent about $240 million last year in 2002 on NOx remediation. That number's down to about $70 million this year and we expect it to decline in '04.

That's all the capitalized portions?

No. That's total CapEx for -- for NOx remediation.

When we say environmental, that's what we're talking about.

David, we got about $5 or $8 million of operating O&M cost related to NOx also, again, it's primarily materials.

Okay. But didn't you say you were deferring $30 million of environmental-related expenses this year?

Yeah. That is true. But that primarily is the return on the amount that we have previously deferred.

As well as the depreciation that would be associated with that as well.

Okay.

So taken together the $240 from last year, $70 from this year, and some smaller amount next year combined with $5 to $8 million of actual expense, that's what you would seek to recover then and earn a return on from the MPSC?

I think the total amount, it's all accumulated capital that we spent on NOx from 1998, 1999 time frame, and took acumulatively, the whole environmental issue represents about $70 million of the revenue deficiency in the rate case.

Okay. Great.

As far as the margin erosion from that current shopping program, do you know what your cumulative deferral will be at the end of this year?

At the end of the year, it will be 40. It's $30 million through the end of the third quarter.

That includes last year as well?

It's the total for this year, the deferrals associated with the Choice program for the current year.

Right.

Was there a deferral from last year as well, though?

A small amount, $10 million, but then you know, the way the process worked out, we had received further clarification from the MPSC and as part of the process we realized we really had to reverse that out but we were underaccruing for this year. So by the end of the year, you get the same cumulative amount, is the way it's going to work out.

All right.

Is this shopping program just -- is it set to expire at the end of 2005?

No, the electric Choice program is a permanent program, and there's also no time limit with respect to the recovery of the loss margins.

Okay. All right. Well, thank you.

Thank you.

Your next question comes from Jim von Riessman with JP Morgan.

Good morning, everyone.

Good morning, Jim.

Can you talk about your fuel hedging strategy for '04 and how much that's hedged out at this point in time?

Sure, on the fuel and purchase power portion, as you know, next year about half of our load will be subject to a fuel clause recovery, assuming that kicks in as planned. For the other portion, the other 50% not subject to that we've hedged actively about half of that.

So in total, about 70, 75% of our exposure on the fuel and purchase power is hedged on the electric side. In addition, we've hedged about 80% of our coal fuel purchase requirements for next year.

Can you talk about the cash flow outlook into '04? I know it's a little bit premature, but I'm thinking about this in terms of the dividend.

A couple things, Jim. Nick Khouri again.

As I've said in the comments, in '04 we expect an improvement in cash from operations. I think as we talk about earnings in '04, at the first of the year we'll give specific cash forecasts. We have talked about the major drivers, though.

Resolution and sale of synfuel facilities will increase cash $200 to $300 million year-over-year. Then the remaining cash or the remaining variables in cash forecasts for '04 will be the performance of the two utilities and rate relief.

Okay.

And then one last question. You guys have talked an awful lot about the synthetic fuels, the energy bill, et cetera. What's Plan B if the energy bill doesn't go through and you don't get an extension of these tax credits, and new tax credits you were hoping to have come in, aren't there? What's the value proposition then?

Well, the value proposition for me starts with the utilities post rate case returning to normal levels of earnings and ROE. You're going to see two utilities that have been depressed down over time as rate relief comes in, especially if Detroit Edison phased in from the rate freeze you're going to see those utilities return to more normal levels of earnings. We still will continue to grow on our existing businesses. You'll see growth in energy services, as we've indicated, our energy services business earns about $10 million where -- we're close to closing our transaction one of the big three auto makers that will double that net income.

We see doing more transactions in that space in the fence space where over several years you can see us doing incremental acquisitions that can grow that business in $5 to $10 million net income chunks and see the business grow over time. Coal services, we're at 60 million tons. We still have aspirations to move to 100 million tons. And then the waste coal business, without credits, we see growing to a net income of $25 to $50 million. We see coalbed methane, without credits, growing to $25 to $50 million net income business in three to five years.

Our base business plan is not depending on credits. We're just -- we're excited about the fact that businesses that we are in that might qualify for credits bring us upside at a time when the utilities are going through this transition.

Thanks.

And just one question back to the regulated operations.

Since you're in the heart of the auto industry up there, what are you seeing in terms of new employment? The productivity numbers coming out are generally pretty good. I know your industrial sales were down in the third quarter but what are you seeing generally with the industry and the demand from the OEMs, the autos, et cetera, that might suggest that this economy is starting to recover?

The -- we've seen the GDP numbers recently here nationally. We're very positive. We're not seeing that in Michigan yet. Michigan is lagging on that front. I think we're lagging on improvements in unemployment.

So we are, I would say from a load standpoint, more in a steady state. What we have seen in recessions, though, is that we step down to the no-growth proposition, and then there's a springback and the springback has not come yet and hopefully will come in 2004.

Okay.

Thank you very much.

Okay.

Your next question comes from Paul Ridzon with McDonald Investments.

My question's been answered, thank you.

Your next question is from Greg Oral with Lehman Brothers. Mr. Oral, your line is open.

Greg?

If you're on a speakerphone, please unmute your phone.

Your next question comes from Paul Ridzon with McDonald Investments.

I just thought of another question.

You're basically guiding towards the 310 area and you indicated that with sell-down of some synthetic fuel capacity, there could be an incremental 7 to 10 cents.

I'm just wondering is that 7 to 10 cents in your guidance or is that upside?

I would say it's not happened yet, it's contingent and it's (inaudible) in the guidance. There's a couple other things that are at play.

I mentioned the marked-to-market of coenergy, we have another item that we're pursuing, and it was a prebankruptcy receivable from one of our customers. If you remember in the second quarter we took a charge to earnings, we set up a reserve for that. We're trying hard to recover that. And it's not clear whether we'll recover that. If we don't, that's an example of something that might flip the other way.

So for now, if we're able to monetize this machine in the next two weeks and then take up production, I would still for now, my caution is that it might enable us to get to the 310 at this time.

Thank you.

At this time, there are no further questions.

I would like to turn the conference back over to Mr. Meador.

Thank you, Tracy.

And I thank everybody for participating and for the great questions.

And we look forward to our next major milestone on a regulatory front which is December 12th, and we'll be communicating to you after the staff files their report. And then the next event after that will be early February when we release earnings and hopefully give you an update on everything we talked about today.

Thank you.