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DTE Energy Company (NYSE:DTE)

Q2 FY08 Earnings Call

July 31, 2008, 9:00 AM ET

Executives

David E. Meador - CFO and EVP

Analysts

Ben Sung - Luminous Management

Peter K. Oleksiak

- VP and Controller

Nick A. Khouri - VP and Treasurer

Operator

Good day, and welcome to the DTE Energy's Second Quarter Earnings Call. Today's conference is being recorded. At this time, I'd like to turn the conference over to Mr. David Meador. Please go ahead, sir.

David E. Meador - Chief Financial Officer and Executive Vice President

Thank you, Hauly. Good morning, and welcome to our second quarter earnings conference call. Before we get started, I encourage you to read the Safe Harbor statement on page two of the PowerPoint document, including the reference to forward-looking statements.

With me this morning are Peter Oleksiak, our Vice President and Controller; Nick Khouri, our Vice President and Treasurer; and Lisa Muschong, our Director of Investor Relations. I also have some of the leadership team with me in the room and on the phone and I might call upon them during the Q&A session.

So let me start on slide five. We believe we have compelling investment pieces that we presented to you and that's dealt on several key strategies. First is our strong utility growth plan, and our utilities comprise about 80% of DTE Energy today after our restructuring. Long-term, we see about 5% to 6% growth in our utilities and that's driven primarily by mandated environmental expenditures. Near term, net growth and earnings is projected to be 7% to 9%, based on passage of Michigan's energy legislation there could be upside to those growth projections.

Given this growth strategy, it's imperative that we continue to maintain a collaborative relationship with the MPSC. It's also very important to know we continue to service our customers while and that we use cost reductions as we have in the last several years, as a method to minimize customer rate increases. Energy legislation is also very important to the strategy and I'll provide a brief update to that this morning.

For our non-utility businesses, we'll continue to build on our history of being value focused and while this is a smaller part of the business going forward, we will be looking for premium returns to the utilities as we continue to make investments to drive shareholder value.

And our dividend is $2.12 per share, and is attractive at a current yield of over 5%. And to put that dividend together with this growth plan, we believe it provides a very nice total shareholder return story.

Now let me turn to page six, and I'll provide a brief business overview before I turn it over to Peter. First I'd like to provide an update on legislation. As you know, the Michigan House passed legislation on April 17th, and the State Senate on June 27th. Both sets of legislation had bipartisan support with consensus on many elements of the proposed new energy policy for Michigan. There are differences that exist; they are primarily in the areas of renewable energy and energy efficiency.

The next step in the process is to reconcile these bills between the two chambers, and last week... and it's an evidence of another step forward in this whole process, the House and Senate appointed their conference committees, and they're currently actively working on compromise [ph] language. If they reach an agreement, this legislation could be voted on as early as August 13th, when the full House and Senate return to Lansing. As we've indicated in the past, this legislation is backed by a broad coalition in Michigan, including the Michigan Chamber of Commerce, the Michigan Manufacturers Association, labor organizations and business leaders. Also the Governor has expressed strong support for the appropriate energy reform and renewables package. We've been really, really pleased with the progress that's been made and we encourage the conference committees to act quickly here to reconcile the few remaining issues and push for passage of this legislation as soon as possible.

Regarding the Detroit Edison rate case, as you know, staff and interveners filed testimony on July 15th. This is another step in our multi-step process. We will file rebuttal testimony on August 8th. And we do respect the views of all the parties in this process, including the MPSC staff, and at the same time we also believe that we can support our position in our original filing and we will do that again when we file our rebuttal on August.

We continue to work collaboratively with all the parties in this case and we are optimistic that we will have a reasonable outcome and that will happen by year-end. Peter will take you through the second quarter earnings in a moment, but I just want to offer a few comments. Our quarterly earnings were impacted by a significant storm cost. We've had storms at... if you went back to the first quarter, we've just had one of those years and then in June, we had the fifth largest storm in the history of Detroit Edison.

We also have in the quarter some timing related mark-to-market adjustments at Energy Trading and what we're seeing a little bit is what we've seen in the past where the accounting treatment in some of our books of business in trading end up in a timing mismatch where the underlying asset is accounted for historical cost in the forward sales mark-to-market. And those are timing issues that we've had in the past, and they will turn around and Peter will talk about that.

And now, also I just wanted to mention, as we went into this year, we understood the challenges of earning our authorized return. We were prepared to engage in one-time cost reductions turn or 11% return on equity, especially at Detroit Edison. With some of the external pressures we've seen, like storm costs, this makes it hard to offset those one-time events and the regulatory lag. But we continue to work that issue pretty hard, and at the same time the other businesses are all doing very well and Peter will take you through that and also our guidance. But we did want to signal that there are challenges at Detroit Edison, caused by these external drivers and the need for rate increase, which we expect to get by the end of the year. And in the meantime, we're going to continue to press hard on cost, including one-time items to move that business as far as we can towards its authorized return.

