Remarks to Analysts by Rick Priory

Duke Energy Annual Analyst Conference
May 30, 2003
Rick Priory
Chairman and CEO
Duke Energy

Good morning.

It’s fitting that we’ve gathered this year in Charlotte, where our roots are deepest. Those roots have steadied and sustained us during the past 18 months. We’ve held on fiercely to our tradition of integrity, operating excellence and financial discipline. You’re going to hear a lot about our tenacity today—and the deliberate steps we’re taking to ensure a healthy future.

Duke Energy has a proud past. But it’s not the glory days that I’ve been reflecting on lately. Instead, I’ve been thinking about all of the tough times we’ve endured—and the resolve and resilience that keeps us going. So I’m going to begin by providing a bit of history that is relevant today—and that demonstrates the character of our company.

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While it may be hard to conceive from where we sit right now—Duke Energy has actually lived through far more challenging periods than what we face today! History’s a stern teacher—but it’s an effective one, so let me share some hard knocks and good lessons that are guiding us today.

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In the early 1970s, Duke Power was confronted with exorbitant coal prices and reduced supply, thanks to the newly enacted Clean Air Act. At one point, we had only a 23-day supply of coal. We enjoyed no fuel clause protection, and regulatory lag prevented us from recovering our costs. The country as a whole was dealing with double-digit inflation, economic recession, and the Arab oil embargo.

Obligated by law to anticipate and meet the electric power needs of our fast-growing service area, we had a massive construction program underway. Yet the cost of borrowing had risen dramatically. Duke’s common stock was selling well below book value, and we had to act quickly to hold on to our single A bond rating.

The combination of high capital costs, a large construction program and the inability to manage fuel cost risk caused earnings to fall and our credit ratings to drop. And, the market for electric utility first mortgage bonds literally dried up for bonds rated below AA.

Sounds eerily familiar, doesn’t it?

We weren’t alone. The 1974-75 recession and stock market decline were widely considered to be the worst since the 1930s. Former Treasury Secretary Robert Rubin commented on that bleak chapter of economic history and concluded: “Success meant that you managed extremely difficult forces effectively enough to…come out at the other end.”

I don’t think I overstate the case when I say our company’s financial condition in the early to mid-70s was critical. At one point we were worried about meeting our payroll and paying our vendors. Now that’s critical! We struggled, along with the rest of the electric utility industry, to keep our company from falling too deep into financial peril.

Those who’ve been in that position know that there are two cardinal rules. Rule number one: When you’re in a hole, stop digging! And rule number two: Never run out of cash! We took those rules to heart—and we took a number of bold and innovative steps to emerge:

We dramatically revised our construction schedule, delaying and ultimately canceling large nuclear projects. We radically cut operating costs. And as an emergency measure to raise cash, we instituted a sale/leaseback of all of our combustion turbines, our two office buildings in downtown Charlotte, our computers, and two million pounds of nuclear fuel.

We sold a majority of our Catawba Nuclear Station to a group of municipalities and electric cooperatives, which proved to be a win-win approach all the way around.

The sale was an unorthodox move at the time, but one that protected the long-term interests of our customers, shareholders and company. The municipalities and co-ops had approached us for years with their desire to invest in power generation—and we were able to take advantage of their more cost-effective financing alternatives.

After several delays, we cancelled our Cherokee and Perkins nuclear projects. Fortunately, we were able to recover through rates a large portion of our investment—over a 10-year time frame. At the time, we took tremendous heat from the North Carolina Attorney General, who was targeting utilities as he prepared for a gubernatorial bid. But the cancellation turned out to be one of the most astute moves we made. Power companies that failed to “stop digging” didn’t fare nearly as well as Duke did. (And by the way, the Attorney General lost his race for governor!) Our capital requirements fell off dramatically and we began to see the financial daylight.

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Looking back on this perilous and pivotal time in our company’s history, my predecessor, former Chairman Bill Grigg tells the story of going home one evening and telling his wife: “I don’t think we’re going to make it.” Margaret Anne said, “Come on, let’s take a walk around the block.”

