第一能源 (FE) 2007 Q1 法說會逐字稿

Good afternoon. Good afternoon. My name is Janelle, and I will be your conference operator today. At this time, I would like to welcome everyone to the FirstEnergy Corp. 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) It is now my pleasure to turn the call over to your host, Kurt Turosky, Director of Investor Relations. Sir, you may begin.

Thank you, Janelle. 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 it have business of FirstEnergy Corp. are based on expectations that are subject to risks and uncertainties. A number of factors could cause actual results or outcomes to differ materially by 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 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 website 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.

Thank, Kurt, and good afternoon, everyone. I'll begin the call by highlighting our performance during the first quarter and will then ask Rich to review our financial results and provide an update on regulatory matters. We're off to a good start in 2007 and made continued progress in achieving our key goals for the year, which include: Maximizing generation output; further improving our distribution reliability; attaining our vital hire and safety goals; pursuing continuous improvement in all aspects of our business; and achieving targeted earnings growth. We recorded earnings on a GAAP basis of $0.92 per share in the first quarter, and our normalized non-GAAP earnings of $0.88 per share were 31% higher than in the same period last year. During the quarter, we also completed the accelerated repurchase of 14.4 million shares of common stock and attained investment grade credit ratings on our unregulated subsidiary FirstEnergy Solutions. Our generation fleet demonstrated strong performance overall during the period. Our nuclear units operated at a 99% capacity factor and achieved their second-highest quarterly output total of 8.3 million megawatt hours. We continue to expand our generation capacity to maximize the potential of our assets and expect to bring up to 500 megawatts online over the 2007 and 2008 period through upgrades at existing units and renewable energy projects.

As part of this effort, Beaver Valley unit 1 completed the final phase of a power uprate project in March. This is the second uprate at Beaver Valley 1 in the past 12 months. We expect they will add approximately 43 megawatts to our system upon final verification later this year. Also during March, a selective noncatalytic reduction system was placed in service at our East Lake 5 unit following a scheduled maintenance outage. The installation is part of our air quality compliance strategy and will reduce NOx emissions and achieve reductions required by the EPA's NOx transport rule. Another key operational achievement during the quarter was the return of the Perry nuclear power plant to routine NRC oversight as a result of the corrective actions that we've successfully implemented over the past 2.5 years.

The capital investments we've made in our utility distribution system continue to result in improved reliability for our customers. During 2006, 0.5 million fewer customers experienced outages than in 2005 and the average outage duration dropped by nearly 20%. This trend continued during the first quarter of this year with a 27% reduction in the number of customer outages compared to the first quarter of 2006 and a 43% decrease in outage duration. We also continued to achieve outstanding results regarding the safety of our employees. In the first quarter, we remained on pace to meet our exceed our record-breaking performance in 2006 when we achieved an OSHA rate of 0.96. That represents less than one incident per 200,000 hours worked, placing us in the top decile of our industry.

Now I'll turn the call over to Rich to discuss the first quarter financial. Rich?

Thank you, Tony, and good afternoon, everyone. As I review our results today, it might be helpful to refer to our consolidated report to the financial community that was issued this morning. As you review our financials, you'll note that we've revised the segment reporting to provide more clarity regarding the results of our regulated and competitive business units. As illustrated on pages 4 to 6 of the consolidated report, this break down includes an energy delivery services segment, a competitive energy services segment, and an Ohio transitional generation services segment. A description of each of these is included in the footnotes, and if you have any questions regarding the segment breakdown, I encourage you to contact our investor relations team after the call today.

