第一能源 (FE) 2006 Q1 法說會逐字稿

Good morning, ladies and gentlemen. At this time, I would like to welcome everyone to the FirstEnergy first-quarter earnings conference call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer period. (OPERATOR INSTRUCTIONS).

Thank you. It is now my pleasure to turn the floor over to your host, Kurt Turosky, Director of Investor Relations. Sir, you may begin your conference.

Thank you. 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 earlier today and is also available on our website under the earnings release link. Reconciliations to GAAP for various non-GAAP financial measures we will be referring to today are also contained in that report, as well as on the investor information section of our website.

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; Jim Pearson, Treasurer; and [Terry Hausen], Vice President of Investor Relations.

I will now turn the call over to Rich Marsh.

Thank you, Kurt. Good morning, everyone. Thanks for being with us today. I will start the call by providing an overview of our earnings results and other financial matters, and then turn the call over to Tony Alexander to discuss our operational performance and also provide an update on regulatory initiatives.

Information regarding first-quarter results was provided earlier today in our consolidated report to the financial community that is available on our website. We do understand that the e-mail distribution of the report was delayed this morning, as the third party we used to distribute the e-mails had problems with their server. We do understand that the server is back in service and that the e-mail distribution began around 9:30. So we apologize for the delay.

Let's start with our first-quarter financial results. Please note that we will refer to earnings and cash flow results on a non-GAAP basis and that reconciliations to results on a GAAP basis are available in the consolidated report, as well as on the investor information page on our website. Earnings on a GAAP basis in the first quarter of 2006 were $0.67 per share, and there were no unusual items. This compares to GAAP earnings of $0.49 per share and normalized non-GAAP earnings of $0.47 per share in the first quarter of 2005.

These results reflect the implementation of the Ohio Rate Stabilization Plan that was approved in 2004, as well as our recently approved Rate Certainty Plan. Certain elements of both plans impacted our financial results for the first time during the period. Specifically, the major earnings changes resulting from the Ohio rate plans compared to the first quarter of last year include a reduction in transition cost amortization of $0.18 per share, primarily reflecting the end of the generation transition cost recovery in 2005, and the deferral of $0.07 per share of certain distribution costs related to reliability spending, partially offset by a $0.04 per share earnings reduction related to a rate stabilization charge discount provided to shopping customers.

In addition to these Ohio rate plan impacts, other positive contributors to our earnings during the period included a $0.03 per share benefit from lower financing costs, a $0.03 per share benefit from the JCP&L rate increase that became effective in June of 2005 and a $0.01 per share reduction in the cost of other postretirement benefits. Factors that partially offset this improvement included a $0.04 per share reduction from increased fossil fuel costs net of deferrals, related to contract price escalations, coal mix, transportation costs and emission allowance prices; a $0.03 per share reduction related to higher purchase our prices; and a $0.02 per share decline in distribution deliveries, primarily as a result of the unseasonable mild weather we experienced during the period. Heating degree days were 15% lower than in the same period last year and 11% below normal levels.

Total electric generation sales rose 2% as a 1.7 million megawatt hour, or 7%, increase in retail sales more than offset a 1 million megawatt hour or 16% decline in wholesale sales. This change in the generation sales mix largely reflects the return of shopping customers to our Ohio utilities following the departure of some competitive generation providers. This reduced the level of shopping megawatt hours at our Ohio utilities from 34% in the first quarter of 2005 to 16% in the first quarter of this year.

Moving on to our financing activities, our 2006 financing plan is largely focused on capital structure management, and this includes reducing debt at the holding company as outstanding issues mature, including the 1 billion, 5.5% FirstEnergy senior note due in November and issuance of $1.1 billion of new debt at some of our utilities to fund the holding company redemption, and also to achieve capital structures that are appropriate in a rate-making context. We plan to maintain the consolidated debt-to-total-capital ratio at about the current level, which will result in the issuance of additional debt over time, as equity grows to maintain our targeted debt ratio.

