Exelon Corporation
Q3 2007 Earnings Call Transcript

Published: 28 Oct 2007

[Operator:]

Good morning. My name is Jennifer, and I'll be you conference operator today. At this time I like to welcome everyone to the Exelon Third Quarter 2007 Earnings Release 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, Chaka Patterson, Vice President of Investor Relations. Ma'am, you may begin your conference.

[Chaka Patterson:]

Thank you, it's sir but that's okay. Good morning, and welcome to Exelon third quarter 2007 earnings review and conference call update. Thank you for joining us today. We issued our earnings release this morning. The release also contains a slide presentation that will accompany John Young's remarks. The slides can be found at the end of the earnings release package. If you haven't receive it, the release is available on the Exelon website, at www.exeloncorp.com, or you can all Dolaras Modia [ph] at 312-394-5222, and she will fax or email the release to you. This call is being recorded and will be available through November 9th by dialing 877-519-4471. International call in number is 973-341-3080. The confirmation code is 9302966. In addition, the call will be archived on the Exelon website. Before we begin today's discussion, let me remind you that the earnings release and other matters we discuss in today's call contains forward-looking statements and estimates that are subject to various risks and uncertainties. Please refer to our SEC filings for discussions of factors that may cause results to differ from management's projections, forecast and expectations. In our press release and during this call, we will discuss adjusted non-GAAP operating earnings that exclude the earnings impact of mark-to-market adjustments from economic hedging activities. Significant impairments of intangible assets, including goodwill, significant changes in decommissioning obligation estimates, investments in synthetic fuel producing facilities, cost associated with the Illinois Electric Rate settlement including ComEd's previously announced customer rate relief, certain costs associated with the terminated merger with PSEG for 2006 only, severance charges for 2006 only, gain or losses on the State Line and Tenaska transactions, and other unusual items including significant future changes to GAAP. We believe these adjusted operating earnings are representative of the underlying operational results of the company. In today's earnings release, we provided a reconciliation between reported GAAP earnings and adjusted non-GAAP operating earnings. With me today are John Rowe, Exelon's Chairman, President, and CEO; John Young, Exelon's Executive Vice President, Finance and Markets and Chief Financial Officer; other member of Exelon Senior Management Team; members of the Generation Company's Senior Management Team; ComEd's Senior Management Team; and PECO Senior Management Team

[John F. Young:]

Thank you, Chaka. Good morning, everyone. As part of our earnings release package, we include slides that I will refer to during my remarks. These slides highlight, both, the earnings for the quarter and year-to-date. My remarks, as they usually do, will focus on the quarter and our outlook for the balance of the year. Beginning with slide 3, Exelon announced third quarter 2007 adjusted non-GAAP operating earnings of $823 million or $1.21 per diluted share, an increase from third quarter 2006 operating earnings of $690 million or $1.02 per diluted share. On a GAAP basis, Exelon reported consolidated earnings of $780 million or $1.15 per share for the third quarter of 2007. One of the main differences between GAAP and non-GAAP operating earnings during the quarter was the $0.12 charge related to the cost associated with the Illinois settlement. As I mentioned on the second quarter call, we believe these costs reflect a one-time event associated with Illinois' transition to a competitive market, and we plan to exclude these cost for future operating earning. These costs would be expensed as credits are issued to customers over time. For a complete reconciliation of GAAP and non-GAAP earnings, please refer to the tables that accompanied the earnings release. Consistent with the first half of the year, Exelon strong performance for the third quarter was driven primarily by increased earnings in Exelon Generation which were partially offset by the extent of decrease in ComEd's earnings. PECO's earnings during the quarter were also up compared to the last year. Turning the slide 4, Exelon Generation contributed $0.90 of operating earning per diluted Exelon share in the third quarter of 2007 compared to $0.51 for the same period in 2006. The major driver of Generation operating earnings growth during the quarter was higher wholesale margins as a result of tree items

[John W. Rowe:]

