PNM Resources, Inc. Q2 2008 Earnings Call Transcript

Aug.12.08 | About: PNM Resources, (PNM)

PNM Resources, Inc. (NYSE:PNM)

Q2 2008 Earnings Call Transcript

August 12, 2008 9:00 am ET

Executives

Gina Jacobi – Corporate Communications

Jeff Sterba – Chairman, President and CEO

Pat Vincent-Collawn – Utilities President

Chuck Eldred – EVP and CFO

Jim Ferland – SVP, Energy Resources

Tom Sategna – VP and Corporate Controller

Analysts

Jonathan Arnold – Merrill Lynch

Brian Russo – Ladenburg Thalmann

Edward Heyn – Catapult

Terran Miller – UBS

Maury May – Power Insights

Chris Nelson [ph] – Millenium Partners

Lasan Johong – RBC Capital

Paul Fremont – Jefferies

Paul Patterson – Glenrock Associates

Operator

Good day and welcome to the PNM Resources conference call. Please be aware that today's conference is being recorded. At this time I would like to turn the conference over to Ms. Gina Jacobi. Please go ahead.

Gina Jacobi

Thank you, everyone for joining us this morning for a discussion of the company's second quarter 2008 earnings. Please note that the presentation and accompanying materials for this conference call and supporting documents are available on the PNM Resources Web site at www.PNMResources.com.

Joining me today are PNM Resources Chairman and CEO Jeff Sterba; PNM Resources' Chief Operating Officer, Pat Vincent-Collawn; and Chuck Eldred, our CFO, 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 quarter and future annual report on Form 10-K and the quarterly report on Form 10-Q as well as other current and future reports on Form 8-K filed with the SEC.

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

Jeff Sterba

Thanks, Gina, and good morning. Thanks for joining us today. As you know we faced numerous challenges in the second quarter as we worked through our recovery. These included a debt financing in a very difficult market, a critical rate case in New Mexico, a volatile ever changing ERCOT market, major plant maintenance outages associated with our environmental retrofits at San Juan plus outages at Palo Verde, and a number of other things.

And I think that we came through most of these challenges in quite good form with one notable and significant exception that being First Choice Power performance, and I will address that in a moment.

First let me touch on a few highlights. We successfully issued debt securities at PNMR and PNM and expanded utility credit facilities to ensure more than adequate liquidity. And given the financial market status that you all know better than we, we feel quite good about the way in which these securities got placed though it incrementally increased our interest expense by about $18 million for 2008.

I just want to note our appreciation for the efforts of our partner banks in these transactions. On the regulated utility front, which Pat Vincent-Collawn will address in more detail in a minute, our performance is on the uptake. Our Texas property, electric property produced strong and stable performance though it does need some rate relief.

The gas business performed well financially while we continue to prepare for the sale closing by year-end. We received over $34 million in base rate increase relief in New Mexico. We've also gone to the Supreme Court on appeal for two narrow issues because they have presidential impact that we feel that they ought to be heard by the court.

And critically, we received an emergency fuel clause which will generate about $35 million in 2008 and somewhere between $60 million and $75 million in 2009. The amount that we can receive under the fuel clause is capped. And for 2009 that capped level is about $75 million depending on KWh sales because the cap is on a rate not on a total revenue amount. And we believe we can stay under that cap level. And Pat will update you on other aspects of utility performance and particularly, on the generation side, which is improving as well.

As you know we terminated our agreement to buy Cap Rock and will received $15 million when the gas division sale closes, which is a fair return on capital that we never spent. EnergyCo also had a good quarter with strong plant performance, availability factors in the 95% to 98% range and good prices in the ERCOT market.

One other item to note after a thorough review, EnergyCo has concluded not to pursue the permit to build Twin Oaks 3 at this time. It's really a combination of uncertainty around both carbon legislation and technology for carbon management that with those uncertainties that just did not provide the kind of risk adjusted return that we are looking for. That site will remain valuable for future expansion as a coal unit with carbon capture, a gas unit or some other form of generation.

Moving on to slide 5, let me spend a moment on First Choice Power. Obviously, the improved performance we've seen in the other parts of our business did not extend here. FCP was afflicted with many of the same factors that you have heard from other market participants in Texas. It had a disappointing negative $18.6 million in EBITDA.

Some of the factors that were most and significant is incremental load due to high weather patterns, particularly in the Houston zone. Had very high service costs given commodity prices and also you have to recognize that the hedges that we place on our retail loads are inherently not perfect and that really came home.

And I think we can do a better job of the hedging strategy and implementation than was done, but they never will be perfect. We also saw significant seller choice differentials or differentials – basis differentials between the various zones, which made seller choice purchases not an effective tool in many instances, because of the significant basis differentials.

We also saw higher – what I will call uplift costs. These are costs that are allocated across all market participants. Typically, they are fairly small, but they have grown in the last, really, couple of quarters because of the things that ERCOT is doing largely to manage congestion and also high ancillary service costs.

On the growth side, it was stagnant. We didn't really lose that many customers. We didn't really gain that many customers. So it held its position, but it didn't grow in any significant way. So while we were adversely impacted by forces that hurt most of the other players in ERCOT, frankly, we just didn't execute all that well either. I think we could have done a better job and that's something that we are obviously going to focus on in the third quarter. And we are already starting to see that turnaround with the results from July.

