Pinnacle West Capital Corp (PNW) 2003 Q3 法說會逐字稿

Good morning. At this time, I would like to welcome everyone to the Pinnacle West Capital Corporation conference call. (Operator’s instructions) I would now like to turn the conference over to Becky Hickman, Director of Investor Relations. You may begin your conference.

Thank you. I'd like to thank everyone for participating in this conference call or webcast to review our third quarter results and recent developments.

This is being simultaneously webcast at www.pinnaclewest.com and a replay will be available for the next 30 days. A replay of the conference call will also be available through October 31st, by calling 800-642-1687, and entering access code 2917767.

This morning I have with me Bill Post, our Chairman and CEO, Jack Davis, who is our President and Chief Operating Officer, and also President and CEO of Arizona Public Service, and Don Brandt, Executive Vice President and Chief Financial Officer of both Pinnacle West and APS.

Here's an outline of our call's topics. Bill is going to make opening remarks then Don will discuss the primary earnings variances for the quarter. After that Jack will update you on the status of regulatory developments and some of our operational results. And finally Bill will wrap up with a strategic summary.

Before I turn the call over to our speakers I need to cover a few housekeeping items with you.

First, our Website contains extensive supplemental information on earnings variances and quarterly operating statistics. To help you easily locate all the new information posted today we have a quick reference menu on the Website for the current quarter and the quarterly statistics section under investor information. The Website also includes comparative quarterly information back to 1999, for your detailed analysis later.

Second, please note that all of our references today to per share amounts will be after income taxes and based on diluted shares.

Third, it is my responsibility to individuals you that this call will have forward-looking statements and the company assumes no obligation to update these statements. Because actual results may differ materially from expectations, we caution you not to place undue reliance on these statements. Please refer to the MDNAs in our 2002 annual report on form 10-K and our June 2003 form 10-Q which identifies some important factors that could cause actual results to differ materially from those contained in our forward-looking statements.

Also, in order to allow more people to ask questions, I'd like to ask each of you to limit yourselves to two questions, when it's your turn. If you have more questions you may ask after another person has a chance to ask a question.

Finally, this call and webcast are the property of Pinnacle West Capital Corporation and any copying transcription redistribution retransmission or rebroadcast of this call in whole or in part without Pinnacle West's written consent is prohibited. At this point I'll turn the call over the Bill.

First I'd like to thank everyone for taking time today to join us. We know that this is a very busy season and in particular, because of the EEI financial conference it's particularly hectic. So we thank you very much and we'll keep our remarks relatively brief.

Operationally, our third quarter results reflect the benefits of our strong customer growth, and one of the hottest summers on record. Again we met the challenge of providing reliable service to our growing customer base. We completed our commitment to reduce our retail electricity prices some 16% over the last ten years, by implementing a 1.5% decrease on July 1st.

We placed West Phoenix Unified in commercial operation. We faced their challenges in the third quarter as conditions in the western wholesale energy market continued to deteriorate and we had several unplanned generating unit outages. As I stated in our earning’s release, our employees maintained intense focus on customer service cost management and profitability as we moved through the third quarter.

Don will give you the detail on our results for the quarter and then Jack will give you an update on our regulatory issues and operations. Don?

Thanks Bill. This morning I will address our results for the third quarter and the more significant earnings variances from the third quarter of 2002. In my comments whenever I refer to amounts in millions of dollars, I will be referring to amounts after income taxes unless I specifically say otherwise. After the call, Becky and Lisa will be pleased to assist you in navigating the greater detail available on our Website.

Turning to our third quarter results, we reported net income of $110 million or $1.20 per share for the third quarter of 2003--essentially flat with the $1.19 we reported last year. First, let me discuss the major factors underlying the overall quarterly results, and then I'll discuss the results by business segment.

The benefits of customer growth and a favorable weather increased our earnings about 19 cents per share. Our retail sales increased 7%, and our peak load grew 9%. Our plan to monetize many of SunCor’s (ph) properties through an accelerated assets sales program remain on track. As a result SunCor's earnings increased $7 million, or 8 cents per share.

