Pinnacle West Capital Corp (PNW) 2005 Q3 法說會逐字稿

Good morning, my name is Marie and I'll be your conference facilitator. At this time I would like to welcome everyone to the Pinnacle West earnings conference call. All lines have been placed on mute to prevent any background noise. After the speakers remarks there will be a question and answer session. [ OPERATOR INSTRUCTIONS ] I would now like to turn the call over to Becky Hickman, please go ahead ma'am.

Thank you Marie. I would 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, our CFO.

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. I encourage you to check the current quarter section. Second, please note that all of our references today to per-share amounts will be after income taxes and based on diluted shares outstanding.

It is 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 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 MD&A in our June, 2005 10Q, which identifies some important factors that could cause actual results to differ materially from those contained in our forward looking statements. Also, during the course of this call, we will be discussing our ongoing earnings, which is a non-GAAP financial measure as defined by the SEC. Our earnings release which is available on our website is accompanied by a reconciliation of our ongoing earnings to our net income.

A replay of this call will be available on our website, www.pinnaclewest.com, for the next 30 days. It will also be available by telephone through November 2nd. 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 will turn the call over to Bill.

Thanks, Becky. I would also like to thank you for taking your time to join us today. I would like to highlight a few of our achievements for the third quarter before I turn the call over to Don and Jack to discuss the pertinent details of our financial results, operations and regulatory developments. Our retail customer growth continues at a remarkable pace. In fact, the growth rate of 4.5% we experienced in the third quarter was the fastest in almost 10 years. During the quarter we added our 1 millionth customer.

At the end of July, we completed the transfer to APS to the Pinnacle West energy generating plants in Arizona, uniting the assets serving our retail customers. The Nevada Public Utilities Commission approved the sale of our share of Silverhawk to Nevada Power. We are currently awaiting approvals from the Federal Energy Regulatory Commission and the Federal Trade Commission and currently we expect the sale to close around the end of this year, closing out our merchant generation business.

Although we have proactively hedged our fuel and purchase power costs for years, our costs for natural gas and power have increased dramatically from the levels covered by our retail rate settlement that was approved last spring. As a result, we filed, as required, a request with the Arizona Corporation Commission for a surcharge under our power supply adjuster, or PSA. Jack will give you more details on that filing.

We recognize the importance of dividends as a component of our total return for our shareholders. Last week we increased our indicated annual dividend by $0.10 per share or 5.3%. Effective with our December 1st payment. This increase represents our 12th annual increase of the same magnitude. The new indicated annual dividend rate is $2 per share. We believe the consistency of our dividend increases is a differentiating characteristic for us. We will consider future increases in the context of cash flow, pay out ratios and industry trends.

Our earnings outlook for 2005 hasn't changed. We continue to expect our earnings per share to be within a reasonable range of $3. Our guidance has not been adjusted to reflect either the regulatory disallowance we recorded in the third quarter as a result of APS's retail rate settlement or the financial effects of the recently announced sale of Silverhawk. As you know, we expect to file a general rate case later this year and we will issue guidance for 2006 and beyond coincident with that filing. Now I will turn the call over to Don to discuss our third quarter earnings.

Thank you, Bill. Today I will review our financial results for the third quarter and significant changes from last year's comparable quarter. I will also update you on our commodity risk management program and our financing activities. 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.

We reported net income of $104 million or $1.05 per share for the quarter, compared with 105 million or $1.15 per share in the third quarter of 2004. The quarterly comparison was affected by 3 unusual items. First, a regulatory disallowance of $0.88 per share that was recorded this quarter to reflect the actual transfer of the Pinnacle West energy generating plants to APS. Second, this quarter's discontinued operations include income of $0.04 per share related to our 2004 sale of NAC. And third, operating results for our Silverhawk plant improved $0.01per share. Silverhawk will be included in discontinued operations until the expected plant sale closing later this year. Excluding the unusual items, our ongoing earnings were $186 million or $1.89 per share for the third quarter compared with 106 million or $1.16 per share in the comparable quarter last year. An increase of $0.73 per share. Several factors favorably impacted the ongoing quarterly comparison. 4.5% customer growth, hotter weather, improved results from SunCor, and the effect related to the ACC rate settlement, including a rate increase, deferred fuel and purchased power costs and lowered depreciation rates.

