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Unisource Energy Corp (NYSE:UNS)

Q3 2007 Earnings Call

November 2, 2007 12:00 am ET

Executives

James Pignatelli - Chairman,President, and CEO

Jo Smith - Director of IR

Analysts

Dan Eggers - Credit Suisse

Brian Russo - Ladenburg Thalmann

Robert Howard - ProspectorPartners

David Frank - Catapult Partners

Operator

Thank you, and welcome to theUniSource Energy Third Quarter 2007 Conference Call. Today's call will behosted by James Pignatelli, UniSource Energy Chairman, President, and ChiefExecutive Officer. First, I would like to turn the call over to Ms. Jo Smith,Director of Investor Relations.

Jo Smith

Thank you, and good afternoon.Thank you for joining us today. In a moment, Jim Pignatelli will brief you onthe company's financial and operating results for the third quarter of 2007.

However, I first need to informyou that forward-looking information contained in this call with respect to therevenues, earnings, performance, plans, strategies, prospects, and otheraspects of the business of UniSource Energy may involve risks anduncertainties. Actual events and results may for a variety of reasons prove tobe materially different from those indicated in the forward-looking statements,estimates, and projections.

Factors that could influenceactual future outcomes include but are not limited to, the outcome ofregulatory proceedings, the cost of fuel and purchase power, performance atTEP's generating plants, weather, resolution of pending litigation matters, thecost of debt and equity capital, changes in asset depreciable lives, changes inaccounting standards, the pace and strength of the regional economy, and otherfactors listed in UniSource Energy's Form 10-K and 10-Q filings.

In addition, the forward-lookingstatements in this call may include assumptions, expectations, predictions,intentions, or beliefs about future events. UniSource Energy cautions thatactual future results may vary materially from those expected or implied in anyforward-looking statements. More information about the risks and uncertaintiesrelated to these forward-looking statements are found in UniSource Energy's SECfilings, which are available free of charge on the SEC's website.

Now, I will turn the call over toJames Pignatelli.

James Pignatelli

Thank you, Jo. Thank you all forjoining us after those caveats, I can’t probably say about anything and [notrelative to anything]. We are reporting our third quarter today earnings of $25million or $0.66 per diluted share that’s compared to $28 million last year.This brings us to a $1.13 per diluted share for the year-to-date. Theseearnings are actually in line with our expectations and in line with theguidance, which we have previously given you.

The key factors really explainthere are a lot of differences obviously between quarters, between thirdquarter last year and third quarter this year. But the key factors that drovethe difference really arose from about a $2 million after tax cost, theincreased amortization of the CTC. For the total year, we will amortize $76million of the CTC in expense.

Another $1 million wasincremental coal costs after tax, which we have discussed with you furtherthat’s the increase in coal costs at basically [sunt] and some at San Juan. And then we hadanother impact this year due to increased outages on planned at San Juan, and Navajo, andI will talk a little bit about plant performances, as we get into this.

During the third quarter, we didenjoy, if you can enjoy harder summer weather in the desert, it resultedactually in our third quarter, cooling degree days being about 7% over the 10year average. The use per customer was up. We are still seeing a 2% base growthin customer. But the usage per customer continues to go up as they use more andmore electrical appliances.

However, without a fuel costactually the incremental sales don’t really benefit us. We have minimal marginon these incremental sales and its one reason why it’s very important for us toachieve a fuel cost so that we can adequately protect our shareholder andprovide great satiability to our customers.

Actually, when we look at oursales to some of our large industrials during the summer, they are actuallybuying it lower than what it’s costing us to provide the power that’s made up alittle bit by the margin on residential but not entirely.

Looking at our plant performance Springervilleunits have just proven to be excellent again this year. Springerville units isoperating at over 96% availability factor sent for in the third quarter out oftheir coal plant here operated at almost 97% availability factor.

For the third quarter, we had 94%weighted average availability factor. That availability factor was reduced bythe performance of San Juan, Navajo and Four Corners. Year-to-date, we have 89% year-to-dateavailability factor, which on average of fairly consistent with where it shouldbe last year year-to-date, we had a little bit over 91%.

Springerville on the year-to-datehas operated at 92% and San Juan at 95%, FourCorners is what’s really holding us down this year operating at 75%availability factor and San Juanat 85.

