Pinnacle West Capital Corp (PNW) 2004 Q3 法說會逐字稿

Good afternoon, my name is Keila (ph) and I will be your conference facilitator. At this time I wold like to welcome everyone to the Pinnacle West third quarter 2004 conference call. All lines have been placed on mute to prevent any background noise. After the speaker's remarks, there will be a question and answer period. If you would like to ask a question during this time, simply press star and then the number one on your telephone key pad. If you like to withdraw your question, press star then the number 2 on your telephone key pad. I would now like to turn the call over to Becky Hickman.

Thank you Keila. I'd like to thank everyone for participating in this conference call to review our earnings for the third quarter and recent developments. Today, 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 CFO of both Pinnacle and APS. Before I turn the call over to our speakers I need to cover a few details with you. First, the quarterly statistics section of our website contains extensive supplemental information on our earnings variances and quarterly operating statistics. Second, please note that all of our references today to per share amount will be after income taxes and based on diluted shares outstanding.

It is also my responsibility to advise you that this call will contain forward-looking statements based on current expectations and the company assumes no obligation to update the statements. Because actual results may differ materially from expectations, we caution you not to place undue reliance on these statements. Please refer to the MD&A in our June 2004 10Q which identifies some important factors that could cause actual results to differ materially from those contained in our forward-looking statements. A replay of the call will be available on our website www.PinnacleWest.com for the next 30 days. It will also be available by telephone through October 29th. 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's written request is prohibited. At this point I'll turn the call over to Bill.

I'd also like to thank you for taking your time to join us today. We know earnings season is always very busy. But today may be especially hectic because of the EEI financial conference that starts this weekend. Our reported earnings for the quarter were down modestly from a year ago. We reported net income of $105 million or $1.15 a share. Compared with $110 million or $1.20 a share in the second quarter of 2003. Don will give you the details of our financial results for the third quarter.

I would like to discuss some of the highlights of our third quarter from the business perspective. In August, we announced a proposed settlement of our pending retail rate case. The rate case continues to be our most prominent regulatory activity and clearly the outcome will be a foundation for our future financial results. I'm encouraged by the broad base support of the settlement among our company, the ACC staff and most of the interveners in the case.

Our operational performance was solid in the third quarter. Our power plants performed at very high capacity factors without major unplanned outages. Although our system was challenged by a major substation fire and the resulting transmission constraints at the beginning of the quarter, our employees performed exceptionally. And as a result, we did not have any customer interruptions due to our lower delivery capability. Overall, our employees handled the incident very well. And in fact, our customer satisfaction ratings improved. Jack will give you more details on the status of our operations and regulatory developments in the quarter.

Earlier this week we increased our indicated annual dividend 5.6% to $1.90 per share effective with our December 1st dividend payment. Because we recognize the importance of dividends as a component of total return for our shareholders and we will continue to annually assess dividend increases in the context of cash flow, payout ratios and industry trends. Best of earnings guidance, our guidance for 2004 and beyond was established in October of 2003. And predicated upon our rate request before the ACC. When we announced the proposed settlement in mid August, we outlined the major differences between our rate request and the terms of the settlement. Since the settlement is under consideration by the ACC, it would be inappropriate for us to make predictions as to future commission actions and therefore we are not updating our guidance. Now I'd like to turn it over to Don.

Thanks, Bill. In my comments, whenever I refer to earnings related amounts in millions of dollars, I will be referring to amounts after income taxes unless I say otherwise. Reported earnings for the quarter were down $5 million or 5 cents a share primarily due to milder weather, increased costs related to new generating units placed in service in mid '03 and mid 2004, increased O&M costs and higher purchase power and fuel prices. These factors were partially offset by improved power plant performance, improved marketing and trading results, lower regulatory asset amortization and higher retail sales. Let me turn to each of these major factors in more detail.

First, we've indicated in the past that weather can be a significant swing factor and this quarter represents one of those occasions. Milder weather in the third quarter compared with one of the hottest summers on record last year decreased earnings by 13 cents a share. To give you some perspective. Actual cooling degree days were 3% below normal for the third quarter of this year compared with 6% higher than normal last year. Also, humidity levels were down over 21% compared with normal in the third quarter of this year.

The net earnings impact of new power plants in service was a 7 cent a share reduction. The higher cost include interest expense, property taxes, depreciation and O&M expense partially offset by gross margin contributions from the plants. As a reminder, West Phoenix 5 and Silverhawk were placed in service in late July 2003 and mid May 2004 respectively. Higher O&M cost decreased earnings 17 cents a share due to increased costs per customer service programs primarily related to customer growth, bark beetle remediation costs and wage and other employee related costs.

