艾索倫電力 (EXC) 2004 Q2 法說會逐字稿

Good day, all on the conference line will be in a listen-only mode. I would like to turn the program over to the Chairman and CEO of Constellation Energy Group, Mr. Mayo Shattuck.

Good morning, everyone. We hope you're not bleary-eyed from the convention last night. We wanted to welcome you to our second quarter 2004 earnings call. Before we begin our presentation, let me remind you of out comments today will include forward-looking statements which are subject to certain risks and uncertainties. And for a complete discussion of these risks we encourage you to read our documents on file with the SEC. Our presentation today is being webcast and the slides are available on our website which you can access at consolation.com under Investor Relations. We will use non-GAAP financial measures in this presentation to help you understand our operating performance and we have attached an appendix to the chart on the website reconciling non-GAAP measures to GAAP measures. So we will start off on slide four. This is the 11th consecutive quarter this management team has met or exceeded earnings guidance. Earnings excluding special items for the quarter were 55 cents per share, exceeding the high end of guidance by 16 cents. On a year-over-year basis, earnings declined 3 cents relative to a strong second quarter in 2003. For the first half of 2004, earnings excluding special items have increased from 94 cents last year to $1.21, up 29%. BGE had a strong quarter and continues to be a stable contributor of earnings and cash flow. At the merchant business, we followed last year's strong earnings with another exceptional performance.

Turning to slide five, heading into the quarter we expected a year-over-year decrease in earnings because of the timing of our refueling outage at Calvert Cliffs and the sizable wholesale origination results in 2003. Strong competitive supply results and better than projected operating performance at Calvert Cliffs and our coal plants drove this quarter's outperformance relative to guidance. At wholesale competitive supply we saw strong portfolio management results. We are seeing the benefit of our increased portfolio scale and expertise. The result is new and improved ways to manage risk and harvest value from our portfolio. In total, wholesale competitive supply added 9 cents more than we expected and New Energy added 2 cents. We are also building a track record of excellence at Consolation Generation. We are doing the little things well, performance is leading to sustained higher output and earnings from our facilities, Calvert Cliffs completed its refueling outage and wrote a replacement in 30 days, 15 days better than projected. Our Ginna integration team took over operations of the facility in record time and without the need for transition services from the seller. Finally our coal and gas fleets performed better than projected. In total the generation fleet's execution added 8 cents to the bottom line in the second quarter compared to our expectations heading into the quarter. Turning to slide six, our business proceeds at a robust pace. Six months into the year and with the Ginna transaction completed we have improved earnings visibility. Accordingly, I believe it is appropriate at this point to further raise our 2004 guidance to a range of 3.15 to 3.25. This is growth over 2003 of between 14% and 18% for 2004, a strong performance by any measure.

We are also investing to drive sustained earnings growth. Investments today in our marketing businesses, our generation fleet, and our infrastructure should yield increased earnings in future periods. The merchant strategy we've been pursuing for the past 2.5 years is working. We believe the costs and risk management expertise would be key competitive advantages in deregulated markets and we built our business with this in mind. At Consolation Power Source, our wholesale business, we built portfolio scale, entered new markets, and invested in intellect technology to reduce our load serving costs. At New Energy we took a realistic view of sustainable margins and believed geographic diversity, customer service and operating leverage would prove winning strategies. In both businesses, we executed business plans which targeted low cost provider status. We are now using this cost advantage to win business, maximize national scale, and realize further operating leverage. A virtuous circle of execution and efficiency is adding to our market advantage and helping us to win further market share. We remain convinced that for the next several years we will meet our targeted 10% growth rate. Strong performance at our competitive supply, BGE, and generation units affirm this view. I realize that in this week's state of earnings releases, some of our competitors have raised alarm about declining margins. As we told you last quarter, our wholesale business is winning load at margins consistent with our plan.

New Energy too will deliver the profitability we expected this year. The fact that we are performing as expected, while our competitors are expressing concern with respect to margins, is evidence to me that our strategy of leveraging cost structure and risk management expertise, over a large national portfolio of business is working. This is the benefit of serving 28,000 megawatts of peak load nationally, an amount more than double that of our nearest competitor. That concludes my remarks and I now want to turn the call over to Follin to review the financials.

Thanks, Mayo. Good morning, everyone, and thank you for joining us today. Earnings excluding special items for the quarter were 55 cents per share, exceeding the high end of our 24 to 39 cents earnings guidance range by 41% and 3 cents below 2003 second quarter earnings. The 2004 21 cents per share of special items was driven by the recognition of section 29 tax credits related to 2003 synfuel production at our South Carolina facility. Turning to slide nine, BGE earned 13 cents a share this quarter, a penny higher than the high end of our guidance range and flat versus last year's second quarter. Warmer than normal temperatures took us up versus our expectations going into the quarter. Compared to last year, weather and increased usage were offset by costs associated with reliability investments and inflationary cost increases. Turning to slide 10, the merchant business earned 43 cents per share, this is well in excess of our guidance and two cents below the 45 cents per share recorded in the second quarter of 2003. The year-over-year comparison reflects first on the favorable side, 10 cents higher synfuel production related income, second, New Energy earned an incremental two cents which includes a $10 million PGE bankruptcy settlement, an extra month of High Desert which began operations in late April of last year and a month of Ginna operations together add two cents and finally wholesale competitive supply added one cent year-over-year. A strong outcome given extraordinary origination in last year's second quarter.

