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El Paso Electric Co. (NYSE:EE)

Q2 2008 Earnings Call

August 6, 2008 4:00 pm ET

Executives

Steve Busser - Treasurer and Chief Risk Officer

Frank Bates - Interim President and CEO

Scott Wilson - CFO

Analysts

Robert Howard - Prospector Partners

Clifford Fisher - Delaware Investments

Brian Russo - Ladenburg Thalmann

Anthony Crowdell - Jefferies

Maurice May - Power Insights

Eric Macarthy - Prestigious Asset Management

Operator

Good day, ladies and gentlemen, and welcome to the second quarter El Paso Electric Company earnings call.. (Operator Instructions)

I would now like to introduce your host for today's conference, Mr. Steve Busser, Treasurer and Chief Risk Officer. Sir, you may begin.

Steve Busser

Thank you, Adrian and good afternoon everyone. Thank you for tuning into the El Paso Electric Company second quarter 2008 earnings conference call. My name is Steve Busser and I am the Treasurer and Chief Risk Officer at the company. 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 will provide an update on our second quarter 2008 financial performance, including a discussion of our pertinent earnings drivers. We will also discuss our recent $150 million bond issuance, our 2000 earnings guidance and assumptions, our stock buyback program, and finally we will 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. 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 logon to the webcast, you can do so via our website. However, in order to ask questions during the Q&A session you will need to be dialed in via telephone.

We currently anticipate that our second quarter 2008 Form 10-Q will be filed with the SEC tomorrow, August 7. As for upcoming IR events we will be attending the EEI conference in Phoenix on November 11 and 12 of this year. We will provide further updates on any IR events on future conference calls. Please call our Investor Relations department if you have any inquiries or require further information.

A replay of today's call will be available shortly after our call ends at 866-837-8032, and will be available through August 20, 2008. A passcode is not required for the replay. You can also access the call 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 facts are forward-looking made pursuant to the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995.

Such forward-looking statements as well as other 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 statement is qualified by reference to the risks and factors discussed in our SEC filings. Our 10-K and other SEC filings contain our forward-looking statements and also layout the Risk Factors that should be considered in the context of the information 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 Risk Factors discussed in these filings are not exclusive. We do not undertake to update any forward-looking statements 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.

Now, I would like to turn the call over to Frank.

Frank Bates

Thanks, Steve. Good afternoon. I want to thank everyone for joining us on the call today. First, I will briefly discuss EPE's second quarter and year-to-date 2008 financial results and earnings highlights. I will then discuss significant items that are affecting the company. Afterwards, Scott Wilson, our Executive Vice President, Chief Financial and Administrative Officer will provide a more detailed discussion on the second quarter and year-to-date earnings results as well as the key earnings drivers for the quarter and year-to-date.

He will also discuss Palo Verde performance, the revised 2008 earnings guidance, the issuance of $150 million in unsecured notes, the status of our pollution control bond refinancing, and update on our stock repurchase program, and finally, he will provide a review of regulatory developments in Texas and in New Mexico.

Now, turning to the second quarter of 2008, we are pleased to report another strong quarter with earnings of $0.43 per basic share and net income of $19.2 million, which represents a $0.22 per basic share increase over the second quarter of 2007 when we earned $0.21 per basic share and our net income was $9.6 million.

During the second quarter of 2008, drivers to our increased earnings were increased revenue from retail customers which was primarily driven by a return to more normal summer weather, and increased sales from the deregulated portion of Palo Verde Unit 3.

For the six months ended June 30, 2008, we earned $0.75 per basic share on net income of $33.7 million which represents a $0.21 per basic share increase from the results of the first six months of 2007 when we earned $24.7 million or $0.54 per basic share.

Following our quarterly results, our year-to-date earnings were also favorably impacted by a return to more normal summer weather, which resulted in increased revenues from retail customers, including increased sales from a deregulated portion of Palo Verde Unit 3 when compared to 2007.

