Pinnacle West Capital Corp (PNW) 2006 Q2 法說會逐字稿

Good afternoon. My name is Brandy, and I'll be your conference operator. At this time I would like to welcome everyone to the Pinnacle West earnings conference call. [OPERATOR INSTRUCTIONS]

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

Thank you, Brandy. I'd like to thank everyone for participating in this conference call to review our earnings for the second quarter of 2006, recent regulatory developments and our operating performance. Today I have with me Bill Post, our Chairman and CEO, Jack Davis, who is 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 caption entitled forward-looking statements contained in the MD&A in 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 today.

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 July 28. 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.

Thanks, Becky. I'd also like to thank everyone for taking your time to join us today. I'll highlight a few items and then turn the call over to Don and Jack to discuss our financial results, regulatory matters and operations. But first a few comments about state regulatory developments. A change in the composition of the Arizona Corporation Commission is forthcoming. Commissioner Mark Spitzer was nominated by President Bush to fill a commissioner vacancy at the Federal Energy Regulatory Commission and last week the U.S. Senate confirmed Commissioner Spitzer's appointment along with two other FERC commissioner nominees.

Commissioner Spitzer is currently scheduled to be sworn in at FERC and resign from the ACC on Monday. His term ends in January of '07 and mid-term vacancies at that time ACC are filled by appointment of the governor to serve until the next general election. The appointee must be from the same political party as the commissioner who vacated office; and accordingly we expect the governor to appoint a Republican to serve the remainder of Commissioner Spitzer's term shortly after his resignation. Commissioner Spitzer met the requirements to run for reelection to ACC this fall. However, after being nominated to FERC, he withdrew from the Arizona race, and in accordance with state protocol the Republican party named a substitute to replace him. Gary Pierce, currently the majority whip in the Arizona house of representatives, will run for the ACC in Commissioner Spitzer's place.

Regarding the ACC elections, there will be two seats on the ballot this fall. Five candidates have qualified for the ballot: Two Republicans, Gary Pierce and incumbent commissioner [Chris Maez]; two Democrats, Mark Manoil, who ran in the last election, and Richard Boyer, a judge from southern Arizona; and a libertarian who was a write-in candidate in the last election, [Rick Folts]. The two candidates receiving the most votes in November will win election to the ACC for four-year terms.

APS implemented temporary rate increases totaling 9% during the second quarter to recover higher fuel and purchased power costs being incurred to serve our customers. Through its decisions, the ACC recognized the need to accelerate fuel cost recovery and to improve APS's financial strength. Jack will review the details of increases as well as APS's pending rate case, which requests base rates that reflect current cost levels. On July the 7th, we placed Palo Verde unit 1 back in service. The steps we described to you in our last call resolved the issue relating to vibration, and following its power ascension testing, unit 1 achieved full power operation and has been running at that level since.

Now I'll turn the call over to Don and Jack to review pertinent financial, regulatory and operations details, after which I will complete our remarks. Don?

Thanks, Bill. For the second quarter of 2006, we reported net income of $112 million or $1.13 per share, compared with $27 million or $0.28 per share for the prior year period. The quarter-over-quarter comparison was affected by two unusual items;. Income tax credits of $0.10 per share related to prior years recorded in 2006, and losses of $0.61 per share associated with the sale of the Silver Hawk plant in 2005. Excluding the unusual items, our ongoing earnings were $102 million or $1.03 per share, compared with $86 million or $0.89 per share a year ago, an increase of $16 million, or $0.14 per share. The primary drivers of the earnings increase were warmer weather and customer growth, which were partially offset by a higher O&M and higher fuel and purchased power costs.

Turning to the details of the quarter-to-quarter comparison for ongoing earnings, warmer weather improved earnings $0.10 per share. Last year's second quarter was about normal. Cooling degree days in this year's second quarter were almost 15% above normal. We experienced the hottest June on record this year, with an average temperature five degrees warmer than normal. Retail sales growth, before weather effects, increased earnings $0.16 per share. APS's customer base grew 4.6% in the second quarter compared with a year ago. Higher O&M costs decreased earnings $0.09 per share. The O&M changes were mainly related to generation maintenance and outage costs and higher customer service costs, including demand-side management programs. Costs related to the Palo Verde unit 1 outage represented about $0.03 per share of the O&M increase.

