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PNM Resources, Inc. (NYSE:PNM)

Q4 2008 Earnings Call

February 6, 2009 9:00 am ET

Executives

Gina Jacobi – Director of Investor Relations

Jeffry E. Sterba – Chairman & Chief Executive Officer

Pat Vincent-Collawn – President & Chief Operating Officer

Charles N. Eldred – Executive Vice President & Chief Financial Officer

Analysts

Jonathan Arnold – Merrill Lynch

Brian Russo – Ladenburg Thalmann

Samuel Brothwell – Wachovia Securities

Operator

Good day, and welcome to the PNM Resources 2008 Earnings Conference Call. Today’s conference is being recorded. At this time, I would like to turn the conference over to Ms. Gina Jacobi, Director of Investor Relations. Please go ahead, ma’am.

Gina Jacobi

Thank you everyone for joining us this morning for a discussion of the company’s fourth quarter 2008 earnings. Please note that the presentation and accompanying materials for this conference call and supporting documents are available on the PNM Resources website at www.pnmresources.com.

Joining me today are PNM Resources Chairman and CEO, Jeff Sterba; PNM Resources President and Chief Operating Officer, Pat Vincent-Collawn; and Chuck Eldred, our Executive Vice President and Chief Financial Officer, as well as several members of our executive management team.

Before I turn the call over to Jeff, I need to remind you that some of the information provided this morning should be considered forward-looking statements, pursuant to the Private Securities Litigation Reform Act of 1995. We caution you that all of the forward-looking statements are based upon current expectations and estimates and that PNM Resources assumes no obligation to update the information. For a detailed discussion of factors affecting PNM Resources results, please refer to our current and future annual reports on Form 10-K and the quarterly reports on Form 10-Q as well as other current and future reports on Form 8-K filed with the SEC.

And with that, I’ll turn the call over to Jeff.

Jeffry E. Sterba

Thank you, Gina and good morning. Thanks for joining us today. I’m sure you have had a chance to read the press release, where we announced ongoing earnings per share for 2008 of $0.12 within a $0.01 of market estimates. If I [was to] summarize 2008, it was certainly a difficult transitional year for us.

Our focus was really on shoring of the foundation for providing sustainable returns in the future, but we had a significant performance shortfall at one of our units First Choice Power. While, the financial results are obviously unacceptable going forward for the entire corporation. We did make significant progress on the four strategic initiatives that we laid out for our owners at the beginning of 2008. Let me just summarize those briefly.

Relative to fair regulatory treatment, this is not something that as we’ve talked before you turn on a dime. It takes time, its building better understanding with regulators, its working with regulatory lag that that keeps rate increases from going in, in a timely way, although we are focused on that.

But if you look at 2008, we had our first electric rate increase in over 20 years. We also had the first fuel adjustment clause implemented for the company on the electric side of the business in over 15 years. Progress is being made; Pat will talk more about the regulatory environment that we’re in, and the improvements that we’re seeing.

We also had a major focus on efficiency and effectiveness, and we drove $35 million of cost out of our structure, which is about 15% of controllable O&M by that I mean non-fuel, non-lease related operating costs. And that process hasn’t done, it will continue.

We also laid out that we wanted to simplify our operation particularly within PNM, where we conducted merchant operations very successfully over the last seven years. But as you move into a period of rate cases, having that that mixed merchant model within the utility was problematic.

We entered into a successful Palo Verde tool at very good prices to take care of the unregulated piece of Palo Verde, and we have reached an agreement to move all of the merchant gas units into Mexico, into our regulated operations and that is waiting commission approval.

And then last, we said that we really wanted to focus on our core electric businesses, and so we executed a sale of the gas business. Pat and I are going to talk about the operational performance of our businesses, and then Chuck is going to provide us a financial summary and discuss our 2009 outlook and major drivers for 2010. But before turning over to Pat, I would like to bring your attention to slide five, in which we identify the checklist that we utilized in our first meeting in January to say this is what our owners can hold us accountable for in 2008.

Of those eight items, seven were accomplished and I think we’re accomplished in pretty good form. Unfortunately one, we felt short on, and we will spend sometime talking about that. Relative to the gas transaction that its closed as of yesterday, we dividended $220 million up to the parent, which will largely be used for debt buyback and I believe most of you are aware the tender process that we’ve conducted. The Cap Rock transaction, we’ve talked about before, where we received a payment of $15 million. In relationship to EnergyCo, as I said I will come back to First Choice in a minute.

We’ve got Cedar Bayou IV moving forward on schedule and on budget to be online in this summer. The Palo Verde’s performance has continued to show steady improvement. I’m sure you all and obviously us also would like to see that improvement come quicker. But when you are dealing with the nuclear facility, it really has about rebuilding regulatory margin.

The good news is that we are seeing very positive signs of acceptance by the regulator that’s being the NRC. As to the execution of the plan to bring Palo Verde out of the degraded cornerstone status. Obviously one of the major things that we are going on in 2008 was about a $360 million construction endeavor to retrofit the environmental back end of San Juan.

We’ve completed that one three units. They are operating very, very well, and the last unit to be going through that project went down this last Friday in fact. So, I think, we not only are seeing good performance out of the units since they come back, but the environmental performance is in fact better than we had anticipated.

I talked about the O&M reductions that we’ve achieved and that we file rate cases in both Texas and in New Mexico that Pat will talk about. Pat is going to talk about the operation of the two utilities in New Mexico and Texas and then I will come back and talk about First Choice Power and Optim Energy. Pat?

