Pinnacle West Capital Corp (PNW) 2008 Q2 法說會逐字稿

Good afternoon. My name is Jennifer, and I will be your conference operator today. 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, Jennifer. I would like to thank everyone for participating in this conference call to review our second quarter earnings, recent developments and operating performance. Today, I have with me Bill Post, our Chairman and CEO, Don Brant, who is our President and Chief Operating Officer and also CEO and President of Arizona Public Service, and Jim Hatfield, our new CFO. 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 to per-share amounts today 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 assumed to 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 with the SEC this morning, as well as the MD&A and Risk Factors sections of our 2007 Form 10-K, each of which identify some important factors that could cause actual results to differ materially from those contained in our forward-looking statements. Also during the course of this call, we will be discussing our ongoing earnings, which is a non-GAAP financial measure as defined by the SEC. Our earnings release, which is available on our website, is accompanied by a reconciliation of our ongoing earnings to our net income. A replay of this call will be available on our website, www.pinnaclewest.com, for the next 30 days. It will also be available by telephone through August 6th. 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.

I would also like to thank you for taking your time to join us. As Becky mentioned, Jim Hatfield is with us today. Two weeks ago, Jim joined us as Senior Vice President as Chief Financial Officer, bringing with him more than 28 years of electric and gas industry experience. He most recently served as CFO of OGE Energy, and we are very excited to have Jim on board. Don Brandt will discuss our financial results and operational highlights for the quarter, and I will complete our remarks by discussing regulatory developments and our plans for the future. Don?

Thanks, Bill. Our consolidated ongoing earnings in the second quarter were $104 million, or $1.03 per share, compared with $85 million or $0.84 per share a year ago. The ongoing earnings exclude $0.30 per share of credits attributable to prior year tax issues resolved in the second quarter of this year. The increase in ongoing earnings of $0.19 per share was driven largely by improved results at our real estate subsidiary, SunCor. SunCor's second quarter earnings improved $0.14 per share because of the sale of a 12-story office building at its Hayden Ferry Lakeside development in Tempe, Arizona. I mentioned on our last conference call that SunCor had a large commercial transaction pending which was expected to close in the second quarter. This sale closed in June and contributed a $19 million after-tax gain. Excluding this one major real estate gain, our ongoing operating results were flat. Now, I will cover some detail on the other variances for the quarter. Rate increases improved earnings $0.15 per share.

The retail base rate increase became effective last July, contributed $0.11 per share, while the wholesale and the retail transmission rate increases that became effective March 1st added $0.04 per share. Non-cash mark-to-market valuations of APS's fuel and purchase power hedges, net of related PSA deferrals, increased as natural gas prices increased dramatically in the quarter. These increases added $0.10 per share. Higher retail sales related to customer growth contributed $0.04 per share. Increased margins related to long-term traditional wholesale contracts added $0.04 per share. These operating earnings improvements were substantially offset by cost increases and other factors. For example, milder weather reduced earnings $0.11 per share. The second quarter of this year was cooler than normal, while the second quarter of 2007 was hotter than normal. May of this year was one of the coolest in the past 15 years, and the five-day period surrounding Memorial Day was one of the mildest on record. On Memorial Day alone, Phoenix temperatures hit a high of only 82 degrees, with a mean temperature of only 72 degrees. We would have to go back to 1965 to find a similar period.

Next item is marketing and trading contributions were lower by $0.08 per share, and higher O&M costs decreased earnings $0.07 per share, related chiefly to higher maintenance costs for our distribution system and power plants, as we prepared for the summer peak season. Increased depreciation and amortization driven by APS's continuing investment in plants and facilities reduced earnings $0.03 per share. With respect to 2008 guidance, we currently expect that consolidated ongoing earnings will be within a reasonable range of $2.50 per share. We estimate that APS will contribute substantially all of the earnings and that SunCor's contribution will be minimal. Our ongoing earnings estimate excludes the $0.30 per share of prior year's tax credits recorded in the second quarter of 2008. Looking at the growth in our service territory, as I mentioned, growth in discussing the earnings variances -- growth has continued to slow in Arizona. Since growth has traditionally been a hallmark of our Company and the entire state, the situation deserves more discussion. Our customer growth in the second quarter of this year was 1.6%, down considerably from the 3.5% growth rate in the second quarter of 2007. We currently expect customer growth to continue to decline to a rate of about 1% by the end of this year.

Furthermore, we expect growth around 1% per year for the next several years. The dynamics of the mortgage and the housing markets, as well as the weak U.S. economy as a whole, have clearly left a mark in Arizona. Economic performance in the metropolitan Phoenix area has declined, particularly in the areas of population, immigration and job growth, especially construction jobs. As a result of the sharp downturn in the real estate markets, we estimate that the metro Phoenix area has about 40,000 vacant homes and apartments, about half of which are in APS's service territory. In robust real estate markets, the level of vacancies has been more on the order of 10,000 units. Over time, as residential vacancies are absorbed and we emerge from this downturn in the construction cycle, we are confident the state will return to its historical robust growth rates. The long-term fundamentals of the Arizona economy are still attractive, and we expect Phoenix will regain its historical stature as one of the fastest growing major metropolitan areas in the country.

While I'm on this subject, let me take a moment to comment on customer usage patterns we are seeing. In the second quarter, residential usage declined by 6.5%. The very mild weather accounted for 6 of the 6.5 percentage points of that decline. In other words, over 90% of the change was due to weather. In the first half of 2008, weather normalized residential usage is lower than the prior year by one half a percent or less, a very small decline. These very small meta-weather usage declines have been routine during economic downturns, as customers respond to job losses and lower incomes; but have been typically short-lived, lasting a couple of quarters to a year. Now I will turn to regulatory developments and operations at APS. Bill will address APS's pending retail rate case and interim rate request, but I will provide an update on APS's transmission rate case at the Federal Energy Regulatory Commission and the related retail rate changes, as well as the status of our power supply adjuster balances.

