Q2 2003 El Paso Corp. Earnings Conference Call - Final.

Original Source: FD (FAIR DISCLOSURE) WIRE

OPERATOR: Good morning, ladies and gentlemen and welcome to the El Paso Corporation second quarter 2003 earnings conference call. At this time, all participants have been placed on listen-only mode and the floor will be open for your questions following the presentation. If you do have a question at that point, you may press 1 followed by 4 on your touch-tone telephone.

It is now my pleasure to turn the floor over to your host, Mr. Bruce Connery, Vice President of Investor Relations. Sir, the floor is yours.

BRUCE CONNERY, VICE PRESIDENT OF INVESTOR RELATIONS, EL PASO CORP.: Thank you and thanks for joining our call this morning. In just a moment, I will turn the call over to Ron Kuehn, our Chairman and Chief Executive Officer. Others who will be joining the call with us this morning are Dwight Scott, our CFO, John Somerhalder who is President of the Pipeline Group, Rod Erskine, President of our production company, Bob Phillips, who is President of El Paso Field Services and Bob Baker, President of the Merchant Group.

Throughout the call, we will refer to slides available on our web site, www.Elpaso.com. We've posted the earnings press release as well as detailed operating statistics on the web site. Additionally, the earnings press release was filed with the SEC this morning as an 8K. Earnings press release include a reconciliation of GAAP to non-GAAP results and discusses our use of interest before, excuse me, earnings before interest and taxes or EBIT, as a performance measure.

This conference call will include forward-looking statements and projections made in the reliance of Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995. The company made every reasonable effort to ensure that the information and assumptions on which the statements and projections are based are current, reasonable and complete. However, a variety of factors could cause actual results to differ materially from those projections, anticipated results or other expectations expressed in this conference call. Those factors are identified under cautionary statement regarding forward-looking statements section of the earnings press release that was furnished to the SEC this morning on form 8K as well as in other filings with the SEC and you should refer to them.

The company assumes no obligation to publicly update or revise any forward-looking statements made during this conference call. Or any other forward-looking statements made by the company. Whether as a result of new information, future events or otherwise.

I will now turn the call over to Ron.

RONALD KUEHN, CEO & CHAIRMAN OF THE BOARD, EL PASO CORP.: Thanks, Bruce. Good morning, ladies and gentlemen and thank you for joining today's call. As you have seen, we reported earnings this morning and as we have indicated previously, we took some significant charges during the second quarter. All of our actions are geared toward getting El Paso back on track, reducing our overall debt and positioning our core natural gas franchise for future growth. We acknowledge that this has been a difficult year but as we look to 2004, we certainly expect a much better earnings picture with continued strong liquidity and ongoing debt reduction.

Reducing our debt was one of the key points of the five-point plan that we announced back in February. We have accomplished a lot against that plan in the first seven months of this year and we are very focused on checking off the remaining items that still need to be accomplished.

If you will look at chart 3, our key directive in this restructuring process has been to preserve and enhance the value of our core businesses. So far this year, we have spent roughly 79% of our capital on our Pipeline Production and Field Services businesses. These businesses have performed well so far this year and have contributed more than 100% of our pro forma EBIT.

We indeed did have a challenging quarter as it began to transition from the company with steeply declining production rates and significant capital needs to accompany with less volatile production rates, free cash flows and smaller capital budgets. We believe that the transition of our E&T operations is very important for El Paso as we've worked to delever the company.

If you will turn to chart 4, we have emphasized that we intend to reduce our obligations seen as a common by $10 billion. Most of this will be accomplished through the sale of noncore businesses and nonstrategic assets and free cash flow. We have completed our announced $2.7 billion of our original $3.4 billion goal with $1.8 billion closing in the first six months of this year. As you recall, in May, we announced another $2.5 billion of asset sales, that principally involve our domestic power assets and the Aruba refinery. We will be moving aggressively to sell those assets and you will get more information on our asset sales programs from Dwight Scott and Bob Baker later in the call.