Now I'd like to review the details of the major variants in earnings for the quarter. Customer growth in the third quarter was exceptionally strong at 4.5%. It has climbed at an accelerated pace since early 2004. This level of customer growth has translated into strong retail sales growth and will continue to be the basis of our long term performance. In the third quarter, retail sales growth increased earnings $0.13 per share. Arizona's rates of growth in population and jobs continue to be among the highest in the nation. The retail rate increase that became effective April 1st added $0.16 per share. The decrease in reported purchase power and fuel costs, including the effects of the PSA deferrals, improved earnings $0.13 per share. This $0.13 per share improvement is a net of the pretax $12 million or $0.07 per share that shareholders absorbed in the quarter as a result of the 9010 sharing provisions of the PSA. As a reminder, our current base rates reflect fuel costs at 2003 levels. At quarter end, the deferral balance in the PSA was $143 million, including the pending surcharge request of 80 million. We have added a section to the quarterly statistics on the website where you can track the PSA deferral balance. Hotter weather increased earnings $0.10 per share. The weather in this year's third quarter was slightly hotter than normal, while last year's third quarter was slightly cooler than normal. We lowered depreciation rates for certain types of plant as part of the recent ACC settlement. This change was the primary reason for the net decrease in depreciation and amortization of $0.04 per share. Although it was partially offset by depreciation on new facilities placed in service. SunCor's earnings were up 16 million, or $0.16 per share for the quarter. This increase is primarily related to the sale of 3 commercial properties. SunCor remains on track for its previously established earnings target. Marketing and trading gross margins increased $0.03 per share, primarily as a result of higher prices, increasing the market to market the value of our forward contracts.

In last quarter's conference call, I mentioned that we expected O&M to be relatively flat when compared with the second half of 2004. Third quarter results confirmed our expectations and we would expect a very similar pattern in the fourth quarter.

Now I would like to update you on our commodity risk management program. We have currently hedged about 85% of our remaining 2005 exposure to purchase power and natural gas commodity price risk for our native load requirements. Similarly, we have hedged approximately 85% of our 2006 price risk and 65% of our 2007 price risk. Our hedged positions are at prices substantially below current forward market prices for the balances of 2005, 2006, and 2007. For example, our 2006 positions are at prices about 30% below current forward prices, on a mark to market basis, our hedged positions have a current value in excess of $425 million. We believe that in terms of both price, and most importantly price stability, are hedging program has and will continue to provide our customers with a tremendous source of value.

Now turning to our financing activity and liquidity. On August 1st, APS repaid $300 million of maturing 7.625% notes. And August 22nd, APS issued $250 million of 30 year notes at a coupon of 5.5%. At quarter end, the parent company and APS continued to be in strong liquidity positions. The parent company had cash and investments of almost $200 million. APS had cash and investments of approximately $750 million, which is primarily from the repayment of the Pinnacle West Energy intercompany loan that I discussed with you last quarter. However, on October 3rd, APS transferred 500 million to Pinnacle West Energy in connection with the generating asset transfer, which was completed earlier in the third quarter. In turn, Pinnacle West Energy used the proceeds to redeem $500 million of floating rate notes. I will now turn the call over to Jack.

Thank you, Don. Today I will update you on the operational performance and regulatory developments. I will start with regulatory developments. The PSA is the power supply adjuster under which our retail settlement that was approved by the Arizona Corporation Commission last spring. In accordance with the PSA, we deferred 90% of the difference between our actual fuel and purchased power costs and the base fuel rate of 2.0743 cents per kilowatt hour included in our base rates. The current base fuel rate approximates our 2003 costs. We will make filings with the ACC each spring to establish an annual PSA adjuster rate. However, we are required to request a PSA surcharge before the accumulated deferred balance exceeds $100 million. We currently have a request pending before the ACC for an $80 million PSA surcharge. As proposed, the surcharge would be, on average, 1.7% temporary increase for a 24 month period. Last week the ACC staff filed testimony in support of our application. There has been no other testimony filed regarding the $80 million surcharge besides ours and the ACC staff's. The Residential Utility Consumer Office, or RUCO, the state's consumer advocate, did file testimony regarding the PSA plan of administration. The hearing on the PSA surcharge and the plan of administration began yesterday, and we expected to conclude today or tomorrow. At this point it would be premature for me to speculate on how the hearing is going. We expect the administrative law judge to issue her recommendation later this year for consideration by the ACC commissioners.

