艾索倫電力 (EXC) 2002 Q3 法說會逐字稿

Good morning and welcome to the Constellation Energy Group conference call.

All participants will be able to listen only until the question and answer portion of the call. At the request of Constellation Energy Group this call is being recorded. If you have any objections please disconnect at this time.

I would like to introduce the moderator for today's call, Mr. Mayo Shattuck, Chairman and CEO of Constellation Energy Group. Sir, you may begin.

Good morning,, everyone and thanks for joining us to revenue our results of the third quarter of 2002.

I'm Mayo Shattuck, Chairman and CEO of Constellation Energy.

Before we begin, let me remind you that our comments today will include forward-looking statements which are subject to certain risks and uncertainties. For a complete discussion of these risks, we encourage you to read our documents on file with the SEC.

We'll be speaking to charts available on our website which you can access at Constellationenergy.com under investor relations. It will be a lot easier if you can see the slides to encourage you to access the website, Constellationenergy.com.

I have several members of our senior management team with me today. Our Chief Financial Officer, Follin Smith, Tom Brooks, the President of Constellation Power Source, Mike Wallace, President of Constellation Generation Group, Frank Heintz, President of BG&E, and Tom Brady, President of New Energy and our other non-regulated businesses.

Turning to slide 3. By now I hope you've all had a chance to review our press release. We earned $1.07 per share excluding special items compared to our guidance of $1.00 to $1.10. This is a 7-cent or 7% increase from the third quarter of last year.

Turning to slide 4. We are on track to meet the low end of prior reported earnings guidance for 2002 with earnings excluding special items in the area of $2.45 to $2.55.

As you recall, we began to transition our New England and Texas load serving businesses from market to market to accrual accounting in the second quarter, which has the effect of reducing reported 2002 earnings. These earnings will be recognized in future periods as we deliver power and receive cash from customers.

We were very pleased that the new direction for energy accounting standards validates the approach we adopted earlier this year. Accordingly the EITF mandated shift for nonderivatives to accrual will have little impact on how we book new non-load serving business.

Our shift to accrual was not built into our original guidance in January. This chart provides a comparison of our January guidance for 2002 and our current outlook. As you can see we currently expect that new accrual origination will be very strong and would have resulted in 20 to 40 cents of incremental 2002 earnings had we not made the accounting shift.

The level of our business activity is very strong and we are on track to meet or exceed the guidance we gave in January. Specifically, we expect our earnings would have been $2.65 to $2.95 had we not shifted our load serving business to accrual accounting. This represents growth from 2001 well in excess of our targeted 10%.

Moving on to slide 5. Let me review some of the highlights of the quarter.

We completed the acquisition of New Energy and are very pleased with the way the integration is progressing. We had strong results from both our merchant and BGE and we made additional progress to monetize our noncore assets and continue to strengthen our balance sheet and liquidity profile. We also rounded out our senior management team.

Mark Ugol joined us as Vice President of Human Resources in September with 20 years experience in major petrochemical, software and telecommunications companies. Most recently Mark championed HR strategies and programs that enabled Tell Labs to achieve recognition by "Fortune" magazine as one of the top ten companies to work for in America. And finally, we believe we have been managing our way through turbulent energy markets as well as any company in the industry.

Turning to slide 6, we completed the acquisition of New Energy from AES in early September. We expect the business to add 2 to 4 cents per share this year. The business has been proceeding well since we began to provide wholesale power and credit support in the second quarter. In fact, New Energy has signed up 870 megawatts of new peak load since mid-June when we began providing credit support off a base of 3800 megawatts of peak load served. We estimate about 50% of this activity represents new business with the balance being customer renewals. The integration is on track.

New Energy was a wholly independent subsidiary of AES and has terrific entrepreneurial spirit. They have offices in every region where markets are open for supplying customers competitively and an enviable customer list that includes AT&T, Verizon, Pepsi, Marriott and Bank One to name just a few.

We are trying to make the best of this great focus on customers and take their ability to design energy products to meet commercial and industrial customers' needs and bring to bear Constellation's strengths. We will be developing a matrix relationship of certain New Energy functions into Constellation functions where we think we can bring strength most notably supply and risk management.

Turning to slide 7. We made good progress on our efforts to monetize noncore assets and to focus our efforts on our core operations. We announced the closure of BG Home's merchandise stores.

As we told you in January, we want to spend our management efforts and capital on scalable, profitable businesses. Clearly, retail appliances and electronics are and will continue to be dominated by the national chains.

Last week we sold our senior living facilities for $77 million after tax ending our participation in that line of business. In addition, we continue to make progress in liquidating our real estate portfolio. We are still on track then to have monetized over $700 million of noncore assets by the end of the year.

Turning to slide 8. Before I ask Follin to review the numbers, I would like to pause to reflect on the environment and our outlook. We still have confidence in our growth outlook for 2003 and beyond.

We realize that this outlook is quite different from what you're hearing from most other industry players. We think we have focused on the things that are key for success in a difficult environment.