Our earnings in the third quarter of last year were adversely affected by severance cost and NAC related losses. The absence of those items in 2003 improved our third quarter results $26 million, or 28 cents per share. APS's return to the more traditional AFUCD method of capitalizing interest and equity costs associated with construction projects for regulated utilities added 9 cents per share.

We recorded income tax credits related to prior years that contributed $7 million or 8 cents per share to the quarter. These positive factors for the quarter were essentially offset by some negative factors, thus, producing our flat results compared with the prior year.

The marketing and trading business was down sharply declining $29 million or 32 cents per share. As shown in the operating statistics on our Website, pretax gross margin for M&T was a negative $2 million in the third quarter of this year, compared with a positive margin of $44 million in 2002. These results reflect the continuing deterioration in the western wholesale energy market.

Costs related to unplanned generating unit outages decreased our quarterly earnings $13 million, or 14 cents per share. The majority of said costs are related to a generator failure at our Choya (ph) plant that we first disclosed in our second quarter 10Q. Higher prices for gas and purchase power negatively affected the quarter to quarter comparison by approximately $11 million or 12 cents per share.

Now turning to our business segments, net income for our regulated segment improved by $19 million, or 21 cents per share, for the third quarter compared with the third quarter of 2002. The earnings increase was primarily due to higher retail sales driven by customer growth and favorable weather, which together added 19 cents per share.

Notably, excluding the effect of weather, our retail sales growth was 5% (inaudible) for the quarter representing a significant rebound from last year's relatively sluggish levels. We believe that sales growth should continue to demonstrate strength given the improving economic trends in our retail service territory.

In addition to sales growth the regulated segment was favorably affected by lower operating costs of 16 cents per share attributable to severance expenses recorded in 2002, AFUDC of 9 cents per share, prior year income tax credits of 8 cents per share, and lower regulatory asset amortization of 5 cents per share. These favorable effects were largely offset by unplanned outage costs totaling 14 cents per share, higher hedge gas and purchase power cost of 12 cents, and a 1.5% retail price reduction totaling 6 cents, and higher pension and other benefit costs of 5 cents.

Regarding higher gas costs, a data point that may be of interest to you. Our delivered cost of natural gas in the third quarter of 2003 was $4.46 per million BTU whereas our gas cost in the third quarter of 2002 was $2.99 per million BTU.

Turning to our marketing and trading segment, earnings decreased $29 million or 32 cents per share compared to the same period a year ago. The primary reason for the decline is a reduction in mark-to-market gains of 17 cents per share and lower realized margins of 12 cents per share. The decline in mark-to-market gains is largely related to lower liquidity, reduced forward market volatility, and fewer credit worthy counter parties in the third quarter of this year as compared to the market environment that existed a year ago.

As an indication of this market environment, our total new deal volume for the future delivery is down 40% from what it was a year ago at this time. The reduction in realized margins is driven by lower unit margins in our trading business and at APS Energy Services.

Now turning to our real estate segment, SunCor recorded net income of $6 million for the quarter. The quarterly results were driven by increased home and land sales. We continue to expect SunCor's 2003 earnings to be approximately double its 2002 earnings of $19 million, and remain around this level through 2005.

As we previously discuss, we estimate that 15% to 30% of SunCor's net income in 2003 will be reported as income from discontinued operations. However, the ultimate accounting will depend on the specific properties sold.

Now, turning to SunCor cash flow for a moment, SunCor is on track to produce cash in the range of $80 to $100 million in 2003. SunCor has distributed $33 million of cash to the parent during the first three quarters of 2003. Just a week ago, SunCor closed on a major transaction that generated an additional $20 million of cash in the month of October.

SunCor has two additional major sales planned for closing during the fourth quarter. Due to the timing of these three major transactions, SunCor's 2003 earnings and cash flows will be heavily concentrated in the fourth quarter of this year. I'll now turn the call over to Jack.

Thank you Don and good morning everyone. I'm going to give you a brief update today on regulatory developments with Arizona Corporation Commission and a summary of recent issues.

Regulatory issues, three issues I'd like to up the on. First to proceeding to establish certain readjustment mechanisms, secondly, the general rate case we filed in ACC in June and lastly, new commissioner with ACC.