In our trading business, we are making steady progress towards the liquidation of our trading book. This is not an easy process given the number of companies trying to sell trading assets. Nevertheless, we still feel confident about our goal of exiting this business by the end of 2004 while recovering a significant portion of the collateral against the books.

We are right on target with respect to the goal of strengthening and simplifying our balance sheet while maximizing liquidity. Dwight and his group have really done a terrific job of restoring our liquidity position from where we were earlier this year. We restructured our $3 billion bank facility and extended its maturity out to August 2005. Just last week, we retired our $1 billion bank facility as planned and our liquidity is in good shape.

You will be happy to know that we have consolidated Electron and Gemstone, which eliminates a lot of complexity that's plagued El Paso over the past 18 months. In addition, we have eliminated two large minority interest financings. So, in the first six months of this year, we have greatly simplified our balance sheet.

Certainly, one of the second quarter highlights for us was our ability to re-establish access to the Capital Markets. We completed a number of important financings and we have a much-improved debt maturity picture for the next two years as a result of these actions.

Turning now to chart 5, our fourth goal was to pursue additional cost reductions in 2003 and beyond. We recently completed the first phase of our Clean Slate Initiative and we have identified approximately $445 million of annual cost savings that will be implemented before the end of 2004.

We are also making some very fundamental changes in areas such as IT, legal and other services, many of which had been consolidated under a large corporate center and supported all of our business units. That structure worked well historically for El Paso but as we retool our corporate structure, we do not believe it makes sense today. As a result, we are now pushing costs and accountability to the business units so that they can decide what services they need and have direct control over their costs.

As we exit various businesses, we have eliminated a number of positions, including cutting the number of senior executives by more than 25%. Finally, we have made excellent progress toward resolving regulatory and litigation matters. During the second quarter, we signed definitive settlement agreements pertaining to the litigation surrounding the western energy crisis. Earlier in the year, when we announced the settlement, we said that this was the best course of action for the company. We needed to eliminate the litigation risk and move forward. We still believe that we made the correct decision, as difficult as it was, given our knowledge of the facts and our convictions that we did nothing wrong.

Before I turn the call over to Dwight, let me say how pleased I am that Douglas Foshee will be joining us on September 2nd as our new President and CEO. I will be working closely with Doug on the transition and as you know, will keep my role as Chairman of the Board of Directors for El Paso. We are all looking forward to having Doug on board and as we have said, one of his first orders of business will be to review and implement the long range plan, which will help us move toward a future with significantly reduced debt and stronger core of businesses.

I'd like now, to turn the call over to Dwight, who will provide you with a financial review of the second quarter. Dwight?

DWIGHT SCOTT, CFO & EVP, EL PASO CORP.: Good morning, everyone. This is Dwight Scott. I think before I get started, it is helpful to put this quarter in perspective. It's hard to believe that it was just last March when this quarter started. We had just signed a very preliminary MOU with California. We did not have our bank facility done at the time and we were concerned we may have to term it out. We had just put in place a very difficult bridge loan that provided us lots of liquidity but was a tough facility, it had collateral against it and was very expensive. We were experiencing rapidly climbing gas prices and we were exiting the trading business and really right in the heart of that process.

When you think back to that to time, what we told investors and what we did internally was focus, at least the financial side of the business, focused on four major issues that we knew we had to address. One, was we had to address our liquidity needs and make sure the company had the liquidity it needed to get through a very difficult period. Second, we knew we had to reduce debt and that was something that was very important, because it reduced the risk involved in owning the securities of the company. We had to make the business easier to understand and simpler to understand so that people can analyze it, especially given the perceived risk in the company at that point in time. Finally, we had to position the company so that we protected the assets that create the earnings and growth as we moved out of this period.

Every decision you will see in this quarter, both the financial decisions and I think all the operating decisions, were made with those key issues in mind. At this point in time, it's hard to think back on some of those issues, because we have solved some of those problems. But, it's good to think about what we were trying to do in this period.