First in a commodity business, providing value-added products and services is an important way to build more durable margins. We think our business model, which is largely driven by customer oriented load serving gives us the opportunity to bundle risk management services and products.

Our shift of the wholesale load serving business to physical accrual means that we are already building a book of supply contracts which will be recognized in the future, thereby adding visibility next year. The acquisition of New Energy further broadens our customer universe and book of attractive margin business. Our generation fleet is primarily a base load fleet with a heavy composition of nuclear and coal-fired assets. This makes us somewhat less susceptible to the spark spread compression that has hurt others with a higher proportion of gas-fire generation.

In addition, we have acted decisively and early to forward sell the commodity we generate and move to become more heavily hedged for 2003 and 2004. We try to maintain a data driven analytical outlook on the future and act based on that outlook. We see attractive opportunities to take cost out of the organization. We are preparing to implement six sigma and our generation operations are rolling our initiatives to achieve a benchmark cost profile.

Lastly, we fixed our balance sheet early in the year and continue to improve it with a $500 million seven-year debt issuance in August. We are not scrambling for basic capital requirements and can focus on executing our business plan. Our load serving and generation customers clearly prefer a strong, stable supplier. Our long-term debt portfolio and strong liquidity portfolio give us the strength to manage through these challenging times and the flexibility to exploit opportunities as they emerge.

We are proud of what we have accomplished this year in preparing the company for the most challenging period our industry has ever experienced. At the end of the day, we think we're being successful by focusing on getting the simple things right.

With that, I'll turn it over to Follin for a review of the numbers.

Thanks, Mayo and Happy Halloween, everyone.

I'll start with a review of our third quarter earnings and then provide guidance for the fourth quarter. I'll close by expanding on Mayo's comments about our longer term outlook.

Starting now with chart 10. Third quarter earnings excluding special items were $175 million or $1.07 per share which compares to our guidance of $1.00 to $1.10 per share. Including special items net income was $151 billion or 92 cents per share.

Special items totaling 15 cents per share include 6 cents per share related to the write down of our equity method investments in two qualifying facilities and 1 affiliated fuel supplier. Four cents per share relates to work force reductions in our generation operations and our technology group. Four cents per share relates to closing BG&E Home's merchandise stores and 1 cent per share relates to the writedown of real estate and international investments.

Moving on to slide 11. For prior year comparisons, our third quarter 2001 earnings were $1 per share. Excluding special items, earnings were up 7 cents or 7% from the third quarter of 2001 due to the addition of Nine Mile Point, the absence of favorable margin sharing with Goldman Sachs and the favorable effects of warmer weather on BG&E. These favorable items were partially offset by lower market to market earnings, the impact of the merchant of the loan loss of BG&E's large industrial customers from price freeze service onto market based rates, and the impact of higher purchase fuel cost.

Turning to slide 12, I'll walk you through the earnings by segment.

The merchant business earned 89 cents per share in line with our guidance of 85 to 95 cents per share. Compared to last year's third quarter earnings of 89 cents the merchant benefited by 24 cent from the addition of the new Nile Nine Mile Point nuclear plant and by 7 cents due to absence of Goldman Sachs margin sharing relationship.

These favorable items were offset by 19 cents lower mark to market earnings partly driven by the shift from mark to market to accrual treatment for our load serving business. The 7 cent impact on the merchant of the rolloff of BG&E's large industrial customers from price freeze rates to lower market-based rates and the 6 cent impact of higher purchase fuel costs.

Turning to slide 13, our mark to market gross margin was negative $2 million which is in line with our guidance. Compares to third quarter 2001 gross margin of $43 million.

As you know we have been making a concerted effort to shift new origination to accrual. We had new mark to market origination of $8 million and new origination which will be recognized in future periods with a present value of $34 million.

The outlook for new origination in the fourth quarter is very strong. We have several accrual load-serving transactions under way or near completion with an approximate present value of between $20 and $40 million.

As you're no doubt aware, the FASB decided last Friday to rescind mark to market accounting for energy contracts that do not meet the definition of a derivative. Energy contracts such as the load serving business will no longer be mark to market.

We are satisfied with this outcome because it confirms our move earlier this year to record these transactions as accrual. The decision by the FASB validates our belief that a physical delivery business model should be recorded on an accrual basis.

Turning to slide 14, here's a review of industry risk metrics. Our bar is at a low level reflecting our response to a reduction in energy market liquidity. The average bar of our mark to market portfolio for the third quarter was $9.4 million on a four standard deviation basis and $4.7 million on the more widely used two standard deviation business. This level of bar represents a 64% reduction from the second quarter of 2002 when our bar was $26 million on a 4 standard deviation basis.

As of October 28, our bar stood at $3.5 million on a two standard deviation basis. As to the market price risk associated with our merchant generation fleet, in the past, we have provided you with a percent hedged statistics.

By this we mean the percentage of our expected future energy output and fuel input that was forward hedged. On this basis, we're currently 92% hedged for power and fuel for 2003 and slightly over 80% hedged for 2004.

