Pinnacle West Capital Corp (PNW) 2009 Q3 法說會逐字稿

Good afternoon. I'll be your operator. At this time I would like to welcome everyone to the Pinnacle West third quarter earnings conference call. (Operator Instructions) Thank you. Ms. Hickman, you may may begin your conference.

Thank you, Kim. Good morning I'd like to thank everyone for participating in this conference call to review our third quarter earnings, recent developments and operating performance. Our speakers today will be our Chairman and CEO, Don Brandt, and our CFO, Jim Hatfield. Don Robinson, who is President and Chief Operating Officer of APS, is also here with us.

Before I turn the call over to our speakers, I need to cover details with you. First, I encourage you to check the quarterly earnings and 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 will be after income taxes and based on diluted shares outstanding. Third, we will be referring to slides today during this conference call and webcast. The slides are available on our Investor Relations website with the webcast and with the 8-K filed this morning. During our prepared remarks we will give you verbal cues as we move through the slides.

Looking at slide two, it is my responsibility to advise you that this call and our slides 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 our forward-looking statements and MD&A sections contained in our third quarter 2009 form 10-Q which was filed with the SEC this morning as well as the risk factors section of our 2008 Form 10-K all of which identify important factors that could cause actual results to differ materially from those contained in our forward-looking statements.

Next, during this call, we will discuss certain non-GAAP financial measures. Our press release and the slides accompanying this webcast which are posted on our Investor Relations website contain additional disclosures regarding these non-GAAP measures including reconciliation of these measure to the most comparable GAAP measures. 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 6. Finally, this call and webcast are the property of Pinnacle West Capital Corporation and any copying, transcription, redistribution, retransmission or rebroadcast of this call in whole or in part without Pinnacle West's written consent is prohibited. At this point, I'll turn the call over to Jim.

Thank you, Becky. As shown on slide four, I will cover the following topics today. First, I'll review third quarter results for Pinnacle West Capital Corporation and discuss the main variances from last year period. I'll briefly touch upon the economic outlook in Arizona. I will review our earnings guidance for 2009 and 2010, and I'll close with a brief comment on liquidity.

A reconciliation of our GAAP EPS to our ongoing EPS is shown on slide five. As you know, we've excluded the real estate segment from our ongoing earnings because of the major restructuring under way at SunCor and the implications for that business moving forward. Don will provide a brief update on the SunCor restructuring in a few moments.

In terms of results, we reported on a GAAP basis consolidated net income attributable to common shareholders of $186.7 million or $1.84 per share in this year's third quarter as compared with $151.6 million or $1.50 per share in 2009's third quarter. I will continue to focus my remarks on our ongoing earnings which exclude results from the real estate segment from both quarters as well as severance cost in last year's third quarter. Consolidated ongoing earnings in the third quarter, a non-GAAP measure, were $199.1 million or $1.96 per share compared with $161.1 million or $1.59 per share in the prior year period.

Moving to slide six and the variances that make up the change to ongoing earnings per share. First, gross margin at a regulated utility was $0.39 per share better than last year's quarter. Embedded in this variance are several pluses and minuses which I'll cover in more detail on the next slide. Also benefiting financial results in this year's quarter by $0.08 per share was lower O&M. Essentially, O&M was lower all across the utility segments. This was related to the effects of our cost savings measure and timing, and we will continue to focus on discipline cost management. These changes in gross margin in O&M excludes dollars to the renewable energy standard, or RES, and our demand side management and energy efficiency programs. These costs are collect and offset through respective rate surcharges.

You may find it useful to the refer to the appendix in today's slides to find the amount of RES and DSM revenues recorded by quarter over the last couple of years. Other items net as a result of many various factors none of which were significant. And, lastly, higher expenses related to infrastructure additions and improvement reduced our earnings for approximately $0.14 per share in this year's quarter. The major components of that change were interest net of capitalized financing cost $0.09 per per share, property tax $0.03 per share, depreciation and amortization $0.02 per share. So in summary, ongoing earnings increased by $0.37 a share driven in large part by higher gross margins.

