Pinnacle West Capital Corp (PNW) 2008 Q3 法說會逐字稿

Good morning and thank you for holding. My name is Bernice and I will be your conference operator today. At this time, I would like to welcome everyone to the 2008 third quarter earnings conference call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks there will be a question-and-answer session. (OPERATOR INSTRUCTIONS) Thank you.

Ms. Hickman, you may begin your conference call.

Thank you, Bernice. I'd like to thank everyone for participating in this conference call to review our third quarter earnings, recent developments and operating performance. We know this is a busy time for you, especially with the upcoming EEI financial conference. Today I have with me Bill Post, our Chairman and CEO, Don Brandt, who is our President and Chief Operating Officer and also President and CEO of Arizona Public Service, and our CFO, Jim Hatfield. 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 our Form 10-Q filed with the Securities and Exchange Commission this morning as well as the MD&A and risk factors section 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 refer to our ongoing earnings which is a non-GAAP financial measure as defined by the SEC. Our Form 8-K filed with the SEC this morning contains a narrative reconciliation related to our ongoing earnings outlook. 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 November 11. 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 the time to join us today. Before I turn the call over to Jim and Don to discuss the details of our financial results and operations, I would like to comment on two items. First, although it is election day, we don't have any preliminary data on today's Arizona corporation commission race. Although this has been the most contested commission race in our history no polling data is available. Second, as we explained to you in our last call, we continue to expect that our consolidated ongoing earnings will be within a reasonable range of $2.50 per share, with APS contributing substantially all of the earnings and SunCor's contribution being minimal. Now I'd like to turn the call over to Jim.

Thank you, Bill. For the third quarter, we reported consolidated net income of $152 million or $1.50 per share as compared with $209 million or $2.07 per share in 2007's third quarter. Net income was down $57 million or $0.57 per share with APS comprising a substantial majority or $0.45 of the total variance. Lower results at SunCor made up the remaining $0.12 of the difference. Earnings for third quarter of 2007 included tax benefits related to prior years of $10 million or $0.10 per share that did not repeat in this year's third quarter.

Now, I would like to provide some detail on the consolidated variance. On a positive note, APS retail sales growth added $0.06 per share. In the third quarter of 2008 APS customer growth increased 1.2% as compared to 3.2% a year ago. As expected, the decline in Arizona's economic conditions mirrors to a large extent what is happening in the national economy. But despite the recessionary climate, our customer base continues to grow, albeit at a much slower pace than in the past. We currently expect customer growth to decline to about 1% by the end of the year. Of course, it's difficult to determine the extent or severity of this economic downturn, but we currently do not anticipate a meaningful turnaround prior to 2010. Going forward, we remain confident of the long-term fundamentals of Arizona's economy and will expect to see customer growth return to the more vibrant levels as the national and state economic environments improve.

Transmission rate increases under the transmission cost adjuster approved by the ACC improved our quarterly earnings $0.07 per share. The earnings improvements were more than offset by several factors. First, weather reduced earnings $0.14 per share. This year's third quarter was relatively normal as compared to hotter than normal weather in 2007. To illustrate, cooling degree days were 6% less in 2008 as compared to 2007. Additionally, non-cash marked to market valuation of APS's fuel and purchased power hedges net of related PSA deferrals reduced earnings $0.17 per share. As a result of precipitous decline in natural gas prices in the third quarter from the steady increases we had seen in the first half of this year, the marked to market gains previously recorded this year through June 30 were completely reversed in the third quarter. Higher O&M costs decreased earnings $0.20 per share, related chiefly to higher customer service and maintenance costs for our distribution system and power plants, about $0.03 per share of the increases related to renewable energy programs. In addition, we recorded severance costs of $0.04 per share, primarily related to headcount reductions associated with pairing back certain construction related activities as a result of lower customer growth.

As Don mentioned on last quarter's call, the ACC approved APS's 2008 implementation plan for the state's renewable energy standard, or RES which provides up to $34 million for APS's renewable energy projects and customer incentives. These expenditures are recorded mostly in O&M expense, but are offset by revenues collected through a renewable energy surcharge. In 2008, through September 30, the RES related O&M was $18 million pretax. The decrease in SunCor's results was in line with our expectation in light of the current distressed national real estate and credit markets. SunCor recorded a loss of $0.06 per share in 2008's third quarter compared with earnings of $0.06 in 2007. SunCor's third quarter 2007 results included the sale of a large commercial property. On last quarter's call, we discussed a review of our capital expenditures that was underway. Our goal was to reduce our CapEx for the next three years by more than $500 million on top of the $200 million reduction announced in January. We have completed the review and are in process of implementing the reductions. We are further reducing our capital expenditures by some $720 million for the three-year period 2009 through 2011. Approximately 80% of these reductions relate to continuing slowing of customer growth while about 20% relate to delays of projects. As a result of these capital expenditure reductions, we expect the related line extension payments collected from new customers to decrease over the period by approximately $200 million. Net of these line extension effects, the additional capital expenditure reductions totaled $520 million. The projected capital expenditures have been reflected in our third quarter 10-Q which was filed this morning.

