第一能源 (FE) 2003 Q3 法說會逐字稿

Good afternoon. My name is Amidras, and I will be your conference facilitator. At this time, I would like to welcome everyone to the FirstEnergy third quarter earnings conference call. Now, I would like to turn the call over to your host, Mr. Kurt Turosky, Director of Investor Relations. Sir, you may begin.

Thank you, Amidras. During this conference call, we will make various forward-looking statements within the meaning of the Safe Harbor provisions of the United States Private Securities Litigation Reform Act of 1995. Investors are cautioned that such forward-looking statements with respect to revenues, earnings, performance, strategies, prospects and other aspects of the business of FirstEnergy Corp are based on current expectations that are subject to risks and uncertainties. A number of factors could cause actual results or outcomes to differ materially from those indicated by such forward-looking statements.

Please read the Safe Harbor statement contained on page eight of the Consolidated Report to the Financial Community, which was released earlier today, and is also available on our Web site at www.firstenergycorp.com/ir under the "Earnings Release" link. You may also view the company's most recent Safe Harbor statements as contained in our most recent 8-K filing that was furnished to the SEC earlier today.

Also participating in today's call are Rich Marsh, Senior Vice-President and Chief Financial Officer; Harvey Wagner, Vice-President and Controller; Tom Navin, Treasurer; and Terry Howson, Vice-President, Investor Relations.

I'll now turn the call over to Rich Marsh.

Thanks, Kurt, and good afternoon, everybody. Thanks for being with us today. We released our consolidated report to the financial community earlier today, and it might be helpful to refer to that as we discuss our third quarter results. Please note that I'll make reference to various non-GAAP financial measures for which reconciliation to the corresponding results on a GAAP basis are indicated on the first page of the consolidated report. The report, which also includes information required by Reg G, is also available on the Investor Information section of our Web site at the address that Kurt just furnished you.

Non-GAAP earnings for the third quarter before unusual charges were $0.81 per share. Excluding costs associated with the Davis-Besse extended outage, normalized non-GAAP earnings were $0.95 per share compared to restated third quarter 2002 normalized non-GAAP earnings of $1.19 per share.

Last year's results were restated to reflect changes in the amortization of transition costs and above-market lease costs for the Ohio distribution companies, as well as a reallocation within the year of the Pennsylvania provider of last resort obligation disallowance.

During the quarter, the Davis-Besse outage resulted in incremental O&M expenses of $17m as well as replacement power costs of $55m, which reduced earnings on a combined basis by $0.14 per share. We also recognized two unusual charges during the quarter. The first reflects a non-cash goodwill impairment charge of $122m, or $0.27 per share, associated with evaluation adjustment for our Facility Services group.

Following the impairment charge, FirstEnergy's equity investment in these HVAC companies has been reduced to $128m, and Tom will provide some additional details regarding this in a few minutes.

The second unusual charge is associated with the New Jersey Board of Public Utilities summary writ in order in our JCP&L base rate proceeding. The summary writ in order, which was issued by the Board in early August, modified both the calculation methodology as well as the interest rate that JCP&L had been accruing on certain assets and deferred costs during the four-year transition period that ended on July 31st, 2003.

This disallowance was accounted for as a one-time $13m pre-tax write-off of regulatory assets and resulted in this quarter's unusual charge of $0.03 per share. Including costs associated with the Davis Bessie extended outage and unusual charges, GAAP earnings for the third quarter were $0.51 per share compared to the restated GAAP earnings of $0.97 per share for the same quarter last year.

The largest single factor that reduced normalized earnings relative to the third quarter of last year was an increase in non-cash pension and non-pension expenses. As for most plan sponsors, the increase in pension and no-pension expense relates to the year ending 2002 asset valuation, as well as the rate of return and discount rate assumptions identified at that time. This quarter's variance is comparable to the variances that we experienced in the first two quarters of the year, and we expect a similar variance to occur in the fourth quarter, as well.

Other factors that contributed to reduced earnings relative to the third quarter of last year included higher nuclear operating expenses due to the Beaver Valley 2 refueling outage, reduced distribution rates at JCP&L following the rate case decision, storm restoration expenses primarily related to Hurricane Isabel, accelerated reliability improvement spending at JCP&L, and higher non-cash Ohio transition amortization expense. Partially offsetting these items were higher electric gross margins and lower financing costs due to our continued debt reduction program and refinancing initiatives.

Now, I'd like to turn the call over to Tom Navin to discuss income statement in a little more detail. Tom?

Thanks, Rich, and good afternoon, everyone. First, I'd like to remind you that the additional details of the major earnings variances for the quarter are included on the first two pages of our consolidated report to the financial community. I will start with an explanation of our sales and revenue statistics compared to last year.

Electric distribution deliveries for the third quarter 2003 were 5% lower than the third quarter of 2002. Residential and commercial deliveries for the quarter were down 7% and 4% respectively. The decrease was primarily due to the milder summer weather experienced in 2003 compared to the very hot summer of 2002. Cooling degree days during the quarter were 19% below the same period last year.

