Pinnacle West Capital Corp (PNW) 2008 Q1 法說會逐字稿

Good afternoon. My name is Kanisha and I will be your conference operator today. At this time, I would like to welcome everyone to the Pinnacle West first quarter conference call. All lines have been placed on mute to prevent on mute to prevent any background noise. After the speaker's remarks, there will be a question-and-answer session. (OPERATOR INSTRUCTIONS) Thank you.

Ms. Hickman, you may begin your conference.

Thank you, Kanisha. I would like to thank everyone for participating in this conference call to review our first quarter earnings, recent developments, and operating performance. Today, I have with me Bill Post, our Chairman and CEO, and Don Brandt who is our President and Chief Operating Officer and also President and CEO of Arizona Public Service.

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 statistics 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 form 8-K we filed this morning, as well as the MD&A and risk factors sections of our 2007 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 6. 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.

Good afternoon. I would also like to thank you for taking your time to join us today. Don will discuss our financial results along with regulatory and operational developments. Before I turn the call over to him, I would like to address a few items. Our service territory continues to grow, albeit at a slower rate than in recent years. This year our growth rate has continued the slowing trend we had in 2007 from the 4% plus pace experienced in 2005 and 2006. However, our growth still remains above the national average. As such, growth is evident throughout our business and continues to dominate our operations and strategies.

In the first quarter, our customer base grew 2%, compared with 2.6% in the fourth quarter of last year and 3.8% in the first quarter a year ago. Based on today's economic outlook, we estimate that our customer account will grow about 1% by the end of 2008. Although we are currently experiencing a slowdown from our historical growth rates, growth in Arizona will continue over the long term. Consequently, we're aggressively focused on the future, our customer's growing energy needs, and the financial strength that is critical to our success. We continue to pursue solutions to reduce our future capital needs. Progress has been made on the regulatory treatment of growth and getting growth to help pay for itself.

In February, the Arizona Corporation Commission approved amendments to APS' line extension schedule. These changes provide for timely collection of a part of our distribution construction costs and as a result, will reduce the amount of future rate increases for APS' existing customers as well as reduce the amount of new capital we will need to meet customer growth. The new line extension payments will offset a portion of APS' expenditures to construct a distribution facility. We estimate collections after tax in the range of $30 million for 2008 and $70 million for 2009, which will offset a part of the required distribution expenditures. Since the end of the last test year, we have spent nearly $2 billion on capital expenditures, primarily for customer reliability and network expansions of our electric system.

Consequently in late March, we filed a request for a retail rate increase to be effective on July 1 of 2009. The rate increase is needed to recover expenditures for our electric infrastructure and to reflect increases in our other costs. Don Brandt will provide the details of the rate request and other regulatory developments in just a few minutes. Resource planning is a critical issue. With growth in both customers and energy consumption, APS faces a need for new capacity in the 2013 and 2016 timeframe, During our last call, I discussed a resource planning initiative we launched in January. Our goal is to build a public understanding of the options and challenges we see in planning for and acquiring new energy resources.

Through this initiative, we are seeking brood input from various stakeholders on APS' resource alternatives and related issues. We've begun hosting a series of stakeholder workshops on resource alternatives. To date, we have conducted three of these meetings, each of has been attended by a wide variety of interested parties. We anticipate conducting several more workshops from now through the middle of the year. We expect to follow our future resource plan, incorporating this broad stakeholder input by the end of the year. An integral component of our resource planning is our commitment to renewable energy resources. We believe renewables will provide a significant amount of the new generating resources we will need to meet our growing energy demand, capitalizing primarily on Arizona's large solar potential.

To that end in February, we announced the Solana Generating Station. Solana is a large step toward making Arizona the solar energy capitol of the world, a step that makes a lot of sense with our abundant sunshine. Plant is planned to be operational in 2011. Here are a few facts about the plant. If it were operating today, it would be the largest solar-powered plant in the world. The plant will be a 280 megawatt concentrated solar plant, sited about 70 miles southwest of Phoenix. It will be constructed and operated by Abengoa Solar, and APS will purchase all the output of the plant through a 30-year purchase power agreement. We filed for regulatory approval of this agreement which we believe will be addressed by the ACC this summer.

In addition to our interest in the Solana project, APS joined a multi-state consortium of southwestern utilities to pursue development of a separate 250 megawatt solar plant in the region. It is anticipated that each of the utilities would sign a purchase power agreement for their share of the output of the plant. As many of you know, the composition of the Arizona Corporation Commission will change at the end of this year. In November, three of the five commission seats will be up for election. Commissioners Maize and Pierce will continue on the commission. However, chairman Gleason and commissioners Hatch, Miller, and Mondell are term-limited. Currently, there are 13 announced candidates for these seats. Eight republicans and five democrats. More candidates could announce their intention to run and all candidates must file their qualifying petitions with the Secretary of State by June 4.