So with that background, let me take... turn it over to Peter and he will take you through the quarter.

Peter K. Oleksiak - Vice President and Controller

Thanks Dave, and good morning to everyone. Let's just start with slide eight, and the second quarter earning results. First I would like to point out for the second quarter we moved our coal services business into the Power Industrial segment in our SEC reports and our Gas Midstream business will now be shown as a stand-alone segment. For the quarter, DTE's operating earnings was $0.16. I'd like to remind everyone that a reconciliation to GAAP reported earnings is contained in the appendix.

Detroit Edison contributed $0.31 while MichCon which typically has a loss on the second quarter came in at a loss of $0.07. The non-utility segments combined to a loss of $0.03. The primary driver to the non-utility quarter results was Energy Trading at a loss of $0.07 and continued solid performance by our Gas Midstream at $0.06 in the quarter. Finally, Corporate and other was a loss of $0.05 in the quarter.

Moving on to page 9, where we can see summary of each segment's performance quarter-over-quarter. I'll be covering each segment in more detail later in the presentation. Overall, as you can see in the slide operating earnings are down $38 million for the quarter. Both these quarterly variances attribute to either timing related items or one-time events that impacted the quarters. Detroit Edison and MichCon results were down a combined $21 million from the prior year. Within the $21 million negative variance there is a $24 million pick up that occurred last year with the PSCR reconciliation true up.

Our non-utility segments are down $35 million, Power & Industrials are down $15 million, primarily due to a true-up of depreciation and amortization expense on the held for sale projects. And Energy Trading was down $18 million with timing related mark-to-market losses. Corporate and other was up $18 million due to favorable interest and timing of taxes within the year.

Let us continue to slide 10 and go through some details beginning with Detroit Edison. Operating earnings for Detroit Edison was $51 million, down $13 million from the prior year. Margin for the quarter increased earnings $6 million as the expiration of the temporary show cause rate reduction and lower customer choice more than offset the reduction in sales due to milder weather and the impact of the economy. We will continue to see the benefit of the show cause related rate increase and the lower choice in the third and fourth quarter as well. I'll talk more about the impact of the economy on sales in the next slide.

As I mentioned on the quarterly summary page in 2007, the second quarter was aided by 2004, and 2005 PSCR reconciliation order that increased earnings by $24 million. Also impacting the quarter was a series of catastrophic storms in June of this year that knocked up power to more than 400,000 customers. And as Dave mentioned, this was the fifth largest in Edison's history. In the quarter, we also increase our bad debt reserves for Electric Utility as we saw an increase in total arrears and ageing of those receivables. Positively impacting the quarter was cost improvement and our generation of fleet, lower benefit costs as well as implementation of EBS start-up cost which occurred in 2007. The 12-month rolling operating ROE for Edison is 9.5%.

Page 11 outlines our year-over-year electric sales for the quarter as well as the year-to-date. Up until the second quarter of this year, we experienced relatively flat to slightly positive temperature normal growth year-over-year. With the American Axle strike and other industrial sector related events, we witnessed a reduction in territory sales in the second quarter. Not only was the quarter down 270 gigawatt hours of reduction due to weather, it also was impacted 2.4% in weather normal sales. But even with this decline in the second quarter year-to-date sales was down only three-tenths of a percent on a weather normal basis. Given the second quarter volume performance, we are going to continue to monitor the impact of the economy on territory sales and overall 2008 expected results.

Moving on to page 12 on a review of MichCon's performance. As I mentioned earlier, second quarter is a typical loss in the seasonal gas utility business. Operating earnings for MichCon was a loss of $11 million, down $8 million from the prior year. Margins were down slightly in 2008 due to milder weather and lower storage margins. Uncollectible expense reduced earnings $3 million in the current year with higher gas prices combined with local economic conditions, MichCon has seen an increase in the amount of ageing customers' receivables with required increase in bad debt reserves. However, 90% of the impact of the increase of uncollectible expenses offset by the uncollectible tracking mechanism granted in MichCon's last [ph] rate case. The 12-month rolling operating ROE for MichCon is 8.6% and 9.6% on a weather-normalized basis.

