愛迪生國際 (EIX) 2008 Q2 法說會逐字稿

Good morning, and welcome to the Edison International's conference call. This call will be available for replay at the following numbers -- domestically, 877-693-4277; internationally, 402-220-0042. You will need to use the PIN code 11701, which is the same PIN used today to access your call. For your information, this call is being recorded. Also, we want to advise you that Edison International is holding a simultaneous webcast of this conference call. This will be available on the Company's website in a listen-only mode for interested parties. When the conference begins, you will be on listen-only and there will be a chance for questions and answers at the end. (OPERATOR INSTRUCTIONS). Thank you for your patience. At this time, I would like to introduce your host, Scott Cunningham, Vice President of Investor Relations with Edison International. Thank you, and have a good conference. You may proceed, Mr. Cunningham.

Thanks, Lynn, and good morning, everyone, and thanks for joining our call. Our principal speakers today are Ted Craver, our Chairman and CEO, and Jim Scilacci, our Chief Financial Officer. After their remarks, there will be a Q&A period, as usual. Also with us to participate in the Q&A are Al Fohrer, CEO of Southern California Edison, and Ron Litzinger, CEO of Edison Mission Group. The presentation that accompanies Jim's financial review, together with the earnings press release and second quarter 10-Q filings, are available on our website at www.edisoninvestor.com.

During the call, we will make forward-looking statements about the 2008 and longer-term financial results, for Edison International and its subsidiaries, and about other future events. Actual results could differ materially from current expectations. Important factors that could cause different results are set forth in our 2007 Form 10-K and our other SEC filings, which we encourage you to read carefully. The presentation also includes additional information, including certain guidance assumptions, as well as reconciliation of non-GAAP measures to the nearest GAAP measure.

With that, I'll turn the call over to Ted Craver.

Thank you, Scott. Good morning, everyone. Today is actually the end of my first week as CEO of Edison International and my first quarterly earnings call as CEO, although I've done a few of these before. So since it is my first call from this chair, I wanted to take some additional time this morning to share some broad overview points, and then we'll turn it over to Jim to talk about second quarter results. And in my opening remarks, I want to touch on three main areas, our management team, the broad value proposition at EIX and our most important business priorities or focus points, if you will, over the foreseeable future.

Last week marked the end of John's 18 year term as Chairman and CEO of Edison International. It also marked the point where Tom McDaniel retired as CFO after 37 years with the Company. And Lon Bouknight retired as General Counsel of EIX. Over the last few weeks, we've had several opportunities here at the Company to thank the three of them for their many contributions and celebrate their long list of achievements. But I really wanted to start my comments this morning by publicly expressing one last time my gratitude for what they have done for the Company, and thank them for the contributions to setting the Company on a path for future success.

I also want to express my deep enthusiasm and excitement for the senior management team we have around this table this morning. Al Fohrer heads up our utility operation and is known to many of you. He's a very able veteran of both the utility and the competitive generation business, but particularly skilled on the utility side. Since becoming CEO of Southern California Edison 6.5 years ago, he has pulled together a management team of seasoned executives who know well the complexities of this business and how to balance the needs of customers, the communities, employees and shareholders. I truly couldn't be more excited to have Al and his leadership as part of this team. I asked Ron Litzinger to return to Edison Mission as CEO, replacing me. Ron and I worked closely together during the restructuring of EME in 2003 and 2004. And Ron has strong experience and skills, particularly in generation operations and in project development, two critical areas for us at EMG in the coming years. Like Al, he also has strong strategic instincts and abilities.

You'll hear this from me many times here this morning and in future calls, but our success is all about superb execution of our business and growth plans. Al and Ron and their management teams and employees are on the front lines of execution and have the primary responsibility for ensuring we deliver on what we all believe is the enormous potential of this Company.

I asked Jim Scilacci to succeed Tom McDaniel as CFO of Edison International. Jim spent 20 years in Southern California Edison in various capacities, but as CFO for the last five years of that time. He then became the CFO at EMG for the last 3.5 years, so he has deep knowledge of both sides of our business. He also has been involved in most the major financings we've done at both companies over the last several years, and I'm very pleased to have Jim as our CFO with his steady, solid competence.

I asked Bob Adler to succeed Lon Bouknight as the General Counsel at EIX. Bob came from Munger, Tolles & Olson where he started more than 30 years ago and was most recently co-managing partner. More to the point, Bob was the most important thought partner and colleague with me on several projects over the last 10 years at Edison, including the gas plant sales at SCE, which were required as part of California's deregulation, the settlement agreement that we negotiated with the CPUC to end the California energy crisis, and the restructuring and international asset sale that put Edison Mission on the track to restored financial health. Bob has terrific business sense and the highest integrity and I'm so pleased to have him as our General Counsel.

I'd put this management team up against any in the industry, which is why I've spent so much time talking about it here this morning. This team is, in my opinion, a difference-maker.

