PG&E Corp (PCG) 2004 Q2 法說會逐字稿

Good morning, ladies and gentlemen, welcome to PG&E second quarter earnings release conference call.

At this time I'd like to pass the conference over to your host, Mr. Gabe Togneri.

Thank you and go ahead Mr. Togneri.

Good morning, ladies and gentlemen.

Thanks for joining us this morning as we report earnings for the second quarter.

As a reminder, all participants are in listen-only mode through a simultaneous webcast and via conference call.

We'll have Q&A after the prepared remarks and a replay of the webcast will be accessible from the PG&E Corporation home page after the call.

The earnings release is posted on our website, if you don't already have it, and it includes our consolidated income statement, earnings and EPS breakouts, the non-GAAP to GAAP reconciliations and supplemental performance metrics for Pacific Gas and Electric Company.

Bob Glynn, Chairman, CEO and President of PG&E Corporation and Peter Darbee, Senior VP and CFO, will take us through the consolidated results and other items.

Gordon Smith, President and CEO of Pacific Gas and Electric Company and other members of our team are also here.

Now I'll turn the call over to Bob Glynn.

Good morning.

PG Corporation and Pacific Gas and Electric Company reported strong earnings from operations for the second quarter resulting from solid operations at Pacific Gas and Electric Company.

These results keep us on track to meet our previously-stated 2004 guidance of $2 to $2.10 per share in earnings from operations.

For 2005, we're setting an earnings from operations target range of $2.10 to $2.20 per share, based on assumptions that Peter Darbee will review in just a minute.

Our second quarter highlights, in addition to completion of the utility's financial restructuring include final approval of the all parties settlement in the utilities general reg case, and enactment of the legislation that authorizes refinancing the utility's $2.2 billion regulatory asset.

The GRC decision which was approved unanimously authorized a base revenue increase for 2003 and a formulaic mechanism to establish annual attrition revenue increases through calendar year 2006.

The first of these advice filings for 2004 was recently approved.

The predictability associated with this attrition mechanism enhances our ability to plan and budget, to provide good customer service, and earn our authorized equity return of 11.22%.

The anticipated refinancing of the regulatory asset is expected to provide significant future benefits for customers, and here are some implications for investors: forecasts that we made last fall prior to the utility's restructuring showed cash available for dividends and share repurchases of about $3 billion between 2005 and 2008.

Refinancing the regulatory asset, as currently planned, would significantly front-end load that cash flow.

Refinancing would provide approximately $1 billion worth of additional savings to customers over nine years in the form of lower interest costs included in their rates.

Our target is to issue the first series of bonds for this refinancing in January of '05.

Hitting that target will advance our aspiration for declaring and paying the dividend into the first half of 2005.

There's nothing that will make this team happier than to articulate more certain dates and we'll do that as soon as we are able to.

Now Peter Darbee will discuss the financial results, provide more detail on the refinancing and address guidance assumptions.

Thank you, Bob.

I'll begin with a review of second quarter results.

That will be followed by a discussion of the financial impacts of refinancing the regulatory asset, and then I'll close with guidance for 2004 and 2005.

PG&E Corporation earned 88 cents per diluted share for the quarter on a GAAP basis.

This compares to 55 cents per share for the quarter last year.

On a non-GAAP basis consolidated earnings from operations were 70 cents per diluted share and this compares to 31cents per share for the second quarter of last year.

On both a GAAP and non-GAAP basis, the majority of the increase resulted from recording the 2003 and year-to-date 2004 financial impacts of the GRC decision.

Pacific Gas and Electric Company contributed 72 cent per share to earnings from operations versus 32 cents per share in 2003.

The quarter over quarter difference was driven primarily by the catch-up in recording the 2004 impacts from the GRC and attrition adjustments.

Because we received the decision in May, we have the first six months' worth of revenue reflected in our second quarter operating results.

And this is worth approximately 30 cents per share.

Also contributing to the improvement was the equity return on the settlement regulatory asset of 7 cents per share.

The remaining difference is primarily attributable to higher electric and gas transmission revenues.

And these were partially offset by higher costs due to rate-base growth and inflation.

Now, turning to items impacting comparability.

These items are excluded from earnings from operations and total 18 cents per share for the quarter.

Approximately 7 cents of the total was due to recording the 2003 GRC revenue increase for gas distribution.

You'll recall that the electric revenue increase was already included in head room revenues last year, but the gas revenue increase was not.

The GRC decision also resolved recovery of certain regulatory assets and liabilities, unfunded taxes, depreciation, and decommissioning.

The net impact of these items was approximately $90 million, or 21 cents per share.

These amounts were offset by 10 cents per share for the following items: the change in the estimated market value for dividend participation rights associated with the holding company's convertible notes; costs related to the NEGT bankruptcy; net interest expense related to amounts held in escrow to pay disputed claims and finally interest for the short period between the end of last quarter and the utility's chapter 11 exit on April 12th.

