Seeking Alpha
We cover over 5K calls/quarter
Profile| Send Message|
( followers)  

Pinnacle West Capital (NYSE:PNW)

Q3 2007 Earnings Call

October 25, 2007, 1:30 pm ET

Executives

Rebecca Hickman - Investor Relations

Bill Post - Chairman and Chief Executive Officer

Don Brandt - Executive Vice President and Chief Financial Officer

Jack Davis - President and Chief Operating Officer

Analysts

John Kiani - Deutsche Bank

Greg Gordon - Citigroup

Dan Eggers - Credit Suisse

Paul Patterson - Glenrock Associates

David Thickens - Deephaven Capital Management

Andrew Levi - Brencourt Advisors

David Grumhaus - Copia Capital

Shalini Mahajan - UBS

Danielle Seitz - Dahlman Rose and Company

Reza Hatefi - Polygon Investment Partners

Operator

Good afternoon. My name is Andrea, and I will be your conference operator today. At this time, I would like to welcome everyone to the Pinnacle West Third Quarter Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speaker's remarks there will be a question-and-answer session (Operator Instructions).

Thank you. Ms. Hickman, you may begin your conference.

Rebecca Hickman

Thank you, Andrea. I would like to thank everyone for participating in this conference call to review our third quarter earnings, recent developments and operating performance.

Today, I have with me Bill Post, our Chairman and CEO, Jack Davis, who is our President and Chief Operating Officer, and also CEO of Arizona Public Service, and Don Brandt, who is Executive Vice President and CFO of Pinnacle West and also President 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 experiences and quarterly operating statistics.

Second, please note that all of our references today to per share amounts will be after income taxes and based on diluted shares outstanding. Is it my responsible to advise you that this call will contain forward-looking statements based on current expectations and the company assumes no obligations to update these statements.

Because actual results may differ materially from expectations, we caution you not to place undue reliance on these statements.

Please refer to the caption entitled forward-looking statements contained in the MD&A and our second quarter 2007 Form 10-Q and the risk factors in our 2006 Form 10-K, each of which identifies some important factors 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 November 1st.

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 written consent is prohibited.

At this time, I will turn the call over to Bill.

Bill Post

Thank you. And I would like to thank you for taking your time to join us today. I’ll highlight several issues and then turn the call over to Don and Jack to discuss details of our financial results, our regulatory developments and our operations.

First, I would like to address our management changes. Last week Jack announced his plan to retire next March, completing a very successful 35-year career with the company. Throughout his career, Jack has focused on meeting the demands of the remarkable growth that our company, through excellence and resource additions, customer service and operations.

Through his leadership Jack successfully maneuvered our company through periods of record growth and significant industry turmoil, including the western energy crisis.

Although we intend to take advantage of Jack's expertise during his remaining time with us, we know he has built a strong team that will carry on his commitment to excellence. And since he is here with us today, I would like to say, publicly, Jack, thank you for all of your contributions. You will be missed.

Our success in planning has been in place and as you know Don Brandt was named President of APS last December. Upon Jack's retirement next March, Don will take the helm as APS' President and CEO.

Don's commitment to our customers and investors is exceptional. Further, he is keenly aware of APS' challenges and opportunities and we look to him to continue emphasizing excellence in customer service and all of our operations.

As we described to you earlier, we have been taking a hard focused look at our organization for opportunities to be more effective and efficient and maintain a steadfast focus on our customers and to ensure that we have clear lines of accountability for results.

With that in mind, we also recently made a number of additional internal management changes that we believe will streamline and strengthen our organization, and Don Brandt will discuss them a little bit later on.

Growth in our service territory has slowed from its pace about a year ago, but still remains strong versus industry averages. APS' customer base grew 3.2% in the third quarter of this year, compared with a year ago and we expect to end the year with customer growth of about 3% over 2006.

On our last conference call, I outlined a multiple-step program to address the issues of growth and the pressure it places on our company. All facets of the program are currently underway and I will briefly summarize the key aspects.

As I said, we are reviewing our capital and operating costs to ensure that we are as efficient as possible. However, we will not reduce our levels of safety, reliability or service. We expect to complete our cost review by the end of the year.

In the regulatory area, our efforts include a FERC transmission rate case and the associated processes to implement result in rates at both the wholesale and retail level.

Retail rate setting options to be presented to the ACC this year to address growth, who should pay for it and how should pay for it and alternative resource plans also to be presented to the ACC by year-end for base load peaking, renewable and energy efficiency resources to meet future load growth. Jack will provide some more detail on the regulatory initiatives.

Finally, we are assessing our need for additional rate relief. The elements of the multi-step program just described will obviously have impacts on APS's revenue requirements and all of these items will be considered and incorporated into future rate funds.

