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Executives

Donna J. Kinzel - Chief Risk Officer, Vice President and Treasurer

Joseph M. Rigby - Chairman, Chief Executive Officer, President and Member of Executive Committee

Frederick J. Boyle - Chief Financial Officer and Senior Vice President

John U. Huffman - Chief Executive Officer of Pepco Energy Services Inc and President of Pepco Energy Services Inc

David M. Velazquez - Executive Vice President, Chief Executive Officer of Potomac Electric Power Company, Chief Executive Officer of Delmarva Power & Light Company, Chief Executive Officer of Atlantic City Electric Company, President of Potomac Electric Power Company, President of Delmarva Power & Light Company and President of Atlantic City Electric Company

Analysts

Paul Patterson - Glenrock Associates LLC

Matthew Davis - Crédit Suisse AG, Research Division

Charles J. Fishman - Morningstar Inc., Research Division

Paul T. Ridzon - KeyBanc Capital Markets Inc., Research Division

Maurice E. May - Wellington Shields & Co., LLC, Research Division

Andrew Levi

Brian Chin - BofA Merrill Lynch, Research Division

Neil Kalton - Wells Fargo Securities, LLC, Research Division

Pepco Holdings (POM) Q2 2013 Earnings Call August 7, 2013 10:00 AM ET

Operator

Good day, ladies and gentlemen, and welcome to the Second Quarter 2013 Pepco Holdings, Inc. Earnings Conference Call. My name is Ayesha, and I will be your coordinator for today's call. [Operator Instructions] As a reminder, this conference is being recorded for replay purposes. I would now like to turn the conference over to your host for today, Ms. Donna Kinzel, Vice President and Treasurer. You may proceed, ma'am.

Donna J. Kinzel

Thank you, Ayesha, and good morning, ladies and gentlemen. Welcome to the Pepco Holdings Second Quarter 2013 Earnings Conference Call. The primary speakers on today's call are Joe Rigby, Chairman, President and Chief Executive Officer; and Fred Boyle, Senior Vice President and Chief Financial Officer. Also available to answer your questions are Dave Velazquez, Executive Vice President for Power Delivery; and John Huffman, President and Chief Executive Officer of Pepco Energy Services.

On today's call, we will be referring to slides, which are available on the Investor Relations section of our website.

Before Joe begins, let me remind you that some of the comments made during today's conference call may be considered forward-looking statements. As such, they should be taken in the context of the risks and uncertainties discussed in the Safe Harbor disclosures contained in our Securities and Exchange Commission filings and found on Slide 2 of our presentation.

Also, please note that today's call will include a discussion of our results, excluding certain items that we feel are not representative of the company's ongoing business operations. These items and the associated financial impact are described in our earnings release dated today. The earnings release can be found on our website at www.pepcoholdings.com/investors. Joe?

Joseph M. Rigby

Thanks, Donna, and good morning, ladies and gentlemen, and thank you for joining us today.

As seen on Slide 3, GAAP earnings from continuing operations for the second quarter of 2013 were $38 million compared to $53 million for the second quarter of 2012.

Both periods include cross-border energy lease results, and the 2012 quarter includes an asset impairment charge at Pepco Energy Services. Excluding these items, which we feel are not representative of our ongoing business operations, 2013 earnings would have been $53 million compared to $46 million in the prior year.

The increase in adjusted earnings quarter-over-quarter was primarily due to higher distribution revenue resulting from higher rates, driven by increased infrastructure investment and lower operation and maintenance expense. This increase in earnings was partially offset by lower default electricity supply margins, mainly due to a favorable adjustment in 2012 and lower unbilled revenue associated with Atlantic City Electric basic generation service.

Later in the call, Fred will address the financial results and our operating segment performance in more detail. But first, I'll address some important matters, starting with the recent distribution base rate case outcomes.

On June 21, the New Jersey Board of Public Utilities approved a settlement agreement in the Atlantic City Electric distribution base rate case. Details of the settlement can be found on Slide 4. The agreement provides for an annual increase in electric distribution base rates in the net amount of approximately $26 million based on the return on equity of 9.75%. The revenue increase includes full recovery of incremental storm restoration costs, by including capital costs in rate base and amortizing the deferred operation and maintenance expenses of $26 million over a 3-year period.

Largely offsetting the increase in amortization expense will be a reduction in depreciation expense of $8 million per year, resulting in an annual pretax earnings impact on the order of $25 million. The new rates were effective on July 1. In light of this outcome, we intend to reduce distribution and other related capital expenditures in New Jersey by a total of $150 million through 2015 in order to more closely align our spending with revenue.

We believe the consolidated tax adjustment policy in New Jersey is greatly hindering our ability to achieve reasonable regulatory outcomes for Atlantic City Electric. As we have discussed previously, there is currently a generic proceeding underway in New Jersey to address the consolidated tax adjustment policy.

While the proceeding is not moving as quickly as we would like, we are pleased that the Board of Public Utilities has initiated a review of the policy. We are actively participating in the process.