Good morning, everyone, and thank you, John. As Chuck has told you we intend to talk about the future at EEI in very short time, so I am going to confine most of what I say to the third quarter in this year. At EEI we will try to give you the best picture we can as to next year and the longer term. We had a very strong quarter with year-over-year operating earnings up from $1.02 to $1.21 per share. As John said, we are reaffirming our operating earnings guidance $1.30 [ph] per share and we are delighted to be able to revise the GAAP guidance upward to $3.90 - $4.20 per share. We are very pleased that all of the characteristics that made up this operating performance. Personally, however, I am even more pleased that this has been a quarter when we have been able to commit to complete a wide variety of commitments too. We told you at the end of the second quarter that we expected our Illinois transaction to be confirmed in legislation. It was. Thanks to the hard work of Frank Clark, Darryl Bradford and the majority in their team. We told you at the end of the second quarter that the financial swap that we had entered into was a fairly valued transaction. I know many of you were concerned that that might not be so. Well, [Indiscernible] and their team work this contract out very favorably and we now have the numbers to illustrate that. We promised you that we were going to implement our value return policy and in August the Board approved it and we have executed that policy as is set forth in the press release. So, to me, the third quarter is not only a superb quarter operating wise, it's a superb quarter in the larger context of protecting the value which you all [indiscernible]. We are very proud of the work that Chris Crane, Chip Pardee and the Nuclear Group did. They achieved a capacity factor of 97% during the quarter. I don't think there is too many more percent left that you can get out of Chris. Mark Schiavoni and his Power Group excelled in operating our Fossil and Hydro Group

[Operator:]

[Operator Instructions]. Your first question comes from John Kiani of Deutsche Bank.

[John Kiani:]

Good morning. We've heard the company talk about M&A recently and I'm trying to better understand the value proposition, do you think Exelon has the currency to do a larger deal when the stock isn't placing in the '11 uplift or carbon at this point? Can you talk through how you see that value proposition working?

[John W. Rowe:]

Sure, John. We can't give a value proposition unless and until we have a proposal, you are not going to do something that we think distract from the value we created here. We understand as keenly as you do the value that we can add in 2011 and 2012. Protecting and getting something for it is at the heart at what we do around here. And so, obviously, you just don't stay... we'll see the currency is pretty good let's spend it, we are not made that way. On the other hand, we continue to believe that this industry is slowly and painfully consolidating. We think there are possibilities that will increase the robustness of our value and we keep looking at them. But we are not going to just give away that value that you just described. So, I can't tell you our transaction when I don't have a transaction to describe to you, I mean, I... I'm not good enough to sell something that I don't have to give you at the moment. Now, you know our basic policy on anything specific when we are looking at lest all the lawyers in the room rise up and strangle me is that we don't talk about it until and unless we have something specific to tell you about, and then we will respond to your questions about the value proposition. John we are simply not going to do something that we don't think capitalizes on that value in 2011 and 2012. I mean, I've been... I've lived for value now for damn near 24 years running utility, so I not see now, I didn't throw it away in some kind of old man's ego.

[John Kiani:]

Thanks, John.

[Chaka Patterson:]

Next question, please.

[Operator:]

Your next question comes from Paul Ridzon of Keybanc.

[Paul Ridzon:]

Given your view that forwards aren't adequately reflecting rising heat rates and capacity values, are there any steps you could... in the financial engineering or contract renegotiations that you could implement to try to capture some of that value you see relative to your... what would be below market contracts?

[John W. Rowe:]

While the answer is, of course, sure, the issue is all those other financial engineering is a wise thing to do. I mean the financial engineering in my view is largely an up to date term for what we call leverage in our use. And we are well aware that we have the capability to increase the leverage on our balance sheet. The issue is whether it's a good idea and increases your real value to do that sort of thing and we keep looking at different ways that might make worth while to do so. But remember there is a swirl of things going on here, there is, of course, rising heat rates, we just given a presentation on that to our Board. There is the issue of what natural gas prices are going to do in the next several years, and strangely we tend to be a little more bullish on that than some of the public forecast. But nonetheless it isn't real until it happens. We have given you our value return policy, we mean it. We will be looking at when and what the next increments of that policy should be between now and the end of the year, you can of course expect there is more roll up in the dividend as it normally does this time of year. We will have to look at what the right share buyback kinds of decisions for next year are as we get there, if we can't we'll give you a little better insights into that down EEI but these tend to be decisions that you get... you must have a grasp if the Board [ph] makes specific one. Philosophically, I look at this as increasingly a commodity price driven company. And I spend a fair amount of time studying how companies in the commodity business behave, and the ones who survive and do well for their investors in the long run tend not to be people who leverage themselves to the help every time the commodity looses grip. And in our case, you have not only the different factors affecting the commodity prices, you have constant need to deal with the political and regulatory issues that affect your value. So, that's why I used words like resilience and robust, I want this to be a company that you can count on.

