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Pepco Holdings, Inc. (NYSE:POM)

Q2 2008 Earnings Call

August 12, 2008 10:00 am ET

Executives

Donna Kinzel - Director, Investor Relations

Dennis Wraase - Chairman and Chief Executive Officer

Paul Barry - Senior Vice President and Chief Financial Officer

Joe Rigby - President and COO

Dave Velazquez - President and CEO of Connectiv Energy

John Huffman - President and COO of Pepco Energy Services

Kirk J. Emge - General Counsel

Kevin M. McGowan - Vice President of Strategic and Financial Planning

Analysts

Ashar Khan - SAC Capital

Paul Patterson - Glenrock Associates

Dan Jenkins - State of Wisconsin Investment

Keri St. Louis - Fidelity

Raymond Lee - Goldman Sachs

Maurice May - Soleil - Power Insights

Chris Shelton - Millennium Partners

Operator

Welcome to the second quarter 2008 Pepco Holdings, Inc. earnings conference call. (Operator Instructions) I would now like to turn the presentation over to your host for today's call Donna Kinzel, Director, Investor Relations.

Donna Kinzel

Welcome to the Pepco Holdings second quarter 2008 earnings conference call. The primary speakers on today's call are Dennis Wraase, Chairman and Chief Executive Officer, and Paul Barry, Senior Vice President and Chief Financial Officer. Our team is at various locations today so Joe Rigby, President and Chief Operating Officer, will moderate the Q&A session at the end of the call. Also participating in the Q&A session are Dave Velazquez, President and Chief Executive Officer of Connectiv Energy, and John Huffman, President and Chief Operating Officer of Pepco Energy Services.

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

Dennis Wraase

I continue to be very pleased with our 2008 operating performance. All three of our major businesses had a very good second quarter result. Our achievement of constructive regulatory outcomes drove higher earnings at Power Delivery. At Connectiv Energy, despite slightly lower run time at the plants quarter-over-quarter, gross margin was up 58% as our assets capitalized on higher spark spreads and capacity prices. At Pepco Energy Services we saw a 9% electric sales growth, reflecting our continued expansion into new markets.

Our second quarter results also reflect an after tax, non-cash charge to earnings of approximately $93 million due to a change in our assessment of our tax position associated with our cross border energy lease investments. I'll discuss this in more detail later in the call. We consider this charge to be a special item and not representative of the company's ongoing business operations.

Earnings for the quarter were $15 million compared to $7 million in the second quarter of 2007 - $57 million in the second quarter of 2007. Excluding the charge associated with our cross border energy leases, earnings for the quarter would have been $108 million, almost double the second quarter of last year.

Paul will discuss the financial results in detail but first I'll address a few items of interest, starting with Power Delivery's progress on certain regulatory initiatives.

As we discussed previously, our transmission assets are subject to FERC jurisdiction and the transmission rates are set under a formula rate process. Under this process, transmission rates are reset each June 1. The estimated annual incremental revenue impact of the rates put in first June 1, 2008 is about $11 million. An increase in investment was a major driver for the rate increases. Transmission rate base as of December 31, 2007 was $94 million, up 4% over the prior year.

Later this month we plan to make a filing with the FERC - Atlantic Power Pathway or [MAP] project. We anticipate the filing will include a request for a higher return on [break in audio] in the scope of the project and its complex technical aspects. We also anticipate the filing will request the construction work in progress be included in rate base and that 100% of prudently incurred costs be recovered in case of project cancellation for reasons beyond our control.

By the end of the third quarter we expect to make a filing with the Maryland Public Service Commission to request approval to begin construction of the Southern Maryland portion of the [MAP] line in the fourth quarter of 2009. This portion of the line will extend from Possum Point, Virginia to Calvert Cliffs, Maryland. The design for this part of the line is scheduled to be completed by the end of the year.

Also in connection with the MAP project, the PJM staff has supported a direct current crossing of the Chesapeake Bay. The estimated incremental cost for the direct current crossing is approximately $400 million. The use of direct current provides system benefits, operating flexibility, and is environmentally friendly. The PJM board is expected to address this issue later in the summer.

