Dominion Resources Q3 2007 Earnings Call Transcript

Dominion Resources, Inc. (D)

Q3 2007 Earnings Call

November 01, 2007 11:00 am ET

Executives

Laura Kottkamp - Director of Investor Relations

Tom Farrell - Chief Executive Officer

Tom Chewning - Chief Financial Officer

Mark McGettrick - Executive Vice President; President and Chief Operating Officer

Scott Hetzer - Senior Vice President and Treasurer

Analysts

Dan Eggers - Credit Suisse

Daniele Seitz - Dahlman Rose

Paul Patterson - Glenrock Associates

Paul Fremont - Jefferies

Paul Ridzon - KeyBanc

Jonathan Arnold - Merrill Lynch

Carrie Saint Louis - Fidelity

Hugh Wynne - Sanford Bernstein

Rudy Tolintino - Morgan Stanley

Steve Fleishman - Catapult Partners

Presentation

Operator

Good morning, ladies and gentlemen and welcome to Dominion's Third Quarter Earnings Conference Call. We now from Tom Farrell, Dominion's Chief Executive Officer and Mr. Tom Chewning, Dominion's Chief Financial Officer in conference.

Please be aware that each of your lines in a listen-only mode. After conclusion of Mr. Chewning's prepared remarks we will open the floor for questions. At that time instructions will be given as the procedure to follow should you want to ask a question.

I would like to turn the call over to Laura Kottkamp, Director of Investor Relations. Laura, please go ahead.

Laura Kottkamp

Thanks, Lindsay. Good morning and welcome to Dominion's third-quarter earnings conference call. During this call we will refer to certain schedules included in this morning's earnings release or to pages from our third quarter 2007 earnings release kit.

These schedules are intended to answer the more detailed discreet questions pertaining to operating statistics and accounting. Investor Relations will be available after the call for any clarification of these schedules.

While we encourage to you call with questions in the time permitted after our prepared remarks, we ask that you use the time address questions of a strategic nature. If you have not done so, I encourage you to visit our web site, register for E-Mail alerts and view our third-quarter 2007 earnings documents.

Our web site address is www.dom.com/investors. Now for the usual cautionary language. The earnings release and other matters that will be discussed on the call today may contain forward-looking statements and estimates that are subject to various risks and uncertainties.

Please refer to our SEC filing, including our most recent Annual Report on Form 10-K and quarterly report on Form 10-Q for discussion of factors that may cause results to differ from management's projections, forecast, estimates and expectations.

Also on this call, we will discuss some measures about our company's performance that differ from those recognized by GAAP. You can find the reconciliation of these non-GAAP measures to GAAP on our Investor Relations web site under GAAP reconciliation.

I will now turn the call over to our CEO, Tom Farrell. Tom.

Tom Farrell

Thank you, Laura and good morning. This morning I am going to discuss our newly aligned business units, provide an update on our growth projects and regulatory status, highlight operational achievements and transactions for the quarter, and comment on the Board's decision to increase our dividend and approve a two-for-one stock split.

Tom Chewning will then review our third-quarter earnings results, explain significant items included in GAAP earnings but excluded from operating earnings, touch briefly on our progress to repurchase common shares with net divestiture proceeds, and discuss financing plans for our growth projects, particularly in Virginia.

This quarter, we closed on the last of the E&P property sales with the sale of the Mid-Continent reserves to Lynne energy for $2 billion bringing total gross from the sale of our non-Appalachian E&P assets to nearly $14 billion.

The separate aspect of the strategic realignment was our reorganization effective October 1st into three operating units. Dominion Virginia Power, which includes the regulated electric distribution and electric operations in Virginia and North Carolina, as well as the nonregulated retail energy marketing and customer service operations.

Dominion Generation, which includes the regulated and unregulated power generation business, and Dominion Energy, which includes the natural gas distribution, transmission, gathering and storage operations including Cove Point, as well as our Apalachicola-based E&P operation and services.

This alignment positions us to best execute our growth projects and construction programs beginning in 2008. In actuality, we’ve begun to take the necessary steps to realize many of these future plans for projects regulated by the state of Virginia, those under FERC jurisdiction, and those in our unregulated portfolio.

We have more than $6 billion in growth CapEx outlined for the next three years for our regulated and unregulated businesses. We have a number of project applications, as well as actual construction running concurrently that position us to begin decade of new construction. As most of you are aware, the legislation enacted in April of this year seeks to make Virginia energy independent.

EJM has shrinking reserve margin in a market with barriers building, the market stands to worsen. Facing a shortage of at least 4,000 megawatts over the next decade for Virginia alone, our legislature wisely took action to close this gap.

Reducing Virginia's reliance on the wholesale markets helps consumers avoid the rate shock that could otherwise had resulted when rate caps expired. As a result, the legislation provides incentives for utilities to build new generation across the state and bears the backing of many stakeholder groups.

We have responded to our new state policy by actively pursuing a number of projects to begin to close our energy gap. For example, we have filed for and have already received State Corporation Commission approval for two peaking units at Lady Smith located on the outskirts of the Washington D.C. suburbs.

