Pinnacle West Capital Corp (PNW) 2007 Q1 法說會逐字稿

Good afternoon. My name is Bonita, and I will be your conference operator today. At this time, I would like to welcome everyone to the Pinnacle West first quarter 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 will now turn this conference over to Miss Becky Hickman. You may begin your call.

Thank you, Bonita. I would like to thank everyone for participating in this conference call to review our first quarter earnings, recent regulatory developments, and operating performance. Today I have with me Bill Post, our Chairman and CEO, Jack Davis, who is our President and Chief Operating Officer and also CEO of Arizona Public Service, and Don Brandt, who is Executive Vice President and CFO of Pinnacle West and also President and CFO of APS. Before I turn the call over to our speakers, I need to cover a few details with you. First, I encourage you to check the quarterly statistic section of our website. It contains extensive supplemental information on our earnings variances and quarterly operating statistics. 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 business overview section of our 2006 Form 10-K as well as the MD&A and risk factors sections, each of 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 refer to our gross margin, 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 gross margin to our operating 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 May 1st. 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 Don.

Thanks, Becky. For the first quarter of 2007, we reported consolidated net income of $17 million or $0.16 per share compared with $13 million or $0.13 per share in the prior year quarter. In summary, the increase in earnings was driven largely by increased retail sales related to cooler weather and by fewer power plant outages. These increases were substantially offset by lower earnings from our real estate operations. Now I'll provide some more detail on the significant earnings variance factors. Weather was a prominent factor in the quarterly earnings comparison, adding $0.08 per share. Both this year's and last year's weather contributed to this variance. First quarter 2007 weather was cooler than normal, increasing earnings $0.04 per share. In fact, the month of January, 2007 was the coldest January in almost 20 years. By comparison, weather in 2006 first quarter was milder than normal by $0.04 per share. Lower operating and maintenance costs increased earnings $0.04 per share. The changes in O&M were primarily related to fewer planned outages at our coal plants.

Higher depreciation and interest costs in large part due to ongoing investment in plant and facilities at APS decreased earnings $0.03 per share. SunCor's results were down $0.13 per share, chiefly related to the absence of a major parcel sale and reduced home sales. There was a land parcel sale to an Arizona homebuilder in the first quarter of 2006, but there was not a comparable sale in this year's first quarter. These conditions are consistent with the slowdown in the western homebuilding markets we have been anticipating. Sales increases related to customer growth of 3.8% increased gross margin $0.06 per share. Significantly, to keep pace with the fastest growing state in the country, we plan to spend $950 million on capital expenditures this year. Of this amount, our CapEx was $185 million in the first quarter of 2007. Furthermore, we expect to invest about $5 billion in electric infrastructure over the next five years. The increase in costs of reliable -- excuse me, reliably serving our customers' growing energy needs, such as fuel, purchase power, O&M expense, interest and infrastructure costs, are being addressed through our pending rate case.

Jack will provide an update on rate case in a few minutes. Now let me turn to the PSA deferrals and our fuel hedge positions. As of March 31st, APS had recorded $118 million of accumulated PSA deferrals. The quarterly statistics on our website detail the changes in the deferral balance. During the first quarter of 2007, we deferred $25 million and recovered a significant $69 million through various PSA adjusters and surcharges. As most of you are aware, the deferral recovery positively impacts cash flow but does not affect earnings because the amount recovered through revenue is also amortized as fuel expense. Our hedge program substantially mitigates natural gas and power price volatility. As of today, we have hedged 85% of our 2007 exposure to purchase power and natural gas price risk for native load requirements. Similarly, we have hedged 65% of our 2008 price risk and 45% of our 2009 price risk. These hedge positions are at prices below current forward market prices. I will now turn the call over to Jack.

Thanks, Don, and good morning, everyone. My topics include overviews of regulatory developments and our operating performance. And I'll start with regulation issues. Today I will discuss the continuation of the 7 mill interim PSA adjuster, the 2007 annual PSA adjuster rate reset and an update on our general rate case. I discussed the first two items in the last quarterly conference call so I will briefly recap them. December the ACC approved our request to allow APS to continue collecting the 7 mill interim PSA adjuster until rates go into effect pursuant to a decision in the general rate case. On the previous call, we estimated that the continuation of the 7 mill interim adjuster through May 1st would allow APS to collect approximately $55 million of pre-tax PSA deferrals in 2007. Further, we estimate that extending the collection of the 7mill adjuster for an additional month through the end of May will allow APS to collect an additional $15 million of 2007 deferrals.

