Spectra Energy Corporation Q3 2007 Earnings Call Transcript

Nov. 7.07 | About: Spectra Energy (SE)

Spectra Energy Corporation (NYSE:SE)

Q3 2007 Earnings Call

November 6, 2007, 10:00 AM ET

Executives

John Arensdorf - VP of IR

Fred Fowler - President and CEO

Gregory Ebel - CFO

Analysts

Carl Kirst - Credit Suisse

Lasan Johong - RBC Capital Markets

Matthew Akman - CIBC World Markets

Ross Payne - Wachovia Capital Markets

Operator

Good morning my name is Amanda and I'll be your conference operator today. At this time I'd like to welcome everyone to the Spectra Energy's Third Quarter 2007 Earnings Review. All lines have been placed on mute to prevent any background noise. After the speakers' remarks there will be a question-and-answer session. [Operator Instructions]. I'd now like to turn the conference over to Mr. John Arensdorf, Vice President of Investor Relations for Spectra Energy. Please go ahead sir,

John Arensdorf - Vice President of Investor Relations

Thanks Amanda and good morning everyone and welcome to Spectra Energy's third quarter 2007 earnings review. Thank you for joining us today. Leading our discussion today are Fred Fowler, our President and Chief Executive Officer; and Greg Ebel, our Chief Financial Officer; Sabra Harrington, our Vice President and Controller is also with us and will be available to take your questions at the end of the call.

Now, normally Martha Wyrsch, President and CEO of Spectra Energy Transmission would be with us as well but she is in Washington today presenting at the FERC Conference on the future of natural gas. Fred is going to begin today's discussion by sharing his perspective on our result1s for third quarter and update you on our progress in meeting our 2007 financial and capital expansion goals. Then Greg is going to provide more detail and context around Spectra Energy's results and those of each of our business segments. And then we will open the line for your questions.

Before we begin, however let me take a moment to remind you that some of the things, we will discuss today concern future company performance and include forward-looking statements within the meanings of the securities laws. Actual results may materially differ from those discussed in these forward-looking statements. So, you should refer to the additional information contained in Spectra Energy's Form 10-K and in our other SEC filings concerning factors that could cause these results to be different than those contemplated in today's discussion.

In addition, today's discussion includes certain non-GAAP financial measures as defined by SEC Reg G. A reconciliation of those measures to the most directly comparable GAAP measures is available on our Investor Relations website at spectraenergy.com. With that I'll turn it over to Fred.

Fred Fowler - President and Chief Executive Officer

Thanks John and good morning. As you've seen by now we enjoyed an exceptionally strong third quarter. Spectra Energy's ongoing net income for the quarter of $240 million was up 32% over the third quarter of '06 and year-to-date our ongoing diluted earnings per share is $1.6. So I believe that we are well on track towards meeting our employee incentive earnings target of $1.40 per share. We saw excellent quarter-over-quarter performance from our U.S. Transmission Group as well as distribution, Union Gas in Ontario and our Western Canada Transmission and Processing business.

Greg is going to walk you through our results in more detail shortly. So, I will focus on the look ahead. Our highest priority it remains unchanged, that's executing effectively on our $3 billion capital expansion growth strategy to drive our 5% to 7% ongoing earnings per share growth over the '07, '09 timeframe. We are backing up that commitment with action and solid results, our year-to-date capital expenditures stand at $940 million with $625 million of that directed toward expansion and by year end we expect to spend a little over $1 billion in expansion capital.

By the close of '07 we will brought into service expansion projects totaling between $625 million and $650 million. Those projects, which include things like Northeast Gateway, The Time II of main line expansion on the Texas Eastern System, mainline expansion, Dawn-Trafalgar on the Union Gas System, the Pine River expansion in Western Canada, the Cape Cod expansion out of Algonquin and the Egan storage expansion. These will all drive incremental revenue, our earnings and cash flow as we move into 2008.

We expect them to produce returns in the 10% to 12% range which equates to annualize EBIT of close to $75 million and we continue to identify attractive capital projects beyond the '07, '09 window. Just last week, we announced the proposed $3 billion Bronco Pipeline which will connect natural gas supplies from the Rockies with the growing western market.

