Jan 30, 2008
Executives
Rebecca Hickman - Director of IR William J. Post - Chairman of the Board and CEO Donald E.
Brandt - President and CFO, Arizona Public Service Company; EVP and CFO, Pinnacle West Capital Corporation Jack E. Davis - President and COO, Pinnacle West Capital Corporation; CEO, Arizona Public Service Company
Analysts
Paul Ridzon - KeyBanc Dan Eggers - Credit Suisse
Operator
Good morning. My name is Sylvia, and I will be your conference operator today.
At this time, I would like to welcome everyone to the 2007 Earnings Conference Call. [Operator Instructions].
Thank you. I would now turn the conference over to Ms.
Becky Hickman, Director of Investor Relation. Ms.
Hickman you may begin your conference.
Rebecca Hickman - Director of Investor Relations
Thank you, Sylvia. I would like to thank everyone for participating in this conference call to review our 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 the Executive Vice President and CFO of Pinnacle West, and also President, and CFO 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 amounts 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 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 third 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 February 7th.
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 will turn the call over to Bill.
William J. Post - Chairman of the Board and Chief Executive Officer
Good morning everyone and I thank you for taking time to join us today. Like other years, 2007 was marked by a number of accomplishments and challenges.
Don and Jack will discuss our financial results and operations in detail. But before I turn the call over to them, I would like to address two items; first, growth.
Growth in our service territory has slowed from its base a year ago. The trend also being experienced in other high growth states.
However, our growth still remains very strong compared with national averages. Arizona's 2.8% population growth is the second fast in the United States just behind Nevada.
That growth is evident throughout our business, and continues to dominate our operations, and our strategies. Our customer base grew 3.3% in 2007, slowed to 2.6% in the fourth quarter, attracting the trends in population growth.
We currently estimate that our customer count will grow at about 2.8% in 2008. EPS has met this rapid growth, while maintaining a very strong focus on customer service.
J.D. Power & Associates again recognized APS for superior customer satisfaction.
APS was ranked number 2 among western investor-owned electric utilities by both residential and business customers. We are aggressively focused on the future, our customers' rapidly growing energy needs, and the financial strength we need to meet that growth.
With growth in both customers and energy consumption, APS faces the need for new capacity in the 2012 to 2015 timeframe. Earlier this month, we filed several resource alternatives with the ACC.
Our goal is to build public understanding of the options, and the challenges inherent and APS is planning for an acquisition of energy resources. Through this initiative, we will see broad input from various stakeholders on APS's resource planning issues.
These stakeholders include customer groups, market participants, policy advocates, and regulatory authorities. This process will be both transparent and participatory.
It will compliment the Arizona Corporation Commission's generic integrated resource planning process with the specific focus on APS. In the short-term, we will seek commission approval to expand APS's purchase power in natural gas hedging program to five years from the current three years.
Such a change will decrease some of the risks from future price volatility. To facilitate long-term planning, APS will seek stakeholder input and ultimately policy guidance from the commission on the appropriate mix of long-term resources, the regulatory treatment, and the recovery of costs for such projects.
The next step in this resource initiative involves a series of stakeholder meetings, APS will conduct in the first half of 2008. First of these meetings is scheduled to be held on February 15th; and in the future we will report progress as appropriate.
Second, I would like to talk about is earnings guidance, the earnings guidance that we issued this morning. In short, we estimate that our consolidated earnings per share will be within a reasonable range around $2.50 per share.
Earnings at APS will be basically flat to 2007 excluding the effects of the abnormal weather, and out of period income tax adjustments. These estimates include the results of the cost, and efficiency review we discussed with you in our last call.
Don will describe the detailed results of these reductions. In total, they offset the 2008 cost increases at APS due to growth, and inflationary impact.
However, today we are not recovering the cost incurred to meet customer growth, since our rate case, which include approximately $1.7 billion of capital expenditures for reliability and the expansion of our electric system. As I explained in our last call, we expected to be dealing with the commission on the line extension issue into early 2008, and then incorporate their decision into our future rate planning.
That remains our plan. However, it may be necessary to file a retail rate request within the next few months depending upon the disposition of that issue.
Our guidance does not include results from either the line extension proceeding or our planned 2008 rate filing. Jack will update you on these and other regulatory developments as well as our recent operating performance.
Now I would like to turn the call over to Don.
Donald E. Brandt - President and Chief Financial Officer, Arizona Public Service Company; Executive Vice President and Chief Financial Officer, Pinnacle West Capital Corporation
Thank you Bill. As Bill said, our consolidated earnings guidance for 2008 is a reasonable range around $2.50 per share.
We expect 2008 EPS earnings to be relatively flat compared to 2007 after excluding the effect of 2007's abnormally hot weather, and prior year's tax benefits. We expect to be able to hold the EPS earnings flat, primarily as a result of efficiency gains in cost reductions, so I will discuss in more detail in just a few minutes.
SunCor's earnings are expected to be $20 million in 2008. Our guidance assumes the transmission rate increases at the wholesale and retail levels go into effect on March 1st of this year.
But it does not include any potential earnings effect from the amendments to APS's line extension schedule pending before the ACC. The partial year effect of the transmission rate increases assumed in our guidance is approximately $25 million pre-tax or $0.15 per share.
Turning to the fourth quarter results; for the fourth quarter of 2007 our earnings were down $0.15 per share versus the 2006 fourth quarter. We reported consolidated net income of 3 million or $0.03 per share compared with $18 million or $0.18 per share in the prior year quarter.
In summary, higher O&M, increased depreciation, and lower results from real estate operations substantially offset earnings contributions from increased retail sales. Now allow me to provide you with additional detail in these variances.
First, increased retail sales volume related to customer growth added $0.05 per share. Next, impacts from last summer's retail rate increased improved earnings $0.03 per share, and lower property taxes added $0.03 per share.
These positive variances were more than offset by the following negative factors. Higher O&M costs decreased earnings $0.17 per share.
The cost increase from the fourth quarter was consistent with our expectations and was primarily due to planned generation maintenance and overhaul expenses including the Palo Verde performance improvement program as well as customer service cost to serve growth. Increased depreciation primarily related to APS electric infrastructure additions reduced earnings by $0.03 per share.
