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FirstEnergy Corp. (FE)

Q2 2018 Earnings Call· Wed, Aug 1, 2018

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Transcript

Operator

Operator

Greetings and welcome to the FirstEnergy Corp. Second Quarter 2018 Earnings Conference Call. At this time, all participants are in a listen-only mode. [Operator Instructions] As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Irene Prezelj, Vice President, Investor Relations for FirstEnergy Corp. Thank you, Ms. Prezelj. You may begin.

Irene Prezelj

Analyst

Thanks, Sherry. Welcome to our second quarter earnings call. Today, we will make various forward-looking statements regarding revenues, earnings, performance, strategies, and prospects. These statements are based on current expectations and are subject to risks and uncertainties. Factors that could cause actual results to differ materially from those indicated by such statements can be found on the Investors section of our website under the Earnings Information link and in our SEC filings. We will also discuss certain non-GAAP financial measures. Reconciliations between GAAP and non-GAAP financial measures can be found on the FirstEnergy Investor Relations website along with a presentation which supports today’s discussion. Participants in today’s call include Chuck Jones, President and Chief Executive Officer; Steve Strah, Senior Vice President and Chief Financial Officer; and several other executives in the room who are available to participate in the Q&A session. Now, I’ll turn the call over to Chuck.

Charles Jones

Analyst

Thanks, Irene, and welcome, everyone. Hot weather and strong operational performance across our company led to great second quarter results. Our earnings exceeded the guidance we provided to the investment community and I remain very proud of our FirstEnergy team’s record of consistently meeting or exceeding the estimates we have provided to you over the last three-and-a-half years. We’re entering the second half of the year with tremendous momentum on our customer focused regulated growth strategy. Looking at the balance of the year, we are currently tracking near the upper end of our 2018 operating earnings guidance range of $2.25 to $2.55 per share and we are pleased to affirm that range today. For the third quarter, we are introducing an operating earnings guidance range of $0.65 to $0.75 per share. We’re also affirming our long-term operating earnings growth projection of 6% to 8% through 2021. This includes the impact of the amended settlement agreement and the FES bankruptcy case to include the FES and unsecured creditors committee. This final comprehensive settlement defines and quantifies all of FirstEnergy’s obligations with respect to FES and FENOC and as a milestone development as we move forward as a fully regulated company. I will touch on the significant updates to the April agreement and principle. You can find more details on these items along with other non-economic terms in the appendix of the Quarterly Highlights Presentation that is published on our website. First, we will provide a credit for nine months of the 2018 shared services cost on behalf of FES above to $112.5 million. In addition, we have agreed to extend the right for FES to purchase shared services from the end of this year to June 30, 2020. Second, we have increased the cash payment by $88 million. And third, we…

Steven Strah

Analyst

Thanks, Chuck, and good morning, everyone. Last night we reported very strong second quarter results. Our GAAP earnings were $0.28 per share and our operating earnings were $0.62 per share. This succeeded the top end of our second quarter guidance. As a reminder, to provide you with a comparative view of our performance, we continue to present all of our operating results and projections on a fully-diluted basis in light of the January equity issuance. This allows us to show all of the preferred shares as fully converted and excludes the impact of conversion timing. While it does not impact our presentation, I’ll note that preferred shareholders did begin to convert these shares in July. You can find reconciliations and other detailed information about our results in the second quarter consolidated report to the financial community, which is posted on our website. Before we move into operating earnings drivers, I’d like to point out a couple additional special items. First our GAAP results include costs associated with the redemption of long-term debt at Allegheny Energy Supply and Allegheny Generating Company. You’ll recall that we used the proceeds from the sale of the Bath hydroelectric plant, which closed during the quarter, and the earlier sale of gas-fired plants to redeem this debt. And second, GAAP earnings results include a $0.17 per share benefit related to two regulatory actions. The first of those actions, FERC approved a settlement that reallocated previously incurred costs of certain transmission projects across utilities in PJM which will result in a refund to our Ohio utilities. This benefited our second-quarter GAAP earnings by 10%. The second action. In the wake of the Ohio Supreme Court’s decision regarding costs incurred to secure renewable energy credits in Ohio, we recognized a $0.07 per share benefit from the reversal of…

Operator

Operator

Thank you. We will now be conducting a question-and-answer session. [Operator Instructions] Our first question is from Greg Gordon with Evercore ISI. Please proceed.