Our earnings release provides more detail on each of these items.

Now, let's spend a few minutes on the refinancing of the regulatory asset.

The base from which we'll discuss these implications, as Bob referenced, is the multi-year forecast we made last fall.

On the basis of that forecast, we expected to use free cash flow in the utility to strengthen its balance sheet until the utility reached its targeted equity ratio of 52%.

After that, we'll have additional cash flow for dividends, share repurchases and the utility's investment opportunities.

We've estimated that the target equity ratio of 52% would be reached by mid-2005, and it's on that basis that we stated our aspiration to begin paying a common dividend in the second half of '05.

Now, with that as background, here is how the refinancing would work and what its implications would be.

We're targeting the first issuance of the Energy Recovery Bonds to refinance the regulatory asset in January of next year.

The timing will be driven by two key items.

First, a financing order from the CPUC that authorizes the utility to issue the new debt.

We filed our application for this on July 22nd.

The CPUC is scheduled to issue an order within 120 days of the filing.

Second, a private letter ruling from the IRS that affirms the refinancing doesn't result in accelerated taxable income.

We filed that request on June 8th, and we estimate this process to take approximately six months from the time of our request.

The timing for both of these items takes us to the end of this year, which is the basis for our January, 2005 target.

We forecast the first series of Energy Recovery Bonds to be sized at approximately $1.8 billion.

This amount is based on our estimate of the remaining after-tax balance of the regulatory asset at that time.

A portion of the proceeds will be used to retire utility debt.

This will rebalance the utility's capital structure, so that it achieves its targeted equity ratio of 52%.

The remainder will be used to retire utility debt and equity, in proportion, so as to keep the utility's capital structure at the authorized level.

Of the $1.8 billion in proceeds, we estimate using approximately $1.1 billion for utility debt retirement.

The rest of the proceeds, when combined with free cash flow generated by the utility during the year, are expected to provide $1.2 billion for dividends and share repurchases in 2005.

As you know, once the utility receives the cash proceeds from the refinancing, it will no longer earn and 11.22% return on the equity portion of the regulatory asset.

Without the regulatory asset, average rate base is expected to total approximately $15 billion next year.

Customers will benefit from the savings achieved by the refinancing of the regulatory asset at a lower cost.

With the utility at its targeted equity ratio in early 2005, we aspire to resume paying common stock dividends in the first half of '05, as well as repurchase shares.

With the regard to the dividend, as we've said in the past, we'll look at comparable yields, payout ratios and growth rates for a group of similar companies in our sector.

And of course we'll also take into account considerations of sustainability and financial flexibility.

In addition to share buybacks, another potential use for this cash is investments in our core utility business beyond those already planned, such as utility generation.

Now, for earnings guidance, a reconciliation of our guidance for EPS from operations to projected GAAP EPS is provided in our earnings release.

For 2004, we're reaffirming our guidance for earnings from operations of $2 to $2.10 per share on a diluted basis.

This is based on 425 million outstanding shares.

With the utility's exit from chapter 11, we're no longer issuing new shares for the employee 401(k).

Our guidance assumes we'll earn our authorized return on equity of 11.22%, including the equity portion of the settlement regulatory asset for 2004.

Our guidance also incorporates a new accounting standard, EITF 03-06, which we adopted last quarter.

This standard changes the impact of our outstanding convertible debt on EPS calculations.

While it doesn't affect earnings, it does reduce bought basic and diluted EPS.

We anticipate that this new standard will reduce diluted EPS from operations by approximately 3 and 4 cents in '04 and '05, respectively, compared to the prior method.

Our first and second quarter 10-Qs provide more detail on this.

Now, looking ahead to next year, we're setting an earnings from operations target range between $2.10 and $2.20 per share for 2005.

The major assumptions for this range are the following: first, the utility will earn an 11.22% return on equity portion of the rate base, excluding the regulatory asset.

Second, the first series of Energy Recovery Bonds to refinance the regulatory asset will be issued in January, 2005, and the second series is assumed to occur in 2006.

Third, proceeds from these bonds will be used to retire utility debt and equity in order to manage its capital structure to the authorized levels.

Fourth, the total amount of cash available for dividends and share repurchases in '05 will be approximately $1.2 billion.

Fifth, the corporation's $600 million senior notes will be retired.

Sixth, the $280 million convertible notes will stay in place.

And finally, seventh, the claims between the Corporation and the NEGT remain outstanding.

If the refinancing of the regulatory asset is delayed, or for some reason doesn't occur, the utility would continue to earn 11.22% on the equity portion of the regulatory asset.

As mentioned in this case, the utility's equity ratio is estimated to hit 52% by mid-year 2005.

Also remember that shares outstanding would be higher, because there would be less cash available for repurchases.

To sum up, we're on track for the remainder of this year, and we continue to make good progress towards next year.

And with that, I'll turn it back over to Bob.

Thanks, Peter.

