RRI Energy, Inc. Q1 2009 Earnings Call Transcript

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by: SA Transcripts

RRI Energy, Inc. (RRI) Q1 2009 Earnings Call May 11, 2009 8:30 AM ET


Good morning ladies and gentlemen and welcome to the RRI Energy first quarter 2009 earnings call. (Operator Instructions) I will now turn the call over to Mr. Dennis Barber.

Dennis Barber

Good morning and welcome to RRI Energy's first quarter conference call. Leading the call this morning are Mark Jacobs, President and CEO; Brian Landrum, Chief Operating Officer and Rick Dobson, CFO. Following our prepared remarks, we'll have a question-and-answer session.

The earnings release as well as the slide presentation we are using today is available on our website at www.RRIEnergy.com in the Investors Section. A replay of this call will also be available on the website approximately two hours after the completion of the call.

Consistent with our past practice, we're using several non-GAAP measures, to provide additional insight into operating results. Reconciliations of the non-GAAP measures to GAAP figures are available on the website. An item we adjusted for this quarter was unrealized gains and losses on energy derivatives, which is an ongoing adjustment. I would also remind you that due to the sale of the retail business that segment has been included in discontinued operations for all comparable periods.

As many of you know, we update our outlook each quarter using forward commodity prices. The current outlook uses forward commodity prices as of March 27, 2009. I would also remind you that any projections or forward-looking statements made on this call are subject to cautionary statements on forward-looking information contained in our SEC filings.

I will now turn it over to Mark.

Mark Jacobs

Thank you Dennis. Good morning everyone. Welcome to our first earnings call as RRI Energy. You are all familiar with that name of course as it has been our ticker symbol since 2001. I am sure all of you saw our announcement on May 1 that the Board of Directors has successfully concluded its review of strategic alternatives which resulted in the sale of our retail business.

You will recall we sold the eastern retail business to Hess late last year and 10 days ago we closed the sale of the Texas retail business to NRG. As you know, it is a very challenging environment for M&A transactions and we were pleased that we were able to get those two deals completed. The sale of the retail business has allowed us to achieve a number of important strategic objectives. It removed $2 billion of current capital requirements as well as contingent collateral requirements and fully resolved the uncertainty associated with the retail credit sleeve.

The transactions also reduced debt and improved liquidity and they significantly reduce our overall business risk profile. The bottom line, with the sale of retail RRI Energy is a well-capitalized, pure play wholesale generator positioned to manage through an uncertain economic climate and deliver value to our shareholders.

I want to underscore the importance of this step. The scope of our business has narrowed considerably and that allows us to sharpen our focus on managing the wholesale generation business in addressing industry challenges. RRI Energy has over 14,000 megawatts of generation capacity in attractive regions. The fleet is operating at top quartile performance levels. So where do we go from here? We have four key priorities on slide four. I will make some high level comments about each of these and I also wanted to mention that we will hold an investor conference this summer and will be providing more detail relating to our go-forward strategy.

There is no question that the economics of our business have changed dramatically over the last 9 months. Rick will review the numbers, but the financial outlook for 2009 remains challenging. While the outlook for 2010 based on forward curves is better than 2009 it still represents a very difficult environment. Our first priority is to manage the risk associated with the current market environment. In light of the uncertain environment we are in, this is critically important. We have always recognized the risks inherent in a cyclical commodity business and have taken a number of steps to mitigate that risk.

Our capital structure and liquidity position are important components of our risk management strategy and they represent a real strength among merchant generation companies. While our balance sheet and liquidity levels provide ample cushion, we are not solely relying on them in forward curves. On previous calls we have discussed that we have carefully evaluated a wide range of potential scenarios. While our energy margin remains largely open, we have added some incremental hedges in 2010 which help mitigate risk enough to ensure that we meet our financial objectives in a stressed commodity scenario. Rick will elaborate on this point in his comments.

