Pinnacle West Capital Corp (PNW) 2006 Q1 法說會逐字稿

Good afternoon, my name is Ashley, and I will be your conference operator. At this time I would like to welcome everyone to the first quarter 2006 earnings conference call. [OPERATOR INSTRUCTIONS]

Thank you. Ms. Becky Hickman, you may begin your conference.

Thank you, Ashley. I'd like to thank everyone for participating in this conference call to review our earnings for the first quarter of 2006, recent regulatory developments and our operating performance. Today I have with me Bill Post, our Chairman and CEO, and Don Brandt, our CFO. Before I turn the call over to our speakers, I need to review a few details with you. First, the quarterly statistic section of our website contains extensive supplemental information on our earnings variances and quarterly operating statistics. I encourage you to check the current quarter's 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 those statements. Please refer to the caption entitled forward-looking statements contained in the MD&A of our first quarter 2006 Form 10-Q and the risk factors in our 2005 Form 10-K, each of which identifies some important factors that could cause actual results to differ materially from those contained in our forward-looking statements. 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 May 16th. 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 to Bill.

Good afternoon. I would also like to thank you for taking your time to join us today. Jack Davis is travelling, so I will discuss our regulatory issues and operating performance with you, then Don will give you the pertinent details of our financial results for the first quarter and then I'll come back and wrap up our prepared remarks. Let me start with our Arizona regulatory development. We have been very focused on regulatory issues. These are the activities that we'll review with you today. First, last weeks decision by the Arizona Corporation Commission related to our emergency rate request, the implementation of the 2006 adjusted rate under APS's power supply adjuster, or PSA. The status of our request for two surcharges to complete recovery of the 2005 PSA deferrals and an update on our pending general case.

In January, we filed a request for an emergency interim rate increase to accelerate recovery of our fuel and purchase power cost. The request represented the fuel portion of our pending generate case. In response to our request, last week the ACC approved an interim PSA adjuster of seven mils per kilowatt hour, which is expected to recover about $138 million of our 2006 fuel and purchase power cost this year. The interim adjuster will provide timely recovery of a large part of our higher 2006 fuel and purchase power cost. It represents an overall average price increase of 8.3% for our customers, or about 7.6% for residential customers. Although the ACC did not approve our full request, the commissioners, ACC staff and interveners recognize the need to accelerate fuel cost recovery and to improve APS's financial strength. In total, we expect to collect approximately $250 million of revenue in 2006, to offset our higher natural gas prices, through this decision and the February PSA adjuster.

Last week's ACC decision was a significant step in the right direction, and although a portion of our 2006 expenses will not be collected until 2007, all our estimated 2006 fuel expenses are set for recovery, subject to a future prudence determination. Through the ACC's decision last week, the commission also reaffirmed APS's ability to defer fuel and purchase power cost above the previously established $776 million annual limit under the PSA, until the limit is considered as part of APS's pending general rate case. A limit, which we have said before, was established to trigger a rate filing, not to disallow prudently incurred fuel costs. As we discussed on last quarter's call, APL implemented the first annual adjuster under the PSA on February 1st. The adjuster rate was set at the maximum four mils per kilowatt hour allowed by the PSA band width. It will recover about $110 million of APS's 2005 PSA deferrals over a 12-month period. The annual adjuster represents an overall average increase of about 5%.

Implementation of the formula annual adjuster in February left about $60 million of APS's 2005 PSA deferrals to be addressed. Consequently, we filed an application for two surcharges. The first is designed to recover approximately $15 million through a temporary rate increase of 0.7% over a 12-month period. On April 5th of 2006, the ACC approved implementation of this surcharge concurrent with the commission's decision on the interim request. Accordingly, the first surcharge became effective May 1st. The second surcharge is related to replacement power costs associated with unplanned outages at Palo Verde in 2005. That surcharge is designed to be a temporary Increase of 1.9% over a 12-month period. The ACC's review of the 2005 Palo Verde outage is underway and expected to be completed this summer. It would then be considered for implementation by the commission, and we have proposed it to begin upon completion of their review.

