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DPL, Inc. (NYSE:DPL)

Q4 FY07 Earnings Call

February 22, 2008, 9:00 AM ET

Executives

John J. Gillen - Sr. VP, CFO, and Treasurer

Paul M. Barbas - President and CEO

Analysts

Operator

Good day ladies and gentlemen, and welcome to the Fourth Quarter 2007 DPL Incorporated Earnings Conference Call. My name is Shikwana and I will be your coordinator for today. At this time all participants are in a listen-only mode. We will facilitate a question-and-answer session towards the end of this conference. [Operator Instructions].

I would now like to turn the presentation over to your host for today's call Mr. John Gillen, Senior Vice President and Chief Financial Officer. Please proceed, sir.

John J. Gillen - Senior Vice President, Chief Financial Officer, and Treasurer

Thank you, and good morning. Welcome to DPL 2007 year-end earnings conference call. I'm John Gillen, Senior Vice President and Chief Financial Officer.

Before we begin today, I would like to remind everyone that all references to earnings per share are dilutive unless otherwise noted. And this call may contain certain forward-looking statements regarding plans and expectations for the future. Investors are cautioned that actual outcomes and results may vary materially from those projected due to various factors beyond DPL's control. Such matters are described in our 2007 Annual Report on Form 10-K that we filed this morning.

In addition, today's discussions includes certain non-GAAP financial measures as defined under SEC Regulation G. A reconciliation of the non-GAAP measures will be provided during this conference call.

With me today is Paul Barbas, DPL's President and Chief Executive Officer. Paul will provide an overview of DPL's performance in 2007 and the company's priorities as we move into 2008. I will then review the 2007 financial results and open up for questions.

Now, I'd like to turn the presentation over to Paul Barbas.

Paul M. Barbas - President and Chief Executive Officer

Good morning and thank you for joining us today. 2007 was a strong year for DPL. Our focus has been and will continue to be on managing the fundamentals of our core electric business.

Operationally, our most significant accomplishment was the progress made on the construction of the Scrubber. As the single largest environmental investments ever undertaken by this company, keeping the Scrubber program on track is critically important to our success. I m pleased to report that we are on the final stages of the project as planned. Last summer we brought the Scrubber at Killen Station online and it is operating effectively. The scrubber is providing efforts to removal rates consistent with our expectations and to date Killen has had no forced outages related to the Scrubber operation. At Stuart Station, we are applying the lessons learned at Killen to benefit the Stuart start up. We recently brought Unit 4 online, Unit 3 is in the startup mode, and the remaining two units will begin operating over the next several months.

Early in this project, DPL made the decision to utilize an innovative Scrubber technology. Developed by Chiyoda Corporation, the flue gas is pumped through a jet bubbling reactor containing a bath of lime stones as opposed to using a tower to spray the gasses with the limestone mix. Our early adoption of this technology will result in capital cost that will be well below the industry averages. In addition, the simple design of the jet bubbling reactor will have a favorable impact on Scrubber operating and maintenance expenses.

As we have said before, once the Scrubbers are brought online we need to perform a theory per cat to determine the types of coal and sulfur content that can be effectively burned in our boilers without causing extra slugging. The end result of this testing will be improved fuel flexibility and minimized total system cost. At Killen the initial fuel burning test are nearing completion. The blower has performed well as we continued to test our operational limits. Prior to the Scrubber coming online Killen burned approximately 1.2 pounds sulfur compliance coal.

At this point we have verified our ability to burn 100% Northern Appalachian coal which has about 4 pound sulfur content. Currently we are finishing up tests of 4 to 5 pounds sulfur coals from the Illinois Basin, blended with 1.7 to 2 pound sulfur coals from Central Appalachia. We have successfully tested a 50-50 mine and are now testing a blend of 2/3rd Illinois Basin coal.

Overall we are very pleased with the blending results at Killen. Initially we had projected post Scrubber sulfur content at Killen to be in the range of 2.5 to 5 pounds. At this point we are optimistic that we will be at the higher end of that range. At Stuart Station the fuel burning process for Unit 4 will begin in March. For the subsequent 3 units we expect to gain efficiencies in the time required for the blending as we apply our learning for the Unit 4. We have historically burned an average of 1.6 pound sulfur coal at Stuart. Post Scrubber, we are projecting Stuart's sulfur content to be in the 2 to 4 pound range. We expect the testing to continue throughout 2008.