Pat Vincent-Collawn

Thank you, Jeff and good morning everyone. I’m going to start on slide seven, as Jeff mentioned while this was not a year that we are happy with the outcome. There was a lot of the solid achievement going on. PNM had its first new rates implemented in May, which was worth about $34 million to us, and then we obtained a much needed fuel clause a month later.

Chuck is going to provide you with more detail, but net of the fuel expense and the planned outages of prior June. Higher rate relief and the fuel recovery clause added about $0.26 per diluted share year-over-year. We then filed a rate increase in September for a $123 million, testimony will be filed later this month on February 27, and we are in nine-month clock for that case. We feel that this case is being put in a much more constructive regulatory environments and we have seen before in New Mexico.

Jeff mentioned we’ve completed our San Juan scheduled environmental upgrades and those have gone very well. We are seeing very good operational and environmental performance out of those. Our completed units for example, we’re seeing 95% SO2 removal and mercury removal north of 90%. One of the things, we keep our eye on here is reliability. In this cost cutting environment and in an enhanced regulatory environment, we need to make sure that our environment, or reliability is still good. And PNM and TNMP have both maintained top quartile reliability, which helps with customer satisfaction.

Jeff talks about Palo Verde, and we’re working with them and they continued their improvement. They went from an EAF of 77% in 2007 to an EAF of 83% last year in 2008, and we also achieved our business improvement plans. We turned to the next slide on page 2009 – excuse me on page eight and talk about 2009. I want to talk about our focus areas, but for a minute I wanted to talk about the economy. One of the things that I think every utility and every business is struggling with is what is 2009 going to look like on an economic basis.

We’re looking at load growth in both of our territories at about 1%, which is very consistent with what we saw at year-end in both territories. And also in PNM for example, half of that load growth comes from one municipal customer, which is already online. Some of it comes from Intel who, as many of you may remember, closed down one of their fabs here in New Mexico last year to retool it. It is now their newest and most automated facility and we will be seeing some load growth from that this year.

We’re working very hard to achieve our appropriate regulatory, ROE. We continue on our cost recovery. Just yesterday here in New Mexico legislature in the Senate, Senate Bill 477 was introduced for those of you that track legislation. It is a bill that allows a historical test year, it puts it in statute including future text year, excuse me, including CWIP it was introduced by Senator Payne, who is the minority whip here and it was cosponsored by Senator Michael Sanchez, who is the majority floor leader.

These are two very senior gentlemen and in the area of utility regulation and energy. They are the leaders in the Senate. We are also working this year on Greenhouse Gas cost recovery legislation. We’re also continuing to enhance our stakeholder relationships, both with our outreach with the general population and the business leaders, but also with the interveners. And I think you’ve seen some positive momentum on this, in terms of the stipulations. We’ve reached two key stipulations in 2008. One was the inclusion of Luna & Lordsburg and the Valencia PPA in our rate base.

And the second was the sale of the gas company, and I just want to emphasize on the sale of the gas company, the commission allowed us to keep a 100% of the gain, and we were just able to dividend, as Jeff said 220 million up to the parent from that sale. We’re also going to look to expand our renewable portfolio through effective recovery avenues, but only if we can get the appropriate cost recovery for those renewables will we be adding those to our portfolio.

The second area that we’re focusing on in 2009 is capital deployment and managing our costs. Jeff talks about the ABI savings, we have continued to bake those into our budget in our numbers and are continuing to identify more cost improvement projects. We’re working on continuing to improve our power plant availability. We will complete the final environmental upgrade at San Juan in a couple of months, started last week, should be done by the end of March.

I talk about TNMP; TNMP also had a very good year in 2008. It was a good contributed earnings, contributed $0.28 in 2008, versus $0.24 in 2007. We filed our first rate case in more than five years, last August. We offered $8.7 million increase and importantly in that case, it allows us to unlock the automatic transmission recovery mechanism that takes place in Texas, one of the features of Texas is very constructive regulatory environment.

We like many other utilities in Texas, faced Hurricane Ike this year. It was the largest restoration effort in our company’s history. We had almost all of our customers up in two weeks and received much praise from public officials in terms of how we restored customers, but also how we communicated to customers and communicated to the public officials. Also in Texas, we achieved our business improvement plans.

On page 10, TNMP focus will sound familiar, appropriate regulatory treatment to earn or allowed ROE. Seeking timely recovery of our costs will be key. The commission and the interveners came to an agreement with TNMP to allow us to abate our rate case filing until March 16.

That’s very good for us, because it allows us to do two things. It allows us to take the Hurricane Ike costs and add them to the rate case and to put at the higher interest expense that we are seeing on our debt going forward. So, they allowed us to keep all the current data in the rate case, but add those new pieces without the data to be considering sales.

We are working very closely with those interveners over there. And hope we can come to a settlement in that case. As at PNM, at the TNMP, we are working to keep our costs down, have baked those aggressive business improvement targets into their budget, and are looking for more savings.

And finally on page 11, if we face this environment, we took a look at our capital spending. The last time we talked with you, we had estimated $1.7 million in capital spending over five years. We have gone through and looked [their] areas, where we could cut out due to the slowing economic environment, and we reduced our capital spending by about $356 million.

A piece of that about a 135 million was the fact that we could include Luna & Lordsburg into the rate base. So we do not have to build in a new base load plants in New Mexico. We were also able to pullout some money due to lower load growth expectations, we have fewer polls to buy, fewer meters, fewer transformers.

We are seeing some reduction in nuclear fuel costs of about $30 million. The fact that we’ve completed two of the environmental upgrades, or three of the environmental upgrades in San Juan and only have one in the 2009, 2013-time period has lowered our capital expenditures. But, we did increase spending in our capital budget for transmission in TNMP. We will continue to spend in areas, where we can get good and timely regulatory recovery. Once we're in a question-and-answer session. I’m happy to answer any questions, and right now I will turn it over to Jeff, for First Choice Power.