I would like to make one final point. We are reaffirming our consolidated earnings guidance of a reasonable range around $2.50 per share for 2008. However, some of the components of our guidance have changed and Don will now provide the details of these changes. Don?

Thank you, Bill, and good afternoon to all of you. As Bill said, we are reaffirming our consolidated earnings guidance for 2008. We continue to expect the consolidated earnings will be within a reasonable range of $2.50 per share. We currently estimate that APS will contribute substantially all of the earnings and that SunCor's contribution will be minimal. Our current estimate for APS is higher than our previous guidance for a number of reasons including improved wholesale revenues, the effects on retail sales in the first quarter of cooler than normal weather, favorable mark-to-market valuations of our fuel hedges, favorable resolutions of various tax matters, and a second transmission revenue increase that we assume will become effective in mid-2008.

We expect these favorable factors to be partially offset by a lower expected customer growth because of current economic conditions. We had previously expected SunCor's 2008 earnings to be approximately $20 million. However, as a result of the weak real estate market, we currently estimate that SunCor's contribution to earnings will be minimal. Turning to earnings for the quarter, the first quarter of 2008, our earnings were down $0.20 per share versus the 2007 first quarter. We reported a consolidated net loss of $4 million or $0.04 per share, compared with net income of $17 million or $0.16 per share in the prior year quarter. In summary, rising costs of APS more than offset contributions from increased retail sales due to growth. The decline in APS' earnings, combined with lower results from SunCor's real estate operations, decreased our first quarter earnings.

Now, I'll give you some additional details on these variances. Higher O&M costs decreased earnings $0.14 per share, almost two-thirds of the increase was due to a greater number of planned power plant overhauls and system maintenance as we prepare for our summer peak demand season. The remainder was primarily related to higher customer service costs. Increased depreciation and interest costs attributable to APS' ongoing investment and plant and facilities to support growth reduced earnings by $0.06 per share. SunCor's earnings were down $0.10 per share, again, reflecting the weak real estate market.

These negative factors were partially offset by higher retail sales related to customer growth of $0.04 per share. A number of other factors added to a net $0.06 per share including increased wholesale revenues, favorable mark-to-market on fuel hedges, and the transmission rate increases that became effective March 1 of this year.

Now, turning to regulatory developments and operations. As Bill mentioned, APS filed an application for a retail rate increase on March 24. The filing requests an 8.1% net rate increase for existing retail customers, plus establishment of a new impact fee for new connections to APS' system. We've asked that the requested rate changes become effective no later than July 1, 2009, a full two years after our last base rate increase went into effect. The requested net increase totals $265.5 million and consists of a $252.6-million nonfuel-related increase, and a $12.9-million net fuel-related increase. APS proposes to collect up to $53 million of these increases from new connections, resulting in a net increase to existing customers of $212.5 million. The significant nonfuel increase components include $127 million related to rate base increases, $48 million related to updates of APS' cost of capital, and $86.5 million for an attrition adjustment.

APS also proposes to increase the base fuel rate to $0.0366 per kilowatt hour from the current $0.0325, which would increase base revenues approximately $119.1 million. However, the base rate increase would be offset by a decrease of $106 million in revenues that would have been collected through the power supply adjuster. The result would be a net fuel-related increase of $12.9 million. The filing is based on a test year ended September 30, 2007. The key financial provisions of the request include a rate base of $5.3 billion, and an 11.5% return on common equity, and a 46.54% debt-to-equity capital structure. The proposed attrition adjustment would provide a mechanism to recover changes in APS' cost between the end of the test year and the time when new rates go into effect, thereby providing the Company with the opportunity to earn its allowed rate of return.

The proposed impact fee would take another step toward having growth pay for itself. The impact fee would be in addition to the line extension payments the ACC approved earlier this year. The payments APS receives for line extensions under the newly approved line extension policy, will recover a portion of the distribution capital expenditures necessary to serve customer growth. What will not be recovered, however, are the caring costs of the tax asset created by APS receiving the line extension payments and the increases in operating expenses related to customer growth. The proposed impact fee would cover these costs. The ACC staff is performing its customary sufficiency review of the filing to determine whether it complies with the ACC's procedural requirements for rate case filings.

