第一能源 (FE) 2006 Q4 法說會逐字稿

Good afternoon. My name is Sharona and I will be your conference operator today. At this time I would like to welcome everyone to the FirstEnergy Corp. fourth quarter 2006 earnings conference call. [OPERATOR INSTRUCTIONS].

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

Thank you, Sharona. During this conference call, we will make various forward-looking statements within the meaning of 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 issues 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 Web site under the earnings release link.

Reconciliations to GAAP for the 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 Web site at www.FirstEnergyCorp.com/IR. 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, Vice President and Treasurer; and Ron Seeholzer, Vice President of Investor Relations. I'll now turn the call over to Tony Alexander.

Thanks, Kurt. And good afternoon, everyone. I'll begin the call today by highlighting our achievements in 2006 and then Rich will discuss our fourth quarter financial results and touch on a few regulatory matters.

Let me start by saying that 2006 was a milestone year for FirstEnergy, as we achieved our strongest financial and operational performance since the formation of the company nearly a decade ago. This was evidenced in our 2006 normalized non-GAAP earnings of $3.88 per share, which exceeded the top end of our October 25 guidance of $3.75 to $3.85 per share. Net cash from operating activities exceeded $1.9 billion and our stock appreciation plus reinvested dividends produced a total return for shareholders of 27.2%.

This favorable performance enabled several developments that will continue to build value for our investors. In August, we repurchased 10.6 million shares of common stock and in January of this year, the board approved the repurchase of up to an additional 16 million shares. Combined, these programs represent about 8% of the shares outstanding before the first repurchase. In December, we announced our fourth dividend increase since March 2005. The new dividend of $0.50 per quarter is an 11.1% increase from the prior level.

And these strong financial results were driven by an equally strong operational performance. We had our safest year ever in 2006 with an OSHA rate of 0.97 incidents per 100 employees, one of the best in the industry. Our record generation output of 82 million megawatt hours represented a 2.2% increase over the record established in 2005. Our base load fossil plants achieved a capacity factor of 89%, which was their third top decile performance as in many years and represents almost a 92% capacity factor when scheduled outages were excluded.

We also successfully completed three planned outages at our nuclear facilities, including the replacement of the steam generators and reactor vessel head at Beaver Valley Unit 1, which was accomplished in record time. We added 99 megawatts of capacity to our system during the year, with uprates at Beaver Valley, Davis-Besse, and our Bruce Mansfield facilities and we plan to add an additional 130 megawatts of base load capacity and about 200 megawatts of peaking capacity over the next two years. On the wire side of our business, we produced top decile performance in our transmission operations and improved our distribution performance by reducing the average duration of customer outages by 20%.

During the year we also continued to make important progress on our regulatory agenda. We began recovery of incremental Midwest System Operator Costs, or MISO costs in Ohio and recently received approval to begin recovery of incremental PJM costs in Pennsylvania. We also received approval to recover JCP&L's deferred costs related to mandated contracts with non-utility generation suppliers and successfully transitioned our Penn Power subsidiary to market-based pricing for generation.

To set the stage for continued progress and to ensure effective succession planning, last week we announced organizational changes involving some of our key executives. These moves help us prepare for retirements that will happen in the near future and expand the skills and responsibilities of our senior team and providing them with new and challenging assignments. 2006 was a good year for FirstEnergy, with the company being in the best financial position I've seen in my 34 years here, and delivering top quartile performance in key measures across our operations.

As we begin 2007, we remain focused on our key strategic goals of first managing the transition to competitive generation market in Ohio and Pennsylvania, second, realizing the full potential of our assets; third, controlling commodity costs and risks; and finally, further enhancing our financial strength and flexibility. We're a stronger company than we've ever been and we're well-prepared for whatever the future may hold. Now I'll turn the call over to Rich to discuss our fourth quarter results.

Thank you, Tony. Good afternoon, everyone. Thanks for being with us today. As I begin my review, it might be helpful for you to refer to our consolidated report to the financial community that we issued earlier this morning.