Both the quarter and year-to-date results were negatively impacted by increased operation and maintenance costs at Palo Verde, due in part to the unscheduled preventive maintenance performed on Unit 2 during the refueling outage in the second quarter, and increased operating costs on all three units.

Overall, we are pleased with our financial performance for the quarter. Later in the call, Scott will provide you with additional details regarding each of our earnings drivers for the second quarter and for the first half of 2008.

Turning now to new generation, construction on the first phase of Newman Unit 5, which we have talked to many of you about in the past, began on July 25. The first phase of this project, the combustion turbine portion, which consists of two 70 megawatt gas turbines, is expected to be operational by May 2009.

The second phase of the project, which will start in mid 2009, will be the conversion of the unit into combined-cycle facility by using two heat recovery steam generators to provide steam to a single steam turbine. The second phase of the project which is expected to be operational before the summer of 2011 will add approximately 148 megawatts to the unit, increasing the total capacity of Newman 5 to 288 megawatts.

Newman 5 will be the most efficient gas-fired unit in the company's fleet when operated in the combined-cycle mode. The total cost of the unit, including allowance for funds used during construction, is expected to be approximately $245 million.

This new generating unit will enhance the overall reliability of our system, provide additional fuel savings to our customers due to improved efficiency, and will insure that we have sufficient energy available to serve the significant growth we are experiencing in our service area. That growth is demonstrated by a new [native peak] of 1,524 megawatts which occurred on June 17. That peak surpassed the previous level of 1,508 megawatts set in 2007.

I would now like to provide you with a brief operational update on Palo Verde. Currently, all three units at Palo Verde are operating at 100 % power. Palo Verde Unit 2 refueling outage was completed on June 5, and the outage duration was 69 days, which included 19 unplanned outage days as a result of unscheduled preventive maintenance performed on a unit. The next refueling outage at Palo Verde is scheduled for Unit 1 beginning in October.

Also, as we have discussed with many of you, all the steam generators and low pressure turbines have been successfully replaced at Palo Verde. These replacements have improved efficiency, will extend the life of the units and have increased the probability of obtaining a plant license extension. To that end, Arizona Public Service has notified the NRC that they plan to file for a 20 year plant license extension in the fourth quarter of 2008 on behalf of the plant owners. The license extension process is anticipated to take approximately two years.

I would now like to update you on a regulatory matters pertaining to Palo Verde, specifically Palo Verde Unit 3, which continues to be in the NRCs Multiple/Repetitive Degraded Cornerstone Column of its Action Matrix.

APS continues to work on the confirmatory action letter, action plans and key metrics that are to be achieved on the 12 open items. During June 2008, the NRC conducted an inspection and acknowledged that APS has made progress on several items. The NRC will conduct another inspection in September and expects APS to correct the remaining items by September 30.

Due to this additional NRC oversight, we continue to anticipate that our 2008 Palo Verde non-fuel O&M cost will increase by 15% to 20% relative to 2007 amounts. We continue to closely review activities at the plant and are working in conjunction with the operating agent and other plant owners to take steps to improve the level of operating performance at Palo Verde.

Now, I would like to briefly discuss the significant growth potential we have in our service area, as a result of the United States government's Base Realignment and Closure plant. The unprecedented growth at Fort Bliss is on track. Currently the Army anticipates that approximately 37,000 troops and their families will be stationed at Fort Bliss by 2012, which will more than double the size of the current base population and will substantially add to our total customer base of over 361,000.

Currently, Fort Bliss is undergoing a $4.1 billion expansion and the economic impact for the region is estimated to be approximately $21.7 billion over the next seven years. In addition, approximately 4,500 new troops will be stationed at White Sands Missile Range by 2013. We welcome the opportunities presented by this extraordinary military growth and we look forward to continuing to meet the energy needs of both Fort Bliss and White Sands Missile Range.

Now, before I turn the call over to Scott Wilson, I would like to personally thank the entire team of employees at El Paso Electric for their hard work and their contributions to the second quarter and year-to-date earnings results.

I will now turn the call over to Scott.