We remind you that we manage these positions dynamically so they do change from time to time, but we expect to continue to follow the posture we have for the past year of being significantly forward hedged. Beyond the disclosure that we have provided in the past, we want to offer some more detail on the 2003 outlook in order to give you more clarity on the e-market price risk affecting our merchant generation fleet.

Turning to chart 15. Here we present our full generation fleet broken into asset classes that help distinguish the way we quantify and manage our key market risk.

Our intent here is to give some more clarity into the generation fleet most important exposures for 2003 to changes in power and fuel prices.

For each group of generation assets we indicate first, the market prices to which that asset class is most sensitive, then we indicate the current percentage hedged relative to that primary sensitivity and last, we show the potential impact on our 2003 EPS for the unhedged portion if we experience the same range of variability in that key price sensitivity in 2003 as we have experienced in 2002.

Of course there's no guarantee we'll experience the same level of variability whether upside or downside next year that we have experienced this year, but we think that this approach gives you a sense of the key market price risks that our merchant fleet is exposed to.

For two of the classes our qualifying facilities and our fully contracted merchants, which are the High Desert combined cycle plant and the Oleander and University Park peakers. We have no appreciable market risk.

For our PJM fleet we are slightly long, flat power being roughly 94% hedged.

If PJM flat power experiences the same range of variability that it has in 2002, 2003 EPS could move up or down by 2 cents.

For Nine Mile Point we are slightly long flat power in New York being 90% hedged.

Potential 2003 EPS variability on the unhedged portion would be plus or minus 3 cents per share. For the other merchant class, which includes two combined cycles, Holland and Reo and two peakers, [Wolfshold] and Big Sandy, the key market sensitivity is spark spread and volatility in the mid continent region.

For 2003, we have hedged 79% of our expected spark spread value. The potential EPS sensitivity associated with the variability is consistent with 2002, is plus or minus 4 cents. Turning to chart 16, our utility, BG&E, earned 20 cents a share versus 15 cents per share in the third quarter of 2001.

Our guidance was 17 to 18 cents. Third quarter earnings were boosted by the [inaudible] third quarter since 1950 which resulted in the delivery of 330,000 more megawatt hours of power than we had forecast. [INaudible] last year BG&E benefited from the weather and from lower interest expense.

Turning to chart 17. Our other nonregulated portfolio businesses lost 2 cents per share, which is in line with our guidance and a 2 cent improvement compared to third quarter of last year. Year over year basis the other nonregulated businesses performed better across the board.

Turning to slide 18. We continue to focus on building a superior liquidity profile and a strong balance sheet. Our liquidity profile is a picture of our ready resource for the next 12 months.

We define liquidity as untapped credit facilities plus cash on hand, plus operating cash flow for the next 12 months. After deducting upcoming debt maturities in the next 12 months you see that we have $2.1 billion in excess liquidity. We think if you compare this to the liquidity profiles of others in the industry, you'll see it's quite strong.

Turning to slide 19 and looking at a more fundamental long-term measure of balance sheet strength, our debt to total capital ratio is one of the strongest in the universe of companies we track. Our third quarter debt to total capital ratio was about flat compared to June 30 at 52% in line with expectations as earnings related cash flows were offset by debt to fund the New Energy acquisition.

Looking forward, before noncash charges, we expect our debt to capital to be about flat at year end at about 52%.

As you'll recall in January we told you we would generate about $600 million organically to be applied toward debt reduction. We still expect this level of cash generation. On the other hand we did add $160 million of net debt with the New Energy transaction.

In total we expect to have reduced net debt by about $440 million from year-end 2001 to year-end 2002.

Turning to slide 20, I want to take you through some upcoming accounting items which will affect our balance sheet. First we expect a minimum pension charge to equity on December 31.

As with many companies in America, equity market declines coupled with interest rate decreases in the past two years have created an unfunded pension liability. Based on estimated performance to date, we expect to recognize an additional minimum pension liability of about $100 million after tax. While this will not trigger a minimum pension contribution requirement, we do plan to responsably increase our funding.

This year we contributed $50 million after tax and in 2003 we expect to make an additional $60 to $70 million after tax contribution. We expect to still have very strong cash flow and balance sheet improvement next year. We are also required to implement FAS-143 by January 1, 2003.

Moving to slide 21. As you note, this statement will require that we revalue our nuclear decommissioning liability. We expect a fairly substantial gain upon implementation of about $140 million after tax due a lower liability, primarily at Calvert Cliffs. The former liability was established in the context of a negotiated regulatory settlement.

The primary drivers of the liability reduction are the higher discount rate, which FAS-143 requires and the license extension of Calvert Cliffs which pushes the commissioning spending further into the future and has the effect of reducing the present value of the liability.

With respect to expense, we expect a favorable change in net decommissioning expense of about $18 million after tax compared to 2002 owing to the lower liability. We caution that the liability is very sensitive to changes in interest rates and could change between now and January 1. For perspective a one percentage point decrease in the discount rate would reduce the gain on adoption by $28 million after tax.

Turning to chart 22. These two items, the pension charge to equity and the gain on the FAS-143 implementation will have a small, favorable noncash impact on our balance sheet.