Our blueprint initiatives continue to move forward. On June 17th, a hearing examiner's report was issued in Delaware recommending that the Commission approve the application of AMI technology in the distribution system. A Commission decision is expected later this month.

In the District of Columbia, a residential pilot program that will test advanced metering technology is underway. This technology, coupled with innovative pricing options, will enable customers to reduce their electricity usage when prices are high. This pilot will be the first in the electric utility industry to test the response of residential customers to three different innovative pricing options under one program. The pilot began on July 21st and includes about 1,200 customers.

Our blueprint programs and investments will enable our customers to better manage their energy usage in an effort to reduce the energy portion of their bill.

Now I'll turn to our competitive businesses. Connectiv Energy had a very good second quarter. Based on the results for the first half of the year and our projections for the remainder of the year, we expect Connectiv Energy to achieve annual total gross margin results in the upper portion of our 2008 forecasted range. Construction of Connectiv Energy's new power plants at the Cumberland and Delta sites continues to proceed on schedule and within budget.

Pepco Energy Services continues to make good progress in its expansion markets. At June 30th, PES served over 900 megawatts in these markets, a 17% increase over year end and a 48% increase over June 30, 2007. Retail electric sales continue to be strong. PES delivered more than 4,800 gigawatt hours of electricity in the second quarter of 2008, which represents a 9% increase over the second quarter of 2007 electric sales.

On the Energy Services side, in June PES announced a 20-year power purchase agreement with the Atlantic City Convention Center to install one of the largest single roof-mounted solar arrays in the United States. Pepco Energy Services will build, own and operate and maintain the 2.36 megawatt solar project. Construction began in June and will be completed by the end of the year. This is a landmark project for the region and one that aligns with our efforts to do our part to lessen the environmental consequences of electricity production.

As I mentioned earlier, during the second quarter we recorded a non-cash charge to earnings due to a change in our assessment of the sustainability of our tax position with respect to our cross border energy lease investments. Under the accounting rules we are required to periodically assess the likely outcome of uncertain tax positions related to these investments, which are commonly referred to as SILOs. Our reassessment considered several factors, including the recent court decisions in favor of the IRS.

Total charge to earnings was $93 million after tax. One component of the charge is an $86 million reduction in the equity value of our cross border energy lease investment as the result of the change in assumptions regarding the timing of cash flows under the lease arrangements. This charge on a pre-tax basis has been recorded on the income statement as a reduction to other operating revenue.

Under the accounting rules, the amount of this adjustment will be recognized as income over the remaining life of the leases, which expire between 2017 and 2047. A second component of the charge is a $7 million non-cash accrual to income tax expense. This accrual covers the estimated after-tax interest payment on the potential taxes that would be due based on the change in cash flow assumptions. The tax payment that would be required based on the assumption changes is approximately $107 million plus $10 million of after-tax interest.

To date we have not made any tax payment in connection with the revised cash flow assumptions. Whether PHI makes a payment of this amount or any amount will depend on a number of factors, including the company's litigation strategy.

Looking forward we expect the revised assumptions as to the timing of cash flows will decrease the annual earnings and cash flow of the other non-regulated business segment by approximately $20 million after tax over the near term. This amount includes interest accruals of approximately $4 million annually.

While we took this charge to comply with the accounting rules, we continue to believe that the tax treatment we applied to these transactions was appropriate based on the applicable statutes, regulations, and case law, and we intend to continue to defend vigorously this position.

At this point, let me turn it over to Paul Barry.

Paul Barry

I hope you've had a chance to review our earnings release. I'll review our results and provide some additional detail. We'll then open the call to your questions.

All three of our major businesses - Power Delivery, Connectiv Energy and Pepco Energy Services - posted higher quarter-over-quarter earnings. Consolidated earnings for the second quarter were $15 million or $0.07 per share compared to $57 million or $0.30 per share for the second quarter of last year. Excluding the special items relating to the cross quarter energy leases, earnings for the 2008 quarter would have been $108 million or $0.53 per share. There were no special items in the 2007 period.

Year-to-date consolidated earnings were $114 million or $0.57 per share compared to $109 million or $0.56 per share for the first six months of 2007. Excluding the special items, earnings would have been $207 million or $1.03 per share for the 2008 period.