Starting with the adjustment mechanisms proceedings, I'd like to say during the last call I talked about the docket that is pending with the ACC, related to the design of four rate adjustment mechanisms for EPS. These mechanisms include a power supply adjustor, which would allow APS to recover several types of costs in a timely manner. The actual adjustment would be pardon of APS generate case which I will discuss in a moment. Therefore a decision in the proceeding would not affect APS's customers APS rate until the commission makes its decision on the generate case.

On October 1st a Commission administrative law judge issued her recommended order on this docket. The proposed order recommends approval of all four adjustment mechanisms we requested subject to conditions and modifications. Decisions regarding the ultimate implementation of the adjustment mechanism will still be made through the pending generate case. The commission is currently expected to consider the recommendation sometime in November.

Now let's turn to the general rate case. On June 27th, we filed a retail rate case requesting a 9.8 % revenue increase to be effective July 1st, 2004. During last quarter's conference call, I outlined the major items included in the filings so I won’t go over those today. They are described in detail in our second quarter 10-Q.

In mid August the procedural schedule for issued for the case we are currently in the discovery phase which allows (inaudible) to request additional data. The next major milestone is the filing of testimony by the ACC and interveners on January 9th of next year. After that, various rebuttal testimonies will be find by APS, the staff and interveners. Finally, the hearing will begin on April 7th. We have a strong track record to achieve constructive outcomes on regulatory issues. We believe our position in this case is very strong. We will work with all parties toward a timely decision that will enable APS to recover the cost providing reliable service to our retail customers.

As many of you may have already heard we have a new commissioner at the ACC. Republican Kristin Mays, was appointed for the vacancy created by the resignation of Jim Urban from the ACC. Commissioner Mays took office on October 6th and will serve until January of 2005. The commission seat she is filling will appear on the November 2004 general election ballot to be filled for the then remaining two years of former commissioner Urban’s term. Commissioner Mays has the option to run for the position in 2004.

As a result of the appointment of the other commissioners APS terms, four of the five commission seats will be on the ballot in 2004. Before existing commissioners will be eligible at that time to run for reelection, I should note though that chairman Spitzer is the only commissioner that is not up for election at that time.

Now I'd like to briefly review some of our operations. We are steadfastly focused on exceptional operations performance and efficiency. As outlined by Don the growth in our retail service territory remains enviable. During the third quarter our customer count grew 3.2% paired to the third quarter of 2002. Our growth continues to be about three times the natural average.

This summer we established a new record for total system peak demand of 6332 megawatts. Our 2003 (inaudible) was 9% higher than last year's and we met the new peak without operational issues.

Looking at our power plant performance the capacity factor was 93% for the nuclear plants in the third quarter, while coal plants operated at 79% average compared with 87% a year ago.

During the third quarter we experienced several unplanned outages at our base load generating plants. The most significant of these occurred at Choya 3 when a generator failed. Choya 3 is expected to be out of service until end of November. Additionally, units 1 and 2 of our Red Hawk power plant began operating at restricted output levels the first week in October to correct a equipment design defect as requested by the manufacturer. The output of the Red Hawk units is expected to be restricted until mid November, or about one and a half months.

The majority of the unplanned outages are attributable to vendors or other system operators. Consequential damages, such as replacement power costs and lost opportunity costs, generally are not recoverable from our from vendors or other system operators. I'm confident that our generating unit practices are solid and I believe our power plant operation performance will continue after these outages.

Our gas plants including the Pinnacle West energy planned have a combined factor of 44% compared to 38% last year. Also I believe it is noteworthy that the new gas fired power plants placed in service in 2001 through 2003 operated very well this summer and aloud APS to reliably meet our customers APS energy demands when our peak grew by 9%.

On September 27th we began the refueling outage of our Palo Verde unit 2. During this outage, we replaced the unite steam generators. So far the outage is going very well. Overall it's expected to be completed in mid December with about a total outage of 75 days.

