艾索倫電力 (EXC) 2004 Q3 法說會逐字稿

Good day. All sites are now on the conference line in a listen-only mode. I would like to turn the call over to your host, Mr. Mayo Shattuck.

Good morning, everyone, welcome to our third quarter 2004 earnings conference call.

Before we begin our presentation today, I first want to congratulate all of the Red Sox fans. And secondly, remind you our comments today that 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. Our presentation today is being webcast and the slides are available on our website which you can access constellation.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 charts on the website, reconciling non-GAAP measures to GAAP measures.

So we start off on slide 4. We are very pleased to report another strong quarter. Earnings, excluding special items for the quarter, were $1.22 per share, exceeding our guidance range. For the first 9 months of 2004, earnings excluding special items were $2.45 per share, up 17% versus last year.

At the merchant business, we followed last year's strong earnings with another exceptional performance. BGE had a solid quarter, and continues to be a stable contributor of earnings and cash flow.

Turning to slide 5, as the nation's largest competitive supplier of energy, we applaud the recent expansion of the PJM interconnection and progress toward toward the adoption of new market rules in the Midwest ISO. We believe ongoing discussions of competitive procurement in Ohio and California, and recent competitive auctions in the District of Columbia signal that, in spite of the turmoil of the last three years, regulatory bodies still recognize that competitive markets reduce consumer prices.

We believe increasing interest in competitive auctions may present incremental opportunities to leverage our low cost platform. We're not counting on new markets opening in our financial projections, but we're bullish in our outlook.

Our Constellation New Energy retail business is going very well, and we are exceeding plan in the challenging wholesale price environment . As you will recall, there was great deal of focus on C&I retail margins last quarter. I am happy to say that the business behaved as we predicted it would.

When wholesale prices stabilized in the third quarter, so did margins. Our retail competitive position is stronger, we now serve 60 of the Fortune 100. Our scale, operating leverage, and geographic diversity are providing sustainable competitive advantages. We remain convinced that for the next several years our earnings will grow at about 10% per year.

This year we're on track to earn $3.15 to $3.25 per share, up 14 to 18% increase over last year. Consistent with our policy of growing the dividend in line with earnings, we expect to recommend to our Board that we increase our dividend for 2005 by a similar percentage.

In sum, the business proceeds at a robust pace. It was a straightforward quarter, we executed well, we exceeded guidance, and invested in the commercial and management infrastructure necessary to drive superior future growth. These are the hallmarks of this management time, near-term execution and long-term focus. So I'll keep my remarks brief and turn the call over to Follin to review the financials.

Thanks, Mayo. Good morning, everyone, and thank you for joining us today.

I'll start on slide 7. Earnings excluding special items for the quarter were $1.22 per share, compared to $1.03 to $1.18 guidance. We had $0.03 per share of special items driven by a loss on the sale of non-core financial investments. We've now whittled support folio of non-core financial and real estate investments to approximately 40 million, from 714 million in 2001, when we started our divestiture initiative.

Turning to slide 8. BGE earned $0.16 per share this quarter, consistent with the $0.13 to $0.17 guidance range presented in July, and up $0.4 cents versus last year's third quarter. We benefited from the absence of costs associated with last year's hurricane Isabel. This positive was partially offset by the absence of a $0.03 market-based rate gas recovery last year, and in 2004, Sarbanes-Oxley enterprise system and other costs.

Turning to slide 9. The Merchant business earned $1.07 per share. This was above our $0.89 to $1.03 guidance, and $0.04 above the $1.03 per share recorded in the third quarter of last year. The favorable year-over-year comparison reflects first on the favorable side. $0.10 higher earnings from our competitive supply activities. Of this $0.10, $0.06 is the result of stronger wholesale result at our commodities group, and $0.04 is related to the growth at our retail competitive supply business, New Energy.

Second, Synfuel production related income added $0.08 on a year-over-year basis. The addition of the Ginna nuclear facility added $0.05, and the absence of the 2003 northeast blackout added $0.02 at Nine Mile Point.

These positives were partially offset by the following negatives. $0.10 of Sarbanes-Oxley attestation, enterprise information system, workforce adjustments, planned outages, and other costs. Also, as we indicated would be the case on our July call, the Mid-Atlantic Fleet gross margin was down for the quarter compared to last year. For the full year 2004, Mid-Atlantic Fleet gross margin will be about flat versus full-year 2003.

