密歇根天然氣 (DTE) 2004 Q2 法說會逐字稿

We are now beginning the conference call. All lines will be muted throughout the presentation. Afterwards, there will be an opportunity to ask questions. Instructions will be provided at that time. At this time, I would like to turn the conference over to David Meador. Please go ahead, sir.

Thank you, Tracey. Good morning, and welcome to our second quarter conference call.

With me this morning are Mike Champley, our Senior Vice President of Regulatory Affairs; Dan Brudzynski, our Controller; Nick Khouri, our Treasurer; and Peter Pintar, our Director of Investor Relations. Let me outline the agenda for today's call. This morning, we will take you through our quarterly earnings and then we'll provide an update on the regulatory and legislative front. We will discuss the continued success of our non-regulated businesses.

But first, before I turn it over to Dan, let me frame the quarterly results. As you know, we are in the ninth inning on the electric rate case and expect the final order in September. The gas case is slightly behind the timing, but should wrap up late this year or in January of next year. This means that both utilities are near the trough of a regulatory cycle that started ten years ago. While both businesses haven't had a rate increase in over ten years, health care pension, infrastructure and maintenance costs continue to put pressure on earnings.

The utility businesses had normal fluctuations in the revenue of cost line items for the quarter, and Dan will take you through those. We will also cover the impact of Customer Choice this morning. However, we continue to seek -- and we'll talk about this, as regulatory and legislative actions to create a framework that will allow both utilities to rapidly return to their targeted net income, return on equity and cash flow levels.

And we remain confident that we will successfully work these issues with Michigan's Public Service Commission and the state's lawmakers. In the mean time, the two utilities will deliver disappointing results. Now with that background, Dan will take you through the quarterly results.

Thanks, Dave. And good morning, everyone. Moving on to slide six and the presentation and second quarter operating performance. Operating earnings per diluted share was 23 cents for the second quarter. Reported EPS was 20 cents per share.

And there is a reconciliation of reported to operating earnings contained in the appendix. Energy resources contributed 29 cents per share. The power generation business unit of this segment was 1 cent per share, negatively affected by the impact of Electric Choice. Energy Services contributed 32 cents per share, driven by synfuel performance. Energy Trading and CoEnergy Marketing had a loss of 4 cents per share.

Energy distribution had a 1 cent loss, largely the result of an impairment charge for a technology investment we made in the second quarter. Energy Gas had a 19 cents per share loss in second quarter, reflecting the seasonality of the gas business and higher operating costs in 2004. Corporate and Other was 14 cents per share, driven by gains from the sale of Plug Power shares, lower financing costs and non-syn fuel related tax savings.

Now moving on to slide seven and the view by legal entity. Operating earnings for the second quarter were 39 million. Regulated electric was 8 million. Regulated gas had a $38 million loss. Our non-regulated businesses contributed 56 million in the second quarter. Key drivers for the quarter included the continuing impact from Electric Choice.

While the migration is beginning to plateau, the continuing negative impact was felt in the second quarter. This was partially offset by regulatory assets recorded for the quarter, and increased interim release from February of this year. Synfuel production for the quarter was down from second quarter 2003 levels. However, we continue to make positive progress in our sell down efforts this year.

Other drivers were the successful closure of the Daimler-Chrysler transaction and the sale of Plug Power stock, as I mentioned earlier. Offsetting some of these positive items was the weakness in the second quarter at MichCon, driven by lower margins, higher uncollectibles and O&M expenses; and I'll cover those in a few more slides.

Moving on to slide eight and some of the details around the regulated electric business: As you'll see, this is a similar waterfall chart format to what we have used in the past. Beginning on the left, with the second quarter 2003 operating earnings of 30 million, then adjusted for regulatory deferrals. There is a summary of these deferrals on page 31 in the appendix. Key drivers included weather upside this year versus last. The demand in the second quarter was still below weather normal. The lost margin impact at Choice had a negative $21 million impact over second quarter 2003.

We still expect the total year impact to be in the 200 to 220 million range. Interim rate release, net of the PSCR mechanism reset, yielded 10 million of upside in the quarter. Other margin changes were -9 million, largely due to an accounting adjustment within the quarter. Pension and benefit costs are continuing to escalate in 2004, together with increased investments in our generation assets and higher uncollectible and liability reserve provisions, led to cost increases year over year. Partially offsetting some of those increases were lower storm restoration costs, due to the catastrophic ice storm that we had in April of 2003.

In 2004, we continue to experience more frequent restoration costs, but they were smaller in nature. Now continuing on to slide nine and a brief look at the electric side midway into the year: In a similar format, you can see consistent drivers that were evident in the second quarter have contributed throughout 2004. The interim rate increase, though, is lower for the year to date view, due to the negative impact of the PSCR restart in January, with interim rate release beginning in late February. So that item was down.

Now transitioning on to the gas side of the business in slide 10: Beginning on the left side of the graph, with second quarter 2003 and an operating loss of 8 million -- as a grounding point, the second and third quarters of this business typically experience operating losses due to the seasonality of the gas heating business. Weather in the quarter was milder than in 2003.

Other declines in the quarter were lower sales, declining customer usage and system losses; Higher pension and benefit costs in the quarter, similar to the electric business. Higher uncollectible expenses, primarily driven by the higher gas prices and the local economy; together with higher legal reserves and maintenance expenses, contributed to higher costs in the quarter. We continue to try and manage these costs through cost reduction initiatives and also are addressing them as part of our regulatory filing for rate relief with the MPSC.

