密歇根天然氣 (DTE) 2004 Q3 法說會逐字稿

Good day and welcome to the third quarter earnings conference for DTE Energy. Our leader for today's call is Dave Meador, Executive Vice President and Chief Financial Officer of DTE Energy. Please go ahead, sir.

Thank you, Tracy. Good morning and welcome to our third quarter conference call. I am going to start on page 3. With me today 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.

Starting on page 4, I am going to provide an overview before I turn it over to Dan. For those of you that we saw at EEI, we said the rate case is very near its conclusion, that we expect the order at any time now. The exact timing is really difficult to predict, but it could happen at an upcoming MPSC meeting or at a special meeting. It's really hard to predict the exact timing on when this might happen. We really look forward to achieving this milestone and we will talk more about regulatory matters later in the call.

The purpose of the call is to primarily focus on the third quarter and we look forward to talking to you on December 2 about broader updates on DTE. The overview for the quarter is that it was challenging due to extremely mild weather that the Midwest was faced with. Also we continued to experience Choice margin loss and higher O&M at Detroit Edison. The non-regulated businesses continue to perform extremely well, led by the synfuel business line. During this transition period the balance sheet remains strong and we have great liquidity after the renewal and expansion of our credit facility. And given our year-to-date performance and the timing of the rate relief, and we will talk more about this later, the year is playing out just as we have communicated. It's a transition year as we expect to receive rate relief for the first time in over than 10 years in the near term here.

So with that overview, let me turn it over to Dan who will take you through the quarterly results.

Thanks, Dave, and good morning to everyone. Today I would like to walk everyone through DTEs results for the third quarter of 2004. Beginning on slide 6 in a discussion of third quarter performance, reported earnings for the third quarter were 93 million, or 54 cents per share, adjusting this level for the effective tax rate adjustment at DTE yields a 40 cents a share operating earnings level. This slide, as you remember we used in the past, it details out the contribution by business unit. Energy Resources came in at 56 cents per share. The regulated generation side of that business was clearly affected by the mild weather this past summer and the continuing impact of Electric Choice contributing 19 cents per share to third quarter performance.

Non-regulated contributions were concentrated in Energy Services in the form of higher year-over-year synfuel production and also contributions within our trading operations. Energy Distribution or the wires part of our business contributed the 13 cents per share in the third quarter; primarily related to the regulated distribution business which was also negatively affected by the mild weather this past summer. Energy Gas had a loss of 28 cents per share reflecting the seasonality of gas heating demand.

Now moving on to slide 7 in a quarter-over-quarter look at the third quarter. Moving from left to right, operating earnings within Detroit Edison, our regulated electric utility was down 50 million due to the weather, Choice and higher operating O&M expense. MichCon, our regulated gas utility was also down driven primarily by tax adjustments. Partially offsetting these declines were improvements in our non-regulated portfolio and also at the DTE parent level in the form of lower financing costs and taxes.

Continuing on to slide 8 in a more detailed look at our regulated electric utility, beginning on the left side with 2003 third quarter actuals of 112 million, noting that 18 million of earnings this period were related to regulatory deferrals. As I mentioned earlier, mild weather was a $20 million drag on 2004, as cooling degree days during the summer were down almost 14% leading to decreased residential and commercial sales. Another key factor in the quarter was the increase in the Choice margin loss by 24 million, and this was partially offset by interim rate relief and regulatory deferrals. O&M expense was up quarter-over-quarter due to higher healthcare pensions and benefit costs.

Also in the third quarter were investments in our generation assets to increase their levels of availability. In addition, we have experienced higher operating costs due to a business system implementation that we are currently in the early stages of. This was a Company-wide initiative to implement new core information systems, many of which are at the end of their life and should lead to improved processes going forward. The largest piece of this implementation is the installation of the SAP software package. We are currently pursuing accounting treatment with the PSE to capitalize much of these costs and hope to have this issue resolved by the end of 2004 or early 2005.

Continuing on to slide 9 and our regulated gas performance. The key drivers of operating margin and operating cost were relatively consistent quarter-over-quarter. The largest driver in the quarter was a tax adjustment at the MichCon level. This accounting adjustment was merely a year-to-date true-up of the tax rate at MichCon given their lower level of pretax income. On collectible expense, levels in third quarter were consistent with last year but remain high on a year-to-date basis. We continue to drive towards solutions addressing these high bad debt costs, which is covered a little bit more detail on slide 10.