That $135 million project is already under construction. Later today, we will file an application to site a new third peaking unit at Ladysmith. In July, we filed an application to construct a 585-megawatt Virginia City hybrid energy, center clean coal plant in Southwest Virginia.

The project is expected to cost $1.6 billion and to be operational by 2012. Our filing request and 11.5% return on equity with an additional 200 basis points requested because the facility is carbon capture compatible.

The plant has already been found to be in the public interest of the State Corporation Commission, the next stage of the approval process is a hearing scheduled in January. As specified by law the commission has expected to render a final order no later then next April.

Later this month, we will apply for combined operating license for our north Unit 3. Knowing the length and seriousness of the licensing process, Dominion first applied to the NRC in 2003 for an early site permit.

We are now four years later awaiting the final decision on that permit, which we expect very soon. This is not an expeditious process, but we are looking to receive licensing approval before making a large capital investment.

It seems the more prudent path for our shareholders and optically accelerating a multimillion-dollar multiyear project. In addition to our generation build; we have three new transmission lines in the queue.

The first line has been approved as to its need and the commission is finalizing the route. This pleasant view line will cost about $65 million. We held public hearings in July and August on the proposed Meadowbrook to Loudoun line, which serves a critical need in northern Virginia.

The evidentiary hearing is scheduled for this coming February. We expect the State Corporation Commission approval process for this $250 line to conclude in the Fall of next year. The evidentiary hearing for our Carson to Suffolk line to serve southeastern Virginia and income, a $215 million project is also scheduled for February with a similar time line expected to conclude that process.

Although these lines will fall under FERC rate jurisdiction when cap rate expire at the end of next year, they are under the State Corporation Commission's siting authority. We expect these electric transmission projects will be subject to the new formula-based FERC ratemaking principles.

We filed that requested FERC last week. Like Virginia's new regulatory model, this new FERC process contemplates forward-looking reviews, trued-up on an annual basis. Because electric transmission rates are subject to rider treatment under our Virginia law, transmission portion of our rates will be refreshed on a near current basis once they are completed. All but eliminating regulatory lag for these growth related projects that are critically necessary to serve Virginia's fast-growing population.

Our gas transmission and storage projects are also progressing. In September, for example, FERC approved our USA storage project, which will provide another 4.4 Bcf of gas storage to our network. Construction will take about two years.

And we continue on with construction at Cove Point. For this quarter, we raised the roofs on both new LNG storage tanks and remain on schedule for a late 2008 completion. Finally, our Appalachian E&P operation has ten rigs running adding over 30 new conventional wells per month.

As we move from a predominantly unregulated entity to a more regulated entity, we will increase the visibility of our new growth projects and their time lines. We also want to ensure that you know about time lines on transactions as well as rate cases in filings under review.

On such matters, in the first week of October, the third Circuit Court of appeals heard oral arguments regarding the sale of Dominion peoples to equitable. The court is reviewing the case on an expedited basis and although no set timetable we expect a decision this month.

In August, the West Virginia Commission set a deadline for final briefs to be filed on November 16 for the review of our sale application of Hope Gas. We believe we will prevail on both matters and expect to close by the end of the year. In late August, Dominion East Ohio filed its first application for an increase in base rates since 1994.

Our file testimony supports 12% return on equity and $73 million revenue requirement increase. The commission typically issues an opinion and order in such cases 9 to 10 months after the application is made. Although we have a number of ways through new legislation and the regulatory process to achieve our earnings outlook and long-term growth rate.

New build is not the only driver of earnings at Dominion. This quarter highlighted many of the ways of how we are recognizing valued opportunities across our portfolio. As part of our goal improve our return on invested capital, for example. Generation completed the sale of Generation facility to AEP for approximately $85 million.

It is what will be, what is an accretive transaction. In the Northeast where peak demand growth has outpaced capacity development, we are well positioned to receive uplift from our capacity and energy revenues. We are the largest generator of power in New England, supplying approximately 20% of the market.

With little new construction expected, we can upgrade current facilities such as at our Millstone Unit 3 to capitalize on the financial incentives this market provides. Additionally as one example of plans to use our proceeds from the E&P sale toward value accretive purposes, Generation executed an agreement with Epsilon to terminate a power purchase agreement associated with our State Line plant.

This agreement will add more than $35 million of average annual after tax cash earnings for the next five years. That transaction closed last night. I have discussed with you our numerous growth projects and applications. Part of our challenge, though, is to ensure while we focus on the future we not lose sight of delivering excellent results in the present, not just from pride as company but as obligation to our shareholders.

As we enter our new regulatory environment the company is incentivized and rewarded for performing at excellent levels. I am pleased that this quarter our business unit performed at a superior level. We met the highest ever peak demand for power, while improving customer service and improving our safety record.

On August 08, we delivered 19,688 megawatt to our Virginia, North Carolina electricity customers, surpassing by 300 megawatts the prior year record, all-time record.

