艾索倫電力 (EXC) 2003 Q1 法說會逐字稿

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

All participants will be able to listen only until the question-and-answer portion of this call. In addition, please be advised this call is being recorded today. If anyone does have any objections, we ask that you please disconnect at this time.

I will now turn the call over to Mr. Mayo Shattuck. Sir, you may begin when ready.

Mayo Shattuck, III: Thank you.

Good morning everyone. Thank you for joining us to review our results for the first quarter of 2003.

I'm Mayo Shattuck, Chairman and CEO of Constellation Energy. I'm joined here today by several members of our senior management team, our Chief Financial Officer, Follin Smith, Thomas Brooks, the President of Constellation Power Source, Mike Wallace, President of Constellation Generation Group, Frank Heintz, President of BGE, and Tom Brady, who's the Vice President Corporate Strategy and head of Constellations Commercial & Industrial Supply Businesses including New Energy and Alliance Energy Services.

Our presentation today is being web cast. Our comments are focused around slides which are available on our web site at constellationenergy.com under investor relations.

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 will use non-GAAP financial measures in this presentation to help you understand our operating performance. We have attached an appendix reconciling non-GAAP measures to GAAP measures. This appendix is available as part of the presentation posted to our web site.

So moving to Slide 4, the first quarter of 2003 built upon many of the themes I detailed for you during our January 31st analyst presentation. Management focus, crisp execution, operating excellence, balance sheet strength and superior risk management. These all proved to be significant contributors to our first quarter success.

Perhaps the most important concept I presented at that analyst presentation was the idea of earning the right to grow. Of note, this represents the 6th consecutive quarter that this management team has met or exceeded earnings guidance. That we were able to achieve this in a highly volatile quarter marked by historic natural gas price increases and severe first quarter weather in the northeast , speaks to the earnings and operational balance that we enjoy at Constellation.

It is this maintenance of balance across businesses in a highly hedged risk portfolio that investors should come to associate with Constellation. A model which was characterized by steady earnings growth and not by dramatic weather or price driven earnings variation to the positive or the negative. Over time, it is our belief that consistency, earning the right to grow will result in a premium earnings multiple and long-term shareholder value.

Turning to page 5, by now I hope you've all had a chance to review our earnings press release. As we explained on January 31st, the industry implemented two significant new accounting standards this quarter which resulted in a $1.20 per share charge to our earnings. Excluding special items and the cumulative effects of changes in accounting principles, we are earned 36 cents this quarter which compares to 49 cents in the first quarter of 2002. This year-over-year decrease was expected, as we had higher mark-to-market earnings in the first quarter of 2002. This result is squarely within the guidance range provided on January 31st, but our underlying performance is stronger even than these earnings reflect.

As Follin will elaborate, the implementation of EITF 02-3 created mismatches between the accounting treatment of positions in our competitive supply portfolio and hedges on those positions. These hedges, which are accounted for under mark-to-market, reduced our first quarter earnings per share by 7 cents. The offset in gain in accrual positions within our competitive supply portfolio will be realized in accrual earnings over the balance of this year, contemporaneous with the negative cash flow on the hedges. Excluding the time impact of these hedges earnings per share for the quarter were 43 cents, at the top of our guidance range.

Turning to Slide 6. The first quarter demonstrated that our objective of building a business model which is not driven by weather or market price swings is working. A balance of cold weather in the first quarter and operating efficiency, resulted in record earnings at BGE. This business continues to provide strong earnings and cash flow stability for Constellation.

As this quarter demonstrated, the T & D business is highly complementary to merchant load serving. Specifically, times of extreme weather driven demand increase the cost of power we supply to our competitive supply customers but are good for the revenues of the T and D business. We like this balance in our business model. Our merchant's performance in this quarter highlights our ability to navigate volatile markets.

The first quarter was a difficult quarter to be a load server due to a significant increase in natural gas and power prices, then the implementation of locational marginal pricing in NEPOOL. Our execution in these markets gives us growing confidence in our fundamental business model and highlights the wisdom of diversifying regionally and along different parts of the value chain. Our ability to model, price and manage risk is very important in market conditions like those experienced in the first quarter. The unique earnings relationship between BGE and the merchant, as well as our highly hedged portfolio, drive reduced earnings volatility and earnings consistency.

In the first quarter, we also continued our efforts to aggregate customers and extend our customercentric business model via our competitive supply business. Through successful origination efforts in North America and portfolio acquisitions from CMS, Nicor and Dynegy we've continued to increase our market share and leadership within this customer segment.

Finally, as highlighted in the press releases we issued last week regarding our Calvert Cliffs steam generator replacement and the early commencement of operations at our High Desert facility, there's a new level of operating excellence underway within our generation business. Both of these plants will meaningfully contribute to earnings this year and for years to come.

Moving now on to Slide 7. We are expanding our competitive supply, gross margin and market share through the origination efforts and marketing tenacity of our professionals. In both the wholesale and C&I load serving markets, we are enjoying success by applying focus and resources at a time when others are vacating the competitive playing field. The retrenchman of our competitors to their pre-deregulation business models is contributing to our customer aggregation strategy.

In the wholesale and structured origination markets, we are leveraging our risk management platform and intellectual capital to meet the complex needs of our customers while earning return for our shareholders. Our C&I business is the largest national provider of enregy cost management and billing services. We enjoyed superior customer retention rates, again, in the first quarter.

In the current capital environment, many merchants have also resorted to selling their contractual portfolios as a means of raising cash. Accordingly, we have seen attractive portfolio valuations within the competitive supply business. Where these portfolios are synergistic with our own, we have been selective acquirers. As we see load serving RFPs issued, or customer portfolios become available in the deregulated markets, we'll employ disciplined modeling and diligence techniques.

We will only submit bids or make acquisitions when they meet our strategic and financial criteria. And let me emphasize, we will only act when we believe returns will exceed the appropriate risk adjusted hurdle rate. We are not buying growth at the price of unquantified risk.

Turning, please, to Slide 8. We completed the steam generator replacement at Calvert Cliffs unit 2 on April 22nd, in just 66 days. This represented a new world record for a two part steam generator replacement. We examined each critical path for the outage and endeavored to improve upon past performance.

