Pinnacle West Capital Corp (PNW) 2012 Q1 法說會逐字稿

Greetings and welcome to the Pinnacle West Capital Corporation 2012 first-quarter earnings conference call. At this time all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. (Operator Instructions). As a 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, Claudia. I'd like to thank everyone for participating in this conference call and Webcast to review our first-quarter 2012 earnings, recent developments and operating performance. Our speakers today will be our Chairman and CEO, Don Brandt, and our CFO, Jim Hatfield. Jeff Guldner, who is APS Vice President of Rates and Regulation, is also here with us. Before I turn the call over to our speakers, I need to cover a few details with you. First, the slides to which we refer are available on our Investor Relations website, along with our Earnings Release and related information. Please note that the slides contain reconciliations of certain non-GAAP financial information. Also, all of our references to per share amounts will be after income taxes and based on diluted shares outstanding.

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. Our first-quarter 2012 Form 10-Q was filed this morning. Please refer to that document for forward-looking statements, cautionary language. 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 for the next 30 days. It will also be available by telephone through May 10. At this point I'll turn the call over to Jim.

Thank you, Becky. The topics I will discuss today are outlined on slide 4. First, I will review the consolidated first-quarter results and discuss the main variances from last year's corresponding quarter. Second I'll provide a brief update on the status and outlook for the Arizona economy. Last, I will close with brief comments on our liquidity and financing activities.

Slide 5 summarizes our reported and ongoing earnings for the quarter. On a GAAP basis, for this year's first quarter, we reported a consolidated net loss attributable to common shareholders of $8 million, or $0.08 per share. Compared to a net loss of $15 million or $0.14 per share for the prior year's first quarter. Our ongoing earnings increased $0.08 per share for the 2012 first quarter. We had consolidated ongoing loss of $7 million or $0.07 per share, versus an ongoing loss of $16 million or $0.15 per share for the comparable quarter a year ago.

Slide 6 contains a reconciliation of our first-quarter GAAP earnings per share to our ongoing earnings per share. The amount for both quarters excludes results related to our discontinued real estate and energy services businesses. My remaining comments on the quarter will focus on ongoing results.

Moving to slide 7, you see the variances that drove the change in quarterly ongoing earnings per share. First, an increase in our gross margin added $0.01 per share compared against the prior year's first quarter earnings. Several pluses and minuses comprise this positive net variance, and I'll cover those items in more detail on the next slide. Second, lower operations and maintenance expense improved earnings by $0.07 per share. The expense decrease largely reflects lower fossil plant maintenance costs as a result of less work being completed early in the year compared to 2011, as well as a net decrease in other items. This O&M variance excludes expenses related to the Renewable Energy Standard, or RES, energy efficiency, and similar regulatory programs. As well as the 2011 first-quarter settlement of transmission rights, OA costs. All of which were essentially offset by comparable revenue amounts.

Third, lower infrastructure related cost increased earnings by $0.03 per share, reflecting both lower interest charges and lower depreciation and amortization associated with the 20-year license extension granted last year by the NRC for the Palo Verde Nuclear Generating Station. Those cost reductions were partially offset by higher property tax related to tax rates. Fourth, the net impact of all other items decreased earnings by $0.03 per share. Finally, our first-quarter 2012 earnings benefited $0.02 per share because of the Arizona Sun plants that were placed in service last year and earlier this year. This net variance is reflected in various items on the income statement.

Total gross margin was up $0.01 per share compared to the 2011 first quarter. If the main components of that increase were as follows. The retail transmission cost adjustor rate increase that became effective July 1 of 2011 improved earnings by $0.03 per share. Line extension fees recorded as revenue pursuant to the 2009 retail regulatory settlement improved our results by $0.02 per share. The net effect of other miscellaneous items increased our gross margin by $0.03 per share.

Lower usage by APS retail customers compared against last year's first quarter decreased our quarterly results by $0.04 per share. Weather normalized retail kilowatt hour sales were down 0.9% in the quarterly comparison, after accounting for the effects of our ACC approved energy efficiency and demand side management programs. Customer growth of 0.8% over year-ago levels helped offset the decline in kilowatt hour sales. The effects of weather variations decreased earnings by $0.03 per share. This year's first quarter was warmer than normal, with residential heating degree days lower than normal by 17%.