Let's get started with a review of fourth quarter results. Earnings on a GAAP basis in the fourth quarter were $0.85 per share compared to $0.58 per share during the same period in 2005. Normalized non-GAAP earnings were $0.84 per share, excluding the net affect of unusual items that increased earnings by $0.01 per share. The unusual items involved a net gain of $11 million related to the sale of non-core assets, partially offset by an impairment of securities held in our nuclear decommissioning trusts.

Our normalized non-GAAP earnings of $0.84 in the fourth quarter compare favorably to the normalized non-GAAP earnings of $0.77 per share in the same period in 2005. This improvement was primarily driven by our Ohio rate plans, which increased earnings by $0.23 per share compared to the fourth quarter of 2005 and the deferral of PJM transmission expenses, which increased earnings by $0.09 per share. Other positive drivers included a $0.07 per share benefit from reduced net transmission costs and a $0.01 per share benefit from lower post-retirement health care costs. In addition, the reduction in shares outstanding following the accelerated share repurchase of 10.6 million shares in August enhanced earnings by $0.02 per share.

Partially offsetting these factors were a $0.05 per share decrease in distribution delivery revenues, reflecting heating degree days that were 15% below the level of the prior year; a $0.03 per share decline in generation revenues, driven primarily by wholesale marketplaces; a $0.05 per share increase in fuel expenses from higher fossil generation output increased coal prices; a $0.07 per share in purchased power; and an $0.08 per share increase in nuclear O&M, both primarily resulting from the refueling outage at Beaver Valley 2 compared to no refueling outage in the fourth quarter of the prior year; a $0.05 increase in financing costs, and a $0.01 per share increase in depreciation expense. Total generation sales were flat compared to the fourth quarter of 2005 with a 5% increase in retail sales being offset by an 18% reduction in wholesale sales.

During the period, we continued to execute our plan to reduce debt at the holding company and appropriately capitalize our regulated utility companies. In November, we redeemed the remaining $600 million of our $1 billion 5.5% holding company senior notes, primarily funded with short-term debt and the proceeds of share repurchases by Toledo, Edison, and Cleveland Electric. We also transferred about $878 million of our pollution control revenue bonds from our Ohio utilities and Penn Power to our generation companies. This brings the total amount of pollution control that transferred from the utilities to the generating companies to $1.4 billion, with an additional $700 million remaining to be transferred opportunistically during 2007 and 2008.

We ended the year with an adjusted debt to capital ratio of about 58% on a consolidated basis, and that includes a decrease in the equity ratio of about 100 basis points, resulting from the adoption of FAS 158 during the year. Consistent with our commitment to remain solid investment grade credit profiles, we plan to maintain leverage in that general range going forward, although the debt ratio may tick up somewhat during 2007 and 2008, primarily as a result of our heavy environmental spend in that period. We would expect it to decline after 2008.

Our financing plan for 2007 focuses on several major elements. These are: executing the repurchase of up to 16 million shares of common stock as authorized by the board in January of this year, securing an investment grade credit rating for our FirstEnergy Solutions business unit, and establishing an entity as a separate SEC registrant, completing the sale and leaseback of the owned portion of Mansfield Unit 1, issuing about $1.2 billion of long-term senior notes at Cleveland Electric, Met-Ed, and JCP&L and Penelec to fund debt maturities, repurchase utility stock, and repay short-term debt, and finally transferring a portion of the remaining pollution control debt from our regulated utilities to our generating companies.

Let me touch on a few regulatory updates. The Pennsylvania Public Utility Commission issued its order in the Met-Ed Penelec transition plan cases on January 11. We were disappointed that the Commission denied our request regarding generation rates and additional note deferrals. The recovery of incremental PGM transmission costs, which was allowed will reduce the delivery risk associated with our polar obligation in Pennsylvania. Several parties to the proceeding, including Met-Ed and Penelec have files for petitions for reconsideration of the order with the Commission. The committee has granted these petitions to provide themselves more time to further consider the merits of the reconsideration request. Because of that ruling, parties now have 30 days after the Commission rules on the merits of the petitions to file appeals with the Commonwealth Court.

