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Executives

Steven P. Busser - Vice President, Treasurer and Chief Risk Officer

J. Frank Bates - Interim President & Chief Executive Officer

Scott D. Wilson - Executive Vice President, Chief Financial and Administrative Officer

Andy Ramirez – Vice President of Power Generation

Analysts

Brian Russo - Ladenburg Thalmann

Maurice May - Power Insights

Michael Lapides - Goldman Sachs

Yiktat Fung – Zimmer Lucas Partners

El Paso Electric Company (EE) Q4 2007 Earnings Call February 28, 2008 4:00 PM ET

Operator

(Operator Instructions) Let me introduce your host for today, Mr. Steve Busser, Treasurer and Chief Risk Officer.

Steven P. Busser

Good afternoon, everyone, and thank you for tuning into the El Paso Electric Company fourth quarter 2007 earnings conference call. Also on the call with me today I have our Interim President and CEO, Frank Bates and our Chief Financial Officer, Scott Wilson.

Today, we’ll provide an update on our fourth quarter and year-to-date 2007 financial performance, including a discussion of our pertinent earnings drivers. We also would update our 2008 earnings guidance and assumptions, our stock buyback program, and finally, we’ll provide an update on our Texas and New Mexico regulatory developments.

I would now like to cover some items that will be pertinent to our call today, before we get started. You should have a copy of our press release and if you do not, you can obtain one from our website at www.epelectric.com on the Investor Relations page.

Along with our call today, we have a webcast presentation available for your viewing, as we progress through the call. Both the audio and video presentation will be done via the web. To log on to the webcast, you can do so via our website. In order to ask questions during the Q&A session, however, you will need to be dialed in via telephone.

We currently anticipate that our 2007 Form 10-K will be filed with the SEC tomorrow, February 29. As for upcoming IR events, we will be attending the Goldman Sachs Power and Utility Conference in New York on the week of May 12 and the EEI Financial Conference, the week following, also in New York. We will provide further updates on any Investor Relations events on future conference calls. Please call our Investor Relations department if you have any enquiries or require further information.

A replay of today’s call will be available shortly after our call ends, at 866-354-2026 and will be made available through March 15. The passcode is not required for the replay. Conference call can also be accessed via our website. Let me cover the Safe Harbor provisions, before I turn the call over to Frank.

Our comments and answers to your questions may include forward-looking statements. Be reminded that statements made on this conference call other than statements of historical fact, are forward-looking statements made pursuant to the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995.

Such forward-looking statements, as well as other oral forward-looking statements made by or on behalf of the company involve known and unknown risks and other factors, which may cause the company’s actual results in future periods to differ materially from those expressed here.

Any such statements qualified by reference to the risks and factors discussed in the company’s SEC filings. Our 10-K and other SEC filings contain our forward-looking statements and also lay out the risk factors that should be considered in the context of the information that we will provide today. These filings may be obtained upon request from the company on our website or from the SEC.

The company cautions that risks factors discussed in these filings are not exclusive. We do not undertake to update any forward-looking statement that may be made from time-to-time by or on behalf of the company. These statements, especially those made during the Q&A session of the call, are subject to risks and uncertainties that are difficult to predict. Please refer to our SEC filings for a detailed discussion of these risks and uncertainties, as actual results may differ from these statements.

Now, I’d like to turn the call over to Frank.

J. Frank Bates

Good afternoon, everyone, I want to thank everyone for joining us on this call today. First, I want to take you through a few highlights of our 2007 fourth quarter year-to-date results, as well as a few significant activities that have impacted our performance or that will have an impact on EPE going forward.

Then Scott Wilson, our Chief Financial Officer will discuss in more detail, key earnings drivers for the quarter and for the year, as well as provide you with earnings guidance for 2008 and then some regulatory updates.

We are pleased with increase in earnings before extraordinary items, for both the fourth quarter, which is $0.31 compared to $0.21 last year and for the year ended December 31, 2007, which as you can see is $1.64 compared to $1.29 for 2006. Including extraordinary items, 2006 fourth quarter earnings per share was $0.34 and 2006 year-to-date was $1.42.

Growth in earnings for 2007 was mainly related to increased kilowatt-hour sales, due to both customer growth and to an increase in weather-related sales. Earnings were also positively impacted by an increase in capitalized construction financing costs reflecting a significant increase in new utility investments and a change in accounting for such financing costs in 2006.

We continue to experience above average growth in our core business, as our customer base grew by 2.1% in 2007 and demand for power resulted in a new record high native peak of 1,508 megawatts set in August, we have surpassed the previous record of 1,428 megawatts set in July 2006. These numbers represent a 5.6% increase in demand year-over-year.