I’ll just give you a littleperspective. We are very pleased with our operating performance and you aregoing to see and hear from the other CEOs what they are doing to increase theoperating performance at those plants. They will probably put some pressure onour O&M as we go out, say bring the performance at least plants up to wherewe would like to see him.

For the remainder of this year,we have now coal plant outages. We have none in the fourth quarter.

Looking at UES, UES is wide inline with the third quarter of last year. I only calling out EUS for one reasonthat’s because of our growth what we have been seeing 5% to 6% has dropped downto between 2% and 3%. Its still good solid growth rate, but its honestly muchmore manageable from my point of view.

Looking at Millennium, we had notransactions in Millennium in the third quarter. We have a current cash balance$24 million in there and we had made dividend payments to UniSource $15 millionduring this year. We are looking at couple of transactions that may come tofruition in the fourth quarter, but they are not included in any of ourguidance at this point.

Looking for the outlook where doI see the rest of 2007 going? We are modifying our 2000 guidance. It’spreviously was $1.55 to $1.85, we are modifying that to $1.50 to $1.75. I wantto stress that this lowering the guidance is really basically because of twononrecurring items.

We had anticipated our gas ratecase in our prior guidance to be effective in the August timeframe. Obviously,it passed August and we still don’t have the rate increase in the gas case.However, it is scheduled for open meeting next week, and I would anticipate adecision. There is no reason that a decision cannot be made at that time andthat we can’t give rates into effect sometime in this month.

Additionally, and that delay istaking about $3 million out of our prior guidance. Additionally, we have a FERCproceeding against El Paso.They are charging us for transmission. We have booked almost $3 million intransmission expense this year, and we booked the same approximate amount lastyear for transmission from Luna. We believe an ALJ agrees with us as well aswork staff that there be should no cost to the transmission, that it’s coveredunder our prior contracts and agreements with El Paso.

We had anticipated in a minimumthat we would not have to pay that or we would get that refunded during thisyear. So that’s not only additional $3 million in expenses, which we areincurring, but hopefully we will see $6 million refund in the relatively nearfuture as soon as we can further to make a decision.

That I don’t believe we will getdone this year. We have requested for to take action on as expeditiouslybecause we are still have to pay the transmission fees. Hopefully that will getdone soon, but we have taken that out of our forecast. And that’s why youreally see those two items contributed $0.10, $0.15 drop in the forecast amount.

Looking forward after where weare on our stock sales. Our forward sales we still have 220 gigawatt hours tosell during the fourth quarter, actually 310 during the fourth quarter, butOctober is gone now. We still say with 220 gigawatt hours to sell.

We are budgeting sales price on aflat basis in the $55 range, on that right now on a flat basis for the fourthquarter. It’s probably a little bit higher than that every dollar increase overthat $55. It produces about say $220,000 in revenue to it. Like I said I hopethat the El Pasodispute, if concluded this year, there is an upside, which we are not planningon, but that hopefully could help us also.

Looking to 2008, we are going tohold guidance until February, until we see exactly how everything runs, wherewe are with the El Pasodispute. We are still doing our budgeting and we are still seeing an upwardpressure on costs, so, I’m going to wait and hold until February. Any guidance,I give you in February you realize its going to pretty broad because, we willhave some $60 million are known how we will be treated by the ACC.

We will be receiving continuingto receive revenues at our current rates. However, we will be deferring therecognition of some of those revenues subject to ACC’s final action. Next yearis the transition recovery asset. We anticipated to be fully amortized in earlyMay or late April. We will be amortizing approximately $26 million in expenseversus $76 million in expense this year.

Looking at the UNS Gas case. Wehave, as I indicated an open meeting on November the 8th. The ALJ isrecommended a little over $5 million rate increase. We have requested $9million rate increase. The ALJ has recommended 10% return on equity and we haverequested an 11% return on equity. I am hopeful that in the meeting with theCommission we will be able to increase the amount of Dollars that ALJ hasrecommended. I certainly think our positions are valid.

We have concluded UNS Electric,the rate hearing on a request of $8.5 million base rate increase. We expect adecision in early 2008. Major issue we have there is the inclusion in rates ofa power plant that we are now building for UNS Electric as we replace the Pinnaclecontract that they are currently under.