Higher purchase power and fuel prices reduced earnings 7 cents a share. This decline was driven primarily by higher natural gas costs and to a lesser extent by coal cost increases related to contractual index based price escalators. Our commodity price risk hedging program mitigated to a large extent the effects of natural gas price increases as we were approximately 80% hedged at the beginning of the quarter. To be more specific, while spot market gas prices increased 11% in the quarter-to-quarter comparison, our earnings only reflect the 5% increase in natural gas prices because of our hedging program.

The negative factors were substantially offset by several items. Performance at our power plants improved significantly and accordingly unplanned outage time was reduced dramatically. Resulting reduction in replacement power cost added 15 cents per share per earnings. In a few minutes Jack will cover more details about our plant operations.

Marketing and trading gross margin increased earnings 15 cents a share in the quarterly comparison. The primary drivers were 8 cents a share attributable to higher market-to-market gains as a result of higher forward prices, 5 cents a share for increased realized margins primarily due to higher electricity prices and a modest improvement from excess generation sales due to our new plants in service. These quarterly results reflect some stabilization of market conditions relative to the weak results recorded in the third quarter of last year.

As provided for in our 1999 regulatory settlement agreement, we concluded the amortization of certain regulatory assets at the end of the second quarter of this year. The absence of this amortization improved our earnings 14 cents a share in the third quarter of this year. The company's fundamental growth remains strong and underpins our long term performance. Retail sales growth contributed 11 cents a share for the quarterly comparison. The rate of growth continues to accelerate with the overall improvement in the Arizona economy. Customer growth for the quarter was 3.9%. The highest level of growth since the second quarter of 2001. We've added over 36,000 customers in the past 12 months. Which is a record for us.

On a weather normalized basis, retail sales grew 6.2%. Residential sales increased 7.6% and business sales increased 4.9%. The sales growth was particularly striking in light of the successful conservation efforts of our customers in July and early August of this year which we discussed in our second quarter conference call. During our second quarter conference call, we talked about the July substation fires, the result in transmission constraints and energy dispatch adjustments and our customer's outstanding response to our request to conserve energy. At the time, we indicated we believed the net impact of these factors on our earnings would likely be modestly negative. Our subsequent analysis confirms that the net effect on our earnings was truly negligible.

Turning to SunCor, earnings were down $1 million for the quarter at SunCor. We continue to believe that SunCor is on track to produce at least 40 million in earnings for calendar '04.

Now I would like to provide some perspective on our marketing and trading activities in the western energy markets. With respect to our exposure to purchase power and natural gas commodity price risk, we are currently hedged about 80% for the remainder of 2004 and approximately 60 to 70% for 2005. These hedged positions are at prices meaning -- excuse me, meaningfully below current forward market prices for the respective periods. Despite improvements to market and trading gross margins in the quarterly comparison, SPARC spread in both the spot and forward markets remain low and continue to reflect difficult market conditions in the west for our off-system generation sales.

As shown in the quarterly statistics on our website, compared with the year ago, spot prices of Palo Verde are down 2% for on-peak power and down approximately 8% for off-peak. For the same periods natural gas market prices have increased about 11%. SPARC spreads in our region in the third quarter range from zero to as high as $30 a megawatt hour with an average of just over $11 a megawatt hour. The average SPARC spread was down 30% from the third quarter a year ago. Additionally SPARC spreads for delivery in the fourth quarter and for calendar '05 continue to be compressed by a similar magnitude. As we previously indicated, we expect market opportunities to continue to be modest for marketing and trading activities in the intermediate term.

Now I will turn to our recent financing activity and our balance sheet. Earlier this week, the parent successfully completed the renewal of our revolving credit facility while increasing its size to $300 million and extending its term to three years. The revolver provides liquidity support for the parents $250 million commercial paper program. At the parent level, we ended the quarter with about $15 million of outstanding commercial paper. APS ended the quarter with approximately $350 million invested. The unusually high invested position is due to our issuance of $300 million of notes in June to prefinance upcoming debt maturities in 2005. I'll now turn the call over to Jack.

Thank you Don. And good morning, everyone. Today I'm going to give you a brief update on regulatory developments with the Arizona Corporation Commission and our summary of our recent operations. I'll start with the regulatory area.