Now I will provide an update on liquidity and pension. As you know, the credit and liquidity markets experienced significant stress beginning the week of September 15. Pinnacle West and APS have been able to access existing credit facilities ensuring adequate liquidity. Cash on hand is being invested in money market funds comprising primarily of US treasury securities. Pinnacle West has a $300 million revolving credit facility that terminates in December 2010. APS has two revolving credit facilities totaling $900 million that terminate in December 2010 and September 2011. Additionally, we have no maturities of long-term debt until 2011. Our $1.2 billion of revolvers included combined credit commitments totaling $51 million from Lehman Brothers that are no longer available due to their bankruptcy filing. Therefore, our capacity under the combined revolvers was approximately $1.15 billion at September 30. On that date, Pinnacle West had approximately $167 million of short-term debt and APS had approximately $200 million of short-term debt outstanding, and Pinnacle West and APS had approximately $95 million of cash and investments at the end of the quarter. As a result, Pinnacle West and APS collectively had over $800 million in available credit capacity and cash at September 30. Conversely, SunCor's ability to consummate transactions in 2009 may be impacted by the lack of counter party liquidity if it continues. As a result of significant declines in the capital markets recently, several analysts have estimated the effects on corporate pension plans and the resulting expense of funding requirements.

In light of investor concerns, I will provide some information related to our plan. At the end of 2007, our plan was 82% funded compared with our projected benefit obligation or PBO. During 2008, we made a $35 million contribution. Adjusted for this contribution, our plan was 94% funded on a cash funded basis at plan year 2007 which is 2% over the minimum cash funded status required by federal law. Actuarial valuations prepared early each year which include the prior year end results. If the funded status were to fall below the required threshold, we could elect a seven-year amortization period to meet the funding requirements. Not surprisingly, our pension fund asset values have declined during 2008 as have most plan funds. In addition to fund asset value changes, the discount rate used for the actuarial valuation is updated each year based on the prevailing interest rates which have increased. An increase in the discount rate would mitigate a significant portion of any decline in the fund asset value. We expect to know the impact of the 2008 market activity on our 2009 pension expense and funding requirements early next year after the next actuarial valuation has been completed.

Lastly, while Bill mentioned 2008 guidance, I would like to touch upon the timing of 2009 guidance. We anticipate providing 2009 guidance when we hold our fourth quarter earnings conference call. At that point, we'll have more clarity on 2009 pension expense and we will have received the ACC decision in our interim rate case which we expect by year end. That concludes my prepared remarks. I'll turn the call over to Don.

Thanks, Jim. I'll begin with the regulatory matters. We have two significant matters pending before the Arizona corporation commission, both of which are critical to meeting the needs of Arizona's energy future. We have a general retail rate case pending at the ACC. We updated the filing on June 2 to reflect a test year ended December 31, 2007, the filing request and net increase in annual retail revenues of $278 million to become effective October 1 of 2009. The filing includes several proposed methods to reduce regulatory lag and resulting earnings attrition. We are currently in the discovery phase of the case responding to data requests. The next major procedural milestone will be the December 19 filing of initial written testimony on revenue requirements by the ACC's staff and other interveners. Thereafter, several sets of testimony will be filed by the parties to the case. The hearing on the general rate case is scheduled to begin next spring on April 2. Although progress is being made in the general rate case, we simply cannot wait until late next year for a decision on that filing.

As you already know, to address APS's financial condition during the intervening time frame, we filed the request on June 6 with the ACC for an interim phase rate increase until permanent rates become effective under the pending general rate case. The interim rate relief would provide critically needed cash flow and be a significant step towards shoring up our credit metrics and our earnings. The interim request asks for a rate increase of 4% which would increase annual pretax revenues by $115 million. The amount would be subject to refund depending on the eventual outcome of the general rate case. It is essential that the ACC grant this request to provide financial stability for APS and to ensure our investment grade credit ratings. Loss of APS's investment grade credit ratings would result in hundreds of millions of dollars of needless additional financing costs that would ultimately be born by our customers. The hearing on the interim request was conducted the week of September 15. The positions of the ACC staff and interveners can be summarized as follows. First, the ACC staff consultants generally do not recommend that the commission grant an interim increase. However, if the commissioners choose to grant an interim increase, the staff consultants recommend that they grant an increase in annual pretax revenues of $65 million. This amount was calculated based on the change in traditional rate base between September 30, 2005, and December 31, 2007, the test year end dates in the last rate case in the current case.