Let us turn to page 13 on the non-utility business segment. Total non-utility operating earnings for the second quarter 2008 are a loss of $5 million, compared to $30 million income in 2007. Gas Midstream earnings are flat as the increases in storage revenue was offset by tax reserve related to our prior year. Unconventional gas earnings are only down slightly from 2007 as increased western Barnett production and higher gas prices almost offset the loss of earnings from the sale of the Antrim and core Barnett properties.

Power & Industrial earnings are down $15 million in the quarter due primarily to the true-up of depreciation and amortization expense on the held for sale monetization projects. Depreciation and amortization expense was suspended in the fourth quarter of 2007 when these projects were classified as held for sale as part of our non-utility and monetization effort.

With our recent announcement earlier this month on our decision to retain full ownership of these projects, we must now recognize the depreciation expense deferred in the previous two quarters. Our coal services business is also impacted by the elimination of synfuel transportation services provided in 2007.

Finally, Energy Trading earnings are down $18 million driven by unrealized margin losses in gas trading and storage. Year-to-date trading company income is $20 million, which is up $12 million from last year. In the appendix, you will find a slide that shows economic net income for the trading business is $57 million for the first six months of the year. So a real strong performance year-to-date. This difference in economic and accounting will flow back in future quarters.

Page 14 provides details on our earnings guidance Dave mentioned earlier. Even with the earnings pressures we're experiencing at both utilities, we continue to hold our 2008 earnings guidance to $455 million to $520 million of operating earnings, or EPS of $2.80 to $3.20 per share.

As I mentioned earlier, Edison will benefit for the reminder of the year with a show cause rate reduction credit expiring, lower choice and lower cost related to our information system implementation from last year, and that is why we're holding guidance for that segment. Another point, our segment guidance has been revised to reflect the movement of coal services into our Power & Industrial Projects segment.

With that, I'd like to turn the discussion over to Nick Khouri, who'll cover cash flow and capital expenditures.

Nick A. Khouri - Vice President and Treasurer

Thanks, Peter, and good morning. As always, improved cash flow and balance sheet strength remains the key priority for both management and the Board of Directors. Page 16 shows the year-to-date consolidated cash-flow statement for 2008 compared to the prior year. Through June, internal operating cash flow is significantly above last year, and above capital and dividend requirements. Adjusted cash from operations reached $1.5 billion, about 25% above last year's level. Asset sales are down year-over-year since 2007 included the sale of DTE's [inaudible] properties. As for cash uses, capital and dividends totaled approximately $900 million, leaving positive free cash flow after dividends of $600 million for the first half of the year. However most of the year-over-year improvement was intra-year [ph] timing, for example, net cash from synfuel swings from a large positive in the first half to a negative in the third quarter. Also MichCon will see its usual working capital requirements, as they move from a positive net cash in the first half of the year to a negative in the second half. So, although the first half came in strong, we are reconfirming our prior forecast for the full-year's base cash and capital.

Page 17 summarizes capital spending for the first six months of 2008. As you can see, total capital spending reached $726 million, about 15% above last year. The year-over-year increase was spread across all business units. For the full year, we expect capital spending to be up about 14% from 2007, including a 20% increase at Detroit Edison.

Page 18 slightly revises full-year 2008 cash and capital spending guidance to reflect last month's decision to suspend monetization of the Power & Industrial portfolio projects. Pre-tax asset sales declined from a previous guidance of $1.1 billion to approximately $300 million. These projections exclude any further Barnett monetizations. Though not included in guidance, we are continuing to target a reduction in parent company debt this year.

The right side of page 18 summarizes capital spending for the full-year. Total capital is expected to grow to $1.5 billion this year, about 80% of the projected capital will be for the two utilities. Non-utility capital spending is roughly equal to $100 million for three of our business segments, but will of course depend on opportunities as and when they rise.

And finally, we expect to end this year well within our leverage target of 50% to 52% and the ratio of cash flow to debt between 22% and 24%.

Now let me turn it back over to Dave to wrap up.

David E. Meador - Chief Financial Officer and Executive Vice President

Thanks Nick. Slide 19 is a repeat slide that I talked to earlier. Again we believe, that we have a very reasonable growth plan near-term that growth is going to be higher than our long-term growth. And there are some catalyst that are coming up here in the near-term that will all be signaled towards that growth. If you put that growth together with the dividend, it's a nice total shareholder return story. In terms of catalysts, we look forward to updating you as we make progress on the rate case, there's a timetable on slide 26 in the appendix on the rate case and we'll be filing our rebuttal testimony here in early August. And then another possible key date is August 13th for legislation.

So, we will open it up for questions now, Hauly.

Question and Answer

Operator

Thank you. [Operator Instructions]. And our first question comes from Caroline Baum [ph] with Merrill Lynch.

Unidentified Analyst

Hi, good morning.