We remain committed to the Texas market structure and believe that the FCP business model has real value and that its performance can and will be turned around in the second half of this year and into 2009. But given the challenges we face in restoring the financial health to our PNM utility, we believe that FCP may have more value to another participant. So after a comprehensive review of our business, we've decided to pursue strategic alternatives for FCP. We expect to have this completed in about 120 days.

In the meantime, FCP will execute a conservative business strategy that focuses on margin preservation and customer retention. There's a very strong commitment to continue to provide excellent service to our customers and to execute an appropriate marketing effort.

We just note that this does not mean that this is something that we will sell at any price. That's clearly not the case. We believe that this is a viable, strong business that provides good returns and that it can be operated that way. But, at this stage we want to find out if there are other market participants that ascribe a higher value to it than we do at this time, given the other issues that we face.

Moving to the Slide 6, the dividend, considering the pending sale of the gas business which we expect to occur by the end of the year, our First Choice Power division, and as we work to restore it the PNM utility to financial health, our board of directors has reduced the annual dividend payment to $0.50 per share from the current $0.92 per share.

This is not unexpected news to most of you and this decision was also a difficult one to make, but I think you would all agree this is a prudent step to improve our liquidity and set a new foundation for long-term value creation. We maintain our target payout ratio of 50% to 60% of consolidated earnings although we expect to be above that ratio for 2008 and 2009, and this will better align our yield to around 4% based on current stock price.

I would also note that we will be instituting dividend policies in each of our subsidiaries. In the past what we have basically done is allowed cash to stay in those subsidiaries earnings from – to stay in those subsidiaries as an automatic reinvestment. I think a much more appropriate approach in our current situation is to dividend earnings under an appropriate dividend policy from our regulated businesses up to the parent and then make reinvestment decisions on the basis of the appropriate deployment of capital. That is being implemented.

In fact, PNM has announced a payment of a $40 million dividend from excess cash sitting at the PNM utility level to PNMR will be advising the commission of that.

Let me move next to Slide 7 and just give a very quick summary on second quarter earnings. Chuck will talk to you about this in more detail, but we have had an impairment charge, mostly on goodwill.

Second quarter is when we do our impairment review and, because of the gap between our current stock price and book value, that impairment analysis takes on a bit of a different flavor as you have seen from many companies in the economy. And so we have about a $140 million impairment which Chuck will go through later.

As we talked about, our regulated utility operations and EnergyCo performed well, but the subpar performance of FCP took away more than its upside and put us into a negative $0.09 ongoing EPS. Chuck will also talk about the outlook for the balance of the year.

Before Chuck goes into more details on earnings, I want to once again introduce Pat Vincent-Collawn to you, who, as you now know from the release, we have promoted to the position of President and Chief Operating Officer of the parent company. Pat has been with us for about 15 months and has made her mark with our company as she did at Xcel. I'm very pleased to have her as part of the team and to have her step into this new role. Pat will talk to you mostly about the utility ops. Pat?

Pat Vincent-Collawn

Thank you, Jeff, and good morning, everyone. As Jeff mentioned, I want to spend a little bit of time this morning talking about our improved performance at the utility, and our plans to continue that improved performance. As Jeff mentioned in May, our new electric rates went into place followed by the emergency fuel and purchase power clause adjustment in June and together those are going to provide a significant foundation for our future earnings.

I like to point out one key aspect of the emergency fuel and purchase power adjustment clause. During that proceeding, we established on the record with the commission that PNM met that legal requirement for a fuel clause.

Many of you have heard us talk about Rule 550 which is the rule here in New Mexico that provides for a fuel clause. The key tests of that are on the slide here, but we think it's very important to note on an ongoing and forward basis that it is on the record that PNM met those requirements for a fuel clause as we go into a new rate case.

In order to continue the improvement that we've started, we have three focus areas. The first is to continue our O&M cost management. We are on track to deliver the $35 million in savings that we had in our business improvement plan for this year. We will give you a formal update once the year is closed. Those plans are proceeding very well. We are also working on maintaining our power plant availability. And I will go into a bit of detail on that in a minute.

Our reliability here at PNM and at TNMP is in the top quartile and we plan to have it remain in there. It's very important as we go forward looking for rate relief that we make sure that our reliability and our service to our customers remains at those levels, so that our customers are supporters of us.

And then finally, I am going to talk about continuing to work on our regulatory strategy, and I will discuss that more in a bit. If you turn now to Slide 10, I have some statistics on power plant performance. I'm sure you recall that we are in the midst of a series of environmental upgrades and outages at our San Juan generating station.

We've completed two of those outages on unit 3 and unit 4. Those were the most major of the outages. In addition to the environmental work that was there, those two units had control upgrades on them so their outages were longer. And while we were out for the environmental upgrade, we went in, planned the maintenance and took the time to make significant repairs on other equipment in the plant that would help strengthen availability going forward.

I think you can see from this chart that we have improved outage execution at San Juan. Our April/May equivalent availability factor at our base load plants was up about 10 points and you can see in June and July we have very strong summer availability at 92.2% and 94.5%. We are also seeing some better performance at our Palo Verde, and that is reflected in those equivalent availability factors.

The other good news now is that the emergency fuel and purchase power clause helps flatten the earnings volatility coming out of our power plant performance. That said, we are still very committed to excellent power plant performance and plan to keep working on those units and getting them to our target EAF level.