Although the staff consultants initially recommended that an equity infusion from Pinnacle West into APS should be required prior to such an increase becoming effective, based on evidence we presented during the hearing, staff determined that such a precondition was no longer appropriate. The residential consumer advocate, RUCO does not support an interim increase. A group of large commercial and industrial customers known as Arizonans for Electric Choice and Competition recommended a $42 million annual interim revenue increase beginning in January of 2009. The Arizona Investment Council and an intervener group of merchant generators both support APS's entire request. The final post-hearing briefs were filed October 8 and we are awaiting the recommended order from the administrative law judge. After the ALJ issues her recommendation, there's typically a ten calendar day period for filing exceptions. The commissioners will consider the matter in an open meeting some time after the exceptions have been filed with a decision expected before year end. As of September 30, APS had $58 million of accumulated PSA deferrals. We expect about half of that balance to be collected by this year end. With a strong enhancements to our PSA that were approved by the ACC last year, we're in a much better position with respect to fuel cost recovery than we have been in past years. With regard to transmission rates, I mentioned on our last call that the Federal Energy Regulatory Commission approved APS's transmission rate settlement including formula rate making. As such, we are well positioned at the federal and state levels to implement annual changes to our wholesale and retail transmission rates. The wholesale rates will be adjusted June 1 of each year, and we expect the retail rates related to transmission charges to be adjusted correspondingly a short time thereafter through our retail transmission cost adjuster.

Now I will turn to our recent operating performance. The Palo Verde units have been running very well. The combined capacity factor for the Palo Verde units was 97% during the third quarter, up from 89% in last year's third quarter. Currently units 2 and 3 are operating at 100% power. Unit 1 is in a planned refueling outage which is expected to be completed in the next week or so. As most of you know, Palo Verde has two refueling outages each year. The next refueling outages are unit 3 next spring and unit 2 next fall. We are making substantial progress on our site improvement plan and we're working closely with the nuclear regulatory commission at various levels to ensure that all issues are addressed. We're committed to returning Palo Verde to sustainable first quartile performance. We currently expect the NRC confirmatory action letter to be cleared and unit 3 to be moved out of column 4 of the NRC's oversight matrix by the end of next year.

Our coal fired plants continue to operate exceptionally. In the third quarter, the units operated at 94% capacity factor, which was essentially the same as a year ago. Our coal fired plants have consistently performed at a level that is substantially above the industry average and we expect them to do so again this year. Our strong commitment to renewable resources continues. In September, the ACC approved our participation in the Solana generating station. Additionally, Congress approved the extension of the federal tax credits for solar and wind generation. These steps move the 280-megawatt Solana plant closer to construction and lead the way toward future opportunities. Employees throughout our organization are focused on operational excellence. Over the Labor Day weekend, the metropolitan Phoenix area experienced several storms that unleashed heavy rain, hail, and winds comparable to a category 3 hurricane. No greater storm has hit the heart of Phoenix in the past 40 years. Initially, 80,000 APS customers were out of service. The APS crews' response to storm exemplified customer service excellence which garnered a very public thank from you the mayor of the City of Phoenix in the largest newspaper in our state. We work hard to maintain top notch customer service and continually strive to raise the bar even higher. That concludes our prepared remarks. Operator, at this point, we would be pleased to take any questions.

Thank you, sir. (OPERATOR INSTRUCTIONS) We'll pause just a moment to compile the Q&A roster. Our first question comes from Paul Ridzon, Keybanc. Your line is open, sir.

Thank you. The $720 million of CapEx cuts, I was a little unclear. Is that the $500 million plus the $200 million in January and an incremental 20 or is that an incremental $220 million?

No Paul, let's be clear about that, because that's a great question. Gross CapEx cuts were $720 million. But because some of those (inaudible) to collect less from the customer charge, the net impact CapEx reduction is $520 million.

Can you hear me?

Yes. Can you hear me?

So is it 920 less 200 --

-- $200 million. Hello?

I'm sorry, is it $920 million less $200 million of line collections?

No, it's $720 million, less $200 million of line connections for a net CapEx reduction of $520 million, and that would be in addition to the $200 million that was announced late last year or early this year.

Okay, it's in addition to the $200 million.

Yes.

Where does that -- given that you have materially exceeded the $500 million, where does that put you with regards to flexibility on your equity issue?

