第一能源 (FE) 2004 Q1 法說會逐字稿

At this time I would like to welcome everyone to the FirstEnergy first quarter 2004 earnings teleconference and webcast. (OPERATOR INSTRUCTIONS) I will now turn the call over to Kurt Turosky, Director of Investor Relations. Sir, you may begin your conference.

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 in the consolidated report to the financial community which was released early this morning and is also available on our website at www.firstenergycorp/ir under the earnings release link.

Participating in today's call are Tony Alexander, President and Chief Executive Officer; Rich Marsh, Senior Vice President and Chief Financial Officer; Harvey Wagner, Vice President and Controller; and Terry Howson, Vice President, Investor Relations. I will now turn the call over to Rich Marsh.

Good morning everybody. Thanks for being with us today. I will provide an overview of first quarter results, as well as some updates on financial and operational matters. And then following me, Tony will discuss our progress on various initiatives and opportunities.

We released our consolidated report to the financial community this morning, and it might be helpful to refer to that as we discuss results today. Please note that I will reference various non-GAAP financial measures and that the reconciliation to results on a GAAP basis are available on page one of the consolidated report.

The solid performance during the first quarter resulted in GAAP earnings of 53 cents per share, including costs associated with the Davis-Besse outage. This compares to the First Call consensus estimate of 44 cents per share and earnings of 74 cents per share in the first quarter of last year, which also included the 35 cent per share contribution to earnings from the cumulative effect of an accounting change related to the adoption of FAS 143.

During the quarter the Davis-Besse outage resulted in incremental replacement power and O&M cost of $65 million which reduced earnings by 12 cents per share. Normalized non-GAAP earnings excluding these costs were 65 cents per share compared with 57 cents per share in the same period last year or an increase of 14 percent.

There were four primary factors that contributed to these improved results. First, the electric gross margin increased by seven cents per share in comparison to the first quarter of last year. This primarily resulted from higher wholesale sales that were made possible by an 11 percent increase in generation output, as well as lower purchase power prices. The second factor was a nine cent per share reduction in operating costs for our generation fleet. In the first quarter of last year there was one nuclear refueling outage, while this year there were none. Also, our fossil unit experienced fewer maintenance outages than in the same period of last year. The third contributor was the seven cent per share decline in financing costs stemming from our continued aggressive debt reduction and refinancing activities. And the final factor was a six cents per share reduction in pension and other employee benefit costs as a result of favorable investment performance last year, changes to health care benefits for retirees and recent Medicare legislation regarding prescription drug coverage. Partially offsetting these improvements were a nine cent per share reduction to earnings as a result of last August's decision in the Jersey Central Power & Light rate case, a five cent per share earnings reduction due to higher Ohio transition cost amortization expenses and dilution of six cents per share following issuance of 32.2 million shares of common stock in September of 2003. Additional information on these and other variances are provided in our consolidated report.

Our continued aggressive debt reduction and refinancing activities resulted in a decrease in interest charges of $34 million from the same period last year. Total debt decreased by $44 million and temporary cash investments increased by 166 million. These cash balances will largely be applied to debt reductions later in the year. Our financing activities during the first quarter, including $256 million in refinancings and repricing, will produce annualized financing costs savings of $6 million.

Our liquidity position is very sound with about $2 billion of undrawn credit capacity, as well as $200 million in cash investments. In fact, our available lines of credit under our revolving facilities are totally undrawn at this time. Next week we will begin the renewal process for our $1 billion three year revolving credit facility at FirstEnergy Corp. which will replace facilities that mature this fall, and our plan is to close on this new revolver next month.

The free cash flow guidance we provided for 2004 is $825 million exclusive of Davis-Besse outage costs. You might recall that we define as measured as cash from operations, less capital expenditures and the common dividend. Although the outage at Davis-Besse negatively impacted cash by $38 million in the first quarter, we're comfortable that our performance during the remainder of the year will be such that we can maintain our guidance of 825 million including the Davis-Besse related outage costs.