Another component of managing risk in the near-term is to focus on expenses. While we are always focused on efficiency, the retail sale as well as the current market environment represent an appropriate time for us to redouble our efforts to streamline our cost structure. While the majority of the cash we have today is part of our contingency plan, not all of it is. Our second priority is to evaluate options to selectively deploy that capital for value-creating opportunities. We are pragmatic. I expect that any actions we take in the near-term will be relatively close to home such as investments in our generation assets or evaluating our capital structure rather than pursuing acquisitions.

Our third priority is to capture the upside of improved market conditions. Admittedly that may sound a little optimistic given the current market but remember this is a cyclical business and no meaningful increase in supply is taking place. I believe that as an investor in this sector the outlook for commodity prices and supply/demand fundamentals represent a significant value driver for both asset values and stock prices. Our strategy is to position RRI Energy to benefit from that upside.

Here is what that means to me. While we may selectively implement some hedging to mitigate risk we are not going to hedge the majority of our output at what we believe is the trough of the cycle. You all know that most of our forward energy margin is open and with the declining commodity price environment that approach has impacted the outlook in 2009 and 2010. But the other side of the coin is we are well positioned to benefit from improved market conditions when they come about. It is one of the factors that distinguishes our company from our peers.

The last priority is to address long-term industry challenges. The political agenda has changed. Initiatives like renewable portfolio standards, smart transmission grids and a focus on efficiency and demand response have gained significant momentum. Of course, we are likely to see more stringent environmental regulations and carbon legislation over time. These factors will re-draw the supply stack but we believe there will be a stable of coal-fired generation plants that will continue to play a very important role in meeting the country’s energy needs for the foreseeable future and several of our stations are in that category.

Brian will provide some perspective on how our fleet is positioned for the future. He will also review the potential environmental spending over the course of the next decade and our approach in making investment decisions. There are a couple of key points you will hear from him. First, we recognize these issues. We understand their potential impact on our business and we are focused on addressing them.

Second, our approach to environmental spending is quite simple. We will invest where and when we have a reasonable degree of certainty that the capital result in a return in excess of our hurdle rate over time. Third, there is a positive correlation between our future environmental spend and the expected long-term profitability of our assets. Scenarios where we spend more in environmental controls are also ones where our lifetime earnings and cash flow expectations are higher.

Size and scale also represent a longer term priority for us. Although RRI has a solid financial and asset foundation, I believe that size, scale and diversity matter in delivering shareholder value through the cycles and it is our job to identify avenues to achieve that objective in a manner that creates value. I would also like to take a moment to acknowledge the fantastic job the RRI team has done in a particularly difficult environment over the last several months. They have maintained our focus on our business objectives and continue to deliver solid operating results.

Let me wrap up by touching on some of the recently announced changes on our Board of Directors. Joel Staff will retire as Chairman at our annual meeting next month. He served as CEO for four years and Chairman for the past two. We are deeply grateful for his many contributions. The Board intends to elect Steve Miller as the Chairman next month. Steve has been on the Board since 2003 and currently serves as Lead Director. Previously he served as Chairman, President and CEO of Shell Oil Company. We are fortunate to have someone of Steve’s experience and track record in this role going forward. I have no doubt that his insight and perspective will prove to be quite valuable.

I will now turn the call over to Brian Landrum, our Chief Operating Officer.

Brian Landrum

Thanks Mark. Let me pick up the theme of how our fleet is positioned for the long-term. As Mark said, we expect to see tightening supply and demand and improving commodity prices as our industry recovers. We also expect the movement towards increased environmental regulations to continue. The timing and degree to which these trends affect our fleet are the primary uncertainties.

We have developed market and regulatory scenarios to analyze the potential impact to our plan. What this analysis shows is that our fleet is positioned for solid long-term performance across the scenarios with upside potential over today’s depressed financial outlook. Our most productive assets require little to no incremental environmental investment and will continue to generate attractive returns in the future.

Many of the less controlled plans deliver value today and will continue to do so if regulatory uncertainty and future economic returns justify additional investments in environmental controls. A handful of assets contribute a very small amount of cash flow and will continue to face challenges over time. Slide six shows our assets broken into three segments. The top row has a core set of assets which make up 55-60% of operating cash flow and produce positive earnings across all scenarios.

