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Executives

Dennis Barber - VP of IR

Mark M. Jacobs - President and CEO

Brian Landrum - EVP and COO

Rick Dobson - EVP and CFO

Analysts

Daniel Eggers - Credit Suisse

Lasan Johong - RBC Capital Markets

Shalini Mahajan - UBS

Michael Lapides - Goldman Sachs

Brian Chin - Citigroup

Elizabeth Parrella - Merrill Lynch

Angie Storozynski - Macquarie

Reliant Energy, Inc. (RRI) Q2 FY08 Earnings Call August 5, 2008 8:00 AM ET

Operator

Good morning ladies and gentlemen and welcome to the Reliant Energy Second Quarter 2008 Earnings Conference Call. Thank you. At this time, all participants are in a listen-only mode. Later we will conduct a question-and-answer session. I would like to turn the call over to Mr. Dennis Barber. Mr. Barber you may begin.

Dennis Barber - Vice President of Investor Relations

Good morning and welcome to the Reliant Energy's second quarter 2008 earnings conference call. Leading the call this morning are Mark Jacobs, President and CEO; Brian Landrum, Chief Operating Officer; and Rick Dobson, our CFO. Following our prepared remarks, we'll have a question-and-answer session. Please limit yourself to one question with one follow up so others can participate. Both our earnings release and the slide presentation we are using today are available on our website at www.reliant.com in the Investors section. A replay of this call will also be available on the website approximately two hours after the call.

Consistent with our past practice, we are using several non-GAAP measures, to provide additional insight into operating results. Reconciliations of the non-GAAP measures to GAAP figures are available on the website. An item adjusted for this quarter is unrealized gains and losses on energy derivatives, which is an ongoing adjustment

As many of you know, we update our outlook each quarter using forward commodity prices. The current outlook uses forward commodity prices as of June 20th that was the last Friday of the quarter for which there was a traded contract for July. Any projections or forward-looking statements made on this call are subject to cautionary statements on forward-looking information contained in our SEC filings.

I'll now turn it over to Mark.

Mark M. Jacobs - President and Chief Executive Officer

Thank you, Dennis, and good morning everyone. Welcome to our quarterly call. Those of you that regularly follow Reliant Energy know how deeply we believe in the value proposition of our company and how much progress we've made to position the company for success. But I'm sure that most of you saw this morning's earnings release and the very disappointing retail results. So, I want to mention that upfront before I cover a few other topics. I'm going to provide some context on retail, and then Brian will go through the specifics around what happened and more importantly, what we are doing in response.

Extreme weather conditions resulted in significantly higher load than we expected. Our cost to serve that incremental load was very expensive, due to commodity prices at the time, and transmission constraints that severely limited the ability to import power into the Houston zone. The result, we had to buy more power at higher prices and that led to a supply cost variance that was unprecedented for the business.

While we expect the retail financial results to vary with market conditions, we consider the magnitude of this variation to be unacceptable. While the quarter and outlook for the full year have been impacted accordingly, we have some hard-earned lessons and have responded with specific actions, which Brian will address. Bottom line is, we believe we'll be better positioned to manage the risks in our retail business in the future.

On slide three, you can see a summary of quarterly results and or revised outlook through 2010. Despite the Q2 anomaly, we continue to believe retail is a valuable business. It has an extraordinary return on invested capital. It represents an attractive longer-term growth opportunity. We have a strong franchise notwithstanding the quarter's results. In fact, during periods of stress and market dislocation in the Texas retail market, we've been able to improve our competitive position.

Moving to the wholesale business. We had good performance in the quarter. Improved plant performance and better market conditions translated into higher contribution margin. Changes in the forward curve had a significantly positive impact on our outlook for the balance of 2008, 2009 and 2010. As Dennis mentioned, this outlook is based on forward curves for commodity prices on June 20sup>th/sup>. Commodity prices have been particularly volatile, and that results in big ups and downs in the near term wholesale outlook numbers. Forward curves have come-off sharply since June 20sup>th/sup>, and if we were to remark with more recent commodity prices, the outlook would be substantially lower. But commodity prices are going to move up and down. I think there are two important points to focus on. First, forward curves don't reflect tightening supply and demand, and that's inconsistent with our fundamental analysis.

Secondly; across our portfolio, forward curves implied low single digit rates of return on new build, as supply and demand fundamentals tightened, we expect rates of return on new build to increase. As you can see on the chart, that would have a $600 million impact on our 2010 earnings. To me, that's a more important long-term value driver than daily changes in commodity prices. I know that recent market events have caused many to question whether or not the wholesale market recovery will happen. In our opinion, an economic slowdown would impact the timing of a recovery, but it wont undo the laws of economics.

Now, I want to spend a few minutes reviewing our key priorities for 2008. You'll remember we established these at the beginning of the year. Rather than discuss them all, I want to hit a few with the high points. One of our priorities in the wholesale business is to invest in the portfolio to create value and an opportunity we constantly evaluate is the investment in environmental upgrades. Recently a Federal Appeals Court vacated the Clean Air Interstate Rule. Here's what that means for Reliant Energy, we will likely see a reduction in our operating cost in the near and intermediate term. But longer term, we anticipate the Clean Air Interstate Rule to be replaced with something else.

Turning to priorities in the retail business, obviously these are in addition to the retail supply actions that Brain will discuss. One of our key retail initiatives is Smart Energy. As we've discussed we expect Smart Energy to play a big role in enhancing the value of our core Texas residential franchise. There are two key developments related to Smart Energy that I wanted share. First, Jason Few has joined Reliant Energy to lead our efforts. Jason joins us from Motorola, where he ran the worldwide Mobile Phones Accessories business. Prior to Motorola, Jason was with SBC and led the team that developed the DSL Internet business. Jason has a track record of successfully launching new technologies to the consumer market which makes him the ideal person to lead our efforts.