We remain solidly on track to meet our debt reduction target of $1.3 billion for this year and to reduce our debt to total capital ratio to about 55 percent by year-end. With Davis-Besse's return to service, continued debt reduction, improved operational performance we believe we will be in an outstanding position to regain our investment-grade rating for unsecured holding company debt from Standard & Poor's later this year.

Before I turn the call over to Tony I would like to briefly touch on the status of our commodity hedging activities, recognizing that the summer months are rapidly approaching and also that the topic of fuel supply has received a lot of interest from the financial community recently.

Our multi-year approach to commodity hedging has significantly reduced our exposure to price volatility and also provides for greater predictability of earnings and cash flow. Our electric supply needs are basically fully hedged for 2004, 2005 on an all hours basis. Our coal and emission allowance requirements are also fully hedged for our provider of last resort obligations and contractual commitments through the end of 2005. Looking toward the summer months, we're well positioned to meet our load obligation and call on 1100 megawatt of single cycle combustion turbines that we installed over the last several years to help us meet our peak loads. The anticipated gas supply and associated transportation needs for these units have also been hedged.

I would now like to turn the call over to Tony Alexander.

Things Rich and good morning.

Earlier this year I laid out the key imperatives for 2004 for our management team. These were -- one, return Davis-Besse to safe and reliable service; two, gain approval of the Ohio Rate Stabilization Plan; three, continue to aggressively improve our balance sheet; four, restore operational excellence and improve the reliability of our electric service, particularly in New Jersey and Pennsylvania; and five, produce consistent financial results that meet or exceed the expectation of our investors.

At the close of the first quarter we've made significant progress on this list. It was an important milestone for the company when Davis-Besse achieved full power operations on April 4th, and I'm confident that we have the right management team in the our nuclear group to operate our fleet safely and reliably, while also achieving stronger operational performance.

Rich talked about our continued progress in improving the balance sheet. This will remain a top priority, and we're committed to using our free cash flow to achieve our target of approximately 50 percent debt to total capital ratio by the end of 2005. We will also aggressive look for opportunities to accelerate this process through the sale of non-core assets.

With respect to our application to the Ohio Public Utilities Commission for approval of our rate stabilization plan, the hearing and briefing period is complete and we anticipate a Commission decision shortly.

Improving the reliability of our electric service is always a critical focus for our management team, and I would like provide an update on some of our activities in this area. We've taken a number of steps to enhance the reliability of our transmission system. One of these initiatives originally identified during our GPU merger activities is to upgrade the computer hardware and software for Ohio and Pennsylvania system control centers. The new computer system will be fully operational within the next few weeks and will provide our operators with enhanced monitoring capabilities over our entire footprint, as well as extensive redundant capabilities at our control centers. Through the improved monitoring capability the new system provides, communication and coordination with the Midwest ISO end PJM will be improve. We've enhanced our control room operator training and procedures and we have gained certification as a NERC approved training facility. We've enhance our vegetation management policies to include both aerial and foot patrols of 100 percent of our 15,000 miles of transmission rights of way in Ohio, Pennsylvania and New Jersey.

We've also centralized management of key energy delivery operations, which will enable us to provide a greater focus on reliability, standardized business practices and an enhanced responsiveness and accountability to customers. One component of that change was installing a new senior leadership at our metropolitan Edison operating subsidiary in Pennsylvania and at Jersey Central Power & Light. We also reorganized our Ohio operations into three regions from the former five to match our utilities service area.

We've largely identified the required reliability enhancements for the former GPU utilities and are well on our way to implementing those changes. We have started to see reliability improvements at Jersey Central and Met-Ed. We are committed to delivering the high-quality service that our customers expect and deserve.

I also wanted to quickly update you on the status of our Chief Operating Officer search. The process is well underway. We've already talked with a number of candidates, and I would expect this process to be completed sometime this summer.