In May, we reached an uncontested settlement of the Transmission Rate Case, which was approved by FERC last Friday. Under the terms of the settlement, APS is permitted to automatically adjust its wholesale transmission rates on June 1st each year, using a preapproved formula rate setting methodology. As we previously discussed, the initial FERC rate request filed last summer was for a $37 million increase in annual transmission revenues based on a 2006 test year. Of that amount, 30 million related to transmissions to serve APS's retail customers. Both the FERC and the Arizona Corporation Commission allowed APS's proposed transmission rates to become effective on March 1st of this year, subject to refund, pending the ultimate outcome of the case. The retail increase was implemented using the Transmission Cost Adjuster mechanism, or TCA as we call it, previously approved by the ACC.

In the settlement, APS agreed to an increase of $28 million overall, of which $27 million applies to retail customers. In May, we filed with the FERC for a second transmission rate increase, based on the formula agreed to in the settlement, using a 2007 test year which produced a net increase in annual transmission revenues of $15 million, of which 13 million applies to APS's retail customers. The second transmission increase became effective at the wholesale level on June 1st and the retail level through a second TCA adjustment on July 3rd. As of June 30th, APS had $23 million of accumulated PSA deferrals, with the very strong enhancements to our PSA that were approved by the ACC last year. We continue to be in a much better position with respect to fuel costs this year than we have been in the past years. On April 8th, the ACC approved APS's 2008 implementation plan for the state's renewable energy standard. The implementation plan for APS provides $34 million for renewable energy projects and customer incentives. The expenditures will be recorded in O&M expense and purchase power costs, but will be offset by revenues collected through our renewable energy surcharge. In the second quarter of this year, about $5 million of the O&M expense increases and offsetting increase in revenue were recorded.

Now turning to our recent operating performance. The Palo Verde units have been running well. The combined capacity factor for the Palo Verde units was 74% during the second quarter, essentially the same as last year's second quarter. Both periods reflect planned refueling and maintenance outages. Currently all three units are operating at 100% power. As most of you know, Palo Verde has two refueling outages each year. The next refueling outages are at Unit 1 in the fall and at Unit 3 next spring. Currently, these outages are each expected to last 40 to 50 days. We are making substantial progress on our site improvement plan, and we are working closely with the Nuclear Regulatory Commission at various levels to insure that all issues are effectively addressed.

We are committed to return Palo Verde to sustainable first quartile performance. Our coal-fired plants continue to operate exceptionally well. In the second quarter of this year, the units operated at an 85% capacity factor, which was essentially the same as a year ago. Our coal-fired plants have consistently run substantially above the industry average, and we expect them to do so again this year. In June, APS placed two new gas-fired combustion turbine units into commercial operation at its Yucca site in Yuma, Arizona. These units add 96 megawatts of peaking capacity in that area to help meet Yuma's summer load requirements. Turning to a different topic, we are very proud of the fact that APS received the 2008 Edison Award from the Edison Electric Institute in June. The award honors one U.S. electric company for outstanding contributions to advancements of the industry. APS was recognized for its development of a new technology known as a Transformer Oil Analysis and Notification System, or TOAN, as we call it here. The TOAN system allows APS to automatically monitor transformer oil data and take necessary preventative actions on a much more timely basis when abnormalities occur.

Catastrophic transformer fires may one day be a thing of the past, not only for APS but the entire electric industry. We are proud of the innovative achievements of our employees in the transmission area and throughout the Company. This Edison Award belongs to them. Similarly, on the customer service side of our business, we recently received the results of the J.D. Power 2008 Survey of Residential Customers. Among large investor-owned electric utilities, APS ranked second in the west and sixth nationally in terms of overall customer satisfaction. We work hard to maintain top-notch customer service, and continually drive to raise that bar even higher. That concludes my prepared remarks, and I will turn the call back over to Bill.

Thanks, Don. I would like to spend some time today talking about our plans for the future and energy plan for Arizona. Although as Don described, we currently are experiencing a slowdown from our historical customer growth rates, growth in Arizona will continue over the long term. Consequently, we must aggressively address the future, our customers' growing energy needs and the financial strength that is vital to our success in serving those needs. Reliable, affordable electricity is the key energy cornerstone in our modern economy. Our employees focus every day on providing top quality customer service, service which has been recognized, as Don said, year after year by superior J.D. Power customer satisfaction ratings. However, great customer service cannot be sustained without ongoing investments in our electric system, and a fair, timely return on those investments. The infrastructure investments we're making today and over the next decade will shape the future of our state's communities, its environment and its economy.

We must invest in our electric system to provide reliable service and to serve our growing customer base. Growth in both customers and energy consumption means APS needs new energy resources; and we currently project needs for peaking resources within the next five to eight years and new base load capacity shortly thereafter. We're exploring a variety of alternatives for both types of resources, renewable, gas, coal, and nuclear, as well as conservation, energy efficiency and demand response programs; however, the specifics of how we acquire and pay for this future will require decisions that will include the public, the Arizona Corporation Commission, and our Company. In addition, I believe energy independence for Arizona is essential in order to insure that APS is not forced to rely on power purchases in volatile and uncertain regional markets to meet the state's energy needs in the upcoming years. Thus, resource planning is critical to serve growth effectively. During our recent calls, I have discussed the resource planning initiative we launched in January of this year. Our goal is to build public understanding of the options and the challenges we face in Arizona, as we plan for and acquire energy resources.

To date, we've held six sessions that have been well attended by a wide variety of interested parties. We are continuing this outreach process by meeting with community leaders and others throughout our state; and by the end of this year, we expect to file our future resource plan with the Arizona Corporation Commission incorporating the input we will receive through this process. Resource optionality will be critical. Peaking capacity does not necessarily mean gas-fired plants. For example, while the Solana solar facility we announced earlier this year has obvious benefits as a renewable energy source, it also competes with gas plants. As we go through the process of determining our future resource commitments, we cannot lose sight of the need for retaining flexibility in our plan; however, planning is not enough. We need the financial wherewithal to meet our future needs. Our financial strength must be improved to insure that we are able to continue serving Arizona's energy needs reliably at reasonable prices. Currently, we're at the bottom rung of the investment grade ratings ladder. Any slip from investment grade would prove costly to our customers, and APS's investment grade status could not be restored easily or quickly. Sustaining superior, reliable customer service requires a financially strong company.