Power Delivery earned $0.37 per share in the second quarter compared to $0.24 per share in the second quarter of 2007. The biggest driver for the quarter was the impact of the Maryland and District of Columbia rate case decisions, which increased earnings by $0.08 per share. About $0.06 of this was due to higher distribution revenue and $0.02 was a function of lower depreciation and amortization expense.

Higher network transmission revenue increased earnings by $0.03 per share, driven by the higher formula rates in effect in addition to the prior year true-up ending on May 31st of last year.

Another positive factor was income tax adjustments related primarily to FIN 48 interest, which increased Power Delivery earnings by $0.03 per share. The partially offsetting factor was higher operation and maintenance expenses in the 2008 quarter, which lowered earnings by $0.03 per share. These higher expenses were primarily due to preventive maintenance and system operation costs and employee-related expenses. While these costs were higher quarter-over-quarter, they were in line with our expectations as presented at our April 4th analyst conference.

Another offsetting factor was lower weather-related sales, which reduced earnings by about $0.01 per share. Heating degree days were down 21% as compared to the second quarter of last year, and cooling degree days were down 3%. The impact of the weather for the quarter versus normal weather is an earnings increase of $0.01 per share.

Year-to-date, Power Delivery earnings were $0.61 per share in 2008 compared to $0.41 per share for the six months ended June 2007. Again, the biggest driver was the impact of the Maryland and District of Columbia rate case decisions, which increased earnings by $0.14 per share period-over-period.

Other positive factors were the impact of higher transmission rates, which increased earnings by $0.06 per share and income tax adjustments, which also increased earnings by $0.07 per share. Partially offsetting these increases were higher operation and maintenance expenses, which lowered earnings by $0.04 per share. Lower weather-related sales also lowered earnings by $0.04 per share. The impact of the weather year-to-date versus normal weather is an earnings decrease of $0.01 per share.

Connectiv Energy's results for the quarter were $0.10 per share as compared to $0.01 per share in the 2007 period. Merchant Generation and Load Service gross margin increased $34 million quarter-over-quarter. About $17 million of this increase is due to higher spark spreads in 2008. Higher PGM capacity prices net of capacity hedges drove approximately $10 million of the increase, and about $7 million of the increase is due to marked-to-market gains related to economic coal hedges.

Connectiv Energy's results for the six months ended June 2008 were $0.34 per share as compared to $0.11 per share for the 2007 period. The higher earnings are primarily due to opportunities resulting from its generating unit's operating flexibility and dual fuel capability and its firm natural gas transportation and storage positions, coupled with increasing fuel prices and volatility. Higher capacity prices and marked-to-market gains related to economic fuel and power hedges also contributed to the increase in earnings.

Taking into consideration results through June, Connectiv Energy expects to achieve annual total gross margins in the upper portion of our 2008 forecasted range of $380 million to $435 million. In addition, we are confirming our forecasted gross margin ranges of $400 million to $475 million for 2009 and $460 million to $550 million for 2010.

Pepco Energy Services results for the quarter were $0.08 per share compared to $0.06 per share for the second quarter of 2007. Year-to-date results were $0.12 per share as compared to $0.07 per share for the 2007 period. The increase in earnings for both the quarter and year-to-date periods was driven by higher earnings from the retail energy supply business. The significant drivers were more favorable congestion costs, a $7 million pretax marked-to-market gain related to certain economic hedges of PGM congestion risk, and increased generation output.

Now I would like to turn briefly to the progress that PHI has made on its capital investment program. As you heard Dennis discuss, we're investing in a number of strategic growth initiatives at PHI, and these opportunities are across both the regulated and competitive businesses. Our planned capital investment over the next five years totals $5.7 billion. In the first six months of 2008 we have completed approximately $370 million of this investment. As we continue our focus on growth, we will also be opportunistic in assessing economic and efficient ways to raise capital, including evaluating the timing and structure of potential securities issuances.

In closing, we are very pleased with our 2008 operating results to date. The strong performance of each of our major businesses has enabled us to make good progress in the execution of our strategic plan.

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

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Ashar Khan - SAC Capital.

