Updated from 11:31 a.m. EST
With his time running out as
CEO,Richard Priory offered his finalconfession on Thursday.
Duke, which missed third-quarter earningsestimates, will not meet the 2003 earnings guidancecritics have questioned for some time. In one of hisfinal acts as Duke's CEO, Priory officially shavedfull-year earnings guidance -- already expected tocome in at the low end of a previous range of $1.35 to$1.60 a share -- to between $1.20 and $1.25 a share.
Prior to that reduction, Wall Street had beenexpecting full-year profits of $1.34 a share. Butsome, including
portrayed Duke's guidance asaggressive almost
since the beginning of theyear.
Specifically, critics have questioned Duke'sability to generate $200 million in pretax profitsfrom its troubled merchant division. Duke's"make-or-break" third quarter, which actually pushedthe merchant Duke Energy North America division deepinto the hole, removed any lingering hope that thecompany could meet its lofty goals.
In a conference call Thursday with analysts, Duke CFO Robert Brace -- expected by many to follow Priory out the door -- acknowledged that DENA's 2003 profit goals are "now well out of reach." Even excluding special items, which hammered the division in the latest quarter, Duke believes DENA will end the year $70 million in the red.
"You were expecting, I think, to see a great quarter from us," said Priory, who will be replaced Monday by
popular turnaround CEO PaulAnderson. But "we didn't get where we had hoped to be."
Duke shares nevertheless inched up 12 cents to $17.82 in late-morning trading.
Counting extraordinary items totaling 30 cents, Duke mustered a third-quarter profit of just 5 cents a share, down more than 80% from the same periodlast year. Even excluding the special charges -- including DENA write-offs, severance costs, asset sale losses and regulatory settlements -- the companyposted a 35-cent profit that was still 31% lower than a year ago.
Before Thursday's update, Wall Street had expected Duke to deliver ongoing earnings of 36 cents a share this quarter and 23 cents a share in the next. But Duke's fresh guidance implies that the company will make as little as 12 cents a share -- roughly half of current estimates -- in the final period.
DENA was the biggest culprit by far in the third-quarterdownturn. During the latest period, the division sawits losses nearly quadruple from a year ago. Themerchant operation posted negative earnings beforeinterest and taxes, or EBIT, of $411 million comparedto an EBIT loss of $107 million for the same time lastyear. Although a $254 million goodwill impairmentcertainly hurt results, the company admitted that"mild weather, high natural gas prices and low sparkspreads in many parts of the nation combined toseverely impact DENA's earnings."
So far this year, DENA has lost $177 million --compared to positive EBIT of $143 million in the firstnine months of 2002 -- rendering the division's hopesfor full-year profitability all but impossible. In fact, one analyst on Thursday suggested that DENA could still deliver fresh downside surprises this year. Specifically, he pointed out that the special charges that hurt third-quarter results are simply expected to disappear in the final period of the year.
"What makes you ... comfortable in achieving that?" he asked.
But unlike Duke's last earnings call -- considered a disaster by many -- Thursday's session sparked few tempers with Priory back to replace his subordinates at the microphone. The most contentious moment came when one analyst questioned the safety of Duke's generous dividend.
"This is a terrible position to put me in," Priory snapped, saying that his replacement would need to study the issue for a couple of months.
Priory acknowledged that he himself has been a strong supporter of the dividend. But he also cited recent comments from Anderson hinting that the dividend might be safe.
"If you think that's leaning toward cutting the dividend ... I would tend to lean the other way," Priory concluded.
For the most part, the same analysts who last quarter hammered Brace about Duke's guidance politely welcomed Priory back for his last conference call. And Priory, who once tried out for a spot on the New York Mets baseball team, began by confessing that he had mixed feelings about retiring from "another wonderful game."
"I am immensely proud to have worn the Duke Energy jersey for 28 years," Priory said. "Duke Energy is a great company. ... I am looking forward to watching its comeback season."
But clearly, Duke has a tough schedule ahead.
Overall, Duke's third-quarter EBIT fell 47% to$352 million from $666 million a year ago. Even someof the company's strongest divisions showed signs ofweakness.
Franchised Electric, which ranks as the company'slargest division, saw EBIT spiral 24% to $436 millionduring the quarter. The company blamed much of theslump on unfavorable weather and the sluggish economyin its stronghold of North and South Carolina. But thedivision was also hit by a series of charges,including a $30 million payment in South Carolina thathelped offset the company's excess earnings thereearlier this year.
Despite questions, Duke defended the charge -- stemming from a temporary rate cut in South Carolina -- as nonrecurring in nature. Priory said the 12-month rate cut came after Duke enjoyed "wonderful blips" in power profits a few quarters back. In essence, he called it a "nonrecurring story."
But RBC Capital analyst Maureen Howe was not convinced.
"I'm still challenged to see why it's a nonrecurring item," she said, adding that the "positive blips" that lifted past results would have to be considered nonrecurring as well.
Duke also reported a slip in profits at its other big division. Duke Energy Gas Transmission saw third-quarter EBIT fall $8 million to $280 million due primarily to severance costs.
Duke's smaller divisions fared better. Duke EnergyInternational posted third-quarter profits of $44million that reversed a year-ago loss of $41 million,which arose after the company took $91 million worthof charges. Field Services grew EBIT to $53 million,more than doubling the $23 million reported last year,due to higher prices for natural gas, the absence ofyear-ago charges and lower administrative expenses.
But Duke's "other" division failed to pull itsnormal weight. There, third-quarter EBIT tumbled 30%to $21 million due to fewer power plant completions byits old Duke/Fluor Daniel partnership. All told, thedivision has generated EBIT of only $13 million thisyear -- compared to $175 million in the first ninemonths of 2002 -- despite improved results from itsCrescent Resources real estate division.
Given the downturn across many of its segments --particularly DENA -- Duke has pledged to aggressivelycut costs going forward.
Taking a Stand
Anderson, who last steered the world's largestresources company back to profitability, is known fortaking painful actions in order to get a company backon its feet.
But some of those tough decisions -- particularlyemployee layoffs -- are already in the works. Asexpected, Duke announced Thursday that it would becutting more staff and expenses than previouslyplanned. The company now intends to trim its workforceby 8%, or 2,000 jobs. It has also pledged to slashcosts by more than $200 million annually -- twiceits original goal -- beginning next year.
In one of his final statements to the investment community, Priory acknowledged that future pain is inevitable.
"The best medicine isn't supposed to taste good," he said. "It's supposed to make you get better. ...
Duke will adhere to a regimen of bitter medicine and tough decisions for as long as it takes."
Ironically, Priory's own exit is viewed by some as Duke's most significant step toward future recovery.
"With pending management changes, look for a thorough round of house cleaning in Q403," Credit Suisse First Boston analyst Dan Eggers wrote Thursday. "New CEO Paul Anderson starts on Monday, and will begin the process of getting Duke back on track."