Scott Wilson

Thanks, Frank. In this section of the call, we will discuss our financial and regulatory highlights for the quarter and for items year-to-date. Key earnings drivers in the quarter year-to-date balance of the year we will discuss, we will also discuss Palo Verde operations a little bit more about Palo Verde operations, 2008 earnings guidance, we will talk about the new senior note deal that we did in May June of this year and we will talk about the status of our pollution control bond, refinancing, the status of our stock repurchase program, and we will give you an update of regulatory events in Texas and New Mexico.

In the second quarter 2008, net income was $19.2 million versus $9.6 million in the same period in 2007 on an EPS basis. That is $0.43 in the current quarter versus $0.21 in the preceding year of comparable quarter.

The story of this quarter really is quite simple. It is a story of increased retail related revenues, primarily driven by a return to more normal summer weather, partially offset by increased costs of several of our generating facilities and those were the key drivers and we will talk a little bit more about those next.

On the positive side, for earnings drivers in the quarter, retail-based revenues increased 6.9% in the quarter, again due to that return to a more normal summer weather pattern and a 2% increase in the average number of customers served. That contributed about $0.16 a share and the earnings pick-up quarter-over-quarter.

The second item of note on the revenue side here is higher proxy market prices for our deregulated Palo Verde 3 power sold to retail customers and there was an $0.08 per share pick-up relative to the same quarter in 2007.

Pictorially, we have got a look at the retail megawatt hour sales growth and total customer growth. You could see that in the quarter we sold 1,837,000 megawatt hours versus 1,718,000 megawatt hours in the same period in 2007 and our customer count is now approximately 361,000 customers relative to approximately 354,000 customers in the same period in 2007.

We mentioned the weather and the weather related affects on our retail base revenues. As you can see here on slide 13, our cooling degree days were up about 20% in the second quarter of 2008 relative to 2007 and that was a function of we had a pretty cool second quarter in 2007, as you can see on this particular chart. The cooling degree days that we saw in the second quarter of 2008 were slightly above at the 10-year average cooling degree days were, but this really is a story of a return to more normal summer weather in the quarter-over-quarter.

On the negative side, our earnings drivers, two primary drivers here. One is the Palo Verde O&M. We had increased maintenance expenses at PV Unit 2 associated with the refueling outage for that unit, and including some unscheduled preventive maintenance done at the plant. We also had increased operating cost at all three units. That was about $0.06 a share in the quarter, and not only in the quarter, but we will talk about it when we get to the year-to-date. The results that we are seeing so far, these increases in costs at Palo Verde are actually tracking our expectations that the plant made known to us early in the year, so even though we are seeing increases, significant increases in costs in Palo Verde non-fuel O&M, we have not seen anything yet year-to-date that we have not anticipated.

The second major category of power plant operation costs that increased, were non-Palo Verde O&M and we basically had some major outages at Four Corners planned major outages at Four Corners Unit 5 and Newman 3 without any major comparable maintenance performed in 2007. This year-over-year negative variance really is just a function of how planned outages fall out.

There was no unplanned outage. There were no unplanned outages of any significance. This just happened to be reflective fact that in 2008 we had two units that were scheduled for major planned outage and we had no planned outages in 2007. That was a $0.03 a share effect in the quarter.

Year-to-date, much like the quarter, year-to-date is a story of an increase in retail related revenues, partially offset by increased costs at several of our generating facilities. Year-to-date net income was $33.7 million compared to $24.7 million in the same period in 2007. On an earnings per share basis that equates to $0.75 a share for the first six months of 2008, relative to $0.54 a share for the first six months of 2007.

Primary positive earning drivers, again, revenue related. Same two things,retail-based revenues, year-to-date they increased 4.7% as a result of return to more normal summer weather and a 2.1% increase in customers for that six-month period. That contributed $0.18 a share for the first six months of the year.

Second primary revenue related driver were the higher proxy market prices for deregulated PV3 power sold to our retail customers. That contributed about $0.12 a share pick-up relative to the same period in 2007.

