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Pepco Holdings (NYSE:POM)

Q1 2011 Earnings Call

May 06, 2011 10:00 am ET

Executives

Donna Kinzel - Director of Investor Relations and Assistant Treasurer

Anthony Kamerick - Chief Financial Officer, Senior Vice President, Chief Financial Officer of Potomac Electric Power Company, Chief Financial Officer of Delmarva Power and Light Company, Chief Financial Officer of Atlantic City Electric Company, Senior Vice President of Potomac Electric Power Company and Senior Vice President of Delmarva Power and Light Company

John Huffman - Chief Executive Officer of Pepco Energy Services Inc and President of Pepco Energy Services Inc

Joseph Rigby - Chairman, Chief Executive Officer, President and Member of Executive Committee

Analysts

Paul Ridzon - KeyBanc Capital Markets Inc.

Paul Patterson - Glenrock Associates

Ali Agha - SunTrust Robinson Humphrey, Inc.

Unknown Analyst -

Operator

Good day, ladies and gentlemen, and welcome to the First Quarter 2011 Pepco Holdings Earnings Conference Call. My name is Derek, and I'll be your operator for today. [Operator Instructions] As a reminder, this conference is being recorded for replay purposes. I would now like to turn the conference over to Ms. Donna Kinzel, Director of Investor Relations. Please proceed.

Donna Kinzel

Thank you, Derek, and good morning, ladies and gentlemen. Welcome to the Pepco Holdings First Quarter 2011 Earnings Conference Call. The primary speakers on today's call are Joe Rigby, Chairman, President and Chief Executive Officer; and Tony Kamerick, Senior Vice President and Chief Financial Officer. Also available to answer your questions are Dave Velazquez, Executive Vice President, Power Delivery; and John Huffman, President and Chief Executive Officer of Pepco Energy Services. On today's call, we will be referring to slides which are available on the Investor Relations section of our website.

Before Joe begins, let me remind you that some of the comments made during today's conference call may be considered forward-looking statements. As such, they should be taken in the context of the risks and uncertainties discussed in the Safe Harbor disclosures contained in our Securities and Exchange Commission filings and found on Slide 2 of our presentation.

Also, please note that the earnings release can be found on our website at www.pepcoholdings.com/investors. Joe?

Joseph Rigby

Thanks, Donna, and good morning, ladies and gentlemen. Thank you for joining us today. Earnings from continuing operations for the quarter were $62 million compared to $28 million in the 2010 quarter. Our operating results were driven by strong Power Delivery earnings that reflect the positive impact of our infrastructure investments and reasonable regulatory outcomes. Lower interest expense resulting from the paydown of parent company debt with Conectiv Energy's generation asset sale proceeds also boosted earnings. Our results for both 2011 and 2010 quarters reflect Conectiv Energy's results as discontinued operations. Tony will discuss the financial results and our operating segment performance in more detail, but first I'll address some topics of interest, starting with an update on our initiatives to improve system reliability as shown on Slide 3.

We have made considerable progress advancing infrastructure improvements and performing system maintenance in the Pepco region that will reduce power outages and improve service to our customers. Since launching our Reliability Enhancement Plan last fall, we have increased our tree trimming personnel from 80 to 350, trimming trees along 16,000 miles of power lines replaced or upgraded on the 70 miles of underground cable and identified overhead lines for underground, among other efforts. We have also made several enhancements to improve customer communications during major storms. I want to reiterate my commitment to improving system reliability. This will remain a top priority for our company.

We continue to make very good progress on our blueprint for the future initiatives. The status by jurisdiction can be seen on Slide 4. About 281,000 advanced meters have been installed in Delaware for our electric customers, and we expect to complete the remaining electric meter exchanges in Delaware in the second quarter of 2011. We began activating meters in October and plan to have all Delaware electric meters activated in the third quarter. The initial functionality includes remote meter reading, the availability of account-specific energy use information and outage detection. In the District of Columbia, we have installed about 50,000 advanced meters with a goal of having the installations completed by the end of 2011.