Seward and Hunterstown are good examples of assets in this segment. Seward is a 521 megawatt waste coal plant that came on line in 2004 with state of the art emissions controls. It is one of the lowest cost plants in the PJM supply stack. The 810 megawatt Hunterstown CCGT began operation in 2003. It has an efficient 7 heat rate with an SCR installed for NOX control. Under virtually any scenario for environmental regulation including CO2 these units continue to perform well.

Shifting to the middle row, we see the mid-tier plants that generate about 40-45% of near-term earnings and may require investments in environmental controls over time. I will address this segment in more detail shortly. The bottom row shows a group of units delivering very little of today’s cash flow that face near and long-term challenges. Given the current depressed environment we are modifying the operating model of these units to improve near-term profitability. For example, Elrama is an older 470 megawatt coal plant located in western PJM. It is fully controlled for SO2 and has an SNCR that reduces NOX emissions. However, the plant is exposed to west to east PJM congestion as well as significant local congestion. Today’s market conditions do not support profitable wholesale operations at Elrama. We have implemented a reduced operating model and improves contribution margin by $10-15 million while continuing to meet our RPM capacity obligations.

Slide seven provides further insight into the mid-tier assets; those from the middle row of the previous slide. This is the framework for how we think about making investments in environmental controls. The X axis of the chart shows possible long-term returns under different market conditions and a stable cap and trade regulatory structure. The bars represent levels of potential incremental investment over different long-term economic returns. To be clear, our scenarios don’t support environmental spending earlier than 2012 and even then the cost will be spread across multiple years.

To reduce investment risk, we will require some level of regulatory certainty and clear line of sight to attractive levels of free cash flow. The left bar shows today’s historically low market conditions under which little to no investments would be justified. In this case, the mid-tier assets will be managed to maximize cash flow until market conditions improve or under modified operations over the next 10-20 years. The middle bar shows the long-term market with returns similar to those achieved in 2007 and 2008 but with clear, stable cap and trade environmental regulations. High dark spreads or capacity payments combined with market based cost for emissions credits could provide returns sufficient to invest in select projects.

For example, it is possible that SO2 scrubbers at good performing assets like Portland or Shawville could be installed in this scenario. The bar at the right shows long-term market conditions that support new entrant returns. Depending on the level of returns, 1-1.5 billion of investments could be economic. Since these investments would be spread over many years, the annual free cash flow from the total fleet would be well in excess of the annual environmental spend under these market conditions. We wanted to introduce this topic today and plan to provide more details at the upcoming investor conference.

Turning to the performance for the quarter, once again our wholesale team delivered operating results at or better than expectations. Commercial capacity factor came in at 82%, on track to deliver full-year CCF over 87%. High level availability allowed us to capture the full value of our PPA’s and capacity payments. As we did in 2008 we quickly rebalanced our coal position to reduce the risk of lower power demand in 2009. The trend of lower dark spreads and declining electricity demand continued into the first quarter in the forward curves. When we normalized load was down in each of our major regions largely consistent with the downturn in the economy. Contribution margin in the first quarter and in the outlook is lower as a result.

Run hours continue to be strong at our base plants. Capacity payments and PPA’s not tied to commodities deliver a meaningful share of margin. We also saw a few instances of gas/coal displacement with CCGT’s running ahead of mid-[merit] coal units. For example, Hunterstown had many more run hours than normal during the quarter. Gas/coal displacement has been limited in Pennsylvania and Ohio however, largely due to local coal supplies and high seasonal natural gas basis. Lower gas basis, as we typically see in the summer would produce more gas coal displacement at current market prices.

We believe there is significant upside value in the majority of our fleet from the current depressed environment. Our strong wholesale operating track record over the past 3+ years puts us in a good position to capture that value. I will now turn the call over to Rick Dobson, our Chief Financial Officer.

Rick Dobson

Thank you Brian. Let’s turn to slide nine and walk through the financial overview. The first quarter of 2009 was generally characterized by weak commodity prices and gas coal spreads driven by a tough economic climate. The result was lower unit margins and fewer run hours for our coal plants. Open EBITDA was $5 million for 2009, down $115 million from last year. While there are some puts and takes, this was predominately driven by a 47% decline in unit margins.

