Pinnacle West Capital Corp (PNW) 2010 Q2 法說會逐字稿

Good afternoon, my name is Michelle and I will be your conference operator today. At this time I would like to welcome everyone to the second-quarter 2010 earnings 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)

Ms. Hickman you may begin your conference.

Thank you, Michelle. I would like to thank everyone for participating in this conference call and webcast to review our second-quarter earnings, recent development 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 a few details with you.

First, the slides we refer to today are available on our Investor Relations website, along with the webcast, the Form 8-K filed this morning, supplemental information on our earnings variances and quarterly operating statistics and our earnings release. The slides contain a reconciliation of certain non-GAAP financial information. Please note that all of our references to per share amounts today will be after income taxes and based on diluted shares outstanding.

Also, 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 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 forward-looking statements contained in our second-quarter 2010 Form 10-Q, which was filed with the SEC this morning as well as the MD&A section, which identifies risks and uncertainties that could cause actual results to differ materially from those contained in our forward-looking statements.

A replay of this call will be available on our website www.pinnaclewest.com for the next 30 days. It will also be available by telephone through August 10.

At this point I'll turn the call over to Jim.

Thank you, Becky.

The topics I will discuss today are outlined on slide four. First, I will review the consolidated quarterly results and discuss the main variances from last year's corresponding quarter. Second, I will provide a brief update on the status and outlook for the Arizona economy. Then I will discuss our earnings guidance for 2010 and 2011, and finally I will close with a brief comment on our liquidity and financing.

Slide five summarizes our reported and on-going earnings for the quarter. On a GAAP basis for this year's second-quarter we reported consolidated net income, attributable to common shareholders of $115 million, or $1.07 per share, compared with net income of $68 million or $0.68 per share for the prior year's second-quarter. From an on-going earnings perspective, results for the quarter increased $0.08 per share compared to the 2009 quarter. Specifically, for the 2010 second-quarter, we had consolidated on-going earnings of $90 million or $0.83 versus $76 million or $0.75 per share for the comparable quarter a year-ago.

A reconciliation of our second-quarter GAAP EPS to our on-going EPS is shown on slide six. The amounts for both quarters exclude results related to our discontinued real estate segment, and our district cooling operations, which were sold in the quarter. On slide seven, I provided a few details about our discontinued operation.

In the second-quarter, we made significant progress on SunCor's major restructuring that was launched in early 2009. With sales of a number of properties closed successfully during the second-quarter, and in July, SunCor has reduced its outstanding debt to about $6 million. We currently expect to complete the restructuring within 12 months. So the entire real estate segment is now classified as discontinued operations. As a result of the SunCor restructuring we estimate the parent will realize approximately $110 million of cash tax benefits by the spring of 2011.

On June 22, APS Energy Services sold its district cool business. The sale further signified our strategy to streamline our business and focus on our core utility operations. Financially the sale resulted in a gain in the quarter of $25 million and produced after-tax cash proceeds of about $70 million. In the remaining second-quarter earnings comments I will focus on our on-going results.

If you move to slide eight, you will see the variances that drove the change in quarterly on-going earnings per share. First, an increase in our Regulated Electric segment gross margin added $0.10 per share compared with the prior year second-quarter. Several pluses and minuses compromised this net variance and I will cover these items in more detail on the next slide.

Second, lower operations and maintenance expenses improved earnings by $0.04 per share, reflecting a number of costs affecting these efforts across the organization. This change in O&M, of course, excludes expenses related to the Renewable Energy Surcharge, or RES, and our demand-side management and energy-efficiency efforts, because those costs are offset by respective rate surcharges. We have provided the amounts of the pre-Tax RES and DSM revenues, that were recorded in the quarter over the last couple years in the appendix to today's slides.

Our Company-wide emphasis on cost effectiveness continues to be a major focus. I have mentioned these efforts in prior calls and I believe we are on track to achieve the amount of savings we were expecting. These initiatives and other efforts should help us achieve our goal to keep operational O&M relatively flat in the near-term. Third, other income, net of other expenses decreased earnings $0.04 per share primarily because of net investment losses related to certain non-qualified benefit plans. Fourth, the increase in shares outstanding resulting from our April equity issuance decreased earnings by $0.04 per share in the quarterly comparison. The net effect of another miscellaneous items improved our results by $0.02 per share.