On July 12, Pepco received a disappointing outcome in its electric distribution base rate case in Maryland. A summary of the decision can be found on Slide 5. The commission's order authorizes a $28 million increase in electric distribution base rates based on a 9.36% return on equity. The increase is less than half of the amount requested in our initial filing.

We view the commission's decision to maintain the punitive return on equity authorized in our last rate case in mid-2012 to be unwarranted. Pepco is exceeding all reliability standards in Maryland, has experienced a significant decrease in the duration and frequency of outages over the past couple of years and has experienced improvement in customer satisfaction ratings. The annual pretax earnings impact of the decision, including the changes in depreciation and amortization expense and other miscellaneous items, is approximately $27 million. The new rates were effective on July 12.

We also find disappointing the failure to adopt mechanisms supported by the Maryland Governor's Grid Resiliency Task Force Report issued last fall. Out of $192 million of proposed accelerated reliability improvements, only $24 million of priority feeder work was approved under a host of conditions.

Costs associated with the feeder project will be recovered through a Grid Resiliency Charge implemented as a rider that is separate from base rates and includes a return on investment. The accelerated vegetation management and selective undergrounding proposals were denied. The commission also denied our request to include forward-looking plan additions in rate base beyond the hearing dates. Again, we believe a more forward-looking rate-making process was supported by the Governor's Task Force report.

On July 26, we filed an appeal on the commission's order with the Circuit Court for the City of Baltimore, and we expect to file Pepco's next rate case in Maryland by the end of the year.

Our priority remains system reliability and improvement of the customer experience, but we expect timely cost recovery and the opportunity to earn reasonable regulatory returns. We are continuing to evaluate Pepco's spend in Maryland and we'll determine any changes by year end.

As seen on Slide 6, on July 17, Delmarva Power, the staff of the Maryland Public Service Commission and the Office of People's Counsel entered into a settlement agreement, providing for a $15 million annual increase in Delmarva Power's electric distribution base rates, with a 9.81% return on equity. The agreement allows for a recovery of storm restoration costs included as a result of recent major storm events.

The annual pretax earnings impact of the proposed settlement, including the changes in amortization expense resulting from storm cost recovery, is approximately $14 million. This settlement also provides for a Grid Resiliency Charge under certain conditions for a recovery of cost totaling approximately $4 million associated with Delmarva Power's proposed plan to accelerate investments related to priority feeders.

The settlement does not provide for approval of the proposed acceleration of tree trimming cycle. Under the settlement, the new rates would become effective on September 15 or as soon as practicable thereafter, once the Maryland Commission issues an order approving the agreement. We view this outcome as more constructive, and we do not anticipate any changes to Delmarva Power's planned capital expenditures in Maryland.

Our other distribution rate cases are proceeding as expected, as shown on Slides 7 through 9. The Delaware hearings in Delmarva Power's natural gas distribution base rate case are scheduled to begin on August 27. And then Delmarva Power's electric distribution base rate case are scheduled to begin on November 13, with a decision expected in the fourth quarter for the Delmarva gas case, and in the first quarter of 2014 for the electric distribution case.

In Pepco's case in the District of Columbia, hearings are scheduled to begin on November 4, with the commission decision expected in the first quarter of 2014.

Now turning to the undergrounding project in the District of Columbia, as summarized on Slide 10. I'm pleased that on May 15, the Mayor accepted the recommendations of the report prepared by the Power Line Undergrounding Task Force. The report recommended a 7-year $1 billion program to underground up to 60 high-voltage lines in areas of the district that are most outage-prone.

The project will be funded through a 50-50 combination of the District of Columbia and Pepco financing methods. Pepco's funding will be approximately 50% debt and 50% equity from PHI, totaling $500 million. The district's funding will be comprised of $375 million in municipal bonds and up to $125 million of District Department of Transportation improvement funds.

Legislation providing for the implementation of the program was introduced in the council on July 10. A vote is expected in the fourth quarter of this year. And if passed, it would be final in the first quarter of 2014. The Public Service Commission is expected to approve the financing and surcharge applications associated with the legislation in the second quarter of 2014.

The Mayor's task force brought together key players, including the utilities, the commission, the people's counsel and community leaders that were aligned in addressing the important issue of hardening the electric grid. While Pepco is currently exceeding service reliability standards in the district, this work will enable our system to better withstand severe weather events, while also stimulating economic growth.

While we are clearly disappointed with the Pepco Maryland outcome and the continued application of consolidated tax adjustment in New Jersey, it is important to note that we have made significant progress in our system Reliability Enhancement Plan, which started in 2010. We are acutely aware of the under-earning of our utilities, and we will make modifications to our investment plan to help close the gap between our allowed and earned ROEs.

However, what we will not do is jeopardize reversing positive trend in reliability improvement. If we were to cut spending to the point that we experience reliability issues, it will only invite an even longer path to closing our regulatory lag challenge.