Industrial deliveries declined 3% as the economy continues to struggle. A 7-1/2% decrease in distribution deliveries was registered in Ohio, with a 3.7% decline in Pennsylvania, while New Jersey experienced a 1.6% increase in deliveries. Total electric generation sales increased slightly as a 6% decline in retail generation sales was more than offset by an 18% increase in wholesale sales.

Based on recent sales growth trends and a struggling economy, we expect sales growth in 2003 to be about 1.6% greater than 2002 on a weather-normalized basis. We project residential sales growth of about 2.5% and commercial sales growth of 3%, which industrial sales are expected to be flat.

Electric gross margins increased $25m after adjusting for changes in regulatory referrals and Davis-Besse replacement power costs. The improvement in electric sales revenue of $107m was driven by higher wholesale spot and contract sales. The increase in electric sales revenues was partially offset by higher adjusted purchase power costs, which resulted from additional market purchases necessary to support the higher wholesale sales and a 5% reduction in generation output.

Generation output decreased due to the Beaver Valley Unit 2 refueling outage, as well as reduced fossil unit output related to the lower retail customer demand. We were pleased with the planning and execution of the nuclear refueling outage at Beaver Valley Unit 2. The outage was completed within the scheduled 28-day period, and was accomplished at an O&M cost of $35m.

Significant activities during Beaver Valley Unit 2's outage included thorough inspections of the reactor vessel head and under-vessel, as well as the steam generator, and all were found to be in good condition. The unit had operated for 474 consecutive days since its last refueling, and had posted an availability factor of 99.6%.

Moving on to operating expenses, as Rich mentioned earlier, the most significant variance again this quarter was pension and other post-employment benefits, which increased approximately $50m from the third quarter of last year. Nuclear operating expenses, excluding incremental expenses associated with the Davis-Besse outage, increased $28m with the increase entirely attributable to the Beaver Valley Unit 2 refueling outage.

Storm-related restoration expenses increased by approximately $20m during the quarter, primarily due to Hurricane Isabel. The storm affected many of our customers in our Eastern service territories. We restored power to 375,000 customers in Pennsylvania, and 152,000 customers in New Jersey. In anticipation of the storm, we mobilized 60 line crews and 70 additional support personnel from our Ohio distribution company to support restoration services in Pennsylvania and New Jersey.

By proactively stationing our support crews at various storm locations, we had the flexibility to send the crews when and where they were needed and restore power to our customers in the fastest way possible.

Finally, as part of our commitment to improve service reliability in Jersey Central Power & Light service territory, we've accelerated $12m of reliability improvement in the region. Our efforts at improving the service reliability in that region included the inspection of over 800 distribution circuits to identify reliability concerns, inspection of about 500 substation transformers, and significant tree trimming and vegetation management.

Total depreciation and amortization expenses adjusted for the regulatory deferrals and the Jersey Central Power & Light disallowance increased $14m. The increase was the net result of a $25m increase in Ohio transition cost amortization and $12m of depreciation expense associated with the Lake plant, partially offset by $19m of lower nuclear decommissioning and depreciation expenses related to the implementation of statement financial accounting standards number 143.

Moving on to financing activities, our continued debt reduction program resulted in a decrease in net interest charges of $19m from the third quarter of 2002. Financing activities during the quarter included $241m in mandatory long-term debt redemption, which will produce annual interest savings of approximately $20m.

Year-to-date, financing activities have included long-term debt, preferred stock redemptions of $656m, debt refinancing of $622m, and pollution control debt repricings of $212m. These and other actions will produce annualized financing cost savings of approximately $80m.

I'd like to comment on our successful common equity offering that closed on September 17th. This was a significant step in FirstEnergy's credit enhancement program, and it provides us with a significant additional degree of flexibility and liquidity. Many analysts anticipated that we would launch an offering of between $500m and $750m.

To demonstrate our strong commitment to credit quality, we launched an offering at 24.8 million shares on September 8th with a value of about $770m. As a result of strong investor demand, we elected to upsize the transaction to 28 million shares at a price of $30 per share. Following exercise of the underwriters green shoe option, the total offering size was 32.2 million shares. The issuance diluted earnings during the quarter by $0.02 per share, and we estimate earnings dilution for the year to be around $0.07 per share.

About 80 percent of the new shares went to institutional investors, with 20 percent being distributed through retail channels. We were very pleased with the quality of the institutional order book as it reflected strong participation by large, sophisticated fundamental buy-and-hold holders. Net proceeds of $935m were received on September 17th and used to reduce our outstanding borrowings on the FirstEnergy Corp revolving credit facilities, which put us in a favorable position heading into the renewal of our $1b facility that matures next month.

I'm pleased to report that the syndication process for the renewal has been successful, with commitments received in excess of the $1b target. In order to reduce and diversify the rollover risk, we are structuring the new credit facilities into two traunches, including a $500m 364-day facility and a $500m three-year facility. We expect to close the transaction later today.

I'd also like to update you on the status of our free cash flow forecast for this year. We now estimate free cash flow from operations after capital expenditures and common stock dividends at about $500m, including the tax benefits from the abandonment of Endursa and the sale of the Aquila note, total free cash generation in 2003 is expected to be about $690m, and our reconciliation to the GAAP measure is posted on our Web site, which is www.firstenergycorp.com/ir.