Let me move on to what I see is the value proposition at Edison International. I believe it boils down to being able to realize our substantial growth potential. This requires outstanding execution. We must execute well to realize what is in front of us. That is one of the reasons why I keep stressing the management team. It's doing hundreds of things right, the right way, every day. The big opportunities I see are in growth. At SCE it is mostly the growth prospects on the wire side of the business, not just building more transmission and distribution, although that's the bulk of it, but also investments in smart meters and the smart grid.

At EMG, the opportunities are mostly in developing renewables, primarily wind and solar, and selectively gas-fired assets. We have to date favored the value proposition of developing assets as opposed to acquiring individual assets. Of course, there are challenges we face in realizing these opportunities. At SCE, the largest challenge is the sheer enormity of the growth opportunity. By this, I mean managing the execution risk of such a huge capital investment program, and the impacts that the pace of installation could have on customer rates, if fuel procurement costs rise dramatically at the same time or political and regulatory conditions sour. At EMG, the challenge has stemmed from the high concentration we have in merchant coal, it's about three-quarters of our megawatts, and the related environmental uncertainties associated with coal assets.

So how are we going to realize what I believe and what this management team believes is one of the best opportunity sets in the industry? Given the inherent opportunities we have at EIX, superior execution is the critical success factor. Over the foreseeable future, there are five main focus points, or business priorities, involved in our execution. My intention for the remainder of my comments is simply to identify those for you without explaining them in great detail. The first is obtaining good regulatory decisions, particularly the pending general rate case and the energy efficiency decisions. Approval of a fair and reasonable GRC is the foundation of our ability to provide reliable electric service to our customers. We, our customers, and the state are at great risk if we can't provide reliability. It's also the basis of our growth program at SCE. This is a huge focus point for us this year and we need a timely decision. We are struggling to get a timely decision on the energy efficiency earnings mechanism by the end of the year, and, as you know, we've identified $0.08 for energy efficiency earnings in our guidance this year and we do not want it to slip into 2009. So there's some important work to do there with the Commission.

I also put our cross-border lease dispute with the IRS into this category as well. It has been over the last 18 months and will continue to be a significant focus point for us to find a reasonable path to resolve this dispute. Jim's going to cover the recent developments in our efforts with the IRS in his comments. Second focus point is managing well our large construction programs. Many parts of both SCE and EMG are engaged in some form of engineering, procurement and construction management activity. This is not just a near-term issue, but something we'll be dealing with for years to come. It is challenging, as we compete with many other infrastructure development needs in the country, but doing it well is how we actually deliver the growth we're also excited about.

Diversification is the third point. EIX has the integrated electric model that combines the scale and stability of our utility business with the flexibility of the competitive generation platform at EMG. But the diversification that I'm talking about here is within EMG. The principal strategy at EMG for more than the last three years has been to diversify our concentration in coal assets. The sale of the international assets in 2004, while raising the $3 billion in cash necessary to restructure the Company, had the effect of making us coal-heavy. That concentration has consistently generated well over $1 billion of EBITDA for each of the last three years as the dark spread has expanded, which has in turn allowed us to equity fund much of our diversification strategy. But we have to deal with the environmental risk, which is a major reason for our focus on renewables as the principal means of diversification.

We hoped we could acquire some gas-fired assets to offset the coal risk as well, but we have balked at the valuations which, in our opinion, require unrealistic beliefs about capacity prices staying at replacement cost levels far into the future. So for better or worse, we've opted to maintain our discipline, pass on the asset options and focus on developing gas assets such as the 500-megawatt Walnut Creek gas fired project we recently announced. Ideally, we would like to be roughly equally balanced between coal, renewables and gas-fired assets. But in the near term, we will continue to focus most heavily on developing our renewables pipeline.

The fourth business priority is meeting the environmental challenge. Our greatest challenges are, of course, at EMG where we have our major coal exposure. We want to meet the environmental challenge. We want to provide affordable reliable electric service and we want to create value for our shareholders. That's why we worked with the State of Illinois to reach a comprehensive environmental settlement on mercury, NOx and SO2. We continue to believe our deal with Illinois was forward-thinking and ground breaking. Our guiding principles in the settlement were, A, move to top tier emissions profiles for the fleet, but in a reasonable timeframe that allowed both us and the state to evaluate the environmental and reliability needs. B, take care of the most sensitive issues first, mainly mercury in the lake front and in-city plants. By the way, we finished installing the mercury controls for Waukegan, Fisk and Crawford last month. C, stage the investments over time to build execution experience and get past the first industry bulge of retro fits. And, D, build in a staged set of options roughly in the order of the degree of difficulty of the decisions that allow us to evaluate the economics of each retro fit to determine if it makes more sense to shut down the plant or put on the retro fits.

We thought it was essential to try to reduce the large uncertainties of the environmental retrofit costs for our fleet. We thought it best to enter into a comprehensive settlement that created specific yearly emission standards and that give us the ability to evaluate our environmental investments. And, in fact, we gained some certainty with the Illinois settlement, but new source reviews, notice of violations from the US EPA and the Department of Justice and, most lately, the court decision vacating CAIR rules, have put us back into an uncertain world.

