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Pepco Holdings, Inc. (NYSE:POM)

Q3 2009 Earnings Call Transcript

October 30, 2009 11:00 am ET

Executives

Brian Shivery -- Manager, IR

Joe Rigby -- Chairman, President and CEO, Pepco Holdings, Inc.

Tony Kamerick -- SVP and CFO, Pepco Holdings, Inc.

John Huffman -- President and CEO, Pepco Energy Services

Gary Morsches -- President and CEO, Conectiv Energy

Dave Velazquez -- EVP, Pepco Holdings, Inc.

Analysts

Daniel Eggers -- Credit Suisse

Carrie Saint Louis -- Fidelity Investments

Paul Ridzon -- Keybanc Capital Markets

Reza Hatefi -- Decade Capital

James Dobson -- Wunderlich Securities

Neil Kalton -- Wells Fargo Securities

Maurice May -- Power Insights

Operator

Good day, ladies and gentlemen and welcome to the third quarter 2009 Pepco Holdings, Inc. earnings conference call. My name is Eric. I will be your audio coordinator for today. At this time, all participants are in a listen-only mode. We’ll facilitate the question-and-answer session at the end of the presentation. (Operator instructions)

I would now like to turn your presentation over to Mr. Brian Shivery, Manager, Investor Relations. Please proceed.

Brian Shivery

Thank you, operator, and good morning, ladies and gentlemen; and welcome to the Pepco Holdings third quarter 2009 earnings conference call. I am filling in for Donna Kinzel today. Primary speakers on today’s call are Joe Rigby, Chairman, President and Chief Executive Officer; and Tony Kamerick, Senior Vice President and Chief Financial Officer.

Also available to answer your questions are Dave Velazquez, Executive Vice President, Power Delivery; Gary Morsches, President and Chief Executive Officer of Conectiv Energy; and John Huffman, President and Chief Executive Officer of Pepco Energy Services.

Before Joe begins, let me remind you that some of the comments made during today’s conference call maybe 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.

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 special items and their financial impact are described in our earnings release dated October 29, 2009. The earnings release can be found at www.pepcoholdings.com/investors. Joe?

Joe Rigby

Thanks, Brian and good morning, ladies and gentlemen. I appreciate your participation on our call today, and I look forward to speaking with many of you in person at the EEI Financial Conference Service this coming weekend.

We continue to face challenging power markets during the third quarter, resulting in lower run-time for Conectiv Energy's generation fleet. Lower energy commodity prices and narrow generation spreads also continued to pressure margins. At Power Delivery, the results were as we expected with the effects of dilution and higher pension and interest costs, as the primary earnings drivers.

Consolidated earnings for the quarter were $124 million compared to $119 million in the 2008 quarter. Excluding two special items in the third quarter of 2009, earnings would've been $97 million.

Tony will discuss the financial results and our operating segment performance in more detail, but first I will address some topics of interest beginning with our progress in executing our regulatory strategy.

During the third quarter, we filed two additional rate cases. On August 14, Atlantic City Electric filed an electric distribution base rate case in New Jersey that seeks approval of an annual increase of $54 million in electric base rates. If our proposal is approved, the typical electric residential customer would see a total bill increase of about 4%. If the commission adopts our proposed bill stabilization adjustment mechanism, the requested rate increase would be $52 million. And this case also requested that the commission authorizes a three-year rolling average treatment of pension and OPEB expenses to be recovered through a separate rate adjustment, which would be updated annually. This rate recovery mechanism is similar to those proposed in our other pending rate cases with the exception that it does not include a component for bad debt expense, which is currently recovered through a separate surcharge in New Jersey. If the separate rate adjustment is approved in New Jersey, it will lower the proposed annual base rate increase by about $8 million. The procedural schedule has not been set for the case.

On September 18, Delmarva Power filed for an electric distribution base rate case in Delaware that seeks approval of an annual increase of $28 million in electric base rates. If our proposal is approved, the typical electric residential customer would see a total bill increase of about 5%. This case also request that the commission authorizes a three-year average treatment of pension, OPEB, and bad debt expenses to be recovered through a rate adjustment, which would be updated annually. If this separate rate recovery mechanism is approved it would lower the proposed annual base rate increase by $7 million. A procedural schedule has not yet being set for this case. As approval by the commission, Delmarva Power will put an increase of $2.5 million annually into effect on a temporary basis on November 17, subject to refund and pending a final commission decision in the case which is expected in the second quarter of 2010.

Delmarva Power's electric distribution base rate case in Maryland filed in May remains on track, with hearings held on late September. A decision is expected by the end of this year. The case seeks approval of an annual increase of $40 million in electric base rates.

