第一能源 (FE) 2007 Q3 法說會逐字稿

Good afternoon, ladies and gentlemen. My name is Tiara and I will be your conference operator today. At this time, I would like to welcome everyone to the FirstEnergy third 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 very much. 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 the nonGAAP 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 Rich Marsh.

Thank you, Kurt. Good afternoon, everyone. Thanks for being with us today. I'll start our call this afternoon with an overview of third quarter financial results and operational performance. I'll then turn the call over to Tony to discuss recent Ohio and Pennsylvania legislative developments and our financial outlook for the remainder of the year. As I review our third quarter results, it might be helpful for you to refer to our consolidated report to the financial community that we issued this morning.

Earnings on a GAAP basis in the third quarter were $1.36 per share, compared to GAAP earnings of $1.41 per share in the same period last year. Excluding special items, normalized non-GAAP earnings were $1.32 per share, compared to $1.42 per share in the third quarter of last year. This year's normalized non-GAAP earnings exclude gains of $0.04 per share related to the sale of a portion of our 32% ownership interest in First Communications. The primary reason for the $0.10 per share decline in normalized non-GAAP earnings compared to the third quarter of the previous year relate to two items that benefited last year's quarterly results. And these were first, a $0.06 per share contribution from the sale of emission allowances and second, a $0.05 per share contribution related to the 2005 estimated manufacturing deduction in connection with the filing of our 2005 federal income tax return in September of 2006.

Kilowatt hour deliveries through our distribution system during the quarter were slightly behind the levels of the prior year, due to the milder weather experienced in the eastern portion of our system where cooling degree days were 6% below the same period last year. Although total system cooling degree days were comparable to the third quarter of last year, we experienced a mild July, which is normally a peak air conditioning month for us. The key drivers for this quarter's financial results included a $0.20 per share improvement related to increased generation revenues from higher wholesale and resale prices as well as higher sales volumes, a $0.06 per share reduction of post-retirement benefit costs due to retiree healthcare design changes and lower pension expense following the $300 million contribution to the plan in January, and an $0.08 per share benefit related to the reduction in common shares from the accelerated share repurchase of 10.6 million shares in August of 2006 and 14.4 million shares in March of this year.

Factors partially offsetting these positive contributions included an $0.11 per share increase in purchase power expense due to the replacement power cost for the 25 day outage at the Perry Nuclear Power Plant in July, as well as higher market prices. A $0.07 per share reduction due to the distribution rate decrease at our Met-Ed and Penelec subsidiaries effective in January, a $0.03 per share decline in distribution delivery revenues, mainly due to weather related impacts on our residential delivery sales that I discussed earlier, a $0.04 per share decrease in investment income from our nuclear decommissioning trusts and corporate-owned life insurance, resulting from the third quarter's investment performance compared to the same period last year. A $0.02 per share increase in depreciation expense resulting from our growing asset base. A $0.02 per share expense in general -- increase in general taxes due to higher property taxes in Pennsylvania, gross receipt taxes. And finally a $0.03 per share increase in financing costs attributable to the interim financing of the accelerated share repurchase program and the January 2007 pension contribution.

I'll now touch on a few of the key financing transactions that we recently completed. On August 30th, our Penelec subsidiary issued $300 million of 6.05% unsecured [D] senior notes due 2017. The proceeds from this transaction were used to fund the repurchase of $200 million of Penelec common stock from FirstEnergy and to repay short term borrowings. On October 4th, the generation subsidiaries of FirstEnergy Solutions closed on the issuance of $427 million of pollution control revenue bonds that were credit enhanced with insurance. The proceeds will be used during the fourth quarter to redeem an equal amount of PCRBs originally issued on behalf of the Ohio operating companies. This transaction brings a total amount of PCRBs transferred from our utilities to the generating companies to approximately $1.9 billion, with about $265 million yet remaining to be transferred. And this process supports the generation asset transfer that took place in 2005. The generating companies also completed the remarketing of $263 million of pollution control revenue bonds on October 1st and replaced the supporting levers of credit previously drawn on FirstEnergy Corp's $2.75 billion revolving credit facility with insurance letters of credit guaranteed by FirstEnergy Solutions.

