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Executives

Donna Kinzel - Director of IR

Joe Rigby - Chairman, President and CEO

Tony Kamerick - SVP and CFO

Dave Velazquez - EVP

John Huffman - President and CEO, Pepco Energy Services

Analysts

Paul Patterson - Glenrock Associates

Maurice May - Power Insights

Ali Agha - SunTrust Robinson

Carrie Saint Louis - Fidelity

Pepco Holdings Inc. (POM) Q2 2010 Earnings Call August 6, 2010 11:00 PM ET

Operator

Good day, ladies and gentlemen and welcome to the second quarter 2010 Pepco Holdings, Incorporated earnings conference call. My name is Francine, and I am your operator for today. At this time, all participants are in a listen-only mode. Later we will conduct a question-and-answer session. (Operator Instructions) I would now like to turn the presentation over to your host for today's call Ms. Donna Kinzel, Director of Investor Relations. Ma'am, please proceed.

Donna Kinzel

Thank you, Francine and good morning, ladies and gentlemen. Welcome to the Pepco Holdings second quarter 2010 earnings conference call. The 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 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.

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 today. The earnings release can be found at www.pepcoholdings.com/investors. Joe?

Joe Rigby

Thanks, Donna, and good morning, ladies and gentlemen. I want to thank you for joining us today. Earnings from continuing operations for the quarter were $76 million compared to $39 million in 2009 quarter. Our operating results were driven by strong power delivery earnings that reflect the positive impact of our infrastructure investments and our progress towards reducing regulatory lag.

Our results for both the quarter and year-to-date periods reflect Conectiv Energy's results as a discontinued operations. Tony will discuss the financial results for both continuing operations and discontinued operations as well as our operating segment performance. But first I would like to address some topics of interest.

I'll begin with the status of Pepco's distribution base rate case in Maryland. Last week we requested that the Maryland commission delay the issuance of the rate order. Prior to our request, our service territories experienced a major storm with high winds and lightening, that cost significant damage to the electric system. Approximately 350,000 customers were without power at the height of the storm with the vast majority of the outages occurring in Pepco's service territory. Given these circumstances, we determine that requesting a short delay in the issuance of the order as we complete the restoration work was prudent.

Turning to our cases in Delaware and Delmarva Power's electric distribution base rate case, the hearing examiner's report is schedule to be issued on August 30, with a commission decision expected on or about September 21st. The filing seats approval of an annual rate increase of approximately $24 million based on a 10.75% return on equity. As permitted by Delaware law, Delmarva Power put $2.5 million of its requested rate increase into effect in November 2009 and the remainder of the requested amount into effect on April 19 of this year.

The increase was put into effect on a temporary basis pending final commission approval and is subject to refund. On July 2, Delmarva Power filed a natural gas delivery base rate case in Delaware for filing six approval of an annual rate increase of $12 million based on a requested return on equity of 11% assuming the approval of the implementation of revenue de-coupling, a decision by the Delaware public service commission is expected in early 2011. Delmarva Power plans to implement an interim rate increase of $2.5 million effective August 31st subject to refund.

We continue to make good progress on our blue print for the future initiatives. Over 155,000 advanced meters have been installed in Delaware for our electric and gas customers and several thousand of the meters have been activated to provide real life testing on the various elements of functionality. Discussing has gone very well and has included functions such as meter reading, billing, turn-on, turn-off capability and customer internet access to hourly usage data. We expect to complete all of the meter exchanges in Delaware including commercial customers by the end of the first quarter of 2011. We also remain on track to begin the deployment of advanced meters in the District of Columbia in the fourth quarter of this year with the goal of having the installations completed by the end of 2011.

The installation of the communication device is necessary to support the deployment of the advanced meters in the district is underway. As approved by the commissions in Delaware and the District of Columbia, regulatory assets have been created to show recovery up and a return on AMI related costs between rate cases. In Maryland we are waiting the decision from the public service commission when the AMI plans followed by Pepco and Delmarva Power.

As you are likely aware, in June the commission decline Baltimore Gas and Electric's AMI proposal and BG&E has since filed a revised proposal with the commission. We note however, that there are significant differences between our proposal and BG&E's initial proposal.