In closing, let me say that we set out an aggressive agenda for the company in 2004, and I'm pleased with our progress towards these goals in the first quarter. We returned Davis-Besse to safe and reliable operation, a milestone for FirstEnergy. We have completed the hearing process in our rate stabilization plan and are awaiting Ohio Commission action. Our fossil generation fleet continues to achieve outstanding performance with our coal-fired plants on track to exceed their record 82 percent capacity factor achieved last year. We have a comprehensive plan in place to achieve further improvements in the reliability of our electric system, and we're executing the plan. We remain on track to meet our debt reduction targets and should be well positioned to regain our investment-grade rating from S&P later this year.

The FirstEnergy management team is very focused on the critical need for consistent and predictable financial performance, and not just for one or two quarters, but all the time. I'm pleased that our first quarter earnings beat the consensus estimate, and I will continue to challenge the organization in the future.

I will now turn the call back to Rich for a few closing thoughts.

Our earnings guidance for the year of $2.70 to $2.85 per share remains unchanged and is exclusive of incremental Davis-Besse outage costs. It's also based on our current Ohio rate plan.

It really is an exciting time for FirstEnergy with the return of Davis-Besse, the solid performance in the first quarter and the possibility of the approval of the rate stabilization plan in the near future. We will continue to use our strong free cash flow to strengthen the balance sheet and bolster our credit profile. And as Tony said, we will remain focused on consistency producing results that meet or exceed your expectations. I'm confident that we have the right team and the right resources in place to get the job done. We're gratified by the interest and support shown to FE by investors and look forward to demonstrating the level of performance that can drive our valuation level to another, higher tier.

I very much appreciate everyone's time and interest in FirstEnergy. Thank you for joining us this morning. And I would now like to ask Monica to open the call to questions from analysts.

(OPERATOR INSTRUCTIONS) Dan Eggers, CSFB.

First question, you guys didn't raise your guidance even though you've come up with another $40 million of free cash flow, give or take. Number one, where is the extra free cash flow coming from? And number two, any motivation for not raising guidance today?

Answering the second part of the question first, it's the first quarter of the year and there's still three quarters left to go. So we will track our progress during the remainder of the year and see where we go. In terms of the incremental cash during the quarter, I think it was a good quarter for us. We did we did have several fossil outages that were not fully completed during the first quarter as we expected, but will be completed during the second quarter. So that will have some impact. But at this point in time it's early in the year, and we're maintaining our existing guidance, although obvious it is now inclusive of Davis-Besse.

Number two, you guys had been hedging the purchased power costs for Davis-Besse just to be certain. What is your exposure of forward bought what power from that in the second quarter? And how is the margin spread in today's price backdrop?

We did have some power hedged for DB in the second quarter, as you said. We will be able to put that back into the market. We don't expect that there will be a significant financial impact one way or the other from doing that.

The last one, I guess now that Davis-Besse is finally on, can you just remind us of the maintenance schedule for that plant since it's been a while?

Yes. It will be scheduling a mid-cycle outage that would be in the first quarter of '05, and the first refueling outage would be spring of '06.

Spring '06 refueling and then a mid-cycle maintenance in first quarter '05.

Right.

Thank you.

Paul Ridzon, Key McDonald.

A couple of questions. If you could give more flavor of where you found extra free cash? And secondly, to what extent did you notice the EBITDA that was assigned on the IPO of Infrasource at Exelon?

In terms of the first question, a couple of things really driving that free cash number. One is, as I said, some of the fossil outages that we had expected to do in the first quarter would be done in the second quarter instead. Also I think the remainder of that is from some tax savings, tax initiatives that reduced our taxes to a level below what we had originally expected.

I'm sorry, Paul. Give me the second question again.

Infrasource, which was an infrastructure services company, recently had a pretty successful multiple assigned to it -- nine plus times EBITDA.

I got you now. I understand. Yes we did notice that, and in fact obviously we do have some non-core assets that we are looking at that could include MYR, which we acquired from GPU in that transaction, as well as some of the facilities service group companies. So we will continue to track that. It is nice to see certainly that the market is coming back.

How would you characterize your interest in maintaining those businesses as a strategic asset?