As Bill stated, the rate case continues to be the most prominent regulatory activity. In August we announced that a comprehensive settlement agreement had been reached among APS, the ACC staff, the [INAUDIBLE] utility consumers office and 20 other parties to the rate case. The proposed settlement is remarkable because it was reached with almost three-fourths of the parties of the case. Most parties having widely diverse interest. We held a conference call to discuss the proposed settlement on August 18th so I will not reiterate the details today. Rather, I will outline the procedural schedule for regulatory approval.. The ACC hearing on the proposed settlement is scheduled to begin on November 8th. We currently anticipate that the hearing will last a week or two and the administrative law judge could issue her recommendation in December. This proposed settlement to be presented to the ACC commissioners for their consideration around the end of the year or more probably early next year.

We expect to file any necessary application with the Federal Energy Regulatory Commission for its approval of the transfer of the Pinnacle West Energy Arizona plants within 30 days after the ACC approval of the settlement. As such, we would anticipate further approval of the transfer by the middle of next year assuming the matter is not set for hearing.

Now I would like to turn to our pending application of Sundance power plant. We did not amend existing rate case to include the Sundance power plant. Rather, we asked the ACC to allow deferral of operating and capital cost net of any savings until the plant is placed in rates. We also asked the ACC to approve rate lease in the assets in our next general rate case under traditional costs of service principles. The ACC hearing on Sundance lasted two days, October 4 and October 5. ACC staff recommended approval of a deferral order that is somewhat more limited than we requested. But indicated it will please the commission does not need to preapprove rate basing the assets at it time.

Several innovators participated in the hearing process and none objected to the acquisition itself. The final post hearing briefs are due to the ALJ on November 5. Sometime after that the ALJ will issue their recommendation for the commission's consideration. Our goal is to have the ACC approval by the end of the year as required on the asset purchase agreement. We expect to file the FIRQ (ph) application for approval of the Sundance acquisition in the next few weeks. We believe the FIRQ approval could be obtained in time for us to close the transaction by the end of the first quarter of 2005.

Now I would like to briefly review some the operating activities during the quarter. Every quarter I talk about the inevitable growth in our retail -- the enviable growth in our retail service territory. This quarter will be no exception. With one of the fastest growing service territories in the county, we face significant challenges every day in meeting that growth. We maintain a steadfast focus on customer satisfaction, and as Bill mentioned customer satisfaction actually increased, and our solid performance throughout our organizations to reliably serve our growing customer base.

On August 11 we set a new record system peak of 6,402 megawatts. This peak reflects 1% increase over last year. However, it also occurred on a day with relatively mild peak day weather conditions on a weather normalized basis our peak grew almost 6% compared with last year.

Our power plants performed admirably in the third quarter. The capacity factor at Palo Verde was 96% slightly better than last year's third quarter. At the coal plants the combined capacity factor was 90% compared to a net 79% a year ago. You may recall that we had an extended outage at our 23 unit last year related to a generator failure following the overhaul. The outage for that unit began in early August and lasted until mid-November.

Palo Verde 3 has begun its current refueling and maintenance outage on October 2. We expect the outage to last approximately 50 to 60 days which is about 20 days longer than normal as we will do some planned maintenance to replace pressurized heater sleeves. During our conference call last quarter, I talked with you about a substation fire on July 4 that reduced transmission import capability into Phoenix load pocket as much as 20%. The fire was at the West Wing transmission substation in the northwest part of the Phoenix metropolitan area. The restoration of West Wing will occur in three phases, two of which which have already been completed. We returned to -- we returned a section of the substation to service within four days of the fire and we proceeded -- we procured an existing [INAUDIBLE] (cough) transformer from the Bonneville power authority transported and installed it within in 34 days. Each of these actions restored about a third of the substation's capabilities. The final phase will be completed before next summer's peak with the new transformers we are having manufactured.

Our employees performed remarkably during the situation doing everything from temporary reconfiguring the grid in the metropolitan Phoenix area to running gas plants in the load pocket to communicating daily with our customers individually and through the media. Our customer response to our request that they conserve energy on peak was outstanding. This was all done without interrupting power to our customers. Overall it was a tremendous effort. We have hired independent consultants to help us determine the cause of the substation fires and to review our maintenance practices and we expect to receive the reports by the end of this year. Don has already commented on the minor effects of the earnings of the fire and result of access to we won't go farther into that.

Our Silverhawk plant near Las Vegas also ran very well this summer. It posted a capacity factor of 55% in the third quarter. However, as Don has indicated with tight SPARC spread in the region and pre-tax growth margin was just over $2 million. The plants energy serve both Nevada and southern California. In summary we are continuing our emphasis throughout the company on providing exceptional service to our customers and we are focused on constructively addressing regulatory issues at the state and federal levels. This concludes my remarks and I will now turn the call over to Bill.

