艾索倫電力 (EXC) 2003 Q3 法說會逐字稿

Good morning. All sites are now on the conference line in a listen-only mode. I'd like to turn the program over to your host, Mr. Mayo Shattuck.

Good morning, everyone, and thank you for joining us to review our results for the third 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; Tom Brooks, President of our Wholesale Competitive Supply and our Risk Management Unit, Constellation Power Source; Tom Brady, Vice President of Strategy and head of Constellation's commercial and industrial competitive supply businesses, includinging new energy and alliance energy services; Mike Wallace, President of Constellation Generation Group; and Frank Heintz, President of BGE.

Our presentation today is being webcast. Our discussion is focused around slides which are available on our website at constellation.com under Investor Relations. On slide 2, you'll see 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.

On slide 4 we will use non-GAAP financial measures in this presentation to help you understand our operating performance. We have attached an appendix to the charts on the website reconciling non-GAAP measures to GAAP measures.

Now, turning to the presentation on your slide 5. The events of the last quarter highlight the important role our industry plays within the economy and society. A blackout in the Northeast and the harshest storm in our utility's history call attention to the importance of doing our job well. Meanwhile, the prospect of an energy bill from Washington and renewed discussion of energy policy in California and other key states underscore the opportunity for Constellation to leverage its operational, risk management and financial skills in deregulated energy markets.

Success in an evolving environment will be determined by how well we meet the needs of our customers. Accordingly, customer focus is a guiding principle at Constellation Energy. It is my belief that customer satisfaction is a critical driver of bottom line performance. While this no great insight in deregulated markets where customers can shop, it is also critically important in regulated businesses.

Regulators of monopoly T&D utilities are keenly focused on customer satisfaction and so are we. We believe our continued focus on reliability and customer service and the expertise and processes to insure quick restoration in a disaster will sustain the constructive regulatory environment that we enjoy in Maryland.

Customer aggregation is also a key component of our strategy. Our 2002 acquisition of Constellation New Energy continues to perform beyond initial expectations and now serves 42 of the Fortune 100 companies. Our recent acquisition of C&I Gas Businesses managing more than 60 BCF in Washington and Illinois, is consistent with our efforts to build a complimentary natural gas platform. Collectively through new energy and alliance, we ultimately expect to meet the fuel and power needs of our C&I customers in all competitive markets.

Turning to page 5, since 1999 we have built one of the leading platforms in competitive supply. Initially this started with our focus on wholesale load serving, marketing and trading at Constellation power source. It has grown to encompass far more of the energy value chain over time. As you can see on the left side of the chart, we have had impressive volume growth in our wholesale electric and C&I gas and electric load serving businesses.

The chart on the right includes load serving profit and profit from other wholesale services to demonstrate the gross margin growth we've enjoyed. The light blue and green bars in 2002 and 2003 represent new additions to Constellation, new energy in 2002 and alliance and Blackhawk and Castex in 2003. We anticipate this competitive supply business continuing to grow in scale and earnings power in the years to come.

Turning to slide 6, continuing with the customer theme, I'd like to spend a moment discussing operational excellence and BGE's response to Hurricane Isabel as indicative of the performance-driven customer focused culture we are cultivating at Constellation. We are a company that learns from experience. In 1999 BGE's postmortem on its response to Hurricane Floyd revealed aspects of its storm preparedness that could be improved. Since then we've invested more than $20 million in new technology, including an automated call system to process outage calls from our customers and an outage management system to better track and plan restoration efforts. In addition, BGE invests on average $68 million per year on programs which target improved system reliability such as tree trimming.

Operationally, BGE has optimized its storm response play book and severe storm drills have been conducted annually where BGE's 3,100 employees are cross-trained to perform storm response functions. We've also stepped up our activity level in national, regional and mutual assistance organizations. Our active participation in this program enabled us to bolster our crews with thousands of workers arriving from out of state.

Turning to slide 7. Ten days prior to the storm hitting BGE's service territory, our personnel were tracking the storm, recognizing the potential magnitude of this weather event, we initiated mutual assistance calls before Isabel reached the Atlantic Coast. As BGE executed an unprecedented premobilization of personnel, mutual assistance crews arrived two days prior to the storm hitting Maryland. In total approximately 2,900 external utility workers from 27 states and Canada assisted BGE in its Isabel restoration effort. Three regional command centers and five staging areas were set up to coordinate and manage storm response activities.

This was no small logistical challenge, our employees reserved 1,700 rooms at 42 hotels, arranged for 120,000 meals, rented 400 vehicles and dispensed 90,000 gallons of fuel. BGE responded to more than 23,000 individual jobs that reported downed power lines, equipment damage and trouble cases. All told BGE employees and out-of-state workers spent more than 700,000 man-hours battling Isabel. Our employees and temporary crews quickly restored power to the 790,000 BGE customer without service with a final few outages repaired on day eight. In all, 70% of BGE's customers lost service.

