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Q3 2007 Earnings Call

October 30, 2007 9:00 am ET


James von Riesemann - IR

Moray P. Dewhurst - CFO

Lew Hay – Chairman, CEO

Jim Robo – President, COO


John Kiani - Deutsche Bank

Greg Gordon - Citigroup

Leslie Rich - Columbia Management

Dan Eggers - Credit Suisse

Ashar Khan - SAC Capital

Paul Patterson - Glenrock Associates

Daniele Seitz - Dahlman Rose


Welcome to the FPL Group 2007 third quarter earnings conference call. This conference is being recorded. At this time for opening remarks, I would like to turn the conference over to Mr. Jim von Riesemann. Please go ahead, sir.

James von Riesemann

Good morning and welcome to our 2007 third quarter earnings conference call. Moray Dewhurst, the Chief Financial Officer of FPL Group, will provide an overview of our performance for the quarter. Also with us this morning are Lew Hay, FPL Group’s Chairman and Chief Executive Officer; Jim Robo, President and Chief Operating Officer of FPL Group; Armando Olivera, President, Florida Power & Light Company; and Mitch Davidson, President of FPL Energy. Following Moray’s remarks our senior management will be available to take your questions.

Let me remind you that our comments today will include forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Any statements made herein about future operating results or other future events are forward-looking statements under the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995. Actual results may differ materially from such forward-looking statements. A discussion of factors that could cause actual results or events to vary is contained in the appendix herein and in our SEC filings and in the investor section of our website

Now I would like to turn the call over to Moray Dewhurst.

Moray P. Dewhurst

Thank you, Jim good morning everyone. FPL Group’s 2007 third quarter results were very good overall, driven again by outstanding performance at FPL Energy. FPL Group adjusted per share results grew approximately 7% over last year’s comparable period while FPL Energy’s grew 25%. The strong earnings growth at FPL Energy reflects higher realized pricing following the roll-off of lower-priced hedges in the existing portfolio as well as contributions from new assets; both of which were anticipated. The merchant portfolio and the wholesale marketing operations also took advantage of market opportunities and delivered slightly better result than we had expected.

Florida Power & Light was roughly flat for the quarter, which was inline with expectations as good revenue growth was offset by cost increases. Customer growth continued at a healthy rate.

Looking forward to likely full year results with three quarters now behind us, we are well positioned to deliver another very good year financially. We expect results to be at or near the top end of the range of what we shared with you last fall, which equates to approximately $3.45 per share.

We expect FPL Energy to come in at or slightly above the high end of the range we originally set out for you at this time last year, while Florida Power & Light will likely come in at the low end. We said last year that this will be a challenging year financially for Florida Power & Light in part because of the impact of our Storm Secure Program and this has proved to be the case. In addition to the fact as we anticipated however, weather effects in the first half were unfavorable and at this point we would not expect to be able to make up the lost ground unless we see unusually favorable weather impacts in the last couple of months of the year.

While we still have much work to do to bring 2007 to a satisfactory close, over the past month or so we have been going through our normal annual planning process as well a complete review of our strategy and our view of FPL Group’s prospects for the next few years has been developing positively. We believe we have put in place the foundation to enable us to deliver a sustained period of about average growth with a very moderate risk profile and one which is supported by one of the strongest financial positions in the industry.

FPL Energy’s growth would be driven heavily by new wind development that will likely encompass growth in a number of other areas as well, while Florida Power & Light should benefit from service territory growth and sustained reinvestment. We expect to deliver average adjusted earnings per share growth of at least 10% through 2012 off a 2006 base year.

I will provide more detail around 2008 and 2009 expectations later in the call. For the moment, let me just note that we now see a reasonable range for 2008 of $3.83 to $3.93 per share, a bit higher than we have previously suggested. For 2009, we see a reasonable range being $4.15 to $4.35 given the drivers we can see today.

As a reminder, when we discuss FPL Group’s earnings expectations, we assume normal weather and mark our currently open positions to the current forward curves. We also exclude the effect of adopting new accounting standards, if any, and the mark-to-market effect of non-qualifying hedges, neither of which can be determined at this time.

Now, let’s look at the results for the third quarter. In the third quarter of 2007, FPL Group’s GAAP results were $533 million or $1.33 per share compared to $527 million or $1.32 per share during the 2006 third quarter. FPL Group’s adjusted 2007 third quarter net income and EPS were $493 million and $1.23 per share respectively compared with $460 million or $1.15 per share in 2006. The primary difference between the reported results and the adjusted results is the positive mark in our non-qualifying hedge category, which I will discuss in more detail later in the call.

Please refer to the appendix of the presentation for a complete reconciliation of GAAP results to adjusted earnings. FPL Group’s management uses adjusted earnings internally for financial planning, for analysis of performance, for reporting of results to the board of directors, and its input in determining whether performance targets are met for performance-based compensation under the company’s employee incentive compensation plan. FPL Group also uses earnings expressed in this fashion when communicating its earnings outlook to analysts and investors. FPL Group management believes that adjusted earnings provide a more meaningful representation of FPL Group’s fundamental earnings power.

Please note that all prior-period amounts have been adjusted to reflect the application in the fourth quarter of 2006 of an accounting standard change related to planned major maintenance activities which had the effect of increasing 2006 third quarter results by $3 million or less than $0.01 a share.

Florida Power & Light performed in line with our expectations in the third quarter. Customer growth continued strong though with some indications of a possible tapering off late in the period. Unfortunately, the influence of weather on the quarter was more complicated than normal as I will explain in a minute, and this makes it more difficult to detect any possible change in trend in underlying usage growth. Nevertheless, at the moment we still do not see any significant change in underlying i.e., weather adjusted usage growth.