Net cash from operating activities during the first quarter, before capital expenditures and common dividends, was 436 million. With a significant increase in capital expenditures during the period associated with the Beaver Valley Unit 1 and Davis-Besse scheduled outages, as well as the cost of replacement power during those outages, free cash generation was negative, as expected, and generally in line with our expectations. We are affirming our annual cash guidance of $460 million as well as our earnings guidance of $3.45 to $3.65 per share, excluding unusual items.

Now, I would like to turn the call over to Tony, who will give us an update on our operating performance as well as our regulatory initiatives.

Good morning, everyone, and thanks for joining us. Let me start with a brief operational performance overview. First, I am pleased to report that FirstEnergy set a new first-quarter generation output record of 20 million megawatt hours, a 7% increase over the prior first-quarter record established last year, even though we had two nuclear refueling outages underway. The generation record was attributable to an increase in fossil generation, with the Bruce Mansfield plant, our largest baseload plant at 2,410 MW, achieving a 95% capacity factor for the quarter. Overall, our fossil plants established their best quarterly output ever.

Respecting our nuclear fleet, the primary area of management focus has been improving our outage performance, both from a duration and cost standpoint. We have seen positive results in our nuclear outage execution this year. Specifically, on April 19th, Beaver Valley Unit 1 returned to service 11 days ahead of schedule, over a complicated construction and refueling outage. The unit became the first plant in the world to cut a temporary opening in its containment building to replace its steam generators and reactor head within a 65-day timeframe. It's also important to note Beaver Valley Unit 1 had operated safely and reliably for a unit record of 465 consecutive days before it was taken offline for this scheduled outage.

The Davis-Besse nuclear power station is also currently in the process of restarting following the completion of its scheduled refueling outage. Major work activities during the Davis-Besse outage included replacing several components in the plant's turbine, which is expected to increase power output by 11 MW, and rebuilding two of the four reactor coolant pumps.

From a regulatory standpoint, we also took a significant step in Pennsylvania to better position us for the future. On April 10th, Met-Ed and Penelec filed a comprehensive transition rate plan with the Pennsylvania PUC. For 2007, Met-Ed has requested an overall rate increase of $216 million or 19%, while Penelec has requested an overall increase of 157 million or 15% under their preferred rate-making approaches. The filing represents the first request to increase base rates since 1986 for Penelec and 1992 for Met-Ed. If approved as filed, customers' rates in 2007 would be comparable to the average rates charged by electric utilities across the State of Pennsylvania today. The comprehensive transition plan addresses essentially all aspects of costs within those companies -- distribution, transmission, transition costs as well as power supply costs. The filing requests increases in the Company's POLR generation rate.

It is important to note that Met-Ed and Penelec's current restructuring plan includes a provision that allows the generation rate to be increased by the commission if 80% of Met-Ed and Penelec's customers are not shopping with third-party suppliers. Under the restructuring plan, the companies were to supply no more than 20% of the POLR load. Since shopping has not been successful and the companies are currently serving virtually 100% of the POLR load, they may seek an increase in the generation price, which is what is being proposed.

Another major component of the filing involves a transmission rate increase to reflect federally imposed charges from the PJM Regional Transmission Organization. We have designed the transition plan to carefully balance the interests of all stakeholders through a combination of rates, tariffs and accounting procedures. Our filing will go to public hearings conducted by the Administrative Law Judge, which we expect should result in a Commission order early in the first quarter of 2007. The details of our filing are contained in an investment letter issued on April 10th, which is available on the investor information in section of our corporate website.

Another significant regulatory development involves the Pennsylvania PUC's April 20th approval of Penn Power's POLR supply plan to secure electricity to supply its customers at market rates following the end of their transition period, which is on 12/31/2006. Penn Power's generation rates are currently capped and are set to expire this year. As noted in the PUC's press release, the Commission is obligated to approved a POLR plan with generation rates that reflect prevailing market prices and that allow Penn Power to recover to all reasonable costs for service. We're pleased that the Commission recognizes the need to move forward with a procurement process to secure competitive market-based power supplies for Penn Power's POLR customers.

