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Executives

Rebecca Hickman - Director of Investor Relations

Bill Post - Chairman and Chief Executive Officer

Jim Hatfield - Chief Financial Officer

Don Brandt - President & COO of Pinnacle West Capital Corporation; President & CEO of Arizona Public Service Company

Don Robinson - President and Chief Operating Officer of ATS

Analysts

Paul Ridzon - Keybanc

Andrew Levy - Incremental Capital

Ed Heine - Catapult

Yiktat Fung - Zimmer Lucas Partners

Paul Patterson - Glenrock Associates

Jonathan Arnold - Merrill Lynch

Julian Dautremont-Smith [Ph] - UBS

Danielle Seitz - Seitz Research

Rick Chauvin [Ph] - GL Partners

Veeza Hedafi [Ph] - Decade

Asses Liggleman [Ph] - Millennium Partners

Pinnacle West Capital Corp. (PNW) Q4 2008 Earnings Call February 20, 2009 ET

Operator

Good morning. My name is Alex and I’ll be your conference operator today. At this time I would like to welcome everyone to the Pinnacle West, year end 2008 conference call. All lines have been placed on mute to prevent any background noise. After the speakers remarks there will be a question-and-answer session. (Operator Instructions)

Thank you Ms. Rebecca Hickman, you may begin your conference call ma’am.

Rebecca Hickman

Thank you, Alex. I’d like to thank everyone for participating in this conference call to review our fourth quarter earnings, recent developments, earnings outlook and operating performance. Today, I have with me Bill Post, our Chairman and CEO; Don Brandt, who is our President and Chief Operating Officer and also CEO of Arizona Public Service; and Jim Hatfield our CFO; these three will be the speakers. Also I have with me Don Robinson who is now President and Chief Operating Officer of APS

Before I turn the call over to our speakers, I need to cover a few details with you. First, I encourage you to check the quarterly statistics section of our website. It contains extensive supplemental information on our earnings variances and quarterly operating statistics. Second, please note that all of our references today to per share amount will be after income taxes and based on diluted shares outstanding.

It is my responsibility to advice you that this call will contain forward-looking statements based on current expectations and the company assumes no obligation to update these statements. Because the actual results may differ materially from expectations, we caution you not to place undue reliance on these statements.

Please refer to the caption entitled forward-looking statements contained in our 2008 Form 10-K filed with the SEC this morning, as well as the MD&A and risk factor section, each of which identifies some important factors that could cause actual results to differ materially from those contained in our forward-looking statements.

Also, during the course of this call, we will refer to our ongoing earnings, which is a non-GAAP financial measure as defined by the SEC. Our website contains a reconciliation of our ongoing earnings to net income. A replay of this call will be available on our website www.pinnaclewest.com for the next 30 days. It will also be available by telephone through February 27.

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 Bill.

Bill Post

Good morning everybody and thank you for taking your time to join us today. Jim Hatfield’s going to update you on the quarter, our earnings outlook for 2009 and 2010 and our liquidity position, and Don Brandt’s going to discuss our regulatory and operational areas and then I’ll come back and close out the comments. Jim.

Jim Hatfield

Thank you, Bill. For the fourth quarter, we reported on a GAAP basis, a consolidated net loss of $39 million or $0.39 per share compared with net income of $3 million or $0.03 per share in 2007’s fourth quarter. Net income was down most notably because of an impairment charge recorded at SunCor in this year’s fourth quarter and lower results at APS.

Looking at earnings from our ongoing operations, we incurred a net loss of $10 million or $0.10 per share for the fourth quarter 2008 versus earnings of $9 million or $0.09 per share to the same quarter last year. For the year 2008, our ongoing earnings were $2.42 per share, compared with 2007 ongoing earnings of $3.06 per share. Reconciliations of our ongoing earnings to our net income on a GAAP basis are included on our website. Our 2008 ongoing earnings were with in our expectations of a reasonable range around $2.50.

Now, I’ll provide more detail on the reconciliation items for the fourth quarter between GAAP and ongoing results. First, SunCor recorded an after tax impairment charge of $0.32 per share in 2008’s fourth quarter as compared to no impairment charge in 2007. As we discussed in November at EI, we review potential impairments quarterly to determine whether impairment should be taken.

Before no,w impairments were not needed; however, three events came together in the fourth quarter to causes us to realize such a charge in the fourth quarter. First the continued deterioration in the real estate markets, which accelerated in the fourth quarter. A further of the credit crisis which continues to limit financing availability for potential purchasers, and finally the renewal of a SunCor revolving credit facility in which SunCor must sell assets to reduce available capacity. The facility was renewed yesterday on an approximate one year term.

Second, we recorded severance cost related to downsizing our workforce of $0.05 per share in the fourth quarter of 2008, as compared to $0.03 per share in 2007 same period. Third, we favorably resolved certain tax issues associated with the 2005 sales of Silverhawk, which added $0.08 per share in 2008, with no comparable benefit in 2007 and lastly we recorded a loss in the 2007 fourth quarter of $0.03 per share from discontinued operations related to an APS energy services project.

The following factors affected the comparison of our quarterly ongoing earnings. From an electricity gross margin perspective, earnings decreased $0.01 per share. Non-cash mark-to-market valuations of APS fuel and purchase power hedges, net of related PSA deferrals reduced earnings $0.07 per share, as natural gas prices continue to decline in the fourth quarter.

Additionally, warmer weather reduced gross margins about $0.01 as residential usage was down 2% and lower retail sales reduced gross margins approximately $0.01. Despite the downturn in customer consumptions, APS customer base increased a modest 1% as compared to 2.6% in 2007’s fourth quarter. However, lower usages per customer offset the modest customer growth.