The Bronco Pipeline would access existing and growing supply basins in Wyoming, Utah, and Colorado and would stretch westward toward its proposed terminus at Malin, Oregon. This project... it's obviously it's in the very early stages. It will be further refined after we held them up in season which we do expect to occur in the next few months. So we still have work to do before we start including Bronco on our project map but I am very excited about its prospects.

At 10 months in counting, we are nearing the home stretch of our first year as a publicly traded company. We're confident in our ability to deliver the financial and operational results that you expect of us. We are focused on expanding our footprint of high performing assets, responding to the needs and the opportunities of a demanding market and continually growing value for the investors and the customers that we serve.

Again I am very pleased with the results delivered by the Spectra Energy team this past quarter. All of our businesses continue to provide strong dependable results. We expect that trend to continue into the fourth quarter and both Western Canada and DCP Midstream should benefit from the continuing strong commodity environment that we are seeing in both crude oil and natural gas liquids.

When you take into account the strong level of earnings growth we anticipate along with the dividend yield of more than 3%, you can expect total shareholder return in the 8% to 10% range in a relatively low risk environment. Further, we are committed to our target dividend payout ratio of 60% of earnings and we would expect to increase the dividend as we grow earnings. That's a value proposition that I believe our shareholder should find compelling over the long term.

With that let me turn it over to Greg to talk in more detail about the results from each of our segments. And then we look forward to take your questions following our prepared remarks. Greg?

Gregory Ebel - Chief Financial Officer

Thanks Fred and good morning everyone. Earlier today Spectra Energy reported third quarter 2007 net income of $234 million or $0.37 per diluted shares. After removing the effect of special and extraordinary items and discontinued operations, ongoing earnings were $240 million or $0.38 per diluted share for the quarter, compared with $182 million last year.

As Fred mentioned this is a 32% increase over the 2006 results. Now let's review each business segment in a little more detail. Let's start with U.S. Transmission which reported third quarter EBIT of $230 million compared with $179 million in the second quarter 2006. The increased results in all of our U.S. pipeline and storage businesses were driven by higher demand for services and increased earnings from expansion projects.

U.S. Transmission also benefited from the capitalization of previously expensed development cost, notably related to our Southeast supply header in Gulf Stream projects both of which received FERC approval in the quarter and are now under construction. This was $13 million net benefit this quarter versus a $12 million expense in Q3, 2006. I'll remind you, that when we start projects, we expense the cost until we're confident that the project will move forward to successful completion. At that time, we reverse the expenses and capitalize those development costs.

Now, let me turn to our distribution business. Distribution posted yet another strong quarter marked by third quarter 2007 EBIT of $40 million compared with $24 million in the third quarter of 2006. This increase primarily reflected higher storage and transmission revenues and increased distribution margin. Favorable market conditions continued to drive strong storage revenue, while transmission revenues benefited from the completion of Phase I of the Dawn-Trafalgar expansion at the end of 2006.

These increases were partially offset by higher operating and maintenance cost including higher cost for conservation efforts which are recovered and raised. Now, let me move on to Western Canada, as expected Western Canada Transmission and Processing rebounded well after second quarter, reporting third quarter EBIT of $102 million compared with $98 million in the third quarter of 2006. The prior year period included a $15 million gain relating to Spectra Energy income funds, issuance of units for the purchase of assets from its parent. Excluding this gain EBIT improved $19 million primarily due to higher plant maintenance cost, a year ago from a turnaround in our Fort Nelson plant as well as the timing of cost related to pipeline integrity work and a stronger Canadian dollar this year.

The Empress frac spread was slightly over $8 for the third quarter, certainly higher than historic norms. However, it's worth noting that it was only about $1.50 higher than it was in the third quarter of 2006.

Now let me turn to Field Services. Our Field Services section which represents Spectra Energy's 50% interest in DCP Midstream reported third quarter 2007 EBIT of $140 million compared with $158 million in the third quarter of 2006. The 2007 earnings include $3 million in costs, related to the creation of standalone corporate functions. Lower margins in gathering and processing and gas marketing as well as higher operating costs were partially offset by favorable commodity prices.

Field Services is faced with an unique environment today. As you know, we've seen unprecedented liquids and crude prices. At the same time, natural gas prices have remained relatively low resulting in extremely high frac spreads. These trends have continued for some period of time. Due to these higher frac spreads some producers are electing to process their own gas and others are moving from key poles to percent-of-proceed contracts, which provide the producer with higher margins. Therefore we're not able to capture all the upside, we might otherwise have expected.