As part of our plan to ensure that sufficient electric energy is available to serve that growth, we began the process of obtaining regulatory approval for the construction of a combined cycle unit at our existing plant in Northeast El Paso. Certificates of convenience and necessity applications were filed in Texas and New Mexico.

A month ago, we received final approval on our application in Texas and we anticipate a decision in New Mexico in April. This new generation will provide for growth, enhance system reliability, and provide fuel savings through improved efficiency.

At Palo Verde, all three units are currently operating at full power. Palo Verde Unit 3 has recently undergone a refueling outage, during which the steam generators and low-pressure turbine were also replaced. That unit returned to service in January, following a longer than anticipated outage due to a variety of equipment issues.

With this work completed on Unit 3, all three units have now undergone successful replacements of their steam generators and low-pressure turbines. These replacements are expected to improve efficiency, extend the life of the units, and increase the probability of obtaining a license extension for Palo Verde.

The next scheduled outage is a 50-day refueling outage for Unit 2, beginning in the end of March. We will continue to monitor all activities at the plant and work closely with the operating agent, Arizona Public Service and other plant owners to improve the operating performance of Palo Verde.

In 2007, Palo Verde continued to experience operational issues as evidenced by the Nuclear Regulatory Commission placing Palo Verde in the ‘multiple/repetitive degraded cornerstone’ column of its action matrix in February. In response to these operational issues, a new management team was brought into Palo Verde by Arizona Public Service to address these issues and to identify action plans to improve performance.

Subsequently, the NRC increased the level and scope of inspections at Palo Verde and required that Palo Verde undertake a plant-wide self-assessment and cultural survey to identify any other issues at the plant. In its confirmatory action letter, the NRC has incorporated action items to address performance issues identified by the plant’s assessment activities and improvement plan, as well as the NRC’s 95003 inspection.

From this process, APS will develop a list of specific tasks, including strategies and due dates for each of the 12 items identified in the letter. Due to these issues receiving increased NRC’s scrutiny and the resulting plant costs to deal with these issues, it is anticipated that Palo Verde’s non-fuel O&M costs will increase 10% to 15% this year.

The new management team at Palo Verde has been well received and has worked hard to establish an environment of open communication with the employees, regulators, and owners. This new team is also working hard to develop the necessary corrective action plans to address performance issues.

Our service area in general and our sales in particular, should continue to be positively affected by the influx of troops stationed at Fort Bliss, due to the government’s base realignment and closure plan. Currently, the Army anticipates that approximately 37,000 troops and their families will ultimately be stationed at Fort Bliss by 2012, which will more than double the size of the current base population, and significantly add to our total customer base of approximately 357,000 customers.

Since 2005, Fort Bliss has already amassed over 6,000 new troops. As you can see here, approximately 3,800 new troops are also expected at White Sands Missile Range by 2013. Needless to say, we are excited about the opportunities presented by this unprecedented military growth in our service area and we look forward to continuing our longstanding relationship with Fort Bliss and White Sands.

Under our existing lease for the Stanton Tower building, which is home to our corporate offices, the company had the right of first refusal to purchase the building, if it were to be sold. On February 8, 2008, the company exercised this right of first refusal and subsequently purchased the office building. Purchase was at a substantial discount to estimated replacement cost and we believe this purchase makes sense for our customers, employees, and shareholders.

And finally, before I turn this over to Scott Wilson for a color commentary, I want to thank the entire EPE employee team for their efforts to produce these results for 2007 and I want to assure you that the same employee team will still be hard at work going forward.

Scott D. Wilson

In this part of the call, we’ll provide you with a financial and a regulatory update, fourth quarter 2007 and year-to-date 2007 earnings per share, will talk about key earnings drivers including retail base revenue increases of system sales, fossil fuel plant maintenances, Palo Verde operations and several other earnings drivers that impacted our earnings, both in the fourth quarter and for calendar year 2007.

We will also in this session of the presentation discuss our stock repurchase program. We will talk about 2008 earnings guidance, and as I mentioned a minute ago, we will provide you with the Texas and New Mexico regulatory update.

Moving on to the fourth quarter 2007, we had net income of $13.9 million compared to $9.7 million in 2006. On an earnings per share basis, that was $0.31 in 2007 and in 2006 that was $0.21, again that’s excluding extraordinary items. If you consider the $0.13 per share effect of the reapplication of FAS 71 in the fourth quarter of 2006, 2006 fourth quarter earnings were $0.34, but excluding extraordinary items, $0.31 versus $0.21, ‘07 versus ‘06.