Pepco's electric distribution base rate case in the District of Columbia filed in May also remains on track with hearings scheduled to begin on November 9, with a decision expected in first quarter of next year. The case seeks approval of an annual increase of $50 million in electric base rates. We are also in the process of preparing a Pepco case expected to be filed in Maryland late this year. As in the other filings, the case will adjust for forward-looking known and quantifiable expenses, such as pension expense. The case will also request a three-year rolling average treatment of pension, OPEB, and bad debt expenses.

Another significant event on the regulatory front is the approval of decoupling in the District of Colombia. In September, the commission approved the adoption of decoupling, effective November 1. As in Maryland, revenue growth will be tied to customer growth, therefore eliminating revenue fluctuations due to weather and changes in customer usage pattern. Decoupling is also a key tool for fostering energy conservation as it aligns the interest of customers and utilities.

In connection with the approval, the commission ordered a reduction of 50 basis points to Pepco's return on equity, reducing the authorized return on equity to 9.5%. With the adoption of decoupling in the District of Columbia, approximately 60% of regulated distribution revenue will be decoupled from sales. With the anticipated adoption of decoupling in Delaware, upon completion of the pending base rate case, which is expected in the second quarter of 2010, about 80% of regulated distribution revenue will be decoupled.

On the blueprint for the future initiatives, our blueprint for the future initiatives continued to pick up momentum. Earlier this week, the Department of Energy announced that PHI has been awarded $168 million in federal stimulus funds to help finance the build-out of our Smart Grid projects in the District of Columbia, Maryland, and New Jersey. The award of these funds provides us with the opportunity to accelerate the building of advanced metering infrastructure, distribution automation, and direct load control technologies. By accelerating the build out of Smart Grid, we can deliver the benefits of these technologies to our customers faster, allowing them to access timely usage information and make informed choices on energy use, lower their energy bills, and allow for improved system reliability. Advanced metering infrastructure field testing is nearing completion in Delaware, with meter installation beginning in mid-November.

In Delaware, a regulatory asset will be created to ensure recovery of and return on AMI related costs between rate cases. As we reported last quarter in June, the District of Columbia adopted legislation approving AMI deployment subject to the Public Service Commission agreeing to the sufficiency of Federal grants received for AMI. The legislation provides for cost recovery and a return on costs by the creation of a regulatory asset. Maryland put in place an expedited process for consideration of AMI. Now that the results of the Smart Grid stimulus grants are known, we will incorporate those economic benefits into the information being considered by the Maryland Commission.

During the quarter, permitting work continued for the Mid-Atlantic Power Pathway or MAPP project. We continue to seek the remaining required certificates of public convenience and necessity as well as the required environmental approvals for the Maryland portions of the lines. We anticipate the Maryland Public Service Commission to hold hearings on the project in March of 2010 in connection with the certificate of public convenience and necessity process. The environmental permitting for the Burches Hill, the Chalk Point segment, is expected to be completed in the early part of the first quarter of 2010 with preliminary construction activities relating to this segment of the line underway by the end of this year. Keep in mind that early this year, we received authorization from the Maryland Public Service Commission to use an existing certificate of public convenience and necessity for the Burches Hill, the Chalk Point segment of the line.

Earlier this month, PJM reaffirmed the need for the MAPP project, as part of its annual regional transmission expansion planning process. The PJM board also authorized additional electric transmission system additions and upgrades throughout the grid, including $138 million of lower-voltage projects at PHI’s utilities. These projects were previously identified and already included in PHI’s five year capital expenditure plan.

Now I will turn to our competitive energy businesses. Construction of Conectiv Energy's 545 MW combined cycle Delta Project in southeastern Pennsylvania continues. The project is within budget and is on track to become operational during the second quarter of 2011. The Delta Project will significantly expand our PJM footprint of mid-merit generation assets. The first phase of Conectiv Energy's solar project in Violin [ph], New Jersey became operational with 2 MW energized in September and the remaining 2 MW are on target to be energized by the end of this year. This product supports our initiative to increase our renewable energy portfolio.

Tony will review Conectiv Energy's financial results. But I want to make a few comments on the energy market. The economic recession and wild weather have clearly lowered demand and dampened one volatility. Decreased demand combined with low fuel prices have displaced cogeneration and compressed margins. Our coal fleet capacity factor this year is less than 25%, and margins are down 80% as compared to the first nine months of 2008. While Conectiv Energy has certainly been challenged, the key value drivers for that business remain in place. Great assets in an advantageous location in PJM.