In addition, the third quarter resulted were affected by lower margins on contract renewals and well connects and plant and pipeline outages due to maintenance. Some of which was related to floods in August, which affected one Oak [ph] system in Oklahoma. Despite these changing market dynamics, Field Services continues to produce strong cash flows and distributions to Spectra Energy.

During the quarter Field Services paid distributions of approximately $247 million to Spectra Energy which included a special distribution of $122 million associated with the sale of certain assets to DCP Midstream Partners. Year-to-date Spectra Energy has received $358 million in distributions from DCP Midstream. Before we move on, let's take a look at crude oil prices for the year compared with the price we forecasted in this year's plan. Much has been made of the dramatic rise in crude oil prices but it's important to keep in mind that at the beginning of 2007 crude oil prices were much lower than they were today. And while currently the forward curve looks to be above our plan for the remainder of the year the settled and forward average prices for the full year is about $72 compared with our annual estimate of $68.50.

Now let me turn to other which is primarily comprised of our corporate governance cost. For third quarter 2007 other reported net cost of $15 million which included $5 million in separation cost, compared with the net earnings of $19 million in third quarter 2006 which included $7 million in cost to achieve both the Duke Energy Synergy merger and the launch of Spectra Energy. Prior year results also included mark-to-market gains of $21 million on the discontinued hedge contracts associated with the Field Services segments and $26 million of management fees, billed to certain Duke Energy operations in 2006. Excluding these items in both periods net cost in other were $10 million this quarter compared with net cost of $21 million a year ago. Other continues to benefit from lower corporate cost to support the Spectra operations as compared to the prior period.

The next slide shows several important additional items. Interest expense for the quarter was $156 million compared with $152 million for the third quarter of 2006. The increase was largely a result of interest cost capitalized in the prior period for projects and businesses transferred to Duke Energy prior to the spin off of Spectra. Third quarter 2007 income tax expense from continuing operations was $110 million compared with the $132 million from the third quarter of 2006.

For the 2007 quarter our effective tax rate was 32% compared with the '06 third quarter rate of 41%. Next quarter you'll see just the reverse, we expect our effective tax rate to remain in the 32% to 33% range while the effective tax rate for the fourth quarter 2006 was about 15%. As of September 30, 2007 our debt to total cap ratio stood at approximately 56%, we expect to be able to fund our CapEx program with the combination of internally generated funds and debt while staying within the 55% to 60% range we told you we expected to maintain.

We also had a successful quarter on the financing front, placing new data of facilities at both Union Gas and Texas Eastern at favorable rates. During the quarter, we successfully launched the Spectra Energy Partners, IPO and received $345 million. At September 30th we had total capacity under our credit facilities of $2.2 billion and available capacity of $1.8 billion. Finally, the positive net income, the strong Canadian dollar was $3.7 million during the quarter compared with the third quarter of 2006. With that let's open the lines for your questions.

Question And Answer

Operator

[Operator Instructions]. Your first question comes from Carl Kirst with Credit Suisse.

Carl Kirst - Credit Suisse

Hey, good morning everybody.

Gregory Ebel - Chief Financial Officer

Hey Carl.

Fred Fowler - President and Chief Executive Officer

Hi Carl.

Carl Kirst - Credit Suisse

Greg you were talking about the reasons for Field Services being a little bit down year-over-year. It sounds like those dynamics then aren't really going to shift, for the fourth quarter. I mean is that correct, should we basically be looking at this as kind of just a continuation in the current environment?

Gregory Ebel - Chief Financial Officer

Yes, I think from a contracting perspective that's fair, Carl for us, even since the end of the third quarter. You know well, what's going on with commodity prices. So, we will just have to see if those two pieces offset to some degree. But I think that the dynamics from a contract perspective are likely to persist.

Carl Kirst - Credit Suisse

Fair enough. Off of that, should we be thinking as perhaps some producers are now choosing to process their own gas, is that changing, tempering annual sensitivities to liquids or oil or however you like to reference it?