The fourth regulatory item I will discuss today is APS's pending general rate case, which is in the discovery phase. The administrative law judge issued an order last month setting up the procedural schedule for the case. The hearing is currently schedule to begin on October 10th and the next major milestone is the filing of testimony by the ACC staff and interveners on August the 18th. We currently expect the ACC will decide this case in the first part of next year.

Now, I'll discuss our growth and our operating performance. Growth in our service territory is remarkable. Arizona's population growth continues to be at least three times the national average. That growth is the foundation to our customer growth, which was 4.5% in the first quarter compared with the first quarter a year ago. This was the third consecutive quarter in which our customer base grew at that pace. Our retail sales grew 3.9% in the first quarter. On a weather-normalized basis, the first quarter's retail sales increased 4.9%, driven primarily by a 6.3% increase in commercial and industrial sales.

Successfully serving our growth requires us to add new long-term resources. On last quarter's conference call, we reviewed the results of two RFPs, or request for proposals, that we had issued in 2005. In January, we announced a base load RFP. With this RFP we are seeking proposals for long-term, unit specific, base load generating capacity of 100 to 500 megawatts per unit. We are requesting delivery as early as 2009, but no later than 2014. A number of parties have submitted notices of intent to bid and the proposals are due in July. In addition to expanding our capacity resources, we have taken steps to expand our transmission resources. Last fall we announced a proposed transmission line between Arizona and Wyoming, and in March APS signed a memorandum of understanding with National Grid USA and the Wyoming Infrastructure Authority to facilitate this development. Since then we have received significant expressions of interest in the project from a number of entities.

Looking at our power plant performance, our combined base load capacity factor was 78% during the first quarter compared with 85% a year ago. Let me first address Palo Verde's unit 1's performance. We began running the unit at reduced power levels in late December, after its steam generator replacement outage, when we measured vibration approaching an internal limit on one of the shutdown cooling lines. Since then we have evaluated a number of alternative remedies for the issue and determined the ultimate solution was to move a 7,000 pound valve closer to where the cooling line intersects with the reactor coolant system line. To do so requires us to offload the fuel. Since mid-March we have kept the unit offline, which allows us to more efficiently complete the engineering, inspections, testing, and modifications. It will better ensure that we will be able to return unit 1 to full power prior to this summer's peak. Currently the unit has been defueled and the work is progressing according to plan, which we currently believe will have the unit back by the end of June.

In the first quarter, Palo Verde units 2 and 3 ran very well, posting a combined capacity factor of 99.6%. Unit 2 has continued that record into the second quarter to date. On April 1st, unit 3 began its spring refueling outage, which we expect to be completed later this week. The next fueling outage at Palo Verde will be this fall for Palo Verde unit number 2.

In 2005, we encountered a number of operating issues at Palo Verde. As discussed on previous calls, we have enhanced the senior management at the plant, realigned plant functions to clearly focus the organization on areas of responsibility, such as operations and engineering, and implemented the performance improvement plan. We have done extensive self-assessment and industry benchmarking. I believe we are aggressively addressing the issues at Palo Verde, and I'm confident that the plant's performance will return to its historical stellar operating levels. Our fossil plants have operated very well. During the first quarter, the coal plants posted an 83% capacity factor compared with 79% in the first quarter a year ago. We set an all-time coal capacity factor record in 2005 and to date, in 2006, we're ahead of last year's performance. Our gas fired plants operated at 20% capacity factor in the first quarter compared with 18% in the same quarter of last year.

Turning to customer service, in March we received the results of the 2006 JD Power survey of business utility customer and, once gain, APS was rated the number one investor-owned electric utility in the west in customer satisfaction, confirming earlier surveys.

At this point, I'll turn the call over to Don to review our first quarter earnings and other operational and financial issues.

Thank you, Bill. For the first quarter 2006, we reported net income of $12.5 million or $0.13 per share compared with $24.4 million or $0.27 per share for the prior year quarter, reflecting a decline of $12 million or $0.14 per share. Several factors impacted the quarterly comparison, including higher fuel and purchase power costs, higher O&M and lower marketing and trading margins. These negative factors were partially offset by a 4.5% customer growth, improved SunCor results, noncash fuel deferrals under our PSA, a retail price increase, and the sale of the Silverhawk plant in January of this year.