However, there are some inter-quarter timing issues--down in the second and third quarters, up in the first and fourth quarters. Finally, we have $0.02 of dilution from shares issued to the dividend reinvestment and benefit plans.

In total, on page 10, the Merchant realized $711 million of gross margin in the third quarter of the 2004. Up 98 million from the third quarter of last year. Gross margin from our Mid-Atlantic plants declined 26 million in the third quarter. As I just mentioned, this is an inter-quarter timing issue, and will change to a positive variance in the fourth quarter. For the full year 2004, Mid-Atlantic gross margin will be roughly flat versus last year. Plants with PPAs were up 60 million, Ginna added 55 million at the gross margin level, and $0.05 of EPS after netting operating cost and dilution associated with equity used to finance the acquisition.

Nine Mile Point benefited from the absence of the August 2003 northeast blackout. Competitive supply provided the largest percentage gross margin boost in the quarter, increasing 51% from last year's level.

Turning to slide 11. Collectively, the third quarter's 169 million of competitive supply gross margin was comprised of 100 million wholesale and 69 million retail gross margin.

Third quarter growth at our wholesale business primarily reflects the realization of our growing gross margin backlog, and strong portfolio management and trading results. New Energy's gross margin growth reflects higher volumes, and includes a $6.6 million bankruptcy settlement.

Turning to slide 12. We had a good quarter originating the business we need to meet our earnings projections for 2004. In total, 100 million of this quarter's origination will be realized in 2004.

Year-to-date, we have originated 265 million of gross margin to be realized this year, and we have 49 million to go to meet our fourth quarter projection. In sum, we've originated 84% of the new business needed to meet our earnings targets.

Turning to slide 13. The wholesale competitive supply business entered into transactions which will create 64 million of 2004 gross margin. Portfolio management contributed 43 million during the quarter. This amount reflects lower than predicted costs to manage our load serving business and good results from trading. In line with expectations, new load serving origination added only 2 million for the quarter, as the third quarter had few auctions.

As you will recall, the first and fourth quarters are big auction periods. We also originated 20 million of customer products business during the quarter, which will be realized this year. We've made good progress on wholesale new business, with 176 million originated that will be realized this year.

In total, 79% of the wholesale commodities group origination to be realized in this year's earnings is done. For perspective, this group's fourth quarter forecast origination is to be realized this year is about in line with what they did last year. The group will also focus on building the backlog of transactions to be realized in future years.

Turning to slide 14. As you can see, not only have we originated 176 million of transactions to be realized this year, we've originated 73 million worth of business to be realized in future years. On the bottom line of the chart, you see that including transactions to be realized in future years, 58% of our total new business target is completed. This is well ahead of last year's pace.

The fourth quarter is typically a strong future gross margin quarter -- excuse me -- typically a strong future gross margin origination period, and we believe we're on track with our plan for adding to our growing backlog of future earnings.

Turning to slide 15. This chart provides an update of the gross margin backlog for our wholesale accrual competitive supply portfolio. It takes into account 2004 new business as of the end of the third quarter, which you see highlighted in gray. These contracts will be reflected in future earnings as power is delivered to customers and we are paid. These margins are highly hedged, and the quantity and pattern of realization is visible.

In total, preexisting contracts will add 162 million in 2005, and 103 million in 2006. We expect this pattern of creating gross margin for future years to continue, thereby building our backlog of future earnings.

Turning to slide 16. Focusing on New Energy. As you will recall, last quarter we talked about megawatt hour margins dropping from business plan levels of $4, to $3.50 to $3.80 this year. We said we thought this was temporary and due to rapidly rising wholesale prices in the second quarter. We said we thought this would be part of the cyclical nature of the business, and that we'd benefit from the same phenomenon when prices decrease. In fact, wholesale prices stabilized during the third quarter, and margins stabilized.

Our current projection is that 2004 margins will be about at plan levels of $4 per megawatt hour.

In the third quarter, New Energy entered into transactions and realized incremental margin which will add 36 million to gross margin in 2004. For the year, we've achieved 98% of our origination target. In the far right column, you can see that for the balance of the year, New Energy only needs to generate 2 million of current year gross margin to meet its fourth quarter projections. This group also will be focused on building its backlog of future gross margins.

Turning to slide 17. As of the end of the third quarter, we had 43.8 million megawatt hours either delivered or under contract for 2004, versus the beginning of the year target of 41.8 million megawatt hours. New Energy has more than 25 million megawatt hours contracted for 2005. This amount is 10% ahead of where we were at this time last year. Quite an accomplishment in this difficult wholesale price environment.

