美國南方電力 (SO) 2005 Q1 法說會逐字稿

Good afternoon. My name is Kimberly, and I will be your conference facilitator. At this time I would like to welcome everyone to the Southern Company first quarter 2005 earnings conference call, hosted by David Ratcliffe, Chairman, President, and Chief Executive Officer; and Tom Fanning, Chief Financial Officer. All lines have been paced on mute to prevent any back ground noise.

After the speakers' remarks, there will a question and answer period. If you would like to ask a question during this time, simply press star then the number 1 on your telephone keypad. If you would like to withdraw your question, press star then the number 2 on your telephone. Thank you. Mr. Ratcliffe, you may begin.

Thank you, Kimberly, and good afternoon, and thank all of you for joining us. I'm very pleased to be with you for our first quarter earnings call, and as Kimberly said, joining me today is Tom Fanning, our Chief Financial Officer.

Before I continue, let me remind you that we will be making forward-looking statements today in addition to providing historical information. There are various important factors that could cause actual results to differ materially from those indicated in the forward-looking statements including those matters discussed in our form 10K and other S.E.C. filings.

As you can see from the earnings materials we released this morning, we had an excellent quarter. Our businesses are performing well, and we're off to a great start to meet our financial targets. At this point, I'll turn things over to Tom Fanning for a discussion of our financial highlights for the first quarter, and our earnings guidance for the rest of '05.

Thank you, David. We are very pleased with our first quarter performance. Obviously, our numbers were well ahead of the estimates we provided you in January. I'll discuss the specific reasons why in a few minutes, but first, let's review our numbers compared to the first quarter of last year.

We earned $0.43 a share in the first three months of this year, this compares with $0.45 a share in the first quarter a year ago. That's a difference of $0.02 a share. For the first quarter, we were $0.02 above consensus.

Now let's turn to the major factors that drove our first quarter numbers. When you think about Southern's earnings, 80% of our net income comes from our retail regulated business, about 16% from competitive generation, and the rest from other. In summary, for competitive generation and other, there were no variances attributable between the first quarter of 2005 and the the first quarter of 2004. Therefore, all of these variances for this quarter relate to the retail regulated business.

First, the negative factors. We were down $0.02 per share due to milder than normal weather, compared to the first quarter of 2004. Weather in January and February was warmer than normal, while March was slightly cooler than normal. In addition, we were down $0.02 per share from increased nonfuel O&M compared with the prior period.

Finally, we were down $0.04 per share from certain regulatory matters, the majority of which is attributable to the expiration of certain of provisions of Georgia Power's 2001 retail accounting order. So in total, we had $0.08 per share of negative items compared to the first quarter of 2004.

Turning now to the positive factors. Price changes and customer growth from residential and commercial customers contributed $0.04 a share to our earnings in the first quarter compared to the prior period. In addition, increased revenues from industrial customers added $0.02 a share to our earnings for the first quarter. So in total, we had $0.06 per share of positive items compared to the first quarter of 2004.

Overall, our quarter came in at $0.43 a share, compared to $0.45 a share in the same period last year. Our earnings estimate for the first quarter was $0.39 a share, so we exceeded our estimate by $0.04 a share. Our positive variance was due largely to underspending on O&M, and higher than expected retail sales, primarily due to increased usage by residential customers. Before I discuss our earnings estimate for the second quarter, I would like to cover some important items that have occurred since our last call in January.

As you may have seen last week, we announced a dividend increase of $0.06, or 4.2% annualized, payable June 6th to shareholders of record May 2nd. The dividend is now 37 ¼ cents per share on a quarterly basis, and $1.49 per share annually. This action is consistent with our objective of delivering long-term earnings growth averaging 5% a year. We believe this new dividend growth rate is sustainable despite the loss of synfuel tax credits in 2008. We look to grow dividend in line with our long-term earnings growth target of 5%, and believe our most recent action is a prudent step toward that objective.

Turning now to our competitive generation business. Earlier this month, we announced the purchase from Constellation Energy of their Oleander facility near Orlando Florida for $206 million. The purchase will be financed by a combination of internally generated cash and short-term debt. We expect the transaction to close in the second quarter of this year.