Fred Fowler - President and Chief Executive Officer

Yes, it's a good question Carl. I think it's a little early for us to make that call but as we come forward with our '08 plan that's what we will be looking at, did the sensitivities become less or more and that's something obviously we will want to give you guys, transparency on as we look to '08.

Carl Kirst - Credit Suisse

Fair enough. Fred, I just want to ask a question on the Branco Pipeline and I apologize if I missed this in your comments. But as you guys are looking at it, and I know it's very, very early stage, are you primarily looking at this as a kind of more of a producer driven pipe or kind of an end-user pool or how are you conceptually thinking about it right now?

Fred Fowler - President and Chief Executive Officer

Yes, I think it's going to be... I think it will be a combination of both Carl.

Carl Kirst - Credit Suisse

Okay. Fair enough. And then just last question...

Fred Fowler - President and Chief Executive Officer

Probably, maybe a little more producer driven but I think it will be fairly balanced between market and supply.

Carl Kirst - Credit Suisse

Okay. Were you guys hearing sort of end user's clamoring for it or was it when you are first kind of thinking about it, is it more just a Rockies and simply going to need another explorer pipeline?

Fred Fowler - President and Chief Executive Officer

Yes, it's something we've been following and working on pretty closely. I think, it's pretty much everybody believes that there needs to be additional capacity built out of the Rockies. I think what, the market right now is kind of standing back and looking at, is you've got RECS coming on to the east, you have a new LNG facility coming on in Eastern Canada next year, you have a new LNG buoy system coming offshore Boston, and I think people are saying, hey before I build more capacity or pay for more capacity to the east, I want to see what happens to basis differentials after all this stuff happens. And so I think kind of what the market's been struggling, with is either it needs to be more capacity but where does it need to go and as we focused on it, in the discussions that we had with markets it became clear to us that the west was probably where we think the next piece of capacity gets built.

Carl Kirst - Credit Suisse

Great. Appreciate the color. Good luck guys.

Gregory Ebel - Chief Financial Officer

Thanks Carl.

Operator

Your next question comes from Lasan Johong with RBC Capital Markets.

Gregory Ebel - Chief Financial Officer

Hey Lasan.

Lasan Johong - RBC Capital Markets

Good morning. Sorry about that, how are you? My question kind of follows up on what Carl was talking about. If you got all this excess capacity coming out of the Rocky Basin and you've got RECS coming in and you guys talk about additional lines going out of Rockies to California. How do you feel about this security supply coming out of the Basin, I mean is there enough supply to be able to get all this done?

Fred Fowler - President and Chief Executive Officer

Well, I think so Lasan. I don't think you are going to have shippers signing up for long term contracts if they don't think, they have supply to fill it.

Lasan Johong - RBC Capital Markets

Okay. And are you guys all concerned about competing with potential LNG sources coming into the Northwest?

Fred Fowler - President and Chief Executive Officer

Not overly so at this point. I just think it's going to be very difficult to sight those kinds of facilities in that part of the country.

Lasan Johong - RBC Capital Markets

And additionally PG&E IS talking about bringing, building a pipeline that basically goes all the way up to Canada from their service territory, would that not be a direct competition to your pipe?

Fred Fowler - President and Chief Executive Officer

No, I think that actually would be complementary.

Lasan Johong - RBC Capital Markets

It would be complementary. And are you going to... trying to receive FERC incentive rate based treatment on this thing or will this be kind of your typical normal new project?

Fred Fowler - President and Chief Executive Officer

Well, I think it's a little too early to get into those kinds of details on it.

Lasan Johong - RBC Capital Markets

Okay. Thank you very much.

Operator

Your next question comes from Matthew Akman of CIBC World Markets.

Matthew Akman - CIBC World Markets

: Thanks very much, I wanted to go back to couple of segments especially Field Services and U.S. Transmission. In Field Services the initial, I guess guidance range that you guys gave was I think around $550 million or $68.50 oil is that right?

Fred Fowler - President and Chief Executive Officer

That's correct.

Matthew Akman - CIBC World Markets

: Okay. And so on that basis if we look at the sensitivities that you gave at the beginning of the year, relative to WTI were three of four bucks above that. So, is it still fair to be modeling something above the sort of 550 range or have cost and other contract issues really significantly changed that in this current year?