As approved by the commissions in Delaware and the District of Columbia, regulatory assets have been created to defer AMI-related costs between rate cases. The commissions have also approved the accrual of returns at the authorized rates of return on the deferred costs until such time as the costs and accrued returns can be incorporated into customer rates.

In Maryland, the Public Service Commission also approved the creation of a regulatory asset for AMI-related costs. For Pepco, the Commission approved the deployment of advanced meters subject to the implementation of a Commission-approved customer education and communication plan. Pepco's plan was approved by the Commission in February, and we intend to begin meter installations in June for Pepco's Maryland customers.

For Delmarva Power, the Maryland Commission deferred its decision on the deployment of advanced meters pending review and approval of an amended business case. We filed the business case in December, and a procedural schedule has not yet been established.

On March 22, Delmarva Power made a filing with the Delaware Public Service Commission requesting permission to implement a dynamic pricing plan for Delaware customers to be phased in beginning in 2012. Under the proposed Critical Peak Rebate structure, the plan would reward Standard Offer Service customers for lowering their energy use during critical peak periods when energy demand and the cost of supplying electricity are higher.

With the build out of the Smart Grid, we will gain added tools to improve system reliability while providing customers with access to detailed usage information that will enable them to better manage their energy use and lower their energy bills. Our energy efficiency and demand side management programs will also help our customers to reduce energy cost. The cost of these programs will be recovered through demand-side management-related rate adjustment mechanisms.

Turning to our regulatory filings in February. Delmarva Power, the Commission Staff and the Attorney General entered into a proposed settlement agreement in Delmarva Power's natural gas delivery base rate case in Delaware. The proposed settlement is summarized on Slide 5 and provides for an annual rate increase of $6 million based on a stated return on equity of 10%. The parties agreed to defer the request to place revenue decoupling into effect until an implementation plan has been developed. We are currently awaiting the recommendation of the hearing examiner. The proposed settlement agreement is subject to final review and approval by the Public Service Commission, and a decision is expected shortly. Delmarva Power implemented interim rate increases of $2.5 million on August 31 and $7.7 million on February 2. Any excess amount collected will be returned to customers.

Slides 6 and 7 summarize the status of Delmarva Power's distribution base rate cases in Maryland, which is proceeding as scheduled. The filing seeks approval on an annual rate increase of $18 million based on a 10.75% return on equity. This filing includes a comprehensive discussion on the topic of regulatory lag and its negative effects, as well as a proposal for the adoption of 2 mechanisms to reduce regulatory lag. The first is a reliability investment recovery mechanism, which provides full and timely recovery of future capital investments related to distribution system reliability. And the second is an annual rate review process, which will adjust rates annually using actual financial data and the return on equity approved in the most recent case to calculate a revenue requirement. This revenue requirement would then be the basis for any adjustment to rates. Hearings in the case are scheduled to begin on May 31 with a decision expected in July of this year.

We remain on track with our preparations to file 4 additional rate cases later this year. As shown on Slide 8, we currently expect Pepco to file in the district later this quarter and Atlantic City Electric to file in New Jersey in the third quarter.

In the fourth quarter, we plan to file cases in Maryland for Pepco and in Delaware for Delmarva Power Electric. Note that this filing schedule is tentative and may be impacted by financial projections or other considerations.

We plan to include in our rate case filings a comprehensive discussion on the topic of regulatory lag and its negative effects. Each of our filings will include proposals for methods to minimize lag.

The status of the Mid-Atlantic Power Pathway, or MAPP project, can be seen on Slide 9. As we've previously reported, PJM currently is in the process of evaluating reliability requirements for the region under its Regional Transmission Expansion Plan process. PJM has stated that it expects to complete this evaluation in August. The outcome of the evaluation could result in a delay of the in-service date for the MAPP project beyond the current in-service date of June 1, 2015.