During September, FirstEnergy Solutions registration obligations associated with the $1.3 billion sale on leaseback of Unit One of the Bruce Mansfield Plant were satisfied, and as a result the transaction which was completed on July 13th is classified as an operating lease under GAAP. As we noted on our second quarter earnings call, our generation company continues to operate the Mansfield unit and remains entitled to its full power output. Last week our 911-megawatt Beaver Valley Unit One plant returned to service following a scheduled refueling outage which began on September 24th. During the outage, the ten year inspection of the reactor vessel head was completed with no significant issues. Beaver Valley One had operated for 378 consecutive days when it was taken offline for the refueling, which is a very impressive performance. Also, in late August our nuclear operating company filed an application with the NRC, seeking to extend the operating licenses for both Beaver Valley units for an additional 20 years, for the year 2036 for Unit One and 2047 for Unit Two. The NRC accepted the application for review last week.

Now let me address a few recent regulatory developments in Ohio and Pennsylvania. On August 29th, the Supreme Court of Ohio upheld rulings by the Public Utilities Commission of Ohio, approving several provisions of our Ohio operating companies' rate certainty plan that had been challenged. However, the court did remand one issue back to the PUCO for further consideration, that being our ability to collect fuel costs deferred between 2006 and 2008 through future distribution rates. The court ruled that recovery of generation service costs through distribution rates would be unlawful. The court did not dispute the commission's authority to allow recovery of the fuel cost, just the recovery mechanism. On September 7th, the companies filed a motion for reconsideration with the court to contest its interpretation and on September 10th, also filed an application on remand with the PUCO to propose the deferred fuel costs be recovered through two generation related fuel cost recovery riders beginning later this year. This matter is currently pending before the PUCO. Other key Ohio regulatory matters that are in process before the commission include the competitive generation supply plan that we filed on July 10th and our distribution rate cases which were updated on August 6th. We expect both matters to continue to progress during the remainder of the year.

In Pennsylvania, a joint petition for settlement was filed with the Public Utility Commission on September 28th seeking approval of Penn Power's interim default service supply plan for the three year period beginning June 1st, 2008. The first phase of Penn Power's default supply plan began on January 1st of this year. The proposal provides for Penn Power to obtain market based generation supply using a request for proposal by rate class for residential and commercial customers. Industrial customers would be supplied through short term markets. The settlement agreement, which is either supported or not opposed by all parties, resolves all issues except those regarding incremental uncollectible accounts expense, and we expect an administrative law judge recommended decision soon with the commission order in late November or early December.

Now I'd like to turn the call over to Tony to comment on other regulatory and legislative matters.

Thanks, Rich. There has been a significant amount of activity recently on new energy legislation in both Ohio and Pennsylvania. In Ohio, Senate Bill 221 was introduced at the request of Governor Strickland. The governor's plan had significant issues, primary of which was it lacked the clarity necessary to effectively determine generation pricing. Hearings were held on the bill. A substitute bill has been introduced and later today we expect the Senate Energy and Public Utilities Committee to consider the substitute bill and additional amendments. That substitute bill as amended is expected to be considered by the full Senate tomorrow. While the substitute bill addresses some of the shortcomings identified in the governor's plan, it still allows the PUCO to subjectively determine whether a competitive market exists, and in addition, continues to lack sufficient clarity on key provisions. Essentially, the Senate's version has helped frame the issues in the bill for consideration in the house. Yesterday, the House Speaker announced plans to refer the bill to the House Public Utilities Committee, once it has cleared the Senate. He has also outlined a topic based schedule for hearings that would begin in early November and extend to January 23rd of 2008.