Jeffry E. Sterba

Thanks Pat. Let me just add one thing on in terms of the economy within the state. For those of you that haven’t followed us greatly in the past, one of the things that you find in the New Mexico economy and it’s to a lesser extent true in Texas is that its resilience in down - economic downturns has been something that’s always been there, the part of it, is because of the large governmental, federal government presence with the labs in the large Air Force bases. And that’s why, but also we see the attraction for people to retire out here and the like, that’s why even in the fourth quarter, we still are seeing 1% customer growth rates in New Mexico. And in fact we are seeing higher than that, growth rates of customers in the fourth quarter, in the properties served by Texas.

Moving to slide 13. Let me spend a few minutes talking about First Choice Power. Obviously, the results in 2008 were unacceptable. If you look at the three prior years, the first three years that we owned Palo Verde, I am sorry that we owned First Choice Power. It averaged an EBITDA performance of about $50 million. Going into 2008, however, it slipped to a loss of $27 million, which is as I said is unacceptable.

All of us in ERCOT experienced to varying degrees, the impacts of really four things. The first was the high congestion that was experienced in the spring and frankly poor congestion management on the part of ERCOT, which has largely been rectified. Second was the extreme commodity price volatility that drives market prices and created very interesting and difficult dynamics particularly as we moved into the late spring and into the summer.

Third, as Pat mentioned Hurricane Ike, FCP has a large number of customers that are in the Hurricane – were in Hurricane Ike’s path. And fourth, largely because of both Hurricane Ike and the commodity price volatility, substantive increases in bad debt. The major drivers for the downturn in performance were lower average unit margins, which impacted us about $32 million.

Bad debt, which was an increase of about $34 million meaning that our bad debt for last year was just above $50 million or almost 8% of sales. That’s untenable, that’s got to be turned around and I will spend a few minutes talking about what our folks are doing with it, and there is a number of different factors in that.

But before I touch on that, I do want to note as I think we set out of release some time ago that, we came to the conclusion that, given that we were going to hold on to First Choice Power, we needed to change its leadership and change its direction. And we brought Brian Hayduk in at the end of last year, who was previously the President of Juice before that Senior Vice President with Constellation on the retail side and its predecessors.

Brian has already has certainly hit the ground running and has given me a greater sense of confidence about the performance capacity of this business unit, for 2009. We are already seeing a return to growth in that business, where we saw a significant reduction in the number of customers as we went through the fall, some of which was forced, we purposely slowed down the rate of customer acquisition.

We are seeing that the marketing efforts are being successful and it is up ticking. And it’s particularly stronger in our term products. So, we’ve gone from under 50% to almost 70% of our customers being on term products. But most importantly is that margins have substantively improved in the product offerings for these new customers.

So, in fact our margins in the second half of the year are more than doubled what they were in the first half of the year. And we have particularly seen strong growth in our commercial sector. Now these are a lot of customer being added that service really just barely got started in 2008, it really goes into 2009 forward, typical contract terms of three years.

On page 14, let me spend a few minutes talking about the bad debt issues specifically. Obviously, as I said this is unacceptable. There is a number of action steps that are being put into place. Some of which obviously, I don’t want to go into details on, because they are market sensitive. But they certainly include diversifying the customer portfolio to a greater extent than has been done in the past. To improve our risk-based pricing and particularly recognizing different pricing, and term provisions for customers that have different kinds of credit profiles. And it’s not as simple as just FICO scores, because there is also as demographics, where you see certain customers that may not have great FICO scores, but they’ve got great payment histories for utility kinds of services.

Then you have others that may in fact have better FICO scores, but frankly hop around. One of the challenges that we have is moving forward with the REP community to help bring about some change on a regulatory side, because there are certain rules that allow customers to REP hop while collecting bad debts at the entity that they just hop from and avoiding contract termination payments, which was the major mechanism that’s been built into the rules that you can use if a customer does hop, but they have found ways to avoid those payments.

We also need to stabilize the margins obviously and, that is obviously focused on our pricing strategies, mitigation of bad debt as I’ve talked and cost management. In terms of where we are positioned for 2009, we are about 95% hedged at margins that we are very comfortable with, the higher level what I call more necessary and appropriate margins in the business, and about 85% hedged for 2010.

I touched on the increases that we are seeing in the customer acquisition side, but this is not a business that we are going to heal by making it up on volume. The primary focus that Brian has got is on the cost side of the equation and the margin side of the equation. And as we are able to ensure that we’ve got those under better control to then continue with the growth plan. So, we can add customers.

Moving onto slide 16. Let me just briefly touch on Optim Energy, which you’ve previously heard us refer to as EnergyCo. Its EBITDA improved from $9 million last year to 49 million in 2008. It has had very strong performance at its two-generation resources, the coal-fired Twin Oaks power plant and the Altura Cogen facility, which operated at availability factors of 98% and 92% respectively.

One of the main focuses that we’ve had in 2008 is really around the optimization of Cogen facility, which is really about building flexibility into how we operate that unit to meet the steam and electrical demands of the chemical facility while maximizing the availability of that plant for market sales and ancillary services. One of its primary opportunities is within the ancillary services market and we are exercising that much more aggressively than has been done in the past.

With that, let me just touch briefly on slide 17, in terms of the strategic growth for Optim. We firmly believe there is the capacity for it to grow its EBITDA at a compounding 10%. We’ve certainly seen short price reductions, in the second half of the year of 2008, and moving into 2009. But with Cedar Bayou number IV coming online in the summer and the optimization efforts were comfortable that we will be able to achieve that kind of growth.