Secondly, there has been an important regulatory development. A unanimous settlement was reached in Centerpoint Energy's request to install an advanced meter information network or AMIN plant. The settlement is scheduled for consideration at the Texas Public Utility Commissions August 14sup>th/sup> meeting. Reliant Energy was instrumental in developing that plan and reaching consensus among the various stakeholders. Here is why this plan is important; it allows us to provide our Smart Energy products to consumers more quickly. The AMIN plant allows us to ask Centerpoint to install smart meters for our customer on demand driven basis. That means we will be able to move past the pilot phase and start providing our new Smart Energy products more broadly to consumers this year.

I want touch on the last point on this page, our financial model for investing in our business. Over the last several months we've all witnessed extraordinary events in the financial markets and there is growing concern about the health of the global economy. Notably for us, the merchant energy sector has undergone a significant revaluation and we have been impacted more than our peers. Ironically, all of this is occurring at a time when most key indicators within our company point in a positive direction. We have restored our balance sheet strength, to a level that is distinctive among our peers. We have robust liquidity levels. And we expect to generate in excess of $2 billion of free cash flow through 2010 in a wide range of commodity price scenarios. Clearly, we will have significant resources to reinvest and create value for our shareholders.

We've discussed our approach to capital reinvestment with you on the last few calls. That slide is in the appendix. We continue to evaluate all of our reinvestment alternatives, including share repurchases. In our view the value proposition in our stock is even better than it was at the beginning of the year. There are many considerations when deciding to implement a share repurchase program.

One of those considerations is economic and financial market conditions. Among the experts, there is wide divergence of opinion on what the future holds. While we hope the optimists are correct, we need to be prepared in the event the pessimists get it right. In this unstable environment, we place a very high premium on our strong balance sheet and robust liquidity level. A share buyback or any other transaction that significantly reduce liquidity levels for that matter would not be consistent with that consideration. That being said, we understand that share buybacks are an effective tool to return value to shareholders and certainly an alternative that we will continue to evaluate.

In conclusion, yes, we were disappointed in the performance of our retail business in Q2. But overall, Reliant Energy is a company with a lot of positive momentum and offers an outstanding value proposition for shareholders. I'll now turn the call over to Brian Landrum, our Chief Operating Officer.

Brian Landrum - Executive Vice President and Chief Operating Officer

Thanks Mark. I'll cover our operational performance and outlook, starting with retail. As Mark said, the retail outlook for the year is down significantly. Extreme weather and market conditions during the quarter caused part of the variance. Our basic approach in retail is to match supply with sales to customers. In concept, if we sell a one year fixed price product to a customer, we buy one year fixed price supply. In reality, what we sell and what we buy can't match up perfectly. For instance, due to the tightness of generation in the Houston zone, we consistently buy some power at much lower cost from other zones to serve our Houston area load. We also buy supply for expected load under normal weather conditions, plus a position to mitigate some of the cost from hotter weather.

Every period, we determine how much to spend, to reduce potential cost of abnormal weather and transmission congestion, using a long term economic view. In Houston, during late May and early June, we had the hottest weather in over thirty years. During this period of high Houston load, North South transmission constraints and changes in how ERCOT managed congestion, forbidden us from meeting the increased demand with lower cost power from other zones. We had to buy power from higher cost sources in the Houston zone. Higher ERCOT wholesale price caps also increased costs to record levels, for an unprecedented number of periods during the quarter. This combination of weather, transmission congestion and ERCOT protocol changes, reduced second quarter results by about $100 million.

We have a set of other supply costs that can be difficult to hedge, but have historically been a small part of total cost with low volatility. An example would be ERCOT charges that cannot be assigned to individual retailers, that are allocated by volume shares across all retailers. Each quarter, we also see variances to forecast on certain supply cost that we bundle into customer products. Costs in this category can fluctuate but have ultimately tended to net out overtime. Given the unusual level of volatility however, we would not expect to recover roughly $50 million of additional costs incurred during the quarter. The second quarter was a difficult time for retailers in Texas in general, with eight companies going out of business five of which dropped customers to the providers at last resort. During the quarter, we assessed the risk of continued high and volatile costs as more likely given how ERCOT was managing congestion at the time. As a result, we took steps for the balance of the year, to mitigate potentially large additional exposures.

We acquired supply to better match our load in each zone and we bought additional fixed price ancillary services in the forward market. The cost of these positions is about $55 million higher than our prior outlook. The remainder of the variance to our prior outlook is associated with reversing the declining customer count we discussed in our last earnings call. We made a concerted effort to improve marketing of across pricing, channels and positioning. Since we implemented this new program in May, our customer count increased by over 25,000 customers, which is a dramatic turnaround and a meaningful increase even after taking into account, customers we acquired from defaulting retailers.

We are taking a longer-term view of customer value that can have a negative impact on results in the near-term, but will increase the overall value for the time we serve the customer.

As a result, our contribution margin was lower by about $10 million during the quarter, and we estimate an additional $20 million reduction for the balance of the year. In total, we are lowering our retail outlook for the year by about $240 million. As Mark said, we consider the magnitude of this variance to be unacceptable. We are applying the learning's from this series of events, to how we manage the business. We worked closely with our ERCOT, on a better approach to managing congestion between zones. We have conducted a comprehensive review of our retail risk management approach, and are updating the economic trade-offs for hedging each risk, especially those that have been historically small.

We are looking at creative alternatives, to reduce variability on the difficult to hedge risks, including the degree to which we bundle these costs in the products versus passing them through to the customers. While we expect to continue to see quarterly and sometimes annual variations from weather, congestion and the difficult to hedge components of supply, we are committed to delivering more consistent retail financial results.

We've had a long track record of success in retail and our overall franchise value remains strong. As the outlook for 2009 and 2010 shows, we do not expect the extraordinary market conditions of the second quarter to have a long term impact on the retail business. The move to a nodal market in Texas should also mitigate some of the congestion exposure. And as we continue to make progress on our Smart Energy offerings and increased sales in new markets, we will further strengthen the value of our retail business.

Let me now turn to wholesale. The outlook for wholesale contribution margin is up significantly, based on June 20sup>th/sup> commodity curves. As Mark noted, commodity prices are substantially lowered today. If we were to remark the curves to last week, wholesale's cumulative three year margin including the impact of hedges and adjusting for lower emissions amortization, would be about $275 million higher than what we showed in last quarter's call. Without the hedges, wholesale margin over the three year's is about $300 million less than our prior outlook.