As Mayo mentioned, this had driven our earlier expectation of a down quarter year-over-year. These positives were offset by the following negatives. 7 cents related to Nine Mile Point. First, Nine Mile Point PPA prices are lower than last year's due to a decline in contract prices scheduled at the time of acquisition. This cost us 3 cents during the quarter, and as you will recall, is projected to cost us 7 cents for the year. Our refueling outage and valve repair outage cost us 4 cents year-over-year. Lost gross margin and operating expenses associated with the Calvert refueling rotor replacement and vessel head inspection cost us 5 cents. Mid-Atlantic margins were down 2 cents year-over-year due to inter-quarter timing. For the year, as you will recall, the mid-Atlantic fleet is expected to be about flat from a gross margin perspective. Lastly, Sarbanes-Oxley, spending intended to drive long term productivity, inflationary and other cost increases, totaled 3 cents. Turning to slide 11, in total the merchant realized 519 million of gross margin in the second quarter 2004, up 24 million or 5% from the second quarter of last year. Gross margin from our mid-Atlantic plants declined 6% due to the loss of eight incremental days generation during the quarter at Calvert Cliffs Unit One during its scheduled refueling outage and the inter company timing issues related to costs to serve load. Plants of PPAs were roughly flat. We benefited from the incremental contribution of our newly acquired Ginna facility and a full quarter of contribution from our High Desert plant. These positives were largely offset by a 19 million decline in gross margin at Nine Mile Point, which I described on the prior chart.

Competitive supply provided the largest gross margin boost in the quarter, increasing 21% from last year's levels. Turning to slide 12, before I describe competitive supply results, let me remind you that we categorize our competitive supply activities based on the size of the customer. Consolation Power Source focuses on wholesale customers who buy energy for further resale, such as utility customers like BGE. This business is expected to contribute approximately two-thirds of our competitive supply gross margin for the year. The key skill sets for that business include a risk management capability, which lowers our cost of serve load and facilitates our extracting value from our large portfolio of contracts, as well as physical logistics expertise. Our retail business, Consolation New Energy, markets electricity and natural gas to commercial and industrial customers. These include customers such as Citigroup, Verizon, Ford Motor Company, who purchase energy for their own consumption. New Energy's key skill set is strong customer interface capabilities. Now, turning to slide 13 and results, collectively, the second quarter's 170 million of competitive supply gross margins was comprised of 104 million of wholesale gross margin and 66 million of retail gross margin. The second quarter growth at our wholesale business primarily reflects our growing gross margin backlog and strong portfolio management results. These factors offset the negative year-over-year comparison associated with several large transactions originated and realized in last year's second quarter which had led us, as I mentioned, to forecast a declining competitive supply result at the beginning of the quarter. New Energy's gross margin of 66 million reflects a settlement related to PGE's emergence from bankruptcy and business expansion.

Turning to slide 14, we had a good quarter originating the business we needed to meet our earnings projections for 2004. In total, 87 million of this quarter's origination will be realized in 2004 earnings. Year-to-date, we've originated 178 million of gross margin to be realized this year and we have 111 million to go to meet our earnings and business growth targets for 2004. In sum, we have originated 62% of the new business needed to meet our earnings target. Turning to slide 15, the wholesale competitive supply business entered into transactions which will create 69 million in 2004 gross margin. Portfolio management contributed 50 million during the quarter. This amount reflects lower than predicted costs to manage our load serving business, good results from trading partially offset by 9 million of mark-to-market losses on non-qualifying hedges. As you will recall, this thing comes -- this comes back to us in future accrual earnings. In line with expectations, load serving origination added 2 million for the quarter as Q2 had few auctions. We also originated 17 million of other customer product business during the quarter, all of which will be realized this year. We have made good progress on wholesale new business, with 125 million done year to date and 98 million of additional origination planned for the balance of 2004. In total, 56% of CPS's target is behind.

Turning to slide 16, as you can see in the third column, not only is CPS originated 125 million, or 56% of our current year origination target, we have originated 50 million worth of new business to be realized in future years. Further down in the third column, you can see that including transactions to be realized in future years, origination is well ahead of last year's pace, with 41% of our 2004 origination target completed. Knowing the third and fourth quarters are typically strong origination periods we're quite pleased with the way this year is shaping up. Origination is on track with our plan and is adding to our growing backlog of earnings to be realized in future periods. Now, turning to slide 17, this chart provides an update of the gross margin backlog for our wholesale competitive supply portfolio that we provided in January. It takes into account 2004 new business as of the end of second quarter which you see highlighted in gray. These contracts will be reflected in future earnings as power is delivered to customers and as we are paid. The margins are highly hedged and the quantity and pattern of realization is visible. In total, pre-existing contracts will add 49 cents in 2005, 31 cents in 2006, and 23 cents in 2007. We expect this pattern of creating gross margin in future years to continue, thereby building our backlog of future earnings. Turning to slide 18, our retail competitive supply business, New Energy, entered into transactions which will add 18 million to gross margin in 2004.