Turning to slide 18. First 9 months cash flow per debt reduction was a use of 4 million, driven by 457 million of outlays for Ginna. Excluding the Ginna acquisition, cash flow for debt reduction was 226 million.

Debt to total capital at quarter end was 46.7%, a 320 basis point improvement from year-end 2003's 49.9%. We project the debt to capital at year end will be at around 46.5%, in line with the debt to total capital projection we shared with you in January.

Turning to slide 20. Let me provide some guidance for the fourth quarter of 2004. We expect earnings of $0.70 to $0.80 per share, compared to $0.67 per share in the fourth quarter of 2003. We expect the Merchants earnings to raise between $0.54 and $0.64, compared to $0.52 of earnings excluding special items in the fourth quarter of 2003. Compared to last year's fourth quarter, the Merchant will benefit from incremental Mid-Atlantic gross margin, the addition of Ginna, synfuel tax credits, and increased New Energy profitability. Wholesale competitive supply will be about flat compared to a very strong fourth quarter last year.

This will conclude a highly successful 2004, for competitive supply and the group will focus on building the backlog of future evenings. These favorable items will be partially offset by Sarbanes-Oxley attestation spending, and other costs. We expect BGE to earn between $0.16 and $0.19 per share, in line with the $0.17 per share in 2003.

That concludes our prepared remarks. We look forward to reviewing our 2005 business plan with you in January. We will now turn the call over to the operator for questions.

Very good.

[OPERATOR INSTRUCTIONS] We'll take our first question from the site of Dan Eggers of Credit Suisse First Boston.

Good morning.

Good morning.

First question I guess, you know with the recent spike in commodity prices we've seen, how is that affecting your ability to sign new contracts? Are you seeing more of a index type product being provided versus a full requirements, and if you could give any color on length of contracts now.

Sure. Why don't I have Tom Brady respond as it relates to the New Energy business. Good morning, Dan. Dan, usually when we get into a high wholesale price environment it does limit certain opportunities where you have utility tariffs. In fact, you cannot beat them at times, and renewals do shorten up a little bit, and we, in fact, are seeing some of that happen right now, but the real best that we have is that the high whole sale environment that you might focus in one reason in the northeast or so doesn't extend throughout the country, and we're able to move the business forward at a specific pace because we're in all the key regions in the U.S

And is length changing at all in the contracts people are signing?

Yes, they are coming down just a little bit. I would say this time last year, we were probably just short of a year and a half, and right now, in the last quarter, what we've signed has been about a year.

And then I guess one of the conversations you've had in the past has to do with the fact that you tended to do well, or be more profitable when weather volatility in the markets are pretty stable. With relatively mild temperatures, kind of going to one extreme. Did that have any impact on the quarter?

Yes, it did. The mild temperatures and steady power prices is what pushed our margins up a little bit in the third quarter. We were over $4, and that's why we do expect it to be over $4 for this year.

Okay. So that won't -- that $4, now that we've had a pretty rapid strike in commodity prices, that $4 margin isn't in jeopardy in the fourth quarter. Is that what you're saying?

No, it's not,

Got it. Thank you. And then on Ginna, the $0.05 contribution this quarter, I thought the full year number was supposed to be closer to $0.04 or $0.05. Was there something we were missing? And then I guess what is the expectation for the fourth quarter?.

The expectation now for the full year for Ginna is close $0.13. The plant is performing well, running well.

Does that just have to do with outage time, or are you guys able to sell beyond contracted obligations?

Do you want to pick this up, Mike?

This is Mike Wallace. It's a combination of things. Of course we had the early close, but, in addition, we've been able to focus on the expenditures of the site in a way that has improved our earnings, as well. And so those two factors, from an operating point, together, have lowered our costs, and are helping to account for some of the earnings.

And I'll add, Mike, I know Dan is referencing where we were at $0.07 last quarter. We were contemplating taking some outage time late this year at Nine Mile Point, and we decided not to do that.

Got it. And I guess just one more. It looks like year-to-date you guys have spent somewhere between $0.30 and $0.36 on Sarbanes or infrastructure costs. How much of that is Sarbanes, and how much of that is going to be recurring into '05, and how much do we expect to be this year only?