Now turning to Slide 11 in sales. While our customer count was up slightly in the second quarter of 2013 as compared to 2012, weather-normalized kilowatt hour sales decreased 2% quarter-over-quarter and 1% year-to-date. The quarter-over-quarter decline was driven by significantly lower usage on all customer classes in the Atlantic City Electric service territory, partially offset by higher Pepco residential sales. The year-over-year decline was primarily due to lower usage by Atlantic City Electric customers, as well as commercial customers at Pepco, partially offset by higher Delmarva Power residential sales.

With decoupling in place in Maryland and the District of Columbia, approximately 2/3 of the distribution revenue was decoupled from consumption.

Due to the changed economic environment in our service territories as compared to last year during our planning period, we have revised our sales forecast. Pepco sales growth has been slowed by the impact of sequestration, government spending cuts and other government reductions, although we believe the effects of sequestration will be temporary.

Growth has slowed in our Delmarva Delaware region, but the decline is expected to be partially offset by the growth in sales in the agriculture and government sectors of Delmarva's Maryland territory. The weak employment and economic climate continues in southern New Jersey and has decreased expectations for sales and customer growth in the region.

Systemwide, we are forecasting a decline of approximately 1% in weather adjusted sales by year end, with 0.5% increase in the number of customers we serve. We are currently reviewing our long-term sales and customer growth rates, and we'll provide an update on our third quarter call.

In the second quarter, Pepco Energy Services completed the wind-down of its retail electric supply business by terminating its customer supply and wholesale purchase obligations that extended beyond June 30, 2013. Accordingly, the operations for both the retail electric supply business and the retail natural gas supply business are now recorded as discontinued operations.

For the 6 months ended June 30, 2013, net income from discontinued operations was $0.01 per share compared to $0.07 per share for the same period of 2012.

The energy services market is still somewhat soft but activity is picking up in the federal government segment. As shown on Slide 12, the prospective project development pipeline has grown to $415 million, up 22% since January 1, driven by the federal market.

PES signed $25 million in energy efficiency contracts in the first half of 2013, including a $16 million construction contract with Appalachian State University in Boone, North Carolina to design and install energy conservation measures. We continue to believe the benefits of energy efficiency provide long-term growth opportunities for this business.

The underground transmission construction market remains strong, with significant bidding activity, many projects in progress and a healthy pipeline of future prospects.

And at this point, let me turn it over to Fred Boyle.

Frederick J. Boyle

Good morning, and thank you for joining us today. I'll now recap our earnings, address our performance by operating segment and discuss some topics of interest. We will then open the call to your questions.

As shown on Slide 13, GAAP earnings from continuing operations for the second quarter of 2013 were $0.16 per share compared to $0.23 per share for the second quarter of 2012. Both periods include cross-border energy lease results, and the 2012 period also includes an impairment charge related primarily to Pepco Energy Services landfill gas-fired electric generation plant. Excluding these adjustments, earnings per share from continuing operations for the second quarter would have been $0.22 per share compared to $0.20 per share for the second quarter of 2012.

The GAAP loss from continuing operations for the 6 months ended June 30, 2013, was $1.61 per share compared to earnings of $0.50 per share for the 2012 period. In addition to the items I just discussed, the 2013 period includes a charge related to a valuation allowance on certain deferred tax assets. Excluding these adjustments, earnings per share from continuing operations for the 6 months ended June 2013 would have been $0.46 per share compared to $0.43 per share for the 2012 period.

A summary of the drivers of our financial results for the quarter and year-to-date periods can be found on Slides 14 and 15.

For the second quarter, Power Delivery earnings were unchanged at $0.23 per share. Higher distribution revenue, primarily due to higher rates related to increased investment in utility infrastructure, increased earnings by $0.07 per share, and lower operation and maintenance expense increased earnings by $0.02 per share.

Items that decreased earnings per share quarter-over-quarter include lower default electricity supply margins, mainly due to a favorable adjustment in 2012; lower unbilled revenue associated with Atlantic City base [ph] generation service and dilution from additional shares of common stock outstanding. Each of these items reduced earnings by $0.02 per share quarter-over-quarter.

Year-to-date, Power Delivery earnings were $0.47 per share in 2013 compared to $0.44 per share for the 6 months ended June 2012. Higher distribution revenue, primarily due to higher rates, increased earnings by $0.11 per share. Earnings also benefited from favorable weather-related sales in our service territories that do not have revenue decoupling, which increased earnings by $0.04 per share.

Heating degree days were higher by 32% in the first half of 2013 as compared to the 2012 period. Items partially offsetting the earnings increase were dilution from additional shares of common stock outstanding; higher net interest expense; lower transmission revenue, partially due to a lower formula rate true-up as compared to the prior year; and lower default electric supply margins.

At our analyst conference in March, we provided a forecast of total 2013 O&M expense for Power Delivery of $850 million to $880 million. Given our year-to-date results and expectations for the remainder of the year, we continue to expect O&M to be within this range.

Pepco Energy Services' second quarter adjusted earnings were unchanged at $0.01 per share period-over-period. Year-to-date, adjusted earnings were $0.02 per share compared to $0.01 per share for the 6 months ended June 2012. The increase in earnings for the year-to-date period was due to lower O&M expense.