Turning to financial issues, we understand the importance of dividends to our shareholders as a component of total return. We also believe our dividend is essential to maintaining our shareholder base and attracting capital to support our large capital expenditure program and to serve our customers' growing energy needs.

Last week we declared a quarterly dividend of $52.05 per share payable on December 3rd. This represents an indicated annual dividend rate of $2.10 per share. Our dividend policy has been that future dividend levels in growth will be dependent on a number of factors such as free cash flow, payout ratios and industry trends.

Historically, our board has considered our annual dividend level in October and for more than a decade we grew our dividend at a rate well above the industry average. After considering all facets of our current circumstances, we held the dividend at its current level.

Finally, this morning we updated our earnings outlook for 2007. Currently we expect our consolidated earnings for 2007 will be within a reasonable range of $2.90 per share, which is an increase of $0.35 per share from our previous guidance.

Let me now turn it over to Don, who will give you more details on the guidance and other financial updates.

Don Brandt

Thanks, Bill. As Bill said, our consolidated earnings guidance is a reasonable range around $2.90 per share. As part of this guidance we estimate the APS's earnings will be about $2.70 per share, which will produce an earned rate return of about 8.25% for the year.

SunCor's earnings are currently expected to be approximately $20 million for the year. The consolidated guidance we provided in July was an estimate of a reasonable range around $2.55 per share.

The primary differences between our current guidance and the previous guidance are as follows. First, hotter than normal weather during this year's third quarter improved our estimate by $0.14 per share and I will talk a little more about the details of just how hot it was this summer in a few minutes.

Tax benefits related to prior years but resolved during 2007 increased our estimate by about $0.13 per share. Deteriorating credit market conditions in the second half of 2007 have lowered our earnings expectations for SunCor by about $0.10 per share.

The decline at SunCor is essentially attributable to three relatively large commercial and partial transactions that we do not now expect to close in 2007. The net effect of numerous relatively minor factors combined improved our estimate by $0.18 per share.

These factors include such items as, lower effective income tax rate, higher than expected retail sales and lower than projected interest expense. Let me emphasize that not one of these numerous items is notable on a stand-alone basis and that some of them are clearly one-time items, while others are the result of our cost management efforts, and those efforts will continue.

Turning to our third quarter results, for the third quarter of 2007 we reported consolidated net income of $209 million or $2.07 per share, compared with $184 million or $1.84 per share in the prior year quarter.

Two factors dominated the quarter-to-quarter comparison. Extraordinarily hot weather in this year's third quarter and tax benefits related to prior years but recorded in this quarter. First, extreme weather increased our earnings by $0.16 per share.

This year's third quarter was very hot even by Arizona standards. We set some summer weather milestones. We had temperatures at or above 110 degrees on 32 days in the Phoenix metropolitan area. This compares with a norm of 10, 110-degree days in a typical summer. We also had the hottest August on record.

Another key factor was the tax benefits related to prior years that were recorded in this year’s third quarter. These tax benefits improved earnings by $0.10 per share. The other principal factors that affected the quarterly comparison were increased retail sales volumes related to customer growth added $0.10 per share.

APS's July 1st retail rate increase improved earnings by $0.10 per share. The components of this increase are $0.07 per share as a result of lower 90/10 sharing under the PSA due to the higher base fuel rate and $0.03 per share for non-fuel rate increases.

Higher O&M expense cost decreased earnings $0.09 per share. These costs increases were largely driven by customer service and regulatory program costs, as well as higher generation costs including Palo Verde’s performance improvement programs.

Increase depreciation, property taxes and interest cost primarily related to higher APS plant balances in capital spending reduced earnings by $0.07 per share. SunCor earnings of were down $0.11 per share chiefly related to lower sales of residential property and parcel sales compared to the prior year.

These reductions are consistent with the slow down in the western real estate markets we discussed earlier this year, but they were exacerbated by the rapid deterioration in credit market conditions during the third quarter.

Now let me cover APS's PSA deferrals and fuel hedge positions. As of September 30th, APS had $150 million of accumulated PSA deferrals. We expect to recover these deferrals through annual PSA adjusters and surcharges by the end of 2008.

During this third quarter, we deferred $69 million and recovered $58 million through various PSA adjusters and surcharges. As you know, the deferral recovery positively impacts cash flow, but does not affect earnings, because the amount recovered grew revenue also is amortize as fuel expense.

With respect to managing fuel and purchase power cost, our hedge program substantially mitigates natural gas and purchase power price volatility for our customers. As of today, we have hedged about 85% of our remaining 2007 exposure to fuel price risk for negative load requirements.