Some earnings drivers in the fourth quarter of 2007 include, we had an 8.3% increase in retail base revenues. This is primarily due to a 4% increase in retail kilowatt-hour sales, largely the result of a 2.1% increase in the number of retail customers served. On an earnings per share basis that contributed about $0.12 per share in the quarter relative to ‘06.

We had a reduction in income tax expense, due to adjustments to income tax accruals related to prior quarters in 2007 and for the years, 2004 through 2006. These adjustments primarily were related to our other post-employment benefits, calculations, and it resulted in total and $0.09 per share for the quarter.

And finally, in the quarter, we had increased capitalized interest in AFUDC due to the reapplication of FAS 71 to our Texas jurisdiction, beginning January of 2007 and also coupled with that, we had higher equip and nuclear fuel balances which are subject to AFUDC and capitalized interest. That contributed about $0.05 a share in this quarter relative to 2006.

We had some relative earnings decreases quarter-over-quarter. We had decreased retained margins from off-system sales, resulting from a decline in energy available for sale due to the refueling and replacement of steam generators at Palo Verde 3 and from lower margins due to higher energy cost. That was an $0.08 contribution to decreased earnings quarter-over-quarter.

We also had increased Palo Verde non-fuel O&M expenses due to increased maintenance costs at Unit 3 associated with the replacement of steam generators and higher operating cost at the other units, also an $0.08 per share reduction in earnings in 2007 relative to 2006.

And finally, we had increased O&M costs at our gas-fired generating plants, primarily due to the timing of some plant maintenance and that resulted in a $0.02 share reduction in earnings relative to 2006.

Taking a look at retail base revenues, you can see that we had heating degree days in the fourth quarter of 2007. We’re down about 69 days relative to the same period in 2006. Conversely, our cooling degree days were up about 79 cooling degree days relative to 2006 and most of that change occurred primarily in October of 2007.

Off-system sales, taking a closer look, our gross margins decreased from $8.6 million to $1.6 million in ‘07. Retained margins dropped from $6.9 million in 2006 to $1.2 million in 2007. A couple of things to discuss here, we obviously had less Palo Verde output due to the aforementioned steam generator replacements at Unit 3. In fact we had 50 more outage days for the Palo Verde units in the fourth quarter of 2007 relative to the fourth quarter of 2006.

We also had higher cost of making these sales, primarily due again to the less availability of Palo Verde in the quarter relative to the prior quarter. And finally, one last thing, as part of our rate stipulation in New Mexico that was implemented in July of 2007, we agreed to share economy margins in New Mexico as we do in Texas.

So in the fourth quarter of 2007, our economy margins or retained margins reflect the fact that we share 25% of the New Mexico margins in the fourth quarter of 2007 and did not do so in the fourth quarter of 2006.

Moving on to some more earnings drivers, Palo Verde non-fuel O&M increased by $3.4 million net of tax. It’s about $0.08 a share. Again, increased maintenance cost at Unit 3 associated with replacement of the steam generators and higher operating costs at all three units contributed to that $0.08 picture change.

In the fourth quarter of 2007, outage days compared to the fourth quarter for Palo Verde 2006, we had a total of 122 total outage days planned, unplanned, and equivalent outage days compared to 73 days in the same period in 2006.

Converting that into capacity factors, you can see that in the fourth quarter of 2007, Palo Verde operated at a capacity factor of 57.1% compared to 74.7% in the fourth quarter of 2006. Again the steam generator replacement at Palo Verde 3 obviously had a big impact on fourth quarter capacity factors.

Our Four Corners, on the other hand, operated in the fourth quarter of 2007 much as it did in 2006. 2007 capacity factor of around 89% compared to an approximate 87% capacity factor for Four Corners in the fourth quarter of 2006.

Couple of other earnings drivers in the fourth quarter worth mentioning, we increased AFUDC and capitalized interest to $2.3 million or about $0.05 per share, again due to the reapplication of FAS 71 in our Texas jurisdiction beginning January 1, 2007. And we had higher balances of CWIP and nuclear fuel subject to AFUDC and capitalized interest.

Those two things helped to contribute to that $0.05 change in the quarter relative to ‘06. And income tax adjustments of $3.9 million net of tax are about $0.09 a share related to what we have described before about $0.05 was pertaining to the period 2004 to 2006. The balance was ‘07 effects that were recorded in the fourth quarter.

