美國電力 (AEP) 2002 Q2 法說會逐字稿

Ladies and gentlemen, thank-you for standing by and welcome to the American Electric Power second-quarter earnings conference call. At this time, all participants are in a listen-only mode and later we will conduct a question-and-answer session with instructioning to be given at that time. If anyone should require assistance during the conference, please press O and then star. As a reminder, this conference is being recorded. I would now like to turn the conference over to our host, Treasurer of American Electric Power, Mr. Armando Pena. Please go ahead.

Thank-you, good morning to you all.

Before we get started in the earnings release and in this call today we are discussing issues that may contain forward-looking statements and estimates that are subject to risk and uncertainty. Please refer to our most recent 10-K and 10-Q filings for list the factors that may cause results to different from management's projections, forecast, estimates, and expectations.

There are several people in the room with us today, but I am going to turn over the proceedings to Linn Draper, Chairman and CEO of the company who will chair this call.

Thanks, Armando, and good morning to you all.

Today, we are going to discuss with you our performance in the second quarter and our expectations for the balance of the year. We are still working our guidance for 2003, and we should have that to you in about a month.

Tom Shockley, our Vice Chairman; Susan Tomasky, our CFO, Armando, our Treasurer; Eric van der Walde, who runs our Wholesale Business and Joe [INAUDIBLE] our Controller and I will be available to respond to your questions and we also have others here who will help with specifics.

Ongoing earnings for second quarter were 56 cents per share. It's a disappointing result, a 33 cent per share drop compared to the second quarter of last year. The 33-cent decline is a result of a 43 cent reduction in earnings from the wholesale business offset by in part by a 5 cent improvement in the energy delivery business and a 5 cent reduction in capital costs and other items.

Year to date, we are reporting ongoing earnings of $1.15 compared to $1.59 for last year. The decline is principally from a 47-cent drop in the wholesale business, which was offset by improvements in energy delivery of 3 cents a share and capital costs and other items of 5 cents a share.

Other investments fell 5 cents from last year, attributable to losses to CitiPower which we originally have arranged to sell. Going back to ongoing results for second quarter, the 33-cent drop from last year is due to a decline in system sales of 7 cents, trading and marketing of 20 cents, and the performance of new investments of 6 cents.

You'll note that the O&M expenses have increase for the first half of the year compared to last year, but we expect this is timing and by year-end we will see flat O&M year-to-year.

I know that many of you were surprised with the change in our earning guidance last week. Events in June surprised us as well, but we think our strategy is sound.

We are more focused than ever on our balanced business model, a strong asset base, and a robust trading and marketing organization. The principle factor for the decline in June and a fundamental reason for changing our guidance is a drop in the core power price curb that occurred in June.

In May, we re-evaluated prices and confirmed guidance prior to our equity offering. Unfortunately, we saw a significant decrease in June. As a result of lower anticipated prices, we lowered our expectation for system sales.

Regarding our trading business, we had mixed results in the second quarter. As you can see, on the power side, we performed well. Our gross margin for the quarter was $86 million, an improvement of $9 million over last year. This includes $19.7 million dollar from coal trading.

On our last call, Eric reviewed with you the first-quarter losses in gas trading. These losses carried over into April and affected this quarter. Gas trading was profitable in May and June.

Overall, trading contributed $66 million dollars in the second quarter. Not withstanding the gas problem, we made money in a very difficult market.

The gas experience in March and April was an anomaly. We took definitive action and have seen the positive results.

Based on performance to date, we expect a significant contribution from gas, coal, and power trading and marketing in the second half of the year. We believe that our wholesale business before new investment will contribute $375 million in gross margin for the remainder of the year. This represents a decrease of about 20 cents per share from the original forecast.

Another factor affecting the quarter, the performance of new investments, should not impact the full year results. Year-to-date, new investments contributed 3 cents a share. We expect they will contribute about 25 cents for the full year.

Specifically, UK generation at Fiddler's Ferry and Ferry's Bridge is expected to contribute 6 cents a share this year. Further declines in UK power prices prevented us from capturing the premium associated with sales into the balancing market during this quarter, but historically, prices have improved in the winter heating season, and we have sufficient room under the SO2 cap.

We expect to run the plants hard in the winter. We expect the plants to achieve their planned contribution for the year. We expect additional improvements in our coal, barge, and IPP businesses over the balance of the year.

In the second half, Houston Pipeline should experience higher volumes delivered under existing contracts. At Quaker Cole, we expect significant improvement in operations resulting from recent changes. Further we expect coal prices to improve. Our barge business MEMCO has performed well and we expect that to continue through the grain season.

The result of lower second-quarter earnings and 20-cent reduction to system sales for second half means our guidance for 2002 is in the range of $3.20 to $3.35 for the year. Although second-quarter results were disappointing, good things did happen, our regulated businesses performed well, energy delivery contributed 58 cents a share compared to 53 cents in the second quarter of 2001. After corporate separation, these core business also continue to contribute roughly 60% of our earnings.

The improvement for this year came from effective cost management and a stable regulatory environment, and we expect this to continue. We strengthen the balance sheet as we had promised. We sold a billion dollars of equity and two noncore investments, Seaboard and Citipower that will result in $2.9 billion in debt reduction.