You will note that market implied heat rates in the PJM and MISO forward curves from last week are backward dated [ph], through 2010, and are lower than they were in our outlook last quarter. We continue to believe that the forward curves do not reflect the tightening of supply and demand we expect to see in the future.

We saw strong performance in our plant operations, with commercial capacity factor, or CCF, almost 93% in June. We're maintaining our 87.4% CCF outlook for the year. Coal prices continue to climb during the quarter. As you may recall, we're fully hedged for 2008, and are now about 55% hedged for 2009 coal requirements, including Seward [ph]. Mark discussed our perspective on the Federal Courts decision to vacate the Clean Air Interstate Rule. In that context, we remain on schedule to complete the scrubbers at Cheswick and Keystone during 2009.

We updated our plant to comply with new Mercury Emissions Regulations in Pennsylvania, by investing approximately $50 million on controlled equipment. The team developed creative solutions that lowered the investment from our prior estimate by about $40 million to $50 million. Our wholesale business is performing well, and the tightening of supply and demand in our core markets will continue to increase the value of our fleet. I will now turn the call over to Rick Dobson, our Chief Financial Officer.

Rick Dobson - Executive Vice President and Chief Financial Officer

Thanks Brian. Let's start with our financial highlights on slide nine. Our open EBITDA decreased $131 million, driven by the challenges in our Texas retail business that Mark and Brian discussed. Our adjusted EBITDA decreased $12 million from 2007. As in the past, lower historical power hedges and in-the-money coal hedges that were procured before the 2008 coal price increases, primarily bridged this $119 million difference.

Now lets move on to the retail business on slide 10. As you can see from this slide, the factor that Brian talked about including weather, transmission congestion and our zone-to-zone supply strategy and competitive pricing decisions were the big factors that contribute to our lower mass and C&I gross margins and ultimately drove the $166 million year-over-year negative variance.

Now let's turn to the wholesale business on slide 11. As was previously discussed, improved plant availability and unit margins generated by tightening supply and demand fundamental and higher commodity prices are the primary story behind the open [ph] contribution margin increase over the prior year's quarter. These improvements were the catalyst for the three positive margin variances. There was a $17 million commercial capacity factors improvement over 2007, powered by fuel plant outages, we experienced unit margin increases of $15 million that were propelled by solid June power prices.

Lastly, there was a $10 million improvement in other margin, primarily resulting from improved capacity payments in PJM. In addition to these positive margin variances, we had 9 million of lower quarter-over-quarter O&M due to fewer planned outages.

On the other side of the ledger, we earned $27 million less as a result of lower off-peak spread and the deconsolidation of Channelview in the third quarter of 2007. The Channelview sale was completed on July 1st, yielding $15 million in initial cash with an additional $50 million expected over the next year.

Moving to slide 12, let's take a look at our year-to-date cash flows. In short, stronger wholesale performance during the first half of 2008 more than offset poor second quarter retail performance, resulting in a $272 million positive free cash flow variance.

Now let's move to our 2008 to 2010 outlook on slide 13. The key takeaway is that we will produce in excess of 2 billion of free cash flow over a variety of commodity price scenarios during this three year timeframe. For this outlook, we have also made modifications to our 2008 retail forecast, primarily driven by our second quarter results and zone-to-zone supply risk mitigation steps taken for the third and fourth quarters of 2008.

The 2009 and 2010 retail outlook amounts are not impacted by the extraordinary market conditions seen in the second quarter of this year. The combination of the June 20th commodity price levels and our hedge portfolio are the primary drivers behind the significant upward revisions from our last outlook.

Given the increase in this outlook, it implies that our entire net operating loss will be utilized before the end of 2009. That being the case, we've included cash taxes of approximately $500 million in this free cash flow outlook.

As we continuingly note, commodity prices can be extremely volatile. In the appendix, we provide directional sensitivities related to the major commodity price drivers so that you can make adjustments to our date specific outlook amounts based on subsequent commodity price movements. We developed a flexible capital structure to allow for all reasonable financial and commodity-based market fluctuations as we move up the tightening supply and demand curve, much like the volatile commodity price environment and unstable financial markets that exist today.

As we discussed earlier this year, it makes sense for a company of our size to maintain permanent debt in the $2 billion to $2.5 billion range in a dynamic and uncertain marketplace. This is a level of debt that allows for flexibility to create value in good environments as well as in more the challenging times. Going forward, we will actually manage Reliant's capital structure by balancing our primary goal of delivering long-term shareholder value with the need to provide adequate liquidity to manage our business throughout the market cycles.

Now let me turn it back over to Mark for some concluding remarks.

Mark M. Jacobs - President and Chief Executive Officer

Thanks Rick. Let me wrap up on slide 14 with a summary of key points. We believe there is a robust value proposition in Reliant Energy stock. In the wholesale business, we expect higher levels of profit and cash flow over time as we come out of the trough of the cycle. And we need to remember that point. It shouldn't get muddled with day-to-day volatility in commodity prices.

In the retail business, we had a difficult quarter. But we are taking specific actions to ensure that we are better equipped to manage through extreme events in the future. Stepping back, we have a solid retail franchise with a successful track record. We are financially strong with ample liquidity. And finally, we expect to generate substantial free cash flow in the next few years. Our commitment is to deploy that capital in a manner that creates the highest long-term value for shareholders.

Thank you and we'll open the line for questions.

Question And Answer

Operator

Thank you. We will now begin the question and answer session. [Operator Instructions]. The first question is from Dan Eggers from Credit Suisse. Please go ahead.

Daniel Eggers - Credit Suisse

Hi, good morning.

Mark M. Jacobs - President and Chief Executive Officer

Good morning Dan.

