NRG Energy, Inc.
Q3 2007 Earnings Call Transcript

Published: 4 Nov 2007

[Operator:]

[Nahla A. Azmy:]

Thank you, Jennifer. Good morning and welcome to our third quarter 2007 earnings call. This call is being broadcast live over the phone and from our website at www.nrgenergy.com. You can access the call presentation and press release furnished with the SEC through a link on the Investor Relations page of our website. A replay and a podcast of the call will be posted on our website. This call, including the formal presentation and the question-and-answer session will be limited to one hour. In the interest of time, we ask that you please limit yourself to one question with just one follow-up. And now for the obligatory Safe Harbor statement, during the course of this morning's presentation, management will reiterate forward-looking statements made in today's press release regarding future events and financial performance. These forward-looking statements are subject to material risks and uncertainties that could cause actual results to differ materially from those in the forward-looking statements. We caution you to consider the important risk factors contained in our press release and other filings with the SEC that could cause actual results to differ materially from those in the forward-looking statements, in the press release and this conference call. In addition, please note that the date of this conference call is November 2, 2007, and any forward-looking statements that we make today are based on assumptions that we believe to be reasonable as of this date. We undertake no obligation to update these statements as a result of future events. During this morning's call, we will refer to both GAAP and non-GAAP financial measures of the Company's operating and financial results. For complete information regarding our non-GAAP financial information, the most directly comparable GAAP measures and a quantitative reconciliation of these figures, please refer to today's press release and this presentation. And now I'd like to turn the call over to David Crane, NRG's President and Chief Executive Officer.

[David Crane:]

Thank you, Nahla, and good morning everyone. I am joined here today by Bob Flexon, our Chief Financial Officer who will be speaking to the Company's quarterly financial results. Also I have with me Kevin Howell who runs our commercial operations group and who is here to answer or not answer, as the case may be, questions you might ask about the Company's commercial operation strategy. And a special guest today, John Ragan, Head of our Northeast Region, who is here, given that we'll be talking in some length, in some detail about the Huntley IGCC project or if you have questions about the recent announcements we made with respect to peaking units in Connecticut, a joint venture with United Illuminating, he can answer those questions. So, I am going to be referring to slides that appear on the website and starting with slide three and this slide which I entered into the slide deck which I got because as usual our slide deck is full of information about all that the company is doing and is part of knowledge quest to make sure that the investors in this company know every single last detail of what we are up to. But I want to start with a very simple slide and use that as a backdrop, something that was easy on the eyes while I gave some bit of context to this call as to where the company has been and where we are going. I want to do that on two levels. First, operationally, and by that in this case I mean really what we have been doing 2007 and looking forward to 2008; and then strategically covering 2008 and beyond. So first, operationally. Here we are in early November and as a company, I think, we are in the process of wrapping up what we believe has been a highly successful year in terms of current operation. Based on the strong performance of our plant and commercial operations group year-to-date we are increasing our full-year adjusted EBITDA guidance by $100 million. Our fully hedged position gives us a very high level of confidence that when the dust settles and the year has closed out, we will have met these revised financial targets. Operationally, at this time we are also looking forward to 2008. We are well placed in terms of winter preparedness, and we are pushing forward a series of operational initiatives which we are planning for 2008. Much of this is encompassed in our highly successful FORNRG program, for which we are raising the bar again today. In terms of positioning this company for the future beyond 2008, we feel that with each day the path we are on and the direction which our business is headed and has been headed is the right one, and that the principle task for us is not to deviate to the left or to the right of where we have been headed, but only to keep going faster, higher and stronger. And what do I mean by this? When we start out here at our NRG four years ago with a business strategy focused on developing multi-fuel across the merit order portfolios of low marginal cost generating assets concentrated in a few competitive wholesale power generation markets in United States. Given what we own coming out of Chapter 11 that was undoubtedly the right strategy for NRG. Aided in significant part by the Texas Genco acquisition, which was announced in late 2005, we have done well to-date in terms of executing on our original core strategy. Also in 2005, we assess six principle long-term industry trends that were emerging at that time

[Robert Flexon:]