On April 22, we and the ACC staff agreed to extend the 30-day review period by an additional 15 days until May 8. During this 15-day extension period, we and staff will continue to discuss and resolve any issues which resolution could involve an update of certain financial information to aid staff in its review of our case. Thereafter, we expect a procedural schedule will be issued which will establish a timeline for addressing our request. In addition, on April 25, we responded to a written request for information on the sufficiency issue from Commissioner Maize. In our letter, we demonstrated that the test period used in our filing was fully consistent with the commission's rule, commission practice in past APS rate filings, and relevant commission orders.

There have been other regulatory developments since the beginning of the year. First, our transmission rate case is pending before the Federal Energy Regulatory Commission. The filing requested a $37-million increase in annual transmission revenues and includes a proposal for the FERC to approve a formula rate-setting methodology to allow APS to adjust wholesale transmission rates on June 1 of each year. The FERC allowed APS' proposed transmission rates to become effective on March 1 of this year, subject to refund pending the ultimate outcome of the case. A number of settlement meetings have been held and we believe progress is being made. Approximately $30 million of the transmission rate increase relate to transmission to serve APS' retail customers.

In February, the ACC approved an increase in APS' retail rates to recover that amount beginning March 1, subject to adjustment based on the final outcome at the FERC The increase was implemented using the transmission cost to adjuster or TCA that the ACC approved in the 2005 rate decision. The TCA provides a mechanism through which changes in FERC-approved transmission charges for retail service can be reflected in APS' retail rates in a timely manner. We plan to update the FERC formula calculations in mid-May. We expect that formula will result in an annual increase in wholesale transmission levels that would become effective June 1 of this year. After we update the FERC calculations, we plan to file an application with the ACC to increase the transmission cost adjuster to reflect the new calculations under the formula.

Next, I'll spend a minute reviewing the status of our power supply adjuster or PSA, and the various adjusters and surcharges. As of March 31, APS had $50 million of accumulated PSA deferrals. With the enhancement to our PSA approved by the ACC last year, we are in a much better position with respect to fuel costs this year than in past years. We expect to recover almost all of this deferral balance through annual PSA adjusters and surcharges by the end of 2008. The four mill per kilowatt hour PSA adjuster that took effect on February 1 of last year will remain in effect through mid-2008 to allow APS to collect $46 million of 2007 costs, deferred as a result of mid-2007 implementation of the new base fuel rate. APS has been collecting approximately $34 million through a PSA surcharge over a 12-month period that ends June 30. This amount represents PSA cost deferrals related to 2005 replacement power cost for Palo Verde outages.

Effective February 1 this year, the 2008 annual PSA adjuster rate or four mills per kilowatt hour became effective for a 12-month period. On April 8, the ACC approved an implementation plan for APS to meet the State's renewable energy standards for 2008. The plan provides for $34 million of renewable energy projects and customer incentives. These expenditures will be recorded in O&M expense and purchased power cost, but will be offset by revenues collected through a renewable energy surcharge.

Finally, turning to our recent operating performance. The Palo Verde units have been running well. The combined capacity factors for the Palo Verde units were 93% during the first quarter of this year. Currently, units 1 and 3 are operating at full power. Unit 1 is in its 151st consecutive day on line, while unit 3 is in its 101st consecutive day on line since returning from its refueling outage in mid-January. Unit 2 operated for 167 consecutive days before it was taken out of service for its refueling outage that began March 29.

Palo Verde has two refueling outages each year. The other outage this year is scheduled for unit 1 in the fall. Each of the 2008 refueling outages is expected to last 40 to 50 days. We're continuing to implement our site improvement plan and we are working closely with the nuclear regulatory commission at various levels to ensure that all issues are addressed, and Palo Verde returns to top tier performance as soon as practicable.

Our coal-fired plants have been operating exceptionally as well. In the first quarter of this year, the units operated at 76% capacity factor, which was slightly better than our plan. The capacity factor was lower than a year ago, because the timing of planned major overhauls at Four Corners unit 5 and [Choya] unit 2. As is typical for our operations, planned overhauls and maintenance were performed at the plants during the first quarter in preparation for the summer peak. The coal plants have consistently run substantially above the industry average and we expect them to do so again this year. That concludes my remarks and I'll turn the call back to Bill.

Thanks, Don. As many of you know Jack Davis retired March the 1st. Effective upon Jack's retirement, our board of directors named Don Brandt to be President and Chief Operating Officer of Pinnacle West and Chief Executive Officer of APS. Don has been with APS for five years, and President of APS since January 2007. He's done an excellent job and his financial focus will lead us well into the future. That concludes our prepared remarks and we would be very happy to answer your questions.