If you turn now to slide 11, I want to talk about our regulatory strategy. Jeff has said on numerous occasions that it will take at least two rate cases to get PNM back to its earnings potential. We first finished the first case and as noted those rates in the emergency fuel and purchase power clause are in place and we are working on a new rate case that we're going to file in the third quarter that the rates would go into effect in 2009.

We have been in weekly discussions with the major parties in the case, discussing the major issues in the case. We are making good progress on the understanding of the issues, and we will have that case ready for filing shortly.

The next key regulatory piece in PNM Electric is the filing of our Integrated Resource Plan. The development of the Integrated Resource Plan was a year long very public process with the staff, the Attorney General and major interveners. And it's designed to come up with a generation plan that is basically balances environmental, reliability and costs. And it's something that we brought everyone into the process to come up with consensus on.

One of the major things that you'll see in that Integrated Resource Plan, it calls for the inclusion of our two assets, Luna and Lordsburg into rate base. And we hope that this process builds support for that when we try to bring those into rate base later this year.

On TNMP, as Jeff said, TNMP is doing very well operationally and doing well from an earning standpoint. But we do need some more rate relief at TNMP. We plan to file a rate case within the next 30 days of TNMP. And one of the major pieces of this rate case will be the ability for us to unlock the transmission rate in Texas and recover the transmission investment that we have put in and possible future transmission investment.

On the PNM Gas operations side, as Jeff mentioned, PNM Gas is performing very well and the sale negotiations are proceeding. The staff and intervener testimony is due tomorrow. We've had weekly settlement discussions there also and we are meeting with the parties at 8.30 our time after this call is over, and we hope to have a settlement on that. The hearing will begin on September 12th and we are on target for closing on the 31st of this year.

With that I would like to turn it over to our CFO, Chuck Eldred to discuss our earnings.

Chuck Eldred

Thank you, Pat. And good morning. As Jeff had mentioned earlier, there's no doubt the quarter's consolidated ongoing financial results were disappointing, driven largely by the poor performance of First Choice. But as I walk you through our financial performance you'll clearly see we are making progress on a number of fronts.

Our financial position is stabilized and we now have about $1.2 billion of liquidity available to us. We've also made progress on the regulated side of the business as Pat just pointed out.

If you turn to Page 13 of our presentation you'll see our traditional walk across. This year we incurred an ongoing loss of $0.09 per share for the second quarter, down $0.28 from a gain of $0.19 per share last year. Clearly, most of the decline is associated with First Choice Power and I will walk you through the drivers affecting the company's performance in just a minute, but first I want to spend a little time reviewing our other operations.

Let's start with PNM Gas. Earnings were up $0.03 per share primarily due to higher retail sales if you recall the gas company implemented a $9 million rate increase on June 29th of last year. Earnings at TNMP came at $0.07 per share, up $0.02 from last year due to the expiration of the synergy-saving give back last year, and warmer temperatures as cooling degree days in Texas were up 0.3% from last year. EnergyCo added another $0.01 to earnings.

For the quarter, the company contributed a total of $0.03 to PNM Resources ongoing earnings and $11.5 million of ongoing EBITDA.

Now let's turn to PNM Electric on slide 14. As Jeff mentioned earlier we have begun to see improvement in PNM's earnings as new base rates were put into place on May 1st, and the fuel adjustment clause was implemented on June the 2nd. These two factors combined added about $0.08 to our earnings per share.

Other positive factors improving PNM's electric's earnings included improved plant availability and modest customer growth at 1.3%. We now expect this year's low growth to approximately 1%, down from about 3% as two of our large industrial customers have decreased their load requirements. The largest unfavorable variance was the non-recurrence of the sale of SO2 credits.

Last year, we sold about 13 million of allowances at an average price of about $650. Higher financing costs also reduced earnings due to higher debt balances and our recent financings.

Now turning to slide 15, I want to walk you through First Choice performance for the quarter. We have been focused on EPS, this slide depicts EBITDA which is how we measure First Choice's performance.

As you know, the ERCOT market experienced extreme volatility in wholesale power prices. This is coupled with additional supply costs associated with higher ERCOT fees and ancillary service in ERCOT congestion management issues dramatically reduced retail margins.

This year, First Choice second quarter margins averaged about $3 per MW hour versus $21 per MW hour last year and reduced ongoing EBITDA by $16.4 million. Now Jeff has made a lot of comments about First Choice and performance, so I just say while it's painful, First Choice has learned from the experience and responded with a number of initiatives that will mitigate future exposure.

Turning to slide 16, talking about the non-cash and impairment charges. As you know accounting rules require us to perform a yearly impairment tests on intangible assets, mostly goodwill. And we do this during the second quarter.

The tests consider several factors, the most significant being a comparison of PNM Resources market cap versus book value at April 1st. This year's assessment resulted in after-tax charges of $140.7 million or 1.73 per share. These charges are non-cash and will not affect the liquidity or regulated rate basis.

EnergyCo also recorded an impairment charge as a result of its decision to terminate the (inaudible) Permian process. The total non-cash charge incurred was 21.8 million of which PNM Resources after-tax share was 7.1.

Turning to slide 17, I would like to now provide you with an update of '09 and '08 guidance. If you recall, in February, we provided you with two rate case scenarios to allow you to estimate the impact of zero to full rate case recovery. The column on the right reflects that outlook adjusted for the final outcome of our rate case and emergency fuel cost.