Turning to slide seven and the drivers of the net increase and regulated electricity gross margin, as shown on the last slide the regulated gross margin was up $0.39 per share compared with last year's third quarter. The various factor contributing to the variance are retail rate increases favorably impacted our quarterly results by $0.17 per share. Of this amount, $0.13 per share related to the interim rate increase that became effective at the beginning of this year and the remaining $0.04 per share relate to the 2009 transmission rate increase that went into effect June 1 through our FERC formula rates and August 1 through our retail transmission cost adjuster.

Volumetric effects related to weather improved our quarterly results $0.05 per share. July was the hottest on record. In fact, it was the hottest month ever recorded in Arizona with an average temperature of 98.4 degrees. The benefits from July's extreme weather were partially offset by lower than normal humidity throughout the quarter, particularly in September. By comparison, last year's third quarter was slightly milder than normal. However, our quarterly results were negatively impacted by $0.04 per share related to lower weather normalized kilowatt hour sales after netting the impacts of customer growth and customer usage.

In this year's third quarter, APS customer base grew 0.6% as compared to 1.2% in 2008 third quarter. However, overall weather normalized retail sales were down 1.3%. Weather normalized residential sales were up 0.8% in the quarter with a majority of the reduction coming from the effects of the ACC approved energy efficiency and demand side management program. This represents some improvement from last quarter but it is reflective of the softness as the Arizona economy and customer conservation. I'll provide more color on the state of our economy momentarily.

The non-cash mark-to-market valuation of APS's fuel and purchase power hedges net of PSA deferrals was better by $0.22 per share compared with a year ago. The major factor driving this variance was the reversal of $0.17 per share of negative mark-to-market from last year's third quarter driven by plummeting natural gas prices during that period. In this year's quarter with more stable but somewhat rising natural gas prices, we recorded a positive mark-to-market of $0.05 per share. For you're reference, our mark-to-market amounts by quarter for the past couple years are shown on slide 12 in the appendix.

Looking at the Arizona economy and our fundamental growth outlook, we currently expect customer growth to average 1% annually through to 2011. Additionally, we expect our weather normalized retail sales in kilowatt hours to be relatively flat through 2011 due to the impact of the national economy, the housing situation in Arizona and the effects of APS's energy efficiency programs. In the near term, the Arizona economy has to deal with a substantial excess inventory of unsold homes and apartments. The excess of housing inventory must be reduced in order to allow a sustained recovery in the construction sector and the broader economy. This situation is a principal reason for a moderate outlook for near-term growth.

Customer research we conducted this summer suggest that the decline in residential usage this year over and above energy efficiency efforts were significantly tied to the recessionary economic conditions and the related uncertainty. That said, it does appear that the economy has stabilized. We have seen some slight uptick in housing prices in metro Phoenix and projections of non-farm payroll growth in 2010 is expected to be flat to slightly positive. Over the long term, we remain confident of Arizona's fundamentals. Therefore, we have an expectation that customer growth and usage will return to levels as the national and state economic environment improves.

Turning to our earnings outlook on slide eight. Our earnings guidance for 2009 and 2010 has not changed. We continue and expect that our ongoing earnings for 2009 will be within a reasonable range around $2.30 per share. In 2010, we continue to estimate that our consolidated earnings will be within a reasonable range of $3 per share. For your reference, the assumptions underlying our 2009 estimate are in the 8K we filed this morning.

Before I turn the call over to Don Brandt I want to give you a quick update on our liquidity, although I don't have a slide on this topic. Simply stated, we have ample liquidity. As of September 30, Pinnacle West and APS collectively had about $1.1 billion of available liquidity after considering cash on hand and short-term debt outstanding. We completed our long-term financing for 2009. Additionally, we don't have any long-term debt maturities outside of SunCor until 2011. Our revolving lines of credit mature in late 2010 and 2011 so liquidity remains very good. And, with that, I have concluded my prepared remarks. I'll turn the call over to Don.