Well, I think, again, part of our plan was the reductions in conjunction with interim relief and rate relief as requested at the ACC, so I think we're certainly not looking at the need for equity this year, and certainly, probably not in 2009, we won't get an order until late in the year, which will ultimately determine what, if anything, we need to do.

Okay. So we could be looking at a '10 issuance.

At the earliest would be 2010.

Thank you.

Next question comes from Dan Eggers from Credit Suisse.

Good morning, afternoon, depending on the time zone. Just following up on Paul's question, the $520 million was '09, '10, and '11 CapEx, right?

Correct.

So are you all going to give your '11 CapEx numbers at you analysts day since the Q only goes through '10?

Yes.

Okay, got it. How are you guys -- as you think about a slowing customer count, usage trends, what do we think about for O&M cost inflation over the next couple years? Do we see that come down as customer growth comes down, or can you guys manage it that dynamically?

Well, I think obviously, with the reduction in customer growth, that's going to drive some reduction in O&M related, if nothing else, just to the reduction in customer growth. I think if you think about O&M going forward, you have, obviously, what happens to pensions, what happens to consumables, will all be into the mix in terms of where our O&M ultimately ends up going forward.

So that's still a work in progress.

Yes.

I guess you talk about a less vibrant backdrop for recovery. How do we think about customer growth? How do we think about usage patterns in 2009, 2010?

I think right now we're still looking, we think we'll be decelerated down to about 1% customer growth end of year. I think that is the trend we see for '09 and '10. We're right now, we're really not seeing any sort of degradation of per customer use. If you look at the third quarter, residential customer use, weather normalized, it was 0.007% increase per customer. So I think we're really seeing it more on the aggregate customer count than we are seeing it on the usage side.

Great. Thank you.

Our next question comes from Jonathan Arnold, Merrill Lynch.

Good morning, guys.

Good morning guys.

Good afternoon, excuse me. I'd like to ask on SunCor, I apologize for being in and out, but I believe that the loss was $0.06 for the quarter, and you have talked about having minimal contribution. Is $0.06 a quarter kind of where the business is tracking on a run rate type basis and you sort of make up the difference through some lumpier sales during the quarter of a year, or how should we think about that and how does it relate to where you expect it to be at this point? How much more can you do to trim those ongoing losses?

Jonathan, let me talk about what we've done on the G&A front. We've substantially reduced staffing and expenditures down to -- compared to this year, next year we'd expect about $2 million a quarter less of G&A. But with that said, one impact we're seeing is liquidity in the market and their ability, SunCor's ability to transact. We had a large transaction in the second quarter, an office building. We don't have anything like that planned, but we do have plans for, I'll call it more normal run rate type of transactions that early indications are the lack of liquidity in the market is going to constrain the ability to -- for buyers to close on those transactions. And that could have a negative impact next year.

Does the $0.06 from this quarter include having trimmed back G&A by a couple of million?

Yes.

Is there any kind of reason we wouldn't assume a $0.20 or so loss next year?

Well, we'll address that when we do guidance in January on our fourth quarter earnings conference call, but I don't think the $0.06, because it's in this quarter, is representative of what we'll see --necessarily representative going forward next year. Again, the quarterlies with SunCor tend to vary on what transactions we have in each quarter. They tend to be lumpy. We don't expect it to be as lumpy next year as it was, for instance, in the second quarter from a positive perspective. But --

All right, thank you.

Our next question comes from Paul Patterson, Glenrock Associates.

Good day, guys. How are you?

Hi, Paul.

The O&M increase, I wasn't clear, it looked like it was because of customer service expenses, and I think you were addressing this earlier, and I guess I didn't completely get it. With the customer growth really being as low as it is, for you guys, 1% seems historically very low. Why is O&M increasing for customer service expenses and what's driving that?

I think you have, if you think about just some of the abnormal drivers this quarter, you have the severance that we talked about, which is $6 million, and that's really related to the CapEx reductions to growth. You have about $3 million in storm related costs, the Labor Day storm that Don mentioned. We have an increase in collectibles, then we have just some consumable cost increases, so I guess I would say that of that, you have some that's more impacting the quarter than would be normally from a comparison perspective.

So customer service I guess is a pretty broad area.

Yes, and that includes the collection, billing, call center to the wires business, as we call it.

Okay. And then the trading and marketing, the margins fell off a bit there. Anything more you could elaborate on that?

Nothing specific related to marketing and trading.

Okay.

As you know, it's not a big focus for us.

Right. And then, I'm sorry if I missed this. You guys mentioned the -- when do you expect ALJ to come out with their ruling on the interim rate case?