West Phoenix Unified of a 530 megawatt plant in the Phoenix lode (ph) pocket was placed in commercial operation on August 1st and construction of our 570 megawatt Silver Hawk plant in Southern Nevada is progressing towards a start date next summer.

In the federal level we are continuing to, we are also active participants in the FERC standard market design initiative and the congressional debate over the energy bill.

In summary, I assure you we are continuing working to maintain our high standards of operational performance and working with our regularities to constructively address regulatory issues. That concludes my prepared remarks. Now we'll turn it back over to Bill.

Earlier this week we increased our indicated annual dividend to $1.80 per share effective with our December 1st dividend payment. This 10 cent a year increase was 5.9%. Over the last five years we've grown our dividends at an average rate of 6.7%. I believe customer growth of three times the national average in related potential for-e and dividend growth are distinguishing characteristics of our company. We continue to provide our customers with the generating capacity to meet the growing electricity needs. We've managed market risks and had a solid track record of working with our regularities.

With these efforts and others we remain focused on providing reliable service to our customers while producing solid return for you our investors.

That concludes our prepared remarks and we'd be glad to take your questions.

Your first question is from Greg Gordon of Smith Barney.

Thanks. Two quick questions, that January 9th date is that a change from the prior schedule? I had thought that the staff position was expected in mid December.

No, Greg, this is Jack. Not a change, second week in January.

Thanks. Second question was, as I look at the APS results, you had 14 cents of outage cost as I recall right and you said you thought your gas costs increased gas cost you 12 cents.

So would it be fair to say if you hadn't had the outages and if you had a fuel adjustment clause in place that earnings would have been 25, 26 cents better on sort of a normalized basis at the utility in the quarter?

Yes. That would be reasonable Greg.

Finally, you made this comparison, $2.99 per MMBTU Q3 last year versus over $4.40 per MMBTU this year. I know you haven't had a rate case in a long, long time but is there some implied cost of fuel that's in your current rates? And can you talk about what you're asking for relative to fuel costs in the rate case?

No, I don't think there's anything that would be meaningful relative to an implied gas cost that's in our existing rates. It's been so long since we've had a full, full rate case. But the costs that are in the rate case are comparable to current level of gas cost.

And as I recall, that represents almost, you know, a significant portion of the revenue increase that you're asking for?

Yes. Two-thirds of it.

Okay, thanks, guys.

Your next question is from Michael Dershowitz of Longacre management.

Are there any plans by management to acquire any more power plants to include in the rate base this year?

Well, in terms of the proposal that we have, that's basically the proposal that's outlined before the commission. And as we go forward, and as we have talked in the past, we're some 800 to a thousand megawatts short in 2006. So depending upon how we deal with that shortage at some point in the future, that's not impossible.

Okay. Do you know if that shortage would be done for an acquisition or through construction?

No, it's just as it stands today it's just a deficiency that we're going to have to meet by 2006.

Okay. And I have a final question for you. Do you know what percentage of the power that is generated in the plants here, is it all inside the rate base in Arizona, or is any of the power sent out to California?

If you look at our Website, I think the best way to answer that question is to look at the off-system sales that are listed there in the Website.

All right, thank you very much.

You bet.

Your next question is from Michael Goldenberg of Luminous.

Good morning guys.

Good morning.

Several questions for you. One, transmissions out of Palo Verde, whether or not Red Hawk gets rate based and that remains to be seen, is transmission for the plant secure at this point in time to generate power and transmit actually into Phoenix?

The answer to that question is yes. In fact as a result of the track V bid we just completed this year, all of Red Hawk is being transmitted to the Phoenix area during our peak periods. And to the extent that Red Hawk will be placed in our rate base to serve our customers, they would have priority to that transmission.

And as far as rate base in the plant, besides the fact that commission did a 180 on you and kind of left you to hang out dry with the plant and Palo Verde, are there other reasons why you believe the plant should be rate based, and deserves preferential treatment over the plants available at Palo Verde?

Yeah, I can tell you as I think we've said before, the result of the track V bid we just had is that without Pinnacle West Energy's plants we would not be able to cover our load this year. And even after all Pinnacle West Energy's plants we are 1000 megawatts short in 2006. That is (inaudible) evidence that we couldn't meet our load period.