In November, we filed an updated application for the Certificate of Public Convenience and Necessity with the Maryland Public Service Commission. Last week, Pepco and Delmarva Power made a filing with the hearing examiner in this case, requesting a 6-month delay to the procedural schedule in order to allow for the completion of the ongoing PJM review. The proposed revision to the schedule calls for direct testimony of the parties to be filed in December 2011 and evidentiary hearings to be held in March 2012.

The total projected construction cost for the MAPP project remains at $1.2 billion. Slide 10 shows the forecasted annual construction expenditures for our Power Delivery initiatives, including the MAPP project. Due to the uncertainty of the MAPP project's in-service date, we currently anticipate that the 2011 construction expenditures associated with MAPP may be lower than our forecast by $90 million to $110 million.

As shown at our April 8 Analyst Conference, Slide 11 shows the MAPP construction expenditures under 3 different in-service date scenarios: 2015, 2017 and 2019. As we discussed at our conference, should the MAPP project in-service date be delayed beyond 2015, we expect to accelerate other Power Delivery projects, resulting in no material change in the total construction expenditures over the next 5 years. If there is a change in the MAPP's project's in-service date as a result of PJM's evaluation, we will update our 5-year Construction Expenditure Forecast accordingly.

At Pepco Energy Services, the profitable wind down of the Retail Energy Supply business continues to be on track, and we continue to make good progress in growing the Energy Services business. PES signed $8 million of new energy efficiency contracts in the first quarter of 2011, including a $6 million construction projects for the National Institutes of Health in Bethesda, Maryland. As shown on Slide 12, the business development efforts we have undertaken over the past 2 years are beginning to show results, and the project development pipeline has grown to nearly $800 million. We believe the benefits of energy efficiency provide long-term growth opportunities for this business, and we can grow Pepco Energy Services in a manner that is consistent with our low-risk profile. At this point, let me turn it over to Tony Kamerick. Tony?

Anthony Kamerick

Good morning, and thank you for joining us today. I'll recap our earnings, address our performance by operating segment and review our recent financing activity. We will then open the call to your questions.

Earnings from continuing operations for the first quarter were $62 million or $0.27 per share compared to $28 million or $0.13 per share for the first quarter of last year. There were no special items in either period. Our results show Conectiv Energy's results as discontinued operations.

In the first quarter of 2011, income from discontinued operations net of taxes was $2 million. This includes income from adjustments to accrued expenses in connection with the sale of the generation assets, partially offset by losses from the disposition of Conectiv Energy's remaining assets and businesses.

A summary of the drivers of our financial results can be found on Slide 13. For the first quarter, Power Delivery earnings were $0.21 per share compared to $0.09 per share for the 2010 period. Higher distribution rates during the quarter increased earnings by $0.06 per share. The higher rates reflect the impact of electric rate decisions for Pepco in the District of Columbia and Maryland, for Atlantic City Electric and for Delmarva Power in Delaware. The higher rates also reflect the interim rates put in effect for Delmarva Power's Gas business in Delaware. These rate increases were driven by higher costs and increased investment in distribution assets to enhance reliability. Higher transmission revenue drove $0.05 per share of the earnings increase due to higher investment in transmission assets.

Higher weather-related sales versus the prior year increased quarterly earnings by $0.01 per share. Heating degree days increased by 2% quarter-over-quarter. Keep in mind that our distribution revenue in Maryland and the District of Columbia, which represents approximately 2/3 of total distribution revenue, is decoupled from consumption, and, therefore, the higher sales due to weather will not increase the distribution portion of customer bills in those jurisdictions.

Also contributing to the earnings increase is higher distribution revenue due to growth in the number of customers, higher margins from the supply of Standard Offer Service, higher unbilled revenue related to Atlantic City Electric's basic generation service and the impact of unfavorable income tax adjustments in the first quarter of 2010. Partially offsetting these increases was higher operation and maintenance expense, which reduced earnings by $0.07 per share. This increase was driven by higher tree trimming and corrective and preventive maintenance costs as well as higher employee-related expenses.