The result was 58 days shorter than our 2002 outage and 32 days ahead of the 98 days included in our January guidance. We also accomplished the outage while meeting stricter NRC ultrasonic testing requirements. The incremental 2003 EPS impact of completing the outage earlier than planned is 6 cents.

Importantly, as was the case with Unit 1 we had an issue-free inspection of the vessel head and associated penetrating nozzles. Nonetheless, we have decided to move forward to replace the reactor vessel heads in Calvert Cliffs units one and two in the years 2006 and 2007 respectively.

The total project, including a number of enhancements which will improve operating performance will cost approximately $93 million. This amount is consistent with our capital plan, which keeps total capital spending below $600 million per annum in 2005 through 2007. With a replacement of both unit steam generators and vessel heads, Calvert Cliffs will be well-positioned to operate safely through 2036.

The early commencement of operations at High Desert is another important operational and financial milestone for Constellation. In prior guidance, we had projected commencing operations at High Desertia in July 2003. The April rollout of that facility adds an incremental 7 cents per share for 2003.

Turning now to Slide 9. I am pleased with our performance in this challenging quarter. The spike in gas prices, severe weather and plant outages in other merchant fleets drove extreme price volatility. Our ability to manage the cost of supplying power to our customers in this environment reflects the wisdom and value of our business model.

Our balance, which comes from diversity along different parts of the value chain, wholesale load serving, C&I load serving, generation, transmission and distribution is an important contributor to our success. And our success in the first quarter increases our confidence in the 2003 outlook. We continue to believe our earnings should be $2.65 to $2.85 per share, representing a 5% to 13% growth over 2002.

As I said earlier, we understand that we must constantly earn the right to grow. Our success in this past quarter meetings meets that test. Our approach is clearly working. We believe our financial strength, operational excellence and overall discipline will continue to create value and opportunity for our company and our shareholders.

Turn to Slide 10. I'd now like to turn the presentation over to our Chief Financial Officer, Follin Smith, who will provide a more detailed description of our financial performance in the quarter.

Follin?

Thank you, Mayo.

Good morning everyone. Thanks for joining us today.

I'll start with the review of the first quarter and then provide guidance for the second quarter.

Turning -- starting with Slide 11. First quarter earnings excluding special items were 36 cents per share. Excluding the timing-related impact of hedges, left behind in mark-to-market by EITF 02-3 implementation, earnings per share for the first quarter were 43 cents. This compares to our January 31st guidance of 33 to 43 cents per share.

Two noncash changes in accounting principles, negatively affected reporting earnings and equity by $1.20 per share in 2003. Consistent with prior projections, there's$1.61 per share impact of implementing EITF 02-3. In January, we presented detail on how earnings will reverse out this quarter and will flow back into the P&L in the future.

You'll also note that EITF 02-3 makes our income statement look very different. The move to accrual requires that we recognize revenues on the energy delivered to customers on a gross basis. Accordingly, you'll note that our first quarter 2003 revenues are $1.6 billion higher than our first quarter 2002 revenues. $900 million of this increase is due to EITF 02-3 implementation, and $570 million is due to the addition of New Energy and Alliance.

Partially offsetting the EITF 02-3 charge, implementation of FAS 143, accounting for asset retirement obligations will favorably affect earnings by 41 cents per share. Special items of a positive 4 cents primarily reflect gains from the continued divestiture of noncore assets.

Turning to Slide 12. Let me elaborate on the 7 cents interquarter timing item resulting from a mismatch in the accounting treatment of some of our hedges. Before EITF 02-3, all of our New England load serving positions entered into before mid-2002 and our hedges against those positions were mark-to-market. With EITF 02-3 implementation in the first quarter, all of the load serving contracts were converted to accrual accounting. On the other hand, several valid economic hedges on these positions did not qualify for accrual hedge treatment and remained in the mark-to-market portfolio.

In the first quarter, increasing forward prices shifted value between the accrual load positions and the associated mark-to-market hedges. We'll realize gains on the accrual load-serving positions which will be realized in cash over the balance of the year, offset by cash losses on the hedges which we had to mark-to-market this quarter.

In the first quarter, the impact of this timing difference resulted in a $20 million pretax loss or 7 cents per share on the mark-to-market hedges. By the end of the year, 7 cents will come back in accrual earnings. Excluding the 7 cents impact, earnings per share results in the first quarter were 43 cents, at the top of our January 31st first quarter guidance range.

Moving to slide 13, to examine the earnings of the segments, the importance of our operating and financial diversity is apparent. Our overall earnings included record first quarter earnings for BG&E, and a loss at the merchant reflecting normal seasonality of this business. All businesses, BGE, other nonregulated, and the merchant, after adjusting for the impact of the accounting mismatch on the hedges, met or exceeded earnings guidance for the quarter.

Turning to Slide 14. The merchant business lost 12 cents per share, or 5 cents per share after adjusting for the 7 cent impact of the hedges. In line with our guidance of minus 5 to plus 5 cents.

The merchant's first quarter loss of 12 cents compares to earnings of 18 cents in the first quarter of 2002. These lower earnings primarily reflect the impact of lower mark-to-market earnings and the timing impact of the hedges we just described. Several additional items also affected the year-over-year comparison. Volatility of power and gas prices, cold northeastern weather, and outages at two plants from whom we source generation hurt the load-serving business.

The new gas-fired plants which commenced operation in the second and third quarters of 2002 have a negative impact in the winter months when their costs are higher than the gross margin they generate. We reversed the PGE and SCE reserves last year in the first quarter when they began payments.

On the favorable side of the ledger, we've benefitted from strong wholesale accrual origination, the addition of New Energy and Alliance, and our push for productivity continues to add to the bottom line.

Turning to Slide 15. In total, we generated merchant gross margin of $271 million, down from $311 million in the first quarter of 2002. Our PJM fleet delivered total gross margin of $165 million, 61% of our total merchant gross margin. Our plants with PPA's contributed total gross margin of $97 million, or about 36% of our total merchant gross margin. The increase compared to last year relates to the commissioning of our Oleander plant ,which went into service in the summer of 2002, and higher availability at Nine Mile Point.