Well, we think that we're going to have spent this year, on Sarbanes, a total of about 15 million. That -- and last year we spent a couple of million, so an increase of 13 million year-over-year. And I'm sure you're starting to hear this from other companies. I know when I'm in CFO forums, we talk about it a lot. It's a combination of the auditors are going to charge a lot for their attestation fees for all companies, and in most cases, we're expecting that it's going to be higher than what the audit fee had done for the new attestation fee. We, and many other companies who keep man power at, you know, try to keep it at the right balance, and this ads a huge new layer of incremental effort have brought there lots of outside contractors to help with all of the first round of documentation requirements that's are required in Sarbanes-Oxley. So, in total, we think that we're going to spend about 15 million this year, and that will year-over-year have been a $0.05 hit.

Got it. Thank you.

Thank you, Dan.

We'll move now to Greg Gordon of Smith Barney. Go ahead, please.

Yeah, good morning.

Good morning, Greg.

On Ginna, should it be our expectation that given how successful you've been in bringing the plant into your portfolio that there's an upside to the previous guidance you've given for 2005 and beyond, and can you refresh our memory as to what that guidance was?

Next year we're going to to have an outage at Ginna, and the expectation is that it will earn -- it's going to earn flat next year.

Right, and I guess my question is, since you've lowered the denominator on the cost structure, as Mike indicated earlier, for the periods of time that you're actually running and not out, would you then be potentially ahead of plan

I'm sorry, what's the --

Dan, I think what you're getting at is compared to the way we looked at Ginna three or four months ago, how do we now look at it for '05. And I think it's fair to say that we're seeing opportunities in the way that we operate the plant to get some mild synergies with the rest of the fleet that will reflect somewhat in our costs, and perhaps even in our outage duration, but I would expect those gains to be mild compared to what we were otherwise contemplating.

Great. And just to follow-on on some of the questions on competitive supply. You indicated that the 47 million in new business for the wholesale that you need to meet your budget for the end of the year is sort of the consistent with what you -- where you were at this point last year. If Tom Brooks is there, could he talk about what the size of the market opportunity is this Q4 versus Q4 last year, number of auctions, number of negotiations under way? Is it the same size, or is the opportunity bigger this fourth quarter.

Yeah, Greg, I guess what I would say is in general, you know, our business has grown, in terms of the number of things we're involved in, so I think we do see a growing base of opportunity. Q4 for our wholesale customers is traditionally a quarter when a lot of different categories of customers are positioning their businesses for the coming year, certainly distribution utility customers, merchant generators, and those trying to procure or sell fuel. So Q4 tends to have a good pace of activity, and that's what we're, certainly what we're seeing this year.

On the specific question of load auctions, you're absolutely right, there are lots of load auctions going on in Q4 and Q1 of '05. Distribution utility sourcing power for the coming year. Given the competitive environment, we can't really talk about our results yet, but to provide a bit of context, we served about 19,000 megawatts of peak load in '04, some of this rolls off each year, and, of course, we target growth in volumes as part of the growing the overall business, so Q4 and Q1 load auctions are important to us.

In the fourth quarter thus far, there have been about 5,000 megawatts of power competitively sourced, and there will be another 20 to 25,000 megawatts sourced in the balance of the quarter, and in Q1of '05. Again, we can't talk about results yet, but I would say that we're more confident than ever about our load business, about our ability to hit the current year and long-term growth targets that we present in our business plan in January.

That 20,000 to 25,000 megawatts includes the 9 in Ohio?

It does, yes.

And one last question on retail. The new business that you need to hit your targets for this year is basically rounding -- or its 2 million in gross margin. Where were -- what was the size of your sort of year-end not at this time last year? You didn't mention that on the call.

I don't have that number right in front of me, but it was -- we had some work to do this time last year to hit our year-end. We just did very well, and in fact moved this number up throughout the year.

I'm sorry, one last question back to Tom. As you look at how the commodity markets have evolved with so many nonphysical players' hedge funds increasing significantly the amount of volatility we've seen, a lot of other classic utility players, names not be mentioned, have talked about how difficult it has been for them to make money with a fundamental view on the power markets. How has your ability to manage variable load risks, Tom, evolved since, you know, over the last year, and are there any significant changes in the market that have either increased or decreased your ability to price that type of risk?

I guess what I would say, Greg, is I don't thing we've experienced what you're referring to in terms of difficulty in managing the markets at all, managing our positions in these markets. On variable load risks particularly, you know, this is -- you know, we've experienced a significant net positive this year, as our portfolio grows, we find that the cost of -- the per unit cost of managing variable load risks declines, and we've continued to experience that this year. So, you know -- and in general, I guess I would also highlight the fact that we have been this year, as in prior years, we've assumed a posture of being very, very substantially forward hedged as the power and fuel prices, you know, between 95 and 100% of our expected power and fuel volumes for current year have been forward hedged for the last three years, and this year is no different, so -- so, you know, our exposure to upward price volatility has been negligible.

