Here’s the entire text of the prepared remarks from Xcel Energy’s (ticker: XEL) Q3 2005 conference call. The Q&A is here. We recognize that this transcript may contain inaccuracies - if you find any, please post a comment below and we’ll incorporate your corrections. And please note: this conference call transcript is a Seeking Alpha product, so feel free to link to it but reproduction is not permitted without the explicit permission of Seeking Alpha.
Richard Kolkmann, Managing Director, IR
Ben Fowke, VP and Chief Financial Officer
Daniele Seit, Maxcor Financial
Ashar Khan, SAC Capital
Paul Patterson, lenrock Associates
Elizabeth Parrella, Merrill Lynch
David Frank, Pequot Capital
John Hanson, Imperium Capital
Reza Hatefi, Zimmer Lucas Partners
Greg Orrill, Lehman Brothers
Good morning. My name is Dennis and I will be your conference facilitator. At this time, I would like to welcome everyone to the Xcel Energy Third Quarter 2005 Earnings Conference Call.
I will now turn the call over to Mr. Richard Kolkmann, Managing Director, Investors Relations. Please go ahead, sir.
Richard Kolkmann, Managing Director, IR
Thanks, Dennis, and I would like to welcome all of you to Xcel Energy's third quarter 2005 earnings release conference call. With me today is Ben Fowke, Vice President and CFO of Xcel Energy. We also have several others here to help provide answers to your questions.
Some of the comments that will be made contain forward-looking information, significant factors that could cause results to differ from those anticipated are described in our earnings release and Xcel Energy filings with the Securities and Exchange Commission.
Now I will turn the call over to Ben.
Ben Fowke, VP and Chief Financial Officer
Thanks, Dick, and welcome everyone. On today's call, I'm going to provide an explanation of our quarterly results, our outlook for the rest of year, our 2006 guidance and finally an update on our construction program in COLI.
Starting with our results for the quarter, I'm pleased to report that Xcel Energy recorded earnings from continuing operations of $0.47 per share for the third quarter of 2005, compared with $0.40 per share for 2004. Total earnings for the third quarter 2005 were $0.47 per share, compared with $0.12 per share for 2004. As a reminder, we recorded a loss of $0.28 per share in the third quarter of 2004, largely due to an asset impairment charge related to our Seren investment.
As you know, the core of our company is our utilities subsidiaries, which provided earnings of $0.46 per share for the third quarter 2005, compared with $0.41 per share for 2004. Utility earnings increased by $0.05 per share, largely due to higher electric utility margins which increased earnings by $0.10 per share and income tax benefits, which increased earnings by about $0.03 per share.
These favorable results were partially offset by lower short-term wholesale and trading margins, higher utility O & M expenses, higher depreciation expense, and various other items. Each of these items decreased earnings by $0.02 per share individually, or $0.08 per share in total.
Our holding company costs and results of other non-regulated companies provided earnings of $0.01 per share for the third quarter of 2005, compared with a loss of $0.01 per share last year. The change is primarily due to temporary timing differences related to accounting for income taxes under GAAP and our own reporting guidance. That summarizes our third quarter results. Now let's look into the details of the quarter.
Starting at the top of the income statement, our base electric utility margins increased by $70 million for the quarter, largely driven by warm summer temperatures and weather-adjusted sales growth. In the third quarter of 2005, we benefited from temperatures in most of our major jurisdictions that were warmer than normal and significantly warmer than last year.
In Minnesota, temperature humidity degree days were 26% above normal and 49% above 2004. In Colorado, cool degree days were 29% above normal and 86% above 2004. And finally, in the Texas Panhandle, cool degree days were 2% above normal, and 23% above 2004. As a result, favorable weather increased electric utility margins by $53 million, or $0.08 per share.
In addition to favorable weather conditions, weather adjusted retail electric sales grew at 1.4%, increasing electric margin by $11 million. On a year-to-date basis, our weather-adjusted retail electric sales also increased by 1.4%. This is below our expectations for the year, and we have revised our year-end electric sales growth guidance range downward to 1.3% to 1.6%. We think the lower sales growth is a result of economic conditions and higher fuel prices. For more information on electric margins, please refer to our earnings release.
Turning to operating expenses, our third quarter 2005, O & M expenses were $22 million higher than last year. The increase in O & M expenses was largely driven by higher benefit costs, accruals for various legal settlements and inventory adjustments.
Overall, our year-to-date O & M expenses are about 6.5% higher than last year. When we experienced hot weather during the summer, we took the opportunity to increase our O & M expense levels to ensure that our operating system was in good shape. Compared with our original plans, we now expect our annual O & M spending to increase at our energy supply business unit.