Thanks, Jim. I'll cover several issues that are important to our investors. Jim has already touched on one of those issues, our growth in the Arizona economy. I'll update you on a few more. Pending regulatory settlement, our commitment to renewable resources, our operating performance and the SunCor restructuring. Regarding our pending settlement, the proposed regulatory settlement before the Arizona Corporation Commission demonstrates positive movement in Arizona's regulatory environment. A near unanimous settlement it is supported by 22 of the 24 parties to APS's retail rate case. Only one party filed opposing testimony and that testimony was limited to objections to the lack of free footage allowance in APS's line extension policy.

In addition to a very small net rate increase, the settlement offers a wide array of benefits for all our customers, our shareholders and other stakeholders. The proposed settlement would only increase our average retail electricity prices by less than 1% over current rates after reflecting an early reset under the power supply adjuster. Besides the financial provisions, the settlement includes a number of provisions benefiting Arizona including rate stability for APS customers, expanded renewable energy requirements for APS above the Arizona Corporation Commission's current requirements and significantly expanded energy efficiency programs. It is critical, however, for the settlement to be approved as proposed so that our customers, investors and other stakeholders may realize the diverse benefits intended by all the settling parties.

On our last two calls, we described the benefits in major financial provisions of the settlement. Rather than prepare remarks in those details again, we've outlined them on slides 13 through 18 in the appendix section of our quarterly slides. Of course, we'd be pleased to answer any questions during the Q&A session on those slides or any others.

The hearing on the settlement was completed on September 18. Going forward, we currently expect the administrative judge to issue her recommended order in mid November. That timing would allow the five ACC commissioners to consider and vote on the settlement in December. Consequently, new rates could become effective on January 1, 2010, as the settlement proposes.

Turning for a moment to renewable resources and operations, our commitment to renewable resources remain significant. In the pending regulatory settlement we have agreed to acquire an additional 1.7 million megawatt hours of new renewable energy resources to be in service by the end of 2015. This increment would be above the resources and commitments we had at the end of 2008. With the new additions, we system renewable resources will supply about 10% of APS's retail sales by the end of 2015 which would be double the amount currently required under the ACC's renewable energy standard.

We remain strongly committed to solar energy. Future projects likely will include various size utility scale plants as well as distributed energy. We are on track with our plans to significantly increase the amount renewable energy we provide to our customers, and just yesterday at a conference in Anaheim, California, the Solar Electric Power Association named me as the utility COE of the year. While it was my privilege to accept that award on behalf of all the employees at APS, it had very little to do with me personally. The award was recognition of the accomplishment and vision of the APS renewable energy team which I think is one of the best in the industry.

Looking at our operating performance for a few moments we are focused on operational excellence. We are recognized for top notch customer service and fossil plant performance. Further, we continually strive to achieve top performance throughout the organization constantly seeking to improve performance in every facet of the Company. On power plant operations, the Palo Verde units have been running well. All three units ran at 100% for the entire third quarter. On October 3, we started a unit 2 refueling and maintenance outage. This is the first unit in which will be replace the vessel head and install our rapid refueling package. The outage, which is expected to last about 60 days, is progressing well. We plan to make similar replacements and refueling package installations during the unit 1 and unit 3 refueling outages in 2010. The Palo Verde team remains focused on achieving safe, sustainable first quartile performance in all aspects of the plant's operations. We are making progress on meeting our established long-term targets to consistently achieve annual site average capacity factors of 88%, refueling outages of 30 days or less, and production cost below $0.02 per kilowatt hour.

Now I'll turn to the SunCor restructuring for just a few moments. The plan announced earlier this year involves the sale of a substantial majority of SunCor's properties. Execution of that plan is underway. SunCor's long-term debt was reduced to $121 million as of September 30 from $175 million at the end of the first quarter this year. SunCor continues to pursue the sale of its remaining properties. SunCor's principal credit facility matures in January of 2010. SunCor is current on all its debt payment obligations under that agreement. There are financial covenant defaults existing as to the banks have taken no enforcement action. SunCor is in discussions with its lenders concerning a proposal. SunCor has made for a replacement facility that would allow the Company time to complete the restructuring plan.