Our competitive supply business contributed total gross margin of $3 million compared to $52 million in 2002. Excluding the $20 million timing impact on the mark-to-market hedges, this was about in line with our guidance for the quarter. We expected a big decrease in the mark-to-market component of the competitive supply segment in the first quarter. New origination was strong and I'll be discussing this in a moment.

Our peakers and qualifying facilities contributed total gross margin of $6.2 million, down from $12.9 million in 2002. The decrease versus last year primarily relates to the fact that we unwound $9 million of PGE and SCE reserves last year as those companies began making payments in the first quarter of 2002.

Moving to Slide 16. Our competitive supply business is generating new business at a pace consistent with our 2003 guidance. Our wholesale accrual business originated 19 transactions with a present value of $53 million in the first quarter. The deals had a 1.5-year average duration and margins consistent with our January 31st guidance.

In January, we projected $60 million in new origination margins for 2003. We expect to recognize $49 million from deals originated in the first quarter of 2003 alone.

Mark-to-market gross margin was a loss of $14 million or a gain of $6 million, excluding the timing effect of the mark-to-market hedges we just discussed. On January 31st, we provided guidance of $110 million mark-to-market., producing a of range of outcomes with a midpoint of $90 million.

Liquidity became quite thin during the volatile periods of late February and early March making us cautious about undertaking mark-to-market activity. We're going to be cautious here because we can be. Given the recent positive developments on the operational side, we prefer to be cautious on mark-to-market, due to the recent liquidity rather than take overall Constellation earnings guidance off for the year. It's just too early for that.

New Energy originated $6 million in the first quarter. This is on track with the quarterly forecast included in our guidance, and in line with the normal seasonality of this business, where C&I customers tend to want enter power contracts in the second quarter before the summer season and in the fourth quarter before the winter season.

We're pleased with the progress of the New Energy and Alliance acquisition as both are performing better than planned. In total, with only a quarter of the year behind us, we have new margin generation in the first quarter representing 30% of the year's competitive supply new margin target.

Turning to Slide 17. Maintaining highly hedged portfolios was important in the volatile markets just described. Through the balancing of load and competitive generation in our competitive supply business, we were able to report earnings within the range issued at the January 31st analyst presentation. Within our accrual portfolio, we're substantially forward-hedged for both 2003 and 2004. For 2003, we're 97% forward-hedged and for 2004, we're 88% forward-hedged.

As a result of our highly hedged approach to managing risk, you should not see wide earnings swings to the negative or to the positive relative to our earnings guidance. We believe this is the prudent course of action and that earnings consistency will be rewarded over time.

Turning to slide 18 and the mark-to-market risk profile, we continue to maintain conservative VAR levels implemented in the last two quarters of 2002. Importantly, despite the increased level of volatility in the market, which by definition increases value at risk, we were still able to maintain VAR statistics far lower than our historical average.

Turning to Slide 19. BGE earned 48 cents a share versus guidance of 37 to 43 cents due to colder than normal weather and better expense performance. BGE earnings were 13 cents better than the first quarter of 2002, benefiting from the first quarter effects of cold weather, lower interest expense, and favorable O & M expense performance.

Turning to Slide 20. Our other nonregulated portfolio of businesses broke even in the first quarter compared with the loss of 4 cents per share last year. The improvement was driven by stronger performance at BGE home.

Turning to Slide 21 and a look at our first quarter balance sheet. Our debt decreased by $132 million, but our equity balance was down $191 million driven by the effects of the EITF 02-3 implementation. Our debt to total capital ratio was unchanged from the level of 52% at year-end 2002, a good outcome given the large accounting principle effects in the quarter.

Turning to Slide 22. Let me provide some guidance for the second quarter of 2003. We expect earnings in the range of 33 to 43 cents per share, compared to 56 cents per share in the second quarter of 2002. We expect the merchants earnings to range between 20 and 30 cents per share compared to 39 cents in the second quarter of 2002.

Several unfavorable items affect the year-over-year comparison. A decline in mark-to-market origination, higher interest expense related to our balance sheet strengthening actions, three new gas-fired plants that came online in 2002, which do not generate enough gross margin to offset their fixed cost.

These negatives are offset by Calvert Cliffs unit 2 returning to service in April, High Desert coming online in April, earnings from New Energy and Alliance and higher expected accrual origination. We expect BGE to earn between 12 and 16-cent per share compared to 15 cents per share last year, and the other nonregulated businesses should break even compared with a gain of 2 cents in the second quarter of 2002.

Turning to Slide 23. As Mayo indicated, we continue to expect 2003 earnings in the $2.65 to $2.85 per share range. The early commencement of operations at High Desert and the early completion of Calvert Cliffs outage will result in an estimated incremental $34 million of EBIT.

We think it's too early to take guidance up for the year because of this. As I mentioned earlier, we're a bit more cautious on undertaking mark-to-market origination given the significant reductions in volumes during February and March.

In addition, first quarter volatility negatively affected the load-serving business, a nine-mile point outage ran longer than expected and combining with the Sarbains-Oxley Act will be costly. For perspective, the SEI estimates that efforts associated with the new requirements for internal control attestation will cost public companies between $4 and $9 million to implement. The net result is that while operational developments are positive, we're not taking guidance up.

In conclusion, our outlook is still consistent with our January projection, but with better visibility, given our good prospects on accrual origination and higher generation plant profits. That concludes our prepared remarks.

Now I'll turn the presentation back to the operator for questions and answers.

Thank you, ma'am. At this time, we'll begin the question-and-answer session.

If you'd like to ask a question at this time, please press "star 1" on your touch-tone phone and we'll announce you prior to the question. If you would like to withdraw that question, press star 2. But again, to ask a question at this time, please press "star 1" now on your telephone.

And we'll take just a moment for the questions to register in our queue. Our first question comes from Steve Fleishman with Merrill Lynch. Your line is open, sir.

