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Duke Energy Corporation (NYSE:DUK)

Q4 FY07 Earnings Call

February 05, 2008, 10:00 AM ET

Executives

Sean Trauschke - Sr. VP of IR

James E. Rogers

Group Executive and Chief Financial Officer

Goldman Sachs

Leslie Rich

Chairman, President and Chief Executive Officer

David L. Hauser

Analysts

Paul Patterson - Glenrock Associates

Jonathan Arnold - Merrill Lynch

Michael Lapides

Columbia Management

Operator

Good day everyone and welcome to the Duke Energy Fourth Quarter and Year End Earnings Conference Call. Today's conference is being recorded. At this time for opening remarks, I would like to turn the conference over to Senior Vice President of Investor Relations, Sean Trauschke. Please go ahead sir.

Sean Trauschke - Senior Vice President of Investor Relations

Good morning. And welcome to Duke Energy's fourth quarter and year-end 2007 earnings review. Leading our discussion today are Jim Rogers, Chairman, President and Chief Executive Officer; and David Hauser, Group Executive and Chief Financial Officer.

Jim will begin today's presentation by providing a general overview of our results and a discussion of our outlook for 2008. Then David will provide more detail and context around our 2007 results for each of our businesses as well as more detail and context around our 2008 plan.

Jim will close with an update of our regulatory initiatives and our areas of focus for 2008. Following those prepared remarks; we'll open the lines up for your questions. Before we begin, 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. And you should refer to the additional information contained in Duke Energy's 2006 Form 10-K filed with the SEC and our other SEC filings concerning factors that could cause those results to be different and contemplated in today's discussion.

In addition, today's discussion includes certain non-GAAP financial measures as defined under SEC Regulation G. A reconciliation of those measures to the most directly comparable GAAP measures is available on our Investor Relations website at www.duke-energy.com. With that I'll turn the call over to Jim.

James E. Rogers - Chairman, President and Chief Executive Officer

Thank you Sean. Good morning everyone and thank you for joining us today. Most importantly, thanks again for your interest and investment in Duke Energy. We had a very strong fourth quarter and a strong year. As we said in our news release this morning, we reported ongoing diluted earnings per share of $0.27 for the fourth quarter of 2007 versus $0.23 in the fourth quarter last year.

Ongoing diluted earnings per share for the full year 2007 were $1.25 compared to $0.99 for 2006. These 2006 results exclude the natural gas businesses which were spun off as Spectra Energy in January 2007, and which are now included in discontinued ops.

Our fourth quarter results reflected an improvement of approximately 37% in combined ongoing segment EBIT from our three largest business units. Of course, we are pleased with our fourth quarter financial results; we are also very pleased with the superior performance of our people and our assets. Equally important, we resolved many of the regulatory and legislative issues that were both on our minds as well as yours last year.

In our news release this morning, we announced our 2008 employee incentive earnings target of $1.27 per share on an ongoing diluted basis. As you will recall, during our Analysts Conference last September, we committed to a compound annual growth rate of 5% to 7% in ongoing diluted EPS through 2012 from the base of our 2007 employee incentive target of $1.15. We’ve come out the gate strong in '07, nearly 9% above target, but you should remember that due to the timing of our construction and capital investments, growth will likely be lumpy over the next several years. Of the $1.15, we believe we will be at the high end of the 5% to 7% range.

If you come off the $1.25, we believe we will be on the low end of that range. Regardless of the 2007 base, we still believe that through 2012 we can achieve a compound annual growth rate of 5% to 7% in ongoing diluted EPS. Our earnings growth will be driven by the following three factors. Capital reinvestment, growth in our customer sales base and execution on our regulatory and legislative initiatives. David will share more details on the assumptions we have used to arrive at our 2008 earnings target, but first I will discuss our segment EBIT expectations for 2008.

We expect the company's total ongoing segment EBIT to be more than $3.2 billion in 2008 before other net expenses. Again, our regulated businesses will be the largest contributor to ongoing EBIT. We expect an ongoing EBIT contribution of approximately $2.4 billion from U.S. Franchised Electric and Gas.

Our Commercial Power segment is expected to contribute approximately $385 million in ongoing segment EBIT. Most of the Commercial Power ongoing segment EBIT comes from serving retail electric customers in Ohio. This number also reflects the continuing improved performance of our Midwest gas plants.

Our international operations are expected to contribute $380 million in ongoing segment EBIT and our ownership interest in Crescent Resources is expected to deliver $75 million in ongoing equity earnings in '08. With that, I'll turn it over to David. David?

David L. Hauser

- Group Executive and Chief Financial Officer

Thank you Jim. I'll begin with the review of our 2007 business segment results. U.S. Franchised Electric and Gas, our largest business segment, reported fourth quarter 2007 EBIT from continuing operations of $519 million, an increase of $96 million from last year's fourth quarter. The quarter-over-quarter improvement in segment EBIT was primarily driven by the completion earlier in 2007 of merger related rate reductions, lower clean air amortization, retail rate increases in the Midwest, favorable weather and increased wholesale volumes.

In the fourth quarter of 2006, we recorded clean air amortization for North Carolina's Clean Air Program of $38 million. We met our amortization obligation under the clean air legislation in the third quarter of 2007 and did not incur any regulatory amortization expense in the fourth quarter of 2007. As we have discussed in the last few calls, the merger related rate reductions ended in the second quarter of 2007, except for a small amount that we will continue to share with our customers in Kentucky over the next five years.