Looking ahead through focused strategies and sound execution, we'll continue to move this company forward. Additionally, we are committed to improving our earnings and financial metrics and thereby sustaining both our credit ratings and our common dividend. We are keenly aware of the vital importance of our dividend to our investors and, thus, to our ability to attract equity capital in 2010 and future years. That concludes our prepared remarks. Operator, at this time we'd be pleased to take any questions.

(Operator Instructions) Your first question comes from the line of Daniel Eggers from Credit Suisse. Your line is now open.

Hi, guys. How are you today?

Hey, Dan how are you. Congratulations on the (inaudible)

Thank you. On the quarter I guess on the outlook on renewables, can you talk a little bit thought process to hit the 15% target how you guys see your ownership role going forward given the most recent RFT cancellation by what might seemed like a pretty creditworthy winner?

I'll let Don Robinson expand on it but first we don't really see the Lockheed cancellation. It's a bump in the road. As a matter of fact, we have a number of plans to backfill that. Just recently we filed with the commission as part of the renewable energy standard program we call Arizona Sun that would involve us investing $500 million in a variety of different [PV] projects going forward, and that would involve an APS ownership structure.

And, Dan, this is Don Robinson. To add to what Don just said. We have other RFPs on the street as part of this process and not surprisingly we have also heard from everybody and their brother after the Starwood cancellation announcement who wants to talk to us about doing more projects. I think it is fair to say that as we go forward, we will be looking at a number of different projects and a number of different ownership structures because we don't intend to just do PPA's on new renewable projects as we go forward.

Can you give a little more color on the Arizona Sun project as far as what is going to be the approval process out of the commission to what you guys or have you guys spend that money and how do you envision recovery, will it be your traditional base rate cases or some other mechanism?

Dan, we filed an application with the commission asking for their approval. It would be the normal process. They could either choose to have a hearing on it. They could choose to make a decision based on just the filing of documents. I doubt that would be the case. And then we do believe that we would recover the cost through any number of different recovery mechanisms. We could have an adjuster but more likely we could also put it in base rates which I think would be the more likely option.

What is the timing do you suppose at this point for a commission action on the application and realistically when do you guys envision the opportunity to start spending money?

Dan, as you know, that's a really hard call with the Arizona commission because this is a subject they are very interested in but they don't have defined terms for how quickly they act on things. So I suspect this is something they want to get involved in. So I expect sooner rather than later but I would be guessing on an actual date. We haven't heard anything from them that would indicate a specific time they were going to take it up.

And then on the 1% customer growth that you guys cited, is that, with the population or housing inventory of about 30,000 homes in your service inventory in the Phoenix area, is that 1% growth effective uptake of those empty homes largely and then a new construction cycle or would that be added to the takeup of homes?

The 1% would be consistent with the growth I think would be consistent with growth for Arizona population generally speaking, and while there may be some new construction, it's really going to be continue to absorb the current housing inventory over the next couple of years. We don't really see economic activity picking up until 2012.

Are you seeing any uptick in new home construction right now?

Not really. Permits are down. Starts are down. We are not going to see an uptick in activity until you get a significant reduction in the inventory.

Okay. Thank you guys.

Thank you, Dan.

Your next question comes from the line of Paul Patterson from Glenrock Associates. Your line is now open.

Good afternoon, guys, or good morning there. How are you?

Real good, Paul. How are you?

Okay. I have a clarification question. I'm looking at the data in your 8-K regarding electricity demand and growth and it looks to me like you had an increase in customer growth of 0.6%. It looks like the retail usage average per customer has increased, I'm talking about residential here, and yet the weather normalized retail sales are down for the residential customer class. What am I -- ?

Well, Paul, I think it's true use per customer went up on an annual basis. Weather impacted that data, if you look at use per customer for residential on a normalized basis, we do see a reduction in usage of about 1%.

Okay. So the retail usage is not weather normalized. The use age per customer isn't weather normalized?

Correct.

Okay. And then back to sort of this question about -- so you guys, are you still seeing flat like, you are not seeing any significant growth at all through 2011. Is that still the forecast?