Additionally, our PJM and MISO coal fleet produced 1.5 terawatt hours less than 2008. This was partially offset by more run hours at our Hunterstown combined cycle gas turbine as Brian mentioned. Partially offsetting the significantly lower margins was an improvement in other margins primarily related to increases in PJM capacity payments. As Brian mentioned our plant operations team performed well, delivering an 82% commercial capacity factor. The slight decline in CCF quarter-over-quarter was driven by planned outages. For the year we continue to be on track to deliver top quartile operating performance over 87%.

Wholesale hedges and gains on sales of emission and exchange allowances formed a bridge from open EBITDA of $5 million to adjusted EBITDA of $19 million. There are several moving parts within our wholesale hedges but the largest delta compared to last year is related to in-the-money coal hedges in 2008 versus out of the money coal hedges in 2009. Our 2009 coal hedges were at prices that exceeded the current market by $38 million versus 2008 when our coal hedges were in the money.

Based on current economic conditions it made sense for us to reduce our 2009 coal purchase commitments, shifting $13 million from unrealized losses to realized losses. Our 2009 natural gas hedges, natural gas transportation and reductions in legacy power hedges partially offset the coal losses. Additionally, we sold emissions exchange allowances generating a gain of $18 million. Free cash flow from operations of $46 million is down from 2008 and is primarily driven by EBITDA variances previously discussed.

Turning to slide ten, let’s review our 2009 and 2010 outlook. With the continued overall commodities spread weakness as embedded in the forward curves, our outlook reflects lower adjusted EBITDA in 2009 and 2010 compared to our last outlook. Let’s review some of the significant drivers.

Relative to our last outlook the biggest driver is on-peak prices in PJM. These prices are highly correlated to [Tecto N] free natural gas prices which experienced forward market declines of $0.83 per MMBtu in 2009 and $0.73 per MMBtu in 2010. For 2010, coal prices are relatively flat but off peak power prices in the forwards have declined since our outlook. The forwards do have heat rates expanding in PJM and MISO in 2009 helping to offset some of the commodity price weakness previously discussed.

General and administrative expenses reflect the cost of transition to our steady-state structure in the second half of 2009. Lower emissions cost for 2009 and 2010 ironed out the major differences from our last outlook. The combination of weak commodity prices, out of the money coal hedges and environmental CapEx to finish scrubbers at Keystone and Cheswick resulted in negative free cash flow from continuing operations in 2009 of $182 million.

However, overall cash flow for 2009 is projected to be positive due to significant retail cash flows through April that are included in discontinued operations. In 2010 with the completion of the scrubbers and forward curve prices for commodities the outlook provides free cash flow from operations of $170 million.

Now, let’s talk about what is not readily apparent in this outlook and what Mark touched upon in his opening remarks. In April we added to our 7 BCF 2010 gas hedge by selling a combination of PJM west hub and ADP Dayton hub power for 2010. The gas and power hedge combination is approximately 23% of the generation in the 2010 outlook and stabilizes our free cash flow profile for this period. We believe this gives us a higher probability of free cash flow break even, even in very challenging NYMEX gas and eastern coal spread scenarios in which the spread narrows to $1 per MMBtu.

This strategy not only helps manage risk but also leaves substantial upside for the generation fleet. Let’s turn to slide 11 where I will discuss our financial positioning both where we are today and where we are going.

With the close of retail on May 1 we derived cash of approximately $380 million for our four-months ended April 30, 2009. Our net proceeds from the retail sale including working capital are expected to be approximately $300 million, $238 million of which we expect to offer to secured bond holders in accordance with the secured bond indentures at par. To reiterate and add emphasis to Mark’s discussion, RRI Energy has cash on hand of $1.6 billion and total available liquidity of $2.1 billion on a pro forma basis.