At Pepco Energy Services, we continue to evaluate a possible restructuring sale or wind down of the retail energy supply portion of the business. We have reduced the collateral exposure of the business with the credit intermediation agreement. We put in place earlier this year, and by not incurring incremental collateral exposure as we enter into new supply contracts. We expect the business to remain profitable based on its existing contract backlog and the margins that have been locked in with corresponding wholesale energy purchase contracts. And we intend to complete our review by the end of the year.

Before I turn it over to Tony, I want to make a few additional comments. PHI, like many companies, has faced a very challenging 2009. And I believe PHI has weathered these challenges well, while remaining focused on the strategy that we believe will position our company for long-term earnings growth. I have reviewed the progress of several of our key initiatives this morning. I know the topic of our 2010 financing plan is of great interest to you all. Tony will provide a high-level review of our plan during his remarks.

Looking forward to 2010, we are making good progress as we assess a broad range of alternatives, financing our growth plan and I believe we can manage through 2010 and continue to grow PHI.

One final comment; since I became CFO in 2004, there has been one question that I have received on a consistent basis, will we consider providing earnings guidance? Just as consistently, I've noted that we routinely review this topic with our board and however up to this point, maintained our no guidance policy. Today however, I want to provide a different answer. I'm pleased to announce that we intend to provide annual earnings guidance for PHI starting in 2010, and we are targeting our analyst conference in March to introduce guidance for the first time.

With that, let me turn it to Tony Kamerick.

Tony Kamerick

Thank you Joe and good morning everybody. I'm going to recap our consolidated earnings and then address our performance by operating segment. Then we will open up the call for your questions.

Consolidated earnings for the quarter were $124 million or $0.56 per share compared to $119 million or $0.59 per share for the third quarter of 2008. There were two special items for the third quarter of this year. First, we recognized a $16 million after-tax gain when the Maryland Public Service Commission approved Pepco’s customer sharing proposal for the Maryland portion of the remaining balance of the proceeds from the Mirant bankruptcy settlement. We also recognized $11 million after-tax Maryland state income tax benefit due to a change in tax reporting for the disposition of certain assets in prior years. Excluding these special items, earnings for the 2009 quarter would have been $97 million or $0.44 per share.

Year-to-date consolidated earnings were $194 million or $0.88 per share compared to $233 million or $1.16 per share for the first nine months of 2008. Excluding the special items in the 2009 period, earnings would've been $159 million or $0.72 per share. Excluding the special item related to the charge associated with the cross-border energy leases, earnings would have been $326 million or $1.62 per share in the 2008 period.

For the third quarter, Power Delivery earnings were $0.43 per share, compared to $0.38 per share for the 2008 period. Excluding the special items related to the Mirant bankruptcy settlement and the Maryland income tax benefit, 2009 earnings would have been $0.31 per share. The effect of delusion negatively impacted Power Delivery earnings by $0.04 per share. The remaining $0.03 per share decrease was due to higher interest and operation and maintenance expenses. A higher interest expense, which impacted Power Delivery earnings by $0.02 per share is primarily due to the debt financing we completed late last year. A higher O&M expense, which had $0.03 per share impact on earnings was driven by increased pension expenses. Excluding the increase in pension related expenses, O&M expense would've been essentially flat quarter over quarter, reflecting our continued focus on cost control.

A positive factor for the quarter was higher distribution revenues due sales and rate mix. Weather did not significantly impact quarter over quarter sales (inaudible) decrease in earnings of $0.01 versus the prior year. Cooling degree days were 11% lower, keeping in mind that our distribution revenue in Maryland which represents approximately 40% of total distribution revenue is currently decoupled from consumption.

Although weather adjusted residential sales have decreased slightly, we have experienced modest customer growth year-over-year.

Year-to-date Power Delivery earnings were $0.76 per share in 2009 compared to $0.99 per share for the nine months ended September 2008. Excluding the special item related to the Mirant bankruptcy settlement and the Maryland income tax benefit, 2009 earnings would've been $0.60 per share. The effect of delusion was 0.07 per share. The earnings decrease for the year-to-date period was driven essentially by the same factors that drove the quarterly results.

As Joe discussed, Conectiv Energy continues to manage through a challenging year. As we experienced during the first half of the year, mild weather and weak economic conditions reduced the demand for power in the third quarter. Eastern PJM's load was down nearly 5% quarter over quarter. Lower energy commodity prices and narrow generation spreads also continued to pressure margins. In the third quarter, Conectiv Energy earnings were $0.09 a share compared to earnings of $0.24 per share in the third quarter of last year. The primary drivers for the earnings decrease where lower generation output and narrow spark spreads and dark spreads.