And finally, maybe can you talk about the continuing collapse in trading in the West earn markets and if, maybe you can give a scenario under which your trading unit can get back to the level of profitability, even remotely close to what it has Ben before. Maybe you could give us a dream scenario, what the trading unit to become a significant part of Pinnacle West.

First I want to come back-- It is important to understand our trading unit is primarily a risk management effort to manage our purchased gas and purchased power cost in exposure to market prices which we have done exceptionally well since we lost the fuel adjustment clause years and years ago.

Now, there was some years of very large profits a few years ago. We don't expect that to return, and we're not focused on creating a real trading business per se. It never has been a trading business. We had some opportunities a few years ago and capitalized on those. The likelihood of that occurring again is slim and nonexistent.

Going forward, where we do excel and we have the skill sets is in structuring transactions for entities, typically municipals and co-ops and those kind of entities, within the Southwestern part of the United States. We've got a good name for doing that, some good relationships.

But right now, the buyers aren't interested in locking anything up long term. That could change. In our earnings guidance we haven't assumed any kind of an uptick until 2005, and then it's a very modest $10 million pickup. Things could change quicker but we're not counting it, and 2005 is likely to be a very modest turn around.

And there's no current plans to become the provider liquidity and basically the market maker there?

Oh, absolutely not. That's not any part of our vision.

Thank you. Good luck.

Your next question is from Jason West of Deutsche Banc.

Hi, yeah, when you guys talked about the rate case impact for next year, I believe you said that it could increase '04 earnings by about 76 cents.

Is that just the second half impact of the rate case, or is that the full year sort of -- or do you get the whole rate case sort of in -- sort of lumped in the second half? You know, would there be incremental above that in '05 I guess what I'm trying to say.

Yes, the 76 cents just assumes the rates that we asked for were effective July 1 of 2004. So it's just as if the rates were in effect. It's as simple as that for that last six months. If, in fact, they went into effect on July 1 of '04, and then again in '05 there would be an incremental boost. And the number for the total year is about $1.15 a share. For a full 12-month period.

Would you guys talked about sort of a $3.40 long term earnings power, you know, off a base of $2.50 next year. That seems like the $3.40 is a bit low, you know, if you say $2.50 plus the $1.15, gets you through $3.65 right there. Or I guess you -- is there other things going on there that we should factor in?

Yes. If you'll look or refer you back to our 8-K and how we describe that. We talk about at least $3.40 a share, and assuming we get the full rate request that we asked for, then we talk about trading contributions is seven cents a share and that's the $10 million of margin I referred to prior in the call here. The combined SunCor and Energy Services earnings are 33 cents a share in '05. And then going down to 11 cents a share after '05. The reason for that decline is '05 will be the last year of the accelerated asset sales program at SunCor. The lion's share of that 33 cents is really SunCor. So SunCor earnings are expected to decline substantially after '05.

Right, okay, thanks a lot.

Again, to ask a question, press star 1 on your telephone key pad. Your next question is from Tom O'Neill of Lehman Brothers.

Good morning.

Hi Tom.

Quick question on Pinnacle West Energy. Did APS take power from anyone else besides PWEC during the quarter?

Tom, this is Jack. Yes we did. We also took under contract as part of track V from PPL Global which was about 150 megawatt peaking. I don't have a list of people but I'm sure we bought from lots of other people, since our actual peak was substantially greater than our predict peak. I'm sure we made other short term arrangements, I just don't have a list of people.

Is there a way to cleanly look at the volumes '03 versus '02, when you look at the Pinnacle West Energy, that $3 million versus $10 million of net income, look at the volumes behind those net income figures? I guess I'm trying to discern how much of that is volume, how much of that is price.

I don't think we could put our finger on it right here, Tom.

Okay. Thank you.

At this time, there are no further questions. Are there any closing remarks?

At this point I'd just like to thank everyone for joining us for our call. And if you have any questions, please call me or Lisa Malagon, and we -- we will be ready to help with you any questions that you may have. Thank you all very much.

Thank you for your time.

This concludes the conference call. You may now disconnect.