That's correct and that's been incorporated in 2009 guidance as well. I will say while we see some customer growth pickup, we are seeing it, are expected to be pretty much offset with the energy efficiency programs that will continue to ramp up over the near term.

You guys seem to be very successful in this. What are the, is there a specific type of equipment that you are using that is causing this? What is the big cause for the big decrease in usage with these efficiency programs? Is it CFLs? What is it that is causing this? Because if you think about the growth in customers and those vacant houses you would think that the usage would go up significantly.

We think there's a fair amount of low hanging fruit on the energy efficiency side, Paul, and it's really some of the initial programs aren't that complex. It's weatherproofing homes, duct work, ceiling. There are very few basements here. Most of the heating and air conditioning duct work goes through the attic, sealing that up and replacing furnace filters and the CFL program, how many millions of CFLs have been deployed in our service territory over the last two years.

Okay. So normal, so basically the normal growth would be -- without this program you would be seeing how much growth I guess?

Well, typically we'd see about with 1% customer growth, we'd see slightly less than 1% sales growth on a more normalized basis. The effective energy efficiency in the quarter was 0.6%. So with 0.8% usage reduction, you are still seeing a little bit of what we call the fear of the economy which is consistent with the survey we did in the third quarter to customers.

Okay. Thanks a lot guys.

Yes.

Your next question comes from the line of Christopher Ellinghaus from Shields and Company. Your line is now open.

Hi, everybody. How are you?

Good. How are you, Chris?

Don, can you give us any more color on what has been achieved with SunCor's asset sales at all?

Well, we closed early in the summer on the large condo building in the Tempe Town Lake project we call Hayden Ferry Lakeside. Also, we sold a large block of land late summer to the Arizona Department of Transportation for a major new interchange in the West Valley, and we are in negotiation process on several other large parcels of land. Actually, the SunCor team in this process has exceeded my expectations. They've exceeded the plan we laid out for the bank group earlier this year, and there is still a lot of work to be done in a very difficult market that is clearly not getting any better but, with that said, we've been producing results and I think we'll continue to do so.

Has your expectation on reducing the debt by year end changed at all?

It will be contingent on what actually gets closed by year end but I don't think a year end date, December 31 in and of itself, is a great significance other than it's the end of the year, but we are targeting to get a lot done by year end.

Okay. Great. Thanks so much.

Your next question comes from the line of Daniele Seitz from Dudack Research. Your line is now open.

Thank you. I was wondering, it seems that the commission was discussing or pondering on giving you some incentives regarding nuclear operations based on a certain level of capacity factor. I was wondering if that was finalized and if you are getting positive added rewards for doing better than actually the threshold?

Daniele, this is Don Robinson. What the commission actually did as a result of our last rate case, they were looking at doing nuclear performance standards at a meeting that they had earlier this week. The commission approved an order that requires us to report standards and it is strictly reporting. There is no monetary penalties or rewards for performance, it is strictly a reporting requirement.

Okay, and what was the -- I guess that you have to maintain. I'm assuming it's an average for the year?

Daniele, I don't remember what that number is, but I can get you that.

It has no major impact, it shouldn't have had any impact?

There's not a monetary penalty or reward that goes with it.

Okay, great. And I was wondering also, I thought that you were contemplating a potential addition to the nuclear units, and I was wondering what is the long-term scenario for that.

Daniele, all we have done is when we filed the resource plan at the beginning of the year we identified that there was the potential that we might need additional base load capacity in the 2022, 2023 or beyond time frame and all we said we were going to do is potentially keep the option open for doing nuclear. We have no commitment of doing nuclear at this time nor we will without the support of the commission and everybody else who is involved. The only thing we would be potentially doing is looking where we might site a plan. So there is nothing happening of substance in that arena.

And I mean, you probably have partners in building the plant or this is too far away to even think about it?

Daniele, I think -- this is Don Brandt. I think it is too far away. More is happening potentially in Washington regarding what the nuclear renaissance and what is happening here and we have to see how it develops on a national basis before we can begin to treat it with any substance out here beyond just staying apprised of developments.