Generation output was down 16% for the quarter and the average spark spreads and dark spreads for our generation fleet declined 57%. These factors decreased earnings by about $0.13 per share versus the prior year. Also contributing to the earnings decline for the quarter was the performance of the economics fuel hedges that were favorable due to rising fuel prices in 2008 and unfavorable due to falling fuel prices in 2009.

Key factors that drove the hedge performance were lower expected load service volumes in generation output impacted economic fuel hedges when combined with the default electricity supply contracts performance resulted in an earnings decrease of about 0.05 per share. A favorable factor that increased earnings by $0.07 per share was higher capacity gross margins.

Year-to-date, Conectiv Energy earnings were $0.06 per share versus earnings of $0.59 per share in 2008 period. Most of the quarterly drivers apply to the year-to-date period as well. Generation output was down 23% year to date and the average spark spreads and dark spreads for our generation fleet declined 58%.

Given the year-to-date results and our expectations for the remainder of the year, we expect to complete 2009 with the gross margin of approximately $270 million, which is at the bottom end of the previously disclosed range. In addition, we are updating the forecasted 2010 gross margin range of $340 million to $450 million to a new range of $340 million to $410 million, and the 2011 gross margin range from $380 million to $500 million to $380 million to $480 million. The lower expected gross margin ranges reflect the continuing weakness in the forward energy markets.

Pepco Energy Services’ second quarter [ph] earnings were $0.06 per share, compared to $0.01 per share in the 2008 period. The higher earnings were due to lower electricity and gas supply costs, lower losses on energy derivative contracts, lower RPM capacity charges, and higher RPM capacity revenues. Year-to-date earnings were $0.15 per share compared to $0.14 per share for the 2008 period. Lower electricity supply costs drove the higher earnings. Higher interest expense associated with the credit and collateral facilities was a partially offsetting factor for both the quarter and the year-to-date periods.

Now before going to the Q&A, I wanted to mention a couple other items. First, as you might expect, we found our recent court decision on cross border leases to be positive and we maintain our view that our tax position is proper. This will still likely take some time to resolve, but it's clearly a good data point.

Now turning to our financing plan, our preliminary expectation of new money financing needs for 2010 is $250 million. This amount takes into account a federal income tax refund of $138 million that we anticipate will be received late this year or early next year related to certain 2008 net operating loss carry backs. It also takes into account about $100 million in proceeds from the remarketing of our tax-exempt bonds that we purchased in 2008 due to market disruptions from municipal auction rate securities. We view this amount of net financing need as very manageable and could potentially make use of several options for funding it including modest additional construction cut backs, receive of stimulus funds, sales of selected assets or even small amounts of additional debt or equity.

It is premature for us to provide more specifics at this time, but as I said, we are confident in our financing plan as manageable and we intend to further pursue these options and provide you with another update on this topic in the first quarter of next year.

In closing, we continue to believe that the long term fundamentals of our business remain strong. We’ve made very good progress on our growth initiatives and believe that we are positioned for long-term earnings growth.

With that, we would like to open the call for your questions.

Question-and-Answer Session

Operator

(Operator instructions) Your first question comes from the line of Daniel Eggers with Credit Suisse. Please proceed.

Daniel Eggers -- Credit Suisse

Hi, good morning. Could you just, Joe, talk a little bit about more about the thought process that you evaluate in the Conectiv assets and PES assets? What are you looking at, is there a market? Or you could see selling those in the current climate? And how you balance your need for other funding sources relative to the outlook for those businesses in every perspective.

Joe Rigby

Okay, let me make a couple comments. One is that, we think we have three very, very good businesses. We have got a strong skill set in all three. We've got a strong T&D company that has certainly more than ample growth opportunities. I think that from a strategic point of view, the path ahead for PES is actually very clear. And as we noted that, the resolution of the retail business certainly are -- we have every intention, and I believe we will get that wrapped up by year-end, and John and his team are already gearing up on the ESCO. Our view that Conectiv Energy is that they are great assets, they are in the right place in PJM. They're having a tough year, but I would expect that they're going to continue to rebound. We've previously mentioned that we don't have CapEx that's devoted to Conectiv Energy beyond the completion of the Delta. And I don't really expect that that position is going to change. So our view is that the growth plan is going to be primarily driven by T&D. We provided you with some level of granularity around the things that we can do to finance our growth plan. The need for $250 million of new money is extremely manageable. We have a variety of things that we can do that obviously, either -- obviously on an individual basis or certainly in an aggregate, we can deal with this. So I feel comfortable. And as it relates to specific things, in terms of anything in the market, we’ve routinely evaluate these other businesses, other than the T&D. We will continue to do so.

