FirstEnergy Corp.
Q4 2006 Earnings Call Transcript

Published: 20 Feb 2007

[Operator:]

Good afternoon. My name is Sharona and I will be your conference operator today. At this time, I would like to welcome everyone to the FirstEnergy Corp. fourth quarter 2006 earnings conference call. All lines have been placed on mute to prevent any background noise. (Operator Instructions) It is now my pleasure to turn the floor over to your host, Mr. Kurt Turosky, Director of Investor Relations. Sir, you may begin your conference.

[Kurt E. Turosky:]

Thank you, Sharona. During this conference call, we will make various forward-looking statements within the meaning of Safe Harbor provisions of the United States Private Securities Litigation Reform Act of 1995. Investors are cautioned that such forward-looking statements with respect to revenues, earnings, performance, strategies, prospects and other aspects of the business of FirstEnergy Corp. are based on current expectations that are subject to risks and uncertainties. A number of factors could cause actual results or outcomes to differ materially from those indicated by such forward-looking statements. Please read the Safe Harbor statement contained in the consolidated report to the financial community which was release earlier today and is also available on our website under the earnings release link. Reconciliations to GAAP for the various non-GAAP financial measures we will be referring to today are also contained in that report as well as on the investor information section of our website at www.firstenergycorp.com/ir. Participating in today’s call are Tony Alexander, President and Chief Executive Officer; Rich Marsh, Senior Vice President and Chief Financial Officer; Harvey Wagner, Vice President and Controller; Jim Pearson, Vice President and Treasurer; and Ron Seeholzer, Vice President of Investor Relations. I will now turn the call over to Tony Alexander.

[Anthony J. Alexander:]

Thanks, Kurt, and good afternoon, everyone. I will begin the call today by highlighting our achievements in 2006 and then Rich will discuss our fourth quarter financial results and touch on a few regulatory matters. Let me start by saying that 2006 was a milestone year for FirstEnergy as we achieved our strongest financial and operational performance since the formation of the company nearly a decade ago. This was evidenced in our 2006 normalized non-GAAP earnings of $3.88 per share, which exceeded the top-end of our October 25th guidance of $3.75 to $3.85 per share. Net cash from operating activities exceeded $1.9 billion and our stock appreciation plus reinvested dividends produced a total return for shareholders of 27.2%. This favorable performance enabled several developments that will continue to build value for our investors. In August, we repurchased 10.6 million shares of common stock, and in January of this year, the Board approved the repurchase of up to an additional 16 million shares. Combined, these programs represent about 8% of the shares outstanding before the first repurchase. In December, we announced our fourth dividend increase since March, 2005. The new dividend of $0.50 per quarter is an 11.1% increase from the prior level. These strong financial results were driven by an equally strong operational performance. We had our safest year ever in 2006, with an OSHA rate of 0.97 incidents per 100 employees, one of the best in the industry. Our record generation output of 82 million megawatt-hours represented a 2.2% increase over the record established in 2005. Our base load fossil plants achieved a capacity factor of 89%, which was their third top decile performance in as many years and represents almost a 92% capacity factor when scheduled outages were excluded. We also successfully completed three planned outages at our nuclear facilities, including the replacement of the steam generators and reactor vessel head at Beaver Valley Unit 1, which was accomplished in record time. We added 99 megawatts of capacity to our system during the year, with upgrades at Beaver Valley, Davis-Besse, and our Bruce Mansfield facilities, and we plan to add an additional 130 megawatts of base load capacity and about 200 megawatts of peaking capacity over the next two years. On the wire side of our business, we produced top decile performance in our transmission operations and improved our distribution performance by reducing the average duration of customer outages by 20%. During the year, we also continued to make important progress on our regulatory agenda. We began recovery of incremental Midwest system operator costs, or MISO costs, in Ohio and recently received approval to begin recovery of incremental PGM costs in Pennsylvania. We also received approval to recover JCP&L’s deferred cost related to mandated contracts with non-utility generation suppliers, and successfully transitioned our Penn Power subsidiary to market-based pricing for generation. To set the stage for continued progress, and to ensure effective succession planning, last week we announced organizational changes involving some of our key executives. These moves help us prepare for retirements that will happen in the near future and expand the skills and responsibilities of our senior team and providing them with new and challenging assignments. 2006 was a good year for FirstEnergy, with the company being in the best financial position I have seen in my 34 years here and delivering top quartile performance in key measures across our operations. As we begin 2007, we remain focused on our key strategic goals of