The main rate filing and I thinkall you are interested in, is the TEP rate filing. In July we have made anextensive filing. This is the first rate increase, that we have sought in overa decade. Our rates are actually 2% below, what they were in 1994 and thatdespite probably close 45% to 50% increase in consumer prices over that periodof time. And as you will follow the energy sector no much higher rate of growthin the cost associated with providing energy.

We have been successful inholding these rates, because we have operated this entity very efficiently. Wehave squeezed out as many efficiencies as possible. We have restructured allour debt. We have obtained efficiencies capital efficiencies and we are comingto the end of the availability, we have continued to increase efficiency.

We will offset costs by buildingadditional power plants that have been as produced benefits to us and it'sreally time for us to get the rate increase. We will actively and presumablyprosecute the rate case. We are committed to providing safe and reliableservice that at these rate levels it becomes more and more difficult to meetthe high level of service with the community desires and should expect.

We also need a fuel costs one ofthe few entities that does not have a fuel costs. We have been successful inprotecting our customer those of our expenses for our coal operations. However,we are even now cost of coal increasing and obviously cost of gas, as muchhigher than it was in 1994.

Consequently, we have requestedanywhere from the 15% to 23% rate increase depending upon the methodology used.We still believe that we are entitled the market based generation rates thatwould produce about 22% rate increase.

We have provided the commissionand the interveners with information based on cost of service case and that isabout 23% rate increase and that includes a transition back to across theservice and asset allow us to transition back to across the service. We willalso included a hybrid case, which take out certain coal units places them atmarket and returns the remaining coal units to across that service treatment.

All proposals include a 10.75return on equity. All proposals include 45% equity, 55% of debt. We have fueland purchase power across in the cost of service and hybrid case in the marketcase. We do not have a fuel and purchase power because by design the ratecontinuously adjust to than existing cost at market.

The procedural schedule has beenestablished for the prosecution of this case. I applaud the staff they’ve beensupportive and the commission been supportive and getting this case completed.The staff now agreed to our schedule, which concludes hearings by around middleof May 2008.

This should allow adequate timeto prosecute and order, which will be effective 01/01/09. In the commissiondecision, which established this procedure, the commission did find it was inthe public interest to resolve this case, to establish new rates as of01/01/09. I am optimistic that will be done and we will be successful.

With that, I will answer anyquestions you might have.

Question-and-Answer session

Operator

(Operator Instructions) Yourfirst question comes from Dan Eggers with Credit Suisse.

James Pignatelli

Hi, Dan. How are you today?

Dan Eggers - Credit Suisse

Hi, good. How are you guys?

James Pignatelli

Fine, thanks. I just want to letyou know I only be the guy. So, I will and ask any specific answers all thosequestions to.

Dan Eggers - Credit Suisse

Right, well. James, in terms oflooking at the quarter the drag that came up with the Springerville lease beenpulled quite earlier than expected, when we think about ’08 I know you are notready to give away guidance. But is that create a bigger risk for third quarter’08 number just a way of the bigger fuel burden continuing either the way atperhaps profitability in the summer month.

James Pignatelli

Well, actually given some cost offuel and what the temperature of sales levels out there. We still make a littleeven at cost in the year $70, $80 range. We still will make a margin. Theunfortunate thing is the Springerville 3 contract it was called back byTri-State was priced in the $51 range.

We didn’t really receive too muchenergy from that this third quarter because as I would call it, it was told. Wereceived just one month of benefit from that this third quarter. So,quarter-to-quarter that won’t be a material impact to us, Dan to when you lookat next year versus this year.

Dan Eggers - Credit Suisse

Okay. How much contribution didyou guys get from Luna in the quarter?

James Pignatelli

I don’t have that. Dan, we can tohave that information (inaudible).

Dan Eggers - Credit Suisse

Okay, right. We’ll follow-up nextweek. Thank you.

James Pignatelli

Okay. Thank you, Dan.

Operator

Your next question comes fromBrian Russo with Ladenburg Thalmann.

Brian Russo - Ladenburg Thalmann

Hello.

James Pignatelli

Hi, Brian.

Brian Russo - Ladenburg Thalmann

Can you just talk a little bitabout the slowing growth at UES, what’s attributing to that?

James Pignatelli

Well, there are various factorsthat attributing. I think there is a slower growth at UES. UES is in someoutlined territories, and it’s basically the growth was being, a lot of thegrowth was being driven on the electric side.