Evolving water quality rules and, of course, very importantly, uncertainty of future carbon regulations further complicate the decision-making around environmental retrofits. But the bottom line is we won't make retro fit investments unless they can be justified and have a reasonable prospect of investment recovery. This will continue to be a huge focus area for us.

We will have some critical information in front of us towards the end of the year when we finalize the specific engineering and cost estimates for the SCRs and FGDs for the two Powerton units. These two units are our largest and the youngest of the fleet and will be the basis for the cost estimates for the rest of our units as well.

And, as I've said, we're focused on building out the renewables portfolio, which provide some portfolio offsets to our carbon footprint at EMG, which brings me to my final focus point, which is to deliver on our wind development pipeline. We've been quite focused on building out our wind portfolio. We made some decent progress since the end of the first quarter. In fact, we've increased our wind installed capacity by 34%. As of the end of July, we had 756 megawatts in service and 429 megawatts of projects under construction. And our development pipeline, which is the feeder stock for potential projects, stood at over 5,000 megawatts at quarter end.

We reported to you last quarter the issues we've had with the Suzlon turbines. We see these turbine supply challenges well along the way to being resolved now and we're pleased with the continued technical and financial commitment from Suzlon in this regard. We don't expect any meaningful earnings exposure from these problems because of the contract protections we put in place at the time of the original purchases, which have been enhanced by some recently negotiated provisions as well. We believe turbine supply conditions are becoming more favorable as we look ahead. We see no further delays in moving projects into construction from our development pipeline. We're in negotiations with a supplier for turbines available for 2009 delivery that will essentially offset the turbines we recently canceled from Suzlon, and we have already started to secure turbines for 2010 delivery with a 300 megawatt order placed with General Electric in the second quarter.

So in summary, because our growth prospects across the Company are so strong, our primary focus is executing well on these five major areas to realize our full potential. At this point, I would like to turn it over to Jim to take us through the second quarter. Jim?

Thank you, Ted, and good morning, everyone. At this time, please turn to page 2 of our presentation. This page summarizes some of the key points for the quarter, which I will cover in my remarks. Going to page 3, we show our quarterly earnings on a GAAP and core basis. For the second quarter of 2008, core earnings, which exclude income from discontinued operations and other non-core items, were $0.79 per share, up 8% compared to last year. Reported earnings for the second quarter of 2008 were much higher than last year primarily because the $0.45 early debt extinguishment charge at EMG.

Moving to page 4, overview of the performance drivers in more detail. SCE core earnings per share were $0.04 per share higher than a year ago. The utility's results benefited from lower income taxes, primarily arising from higher deductions from our capitalized software and infrastructure replacement programs, and favorable net interest expense, primarily from lower amounts owed in our regulatory balancing accounts. These benefits were partially offset by lower operating income, which largely reflects timing differences between operating expenses and revenue recognition established through rate design. As discussed previously, SCE's operating expenses are recognized more evenly throughout the year, while revenues are more weighted to the third quarter.

For the second quarter, EMG's core earnings were also up $0.04 over the prior year. You can see in the presentation, Midwest Generation had a solid quarter as margins benefited from higher generation, higher realized energy prices, and capacity revenues. However, this performance was mostly offset by results at Homer City which had lower generation, driven largely by forced or extended outages during the quarter.

In the balance of the generation portfolio, this is -- which is reported in the corporate expense and other line item in the presentation, we saw good growth from our wind portfolio, contributing roughly $0.04 per share. As expected, the big four project earnings were approximately $0.03 per share lower than last year. This reduction is less than we originally anticipated in our guidance, primarily because of higher margins than we expected. Our Watson and Sycamore projects are now operating under extensions of their old SCE contracts, with revised pricing approved by the CPUC. We also continued to see higher G&A related to our growth platform that Ted talked about.

The EMMT, our trading operation, had a good quarter, with trading revenues of $51 million compared to $36 million for the quarter before. As you are aware, our trading activities are largely focused in regions where we have developed strong market knowledge primarily supporting our assets.

Edison Capital had a strong quarter, primarily from the $0.07 per share benefit from an early buyout of its lease in the Beaver Valley Nuclear Plant. As we have mentioned before, we are not making any new investments through Edison Capital. Excluding the Beaver Valley gain, ongoing results were down slightly compared to last year, consistent with the rolloff of its investment portfolio.

Included in the Midwest Generation and Homer City results are FAS 133 adjustments which reduced earnings by about $0.02 per share compared to last year. These primarily relate to the ineffective portion of our hedges. As of June 30, we had recorded $54 million of FAS 133 pretax unrealized losses for our coal fleet. These losses do not affect cash flow and will be recognized through earnings over the next three years as our hedge transactions close out.

To finish up the drivers, EIX corporate costs were in line with our full year trend assumptions and discontinued operations were not a factor in the quarter.