And on the side of our mark-to-market portfolio, you know, we operate a pretty -- a relatively limited mark-to-market portfolio. Our mark-to-market bar has actually declined substantially year-on-year. Through Q3 our average bar from '03 to '04 declined a bit -- by a bit under 50%, so a significant reduction year-on-year in our total risk exposure.

But Tom, as I think about it, your portfolio management revenues were up substantially. You've talked before about trying to manage a modestly net long position relative to your expected load with the weather having been so mild, and commodity prices going up in the quarter. Is that the basic math on how you're able to generate such a large portfolio management number in the quarter?

Well, I would say a couple of factors. Number one, yes, variable load risk is across the earth generally been a net positive. Our ability to manage congestion cost has likewise been a positive for us. Both of these things we think are affected significantly by the scope of our portfolio, as the portfolio gets bigger, the cost of managing these things declines. And then finally, while we did maintain a pretty modest bar in our mark-to-market portfolio, we experienced good results, so we were very effective with the limited amount of risk capital we were deploying there, and that certainly drove the good results as well.

Our next participant is Steve Fleischmann [ph] of Merrill Lynch.

Hi, guys.

Good morning, Steve.

A couple of questions. First, I know this year we've had a significant increase in costs for Sarbanes-Oxley and a variety of other things. What's kind of your view on cost outlook going forward? When do we start seeing more kind of bottom line benefits of the six sigma actions and such?

We -- what we've talked to you about in the past, Steve, is we told you we would have negative productivity this year as we invested in enterprise systems, as we invested in Nine Mile Point reliability, and as we undertook some other initiatives. For example we began to have steam generator costs, and output is ramping up, but as we invested in productivity, you will see real productivity come through in next year's results, and then 2006, you'll start to see a notable ramp up in our productivity.

Okay. Good. Secondly, on the balance sheet,, where -- where do you guys think you need to take either these debt to capital or coverage metrics to the point where there's nothing that you really need to do?

Yeah, you know, I -- you know, we -- we spend a lot of time thinking about this. And in the past, we've said we are targeting debt to capital in the mid-40s, and that we should have achieved that by year-end 2005, which would put us in a position to use excess cash flow to either reinvest in above hurdle rate opportunities, or to buy back stock. As we focus on what our target should be, you know, we step back and we say credit quality is very important to our commercial activities. We want to have a strong balance sheet to support our growth in customer facing activities.

We are now thinking, Steve, we should have closer to 40% in debt to capital. We will get there sometime in 2006, and then we would be in a position to stop dedicating excess cash flow after paying a growing dividend to balance sheet improvement.

Okay. And then one last question with respect to this Ohio auction. Could you comment on whether you think given the way the auction is structured, given First Energy's comments about not bidding, and given the commodity environment whether you think the auction can succeed competitively?

Sure. A couple of comments, Steve.

First, just clearly to echo Mayo's comment, that we're pleased with what this indicates about the regulatory climate. We think that with the success of competitive procurement in New England, PCG and elsewhere, we're clearly seeing regulators become increasingly focused a on competitive procurement as part of the resource mix. And in this instance in particular we think that PUCO has followed quite a thoughtful and disciplined process, and we're optimistic that this auction will succeed. At this point we think there's plenty of potential auction participants, so I think the real key uncertainty comes down to energy prices.

You know, as you know, in FE's rate stabilization plan, there was a price for wholesale power, $45 a megawatt hour for full requirement service, which the PUCO used to construct a maximum auction clearing price of $55 a megawatt hour, adjusting for certain costs that FE can pass through as part of its plan. Since the FE plan was filed, energy prices have increased dramatically as you know. And I would say if they increase much more from current levels, it could happen that the auction might not produce a lower clearing price than the price from FE's plan. So we really think energy prices are the real uncertainty underlying this auction at this point.

You know, while we're pleased with what the auction implies about the constructive regulatory climate, this particular auction is absolutely not critical to our ability to achieve our business plan growth targets. I think kind of as we look at it, if the auction fails to clear, it's probably going to fail to clear because prices -- energy prices have increased even further, and frankly as a company that produces more than 40 million megawatt hours of base load power annually, higher prices don't exactly break our hearts. So we are, I think, optimistic about the construction of the auction. We're -- we think it's likely to work, but we think market prices could be a factor.