Slide 17, we have a pictorial of our retail megawatt hours sold and our customer growth. You can see that we sold about 3.4 million megawatt hours in the first six months of 2008, contrasted with 3.25 million megawatt hours in the same period in 2007. Our customer count is again 361,000 customers versus approximately 354,000 customers at the end of the same period in 2007.

Turning to cooling degree days, first, actually, since that was the bigger driver. You can see again on slide 18 that year-to-date we had 1013 cooling degree days, significantly higher than the cooling degree days that we saw in comparable period in 2007, and again a return to more normal summer weather. The 10-year average being 986 cooling degree days, so what we experienced in 2008 was certainly much more like what we saw in the last 10 years, 2007 again being much cooler than normal.

Taking a look at some of the primary negative earnings drivers, again, in this case, there were two power plants once and we also have another category, depreciation/amortization. The power plant drivers, same as they were in the quarter. PV non-fuel O&M increased associated with the PV2 refueling outage, including that unscheduled preventive maintenance and increased operating cost at all three units. Year-to-date the effect is about $0.12 a share and again, that is actually tracking our expectations relative to what we heard from the plant early in this year.

Non-Palo Verde O&M, same exact set of facts. Four Corners Unit 5 plant outage and plant maintenance in Newman Unit 3 in 2008, no comparable amounts in 2007 and that was $0.06 a share year-to-date..

Finally, something that we saw this year and we will continue to see as our capital program builds out and we place more assets in service. Depreciation and amortization increased due to higher depreciable plant balances and that was an increase in depreciation of about a nickel per share year-over-year.

Couple slides here on Palo Verde operations for the quarter and year-to-date. Slide 21, you can see capacity factors 2008, 72.6% versus 73.8%. Very similar capacity factors, the plants operated, very similarly between the periods. The capacity factors, again, are impacted in both periods by refueling outages. We had units down, a unit down in each period for refueling, hence the capacity factors being in the low 70s.

Looking at outage days and equivalent outage days. (.. In the second quarter 2008, we had about 72 outage days in total compared with 76 outage days in the same period in 2007 and again, hence the similarity in the capacity factors, we would note that our available capacity increased due to the steam generator replacement for Unit 3, we now have 633 megawatts available out of those units instead of 622 and that will also have a slight impact on the capacity factors year-to-date.

Looking at year-to-date, PV capacity factor, you can see that year-to-date we operated at 81.9% and in the same period last year, 83.3% again the same up-rate, slightly affected capacity factors in the period. You can also see on slide 24, that equivalent outage days and equivalent outage days in the first half of 2008, we had about 98 days of outages and equivalent outage days compared to 96. So the plant has operated about the same '08 versus '07. We have been very happy with how the plants have been operating except when they are down for refueling and some of that preventive maintenance we have seen the units operate at 100% capacity factors. In fact Unit 3, once it exited the steam generator repair replacement has operated in excess of 190 days straight at a capacity factor of 100%.

Earnings guidance, we have revised our guidance. It was $1.50 to $1.90. Our revised range is now $1.60 to $1.95. The primary factors for the revision are that we had better than expected off-system sales performance in the first six months of the year which caused us to revisit the lower end of our guidance range..

The second factor that affected, both the low-end of the range and the high-end of the range is that we had better margins on our Palo Verde 3, the deregulated portion of Palo Verde 3. We saw, both better margins and better capacity factors on the low-end of our guidance or previous guidance and we saw better capacity factors and pricing on the high-end of guidance as well. So, those two factors were the primary drivers in us revising our range up a [dime] on the low-end and up a nickel on the high-end.

Some of the key drivers affecting the balance of 2008 include the economy market prices in Palo Verde availability. Those are obviously big drivers for us. Palo Verde operating cost and Palo Verde 3 operations and margins, Palo Verde 3 is deregulated and as a deregulated unit, that is a unit that we only derive revenue from that unit when in fact it operates.

Customer growth in energy usage, we are in a big quarter right now, in the third quarter for summer sales of energy, so that's obviously a driver for us as well as we look at the balance of 2008.