Weather contributed to the quarter-over-quarter increase in the segments on going EBIT. For the full year, the EBIT contribution from weather was about $100 million above normal. Keep in mind this was offset by higher employee incentives and increased O&M cost due to plant maintenance. Long-term contracts that took effect in early 2007 drove the increase in wholesale volumes, primarily in Indiana.

In addition to incentives and plant O&M costs, the segment’s ongoing EBIT was also partially offset by a charge associated with the write-off of a portion of Duke Energy Carolina’s GridSouth development cost in accordance with the recent North Carolina Utilities Commission rate order.

Our regulated customer base continued to grow. Approximately 44,000 customers were added in the Carolinas, since the fourth quarter of 2006, a 2% increase. Approximately 15,000 customers were added in the Midwest in that same time period, a 1% increase. While we continued to add customers for all of U.S. Franchised Electric and Gas, we are affected by general market conditions, including the general decline and the textile industry as well as softening in some other industries.

For the quarter, the EBIT contribution from Bulk Power Marketing was approximately $32 million, net of the impact of sharing of profits with industrial customers.

Next, I will review Commercial Power. Ongoing EBIT for this segment increased approximately $57 million from the fourth quarter of 2006, the segment’s improved EBIT was driven by lower purchase accounting expense, the favorable timing of recoveries of fuel and purchased power cost, and improved mark-to-market results from economic hedges due to increasing coal prices.

The quarter's positive drivers were partially offset by higher expenses from increased plant maintenance. Increased generation and higher capacity revenues continued to improve the results of our Midwest gas-fired assets. For the year, these assets was $14 million. As we told you in the past, we now expect these assets will reach their break-even point by 2009 on an ongoing EBIT basis. One additional item, we pledged approximately 2,700 megawatts in the recent PJM 2011, 2012 auction, at a price of a $174 per megawatt day. This price is 70% higher than the auction results in October.

Finally for the fourth quarter, Commercial Power’s EBIT included $13 million of mark-to-market net gains on economic hedges. I will remind you that we consider any market-to-market impact as part of ongoing earnings.

Now lets turn to our international business. For the fourth quarter of 2007 Duke Energy International reported ongoing segment EBIT of approximately $105 million, an increase of $25 million over last year’s fourth quarter. DEI's improved results for the quarter were driven mostly by higher margins at National Methanol, partially offset by less favorable hydrology in Argentina. We continue to be pleased with the overall contribution of International, particularly Brazil and Peru.

Next, is Crescent Resources. Ongoing results for this segment were $32 million in the fourth quarter of 2007. That is a $15 million increase over the ongoing results for the fourth quarter of 2006. The higher current year results, were due to increased legacy land sales and a gain on the sale of the Piedmont Town Center in Charlotte, North Carolina. These increased results were partially offset by impairment losses of about $32 million on some residential developments.

I want to make it clear that these impairment charges are related to a few individual Crescent developments and not our overall investment in Crescent. The overall fair value of our Crescent investment continues to exceed is carrying amount.

Next I'll review our other category. Other primarily includes costs associated with corporate governance, and Duke Energy's captive insurance company. The fourth quarter ongoing results for other were relatively flat when compared to the same quarter in 2006. Other’s ongoing net expense from continuing operations was $92 million compared to $86 million in the prior year's quarter.

Now I'll focus on a few important non-operating items on a year-over-year basis. We ended 2007 with a net cash balance of approximately $400 million; about $1.1 billion of cash, cash equivalents and short-term investments offset by about $700 million of short-term commercial paper outstanding. Interest expense was $685 million for 2007 compared to $632 million in 2006. The increase is primarily due to the inclusion of a full year of interest expense in 2007, associated with debt of the former Cinergy companies compared to only nine months in 2006.

The effective tax-rate for 2007 was approximately 32% compared to approximately 29% in 2006. This is higher than what we have been telling you because the 2007 tax rate is absent synfuel credits, which expired in 2007 and are now included in discontinued operations. For the full-year 2007, our synfuel operations contributed about $0.02 to net income. The higher tax-rate in 2007, was primarily due to the previous year's favorable tax items, including settlements, tax benefits related to the impairment of the investment in Bolivia and the reversal of previously recognized taxes related to dividends on foreign operations.

With that let's turn to our 2008 expectations. This slide provides the ongoing earnings per share assumptions used to set our 2008 employee incentive target of $1.27. As always, out plan is based on normal weather. The 2008 incentive target in corporate, the rate adjustments resulting from the recent rate proceeding in North Carolina. The target also assumes lower net purchase accounting charges. We’ve assumed an effective tax rate of 33% for 2008. You should note that this tax rate is absence synfuel credits, which expired in 2007. We expect interest expense to be approximately $700 million, as I mentioned at the beginning of 2008 our cash, cash equivalents and short-term investments balance was approximately $1.1 billion. Our plan reflects a quarterly dividend increase of $0.01 per share beginning in the third quarter of 2008, of course this is subject to Board approval.

Now let's take a quick look at our projected CapEx spending in 2008. We plan to spend approximately $5.1 billion this year. This represents a slight increase from what we showed you in September. The primary drivers for the change are timing associated with the gas plant and nuclear development costs of $40 million. Over 75% of these dollars will be spent on our regulated businesses. It includes new generation resources to meet our growing demand, environmental expenditures to meet Federal State and Local Pollution Control requirements, and maintenance and new customer additions.

Most of the CapEx in our commercial businesses will be spent completing the wind projects we acquired last year and expanding our International segment. We continue to use a measured approach when we access international investment opportunities and any investments will be made with offshore [ph] cash.