Let's get started with our results in the first quarter. Earnings on a GAAP basis in the first quarter were $0.92 per share compared to GAAP earnings of $0.67 per share in the same period last year. Normalized non-GAAP earnings were $0.88 per share, excluding the net effect of two special items that increased earnings by $0.04 a share. The first of these resulted from a Pennsylvania Public Utility Commission order authorizing Met-Ed and Penelec to create a new regulatory asset for costs incurred in prior years related to the decommissioning of the Saxton experimental nuclear reactor. This item increased earnings by $0.05 per share, and that was partially offset by a $0.01 per share charge from the impairment of securities held in trust for future nuclear decommissioning activities. The improvement in this quarter's non-GAAP earnings resulted from continued favorable operation performance, the execution of several [vario] enhancement initiatives highlighted at our analyst meeting on February 1st, and some quarterly timing differences.

Positive earnings drivers included: An $0.18 per share improvement related to higher generation revenues stemming from a 3% increase in generation sales, as well as higher wholesale and retail market prices; a $0.05 per share increase in distribution delivery revenue reflecting heating degree days that were 15% higher than in the same period last year, as well as in normal sales growth; the $0.06 per share reduction in generation O&M expense driven by the absence of nuclear outages in the first quarter of this year compared to refueling outages in the first quarter of 2006; a $0.06 per share reduction in other post-retirement benefit costs due to retiree healthcare design changes and lower pension expense following the $300 million contribution to the plan that we made at the beginning of the year; and a $0.05 per share benefit related to the deferral and recovery of incremental transmission expenses at our Met-Ed and Penelec subsidiaries. The benefit for the first quarter of 2006 wasn't recognized until the second quarter of last year due to the timing of the Pennsylvania Commission's decision authorizing the deferral accounting. In addition, reduction in common shares outstanding from the accelerated share repurchase of 10.6 million shares in August of 2006 and 14.4 million shares in March of this year, enhanced earnings by $0.03 per share during the quarter.

Factors that partially offset these favorable trends included: A $0.06 per share increase in fuel and purchased power expense, primarily driven by higher purchase costs to support the 3% increase in generation sales and a 3% decline in total generation output. this reduced output stem from a heavy plan maintenance schedule at our East Lake and [Samus] units, as well as unscheduled outages at Mansfield one and two during the period; a $0.04 per share reduction in earnings due to the implementation of lower distribution rates at Met-Ed and Penelec subsidiaries in January following the Pennsylvania Commission's decision in our rate cases; a $0.02 per share increase in depreciation expense resulting from our growing asset base; a $0.02 per share increase in general taxes due to higher gross receipts and kilowatt hour taxes, as well as higher property taxes; a $0.03 per share decrease in investment income from our nuclear decommissioning trust and corporate-owned life insurance; and a $0.04 per share increase in financing cost, primarily attributal to higher short-term borrowing levels related to the interim funding of the accelerated share repurchase programs and the $300 million pretax pension contribution.

Let me touch on a few important financial activities during the quarter. As I mentioned, on March 2nd we repurchased approximately 14.4 million shares or 4.5% of our total common stock outstanding under an accelerated program with an affiliate of Morgan Stanley. The initial purchase price was $900 million or $62.63 per share and was funded on an interim basis through short-term debt. The final purchase price will be adjusted to reflect for volume weighted average price of the stock during the period of time that Morgan Stanley acquires the shares, which may take up to one year. Coupled with the prior accelerated repurchase program executed in August 2006, we've now repurchased about 25 million common shares or 8% of the total shares outstanding as of July 2006. During the quarter, both Standard & Poor's and Moodys assigned investment-grade credit ratings to our unregulated subsidiary, FirstEnergy Solutions. FES is the holding company of FirstEnergy Generation Corp. and FirstEnergy Nuclear Generating Corp., the owners of our fossil and nuclear assets, respectively. To provide additional transparency, we recently furnished FES' audited financial statements for the years 2004 through 2006 in an 8-K filing, and we expect FES to become a standalone SEC registrant later this year.