Of equal importance, we executed a coordinated media plan focused on customer safety and education, providing factual updates informing customers when they could expect a return to normal service. Our bge.com website became a newly used communication outlet which saw a record number of hits.

Turning to slide 8. I told you of our planning and response and our storm response. Now let me tell you of the results. On the left half of the slide you will see key storm metrics from Hurricane Floyd and on the right side metrics from Isabel. One only has to look at this comparison and acknowledge our success. Almost 300,000 more customers were without power during Isabel, but were restored by the end of the same eight-day period despite severe flooding.

More than double the number of customer calls were received and processed during Isabel, enabled by our automated call systems and storm management system. Almost triple the number of workers and support staff actively worked the storm, the key being not just the number of workers but the fact that half of these personnel were in place before the storm hit as part of an precedented premobilization effort. In total we spent almost $76 million, which was offset by $10 million of insurance. We spent what it took to insure a well planned and well executed response and restoration effort. As you can see, our company and our employees have taken to heart that at Constellation the customer always comes first. Over time we believe this approach will contribute to improved earnings performance and sustained returns for our shareholders.

We might be a bit off by page number, so we're now on the slide that has the picture. BGE was just one part of our organization that responded to the challenge posed by Isabel. Here you can see a picture of the Candler building on Baltimore's inner harbor. More than 500 Constellation personnel work here including professionals from our wholesale competitive supply operation, Constellation Power Source. During the storm and for two weeks thereafter we relocated Constellation Power Source to our disaster recovery center. Business continued without any impact on customers or profitability. Again, just one more sign of operational excellence at Constellation. And incidentally, the picture of the Coast Guard ship is not there to evacuate our employees. That is actually docked there at the inner harbor.

This is the 8th consecutive quarter this management team has met or exceeded earnings guidance. Excluding special items and restoration costs associated with Hurricane Isabel, earnings for the quarter were $1.26 or 18% higher than the $1.07 per share earned in the third quarter of 2002. Our reported numbers highlight even better than expected earnings strengths, specifically in a quarter that included the worst storm damage in BGE's 187 year history and a blackout in the Northeast, we were able to report earnings excluding Isabel expenses above our guidance range.

Turning to the slide that has the summary outlook, with three quarters of 2003 complete, I am raising our 2003 earnings guidance excluding Isabel restoration expense to a range of $2.75 to $2.85 per share. This implies an earnings guidance range of $2.63 to $2.73 per share including Isabel restoration expenses. We still have much to accomplish in the fourth quarter, but we are confident now that we are heading to the upper end of our initial $2.65 to $2.85 EPS objective for the year. With respect to 2004, we are in the process of building our business plan and we will discuss the specific EPS forecast for 2004 during our presentation in January.

Our performance enables me to affirm our targeted 10% long-term EPS growth rate based on 2,000 earnings of $2.52 per share excluding special items. As we further our reputation as the premier energy service provider, realized productivity initiatives and wisely reinvest capital, we will drive an improved bottom line and create incremental shareholder value.

With that I'll turn the call over to Follin.

Thanks, Mayo. Good morning, everyone, thanks for joining us today. Turning to the comparison of Q3 EPS versus guidance, earnings for the quarter, including Isabel restoration expenses were $1.15 per share, solidly within our July 31st earnings guidance range. Excluding Isabel restoration expenses, which to state the obvious were not contemplated at the time we issued guidance, EPS was $1.26 per share. This compares to our July 30th earnings guidance of $1.05 to $1.20 per share.

Turning to the next slide and a comparison of Q3 EPS versus guidance for the business segment, merchant earnings were up compared to our July forecast due to first strong wholesale risk management results. And when I refer to strong risk management results, I'm referring not only to mark to market trading during the quarter and preexisting mark to market positions, but also to incremental value realized out of the accrual book of transactions that existed as of July 1st and that were scheduled to be delivered and realized over the third quarter.

A key skill set at CPS is managing our transactions day-to-day to maximize value. Second, strong plan operations for the quarter. And third, stronger than forecast new energy results. New energy peak load is up 50% in the last 12 months and new energy renewed over 80% of expiring contracts this quarter. These positives were partially offset by the Northeast blackout and margin loss to Isabel and lighter than forecast new origination. Now, with respect to new origination, the closure of a number of transactions fell into the fourth quarter. A strong level of wholesale origination in October tells us this business is as strong as ever. BGE also reported earnings above the top end of guidance, excluding Isabel restoration expenses.

Turning to the next slide is an overview of Hurricane Isabel-related expenses at BGE. In total our estimated Isabel costs, including capital and O&M expenses is $75.9 million. We incurred the majority of these costs in the third quarter with a modest residual amount to be incurred in the fourth quarter of 2003 to make permanent repairs in situations where temporary fixes were put in place to quickly restore service to customers. Reflecting $10 million of T&D insurance coverage, our net cost for the storm is expected to be $65.9 million. Of this total cost, $31.8 million or 11 cents is third quarter expense, and we expect to expense an additional penny in the fourth quarter. While there's no explicit mechanism for reimbursing the utility for Isabel expense, our O&M cost of Isabel will be factored into the average annual storm expense calculation during BGE's next rate case and the capital is recoverable in rate base.