For the year we've achieved 80% of our origination target. In the far right-hand column you can see that for the balance of the year New Energy only needs to generate 13 million of current year gross margin to meet its 2004 business objectives. Turning to slide 19, New Energy's business is healthy and poised for continued growth. Profit projections for the year are consistent with business plan projections. We are taking market share and megawatt volumes are expected to be up over 60% compared to last year. As you will recall, in January we projected margins of about $4 per megawatt hour for the year with new business margins in the area of 3.50. When we bought this company, we expected sustainable margins in the $3 area. We've done better than that in the past, due to some unsustainable phenomenon. While from time to time and region to region, higher margins may be available, we have never viewed this as a $6 margin business. We see this as a business for scale, national presence, regulatory expertise, and customer service drives sustained profitability. Our current view is that margins will be between 3.50 and 3.80 this year, so margins are down a bit from plan. Longer term, we have planned to gravitate towards $3 per megawatt hour. Now, of course, we track the drivers of a margin decline relative to our business plan. And as you get behind the margin decline, it is not alarming and it is in line with the business behavior we have told you to expect.

The vast majority of the decline is a temporary phenomenon driven by rising wholesale prices. Two things happen in a rising or a high priced wholesale market. One, New Energy temporarily may not be able to compete with the local utility. In many deregulated states, the price the local utility charges is set by periodic auctions and then holds static for some period. So prices are rising rapidly, we may not be able to compete until new auctions reset the utility price to beat. Now, separately, in high-priced environment, some customers opt for lower margin index products. Overall, this is a lot like the impact of rising interest rates at a bank, where changes help them in one direction and hurt them in the other. It is part of the cyclical nature of the business. Importantly, this year demonstrates the strength of our business model. Retail geographic diversity and a strong wholesale business allow us to capture margins in attractive markets. Scale allows us to spread our costs over a larger base and you can see the relative improvement of our SG&A cost per unit as we leverage our national platform. Turning to slide 20, as I mentioned on the previous slide, New Energy has already exceeded its full year volume targets for 2004. As of the end of the second quarter we had 42.3 million megawatt hours either delivered or under contract for 2004 versus the beginning of the year target of 41.8 million megawatt hours. For new contracts signed in the second quarter we are seeing an average contract length of 14 months.

New Energy has more than 23 million megawatt hours contracted for 2005. Turning to slide 21, first, six months cash flow for debt reduction was a use of 86 million driven by 430 million in outlays for Ginna. Excluding the Ginna outlays, cash flow for debt reduction was 344 million. We completed a 6 million share equity issuance at the beginning of July which raised 226 million to fund half of the acquisition purchase price. Proceeds from this offering will show up in the third quarter's cash flow. Proceeds from the sale of Puna and other noncore assets during the quarter also contributed to our cash flow. Turning to slide 22, debt to total capital at quarter end was 49%, a 90 basis points improvement from year-end 49.9%. A pro forma including our July 1st equity offering, our debt to capital at quarter end would have been 46.6%. We project debt to capital to end the year at around 46.5%, in line with the projections we shared with you in January. As you can see, compared to year-end 2001, we've made a steady and a material improvement in our balance sheet profile. Now, turning to slide 23, let me provide some guidance for the third quarter of 2004. We expect earnings of $1.03 to $1.18 per share compared to $1.15 in the third quarter of 2003. We expect the merchants earnings to range between 89 cents and $1.03 compared to $1.03 in the third quarter of 2003. The merchant will benefit from a good wholesale backlog of transactions, synfuels and the addition of Ginna but be hurt by mid-Atlantic load costs for the merchant which will largely reverse in the fourth quarter and by Sarbanes-Oxley and some other cost increases.

We expect BGE to earn between 13 and 17 cents per share compared to 12 cents last year. The favorable comparison driven by 2003's11 cent impact of Hurricane Isabel will be partially offset by inflationary cost increases and spending for safety and reliability initiatives. And turning to slide 24, before giving specifics on guidance for the year, let me update you on forecast Ginna accretion. We completed the purchase of the 495 megawatt Ginna nuclear plant from RG&E on June 10th. This is the fastest acquisition of a nuclear facility from announcement to closing and we executed a complete transition, in other words no transition services are being provided by the seller. It is another small operational victory and it is indicative of a growing integration process expertise. We have also taken steps to move forward the 17% upgrade of this facility to the fall of 2006. Upon completion, we anticipate the plant will have a rated capacity of 580 megawatts. With the transaction closed we now expect Ginna to add 7 cents to 2004 results, 2 cents next year to be breakeven in 2006 and then to add 17 cents in 2007 following completion of the upgrade. Turning to slide 25, since the beginning of the year, we've added Ginna and our South Carolina synfuel plant to our outlook. Collectively this is a 25 cent adder to the year. Offsetting these positives are a number of incremental items with a combined impact of 11 cents.