Thank you, David and good morning. Today in addition to our customary review of the third quarter and year-to-date financial performance, I'll also cover our third consecutive quarter of improved outlook for 2007, our first comment on 2008 guidance, and finally several significant events impacting the company's liquidity and capital structure. I'll began with the third quarter results shown on slide 19. Third quarter 2007 adjusted EBITDA, excluding mark-to-market was $719 million versus $519 million for the same period last year, resulting in the second consecutive quarter where performance exceeded our forecasted expectations. The current quarter benefited from a $180 million revenue increase in the Texas region from the November 2006 contract hedge reset. Partially offsetting this was 1.1 million megawatt hours of Lower Texas gas generation due to cool and wet weather which reduced demand for our gas peaking units. This decline, accompanied by a 30% quarterly drop in average peak market power prices, although largely offset by our hedge positions in our cost, resulted in a $31 million decrease in energy margins for the quarter. Development expenses this quarter, mostly in support of September's COLA submission increased $40 million. We will recover 40% to 50%, of our development cost incurred to-date from our partner in the project CPS of San Antonio. Demonstrating the value of our geographically diverse portfolio, the Texas region decline was offset by the improvement in the Northeast region results. The current year's third quarter adjusted EBITDA versus 2006 improved by $95 million. Quarterly adjusted EBITDA improved despite a 1% decrease in Northeast generation. Our hedge positions in the Northeast also helped offset generation and pricing decline. In Northeast, capacity revenues increased $28 million over the third quarter of last year as new capacity payment programs, the NEEPOL and PGM went into effect this year. Fuel mix led to a $12 million net decrease in the region's fuel cost. A 31% increase in gas generation at our Arthur Kill plant led to higher natural gas expenses by $14 million, which was more than offset by the $26 million decline in oil fuel expense, as oil fire generation declined 47%. Our year-to-date earning comparisons are illustrated on slide 20. Our adjusted EBITDA, excluding mark-to-market activity, grew almost $600 million due to many of the same factors that influenced our three months comparison. Again, these include the Texas revenues, revenues attributable to last November's hedge reset, the new Northeast capacity revenues and the partial offset of increased development spending. These and other key contributors to the year-over-year improvement include $123 million and $8 million of adjusted EBITDA, respectively, for the full year inclusion of Texas and West regional results. $425 million from the year-to-date impact of the hedge reset on Texas contract revenue, a $2.1 million megawatt-hour decline in Texas gas generation, largely offset by successful hedging programs, and $220 million of higher Northeast margins due to increased generation and realized pricing in the region as well as increased capacity revenues. These improvements were offset by development expenses that increased $93 million, mainly $75 million to support the STP COLA submission and a $41 million decline in sales of emission allowances. The cash flow for the first nine months of 2007 is shown on slide 21. The $596 million improvement in adjusted EBITDA was offset by collateral postings, higher working capital and increased interest payments. The majority of the free cash flow decrease is due to the $504 million year-over-year swing in collateral movement. This year we paid out or returned a $107 million in collateral to counter parties while in the first nine months of 2006, we received a net of $397 million due to a decrease in gas prices and trade settlements during the first nine months of last year. If collateral swings are excluded, adjusted cash from operations was $432 million higher than 2006 and free cash flow from recurring operations would have been $895 million almost doubling the comparable 2006 nine-month period. Cash interest payments increase for 2007 versus 2006 due to a full nine months of interest related to debt incurred to finance to Taxes Genco acquisition and additional debt associated with hedge reset in November of 2006. Cash flows upon working capital increased by $97 million, accounts receivable balances increased by $186 million, mainly due to higher market and contract pricing. Substantially all of the accounts receivable increase is current and has since been collected. As shown on slide 22, with over $500 million of operating cash flow for the quarter... for the third quarter of 2007 our liquidity has substantially strengthened since June 30, with a cash build of almost $400 million. Liquidity at September 30, 2007 was approximately $2.3 billion, an increase of $444 million since the end of the second quarter. Major cash uses during the quarter were $104 million for capital expenditures and $53 million for common share buyback. I'll provide more detail later on but our liquidity today giving effect for the changes in our hedging collateral structure has reached approximately $3 billion. Moving to 2007 guidance with our third quarter performance, we are increasing our 2007 full year outlook by $100 million to $2.3 billion and adjusted EBITDA as outlined on slide 23. Operating cash flow guidance is being increased $80 million due to the increased EBIT expectations partially offset by an increase in cash collateral posting. Recurring free cash flow from our base business before Repowering an environmental, capital expenditures is projected to be $1.2 billion for the full year, almost a $100 million higher than our previous guidance. This represents recurring free cash flow yield of around 11%. Total projected capital expenditures for maintenance, environmental and Repowering was $569 million, a $61 million declined from the estimate we provided on the last earnings call, mainly due to a delay in timing in wind and environmental capital spending into 2008. Our initial full year outlook for 2008 is $2.2 billion, as provided on slide 24. Next year is expected to be a $100 million lower than this year, mainly due to a decline in the average prices of hedge generation. Free cash flow from recurring operations, however, is expected to remain at the 2007 level of about $1.2 billion. Also on slide 24, the primary differences between 2007 and 2008 have been listed. Development spending is lower in 2008 versus 2007 as we expect to begin capitalizing STP cost in 2008. This EBITDA... the EBITDA benefit of FORNRG, of approximately $30 million, is expected to be offset by the inflationary impact on cost and wage and benefit increases. Cash flow from operations for 2008 is expected to remain at the 2007 level of $1.5 billion. The environmental and Repowering CapEx numbers are before financing and are further discussed on slide 25. Our environmental, Repowering and maintenance forecast to capital expenditures for the balance of 2007 and for 2008 are shown by region on slide 25. As mentioned earlier, the full year capital forecast, including Repowering, environmental is $569 million. Capital expenditures for the nine months ending September 30, 2007 were $309 million including $47 million for STP nuclear fuel and maintenance, $45 million in the Texas South plant turbine and combustion system and $46 million to the Huntley and Dunkirk bad gas emission project. The principal investments to be made during the last three months of 2007, totaling $260 million include