Turning to operating performance on page 5, Midwest Generation's performance shows generally improving trends in generation, availability, load factors, and average realized prices, which mirror the improved earnings.

Moving to page 6, higher forced outages meaningfully reduced Homer City's operating and financial performance. Both the quarterly and first half E4 rates exceed 10%, which is at the upper boundary of our target rate. There were three main causes for the forced outages. Boiler 2 leaks were the leading cause of recurring forced outages in our coal fleet and we are observing an upward trend at Homer City. EMG is implementing the Ephrie Boiler 2 Failure Analysis Program, and we are targeting a 50% reduction in boiler 2 leaks over the next several years, which should significantly contribute to returning our forced outage rates back to about 5%, which is in the lower boundary of our target E4 range.

Secondly, a major fan motor failure at unit 3 caused 150-megawatt D rating for nearly six weeks. This fan motor, added as part of the FGD installation in 2003, failed well before its expected life, and we did not have a spare in inventory. As a result of this incident, we have expanded our critical spare part review to include all critical electrical components, such as transformers and large electrical motors. We will consider purchasing additional spares where economically justified.

And finally, a planned maintenance outage at unit 1 ran over schedule. EMG has absorbed several scheduled outage extensions in the past two years and has launched an initiative to improve our outage planning, execution and quality control practices and procedure. One additional factor was that we intentionally removed unit 3 from service for nine days in late May and early June to make numerous preventative tube replacements in a section experiencing high erosion rates.

Moving on now, realized prices at Homer City were about the same as last year, although market prices rose substantially during the quarter. This was primarily due to hedge contracts entered into prior to the increase in market prices and the impact of wider basis between PGM West Hub, where we hedge our power, and Homer City busbars, where we sell our power.

Finally, the previously mentioned forced outages also limited our ability to capture higher pricing with our unhedged position. As we have said before, we typically hedge only two of the three units at Homer City. You can find year-to-date results on pages 7 and 8 of the presentation.

Turning to page 9 of the presentation, you will notice that Midwest Generation and Homer City added 11 million megawatt hours to their hedge positions for 2009 and 2010. You will note that we've updated our Homer City disclosures to reflect the fact that we previously entered into option agreements to purchase 1.7 million tons of coal for 2009 and 1.2 million tons of coal for 2010. Since we have not exercised these options as of yet, they are not included in the amounts shown on the charts. These additional hedges, together with our coal position, will reduce earnings volatility over the next two calendar years.

Given the volatility and uncertainty associated with power markets, we reduce earnings at risk by employing a rolling 24-month to 36-month hedge program. This means hedging a higher percentage of the dark spread in the current year, as we've done in 2008, with lesser amounts two years out. That would be 2009 and 2010. Generally, for the (inaudible) year, we like to be in what we call a hedge-neutral position, where we have hedged about 50% of the total kilowatt hours that we expect to produce. We believe this is a good balance between reducing earnings volatility and the trade-off between potentially higher collateral requirements and preserving upside should market prices improve.

Turning to page 10, this shows our capacity hedge position. We updated this chart to show capacity sales for the 2011 and 2012 RPM planning years at a price of $110 per megawatt day.

The next topic I would like to discuss is the current status of our cross-border leases, or so-called Lilo Silo investments. During the second quarter, three court cases addressed income taxation of cross-border leveraged leases. After careful review of these cases and assessment of our specific facts associated with the leases, we concluded that no change in our accounting treatment of our leases should be recorded. Had we been unable to reach this conclusion, we believe the maximum earnings exposure related to the leases alone, measured as of June 30, would have been approximately $1.25 billion after taxes. As previously disclosed, we have been engaged in settlement negotiations with the IRS for some time. These negotiations seek to resolve on a global basis the lease issues and all other tax disputes for the years 1994 through 2002, including certain affirmative claims for unrecognized tax benefits. Edison International and the IRS have reached non-binding preliminary understandings on material principles for resolving all of these disputes. Final resolution, however, is subject to reaching definitive agreements, agreement on calculations, and a review by the staff of the Joint Committee on Taxation, a committee of the United States Congress.

Edison capital has executed term sheets with their counter parties to its Silo and Lilo transactions, which contemplate termination of the leases. Our current understandings anticipate this happening before the entire IRS settlement is completed. Upon termination of the leases, the lessees would make termination payments from certain collateral deposits associated with the leases and we will have an immediate earnings charge of at least $650 million after taxes which could occur this year. We would expect, however, that when the dust settles and we complete the entire settlement of the disputed leases and affirmative claims, our ultimate net after-tax earnings charge will be less than half of our maximum $1.25 billion after-tax exposure mentioned previously. Were all settlements completed in a manner consistent with the preliminary understandings, the net cash impact upon Edison International as a whole of the settlements and lease terminations would be positive over time. It is not anticipated that borrowings would be required in connection with implementation of the settlements. Finally, we still have much to do to finalize our settlement and there can be no assurance that we will in fact complete the settlement. There is additional information regarding this topic included in EIX's 10-Q. Our Q was filed this morning.