In closing, we had solid performance during the first quarter, and we remain on track to achieve both our earnings and cash flow guidance. We are off to a strong start toward meeting many of the objectives we established for 2006, including our generation fleet continues its exceptional performance, we had excellent execution on our two nuclear refueling outages, we filed a comprehensive transition plan in Pennsylvania, and we continue to deliver consistent financial results that meet or exceed our guidance.

Looking forward, we continue to make progress on the development of our air quality compliance plan. We expect to have that completed by midyear. As we have previously discussed, completion of that plan is the last remaining issue we need to address before considering a share repurchase program. By focusing on excellence in operations, timely regulatory recovery of our costs, increasing productivity and reducing costs, we will continue to improve the value proposition for our investors and customers. We appreciate your support and interest in FirstEnergy and your time today.

I now ask the operator to open the call to questions from analysts. Thank you.

(OPERATOR INSTRUCTIONS). Ashar Khan, SAC Capital.

Going to Tony's comments at the end, what is remaining on the air quality expenditures, in terms of why it would take another month or so, month or two for you guys to finalize that?

We're still finalizing the engineering design, for one thing, and that impacts the pattern of capital expenditures. We're still looking at market conditions in terms of shop space and availability, and working that through the equation in terms of how we want to design the program. So they are still going through the final phases of that. I'm confident by midyear we will be done with that, but that's a process that is still going on as we speak, actually.

And then, just going back to the plans filed in Pennsylvania, could I ask you -- I guess they're earnings-enhancing as well as cash-flow-enhancing. Could you just describe what's the use -- if you're successful, what the use of those cash would be going forward?

Are you talking about the Pennsylvania plans --?

Yes.

-- for Met-Ed and Penelec? You know, Terry's investment letter really laid out a lot of the financial details regarding the filing, and I would refer you to that. And if there's additional detail questions, follow-up questions, it would probably be more expedient to handle that offline. But I think Terry's letter did a good job of laying out all the financial details regarding the filing.

My only issue is, if you had more cash, what would be the use of it going forward into the system?

We have talked before about our uses of cash in general, in terms of growing the dividend, reinvesting in the business and repurchasing shares. And that priority I don't think would change. We have also talked about how over the next several years, in particular, starting in 2007 we will have significant capital outflows as a result of the air quality spending program, and also in terms of reinvesting in the wires business to improve reliability. So, to the degree we are able to realize additional cash, that will obviously help us keep all of three of those priorities.

Greg Gordon, Citigroup.

A couple questions on the 2006 outlook and then one on 2007. As we stand today looking at how well the Beaver Valley outage went and the number of customers are coming back to the system, and we look at just the broad array of [inputs] that you gave in your 2006 guidance, in your analyst meeting (technical difficulty) [point] to any structural issues that are different -- you know, more customers coming back, less, Beaver Valley being up sooner -- that would affect movement up or down as we move through the year, looking at guidance?

A couple of factors, I guess. Number one, obviously, the weather was mild during the period, and that restrained sales somewhat. So that would be a slight negative. As you mentioned, Beaver Valley coming back about 11 days ahead of schedule was a slight positive for us. The customers returning is actually not a positive for us, from an earnings standpoint. Basically, those are customers that are coming back to us at retail tariff rates. So what that does is it displaces our ability to do wholesale sales that actually generate a higher margin for us than under the retail tariff. So those customers are essentially all back at this point, though much of that migration occurred towards the end of last year. There's really virtually no shopping outside of our affiliates. So at this point, I don't expect that to change during the year. But those are the major dynamics.

And then, when we think about Penn Power, right now the Penn Power -- the utility is served completely by generation output from FirstEnergy's generation fleet, correct?

Correct.

So, when we think about the '07 -- the change in the dynamic there, at a minimum, the power that you're selling into Penn Power would be repriced to something more comparable to where the wholesale market is. And if you win the competitive RFP, it could be at what we would consider to be a more -- a retail price more reflective of current wholesale conditions. Is that a fair way to think about it?

