Pinnacle West Capital Earnings Call Nuggets: OpEx Budget and Arizona Public Service Co.

Pinnacle West Capital (NYSE:PNW) recently reported its second quarter earnings and discussed the following topics in its earnings conference call.

OpEx Budget

Greg Gordon – ISI Group: Jim, can I go to the appendix and – Page 15 in the appendix and just have you talk us through some of the changes to your factors for ’13.

James R. Hatfield – EVP and CFO, Pinnacle West Capital Corporation and Arizona Public Service Company: Sure.

Greg Gordon – ISI Group: Obviously your electric gross margin is up, given the weather and other factors that you laid out in your formal presentation.

James R. Hatfield – EVP and CFO, Pinnacle West Capital Corporation and Arizona Public Service Company: Right.

Greg Gordon – ISI Group: But can you focus on for me – you’ve got a significant increase in your OpEx budget for the year and a pretty meaningful decrease in your interest expense expectation. Is the OpEx up because you’re making investments that you think will allow you to control O&M in the future? That’s something we’ve talked about. So just want to make sure I understand that. And then, where is the interest expense delta coming from?

James R. Hatfield – EVP and CFO, Pinnacle West Capital Corporation and Arizona Public Service Company: Sure, sure. So I think if you look at OpEx, you have a couple of factors going on. So if I look at the quarter, year-over-year; O&M was essentially flat other than the amortization of the pension and OPEB which theoretically, we got paid for in the rate settlement. Our approach to these ranges really is, we do – we put sort of parameters around each of these and then we run a probability distribution, and I think – as I look at O&M, where we are in cost – there’s probably more downside than upside with flat O&M for the year. And then, we’re making some strategic investments, especially in the IT area to accelerate the benefit in the later years based on where we are today in our financial performance. If I look at interest expense, a couple of things there as well. You’ve got the delay of Four Corners, but you also have the fact that we’ve refinanced at lower rates, and we have less debt outstanding because as I said, we’re – no short-term debt as we sit here today. So we’re in a great liquidity position. So that would be the things that would drive those changes in ranges. I’d also point out Greg, on the gross margin besides weather, if you remember, we had first quarter usage that was positive, and that also impacts our gross margin…

Greg Gordon – ISI Group: I know – look, I know we can’t necessarily capitalize the weather into what we expect your earnings power to be, but to the extent you continue to have good weather quarters, that obviously does impact earnings power in the long run, right, because it increases retained earnings, and so down the line the necessity, correct, what you might – either be decreased or obviated all together, is that a fair observation or not?

James R. Hatfield – EVP and CFO, Pinnacle West Capital Corporation and Arizona Public Service Company: No, that is in fact – well, we can’t count on weather year-to-year; any positive weather is less equity we’ve to raise down the road, so that’s obviously positive long-term story as well.

Greg Gordon – ISI Group: Last question, Don, you earned a 9.9% ROE on a consolidated earns last year. It looks like you’re in good shape this year in part because of the weather. But if we adjust for weather and then we look at the underlying trends, and where you think you could bring in your cost profile, is there any reason for us to expect that there’d be a significant degradation in earned ROE from the 9.9% you earned in ’12 as we look through the forecast period?

Donald E. Brandt – Chairman, President and CEO, Pinnacle West Capital Corporation; and Chairman and CEO, Arizona Public Service Company: No, Greg, I’m very confident. As Jim alluded to in talking about the changes in O&M, we’re making some investments that we’re confident are going to pay dividends in cost savings in the years ahead and other aspects of our cost containment program are going to provide benefits down the road. So I’m very comfortable where we’re at in our future.

Arizona Public Service Co.

Kevin Cole – Credit Suisse: Becky, congrats on the retirement. You’ve been a great mentor for the years and I appreciate all your help. Thank you very much. And so I guess, for the question on deregulation, Don, can you provide a little perspective on what happened last time Arizona to disexercise? And can you give, I guess, some comments on just your general confidence that this will be resolved in September, October timeframe?

Donald E. Brandt – Chairman, President and CEO, Pinnacle West Capital Corporation; and Chairman and CEO, Arizona Public Service Company: Sure, Kevin. Let me first start with your last part of the question. I am very confident that the Corporation Commission is going to act in the best interest of all our customers, and to do that action on a timely basis. Where I sit now, I think we could count the number of customers that are proponents of dereg, so-called deregulation on one hand, and I’m looking at a list of a 153 organizations, elected officials, chambers, numerous other business leaders of the Arizona Senate, the Arizona House of Representatives, numerous mayors, city managers and other local elected officials across the state that have come out strongly against it. I don’t think the proponents of deregulation necessarily counted on the negative reaction that’s received. As you know, reliability of an electric system is very important and it’s also a fundamental of all advanced economies. But in Arizona, the hottest state in America, reliable electric service is literally a life or death necessity. Regarding what happened last time around and that was the latter half of the ’90s and the first couple years of 2000; first, I’ll direct your attention to when the utilities in the state made the filings the middle of this month. APS is filing, had a cover letter from me on it as did – Paul Bonavia did the same at UNS, and Mark Bonsall who is the Chief Executive Officer of Salt River project; he also addressed Salt River project’s filing with a cover letter. I don’t know how accessible Mark’s letter is. If you can’t find it on their website or the Commission’s website, we would be happy to provide it. Mark is one of the three of us that was actually around here for that period of time. But let me respond to your question is – is the Commission at that time before the debacle in California, was pursuing deregulation, had put the rules in place. The utilities incurred many millions of dollars of cost in systems and other projects to get ready for a deregulated environment. Then you had the California energy crisis which brought that movement towards deregulation to a screeching halt. Similarly at that time, essentially the Arizona courts concluded that most of the rules and other processes had been put in place for unconstitutional and/or illegal for a variety of different reasons. So that obstacle to deregulation still exists. But it was a very expensive endeavor for the utilities, for our customers and there was no visible benefits that came of that exercise. I think once the Commission has a chance to review of all the comments and reply comments, that’d be later in August. They’ll have a good sense that there’s not too many opportunities here for Arizona customers, and significant risk and cost that are almost a virtual certainty. So, I hope that was a long-winded answer to your question.

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