Lastly, let's turn to page 11 of the presentation. This morning, we reaffirmed our full year core guidance range of $3.61 to $4.01 per share and we still see guidance around the higher end of the range. We also updated where we stand on some of the key guidance elements we discussed in our original guidance, as you can see in the presentation. Let me highlight a few of them. In updating our guidance, we have used forward market prices at July 31, 2008, and reflected the actual results through June 30. You will note that the substantial move downward in forward gas prices and power prices during the month of July. This reduced EMG's potential upside, but it also brings helpful relief for our SCE customers. Lastly, we've included $92 million in EMMT's year to date pre-tax trading income compared to $75 million previously. We also noted that our guidance assumptions exclude an expected impairment related to the $48 million in annual NOx emissions allowances. These allowances were purchased by Midwest Gen in anticipation of the CAIR rules that have now been overturned. The actual amount that is impaired will be determined in the third quarter.

With that, operator, we'll now take the questions.

(OPERATOR INSTRUCTIONS) Our first question comes from the line of Paul Patterson with Glenrock Associates. Please proceed.

Good morning, guys.

Hi, Paul.

When I was on the first quarter conference call, I think I asked about the Beaver Valley lease buyout and I believe that was not in guidance. And if I read and listen to the presentation correctly, I think it sounds like it now is in guidance. Is that the case? And if it is the case, what was the offsetting thing that offset that?

You are correct. We've now updated -- besides Beaver Valley, there are a number of puts and takes that go on during the course of the half year and what we see going forward. When you think about looking back over the first half of the year, you can see that Midwest Gen performed well. Homer City was off. EMMT performed well, and so just generally -- I'm hitting the highlights -- there are a number of puts and takes. So we've tried to reflect those in our guidance as we see for the full year.

Okay. So this is not a specific, in other words, it's just a mix in general. As you look forward, there's not a particular item that sticks out that offsets the $0.07 gain?

There are - - as I went back, I think there is a lot of puts and takes.

Okay.

Clearly the thing we watch the most is what's happening with the forward curve.

Okay. And the capitalized software tax benefit, was that about $0.04? Did I read that correctly? Or was it more--

Let me have Tom Noonan from the utility answer that.

Yeah, the $0.04 was the entire benefit for that period of time. The software benefit was slightly larger than the $0.04 and it was related to an implementation of an ERP, SAP program that we've went live with in the second quarter.

But it's kind of unusual item. We shouldn't expect that to recur a lot, is that correct?

It will recur a little over the next two years because we are still implementing a little bit more of the ERP program. We just put in the finance portion. We till have a customer service portion and a work management portion. So we'll still get a little bit of benefits over the next couple of years.

Okay. But of similar size, you think, or just--

No, not in similar size.

Okay. And then the impact of emission allowances, just financially speaking for the year, what has that been and how does CAIR effect that, let's say, in 2009 if the current market holds up like this?

I think that's a tough question I think we said we bought the NOx emission allowances in anticipation of meeting our requirements in 2009. So to the extent that there's an impairment charge, there would be lower costs than what we would have expected in 2009 had we used those credits.

Okay. So in other words, since you guys are in the business of buying emission credits, it sounds like you guys might actually benefit from the fact that the CAIR rules, is that correct?

There's a possibility, and you have to sit here and expect that maybe certain states would respond in kind. I don't know if there's enough time, but there is a concern about that. But there's a potential for some benefit, especially at Homer City, where the SCRs, there's a certain cost associated with running those emission credits that may not be there now.

And the NOV at Homer City, any exposure there that you could quantify. I know you have an indemnification agreement with the sellers of the plant. I forget who they were. I can't -- I don't know why I forgot, but have I forgotten. Who did you actually buy it from? I forgot.

What I'm going to do is have Ron Litzinger address that.

Yeah, we are getting ready to have our initial discussions with the EPA, similar to the discussions we've been having on the Midwest Gen NOV and we will see how those proceed. We did put in an indemnity claim with the original owners at Homer City, which are GPU and NYSEC.

Okay, great. Thank you.

Thanks, Paul.

Thank you, Mr. Patterson. Our next question comes from the line of Hugh Wynne with Sanford Bernstein. Please proceed.

Good morning.

Good morning.

Couple of sort of detailed questions around the earnings at Southern California Edison. I was hoping you could help me with. You mentioned that the improvement there is attributable in large part to the lower income tax expense. The first clarification I wanted to ask about was whether that would be something that would be -- in the future adjustment to your revenues, or is that something you keep?

These benefits occur in 2008, which is not a rate case year, so these benefits would be kept by the company.

Great, thanks. You point out that the operating income is down as indeed it is, by about $60 million, but mention that operating income is back loaded to the second half of the year. What is the relevance of that when we're comparing Q2 '08 to Q2 '07? I didn't understand the explanation.