The highlighted column on the left reflects our current outlook for the year. We're now expecting to earn between $0.13 and $0.28 per share in 2008. You'll also notice we have updated guidance for each segment based on the year-to-date performance and other known factors.

Now let me walk you through each business segment. PNM Electric, we are now projecting to earn between $0.05 and $0.09 per share. The decline in earnings from the adjusted February outlook reflects a number of factors. Higher financing costs of $0.12 per share, reduced industrial low growth, year-to-date losses of Palo Verde decommissioning trust. Pat and her team are expected to mitigate some of these negative drivers through strict cost control.

Earnings at TNMP and the gas company are now projected to come in a little higher than originally expected back in February, reflecting actual year-to-date weather. First Choice ongoing earnings are now expected to range from a loss of $0.07 per share to a gain of $0.01.

During the second half, we project average margins of $18 to $22 per MW hour and a flat customer growth. EnergyCo's earnings are forecasted to be up slightly due to the lower interest expense, but no change is expected in the original EBITDA of $60 million to $70 million.

We are also predicting a greater loss at corporate and other due to financing costs of the holding company. And for 2009, we've updated our outlook for only those known changes; and we've looked at those on slide 18. Again we've updated the February outlook and the final result for the PNM Electric case which totaled about $0.36 per share. Other known changes in 2009 include $0.15 of higher interest expense, lower earnings at First Choice and determination of the Cap Rock purchase.

As a result of all of these changes we are now projected to earn $0.45 to $0.75 next year. Keep in mind that this range does not reflect the impact of our third quarter rate case filings. Assuming that rate cases take a year to resolve, we should see some additional benefit in the fourth quarter of next year. We plan to provide you more detailed guidance during the fourth quarter earnings call next year.

Turning to slide 19 you'll see our revised cash flow projections, which are based on a revised earnings outlook. Cash generated from operations (inaudible) the gas company, termination of the Cap Rock purchase and the remarketing of equity links securities expect to yield almost $1.3 billion of cash.

During the same two year time frame, cash flows excluding any financing activities are expected to total $816 million, leaving about $415 million in cash which could be used for debt reduction and other corporate purposes. In addition we have $1.2 billion dollars of liquidity available to us giving us plenty of financing flexibility.

As you have seen, the second quarter was extremely challenging. But we weathered the obstacles and currently find ourselves in a more financially secure position. We were able to issue debt in a very tough market thereby easing the liquidity concerns. We put in place new rate base and a temporary fuel clause at PNM Electric subsidiary and are beginning to see those benefits flow through.

Our plants are performing well and we are seeing the benefits of our environmental upgrades at San Juan. We remain optimistic during the disappointing results at First Choice and continue to work towards achieving the objectives we laid out in the back in February. Jeff is up next and will speak to more to those objectives.

Jeff Sterba

Thanks, Chuck. In the February visitation we had with you, we laid out the 2008 objectives. And on page 20 we show you where we stand on each of those. Certainly we've closed out the Cap Rock one in a way that I think is certainly satisfactory to us. The only down one that we have is our First Choice Power retail business, and as Chuck mentioned we do – we are very focused on having that turned around. We are going to explore strategic alternatives.

And while we continue to believe in the business we think that it may have more value to someone else. Each of the other objectives is on track with good interim results coming in, and we will update you as the rate cases get filed at both TNMP and PNM.

At this time I think we stand ready to take any questions that you may have.

Question-and-Answer Session

Operator

Thank you. (Operator instructions) And we will take our first question from Jonathan Arnold with Merrill Lynch. Please go ahead.

Jonathan Arnold – Merrill Lynch

Good morning guys.

Jeff Sterba

Good morning, Jonathan

Chuck Eldred

Hi Jonathan

Jonathan Arnold – Merrill Lynch

Quick question if you – can you provide some insight into what kind of – where the rate base of PNM currently stand? And what sort of ROE assumption you embedded in your 2009 guidance?

Jeff Sterba

Jonathan, on the 2009 guidance the only thing that's in there is the result – is the result of the rate case that's already been litigated. There is nothing in the numbers that reflect the impact of the new – of any rate case that we filed this year. So --

Jonathan Arnold – Merrill Lynch

What kind of ROE would you be earning in 2009?

Jeff Sterba

Earning ROE. On that basis of that – I don't have that. Probably in the 5% range for 2009. That sound about (inaudible) That's an earned ROE, not what we would file for, obviously.

Jonathan Arnold – Merrill Lynch

And what – and the rate base sort of – I think you've given disclosure on what it was in – last amount was $1.2 billion. Any sort of update as to where that is today?

Jeff Sterba

We are in the midst of getting very close to filing that case. I really – we will release that at the time that we file the case.

Jonathan Arnold – Merrill Lynch

If I may want to follow up on one other subject, on First Choice situation, can you provide some sense of kind of how much – what went on in the second quarter was really confined to the second quarter? And how much the dislocations in the market and how much is really more ongoing pressure?