The key drivers of our collection issues are factors such as the economy, unemployment, gas prices and the level of available low income funding to go our customers. As we've detailed in our previous updates we continue to make good progress in our collection efforts and our ability to access low income funding. We are currently projecting a $60 million bad debt level for 2004. As part of our current regulatory proceedings, we are pursuing a tracking mechanism for 2005 to recover or return to customers 90% of the uncollectible cost either above or below a baseline level which was identified as 37 million. In 2004 terms, if this tracking mechanism was effective for the full year, this would have led to uncollectible expense of 39 million versus the 60, or 10% of the incremental amount above that baseline $37 million level.

Continuing and to slide 11 and a look at our non-regulated businesses. Non-regulated earning are up over 20% from third quarter 2003 levels. Our synfuel production is up in the third quarter of 2004 by almost 3 million tons. During 2003 if you remember we curtailed production in the second half of the year as we worked the chemical change issue through its conclusion with the IRS. We also saw higher Coke battery prices due to the higher coal prices in the commodity markets. Partially offsetting some of these improvements were declines within our CoEnergy portfolio due to marked-to-market changes of some of our forward positions, while the inventory related to those forward positions or contracts is not market-to-market but remains at average cost until it is withdrawn and sold. This should turn sometime later in 2004 and into early 2005. Another decline in 2004 was the gains in 2003 that we recognized for the - on the Energy Gas side of the business for the divestiture of our Portland pipeline interest.

Slide 12 details out more of the mechanics related to the marked-to-market changes at CoEnergy trading. Recognize this is a simplified illustrative example that attempts to depict the changes in isolation that flow through earnings as gas prices shift over time. Our example assumes a $5 contract price with a $4 price for gas yielding a $1 margin. As gas prices move, the forward contract is marked-to-market under current accounting and moves in the opposite direction while the underlying inventory that supports that contract remains at the average cost basis. Ultimately at settlement the locked in margin for the original deal is realized, but not with the interim earnings volatility that we are seeing as an example in our third quarter results.

Now continuing on to slide 13 and an update on synfuels. Production for the third quarter of 2004 was 4.4 million tons, up over 2003 levels. Year-to-date levels of 11.2 million tons, and we also project 15 to 16 million tons by the end of the year. We are holding to our previous forecast range within this line of business in the 190 to 210 million range for 2004. Through third quarter we have also sold 82% of 2004's capacity and expect to be over 90% of capacity sold by year end.

The amount of credits recognized in the year is also impacted by the average calendar year price of oil. If it crosses over a defined average threshold price for the year. If the average year reference price for oil exceeds the threshold price per Section 29 guidance, then the tax credits would begin to be phased out. Through September 30 of this year, the average reference price was just over $38 per barrel, well below the threshold price of $51 for 2004. Given this fact, the average price of oil would have to exceed $100 per barrel for the fourth quarter of 2004 to pull the average up over 51 before the credits would begin to phase out. Based on those mechanics we believe that the current prices are not like to impact the credits produced in 2004.

With that synfuel update, what I would like to do now is turn over the discussion to Nick Khouri for an update on the balance sheet and cash flows.

Thank you, Dan. Good morning, everyone. Turning to page 14, improved cash flow and balance sheet strength remains a key priority for management and the Board of Directors. There has been sharp improvement in both ongoing cash flow and reduced leverage through the first 3 quarters of 2004. Leverage declined to 49% at the end of September falling from about 52% in 2003. Part of the decline was attributable to February's $170 million equity contribution by DTE to the pension fund. But a second reason for the decline in leverage was the ongoing improvement in operating cash, led by the flip in our synfuel business from cash negative in 2003 to cash positive in 2004. As always, as Dave mentioned, we retain more than sufficient liquidity. In fact, we just successfully closed on our renewal of our credit revolver.

Page 15 details year-to-date cash flows through September compared to the same period in 2003. Adjusted cash from operations reached 400 -- 741 million during 2004, 387 million or more than double last year's total. Part of the increase was inter-year timing and one-time events. For example, last year 2003 in the first quarter included a $220 million cash contribution to the pension fund that reduced 2003's reported cash from operations. But on the other hand, some of the improvements so far in 2004 is ongoing.

For example, synfuel production payments were up 84 million from 2003. Even adjusting for one-time items and unusual events, ongoing cash before asset sales so far this year has showed sharp improvement from the prior year. As discussed in prior calls, through a combination of cash initiatives in the normal cycle of fourth quarter net cash at DTE, we believe DTE will generate more than enough internal cash this year to fund the dividend in capital spending. In other words, leverage will continue to decline.

Page 16 shows capital spending by business line. In total, CapEx through September totaled 643 million, above last year's pace. The largest driver of capital spending this year has been the additional investment in Detroit Edison's base business. In addition to this investment, higher spending to replace outdated corporate HR and financial systems mentioned by Dan, has also contributed to the year-over-year rise in capital.