Pepco Energy Services' first quarter earnings were $0.05 per share compared to $0.06 per share in the same quarter of last year. The decrease in earnings was due to lower retail electricity sales volumes due to the ongoing wind down of the Retail Energy Supply business, partially offset by higher construction revenues. Note that each of the 2011 and 2010 quarters includes net mark-to-market losses on energy supply contracts of approximately $0.01 per share.

In our Corporate and Other segment, which is primarily unallocated corporate costs, earnings improved by $0.02 per share quarter-over-quarter. The earnings improvement resulted from lower interest expense due to lower parent company debt outstanding.

Turning to Slide 14. Given the year-to-date results and our expectations for the remainder of the year, we are reaffirming our 2011 earnings guidance range of $1.10 to $1.25 per share.

I'll now turn to our recent financing activity, which is summarized on Slide 15. On February 25, Atlantic City Electric redeemed all of its outstanding cumulative preferred stock for approximately $6 million. This redemption leaves no outstanding preferred stock at PHI or any of its subsidiaries.

On April 5, Atlantic City Electric issued $200 million of first mortgage bonds. The bonds bear interest at an annual fixed rate of 4.35% and are due on April 1, 2021. The proceeds from the sale of the bonds were used to redeem Atlantic City Electric commercial paper and for general corporate purposes.

Earlier this week, Delmarva Power repurchased $35 million of 4.9% tax-exempt bonds due in 2026, pursuant to a mandatory repurchase obligation. We plan to remarket the bonds later this quarter. Now let me turn it back to Joe Rigby for some closing remarks.

Joseph Rigby

Thanks, Tony. In closing, I believe we continue to make very good progress on our strategic initiatives that position us to provide value to our customers and our investors. And with that, we would like to open the call to your question.

Question-and-Answer Session

Operator

[Operator Instructions] And our first question is coming from the line of Paul Patterson from Glenrock Associates.

Paul Patterson - Glenrock Associates

The weather versus normal, what was the impact there? I wasn't sure about that. Sorry if I missed it.

Anthony Kamerick

Let's see. It looks like for the quarter, Paul, it's pretty much a wash.

Paul Patterson - Glenrock Associates

Okay. The pension, was that -- what was the impact of pension in the quarter?

Anthony Kamerick

Well, let's see. The pension estimate for the year, now this is Tony, is $107 million, Paul. And I don't know exactly how much.

Paul Patterson - Glenrock Associates

Okay. I don't mean to put you on the spot, but...

Anthony Kamerick

If the pension cost is down slightly for 2011, then that would reflect itself proportionately in the first quarter.

Paul Patterson - Glenrock Associates

Okay. Let me ask you something about all these efforts that you have with the dynamic pricing plan, the demand response to smart meters. Clearly, you guys are being pretty aggressive on the energy efficiency side. What do you think that holds for demand in your area? Weather normalized, obviously. Just going forward, how much do you think demand will grow with these kind of efforts? And if you could just elaborate a little bit more on that in terms of what your sort of longer term outlook is for that?

Anthony Kamerick

Paul, this is Tony again. We provided a forecast at the analyst conference of our sales. And it looks like our sales are going to grow somewhere in the neighborhood of 1%.

Paul Patterson - Glenrock Associates

And that's with these efficiency efforts?

Anthony Kamerick

Yes. That's as best we can forecast that, yes.

Paul Patterson - Glenrock Associates

And what would have it been without these efforts, do you think? I mean, I guess what I'm trying to figure is what the impact of these efforts are, I guess.