Let me conclude by giving you a quick walk-through of our projected 2008 cash flows. Based on our $1.27 per share target, we expect total sources of cash to be about $3.4 billion. Total uses of cash are estimated to be $6.5 billion. This total includes approximately $5.1 billion in CapEx for expansion, environmental, maintenance, and other. The primary uses of cash are mostly the capital expenditures and investments that I just outlined along with the dividend payments of approximately $1.2 billion. The total dividend payments include the projected quarterly dividend increase of $0.01 per share beginning in the third quarter of 2008. So we expect our cash outflows to exceed our cash inflows by about $3.1 billion. This of course is driven by our re-investment in the businesses.

Our strong investment grade balance sheet will provide us with significant flexibility in achieving our CapEx plans. We do not need to issue equity to fund our CapEx program. And while we started the year with $400 million in net cash, we still anticipate taping the debt capital markets in 2008. In fact, we already have done so. Duke Energy Carolinas raised $900 million in a two part first mortgage bond sale last month. We will be posting our financing plans on our website next week. With that, I will turn it over to Jim, for closing remarks.

James E. Rogers - Chairman, President and Chief Executive Officer

Thank you, David. As you all can see, 2007 was a good year. I want to take this opportunity to thank our employees for such a productive year. I appreciate their hard work and their commitment to our company, they made it happen. Some of that productivity was on the regulatory front, and this slide provides a good view of how we resolved many of the regulatory uncertainties we faced in 2007. As you saw last week, we received our final air permit for the new Cliffside unit six in North Carolina. A week earlier, we’ve received the final air permit for the new coal gasification plant in Edwardsport, Indiana.

We are proceeding the construction of these two plants, a total investment of approximately $4 billion over the next five years. These projects enable us to continue our long history of providing safe, affordable, reliable electricity to meet our customer's needs and support our state economies. These advanced coal technologies that we are building will eventually replace nearly 1,200 megawatts of older, hard meting units. These new plants along with our plans for energy efficiency, renewables, new gas plants, and a new nuclear plant serve as major steps in our efforts to reduce our carbon footprint.

Internally, as you might expect, we used a more detailed scorecard to measure how we are doing, especially in generation, reliability, safety and customer service. Out commitment to continuously improve, means we annually set the bar very high. As an example, by every standards our nuclear fleet had an outstanding year, the third best ever. When as you can see the fleet's capacity factor is just all of our stretch target. This is an example of how we push our operations to do better everyday, every month, and every year.

We are doing well in providing reliable service except for gas outages where we’ve had some work to do, we are tracking well on our safety record and our residential and large business customer satisfaction continues to improve every year.

We focus on this scorecard because we understand the linkage between operational excellence and regulatory success. Keeping our customers satisfied, our rates comparative and our reliability high increases the probability that we can achieve favorable regulatory outcomes in the future. To give you a sense of what we are focusing on this year, I would like to quickly put 2006 and 2007 in perspective.

In 2006, we completed the Cinergy merger. We successfully integrated the two companies, and we completed the spin-off of Spectra Energy, great momentum for '06. In '07, we sustained that momentum by continuing to harvest the merger savings. We achieved our financial targets and we removed significant regulatory uncertainty. So the question is, how do we continue creating shareholder value in '08 by maintaining this momentum? Our answer is by focusing on three primary areas. First, advancing our asset modernization strategy. I am so proud of the efforts of so many Duke Energy employees who helped us win state regulatory approval to build two of the cleanest coal plants in the nation. Our 630-megawatt IGCC plant in Edwardsport and our 800-megawatt advanced clean-coal plant in Cliffside North Carolina.

These plants provide great value to our customers by enabling us to meet growing demand, while simultaneously retiring older, less efficient assets and shrinking our environmental footprint, an important step in decarbonizing our fleet for the future. But winning approval to build these assets is only the beginning of our asset modernization strategy. Across our operations in '08, we are carefully evaluating opportunities to deploy capital, further constructing wind turbines in Duke Energy Generation Services, new power generation facilities in Duke Energy International, our Clean-Tech infrastructure in franchised electric and gas, in a disciplined manner that provides benefits to our customers, our shareholders, and the environment. You will hear much more about the progress of this strategy as we move through the year.

Second, continuing our proactive regulatory and legislative strategy. As we have said, '07 was productive and noteworthy year on the regulatory legislative front, from base load legislation in South Carolina, to regulatory approval power plants in two different states to resolution of our North Carolina rate review, I am pleased with all that we have got done. But ’08 will not be a year for resting on our accomplishments. There is much work to do to enhance customer and shareholder value so you will see us busy on the number fronts. These initiatives will focus on both creating value, such as securing implementation of our innovative Save-A-Watt plan in all of our states, as well as on protecting value, such as working to secure passage of federal carbon legislation that applies to all sectors of the economy and is fair to our customers as well as our investors.

Later today, I am traveling to Columbia, South Carolina to testify before the Public Service Commission, where we have a partial settlement on our energy efficiency plan. I am especially pleased that we are receiving broad support for our plan, including from industrial customers and major environmental organizations. With this support, South Carolina could be the first state to approve our Save-A-Watt plan in '08. And yesterday, three major national energy efficiency organizations announced support for our Save-A-Watt proposal.

Let me now turn to our third major initiative, and that is a continued relentless focus on operations and cost. I am proud of our way our employees kept their eye on the ball this year in running our operations. Particularly in the phase of record-setting heat and record-setting drought. Many CEOs in our industry would love to see the kind of operational scorecard I reviewed with you earlier. We are all about improvement and we have a belief that no matter how good you are, you could always be better. I have challenged the team to improve in everything we do and to continue to find ways to control our operating cost.