Specifically, Pepco and Delmarva Power proposed cost recovery to a regulatory asset and base rates rather than a surcharge and voluntary rather than mandatory time of use rates for residential customers.

As we have previously reported, PJM is in the process of reassessing reliability requirements under its annual regional transmission expansion plan which evaluates the region's overall transmission needs. On July 14 (inaudible) announced its determination that additional transmission capacity is needed in the Eastern mid-Atlantic region for reliability and that map is the most robust transmission alternative.

The PJM process is expected to be completed this summer with additional updates and recommendations regarding the transmission alternatives presented at PJMs transmission expansion advisory community at its next meeting which is scheduled for August 11. The outcome of the review process will determine the impact of the current 2014 in-service date for the MAPP project.

We continue to expect the project to move forward, but with the likely one or two year delay in the inservice date. During the review process, we have continued our work to define the lines 150 mile route and to complete the required environmental studies. On July 1 2010 we completed the sale of Conectiv Energy's power generation business to Calpine Corporation. In accordance with the terms of the purchase agreement, several adjustments where made to the $1.65 billion sales price including the $49 million increase for the value of the fuel inventory at the time of closing and a $60 million reduction due to the lower than anticipating capital expenditures incurred on the Delta project. After giving effect to these adjustments $1.63 billion of proceeds were received at closing. The proceeds were used to reduce Pepco Holdings debt as Tony will discuss in more detail.

We are in the process of liquidating Conectiv Energy's remaining assets and contracts are in track to complete the liquidation by year-end. Coincident with the sale of Conectiv Energy, we began a comprehensive organizational review, to identify opportunities to streamline the organization and achieved reductions in corporate overhead costs that were previously allocated to Conectiv Energy. The organizational review is still underway and we are in the final stages of developing a detailed plan identifying headcount reductions and other cost reduction opportunities, that will result in the elimination of at least $20 million and annual corporate overhead costs.

Realization of the cost reductions is expected for the full year of 2011 and is reflected in our 2011 earning's outlook. We also expect to incur employee severance and other restructuring costs associated with the reduction of the corporate overhead. However estimates of these costs will not be available until the detailed plan has been finalized, our earning's guidance range for 2010 excludes the impact of these restructuring costs.

Our Pepco Energy Services, the profitable line down of the retail energy supply business continues to be on track and we are making good progress on our efforts to ramp up the Energy Services business. As an example, Pepco Energy Services recently signed a fourth comprehensive energy savings performance contract with the Prince George's County, Maryland Public Schools. Under the contract, Pepco Energy Services will provide 103 County School system facilities with approximately $35 million in new energy infrastructure, including eating and cooling equipment, lightning and building improvements as well as water conservation, energy controls and renewable energy systems. Construction will began shortly and is expected to be completed by the end of 2011. And now at this point, let me turn it over to Tony Kamerick, Tony?

Tony Kamerick

Good morning and thank you for joining us today. I will recap our earnings, address our performance by operating segment and review our recent financing activity. We'll then open the call to your questions. Our results for both the quarter and year-to-date periods show Conectiv Energy's results as discontinued operations. Year-to-date Pepco Holdings has incurred an after tax loss of $122 million from discontinued operations. Included in this loss is a $67 million after-tax write-down of the wholesale generation assets that were sold to Calpine.

The year-to-date loss also includes $50 million of after tax unrealized losses on derivative instruments associated with Conectiv Energy's load service business that were previously recorded in accumulated other comprehensive income. These unrealized losses have been reclassified into income as a result of the intention to liquidate the load service supply contracts and related hedges. We expect these losses will be partially offset over the remainder of the year by gaining some of the liquidation of the load supply contracts and other remaining assets. Upon completion of this liquidation, we currently expect the overall after tax loss on the Conectiv Energy disposition to be in the range of $75 million to $100 million.

Earnings from continuing operations for the second quarter were $0.37 per share compared to $0.18 per share for the second quarter of last year. For the year-to-date period earnings from continuing operations were $0.47 per share compared to $0.37 per share for the 2009 period. Excluding the special item related to the Mirant bankruptcy settlement, earnings from continuing operations for the 2009 year-to-date period would have been $0.33 per share.