Investment grade credit ratings are an integral foundation for our business. Certainly without investment grade ratings, costs of borrowing increase and financing flexibility decreases, and a lack of financial flexibility puts at risk our ability to acquire the generating resources to supply Arizona's future energy needs. For example, APS has made significant commitments to sustaining Arizona's energy future through renewables, including the recently announced Solana solar plant, which is scheduled to begin delivering energy in 2011. This project is not only crucial to our sustainable energy future, but also significantly helps APS meet the renewable energy standard requirements prescribed by the Arizona Corporation Commission. With financial flexibility, we expect Solana to be the first of several large-scale solar projects. Failure to maintain investment grade credit ratings puts Solana and the future of our renewable energy programs at great risk. In fact, APS's entire resource acquisition program would be at risk. In addition to our credit ratings, we must also insure that we operate as efficiently and cost effectively as possible.

During the second half of 2007, we conducted a complete review of our organization and our costs. We previously discussed the results of that cost with you, so I will just summarize them quickly. We reduced 300 staff positions, resulting in annual pretax O&M savings of $7 million. We reduced non-staff O&M, producing annual pre-tax savings of another $7 million; and we eliminated more than $200 million of capital expenditures over the next five years. Each of these previously announced cost reduction efforts is on track. Our efforts to date have been rigorous; but the fact remains that our current electric prices do not reflect our costs of doing business. Over the past five years, significant steps have been made with the Arizona Corporation Commission to reregulate Arizona and rebuild the regulatory model; however, our financial health has deteriorated over this time period and our ability to perform in the future has been jeopardized because of the regulatory lag. We have two significant regulatory matters pending before the Arizona Corporation Commission, both of which are critical to meeting the needs of Arizona's energy future.

In March, we filed a retail rate case. We updated the rate case on June 2nd to reflect the test year ended December 31st, 2007. As updated in June, the filing requests a net increase in annual retail revenues of $278 million to become effective October 1st of 2009. Consistent with the original filing, we are continuing to propose several methods to reduce regulatory lag and the resulting earnings attrition. The hearing on the rate case is scheduled to begin next spring on April 2nd. Although progress is being made in the general rate case, we simply cannot wait until late next year for a decision on that filing. Time is truly of the essence. Bold steps must be taken and tough decisions must be made now that will prove beneficial to our customers and investors alike. To that end, on June 6th, we requested that the ACC grant APS interim-based rates until permanent rates become effective under the pending general rate case. The interim rate relief would provide critically needed cash flow and strengthen our credit metrics and earnings. The interim request asked for a 4% rate increase, which would increase the annual pretax revenues about $115 million. The amount would be subject to refund depending upon the eventual outcome of the rate case.

It is essential that the ACC grant this request to provide some financial stability and strength for APS; and accordingly, to help our investment grade credit ratings. Very simply, the amount of the interim request approximates the increase which results from updating only for the new text year data, using staff's methodology from the last case, while not including any of the attrition mechanisms we have proposed. Two weeks ago, the ACC Administrative Law Judge issued a procedural schedule for consideration of this request. The key dates are as follows: Staff and interveners testimony is due August 29th; APS's rebuttal testimony is due on September 8th; and the hearing will begin on September 15th. This schedule is designed to allow the Commission to render a decision on the request by November, allowing the interim increase to take effect at the same time APS's winter rates go in effect. Since winter rates are lower than summer rates, concurrent implementation of the interim request would result in an average net decrease to customers of approximately 14% compared with the rates they are paying today. Even if implemented before winter rates go into effect, the interim would not increase customer bills, but instead offset the 4 mill fuel decrease that is currently estimated to go into effect later this week.

While constructive, timely rate treatment is a critical component of maintaining and restoring APS's financial strength, we are also prepared to do whatever we can to improve our financial strength. As Don indicated, our customer growth has continued slowing during the year and the situation is expected to continue for several years. Since last fall, the real estate slowdown has been exacerbated by higher gas and oil prices and a turndown in the national economy. Therefore, we have undertaken a further review of our costs. Although this review is still underway, we are pursuing efforts to reduce our capital expenditures by at least $500 million over the next three years. We will not know the exact amount of these potential cuts until we have completed our implementation plan. These cuts will recognize the additional growth declines, and they also will involve cuts in other areas that may impact our ability to serve future customers. We cannot continue to impair our current financial health for future customers. Growth must pay for itself on a timely basis. APS's electric prices must cover the cost of doing business to insure the viability of Arizona's energy future. Short-term approaches will have long-term negative consequences for Arizona's economy and its people.

The capital expenditure reductions will involve downward revision of our distribution expenditures, but they will also include delays or cancellation of some transmission projects and other facilities. Without consistent, constructive regulatory score, now and into the future, we simply cannot continue a $1 billion a year capital expenditure program. Electricity is a vital component of a vibrant growing economy, and we want to be the cornerstone supporting Arizona's energy future; but we cannot do it without a solid financial foundation. It is our goal to fully finance our capital expenditures internally within three years. The four key steps of the program we're implementing are: First, the cost reductions announced and implemented earlier this year; second, the interim rate relief, which is essential to maintaining our financial strength; third, the further capital reductions just discussed to be implemented beginning late this year; and finally, a constructive process and decision in the pending general retail rate case.

With the successful implementation of this program, which I believe will be achieved, we will eliminate the need for an equity issuance in 2008. Obviously, much of this plan, as well as the outcome of our pending rate case, depends on our ability to work closely with our regulators to bolster our Company's financial health. As I said earlier, the fundamental issue is that our prices do not reflect our costs of doing business, and it's time to restore our financial health. As innovative as we are, we cannot invest in the infrastructure needed to reliably meet our customers' growing energy needs without sufficient financial health. Without positive, consistent regulatory support, our state's energy future is in jeopardy. We have been working aggressively with the Arizona Corporation Commission to rebuild the Arizona rate regulatory model. In the fuel area, transmission price increases, generation resource additions, and now with our second interim request in as many years, the ACC has understood and has made the necessary decisions to implement major components of the new regulatory model. However, it is now time to address our financial ability to meet Arizona's future energy needs. We cannot continue to finance growth by imparing our financial health, and we cannot efficiently finance Arizona's energy future with today's impaired financial strength. That concludes our prepared remarks, and we would be happy to answer all of your questions.

(OPERATOR INSTRUCTIONS). We will pause for just a moment to compile the Q&A roster. Your first question comes from Dan Eggers with Credit Suisse.

Hi, good morning.

Hi, Dan.