Our units performed exceptionally well, not just in our Virginia service territory but in our merchant Fleet as well. Across the board, I found some hydro-coal units achieved a equivalent availability factor of 93.1%, its third best quarter performance, since the year 2000.

At the same time that we were increasing our output, our average speed of answering service calls was over 50% faster than last year and we saw OSHA recordables reduced by over 30% in both the former energy and delivery company.

We are embarking upon a period of capital growth projects while continuing to deliver operational results at a high level. Our growth prospects in this quarter's operating results support our outlook for 2008.

We confirm our operating earnings outlook for 610 to 625 a share in 2008 with annual growth of at least 6% thereafter. With this view of our future growth and a earnings stream that is more regulated and less volatile, after the divestiture of our E&P properties.

Our Board of Directors last week voted to increase the quarterly common stock dividend. A higher dividend is a testament for ability to deliver return to shareholders and the fundamental strength of our company in our business plan.

The increase to $0.79 equates to an 11% increase over the current dividend and brings our current payout ratio to slightly more than 50% of our forecasted range of EPS for 2008.

The board also affirmed management's recommendation to establish a policy to achieve a 2010 payout ratio of approximately 55% in line with the average of our utility peer group. And considering our expected operating earnings per share growth rate, shareholders should expect similar size dividend rate increases or 11% or more in 2009 and 2010 to reach this payout ratio.

Our Board of Directors also approved a two-for-one stock split. While you understand that the fundamentals of our stock remain intact and unaffected by this action, you also know that a lower entry point for quality stock often entices new entrants, especially in the retail sector.

These actions signal the board's confidence in our future earnings stability, as well as, it is an indication of management's positive outlook for the direction of our company.

With that, I’ll turn the call over to Tom Chewning.

Tom Chewning

Thanks, Tom. Before, I review the third-quarter results, I want to discuss the newly aligned business units in terms of how they affect our financial reporting.

We realigned our business units on October 1st, as Tom Farrell previously outlined and we will report by these new business segments effective with year-end 2007 results, however, our third-quarter and year-to-date numbers continue to be reported under the organizational structure including our E&P segment.

Dominion produced operating earnings of $1.72 per share in the third-quarter 2007 compared to $1.88 per share in last year's third quarter. The decrease is primarily attributable to lower natural gas and oil production, due to the sale of our non-Appalachian properties, the absence of a benefit from business interruption insurance recorded in the third quarter of 2006.

Lower contributions from the company’s producer services and gas transition businesses. And non-recurrence of gains from sales of excess emission allowances. These negatives were partially offset by the recovery of Virginia fuel expenses, which is returned as a pass through to customers on July 1, higher contributions from the merchant generation businesses, lower interest expenses and lower average common shares outstanding.

Complete details of third-quarter 2007 operating earnings compared with third-quarter 2006 can be found on schedules 4 and 5 of our earnings release. Most significantly, in the wake of our sale of E&P, we saw better-than-forecasted earnings in our delivery, energy and generation areas.

With the realignment of operating units, we anticipate that you will see greater transparency in our earnings drivers within each business unit, beginning with guidance in the first quarter and full 2008 year, which will provided in our January 2008 call.

On a GAAP basis $7.24 in the third quarter of 2007, compared to earnings of $1.85 per share in the third quarter of 2006. Factors that led to most of the third quarter gain included in reported earnings, but excluded from operating earnings right to the E&P divestiture. Net against the gain on sale of $2.1 million, our charges for the de-designation of certain hedges and charges related to the early retirement of debt associated with our debt tender offer.

The resulting net benefit relation to sale of our E&P businesses in the third quarter was $1.9 billion. We also took an impairment of $140 million related to the termination of State Line's power purchase agreement and a $55 million charge related to the impairment of certain Dominion capital investments.

A complete reconciliation of GAAP to operating earnings can be found on schedules two and three of our earnings release. In light of our termination of the power purchase agreement at State Line, we have new market price exposure in the Midwest. As part of the termination, the existing coal contracts were assigned to us and account for the majority of expected requirements in 2008 and 2009.

And keeping with our hedging philosophy, energy margins have already been locked in to match these coal purchase volumes. Over the time, we will supplement these existing coal contracts with additional purchases and will match them with energy sales to lock in margin.

For our current hedge positions, please see the schedules on pages 29, 30 and 31 of the earnings release kit. You will notice that we have expanded our hedge disclosure to include our positions for the year 2009. Last quarter we discussed our debt tender, which along with reductions in other securities has resulted in a debt reduction of approximately $3.3 billion.

In the third quarter we completed an equity tender for nearly $58 million shares and then purchased another $4.5 million shares of stock in the open market. When added to the market purchases we completed in June, we have repurchased nearly $64 million shares for just under $5.8 billion. The average price to buy back stock was less than we expected. As a result of that positive variance, we now have approximately $300 million unspent from our projected divestiture activities.

We have not yet determined how to apply these funds. Our options include funding another accretive transaction such as the State Line contract buyout. Repurchasing additional shares and reducing the year end 2007 debt balance. All of these options will be positives to our original divestiture pro forma for 2008.