As you know, rail constraints on the East Coast have hindered shipments of coal from Appalachia to our mid-Atlantic fleet plants. We have taken risk mitigating steps to manage our potential exposure to coal short falls and we have included known costs in our forecast. There is of course incremental downside risk if the rail situation deteriorates further, but we believe we can handle this within our guidance range. We are also investing in infrastructure and positioning the business for growth in future business. In 2004, we are implementing finance, human resources and risk management systems infrastructure that will lead to productivity savings in future periods. We are also investing in Nine Mile Point to improve reliability and output. Finally, Sarbanes-Oxley's 404 certification is costing us more than we expected going into the year. On balance, we are raising guidance to a range of 3.15 to 3.25. This is a 14 to 18% increase from 2003 and a 13 cent increase midpoint to midpoint from our January guidance. We have also considered earnings beyond 2004 and we still believe that at 10% cumulative average growth rate off of 2002 provides an appropriate baseline. With respect to 2005 specifically, at the beginning of the year our business plan projected earnings of $3.35 per share. Given strong performance so far in 2004 there may be some upside. We will revisit this forecast as part of our normal business planning cycle, which runs through December, and we will update you in January. That concludes my remarks. Now, let me turn the call back over to Mayo for the Q&A. Great. Thank you, Follin. Operator, will you proceed with the Q&A?

Absolutely. At this time, if you would like to ask a question, please press the star and one now on your touchtone telephone. To withdraw yourself from the queue you may press the pound key. Once again to ask a question, please press star, one now on your touchtone phone. To with drawer yourself, you may press pound. We will take our first question from the site of Dan Eggers of Credit Suisse First Boston.

Hi, Dan.

Good morning. First question for you guys, looking at the backlog trends in the competitive business, you know, how would you rank filling out the backlog for 2004 as you guys have done relative to what you would have expected at the beginning of the year?

As you know, Dan, the timing of transactions in wholesale competitive supply is difficult to predict on a quarter by quarter basis. But if you go back to the chart that we -- we provided, you can see that the pace is much faster than it was last year. So we're very positive on what we've demonstrated through the year.

Dan, this is Tom Brooks. I would add to that, to say, as to -- as to transactions that contribute to the balance of this year, we've already exceeded our annual target for new business, both out of the load -- the load segment -- load serving segment in the business and the portfolio management segment of the business. So we're feeling pretty good about our momentum at this point.

Got it. Hey, Tom, since I have you, can you just give us a little more color on what you're seeing in the coal markets from a procurement standpoint? I was interested in your comments on the rail business, you know, what are you guys seeing and how is that affecting the outside business separate from the constellation actual consumption needs?

Sure. Let me-- let me answer -- answer the question in three parts. One, as to the impact of increasing spot prices, essentially no impact on us there. As Follin indicated, of course we all know that CSX has been having some delivery issues on their system, it's affected our plants a bit as well as those of virtually everybody else taking coal from CSX, given the uncertainty in CSX's ability to perform we've taken some mitigation measures. The cost of these measures as well as what we see as potential further impacts has been included in the guidance that Follin characterized to you. Number two, of course, there has been a significant forward price impact this year. The 12-month forward strip, by example, for eastern coal is up by about 50% since the beginning of the year. Forward power prices are up by about 20%. It has been a volatile market. So it is a fair question on that score. From our point of view, our forward hedging approach focuses on our total portfolio of power and fuel. We're hedging the dollar value of the whole portfolio in the aggregate, not the individual value of separate sub-components, that is power in various regions, coal and other fuels. The forecasted gross margin value of our portfolio of physical and contractual assets, you know, is of course driven principally by the forward prices of power, coal and -- and any other fuels we consume. In terms of our -- in terms of our management of the portfolio in view of the coal price and power price increases that we've seen, we've managed the forward value of the portfolio in a way that has caused us to benefit slightly from these price moves in aggregate. As evidence to that, since our January presentation, the forecasted gross margin value of the physical and contractual portfolio has -- we project has increased by about 3% for 2005 and by about 6% for 2006 -- for 2006, based on -- based on changes to -- to forward prices of power, coal, and other fuels. So -- so, you know, we're feeling pretty good about our ability to handle forward price volatility. And then finally, on strategy, as we began describing to you in January, we have made efforts to build a coal logistics business. This had very positive effects on our 2003 results. And we've continued to invest in building a coal logistics business. We have become increasingly focused on serving coal producing and consuming customers. And, you know, I would say from our point of view, in this environment of price volatility, we see this as a business full of significant opportunities. So -- so from our point of view, you know, this time of market volatility looks like one on the coal side is going to create opportunities for us.