I would like to emphasize just a few points. Growth in our electric service territories is remarkable. 3.9%. As Don said, we set a company record last month with over 36,000 new customers over the same period last year. Our service territory continues to be one of the five fastest growing markets in the United States. That growth provides a sound foundation for our business but it also presents challenges in serving the energy needs of our customers and providing the infrastructure necessary to reliably do so.

I would like to echo Jack's comments about our employees. They focused intently each day on every facet of our business. Providing exceptional customer service. Improving our operations. Managing the risks of our business. Controlling the costs and planning for the future. In the third quarter they were challenged by a sequence of operational events and they rose admirably to the challenge. I'm proud of our employees and their accomplishments.

I continue to believe that our underlying customer growth and the related potential for earnings and dividend growth are distinguishing characteristics for our company. Our goal is to continue capitalizing on these advantages. Great case outcome is clearly the most significant single factor affecting our outlook. We were fully committed to achieving an outcome that will cover the costs of providing reliable service for our fast growing customer base. While providing a fair return to our shareholders for their investment in our company. That concludes our prepared remarks and I'd be -- and Don and Jack and I would be happy to answer all of your questions.

At this time, I would like to remind everyone if you like to ask a question, press star and then the number one on your telephone key pad. We will pause for a moment to compile the Q&A roster. Your first question comes from Dan Eggers.

Good morning your time I guess still.

Good morning, good afternoon to you.

Yes, thank you. First question. You started -- you pointed to it but can you just give us an update on what all is going to go into the next rate case, when are we to look for that to be filed and I hate putting the next one in front of us but it's creeping up?

Yeah, this is Jack. Obviously with the deferral order we are requesting for the Sundance acquisition, that would be part of the next rate case and that's why we asked for the deferral. Recall that we asked for a five year deferral the staff's recommendation in their filing is a three year deferral. So you can anticipate with just a three year deferral sometime in that time frame they will have to file a rate case to cover the acquisition of Sundance and when we do that, we would cover all of our other changes and costs in our company.

Okay. So is that reasonably going to be an '05 event or do you guys plan to stretch it out a little bit further?

Well, until I see the actual signed order for the Sundance acquisition, I'm not going to make a prediction one way or the other.

Okay. On the wholesale side, you continue to see margins pressure there look a little better there this quarter. When will the assets -- I know FIRQ approval's required before you can put them into rate base but the lease structure will be affective as soon as the ACC signs it so you start earning your 10-25 on those assets at that point and the wholesale impact then is spread amongst the customers. Is that the right way to think about that?

Yes.

Okay. And last one, I was wondering if you guys can give us a little update on what's going on with the elections for the commission now that we were a week and a half away?

Well, Dan, obviously we have four commissioners that are up for election. One commissioner had a primary and she won republican primary and she really doesn't have a democratic opponent in the general election. That's commissioner Mays. The other three commissioners are up for election. There's two democratic opponents and I can only comment this way is you drive around you don't see many signs on the two democratic opponents. And so at this point in time I won't -- I'm not going to predict the outcome but we will know on November 2 how well they did.

Jack, you see signs of three incumbents?

Oh, yes. The incumbents, three incumbents have signs all over the place.

Great, thank you.

Dan, let me just add something there. We don't really have polling data that we could give you. If we did, we certainly would. But we don't have any polling information on those races.

Our next question comes from David Grumaz (ph).

Good morning, guys. How are you?

How are you?

Good morning.

Just, I want to talk to you a little bit on Sundance. You talked about the order being more limited than maybe you hoped. Can you explain what you mean by that? And then on FIRQ approval, did I hear that you thought you might be able to get that by Q1 '05? And if so, are they likely to wrap Sundance into the approval of the larger rate case?

Well first off, we don't have an order on the Sundance. What we have is a staff testimony that took place during the two days where they are suggesting a three-year deferral as opposed to a five-year deferral.

Okay.

And another piece of that where they are proposing no return on the deferral where we had proposed a bond life return on the deferral. But we don't have an order out yet. That's why on the earlier question I can't make a prediction on anything without a order or even a proposal sitting in front of me. I did say we will file by the end of this month for approval with FIRQ for the acquisition of Sundance and we anticipate that approval being given to us by the end of the year. I do not think that the Sundance request and request to move Pinnacle West Energy Arizona assets to APS will get co-mingled.

Okay. But, it sounds like good news is you think that Sundance will not run into any FIRQ issues.

At the present time I think we reported in the last conference call that we had passed both market power screens. Until we actually file the request, it's hard to predict what interveners may say or who they may be.

Okay. Second question for you, when you -- I know the way the rate case settlement was reached. You get the benefit of having those plants and rate base whether the FERCs approve them or not approve them. In the six month period you wait for the FIRQ approval, does that have any effect on the accounting or will it be pretty transparent from when your basically have a PPA to when they are actually fully in the rate base?