Ashar Khan - SAC Capital

Just going to the leases, I wanted to know what happened, I guess, between the first and the second quarter. The first quarter, if I remember from your comments, you said your leases were different from other people and you didn't feel any need for any kind of write-downs. And then - I just wanted to understand what was the major difference that happened between the end of the first quarter and now.

Dennis Wraase

I guess the biggest thing is the point I made in my earlier remarks. There were some recent decisions by the IRS on some LILOs and some - what is commonly called SILOs. While we believe our leases are different, those unfavorable decisions sort of made us take a second look at this. And I think that's probably the major reason that we made a decision to consider an adjustment in this period.

Ashar Khan - SAC Capital

Because you know those decisions had already come in by the time you had reported your first quarter, if I am right.

Dennis Wraase

They came in after the close of the quarter. For accounting purposes, they were second quarter issues.

Ashar Khan - SAC Capital

And then can I just ask you, you know, you've had like two companies which are, I guess, giving us that they might be pretty close to settlement talks. Should we expect this issue to be settled this year? What's the chance of that as we sit down over here?

Dennis Wraase

I think it's highly unlikely it'll be settled this year. I think one of the things you can conclude from at least what I've been able to read from all of the various announcements that have been made regarding these decisions by utilities that many of these cases are very fact specific. And it's unfortunate that from you all's perspective and from the public's perspective they sort of get categorized as big buckets called LILOs and SILOs because the reality of it is each of our facts and circumstances are unique distinct, and you can't characterize where one company is and compare it to where another company is at this time.

So I think it's highly unlikely we would have a settlement.

Ashar Khan - SAC Capital

So that means you and the IRS are way apart in terms of where things are at the present moment?

Dennis Wraase

Well, we don't want to discuss where we are, but obviously we don't have a settlement.

Operator

Your next question comes from Paul Patterson - Glenrock Associates.

Paul Patterson - Glenrock Associates

The marked-to-market gains, some of those are associated with economic hedges and I think others are sort of an optionality that you guys have been able to capture. Could you give us a little bit of a breakdown as to what you think, if any of this will reverse and when it might reverse?

Dave Velazquez

There's actually, if you look at the six months' results, a couple of different marked-to-market gains are ineffectiveness gains reported. You know, in a general sense it's kind of hard to predict, you know, where future prices are, which will have an impact on that.

You know, to give you a little bit of color on it, we report in here on the coal contracts. We have some marked-to-market gains on those. I guess I would say that it's, you know, some of those gains could be reversed as time goes on, depending what happens with coal prices. But most of the hedges we have on the coal side were put on, I'd say, middle to third quarter last year when coal prices were much lower than they are today. So I think a lot of those gains will stay.

I think, you know, as an overall statement, we've just reaffirmed our guidance or our forecast for where our gross margins are going to be, both for '08, '09, so we're not expecting that any change in the value of those marked-to-market gains will have, you know, a significant impact.

Paul Patterson - Glenrock Associates

So in other words they don't hedge a physical asset, and as a result, it isn't just - it isn't hedging effectiveness that's happened here. It's an increase in a position that you think will be realized, and that's just how it works, right?

Dave Velazquez

Well, the reason for the, on the coal contracts, ineffectiveness is they failed on the volume test so they're considered excess from an accounting perspective. But we expect, when we look at our model results going forward, we would expect that yes, we would end up burning that coal over the next few years in the plants.

Paul Patterson - Glenrock Associates

And then on the Panda-Sempra Energy Trading deal, I'm not completely clear. I mean, it looks like you guys are going to be assigning your obligations to Sempra and then you're going to be paying Sempra. Is that correct?

Kirk J. Emge

That's correct. If the transaction closes with Sempra, we will have terminated all of our responsibilities and obligations under the current PPA and assigned those obligations to Sempra Energy for a price.

Paul Patterson - Glenrock Associates

How much is that price?

Kirk J. Emge

That's confidential. I can't disclose it at this point.

Paul Patterson - Glenrock Associates

Okay, but this is obviously an obligation that you guys are, what, losing money on, and as a result you're giving them money to take the obligation off your hands. Is that the way to look at it?

Kirk J. Emge

Well, the transaction requires Pepco to pay a certain amount to Sempra for Sempra to take the assignment of the obligations and responsibilities under the Panda PPA.