Moving to slide 23, let me provide some guidance for the fourth quarter. We expect earnings of 33 to 43 cents per share compared to 40 cents in the fourth quarter of 2001.

We expect merchant earnings of 15 to 24 cents per share which compares to 31 cents in the fourth quarter of 2001. Merchant earnings will be lower due to the impact of new billed gas-fired plants which are not expected to generate enough gross margin to offset their fixed costs in the quarter, the impact of higher purchased fuel costs and higher interest expense as a result of actions to improve our liquidity.

BG&E earnings of 18 to 19 cents per share compared to 13 cents per share in the fourth quarter of 2001 with the improvement driven by cost reductions and lower interest expense. The other nonregulated businesses are projected to be about break-even for the quarter compared to a loss of 4 cents in 2001. The improvement relates to a lower level of operating expenses across most of these units.

Turning to chart 24. We aren't ready to provide a point estimate for 2003 earnings. We plan to complete our annual business planning exercise and will be in New York on January 31 to review 2003 results and to roll out specifics for our 2003 plan.

As we look forward to next year, Mayo mentioned that one thing that makes us different is our focus on customer-oriented full requirements load serving. In the interest of helping you understand just what that means and why we believe it's key to our success, I want to take a few minutes to discuss our approach.

Moving to slide 25. Fundamentally, what we do is to provide energy products to customers to help them manage risk. The primary driver of our growth in origination and risk management has been what we referred to as full requirements load serving.

By this we mean providing to distribution utility customers and now, the New Energy, commercial and industrial customers, all the energy and capacity products needed to satisfy their fluctuating end user demand. This is a complex analytical exercise requiring significant investment in systems and human capital.

Let me describe the key components. First we forecast our customers' demand, which is a highly analytical exercise in itself. We disaggregate the complexity of that demand into integral components that can be managed at a liquid market or through bilateral arrangements to neutralize as much of the risk as possible. We hedge the expected position in energy, capacity and ancillary service products through a combination of our own generation fleet, bilateral contracts with other power generators and traded market products.

We also estimate and manage other risks surrounding load and our sources to serve the load. For example, weather drives changes from expected load and forward power prices.

These risks can be managed in part using traded weather derivatives and insurance products. Our sourcing requires varying degrees of unit outage exposure. This risk can be managed at the portfolio level using market based and outage insurance products.

The key elements from our point of view are understanding the customers' need in great detail and neutralizing the risks dynamically. An attractive feature of our load serving business, it also allows us to provide risk management products to generation oriented customers who don't view origination and risk management as a core business.

As a substantial seller of power through our load serving business, we have a very effective network for providing risk management services to generators.

In the interest of definition I should also highlight a few things that are not integral to our business model. We are not driven by the objective of winning money from other energy merchants in the [scrawm] of traded markets. Our earnings have not been driven by the mark to model impact of the 20-year totaling arrangements. When we have entered into totaling arrangements, they have been shorter dated and intended to serve as supply for load-serving arrangements.

And three, we didn't benefit from outside margin opportunities through a big trading presence in western power or natural gas in 2000 and 2001. Our business has been about providing value to customers and managing risk.

Turning to slide 26. We have used our load serving capability to forge very strong customer relationships throughout North America. Here you see the significant growth in peak loads served combining wholesale and commercial and industrial volumes.

Also important to us is the fact that we have been able to build our load serving business outside our home base in PJM.

You see that for 2003 we expect more than 70% of our load serving volumes to be with customers located outside you've of BJM. Geographic diversity is important to us, particularly given the growing geographic diversity in our generation fleet. It's important to us to be able to reach high value customers outside of PJM and we think our load serving business as enabled us to do that.

Turning to slide 27. We continue to see strong growth opportunities to provide risk management products to customers. While trading markets have been less liquid we have been able to size our positions consistent with the market's liquidity and management our risk.

We believe, that in the ISO markets, we are generating assets and load serving obligations are under separate ownership our services will continue to be needed. Providing these services to customers will continue to provide us with the means to manage the risk associated with our own merchant fleets. Our balance sheet has become an increasingly important source of competitive strength and the inclusion of New Energy's expertise in the Constellation family is already paying dividends in terms of our ability to extend the wholesale load serving franchise.

Moving to slide 28. In conclusion, our business model continues to support our faith and our outlook for growth. In January and July, we reviewed the structural building blocks for 2003 earnings growth. Those remain intact.

We have had a few changes in our outlook, summarized in the right hand column, which taken together are about neutral for 2003 outlook. You'll note that market power price changes are not driving a deterioration in our outlook. Actually the impact is about neutral.

PJM prices are up since January, which helps our base load fleet which is largely hedged somewhat, while spark spreads are down which hurts our relatively small unhedged gas-fired generation portfolio.

The shift from mark to market to accrual accounting for load serving will drive lower mark to market earnings but this will be offset by the higher accrual earnings and better quality on earnings overall.