The primary reason for the change, maybe two-thirds of that change had to do with other post-retirement benefits and the lack of taxation on the reimbursements from Medicare for drug costs that previously we had assume to be taxable, so that contributed to that. About $0.05 of that is, again is something from prior periods. About $0.04 of that tax change is an ‘07 item and one would expect that to continue on in future periods.

Moving on to full year 2007, we recorded net income of $74.8 million compared to $61.4 million for 2006. Earnings per share, $1.64 in 2007, in 2006 excluding extraordinary items was a $1.29, including extraordinary items, earnings per share in 2006 were a $1.42.

Key earnings drivers, full-year-over-full-year include a 4.2% increase in retail base revenues, primarily due to a 3% increase in retail kilowatt-hour sales, that resulted largely from a 2.1% increase in the number of retail customers served.

We also had a reversal of a reserve for one of our large customers of approximately $1.7 million pre-tax, which also helped full year for the increase in retail earnings, the retail base revenues that the sum of all the changes in retail base revenues year-over-year was about $0.25 a share.

And this year-over-year increased capitalized interest and AFUDC also played a part as it did in the quarter. FAS 71 for Texas, higher CWIP balances, higher nuclear fuel balances, subject to AFUDC and capitalized interest increased our year-over-year earnings by about $0.13 a share. And also, year-over-year decreased O&M cost at our gas-fired generating plants due to a reduction of unplanned maintenance and planned maintenance in the first three quarters of 2007 resulted in an $0.08 pickup 2007 over 2006.

We had a couple of relative earnings decreases year-over-year. Decreased A&G expense is due to an increase in capitalized employee salaries and benefits, decreased workman’s compensation expense and a sales tax refund resulted in a $0.07 pickup year-over-year. Reduction in income tax expense to the aforementioned items related to OPEB resulted in a $0.05 per share pickup year-over-year.

We had increased investment and interest income due to gains on the sales of securities held in our decommissioning trusts and interest income from trust, along with the Texas sales tax refund with no comparable activity in ‘06, resulted in a pickup of $0.04 a share.

And finally, we had improved proxy market prices for Palo Verde Unit 3, which is the deregulated decertified unit in New Mexico, subject to our 2007 New Mexico Stipulation. That was about $0.04 a share pickup year-over-year.

Couple of relative earnings decreases worth mentioning, increased Palo Verde non-fuel O&M expenses in 2007. These increased expenses at Unit 3 due to steam generator replacement and higher operating costs at all other Palo Verde units cost us $0.15 a share, relative to ‘06 earnings.

A reduction in deferred income tax expense, resulting from the changes in the Texas franchise income tax law that we recorded in 2006 as a $0.13 benefit in 2006 that did not recur in 2007, decreased ‘07 earnings relative to ‘06 by $0.13 a share.

And finally, decreased off-system sales margins retained due to lower margins per megawatt-hour, as a result of slightly lower market prices. And higher costs of energy use to make these off-system sales, which were partially offset by increased megawatt-hour sales, resulted in a $0.04 per share decrease in 2007 earnings relative to 2006.

Two more earnings decreases year-over-year, both $0.03 items. One is decreased transmission wheeling revenues in 2007, that’s a result of the reduction in transmission wheeling revenues that we discussed before relative to the Tucson Electric Power matter that we had. It’s currently in front of the Federal Energy Regulatory Commission. That was a change in $0.03 per share ‘07 less than ‘06.

And the second $0.03 item is an increased fuel revenues in 2006 due to a catch-up adjustment for 2004 and 2005 for recording a fuel-adjustment clause in New Mexico, where we were able to record for fuel purposes, capacity payments we made on purchase power, again $0.03 a share in ‘06 that did not recur in ‘07.

Taking a look at year-to-date 2007 key earnings drivers retail base revenues, and this really was a big driver for us year-over-year. We had 266 heating degree-day increase in 2007 relative to 2006. Most of that occurred in the first quarter of 2007 and that was a big factor in our retail kilowatt-hour sales growth along with customer growth. Our cooling degree days year-over-year increased about 55 cooling degree-day. So our heating degree-days were a big driver for our kilowatt-hour sales increases in 2007.

Off-system sales are for the year, our gross margins were $19.6 million compared to $22.6 million in 2006, retained margins, $15.5 million relative to in 2007, relative to $18.3 million in 2006. And our megawatt-hours sold increased however by a little less than 600,000-megawatt hours, reflecting two things. An increased power exchange agreement with another company and we began in the middle of the year, a power sale with another utility and those resulted in the increased volumes relative to 2006.

Looking at some key earnings drivers for 2007, fossil fuel plant operation and maintenance decreased by $3.6 million or about $0.08 per share, due to the aforementioned reduction in planned and unplanned maintenance in 2007 relative to ‘06.