With that let me turn it back over to Dave.

Thanks, Nick. And I am going to turn to page 18. As I mentioned in my opening comments, 2004 is a transition year with electric rate relief coming so late in 2004 and the gas case scheduled for the first quarter of 2005, our utility results for this year are disappointing. But the good news is that starting next year we step forward to our goal of returning the utilities to a normal return on equity levels starting in 2006. On page 18 we outline some of the year-to-date drivers that result in the decline of earnings. Many of these items are the result of the interim orders from the 2 cases or are issues that will be addressed in the final rate order. That would include things like base rates, Customer Choice, loss, regulatory assets and uncollectibles. Adding to that list is a tough weather year that many of us in the Midwest have experienced, including a windstorm this weekend.

Our non-regulated earnings are our bright spot. The year-over-year decline year-to-date is timing, as I will show you on the next page, on page 19. On 19 what we wanted to outline for you was an overview of the outlook and some of the factors that would drive our results for the remainder of the year. As you know, we haven't provided guidance for 2004. We still can't can't do that for the enterprise due to the pending electric rate order. So let me walk through some of the pieces here. I am going to start on the left-hand side of this chart. On the left-hand side, we start with the year-to-date earnings of $263 million that Dan took you through. This includes, if you look at the bottom of the left-hand bar, a year-to-date loss for MichCon of $22 million.

Now the outlook for the regulated gas business for the fourth quarter since we've received interim relief and there's really no other regulatory issues for the quarter, the outlook for the regulated gas business is $32 to $37 million. The drivers we've highlighted below that bar, so the drivers here for the gas business are weather, rates and then uncollectible expense, bringing the total year forecast for the gas business over on the right-hand side to $10 to $15 million of net income.

The non-regulated year-to-date earnings on the left-hand side is 165 million, and while the non-regulated quarter will then provide a $50 to $90 million outlook and that's driven by synfuel production and the gas storage accounting item that Dan took us through at the CoEnergy portfolio. Bringing the total non-regulated guidance of to $215 to $255 million. The holding company will have about $5 to $10 million of expense in the quarter and it brings the total outlook there to a minimal amount of $1 million to $4 million of expense.

That leaves Detroit Edison, which for now in an outlook all we can provide is the year-to-date earnings of $114 million. As you know for the electric utility we can't provide guidance due to the pending rate case and this is a case that's going to land in this quarter, and will change the regulatory framework. So it's very difficult to impact even a range for the quarter for Detroit Edison. So what we've tried to do here is at least provide you the pieces that we can, which is the non-regulated business lines, the regulated gas and then year-to-date on the electric utility.

When you think about the electric utility if you are trying to think where this might go, I would just caution you to be careful about looking to prior quarters including the fourth quarter of last year if you were trying to do a year-over-year analysis, or to the third quarter because those quarters include Choice- related regulatory deferrals. Given the near-term timing of the case, we are all better off just waiting for the order to understand not only the impact on 2004, but more importantly, as a footprint that we are going to develop for 2005 and 2006. And I really appreciate your patience on this whole issue of us not providing specific guidance during the year.

The detail for the non-regulated businesses are on the next page on page 20. We are maintaining our guidance at $215 to $255 million. As you can see as you go down the list here, synfuels, Coke batteries, energy trading, upstream/midstream gas are all having another solid performance year. D/Tech, this having a tough year, and we've appointed a new leader to run that business who is currently reshaping the business and we expect improvements for next year.

On the regulatory update on page 22, as we've said a couple times here already this morning, we expect the electric rate order soon and we continue to be hopeful that the MPSC will address not only the base rate request that we've made, but also the key Customer Choice policy issues. At the same time we are supporting legislation that is being pursued on a parallel path. The legislation continues to move forward and has been introduced into the Michigan Senate. As we said in the past, regardless of the outcome of the rate case or legislation we will pursue a rate de-skewing case that will be filed next year. And the reason for that is because this is an underlying cause of about 2/3 of the Choice margin loss. And then last, on the MichCon rate case, the final order is expected in the first quarter, and as we've said before, this is a much less complex case. It's a standard cost of service case.

So in summary on page 23, we are close to putting the rate cases behind us and we look forward to the rebuilding year of 2005. As Nick took you through our balance sheet remains strong during this transition period and on December 2 we scheduled an analyst meeting that we would provide an overview of not only the Detroit Edison final order, but also more thinking on the redeployment of our future cash flows, 2005 guidance and then key drivers for 2006. Given the current timing of the electric case, the exact meeting date could be impacted if the rate order doesn't come in the near future here.