While the anticipation, the completionof the bridge below the dam thereby opening actually Las Vegas to this sector Arizona.And that growth has slowdown. The bridge, the dam is being delayed because ofthe crane failure. Additionally it’s a little bit held up I think, up therebecause of disagreements over water availability and water rights, which hasslowed down some of the development.

When we get into the gas, itsgrowth is more driven by the Prescottarea. And that area of Prescott’slike that area has just slowed down and I think because of the housing marketswith the sub-prime and other issues. So, I think, both are being affected bythe housing market. But UES Electric is also reflecting a little delay in somegrowth expectations surrounding the expansion of Las Vegasinto Nevada.

Brian Russo - Ladenburg Thalmann

Okay. And then it looks like, youstill got a fairly wide range for the 2007 full year earnings guidance and I’mjust wondering in terms of the fourth quarter, what’s get you to the top endversus the low end?

James Pignatelli

Well, top end, we’re successfulin doing anything with FERC that’s going to affect the top end. The top endgets affected. By then sooner, we can get new rates in and the rate level atUNS Gas. You’re also affected by the price of power in the wholesale market.The gas, we don’t use so much gas in the fourth quarter. So, it’s more, how theprice of power in November and December responds to the upward pressure thatgas is currently doing.

We’ve seen some increase in thepower prices. They’re probably on peak going up into the low to mid 60s and thesame with the flat price is coming up. The other thing that we do benefit atthis time in October and early November, we do get some benefits, if there issea in California.

We didn’t get that real benefitbecause of fire situation in San Juan thatdidn’t produce higher sales in the Californiain October because of the condition they were in their fire situation. Otherthan that, we expect continuation on if we have any outages obviously it willimpact, if we have any unplanned outages. But we don’t like to give guidance ata tighter band and than what we are currently looking at that 25% of band.

Brian Russo - Ladenburg Thalmann

Okay. And in terms ofavailability, wholesale pricing you said it’s strengthening a bit. Does fourthquarter of '07 prices or they higher than fourth quarter of '06?

James Pignatelli

They are slightly higher. Theincreasing later in the year than they did last year. In that function ofactually a hurricane, as you spike price, gas prices in the August, Septembertimeframe. Because of hurricanes you usually push up to fourth quarter pricesfor power little earlier.

Now, we are getting into thesituation, where the fourth quarter, the gas prices and they can going up withoil at this point in time. We haven't really had a real close snap to startcausing gas prices to go up. So, even though they are little higher than theywere in the fourth quarter of last year as we look out it happening a littlelater.

Brian Russo - Ladenburg Thalmann

Okay. Thank you very much.

Operator

Your next question comes fromRobert Howard with Prospector Partners.

Robert Howard - Prospector Partners

Hello.

James Pignatelli

Hi. How you doing, Rob?

Robert Howard - Prospector Partners

Good. Just going back with the, Iguess increasing gas generation is that you were saying that it was caused bythe lack of coal. And I guess, how much of that coal drop was, the loss of the100 megawatt from Springerville 3 versus the bad performance at the other twoplants?

James Pignatelli

We had great performance at ours.

Robert Howard - Prospector Partners

Right, right, yours, but--

James Pignatelli

Actually the difference in thecoal production on the plants, the coal was about 52 gigawatt hours, say 50gigawatt hours. Now, we’ve lost another 100 gigawatt hours for month because wehad that for one month. It was a couple of 100 gigwatt hours probably duringthat timeframe.

Also during the third quarter oflast year, we ran on hedging a little bit. You asked specifically about thecontract. But we also got third quarter last year; we’ve got [full release]energy from Springerville 3. And that benefited us, as I recall around the $1million last year.

So, I can get the exact number onhow many megawatt hours, we pulled from Springerville 3 in last year. I think,it was around a 100, but I’m not sure megawatt hours. So, if we add that to thedecrease I think, you will get close. You’ve got the, like I say, the fullrelease energy, which was about $1 million and then you have about 100,000megawatt hours that came out at Tri-State.

Robert Howard - Prospector Partners

Okay. And then I guess you weretalking about the coal cost being higher, when had you reset those coal pricesor they was that a contract that was, you had an increase due or rebind stuff alittle bit?