Looking forward, we continue to experience modest growth in our service territory, albeit at a slower rate than historically. We expect slow growth to continue over the next couple of years until the national economy begins to recover, not unexpectedly the customer growth rate and usage decline are related primarily to Arizona’s economic conditions which continue to reflect a deepening national recession.

Over the longer term, we remain confident of Arizona’s fundamentals and expect to see customer growth return to stronger levels as the national and state economic environments improve.

Partially offsetting these declines were higher transmission rates of approximately $0.05 per share, as compared to 2007, resulting from our formula rates approve by the federal energy regulatory commission and the operation of our transmission cost adjustor at the retail level. Miscellaneous gross margin items improved earnings by a net $0.03 per share.

On the expense side excluding the effects of Renewable Energy Standard or RES and severance cost, O&M expenses decrease by approximately $0.01 per share, as lower fossil generation expense was partially offset by higher expenses throughout the rest of the business.

As a reminder, expenditures related to the RES, our earnings neutral, since they are recorded mostly in O&M expenses, but are offset by revenues collected through surcharge. The pretax RES related O&M was $7 million for the fourth quarter 2008 and $25 million for the full year.

Higher expenses related primarily to the infrastructure additions, and improvements reduced earnings $0.14 per share. Specifically higher interest expenses, net of capitalized financing cost reduced earnings $0.08 per share. The increased property taxes reduced earnings $0.04 per share and higher depreciation and amortization decreased earnings $0.02 per share.

In terms of SunCor, the depressed economy in real estate markets reduced our contribution by $0.10 a share, because of fewer sales of homes and land parcels. All other items net increased earnings $0.05 per share in the 2008 quarter as compared to 2007. The following summarizes the components of the reduction in ongoing earnings of $0.19 per share.

Lower electric gross margin, minus $0.01; lower O&M expenses, plus $0.01; higher expenses related to capital expenditures, minus $0.14; SunCor operations, minus $0.10 and other items net, plus $0.05.

Turning now from historical variance to earnings outlook; for 2009 we estimate our consolidated earnings will be within a reasonable range around $2.30 per share, excluding the impact of SunCor; including any potential future real estate impairment or other charges. This guidance does not include any potential earnings benefit during the year from a base rate increase, at the conclusion of APS’s spending general retail rate case. It does however assume that the interim base rate surcharge will remain in effect throughout 2009.

Our earnings estimate would increase to the extent that general rate case ultimately includes a 2009 base rate increase in 2009 that exceeds the amount of the interim base rate surcharge.

Projections for our subsidiaries that are included in 2009 consolidated earnings guidance were as follows. We estimated APS of 2009 earnings will be within a reasonable range around $2.35 per share, which is equivalent to a return on APS’s average common equity of about 7%. This highlights our continuing need for substantial rate relief.

We currently estimate a gain excluding the impact of potential impairment or other charges. SunCor will have no meaningful impact on 2009 consolidated financial results, consistent with our outlook for continuing recessionary real estate markets and continued limited credit availability. We currently estimate holding company expenses and other items net will be within a reasonable range of a $0.05 per share loss.

Looking beyond the general rate case resolution, in 2010 we estimate our consolidated earnings will be within a reasonable range around $3 per share. This projection assumes that APS’s general retail rate request has been granted in full and will be effective for the entire year. We estimate APS’s 2010 earnings will be within a reasonable range around $3 per share. We currently estimate that SunCor, holding company expenses another items net we’ll have no material impact on our 2010 consolidated financial results.

As you recall, in the interim rate order, the Arizona Corporation Commission ordered us to examine our operations and expenses to target additional reductions of $20 million. That study is due March 18 and thus is still underway. As a result, we do not know with certainty the classifications of cost reductions we ultimately will identify. Those reductions could include O&M, cash working capital or capital projects. As a result our guidance for 2009 and 2010 has not been adjusted for the impact of the additional cost reductions.

You can find in the 8-K we filed this morning and on our website, further detail reconciling our 2008 results to our 2009 estimates and our 2009 estimates to 2010 consolidated earnings guidance. Now, I would like to give you an update on our liquidity and pensions.

Despite continued disruptions in the credit and liquidity markets, Pinnacle West and APS have been able to access existing credit facilities, ensuring adequate liquidity. To remind you, Pinnacle West has a $283 million revolving credit facility that terminates at December 2002 and APS has two revolving credit facilities totaling $866 million that terminate December 2010 and September 2011. For a total combined capacity of approximately $1.15 billion at the end of 2008.

On December 31, Pinnacle West and APS collectively, had about $560 million in available credit capacity, after accounting for short term debt outstanding and cash on hand. Additionally, we have no maturity of long term debt at either company until 2011. We will attempt to issue long term debt at some point in 2009.

In addition to having adequate liquidity, we have a very positive story as it relates to our pension plan in 2008. Despite as disastrous year in the financial markets, our pension plan earned an approximate 12% positive return in 2008.

We accomplished this by implementing a hedging strategy in July and we begin utilizing long duration bonds and interest rate swaps to better match the interest rate sensitivity of the plants assets with the plans liabilities. The result of this strategy was a gain on our proposition, when absolute treasury yields fell in the fourth quarter. As a result, our funding status at the end of 2008 remained comparable to 2007.

From an accounting perspective, our PBO or Projected Benefit Obligation was 82% funded at the end of 2008 and on the cash funded basis, which is based on the internal revenue code regulations, our pension plan was 98.6% funded at plan year 2008.

We estimate the minimum required contribution to our pension plan will be approximately $36 million in 2009. Execution of the hedging strategy saved Pinnacle West from having to make an additional $100 million contribution to the pension plan in 2009, and additional contributions thereafter.