The absence of prior year tax benefits that were recorded in the fourth quarter of 2006 reduced earnings by $0.04 per share and SunCor's earnings were down $0.03 per share mainly related to lower sales of residential property. Now allow me to update you on APS's PSA deferral balances and fuel hedge positions.
As of December 31st, APS had $111 million of accumulated PSA deferrals. With last summer's ACC enhancements to our PSA, we are in a much better position with respect to fuel cost this year than in the past few years.
As a result, we expect to recover this deferral balance through annual PSA adjusters and surcharges by the end of 2008. Details of the changes in deferral balances are included in the quarterly statistic section of our website.
As you know, our hedging program substantially mitigates natural gas and purchase power price volatility for our customers. As of today, we have hedged about 85% of our 2008 exposure to purchase power and natural gas price risk.
Similarly we have hedged about 60% of our 2009 price risk and 40% of our 2010 price risks. These hedge positions are prices generally in line with current forward market prices.
Finally turning to our reviews of operation and maintenance expenses and capital costs; during the second half of 2007, we took a thorough look at our company's organizational structure and reviewed our operating and capital cost that imply opportunities for streamlining and gaining efficiencies. We want to make sure that we are as customer focused and cost effective as possible without sacrificing service reliability or safety.
First I will frame some of the relevant issues that affect our cost situation particularly our capital expenditures. Consistent with the slowing economy, our day-to-day construction activities have declined somewhat from their peak levels over the last few years.
We added 34,000 new customers and 2007, but we expect to add fewer customers in 2008. Albeit slower, we still expect growth at a rate well above of the national average.
Also, we like most utilities have experienced sharp increases in the cost of materials, equipment and land used for construction. These increases have been driven by dramatic increases in the price of basic commodities such as copper, aluminum and steel, the impact to the weak U.S.
dollar and an apparent insatiable worldwide demand for these types of products and materials. Just as an example, 500 kb to 230 kb three phase transformer that would have cost APS just under $2 million in 2004.
Now costs more than $5.6 million, an increase of 180% over the relatively short period of time. Looking at our capital expenditures, we eliminated more than $2 million of capital costs over the next five yeas.
First, as a result of slower projected customer growth, we decreased our expected expenditures $130 million for the five year time frame. Second, we were able to reduce capital forecast more than $60 million through improved planning logistics and scheduling principally on our delivery business.
And third, differing certain system upgrades and projects that would not adversely affect reliability reduced our projected capital spending almost $20 million. On last quarter's call, I talked briefly about our organizational realignment.
These changes were made with the intention, the intention of enhancing the speed and effectiveness of decision making and improving efficiencies. The new organization enhances our focus on customers and sharpens roles and the responsibilities to improve accountability in overall performance.
During this process, our executive team identified 300 staff positions that will be reduced in the first quarter of 2008. These reductions should generate $7 million pretax of annual O&M savings.
In addition to the staffing reductions, we identified some $7 million pretax of other annual O&M savings. The majority of these savings relate to process efficiencies and reducing projects in various parts of the organization.
The rest largely relate to reductions in employee benefit, communications and advertising cost. Our capital expenditures in 2007 were some $900 million.
We expect such expenditures to exceed $1 billion a year for the next five years to support the growth and reliability in our electric system. Further climate change or other environmental legislation could increase our capital spending requirements.
We expect to finance these expenditures with a mix of internally generated cash and external financings both debt and equity. Additionally cost related to capital spending such as depreciation, interest, and property taxes will continue to increase.
Although these specific cost and organizational reviews have been completed, the effort to identify and implement cost reductions throughout our organization will be ongoing. We will continue to maintain strict discipline in managing our cost.
Now I will turn the call over to Jack.
Jack E. Davis - President and Chief Operating Officer, Pinnacle West Capital Corporation; Chief Executive Officer, Arizona Public Service Company
Well, thank you Don and good morning everyone. I will start by summarizing regulatory issues.
As Bill mentioned, we have been working on regulatory issues related to growth in our state. The ACC commissioners have expressed concerns about how to support the vitality of our state and its considerable growth.
They have also expressed concerns about commercial [ph] paper growth and how? We share these concerns heading for growth we require innovative great setting policy.
And the decision on APS's retail rig case last summer, the commissioner required APS to follow the wise line extension schedule for ACC approval. The required revisions will eliminate certain allowances for new or expanded services, which will permit APS to collect cost related to line extensions on a current basis thereby reducing the amount in effect of future rate increases on EPS's customer base as a whole.
These costs average $3,500 to $5,000 per new meter set. In October, APS filed...APS filed proposed amendments to its line extension schedule.
The proposal will eliminate the construction allowances and treat payments received as non-refundable revenues. It also includes provisions to grandfather existing line extension agreements.
If the ACC were to improve...were to approve APS's proposal by the end of the first quarter of this year, we estimate that the changes would increase APS's pretax revenues by approximately $35 million in 2008. Late yesterday we received the ACC staff before on this issue.
Among other things the staff continues to support our amendment to collect line extensions. However we recommend their payments received by APS should be accounted for as contribution as an aid of construction not miscellaneous revenues as we have proposed.
We are evaluating the staff report and recommendations and will respond appropriately. We expect the commissions to consider the staff report as well as our proposal and future open meeting has not been scheduled as yet.
Our transmission rate case is spinning before the Federal Energy Regulatory Commission. As a reminder the filing [ph] as for $37 million increase in annual transmission revenues and includes a proposal for FERC to approve a formula saying methodology to allow APS to adjust wholesale transmission rates on June 1st of each year.
In September, the FERC issued an order allowing APS's proposed transmission rates to become effective March 1st of this year subject to refund. Several sub-server mains [ph] have been held and we believe progress is being made.
However at this point, we do not know where the case ultimately will be settled or go to a hearing. It is important to understand there are approximately $30 million of the transmission rate increase related to transmission...relates to transmission to serve APS's retail customer.
In December, APS filed an application with the ACC to increase retail rates affective March 1st through the transmission cost adjuster or TCA that ACC approved in the 2005 rate decision. The TCA was intended to provide a mechanism through, which changes in retail transmission charges can be reflected in APS's retail rates in a timely manner.