Yeah, hi guys. Can you hear me?

Mayo Shattuck, III: Yes, we can.

Okay. Can you give any update, if possible, on cash flow targets and CAP EX targets for this year?

Sure.

Is cash flow better because you're targeting now more cash earnings?

Well, as you'll recall, Steve, the mark-to-market deals that we were projecting were pretty short. I don't think this is going to have a major impact on cash flow for the year. I looked at cash flow a couple of days ago and we're still expecting it to be about in line with what we showed you in January.

And can you just repeat those numbers again, cash flow and CAP EX?

Sure.

CAP EX, let me get this out there, because it hasn't been.

We told you CAP EX would be about $735 in 2003, and we told you it would be under $700 million in 2004. Our projections for 2005, 6 and 7 are under $600 million per year and I wanted to make sure that's clear to everybody. That with the declines in our new-built program, we're able to accommodate the big project that we're scheduling at Calvert Cliffs even with the significant decrease in the overall level of capital spending.

And cash flow, here, let me just look to it. Okay, the midpoint of the range for net income is $455 million, D&A is $483 and capital spending is $735, such that net CAP EX is a use of $152. We project that after tax cash flow from asset dispositions will be $128 million.

Working capital and other balance sheet changes will be about a source of $49 million. The pension contribution after tax will be an effect of $62 million negative. And then we will do small equity issuances to our benefit plans, to source the shares required for those, as well as, we committed to fund 50% of the Alliance and CMS acquisitions with equity. And that's about $27 million in equity for total equity issuances of about $63 million, dividends of $169 million gets you to cash flow for debt reduction of $313 million.

Hang on, there was a shift in the working capital. Working capital should have been more like $150, which gets you to cash flow for debt reduction in the area of $400 million.

Okay.

Oh, and I've got someone next to me just correcting me saying that I said $483 for D & A , depreciation and amortization, and it's actually $583.

Okay, yeah. I don't know if Tom is on the line, but can you give a little flavor on kind of how you managed the New England market during the quarter? When, you know, prices were high, plants down. I mean, this is kind of the whole test of the -- somewhat a test of the strategy, essentially. How you managed earnings. In tough markets like this.

If you could give a little more flavor on how you deal with that, it would be helpful.

Mayo Shattuck, III: Tom is here.

Sure, Steve.

Absolutely, I think, you know, we regarded the level of market volatility that occurred in late February and March as very much sort of a pressure testing event for our risk management approach. And I'd say overall, certainly we, as we told you in January, we're managing a balanced portfolio. I think the balance caused things to perform pretty well over that volatility period.

There were, you know, a couple of items which were negatively affected by the price spike, particularly in NEPOOL. You know, particularly the effect of the correlation between power prices and load had some cost to it.

And in addition, as another example, we served a certain amount of default service in New England. And some of the other competitive suppliers were putting customers back on the utility who then were served at default service. So our load grew to a certain extent due to increasing prices.

But those, sort of notable, kind of, price-spike-related events, we had those price spike related events out there in addition, in terms of sort of the full year, we told you in January that our portfolio was hedged, you know, between 95% and 100% hedged, that level of balance, you know, continues to exist. And the impact of that basically is, you know, is relatively positive in terms of -- or is, you know, yields no, you know, no huge impact one way or the other.

Mayo Shattuck, III: Steve, I might just add that that, you know, you are absolutely right sort of in making the comment. It's really the test of the business model that, you know, that NEPOOL turned out to be, in effect sort of an event, but well-balanced against other aspects of the company.

In particular with BGE performing so well, it sort of proves the balance in the model itself. So we, you know, we're delighted to see, what I think some people described as the 16 sigma event in gas prices, not affect the performance at CPS to any significant degree.

Okay. Thank you.

Mayo Shattuck, III: Next question?

And the next question comes from Jay Dobson with Deutsche Banc. Your line is open, sir.

Hey good morning. Three questions, if I can.

First, can you, I think Follin you went through the two plant outages, maybe you can just review and let me know what those were, confirm what they were.

Second on page 15, when you sort of break out the merchant results I'm just wondering where I should look for whatever amount of prop trading happened in the quarter.

And then, Tom, if you can just go back over a comment you just made where you were going through one of the hurts in New England were a negative impact of the correlation between price and load. Can you just help us understand that comment?

Let me -- the first part of your question, what did you say about the plant?

Yeah, I think when you were talking about the merchant operations you said what negatively impacted you were two unexpected outages of plants that you buy or get load -- get supply from, and I just wanted in detail with a those were, and the impact of them in the quarter.

We had two different unplanned outages of third-party generation from whom we source. I don't think I should mention the names of the firms from who we source who had unexpected outages. The impact on profitability for us was about 3 cents per share. It was, you know, again sort of a perfect storm where we lost generation right when there were spikes in market prices. This gets back to -- this was the test of the business model this quarter.

Okay. And assuming they're unit contingent you had to go into the market and buy that power.

Mayo Shattuck, III: That's right.

Perfect.

Right. Although you should be aware, Jay, that before we're heading into -- in general, before we're heading into peak periods we evaluate things like outage insurance, buying out of the money calls, we look at economic ways to limit our downside on these kinds of exposures.

We have, relative to our particularly non-owned -sources of generation that we do not own, we have in past years purchased outage insurance. That typically -- the typical product that has been offered has been a summertime product. And obviously the event that occurred was not a summertime event.

And, you know, it may be that insurance products will develop to cover such events in nonsummer months and certainly we would evaluate them if they were available.

On the price load correlation comment, Jay, the concept there is simply in our competitive supply segment, when prices -- if it's very cold in New England in February, loads will be higher and prices will be typically correlated to those high loads and will likewise be higher. So the effect of -- so if we plan for -- if we plan for normal weather and very cold weather occurs, you have both higher prices and higher loads and you're in a circumstance of replacing power at higher prices.

Now we recognize that that risk exists and we actively manage the risk through combinations of weather derivatives and hourly options to purchase power.