Also during the quarter, the Cleveland Electric Illuminating Company issued $250 million of 5.7% senior notes due 2017. The proceeds from the transaction will be used to meet CEI's 2007 maturing long-term debt obligations of $120 million and to repay short-term borrowings. Yesterday, we announced the Cleveland Electric will redeem all four million shares outstanding of its 9% trust preferred securities on June 1st at a price of $25 per share plus an accrued distribution to the date of redemption. Over the remainder of the year, our financing plan will focus on completing the sale on leaseback of owned portion of Mansfield unit 1, which we continue to expect to close during the second quarter, issuance of about $1 billion of long-term unsecured debt at our New Jersey and Pennsylvania subsidiaries, primarily to fund debt maturities and repay short-term debt, and opportunistically transfer a portion of the remaining pollution control debt from our regulated utilities to our generating companies.

Let me conclude this afternoon with a brief update regarding regulatory matters in Pennsylvania. Following the January decision of the Pennsylvania PUC in our Met-Ed and Penelec transition cases, several parties, including the companies, filed appeals of the decision with the Pennsylvania Commonwealth Court. The companies have appealed the denial of generation rate relief and a consolidated income tax adjustment related to the cost of capital. Other parties have appealed the recovery of certain transmission costs and universal service program costs to a surcharge mechanism assessed to residential customers. All of these appeals are pending before the Commonwealth Court. in a separate proceeding to address Met-Ed and Penelec's request to retroactively correct a NUG accounting issue, an evidentiary hearing was held in late February. The companies are seeking to modify the accounting methodology for NUG's drain of costs to eliminate reductions of the preferred cost balance during which periods in which market prices exceed NUG payments. The value at issue in this request is estimated to be about $40 million for the period 1999 through 2006. Legal briefs were filed in March and the companies are awaiting the administrative law judge's recommended decision.

And on May 2nd, our Pennsylvania Power subsidiary made a filing with the Pennsylvania Commission to propose a mechanism to procure power for default service customers beginning June 1, 2008. Our Penn Power customers transition to Competitive Generation Market on January 1st of this year and the default service plan previously approved by the Commission covered the 17th month period ending May 31, 2008. We've conformed this filing to the Commission's proposed default service rules and incorporated input from other parties. The filing proposes procurement of a full requirements product by class through multiple RFPs with staggered delivery periods extending through May 2011. It also proposes a three-year phase-out of promotional generation rates. We expect the Commission to address our filing later this year.

In closing, let me just say we're gratified by our good start to the year and we're looking forward to continued operational and financial performance over the remaining quarters. We are affirming our non-GAAP earnings guidance for the year of $4.05 to $4.25 per share. As always, we appreciate your time and interest in FirstEnergy, and I'll now ask our Janelle, our operator, to open the call to questions from analysts.

Thank you. (OPERATOR INSTRUCTIONS) Thank you. Our first question is coming from Paul Patterson of Glenrock Associates.

Good afternoon, guys.

Hey, Paul, how are you?

All right. I was wondering if you could -- now that we've had the RPM auction and it's a little bit more complicated with the set up that you have in multiple states, but I was wondering if just in sort of an aggregate way you could tell us what you think about that auction and what the impact might be for the rest of this year and going into '08 and just maybe further than that?

Yes, I'll be glad to take a shot at that, Paul. As you know, RPM is being implemented on June 1st of this year and there's a series of auctions in association with that. We have three companies, three operating companies in the PGM region; JC P&L, Met-Ed and Penelec. The impact is a little different for those companies. Let's focus first on JC P&L. That company has about 900 megawatts of capacity to bid into RPM, but at JC P&L generation revenues, both energy and capacity, are used to reduce NUG deferral balances, so that means there's not going to be any earnings impact. There will be in essence in acceleration of cash flow from this, Paul. Basically it accelerates receipts of cash under the deferred NUG balance, so we recover those costs faster. So an acceleration of cash, no earnings impact at JC P&L.