With that, Tracy, we would like to open it up for questions.

(Operator Instructions). Your first question comes from David Frank of Zimmer Lucas Partners.

Good morning, guys.

Good morning, David.

Dave, I was wondering if you could review for me on the synfuel plants, which of the plants actually have had audits concluded on them and which may not have?

We have 9 synfuel facilities and 6 of the 9 facilities have determination letters relative to in-service and then we had 4 units that were audited. And 2 of the units that were audited are not in the 6 that have determination letters. So as part of the audit that we went through we picked up another 2 units that either through determination letters or audits we believe we have covered it in service issues, if that's what you're asking about. And the remaining units we believe the tax facts are very strong. So we are comfortable with where we are in that issue.

And I was just curious, on the audits were they actually litigated or taken to conclusion or were they just signed off on and were there any kind of no change letters issued at the end of the audits or?

These were just what I would describe as, from a process level, just regular audits that have gone to conclusion and we received letters from the IRS that the audits are closed. They weren't litigated.

Okay. But they did say they were officially closed.

Yes.

Okay. All right. Great. Thank you.

Thank you.

Your next question comes from Paul Patterson of Glenrock Associates.

Can you hear me?

Yes, good morning, Paul.

Good morning. You mentioned that you didn't think that the average price for oil would impact you in 2004 because of where oil prices have been. But if oil prices were above $51 for 2005, let's say, hypothetically what would that do to your synfuel production or earnings or what have you?

Let me cover off this question about the reference to oil; just to back up a little bit. There is a connection and a potential phase out of the value of credits that's tied to a well-head price. That well-head price is actually $3 to $4 on average lower than a NYMEX price. So it's easier and I think less confusing to think on a NYMEX equivalent, or else people get confused between the 2. So this reference price is actually set in the spring for the prior year. So in the spring of 2005 the phase-out range will be set for 2004. But you can go back and look at the trend and compare it to inflation rates and kind of get an idea. So on a NYMEX equivalent basis for this year the range would be $55 you would start phasing out and at $68 roughly the credits would not have value. So when you go to 2005, which is what your question, that index will move up and it moves up roughly with inflation. So you can take the $55 to the $68 range and basically think about it possibly at 2% higher. So the way the mechanics work is that at the beginning of the phase-out range, the credits actually have less value and that at $68, roughly, there is no value to the credits.

So if we don't go above $55 on average for the full year, is that what the story is, we won't have --

Yes.

And you say it's set in the spring of '05, but I'm a little confused by that. I guess what I'm saying is, if for all of '05 we don't have prices on average above $55 there's no impact.

Yes.

And then if it's somewhere between, of course, you got a 2% increase in there, whatever, roughly speaking, if there's some number in between 55 and 68 it goes down precipitously until you get to 68 and 0, I guess, is that?

That's correct.

Okay. And what's the -- okay, okay, that's helpful. And when we are looking at this though, I guess, we just have to look at what the average price is for 2005 while that year is continuing, right?

That's right. And I'm sure during the year we will be asked and provide updates relative to the reference phase out. But as Dan mentioned, it's not an issue for this year because the price of oil would have to be well over $100 per barrel for the remainder of the year. And so for next year it will be a phase-out range that will be slightly higher than 55 and slightly higher than 68. And as you mentioned, it's about roughly you could estimate it would be about 2% higher.

And then if we are looking at -- just another question I have for you, DTE2, the impact in '04 versus '05, I guess you guys obviously had some expense of putting the system in. A, will that expense will be there in '05? How much will it be for the full year of -- I mean, what are you estimating for the full year of '04? Would it be there in '05? And wouldn't there be some benefits to this information system would create more efficiencies, I assume, but I don't know, could you give us a little more feeling on that?

Sure, Paul, this is Dan. We anticipate -- we've estimated through the first 9 months of the year it's about $22 million of incremental expense that's hitting the income statement. Based on our accounting application with the Public Service Commission pretty much all of that would be capitalized. We would probably, based on that accounting methodology in '05, see some degree of expense in probably the $5 to $10 million range for the full year of '05. So it's really a very small amount.

Now answering your question around benefits, that's one that's a little farther out in the future. We are pursuing a migration approach into the SAP and we've got a work management system called Maximo that we are also implementing. The current launch plans are, it's a multi-year launch. So we will not be fully into this sort of ERP solution until well into 2007.

Okay. So just to understand the expense of $22 million in '04 for the last 9 months is being capitalized right now or?

It's currently being expensed because we have not gotten firm guidance at least from the Public Service Commission yet.