Daniel Eggers - Credit Suisse

Hey, Mark, I don't want to belabor this too much, but if you look at where you guys are right now, the stock is down about 30 some odd percent this year, you're going to generate over $2 billion of free cash over the next three years on a series of commodity price outcomes your basket of payments after the big net income in the quarter is going to look over close to $900 million. At what point in time do you get comfortable enough to say go ahead, we are going to put the money back to shareholders and start using free cash for using [ph] the outlook you guys have?

Mark M. Jacobs - President and Chief Executive Officer

Yes, Dan, it's a great question. And I'd say we certainly believe our stock is at a very attractive level, and we've... I have felt that for quite sometime. And with the latest... what we have seen in the markets, the economics of the share buying back program has improved since the beginning of the year. We are considering share repurchases along with other alternatives we have to reinvest capital. I'd tell you, when I reflect on this market environment, though, we place a very high value on a strong balance sheet and robust liquidity levels. And I think it is very important that we are prepared for the worst case scenarios. And we've done a lot of scenario planning here over the last several months and believe that we are in very good shape. And I don't think it's prudent at this point for us to pursue any action that would result in a significant reduction of that liquidity level.

And I would just note as we went through the quarter here with the commodity price volatility that we saw, we did take note that other companies in the sector had to arrange for emergency liquidity facilities. And while that credit was available, you wouldn't have to roll the clock too far forward to say what would that have looked like if that had also coincided with the financial meltdown scenario and that credit was not available. That could have been a very difficult position for those companies.

So, clearly, I think before we pursue any alternatives that's going to use a lot of liquidity, we are really looking for to see more stabilization in the financial markets.

Daniel Eggers - Credit Suisse

But does that mean that you're going to look at your other ways of increasing liquidity so you can more effectively use the balance sheet, I guess, or how should... what benchmarks should we be looking at to make a determination in the liquidity as ample?

Mark M. Jacobs - President and Chief Executive Officer

Yes, Dan, we are exploring all of those alternatives. One of the things we've talked about is having a capital structure that is a value-add capital structure. That's one of Rick's highest priorities right now. As you know, in the types of credit markets we have today, getting incremental capital here is a fairly expensive proposition relative to what it was a year ago. But that's certainly something we're looking at if... are there ways... things we can do in the capital structure to give us that additional liquidity.

Daniel Eggers - Credit Suisse

Okay. Thank you.

Operator

Thank you. The next question comes from Lasan Johong from ABC... RBC Capital Markets. Please go ahead.

Lasan Johong - RBC Capital Markets

Thanks. A quick question... a couple of questions on the retail business. My understanding is that the retail business hedges up to about 1.5 to 2 standard deviation moves in weather from norm. This extreme weather is not something Reliant can control, and yet you're telling me that... or there is an implication that the risk management that was in place was inadequate. And that doesn't seem right to me. And I don't understand what specific mitigation measures you would need above and beyond kind of your statistical analysis to warrant this additional $55 million spending.

Brian Landrum - Executive Vice President and Chief Operating Officer

Yes, Lasan, this Brain, and let me just step back and talk about kind of our approach to retail supply. Our goal in managing retail supply is to find the right economic balance between the total cost of the supply and the risk of being long or short. So, for instance, it would not make sense for us to fully hedge to all extreme weather cases.

Lasan Johong - RBC Capital Markets

Right.

Brian Landrum - Executive Vice President and Chief Operating Officer

And we also... but we would consider buying some heat rate options to cover higher or low than normal than depending on the level of that option premium compared to the benefit we see.

Lasan Johong - RBC Capital Markets

Right.

Brian Landrum - Executive Vice President and Chief Operating Officer

And because the Houston zone is short generation, we rely on lower cost imports from other zones to meet that Houston load.

Lasan Johong - RBC Capital Markets

Understood.

Brian Landrum - Executive Vice President and Chief Operating Officer

So during the second quarter, we really did have truly extreme conditions. Weather was --

Lasan Johong - RBC Capital Markets

Agreed.

Brian Landrum - Executive Vice President and Chief Operating Officer

It had been in over thirty years. Transmission congestion reached record levels, and in part due to how ERCOT managed congestion, how it changed its approach to managing congestion. ERCOT also increased the generator bid cap and the price for congestion, or the shadow price for congestion and then commodities such as natural gas were up dramatically. So let just kind of belay this out. As a result of that, from March to mid-June this year in ERCOT, we had almost 200 intervals that cleared at the shadow price cap of $5600 a megawatt hour. And that compares to about a 150 intervals for the prior 2 year and 2 months. So, what we have, previously we've seen about six intervals a month hit the cap and in the March to mid-June timeframe, we had 55 intervals hit the cap. In other words, we were hitting the price caps about 10 times more often during that period and more than double the cost. So, given this event, anyway you look at it, we were going to have a sizeable variance to that plan, because overtime the cost to hedge at outlined [ph] events, would outweigh the benefits.

Now, I also noted that we spend some money to turnaround our customer count during the period and that money we would have spent as well because, it's an investment which we think has longer term value. That all said, we believe there is room for improvement in how we manage our risk associated with retail and believe we can reduce the magnitude of these source of variance going forward, so here's what we've done and we're continuing to work on to improve performance in that regard. Like I said in the prepared remarks, we worked with ERCOT to modify the approach for managing congestion, so since the new protocols went into effect, ERCOT's had a total of... ERCOT's hit the shadow price cap [ph] a total of five times. We've reduced our dependence on imports to meet zonal demand, so for instance late last year, as we saw some congestion issues, we had... we reduced our severance [ph] choice position, mainly because of what we saw going on with wind generation. Well we think that avoided about $25 million of additional cost as a result. Now the incremental spend that we took to reduce imports for the balance of the year, was based on our assessment of where those cost could go if ERCOT continued to manage congestion, how it was and we had another set of extreme events.

So, thirdly we're revisiting all of the risks and how we manage all of the risk in the business, including those that have been small historically. So, we're not only looking at risk like weather, imports and natural gas and heat rate variability, we're fully stretching all of the components of supply, as well as those elements that we bundle into our products to customers, we've already begun to apply some of these changes to the position and will continue to improve those trade-offs through time. And then finally, we have selected an independent risk management expert with specific ERCOT experience to provide us with an external perspective on our practices going forward. So, I think in effect, while our current practice look set up to mitigate risks, we think there is some improvements we can make to further reduce the variability when we get these sorts of extreme events.