On Monday, the ACC staff issued its recommendation on the TCA adjuster, we approved as proposed by APS, subject to adjustment based on the final outcome at the FERC. Now, I will review the various adjusters and surcharges of the partial plan adjuster for the PSA.
First, the 4 kilowatt hour PSA adjuster that took place on February 1, 2007 remain in effect as long as necessary to collect an additional $46 million of 2007 costs, differed as a result of the mid 2007 implementation of the new based fuel rate. We estimate this adjustment will remain in effect through mid this year.
Second, July 1...second, since July 1 APS has been collecting approximately $34 million, including interest through the PSA surcharge. This amount represents PSA cost deferrals related to the 2005 replacement power cost prudently incurred for power rheologist [ph].
This temporary surcharge will be affected through June 30th of this year. And third, the process is underway to set the 2008 annual PSA adjuster rate.
Based on calculations we found with the ACC in December that rate will be 4 mills per kilowatt hour for 12 months beginning February 1st of this year. Now, I will provide some highlights regarding growth in our market.
As Bill discussed, our service territory continues to grow. Our retail sales increased 10.4% for the year.
On a well normalized basis, retail sales grew 2%, reflecting 2.8% increase for residential customers and 1.5% increase for business customers. Our customer and sales growth also translate into peek lower growth.
Our 2007 peak was 7,545 megawatts. While this was not an all time record on a vendor normalize basis, our peak de-grill 3% compared to the previous year, which was consistent with our expectations.
During the past five years, our peak has grown at an average annual rate of 5.4%. So, in spite of the economic slowdown throughout the country, including its impact on the housing market, we continue to experience growth at a rate much higher than the national average and we expect the growth to continue for years to come.
Now, let me turn to operating performance. Looking at our nuclear plant performance, the combined capacity factor for Palo Verde is for full year 2007 was 79%, up from 71% in 2006.
For the fourth quarter of 2007, the site average capacity factor was 57% compared with 75% in the comparable quarter a year ago. The capacity factors in both fourth quarters were affected primarily by plant refueling outages.
Unit 3 in 2007 and Unit 2 in 2006, of note 2007 refueling outages at Palo Verde Unit 3 included the plan replacement of those steam generators, low pressure turbines and coal protection calculators, which require longer than a normal outage. Similar work was completed for Unit 2 in 2003 and Unit 1 in 2005.
With the completion of the replacements in Unit 3, the production capacity for each of the three units has been increased by 5%. Palo Verde has two refueling outages each year.
During 2008, Unit 1 is scheduling for an outage in the spring and...why it's scheduled for an outage in the fall. We expect these outages to last 40 days to 50 days.
The Nuclear Regulatory Commission conducted a rigorous comprehensive inspection in October at Palo Verde. During a full-week-inspection, the NRC looked at detail all the areas of the plant's operations.
We expect to receive a follow-on special report late this month or early next month. As I stated earlier about the inspection, you are aware, we are in the midst of the NRC's 95003 process.
This is the process I just described. During the process, we are kicking a conservative approach to the operation at Palo Verde.
In doing so, issues have and will continue to arise that may impact the operability of Palo Verde units. We continue to work honestly with the NRC to address these issues.
Turning now to our coal plants; our coal part plants continue to operate superbly. During 2007, the coal plants posted an 87.5% capacity factor, a new all time fleet record slightly ahead of the record set a year ago well ahead of the available industry average of 71%.
This achievement was led Four Corners...by Four Corners and Cholla plants. Four Corners posted a capacity factor of 86%, while Cholla Units recorded capacity factor of 90%.
That concludes my prepared remarks, and I will turn the call back over to Bill.
William J. Post - Chairman of the Board and Chief Executive Officer
Thanks Jack. In October, Jack announced his plan to retire March 1st, completing a very successful 35 year career with our company.
Throughout his career, Jack has provided leadership and focused on excellence in every aspect of our business. This will be Jack's last earnings conference call.
And I would like take this opportunity to say publicly, Jack, on behalf of myself and the 7,000 men and women of our company, thank you for all your contributions; you will be missed.
Jack E. Davis - President and Chief Operating Officer, Pinnacle West Capital Corporation; Chief Executive Officer, Arizona Public Service Company
I appreciate those comments there.
William J. Post - Chairman of the Board and Chief Executive Officer
Thanks Jack. As you know and as previously announced, Don Brandt will take the helm as CEO of APS upon Jack's retirement.
That concludes our prepared remarks. And we would be happy to answer all your questions now.
Question And Answer
Operator
[Operator Instructions]. Please hold for your first question.
Your first question comes from the line of Paul Ridzon from KeyBanc.
William J. Post - Chairman of the Board and Chief Executive Officer
Hello Paul.
Paul Ridzon - KeyBanc
Just a quick question with regards to 07 actual versus kind of the guidance you gave most recently; could you kind of walk through some of the big deltas and drivers there?
Donald E. Brandt - President and Chief Financial Officer, Arizona Public Service Company; Executive Vice President and Chief Financial Officer, Pinnacle West Capital Corporation
Sure, Paul, this is Don Brandt. So, we continue to see revenue...additional revenue from growth, but it's more than offset.
Just the single largest item or combination items is as I would call it capital related expenses, depreciation, financing, and property costs, taxes just related to the assets we have put in service. As Bill mentioned to you in his comments, we have invested...put in service $1.7 billion of capital expenditures since the amount of capital expenditures reflected in the last test year.
So those are I mean there is a number of smaller ones, but that far outweighs any other cost positive or negative.
Paul Ridzon - KeyBanc
I am sorry, I should have been more clear on my question.
Donald E. Brandt - President and Chief Financial Officer, Arizona Public Service Company; Executive Vice President and Chief Financial Officer, Pinnacle West Capital Corporation
Okay
Paul Ridzon - KeyBanc
Could you contrast 07 actual with your last 07 guidance?
Donald E. Brandt - President and Chief Financial Officer, Arizona Public Service Company; Executive Vice President and Chief Financial Officer, Pinnacle West Capital Corporation
Okay. 295 versus our actual.