Similarly we have hedged 85% of our 2008 price risk and 50% of our 2009 price risk. These hedge positions are at prices generally in line with current forward market prices.

Finally, I would like to make a few comments on the management changes Bill mentioned. We have realigned our executive management organization to enhance our focus on customers and to sharpen roles and responsibilities so as to improve accountability and overall performance.

While each of the management changes are significant for APS, there are three changes I believe should be of particular interest to our investors.

First, Don Robinson was promoted to Senior Vice President, Planning and Administration. Second, Tammy McLeod has been named Vice President and Chief Customer Officer. And third, Jeff Guldner has been named Vice President Rates and Regulation.

Many of you have met Don Robinson in our offices and on a few investor road shows. Don is a solid experienced executive and in a number of administrative functions has been centralized under Don, along with importantly our all of our planning functions including resource planning and energy procurement.

Tammy McLeod is Wharton graduate who joined APS in 1995. She has a solid background in customer service programs, marketing and T&D operations. Her responsibilities include system-wide customer service, corporate communications and community development. Essentially every aspect of APS that touches our customers and the communities we serve is under Tammy's direction.

Jeff Guldner, formerly a law partner at Snell & Wilmer here in Phoenix, with an expertise in energy and regulatory law, joined APS about three years ago to run our compliance programs and manage federal regulatory matters. His responsibilities now include all aspects of APS's Arizona and federal rate and regulatory activities.

I have every confidence that these three executives along with the entire APS officer team will lead APS to deliver outstanding service and value to our customers and create value for our shareholders in the many years to come.

I’ll now turn the call over to Jack.

Jack Davis

Thanks, Don. Today, I will update you on recent regulatory developments and operational performance. Although this maybe one of the shortest regulatory updates I have given you in recent past, we continue to be very focused on regulatory issues.

On last quarter's call I outlined the key provisions of the ACC June decision on APS -- on the APS rate case. That decision closed a significant proceeding in our regulatory history. A preceding that lasted some 20 months and resolved a number of significant issues. Principally timely recovery of our fuel and purchase power costs yet other issues continue.

The formula for kilowatt hour PSA adjustment that took effect on February 1st of this year will remain in effect as long as necessary after January 31st of 2008 to collect an additional $46 million of 2007 costs deferred under the PSA as a result of the mid-year implementation of the new base fuel rate. We estimate this adjustment will remain in effect through mid 2008.

Effective July 1st, APS began collecting through a PSA surcharge of approximately $34 million including a crude interest of PSA cost deferrals led to the 2005 replacement power cost for Palo Verde outages. This temporary rate increase will be in effect for a 12-month period.

Regarding 2006 Palo Verde related PSA deferrals, APS deferred $79 million under the PSA related to 2006 replacement power cost for Palo Verde outages. Virtually all of those referrals were associated with the unit one vibration issue.

The ACC directed its staff to conduct a prudent review of the outage costs. Earlier this month the ACC staff filed a report with the ACC concluding that the APS' response to the unit one vibration was reasonable and prudent.

We have been recovering those referrals and will continue to do so through the PSA. On August 7, APS submitted to the ACC a plan to meeting the five years -- a five-year plan of Arizona renewable energy standard.

In addition to projects already in operation or under contract, the plan calls for APS to acquire around 2000 gigawatt-hours of renewable energy between 2008 and 2012. And also I’ll outlines significant increases to APS distributed energy program, which pays customers to install their own renewable generation sources such as solar electric systems or solar water heaters. The ACC staff is currently reviewing this plan and will file a report with the ACC.

As Bill mentioned we are continuing to work on regulatory initiatives related to growth in our state. The ACC commissioners have expressed concerns about how to support the vitality of our state and its remarkable growth. It will also expressed concerns about who should pay for growth and how.

Paying for growth will require some innovation in our rate making policies -- in our rate setting policies. We were developing alternatives to address growth from a regulatory perspective and plan to take them to the ACC this year.

Also before year-end we plan to provide the ACC with resource alternatives to meet future load growth. We will also offer alternative proposals that curve peaking and base-load resources, as well as, renewable and energy efficiency options.

Turning to the federal scene issues for a moment. As I discussed in our last call, APS filed a on July 10, its first transmission rate case with the Federal Energy Regulatory Commission since 1996. The filing asked for a $37 million increase in annual transmission revenues.

The filing also includes a proposal for the FERC to approve a formula rating setting methodology to allow APS to adjust wholesale transmission rates on June 1st of each year.

On September 21st, the FERC issued an order allowing APS proposed transmission rates to become effective on March 1st of next year. And the FERC order also established settlement judge procedures. Initial settlement conference meeting has been held and additional settlement conferences will be scheduled.