The new bond issuance, in June 2008, we issued $150 million in Senior Unsecured Notes with a 30 year term. The coupon was 7.5%. It priced the treasuries at 280. It priced effectively at 99.146% for an effective yield of approximately 7.6%. We used $44 million of the proceeds to paydown short-term borrowings and the remaining proceeds will be used to fund our construction program and for general corporate purposes. This should provide us all other things equal, the necessary liquidity for the next 12 to 18 months.

Our pollution control bonds, as we have talked to you before, we have about $100 million of weekly auction rate bonds outstanding. These bonds obviously are like all the other auction rate bonds in the country. The auctions have not gone as people expected. We have received all necessary regulatory approvals to refinance these bonds. What we have seen in the interim since we have received these regulatory approvals is that the interest rates in the weekly auction market have come back down below what we could refinance these bonds for at fixed rates.

So given where we are today, we are prepared to refund and reissue the PCBs at a fixed rate if and when market conditions warrant. Right now we are seeing that the rates in the weekly auction rate market though not as low, certainly not as low as they were before the market ceased up in the early part of this year, the rates are low enough to be low, fixed rates that we are going to maintain the status quo until we see some kind of movement in either market.

Our stock repurchase program, current 2 million shares repurchase program authorized by the Board, November 2007. In the first half, we bought 479,000 shares at a cost of about $9.9 million. That repurchase was done in the first quarter. No stock was repurchased during the second quarter of 2008. Partly for and we will talk about this in a little bit, we have a significant balance of unrecovered fuel in Texas, which obviously caused us to be concerned about liquidity and so that was one of the reasons why we did not do a repurchase in the second quarter. Approximately 1.5 million shares remain for repurchase at June 30, 2008. Since the inception of our buyback program in 1999, we have repurchased almost 20 million shares for about $279 million.

Turning to a regulatory update in Texas. July 2008, we filed for a fuel factor surcharge and the filing seeks to increase the fuel factor due to increases in natural gas and purchase power prices and the surcharge previous under-recoveries. We are requesting a 12 month surcharge of approximately $39 million, including interest for fuel cost under-recoveries for the period December 2007 through July 2008. The inclusion of the June and July 2008 under-recoveries, which are approximately one half of that request requires a good cause exception as normally in a filing like this, when you file in July, your surcharges are normally cut-off in May. Final PUCT decision is anticipated in September 2008 and we would expect any new fuel factor and surcharge coming from this filing to be implemented in October of 2008.

January 2008, we had a surcharge filing. It was approved in April of 2008. We implemented a fuel surcharge of $30 million including interest for unrecovered fuel expenses and that will be recovered over a 12 month period beginning in May of 2008.

At June 30, 2008, Texas fuel under-recoveries were approximately $56 million. This excludes the July 2008 under-recovery you saw in the most recent filing that we just discussed, but it includes the remaining surcharge that we just described above, the $30 million surcharge that was approved in April and began to be billed in May of 2008. So the run-up in natural gas prices certainly has impacted us like it is impacted a number of people, and it's resulted in us having an unrecovered balance of about $56 million at the end of June.

We recently concluded a Texas fuel reconciliation case, where $548 million of eligible Texas fuel and purchase power expenses covering the period March 1, 2004, through February of 2007. The stipulation and settlement were approved by the PUCT on July 21. We agreed to a $1 million Texas retail jurisdictional disallowance of eligible fuel cost and exclusion from fuel of about $200,000 of renewable energy costs during this reconciliation period. The reserves that we had set aside covered any of these particular items, so there was no income statement effect from the settlement of this particular docket.

Turning to New Mexico, no new activity on the open New Mexico dockets. Those being fueling rates, executive compensation, and the statewide fuel and purchase power clause investigation. So there is no new activity there. Nothing to update you on there.

We agreed voluntarily to defer fuel and purchase power adjustments under-recoveries in excess of $0.01 per kilowatt hour, post March 2008 to the period beginning in October of 2008. At June 30, 2008, our New Mexico under-recoveries were approximately $10 million. So, between Texas and New Mexico, we are under-recovered for fuel as we sit here today, about $66 million.