They walked, and when they got back, Bill shook his head and said, “I still don’t think we’re going to make it.” So they walked around the block again…and again…and again.

Thanks to the encouragement of a loving wife, Bill got a healthy dose of exercise and mental clarity during that year! And thanks to the concerted, disciplined focus of our company, Duke Energy did emerge from the dark hole of the ‘70s—better, stronger and wiser.

The moral of the story is that Duke Energy has been around this block before. We’ve managed through cycles and events that challenged both our business sense and our spirit. We have deep reserves of managerial and financial fortitude. We have a strong defense to play when times are tough—and an outstanding offense that can seize the opportunities of an upturn.

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Let’s move from the ‘70s to the ‘90s, when the gas side of our business went through its own challenging times. In 1992, the FERC issued Order 636, mandating the unbundling of merchant service—and creating a sea change for the former PanEnergy Corporation. Overnight, the company moved from being a seller of natural gas to a transporter. It was required to dramatically restructure its business and services in very short order.

As you would expect, we responded dutifully to the FERC mandate, and Pan Energy interstate pipelines were among the first major U.S. pipelines to operate under the new order. The company moved quickly to develop marketing capabilities for transportation services to improve its competitive position. Looking back—and compared to the power side of the house—restructuring of the natural gas industry went smooth as glass!

But any major regulatory change is bound to create other issues while the industry recalibrates. Restructuring and unbundling of the gas industry brought with it customer, liquidity, and credit issues. A prime example: Prior to Order 636, Texas Eastern served the CNG and Columbia pipelines, which were regional pipelines serving Ohio and western Pennsylvania—and, at the time, two of our five top customers. But heavy competition and an abundance of capacity in western Pennsylvania and Ohio led those key customers to turn back Texas Eastern’s capacity. So we were left with the costs associated with the capacity—but not the customers! The hit to EBIT would have been substantial—in the range of $60-90 million a year.

The company obviously had some tough choices to make. We had to figure out what to do with Texas Eastern’s “turned back” capacity. We could stay in that market and compete, and assume a discount of about 60 cents on the dollar. But as you get to know Fred Fowler, Bobby Evans, Tom O’Connor and the other veterans in our Gas Transmission business, you’ll understand why that that notion was quickly abandoned.

We opted for a longer, sustainable view. Utilizing the turnback capacity as the starting point, we built additional capacity to increase service to our strong customer base in eastern Pennsylvania, New Jersey, New York and New England. And we worked hard to understand and satisfy customers’ changing needs and expectations. Price was no longer the sole factor, so we expanded our portfolio of services and focused on relationships and reliability. We were successful, and today Texas Eastern continues to be fully contracted.

In the ‘90s, we also took a long, hard look at what markets we wanted to be in long-term. Exiting the Midwest through the sale of the Panhandle Eastern and Trunkline pipelines was a gut-wrenching decision. Those businesses represented the foundation and core fundamentals of PanEnergy, and we had invested lots of sweat and emotion.

But redeploying the cash long-term was absolutely the right move. We moved into the faster growing eastern markets with our Maritimes & Northeast pipeline, and with our East Tennessee system. We also expanded our storage capacity, and just last year gained long-term access to rich Canadian supply basins with the purchase of Westcoast Energy.

The early ‘90s were enormously challenging and redefining to the natural gas industry. A number of pipeline companies weren’t able to see their way through the newly configured regulatory and competitive environment. We did—by applying the same diligence, discipline and gritty determination that is helping us make our way around the block today.

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As we approach our 100-year mark, there are many more hard-fought lessons I could point to—lessons that are engrained in our culture and our strategy. Duke Energy is a survivor—in the truest, non-reality TV sense of the word! Our staying power is fueled by strong corporate character, a proven business model and solid financial fundamentals. When market and economic indicators are weak—those are the strengths that pull us through, time and time again.

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I’ve provided some historic context that speaks to Duke Energy’s longevity. The rest of the day you’re going to hear from Fred Fowler and our roster of leaders—many of whom are new in their positions—about the concrete steps we’re taking going forward.