Joseph Rigby

Hey, Paul, this is Joe. I think we'd be hazarding a guess there. As we think about the economy and factor in all the diversity across our service territory, it's how it all nets down, on a net basis, to about 1% annual growth. One thing I would ask you to keep in mind is that there is still a very strong appetite for energy efficiency. And for the most part, we operate in states that have very strongly stated goals of reducing energy consumption by fairly aggressive amounts. So that's one of the reasons why I think on a relative level we appear to be somewhat aggressive in that, because we're very much attuned to the policy of our service territories. So a rather long-winded way to say that it's about 1% growth year-over-year, factoring in what we would anticipate impacts from energy efficiency.

Anthony Kamerick

Right.

Paul Patterson - Glenrock Associates

Okay.

Anthony Kamerick

And Paul, this is Tony. Our customer growth is around 1% a year, too. So if you look at it from a usage per customers, it's basically flat.

Paul Patterson - Glenrock Associates

Okay. The reliability proceedings. If you could you just give us a little bit of an update on that? I mean, it seems like that the more onerous legislative proposals didn't happen. Am I right about that? And, I think we are getting pretty -- I think the legislative season is sort of is ending. What do we have there that we should be -- is there anything that we should be looking out for there in terms of reliability stuff that was going on in Maryland that you see? [indiscernible] [26:24]

Joseph Rigby

Well, Paul, this is Joe. And let me -- maybe I'll start with some comments and the other guys can jump in. It's been a tough quarter. We've had a lot of criticism. I think that this got fairly involved from the political front in the State of Maryland. I think having -- sitting here now, I think we feel that it's going in a productive direction. And even with the legislation passed with the hearings or the cases that are underway, I'm pretty -- I don't want to say optimistic, but we're obviously working very collaborative with the other parties. And my sense is that there's going to be a very balanced approach taken here. And as the standards are put in place, I believe that we have every reason to think that we'll be able to meet those standards, to grow into those standards. And I think that the Commission understands that we're somewhat digging out of a little bit of a problem here but also understanding that these are good and necessary investments. So I'm positive in terms of how this will all play out. I would say this. We're absolutely committed to making the necessary investments to improve customer service. And we totally get it in terms of the relationship of how our customers feel relative to having good constructive regulatory outcomes. So we're going to work very collaboratively with the Commission and our communities, and I think we're going to end up in the right place.

Paul Patterson - Glenrock Associates

Okay, great.

Operator

Your next person comes from the line of Paul Ridzon from KeyBanc.

Paul Ridzon - KeyBanc Capital Markets Inc.

Just at PES, can you parse how much the drop was attributable to lower electricity sales versus the pickup in the more contract and pay business?

Anthony Kamerick

Sure. Paul, this is Tony. If you've got a copy of the earnings release, you'll notice that we identified $0.02 reduction due to the wind down of the Energy Supply business, and an increase of $0.01 from the construction part of business.

Paul Ridzon - KeyBanc Capital Markets Inc.

And how shall we think about the seasonality of BGS now? And do you think you could earn 4x $0.05 or...

Anthony Kamerick

I think I'll pass that along to John Huffman.

John Huffman

Yes, hi, this is John. I'm sorry, could you repeat that question? What exactly are you looking for here?

Paul Ridzon - KeyBanc Capital Markets Inc.

Well, can I just multiply the $0.05 you earned in the first quarter times 4 and kind of get a rough estimate of what you think is the yearly run rate of this business for '11?

John Huffman

Yes, I guess at an extremely high level there, you could probably do that. Obviously, for the Retail Supply business, weather is still going to have an impact. As well, the volatility in level of energy prices, which we'll just have to wait and see there. So there is that impact.

Operator

Your next quarter comes from the line of Ali Agha from SunTrust.

Ali Agha - SunTrust Robinson Humphrey, Inc.

Tony, I was curious. When you look at your first quarter results, the $0.27, do you categorize them as on plan? And the reason I ask that is obviously, it was a very strong year-over-year comparison, and yet your guidance has not changed even at end of the guidance. You're essentially flat for 2010. So just curious on what are the headwinds and offsets that will drive you to be higher in '11 versus '10 [indiscernible] [30:59]?

