Q2 2005 El Paso Corp. Earnings Conference Call - Final.

Original Source: FD (FAIR DISCLOSURE) WIRE

OPERATOR: Good morning and welcome to the El Paso second quarter earnings conference call. [OPERATOR INSTRUCTIONS]. It is now my pleasure to turn the floor over to Mr. Bruce Connery. Sir, the floor is yours.

BRUCE CONNERY, VP, IR, EL PASO CORPORATION: Thank you and good morning. We appreciate you joining our call.

In just a moment, I will turn the call over to Doug Foshee, our President and Chief Executive Officer. Doug will be followed by Dwight Scott, who will review our financial results. Then Steve Beasley will go over our pipeline operations. Lisa Stewart will review the progress in our Production business, and Mark Leland will review the results of our other nonregulated businesses. Throughout this call, we will be referring to slides which are available in our website, ElPaso.com.

This morning, we issued a press release and filed it with the SEC as an 8-K. It is also on our website. During the call, we will include forward-looking statements and projections made in reliance on the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995. The Company has made every reasonable efforts to ensure that the information and assumptions on which these statements and projections are based are current, reasonable and complete.

However, a variety of factors could cause actual results to differ materially from the projections, anticipated results or other expectations expressed in this conference call. Those factors are identified under the cautionary statements regarding forward-looking statements section of the earnings press release that was furnished to the SEC this morning on form 8-K. As well as in other of our SEC filings. 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. Please note that during the call we will use non-GAAP numbers such as EBIT and EBITDA and we have included a reconciliation of all non-GAAP numbers in the appendix of our presentation.

I will now turn the call over to Doug.

DOUG FOSHEE, PRESIDENT AND CEO, EL PASO CORPORATION: Thanks, Bruce, good morning and thank you for taking the time to join our second quarter call. I'm going to take a few minutes up front this morning to tell you how I think we did in the quarter and then I will come back at the end and wrap up.

The second quarter was another quarter of significant progress in El Paso's turn around on almost all fronts.

In the pipes, we had another in a string of solid quarters. You will hear Steve talk later about the fact that we continued to execute on our commitments, whether it's rate cases, recontracting, connecting new supplies, meeting our customers' increasing needs for gas or adding new projects to expand in the markets we serve, and we're doing all of that very reliably and safely.

At E&P, we've missed the Production targets we set for ourselves this year. I don't want to minimize the importance of meeting our commitments to you, but I also don't think this should overshadow the real progress we're making in many other areas, notably value creation and I will come back to that notion of value creation in a minute.

First, our largest region onshore continues to deliver the kind of results we told you it would. Organic growth has been substantial virtually across the board in this region and we have a multiyear inventory of low risk, repeatable prospects to drill, even before considering the acquisitions we made to date and the addition of the Medicine Bow and Four Star properties later this year.

In the Gulf of Mexico, Production performance hasn't yet caught up with drill bit performance, but that's about to change as we fast track West Cam 75 and West Cam 62 two significant deep shelf discoveries later this year and you will hear more about that from Lisa. Our challenge, of course, remains the Texas Gulf Coast, which we talked to you about before, but we think you should be looking to the Gulf of Mexico as a go-by here and we're already seeing positive signs in that direction. If you think about where our Texas Gulf Coast portfolio was, we had a significant number of prospects but more high-risk deep exploratory prospects and we were lacking in the shallower, more repeatable development kind of opportunities, we've already begun to change that and we're going to give you a progress report this morning.

In the international area, which is the smallest of our regions, we had a Production shortfall, but that primarily relates to timing and doesn't have anything to do with the quality of the portfolio or any underlying reservoir performance issues. What we do know is this, we're now spending our capital wisely, in a short period of time, we've improved virtually every element of risk in our Production business. Whether you're talking about Production profile and natural decline rates, reserve life, reserve mix or our prospect inventory, across the board those things have already improved and the Medicine Bow acquisition will continue that trend.

I mentioned value creation a minute ago and, of course, two important measures of value creation are reserve growth and reserve addition and F&D costs, and we expect to show this year material improvement on both of those measures. On the balance sheet side, we continue to make great progress as evidenced by the upgrade this quarter from S&P. In fact, with the midstream announcement we made yesterday, we now believe we will hit our debt reduction target of $15 billion, even with the $814 million Medicine Bow acquisition funded with cash.

Said another way, when the equity sold on the Medicine Bow deal, we will be well ahead of our original 2005 debt reduction targets and finally, we're beginning to see the wind down of some of the government reviews of the past that will free up our management time and resources to devote to the future. As reflected in the 10-Q, this includes the termination of the reviews of our power restructuring business, the Department of Justice review of our oil and gas reserve provision and the grand jury review of our past pipeline rupture.