Turning to slide nine and the components of our net increase and regulated electricity gross margin. Total regulated gross margin was up $0.10 per share compared to -- with 2009 second-quarter. The components of that increase were as follows. Retail rate increases favorably impacted our quarterly results by $0.26 per share. Of this amount, $0.21 per share related to a net base rate increase and $0.02 per share related to line extension fees, recorded as revenue. Both of these items became effective January 1 of this year, under APS's retail regulatory settlement. The remaining $0.03 per share related to the 2009 transmission rate increase, that went into effect last summer through our FERC formula rates and our retail transmission cost adjustor. Don will provide an update in his comments on the 2010 transmission rate changes, which will begin impacting our results in the third-quarter.

Higher weather-normalized kilowatt hour sales compared with the second-quarter a year-ago, improved our quarterly results by $0.02 per share. This year-over-year weather-normalized kilowatt hour sales increase is our first quarterly increase since the third-quarter of 2008. In this year's second-quarter, APS's customer base grew 0.7% year -- over year-ago levels. Where the normalized retail sales were up 0.6% in the quarterly comparison after reflecting the effects of our ACC approved energy-efficiency and demand-side management programs. I'll provide more color on the economy momentarily.

The non-cash mark-to-market evaluation of APS fuel and purchase power hedges net of related PSA deferrals, lowered earnings by $0.03 per share compared with a year-ago. This variance reflects a small mark-to-market impact in this year's second-quarter, and the reversal of the second-quarter 2009 favorable mark. For your reference our mark-to-market amounts by quarter for the past couple of years are shown in the appendix slides.

The main story in the second-quarter comparison was weather. Unusually mild weather, especially in April and May, decreased our earnings by $0.15 per share. This year's quarter was inordinately mild, while last year's second-quarter weather was relatively normal. In fact, this May was the mildest in more than a decade. Residential cooling-degrees were 17% lower than in the second-quarter a year-ago.

Looking at our fundamental growth outlook in the Arizona economy, we currently expect annual customer growth to average 1% for 2010 through 2012. Additionally, we expect our annual weather-normalized retail kilowatt hour sales to be relatively flat from 2010 through 2012, because of the impacts on the national economy, the housing situation in Arizona, and APS's energy-efficiency programs. However, for the full-year 2010, we expect weather normalized retail kilowatt hour sales to be down slightly compared with the year 2009, primarily because of the first-quarter effects, which I discussed in our last call.

In the second-quarter of this year, we continued to see signs of stability in the Arizona economy. As shown on slide 10, housing prices and commercial building occupancy in the metro Phoenix area have stabilized over the last couple of quarters. On the commercial side, vacancy rates are expected to peak at very high-levels this year, but the trends in demand for both office and retail space are positive again after several quarters of decline.

Turning to slide 11, Arizona job growth has turned positive when looking sequentially quarter-over-quarter, although unemployment remains very high. Total non-payroll is up year-over-year, yet construction remains very weak. Other indicators are the total economic activity have improved somewhat, including growth in household earnings as reflected by personal income tax withholding trends. That said, there is no change in our outlook from last quarter. Taken as a whole, we continue to be cautiously optimistic, the Arizona economy is [on the] bottom, and we can begin the long process of recovery. We expect the economy, both nationally and locally, to improve gradually as we move through 2010.

Importantly, we need to see more robust consumer confidence in order to support a stronger recovery in the residential usage patterns, ignoring weather effects and the impacts of our energy-efficiency programs, but we have yet to see this improvement. Similarly, commercial and industrial customer usage is likely to remain flat as office and retail properties struggle with weak demand for the balance of this year. Over the long-term, we remain confident of Arizona's fundamentals and we expect customer growth and usage to return to stronger levels as the national and state economic environments improve.

Turning to our earnings outlook on slide 12. We continue to expect our consolidated on-going earnings for 2010 will be between $2.95 and $3.10 per share. Year-to-date we have been able to offset the impacts of weather with the focus on cost. However, we still need third-quarter weather to cooperate for us to stay within current guidance. I will point out July on the cooling-degree day basis for residential customers was 10% above normal. For your reference a list of assumptions and key factors underlying our 2010 outlook is included in the appendix to today's slides. In addition, we continue to estimate our 2011 consolidated on-going earnings will be within the guidance range for 2010 consolidated on-going earnings with some opportunity to modestly exceed that range.