So, can I watch the forward curves up to December 8th?

I guess so. You know, what's probably what I would say.

Steve, I might just add that from a broader policy perspective, it's obviously very encouraging to us to have Ohio stepping forward as it is, and I think that, you know, even in the course of the last month or two months, we've begun to develop this sort of increasing sense of commitment and interest on the part of other commissions in other states with respect to the deregulatory process, so again, sort of independent of what happens specifically here in Ohio, you know, this is very good news from the standpoint of competitive markets.

Okay. Thank you.

Thanks, Steve.

Our next participant is Ali Agha of Wells Fargo Securities.

Just a couple of quick questions. Follin, if I heard you correctly, you mentioned that the New Energy results included I think 6.6 million of bankruptcy settlement payment. Was that expected in your plan, and was that one of the reasons why Merchant came in above your budget.

This is New Energy's part of the AES Enron settlement. We set up a liability at the time we acquired them. It was settled for $6.6 million less than what we had expected it would be settled at. We had viewed it as a possible upside to our plan for the year, because as you know, the timing of that kind of settlement is not -- is never clear.

Okay. So that settlement plus the Ginna results, would those be the main drivers for Merchant being stronger than what you had originally thought?

Well, it was part of New Energy's strength for the quarter, and Ginna was part of the Merchant, as you saw on the chart, which gives you the variances for the Merchant. We also had strong results out of wholesale competitive supply.

Right. I was comparing that to your budget as opposed to year-over-year. Separate question was the 40 -- I think it's 43 million megawatt hours that you have in New Energy's backlog, 43.8 million to be exact. Just so I'm clear on the numbers, what's the dollar amount of backlog that goes against that?

the -- if you're discussing the $43 million, that -- I mean 43 million megawatts --

$4, isn't it?

No, that's $3.00 to $3.50.

Yeah, I'm looking at your slide on chart 17.

Yes.

2004 delivered load and backlog of 43.8 million megawatt hours.

Right.

I'm just saying what's the equivalent dollar amount against that?

The backlog for next year for New Energy is 25.3 million megawatt hours, and then you see also the '06 and '07 contracts already in place. We have never disclosed, Ali, a gross margin backlog for New Energy.

If I assumed $4, a little below that, I wouldn't be too far off the mark?

No, you would not be too far off the mark.

Okay. Fair enough.

Hang on, Ali. What we've said is we expect that our margins are going to trend down towards $3 over a number of years. So we've said that we're going to come off of the $4 that's in our business plan for this year, and you can kind of step it down over a course of years towards $3.

But with regard to the 43.8 that you're referring to, the $4 is correct.

Okay. That's helpful. And can you update us on your amount of your output in fuel hedging for '05 and '06, currently?

Ali, this is Tom Brooks. Our -- on the wholesale side of things, our fuel and power hedging posture hasn't really changed much since last time we talked to you. That is to say for '05, very close to 100% hedged, and in '06, sort of high 80s, low 90s, across power and fuel.

Okay. Last question. You folks didn't have a fair amount of gas-fired sort of Merchant capacity in your portfolio. Is there any thought on, you know, looking at that capacity and, perhaps, writing it down somewhat, or even potentially getting rid of it? How does that fit into your overall portfolio, given the kind of sparks [indiscernible - highly accented language] seeing going forward?

I guess you've asked a couple of different questions, Ali. The first is, have we considered writing it down. And the test that you have to do as to whether or not to impair an asset are pretty clear, and that is you have to assess the cash flows over the life of the asset, and evaluate whether or not you will recover your initial investment. And right now the answer on all of our new billed gas-fired assets is unequivocally yes, we believe that we will recover the investment.

Now, that is a very different answer than do you think these were an investment which will earn an above hurdle rate return, because, no, we don't. We think the cash flows on are going to be scarce on those over the next few years. But then there's a second question. You said would you ever consider selling them, and we always evaluate all parts of our portfolio, both from a strategic perspective, and from the perspective of whether or not it's worth more to somebody else than it is to us, and that's part of our ongoing business reviews.

Okay. Thank you.

Thanks.

Our next participant is John Keyone [ph] of Morgan Stanley.

Good morning.

Good morning.

I was wondering from, either a growth standpoint, or a portfolio balancing standpoint, are you interested in growing your whole fired Merchant capacity at all?