Paul Patterson - Glenrock Associates

Right. So but I guess what I'm trying to understand is the financial implications of it. It would seem to me that you wouldn't be paying them money unless what they were taking was below market or out of the money, I guess, is a better way to put it. So, I guess, is that safe to assume or is there something I'm missing here?

Kirk J. Emge

As you may recall, last year - well, two years ago - we settled the Mirant claim that we had for rejection of the backtoback agreement, and in return for that settlement we received approximately $450 million. The amount that remains in the account, which is a restricted cash account, the amount that remains as of June 30th was specified in the 10Q, and we will use a portion of that amount that remains to terminate our obligations under the Panda PPA.

Paul Patterson - Glenrock Associates

So from a financial perspective, that would mean that something that you were losing money on will go away. Is that right? And, of course, the cash that you guys got as well will go to Sempra to a certain degree?

Kirk J. Emge

The termination of the back-to-back as a result of the Mirant settlement required Pepco to assume the responsibilities of paying the price specified in the PPA, which historically has been above market. And that will go away once the Sempra transaction closes.

Paul Patterson - Glenrock Associates

And how much money have you guys been losing on the PPA?

Kirk J. Emge

We're not losing money because we set aside the amount -

Paul Patterson - Glenrock Associates

Because you got the cash from - okay, right.

Kirk J. Emge

And we're using that to pay the above-market cost to the extent that in any particular month the Panda contract is above market.

Paul Patterson - Glenrock Associates

Okay, so going forward perspective, how might this impact earnings or will it have an impact on earnings or cash flow?

Joe Rigby

It would not have an impact on earnings.

Operator

Your next question comes from Dan Jenkins - State of Wisconsin Investment.

Dan Jenkins - State of Wisconsin Investment

First of all, just kind of following up on the questions along the Panda PPA, so is the cash you're talking about, is that part of the restricted cash that shows up on the balance sheet?

Joe Rigby

Yes, it is.

Dan Jenkins - State of Wisconsin Investment

So that should - those balances will drop, then, related to this payment that you're making to Sempra, I would assume?

Joe Rigby

It would have that impact, yes.

Dan Jenkins - State of Wisconsin Investment

Then I was curious, you know, you mentioned in the release the new obligations that you're fulfilling related to the New England Power capacity sales or whatever. I was wondering how much of that impact was on the quarter's results?

Dave Velazquez

I don't have the exact numbers in front of me to how much impact it had on the quarter, but clearly it wasn't one of the top drivers, you know, that we went through in the Q and in the release. So it was not as large as some of the other things you've seen there.

Dan Jenkins - State of Wisconsin Investment

Then also I was curious, your gigawatt hours supplied to both the base-load and the mid-merit were down from last year. You also mentioned that you had higher outages. Was that mainly due to demand factors or more [inaudible] due to the outages or what was kind of behind that?

Dave Velazquez

Sometimes it's hard to, you know, discern exactly from PGM exactly why our units get dispatched a little bit more, a little bit less. Most of the decrease year-over-year for the quarter was due to the coal units being dispatched less by PJM. I don't think we've had significantly higher outages in either the coal units or the mid-merit units. We've had outages, you know, normal maintenance, planned maintenance outages on both coal and mid-merit, but I don't think they were significantly larger this year in the second quarter than last year.

Dan Jenkins - State of Wisconsin Investment

Then another thing on the balance sheet. You know, you have almost $300 million of cash, you know, beyond the restricted cash. Are you going to use that just for Capex or are you going to use that to reduce short-term debt or is there something that that cash is going to be dedicated to?

Joe Rigby

That is largely related to collateral, so we would not be targeting that for any use. We'll be watching as the market changes and the impact on that collateral.

Operator

Your next question comes from Keri St. Louis - Fidelity.

Keri St. Louis - Fidelity

I wanted to talk about the leases. It mentions in your 10-Q that you've received a letter for a potential settlement from the IRS, and I was just curious if you've had any time to review that and what the delta might be in terms of total cash outlay versus the $510 million estimate that you provide in the 10-Q?