Because of the extension of the interim adjuster until the rate case decision becomes effective, the incremental net increase in APS's rates would be 12% based on the Company's request. Our annual PSA rate for the 12 month period that began February 1st was set at essentially the same level, 4 mills per kilowatt hour, as for the preceding 12 month period. This amount is designed to recover $109 million of 2006 PSA deferrals that were not recovered in 2006 through the 7 mill adjuster. Clearly, the most significant rate related item is the pending retail rate case. As a reminder, APS's current request is for an increase of $435 million or 20.4%. Increased fuel and purchase power costs represent 14.8 percentage points of the increase. Requests based on 11.5 return on equity and a 45/55 debt equity capital structure. While the tremendous growth in Arizona provides significant opportunities, it carries with it the burden of higher costs and increased investment to serve that load. Our prices must reflect that higher cost and infrastructure investment on a more current basis. These are the messages -- these were the messages that we presented to the ACC during the rate case.

The positions of the ACC staff and the Residential Utility Consumers Office, or RUCO, are summarized as follows. The staff recommends a total increase of 9.1% or $193 million consisting entirely of fuel related expenses. It also recommends a 10.25% return on equity and APS has requested capital structure and miscellaneous other items. Further, the staff also suggests changes to our PSA that would accelerate fuel cost recovery. RUCO recommends an increase of 10% or $212 million, with a 9.25% ROE and a 50/50 capital structure. We presented extensive testimony rebuilding the staff's, RUCO's and other intervener's positions. The adoption of either of the staff's or RUCO's recommendation will result in a seriously inadequate outcome of this rate case. Our witnesses testified that the ACC's adoption of either staff's or RUCO's position would result in a downgrade of APS's credit rating to non-investment grade. A constructive outcome for the rate proceeding is essential for APS to maintain its investment grade credit ratings.

Such an outcome must allow APS to recover its fuel and other operating expenses as well as provide APS the opportunity to earn a reasonable rate of return, when those new rates come into effect. In addition, it would position the Company to continue to reliably serving our energy needs of our rapidly growing customer base. In addition to the retail base rates, APS's request for a $45 million PSA surcharge related to the Palo Verde outages of 2005 will be decided as part of the rate case decision. The Company's request is designed to be a temporary increase and averaging about 1.9% over a 12 month period. The ACC staff has recommended that the ACC disallow approximately $16 million, or $10 million after tax, of the request. We continue to believe that the expenses in the -- in question were prudently incurred and therefore should be recoverable. At this time, we are awaiting the recommended order of the administrative law judge in the case. As the recommended order is issued, the parties to the rate case normally have 10 days or so to file their exceptions or comments on the recommended order. Thereafter, the commission will consider the ALJ's recommended order and the exceptions.

We anticipate that the ACC will vote on the rate case in the second quarter. In addressing growth in our service territory, Arizona's population continues to grow at the rate that is three times the national average. The growth is the foundation of our customer growth, which was 3.8% for the first quarter of this year compared with a year ago. Customer growth usage and weather variations translate into sales growth. Our retail sales increased 7.1% in the first quarter, compared with the same quarter a year ago. Now looking at operating performance. Looking at our nuclear plant performance, the combined capacity factor for Palo Verde units was 94% for the first quarter of this year. During the quarter, there were 14 days of unit outage time. Five of these days were for required testing of safety related batteries on unit three. This year's refueling outages at Palo Verde will be at unit one beginning in mid-May and at unit three in the fall. The unit three refueling will include replacement of its steam generators, low pressure turbines and core protection calculators. Unit three will be the final unit to receive these replacements, thus completing the largest equipment replacement program in Palo Verde's history.

On February 22nd, the Nuclear Regulatory Commission issued a white finding regarding a Murphy diesel generators on Palo Verde unit number three. These generators produce electricity for safety systems and components in the event of loss of off-site power during an emergency and are tested monthly. This NRC finding indicated that the issue was of low to moderate safety significance. As a result of the white finding, the NRC has moved unit three into the multi -- multiple repetitive degraded cornerstone column of its action matrix, commonly referred to as column four. Consequently, Palo Verde will be subject to increased scrutiny and inspections by the NRC. We are treating the entire plant as though it was in this column and performing additional internal evaluations to ensure that all the appropriate issues were being dealt with. At this time, we do not expect costs related to such increased scrutiny to be material.

As we have -- as we have previously discussed, Randy Edington became APS's chief nuclear officer in January. We are in the process of implementing a performance plan under Randy's direction. The plan emphasizes safety, accountability, leadership, human performance, corrective actions and equipment reliability. Safe and efficient operation has always been our primary objective and always been achieved. Regarding our base load coal plants, they continue to operate superbly. During the first quarter they posted a 84% capacity factor. Turning to customer service for a bit, in March we received the results of the 2007 JD Power's survey of business utility customers. APS was ranked the number 2 investor owned electric utility in the west, continuing a record of superior performance. That concludes my prepared comments and now I turn -- I will now turn the call over to Bill.