So in closing, we have sufficient liquidity and coupled with our reduced CapEx and cost cutting efforts, we have the wherewithal to execute on our plan to serve the long term growth of Arizona. Adequate rate relief is the next benchmark to restoring our long term financial house.

I’d also like comment on the dividend. Our Board of Directors and management understand that near term, the dividend is a value to our Pinnacle West common stock and therefore we consider the dividend sacred. Long term we view the dividend as a piece of the total return puzzle. It is also essential to accessing the equity markets when needed overtime.

That concludes my prepared remarks. I’ll turn the call over to Don Brandt.

Don Brandt

Thanks, Jim. I’ll begin with regulatory matters. In January three new commissioners took office at the Arizona Corporation Commission. There were now three republicans and two democrats on the commission. The new commissioners are Sandra Kennedy and Paul Newman who are both democrats and Bob Stump a republican. Commissioners Chris Mayes and Gary Pierce continue on the ACC and in January commissioner Mayes was elected Chairman of the Commission.

We believe the changes at the ACC provide opportunities for constructive dialogue and action, to insure that we meet Arizona’s future energy needs with revivable electricity and excellent customer service at reasonable prices, with appropriate consideration of renewable and other resources and the financial health of APS.

We have made progress on the regulatory front in a number of areas. APS’s interim base rate surcharge request, the pending retail rate case, setting the 2009 PSA annual adjustor rate and finally APS’s resource plan and allow me to elaborate on each of these.

On December 18, the ACC approved an interim base rate surcharge for APS. The surcharge is expected to increase annual free tax retail revenues by approximately $65 million. It became effective for customer bills issued after December 31, and will remain in effect until the decision in APS’s pending general rate case becomes effective.

By authorizing the company to implement the interim surcharge, ACC provided a degree of financial stability for APS to help insure that we retain our investment grade credit ratings and to avoid the certain future cost increases that would otherwise result if APS’s credit ratings were down graded.

As part of the interim rate decision, the ACC asked APS to target additional cost reductions of at least $20 million. We have assured the commissioners that the company will meet their target. We are completing that review and as Jim mentioned, we plan to file the required report with the ACC by March 18.

Clearly the most significant regulatory related item is APS’s general rate case pending at the ACC. As a reminder we have requested a net increase in annual retail revenues of $278 million to become effective October 1 this year. The net increase represents a base rate increase of $448 million, less $170 million of fuel related revenues that would be reclassified from the existing PSA.

The request is based on a rate base of $5.4 billion as of December 31, 2007, a return on equity of 11.5%, and 46% to 54% debt-to-equity capital structure. The filing also includes several proposed methods for reducing regulatory lag and the resulting earnings attrition. On December 19 the ACC staff and interveners in the rate case filed their initial written testimony.

The ACC staff recommends a net increase of $166 million based on 11% return on equity and APS’s proposed capital structured, as well as number of cost test allowances and test year adjustments. The residential utility consumer office or RUCO recommends no net rate change after reclassification of a $170 million of PSA revenues to base rates and a coalition of commercial and industrial customers recommends a net rate increase of $215 million.

In late January, we began settlement discussions with the ACC staff and other parties to the general rate case. On February 4, the administrative law judge suspended for at least 30 days, the traditional procedural schedule that had been established for the case.

APS or the staff is to make a filing prior to the end of the 30 days suspension period updating the commission on the status of the settlement discussions and recommending appropriate procedures going forward. Because we are in the early stages of the discussions, we cannot predict whether settlement of the case will be possible.

The third regulatory topic outlined is setting of the 2009 PSA annual adjustor rate. The adjuster rate will be $5.3 mills per kilowatt hour for the 12 months that began February 1, 2009. This rate was slightly higher than the $4 mills per kilowatt hour that was in effect through the presiding 12 months. With the enhancements to our PSA that were proved by the commission in mid 2007, we’re in a much better position with respect to fuel cost recovery than in previous year. At the end of 2008, APS had accumulated PSA deferrals of only $8 million.

Turning to growth in our service territory and resource plans, growth in Arizona continues, albeit much slower during the current economic environments than the robust levels we are accustomed to. Historically, Arizona’s growth slows during national economic downturns and accelerates after recessions.

In 2008, APS customer base grew 1.4%, down from the 3.3% growth we had in 2007. We are currently projecting annual customer growth around 1% for the next couple of year, with an increase in the rate of growth thereafter.

Looking at the longer term, we currently project that customer demand in 2025 will be more than 50% higher than today. As such, we must continue planning to serve Arizona’s growing energy needs.

Throughout 2008, we talked about our resource planning initiative, an extensive series of workshops and meeting with stakeholders through the state to obtain input and to build public understanding of the options and challenge we face in Arizona as we plan for and acquire energy resources.

Late last month we filed ASP’s resource plan with the commission. In working with the commission, the steps we now will take will provide for Arizona’s energy future. They will also provide energy security for customers, reduce climate effects and position Arizona as a renewable energy leader for decades to come.

The primary recommendations with the resource plan include, first increasing the role of renewable energy resources such as solar. We will accelerate the development of renewable energy and propose to exceed the current renewable energy standard requirements.

Second, providing opportunities for all customers to improve energy efficiency through commission approved programs and finally leveling off fossil fuel consumption and continue evaluating the potential for future nuclear power to serve base load growth needs beyond the year 2020.

Turning to our recent operating performance, as Jim indicated SunCor’s operations have been affected by the distressed state of the real estate markets nationally and the limited financing available for developers and potential purchasers. Our overall objective at SunCor’s is to maximize the value of SunCor’s assets.