Right. Really what we were trying to explain there was that during the year, our revenues, first of all, are not collected evenly throughout each quarter. Most of our base revenues, which go for operating the company are collected more heavily weighted in the third quarter. What happened during 2008 was our expenses were slightly higher in the first and second quarters due to costs on the our nuclear plant at -- so we were just trying to explain that our expenses have occurred more evenly this year than they did last year, but, again, the revenues are collected unevenly during the year. This will wash itself out or even itself out over the entire year.

That's because those San Onofre and Palo Verde costs are ultimately recoverable?

What it is, is we will have lower Palo Verde costs than we've had in the first two quarters because of the outages that occurred in those two units.

Got it. Then the last question, I noticed this large decline in minority interest, about $40 million. You haven't talked about that and as an explanation for the results of the utility. Could you explain to me what that reflects?

Yeah, what that reflects is an accounting requirement that we reflect our Big Four is not owned by Southern California Edison, but there is a share that is owned by EMG. What we have to do is, because of accounting rules, we have to reflect that the Big Four in our financial statements, and then what we do is, we wash them out. So from an accounting standpoint, really this has no impact on our income statement. It's an accounting requirement to put big four in and then we take it out. We put it in as minority interest and then it's taken out in other line items within the income statement.

Right. That's why you've not highlighted it. Thank you very much.

Thank you.

Thank you, Mr. Wynne. Our next question comes from the line of Lasan Johong with RBC Capital Markets. Please proceed.

Thank you. I'm not disputing the need for Edison Mission Group to diversify its fleet, but focus on wind presents its own challenges, one of which is the wind itself. That also then could produce very interesting opportunities on the gas side of the equation. Is there a comprehensive plan to go from wind to gas, kind of joint develop projects while you're doing one versus the other?

We'll have Ron answer that.

Yeah, as we look at our wind program going forward, one of the areas that we are focused on is looking at it more broadly as a business rather than a project by project by project opportunity and we are evaluating what are things we can do in other fronts that add more value to the grid.

Would you even contemplate doing independent transmission projects?

That's one of the things that we may consider.

And on the lease negotiations with the IRS, did I understand correctly that you're pursuing cancellation of these leases and which would result in a cancellation payment from the lessees back to Edison International?

That's correct. It would first go to Edison capital, yes, and then we used as proceeds that could be used to make the payment to the IRS.

So the net cash impact could be close to zero?

What we said in the statement was the net cash impact over time, because it's going to -- this won't occur -- everything won't occur at once, so we'll terminate the leases, we'll go through review of the settlement through the joint committee on taxation, and when that's all resolved, when it's all said and done, we said it would be cash flow positive to Edison International.

Even after the payment to the IRS?

Yes, and an additional aspect on that. There are the leases, and we want to emphasize there are two pieces, the leases themselves and the affirmative claims that we have pending as part of this global discussion with the IRS.

Great, and you said the potential earnings impact would be around $600 million.

That's -- there's different things going on here. What we said, if we write off and close out the leases, there could be a charge up to $650 million after taxes. Over time, as the settlement is reviewed, there is a potential for some of that to get reversed. However, what we're sailing for guidance purposes year all, that we're seeing that the maximum exposure as we sit now is half the $1.25 billion that we stated as our maximum exposure.

Fantastic. Thank you.

Okay. Thank you.

Thank you, Mr. Johong. Our next question comes from the line of Paul Fremont with Jefferies & Company. Please proceed.

Yeah, I just want to sort of just understand one thing. The $650 million charge associated with the leases is not incremental to the charge that you would ultimately take, which would be 625, or is it incremental to that?

It is not incremental. What we're trying to guide you to that, it's management's judgment that the maximum exposure here would be half the 1.25 when it's all said and done.

Okay. So the maximum income statement charge would be $625 million.

That -- if you go half, that's right.

Okay. The other question that I have is really one of pricing, which I guess is both Midwest Gen and Homer City, but if I just take the second quarter realized prices and divide by the average gas price, it looks to me as if there's a significant decline in sort of the implied market heat rate relationship from -- it's close to like 1500 or 2000 implied market heat rate decline, which I think is sort of being experienced not just by you, but in a lot of, in a lot of regions. Can you help us -- and this -- I would think has nothing to do with the basis differentials between Homer City and PJ Amwest. It looks like it's happening sort of universally across the board. Can you help us understand what's driving that and is it your expectation that that will improve over time or does it remain at these much lower levels?

I'm going to have Ron address that.

Yeah, the implied heat rates are down, as you noted. We don't see any fundamental change in the marketplace and our view currently is it's just less liquidity at Nye hub as opposed to liquidity in the gas market.

So you wouldn't -- on a going-forward basis, we should be looking at these relationships to stay where they are now, even though gas prices have dropped considerably over the past month?

We think they are at the bottom and we're just going to continue to watch them.

So you, you at this point don't have an opinion as to whether this reverses or whether it stays where it is and it -- you just need to sort of watch it and try and figure out directionally which way it goes?