We really bought those not as a strategic business line, Paul. Certainly the FSG companies we formed as a product offering, and that's why we built that platform. MYR came over in the merger with GPU. Once again, not really a strategic line of business for us. We have been continuing to take steps to improve the operation of that unit. We've installed a new CEO there. We're going to pare back some of the business lines that are less profitable and really concentrate on their core business which is really largely T&D related work for utilities, which is a real profitable and cash flow generating line of business there.

Thank you very much.

Kit Konolige, Morgan Stanley.

I think Tony mentioned that the coal plants are on track to exceed last year's capacity factor. Should I understand that to be -- can you just give us a little color on that? You'll have Davis-Besse running as well this year, so I assume having the higher capacity effect for the coal plants in addition to that should mean that your average production costs will look pretty good this year relative to last year.

That's correct, yes. As you may have heard us talk about certainly one of our initiatives has been to change how we operate our large base load fossil units, and that is to operate them as they were designed -- base load flat out 24-7 -- to the degree that is possible. One of the ways we've been able to do that is to really use the lake plants (ph) that we had previously had on the market; use those to do more of the cycling and load following, which allows us to run those plants flat out (indiscernible) their capability factor, and also reduces wear and tear, which reduces maintenance, which means less maintenance outages or longer times between outages. So that's been a significant initiative for us and so far I would say the results are very positive and I think we're going to see some more improvement this year as we continue to use the base loads to meet the bulk of our round-the-clock needs.

Rich, can you give us any sense of -- I know at the peaks you guys are typically not going to be selling to the open market. So higher open market prices are not a benefit at those times. Are there other times when you are benefiting from overall higher prices that we're seeing in the Midwest and PJM?

Yes we are, and I was just looking -- in the first quarter wholesale sales actually were up about 20 percent from the prior year. So there are periods when we are able to certainly take advantage of that.

Can you give us any sense of average prices compared to last year or average margins compared to last year on those sales?

I can't off the top of my head. We could certainly talk to our commodity supply guys and get that for you, though.

Sounds good. One last question, if I could, from Tony. Tony, can you give us any insight into -- obviously I don't think you want to disclose the names of people you're talking to for the COO slot, but any insight into types of backgrounds, or types of characteristics, or types of people that you're thinking of?

It's pretty much along the same lines that we've discussed before. We've got some candidates that we're looking at that have an extensive backgrounds in the wires businesses, as well as fossil generation business. So that's really what we're looking for. We have got a list that we've already -- well, several that we've already interviewed, and we're still in the process.

Thank you.

Hugh Wynne

When you all increased year generation sales by 1.5 GW hours it seemed to me that that would be reflected ordinarily in an increase in your capacity factor, but I see that your fossil capacity factor is flat and your nuclear capacity factor is down. Did you all upgrade some plants or add some capacity? How do we square that?

I think the statistic that you're looking at the bottom of page eight, those are twelve-month ending statistics. Actually in the first quarter our fossil output increased 9 percent; generated about 11.9 million MW hours in the first quarter this year compared to about 10.9 million last year. As Rich did mention, we did have some fossil outages that we did move from the first quarter plan this year into the second quarter, so that's a piece of it. But the units were running very well in the first quarter.

Very good. Okay. Thank you. The other quick question I had was regarding electric sales shopped. In the box on top of page eight you've got an apparent increase in the rate of shopping by your residential customers and your commercial customers. I wonder if you could explain how that affected revenues in the first quarter of 2004 and how it might be expected to affect revenues in 2006 if the rate stabilization plan were implemented and this type of market share erosion were to continue?

I'll take a stab at the first part of that question for you. As you're seeing the total electric sales shopped, you're seeing an increase it looks like about 1.3, 1.4 million MW hours. That is predominantly coming out of the Jersey Central Power & Light territory and it's just based on function of how the market rules have changed for the BGF option. I believe it was implemented in August of last year, a change. And since that time you have seen a higher level of shopping and it pretty much amounts for the vast majority of that change. In the Ohio territories, which is where I think you were really going to in terms of your question, the level of shopping is pretty consistent year-over-year 2004 versus 2003. And I think that we haven't seen much of a change. So assuming going forward, we would anticipate similar shopping levels to what we are currently experiencing.

Thank you very much.

Margaret Jones, ABN AMRO.