Jeff Sterba

Yes. The – a fair amount of it was confined to the second quarter and was largely brought about by the obvious volatile nature that we saw of gas prices and power prices, heat rate spreads as well as the – not just the issue of congestion, but the manner by which ERCOT managed that congestion. They have through the course of this year made a number of changes and we have worked closely with them to make changes and how they managed congestion since the trading issue that developed for us in the first quarter which was largely – it was totally on sellers' choice instrument. So most of it is really focused on the second quarter, and so far in the third quarter, we are seeing the results of not only a settling of the market, but also some of the risk management strategies that we've put into place since we saw the deterioration occurring during the second quarter. So we are seeing a pickup in FCP's performance. I think the bigger challenge is going to be – which will be based on what happens in the competitive market, how participants react to what – in terms of their pricing strategies, how they react, given the performance of most of us in that market had in the second quarter. So we expect to see significant improvement in the operations of FCP, but I think for 2009 about the best we can hope for is to dig out of the hole that was created.

Jonathan Arnold – Merrill Lynch

So are you currently back in the 18 MW hour to 22 MW hour margin you are targeting for the second half, or is that –?

Jeff Sterba

Yes, we are.

Jonathan Arnold – Merrill Lynch

Thank you.

Operator

And our next question comes from Brian Russo with Ladenburg Thalmann. Please go ahead.

Brian Russo – Ladenburg Thalmann

Good morning.

Jeff Sterba

Good morning.

Chuck Eldred

Good morning.

Brian Russo – Ladenburg Thalmann

You mentioned earlier that you have been in discussions with parties in New Mexico regarding the upcoming rate case, and you mentioned that there are several major issues you're discussing. Maybe you could elaborate on that?

Pat Vincent-Collawn

Yes, Brian. Pat Vincent-Collawn. The major issues that are coming up in this case are the inclusion of environmental upgrades at San Juan. As you know, we have undertaken significant environmental upgrades there and the inclusion of Luna and Lordsburg, the two formerly merchant plants into our rate base along with the Valencia purchase power agreement. Those are the major issues that are going into the rate case along with a permanent fuel clause mechanism.

Brian Russo – Ladenburg Thalmann

Do you get the sense that the commission is committed to restoring the utility back to investment grade? And how does the higher borrowing costs now that your sub-investment grade, how does that all play into the rate relief or rate recovery?

Pat Vincent-Collawn

Brian, I will answer the first part of your question and I will let Chuck answer the second part of your question. Yes, the commission is concerned about the financial health, the utility, I think we saw during the emergency fuel and purchase power agreement that they understand that the company needs to recover its cost and earn a fair rate of return. And we are very pleased with the actions that they have taken and talking with the commission staff and the interveners that they understand the issues. The higher borrowing costs will be reflected in our next rate case and if we don't have the exact amount yet that will go into the rate base, but those will be reflected in the new rate case.

Brian Russo – Ladenburg Thalmann

And then I think you mentioned earlier that in 2009, the capped emergency fuel clause, will that be enough to recover fuel costs or will you still be under recovering on fuel?

Pat Vincent-Collawn

That will allow us to recover our fuel costs.

Brian Russo – Ladenburg Thalmann

What is the embedded gas price in that fuel adjustment clause?

Pat Vincent-Collawn

I will have to get back you on that. I don't have that off the top of my head. We will follow up with you, Brian.

Brian Russo – Ladenburg Thalmann

And then just lastly the First Choice power assumptions in 2009, what kind of margin per MW hour are you assuming?

Chuck Eldred

In that same range, 18 to 21.

Brian Russo – Ladenburg Thalmann

Thank you very much.

Operator

And our next question comes from Edward Heyn with Catapult. Please go ahead.

Edward Heyn – Catapult

Good morning.

Jeff Sterba

Good morning.

Chuck Eldred

Good morning.

Edward Heyn – Catapult

I have a quick question on the strategic alternatives for First Choice. What would you guys expect if you were to sell that business, what would you expect to do with proceeds? I'm just thinking about is there a potential for stock buyback and also does any of the goodwill impairment hurt your balance sheet to the extent where you wouldn't want to buy back stock from that?

Chuck Eldred

Yes. This is Chuck Eldred. The latter question about the impairment and any impact on our revolvers and our covenants, no, it did not have any difficulty in meeting our current requirements and our debt cap covenants. So there's no concern there at all. We still have very strong liquidity. You know actually selling First Choice gives us some additional liquidity and the financial flexibility to do a number of things. One is to pay down debt. Certainly other options, one of which you mentioned would be a consideration, but we've made no plans at this point to identify further use of those proceeds.

Edward Heyn – Catapult

Got you. And then I just had a quick question. Just some clarification on the preliminary '09 outlook. It looks like from the presentation that the PNM Electric guidance for '08 assumes some reduced low growth. How much – is any of that kind of – of the ongoing, either low growth or pressures or any other benefits that you are actually seeing in '08 being reflected in the '09 outlook? Or are you just solely reducing your guidance from February based just on the rate case outcome?

Chuck Eldred

Yes, the latter is correct. We just took very clear known changes that are mentioned within the presentation and made adjustments to that and have made no other assumptions or other changes for 2009 guidance that we reflected in February.

Jeff Sterba

Ed, just one addition. It's not just the reflection of the rate case outcome, but it also is the higher interest expense (inaudible) and adjustment relative to First Choice, those three items.

Edward Heyn – Catapult

Got you. Thanks a lot.

Operator

And our next question comes from Terran Miller with UBS. Please go ahead.

Terran Miller – UBS

Good morning. Two unrelated questions. One is, what confident – level of confidence do you have that you'll be able to file your 10-Q within the five-day window? And what are the requirements under your bank agreement or do you need a waiver?

