Pinnacle West Capital Corp (PNW) 2010 Q3 法說會逐字稿

Greetings and welcome to Pinnacle West Capital Corporation's third quarter 2010 earnings conference call. At this time all participants are in a listen-only mode. A brief question and answer session will follow the formal presentation. (Operator instructions). As reminder, this conference is being recorded. It is now my pleasure to introduce your host, Becky Hickman, Director of Investor Relations. Thank you, Ms. Hickman, you may begin.

Thank you, Christine. I'd like to thank everyone for participating in this conference call and webcast to review our third quarter earnings, operating performance and recent developments. Our speakers today will be our Chairman and CEO, Don Brandt; and our CFO, Jim Hatfield. Don Robinson, President and Chief Operating Officer of APS, is also here with us.

Before I turn the call over to our speakers, I need to cover a few details with you. First, our slides today are available on our investor relations website along with our earnings release, supplemental information on our earnings variances and quarterly operating statistics, the webcast and the Form 8-K we filed this morning. The slides contain reconciliations of certain non-GAAP financial information. Please note that all of our references to per-share amounts today will be after income taxes and based on diluted shares outstanding.

Also, it is my responsibility to advise you that this call and our slides 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 forward-looking statements contained in our third quarter 2010 Form 10-Q, which was filed with the SEC this morning, as well as the MD&A section which identifies risks and uncertainties that could cause actual results to differ materially from those contained in our forward-looking statements. A replay of this call will be available on our website, www.PinnacleWest.com, for the next 30 days. It will also be available by telephone through November 3.

At this point I will turn the call over to Jim.

Thank you, Becky, and good morning, everyone. As you see on slide four, the topics I will touch upon today are, first, a review of the consolidated quarterly results and discuss the main variances from last year's corresponding quarter. Second, I will provide a brief update on the status and outlook for the Arizona economy. Then I will discuss our earnings guidance for 2010 and 2011. Finally, I will close with some brief comments on financing and liquidity.

Slide five summarizes our reported and ongoing earnings for the quarter. On a GAAP basis, for this year's third quarter, we reported consolidated net income attributable to common shareholders of $234 million or $2.14 per share compared with net income of $187 million or $1.84 per share for the prior year's third quarter. Our ongoing earnings increased $0.12 or share. For the 2010 third quarter we had consolidated ongoing earnings of $227 million or $2.08 per share versus $198 million or $1.96 per share for the comparable quarter a year ago.

A reconciliation of our third quarter GAAP EPS to our ongoing EPS is shown on slide six. The amounts for both quarters exclude results primarily related to our discontinued real estate operations. In July, SunCor sold land parcels, commercial assets and a master-planned homebuilding community and, as a result, has reduced its outstanding debt to about $6 million. As result of the SunCor restructuring we estimate the parent will realize approximately $110 million of cash tax benefits. As result of bonus depreciation being extended into 2010, we now expect those tax benefits will be revised in 2012 as compared to our prior expectation of 2011. And as always, my remaining comments will focus on ongoing results.

Turning your attention to slide seven, you will see the variances that drove the change in quarterly ongoing earnings per share. First, an increase in our Regulated Electricity segment gross margin added $0.27 per share compared with the prior year's third quarter. Some pluses and minuses comprises that variance, and I will cover those items in more detail on the next slide. Second, an increase in capitalize financing costs, also known as allowance for fund used during (technical difficulty) or AFUDC, approved earnings by $0.06 per share, primarily because of increases in the rates used to capitalize such costs. Third, the net impact of miscellaneous items increased earnings by $0.05 per share. The primary factor affecting this comparison was continuing favorable resolution of tax matters which we discussed in our first quarter call. Fourth, the increase in shares outstanding resulting from our April equity issuance decreased earnings by $0.14 in the quarterly comparison. Fifth, higher operations and maintenance expense decreased earnings by $0.09 per share. The expense increase largely reflects higher employee benefit costs and the acceleration of a fossil plant overhaul. This change in O&M excludes expenses related to the renewable energy standard, or RES in our demand side management and energy efficiency efforts because, as you know, these costs are offset the respective rates surcharges. We have provided the amounts of pretax RES and DSM revenues that were recorded by quarter by quarter over the last couple of years in the appendix to today's slides.

Our cost containment initiatives and other efforts continue, and we should achieve our goal to keep operational O&M relatively flat in 2010. Finally, higher infrastructure-related costs decreased earnings by $0.03 per share, reflecting increases in both property tax and depreciation.