In addition, we also expect bad debt accruals to increase. We believe the increase in bad debt expense reflects a slowdown in the economy and the recent change in bankruptcy laws. Finally we recently made a donation to help our customers manage high-energy bills. As a result, I now expect our annual 2005 O & M expenses to increase to approximately by 5% compared with last year.
Depreciation expense for the third quarter of 2005 was $13 million higher than 2004 levels. This is a continuation of a trend that we expected for the year. The increase is due to growth associated with normal system expansion and incremental depreciation for several large projects, including a new steam generator at Prairie Island and a new billing system. We expect recovery of these investments in future rate filings.
During the quarter, we recognized approximately $11 million of income tax benefits, largely associated with prior periods. The benefits consisted primarily of research tax credits and a net operating loss carry back. As a result of these benefits, we have modified our effective tax rate assumptions to a range of 25% to 27% for 2005. That covers our earnings results for the quarter.
Let me touch upon our year-end outlook. While we have modified some of our individual assumptions as detailed in our earnings release, our 2005 guidance range from earnings from continuing operations, remains at $1.18, to $1.28 per share. Through the first nine months we have benefited from warm weather and tax benefits, but these positive variations have been offset by higher O & M expense and lower sales growth. Based on the year-to-date results and our projections for the last quarter, we have narrowed the range and expect to end up in the lower half of our guidance range.
Let's look ahead to next year. We are initiating our 2006 guidance range for earnings from continuing operations at $1.25, to $1.35 per share. Our 2006 assumptions are detailed in our earnings release.
I'm going to spend a bit of time on two assumptions that are the most difficult to handicap. The realized revenue from our rate filings and the potential impact of high fuel costs. In 2005, we have or will file several rate cases as part of our regulatory strategy.
In May, we filed a natural gas rate case in Colorado, requesting a $34 million rate increase, based on a return of equity of 11%. In June, we filed an electric and natural gas rate case in Wisconsin, requesting an electric rate increase of $53 million, and a gas rate increase of $8 million, based on a return of equity of 11.9%.
Next week, we will file an electric rate case in Minnesota. Finally, later in November, we will file an electric rate case in North Dakota.
As far as the timing of the rate cases, we expect a final decision in Colorado and Wisconsin cases at the end of this year, or the beginning of next year, with final rates in effect in early 2006. In both Minnesota and North Dakota, we will implement interim rates subject to a refund, which will be effective 60 days after the filing. We expect a final decision in both Minnesota and North Dakota in the summer of 2006.
Now I know you have lots of questions about the Minnesota rate case. Since we haven't filed the case yet, I can't provide too much detail. After the filing is made, we will provide you with more details at the EEI meeting in early November. There are a couple things I can tell you. Overall, we expect to increase rates 7 to 9%.
Approximately 61 million of the request is for decommissioning accruals; however, we are going to present various proposals to extend the collection period, which may lower the revenue requirements and the decommissioning accruals but will have no impact on earnings or cash flow.
We are also looking at a different design to short-term wholesale margins, which would incorporate a sharing approach. This would provide us with an incentive and allow the ratepayers to share in the upside potential. We are requesting an 11% return on equity.
Any time you file a rate case, there are regulatory risks. Clearly we are concerned about the high impact, the impact of high fuel prices on our customers; however, there are several key points to our case. We have increased investments to meet expanding customer needs and improve reliability. We have competitive rates, which are the result of careful cost management and two mergers, which allowed us to reduce our costs and avoid filing rate cases. Finally, we are environmentally responsible and lead the industry in developing renewables, promoting energy efficiency and reducing emissions.
Our strategy is to file reasonable rate cases and get recovery of legitimate investments and expenses. We believe that our commission will provide us with reasonable recovery and it's important to note in our guidance range that we assume to get reasonable rate recovery.
Another area of uncertainty is the impact of high fuel prices on our business. As you can see in our 2006 assumptions, we are projecting weather-adjusted electric retail sales growth of 1.3% to 1.7%. This is lower than our historic growth rate, and reflects our estimate of the impact of higher fuel costs on sales. We think this is a reasonable assumption, but it's very difficult to determine what impact $13 to $14 natural gas prices will have on customer usage. We will be closely monitoring this situation.
In addition, we expect that higher fuel prices will increase working capital. We are in the process of expanding our credit facilities by $275 million to enhance our liquidity position. Increases in working capital will have some impact on our interest expense.
Finally, higher fuel costs will potentially impact our bad debt expense. We have seen some impact in 2005, and we think our 2006 budget captures the potential exposure, but current prices are beyond historic levels and may provide our projections inaccurate.