Moving now to a look at the Merchants earnings, the Merchant business earned $1.03 per share, up 16 cents compared to earnings of 89 cents in the third quarter of 2002. This year-over-year increase primarily reflects, first on the favorable side, a 10 cent increase in new wholesale transactions booked year to date in 2003 and realized in the third quarter. Second, the year over year impact of higher power prices was a favorable [Inaudible] cents. Third, while it's impossible to perfectly quantify, we think the year-over-year impact of the EITS 023 accounting change was about 6 cents favorable in the quarter. For the year we believe that this accounting change hurt the year-over-year comparison by about 16 cents .

We had 4 cents favorable generation performance due to the 2003 start-up of the High Desert plant, partially offset by the impact of outages at Nine Mile Point. We also benefited from our productivity initiative and strong performance at New Energy. These positives were partially offset by, first, higher interest expense related to balance sheet strengthening action, and a reduction in capitalized interest expense with the completion of our large power construction project. Second, the impact of the Northeast blackout and lost gross margin associated with Hurricane Isabel hurt us by 3 cents. And finally, we have about 10 cents negative driven by year-over-year cost increases partially offset by some miscellaneous positives in gross margin. So, to recap, the Merchant was up 14 cents per share compared to last year or 16% year-over-year increase.

Turning to the next slide and a look at the Merchant's gross margin, Merchant gross margin up $614 million was up from $490 million in the third quarter of 2002. Our PJM region delivered total gross margin of $312 million or about 50% of our total Merchant gross margin. The PJM business was up due to positive market conditions. Our plants with PBAs contributed total gross margin of $192 million or about 31% of our total Merchant gross margin.

The increase compared to last year is driven by our newly commissioned High Desert plant and offset by outages and the blackout at Nine Mile Point. Our competitive supply business contributed total gross margin of $100 million compared to $19 million in 2002. Competitive supply was up $36 million due to the inclusion of a full quarter of new energy gross margins. $25 million due to wholesale transactions originated this year and realized in the third quarter. And about $17 million due to the accounting change I mentioned. In sum, we're delighted with the growth that the Merchant has been able to attain this year.

Turning now to the market risk slide. As we've discussed in past presentations, we seek to maintain a highly hedged generation and fuel profile. We believe the strategy is an important contributor to earnings consistency. Our wholesale and commercial and industrial accrual electricity load-serving portfolio is substantially forward hedged. Our value at risk declined from last quarter and is below our historical average.

Turning to a look at BGE, on a reported basis, BGE earned 12 cents a share. 11 cents of Isabel restoration expense is recognized in the quarter and weather hurt the comparison due to the warmer than normal 2002 third quarter. On the positive side of the ledger, we recognized a 3 cent gain related to a market-based rate gas recovery allowed by the Maryland PSC and had 3 cents of favorable cost changes.

Turning to the next slide and a look at the balance sheet, our debt to total capital improved by 50 basis points to 52.5% in the third quarter. We expect approximately a 1 percentage point improvement by the end of the year. You'll note this implies a debt to capital level above the 50% level we originally targeted in January. While earnings have exceeded targets, cash flows behind plan due to a number of working capital timing items, primarily reflecting higher gas prices on gas inventory, receivables and payables at the utility and CPS, as well as incremental capital expenditures related to Isabel. Ultimately this all comes back to us.

We are assuming that based upon current lower level of interest rates we'll recognize a $35 million pension charge to equity at year-end. All in all, we're pleased with the real progress we've made on the balance sheet this year despite the headwinds of bringing the High Desert financing on balance sheet ant impact of the EITS 023 and pension charges to equity.

Turning to the next slide, let me provide some guidance for the fourth quarter of 2003. We expect earnings of 55 to 65 cents per share compared to 41 cents per share in the fourth quarter of 2002. We expect the Merchant's earnings to range between 35 to 50 cents compared to 22 cents in the fourth quarter of 2002. Several favorable items affect the quarter over quarter comparison.

First, let me be specific in saying that we are not counting on a big year-over-year increase in fourth quarter origination. We forecast 8 cents of earnings related to transactions done in the first through third quarters of this year and scheduled to be realized in the fourth quarter. Additionally, we have another 15 cents relating to prior years' transactions net of other negatives from the EITS 023 accounting change. Second, we have positive contributions from our new High Desert plant. And third, productivity. These positives are partially offset by higher interest expense and other costs.

We expect BGE to earn between 16 and 21 cents per share compared to 22 cents per share in 2002. The decrease versus 2002 is largely driven by an assumed return to normal weather in 2003 compared to a colder than normal 2002 fourth quarter. The other non-regulated businesses are expected to range between a loss of 2 cents and break even compared with a loss of 3 cents in the fourth quarter of 2002. In sum, we're looking forward to a strong fourth quarter.