Lasan Johong - RBC Capital Markets

Okay. Then... clarify something for me... something else for me as well Brian, if you look at the amount of power that was purchased in the second quarter, the mass to [ph] volumes were basically flat to '07, and the C&I volumes were slightly up about 12%-13%. It doesn't seem like to me this indicates extreme weather. So, was this a situation in which there was an overall similar type of the power consumption, but there were spikes during the day or spikes during a particular time period, and how much volume difference was that number one? And number two, what was the average price you purchased this extra power at?

Unidentified Company Representative

Yes, Lasan. Some of the details, I won't be able to give to you in that. But let me give you two things; one is that the extreme weather I'm talking about happened during the lastly roughly two weeks of May and the first ten or twelve days of... sorry, yes, the first ten or twelve days of June. And so, while it was over the full quarter, that might not show up in higher usage, linearly that's the period of time when it happened. That said, when you look at mass markets being both 6.6 terawatt hours in the same quarter last year and this year, we actually had about a 100,000 fewer customers than we had same quarter last year. So, usage was up about 400,000 megawatt hours quarter-over-quarter.

Lasan Johong - RBC Capital Markets

I see.

Unidentified Company Representative

So, there was higher usage for customer in that period.

Lasan Johong - RBC Capital Markets

I see. Okay. Quick question on wholesale, can you tell us what kind of pricing levels you're hedged at for coal in '08 and '09?

Unidentified Company Representative

I don't know if we've given that specific number for what we are hedged at, for '08 and '09, it's in the appendix. Let me see, we'll find it real quick. Let me give you some information on our coal position just so that we can be clear here. We give numbers in the... on slide 17, on our average hedged fuel cost and we give it on an MMBtu basis. So our '08 hedge value is about 244, our '09 is about 329. And we also give what we think is an estimated margin fuel cost on that same slide. But Lasan, while we are talking about our coal position, we are open on the bulk of our power sales. So our approach to coal is to lock in the cost of coal as close to when the power we generate is priced.

And that said, the types of coal we buy generally have to be bought forward to ensure availability. And so historically, that's been about a year in advance. But recently, that's been a little bit longer. And let me just give some data that's here. We are fully hedged for 2008 and we're about 55% hedged for 2009. But only something that's not on the chart is that we are about... to make sure we have availability, we're committed to unpriced supplies of coal for about 90% of our 2009 volumes and 65 to 70% of our 2010 and 2011 volumes. Now prices for that incremental amount will be set later, but what that does is that it gives us some availability insurance for the types of coal we like to buy.

Operator

Thank you. The next question is from Mora Shenessey [ph] from Massachusetts Financial. Please go ahead.

Unidentified Analyst

Good morning.

Mark M. Jacobs - President and Chief Executive Officer

Good morning.

Unidentified Analyst

First of all, I was just kind of getting on to Dan's question. What is the RP basket availability at the end of the second quarter specifically?

Rick Dobson - Executive Vice President and Chief Financial Officer

Yes, this is Rick Dobson. It's $800 million specifically at the end of the second quarter.

Unidentified Analyst

Okay. So Mark, just... I mean the stock is down 35% year-to-date. I'm trying to understand, I mean we all know that the markets are exceedingly bumpy, but frankly, when markets are bumpy, one would think that there are opportunities. Your stock is yielding in the mid teens in terms of a free cash situation and you're citing market experts. But we... if we all listen to market experts, we'd be out of a job next week.

I don't get it. It doesn't mean you have to make a gazillion dollar share buyback, but your stock's been hammered. And you're telling us that the retail situation this quarter is somewhat of a one-off and you have the confidence as it's showing in your own expectations that that business is going to bounce back. You have the continued belief that the wholesale markets will tighten and that will... and economics will work out and it's a matter of when, not if. And yet your stock has been hammered trading in the mid teens on a free cash flow yield on your own numbers and we're citing market strategists and market fundamentals. And again, and we all know that it's... the markets have been incredibly bumpy and credit markets have been tough, but your stock is at 17 bucks. So does it have to get to 10 before you do a share buyback or does the stock price not matter to that decision?

Mark M. Jacobs - President and Chief Executive Officer

Well, Mora, I would say this. We... I agree with almost everything you said. We fully understand the value proposition with our assets and believe it's very attractive. As I mentioned to Dan that the economics, when we look at it from a share buyback standpoint, they have clearly improved since the beginning of the year. Our stock is gets down significantly. It's been part of a broader revaluation in the merchant energy sector. And I think we are in a very strong position and I think the RP basket that we have, the size of that, the balance sheet we have and the liquidity level we have are all things that when I look at that is I think we are in a very, very good position.

That being said, we're going to be prudent and we're going to be conservative just given what we see out in the market conditions. And as I've said before, we're not going to prematurely commit to what we are going to do prospectively. But clearly, these things are getting a whole lot of conservation here internally as you would expect. And we continue to evaluate this. I do think that finding some more stability in the financial markets before we would take a step that would meaningfully reduce our liquidity level is something to us that's an important milestone here.

And again, we're looking across... I don't... I know you asked the question about the share repurchase, but we're really using that as we would look across kind of all the different alternatives we have to reinvest cash flow.

Unidentified Analyst

Yes, I mean... but I think the last time you and I spoke, the stock was in more close to the mid 20s, and that's an understandable situation. I mean the stock is at 17. I mean that's what's changed and your stock is the worst performing IPP this year. And after a great last year, I am just... is there... I mean we'd all like to see the financial markets chill out. But that's not under my control or your control, but the stock price is what it is, and I'm certainly not smart enough to figure out what the financial markets are going to do. But I certainly know whether... hopefully, can figure out whether there is some good value in something. And so I find that interesting, but --

Mark M. Jacobs - President and Chief Executive Officer

Yes, look, I appreciate your perspective, Mora, and again it's something we said we clearly believe very strongly and deeply in the value proposition in our stock. And that's clearly something we are evaluating and will continue to evaluate.