For Met-Ed and Penelec, those two companies have a total capacity of about 2,300 megawatts. And since the capacity they need to meet their load obligation is greater than their own generation, we, of course, also have third-party contracts for energy and capacity or just capacity. And over the coming several years, we're well hedged for capacity over that period, so there's really negligible impact at those companies. So no earnings impact for any of the companies. Slight acceleration of cash flow at JC P&L, and that's about the impact of RPM our on our PGM companies.

Okay. Great. And then on the stock buy back that you guys implemented with Morgan Stanley, do we have an idea about where Morgan Stanley is on that buy back yet?

No.

We don't? Okay. And then -- okay, that's it. Thank you very much.

Thanks, Paul.

Thank you. Our next question is coming from Paul Fremont of Jefferies & Co.

Thank you very much.

Hi, Paul.

Really, two questions. One, with respect to the deferral benefit that you reported in the first quarter, will that be -- should we think of that as a $0.05 drag in the second quarter since you reported two quarters at once last year?

No, it's not going to be a drag in the second quarter. It's a flip, actually, is what it is. So in the first quarter of 2006, there was no deferral. There was two quarters worth in the second quarter of 2006.

Right. So in other words the net comparison then would be -- wouldn't that be still a negative comparison quarter over quarter?

Comparative quarter over quarter, yes.

Yes, that's what I meant.

Okay, sorry. Yes.

And then the second question is, with FirstEnergy Solutions, are you going to switch ultimately your segment reporting so that we're seeing the legal entities as opposed to the breakouts that you're giving us now, which are more accounting breakouts?

Paul, this is Harvey Wagner. The segment is going to be very, very close to what you see in the financial statements for FirstEnergy Solutions as a legal entity. There are a few things that are included in that that are competitive businesses that aren't really part of the legal entity itself, but are managed that way and that's how we're reporting our segments.

And the Ohio transition segment, is that in FES or would that be in the regulated operations?

That's carved out of the regulated operation, just to isolate the generation portion of that that's remaining in transition.

Thank you.

Thanks, Paul.

Thank you. Our next question is coming from Gregg Orrill of Lehman Brothers.

Thanks very much.

Hey, Greg.

Hi. Given where the stock has moved and the view of the value of the Company, would there be a potential to recut the incentive structure around the buy back?

What do you mean the incentive structure, Gregg?

The kind of the incentives for -- with your executer, Morgan Stanley

I wouldn't use the term incentives. There's a pricing grid that's embedded in the contract such that more shares are purchased as the stock price decreases. I wouldn't call that an incentive per se. We do have the option if we wished we could redo that grid at some point, however. Does that answer your question, Gregg?

Well, I guess. If you thought the stock was still going to be improving, you might look at redoing that?

Right. Right. And certainly the stock's had a nice run since we have started the program in -- earlier in the year. So yes, that's something that -- that's something we're keeping on our possibilities list.

okay. Great.

Thanks, Gregg.

Thank you. Our next question is coming from Danielle Seitz of Dahlman Rose.

Hi. Could you bring us up to date on the developments in Ohio? And it looked like the governor was somewhat more vocal about his position, but was really -- not really defining how he felt and the transition to market base rates should take place. Could you give us a bit of a behind the scene look of the -- how do you see this developing?

Sure -- Yes, let me take a shot at that. Sure, Danielle. Like we said before, there are -- there's some discussion and I believe the governor's recent speech, in which he identified several areas he'd like to -- the general assembly and the parties in Ohio that are typically engaged in these kinds of discussions to try to work through. They had to do with renewable energy, they had to do with energy efficiency, they had to deal with infrastructure improvement, both on the wire side of the business as well as the potential for building new generation in Ohio. And he expressed in that speech, as you well know, that his opinion that you can't put the genie back in the bottle with respect to market based or reregulation, if you will. I think what you really have now is additional data point out there. As far as I know there's still nothing pending or no legislation at the general assembly that's been introduced. And the parties are still just generally discussing some of the issues that might arise at the next transition.