Our gross debt will decline to $3.1 billion and net debt of $1.5 billion on a pro forma basis. This debt level and liquidity profile leaves us in good shape to meet our modest, near-term maturity profile and the potential for prolonged tough economic times. Going forward there are two points I want to make relating to our cost structure and optimal capital structure. Achieving top quartile operating performance has always been a key priority. Considering the challenging commodity price environment and the sale of the retail business our overall cost structure will become a major focus moving forward.

Second, with the confirmation of the retail transaction it is time to reassess our capital structure to see how much lower our current $2-2.5 billion target growth debt amount should be without the retail cash flows. We will give more clarity on this subject at the investor conference later this summer.

As Mark said, our capital structure will work not only to protect against financial distress but will be used to create value by investing in near-term, close to home opportunities where the return on invested capital exceeds our weighted average cost of capital. We have ample cash and liquidity for the $400 million May 2010 maturity and to weather scenarios whereby gas and coal spreads get substantially tighter. I also believe that with proper sizing of our capital structure we will be in a solid position to fund potential economic environment capital expenditures with operating cash flow.

I will now turn it back to Mark for some concluding statements.

Mark Jacobs

Thanks Rick. Let me wrap up on slide 12 with a summary of key points. The sale of the retail business represents a critical milestone. We are a well-capitalized company exclusively focused on wholesale power generation. I think there are a couple of key factors that distinguish RRI Energy. First, we have the financial strength to persevere in very challenging market conditions in the near-term. We are confident we can operate through even the most difficult of scenarios. Second, when the environment improves RRI Energy will be well positioned to benefit from market recovery.

We are also keenly focused on long-term value drivers and developing strategies to ensure we stay strong and flexible over the long haul. As I mentioned earlier we will hold an investor conference this summer and look forward to providing you with much more detail on our go-forward strategy.

With that, operator let’s open the line for questions.

Question-and-Answer Session


(Operator Instructions) The first question comes from the line of Daniel Eggers – Credit Suisse.

Daniel Eggers – Credit Suisse

On the strategic review process with completion, can you just share a little more though process behind what you looked at and kind of how you came to the plan of comfort of keeping the wholesale business intact as it is?

Mark Jacobs

As we talked about before, the strategic alternatives process that we kicked off in October the Board went through in a very systematic and thorough manner. We looked at every possible alternative and no alternative that was remotely reasonable was excluded from that discussion. One of the conclusions that the Board came to in that process was that it made sense to separate the retail and wholesale business. That really for us I think brought forward a number of strategic benefits. It eliminated the capital requirements of the retail business both the ones that would have come on the balance sheet right away as well as contingent ones. It fully resolved the uncertainty associated with the credit sleeve, reduced debt and improved our liquidity and I think importantly lowered the overall risk profile of our company going forward.

That really leaves us in a position today where we are a well capitalized, pure play merchant generator. We think we are well positioned to manage through an uncertain economic climate and deliver value over the long haul to shareholders and it narrows the scope of our business and allows us to really sharpen our focus on the wholesale generation business. I did make the comment as well that we do think if I look forward out in the distance here that size and scale are going to be important factors for delivering shareholder value over the long haul. Again, we are still committed to exploring all avenues to achieve that objective.

Daniel Eggers – Credit Suisse

Along those lines, if you think about even in 2010 the corporate G&A rate of the low $80 million range relative to the earnings guidance you gave, is there a way to bring costs down even further from an overhead perspective or is that about as good as we are going to see?

Mark Jacobs

I think we have always been focused on being highly efficient in operations. I think it is one of the key success factors in being in the commodity business. The current support structure we had was designed around supporting both the retail and the wholesale business. So obviously we have got work that we have undertaken now to really get that oriented around supporting just a single business. The other point I would make on the expenses and I know sometimes it is an apples-to-oranges comparison looking at the different tiers out there but there is a lot of spending, obviously more of the spending is on the O&M side of the business. Remember, the last couple of years we have had a very concentrated effort here to improve the performance of our fleet and we have improved the commercial capacity back from about 79% in 2004 to the high 80’s we have now.