Tom Sategna

This is Tom Sategna, the Controller. We will be able to file. We just filed the 12b-25 to get the automatic extension, but we see no issues filing the 10-Q within that time frame.

Terran Miller – UBS

And in terms of the First Choice strategic review, should we only expect an update at the end of that approximate 120 day period? Or do you think you are going to give us updates in the interim?

Jeff Sterba

I can't tell you for sure, because it depends on how things develop, but certainly, we will do it at the end. Whether we say – we are able to say anything in the interim will really kind of depend on how that process unfolds. So it's pretty hard to prognosticate on that.

Terran Miller – UBS

Thank you.

Operator

Our next question comes from Maury May with Power Insights. Please go ahead.

Maury May – Power Insights

Yes. Good morning, folks.

Jeff Sterba

Good morning.

Chuck Eldred

Good morning.

Maury May – Power Insights

Could you remind us of the book values, the carrying cost of Luna and Lordsburg and also the amount of CapEx that have gone into the San Juan upgrades?

Jeff Sterba

Luna and Lordsburg are roughly the total net book value. It's just under $100 million. And its – the split is roughly 50-50. So and then I'm sorry, your second question?

Maury May – Power Insights

The capital expenditure for the San Juan upgrades?

Jeff Sterba

Jim.

Jim Ferland

Yes, Maury, this is Jim Ferland, run Generation and Operations for PNM. Total costs of the San Juan departmental upgrade roughly $320 million, half of which is our share, so about $160 million. Just over half of that has been spent year-to-date, giving that we completed the outages on 3 and 4 and getting ready to move into that outages on units 1 and unit 2.

Maury May – Power Insights

And moving to the longer-term profitability of EnergyCo. Can you talk about the existing contracts on Twin Oaks, Cogen and then also what – how you intend to market the power from Cedar Bayou?

Jeff Sterba

Yes. On Twin Oaks we have a totaling arrangement that goes into 2010. I think it's through September of 2010, and that's for 75% of Twin Oaks. The other 25% we hold and we have done limited hedging relative to that piece of it. On Cogen, obviously, we have the agreements with Lyondell for both steam and power and – Chuck, I'm trying to remember what the amount on the power side is. It's (inaudible) yes.

Chuck Eldred

A little over 200.

Jeff Sterba

70. Yes, it's fairly small out of the total capacity of the unit. And then, relative to – you know the one – just keep in mind as most of you know the Texas market has – its locational value is exceptionally important. And with Cedar Bayou located in the Houston marketplace and in the Houston zone, we feel that that plant is going to have very high profitability, and it's really going to be based – because we are all going to be buying gas, it's going to be based on the heat rate, what happens to heat rates in that marketplace. While I think we are seeing some impact of economic slowdown in Texas, if you notice last week with 107 degree temperatures, they did not set a new system peak record, which I think most people projected. We frankly didn't think it would happen because of some economic slowdown, but it wasn't much. So they were pretty close to hitting their peak. But what we did see is significant differentials with the southern zone, the Houston zone, having very high prices throughout most of the period. So we think that, that resource is going to be very effectively marketed. We are looking at putting hedges in place as we move into next summer, but quite frankly, that's going to depend on where we see the marketplace today. It has moved down somewhat significantly as you all have seen, maybe a bit over – maybe a bit too much.

Maury May – Power Insights

And final question on the output of unregulated Palo Verde 3, I think it's about 135 MW. You just extricated that from the old wholesale contracts and sold the old wholesale contract book. And then you entered a new contract for the output. And can you give us some kind of sense of the profitability of that new contract, going forward?

Jeff Sterba

I can't give you the specific numbers, Maury, but I can tell you that it was very profitable. It is – it was sold at slightly above market. That we sold it under a three year toll for the specific reason people wanted a much longer toll. We would not sell it for a longer period because we believe that as we continue as a country to decide how we are going to address carbon that its value will go up even further. So the toll frankly helped – there is couple of reasons for wanting to do the toll. First was to isolate it and set it at the system purchase that someone was making, that it is a purchase of nuclear power, and so it would help their view of what happens on carbon. Second, that isolating that resource and avoiding system sales simplified the process of calculating the fuel adjustment clause for our New Mexico jurisdiction, because it takes it out of what we had as the common and joint dispatch. So the reasons for the toll were – and then, third, we wanted to do a nearer term toll, no more than three years, in order to protect the longer-term inherent value of that resource.

Maury May – Power Insights

Good. Thank you very much, folks.

Operator

And our next question comes from Jeff Gildersleeve with Millenium Partners. Please go ahead.

Chris Nelson – Millenium Partners

Hi, good morning, guys. It's Chris Nelson [ph].

Jeff Sterba

Hi, Chris.

Chris Nelson – Millenium Partners

Couple of quick questions. First a follow-up on some of the utility questions. I was wondering, compared to the last filing, where is the equity ratios? I think last time around it was 52% if I remember right. And the rate base, I think on your first quarter call, you said it was $1.4 billion. I was wondering if you could talk about any changes from that and maybe magnitude?

Pat Vincent-Collawn

Yes, it was, $1.2 billion was the rate base we had in the last rate case and until we file the rate case, I really want to hold off on those questions. When we file the rate case, we will post it on the Web site and put a summary of the key points in? But until we file that –

Jeff Sterba

Although it is safe to assume that (inaudible) that it's in the $1.4 billion, $1.5 billion range.