The year to date picture for this business is on slide 11, with uncollectible expenses being the largest driver year over year, followed by lower weather-related demand. Moving on to slide 12, which details out more of our ongoing plan of action for this business, in addressing the uncollectible issue. The graph on the left displays uncollectible expenses over the past five years and overlays upon add two of the largest contributing factors --unemployment, which is an indicator of the local economy, and the changing -- changes in gas prices.

Other key contributing factors include the higher percentage of lower income households and the related fall in state funding available for these customers. On the right side of this slide are some of the actions we have been pursuing. These include increased collection efforts, accelerating disconnect activities, utilizing new technology where possible and pursuing greater low-income funding being made available to these lower income customers. We have seen declines in both the number and outstanding balances of some of our aged accounts. In addition, we are also pursuing higher bad debt recovery in rates.

Now transitioning on to the non-regulated side of DTE in slide 13: As you can see, operating earnings are roughly comparable to 2003 levels. We have lower synfuel contributions due to the production timing in 2004 versus 2003. If you recall, 2003 was more front end-loaded. And our power generation business unit experienced a favorable impact of a contract termination in 2003 that was not there in 2004.

Partially offsetting these were larger contributions due to higher coke prices in 2004, improved margins at CoEnergy Trading, the closing of the Daimler transaction and the gain on Plug Power stock sale, which was partially offset by some impairment and restructuring costs within our technology portfolio. A year to date look at the non-reg portfolio is on slide 14. Again, this is similar drivers to the second quarter, with the difference being the second quarter gains in CoEnergy were offset by first quarter short falls. On a year to date basis, the non-regulated contribution stands at 102 million. Later in this package, Dave will provide updated guidance around these businesses.

But before that, I would like to turn the discussion over to Nick Khouri for an update on cash flow and the balance sheet.

Thank you, Dan. And good morning, everyone. Turning to page 15, improved cash flow and balance sheet strength remains a key priority for management and the board of directors. There have been some significant improvements in both ongoing cash flow and reduced leverage in the first half of 2004.

Leverage declined to 49% at the end of June, falling from 52% in mid year of 2003. Part of this decline was attributable to February's equity contribution by DTE Energy to the pension fund. But the second reason for the decline in leverage was the improvement in ongoing operating cash led by the flip in our synfuel business from cash negative in 2003 to cash positive in 2004.

As always, we retained more than sufficient liquidity, ending the first half of the year with over $1 billion of excess borrowing power. Of course, as Dave will discuss later, continued improvement in cash flow and balance sheet strength will depend on successful resolution of the rate cases. Page 16 details cash flows for the first half of 2004 compared to the same period in 2003. Adjusted cash from operations reached $607 million in the first half of 2004 -- 236 million, or over 60% above last year.

Part of the increase was intra-year timing and one-time events. For example, last year's first quarter included a contribution to the pension fund that reduced reported cash from operations. But on the other hand, some of the improvement in the first half of 2004 is ongoing. For example, synfuel production payments were up $45 million or nearly double the level in 2003.

Adjusting for one-time items -- items and unusual events -- cash in the first half of the year still showed sharp improvement from the prior year. Even with the lower asset sales in 2004, internal cash was sufficient to cover CapEx and the external dividend. Turning to page 17: This page shows capital spending by business line. In total, CapEx in the first half of 2004 was $432 million, about even with 2003.

The largest driver of capital spending this year has been a $30 million reduction in NOx environmental spending, offset by higher Detroit Edison plant maintenance investments, and the first phase of spending on a project to replace outdated corporate HR and financial systems, which we call DTE 2. CapEx is being held close to last year's levels until we get greater clarity on the regulatory front. Now let me turn it back over to Dave.

Thanks, Dan and Nick. I will now provide an overview of the regulatory and legislative matters, and start on page 19. Our number-one priority is the successful resolution of the electric rate case, the reform of the Michigan Electric Choice program and the gas rate cases that are underway.

As I mentioned earlier in this call, we are close to having the electric rate case behind us, and with the successful conclusion of that case and the gas case later this year, we will then have moved beyond what we believe will be a wave of regulatory proceedings in the industry. The Choice program continues to be a concern for us. As we said before, the MPSE has made positive movements in the interim order.

But there's much more work that needs to be done to fix this program, including addressing customer class-specific issues. We are very pleased that a bipartisan group of state senators introduced a package of bills in July. And I'll talk more about that in a minute.

As we have mentioned, about two-thirds of the Choice margin loss is the result of an outdated pricing structure that is not consistent with competition. To rectify that issue, we plan to file a rate deskewing case later this year, regardless of the electric rate case outcome. And last, I will comment on the staff recommendation for MichCon's final rate order, which was filed Monday of this week.

Now, if you turn to page 20, I have a Choice update for you. As I mentioned, we have communicated that the MPSC interim order was a positive first step in fixing structural issues within this program. The elimination of the customer incentives and a new transition charge were a positive movement in the right direction. However, the leveling off of the Choice sales that you see in this chart have been primarily driven by a rise in wholesale prices and customer uncertainty, not really due to regulatory changes.

Without further remedies to level the playing field, the 2004 margin loss will be in the 200 to $220 million range. There are additional costs and recommendations that we have all seen in the staff filing for final, but they haven't been acted on yet. So DTE will continue to pursue significant changes in this program through both the final rate order and legislation.

Speaking of legislation, on page 21 is a summary of the package of bills which have been designed by the bill sponsors to create a fair choice program for customers in Michigan, while at the same time, creating a level playing field for all Michigan utilities.

The key provisions of the bill are outlined there in the center column, and the ones I would like to point out are the return to service provision, the refinement on the calculation and timing of transition charges, the rate deskewing and the unbundling provisions, the reserve requirements for alternative suppliers; and then the other last key provision is the wires charge for low income assistance and environmental costs.