I guess first question, on the no need for external funding in 2008, or the no need for equity, how much flexibility is there between the four points as far as, you know, if you don't get your interim relief, are you still in a position where you can avoid issuing equity or does that change the conversation quickly?

Well, Dan, our primary -- this is Don speaking. Our primary focus right now is getting that interim adjustment. As Bill said, we are confident that we are going to carry that decision with the Arizona Commission. I think they understand our situation. They have accounted responsibly with the transmission cost adjusters and the substantial improvements they made a year ago in our fuel adjustment mechanism, and I think they will understand that implementing this interim adjustment is the responsible thing to do at this point.

Dan, I think the fact that they scheduled this and have addressed issues dealing with our credit issues over the last year, year and a half, show that they have been very focused on this. They understand how important it is for us to be able to maintain the financial strength we've had and improve it, and I think the key is that interim decision.

Okay. If I do my math right now, it looks like you guys are earning less than a 7% ROE this year. With the interim adjuster, would that put you guys a lot -- how close to your earn would you guys be at that point?

We would probably make up a little better than half of that distance. It would put us in the nine.

In the nine range?

Nine range.

Okay.

Maybe on an annualized basis, Dan.

Yes.

Remember that this year you only have two months and low sales months.

No, I meant on annualized basis. Sorry about that. Thanks, Becky. And I guess just kind of last question, Dan. I don't know if you could walk through kind of some of the pluses and minuses from the old 250 guidance and the new 250 guidance, and do you guys -- are now stripping out the tax benefits from that number?

Yes, actually, there are not any very large ones, Dan. I'm looking at the reconciliation here. You know, the mark-to-market is a little under a dime. Actual realization on sales is around a nickel. It is split between commercial and residential. Higher volumes on our wholesale contracts is $0.03 to $0.05. Then we've got a multitude of other items and some of our cost reductions that Bill mentioned that we went through as a result of '07, some of those have come in earlier and better than we had anticipated.

Okay. Thank you, guys.

Thanks, Dan.

Your next question comes from the line of Bill [Apostile] with Citigroup.

Actually, it's Greg Gordan. How are you doing?

Hey, Greg, how are you?

Good. So when you -- Dan asked a big chunk of my question.

Okay.

When you look at the potential for interim rate relief and the improvement in -- potential improvement in returns, does that pick up that you just articulated, take into account the deceleration in customer growth and sales growth that you are looking at?

The short answer is yes.

Okay. And you are basically presuming -- we should be presuming going forward that your revenue growth rate is going to decline about 1% a year?

Correct. And for the next several years. Yes. Let me respond a little broader to that. I think what we are saying is the customer growth rate is 1% per year.

Right, I'm asking if we can extrapolate that constant usage, though. That would be about 1%, or if you were to see some deceleration in usage that you would see top line revenue grow even slower.

Under current rates, you mean? So when you say revenue, you are talking kind of about projecting revenues under today's rate levels?

Right, all things equal.

All things equal, yes, that's in the ballpark.

Okay. And is the interim rate relief that you requested, is this an all or nothing number? Or is this similar to any other rate filing, where the Commission could hypothetically come up with a different -- still grant you relief, but grant you a different number than you requested?

The latter.

The latter. And at what point -- you said basically that you are not planning on issuing equity now in '08. If you were to get a decision in the interim case that was -- how soon after you get a decision in the interim case would you make a final decision on that, or is that basically already in the plan and you will be assessed in '09, no matter what happens in '08? In the September decision?

That's essentially our plan going forward.

Okay, so if you need equity, it's going to be an '09 event, irrespective of what happens in the interim case?

That's correct.

Thank you very much.

Thanks, Greg.

Your next question comes from the line of Paul Patterson with Glenrock Associates.

Good morning, guys -- well, good morning over there, I guess. How are you?

Hi, Paul. How are you doing?

All right. Just with the equity issuance, assuming that everything works out with the interim increase and everything else, does that mean that the equity issuance is really limited for the foreseeable future, or just simply postponed?

I think highly likely it would be eliminated -- clearly, for 2008, it's out and for a good part of 2009, I think we would be comfortable moving forward with that equity.

Okay. And then the $500 million capital reduction, I heard your prepared remarks. I wasn't completely clear as to, does this impact future growth or -- I mean, in other words, if you -- growth comes back and what have you, I wasn't clear as to whether or not this does have the potential for affecting future growth or not.

Well, when -- let me ask you to clarify your question. When you say future growth, are you talking about the capital expenditures somehow stopping that growth level or -- ? I'm not sure of

You are reducing the capital. My understanding is that you guys are going to be reducing CapEx going forward over the next three years by about $500 million now. And I also heard in your prepared remarks that there was some issue with respect to having the right kind of spending longer term set up to facilitate the growth for customers. And I was wondering just how -- does it capital reduction -- I mean, you guys are going through some pretty substantial realignments of the business plan and I guess what I'm trying to understand is whether or not this -- I mean, you mentioned that there was some concern, I thought, that you were voicing, about the ability to fund future growth for the state, and I'm just wondering how this CapEx reduction plays into that?

Great. Okay. Thanks for clarifying that. As we said, the key for us as we look to the future, we have got to be able to meet the energy requirements of the state, not only in the short term but in the long term as well. As we look to the future -- and we plan on filing with the Commission in December of this year a full resource plan that will deal with not only issues of renewables and purchase power, but also base load additions into the future. As we deal with that, we have got to improve our financial strength to be able to add in the -- in the next 10 to 20 year period, base load additions. For example, if you look across the country at efforts that have been underway by various regulatory jurisdictions in Florida, for example, where the Commission has evaluated the need for new nuclear and has granted mechanisms for recovery of those expenditures through that process, that's the type of thing that we would consider here as we deal with new construction for our base load. We would not make commitments in terms of new base load capacity of that substance without doing that. Therefore, we would remove any projection, if you will, of base load expenditures for that today, based upon the outcome of that resource filing that we're going to make in the -- later this year.

Okay.

Let me also say that it's very important for us to meet the reliability requirements of our customers and we haven't diminished that. It is the way we are going to finance to meet that reliability, not the fact that we are going to diminish it.

Okay. And then with the $500 million, if I understood you guys correctly, that's mostly distribution and some transmission. What -- could you just give me a feeling from a capital budget perspective what percentage of that is? I mean, how much you're reducing your --

The total?