Now, I'd like to discuss the goodwill impairment charge of $122m for our Facilities Services group that Rich had mentioned earlier. During the past two years, FirstEnergy has continued to consolidate its unregulated operations in response to the slow development of the competitive retail electricity market. Our Retail group has undergone several downsizing, the most recent being the elimination of 55 positions this month. These actions have been targeted at consolidating and improving our market position and increasing our profitability.

FirstEnergy acquired 11 HVAC mechanical contracting companies in the late 1990's to support our unregulated energy services businesses. The slow development of the competitive energy service market, combined with the economic recession, has negatively impacted the earnings contribution from these companies and, last year, FirstEnergy sold two of these HVAC companies. In connection with the annual review of goodwill required under SAS142, we've determined that a portion of the goodwill associated with these companies was impaired, necessitating a $0.27 per share charge discussed earlier in the call.

We'll continue to review the strategic fit of these companies and look for opportunities to increase their earnings contribution to FirstEnergy.

Another item that impacted our balance sheet this quarter was the adoption of SFAS150, which resulted in a reclassification of our $303m of trust preferred and mandatory redeemable preferred securities as debt, which increased reported balance sheet leverage. Given this change, we now project that our debt to total capital ratio will be about 60%, including all debt equivalents, by year-end.

Now, I'll turn the call back to Rich.

Thanks, Tom. We continue to make good progress in our efforts to return Davis-Besse to safe and reliable service, and I'd like to give you an update on our activities. On October 14th, we announced that the recent pressure test at the unit has met all of its objectives, including validation of the integrity of the bottom of the plant's reactor vessel, as well as that of the reactor coolant system.

The overall leak rate for the 90,000-gallon reactor coolant system was less than a teaspoon per minute, well below the design specification of one gallon per minute. Using a robotic camera to closely examine the bottom of the reactor vessel and the 52 instrumentation tubes located there, we were also able to confirm that there were no leaks in the bottom of the vessel. The remaining work to be completed prior to restart includes modification of the high-pressure injection pumps, modifications to the electrical distribution system, continued additional training for employees regarding performance issues, regulatory compliance and safety culture, and enhancements to our corrective action program.

We remain on target to complete this work by late November. Still project that we'll have the plant ready to return to service before the end of the year. The NRC has to approve the restart, of course, in the next NRC's 0350 public meeting that's scheduled for November 12th.

I'd like to also touch briefly on a few state regulatory matters. FirstEnergy's provider of last resort obligation to its Ohio retail customers is currently schedule to expire at the end of 2005. Absent any changes, our Ohio customers would be exposed to market prices for their generation service at that time.

Public Utilities Commission of Ohio has encouraged Ohio Utilities to consider rate stabilization plans that would provide additional certainty for customers and market participants, while at the same time encouraging the continued development of competitive generation markets. In an order issued on September 23rd, the Commission specifically encouraged FirstEnergy to develop plans for 2005 and beyond, which balance three objectives: first, being rate certainty; second, being financial stability for the distribution utilities; and the third being further development of the competitive market.

On Tuesday of this week, we filed such an application on behalf of our Ohio Electric Utility companies to establish generation rates beginning January 1st, 2006. In the application, we proposed two alternatives. First is to establish a competitive bidding process to determine standard offer generation service rate to 2006, while the second is to implement a comprehensive rate stabilization plan.

The rate stabilization plan is intended to provide stable and competitive pricing of energy services, provide an assured supply of generation for our Ohio customers, and enhance economic development in our service territories. If the plan is approved by the Commission, generation prices for our customers will essentially be maintained at current prices through 2008 subject to limited adjustments.

As detailed in the news release announcing the filing, the plan also provides significant customer savings totaling approximately $285m, as well as various consumer protections. The plan also affords certain benefits for the company, such as the opportunity to file for recovery of increases in certain costs, such as fuel, environmental costs, nuclear security and regulatory costs. The plan would result in predictable earnings and a cash flow post-2005, although the company would retain the polar obligation and would also forego the potential upside should market generation prices remain high during the period.

We've requested the Commission to act on our proposal by the end of the year so we can begin making our generation and commodity supply plans for the year 2006 and beyond. We issued a detailed investor letter on Tuesday that describes the plan, which also included various documents from our filing. The letter and these attachments are available on our corporate Web site under the "Investor Information" tab.

Another positive recent development was the agreement announced this week to sell our 20.1 percent interest in Avon Energy Partners to a subsidiary of PowerGen. The principal asset of Avon is the Midlands Distribution Company in the U.K., and this transaction also includes the 79.9% ownership interest held by Aquila. FirstEnergy expects to realize cash proceeds of about $8m from this sale. The transaction is contingent upon a recent agreement with Avon bondholders to sell their bonds for 95.8 percent of par value, approval by the European Merger's Commission and approval of Aquila's participation in the transaction by the State Corporation Commission of Kansas.