With that, I'd ask you to turn to page 7, actions that affect the financial results. There are some changes in the company this quarter, that are important for you to understand. There will be a lot more discussion about this in our 10Q that we will file tomorrow. But importantly, we've moved our petroleum operations to discontinued operations in the period. We discussed that on our last call and we've also had a number of discussions and press releases talking about that. This is all of our petroleum assets, not just our Aruba refinery.

The impairment was a large one at Aruba but also some impairment at other assets within that group. Bob Baker later will discuss the sales process, but it's important to note that the sales process is under way for all of those assets and you know, in the context of what we were trying to do this quarter, what this allows to us do is it will provide liquidity, it will provide debt reduction and we believe, based on the historical earnings of this set of assets, will help our earnings going forward, so, we thought that was a very important action in the quarter.

We will restate our prior periods for discontinued operations, that's a GAAP requirement, so, you'll see in our 10Q this quarter that we restate the previous quarters that are addressed in the Q. We will file an 8K with information on the historical annual numbers look like with petroleum in discontinued.

We consolidated Electron and Gemstone. We've talked a lot about that. This actually, they were consolidated by May. They were both by the end of April, consolidated within our financials. Electron, since we completed the acquisition in May and it was treated as a step acquisition, will be treated in our financials as if we acquired it on January 1.

Gemstone we consolidated effective April of this year. This was important. We paid $225 million in equity to get these transactions done. It gives us better control over the assets and certainly gives us a simpler capital structure that's easier to understand. This also provides us with better liquidity as we're able to sell assets, particularly some of the power assets that we've been talking about selling, it gives us control over both the timing and power we can receive over those assets.

Finally, we did talk earlier about the impact of some of the bank refinancings. We provided collateral to a number of our bank lenders and also to some of our investors in our lease structures. That causes those to come back on balance sheet. I will talk more about that throughout the presentation.

If I could ask you to turn to page 8, we are revising our outlook down for the year. I thought that we ought to do this early in the presentation, so as you go through the rest of the discussion about the business and what's going on in the business, you could have some context to think about these projections. Our previous guidance we had given the guidance of 87 cents, we are reducing it for a couple of reasons. One, you will hear a little more, you saw in our press release, we are lowering our volume expectations for production. That business has gone through a process of asset sales. We have reduced capital and continue to reduce capital and we, as Ron mentioned, are moving that business to provide more free cash flow. But, that is causing a reduction in our production levels right now and you will hear more about that. We also have slightly lower natural gas prices than last time we came out with our estimates. In fact, some of that has come back even in the last few days, in the last few days it's moving closer to the 577 average.

We do have greater losses in our trading business. You will hear from Bob Baker, we have about 50 million more in losses this quarter than we had projected. Most of that 50 million is noncash. That is very consistent with how we continued, we expect to continue to manage that business, at least in the near-term, which is to reduce the cash demands of the business, exit the business and focus less on mark-to-market losses or earnings and more on cash.

Also, we had, in the quarter, a loss on our euro bonds. As we have about $775 million of euro bonds that are unhedged. In other words, we do not have a hedge against the euro dollar/dollar exchange rate, since we report in dollars, as the euro dollar strengthens relative to the dollar, we have created losses. That's been the case for about the last four quarters and this quarter it cost us 6 cents a share.

Finally, we repaid our bridge loan in the quarter. That resulted in early recognition of $37 million of expenses related to that bridge loan and that flowed through the earnings at 5 cents. So, we are revising our estimates downward to 30 cents, plus or minus 15 cents on either side. Sensitivities, and just to highlight, we are now turning the corner on some of these issues that we have been focused very much on cash and less on earnings, especially as it relates to the euro and some of the trading issues. We have begun to review ways to strategically apply some capital to reduce some of the earnings volatility in these activities and we'll provide an update as we move forward in the year.

Our sensitivities, we have sensitivities, obviously, in our natural gas, primarily …