We had a major unplanned outage at Rio Grande 6 in 2006, in the first half of that year with no comparable outage in 2007. And we had a major planned outage at Newman 1 in the first quarter of ‘06 with no comparable activity in ‘07.

Year-to-date PV non-fuel O&M net income effect, $7.1 million reduction in net income, relative to the same period in ‘06 or about $0.15 a share, due primarily to increased maintenance costs at Unit 3 for the steam generator replacement and higher operating costs at all three Palo Verde units.

Looking at PV operations, our year-to-date outage days, we had about 253 outage days in 2007 compared to 324 outage days in 2006. So that manifests itself in a better capacity factor for Palo Verde in 2007, relative to 2006. Our 2007 capacity factor for Palo Verde was 78.5% compared to a capacity factor of about 70.4% for Palo Verde in 2006. The Four Corners capacity factor decreased from 90.8% in 2006 to 78.4% in 2007.

Continuing on with some key earnings drivers, just like in the quarter, our AFUDC and capitalized interest contributed to a pickup year-over-year. We added $6.2 million net income effect or $0.13 per share for the reapplication of FAS 71 and those higher CWIP and nuclear fuel balances subject to AFUDC and capitalized interest. The income tax adjustments that we mentioned before contributed $0.05 a share year-over-year.

I would like to draw your attention 2008 earnings guidance. We have revised our range of guidance from $1.60 to $1.95, that’s our previous guidance to a new range of $1.50 to $1.90. There were three principal drivers for the downward revision in our earnings guidance.

The first and most material was we did not buy back shares in the fourth quarter of 2007. You will recall that we had planned on purchasing about 1.8 million shares in the fourth quarter of 2007. We did not make that repurchase and that accounted for roughly about half the change in our guidance estimate, due to that share buyback. We’ll talk a little bit more about why we did not buy back shares and what the outlook is for the future in just a moment.

The second item that contributed to the revision in the downward revision in guidance is our pollution control bonds. We are experiencing interest rate changes. About 4100 million of our $193 million of pollution control bonds are in fact auction rate issues, weekly auction offsets.

And like everybody else in this market, we have not a failed auction but interest rates in this auction have in fact more than doubled for us and so, we are actively looking at our auctions including refunding or remarketing these particular bonds.

We think, based on what we have seen so far in the auctions that have happened in the past 30 days and what we anticipate if we should remarket or refund these bonds in terms of the spreads over what we anticipated paying back in November, when we first issued guidance and what we are anticipating paying now, we think that the PCB auction rate market problems will cost about $0.02 a share.

And finally, the last thing that impacted our guidance a little bit is CEO severance, which is about $0.02 a share.

Turning to our stock repurchase program, in 2007 we bought about 1.3 million shares at a total cost of $31.4 million. Since the inception of our share buyback program, we have repurchased 19.3 million shares at a total cost of just over $269 million. As most of you know in November 15, 2007, our Board authorized an additional 2 million-share repurchase program.

As I mentioned a minute ago, no stock was repurchased in the fourth quarter of 2007, and our lack of buybacks was really a function of liquidity, and there were two things driving our liquidity issues in the fourth quarter and today. The first is the approximate $30 million fuel under-recovery in Texas.

And the second issue and nowhere near is significant as the $30 million fuel under-recovery, is the purchase of the Stanton building. The purchase of the Stanton building is something that as Frank mentioned, makes a lot of sense for our employees, our customers, and our shareholders, and it actually will turn out to be slightly accretive to earnings in the first year, relative to what we were paying for leasing the building. But it also certainly absorbed a little bit of liquidity that we had anticipated being able to use for stock buybacks.

Fuel under-recovery again, was a much larger factor than in the buyback decision than the building purchase and we anticipate at this point in time, as we will talk about in a minute, that our surcharge for approximately $30 million will be put in place in the April or early May timeframe, hopefully April and that this surcharge will be recovered over a 12-month period with interest.

Our revised guidance of $1.50 to $1.90 a share assumes that we don’t buy any shares for the rest of the year and I think we did that as sort of a conservative assumption, but that’s far from set in stone. We will certainly see how our liquidity shapes up for the balance of the year and depending on what we see in the next ten months of the year, we certainly will revisit our share buyback program.

We have been buyers, as you know of our stock for a long time. In the last two calendar years, we’ve repurchased 4 million shares. We are big believers in share buybacks. And when we’ve had to pause in our buyback program, in the last couple of years, it’s really been a function of liquidity, not a change in focus or intent. So, at this point in time, although our revised guidance does not reflect additional buybacks for ‘08 that is far from set in stone.