Let me tell but those two sales of Seaboard and Citipower. The transactions are valued at about $2.9 billion. The net cash proceeds of $1.5 billion will be used to repay short-term debt and establish a liquidity reserve of $300 million.

The balance of $1.75 billion will be a reduction of debt in our balance sheet that is assumed by the buyers. Therefore, the asset sales will reduce the company debt by $2.9 billion, and this will be reflected in the third quarter.

The Seaboard transaction is expected to close on Monday July 29th and Citipower should close on August 30th. Associated with these asset sales is a loss of $518 million, reflected in the reporting earnings.

A portion of the loss was reported in the first quarter as a change in accounting method due to our June 30th adoption of FASB 142. Pro forma after these transactions should be approximately 15% debt and 44% equity, an improvement from the 63% debt at the end of the second quarter. This is consistent with our commitment to maintain a high triple B rating.

We also pay close attention to liquidity. It is an important factor supporting our credit quality. The company has $5.5 billion in available lines of credit, available credit of $2.5 billion remains unused. In addition, we have $300 million funded cash liquidity reserve.

The additional cash proceeds from the sales I just mentioned will increase available liquidity to about $3.5 billion. We are confident this is adequate to meet our needs and to capture opportunities as they arise.

Yesterday, our board declared that 369 consecutive quarterly dividend. At the current rate of 6 cents a share for the quarter and $2.40 for the year.

As I reflect on the continuing turmoil in our sector of the economy, I am disappointed over the loss of value in AEP stock. That loss of value is out proportion to our earnings results and certainly not reflective of our future. Ours is a good business. AEP is a strong company built on assets. We have a strong balance sheet and able people. We like our business. It provides an essential service to mankind. It's real. Energy is essential to our lives, to our economy, and to our well being.

We like our job because it is about supplying a fundamental requirement of modern living because it is honorable and because it is for the long term. I believe our business model should be supported by good assets. We will continue to look for opportunities to enhance the asset base.

We will pay special attention to ensuring an adequate return on the capital we invest. I also believe that we need a competitive advantage in the marketplace through commercial acumen provided by smart people and systems that enhance the value of our assets and we have that advantage. The value of trading and marketing has come into question by many, but we will not overreact. At issue is the risk reward it provides.

We will talk specifically about growth when we give you our guidance for 2003. I would emphasize that we have always talked about growth as something that occurs over time. This is not the environment in which we expect very aggressive growth. We expect there will be some investment opportunities in this market. We think our balance sheet, credit, and financial stability give us an advantage in pursuing these options.

But in the turmoil of the current market, our priority is to protect the strong foundation we have built. We will pursue growth opportunities reasonably with all these factors in mind. At this point, we can deliver earnings of $3.20 to $3.35 for 2002. We will work very hard on the upper end of the range and we will be ready to take cautious advantage of opportunities.

At this point, operator, I think we are ready to open the call for questions.

Thank-you. Ladies and gentlemen, if you do wish to ask a question, please press one on your touch-tone phone. You will hear a tone indicating you have been placed in queue, and you may remove yourself from queue at any time by repressing the pound key. If your using a speakerphone, please pick up your handset before pressing any numbers. Again, ladies and gentlemen, if you do have a question, please press one at this time. One moment please for our first question. We have a question from the line of Raymond Niles with Salomon Smith Barney.

Good morning, I have two questions. First is just asking about the gas trades that you undertook in the first quarter and I am glad to see that it has turned profitable in May and June. How did your position compare with bar limits or maybe you can comment overall in terms of the performance of the trading operation versus borrow limits year to date.

Let me ask Eric van der Walde to comment on that.

We were within our borrow limits, I believe, for the entire quarter, again, as we spoke before. Our bar limits, our position limits are based upon the totality of our portfolio, coal, gas, power, and some other things. We were within the bar limits. In general I think we had a good performance in trading as Linn said, we made $66 million in a very difficult quarter. We did well in power. We did very well in coal. We are still not pleased with the results in gas, but overall net, it was a solid quarter.

Second question, just if you can comment on European performance in general. Maybe on the continent, how -- how much have you gotten ramped up over there and what's your outlook in that area?

The continent continues to be difficult. You know, one of the -- one of the primary things that have occurred over the past couple of years is it has been a continued consolidation of electric generation in the hands of a few big players in continental Europe. An area we are paying a lot of attention to in terms of our strategy and size of our business going forward. We have done -- we did a couple of things in the second quarter that we think will lead us to enhanced profitability there, but obviously that's something that we are keeping a very close watch on.

And if I can just get one more real quick question. On the curve shift that you mentioned in June, and I think the curve, you know, did decline throughout the second quarter, but did that affect market-to-market profitability on the book or --

Where are you talking about right now?

The curve shift in the U.S..

In the U.S.?

Yeah, I'm sorry. Did that affect -- was there a market-to-market change in profitability one way or the other as a result of the curve shift?

Well, sure, to the extent there is open positions in various commodities as they occur, you have market-to-market shifts as well.

Okay, great, thank-you.

We do have a question from the line of Greg Gordon from Goldman Sachs. Please go ahead.

Couple of questions. First, you spoke about the 369th consecutive dividend authorized by the board, but you didn't speak to the management's opinion as to whether they feel that the current dividend payout is both appropriate and sustainable over the -- over the intermediate term, so can you or can you not say that you will continue to recommend to the board the current dividend payment for the foreseeable future. Second, as you rein in your horns on the asset growth strategy in the short to immediate term, is it fair to say that vis-a-vis growth expectations the billion dollars of acquisitions that you hope to pursue this year are not -- are not now in the company's plans?