Now I'd like to review the details of the quarter-over-quarter comparison. Fuel continues to be the central story for our Company, as it is for many others in the industry. Higher fuel costs decreased earnings by $0.34 per share, mainly due to increased base load plant outage time, higher fuel and wholesale power prices, and incremental load growth served with high-cost, natural gas resources. Noncash PSA deferrals partially offset the higher cost by $0.08 per share. As a reminder, the deferrals represent the difference between the amount APS is currently collecting in base retail rates for fuel-related costs and the amount it is currently paying for those costs. Current base rates reflect 2003 fuel cost, when natural gas prices were $5.78 per million BTUs.

Since that time, spot prices for natural gas and wholesale power have increased about 25%. The fuel cost increase in the first quarter was only partially offset by deferrals, because the PSA did not become effective until the second quarter last year. Additionally, average fuel costs in the first quarter of 2005 were below the base fuel rate in the PSA, which is $0.020743 per kilowatt hour. In the first quarter of this year, fuel cost averaged $0.0233 per kilowatt hour, some 12% higher than the level in retail base rates. At the end of the first quarter, APS had $169 million of pretax accumulated PSA deferrals. The deferrals recorded in the first quarter included cost associated with reduced power operations and outage time at Palo Verde unit number 1. The quarterly statistics on Pinnacle West's website shows the change in the deferral balance, including recovery of $18 million during the first quarter. I think you'll find the information on our website useful in tracking the different components of the deferrals.

In addition to higher fuel and purchase power costs, a few other factors negatively impacted the quarterly comparison. First, higher O&M cost decreased earnings $0.14 per share. The O&M changes were mainly related to cost for planned generating overhauls and maintenance of $0.11 per share, and higher customer service cost, including demand side management programs. Lower marketing and trading gross margins decreased earnings $0.05 per share, primarily due to lower mark-to-market gains on structured trading contracts..

Turning to the positive factors impacting earnings in the quarter-to-quarter comparison, retail sales growth increased earnings $0.08 per share for the quarter. APS customer growth continues to be enviable, with the third consecutive quarter of 4.5% growth. Arizona's population and job growth rates also continue to be among the highest in the nation. SunCor's earnings, including discontinued operations, were up $0.12 per share, largely related to increased parcel and home sales in the quarter. The retail rate increase that became effective April 1, 2005 added $0.04 per share. The quarterly comparison also was favorably impacted by $0.07 per share, with the absence of Silverhawk discontinued operations in the current quarter.

Now I'll turn to our commodity risk management program and related FERC order related to our wholesale sales activity. As of today, we currently have hedged 85% of our remaining 2006 exposure to purchase power and natural gas price risk for native load requirements. Similarly, we have hedged about 65% of our 2007 price risk and 40% of our 2008 price risk. All of these hedge positions are at prices below current forward market prices. For example, our 2006 positions are at prices of approximately 10% below current forward prices and our 2007 positions are at prices about 15% below current forwards. With respect to our wholesale sales, on April 17th FERC issued an order revoking market-based rates for the Pinnacle West companies for wholesale sales in APS's control area, retro active to a February 27h, 2005 effective date. We are still authorized to sell at market-based rates in all other areas, including the major market hub, Palo Verde, which is not in APS's control area. We are also authorized to sell within the APS control area at cost-based rates. Significantly, the order did not find that we either possessed market power or any engaged in any anticompetitive conduct.

The FERC order was attributed to proported deficiencies in the simultaneous transition import capability limit studies that is the Pinnacle West companies filed as part as a 2004 FERC update process for market power screens. FERC Chairman Kelliher strongly decented on this order. In his decent, he stated that we were not given sufficient notice of the alleged deficiencies in our import capability studies, and we did not have an opportunity to address the deficiencies. We concur with the chairman's decent. This order is not expected to have a material affect on our financial results, as the vast majority of the wholesale sales take place outside of APS's control area. However, we plan to file for a rehearing on the order on or before May 17, 2006. We are hopeful that an open and productive process can take place on rehearing.