Daniel Eggers -- Credit Suisse

Okay, got it. And I guess just along the lines of PES and ESCO, can you talk a little bit more about your thinking there, the growth opportunities as you see of your wider and wider portion in the energy efficiency and government money kind of sloshing around these days.

John Huffman

Yes, Dan, this is John. As you know we have shifted our focus to the ESCO side. And we do see tremendous growth opportunities there. Keep in mind it's very much a people business. And our growth prospects and our ability to win new contracts is really driven by having key talent, namely sales and engineering staff. Year-to-date, we've increased that staff by 40%. So we are very focused on growing our infrastructure. Now keep in mind, this business in terms of winning new contracts has a relatively long lead time, 18 months to two years. So what we are doing now, we expect to bear fruit over the coming timeframe.

Daniel Eggers -- Credit Suisse

Is there a way to think about backlog in that business then between kind of contract signing and those rains come in as something that we could look at it at some point?

John Huffman

Absolutely. We provided some backlog information at our Analyst Day conference back in March, but that is something we can routinely update and provide for you.

Daniel Eggers -- Credit Suisse

Great, thank you. Joe, on O&M expectations kind of looking forward, obviously it sounds like the pressure this year has been pension related with the markets hopefully railing up expectations that pension for next year, can you manage O&M below inflation and maybe even toward a flat level do you think?

John Huffman

I think it might be tough on a flat level, but certainly be -- our expectation and the plans we are putting in place now should get us no worse than inflation and hopefully below it. So that's just a way we normally manage the business and that would be our intention going forward.

Daniel Eggers -- Credit Suisse

Okay. And one last one just with the guidance coming in March at the Analyst Day, how many of your rate cases do expect to have resolved by the time the guidance comes?

Tony Kamerick

Dan, this is Tony Kamerick. The Delmarva/Maryland decision is due out in December of this year, and if the district commission sticks to its nine-month historical policy, it would come out in early February. So we will have two of them done.

Daniel Eggers -- Credit Suisse

Okay, got it. Thank you, guys.

Joe Rigby

Sure.

Operator

Your next question comes from the line of Carrie Saint Louis with Fidelity. Please proceed.

Carrie Saint Louis -- Fidelity Investments

Hi, good morning.

Joe Rigby

Good morning.

Carrie Saint Louis -- Fidelity Investments

I wanted to start with the 2010 financing update; that seemed pretty vague to me. You mentioned the $250 million in new money, but I believe there is about $450 million of parent refinancing that needs to be completed?

Tony Kamerick

Yes.

Carrie Saint Louis -- Fidelity Investments

Is that still the assumption?

Tony Kamerick

There are two parent company bonds that come due in next May and June, yes.

Carrie Saint Louis -- Fidelity Investments

It seems to me like you’ve got low rate, pretty attractive spreads, what is the timing on looking to get that financing completed?

Tony Kamerick

But we've been looking at that for quite a while Carrie, and more to come I guess if we find something that suits us.

Carrie Saint Louis -- Fidelity Investments

And you don't think current markets are attractive enough?

Tony Kamerick

Yes, they are attractive and we are looking at it.

Carrie Saint Louis -- Fidelity Investments

Okay. Are you thinking you would like to do one tranche of new financing or what are your thinking?

Tony Kamerick

Well, we are still evaluating. It would be our hope to maybe do some of that a little early –

Carrie Saint Louis -- Fidelity Investments

You didn’t mention your $1.2 billion to $1.5 billion equity commitments over five years. Is that still intact?

Tony Kamerick

We still have a very significant build out at the equity over the next several years. And yes, there would be definitely be some equity involved in that, yes.

Carrie Saint Louis -- Fidelity Investments

Did that – wait a second; that sounds different. What is –

Tony Kamerick

Carrie, I don't know if the number is exactly $1.2 billion to $1.5 billion at this point, but it's going to be enough to maintain our capital structure where we like to have it which is in the mid to high 40s. But, given that we’ve stimulus money coming in, we’ve got this tax refund that we are going to get later this year, we may be around the edges of those numbers that we quoted a year or so ago.

Carrie Saint Louis -- Fidelity Investments

All right. What about potential OpCo funding, could you maybe comment about doing, are your OpCos funded as appropriately as they could be? If some of the $250 million and new money going to come from OpCo funding?

Tony Kamerick

It could Carrie. We haven't pinned down that –

Carrie Saint Louis -- Fidelity Investments

-- issue the OpCos right now?

Tony Kamerick

Excuse me.

Carrie Saint Louis -- Fidelity Investments

Do you have authority to issue at the OpCos right now?