Credit and real estate market conditions necessitate that we undertake reevaluation of SunCor strategy, including the markets in which that operates and this is a process which is under progress. While our reevaluation’s not complete, a reshape of SunCor is likely to be more focused and more agile; if conditions in the broader economy or the real estate markets worsen, or as a result of a change in SunCor strategy, we maybe require to record additional impairments.

Looking at our nuclear plant performance, the combined capacity factor for the Palo Verde units for the full year of 2008 was 84%, up from 79% in 2007. For the fourth quarter of 2008, site average capacity factor was 74%, compared with 57% in the comparable quarter a year ago.

The fourth quarter capacity factors were affected primarily by planned refueling outages, Unit 1 in 2008 and Unit 3 in 2007. Of note, the 2007 Unit 3 refueling outage was an extended outage, because it included the planned replacement of the steam generators, low pressure turbines and core protection calculators. The outage represented the completion of our program to replace this equipment in all three Units.

Palo Verde has two refueling outages each year. During 2009 Unit 3 is scheduled for a 40 to 50 day outage in the spring and in the fall Unit 2 is scheduled for an outage of about 60 days, which will be with the outage during which we replace that units reactor vessel head and install a new rapid refueling package. We plan to make similar improvements in the other units in 2010.

We were making substantial progress on site improvement plan and we continue working very closely with the Nuclear Regulatory Commission at all levels to ensure that all issues at Palo Verde are being addressed. We’re committed to returning Palo Verde to sustainable first quartile performance in all aspects of safety and operations. Currently, we expect the NRC confirmatory action letter to be cleared and Unit 3 to be moved out of column four of the NRC’s over site matrix later this year.

Our coal fired plants continue to operate superbly, performing at the upper end of the industry’s top quartile. During 2008, the coal plants posted an 86% capacity factor, which was comparable with their 2007 performance and well ahead of the industry average as 75%. This achievement was led by our Four Corners and Cholla Plants.

Four corners posted a site capacity factor of 86%; while APS’s Cholla units recorded a capacity factor of 87%. Four corners Unit 3 set a new record, with a 94% capacity factor as did Cholla’s Unit 3 with a 91% capacity factor for the year. Our delivery business had one of the best years ever from a reliability perspective, continuing its tradition of industry top quartile performance.

Our retail customers experienced a record low average number of service interruptions per customers. Employees throughout our organization are focused on operational excellence. We work hard to maintain top-notch customer service and we continually strive to raise the bar even higher, constantly improving efficiency and effectiveness in every aspect of our business.

As most of you know, Bill plans to retire from our company at the end of April, marking the end of a very successful 38 year career. During his career, Bill has provided strong leadership and tireless energy in our company and throughout the communities we serve.

He has guided the company through many milestones, since becoming President and CEO in February 1997, including managing the period of the fastest growth in the company’s 123 year history, while performing at record efficiency and elevating our service to top tier levels, and navigating significant regulatory transitions including a move to the edge of competition and then return to traditional regulation after the failed California deregulation experiment.

On a more human note, the Pinnacle West family of companies have a truly unique culture that embraces integrity, innovation, trust and respect. Everyone who works here knows that Bill Post champions that culture and that culture will be one of his enduring legacies. Bill, thank for your contributions, you’ll be missed.

Finally, as the incoming Chairman and CEO of Pinnacle West, I want to ensure our investors of our Boards and my management team’s commitment to driving shareholder value. As Jim mentioned, interfolded with that commitment, we fully understand the significance of the current dividend level and the prospects for dividend growth over the longer term as part of the Pinnacle West shareholder value equation, and we are committed to preserving that value. Going forward, I believe both our earnings levels and our focus on strong liquidity, will allow us to stand firmly behind that commitment.

Now, I’ll turn the call back to Bill to wrap it up.

Bill Post

Thanks, Don. As this is my last earnings call, I would like to thank all of you for your interest in Pinnacle West and many of you for your investment in our company. I appreciate the opportunity I’ve had to work with all of you and with some of you it’s been a relationship that goes back several decades.

My decision to retire was not an easy one, because it’s been my privilege to work with many wonderful people, in our industry and obviously with the dedicated people of Arizona Public Service Company and Pinnacle West. It’s also been an honor for me to serve the customers of our company, and the residents of my home state.

We take our obligations to you, our customers and our employees, very seriously and I’m very confident that under Don Brandt’s strong leadership, we will continue to do so. He alone with Don Robinson and the entire management team are very focused on providing high performance and I have absolutely no doubt that Pinnacle West will continue to do so.

Thank you for your time, thank you for your attention and we would now be happy to answer all of your questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from the line of Paul Ridzon from Keybanc. Your line is open.

Paul Ridzon - Keybanc

Good morning. I just had a couple of questions. How much equity is now left at SunCor?

Jim Hatfield

SunCor’s equity now is $263 million.

Paul Ridzon - Keybanc

Just a clarification here; your ’09 and ’10 guidance assumes that SunCor’s G&A losses are offset with some level of property sales?

Jim Hatfield

That’s not what we’re seeing specifically. Right now as Don mentioned, reviewing SunCor’s operation, going forward, the impact to the P&L will be dependent upon the route that’s ultimately taken so with that sort of sort of still underway, we’re making no assumptions about SunCor and once that is done we’ll comeback and update SunCor’s impact for ’09 and ’10.

Paul Ridzon - Keybanc

What was kind of the G&A run rate at SunCor at that 12/31/08?

Jim Hatfield

The G&A run rate at 12/31 was about $44 million pretax.

Paul Ridzon - Keybanc

$44 million?

Jim Hatfield

Yes, for the year, pretax.

Paul Ridzon - Keybanc

So about $0.25?