Thanks, Jack. I'd like to make just one last financial point. We are not changing our guidance for 2007. As Jack discussed, the timing of our rate decision is not currently known. However, in our January 30, 2007 Form 8-K, we provided quarterly estimates of the rate case impacts, which you can assume to be relatively uniform by month within each of the quarters. This gives you the opportunity to make your own assumptions as to timing and rate case impacts in 2007. We are, as you are, awaiting the ALJ's recommendation. And ultimately the commissioner's decision on APS's pending retail rate case. We remain focused on meeting Arizona's growing energy requirements and the financial position we need to meet that growth. The constructive outcome in our pending case is fundamental to allow APS to continue to meet customers' needs today and into the future at the lowest overall cost. I believe the Arizona Corporation Commission has recognized this goal. For example, last year they understood and quickly responded to the tough realities of our rising fuel costs. I believe their decisions have shown their commitment to a financially sound utility and its importance in meeting the energy future of our state. Thank you for your time and interest in our Company. That concludes our remarks and we would be happy to answer all your questions.

(OPERATOR INSTRUCTIONS) We'll pause for just a moment to compile the Q&A roster. Your first question comes from the line of Greg Gordon from Citigroup.

Good afternoon, gentlemen.

Hi, Greg.

Hi, Greg.

When I look at this rate case, it's been pending for, what, over a year now. And I know that on the margin it seems like we've gotten a more balanced decision making out of this commission, especially when it comes to fuel. But, even -- even if you were to get a reasonable sort of regulated ROE out of the commission here, let's say you got the -- the 11.5% ROE that you've asked for, what would you actually earn on a GAAP basis, given the regulatory lag in the case?

Greg, this is Don. AsI testified in the case, even if we were granted our complete rate request, including the 11.5, the assumptions you lay out, it would be in the 8% to 9% return on equity and we addressed that situation in response to then Chairman Hatch Miller's request mid-summer last year to provide ideas, concepts the commission could consider to improve our credit worthiness and one of them to address that very factor was an [atrip] potential attrition adjustment that would essentially compensate for the regulatory lag implicit in the regulatory process here.

That was actually -- you just answered my next question. I mean, how quickly post resolution of this case should we expect you to be back in front of the commission to try to get more timely relief and to close the gap between your authorized ROE and your regulated ROE?

Our focus right now is on this rate case and the successful completion of it. And, obviously, anything beyond this rate case will be dependent upon the results of this one.

The second question is Palo Verde, Jack commented that -- that operating expenses associated with the -- the current NRC rating weren't going to be materially higher, but how much higher overall are your Palo Verde expected annual operating expenses than what was for instance baked into the rate case when you filed it over a year ago?

Gosh, I don't -- Greg, this is Jack. I don't have that off the top of my head and -- and I'll have Becky get back with you on that number.

Okay. But the -- but the numbers -- it would be fair to say that the numbers are in fact higher?

Well, they would be higher, but not as much as you would expect, I don't think.

Okay. And, relative to the -- the housing business, I know that you guys have given us guidance pretty recently.

Yes.

Both for the utility and for SunCor, but this has been a pretty fast-moving situation in terms of the evolution of people's perception on what's going on in the housing market, day to day, week to week. So can you give us sort of a more up-to-date outlook on whether any of the trends that you identified that caused you to -- to modify your guidance in January have continued to worsen, gotten better, stabilized, etc.?

I think basically the assumptions we -- we used to bake in are on SunCor $0.30 to $0.35 a share are very -- it's playing out as we saw it. I -- I'd characterize it as stabilizing. We -- we have seen prices level out. They haven't declined. Homebuilding's down, but -- actually, yesterday I was out touring Surprise, Arizona with some of our crews and that's the northeast valley up toward Sun City. And while the homebuilding slowed and give our crews a chance to kind of catch up, we still see the developers working on additional land. I think there's a high degree of confidence that -- that the market will come back here.

Thank you, gentlemen.

Thanks, Greg.

Your next question comes from the line of Dan Eggers with Credit Suisse.

Hi. Can you guys hear me okay?

Hi, Dan.

Real fine, Dan.

First question for you on the O&M expense. Obviously there was a lot of extra expense in the first quarter of last year. You seemed to regain a decent amount of that. As we look at the full year, we should still be expecting kind of normal cost inflation on the O&M line on a full-year basis, correct?