Cost increased in the period, but overall were in line with our expectations. We indicated last year that higher than typical cost increases driven in part by our Storm Secure Program would inhibit FPL’s earnings growth in 2007 and this was the case in the third quarter. Fortunately we expect to be able to revert to more typical growth patterns in 2008.

Results were aided by the impact of the 1144 megawatt generating facility which went into service in May slightly ahead of schedule and under budget. The addition of this facility to our portfolio is beneficial both to customers and to shareholders with a slight increase in base rates more than offset by the fuel savings arising from the incremental efficiency of the new unit.

Also during the quarter, we announced important steps in our generation expansion plan designed to support continued strong long-term growth in Florida. We announced our intention to implement further power upgrades at all four existing Florida Nuclear units subject to various regulatory approvals and we filed the petition for need to termination for two new nuclear units to be constructed at our Turkey Point site, also subject to numerous required regulatory approvals and satisfactory resolution for outstanding technical and economic uncertainties. If all goes well, the upgrades will provide roughly 400 megawatts of incremental base load capacity with zero greenhouse gas emissions by the end of 2012, while the new units will come into service by 2020.

In July, Governor Charlie Crist hosted a Florida Global Climate Summit and laid out important new policy directions for the entire state on this issue. Of the most direct significance to Florida Power & Light are two executive orders setting targets for renewable energy supplies and for greenhouse reductions. While specific implementation plans remain to be worked out, the policy direction is consistent with FPL Group’s view of the climate change issue and we support the establishment of stretch goals.

Partly in response to the Governor’s challenge to the state we have accelerated plans for new initiatives in Florida. Among these are plans for new solar generation projects and we continue to seek ways to take advantage of the limited wind resource generally available in Florida.

We also announced our intention to invest significantly in upgrading our network infrastructure to create a smart network using advanced technology and two-way communication with customer premises to enable more automation and network intelligence.

As part of this effort, we expect our advanced metering initiative currently in a test phase and proceeding well to enable us to leverage our existing industry leading energy conservation program portfolio. Overall, we expect to commit up the $500 million to this effort over the next several years.

For the third quarter, Florida Power & Light reported net income of $326 million compared with $328 million in last year’s third quarter. The corresponding contributions to EPS were $0.81 this year compared to $0.82 last year.

For the third quarter 2007, the average number of FPL customer accounts increased by 90,000 or 2%. While this is a very strong growth level and consistent with our long run history, I should note that we saw flat month-to-month change in customer accounts from August to September when we would normally expect to see some increase. The preliminary data for October do not show growth at levels we would normally see at this time of the year. Whether this is indicative of a real slowdown or is just a transitory phenomenon, we do not yet know. We will continue to monitor short-term developments and keep you informed, but I should also reiterate that we expect any slowdown to be temporary.

As we’ve said before, Florida remains an attractive place to live and work, its economy continues to perform well and we certainly anticipate that the beginnings of the baby boomer retirement wave will support FPL’s long-term growth.

Despite weakness in the housing sector, economic growth as reflected in the growth in real personal income continues at a healthy pace which is generally positive for growth and use per customer.

Unfortunately, analysis of usage trends in the quarter is made challenging by the large and somewhat atypical impact of weather. Average temperatures were above normal and this typically translates into higher usage in a fairly predictable pattern. We estimate that the temperature effect by itself would have been positive for sales volume by about 4.1%. However, the third quarter had a high incidence of afternoon showers and thunderstorms which invariably reduce peak loads and usage. Our modeling of these effects is more limited than our knowledge of the temperature relationship, but rough estimate suggest this in fact could be as much a negative 6%, and thus the net weather impact relative to “normal” was negative 1.9% or negative 0.3% relative to last year, which would imply that underlying growth was a healthy 1.8%.

Because of the high degree of uncertainty about the rainfall effect, however, especially relative to prior years, we are a little skeptical of these analyses. Perhaps the best we can say at the moment is that there is enough statistical noise in the weather data to overwhelm any signal in the underlying usage data and thus we cannot at this stage draw any meaningful conclusions about trends and usage.

In prior earnings calls we have noted uncertainty in our underlying usage outlook near term and this continues to be the case even though it remains hard to see much of an impact on our recent results. Common sense tells us there must be some effect, for example an unused condo clearly won’t have the same electricity pattern as one that’s occupied, but at least so far that doesn’t seem to be much of an effect showing up in the data.

As a reminder, over the long term we have seen annual usage growth of about 1%, but this figure has always been quite volatile from quarter to quarter and year to year. As with customer growth, we will continue to monitor usage trends and let you know if we see any reason to change our outlook.

For the third quarter, FPL’s 2007 O&M expense was $378 million, up $43 million from the prior year figures driven by higher distribution, nuclear power generation, employee benefits and customer service costs. For the full year, we continue to see increases in distribution, nuclear and fossil generation as well as employee benefits and customer service costs and of course our Storm Secure Program as being the main drivers of O&M growth.

We indicated last year that we did not expect to be able to offset the one-time ratcheting effect on O&M of the full implementation of Storm Secure through productivity gains in other areas. This is the main reason why we expected FPL’s income growth to be challenged in 2007. For the next few years, we expect to spend about $50 million in O&M expense and a $100 million to $150 million in capital per year on Storm Secure activities.

Depreciation in the third quarter fell $3 million to $194 million as higher distribution and generation depreciation including the impact from the addition of the Turkey Point 5 unit were offset by reductions in certain amounts recovered through the capacity clause. Underlying base depreciation increased by $7 million.