Jim Hatfield

Roughly, yes.

Paul Ridzon - Keybanc

Then the guidance does not include the forced $20 million of O&M savings, because that's still under review?

Jim Hatfield

That’s correct and one thing I want to point out; it may not be totally O&M, it maybe part capital, maybe part working capital. So, instead of just assuming the impact to $20 million, we will update that. Once we’re through with our review and we reported at the commission which will be March 18.

Paul Ridzon - Keybanc

On a percentage basis, what percent of that $20 million do you think is going to flow through the P&L?

Jim Hatfield

I would say since we’ve already cut somewhere around $20 million net of capital, the large majority of it will flow through the P&L either as O&M or working capital would be my guess at this point.

Don Brandt

This is Don, you used the term forced and they did order us to that, but we’ve had a long history of trimming expenses and you saw that last year in 2008 and 2007 and years before that and in my remarks to the commission at the opened hearing, I told them we would substantially exceed that $20 million. That’s part of the way we do business here. They wanted to see it. We were going to deliver it anyway.

Paul Ridzon - Keybanc

Is it substantially exceeding incorporating guidance?

Don Brandt

No.

Paul Ridzon - Keybanc

So, it’s 230 plus something substantially more than $20 million. Is that the right way to look at it?

Don Brandt

Yes, depending on your definition of substantial; but yes it will be more than $20 million.

Paul Ridzon - Keybanc

Thank you very much for the clarification.

Operator

Your next question comes from the line of Andrew Levy from Incremental Capital. Your line is open.

Andrew Levy - Incremental Capital

Hello.

Bill Post

Good morning Andrew.

Andrew Levy - Incremental Capital

Hi, how are you doing? Sorry about that. Just going back on the dividend, I understand your commitment to it and I understand obviously your 2010 guidance incorporates the full amount of the rate increase right, if I read correctly in your statements as well?

Jim Hatfield

The 230 incorporates only the interim…

Andrew Levy - Incremental Capital

The 2010 that $3 number incorporates?

Jim Hatfield

That would include the full asset, yes.

Andrew Levy - Incremental Capital

Okay, which is like $200 million. What happens if you get half of it, which is actually fairly generous in the regulatory world in this aspect of what’s going on? Are your statements on the dividend still valid or your dividend is depended on revenue relief from the commission.

Bill Post

In this particular circumstance I wouldn’t agree with your assertion that half is generous, but with that said, yes we believe going forward we are still comfortable with the dividend.

Andrew Levy - Incremental Capital

Based on full rate relief or based on partial rate relief?

Bill Post

Even based with partial rate relief

Andrew Levy - Incremental Capital

Okay, thank you very much.

Operator

Your next question comes from the line of Ed Heine from Catapult

Ed Heine - Catapult

I had a few quick question; first, just to clarify, sorry to be the dead horse on this, but on the SunCor are you excluding just the impairment charges from your guidance or are you excluding SunCor altogether because there maybe an operating loss for the next couple of years.

Jim Hatfield

Well, that’s certainly not the case in ’10. I think in 2009 were excluding SunCor in totality at this point, because the P&L impact will be depended upon the ultimate course that’s chosen, as Don said it’ll restructure of the business. We continue to believe that 2010 will be a challenging year on the real estate and 2010 we assuming zero operating results from SunCor.

Ed Heine - Catapult

Okay, so in 2010 you’re assuming that it’s a breakeven business, ex any charges. Then does that relate to -- you mentioned that you finally got this refinancing and that there maybe some actual forced divestures; is that basically you are going to be forced to sell a portion of your assets this year at kind of prices you would rather not, just to meet the covenants in that renewal.

Jim Hatfield

Well, the refinancing steps down the available capacity over time, and so in this environment the way to be able to achieve that is to divest itself of assets that they move throughout the year. That’s not to say that SunCor doesn’t have assets and the value today is greater than book, but obviously if you look at what’s happened in home building and raw land, we’ve seen a deterioration of that market value. So we’re taking the impact of that as well.

Ed Heine - Catapult

Then actually just a quick question on, just some details on this earning drivers that you gave out. On the 2008 to 2009 you are talking about a $0.35 to $0.45 step up from gross margin; could you give us a little color on what the break out is there. Because if I do the math on just the $62 million of interim, that gets you to kind of the full 45 and I think if you just look at the stub piece of the TCA charge or the transmission charges you have, that’s another $0.15 so. Can you give us a break out, give us a feeling and then why are purchase power costs going up, if gas is going down.

Bill Post

Sure, you’re right on the interim increase. The transmission revenue increase we have is about half of what you assumed and keep in mind we have significantly slowed transmission build because of the slowdown in customer growth. The other offset to that would be, as we look at where we’ve hedged and gas prices continuing to fall, we expect there will be some mark-to-market decline in 2009, reflecting the 10% of our non-detained sharing.

Ed Heine - Catapult

Okay, so you’re going to take a negative mark-to-market hit because you’re hedged at higher prices in the PSA and gas continues to fall.

Bill Post

That’s correct and that’s based on today. Obviously we’ve seen that turnaround throughout the year, so.

Ed Heine - Catapult

But that $0.35 to $0.45 includes that mark-to-market hit.

Bill Post

Correct

Ed Heine - Catapult

Okay and then, I’m sorry, just on the TCA, not to get in too much detail, but I think you got a $30 million increase in March of last year and then another $13 million halfway through July, so even just if you pro rata, shouldn’t there be just another $17 million from the full year effect of those.

Becky Hickman

Ed this Becky; you got most of it before they had a use period and the transmission rate increases actually seasonalize, so most of it was in effect for the summer last year.