This FERC order also led to the revocation of the parents blanket financing authorization at FERC. For background, the parent, Pinnacle West, is a public utility subject to FERC regulation because the parent company is a party to certain wholesale contracts. FERC must approve securities issuances by public utilities whose financings are not otherwise approved by a state regulator. Thus, FERC approval is required for the parents' financing, but not those of APS, because the ACC approves APS's financings. In April we filed an application to obtain the appropriate financing authorizations from FERC. On May 3rd, FERC approved our request to allow the parent to borrow under an existing $300 million revolving credit facility and to issue a broad range of debt and equity securities. These approvals provide the parent with adequate financing authority and flexibility. going forward.

And finally, regarding recent rating agency actions and financing activity, on April 27th, Moody's downgraded both APS and Pinnacle West's debt ratings, after the ACC administrative law judge issued a recommendation on the emergency interim rate request. The senior unsecured debt rates of APS were lowered to BAA2 from BAA1, and Pinnacle West's ratings were lowered to BAA3 from BAA2. Moody's primary concern is the Company's ability to recover prudently incurred fuel and purchase power cost in a timely manner. Moody's affirmed APS's commercial paper rating at P2, and downgraded the commercial paper rating of the parent company to P3 from P2. APS currently has a negative outlook reflecting the potential for downward pressure on the ratings, if the utilities is not received timely recovery of its fuel and purchase power cost. Yesterday, in what we view as a very positive development, Standard and Poor's affirmed the current ratings of both Pinnacle West and APS with a stable outlook, premised on the ACC continuing to provide sustained regulatory support that addresses permanent rate relief and manages the fuel deferral balances downward. In the S&P rationale for the rating affirmation, the May 2nd vote of the ACC was the clear driver.

We completed one financing in the quarter. On February 28th, the parent issued $175 million of 5.9%, 5-year senior notes through a private placement. We used the proceeds of this debt, combined with short-term debt and cash, to repay $300 million of 6.4% of senior notes, which matured April 3rd. The parent has completed its financing needs for the year, but APS will need to issue long-term debt later this year. Both companies have strong liquidity, with combined revolvers totaling $700 million.

I'll now turn the call back over to Bill.

Thanks, Don. One last financial point. Our earnings outlook for 2006 has not changed. We still expect earnings to be in a reasonable range, around $3 a share. In summary, our employees have an unwaivering commitment in every facet of our business. We will continue to focus on high levels of operating performance throughout the organization, improving our efficiency and innovation, managing the risks and costs of our business, providing reliable top-tier service to our customers at reasonable prices, and providing a fair return to our investors.

That concludes our remarks and we would be happy to answer your questions.

[OPERATOR INSTRUCTIONS] Your first question comes from the line of Ashar Khan with SAC Capital.

I guess good afternoon.

Good afternoon.

I was trying to -- Don, I guess I'm trying to do an exercise in terms of normalizing earnings for the first quarter. The fuel and purchase power. how should I look at it? If the outage had not been there, how much of that could have been -- is outage related? Could you help me with that?

Yes. Basically in the first quarter, the net variances due to outages are about $11 -- $11.5 million.

Is that pretax or after tax?

That's after tax.

Okay. And then, Don, going back to real estate, I guess, it did very well. Can we expect, based on the first quarter, that real estate, you know, coming up higher than last year? Or is this just a timing issue that there more sales in the first quarter verses expected in the remaining three quarters?

Yes, I think it's the latter. I think SunCor is pretty much on target, and we gave some guidance back -- as part of our guidance back November 4th. Talked about the range of earnings going forward for SunCor and we're comfortably within that.

Okay. And then -- and then how should we look -- you know, I guess you've -- I guess the fuel and purchase power negative variance will continue in the second quarter until all the units are back online, is that correct?

Well -- make sure I understand the question. I think --

I'm just trying to see what additional exposure is going to be in the second quarter because of the unusual outages.

Okay. Well. A good part of it will get caught -- the earnings impact will be minimized through the deferred fuel accounting. We're looking at total cost of -- for the -- going -- including our estimate for the second quarter-- And I just mentioned the $11.5 million for the first quarter -- the second quarter'd be about $28 million, and that's net of tax, for a total of right at $40 million, of which about -- the deferrals would be about $36 million.