Unidentified Analyst

Okay. Because if I recall, at the end of the year, the RP basket capacity was around 400. I mean it's already doubled in two quarters... and I think numbers are right. And the second quarter obviously didn't go as planned and yet your RP basket has doubled, so, which is a nice position to be in. I guess the second question is in terms on the retail side. Can you just help us out on the '09 and '10 expectations, what sort for customer growth expectations you have as well as what sort of pricing dynamics you are expecting in that marketplace?

Brian Landrum - Executive Vice President and Chief Operating Officer

Yes, this is Brian. The 2009 and 2010 outlook is based on fairly typical performance to historical outcomes and a continuing trend in the performance improvement we saw in the second quarter of our customer account increases that we saw after we implemented our new approach to managing customers for life cycle value. We do see an increase in '10, and part of the reason you see the improvement from 2009 to 2010 is we see an increase in our customer count and in the average size of the customer that we have at our residential and small commercial segment. And so I do think that we are showing the benefits of the investments we are making now in improving the life cycle management with our customer base and modestly effected [ph] margins. But I think that's the results you are seeing out there in 2009 and 10.

Unidentified Analyst

And remind me, before you had something like 2 to 2.5% customer growth in your expectations, is that correct?

Brian Landrum - Executive Vice President and Chief Operating Officer

Well, you know what, I don't have that at my fingertips in terms of a percentage. We are showing an improvement in both count and mix in the prior outlook, but I can't recall exactly what the specific was.

Unidentified Analyst

Okay. All right, thank you.

Mark M. Jacobs - President and Chief Executive Officer

Thank you.

Operator

Thank you. The next question is form Shalini Mahajan from UBS. Please go ahead.

Shalini Mahajan - UBS

Thanks and good morning.

Mark M. Jacobs - President and Chief Executive Officer

Good morning, Shalini.

Shalini Mahajan - UBS

I just wanted to follow up on the last question on retail. Your average gross margin per megawatt hour, as you show on slide 28 has gone up for '09 and '10 versus the last forecast that you guys gave. And it seems from your comments on the steps that you're taking to avoid a repeat of second quarter is all pointing towards higher costs and whether hedging or reducing imports [ph]. So if you could maybe just kind of speak to that a little bit and is it the assumption of customers' growth? Is that driving your gross margin and contribution margin assumptions?

Unidentified Company Representative

I don't think what we're seeing here is a significant change in our overall customer acquisition and retention strategy other than what we've talked about already in terms of improving our approach to managing customer lifetime value. I think these average gross margins and the contribution margins are fairly consistent with what we showed last quarter. We do see some improvement in those outer years as we reduce churn associated with our customer base. One of the benefits of this lifetime... customer lifetime value approach is that we see kind of less... fewer ins and outs at our customer count, and that translate... typically translate into slightly better performance in these numbers. But generally, our kind of customer acquisition and retention pricing strategies should result in similar gross margin and contribution margin to what we saw in last quarter's outlook.

Shalini Mahajan - UBS

Okay. So how should we be thinking about the recurring cost of you to, as I said in my earlier question, was to mitigate the repeat of the second quarter revamp?

Unidentified Company Representative

Well, it doesn't necessarily mean that we are going to have significantly higher costs through time associated with that activity. Our... what we are working on and what we are implementing is an improved approach to assessing the trade off between how much to spend versus the degree of variability we see around our position. And so I think what we are going to find is that's going to translate into similar margins to what we see today. One thing I would note is that part of what we are seeing in 2008 is by the time we got into on the situation in the second quarter, a lot of our prices for customers were fixed to either contracts or within the window having had the last reprise. And so, what we're going to see forward is if we have a cost associated with reducing the variability, that will tend to be embedded in our cost of goods sold, and therefore will be part of what our pricing is for customers. So, and ultimately our pricing should catch up to what our cost structure is.

Shalini Mahajan - UBS

Okay. And just one last question, this is on wholesale, we've seen heat rates continue to remain depressed trend that now you are seeing for more than six months now, it does not seem to be complacent with the fundamentals that you guys have. But it would be good if you could break your comments on your outlook, on your fundamentals to more between kind of what you see play out in one to two years. I think Mark mentioned an economic slowdown in his comments, so how do you see the fundamentals playing out within the next one to two years, and then separating that from a long-term view?

Brian Landrum - Executive Vice President and Chief Operating Officer

Yes. Even in the relatively short timeframe, the heat raters we're seeing even the ones we saw in the second quarter, especially in the off-peak periods in PJM and particularly in MISO. We still don't think we're going to make sense and not really sustainable heat rates we would wish to see through time. So, even in the one to two year timeframe, in these outlooks, barring the familiarity [ph] and change in demand, that we've picked those heat rates are not until they're reflecting even current market conditions. So, let me give the... since you might notice that we had some reduction in the economic generation and are pleased, during the second quarter, and that decline, a big chunk of that is from reconsolidating Channelview. So, we don't overstate this, but some portion, a relatively modest portion of that decline was from what we see, what we can see is, looks like uneconomic bidding behavior by some coal generators, who were setting the price during those off-peak hours, especially in MISO. When we look at those off-peak spreads, we don't think those numbers reflect the market price of the coal, and so we can't say a generator would choose to run their plant at a lower return, than they would earn by not running the plant and selling the coal. It seems to us that this approach in resulting off-peak spreads aren't sustainable, and they are especially not sustainable, if the supply and demand start to tighten.

Shalini Mahajan - UBS

Okay, that's helpful. Thanks Brian.

Operator

Thank you. The next question is from Michael Lapides from Goldman Sachs. Please go ahead.

Michael Lapides - Goldman Sachs

Hey guys. A couple of questions. First of all, want to make sure I understood correctly, at today's forward prices or at last week's forward prices, how does your guidance work both for EBITDA... open EBITDA and for free cash flow match up versus the current guidance level and the first quarter guidance level? And second, I noticed there is some moving around a little bit of both maintenance, CapEx numbers, meaning they are coming down a bit. Just wondered, what's the driver for that?