Other than a relatively small equity position in two Latin American generation companies, the sale of Avon completes our exit from the international business portfolio acquired from the former GPU. We're currently in the process of divesting the remaining Latin American assets, and hope to complete this process around year-end.

Over the last few months, we've laid out an aggressive agenda for a series of near-term objectives to better position FirstEnergy for the future. I'm pleased that we've made substantial progress during the quarter on many of these fronts. We've taken several significant steps to continue to improve our credit quality, including our common stock offering, which raised $935m in net proceeds and were used to reduce bank debt, renewal and restructuring of the billion-dollar revolving credit facility that we expect to close later today, and the redemption of an additional $241m of long-term debt during the quarter, bringing our year-to-date total to 656 million.

On the operational front, we successfully completed the Beaver Valley Unit 2 refueling outage within the planned 28-day outage period. We also completed the very important pressure test of Davis-Besse, which demonstrated the integrity of the reactor vessel and the reactor coolant system. As I just mentioned, we completed another important milestone, which was the filing of the application with the Ohio Commission to extend our rate plan and, thereby, offer important benefits for our customers and the company.

We're gratified by the progress we made during the quarter, and believe that the investment fundamentals of our story remain strong. I appreciate your time and your continued interest in FirstEnergy. Thank you for joining us on what I know is a very busy earnings release day, and we look forward to seeing many of you next week at EEI in Orlando.

So, thank you again for your call, and I'd now like to ask the Operator to open the call for questions from investors.

Your first question comes from Kit Konolige of Morgan Stanley.

Hey, Rich, how you doing?

Hey, Kit, how are you?

Good. I was wondering if you could describe for us any public or private reaction, for that matter, to the plan that you filed.

I think at this point all the relevant parties are probably assimilating the plan, so at this point I don't know if there's been much public reaction. I think the plan was responsive to the objectives laid out by the Commission, and I think that it clearly is a good balance between benefits for customers and providing the stability and the certainty of cash flow that the company is looking for, as well.

So, we think it's off to a good start. Obviously, it's got to run through the process in Columbus to get to approval. As I mentioned, we're hoping we can get to the finish line by the end of this year. I know there's a lot of work to be done by the various parties on that, but we think that's a doable objective for us.

What would you expect the process to look like?

Don't know specifically yet, Kit. It could include public hearings that will have some sort of a due process, I guess if you will, in Columbus to make sure everybody has a chance to have their say on the plan, and so forth. So, I think we'll be hopefully getting some more clarity on that from the Commission in the relatively near future.

Great. Separate area: talked about the free cash flow from operations this year. Pretty good number, considering, and in the past you've discussed I think the '04 as a run rate possibly approaching a billion or maybe somewhat less. Do you have any clearer idea on what free cash flow might be at this point?

Well, for 2004, Kit, we'll have mandatory redemptions of $919m during the year, and our expectation is that we'll have free cash after capex, after common dividends, that will allow us to substantially redeem that other $19m of mandatory redemptions. We haven't specifically given earnings or cash flow guidance for 2004 yet, but directionally, that indicates that cash flow will continue to be robust and an improvement certainly from this year.

And the--relative to this year, what are the big changes in cash flow for next year that you see? Principally just operating income?

Well, certainly, we won't have Davis-Besse, which is a big impact for us. This year, we've had up through the third quarter expenses of about $225m for O&M and purchase power. We'll have additional debt redemptions through 2004. We'll have continued ramping up of our merger and SSAI cost savings initiatives, as well. So, all those things plus the sort of organic growth you would expect from our wires business will help support that increased cash flow next year.

Okay, thank you.

Thanks, Kit.

Your next question comes from Steve Fleishman of Merrill Lynch.

Hi, Rich.

Hey, Steve.

On that same topic, I think you said 690 million in free cash flow this year.

Yes, in total.

Now, I think before, that number had been 575?

Yes.

What's the change?

Steve, this is Tom. One of the benefits that we became aware of following the release back in July for some additional tax refunds related to a 2002 return that came in. I believe there was some other small asset sale-related kind of cash flows that we had not picked up in the $575m projected number, and I think the balance of that is really just cash from operations.

Okay. It sounds like this tax refund could have been material. How much was that number?

Steve, this is Harvey Wagner. When we filed our return, I will say it was probably in the $120m range.

That sounds like that was the main piece.

Yes. That was certainly a big piece.

Okay. Secondly, any change in your earnings guidance for this year?

No, we have not changed our earnings guidance for this year, Steve.

Okay. So, I assume you're reaffirming the same guidance?

Yes. Certainly the mild weather during the third quarter was a little bit of a disappointment to us, but hopefully we'll get some lift in the fourth quarter. Pray for cold weather.

Okay. So, you might be a little bit behind that plan, but--.

--But hopefully still within reach. We're going to work hard to make that happen.

Okay. And then, just finally on the economy and the sales impact there, could you discuss a little bit for me, I guess you said your growth now for '03 is 1.6% assumption?

Yes.

Before, it was about two?

Yes, and probably something in that same magnitude for next year as well, Steve, and it's not uniform across our service territory, but where the economic impact is felt most heavily is in our Ohio service territory. We have a heavy concentration of manufacturers, large industrials, steel and auto-related people, and obviously they're very much impacted by the economy.