Power Delivery earnings were $0.29 per share in the second quarter compared to $0.14 per share for the 2009 period. There were several factors that led to the increase in earnings period-over-period. Higher transmission revenue drove $0.04 per share of the earnings increase. Of the $0.04 per share, $0.03 were due to a true-up of transmission revenues for the 2009, 2010 rate year.

Higher distribution rates during the quarter increased earnings by $0.02 per share. The higher rates reflect the impact of rate decisions for Pepco in the District of Columbia, Delmarva Power in Maryland and for Atlantic City Electric. The higher rates also reflect the interim rates put in place for Delmarva Power in Delaware as Joe discussed earlier. Higher weather related sales verses prior year increased quarterly earnings by $0.03 per share. Cooling degree days were up by 77%. Keep in mind that our distribution revenue in Maryland and the district of Colombia which represent approximately 66% of total distribution revenue is decoupled from consumption and therefore is not impacted by weather.

Another factor that increased earnings quarter-over-quarter was the impact of unbilled revenue related to Atlantic City Electric's basic generation service. Under New Jersey regulation, ACE is entitled to recover from its customers all costs of providing default device. Any differences between the total revenue and the total cost of providing the service are deferred for future recovery from customers or return to customers. However, unbilled revenue is now included in the deferred calculation and therefore can impact earnings.

Typically, the earnings impact is negligible. However, given the much longer weather in June of this year as compared to June of 2009, we realized a positive impact of $0.04 per share. Over the last few years on an annual basis, we have experienced minimal earnings impact from unbilled revenue. Other positive factors for the quarter were higher at distribution revenue resulting from the growth in the number of customers, as well as lower operation and maintenance expense, primarily due to lower pension expense.

Year-to-date Power Delivery earnings were $0.38 per share in 2010 compared to $0.33 per share for the six months ended June 2009. Excluding the special item related to the Mirant bankruptcy settlement, 2009 earnings would have been $0.29 per share. Most of the quarterly drivers applied to the year to date period as well. The higher earnings were due to transmission revenue.

The higher earnings were due to higher transmission revenue, higher distribution revenue due to higher rates and growth in the number of customers, as well as the unbilled revenue related to Atlantic City Electric's basic generation service. Higher weather related sales versus the prior year increased earnings by $0.01 per share. Partially offsetting factors in the year to date period where higher depreciation expense as a result of utility plant investment and higher operation in maintenance expense driven by the winter storms partially offset by lower pension expense in cost reduction efforts.

Looking ahead to the third quarter, we currently estimate the cost of system restoration incurred after the recent severe storm that Joe referred to, will range between $10 million and $13 million with one half to two-thirds being expensed and balance being charged capital. The actual cost of system restoration may vary from this estimate because a large portion of the cost relates to services provided by outside contractors and other utilities that have not yet submitted bills.

Pepco Energy Services second quarter earnings were $0.05 per share and were unchanged from earnings in 2009 quarter. Higher generation output driven by warmer weather offset lower retail energy supply gross margins to the expiration of supply contracts in connection wind down of the retail energy supply business. Year-to-date, Pepco Energy Services earnings were $0.11 per share compared to $0.08 per share for 2009 period.

The increase in earnings is due to higher generation output and lower capacity charges, partially offset by lower retail energy supply gross margin. In our corporate and other segments, which is primarily un-allocated cooperate overhead costs. Earnings improved by $0.02 per share quarter-over-quarter. We incurred higher capital cost due to the $450 million bridge loan facility. Pepco holdings entered into in April which I will discuss further in a few minutes. The higher capital costs were more than offset by a $0.04 per share favorable state income tax effect resulting from the restructuring of certain PHI entities.

Year-to-date earnings improved by $0.03 per share, the quarterly drivers apply to the year-to-date period as well. We are reaffirming our 2010 guidance range of $0.80 per share to $0.95 per share for ongoing operations. Given the year-to-date results and our expectations for the remainder of the year, we believe it is likely that earnings per share will be above the midpoint of that range.