Tony Kamerick

Yes.

Carrie Saint Louis -- Fidelity Investments

Could you go over that, you know where like which subs you have the authority to issue?

Tony Kamerick

If you call back later, Carrie, we can give you that. I don't have it right here in front of me.

Carrie Saint Louis -- Fidelity Investments

Okay. Joe, could you comment, I mean I understand you feel that (inaudible) is attractive business, but I think you announced the decision on evaluating it in March, and six months later there has just really been little color given. So I'm just struggling with what's taking so long.

Joe Rigby

Well, couple comments. It's a challenging market in general to do even, let’s say, if we were contemplating a sale. But the reason that it's held on this long is because we are in fact evaluating alternatives. And what I was trying to communicate earlier in my comments is that I have every intention of resolving this issue this year. I don't like -- the uncertainty, I don’t like it from the employee point of view. We announced something earlier and I'm pleased that John and his team have performed very, very well this year. But I'd now feel like we are getting enough information that we can bring this thing to closure, and I expect that that would happen by the end of this year.

Carrie Saint Louis -- Fidelity Investments

So, is the – because I mean we have a comp out there. Entegris has been kind of winding down its business with some success. They've hired an advisor. Can you comment on, there is an active advisor being used for your business?

Joe Rigby

Carrie, we don’t comment on that.

Carrie Saint Louis -- Fidelity Investments

Well, I guess the thought was that it would be either a sale or an expedited monetization that the monetization would be something over like 18 months. Is that still fair?

Joe Rigby

Yes, if we went down that path, but what hopefully I'm able to communicate to you is that the time is drawing short on when we’re going to give you a final answer.

Carrie Saint Louis -- Fidelity Investments

So the answer isn’t going to be just status quo. Is that a fair answer? So it's going to be some change from where we currently are.

Joe Rigby

It will be a definitive answer around the direction. And it won't be –

Carrie Saint Louis -- Fidelity Investments

Is one of those outcomes, status quo?

Joe Rigby

Pardon me?

Carrie Saint Louis -- Fidelity Investments

Is one of those outcomes, status quo?

Joe Rigby

No.

Carrie Saint Louis -- Fidelity Investments

Okay. That’s what I –

Joe Rigby

We will provide clarity.

Carrie Saint Louis -- Fidelity Investments

And one of the outcomes is not just saying as you are?

Joe Rigby

That's correct.

Carrie Saint Louis -- Fidelity Investments

Okay. Thank you.

Operator

Your next question comes from the line of Paul Ridzon with Keybanc Capital. Please proceed.

Paul Ridzon -- Keybanc Capital Markets

I just had a quick question on the delivery business, margins improved on lower sales. What drove that? Is that a function of just lower supply costs?

Tony Kamerick

Yes, I think what you are referring to, Paul, is --

Paul Ridzon -- Keybanc Capital Markets

It’s at $0.03.

Tony Kamerick

Excuse me?

Paul Ridzon -- Keybanc Capital Markets

It’s at $0.03 positive in the release.

Tony Kamerick

Yes, it’s most to a change in the customer mix.

Paul Ridzon -- Keybanc Capital Markets

But all customer classes were volumetrically down?

Tony Kamerick

But some rate classes have higher rates than others. And so, when the sales shift between customer classes there can be a rate effect or value effect, I should say.

Paul Ridzon -- Keybanc Capital Markets

So you did more higher margin business, okay. I guess I understand. Thank you.

Tony Kamerick

Thank you.

Operator

Your next question comes from the line of Reza Hatefi with Decade Capital. Please proceed.

Reza Hatefi -- Decade Capital

Thank you very. I was wondering in your updated Conectiv guidance what are you embedding in terms of economic recovery or load/demand growth or of that nature?

Gary Morsches

Yes, this is Gary Morsches. Looking forward, we are using the most recent forward markets, forward volatilities to device where our revenues and expected generation runs will be.

Reza Hatefi -- Decade Capital

So, I guess, if – I guess we have the forward power prices and commodity prices, but if for some reason there is not much load growth, how does that affects your guidance or the equation?

Gary Morsches

Well, given the forward markets, forwards spark spreads, forward dark spreads reflect that. And quite honestly, they are fairly narrow from a historic standpoint. So that's fully discounted in the forward markets that we're using in devising our forward expectations.

Reza Hatefi -- Decade Capital

Okay. And PES, if I remember correctly at the Analyst Day, the run rate after the divestiture was going to be about $0.08 to $0.10 going forward. Is that still a fair run rate?

Tony Kamerick

I think that what you are referring to is the contribution of the ESCO portion of –

Reza Hatefi -- Decade Capital

Correct.