Gregory Ebel - Chief Financial Officer

Well I think we had some kind of change in our numbers during the year obviously. So, we are still confident we are going to hit the number we put out there for Field Services. I think some of... there is no doubt that we had some cost issues earlier in the year. You might recall weather was kind of $50 million type of hit for us through the year. So, there is some impact that while you see a pick up in commodity prices, we try to pick up $25 million or $30 million in the third quarter on commodity prices. Some of that gets taken back through some of these higher operating costs. So, I think... I wouldn't suggest there is anything changing from a commodity perspective, but you got to take into account, have you seen any volume declines and if you've seen some higher operating cost and I think we've indicated, looks more like the operating cost will be in the 750 range, closer to what we thought closer to earlier in the year.

Matthew Akman - CIBC World Markets

Okay. That's helpful thanks for that. And on U.S. Transmission it's not only that costs are coming down but revenues are up nicely year-over-year. So which pipelines generally, would you say those are coming from those improved revenues?

Gregory Ebel - Chief Financial Officer

We are seeing it across the board.

Fred Fowler - President and Chief Executive Officer

We had expansions come on in Gulfstream. You had Maritime's is up this year. We also had expansion projects come on in... on Texas Eastern. We're seeing additional throughput this year on Texas Eastern. Storage is contributing nicely as a result of just higher values. We continue to see good pricing on our storage that gets renewed. So, what's more a little bit on everything really, most every system is participating in it.

Matthew Akman - CIBC World Markets

Okay. Thanks and maybe if I could just follow up on other because the numbers there... the costs are a lot lower than on a run rate basis than I thought, you guys have talked about it too. So, is there something unusual in the quarter there or have you just reduced... been able to reduce cost?

Gregory Ebel - Chief Financial Officer

We're just doing better on the cost Matt, as you know, we said we probably spend about $100 million there for the full year, sometimes there is some quarterly differential but we still feel good about that. And I guess importantly, as we said were to bringing those cost down to the $80 million range, if you will for next year. Now some of that might be spread in a different unit. But I think generally we are finding it cheaper to run the operation at Spectra then it was in the past.

Matthew Akman - CIBC World Markets

Okay. I mean generally the numbers are looking very good, I guess there's no real opportunity for you guys to increase guidance because you don't have guidance. So, I mean the employee incentive target wouldn't change, mid year even if things were looking better I guess for that Fred?

Fred Fowler - President and Chief Executive Officer

Correct.

Matthew Akman - CIBC World Markets

Okay. Thanks those are my questions.

Gregory Ebel - Chief Financial Officer

Thanks Matt.

Fred Fowler - President and Chief Executive Officer

Thanks Matt.

Operator

Your next question comes from Ross Payne with Wachovia Capital Markets.

Ross Payne - Wachovia Capital Markets

Hey guys

Gregory Ebel - Chief Financial Officer

Hey, Ross

Fred Fowler - President and Chief Executive Officer

Hey Ross.

Ross Payne - Wachovia Capital Markets

First question is, can you give us an update on where Northern Bridge is... how Northern Bridge is doing and secondarily I guess KMP followed about a week or two later with their own Northeast expansion, how will that impact your project?

Gregory Ebel - Chief Financial Officer

Yes, I think Northern Bridge is proceeding, I think, I forget the precise volume that we have on it. But it's moving along. I have long felt that probably most of the pipelines serving the Northeast will ultimately or the major pipelines I think ultimately will participate in moving gas from the Ohio area to the various Northeast markets. So, from our standpoint, we'd love to get it all, we are not going to, everybody would love to get it all. But I think, just because of the way the market is somewhat segmented, I think that each of us will participate to some extent in moving that gas further to the east. I've always said that from my perspective, it made a lot more sense to expand those existing systems, I thought that they could do it on a more efficient basis, than try to build a new grass routes pipeline, where you have to come in and get a Bcf a day immediately on it to make the rates work. The existing systems can kind of expand to the size of the market, that's there at that moment. And so it's really starting to play out like I guess, we've always thought it was going to.

Ross Payne - Wachovia Capital Markets

Okay. That's very helpful. Also you guys kind of touched on it, in your earlier comments, but could you add anything to what you think Rockies Express will do to kind of Midwest and Mid-Continent basis?

