Pinnacle West Capital Corporation
Q2 2009 Earnings Call Transcript

Published: 4 Aug 2009

[Operator:]

Good afternoon. My name is Sarah and I will be your conference operator today. At this time I'd like to welcome everyone to the second quarter 2009 earnings conference call. (Operator Instructions) Ms. Hickman, you may begin your conference.

[Rebecca Hickman:]

Thank you, [Sarah]. I'd like to thank everyone for participating in this conference call to review our second quarter earnings, recent developments and operating performance. We know today is an especially busy day for you, with a number of conference calls. 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, 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 Form 8-K filed this morning. During our prepared remarks we will give you verbal cues as we move through the slides. Looking at Slide 2, 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 the Forward-Looking Statements and the MD&A sections contained in our second 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, the slides accompanying this webcast, and our filings with the SEC, all of which are posted on our Investor Relations website, contain additional disclosures regarding these non-GAAP measures, including reconciliations of these measures 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 August 11th. 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.

[Jim Hatfield:]

Thank you, Becky. As shown on Slide 3, the topics I will cover today are

[Don Brandt:]

Thanks, Jim, and thank you all for spending time with us this morning on this call. Today I'll discuss several issues that I believe are at the top of investors' minds. Jim's already touched on our intrinsic growth and the Arizona economy. I'll update you on these items

[Operator:]

(Operator Instructions) Your first question comes from Paul Ridzon - Keybanc Capital Markets.

[Paul Ridzon:]

One thing that we have seen is that large reductions in C&I tend to have a smaller-than-expected earnings impact because a lot of the revenues are structured more as capacity reservation. Are you less than others in that regard? I was surprised by the $0.08 degradation of earnings.

[Jim Hatfield:]

Well, if you look at where we've had our reduction, it's really been manufacturing, 17%, warehouse, about 10%, and really retail and office and that category. In terms of contribution we saw, like I said, over 80% of that sales reduction in the C&I. So in terms of the $0.08 degradation relative to C&I, I'm not sure the rate designs of others but our rate design is structured so that we're trying to levelize those more across the board with residential. Don, do you have anything specific on rate design you want to add to that?

[Don Brandt:]

I don't.

[Paul Ridzon:]

How hot has July been?

[Jim Hatfield:]

Well, we had the hottest July on record. We had several days in July where the average temperature was 100, so just from a relative basis, significantly above normal. I don't have degree days in front of me, Paul, but the fact that it was the hottest on record I think gives the magnitude of the heat in July. And August is sort of starting off the same as July ended up, at least through the first four or five days.

[Paul Ridzon:]

So that should be a nice tailwind.

[Jim Hatfield:]

Well, we're hoping.

[Paul Ridzon:]

And then just lastly just an update on potential tapping the equity markets. Is that still a '10 event?

[Jim Hatfield:]

Correct, no change in terms of equity plans at this point.

[Operator:]

Your next question comes from Greg Gordon - Morgan Stanley.

[Greg Gordon:]

So the degradation you saw in sales, that might have been partly from weak weather in the second quarter. Would it be fair to say that the four or five weeks you've had in July and August have sort of put you back on track?

[Jim Hatfield:]

Yes, just a couple things. You know, I talked about this at length in the first quarter, you know, the role of weather and what's usage. I can tell you that even through sort of normal weather residential sales were down 3% and humidity was 10% below normal. What's that do vis-à-vis normal? I'm not sure. But certainly July, we feel good about the 230 and about sales and don't think that anything so far is off track to achieve our numbers.

[Greg Gordon:]

Don, I know you're trying to keep things extremely positive when you talk about the dependency of the vote on the rate settlement, as you should. What would you guys have to do in terms of changing the financial strategy of the company to react to either a rejection of the settlement or a material modification of the settlement?

[Don Brandt:]

Well, we're focused now on getting the settlement approved, Greg. As I mentioned, we've got 22 out of the 24 parties supporting it; only one party objecting and that's on a very limited aspect. We've had, I think, a level of spirit of cooperation in this settlement process that we have not had before. The settlement addresses a wide variety of factors other than earnings and rate issues relative to environmental aspects, renewable energy, low income customers. I think once it's explained and reviewed by the Commission in detail the Commissioners will find it a very attractive result of the settlement process.