Oleander is a dual-fuel, four-unit, 680-megawatt, simple-cycle combustion turbine or peaking plant. The plant went into commercial operation in 2002, and has purchased power agreements with Florida Power and Light, and Seminole Electric Cooperative. For PPA with FPL for unit one expires in 2007, and the agreement with Seminole for the other three units ends in 2009.

We are confident about our ability to remarket this capacity, particularly since it is located in a high-growth region, and a region where investor-owned utilities are required to target reserve margins of 20%. In addition, we have excellent relationships with many potential customers throughout the Florida market. One final comment about the attractiveness of this unit concerns its operating performance.

In 2004, Oleander had the fourth highest capacity factor, 8.1%, out of 28 simple-cycle gas turbines in Florida, which averaged about 4.8% capacity factor. In 2003, Oleander had the second highest capacity factor. So we believe its operating history is excellent.

The purchase of this facility is consistent with our competitive generation strategy. We've said we would make asset purchases that are accretive to our earnings and are contracted with a solid credit-worthy counter party. The Oleander facility meets those criteria, and will help Southern Company achieve our goal of producing 300 million of net income from the competitive generation business by 2007.

Turning now to synfuels, I know that a number of you are interested in, how the recent increase in oil prices could impact our ability to recognize synthetic fuel tax credits. We've secured a hedge to reduce our exposure to rising oil prices. As a result, according to our latest projection, the price of oil on the New York Mercantile Exchange, or NYMAC, would have to average approximately $65 per barrel for the remainder of the year before we would recognize any negative impact to earnings.

Including fee-related income, our synthetic fuel business represents approximately $0.11 per share on an annual basis, or approximately 5% of our earnings. In reviewing our current earnings guidance, it's clear that all of our businesses are performing well. However, given the nature of the variances we experienced and since the majority of our earnings are made during the summer months, we are still comfortable with our year-end EPS range of $2.04 to $2.09 per share.

In terms of providing an estimate for the second quarter, we're projecting to earn $0.49 per share. Now I'll turn it back to David for his closing remarks.

Thanks, Tom, and as Tom just outlined, we're off to an excellent start for the year. Our businesses are performing well, and we're executing on our plan. With the rate case activity we completed last year, we're on track to deliver on our earnings estimate of $2.04 to $2.09 for the full year. That concludes our formal remarks.

At this point, we'll be glad to answer questions that you might have. Operator, we'll be glad to take the first question.

At this time, I would like to remind everyone in order to ask a question, simply press star then the number 1 on your telephone keypad. We'll pause for just a moment to compile the Q&A roster. One moment please for your first question.

Your first question comes from Vic Khaitan with Deutsche Investments.

Yes, thank you. David or Tom, you talked about this competitive general acquisition which is earning accretive. Could you also talk about the return you get on the investment you make, as well as what kind of a approval process is needed to alleviate any market power issues?

Well, let me hit the last one first. We don't believe we have any market power issues in Florida, number one. It has to be approved by FERC. We believe that based on a normal schedule, we would get this approved by the second quarter.

With respect to the kind of returns that we seek to get out of the competitive GEN business, we really don't comment on any asset. What we have said in the past, generally-speaking is, we try to get some premium return compared to our retail regulated returns on these assets, and we evaluate them just as a rigorous manner as we have on anything else. We generally use the same kind of criteria that we would use for other sorts of analysis that must be accretive to earnings per share, it must contribute to our 5% growth rate, et cetera.

So this premium return means at least 100, 200 basis point of all your regulated returns?

That's a decent guess.

Okay. Thank you.

Sure. Thank you.

Your next question comes from Paul Ridzon with Key McDonald.

This Seminole acquisition's a little bit of a deviation from your past practices of entering into unregulated market only with longer term contracts. Is this trend going to continue? And was Seminole more along the lines of upside that you see when the contracts expire, or just capturing some of the upside in the current contracts?