However, at this point we do not know where the case ultimately will be settled or go to hearing. It's important to understand at this point that only about $7 million of the annual increase amount would come from wholesale customers and approximately $30 million of increase represents charges for transmission services to serve APS' retail customers.

The ACC approved a transmission cost adjuster mechanism as part of the 2005 rate case decision. We are currently addressing the appropriate procedure to recover the retail transmission rate changes from our customers.

Now let me discuss growth in our market. Growth in our service territory remains solid. Arizona's population grows at three times the national average. That growth is the foundation for our customer growth, which was 3.2% in the third quarter, compared with a same quarter last year.

Customer growth translates into increased sales. APS' third quarter retail sales grew about 6.4% compared with the prior year and on weather normalized basis third quarter retail sales grew 1.9%.

Customer growth also translates into peak load growth. On August 13, we set our system peak for 7,545 megawatts. The peak was right in line with our forecast for the year and reflected a 1% decrease from last year. However, on weather normalized basis the peak was approximately 33% higher than last year.

Last year we set our peak on a day that reached 118 degrees in Phoenix, which happens only once every 10 years. Most important our system operated very well to meet the record peaks.

Now I will discuss our power plant performance. The combined capacity factor for Palo Verde nuclear units was slightly better than 89% for the third quarter this year. Better than the same quarter a year ago. We have two scheduled refueling and maintenance outages at Palo Verde each year.

This year's spring outage of unit one was completed on July 19th. The fall outage of unit three began last weekend in September -- began last week in September. We expect unit three outage to last about 80 days during which we will replace the unit steam generators, low-pressure turbines and core protection calculators.

Unit three will be the final unit to receive the steam generators thus replacing -- thus completing the largest replacement program in Palo Verde. We are aggressively addressing our operations at Palo Verde with a goal return the plant to top tier performance as soon as possible. We are continuing implementation of a thorough self-evaluation of the plant to identify and correct any issues.

In addition, we are working closely with the Nuclear Regulatory Commission to ensure that our plans and procedures for addressing issues are coordinated. The NRC is in the process of completing a rigorous comprehensive inspection at Palo Verde. In the four-week inspection the NRC is taking a detailed look at all areas of the plant's operation. By the end of the year, the NRC expects to issue its inspection report. The NRC findings will be incorporated into our improvement programs.

Our coal fire plants continue to operate superbly. During the third quarter the coal plants posted a 93% capacity factor essentially the same as their performance a year ago. That concludes my prepared remarks and I will turn the call back to Bill.

Bill Post

Thanks, Jack. In summary, we understand what it takes to serve the fastest growing state in the country. Over the years, we have consistently met our customer's growing energy needs and we will continue to do so. That concludes our prepared remarks and we would be very happy to answer your questions.

Question-and-Answer sessions

Operator

(Operator Instructions)

We'll pause for just a moment to compile the Q&A roster. Your first question comes from the line of John Kiani from Deutsche Bank.

John Kiani - Deutsche Bank

Good morning. Can you talk a little bit more about the components of the $0.35 per share guidance increase? I want to just get a better sense for how much of the items that you highlighted in the 8K are recurring or will continue beyond '07. If I look at some of the pieces to me it looks like maybe a subset of the $0.18 other category and then perhaps the higher retail sales is the portion that we could expect to see as a continued benefit. Am I think being that correctly?

Don Brandt

John, this is Don here. To a degree, possibly yes. I hate to be equivocating on that but some of that is potentially attributable to the weather extremes just how accurate splitting weather from growth might be. On that front, but it did surprise us. There was still strong growth there. In my prepared remarks, I just wanted to stress that there -- most of the items individually are not of the recurring type nature. But some of it, about half, or 40% I would put in the category as a result of management efforts.

And those will continue, whether the exact same opportunities will present themselves again in the future periods. Those exact circumstances probably won't be there. But our dedication to the minimizing costs will be and we continue to focus on that. But some of them are really one-time quirks that came out --

John Kiani - Deutsche Bank

That's helpful, Don. Just to be clear. When you say kind of ballpark 40%, do you mean 40% of the $0.18?

Don Brandt

Yes, correct.

John Kiani - Deutsche Bank

Not of the $0.35.

Don Brandt

Hey, 40% of the $0.18.

John Kiani - Deutsche Bank

Got it. Okay. That's helpful. And then just a quick question on SunCor. If we were looking out kind of beyond '07, should we take what's kind of implied by the fourth quarter, which to me seems like about $4 million or so, and extrapolate that and assume that that's sort of the new run rate? Or will those parcel sales you mentioned that are going to get pushed off benefit above and beyond what that math would show?