With that, I will turn the call back over to Steve.

Steve Busser

Adrian, at this point in the call we normally take questions if there are any. So we will do that.

Question-and-Answer Session

Operator

(Operator Instructions) The first question is from Robert Howard from Prospector Partners.

Robert Howard - Prospector Partners

Hi guys.

Scott Wilson

Hi, Robert, how are you?

Robert Howard - Prospector Partners

I am doing good. Just a couple quick ones. At least on the release, it showed an increase in interest expense was that driven by the auction rate securities or was that more just issuance of the new debt?

Scott Wilson

Actually, both. We certainly saw an uptick in interest expense associated with our auction rate securities and the new bond deal was issued late in the quarter. I mean, we only had about a little less than one full months of interest expense associated with the new bond deal..

One other thing we did, Rob, because we were concerned about liquidity at the time we did this deal, the capital markets were a little uncertain to say the least and given the size of our construction program, we decided that we would actually size this deal larger than we maybe initially anticipated..

So we issued between $25 million and $50 million more than we initially thought to provide us with the liquidity cushion over the next 12 to 18 months to make sure that we can fund our construction program without having to do any additional financings.

Robert Howard - Prospector Partners

Okay. So, I guess in terms of trying to figure out maybe what the steady state level of interest is going to be here.. Is that a couple hundred or a couple million dollars here because that part looks like it is going to come back down? How much of an impact should we say that that specific piece had? Can I make an adjustment there?

Scott Wilson

Well, maybe the easiest way I think on a run rate basis, you could obviously calculate the interest expense on the senior note deal. Just to give you and this is subject to change because the auctions happen every week, but recently we have been paying somewhere on average when you average the two issues together, somewhere between 4.75% and 5.5% on average. Now that is subject to change. It could go up, it could go down but that is about what we have been paying on that and we have got some existing fixed rate stuff out with an average in the high fours. So for today, given where we are today a walking around number of 5% on all the PCBs you would be in the ballpark, again subject to change.

Robert Howard - Prospector Partners

Right, okay. How long are those, you said you got some approvals to issue new PCBs. How long are those approvals good for?

Scott Wilson

Two years. Two years going back to April or May. So we have got a big window to do that and also as part of a similar process with those senior notes, we have approval to issue up to another $150 million in debt and we have two years to get that done.

Robert Howard - Prospector Partners

150 on top of the 100?

Scott Wilson

150 on top of the 150.

Robert Howard - Prospector Partners

Okay.

Scott Wilson

So I am shifting gears on you. We can refinance the 100 the pollution control bonds for up to two more years and on the senior notes where we did 150, we got authority to do 300.

Robert Howard - Prospector Partners

Okay, I have got you.

Scott Wilson

So we do not have to go back to the New Mexico Commission or the FERC to issue the other 150 as long as we do it by I think May of 2010.

Robert Howard - Prospector Partners

Okay. All right, and the Palo Verde, The extended outage or those extra days, do you have any estimate on potential lost sales from that, what you might have been able to get? Were there some hot days there that you might have been able to sell stuff in the wholesale market and gotten a lot?

Frank Bates

No. We do not have, we really do not have an estimate. We have not pulled that together of what we might have sold. We make a lot of our money 40% to 50% of it in the first quarter of the year, so this outage, the extension of this outage really in the second half of May and early June comes during a period where we make less money than we would in, let's say the late fall or the winter period, but that is about a specific information as I have here.

Robert Howard - Prospector Partners

So would it have been more driving the cost for your retail customers or was there much surplus available at the time outage extended anyways?

Frank Bates

Well, there are two effects and you are right. One is that when the units not available we are having to replace the energy, so that is a cash issue for us, and two, if the unit were available, we would be selling it on-peak to our retail customers and we would have an opportunity to make some sales off-peak to our customers, but I just do not have a specific number for you to tell you what that opportunity cost was.