In order to achieve that we ramped up the spending levels here to what I would say is really catch up spending to get that performance level. One of the things if you look at our wholesale O&M and track back from I think 2007 was when we hit the high point you are going to see consistent reductions in that in 2008. You will see the outlook for 2009 is lower than 2008 and you will see the outlook again in 2010 is lower than 2009. So I think there is some opportunities we continue to have on that front as well.

Rick Dobson

Especially the G&A costs that is going to be one of my top focuses. Right now we are going to break everything out from the bottom up and see what is absolutely necessary to run this company as lean as possible. It is early days right now but you will see some clarity on that as we move through the year.

Daniel Eggers – Credit Suisse

On the increased hedging for 2010, kind of the thought process there, are you done hedging for 2010 at this point in time now that you think you have gotten comfortable with the free cash flow break even position? How should we think about hedging on a long-term basis for you?

Mark Jacobs

Let me give you some context on the hedging. We have an open model here but I would encourage you don’t confuse the open model with the hedging strategy. The open model to us is a way of reporting our financial results and really what that means is breaking out the financial result of the assets on a different P&L line item from the hedges. We think it is a more transparent way to show our results. There are a couple of reasons we would consider hedging. One is to preserve financial strength. That really is the bucket of the 2010 power hedging that we discussed today. Our design to help mitigate financial risk around the scenario where commodity prices are further depressed for a sustained period of time. Again, as Rick mentioned these are less than 25% of our total output. We do intend to keep the majority of our energy margin open and that is really in keeping with our strategy to make sure we are positioned to benefit from improved market conditions when they occur.

I guess the way I look at that too is that you put it together and there is a wide range of outcomes here in front of us. The way I look at it, we positioned our company so that in a very depressed scenario we have got the financial wherewithal to persevere and in scenarios where market conditions improve significantly we are positioned to benefit from that.


The next question comes from Lasan Johong - RBC Capital Markets.

Lasan Johong - RBC Capital Markets

The whole premise under which you are keeping an open margin and following the commodity price curve and building up liquidity one of the prime reasons for that is to find opportunistic moments where there is a dysfunction in the market and you have the opportunity to buy assets on the cheap. Given your cash position, about half of your gross debt, and the fact I believe at present you are not looking at more than $100 million of investments in generation and you have only something like $400-500 million due next year, that leaves you with a whopping total cash balance. There has got to be opportunities out there that you think are valued ways of creating shareholder value outside of just the immediate pale. Am I going crazy here or is this not what we had been told from you going back several years?

Mark Jacobs

I think that is accurate. Let me share with you my perspective. I think you have to break it into the near-term and then longer term view. In the near-term we place a very high premium on most of our cash being part of our risk management plan. For example, as Rick mentioned in the prepared comments the limited near-term maturities but we do have the bond maturity that is $400 million next year. So one of the things we have done is we have set aside $400 million of cash to address that maturity. We also look at a lot of different scenarios including some that have very depressed and sustained commodity price declines. Our first priority is to ensure that we have got the wherewithal to persevere through a sustained and difficult market.

That being said, when we look at the cash balance today we certainly would consider using a modest portion of that for the right opportunity but we are also pragmatic here and I would expect that in the near-term those opportunities are going to be relatively close to home and whether that is investing in fleet or Rick mentioned the work we are doing now to go back and look at target debt structure getting us to look at capital structure opportunities. In the longer term we certainly recognize that carrying $1.5 billion of cash is not terribly efficient from a cost of capital standpoint and we have seen some improvement in the market recently but we are not ready to declare the economic downturn is behind us. I would say as market conditions improve and capital markets open up under more favorable terms I would expect us to deploy more of that cash in a manner to create value.

Looking forward from here I would say the biggest use of that cash is going to be to reach our capital structure objectives and investing in the fleet. We have also talked about don’t look for us to do much green field investment. We have talked about acquisitions here at distressed prices as a way to create value. I would look at that sitting here today as more of an intermediate or longer term opportunity.

Lasan Johong - RBC Capital Markets

Let me focus on the immediate term, 2010. You said you had about 25% of your energy contracted through what I would call bridging mechanisms. What conditions would you put forth that would allow you to increase that to say 50% or more?