Chris Nelson – Millenium Partners

And the equity ratios, is that base constant or are you going to hold off on that as well?

Pat Vincent-Collawn

About the same.

Chris Nelson – Millenium Partners

And then couple of First Choice questions. I was wondering if – could transferring it to the EnergyCo or selling it to EnergyCo, is that an option for First Choice or – I didn't see it mentioned or in your opening remarks.

Jeff Sterba

No, I didn't mention it in our opening remarks. It is – anything, frankly would be looked at as an option on FCP. That's why it's not just a sale process. We will look at other options, but frankly, the primary focus will be on putting it into someone else's hands. That doesn't mean that if we don't receive a bid that we think has appropriate value that we would not look at moving it into EnergyCo with the support of our partner. But our first – our primary focus at this stage is clearly on moving it into someone else's hands if in fact they have a higher value for it than we do.

Chris Nelson – Millenium Partners

And then one other quick question. Do you have a tax basis for First Choice?

Jeff Sterba

Not in the – not in First Choice itself. We had the tax basis resides in the stock which sits at the TNMPE level – PNPE level.

Chris Nelson – Millenium Partners

So if you were going to – I'm trying to figure out what your tax liability would be if you sold the business. Do you have a – ?

Jeff Sterba

See, this will be a function of as we go through the process. We can look at selling First Choice in which we would not have a tax basis. But the buying party will obviously be able to get a step up which would make it have greater value to them, or we can look at potentially selling PNPE selling the stock in which we would have a tax basis, but they won't get the step up. And so you have to think about what, which of those combinations is going to provide the greatest net value? And it really depends not – it depends on us certainly. But it really depends on the position of the buyer.

Chris Nelson – Millenium Partners

Thank you, guys.

Operator

Our next question comes from Lasan Johong with RBC Capital. Please go ahead.

Lasan Johong – RBC Capital

Good morning. Wanted to ask you a few questions on, first of all was part of the reason why you are cutting the dividend, a requirement from the bond financing, by any chance?

Chuck Eldred

No. Lasan, it's Chuck. No, not at all.

Lasan Johong – RBC Capital

So this was made independently of that –?

Chuck Eldred

Yes. I mean it's just what we talk about is the fact that we are not pursuing Cap Rock. We are selling the gas business, looking at strategic alternatives for First Choice Power, and focusing on restoring the health of the utility. We just think this is the right dividend decision at this point to go forward with a cut.

Lasan Johong – RBC Capital

And help me understand the mentality of why the rate – or why the regulators would help out PNM at this point when there's at least $450 million of cash expected to be received and/or made via sale of assets to provide the liquidity, especially in a high-priced commodity environment.

Pat Vincent-Collawn

Lasan, what we are asking them to do is, really, I wouldn't say it's “help us out,” but it's to put in place a permanent mechanism to recover our fuel costs and to earn the appropriate return on the significant amount that we've invested here in our generation and our transmission and distribution system.

Lasan Johong – RBC Capital

Then could you possibly strike a deal in which Lordsburg and Luna stays out of rate base? And then there's a contract that you wouldn't put in place to sell back and pass that through as a purchase power?

Pat Vincent-Collawn

Luna and Lordsburg are very good assets. And if you look at the integrated resource plan that I talked about, it shows bringing them into rate base. The commission here actually prefers that we own conventional generation as opposed to doing purchase power agreements.

Lasan Johong – RBC Capital

And just a quick cleanup question. First Choice Power really has no book value, correct, or very minimal book value?

Jeff Sterba

It's got goodwill. It has maybe $7 million, $10 million or something, $5 million of assets, but the balance is really goodwill.

Lasan Johong – RBC Capital

So essentially it's worth about $160 million on your books right now or $165 million or so?

Chuck Eldred

After the…

Lasan Johong – RBC Capital

After the write-off [ph]

Chuck Eldred

Yes, after goodwill.

Lasan Johong – RBC Capital

Thank you. I appreciate it.

Jeff Sterba

Thank you, Lasan

Operator

Our next question comes from Paul Fremont with Jefferies. Please go ahead.

Paul Fremont – Jefferies

Thank you. If you look at the second quarter where the congestion problems occurred, there has really been no recurrence of the congestion problems into the third quarter. What I'm trying to understand at First Choice is are you still exposed on a going forward basis to the basis differential or the pricing differences resulting from the geography? And second of all, have you protected First Choice on a going forward basis either by scaling back your customer base in places like Dallas? Or putting into place hedges to prevent those blowouts from hurting margins in the future?

Jeff Sterba

A couple of comments, Paul. First, we have liquidated the sellers' choice position. So the exposure that you have on sellers' choice would then significant blowouts of basis differential is not there. The purchases are being made specifically within the zones. And that was really done in the second quarter. So certainly what we're seeing as better congestion management, if you will, as we move into third quarter is one of the reasons why we've seen margins move back up into the 18 to 20, 22 range so far in the third quarter. The management of location of customers is an ongoing process to help ensure that we maintain a balance between our supply within those zones. I think one of the big lessons that the whole market learned is that it isn't just the instruments that are used like the sellers choice instrument that has been the predominant use, but it is clearly how ERCOT manages congestion. And they, I think they clearly recognize that that is one of their largest challenges. And they, frankly in our opinion did not execute it very well at all in the first and second quarters. And I think they are stepping up to the table to do a better job in congestion management.