And I guess just the last one and then I will let you guys go, but with this new coal logistics business you're probably seeing more of what is out in the market, you know, what are you seeing as far as inventory patterns and, you know, as people go to mitigation procedures to avoid CSX shortages, are you seeing, you know, massive drops in days of cover? And are people reducing utilization levels at their coal plants to keep them burning?

I would say, you know, honestly we don't have significant visibility into -- into, you know, inventory patterns overall. I think one -- one indicator might be look at -- look at off-peak power prices which, you know, which haven't changed all that dramatically in the last, you know, in the last couple of months. So -- so, I mean I think that is probably a pretty good indicator of people feeling in aggregate about -- about, you know, the potential for coal shortages.

Got it. Thank you, guys.

Thanks, Dan.

Our next question comes from the site of Steve Fleishman of Merrill Lynch.

Hi, Steve.

Hi, guys. A couple of questions. First, on the retail margin analysis you provided, I think you said before that you had assumed $4 for the year, and -- but that assumed new contracts of 3.50.

Correct.

Now you're saying 3.50 to 3.80 for the year. What does that assume for kind of new contracts then?

This is Tom Brady, Steve, how are you doing, this morning?

Good.

Basically we look through the first half of the year, we are seeing gross margins in the $3 and maybe a little bit north of $3 area this year and that's what is causing that average to come down to let's say the 3.75 type area, as we disclosed earlier.

Okay. And how concerned are you about volumes next year to the degree -- do you think the issues, particularly with utility prices coming up, can get, you know, -- is this kind of a -- how long a lag do you think before there is more headroom, essentially, I guess, to compete with utility prices.

Steve, depending on the region, where we are being impacted by the utility prices, they reset some -- some areas reset in a three to six month period, some areas in an annual period. By the time you get to this time next year, most of the areas will have had at least one reset and that will, in fact, start bringing up some of the utility prices. So you would expect at that point headroom will start changing a little bit. Also, in some of the other regions where there are customers coming off it, I think there is headroom there already. This is probably the benefit of having a multi-regional business with significant load in each of the areas. I would say that we are now closing in on six regions with over 1,000 megawatts in it. When I look at where we are right now, we've -- when we look we have booked into next year, we already have 23 million megawatt hours contracted in the next year. That's 55% of what we have either delivered or contracted for 2004. That's a very good number. Traditionally, we would expect that to be a third of our volumes, assuming we are doing a better job of contracting volumes at an earlier rate, even if you assume at, let's say, a 20% increase in volumes for 2005, that would mean that we are well over 50%, or about 50% contract for next year, so we feel very good about that.

Okay.

We also took a look at, Steve, where were we this time last year and we think we were about on pace for creating margin for the next subsequent year as we were last year at this time.

Steve, I might just add that, you know, there is a pretty simple message in all of this, is that when power prices are going up, there is going to be a little bit of a lag effect until you get the resets in place and so you're going to have sort of modestly declining margins, but you do catch up. When power prices are going down, of course, we are ahead of the curve and margins are going to expand so it is a -- that cycle is probably something that people ought to understand, and -- but, you know, the fact of the matter is, that you, you know, you catch up eventually on the upside and then on the downside, you know, you just have -- you an expansion and that's something that we've planned for.

Okay. Fair point. On -- on the -- you commented at the end on 2005 guidance. I kind of somewhat missed what you said, could you just clarify, again, what you said again about 2005 outlook?

Yeah, what I told you, Steve, is that when we first developed a business plan for 2005, which would have been late last year, you know, going through a real bottoms up detailed analysis, we -- our internal point estimate was 3.35. And that's why we got comfortable with giving you a kaker(ph) of 10% off of 2002 because that happens to be exactly a 10% kaker of 2002 or 2003.

Right.

And, you know, clearly, we've been outperforming this year and there are some reasons to think that there may be upside to that number but we're not ready to give you guidance above that number until we've gone through our business plan and have locked it down.

And you will do that in January, again, you think?

Correct.

Okay. And then one last question, just on this mid-Atlantic timing change in terms of when the margins come in there, can you just explain what that's coming from?

Yeah, here is the issue, we had -- we had a bit of a positive when you looked at year-over-year mid-Atlantic. We had about a negative 12 million gross margin impact this quarter. It will be a negative 26 million gross margin impact next quarter. And then it turns around to be a favorable impact in the fourth quarter when you look at year-over-year timing of each quarter. And essentially, as we've moved into the BGE and the BGS auctions, the phenomena now is that we tend to bid flatter prices than our actual cost, so it is going -- it creates this seasonal squeeze in the second and third quarters.

Okay.

So it is just a timing issue that will become our new pattern of how gross margin is realized at the merchant and mid-Atlantic, so in 2005 it won't create the timing issue.

Okay. Thank you.