That is the right way to think about it, Greg.

And how many megawatt hours do you expect to serve there this year? Is it about 4.6 terawatt hours of load?

Yes, about 4.6.

Steve Fleishman, Merrill Lynch.

Just to rehash on the Pennsylvania filing and the legal argument on it that you went through, Tony, just under the initial deal with GPU that was done as part of [stranded] costs and all that, what you're saying is that it's very clearcut that they were only supposed to serve no more than 20% of the load?

Basically, the document provides that for 80% shopping, if you don't reach 80%, then the Commission is to change the generation price.

To get to the 20%?

Correct. To get to the --

To get to the 80%.

80%.

Right. And then my recollection is you then, kind of as part of the merger, then settled on a deferral plan to bring this up, to bring this generation rate up? But that got rejected in the courts for other issues, but that's kind of irrelevant at this point, because the rate freeze in the dereg law is over?

The statutory generation cap expired at the end of 2005. That's correct.

What kind of reaction have you gotten politically to this filing? Has there been any big negative reaction to the rate increases, or has it been quiet?

I think generally, Steve, I judge my reaction to it from what I've seen in the press, in the main. And overall, it has been very calm, also not a lot of customer calls into our call centers. So I'd say it was handled very professionally by the (technical difficulty) very fact-driven, and at this point, pretty straightforward. And again, I think in large measure they recognized two things -- one, that the increase itself is relatively modest, given price increases that you are reading about elsewhere in the newspaper; and, two, there hasn't been a price change in 15 or 20 years, which I think both bode well and favorable to the companies, particularly as people on the outside begin to look at the case.

And this is, I think, a follow-up to Ashar because I frankly think I missed part of his question. But just to clarify on the share buyback, I think you have met every single driver that you were trying to meet except the environmental plan?

At this point we have, Steve. That's correct.

And your plan was to address all these by midyear. And is that still the case?

That is still the case.

Paul Patterson, Glenrock Associates.

I just wanted to touch base with you on the tax rate. It looks like it decreased quarter over quarter. And just could you remind us what we should expect going forward?

The largest part of that is the amortization of tax regulatory assets that were being recovered by the former GTC charge, and that was amortized through the income tax line on the income statement. So that actually reduced the effective tax rate by about 5%. And then also last year, we had about 2% of the effective tax rate that was attributable to the non-deductibility of the penalties associated with the new source review case and the Davis-Besse fine. So those were the two primary drivers. So we also -- you might recall in the middle of 2005, the Ohio tax law changed, and that really is driving down for 2006 our marginal composite tax rate by about 1.5 percentage points. So those things taken together are what is driving that.

And then, going forward, we should expect them to be pretty much the same as they were for the quarter?

Yes.

So just going forward, this would be sort of the tax rate that we will be at.

Right. In the 38, 39% range.

And then, I know weather was bad, but industrial sales seemed to be, in every one of your jurisdictions, to be down pretty substantially. And we think of them as being less weather-sensitive. So I was wondering, are we seeing any elasticity there? Are there any general economic conditions, or is it just anecdotal changes in each one of those jurisdictions as to why we are seeing industrial usage down so much?

Prices have not changed for those customers, so it's not an elasticity impact. I think it's more related to general economic conditions. The story is probably a little bit different in the different areas of our service territory. Most of the industrial activity is in Western Pennsylvania and Northeast Ohio -- area that's heavily dominated by steel, auto, glass related sort of manufacturing. I see the reports every month that come through in terms of our sales, and it tends to be almost a company-by-company analysis. Some are up, some are down. I can't point to any general overall trends, other than general economic conditions.

I guess, because they can go back -- if they are shopping, I guess they can come back. So that hasn't changed any of the --

Yes, it's not a shopping impact. And many of these customers are on very advantageous rates under contracts that were originated a long time ago, so these are our lowest-margin customers. So to the degree they are not using that power, it does make it available for us to sell wholesale or to other higher-margin customers.