Hi Margaret.

My questions were around, firstly, proceeding at the PUCO. And I'm sorry if I missed something that you may have said about when you expect the order, other than that I think you expect it fairly quickly. Is there anything you can say about what may have come up that resulted in this delay from when you had originally expected the order? And then you said something about how guidance for '04 assumed that your current rate plan remained in affect this year. Is there some possibility that the order might be revised so that something changes this year?

First, let me say, we didn't have any specific expectations for when the Commission would issue their order. It's going to be a pretty long, involved order, and I think they're just carefully writing that out. We have no indication of anything differently in that. We are expecting to hear relatively soon, but we don't know specifically when.

In terms of the second part of your question, the guidance we gave is exclusive of the rate plan -- the new rate stabilization plan being approved. And I guess what we were really referring to is if the plan were to be approved as filed, that would increase earnings -- not cash flow, but earnings per share -- by about 12 cents over the remaining three quarters of the year. So the guidance we gave was exclusive of the new rate plan being approved.

How does the earnings improvement occur? Is that through a different amortization --?

That is the large driver, yes.

Thanks very much.

Paul Fremont, Jefferies.

Quickly on the pension, back at the analyst meeting in December you were projecting a flattish profile of pension expense. I guess it's sort of improved in the first quarter, and it looks like you came in sort of way ahead of expectations. Should we annualize the first quarter in terms of pension benefit? Secondly, can you tell us roughly what the additional costs of computer systems might add? And can you talk a little bit about uranium contracts for the nuclear plants and when they mature?

In terms of pension expense, performance in the latter part of the year was just a little bit -- market performance was better than what we had expected, and that really drove lower cost. The delta that you saw in the first quarter relative to the prior year should be representative of what it's going to be going forward. Your second question was?

So that's like 30 -- that's 24 cents on the year?

Yes, about 20, 20 -- roughly 20 cents.

Oh, investment in the computer systems at the control centers, that was incorporated in our budget. As Tony mentioned, that was something that we had anticipated to really at our GPU merger activities. Don't know the specific dollar amount, but it was not a material amount in the grand scheme.

And you third -- I'm sorry, your third --? Uranium contracts, what would you like to know about those?

(multiple speakers) and whether you expect an increase in commodity cost when those contracts are renegotiated.

Our current hedging status -- we're very well hedged both on the uranium side, as well as the nuclear fuel enrichment services. On the nuclear fuel enrichment services we're 100 percent hedged through 2006. On the uranium side I know we're 100 percent hedged for '04. I believe we're fairly close to 100 percent in '05 and also 90-plus percent greater for 2006.

Thank you.

Terran Miller, UBS.

I was wondering, looking at the debt levels between year-end and now there was not a significant change, and yet we're talking about a fairly significant reduction over the 2004 period. Can you give us a better understanding of when we should start seeing those numbers? Is it mostly in the third and the fourth quarter?

The mandatory debt pay down schedule is back-end loaded this year. We did have mandatory redemptions that we took out in the first quarter of about $40 million. We did also issue some new money debt -- or not new money debt, I am sorry -- some new financings in the first quarter that will be used to refinance in the second quarter. So there's a timing issue there. So we have issued the new debt. We haven't yet called the refinancing debt. That will happen in the second quarter. So you get a little bit of a deviation from that. For the rest of the year about $140 million of mandatories in the second quarter. The big quarter is the third quarter -- $600 million -- and then roughly about 140 million in the fourth quarter. So it is very heavily back-end loaded into the second part of the year.

And we should assume that the timing difference between the first and the second quarter is that 140 million approximately?

Of the refinancing debt?

Yes.

Do you know the numbers (multiple speakers)?

We issued 400 million of refinancing dollars first quarter, and we only have redeemed 50 million (multiple speakers) financing associated debt. So 350 is the delta.

350 plus the 140 for change in the second quarter? Or is the 140 in the 350?

140 is not in the 350.

Thank you.

Paul Patterson, Glenrock Associates.