Ed Heine – Catapult

Okay, I got you. Thank you very much. I appreciate it. Congratulations, Bill.

Bill Post

Thank you.

Operator

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

Yiktat Fung - Zimmer Lucas Partners

Good morning.

Don Brandt

Good morning, Yiktat.

Yiktat Fung - Zimmer Lucas Partners

Hi, I’m just wondering if you could comment on your needs for any external equity within the next two years.

Don Brandt

Well, as we said in prior calls, the equity we need will be depended upon really two key factors and one is the general rate case outcome, as well as our ability to reduce capital and O&M expenses. We’re not going to know, what equity we need if any, until we get to this regulatory cycle. So, to the extent we need any, I would think it’s a 2010 event and not a 2009 event.

Yiktat Fung - Zimmer Lucas Partners

Okay and do the sort of guidance numbers for 2010, assume any sort of equity issues?

Don Brandt

Yes, they do.

Yiktat Fung - Zimmer Lucas Partners

Okay and how much is the impact of that?

Don Brandt

The impact in 2010 is embedded in the $0.10 to $0.15 miscellaneous, other items net on your reconciliation.

Yiktat Fung - Zimmer Lucas Partners

So the $0.10 to $0.15 is the dilution.

Don Brandt

Well, it’s not just that, there’s other items in there as well, but it’s embedded in there.

Yiktat Fung - Zimmer Lucas Partners

Okay, can you break out which part is dilution? Is it half of it or…

Don Brandt

It’s about half of it, yes.

Yiktat Fung - Zimmer Lucas Partners

I think you talked about before that you’re fairly comfortable with your dividend. What are your thoughts on your pay out ratio, given that you’re guiding to 2.30 in 2009?

Don Brandt

Well, obviously we look at 2009 as an aberration really. When we say we’re strongly committed to dividend, we’re really looking at the growth potential of APS overtime. The one factor that goes into that obviously is getting substantial rate relief to compensate us for the capital that’s being put in the business.

I think long term as you think about the growth that an APS has, we’ll be comfortable with ultimately a pay out of 60% to 65% of dividend to retain as much capital for growth, but still compensate investors in the yield and obviously that implies that we have ways to get to the next opportunity to increase dividends.

Yiktat Fung - Zimmer Lucas Partners

Regards to the renewed SunCor revolver, I think you mentioned that the capacity decreases overtime. Can you be a bit more specific on that?

Don Brandt

Well, the capacity was 150, it’s 125. They are underneath that in terms of current borrowings and it steps down overtime to about $85 million at the end of 2010; it’s just had periodic step downs.

Yiktat Fung - Zimmer Lucas Partners

Okay and how much borrowings do you have under that revolver?

Don Brandt

We have about $100 million at December 31.

Yiktat Fung - Zimmer Lucas Partners

Okay, so basically you just need to trim it by about $50 million to hit that lower capacity number of $85 million.

Don Brandt

That’s correct.

Yiktat Fung - Zimmer Lucas Partners

Okay and as for the mark-to-market impact that you were talking about in the 2009 guidance, that’s embedded in the gross margin; how much is embedded in that figure?

Don Brandt

Well, we have potentially within that range up to about $0.07 of higher mark-to-market, but obviously that’s going to be depended upon ultimately gas prices, which continue to fall today.

Yiktat Fung - Zimmer Lucas Partners

Okay and just one final question, you said you still expect about 1% customer growth in 2009 and 2010, is that correct?

Don Brandt

Correct.

Yiktat Fung - Zimmer Lucas Partners

Is there any expectation for usage declines to offset that growth?

Don Brandt

We have not seen that heretofore. If you look at residential, we’re not seeing usage increases at this point, but certainly not decreases; we’re seeing usage a pattern pretty flat in the C&I, especially the smaller customers in that category. So, at this point we’re just assuming no growths and usage per customer, but with continued smaller customer growth, I mean in the next couple of years anyway.

Yiktat Fung - Zimmer Lucas Partners

Okay so the usage decline that you saw in 2008 that’s mainly due to weather, is that correct?

Don Brandt

Well, it’s weather and there is some in the fourth quarter, but keep in mind that in the third quarter we saw customers up seven tenths of 1% on a per customer basis, so that’s going to vary with a lot of factors and the weather is not a perfect number.

Yiktat Fung - Zimmer Lucas Partners

Okay, got it. Thank you so much.

Operator

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

Paul Patterson - Glenrock Associates

Hi, guys how are you?

Jim Hatfield

Fine, Paul.

Paul Patterson - Glenrock Associates

Congratulations Bill.

Bill Post

Thanks Paul.

Paul Patterson - Glenrock Associates

On the expectation for trading and marketing in 2010, what are those? Are those just basically flat with the expectation 2009?

Bill Post

Yes. Marketing and trading here is not a significant line item.

Paul Patterson - Glenrock Associates

Okay, and the $200 million plus of common equity or equity in the SunCor business. I believe the total assets in the 10-K were around $460 million, is that correct?

Bill Post

Yes, that’s $493 million.

Paul Patterson - Glenrock Associates

Now, is the debt, I assume it’s a reason of that debt that’s offsetting the asset there, is that recourse back to Pinnacle?

Bill Post

No, there is no hook at all between SunCor and APS or Pinnacle West, either to recourse or cross defaults or any other mechanism.

Paul Patterson - Glenrock Associates

Okay, and then just finally just if you could refresh and I apologize for this because I got slightly distracted. On the O&M that you guys are planning on reducing, but isn’t in guidance, could you just refresh what that amount is?

Bill Post

I’m sorry, would you say that again Paul.

Paul Patterson - Glenrock Associates

I believe there was some O&M reductions that you guys are not including in guidance, correct?