During the third quarter of 2007, the Company paid down its commercial paper balances from the proceeds of its E&P asset sales, the only uses of our liquidity facilities as of September 30, 2007 was to support letters credit for issues of collateral for hedge volumes. Including cash and cash equivalent, we ended the quarter at $5 billion of liquidity.

Tom Farrell commented on this quarter's operational results as a testament to the viability of our model and supportive of our outlook for 2008. Our core units are performing better than forecasted and we set in motion a number growth projects that will add incremental and significant dollars to our rate base going forward.

On the heels of Tom the telling the growth opportunities and generation and transmission that we are undertaking or plan to undertake in Virginia, I would like to touch on the financing of these projects. We do not expect to be free cash flow positive in regulatory environments that provide attractive incentives for new required instructions.

You can however, expect us to be free cash flow positive after maintenance CapEx and dividends including the recently announced increase. We have no plans for a market equity issuance in 2008; however, we do plan for new equity to be issued in 2008 and supportive our direct stock purchase plans including our dividend reinvestment program.

Those issuances in addition to the expected conversion of our contingent convertible securities they provide approximately $200 million in new equity in 2008.

Beginning in 2009, in addition to our direct stock purchase plans, you can expect the Company to have smaller, more frequent share issuance to support a 50% equity component when financing our growth projects because these issuances will fund specific, accretive and approved projects, we expect that the market will readily accept these transactions.

We are dedicated to maintaining a strong triple B or higher credit rating even with the large capital expenditures we will see with the upcoming Bill projects.

That concludes the financial portion of our quarterly call. I will speak on behalf of all management when I say we are pleased with our strategic alignment and excited for the future. Lindsay, you may open the line for questions.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question comes from Dan Eggers with Credit Suisse. Sir, please go ahead.

Dan Eggers - Credit Suisse

Good morning.

Tom Farrell

Good morning, Dan.

Dan Eggers - Credit Suisse

The first question I guess can you talking about Virginia city a little bit given and our position we have seen elsewhere in the country it new called. What is the appetite in the state and is there any risk we should be thinking about as far as getting all the approvals there.

Tom Farrell

Good morning, Dan. The couple of things to keep in mind about Virginia city. It is being built in the coal-producing region of Virginia. The plant was initially thought of or encouraged by an act of our General Assembly, which established the construction of the coal plant in that region of the state.

It’s is not only meeting helping to meet Virginia's energy needs but also specifically as an economic development project for that portion of our state which is relatively higher unemployment. The plant has already been found to be in the public interest by the State Corporation Commission in an initial preceding that was filed last year.

So we are very confidence that the plant will be approved. There are obviously people concerned about coal as there are -- every other part of the country. But we think we had, there is an unique situation here. We do believe the plant will be completed.

I will also, point out that this is a fluidized bed technology which has very low NOX, SOX, mercury emissions, and we are working with Virginia tech University on carbon sequestration projects in the region, the plant is carbon capture compatible in its construction and design. So we think, we will be able to demonstrate to everyone that it is perfectly appropriate to proceed with that plan.

Dan Eggers - Credit Suisse

Great, thank you. On the State Line decision to unwind that contract. I know that was planned at one point in time that you considered selling. Can you just talk about the thought process of deciding a core asset you guys want to hang on to and how it fits into your portfolio from your perspective?

Tom Farrell

We, as part of the marketing of our three peaking units that were sitting there in the Ohio valley, basically we included State Line. We saw more value in State Line than any of the bidders did so made the determination that, to keep it.

And I am thrilled that we did particularly now that we have been able to buy out the contract with Exelon in a transaction we said is that we could use these funds from the E&P transaction and buy back stock or can we find a transaction that is more accretive than using the funds to buyback stock.

So we talked to Exelon about it, they are willing to discuss it, the negotiations went on for an extended period of time as you might expect and but fortunately we were able to consummate that. It is an excellent plant. It sits in a perfect spot to help serve the needs. It right outside the city of Chicago.

And we are very pleased to be able to get, capture the market value of that plant now rather than having to wait another four years. As you know, we have similar contracts at Kincaid which is twice the size of this plant same ten year on it we have a similar contract on our Elwood peaking facilities and we have a contract on a Kiwanis facility that expires a year after this fossil plants.

Part of our job here is to safely converting some of that locked-up value forward. Prior to the State Line plant, we had about $250 million in pretax margins that we were missing out on because of those long-term contracts we got when we bought those facilities.

So, we are working away on that. But at the end, those contracts will expire and we will benefit from that happening.

Dan Eggers - Credit Suisse

I guess just one last question. When do you expect the pieces of Cove Point to come? I think there was same year kind of a phased start-in from those. Should we assume its all end of '08 or where it ends earlier in '08?

Paul Patterson - Glenrock Associates

Hi, Dan, this is Paul Patterson. You should expect that to come into service like third quarter early fourth quarter '08.

Operator

Thank you for your question, sir. Next question comes from Daniele Seitz with Dahlman Rose. Madam please go ahead.