The accompanying chart summarizes the third quarter 2007 earnings drivers of Florida Power & Light which netted to a decrease of $0.01 per share. In the interest of time, I will not read each numbers for you. For those of you without immediate access to the slides, they are available in the investor section of our website,

To summarize, Florida Power & Light’s earnings were largely inline with our expectations, a combination of customer growth, usage growth and the addition of the Turkey Point 5 natural gas facility were offset by higher operating expenses, increased base depreciation and a number of other small negative effects.

FPL Energy had another very strong quarter with adjusted earnings increasing 25% over last year’s comparable period. Last fall, we indicated that 2007 would show very healthy growth, owing primarily to two key drivers: the rollover of older, lower-priced hedges to more current market values, and the additional contributions from new wind. Both drivers are playing out very much as we expected, but FPL Energy is a bit ahead of where we expected it to be, primarily because the existing portfolio has been stronger than anticipated and because the opportunities available to our wholesale marketing and trading arm have been better. This has helped us more than offset disappointing wind resource availability in the first part of the year.

FPL Energy is very well positioned for further sustained growth beyond 2007. In late September, we closed the acquisition of Point Beach, adding 1023 megawatts to our nuclear portfolio. The long-term contract on Point Beach will be increasingly accretive to EPS over the years, and we expect to be able to add output through capacity upgrades as well. Our wind development program is proceeding well, and we continue to see 8,000 to 10,000 new megawatts in the 2007 through 2012 period as being a realistic program.

We are pursuing a number of other growth opportunities, including solar and transmission projects, and are exploring selective greenfield gas development opportunities in our core markets. Finally, the business is well-positioned relative to longer-term fundamentals including commodity prices and the likely impact of climate change initiatives on wholesale power markets.

FPL Energy’s 2007 third quarter reported results were $220 million or $0.55 per share compared with $218 million or $0.55 per share in the prior period results. Adjusted earnings for the third quarter of 2007, which exclude the effect of non-qualifying hedges, were $180 million or $0.45 per share compared to $144 million or $0.36 per share.

In the third quarter of 2007 we recorded a gain in the non-qualifying hedge category of $40 million after tax with $35 million reflecting the decrease in forward commodity prices we experienced during the quarter and $5 million representing the reversal of prior period losses.

A gain in the non-qualifying hedge category is typically associated with the reduction in the value of our open or unhedged positions and is thus a negative indicator for future expectations and vice verse.

Fortunately, the net market movement in the quarter was small as I will discuss in a moment, and so the impact on our expectations is not significant. As a reminder of the types of transactions that we classify as non-qualifying are those that must be mark-to-market under GAAP, but to provide an economic hedge to a position that is not mark-to-market thus creating an unavoidable mismatch in current period GAAP results. We continue to believe it is more useful to think of FPL Energy results excluding the impact of the non-qualifying hedge category whether that impact is positive or negative. Comparisons of period to period GAAP results can be quite misleading when there is significant volatility in the non-qualifying hedge category.

FPL Energy’s third quarter adjusted EPS contribution increased $0.09. New investment, primarily new wind projects, contributed $0.02 per share, the existing portfolio added $0.05 per share and asset optimization and trading added $0.03 relative to last year’s comparable period. Much of the growth in the existing portfolio came from the anticipating rollover of older lower price hedges, but we also saw better market conditions and additional opportunities for asset optimization. All parts of the existing merchant portfolio contributed to the strong performance.

The existing wind portfolio was roughly flat with last year. You may recall that our wind index was abnormally low particularly in Texas in the second quarter owing to unusual weather patterns. These trends continue through July and then reverted to more normal conditions.

Across the entire portfolio, the wind index for the quarter was good although ironically this was one quarter in which the correlation between our wind index and actual realized wind speeds at our sites was not particularly strong.

As I’ve mentioned before, the wind index is a reasonable approximation of the underlying resource available to our projects, based on easily verifiable data from reference towers, but the correlation between the index and the actual output in the portfolio was not perfect. Please refer to the appendix of the presentation for additional detail on the wind index.

Operationally, the fleet continued to perform very well. All other factors were a negative $0.01 per share, driven primarily by additional interest expense and overhead, which reflects continuing investment in the growth of the business.

During the quarter, we saw continued volatility in commodity prices, but not a great deal of net change. As this chart shows, the ten-year natural gas strip decline modestly over the period, which is consistent with gain in the non-qualifying hedge category. Although this trend by itself as negative for our future expectations, the magnitude of the impact is not large and as the chart also shows the ten year strip remains above the levels of late last year. Further, since the end of quarter prices have risen again. Focusing for a moment on the fundamentals rather the short-term fluctuations, we continues to like the inherent long position of the FPL Energy portfolio relative to natural gas and to spot spreads in New England and Texas.

To summarize the 2007 third quarter, on an adjusted basis FPL contributed $0.81, FPL Energy contributed $0.45 and corporate and other was a negative $0.03. That is a total of $1.23 per share compared to $1.15 per share in the 2006 third quarter on an adjusted basis.

Let me now turn to our earnings outlook. For 2007, we expect adjusted EPS to be at or near the high-end of the range we set out last fall or in other words, around $3.45. FPL Energy has had very strong performance for the first three quarters and is likely to be at or above the top of its range, while Florida Power & Light hindered by the weather driven revenue shortfalls earlier in the year, it is likely to be at the lower end of its range.

For 2008, our current expectations are better than the early view we shared with you this time last year, based on everything we see today, we believe a range of $3.83 to $3.93 is reasonable, which should mean at least an 11% growth in adjusted earnings per share. With normal weather, we expect Florida Power & Light to show modest growth, while at FPL Energy we see another year of growth in excess of 20%.