Don Brandt

Let me address those two different ones. No, you shouldn't take that $4 million run rate and --

John Kiani - Deutsche Bank

Okay.

Operator

Your next question comes from the line of Greg…

Rebecca Hickman

Wait, wait, wait. Andrea, we were still answering Mr. Kiani's question.

Operator

Mr. Kiani, please press star-one again.

Don Brandt

John, John, are you still on?

John Kiani - Deutsche Bank

I'm here. Okay. Thanks, Becky.

Don Brandt

Good save, Becky. The $4 million for fourth quarter, you're about right. That's the way the math works. I would not take that as a run rate going forward.

John Kiani - Deutsche Bank

Okay.

Don Brandt

And I will answer your question the second part a little differently than the way you asked it. But the three deals that failed to close that we thought would close, it doesn't reflect the change in value. It was purely the entities ran into financing problems.

John Kiani - Deutsche Bank

Okay.

Don Brandt

And it was very unexpected I'm sure on their behalf. Anybody who was in the financial markets in early-to-mid August, even our own commercial paper program was a little disruptive for a few weeks. And they put together. Some of them are looking to restructure those deals, take another run at it. But the issue is, one of these commercial deals falls apart, it's not something you put back together in two weeks. It's two to four months’ process. The value is still there for future years.

John Kiani - Deutsche Bank

Got it. That's helpful, Don. Thank you.

Don Brandt

Okay.

Operator

Your next question comes from the line of Greg Gordon.

Greg Gordon - Citigroup

Follow up on John's question and then one other question. Are we -- should we be comfortable that the underlying economic value of those transactions isn't in fact diminished when you come back to re-value those transactions in '08? To put another way, I think we leaned away from valuing the real estate business on earnings and look at more as -- as an asset value play. What do you guys seeing in terms of asset value, and what are your accountants sort of do on a regular basis in terms of trying to assess impairments on the real estate value?

Don Brandt

No. Greg, one, no, we think the long-term value is still there. And relative to the impairment issue, we don't believe there is an issue there. Actually on the parcels that didn't close, the basis is literally a small fraction of the current market value. And even if you take plus or -- 20% plus or minus of those current market values, we are still substantially in the money.

Greg Gordon - Citigroup

Okay. My second question goes to timing of regulatory activity. I know you guys are taking a hard look internally at both your operating and capital costs. At what point will we see you approach the commission again to get rate making treatment, either for the pass through of the transmission revenues that you require, or taking another look at the underlying revenue requirement of the utility?

Bill Post

Greg, this is Bill. As far as dealing with the growth issues, we are going to be dealing with the commission on those growth issues through the rest of this year and probably into next year. And then based upon all of the things I mentioned, we will be taking a look at some kind of potential filing. And it's hard to basically predict that at this point because it depends on several of the things between now and then next year.

Greg Gordon - Citigroup

Thanks.

Bill Post

Good.

Operator

Your next question comes from the line of Dan Eggers from Credit Suisse.

Bill Post

Hello, Dan.

Dan Eggers - Credit Suisse

On your last comment to Greg, what would cause you not file another rate case, kind of given this 825 ROE type of level?

Bill Post

Well, it obviously comes down to our success in dealing with several of the issues that we're dealing with today. One is the growth issue and how the growth issue is dealt with and certainly that could have a substantive impact. I don't believe as I have mentioned we've been going through our expense reviews and I know as you know, Dan, when you benchmark our company on expenses, we perform very, very well.

So we are in a situation there where we are going to drive our costs down as I mentioned as low as we possibly can, but we aren't going to go below levels that have a negative effect on safety or customer service. And cost savings alone will not offset the growth impacts that are placed upon us from new customer growth as we go forward. So savings alone will not offset that.

Our transmission, as Jack mentioned, we filed a transmission rate case, and we expect that to go into effect early next year in the first quarter of next year, and so all those variables kind of come together. But from our standpoint, the big issue's growth and dealing with that on a going forward basis.

Dan Eggers - Credit Suisse

As you have the conversations with staff, with parties, with commissioners about addressing growth, is it a bit of a challenge to get too far down the path of the conversation given the fact that three of the commission's seats will be different by the time you could actually get an effective rate case done?

Bill Post

Well, our commission as you know, it's an elected commission and every two years we will have either two or three seats up for election. That's been the case in terms of election for some time. And the timing of these decisions in my memory has never been affected by that.

More specifically, as we have put forward rate cases that went as this one did over some months. It did not impact the new commissioner's ability to be able to engage on that and to deal with that issue. And I don't expect it will going forward.

Dan Eggers - Credit Suisse

Don, do you happen to have right now where the equity ratio was at APS at the end of third quarter?