We had some...about eight times worth of positive on the mark-to-market on the trading side. SunCor was actually $0.03, came in $0.03 better some capital related savings from our forecast of about $0.03, and then we get into a variety of smaller item that impacted actual 07.
Paul Ridzon - KeyBanc
When you give guidance you assume mark-to-market is zero, or how do you do that?
Donald E. Brandt - President and Chief Financial Officer, Arizona Public Service Company; Executive Vice President and Chief Financial Officer, Pinnacle West Capital Corporation
Yes.
Paul Ridzon - KeyBanc
Okay.
Donald E. Brandt - President and Chief Financial Officer, Arizona Public Service Company; Executive Vice President and Chief Financial Officer, Pinnacle West Capital Corporation
We do assume zero.
Paul Ridzon - KeyBanc
So, higher GAAP prices was a...were a benefit for you?
Donald E. Brandt - President and Chief Financial Officer, Arizona Public Service Company; Executive Vice President and Chief Financial Officer, Pinnacle West Capital Corporation
Yes.
Paul Ridzon - KeyBanc
Thank you very much.
Donald E. Brandt - President and Chief Financial Officer, Arizona Public Service Company; Executive Vice President and Chief Financial Officer, Pinnacle West Capital Corporation
Okay.
Operator
Your next question comes from the line of Dan Eggers from Credit Suisse.
William J. Post - Chairman of the Board and Chief Executive Officer
Good morning, Dan.
Dan Eggers - Credit Suisse
The first question I guess is can you walk us through a little bit of the decision tree when you decided to file this retail rate case how the line extension conversation layers into that, and if there is not a revenue treatment, but it's a construction and aid, does that accelerate the need to file the rate case?
William J. Post - Chairman of the Board and Chief Executive Officer
Sure, let me take a shot at that, and then Jack can add his thoughts. As you know, in fact as I think, as youand I talked in our last conference call, we have been working with the commission to deal with the growth issue, and particularly schedule three on a schedule that started with really with their request last summer, and that has been something that obviously has an affect...impact on our future rate planning in large part because of the way it's accounted for.
Literally, since that time there hasn't really been any disagreement in terms of the issue of charging a connect fee in the regulatory filings, and proceedings. It's been really focused to a great extent on the accounting treatment.
And obviously the reason, I mentioned that is the accounting treatment has a very significant effect upon our overall earnings level. And it has been our hope that this was an issue that we could resolve.
We've been working as aggressively as we know how with the commission at their request. And as Jack pointed out, literally last night they filed...or the staff I should say filed their report, which proposes contribution in aid of construction treatment rather than revenue recognition treatment.
That has an impact. And what it would do?
What contribution that aided construction treatment does compared to revenue recognition treatment is it pushes the need for a rate increase even quicker, and depending upon the disposition of that, and the timing of that issue, as the commission deals with this. That's how we would be dealing with the potential filing for base rates.
It's something that...from our standpoint, it is critical dealing with this issue of growth not only from the standpoint of in effect recovery for the incremental capital expenditures that Don talked about, but also the issue that growth has on our company in terms of the attrition issue. And they are really although sometimes described as the same issue that really two different ones.
And so from our perspective, it's both dealing with the attrition and the capital requirement. We will take into account the consideration of the commission in terms of the process and the schedule and certainly their decision as they deal with this.
But it's also important that we deal with the $1.7 billion of additional expenditures that we have made. And as I mentioned in my comments, we may find ourselves in the situation, where we would be dealing with these things in parallel after we filed a rate case sometime in the next couple of months.
It really comes down to the...to how this issue is going to be dealt with at the commission and then whether or not we can do it sequentially or in parallel.
Dan Eggers - Credit Suisse
As getting of our fall in this rate case and do you have kind of the transition of three commissioners at your end 08. What are you thinking about as far as timing and implementation of rates?
It seems like we can potentially see this push toward a year-end 09 type of resolution given the experience that we tend to see in Arizona?
William J. Post - Chairman of the Board and Chief Executive Officer
Well, certainly if you look at the past in terms of dealing with rate cases, they have been in that range of 18 months to 24 months. I think, if you look at the last couple of years and some of the things that we have dealt with, and I say we mean both the Commission and the company, those issues have often been dealt with certainly the base rate case was of that kind of a timeframe.
But if you look at their actions in terms of the fuel cost for example, we were able to get fairly quick action. This is an issue that...as you know the attrition issue was an issue that was addressed in the last rate case.
It's something that will be addressed in our next filing both in terms of the accounting treatment and in terms of the rate-making treatment that is associated with that. And so our hope would be to be able to keep a decision on this earlier than our historical timeframe would suggest.
Dan Eggers - Credit Suisse
Okay.
Jack E. Davis - President and Chief Operating Officer, Pinnacle West Capital Corporation; Chief Executive Officer, Arizona Public Service Company
I don't want to add, but to emphasis to Bill's comment...this is Jack. We have no intend just let's go on and on and on.
We recognized it; we can't get a quick resolution to the impact free issue. We must file a rate case and then address whatever impacts are in the rate case as relates to Schedule III.
Dan Eggers - Credit Suisse
Not to take up too much time here, but Don if you...you kind of think about the earnings impact and the timing or uncertainty of timing of cash and the fact that ROEs you are not going to look at 7% plus or minus the utility in 08. What are your conversations right now with the rating agencies?
And how are you guys thinking about equity for 08 at this point?
Donald E. Brandt - President and Chief Financial Officer, Arizona Public Service Company; Executive Vice President and Chief Financial Officer, Pinnacle West Capital Corporation
I think the conversations have been positive. As I made my remarks and as I have said in my comments earlier calls we will have to rely on the equity markets and the debt markets as going forward, given the size of $1 billion to $1.1 billion a year, capital expenditures and given relatively modest level of internal cash generation.
We are going to in both markets.
Dan Eggers - Credit Suisse
And do you have equity issuance in the 250 guidance for this year?
Donald E. Brandt - President and Chief Financial Officer, Arizona Public Service Company; Executive Vice President and Chief Financial Officer, Pinnacle West Capital Corporation
We are giving consideration towards them.