We modified our PSA surcharge request since we originally filed it, so let me recap how we arrived at the current $80 million amount. In July we filed a request to recover $100 million of deferred fuel and purchased power costs through a surcharge over a 24 month period. Subsequently we agreed with the ACC staff and RUCO to withdraw $20 million from our surcharge application to streamline and expedite the ACC's consideration of this request. The $20 million was withdrawn without prejudice and will remain in our deferred balance for consideration in a later proceeding. It represents the approximate cost for replacement power related to unplanned outages at our nuclear plant in Palo Verde in the April to July timeframe. I will discuss Palo Verde's operations in a few moments.

Our rate case application -- I'm sorry, our rate case settlement includes a provision that would appear to impose a $776 million limit on the annual amount of net fuel and purchased power recoverable through the PSA. On our last conference call, we indicated we did not expect such costs to exceed the limit in 2005 or 2006. At the time our forecast had not contemplated 2 major hurricanes ravageing the oil and gas infrastructure along the Gulf Coast and the subsequent dramatic escalation in natural gas prices. We remain confident that 2005 costs will not exceed $776 million. However, based on current forward gas prices, it is likely that our cost in 2006 will exceed $800 million. On our last call, I said the $776 million limit was added by the ACC as a safe for us to follow a general rate case, a task we will complete before the end of the year. Having been a participant in the hearing process that generated the limit terminology, I am confident that in adding such a provision it was never the intent of the ACC to deny APS recovery of prudently incurred in fuel costs that otherwise would have been recovered through the PSA. Again, as I have said in the past, we will pursue a waiver of the limit through the upcoming regulatory process if it appears that we may exceed the limit before the general rate case is fully adjudicated.

Regarding our upcoming rate case, we expect a primary component of the case to be recovery of increased fuel and purchased power cost. Will also seek recovery for changes in our rate base, including the Sundance Plant which we purchased last year -- earlier this year, our cost of capital and capital structure, and other costs of service.

I would like to turn now to the growth in our market and being the resource needs for the growth. Growth in our service territory continues to be extraordinary. Population growth in Arizona continues to be a least 3 times the average in the U.S.. That growth is the foundation of our 4.5% customer growth, which both Bill and Don have mentioned, as well as growth in our peak load and retail sales. This summer our peak hit 7,000 megawatts, which represents a 9% increase from last year. In the third quarter our retail sales increased 7.3%, including a 10.5% increase in sales to residential customers. On a weather normalized basis the quarter's retail sales increased 4% and residential sales increased 5.1%.

Historically we have successfully met the challenges reliably, serving a high-growth service territory and will continue to do so. To that end, we are continuing to add long-term resources. Earlier this year we issued 2 requests for proposals, both in accordance with our rate settlement. The first RFP was for at least 100 megawatts of renewable resources. The second, which we will refer to as a reliability RFP, was for at least 1,000 megawatts of long-term capacity with delivery beginning in 2007. Responses to both RFPs were strong. We have selected a total of 150 megawatts of renewable resources, and are awaiting the regulatory approvals required by our rate settlement on out of state contracts. We are in the final stages of selection and contracting for approximately 1,000 megawatts under the reliability RFP. In addition, last week we announced that APS it will conduct a feasibility study for a new interstate transmission project that will connect northern Arizona to Wyoming. The goal would be to have the new system in operation in the 2012 to 2013 time frame. It would provide an access to additional resources by connecting our system to additional capacity including baseload coal, gas and renewables. Further, it would provide optionality by connecting our summer peaking system with the winter peaking systems in the Northwest.