Looking out to 2009, the range of likely outcomes is of course larger, but the drivers we can see today suggest a range of $4.15 into $4.35, again the big growth driver will be FPL Energy. Beyond 2009, we expect to continue strong growth. For the period of 2006 through 2011, we expect to see adjusted EPS grow by an average of at least 10% per year.

As always our EPS expectations assume normal weather and mark our currently open positions to the current forward curves. We also exclude the effect of adopting new accounting standards, if any, and the mark-to-market effective non-qualifying hedges neither which could be determined at this time.

Our outlook for sustained high EPS growth will naturally raise the question about the implications for the dividend. While the dividend decision is of course one that the board will make, our current thinking is that the company is well positioned to offer more rapid dividend growth than we have seen in the past.

Because of our growth profile, our capital investments needs are substantial and so we want to maintain a moderate payout ratio, but a dividend growth rate of about 8% appears to us to be a reasonable balance between immediate shareholder return and supporting the continued growth of the business.

Let me now provide a little more detail around the drivers of our growth expectations starting with the 2007 to 2008 bridge for Florida Power & Light. Broadly speaking, we look for a normal year of growth from FPL with the positive effects of regular revenue growth and AFUDC being partially offset by modestly rising cost levels. On the revenue side, we expect about 5% volume growth or 3% on a weather adjusted basis and we will also see the full year impact of Turkey Point 5, which will add about 1% to base revenues. Construction projects, most notably the West County combined cycle units, will add to AFUDC and environmental capital projects and some of our fossil facilities will contribute to earnings through the environmental clause. As a remainder, prudent environmental investments are entitled to recovery at a fair of rate of return through the environmental clause.

We anticipate O&M growth of about 6% with the primary drivers being continued cost pressures in nuclear, employee costs and an increase in the number of plant fossil unit outages. Depreciation, interest and other factors will grow roughly inline with the general growth of the business with additional modest increases due to the full year impact of Turkey Point 5.

The FPL bridge for 2008 to 2009 looks broadly similar. AFUDC will grow with spending on generation projects, primarily the West County combined cycle units due to enter service in 2009 and 2010. The first West County unit is due to enter service during the period of the existing rate agreement and therefore is expected to bring with it a base rate adjustment, thus contributing to revenue growth. Depreciation expense will increase a little more rapidly, reflecting the continued growth of the business and the introduction of West County Unit I. Other drivers will be roughly the same as from 2007 to 2008. All this should lead to another year of moderate growth.

As you know, Florida Power & Light’s rate agreement comes to an end at the end of 2009 and this will us an opportunity to reset base rates for 2010 and beyond to reflect the significant capital expenditures that we have been and will be continuing to commit to the business during this fixed rate agreement.

Turning to the earnings growth outlook for FPL Energy, this chart shows the bridge from 2007 expectations to 2008. Not surprisingly the story is one primarily of growth from new asset additions, but with additional growth anticipated from the existing portfolio and from related marketing and trading activities, the opportunities for which grow along with the overall growth in the business.

These positives will be partially offset by the cost of a growing business, primarily increased interest expense and increased G&A. Of course, the growth in these itself is a function of our success with the growth plan overall and they can be relatively easily scaled to match the level of success we have in building the portfolio.

The $0.07 to $0.11 of growth from the existing portfolio is a function of a number of smaller parts. In 2008, we still have a certain amount of built-in momentum from the roll-off of older and lower priced hedges and forward capacity pricing in key markets primarily in New England, is a bit stronger. Together these would account for roughly $0.20 of growth. Offsetting these and some smaller positives will be the fact that 2008 is an outage year for Seabrook which 2007 was not, as well as the roll-off of some favorable pricing on older contracted assets.

Turning finally to the 2008 to 2009 bridge for FPL Energy. Again, we expect the primary driver of growth to be new asset additions. At this stage, we anticipate little if any growth in the existing portfolio in 2009 for a combination of reasons. In 2009, we’ll have outages at Seabrook, Duane Arnold and Point Beach. We also have plans for this time period some significant work on some of the fossil units. 2009 will be the first year where the roll-off of PTCs and all the wind projects has any impact. We think it is a testament to the strength of the business that despite these combined effects, the existing portfolio still shows the potential for maintaining its earnings power while being positioned for return to growth in 2010 and beyond.

Before closing, let me address potential drivers of variability in our results. As always, I urge you to consult our SEC filings and the risk factors described in our cautionary statement attached to this presentation for a fuller discussion of risks. My comments here relate only to a subset of the possible reasons while actual reported results might be different from our current expectations.

In the appendix, we have included what I refer to as our plus and minus charts which show some key sensitivities. With the chart shown here I’d like to address hedging and commodity price exposure and try and explain some refinements to our thinking about communicating with you on this topic.

Last January we introduced a slightly modest and more detailed description of our commodity exposure and we have built on that here. As FPL Energy’s business has grown and become more complex, it has become less easy to speak simply of the percentage of the portfolio that it has hedged or unhedged. In fact, we do not think it is meaningful to think about a single measure of the exposure of the entire business since it is made up from very different pieces.

For these purposes it is useful to think of FPL Energy’s portfolio in three broad categories:

First, the existing portfolio of physical assets with varying degrees of contract coverage and hedging and varying degrees of exposure to different commodity prices.

Second, new assets primarily wind for the next couple of years, which for the purposes of these charts are defined as assets not in the portfolio as of December 31st of this year.

Third, non-asset based activities, which are driven by our marketing and trading capability.

The nature of the exposure to commodity prices in these three categories is somewhat different. Please note also that the definition of new assets here is different from what we use when reporting quarterly results and on the previous bridge charts for which purposes we used an approach similar to the same-store sales concept often used in retail businesses.