The Senate Energy and Technology Committee, chaired by Senator Patterson, will hold hearings on these package of bills, and they will start on August 4th. And as our top priority, we will actively support the passage of legislation. The CLEAR Coalition that we've referred to before, which is the broad-based coalition in Michigan that is supporting a reform of Customer Choice, now has over 22,000 members, and has generated almost 50,000 letters to Michigan officials in this matter.

There is a growing consensus in the state that the Choice program must change, and the basis for legislation, which really is level and fair playing field concepts, are being well-received. The legislation was the product of almost six months of hearings by the Senate Energy Committee, where many of the issues were gutted out.

On page 22 is the summary of the staff recommendations on the MichCon Gas filing case. There are many positive items in the filing that was made this week. The key components of the staff recommendation include a proposed ROE of 11%, with a 50/50 cap structure; a revenue deficiency of 70 million, which included items like base revenue, uncollectibles and safety in training.

In the recommendation, we saw O&M, pension, other post-employment benefits and uncollectibles, all addressed in a reasonable manner. And we really appreciate the constructive approach in the final recommendation made by the staff. However, our sense is the filing is substantially short of what is required to quickly move MichCon back to 11% return on equity and ensure that the credit ratings for that company are maintained.

The MichCon rebuttal is due a week from today, and our detailed positions will be outlined in that filing. In the meantime, I could just summarize the MichCon rate case progress as good, but there's much more work to do. Our goal is to pursue improvements in this rate case that would combine with the fixes to the MichCon bad debt issue that Dan covered on page 12, and continued cost control will return this utility back to its historical earnings and cash flow levels in 2005. The regulatory calendar is on page 23. We are almost done, as we mentioned, on the electric side, and near-complete on the MichCon rate case, as you can see on this schedule.

Now I would to shift and talk about our non-regulated business portfolio on page 25. This is our detailed guidance schedule, and we've updated it for the remainder of the year. We have increased the guidance for this group to 215 million to $255 million in profit. The key driver would be in the first line, which is higher synfuel earnings, which have driven by higher accounts produced of synfuel and resulting from our recent sell downs. We are making modest adjustments in our coal services line related to our waste coal process and in our energy trading business, and the driver there is a tightening in the power marketing margins.

Farther down on the page is our D/Tech business, where you can see there's initial losses there. D/Tech is going through a restructuring and a reshaping process. We have changed leadership in that business, and we are taking on a small charge in this quarter. There might be an additional small charge in the third quarter as we drive this business to break even next year.

And last, our energy technology investment business -- this is where we hold our Plug Power stock -- will be higher due to the sale of the Plug Power stock. And as you can see, this line almost offsets all the D/Tech operating restructuring losses. On page 26 is an update on synfuels. As we mentioned this quarter, we sold interest in two more units, which brings our total capacity sold down to over 80%. We have been very successful on that front.

Regarding issues that have surfaced in the industry around some particular units, our view is those are very site-specific issues that shouldn't impact us. So as you know, we have IRS termination letters on six facilities that represent almost 80% of our capacity. And we've successfully completed the field audits on four more units. We are in serious discussions at this time to sell the remaining capacity, and our sense is that we will sell down our units and meet our objective of having the units sold down by year-end.

All of this means we are taking up the volume and the profit forecast. Now you saw the profit forecast on the previous page for the remainder of the year. But as you can see on the chart on the right hand side of this page, the 2004 quarterly earnings profile will be back end loaded, so we are taking this up. There's still a range, as you can see, for the total year. And it's more back end loaded than 2003.

On page 27 is an update to the schedule for the synfuel net income and cash flow. So this is a schedule that we've shown in the past. The 2004 amounts are updated to reflect my comments in regard to higher volumes and profits, as we will only run the machines once we've sold -- primarily sold them down. There are some timing adjustments in the forward years, but the total is still $1.8 billion. That's not changed between now and 2008, which is very, very strong positive for us. This cash flow provides an opportunity for us to pay down some parent company debt and to pursue growth opportunities after the rate cases are completed.

On page 28 is an update on some of this quarter's non-regulated activities. We closed the Daimler-Chrysler transaction -- Dan mentioned that. In the process, we acquired the utility service assets at nine locations under a 20-year contract. You know, this is related to steam, chilled water, compressed air, and waste water treatment at a lot of their key facilities.

We also acquired the onsite assets that produce steam and electricity at a Kimberly-Clark tissue plant, with a 15-year off-take agreement. These two projects will provide $9.2 million of net income this year, and then on a going forward basis will provide 3 to $4 million of net income starting next year. We like these types of projects -- these onsite projects -- because they provide a steady, utility-like return, and you can expect to us do more of these down the road.

Our coke batteries, also as we pointed out in the past, are performing better this year, driven by higher coke prices. This year, we expect this business line to earn 6 to $8 million, which is up from last year. And we also expect an uptick in this business going forward, as we sign new contracts on coke output going forward. And all’s I can say is you will hear more about that later in the year. We will provide you more details on where we see this business going in 2005 and forward at a meeting we expect to have later in the year.

Let me summarize on page 29, and then we will take your questions. The second quarter, while disappointing, demonstrates the clear need for regulatory action in both utilities. This should come within 60 days for Detroit Edison and not too much later for MichCon. So we are near the end of the rate proceedings. The Electric Choice program must be fixed, and this -- as we've outlined, we are pursuing changes on the regulatory and legislative fronts. During this transition year, our balance sheet is very strong, as Nick took you through. And our non-regulated businesses continue their pattern of very strong performance. And we continue to grow our business through modest investments, like the Daimler-Chrysler and Kimberly-Clark projects.