(OPERATOR INSTRUCTIONS) We'll pause for just one moment to compile the Q&A roster. Your first question comes from John Kiani.

Good morning.

Hi, John.

Don, I know you touched on this in your opening remarks. But can you give a little more color around some of the benefits that APS is going to realize? You now expect APS will realize like, for example, how much earnings, contribution is associated with the favorable mark on the fuel hedges? Maybe the wholesale revenues piece? And also the tax piece as well, please?

Sure. Sure. I'll maybe -- a little backwards here, John. The taxes are about $0.16 a share.

Okay.

The mark-to-market is about $0.04.

Uh-huh.

And the improved wholesale revenues are about $0.04.

And what was the tax associated with, the tax benefit?

Just some resolution of some outstanding tax matters, principally income tax.

Then from a long-term forecasting perspective, should we expect something like that to re-occur in '09 or that is just more of a near-term benefit?

More of a near-term benefit.

Okay. And then, as far as SunCor is concerned, I think you laid out pretty clearly your near-term expectation for SunCor. How should we think about SunCor a little bit longer term from an earnings contribution perspective? Do you have a view on when you think that business will eventually turn around?

I think our sense is that the earliest towards the end of 2009.

We should think then more about kind of the similar level of contribution perhaps into '09 and then maybe something better beyond that?

Well, we haven't gotten to that today. But we have -- within the level of earnings at SunCor, which I said is minimal.

Right.

We do have a number of transactions. Home sales are relatively low, almost half of what we thought going into the year. But on the commercial side, we've got one very large transaction that we expect to close in the second quarter of this year. Next year, we'll be dependent on, to some extent, our success at closing some of these commercial transactions. The real state market, both residential and commercial, is weak, but one of the issues we've run into that I know everyone has, is the liquidity issue in the credit markets, and trying to put financing packages together. There are buyers out there, they just can't finance or they're having a difficult time. While the real estate market, per se, we don't expect that to turn around until at least towards the end of '09. Some improvement in the credit markets could provide some impetus.

That's helpful, Don. Thanks a lot.

Okay.

The next question comes from Paul Ridzon.

Good afternoon guys, can you hear me?

Hi, Paul.

Hi. On the mark-to-market change there, I know it's only $0.04. But how does that work? When did that get realized, I guess?

How does it work? That's the --

How does it flow through if you follow me? It's going to be recognized, I guess --- when, I guess, is that the first quarter you guys recognized it already?.

Yes. To answer your question, we recognized it in the second quarter. And it relates to fuel price movements in the years beyond 2008. What happens is how we designate the hedges, the cash flow hedges flow through as OCI. The noncash flow hedges, the 10% sharing mechanism under the fuel clause, that is the portion that gets recognized currently in income or expense.

Okay. It will reverse itself past 2008.

Correct.

Okay. Then settlement discussions with the rate proceeding. I know that the previous rate case is a little bit different in that it was --- it had been some time and what have you. Do you think there's a greater possibility for a settlement or -- I mean, I know it's early in the process. You know what I'm saying.

It's very early in the process. We're always open to settlement. I think we'll be exploring that. We're in the very first stage -- literally the first stage of the rate case. I think generally settlement's a good thing. We'll be broaching that subject further down the road.

To follow along that line, this case, as you know is much more straightforward. The last case we had was very complex. It dealt with many more issues. This one is more straightforward.

Maybe it's more of a possibility to settle it sooner, rather than what happened in the previous case.

I think that's true.

Okay. And then just finally on SunCor, is there a possibility or I mean, what are the chances that things could be worse in 2009 than 2008 when you look out to that? I mean, I understand you don't expect the situation to improve until late 2009, but is there anything that we might want to think about with respect to 2009 in that outlook?

I don't think it can get much materially worse. We've got -- we were coming off, if you back up a couple years, the pace we were going on home building was close to 800 to 1000, and we are looking at about 150 homes this year. Condo sales we're closer 50 to 100. We're looking at 25 or 30. Commercial transactions at a relative minimum.

Okay. Great. Thanks for the color.

Thanks, Paul.

Next question comes from Jonathan Arnold.

Good afternoon, guys. Follow up on that SunCor question. You said that you expect minimal addings in 2008 with a fairly sizable commercial deal expected to close in the second quarter. As we look into kind of Q3 and Q4 and absent the lumpy commercial transactions, do you think the run rate of loss that we had in Q1 is about where it stabilizes? Or could the business slip to a larger loss assuming? Is that already reflecting the current pace of slow sales you just referenced?

I think that reflects the current pace, Jonathan.