On the other hand, the event that occurred was well outside -- very much a tail event in terms of wintertime loads and price load and price spikes. So, you know, the cost of that event was sort of outside of what we would -- you know, what we would have considered, you know, a good decision to insure against, if you will, apriori. So there was some cost associated with that.

Does that take care of all of your questions, Jay?

Just the second one, though, I believe on page 15, when you broke out the merchant business, I was just wondering, I assume any prop trading - proprietary trading would have shown up in the PJM platform line?

No, it shows up in competitive supply and it was in the mark-to-market earnings number that we gave you on page 16, is where that would show up.

Great, thanks a lot.

Mayo Shattuck, III: Thanks, Jay.

And the next question comes from Carrie Stevens with Morgan Stanley. Your line is open.

Hi, good morning.

Mayo Shattuck, III: Hi, Carrie.

I just wanted to ask a few questions.

What was the impact of weather relative to normal?

Hang on just a second, Carrie. It was 3 cents.

3 cents?

Compared to normal. Compared to last year, Carrie, it was about 7 cents because as you'll recall, first quarter was fairly warm last year. Right.

And then just so I understand, the impact of the 7 cent mark-to-market adjustment, that's going to be coming in the future (INAUDIBLE), so basically we should just kind of use our 36 cent number because otherwise we'd have to book out earnings later in the year; correct?

Yeah, let me elaborate on that, on this, Carrie.

There are some other companies that put corporate hedges on dominion, for example, and they just kind of treat that impact as kind of an operational item as it adjusts over the course of the year.

Yeah, this is neutral for the full year. And so this all occurred within our load-serving business. There's different accounting treatment for the two different hedges.

Yes.

Does that answer your question?

Yeah, but is it going -- but it will reverse out; correct?

Yeah, let me describe it one more time.

All of our load-serving positions that we booked prior to mid-2002 were accounted for as mark-to-market under 98-10. And to hedge some of those positions we bought or sold options.

And while both sides of the equation were accounted for as mark-to-market, if market prices changed, you would have an accounting gain on one position offset an accounting loss on the other, reflecting the true underlying economics of the situation.

And what happened with EITF 02-3 implementation is that it required that the load-serving position be treated as accrual, so if market forward prices change and that drives higher forward cash flows in the future, we only recognize that for accounting purposes over time as the cash flows occur.

Now, in this example that we've just had, the most significant driver was that we had sold options as a hedge. FAS 133 explicitly disallows accrual hedge accounting treatment for written options, you know, even if they're good valid economic hedges.

So that means that the written options have to be mark-to-market. And projected cash flow impact of a change today forward market prices have to be recognized for accounting purposes today.

So while the cash flows are below serving position and the hedge are symmetrical, the accounting gain on the accrual positions gets recognized over the balance of the year while the accounting loss on the mark-to-market hedges occurred in the first quarter.

Okay.

So, you know, we actually -- we realized this outcome was possible. We -- you know, this timing mismatch in our earnings was possible and we really evaluated whether to incur a real economic cost to buy in these options. We chose to do what we think's the right thing and keep the hedges intact. At the end of the day, this is an intraquarter event, negative 7 cents in the first quarter, positive 7 cents in quarters 2 through 4, so it's neutral for the overall year outlook.

Okay. Okay.

And they be if I could have a question to Frank Heintz, I was wondering if we could get an update on the Polar 1, the final approval of that and the filing of the Polar settlement to, I guess, plan.

Yes, good morning, Carrie.

Hi, good morning.

Yesterday mid-afternoon the Maryland Public Service Commission released its order in case Number 8908, the provider of last resort case.

You may recall that that case is the source or comes from a 20-party settlement that was filed by the commission, that establishes the framework for what we might call the second round of provider of last resort after the first round comes to an end in 2004.

Uhm-hmm.

And the commission essentially approved in every respect this agreement. The agreement is a win for, I think, all participants in the marketplace. It gives choice to customers, including a utility supply choice.

That utility supply will be market-based in its pricing, flowing from a wholesale bidding that will acquire the wholesale supply in the competitive market. There is enough headroom for retail suppliers to be vigorous competitors in future years. And there is a profit potential for the utility for handling this provider of last resort role.

So that in sum, beginning July 1 of 2004, BGE and the other utilities will have a provider of last resort option for customers for a period of time, two years for commercial customers, four years for residential customers.

Okay. And then I remember there was a second phase to that initial plan that you were expected to file, I think about the actual auction?

Yes. There is a Phase II of this proceeding that gets into what I'd tall the real details of the bidding process. And the -- our request for proposals that the utilities will use. So it fleshes out the details of this structure.

Okay. And that's still expected to be sometime this -- the first half of the year? What's the timing for that?

It is currently under negotiation with all the stake holders. It's a very close to conclusion. I would anticipate a filing with the commission probably next month. And of course, after approval by the commission, we would anticipate wholesale bidding to occur in very early 2004.

Okay. Great. Thanks so much. Take care.

The next question comes from Neil Stein with John Levin and Company, your line is open.

Good morning. Just had a couple of questions.

First, you know, it looks like there's a lot of moving parts to your numbers particularly this quarter. You've given a pretty good list of the positives and negatives. Could you try to quantify some of the major items? Particularly on page 14?

Sure. Mark-to-market was down 11 cents.

Obviously the hedges were 7 cents.

Hang on just a second. Let me -- mark-to-market was down about 11 cents, we would say that the various impacts of volatility in the quarter on the load-serving business cost us about 3 cents. We talked about the outages at third-party generation to cost us about 3 cents. Outages are separate from the volatility? Yes.

Okay.

New Energy and Alliance were up about 4 cents, productivity was about 2 cents. I think that takes care of it.

This is -- oh, excuse me, all of that walk-through that I gave you is versus our expectations and versus guidance.

Oh, that's versus guidance-- okay. What about versus last year? Did you have any -- we could do it off-line if you don't have it right in front of you.

Yeah, I think I should do that breakdown with you off-line. I see one question as to how to split things out between catagories.

What about wholesale origination versus guidance?

It was -- if I take you back to page 16, I think the right way to look at wholesale origination is versus, you know, the pace we're keeping for the whole year. And you can see here that it was a pretty bangup quarter.