David, on the consolidated level at Pinnacle West, it will be fairly transparent. And I designed the settlement as to mimic the economics of whether they're rate based or not. Either rate based or through the PPA. Obviously, APS is a separate reporting entity and you will be able to see the difference there.

Great. Thank you for the time. Look forward to seeing you out in California.

Thanks.

Your next question comes from Michael Goldenberg.

Good morning, guys.

Good morning

First of all, I wanted to ask following David's question on whether FERC rated basis them or not. Can you elaborate just exactly what he said that you are indifferent as to whether FERC approved the settlement or not?

Michael, the way the settlement agreement reads, is there is a purchase power agreement between the Pinnacle West Energy and Arizona Public Service. The first one being the bridge agreement, which the bridge between the ACC decision and the FERC approval, and that's put together to mimic as if they are in rate base. And then should the approval not take place at FERC, that bridge agreement essentially turns into a 30-year power purchase agreement. I would like to say that we aren't indifferent to moving the assets into APS because there is the other aspect of this of how you operate a bifercated generation company and so we are not indifferented. It's clearly our preference to move those assets back into Arizona Public Service where they belong and where they were originally intended to serve the load of our customers.

But the bottom line is even if FERC does have issues with the settlement you're earnings insensitive and these assets will be earing a fair amount of rate of return.

They would be earning the same rate of return as they would have earned had they been moved in to APS.

And another question to concentrate maybe I didn't -- I missed a little bit of the presentation. Just given that some markets back east are having problems, you seem to be doing very well out west. Is your long-term earnings guidance for the trading units changing for the better or is it still where you stood before?

It's where we stood before.

Okay, and just one more question if I may. As far as being hedged on gas going into '05 and beyond, given in your rate settlement, it seems you are going to get a fuel pass so you will be a lot less sensitive to hedge and not your demand of gas or power, correct?

I missed the last part. Did you say we'd be less sensitive?

Yes, hedging your supply of gas or power would be less relevant because of fuel pass.

No we think it's entirely relevant. We want to manage the business well. We've been managing it well from a price exposure standpoint. And we will continue to manage it that way, the settlement will have no impact on how we conduct operations relative to hedging.

No question you want to keep the rates low and do the best for the customers. But, I'm saying the new fuel pass will give you more leeway, I guess, more margin for error just in case?

No, it does not.

Let me be real clear about that. No, it does not.

Okay. Well, thank you very much.

Again I would like to remind you if you would like to ask a question, press star 1 on your telephone key pad. The next question comes from Ashar Khan.

I guess good morning. How are you guys doing?

Great, Ashar, how are you?

Pretty good. Jack, can you remind -- I might have asked this question before our meeting, but I wanted to -- where do you stand on the market power test? Have you filed your study with the FERC? And are you still have to file it as yet?

Ashar, this is Jack. We have already filed our market prior test with FERC and we passed both tests.

Okay. And even with Sundance in? I mean the plant that you are buying from PPL, I forget the name that will have no impact?

That's correct. In fact the test we did also included the Pinnacle West energy assets being moved to APS.

No impact in that we passed.

And then can we expect a rate case filing as early as next year?

I think as I said earlier, the timing of us filing a rate case will have a lot of dependence upon what the final order of the Sundance proceeding is. I mentioned, the staff testimony recommended a three-year deferral and we request a five-year deferral. Obviously if it's something different than the five-year deferral, and it's a three-year deferral we'll to seriously look about how we tie in the next rate case request because that would include the cost of Sundance being in the rates. Without seeing the final order that's actually signed, I can't make any predictions when the next rate case filing would be.

Okay, but just going back to that comment that if it is -- if they do reduce the years, that means you want quicker recovery in terms of a rate case filing. Is that a fair conclusion?

Yeah, the fair conclusion would be if they reduced the deferral years then that would probably force us for a rate request sooner.

Okay, I appreciate it. And is there anything -- I know a year ago you provided us with your real estate assets, SunCor and how the earnings were going to a little bit drop off as the years went by. Is there any change in those projections that you provided, if I'm right, they're now nearly a year older so at this time last year?

No.

So those projections stay correct as they are right now?

Yes.

Okay. I appreciate it. Thank you very much.

You bet.

At this time there are no further questions. I would now like to turn the call back over to Becky Hickman. I'd just like to thank everybody for joining us and obviously if you have questions please call me or Lisa Malagon (ph). Thank you.

And we'll look forward to seeing you in California. Thanks.

Thanks.

This concludes today's conference call. you may now disconnect.