Turning to slide eight and the composition of the net increase in our Regulated Electricity gross margin, total regulated gross margin was up $0.27 per share compared with 2009's third quarter. The components of that increase were as follows. Retail rate increases favorably impacted our quarterly results by $0.33 per share. Of this amount, $0.30 per share related to net base rate increase, and $0.03 per share related to the line extension fees recorded as revenue. Both of these items became effective January 1 of this year under APS's retail regulatory settlement.

Weather effects improved earnings by $0.02 per share. Since actual cooling degree days in the quarter were above normal and similar to last year's third quarter, the favorable variance was mostly attributable to an increase in average humidity of approximately 5% over the same period in 2009. Lower weather-normalized kilowatt hour sales compared with the third quarter a year ago decreased our quarterly results by $0.05 per share. Weather-normalized retail kilowatt hour sales were down 1.7% in the quarterly comparison, largely reflecting the effects of our ACC-approved energy efficiency and demand side management programs. Customer growth of 0.6% over year-ago levels helped offset the decline in sales. I'll provide more on the state of our Arizona economy momentarily. The net effect of miscellaneous other gross margin items decreased our results by $0.03 per share.

Looking at our fundamental growth outlook and the Arizona economy, we currently expect annual customer growth to average about 1% for 2010 through 2012. Additionally, we expect our average annual weather-normalized retail sales and kilowatt hours to be [relatively flat] from 2010 through 2012 because of the impacts of the national economy, the housing situation in Arizona and APS's energy efficiency programs. However, for the full year 2010 we expect weather-normalized retail kilowatt hour sales to be down compared with the year 2009 as a result of the combination of our energy efficiency programs and weak underlying demand.

In the third quarter of this year we continued to see signs of stability in the Arizona economy. As shown on slide nine, housing prices and commercial building occupancy in the metropolitan Phoenix area have stabilized over the past couple of quarters. Excess housing in the Phoenix metro area is starting to be absorbed as the demand for housing continues at low levels but faster than new supply being added. We expect this situation to continue for at least two to three years. On the commercial side, vacancy rates are expected to peak at very high levels this year, but the trends in demand for both office and retail space are positive again after several quarters of decline.

Taken as a whole, we continue to be cautiously optimistic the Arizona economy has found a bottom and we can begin the long process of recovery. We expect the economy, both nationally and locally, to improve gradually as we move through 2010. Importantly, we need to see more robust consumer confidence in order to support our stronger recovery and residential usage patterns, ignoring weather effects and the impacts of our energy efficiency programs, but we have yet to see this improvement.

Similarly, commercial and industrial customers' usage is likely to remain flat as office and retail properties struggle with weak demand for the balance of this year. Over the long term we remain confident of Arizona's fundamentals. We expect customer growth and usage to return to stronger levels as the national and state economic environments improve.

Turning to our earnings outlook on slide 10, we continue to expect our consolidated ongoing earnings for 2010 will be between $2.95 and $3.10 per share. For your reference, a list of assumptions and key factors underlying our 2010 outlook is included in the appendix to today's slides. In addition, we continue to estimate our 2011 consolidated ongoing earnings will be within the guidance range for 2010 -- for -- consolidated ongoing earnings, with some opportunity for modestly exceeding the range. Our 2011 forecast includes an expected contribution from our Arizona Sun program of about $0.03 to $0.04 per share. Don will speak about the Arizona Sun program and its progress to date in a few moments.

Now a quick update on financing and liquidity. Since the beginning of the third quarter, APS changed the interest rate modes on approximately $180 million of its pollution control bonds from a daily rate mode to term rate modes. The letter of credit supported each of these bonds were terminated in conjunction with the rate change. These financing efforts enabled us to take advantage of current attractive interest rate levels and to reduce bank liquidity utilization. Overall, we continue to have ample liquidity and access to capital and bank markets. We continue to believe we will not need to issue additional equity until at least 2012.

And that concludes my prepared remarks. Now let me turn the call over to Don.

Thanks, Jim, and thank you all for joining us today. I know it's a particularly busy day for you with all the earnings announcements, and we hope to make it worth your while to be on our call. We look forward to seeing you next week at the EEI Financial Conference.

Jim has touched on several issues important to our investors, including our growth in the Arizona [economy]. Although the recession has slowed our historically robust growth patterns, Arizona retains numerous qualities that make it a desirable place to live and do business, and its past record of strong growth remains an attractive distinguishing characteristic for our Company.