Don Brandt

No, I don't.

Dan Eggers - Credit Suisse

And I guess lastly just kind of as we think about -- start thinking about '08, more actively the drivers, some help from loads, some help from cost savings, some help from implementation of this year's rate case resolution, those will all be positives. The negatives are going to be a more normalization of tax rate and higher financing expense. Is that fair?

Don Brandt

Yes.

Dan Eggers - Credit Suisse

Is there anything else we should be thinking about right now?

Don Brandt

Well, let me start by a couple of things. Relative to '07, is jumping back there. I said in the last call that we'd expect an increase in O&M expense pre-tax $10 million to $15 million a quarter. And whereas the third and fourth quarter and I was doing simple math dividing by two and for the third quarter we were up about $5 million pre-tax.

So we still see that number on O&M coming to fruition for the year. In the fourth quarter we will see an increase pre-tax of -- in the neighborhood of $25 million. In addition to that, something in the fourth quarter, and in future quarter’s kind of a run rate on capital-related expenses as I will categorize them, and there is depreciation property taxes and interest expense is about a $0.10 per share quarterly impact going forward is the cost of new plants going into service.

Dan Eggers - Credit Suisse

Okay. Thank you.

Operator

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

Bill Post

Hello, Paul. How are you doing today?

Paul Patterson - Glenrock Associates

All right. Just to clarify things here because I sort of -- it was coming in, I don't know if it's on my phone, but I wasn't able to hear everything completely. It sounds to me like about 40% of the $0.18 is non-recurring in your estimation with respect to the guidance number that is sort of miscellaneous?

Don Brandt

No, I think it was the opposite. I'm not sure I'd categorize 40% of it as recurring, but it was attributable to our cost management efforts. And those efforts will continue, whether the exact same type items are repeatable or not, in their entirety I doubt it. But the other 60% is clearly one-time oddities that just came to fruition.

Paul Patterson - Glenrock Associates

Okay. And then in terms of the real estate market there and what have you and what we are seeing just generally in the press, I think you indicated you saw no significant impairment at all in the business. And I wanted to get a flavor for that. Is that because the market dynamics in -- where you are operating, is that because of your low cost basis to begin with?

Could you give us more flavor as to sort of the outlook there? What you are seeing and whether or not -- what you see the trend going forward into 2008 in terms of different markets. I know that the commercial market might be offsetting to a certain degree. But just in general, what the flavor there is if you could elaborate on that a little bit more?

Don Brandt

Yes. First you mentioned the real estate market and I will address that two aspects. The commercial side and in commercial I'll throw in our potential parcel sales and then there is the residential home market and home building market. And the commercial market we think is still very solid. And a combination of market dynamics here in the west valley of Phoenix, where a good deal of our operations on the commercial side are centered.

And we have an extremely low basis in the land we own in the west valley. Now on the home building front, that has slowed dramatically, and in a solid year we would have expected home sales in the 800 to 900 unit. And we will do a little better than 200 units this year with a good part of that occurred in the first six months and it's dropped off dramatically in the fourth quarter.

But with that said, we don't have much inventory in the way we develop and do our home building with these planned unit developments. It's significant, we just don't have a big inventory at risk.

Paul Patterson - Glenrock Associates

Do you see the market improving or declining or staying the same kind of six months out, or what do you think about -- I mean I know it's predicting and not easy to do, but --

Don Brandt

Well, based on the number of homes we expect to close in the next quarter and it's hard for home building to go much lower. I don't think we're going to see a significant turnaround until 2009 at the earliest.

Paul Patterson - Glenrock Associates

Okay. And then on the power plant performance, Palo Verde and what have you. How much -- I guess in terms of turning it around and getting it back to the top tier, what would the financial impact of that be?

I mean, obviously it's something you guys want to do and it obviously helps customers. But from a financial perspective, should we expect a benefit -- a financial benefit to come about as a result of that in any significant way?

Jack Davis

To address -- this is Jack, to address the turnaround at the plant, I think as I said last time I don't think we mentioned this time and we didn't see a large impact on our costs to return Palo Verde to its former top position, mainly because the -- all the capital, the major capital costs were part of our plan in the first place.

And so we haven't identified large capital items especially upon completion of the steam generator replacements and low-pressure turbines that we're doing in unit three now, large capital items that would impact us negatively in the future.

In fact, just the opposite the -- we see that once we get these capital items passed us, we don't see larger ones coming into the future. The other side of that is, as we seen a steadying increase operating performance at the plant and I'm going to give you a fact I didn't give in my prepared remarks.

But for two months in the third quarter I had two plants operating at about 100% for that two-month period. So as we bring Palo Verde back to its normal annual capacity factors of the 90% to 93% range that's bound to have a positive effect on our company.