We will communicate with you -- our plans are now to get back to you after the Detroit Edison rate order in September, and we are planning an analyst meeting in December. We will provide a comprehensive review of all of our businesses, including the coke battery business, which I just mentioned on the previous page. So with that, we will be happy to take your questions. And Tracey, if you could open up for questions, we would appreciate it.

If at this time you would like to ask a question, please press star and then one on your touch-tone phone. Your questions are answered in the order received. If you are in the question queue and you no longer wish to ask your question, please press star and then 9. Again, to ask a question at this time, please press star 1 on your touch-tone phone. Your first question will come from Margaret Jones.

Hello. I had a couple of questions. First one is, when do you anticipate that a legislation might actually pass?

I'll let Mike Champley take that question, Margaret.

Well, first of all, the hearings are going to commence next week, and then the legislature is in summer recess now and will return in September. But because this is an election year, it will be an abbreviated fall schedule, so it's our expectation that this is likely to occur later on this year.

So after election day? Is that basically what you're saying?

Perhaps.

Okay. And when do you expect the ALJ proposed decision in the Detroit Ed case to come out?

As it was shown on one of the slides, we expect it very shortly.

Do you know if that's going to be next week, or if it may be a little bit later?

We don't know. There was no absolute date.

Okay. And a last question. In the event that you obtain a rate order along the lines of the staff recommendation, and the unregulated businesses perform basically as you've outlined, do you think that you would be able to keep current rating levels at DTE Energy?

Yes. Our current plans right now -- this is Dave -- is that if the rate orders were successful -- the rate orders that we restructure the Michigan Choice program -- that both utilities will move back to their historical earning levels and our cash flows will follow that. That, combined with very strong cash flows with synfuel, our cash flows will be enhanced going forward in our objective of obtaining a strong investment grade rating. Our anticipation is that there will be absolutely no problems in doing that.

And strong investment grade rating basically means mid-triple B ratings, the way they are right now?

Mid-triple B, triple B plus.

Okay, thank you very much.

You're welcome.

Your next question is from Paul Patterson of Glenrock Associates.

Hi. Good morning, guys. I wanted to touch base with you on the Choice loss margin. It sounds like customers really haven’t over the last quarter or so really actually left any really new customers, in other words. I guess what I was wondering is if the regulatory outcome is that they essentially allow for you to be -- you know, they take care of your revenue requirements in the traditional sense, sort of make up for the lost Choice margin. How much more do you think the program has to be fixed, if you follow me? I mean, the customers aren't leaving anymore – A), am I right about that? And B), would that be something that could be an outcome?

I will let Mike Champley talk about the patterns we are seeing on Customer Choice. Our sense is that -- well, first of all you have to go back to one of the structural problems is this race deskewing issue. As I look across the country and states that have rolled out sustainable Choice programs, they did two things: They deskewed rates and they unbundled rates. And we have not done that in Michigan. We think that's a fundamental issue that has to be addressed and if you deskew rates -- you know, we have a fair number of rates that are out of market -- and then you open up the markets to Choice, it's very natural that they all went to Choice. Two-thirds of the Choice problem goes away by just going back to the cost of service rate structure. We feel that it's just a fundamental issue that has to be addressed. There's other fairness issues that -- you know, an example would be reserved margins or return to service that must be implemented, and actually have been recommended, and the staff recommendations were final. So we feel there's a fair number of -- in addition to this deskewing issue -- there's a fair number of level -- level the playing field issues that need to be addressed. And naturally, then, you would expect that, if implemented, that Choice number would not be where it is today. But I'll Mike comment on the pattern on what we've seen in the Choice pattern.

Yeah, first of all, we are seeing customers leave. What's happened is is that we are seeing -- if you will, the smaller customer; but albeit our higher margin customers, those that have the biggest rate subsidies built into their rates, are in fact, continuing to leave, and their loss is really being offset biometrically by a few low margin, large customers that have returned. But while the sales volume has been flat, the margin loss continues to deteriorate. And then the other thing we got to keep in mind that a lot of this leveling off was due to the run up in wholesale market prices earlier this year, and the question will be going forward, you know, what happens to wholesale market prices. And then one of the things that we are pressing for is a mechanism that will adjust the transition charges for changes in the wholesale market price so that we have some dynamic mechanism that responds to changes in market conditions.

Okay. That's very help. But let me ask you something here. Just to sort of elaborate a little bit more on the legislative profits here. Going to the legislature and asking them to deskew rates sounds like something that could be sort of fraught with political problems. I mean, you're sort of asking them to sort of, you know, even out the situation. And as fair as that might be, often politically we find that there's sort of hesitancy to -- I mean, there's going to be some vocal groups that's being subsidized right now who won't want that, if you know what I'm saying. And I was wondering if you could comment a little bit on that. I mean, I understand where you're coming from, I guess. I'm just wondering whether or not, you know, what the -- whether or not legislatively that -- what kind of reception you'll get, if you know what I'm saying.

Well, if I can respond. Well, first of all, I think we got to look at the fact that this was a bipartisan group of senators that introduced legislation. And I think what they were concerned about was this very process. But one of the provisions in the legislation is that this rate restructuring or resetting takes place over a ten-year period, which allows it to have, you know, gradual rate changes. But one of the things that Michigan must decide is, you know, what paradigm, if you will, we want to reside in. These rate subsidies are really a long-standing policy that existed when we had full regulation and no competition. Now that we have gone to competition, we have to, you know, address some of the policy issues that are, you know, messages of the past regulatory framework. And so we will never achieve a sustainable, workable Choice program in Michigan without addressing this issue. And I think there's increasingly a realization of this fact. And we're hopeful and confident that it will be addressed in an appropriate manner fair to all parties.