The first category is relatively straightforward. The sensitivity of existing assets to commodity prices can be roughly thought of in terms of the percent of expected gross margin that is covered by a contract or is hedged and the two basic types of exposure in our portfolio are to natural gas and to spot spreads. For these purposes we have grossed up wind production tax credits to equivalent pre-tax values for comparability, so the equivalent gross margin measure is not a normal accounting measure. Obviously PTCs on existing projects do not have commodity risk.

We have also included our share of expected revenues, net of fuel costs, for equity method investments to put these projects on a comparable basis. As you can see the existing portfolio is heavily hedged for 2008 with more than 90% of our expected gross margin from this category protected against commodity price volatility.

The third category -- that is the non-asset based businesses -- is also relatively straightforward. In general, FPL Energy’s non-asset based activities of which wholesale forward requirements is the most notable are independent of specific levels of commodity prices. A more useful way of thinking about these activities when thinking about the potential variability of their contribution to a particular year’s expected earnings is to consider how much of the expected gross margin associated with them will come from deals that are already executed i.e., in backlog as opposed to deals that have yet to be originated.

As you can see for 2008 32% of the margin we expect from this category of activities is associated with deals already on the books. Of course this does not mean there is no uncertainty about these gross margin dollars; we must still execute effectively and many other risk factors beyond commodity prices come into play. But it does mean that the origination effort has been successfully completed.

As a general guide, we would expect these kinds of activities to add about 5% to 10% to the FPL Energy portfolio gross margin, and to enter a year with about one-quarter to one-third of our expected activity and backlog. This was the case going into 2007 and it also the case going into 2008.

The middle category, the newer assets, can be a little more complex. For a new contracted wind project that has past all its development hurdles, it is easy to determine the commodity exposure. But for many new wind projects particularly those a couple of years out it is much less so. We manage a development portfolio with many different projects in different states of development at any point in time. If one project slips in its development schedule, it is likely that another would be a little ahead thus the commodity exposure of a wind development portfolio is not obvious. Clearly a higher power pricing environment makes a new wind project relatively more attractive but the relationship is not as clear as, for example, the impact of an extra $1 per megawatt hour on Seabrook’s margins.

For the purposes this chart we assumed that PTCs on future projects are independent to commodity prices and we have made rough assumptions about the mix of likely wind projects and particularly the percentage that would be PTA-type deals.

As you can see from the chart on this basis roughly 40% of the expected growth margin is protected from commodity price volatility, but we recognize that different assumptions could cause this figure to vary somewhat.

Perhaps more important, we believe the bigger driver to be considered for this category is development success. While a higher commodity price environment certainly enhances our odds of meeting our volume goals, it is by no means the most important factor.

As you can also see from this chart, the equivalent gross margin contribution from this category to 2008 expected results is modest, as you would expect. This is a function of the fact that projects that are not in the portfolio at the beginning of the year are likely to come in late in the year, and thus contribute little to that year’s results.

The 2008 wind program is much more important for 2009 expected results, and so on. Because the nature of these three categories is quite different, we do not think it is meaningful to try and use a single measure to capture a hedging for the entire portfolio.

This chart provides the same information as the previous one for FPL Energy’s 2009 positions. As you can see, about 80% of our expected equivalent gross margin from existing assets is hedged, and the most significant open positions are with spot spread sensitive assets. In prior years, we have typically hedged out underlying gas exposure a bit further than spot spread exposure, and this is still true today, largely owing to our belief and experience that the greater depth and liquidity of the gas market makes forwards based on gas prices more reliable as indicators of a fair level of future prices.

Not surprisingly, the expected contribution from new assets, which to repeat for these charts means assets not in the portfolio as of the end of 2007, is much larger. But, because most of this is wind projects, and because of the nature of wind economics, the exposure of this expected margin to commodity prices remains proportionally similar to 2008.

Finally, again as you would expect very little of the non-asset based business activity that we expect to realize in 2009 is in backlog today. Our activities in this area, both wholesale and retail tend to be conservative, and among other characteristics the tenure of the book of business is typically quite short. Most of the activity is originated in a year for delivery and settlement within the same year.

Again, I would note that our growth plans call for these kinds of activities to grow roughly in line with the overall growth of the portfolio. Historically, they have consistently delivered an increment of about 5% to 10% to the equivalent gross margin of the asset portfolio and we expect them to continue to do so in the future.

Summing up therefore, we are pleased with 2007 performance to-date and also closed the year at the high end of the range we set up for you at this time last year. We have solid plans in place which we expect to yield continue strong growth for 2008 and 2009, the drivers of which are clear and the range of variability readily understandable.

We remain well positioned for longer term, with what we believe are the right exposures to the likely fundamentals of commodity prices and the important issue of global climate change. We are confident that achieving average adjusted EPS growth of at least 10% from 2006 through 2012 as a realistic expectation.

With that, we will believe happy to take your questions.

Question-and-Answer Session


Your first question comes from John Kiani - Deutsche Bank.

John Kiani - Deutsche Bank

Moray, can you talk a little bit about your current level of interest in pursuing some sort of a separation or spin or monetization of a portion of the wind business, especially in light of some of the activity in Europe that’s obviously fetched some very attractive valuations? I know you’ve mentioned it before obviously.

Moray P. Dewhurst

By way of an update of our thinking, the bottom line is, our thinking remains really where it has been, so let me just reiterate that. The way we operate our businesses, they are real operational linkages between the wind and solar portfolios and all other aspects of generation. So, there would be some real costs incurred in separation, a real loss of value as well as incremental cost obviously in creating a separate entity. Before we would be willing to undertake that we’ve to be convinced that the gain from such a separation would more than offset the loss of value.