Regulatory update, Texas, I just mentioned the surcharge filing, Docket 35204; we hope that this surcharge collection begins in April 2008. We are pretty far down the road in that process with all the parties and the commission. We have a Texas Fuel Reconciliation, Docket 34695 that was filed August 31, 2007, for the period March 1, 2004 through February 28, 2007.

We are seeking to reconcile $548 million of eligible Texas fuel and purchase power expenses. Intervenor testimony in this case is due March the 25. Hearings are scheduled to begin May the 12 and our final orders expected by the third quarter of 2008.

And finally, last thing, a regulatory update for New Mexico. New Mexico, the NMPRC has not identified any other actions it’s going to take for the scope of its inquiry into fuel and purchase power costs, nor has it identified any further action it intends to take as it relates to the investigation of the company’s commercial and industrial rates.

And that concludes the formal part of our presentation.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question comes from Brian Russo - Ladenburg Thalmann.

Brian Russo - Ladenburg Thalmann

What types of capacity factors are you assuming at Palo Verde and Four Corners in 2008?

Scott D. Wilson

Palo Verde, I think we are in the mid-to-high 80s.

J. Frank Bates

And Brian, I don’t know if we have the Four Corners number off the top of our head.

Scott D. Wilson

Four Corners is a 104 megawatts for us and so obviously important, but we tend to focus a lot on Palo Verde and the last numbers I’ve seen on Palo Verde is we are assuming something in the neighborhood of mid-to-high 80s and all three units are operating at 100% right now.

Brian Russo - Ladenburg Thalmann

I am sorry if you quantified this earlier, but what was the weather impact in 2007 in terms of earnings?

Scott D. Wilson

Well yes, we didn’t actually turn it into a dollar amount, our heating degree days were up about 13%, and our cooling degree were up about 2%. So although we didn’t quantify it, the sum of the weather changes and the increase in customers, which is over 2%, played quite a big part in our change in revenues.

Brian Russo - Ladenburg Thalmann

And what type of peak load growth in terms of megawatts do you expect going forward?

J. Frank Bates

Brian, historically we, prior to the last couple of years we have grown probably between 30 and 40 megawatt on an average year. Obviously with last year grown at a rate greater than 50 megawatts and this year grown at another 80 megawatts, we are clearly not in normal territory.

I think going forward at least until the Fort Bliss things work themselves through next four, five years we are seeing a growth in demand probably between 50 and 75 megawatts on average a year. In some years, it’s going to be more, and some years it’s going to be less and as you know the demands are very weather driven things and especially extreme weather in the summer, given our summer peaking propensity.

Brian Russo - Ladenburg Thalmann

Your assumptions for roughly $10 million increased non-fuel O&M Palo Verde expense in ‘08. Is that dollar amount something can wage you by the operator of the plant or is that your own kind of internal estimation?

Scott D. Wilson

No, that’s clearly been conveyed to us by APS. They submitted us a budget for 2008 and that’s little of the effect of that budget.

Steven P. Busser

We get that starting point that we use, as Scott mentioned, is the budget. And we make adjustments to that as do they on their side, so we are pretty comfortable with our number.

Scott D. Wilson

And one of things we did Brian, and frankly is we have experienced over the last several years an increase in actual Palo Verde non-fuel O&M relative to budget estimates that they’ve given us in previous years. So we actually built the contingency in this year and have reflected that and all the information that we’ve provided. We’ve factored a couple of million-dollar contingency into Palo Verde non-fuel O&M budgets for our own planning uses and for external purposes.

Brian Russo - Ladenburg Thalmann

And just lastly, how much did the building cost?

J. Frank Bates

We have a non-disclosure agreement that we signed when we purchased the building. So we are not at liberty to describe it, but we are extraordinarily happy with the purchase. And as I mentioned earlier, it actually looks to be absent any extraordinary events. It looks to be slightly accretive to us relative to what we pay to lease the space that we have.

Operator

Next question is from Maurice May - Power Insights.

Maurice May - Power Insights

I’ve got a question on the termination of the SPS contract. They exercised some clause to terminate it and you all agreed to terminate it at the end of the third quarter in ‘09, this is 133 megawatts. And I was just wondering what your plans are, first of all to make up for that lost power and second of all, is it going to have any impact on earnings?

Scott D. Wilson

Let me start with the plans first. The 133 megawatts will in fact terminate after our peak of 2009. So, it won’t result in any kind of planning shortfall for us in 2009. And we are still working towards what we would need to do in 2010. We have identified some alternatives.