And we will continue to evaluate expansion of that fleet, which with Cedar Bayou will be at about 1200 megawatts. But we don’t see the kinds of market incentives today that would trigger us to want to build new facilities expect potentially in a very small niche application, where we can bring in a facility at exceptionally low cost. And we have not committed to any of those at this stage.

And we’ll continue to look at the opportunity to buy assets, but it’s not exactly a robust market. Its moving to more of a buyers market but there are many plants that have term financing in place and I think a lot of them are trying to weather the storm and determine how long the depressed prices will last and as to whether they see at the opportunity to get their returns down the road, if not we will start to see I think more owners in the market look at exiting at prices that maybe attractive for us.

With that, let me turn it over to Chuck to go into the financials at a little more detail.

Charles N. Eldred

Thank you, Jeff, and good morning everyone. As Jeff mentioned earlier 2008 was a challenging year, and while our financial results don’t show year-over-year improvement. We have made significant strides on the four key initiatives that Jeff mentioned in his opening remarks.

So turning to slide 19, I want to point out some of the significant year-over-year performance drivers. Ongoing earnings were $0.12 per share in 2008 down from the $1.11 we reported in ’07 what's not evident in our financials is the steady improvement we made on the regulated side and how the successes we achieved during the year. Most of which, Pat mentioned in our comments but in the first quarter prior to the implementation our new base rates, and the emergency fuel clause adjustment PNM’s earnings were down $0.34 from the prior year.

However, since that time PNM’s earnings have rebounded during the second half of 2008 the utilities earnings were up about $0.10 or 45% above last year. I walk across graph, clearly shows the benefit from implementing new base rates and fuel adjustment clause for PNM. The $0.26 increase in the graph reflects the impact of the higher retail rates and fuel recovery, which were partially offset by the cost incurred early in the year related to the power plant availability and higher coal cost.

Regarding scheduled generation outages, the $0.14 decline in EPS as due to generation outages reflects the O&M associated with last year’s scheduled outages. With implementation of the fuel adjustment clause, we are able to timely recover the cost of purchase power whenever we take the plants down for scheduled outages. However, we still incur the O&M expense related to those outages.

As Jeff talked about in First Choice, we begin to see a return to growth in our fourth quarter. However, the bad debt expanse more than offset that growth. During our third quarter call, we affirmed guidance; we had expressed continuing concern regarding First Choice bad debt expense, given market price volatility and the market rules in ERCOT. Unfortunately, year-end results reflect a continuation of this issue.

On financing and dilution other negative drivers experienced in 2008 include higher financing costs of $0.10 reflecting last year’s financing activities, and the credit downgrades. Dilution associated with the conversion of the equity linked securities into stock reduced earnings by $0.06; approximately $14 million new shares were issued last year.

Optim Energy, while Optim Energy’s EBITDA was up substantially year-over-year, changes in the amortization of sales and purchase contracts reduced our share of earnings and results in a $0.09 unfavorable earnings variance. The transfer of Twin Oaks to Optim Energy in the middle of 2007 also reduced our earnings by $0.09 year-over-year. The other reflects primarily the $0.07 of Valencia demand charges, which won’t be recovered until the stipulation is resolved that’s currently pending and being reviewed by the commission, which we’ll collect that through the fuel clause.

Turning to slide 20. I’ll walk you through our current outlook for the year, excluding the impact of the pending rate cases. On the electric side, we’re projecting that our regulated utilities, which include PNM and TNMP, will earn $0.32 to $0.47 next year. I’ll go through the details and drivers in a minute. The gas company, as we kept the gas an extra month. We expect $0.04 to $0.05 earnings per share for January.

On First Choice, we’re projecting substantial improvement in First Choice profitability from a loss of $0.26 to a gain of $0.10 to $0.15 per share. We recognized this is a challenge, but as Jeff has pointed our focus and attention will continue to work towards restoring the value of that business.

On Optim Energy, although Optim Energy’s EBITDA has projected to grow from $49 million to $55 million to $70 million. Our share, PNM share of Optim Energy’s earnings is expected to decline from the loss of $0.03 per share 2008, to projected loss of $0.03 to $0.08 in 2009.

The main drivers are higher depreciation and interest expense associated with the start up of Cedar Bayou IV and certainly the current market prices, which are slightly depressed or considerably depressed since we projected 2008 going forward.

The corporate is really reflects the holding company interest expense, we see that will decline by $0.32 in 2008 to a range of 16 and 20. The reason is for the long-term short-debt balances that were able to pay off in the impact of the results of the tender, which we’re able to pay off $157 million of debt at the holding company.

I want to point out since we sold the gas business before to realize going forward that we will have a different distribution of earnings quarter-by-quarter. In the past 15% of our annual earnings were generated in the first quarter, following the sales of gas business, we will no longer be the case in our quarterly earnings space, we will be closer to that, it’s a difficult electric utility.

We expect to incur loss in the first quarter, and generated about 75% of our earnings during the third quarter, but those of you that project quarterly earnings please look at page in the appendix A4 for an approximation of our new quarterly earnings distribution.

Now turning to slide 21. I will walk you through the impact of the pending rate cases on our earnings outlook for the year. We have included considerably more detail on our rate case and revenue requirement calculation and the appendix on page A10 through A14. So, I will summarize the impacts on EPS.

We are providing you with a rate case assumption as filed. You can use these factors to determine projections for the year based on your own rate case expectations. But first with PNM as you know the utility filed another rate case in September last year in which we projected in annual rate increase of a 123 million. And which only 85 will flow through the bottom line. This is because of the incremental fuel clause that we’re not collecting via the fuel clause some of that will be covered through the new base rates. $85 million translates into $0.57 per share, assuming rates go into effect in October 1 of this year. And we would see a $0.15 increase in EPS for 2009.