Fuel costs remain a key issue for our Company, as they are for many others in the industry. Higher fuel costs would have reduced earnings by $0.26 per share. However, noncash PSA deferrals offset 90% of this increase or about $0.24 per share. The increase in fuel costs APS incurred was mainly due to the high price of natural gas used for serving new customer growth and replacement power costs. As of June 30th, APS had $175 million of pretax accumulated PSA deferrals. The quarterly statistics on our website reconcile the changes in the deferral balance. We recovered $93 million of deferrals in the first half of this year through various PSA adjusters and surcharges. While the recoveries positively impact cash flow, they do not affect earnings because we amortize the same amount of deferrals and recognize such as fuel and purchase power expense.

In the year to date through June, we recorded $91 million of deferrals. About $70 million of the deferrals resulted from replacement power costs associated with reduced Palo Verde generation. However, approximately $27 million of these deferrals were offset by a lower replacement power cost related to strong performance at our fossil generating units. The remaining $48 million of deferrals in the first half related to other current fuel costs that were higher than our base fuel rate. As of today, we 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 80% of our 2007 price risk and 50% of our 2008 price risk. These hedge positions are generally at prices below current forward-market prices.

I'll now turn the call over to Jack.

Thank you, Don. And today I will update you on the highlights of our recent regulatory developments and our operational performance. As expected, we continue to be very focused on regulatory issues. I will discuss the following matters: The retail rate increases we implemented during the second quarter; our pending request for a $45 million surcharge to complete recovery of our 2005 PSA deferrals; and an update of our pending general rate case. As we discussed during our last call, the ACC approved two temporary retail rate increases to recover portions of our PSA deferrals, an interim adjuster rate and a PSA surcharge. Both of these increases became effective May 1st and represent a total average rate increase for our customers of approximately 9%. The interim adjuster was approved in response to the emergency interim rate request we filed in January to accelerate recovery of our fuel and purchase power costs.

The ACC approved an interim adjuster of 7 mils per kilowatt hour or an 8.3% average increase is expected to recover $138 million of our 2006 fuel and purchase power cost this year. The ACC also approved a PSA surcharge to recover approximately $15 million of our 2005 PSA deferrals. The surcharge is a temporary rate increase of approximately .7% over a 12-month period. This year the commissioners' ACC staff and interveners have recognized the need to accelerate fuel cost recovery and to improve APS's financial strength. The adjuster and surcharges increases I just described, along with the 4 mil per kilowatt hour PSA [inaudible] adjuster that was implemented in February, were all temporary price changes to facilitate timely recovery of higher fuel and purchase power costs APS is incurring to serve our customers. Ongoing rate levels, including a new basic fuel rate, will be addressed through our pending general case, which I will discuss shortly.

We have a request pending for a $45 million surcharge, which represents the final step in recovering our 2005 PSA deferrals. The surcharge is related to replacement power costs associated with unplanned outages at Palo Verde in 2005. It is designed to be a temporary increase, averaging 1.9% over a 12-month period. An ACC review of the Palo Verde unplanned outages is underway. We have proposed that the 1.9% surcharge be implemented upon completion of that review. The ACC staff report on this review is expected to be completed soon. Thereafter the commissioners will consider the staff's finding in a hearing, along with input from APS and other parties.

The final regulatory item that I will discuss today is APS's pending general case, which is in the discovery phase. The Ministry of Law judge issued an order in April setting out the procedural schedule for the case. The hearing is currently scheduled to begin on October 10th. The next major milestone is the filing of testimony by the ACC staff interveners on August 18th. We currently expect the ACC will decide this case next year.