[David Crane:]

Thanks, Bob. We have taken a lot of time, so I am going to... Jennifer, I am going to turn it over to you to open the lines for some questions? Question And Answer

[Operator:]

Thank you. [Operator Instructions]. Your first question comes from John Kiani from Deutsche Bank. Please go ahead.

[John Kiani:]

Good morning, David, Bob.

[David Crane:]

Good morning, John.

[Robert Flexon:]

Hi.

[John Kiani:]

Bob, you touched on this a little bit in your opening comments but can you walk us through how the 50% CPS ownership and the STP development project, how that applies to cost sharing of development costs and perhaps in conjunction with that, how much you are estimating for development costs in the '08 EBITDA guidance?

[Robert Flexon:]

John for, the way that will work is through October from inception to date, the CPS share of the development will be around $40 million to $45 million and that takes you through October, and then in November and December we estimate that their share which they will be picking up will be about another $6 million say for each month, so in round numbers that puts you to the $50 million to $55 million level. So, I think what you'll see is a lower development spend in November and December, since we are only picking up say half of it and then we will also have a credit coming in of about $40 million to $45 million for the inception to date cost that we have had. For 2008 our intent at this point in time remains to start capitalizing, so we don't have much of anything in the development expenses for 2008 for STP. Included in our CapEx budget is about $75 million of CapEx related to STP in 2008.

[John Kiani:]

Thanks. That's helpful. And then one follow-up question on '08. What contribution are you assuming from your gas and oil fired assets in the '08 EBITDA guidance?

[Robert Flexon:]

Generally from... really from on how we view those assets, we look at the contributions from a margin standpoint to be roughly $100 million to $150 million kind of number, and then there will be some variability around that, depending on what's going on in the market, fuel cost and the like, so that's the order of magnitude, virtually of all the forecast is obviously heavily driven by base growth.

[John Kiani:]

So $100 million to $150 million for 6,000- to 7,000 megawatts of capacity?

[Robert Flexon:]

Correct.

[John Kiani:]

Okay. Thank you.

[Operator:]

Your next question comes from Dan Eggers from Credit Suisse. Please go ahead.

[Dan Eggers:]

Good morning. David, you are talking about the carbon capture technology, kind of at the two facilities, can you talk to the Texas project, both by way of what kind of Government support you are looking for to help develop that project, how much capital NRG will be investing in this project, and then what implications that is going to have as far as operating plant efficiency as far as energy losses etcetera?

[David Crane:]

The, well, let me... in terms of the power... you are talking about the Powerspan project, is that right?

[Dan Eggers:]

Yes.

[David Crane:]

On the Powerspan project, the total spend about $150 million in terms of the type of support we are expecting for that project from Federal or state sources and the form of that, there is always a wide range of different approaches to that, but I mean I think grants through the DoE program, there's money in the current energy bills before congress. Absolutely we like to get some money at the state level as well as the Federal level, but in terms of the type of a commitment that we would expect as a company, I mean if at all proves out the time of our coal capital costs about 150, I would say that a rough number for where we would be investing would be in the $30 million to $40 million range, that's sort of our operating assumption. The technology that they have, it has current economic benefits now in that to get to the point where you can the capture the carbon, you actually have to take out even more SOx as well, so the saved SOx obviously has economic value in the market already since there is a traded market for SOx as you know. The issue with anything that you do in terms of carbon capture, again is that we are anticipating that the carbon will have a value, and so how much we investment in it, how it actually gets financed sort of depends on whether we continue to live in an environment where carbon emissions are going to be free and they are not going to have an economic value. And then finally, the last thing we have to prove up is that the sequestration in the case of the Powerspan project, we believe can be used for enhanced oil recovery in the area of the Parish plant, and you know what value we can secure from that is also a question that we need to answer over the next several months.