Well when you look at PCG, you can see a strengthening utility balance sheet; a growing track record of steady, positive regulatory decisions; $3 billion in cash available for common dividends, share repurchases, and additional utility investments from 2005 to 2008 with the current regulatory asset; and with the refinancing, a front end loading of the cash flow over that period.

You see an aspiration to advance, the re-establishing of regular dividends, and a management team committed to deliver these results to shareholders.

And now Gabe again.

All right.

In addition to our earnings release we, as usual, are filing our form 10-Q with the SEC today.

Let me remind you that the prepared remarks and the Q&A session to follow contain forward-looking statements, based on expectations and assumptions reflecting information currently available to management.

Actual results may differ materially from those forward-looking statements.

We encourage you to review our SEC filings to obtain additional information and to better understand the many factors that can influence future results.

Now for the Q&A session, as usual, we'll take one question per caller in order to provide everyone an opportunity to be heard.

And, of course, you can rejoin the queue if you have additional questions.

With that, operator, can you provide the instructions?

Absolutely. [Caller Instructions] Our first question comes from Teresa Ho of Solomon brothers.

Go ahead, please.

Yes.

Only one question, huh?

As far as the use of proceeds for 2005, in your footnote 1 for '05 guidance, you say that the estimates include a range of shares outstanding.

Could you provide a bit more color in terms of what the range is for the '05 guidance?

Well, our general estimate is approximately 425 million shares for the year.

And the principal question that we have is what will be the amount of dividends that will be paid?

And so that factor is really the driving issue as we go forward.

Excuse me, I just wanted to say 425 million for 2004 is the number we had in mind.

So the question will be how much in the way of dividends do we pay?

And you obviously have a tradeoff between a smaller dividend and more share repurchases and a larger dividend and less in the way of share repurchases.

And, as we mentioned before, we haven't finalized what our dividend policy will be.

Those decisions will be made closer to the point at which we actually pay the dividends outstanding.

Okay.

Next question.

Our next question comes from Vic Khaitan of Deutsche Asset Management.

Go ahead, please.

Thank you, Bob and Peter and others.

Question about the California resource planning and where do you stand in terms of your short position and how do you plan to meet that through buy or building?

Or how do you manage that?

Vic, this is Gordon Smith in Pacific Gas and Electric.

Let me just say, your question kind of gets to two parts, one is looking at this year and then looking out a little bit farther.

We've completed securing capacity for 2004 to meet our peak demand.

And, in fact, even two weeks ago when there were record demand for kilowatt hours in California, we had adequate supplies to meet our demand and still be able able to choose between the purchases from the market and supplies that we had previously secured.

I think the concern, again, a couple of weeks ago was seven transmission lines out of service in southern California, and a couple plants were off line.

As we look to the longer term electricity procurement plan proceeding, which is ongoing at the California PUC, PG&E filed our response to the commission's request on July 9th.

The period of time we're looking is between 2005 and 2014, and we're requesting the PUC clearly establish electric reliability standards, long-term cost recovery protection, and non-bypassable rates for recovery of procurement costs.

As we look forward to where we're going to meet the demand for electricity we, like the state, are first emphasizing a new cost effective customer energy efficiency programs and other demand response programs; before we either acquire or build new generating capacity.

We're requesting about $250 million for the periods 2006 through 2008 for new energy efficiency funding, and then we're proposing to accelerate our renewable energy resource portfolio to about 20% of our total on a schedule that's earlier than the current 2017 legislative mandate.

Like the current authorization, we're requesting authority to enter into short and midterm power purchase agreements over the next five years.

But over the longer run, we're requesting that the commission approve our solicitation of offers for approximately 2,200 mega watts of reserves additional capacity between now and 2010.

We're proposing that 50% of that 2,200 mega watts be utility owned and 50% be long-term power purchase agreements with a caveat to ensure our financial health and, quite honestly, to have a correct economic decision that the -- that our plan requested commission adjust our authorized capital structure to mitigate debt equivalent impacts of long-term power contracts in our portfolio.

So we're looking to about 2,200 mega watts of new capacity through 2010; 50% utility owned, 50% solicited from the market.

And the current PUC schedule calls for hearings this fall and, again, the commissions holding hearings for San Diego Gas and Electric as well as SoCal Edison, and we're hopeful to get a decision issued by the end of this year.

Okay.

Next question.

Our next question comes from Paul Fremont of Jefferies.

Go ahead, please.

I guess my question relates to the timing.

If you're issuing the securitization bonds in January and you're not projecting to get to the 52% equity ratio until mid-year, does that relate to the timing of when you would actually be able to either call or pay off debt maturities at the utility?

And would you not be able, in the interim until you are able to reduce debt at the utility, would you not be in a position to dividend funds out of the utility and up to the holding company before the actual right sizing of your debt?

Let me clarify a couple of points because you mentioned some things that aren't precisely correct.

There are two scenarios that we have outlined for the public.