With that, I will turn it over to Dwight and come back at the end.

DWIGHT SCOTT, EVP, CFO, EL PASO CORPORATION: Thank you, Doug. Good morning, everyone. I'm starting on page 5, titled financial results, before I go into the details, I want to give you a view -- or at least my view of how the quarter looked.

First of all our financial results were generally on plan and importantly, the significant items that impacted the quarter were related to issues that we have been highlighting for you, the investor, for the last few quarters. So, there was no big surprise in the significant items for the period. Our cash flow continued to be impacted by discretionary items, but excluding these items, we were very close to free cash flow for the quarter and have been year to date. Our debt reduction is on plan, Doug mentioned that, it's really ahead of plan and our asset sales are going very well. You will hear more about that in detail from Mark.

And finally, the balance sheet simplification that we started about three years ago is essentially complete, we still have some work to do on the legal structure simplification, but the balance sheet you see today for El Paso is the one we were working toward over the last few years. If you would turn now to page 6 titled earnings, I will start at the bottom of the chart, the loss of $246 million for the quarter was impacted by significant items. Without these, the significant items, we would have been slightly ahead of our expectations for the period.

Our interest costs, as you see moving up the chart, are trending down nicely, obviously directly related to debt reduction, they're down 17% year-on-year and that was generally what we expected. The restructuring and sales activity, the timing here is important, we did have significant charges this quarter, although I will talk more on the next page about those charges and also some things that we expect to happen in the second half of the year that will have the impact of the significantly offsetting those charges.

Our tax rate, also because of this, the international assets that we are selling and impairing, it does create an unusual tax rate for us in the period and has year to date, our normal ongoing tax rate should still be in the 35 to 38% range, though that is a book number, our cash taxes remain relatively small due to the large NOL position. The other thing is our discontinued operations, that had our petroleum activities and international E&P activities in it. It is a moving to a very small item. We did move our field services assets in there in anticipation of the sale of those assets and so the gain that we will record upon the completion of that sale will show up as a discontinued item gain, as well.

So, what can you take away from the results? We don't adjust for significant items when we discuss earnings and, of course, are working very hard to eliminate those items. However, if you want to look at ongoing earnings for the Company, generally what I look at is pretax earnings, add back the significant items that I think are appropriate and apply a normal tax rate of 35 to 38%. That's the easiest way to calculate our ongoing earnings power.

If you turn to page 7, summary of significant items, the key items in the quarter, Mark is going to talk more about the details of these items, so, I'm just going to give you some numbers. Largely, the asset impairments were in our power business, primarily international power, dominated by $294 million impairment of our Macae plant in Brazil. We continue to negotiate to the settlement of that dispute with Petrobras

We took $134 million charge on our central American assets as they're being prepared for sale and we took further impairments on certain of our Asian assets as we signed definitive contracts with the sale of those assets. We also finalized the agreement with the owner of our Greenway lease, resulting in a charge this quarter. The remaining payments under that lease equal approximately $125 million and will be paid over the next three years. Other than accretion of the discounted obligation, we don't expect significant additional charges there.

And yesterday we announced the sale of our remaining midstream assets, or a large portion of our midstream assets, and we stated that we expect a gain of about $400 million on those sales. In addition we had a gain in July when we completed the sale of our Korean power plant. When I said earlier there would be offsets, those are the two primary offsets to the year-to-date significant items, as you can see they're large numbers. I will now turn to page 8 on the business unit contribution. The chart shows the contribution by business unit. You will hear a lot more about this from each of the business units, but the pipelines are slightly ahead of our expectations, they have limited significant items and slightly lower than planned for Capex.. That group remains a strong cash contributor as measured by the EBITDA less Capex.

Production was slightly ahead of expectations due to pricing, offset somewhat by lower volumes and higher costs. It also had limited significant items and the Capex was on plan. Interestingly enough, even with the significant acquisitions in the first quarter and the CapEx related to that, the business was self-sustaining from a cash flow standpoint in the first half of the year.

Marketing training loss significantly smaller than the last quarter was -- and was in -- was primarily influenced by losses on our hedge-related option portfolio and also on the tolling contract and then the power, of course, is significantly impacted on these items, these charges. Operating cash flow, which is page 9, something that we pay a lot of attention to. We know investors pay a lot of attention to. The cash generated in a period from our operations and this is before working capital changes, was consistent with our expectations and slightly ahead of our cash generated in the same period in 2004. The working capital use this year is large and requires some discussion. I have more detail in the next page and will talk about the specifics there. And, of course, our cash from asset sales, we look at how much of the cash from …