We have got some things that we are considering for 2010 should we need to backfill that capacity. We are bringing 140 megawatts at Newman 5 on in the summer of 2009. And then we have a heat recovery steam generator that’s in 140 megawatts plus. And we are still trying to firm up when that will be available. So at this point in time, it’s fair to say that we are looking at various options for 2010 and beyond.

Maurice May - Power Insights

Could you in fact speed up the installation of the HRSG from late 2010 or early 2011 to like the spring, early summer of 2010?

Scott D. Wilson

Some of that is a function of the labor and capital markets. And yeah, it’s very difficult at this point in time to do anything with the HRSG market. There is a backlog of orders and its difficult accelerating anything beyond the time periods that we are taking about.

Maurice May - Power Insights

Okay, I’ve heard that the HRSG backlog was about 22 months, and you are implying that it’s possibly longer than that.

J. Frank Bates

Yes, our productions slot begins in March and it varies anywhere from 16 to 20 months delivery in different stages. But right now the areas that we are looking at, is the end of ‘10. We can’t make it by summer peak of ‘10; and for sure we will make it by the summer of ‘11.

Maurice May - Power Insights

Is there any impact on the termination of this contract or if you have to buy a replacement power say in the summer of 2010, you can just use few clauses to pass it through, can’t you?

Scott D. Wilson

Well, certainly they would be eligible for recovery. I mean I think that we believe that when we get in front of Texas and New Mexico commissions and talk about this, our only other alternative to determination of the SPS contract was to actually renegotiate that contract.

And in effect with what happened with the regulatory situation, they were going to have to price this at their system incremental cost, and they have old gas units much as we do. So in effect we would be importing Rio and Newman Power, old unit power, a couple of hundred miles into El Paso.

So we believe that the termination of this contract given that they were required by their regulators to charge incremental cost will be found in front of these commissions to be prudent and the right thing to do. So, we would suspect that when we go out, and if we have the purchase power to fill that hole, that we would be able to prove a case that that was certainly more reasonable than continuing the SPS contract at incremental cost.

Maurice May - Power Insights

Second question has to do with ROE sharing in Texas once you passed the threshold. We’ve had a decline in interest rates. I know, in the recent past, we’ve talked about a threshold for sharing at 12.3%. I am wondering whether that threshold has actually declined recently. Can you go through the mechanism and the threshold and all that stuff?

Scott D. Wilson

Although reference rates like treasuries have certainly declined, what we have seen is corporate spreads have widened. Our mechanism is a 12-month calculation of bond yields of comparable quality, BBB bond yields, and we just actually went through that calculation, not more than a couple of days ago, again because it’s getting close to that time that we need to report this to the City of El Paso and to the State of Texas.

Our latest information suggests that that the decline in treasury bond yields has been offset almost exactly by the increase in spreads, corporate spread, such that the reference rate that we use, the credit quality adjusted 12-month average of interest rates is in fact about where it was, about 6.3%.

Maurice May - Power Insights

So the threshold is still 12.3?

Scott D. Wilson

Yes, roughly, give or take a couple of basis points, that’s where we are.

Operator

Next question is from Michael Lapides - Goldman Sachs.

Michael Lapides - Goldman Sachs

Can you outline the Newman construction schedule? I know you will probably have it in the 10-K, but I don’t think I have seen it filed yet?

Andy Ramirez

The 278 simple cycle turbines go commercial operation in the end of May of ‘09, and then the combined cycling units will go online at the earliest, at December of ‘10 or at the latest summer peak for 2011.

Michael Lapides - Goldman Sachs

Can we get little more granular than that, can we walk through the capital expected to be spent, ‘08, ‘09, first part of ‘10?

Scott D. Wilson

Roughly speaking, probably two-thirds of the capital and these are round numbers, little less than two-thirds are in HRSG. And that money starts getting spent later in the year and it’s scheduled out.

Probably Michael I would encourage you, if you could, tomorrow we file our K. And we’ve got a construction; we actually have four years of CapEx going through 2011. And I think you’ll get a pretty good feel not necessarily for the granularity in the Newman build-out, but you get a feel for if you’re looking for total CapEx dollars, which you probably are to. That will give you a better feel for whatever CapEx schedule looks like for the next four years.

Michael Lapides - Goldman Sachs

Thinking about exposure to coal prices and impact on off-system sales margins, can you just talk about the coal contracting at Four Corners, etc., what you are seeing in terms of coal cost for the next couple of years?