And then finally, the healthcare benefits. You guys keep on doing very well in this area in terms of keeping expenses down, and I was just wondering -- this 6 million or so, how is that going to change going forward? Is it just a carryover from stuff that you were doing last year, or is there stuff you're continuing to do?

It really reflects the latest round of plan design changes. So you should see that stay [passed] each quarter during the year.

Paul Ridzon, KeyBanc.

Congratulations on a solid quarter. I don't want to beat a dead horse on the buyback and the last hurdle here. And I know the process is ongoing, but are things basically turning out as expected, or one end or other of the range that you talked about?

Are you talking about for the environmental program?

Yes.

You know, I don't expect the total number to change much, Paul. We have talked about that 1.6 to $1.8 billion range. But there could be some movement within the different years in terms of when we spend the capital. And as I mentioned before, we are looking at things like shop space availability, labor availability, material pricing, things like that which could lead us to either accelerate or defer spending in various years. So it really is down to that sort of more granular engineering analysis at this point. I don't expect the overall dollars on the program to change materially, but when they get expended could shift a little bit. That's really what we are looking at.

And then, on the Beaver Valley outage, you picked up 11 days against budget. Is there some way to quantify that?

The old rule of thumb we used to use was $1 million a day for a nuclear outage, a typical refueling outage. This was not a typical refueling outage, though. Obviously, it was much more extensive than that. And the old rule of thumb we used to use for replacement power was about $1 million a day, too, and that's probably not material anymore, given what prices are. So I don't have a number in my head, but obviously there was a benefit to that.

And then, on Ohio returning customers, is the rate of return different from assumptions upon which guidance is built?

No, that was all built into guidance.

Are you seeing more or less than guidance?

No, it was pretty much as expected.

Paul Fremont, Jefferies.

Two questions. One is on the targeted level of generation for the year, you guys were targeting over 80 million MW hours. The first-quarter record result -- is that sort of in line with getting to the annual target, or are you running better?

The first-quarter result was consistent with our expectation.

And the second question is on the Ohio front, I guess the Chairman of the Ohio Commission has indicated in past conversations with the investment community that he would be interested in sort of having companies initiate filings for addressing the period beyond the 2008 expiry of your plan. Do you see any type of filing taking place during the remainder of the year this year?

I have not had that conversation, and I have not seen Dr. Schriber talk about that. But I don't contemplate -- at this point, I'm not contemplating any filing in Ohio this year.

Gregg Orrill, Lehman Brothers.

I was wondering if you could talk a little bit about Powerspan and what role that is going to play in your compliance on SOx and NOx, but also what the potential and testing is you are doing on CO2 control.

Let me try to give you an overview. I'm not an expert on Powerspan, but Powerspan is a unique proprietary technology that we are testing at one of our facilities; it's called, I believe, electrocatalytic oxidation, which is a new method to remove pollutants. It, we think, has a high model of potential in terms of both CO2 and removing some of the heavy metals such as Mercury, which makes this technology unique. So it is not yet in a commercialization stage; it is still at a testing stage. We are an equity investor in Powerspan. I know our technology guys are very excited about the possibilities of this, but it still has to go through the full commercialization run, test run, to make sure that these benefits that they are at least potentially seeing at this point actually come through in practice.

Another benefit of that technology is the byproduct that results is basically fertilizer, which obviously is a sellable byproduct. So whether that conventional technologies, or you have sludges and other things, they have [taro] or gypsum or whatever has to be disposed of, in many cases. This provides you a byproduct that is actually sellable. So we are pretty excited about it. It still has a ways to go, but we think that the potential is high (multiple speakers).

Actually, we have committed to install this, and we are going through the preliminary engineering now to install this technology at one of our Bay Shore units (multiple speakers) Ohio.

David Frank, Pequot Capital.

Could you tell us what the spread was between PJM West and Beaver Valley in the first quarter, as far as power prices go?

I cannot.