Bill Post

Paul, if I could just add, this is Bill -- if I could add something to that. I think if you compare our capacity factors this year to last year on average, I think we will be up in the range of about 10% to 15% improved performance.

And that includes the fact that we are replacing that steam generator and the outage that Jack mentioned. As we finished that effort, that will be the completion of the replacement of all of our steam generators at Palo Verde.

As we go forward we would expect to benefit from that as you can see in the capacity factors.

Paul Patterson - Glenrock Associates

Right. But in terms of the O&M and what have you and the scrutiny and what have you -- that we've had, this year and some of that going away, is that have any substantial impact or is that capitalized, I mean and just as there is any sort of lift up from that, sort of going back to the higher capacity factor and maybe having a little of the NRC review kind of, activity or is that significant at all?

Don Brandt

Well, there are some significant dollars involved, Paul. And let me give you a little color on that. In the third quarter '07 compared to third quarter '06, our share -- the APS share Palo Verde O&M is up $7.5 million, and some of that is attributable improvement program that's going on.

We expect a like amount in the fourth quarter this year. And the impact in next year is largely dependent on how the finalization of the NRC inspection and what tasks lay ahead of us.

And we will likely see some costs next year. But the net-net benefits of having Palo Verde up to its traditional industry-leading performance will be measurable for both shareholders and customers in the future.

Paul Patterson - Glenrock Associates

Great. Thanks a lot.

Operator

Your next question comes from the line of David Thickens from Deephaven Capital Management.

David Thickens - Deephaven Capital Management

Questions have been asked. Thank you.

Bill Post

Thank you. Do we have any other questions?

Operator

Your next question comes from the line of Andrew Levi from Brencourt.

Andrew Levi - Brencourt Advisors

Hi, guys, how are you?

Bill Post

Good afternoon.

Andrew Levi - Brencourt Advisors

Just a question. Could you go over dividend policy for us, please?

Bill Post

I'm sorry I missed your question. Could you say that again?

Andrew Levi - Brencourt Advisors

Could you go over dividend policy for us, please?

Don Brandt

Sure. As I mentioned, we look at that every single year. It's a function of basically all the financial statistics that we have. As I mentioned to you, we have had a history there of significant increases every single year, basically a flat number of $0.10.

As we looked at the situation today, we concluded to hold our dividend at its current level.

Andrew Levi - Brencourt Advisors

I'm sorry I missed that. Thank you.

Operator

Your next question comes from the line of David Grumhaus from Copia Capital.

Bill Post

Hi, David. How are you doing?

David Grumhaus - Copia Capital

Good. Just two questions for you. One, Don, you talked about the tax rate, what's a good effective tax rate to use going forward?

Don Brandt

Incidentally, I happen to have something like to at my fingertips. Let see, somewhere around 32%, 33%.

David Grumhaus - Copia Capital

Okay. That's helpful. And then second question, Don, you talked a little bit about the O&M and this $10 million to $15 million pre-tax per quarter. And I know when you gave it you were really referring to Q3 and Q4.

Is that a decent number to be thinking about just given your growth as we look to '08 and beyond? Or is that -- can that, will that number change significantly in your potentially change significantly?

Don Brandt

David, that number I mentioned, the $0.10 that was related to the capital-driven expenses, depreciation property taxes and interest.

David Grumhaus - Copia Capital

Okay.

Don Brandt

That's a reasonable number for the next 12 to 18 months per quarter.

David Grumhaus - Copia Capital

Okay. So when you say $0.10, is that $0.10 each quarter or that's just a flat $0.10 we should put in and assume.

Don Brandt

$0.10 each quarter.

David Grumhaus - Copia Capital

Increase, just from adding the capital in front of your generation and that type of thing. Okay, that's great. All right. Thanks for the time.

Bill Post

Okay.

Operator

Your next question comes from the line of Shalini Mahajan from UBS.

Bill Post

Good afternoon.

Shalini Mahajan - UBS

Just had a few follow-up questions on what 2008 could look like. If I just start with 2007, stripping out some of the one time items of that have -- that took revised that items of 200, I come to a recurring base of between 260 to 265 for '07.

And then it seems that it's large head winds for the interest you mentioned that's $0.10 a quarter, probably about a $0.25 hit from O&M. Some other impact, too, because the weather was favorable this year. Are we looking at best flat earnings in '08, or possibly a declining trend?

Don Brandt

As I mentioned, we are going through several things right now as we deal with, for example, taking a look at our organization and our expenses. We would expect to provide guidance on '08 at the end of this year.

Shalini Mahajan - UBS

Okay. But did that need any color you could throw in. And the trend?