Scott D. Wilson

That’s a mine-mouth operation, and there are agreements in place, I think, with escalators if I remember. Yeah, and so I don’t think, we are subject to the same vagaries in the coal market and maybe other folks are in other parts of the country.

Operator

Next question is from Yiktat Fung – Zimmer Lucas Partners.

Yiktat Fung – Zimmer Lucas Partners

Anyway, let me start with a question on the pollution control bonds, the auction rate bonds. From what I remember from the 10-K, last time it was auction rate at the end of ‘06, it was auction rate of something like 3.85%. And I guess there will be something maybe somewhere around there at the end of ‘07. What have been re-priced recently? You say it was half double that.

Scott D. Wilson

Yes, we are seeing auction rates in north of 10. Now the good news is we haven’t pegged our default rate yet. I guess a couple of the other utilities and lots of other folks have actually hit their default rates. We haven’t hit our default rate, which is 15%. But we are feeling enough pain that we are actively considering and working with our advisors on looking at refunding or remarketing these bonds.

There is a perverse thing going on right now that believe it or not that paper that has insurance on it is trading at a greater yield than paper that’s uninsured and unsecured. It’s really an Alice in Wonderland kind of situation right now. So we are actively working through our auctions.

Yiktat Fung – Zimmer Lucas Partners

So, you could kind of have finance on with like unsecured bonds.

Scott D. Wilson

Well, in this particular case one of the things we consider among many things is actually going out unsecured on our own credit rather than securing it.

Yiktat Fung – Zimmer Lucas Partners

Going back to fourth quarter results, one of the items that you mentioned were the tax items that were beneficial to you this quarter. And in fact this quarter, you had I think it was like a negative tax rate basically. Even adding back that $3.9 million I am still coming out with a tax rate of around 20%. What’s making up the difference between the 35%?

Scott D. Wilson

Primarily AFUDC equity, we are beginning to record. Two things are going on now that we are subject to AFUDC in both of our jurisdictions and our construction program over the last 36 months has basically tripled.

We are starting to record some reasonably significant amounts of AFUDC debt and equity. The equity piece of AFUDC is a permanent timing difference and it is not subject to book income tax at the time that you record it. You actually pay income tax when that AFUDC equity is put in rates and depreciated.

Yiktat Fung – Zimmer Lucas Partners

And my final question pertains once again to the SPS contract. When this expires at the end of 2009 obviously if you go and buy part of this still under a fuel clause so it is like a fuel recovery on that. But that contract price also set the price for the megawatt-hours that you’re sell from Palo Verde 3 into New Mexico, correct? And under the settlement, it’s just basically, if that contract is canceled, you will just price to the 12 months before that contracts expiration.

Scott D. Wilson

That’s correct. There is an average calculation. It wasn’t contemplated that the contract would terminate, but it was certainly contemplated that was possible when we entered into that agreement. And so there is a mechanism there that provides for a 12-month average price up to the termination date. And that’s what would be in place until that is revisited in another New Mexico proceeding.

Yiktat Fung – Zimmer Lucas Partners

And basically, they will be revisited maybe nine months after that when the retail expires?

Scott D. Wilson

Well, actually the parties have the potential to revisit this as soon as July 2009. Anyone of the parties to this, including ourselves could suggest that the SPS contract is not representative of market prices and could seek to reopen that, and this contract expires September 30, 2009. So it’s conceivable one of the parties might come in and try to modify that as early as July of 2009.

Yiktat Fung – Zimmer Lucas Partners

Do you plan to revisit that?

Scott D. Wilson

Well, it all depends where the markets go. It’s a little too early to tell. We are 16 months out and clearly we believed when we did this case that although we were willing to live with the SPS price, we thought that the Palo Verde hub was a more reasonable representation of a market price in the Southwest, a true market price.

So we still are of the position that the hub probably makes the most sense. So, but it’s too early for us to tell what we will do in July 2009.

Yiktat Fung – Zimmer Lucas Partners

Obviously the current settlement in Texas right now bases your ROE on kind of GAAP ROE?

Scott D. Wilson

Yes.

Yiktat Fung – Zimmer Lucas Partners

Can you give us any indication on what the ROE is on a regulatory basis, if you are the PUCT and you are looking at regulatory accounting?

Scott D. Wilson

Yes, we’re hesitant to get into this on the call because there is an number of adjustments that need to be made to those numbers to come up with a regulatory calculation. And so what we proposed to do probably is we got to do that in another forum. We don’t have those numbers handy.

Operator

At this time, we have no further questions.

Steven P. Busser

We appreciate everybody joining us today. Thank you and have a nice day.

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