There will be a deterioration in our 2003 outlook compared to the one we shared with you earlier this year of about 7 cents due to higher interest expense which is a direct result of our prudent decision to turn out our debt at attractive long term rates And to increase the amount and tenor of our credit facilities.

We have better visibility into the impact of various productivity initiatives under way. We will try to put more scope on these in January but as a bit of color we recently hired our first black belt to help implement a six sigma program.

Today we recognized costs for our IT department to combine infrastructure groups from across the company in to leverage our purchasing power and to reduce operational support requirements. That initive alone should add 3 cents per share improvement by 2004.

Calvert Cliffs, we mentioned earlier launched its top quartile production cost initiatives. This initiative alone should add 3 cents per share improvement when fully implemented in 2004. Finally, we added New Energy to the family.

In closing, we remain confident in our prospects for growth and look forward to meeting with you in January to take you through our business plan in detail. That concludes our prepared remarks. Now we would be happy to take your questions.

Thank you. At this time we are ready to begin the formal question and answer session.

If you would like to ask a question, please press star one. You will be announced prior to asking your question. To withdraw your question, please press star two. Once again, to ask a question, please press star one now. It will take a moment for the question queue to fill.

The first question comes from Kit Conolodge.

Hi. Actually is Carrie Stevens. First question would be, I noticed you are now targeting the lower end of guidance for 2002. I was curious what factors were bringing you down to the lower end specifically?

What I would say, Carrie, is we gave you a broad 20-cent range, and some -- we had some possibility of the more favorable outcomes with respect to assets such as the unfired gas and with respect to cost performance and I would say now we'll be in the lower half of that range, after our experience to date.

So like the unhedged power plants and cost of things?

Just a combination of the two, but as you'll note we are still within the center of that range and in the last factor, of course, is as you know, we gave you a broad range for the outcome of mark to market earnings and we were at the lower end of that range in this quarter.

Okay, great. And then I know you're not providing a point estimate for '03 but I believe Mayo, in his opening comments, said you're comfortable with prior outlook. So you're still somewhat endorsing a 10% growth rate or is that kind of under -- still kind of evaluating?

Yes. We will of course give you a range, but we still expect that that's going to be part of the range, Carrie.

And then just two more quick questions. First of all I noticed you have a large cash balance. Is that the kind of intention to keep that kind of level going forward or should we expect near-term debt retirement, what's the thinking there?

I think as long we're in such turbulent markets the prudent course of liquidity management action is to maintain a cash balance rather than a commercial paper balance. It's just simply prudent capital structure, liquidity management tool for these times.

Lastly, is -- with your strong free cash flow position going into next year, are you going to be re-evaluating the dividend payout and looking to grow that as kind of more direct return to shareholders as potentially earnings growth isn't as high?

I think in January, of course, we will be reviewing the dividend and announcing where we stand on that. I think consistent with the past our dividend policy will reflect a total shareholder return approach. Keeping in mind the context of our growth rate and normal payout ratios as well as what we see our peers in the industry doing.

Okay, great. Thanks.

The next question comes from Devon Gaughan.

Hi. Congratulations on a great quarter. Just a couple of questions on mark to market. Can you update me on the cumulative mark to market - uhm, gross margin this year?

Sure, Devon. Okay. Gross margin-wise 52 in the first quarter, 80 in the second quarter and negative 2 this quarter.

And just to reiterate, the change from -- you don't expect in term of reclassifying, a lot of this was already accrual. In terms of a magnitude hit, what are you guys thinking?

I think it's really premature.

First of all, from an ongoing business perspective, this is the way we have moved our accounting. From an ongoing business perspective, if anything, this is somewhat positive for us.

As you know, and I think you just alluded to, there is a one-time cumulative adjustment for any nonderivative profits historically recognized. As to what that amount will be and whether it's positive or negative, it is premature for us to speculate as to what that one-time noncash adjustment will be.

You know, we will quite literally have to sort through all transactions and classify every one that's on the balance sheet from history as whether it's a derivative or nonderivative. It's premature to speculate what that will be.

I think the important thing to remember is whatever it is, it is noncash.

And do you think it's rational to assume it's going to be -- the magnitude won't be such that the capitalization ratios will be moved significantly out of whack from where they are now?

I just hate -- I can share my personal guesses with you that it's small, but I hate to speculate until we have done some analysis on it.

Okay. One last question. In term of us the one-time charge, are you just reversing what hasn't been -- what hasn't been "realized yet" but has been recognized. You're not having to take a charge for anything that's been realized right?

You're talking about this new EITF adjustment?

Yes.

Yeah. It will be for any profits that we recognized on nonderivatives.

So I'll give you an example. The profits recognized on a load serving transaction, we'll have to, quite literally, go through and disaggregate.

So something sitting in our [need pool] portfolio from history will have to disaggregate what is nonderivative in terms of what we sold to our customer since it's full requirements and doesn't have a notional amount. Our sourcing will would typically be a mix of derivative, nonderivative and we would have to reverse the part that is nonderivative.