And that is, the first is, if we do a securitization in January, which is what we'd like to do and is really the primary forecast scenario for us.

In that event we'd raise the money, the equity ratio we would pay down debt in the utility essentially immediately.

The equity ratio would go to 52%, essentially immediately in January.

Then we would reduce debt and equity in proportion, and the equity that would be reduced would be paid up almost immediately to the parent corporation.

And that would be available for the payment of dividends and share repurchase.

The alternative -- let me just continue.

The alternative scenario that we mentioned in the script was in the event that the securitization did not take place, in January, then, all other things being equal, we would hit the 52% equity ratio approximately mid-year in '05.

Now, in response to the second part of your question, at the point that we had the funds available in the utility, we would then be in the position to retire debt and equity immediately.

So that would either be sort of in the January timeframe or alternatively later in the year if there was no securitization in January.

Under the generic -- under the January scenario, you would then be in the position to reimplement the dividend either like January or February, not mid-year.

What we said in our script was during the first half of the year, and the months January through June 30th fall in the first half of the year, so it could be any time during that period.

There are a number of factors that will impact on that and we'll just have to look at them, as they arise.

We do appreciate the investment community's desire to have dividends paid as quickly as possible.

And we share that.

And we share it, right.

Sort of a related question would be the $1.2 billion that you talked about in terms of the amount of utility dividend up to the holding company, is that just the proceeds from the securitization bonds, or does that also include transferring the earnings up to the holding company as well?

Or, in other words, I assume there would be more cash available beyond the 1.2.

Yeah, Paul, this is Kent Harvey.

The 1.2 reflects both the equity distributions available from the refinancing as well as those available from the ongoing operations of the business during the calendar year '05.

Thank you.

Okay.

Next question.

Our next question comes from Scott Pearl of Huntington Capital.

Go ahead, please.

Hey, guys, good morning.

I was wondering if you could go through, from a tax standpoint, when you guys get the proceeds in, I guess the billion eight, in 2005, you don't pay any taxes on that but when you get the next traunch in, at that point you pay -- that next traunch is supposed to cover the taxes on that regulatory asset?

Those are applied to pay down the taxes?

Yes, this is Kent Harvey.

We are seeking a private letter ruling which would not require us to pay taxes on receipt of the proceeds.

Instead, we would pay taxes as the regulatory asset that was put in place was amortized and collected from customers over its life.

The second traunch is to provide for those tax payments throughout the life of the bond.

Okay.

Next question.

Our next question comes from Teresa Ho of Solomon Brothers.

Go ahead, please.

Hi, again.

I just wanted to ask the incremental interest expense that you have listed in your '05 guidance, could you explain what that is?

Teresa, are you taking a look at the interest expense in that schedule of non-GAAP to GAAP in '05?

Yeah.

I believe that's the interest expense arbitrage that relates to the money that we have held in escrow, which is $1.5 billion or something like that.

We're holding that in escrow for disputed claims.

So what has happened is we borrowed the money at one price and we also earned income on the funds that are invested.

So it's the differential between those two.

Okay.

Thank you.

Our next question comes from Vic Khaitan of Deutsche Asset Management.

Go ahead, please.

I'm back again.

Follow up question to Gordon about what kind of rate base growth can one expect given what you talked about, the resource planning as well as any other needs?

You know, Vic, this is actually Kent.

You've probably seen projections of our rate-based growth excluding additional new investments in generation because those are included in the multi-year forecast that we put together last fall.

In terms of the generation, the new incremental generation that Gordon was referring to, he referenced about 2,200 mega watts of new generation that was long-term, of which 50% would be utility owned.

So this is over the next several years.

So if you were looking at about 1,100 mega watts and you could see a price of maybe 500 -- 5,000 -- excuse me, 500,000 to $600,000 per mega watts.

It gets you in the 500, 600, $700 million range for total cost for the utility owned portion.

So those are those two traunches that would get you the 1,100 and that goes through 2009.

Then we have the normal rate-based growth which is capital expenditures in excess of our depreciation.

Do you have in mind what that is?

In the neighborhood of about 2 to 300 million per year in rate-based growth over that five, six year -- five-year period.

Okay.

Thank you.

Our next question comes from Steve Fleishman of Merrill Lynch.

Go ahead, please.

Yeah.

Hi, gentlemen.

Good morning, Steve.

In the guidance you're providing for 2005, on the proceeds that you assume for share buyback, whatever that number is; do you assume you're able to institute that immediately up front through some kind of, you know, transaction so that you get the lower share count at the beginning of the year onward, or do you average that in through the year?

What I will say, Steve, is that has been the approach that we've taken in the past.

And when we have spoken to investors, many of them potentially --or possibly not all --but many of them have indicated that that would be their preference.

And clearly from an earnings per share consideration, that would reduce the number of shares outstanding at the front end, and therefore have the most positive impact on earnings per share.

So it would not be unlikely that we would take an approach like that.

Okay.