Overall, I think we have done a good job of capturing the impact of regulatory risk and higher fuel prices on our budget. I'm very comfortable with our guidance range but we are aware of the potential sensitivities. In addition to our 2006 earnings guidance, we have also updated our five-year capital expenditure forecast outlook as detailed in the earnings release.
The forecast is not materially different from what you have seen in the past; however, we will continue to look at additional opportunities to invest in our utility business, particularly in the later years of our forecast. We will work very hard to obtain regulatory and legislative support necessary to make those investments attractive to our investors. If the past is any indication, for example, projects like Merck and Comanche 3, we will be successful.
Next, I would like to provide you with an update on our major construction projects in COLI. We continue to make outstanding progress on the development of our new coal plant in Colorado. Permitting for construction of Comanche 3 is now complete. All environmental permits are in hand. Water rights have been obtained, county road access has been authorized and an annexation agreement with the City of Pueblo has been approved.
Additionally a permit for ash disposal site was granted. And building permit applications will submitted as the project proceeds. In terms of project construction, oiler, turbine, air quality control systems, site development and stack contracts have been awarded, and the costs are in line with our expectations.
At the site, the evaporation pond removal is complete, the stack foundation work has begun, and the site development contractor has begun preparing the site for construction. We expect to have the formal ground breaking ceremony later this year.
We have also made good progress on the Merc project. We broke ground for the King plant rehabilitation project in April of this year. Details design work is nearly 70% complete, and approximately 90% of the contracts for equipment supply and construction have been placed.
A large use of the long lead components like boiler, turbine and pollution control equipment have been designed and are well into manufacturing. The pilings, foundation and slabs for the new pollution control equipment and cooling towers will be completed by year-end. I'm happy to report that both projects remain on track and within our cost expectations.
So now let me touch on everybody's favorite topic, our company-owned life insurance program known as COLI. As I mentioned in the past, there are two issues related to COLI, the first and most significant issue is the actual IRS dispute. The second issue is the potential accounting pronouncement from the FASB, which affects accounting recognition, but not actual cash flows.
I will start with the IRS dispute. In October, the district court denied our motion for summary judgment in the IRS dispute. The court also denied the IRS motion for summary judgment, which asserted that PSCo had no insurable interest in the lives of its employees. The court did grant partial summary judgment to us, affirming that we had an insurable interest in the lives of our employees.
A ruling and summary judgment is issued if there are no disputed issues of material fact. Generally speaking, it is difficult to prevail on a motion for summary judgment, so the denial of our motion is understandable. In this situation, the court decided that it would need a full hearing to determine the case, because questions of fact remain.
We are pleased that the court affirmed that we have an insurable interest in the lives of our employees, litigation is currently proceeding with discovery and with the trial to be held sometime after 2006. We do not have a specific date yet for the beginning of the trial. Because the decision reached following that trial can be appealed, it may be another two to three years before the litigation is finally concluded. In any event, we believe our case has strong merits and we feel confident about our facts and circumstances.
Now, let me touch on the FASB issue. In September, the common period expired on the FASB exposure draft on accounting for uncertain tax positions. There are more are than 100 comment letters submitted and many letters indicated significant opposition to the new rules. The FASB has since announced that the effective date of the potential new rules has been delayed until at least the first quarter of 2006.
At this point, we believe there's considerable uncertainty about the FASB's eventual decision on this issue. They could revise rules, continue to delay the project, issue a completely new exposure draft or abandon the project. As a result, we will continue to record the tax benefits of COLI in our actual results and we'll continue to include the tax benefits in our guidance range.
So with that, I will wrap things up. Overall, it was a good quarter. We are on track to meet our 2005 guidance, and our 2006 guidance represents excellent growth prospects. We have a solid strategy , one that works for us. Our build to core strategy is not changing, it is easy to understand, and it is low risk. Invest in our utility business, earn original return on that investment.
We continue to balance and align the interests and the needs of our customers, the environment and our shareholders. Like any plan, it has its challenges, and the high-priced fuel environment will require Xcel Energy and its stakeholders to be forward looking.
We have developed an action plan, which we shared with the public recently. Part of the plan includes donations of $5 million to the Salvation Army's Heat Share program, and other local programs in our service territories. We have also made significant investments in our utilities to improve reliability, increase capacity and reduce emissions.
Clearly this increased investment is driving the case for rate cases over the next few years. Fair regulatory treatment will ensure that we can continue to make long-term investments that will benefit our customers. We recognize that it's important to be customer focused. Our view is that if we take care of our customers, our shareholders will benefit. So with that, let's open the lines up for questions.
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