At TNMP, we filed an increase at an $8.7 million as Pat mentioned in her comments, the case has been evaded so that we can add Ike restoration costs of about $4 million and higher financing cost into that rate case filing. Based on our current market conditions, we are estimating an incremental interest expense to cost about $9 million, yielding an annual increase in base rates of about $18 million or $0.12 of EPS. Assuming new rates are implemented during the fourth quarter. We should see a $0.02 increase in EPS for the year. Keep in mind this is a 100%, assumption of rate increases.

Now turning to Slide 22. You will be able to compare our 2009 outlook assuming no incremental rate relief without assuming, we get a 100% of what we requested in our rate case filings. I don’t want to spend a lot of time on this slide, as you’ve already seen most of these ranges previously on slide 20. But I just want to point out to the highlighted numbers. These are the EPS ranges that are dependent upon the outcome of the $0.02 rate increases.

Turning now to Slide 23, I’ll walk you through the major earning drivers for 2009, are electric utilities. We are projecting to earn between $0.32 to $0.47 per share at our electric utilities, compared to $0.47 in 2008, excluding the impact of the pending rate cases. The increase in earnings reflects the full year impact of new base rates and fuel adjustments clause implemented in the second quarter of last year, which has $0.08, other positive drivers include the expiration of some two long-term wholesale contracts, which are expected to add about $0.10 to $0.13 of earnings in 2009.

We entered into these contracts in 2003, and that we are costing us more to serve that revenue then what we’re able to generate. So that’s when we see a pickup of $0.10 to $0.13 in 2009. The impact of lower market prices in Southern New Mexico. The lower fuel clause in the former TNMP territory in Southern New Mexico, are expected to add $0.03 to $0.05 per share in earnings.

This territory is served by Afton gas plant and now subject to the fuel clause. So, it’s benefitting from lower gas prices and favorable hedging activities. I’ve talked about load growth; it’s a big uncertainly given the current state of the economic conditions. Our base case assumes load growth of about 1% for the year, which is down substantially from previous years.

However, we reflect the uncertainty of load growth in our guidance range, which we reflect an assumed decline of load 2.7%, or slightly under the 1%. Unfavorable drivers affecting 2009 utility earnings include the new depreciation rates. We just finalized the new depreciation study and are expecting rates increased from about 2.5% to 2.8%. Pension income is also expected to reduce earnings. Last year, we earned about $8 million in pension income, while this year we anticipate pension income to approximately flat zero due to the reduced market value of our pension assets.

Higher interest expense, we expect interest expense to be substantially reflecting last year’s credit downgrades, the full year impact [that are] financing the PNM. And this year is refinancing at TNMP the debt expired and will be refinanced later. Dilution associated with the conversion of the equity linked securities expected to reduce earnings per share by $0.05, 2008 our average diluted shares outstanding averaged about $83.5 million that numbers is expected to increase to $91.7 million shares in 2009.

And moving on to the unregulated side of the business on slide 24, if you recall we measure the performance of unregulated businesses in term of EBITDA and not EPS. So that’s one of the focus on the slide as on EBITDA. Our First Choice, we’re projecting $20 to $35 million of EBITDA in 2009 and we feel confident First Choice’s can achieve this EBITDA level to the numbers that we’ve reasons that Jeff had talked about. But again reemphasizing higher margins, we’re projecting EBITDA margins in the mid 20s inline with average unit margins between 2005 and 2007.

First choice has increased its products and offerings in the marketplace, appeal to a broader set of customers and actively adjust those margins based on marketing competitive pressures. And we’re also managing a tighter retail book, matching energy sold with energy purchase, which should provide alignment to cost with actual cost, with estimated cost to the actual cost. And as Jeff pointed out early, we’ve already begun to see higher margins and return to customer growth in the fourth quarter of last year. We’re confident that First Choice can achieve its targets.

On lower bad debt, another favorable drivers, lower bad debt First Choice is seeing a positive trend in customer retention with departure rates on the decline in the recent months. We expect that bad debt trends to follow suit over time. However, we anticipate the challenges of extreme price volatility experienced in 2008 to impact 2009 to some degree.

First Choice is projecting bad debt in 2009 to average about 7% of the revenue down from about 8% experienced in 2008. Marketing offsetting the positive drivers are higher marketing cost of $46 million reflecting the return in that growth.

And moving onto Optim Energy, EBITDA is expected to increase from 49 million in 2008 to a range of $55 million to $70 million in 2009. Some of you might notice that the projection is down from the $100 million we projected last year. This decline primarily reflects the decline in forward power prices. Current forwards for 2009 are about 40% below 2008’s average power prices.

The key factors that are driving the year-over-year increase in EBITDA include the startup of Cedar Bayou IV in the summer of 2008 and favorable asset optimization of the plants. Optim is adjusting plan operating configurations successfully and as Jeff pointed out bidding into ancillary services market and effectively managing plant output and commodity exposures to natural gas and purchase power or power prices, purchases and sales.

And moving onto slide 25, given the pending rate cases in New Mexico and Texas will be major determinants on our earnings in 2010. We have decided to hold off issuing guidance for that year until we get better clarity around the outcome of those two cases. However, we do want to provide with enough information to provide you some modeling 2010 and beyond.

The first item to consider is the impact of the two pending rate cases. Assuming we get a 100% of rate case request PNM's net increase in revenues would be worth in incremental $0.42 in 2010 while TNMP’s incremental revenues would be worth about $0.10 earnings per share.