[Chaka Patterson:]

Next question please.

[Operator:]

Your next question comes from Hugh Wynne of Sanford Bernstein.

[Hugh Wynne:]

Hi, I wanted to ask a question or kind of a treasury sort. I was looking at the cash flow statement for the nine months --

[Chaka Patterson:]

People I advise that we are not on video, how far your treasury source... on treasury resource?

[Hugh Wynne:]

Good. The question is this, the cash from operations, excluding changes in working capital has increased enormously this year as a result of the growth in revenues in Illinois by about $850 million. Cash flow from operating activities is actually down a tad, because of the accumulation of investment or working capital, primarily related to collateral assets and liabilities and then also accounts receivable. And I was wondering if I could just get a little bit a light about what those very large cash movements mean, and when they will be reversed as I assume these collateral assets are associated with hedges?

[John W. Rowe:]

Yes, and Hugh I don't know if I can give you all the details, I might have to look at that and get back to you, but I think in general you're right that basic cash from operations is much stronger and higher than last year driven by... the same things that are driving earnings higher, meaning on the Generation side as result of the higher revenues from Generation margins and the expiration of the ComEd EPA. As far as the overall cash position it can also swing around a lot due to margining of cash in and out, and when we had hedges on the books and prices go up we're being margin, and that can move us $400 million, $500 million in either direction because we have quite a bit of volumes that we sell into the wholesale market bilaterally. So my presumption and we can go check that if that's the result of cash, margin cash out of the company, as a result the agreements with counterparties.

[Hugh Wynne:]

Okay. As a result of that we would expect these cash flows to revert to positive as it begin to benefit from those higher prices on your sales, is that right?

[John W. Rowe:]

Yes.

[Hugh Wynne:]

Okay, thank you.

[Chaka Patterson:]

Next question please.

[Operator:]

Your next question comes from Jonathan Arnold of Merrill Lynch.

[Jonathan Arnold:]

Good morning.

[John W. Rowe:]

Good morning, Jon.

[Jonathan Arnold:]

Can, I ask you guys to just comment a little on the specifics of the Carbon Bill that was recently put before congress and what in that you find to be acceptable and I know you have generally been in support of a lot of the proposed legislation but how could that be improved to be a better bill in your opinion?

[John W. Rowe:]

Well there are pieces of that Bill that we like and pieces that we... I am troubled. And we would like... the fact is one more step towards comprehensively dealing with the problem because we think comprehensive gap and trade carbon legislation, we will deal with this problem more effectively and at less cost than simply throwing money at every new renewable is some obvious like. We do not think ethanol is the only scandal with [Indiscernible] in this book. So, we strongly like the gap in trade approach. We like the fact that the, people in Water Bill doesn't just give all the allocations away for free. We had no wish to place unnecessary burdens on states or companies that are more coal dependent than we are, but at the same time our investors and our customers have learned the burdens of a relatively clean fleet for a great many years and we don't think somebody else is entitled to permanently lower prices because they put more stuff up in the air. So, we like the way that we've been learning our dealing with partners. Our biggest questions on this bill involve this sort of new Federal Reserve Bank NOI that they put in place of the kind of safety valve that the Bigham Inspector [ph] Bill has. We are strong supporters of the safety bill concept. We do not think the nation's economy can afford, we do not think the utility industry can afford, to have a bill where the price impacts in the early years are just utterly unknown. So, I don't suppose given the dynamics of the Senate at the moment that the Bigham Inspector safety bill provision will just get added into the Liberman-Warner, I think there will be some complicated set of guidelines. But this sort of Federal Reserve Bank concept won't work unless the legislation contains some guidelines on how this new entity should use floors of ceilings to make certain that carbon is priced into the market in an orderly way and not in a chaotic way. That maybe more than you wanted to know about Liberman-Warner, the bill is of course very long very complicated in that and that there is infinite number of things about it that I don't understand yet. But that's my view as of the moment.

[Jonathan Arnold:]

Thank you, John.

[Operator:]

Your next question comes from Rudy Tolentino from Morgan Stanley. Sorry about that.

[Rudy Tolentino:]

Hi. In your press release, higher labor costs were account for Nickel determent to earnings, can you comment on whether or not it's from your existing employee base or just a reflection of higher contract labor costs and if it is due to higher craft labor, can you give me an idea of how that's trending.