We are also reaffirming our 2011 outlook range of $1.10 per share to $1.30 per share. I will now turn to our recent financing activity. The sale of Conectiv Energy's power generation business to Calpine was completed on July 1st approximately $1.63 billion of proceeds were received at closing and were used to retire Pepco Holdings' debt. The details of the debt reduction can be found in our earnings release.

In summary, on July 1st we paid off the $450 million bridge loan facility put in place in April to repay $200 million of notes due in May and $250 million of notes due in June. In July, we retired $750 million of notes due 2012, a $129 million of notes due in 2017 and $65 million of notes due in 2032. In total an aggregate principal amount of $1.4 billion of PHI long-term debt was retired at a cost including premiums of $1.5 billion.

The balance of the proceeds received was used to pay down short-term debt. As a result of the debt repurchases, two charges to earnings will be recorded in the third quarter of 2010. The first is an after tax loss of $70 million for debt extinguishment costs. The second is an after tax loss of $9 million related to losses on rate blocks that will now be reclassified to income. We expect to treat these charges as special items. Looking ahead, we plan to file our shelf registration statement with the SEC to replace an existing shelf that expires later this month.

As we have done in the past, we will register debt in equity securities for Pepco Holdings and debt securities for the utility subsidiaries. As we have previously communicated, with the exception of equity issued to our dividend reinvestment plan, we do not expect a need for additional equity until at least 2012. Now let me turn it back to Joe Rigby for some closing remarks.

Joe Rigby

Thanks Tony. In closing, I am certainly pleased with our results for the quarter. And we believe we have made very good progress on our strategic initiatives that position us for longer term earnings growth. We remain ahead of curve on implementing the smart grid and we continue to demonstrate the strong competency in a regulatory arena. Sale of Conectiv Energy was completed consistent with our timeline and has repositioned PHI as fundamentally regulated utility company has lowered our capital requirements, strengthened our credit profile and supports our commitment to the current dividend. So all-in-all it was a good quarter.

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

Question-and-Answer session

Operator

(Operator Instructions) Our first question comes from the line of Paul Patterson from Glenrock Associates.

Paul Patterson - Glenrock Associates

I want to ask you about guidance I guess. It looks you guys had a pretty good first half of the year and I know you're decoupled to a certain degree and what have you but and I know you got some storm calls. A, I am wondering are the storm calls that you are expensing, will be perhaps that you are expensing. Is that in the 80% to 95% guidance or is that sort of a special item? And just in general, how should we think about this as such a positive first half what might be keeping you from raising guidance I guess for this year?

Tony Kamerick

Okay. This is Tony. Let me start with your first question. The storm costs are not considered special items so they are included in our guidance estimates. The reason we're not raising the guidance at this time is that as most of you probably know, the third quarter is usually a pretty pivotal quarter for us and there are still a number of uncertainties out there, you mentioned the storm's, Paul. It's been a very active storm season so far. We also have the mineral under water is due probably later today, we have the Delaware order due in September, so there are just some uncertainties out there that we will prefer to win till the end of the third quarter before we re-address the guidance range

Joe Rigby

Hey Paul, this is Joe. Just may be pile on the storm issue, we had the severe storm on the 25th and then we had another one just come through last night, that took out about 70,000 customers. So, I think we're trying to be prudent around where we stand at this point of the year, starting up in the storm season and obviously we just feel that we need to get through the third quarter before we would do anything more relative to guidance than what Tony already discussed.

Tony Kamerick

And as I said in the script part of the call earlier that we are acknowledging, and we will certainly be above the midpoint.

Paul Patterson - Glenrock Associates

And then the map line, PJM has been also looking at this (inaudible) Northern option. How do you see that as a potential competitive alternative that PJM is looking at and how that might or might not impact the map?

Dave Velazquez

Paul, this is Dave. The northern, I guess what's called the Northern alternative we think that map is superior in a number of respects both around it's constructability, the timing of being able to build it but also in the sense that the efficacy of the northern alternative is somewhat dependent on the path line being completed, where map is a more robust solution in the sense that it's not dependent on any other line as far as its ability to solve the problems.