Yeah, Paul, thanks for the question. First of all, let me assure you, that when we went through the evaluation of this transaction, we assured ourselves that we felt comfortable that we were going to be able to extend these contracts in an attractive fashion to us, and so that's kind of, one our internal predicates going forward. So we believe that there is an attractive market. We believe this is an attractive asset in a good location with a good operating history, and we believe we've got great relationships with customers around that area.

Okay. What did your synfuel hedge cost?

About half a cent.

Your next question comes from Dan Jenkins with the State of Wisconsin Investments.

Hi.

Hey, Dan.

I was looking on page 9, plus I think you mentioned about the nonfuel O&M up about 10% or 9%. I was wondering if you could explain what's behind that.

All right, I'm sorry, Dan, I couldn't hear you. Are you talking about the nonfuel O&M?

Right.

Sure. Most of the variance for the quarter was attributable to a special expense we made associated with the Natural Disaster Reserve, essentially the Storm Damage Reserve in Alabama. When you look at the total variance for the quarter it was about $71.6 million. 45 million of that was essentially a contribution to replenish Alabama Power's Storm Damage Reserve account.

You may remember that we had, last year, Hurricane Ivan go through. And so essentially that 45 million contribution replenished that account and actually made it a little bit positive. I guess right now, I think it will have a balance somewhere around 5 or $6 million. Working with the Alabama commission, we intended to make that transaction income neutral, and as a result, we did a partial reversal of unprotected excess deferred income taxes, that was about $28 million that shows up as a credit to tax expense.

So when you consider the $45 million contribution to the storm damage reserve, which would show up in our income statement in the maintenance portion of O&M associated with transmission and distribution, tax effect of that is about 28 million, 20 million tax credit offset.

Okay. So I was going to ask you, then, on page 10, that would then explain what's going on with Alabama there with the earnings before income tax

That is exactly right.

Net income.

That's it.

So that would be something that shouldn't recur in the future quarters, I would expect?

Correct.

Okay. Then also I was wondering if you could give me what the funds from operations were in the first quarter, and then what the equity ratio?

Well, the equity ratio -- the funds from operations in the first quarter. Do we have that? I'll tell you what, we'll get back to you on that. Funds from operations in the first quarter. Equity ratio, you may remember, going back to 2003, we had a goal to get to 38% by 2005. We actually moved our equity ratio up to north of 41%, and that's where it is roughly right now. We expect that we'll be able to stay above an equity ratio of 40% until about 2009, where we'll have to issue some new shares, but between now and through the end of 2008 we don't contemplate issuing any new shares.

Okay. I think that might be all I had. Thanks.

Thank you.

Your next question comes from Paul Patterson, with Glen Rock Associates.

Hi, how are you doing?

Hey, Paul. How are you?

All right. I wanted to follow up a little bit more on this tax thing here and this expense item on the O&M. You had $45 million in terms of storm damage reserve. Is that what it is?

Well, we booked an expense of a storm damage reserve to replenish it. It was negative after Hurricane Ivan. The effect of the 45 million actually made it slightly positive.

Okay. So it's $45 million increase in expense that you had from that. Correct?

Correct.

Okay. And then you also had a $28 million benefit to income tax? Is that what you said?

Reversal of excess deferred income taxes, which showed up as a credit to tax expense.

Okay, so that's the $28 million after-tax number?

Yes.

Okay. That -- why is it a 50% differential between the two of these?

Because one is pretax and one is after tax. Tax effect of $45 million, that nonfuel O&M is before tax. So if you take the after tax portion, it's about equal to the tax effective of the credit to income tax expense.

Okay, I gotcha. So basically they wash with each other; is that the idea?

They're income neutral.

They're income neutral. Now, what is the effective tax rate on a normalized basis that you guys are expecting?

Well, for the quarter, you would see something that's pretty significantly different. For the quarter, what we would show, is '04 effective tax rate of something 27.1, and for '05, 19.7, but that is overwhelmingly impacted by this adjustment in Alabama. We think for the year that we'll see an effective tax rate including this be to around 27%, without the adjustment, it would be, like, 29.