Now a quick update on liquidity and financing. We continue to have ample liquidity and access to the capital and bank markets. At June 30, the parent and APS had combined cash positions totaling $45 million and no short-term borrowings outstanding. We have total about $1.2 billion of available liquidity. Additionally, the cash tax benefits related to the SunCor property sales and the after-tax cash proceeds from the district cooling business sale should reduce our need for future equity issuances. Lastly, on June 28, Standard & Poor's changed the outlook to positive on its credit ratings of both APS and the parent Company debt. We are pleased S&P recognizes the progress we have had made to date. However, it is imperative that we continue to execute against our operating plan.

This concludes my prepared remarks. I will turn the call over to Don.

Thanks, Jim and thank you all for joining us. I know we have a busy day ahead of you and appreciate your time on your call.

Jim has touched on several issues that are important to our investors, including our growth and the Arizona economy. Although it's evident that the recession has slowed our growth, Arizona's intrinsic economic strength remains an attractive, distinguishing characteristic for our Company. During the second-quarter we made distinct progress in some key areas and continued our track record of excellence in operations. Accordingly I will update you on the following topics this morning, one, regulatory developments, two, our strong commitment to renewable resources and three, our recent operating performance.

First looking at regulatory matters, we continue to work with the Arizona Corporation Commission and other various stakeholders to further enhance the State's regulatory framework to benefit APS's customers, our shareholders and other stakeholders. The Commission has been conducting workshops this year on several generic policy issues affecting Arizona regulation. The workshops addressed topics, such as weather and what financial mechanisms are needed to enable Arizona utilities to meet the Commission's energy-efficiency standard with a particular focus on decoupling. Transmission planning and the development of renewable transmission lines, feed-in tariffs for renewable resources, externalities and utility line extension policies.

These workshops are intended to gather information from various stakeholders about the topics at hand. We view many of the Commission's inquiries to signal positive developments in Arizona's regulatory environment. We anticipate additional progress on many of these issues throughout the remainder of the year.

Along those lines, last week, the Commission unanimously approved its energy-efficiency standard and rules. This rule-making, which still requires certification from the Arizona Attorney General, sets aggressive targets for energy-efficiency achievements that step up each year from 2011 through 2020, with cumulative savings equal to 22% of retail sales. As with other matters, APS participated actively in the ACC's energy-efficiency rule-making proceedings and advocated for regulatory mechanisms, such as decoupling that would minimize the adverse financial impact of meeting aggressive energy-efficiency goals.

The new rules require the Commission to formally address this issue, a requirement that has resulted in a productive series of workshops, focused on addressing utility financial disincentives and potential decoupling for Arizona utilities, as I previously noted. APS views implementation of an effective decoupling mechanism or similar device in its next rate case as essential to achieving the Commission's energy-efficiency standard. APS is the leading provider of energy-efficiency programs in Arizona. Through 2010, we expect to achieve cumulative savings of about 3.5% of our retail sales.

Both energy-efficiency program costs and performance incentives awarded for achieving certain goals, are recovered automatically through APS's demand-side management adjustment clause. Our retail regulatory settlement also requires cumulative savings of 3.75% from energy-efficiency programs implemented in 2010 through 2012. Both the settlement and the rules provide APS enhanced performance incentives for achieving these ambitious goals. For 2010, we estimate that APS will earn incentive revenues of about $7 million pre-tax, collected through the adjustor clause. As reflected in our 2011 energy-efficiency implementation plan, now pending before the Commission, we expect that amount to grow for 2011.

On the rate front, this summer, APS's FERC formula rate update operated to reduce our annual transmission revenues by $12 million pre-tax. This decrease resulted from lower costs reflected in the normal operations of the FERC formula. $2 million of this amount became effective at the wholesale level on June 1. Last week, the Arizona Corporation Commission approved a related reduction of $10 million annually in Arizona retail rates through APS's transmission cost adjustor, and that change is effective August 1 of this year.

This fall, elections will result in change at the Arizona Corporation Commission as two of the five seats will be on the ballot. Chairman Mayes is term-limited so her seat will be filled by a new Commissioner. Commissioner Pierce is running for re-election for a second term. In total there are currently nine candidates for the two seats; three Republicans, three Democrats and three write-in candidates. The field will be narrowed to two candidates from each party, plus the write-in candidates following the primary election on August 24, with final elections this November.

Turning to renewables, our commitment to renewable resources remains strong. We're on track with plans to significantly increase the amount of renewable energy we provide to our customers. Arizona's solar potential is among the best in the world, making solar energy an obvious choice. APS's AZ Sun program, which is outlined on slide 14, will be our first significant step toward owning large utility-scale solar facilities.