I look forward to seeing you all in New York City this coming January when we roll out our plans for 2004. With that I'll turn the presentation back over to Mayo.

Thank you, Follin. As you can see, this was a tremendous quarter for Constellation, both operationally and financially. We believe our customer-focused strategy is only just beginning to pay dividends. We look forward to leveraging our strengths in this area to realize further financial success from the opportunities the future portends.

Thanks for your time this morning. That concludes our prepared remarks and now I will turn the presentation back to the Operator for Q&A. As a reminder, we ask that you limit your questions to one question and a follow up and I'll be sure to direct questions to the appropriate member of the management team here today.

Very good. If you'd like to ask a question at this time, please press the star and 1 now on your touch-tone telephone. To remove yourself from the queue, you may press the pound sign. Once again, to ask a question, please press star 1 now on your touch-tone phone. One moment, please . We'll take our first question from Mr. Dan Eggers, Credit Suisse First Boston. Go ahead.

Good morning.

Good morning, Dan.

I guess the first question is, I'm kind of missing a table that we'd' like to see. Last quarter, I think it was page 12 where you break out the origination, kind of timing of recognition, that sort of thing. Do you have the numbers that go along with that so we can fill out that table for this quarter, as well?

I've got the chart with me. The number completed year to date, Dan, on that chart is 75%. So, the number of new originations for the quarter is 10 for wholesale. Let me come back to you later on the call, Dan, with those numbers filled in. But the bottom line is it's 75% of the target origination for the year is complete at the wholesale and commercial and industrial levels. And as I said in the presentation, origination in the third quarter was light at the wholesale level. And we can let Tom Brooks discuss that right now. But what we've seen in the fourth quarter is that it's been a tremendously strong period to date. So, we're quite comfortable with the health of the business.

In terms of sort of an overall activity within the wholesale unit , certainly a big issue in terms of timing, driving when deals get completed. Obviously, we're focused now on accrual-based load-serving transactions as opposed to mark to market activity. We continue to have a very strong growth in new business activity. A couple of examples to that effect, in the base business of load-serving for distribution utilities, our peak load has grown by about 20% over the course of the year. That is from about 14,000 megawatts to about 17,000 megawatts. That's very consistent with the plan we laid out for you in January.

The beginning of the fourth quarter has been actually particularly strong. During the first month of this quarter deals that we were working on during the third quarter, a number have been completed, through which we've brought on about 3,500 megawatts of new load and renewals. These obligations have varying durations, mostly ending by 2006. Through these transactions we'll provide about 27 million megawatt hours of energy over the period. And we expect a gross margin, including the associated supply hedges, of about $95 million. A bit more than half of that will be realized during '04. So, all that put together points to very good momentum in terms of new business activity.

Okay. So, we'll have the origination numbers and have a gross margin breakout for us here at some point in the call, correct?

Yes.

Okay. I guess I'll just ask this other competitive question while we're on the topic. With the purchase of the Wisconsin assets, is this a sign that you guys are really ready to start moving forward more aggressively following the Alliance acquisition last year, trying to get a position in the gas market?

Yes. I'll have Tom Brady respond to that.

Yes, Dan. The Blackhawk and Castex acquisitions, that's a full-service provider, firms that are identical to the Alliance Fellon-McCord firm that we purchased the end of last year. We looked at this and added 63 billion cubic feet of gas in Wisconsin and Illinois, plus a couple hundred megawatts of Illinois power. And it's a platform that has demonstrated effective cross-selling in Illinois. And we saw all this as additive to our model.

It extended our footprint and it gives us a scale in gas that we did not have heretofore, and it really fits in with the broader context of our Midwest Merchant energy platform. Right now we are a large national provider in both the power and the gas business for the commercial/industrial groups. So, I would say that we are there now. We're where we want to be. We think there's a lot of organic growth left in this business.

Are you guys gonna follow the strategy you've been using at new energy on the gas site, too, as far as buying books or buying other people in markets, trying to get a foothold in markets beyond, I guess where you currently are?

Obviously, as markets deregulator goes in our next phase of deregulation, if we see attractive books that we can add into our two platforms and we can get it at the right price, of course we're going to do that. But like I said, I also think we have a lot of organic growth that we've been going after right now.

I think the really interesting thing for us is the fact that these platforms are complementary, and we're now in really most of the competitive markets. And the cross-selling opportunity is really quite interesting. So, I think the next phase for us is integration and cross-selling to create a purer national platform. Could we have the next question, please?

We'll take our next question from the site of Jay Dobson of Deutsche Bank. Go ahead, please.

Hey, Mayo.

Hi, Jay.

Two questions, if I can. First on acquisitions, I think Follin had indicated that a full quarter of New Energy gave us maybe $36 million in gross margin in the third quarter. I was just wondering how we or maybe you should think about, sort of acquisitions in the quarter. Can we look at it as, here is what we were ex-acquisitions and here is where we are with acquisitions, obviously the reported results, and going forward how we think about acquisitions versus organic growth. And I am thinking of that specifically in the Merchant business. And then an unrelated question, just accounts receivable look like they went up pretty big, and I'm sure there's an explanation for that. But I just wondered if you could address it.