Robert Howard - Prospector Partners

Lastly, just with the stock repurchases, you were saying there were none in the quarter and when these fuel issues get settled with the Commission, is that sort of when you might be able to go in the market or is this higher CapEx going to be holding you back a little bit as well or what needs to happen, because it has been a couple months here and we have had some low prices that would have been nice to buy it back at.

Scott Wilson

Right. Well, we clearly want to get the surcharges and fuel factors fixed before we undertake anything like that and of course, we are always paying attention to what our equity ratio is, and so I would say that the two main drivers here are getting our fuel under-recovery, under control and one thing I would add to that, Rob is that we were under-collected about $66 million through June and that does not include July, where we had the same conditions in July that we saw in June, so there is going to be a significant under-recovery just for the month of July.

So, we have got to work that down a little bit, but we still had the same commitment to buybacks that we have always had and as soon as the liquidity gets to where it needs to be, then I think it is fair that we will be looking at buybacks pretty hard.

Robert Howard - Prospector Partners

Okay, great. Thanks a lot.

Scott Wilson

You bet.

Operator

The next question is from Clifford Fisher from Delaware Investments.

Clifford Fisher - Delaware Investments

Yes. Gentlemen, is there anything further going on with your relationship with the city of Las Cruces in terms of your agreement as their supplier through 2009?

Scott Wilson

No. Certainly the franchise is revisited during that time period, and we periodically meet with them on a number of matters, but there is, to my knowledge no formal discussions on that at this point in time.

Clifford Fisher - Delaware Investments

Okay. Thank you.

Scott Wilson

You bet.

Operator

The next question is from Brian Russo from Ladenburg Thalmann.

Brian Russo - Ladenburg Thalmann

Good afternoon, guys.

Scott Wilson

Hi, Brian, how are you?

Brian Russo - Ladenburg Thalmann

Good. On the refueling outage expected in September of '08, how many days is that outage supposed to take and then was there a similar outage in September of 2007?

Scott Wilson

It is planned to be 40 days into fall outage of this year and, I am not sure about the '07 outage length.

Steve Busser

I have got it right here.

Scott Wilson

Yes, that is right. There was a steam generator replacement, so that is going to be a little…

Steve Busser

It went through January…

Scott Wilson

Yes, that is going to be a little tough to compare, because that was not just the straight refueling. That was a refueling and a steam generator and Brian, you will recall that did not exit until the third week in January. So that was probably more like a 100 day outage or something.

Steve Busser

Yes, I will get you the number here.

Scott Wilson

We will get you a number but, we would certainly anticipate that this outage coming up being significantly less than the '08 outage.

Brian Russo - Ladenburg Thalmann

Right, so I guess we can conclude that you will have year-over-year or quarter-over-quarter incremental Palo Verde capacity to sell in off-system sales?

Scott Wilson

Yes, we should. And Brian that outage last year for the steam generator replacement in the fourth quarter of 2007 and extended through January of 2008 was 95 days.

Brian Russo - Ladenburg Thalmann

Okay. What percentage of annual off-system sales or margins do you derive in the fourth quarter?

Scott Wilson

I have to go back and get a number for you because the November-December period usually is pretty good and the first quarter of the year is always good, but we would have to get some information for you on what that specific percentage is in the fourth quarter.

Brian Russo - Ladenburg Thalmann

Okay, and on the Palo Verde O&M looks like $0.06 per quarter and depreciation of $0.02 per quarter. Can we just extrapolate that forward and assume $0.06 per quarter going forward for the remainder of the year on PV O&M and then the additional $0.02 per quarter for depreciation?

Scott Wilson

I think the PV is probably a good estimate, and I would anticipate depreciation also is a reasonable estimate.

Brian Russo - Ladenburg Thalmann

All right, great and then two last questions, what is your target equity ratio?

Scott Wilson

We try to target 46 to 48.

Brian Russo - Ladenburg Thalmann

Okay. And where are you now?

Scott Wilson

We are about 45.

Brian Russo - Ladenburg Thalmann

Okay. Then just with the share buybacks, what is the timing of when recovery of your under-recovery balance could start? How long do you think you are going to have $50 to $60 million of under-recovered balances on your books?