In our other nonregulated segment, adjusted earnings were essentially breakeven for both periods. With the completion of the cross-border energy lease terminations, we expect to treat substantially all of the other nonregulated segment as discontinued operations going forward.

Now I'll turn to some topics of interest. As seen on Slide 16, we have completed the early termination of all of our cross-border energy lease investments. Interest in 5 of the 6 lease investments were terminated in the second quarter, and we received aggregate cash proceeds of $693 million. An after-tax loss of $9 million was recorded in the second quarter in connection with the lease terminations.

On July 26, the early termination of the remaining investment was completed, and we received aggregate net cash proceeds of $180 million. The after-tax gain to be recorded in the third quarter is expected to be $7 million.

For 2013 in aggregate, the early termination of the 6 lease investments has resulted in $873 million of cash proceeds and a net after-tax loss of $2 million. The proceeds from the liquidation have been used to repay $784 million of parent company short-term debt, including the $250 million term loan entered into in March of this year.

The balance of the cash proceeds is in short-term investments. Ultimately, we expect a significant portion of the proceeds to be allocated to the utility subsidiaries to fund construction expenditures.

Turning to Slide 17. On August 1, PHI and the utility subsidiaries extended the expiration date of the $1.5 billion credit facility by 1 year to August 1, 2018. The other terms and conditions of the credit facility remain unchanged.

On May 10, Atlantic City Electric entered into a $100 million unsecured term loan agreement due November 2014. The net proceeds were used to repay outstanding commercial paper and for general corporate purposes. Given the net proceeds received from the early termination of the cross-border energy lease investments, we continue to anticipate PHI's next equity issuance will be beyond 2015.

Turning to Slide 18. Given the year-to-date results and our expectations for the remainder of the year, we are reaffirming our 2013's earnings guidance range for ongoing operations of between $1.05 to $1.20 per share. The guidance range excludes the results of discontinued operations and the impact of any special, unusual or extraordinary items. The guidance range also excludes earnings or loss associated with the cross-border energy lease investments, including the associated interest on the tax liability.

Now let me turn it back to Joe Rigby for some closing remarks.

Joseph M. Rigby

Thanks, Fred. So far, 2013 has been a year of both significant progress and significant challenges. We are pleased with our progress on the smart grid, the improvements we have made in system reliability and the positive trends in customer satisfaction. We believe our regulatory challenges can be overcome. It will take time, longer than we want it to, but the best path forward is to continue our reliability and customer service improvement efforts. We believe that over time, this will yield the best outcome for our customers and investors. We remain committed to the dividend and believe our earnings growth opportunities provide a foundation for enhancing value.

And with that, we would like to open the call to your questions.

Question-and-Answer Session

Operator

[Operator Instructions] Your first question comes from the line of Paul Patterson with Glenrock Associates.

Paul Patterson - Glenrock Associates LLC

First on the PES pipeline increase, are you guys feeling different about the outlook? What do you think about the outlook longer term for the business?

John U. Huffman

Yes. This is John Huffman. I'd say in the near term, the federal market is definitely picking up. We're seeing an increased activity. The challenge is to convert those opportunities into signed contracts. The local and state markets continue to remain soft. There is some activity but we think that's going to take longer to pick up. But I think over the longer term, we're expecting to see modest growth in the energy efficiency business.

Paul Patterson - Glenrock Associates LLC

Okay. In terms of the impact of sequester, if it wasn't for sequester, what do you think your normalized sales growth would have been?

Frederick J. Boyle

Well, as far -- this is Fred. As far as the exact impact of sequestration, it's difficult to identify specifically what it is. We had projected to have some increase, a minor increase in sales, but we haven't seen that and we've seen a little bit of a tailing off. And in the Pepco region, where you'd expect more impact from the sequestration, the commercial sector is down the most. So we are seeing an impact there. But as far as how much we could exactly attribute to sequestration, I couldn't say.

Paul Patterson - Glenrock Associates LLC

Okay. But it would probably be negative anyway, your sales growth, is that fair to say?

Frederick J. Boyle

Not in the Pepco region. We weren't anticipating negative sales growth.

Paul Patterson - Glenrock Associates LLC

But with -- but you think the sequestration is the reason for that?

Frederick J. Boyle

I think that is a driver because we had projected to be flat to a little bit up, and we are down. We're now projecting to be down in Pepco about 1% for the year.

Paul Patterson - Glenrock Associates LLC

Right. Now -- but so, I guess, and you take -- I guess, okay, fair enough. So -- and you think the primary driver in that is sequestering as opposed to anything else?

Frederick J. Boyle

Yes.

Paul Patterson - Glenrock Associates LLC

Okay. And then in terms of the SOS margin, I guess, quarter-over-quarter, how should we think about what the longer-term impact on that is?

Frederick J. Boyle

Well, quarter-over-quarter, there is an adjustment we had in 2012 relating to SOS. And if we look back at even the waterfall chart that we had at the Analyst Day, we had shown an unfavorable, I think it was $0.02 to $0.03 because of the SOS and the favorable adjustment made in 2012 that was out of period. So that's what we're seeing come through here.