James Pignatelli

Yeah, that is the [sunt] coalcontract we entered into, it’s a three year contract last year and thatproduced an increase for the year of about $10 million to $12 million. That’sthe major win. And there was also an increase in San Juan,but I’m not sure the contract linked on that, Rob when it was renewed, but Ican give you that information in Florida.

Robert Howard - Prospector Partners

Okay, great. Thanks guys. See youin next week.

James Pignatelli

Okay, take care.

Operator

Your next question comes from DavidFrank with Catapult Partners.

David Frank - Catapult Partners

Yeah. Hi, Jim. How are you?

James Pignatelli

Hey, David it’s good to hear fromyou again. I have been on the call for a while.

David Frank - Catapult Partners

Well, we got a lot of guys, doingdifferent things here now.

James Pignatelli

All right, welcome back.

David Frank - Catapult Partners

Thank you. Hey, Jim I want to askyou, you’ve talked in our opening remarks about the need for fuel cost and Ijust want to make sure I understand what you’re saying, usually when after fuelcost you give up all margins on wholesale sales and you’re just strewed up onyour cost of purchasing power and fuel, is that type of fuel cost you arespeaking up?

James Pignatelli

Well, a fuel cost, when we lookat the net benefit between short-term all sort of sales and cost of fuelincreases. We’re not benefiting the bottom-line at this point in time. Thewholesale short-term sales helped us all through since 1994 and to offsethigher O&M and other things because we were operating with the profitmargin over what we had to buy power for.

Now, with the growth in thesystem, I don’t see that equilibrium anymore or that benefit anymore. And weco-offered a couple of different styles of fuel recovering mechanisms what Icall Energy Cost Adjustments by which the company or the shareholder retain theoperating risk, I think, you’ll agree on a certain level or certain capacityfactor, and if you operate better than that the shareholder benefits, if youoperate worse than that shareholder operates have deficit on that.

The other type of fuel costs isthat more or like what APS has where operating risk of the plant shifted to therepair. And what you do, as you’ll just agree on essentially across the fuelper kilowatt hour as one of the basis basically gets to which sort of ensuresyour margin. If you sell more than or if your fuel cost more than it had beenagree to in establishing the fuel cost. And if your fuel is less per unit thenwhat should we do then you give that benefit back to the results.

So, you are in a neutralposition. So, both of those have been proffered, David. But to your basequestion, I don’t see us benefiting any more from the hedge there areshort-term wholesales provided us over the last 10 years.

David Frank - Catapult Partners

Okay. So, if that the case then,here you are going back to a fully regulated, traditionally regulated,integrated, vertically integrated utility and now its just about cutting thebest regulatory deal I guess you can is that?

James Pignatelli

You make the assumption. We putall of our assets back on cost of service.

David Frank - Catapult Partners

Aside from Luna, yes.

James Pignatelli

The hybrid of the market wouldnot have a fuel cost, you are just continuously changing to rate. The hybridwould have a fuel cost, but if it would only cover those assets that were,those generation assets, which were included in rate base, which we have takenback in to rate base.

David Frank - Catapult Partners

Right and I’m sorry. I don’t meanto speech up on this, but I just want to understand clearly that if you wouldbe okay with an APS file, Arizona Public Service file fuel cost and I’m sureabout how to decommission with other things you would get in your cases. Well,but that the kind of fuel cost you think, you need?

James Pignatelli

I actually to be honest with youmore favorable to the other type of fuel cost, across where you take thebenefit and take the risk of operating. However, sometimes the staff of thecommission focuses on what they have done in the past.

Again I’m confident in my people;we’re going to operate our plants, and we’re going to operate them well. And Ilike to have the incentive of bettering my operation continuously and keepingefficiencies that I can produce in the operation of my system. That’s just mynature. So, my preference is really for that type of fuel cost.

David Frank - Catapult Partners

I understood. Thanks Jim.

James Pignatelli

Okay. Thank you all. I hope seeyou too in Hawaii, excuse, in Florida. It’s equallyfar for us.

Operator

(Operator Instructions)

James Pignatelli

Well, I want to thank you all forparticipating. And I look forward to seeing all of you in Florida. I’ll be there Sunday late afternoonbe more than happy to say that and talk to anybody. Thank you so much for yourcontinued attention and support.

Operator

This concludes today's conferencecall. You may now disconnect.

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