[Operator:]

Your next question comes from Daniele Seitz - Dudack Research Group.

[Daniele Seitz:]

Could you give us some details on the cost of the solar plant and is there a special regulatory treatment for these types of plants in Arizona?

[Jim Hatfield:]

In terms of solar, Daniele?

[Daniele Seitz:]

Yes, yes. And if you could give us an idea of the cost and how will you recover those costs?

[Jim Hatfield:]

Well, the cost is confidential according to our agreements. We'll enter into PSAs with the two large ones and those will be passed through the PSA 100%. And right now I guess I would characterize it as the state is very positive on solar. We have all the attributes for solar that you would want. We're planning on continuing to increase our renewable energy and under the framework of Arizona regulation that is passed through the PSA at 100% and through the RES. So there's really no net costs from a shareholder perspective because that's all being recovered.

[Daniele Seitz:]

Okay, so it's pure purchased power cost? You're not involved in the investment?

[Jim Hatfield:]

Correct.

[Operator:]

Your next question comes from Paul Patterson - Glenrock Associates.

[Paul Patterson:]

Just on the customer growth outlook and weather-normalized sales, looking at your release if I'm reading it correctly it appears that you guys have had about 0.7 of 1% customer growth yet a decline weather normalized. And you mentioned, as you guys did previously, that you still expect 1% growth.

[Jim Hatfield:]

In customers, that's correct.

[Paul Patterson:]

How shall we think about the outlook for actual kilowatt hours through this 2009 through 2011 period?

[Jim Hatfield:]

As I said when I was talking about that issue, we're planning on flat sales year-over-year really driven by the economy as well as energy efficiency efforts.

[Paul Patterson:]

That's this year.

[Jim Hatfield:]

And that would be a statement that we see it through 2011 at this point.

[Paul Patterson:]

Oh, really, through 2011 you don't expect any significant growth in kilowatt hour sales?

[Jim Hatfield:]

That's correct.

[Paul Patterson:]

Is that because of the economy or is that efficiency? How do we think about that? I mean, that seems like a pretty less-than-robust outlook from what you guys have traditionally have.

[Jim Hatfield:]

Well, I think you have to look at it in two ways. One of the things we're doing - and we filed this with the Commission - we're getting about 0.4 of 1% reduction in sales just through our energy efficiency efforts so far, so, for your thinking, that's where that's going. The other is just, like we said, an economy that needs to absorb these 30,000-plus houses that are available out there before we see any meaningful pickup. From a C&I perspective the only growth year-to-date has been in hospitals and schools, which have been very modest sales growth. So we're just seeing that pattern continue until we get back to what we believe will be more traditional growth in customers and kWh sales.

[Paul Patterson:]

So basically it's real estate dependent, I guess, is the way to think about the big driver in Arizona?

[Jim Hatfield:]

It's real estate dependent and tourism driven, and that's been our drivers. We expect we'll continue to see robust growth once economic factors point to a positive direction. But keep in mind with the 30,000-plus homes here, we have a lot to absorb before we get back on that growth track.

[Operator:]

Your next question comes from [Tom O'Neill] - Green Arrow.

[Tom O'Neill:]

I have a longer-term question just on how you're evaluating rate-based opportunities in solar. I guess A) your thoughts on that, and then B) what filing you might need to do to address the self-build moratorium that I think would keep you from that.

[Don Robinson:]

The self-build moratorium doesn't apply to renewable resources, so we have the ability to build renewable resources and that is one of the things that we are looking at as we go forward and what should our investment in those be. And we're evaluating different structures right now because clearly, as we go long term, we are going to be a large player in the solar development in the state and I think ownership of a portion of those plants are where we're going. Jim, you want to anything?