So, we've seen some weakness there. I guess the flip side of that is that a lot of those larger customers are on some very beneficial rate structures such that reduced usage may not have quite as much of an impact on the bottom line as one might first think, even though the change in kilowatt hour sales could be fairly noticeable when those types of producers either drop a shift or reduce production, or whatever.

But, it's like I say here in New Jersey service territory, which is much less industrial, more residential/commercially oriented. It's been very bright, very vibrant and growing and, as Tom mentioned, actually experienced an increase during the quarter.

Okay. Okay, thank you.

Thanks, Steve.

Your next question comes from Dan Ayer of Credit Suisse First Boston.

Good afternoon.

How are you?

Good. Listen, first question: saw that you guys went ahead and appealed the JCP&L rate decision. I was wondering if you could give us some more color on what is going on in New Jersey.

Yes. We filed a motion for the Commission to reconsider their decision that was rendered in July, and you might remember there were several major pieces to that decision. One was disallowance of a portion of deferred cost that had been accrued over the years, and second were some of the more, I guess you would say, traditional rate case elements. In particular, we were very surprised by the disallowances of the deferred items, given that the Board's own consultant had come back with a recommendation that virtually all of those costs should be allowed.

So, we weren't clear of the logic that was used in determining that disallowance. So, clearly that was one reason, and also, obviously, we wanted them to take a look at the rate case as a whole and the other element, return on equity and so forth. So, that process has been started. Don't know that there's a definitive timeline. I don't think there is. It's going to have to work its way through the New Jersey Board itself.

I guess if that doesn't produce results that we think are acceptable, you always have the option, not to say that we would necessarily do it, but we have the option to also appeal that up to the judicial system in New Jersey.

Great, thanks. Expanding on New Jersey, you guys also have the rate incentive based on your ability to get the reliability of the system up. What benchmark should we be looking for I guess over the next couple quarters to track how you guys are coming along, and get a feel for whether that's going to go your way or not?

Well, as Tom mentioned, we're certainly investing some significant dollars in the New Jersey territory to make those kinds of changes happen. I don't know that a specific set of benchmarks has been arrived at yet, but I would assume they'll be looking at traditional measures, duration and frequency of outages, and the kinds of things that are pretty well established within the distribution world in terms of how you measure reliability from a customer perspective.

Great, thank you.

Thank you.

Your next question comes from Paul Fremont of Jeffries & Company.

Thank you. Looking at page six of your handout, I don't understand the accounting in the unusual charges. Looks like you've got a charge for goodwill impairment and then an add-back to the JCPL rate case, which gets you to a net pre-tax charge of $108m. The way you describe it is as if both are basically charges, one a $0.27 charge and one a $0.03 charge.

And the other question that I have is, looking at the competitive service breakout, the gas numbers and the MYR numbers are different than they are when you look at the consolidated company, and I'm just wondering why that would be the case in 2003 when those numbers were identical in 2002.

Start by asking Harvey to talk about the goodwill impairment JPC&L rate case.

Paul, that should be in parentheses. The total should be 134,608. The earnings per share impact is correct.

Okay. So, it should be 134,608. Okay, that would account for why the tax rate would have been so weird if you'd used the lower number.

Right. And one thing about the tax rate associated with the goodwill, some of the goodwill is tax deductible and some of it was not, so you're not going to be able to get a straight marginal tax rate there.

Okay, and the differences in competitive services, MYR and gas?

What page are you on, Paul?

If you look at page four--hold on. This is again for the three-month period. If you look at page three versus page four, take for instance the purchase gas number on page three for the total company is 95 million, and the purchase gas number under competitive services I think is, like, 98 million. And then, in the case of MYR, the numbers are, like, 20 million higher on the consolidated page versus on the competitive service breakout page on page four.

Well, I think you have to look on page four, what you're looking at the top of the page is 2003, and I think you want to look down at the second half of the page, and you'll see under competitive services, line 14--.

--Oh, right, I see, okay.

It is the same number.

That's good to know that you read that though, Paul.

Okay, thanks.

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

Yes. Hi, guys.

Hi, David.

Just wanted to ask you, could you quantify what the impact of weather was on the quarter relative to normal?

We don't really attempt to do a weather quantification. I personally have some issues with how some of those are done. But, as Tom mentioned, it was abnormally cool. It was compared to a very hot summer last year. I mean, if we were going to--I don't know, Kurt, if you want to take sort of a directional guess at what the impact would be.

Sure. Hi, David. What we indicated on the call is that the third quarter 2003 compared to the third quarter 2002, the cooling degree days were down 19.1 percent. However, compared to normal, the cooling degree days were actually up 3%. So, just had a very hot summer last year in 2002. It was relatively normal this year, but again, in comparison to the third quarter last June--last year was extremely mild compared to last year.

Okay. And you guys commented in your release that pension was a $50m incremental expense year-over-year. Can you remind us again what type of pension plan you employ, and what happens next year if you actually exceed your targeted returns for this year?