[John F. Young:]

John Young, I think the answer I yes, yes and yes. But John --

[John W. Rowe:]

And I think and I'll have go back to look at the table that you are referring to but yes to all of the questions but last year we had an offset in ONM expenses related to some one-time recoveries as of DST case that we attributed to last year. So you have a... an increase that looks bigger than the otherwise would look, but yes we are seeing normal kind of inflation related labor cost increases year-over-year, that are in the 3 percentage point ranges.

[Rudy Tolentino:]

It's just more on your, for your... the employee end or just more on the craft labor end, for outages?

[John W. Rowe:]

It's actually booked. Obviously we have that built into our labor contracts and then... and maybe Chris Crane, might want to talk to the outage cost of labor specifically.

[Christopher M. Crane:]

The outage labor costs are standard or average escalation is 3.5% to 4% a year. Our material cost has been a little bit higher, they've been averaging about 7% a year. But year-over-year we have adjustment in work scopes based off of cycles that the reactors are in. If we are on a ten-year cycle like we are, a PWRs right now we are doing more extensive inspections that will drive our costs and they'll balance out over the period.

[Rudy Tolentino:]

Okay, so the higher outage costs for this year is looked to the ten year reactor inspections do you think?

[Christopher M. Crane:]

That's partially is with escalations coming in on inflation as it's grown to.

[Rudy Tolentino:]

Okay. Thanks very much.

[John W. Rowe:]

As you look at cost of almost everything in facility does... then it is true for oil refineries and anybody else building these complex things. All of the input for amateurs

[Chaka Patterson:]

Next question please.

[Operator:]

Your next question comes from Paul Paterson of Glenrock Associates.

[John W. Rowe:]

Good morning, Paul.

[Paul Paterson:]

Good morning, guys. I want to touch, based with you on the announcement that public service made with respect to, I think, it]s about 400 megawatts that they think that they are likely, I guess, to announce building because of the higher RPM prices. And just in general, I mean, you are looking at robust market and everything that you just mentioned, what are your thoughts on that and the potential for you guys to make maybe a similar announcement or something like that, just what are your thoughts about the new entrants with respect to the RPM price difference and what have you?

[John W. Rowe:]

Well, I'll invite John in the end to chip in, after I finish my opening here, but first we think the BSEG announcement is a constructive thing. New Jersey is just playing short on capacity and on something redundant in that space. Second, we are fortunately better off in Pennsylvania and Illinois but we keep looking at those same factors, that's partly why I said we just can't camp on what we have. We have to keep looking at what needs to be done. Now, my basic point of view and this is actually quite consistent with these actions is that the current prices are high enough to support peaking in some commitments that are not high enough to support new base-load. Maybe, Ian, would say that most of PJM is still not high enough to support seeking commitments too. But the ones have to stay on, have to make the market broader, and PECO will to have the kind of stake in these markets that we do, after we do that as well. I think this is what Governor Rendell is most concerned about, Pennsylvania, we want to make certain that the state is going to enough... to have it in a greener way, and to do it without prices just skyrocketing, and Dennis O'Brien and our Genco [ph] people haven't stayed with that too, but we don't have any big surprise announcement for you. We are looking very diligently at our possible two nuclear units in Texas. We think that the particularly attractive markets for base-load proposal, we ardently commented the Bush administration on what it's done to implement the Energy Act several years ago and putting out a Loan Guarantee Program that really works because without that, I don think, even we consider merchant nuclear plants at the present time, but with it, it just might work. So, we are looking at those very hard, that's our principal project. But I think, you will see us constantly trying to lead with our energy efficiency program, do the renewals, where they are required by public policy, and they will peak as...where that's needed to keep the lights on. Fortunately, we have a little more time than they do in New Jersey.

[Paul Paterson:]

How much more time?

[John W. Rowe:]

Well, I don't think, we need them in Illinois a lot, 12 or 13, John, and Pennsylvania perhaps a little sooner. Ian, do you want to tell me, when you think Pennsylvania just has to have more capacity.

[Ian P. McLean:]

Yes, I think, early part after 2010, 2011. And what I would just add to what you said is that. Right now, what's happening is, we've got the prices to the point where people are reinvesting in the older plants and keeping them going. We have done that ourselves, I think that the prices aren't quite yet where we would go and build some new PECO's. But we certainly would like to send the price signal, at what cost, we do that. And I think that right now PJM is looking at CONE. The cost of new entrant and then they may even be announcing it today, to raise that. And I think once you get that confidence, and I really do think you start to get some new iron in the ground.