With respect to the dividend, we can't say indefinitely what we will recommend, but we certainly don't see anything in the foreseeable future to not to recommend the continuation of the dividend. With respect to investment opportunities, we will have to see what they are, as I attempted to indicate in my opening statement. We think this is a time when there will be some opportunities. If they are attractive, we will take advantage of them. We will be cautious given the difficult environment in which we now find ourselves, but we certainly won't pass up opportunities that are both strategic and attractively-priced.

Just to reiterate, Linn as you see the corporate financial outlook today, you don't see a reason to be concerned about the current dividend policy of the company?

That's right

Thank-you

We do have a question from the line of Tim Fellow with George Rites and Associates. Please go ahead.

Hi, actually it's Brad Donovan. Can you describe the percentage reduction in the forwards in the U.S. between the time of the offering and the end of June? Can you also elaborate on the relationship between the drop in forwards and the reduction in system sales?

Sure, I can give you some -- one of the primary -- this is Eric van der Walde. One of the primary -- in early May, synergy, July, August forward prices were in the low 50s. By the time we got to the second week of June, those prices were in the high to mid-30s. So that's a pretty substantial drop over a fairly short period of time.

Okay.

In -- well, yeah. So you had a comparable, if not larger drop in [INAUDIBLE ] although that is not significant to AEP given the fairly balanced nature of our generation and our load down there. The bulk -- the bulk of the effect is as a result of midwest prices dropping.

Can you talk about how that leads to a reduction in system sales?

I'm sorry, you mean the mechanics or what the numbers are?

Well --.

Well, the -- what the specific numbers are or mechanics? We use the forward prices in the markets, applied to what our forecasters of the excess generation by month to determine what our system sales forecast is going to be. When you take a drop like that, that's a significant -- that has a significant impact on that system sales forecast.

Okay.

We had a similar drop September through -- and in the fourth quarter, although not -- the prices were lower to start with so the percentage drops were not as large, but we saw September move from the high 20s to the low -- low to mid-20s and saw the fourth quarter move from the $27, $28 range to the $23 to $24 range on peak.

Is it possible to get a $1 megawatt change in forwards implies an X percent change in earnings?

Uh ....

Depends on when because volume --.

Yeah, I mean I think that we could try to come up with a metric for you on that, but we got different volumes for different times of the year.

Okay. Last question is --

Overall it represents a 20-cent decline.

Say that again?

We did say that overall it represents a 20-cent decline in our forecast.

Okay. 20-cent share.

Yes.

Lastly, when do you expect to give some more color on '03 guidance.

We will do that in about a month.

Okay. Thanks very much.

We do have a question from the line of Andrea Feinstein with Angelo Gordon. Please go ahead.

Hi, I want to clarify one thing and then I have another follow-up question. With regard to the potential billion dollars of annual investment you have talked about in the past and current range of earnings guidance, should I still be thinking as I had -- you had gotten the pass at the higher end of that range is indicative of successfully completing or announcing some of that billion dollars of asset acquisitions or is that out the picture now?

No. You should not assume that. Those -- that range has to do with the variabilities that we are at least capable of anticipating now with respect to prices, performance on O&M and our expectations with respect to the new investments.

Great, the other question was for Eric. Eric, I want to understand a little bit better what you were saying about your expectations in the UK for the winter months. Given the size of Triple F, if you run those plants much harder than you had expected to and much harder than they had been turned on in the past, wouldn't you expect that to some extent limit the upside that you normally see in prices in that season? I mean, the added capacity to the market is going to have some kind of effect on the normal flow of pricing.

Yes. Certainly to the extent we run harder and put more energy out into the market, there will be some depressive effect there. I think we have accounted for that in our forecast.

Okay, great. Thank-you.

We do have a question from the line of Paul Ridzon from McDonald's Investment. Please go ahead.

As you look out towards your billion annual Cap-X budget for acquisitions, are you still thinking about maybe moving across the value chain as we have seen you do in the past with MEMCO and Quaker?

Yes, our investment strategy relative to the wholesale business has not changed in terms of the type of assets that we think will make sense.

And could you give an update on how much of this $66 million at trading was realized in cash.

Joe?

Approximately $40 million of it so was unrealized during the period.

Thank-you.

We do have a question from the line of David Reynolds with Morgan Stanley. Please go ahead.

Yes, good morning, everyone. Could you just give us a quick update on where you stand with the cash flows, operating cash flow and your maintenance Cap-X numbers for this year and next?

Talk about operating cash flows.

Yeah. The operating cash flows during the quarter were affected by increasing working capital demands from the operations UK, MEMCO, for example. It was also affected by net increases in trading receivables, increases in gas and balances, and margin deposits. In addition to those operating factors, we also did not continue to sell receivables in certain of our operating units, and that -- that has an impact in -- that had a negative impact on our operating cash flows. With -- with those increasing demands, we still have an estimate at this point preliminarily that we generated approximately 185 million dollars in cash flows from operations during the second quarter.

Can you give me those -- can you give me just what your rough estimates are for those -- for operating cash and maintenance Cap-X for the full year 2002 and 2003?