Next I will briefly review some of our operating activities. Looking at our PAD performance, the capacity effect for our Palo Verde nuclear units was 88% compared with 96% the same time -- or the same quarter a year ago. The decrease in capacity factor resulted from unplanned outage time related primarily to reactor coolant pump seals, pressurizers and other equipment on unit 1. All 3 Palo Verde units ran flawlessly in September. We took Unit 1 off line on October 8th for a planned refueling and maintenance outage that is expected to last 75 to 80 days. During this outage we are replacing the steam generators and low pressure turbines, in addition to performing routine maintenance. Replacing the steam generators in Unit 1 will complete the second phase of our replacement program. We are planning to replace steam generators in Unit 3 in the fall of 2007.

From October 11 to the 20th, we took Units 2 and 3 out of service in accordance with our technical specifications for the plant. We took the action when plant engineers were not able to demonstrate, in response to a question by a Nuclear Regulatory Commission Inspector, in the 6 hours, the original design of the emergency cool coring system would operate within acceptable parameters under various scenarios. Following extensive analysis which supported our original design, we showed that the system would operate as designed under all scenarios and we brought the units back on line and they are operating at full power today. As I said before, we are unwavering in our emphasis on safety and operational excellence. I believe Palo Verde and the people who work there have proven they are among the top in the industry.

That being said, we have done a lot of self assessment and industry comparison. From these actions we have taken several steps to ensure that Palo Verde maintains solid operations. Specifically, we have recently realigned the operations, engineering and staff site maintenance responsibilities to streamline their functional responsibilities. This allows operations and engineering to clearly focus on short and long term operations and design, while allowing staff site management focus on ancillary functions. We have developed a performance plan emphasize key operational areas and standards.

At the executive management level, Jim Levine, our Executive Vice President of Generation is spending the substantial majority of his time at the site. Jim was originally hired to run Palo Verde and has been managing all of our generating operations for the past several years. We also hired Cliff Eubanks as Vice President of Nuclear Operations. Cliff came to us from Arkansas Nuclear 1, where he was General Manager. This allows the Plant Manager to focus more on day-to-day operations.

Our fossil plants performed exceptionally during the third quarter. The coal plants posted a 95% capacity factor compared with 90% in the third quarter a year ago. Our gas plants operated at 40% capacity factor, continuing their record of solid performance. Our combined generation fleet gave us operational flexibility and control to meet our customer's need during the quarter and manage our costs.

In summary, our employees throughout the Company are focused on providing excellent, reliable service to our customers at reasonable prices. At the same time, they emphasize safety and efficiency. That concludes my prepared remarks and I will turn the call back over to Bill.

As Jack said, we aggressively focused on the regulatory proceedings that he described. And I believe our tremendous customer growth and the related potential for earnings and dividend growth are distinguishing characteristics of our Company. We will continue to capitalize on these advantages. That concludes our prepared remarks and we will be happy to take all of your questions now.

[ OPERATOR INSTRUCTIONS ] Your first question comes from John [Kiana] with Credit Suisse First Boston.

Morning.

Morning.

Can you clarify how the PSA different has grown since 9-30 of '05, specifically for recent rises in commodity prices and also for Palo Verde being down?

It has increased. I don't have the correct number handy right here, John.

John, I think one thing with respect to the Palo Verde outages since the end of the quarter, the refueling outage is planned. So that's not a significant factor and, as Jack said, we were down for 9 days with respect to Units 2 and 3. That was about $1 million a day pretax.

Right.

And we would differ 90% of that number. Okay and then what is the ACC's outlook or view on fuel costs passed through from operational issues? Have they made any comments on the in the past?

This is Jack, we are in the middle of those proceedings now, so I can't give you any clear comment they made. But obviously the issue there, were these costs prudently incurred. And that will be discussed in a future proceeding.

Okay, and than with regards to SunCor, if we take the amount that is shown in discontinued operations of about $14 million and assume the reason it was included in discontinued operations was really purely because of FAS 144, forcing you to classify it as discontinued operations, it looks like you all have sold about $42 million -- or booked about $42 million year to date. Do you feel like you are on track to actually surpass the $50 million guidance you've initially provided, or do you think that fourth quarter is actually going to be a little bit slower? I think traditionally fourth quarter seems to have been sort of your peak period for SunCor?