$36 million. Okay. Okay. And could you just give us some update on your -- you have -- June, I believe you said middle of June when you expect the unit back on. Could you just tell us what's happening? Any update in the process? How confident you're feeling on that date?

Sure the -- we are now -- in fact we started today the inspections on the core barrel. We are starting to perform work in the unit to start to move the valve. And, as I mentioned, we believe we will have it completed by the end of June, and I'm very confident that this will resolve the problem.

So I guess -- so now you're expecting it to be back on line by the end of June?

Yes.

Okay. Thank you.

Thank you.

Your next question comes from the line of Michael Goldenberg with Luminous Management.

Good morning, guys.

Good afternoon.

I just wanted to confirm something about your $3 -- mot guidance, your $3 goal. It seems that, since the start of the year when you issued guidance, several things have not gone your way, whether it be Palo Verdi outages or whether -- should I, therefore, imply that your original target was conservative? Or do you now need several things to break your way on the regulatory front to hit the $3? Just give me some color, given that several things have happened that you could not have envisioned, that you still feel comfortable about a $3 target.

Well, first, Michael, I wouldn't characterize it as conservative or otherwise. Our guidance stands as we gave it to you back in November. On the subject of weather, the first quarter we did have the warmest winter on record, but you've got to remember this is Phoenix in Arizona. The deviation from normal weather was about $0.03 to $0.04, at the most, so I'd put weather as a rounding factor. And as I've mentioned on the net outages, the Palo Verdi, combined with what's been year-to-date exceptional performance, particularly at our coal units, total cost there is about $40 million, of which the deferrals will be about $36 million. So again, the bottom line impact is relatively small, those costs combined with weather impact.

Got you. Should we also imply that the balance -- the different unit that will make up your guidance has not changed -- the mix has not changed, meaning SunCor is still expected to produce X percent on everything else is still the same?

Yes. SunCor's pretty much in line with our budget for the year and our outlook that we had before the year started.

And finally, as far as your assumptions on the overall regulatory outcomes, could you give us any sort of color as to what it is when you model out Pinnacle for 2006 that it is, that you expect to occur on the regulatory front?

Well, again, going back to our November guidance, and it hasn't changed, we did not assume in 2006 any kind of general increase becoming effective during the course of 2006. So, I guess a short answer to your question is zero change in earnings due to the rate case.

Got you. And finally, the Arizona commission over the years has been fair in their decisions and their adjudications, but timing has not always kept up to schedule. From where you stand today, do you feel comfortable and confident that timing on your regulatory processes that you have in front of ACC will be kept on schedule?

Well, I think you should take notice of the decision on the interim increase. That was filed on January the 6th, and we received a decision on May the 2nd. So I believe that is significant, and I think that was a very timely consideration of our request.

Got you. So, for where you stand today you think everything should come out on time, whichever way it comes out?

I don't know how to answer that question. I think given the schedule that we outlined to you, I think we're on target for that schedule.

Got you. Thank you very much.

Thank you.

[OPERATOR INSTRUCTIONS] Your next question comes from the line of [Ed Heine] with Citigroup.

Good afternoon.

Good afternoon.

Just had a quick question on your O&M. On the variances you talked about, the maintenance and overhauls costing you about $0.11 versus last year, is that something we should think of as an ongoing cost or was a lot of that related to one-time events with Palo Verdi or something that's not ongoing?

No, actually it was maintenance overhauls. It was concentrated that our four-corners unit in Cholla, It's -- no, I wouldn't factor it in going forward. That's -- I mean, it's routine maintenance, but it's significantly higher because of the nature of the type of maintenance that was scheduled for those units.

Okay, so you see your expectation would be in next year's first quarter, that that discrepancy would reverse out to some extend?

Oh, I don't have next year's first quarter right in front of me, but it's not necessarily indicative of an ongoing first quarter trend.

Great, understood. Thank you.

Thanks.

[OPERATOR INSTRUCTIONS] There are no further questions from the phone line.

Well, again, thank you very much for your time. We really appreciate the attention and we thank you for participating in the call. Thank you very much.

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

This concludes today's first quarter 2006 earnings conference call. You may now disconnect.