Don Brandt

And we will provide that guidance as we complete these efforts and we expect that to be as I said toward the end of the year.

Shalini Mahajan - UBS

Okay. Thank you.

Operator

Your next question comes from the line of Chris Turo (ph) from Dahlman Rose.

Bill Post

Good afternoon.

Danielle Seitz - Dahlman Rose and Company

Hi. I think you just send me outside -- I just wanted to ask you in terms of the Palo Verde units, you are anticipating to be back to normal by the end of '08. Is that pretty much the NRC report sort of a final, final? Or do you just still not quite sure?

Bill Post

Danielle, as Jack mentioned to you we have a two fuel outages per year.

Danielle Seitz - Dahlman Rose and Company

Right.

Bill Post

And we would expect as we complete the steam generator replacement, our last generator replacement in our current outage, that we would be on that kind of a cycle going forward without extended outages like we have had over the last three or four years as a result of the steam generator replacement.

But from the standpoint of maintenance and planned maintenance, this outage would be very significant in terms of putting us on that path of fuel outages that would deal for the most part with fuel replacement. Obviously, you do a lot of other work while you are doing that. That would put us on a path that would be predicted going forward.

Danielle Seitz - Dahlman Rose and Company

Okay. And it's the NRC inspection is more of a final after everything has been done. Is that all you see it?

Bill Post

I'm not sure, I understand your question, but let me explain where we are with that. This year we were going through the 95003 inspections. That process has been underway for sometime.

And will be underway through the end of this year in terms of the inspection process and would continue through 2008. So we do expect to have continued participation on the part of the NRC through the year 2008.

Danielle Seitz - Dahlman Rose and Company

Okay. Great. Thanks a lot.

Operator

Your next question comes from the line of Reza Hatefi.

Bill Post

Good afternoon.

Reza Hatefi - Polygon Investment Partners

Yes. Just a little bit confused. Can you hear me now by the way?

Don Brandt

Yes. That's fine.

Reza Hatefi - Polygon Investment Partners

I think, you mentioned that you are on pace to earn eight an quarter ROE at APS this year. Is that what the comment was?

Don Brandt

That's correct.

Reza Hatefi - Polygon Investment Partners

And does that eight an quarter include the benefits of the good weather as well as the tax benefits?

Don Brandt

Yes. It does.

Reza Hatefi - Polygon Investment Partners

And so, I guess, if we were to sort of normalize that and strip those one times out, certainly the ROE would be lower. So I don't know what it would come out to calculation, but assuming it's 7% or something.

I'm a little bit -- I guess going into next year and facing further rate base growth as well as O&M pressures can you expand a little bit on the reason of not filing a case?

And I guess -- because it looks like if you were to wait and file one and let's just say mid 2008, it probably wouldn't be effective until early 2010. Just wanted to get a better feel for I guess what's going on.

Don Brandt

Well, as Bill mentioned, a couple of times on the call here as we got -- it's not just about a traditional rate case. We've -- we're exploring other alternatives relative to addressing growth and we have been encouraged by the commission to do so.

They've expressed that in hearings in the past. And we are taking their lead on this matter. And also relative to looking at the cost structure of the company we've just got a few other things that we have to be in place before we can address the timing and the extent of any rate case needs.

Reza Hatefi - Polygon Investment Partners

So, so to speak you are sort of have decided to sort of, I guess for a lack of a better term take some pain in the early time frame to get into positive benefits and a better relationship with the commission, once we get out a couple years from now.

Don Brandt

Well, I wouldn't call it take the pain. I think we were doing what makes the best business sense.

Reza Hatefi - Polygon Investment Partners

Great. Thank you very much.

Operator

(Operator Instructions) You have a follow-up question from the line of John Kiani of Deutsche Bank.

John Kiani - Deutsche Bank

Hi, Don, just one more quick question. Thinking about the rate base growth that Reza was just highlighting, and looking out into '08 and beyond, and thinking about the sources of funding for that.

Can you talk a little bit about how you intend to finance the rate base growth, and whether equity would potentially be a part of that?

Don Brandt

Well, I can talk in terms of over longer period of time. We're going to have to rely on both the debt and equity capital markets.

John Kiani - Deutsche Bank

Got it. Okay. Thank you.

Don Brandt

Thank you.

Operator

At this time you have no further audio questions.

Bill Post

Well, I would say thank you for your time. We know it's very busy, and we appreciate you giving us your time today. Thank you very much.

Rebecca Hickman

And if you have any questions following up, please call me or Lisa. Thank you very much.

Operator

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

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!

Source: Pinnacle West Capital Q3 2007 Earnings Call Transcript
This Transcript
All Transcripts