Paul Patterson - Glenrock Associates LLC

Okay. So there should be -- past that, there shouldn't be any change, right?

Frederick J. Boyle

Correct.

Paul Patterson - Glenrock Associates LLC

Okay. And then just in terms of the regulatory challenges that you guys have mentioned, we now have, I guess, New Jersey and Maryland out of the way. And I don't think you guys are all that happy with the Maryland outcome, right? So I was wondering, I mean, how should we think about -- I mean, you're not going to cut back on reliability and what have you. Do you think that, that means that perhaps, we should just get ready for more regulatory lag? Or how should we think about how the company is going to be addressing regulatory lag? I mean, what are your thoughts about this? Do you follow me in terms of regulatory strategy, given the outcomes that you guys have had the last couple of rate cycles here?

Joseph M. Rigby

Paul, this is Joe. You're right, we're disappointed. We've expressed that disappointment back up even to the Governor's office. I think that it's fair to say that obviously, we express that disappointment in our appeal. We understand that it's going to take us longer now to chunk into this than any of us would like to. The -- I think what we're trying to manage through is while we're assessing our spend, particularly for Pepco in Maryland, it would, I think, kind of exacerbate a problem that we've just kind of recently worked our way out off if we changed our behavior dramatically, so we're not going to do that. I think that we're taking a look at everything in terms of how we approach the cases, how we present the materials. We're not going to assume that we're doing everything perfectly ourselves. But we do feel strongly that we now have operating performance on our side. And as we go in, that I'm hopeful that the next time when we make the Pepco Maryland filing, that we are going to get a better outcome. Because there will, candidly, be more distance between, I think, what had been a tough period in our history to that point in time. The one thing that I just kind of maybe go on a little bit that surprised me was the reaction that the commission had to the recommendations that we proposed vis-à-vis the Governor's Task Force. I can't really explain why they didn't embrace more of that, because obviously, that was to the benefit of the customer with not really significant cost impacts. But we feel very strongly that we've made such significant improvements that even though it's going to take us a little bit longer, that we will eventually be able to chunk the lag down.

Paul Patterson - Glenrock Associates LLC

Do you think that -- I mean, you guys have filed several rate cases in the short period of -- pretty consecutively. How should we think about the next rate cycle in Maryland?

Frederick J. Boyle

The next rate cycle as it relates to Pepco Maryland, we'd anticipate being back in again later this year.

Operator

Your next question comes from the line of Dan Eggers with Crédit Suisse.

Matthew Davis - Crédit Suisse AG, Research Division

It's actually Matt Davis. Just one quick question on the appeal process. Can you walk through what could come out of that and what the process is going forward for -- in Pepco Maryland, excuse me?

Frederick J. Boyle

We've filed the appeal. As far as the timing on that, there's not a set schedule. And from my understanding, that could take approximately 12 months to work itself through.

Operator

Your next question comes from the line of Charles Fishman with Morningstar.

Charles J. Fishman - Morningstar Inc., Research Division

Just on that last question, just as a follow-up, what has been the track record on those appeals through the years?

Frederick J. Boyle

As far as success in appeals, I'd say in general, it's probably not generally a favorable outcome from the company's perspective as far as success in appeals. But nonetheless, we believe it's important to stake out our position and make clear where we feel the ruling wasn't fully equitable from our perspective.

Charles J. Fishman - Morningstar Inc., Research Division

Okay. And then also in Maryland, what does Maryland have against tree trimming? It seems like that's the first line of defense throughout the country. The first thing that's usually addressed when there's reliability issues, yet Maryland seemed to shoot you down on -- in both jurisdictions.

Frederick J. Boyle

Well, as far as tree trimming, we have completed a full round in Maryland now within Pepco Maryland, a full round of tree trimming here over the past 2 to 3 years, and we're on a regular cycle. What we were proposing was to accelerate it, and the commission determined that the current cycle we are on is sufficient.

Charles J. Fishman - Morningstar Inc., Research Division

Okay. And then if D.C. moves forward with the undergrounding project that's been -- that came out of the, I guess, the Mayor's committee, would PES do the -- some of the engineering and construction management of that? And does that give you an opportunity to have some earnings at -- unregulated earnings at PES?

Joseph M. Rigby

I think -- this is Joe. I think it would be way premature to try to come up with some kind of an estimation of that, so we'll have to see how that process plays out

Charles J. Fishman - Morningstar Inc., Research Division

That is something PES could do, correct?

Joseph M. Rigby

They're primarily focused on transmission [indiscernible] distribution level.

Operator

Your next question comes from the line of Paul Ridzon with KeyBanc.

Paul T. Ridzon - KeyBanc Capital Markets Inc., Research Division

On the sale to cross-border leases, it seems like you got out of that in pretty good shape. Are you generally pleased with the exit?

Frederick J. Boyle

Yes, we are pleased with the exit.