To recap the AZ Sun program, APS plans to develop and own 100 megawatts of photovoltaic solar plants with a capital investment of up to $500 million. We currently anticipate the solar capacity will be placed into service in the years 2011 through 2014. However, the ultimate timing will depend on the outcome of current and future procurement processes. The AZ Sun program was approved by the Commission on March 3, with very constructive rate recovery, including returns on equity and debt capital. As such, we will not have to wait for a general rate case to begin recovering all of our costs and we'll be earning a full return on these facilities when they are placed into service.

As discussed on our last call, we received an exceptionally strong response to our request issued earlier this year for proposals for PV solar projects. We have short-listed bidders and are in the process of negotiating contracts, which will allow development of a portion of AZ Sun. We plan to complete contracts in the next several months, because we are currently in final negotiations, further discussion of the proposals at this time would be premature.

Also early this year, as part of a commitment made in our regulatory settlement, APS issued a request for proposals for wind projects to be physically located in Arizona. All proposals we received were for purchase power agreements and last month we executed a 25-year agreement with the developer of a 99 megawatt project to be built in northern Arizona. That agreement is subject to approval by the Arizona Corporation Commission. The developer plans to have the project in commercial operation in the late 2011 or 2012 timeframe. The combination of these efforts with renewable initiatives we already have underway are important steps in advancing Arizona's sustainable energy future.

Looking at our operating performance now, our baseload nuclear and coal fleet continues to perform admirably. In the second-quarter our Palo Verde Nuclear facility operated at an 80% capacity factor, comparable with last year's second-quarter. Both quarters included planned refueling outages. The most recent quarterly performance reflected the 50-day Unit one refueling outage, which began on April 3. During the outage we replaced the reactor vessel head and installed a rapid refueling package. We completed a similar refueling outage at Unit two last fall and plan to complete the work for the third unit, Unit three, during its planned refueling this fall. Because of the extent of the additional work, each of these outages typically last 50 to 60 days. Other than the Unit one refueling outage during the second-quarter, there was only one outage day at the Palo Verde facility, continuing the strong operating performance. Looking ahead, the Palo Verde team remains focused on achieving safe, sustainable, top-tier performance in all aspects of the plant's operations.

On the fossil side of our business, our coal and gas fired plants have completed their planned spring maintenance outages and are performing well, helping meet our customers' energy needs, particularly during our summer peak months.

Regarding our customer service, last month, J.D. Power and Associates released results of its 2010 residential customer survey. I'm very pleased with APS's continuing record of performance excellence in overall customer satisfaction. In seven of the last eight years, APS has ranked by residential or business customers in the top-ten nationally among all large-segment utilities in overall customer satisfaction.

In the most recent J.D. Power results, APS ranked third nationally among 55 large investor-owned electrical utilities in the study. More specific to our region, we were rated second among the 10 investor-owned utilities in the west. In addition, to the overall customer satisfaction index, APS ranked in the top-10 nationally on four of the six components of customer satisfaction as defined by J.D. Power.

Not only in customer service, but throughout our organization, we continually strive to maintain top-tier performance and we constantly seek to improve performance in every facet of our Company. As Jim discussed, we have sold a number of Pinnacle West non-core assets and our focus looking forward is a strong commitment to maintaining operational excellence and achieving superior financial results by concentrating on our core utility business.

This concludes our prepared remarks. Operator, at this time we would be pleased to take any questions.

Okay.

(Operator Instructions)

Your first question comes from Daniel Eggers from Credit Suisse. Your line is open.

Good morning guys. I guess the first question, Jim going back to your comments on some of the cash raise opportunities and how it affects the equity issuance. You guys are going to end up generating an extra about $200 million of cash in the next six or nine months that you weren't anticipating in the original plans?

Well I think we came into 2010 with the SunCor tax benefit, I think, pretty much understanding what that would be. I think that the new thing is the sale of North Winds. And we had some proceeds in our forecast, and that is one of the reasons we were able to go out with the smaller equity offering in April, because of the other cash generation. So, I think looking forward from a Pinnacle perspective we'll have the ability, we'll have a lot more flexibility to reduce equity needs going forward with the cash we have generated here.

And this will be incremental to plans so we'll probably be able to avoid some in the next phase of equity raise whenever that is to happen.

With the flexibility that we have now.