To-date, we have not been convinced that there would be that much fundamental value creation. Here we are most concerned with making sure that whatever the effect of a partial spin might be that it flows value back to existing shareholders, not simply create a good trading platform in the new entity, but has to create value for existing shareholders.

We spent a lot of time looking at historical examples of separations everywhere from partial to full. Simply at this stage have not been convinced that we can reliably count on enough, what I would call value flowback to more than offset the real cost increments to the business.

At the same time, we have not by any means ruled it out as a future possibility, and one thing that we did indicate earlier in the year is that we were going to be looking with great interest that [inaudible] partial IPO when it occurs to see how that trades and see if we can develop any additional information from that.

We really haven’t changed that view, I think its still makes sense based on everything that we see today, but as I said, that doesn’t rule out possible changes in that view in the future.

John Kiani - Deutsche Bank

As far as development is concerned, do you have any interest or is it possible for you to invest in wind outside of the US in other markets?

Moray P. Dewhurst

It’s certainly possible, we certainly have interest. We have actually for the last couple of years spent quite a bit of time evaluating wind projects in Europe. But frankly, we at the moment that we just see a more attractive opportunities for us in the US, given that we are essentially growing the capability in the business as rapidly as we can consistent with maintaining very effective level of profitability we really want to go up to the most attractive opportunities first and we have more than enough for those keep our plate very full here in the US.

So, it certainly doesn’t preclude the possibility of us going elsewhere in the future, but at least for the short term, as I said we’re very happy with the opportunities that in front of us in the US.


We’ll go next to Greg Gordon - Citigroup.

Greg Gordon - Citigroup

You have given sort of rough rule of thumb based on your current sort of point of view on wind economics and how you finance your wind business as to the earnings accretion from every 100 megawatts of wind additions. Is there in fact a number out there and what is it?

Moray P. Dewhurst

We said that every 100 megawatts, you can figure an average of sort of a penny to a penny and a half of accretion averaged over the first few years of the project’s life. There is quite range in that obviously depends in part on how we finance it, what type of project it is, but that’s a reasonable range.

Greg Gordon - Citigroup

When I look at the ‘08 and the ‘09 earnings drivers for FPLE, you are targeting 1100 megawatts in ‘08 and 1500, 1600 megawatts in 09’. So by that math you are looking at accretion of about $0.15 to $0.20 in ’08 and $0.25 to $0.30 in ‘09 but the new investment driver for ’07 to ‘08 and ‘08 to ‘09 is materially higher than that. What explains the delta if it’s all wind?

Moray P. Dewhurst

You can’t just take that penny to a penny and a half and apply it the way you are applying, because there is a specific timing of when the new projects come in. That math doesn’t work; you’re going to have to do it slightly differently. In the interest of everybody else’s time, I can take you through that separately.

Greg Gordon - Citigroup

In ‘08 probably a part of it is the nuclear plant addition which is a new investment?

Moray P. Dewhurst

Both ‘08 and ’09. Point Beach is showing up in the new category.

Greg Gordon - Citigroup

We would subtract Point Beach from the new investments number, but if we could walkthrough that offline that would be great. I am sure it’s an easy explanation, but the driver seems to be higher than what the rule of thumb would suggest.

Moray P. Dewhurst

It’s a little bit of a complicated sort of laying out of the numbers. It’s conceptually simple, but I prefer to do it separately.

Greg Gordon - Citigroup

When you look at your earnings aspiration in aggregate obviously there is review out there somewhere in the distant future in ‘09. So when you look at your posted 2010 earnings aspirations what types of equity returns and capital structures do you assume or ranges of potential returns and cash structures do you assume you will be able to earn at FP&L?

Moray P. Dewhurst

Let me take the capital structure first. We have maintained a very consistent structure at FPL for many, many years., certainly longer than I have been around and it has served as well, and I see no reason why that would change going forward. On the actual return, I think all I would say is that Florida as a jurisdiction has historically provided the opportunity for well-managed companies to earn a little bit above the nationwide average rate of return and we see no reason why that would not be the case going forward.


We will go next to Leslie Rich - Columbia Management.

Leslie Rich - Columbia Management

I wondered if you could walk through the non-asset-based businesses with a little bit more detail? I am not sure I understand what’s in that bucket. And then as you look at your contribution from I guess you call it trading and asset optimization, strategically has your approach to that changed at all? How do you look at that?

Moray P. Dewhurst

Well let me take the second part of that first. Strategically it hasn’t really changed, not greatly although it would be non-asset based businesses now include the retail operation in Texas, which of course was not true a few years ago.

But me talk a little bit about what we call the non-asset base businesses. This is really an umbrella term to capture everything that is based on the core marketing and trading capability that we have built up to be able to handle the risk positions that are inherent in the physical assets. Once you have that capability it sort of automatically provides you opportunities beyond just what the assets themselves bring along.

The biggest single area for us particularly this year is our wholesale requirements business which has been growing reasonably steadily over the last few years. That is a business that we got into because we knew a good deal initially about the New England market and subsequently expanded to other markets, typically where we have assets although not necessarily so. It is in a sense a freestanding business even though its existence hinges on capabilities that were developed in connection with running the assets.

There was also a small amount of just pure spec trading involved in there, again once you have a significant position in a market and you have an information based sort of automatically provides you certain opportunities to take limited positions.

The three big ones, I would note in the non-asset base category, wholesale requirements, the retail business, and then pure spec trading. This pure spec trading can range anything from just arbitraging real-time day ahead markets to trading around transmission nodes those kinds of things.

Collectively if you look back over five to six years of history, the sum of those kinds of activities even though the specific activities themselves have changed, the sum of those activities has contributed an increment of about 5% to 10% beyond the gross margin that we just extract from the assets themselves. So, as the portfolio builds we have been consistently building our capability and exploiting it in these other areas.