During the third quarter we made distinct progress in some key areas and continued our track record of operational excellence. Today I will update you on the following -- first, Arizona regulatory developments, then our strong commitment to renewable energy sources, then our recent operating performance, and finally a regulatory matter related to our Four Corners power plant.

Looking first at Arizona regulatory matters, we continue to work with the Arizona Corporation Commission and various stakeholders to further enhance the state's regulatory framework so as to benefit both our customers and our shareholders. As I've discussed in the past, the Commission has been conducting workshops on several generic policy issues affecting Arizona regulation. We view many of the Commission's activities as signaling positive developments for Arizona's regulatory environment and anticipate additional progress on many of these issues through the remainder of this year and well into next year.

At the time of our last earnings conference call, the Commission had just approved its energy efficiency rules, which await certification by the Arizona Attorney General. From APS's perspective, the Commission must implement an effective decoupling mechanism or a similar device in the next APS rate case if APS is to achieve the rigorous energy efficiency standard contained in the rules. Along those lines, on October 18, Chairman Mayes issued a draft decoupling policy statement. The draft supports the concept of decoupling calculated using the revenue-per-customer model that APS and a number of other parties endorsed. The proposed policy permits any interested utility to file a decoupling plan in its next general rate case. Comments from various stakeholders on the draft statement are due today. Subsequent steps by the Commission prior to approving any policy statement will likely depend on the nature and extent of the comments received.

In addition to participating in the ACC's generic workshops, we have been actively meeting with various stakeholders to identify and discuss matters specifically relevant to APS's next general rate case, which we plan to file in mid-2011. Discussion topics include, for example, how to best balance our resource portfolio to serve the state's future energy needs while meeting Arizona's requirements for renewable resources and energy efficiency and how to improve the efficiency and transparency of rate case proceedings with the goal of processing the rate case within 12 months, as agreed upon in the last APS regulatory settlement.

Towards that end, the parties have drafted standard data requests which APS will answer and file at the same time it files the case, and have identified other procedural efficiencies that should help accelerate the process.

On a related topic, next Tuesday's elections will affect the composition of the Commission, as two of the five seats are on the ballot. Commissioner Pierce, a Republican, is running for reelection for a second term, and Chairman Mayes, on the other hand, is term limited, so her seat will be filled by a new commissioner. There are currently seven candidates' names on the ballots.

Turning to renewable energy resources additions, we are on track with plans to significantly increase the amount of renewable energy that we provide to our customers. Slide 12 outlines APS's AZ Sun program, our current model for developing and owning utility-scale solar facilities. To recap the AZ Sun program, APS plans to develop and own 100 megawatts of photovoltaic solar plants with a capital investment of up to $500 million. We expect that those plants will be placed in service in 2011 through 2014. And to date, we have announced projects totaling 33 megawatts with overall estimated capital expenditures of about $150 million. These projects include, one, a 15-megawatt facility to be sited at Luke Air Force Base just west of Phoenix. This project, which we plan to bring online in mid-2011, is expected to be the largest solar facility on US government property. And, two, an 18-megawatt plant in Gila Bend, Arizona, about 70 miles southwest of Phoenix, which we plan to place in commercial operation in late 2011.

We continue to evaluate new projects and we'll provide updates as we progress under this important program. From a regulatory perspective, the Corporation Commission has approved a highly constructive rate recovery for the plants procured through the AZ Sun program.

Looking at our operating performance and a related regulatory matter, our baseload nuclear and coal fleet continues to perform admirably. All three units at our Palo Verde nuclear facility operated at full power for the entire third quarter, as they did in last year's third quarter. Palo Verde Unit 3 is now undergoing a planned refueling outage that began on October 2. During this outage we were replacing the reactor vessel head and installing a rapid refueling package. Work of this extent typically requires an outage to last 50 to 60 days. When finished, the program we began in the fourth quarter of last year to install this equipment in all three Palo Verde units will be complete. Looking ahead, the Palo Verde team remains focused on achieving safe, sustainable top-tier performance in all aspects of the plant's operations.

On the fossil side of our business, our coal-fired and gas-fired plants continue to meet our customers' energy needs during our peak summer months. During the quarter we optimized a forced outage at our Cholla Unit Number 2 by accelerating an overhaul that had been planned for next spring. On October 6 the United States Environmental Protection Agency issued its proposed determination for best available retrofit technology, or BART, as it's known, requirements for the Four Corners power plant. The EPA's proposed measures are intended to address regional visibility, not health issues. As proposed, these requirements would require plant participants to install new pollution control equipment on all five of the plant's units to reduce emissions of nitrogen oxides and particulates. We currently estimate that APS's total cost for the proposed controls could be up to approximately $422 million for nitrogen oxide controls and about $220 million for particulate removal equipment. We are currently completing a thorough evaluation of the impact of the EPA's proposed rule and intend to submit comments to the agency during the comment period.