[Dan Eggers:]

Okay, and then I guess one other question looking at the RepoweringNRG program, particularly on the wind side for 2008, it looks like about $390 million, give us a little color on size or projects, where you expect them to be, when we should anticipate and serve a statement --?

[David Crane:]

Well, I think the lead projects will certainly be in West Texas and they will be in the 100- to 200 megawatt range and... at least some of them are likely to be with significant partners. We are also got some very active wind development in California but it takes longer in California, so I think the first ones you'll hear from us about will be in Texas.

[Dan Eggers:]

Okay, thank you.

[Operator:]

Your next question comes from Elizabeth Parrella from Merrill Lynch. Please go ahead.

[Elizabeth Parrella:]

Yes. Thank you. I'm just following up on the $626 million growth CapEx this year. You mentioned there are $75 million in there for STP and just looking at your slide 25, can we assume that the rest of the Texas spend which would be about $100 million is for Cedar Bayou or is there --?

[Robert Flexon:]

That's Cedar Bayou 4.

[Elizabeth Parrella:]

Cedar Bayou. And then the 390 is all wind?

[Robert Flexon:]

Yes.

[Elizabeth Parrella:]

Now, where is the... this Powerspan project showing up? Have you included that in the Repowering or the environmental bucket?

[Robert Flexon:]

We don't have much, we don't really have the Powerspan in the end until we get more clarity around what the cost are going to be for '08.

[David Crane:]

Yes. I don't think that the Powerspan is going to be in the design engineering stage in '08, so that would be... that would start to hit in '09 and beyond.

[Elizabeth Parrella:]

Okay. And then a question in a different area, what's your view on the outlook for New York City capacity prices near-term, medium-term, long-term, just in light of the ISOs compliance filing and updated three-year demand curve?

[David Crane:]

I think, Elizabeth, that we can burn that question slightly to what our point of view on capacity prices in the Northeast. I would say that we are bullish on capacity prices in Connecticut, rest of the state and New York and PJM and we're bearish, we think that the measures you are taking about will reduce capacity prices in New York City, but the net effect in the capacity price area across those four areas we think are about mutual to us.

[Elizabeth Parrella:]

So, you're saying the reduction in New York City is offset by what you see is the up tick in those three other regions?

[David Crane:]

That's exactly what I am saying is, of course, you said it with much greater brevity than I do.

[Elizabeth Parrella:]

And over what timeframe? Is that just '08 or multiyear or --?

[David Crane:]

I would say that's from... the time period we are looking at there is 2008 to 2011.

[Elizabeth Parrella:]

Okay. Thank you.

[Operator:]

Your next question comes from David Silverstein from Merrill Lynch; please go ahead.

[David Silverstein:]

Good morning,

[Robert Flexon:]

Good morning, David.

[David Silverstein:]

Hey, just to clarify from some of the comments you made about the backstop facility. Can you give us some detail in terms of what the rate is, it looked like your earnings release kind of alluded to some sort of a backstop facility being at a rate that was 1% above your existing non-callable loans?

[Robert Flexon:]

It's a $4.2 billion backstop and the pricing I believe is LIBOR plus 250. My believe we will be filing the commitment letter, no, just would be a filing an 8-K on the commitment letter. There are more details to be provided, but it's a $4.2 billion facility, reasonably sized at that level, David, with the liquidity we have on the synthetic LCs, we don't need a $4.7 billion backstop, we have got the $500 million ready to go and so it's $4.2 billion backstop facility.

[David Silverstein:]

Okay.So this is backstop facility. Okay. Then not the 1% than that was alluded to in the press release.

[Robert Flexon:]

No I mean... I am not sure what the 1% was. I mean, obviously the call on the offer on the bond is 1

[David Silverstein:]

Yeah, I know, there was something alluded to the fact that you had a financing available that would cost only 1% above the bonds. Just moving on then, in terms of the seniority of that facility, is that facility senior secured.

[Robert Flexon:]

Yes, David, I mean that on the press release... just to come back and all we are saying there is that we have the right to buy the bonds at 1

[David Silverstein:]

Great. Okay. Thank you very much.

[Operator:]

Your next question comes from Gregg Orrill from Lehman Brothers. Please go ahead.

[Gregg Orrill:]

Thanks very much. Two quick questions, the first on the various carbon control initiatives that you've talked about. David, do you have ultimate goal of, that you can quantify in terms of funds reduced or assets created for the company. Could it actually turn into a new business line for NRG? Also on the offer to the bondholders, the way of the change in control at 12.5 basis points. Looks like a reasonable offer maybe not full, maybe you can comment on your commitment level for the new Holdco structure? Thank you.