Do you anticipate then, that there will be a proposal coming from the commission and that the legislature will agree on and will be eventually passed as a new bill? Or do you see more and the legislature actually handing that responsibility to the commission alone?

I believe -- if there's going to be legislation, it's going to be driven by the decisions of our legislators here in the state of Ohio.

And your sense of the timing for that, is it still not really easy to pinpoint at this time?

I think that's a fair statement. They're very engaged right now in the budget process, which won't wrap up until probably the end of June. And I think that's where -- that's where a lot of the attention seems to be by the members at this point. That doesn't mean they couldn't start discussions or ask for some additional information through hearings, but at least at this point they have not.

So it sounds like it is more of a fall -- kind of a finalization in the fall instead of summer?

Danielle, I really couldn't tell you how fast they'd be willing to move on it. But it does take ti -- the legislative process does take time. And when it gets started, everyone will know that, and that process will run however long it takes in order to -- for the general assembly to be comfortable if they decide to make any changes.

Great. Thank you.

Thanks, Danielle.

Thank you. Our next question is coming from Paul Ridzon of KeyBanc.

Actually my question was just asked and answered.

Okay, thanks, Paul.

Thank you. Our next question is coming from Dan Jenkins of State of Wisconsin.

Hi, good afternoon.

Hi, Dan.

Couple of things here. First I was wondering, I saw on page 7 of your release you have quite a bit of increase in the short-term debt.

Right. I'm sorry, Dan, I was going to say that is is that's the share repurchase and the pension contributions interim funded through short-term debt. We will, in the second quarter, be closing the Mansfield sale leaseback transaction. That'll generate about $1.2 billion after tax cash for us, and that cash will be used to permanently fund the share repurchase, the stock buy back and also to pay down short-term debt. That's just a temporary little blip and you will see that go away as we go through the year.

Okay. That's what I was going to ask, if the Mansfield proceeds were going to go for that. Then given all the activities you've done related to FirstEnergy Solutions, would it be reasonable to expect some sort of issuance out of them before the end of the year?

No, the sale leaseback obligation debt will be issued out of the [positive] generation company within FDS, but other than that, we're not expecting any other activity this year. And the pollution control bonds coming back, of course, right?

Okay. Then on the balance sheet -- or the capitalization that you show on page 7 there, would that already have reflected -- you mentioned on your development to April 7th common share acquisitions, would that already be reflected on the figures on page 7 or not?

No.

So what would the capitalization -- the debt percentage or or the equity percentage look like accounting for that April 7th transaction, do you have a sense of that?

It really wouldn't be anything significantly different, Dan.

Okay. The other thing I was wondering is you mentioned that part of the quarter-over-quarter earnings increase is due to the retiree healthcare design changes and the voluntary pension plan contributions. Is that something that would be expected to carry forward into the future quarters?

Yes, it will, in future years, actually, yes.

Okay. And then I think the last thing I had is on your page 8 where you show the condensed consolidated cash flow --

Yes.

-- statement. There's about a $300 million decrease due to changes in working capital. I was wondering if you'd give me a little color on what's going on with that?

Dan, this is Harvey Wagner again. Primarily it reflects an increase in receivables. If you take a look at our fourth quarter income statement compared to our first quarter of 2007 income statement, you'll see that revenues were up about $300 million. So that just reflects a natural increase in the unbilled receivables, the uncollected receivables at the end of the quarter.

Just from higher sales level.

So should that reverse then as the year goes forward?

I'd expect so, although with a growth scenario, I would hope not, actually.

Okay. And then the only other thing is on the environmental CapEx, you mentioned you had some of that in the first quarter, but I guess what's the balance left for the rest of the year for your (inaudible) CapEx spending?

I don't have that exact number, Dan. Our projects are progressing on schedule. The biggest obviously is at the Samus plant. I don't know how much is remaining in the remaining quarters, but we're on track and on budget from our perspective in terms of completing those projects.

Okay. Thank you.

Thank you.