Where we bought power on a unit contingent basis, that generally doesn't qualify as a derivative, and we would reverse any open positions, things that have already been realized, of course, this doesn't affect, but any open positions we would have to reverse, whether there's been a cumulative gain or loss on the nonderivative portions of the transaction.

That makes sense. Thank you very much and congratulations on a great quarter.

Thank you.

Next question comes from Jay Dobson.

Hi, Mayo. Was wondering if you could go over a couple things.

Give us a little insight, if you can, on this origination, particularly the, I think it was on your slide 13, this origination to be recognized in future periods, but looks like it will be on a sort of accrual basis, just where that's coming from and, I think related to that, sort of the '03 gray block on page 26, what you call new wholesale, I'm guessing those two are related. Wondering if you could give us a little insight into what's going on there?

Sure. I'll make a comment. Maybe Tom Brooks would like to expand on it.

I think what we have tried to display on slide 26 is in essence an explanation of the somewhat changing paradigm, but probably more appropriately, a balanced perspective on what Constellation's all about. I'm fond of saying that a couple years ago everyone talked about megawatts owned or megawatts generated.

In this world I think we are trying to convey to people that megawatts served is the balanced part of our portfolio and an important direction for us with a combination of our load serving business and the acquisition of New Energy.

We have really taken a major step towards a much more balanced and comprehensive customer base in other regions aside from PJM. We believe that our expertise in this area is clearly differentiated from others.

The slide that Follin displayed that tried to outline where we were in our business proposition between customers and in essence the supply side of the equation, it's a very sophisticated expertise and one that we think that we're better at than most people in the market . With many of our competitors retreating from really active trading markets, by definition they also have lost their expertise in this type of risk management services.

So we see the direction of the market really coming to us and we have seen an acceleration in activity, a lot of interest in the services that we provide in unregulated markets and we are excited about the proposition that this part of our business paradigm really has quite an exciting future to it.

I might ask Tom to elaborate on that.

Just a couple of other quick comments.

Jay, one in terms of your question on page 13 as to the $34 million which we characterize as present value of origination to be recognized in future periods.

Over the last two quarters when we began the shift for our load business from mark to market to accrual, we wanted to continue to present our business results on an apples to apples basis, so when we present results, report to you the present value of new origination entered into to give you a sense of our overall results consistent with the basis that we projected them in January. We just continued to provide that information to give you a sense of our overall momentum.

In terms of your question on its impact on '03, I guess what I'd say as Follin indicated on page 28 in her puts and takes from the -- from our January '02 outlook for '03 based upon what we have experienced year to date, certainly the impact of the origination that's been -- that will be accounted for on an accrual basis is part of our her overall outlook. In terms of the specific impact I think what what we'll do will provide you more detail on that in January.

Thanks. Just to get a little more specific, though, I'm looking for a customer makeup of that origination, the $34 million on page 13 and thinking how much of that is wholesale meaning as depicted on page 26 new for '03 would not be New Energy and then how of of that 34 is New Energy, if any?

None of that is New Energy.

If I could just follow-up then with two more questions.

Can you review with us, sort, of the cost savings outlook for, sort of, '03 and the next couple of years and then what six sigma could do to that? And then, relative to the price hedges you have on for '03 and '04 that Follin reviewed, can you give us some idea what the hedges are on a price basis or how they would compare to '02 so we could get an idea, if any, margin compression we would see --

Let me take the first part of your question, and I'm not going to give you numbers yet, Jay, I'm not ready to quantify how much cost savings will be in '02 and '03 because, quite literally, we are still working through that and developing a plan and before I give you numbers, I want us to have a plan we have all agreed to and committed to. I tried to give you a little color in my closing remarks by just showing you two initiatives which we announced today and which you saw the cost of today, which were the IT rationalization and the Calvert Cliffs product cost initiative.

I'll let Mike jump in here and talk a bit about some of the initiatives in a second but before I do that I would just say, we - beyond Mike's operation are launching six sigma and have productivity initiatives marching through a number of realms.

The most logical realms where you see these kinds of initiatives bear fruit are in procurement, they are in bringing together transactional services throughout a company in a shared services organization. Those are the kind of things that you see happen. At the staff level and let me let Mike talk to you about the things you can see from a generation perspective.

Hi, Jay. We're leading, as Follin indicated, with the top quartile production initiatives at Calvert Cliffs.

Results of that are actually being experienced in the fourth quarter of this year carried through next year and on the heels of that, next year we will be evaluating Nine Mile Point off the Calvert Cliffs experience and lining up a similar approach following in some respects the same sort of benchmarking analysis, but it will be further in time, about a year delay, before we see the results from Nine Mile Point. Beyond that, on the fossil side, we have process reengineering under way right now.

You'll recall that at the beginning of the year we reduced the work force by about 200 people. The process reengineering that is going on right now will lead to areas where we can improve the overall efficiency of the operation, especially with more flexibility in the fuel spec that we use and the utilization of synthetic fuels in our power plants, both of which will significantly take down our fuel costs. That of course helps with competitiveness of that generation and therefore also brings us up on the revenue side.