Other factors to take into account include higher pension expense of $0.03 to $0.05 per share due to market conditions and increased interest costs associated with our borrowings in 2009. 2010 earnings will also be impacted by several plant outages; we have scheduled maintenance outages at Afton and Reeves, two outages at San Juan and extended three-month outage at Four Corners. In total, we expect the outages to increase our O&M costs and reduce our earnings $0.03 to $0.05 per share.

For these reasons, our view in 2011 has a more reflective of our true earnings power, we’ll be able to recover operating cost and earn an appropriate return in the from TNMP in New Mexico territory in southern New Mexico, where rates have been frozen through 2010.

If you turn to slide 26, I will walk you through our regulated utilities potential earnings power beyond 2010. By the end of 2010, we estimate we’ll have about $2.6 billion of regulated rate base, then once we work through the regulatory process we should provide earnings power of the $1.52 per share.

We’ve always said that, we take several rate case to achieve our regulated earnings potential and earn an appropriate turn on that business and that outlook is not change. Before I hand it back to Jeff, for his concluding remarks I want to quickly take you through our projected cash flow and liquidity position for 2009.

On Slide 27, you will see our projected cash flow for 2009; total sources of cash, including cash from operations, proceeds from the sale of PNM Gas on the Cap Rock termination fee are projected $860 million.

Total uses of cash were projected at $1.1 billion 640, which will be funded through the proceeds in the sale of the gas company. Currently we anticipate paying down $349 million of short-term debt at both PNM and the holding company with the remainder of the proceeds, being used under our tender offer and pay taxes on the sale of proceeds.

Given that are uses of cash were greater than our sources of cash. We anticipate a cash shortfall of about $192 million. Despite the shortfall, we project our adequate liquidity to cover us through the year. Graph from the right picture available liquidity in January 29, before the close of the gas sale and as well as our projected year-end liquidity broken out by entity. As you can see we expect to have ample liquidity that all our entities during the current year.

Now, I’d like to turn it back over to Jeff for his closing remarks.

Jeffry E. Sterba

Thanks Chuck. Let me just close with the few comments about the economy that the big uncertainty that we are all facing, in terms of the impacts of the recession and particularly the duration of that recession. We’ve tried to build that into our ’09 guidance through a number of factors first on our load growth as we talked about before.

If you strip out this one municipal load, which is already starting to show up, we’re looking at a just barely a half a percent load growth, which is even in the height of the 1982 recession, when we went back and look at that data. We saw almost 2.5% growth in the 82 recession. In Texas, we’re looking at stuff about 1%, and we’re continuing to see customer growth in both of those territories.

Second, relative to FCP, while it pains me greatly we have build in a 7% bad debt write-off. And even with that we believe and have shown you what our forecast is for that business. Obviously, we’re going to do everything we can to reduce that. But given the recessionary impacts that we’re seeing, I think it’s prudent to recognize that bad debt is something that virtually all businesses are going to have to deal with. And so, we’ve built that into our plans for FCP.

What we’re seeing and going back to New Mexico is while we have had some minor layoffs; and Intel for example is gong to layoff a 100 people. We’re seeing that are more in terms of job additions in other pieces particularly at the air force spaces, where we’ve got through the BRAC process increases at the scientist level and certain other levels. The addition of probably total up to around 500 jobs or something like that. So, no one really knows what this is going to actually do, but we’ve tried to take into account is potential impacts of a more prolonged recession within our forecast.

With that, let’s turn to questions.

Question-and-Answer Session

Thank you. (Operator Instructions). And we’ll take our first question from Jonathan Arnold, Merrill Lynch.

Jonathan Arnold – Merrill Lynch

Hi, good morning guys

Jeffry E. Sterba

Hi, Jon.

Gina Jacobi

Good morning

Jonathan Arnold – Merrill Lynch

I had a quick question on, you talked about this the new legislation that’s being introduced with the future test year and CWIP et cetera. Two questions on that, what is the timing, how long is it likely for that to take to navigate through the legislature. And then just some reminders around when the session is open would be helpful. Secondly, I am guessing you would want to file a new case to take – it reflecting that at some point. How should we think about your future rate plans beyond the current case in PNM?

Gina Jacobi

Thanks for the question Jonathan. The session is a 60-day session this year in New Mexico. It’s started in mid January, so it will end in mid March. We think this bill will probably take the whole amount of time, just because most of the bills are taking the full 60 days, and the first priority on the legislature plate here is obviously the budget deficit in New Mexico, which is not as bad as in many states, but we do have a deficit. So, I would look for that, probably the middle of March to come out. In terms of future plans and when we would have a new case that question is really dependent upon the outcome of the current case that we have now. So, once we have the conclusion of that case will take a look at what we won’t want to do. In the future test year, you’re obviously, we would want to get our costs under the future test year as soon as possible after that. But I think the biggest determinant is going to be what happens in this case.

Jeffry E. Sterba

One thing to add to that Jonathan is, for our Southern Mexico territory, its real clear that we will be filing a rate case, that isn’t dependent so much on the outcome of the current PNM rate case for rates to go into effect in early 2011. And if this ball passes Pat would you use that legislation for the shaping of that rate case for the southern territory.

Pat Vincent-Collawn

Thank you, Jeff.

Jonathan Arnold - Merrill Lynch

Thank you.

Operator

We’ll take our next question from Brian Russo, Ladenburg Thalmann.

Brian Russo – Ladenburg Thalmann

Hello, good morning.

Jeffry E. Sterba

Good morning.

Charles N. Eldred

Good morning.

Brian Russo – Ladenburg Thalmann

Could you just comment on what was the driver for the impairment charge on First Choice Power in the fourth quarter?