Turning to slide 9 and looking at our fundamental growth outlook and the Arizona economy. Economic growth in Arizona continues to improve in the first quarter, although modestly. As shown on slide 9, growth in non-farm jobs and consumer spending are both solidly ahead of the prior years' levels. In particular, the rate of overall job growth has held up well for almost a year. And virtually all of the major industrial sectors are experiencing some growth. Other indicators, like income growth and the unemployment rate, all show steady improvement, although the patterns remain uneven. Additionally, APS's customer base grew 0.8% in the first quarter, which is the strongest growth we've seen in three years. All in all, these trends indicate that the Arizona economy is headed in the right direction, even though we have significant headwinds to contend with. Unemployment remains too high and vacancy rates in housing and commercial real estate are only marginally lower than their peaks of 2010.

One bright spot has begun to emerge in the demand for industrial space in the metro Phoenix region, with vacancy rates down 20% from their peak. But other sectors are seeing only slow absorption of excess space. We believe that this situation will continue to restrain new construction and higher levels of growth for at least two to three years. Over the long term, though, we remain confident in Arizona's fundamentals. We expect customer growth and usage to return to stronger levels as the national and state economic environments improve. Looking at the next several years, we currently expect annual customer growth to average about 1.6% for 2012 through 2014. Additionally, we expect our average annual weather normalized retail sales and kilowatt hours to be relatively flat from 2012 through 2014, primarily due to APS's energy efficiency programs offsetting a modest recovery in the economy.

Finally, I want to comment on our liquidity and financing plans. At the end of the first quarter, the Parent Company had no short-term debt outstanding. APS had $217 million of short-term borrowings. And both have ample liquidity. Our higher credit ratings have provided APS and the Parent Company improved access to short-term funding, as well as lower cost funding through the debt capital markets. As we previously indicated, we do not intend to issue earnings guidance for 2012 until after the final decision has been rendered in APS's pending retail rate case. However, to assist with your estimates, a list of key drivers that may affect 2012 ongoing earnings is included in the appendix to today's slides. Additionally, if the constructive settlement in the pending retail rate case is approved by the Arizona Corporation Commission, we would be comfortable with our ability to fund APS's capital expenditure program with no new equity needed until 2013 at the earliest.

And with that, I'll turn the call over to Don. Don?

Thanks, Jim. And thank you all for joining us today. I'll update you on developments in the following areas. Arizona regulation and APS's pending retail rate settlement, our investments in generation including renewable resources, and our overall operating performance. I'll start with APS's pending rate settlement.

On January 6, we filed a proposed settlement of APS's pending retail rate case, which was signed by 22 of the 24 active parties to the proceedings. Very late yesterday, the Arizona Corporation Commission's chief administrative law judge issued her recommendation that the settlement be approved without material modifications. Collectively, the settlement terms would produce a net zero dollar change to existing base rates in 2012, an important benefit for APS customers. In addition to the base rate changes, the settlement contains a number of key financial provisions, which we discussed during last quarter's conference call. Details of the settlement, as well as key underlying assumptions, are outlined on slides 13 through 17 in the appendix to your slides today.

The settlement contains a number of benefits for our customers, the communities we serve and our shareholders. Notably, the requested regulatory treatment would build upon the constructive framework established in the 2009 settlement. And provide financial support for APS that will help us achieve Arizona's energy goals over the next four years. The settlement also includes a four-year stay-out for the next general retail rate case. Under this provision, APS may file its next general rate case on or after May 31 of 2015. For base rates to become effective no earlier than July 1 of 2016. We believe several factors will support us financially during the stay-out period. These factors include, first, APS's rate adjustment mechanisms, such as the power supply adjustor and the transmission cost adjustor. Second, a provision to allow APS to seek rate adjustments related to the Four Corners acquisition, if it is consummated. And I'll review the Four Corners progress momentarily. Third, certain features of the settlement, such as the lost fixed cost recovery mechanism and the property tax deferrals. And finally, our continuing focus on cost management and operational excellence.

Looking at key procedural dates, the parties to the case have until May 11 to file any exceptions to the ALJ's recommended order. Thereafter, the commissioners will consider the settlement at an open meeting, which has not been yet scheduled. APS and other settling parties have requested that the settlement become effective July 1 of this year, and that's supported by the judge's recommended order. We view the settlement agreement as a further sign of progress in Arizona's regulatory environment. With its broad-based support, the settlement demonstrates significant collaboration and cooperation among APS, the ACC staff, and the variety of other parties. We appreciate the opportunity to continue to work with the Arizona Corporation Commission and the various stakeholders to enhance the state's regulatory framework. And to find solutions that balance the interests of customers, shareholders, and other stakeholders.