[Richard H. Marsh:]

Thank you, Tony and good afternoon, everyone. Thanks for being with us today. As I begin my review, it might be helpful for you to refer to our consolidated report to the financial community that we issued earlier this morning. Let’s get started with a review of fourth quarter results. Earnings on a GAAP basis in the fourth quarter were $0.85 per share, compared to $0.58 per share during the same period in 2005. Normalized non-GAAP earnings were $0.84 per share, excluding the net effect of unusual items that increased earnings by $0.01 per share. The unusual items involved a net gain of $11 million related to the sale of non-core assets partially offset by an impairment of securities held in our nuclear decommissioning trusts. Our normalized non-GAAP earnings of $0.84 in the fourth quarter compared favorably to normalized non-GAAP earnings of $0.77 per share in the same period in 2005. This improvement was primarily driven by our Ohio rate plans, which increased earnings by $0.23 per share compared to the fourth quarter of 2005, and the deferral of PJM transmission expenses, which increased earnings by $0.09 per share. Other positive drivers included the $0.07 per share benefit from reduced net transmission costs and a $0.01 per share benefit from lower post-retirement healthcare costs. In addition, the reduction in shares outstanding following the accelerated share repurchase of $10.6 million shares in August enhanced earnings by $0.02 per share. Partially offsetting these factors were

[Operator:]

(Operator Instructions) Our first question is coming from Paul Ridzon from Key Bank.

[Paul Ridzon:]

Rich, I was wondering if you have made any progress in deciding how you might want to take these additional 16 million shares in and the timing of that decision.

[Richard H. Marsh:]

I think we have made some progress, Paul. We have to push the 10K out before we go forward with the share repurchase, but that will be done towards the end of next week, I believe. I am still thinking that the share repurchase is going to be a first quarter event and we would expect that the bulk of it would be through an ASR structure, similar to what we did before.

[Paul Ridzon:]

Do we need to have some sense of finality around the leasebacks before we see that?

[Richard H. Marsh:]

No, we don’t.

[Paul Ridzon:]

Then, just the strategic rational behind putting solutions in a standalone SEC reporting entity.

[Richard H. Marsh:]

I think in part it is to give more clarity to the investment community. It will also enable them to down the road issue debt, which is an important part of our financing plan longer term. Obviously as we move towards a competitive generation market, FirstEnergy Solutions is going to be a very large driver of our earnings, so we want to make sure that we get prepared for that.

[Paul Ridzon:]

Thank you very much.

[Operator:]

Our next question will be coming from Paul Patterson from Glenrock Associates.

[Paul Patterson:]

I just wanted to follow up on Paul Ridzon’s question with respect to the previous accelerated repurchase program, is J.P. Morgan finished with their buy-back?

[Richard H. Marsh:]

They are not finished but I believe we said they will be finished by the end of next month.

[Paul Patterson:]

Okay, thanks a lot.

[Operator:]

(Operator Instructions) Our next question will be coming from Dan Jenkins from State of Wisconsin.

[Dan Jenkins:]

Good afternoon. I have a couple of things here. I am looking at your income statement, both for the quarter and the year, other operating expenses is down about $55 million in the quarter and $104 million for the year. If you could give a little color on what was behind that.

[Richard H. Marsh:]

Do you want to do that, Harvey?

[Harvey L. Wagner:]

Sure. A lot of that reflects the reduction in transmissions costs in our MISO and PJM markets, and also the reductions that we have been experiencing in our employee benefit costs.

[Dan Jenkins:]

So lower transmission and then lower employee costs. I was curious on the pollution control, how much still remains at the operating company that is available to transfer over to the --

[Richard H. Marsh:]

A little less than $700 million, Dan, and we will do that opportunistically in 2007 and 2008.

[Dan Jenkins:]

Then, on this FirstEnergy Solutions, what is in that entity? Is that just the merchant part of the business or are the plants there too?

[Richard H. Marsh:]

It contains all of our competitive business. As you may remember, at the end of 2005, we transferred ownership of our generating assets from our regulated utility companies over to FES, so they are all contained within FES as our competitive retail business.

[Dan Jenkins:]

Okay, so all the non -- okay. And then, you may have said it but I didn’t get it down; what did you say your target adjusted equity ratio was going to be going forward?