We don't have those at this point. -- up dated to reflect the current quarter's cash analysis.

Okay, thank-you.

What I can say, David. This is Armando, that we are running under budget on Cap-X to date, about $100 million.

Okay. Thank-you.

We do have a question with the line of Ryan Collins with Ohio Teachers.

Actually it's Terrell Armstrong. Given that the market is applying lower evaluations on merchant power assets in general, could you quantify the likely size of an impairment if you had to kind of mark-to-market, the 22,000 megawatt portfolio. And the second question, if you can quantify the end in the quarter in terms of a short-term debt balance?

I would think given the cost of our generation, there is certainly no impairment.

And the contractual -- underlying contractual commitment back to our regulated side.

Because the majority of it is under longer-term contracts.

Because it's -- well, it is also -- it's also very low book value to start with and low cost. I don't know whether there is an impairment there.

We see no basis for this.

You had another question?

The second question was, could you quantify where you ended the second quarter in terms of short-term debt balance?

Yes, we can. Just a second.

2.7 billion.

$2.7 billion? Thank-you.

A reduction from $4 billion at the end of the first quarter.

Correct.

We do have a question from the line of Margaret Jones with AB and M. Please go ahead.

Hi. Could you discuss the situation in Texas with regard to future impact on profitability there if the price to beat is not raised, and what -- how that plays into your contract to sell, I believe, 90% of their requirements to Centrica through 2004. And for that matter, could you outline a couple of the relevant things about how the arrangement with Centrica will impact ongoing profits in Texas.

Okay. I'll start and then ask Eric to follow up. First, when we reforecasted the guidance that we have -- the guidance that we have provided you does not assume the price increase that we have requested, and to which we believe we are entitled in the state of Texas. We are pursuing action through legal means in order to secure that, but we did not assume it for purposes of these numbers.

The second question we also have seen as you know doubt have observed a delay in the regulatory process around the Centrica proceeding. We don't believe in the eyes of the commission that the two are related. But I do think that it certainly will have effect on our numbers for the rest of the year. We have assumed that we won't see an approval of that this year, and as a consequence, we have adjusted our forecast to reflect the expectation that we will continue to serve the price-to-be customers at the current levels for the remainder of this year.

And in terms of -- in terms of the Texas commission action or inaction on our request to increase the price to beat, that is not -- we do not believe that puts our deal with Centrica in jeopardy given the way the contract is written between us and Centrica.

Should I follow-up off-line on some more specifics of the contract? I mean, whatever you are able to discuss about it?

Sure, if you would like to.

Might be better too.

Good, thank-you

We do have a question from the line of Steve Fleishman with Merrill Lynch. Please go ahead.

Hi, good morning.

Good morning, Steve.

Hi, Steve.

A couple of questions. First, with respect to the gas issue, it seems like you were hit -- hurt by gas prices across several of your businesses. And I guess I am just wondering when you say you are kind of within your bar, does that incorporate VaR into in the CP&L business in Texas and other areas in not only the quote, trading area.

The VaR we are referring to is in the trading books and trading portfolios. That VaR does not reflect the underlining generation and distribution side of the business.

Okay, but obviously it does seem you took risks there that didn't pan out. Is there a look at potentially broadening out the VaR?

I am not sure -- could you give me a little help on that?

I thought when you had previewed the earnings a week or so ago, that there was -- that there was some sure position on gas in Texas. Essentially, sure position on power related to the CP&L servicing the price to beat. Then also potentially in some of the -- the former CSW, IPP plants. Is that incorrect or --

In the first case -- in the first case, relative to CP&L, gas -- I don't think there is -- I don't believe that there's a negative effect there. And the second issue, there is an issue there with respect to the one specific project, and we made a decision not to hedge the gas exposure on that project primarily because we were in active negotiations to try to restructure that project and had we gotten that done, the gas hedge wouldn't have been appropriate. We didn't get that restructuring done, however, in the second quarter.

Steve, with respect to the -- the issue that I believe underlies your question, which is how do we monitor risk across the enterprise and other businesses and ought we to be integrating all gas-related risks into a single VaR. We haven't come that latter conclusion. What we have -- and VaR is such an important tool for managing and the risk with respect to the entire trading book. I would be a little -- my instinct is to be a little reluctant to attempt to manage the two together.

I will tell you they are deeply related however in there is value-added and we do have other systems in place for monitoring these other risks through our risk management structure. We monitor risks across other businesses. We meet regularly once a week to talk about what those other issues are and the interrelationship between what we know about gas prices and the effect it's having across the system. We just haven't taken that step that you have talked about.

Eric, do you want to -- or Linn.

The only thing I would add, the IPP is a small amount of money, a few million dollars.

It affected the quarter, but it's not -- other than its affect on the quarter it wasn't something that affected our guidance revision.

Okay. Just so I really understand on what happened at CP&L then. Is this a case where it was just a mild season. You didn't sell as much to your own customers there as a result. So -- so you end up having more excess generation in the low-priced market because of the low -- load. Is it just as simple as that?

I don't think that's quite it. We didn't sell as much to our own customers. The weather in the cities where we serve in Texas was somewhat cooler than average, not a huge amount. And the fact that our own plants did or didn't run is really almost a matter of indifference because we could either get it from our own plants or elsewhere.