As to FirstEnergy, remember, our utilities do not own generation, so their generation prices to customers will be based upon the competitive market for generation, essentially purchase power. However, the substitute bill would not foreclose our ability to negotiate an electric security plan if doing so would provide advantages to the company and its customers. There is still considerable work to be done on this legislation, so it will likely be some time before we can fully evaluate its impact, including those from the mandates for renewable and advanced energy resources and energy efficiency. FirstEnergy will remain very active in the hearing and legislative process in the House and we hope to continue to improve the legislation so that it offers a real opportunity for competitive generation markets to develop in Ohio.

Turning to Pennsylvania, a special legislative session on energy is currently under way. This session began on September 24th when Governor Rendell reintroduced his Energy Independence Strategy Proposal. The centerpiece of this proposal involves the creation of an $850 million energy independence fund for the purpose of supporting clean energy initiatives, grants for solar installations and venture capital grants and loans for alternative energy projects. The fund would be created through a systems benefits charge that distribution utilities would collect from customers. There also has been numerous bills submitted in the special session in both the House and Senate dealing with alternative energy funding, tax credits and sales tax exemptions. Energy matters are also being considered in the regular legislative session. Energy bills have been introduced to deal with demand side management, energy efficiency, conservation, rate increase mitigation and the generation procurement process. The administration is also working on proposed energy legislation. Additionally, there has been some discussion regarding possible legislation that would extend electric generation rate caps. I understand that yesterday such a bill was introduced in the House. While I haven't yet reviewed the proposed bill, we believe that a better solution would be a price mitigation plan which would phase in price increases over time. Although it is difficult to predict the final outcome of the various legislative initiatives in Pennsylvania and Ohio, FirstEnergy remains actively engaged in the process to ensure that the transition to competitive markets is managed in the best interest of our investors and customers.

In closing, I was pleased with our operational and financial performance during the quarter. This outcome, coupled with our positive results during the first half of the year, enable us to revise our 2007 normalized non-GAAP earnings guidance to $4.15 to $4.25 per share, which is at the top half of our prior guidance of $4.05 to $4.25 per share. Thanks for your time and interest in FirstEnergy. I look forward to seeing many of you at the EEI Financial Conference next month, as well as at our annual analyst meeting in New York on December 6.

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

(OPERATOR INSTRUCTIONS) We'll pause for a moment to compile the Q&A roster. Your first question is coming from Ashar Khan of SAC Capital.

Good afternoon. Congratulations.

Hello.

As you mentioned, is the Senate version of the bill to be passed as you said with amendments today and tomorrow, would that allow you as you said to proceed with going to market or no?

Since our Ohio utilities do not own generation and do not have any contracts for generation services as of January 1st, 2009, their option for supplying and meeting their generation obligation will be from the market and that price will be passed on to customers.

Rich, can I just ask you a question on the results? The $0.20 increase in the generation business, is that due to higher margins or more volume?

You're talking about the generation revenues?

That's correct.

It was mostly price related as opposed to volume.

And that is because you had higher I guess prices in the MISO area in Ohio. Is that the way to look at it?

Yes, through the service territory, yes, that's correct.

Okay. Thank you, sir, very much.

Thank you, Ashar.

Thank you. Your next question is coming from Paul Fremont from Jefferies & Company.

Thanks. If I take what you said in the second quarter, which is that you expect 56% of the remaining year to come in the third quarter, it would have been a guidance range of about $1.14 to $1.25. You came in I think $0.07 above that in the third quarter. And I'm curious why you held the top end of your guidance range on the year stable? Is there something negative that we should be anticipating later in the fourth quarter?

We set it there because we think that's the appropriate range, Paul. I mean, obviously every quarter is unique based on weather and other circumstances. We think the $4.15 to $4.25 guidance that Tony just issued captures where we'll be at year-end. So it's our best thought of where we'll actually ultimately be, notwithstanding the third quarter results.

Okay. And I guess the second question that I would have is with respect to the Ohio plan, or Ohio proposed legislation -- should we think of the timing of the passage of legislation as potentially preceding any potential deals that the Ohio utilities would cut with the PUC, or should we think of those as more or less simultaneous events?

My sense, Paul, this is Tony -- my sense is that they would have to wait until any new legislation is adopted, so that they could be consistent with that new law.