And just on the senior notes that you're taking out, are you taking those out essentially with cash on hand, and why are you taking those out?

Right.

The answer to the question is yes, that we would take that out with primarily cash on hand.

And the reason for that is as we've gone through it in great detail, we've examined the covenants and they would restrict our ability to buy back as many shares as we would like to buy back.

So basically the way that covenant works is it restrains the amount of stock we can buy back based on the amount that is paid up to the holding company.

And it is 1/2 of that amount, with different adjustments that are made over time.

And, therefore, as we work through each of the covenants in the cash forecast, we realize that we would not be able to buy back as many shares as we would like to or the investment community would like us to.

Thank you.

Our next question comes from Ashar Khan of SAC Capital.

Go ahead, please.

Good morning.

Morning.

Peter, can you just discuss a little bit the 10 cent increase, generally, in the guidance from '04 to '05, what is that made of?

If you can just go through, I guess, rate base or regulated return interest.

And I guess, if I'm right, what I heard is that the share count number could change depending upon the dividend policy and that's not really set in.

Could you put a little more fleshed out how the 10 cent increase happens?

Right.

Well, the first answer is all of the things that you mentioned really impact on our guidance.

But we talked about a -- assuming the securitization takes place, we talked about a rate base of approximately $15 billion.

We're assuming that we go to the 52% equity ratio and we're assuming that the securitization takes place in January.

And we're assuming an 11.22% return on the equity portion of the rate base as we go forward.

Now, what we also mentioned was there's $1.2 billion of cash available for the repurchase of shares and the payment of dividends.

So what you need to do, then, is you need to make an assumption about what our dividend policy will be, and we have specifically not indicated what it will be, so you'll have to make an assumption about that.

You need to make an assumption with respect to our share price and the amount of shares that we would therefore repurchase.

And then given the net income in the numerator that I described above, which gives you your, you know, earnings; and the number of shares that you come up with based on the repurchase, you'll be able to derive an earnings per share.

Now, importantly, don't forget the 4 cent drag related to the new EITF calculation on diluted earnings per share relating to that convertible issue-- the $280 million convertible issue that we have outstanding.

So that's generally how you would approach it.

And I think actually that's a pretty high degree of specificity.

Okay.

And then, I guess, on the corporate level you mentioned the 600 million will go away, correct?

That's the assumption that we have underlining the guidance, yes.

Okay.

Is--

Ashar, I'm going to interrupt you and ask you if you have another question to get back in the queue just so we can allow other folks who might be waiting to ask.

Okay.

Thanks.

Our next question comes from Kit Konolige from Morgan Stanley.

Go ahead, please.

Good morning.

Good morning, Kit.

Hi.

In the assumptions you're making for '05, the capital structure of the utility is obviously going to be 52% equity.

Are you also assuming that the parent is going to have 52% equity, or is that a work in progress?

No, the answer to the question is we have never said that the parent would have a 52% equity ratio.

What we've said is that the $600 million would be paid off.

The 280 million convertible would remain and we do not currently have any plans to refinance the $600 million.

Okay.

Next question.

Our next question comes from David Frank of Zimmer Lucas partners.

Go ahead, please.

Yeah, hi, good morning.

I think there's just a little confusion over some of the '05 guidance still, and maybe there is a little in my mind.

So I guess can we just go through the sum of the parts again, excluding any stock buyback or use for that $1.2 billion for now.

But if I just take the utility rate base, multiply it by 52% and allowed ROE over 425 million shares I get like $2.06 of earnings.

And then there's the EITF you mentioned of 4 cents.

And then what else have you budgeted, aside from a stock buyback, that would account for a drag or benefit at the holding company or other operations that I need to factor in?

Right.

So David, I think that what happens is we're at 425 million shares before we do the buyback.

So, that's for the year '04 and where we wrap up the year at 425 million.

So then what you have to do is think about the 1.2 billion and think about, okay, how much of that would be consumed from the dividends.

And then take the remaining amount that's available of the 1.2 billion, to reduce the share count from the 520 -- from the 425 million.

I understand that.

But what is the drag projected for the holding company, say, in terms of net income for 2005?

Is that assuming that you would take out the 600 million and you would still have the 1.2 billion of cash left over?

David, give us a second here.

I think we're trying to understand your question.

And I'm not sure it's clear.

Do you want to rephrase that?

Sure.

Your guidance for '05, did you say you're taking out the notes at the parent?

The answer to the question, David, is we would use cash on hand at the parent.

To take that out.

Right.

And one question that hasn't been asked today that is normally asked that might sort of fill out more people's understanding is the current cash at the parent as of the end of the quarter was $1.228 billion.

And of that amount, 361 million is restricted.

So we have cash on hand at the parent available to take out that 600 million.

Then in addition to that, we have the 1.2 billion coming up from the utility that would be available for share repurchases.

Okay.

And then what would the drag be from the holding company after that, assuming you use cash from the parent to take out those notes of 600, what debt remains or operations remain that would potentially impact your earnings?