This is Mike Wallace. We are looking at all types of future generation, whether it's gas, coal, nuclear, or renewables, to consider what type of addition to the fleet constitutes the right mix for us. Of course we look at acquisition opportunities for coal plants, and would seek to add those in markets that are important to us. We've been very active in that regard, and we are also active in discussions on clean coal technologies, so-called IGCC and the potential for adding those to the fleet as well, where base load capacity may be needed. So we're actively involved in discussions in both existing and new clean coal technology plants.

Thanks. And I have one more question. Its actually for Tom Brocks. Tom, what aspects of trading were the main drivers of the strong performance in Q3? Can you give a little more color on what commodities were the main drivers, or what deal types?

I think, John, I'm not really in a position to break it down. I think, again, in general, we operated at a pretty contained level of value at risk, about $2.8 million on a 95% confidence interval.

And that's an overnight number?

Yes. And we -- and we feel like we earned, you know -- we had very effective performance, we earned good returns, on the limit amount of risk capital we deployed.

All right. Thanks a lot.

Our next participant is Paul Patterson of Glenrock Associates.

Good morning, guys.

Good morning.

You mentioned that your mark- to-market portfolio did well, but with lower bar. Could you break down the amount of mark-to-market for the third quarter and nine months that isn't realized yet?

Hang on, let me just pull that out. Q3 mark-to-market was 35.4 million. Do you have a year-to-date number handy? I'll tell you what, Paul, I'll have to pull out year-to-date. I can -- I can give it to you later.

Okay. Great. The second thing I wanted to ask was looking at your tax rate, it's much lower for the nine months, but for the three months, the last quarter, it looks like it's gone back up. And I was wondering, just going forward for '05 and what have you, what should we expect in terms of a tax rate?

Give me just a second, we'll pull out the tax rate for the year. But it would have been lower in the first six months of course because we recognized catch-up tax credits on that South Carolina synfuel facility. For the calendar year, you can expect a tax range in the 28% area.

And is that pretty much what it will be going forward? Because you did have that catch up in the first six months. In '05, and '06, what should we be sort of putting in our models?

Good point. The tax rate will trend up as synfuel becomes a smaller percent of our total income.

Okay. Great. And then I did notice that QFs did a little better. Was there anything going on there?

We continue to have good performance at our partnership plants, and frankly benchmark performance in many cases, and that allows us to receive top performance bonus payments associated with how we run the facilities, and we're confident that that level of performance will be able to be sustained.

Okay. Then I just wanted to circle back with Tom on opportunities going forward, and, you know, for new businesses, et cetera, you know, if you see anything that's changed, or, you know, in the new quarter, or excuse me, going forward in '05 and '06. Is there anything that looks particularly exciting, or, on the other hand, anything that you think that you might change your business mix in terms of portfolio management, full requirements, that kind of thing?

I think of the -- of the, the businesses that we've been in for years now, full requirements, full requirements power, portfolio management, customer products. You know, we're experiencing good progress in all of those base businesses, and, you know, as to our initiatives to extend our business model and to serve coal customers and natural gas customers, probably, you know, not a lot of key events to report to you right now, but we're pretty optimistic about our opportunities in these areas. You know, we think it's very much a matter of extending the business model that has produced success in our base business to customers and to markets that are very closely tied to and related to our base of success. And that, you know, is in coal and gas that we're already fundamentally involved in, given our power business. So, you know, we think extending into these markets provides a good opportunity, it's a natural fit for our business, and we're pretty optimistic about what those efforts will produce.

Okay. Great. Thanks a lot, guys.

We'll take our next question from the site of Ashar Khan [ph] of SAC Capital.

Good morning, and congratulations on a good quarter. Follin, you had mentioned on the second quarter call that you thought '05 would be higher than the budgeted $3.35. Are you feeling more and more confidence as you look in '05.

Last quarter, for everyone's benefit on the call, we told you that our business plan, which was developed late last year, early this year, called for $3.35 in 2005, and we said that given our 2004 performance, there may be some upside to that number. We are revisiting our forecast as part of our normal business planning cycle, which runs through December, and we're always -- we always hate to give specific guidance range until we've gone through that planning cycle, and everyone here on the management committee is committed to a new number. We are very positive on our outlook for 2005.

Some of the fundamental issues you will see in a waterfall, when we walk from 2004 to 2005 early next year, are of course, as we just said, Ginna accretion is going to be lower -- or Ginna will be flat, because we will have an outage. Our competitive transition charge starts to bleed off next year, and of course we have some inevitable inflationary cost increases. Those headwinds, we believe, have already been overcome by growth in the PJM fleet value, and already booked business. So together, those issues would make earnings about a push year-over-year.