Unidentified Company Representative

To your first question Michael, the... one of the challenges that we have in the mark we did for July, for last week, excuse me, compared to what the June 20 mark was our last quarter's mark is that we had the decision by the Federal Courts to vacate care. So, that changed the market prices of SO2 and NOx and essentially zeroed out the annual NOx charges as well. So, these comparisons what I gave in the prepared remarks were the comparison that included the effects on emissions amortization. As you know, we don't really include the effect of emissions in gross margin, we show them as an amortization line below gross margin. And so, when you look at open EBITDA comparison, there is an big effect of this change in amortization. So, the numbers I gave were that if you take open margin which is before hedges, but you include the effect on emissions of this difference, with what happened with care, it's about $300 million down. And if you take gross margin including the hedges but also take into account the change in the emissions amortization it's about $275 million up. And I think that's sort of as specific as we can get on that comparison.

Michael Lapides - Goldman Sachs

Okay. I just... I want to make sure I understood that so, let me just ask --

Unidentified Company Representative

That was... I'm sorry, that was the comparison to last quarter's outlook. Michael sorry about that. What was your question?

Michael Lapides - Goldman Sachs

Okay. So, if I'm looking at '09... if I am looking... maybe I should simplify. If I'm looking at your current from this quarter '09 and '10 open EBITDA guidance, 1.581 billion and 1.478 billion, how different are they at today's commodities prices? I am sorry, I caught some of what you were saying; I didn't catch it all and I wasn't sure I was tying together from first quarter to this quarter.

Brian Landrum - Executive Vice President and Chief Operating Officer

Okay. So you're saying look at 2009's open EBITDA that we gave in this document, which is --

Michael Lapides - Goldman Sachs

Yes.

Unidentified Company Representative

1.581 billion.

Michael Lapides - Goldman Sachs

Yep.

Brian Landrum - Executive Vice President and Chief Operating Officer

The marked difference, if you look at last week, is pretty sizable. I mean you can use the sensitivities we put in the back to get pretty close. It's a combination of lower gas prices and slightly higher coal, and that gives you a range of what that variance would be. And then if you add that up, it adds up to around 575 million.

Michael Lapides - Goldman Sachs

For both years or just for '09?

Brian Landrum - Executive Vice President and Chief Operating Officer

Just for '09. Because really, you have a $4 gas move roughly and a little bit of improvement in coal. But then an increase in coal costs, but we also have the effects from the care vacating... care being vacated and that's why I kept trying to include the change in the kind of emission amortization, which is pretty sizeable because the market prices for SO2 and NOx... and seasonal NOx fell quite a bit after that was vacated.

Mark M. Jacobs - President and Chief Executive Officer

So when you look at the... and again, what Brian is trying to get at Michael is looking at open EBITDA, but also taking into account the effect of the emission amortization expense, which is a cash expense for us, so really looking at the cash margin of the business. That's a substantially smaller impact because there is a lot less emissions amortization expense that you see if you remarket to last week's curves.

Michael Lapides - Goldman Sachs

Got it, okay. And the question on maintenance CapEx.

Brian Landrum - Executive Vice President and Chief Operating Officer

We revise that forecast based on what we think our needs are for the plant based on how they are operating each quarter. And I think the change is relatively modest.

Michael Lapides - Goldman Sachs

Yes, I mean the biggest decrease was '09. A little bit more than a 30% decrease.

Unidentified Company Representative

Some on that, Michael, too is the shifting between maintenance and capital expenditure dollars.

Brian Landrum - Executive Vice President and Chief Operating Officer

Yes, what we decide to put in an outage versus what we decide to do as maintenance CapEx.

Michael Lapides - Goldman Sachs

Got it. Okay.

Brian Landrum - Executive Vice President and Chief Operating Officer

Show up in different places.

Michael Lapides - Goldman Sachs

Got it. Just shuffling a little bit between the income statement and the cash flow statement.

Brian Landrum - Executive Vice President and Chief Operating Officer

Yes, I think that's an explanation. We can follow up with you if there is more specifics.

Michael Lapides - Goldman Sachs

Okay, thank you guys. Much appreciate it.

Brian Landrum - Executive Vice President and Chief Operating Officer

Thank you.

Operator

Thank you. The next question is from Brian Chin from Citigroup. Please go ahead.

Brian Chin - Citigroup

Hi. Sorry to belabor this question on the retail stuff, but when you guys were talking about the lifetime value of the customer and the actions you did, can you just give an example of that? How do I know that whatever you did to enhance the lifetime value of the customer by reducing contribution margin this quarter won't be extended to future periods?

Brian Landrum - Executive Vice President and Chief Operating Officer

Brian, it's a kind of approach that we've really... it's one of our... what we view as a little bit of a competitive advantage right now is how we think about this. So I can give you some general concepts about how this works without getting into specifically what we are doing. But a big part of what we are looking at is once we have a customer what are the series of things that we can do to extend the life of the time the customer stays with us so that we don't incur the cost of an attrition and a subsequent acquisition, because that's got a substantial amount of costs associated with it.

And so the trade off between having someone leave us and then having to acquire a separate customer and possibly having... making the trade off between having a customer in one market where margins are a little better shift to a market acquire... leave from that market and acquire a customer in a market that may not be as attractive in terms of margin, that's all going into our decisions around what to invest to improve that churn effect so that over time with the reduced number of ins and outs in the customer base, we're going to see improved performance.

Brian Chin - Citigroup

So basically, we are saying shifting the customer base from lower profit regions to higher profit regions as much as possible [ph].

Brian Landrum - Executive Vice President and Chief Operating Officer

That's one component. The other component could be some pricing decisions, incentives, customer service levels, some particularly responsive outbound communications. It's a series of... a combination of kind of pricing, marketing, brand positioning and services. And I think that's the bulk of what we are talking about on the commodity side. Of course, as we go through time, it's our view that we'll be able to bring smart energy solutions to market and change the basis of competition from the commodity to a broader set of services around demand.

Brian Chin - Citigroup

Okay. Great. And then you said that the NOLs will be used before the end of 2009. Can you just give me a quick update on what is the value of NOLs as of right now?