Fred Fowler - President and Chief Executive Officer

Quite frankly I haven't focused on that. Since we don't really serve the Mid-Continent market, to an extent anymore, I haven't really focused that much on what I think is going to happen to Mid-Continent, Midwest.

Ross Payne - Wachovia Capital Markets

Okay. That's fair enough. I'm just trying to get a tally from a number of people. So, thank you very much.

Gregory Ebel - Chief Financial Officer

Thanks Ross.

Operator

[Operator Instructions]. Your next question comes from Sara Nainzadeh with Millennium Partners.

Unidentified Analyst

Hey guys, its actually Mark Russo, how are you?

Gregory Ebel - Chief Financial Officer

Good, how are you?

Unidentified Analyst

Good, I just want to, if you could get some clarification I don't think I heard the number, for U.S. Transmission the capitalized cost, did you give a number for that and what it was during the quarter?

Fred Fowler - President and Chief Executive Officer

Yes, well basically given net numbers, so it was... it's a benefit of about $13 million.

Unidentified Analyst

Okay.

Fred Fowler - President and Chief Executive Officer

Versus a year ago would have been a net expense if you will of $12 million. So the turnaround year-over-year is about $25 million.

Unidentified Analyst

Got you. Okay, great and then as far as the Branco Pipeline goes, Fred I wondered... I was curious, I know you'd mentioned there was a kind of a combination of producer push and demand pull would an expansion at Kern River and/or Northwest impact that, or is there enough demand pull going, I guess into Oregon and into the West Coast in general.

Fred Fowler - President and Chief Executive Officer

Yes, I think there is going to...I think there will be an expansion on Kern River, it will go further south and probably not make it all the way to the west, with what you are seeing, that's going on in the Nevada area?

Unidentified Analyst

Got you.

Fred Fowler - President and Chief Executive Officer

And then there is going to be the need for pipe going further west and we think, in our opinion that's where a new entrant can't come in and be competitive, with existing systems.

Unidentified Analyst

Got you. And then as far as Midstream goes, can I dig deeper into that, I know you had mentioned that people are processing their own gas, having some contracting issues. Is that something where you expect that to continue or is that kind of alleviated as we move forward, I mean price spreads are very strong, I am just trying to gauge your ability to monetize that opportunity.

Fred Fowler - President and Chief Executive Officer

Yes, I think it's clearly when you have frac spreads of this magnitude it's obviously going to put pressure on margins. Because people are, I mean they see the kind of returns it's a question of how long the people believe that these frac spreads are going to happen. Because building a plant its, you are making a fairly long term investment. There again, there have been some areas, where we have seen some producers just say, hey I am going to build a plant. And we have lost that volume. But it's something that we just have to deal with commercially. And again, I think the key message is we are experiencing some margin pressure as a result of that.

Unidentified Analyst

So, it's more a function of producer seeing the opportunity rather than your contract mix?

Fred Fowler - President and Chief Executive Officer

I think it's a combination of both. I mean on certain of our contracts they do have... they do have some optionality as to what kind of processing they choose to do.

Unidentified Analyst

: Got you. Okay. And then as far as the experience on guidance goes, so, it look like there are some mitigating factors on Midstream. Are there any other helpers that we should be kind of looking towards as I said, it looks like Transmission is doing better to kind of offset things as far as to hit the your sort of outlook?

Gregory Ebel - Chief Financial Officer

Well to me, kind of the wind at our back is definitely commodity prices. Weather always plays a role in the winter time in our business. We are still, we still have some seasonality. So, better weather always helps particularly in our Union Gas operation. I think those are probably the two main factors to watch for the balance of the year.

Fred Fowler - President and Chief Executive Officer

Yes and to be clear. We are confident in our ability to hit our financial targets there. So wouldn't want to take some different message away from this, that's for sure.

Unidentified Analyst

: Because I remember you guys were saying the first half of the year didn't catch up. So, I just didn't know if the market was stable enough to kind of speed that up a little bit?

Fred Fowler - President and Chief Executive Officer

Obviously the Canadian dollars is helping us a little bit too, it's all about parity and I think we had indicated to you all that we sort of had a... the Canadian dollar would be or the U.S. dollar be above 10 Canadian or so. And now we got it worth a... Canadian dollars now worth $1.04 or $1.05 U.S., so that's reversed and somewhat helpful.