Daniele Seitz - Dahlman Rose

Thank you and I was just wondering what is the total capacity of the peak you intent to build and what should be -- what do you anticipate to be the total cost?

Mark McGettrick

Daniele, this is Mark McGettrick. The two peakers that we’ve applied for at Ladysmith and gotten approved in aggregate that’s 300 megawatts and they are going to cost about $135 million. They will come on line summer of next year.

The third peaking unit that Tom referenced was an additional unit at Ladysmith, which will be 150 megawatts and will cost about $79 million, and it will come on in the late summer of '09.

Daniele Seitz - Dahlman Rose

Okay and in the best-case scenario, when do you anticipate to see the beginning of earnings on that core plant. I know it could be far in the future, but in the best-case scenario.

Mark McGettrick

On the coal plant.

Tom Farrell

On the coal plant, that regulatory proceeding is scheduled for January of next year. We are already accruing AFUDC on that plant, but we will see some book earnings next year. Once the plant is approved, it will get wider treatments so we will begin to get cash earnings beginning 01/01/09 on that.

Daniele Seitz - Dahlman Rose

Great, thank you.

Mark McGettrick

Thank you.

Operator

Thank you for your questions. Our next question comes from Paul Patterson with Glenrock Associates. Please go ahead, sir.

Paul Patterson - Glenrock Associates

Good morning, guys.

Mark McGettrick

Good morning, Paul.

Paul Patterson - Glenrock Associates

Just a few quick questions, the first one is on the more frequent equity issues in 2009. I think you indicated it the accretive.

Can you give us a little bit a little more sense of kind of the total amount you might be thinking about there. And then Dominion Capital, what caused the impairment and should we -- is that finally done? Are we sort of over with Dominion Capital or there a potential for other things to happening is there any credit situation?

Mark McGettrick

I am going to, let Scott to answer the second question and then I will answer the first.

Scott Hetzer

Well, at Dominion Capital, we have about $200 million of financial assets left. $125 million will in the of CDOs and mortgage residuals, which are left over and we are currently talking about a buyer in each case, and those the impairment for the third quarter certainly reflects current market conditions for that.

The remaining -- the remainder of that $200 million about $75 million is associated with Vidalia Hydro Assessment, which is strategic and we will plan on keeping that going forward. We also have $167 million, $168 million of tax assets roughly 40 of it are simply prepaid taxes and in the balance about a $125 million are deferred taxes, some of which are expected to be released, when we actually sell the financial assets I just mentioned, the $125 million.

So, we are making progress, we sold another operating company in the third about $30 million. We are making progress, this current market disruption has slowed us down just a little bit, but we expect to make more progress either between now and the end of the year, certainly into '08.

Paul Patterson - Glenrock Associates

And for the write-offs for the most part look like they are out of the way?

Scott Hetzer

That's correct.

Paul Patterson - Glenrock Associates

Okay, great.

Mark McGettrick

Paul, the first question, when we take a look at our cash flow after maintenance CapEx and dividends we do have positive cash flow, but not sufficient to fund a 50/50 ratio of equity to debt on our new growth projects.

So its we have a situation in which you will have well under $1 billion dollars of new weak equity each year in 9 and 10 that we would expect to be breaking up in the form of our dividend reinvestment program that will account for $200 million or more and then obviously relatively small equity offerings.

We are being intended particularly in Virginia, to we have a 50/50 debt cap structure there and we are getting projected quick and beginning in 2009. So, it makes a lot of sense to go ahead and issue that equity rather than let it hang over the market as we are actually collecting rates from our customers that will pay us a return on equity, as well as the interest expense on the debt

Paul Patterson - Glenrock Associates

Okay great thanks a lot guys.

Operator

Thank you for your question sir our next question comes from Paul Fremont with Jefferies. Sir, please go ahead.

Paul Fremont - Jefferies

Just a quick question on the 2008 guidance. There is going to be a remaining stream of earnings that I think are associated with VPP transactions that you took back in house. Are those should we look at the earnings from those as being included in the of 610, 625, or are they going to be held off as nonrecurring.

Tom Farrell

Well they are included in the 610 and 625; however, when we look forward to 2009 and beyond, when they are not going to be there our plans still grow 6% or greater over the EPS of 2008 and 2009. So, yes, they are included. They will drop off, but we more than make up for it in other ways.

Paul Fremont - Jefferies

Thank you very much.

Tom Farrell

Thank you Paul.

Operator

Thank you, for your question sir. The next question comes from Paul Ridzon with Deutsche Bank. Sir, please go ahead.

Paul Ridzon - KeyBanc

It’s Paul Ridzon With KeyBanc. Can you hear me?

Tom Farrell

Yes Paul Good morning. Everybody is named Paul. But…

Paul Ridzon - KeyBanc

I think Paul Debose is next. Just a detail. The $300 million that you still have sitting, is there kind of a placeholder for that in your guidance or could that investment opportunity be incremental?