Tony Kamerick

Well, again we haven't really provided any guidance to date on that. But as we've said, we intend to grow that part of the business.

Reza Hatefi -- Decade Capital

And I guess year-to-date at Conectiv, you've had margins of I think $169 million and relative to your 2009 guidance of $270 million, I guess that sort of implies you need $100 million in the fourth quarter. And I guess last year, I think you had around $54 million in the fourth quarter at Conectiv. What are the drivers driving Conectiv I guess higher in fourth quarter of ’09 versus fourth quarter of ’08?

Gary Morsches

The drivers basically are three. First being that we are receiving much higher capacity revenues this year than last. Secondly, we are in a stronger hedge position. And finally we been in the array of favorable marketing opportunities out there that are within our course of business that we are conducting this quarter.

Reza Hatefi -- Decade Capital

Okay, thank you. And just lastly, your previous Conectiv guidance for 2010, I think you said lower half, is the new guidance – should we assume like – is there a lower half or is it like midpoint or how should we think about that?

Gary Morsches

Midpoint is a good assumption there.

Reza Hatefi -- Decade Capital

Okay, thank you very much.

Operator

Your next question comes from the line of James Dobson with Wunderlich Securities. Please proceed.

James Dobson -- Wunderlich Securities

Hi, thanks, and good morning. Gary, if I could just follow on that, could you give us an idea just how much of the ‘10 is hedged? I know it might be a little early for that, but how much of that ’10 guidance would be hedged?

Gary Morsches

We are actually 64% hedged in 2010. And that really comes from capacity and mostly marketing revenues that we’ve locked in.

James Dobson -- Wunderlich Securities

Perfect, thanks. Joe, you mentioned the potential for CapEx cuts, and I know it's fairly early, you are probably still in the budgeting process. But where would you say if they were going to be CapEx cuts, just from a color perspective, where those might be?

Joe Rigby

Probably come from the distribution component. And this is very preliminary, but I think about maybe $50 million to $75 million, which is again, preliminary but would not trigger any problems from reliability or service. But there is just more to come on that.

James Dobson -- Wunderlich Securities

Perfect. I absolutely understand. And that’s very helpful. Joe, could you also give a little -- I know it's very early days, just some info on DoE, and that stimulus and sort of when we could see that flow and sort of how much we would think of offsetting, I think there is $71 million in blueprint spending in your budget, how much we have to think that offsets in ‘10?

Joe Rigby

I’ll make a couple comments. I’ll ask Dave maybe to get into more than numbers. The next phase is to get into a negotiation with the DoE, which I think is set for November 16. I think it’s in the middle of this coming month. So, my understanding is that we will expend dollars and we will provide proof of spend and – part of the issue is that there is quite a bit of reporting as you would expect that comes along with that. But I would think that there would be fairly quick reimbursement, if you will. I think as we thought about the impact in 2010, we could see a level of acceleration off of the CapEx, which is probably in the $20 million ballpark. So I don’t look at in 2010 anyway the receipt of stimulus is putting a lot of pressure on our CapEx. Dave, I don’t know if you want to offer any further commentary.

Dave Velazquez

Think about the different things we are doing, the Delmarva deployment is going to continue as it is, but it is more around the Pepco Maryland [ph] and Pepco DC that the activities it would be, spread out. But as Joe has said, we take a preliminary look at that and we net out what we would -- the matching grant we would receive from stimulus, the overall impact might be on $20 million. So certainly, very manageable.

James Dobson -- Wunderlich Securities

And Tony, could you just clarify on that new money issue of $250 million, just remind me the CapEx that you are using for ’10?

Tony Kamerick

It’s a little over $1 billion. I think it’s $1.13 billion.

James Dobson -- Wunderlich Securities

And then last question, Joe. I didn’t hear you admittedly. You declared the dividend last week. So perhaps that’s an upset. But I was wondering if you just would reiterate or give us your current thoughts on the common dividend, where it is currently?

Joe Rigby

We are committed to the dividend. Was the clear enough? That’s it.

James Dobson -- Wunderlich Securities

That is clear. Thank you, sir.

Operator

Your next question comes from the line of Neil Kalton with Wells Fargo Securities. Please proceed.

Neil Kalton -- Wells Fargo Securities

Good morning, everyone.

Joe Rigby

Good morning, Neil.

Neil Kalton -- Wells Fargo Securities

Most of my questions have been asked. But I do have one clarifying question, just on the retail marketing business. If you still think of it if you were able to sell that would free up about $100 million in working capital?

Joe Rigby

That's correct, Neil.