Yeah. In terms of year-over-year, New Energy and Alliance added 2 cents, Jay, this quarter. And in general, I think the way you should think about is that the projections that we're giving you of long-term growth of 10% assumes reinvestment of excess cash that we generate. It does not assume incremental acquisition.

Your second question was receivables were up. Yeah, both receivables and payables were up, as I mentioned, as well as BGE inventories have been up over the course of the year as a result of higher gas prices creating, of course, bigger dollar transactions and driving higher working capital.

Back to the acquisitions question, and thanks for the response on accounts receivable. Right now can we look at it sort of on a customer maybe in the competitive supply business, acquisition versus organic growth and compare those, what a customer costs? And obviously, I guess there's no average customer per se, so it's hard to look at that, but how you look at organic growth versus acquisitions in that business?

Well, I guess I'd respond this way, Jay, that we've been in an unusual period of time for 18 months. I think you'd say that we were a first mover in a very troubled environment when we bought AES New Energy. It turned out to be really a homerun for us and really available to us because of the credit situation in the market at the time. Since that time, I think a number of other players that are regional have -- I wouldn't say they've necessarily thrown in the towel, but have realized that the national platform is gonna be important and its competitive position is gonna be dictated to some degree by scale.

So, we've been able to buy these other businesses and to grow what is clearly the largest platform now nationally. And as you know, we have bought all these companies at multiples of EBITDA that are extraordinarily low. In a historical context, the New Energy purchase price was not much over 1, 1.5 EBITDA, which is unheard of. And so, from that standpoint, the hurdle rate is so ridiculously lower than our realized returns that it's -- if we could continue doing that forever, that would be great. But, obviously that's not gonna last forever, and so, there's a phase here where the management of all these enterprises in an integrated fashion and focusing on the cross-sell is really gonna matter.

These are large customers, and so, customer acquisition costs are relatively small relative to the volumes that one can achieve in the acquisition of a new customer. It is a sophisticated sell, and we have a very sophisticated group of people. But there's no question that in isolation, the economics of acquiring a new customer of the size that we're going after are absolutely fine. And so, as we move into a phase where the growth might proportionally be more organic, the economic model sustains itself.

Great. Thanks a lot.

Thanks, Jay.

Very good. We'll take our next question from the site of Greg Gordon of Smith Barney. Go ahead.

Good morning.

Hi, Greg.

Follin, could you just give us those numbers one more time on what the -- and Jay alluded to it, to the one trunch the $36 million gross margin from Alliance and New Energy ventures, could you just give us the last two pieces of that puzzle on the incremental gross margin again?

For the Merchant's?

Yeah.

Yeah.

I think you gave us $36 million, $25 million and $17 million.

$36 million was New Energy's gross margin. $25 million was wholesale of transactions which we originated this year and which were realized in the third quarter. So, there may have been deals that originated in the first and second quarter but realized -- the power delivered and we realized the profit in the third quarter. And about $17 million was due to the accounting change that I mentioned.

And when I talk about the accounting change, it's something we've been trying to grapple with. It's how to explain to folks the impact of EITS 023 on our results. And it's difficult to precisely say what our earnings would have been this year had we been on pre-EITF 023 mark to market accounting, but the way we think about it is we look at benefits we had last year from still marking to market our NEPO load serving book, which we don't have anymore because it's now fully on accrual. So, that's a negative in the year-over-year comparison.

We look at, now we have accrual recognition of deals booked in prior years. That's a favorable in the comparison. And as we've talked about in the last couple of quarters, moving to this accounting basis has created some odd outcomes whereby we've got load-serving contracts accounted for on an accrual basis, and yet good economic hedges on those positions sometimes are required to be mark to market, which can create an earnings timing recognition impact.

Those are the non-managed hedges, right?

Exactly. That's been negative for us this year. So that year-over-year you take all of that into account, we think the accounting change had a favorable 6 cents impact for us in the quarter. But for the year it's gonna be about a negative 16 cents.

Great. Two more quick questions. Tom gave a great overview on how robust your business is going into year-end, and he mentioned a number, two numbers. 27 million megawatt hours of new load to be served by -- mostly through 2/06, and 95 million of gross margin over that periods. But he also said that part of that was renewals. As I think about the incremental load over your existing run rate is, can you give us a breakdown of how much of that 95 million is renewals versus actual new load?

It's actually a little bit difficult to characterize it based on sort of new and renewal simply because there are different classes of service for different of these utility customers. But I think a very rough ballpark would be about half and half.

Great. And then one last quick question. Of the outage costs, if we added all the outage costs back just to BGE, you would have been well ahead of your estimate for BGE for the quarter. Was there a little bit of that that actually gets allocated to Merchant because there were costs associated with generation? Can you give us a breakdown?