Met-Ed and Penelec have separately requested to correct, on a retroactive basis, the determination of a NUG accounting issue, and the aim of this proceeding is to eliminate improper deductions of the deferred cost balance during periods at which market prices exceed our payments to NUGs. The value at issue in this request is about $40 million for the period 1999 through 2006. That case will go to hearing tomorrow.

On January 31, we issued our earnings guidance for 2007. Our non-GAAP earnings guidance is $4.05 to $4.25 per share. GAAP earnings are expected to be $0.05 per share higher than that, or $4.10 to $4.30. The non-GAAP guidance reflects the normalization of a regulatory asset created this year, regarding the recovery of costs incurred in prior years because of the decommissioning of the fast and experimental nuclear unit. On page 2 of this quarter's consolidated report, we did provide our estimate of the quarterly earnings pattern for our 2007 guidance.

Before we start the Q&A, I would like to remind everyone that the presentations from our February 1 analyst meeting as well as a link to the meeting's Webcast are available on the Investor Relations section of our corporate Web site. I encourage those of you that weren't able to attend the meeting to review that information, as it provides a full briefing of the Company's operations and outlook by many members of our senior executive team.

In closing, we were pleased with FirstEnergy's performance in 2006 and remain enthusiastic about our future. We believe that FirstEnergy is well positioned to continue to deliver shareholder value and we appreciate your continued support and interest. Now I'll ask Sharona to open the call to questions from analysts.

[OPERATOR INSTRUCTIONS] Our first question is coming from Paul Ridzon from KeyBanc.

Good morning. Can you hear me?

Hi, Paul. Yes, we can.

Good afternoon, excuse me.

How are you?

Rich, I was wondering if you've made any progress in deciding how you may want to take these additional 16 million shares in and the timing of that decision?

I think we have made some progress, Paul. We have to push the 10-K out before we go forward with a share repurchase, but that will be done towards the end of next week, I believe. I'm still thinking that the share repurchase is going to be a first quarter event, and we would expect that the bulk of it would be through an ASI restructure, similar to what we did before.

Do we need to have some sense of finality around the sale leaseback before we see that?

No, we don't.

Then, just, strategic rationale behind putting solutions in a stand-alone SEC-reporting entity.

I think in part it's to get more clarity to the investment community. Also will enable them to down the road issue debt, which is an important part of our financing plan longer term. Obviously as we move toward the competitive generation market, FirstEnergy solutions is going to be a very large driver for our earnings. I want to make sure we get prepared for that.

Thank you very much.

Thanks, Paul.

Our next question will be coming from Paul Patterson from Glenrock Associates.

Hi. I just wanted to follow-up on Paul Ridzon's question. With respect to the previous accelerated repurchase program, is JPMorgan finished with their buyback?

They're not finished, but I believe we said they will be finished by the end of next month.

Okay. Thanks a lot.

Thanks, Paul.

[OPERATOR INSTRUCTIONS] Our next question will be coming from Dan Jenkins from State of Wisconsin.

Good afternoon.

Hi, Dan.

Hi. I got a couple things here.

Okay.

Just looking at your income statement, both for the quarter and for the year, the other operating expenses down about $55 million in the quarter at $104 million for the year, just if you could give a little color on what was behind that?

Sure. Want to do that, Harvey?

Sure. Dan, this is Harvey Wagner. A lot of that reflects the reduction in transmission costs in our MISO and PJM markets and also the reductions that we've been experiencing in our employee benefit costs.

Okay. So lower transmission and then lower employee costs. I was curious on the pollution control debt, how much still remains at the operating companies that's available to transfer over to the gencos?

A little less than $700 million, Dan. We'll do that opportunistically in 2007 and 2008.

Okay. On this FirstEnergy Solutions, what's in that entity? Is that just the merchant part of the business, or are the plants there too?

Yeah, it contains all our competitive business. As you may remember at the end of 2005, we transferred ownership of our generating assets from our regulated utility companies over to FES. They are all contained within FES as our competitive retail businesses.