Okay. And kind of with some stabilization in customer counts in the quarter and a little bit of usage improvement, I know you struck a cautious tone. Are you starting to see some of these vacant homes filling at this point in time or are low usage meters starting to turn finally?

You know, really no change in that, Dan. I think we -- the thing of note was for the first time since third-quarter of '08, we saw sort of increase in sales. We saw an increase in usage per residential customer about 0.7% to 1%, so while I think that's positive, we're still fairly bearish on the economy in the next couple of years, knowing that as we've talked about, we do have the house is empty that have infrastructure and every 1% incremental increase in customers and usage is about $10 million of net income. So if that comes back, you could see that come, but I'm not sitting here very optimistic just because of one quarter.

And then, I guess, Don on the efficiency comments you made. Did you say a 22% targeted efficiency gain at the retail level? So I guess the residential level. Is that what the goal is?

Yes.

What initiatives do you guys see or what kind of change in spending do you think is going to have to happen at the utility level to facilitate that?

Let me have Don Robinson touch on that.

Dan, this is Don, obviously we are going to see a significant increase in the cost of those programs and we're also going to have to see the customer acceptance of those programs to make that happen. And as Don mentioned, crucial to any of it being successful is getting a decoupling mechanism put in place as part of the next rate case, so that there is every incentive for everybody to work as hard as they can to make that happen.

When you guys look at that, what kind of programs have you guys envisioned as far as delivering on that magnitude of reduction?

Well we have already got a lot of programs in place. We do energy audits. We have a CFL program. We have an old refrigerator program. We have a air conditioning program. We have a pool pump program. We have got a number of commercial programs that are being rolled out. So we're going to continue to expand and develop on what we have done and see where the market goes and where the real interest from customers are.

Okay. And I guess just one last question, when you guys had the workshops on the decoupling design, were there any major takeaways where the program could be leaning based on the input of all your stakeholders?

The majority of stakeholders were pushing toward a fixed cost revenue per customer approach for decoupling, which is one that we suggested and I would say the vast majority of the other stakeholders have got on to that as well. So that is where I would think it's going.

Great. Thank you guys very much.

Thanks, Dan.

Your next question comes from Paul Ridzon from KeyBanc. Your line is open.

Can you give us an update on recent discussions around line extension?

This is Don Robinson, Paul. The line extension, the Commissioners continue to have workshops around the State, where they are taking comments from interested people on that. There has been no other formal action taken or scheduled for them to deal with it in any normal manner. I would continue to believe that if they want to make changes in a program, because of the revenue impacts, it would have to be part of our next rate case.

Any legislative efforts? Have those basically died?

The legislature is out of session and everything has effectively died for this year.

Any update on Solana financing?

Solana continues. They have got the government approval they were looking for and they continue to move forward on what they have to do on that factor.

It was about three or four Saturdays ago, President Obama as part of his Saturday morning address, announced the DOE's loan guarantee conditional approvals on the Solana project.

Do you think that makes it -- Do you think it's going to happen given that development? Is there still work to do as far as financing?

They continue to push forward on it and I know [get up and] go with it.

Is it too early to give some sort of indication of how much capital could be deployed at AZ Sun in '11?

Yes, it's still early for that, given where we are in negotiations. So we and the proposers are sensitive about timing and I'd just as soon not get into that right now, today.

If you had decoupling today, what kind of incremental pick up could we see on your energy-efficiency programs that have some sort of lag associated with them? Or do you have real-time true-up on that?

You are going to have -- I guess what's envisioned is you would have an annual lag. So you would true up at the end of the year for what impact we had in the following calendar year and like I said earlier, about 1% increase in sales is about $10 million of net income. So it would really be dependent upon how effective those efforts are.

How would you say your current-year earnings are being impacted by efficiency?

We think sales have been reduced by about 1.1% through all the various initiatives on efficiency and so on.

Okay, thank you very much.

Yes. Thanks, Paul.

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

Good morning, guys.

Hey, Paul.

Just on the sales growth, I guess. It looks to me like the weather adjusted growth was up pretty strong in the quarter and looks like DSM expenditures were also up. You guys are still sticking with that flat growth rate through 2012. I just was wondering what your thoughts are with respect to that?

It's true weather-normalized sales were up, I think residential was up [1.4] and total was up [0.6]. And you know, we look at -- As we look at 2010, we know what the impact has been the first half of the year. So that has sort of been picked up. Going forward, we still see on the commercial and industrial side, other than healthcare, every other segment is down year-over-year. So we're taking a conservative assumption based on the absorption it takes to [get] construction moving back forward and time will tell whether that's a correct assumption or not.