Steve, let us take responsibility for confusing you a bit with that earlier press release. We had -- we knew we were in a position that we were going to revise guidance downward. We knew generally where it would go.

We put together some pieces of the puzzle that we saw at that time, which is a little bit of a decline in the quarter over retail over what we had with the guidance, the lower prices, lower heat rates in the region and came up with a view with respect to Texas that as we continue to do -- go forward was actually overwhelmed by the real issue, which is the consequence with respect to system sales, which is what what I think, Eric described later and it is really -- the issue across the quarter is not what for guidance. The look at the price curve and the effect we would see in future quarters --

In the east.

-- in the east, included in the east, that led us to the conclusion -- well, primarily in the east that has led us to this conclusion with respect to guidance.

Okay. That helps clarify some things. One other -- one other separate question with respect to this prior question has been asked on operating cash flow relative to kind of normal capital expenditures. While you don't have specific numbers there, maybe Armando or someone could give us some sense of just generally on a going-forward basis, if you are not -- if -- if you are not ending up spending the billion dollars on acquisitions, do you expect that your operating cash flow can cover your basic capital expenditure needs and the dividend?

I think we are going to be lower than we thought earlier in the year because of the downward revision on the earnings. I think will be a deficit in cash on that. We are working right now -- the reason we weren't more specific is we are working on the ongoing Cap-X that is necessary to maintain our system. We have seen, to date, we are running $100 million under. We intend to keep that and look forward to see if we cannot establish a better balance to get back to where we were earlier and doing just precisely what you said, which is make -- working toward the goal that the internal cash plus depreciation meets our ongoing Cap-X plus dividend.

Okay. I guess one other just quickie. I believe the -- the CFTC had requested some information from you on these wash trade issues.

Yes.

I think you had said you had only done a very, very minimal amount of these. Could you just update us on what their, why they would be looking for anything from you and what else -- are any other agencies looking for something?

The request that we got only pertained -- is the same request that we believe many, many others got, identically. And we have had had no further communication with them, so I know of -- at this point, we put this in the information-gathering, overall investigation category. We know of nothing, and nothing has been communicated to us around anything specific. And we -- other than the responses that we have given to FERC, and occasional fact-finding we get from other -- from other agencies, you know, what did you know about something that happened in a particular day that we infer is related to other investigations. We haven't heard anything else.

Okay, thank-you very much.

We do have a question from the line of Charles Fishman with A. G. Edwards.

Yes, this is Doug Fischer. Just a few questions here. Can you give a -- a little more color on the new '02 earnings range of 3.20 to I believe 3.35. I think you implied that it's power prices in the -- in the Midwest, and maybe activities in the UK plus O&M that provide that variability. Can you give us a little more color on whether you need to take some -- whether we need an upward move in the price curve and/or decreases in the O&M budget to achieve the mid or higher end of that range and how likely those things are?

I'll take the O&M and let Eric speak to prices, but basically the price curves are the price curves. And we didn't --

But it is true to say that if prices strengthened in the Midwest, that would push us --

Push us up to the higher end of the range. But with respect to the O&M, we have taken a close look. We have looked -- we have imbedded in the range some existing reductions. We will continue to look for others, but we don't require extraordinary action that we have identified and committed to in order to get to the high end of the range. How successful we are in additional cuts will, of course, push us to the high end.

So, at this point, would it be fair to say that the probability of distribution using today's price curve of achieving that range would be the highest probability would be around the midpoint?

Yeah.

Yes.

And then are you in Texas with regard to the price to beat, are you talking only about a delay? Or are you talking about concern without the courts helping you that you will not get a increase in the price to beat?

The latter. At this point, what the -- what we also believe that the law is quite clear. Essentially, what it's -- what has happened is the Texas commission has said that they don't believe that they are going to act. So we've gone to court to get them to act. Then they have to act, and we see what they come out with that point. And it's because of that many steps, that we have been reluctant to count on that money coming in the door, but we believe that it is clear and that we are entitled to it and we should get some big chunks of it sometime. But we are not embedding it into our numbers at this point

Okay. And then can you give us any color on your view into '03 for power prices in the east? Do we think we are going to continue to see the -- assuming normal weather, that we are going to continue to see the low prices we are seeing now? Or do you think we are going to see some rebound? Or is that going to be mitigated by further additions of capacity, et cetera.

I am not tremendously optimistic that there's a lot of upside to prices where they are right now. But having said that, the market has gotten thinner and gotten more volatile, and it is not inconceivable that prices could rise, and we will certainly take advantage of that if that is the case. But, I mean, look, we continue to have generation added. It is not a real bullish scenario for power prices.

How important is the current industrial demand level to this whole equation in a potential rebound there?

Clearly a rebound in industrial demand contributes to the higher end of the range. What we have seen in this quarter is a leveling off, but it is a leveling off at the low level that we experienced about 8.5% decline year to year, and we have not seen the kind of rebound by midyear that we would hope. We do expect some return to normality there. But we haven't seen it yet.

The half percent that Susan is talking about is the decline in industrial

Correct.

Finally with difficulties at Williams and Synergy, et cetera, are there any serious concerns that you have about their ability -- you know, is that having any material impact on your third-quarter expectations for trading and marketing?

Are you asking about our opinion relative to how much money --

Activities with them and difficulties that might result from that, how much of a concern do you have about that?