On a more positive note, in the recent quarter several prominent organizations recognized our Company's sustainability efforts. I am pleased that for the sixth straight year, Pinnacle West was named to the Dow Jones Sustainability index for North America and as one of the Davos Global 100 Most Sustainable Companies in the World. Pinnacle West was one of only 11 US electric utilities included in the Dow Jones index and was one of only 12 US-based companies in any industry to be named to the Global 100. The Company also ranked in the top one-third of the newly created Justmeans Global 1000 Sustainable Performance Leaders.

In summary, our Company's goal is to achieve top-tier performance, and we constantly work towards that objective in every facet of our business. Going forward, we are committed to maintaining operational excellence and achieving superior financial results by concentrating on our core utility business.

This concludes our prepared remarks. Operator, at this time we would be pleased to take any questions.

(Operator instructions) Greg Gordon, Morgan Stanley.

So thinking about the drivers for the potential for earnings growth post-2011, is it fair to say at a fairly high level that, one, is hopefully the economy starts to improve and the current rate structure would allow for benefits both from increased to our sales usage, but also from increased revenue from hookup fees, given the structure of the last rate deal? Is that fair?

Yes, that's fair, Greg.

But you are looking to modify that, and you would look to modify that in the next rate case to get some level of decoupling, and you think that that is a better risk/reward in terms of allowing -- hopefully, finally, after a decade of driving your ROEs up to a tight spread to your authorized returns? I'm just wondering what the trade-off is here in terms of, do investors -- are investors better off in the long run being levered to an economic recovery thesis here where you are not decoupled, or are they better off with you pursuing a decoupling scheme where we don't necessarily get massive benefits, but we're also immunized from big swings over the long run?

Yes, Greg, this is Jim, and I think the right way to look at decoupling is the trade-off for us and consumers are the high energy efficiency standards in Arizona. If you think about the decoupling mechanism that we had advocated, as have most of the people in the open meetings (technical difficulty) mechanism called fixed revenue per customer. And the benefit for us is, as we continue to grow customer, we will continue to get incremental recovery of costs associated with not only the energy efficiency, but that additional customer growth on the system. So from our perspective, it doesn't really mean a trade-off between traditional regulation and decoupling; it's really additive to the traditional regulation.

Okay, thank you.

Greg, it has been important from our perspective in pursuing decoupling that we didn't trade away any of the intrinsic value of this Company, and that's the long-term growth profile.

Dan Eggers, Credit Suisse.

Good morning, guys. This is actually Kevin. Can you kind of actually (technical difficulty) when looking at decoupling, it makes complete sense to us and it feels like it makes complete sense for all the parties involved as well. And actually, the Commission wants to get their renewable energy strategy done, they need decoupling. Am I missing any rational opposition that was explored during the vetting by the Commission?

No. In fact, I think you hit it on the head, Kevin. I think the commissioners believe and most of the stakeholders believe that to take away the disincentive, i.e., the inability of the utilities to achieve the high standard we have, decoupling is a necessary mechanism to facilitate that happening.

Okay, and then on dividend policy, now with -- it seems like you have somewhat visibility into your earnings growth and at reasonable cash levels, what is your willingness and ability to step up the dividend near-term?

That's something we'll look at down the road a little bit, Kevin.

Ali Agha, SunTrust Robinson Humphrey.

Don, you mentioned with two Commission seats up for grabs, presumably one of the seats with the incumbent will come back, but Chairman Mayes will be retiring. Are you looking at any change in the regulatory regime or the overall regulatory framework post-elections as you're going into your next rate case?

Well, I think we have been -- both we, the Commission, the staff and other interveners in our cases have, over the last two years, developed a very constructive working relationship, and we've made some real progress. And it's benefited at all the [constituencies], and I really don't see that tack changing. (Multiple speakers) commissioners.

Okay, and then more near-term, through the nine months' results, Jim, perhaps to you, would you say that results so far have come in at plan or above plan? And, with just one quarter to go, should we be really thinking about, say, the mid to high point of the range that you've laid out for the year?

Well, Ali, I'm not going to point you to anywhere in the range. I would say that we feel like we are on track. We've seen gross margin deterioration on a usage basis in the year. We expected that. I feel very confident about our cost initiatives. So I would say that we are on track at this point.