Okay. So all the nonregular --

Yes, that's right.

Okay. And then you may have said it, but I didn't get it down. What did you say your targeted adjusted equity ratio was going to be going forward?

Going forward, obviously we want to make sure we maintain investment-grade metrics. Debt to total cap is one of the things that rating agencies look at. Obviously they'll look at other metrics as well. What I said is by the end of this year -- or, I'm sorry, by the end of 2006, we had an adjusted debt to total cap ratio of 58%. That includes the off-balance sheet items that the rating agencies consider to be on credit, but it's a higher number than what you would see in our financial statements. Also, I would mention, that was about 100 basis points higher than it otherwise would have been because of the adoption of FAS 158 during the year.

Okay. And what -- the affect of the Mansfield transaction, that would probably -- would that make that go up, or would it not really have much of an affect? Do you have a sense of that?

That will bump that up for a period of time, and that's why I mentioned -- as a result of our capital spending program, primarily, I would expect to see that creep up somewhere over the seven and eight period and then decline again thereafter. But still maintaining well within the investment grade range.

Okay. Then the last thing I was wondering, it looks like for the year in particular, I'm looking at the industrial sales were down about 1.4% and particularly weak in New Jersey it looked like. They were down 7.9%, just if you could give us some color on what the industrial sales situation looks like in your service territories.

I don't know specifically the New Jersey situation, but we have a very small industrial load in New Jersey, so any little change can have a big percentage impact on that. Overall, I think probably you're seeing as much as anything just a reflection of the auto industry during the year. A lot of our manufacturing is related to auto in one way or another, steel, glass. So I think that's probably as much of what we're seeing as anything.

Okay. Thank you.

Thanks, Dan.

Our next question will be coming from Stephen Huang from Citadel.

Good afternoon, guys.

Hi, Stephen.

Just a quick question here on the share buyback. Your authorized last year was for 12 million shares, but you only used 10.6 in the ASR. Does the remaining 1.4 carry over to the new 16?

No, what we said, the new program supersedes the old program, Stephen, so what that means, the old program's done at approximately 10.5, the new program will be up to 16.

Okay. And the ASR will be like last year, it won't be for the full amount, but will probably be for a large chunk?

It could be even for the full amount. It will definitely be for a large chunk of it, if not all of it.

and would you guys do it on a shorter time horizon than the last one, or would it be similar in terms of how long you stretch out the buyback?

It's a pretty big-sized program, considerably larger than last year. So I wouldn't expect it would be done in less time and probably take a little more time. Just because of the size of it.

Okay. What -- any announcements yet from your discussions with the IRS or other people with regards to the lease treatment on the Mansfield? Is it going to be a capital operating?

Go ahead, Harvey.

Stephen, we haven't had any discussions with the Internal Revenue Service. We wouldn't anticipate that. We are working toward having it be an operating lease. We will not know that until we actually have a final structure in place.

Is the cost of the lease embedded in your guidance right now?

Yes.

Like any lease payments?

Yes. Yes, it is, Stephen.

Thank you.

Thank you.

[OPERATOR INSTRUCTIONS] We have a follow-up question coming from Paul Ridzon from KeyBanc.

Will there be a trueup component from the previous buyback once it's complete, depending on what the average share price is?

Yeah, there's a settlement process involved. That's a cash event, it's not an earnings event, but yes.

Will not be an earnings event?

No.

What was the assumed share price when you did that?

$56.44 was the share price on the day that we executed the ASR.

I guess it's a good problem to have, this trueup, huh?

It's a great problem to have. We'll take those all day.

All right. Thanks a lot.

Thanks, Paul. Okay, I think that's it. We appreciate everybody's time today. If anybody has any follow-up questions, please feel free to contact us. We appreciate you being on the call today and as always we appreciate your support and interest in FirstEnergy. Thanks very much. Have a great day.

Thanks for your support, guys. Have a good day.

This concludes today's FirstEnergy Corp. fourth quarter 2006 earnings conference. You may now disconnect.