And Paul, this is Dave. I would just also add that if you stand back and said if nothing is done, what will happen is the electric utility will continue to file rate cases over time, because it's fully regulated. Generation was not deregulated, and that will, in effect, deskew rates over time, but in a very lumpy way; and arguably, in a politically shocking way. We think what we have laid out is a fix that smoothes things out over time, and that's why we would file the rate deskewing case. And then in legislation, it would tie transition charges to a level until those rates are deskewed. So the alternative to rates not being deskewed is just to maintain transition charges at a higher level and almost at a permanent surcharge level.

Okay, and just to recap here. Regulatory speaking, a lot of this could be solved by the regulator. Is that not correct? I mean, a lot this stuff could be solved with a regulator if they choose to do so -- if legislation doesn't happen, let’s say. Is that true?

Yeah. Quite a few -- but we've said in the past that a lot of these problems can be addressed through the regulatory process. But what legislation does bring is, you know, some permanency, if you will, to the situation. And it also established a state-wide policy, not a utility-specific policy, towards these issues.

Okay, thank you very much.

Your next question is from Jeff Gildersleeve of Millennium Partners.

Hi, good morning.

Hey, Jeff.

Sorry if I missed this, but I wanted to ask you on these projects that you're landing, the Chrysler and then the Mobile Energy Services, Kimberly-Clark deal.

Right.

What sort of hurdle rate or return on capital are we looking at there?

These projects tend to be utility in nature-type projects, where these are 15 to 20 year off-take projects. And if you look at -- on an ongoing basis, for example, we've all invest -- this year, I think the two projects we invest about $36 million, and we're going to earn $4 million a year on that equity we put into the projects. So they tend to be, you know, utility-type returns, but they have utility-type risk profiles to them also.

Okay, and the -- like the Daimler deal, these assets were purchased for $288 million. What, again, is your share or your equity contribution?

We -- on the Daimler transaction, there was -- the total amount that was purchased in the project was $307 million. Our equity was $31 million on the project. We actually had an equity partner in that project. And then the remainder of the project was project finance.

Okay. Great. And secondly -- you may have touched on this -- but given the increased cash coming in from synfuel, and you mentioned the balance sheet's in good shape. I know you're looking for some certainty in Michigan, but when you address the investment community this fall, what are the options you're thinking about with the cash you're bringing in from the synfuels?

Sure. The first point that we will provide some clarity on is how much of that cash is being earmarked to pay down parent company debt. You know, the synfuel cash ends in 2008. So we are looking out to 2009. And everything else equal, where do we want the parent company debt to be? So I think we're going to have to be clear with folks on how much is being earmarked for debt paydown. And then we will go through our opportunities and our business lines. And basically, we look at our non-regulated businesses in three groups. We have a group of power and industrial projects, our non-conventional gas group, and then our fuel transport marketing group. And we will take through those -- take you through those business lines and talk about business prospects. And at the same time, you know, we're going to reemphasize our approach of discipline to say -- you know, we are looking at cash on cash investment hurdles to say, you know, can the cash returns succeed our cost to capital? Are they within strategy, and do we have the leadership capacity to take on these projects? If we do them and if we can find them and execute, we will. And if not, we will look to return cash to shareholders.

Okay. And on that note, do you have a drip going now?

Yes.

You do. And you said that the analyst meeting would be in September or December?

No. In September, we will communicate the results of the Detroit Edison final when it comes out. And then the analyst meeting we are looking in December to have in New York.

Great. Thank you very much.

Thank you.

Your next question is from Ben Sun of Adams Harkness.

Good morning. I have a few questions, mainly regarding the synfuel operation. First question is on the guidance page on 27, in the presentation. It stated that the production volumes will increase from 15.6 to 19 million pounds from 2004 to 2005?

Right.

So my question is, is that based on the assumption that the remaining 20% or so of the capacity is being sold?

It's partially on that. But really what you're seeing is, we have taken the approach that we cannot use the tax credits. So we are only running the machines when they have been sold down. So it's the remaining units that are sold plus a full year effect of what is being sold during the year this year. The total capacity is 19 million. And this year, it was back end loaded in the production.

Right. It's more than the 20% remaining to be sold. It's a full year impact of what we had this year with some machines that only ran for six months, as an example.

I see. So, in other words, we are also expecting the ramp up in production in the current sold facilities too?

Right.

Okay. And the second question is, you mentioned that -- I guess, the site-specific issues with IRS. I'm just wondering what percentage in terms of the total capacity actually are affected, or is affected by this IRS issue, regardless of the outcome.

We believe at this time that none of the capacity is impacted by the IRS issue. The IRS issue is actually affecting some companies' machines, and we don't believe that the fact and circumstances that they are facing impact any of our units at this time at all.

Your next question is from David Plumhouse of Copia Capital.

Good morning, guys.

Good morning, David.

A couple of questions. You mentioned some tax benefits that helped at the holding company. What were those, and what was the amount?

It was -- I'll start, and ask Dan for help. It was primarily state-related taxes. And you know, it's not related to synfuel, so . . .

14 million.

It was $14 million pretax.

Okay. And on the Chrysler portfolio, which is nice see, the Chrysler project, which is nice to see it finally got signed --

Your next question is from Laura Blanco with CSFB.

Good morning.

Good morning, Laura. It looks like David dropped off. We will save a spot for him on the back end of the call. Laura, what's your question?