Greg Gordon

Analyst

Thanks. Good morning. Congratulations on the quarter and on the settlement.

Charles Jones

Analyst

Thanks, Greg.

Greg Gordon

Analyst

You reiterated your short and long-term earnings guidance notwithstanding the increase in the agreed-upon remediation to the debtors and the creditors at FES. You know is it that there’s some offsetting aspects of better performance in your core business that eat through that potential incremental cash out flow? Or is it just simply that it’s bounded by the range that you’ve already articulated?

Charles Jones

Analyst

I would say it’s just simply bounded by the range that we already had articulated, Greg.

Greg Gordon

Analyst

Okay. Thanks. My second question is a bit off the beaten path, but I think pretty important. You’re going to be cleaned up sort of across the Rubicon [ph] here on separating from FES later this year. The dividend was cut from $2.20 a share to $1.44 a share several years ago. It’s been unchanged since then. The payout ratio I’m looking at on your earnings growth aspirations would seem to indicate there was some opportunity for consideration of resuming some type of dividend growth. At what point will you bring to the Board for their consideration a change in the dividend policy?

Charles Jones

Analyst

I think as we get this separation done, I will be having conversations with the Board. But I think it’s too early to go there. But clearly I think if we’re going to be expected to be valued as a fully regulated company, we’re going to have to have a dividend policy that matches what other fully regulated companies do in the very near future.

Greg Gordon

Analyst

Okay. So not right away, but at some point in the near future?

Charles Jones

Analyst

So that would get this FES fully behind us, which we – this was a huge milestone, and it gives us the ability to now quantify what the fully regulated company looks like going forward. And that puts me in a position to have more meaningful discussions with the Board than we were able to have up until now.

Greg Gordon

Analyst

Thank you, Chuck. Didn’t mean to put the cart before the horse, but just getting a little excited on you resolving all this stuff. Take care.

Charles Jones

Analyst

We’re excited too.

Operator

Operator

Our next question is from Stephen Byrd with Morgan Stanley. Please proceed.

Stephen Byrd

Analyst

Hi. Good morning.

Charles Jones

Analyst

Hey, Stephen.

Stephen Byrd

Analyst

I just wanted to touch on you FE Tomorrow update, very positive update. Again, maybe this falls on the cart before the horse category too but you mentioned in your remarks that you expect the initiative would offset the $30 million in depreciation for common systems. As you look at the scope of possibilities around continued cost cuts, is that the general ballpark level we should be thinking about or is there a series of initiatives that could significantly exceed that $30 million?

Charles Jones

Analyst

Here’s what I’d say. We started planning for this exit over a year ago with that feed tomorrow. We had a lot of that groundwork done in advance. We’ve obviously implemented this voluntary early retirement program to facilitate that. We’re working through re-designing our entire corporate structure to fit what we need to be a regulated utility business going forward. That’s a work in progress. It’s going to result in savings but we’re not ready to communicate what that total amount means and how it’s going to look going forward. Internally, there are lots of people involved and we’re taking into account the feelings and emotions and everything else that goes into what we’re putting this corporate structure through right now. At the appropriate time, we’ll tell you what the financial impacts are.

Stephen Byrd

Analyst

Totally understood. And then at a high level just thinking about your financing plan, you’ve laid out some incremental CapEx opportunity so I just wanted to level set and check in again in terms of just making sure I understand how you would approach financing incremental CapEx needs to the extent that you do get approval?

Steven Strah

Analyst

Steve, this is Steve Strah. So from a financing plan perspective, we would use internally generated cash flow as well as debt issued at the utility. So we have no incremental equity needs through our planning period through 2021.

Stephen Byrd

Analyst

Great. That’s all I had. Thank you.

Operator

Operator

Our next question is from Chris Turnure with JPMorgan. Please proceed.

Chris Turnure

Analyst

I appreciate the details on the tax reform process especially in the appendix that you provided today but I was hoping you could give us a little bit more color on the process in Ohio right now where you stand on the tax benefits outside of the writers and if you’re deferring them currently and what the next steps are.

Steven Strah

Analyst

This is Steve. Thanks for the question. We continue to work with regulators and staff in Ohio. We are currently deferring the full impact of the number of tax savings dollars there beyond the writers that we’ve already trued-up. So we’re working with them just as other utilities are working with them through the process. And once again, we’re following the lead of regulators also in West Virginia, as an example, where we have filed as asked and we’ll work through the process with them.