Okay. Without the adjustment it would have been an 29%

That's right, and that's what we would expect for the year.

That's what you would expect on a normalized basis for the year, would be 29?

Yes.

Okay. Without the this adjusted that we just went through?

Right.

Okay. Now, with the synfuel, you said $0.11, approximately, a share from this, and you mentioned you were hedged in 2005, and you said you wouldn't have a negative earnings impact -- if I understood you correctly -- unless for the rest of the year the price of oil averaged $65 or above. Does that mean that you would begin to enter into the phaseout range at $65?

Yes.

Okay. And before that, there would be no impact what so ever, you'd have a normal impact?

Well, we're hedged up to $65, so even though you would enter into the phaseout range, at a any point we're hedged unless the average for the balance for the year is above $65.

Okay. Now, what about 2006? Are you hedged for that at all?

We are not.

Okay. And what's the thought process? I mean this thing just only cost you half a penny, I think that was Paul Ridzon's question, what's your thought process in terms of 2006 and 2007? I mean any thoughts there in terms of locking this sort of issue out of the picture?

Sure, we look at it. You know, the way we think about synfuel, you know, it continues to evolve. It's interesting. I think more and more -- in fact feedback I get from people like you and others is that, synfuel earnings may not be considered to be part of sustainable earnings, and rather synfuel earnings are reflected in the stock value, really, as kind of cumulative present value of future cash flow. You know, if you take kind of future synfuel earnings for Southern, discounted at 10%, you get something like $0.25 per share. Okay? So you're really dealing with that kind of increment of value.

Right. I mean, I'm just trying to figure out is -- I mean, since it only cost a half a penny to sort of hedge 2005 --

Why not do it for the rest of the years?

Yeah.

We actively talk about it all of the time. Kim Greene and I work on that, and she runs herd on all of those issue, so it's under discussion.

Thanks a lot, guys.

Sure. Thank you.

Your next question comes from Kerry St. Louis with Fidelity.

Hi, good afternoon.

Hey, Kerry.

I just wanted to ask about your fuel recovery. If I remember correctly, I think you're going to be filing for new fuel rates in Georgia.

That's right.

I just wanted to go over that process, and then also get an update on your fuel recoveries in other jurisdictions, just to make sure there has not been any kind of big working capital drag.

Okay. Super. Georgia Power filed for a fuel rate increase on February 18th of this year. The number right now represents something like an 11.8 increase in total revenue. The projected amount kind of at the end of May would be somewhere around $500 million. We would expect to recover that over a 24-month period. I believe the date in which we think we'll get a result will be around May 17th, and the new rates would be effective June 1.

Okay.

What else did you --

How are you in terms of your other recoveries in other jurisdictions?

Got it, thanks. We're actually in pretty good shape. In April, Alabama Power had a fuel filing where its cost recovery factor increased slightly, from $1.52 to about $1.79 per kilowatt hour. It's about a 4.5% increase in annual retail revenue. So that's already kind of happened. For year end, you know, we continue to monitor the situation, but I think with Alabama and Georgia spoken for, that covers the majority of the issues.

Do you have hearings on the Georgia Power or what's the process?

Oh, sure, there have been hearings, and the hearings are going fine. Certainly we have lots of different testimony. We had a staff expert testify that generally he found to be supportive to the Company's position. Other people have testified. You know, as with our constructive relationship with the Georgia commission, I think we'll be treated fairly.

Great. Thanks so much.

Sure.

Your next question comes from Rudy Tolentino with Prudential Equity Group.

Hi, good morning. Can you give us an update on your market power case at FERC.

Basically it's still in process. We made all the filings and we are awaiting FERC's decision, and we'll go from there.

All right. Thank you.

Your next question comes from Greg Gordon with Smith Barney.

Thanks, guys, but you've answered my question.

Hey, Greg.

Your next question comes from Terran Miller with UBS.

Good afternoon, Tom. I was wondering with the Oleander deal, are we supposed to start backing down the place holder that you had in Southern Power CapEx in 2007?