[Jim Hatfield:]

I would just say from a financial perspective we're not opposed to PPAs; however, without any ability to earn on those commitments we're seeing a negative impact to the capital structure through imputed debt and I think that's something that we have to keep in mind as we address this issue going forward.

[Tom O'Neill:]

And just along those lines, how would you envision a regulatory compact that you would get comfortable with just to avoid some of the lag problems of the past?

[Jim Hatfield:]

I think we would go out to the Commission in the front end just like we would for any new baseload generation that we would be looking at and get an agreement from them on how we would be paying for this and when we would recover costs along the way as [WIP] or some other innovative process so we are not waiting until the end of the period to recover our total costs. We're not going to do that.

[Operator:]

Your next question comes from Chris Shelton - Millennium Partners.

[Chris Shelton:]

I just wanted to clarify, actually. It seems like there's a couple of moving parts in the guidance for '09. I guess you're ahead on weather - it sounds like July was pretty warm - but usage is tracking a little bit behind, and I just wanted to see which of those or if any was kind of assumed in the 230 for '09?

[Jim Hatfield:]

I want to just clarify your first point. I don't think we're ahead on weather; I think July sort of brought us back to close the gap. As I said earlier, even though second quarter was normal it was a hot May and a cool June and we saw residential cooling degree days off 3%. So I think July just was more of a catch-up. From a usage pattern what July told us, I mean, we understand the C&I industrial pattern and we have planned for that. July residential sales, we saw robust residential sales which is consistent with the weather pattern, so I don't think there's any real impact on usage that we're seeing today. Energy efficiency's been built into the outlook. And weather, we look at sort of normal weather over the course of the year and I think July is bringing us back to that bogey.

[Chris Shelton:]

The usage, I guess, is tracking for flat for the year still? Is that fair?

[Jim Hatfield:]

Usage is tracking or weather adjusted would track more toward a flat '09 over an '08.

[Chris Shelton:]

And then also to clarify, July bringing weather back to normal, that was assumed in the 230 also, right?

[Jim Hatfield:]

Exactly. We did get the benefit of July behind us when we looked at that. I also want to point out there is a lot of unsold homes in the service territory and those homes count as customers although their usage is de minimis at best at this point. And that's also a factor when we look at usage, but we believe we've built all of those things into the 2009 guidance.

[Chris Shelton:]

Don, when you were talking about not earning a 9% ROE under the settlement, do you have the rate base on the equity layer that you were assuming in that or maybe which year you were assuming?

[Don Brandt:]

I was talking about actual reported earnings for 2010, those levels of return on equity.

[Jim Hatfield:]

And we've provided CapEx updates for the utility as well and we're assuming a 54% equity at APS, which is consistent with the cap structure in the settlement.

[Chris Shelton:]

Okay, so just to clarify, the rate base would be a projected 2010 rate base not the rate base in the settlement or 2009?

[Jim Hatfield:]

Correct.

[Chris Shelton:]

Who's objecting to the settlement at this point?

[Don Brandt:]

Just one party relative to our line extension agreement, where the Commission two years ago changed it. There was generally a 1,000-foot free allowance for new residential development and that was eliminated.

[Chris Shelton:]

And who's the party objecting, I guess, or is that the only objection.

[Jim Hatfield:]

It's a group basically representing development. I don't have a name, but [Barbara Wylie] is the person whose name it is.

[Chris Shelton:]

It's the developers, though? That makes sense.

[Operator:]

(Operator Instructions) Your next question comes from Paul Ridzon - Keybanc Capital Markets.

[Paul Ridzon:]

What have we seen out of the Commission as far as data points to how the new Commissioners think about the world?

[Don Brandt:]

Relative to our case, Paul, they really haven't had an opportunity to comment on it. We have the hearings starting. I think that'll give us a reasonable perspective. Again, both in the settlement and part of the aim of the parties putting together the settlement was to address the issues that we thought were important to all the parties and to the Commission and the state as a whole and our customers, most importantly, again, besides the rate and earnings issues for APS and our investors, but also renewable energy, environmental benefits, low income assistance for customers, rate design issues. Again, I think when they have the opportunity to review with all the parties the aspects of the case they'll find it's a very attractive proposal before them.