And then you've made comments about your liquidity in the trading markets and so forth. Could you expand a little bit on that? Maybe, you know, some kind of what's driving that? I think you said the onset of it was in late March. What kind of explains the timing there?

And then this year you have the benefit of the shorter Valvert outage and the High Desert taking a shorter amount of time to complete construction. What about going into next year? Do you expect the impact on the trading business to last and if so, how do you offset it?

Mayo Shattuck, III: On the liquidity question, sort of as to what happened, I'd say the following; energy markets in general and the power markets in particular tend to demonstrate the phenomenon where during times of significant market volatility, liquidity is you know, can be reduced and potentially significantly.

What we observed in -- given the price spike that occurred last week of February and then first couple of weeks of March, particularly in March, was a significant decline in market liquidity.

Now, in terms of our presence in these markets, you know, this is an important means for us to manage our risk. So when we think about market liquidity, what we really care most about is not sort of the level of liquidity that's base load under stable market conditions, but rather the liquidity that exists during times of high volatility. Because that's specifically the time when you want a market to lean on to manage your risk.

So we saw lower liquidity, significantly lower liquidity, during this high volatility period. I would say as a result, as Follin indicated, our outlook for the balance of the year is a bit more cautious in terms of the longer term outlook.

I would say, we don't think that this is, this doesn't look necessarily like a permanent condition to us. So I don't think this has a big effect on our 2004 outlook. But in terms of the balance of the year, we feel like it makes sense to be a bit more cautious.

What gives you conviction that it's not a permanent condition?

Mayo Shattuck, III: Well, time will tell, of course, but this was a pretty historic event that occurred in March.

And, you know, we think at this point there's, we see liquidity today that's probably higher than the level of liquidity at the start of the year. Now prices have been relatively stable for a couple of weeks.

The presence of liquidity in the market today, I think, suggests to us that the market hasn't disappeared. There are still, there still are counterparties out there who need to manage their risk through, you know, through liquid markets. But on the other hand, in terms of our own management of our positions, given the decline in liquidity during the high volatility period, we're a bit more cautious over the balance of this year.

Go ahead.

Neil, I would add to that, you know, we hope this phenomena is temporary, but I guess I'll remind you that, you know, to put it in perspective, $20 million is 7 cents or 2.5% of this year's earnings.

We told you, you know, if you want to think about it in the context, I think I heard you asking, what if it's not temporary? We told you we expect next year's earnings growth rate to be above 10% and we still believe that. And competitive supply earnings overall feel very healthy. And the good pace of accrual deal origination, you know, of course that starts to build a base of earnings that will be recognized in future years.

Have you given any explicit guidance next year for mark-to-market gross margin relative to this year? I know this year it was down substantially from last year.

I do not think we explicitly gave that. I will tell you that we have not been counting on big growth in mark-to-market earnings in our projectionss.

Okay.

We're trying to, given the --

This is, I guess, just kind of repeating or reemphasizing the point that Follin made, but we really view this as an origination business. We've seen very healthy growth in accrual origination opportunities and actually providing power to distribution utilities and C&I customers. And we're not -- that's what we focus on, the growth in that overall business, the distinction between mark-to-market and accrual accounting is not a significant point of focus for us.

Mayo Shattuck, III: And I'll -- just to really pile on, on this issue, because I use the expression often that, you know, mark-to-market is an accounting outcome. It's not the business. The business is origination. And the fact that the mix has shifted to accrual should be interpreted as good news. Not only because of its quality, but because of its ongoing nature with respect to future years.

And, you know, recognizing that I know that particularly in January there were a lot of questions about the mark-to- market, almost in the sense as being interpreted as a business in and of itself. It's not. The underlying business is competitive supply and origination and there is a shift to the recognition of that business on an accrual basis. That's the main point that I think we want to get across.

Thank you very much.

And the next question comes from Phil McLaine with McLaine Value Management. Your line is open.

Good morning. This is sort of following on the mark-to-market.

Can you help me with the following? How much of the decline in guidance and/or this quarter, however you want to think about it, has to do with less activity that you were able to close because the markets weren't there versus just different accounting versus position losses?

The decline or the cautiousness, I think is a better word, Phil, we really had a decision to make when the plants came on early, when we were able to successfully complete both of these outages. And see that there was a $34 million addition to EBIT. And that was, do we let people assume they should take their earnings up? We said no, we think it's too early in the year for that, we think we need to be cautious here.

The decline has to do with the, in fact, that we saw liquidity just evaporate in late February and March and that creates risk. Because you're trying to execute any mark-to-market activity in absence of liquidity.

We're saying we just want to be cautious about what we commit to in terms of mark-to-market until we see market liquidity be sustained in a volatile period. It's purely a cautious stance on the balance of the year and how much mark-to-market we will want to enter into given the fact that the markets tended to evaporate very quickly in the February and March liquidity.

Just in terms of understanding in that February and March, the lack of liquidity affected you again from a position loss standpoint, from -- we couldn't complete deals, or the deals we completed just didn't qualify for mark-to-market treatment?

The lack of liquidity made us realize that were we in the mid-of executing a big mark-to-market deal, it could be a frightening situation. So it made us be more cautious about the next nine months.

This is a perspective consideration. When you see what our mark-to-market results were in the first quarter, they were below 25% of what you would expect for the year. If you go back to chart 16, you'll see the mark-to-market results for the first quarter were less than 25% of what we were talking about for the year.

Right. And so for the next nine months it's sort of cautiousness because you wouldn't want to enter into some of those deals perhaps if liquidity isn't there?

In the midst of an environment like that, precisely.

In the February, March, first quarter, the fact that it was lower than that, because again, you didn't complete deals or some of the things you had to take positions that weren't as attractive as you might have liked?

Mayo Shattuck, III: Again, I'd reemphasize that the origination business that results in accrual recognition was very strong and so the -- you know, what we were trying to convey is that, you know, it's a business that includes accounting treatment both on an accrual and a mark-to-market basis. The mix is becoming less relevant. Although, of higher quality.