Yes, John, Don Brandt here. First your conclusions about the accounting are 100% correct. I think for your and my purposes, you probably want to ignore where it is at and look at the total amount. I think you'll see this year the earnings for SunCor are not going to be as fourth quarter loaded as has been the tradition for the last 2, 3 years. We are very firm about our guidance of the $50 million this year for SunCor.

Okay, and then as far as hedging is concerned, you said your '06 hedges were approximately 30% below the current forward strip? Can we assume that '07 is at a similar level?

'07 is actually in the 15 to 20% below the forward.

So it's a little bit closer to market?

Correct.

Has anything been done on '08?

Yes. To a lesser degree, the hedged positions are in the 30 to 40% range and they are below market, but that's about as much market information as I want to give out. That's principally from a competitive standpoint, because we are very active in that year at this point and it doesn't do us any good to have our counterparties aware of our situation.

Right. Lastly, with regards to the annual adjuster coming up this spring, do you anticipate hitting that $24.74 per megawatt hour cap?

I'm sorry, I'm not familiar with the $24.74 cap you are talking about.

Are we going to be at 4 mills.

The additional 4 mills.

At this point in time, I can't predict that. It depends on remaining -- the remainder of the year. The request that would be made in April would be wherever the deferred balance is less the 80 million.

Got it, thanks.

Your next question comes from Steve Fleishman with Merrill Lynch.

Hi, everyone.

Hi, Steve.

Jack, I apologize but could you go through a little bit more your discussion of the fuel and purchased power? I think you said you expect the number for '06 now to be over 800 million?

Yes, based on our present forecast of where hedged positions are and the forward strip, we would anticipate that our total fuel and purchased power costs would be in the 800 million range in 2006.

Okay, and the cap is what again, 700 --

776 million. As I mentioned in my prepared remarks, we have never viewed the cap, and I don't think the commission views that cap as something that can't be moved. In fact, in our rate filing that we make in the latter part of the year, we will be asking for a waiver of that 776. The purpose of the 776 was to ask us to file a rate case.

Okay, so the purpose of that was that if it went up over that amount, you should be filing a base rate case to address these issues.

Steve, the real purpose was in order for them to take a look at all of our costs, to make sure all of our costs or with an order, and fuel costs being such a large piece, they wanted to make sure they were able to look at all costs in a reasonable time frame.

Okay. And what percent are you hedged for '06?

85% in natural gas and power.

Okay. And then timing of all these filings, both fuel, waivers on fuel, base rate case?

Well, as I mentioned, the base rate case we will be filing at the end of the year and in that rate case we will be asking for a waiver of the 766. In fact, just by the nature of the rate case, we should get the waiver. We will be filing in March of next year for the PSA adjuster.

Okay. Thank you.

Thanks, Steve.

Your next question comes from Reza Hatefi with Zimmer Lucas Partners.

Thank you for taking my question.

Good morning.

Good morning. Can I think of your gas hedges, you talked about 85%, 65% and 30, 35%, should I just compare that to the Palo Verde -- I think it's El Paso gas hub over there? Should I compare it to current prices versus that or Henry Hub?

Versus Henry Hub.

Versus Henry Hub. And that's just current meaning --versus current prices meaning the prices in the last week or two, right?

Prices as it closed yesterday.

As of yesterday. And just one thing I was confused about was, you mentioned you might hit or go above above the $800 million in fuel costs. You are going to ask for a waiver in the coming rate case, not for an earlier waiver, not part of that rate case, correct?

No, I wouldn't interpret that way. What we are asking for is a waiver now.

A waiver now.

Sure because we already predict we are going to be above 766, so what we would be asking for is a waiver now.

So theoretically if they agree, in '06, you could have a cap, or no cap at all and thereby you wouldn't have the effect of going above the 766? That wouldn't hurt you?

In theory, that would be the case.

In theory. And is this to be a separate filing that you are going to make other than the rate case filing?

I guess we haven't figured out the form that request yet.

Okay, so its something we should just watch out for. Great, thank you very much.

Your next question comes from Ashar Khan with SAC Capital.