Chris Turnure

Analyst

And is the process in Ohio going kind of as you expected it to go at this point?

Steven Strah

Analyst

I think we’re within the expectation level that we had. It’s a two-way dialogue. It’s very clear that we’ve returned roughly $40 million through the writer process for the DMR and DCR writers. The remainder is to be worked out.

Chris Turnure

Analyst

Great. And then separately for the distribution business this quarter, I think you were clear that you guys did include a $0.03 benefit from the Ohio decision and adjusted EPS. But were there any other items that were nonrecurring or unusual in nature and adjusted EPS for the distribution business. And then I was also hoping you could quantify weather versus normal and a normalized load growth impact on an EPS basis as well.

Steven Strah

Analyst

There were no other onetime adjustments to the quarterly earnings. The weather impact was about $0.03 compared to last year.

Chris Turnure

Analyst

And did you guys have that on a versus normal basis as well?

Steven Strah

Analyst

The total weather adjusted experience that we had is roughly 1% above normal when you look at it on a year-to-date basis.

Chris Turnure

Analyst

Okay. But for the quarter specifically, we don’t have the EPS impact of weather versus normal or normalized load growth versus normal?

James Pearson

Analyst

Yeah, Chris. This is Jim. We were about $0.03 to $0.04 higher associated with weather during the quarter.

Steven Strah

Analyst

This is Steve again. As I said in my open remarks, we had a cool April, but we had a very warm May and June that got us to that $0.03 number.

Chris Turnure

Analyst

Great. Thanks, guys.

Operator

Operator

Our next question is from Claire Huang with Bank of America. Please proceed.

Unidentified Analyst

Analyst

Hey, good morning. I’m slipping in for Julien here.

James Pearson

Analyst

Good morning.

Unidentified Analyst

Analyst

Hey, good morning. Congratulations on the great update. I just had two quick questions, not necessarily on FES here. The first is in terms of ROEs in Ohio. So they’re trending upwards. Just wanted to confirm any details about the seat test and your thoughts there.

James Pearson

Analyst

So, as of this point in time, we have not even triggered the first threshold under the seat test. So, I think all is good with regard to ROEs in Ohio for the moment.

Unidentified Analyst

Analyst

Okay. Got it. I know this is a little forward-looking, three is a change in the commission potentially with the election, just want to get your thoughts on the seat test going forward, if there’s anything you can say now or this is much more far away of a topic.

James Pearson

Analyst

That is way forward-looking and I don’t know that there’s, I think probably there are some commissioner spots that are coming due next year but we have no idea who the governor is going to be at this point. It’s too premature to even think about that.

Steven Strah

Analyst

With regard to the seat test, the seat test is statutory, so that is not something the commission is allowed to just ignore.

Unidentified Analyst

Analyst

That’s fair. Okay. And then my second question is just, I noticed you didn’t have any commentary on the nuclear assets. I know that since you guys are totally out of FES now, that it’s not really related to your ongoing business, but just curious if you have any thoughts on support for those nuclear assets and your thoughts there.

James Pearson

Analyst

So, any thoughts around the future of those assets are now questions to be posed to FES. I would say that from my perspective, I continue to feel that that the market policies in our countries have severe flaws, that closing perfectly good nuclear plants in the long run is not going to be a good thing for our country. In the long run, it’s not going to be a good thing for the six million customers that I’m paid to look out for. Because I think you know having a diverse mix of generation provides the most secure future for those customers from both a physical security, grid resiliency, and an economic stability perspective. So, to the extent my voice matters in this process, I’m going to continue to be a loud advocate for it. I do believe that the Department of Energy is still very seriously looking at this issue and we’re hopeful that they intend, that they will eventually step forward and do something to stabilize it.

Unidentified Analyst

Analyst

I appreciate that. Thank you.

Operator

Operator

Our next question is from Andrew Weisel with Scotia Howard Weil. Please proceed.

Andrew Weisel

Analyst

Thanks. Good morning everyone and congratulations to Jim and Leila. I want to quickly first follow up on the comment about no incremental equities through 2021. Was that meant to indicate that your internal cash flow and small inclement to leverage would be a limiting factor on CapEx? So, in other words if you were successful, it would be the approvals for the Ohio DPM, the New Jersey IIP, potentially some transmission projects. Would you not spend if you needed equity or would you raise equity if those opportunities came up?