You guys mentioned that customer growth was, I think, up 1%. Or at least that is what you were looking at for the year, correct?

It was up 0.7% year-over-year. The average is about 1% over the three-year timeframe.

Okay. There is some discussion about at least these sort of anecdotal reports of illegal immigrants leaving the State in anticipation of the law that I guess has been stayed. Do you see that as having any potential impact one way or the other on electricity demands? Any thoughts about that at all?

Paul, this is Don. No. There is a lot in the media about that situation. The facts, I think, that are driving the economics here in Arizona is that the housing construction industry is down at a record-low, and that's the fundamentals here.

Okay. Thanks a lot.

Your next question comes from Chris Ellinghaus from Wellington Shields. Your line is open.

Hi.

Hi, Chris.

A couple of questions. Jim, sort of the third-quarter last year, I think, you guys had talked about weather contributing about a nickel, but you also had lower usage. Given the trend that you may be, hopefully, can build on after the second-quarter, should we be thinking, absent knowing more about cooling-degree days for the third-quarter, that if you have a return to normal that weather would be a drag, but you're hoping that usage picks up? So you might net-net have sort of a normal quarter in the third-quarter?

Well, remember last year, we had the warmest July on record. And so that drove some weather benefit and, again, we did see negative sales growth. I think it's fair to say if you have normal weather and normal sales growth, you're going to see an improvement in gross margin. But, again, one quarter doesn't necessarily make a trend. So, we're being very cautious on that.

Sure. Can you elaborate a little bit more, was North Winds the predominant pick -- improvement in SunCor's debt level? What other transactions can you add a little color to?

Well, North Winds was not part of SunCor. It was a district cooling business that served primarily downtown.

Right.

-- and Tucson. And that was a decision to not invest any more capital and really take our chips off the cable. SunCor has made considerable progress in the second-quarter in July by selling a significant amount of its assets or certainly a portion of its assets.

We only have about $6 million in debt left at SunCor and a few assets. So in that regard, SunCor is pretty much a non-issue going forward. Other unregulated, we don't have much at this point. That pretty much represents the bulk of the unregulated footprint.

Okay. And lastly, you did a really good job with costs to help offset the weather this quarter. Can you talk about, what elements are recurring from that effort and what was sort of a special effort?

Well, go ahead.

Excuse me. I was going to saying Chris that is a very good point. Anyone can defer maintenance to save money, but that is not what we're doing. We're looking at ways to change our processes, to make those cost reductions sustainable in the future and I will let Don Robinson comment on a few of the initiatives we have going.

Chris, this is Don Robinson. What we have done is in the fossil organization, we have taken an entirely new look at that whole way we operate. The operating model. We have gone to a fleet approach, where we're looking at that as one large fleet, which we're gaining significant efficiencies from that. We're putting in a lot of process improvements and standardizations that we see having long-term and ongoing savings associated with that.

We have just recently begun the same type of process in our IT area, which had been previously organized by line of business and have found that is not the most effective and efficient way of doing that. So we have done the same thing there with a number of process improvements and standardizations in place and relooking at how we make decisions going forward on systems, which I think will have long-term cost-savings associated with them.

As you have heard in our past calls, we have a supply change initiative that has gone underway, that should be saving us money now and as we move into the future. We have been doing some benchmarking in the shared services organization to make sure that we're as effective and as efficient as we can be there, and if you look at Palo Verde, obviously, it's going from being a plant that had trouble and issues to being more normal. So we see some long-term improvements there as well.

Okay, great. One last thing. I believe the tax benefit has grown a little bit. Can you just talk about that and what the source was.

The tax benefit there was really no impact to taxes in the second-quarter, but the impact was really the first-quarter. We do see a little bit of SunCor realization, because we actually did execute on some asset sales.

Okay great. Thanks so much, guys.

Thanks, Chris.

Your next question comes from Edward Heyn from Catapult. Your line is open.

Good afternoon.

Good afternoon Edward.

I guess it's good morning to you guys. I had a few questions about the guidance. It looks like you've changed the gross margin and the OpEx ranges down $40 million, which I calculate to be around $0.25 for the year. I guess on the gross margin side it looks like there's about $0.15 from abnormal weather this quarter. I was hoping you could elaborate on was the other $0.10 was and then maybe a little bit of color on the $0.25 of OpEx savings off-setting that.