We will take our next question from --

And -- and Steve, just -- just let me make sure that I was clear. Net-net for the mid-Atlantic fleet we're about flat from a gross margin perspective. If you go back to our January presentation, I think we said it's down 12, mid-Atlantic fleet, year-over-year, we now expect for the full year, it is going to be down about five. So the entire -- this is really an inter-quarter timing issue.

All right, next question?

Our next question comes from Ali Agha of Wells Fargo.

Thank you.

Hi, Ali.

Good morning. One thing, Mayo, that I wanted to clarify and maybe dunk in some of the dynamics were you talking about for the second half, it appears in the second quarter you beat the high end of your guidance by 16 cents. And yet, you're raising the full-year numbers by just 5 to 10 cents. So can you just remind us why, you know, there is that difference in the two numbers?

Sure.

Yeah, I -- here is the -- first of all, I would, you know, first take you back to the big picture of the full year, Ali, you know, go back to page 25 and what is new news from the projections that we gave you back in January, one is the addition of the these synfuel earnings and the addition of Ginna and then the take-aways since January are the coal rail delivery constraints and the fact that we have taken this opportunity to invest in the business, so it's a -- in Nine Mile Point and in IT systems. And lastly, Sarbanes-Oxley has cost us more than we thought going into the year. So I've just described to you a net out of 14 cents for the year, we took guidance up 13 cents midpoint to midpoint. Now, what you see is you see some timing issues primarily with respect to wholesale competitive supply. When you say, well, you were up more positive in the first half than what you're describing as your entire guidance increase and, you know, that's true, wholesale competitive supply has, for the first six months, beat what we would have expected going into the first six months. And as you know, that business is lumpy and difficult to predict as to timing and that is what is causing the difference between change in our annual outlook and what our outperformance was in the first six months.

Okay. Second question, the 23 million megawatt hours of backlog that you have for New Energy delivery for the rest of the year, should we assume from a dollar perspective that that is about $3 a megawatt hour margin?

No, you would -- you would consider -- it probably be a little bit higher than that.

In the past have you given us the dollar amount. Could you give that again?

For the -- I do not believe that we have given future -- future gross margins. The information we've told you is that in our business plan we're expecting margins to trend down towards $3 and we've told you that that's happening over a number of years, so you would assume that we aren't counting on quite going -- quite hitting the $3 number by next year.

Okay. I thought you did, Follin, and I will follow offline on that. Last question. In your guidance, the operating guidance that you have for the year, what is the assumed effective tax rate?

Let me pull that up. Do you know it off the top of your head? Yeah, I tell you what. Let us get back -- let us get back to you with the assumed effective tax rate and the guidance for the year.

Okay, fair enough.

But we have, you know, so you've got the information, we have given you the detail on -- the big difference between statutory rates and our effective tax rate is, of course, synfuel tax credit and we've given you precisely what we're counting on for synfuel tax credits in an addendum to the presentation that is on your website. Oh, and I've just gotten the effective tax rate worked out for the year, with the benefit of the synfuel tax rate, it works out to 28.6% for the year.

Thank you.

We'll take our next question from the site of Mr. Thomas Hamlin of Wachovia Securities.

Yes, good morning.

Hey, Tom.

Two questions. One has to do with BG&E, page nine. There was -- I guess relative to guidance of 12 cents, how much of the two variable factors had -- were in the 12 cents and how much wasn't counted on as far as inflation and the other investment?

You're asking for an analysis of varying -- .

Yeah, just how much was weather above what you thought it was going to be. Above normal.

Hang on, let me give you that real quick. Above forecast? 2 cents, Tom.

2 cents? Okay. And this inflation and reliability investment, was that unexpected? 5 cents a share.

No, that was expected. That has been in our plan.

Okay. Great. And just one other question.

So Tom -- Tom, to clarify, the increase versus guidance was about 4 cents from the midpoint of the guidance range and it was a combination of 2 cents weather and about 2 cents usage.

Okay. So usage was 2 cents higher than you thought.

Yup.

Over and above wether.

We've had some favorable usage patterns this year.

Great. On the competitive supply gross margin, you mentioned the PGE settlement. Was that 10 million or 10 cents?

It was $10 million. Essentially, we - we had -- we had a receivable of 8.9 million on our books at the time we acquired New Energy and we valued it at zero due to the bankruptcy, and so when the reorg was implemented in April we received that 8.9 million receivable plus another 1.4 million of interest.

So that accounts for some of the guidance going up? This part --

Not -- we were counting on that for cash for the year, actually.

You were? Okay.

The timing was uncertain but we were counting on it.

Great. Okay, thanks, Follin.

We will take our next question from the site of Paul Patterson, Glenrock associates.

Hi, Paul.

Hi, how are you doing?

Good.

I wanted to touch base with you on the -- on slide 17, with respect to the contracts. It looks like the contracts that you guys are originating now are of shorter duration than they were, I guess, in previous years. I mean is that the case? In other words, just if you could comment on the market there and it looks like, you know, origination going forward is, you know, -- this year, it looks like you guys are locking in for a shorter period of time as opposed to longer period of time. Is that correct?