Well, when you saw us talk about Isabel restoration costs, we were purely talking about the cost at BGE. We said separately that it cost us in terms of gross margin the equivalent of 2 cents at the Merchant. And that's in the Merchant's results. And also in BGE's results as they lost about a penny's worth of gross margin due to customers being out and not selling the power.

So, really, the utility business, if we had had normal weather and we hadn't had the storm, would have been a pretty robust quarter?

Yeah. If you want to include everything you can possibly attribute to Isabel for the utility, it wouldn't be 11 cents, it would be 12 cents because they lost a penny's worth of gross margin.

And so, you would have been in the low 20s versus 14 to 19-cent guidance?

Correct. And the reason that we were above the top end of the guidance, even adjusting out Isabel, is as I mentioned, we had a recovery from the Maryland PSC on market-based rates gas.

Great. Thank you, guys.

Thank you.

Our next question comes from Lee Hanson of Alliance Capital.

Good morning. Fallon, I'm wondering if you could go through the '03 expected operating cash flows and sort of highlight for us the working capital impact.

Sure. Here's where we are. If you take the midpoint of our earnings guidance range, you'd be looking at net income of about $450 million. Deappreciation and amortization we expect is $629 million. And capital spending is a use of $749 million. So, net capital spending is expected to be a use of about $120 million this year. Asset dispositions this year, which is our real estate investments and financial investments, which we've been working on monetizing, is gonna be a source of about $133 million after tax. Working capital will be a use of about $84 million for the year. The pension contribution compared to our pension expense creates a use of about $62 million. Dividends are $169 million. So, that's free cash flow of about $148 million.

Then we've issued for satisfying our benefit plan requirements and our Alliance and CMS acquisitions, issuance to support those and keep the balance sheet neutral is $71 million. So that in all we expect cash flow to be applied to debt reduction to be about $206 million. Now, when you look at the year-over-year -- or let's do a comparison versus what we presented to you back in January as our expectation, Lee.

Mm-hmm.

What you'll see is capital is up $33 million. That's due to Isabel. And then working capital had been -- we'd been planning for it to be a source of $114 million, it's actually a use of $84 million. And the swing in that outlook is about $75 million at BGE working capital. It is the higher gas price impact on BGE's inventory and accounts receivable and accounts payable. It is about $36 million at CPS, which again has to do with higher power and gas prices driving the level of their receivables and payables up. About $8 million at New Energy due to just a higher level of income than we had planned on. And then there's about $18 million which is bond issuance cost. We've issued debt this year, and the way that will show up on your sources and uses, is the total in-flow of debt financing shows up in financing, and then you've got the bond expenses which are amortized in the future, which creates a use of about $18 million.

On the CAPEX number of roughly $750 million, can you just break that out between the different segments?

Yeah. Hang on a second. Let me dig that up . All right. We're looking at for the Merchants about $403 million, the utility $290 million, the other non-regulated businesses about $48 million, and other miscellaneous of about $9 million. And that gets you to $750 million.

And the $403 million, how much of that is new billed?

At the Merchant -- there's really not significant new billed spending at the Merchant because of High Desert was financed by an operating lease up until the point at which we completed it. Hang on. I'm just gonna try and do a comparison for you versus '04. Let's take it off-line, and I'll try to break down the elements of the spending for you, Lee, going into specifics in a way that might be helpful for you. I could walk through the composition of the spending as to how much is nuclear fuel, 60, steam generators are 60, which is, of course, a one-time investment. We've made investments in --

Fine. I don't want to take up the whole call. So, I'll take it off-line. Thank you.

Thanks, Lee.

We'll take our next question from Greg Orrel of Lehman Brothers.

Thanks. Good morning.

Good morning.

I was wondering if you could provide the 2003 gross margin guidance for competitive supply, and then just kind of a thought on, as we head into '04, how much of that margin kind of needs to be replaced with renewals or new business as agreements fall off?

To be honest, I don't have a breakdown with me of gross margin for the fourth quarter for competitive supply. But let me help you, Greg, in terms of how we're thinking about 2004 and how to think about -- I know the question you have is how much are you assuming that you're gonna have, huge growth in new business at wholesale competitive supply. And we don't like to put out a point estimate for 2004 EPS until we have finished our business plan initiatives and can present a number to you that our whole management team is committed to achieving.

I'm comfortable that the 10% trend line off of the numbers of $2.52 for 2002 and $2.75, which was the initial midpoint of our 2003 guidance, will continue next year. But I'm not comfortable with you taking the high end of the 2003 guidance which we provided and adding something well above 10%. But a few factors that we can point to when we think about 2004 for now without a point estimate for EPS is first, as you'll recall, two building blocks for '04 growth, which we shared with you back in January, were a full year of High Desert operation and no steam generator replacement outage for Calvert next year. And as you also know, we brought up High Desert two months earlier than we thought this year, which reduces that year-on-year growth impact by 7 cents. And the Calvert outage was 32 days shorter than planned, which results in a reduction of the year on year 2004 benefit of 5 cents. So, those big accomplishments this year lowered the percent increase for next year.