Joe Rigby

Obviously, we've had a chance to look at it but we're still in the process of evaluating it, and it would be premature for us to comment more beyond that at this point.

Keri St. Louis - Fidelity

Is it fair to say that settlement would be less than the $510 million that's identified in the Q?

Joe Rigby

I really wouldn't want to try to discuss a settlement at this point in time.

Keri St. Louis - Fidelity

Is it also understood that the settlement would occur over time? Because I believe that, in past discussions with management previously, before there's this type of global settlement, that you thought that if there were to be cash payments made they would occur over time. Is the thinking that, with this new situation, it might be due all at once or is it still thought to be coming in over time?

Joe Rigby

We haven't really taken a position yet. One comment I'd make going back to your earlier point, just keep in mind the $510 million was a worst case, so certainly we wouldn't think that a settlement would fall within that, you know, close to that range. But, you know, we're still evaluating all of this and, you know, we've not made any determinations with regard to cash impact.

Keri St. Louis - Fidelity

And not even if it occurs all at once or over time?

Joe Rigby

We're still working our way through all that.

Keri St. Louis - Fidelity

What about the charges? Is it thought that you would have to - because it said, I guess, that you would have to terminate the leases. Would that require different charges than maybe previously thought?

Joe Rigby

Let me ask Kevin McGowan, who's our VP of Strategic and Financial Planning - I think many of you probably have had a chance to talk to him on the leasing issues - if he'd like to comment on that.

Kevin M. McGowan

Sure. The $510 million that's disclosed in the 10-Q, that represents 100% disallowance of the deductions plus the imputing of the OID income. That does represent the worst case. In the IRS' global settlement offer, it's deferral of a less amount and the termination of leases. That would have a different impact. Whether it's [higher] than the 5K or not just depends on the timing of when those leases are terminated.

Keri St. Louis - Fidelity

Do you know when you'll be able to comment on that? Is that like a third quarter event?

Kevin M. McGowan

The letter requires - 30 days to reply to the letter. We kind of view that as part of the whole, you know, we just began our settlement discussions with the IRS in July. That's part of the whole process, which we think will take several months to at least wrap up that portion.

Keri St. Louis - Fidelity

So the 30 days isn't really valid then?

Kevin M. McGowan

Well, the 30 days is to respond to that specific letter. We are still, you know, part of the whole process is to go to appeals. That may take through the fourth quarter or first quarter of next year. That letter does not change that process. If we don't settle with the IRS - if we don't agree to the letter, we still are in appeals discussion with the IRS.

Keri St. Louis - Fidelity

I guess we'll know within 30 days whether or not you agree to the letter?

Joe Rigby

I think that's possible. Just one thing I would go back to, I guess, and maybe Dennis can weigh in again, but I think on the first call we were talking about this, that, you know, we're really not expecting any activity around a settlement really for the rest of this year.

Keri St. Louis - Fidelity

Yes, but the letter obviously is different than the settlement discussions, so I'm just trying to get an understanding of what may have changed. I know that that was your previous view, but obviously that might - this letter might change things, correct?

Joe Rigby

I don't think that's really a - sitting here right now, that's not our view, that it would change things.

Keri St. Louis - Fidelity

Okay. And then - all right, so then I guess your view on equity issuance still is for 2009 unless there's a view that maybe IRS settlement changes and cash outlay is more of a near-term event?

Paul Barry

Yes, I mean, I think the charge that we're taking with respect to the leases, it's a non-cash charge so it really doesn't sort of enter the calculus for financing plans. And, you know, Keri, on the call we talked about issuing a significant amount of equity to fund our investment plans, from $1.2 to $1.5 billion of equity, and I guess, you know, we just expect to be opportunistic in the face of what's been pretty turbulent capital markets. And so if, you know, there's favorable conditions, we'll just be opportunistic and try to take advantage of that without setting any specific time schedule.

Operator

Your next question comes from Raymond Lee - Goldman Sachs.

Raymond Lee - Goldman Sachs

Have you guys updated any reserves related to the leases, and can you talk about, you know, just following on Keri's question about equity, does this potentially accelerate your potential to issue equity here to sort of support your credit profile?