Good morning. Don, could you just take as a little bit through this over 800 million request, what cap factor have you assumed for nuclear production next year? And what factors have changed, if you can just take us through? Because your comments on the last call 3 months ago was that you saw a very, very low probability of you guys surpassing this, and so I just want to know what's happened in the last three months for this going over 800. And if you can to help us with what cap factor have you assumed for nuclear production next year.

First of all, what's happened in the last three months, hurricane Katrina and Rita and the, as Jack mentioned, the dramatic escalation in natural gas prices. I think at the time I responded to someone's question and said under -- what we could envision under reasonable scenarios and at the time, that wasn't in my definition of reasonable scenario. And the capacity factor -- do you, Becky --

I don't have the projected capacity factors for Palo Verde for next year.

But is expected -- is there anything unusual next year in terms of any steam replacements or --

We haven't changed that forecast that Don predicated his earlier comments on. The change is due to natural gas prices.

Yes, Palo Verde is not an issue in the determination of 800 million. Its purely natural gas prices.

Okay, and can you just remind us, how much have you -- I forget, how much is the amount related to Palo Verde that you had deferred out of the initial request that you made to the commission, which is up for hearing?

The part that is deferred is $20 million in the request. So we went from $100 million to $80 million.

Okay, and then if I could just go to the quarter, I am a little bit confused. If I am right, you are running 336 LTM. Your note said that your guidance is 3 -- around 3. And I know you had mild weather in the fourth quarter, I'm just trying to understand how do we get to $3? Are we going to have a 0 earnings in the fourth quarter or what's happening?

Couple of things. Ashar, first we've just reaffirmed the $3 guidance, a reasonable range around $3. SunCor, last year, was loaded in the fourth quarter as I said a few minutes ago in response to another question, we won't have it as fourth quarter as intensive as has been historically for the last 2 to 3 years. It was up $0.16 in the third quarter and I believe $0.31 or show on a year-to-date basis. We have a meaningful amount of mark to market gains on our trading book right now. That carries some risk that prices could decline and we would give some of the back. So we are holding at our guidance of a reasonable range around $3.

Okay, and Don, was this discontinued on the real-estate anticipated in that 50 million? The first time I saw this discontinued, how was that 50 million when you gave the guidance in the beginning of the year? It gave the 16 million in the discontinued, or not in the discontinued?

It gave the 50 million of SunCor as part of the $3 used in the reasonable range around $3. As I mentioned earlier, I believe it was to John's call, for your purposes and my purposes, I consider you -- or I suggest you ignore that discontinued operations accounting. That's a quirk of FASB's that obviously we have to comply with, but it creates an odd situation when you get into real estate accounting.

Okay, but should expect something similar in the fourth quarter?

Similar to what?

A discontinued?

There will probably be some relative to SunCor.

Okay, but the income from continuing operation is the guidance of 3, right? Am I correct and that includes -- ?

That includes SunCor whether it is continued or discontinued.

At 50 million?

Correct.

Okay, thank you.

[ OPERATOR INSTRUCTIONS ] Your next question comes from Ted [Hane] with Citigroup.

Hi. Its actually Greg Gordon. Good morning. I missed a portion of the call. I did hear that you guys are now assuming that, given the current commodity price backdrop and your current hedge position that your total fuel costs would be north of 800 million next year, is that right?

Correct.

And that is a change from what you had said several months ago when you came through to visit with investors?

That's correct.

Are you saying the only change is the incremental change in the gas price over the last 3 to 4 months?

Correct.

Okay thanks, just wanted to make sure I understood that. Thank you.

Next question comes from Michael Goldenberg with Luminous Management.

Good morning, guys.

Good morning.

I wanted to continue the discussion about the $800 million barrier that you are planning to break, or at least the way it looks right now, that you will break in 2006. Should you file -- As we know, things in Arizona always end up taking longer than they are supposed to, and should this filing take a while to go through the commission and be adjudicated, is there any sort of a true up process built in right now? Meaning that if you finally get this cap lifted after you have already broken the cap, if you could then recovered the difference?