Okay. Lastly, you had mentioned that in '11, I believe you are assuming about $0.03 to $0.04 from the Arizona Sun program. The two projects that you have identified and the timing of them coming online -- does that give you the visibility that, assuming they're on track, that those $0.03 to $0.04 should materialize?

Yes. We are recovering that through the RES and we have filed the RES and expect to get an order consistent with that before the end of the year. So we do think that gives us the visibility needed to speak about the contributions.

Ted Heyn, Catapult Capital Management.

I had two quick questions. First, I think you guys had talked about potentially giving a discrete '11 guidance range, and it looks like you kept the same language as you did from the second quarter call. Was there any thought process in why you chose to do that versus laying out some more defined goalposts?

No. I think that we are still in the budget process here. And when we come out with it, I think we want the most certainty we have, and so we are not quite there yet. We'll do it at our fourth-quarter call, and we've done it either third or fourth quarter, historically, I've been told. So I think we're still on track with [normal] (technical difficulty).

And then I guess the second question I had was relating to the discussions about 2010 guidance in the press release. There's some bullet points that walk through what the changes to your gross margin and operating expenses were relative to the second quarter. And it looks like your gross margins are now coming down; the range came down zero to $30 million, and the operating is (technical difficulty) actually went up $20 million to $30 million, offset by interest expense being about $10 million lower. That gets me a $30 million pre-tax reduction, which seems -- is there something that's not in those numbers? Because it seems like you reiterated your range, but that $30 million seems like a pretty big piece of the range.

Well, I would say this about the guidance ranges. Gross margin -- we just really tighten the range after nine months of actual at this point. The operating expenses, we did get an increase, a significant increase, in property tax in the third quarter. We reflected that in total operating expenses.

Now, I wouldn't look at it is cutting it down the middle. We create these ranges or goalposts as a way to communicate possible ups and downs, but it's not linear through the ranges.

Okay, so we shouldn't just add up the middle and then say that's about $0.15, and that's -- it could be any portions of the pluses and minuses?

That's correct.

Okay, and then -- I'm sorry -- so, you said the biggest swing on the OpEx was property tax?

Well, we had -- in the third quarter, we had the increase in benefit costs. We had the overhaul, but that's a timing issue. That was really slid forward. And then we had an increase in property tax. The assessed valuations in Maricopa County and Pinal County in residential dropped significantly; in 2010, Maricopa County 19.4%, Pinal, 21.3%. As a result, of the first valuation decrease in Arizona in property tax since '93, we had our first increase in property taxes since 1998. And so, because our valuation is not consistent with the drop in residential, we had more property and higher rates. And we were a bit surprised by that, but we'll get through it as well.

Well, I guess the tax man is more bullish on values in the near-term than you are, because it's beneficial to them; right?

Well, they have a budget too, so --

Yes, okay, thanks a lot, I appreciate it.

(Operator instructions) Brian Chin, Citigroup.

A quick question on the BART requirements for Four Corners. Could you just walk through the time line over which the Commission might have to look at some of the estimates that you have put out there? I think you've put out, in the 10-Q, about $640 million of environmental CapEx that might be necessary. Just looking for the time line of looking at that going forward?

The time line of actually having to comply with that comes five years after the rules actually go in place. So we would be actually putting those expenditures in and seeking recovery from probably 3.5, four years from now.

Michael Worms, BMO Capital Markets.

Just a quick question or two -- one would be, has it been determined who the next Chairman of the Commission will be?

No, it has not. That will be up to the Commission to elect the Chairman.

Okay, and then secondly, you have suggested there would be opportunities to exceed the guidance range in 2011. Can you just give us some color as to what opportunities there would be? Other than the Sun project; or I'm assuming that's in there already.

Yes, we assumed a contribution at some level of Arizona Sun. I think you have higher hookup fees, you have upside potential or downside, I guess, as well from just customer growth. We also have a higher -- we have that pension deferral next year as well, which kicks in as part of the settlement, and then we are going to do our best to continue to hold expenses relatively flat.

Great, thank you very much, see you next week.

There are no further questions in the queue at this time. I would now like to turn the floor back over to management for closing comments.

Well, again, thank you for taking the time today, and we'll see you next week. Becky, if you have anything to add?

Thanks, and if there's anything you need, please give me a call. Thank you all.

Ladies and gentlemen, this does conclude today's teleconference. You may disconnect your lines at this time. Thank you for your participation.