Neil Kalton -- Wells Fargo Securities

Okay. And then if you did sort of an expedite or wind down, how should we think about that in terms of the cash flow outlook for 2010?

Joe Rigby

I’ll ask Kevin Mcgowan to comment on that.

Kevin Mcgowan

In terms of the working capital, there would still be some working capital in the business at the end of 2010. But I think what’s important is the cash collateral and the LC that support the business. A significant part of that would wind down by the end of 2010.

Neil Kalton -- Wells Fargo Securities

Okay. Thanks.

Operator

(Operator instructions) Your next question comes from the line of Maurice May with Power Insights. Please proceed.

Maurice May -- Power Insights

Yes. Good morning, folks.

Joe Rigby

Good morning, Maury.

Maurice May -- Power Insights

I’ve got two questions this morning. First of all, can you give us more color on that recent decision in regard to the cross border leases? I guess the lease in, lease out decision is -- those are leases similar to yours, is that correct?

Kevin Mcgowan

Maury, this is Kevin Mcgowan. The (inaudible) lease in, lease out transaction. We did not do that structure. Ours was the sale in lease out silo structures, which we believe are more conservative than the ones at ConEd [ph].

Maurice May -- Power Insights

Okay. And you considered as more conservative than those?

Kevin Mcgowan

Yes. Absolutely. I think most would agree with that.

Maurice May -- Power Insights

Okay. And second, the US Court of Federal Claims, can you tell me where its stature is? If this were to be appealed it would go to what higher court?

Joe Rigby

It would go to the US Court of Appeals for the Federal Circuit (inaudible).

Maurice May -- Power Insights

Okay, US Court of Appeals in DC?

Joe Rigby

For the Federal Circuit, and it is located physically in the District of Columbia, but it's a national court.

Maurice May -- Power Insights

Okay. And from there to the Supreme Court.

Joe Rigby

Yes, that’s correct.

Maurice May -- Power Insights

Okay. And what kind of -- the implication here is obviously positive, but from a timing standpoint your own challenge to the IRS ruling is, I believe in tax court. And it can go on into what 2010 or 2011? Or will this decision have any impact there?

Joe Rigby

Actually, our case is still at appeals with the IRS. The next step is – will then be issuing 90 days efficiency letter at which time we have the option to petition tax court. We have 90 days to that or pay the tax and sue for refund district court or the Federal Court Claims. We expect that to probably happen in the second quarter of next year.

Maurice May -- Power Insights

Okay. So if you lose it at the IRS level you do petition in to the tax court and that can go on for years.

Joe Rigby

We have an option to do that or we can pay the tax and sue for refund in the Federal Court Claims or district court. And once we do that it could take good 18 to 24 months for that to be resolved.

Maurice May -- Power Insights

Okay. You have been kind of strong in your opposition to this in the past. And it kind of surprises me that did suggest paying the tax and then suing for refund. Is that change in your thinking?

Joe Rigby

Yes, I think, historically we’ve always mentioned we have those three paths. If we pay the tax it’s $72 million on the returns that are currently being audited in appeals. But each of those courts have – the tax court is under the jurisdiction of the IRS. If you go to district court, you and the rest of the IRS would request a jury trial. If you go to Federal Court Claims, it is a judge trial. So each of those have their own merits, and I think given where is there ConEd came out, I think the Federal Court Claims is probably our most likely path at this point.

Maurice May -- Power Insights

Okay.

Joe Rigby

That decision will have to be made until we actually receive the notice from the IRS.

Maurice May -- Power Insights

Okay. All right. My second question has to do with 2010, the $250 million in new funding that you are talking about. Is it possible that upwards of 50% of this maybe equity? And if so can this be done with various dividend reinvestment programs and debt programs, rather than full blown offering?

Tony Kamerick

Maury, this is Tony Kamerick. We haven’t really pinned down a number yet. I just put it out there as it is a possibility of a small kind of equity issuance. And it would not be probably a full blown road show and that kind of a thing if we did it. But again, we haven’t decided if that’s the route we are taking.

Maurice May -- Power Insights

Okay. Good. Thank you very much.

Joe Rigby

Thank you.

Operator

We’re showing no more audio questions in queue. I would like to turn the call over to Joe Rigby.

Joe Rigby

Thanks Eric. I just wanted to again thank you all for joining us and for your interest in PHI, and we are looking forward to see many of you just over the next couple of days. Have a good day.

Operator

Thank you for your participation in today’s conference. This concludes our presentation. You may now disconnect. Have a good day.

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Source: Pepco Holdings, Inc. Q3 2009 Earnings Call Transcript
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