Thank you. Our next question is a follow-up from Paul Patterson of Glenrock Associates.

Hi, guys. Just wanted to go over the nuclear decommissioning trust fund, which seems to have been hit a little bit as well as this impairment for securities that are held for future decommissioning activities. Could you just elaborate a little bit on what happened there?

Well, I'll try to. The impairment resulted from a -- I guess you'd call it a change in SEC interpretation, is that correct, Harvey?

Yes.

And this impacts all utilities that have nuclear decommissioning trusts. And the way we used to do it is the value -- the change in value of the assets within the nuclear decommissioning trust was not reflected in earnings. You would only see an earnings impact when gains or losses were realized when you sold the securities. SEC interpretation said that, in their view utilities were unable to demonstrate an ability to hold securities in an NDT until any such impairment might be resolved. The reason they said that, Paul, was because those funds were managed by external investment managers not directly under control of the Company. So in their view the correct way to approach this is that, if the end of any period there was an impairment, those assets are worth less than book value then you reflect that in earnings. At the end of the period if those assets are greater than book value, you don't do anything, so it's sort of an asymmetrical approach. But it's an SEC interpretation change, that's what was driving it. It impacts all companies with NDT trusts. I don't know, Harvey, do you want to say anything else?

No, that's it. Really 2007 is the last year that you're going to see this kind of dichotomy. With the changing accounting rules with fair value accounting beginning in 2008, those unrealized gains also will be going through P&L, so we'll at least be a levelized playing field on that.

Okay. And then the nuclear decommissioning in [Coley], what happened there?

That's just a reflection of general capital market conditions, Paul.

Okay. So I guess the capital markets were down at the end of the quarter?

I think the S&P 500 was up like 1% for the quarter. It's invested -- both of these are investing in various types of asset classes.

And remember that that's a comparison to last year's first quarter.

First quarter of last year.

Okay. Okay, that explains it. Then -- and then finally when you guys mentioned the lease -- the $0.04 that was associated with the increase financing costs as being a one-time blip and that the lease is going to be replacing a large amount of the short-term borrowing, what's a different between a lease cost and the short-term borrowing cost that we're looking at here? Do you follow me?

Because -- yes, we haven't finalized the lease, but when we were at the January analyst meeting, I indicated because of our ability to use that tax loss carry forward, we were able to in essence secure this $1.2 billion after tax in a low single-digit equivalent debt rate. So, because of the use of the tax loss carry forward, that became a very economic way to do it. In terms of our short-term borrowing costs, Jim, I don't know what we're -- what are we averaging now?

We're averaging about 5.8%, 5.9% on our short-term borrowing cost.

Right. No, I remembered that it was an advantage for you guys to do it. I guess all I was wondering was how much, I guess, from a quarter-over-quarter perspective as this lease comes into play should this $0.04 number be lower as a result of this? Do you follow me?

That's a hell of a question. In other words if -- We have to see when we finalize -- when we finalize, but there will be -- your theory is correct. Your theory is correct. We'll be a little bit lower.

One other thing to remind you, Paul. Assuming that it is an operating lease at the end of the day that there would be also an amortization of a rather sizable book gain from the sale that would cross that path.

Right.

But we'll have to see when you guys actually cut the deal, I guess?

That's exactly right.

Thanks a lot, guys.

Thanks, Paul.

Thank you. We have no further questions. I would like to turn the floor back over to Richard Marsh.

Well, I just want to thank everybody for being with us today. I know this is a very busy earnings release day, so we are certainly appreciating your continued interest in FirstEnergy and look forward to seeing many of you at the various conferences that we'll be appearing at over the next six weeks. Thank you again for your time. If you have any follow-up questions, please contact our investor relations group. Have a great day. Thank you.

Thanks, everyone.

Bye, now.

Thank you. That does conclude today's FirstEnergy Corp. conference call. You may disconnect your lines, and have a wonderful day.