I think that the question -- a part of your question, I think, related to, is the market smaller for mark-to-market earnings than it has been in the past and the answer to that is yes. But that's reflected in our much lower guidance relative to last year's performance since more transactions are likely to be recognized on an accrual basis given the EITF ruling.

Right, and that's terrific, as the guy from Levin said, it's a nicer way to-- it's a better way to have the accounting work. I'm just trying to understand what the liquidity effects are and whether that affects future activity of the entire business really.

Mayo Shattuck, III: Right.

So I was trying to understand what the impact of less liquidity is in what areas. So I guess I've got it as best I'm going to get it for the moment.

Mayo Shattuck, III: Again, I think that our point that we would like to get across is that the origination business is still healthy.

And again, I feel like you're not totally comfortable with the answer we've given you.

Phil, in terms of what about the illiquidity of the February March period made us be more cautious on the outlook for the year. If we were in the midst of originating a big mark-to-market deal, and even if there were a matter of 24 hours between the time we executed one side of the transaction and executed the other, in an environment like we saw in February and March, that would be risky for the company. Because it would make -- you know, if a big volatile period hit right when we've done one part of the transaction but haven't executed the rest and liquidity evaporates and we can't conclude the balancing side of the transaction, it would expose the company to big risk.

That's why we're being cautious. So this is an abundance of caution.

Okay. That helps on that side.

Now, there aren't things where you've got in terms of the first quarter, did you have much where -- I forget the hedging terms, but your hedges weren't perfect, did that contributed to lack of 25% of the guidance, if you will, for the year?

That was more of the -- I think you would see that more on the wholesale load serving side. And that's where we talked about the impact of the volatility in the first quarter.

Okay. All right, thank you.

The next question comes from Paul Patterson with Glenn Rock Associates, your line is open.

Hi. I just wanted to briefly ask you something.

It looks like you guys had about $110 million originally budgeted for mark-to-market. If we add $34 million that -- that you're now expecting being less now and the $6 million that you already got, is it roughly right for us to come up with about $70 million in additional mark-to-market for the next three-quarters?

Well, if you go back to chart 16, you'll see that we have done $6 million to date, exclude the impact of the hedges, since that's going to be reversed in accrual.

Right.

If you see, we've done $6 million excluding that effect. Then we have to -- we're giving you a range that we think it's reasonable to expect between $64 million and $104 million to be done in the last three-quarters.

Okay. And then just briefly, looking over the financials, it looked like depreciation was down a little bit. And I wasn't able to read everything but it looks like your taxes other than income were up, which would indicate a little bit more property.

And I'm just a little surprised that depreciation was down as opposed to being up. Is there something I'm missing on that?

Hang on just a second.

$117.1 versus $111.1 went down about $6 million.

You know what, I'll have to get back to you on that as to why depreciation was down.

Okay.

Let me give you a buzz back.

Okay, great, well thanks a lot and talk to you later.

The next question comes from Devon Gaughan with Luminous Management. Your line is open.

Hi, thanks for the time today, I appreciate it.

I just wanted to ask you sort of an accounting question about competitive supply and merchant. And one of the things I've been doing is looking at you guys versus Great Plains Strategic Energy and other similar businesses, and trying to reconcile the gross margin per megawatt hour marketed between most clearly you guys and Great Plains.

Is it -? Can you shed some light on why your margin might be less?

One of my thoughts was that you may be transferring some of the margin actually earned by comp supply over to merchant for credit-support reasons. Is that completely off base?

Devon I'm not sure I understand your question.

The question is, you guys earned, I think, $3.50 on average per megawatt hour for competitive supply, I think that's what was in the guidance.

Right.

Strategic Energy is I guess one of your competitors guided towards, it's more $5 to $6 going forward.

So what I'm trying to do is reconcile the differences, why a similar business would be earning twice or conversely, why you guys would be earning half.

And one of the comments I've heard from some people is just that generators or companies with generation that have competitive supply can move some of the margin into merchant, if you will, it's just a classification issue. I'm just trying to reconcile gross margin per megawatt hour on competitive supply businesses.

Mayo Shattuck, III: I was trying to look back at the January presentation, but we described a differential in gross margin between the wholesale business and the C&I business and they were different. I think that the wholesale business in -- I don't know if this shows it here. The -- actually, the range in 2002 for the C&I business, the midpoint of that range was actually $4.50.

And I believe that we have described the wholesale business is about 50 cents lower, 50 to a dollar lower than that on average. And so -- and the variance around that midpoint can be different. But I think if you're comparing it to another company that's specifically on the C&I side, it would be more relevant to compare to it how we disclosed and outlaid the C&I side in the January presentation, which, if you have access to that, I believe, I'm looking at it now, was page 37 of the January presentation.

Sure.

And you're right, Devon that we gave a lower margin projection for 2003 than we've experienced historically. And I think that was just caution. This is a new business that we don't know well.

Okay, fair enough. That helps a bit. Thank you very much.

The next question comes from Greg Arl with Lehman Brothers. Your line is open.

Thanks, morning.

Mayo Shattuck, III: Morning.

I was wondering if you could provide some additional color or specifics as to why the origination accrual business was good in the first quarter?

Mayo Shattuck, III: We saw good opportunities to provide power products to distribution utility customers in -- across a variety of regions.

In terms of why, you know, demand remains strong and we feel like we're -- we have found ourselves in a pretty good -- we found ourselves in a pretty good competitive position over the quarter. And we think the outlook for the rest of the year likewise looks pretty strong.

Are there any particular places where you won customers that were more notable than others?

Mayo Shattuck, III: You know, I think -- I mean I think we made public, for instance, our acquisition of the CMS load-serving portfolio in the midwest. That's important from our point of view because it provides certainly an attractive margin opportunity but importantly, an opportunity to use our midwest generation fleet to serve load.

And so that's certainly an important strategic objective in terms of the paring of our competitive supply business and our generation business. You know, good continued progress in other regions, but probably nothing notable.

Okay. You mentioned you're looking at 10% earnings growth in '04. I was wondering if you could comment on the long term earnings growth rate?