Yeah. Generally-speaking, I think what we've got is $300 million a year for the next three years on the average, and so you would essentially include the CapEx associated with Oleander, deduct it from, kind of, that place holder. Yes.

Okay. Thank you.

Sure.

Your next question comes from Ashar Khan with SAC Capital.

Good afternoon.

Ashar, how are you?

Pretty good. Tom, could you give us just generally the forecast for the second quarter, 49 I guess last year it was 47. What would be the differential for the higher earnings generally, if you can just walk us through, if you can.

Sure. Just sec, I can get that for you. Let me just get my hands on it. Yeah. Basically -- basically what we -- no, you want it against the second quarter. Perfect. The second quarter versus the $0.47 last year?

Yeah, second quarter of last year was 47, right?

Yeah, I think that's right. I've got it right -- yes, it was. I guess its gonna go to something like this. We expect that competitive GEN is going to basically track what it was last year. I think the interesting story on competitive GEN, is that we're seeing -- while the numbers look consistent, we're seeing a transfer from energy numbers to kind of long term contract numbers. In fact, the numbers last year were, like, 30% energy marketing, and 70% contract.

Now they're, like, 12% energy marketing, 88% contract. So we feel good about that. As well, we see an increase coming from a new imbedded wholesale contract associated with the 30 electric membership co-ops in Georgia that's coming out of Georgia Power, so that will be a positive factor. We would expect to see normal weather. Let's see. And I guess right now, what you saw at Georgia was essentially an offset between the price increase and the expiration of this regulatory rate that were in place. As we get to quarters where there is greater consumption of electricity, we think that the rates will have a bigger impact. So essentially that's the difference.

Okay. And then, Tom, going back to your, could we expect more deals in the competitive generation business in the next one year? Are there more things in the pipeline that you can kind of announce in the next year or so?

Well, yeah, Ashar. We really -- you know our conservative nature here. We really don't talk about our backlog. I have in my big book of knowledge here a whole section on our backlog, but all I can say is that we've got one, that our people are kicking every rock we see in the Southeast. We're staying true, we think, to our SuperSoutheast strategy in our conservative posture going forward. We certainly encourage our guys at the competitive GEN business to develop new deals, and we debate those things here internally when they come up. So, yeah, we look forward to doing more deals, but other than that, I can't say a whole lot.

And you -- and you mentioned that this deal with Constellation, it is accretive in the first year, as well?

Yep.

Okay. Thank you.

Sure.

Your next question comes Jay Yannello with UBS.

Good morning. Ashar asked my question, but let me just have a quick follow-up. Has weather been fairly normal thus far in the second quarter?

Yeah, everybody makes fun of me about weather here, but, yeah, it's been relatively normal. You know, it's awfully early. I guess if anything it's been a little mild, but generally it's a mild month anyway and so I would throw a blanket over it and call it normal.

Okay. Also, industrial demand year-over-year still looked fairly decent. How are the most recent run rates, is it still holding up?

Yes.

Okay. Thank you.

Your next question comes from Paul Ridzon with Key McDonald.

I had a follow-up on that industrial. How close are we to full capacity, and how much upside is there on industrial? And then second question, I was unsure about your answer to Paul Patterson's question. At $65 average oil price for the balance of the year, do your synfuel credits drop off, or do they start to feather down?

We are protected up to $65, and then it would feather down beyond that.

So you bought yourself about $10 of upside? Is that the way to look at it?

Yeah, sure. And remember it's an average for the rest of the year. So you've got to see a pretty -- in our opinion anyway, you've got to see a pretty dramatic price move in order for that limit to be reached. Our own, you know, gee whiz who knows about probabilistic analysis with oil prices these days, but we just think it's unlikely. We bought ourselves a lot of protection with that level.

Let me hit the other one. And David Ratcliffe here is the Chairman of the Federal Reserve Bank in Atlanta, and he has a particular insight on these matters, so I'll ask him to comment. My quick answer is from the data we see, we're at kind of an interesting influxion point in the economy. What we see is the economists called it exactly right back in '03, that at the end of '03, we saw an improving economy. Through '04, we saw further improvement, and then sustained that improvement through the last half of '04. Frankly that's what we saw in '05.