Now I would like to turn to growth in our market and meeting the resource needs of that growth. Solid growth in our service territory continues. Arizona's population continues to grow at three times the national average. That growth is the foundation of our customer growth, which was 4.6% in the second quarter versus the prior year. Customer growth translates into sales growth. Our retail sales increased 10.4% in the second quarter over the prior period. On a weather-normalized basis, the second quarter retail sales still are at 6.6%. Customer growth also translates into peak-load growth. On July 14th, last Friday, we set our preliminary system peak for this year so far -- I'm sorry, we set our preliminary system peak for this year so far of 7,429 megawatts. This peak was .05% above our forecasted peak for the year and reflected a 6% increase over last year. On a weather-normalized basis, our peak grew some 3% compared with last year. We have a significant amount of summer left, so I do not know whether we have reached our final peak this year. That is predicted to be about 115 degrees today.

Successfully serving our growth requires to us add new long-term resources. The request for proposals we issued in 2005 -- earlier this year we entered into long-term purchased power agreements 1,150 megawatts of total capacity to begin delivery in the summer of 2007 with durations of nine to ten years. In addition, we have secured 150 megawatts of renewable resources. In January, we announced a baseload RFP. Through this RFP we are seeking proposals for long-term, unit-specific baseload generate capacity of 100 to 500 megawatts per unit. We're requesting delivery as early as 2009, but no later than 2014. This week we received proposals in responses to the 2006 RFP; therefore we are in the very early stages of evaluating the proposal. We expect to short-list bidders for further consideration in early October and to complete the selection process in first quarter next year. It goes without saying that we'll be working to get the best deals for our customer. As with our past RFPs, I cannot share with you much about the proposals we receive because of confidentiality agreements with the bidders. However, I can tell you that the response was very strong.

In addition to expanding our capacity resources we have taken steps to expand our transmission resources. Last fall we announced a proposed transmission project between Arizona and Wyoming, called Transwest Express. A few weeks ago we announced that phase 1 analysis completed to date by APS and interested stakeholders indicate that the project alternatives being studied are feasible and could provide significant economic benefits.

Now I will discuss our recent operating performance. Looking at our power plant performance, our combined base load capacity factor was 70% during the second quarter compared with 75% a year ago. The combined capacity factor for our nuclear units was 49% during the second quarter, compared with 67% in the same quarter a year ago. The decreased capacity factor is related to Palo Verde unit 1. Let me address the Palo Verde unit 1 performance. We took the unit out of service from May 18 -- March 18th to July 7th because of a vibration in one of the shutdown cooling lines. The outage was necessary to efficiently complete the engineering, inspections, testing and modifications to remedy the situation. The vibration issue on the shutdown cooling line has been resolved. From July 7th to July 16th, unit 1 completed the required power extension testing following the outage and has been running at full service. We expect the unit to continue operating at full power until the next scheduled refueling outage, and all nuclear link units are operating 100%, as we speak.

Power units 2 and 3 have run very way. Unit 2 has run at 95% capacity, in fact, in the second. Unit 3 scheduling refueling and maintenance outage was completed during the second quarter, causing its capacity factor for the quarter to be 52%. Both units have run at full power so far this year, except for unit 3's refueling outage and three minor outages totaling eight days. The next refueling outage at Palo Verde will be this fall at unit 2. In 2005 and 2006, we encountered a number of operating issues at Palo Verde. As discussed on previous calls, we have enhanced the senior management plan, realigned plant functions to clearly focus the organization on areas of responsibility, such as operations and engineering, and implemented a performance improvement plan. We have done extensive self-assessment and industry benchmarking in this process. We are aggressively addressing the issues at Palo Verde, and I am confident that plants performance will return to historical stellar operating levels.

Our coal fire plants continue to operate superbly. During the second quarter the coal plant posted an 84% capacity factor compared with 83% in the same quarter a year ago. It is noteworthy that our coal plants operated at a record all-time capacity factor in 2005, and to date this year we are ahead of schedule -- we are ahead of last year's performance. Our gas fired plants operated at 28% capacity factor in the second quarter, which is similar to their capacity factor in the same quarter last year.

That concludes my prepared remarks. Now we'll turn the call back to Bill.