David E. Meador - Chief Financial Officer and Executive Vice President

Good morning.

Unidentified Analyst

I just have a question on your Energy Trading business results in Q2. On your mid-year update conference call in early July, you said that Energy Trading was doing well in '08 and that we would see that again in Q2 as we did in Q1. But Energy Trading actually recorded a loss.

David E. Meador - Chief Financial Officer and Executive Vice President

Right.

Unidentified Analyst

So I'm just curious if you could go into that a little bit, I am wondering what happened?

David E. Meador - Chief Financial Officer and Executive Vice President

We managed the business on an economic margin and economic net income basis, and if you look at the economic margin year-to-date right now they're at about $135 million, which is significantly ahead of where they were on a six-month basis last year. What happens is, it's the way the accounting works on this. So if you went back to the first quarter as an example, we reported net income of $30 million for the... $30 million per trading and all of that was realized. Now when you get to the second quarter, what happens is, the accounting the way it works is... and it's only slices of what trading does. But for example in storage, we put gas on the ground then storage is accounted for at an average cost for inventory, but the forward sale is mark-to-market. So we have a transaction that's economically hedged and the way the accounting works is you could have mark-to-market gains or mark-to-market losses during the year based on gas prices. So in the second quarter, we saw had a net realized gain but there was a mark-to-market loss on some of the gas storage positions and the gas transportation positions there, because they're economically hedged, that will turn around over the next several years. So if you look at on a six-month basis, trading net income is $20 million and when you net all the realized and unrealized, the net income is all realized because of what happened in the first quarter. So from time to time you'll see these mark-to-market losses or gains but the business is still doing well, it's on track, and the six months earning on a net income basis is reflective of our guidance for the full year.

Unidentified Analyst

Okay, thank you.

Operator

Next we will hear from Leon Duval [ph] with Catapult Capital.

Unidentified Analyst

Hi, Good morning. I just wanted to double check. You guys show industrial sales down about 3% in 2Q '08 versus 2Q '07, does that include the Roche [ph] plant that moved over from I guess CMS service territory? And then bigger picture if you could sort of just comment on the economy on what we're seeing with industrial sales overall and whether you're seeing residential, also following some of the reduction in the industrial load or is that just purely from the weather?

Peter K. Oleksiak - Vice President and Controller

This is Peter Oleksiak. The sales does include the Roche plant moving and that is territory sales for us. But that is in the numbers. Industrial sales were impacted by the American Axle strike. So as you mentioned... about third of the reduction is related to that one event. Auto sales are down as well although those are event driven, and potentially it could be temporary in nature with some plant shutdown or temporary stoppages at work. So we are seeing the auto sector down, but we're seeing increases in the steel related business as well. But overall, industrial is down year-over-year and quarter-over-quarter. Residential actually is holding relatively flat on a year-to-date basis. We are seeing some slight reductions in the overall commercial sector as well.

David E. Meador - Chief Financial Officer and Executive Vice President

So, relative to the economy as we've indicated, Michigan has been economically struggling here for a while. And because of that, we have been forecasting flat float and that's better than our guidance. Year-to-date, we're almost flat, the second quarter was slightly off and as Peter indicated, we believe some of that was event driven, but we'll just have to watch us going forward.

Unidentified Analyst

Okay, thank you very much.

Operator

[Operator Instructions] Next we'll hear from Ben Sung from Luminous Management.

Ben Sung - Luminous Management

Hi I had a question about the uncollectible expenses at MichCon. The $3 million that you have listed there... is that net of the offset so that if you would gross it up and in reality it's sort of $30 million, or is $30 million the total and that there is an offset of 90% against that?

Peter K. Oleksiak - Vice President and Controller

I think, either way you phrase it, it's correct, it is roughly $30 million gross. I mean, net off the track or it is about $3 million effect.

Ben Sung - Luminous Management

Okay, thank you.

Operator

Looks like there are no further questions at this time. Mr. Meador, I'd like to turn the conference back over to you for any additional or closing remarks.

David E. Meador - Chief Financial Officer and Executive Vice President

Thanks, Hauly, and thanks for joining us today. We know that there are other calls going on this morning, and for those of you that are listening to the archive, if you have follow-up questions, you can call our Investor Relations department. As I indicated, the next catalyst and things look for in the August timeframe, both the rebuttal filing and Detroit Edison, and then the August 13th date on legislation, and hopefully, we'll have good news on that side and look forward to seeing you at future conferences in the September timeframe, then also at the fall EEI. Thank you.

Operator

And this does conclude today's conference. We thank you for your participation and have a wonderful day.

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Source: DTE Energy Co. Q2 2008 Earnings Call
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