Just to follow up on Paul Fremont's question here, with the OPEB and pension expense, of that $30 million reduction for the quarter I guess 20 cents a share that you're looking at for the year, how much is actually coming from pension and how much is coming from reduced health-care benefits for retirees and that kind of thing?

If you look at the first quarter impact, pension was a little bit over one cent of that six cents number that we talked about. OPEB benefits redesign for retiree benefits was a little bit over one cent. Medicare legislation related to some of the of the Rx prescription drug things were a little bit over two cents, to get you around four cents, something right there -- I'm sorry, five cent, six cent range.

Okay. Let me ask you also I noticed that D&A was up, but on page 3, line 19 the provision for depreciation expense had actually decreased by 15 million. What is sort of the thought -- what's going on there, I guess?

That would really stem from the JCP&L rate decision last August that's driving that.

They gave you a lower depreciation rate?

Right.

Finally, you mentioned the sales of these non-core business and what have you, and the possibility of them, I know, hasn't been all that great but what would the financial impact be if you -- obviously it depends what you sold them for. I realize that. But are these business is losing money? Is there a potential for accretion from that? Any thoughts that you could elaborate a little bit on that?

It depends on what we sell and when we sell it, but largely I would expect it to be generally earnings neutral.

Great. Thanks a lot.

Ashar Kahn, SAC Capital.

Where do you stand in terms of New Jersey? First of all, do you have a final order? And what is happening on that review process in terms of the ROE?

We do not have a final order yet, and we cannot really start the process until the final order is issued.

Okay. Thanks.

Sen Sung (ph), Luminous Management.

I apologize if I missed this somewhere, but on page 5, line 15 where you show other operating expenses having decreased sort of significantly year-over-year, could you just give us a little more flavor as to what's going on there?

Off the top of my head, no. But we can certainly work that out and get back to you.

That's the area where you would reductions in the pension and OPEB (ph) costs and similar items.

Okay. Thank you.

Paul Sabaz (ph), Value Line.

Regarding the non-core assets that you might sell, what's the book value? And is there anything else besides MYR and some of the facilities services groups companies that you would be including in that?

The book value would depend on what we ultimately decided to put onto the market, and we haven't decided that yet.

The assets you mentioned are some of the most significant candidates that we're looking at, but we haven't completed that process of really going through and evaluating and announcing which of those assets we would actually plan to sell. But clearly we are looking across operations and looking to see looking to see what we need to support our strategy going forward and what might be surplus to that, and that's what's really driving the process. And we will continue doing that for the foreseeable future, although I don't think it will take us too much longer to really come up with a list of candidates that we're definitely going to put onto the market.

Thank you.

Jose Almonte, The Clinton Group.

A quick question with respect to the bank lines at I guess the parent level. Are they the lines that mature this fall? That includes a line at Ohio Edison that you kind of put in there for backstop. Can you give us a sense for the total dollar amount you would look to structure a new line; some sort of parameters and whether or not you would expect maybe the Ohio Ed line to go away?

We're looking to -- as Rich had mentioned earlier, we're going to be launching the renewal of the credit facility next week and we're going to look to redo $1 billion under the FE name three-year term. That will be replacing two FE facilities that exist right now, along with one OE facility. As you mentioned, that OE facility is for 125 million. Again, we're just going to be replacing and doing a name change; replacing 1 billion for 1 billion with a name change OE to FE.

So it will be all at the parent level?

Correct.

Thanks.

Why don't we take one more call please if there is one?

Paul Patterson, Glenrock Associates.

Just a quick follow-up. On the Medicare legislation, is that simply a situation where the federal government is basically going to provide prescription benefits, and therefore you don't have to? Or could you just elaborate a little bit on that? That's about half, I guess, of the six cents or so.

Basically (indiscernible) that is the same legislation obviously (multiple speakers) employers.

They will actually be providing us a subsidy, a tax-free subsidy.

Thanks a lot.

We appreciate everybody's time today. Hopefully the call was useful to you. And again, thank you very much for your continued support and interest and thank you for joining us today. Have a good day.

This concludes today's FirstEnergy first quarter 2004 earnings teleconference and webcast. You may now disconnect.