Paul T. Ridzon - KeyBanc Capital Markets Inc., Research Division

And can you just outline the next steps with regards to the dispute with the IRS and how you see that playing out?

Frederick J. Boyle

Well, we're in discussions with the IRS. Currently, the court litigation has been stayed. So that's on hold, the way I think about it. And we are then in discussions with the service and plan to have discussions with them to try and reach a settlement as it relates to this and other open issues for a lot of those years, which go all the way back to the early 2000s.

Paul T. Ridzon - KeyBanc Capital Markets Inc., Research Division

And what is the current IRS claim of what you owe?

Frederick J. Boyle

Well, their position had been to disallow all of the costs associated with that. And when we -- the recordation we made during the first quarter reflected that, so we've already taken the book income charge and made a deposit with the service that reflected that. So it's a matter then of settling -- finally settling with the service as it relates to these cross-border leases, and the position they take for all the intervening years.

Operator

Your next question comes from the line of Maury May with Wellington Shields.

Maurice E. May - Wellington Shields & Co., LLC, Research Division

A couple of questions. First of all on guidance, you're sticking with the range of $1.05 to $1.20. But given the first half results, I was just wondering whether you could guide us to the, perhaps, the midpoint of that range or the lower end of that range or give us some kind of pointer here.

Frederick J. Boyle

At this point in time, we have a long way to go for the year, so we're sticking with the range at this point in time and not directing either high or low.

Maurice E. May - Wellington Shields & Co., LLC, Research Division

Okay. And the second question has to do with the Maryland appeal. And I guess the appeal, is it just ROE or are there other factors involved?

Frederick J. Boyle

There's ROE, there's AMI, are the main items.

Maurice E. May - Wellington Shields & Co., LLC, Research Division

Okay. You've got meters disallowed, didn't you?

Frederick J. Boyle

That's correct.

Maurice E. May - Wellington Shields & Co., LLC, Research Division

Okay. So how much meter disallowance are you asking to be included?

Frederick J. Boyle

I think the amount of the meter disallowed was $41-somewhere-in-that-range million of rate base. So we'd be looking to have that reflected in rate base.

Maurice E. May - Wellington Shields & Co., LLC, Research Division

Okay. And the ROE, are you still going back for the 10.25? Or are you just proposing a certain amount of basis points above what you're authorized?

Frederick J. Boyle

Well, we'll be appealing the conclusion they reached.

Maurice E. May - Wellington Shields & Co., LLC, Research Division

Okay. But without any point target?

Frederick J. Boyle

Well, we haven't actually filed that yet, so we're still working on that.

Maurice E. May - Wellington Shields & Co., LLC, Research Division

Okay, okay. And then my last question has to do with the Standard Offer Service. What percentage of retail in -- at Pepco Maryland and Pepco D.C. are you still getting procurement fees on?

Frederick J. Boyle

At Pepco, it's about -- I think it's about 35% of the sales are SOS, but I'll have to confirm that, and Brian can get back to you. I may not have that right.

Maurice E. May - Wellington Shields & Co., LLC, Research Division

Okay, okay. And is that 35%, is that both D.C. and Maryland?

Frederick J. Boyle

Yes.

Operator

Your next question comes from the line of Andy Levi with Avon Capital.

Andrew Levi

Just a couple questions. On the O&M side, where are we year-to-date relative to last year? Are we kind of flat or down?

Frederick J. Boyle

Well, for the -- on a year-to-date basis, we're kind of flat right now from an O&M perspective.

Andrew Levi

Okay. And so the savings of, I forget, I think it was like $13 million that we should see in the second half of the year?

Frederick J. Boyle

That's right.

Andrew Levi

Okay. And will that come -- start coming in the third quarter? I mean, I guess second quarter was actually down, right, $7 million?

Frederick J. Boyle

Yes, it was $0.02, down year-to-date -- I mean, favorable $0.02. And then year-to-date, we're $0.01 unfavorable. So yes, in the third and fourth quarter is when you'll start seeing it come through.

Andrew Levi

And were there any storm costs in the second quarter?

Frederick J. Boyle

Well, as we're looking forward for this year for the third and fourth quarter, there were storm costs last year.

I don't think we had any significant storm costs in the second quarter this year.

Joseph M. Rigby

Yes, we had -- that was in June, but nothing significant.

Andrew Levi

All right, okay. And some of the reduction for the third and fourth quarter relative to last year is storm cost related. Is that fair?

Frederick J. Boyle

Yes.

Andrew Levi

Okay. And can you just tell us how much we're talking about as far as storm costs last year, the second half versus the...

David M. Velazquez

This is David. In last year, we had both derecho and Hurricane Sandy, which costs, primarily we saw in the third quarter were about $12 million.

Andrew Levi

$12 million, great.

David M. Velazquez

So those are the common -- those are the only costs that hit O&M costs...

Andrew Levi

Right, right. Capital, obviously, was there.

David M. Velazquez

[indiscernible] that actually went to the O&M.

Andrew Levi

Okay. And on the sales side, just any color on what's kind of happening in southern New Jersey, why the sales are affected so much?