Again, I'd like to thank you for your time and focus on our Company. I have one last financial point, and we are not changing our earnings outlook for 2006. We still expect earnings to be in a reasonable range, around $3 a share. That concludes our remarks, and we would be happy to answer your questions.

[OPERATOR INSTRUCTIONS] Your first question comes from Dan Eggers with Credit Suisse.

My first question for you related to the hedge positions for fuel for six, seven, eight. Can you give us any color, either where you are on an effective gas price, or if we were to compare the six to the seven to the eight numbers, if that fuel cost is higher or lower?

Higher than lower than what, Dan?

Is seven higher than six and eight higher than seven, or is it backward dated like the forward curve or --

Well, we're looking forward out all three of those years. The hedge prices where we're at are meaningfully below market levels. Seven is -- '07 is higher than '06. '08 is slightly above '07. But in the -- looking at the numbers, we're -- in '06, we're somewhere between $0.50 and $1 under the forward market. For '07, we're more than a dollar under the forward-market price. In '08, it's slightly below a dollar below the forward-market price. Is that helpful?

Yes, that's helpful. When we think about rate increases for customers because of the way the fuel is procured right now, because you guys were doing some makeup from '05 and '05, are you going to expect to see rate increases for customers related to the higher purchase power cost or do you guys think you're getting close to being settled out on that front?

This is Jack. The prices is is that Don just quoted you are still slightly above what's embedded in our present price.

Even with the '05 adders?

Yes.

Okay. Got it. Question for you -- a second question, and then I will stop, but on the change at the commission. Can you just give us a rundown? Step one, I guess the governor will name a replacement to fill between now and whenever the elected official is put into the role. How will that affect your case as far as the commission's involvement with the new commissioner, and then presumably with the elected commissioner come next year?

Of course, that does, Dan, depend on when the governor announces, but we believe that she'll do that relatively quickly after Spitzer's resignation. The appointed commissioner would then hear all things through, basically, the second week of January, or first week of January, and then the elected commissioner would step into that position. The appointed commissioner is not going to be able to run for office because the dates have already expired in terms of qualification for the November election. And so, the ballot is basically set with those five people that I mentioned. As to timing, it could impact timing. At this point in time we don't expect that, but it very well could.

And the new commissioner, even though they will not be there for the initial hearings and that sort of thing, will still be able to get up to speed to cast a vote come sometime next year?

Yes, I believe so.

Thank you, guys.

[OPERATOR INSTRUCTIONS] Your next question comes from [Paul Peterson] with Glenrock Associates.

Hi, can you hear me?

Yes, Paul.

Just a few questions. If I understood you guys right in your comments, last year was normal, so the change in weather is pretty much above normal, that $0.10 or so. Is that correct?

That's correct.

Okay. And then O&M was $0.09 higher, $0.03 of which was -- if I got this right, $0.03 of it was associated with Palo Verde. Was there -- with the Palo Verde outage. Was there anything else that was abnormal? You mentioned a few things, but are those sort of repeatable things, or was it sort of unusually high? Do you follow me?

Yea, I think I follow you. The Palo Verde cost, the $0.03, was, I'll call it, the anomaly. Theer others, there's nothing that really stands out as unusual, although our plant maintenance costs and that will vary, depending on planned outages, so they can be up and down. But generally those are repeatable-type costs to balance.

Okay, and then I wanted to ask you about the real estate market. On the one hand we're seeing very strong utility customer growth it looks like from you guys. And on the other hand we are hearing, at least around the country, about how real estate might be slowing down, sort of from a national perspective, or at least certain key markets might be slowing down. So I was wondering, you know, what your outlook is there and what you're seeing there, if you follow me? Has anything changed?

Sure. Let me answer that from kind of the two perspectives you've described. First, from the utility perspective, we don't see any downturn as of yet, in terms of current workload. The building permits here are running very close to record rates. On the other side of the coin, as you look at from the the market and from the real-estate market, we do expect to see some downturns there. That market has softened, and our expectation, it will continue to soften. That is not outside the range of our earlier expectations.

Primarily on the residential front?

It is on the residential side. The commercial side is still strong.

Okay, great. Thanks a lot.