Turning to the Four Corners plan. We continue making progress on our plan to acquire Southern California Edison's interest in the Four Corners plant in northwestern New Mexico. The multi-part plan addresses environmental regulations while maintaining our well-balanced resource portfolio. It has substantial merits, economically, environmentally and socially. A summary of the plan is included on slide 18.

The acquisition requires approval by Arizona, California and federal regulators and other government agencies. Noteworthy progress has been made in this regard. On April 18, the Arizona Corporation Commission authorized APS to proceed with the acquisition and to defer certain transaction-related costs until the acquired generation is placed into retail rates. With a condition that the transaction may not close prior to December 1 of this year. The Commission established a closing date parameter to reduce the cost impacts of the transaction on customers. Separately, as I have already mentioned, APS's pending retail rate settlement contains a proposal that would permit APS to seek to reflect the Four Corners transaction in retail rates on or after July 1 of 2013, if it is consummated. In addition, the California Public Utilities Commission approved the transaction for Southern California Edison on March 29.

Other conditions that must be met prior to closing the transaction include negotiation of a new coal supply contract. Approval by the Federal Energy Regulatory Commission. Expiration of the Hart-Scott-Rodino waiting period. And other typical closing conditions. We remain optimistic about obtaining the remaining approvals and completing the related required activities to allow the completion of our Four Corners plan in a timely manner.

Turning to renewable resources and our AZ Sun development activities. We're on track with plans to increase the amount of renewable energy APS provides for our retail customers. Under the AZ Sun program, APS plans to develop and own up to 200 megawatts of utility scale photovoltaic solar plants in Arizona. The projects are to be placed in service in 2011 through 2015. And the Arizona Corporation Commission has approved the program with a constructive rate recovery mechanism. To date, we have announced AZ Sun projects that have a total production capacity of 104 megawatts, at an estimated capital investment of $451 million. A summary of the program is included on slide 19.

In late 2011, and earlier this year, we placed three new AZ Sun plants into commercial operation, adding a total of 50 megawatts of solar capacity to APS's generation mix. Construction and other development activities are currently underway at two sites for another 54 megawatts. And we anticipate these facilities will be placed in service in late 2012 and in 2013. Additional planning and procurement activities are in various stages for the balance of the capacity needed to complete the AZ Sun program.

Our renewable energy initiatives, particularly AZ Sun, are important measured steps toward advancing Arizona's sustainable energy future. These projects also support our economy. New solar and wind plants to serve APS customers have created more than 2,400 design, engineering and construction jobs for our state. We are pleased that APS's accomplishments installing and promoting solar power have been recognized by a number of independent third parties. For example, in April, APS was named one of the top 10 solar electric utilities in the United States by the Solar Electric Power Association.

Looking at our operating performance, our base load nuclear and coal fleet continues to perform well. During the first quarter, our Palo Verde nuclear facility operated at a 94% capacity factor. This capacity factor reflects the fact that Unit 3's refueling outage began during the quarter on March 17. And that 32-day outage was successfully completed on April 17, making it the second shortest refueling outage in the Palo Verde site's history. The shorter duration demonstrates Palo Verde's commitment to reducing its average refueling outage time, while maintaining its commitment to safely and efficiently generate electricity for the long-term. The site's next refueling outage will be Unit 2 this fall. Our coal-fired plants also continued their run of solid performance.

Turning to the quality of our customer service. In February of this year JD Power and Associates released the results of its most recent business customer survey. I'm pleased that APS continues its record of performance excellence and overall customer satisfaction. In the most recent results, APS ranked fourth nationally among 47 large investor-owned electric utilities. More specific to our region, we were rated second among 10 investor-owned utilities in the West. In addition, for the third consecutive year, APS was awarded the Environmental Protection Agency's highest honor for continuing leadership in protecting the environment through energy efficiency programs. The EPA's Energy Star Sustained Excellence Award recognized two APS programs for promoting energy efficiency and reducing greenhouse gas emissions.

In summary, our Company aims to achieve top tier performance. And our employee team constantly strives to meet that objective in every facet of our business. Going forward, I assure you we remain focused on our core utility business, operational excellence, and achieving a constructive regulatory outcome. All for the benefit of our customers, our shareholders and the communities we serve.

Operator, this concludes our prepared remarks. And we'd be pleased to take questions at this time.

(Operator Instructions). Shar Pourreza with Citigroup.

Just a quick question. Jim, I know you mentioned that you would look to issue 2012 EPS guidance following a final order in the GRC. Don did a great job presenting some growth drivers outside of base rates, during his prepared remarks. Given that you could be in a multi-year stipulation under the settlement, would you also issue some type of an EPS growth trajectory during the stay-out period when you begin to issue guidance again?