With our focus on modernizing and decarbonizing our asset base, we are committed to keeping our major construction projects, such as Cliffside and Edwardsport on budget and on schedule. We will be very transparent with regulators and other interested parties about our progress. Additionally we face a large number of employee retirements in the near future and we are working to develop a plan to replace them. As you can see, we have a full plate in '08 and I will look forward to updating you on the progress of these initiatives throughout the year.

Putting it altogether, we think we have a great value proposition for investors. We continue to make good progress toward achieving our goals including maintaining a strong financial position. We have a proactive regulatory approach, a 5% to 7% compound annual growth rate in ongoing diluted EPS through 12, annual dividend growth, our current dividend yield is approximately 4.5%, no anticipated equity offerings through 2012, excluding internal plans, and a strong balance sheet to provide flexibility.

In closing, I would take up a moment to highlight some changes in our management team. Brew Barron, our Chief Nuclear Officer will be retiring next month. We really thank Brew, for his more than 35 years of service to our company. Later this month, Dhiaa Jamil, currently our Senior Vice president of Nuclear Support, and who has more than 26 years of nuclear experience with our company will succeed Brew as Chief Nuclear Officer. We have long been and one of the premier operators of nuclear plants in the U.S. and we have a deep bench of talent in our nuclear operations. Dhiaa is just one example of that talent.

Since our last earnings call in November, Lynn Good became Group Executive and President of our Commercial businesses. With her extensive financial and energy experience, we know Lynn will do a great job. I know we've given you a lot of information in a relative short amount of time and want to ensure there was ample time for your questions. David and I are now ready to take them.

Question and Answer

Operator

[Operator Instructions]. And we'll hear first from Paul Patterson with Glenrock Associates.

Paul Patterson - Glenrock Associates

Good morning, guys. Can you hear me?

James E. Rogers - Chairman, President and Chief Executive Officer

I can, Paul. Welcome.

Paul Patterson - Glenrock Associates

Thank you. Just wanted to touch basically on some sort of quick questions here, the favorable timing of fuel and power, could you just explain a little bit more about how much that was and what's causing that in terms of the timing and how that impacts earnings?

David L. Hauser

- Group Executive and Chief Financial Officer

Basically, in the Commercial businesses, they are not under FAS 71. So we under-collected fuel by about $40 million in '06 and we... that was over-collected in '07, by about $40 million.

Paul Patterson - Glenrock Associates

So it's about an $80 million difference?

David L. Hauser

- Group Executive and Chief Financial Officer

That's about the swing.

Paul Patterson - Glenrock Associates

Okay. And that's a pre-tax number?

David L. Hauser

- Group Executive and Chief Financial Officer

Yes.

Paul Patterson - Glenrock Associates

Okay. And then... and so... okay, I got you. And then, in terms of the... what was the actual loss on the residential properties, what was the impairment on this?

James E. Rogers - Chairman, President and Chief Executive Officer

Our share was about $30 million, keeping that way [ph] on 49%.

Paul Patterson - Glenrock Associates

Okay. But you guys feel pretty confident that there are no losses going forward because of the value of your properties, correct?

James E. Rogers - Chairman, President and Chief Executive Officer

Yes. Those were specific projects in Florida that we had to write down and were confident that the total portfolio is still very good.

Paul Patterson - Glenrock Associates

Okay. Great. And then, finally with the interest expense, you said in the press release that about... it looks to me like the majority of that was associated with DEI. I'm sorry if I missed this, but what is it that DEI did in the quarter that impacted it and what currency impact was there in '07? I am sorry if I missed that as well, I got a few calls during the... I am sorry.

James E. Rogers - Chairman, President and Chief Executive Officer

We have a piece of debt at Paranapanema that's about $540 million. That updates regularly based on inflation in Brazil and that was the interest impact that we were talking about.

Paul Patterson - Glenrock Associates

Okay.

James E. Rogers - Chairman, President and Chief Executive Officer

And then, the EBIT number for FX was $18 million for the year of EBIT and $6 million of net income.

Paul Patterson - Glenrock Associates

Great. Thanks a lot.

David L. Hauser

- Group Executive and Chief Financial Officer

Paul, thank you.

Operator

Thank you. We will now move on to our next question from Jonathan Arnold with Merrill Lynch.

David L. Hauser

- Group Executive and Chief Financial Officer

Welcome, Jonathan.

Jonathan Arnold - Merrill Lynch

Thank you guys. Couple of quick things. I noticed in the forecast for the corporate segment; you have it as a drag of about $265 million for 2008. And I think remembering back to when you gave this original post-merger guidance, I think you've been talking about numbers more in the 200 range and maybe even a little below. So can you help sort of bridge what the differences, why are you not expecting that to be higher, is it costs that were previously in the segment, so something different?

David L. Hauser

- Group Executive and Chief Financial Officer

Well let me give you three numbers; when we came out with our '07 forecast, the number was $215 million that we told you for the other segment, and that is actually where we had a fair amount of our stretch. That number ended up at $235 million for the year and then next year it's $265 million. I think if you think about the $265 million, that range is a good run rate going-forward. Obviously we would hope to beat that, but that also has some of the activities associated with energy efficiency and some of the gas activities really.

Jonathan Arnold - Merrill Lynch

So you are saying that you haven't managed to drive down this corporate cost quite as much as you might have hoped a year ago. Is that…

David L. Hauser

- Group Executive and Chief Financial Officer

Well I think we have driven them down pretty effectively. In '06 they were $344 million, so we have driven them down a lot, but it looks to me like the run rate is going to be in the $265 million range.