Yeah, actually, I think if you go back to our presentation from January 31st, Greg crew you'll see that we said growth in 2004 would be above 10%. And we didn't give a specific number, we just said it will be very strong in 2004. And we continue to think our outlook beyond 2004, 10% growth rate is the right way to think about our growth prospects for the foreseeable future.

Okay, thanks.

The next question comes from Andre Mead with Lazard. Your line is open.

Hi, a couple of questions.

First, your merchant plants that are coming online obviously lost money in the first quarter because the margin didn't cover the fixed O & M, and I think your comments said you expect the same thing in the second quarter. My question is why, if that's the outlook, why don't you seasonally staff these units and just mothball them until June? Why do you continue to incur losses there?

Andre, this is Mike Wallace talking.

We look at all of our assets on a regular basis from the point of view of how we value them. And when we do, we look at it not only from today's perspective and the market, but the optionality that they provide for us in the current year and going forward. Mothballing, as well as shutdown, have been options that we have evaluated and we find them not desirable at all.

Moreover, as Tom just indicated in the previous question, the fact that we had our midwest generation allows us with it now coupled to the CMS business that we picked up there, to move in a position where we're beginning to realize the value for those assets. So on balance, we value the optionality and we are able to staff those and run them at a top decile level compared to competitors in the industry. So we're quite comfortable with the efficiency of the operation and the optionality that it provides.

Okay. When speaking of the CMS contract, you did, I guess, three deals recently to buy (INAUDIBLE), CMS Nicor and Dynegy. We never got a lot of information about those.

Could you give us the total amount you spent on the contracts, the earnings impact you expect from those three deals this year, and then the duration of the contracts on average?

Okay. We disclosed the amount that we -- we disclosed the amount for CMS. That was $34 million. It was a 940 megawatt load-serving portfolio. With hedges from CMS in the midwest. We think that that transaction takes our midwestern megawatts of the free to shop market to about 13% and will allow us to leverage our existing merchant generation capacity at Holland, Big Sandy and Wolf Hills and will use those as facilities to manage peak exposures in the region.

We acquired 300-megawatts of customer load serving contracts from Nicor in Illinois and Michigan. We did not disclose the value. We did not disclose the value that we paid for that, but you can see this was a lot smaller than CMS, for example, as measured by megawatts. And it was small enough that we didn't feel a need to disclose the value. The load-serving requirement was about 70% hedged so it's well-hedged.

And we also acquired a load-serving business in Calgary from Dynegy, it had a portfolio of about 125-megawatts of load and it expands our presence in that region. In terms of accretion, summarizing it all, it's about neutral for 2003, about 2 cents in '04 and '05.

And do most of the contracts expire by '05? Or what's the average duration of these?

Okay. The duration on the CMS contracts was -- most of them are over the 2003 to 2006 time period, but some extend to 2012. The duration is just under four years.

Do you have it for the other two, Dale?

Oh, the other two are shorter dated but I don't have duration on them, Andy. Okay. I'd be glad to get back with you but share shorter deals.

Okay. I'll follow up. And would it be absurd to assume just a proportional acquisition cost or is there something very different about Nicor and Dynegy versus CMS?

It's negligible. It's not going to be a rounding error on your cash flow.

Okay. Now, last question is on the NEPOOL business where you have a fairly sizable chunk of your load serving businesses is in NEPOOL and there's a series of contracts up there.

Could you give us some indication of, you know, maybe the top three or four, when those expire?

You know, a lot of them were transition contracts around the time the utilities sold their power plants.

When are they up for renewal?

The largest contracts expire over the course of the years 2005 through 2009.

Okay. And.

These are the accrual load-serving deals. So we've got earnings and you can get a size on what was already in the book as of year-end by going back to the January 31st presentation and looking at, in the slides about EITF 02-3, you can look at the timing and you'll see those earnings coming out in the future and what they're projected to be. And then of course we've booked some new deals in Q1 which will have some impact in future years.

Okay. I'll check that out. Thank you very much.

Mayo Shattuck, III: Thank you.

The next question comes from Tim Bond with Bank One Investment Advisors. Your line is open.

Yes, good morning.

I was just wondering if you could help me get to a free cash flow number for the quarter, if you can give me cash from operations,CAP EX and dividends and possibly go over the cash flows from between Baltimore and the Merchant Energy Group up to the parent.

Okay. Hang on just a second. Let me flip to that.

Let me walk through it on a total company perspective. I don't have the BG&E versus the rest of the company intercompany stuff broken out here. So we can take that off line, if you don't mind following up. That's a - very material information.

And you can get to it through the (INAUDIBLE) but in terms of total cash flow, income before special items was $59 million, depreciation and amortization was $150 million, capital spending was $161 million, so net capital spending was a use of $11 million. That is a favorable of $96 million compared to last year when we were still in construction on some new build plants. We sold noncore assets of $82 million after tax, that compares to $501 million last year in the first quarter when we sold Orion.

Working capital and other balance sheet movements were a source of $103 million, which is down from $295 million in last year's first quarter. The big sources that were in last years first quarter in terms of working capital and other balance sheet items were; you know, number 1, Orion, and number 2, we had some collections that were follow-on payments from (INAUDIBLE) from Mohawk associated with our purchase of Nine Mile Point from them. So it's some one-time favorables, drove the number bigger in the first quarter of 2002.

Our after-text pension contribution was $72 million, we made that in the first quarter. We issued equity benefit plans of $10 million. We paid dividends of $40 million, so that is where the , those are the items that drove debt reduction of $132 million. If you want to get to free cash flow, you would subtract out of that the equity issuances of 10, right?

Great. And then, I think for last year (INAUDIBLE) didn't pay a dividend up to the parent. Is that true for the first quarter as well?

Yes.

Okay. Thank you.

Mayo Shattuck, III: Well thank you, I think that reaches the end of our session this morning. I want to thank everybody for participating.

I understand that there's some other earnings releases this morning so people will rush off to other calls. But thank you very much on behalf of the management team at Constellation. We look forward to seeing you next quarter.

This does conclude today's conference call. We thank everyone for their participation. All parties may disconnect at this time.