Scott Wilson

Well, there are really two moving parts here. One is, when we implement, what we sought and whether we get that, and so the best case that happens in October and we get the full amount that we are trying to surcharge and then the second piece of that puzzle is do we continue to under-recover in the interim before those new rates are set and then what happens once we get these new rates? Where do they go?

So, I do not mean to be vague here, but I think we are just going to have to wait and see a little while to look at what the liquidity situation looks like and go from there. It is just a little too early to tell.

Brian Russo - Ladenburg Thalmann

Right. So it was $56 million total and then how much more in July?

Scott Wilson

Well it is $66 million including New Mexico, and we do not have a July number available at this point in time, but it is going to be a good size number. So we just have to see where all this winds up before we can make any real prognostication about when we would feel comfortable resuming a buyback.

Brian Russo - Ladenburg Thalmann

Okay, great. Thanks a lot, guys.

Scott Wilson

You bet, Brian.

Operator

The next question is from Anthony Crowdell. from Jefferies.

Anthony Crowdell - Jefferies

Thanks. Just a quick question, I don't know if you went over it but, it looks like your effective tax rate declined below 30s versus last year at this time of almost 40%. Is there any driver behind that?

Scott Wilson

Increased AFUDC.

Anthony Crowdell - Jefferies

Okay.

Scott Wilson

AFUDC is a permanent difference, and so when you record AFUDC income, your effective rate will drop.

Anthony Crowdell - Jefferies

Okay. Thank you.

Scott Wilson

You bet.

Operator

The next question is from Maurice May from Power Insights.

Maurice May - Power Insights

Yes. Hi, gentlemen. A little bit more on the fuel under-recovery. The $10 million under-recovery in New Mexico, what would be a likely schedule for recovery of that?

Scott Wilson

Well, it is a little different there. The fuel clause operates differently but what we would seek to do is balancing our recovery with our customer's needs and so at this point in time once we get a little bit closer, Maury to where we are and what that ultimate balance is, we are going to draft a plan in combination with the various folks in New Mexico to try to come up with a schedule that works for everybody.

Maurice May - Power Insights

That is pretty vague.

Scott Wilson

Well, that is because we don't have a better answer for you. Frankly, it is the truth.

Maurice May - Power Insights

Okay.

Scott Wilson

Really at this point in time we don't know what that balance is going to be at the end of September, and we would like to recover it before summer of the next year. The thought behind this Maury was, we didn't want to see a big increase in fuel because natural gas spiked as people were seeing increased consumption in the summer months..

So ideally here is what would happen. Whatever the balance is in September, the under-recovery would end before the next summer's cooling period began, but again, we need to get to September. We need to see how big that balance is and go from there.

Maurice May - Power Insights

Okay. If you do get implementation on the second Texas surcharge, in October, you will be recovering, assuming the market doesn't go against you, you will be recovering over $5 million a month.

Scott Wilson

Right.

Maurice May - Power Insights

On those two surcharges.

Scott Wilson

Right.

Maurice May - Power Insights

Okay, so that would be the beginning of substantial cash there, assuming the market doesn't continue to go against you in the future.

Scott Wilson

Yes, and that's why we are being circumspect about when we might revisit this topic because you are exactly right. That is part of it and then when we got to see where the markets are when we get out to that point.

Maurice May - Power Insights

Okay. There could be share repurchases later in the fourth quarter?

Scott Wilson

We won't rule them out.

Maurice May - Power Insights

Okay, great. Thanks, Scott.

Operator

(Operator Instructions). The next question is from [Eric Macarthy from Prestigious Asset Management]

Eric Macarthy - Prestigious Asset Management

Hey, guys. My question has been answered. Thanks.

Scott Wilson

Okay.

Operator

There are no further questions.

Steve Busser

Okay, everybody. Thank you for joining us on the call today. We look forward to seeing you guys in the future. Thank you very much and have a good day.

Operator

Ladies and gentlemen, thank you for participating in today's conference. This concludes the program. You may now disconnect.

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