[David Crane:]

Hi Gregg... obviously, I'll answer the first question and Bob will handle the second. On the carbon control, we haven't set a formal target, but if we did set a target, we are very aware of our carbon intensity as a company, and it's pretty high, we produced almost a ton of carbon, I think we are 0.9 tons of carbon per megawatt hour of NRG output across this week. Actually we'd like to add numbers as low as possible. We continue the current Repowering program taking us down towards the 0.6, 0.7, now I'd say I'd like to be 0.3, but we haven't set a target. But that's way we will look at, because obviously we are a growing company, we'll be somewhat reluctant at least at the company-wide level to set a fixed absolute level of carbon. Is it... in terms of new business areas, Gregg, absolutely, the one true growth area in this mature industry of ours is in the environmental area, and carbon maybe the biggest growth area, so we superseding or supplementing renewables, but in both areas, I think this is something that you should expect to hear more from our company. And particularly in those areas within Renewables and in terms of environmental control, carbon controls, that are very closely tied to what we are doing today. Where we feel that we have a competitive advantage, we want to move very aggressively in this area. We're very pleased with what Padoma is doing for us in the wind area but there is no question that if we... we don't want to be last mover in these other areas, the way we are, we were served at the tail end of the wind movement, so yes you should expect to hear more from us in this area in the future.

[Robert Flexon:]

Gregg, on the consistency, the consistency been offer of the eight [ph], and the way that it works for each class of bond, there is an incentive fee on the pool of bonds, so it would and eight times the pool amount of the pool, and then for those that vote yes. They share in that entire pool. So we expect, say, just for the math purposes, if half of the bond-holders accepted and half didn't the incentive fee would be go from an eight to a quarter, so there is an incentive there. And we view that where the bonds are trading today, at or slightly above par. The various credit accretive events that we have been doing as well as the strengthening that we expect the bonds to get with the Holdco or moving a $1 billion behind them, it offers the appropriate incentive for us to get this thing across the line. On the other hand, we are not going to... we will not be coming back and raising fees or anything, otherwise, we have very solid alternatives to the... for some reason it doesn't move forward. So, we think we have got the right balance out there on economics to make this attractive for bondholders and good for shareholders, so we are optimistic that this will get us there.

[David Crane:]

Jenifer, I think a lot of our listeners have another call to attend. So, we will take one more question, so people can get off the phone.

[Operator:]

Our last question will come from Michael Lapides from Goldman Sachs. Please go ahead.

[Michael Lapides:]

Hey guys, congratulations, on a great quarter. David, on the Repowering initiatives, two questions. One, can we get just the latest status update on Carl Stat [ph], and then second on Big Cajun in terms of partnership in the off-take agreement?

[David Crane:]

Mike, I am a little bit... your chemistry here is little disappointed, that you didn't ask your question to him about our trading position, but --

[Michael Lapides:]

I learned my lesson.

[David Crane:]

Well let me... in terms of Carl's [ph] that you are talking about, you are not talking about the existing plant, you are talking about our efforts to re-power that --

[Michael Lapides:]

Yes.

[David Crane:]

Get a contract for that. I think we are in good shaping and you should stay tuned in that regard. I mean, I don't know if there is going to be. I mean, we would certainly expect to be able to give you some news on that before the end of, before the next quarterly call. I am just reluctant to say anything about that, because the confidentiality... confidentiality arrangements around the bidding processes in California are very extreme, but, I certainly expect something before the next quarterly call, and even if there is a little bit of a delay because of the distraction in terms of the companies, all the companies down there struggling with the wild fire situation, but stay tuned. As to Big Cajun I, we are actually in a very good position. I think, both, with respect to partnership and off-take on that project. What we are waiting for is for the air department to clear the EPA, and as soon as that happens you should be hearing from us something about that project as well. And again that's serving the same eminent basket as Carl said.

[Michael Lapides:]

I may have missed this or it may have not been disclosed yet, did you at all information at all about who the partners are, who the off-take agreements are with? On Big Cajun I.

[David Crane:]

Have we?

[Robert Flexon:]

I don't think we.

[David Crane:]

No, we haven't.

[Michael Lapides:]

Okay. Great. Thanks guys. Congrats on a good quarter.

[David Crane:]

Thanks. Well, thank you, Jenifer, and thank all of you who listen. We appreciate you joining us for this call, and of course your continues support and interest in NRG.

[Robert Flexon:]

Thank you.

[Operator:]

Ladies and gentleman this concludes the conference call for today. Thank you for your participation, and have nice day.