Jonathan Arnold - Merrill Lynch

Okay. Thanks David. And one other thing I had was that you gave the $700 million forecast for interest in 2008. Is that net of interest income or is that the actual interest expense?

David L. Hauser

- Group Executive and Chief Financial Officer

That's the gross number. We would expect to have some interest income. The interest income will... we have less cash now, the interest income should be $50 million or a number of that nature.

Jonathan Arnold - Merrill Lynch

And just finally on the same subject, how much capitalized interest is there within that forecast, more or less?

David L. Hauser

- Group Executive and Chief Financial Officer

Well, to tell you the truth, Jonathan, I don't have that number. We can get that number. But if you look at our expenditures, the biggest expenditures would be on Cliff side and on the IGCC, and the ADC rate in the Carolinas is 8.7%. But we can get you the number of how much is capitalized interest.

Jonathan Arnold - Merrill Lynch

Thank you. I might just squeeze one last thing, and you have mentioned mark to market at Commercial Power, I'm not sure you've mentioned this in response to Paul's question. Well how much was that in the quarter and maybe the year?

David L. Hauser

- Group Executive and Chief Financial Officer

It is $13 million positive, and so the driver was that is that coal went up so it has a positive mark-to-market, power went up also, which has a negative mark-to-market. But the gains on the coal were bigger than the losses on the power.

Jonathan Arnold - Merrill Lynch

That's the quarterly numbers.

David L. Hauser

- Group Executive and Chief Financial Officer

$13 million is the year number.

Jonathan Arnold - Merrill Lynch

Okay.

David L. Hauser

- Group Executive and Chief Financial Officer

Actually it's the same number, the year and the quarter.

Jonathan Arnold - Merrill Lynch

Okay. Thank you very much guys.

James E. Rogers - Chairman, President and Chief Executive Officer

Jonathan, thank you.

Operator

All right. Now I will move on to our next question with Ashar Khan with Beth Capital [ph].

Unidentified Analyst

Good morning.

James E. Rogers - Chairman, President and Chief Executive Officer

Welcome Ashar.

David L. Hauser

- Group Executive and Chief Financial Officer

Good morning.

Unidentified Analyst

I just wanted to go through Commercial Power, how to bridge between '07 and '08. And David, if I am right, Commercial Power is being reported without synfuel rate because that's how the earnings are being shown. So now the '07 reported number has no costs of synfuel operations, if I'm correct?

David L. Hauser

- Group Executive and Chief Financial Officer

You are correct.

Unidentified Analyst

Okay. Then if you can bridge me through '07 going to '08, especially with what Midwest assets did in '07, and what you are projecting them to do with '08, and I think so there is a purchase accounting adjustment as well, if you could help, I would appreciate it?

David L. Hauser

- Group Executive and Chief Financial Officer

Okay. Let's walk through a few numbers. So we... 2007 was $278 million, but we talked earlier about the fuel over-collection of $40 million that is from the '06 time period, so that's in the $278 million, and we had a positive mark-to-market of 13. So if you take those two items out that wouldn't repeat in '08. You would have $225 million as a starting point. Purchase accounting is going to improve $105 million next year so, we add $105 million to that to $225 million and you are at the $330 million and the balance of $55 million is improvement in the business. And that's improvement in three areas, one is in the gas plants that you mentioned, one is in Duke Energy Generation Services as the wind facilities begin to come home, and the final one is improvement in sales and margins associated with the commercial business.

Unidentified Analyst

Okay. That was very helpful. And then David, why are we expecting flat growth in the international business '07 to '08?

David L. Hauser

- Group Executive and Chief Financial Officer

I think the big strength of the international business this year was in two areas that we have assumed aren't as strong next year. One is in Peru, which had some transmission constraints that ended up very positive for us, and second one is in National Methanol, and we have assumed a bit lower prices from Methanol next year.

Unidentified Analyst

But then we are investing in the international business. Could you just mention about that and how those investments return into profitability... your earnings going forward?

David L. Hauser

- Group Executive and Chief Financial Officer

Built into the numbers, we’ve given you for international. We do have some growth and that growth is really associated with the Hydro plants we're building in Brazil. But the detriment in Peru and the reduction in National Methanol more than offset that and kept it flat basically.

Unidentified Analyst

And if I can end up, this is from memory. You had mentioned in your September Analyst Meeting that from a base of… I guess the Commercial Power and the Duke International, the '08 base and then you expected a 10% growth rate in EBIT going forward. So, would that still stands today rate so we can take the 380 and the 385, which is something like 765 and expect a 10% growth rate in that EBIT going forward on an annual basis?

David L. Hauser

- Group Executive and Chief Financial Officer

Well, that's what we talked about through 2012, but that will be lumpy also.

Unidentified Analyst

Okay. Could you just mention the lumpiness?

David L. Hauser

- Group Executive and Chief Financial Officer

That growth rate has presumptions of investments that we make, both in wind forms and in international, and the exact timing of those depends on when we can find the right opportunity.

Unidentified Analyst

Okay. But you already...

David L. Hauser

- Group Executive and Chief Financial Officer

The underlying business should grow pretty smoothly. It's the... the new deals that you have to find.

Unidentified Analyst

Yes. But you are on track for those new deals as we are investing today, correct?

David L. Hauser

- Group Executive and Chief Financial Officer

Yes. We are making investments today both in the wind and in the Hydro in Brazil.

Unidentified Analyst

Okay. Okay. I appreciate it.

David L. Hauser

- Group Executive and Chief Financial Officer

Okay. Ashar thank you very much.