As the environmental projects become operational and the flexibility around coal blending is determined, opportunities may exist to monetize environmental allowances. We currently have approximately 25,000 SO2 allowances in excess of our projected requirements and as the Scrubbers come online, we anticipate this will grow over time. With 2008 SO2 allowances trading from $400 to $450 per allowance, this represents a significant potential upside opportunity for us.

In addition with the operation of selective cataleptic [ph] reduction equipment and the resulting reduction in NOx emissions, we have the ability to earn early reduction credits in 2008 which could provide approximately 3000 annual NOx allowances. We also anticipate having additional excess NOx allowances each year beginning in 2009. With annual NOx allowances trading in the $2800 to $3200 range this too represents significant potential of upside opportunities for us. The timing of any SO2 or NOx sales will be dependent on a number of factors including, but not limited to the number of excess allowances, our forward position, current market prices, and our view of the fundamental value.

Turning to fuel, I am sure you are all aware of the recent increases in spot prices of coal. For this reason as well as the fact that our retail rates are set through 2010, we feel very good about the progress we have made strengthening our hedge positions through 2010 for our committed burn. The committed burn is the amount of coal required to generate electricity for our fuel requirements or retail load in any forward power sales.

On a committed burn basis, we are 100% hedged for 2008 and 2009, and 73% hedged for 2010. These numbers can change if we execute additional purchase contracts or increase our output in response to attractive energy prices. With our favorable market opportunities for spot energy sales, we will mix upwards to the coal. Spot energy sales typically consume 10% to 15% of the company's total coal consumption.

In addition, with the increase in price volatility and spreads between Northern Appalachian and the Illinois Basin coal, we also feel very good about our improved fuel flexibility as we work through the blending process. Post Scrubber, the ability to burn varied coal mixtures will bode well for our competitive positions in a volatile fuel market.

Unfortunately, the rising price of coal can pose an increased risk of delivery to disruptions. While we fully expect delivery of the contracts we have in place, we have increased our inventory levels to further protect us from supply disruptions.

For the year, we were very pleased with the performance of our DPL operated plants. As expected heat rate was up slightly with the start of the Scrubber at Killen, but the overall efficiency of these plants remain strong. Likewise we had a good year with regard to availability at DPL operated plants. Our equivalent forced outage rates dropped to 7%, which is a 17% improvement over 2006. Additionally the outset of our mid [indiscernible] Station was up approximately 50%. In partner operated plants however total output was down approximately 12% due to planned and unplanned outages. Power plant performance both DPL and partner operated will remain a key area of focus for us as we go forward.

Turning to our distribution assets, we once again exceeded regulatory reliability standards. This strong performance came during a year in which we set a new peak demand of 3270 megawatts back in August. At the same time our customers gave up positive marks for quality service. In our annual customer satisfaction surveys we saw steady gains and a number variance such as professionalism, responsiveness, and overall customer service.

Corporately we also reached a number of milestones. We resolved litigation with former executives and put those events behind us. We successfully closed on the sales through peaking plants. We achieved our goal of running an investment grade credit ratings from all three rating agencies and we announced dividend increases on two separate occasions during the year, for a total increase of 10%.

As we look to 2008, we are very clear about our priorities. First we will continue to work with Ohio's leadership and all stakeholders as a new energy bill worked its way through the legislative process. As many of you know the bill is currently at the Former House Public Utilities Committee. Some of the issues being actively debated includes the need for renewable benchmarks or market criteria, that need to exist before market pricing can be implemented and the mechanism for developing negotiated rates under an eclectic security plan option.

Our priority continue to be maintaining a true market option, the potential to invest infrastructure with an appropriate return, and the ability to recover certain expenses related to fuel, environmental, and demand side management program costs. This is an important debate for a stake at our company and of course we will continue to actively participate in the dialogue.

Second, as I mentioned earlier, we improved our performance remarkably during 2007 at DPL operated plants. Continued improvements and the operational performance of our power plants both DPL operated and partner operated is a key success factor for the company. As a step forward we will follow in the leadership in the power production group and will reorganize and better utilize our resources and share best practices across plants.

Third, we will focus on bringing the remaining Scrubbers online as planned and determine the optimal blend of higher sulfur coals that we are able to efficiently burn in our boiler. Our fourth priority is cost control. Aside from plant increases, power production is driven principally by Scrubber related expenses, our remaining outages is anticipated increase less than 3% annually.