Steven Strah

Analyst

This is Steve again. Our forecast, with or without, those capital programs, we would generate enough internally generated cash flow and be able to fund the difference in debt issued at our regulated companies.

Andrew Weisel

Analyst

Okay. Great. Thanks for the clarifying. Next one, given the strong start to the year so far and little bit of help from weather, do you see any opportunity to maybe accelerate from O&M from P19 into 2018. Is that part of why you didn’t raise guidance for the full year?

James Pearson

Analyst

No, we didn’t raise guidance for the full year because we’re halfway through the year and a cold August and a warm December would result in reversing everything that we’ve seen. So, I think I’ve said before I’m not going to take credit for good weather but I’m also not going to plan on it either. So, you know, we are on track with our plan as we laid it out for 2018 with basically the only difference being the Supreme Court ruling and the weather in this quarter.

Andrew Weisel

Analyst

Understood. And lastly, just to clarify, given the progress made with FES and the settlements, should we think of the restricting working group as basically done at this point or is there anything more that they’d be working on that we can be looking for to updates on?

James Pearson

Analyst

I would say you can think of it as basically done, but not done. We still have work to get definitive agreements in place and get the courts to approve it. But I’m not planning to use the restructuring working group to advise me on anything but the bankruptcy.

Andrew Weisel

Analyst

Great. Thank you.

Operator

Operator

Our next question is from Charles Fishman with Morningstar Research. Please proceed.

Charles Fishman

Analyst

Good morning, Chuck. A couple years ago, when you first started your appeal about the importance of the three nuclear plants, you know notwithstanding the grid reliability, and resiliency issues. One of the arguments you made was that the closure of those facilities would require material investment in the transmission system. You now moved the upper end of your transmission guidance for 2019 through 2021. I think the guidance was just the unlocking the future slides this year, does that, have you started including anything in there or are you going to wait until we get closer to the retirement dates that FES has set or could that go higher I guess is my question.

Charles Jones

Analyst

I'll go first. I’ve talked generically about the costs that are imposed on the transmission system when existing power plants close. Generally that’s not around the nuclear plants though. The nuclear plants are very heavily networked as a result of the need to ensure multiple sources of off-site power for reactor coolant. So the nuclear plants themselves don’t generate a lot transmission costs. I’ve spoken about the costs we did incur when we closed the Lake plants and as well as costs that have occurred throughout the markets as other power plants have closed. But inside our plan we include all of the RTEP projects that PJM identifies for our footprint. And those go up and down each year but they are included within our plan. So I wouldn’t anticipate any significant change from the $1.2 billion that we talked about over the next four years after this year.

Charles Fishman

Analyst

Okay. Thank you. That’s all I had.

Operator

Operator

Our next question is from Steve Fleishman with Wolfe Research. Please proceed.

Steve Fleishman

Analyst

Yeah. Good morning. So just the shared services agreement with FES that you – they have a right to extend, is that something where it’s pretty much done at your cost so you don’t have to worry about – it’s not an issue for FE if it’s extended?

Charles Jones

Analyst

That is correct. Our financial ties to FES will end this year so that we can focus being a fully-regulated company starting in 2019. Any shared services that they may want after that they will pay for at the appropriate costs.

Steve Fleishman

Analyst

Okay. Great. And then just the Potomac Edison, what kind of returns – and I might have missed an answer in this but what kind of returns has that subsidiary been earning?

Leila Vespoli

Analyst

So that subsidiary, this is Leila, has been earning returns in the 5.6% range and so obviously rate case we are seeking to put that in a proper place, which is also the reason we are hoping to take care of the tax issue associated with that because we’ve been underearning for a substantial period of time.

Steve Fleishman

Analyst

Okay. Great. Thank you.

Operator

Operator

[Operator Instructions] Our next question is from Praful Mehta with Citi Research. Please proceed.

Praful Mehta

Analyst

Thanks so much. Hi, guys.

Chuck Jones

Analyst

Hi.

Praful Mehta

Analyst

So well congrats on further movement on the FES settlement. As that movement happens and as you clean up the purely regulated story, just want to understand from a strategic perspective how you’re thinking about your story. Do you feel like you have the right size? Is there any need to increase or decrease operations? Just as I look at your portfolio today, your I guess portfolio post-FES, anything from a strategic direction perspective that we should be thinking about?