I have two little questions. The first one is, how much was the gain in the sale of Power Sales?

Laura, the after-tax gain unplugged after netting some writedown in the investment portfolio was about $10 million.

Okay. But just the sales without net in there?

Without the netting, it was about 14 million.

Okay. And are you expecting to sell more sales -- more shares?

No. At this time, we don't have plans to sell any additional shares.

And you mentioned that you will continue the restructuring for the portfolio next year into next year so that it will generate some losses next year, is that right?

Dave was referring to the D/Tech, DTM Technologies. Changed the management team and wrote down an investment there as part of that restructuring, and we will continue that process to achieve the goal of turning that business into a profitable business within the next 12 months or so.

So what I commented on is that there -- we took a charge in the second quarter relative to some of their activity. And because we showed a range on the non-regulated earnings page, there might be additional losses that are recognized in the remainder of this year. But our goal is to get that all behind us this year. And our goal is to move that business to a break-even position in 2005.

Okay, and then my other question is, when you look at the gross margin loss in the quarter -- or year to date -- it's net of the PSTR impact. Right? That's how you show it, in those lines. Could you breakdown those two components? Also, in other gross margin, the rate release. The rate release is net of the PSTR impact. So you can look at those too?

It was -- the impact of the PSTR was a negative 19, and the impact of the interim rate order differential was 29. So those two together led to the positive impact for the interim order.

Your next question is from Ashar Khan of SAC Capital.

Good morning. Can I just ask you, the legislation, I guess you mentioned their hearings coming up. But you might -- what is the probability, I guess, the low probability of it getting passed before you get your final decision on the rate case, which is, I guess, expected at the end of September? If the decision is good or acceptable, what happens to the legislation? Does the legislation keep on going? Or -- I just want to understand the policy behind the steps and timings.

The legislation -- you know, let me back up a little bit. To this point, we have had six months of public hearings where there has already been a fair amount of very public betting out of a lot of these policy issues. So the legislations introduced in July -- we do not anticipate that the legislation would be voted on until after the final rate proceeding. Now there's a good chance a lot of the rate -- the policy issues could be in the final rate order. If it is, the legislation might be more codifying in nature. If there's a shortfall, these policy issues could be addressed in the legislative proceeding; but nonetheless, it will be later on this year in terms of getting real traction on the legislation. In the meantime, there are real public hearings on the specifics of the legislation, and they start on August 4th.

Okay. And can I just ask you, is there any support? I guess for it to be qualified, you have to get it past the House as well. How does it go to the House? The bill gets accepted in the Senate, and then it gets introduced in the House? Is there any support in the House for this? Could you just tell us how the next process might be if it gets passed through the Senate?

Well -- this is Mike Champley. Obviously, any legislation in Michigan has to pass both the Senate and the House. The bills were introduced in the Senate and likely will be taken up there first. And then following that, it would then been considered by the House, and then ultimately would be enacted, then.

But is there any -- are there any members of the House which are on board to take this up right now? I just want to understand the strategy in the House.

Well, again, I think this has a lot to do with the bill sponsors and how they want to manage the process. But clearly, there's a recognition throughout the legislature, both in the Senate as well as in the House, you know, of the need to make some fixes to the current Michigan Choice program, that basically the structure is such that it doesn't produce a level playing field for all the parties concerned.

Your next question is from Daniele Seitz of Maxcor Financial.

Good morning. I'm sorry, I didn't catch the coke [INAUDIBLE] returns for the quarter, and your outlook.

Well, in the outlook, on page 25, what we show there is we're holding our forecast for the year at $6 to $8 million. But, if you recall, Daniele, that's a significant step-up over 2003. There will be an increase in 2005. And when we have our analyst meeting in December and go through all of our business lines, we will talk more about the opportunity that we see there. So there's no change in the forecast, but it is an improvement over last year.

Okay. On the debt ratio, do you have any long-term goals as far as your cap structure? It seems it's relatively conservative now.

Yeah. The -- you know, the goal, as we have indicated, is to maintain a strong investment grade rating. In the past, we had talked about maintaining leverage in the 50 to, you know, 55% level. And you're right. The consolidated debt structure is in very, very good shape right now. You know, what we have to sort out is going forward with the mix of businesses, is that are we in essence going to lower the range? And it's something we are looking at right now where we might slightly lower the targeted range on leverage. But the balance sheet's in real good shape right now.

Thank you.

Thank you.

Your next question is from Ben Sung of Luminous Management.

Hi, guys. You mentioned as one of the increasing costs employee costs and pension costs and things like that. Is that -- how much of an increase would you say that has been, or how much of an unexpected increase has it there been between the filing of the electric rate case and the gas rate case, up until now in some of those costs?

Go ahead, Dan.

Ben, this is Dan. It's actually been pretty consistent with what we filed in our projections within the rate case.

Okay.

We haven't really seen too much of a recovery on that front. You know, again, those are -- there are smoothing mechanisms around returns and discount rates and things, at least with pension and retiree health care. But I would say it's pretty consistent with our filing.

Okay. And also, in terms of synfuels, could you just remind me, was there -- is there some sort of a phaseout period that is tied to the price of oil? And if so, at what range does that sort of kick in?

There is a value per tax credit that is indexed and changed -- changes slightly from year to year. I don't think it's a big factor in the numbers that we have outlined here. You know, all of these expire at the end of 2007. The credits expire. But there is a small value differential year to year in the value per credits. But we think the range of dollars that we have outlined on page 27 takes that into consideration.

But there is -- is there no phase-out period that is tied to the price of oil?

Well, the credits expire in 2007, and the cash flows expire in 2008.