Yes. It's a traditional defined benefit pension plan, and what you're referring to, of course, David, is if the asset gains that we've seen so far this year hang on until the end of the year and if interest rates don't go down too much, we would expect that pension cost next year would be less than it is this year. We've not done a real look at that from an actuarial basis, so I don't know what the number might be.

I'm always suspicious of doing that till we get closer to year-end because it can change so rapidly. But, you're right. To the degree that assets are worth more at the end of this year than they were at the end of last year, and to the degree interest rates maybe are a little bit higher than the end of last year, those would both work in our favor.

But we probably wouldn't see quite as dramatic a swing as we saw this year where the 200 million incremental expense, would we?

No, I certainly would not expect that. We'd have to have a really huge market rally to make that even feasible.

Okay. All right, great. Thanks a lot.

Thanks, David.

Your next question comes from John Raleigh, Goldman Sachs.

Hey, Rich.

Hi, John.

On the '04 guidance question, typically you guys have come out just around now and sometimes between the third quarter and EI, in terms of guidance, what is the delay this year, and secondly, when we went through the second quarter and some of the things that negatively impacted year-to-date results at that point, other than Davis-Besse, some of the hedging and some of the non-Davis Besse-related nuclear costs, now that you've had time to observe those things, are they thought of as non-recurring, or some of those recurrent at this point going into '04?

Your first question, John, our practice has been to give, following your earnings guidance at our Analyst Conference, which is typically in the first week of December, and that's what we plan again to do this year. So, it's not a delay. It's just been our normal practice, and that sort of ties into a Board planning retreat that we have in November of every year where we discuss our going-forward plans with the Board and, after they approve that, that's really the next analyst touch point. So, that's why we follow that practice.

In terms of the items we discussed on the second quarter, thinking on those has not really changed in terms of a lot of those items have come out of these supplies that were covered in the first quarter will largely be contained in 2003 and not spill over to 2004. So, really no changes in our thinking on that.

Okay. Rich, just another question. The cash flow obviously looks very strong, and the free cash flow potential looks very strong. One of the numbers that's a little bit troubling tied into that is the very low projections associated with maintenance capital spending. You compare your budget or forecast to other companies, whether it be a PPL or Detroit or Cinergy, it seems to be in the hundreds of millions lower, and just given the focus on reliability and some of your issues on the operating front, is that something that's going to be looked at and we should expect something materially different going forward?

Our capital spending this year is going to be in excess of $700m, so it's certainly not a small number on an absolute basis. We are formulating our capital budget for next year. We've said in the past that, absent major projects or environmental expenditures or things like that, we would expect the sort of long-term capital spending level to be somewhat below that.

We're looking at that right now. We're looking at what special projects we might want to fund in the future or not, and we're also, as we always do, looking at other ways we can more effectively spend those dollars.

So, it's not a matter of how many dollars you spend, it's how wisely you spend them and where you spend them. So, we think our spending certainly is more than adequate. It's actually been increasing over the last several years, particularly in the distribution area, transmission areas, and we think we're approaching this from the right perspective.

So, don't know about other companies. You'd have to look over the long term I guess to really have a valid comparison there. But, we think the expenditures that we're making are what we need to do in order to continue to produce reliable service for our customers.

Thank you.

Thanks.

Your next question comes from Paul Ridzon of McDonald Investments.

Good afternoon. How are you, Rich?

Good, Paul, how are you doing?

Good. Couple questions. Firstly, kind of what your current Davis-Besse hedge looks like. And secondly, I didn't catch what the pro-forma operating number was for the third quarter last year, and just some explanation of improved gross margin at Generation. Is that just selling into some higher pricing where natural gas is setting the marginal price?

Your last question first, Paul. I think that reflected some largely increased wholesale prices, which we were able to take advantage of to increase the gross margin. Your first question was--.

--Davis-Besse hedge.

Davis Besse hedges. We're hedged for the remainder of the year, and we're also hedged really through the first quarter of next year not because we expect the plant to be down, because we don't, but we're doing this from a risk management/prudency standpoint. Not necessarily 100% hedged.

In fact, we're not 100% hedged for that period, but we have in place some contracts that we were able to acquire that if Davis Besse comes back online, as we bank and expect it will, be able to use those someplace else in our portfolio, as well. But, from a risk management standpoint, and in the context of our overall power supply portfolio, that made sense for us to do. And you had a second question, which I also forgot--the pro-forma number last year, on a normalized basis, was $1.19.

And a quick question on the facilities service business kind of--what's the strategic outlook there, and where do you see that business going?

Well, I think Tom mentioned that the markets have not opened up in a manner as fast as we though they would, and we've continued to downsize our operations there in two ways. Number one, in just the magnitude of the operations, and number two, narrowing our focus and narrowing the number of product lines that we offer, trying to focus on those offerings. But, number one are possible, and number two, are in most demand by our customers in terms of supporting our integrated, bundled retail strategy. So, we're basically trying to manage our operations to the market demand that currently exists.