Yes, the (inaudible) distribution transmission, how much is -- how much of that CapEx is going to be -- how much $500 million represents, I guess, of the total bond?

Well, the only thing we can do as of today is kind of -- you can look at it compared to the total amount and you can see the 500 against the $3 billion round numbers over that time period. As far as the individual specific programs and projects, that's something we're going to finalize in the next 60 days or 90 days.

Does the $3 billion include generation or anything like that?

It has generation expenditures in it, but no real significant new plants. As you know, it has got continuing nuclear fuel expenditures, as well as capital expenditures in all of our generation plants.

Okay. Then just finally, I mean, you guys mentioned the long-term fundamentals with the growth in the service territory and the .5% weather normalized decrease in sales. And you said you expect that for a couple of quarters and then things get back to normal. What recessions have there been in Arizona recently or -- how -- what are you comparing that against? Is that sort of like the 1990s slowdown or -- ?

Comparing it -- that was our experience in the 2001-2002 period. The '90/'91 period, also very similar type of a usage pattern.

So basically by 2009, you expect the weather -- normalized usage to be what it was historically?

Yes. Basically our growth is driven by the type and size of new homes. And the trend and even the continuing trend -- obviously, home building has slowed down; but towards larger homes, higher ceilings, more cubic feet. That's what the primary driver of usage is for the growth.

Okay. Thank you very much.

Thanks, Paul.

Your next question comes from the line of Jonathan Arnold with Merrill Lynch.

Good morning, guys.

Hi, Jonathan.

A quick question on SunCor. You obviously have this gain in the quarter. You are talking about minimal contribution for the year, which seems to imply you will be losing money in the second half. Can we revisit, you know, fundamentally, what is going on in this business, outside of this big sale, and any changes we should anticipate and maybe just an update on what the embedded book value is at this time?

Well, Jonathan, I think you are right in your assessment in the balance of the year, and it will -- the earnings will be essentially minimal for the year. And we expect that for the next year or two. SunCor has actually gone through and continues to go through some cost management exercises. We've cut more than 33 positions this year, and that's on top of 21 last year. That's just under half of the organization. We also see -- we have been cutting back on G&A expense about $40 million in 2008. And also that's on top of a 21% decline last year. And basically, the home building business is flat, very low levels. And preparing the business to endure the next two years; but at the same point in time, looking opportunistically at what type of development opportunities there might be in this depressed market.

You know, Jonathan, you will remember our discussion back in 2002 about recasting and developing a different portfolio for SunCor, which we achieved; and one of the fundamental objectives of that process to recast that portfolio was for us to be able, as we had downturns like the one we are in right now, to be able to adjust our expense to the downturn in revenues which is really fundamentally a downturn in terms of volume and opportunities. That was achieved, and that's basically the mode that we are in.

Do you expect the business to be a negative contributor in 2009?

No. I think it's going to be relatively flat. Minimal either direction.

Okay. And is there a book value number that you could give us?

Well, book value -- the balance sheet is about $500 million. And it's consistently stayed around that level, Jonathan.

Okay. I think my other questions were answered, I think. Thank you.

Thanks, Jonathan.

Your next question comes from the line of Paul Ridzon of KeyBanc.

Just on top of Jonathan's question, I guess the implication is that SunCor will have about a $0.15 loss in the back half of the year. How much of that is cash as opposed to just noncash?

Majority of it will be cash.

And then driving your decision for the $500 million decrease in CapEx, I know it's a hard question to answer, but how much was driven by reduced good growth projections and how much was just you had to draw a line in the sand where if you're not allowed to structurally earn your cost of capital, you can't continue spending money?

They are both important themes. I'm not sure I can give you a percentage allocation between the two. As we look to that, basically the analysis is going through our whole Company, and this isn't an estimate that Don and Jim and I put together and said, okay, now go figure out how to do it. This is an estimate that we have been doing really from the bottom up, looking at every single project in the -- in the organization and evaluating it for a set of criteria, of which those are two important ones. But as I mentioned before, reliability is also important and it's -- it's not something that we want to see decline; and, fact, if you looked at our history, we've over the last 10 years had a significant improvement in our (inaudible) reliability and that's something that takes years to do, and we fully appreciate that. So it's not easy to answer that question because it's really a set of -- a set of criteria that the entire management team looks at; but we are doing it very aggressively and we are doing it with a prospective on the future that really requires a different method and different approaches to be able to finance those capital expenditures.

And just -- I wanted to make sure that I understood you, I think with Greg's question, that -- there's no equity coming in '08, regardless of the interim treatment?

That's correct.

That will be pushed into '09, but how late in '09 depends on the interim treatment?

It would depend on that and other events.

Okay. Thank you.

Yes, sir.

Your next question comes from the line of Raymond [Leong] from Goldman Sachs.

Hey, everyone. A couple of questions. With respect to CapEx, can you elaborate a little bit more, given that we are half way through the year, how much is the savings of that half a billion is this year? Can you sort of say is it this year or is it mostly back end loaded, given the time of the year? And then if you could also talk about some of your external financing needs on the debt side to fund the capital program for this year?

Relative to, I think, Bill's comment earlier was we would be implementing these additional reductions later in 2008. We -- we aren't finished with the internal process yet. So there will be relatively minimal amounts on 2008 capital expenditures of this new $500 plus million reduction. After that, it's probably going to be relatively evenly spread over the 2009 to 2011, maybe somewhat of a slight bias towards the front end loading.

Okay. And any debt financing plans for the balance of this year?

No.

Okay. And one other thing, given the softness of the economy on collectibles, delinquencies, can you talk a little bit about that, please?

We have seen an increase, but nothing I would put into the material category. Naturally, with the downturn in the economy, and construction jobs being lost and the overall impact of the housing market and the mortgage market, naturally you are going to see uncollectibles go up and bad debt writeoffs increase. But -- you know, like I said an immaterial amount.

Great. Thank you guys.

Thanks.

Your next question comes from the line of Danielle Seitz of Seitz Research.

I was wondering, assuming you resume normal growth in 2009/2010, when would you require new generation?

Well, Danielle, if you look out in the next five to six years, it's basically peaking capacity. And then after that, it would be base load.

Okay.