[Paul Paterson:]

Okay thanks.

[Chaka Patterson:]

Next question please.

[Operator:]

Your next question comes from Paul Fremont of Jefferies.

[Paul Fremont:]

Thank you, I guess you mentioned in the presentation that the State Line transaction is expected to result in a $0.05 dilution going forward. Can you elaborate on what you see as the benefits of that buyout? And can you also discuss Kinkade and whether you would consider a buyout of that contract?

[John W. Rowe:]

Well, there are several benefits here. First, we are getting a nice lot of cash and based on our valuation model we are getting, at least a fair price for the buyout of the contract. Second, State Line is a plant where Dominion needs to make a lot of decisions about how it's going to run the plant and how much it's going to invest in the plant. We don't think they would make those decisions on, as plane and rational basis, if they are confined by the contract with us, as they will, when they have, both the expenditure and the output side. So, State Line is a little different then Kinkade, where it's both bigger and our team has more interest in its loan following capability. But that said, we are interested in value and we can afford to deal with a little volatility in earnings if we get more value and it wouldn't shock me, if we would end up looking at Kinkade. But I don't have something to tell you about it, at the moment. But it is, for us it's pure value and with this volatility we need to keep the lights on, Ian do you want to supplement that.

[Ian P. McLean:]

Yes, I think simply put it was a transaction where we got more in cash than we valued the plant at, I mean it was that simple, and that's why we did the transaction.

[Chaka Patterson:]

Next question please.

[Operator:]

Your final question comes from Nathan Judge of Atlantic Equities.

[Nathan Judge:]

Good morning, I wanted to follow up on the question on Carbon Bill. If prices were to rise significantly, following on some type of carbon legislation on the Federal level. What repercussions... could states do anything to change, what impact it has on their customers in the states and would there be any risk of repercussions to utilities and generators in the state.

[John W. Rowe:]

I would like to say not with my lawyers. But even with the best lawyers around. After what you have seen in Illinois and Pennsylvania, the answer to that is pretty obviously, yes, repercussions abound. I mean let's put it very simple, we believe that with what's going on in natural gas markets over the next decade, where most new capacity will still be gas. Because it's what's you can build, we believe that with what's going on in carbon. We believe that with what's going on in capacity shortfall, we are absolutely and uniquely well positioned to benefit. But if those prices go up too much, we will have more than our share of problems. I just finished at our Directors retreat, showing our Board, a three nice photograph of commodore orders Gunboats [ph] going under the guns in Pittsburg, and I said, it must seem to you that somebody is always shooting at us. And the answer is that they are, and they will continue to do so as long as has we have the most valuable platform in the business. And I intend that we shall continue to have the most valuable platform in the business. But that's one of the reasons we support a safety valve on the carbon legislation. The old axiom, bulls make money, bears make money and pigs get slaughtered probably applies to Exelon carbon, we need to make certain move that when carbon legislation come, it's both efficacious and practical. And practical means not shocking this economy with huge cost, all at once, that's why we push the bill. We also defend the safety valve which ought to be of more interest to our core marine brethren. I believe that carbon legislation will create, very major long term value for Exelon shareholders. But it only does that, if we make certain, that it doesn't hurt our customers unnecessarily, and that's what we're setting out to do. We need to show that Exelon is at the forefront of viewing this environmental issue, because this one is real and this one is bigger than any of the others. There is no cheap, one way out of the carbon problem, as the old Star Trek movie says, we are carbon-based organisms and we live in a carbon-based society, and it's going to be very expensive and very long term to deal with this problem. We are well positioned to benefit from it, if we aren't sinking... but if you have huge pricing increases all at once, then you just have to assume, we will have to share more than we might want to share. So, we are looking at how we can help the public most with the environmental problem, and at the same time keep the most we can of our value for all of you.

[Nathan Judge:]

Thank you very much.

[Operator:]

I will now turn the floor over to John Rowe for any finishing remarks.

[John W. Rowe:]

I just made them. This is going to be a really tough business in the next decade. And Exelon has better opportunities and more armor on its boat than anybody else. Thank you.

[Operator:]

Thank you. That concludes today's Exelon conference call. You may now disconnect.