Paul Fremont – Jefferies

And then sort of as a follow-up, I mean how much of your business is in the TNMP area versus other parts of Texas?

Jeff Sterba

The TNMP customers are only about 40% of the customer base of First Choice at this stage. So the growth that we've had in over the last three years has all obviously been within other areas, some of which are nearby. For example, our largest areas of growth had been in Houston and in parts of Dallas. But that also is where large chunks of the load that are accessible to the competitive market are. So you would generally tend to expect that. But only about 40% or so of today's load is traditional TNMP customers.

Paul Fremont – Jefferies

Thank you.

Operator

And our next question comes from Paul Patterson with Glenrock Associates. Please go ahead.

Paul Patterson – Glenrock Associates

Good morning, guys.

Jeff Sterba

Good morning.

Paul Patterson – Glenrock Associates

Eliminating the sellers choice was one of the things that you guys did. Is there anything else that you can elaborate in terms of mitigating the exposure for First Choice?

Jeff Sterba

Yes, there's a number of things that are being done and they span everything from what we've done relative to sellers choice to what – more fine tuned hedging strategies, that take into account – one of the problems you have when you have a very large residential population is, you can't hedge every transaction whereas on commercial, industrial, they are a little more discreet. So you have to aggregate residential and start putting in place hedges. Given what happened in the marketplace and the rapidity with which there were changes in both natural gas prices and heat rates that left you in our situation frankly exposed and particularly when customers loads for example, in the Houston zone went up more rapidly. That unserved or that unhedged load frankly created significant exposure. So we are focused on doing a more fine tuning of how those hedges are put in place. So that's a second. A third is that we have our service contract with ADS who as you know has been sold to Vertex. We are settling out as part of our concurrence with the assignment of that contract to Vertex. We are settling out with them a number of claims that have where issues associated with their system aggravated our bad debt and our inability to manage some of our customers that were not prompt at payment, with disconnects and the like.

Chuck Eldred

Yes. Let me add one to that, too, Paul. We had some contract limitations on what percent we were able to increase for customer margins relative to those customers' contracts changing. And that was a regulatory process we had to go through, roughly, 30 to 45 days to get that limitation removed. That's been completed and now we can deal more with the timeliness of when these price increases occur and our ability to react or more responsive to what the fair margin and a fair charge to recover those costs.

Jeff Sterba

That's on our month to month customer.

Paul Patterson – Glenrock Associates

Great. And then on the valuation for First Choice, can you help us out here a little bit? I mean, (inaudible) strategic energy maybe its recent sale. Not a lot of data points come to mind. What kind of thought are you guys having with respect to what something like this might roughly go for?

Jeff Sterba

Keep it (inaudible). You're right, there aren't a lot of comparables. Strategic energy, frankly, is a bit different because it is all commercial industrial, doesn't have a residential base. So there's a lot of challenges in its comparison. We believe that this business has strong value and we believe that the performance that we demonstrated in SAP in 2005, 2006 and really 2007 even though it came down a little bit in 2007, it still generated a very, very strong return on investment given that it's a 100% equity investment and that's on the goodwill that we think it has great value. It has stumbled in the first and second quarters for reasons that are unique to Texas as well as some misses in the execution. I think the market in within 120 days will specify what its value is. I think it's a very strong asset that ought to be well received by the market.

Paul Patterson – Glenrock Associates

In terms of the goodwill impairment, was that solely because of the stock price being where it was or was there anything else that led to those impairments?

Tom Sategna

This is Tom Sategna again. That was one of the factors that was considered. Obviously, the impairment requirements you have to look at the values of the different reporting units on a discounted cash flow basis. But as Jeff indicated in his early remarks that because market cap was significantly below book that was a contributing factor that we had to evaluate in the overall impairment analysis.

Paul Patterson – Glenrock Associates

But then – but that was one of the elements and there were others that also triggered this, is that correct? I mean in other words, you guys have lower cash flows projected than what you had previously when you actually booked the goodwill?

Tom Sategna

That is correct. If you look at the performance of First Choice Power, we had to take into consideration the decline that occurred in those businesses. Also the fact that TNMP in the southern part of the state we call PNM South has pressures on it from a purchase power side that we're not anticipated, will follow rate case there probably in 2010. And so that also impacted the goodwill impairment analysis.

Paul Patterson – Glenrock Associates

Thanks a lot, guys.

Operator

Thank you. And ladies and gentlemen, that does conclude our question-and-answer session for today. I would like to turn the conference back over to Jeff Sterba, Chairman and CEO for closing remarks.

Jeff Sterba

Thanks very much for joining us and as we said, we are very disappointed in the FCP performance. But that should not overshadow what I believe is continuing improvement and performance in our other areas of business both on the regulated side and at EnergyCo. I know that a lot of you are looking for better, more updated guidance on 2009. What we've provided today only makes adjustments to what we showed you in 2008. It is not a complete reforecast. We will be providing that on the time line that Chuck indicated. If you have follow-on questions, please feel free to get hold of Gina Jacobi or one of her folks and we look forward to seeing you down the road. Thank you very much.

Operator

And that does conclude today's conference. Thank you for your participation. You may now disconnect.

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