Anthony Kamerick

Okay. Ali, again, this is Tony. It was a reasonably good quarter, and we're not ready to change our guidance as a result of it. However, we want to see a little more of the year play out. Having said that, it pretty much is on plan in that regard.

Joseph Rigby

Hey, Ali. This is Joe. Let me just maybe tag along there. As we think about the full year, obviously, from a financial results, it was a good quarter. But, obviously, a challenging quarter on the customer front. And as we think about the remainder of this year, obviously what we're weighting is the additional expenditures that we may have to make as we work our way into these standards. And so we're not ready to modify our overall projections at this time until we get a little bit further down the path. But we do obviously feel good about that we're in the range, and I expect that that's where we'll be able to stay.

Ali Agha - SunTrust Robinson Humphrey, Inc.

Okay. But to be clear, John and Tony, you were saying the quarter's on plan. But it seemed to me that it may be more better than plan to give you some cushion for those expenses? Is that a way to think about it?

Anthony Kamerick

I'll repeat what I said. I said it was a good quarter.

Ali Agha - SunTrust Robinson Humphrey, Inc.

Okay. Okay, good. Joe, a question for you with regards to your regulatory lag, reduction initiatives. As you pointed out, the staff in Maryland came back and they did not endorse the initiatives that you had laid out. Were you surprised by their position? And what could you read into that in terms of how Maryland may look at those initiatives and obviously implications for your other jurisdictions as well?

Joseph Rigby

I wouldn't characterize it as being surprised or anything else. It's just a step in the process. And this is just a process that's going to play out. So I feel that the positions that we've put forward are extremely valid. There's precedent in other parts of the country, and we're looking forward to having the dialogue in front of the Commission.

Ali Agha - SunTrust Robinson Humphrey, Inc.

And, I mean, obviously, the Commission will make its final position when it does. But just anecdotally, can you just share with us some color not just in Maryland but in the other states where you've had these discussions? Are you getting good receptivity? Are they absorbing it and saying, "Okay, we will come back to you?" Any color you could share with us?

Joseph Rigby

Well, Ali, we haven't -- we're so much on the front end of this that only real perspective is the one you're aware of, which is the staff's reaction. So I really don't -- I honestly don't have any further color to offer to you. Obviously, the other states, they look at all the filings, but I don't have a perspective that I could share at this time simply because I'm not aware of one other than what the staff said.

Ali Agha - SunTrust Robinson Humphrey, Inc.

Understood.

Operator

Your next question comes from the line of John Hansen [ph] from Persedus [ph].

Unknown Analyst -

Just my question's pretty well has been asked and answered, but just one minor thing here on your drivers. I see you have your whole list of items, and everything's pretty well covered. But, one items is left over as other. Is there anything in particular kind of things are in there just so I can kind of close out my stuff?

Anthony Kamerick

Well, there's usually several items that get rolled up into the other.

Unknown Analyst -

They're not expense items, so we've pretty well covered everything else. So I was just trying to figure out what kind of things might be left over.

Anthony Kamerick

Well, there's -- one of the items has to do with some investments, John, that we made several years ago.

Unknown Analyst -

Oh, yes, yes. Okay, yes.

Anthony Kamerick

And there's a kind of a mark-to-market changes quarter-to-quarter, and that was a little bit of it. We also make mention in the Q to a payout from a company-owned life insurance policy.

Unknown Analyst -

There is ongoing. All right, good.

Anthony Kamerick

And that's the bulk of it.

Operator

At this time, I'm showing no further questions. I would like to turn the call back to Mr. Joe Rigby for any closing remarks.

Joseph Rigby

Okay. Thank you, operator. Again, we thank you all for joining us today and for your interest in PHI. And we hope you have a great day and a great weekend. Thanks.

Operator

Ladies and gentlemen, that concludes today's conference. We thank you for your participation. You may now disconnect. Have a great day.

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