So the growth plant calls for essentially a continuation of that again keeping it roughly in the same proportion as the rest. We’re not changing our overall risk profile. We’re not planning to build a large standalone trading platform, but as that overall portfolio grows there are just more opportunities in absolute terms for these kinds of activities.

Leslie Rich - Columbia Management

What is your outlook for the retail business? Do you plan to just stay in Texas. Are you adding customers, are you trying to grow it or is it just sort of added growth?

Moray P. Dewhurst

No the business is growing. It’s done quite well. We’ll continue to grow it, but I guess the best way to say it is it will be a controlled growth consistent with the existing market structure in Texas. I think there is a significant opportunity for a relatively small or handful of relatively small share of players to make money given the market structure, but I don’t think it’s a market where you want to effectively challenge the market leaders shall we say.


We’ll go next to Dan Eggers - Credit Suisse.

Dan Eggers - Credit Suisse

Can we just talk a little bit about the implications of language floating around Congress as part of the Energy Bills as far as potential for a national RPS standard, potential for renewable energy credit on a national basis, what that would mean for your existing fleet and how you contract forward construction programs?

Moray P. Dewhurst

Historically we have been really more in favor of letting states decide what they wanted to do in the way of RPS. Over the time there has become a lot more activity and it’s become lot more diverse and it has changed our view to the point that we are now supportive of a national renewable portfolio standard.

The reason we’ve really changed is because what has grown up is a bit of a patchwork quilt with different definitions, different categories which is probably not the most efficient way at the national level of moving the country where we think it needs to go in order to help address the climate change issue. We do believe that the primary importance of renewable energy in a power sector is to support climate change issue.

So, at this point we believe it would be more efficient to have a national system which would have a single definition that can be uniformly traded everywhere. But whether that is a practical proposition at this stage is certainly something that we could debate.

As a business, we’re certainly quite prepared to continue to operate in the existing patchwork quilt environment obviously we have successful in that. I think we would probably have a little more upside in a uniform national market.

Lewis Hay

Dan, I just want to add a point though, we have to be realistic about what the targets are for a national program, and some of the proposals that floating around up there are in our opinion, unreasonably aggressive.

Dan Eggers - Credit Suisse

Any desire to comment on what unreasonable was?

Lewis Hay

I just prefer not to comment on that at this point, but just to point out, how much renewables would be required in a pretty short period of time under the current proposals. So, I think the targets either have to be relaxed or the definition of what’s renewable has to be expanded.

I would say the other point we have on that is, you don’t want to start slicing it, whatever the requirement is and saying for instance that, if the target is 15% by a certain date that 5% of that has to be solar or something like that, we can’t put it onto constraints, just given geographic limitations.

Dan Eggers - Credit Suisse

Jim, could you comment on pricing economics for new wind projects as we see more of the Europeans come into the US with presumably a low cost of equity, it seems. Are project economics changing at all at this point?

Jim Robo

Dan, we remain pretty comfortable with the returns that we’re seeing in the projects that we’re developing. You have to remember, we have a very large scale advantage from a development standpoint, relative to our competitors here in the US. We have been working very hard to capture more of the wind value chain in our projects. We are very comfortable with the economics that we’re seeing.

So, I think the short answer is our wind project economics are strong or stronger now than they ever have been.

Moray P. Dewhurst

Dan, let me see if I can tie a couple of those responses together for you. One of the key things that led us to the 8,000 to 10,000 program was the realization that the market opportunity here is just growing. It is larger than perhaps we had previously anticipated.

So I think in the context of impact on margins, that’s one of the reasons why we’re not seeing any noticeable trend in margins, because there is plenty of room for a number of competitors to play.

At the same time, that is to Lewis comments about being realistic about the RPS standards. That market expansion is consistent with State Level RPS targets that we’re already seeing today. I think it actually ties in very neatly with what Lew said. There is a limit to how much we collectively as an industry can do in any given period of time. If we try to force much beyond that, all we will do is end up incurring a lot of extra cost without actually creating a lot of additional renewable energy in a given time period or avoiding carbon emissions.

So, it’s perfectly possible to have a very, very healthy rate of growth for the renewable space overall without going to extremes on the specific targets for the national renewable portfolio standard.


Our next question will go to Ashar Khan - SAC Capital.

Ashar Khan - SAC Capital

Could you tell us what kind of ROE we will be at FPL in 2009, based on your projections roughly?

Moray P. Dewhurst

At the moment what we are looking at is probably a little below 10%.

Ashar Khan - SAC Capital

Moray, you mentioned in your remarks that as part of the Florida’s green initiative you were looking at solar and other energy efficiency measures on green. How do you contemplate getting the return on that CapEx? I just wanted to get an understanding of where that was and how does the company get a return on those spendings, apart from the rate deal or separate from the rate deal or how is it being anticipated as we look forward?

Moray P. Dewhurst

Right. Well, obviously going to depend on what the specific investments are because some are already covered under the existing regulatory framework. For example, capital investments in energy efficiency programs are recovered with a return through the conservation clause. So, there is already a framework that exists for that. That doesn’t preclude the possibility of otherwise thinking about that going forward, but at least at the moment we already have that that piece of the framework in place.

On things like renewable energy, again there is an existing framework which is the resource planning process that the state employs, and any new generation that came in under the existing rate agreement would be entitled to its generation base rate adjustment. So, right now there is a framework that accommodates anything that might be contemplated.

For example the 2008 test year would then get rolled into 2009 rate resetting process. So, there is an existing framework and again it doesn’t preclude the possibility that there might be changes to that framework.