Rick Dobson - Executive Vice President and Chief Financial Officer

We don't actually calculate that. Let's back up... it's Rick. So what we have is the June 20th forecast, which has substantially more EBT to it [ph] now. And when you have that much... when you add almost a billion dollars of EBT from the last outlook, basically it throws the NOLs and then accelerate some sort of, they are all used up by end of '09. And if that was the profile that was going to happen, you would have basically very little discounting at the NOLs, they'd almost be worth their notional amount, that's in the... disclosed in the 10-K and the tax footnote. But that changes every time we have an outlook, and so depending on where... how you have those NOLs play out, whether it's over two years or three years, you pretty much get pretty close to a slight discounting on the notional number that's setting in the tax footnote, which is a billion... I'll have to get that number, I think it's a billion three, around a billion three in the tax footnote.

Brian Chin - Citigroup

Okay, great. Thanks.

Operator

Thank you. The next question is from Elizabeth Parrella from Merrill Lynch. Please go ahead.

Elizabeth Parrella - Merrill Lynch

Yes, thank you. Mark, you mentioned a lot of focus on liquidity. Can you remind us what the liquidity was at the end of June? I think it was about 1.6 billion at the end of March, and where do you think it needs to be on a kind of sustainable basis?

Unidentified Company Representative

Elizabeth, at the end of July, our liquidity level was at $1.5 billion, so not a big change for that. And look, as we think about liquidity going forward, I certainly would like to see our company with at least a billion dollars of liquidity in a normal operating environment, here just to manage the kind of ins and outs of cash variations as we go through the year. And again, given extraordinary market conditions we have now, that's part of which you hear in the conversation is, by us to keep that number a little bit higher.

Elizabeth Parrella - Merrill Lynch

Just then following up on your comments on that being a primary concern in terms of not undertaking a stock buy back at present. And when I think about the puts and takes, you don't hedge on the wholesale business, so you don't need a lot of liquidity for posting collateral. On the retail side you've got the Credit Suisse, so versus other generators you have less need for liquidity because of your hedging strategy. Then I think you're getting, is it $500 million plus, and what's net assets... net proceeds from the two asset sales and when are they going to close, but presumably that's before the end of the year? You've got third quarter which is the big quarter, free cash flow coming up, I mean should we be anymore optimistic that you'll revisit this after the third quarter and after the asset sales close? Maybe you can just walkthrough with some of the issues I've raised?

Unidentified Company Representative

Yes. Elizabeth, we are revisiting this every single day, here it's a high priority for us to look at our situation in terms of all the different alternatives we have. Again, I don't think it makes sense for us to prematurely commit to, what we're going to do with cash that we don't yet have. And I said, I used an analogy on our last quarterly call that I think is still very appropriate. But if we were investing in stocks rather than being an electric company, we wouldn't be deciding today what we're going to do with cash inflows that we're going to have in our funds next quarter or next year. But rather what we do is, we'd have an investment philosophy and we'd look at that opportunity set that we saw at the point in time. And the other point is that remains that in a difficult market, we might choose to keep more of the position in cash to manage risk. But I certainly agree with you, we feel very good about, again with our hedging profile, we feel like we're in very good position here.

Elizabeth Parrella - Merrill Lynch

And the timing on the asset sales, just remind us so to those third quarter events, working on it [ph]?

Unidentified Company Representative

Well I... we're speaking to Bighorn, the debt timing is... it's a second half event, it could be as early as October, but it could be in the fourth quarter. We still have the PUC, Nevada PUC approval to obtain or they do, excuse me, and us. And also as a reminder, there is the potential, I use that word carefully that secured bondholders could if they choose, could take $300 million of that at basically at par. And so, that's the potential, at this point well they are trading at a very high potential. And then Channelview did close on July 1st as I've referenced and we did pick up $15 million of cash and then we expect to pick up another $50 million works through it's cycle to closure.

Elizabeth Parrella - Merrill Lynch

Thank you.

Dennis Barber - Vice President of Investor Relations

Operator, I think we can take one more question.

Operator

Thank you. The last question is from Angie Storozynski from Macquarie. Please go ahead.

Angie Storozynski - Macquarie

Yes, thank you. I have a question about those 25,000 additional mass customers that you guys signed up. Should we assume that being that they were signed up when the commodity prices were really high, is there an implication that basically implied gross margins for these clients will be significantly higher than your average or your normalized levels?

And secondly, how about C&I customers? We saw this incredible drop in margins. Is it... does it have to do with the length of contracts? Is it something more substantial? Is it just a temporary variance in margins realized or is it something that the approach to... of C&I customers differs regarding the length of contract or the type of products that they are buying?

Brian Landrum - Executive Vice President and Chief Operating Officer

Let me address the effect on margin first. The effect on margin that you are seeing in the 2008 numbers is purely related to the events of the second quarter. And that you can see in the waterfall on the retail slide in my section of the presentation. And I think that's entirely the reason why we are seeing the C&I margin compression.

The commercial industrial business, we continue to be a leader in that business. We added new load year-over-year from ERCOT, from new markets outside of ERCOT and PJM particularly, Illinois as well as in our existing markets in PJM. So we feel like we are in a very good place in that commercial industrial business. And in fact, we continue to asset that we are the market leader in the commercial industrial space and so don't see any ongoing issues associated with volume or margin in that business.

On the 25,000 customer question, the margin issues that we had during the second quarter and what we see for the downhill in 2008 are really related to customers that we had prior to getting into that environment. And those customers were priced in a different environment. The customers we acquired during the second quarter... and that... by the way, that trend of improved customer count has continued through July in our residential market. For those customers we are going... we expect to have for a long time and any effect that we had during the second quarter or early third quarter on those margins, we expect to work out through time and that's why you see our 2009 and 2010 outlooks where they are.

Angie Storozynski - Macquarie

Okay, great. Thank you.

Operator

There are no further questions at this time. Thank you ladies and gentlemen. This concludes today's conference. Thank you for participating. You may all disconnect.

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