On the duration of the contracts, so the term of the contracts, I would say the -- on -- as to the -- as to load serving, there was a period of time in '99 and '00, particularly, when some of the -- some of our utility customers, as they went through their restructuring, did enter into longer standard offer service procurements, multi-year standard offer service procurements. For the last -- the last two or three years, that -- that just has not been the case. So there hasn't been, let's say, last year to this, any appreciable change.

Okay. And then secondly, in terms of mark-to-market, just looking at the balance sheet there seems to have been a substantial increase in risk management assets and to a lesser degree mark-to-market assets and I was just wondering if you could A, just sort of define the differences between the two, and B, what was the mark-to-market effect for the quarter?

The mark-to-market earnings for the quarter were 6.1 million.

Okay.

And --

I mean if you look at the-- the press release and if you look at the assets, you see at risk management assets went up, you know, from 249 to 588 and then there is investments in other assets where the same category is there and it goes up a bit as well. And it seemed to go up a little bit more than liabilities, you know, at least a lot more actually in the risk management assets, I was just wondering what is -- what's the difference between the two?

Well --

And what caused it to jump so much?

Well, I guess, you know, first of all, the -- the big -big increase, you know, nominally in the category, is the commodity prices went up. Right? That would drive up assets, drive up liabilities. Right. The Delta in the value of assets going up more than liabilities, you know, is primarily phenomenal, like the way -- the way -- the way we are -- you handle accounting now on mark-to-market gain is if you do not have observable price data, you reserve the gain. So we are booking transactions which have -- that are derivatives which have gains on day one, but where we don't have liquid observable price, we aren't taking the income. We are reserving the income.

Oh, okay.

So that will play out in future earnings, in otherwards.

That's great. I really appreciate it. Thanks a lot, guys.

Thank you.

Our next question comes from the site of Craig Shear of Standard and Poor's.

Hi, Craig.

Three quick questions. Follin, two for you. First, do I understand the $10 million gain of receivable at New Energy was originally already factored into your Q2 guidance?

I'm sorry, I cannot hear you, Craig. I think you're asking about PGE?

Right. The gain -- .

It was factored into our calendar year guidance. We did not have it into the second quarter guidance. So as we came into the year, right, we knew that PGE was heading towards a bankruptcy settlement but we did not know what quarter it would happen in.

Okay. Great. And also, your Ginna guidance for the accretion in future years, one, can you tell me again what the '05 and the '06 numbers are? And two, this is better than I thought because I thought we were taking a hit on some noncash higher than expected retirement costs. Can you comment if that is net of those noncash costs?

It is -- it is net of those noncash costs. We've also had a phenomena since the date we entered into the acquisition to now, where wholesale prices have gone up, such that wholesale prices are somewhat higher than the contract prices. So that was created as a -- that has to be booked as a liability on our opening balance sheet. That's negative value of the contract between contract prices and wholesale prices of the day we closed the acquisition. That liability gets accreted into income over future years, so it is just somewhat offset those -- the noncash items that we talked about at the last call.

I gotcha. And lastly, Mayo, maybe you want to comment on this. I just want to get some, you know, and maybe this is a really basic question, but I want to try to position in my mind what you're doing versus the old, you know, not working energy merchant model. When you all say that you have contracted or originated and you've locked in gross margin in these future year, do I understand correctly that not only do you have the contract with your customer, but all the costs associated with that are known and locked in, so you really, absolutely, have contracted gross margin in future years, which contrasts with the old energy merchant model which took mark-to-market present value of unhedged future assumptions?

That is essentially correct. Recognizing that, you know, in some cases you may not have perfect hedges, but we are, you know, we run the business towards price neutrality and as a consequence, attempt to match -- to run a matched book in that respect. And you're right. That is fundamentally different than what I perceive the old merchant model being.

As an addendum to that, what is the growth rate in terms of new generation acquisition that you need to, in terms of megawatts on the ground, that you need to try to implement to keep pace with the growth in this business going forward?

You know, I think the answer to that is that we don't need to acquire generation assets to keep the growth of the business going as we had planned. We -- you know, the way we look at it, is that, you know, they are two separate businesses. You can own assets, which is a good business. And/or you can control the output. And we look at those as two distinct opportunities and, to the extent that we have a substantial load serving obligation in an area, it really is not of great significance to us as to whether we own the output and own the asset itself. Having said that, we obviously take great pride in our generation expertise, in our history there and, to the extent that we can get above average risk adjusted returns, we're going to buy assets and I think that with respect to the Ginna acquisition, which we regard as being an important addition in two way, not just financially but also expanding the nuclear fleet, and really putting us into the arena of the top eight nuclear operators, such that, you know, we will be a long-term player in nuclear. We believe in it 100%. We think it is important that we get the country to believe in it in, you know, in the forward years, and so we're -- you know, we have a special expertise in that arena. But we -- we look at generation as a, you know, as an opportunity for us to build the business and, I think, you know, that the last comment would be that to the extent that we can buy assets that have some relevance to our load-serving competitive supply business, by being in the same region, by perhaps giving us more degrees of freedom as to how we might hedge a position, so much the better. But it is not really regarded as being necessary to that side of our strategy.