We're waiting for that now. We would expect it in the not too distant future, and as I mentioned, we would expect the open meeting to occur in a commission decision before year end.

So it could it happen any time now I guess.

Yes.

Okay, thanks a lot.

(OPERATOR INSTRUCTIONS) Our next question comes from Paul Ridzon, Keybanc.

Did SunCor include any severance costs?

No, the severance I mentioned was totally related to APS.

Okay. Is there any severance opportunity at SunCor, or have you scaled that back already?

We've been scaling it back over the last 18 months, almost two years, so there's severance built in there, but it's been not in any one particular quarter.

Thank you.

Our next question comes from Ted Heyn with Catapult Capital.

How are you doing?

Good, how are you?

Good. Just a quick question on the O&M tracking for the year. I think at the beginning of the year, Don, you said $40 million. I know that there's the renewables, things running through there too, but I think even if I back that out, it looks like you are still at over $50 million for the year so far.

Right.

Is there going to be a reversal in the fourth quarter? Is there less planned maintenance?

The fourth quarter will be essentially flat, we say about $50 million. What Jim mentioned, the severance costs are about $6 million, $7 million, and the storm costs were about $3 million in the third quarter, and uncollectibles, charge-offs, that's much of a reflection of the economy, about $2 million to $3 million. So that's basically the difference you are seeing, Ted, compared to the 40 that I talked about earlier in the year.

So a couple of cats and dogs year to date, then it should be flat for the rest of the year.

Exactly. The fourth quarter is literally flat, as we're seeing it now.

Got you. And just to clarify on the CapEx again, I'm sorry, I got a little mixed up there, but at the beginning of the year, you guys announced the $200 million reduction, and then on the second quarter call, you said you were aiming for $500 million plus. So what's the net impact for the entire year now? Is it the net impact of the 720? Is that right?

Well, the $200 million was looked at earlier this year, began to put in place. I think that was reflected in the Q earlier this year. Second quarter call, we talked about a goal to reduce the additional $500 million. We ended up getting $720 million gross. $200 million of that is also going to be a reduction of impact fees from customers. So net additional reduction CapEx is $520 million. Those numbers are 2009 to 2011.

Okay, and how much of that is falling into the '11 time frame versus '10 and 11 -- or '09 and '10? Is that something you are going to talk about at the --?

He we'll talk about that Friday. We'll take that by year.

Got you. Okay, thanks a lot.

Our next question comes from Yiktat Fung, Zimmer Lucas Partners.

Good morning.

Good morning.

Just a quick question about pension expense. How much of your pension expense is at the utility, and are those expenses recoverable in rates?

Your first question was how much. It's like 94% of total, pension is really at APS. Of the pension expense, about 50% is ultimately capitalized in the plant. The rest has typically been recovered in rates.

Okay. That's all my questions. Thank you.

Thanks.

Our next question comes from Danielle Seitz, Seitz Research.

Hi. I just was wondering, assuming the interim is going to be voted by the new commission, new members, or just the remaining members attending the hearings.

Danielle, we believe it's going to be decided before the end of this year, which would be the existing members.

Okay. And assuming it's really on the very low side of what your expectations are, would you -- would that change anything to your financing schedule, from the point of view of new equity? Would that make a difference?

No, Danielle. I think, again, if you think about the ultimate, we still have -- this is just one part of the base rate increase, which is a late '09 event. So I think we're ultimately got to see where we end up at the end of the day before we make those decisions.

Thank you.

Our next question comes from Paul Ridzon, Keybanc.

Just a follow-up to Ed Heyn's question. With O&M $10 million over budget but guidance maintained, what are we seeing as the offsets?

I guess from an offset perspective, I guess the original range of around 250 that Bill reemphasized for '08 would include the higher O&M. There's many things that go into that guidance, and I don't think you can just point to O&M as the only thing impacting 2008. If you look at where we are for the year, we're at $2.78. If you take out the $0.30 tax benefit, we're at $2.48. Last year I think we made about, slightly positive net income in the fourth quarter, so that would still get you the $2.50, all things equal.

Thank you.

(OPERATOR INSTRUCTIONS) We have no questions in queue.

Thank you. This is Becky. Thank you for joining us today. On our call, a couple of people have mentioned our analyst meeting on Friday. Those slides will be posted on our website and filed with an 8-K Friday morning. So for those of you who are not able to be with us, they will be there. With respect to those who will be able to be with us or who will be attending the EEI Financial Conference in Phoenix next week, we look forward to seeing you. Meanwhile, if you have any questions or need further details, please contact me or Lisa Malagon, and thank you for calling in.

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