The drag would be about 3 to 4 cents.

And that's with the assumption that the 280 convertible would remain outstanding.

Oh, okay.

So you have about $2.06 coming from the utility, 4 cents impact from EITF and about a 4 cent drag at the holding company and then you've got hundreds of millions of dollars left over which you could potentially buy back stock with?

Am I thinking about that correct?

I think at the high level that's correct.

Okay thank you.

Our next question comes from Steve Fleishman of Merrill Lynch.

Go ahead, please.

Yes, hi.

Is there anything that limits you from potentially earning better than the allowed rate of return?

Steve, this is Gordon Smith.

And, no, there isn't.

We budget, as you know, to earn the authorized 11.2 as it's currently allowed.

But if we can do better, we can earn more; if we do worse, we earn less.

We always consider targeting to earn that return as a minimum.

Okay.

And maybe--could you just kind of tie in your operational plans at the utility to give us a sense, you know, why you feel confident you can earn it, or maybe you could do better or not?

Any flavor there?

Just generally speaking and I'll turn it over to Kent for specifics, if he wants to jump in.

But we budget, we have a number of programs on how we do business, we have the general rate case for 2003, and now the attrition approved for 2004, so we know what our rates and our revenues are going to be.

It's up to us to do programmic budgeting that allows us to at least earn that.

And if we can do better on certain revenue items on the electric or gas side or on the expense side, it'll drop to the bottom line.

Again, as Bob indicated, we start every year and we run the business on an operating basis to earn the ROE.

It's authorized by the PUC.

Okay next question.

Our next question comes from Terran Miller of UBS.

Go ahead, please.

Good morning.

The 6 7/8 of '08 are non-call through '06, and if you're going to retire them early in '05, are you implying that you're going to use the Treasury makewhole?

Yes.

Thank you.

Or next question comes from Wen-Wen Chen from ABN Amro.

Hi, do you have a sense of when the rating agencies are going to look at your ratings again, give you an upgrade, and perhaps cause that first lien of the first mortgage bonds to fall away?

We have no specific timing in mind with them.

Obviously, we believe that when we did our exit financing and received our ratings at the utility that the rating agencies held us to a higher standard in part because of the fact that we were coming out of chapter 11 and all the recent-- over the last several years, the risks in California.

And I think they were largely looking for a continuous track record of improvement.

We think that there has been a very solid track record over many months now in California and in the regulatory environment.

But that is a qualitative assessment and as such it's very hard for us to forecast the timeframe.

Thank you.

Our next question comes from Ali Agha of Wells Fargo Securities.

Go ahead, please.

Thank you.

If my math is right your effective tax rate for the quarter was unusually low, I think it was 26.6%.

Could you explain why that is and what should we assume for tax rates for full year '04 and '05?

Ali, you're exactly right that the tax rate, as I calculated it earlier, was 26.6%.

And the answer to the question is, as part of our GRC, we received --and there was a provision in there for the funding of taxes that previously had not been clearly provided for.

And so that had the affect of reducing our taxes and our effective tax rate.

And that contrasts from the year before, of the 39.3% that we had at that time.

I'll ask our controller Chris Johns about what we might anticipate going forward in terms of tax rate.

Yes.

And the item that Peter mentioned was a one-time item.

So you'll only see that in the second quarter.

We created a regulatory asset to recognize the fact that we'll collect those taxes in the future.

So that's a one quarter impact of reducing our effective tax rate.

Excluding that one item, our effective tax rate, we would expect to be in line with our historical amount which has been just shy of 40%.

And that's in the '05 guidance, right?

That's correct.

Thank you.

Welcome.

Our next question comes from Matthew Mark of Jet Capital.

Go ahead, please.

Can you talk about implicit in the $1.2 billion number of free cash in 2005, what you're assuming for capital spending as well as DD&A, and whether or not we can look to the old exhibit that you referenced at the start of the call as a proxy for evaluating those two items going forward?

We have not provided any updated capital expenditure forecast since that multi-year forecast last fall.

Is your guidance for free cash flow, which you are giving on this call consistent with what you've said in the past?

I wouldn't expect our cash flow forecast to be very volatile.

They're usually pretty steady.

And so I don't think you'll see a major driver there.

And just to be clear, because I think I sensed it from your question, the 1.2 billion of cash available over the course of the year for dividends and share repurchases has already taken into account all of the anticipated capital expenditures at the utility, and we would not anticipate any incremental generation expenditures to be occurring of any substance in 2005.

That's a little bit my question.

But also my question is if you're going to earn, let's say, $2.10 on 400 million shares, just to use a rough proxy, that's $840 million in net income, and you're talking about in addition to the 700 million in cash that's going to be available from that $1.8 billion assumed securitization, another $500 million in free cash in 2005.

So to go from 840 down to 500 in free cash, you know, it's backing into a level of capital spending I think is higher than what has been laid out in the past.