Dan Eggers - Credit Suisse
Okay, thank you.
William J. Post - Chairman of the Board and Chief Executive Officer
Thanks Dan.
Operator
Your next question comes from the line of Edward Haim from Canaccord Capital Management [ph].
Unidentified Analyst
Good morning.
William J. Post - Chairman of the Board and Chief Executive Officer
Good morning.
Unidentified Analyst
Just had a quick question on...in regards to what sort O&M you are assuming in your 2008 guidance and does it include the $7 million of head reduction and 7 million of non-head reduction? And also what kind of your view on O&M increases at Palo Verde are?
William J. Post - Chairman of the Board and Chief Executive Officer
Yes. Ed, I've got some numbers here.
We are looking at...yes we have included the 7 million of savings actually 14...7 of staff reduction and 7 of others. But in spite of that, we are looking at Palo Verde actually relatively flat from 07 actual to our forecast for 08.
But if you give me a moment of that, we are looking at around a net of about $40 million increase in O&M, that's a pretax number overall.
Unidentified Analyst
Okay, on a percentage basis that's around like 5% or so, 5% or 6%?
William J. Post - Chairman of the Board and Chief Executive Officer
Already over by the base of around seven...
Unidentified Analyst
700
William J. Post - Chairman of the Board and Chief Executive Officer
700 to 710
Unidentified Analyst
Okay. But the Palo Verde is relatively flat and can you just walk through why that is...that's just because you don't have a steam generator replacement this year or...
William J. Post - Chairman of the Board and Chief Executive Officer
That's partially, yes. Our improvement program was up and running good part of 07 and we don't see substantial increases going into 08.
When I say relatively flat our 07 actual was 120 and we are looking at 122 to be precise next year, so...
Unidentified Analyst
Okay, great. And then just a quick question on...I think you touched a little bit on this with Dan's question.
But, have you got any indication whether on the free footage extension issue whether the commissioners are going to call for a...and I think commissioner Mayes [ph] had asked for an extended or potentially an extended hearing to look at this issue or whether it will be addressing kind of the next open...one of the next open meetings?
Donald E. Brandt - President and Chief Financial Officer, Arizona Public Service Company; Executive Vice President and Chief Financial Officer, Pinnacle West Capital Corporation
Yeah, I think commissioner...I will be happy to answer...respond. I think commissioner Mayes did mention a hearing.
I do not believe she used the word extended and I don't think that would be her intent. And I will go back since I was the one on the witness stand and commissioner Mayes and other commissioners asked me about this subject and I will call it growth paying for itself and ask us to think outside the box; we gave a lot of thought to it.
And late last summer, early fall had a number of discussions at some of the discussion sections of the commission, workshops and which many of the commissioners including commissioner Mayes and firstly all the others participated in are set through. And I think they were impressed by what we said forth.
Now, the staff recommendation is for Kayak, that sort of a traditional view and that in most places you would treat these as Kayak, APS with our growth almost three times, the national average is a different situation. The commissioner has asked me...all of us to think outside of the box, we did.
I think they will look at our proposal and give it a serious thought or something outside the box and maybe something that is warranted in the unusual situation that a growth situation like APS presents. So, I take them at their word that, and I don't think they are looking for an extended process.
William J. Post - Chairman of the Board and Chief Executive Officer
If I can add something to that. If you look at contribution and aided construction accounting, that's not new.
What makes this new is that we are dealing with a very high growth impact in terms of our earnings and our capital expenditures. So, what we are trying to do is take ineffective accounting concept that was used to deal with almost one off type of extensions, where you had large investments for individual customers and apply that kind of accounting treatment, which made sense if you are doing it, one customer here and one customer there to minimize the overall effective socializing those costs for one customer.
But now we are dealing with the concept of growth, which is affecting the entire company, the entire state, and all of our customers. And so you have got really a different issue you are dealing with here in terms of growth.
And I think a letter that was sent by commissioner Mayes as well as the dialogue that's taken place in some of the workshops whether the commissioners recognizes that this is a different issue. And that is one of the things that I believe, they have been trying to take a look at.
One of the reasons that they ask for more analysis by the staff report, which was provided literally yesterday and I think their intent here is really to incorporate the more specific issues that we have rather than generic ones that may apply to accounting process throughout the country.
Unidentified Analyst
Understood. Thanks a lot guys.
Donald E. Brandt - President and Chief Financial Officer, Arizona Public Service Company; Executive Vice President and Chief Financial Officer, Pinnacle West Capital Corporation
Thanks Ed.
Operator
Your next question comes from the line of Bill Hillary [ph] from Citi Investments.
Unidentified Analyst
Hi, good morning.
William J. Post - Chairman of the Board and Chief Executive Officer
Good morning.
Unidentified Analyst
I think most of my questions have been asked, but I guess, you just...you said that the hook up fee were to be treated as you guys have requested. You believe that would add $35 million to 08, is that correct?
Donald E. Brandt - President and Chief Financial Officer, Arizona Public Service Company; Executive Vice President and Chief Financial Officer, Pinnacle West Capital Corporation
That's correct. It's...and the hypothetical, if it was put in place by the end of the first quarter of 2008 and with the, I will call it phase in of the contracts that are in place, we had about 35 million pre-tax revenue.
Unidentified Analyst
Okay. And then this...regarding the transmission rate increases.
So you are basically assuming that the next open meeting given for stack to support your position, the TCAs approved in an your early guidance assuming that both the 7 million a piece and the 30 million piece going to affect March 1?
Donald E. Brandt - President and Chief Financial Officer, Arizona Public Service Company; Executive Vice President and Chief Financial Officer, Pinnacle West Capital Corporation
Correct
Unidentified Analyst
Right. And then you said it within that guidance, you have assumed $25 million?
Donald E. Brandt - President and Chief Financial Officer, Arizona Public Service Company; Executive Vice President and Chief Financial Officer, Pinnacle West Capital Corporation
That's correct.
Unidentified Analyst
Is impactful to 08. Okay.
Donald E. Brandt - President and Chief Financial Officer, Arizona Public Service Company; Executive Vice President and Chief Financial Officer, Pinnacle West Capital Corporation
Correct.