I don't have a concern about the credit exposure --

Nor do I. We have worked very hard on managing --.

Yeah, we don't -- I don't think we have an issue there. Obviously, the more parties that go away, the less liquidity there is in the market. That's always a concern. Having said that, both of these companies have not been in great financial shape for more -- for a while now, and I am not sure how much incremental affect there would there for their latest round of difficulties.

Okay, thank-you.

We do have a question from the line of rose Lynn Armstrong with ABC Capital.

It is actually Vidulla [INAUDIBLE]. Good morning.

Good morning Vidulla.

I think I got it, but can you once again kind of go over the items that constitute the -- you know basically the 40-cent reduction in the range? You said to shift into forward curve is about 20 cents. How would you allocate the remainder of the 40-cent shift?

It is basically the second-quarter performance.

I think specifically Vidulla, it is not recoverable because we are further reducing sales in the second half. The performance of new investments has turned around. That's not it. The balance is the performance of the trading and marketing all of which is not recoverable in the second half.

Okay. And I know that you also indicated a few things in terms of -- and I missed some of these numbers, in terms of if I Fiddler's Ferry and some of the other expectations and some of the other new businesses in the second half and how that compares to the original expectations.

We expect on a calendar year basis they will meet expectations. That's roughly 25 cents for the full year. And that's it.

Thank-you very much

We do have a question from the line of Peter Case with the CIBC World Markets. Please go ahead.

Thank-you very much. I wonder if we can return to liquidity in the dividend for a second. Are there any covenance, any rating triggers or anything like that that might impair your ability to pay that dividend in the future?

No.

Okay. Then with respect to your -- your generation portfolio, can you tell us what -- what percent is effectively contracted?

About 80.

It's in -- it's in the low 80s.

And then lastly, you talked about the investment strategy, the wholesale investment strategy being unchanged, any change in your investment strategy on the regulated side?

No. We have essentially said that the substantial new investment that we contemplate will be to strengthen our wholesale business and that has not changed.

Okay, thank-you.

We do have the question from the line of Terry Shoe with JP Morgan. Please go ahead.

I have a number of questions. If we can go back again to the earnings components. I apologize if I don't have your full release. I printed that off your -- the web site's release. If you look at, Eric, on the gross margin on energy sales and trading, et cetera. You give the retail and wholesale of 74 cents.

You are looking at the second quarter or year to date.

Year to date just to make it easier. I want not precise numbers of magnitude. As far as the wholesale, much of that I would assume is tied to your legacy assets. Just wholesale sales, both back to your own franchise area, as well as any kind of other assets and sales. Is that correct?

That's essentially what all of that is.

Okay. As far as structure transactions and such that may be more trading-oriented, is that in the power trading and marketing part? Where exactly is that part? You used to give different pie charts and different breakdowns. If we want to get a good fix as to what's asset-based tied to your own legacy assets and what's pure trading and marketing. What structure transaction. And we look at those gross margin numbers that you give, is there some way to sort it out? Or is it hard to sort it out?

Well, basically, the retail and the wholesale is what you described.

Right.

The -- from this, you will not be able to get the number you want, but we do have that --

Right.

-- that data for you. All of those transactions, including the structure and origination are showing those numbers. Eric, do you have that?

That's right. The wholesale line is system sales off of our generation. The trading and marketing transactions all show up in the power trading and marketing and gas trading and marketing lines and we have the breakdown amongst those things. It is a lot of numbers. I am not sure --.

Okay, now I just really want to get a fix. Like, what proportion roughly are structure transactions. And what proportion of earnings really are derived from your legacy assets. Is it fair to say more than 80% or about 80% comes from your legacy assets? Is that a good enough number?

You are trying to --

I am not sure I understanding.

Meaning the wholesale sales, by your assets. Not trading activities per se, getting margins off that.

I am going to ask Joe who has some numbers that may be relevant. By won't take. If those don't satisfy you, we will take it offline.

I will try to talk in terms of the pie charts you refer to. That kind of information that we have passed along historically. For the quarter, we had a very small number associated with structures -- structured transactions, about $2 million contribution for the quarter from structured transactions. About $38 million from risk management or proprietary trading activities and approximately $128 million from off-system sales.

If you look at your full-year expectation, the low 2, $3 area, do you expect more structured transactions, risk management type. Should we assume that the proportion stays roughly the same?

No, I think the proportion in terms of what we did in terms of origination in the second quarter is low. I think -- I expect looking at the pipeline out there that will increase significantly and increase as a percentage very significantly.

Okay. If we could go back to the balance sheet issue. I have some of my own forecasts, and I assume now with the weaker results, you'll just about make or generate a bit short. Armando, am I right? A bit short of your Cap-X plan that you had given as 1.8 billion dollars.

That is correct in now what I said, Terry, that 1.8 billion is a little under. And intend to hold on to that.

Right.

And looking at the internal operations, looking at what happened in the second quarter which I really don't have all the details yet to see how we can make it up

I called in a little late. So the number Linn cited is $3.5 billion in liquidity, does that include asset sales, the stock sales you made, et cetera, et cetera, correct?

Uh, yes.

Yes.

Pro forma for that.