Operator

We'll now hear from Lishan Julang [ph] with RBC Capital Markets.

Unidentified Analyst

Good morning.

James E. Rogers - Chairman, President and Chief Executive Officer

Welcome.

Unidentified Analyst

Thank you. Yesterday there was an article in the Wall Street Journal that said three major banks are going to stop funding new coal-fired projects. This seems to be a trend in the whole power sector. Could you comment on effects on Cliffside financing, potential? And second if you are confident that any kind of carbon cost leveraged by the federal government would be appropriately recoverable by Duke and basically are you sure that you can pursue a nuclear facility without Yucca Mountain completely authorized to collect nuclear waste?

James E. Rogers - Chairman, President and Chief Executive Officer

Those are three really good questions and I think it would take the rest of our time for me to do justice to them, they are such good questions. But first with respect to the three banks, the bottom line is those our… power plants will be basically funded on our balance sheet. We will be raising… as we raise debt in the future to fund this, it will be for the entire operations. We won't be specifically funding any... either one of these two plants.

Most importantly is the coal gasification facility in Indiana really is a plant that gives us the capability to be able to capture carbon to the extent we can do carbon capture sequestration at that facility and of course, our Cliffside plant has the capability to be ready for any new technologies that may along with respect to carbon capture. So, we think the bank's position on this is we understand it, we don't think it will have any impact on our funding of our capital program going forward.

With respect to carbon legislation, it's clear that we are on track to get carbon legislation in this country. I believe in '09 or '10, it looks like it will be a nation-wide cap and trade system. There is a lot of debate with respect to the allocation of allowances and that is really critical from our standpoint in terms of impact on our customers. But in every jurisdiction, we do business today, we have the ability to recover the cost of compliance with Federal Environmental Laws. And in fact, we just came out of $5 billion cap spend where basically on the capital program, we were nick to nickel [ph] by any other regulators with respect to those expenditures and all of them is to reduce SOX, NOX and mercury from our existing plants.

So, we are confident that we will be able to recover these costs going forward. We believe that we are really standing in the shoes of our customers as we debate these issues in Washington to try to minimize the impact on our customers and on the communities we serve and our communities have long been reliant of upon coal to supply electricity.

With respect to your third question on nuclear, we filed in December, our construction operating license application with the NRC for our lead plant. We believe that under the existing laws even though Yucca Mountain has not been resolved that the NRC will be able to grant us a license… construction operating license to go forward. We do believe that the Yucca Mountain issue or the spent fuel issue needs to get resolved. And we are working hard to get resolution of that issue.

Unidentified Analyst

How many years of storage do you have planned for your new nuclear plant should Yucca Mountain not be ready in time?

James E. Rogers - Chairman, President and Chief Executive Officer

We have adequate storage at all of our existing sites to continue to operate them in terms of their licenses.

Unidentified Analyst

Fantastic. Thank you.

James E. Rogers - Chairman, President and Chief Executive Officer

Thank you.

Operator

All right. And we get Next from Paul Wilson [ph].

James E. Rogers - Chairman, President and Chief Executive Officer

Paul, welcome.

Unidentified Analyst

You indicated that the $100 million of weather EBIT benefit was offset by comp and I guess O&M to meet the higher operating requirements of plants in the heat. What was the split between those two?

David L. Hauser

- Group Executive and Chief Financial Officer

The incentive goals were about $45 million over last year. They were about $60 million over the plan. And then maintenance was... I think that was $40 million, does that sound right?

James E. Rogers - Chairman, President and Chief Executive Officer

I think that's right.

Unidentified Analyst

These are pre-tax numbers?

James E. Rogers - Chairman, President and Chief Executive Officer

$50 million of maintenance. Yes, those are both pre-tax numbers.

Unidentified Analyst

What should the O&M look like directionally versus '07 through '08?

James E. Rogers - Chairman, President and Chief Executive Officer

We run the budgets, the O&M is up very, very modestly but that's all we reflected in the 24,20 of earnings that we provided as the EBIT goal. So we expect the total franchised electric to be up $115 million next year, and that's with normal weather.

Unidentified Analyst

Thank you.

James E. Rogers - Chairman, President and Chief Executive Officer

Thank you very much for your question.

Operator

Thank you sir. And now, we will go to Bern Court, Andrew Levy [ph].

Unidentified Analyst

Hi guys. Good morning.

James E. Rogers - Chairman, President and Chief Executive Officer

Good morning and welcome.

Unidentified Analyst

Glad, I got a welcome. Jim, this question is for you, I guess you recorded is a Reuters' story out of Duke has earned the right to do and another deal. And there is some statement in there about why them have a smaller carbon footprint. Could you may be just go into that?

James E. Rogers - Chairman, President and Chief Executive Officer

Sure, I'll be delighted to. We are not look back that fact that we gained approval for our merger 11 months from five states that was work speed. And I put a tick in the box as a success in terms of getting the requisite regulatory approvals. When I looked at how we have intergraded these two companies, how we harvest cost savings with more work to do, but I can put a tick in the box that we've been able to achieve what our expectations there. And so, it will be my judgment that we've earned the right to do another deal.

The question is what is the criteria and when. And if were are fortunate enough to do another deal and that's just a matter of the timing and the opportunities that may present themselves, but our criteria obviously is it is for any combination its got to be accretive to earnings. It has got create value for shareholders. It has got to make sense from our customer's stand point. It has got to allow us to have the size and scale that is, I believe, will be increasingly necessary as the price tag on nuclear plants and coal plants continue to go up as we look at the significant capital programs that we have, so it would be my belief that we are well positioned.