Okay. Thank you.

Your next question is from Selene Mahajan of UBS.

Hi, could you give a breakout of the $83 million gain that you booked on sale of assets in this quarter?

I didn't hear the question.

Breakdown on the gain on the sale of assets? Can you -- I'm sorry, could you state the question again? Because I'm not sure we recognized the number that you're asking.

This is the consolidated income statement that is the gain on sale of assets in this quarter of $83 million.

If you can let us look at that, and then I will come back to your question.

Okay. I had another question about the O&M costs at Detroit Edison and MichCon. There is sequential increase on the quarter basis in these costs. Could you indicate what trend we can expect for the next two quarters?

In Detroit Edison or both utilities? I'm sorry.

In Detroit Edison, we have the O&M costs going up on a sequential basis 4% -- with the first quarter in MichCon, O&M costs are going up 7%. I just wanted to know what kind of trend we can expect in the second half of the year.

We are not providing guidance for this year in general. But you know, what the MPSC basically is outlining is a framework that said they would hold us to a 2% inflation rate overall. And speaking in general terms on O&M, we believe while inflation from time to time could be higher than that, especially in health care, you know, we will have to live within that framework going forward where, you know, if we get rate relief, we would expect O&M to go up and we would have to offset some of that increase through productivity savings. So you know, I generally say in a 2 to 3, maybe 4% range, would be a reasonable presumption. But it's also ours to work to offset to move it more down towards the 2% number.

Dave, I would also add to that that we do expect to see the continuing trend around benefit and pension costs that we are seeing first half of the year.

Do you guys give any guidance for -- specifically for MichCon? How much do you expect the pension and health benefits to be higher year over year?

The -- what we have done for this year is because both utilities are in rate proceedings and it's really difficult to understand what level of interim and final rate relief will be provided, we have not provided guidance on either of the utilities. And my only suggestion would be is if you want to look at our expectations on cost trends would be to look at the rate filings that were made. And that's where that detail is laid out -- and if you need help getting to those numbers, our investor relations group can help you get those documents.

Okay, I mean, one reason I'm asking is because there seems to be a higher variance in the second quarter, which we didn't see in the first quarter.

Well, there's higher variances in both businesses that are driven, you know, by pension health care, and maintenance costs in particular. In Detroit Edson, what you're seeing is a higher cost due to investments, primarily in our power plants. And then also, the remaining item that you see in both of those businesses is that's where bad debt expense runs through the business. And MichCon, in particular, relative to its size of business, is having a larger bad debt expense experience, and it runs through that line.

Okay, that's perfect. Do you have my answer to the sale of assets?

Primarily related to synfuels.

This is primarily related to synfuels. When we sold down our synfuel machines -- these are contingent sales, for the most part -- there is a portion of some of these units, depending on the structure, when we sell them that, that we actually take a gain on sales in the current quarter, and then the remainder is a contingent gain that basically gets booked as the synfuel machine produces products. So a lot of the gain is then spread over the next several years, but there are some of these that have small one-time gains that come in the quarter. And it's synfuel related.

It's really more just geography between the tax expense line and up above the line, up in operating expenses. So it's really -- it's a reflection of just the switch of retaining credits versus monetizing credits.

How does this gain on sale of assets reconfirm what I'm looking at it? Where would this then appear on a segment-wide basis?

It would -- as far as a segment-wide basis, when we put out our 10-Q, you'll see that in the details there. It's within the energy services business segment.

Your next question is from Zach Schreiber of Dupane Capital Management.

Hey, guys, Zach Schreiber. Can you hear me?

Yep. How are you?

Good, how are you, David?

Doing good.

Just -- I don't want to beat a dead horse here, but I would like to kind of mention some of these numbers. Just on the price of the Plug gains, just to confirm, you said it was $14 million. And then were you netting some stuff again and said that was $10 million?

Yeah. Zach, that's right.

[INAUDIBLE] any operating losses?

No. This is -- Plug Power is held in a corporate venture fund that we now call VP Energy Ventures, so it represents about half of the total assets. We have a range of other investments throughout the whole company. And there were some change in the evaluation of two of those companies plus the Venture that resulted in a $4 million write-off differential between that, the pro gain and then the net gain.

So were we to take -- so basically, taking the Plug gain and then offsetting the write-down of the -- for the fair value impairment change of 3 cents. That gets us the net $10 million? Or is that fair value impairment charge something different?

If you are looking at the fair value impairment charge related to D/Tech, that's a different charge than the charge that was offset with the Plug Power gain in the Venture portfolio. Within D/Tech, they had an investment in a relationship with a company that makes product, that was re-evaluated as part of the restructuring of D/Tech there.

Got it. And just -- can you guys quantify how big the onsite -- the gain on sale for the onsite energy project is or was? And was it greater than or equal to, let's say, that 3 cent charge for the impairment of, like, the fair value of a tax investment?

You're asking about the Daimler-Chrysler transaction. The Daimler-Chrysler transaction, there was -- in the second quarter, the net income was 6 million. For the total year, this year, it's -- it will be close to 9 million. And then on an ongoing basis, Daimler is roughly a 2 to $3 million net income going forward. So there's a $6 million number in the year to date net income in the second quarter for Daimler. And again, as you know, Zach, these are all showing up in different business units.

Sure.

The Daimler-Chrysler number is in energy resources. The D/Tech number is in our energy distribution, and then the Plug Power shows up in that chart on the holding company in the different business unit.

Okay. But -- so your view, though, is that we should include all of that in the operating number?