The HVAC companies play an important role in that in terms of allowing us to bundle non-commodity products and services towards that market segment, which is larger commercial and industrial customers. We continue to assess our whole strategy and, as Tom mentioned, we've made changes and will continue to make changes, I'm sure, in order to make sure that that product line is profitable to us. And HVAC's are part of that thinking.

So, this is something that we're going to continue to look at. We've made changes in the management structure at some of those companies. We've made changes at the holding company level, as well, in order to improve the profitability of the HVAC companies and to more tightly integrate their offerings with our commodity offerings.

So, that's something that's going to be reviewed on an ongoing basis as we go forward, and what we do with that whole business line, how we offer it will largely depend on where we go with the market.

On a trailing 12 basis, what has that business segment delivered?

When you say that business segment, do you mean the HVAC's alone? Hang on; we'll see if we can find it for you. We can get back to you on that.

Okay, thanks.

Thank you.

Your next question comes from [Peggy Jones] of ABN Amro.

Hi, Peggy.

Hello. I had a couple of questions. The first one was you alluded to a going-forward rate of interest expense, and I didn't catch it. Was it an allusion to just multiplying the third quarter by four, or did you mention some other going-forward reduced number?

I think we had talked about the year-to-date financings that we've done and the interest savings we plan to capture from that. And on a year-to-date basis, we redeemed about $656m. we've refinanced about $622m at PCN repricings of a little over $200m, all of which combined will give us annualized financing cost savings of about $80m.

Versus what? Versus '03 actual?

Well, that's the delta that is produced by those actions during the quarter and year-to-date.

Right, got it. Second question, with regard to the free cash flow for '04, if I recall correctly, the ongoing level of cash flow from '03 was something like 370 million, and I just wondered how to get from that up to the--close to 950. I'm clear on the fact that I would add something back for Besse.

You had mentioned the nine-month number, I think, of 225, and I would throw something in there for interest, let's say for the sake of argument it was 80, and then do I put in 100 for cap-ex, and I'm thinking more or less along the lines that you might be?

Going back to the first part of your question, the 370 I think was our earlier estimate of free operating cash flow. That's now about $500 million. One of the factors, as we discussed on one of the previous questions, was the income tax refund, which helped boost that number up.

I figured that was non-recurring, though.

That's correct. But, that's generally--I mean, some of the things that will be impacting cash flow, and the Davis-Besse outage won't be there. As I said, that's year-to-date through the third quarter, about $225m. We'll have two fewer refueling outages next year, three this year, one next year, so that's a benefit.

Considerable additional debt reductions next year, some of which won't take place until later in the year, however, but we'll get some very significant cash flow benefits from that, and continued ramping up of our cost reduction program, and the kind of rather mild organic growth you would expect from our wires business under these kind of economic conditions. That's on the plus side.

On the minus side, you have lower rates from the JCP&L rate case decision, slightly higher dividend payment based on the common stock offering, the additional shares that we have outstanding.

Right, okay. and with regard to the plan that you just submitted into PUCO, should we be viewing this as an either/or situation, or are there some shades of gray in here, and may just wind up still as some sort of a negotiated resolution of the situation?

When you say an either/or, Peggy, are you referring to the two alternatives we offered?

Yes.

Well, those are two different and distinct things. The first alternative with the competitive bid is really just maintaining the world as we know it today, okay, so that's kind of a status quo. The second is to really be responsive to what the Commission asked in terms of extending generation rates for our customers through 2008. So, they're two different plans.

Now, assuming the Commission wants to have a rate stabilization plan in place to give customers that stability and predictability, they would be focusing on the second alternative, as we would hope they would. But, I'm sure there will be negotiations, discussions, and potential modifications to that before it totally gets approved.

Okay. well, thank you very much, and good luck with it. I'll see you at the EEI.

Thanks, Peggy. Look forward to it.

Your next question comes from [Dan Shinkin] of State of Wisconsin Investment Board.

Hi, Dan.

I have a couple. First, on the cost of accelerated and reliability improvements in New Jersey, you kind of broke those out. I was curious, though; will those continue into '04? I would imagine that's probably not a one-time thing. And is it, or is it a one-time thing?

Dan, this is Tom. That's right. We're going to continue to have reliability project spending in 2004. we had forecast to do a number of projects in the '04 time frame, and maybe a little bit beyond. But, what we've done is accelerate some of those projects into 2003. That was the--what impacted the $12m increase that I talked about earlier. I think we are probably talking about a comparable amount in 2004.

And this, Dan, is all under our commitment to New Jersey, that we would accelerate the spending of $60m that would have been spent--would have been spent down the road, accelerate that spending into '03 and '04 in order to improve reliability for our New Jersey customers.

Right. Also, I didn't get down the information on what you expect the new bank lines to look like as far as amounts and the terms.

Dan, that's one of the points that we were talking about was really the renewal of FirstEnergy's billion dollar facility that we expect to close today, and what we have done there is actually split it into two traunches to help reduce the rollover risk associated with the renewal, especially next year. The FirstEnergy Corp lines really are comprised of two primary facilities. There's a billion dollar 364-day facility that's maturing November 7th, and there's also a $500m three-year facility that matures in November of 2004.