And if I'm doing something wrong, I'd be interested in understanding what.

That's the sort of thing that maybe we can take off line, Matthew.

But I think you must be looking at something differently.

Okay.

Okay.

Next question.

Our next question comes from Michael Goldenberg of Luminous Management.

Go ahead, please.

Good morning, guys.

Morning.

Just wondering on the cash numbers, looking at $1.5 billion of cash that you have now and about another $2 billion that you're going to get in 2005; and yet you'er only allocating $1.2 billion to the dividends and share repurchases and then another--about another $600 million to corporate bonds being bought back.

So am I right, then, to estimate about 1.7, $1.8 billion of cash on the balance sheet in 2005 that's just sitting there?

What I would say is I'm not sure we agree precisely with all of the numbers that you just went through, so let me articulate the numbers that we have, that we have disclosed.

In the utility we currently have, of unrestricted cash, $553 million as of the end of the second quarter, and restricted at the utility of 2.144.

So those combine to make that $2.7 billion cash at the utility.

At the holding company, we had 867 million of unrestricted and 361 million of restricted for 1.228 of total cash.

So, just to get the cash numbers correct, okay, as to where we're at, that describes it as of the end of the quarter.

Those numbers are slightly different than the numbers that were mentioned-the 1.2 billion because what that -- what we indicate is after a variety of all sorts of movements in cash, capital expenditures, this, that, and the other thing, there's 1.2 billion that becomes available to pay up to the Corp.

That's available at the Corp. for the payment of dividends and share repurchases.

Now, that number does not include the cash on hand at the Corp. that we expect to have at that time which will be, you know, somewhat a derivative of the 1.228 billion of cash that we currently have on hand.

So the way we think about it is we'll use cash on hand for the reduction of the 600 million in debentures.

We'll use the remaining cash that we'll keep on hand for the restricted 361 plus free cash available to manage contingencies, and then we'll use the 1.2 billion for the payment of dividends and the share repurchases.

So that's the way we're thinking about cash.

I wanted to make sure you had the numbers that we currently have in terms of cash balances on hand.

Aren't there like several hundred millions of dollars, whether restricted or not, that will be throughout the system just sitting creating a cash cushion?

What's going to remain on the utilities, we had the still disputed claims resolution.

So that's going to be worked down over time, the 2.1 billion there.

So we have claims, and we have cash, and the two will sort of be offset, one against another, and then we anticipate we'll have maybe a little left over then-- some amount left over, because we think that the actual claims will not likely come up to the -- up to the disputed claims number.

Then at the holding company, we're restricting the 361, and then included in our numbers is some amount of money for, you know, rainy day contingency, which is I think about 1 to 200 million when you go through all of the calculations.

Okay.

Just one final question, I'm sorry if I'm taking up a lot of time.

But you said you wanted to repurchase the corporate notes because of problems with dividends and repurchasing shares and things like that.

Would it be possible to issue similar type of leverage at the Corp. without such restrictive covenants?

Yes, it would be.

Okay.

Thank you very much.

Our next question comes from Greg Gordon of Smith Barney.

Go ahead, please.

Thanks.

Good morning, guys.

Good morning, Greg.

So if I think about this right, this 361of restricted cash to the parent, that's related to the tax sharing arrangement--or tax sharing dispute that has yet to be resolved with the NEGT, is that correct?

That's correct, Greg.

So if we wanted to make an assumption that you were going to win that dispute, then at some point in the course of 2005, that cash would become unrestricted?

That's correct.

And we would have to assume a use for that cash?

That's correct.

You also, can you just reiterate what you said earlier with regard to share repurchases, did you say you're currently assuming a sort of buyback that averages over the course of a year, but that you're considering doing something more aggressive like a tender that would front-end load the repurchase.

Is that a fair translation?

Yeah.

You'll recall historically that the company has undertaken an accelerated share repurchase program when we had the sale of the power plants.

I would say that we're giving favorable consideration to a similar approach.

Okay.

So when we think about share count for 2005, we ought to consider a scenario where the-- as opposed to sort of an averaging over the four quarters, there might be a front-end loading to that repurchase?

I would certainly say that that's a possibility, probably a good possibility.

And then you've got--so you've got the dilution from the converts, hopefully at least an 11.22% ROE on a 52% equity ratio at the utility and a share repurchase, which might be front-end loaded and hopefully another 361 million of cash coming free for shareholder uses over the course of the year, is that --

The -- we have not included in our guidance the 361 for share repurchase.

So that will be something that is an assumption you can make or not make.

Is there anything else you would do with it--or that if it were to become free that we ought to consider, or should we assume that's either going to be used for dividends or share repurchases as a default assumption?

The answer to the question is we haven't really identified any such use.

We recognize that a very good use of that would be for share repurchase.

Okay, and then going forward the rate base grows absent an increase in the plan relative to the current stock in front of the commission, the rate base would grow under the normal course of about 300 million a year?