Well, back to gross margin, what we reflected is weather year-to-date as well as the impacts we saw the first-quarter, with the reduced usage for the most part. On operating expense, we expect to see all the categories in operating expense down. The big item in there is the implementation of FAS 167, which pulled Palo Verde sale lease back out of operating expense and put it down as a item for noncontrolling. And that is the biggest impact. We are seeing a little less in Cap Ex, so depreciation as well as other taxes. The big item is pulling that down below the line.

I'm sorry, could you elaborate a little bit on that? So the Palo Verde minority interest is now getting pulled out of OpEx, but it's still showing up on the income statement correct?

It is showing up on a noncontrolling interest, below the line, so to speak.

So you guys don't include the minority interest in your operating income to common equity?

No, we do not.

Okay.

We have essentially taken it from showing it as a sales leaseback to a -- more of a consolidation approach.

Got you. Okay. And then just to clarify Chris' earlier question about the tax gain. I think you said it was $0.14 -- You had I think in the first-quarter said you had expected $0.14 benefit for the year, is that still --?

Correct.

Okay, so you've recognized I think $0.06 in the first-quarter and not too much this quarter so the rest will hit in the end?

That is correct.

Okay. And then just the last question, I guess, this is theoretically, weather is more of an art than a science and it seems like weather was pretty dramatic effect this quarter, but the offsetting fact was a little bit of recovery in the economy. Do you guys have any more flavor around how you got comfort around that weather wasn't a little bit more of a hurt in the economy, or a little less of a hurt and the economy hasn't really shown weather-normalized growth versus it having it? Does that make sense?

Yes. To answer your question, weather is an art, not a science, so we in our case, we have a revenue group, who does significant analysis around this. You know was it $0.15 or was it $0.16? I feel comfortable that the impact was about $0.15. That is why I don't get real excited about one quarter trend to say that we have a breakthrough here.

I got you. I see what you are saying. I appreciate it. Thank you for the help.

Thank you.

Your next question comes from Ali Agha from SunTrust Robinson. Your line is open. Your line is open. Mr. Agha?

We might move on to the next question now.

Your next question comes from Tom O'Neill from Green Arrow. Your line is open.

Hi Tom.

Operator, maybe try another one. Maybe they will come back.

We will try Greg Gordon from Morgan Stanley. Your line is s open.

Operator, we're not hearing anything on this end.

I'm going to try Ali Agha again from SunTrust Robinson Humphrey. Your line is open.

Hi there.

Hi. I was still on last time, I don't know what happened there. Anyways, I was -- Jim clarifying the question on the weather -- the $0.15 was the year-over-year change. What was the actual impact in the quarter itself?

Would have been about that, because last year was near normal.

I see. Okay. And then second, also clarifying when you talked about financial flexibility with the asset sales, et cetera, coming in, are you still looking at 2012 as kind of when you may need to raise more equity?

That would be the earliest we'd be looking at equity. As Jim inferred earlier, I believe it was Dan Eggers question, is the additional $70 million net cash from the North Winds sale and the fact that SunCor net tax proceeds are in the $20 million to $30 million more than we thought they would be going into this year. That will have the effect of reducing our equity needs in the future.

And Don, I know the early stages with all the elections still to come, but I mean as you look at the field of candidates, et cetera, are you anticipating any real change in the regulatory climate in Arizona going forward next year, post elections?

Well, I think it will depend on the ultimate election and I can't speculate on that, but what we have been driving towards here is the relationships we have developed with all the participants in our typical cases and not just the Commissioners, but the staff and the other stakeholders. And I think that process has been very beneficial and I'd expect that to continue to grow regardless of who is in office.

And final question, as you file the next to rate case next year, is it fair to say, would you expect, presuming you get what you ask for and of course, nobody ever does, that you would be pretty much close to owning your authorized returns or do you think there is one more case beyond that, that will eventually get you there?

That is where we would like to be next time around.

Okay. Fair enough that. Is helpful. Thank you.

Your next question comes from Tom O'Neill. Your line is open.

Good morning.

Hey, Tom, how are you?

Good, how are you doing? Just a couple of questions to clarify on that Arizona Sun, if I understood you correctly, you were saying later this fall, once the negotiations are complete we'd have a better picture just on how the capital would lay out and the income recognition between here and 2014?

Yes.