For example, in implementing the governor’s target of a renewable portfolio standard the PSC has been charged with examining that issue and looking at possible different rules that might help encourage utilities to be able to retain that standard. We don’t yet know what may come out of that process. But certainly there is a possibility for some change to that framework so we are particularly supportive of renewable development.

Ashar Khan - SAC Capital

When do you expect those CapEx to be put into the budget, what -- when should be we looking?

Moray P. Dewhurst

There is some in ‘08 budgets, but it will start really to build in ‘09 and ‘10.

Ashar Khan - SAC Capital

If I can just end up, in your opening remarks you mentioned ‘09 FPL Energy had a negative from PTCs rolling off, could you quantify how much that is?

Moray P. Dewhurst

I think it’s in the order of $10 million.


We will next to Paul Patterson - Glenrock Associates.

Paul Patterson - Glenrock Associates

I just want to ask you about the four capacity markets in New England , with the auction coming up I know the results in terms of the financial impact it might be not exactly completely within the timeframe that you guys are providing earnings guidance, but could you just give a little bit of flavor as to what you see there now that we are getting closer to that auction and what the potential impact might be for you guys?

Jim Robo

First of all, I would say it’s not getting any easier to build power plants anywhere in the country, but particularly in the Northeast.

Secondly you are right any results from this upcoming auction really will have only a few months of impact in the ‘09 guidance we have given you, it’s really more of a 2010 and beyond type of impact. We feel like the markets are, we feel like this is a favorable and positive development and we expect auction to clear at a number that is higher than the current fixed price numbers.

We will see. It is going to depend a lot on how many projects come out of the wood work and bid into the auction, but I think fundamentally it’s not very easy to develop right now in the Northeast. I think this will be a positive earnings driver for us out in the next decade.

Paul Patterson - Glenrock Associates

The ISO New England has put out those same statements that there is 17,000 megawatts. I mean, obviously a very large number that could theoretically be available to it. When you are looking at this, what do you realistically think might show up in the form of new capacity? I mean, can you give us any flavor on that?

Moray P. Dewhurst

No, Paul. We have a view it’s not a view given that it’s going to be an auction and we may or may not be participating in it. I am not really in a position to give you exact numbers around what our view is, what s going to be available and what we think is actually going to happen in the market.

Paul Patterson - Glenrock Associates

Okay, fair enough. Finally on offshore versus onshore wind, have you guys seen a difference with respect to response that we have seen, I mean obviously we had the [Lippa] situation, but there is also been some other stuff that’s happened with other developers that maybe indicate a little more resistance to offshore. Are you guys seeing that, or is that just sort of anecdotal stuff?

Jim Robo

First of all, offshore in the US is challenged by fundamentally by two things: one is none of the manufacturers have ever manufactured an offshore wind turbine for the US market. There needs to be a real demand in the US for offshore wind before; it’s a bit of a chicken and egg issue there. But there needs to be a real demand out there for offshore wind before any of the manufactures are going to step up to the plate and do the R&D and tooling and all the things you need to do in order to produce offshore wind turbine for the US market. That’s a challenge.

The second piece of it is that many of the cost associated with offshore winds have been escalating very quickly outside the tower and turbine. There are significant steel and EPC and marine costs that you’re competing in a global market for those things and other industries such as the oil and gas industry that really put a lot of inflationary pressure on those costs. So, I think overall offshore wind economics are very challenged relative to onshore.

Moray P. Dewhurst

But, let me just add that that’s been our view of offshore wind in the US for sometime, now, we just don’t see a major opportunity any where comparable to the onshore opportunity at least for a long time. So, our interest has been strictly limited by specific projects particularly where we might have an existing strong customer relationship.

The offshore sector has not been something that we have really focused on. There are plenty of opportunities for us onshore, the economics are much better. It just makes a whole lot of sense for this country to focus on exploiting its best onshore resources first. So, there is a long way to go before we really frankly need to go offshore.


We will have our final question from Daniele Seitz - Dahlman Rose.

Daniele Seitz - Dahlman Rose

I just was wondering if you had any estimates on solar construction in terms of capacity factor and how does that compare to wind power?

Moray P. Dewhurst

Daniele could I ask that we get back to you separately on that?

Daniele Seitz - Dahlman Rose


Moray P. Dewhurst

The answer is, it depends on a great many different factors. We can give you some reasonable ranges for different types of technologies in different situations.

Daniele Seitz - Dahlman Rose

Does it compare to wind easily or is it a totally different world?

Moray P. Dewhurst

Well, it’s a very different type of resource. Bottom line though at least in the US context even the best solar projects are still well off the typical good wind projects. So, it’s still got a long ways to go. But the answer to your question is, we’re happy to tackle it, but it will take a little bit longer.

Daniele Seitz - Dahlman Rose

In terms of the schedule of the 10 gigawatts you’re planning on the wind side, if you wanted to extrapolate to further years out it is roughly a maximum of 2,500 a year, given the logistics, do you feel? Or do you feel that number is not the maximum, you can do more than that?

Moray P. Dewhurst

Daniele, at this stage I don’t think we are in a position to say what a maximum might be. Let me tell you what is baked into that. Essentially what we are doing is taking a development and construction system that’s capable of delivering about 1,000 megawatts a year today and scaling it up to one that’s capable of delivering roughly twice that in that five or six-year period. What we might be able to do beyond that, obviously, if we continue to grow if the markets continue to be attractive, but that is just too far out for us to say. In fact we were talking about doubling our throughput capability.

James von Riesemann

Thank you everyone. That concludes today’s conference call.

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Source: FPL Group Q3 2007 Earnings Call Transcript
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