Last night, on -- how would you respond to people that are concerned about the analogy to the old asset light energy merchant model when you talk about what we don't have to own all the facility, we can contract for it and control the output, and then we contract with our customers. You know, there is a lot of people who hair stand on the end on the back of their necks when they think about the old asset light energy merchant models from 3 or 4 years ago from other competitors. How would you clarify that in people's minds?

Well, I think that there is a really a substantial difference in the environment and that is when people were concerned about the so-called asset light strategy, they were looking at wholesale markets that were not particularly evolved, and then you have the collapse of Enron that seemed to exacerbate the concern about whether wholesale markets would even survive. You know, obviously, just the opposite, the wholesale markets have continued to evolve, they have become more liquid, they have expanded across the country, and you will even hear those companies operating in what you think of as highly regulated markets talking about the fact that they have a healthy wholesale market, even Southern would say that in their public presentations, but that -- that is the most important grounding to taking the strategic position that we have, is that you have to consider that, you know, the way the market has -- has gone, is people with generation assets that are considered merchants don't have very good sales and marketing arms, they're not oriented that way, they don't have the sell side of the equation, and as a consequence, we are delivering a service as much to those generation providers as we are to the customers who don't have generation or who would like to buy their generation competitively. And so -- and we have told you, I think, in the past that we expect to manage that -- the intermediation relationship by adding value to both sides of the equation. So if you look at the people that we regard as our customers, it would include the Reliants of the world and the Echelons of the world, and we treat them as customers, and so as a consequence, I think that the, you know, the notion of asset lightness, of which we don't try to put forth at all, because obviously we have lots and lots of assets, but at the same time, I think the way to build the business is to concentrate on the appropriate risk-adjusted returns to both sides of the equation and not necessarily command that they are inter-related. And that's why I think both sides are going as well as they are.

Great. Thank you.

Our final question comes from the site of Andy Smith of J.P. Morgan.

Hi, Andy.

Good morning. Just a couple of quick questions. One is, I just want to see if you guys could comment on P&M, as part of the deal they announced a little while ago, talked about a contract they -- that was in place with you guys to serve, load and taxes, and one of the things that jumped out at me is they made the comment that there was a 30 day cancellation term in that contract and, I guess, there was some discussion around using balance sheet and things like that, you know, for the load serving. Is that sort of cancellation term common in a lot of your contracts or is that a unique situation? And if it is, can you sort of give me a feel for -- like what portion of your book might be exposed to that type of cancellation?

I would say in general, across the whole book, no. In -- in regard to the retail subsidiary of TNP, to be honest, I'm not aware of what P&M said, but I think I probably -- probably not comfortable to comment on the details of our relationship with First Choice Power. We do serve -- we do serve First Choice Power, as you know.

Sure.

But -- but, you know, it is certainly is not a common -- you know, cancellation feature is not commonly part of our arrangements.

Okay. And then just on that one particular issue, it sounds like it is not a big portion of your book, yet you guys mentioned about running basically fully hedged and not taking a lot of market risk. I mean how would you guys, or how could you characterize that situation, well, let's say, for example, that contract changed in some way, shape or fashion. Would that leave you guys exposed somehow on the other side of the hedge? Or have you been able to deal with that in such a way that you wouldn't be exposed?

Yeah, I guess I would say in general, we're -- we're-- again, I'm not going to comment on the details of our arrangements with First Choice. We're -- we're very comfortable with -- with our Texas position and with the balance between, in effect, our assets and liabilities in the Texas market.

Okey doke, great. And then just one last quick question. I appreciate the color on that. Just if you guys could clarify, I thought Follin made a comment on slide 20 about a 14-month average contract length. But then there was a question earlier where you guys said you really hadn't seen the contract length changing. Was that in different classes of contracts? Or how can you guys reconcile those two statements for me? Page 20 is about retail, Andy, and earlier, Tom Brooks was asked about wholesale. Okay. I just wanted to clarify. That's what I thought the difference was. Okay, that's great. Okay, thanks, guys. Let me clarify one point that I made earlier as to when we knew about the PGE settlement. We knew about the -- we did not have the PGE settlement in calendar year guidance. We knew about it in April when we set Q2 guidance, so it was an April guidance, it was not in the full-year guidance. So if you go back to the page that we showed you on the details on the retail outlook, page 19, you see an increase in gross margin from 2.20 to 2.25. So of that the 9 million of the PGE settlement, which hit gross margin, would be in that increase and then there would be negative 4 million of other negatives. So a small point, not particularly relevant to the overall story but that is the timing as to what we knew when.

All right. Well, we want to thank you for attending this morning. Obviously we're very pleased with the progress this year and we will be back after the third quarter. Have a nice summer.

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