If you do get the guidance from the Commission then we should expect $22 million not to hit the income statement, that's pretax I assume, correct?

Right. And there will be a small increment in the fourth quarter also and we would make that accounting entry in the fourth quarter. Or potentially early in 2005.

Great. Thanks a lot.

Your next question comes from Ashar Khan of SAC Capital.

Good morning. Could you just, if I'm right, in January you had mentioned that you had expected 240 million pretax loss from the Choice program. Based on the current results and what you know currently, are you going to be pretty much close to that number or what can we expect versus that 240 number for the year 2004?

Just to remind everybody when the interim order came out, the credits were removed and a 4 million transition charge was implemented for the first time, which was a very positive step, and what that had the impact of doing was leveling off Choice. So we expect changes in the order, but as of today Choice is leveled off and is running in the $200 to $220 million margin loss range.

So that's 200 to 220 on an annualized basis. Is that the way to look at it?

Yes.

Okay. What kind of gigawatt hours can you -- will that equate to?

It's roughly 18% of our low, a little over 9,000 gigawatt hours just roughly.

Fine. I appreciate it. Thank you.

Your next question is from Paul Ridzon of Key McDonald.

Good morning. I have a couple of questions. Is the synfuel linear between the bottom end and the top end of the phase-out range?

Yes.

And with regards to the SAP system, I was a little confused on the 22. You've expensed it thus far this year so you could potentially see a reversal of that expense in the fourth quarter?

If we get the accounting treatment that we want, yes.

What's the outlook for getting that?

We are still working that through with the Public Service Commission. I don't really want to weigh in on their behalf.

We believe the principal is right and it would actually conform the accounting with other previous standards. For example, how MichCon has consistently accounted for items like this. So we feel comfortable that we will eventually achieve the right accounting, but procedurally we have to work through this and there's other thing that are happening including electric rate case and a gas rate case. If it came this year that would be great. If not we will pursue it early after the first of the year.

This is a separate proceeding from the electric and gas rate cases, though?

Yes.

Then any, the mark-to-market on the trading, is there any way to predict how that will flow between '04 and '05?

Not really. At this time there, obviously is an imbedded assumption in our non-regulated guidance that we have provided guidance for the Energy Trading CoEnergy portfolio, but it's really dependent on prices and then the withdrawal out of storage. So if you have a very early and cold winter you could be withdrawing at a different pattern than normal pattern. So it's really difficult to predict how much of it will land in 2004 versus how much of it comes in 2005.

Thank you very much.

Thank you.

Your next question is from Leslie Rich of the Columbia Management Group.

Hi, Dave. In your press release you say that FERC approved the sale of some peakers at the end of October.

Right.

What's the dollar amount of that?

We have not disclosed that transaction yet. It has not closed. It was pending regulatory approvals and one of them was the approval process in FERC. But on our merchant energy group we have about 900 megawatts and this would reduce that merchant energy group by 160 megawatts of capacity.

Is it possible there would be a write off in conjunction with the sale or?

If there is it's minimal, very diminimus and this is really just something for to us reduce our exposure in that merchant fleet right now. When the transaction closes I imagine we will put out something, but don't expect that it's going to be a significant write off.

And it would close before the end of the year or?

I think that's the current timing we anticipate before the end of the year.

Thank you.

Your next question comes from Raymond Long of Bear Stearns.

Hey, gentlemen, just a quick question. How much CP do you have outstanding currently and at what type of rate?

As I mentioned we just renewed our revolver a few weeks ago, so we actually have about $1.8 billion liquidity. At the end of the quarter we had CP outstanding of 475 million.

475 million. What kind of rate are you achieving on that?

It's typically short term so it's typically about 1%, 1.5%, depends on the tenure, depends on the time, but a good average is 1 to 1.5%.

And the liquidity, is that available liquidity or is that the total lines?

That's the total lines. If you take 1.875 and minus 475 is available capacity.

Thank you.

Your next question comes from Ben Fung of Luminous Management.

Good morning. Some other utilities saw an increase in industrial load growth. Did you see anything similar to that and how did that work towards mitigating the weather affect?

Ben, this is Peter Pintar. No, we didn't see an increase in industrial. In fact, industrial has been down a bit in the quarter relative to third quarter last year. So we haven't -- we haven't seen really a bounce back in the industrial sector even though the broader economies has improved this year.

Thank you.

At this time, you have no further questions.

Well, thank you and as we said many times here, we are looking forward to the resolution of the electric rate case. That event will happen in the near future here and we will be communicating to the investment community soon after that happens and look forward to seeing you at our analyst meeting.