Then finally, we have over arching synergies that we are now drawing together as we have pulled the entire fleet together as one. In technical and business service areas and probably the principal one there will be our procurement initiative which we refer to as Constellation Competes which is also under way and we expect to produce significant savings next year as we reduce the number of vendors that we work with and seek to get more competitive pricing due to the aggregate size of the fleet we now have. Just a few of the things.

In January we'll be positioned to take you into more detail as to how we expect to realize those specific savings in '03 and '04.

I think the second part of our question, Jay, was at what prices have you established hedges?

I think I would like to defer that question until January, but I will take you back to the overarching comments of in January of '03 when we met we told you we were about 75% hedged for 2003 and we are now 92% hedged for 2003, and as we've marched through the year, we have been increasing that percentage hedge for 2003 and the impact of changes in power prices since we first sort of gave you a profile of our what our '03 earnings would look like over the course of this year on both of the parts that were unhedged at the beginning of the year and the parts that remain unhedged is about flat. What we have seen since January of '02 for '03 forward prices has been a slight increase in PJM prices and of course a collapse of spark spread which has hurt -- PJM prices have helped us on the unhedged part whereas spark spread collapses have hurt us and the two impacts have been about offsetting with respect to our 2003 outlook.

Thank you.

The next question comes from Greg Gordon.

Hi, Greg.

Morning, guys. One or two questions. One was at the beginning of the call, you sort of gave a wishy-washy to the question on earnings outlook. As we stand today, you guys are still supporting a 10% earnings growth goal for 2003, is that correct?

I'm sorry if that came across as a wishy-washy answer,Greg. We will give you a range, similar to what we usually do in January. We will give you an EPS range for 2003 and not a $1 figure number and included within that range will be the EPS number that is 10% growth. Is that helpful?

Yes. At this point do you consider the 10% goal as being sort of a mid-point of that evolving range or is it too soon to say?

I think it's premature for us to give you that. We want to complete the exercise and give you that answer in January.

Great. Second question, one of the things that seemed to be missing from your sort of incremental positives and negatives was the $18 million reduction in decommissioning expense, so would that be an incremental positive above and beyond the new factors for building blocks for '03 or is that already anticipated?

I guess there were a couple of accounting changes always baked into our outlook and one is frankly there is the likelihood that the FAS exposure draft that was released in late June with respect to consolidation of special purpose entities will require that we bring the High Desert lease on balance sheet and for that reason we have always shared with you what the balance sheet debt is.

If we have to bring that on balance sheet, that will actually have a negative effect on earnings as the lease payment goes away and interest expense and depreciation come into earnings. So I guess I've kind of used those accounting items as together not being very material change.

Okay. Thank you.

The next question comes from Mark [Macoeyak].

Hi. Good morning. Two questions really. One relates to the load serving business.

If new New Energy seems to be going strong since July and non-New Energy both in Q3 and Q4 pipeline is strong, I wanted to kind of put that strength in up against the fact that between PJM and New York the flat power expose injury the unhedged is 500 to 600 megawatts if I did the percentages correctly, and kind of understand if the growth in the load serving businesses can absorb the unhedged portions in PJM in New York and turn the flat power exposure into more of a structured product so that you can get a premium over flat power.

I would say yes, there's a reasonable outlook for that.

As we serve more load volumes, we certainly will source power from our own resource as well as from bilateral transactions and from the traded markets. So we would expect both with respect to our PJM fleet and with respect to some of the uncommitted capacity from our midwest fleet to use those resource as part of future load serving opportunities.

In general, I would say yes, we believe that the load serving business enables us to achieve somewhat higher margins than we could achieve were we selling the undifferentiated product at the liquid hub.

Okay. Second question off of that, as you layer on these traunches of PV each quarter, what kind of average life should we assume?

Assume three years, Mark.

Lastly, there's been a lot of chatter in the marketplace regarding who and who does not need to raise equity. Could you kind of confirm that what you've gone through in your liquidity analysis and also any thoughts out of rating agencies that for the near term you would expect not to have to tap any equity issuance?

Yeah. I -- I can't do comparisons.

Probably inappropriate for me to do comparisons of our liquidity profiles and our debt to capital ratio versus other companies who are rated triple B plus, mid triple B, I think if you do that, you will see that our profile is very, very strong, you can couple that with the fact that we issued debt in August and the rating agencies confirmed our ratings and subsequent to that in September, Standard and Poor's put out a piece on comparing the profiles of different companies and why different companies with the same debt to capital ratios can merit different ratings and they used us as the example of a company whose rating is also supported by strong cash flow coverages.

All of that comes together to say there's no need for us to issue equity to support our ratings.

The -- you know, event-related items such as if there were a big investment we wanted to make, we would take an approach of a balanced funding on something like that. We would use a mix of debt and equity, but our status quo outlook is that there's no need for us to actually issue equity to support our balance sheet.

Thank you.

The next question comes from Paul Rosen.

Good morning. A few questions. Some of them pretty simple, one is a little more philosophical.

Have you completed an investigation to assure there's been no bogus reporting to index compilers.