Tom Farrell

Well it really won't change the range for this point. Is the sale will beyond the year January 31 and update our range for the year. Is anything, it can certainly raise the low end above where we have given it to this point.

But and help us get to the top end. We have certain options. And so some are more accretive than others and so we won't be able until year -end to know what happened with that money. And we will give you more guidance. So we wouldn't change necessarily our range right now as we haven't accounted for it yet, but it will definitely help.

Paul Ridzon - KeyBanc

Okay, thank you very much.

Operator

Thank you for your question, sir. The next question comes from Jonathan Arnold with Merrill Lynch. Sir, please go ahead.

Jonathan Arnold - Merrill Lynch

Good morning.

Tom Farrell

Hey, Jonathan.

Tom Farrell

Hi, Jonathan.

Jonathan Arnold - Merrill Lynch

Just reading the press release on your statements on the dividend and how people we should expect similar sized dividend increases in '09 and '10 to reach the payout ratio and firstly I am guessing you are talking percentages.

And secondly, does that mean that the increase we just had effectively you see that as a 2008 increase and the next one would be we’ve look at late '08 for payment in '09.

Tom Farrell

We can't speak for our directors. They took the decision to go to $0.79 for this quarter. I think we can obviously assume that if that unless they get together again was they can any time and decide to want to change it, but I would assume that we would get back short of that to having that as an annual rate.

And then the increases we would have in '09 would be guided, say, to around a 53% payout ratio and then take earnings for '08, add 6% times 53 if you want to play a modeling game and then add 6% to those earnings and then go up to 55%. And but I would think the calendar year '08, just a model for modeling purposes right now would be at this rate of $0.79 a quarter.

Jonathan Arnold - Merrill Lynch

Okay, thank you. One other thing I apologize. I might have missed this. I believe there was a date in the merger agreement with equitable on the LDC sales where you of November 1. I think, that is today to either to extend the agreement or not. Can you just have that been extended until they have new final days or anything like that?

Tom Farrell

Jonathan, actually I think, the original merger agreement had a June 1st date or some like that. We have extended that twice. And the present state of it is that at the end of November 1st, either party has the right to give notice that they don't want to proceed.

So there's no additional extension drafted up or written up. We are now in a position sort of if anybody wants to walk, they can walk. I think that we do not expect that to occur. We have no indication that that will occur.

We talked to equitable on a daily basis about proceeding with the transaction. And as we said in the beginning Jonathan, you may have missed this part, we expect a decision from the Third Circuit during the month of November on the Peoples part of it.

As far as Hope goes in West Virginia, the commission I think, the opening briefs are actually due today and the final briefs are due on the 16th, simultaneous file briefs on the 16th, and they could rule any time thereafter.

All the evidence is done and all that. It is just now, the lawyers putting the briefing. So we are confident that we will prevail on both of those and that we will close by the end of the year.

Jonathan Arnold - Merrill Lynch

But you anticipate some further extension, sort of an open-ended agreement that the point?

Tom Farrell

Yes.

Jonathan Arnold - Merrill Lynch

Okay. And one quick other one if I may. On Dominion capital, I think I heard this right. You said you will $200 million of financial assets left, which 125 were, CDO’s and mortgage residuals. And if your writedown in the quarter was 55, if we grossed that out for tax it would be around 85.

And If that was all related to the financial asset book, it looks like you might have written that down to say 40% of what is happening on the books for us. Am I doing that math correctly? And when you make the statement around that's more or less reflecting the current market. Is that what you are getting at?

Tom Farrell

I think you might have written it down about 40%.

Jonathan Arnold - Merrill Lynch

Yeah.

Tom Farrell

But not written down to 40%.

Jonathan Arnold - Merrill Lynch

Written down by 40%. That is what I meant.

Tom Farrell

Yes. I think, that is about right.

Jonathan Arnold - Merrill Lynch

Okay. Thank you.

Operator

Thank you for your question, sir. The next question comes from Carrie Saint Louis of Fidelity.

Carrie Saint Louis - Fidelity

Hi. I have a couple of quick questions. Going forward. I was just wondering, if you could comment how much CP you are expecting to have outstanding or you are going to be using that program as largely as you used historically?

Tom Farrell

We currently have zero outstanding right now as a result of the proceeds from the divestitures. As we fund the tax Bill in the fourth quarter for December 15, we expect to use that market and we would expect to have balances somewhere around $1 billion and a half or so. And so, we feel very good about that.

Actually, we also have some potential to issue some other debt, either Virginia Power or Dominion to reduce some of that exposure. We will certainly keep an eye on the market. As you know during the meltdown, the liquidity meltdown, we were okay and still acceptable in the market but spreads have widened out.

We want to maintain our flexibility and if we think, that the markets are running into some sort of train wreck near your end, we will take a capital markets issue once to avoid that.

Carrie Saint Louis - Fidelity

Okay. And then turning towards the discussion recording free cash flow and so forth, I have a couple of questions here. So looking at your new CapEx forecast, do you have quite a considerable amount in the growth category? And I am just trying to understand. So you said, you would be free cash flow positive, just assuming the maintenance CapEx?