Mark Jacobs

Again, philosophically those hedges were put in place as part of our risk management plan. So we look at a lot of different commodity price scenarios. As Rick had mentioned in his comments what we have done is we wanted to ensure in a commodity price scenario where we see a collapsing in the gas coal spread down to $1 on a sustained level we would be at or very near free cash flow break even. So, what would cause us to do more of those is if we reassessed that commodity price environment and wanted to run an even further stressed commodity scenario but sitting here at this point we feel like we have got the hedges in place from a risk mitigation standpoint.

The other reason we have talked about hedging prospectively is if we have a point of view on prices. As we sit here and look at the world today we think there is a lot more upside in both natural gas prices and spark spreads, dark spreads than we do downside. So again that is why we have positioned the portfolio to be largely open. If those market conditions were to magically improve over the next three months would we consider hedging more? We would.

Lasan Johong - RBC Capital Markets

By the time you realize or you see that the spreads have collapsed it is kind of too late to hedge isn’t it?

Mark Jacobs

Well that is again why we put some of the hedges in place that we did. I feel very comfortable with the amount of hedge we have in place for 2010 that in a distressed commodity price scenario we are still going to meet our financial objectives.

Lasan Johong - RBC Capital Markets

If you do continue to see coal to gas switching it sounds like in summer in Pennsylvania that might be the case, what would you do with your scheduled coal deliveries? Are you going to pile it up or are you going to sell it and try to salvage some money out of it?

Brian Landrum

We would do what we have done all along here as we have seen demand for power roll back into demand for coal for us. We would look at rebalancing that position just like we did in 2008 and just like we did in the first quarter of 2009. What we do is we look at our physical ability to take on inventory and the cost of capital associated with holding that inventory versus the price risk you take by taking a long coal position and holding it. Typically when we play those out the price risk position is a much bigger issue so we tend to lean towards a sale and settlement on coal as opposed to stick it in inventory.


The next question comes from Michael Lapides - Goldman Sachs.

Michael Lapides - Goldman Sachs

Can you talk a little bit about your thoughts on some of the assets outside of PJM and MISO or your California assets in terms of which would you view as being core to the business, which ones you view as being a little less core to the business, thoughts a little bit on valuations for similar type plants in the market and the kind of short-term and long-term internal and external strategies for those units?

Mark Jacobs

Our focus as a company is on competitive markets so that has us focused on PJM, MISO and California I would say are the core regions. The Florida assets, the Choctaw plants are in regions that are not as far along on the competitive spectrum. So with those that is where our core focus is. If we saw the right opportunity here to those assets I point out as we did with Bighorn last year, as I said that is something you should expect us to explore fully.

Michael Lapides - Goldman Sachs

Are you seeing the Florida market tighten up to the point where the regulated utilities there might have to act in terms of closing supply/demand balance?

Brian Landrum

You are seeing the same issues in Florida that you are seeing around the country with power demand having come off proportionately with the economic downturn. So in the short run I don’t think you are seeing that tightening pressure. I think you will over time see pressure on that market. As we have said before Florida has the ability for regulated entities to add generation on a rate base so our strategy typically is for these assets to look for either one or two approaches to commercialize them. One Mark mentioned by looking at potential asset sales. The second one is to look for PPA’s with load serving entities to give them and regulators better economics than what new builds do.

Michael Lapides - Goldman Sachs

When you think about the capital structure and investing in the fleet and investing in the company, outside of the Orion debt coming due next year can you talk a little bit about your views of your own debt? Meaning kind of whether or not a lot of people will push for share repurchases, just thinking about how you make the decision between share repurchases versus debt reduction given where a lot of the merchant or IPP debt is trading these days?

Rick Dobson

Let me address the share repurchase one first. With our restricted payment basket and the challenge that we face in earnings in the near-term and what we are seeing in the outlook right now that basket only [inaudible] so that limits what we could do on a share repurchase perspective even if we thought that was the best return for the shareholders. Secondarily, when we look at investment we still follow very, very methodically making sure the deployment of capital is a return on invested capital that exceeds our [WAC] but that being said we also are very focused on the fact that cap structure with permanent gross debt below $2.5 billion range that doesn’t have retail cash flows any longer is likely oversized for the size of our company. That will be something we are focused on as a use of capital to methodically reduce that level of debt. One being the Orion maturity and then potentially other things in the open market that make sense from a shareholder return perspective.