And one other factor you need to bake into your thinking for 2004 is our outlook now reflects that we are going to spend incremental O&M for the Nine Mile plant. Essentially we are making the investment in major maintenance in that plant next year to increase the reliability of that plant. So, we've got a few things that slightly lower the growth outlook for next year.

On the other hand, the competitive supply outlook is really strong. And we are not counting on an overly aggressive growth assumption for wholesale competitive supply because we already have a strong base of business as we head into next year. And to be specific, the backlog, if you will, of already booked transactions that will be recognized next year is $195 million. And to give you a comparison, that compares to our book of 2003 transactions at the beginning of 2003 of $85 million. So, you can see the backlog is substantially higher heading into next year than it was heading into this year.

So, in short, 2003 is shaping up as a good year with strong growth. And until we are complete with our business plan process, I'm comfortable with your counting on 10% growth off of the $2.52 to $2.75 this year trend line. I don't want to guide you above that now.

Thanks, Follin. That's very helpful.

We'll take our next question from Carrie Stevens of Morgan Stanley.

Good morning, Carrie.

Just a quick question. Hoping I didn't miss this, but on the Merchant page 15, that negative 10 cents of other, did you guys detail what was in there?

Hang on, Carrie. I can get you some specifics on that. You're talking about year-over-year Merchant?

Yeah .

Well, as I said, there were some miscellaneous favorables in gross margin. That was about 5 cents. And then we have 3 cents higher depreciation and amortization, we have some higher operating expenses supporting wholesale growth of about 2 cents, and various wage, benefit and compensation costs of about 5 cents year-over-year, Carrie.

Great. Thanks. And back to the operating cash flow number, can you just tell me where you are year to date versus where you were year to date last year?

Sure. I'll go through this really quickly and let me just talk about where we are versus last year. And if you want to get into more specifics, Carrie, just give me a call afterwards. As you walk through cash flow for the first nine months, you will see that we generated free cash flow -- free cash flow was a use of $17 million. Cash flow for debt reduction, including equity issue to benefit plans and to support the two small acquisitions we've done this year, gets you to cash flow for debt reduction of $45 million.

If you look at cash flow for debt reduction excluding asset sales and acquisitions, so trying to give you a sense of an operating number compared to last year, it's a use of $71 million, which compares to a source of $11 million last year. So, down about $82 million. Now, what drives that is, you've got lower net CAPEX compared to last year of $156 million. So, a nice source out of lower CAPEX. On the other hand, working capital timing-type items have been a use of about $250 million compared to last year.

Last year we had a favorable, which was a collection of a receivable from the sellers of Nine Mile Point related to the pension of almost $100 million. We have $53 million of higher wholesale Merchant receivables and payables, which is, as I mentioned, the phenomena of higher gas prices and higher power prices driving higher receivables and payables. We had High Desert commencing operations in 2003. We had $41 million of increased net receivables and payables related to the addition of New Energy, much of which comes back in the fourth quarter following the seasonally high third quarter. Lower accrued interest was about $36 million. Last year we were, as you'll recall, earlier in the year heavily reliant on commercial paper. So, you build up very little accrued interest. Now we're on longer term financing where you do semi-annual pay. That creates a use of cash.

And the last thing is, towards the ends of last year woe had $36 million of expenses on the book to prepare for the steam generator replacement. And that's been paid this year. So, to restate, when you think about core operating cash flow, it's improved because we have lower net CAPEX as a use. That's favorable. On the other hand, we've got working capital timing items negatively affecting the nine-month comparison.

Okay. Great. Thanks for the detail. And then just one last question on your acquisition. Did you guys disclose the dollar value of your most recent, I think it's the Wisconsin acquisition that you made?

Yeah. This is Tom Brady. The acquisition price was $26.9 million. And from our perspective it's accretive immediately. It will be accretive next year and has a very attractive internal rate of return.

Great. Thank you very much.

Thanks, Carrie.

We'll take our next question from the site of Neil Stein of John Levin & Company. Go ahead please.

Good morning. I just had a couple of questions. First, kind of general, are you still looking at asset acquisitions? And if so, could you talk in a little bit of detail about what you're looking for?

We still have a very active development effort in looking at acquisitions. As we've talked about before, there is little evidence yet that generation assets specifically have reached their appropriate equilibrium. However, I think we're beginning to get close to enough stability in the marketplace that more assets will actually trade. I think we're in the flow of most things. We are specifically interested in physical assets that match our portfolio of load serving geographically. We're also interested in making sure that we're leveraging off of the fleet that we currently have from the standpoint of synergies and productivity. So, I wouldn't be too surprised whether over the course of the next year or so you see resolution to more troubled situations and perhaps more assets changing hands. So, I think we're appropriately in the flow. Again, we are vigilant about our hurdle rate analysis on physical assets and we are not going to sort of violate our principles in that sense. But as I say that, I would tell you that I think in some cases it's getting a little bit closer where we could make a productive investment in a generation plant that would be both accretive to us and matching the type of business we're in from a load-serving standpoint.