Great question, Shar. And the answer to that is yes. If you remember, our last settlement we issued guidance over a couple year period. We would look to do some sort of EPS growth looking over the settlement period again to give investors comfort of our ability to manage through that.

Terrific. Thanks. Congrats on the great quarter.

Kevin Cole with Credit Suisse.

Just checking the weather for AGA. It looks like mid-90s for the weekend. Is it still too early to have any cooling-driven weather at all?

A couple weekends ago we had a record 106 degrees, I believe, on a Saturday and Sunday. It's gotten hot here before in May. I think you might have a pleasant visit for AGA.

Okay. Good. And so with the Four Corners approval a couple weeks ago, does this implicitly approve the $300 million of environmental CapEx and also treatment of Units 1, 2, 3?

From a CapEx perspective I would say no. From a Units 1, 2 and 3 treatment, the answer would be yes.

What is the process for getting the $300 million of environmental CapEx approved?

Assuming we close, we'll put our CapEx plans in, dependent upon when that's needed to be in service, 2016 to 2018, we'll begin design and engineering work for the plan. Which is consistent with what was filed in our IRP back on March 30.

Okay. And then with the $700 million of equity, I think you agreed to in the last settlement, from my chair it doesn't look like you need that much. And from a customer perspective I would imagine that's the most expensive form of financing. With this new settlement are you able to rebase that number? Or does it nullify the previous number?

It does not nullify it, Kevin. But obviously, if we don't believe we need that amount of equity by 2014, we'll certainly make our case to the settling parties in 2009. And I would not expect that they would want us to issue the most expensive form of cost of money if it's not needed. Keep in mind, too, since that last settlement of in '09 we have been upgraded as well, which helps the situation.

Thank you, guys.

Neil Mehta with Goldman Sachs.

With an earnings uplift likely upcoming, pending the implementation of new rates, how do you think about dividend growth? You've been in a flat dividend trajectory for the last couple years. How do you think about that going forward?

Obviously, assuming the settlement's approved, and the ability really to have a runway now through the next filing, I would expect a dialogue with the Board on the appropriate dividend level for Pinnacle West going forward.

Okay. But you haven't talked about historically a targeted dividend payout level, have you?

No, and I don't think we would specifically say a payout level. I think we would, consistent with earnings growth of X, look at a dividend growth rate of X minus or something of that regard, as opposed to saying an explicit payout ratio.

Thanks, Jim. And any notable changes from this morning's announcement in terms of the settlement terms with ALJ recommendation?

No.

The last question I had, has there been any update in terms of what happened with the Southwest Utility's outage last year? There's been some headlines that have been coming across our screens here.

The report's out. At this point, that's all we know, is a report's out.

Okay. All right. Thank you, Jim.

Greg Gordon with ISI Group.

One of the things that jumped out from the release was, while you're saying you're seeing some signs of pickup in economic growth, you also had significant impact from energy efficiency in demand side management in the quarter.

That's correct.

Can you refresh our memories on how the recovery rider prospectively will work to incentivize you to continue to pursue those and/or compensate you for continuing to pursue those types of savings?

Sure. The mechanism, the lost fixed cost recovery mechanism envisions that we'll file the first recovery March of 2013. And it recovers the distribution fixed cost associated with lost sales through those mechanisms.

Great. So assuming approval of this as filed, prospectively there will be an offsetting revenue to the extent that you see incremental energy efficiency driven load reductions?

That's correct. I would not characterize it as a one-to-one offset. But you do get a partial revenue pickup from what's lost through the programs.

And you currently do not get anything like that, correct?

Correct.

A second question with regard to financing plans. You said 2013 at the earliest for equity. But when I just think about regulated utility model, the fact that you won't be filing a rate case until 2014 -- at the earliest 2014 -- for rates in '15, and that you have an historic test period, what are the factors that are going to go into the timing of the equity issuance? It would seem to me that it would behoove you to try to time it more concurrently with when you would need to update your capital structure for the next rate review which is some time away.

Greg, I think you're exactly right there, because it would be certainly no sooner than we need it. And the driving force would be rebalancing our capital structure going into that test year.

Great. Thanks very much. Sorry I'm going to miss AGA but I'll be in Bermuda.

Tough duty.

So will I, Greg.

Ali Agha with SunTrust.