I think what we said, Paul, is the fundamentals in our mind don't match now what we're seeing in the forward markets and we're also concerned in talking with our traders that the liquidity we see at NI Hub is pretty small, and so we're concerned about the integrity and there's good integrity, but it's clear that there's not a lot of trading going on. So don't draw too many conclusions, so we'll just have to see how it goes forward.

And the last question, sort of housekeeping, the 92 million in guidance at EMMT is what you've already done so far in the first half, so you're assuming zero EMMT contribution for the second half?

That's what the guidance shows. Of course we have spent EMMT, the assumption that's in the guidance elements, we would expect it to beyond that level, but for conservatism, we typically don't peg a level of expected earnings from EMMT.

Thank you.

All right.

Thank you, Mr. Fremont. Our next question comes from the line of Ashar Khan with SAC Capital. Please proceed.

Good morning.

Hi, Ashar.

Jim, I wanted to understand if the settlement goes through as you have talked about, what would be the impact to earnings in 2009 if all leases are written off and everything? Is it a negative impact to earnings going forward, on an ongoing basis, and could you quantify that?

Okay. What we try to guide in our disclosures and my statements, what we said the maximum exposure on an earnings basis is about half the maximum exposure number we mentioned. That's the 1.25 billion. From a cash flow perspective, and I want to separate it, we see that being positive.

Correct.

So now I just want to clarify, too. It may occur over a two-year period and we may have to take the charge for the leases in 2008 and then there would be a gain that would occur in 2009, so we're trying to put it all together to give you a sense for what could occur. But from where we sit today, it may occur over a two-year period, but we're trying to guide you to what the net-net-net of all this might be.

But don't the leases contribute some operating earnings, like, I don't know, just to kind of give you an example of what PSEG showed was that their operating earnings would decline for the first four years and then they would reverse themselves in the remaining I guess five or seven years? Once you've taken these write-offs, is there similar impact to your earnings where, because of a contributing on an ongoing basis they go out and then they reverse themselves, or -- I'm trying to see if, you know, on an ongoing basis, what is the impact to earnings apart from these charges, from the current contributions?

Yeah, it's a good question, Ashar. What we're seeing is given the state of the leases and the cash flows associated with them, there's a minor earnings impact from terminated leases. As you recall, Ed Capital's earnings were going down already. We've been guiding people to that fact over the years, and there would be just a minor amount of earnings associated with these leases going forward.

Okay. So there would be minor. Minor meaning one or two cents or something in that range?

In that range.

In that range. So they just go out. Okay. So that's a very minimal impact going forward. Okay. Thank you very much, sir.

You're welcome.

Thank you, Mr. Khan. Our next question comes from the line of Jonathan Arnold with Merrill Lynch. Please proceed.

Good morning, guys.

Good morning.

Quick question on the new hedges that you added. Can you give us any color as to whether those were mainly peak pricing or more weighted to around the clock and just how we should think about them as we look forward?

Are you referring to the power hedges or the coal hedges?

Well, maybe if you could answer them both, that would be great.

Typically what we tend to do is when we hedge out in the future years, we try to lock in some of the peak hedging pricing and then we'll add, as we get closer in time to the -- if necessary, for the off-peak. For the coal hedges that we mentioned for Homer City, what I can clearly say that those hedges, or those option agreements are in the money.

Okay. But when you say you typically do the peak first and those are additional hedges, so would you put this in the category as sort of still part of the initial hedging of "09 and '10 or for the blend or more of a filling in?

I think it's fair to assume that.

Okay. And then I noticed the basis differential on Homer City overseas widened out. Do you see that as you kind of going through the third quarter here, is that a -- is it a reasonable assumption to keep it wide, or any reason to see that coming back in?

I think it's fair when you look at the basis on a percentage basis, it wasn't different. It goes up as prices -- power prices go up, you see basis go up. As prices come down, you typically see bases come down. Of course it's seasonal, too. But I wouldn't forecast it being any much different than what we've seen already.

But you would do it on a percentage by the sound of it?

I think that's a fairer way of looking at it.

Okay. And then just on the wind portfolio, I belive you had a while back a target of getting to, I think it was 2000-megawatts in service by '09 and they had the comment about the new contracting you're doing and hoping to kind of get this pipeline back on target. Is that still a reasonable target, or are you off that target?

This is Ted. I think generally that target is still in the right neighborhood. By the time we get to the end of 2009, we should be fairly close to that. But frankly it's in our minds a lot less of what the exact timing is -- but more a matter we've got now a little over 5000-megawatts of stuff in the pipeline, not all of that, of course, is going to get billed out, but that's really our feeder stock for future projects and this is a major area of emphasis for us as I indicated in my remarks.

Okay, thank you. And maybe if I may, one other thing. You've made the statement around the leases that wouldn't require if you have financing. Is that a statement on, that you wouldn't have to issue any long-term debt, you would be able to manage this on the short-term, financing arrangements, or can I get a little bit more clarity on what you mean by that?

I think there's cash within a system that we would have the collateral deposits and deposits we've previously made with the Internal Revenue Service and the affirmative claims that have sufficient cash to cover all the requirements that would be needed.