If you look back over the last 15 years, there has been continued consolidation at our industry. I think that's going to continue. I think the fact that we had two failed mergers in recent past, it seems to a period of where it is ebbing. I do believe that you're going to see addition combinations occur in our industry in the further and we'll start to move into more of a... the ebb and flow analogy a little more flow there. But from our standpoint our primary focus is what I would like to say is on the cake. And so I'm getting that 5% to 7% growth hammering it out, hammering out our... and getting the regulatory initiatives we have resolved as we did last year. It is bringing these two plants in on time under budget. That's our primary focus and that's going to create the value. It will be icing on the cake for us, if we're able to find the right strategic partner that will allow us to meet our criteria, one the criteria you mention is a combination, may be with the company that at the end of the day there's a carbon footprint a smaller as a consequence of the combination.

I mean that's just one the many criteria, and quite frankly you never find a partner that matches up on every one, that's just the reality of combinations. But, my point was simply, we've earned right, we're opportunistic, our primary focus is on the blocking and tackling and to make sure, there is no confusion about that. Thank you though for the question.

Unidentified Analyst

Thank you, as always thanks.

Operator

Okay. And now, we will move on to Michael Lapides with Goldman Sachs.

Michael Lapides - Goldman Sachs

Hi guys, congratulations on a good quarter and a good year.

James E. Rogers - Chairman, President and Chief Executive Officer

Thank you. And welcome Michael.

Michael Lapides - Goldman Sachs

Thank you guys. Couple of easy questions for you. When you think about the long term growth rate of the Latin American business on the existing assets, how should we think about that, and it's kind of hard for us to model out growth of the acquisitions owned because it's... we don't really know what's you're going to buy. So, on the existing asset base what do you view as the long-term growth rate?

James E. Rogers - Chairman, President and Chief Executive Officer

We haven’t really thought about it exactly like that... Michael but I think as demand keeps growing in Brazil, the key driver is going to be the new assets that we bring in and the higher prices. So, I think if you thought about it in a way that parallels the growth in Brazil, you should see our underlying growth move with it.

Michael Lapides - Goldman Sachs

Got it. Also on the real estate business… on your equity investment in Crescent. Can you talk about kind of your outlook for the next year or so given the overall U.S. real estate market?

James E. Rogers - Chairman, President and Chief Executive Officer

We've put out… our 49% target is the $75 million. Our businesses that are in the commercial area especially in the Charlotte area are doing well. Our businesses that are far amount of bluffs down in the Hilton Head [ph] area is doing very well. The businesses in Florida are not doing very well. So, that's really kind of the split, and for the question is how fast is this Florida bounced back?

Michael Lapides - Goldman Sachs

And how much of a percent of total is Florida versus the other two component?

James E. Rogers - Chairman, President and Chief Executive Officer

I don't have an exact percentage, but it's much smaller than the Hilton Head area and the Charlotte area.

Michael Lapides - Goldman Sachs

Got it. And last question, we've seen Appalachian coal prices pretty much shoot to the roof over the last couple of weeks or so really last month or so. Can you talk about whether that's has any impact on what ever agreement you and the other companies reach in Ohio in the next few months?

James E. Rogers - Chairman, President and Chief Executive Officer

It would be my judgment that this volatility and pricing for coal will not, we are at a delicate part of the negotiations today, before the legislature trying to put in place new legislation that would allow us to operate beyond the... into the rate stabilization period which ends at the end of '08. But, we don't see this volatility in pricing affecting that negotiation at this time.

Michael Lapides - Goldman Sachs

Okay. Thank you guys, much appreciated.

James E. Rogers - Chairman, President and Chief Executive Officer

Thank you Michael.

David L. Hauser

- Group Executive and Chief Financial Officer

Thank you.

Operator

Okay. We'll now move onto Steve Weiseman [ph] with Catapult Capital Management

Unidentified Analyst

Yes. Hi Jim.

James E. Rogers - Chairman, President and Chief Executive Officer

Hi Steve. Welcome.

Unidentified Analyst

Thank you. Couple of questions, first just detail one, the discontinued operations for 2007 was that, did you say that was the synfuel?

James E. Rogers - Chairman, President and Chief Executive Officer

That's the biggest single thing in there we moved that to discontinued operations in December.

Unidentified Analyst

Okay. Did that basically move all synfuel earnings out for the year?

James E. Rogers - Chairman, President and Chief Executive Officer

Yes, so the entire thing has moved out.

Unidentified Analyst

Including the tax benefits or not?

James E. Rogers - Chairman, President and Chief Executive Officer

That's right, both the expense of operating the plants and the tax benefits is netted in discontinued operations.

Unidentified Analyst

Okay. So that was net positive $0.02?

James E. Rogers - Chairman, President and Chief Executive Officer

That was a positive $0.02.

Unidentified Analyst

Okay. Secondly on the Cliffside plant, you guys had put out a release prior to the approval by the department regarding I guess some of the democrat gubernatorial candidates coming out against the plan and the approval. Obviously, you got the approval now. What happens if one of those candidates becomes governor? As they indicated, it is a kind of water over the bridge at this point, under the bridge at this point or?

James E. Rogers - Chairman, President and Chief Executive Officer

Probably under the bridge for one and over the bridge for the other. So, they will both be around in the election, but I think their position when you parch through the position and we've obviously had conversations, with the candidates since then, they will focus more on delay in the issuing of the permit not whether it should be done or not, it's the way I've read their press releases. The bottom line is that the permit has been issued and that ends the conversation, because we have both a certificate saying we need to build the coal plant and in fact our state commission say it would be improved to have not built it and built gas in lieu of it. When you see the article on the New York Times today on gas pricing the volatility is rising grass pricing it kind of reinforces the judgment that was made by the North Carolina commission on that point.