You’ll hear about a trio of recently announced steps that further move us in the right direction.

Earlier this morning, we announced the sale of approximately one-third of Gulfstream’s capacity to Florida Power & Light, via a 23-year agreement. Terms of the agreement are for 350 million cubic feet per day of firm service to their Martin and Manatee power plant expansions, beginning in 2005. This contract will bring Gulfstream’s subscribed capacity to approximately 65 percent. Tom O’Connor will brief you further on the details of this very positive agreement.

Second—we continue to focus on containing and enveloping the volatility of our merchant business. To that end, we have implemented new stress matrices at DENA that better quantify our exposure to gas and power price moves. Rob Ladd and Rich Osborne will delve deeper into the results of our rigorous testing.

And finally, we continue to strengthen the financial position of Duke Energy and Duke Capital Corporation. This week, Duke Energy invested another $250 million in Duke Capital, with the intent of calling $250 million of trust preferred securities. David Hauser will cover the specifics, but this is yet another move that bolsters our financial strength.

You’ll hear each of these moves addressed in detail today, but I wanted to point to them collectively as demonstration that we are making excellent progress across the businesses—in long-term customer contracts and earnings growth, in our financial strength and flexibility, and in our management of risk and volatility in the merchant sector.

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You’ve seen our six strategic directives before—and you’ll see them often over the coming months. These six directives set the course for our near-term actions. We’re using them to monitor and report on our progress—so they have become a familiar drumbeat across the company.

While these directives are intended to see us through the immediate challenges, we have not lost sight of the long-term. None of our near-term actions compromise our long-term strategy. Quite the contrary. Our near-term measures are focused on preserving a strong and lasting competitive position.

Duke Energy wasn’t born of the recent boom days—and we won’t perish in the down cycle. We take a long view of value creation, and you see that long view reflected in recent decisions.

Our leadership changes are a case in point. These changes reflect the shift from a rapidly expanding business to one that has entered a period of rationalization—where tight cost controls and discipline are called for—and that calls for a different style of leader.

Fred Fowler’s role as president and chief operating officer is designed to provide the high-level focus on operational and financial results that is so critical today.

No matter what the business cycle, some things about our leadership will never change. All of the new leaders you’ll be introduced to today exemplify the evergreen values that we expect and cultivate throughout our company. They share our commitment to ethical behavior and honesty in all we do. They would not be in their jobs if they did not.

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You can also see our long view with the asset sales we’ve announced this year, in our public offering of convertibles, and in our exit from the merchant financing and proprietary trading businesses. All are very purposeful, positive steps designed to build long-term value for our investors.

We are pleased that the business model we engineered six years ago has withstood the shock and awe that energy markets threw at us over the last couple of years. We didn’t adopt the popular plan of the month. We didn’t stray from our core strengths and knowledge base. We didn’t finance our model with stealth-like leverage through special purpose vehicles.

We focused on building value, managing risk and serving customers. We crafted a business model based on balance and diversification—of business lines, commodities, fuel types and geography. We took a long-term view of value creation—recognizing and preparing for the inherent volatility in the energy industry. And our strategy and execution adhered—always—to the highest standards of integrity.

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Tough times are tough to live through, but every time we go around this block, we gain strength, perspective and resourcefulness. Experience has taught us to avoid the potholes of a bear market and a troubled sector. We’ve certainly felt the bumps, but we’re steering clear and moving forward.

It’s beginning to feel like we’ve rounded the toughest curves. We’ve taken a number of decisive steps to protect our financial position and ensure that we’re positioned for growth. We had a good first quarter and are seeing some promising indicators. A large part of our company has been discounted, so right now investors are essentially enjoying a six percent yield to wait out the market cycle. We believe—and I hope you do as well—that Duke Energy is on our final lap around this block!

Thank you again for being with us today. I’ll be back with you this afternoon, and Fred and I will take your questions then. Now let me turn things over to Robert Brace, who will bring you up to date on the company’s key financial initiatives.