The growth that we will see next year are going to come from again competitive supply growth, and from productivity. As we've discussed, the market share and lowered cost positions we've created this year, the fuels business we've set up all make us feel very confident that we can continue to deliver growth next year. And we've also laid important ground work to begin to deliver productivity. So we feel good about 2005, and we will give you more specifics in January.

Thanks. And, Tom, you mentioned that for the auction in Ohio, it's -- the energy prices at some level make the auction -- I guess the price set in are not economical. Could you tell us what's breakeven price might be as we look at the forward curve at which you think the economics start going south?

Well, as -- using the forward curve as a point of comparison, I probably can't really do that. In terms of of the -- simply because, you know, we, and other potential participants in the auction would look at the aggregate cost of the various products necessary differently. In terms of the absolute thresholds, as you're probably well aware, first, the generation supply cost implicit in First Energy's rate stabilization plan was $45 a megawatt hour. You know, this included, however, certain costs that First Energy, as part of that plan, has the ability to pass on directly to its customers, and recently, the Ohio commission indicated that their view was that these additional cost passthroughs equated to about $10 a megawatt hour, so they indicated that $55 a megawatt hour would be the point of comparison for a successful auction. That is to say if the auction clears, the auction price will start at $55 a megawatt hour. If there are no takers are at that level, the auction will not clear. So that's for the full requirements product, that's really the level at which the -- you know, which is the key threshold.

Okay. And you mentioned that you felt that there were enough participants right now which could provide the whole load currently, correct?

I would say that's our feeling, you know, we don't know that to be the case, of course, but that's our feeling.

Okay. Thank you very much.

We'll take our next question from the site of David Frank of Zimmer Lucas Partners.

Yeah, hi, good morning.

Good morning, David.

Follin,, I was wondering if you could give us consolidated O&M results for the third quarter and year-to-date.

Yeah, hold on, David, let me pull it up. Year-to-date at the operating expenses for the nine months ended 2004, this is in the back of your press release, David, is 7.8 billion.

Operating expenses year-to-date. Oh, no, I see the operating expenses, but that includes things like fuel, I would assume, purchase power?

Fuel is -- yeah, you're right. Hang on. And we're pulling up year-to-date O&M. I'll tell you what, David, let us get back to you with year-to-date O&M breakout.

Okay. That's fine. Well, congratulations on the quarter.

Great. Thank you. We have time for one more question, I believe.

Our final question will come from David Reynolds of Banc of America Securities.

Yes, thank you. Getting back to the Ohio situation, there's a lot of talk about the auction being successful. Should you garner a good piece of the load, could you possibly mention or remind us what assets you believe in the region, you know, either be fuel type, or specificity are going to be available there, and what assets you might be looking to back up your bids with?

Probably couldn't go to that level of specificity. I guess what -- simply because, of course, in a competitive environment, that's pretty sensitive information from our point of view.

What I would say is I think we regard -- this is a situation we've seen before in other contexts. In New England, as competitive procurement rolled out there, in PJM, Eastern PJM, BGS auctions, and sort of on day one, or at the inception of these competitive procurement processes, you know, they're -- that's always a key issue, sufficiency of supply, both of energy, but particularly of capacity products and ancillary services. What we've found in general, and what we believe will prove to be the case in Northern Ohio, is that using, from our point of view, using the basic game plan that we've followed in other markets successfully of aggregating supply based upon owned and contractually controlled generating resources, you know, we'll be able to procure the supply necessary to supply full requirements power in East Ohio, if we were to participate there.

Let me ask it just a little bit differently. Do you believe there are enough resources from a capacity standpoint non gas-fired CCGT assets, to cover up the load and get it into First Energy service territory? Yes. Okay. Thank you.

Great. I wanted to close by pointing out that it occurs to me that this is the third anniversary for this management group on these quarterly calls, and obviously a tremendous amount has happened to both the industry and to us, but here we are three years later with what we believe is the best commercial front end in the business on both the wholesale and retail level, diversely all problems cleaned up, the balance sheet moving in the right direction. Obviously we're very encouraged about the fact that we have a platform that has real growth to it, and that we've, over the course of 12 quarters, proven the sustainability of that growth. So we will look forward to laying out, once again, the complete story in January, encourage everybody to come, so we see a very bright future ahead. Thank you very much.

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