Secondly, wondering, Bill, you mentioned the large number of candidates running for the ACC elections. Any we should be particularly focused on that could have the most traction or seem to be the frontrunners out there? Any color you can add around that would help.

Sure, John. I really don't have much. It's very early in the process. As I mentioned, it's still open in terms of new candidates and their entry into the process. I would say this, I don't think we've ever had, at least in my experience recalling back in terms of the election, we have never had as many candidates as are interested in the commission as we have today. The approximately half of them or so, maybe a little bit more, are either current legislators or ex-legislators. I think the interest in terms of the commission is a positive thing. As far as individual candidates, I don't have any comments on that.

How does the -- who would be eligible for chairmanship? How would that work?

Well, there isn't a formal process for that. There isn't a set time, nor a set term, in terms of the commission chair. I would expect -- my guess is it would probably stay the way it is, but that's literally a guess.

Okay. Thank you.

Your next question comes from David Thickens.

Good morning. Most of my questions about SunCor have been asked. I'm just going to beat this horse a touch more. Just trying to focus on what the earnings drag could get to if the remaining sales that are on the table fall off. Maybe put it another way, what is kind of the minimum earnings burn level that you can maintain SunCor at to keep the human capital in place that would allow you to ramp things up if and when the real estate markets turn? Does that make sense?

I'll try.

No one knows really how bad this real estate market is going to get. What I'm trying to figure out is, if it's worse than expected, what kind of ongoing loss are we going to see out of SunCor until things get better?

Okay. Even this year -- let me try it this way. If we pulled the commercial transaction, the one large commercial transaction that I was talking about in the second quarter, that's roughly about $15 million. Going forward -- well, we've reduced staffing levels substantially by about -- they weren't large, but somewhere in the range of 30 to 40%. The key folks relative to the residential side, the planned unit developments, the management teams in place, it was principally the sales force because homes just aren't selling. That's not a difficult proposition to bring that back up to levels when the market comes back. I think going forward, we've really cut our expenses back and will continue to look at that to keep the number -- I don't see it -- the likelihood of it getting measurably worse than it is this year.

If I could add something to that. As many of you know, we were on a program for four years to change the portfolio of SunCor. We were successful at that. And as a result, it has really given us an opportunity to deal with this kind of a swing in a much, much more positive way. Certainly not positive in terms of decline of the residential market, but our capability to be able to manage this process has improved very significantly. Even at the current levels, even at levels that we see that could be potentially worse, we don't see any impairment in the assets of SunCor.

Okay. And one question just kind of following up on the filing with -- comparing the fuel increase of roughly $13 million. Am I correct in that that presumes you get 100-some odd million from new connections to offset that, you're presenting the two together to the connection?

Those are really not related. If we gave you the impression that those were related, they're really not related.

Okay. If you don't get the connections, that doesn't change the fuel increase.

Not necessarily. That's right.

Okay. Thank you very much.

Thank you.

Your next question comes from Edward Hine.

Good afternoon. Had one quick question. You mentioned --- just a little color on the transmission rider. It sounds like you're going to file for another rate increase with that this summer. Is that in addition to I think the $37 million that you have already announced is going to be the revenue increase that you filed with FERC?

You're correct.

Okay. Have you quantified how much you expect that to be? That's part of the portion that's offsetting some of the SunCor weakness?

No. We have not.

Okay. And I guess the other question, Don, was just on the O&M. I think on the last call you talked about O&M being up about $40 million for the year.

That's correct.

Looks like there was a big chunk in this quarter. Is that really just related to timing? I think it was up $23 million this quarter. Is that still a good $40 million --

Yes, it is, plus or minus a million or two. We just looked at that again yesterday. It was very much skewed. Typically, the O&M would be skewed towards the first and fourth quarter of the year, because there were maintenance activities. With the large overhauls going on at the units at Four Corners and Choya, it's a little more exacerbated towards the first quarter. To answer your question, the $40 million, plus or minus a couple million, is still good.

Great. Okay. Just lastly, can you give us some updated thoughts on the financing, and particularly in regards to equity needs and this current market environment?

Well as I said in the past a number of times is that over the intermediate term, we'll have to access both the debt and equity markets. We really haven't talked about the timing specifically of either one yet.

Okay. Fair enough. Thanks a lot.

Okay. Thank you.

There are no further questions at this time.

All right. Well, thank you very much for taking your time. We know it's a very, very busy time, and we thank you for your attendance.

As always, if you have any follow-up questions, please give me or Lisa [Nalagone] a call. Thank you very much.

This concludes today's teleconference. You may now disconnect.