Jim, I wanted to just be clear. The Four Corners acquisition, assuming that it does close as planned, the earnings that you are to book for that incremental, will that be timed with when it goes into retail rate base? In other words, July 1 onwards of '13 is when we should see earnings?

That's correct, Ali.

Okay. And the full-year stay-out period, I know that obviously has not been approved yet but assuming it is, should we also assume, as you're planning through that time period, that you're fairly confident that ROEs will be maintained, we won't see any erosion? Is that a fair way to be thinking about that period when you have a stay-out?

I think to say you wouldn't see any erosion over that time frame is probably a bit strong. I think, depending upon factors, including our ability to have CapEx at the right level and control expenses, I think over the time frame you would see ROEs in the mid 9%s.

Okay. And lastly, just clarifying, you made a couple of comments on the need for equity in the future. But how much of that is also driven by liquidity and credit rating concerns? As you said, you've been obviously upgraded and so on. But in terms of what would be causing you to issue equity in '13 if you were to do it? What are the main issues, in your mind? Obviously the rate case would not be one of them.

That's correct. And back to Don's earlier comment, we're not going to issue equity any sooner than we need it. But I think the factors that go into that are obviously liquidity, which we have ample liquidity so I'm not necessarily worried about that. But we do have to watch our credit ratios, as well, which will be part of the equation. And that's going to be driven, obviously, by funds from operation CapEx going forward. I think there's a balance there between trying to maintain ratings and not piling on too much debt. But it's going to be delayed as long as possible.

Understood. Thanks.

Brian Russo with Ladenburg Thalmann.

Just to follow up on the equity needs question. Could you maybe be more specific on the target ratios that we should monitor that may lead to equity, or push equity out, and preserve your credit rating?

Sure. From a regulatory ROE, or regulatory equity layer, our last case was 53.9% which was our actual capital structure. The last one before that was 53.8%. So it's in that range. And at the consolidated level it's 50/50. What we also have to monitor is the impeded debt and the other factors that S&P puts into the rating.

Okay. And in terms of when Four Corners gets added into rates, July of '13, will there be some regulatory lag in terms of when the purchase is completed, no earlier than December of '12? And we could see some incremental D&A and operating expenses without the rate offset? Is that accurate?

We get to defer the costs associated with 4 and 5. We get a debt return. So the real lag from an earnings perspective is just the offset of the equity return. It's more of a cash flow issue than it's going to be a book issue during that time frame.

Right. Understood. And then lastly, just could you remind us how the property tracker works? Is there any cap and are you at risk of under-recovering those taxes?

The deferral starts at 25% in 2012 and ramps up to 75%. So yes, there's a risk there, obviously, if property taxes, the assessment rates, continue to go up. Property tax assessment rates typically are about 18-month lag to values. So it's really going to depend upon what happens in the turnaround in property values in Arizona between now and the next rate case.

Okay. Thank you.

(Operator Instructions) Jim Krapfel with Morningstar.

Recent net migration from Mexico has recently turned negative for the US. To what extent is that going to have an impact on customer growth opportunities?

It won't have an impact on us at this point. Keep in mind, migration into Arizona really follows job opportunities and that's not going to happen until we see the absorption of housing and construction pick up again.

Okay. Thanks.

Paul Patterson with Glenrock Associates.

Just wanted to touch base with you guys on sales growth. You guys are predicting flat sales growth going forward. And that's because of customer growth being offset by energy efficiency, correct?

That's correct, Paul.

And what would it be without energy? What is the energy efficiency impact? And is this completely APS's efforts or is it just stuff that we're seeing as well in other efforts that might be going underway?

That's pretty hard to track exactly, Paul. But I'd say we have energy efficiency standard and a distributed generation standard. We can track pretty much what we're doing. Customers are also doing things, as well. But primarily I would say it's the ACC compliance programs that's involved.

And what is that versus the normalized? What would the growth rate be without your efforts?

Over this time frame, probably slightly less than 2%.

A little less than 2% growth, correct?

Correct, sales growth.

For the quarter, you had a decrease in sales growth of 0.9%, weather adjusted?

That's correct.

Okay. And did that include leap year?

Yes, it would.

Okay. So it would even be lower. Is there anything in particular with this quarter that would be causing that or is that just something that --? How should we think about that?

The leap year is one day out of three months and the first quarter is not a big sales month for us, so not a big impact from that.

Okay. Thank you very much.

There are no further questions at this time. I will now turn the floor back over to management for closing remarks.

Thank you again for joining us today. As always, if you need further details about our earnings or other information about our Company, please contact us. This concludes our call.

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