Paul Patterson - Glenrock Associates

Okay. And has PJM made its final determination on this?

Joe Rigby

No. I expect that map will discussed next week at the TIAC meeting and we expect later in August that we will get some further direction from PJM. We continue to think map is the best solution and we also continue to think that the current 24 team in service data can push back a year or two, but we are pretty confident that that project will move ahead.

Operator

Our next question comes from the line of Maurice May from Power Insights.

Maurice May - Power Insights

The previous speaker asked about the 2010 guidance, I would like to move on to 2011, I would look I think you call it, and at the conference in May, you gave it as $1.10 and $1.30 and you just reaffirmed it Tony, but I would like you to give us some color on that outlook where do you think the increase in earnings is coming and whether you are still comfortable with that on the mid-point or the upper end and lower end.

Tony Kamerick

We're basically not commenting on where within the guidance range, but you know $1.10 to $1.30 I think you can come to your own conclusions on that. A lot of the increase Maurice is the 2010 lease for the first half of the year has a lot of holding company interest in the ongoing earnings that are going to go away next year because we retired all that debt. We also have the two rate orders that I mentioned that are coming one today and one in September we think. And so, those are the main driving factors. Joe mentioned that the reorganization efforts that are underway to move some of the overhead costs out of the company. So those three items are probably the biggest three drivers.

Operator

Our next question comes from the line of (inaudible).

Unidentified Analyst

First question, could you give us for comparative purposes what the third and fourth quarter containing the ops earnings were for last year? So, if you were to do comparisons going forward when you report, we have a good number as to what to compare with, is that some information available on that?

Tony Kamerick

We do not have that information disclosed at this point.

Unidentified Analyst

And then secondly, the way if I read it right, for six months the continuing op earnings are $0.47, right? And as you mentioned we should try to take nearly like, what $1.4 billion debt and subtract the interest cost out of it. To do a pro forma number for real apples-to-apples for the first six months. Would that be something correct?

Tony Kamerick

I don't see anything wrong that, just sitting here. No, I think you could probably do that.

Unidentified Analyst

So that would give us the real earnings power for the six months, right?

Tony Kamerick

I would give you the first six months without that interest expense was what I would give you.

Operator

Our next question comes from the line of Ali Agha from SunTrust Robinson.

Ali Agha - SunTrust Robinson

Joe, could you elaborate a little more on or Tony, perhaps it's more for you that the tax savings that you talked about. That the $0.04 in corporate and other, is that ongoing and what does that mean as far as an effective tax rate, we should be thinking about for '10 and '11.

Joe Rigby

Ali, I will ask Tony to answer that.

Ali Agha - SunTrust Robinson

I thought so you would.

Tony Kamerick

Ali, the portion of the tax that is due to the restructuring is a one-timer. It is not a repetitive item.

Ali Agha - SunTrust Robinson

So what is an effective tax rate we should be thinking about in terms of modeling you guys?

Tony Kamerick

Well, we give you the pretty standard answer that incrementally it is about 40% when you include the federal and the state taxes, but I think you sort of have to look at the effective tax rate table that we provide in the quarter. And you look at each of the items there, some of them are ongoing and some of them are not, so you sort of have to make a judgment on those.

Ali Agha - SunTrust Robinson

Okay and the debt that's been paid off also Tony what's the average interest cost associated with that would be the minus.

Tony Kamerick

I actually do not know what the average is Ali but the biggest item was the $750 which was 6.45% rate. Then there was a 129 that I think $745 and then there was a $65 million piece at 6.8%, I believe.

Ali Agha - SunTrust Robinson

Okay, that's very helpful. And Joe for you, you've out for us an outlook of CapEx and comments, we have great based growth for the next five years or so. As you are looking at your planning going forward and tightening that up, are you still comfortable with that opportunity of spending out there? Are you hitting anything from your regulatory regimes that would cause you some concern of any push back or any such issues that may cause you to change that kind of CapEx program?