Charles N. Eldred

Yeah, let me comment on that. We continually have to look at the evaluation of the business using the accounting methodologies that incurred earlier in 2008 when we have the impairment write-off. So we go through that analysis and in doing such we look at three areas one of which is the trade name, which is our assumption is that 1% royalty rate. You can look at that as the value of the First Choice Power name in the market relative to that methodology. We reduced that to 0.5%, that’s a non-amortized intangible asset and also what kind of discount rate we would use to apply to that would result in part of that $24 million write-off we mentioned in the press release.

Also we have to look at the customer list, which is another amortized intangible asset, which is amortized over 7 years. We have to look at that value and reflect that relative to where the market is, that is part of that after tax $24 million write-off. And so the additional amount is really the enterprise value that’s associated with goodwill and we’ll go through that analysis in the second step and announce any changes to that as we finalize the 10-K. But this is something we have to go through. And we given the fact that the First Choice didn’t perform as expected for 2008, and given that valuation that triggers the methodology for the accounting approach to making these determinations to any adjustments to goodwill and intangible assets. And as result of that performance we are adjusting accordingly to that.

Brian Russo – Ladenburg Thalmann

So, was it more of an historical look at the value of the business or is there some sort of forward-looking component?

Jeffry E. Sterba

Brian, let me. The biggest change is on the intangible at the trade name. And frankly, from a layman's perspective, I will tell you my rational for it, is that we see particularly in a recession that price is going to drive much more than the value of trade name. So, when we look at what is typically used as 1% for a value of the trade name frankly, I don’t think it worth that. And so in a sense that is a going, looking forward analysis, where we don’t think the value of any trade name frankly in a recession is worth what it was in the non-recession. And so we are appropriately reflecting that adjustment.

Brian Russo - Ladenburg Thalmann

All right thanks. And one more question. Could you just add some more color to the increase in bad debt expense in 2008? Was it primarily related to the impact from Hurricane Ike or is it increased customer switching without paying bills or is it more related to commercial and industrial slowdown that we are seeing here?

Jeffry E. Sterba

Really all of the above in particularly the first two, with Hurricane Ike, we’ve got a lot of customers that are still trying to rebuild or that you’ve got a meter set that now the house is completely gone or they haven’t been able to come back and take on employment. They maybe still paying the small amounts on the bill or they’ve asked for bill terms. So we’ve got obviously a continued amount of accounts receivable and we take the total amount of account receivable into account as we took at total bad debt. So Ike is definitely had an impact. I think probably a bigger piece is has got to do with some of the rules for example, in Texas if you're a customer under a term contract, if you leave that contract, you are supposed to pay a termination penalty, but what some people have found out is that they can use what’s called the move-in, move-out procedure. Where no one knows that’s it’s the same customer on promise.

None of the reps know, so they just switched to a new provider and don’t pay the termination fee, because its not under move-in move-out and then they just don’t pay that last bill, and because of the fly-up in gas prices that we saw in early year, we ended up with much biggest last bills. And then we saw a very short increase in the percentage of customers, who defaulted under last bills. So, it’s a combination of all of those factors, and the way that we have to manage it, obviously is through a credit policies, through our much more aggressive deposit and tier deposit structures, as well as working with the commission and the REP community to change some of the loopholes that were never intended to be utilized in this way. One of the things I think the commission is really coming to understand is that everybody in Texas is paying a high price, because the rules enable people to avoid paying their bills. And that, Texas has been sensitive to what’s happened to electric prices, and this is the way to help, mitigate electric prices to the vast majority of customers.

Brian Russo – Ladenburg Thalmann

One more question on First Choice Power, you are forecasting 7% of revenues and bad debt expense in 2009. That seems awfully high, I mean its just kind of the reality of Texas retial.

Jeffry E. Sterba

No, I would say it is high. And on a steady state basis, we would not expect nor we would we tolerate 7%, but part of this our intention to build in the impacts that may very well occur in a recessionary environment, where it might be that you will continue to see people not be able to pay bills or that we are not able to get the adjustments that we believe are appropriate in the regulatory rules. If we’re able to get those rules adjusted to more rapidly we’re able to get those adjusted then frankly you’ll see these percentages come down. So, I think part of it is the conservatism because of what we experienced in 2008 on a going forward basis long-term though, in an improved economy we would not tolerate or expect to see 7%.

Charles N. Eldred

Brian, this is Chuck. I want to add a comment too on the impairment to be clear because you asked about the forward-looking view or the valuation of the business. Keep in mind that we’re valuing the business with the accounting methodology at year-end 2008. So, we look at the impact of that business look at the full enterprise, look at fixed price contracts associated to where they are relative to the market at the end of 2008. And make a determination based on that to the performer that we would project the accounting valuation. So, we can have a debate about market valuations and accounting valuations, but this is the right thing for us to do to reflect the appropriate impairment charge against the business giving the results that occurred at the end of 2008.

Brian Russo – Ladenburg Thalmann

All right. And then lastly on slide A14 of the presentation you outlined the revenue requirement in the pending PNM electric rate case. It looks like a good portion of it has already been, so to speak pre-approved on Luna & Lordsburg and some other things. I’m just wondering how much of the revenue requirements relates to the incremental financing costs experienced as your credit rating was cut below investment grade.

Charles N. Eldred

I’m not sure I have that; well I know I don’t have that number. We would have to get back with you on the specifics of the increased financing costs. There is certainly some in there.

Brian Russo – Ladenburg Thalmann

Yeah.

Charles N. Eldred

But there is obviously in addition to the – what you might call pre-approval, although remember we don’t have that stipulation yet approved by the commission. Yeah, we obviously have other investments that have been made and increased O&M and depreciation costs that are pretty critical to us. But we’ll get back to you, okay.