Okay. Thank you very much.

Thanks, Paul.

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

Thanks very much.

Hi, Gregg.

Hi. Was just wondering if you could update us on where MISO stands with implementing ancillary services -- new ancillary services market?

That process is continuing to move along, Gregg. I don't know that I've gotten an update recently in terms of when that would be completed. My understanding was by 2008. Probably mid-year. But I've not heard any updates on that recently.

Completed mid- '08 for '09 implementation?

I'm not sure. We can check on that and get back to you. We'll talk to our guys at FES and find out.

Okay. Thanks.

Thank you.

Thank you. Your next question is coming from John Kiani from Deutsche Bank.

Hi, Tony. Hi, Rich.

Hi, John.

Tony, what's your view -- I know it's probably difficult to project at this time, but what's your view on roughly how long it will take to iron out the post '08 rate situation in Ohio or come to some agreement on an ESP?

I'll tell you, John, I think it's going to be how complicated the bill is, with respect to what has to be included in that consideration. If it's moving in the direction that the substitute Senate bill appears to, which would have some sort of potential cost-based analysis required, that could be time consuming. So much of it is going to depend on how that legislation sets itself up for those very first negotiations.

That makes a lot of sense. Looking out longer term, and I know you're very focused right now on the best outcome possible in Ohio and obviously in Pennsylvania as well, but as we look out longer term, and the environmental capital spending starts to come to an end, what's your view on monetizing more of the balance sheet?

Certainly you know, we have taken advantage of opportunities that have come our way, as you know, John, in terms of Beaver Valley, Bruce Mansfield, some of the opportunities that have happened. We're continuing to obviously look at that. Most of our attention is focused really on the 2009 transition, making sure that we focus on getting the transition in Ohio and Pennsylvania correct. So we haven't really gone beyond that in terms of issuing any definitive guidance or views, if you will and I think we need to have some of these things clarified before we can go there.

Got it. Thanks, Rich.

Your next question comes from Paul Ridzon from KeyBanc.

Good afternoon. How are you?

Hey, Paul, good. How are you?

Okay. As I read the governor's legislation, I saw language that specifically addressed generation that has been divested. But you think the way things currently stand, you can side step that and just pass Ohio to market at the distribution company?

Yes.

Well, legislation has drafted, if you think about this plan as discussed, it had some provision in there or discussion with respect to assets that have been transferred. The legislation itself really doesn't deal with it in any direct way, because it's -- you simply can't. So I think the -- I think there's a recognition, however. But if there's an energy security plan and there's a pass-through of costs, you would look through to try to determine how those costs were incurred. But generally speaking, the point at which you start with from a Ohio Edison CEI and Toledo Edison perspective is their cost to meet the generation obligation is purchase power cost.

Thank you. And on the second quarter call, I kind of asked why you weren't raising guidance and you talked about Davis-Besse and weather. What was it that came in better than expected that allowed you to do this?

I think it was weather during the quarter and just general overall results. Obviously it was a good quarter for us, that's what gave us the confidence to limit it to the upper end of our existing range.

Lastly, just housekeeping, your reconciliation, the $0.04 unusual, that is one and the same, the gain on First Communications?

Yes, it is.

Thank you.

Thanks, Paul.

Your next question comes from Jonathan Arnold from Merrill Lynch.

Good afternoon.

Hey, Jonathan.

Just a couple of Ohio follow-ups. First one, in terms of the proposal you have before the commission on the competitive -- transitioning to competitive pricing and how that marries up with the timetable that's being outlined in the House. What are the next dates in the commission process and does that effectively have to move a long way down the track before the House actually ends up making a decision on this bill?