So we have a certificate in hand, we have an air permit in hand that we've expected and we will be turning dirt and starting the construction process now. So we do not think that their position on this will affect us, now if you are looking forward in terms of building additional coal plants in North Carolina, our current view is that, as we look at our RFP and given the fact that we have a nuclear plant a plan to come online in 2018 timeframe, as that we look out we don't see the need for another base load coal plant for many years. In fact, I would go so far to say we don't need a another base load coal plant until carbon capture and sequestration technology has been commercialized with some people say could be as much as 15 years off. So, that's my way of saying that this issue will not present itself in the near term again and what's been done on the Cliffside can't be undone at this point.

Unidentified Analyst

Okay. Great and then finally just on the growth rate comments that you made Jim, are you basically saying that you are still out of 5% to 7% long-term growth off of that $1.15, but feel more confident that you might be able to reach the high end of that?

James E. Rogers - Chairman, President and Chief Executive Officer

Yes.

Unidentified Analyst

Okay. Thank you.

James E. Rogers - Chairman, President and Chief Executive Officer

Thank you very much.

Operator

And we will now take our last question from Leslie Rich with Columbia Management.

Leslie Rich - Columbia Management

Oh, I got in under the wire.

James E. Rogers - Chairman, President and Chief Executive Officer

You did Leslie, welcome.

Leslie Rich - Columbia Management

Thank you. As you look at the capital spending required for Cliffside and Edwardsport, have your projections changed?

James E. Rogers - Chairman, President and Chief Executive Officer

Our projections have not changed and as you may remember with Edwardsport this is a cash quip project. And with respect to Cliffside it is AFP [ph] allowance or funds used during construction project with the ability to get cash quipped at our next general rate case, which our current plans, is probably in 2010.

Leslie Rich - Columbia Management

Okay, so the timing and magnitude of the spend is more or less in line with what you've laid out?

James E. Rogers - Chairman, President and Chief Executive Officer

That is correct and actually one of the things we are doing Leslie and this is really a good question on your part. When the certificates in hand, our people have gone to work to really tie down the cost of the equipments that we'll be using, at the same time working to tie down the cost of labor in these projects. We are committed to on periodic basis and its monthly in the Carolinas and I don't have a remember the exact timeline in Indiana but to go back... in Indiana its every six months is to go back to the state commission and show them what our numbers are, show them how the cost are trending to keep them fully informed with respect to any cost increases we may experience. But our number one objective today is to tie these cost down, the fact there has been so many coal plants cancelled, our plants abandoned, this might take some of the pressure of the skilled labor market in the U.S. But more to come on that, but the goal line is to tie the cost and lock them down and bring these things in on time under budget.

Leslie Rich - Columbia Management

Okay and then a question for David in terms of cash flow and funding, you show negative free cash flow of $3.1 billion and you said $1.1 billion of that would be funded with cash, is that what you said?

David L. Hauser

- Group Executive and Chief Financial Officer

Well, we have about $1.1 billion in cash and so we will use up our cash substantially this year, yes.

Leslie Rich - Columbia Management

And so you'd issue net debt of $2 billion?

David L. Hauser

- Group Executive and Chief Financial Officer

We actually have about $1.5 billion of maturities this year also that will have to replace, so you have to add that in.

Leslie Rich - Columbia Management

So it's a $3.5 billion of new debt.

David L. Hauser

- Group Executive and Chief Financial Officer

That is a good way to think about, we already did $900 million of that.

Leslie Rich - Columbia Management

So I am just wondering why your interest expense only goes up by $15 million, am I missing something?

David L. Hauser

- Group Executive and Chief Financial Officer

I think the big driver is we had... we will be decreasing our use of commercial paper this year, we had a lot of commercial paper last year where we had sold the commercial paper and then reinvested the money. And I think that probably the difference is associated with our commercial paper plus the timing of the debt, a lot of the debt won't be till late in the year.

Leslie Rich - Columbia Management

Okay and then finally, I am sorry you have said this twice or more. The purchase accounting adjustment of $105 million in Commercial Power in '08, is that what you are referring to when you said coal prices went up, power prices didn't go up as much or that was the comment about '07?

David L. Hauser

- Group Executive and Chief Financial Officer

No. The mark-to-market question is what I was answering when I talked about coal prices and power prices.

Leslie Rich - Columbia Management

Okay. So, what's happening with the purchase accounting?

David L. Hauser

- Group Executive and Chief Financial Officer

So, purchasing accounting was about $110 million this year and it will be about $5 million… it was $110 million in '07, it will be about $5 million in '08, that's the $105 million plan.

Leslie Rich - Columbia Management

Okay, great, thank you.

James E. Rogers - Chairman, President and Chief Executive Officer

Okay, Leslie, thank you very much.

David L. Hauser

- Group Executive and Chief Financial Officer

Thank you, Leslie.

Operator

And Mr. Trauschke, I'll turn the conference back over to you for any closing or additional remarks.

Sean Trauschke - Senior Vice President of Investor Relations

Okay. Thank you, Wendy. We want to thank you all for joining us today and as always our team will be available to answer any follow-up questions you may have. Thank you.

Operator

And that concludes today's conference call. Thank you for your participation. You may now disconnect.

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Source: Duke Energy Corp. Q4 2007 Earnings Call Transcript
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