I can't either, David. We'll have to get back with you on that one.

Can you give us an idea of historically the kind of spreads you see between the two hubs?

Let us get back to you. I don't have that on the top of my head. We'll check with our commodity supply people and get back to you on that.

DQE was saying it could be -- it's currently around $15, but I don't know if that's in line with what you're seeing or projecting.

We will check with our knowledgeable people and give you a buzz back.

Do you think, if you're successful and you no longer have to serve Met-Ed or Penelec at the tariff rate, given the potential spreads between the two zones, will you actually see a pickup in the margins if you are able to sell your power at the round-the-clock wholesale spot prices?

It should be a pickup in margin. Obviously, PJM West is a lower-priced market than further east in PJM. But there still should be a pickup if we're successful in terms of reducing the amount of POLR load we provide to those two companies.

So you do think that the prices that -- you are seeing prices higher than -- even in the Beaver Valley area -- that are higher than your incumbent tariff?

Yes, correct.

And can you comment a little bit about the prices, one versus the other?

In terms of what those are?

Yes, like what you're seeing versus what you are currently serving at?

No, because I don't have it on the top of my head. But we will get that for you, David. We'll check with our supply folks.

Dan Eggers, Credit Suisse.

Just given how well the power plants have been operating and being at record levels in the first quarter, do you guys still room for improvement as we look out to 2007/2008, relative to where you expect 2006 to come out?

Looking at the fossil fleet, we need to divide it into a couple tiers, I guess. The baseload units have made enormous progress over the last few years, and there is still some room to go. But every year we are getting a little bit closer, probably, to what they can theoretically run at. There is still potential in the mid-merit fleet or the load-following fleet, and that is one of the areas we are really focusing on right now, in terms of how we run those units, and we are running them harder to generate additional output. So that's an area that we are focused on.

And on the nuclear side, as Tony said, we have been focused on [our] execution, primarily, to make sure that those plants run breaker to breaker without any interruptions and then have crisply executed outages. So if you look at the generation of fleet as a whole, we think there is still some upside potential there for [fleet], and we know they have done a great job of improving.

Do you have any concerns about coal supply, just as you continue to move up utilization levels at the coal plant, as far as making sure you have enough coal in place for the rest of this year and looking beyond to make sure it's always available?

We have done a lot of work in terms of coal supply, both in terms of contracting for coal supplies and also the transportation to get that coal to our units. And I think we have been fairly successful in terms of that. To this point in time, inventories are at our target levels. We have not experienced any significant problems, in part because we do have, typically, multiple modes of delivery. We always try to have for our major units three modes of delivery -- often barge, truck, rail -- such that from a transportation standpoint, we will be able to get that coal in. And with the contracts we have in place, we have not experienced any significant issues.

Like many companies, some of the PRB deliveries have been down a little bit from prior expectations, because of transportation constraints coming out of the basin. But with our fuel-switching ability, that has not been a major problem for us. So long answer to your question -- no, we don't see any problems at this point in terms of having the coal supply at our target levels going forward.

Commodity prices are obviously still quite high. The curves have come down from last fall or even the beginning of this year, say, at fourth-quarter conference call times. Is that going to have any impact on how we think about the range for guidance this year, when you think about wholesale sales?

It shouldn't. I think prices are still within the realm that we had contemplated in the guidance, so not expecting any deviation from that.

Why don't we take one more question, and then if there's any follow-ups, certainly Terry and Kurt will be happy to take those.

Greg Gordon, Citigroup.

First, refresh my memory. Is a second-half buyback in your current earnings guidance?

No.

And what is the statutory timing, the maximum potential statutory timing for a decision on the Met-Ed and Penelec rate case?

Nine months, which puts us in the first quarter of '07.

We appreciate everybody's time and attention today. Thank you for being with us. If there's any follow-up questions, please feel free to give Terry or Kurt a buzz. And have a good day. Thank you.

Thanks, everyone.

This concludes today's FirstEnergy first-quarter earnings conference call. You may now disconnect.