Okay and then second question, just sort of longer term, gotten a sense that there is some discussion of a forward-test you are being contemplated again in the State. Just wanted I guess to review from your perspective what would need to change legally in order to facilitate that?

Well, I think it's the end product as opposed to the actual semantics, whether it's a forward test year or other vehicles. And so far, in the last case, we were very successful in utilizing other vehicles to help bridge the gap over regulatory lag and to get us a little closer to our allowed rate of return. We continue to focus going forward, the end game is closing that gap, just specifically any particular vehicle, be it forward-test year or otherwise. Until we actually get into discussions with the parties on the various issues, what kind of legal complexities come up, sometimes that is in the eye of beholder, also.

Okay. Got you. I misunderstood then. Thank you.

Your next question comes from Greg Gordon. Your line is open.

Good morning, guys.

Hi, Greg.

So stepping back a little bit, Don, on your cost efficiency goals, I think when I look at my forecast, the earnings guidance you have given for '10 and '11 infers you continue to under-earn your authorized return, although it's obviously an improvement from where you have been historically.

Yes.

So can I conclude that if you are successful in achieving those goals, that you have the potential to maybe start earning your authorized returns sooner than the next rate case or are there just a whole set of other factors that come into play in terms of getting DSM recovery forward-test year, the economy getting better, that all have to happen for you to be comfortable in guiding us to you earning your return?

I think you are right. There is a full plate of issues in front of us and we look at them all as opportunities. I think before the next rate case, it's unlikely that we'd achieve our allowed return.

Okay. Thank you, Don.

Your next question comes from Daniele Seitz. Your line is open.

Thank you. I have one more question. The timing of the next rate case as well as when the decision is likely to be made?

We will file June 1, 2011. That is the earliest date we can file under the settlement and there is a 30-day sufficiency process here. We assume it will take 30 days to for them to deem our filing sufficient. Then it was an agreement of the parties to use our best efforts to render a decision within 12 months. So the earliest you would have rates in is July 1, 2012 and that assumes of course all of those things I mentioned with the sufficiency process as well as the cycle of the rate case.

Great. And on a more general basis, do you prefer to go for PPAs at this time, especially regarding renewables or do you have in mind some sort of a percentage of capacity that you would like to build yourself?

I think on that subject, the comment that I made at the open meeting, which is actually reflected in the settlement is that APS cannot just rely on a PPA model and expect that we can maintain an investment-grade rating. That said, we need a balance and you saw coming out of this case that we did Arizona wind under a PPA structure. Arizona Sun under an ownership structure and that is the sort of balance we'll continue to strike as we move forward.

Great. You don't have, you have not come up with a magic formula that says the percentage you would prefer to build to maintain your -- ?

There is no internal formula, nor have we agreed with any formula of the stakeholders in this process.

Great. Thank you.

Your next question comes from Steve Fleishman from Bank of America, your line is open.

Thanks, hi guys.

Hi Steve.

Just to clarify, I guess it was Ted's question, on the revenue and the operating expense assumptions.

Yes.

If the reduction of operating expenses is just another line item below a good chunk of that $40 million, does that mean there is a net loss between revenue and expense from what you had before? Because on the surface it looks like they came down the same amount?

They did. Keep in mind there is a lot of things within those numbers that go both ways. But, the big driver on the expense side was just the FAS 167 treatment.

Okay. In items other than revenue expense, they still net out that you are not really changing the guidance assumption?

That is correct.

Good, I just want to clarify that. Thank you.

Thank you, Steve.

Your final question comes from Stefka Gerova from JPMorgan.

Thank you and good morning.

Hey Stefka.

Going back to the additional cost savings embedded in the affirmed 2010 guidance range, can you give us a sense of what portion of the savings is coming from lower operating costs at Palo Verde?

Very little of the 2010 is coming from Palo Verde. Keep in mind Palo Verde is on year one of their return to normalcy, and we get 29.1% of any benefit from Palo Verde so I would not look at that as the main driver of cost and that is also something that we're very aware we have to be very careful of.

Okay. And what is the current level of operating costs, excluding nuclear fuel at Palo Verde on a dollar per megawatt hour basis?

It's been around high 21, low 22 on a per megawatt hour basis.

Great. Thank you very much.

I have no further questions and I will turn the call back to the presenters.

This is Don Brandt and let me thank you all again for joining us today. And if you have any follow-up questions, don't hesitate to give me, Jim or Becky a call. We'll talk to you all soon. Thank you.

Thank you.

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