Well, the way the settlement -- I'm sorry, the way the order on the settlement agreement reads would tell you that 776 million-dollar cap. But it doesn't prevent us from asking now, with a prediction to understand that we may exceed that cap. For instance when we made our PSA filing in July this year, we had not actually increased -- or actually incurred cost above 100 million or deferrals above 100 million, but we were allowed to ask for the deferral, recognizing that we were --ask for a recovery of the deferral recognizing we were going to exceed the deferral of 100 million after the filing. S it would be consistent with that kind of filing.

But the question -- my question is more to the fact -- lets say you file it this year and it takes 11 or 12 months to get it resolved and you only get the waiver in. lets say November, 2006, and you break the $800 million barrier in September. Will you be able to recover those costs between September, which is when you break the barrier, and November for example, hypothetically speaking?

We would be asking to do that.

So you would be asking for a catch up part as well should the proceedings take longer than expected?

Yes.

Okay, my other question is regarding the filing you currently have. You willingly took out the Palo Verde cost. Is it reasonable to assume that any of unforced outages at Palo Verde or any other plants, especially coal or nuclear, would ultimately be -- the cost would be eaten by the shareholders?

No, that's not a logical assumption.

Is it just a one time event, where he decided to not collect the Palo Verde cost and should you have any unforced outages at Palo Verde down the road, you would ask to recover them?

Well first of all, you are always going to have unforced outages no matter what the technology is. So the issue is how we operate the plant and make decisions that are consistent with prudent operations regarding safety and reliability. From that standpoint, we will be asking for recovery of those dollars.

Michael, one thing I want to make sure I heard you correctly in your question, I think you said -- it sounded to me like you thought that we were foregoing collection of the 20 million. No, we just withdrew that from this request, and as Jack said, we withdrew without prejudice. So those deferrals continue to stay on the books for future recovery at a later period.

Understood.

We believe that is something that will be considered in the spring fuel filing that Jack talked about earlier.

Just so I understand correctly, at the time the settlement runs out, are all fuel related caps, recoveries, things like that, do they automatically seize or will they continue in effect until you settle another rate case? As we know in Arizona things may take longer and the new rate case may take longer to settle past whatever the current effectiveness of the existing settlement is.

Well, let me go through some one at a time. The PSA adjuster we have, which is a 24 month request will go on. As I mentioned earlier, we will be asking for a waiver of the 776 so that will go on. Whatever the result is of the PSA adjuster filing we make in March of next year will go on.

So majority of the fuel related issues are separate from the general rate case and will continue to remain in effect, regardless of what happens at the actual general rate case proceeding?

No, not regardless of what happens. Basically they stay in effect until there is another decision. That decision could be in the next base rate case.

Right, that's exactly what I meant. Thank you I very much.

Michael, I need to correct a few things to make sure we -- you and/or we haven't confused anyone else listening in. I believe one of the hypotheticals early in your question, you posed to Jack was if we hit the 800 limit in September of '06 -- first the limit is 766 -- and I Think everybody knows that. We will not -- I don't want to get into a lot of detail but we will not hit 800 million, and this is based on current forward gas prices. We will not hit 800, nor will we hit 776 in the month of September of 2006. It would be after September.

Got it, thank you very much.

Your next question comes from Philson Yim with Morgan Stanley.

Hi, good morning.

Good morning.

Just a clarification on the around $3 in the guidance. At the time when you had announced that you were looking at selling Silverhawk, I think it excluded the $3 per share guidance excluded the $0.20 or $0.25 EPS drag from Silverhawk, is that right?

No. The $3 guidance assumed the $0.20 to $0.25 drag of Silverhawk.

Goes away.

No.

Is included.

Its part of it.

So we would expect after the sale, assuming the sale closes of this year, that earnings EPS is $0.20 to $0.25 higher than the $3 per share range guidance?

All other things being equal, yes.

Right, okay. Thank you.

Obviously they're not but if you just isolate that one assumption --

Silverhawk is already down in discontinued operations.

Right.. So my question is why wouldn't you just say guidance would be around 3.25 or so? Is that because you are not so sure the sale will happen this year? lose this year?

No, that's not the reason. We just said its $3 including the Silverhawk drag. If you want to back it out you can come up with a different number.