Frederick J. Boyle

In south Jersey, the economy just continues to struggle. There have been expectation about recovery. We had actually projected a little bit of recovery. And in fact, we're not seeing that. And employment is rather stagnant, as far as I look at some of the projections for when employment will get back to pre-recession, and it's going out now more than 5 years from now. So the economy there is continuing to struggle, and that's what's being reflected in our sales volumes.

Andrew Levi

Okay. So I guess in the third quarter, we'll hear kind of -- I mean, again, you're decoupled in the majority of your service territories with the exception of, what, Delaware and New Jersey, right?

Frederick J. Boyle

That's correct.

Andrew Levi

So I guess, we'll hear in the third quarter a plan to kind of offset the lower sales. Is that kind of a fair way to look at it?

Frederick J. Boyle

Well, when you're saying as far as the plan to offset the...

Andrew Levi

Not much for this year, but I guess longer term, I guess is...

Frederick J. Boyle

Well, as we roll forward and we talk about '14, which will be -- usually, we'll provide guidance for that on the annual earnings call in February, early next year.

Andrew Levi

Okay. And then just my last question, just kind of overall kind of strategy going forward, maybe for Joe. So the strategy has been kind of continue to file rate case after rate case in every jurisdiction. And you have been getting rate increases, obviously not to your satisfaction. But -- so you might be again, just my opinion, getting into a situation of kind of rate fatigue or rate case fatigue. And then you kind of look at, let's say, like a state like Michigan, where you were kind of having rate case after rate case, but the company's kind of decided to kind of slow the process down and look at the cost side of the business and try to kind of absorb earnings growth that way and hold off on the rate cases. Any thoughts of kind of changing the strategy of just kind of going in every 6 months? I mean, it ends up being -- like you look at Maryland, where they -- maybe the reason why they didn't change the ROE had nothing to do with improvement or not improvement, but just that you had come in so recently. Just any thoughts on that?

Joseph M. Rigby

We -- Andy, this is Joe. We've talked about that quite a bit, but the conclusion we've reached is that although there is a sense of fatigue on all the parties that the fact that we're under-earning to such a significant degree, given the pace of investment that's necessary, we don't want to exacerbate that problem. When we step back and look at what's happening in our jurisdictions, I'm pleased that we're now addressing the consolidated tax adjustment in New Jersey. So I'm hopeful that by the end of this year or early next year, that issue gets resolved one way or another, and we'll know what the game plan is. We're still pursuing a multiyear settlement opportunity in Delaware. I think that the -- that we do see a kind of an improved tone here in the district. The fact that we were able to put together the public-private partnership with the undergrounding is, I think, is a good indicator. The fact that we've got what we thought was a reasonable settlement for Delmarva Maryland was good. The issues are mostly around Pepco Maryland. And we just don't see a strong basis to then say, "Well, we're just not going to file for 18 months or whatever." We feel that the investments we're making is having a significant impact and we're going to go back in. So the utility earnings are growing. It's not at the pace we would -- any of us would want it to. But I think if we stepped away from the filing plan, we would just find ourselves in a more serious problem that we don't want to have.

Andrew Levi

Okay. Because I mean, I guess, another way to look at it is if you kind of slowed it down a little bit, kind of rightsize the company O&M-wise, whether it's employee count, whether it's benefits, no one wants to have higher deductibles and higher copays and things like that. And obviously, you don't want to let go employees. But maybe that strategy would be better in the short run, stay out a little bit, find other ways to cut costs. And then when you do go in, get treated better. I don't know if there's been any thought of that.

Joseph M. Rigby

Andy, let me comment to that. We've been focused on cost containment for several years. I mean, we look at this all the time. We've had a hiring freeze in place for -- we're now in the second year. There's -- the only exceptions we make to that are for just very critical positions. We've made reductions to our overall employee benefit and incentive costs. So we are managing that part of the ledger. It's -- what we also have to recognize is the level of work that we're completing across the entire property is going to require that we're spending O&M dollars. So we're trying to be very judicious in the way that we manage that cost. But we still have to be able to get the work done. Candidly, I think if we found ourselves dramatically cutting O&M, given the rate case cycle, it's, in some ways, you -- obviously, that would not be included in your cost of service. So there might be some very short-term temporary positive impacts. I think that it would -- that actually would make it more difficult for us to get the work done that we see ahead of ourselves.

Andrew Levi

Okay, fair enough. And then the last question is -- that I always ask you, just if you could just reiterate your dividend policy?

Joseph M. Rigby

Well, the dividend policy is that we want to grow dividend in line with utility earnings growth. But as you well know, we have a very high payout. And we remain absolutely committed to that dividend. So that would be a takeaway that I'd like you to have.

Operator

Your next question comes from the line of Brian Chin with Bank of America Merrill Lynch.

Brian Chin - BofA Merrill Lynch, Research Division

Any reaction to the ALJ decision -- proposed decision at FERC on transmission line ROEs, the sort of a parallel situation that you guys have? Just wondering if you have any preliminary thoughts on that.