You said 2 to 300, Greg, that's right.

Is there any FERC jurisdictional -- are there any FERC jurisdictional assets on which you earn that we should think about in addition to the 15 billion in rate base or any other earnings assets?

The electric transmission -- this is Kent.

The electric transmission rate base which is included in the 15 billion overall number is FERC jurisdictional.

Okay, so there's no incremental assets at the utility that we should layer into that 15 billion?

I think it's all reflected in that estimate.

Okay.

Thanks, guys.

Welcome.

Our next question comes from Greg Schultz of SAB capital.

Go ahead, please.

Hi.

I wasn't clear, the securitization that you're going to do in January, is that the entire 1.8 billion?

It would be approximately 1.8 billion, that's correct.

That's the first traunch of the securitization.

The second traunch could be up to an additional 1.2 for a maximum of 3.0 billion.

We currently don't anticipate doing the second until early '06.

Oh, because I thought the whole -- I thought the asset was 2.2 billion.

That's an after-tax amount.

And we're--the legislation provides for us to refinance both the after-tax amount as well as any future taxes, up to a maximum of $3 billion total.

Right, so the pre-tax amount is actually a total of 3.7 billion.

Okay.

The agreement provided for a securitization of 3 billion of that 3.7 billion.

So the 1.8 that you're assuming that you do in January is a pre-tax number, right?

The 1.8 is our estimate of the forecast remaining after-tax balance excluding any tax liability at that time.

Okay.

And then how much do you expect to actually securitize in January?

That is the $1.8 billion figure that we expect to securitize.

Okay, so you've got 1.8 billion in cash, you pay off -- you right size the capital structure at the utility and then everything else goes up to be used for corporate purposes; buy backs, dividends.

Correct.

That's correct.

Okay.

Greg, I'm going to cut you off.

I'll invite you to come back in, but I'd like to go to the next question.

Our next question comes from Tom O'Neal of Lehman Brothers.

Go ahead, please.

Just curious what assumption you've made around the renewal of the gas accord and then just a reminder on what level of the rate base of the 15 billion it would be.

We're in the process for the gas accord, which is the regulatory structure within California for our intrastate pipeline.

That's roughly 10% of the total rate base, so it's a smaller portion.

We still don't have clarity on the gas accord at this point, but I think we've indicated before that our guidance for next year, as it has traditionally, is based on the overall utility earning and authorized return of around 11.22.

Okay.

Thanks.

Our next question comes from Neal Stein of John Levin & Company.

Go ahead, please.

Yeah, just one quick question.

Wanted to clarify, the second traunch of securitization, basically that money goes to the government, not shareholders or the current debt holders?

Yeah, ultimately those funds will be used to pay taxes as the we amortize the regulatory asset over its nine-year life.

So does that sit on the balance sheet over that period of time?

It will sit on the balance sheet and the funds will be held in an escrow and what they earn during that period-- we've proposed will be credited to customers through rates, until we actually use the funds to pay the taxes.

Okay.

Our next question comes from Nicholas Singer of OZF.

Go ahead, please.

Hey, guys.

How is it going?

Good, Nick.

Just generically, how do you guys think about the capital structure at the holding company because, I guess, pro forma for the paydown you're only going to really have the convert.

Right.

The answer to the question is we haven't finalized our decision making at that time or our policy around that.

But, as we mentioned, in the near term, at least, the plan is to pay down the 600 million.

We do not have any current plans to refinance that with, let's say, $600 million of debt that would not have currents.

I guess have you guys weighed possibly just offering kind of a fee to the bond holders to wave the covenants, they're problematic rather than having you pay the Treasury makewhole?

Nick, you know, we've been through a tremendous amount of during the last few years, and I think we've demonstrated during that period of time, that we evaluate all reasonable alternatives.

And we're constantly doing that.

So we look at refinancing, we look at, you know, all different instruments we have out there.

So you can be assured that we're constantly doing what you would expect and want of us, which is to evaluate all those different alternatives.

Fair enough.

I really appreciate it.

Thanks, guys.

Chris, we probably have time for one more question as we're getting up on 60 minutes here.

Okay.

Our last question comes from Derek Krebbs of Glenview Capital.

Go ahead, please.

I'm sorry, guys, if you already touched on this, but could you reiterate what your free cash flow and CapEx guidance is for 2005?

What we've mentioned in the course of this is that $1.2 billion would be available for the repurchase of stock as well as the payment of dividends.

And we haven't provided a specific capital expenditure number.

But what we've indicated is the last point of reference on that are the forecasts that we provided in connection with the bankruptcy.

We've referred to generically as exhibit C.

Okay.

Well, we're very pleased to have had this opportunity to discuss these strong second quarter earnings with you.

We're pleased to be looking for 2005 with continued strong performance and dividends and share repurchases in the picture.

We appreciate your interest in PG&E Corporation and we look forward to these discussions with you as we continue our progress.

So thank you and have a good day.