So as we said today, the picture would be peaking first and then base load.

Okay. And because of the lead time for base load you -- you are talking about beginning the construction in five to six years for base load?

Well, Daniel, we are on a path this year to go through really an evaluation that includes all of the parties in our state in dealing with future base load capacity. The need for that fits that schedule. Let's put it another way. As we go through the sessions that we have been having throughout the state, the filing that we expect to make later this year with the Commission, there is sufficient time in there for us to be able to achieve a decision in the regulatory process, as well as the public process, consistent with our need.

Okay. Thank you.

You bet.

Your next question comes from the line of Edward Heyn with Catapult.

Good afternoon.

Good afternoon.

Can you hear me?

Yes.

I had a quick question on the O&M side. I think in the last call you had been targeting about a $40 million increase for the entire year on O&M. It looks like through first half of the year, you are already there. I wanted to kind of talk about that, and is there timing issues there or is there revisions to kind of what you are seeing on the cost front?

Let me gather -- I have got the information in front of me here. We're looking at -- let's see -- still in that number for the year. Now, you've got the $5 million renewable energy standard factored into those numbers too, which is offset on the revenue side.

Okay.

So you need to back that out.

And then would the rest -- because you've already got like 40, so that would bring it down to 35 for the year so far, so the rest is more timing issues --?

Yes.

Then you add higher O&M last year than you will this year?

Yes.

Just on a quarterly basis? Okay. And then I think the base of '07 was $735 million, which kind of a $40 million number implies like a 5% kind of escalation in cost. Is there -- with your revenues -- with your revenue line going down to the more 1% rate, do you -- how do you see the escalation of costs going and any impact from the reduction in the CapEx as well that may affect that?

Well, let me address the first part. I'm not sure how the CapEx impacts on the O\&M side; but the 5% rate is -- you see in there, and that's about right, but when we look at certain segments of business, like particularly just the other day we were looking at our fossil generation folks, the chemicals that they use that are petro-based, they are seeing 20 and 30% increases in those, and not an insignificant number of dollars, and it's just simply tightening down the belt in a lot of other areas that's been able to reduce these very large inflation rates down to about 4 to 5% overall range. You know, and about half the O&M costs are labor, and that rate is less than 5% inflation, which moderates the overall somewhat.

Okay. So as the revenue rates decline and we are not going to see -- you are going to see pressure from the inflationary side?

Yes, unfortunately I think so. We see that -- I'm not sure if it was your point on the CapEx side, but --

Yes, I mean, I guess you'd see lower depreciation rates from not spending that --

Correct.

-- those dollars. But it's mostly there, so there's not as much on the O&M side from that?

Right.

Okay. Okay. That's helpful for some color. Thank you.

Okay. Thank you.

Your next question comes from the line of Yiktat Fung from Zimmer Lucas Partners.

Good morning.

Good morning.

First I would like to revisit Dan's first question regarding the flexibility of the plan to avoid the -- to eliminate the equity issuance. Obviously, you have laid out four points -- one was in this kind of a rate on the $200 million in dollar reduction in CapEx. I was wondering with regard to the other points, how much flexibility is there? For example, if you get only like a $50 million interim rate increase, or even like a zero interim rate increase, would that revive the need for equity?

For 2008, it would not revive the need for equity.

But for 2009 it might?

It very well might -- that and other factors that might change between now and then.

And I guess the same thing goes for the $500 million reduction in CapEx, correct? So, for example, if you only find $200 million of CapEx reductions --

That's not a possibility. It will be at least $500 million.

It will be at least $500 million.

We have a very detailed process that Bill talked a little bit about. And we are not going to jump ahead of the team because we put a group of our best managers on this to go through the Company in detail, and we're using the 500 number as a very preliminary number but it is a solid number. It will not be less than 500 million.

And when will you announce the finalized numbers? I think you said before -- the implementation plans would be finalized in the next 60 to 90 days?

Yes.

So should we expect it in like the third quarter conference call?

That's very likely.

Okay. And just one more question with regards to the second transmission rate adjustments. Does that change the TCA requiring other approval from the Arizona Commission or does that just flow automatically through?

That second one was approved by the Commission.

Okay. All right. Thank you so much.

You bet.

Your next question comes from the line of Yuv Neginsky with Tindale.

Hello, can you hear me?

Yes, good afternoon.

Hi, it's (inaudible) from Tindale. I just have a really quick question. I believe at some point Arizona Public Service had some auction rate securities;e and in the light of the disruptions in that market, have you redeemed those securities or do you plan to redeem them at some point in the future?

We have not redeemed them, and actually we have seen some of the results of those auctions stabilize at relatively attractive pricing.

So it sounds like as long as the prices are attractive, you will let them stay out there?

Yes.

Okay. Thank you.

You bet.

You have a follow-up question from Bill Appicelli with CitiGroup.

Hey, guys, it's Greg again.

Hi, Greg.

So I know you've been asked this question several different ways. But as you think about the capital formation plans, you are not going to issue equity in '08, and depending on the level of interim rate relief and how you are feeling about the progress in the GRC in conjunction with how well you do in meeting or beating your CapEx reduction targets, equity may or may not actually be needed in '09? Is that the summary of the five different questions have you been asked and the answers to those?

Yes.

Yes.

Okay. The second question is on the real estate. When we think about the book value, how much of that is sort of the raw land that was for the initial genesis of the real estate investments that the Company made, you know, decades ago and how much of that is relatively new stock so we can get a sense of whether we ought to be thinking about the value of those assets at book value or discounted book value, maybe a (inaudible) value given the real estate market as it stands today.

Well, the -- as you know, we went through about a four to five year effort there in terms of reposturing that portfolio. The land component declined over that period and, Greg, I don't have a number just off the top of my head of what proportion that is. We could get that for you, but I don't have it off the top of my head.

Okay. So qualitatively speaking, what makes up that portfolio today?

It's -- it's the land. It's the planned community investment, particularly in infrastructure. Those planned communities are not basically recording significant amounts of land. If you take a look at their investment, it is mostly in infrastructure, which turns fairly quickly, rather than long-term investments in land. We've got an investment in the golf courses that we've had fundamentally for the last decade plus, that stays in that category, and then some commercial just like the building we just sold. But we would be glad to give you a break out on those percentages.