Well, we should go through these one at a time. The Plug gain -- we have put in operations, because for years, as you know, we took Plug losses and we didn't strip those out. They were always in operating earnings. So we -- as we thought through this, we thought -- you know, to be symmetrical, we would include the Plug gain, but we want to disclose it separately, and if people want to pull it out, they can. The D/Tech adjustments that we've made -- that business has not turned a profit. And it has operating losses, and then there was an additional write-down there of several million dollars. And then when you now go to the Daimler-Chrysler transaction, on that side of the business, the structure of these project businesses have different income streams. And part of the income stream there is an ongoing income stream related to operating the plants, or else incentive to drive energy efficiency. There also was a development fee. We worked on this project for years. And there -- so some of our projects, as we close these going forward, we will have a stream of income relative to identifying, siting sourcing, constructing projects. And we feel that in that side of the business, it's fair to include those in operating earnings.

Okay. And just on this oil issue that's been raised. The way I understood it, from reading those provisions, you know, years ago, was that if oil got to above $50 a barrel for some sustained period of time, then the value of the credit either goes away or is diminished because the original public policy -- the original public policy was to kind of create -- alternative forms of energy in that the technology is supposed to be viable on its own in a $50 oil environment. But then that was $50 of oil like 20 years ago. So maybe for inflation it's a higher bogey. Do you know where I'm going with that?

Yeah, and I'm not -- I probably shouldn't go into too much detail, because I don't have a lot of background here. But there is a tie to oil prices, and prior to expiration of the credits, if oil was sustained at a high price, the value of the credits go down. So the phase-out starts at $50 and it would be totally phased out at $60. And the current price of oil is at $44. So, you know, I think it's just something for people to keep their eye on, but the question would be in asking this risk question, do you believe that oil would be at a sustained price of $60 on an ongoing basis? And, you know, while you never say never, we don't view that as likely.

How much phase out, just out of curiosity, at 50?

I don't have that information.

Okay, and just on the non-regulated earnings guidance, if I read the release right, you raised the synfuel numbers by 20 to 40 million, from 150 up to 190, to 190 to 210. But you only raised the total non-regulated guidance by 5 to 21. And given all the positive developments on some of the other non-regulated businesses, I would think that that increase in synfuels would kind of fall through to the bottom line for the overall non-regulated earnings. What's the offset that I'm not factoring in?

We took down our guidance for our coal services business, and we took down our guidance for the trading business slightly. So the coal services were adjusted down to 8 to 10 million, and Energy Trading 30 to 35 million. So that was brought down 5 million. And then the energy technologies loss was widened on the bottom. So it doesn't entirely flow through. We have seen this in the past where these portfolio businesses have worked where, in any given year, you know, where we have one slightly unperforming. We had another one outperform and more than make up. So the synfuels is offsetting some of the slight deterioration in the other businesses and allowed us to bring the total number up.

Okay. Last question. Just on the balance sheet and the cash flow, I mean, are we -- what are we thinking about doing with the cash? Are we -- you know, are there projects out there? Are we done with the debt paydown? Are we going to join the list of companies, you know, returning value back to shareholders in dividends in other kind of ways, or is that all "let's wait on that?”

For the details, we will have to wait until our analyst meeting in December. You know, we are exploring opportunities in the three groups, the power industrial project groups. You've seen us do the Daimler transaction. There is exploratory work going on in a variety of areas, but our number one priority is to get through these rate proceedings and get Choice fixed, because without that, it's going to be difficult to have a second conversation. But our goal is to get through the rate proceedings and to fix Choice, and then in December we'll be able to go through business line by business line and talk about what do we believe the prospects -- likely prospects are and what is our criteria. And then you know, what's our thinking about timeframe, too, and under what conditions you know, would we be willing to return some of that cash to shareholders? But it's too early right now.

Okay, great. Thanks, Zach.

Tracey, we can take one more question.

And that question will come from Charles Fishman of AG Edwards.

Thank you. David, at one time, I believe you indicated that the PEP technology might create 20 to 40 million of annual earnings. In your comment that there's a delay in the ramp-up, is that just a short-term issue? Or has your view of this technology and its potential earnings potential changed?

You are right that our previous comment said that we saw this business growing to a 20 to $40 million net income by 2008. And underlying that was the view that we would have 10 to 20 projects. You know, our first site is up and running right now, and it's actually producing coal from the [INAUDIBLE]. The technology works. What we are struggling with is actually, you know, excavating the fee stock and creating a slurry process that can allow this to run on a 24-7 basis. So -- and -- you know, so this is the first time anybody has ever done this. The good news is technology works, we are working through some process issues. And in doing that what we are doing is what we have done in the past in regard to discipline. Our approach is to take a business prospect, test out the hypothesis, and when it works expand it. So what we said earlier in the year was we hope to have 3 to 4 more sites constructed by year-end. Until we can work out the process problems, we are not expanding the sites, even though we could do that in short order. But we are focusing on process right now. And so recently, for example, there was a press release put out where we retained a company that specializes in excavating, basically, what we are dealing with, which is digging up mud and sludge out of a landfill, and then running it through this process to extract coal. And it doing that they run into problems and everything, from in the winter to when it froze, to in the spring when it was raining. So the team is working through these issues and that's something else, I think, that when we have about three four more months under our belt here, we'll be able to give you a much better feel for where we see this business going. But we are still optimistic. But we have to work through these technology process issues.

Okay, thank you.

Thank you. Well, again, thank you for joining the call. Sorry, David Plumhouse, for dropping off. And if you give us a call in the IR group, hopefully we can answer your question. And we look forward to communicating to you after the final rate order in September, and seeing you in person at the end of the year. Thanks again.