Chuck Jones

Analyst

From a strategic direction we’re committing to 6% to 8% growth over the next four-year period and beyond that, there’s nothing that I would comment on. I would just say any inquiries we would take seriously and look at and we’re going to always do what’s right for our shareholders but strategic plays for growth in this industry today are very complex especially if you take a company like ours where we have five regulatory jurisdictions so that would imply six or more likely regulatory jurisdictions. They’re just very complex and right now I think we’re just focused what we’ve said. We’ve had 6 million customers across five states, 10 distribution utilities, three transcos [ph] and now we’re looking at how we deliver the value that our shareholders had been asking for from us starting in 2019 and then well into the future.

Praful Mehta

Analyst

Fair enough. That’s good color but as you look at any opportunities that do come your way, how should we think about the criteria apart from obviously getting the right premium, the right returns for shareholders? Are there anything else that we should be thinking about as you kind of evaluate these opportunities?

Chuck Jones

Analyst

I have no comment, Praful.

Praful Mehta

Analyst

All right. Fair enough. I at least tried. I guess one more specific question on the economic lease of Pleasants. As a part of this restructured settlement, just wanted to get a little bit more color for this economic lease by FES or Pleasants beginning no later than January 2019. Can you just provide a little bit more color on that?

Chuck Jones

Analyst

It fulfills what I’ve said earlier that starting in 2019 any financial exposure to the commodity markets is gone and the financial lease for Pleasants will move all of that to the FES creditors.

Praful Mehta

Analyst

Got you. Fair enough. Thanks, guys.

Operator

Operator

Our next question is from Michael Lapides with Goldman Sachs. Please proceed.

Michael Lapides

Analyst

Hey, guys. Thanks for taking my question. Chuck, just curious. How are you thinking about where you are in the transmission investment cycle? Meaning the $1.1 billion, $1.2 billion range. Do you kind of view that as kind of a long-run normalized run rate? Or do you think – and if you don’t mind – maybe touch on the specific geographies. Is there an uptick coming in one of the geographies, a downtick coming in others? You talked a little bit about this over the years but just kind of curious trying to get your multiyear view on where transmission been hedged.

Chuck Jones

Analyst

For the next two years, it’s going to be $1.2 billion. It was $1.1 billion this year and $1.2 billion for the next four years. We are moving it around our system. That’s the clear benefit that we have of having a five-state territory with almost 25,000 miles of transmission. We can move it around. I’ve talked about the benefits already at 37% reduction and equipment related outages on our ATSI system. That’s a direct result of the investments we’ve been making. We’re now moving more into the make [ph] part of our system and I’m sure down the road we’ll look at the Allegheny transmission that is in currently still instated rates and see if it makes sense to move to a forward-looking transco [ph] for those. But I think for now, for the next four years, it’s going to be $1.2 billion. We’re doing 600 to 700 projects a year and we have to be cognizant of the execution risks. And as I’ve talked before, there’s not an unlimited workforce out there in our country today for transmission line and substation projects given that a lot of our other peers are focusing on this area too.

Michael Lapides

Analyst

Got it. And one quick follow-up. If you think about the next three to five years and what may be on your long-term regulatory wishlist, meaning is there a state in your various service territories where you think there’s opportunities to upgrade or improve the regulatory mechanisms that would A, potentially increase investment in that state, distribution, whatever, and B, help reduce to the lag that impacts your company?

Chuck Jones

Analyst

Well I don’t have anything specific to talk about but clearly we have a good track record of working our regulators to come up with different mechanisms other than traditional rate-based type of rate making. So whether those are writers or formulas or trackers in Pennsylvania. We have that as IIP in New Jersey as a helpful addition to how we do business there. We’ve had the DCR in Ohio. And so anything that is [indiscernible] to investors so that you understand when we’re making investments what the returns are for you. That is constructive for customers. And obviously if we can reduce flag [ph] all of those are goals that we would like to achieve.

Michael Lapides

Analyst

Got it. Thank you, Chuck. Much appreciated.

Operator

Operator

[Operator Instructions] Our next question is from -- we do not have another question, I’m sorry.

Charles Jones

Analyst

Okay. Well, thank you, all. As I said earlier, this settlement is a big milestone in our evolution to be in a fully regulated company. We thank you for support and I look forward to seeing you all in between now and the third quarter call and then talking to you again at the third quarter. Take care.

Operator

Operator

Thank you. This concludes today’s conference. You may disconnect your lines at this time and thank you for your participation.