Okay. And could you talk about corporate M&A, whether the buyer or the seller, what's your view there?

Well, as you can guess, I really can't talk about that. But we're also anticipating with the energy bill and perhaps the dissolution of PUCA that as that phases in over the 12 months later or 18 months later that activity will begin to increase. And it would be natural to expect that there would be a lot more interest in the sector. Other industry participants or related industry participants could conceivably find the utility industry attractive in the same way that Buffett has found specific assets attractive in the industry, and there's more private equity out there. So, much like what you read about today in healthcare and in banking, I suspect that the M&A activity level will come back into vogue here. But a lot of it would be predicated on the PUCA dissolution. I think that you probably really will not see a whole lot until there's a clearer line of sight on that.

And I guess as a general comment on the industry, what about your willingness to engage in that type of activity?

We're here to increase shareholder return. That's our sole objective.

Good answer. I have a question for Follin, a little bit more detail. Going bar to slide 13 where you talk about actual results versus guidance for the third quarter.

Right.

Could you talk about maybe the relative order of magnitude of some of these items?

Sure.

Risk management, plan operations, et cetera?

Okay. We talked about risk management, and compared to our expectations, and of course, we gave you guidance in a range, Neil. So, I'll give you sort of a general order of magnitude number as to where we were. Risk management helped us by about 7 cents versus what we would have expected. The plant operations, and this is just a little bit favorable at a number of plants, Brandon Shores, High Desert, Nine Mile Point, Oleander, the QFs, they all ran a little bit better than we would have forecast going into the quarter. That was about 7 cents. New Energy and Alliance were about 3 cents better than we had forecast. On the other hand, between the blackout and lower business origination than what we expected, the combination of the blackout, lost Isabel margin, lower origination than what we expected hurt us on the order of magnitude of about 11 to 13 cents. Is that helpful?

Let's see. I'm just looking. Okay. Those risk management and plant operations were 14 cents. Yeah, that's very helpful. And then what about at the utility? What exactly is MBR gas recovery?

This is Frank Heintz, Neil. Five years ago the Maryland Public Service Commission approved what we call the gas MBR, or market-based rate mechanism, by which we are incented to make economical purchases of gas supply for our customers. And this mechanism, this gas MBR mechanism sets the price for our customers. And if we acquire gas at a lower cost, then those savings are shared between customers and shareholders. In 1999 and 2000 there was an error in our calculation and we undercharged our customers. Last year, 2002, we sought permission to recover that amount, and a proposed order by a hearing examiner disallowed the recovery of $7.7 million. Then this year we vigorously appealed from that disallowance by the hearing examiner, and in mid-August the Public Service Commission ruled in favor of the company and allowed our recovery of that $7.7 million.

Okay.

Great. I think, Operator, we have time for one more question, and then we'll close it out.

Very good. Our final question will come from Paul Patterson of Glen Rock Capital. Go ahead please.

Paul Patterson of Glen Rock Associates. How are you?

Hi, Paul.

Just a quick question. You mentioned 6 cents for the quarter due to due to prices. Could you just elaborate a little on that and just what your price sense might be on an annual basis to power prices or to gas prices or whatever that's driving that ?

Paul, we'll have Tom Brooks respond to that .

Okay. Year-over-year price changes have benefited us about 4 cents in PJM, 2 cents at Nine Mile Point and hurt us about 3 cents in the mid-Continent, hoped us about 3 cents in Texas.

So, the quarterly number of 6 cents is the same as it is for the year to date?

Ask that again? I'm sorry?

Well, if I look at 515, it looks like 6 cents-plus for price changes for the quarter. So, the quarter is pretty much year to date in price changes and its impact on you guys?

That was the quarter. I don't have the year to date handy. I can dig it up and share it with you.

Okay. Do you guys have any idea, can you elaborate a little bit on the sensitivity that you guys have to prices in this market? Obviously, we've had a big push in gas prices and you guys had some fossil, nuke and what have you. Just what your sensitivity might be in terms of, you know, gas prices, power prices, the dark spread? Anything more you can elaborate on that?

Let's see. In general, as we've indicated, we have chosen to manage a very substantially hedged portfolio. For the balance of this year we're essentially 100% hedged, for instance, and very substantially forward hedged. For the coming year, as well.

So, can we assume that the variations that you saw this year over last aren't gonna be there? In other words, we're not gonna have these kinds of sensitivity to price in '04?

A dollar move in power prices, to give you a sense of magnitude, a dollar move in power prices equates to about 2 to 3 cents in EPS change.

For next year.

For next year.

Okay. Great. Thank you very much.

All right. Thank you all for joining us this morning. And we'll look forward to seeing you all in person in January in New York. Thanks very much.

This concludes our conference call for this morning. You may now disconnect your lines, and thank you for participating.