We have provided a pretty limited amount of information to various publications that compile indices.

Of note is the fact that we are not and have not been a significant player in gas trading. The gas market seems to be the area where there's a significant amount of contracts indexed to various published indices. So we are -- we don't think this is particularly a significant issue for us.

We have done a preliminary review of our past practices in this area and that review would confirm that assertion.

More recently, because of the level of focus on this issue throughout the industry, we made the decision to discontinue providing information to publications because we're a part of the industry Chief Risk Group -- our Chief Risk Officer, John Collins is an active participant there.

The CRO group is in process of developing guidelines for interactions with these publications and we made the decision to hold in abeyance further provision of information and publications until that guidance comes out from the CRO group.

My second question is have you extended the depreciation lines for Calvert Cliffs, I was wondering if you had a breakout of what weather contributed versus '01 and normal.

Lastly, you talk about your percent hedged position, but that's subject to your assumptions regarding capacity factor. I was wondering if, in the future, you would like to give us what your factor assumptions are, because absent that the percent hedged is kind of a useless number. Can you comment on those things?

With the latter, the capacity factor assumption on percent hedged, sure, we'll be willing to share that with you in the future, Paul.

That would be very help.

And show you it's very reasonable compared to past performance.

Because on the capacity part, you have 104 percent hedged?

Exactly.

Importantly here, I think what we're trying to indicate is not the full scope of all the potential sources of earnings variability, but only the exposure to market prices for power and fuel.

Culvert Cliffs deprecible lines have been extended.

What the weather did for the quarter versus last year normal?

BG&E's -- earnings were improved 3 cents over prior year associated with the weather and versus our forecast. It was up about 3 cents. I think I indicated 330,000 more megawatts delivered than we had forecast and a good rule of thumb, for about every 100,000 megawatts of power it draws about a penny in earnings.

'01 is basically normal?

Slightly cooler than normal.

Thank you very much.

The next question comes from Zach Schweiber.

Hi. It's Zach Schweiber. Can you hear me? Just wondering and trying to sort of model up 2003 and the whole shift from mark to market to accrual based earnings, you mention that the average life of the foregone mark to market earnings in '02 was three years. Can you talk about sort of on a year to date basis, you gave a number for the third quarter, what it was for the second quarter, so we can sort of look at the whole bucket and try and spread it out over three years and also what the discount rate is that we ought to use, probably some liable discount rate plus the credit spread?

Yeah. -- I guess I would -- I think we told you assume 20 to 40 cents per share from this sort of incremental category of earnings that plays out in the future. If you gross that up to a gross margin and divide it over the three quarters that it occurred in, that gives you a range of what the run rate has been this year and then if you take that and amortize it into earnings over three years, just ratably over 12 quarters. And each quarter there's this new traunch coming on of business that 's been originated, you'll get a fair picture.

Great.

And sort of looking at the June balance sheet and looking at the balance sheet for the third quarter, it looks like you had about $500 million of net mark to market energy assets total as per the June quarter. $256 million which is pretty small if you exclude the New England load serving business.

Is there any way that we can just say this whole one-time adjustment noncash to the balance sheet shouldn't be greater than either the $256 or the $509 on a pretax basis just to put some parameters around it?

We broke out for you, as you'll recall, last quarter we broke out that asset into three buckets. One is the New England load serving business, which at September 30 was $304 million. We talked about the hedge against the PJM fleet, which is an option which must be accounted for in a mark to market basis. And then --

How much was that again?

That is $111 million. And then the remainder, which is -- hang on, I'm punching it out on my calculator, which is $81 million to get you to the total mark to market. September 30 is heavily influenced by the CDWR contract.

Which one is influenced by the -- the $81 million?

By the small two-year sale of power this year and next year that was done with the CDWR. You know that that option that I described will continue to be treated as a derivative. I know the DWR buy-sells of power will be treated as an option.

On the remainder, a lot of analysis everyone analysis has to be done to disaggregate it. It would be premature for me to tell you how to relate that number to what the balance sheet impact is likely to be on implementation.

Hypothetically under a worse-case scenario, were we to just write off the $300 million and tax effective, is that the worst case impact on the balance sheet, $200 million?

I just don't want to speculate on it, Zach, until we go through the analysis.

Okay. Thank you so much.

We have time for one more question. This question is from Greg Arl.

Thanks. Good morning.

Morning.

Was wondering if you could update us on the level of guarantees on the third quarter?

This is John Collins, Chief Risk Officer of the company. At the end of the third quarter, we had about $1.6 billion dollars of guarantees outstanding.

Compared to what in me second quarter?

I don't have that handy, it's not much different. May be slightly higher.

I think the key piece to look at there, that's the dollar value of the issues. Market value of those guarantees is closer to $400 million. So I meanwhile the obligation are a lot higher on the face, the absolute market value of those guarantees if you were to basically look at the underlying liabilities to support those is $400 million.

Thank you.

Great. Thank you all for joining us. Have a Happy Halloween and we'll look forward to seeing you all in January.

This concludes today's teleconference, you may disconnect at this time.