Paul Barry

Yes, I mean, I don't think this is a significant portion of our overall financing plans, this charge. And, as I said, it's noncash, so I don't think it really, you know, would impact, you know, amounts or timing in a material way. Obviously it's something we have to monitor closely, but no, I don't think it's significant and really changes what we've talked about before in terms of how we expect to finance ourselves.

Joe Rigby

And Raymond, with regard to the question on the reserve, you know, the charge that we just disclosed is the reserve.

Raymond Lee - Goldman Sachs

Okay. Is it a cash reserve?

Joe Rigby

A non-cash [charge].

Raymond Lee - Goldman Sachs

And one final thing, any update on financing plans for the remainder of the year?

Joe Rigby

Paul commented on that in his earlier part of the call. If you want to maybe go back to that, Paul, if you would?

Raymond Lee - Goldman Sachs

Okay, sorry I missed that. Thanks, guys.

Paul Barry

I don't have much more to add. I mean, our financing plans are pretty consistent with what we've talked about before, and I think we've always said that we wanted to be opportunistic. When the capital markets are open and available to us on favorable terms and conditions, we may seek to access it because we know we've got a significant amount of both equity and probably equity like securities to issue to fund our overall investment plan.

Operator

Your next question comes from Maurice May - Soleil - Power Insights.

Maurice May - Soleil - Power Insights

I have a question on the leases again. I think earlier, Dennis, you mentioned that the ongoing profitability of the leases will be reduced $20 million. Is that correct?

Dennis Wraase

Yes, that's right.

Maurice May - Soleil - Power Insights

Okay. And the leases had been providing about $35 million after tax and benefits?

Dennis Wraase

I think they were - they may have been. The timing's different, but I think we think of them in terms of around $30 million on an ongoing basis.

Maurice May - Soleil - Power Insights

Okay, so they immediately now, starting with the third quarter, begin to earn at that reduced level?

Dennis Wraase

That's correct.

Maurice May - Soleil - Power Insights

Okay. And then second of all, on the litigation track versus the settlement track, given your history with [merit] issues, where you litigated for a couple of years before you settled, can we expect, you know, some vigorous litigation going forward, at least for the near term, with the tax issue?

Dennis Wraase

Well, let me respond. I think the concluding comments I made were we still believe that these leases met all the rules and obligations that were required and that they are appropriate and our tax deductions are appropriate. And at the moment, we intend to - if we can't reach some kind of a settlement, which at the moment, as I said, is way out in the future in my view, we intend to vigorously litigate.

We believe, as I said, that all these leases are somewhat different, so you can't compare what one company has to another, but we know about our leases and we know our position. So at the moment my intent would be to litigate, which means it could be lengthy.

Operator

Your next question comes from Chris Shelton - Millennium Partners.

Chris Shelton - Millennium Partners

I actually had a question for Dave on the spark spread increase year-over-year. I was curious what - if you saw  was that a product of the market spark spread increasing or was that, you know, hedging related or, you know, how  a little more color around the spark spread increase if you could.

Dave Velazquez

That was more a product of the market. And it may not be, if you just follow PJM West Hub tower and Henry Hub gas, it may not be as apparent, but congestion west to east was much higher this quarter this year than the same quarter last year, and that helped - it more than offset, if you will - kind of the slightly lower spark spread if you just looked at West Hub versus Henry Hub gas.

Chris Shelton - Millennium Partners

Okay, and then also on the - you said you reiterated your gross margin guidance today. Had a couple of pretty good quarters. Is there a [inaudible] going through the second half or, you know, something - some timing related issue on the gross margin?

Dave Velazquez

No, I don't think so. I think just when we look at the year and our projections, you know, for the year, we look at where we are and where we expect to be, you know, we think it adds up to us being in the upper portion of the range. But there's no single event that we're looking for in the second quarter, you know, either hugely positive or negative.

Chris Shelton - Millennium Partners

So kind of on target there?

Dave Velazquez

Yes.

Operator

I would now like to turn the call back over to Pepco Holdings.

Joe Rigby

We want to thank all of you for joining us today and for your interest in PHI, and we will look forward to talking to you over the next quarter.

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Source: Pepco Holdings, Inc. Q2 2008 Earnings Call Transcript
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