Brian Russo – Ladenburg Thalmann

Okay, thank you very much.

Operator

(Operator Instructions). We’ll go next to Sam Brothwell, Wachovia

Samuel Brothwell – Wachovia Securities

Hi, good morning guys.

Jeffry E. Sterba

Hi, Sam.

Pat Vincent-Collawn

Good morning, Sam.

Charles N. Eldred

Good morning.

Samuel Brothwell – Wachovia Securities

Jeff, a couple of questions on the Texas business that I’m not trying to beat the First Choice horse to death, but when you made the decision last year to hang on to it. Did you and the Board kind of discuss a window of time that you are willing to allow to rebuild that business?

Jeffry E. Sterba

Sam, I don’t think you could beat it to death many more than we have. And the answer to that is absolutely. FCP it understands that they are being watched closely and being actively supported. And that their performance, as we move through particularly the first three quarters of 2009 are very important. And I have a large amount of faith in Brain and in what Brain is going to be able to accomplish. But obviously it’s within the constraints of that marketplace and what happens and what the regulators may or may not do. But I’m not putting any specific timeline on it. But we’re not going to tolerate another kind of performance like we saw in 2008. That’s if we can’t turn this business around then we’re not going to stay in it regardless of how we may have to exit. We made a decision that we believed the best way to add value associated with FCP was to restore its level of performance. Then we will make a determination about what to do. Obviously, if that performance is not restored, we are faced with the issue.

Samuel Brothwell – Wachovia Securities

It sounds like the spotlight is definitely going to be on at this year?

Jeffry E. Sterba

Spotlight, heat lamp you name it yes, sir.

Samuel Brothwell – Wachovia Securities

And I guess the other thing is looking at some of your assumptions going into ’09, if I am doing this right, we are looking at 11% customer growth, pretty good improvement, pretty margins. And what do you see happening differently versus the last two quarters of ’08, especially in light of the some of the petrochemical industry in Texas in particular, which I imagine you have some exposure to is coming under a lot of pressure?

Jeffry E. Sterba

Yeah, the only exposure we have to the petrochemical industry frankly is on the employment side. We don’t serve any of the petrochemicals and frankly the commercial customers that we serve are really not in that supply chain for the petrochemical side. But obviously as an overall economy turns, that will affect customers in general. We do have customers in the Houston area, but remember we also have a pretty junk of customers that are up in the Dallas area that are really, fairly well disconnected from the petrochemical industry. The challenges that we face in relative to FCP on growth really have to do with how we look at pricing our products. One of the things that we’re seeing in ERCOT this year, as we move into year is everybody and you all don’t have transparency into it except for a couple of us that are publicly traded, but everybody in that business has gotten buffeted hard and as there is a rebounding that’s a kind of occurring.

People realize that the market hit everybody. So, hard in 2008 that margins have to move up and I think what you are seeing is pricing within that market that is much more rational than it was last year. How long does that last, before someone starts to try to drive down prices, thinking that they can chase something. Well, I don’t know we will have to see. We are going to be disciplined about maintaining the kinds of margins that we are seeing today, which on average are certainly in the mid 20s, if not a little higher and that’s going to be a matter of the target markets that we go after and the way in which we price that product and our ability to control costs.

Samuel Brothwell – Wachovia Securities

And just one last quick one, with respect to petrochemicals specifically isn't Altura, isn’t the host there a Lyondell facility.

Jeffry E. Sterba

It is, it's Basell Lyondell and as some of you may know that they did, they had have gone into Chapter 11. We are actively involved in that process, we do have a small amount that’s immaterial of pre bankruptcy debt, but in the post bankruptcy period this is not a facility that is on the list but they have submitted to the bankruptcy judge for potential closing of facilities. And we are in discussions with them about how we can enhance this facility. So, we feel, we are in pretty good shape relative to the bankruptcy, but obviously that’s something that we are going to be paying very, very close attention to, it has not demonstrably changed the operation, they certainly have cut back production, but what that is done is freed up the ability to deploy Lyondell capacity into the ancillaries market which is still a very strong market particularly for the Houston zone…

Samuel Brothwell – Wachovia Securities

Thanks guys.

Charles N. Eldred

Let me just add a comment to in regards to Lyondell and what Jeff had alluded too, but under the very worse-scenario, if there were consequences of that plant shutting down. We still have plants and continue to see that will allow for those units to be essentially merchant units as Jeff pointed out, whether small capital investment would allow us to dispatch this units, still in the ancillary market and provide the ability to serve the load within the Texas market. So, even on the worse-case scenario, we don’t lose the ability to manage the output of that plan, it just has to be reconfigured and accessed water rights et cetera allow us to running it as a merchant plant going forward.

Samuel Brothwell – Wachovia Securities

Okay, thanks for the extra help, Chuck.

Charles N. Eldred

It’s okay.

Operator

And we have no further questions at this time. I would like to turn the conference back over to Mr. Jeff Sterba for any additional or closing remarks.

Jeffry E. Sterba

Well, again thank you very much for joining us in many ways obviously we are all happy to close the door on 2008 and open the door on 2009, I would also point you to slide 29, where we provide a checklist much as we did last year of the things that you can hold us accountable for as we move through 2009 which will be the industries of our ability to beat our earnings target. Please feel free to make contact with Gina or her folks if you have any follow-on questions and we look forward to a better 2009. Thank you very much for joining us.

Operator

Ladies and gentlemen that does conclude today's conference. We appreciate your participation. You may disconnect at this time.

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Source: PNM Resources, Inc. Q4 2008 Earnings Call Transcript
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