Joe Rigby

No, Ali it's kind of responding to several points that you made. We're not getting any push back. I think obviously the single biggest variable if you will, be the timing around the mid Atlantic power pathway and I think what we've talked about previously that we have opportunities to "fill in" with very, very good projects whether they be at the distribution or the transmission level. So sitting here today when I think about the next five years, we don't have a different push back with regard to the opportunities to increase rate base.

Tony Kamerick

I need to correct some of what I told you earlier. The $750 million was at 6.45% but I got the other reversed the rates on those. So there was $129 million at 6.8% and $65 million at 7.45% and then as you know, we also reduced some short-term debt and that rate was just under 1%.

Operator

(Operator Instructions). Our next question comes from the line of Carrie Saint Louis from Fidelity.

Carrie Saint Louis - Fidelity

Just wanted to follow-up on the few points. So you mentioned I think the cost to unwind remaining Conectiv Energy cost. I think your estimate was $75 million to $100 million?

Tony Kamerick

Well that's not the remaining Carry. That's the one, when all the dust is settled and when everything is done that's the range.

Carrie Saint Louis - Fidelity

Okay and you said $60 million may have been absorbed today in last quarter. I am just trying to understand how much risk, I mean is that a very comprehensive number that $75 million, $100 million meaning like it takes into account kind of like stress scenarios, potential or you feel good about that numbers being…

Tony Kamerick

We feel very comfortable about it, Carrie, as to the total range for everything. Joe?

Joe Rigby

You'll probably recall that when we announced the transaction and we were talking about the completion of the transaction. We provided a range of 60-90 and one the things we wanted to do as we were into this call given all the progress we've made, we've made a lot of good progress in the liquidation process. We'll still hopefully tighten the range and as we looked at that, and as you mentioned we ran different scenarios which caused us to say okay, lets pull up the bottom base than what we know and in thinking about different potential outcomes, we did land on the 75 to100 but as Tony mentioned, we feel very, very comfortable with it, that's a good representation of the end game

Carrie Saint Louis - Fidelity

And then after (inaudible) by year-end so basically kind of 2011 for work Conectiv Energy is essentially just non-existent?

Joe Rigby

That's the plan

Carrie Saint Louis - Fidelity

That's the plan, I've been out but you've been unwinding energy services or at least the portion of the business that you wanted to get out of there and then that was going to be like an 18 month work down that should be completed by one.

John Huffman

Hey Carry this is John Huffman. Yes we actually have contracts that go up through 2014.

Carrie Saint Louis - Fidelity

Okay.

John Huffman

So the wind down is on track. Our current backlog at the end of the quarter was about 14 million megawatt hours. About 70% of that is going to go away by the end of 2011. So there is a smaller tail that carries out to 2014.

Carrie Saint Louis - Fidelity

Okay great, that's really helpful. And then on your debt repayment, you guys still have strategy where you kind have left a (inaudible) pieces of debt outstanding like 200 million or less in kind of a reform maturities. I didn't know, is this kind of the end game that you want because it's a little challenging for fixed income investors to be in debt issues that small and some of those debt issues have high coupons. So, have you thought about further I won't necessarily say buying but like exchanges or anything else that kind of may be create a little more simplistic you know, whole coat the latter.

Tony Kamerick

Carry that's something that we will have on our plate to look at that. Yes.

Carrie Saint Louis - Fidelity

Is it your intention to keep funding at that sub or do you think most of your funding will now be done down at the (inaudible)?

Tony Kamerick

Most of the construction of course is at that (inaudible). So and looking forward, that's probably where you will see the debt being issued out of.

Carrie Saint Louis - Fidelity

Okay, but may be you have some remnant of kind of (inaudible) that. And I know there is no maturities in your term but there is if you would at least keep some outstanding?

Tony Kamerick

That's an issue that we will continue to look at Carry. Its how much (inaudible) debt is outstanding is there a way of lowering that amount of debt and lowering the interest element of that. So, its something that we will be continuing to look at.

Operator

And we have no further questions in the queue. I would like to turn the call over to Mr. Joe Rigby.

Joe Rigby

Thank you operator. And I want to thank you all again for joining us today and for your continued interest in PHI and with that have a great day.

Operator

Ladies and gentlemen we 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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