Bill Post

Yes, we were referring to and responding to the commission request, but we continue to look at our operations and expenses with the goal to reduce that by $20 million.

Paul Patterson - Glenrock Associates

Okay and that would be in what year?

Bill Post

2009.

Paul Patterson - Glenrock Associates

Okay, and what would you think it would be in 2010 or would it be?

Bill Post

Well, what we intend to do is do sustainable cost reductions. So, for the most part we would expect anything we get in ’09 carries over.

Paul Patterson - Glenrock Associates

Okay, but there wouldn’t be anything more, is that right?

Bill Post

We are not planning any. I will say this company has a culture of cost consciousness and we’re always looking at ways to improve productivity and become more efficient. So, that’s something that’s embedded in our core.

Paul Patterson - Glenrock Associates

Sure. I guess what I’m wondering here is; now we’re in February, this is under review and apparently not in guidance, do I understand that correctly?

Bill Post

Correct.

Paul Patterson - Glenrock Associates

Okay and that would indicate to me that it hasn’t been implemented yet. So I guess I’m just wondering whether or not, if you’re able to effectuate that in 2009, whatever those reductions would be, I’m just trying to figure out how we should think about (a) I guess the fact that it isn’t in guidance indicates you’re not putting it in there because it’s still under review and you’re not certain about it, but I guess I’m wondering, would there be any carry through from an annualized basis into 2010 or do you follow me?

Bill Post

No, I expect we’ll achieve the $20 million in calendar year 2009. Some of it’s already been implemented.

Paul Patterson - Glenrock Associates

Okay, so it is already been implemented.

Bill Post

And some of it is being identified for implementation. So, I know its March, but I don’t think you can think of it as 9/12, so the number gets implemented in ‘09 and to carry over to ‘10, we are expecting the $20 million in ‘09.

Paul Patterson - Glenrock Associates

And I’m sorry to be so slow, why is it not being included in guidance?

Bill Post

The $20 million has not been totally identified, nor have we reported it to the commission yet.

Paul Patterson - Glenrock Associates

Okay, I appreciate it guys. Thanks a lot.

Bill Post

Thanks.

Operator

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

Jonathan Arnold - Merrill Lynch

Good morning guys. Just a few housekeeping type questions, just to ask you to refresh us on what level of CapEx we should be thinking about and then how much additional flexibility you feel you might have in that, given the kind of sales assumptions you are making?

Don Brandt

Well, our CapEx in total is going to be about $900 million, which is consistent with what it was in 2008. I think $906 million total in ’08 and the same in 2009. APS is going to be the majority of that, about $883 million and in terms of flexibility we are always looking at our CapEx and obviously to the extent you see continued slowdown, that will drive that CapEx number down.

We think we’ve done a pretty through job last year, when we did the review of CapEx that led to the $720 million gross, $520 million net, after the customer charge, but we will continue to spend money prudently, especially when we’re in a period of earning 8% of return on equity.

Jonathan Arnold - Merrill Lynch

Thank you.

Operator

Your next question comes from line of Julian Dautremont-Smith from UBS.

Julian Dautremont-Smith - UBS

Hi, good morning.

Bill Post

Good morning.

Jim Hatfield

Good morning.

Julian Dautremont-Smith - UBS

Would you mind running through the various scenarios that could play out with regard to the SunCor and the review and what are the possibilities, what are the timeframes we’re talking about there?

Bill Post

We’re in the process of the review. We’re not completed and there is nothing that’s not on the table.

Julian Dautremont-Smith - UBS

Okay, I mean I was just looking as to are there potential scenarios that you could disclose? I mean what avenues, and maybe a second question unrelated would be in light of the continuing economic deterioration, has that affected your IRP that you filed recently and particularly with regard to your future needs for our base load nuclear or anything like that?

Bill Post

No, I think in developing our resource plan we’ve taken into the account the slowdown that’s in customer growth that’s occurred. It started last year in a significant way and is expected to continue for the next few years, so that was factored into the resource plan as we filed it at the end of the year.

Julian Dautremont-Smith - UBS

Just one last detail, with regards to the base load nuclear that you alluded to in IRP, would it be possible to add another unit at Palo Verde or any preliminary thoughts in that regard?

Bill Post

Well, ours is a very high level look at nuclear as an option and again beyond the year 2020. Palo Verde was originally designed the site for five units and there are three there now, but that we’re not limiting our review to just a Palo Verde site.

Julian Dautremont-Smith - UBS

All right great. Well, thanks again for the time this morning.

Bill Post

Thank you.

Operator

Your next question comes from Danielle Seitz from Seitz Research.

Danielle Seitz - Seitz Research

Thank you. I was wondering if the fuel reduction that you have mentioned in your rate case could be actually larger and therefore would help settlement discussions when you approach October.

Bill Post

Well, Danielle to the fuel cost reductions will effectively flow through to customers in the PSA. So, naturally any and all reductions to customer, the costs that are borne by customers, helps customers and it’s good for APS also.

Danielle Seitz - Seitz Research

I was just wondering if the settlement, if the new commission would actually favor a settlement of the case given the fact that they are like new to the system?

Bill Post

We already are very new and we’re pursuing this settlement and we think it’s a worth while endeavor at this point.

Danielle Seitz - Seitz Research

And you are actively optimistic it’ll be successful there?

Bill Post

Well, it’s still very early in the process. We wouldn’t be pursuing it if we didn’t think it will worth while and ever.

Danielle Seitz - Seitz Research

Great, my other questions have been answered and I just wanted to wish Bill, Bon Chance, it was a pleasure working with you.