Thank you. I appreciate.

Your next question comes from the line of Brian Chin from Citigroup. Your line is now open.

Hi. Good morning, you guys.

Hi, Brian.

When you had your guidance for 2009, did you include mark-to-market swings in that guidance because when I look at your slide 12, there's a big mark-to-market reduction in third quarter of 2008. So I wonder whether you thought that that might reverse into 2009 and incorporated that into your guidance.

We did, Brian, include the mark-to-market swing and the gross margin outlook, and we did have a slight mark-to-market gain in that number which is mostly reversals of the second half of last year when prices were escalating and we were recording negative mark-to-market.

Okay. Great. And then secondly on the solar announcement that you guys had just in the last few days which I think was for 100 megawatts, the contract that was canceled was for 300-megawatts, the Lockheed contract, so if I recall correctly, that PPA that was canceled was necessary to get your RES standard sort of requirement met. Would it be fair to say that since the most recent announcement the 100-megawatt that is we will hear more announcements from you guys over the next year or so? Is that the right way to think about it?

Brian, first, this is Don Robinson, let me correct that. The contract was canceled would have put us well above the standard that we were required to meet. It has been our intention to exceed that standard. Having said that, we are continuing to evaluate every day potential new opportunities in the renewable arena. So new announcements over the foreseeable future are certainly likely because as Don said in his remarks we are committed to renewables and solar is our renewable option.

Great. I appreciate that. Thank you.

Our next question comes if the line of (inaudible) from (inaudible) Capital. Your line is now open.

Thank you. Hi. I am just trying to get a sense of 2011 earnings directionally from 2010 and with the sales growth flat I guess you get a little help from pension in the line extension fees from the settlement. I am just wondering if there's anything else that helps you overcome higher D&A, O&M and dilution to kind of keep earnings flat or drive them higher?

Scott, this is Don Brandt. We are not going to touch on 2011 earnings today.

Okay. Are there other things in the settlement that I'm missing? Because the settlement you laid that out, right?

That would be incorporated in the settlement, yes.

Okay. Thank you very much.

(Operator Instructions) Your next question comes from the line of Kevin [Fallon] from [Blenheim] Capital. Your line is now open.

Hi. I wanted to get some clarification on the requirements under the settlement for issuing equity. The $700 million, are you required to put $700 million of new equity down into APS by 2014 under the settlement or do you guys have discretion along those lines?

The settlement calls for $700 million of the new equity into APS by 2014.

Okay. So you would have to put $700 million of new equity down there.

Correct.

And conceptionaly with the renewable program, if this, are there limits on what you are willing to do from investing your own money in this stuff along the lines of resolving the regulatory lag issues? In other words, if you have to go through base rate case-type situations, will you still make those investments?

Well, obviously, Kevin, we would have to evaluate the impact of potential regulatory lag to the extent you recover other mechanisms along the way would help that. I think from a rate base perspective, we have a significant negative impact on PPAs on our financial metrics with rating agency. So I think we've been fairly clear that the PPA model is not sustainable for us going forward with our credit rating. So we would welcome the opportunity, rate base renewable projects, if the project is right.

But do you think that the state is likely to step up and give you some more of a forward-looking type of mechanism so you are not going to be in the same type of situation with your existing investments?

I can't really project what the state is going to do. I think if you look at the settlement there's a lot of positive in that. We will certainly try to do that at some point, but at this point that's an unknown here in Arizona.

Kevin, let me add, too. It's somewhat pointless to speculate on what mechanisms might be employed in the future from a rate making relative to the renewables or solar energy. We at APS are committed toward that. It is a policy objective of the Arizona Corporation Commission and so both APS, our customers and the commission headed in the same direction together to resolve the tactical issues involved with deploying solar.

Okay. Thank you.

(Operator Instructions) There are no further questions at this time. Ms. Hickman, I will turn the call back over to you.

This is Don Brandt. Let me wrap it up and thank you all for taking the time. I'm sure you have a busy afternoon or morning wherever you might be and we look forward seeing many of you next week at EEI and travel safe to Florida. Thank you.

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