Okay. And on that whole subject, is it -- with this announcement from the IRS a couple of days ago that they had issued these kind of ultimatums to 45 companies, is it reasonable to assume you're not one of those companies because you're in this sort of broader settlement discussions?

I think it's reasonable to assume that we are negotiating a global settlement with the Internal Revenue Service that covers a broad set of issues, including our leases.

Okay. Thanks a lot.

You're welcome.

Thank you, Mr. Arnold. Our next question comes from the line of Dan Eggers with Credit Suisse. Please proceed.

Good morning. Just a follow-up just for clarity perspective, the CAIR decision right now, that does not necessarily change your environmental spend obligations in Illinois, given the fact the settlement was at the state level?

We're reviewing that right now, but if you look at the rules that Illinois put forth with regards to their state implementation plan on CAIR, the retro fit versus shutdown portion of those rules were separate and that's the way we're currently assuming it will be.

So plans are going ahead with the environmental upgrade, then.

At this point, yes.

Okay. Were there any liquidity issues or any challenges at emission group in the quarter given some of your hedge positions and the volatility in commodity prices or how was that managed during the quarter?

This is Jim Scilacci. I'll take it. I was there for most of the quarter before I switched over. There was higher levels of deposits we made with carrying companies, but what we've done, worked on over the last couple of years to switch our hedges, as you recall, we've talked about it before at Midwest Gen, we put together a leanback structure under our revolver and so if we enter into transactions with our financial institutions and the revolver, we don't have to post collateral. So that benefited us during the course of the quarter. So we didn't see a significant surge. There was some, but it was muted by the fact that the financing program we put in.

And I guess just turning to the utility real quick, there's growing talk of California pursuing the 33% -- standard by 2020. Any thoughts as far as, I guess number one, where you guys will be from 2010 or thereabouts delivery as far as hitting the 20% target and kind of the investment by the challenges to get to 33% for your territory?

We're going to have Al Fohrer address that question.

Let's take it in two pieces. The 20% by 2010, we have said that on a delivered basis we will not make that number. The state -- there is a flexible compliance. We can include contracts signed. The key there is that there needs to be adequate transmission and as you know, we are building the Tehachapi renewable transmission line that's key to getting additional renewables for not only us, but for the other utilities. In terms of 33% today, that is a preference. It is not a law, and the ISO has indicated to make 33%, there needs to be substantial additional transmission beyond what is planned today to get that. I think what they've said is that there has to be -- additional 502 kV transmission line. So it is just a preference today, not a law, and there's a lot of discussion going on.

Will most those lines, I assume kind of the next phase is going to be more solar intensive, probably just given where you've been using resources. Does that mean that a lot of those lines are going to be the opportunity for SCE development?

I think it's fair to assume that solar has got to be a major part going forward and the primary sources are obviously the Mojave Desert, which is in our service territory.

Okay. Thank you.

Thanks, Dan.

Thank you, Mr. Eggers. Our next question comes from the line of Michael Goldenberg with Luminous, please proceed.

Can you hear me?

Yes, we can.

Okay. Just wanted to ask a couple of questions. First of all, on these leases, I'm still trying to understand. It seems various companies in our universe have taken different approaches to treating the leases. Is there any fundamental difference that at least you can think of between your leases and maybe -- or are they all generally the same?

What we like to do is have Bob Adler, our General Counsel address that.

Thank you, Jim. If you look at the cases in this area, there's a heavy emphasis upon the particular facts and circumstances of each lease. We've done that analysis. We think every situation is different and based upon that analysis, we continue to believe in our facts and the likelihood of the successful outcome.

Okay, but let's say picking one company specifically, I don't know how much you know about PSE&G's leases, but it seems like there should be some since you were involved in transactions with them. Do you know of significant differences, at least on the big ones?

Each company's going to have to analyze their own. I assume that PSE&G did theirs. All I can say is that we've looked at ours and believe that our facts support the conclusions that we reached for accounting purposes.

Okay, and on the IRS letter, did you get a letter, or if you did, would you disclose that?

To my knowledge, we have not received a letter.

Okay. Understandable. Finally, just two other partially housekeeping items. One, on the -- on your Midwest Gen portfolio, and you have alluded that the drop in commodity prices has somewhat diminished profitability of those in Q3. Is that purely from prices standpoint, or is there capacity factor changes as well, since I know that at times they are the load following units. Has there been changes in capacity at those units?

What I said was the potential for earnings, and it was price-driven.

Okay. So the units are still operating in their kind of 60-plus, 70% capacity factor?

Yeah, I'm going to go back. It was price-driven.

Okay. All right. I think that's about it. Thank you very much.

Thank you, Michael.

Thank you, Mr. Goldenberg. Ladies and gentlemen, that was our final question. At this time, I would like to pass the conference back over to your host, Scott Cunningham.

Thanks very much, everyone, for participating. Feel free to contact us if you have any follow-up questions. Have a great day. Bye-bye.