Thank you very much.

You bet, Greg.

Your next question comes from the line of Jonathan Arnold with Merrill Lynch.

Just a couple of other things. How much of the mark-to-market gain you had would you anticipate reversing in the year and what's embedded in your 250 number on that front?

Well, obviously, some of that is based on where gas prices go for the balance of the year, but actually a very small turn around for the balance of the year.

And that's what you've baked into guidance is a small turn around?

Yes.

But if gas prices stay where they are now, would we see something bigger than that?

I missed the last part of that question?

Well, based off the view that, you know, gas prices at the end of the quarter or, you know, they stay where they are today, could the answer to that question change?

No. It's not -- actually, it's driven by the level our hedges and how they interact over the balance here more so than gas prices.

And one other thing, I just feel -- would you be able to give us a quick update on the Commission heading into the elections in November and just the latest thinking around candidates, et cetera?

Well, as much as I can. I mean, that process has really just started. That election really doesn't get going and really with a lot of attention of the candidates until almost the end of the summer and just right before the election. There's 12 candidates that have been announced. Eight of them are Republicans and four of them are Democrats. They coverall kinds of backgrounds. I would say probably the most common one is experience as legislators, but we've got business people, consultants, engineers, et cetera, through that process. It also is broad in terms of geography throughout the state. We have people from regions outside of Phoenix that are involved in that. This is, in my experience, the largest number of candidates that I have ever seen in the last 25 years. And so there's a lot of attention in terms of the primary, and it will really depend upon the campaign and the primary elections. So it's one where there's quite a bit of attention in terms of candidates, and I don't know how to generalize it anymore than that.

It's still a little early?

It really is. They've had one big debate so far, and only one. And there's more scheduled. So over the next couple of months, I think we'll get a better feel for what their positions are.

Thank you.

Your next question comes from the line of Peter Hark with Talon Capital.

Hello, everyone.

Good afternoon.

Hi, Bill.

Hi.

First, I just want to just congratulate you on the hiring of Jim Hatfield. He's a solid addition to your management team.

Thank you. We agree with that. We're glad he's sitting here.

Check's in the mail, Peter.

Thanks, Jim. Actually, I just have a host of clarification questions more than anything. First, when you filed the interim rate request, it was to dove tail with the falloff of the PSA adjuster. So will the PSA go away as you recover those amounts in the next few days and thereby setting up what you wanted to avoid, which was a step up in rates when you do get interim rates in place?

Well, it's -- as you know, that's a fairly complex process, as you deal with 21 cycles in the month and you deal with this effort over the period as well as the variances in weather. If you look at the bill, which is what I think the customers care about first and foremost, is how much is the bill? And when you look at 4% variations given our weather, it's -- it's not quite as precise as the algebra might suggest. I think the key is, is that we are going to be able to deal with this interim in an environment given that decrease that won't increase overall bills, and I think that's the most significant piece.

Right and then actually to follow some of your comments earlier, Bill, you were talking about actually seeing rate decreases in the November time frame, I think of around 14%. How do you get to those numbers? I mean, how is the decrease so pronounced?

Why is that? That's a good question. And it goes back over years and years and years through rate cost allocation studies that allocate the costs between the summer and the winter and do that on a basis of, fundamentally the driver is the generation plant. And as you -- as you deal with Arizona, as you all know, we are a summer peaking state, driven largely by air conditioning load and as a result, most of the costs we have is in order to meet that large peak demand, and therefore most of the costs are associated to that. So it is a -- it is a cost allocation methodology that has been accepted and approved by this Commission over decades, and it has its foundation -- kind of the fundamental driver that is contributing to those costs. So summer costs for us are actually more expensive than winter, and that's the reason the prices are higher.

Okay. Thanks. And when you made the filings, I guess even the GRC, especially, you had -- I think you said you could increase your equity investment in APS to the tune of $400 million, but now that you are not issuing the equity currently, how will you make that equity investment?

Well, I'm not sure that $400 million was explicit in the general rate case. The general rate case is predicated basically on equity levels, and we believe those equity levels are valid.

Okay. Okay. Fair enough. And then just conceptionally so I have it clear, assuming you get something on the interim rates, would that be a net deduction from the GRC case?

In the most simplest form, yes; but I think a better way to look at it is it's embedded in it.

Right. Okay.

So I think that's a better way to look at it.

Okay, great. And then somewhat at odds for what you are trying to accomplish, in describing your financial situation, I guess a few days ago, Moody's had actually improved your outlook from negative to stable, citing what they are calling improving regulatory environment, I guess. And so I was hoping you could comment on that and what that might mean. You know, also given the continued efforts of Commissioner Mayes to get you guys to apply the various mandates of the state, including renewables, I think in most particular on the renewable side and coming up with a plan to address that. But just trying to get your position or your perspective on -- you know, what Moody's says is an improving situation, particularly, you know, on cash flow and some of the mechanisms the Commissions put in place. You -- and you continue to kind of describe a deteriorating financial situation.

Well, let me comment on it, and Don can as well. If you like look at the last couple of years, we have had a large number of regulatory decisions. I don't think there ever is any doubt about that, whether that covers everything from renewables to FERC transmission revenues to fuel adjustment clauses to dealing with resource plans, et cetera. So we've had a lot of issues that this Commission has addressed; and including, as I mentioned in my prepared remarks, two interim emergency cases over that period. This is a Commission that has had to deal with literally the reconstruction, the reregulation of Arizona from decisions that were made now almost a decade ago and then put into a situation where we had to come back and make decisions on fuel adjustment clauses and various other things. The one that remains is the one that I mentioned in my prepared testimony, which is having sufficient financial strength to be able to finance Arizona's energy future. The Commission's made a lot of tough decisions; and as we go forward, I think it's going to be critical that we have the financial strength to be able to meet the requirements, not only in the terms of our customers' growth, but also to provide an energy platform for the economy for the state of Arizona.