Unidentified Analyst
And that's kind of just weighted given the amount of time it's early lost this year and how the transition revenues come in?
Donald E. Brandt - President and Chief Financial Officer, Arizona Public Service Company; Executive Vice President and Chief Financial Officer, Pinnacle West Capital Corporation
Correct.
Unidentified Analyst
Okay. All right, thank you.
Donald E. Brandt - President and Chief Financial Officer, Arizona Public Service Company; Executive Vice President and Chief Financial Officer, Pinnacle West Capital Corporation
Okay.
Operator
[Operator Instructions]. Your next question comes from line of Andrew Levy from Braincourt [ph].
Unidentified Analyst
Hi, guys.
Unidentified Company Representative
Good morning.
Unidentified Company Representative
Good morning.
Unidentified Analyst
Just have two questions. The first question is just for the 2008 guidance, what are you assuming as far as sales in customers growth?
Donald E. Brandt - President and Chief Financial Officer, Arizona Public Service Company; Executive Vice President and Chief Financial Officer, Pinnacle West Capital Corporation
Customer growth is 2.8 %.
Unidentified Analyst
And you had 2% in 2007; is that correct?
William J. Post - Chairman of the Board and Chief Executive Officer
That's 2% sales.
Donald E. Brandt - President and Chief Financial Officer, Arizona Public Service Company; Executive Vice President and Chief Financial Officer, Pinnacle West Capital Corporation
Sales growth.
Unidentified Analyst
Sales growth, I am sorry. Okay, and what did you have in 2007 customer growth?
Rebecca Hickman - Director of Investor Relations
3.3%.
Unidentified Analyst
Okay. So, this is lower, but still high; okay.
And then this is just a kind of a longer kind of thought question. I don't know if you can answer it, but obviously the commission hasn't been a very favorable with you guys.
I don't think you deserve the treatment you are getting, but it is what it is. And obviously the guidance you gave this year is in the 250 range.
And I guess the question in my head is, if the commission continues to go down the past of under funding you, whether it's right or wrong. I think it's wrong, but that's all another thing.
Does the dividend become a question at some point with the 2005 dividend, and the continued...the commission continues to kind of deteriorate your earnings?
William J. Post - Chairman of the Board and Chief Executive Officer
Well, I guess the way I would look at that is to look at the last few years in terms of the issues that this commission addressed. If you look at this kind of the process that we have had in place here, what we have dealt within the last two years have been legacy issues that have remained from movement towards competition and then back to a fully vertically integrated electric utility compounded by very significant increases in fuel cost that we all know about.
So, when you take into consideration, for example, the creation the construction, and the enhancement of the fuel cost. If you take a look at the issues associated with establishing a process to deal with new resource planning.
If you look at the issues that we have dealt in term of putting forward literally a new regulatory structure, we have dealt with many substantive issues over this time frame. So if you look kind of below the numbers, there has been a significant amount of substance in dealing with many of the issues.
Obviously, when you take a look at the customer impact, we have had a large impact in terms of customers over this period; and that's something that we all give consideration to certainly they do, and we do as well. So in our next case, we are going to focus even more aggressively on the issues that we talked about here related to grow; in particular the issue to growth.
In particular, the issue associated with attrition, and also the issue associated with advances. And depending upon, as I said the disposition of this issue, it would be incorporated into that filing or will deal with that in parallel.
In either case, we will be dealing with it in terms of the overall structure in this next case on both pass. And when I say both pass, let me explain what that means.
The first one is to ameliorate the in effects socialization of extraordinary charges that come about because of high extension fees to individual customers. That fits with the dialog that exist across the country in providing customer advances in dealing with customer advances in a way it deals with the whole customer base.
The second way we will be dealing with this is the issue of attrition and the impact that has generally on our company, our state, our customers, and the way that we need to pay towards the cost of growth. So, I would ask you to think about it from really both of those perspectives and they often give kind put together, they are really quite different.
And so from my stand point, I think it's going to be very important that we deal with that issue and find a mechanism to deal with the historical test year challenge that we have in our state. The historical test year here when you take a look at the fact that we are about depending upon the year, the highest, or the second highest growth in the country in terms of customer growth is not a model that accommodates the reality that growth has.
We have obviously constitutional issues in dealing with the historical test year. But I think it's going to be absolutely critical that we focus aggressively on the issue of incremental growth and its impact on our state and our customers.
So that's a long answer to what you described as kind of theoretical broad question, and unfortunately I have to give you a theoretical broad answer to it. But I am not sure I would just take the last few years and extrapolate them in, in terms of making a determination of their intent for our future recovery.
Unidentified Analyst
Definitely not doing that, I just want to understand that, I guess you definitely need better treatment than in the past two years to kind of continue to keep your financial ratios, and everything like that where they are. I guess that's kind of where you are at, is that fair?
William J. Post - Chairman of the Board and Chief Executive Officer
That's what we are aggressively working on. You're right.
Unidentified Analyst
Okay. And I hope that all work it out here, because clearly the commissions listing.
They deserve some money guys. Thanks
Donald E. Brandt - President and Chief Financial Officer, Arizona Public Service Company; Executive Vice President and Chief Financial Officer, Pinnacle West Capital Corporation
And let me just add to that the attrition continues to be an issue as Bill said we will deal will that, but my prepared remarks relative to the PSA, I just want to under score that we have got a balance of $111 million. We will essentially collect all of that through the existing adjusters and surcharges.
And when you look back just two years ago, we were faced with the balance growing towards $300 million. The commission addressed that very proactively with the, the forward-looking PSA in combination with our hedging program.
We essentially take fewer risk, and fewer under recovery off the table for us and our shareholders and we add a tremendous amount of stability in fuel prices for our customers on a going forward basis. So, that was a huge problem.
They responded to it in a very timely fashion. Now we have got other issues, and we will address those in coming months.
Operator
Your next question comes from the line Danielle Sykes from [indiscernible].
Unidentified Analyst
Thanks. And I was wondering if you are looking longer-terms, when do you anticipate that the Palo Verde units will be back to their normal status, and normal capacity factors et cetera.