Yes, that's correct. If you recall, I think last year, the first quarter, I mentioned that the first quarter and second quarter the O&M expenses were up largely driven purely by timing of planned outages, principally at our -- our coal units and we expected the first and second quarters to be skewed higher than normal, particularly relative to the third and fourth quarter. But that was purely timing and wasn't a recurring, so you saw I'll call the timing of expenses this year more of a normal pattern that didn't exist last year, so -- so just normal inflationary increases.

Okay. So second quarter should also be down year-over-year, correct?

Yes.

Okay. Next question just on the rate case, make sure I have this clear. The ACC, the commission itself, after the ALJ gives a decision in the 10 days of -- of follow-up comments, the ACC has no specific timeline in which they must act, do they?

Dan, they don't have a -- any kind of statutory timeline, that's correct. But I would expect that once they get the full comments from the -- the parties on the recommended or that they wouldn't, let's say, dilly-dally.

Dan, once the -- once that ALJ order's come out they're history in terms of scheduling a meeting and making a decision has been pretty quick.

Okay. Have you guys gotten much follow-up requests? You put forward some ideas as far as the [tristner] adjusters and that sort of thing a while back now, have you had many data requests or follow-up commentary from commissioners or -- or any other constituents since then?

No, Dan. After -- we pretty much wrapped up hearings by mid-December of last year and then the briefing process, pretty much the discovery phase and trial phase was over with by December.

Okay. And the last question you guys had talked a little bit about concerns about conservation at the customer level. Obviously you had good weather in the first quarter, weather adjusted, did you see that -- that same responsiveness you were concerned about in January or is that less of an issue?

The first part of your question I understood. What response did we see or -- .

Were you concerned about -- there was concern about some level of conservation, wasn't there, just in response to higher prices, people would per capita consume less?

Yes, we had factored into our forecast last year and this year some element of response, the price elasticity in response to price increases. And we have not seen that.

Got it. Okay. Thank you, guys.

Thanks.

Your next question is from the line of Daniele Seitz of Dahlman Rose.

Hi, Daniele.

Hi. I just was wondering is the RCA NRC asked you to list in your, what you were going to do and usually you propose it to them and then they send it back saying yes, that's what you would like you to remedy or are you just operating as usual and they are watching?

Daniel, your question is has the NRC asked us for a list of what we're going to do specifically?

Yes. (Multiple speakers) And sometimes they do that and then -- yes. And then they -- they comment and then you have to wait for the comments (Inaudible) and, obviously, it's a long process. But I was wondering if that was the case in -- in this particular case, or are you just being watched? That's all.

No. No, that is the case, Daniele. We're in the process of doing a full review that we will then provide to the -- to the NRC. And then we will reach, as you mentioned earlier, agreement on any issues that we need to deal with. So it is a process where we are going through a total evaluation and we're obviously working with the NRC on an ongoing basis with that. And then we will sit with them and go through that process towards the end of the third quarter. And then reach agreement on if there are any things that we need to pursue, what those items would be.

Okay. And so the third quarter is when you have (Inaudible) an exchange of ideas and where you have really a -- a method that you are going to be applying?

Well, that would be one of the processes, yes. But I -- we're doing it on an ongoing basis as well.

Okay, great. And -- and on the rate case, just -- I was wondering, has there been any proposal of changing the system of these very long review of fuel costs, etc.? Has anyone proposed something a little bit more streamline so there was a little less of a delay process in the future, or is this left to the next procedure?

Daniele, in terms of recovery of fuel costs, in fact, this year when we filed our 4 mill adjuster for this year, we filed a 4 mill adjuster and it went in uncommented on. So I think compared to a year ago, the whole process has been significantly streamlined.

Okay. So --

And also Daniele, in this case, the staff has proposed specific changes in dealing with the fuel adjuster itself that would also achieve the goal you're talking about.

Okay. So it's in the process already?

Yes.

Okay. Great. Thank you.

Thanks, Daniele.

(OPERATOR INSTRUCTIONS) This question comes from the line of [Yikpak Fong] of Zimmer Lucas Partners.

Good afternoon, ladies and gentlemen.

Good afternoon.

Just one quick house cleaning question. I see on your quarterly consolidated summary that the parent Company for this quarter earned $5 million versus negative $3 million the quarter a year ago. I was just wondering what accounts for this change, this upswing?

This is Don Brandt speaking. It's primarily driven by mark-to-market changes on the -- the unregulated trading book.

Okay. So we shouldn't expect this to be kind of like an ongoing item, should we?

You shouldn't.

Okay. Thank you.

Thanks.

(OPERATOR INSTRUCTIONS) There are no -- I apologize, there is a question from the line. I'm sorry, there are no further questions.

Okay. Well, I would just say thanks. We know this is a busy time. We appreciate your attention and thank you for your time.

I echo those sentiments. And if you have any follow-up questions, please call me or Lisa Malligon. Thank you very much.

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