Well, when you think about the process, and I think that's probably the easiest way to think in terms, Jonathan. To me, the -- since we know that the Ohio utilities don't have generation and their first step is going to have to be in the competitive market, the fact of the matter is, the more time the commission chooses not to act, the less time we will have to manage a process that has multiple bids, as an example, instead of just one day, or give customers notice, an adequate notice with respect to what the prices to beat are in 2009. I mean, in theory, the price can be established as of the end of the year, because it will be effective January 1st of next year. All that means, however, is that customers won't have a lot of time to respond to it. It will take a little more time for alternatives to develop and the retail market to develop underneath. But nevertheless, it can go that long. You've just limited the options and the choices, and your ability to mitigate perhaps volatility that might occur on one day, if that's the only day you have left to do an auction.

The commission has the ability to wait and spend time on this if they so choose?

It has consequences, but yes, they can.

One other related topic, there was some moving around of the membership of the House committee I believe in the last week or so. Any comments on that, how we should think about the changes there?

I think that's the Speaker of the House's choice. He's obviously selected some very good, talented members to represent the House and take testimony on this very important bill.

Thank you.

Thank you. Your next question is coming from Paul Patterson from Glenrock Associates.

Good afternoon, guys.

Hi, Paul.

Just to sort of follow up here on Ohio, sort of your political crystal ball here, you guys are sort of a little bit in a different position than perhaps some of the other utilities. And what do you think the chances are of this bill being exercised by the end of the year? Do you think that there is potential for further sort of battles over how their situation is, vis-a-vis, where some people would like it to be, some of the other parties? Do you follow me? In other words, you guys have transferred the assets. It looks like there's a specific situation that applies to you guys that may not apply to others and do you see that as being a potential hang-up or problem or is it too hard to say?

Let me address the first part of it, Paul. That is that we don't -- given the House's schedule at this point -- it was just announced, we would not expect this legislation to be passed in 2007. Because their schedule includes hearings through January 23rd of 2008. So we would not expect action this year to close it down, unless the House changes its schedule at some point. With respect to the other issues again, there is a lot of -- there's a lot of issues in this legislation and a lot of parts to it that need clarity in terms of how it will apply particularly to utilities that continue to own generation, as opposed to us, because we don't own generation any longer. Those things need to get cleared up. I think the House is going to, the way their schedule looks like, they will allow for full debate and discussion with respect to all the issues that I think have been identified in this legislation. And that should give everybody an opportunity to try to address them through further legislative action. Again, assuming that they're not fully addressed when the Senate deals with the bill today and tomorrow.

Okay. And finally, just a quick one on pension and (inaudible), you guys have been pretty creative in terms of lowering the cost there and I was just wondering whether or not going into 2008 we might see a similar -- what your plans might be with respect to -- could you do something similar to what you did this year? Just any thoughts on that.

Well, the change has largely been driven by the pension contributions we made over the last three years, Paul. We put in about $1.3 billion over the three year period. Right now we're fully funded even on a PPO basis. We have the plan funding in a spot that we think is attractive. We're not contemplating any additional funding going forward. Hopefully those assets will continue to do well from an investment standpoint and earn a good return, but we're very happy with the funding where we're at.

And the healthcare thing, you guys don't see any big changes in that either?

We've announced those changes that have already taken place or will be taking place shortly. Once again, I think we've been pretty diligent, looking at the options. So right now I wouldn't anticipate any further significant changes.

Okay. Great. Thanks a lot.

Thanks, Paul.

Thank you. Your next question is coming from Daniele Seitz from Dahlman Rose.

I just was wondering, when is the extension -- life expansion on the Beaver Valley plants will be in effect? I mean, when do you anticipate the NRC to be completing the review?

The license extension request?

Yes.

It's a fairly long process. Typically takes several years.

You don't expect that before two years from now?

Could be as long as four or five years.

Oh, really? Okay.

It's a pretty regimented process that they go through. It typically takes a period of time.

Okay. And in the purchase power cost that you presented in the reconciliation, how much was for the Perry outage, I mean, roughly?

I'm sorry, could you repeat that?

The Perry outage, represented how much of that increase in purchase power cost?

About $0.06.

Okay. Great. Thank you.

Thank you.

Thank you. Your next question is coming from David Frank from Catapult Partners.

Yes, hi, good afternoon.

Hey, David.