Bill Post

Thank you, Danielle. I appreciate that and I enjoyed working with you, thanks.

Operator

Your next question comes from line of Rick Chauvin from GL Partners.

Rick Chauvin – GL Partners

Hi, how are you?

Bill Post

I’m good. How are you?

Rick Chauvin – GL Partners

Good, thanks. Thanks for taking it. I just wanted to ask a question with regard to the wholesale sales. I noticed that there was a big drop off in wholesale sales year-over-year and I was just wondering what that was attributed to and then also how it impacts the utility in anyway or even if there is an impact?

Bill Post

Rick, we had talked about for the last several years about a relatively large contract. Actually there were two to three of them, but the vast majority of it was is in one, then that contract rolled off last year and we don’t expect to have something to duplicate it and as Jim indicated, marketing, trading going forward would be relatively minor and flat.

Rick Chauvin – GL Partners

Just a follow-up, how are the wholesale sales treated as part of like the rate setting mechanism; are they deducted from the fuel cost? I mean how does it work with regard to the utility?

Bill Post

It depends on the nature, but most of them are segregated. It’s as wholesale jurisdictional sales.

Rick Chauvin – GL Partners

So those would go above and beyond the ROE of the utility, is that how we should look at it? I guess what I’m saying is, if you built more generation and you had a tremendous excess of power, would that be included as part of the ROE of the utility or would that be excess?

Don Robinson

This is Don Robinson. The off system sales that we make are traditionally treated through the PSA. So, we get to keep the 10%, but the customers would get the other piece.

Rick Chauvin – GL Partners

Okay, great thank you very much.

Operator

Your next question comes from Veeza Hedafi from Decade. Your line is open.

Veeza Hedafi - Decade

Thank you very much. What is the expected O&M growth in 2009 and 2010 as part your guidance?

Bill Post

That the guidance at this point for O&M is about a 4% increase, 5% increase year-over-year; you going to take out the rez and the other things when you look at O&M, because they tend to skew the number.

Veeza Hedafi - Decade

Okay and what is the tax basis on SunCor?

Bill Post

It’s relatively close to book value.

Veeza Hedafi - Decade

Okay great and you I know you have been asked this question a couple of times, but is the complete sale of SunCor on the table, is that one of the options?

Bill Post

We’re considering all alternatives.

Veeza Hedafi - Decade

You mentioned mark-to-market hurting your 2009 earnings guidance. Is that mark-to-market only associated with the 10% in the 9010 fuel cost or is it generally across the board mark-to-market head?

Bill Post

No, it’s the 10% piece of the fuel, that 90% flows through as a mechanism under the PSA.

Veeza Hedafi - Decade

Okay, so to confirm it’s just your exposure on the 10% of worth. I think you said like 7% or something?

Bill Post

Yes, that’s correct.

Veeza Hedafi - Decade

And then that goes away and there’s no mark-to-market in your 2010 guidance?

Bill Post

There is a slight mark-to-market decrease in ‘10, but keep in mind that’s based on a forward curve and if gas prices go the other direction, obviously those will evaporate. As we say in the first half and second half of the year, they swing from benefit to a loss.

Veeza Hedafi - Decade

Okay great, thank you very much.

Operator

Your next question comes from the line of Asses Liggleman , Millennium Partners. Your line is open.

Asses Liggleman - Millennium Partners

Hi guys.

Bill Post

Good morning.

Asses Liggleman - Millennium Partners

Good morning. I had just three quick questions. Can you breakout the write-downs relative to the housing units versus the commercial units that you guys have?

Bill Post

Yes. I’ll be going to do that. There were really two components to the impairment charge. Of the $53.3 million pretax, $23.8 million was the Bridgeview Condos part of the Hayden Ferry complex in Tempe. Because, they are condos and if you remember, this is the second condo building they built, the first one sold out relatively quickly. These are held for sale and under the held for sale accounting rules those for mark-to-market. It’s impacted by everything that’s going on the real estate market.

The rest of it, the pretax charge which is equivalent to $29.5 million related to various residential and commercial, either home building, golf courses or just raw land or office building throughout SunCor territory that are held for sale, but failed the fair value test under144 and so they were written down as well.

Asses Liggleman - Millennium Partners

Okay, what kind of cash burn do you think you guys are going through in SunCor to restructure the business?

Bill Post

Well, I think it depends on the ultimate path of restructuring. Obviously, status quo isn’t a sustainable business plan in this environment and so first and foremost we would look to minimize cash burn, because cash is king.

Asses Liggleman - Millennium Partners

Okay and just last question, on the pension, you guys are doing a treasury swap. What kind of collateral do you guys need to put up against that? Who is the counterparty for the swap and considering the reversal that happened since the beginning of the year in the treasury markets, how does that affect your pension expenses going forward?

Jim Hatfield

Well I guess, I’ll say three things: one is we unwound the swaps in January to preserve the gain. Second of all, there was no collateral involved, our investment manager just went out and executed swaps in the marketplace. So I mean we bought the swap instrument, there was no collateral need on our part and the counterparties, we don’t know exactly who they are because they were done through the investor manager just in the marketplace, but those swaps were now gone.

Don Brandt

We have a $497 million gain that was locked in.

Asses Liggleman - Millennium Partners

Okay. Thank you very much.

Operator

Thank you for your questions. Now I’d like to turn the call back to our host for closing remarks.

Rebecca Hickman

This is Becky. I want to thank all of you for being with us today and if you have any follow-up questions, please call me or Lisa Malagon. Thank you very much.

Bill Post

Thank you.

Operator

This concludes today’s conference call. You may know disconnect.

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Source: Pinnacle West Capital Corporation Q4 2008 Earnings Call Transcript
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