The next question comes from Leslie Rich – Columbia Management.

Leslie Rich – Columbia Management

On your fourth quarter call you had a slide that talked about your hedging not just on the energy component but also including the capacity in terms of your total gross margin. The slide said you were 50% contracted on your open wholesale gross margin and I’m not certain but I’m sort of assuming that none of the power was hedged and the component of the gross margin that was hedged was the capacity. Now that you have done some incremental hedges how should I think about that? Should I just say 25% of your open energy for 2010 is now hedged so that brings your total hedged open gross margin for 2010 to about 60+%? Is that the right way to think about it?

Rick Dobson

I don’t have those numbers right at my fingertips but that is the right way to think about it. Again remembering our wholesale gross margin a significant portion of that comes from RPM capacity payments and comes from PPA’s especially on our California assets. So that really is, as I said, that margin is generally contracted for several years in advance and we are in the midst now of the next RPM option so we will have the results of that. Again, that will further take that out there. We have stayed generally open on the energy margin piece of that so the 25% energy margin you talked about you could add that again to the 50% plus or minus of the capacity to get to the figures you talked about.

Leslie Rich – Columbia Management

For 2009 have you done incremental hedges there on the energy or are you totally open?

Mark Jacobs

We are largely open on the energy margin in 2009. What we have left, still we have the pro rata portion of the 27 BCF that was hedged in gas at 830 the NYMEX.


The next question comes from Brian Russo - Ladenburg Thalmann & Co.

Brian Russo - Ladenburg Thalmann & Co.

I was just curious on your comments earlier on the seasonality of the coal to gas switching that might pick up in the summertime. Should we see the same year-over-year type of quarterly decline in volumes that we saw in the first quarter in the second and third? Or more or less embedded in your current guidance?

Brian Landrum

We don’t give quarterly guidance in our conversation but typically what you see during the second quarter is you see a seasonal slow down because of weather. With weather normalized we are going to see the volumes come down. As long as we see the kind of GDP decline year-over-year at about 6% which is what we saw in the first quarter you should see a proportionate response in demand. You will see quarter-to-quarter that ran about 3-3.5% during the first quarter so as long as we are continuing to see that relationship hold I expect to see the same kind of year-over-year difference in demand.


We have a follow-up question from Lasan Johong - RBC Capital Markets.

Lasan Johong - RBC Capital Markets

Just kind of more strategically on a high level outlook, why would you not trade say Newcastle, Niles, Elrama and Indian River for something that is more core to your business strategy like Seward, Keystone, Conemaugh and Cheswick as an example? Is that something we could look forward to at some point?

Mark Jacobs

The question on trading I think really gets into a relative value of what value are you getting for those assets relative to what are you paying for those. Certainly as we look out we will be looking at ways to incrementally position our fleet more strongly. I do think in the near-term as I said our strategy is really around managing the existing fleet of assets we have. I think really to pick up on the comments Brian made one of the things we are introducing here really in the spirit of trying to provide more transparency to the investment community is how we have segmented our operating fleet. Those assets, as I said, are assets that I think make decent returns. I think they do have some challenges here down the road and our plants that are not likely to see significant capital investment going in because of that we are committed by looking at the way we operate those plants to manage those in a way that is going to generate the most cash for us here in the near-term.

Brian Landrum

I will just reinforce Mark’s point that we are always looking for ways to improve the portfolio through time. That is not something we would step away from it is just more of a near-term issue of trying to operate the units the way we described on slide six and then focus in on the financial challenges that Mark mentioned.


At this time I am showing we have no further questions.

Mark Jacobs

Thank you very much for your participation. A replay will be available in about two hours.


Ladies and gentlemen this concludes today’s conference. Thank you for participating. You may now disconnect.

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