Rich, a couple quick questions. One, could you give us an update on where the ASR stands?

The ASR from our perspective of course was completed the day we did it. In terms of Morgan Stanley, their short position, David, that will be done in the fourth quarter.

Okay.

To be completed by year-end.

Completed by year-end. Other question I had was on the basis differential in Pennsylvania. When you look at your Met-Ed and Penelec utilities and you look at some of the sources of supply coming from the Duquesne region, specifically Beaver Valley, in the out-years now there's a bit of a spread between the capacity payments you're obligated to pay in [MAC] plus APS versus what you're receiving on your generation in the rest of pool of Duquesne there in 2010. How will you seek to hedge that differential? Or should we just assume it's a one year thing -- you'll just eat it for the year?

Probably the best thing for us to do, David, would be to get back to you on that. That's not an easy question to answer here in a little sound byte here. So let us get back to you. We'll take that as a homework item.

Okay, thank you.

Thanks, David.

Your next question is coming from Dan Jenkins from State of Wisconsin.

Good afternoon.

Hi, Dan.

Hi. First, a couple things on the philosophically the Ohio and Pennsylvania situations. I guess related to the generation, how committed are you to preserving the value of that generation for the investors? Are you willing to go to the extent to potentially spinning off your Ohio utilities or somehow separating them if that becomes an issue, that the state tries to go over the value of that generation for distribution customers?

Well, remember, Dan, obviously in Ohio we already separated the generating assets out of the regulated distribution companies. So those are assets that are engaged in interstate commerce regulated by FERC, not the state commissions. So as far as that issue goes, we've already taken the step of separating that out. Maybe the second part of the question you're talking about in terms of the ability of the regulators to somehow -- claw back is how I usually hear it termed something through a distribution case. Obviously that's going to depend on how regulators view these requests and act on these requests going forward. We continue to like the integrated business model. We think it makes sense. It makes sense for the customers in Ohio as well. I would have to believe the commission could very well see it that way as well. So we don't have any indications otherwise at this point that might lead us down the path to unbundle those two businesses.

Okay. And then just a few items on your release. I noticed in the most recent quarter on your cash flow statement, you had a big cash flow provided from investment activities. Is that related to the sale leaseback?

Yes, it is.

Okay. Then you mentioned that you were also looking to build some storage for spent fuel at the Perry plant.

Yes.

And I was wondering, a number of other utilities have sued the DOE to recover those costs related to the fact that the Yucca Valley or the Yucca Mountain isn't open yet. Have you guys gotten that sort of recovery put in place or do you plan to pursue that?

We have not done that, Dan, no.

Do you plan to pursue that or is that something you're thinking about?

We're participating in the proceedings around that issue, but at this point we have not taken any action.

Okay. And then I was just wondering if you could comment on the industrial sales in your areas? I noticed you had close to 1% down in the third quarter and most of them are down for the year -- just kind of what you're seeing economically or from customers in the industrial sector.

Our industrial sales tend to bounce around a little bit from quarter to quarter. I mean, most of our industrial exposure is in northeast Ohio, Western Pennsylvania. A lot of that tends to be steel, auto glass related concerns. They tend to from an economic standpoint generally follow along those trends. I haven't seen anything very significant related to customers that overall have impacted that. Harvey, do you have anything else you want to add to that?

I was just going to add that Penn Power's industrial customers for the most part are shopping. That was different from last year.

You're not seeing any trends weaker versus quarter versus quarter or anything like that?

Nothing out of the ordinary.

Generally they'll trend to track along with general economic trends. I don't see anything unusual.

Okay. Thank you.

Thanks, Dan.

Why don't we take one more call and we'll let everybody get back to work. If there is one more call.

Thank you. There appears to be no further questions at this time.

Very good.

Great. Well, we appreciate everybody's time and interest today. Look forward to seeing many of you in Florida for the EEI financial conference and hope everybody has a great day. Thanks for your time.

Thanks, everyone.

Thank you. This concludes today's conference call. You may now disconnect and have a wonderful day.