Is there some sort of a date that you are looking at where you feel you will have accomplished all the upgrade you wanted to do?
Jack E. Davis - President and Chief Operating Officer, Pinnacle West Capital Corporation; Chief Executive Officer, Arizona Public Service Company
Danielle, this is Jack. As I said in my prepared remarks, unit free overhaul is done.
We have put into steam generators to core protection calculators, new pressure turbines, which complete for all three units. All three units were up and ranked today to 100% output.
And as I mentioned, what we look forward in 08, is we do have as in the normal year two refueling outages; one for Unit 1, and one for Unit 2.
Unidentified Analyst
Okay, so essentially if you get to 09, you should be completely operating at the normal capacity factor with all of the upgrades, and efficiencies that you put in the system?
Jack E. Davis - President and Chief Operating Officer, Pinnacle West Capital Corporation; Chief Executive Officer, Arizona Public Service Company
Well, actually barring unforeseen circumstances, but I can't figure, predict any unforeseen circumstances, which is always a possibility, and also the fact, as I mentioned in my prepared remarks that we are in a 95003 NRC process, which requires more scrutiny.
Unidentified Analyst
Right.
Jack E. Davis - President and Chief Operating Officer, Pinnacle West Capital Corporation; Chief Executive Officer, Arizona Public Service Company
With those qualifiers, what I can say is that in 2008, we would hope to approach a more normal year, and in fact we don't only plan for two normal refueling outages.
Unidentified Analyst
Right. And I was wondering also the in terms of costs; do you see costs a sort of tapering off, or do you think that this is pretty much be excluding refueling.
This is pretty much the level that you will be at?
Jack E. Davis - President and Chief Operating Officer, Pinnacle West Capital Corporation; Chief Executive Officer, Arizona Public Service Company
Are you referring to...
Unidentified Analyst
In terms of O&M, yes.
Donald E. Brandt - President and Chief Financial Officer, Arizona Public Service Company; Executive Vice President and Chief Financial Officer, Pinnacle West Capital Corporation
Danielle, Don Brandt here. As I mentioned, we see Palo Verde costs relatively flat within a couple of million dollars between 07 and 08.
And I think going forward other than unforeseen events that being an adequate level, obviously with some...
Unidentified Analyst
Great. I was wondering if you are really still going through extraordinary measures and that the curve was basically either tapering off a little, or just staying flat.
So your anticipation is that you probably will stay at the same levels.
Donald E. Brandt - President and Chief Financial Officer, Arizona Public Service Company; Executive Vice President and Chief Financial Officer, Pinnacle West Capital Corporation
Yes.
Unidentified Analyst
Great. Thanks.
Operator
Your next question comes from line of Raza Griffith [ph] from Polygon Investment.
Unidentified Analyst
Thank you. Good morning.
William J. Post - Chairman of the Board and Chief Executive Officer
Good morning.
Unidentified Analyst
I just had a quick follow-up on the last question. So I guess the O&M and Palo Verde is supposed or I guess you guys are saying $120 million in 2007, $122 million in 2008 is very flat.
Was the issues that Palo Verde has gone through in the last couple of years were the expenses or costs associated with that? Were they all capitalized and that's why we are not seeing a decrease in O&M?
William J. Post - Chairman of the Board and Chief Executive Officer
No, they were not all capitalized. The bulk of the expenditures at Palo Verde are expense.
The comparison that you are looking at comparing 2007 and 2008, in 2007, we had additional expenses as a result of 95003 and the efforts that we had underway there to build our performance improvement plan. And as we shift from 2007, where our focus has been building a plan to take us back to the level of excellence that we have had in the past, our focus in 2008 is more in executing.
So what you are seeing is the shift from in fact development cost in 2007 to build their plan to 2008 in executing their plan and that's how they end up about the same, but they are for different things.
Unidentified Analyst
: So, is there an opportunity to reduce O&M as we move to 2009 and 2010 from the Palo Verde perspective as you accomplish your plans, and your execution plans?
William J. Post - Chairman of the Board and Chief Executive Officer
Well, let me just kind of address that philosophically. We are not providing projections beyond 2008, but if you look at it philosophically as I mentioned to you our focus is to bring Palo Verde back to excellence over the long-term.
And it's not just a deal with some of the current issues. It's basically to perform at the highest level on an on-going basis over that long-term.
And if you look over the long-term, the issues associated with 95003, the issues that we have the year before last, as we dealt with the vibration issue on Unit 1, the issues that Jack talked you about in terms of the steam generator for each of the three units, have an opportunity as we go forward to provide efficiency savings. And certainly that's a part of our plan in achieving excellence.
But that is a long-term plan. Our focus right now, as Jack mentioned to you, is to be very conservative in our operation at Palo Verde and to focus on everything that we do in dealing with the NRC to ensure that that operation is the safe as it can possibly be.
That has been our focus and will continue to be our focus until some point in the time, some time in the future when we can start thinking about efficiencies. But today that is not our focus.
Today our focus is really on safety and working with the NRC, and as he mentioned to you, in a mode of operation that's very conservative.
Unidentified Analyst
Great, thank you very much.
Operator
Your next question comes from the line of Paul Ridzon from KeyBanc.
Paul Ridzon - KeyBanc
You mentioned your question the constitutionality of a historical test year. How owners, where things have to get before you would play that card, and what form would you play that?
William J. Post - Chairman of the Board and Chief Executive Officer
If you got the impression I was questioning the constitutionality of that, in no way am I questioning the constitutionality of that. My reference was it is constitutional and in Arizona, because our commission has basically constitutional authority to historical test years constructed underneath the state constitution.
So my reference was to the way it restructured in our state, not that it's some how illegal or inappropriate from a legal standpoint.
Paul Ridzon - KeyBanc
I misunderstood your comments. And then just...could you just kind of summarize the staff position that they filed last night?
The revenue achievement just seems like a great opportunity to keep you out of rate cases and way of meliorating a lot of the rate pressure that customers are seeing. If you could just help us understand they are thinking?
Jack E. Davis - President and Chief Operating Officer, Pinnacle West Capital Corporation; Chief Executive Officer, Arizona Public Service Company
Sure, well Paul as I mentioned in my prior remark, we just did late last night. So I must have made our front nervous here.