So just to put kind of an overall broad picture on it, that's the way I look at it. And they've dealt with many things. As we have described today, one of the keys is our ability to be able to finance and our ability to be able to meet those requirements. And with the plan that we've outlined, I think it's absolutely critical that we get to a point where we can finance that capital budget going forward on a basis that makes sense for our customers today and tomorrow. And so it's not just an issue of changing this particular structure and that particular structure -- although we've had to do that over the last several years, now we are in a position where we have to look at the larger picture and position Arizona in a positive way. I think the decisions that you have seen in the last 12 to 18 months, 24 months as this Commission has dealt with fuel issues, they have dealt with the FERC revenue, they have dealt with issues that are forward-looking; and I think there is an understanding today about the importance of our financial strength. So that's a component of our plan to be able to get there.

Now I'm also -- as you heard me say earlier, we have taken very aggressive steps and are taking even more aggressive steps to insure that we're doing everything we can to get to that goal as well. You can't get to an ability to be able to finance the future, however, purely on cost savings. Cost savings are critical. They are important. It's the key that you be efficient, but it's also important that you provide high levels of customer service and reliability. So you have got to factor all of these things together in a way that meets that requirement. And it's -- we have seen in a positive decisions in terms of the Commission, and an understanding an the part of our need for financial strength. And I think as we go forward, the Commission will deal with this issue as I mentioned. I believe that they will deal with it effectively.

Thank you for those comments, Bill. In addition to that, I think I had seen a letter recently from Commissioner Mayes that actually asked why won't you update your GRC through a more timely period. I think she was asking through June of '08, and you had updated your testimony I think through the end of '07. Will you continue to update the rate case stacks as you move through quarters, or what can we use, I guess, as a -- the right rate base or the test year for the case on its finality?

Well, it certainly is true that as we go forward, we'll get further and further distance from the test year. But I think it's also important to understand that just if you compare this test year to the previous test year, we have an additional $1.8 billion in capital expenditures that's in the current test year versus the one that's in the previous rate case, just for the ACC jurisdiction, and not including FERC. So I think it's important to understand that this test year provides the foundation and the base for this interim decision, and it's not required to update this every single month in order to deal with the interim decision. It is true we have to stay current; and as we go through the process, we provide ongoing information. But this test year -- as I mentioned in my prepared remarks, this test year, if you use the methodology that the staff used in the last rate case, you'd produce the result of interim increase.

Okay, perfect. Perfect. And these are the last two, I promise, real quick. What's your expectations on -- I think there was an earlier question on O&M expenses and in particular, I'm interested in what the Palo Verde O&M line is going to look like in '08. There was some heightened NRC involvement and there was some additional cost associated with that. But I was just trying to gauge what direction Palo Verde expenses will be going -- on a going forward basis, have we peaked or do you expect that to continue to escalate or actually could it even begin to start falling off? And then the second question is just more of a finer break out. I think somebody asked earlier what the book value was of SunCor, but if you have the current book value of all the subsidiaries -- APS, SunCor, and then, kind of adding up to that $37 per share for the consolidated Company? And thanks for all your time and answers. Thank you.

Sure. First on your question on Palo Verde, we are going through a very aggressive performance improvement plan at Palo Verde, and we have been doing that for some eighteen months, but there's approximately 2300 items in that performance improvement plan, and we expect by the end of this year to have completed over 90% of those. So I think the bulk of the expense is associated with the performance improvement plan will have been incurred as we deal with the obviously fairly long list of issues that we have chosen to address, and in terms of -- that's a list much, much longer than the ones that are included in the request from the Nuclear Regulatory Commission. However, it's premature for us to start talking about costs at Palo Verde. Our key at Palo Verde, as Don mentioned to you, is we want Palo Verde in the top quartile performance in the industry, and that's our goal and that's the goal we're going to achieve. And as we look to the future, it's not an issue where we're going to see significant cost increases to be able to do that, and it's really premature to talk about cost decreases. And your second question on book value, you may have to refresh us a little on that question.

Oh, it was just if you can separate out on a subsidiary basis what the book values are on each subsidiary that add up -- I think the reported book value at June 30th '08 was around $37 a share. Just didn't know if you have that broken out across the subs.

I know we do, but not handy, Peter. Becky would be happy to walk you through that later, and anybody else that's interested. I might just -- couple things at the risk of going back to a few of your questions. On the Moody's stable rating one, as you might expect -- reasonably expect -- Moody's has access -- we previewed virtually all of this and then some with them on our expectations, and they're well aware of the Commission's improvement in the fuel clause of a year ago and the transmission cost adjusters, which contributed, I believe, to their statement about the improving regulatory environment. But reading their -- it would be a (inaudible) to overlook their language that their stable rating is based on a continuing regulatory recovering of cost. And premised on the continued support of regulation that we've had in the past going forward, and I interpret that as being the -- addressing the general rate case and the interim adjuster, which is part of the plan Bill laid out and part of the plan we laid out to Moody's when we talked to them shortly before they issued that last publication.

Also, in one of your questions, you had a tail end about Commissioner Mayes trying to get us to comply with the renewable energy standard. The renewable energy standard is a promulgation of the entire Commission -- Commissioner Mayes is no doubt a very strong supporter, as are other commissioners. But we are complying with it. We're actually beginning to over comply with it, and I had the opportunity to speak with Commissioner Mayes just a -- two weeks ago about the renewable energy standard and our commitment. We've come out vocally, both myself and key representatives of the Company that are more intimately involved with the details, and essentially put my discussion with her in the form of a letter, of which again, if you or anyone else is interested, just ping Becky, she can send you a copy of that.

That's great, Don. Thanks for that clarification, and keep up the good fight. Thank you for your time.

Thank you.

Our next question comes from Paul Ridzon from KeyBanc.

(inaudible) a large wholesale contract, I think it just recently expired, and you had hedged that out with a strip? Can you talk about what we should expect for the balance of the year from that?

We'll continue to generate some earnings over the balance of the year as that strip runs out.

How much of that strip have you sold?

Basically all of it, but it's a relatively complicated transaction. We'll generate 3 to $5 million a quarter off of that structure for the balance of the year.

You've already sold it, you just book the earnings as it's delivered?

Like I said, it's a complicated transaction. It's not as simple as we just sold off the -- that part of the strip.

Okay, thank you.

Okay.

At this time, there are no further questions. Do you have any closing remarks?

I'd just like to thank all of you for your time, and any further questions that you have, don't hesitate to talk with Becky. We know this is a busy time and we appreciate your attention. Thank you very much.

We do appreciate you being on the call. Please do call me or Lisa Malagon if you have any questions. Thanks.

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