And I've been dying to get this out in the earnings call, but one of the other factors that you should evaluate in energy sales between '04 and '05 is leap year. That adds about a percent to your sales statistics in the first quarter of the year. As we have seen, the manufacturing sector particularly reached it's capacity, we have seen unemployment levels go down, we've seen capacity kind of maxed out, and what we're still waiting for is for people to build new capacity. I think that's the influxion point that we're waiting to see. David, do you want to comment further on that?

I think that's exactly right. I think most folks who are in the industrial or manufacturing part of the economy are trying to maximize their capability with the infrastructure they have, and are resisting investing new capital unless it's absolutely necessary, and I think as we go forward into the economy, with the impact on some indications of inflation and rising interest rates, and I think people are going to be reluctant and are going to hang on as long as they can to avoid that, and that's really the big question, is will people invest in new infrastructure. Basically the folks we have, for all practical purposes, are running pretty much flat-out right now.

As a reminder, ladies and gentlemen, if you would like to ask a question, simply press star then the number 1 on your telephone keypad. Your next question comes from Douglas Destaebler (ph) with Dequesne Capital Management.

Asked and answered. Thanks a lot.

Hey, Doug.

Your next question comes from Mark Sonnenblick with Citigroup.

Hi, good afternoon. I joined the call late so I apologize if this has been addressed. Can you make a comment about the potential lawsuit from Mirant in terms of intercompany transfers back before the spin-off?

Yeah, we haven't talked about Mirant, so this is new territory for everybody, but unfortunately there's not a lot we can say about it. We have not been served with any lawsuit right now, so we can't comment on it contents, because we don't know of any contents. But what we've said on prior calls remains true. You know, a lot of people worked on that lawsuit, and we had lots of the good help, we involved the rating agencies – I meant the spin -- and in fact, we don't -- from everything we know right now, we don't believe there's any claim, any merit to any claim that may be represented by such a lawsuit, but the facts are we haven't seen anything, and so, therefore, we really can't comment on it.

Okay. Thanks.

Sure.

Your next questions from Vedula Murti with Tribecca Global Management.

Good afternoon.

Hey.

A couple of things. In your '05 to '07 capital expenditures, it's a about $2 billion for environmental. I'm wondering if you can kind of remind us how that's spread out, and what regulatory mechanisms are in place to recover that. And then I have a second unrelated question.

Okay. Sure. Let's go through the capital budget. Environmental over the next three years. Okay? For the system is going to be about $460 million in '05, $620 million in '06, and about $900 million in '07. Okay? That represents something like 29% of our total CapEx for the retail regulated business.

We have recovery mechanisms in place already in Florida, in Mississippi, and in Alabama, and while we do not have such a mechanism in place at Georgia, the accounting orders that we've been traveling under at Georgia, those generally have been three years in duration, and really commence kind of in the '96 time frame, have been certainly sufficient to recover any environmental spend that we've had.

Okay. So sound like things are reasonably covered on a current basis in Florida, Mississippi, and Alabama, and then Georgia will probably be dealt with at the end of the next rate agreement?

That's right, as they have for the past 10 years or so.

My second question, there has been some increasing talk about at some point in time somebody being willing to build a nuclear plant, and I'm just wondering given your nuclear sites, one, whether there is exiting capability there, and whether there's any interest at all in terms of participating in something like that on your sites?

We do believe that we have additional capability in both the Vogtle site and the Farley site in our system. And we are part of the NuStart consortium that is evaluating moving forward with the next increment of nuclear generation in this country. We have put NRC on notice that we are exploring filing for an early site permit, and we'll make that decision sometime later this year.

All right. Thank you very much.

Thank you.

And there are no further questions at this time.

Okay. Thank you very much. Thank all of you for being with us.

Thank you.

Ladies and gentlemen, this concludes the Southern Company first quarter 2005 earnings conference call. You may now disconnect.