I have done it...analyze it in depth. But in general they took the traditional approach as Bill mentioned in his...in an answer to a question earlier.
The staff to pay traditional approach, that's the best way to handle these issues with the contribution into construction and that's...I guess what I stated you are very away from what they have always done and we'll continue and want to do it. The positive aspect to that is the report...nowhere in their report says that we shouldn't actually get money upfront for an impact fee or connect fee, whatever term you want to use.
And the difference we have is with the staff is the revenue treatment versus the staff recommendation. And I should mention this is really...it is staff recommendations, but they hired a...should I say traditional rate consultant in order to evaluate the analysis.
And I think as Don mentioned in his comments that I don't...this doesn't close the book, because the commissioners actually ask us, don't go out and do something, do some things different, and we did something was different. And so our hope would be in the context of trying to say what we are going to do that we would get our...should I say face time soon with the commissioners to bring this particular issue to a close.
William J. Post - Chairman of the Board and Chief Executive Officer
Let me just add a couple of things to that if I could. First, the commissioners as I think are not bound by our staff position.
That's one of the things that they will consider. And in the staff report, the consultant addressed the issue that we had proposed of recording this as miscellaneous revenues and the fact that this provides much earlier benefit to our customers than the traditional utility method that's been used for years throughout the country.
And I would just re-enforce what I said earlier, I apologize for being redundant here. But I think it's a very important point.
And if what you are looking at is the issue associated with an extraordinary cost for A, particular extension, and then the contribution in A to construction accounting, which is really built around that theme make sense. On the other hand, if what you are thinking about is the fact that customer growth significantly stretches and organization that has a historical test year to be able to deal with the issues of attrition during that period.
Then ineffective socialized through all different kinds of cost categories, not just capital expenditures, but it covers everything from return on equity to the cost of debt to literally the operating expenses that we have every single day. That's a different concept.
And so that concept is really the one that we provided to the commission that said maybe we because of our unique situation applying a tool of contribution in aide of construction that was used for kind of a one-off impact that was built to solve in effect to national issues through FERC accounting may not be the most appropriate method. Such kind of a long answer to your question, but I think it really identifies, one: the fact that the commission was the one that said we really need to deal with this in a more creative way; and two: our response to that, which is to give them a different approach than we've had historically.
So it's really in the hands of the commissioners.
Paul Ridzon - KeyBanc
Thank you.
Operator
Your next question comes from the line of Jeffrey Coviello from Duquesne Capital [ph].
Unidentified Analyst
Hi good morning guys. How are you?
Unidentified Company Representative
Good morning.
Unidentified Analyst
I just had a question, you were speaking about some of the regulatory issues in Arizona, and I think one of the things that came with the potential change to test year from what is that believe were backward looking test year to forward-looking test year. I was wondering in the legal framework of Arizona is unique as it is.
What would have to change...what would have to occur for that change to take place? Is there any process ongoing now for to take place and what essentially kind of what are the prospects for it?
And how could it come about I guess the asked the question broadly?
William J. Post - Chairman of the Board and Chief Executive Officer
Sure the let me back up because I want to make sure everybody has a little foundation for comment than I made earlier. Our commission has authority under our state constitution and that state constitution basically prescribes an approach that the commission in general terms that the commission uses to establish fair value and then from fair value a determination of fair return.
Because of that constitutional structure and because of the history and practice that exist in Arizona, we have a long standing record of using a historical test year. That's not true for just APS, that's true for all public utilities in Arizona.
So, given that structure, what I was talking about earlier is that, do we have a mechanism other than changing the historical test year? To accommodate the reality that customer growth has an effect not only on our ability to be able to finance it, but also the resulting cost as those resulting cost from incremental growth get socialized to all customers.
So, what I was saying before is that we can develop in effect a surrogate mechanism, a mechanism that fills that gap that exists in the current legal model to deal with the influence that new customer growth has on our company, our customers and the state. I didn't mean to say and if people inferred that our goal is to change the historical test year structure that that is the goal we would have.
However, that has been looked at in the past, and in fact what it takes is a ballot initiative and a vote of the people to change the state constitution in the way that it deals with fair value. That's actually occurred here in our state in the past, many years ago and because of the complexity of that and many other issues that I could go in to if you want me to.
That was a process that failed in terms of the ballot initiative. So, from my standpoint what I was doing is saying given the promise, given the assumption that we have a historical test year and a rate methodology that allows for making adjustments to that historical test year to normalize that period for known and measurable events of which growth is certainly one.
Can we come up with a mechanism that supplemental to and fits inside of the legal structure that exists in dealing with the historical test year. So my comment there assumed that the historical test year remains in place, and it is our assumption that it will continue to stay in place as we go forward.
Unidentified Analyst
Got it and the surrogate mechanism was the comps that the attrition adjustment. Is that right words about that?
William J. Post - Chairman of the Board and Chief Executive Officer
Yes, that's correct.
Unidentified Analyst
Okay. All right, thank you very much.
Operator
: Your next question comes from the line of Ron Zimmer [ph] from Zimmer Lucas.
Unidentified Analyst
Hi guys. I was wondering if you can give us any indication of how much equity issuance is embedded in 2008 guidance numbers.
William J. Post - Chairman of the Board and Chief Executive Officer
We haven't made any decision on the amount or timing.
Unidentified Analyst
Okay. Thank you very much.
Operator
At this time, there are no further questions. I will now turn the call over to Ms.
Hickman for closing remarks.
Rebecca Hickman - Director of Investor Relations
Thanks. I will let Bill say few closing comments and then I will close this out.
William J. Post - Chairman of the Board and Chief Executive Officer
Well, I would just say thank you for your time. We know this is a very busy time for you.
And please feel free to get a call to Becky on any of the details or other issues that were brought up here in terms of numbers or any other numbers that we have in our website that you want additional explanation about. And thank you for your time.
Rebecca Hickman - Director of Investor Relations
And Bill just stole my comments. Basically, let me know if you need anything and thank you very much for being with us today.
Operator
Ladies and gentlemen, this concludes today's conference call. You may now disconnect.