Tom Farrell

Maintenance CapEx and dividends, we have not released to the market but we have done a three-year forward projection. We have positive cash flow in each of those years after CapEx and payment of dividend. We do not have sufficient...

Carrie Saint Louis - Fidelity

Right.

Tom Farrell

…excess cash flows to fund 50% of those projects. So we will go to the market and to a dividend reinvestment program to try to keep up pretty much contempt ruinously with the expenditures.

Carrie Saint Louis - Fidelity

Right, but your growth CapEx is $2 billion. I don't assume the free cash flow deficit is that large but I think, you mentioned earlier and if I heard this right it’s about billion of free cash flow deficit?

Tom Farrell

No I said that the equity that we will need to raise is less than $1 billion dollars a year.

Carrie Saint Louis - Fidelity

Okay.

Tom Farrell

50/50.

Carrie Saint Louis - Fidelity

Okay.

Tom Farrell

Financing of growth Cap Ex.

Carrie Saint Louis - Fidelity

Okay. And can you just remind us regarding your new credit targets going forward? I appreciate the commitment to the strong triple B, but what metrics are you specifically targeting and since you are issuing or not planning or issuing equity in '08, I am assuming that you are still be achieving your credit targets in '08 minus the equity issuance.

Tom Farrell

Carrie, before I turn it to Scott, we will have equity issued in '08 we’ll not have a public market estimate a public issuance. We will raise about $200,000 from our dividend reinvestment program and from some convertible securities that we expect to convert.

So it’s just that we are not going to have public Capital Markets equity issuance. We don't anticipate it in '08, but I will turn over the question of metric targets to Scott.

Scott Hetzer

And Carrie, the targets that we are using those that are appropriate for what we consider to be a risk profile file company for the triple B plus rating and that’s what we are striving for and we see that as FFO to interest of 3.6 times or greater. FFO to debt low 20% range and debt-to-cap, low 50% range.

Carrie Saint Louis - Fidelity

Okay. And these targets, when are you targeting achieving them even though you are not at that FFO to debt currently.

Scott Hetzer

That at end of the third year, we would expect to be there. About 2010.

Carrie Saint Louis - Fidelity

By 2010. Okay. All right.

Scott Hetzer

Carrie, along the way we will be exceeding some of those targets.

Carrie Saint Louis - Fidelity

Okay. Because I thought you were high teens for FFO to debt currently.

Scott Hetzer

That's correct.

Carrie Saint Louis - Fidelity

Okay. But that high teens not expected to drop is what I am saying.

Scott Hetzer

No, it is not.

Carrie Saint Louis - Fidelity

Okay. Thank you.

Operator

Thank you for your questions. Our next question comes from Hugh Wynne with Sanford Bernstein. Sir, please go ahead.

Hugh Wynne - Sanford Bernstein

Hi. I have two questions. One just tracking the growth of O&M expense at the Company. I see there was a 46% increase in O&M expense and the consolidated results of the third quarter and broadly speaking, a 30% increase in O & M expense over the first 9 months of the year.

My first question was, what was driving that and seems to be primarily in the generation business. And then the second question is in order to track the progress of the Virginia City Plant and make sure that it makes the various hurdles that could feed from entering rate base, could you detail the various permits that lie ahead and the deadlines for obtaining them, construction, air, regulatory approval and so far.

Tom Farrell

You go.

Tom Chewning

I will take on the O&M increase and you are right, it was really driven at generation and really three big drivers of that year-over-year change. One is the way that emission sales are accounted for that’s actually a credit to O&M expense. And emissions sales are down this year versus last. So that's one of the drivers.

Another is just hedging effects as we have seen this in other parts of the business in the past. Oftentimes, when you hedge the impact of the hedging goes through O&M and in this case it actually resulted in an increase in O&M, but there is offset in revenue.

So there is no bottom-line impact because you realize, the realized revenues that were contemplated by the hedging but what it does it has the effect of distorting the O&M.

And then finally, it is also financial transmission rights in a way that is a credit to expense as well. And a big impact that happened this year was we actually, we went back on to fuel clause, those credits started willing to the fuel and therefore again. So really these impacts that you see end up getting washed out for the most part to the bottom line, but it distorts the O&M line.

Tom Farrell

And I guess the -- to give another bottom line. Our margins did not suffer in the third quarter actually. Our margins were improved across the board.

Hugh Wynne - Sanford Bernstein

What, operating income to revenues you mean?

Tom Farrell

In terms of our, the way we keep score internally. Not GAAP and not according calendar but when we take a look, for instance, at merchant generation or Virginia generation or whatever, expenses have not cut into margins. Margins have actually improved.

Hugh Wynne - Sanford Bernstein

Operating income as a percentage of revenue has declined I believe, right? It is either here nor there. I just want an explanation of the O&M? It’s all right.

Tom Farrell

I think our explanation is being pretty solid up here and that is that sometimes like sales of emissions really -- we didn’t have any omission sales which we pointed out so that changes O&M.