[Richard H. Marsh:]

Going forward obviously we want to make sure we maintain investment grade metrics and debt-to-total-cap is one of the things the rating agencies look at. Obviously they look at other measures as well. What I said is by the end of -- or, I’m sorry, at the end of 2006 we had an adjusted debt-to-total-cap ratio of 58% and that includes the off-balance sheet items that the rating agencies consider to be on credit, so it is a higher number than what you would see in our financial statements. Also, I mentioned that was about 100 basis points higher than it otherwise would have been because of the adoption of FAS-158 during the year.

[Dan Jenkins:]

Okay, and what is the effect of the Mansfield transaction? Would that make that go up or would it not really have much of an effect? Do you have a sense of that?

[Richard H. Marsh:]

That will bump that up for a period of time and that is why I mentioned, as a result of our capital spending program primarily, I would expect to see that creep up somewhat over the ’07 and ’08 period and then decline again thereafter, but still maintaining well within the investment grade range.

[Dan Jenkins:]

The last thing I was wondering, it looks like -- for the year in particular, I am looking at -- the industrial sales were down about 1.4% and particularly weak in New Jersey it looked like. They were down 7.9%. Just if you could give us some color on what the industrial sales situation looks like in your service territories.

[Richard H. Marsh:]

I do not know specifically the New Jersey situation. We have a very small industrial load in New Jersey, so any little change could have a big percentage impact on that. Overall I think probably you are seeing, as much as anything, just a reflection of the auto industry during the year. A lot of our manufacturing is related to auto in one way or another -- steel, glass, so I think that is probably as much of what we are seeing as anything.

[Dan Jenkins:]

Okay. Thank you.

[Operator:]

Our next question will be coming from Stephen Huang from Citadel.

[Stephen Huang:]

Just a quick question here on the share buy-back. Your authorized last year was for 12 million shares, but you only used 10.6 in the ASR. Does the remaining 1.4 carry over to the new 16?

[Richard H. Marsh:]

No, what we said is the new program supercedes the old program, Stephen, so what that means is the old program is done at approximately 10.5. The new program will be up to 16.

[Stephen Huang:]

Okay, and the ASR will be like last year, it will not be for the full amount but it will probably be for --

[Richard H. Marsh:]

Well, it could be even for the full amount. It will definitely be for a large chunk of it, if not all of it.

[Stephen Huang:]

Would you guys do it on a shorter time horizon than the last one or would it be similar in terms of how long you stretch out the buy-back?

[Richard H. Marsh:]

Well, it is a pretty big sized program, considerably larger than last year’s, so I would not expect that it would be done in less time, and probably take a little more time, just because of the size of it.

[Stephen Huang:]

Any announcements from your discussions with the IRS or other people in regards to the lease treatment on the -- is there going to be a capital operating?

[Harvey L. Wagner:]

Stephen, we have not had any discussions with the Internal Revenue Service. We would not anticipate that. We are working toward having it be an operating lease. We will not know that until we actually have a final structure in place.

[Stephen Huang:]

Is the cost of the lease embedded in your guidance right now, like any lease payments?

[Harvey L. Wagner:]

Yes.

[Richard H. Marsh:]

Yes, it is, Stephen.

[Stephen Huang:]

Great. Thank you.

[Operator:]

(Operator Instructions) We have a follow-up question coming from Paul Ridzon from Key Bank.

[Paul Ridzon:]

Will there be a true-up component from the previous buy-back, depending on what the average share price is?

[Richard H. Marsh:]

Yes, there is a settlement process involved, Paul. That is a cash event. It is not an earnings event, but yes.

[Paul Ridzon:]

It will not be an earnings event?

[Richard H. Marsh:]

No.

[Paul Ridzon:]

What was the assumed JR price when you did that?

[Richard H. Marsh:]

$56.44 was the share price on the day that we executed the ASR.

[Paul Ridzon:]

I guess it is a good problem to have, this true-up?

[Richard H. Marsh:]

It is a great problem to have. We will take those all day.

[Paul Ridzon:]

Thank you.

[Richard H. Marsh:]

I think that is it. We appreciate everybody’s time today. If anybody has any follow-up questions, please feel free to contact us. We appreciate you being on the call today and as always, we appreciate your support and interest in FirstEnergy. Thanks very much and have a great day.

[Operator:]

This concludes today’s FirstEnergy fourth quarter 2006 earnings conference. You may now disconnect.