I did a pro formula balance sheet analysis, and after you write down all your good will, the number I come up with that your debt ratio -- they are quite different from yours, is just about 57, 58% with a full write down of all of your good will. And I come up with a pro forma, what I call interest originate number that rises from the low 2s, mid-2s up to the high 2s to 3. Armando, is that approximately correct?

The capitalization number that you have is -- is in the ball park.

Okay, how about the coverage ratio number. Is that approximately correct? You do a pretax interest cover?

About 3.

Yeah, that's what I come up with on a pro forma basis. Leading to the question for Linn then. Given that your capital structure has been strengthened through your timely asset sales and stock sales. Good thing you sold it before the recent scare with price declines. What would make you deploy your growth capital, considering that capital now is so very critical, and if you were to spend it, you know, you can't further strengthen your capital ratio or keep it where it is, even now with the equity ratio in the mid 30s is hardly, you know, robust. Why would you want to deploy that growth capital, given that the record to date of all of the utility companies have not been great. I mean empirically, everyone has taken massive write-offs over the past couple of years. What would make you deploy that billion dollars rather than conserve it to strengthen your balance sheet.

I think, Terry, the answer is sort of an obvious one that we wouldn't unless we thought the opportunity was particularly attractive, both in terms of strategic fit to what we would like to do and the return that we thought we would earn.

Then is there a good probability and fact that you would keep that money for the time being, just because -- I mean, these are tough times that you want to have as much capital as you can because otherwise, you know, commodity markets are unpredictable and you just can't tell. You need to weather the storm. Is that a fair comment?

It's a comment, but it depends on what the opportunity might be and if we thought it was particularly attractive from a strategic point of view and if we thought the return was right.

What is "particularly attractive"?

We don't know unless we have a specific opportunity.

Can you give a number, a hurdle rate, or a particular strategic focus. What would tempt you or no number or no specific?

Well, the focus is clear. It has to fit with the wholesale strategy of being in the electric gas, coal business. The number would depend on what the opportunity were.

Okay, and then finally, the last question on triple F. With the shortfall after you purchase the entity and you do expect things to get better. I don't know exactly I guess the volatility or prices, et cetera. For this full year for triple F, your full year of ownership, how -- how much -- how far off would it be relative to your original expectations?

We don't expect it to be off by much at all because the issue with the triple F plants is they operate with a cap on emissions. We have not used that cap. We expect to be able to by year-end in running the plant in the fourth quarter in particular.

Okay. So you expect to kind of make it back? So that overall it will be -- it will be fine. It will meet your target for this year?

We think it will.

What is that target, in full year in terms of cash return on investment?

6 cents a share.

6 cents a share. Thank-you

We do have a question from the line of Jim von Riesemann with J.P. Morgan. Please go ahead.

Hi, Can you describe who your trading partners are or if you increased any of your reserve positions in the quarter.

Sure, our trading partners are probably the people you would expect them to be, Duke and a number of the banks, trade, financial gas, Bank of America. People like that. Goldman Morgan, Stanley. The usual suspects. We still got all of the former traditional players are still out there, not as active as they used to be, but still doing business. We spend a lot of time focused on making sure that we've got adequate collateral to cover our position and we are not increasing risks -- credit risks with count parties we are not comfortable with. You know, in terms -- in terms of our reserves. Our reserves are adjusted on a quarterly basis based on a credit-scoring model and to the extent that the counter parties we do business with have deteriorated from a credit standpoint it will cause the reserves to go up in that model.

So what sort of change delta did you have from the first quarter to the second quarter with reserves?

I don't have that number at hand but -- I don't have that number at hand.

A question on Texas with all the stuff that's going in Houston right now and the Reliant and its derivative and sister company under pressure. Is the Texas PUC worried about competition in the state of Texas at all? And what action might they take?

I don't -- I think they worry, but their focus has more been around the mechanics and the issues around implementation with respect to ERCOT getting customers -- we get customers hooked up, like getting them billed after you hook them up. Those sort of issues have been more of their focus. I think they are watching and I would look more toward the legislature than toward the PUC for initiatives with respect to cut back of competition. I do think that their reaction on the price to beat is symptomatic that they are not going to be reliable in implementing all of the pieces correctly, but overall, I don't see cutbacks.

Just -- a couple of mid-questionings if I may. The one is on the Quaker coal. You say you see strengthening in the coal prices. What sort of delta is there in terms of earnings sensitivity if the coal prices stay flat?

The forecast is based upon current coal prices in the market. So the forecast does not contemplate an increase in coal prices.

We do expect improvements from operational and other issues.

Okay. And then one last question is on the pension issue. As you pursue this corporate separation, what are the requirements under corporate separation to making sure that both the regulated and unregulated are fully vested. Can you walk through that and especially in light of the bear market right now what could do you expect in senior pensions this year.

Yeah, we haven't really worked that out, but we know that's not going to be a problem. I mean, we are certainly going to address it. I mean, we are not -- We are not excluding the pension plan.

It is still one company.

Okay, but no legal requirements underneath to have --

No.

Okay. All right, thank-you.

Sorry

We do have a question from the line of Jeff Gildersleeve with Argus Research. Please go ahead.

Yes, good morning. Most of my questions have been asked, but Eric I just wondered if you could give us any specific dollar amount exposure to Williams and Synergy.

We don't give out specific dollar limits to parties. What I did say before is appear applicable. I am not concerned about the exposure there.