But thank you for your question, but I will say this that one of my jobs as CFO is to take a look at expenses and expense controls in the company and our records is way ahead on expense control this year and at looking at margins in the third quarter and margins for the year, there are positive what we projected them to be.

Hugh Wynne - Sanford Bernstein

Okay. Thanks. And then on the Virginia City side?

Tom Farrell

Hugh, Mark McGettrick again. Two key milestones in terms of approvals in permitting. We touched on one. We filed for this facility in July of last year. Regulators have a schedule where they will hear the case in early January or are required by statute to have an order within a nine-month period so that reported right at the end of March, first part of April so that will be a certificate process.

The only other major permit that you have to get in terms of can your plan approved is a air permit. We expect to draft an air permit to be out for public comment within the next couple of weeks and that time frame in terms of approval coincides really with the approval by the regulators on the certificate. So, we would expect that late March.

Hugh Wynne - Sanford Bernstein

Okay. That is very simple. You basically have two approvals, the SEC certificate in March, early April draft, and then the air permit expected to be out at the same time. And that's the end of the story as far as pending approvals?

Tom Farrell

Any approvals of significance. That's true.

Hugh Wynne - Sanford Bernstein

Okay. Thank you very much.

Tom Farrell

Thank you, Hugh.

Operator

Thank you for your question sir. The next question comes from Rudy Tolintino with Morgan Stanley. Please go ahead.

Rudy Tolintino - Morgan Stanley

Hi. As far as State Line goes, will there be any environmental upgrades needed to comply with any state laws?

Tom Farrell

Right now, we don't anticipate any significant upgrades for State Line over the next three or four years. We may look at putting a SNCR on one or both of those units next decade but nothing in the next three or four years.

Rudy Tolintino - Morgan Stanley

Okay. And then back to Hugh's question on the O&M. I take it the Epsilon transaction and impairment that slide through O&M at generation?

Tom Farrell

Rudy, it would not be on any operating earnings measures.

Rudy Tolintino - Morgan Stanley

Okay. So still on page 20, the 401, that was…

Tom Farrell

Yeah, that has nothing to do with that transaction.

Rudy Tolintino - Morgan Stanley

Okay. Thank you.

Operator

Thank you for your question, sir. Our next question comes from Steve Fleishman with Catapult Partners. Sir, please go ahead.

Steve Fleishman - Catapult Partners

Yes. Hi, thank you. Couple of questions. First, on the proceeds from the E&P sales. Just to check the numbers you said you’ve done $5.8 billion of share repurchase and then its $240 million for the contract buyout?

Tom Farrell

Well, actually you are using about $139 million for the contract buyout after tax.

Steve Fleishman - Catapult Partners

Okay. So if we took, that would then been $5.94. So basically that would imply that you were expecting another 300 on top of that as available to use.

So, okay. Got you. And secondly, in the certificate case on the coal plant, are they still reviewing whether you need this power and if this is the best way to get this power or are they just reviewing the regulatory treatment of the plant?

Tom Farrell

The plant has already been deemed in the public need. Now, they will look and there has been testimony filed in terms of the economic viability of the coal plant versus other options. So they will look at that but main proceeding will be around prudency of cost as dictated by the legislation.

This plant has to be built in very specific areas. It has to be coal. It has to buy coal from Virginia local mines. And so the vast majority of the review will be, did we pick the right technology at the right place for the region that we have been mandated to build in.

Steve Fleishman - Catapult Partners

Okay. One last question. And you probably won't answer it, but just on the hedging data that you gave for Millstone and New England going out one more year, is there any to give sense of at least within the '08 guidance were Millstone and the coal plant or this milestone what you give is hedged?

Tom Farrell

The percent hedge is on the schedule, Steve.

Tom Chewning

We won't answer price.

Steve Fleishman - Catapult Partners

Okay. And you will give that, just important terms in looking off of '08 for future prices to know where that is hedged.

Tom Farrell

Right.

Steve Fleishman - Catapult Partners

Okay.

Tom Farrell

As we roll through and we get more under our belt, we will release that. That has been our custom is to not release it until we we’re pretty much out of the market.

Tom Chewning

Steve, now with the realignment of the Company, you can expect us to give you kind of more clarity on how to look at the business lines within the Company, and, you know, certainly the area of merchant generation is an area we are looking at very hard.

Steve Fleishman - Catapult Partners

Okay, great, Thank you.

Tom Farrell

Thank you, Steve.

Operator

Thank you, for your questions, Mr. Fleishman. Ladies and gentlemen, we have reached the end of our allotted time. Mr. Chewning, do you have any closing remarks?

Thomas Chewning

Yes, Lindsay, thank you. Just a reminder that our Form 10-Q will be filed with the SEC later on today and our fourth quarter earnings release will schedule for January 31, 2008. We would like to thank everyone for joining us this morning and wish you a pleasant fall. We will see many of you next week at the DI conference in Florida. Good day.

Operator

Thank you. That does conclude today's teleconference. You may disconnect your lines at this time and please have a wonderful day.

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