You bet.

Your next question comes from [Filson Yam] with Luminous Management.

Hi, my questions are answered. Thank you.

Thanks.

Your next question comes from David Grumhaus with Copia Capital.

Good morning.

Hi, David.

How are you? Trading, it looked like you had a little pickup in the quarter. Any -- are you seeing anything there? I mean are you expecting -- should we look for that to continue to be a little better or was it more just -- I know the first quarter was actually a little weaker, just things even in and out.

Yes, that $0.03 you're probably referring to. I wouldn't read anything into that. That is more of a house -- some hedge positions rolled off on some of our energy services business in California, not necessarily repeatable-type situations.

Okay, that's helpful. On the growth side, you obviously saw very strong customer growth, but even stronger weather normalized retail growth. What's driving that?

l, there's two aspects from that -- this is Jack. There's two aspects from that one is the continued strong customer growth and we also have an increased use per customer doing that. We have two things going on in the growth area.

Right, and I guess on the use side, what's the driver of that?

Well, you mean the customer's usage drive --

Yes.

-- more volume in the homes, you know, where it's higher ceilings, more appliances in the homes.

So that's counteracting the better efficiency that you would expect to be seeing in newer homes?

Even though they have more efficient appliance and more efficient air conditioning, but you're basically cooling more volume in the home itself, and customers are actually having more appliances in their home than they had in the past.

Okay. That's helpful. Thanks for the time.

You bet.

Your next question comes from John Kiani with Deutsche Bank.

Good afternoon.

Good afternoon.

Can you go over the timing and expected EPS impact for the expiration of the parent company legacy trading contract, the end of money contract, please?

Those contracts roll off in the 2008 through 2009 period, John.

And have you quantified -- I can't remember -- the contribution from those contracts?

It's typically in the $0.20 to $0.30 on an annual basis.

Thanks, Don.

Okay.

your next question comes from Daniele Seitz with Dahlman Rose.

Hi. I just was wondering if you were supposed to go through additional reviews from the NRC or is Palo Verde completely in the clear now?

Yes, the question is additional reviews from the NRC?

Yes.

We still have an open issue with the NRC, what we fondly refer to as 95-002, which is closing out of the issue. As you recall, back in 2004, what I call a dry pipe issue, so we still have that ongoing. Daniele, there's no operating requirements or restrictions from the NRC.

None.

Okay, that's what I was wondering. Thank you.

Your next question comes from Ashar Kahn of SAC Capital.

Good afternoon, how are you guys doing? Don, could you tell me, based on the results first half, are you running above expectations, on expectations, in reference to your earnings target of around $3, if I'm right? That is still the restated target, right, for the year?

I don't think we restated it. As Bill mentioned earlier, we're staying with our guidance to a reasonable range, around $3, so far this year, we're on target within a reasonable range of where we expected to be at this point in the year.

So you're saying you're on target, you're not ahead or anything?

We're on tar -- we're on track.

Okay. But can I just ask you, LTM, I'm getting around 320ish of earnings. What are the negatives in the last half that we should look at to get us back to around $3?

I'm not sure what kind of a base you're coming off of. Maybe if you, Ashar, give Becky a shout afterwards. She'd be happy to help you walk through some of it.

Okay. But is there anything visibility negative in the -- in terms of any factors in the next half?

No, I don't think there's any negatives.

Okay. Thank you.

[OPERATOR INSTRUCTIONS] Your next question comes from Phyllis Gray with Dwight Asset Management .

Good afternoon.

good afternoon.

We've seen a number of companies continue the trend to sell their nuclear plants to large portfolio holders, I wondered if that's something you're giving any consideration to?

We believe Palo Verde's critical to our resources and the resources that we have here in Arizona. And as you heard today in terms of the growth, as we look to the future we are going to see the need for significant new capacity. That's not in our plan.

Thank you.

At this time there are no further questions.

Okay. Well, thank you again. We really appreciate your time. We know how busy you are, and we thank you for your focus on our Company.

I thank you also, and if any of you have follow-up questions, please call me or Lisa Malagon. Thanks.

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