Unidentified Analyst

: Got you. Great, thanks so much guys.

Operator

[Operator Instructions]. You do have a follow up question from Carl Kirst with Credit Suisse.

Carl Kirst - Credit Suisse

Yes, sorry. Actually Mark kind of hit my follow up. But just one other small question to pull them on specifically distribution percentage wise, that was a nice increase between 24 to 40. How much of that was due sort of distribution step up versus better storage revenues if you will. And I guess obviously the rules for storage are going to be changing over the coming years. But on apple-to-apples basis, does the 40 represent more of kind of a base line here for third quarter as we begin do more detail in '08 or '09, etcetera?

Fred Fowler - President and Chief Executive Officer

Obviously third quarter is not a big quarter Carl. The bulk of the money is made in the first and the fourth quarter. But storage and transmission added about $10 million and then just higher distribution margins were about $5 million. So, that's kind of look the way I look at the breakdown.

Carl Kirst - Credit Suisse

Okay. All right, thanks guys.

Gregory Ebel - Chief Financial Officer

Okay. Thanks Carl.

Operator

Your next question comes from Josh Golden [ph] with J. P. Morgan.

Unidentified Analyst

Hi, good morning.

Gregory Ebel - Chief Financial Officer

Hi Josh.

Unidentified Analyst

Could you just sort of remind me, have a sense of the balance sheet, particularly your credit ratings and going forward after the initial $3 billion of CapEx projects here, what credit ratios are you targeting going forward and where do you want to be within the rating spectrum?

Fred Fowler - President and Chief Executive Officer

Yes, well we have made it very clear that obviously investment grade balance sheet is very important for us. We have taken our full plans to the rating agency, so they have seen our three year forecast. And the balance sheet metrics they are very much where they are now from a debt to cap perspective 55 to 60 and the FFO to debt and FFO interest coverage is also very strong BBB, BAA1 type rating. So, with the retained earnings, the cash we are producing we actually see very little change and that's without raising any equity.

Unidentified Analyst

Okay, great. Thanks.

Fred Fowler - President and Chief Executive Officer

Okay. Thank you.

Operator

Your next question comes from Lasan Johong with RBC Capital Markets.

Lasan Johong - RBC Capital Markets

Yes, thank you. Hi, just quick follow up on capital and operating cost, are you guys feeling any kind of upward pressure and can you tell kind of what magnitude are we talking about in terms of cost increases both on the OpEx and CapEx levels going forward?

Fred Fowler - President and Chief Executive Officer

Yes, Lasan I mean nothing new. It's kind of a continuation of what we've been saying in the last year and half. I'd say that probably on the material side, it's... we've seeing a little bit of easing. On the labor side, it continues to be very tight and the contractors are fully occupied and we continue to see a tightness in that market. But the other thing that we are seeing is a little bit of a down tick in the quality of work because they are trying to rebuild their capability by hiring a lot of new people. And so they are going through the training period of getting them up to speed. So, that part construction, engineering and construction labor continues to be very tight.

Lasan Johong - RBC Capital Markets

Are you at all concerned about the availability to be able to execute on your growth projects with skilled labor or is this a matter of paying up another few percentage points more to get that security of labor?

Fred Fowler - President and Chief Executive Officer

To me it's more Lasan. Are they going to finish the jobs they are on and get to ours on the timely basis and kind of always the wildcard on that is weather.

Lasan Johong - RBC Capital Markets

Is it a matter of timing not availability per se?

Fred Fowler - President and Chief Executive Officer

Right.

Lasan Johong - RBC Capital Markets

Okay, great. Thank you very much.

Operator

[Operator Instructions]. At this time there are no further questions, I would now like to turn the call over to Mr. John Arensdorf for closing remarks.

John Arensdorf - Vice President of Investor Relations

Okay. Thanks everyone for being on the call today. I would like to remind you that, we are going to host an Analyst Breakfast in Boston and a lunch in New York on Wednesday, November the 14th. So, if you haven't already registered, I would like to ask you to please do so. We would like to see you there. Both of these meetings are going to be webcast and you can find details about webcast on our website. So, again thank you very much for joining us on the call today and as always if you have any additional questions please feel free to call Patti Fitzpatrick or me. Thank you.

Operator

This concludes today's conference. You may now disconnect.

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