And lastly we will evaluate alternatives for the use of positive free cash flow which we will generate as we wind down our environmental construction program. We will first look to make investments in the core business, in addition, we will continue to evaluate increases in the cash dividend in continuation of our balance sheet restructuring. The bottom line, we are in a solid position if we look to 2008 and 2009 with our rate stabilization plan providing steady revenues, growth and capital expenditures declining, execution becomes the key to growing shareholder value. Now, I will turn it over to John for an overview of the 2007 financial results.

John J. Gillen - Senior Vice President, Chief Financial Officer, and Treasurer

Thank you Paul. DPL's 2007 earnings from continuing operations were $1.80 per share compared to $1.03 per share for 2006. On a non-GAAP basis 2007 earnings from continuing operations were $1.53 per share compared to $1.40 per share for 2006. A reconciliation of GAAP to non GAAP earnings is as follows, in 2007 we had $0.17 gain on the executive litigation settlement, a $0.07 gain on insurance settlement related to the executive litigation, and $0.03 gain on the sale of a corporate aircraft. In 2006 there was $0.37 impartment charge for the sale of the peaking wells.

Now for a review of the drivers behind the earnings. Revenue increased 9% or $122.2 million due mainly through recovery of environmental investments through resell rates, and the weather driven increase in retail sales. Total degree days increased 9% for the year.

During 2007 we are recorded $30.9 million in additional capacity revenues associated with the first year of PJM's new regional pricing model. It should be noted however, that these capacity revenues were offset by $28.4 million of capacity expenses which are reflected in purchase power. Fuel which includes coal, natural gas, oil, and emissions allowances decreased 6% over 2006 due to lower average fuel prices and lower generation volume.

Purchase power cost increases $128.2 million in 2007. $57.6 million of the increase was due to higher purchase power volume and $41.2 million was due to higher average market rates. The increase to purchase power volume was mainly driven by the result of increased retail sales and reduce availability of partner operated generating facilities due to planned and unplanned outages. And as I mentioned earlier also included in purchased power was $28.4 million increase due to PJM capacity charges which were offset by $30.9 million in PJM capacity revenues. The net impact of revenues, fuel, purchase power was $14.9 million or 2% increase in gross margin.

Moving to other income statement items of note, operations and maintenance expense increased $7.4 million or 3% due mainly through an increase in power production operating and maintenance expense as we continue to invest in the operations for the generating plants. Depreciation and amortization increased 7... decreased $17 million from earlier reflecting 2007 sale to peaking plants and the impact of lower depreciation ratio for generation of property. And interest expense decreased $21.2 million or 21% due to the redemption of $225 million of debt in 2007 and greater capitalization of interest associated with the DPL major construction projects.

Turning to the liquidity and cash flow, DPL's cash and cash equivalents decreased $127.3 million to $134.9 million at December 31, 2007. The decrease was attributable to $346 million in capital expenditures, $225 million used to retire long term debt, and $112 million in common dividends. These decreases were partially offset by $218 million in cash from operating activities, $158 million from the sale of peakers and the corporate aircraft, and $63 million of restricted funds drawn for pollution control capital expenditures. Construction additions were $347 million in 2007 compared to $352 million in 2006 and are expected to approximate $205 million in 2008.

Over the next three years DPL is projecting to spend an estimate of $490 million of capital projects. Construction additions in 2008 are expected to be financed with a combination of cash on-hand, short term financing, factors on debt, and cash from operations. And lastly, we are reaffirming our 2008 earnings estimate range of $1.90 to $2.10 per share based on an estimate of 118 million shares outstanding and 2009 earnings estimate range of $2.10 to $2.40 per share based on an estimate of 120 million shares outstanding. With that, operator, I would like to open up the conference call to questions.

Question And Answer

Operator

Thank you. [Operator Instructions]. At this time, there are no questions. I would now like to call back over to Mr. John Gillen for closing remarks.

John J. Gillen - Senior Vice President, Chief Financial Officer, and Treasurer

Well, thank you everyone for attending. We appreciate your attention and look forward to talking to you again in the near future.

Paul M. Barbas - President and Chief Executive Officer

Thank you everyone.

Operator

Thank you for your participation in today's conference. This concludes the presentation. You may now disconnect and have a good day.

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