Right, okay, thanks very much.

Your next question comes from Steve Fleishman with Merrill Lynch.

Just a couple clarifying questions. Could you just remind us what the current level of the fuel and purchased power recovery is on an annual basis?

Are you talking about in the base rate, Steve, or in total?

Yes.

It's the 2.0743.

Do you have that in comparable to the $800 million?

I don't know off the top of my head, but Becky can give you that.

Steve, if you took the 2.07043 times our 25 million megawatt hours of retail sales, that would give you how much we recovered through base rates. Last year I think there remember that for the year 2004, our total regulated fuel and purchased power costs were around $600 million. And I'm not looking at anything, but I think you find that for APS. And that needs to be jurisdictionalized to take out [FERK] so it's probably in the very high 5s, 590 or so.

And then what did you say the number you expected to be in '05?

We didn't, we said we expected to be below 776 so it won't be a problem.

Below 766, but you didn't give a specific number?

Right.

Maybe ask the question another way. Do have a number on how much the 10% that you've got to absorb is going to end up hurting this year?

In the third quarter, it was pretax $12 million.

Okay. And one last question. When you anticipate providing 2006 earnings guidance?

We will provide that coincidence with the rate filing.

So sometime in December? Which we expect to do before the end of the year. Okay, thank you.

Thanks, Steve.

Your next question comes from Reza Hatefi with Zimmer Lucas Partners.

Thank you, just had a quick couple of follow-ups. Could you take legal action to lift the 776 million-dollar cap, or is it just basically through another negotiation with the commission?

It would be an application with the commission as a part of the filing that we make.

So this could take effect in '06 if they grant you it. And going back to a previous question, I just wanted to clarify something. The current settlement and fuel cost stay in effect up until your next rate case goes effective, so let's just say it gets delayed and it's fall of '07 so this whole plan would stay up until that point? This is a worst case scenario?

Your statement is true to the extent -- What we have in place today would stay in place until our rate filing we make at the end of the year is fully adjudicated.

Meaning that there is no -- the fuel clause doesn't end in March of '07, right? It just continues on as the case drags on.

We continue on.

Great, thank you very much.

[ OPERATOR INSTRUCTIONS ] Your next question comes from Ashar Khan with SAC Capital.

Don, I just want to clarify the point you made first, that based on your current numbers, you don't expect to exceed the limit until later in the fourth quarter. And secondly --

Fourth quarter of what, Asher?

Fourth quarter of next year.

Correct.

Secondly, just going back to what is being said, if you don't have a decision at year end when you report, say, 2006, just putting it hypothetically, from the commission, and if you are above it, will you be forced under accounting rules to expense those costs or will you still be allowed to defer those costs above the limit in anticipation of a Commission order coming out?

Asher, the accounting at that point in time would depend on the facts and circumstances. We couldn't -- we don't have enough time to narrow down all the assumptions that might go into that hypothetical.

Okay. But if you don't have an order, Don, wouldn't you have to start expensing of those costs?

I don't Think that's correct. It depends on what kind of -- the accounting takes into account all facts and circumstances. Depends on what kind of proceedings we've had, filings, testimony. I can't predict what would happen between this point in time and year-end 2006, to make an accounting call on that. Okay, I appreciate it.

Your next question comes from Ted [Hein] with Citigroup.

Hey, it's Greg with a follow-up. Could you give us -- or are you prepared to give us some rule of thumb of what approximate gas price you think your breakeven with your cap, given your hedge position? I'm looking at some data right here, Henry Hub prices for '06, and these may not be exactly consistent with what you're seeing, or a little bit over $11.5. If we were at 10would we be at break even with the cap, does it have to go to 8, can you give us a sense of the magnitude of the decline we have to see for you guys to be out of harm's way on this?

Under 10. It probably takes more than going under 10, Greg.

Okay, so some things significantly less than 10?

Well, depends what you say. Somewhere between 8 and 10.

Okay, that's very helpful, thanks.

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

We'd just like to take everybody for your time. We know how busy you are. Thank you.

If you have any follow-up questions please call me or Lisa. Thank you.

This concludes today's Pinnacle West earnings conference call. You may now disconnect.