Frederick J. Boyle

This is Fred. We certainly have -- are aware of what the ALJ came out with in New England. And the go forward rate, as I understand it, was 9.7%. However, I think there's also an adjustment that would be made if those rates were to be put in place today, which would increase that by about 80 basis point, taking up about 10.5%. Our base rate right now is 10.8%, so there's not a big spread there. However, the mechanics and the period of time over which the DCF is different for what's happening in New England versus here, but it is a data point that we're watching.

Brian Chin - BofA Merrill Lynch, Research Division

Okay, very helpful. And then also just going back to Andy's question on Atlantic City, I know that you mentioned that you didn't see any sort of significant recovery in southern New Jersey. But we did see one of your peers a few quarters ago, where they were running their weather-normalized sales number and they had a very meaningful drop. And after the fact, it turned out being sort of a change in their modeling assumptions for weather normalization. Were there any changes in your weather-normalized calculation that might explain that? Because 6% increase [ph] just seems like a very large number.

Frederick J. Boyle

No, there's no specific change in the method that we've used in our weather normalization.

Operator

[Operator Instructions] Your next question comes from the line of Neil Kalton with Wells Fargo Securities.

Neil Kalton - Wells Fargo Securities, LLC, Research Division

Just a question on the CapEx outlook longer term. Do you envision that there could be any meaningful changes just given some of the issues, obviously, in response to the rate decisions in New Jersey and Maryland? And then with the lower sales forecast, do you think that's going to cause any changes in the CapEx outlook going forward?

Joseph M. Rigby

Neil, this is Joe. The only thing that we've identified is the reduction for ACE of about $150 million. We're taking a look at all of these factors as we actually go into our planning process. So I think what you would find is sometime in November, we would be able to refresh the 5-year CapEx vehicle.

Neil Kalton - Wells Fargo Securities, LLC, Research Division

Is it fair to say that it's more likely to be a little bit lower than the last 5 years? Or is it too early to tell at this point?

Joseph M. Rigby

I think it'd be way too early to tell. I mean, one of the things that we'll have to obviously factor in is the undergrounding in D.C. So as we kind of monitor what's happening there, that would obviously would add to it. So we have to just -- we just need a little bit more time to flesh through all of that.

Operator

You have a follow-up question coming from the line of Charles Fishman with Morningstar.

Charles J. Fishman - Morningstar Inc., Research Division

Just one follow-up. Effective tax rate, income tax rate, I think at the Analyst Day, you were talking, give or take, 40%. I mean, now that you have the cross-border leases pretty well wrapped up, is that still what you're thinking for a long-term rate we should use?

Frederick J. Boyle

Yes, this is Fred. Long-term rate would be yes, right around the 40%.

Operator

You have a follow-up question coming from the line of Andy Levi with Avon Capital.

Andrew Levi

I apologize, I had one more question. Just on the cross-border leases or just the whole kind of IRS negotiations, is there any exposure, either up or down, in those -- on the outcome of that? I mean, is it possible that you could do a write-up or a write-down depending on how that goes? Or have you written down everything, there's no further risk of another write-down?

Frederick J. Boyle

As far as the leases go, we've taken the charge associated with that. There's a lot of open years. We're open going back to 2000. So depending how various issues settle out, you can have interest movements. And I think there are going to be some consequences of the settlement to the extent any issues end up being agreed at a level different than what's assumed right now. But there shouldn't be -- it's not as though there should be any significant write-down or anything when you're going back to the leases. Is there another write-down? The answer is no.

Andrew Levi

And are there any other issues that you're discussing with the IRS in this kind of global settlement for no, no way to put it beyond the cross-border leases?

Frederick J. Boyle

Well, we're open back to, I guess, around 2003 for issues for all those years are open. In other words, so there'd be things such as repair allowance. There's the IDD 5. So there's other issues that are open for all tax years. And the idea of a global settlement would be to get closure on all items up through the date of the global settlement [indiscernible] settlement [indiscernible]

Andrew Levi

Are things like the aircraft leases and things like that still open and...

Frederick J. Boyle

No, those wouldn't be part of that, no. The only thing open, as it relates to any of the lease kind of activity or legacy lease activity, was the cross-border, and that's been addressed.

Andrew Levi

Okay. So there are a bunch of it -- just to understand because by no means am I anywhere close to a CPA or CFA. But it sounds like there's settlement talks going on. Obviously, we have no idea time-wise when that's going to happen. But we shouldn't anticipate there being any type of material negative effect or outcome of those settlement talks or a final IRS ruling if you can't settle or court ruling, I guess, I don't know what it would be.

Frederick J. Boyle

I agree with that statement.

Operator

There are no further questions in the queue at this time. I would now like to turn the call over to Joe Rigby for closing remarks.

Joseph M. Rigby

Okay. Thank you, operator, and again, thank you all for joining us today and for your interest in PHI, and have a great day. Take care.

Operator

Thank you for your participation in today's conference. This concludes the presentation. You may now disconnect. Have a great day.

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