[Jim Hatfield:]

I think, Paul, most recently we had our implementation of the retail rates of the TCA; that was approved. That went into impact in August. That's probably the latest data point as it relates particularly to APS.

[Paul Ridzon:]

Have there been cases outside of APS where they've looked more or less constructive than historically?

[Jim Hatfield:]

Well, I mean, Tucson got their settlement last year. They're [inaudible]. Southwest Gas was late last year. I haven't really seen anything as it relates to a rate.

[Don Robinson:]

They just had a rate case regarding a company called Trico that was approved in the last opening meeting, I believe.

[Jim Hatfield:]

Right. And that was July. And that's been about it; most of the others have been more normal course - renewable energy, energy efficiency, demand-side management type programs.

[Operator:]

Your next question comes from [Vedula Merti - CDP US].

[Vedula Merti:]

A couple things I just want to make sure I have clarified. The time period for the rate base that constitutes settlement is, again, which time period?

[Jim Hatfield:]

It's 2007 with some pretty much what's in service in 2008.

[Vedula Merti:]

Now, the next opportunity you would have under the settlement to go in would be during I it's 2011. Is that correct?

[Jim Hatfield:]

June 1, 2011. And we would do that on a 2010 test year, so we would pick up '09 and '10 in that timeframe.

[Vedula Merti:]

If one takes a look at the CapEx less DD&A and everything like that, would we be talking like somewhere in the range of about $1 billion of incremental rate base between the two periods in terms of the rate cases?

[Jim Hatfield:]

Yes, roughly in that area. Our CapEx that we previously talked about as an estimation for '10 has not really changed and it is down from 2009.

[Vedula Merti:]

Okay, so then the period in which you would then be able to realize hopefully a reasonable rate of return on that incremental rate base would then be some time during 2012, 2013, so this period while you're in the reasonableness range of $3 give or take and your other cost management efforts and things of that nature to manage things, your next potential increment in terms of realizing better returns on your rate base would then become 2012 basically?

[Jim Hatfield:]

That's correct, yes. Again, because the parties are going to use their best efforts to try to get that process in '12, which would imply potentially a mid-year 2012 increase.

[Vedula Merti:]

And is there any opportunity do you think as part of that process that even though you'd have a 2010 test year that things that are fairly known or measurable or significant that would be 2011 items could be reflected as well?

[Jim Hatfield:]

It could be. It really depends upon the framework going forward, and we've talked about that before. But at this point we're looking at the schedule that's in front of us.

[Operator:]

Your final question comes from Daniele Seitz - Dudack Research Group.

[Daniele Seitz:]

Could you give us update on the restructuring of SunCor? What are your goals and timing?

[Jim Hatfield:]

Yes, great question. First of all, we stated before our goal is really to optimize the assets and to pay down debt and be left with sort of a de minimis impact from SunCor. Where we are in the process is the Hayden Ferry Lakeside Condos is in escrow and will close this month. Homebuilding, we have LOIs and we're working that sales process; we still expect a 2009 close. Golf course bids are due on Friday; still expect a 2009 close. We have various Palm Valley partials that are in escrow or LOIs and we're still working that process for a 2009 close. And the Hayden Ferry Lakeside development project is in process at this point. We still appear to be on track for around a year end 2009 completing the restructuring and the goal is to pay the banks down to zero. And, as we said before, there's some consolidated tax benefit. But nothing at this point tells us that the restructuring won't be what we've planned all along in terms of sort of assets and timing and dollars.

[Daniele Seitz:]

And no estimates in terms of potential write-offs or anything like that?

[Jim Hatfield:]

No, we had about $6 million of additional impairment charge in the second quarter but, like I said, everything right now is sort of meeting expectations, with some things still ahead of us to go at this point.

[Operator:]

There are no further questions at this time.

[Rebecca Hickman:]

Thank you, again, for joining us today. Meanwhile, if you need any additional information or further details about earnings please contact me or Lisa Malagon. This concludes our call.