So, what we've done with the renewal of the one-year line that matures next month is split it into two pieces, as I said, of $500m 364-day piece and a $500m three-year term piece. So, in total, we'll continue to have $1.5b of credit facilities at the FirstEnergy parent , as well as another $250m at the Ohio Edison subsidiary, and those are our primary bank credit facilities.

Okay. Then, finally, I was wondering--obviously, there's been a lot of investigation and study and so forth on the blackout as far as potential factors and causes, or things that contributed to that since the last time we--you held an earnings call. I was wondering if you could shed any light on maybe some of the things you've found out since then.

Well, those investigations continue. That's largely being led by the joint DOE/Canadian Task Force, and we are fully participating in that activity, and I think they are expecting within the next several weeks or so, is what I understand, to release their interim report. And I think more information has become available, much of which has appeared in the press in terms of the conditions that existed that day.

We do know that, on that day, there were abnormally heavy south-to-north power flows going up into Ontario, much heavier than in previous days. We also know that those power flows were associated or accompanied by a lack of reactive energy, which is--I'm not an engineer, but basically the energy that helps move that power across the grid. So, those were some abnormal conditions. We know that FirstEnergy was generating reactive energy VAR's and was actually a heavy exporter of that during the day to try to help correct that situation.

So, those are the general facts that I think have been reported at this point in time. As I say, we continue to participate with the Joint Task Force investigation. We continue to believe this is a complex event, certainly much bigger than the events on any single transmission operator system, and probably the answer or answers will involve issues that span control and communication issues as well, and get into issues such as how merging generators interact with the grid, and how VAR's are supplied, who's responsible for reactive energy, and so on and so forth.

So, not a simple situation at all, but hopefully one that we'll get some additional clarity on as we go through the remainder of the year.

Okay, thank you.

Your next question comes from [Darren Miller] of UBS.

Hi, [Tarron].

Hey, Rich, how are you?

Good. How are you doing?

I'm fine, thank you. First, I was wondering if Tom could give us an update on any communications you've had with S&P and where they stand with reference to the negative credit watch.

Well, [Tarron], I think that S&P continues to have pretty strong interest in watching the credit profile. I think that they're continuing to monitor progress at Davis-Besse. They've been monitoring the progress with the credit facility renewal and our overall liquidity position. In terms of what's really going to drive their next action--and always obviously, it's better to ask Standard & Poors what they think than the company--but, I'll tell you, I really do believe that we're going to have to see a little bit more progress with respect to working with the NRC on Davis-Besse related to, perhaps, consideration to remove the credit watch negative.

This is Rich. - Hopefully, by the end of the year, we'll have clarity on two issues, that the rating agencies have publicly said are very important to them, one being return of Davis-Besse to service, and the second being the filing of the Ohio Rate Plan, which would give stability and predictability to cash flows post-2005. So, hopefully by the end of the year, we'll have clarity on both of those things. We can only hope.

Okay. Second question is, if they adopt your rate stabilization plan, should the free cash flow position of the company stay fairly constant beyond 2005?

In general, I mean, it would be relatively linear post-2005. Can't say it's going to be exactly the same, but it would give certainly much more predictability to it.

Okay. And last question, in order to try to bridge the gap between '03 free cash flow and your area guidance, I would say on 2004 cash flow, 2003 you included asset sales in the number. Should we anticipate, or is it your estimation, are there some asset sales that we should think about being included in the '04 guidance?

Most of the asset sales we've had on the table are done or getting done at this point, [Tarron]. We've said we wanted to exit the international business, and we're just about done with that. So, I think that process will be largely behind us by the time we get into '04.

So, it's going to be a much more cash from operations kind of number?

Absolutely.

Okay, thank you.

Thank you.

Your final question comes from [Ernie Calsden] of Citigroup.

Hi, guys.

How are you doing?

Good, how are you?

Good, thanks.

This is a general question, and it relates somewhat to the cash flow. But, it looks like over the past few years the depreciation rate has been pretty high, if you look at it both as a percentage of kind of your fixed assets, and also as related to your capital expenditures. I just wondered if you could explain kind of the dynamic behind that and what we could expect on the D&A rate going forward.

Ernie, this is Harvey Wagner. You're probably looking at a number that includes the amortization of our regulatory assets, the combined depreciation and amortization on the income statement. As you know, the Ohio Transition Plan, those amortizations continue to grow each year. So, if you probably--if you want to do an analysis with depreciation--and we can help you offline--you want to strip out the amortization component of that.

It's a big number.

Yes.

Okay. Yes, I figured it was something like that. I'll give you a call.

Great, we appreciate it.

And again, I'd like to thank all of you for making time to be with us today. Third quarter had a lot of positive events for FirstEnergy, and we're looking forward, as we move towards the end of the year, to have Davis-Besse return to service and also get the clarity from the Ohio Commission regarding our rate plan, both of which I think would be major milestones for us. We appreciate your time and continued support, and please feel free to call any of us with any other additional questions you have, and look forward to seeing many of you next week in Orlando. Have a good trip down. Thank you.

Thank you for participating in today's FirstEnergy Corp Third Quarter Earnings Conference Call. You may now all disconnect.