Fine, and Eric, if May and June were good months in gas trading, how -- I mean, how much was made up in May and June to take care of April? I mean, still -- still a $20 million loss.

Yeah, I don't -- I don't know how to answer that question for you without starting to get into individual monthly numbers.

I mean it seems that April must have been pretty ugly.

April was pretty ugly.

Okay, you can't give us --

One the other things that we talked about on the last call was one of the things that you need to do is to lower the level of risk in your portfolio when you -- when you start to have a problem and when you are in the process of correcting it. That has an implication which is that -- for the period that you -- you do that you have lower profit potential, you have lower profit potential as a result of that. So --

Right. And finally, you -- you held a bearish view on gas I believe back in April. What is your view now on gas prices?

I don't see -- I haven't seen a fundamental change in the gas market relative to what I've commented on in the past. I still think we be more than adequately supplied for this winter and I still think that storage will be full prior to the beginning of the heating season. I still, however, have a somewhat -- and have had a fairly bullish longer-term view once we get past this winter and we still see an inability on a long-term basis to -- to do much better than covering depletion in terms of gas production.

Okay. Just that -- you were pretty bearish in April and then gas prices sort of moved against that view. I was wondering if you changed your position at all?

Well, we certainly change our position all the time. I haven't changed my -- I don't believe that the fundamental of the gas market has changed -- changed dramatically since then.

Okay, thank-you.

We do have a question from the line of Curt Launer with Credit Suisse First Boston. Please go ahead.

Hi, it's actually [Tyson Conner] in place of Curt Launer. I was wondering if you will comment on your higher expense from the first quarter and the first quarter versus in the fourth quarter of 2001. 130 million versus 98 million and then 95 million in the fourth quarter of '01.

Can you lead us a little more directly to what number you are talking about.

It's capital costs, you call it. Capital costs and others.

And others?

Okay. The quarter is down.

Well -- the quarter is -- isn't it up over last quarter?

Oh, over last quarter, okay. I don't think we have the first-quarter number in front of us. Give us one second. Yes, it's -- I think what we would like to do is answer this off-line. There's some reallocation that happens between first and second quarter, and so in a number of circumstances by very, very small margins there are differences between -- it is difficult to just add up the first quarter and the second quarter and get to the results you need. So if we can answer that for you off-line, I would appreciate it. Okay.

We do have a question from the line of Tom O'Neill with Lehman Brothers. Please go ahead.

Good morning, just try to be quick. Just curious if you could provide some clarity on the assumed prices on the synergy hub for the balance of the year. And the assumption for marketing and trading for the full year and then lastly, what pricing assumptions that you are envisioning for the UK in the winter versus price indications now.

The pricing assumptions that we are using are the market prices as of the end of last week. So you are talking about mid--- percentage you are talking about mid-30s for the balance of July and August. You are talking about -- this is on-peak. You are talking about 23-something dollars for September. And then about the same amount for the fourth quarter. In the UK, we are talking about, you know, the market prices for the third and fourth quarter. The fourth quarter with a bulk of the -- where the bulk of the ups -- where the bulk of the remaining income would come from, you are talking about around-the-clock prices in the mid-17 pound range. I am sorry, was there more to the question than that?

The marketing and trading assumption for the full year.

I think we gave you earlier a gross margin assumption for the for the balance of the year for system trading together.

We analyzed the composite factors including year to date where we think the prices are and judgments around the marketplace.

So the combined number was ....

$375 million.

Okay, in -- you don't want to break that apart?

No.

Okay. Thank-you.

We -- operator, we ought to take two more questions probably

Thank-you. We do have a question from the line of Douglas Lee with UBS Warburg. Please go ahead.

Good morning, everyone. Quick question about the $2.9 billion debt reduction. Can you please review how we get to that number?

Yes.

Yes, we can. The 2.9 debt reduction that Linn talked about was essentially the proceeds with the sales with respect to Citipower and Seaboard. Those transactions together are worth $2.9 billion.

It's a billion 8 of long-term debt roughly associated with the two properties and then another billion and 1 of cash proceeds that paid out in short-term debt

The billion 8 is the debt on the books that is assumed by the buyers of these two companies and they go off our balance sheet and the additional amount is cash proceeds that we get, and we use to repay our own debt.

Okay, great, thank-you.

Our final question comes from the line of Ryan Columns of the Ohio Teachers. Please go ahead.

Terrell Armstrong again. If I can get clarification on a question from earlier. Could you comment on the impact on various investigations into the business practices of wholesale power market participants I guess specifically is AEP the subject of investigation/inquiries from -- you know, for DOJ, SEC, I think you mentioned the CFTC earlier. Can you expand it to those entities also?

Yeah, I think the major impact is that we've spent a great deal of time and effort responding to the industry-wide inquiries. Beyond that, all we have is the general request for information that the CTFC sent out to everyone. We have no requests for -- no reason to believe there is any investigation going front anyone else. We have not been contacted. We do get inquiries from time to time about specific market conditions or market issues that appear to be related to other investigations.

But you anticipate no impact from the concerning surrounding wise sales?

We have no knowledge of anything that will give us concern.

Thank-you.

There are no further questions. Please continue.

Thank-you very much all for participating in our call. And the operator will give you some instructions on the replay of the call. We will talk to you soon. Bye.

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