Pinnacle West Capital Corp (PNW) 2014 Q4 法說會逐字稿

Greetings and welcome to the Pinnacle West Capital Corporation 2014 fourth-quarter and full-year earnings conference call. (Operator Instructions) As a reminder, this conference is being recorded.

It is now my pleasure to introduce your host, Paul Mountain, Director of Investor Relations. Thank you, sir. You may begin.

Thank you, Christine. I would like to thank everyone for participating in this conference call and webcast to review our fourth-quarter and full-year 2014 earnings, recent developments, and operating performance.

Our speakers today will be our Chairman and CEO, Don Brandt, and our CFO, Jim Hatfield. Jeff Guldner, APS's Senior Vice President of Public Policy, and Mark Schiavoni, APS's Chief Operating Officer, are also here with us. First, I need to cover a few details with you.

The slides that will be using are available on our investor relations website along with our earnings release and related information. Note that the slides contain reconciliations of certain non-GAAP financial information.

Today's comments 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 2014 Form 10-K was filed this morning. Please refer to that document for forward-looking statements, cautionary language, as well as the risk factors and MD&A sections, which identify risks and uncertainties that could cause actual results to differ materially from those contained in our disclosures.

A replay of this call will be available shortly on our website for the next 30 days. It will also be available by telephone through February 27.

I will now turn the call over to Don.

Thanks, Paul, and thank you all for joining us today. The fourth quarter wrapped up a productive year and set the stage for further progress in the year ahead.

Earnings finished the year in the middle of the range after adjusting for below-normal weather. APS's reliability and customer satisfaction remain in the top tier. Safety had another solid year and Palo Verde set a record for power production. In fact, Palo Verde unit number 3 produced the second-highest electricity output of any nuclear unit in the world in 2014 and all three Palo Verde units individually ranked among the top six producers in the United States.

Jim will discuss the 2014 financial results, but first I will update you on the regulatory progress and discuss a few significant projects. In December, the Arizona Corporation Commission voted on several key issues and we appreciate their commitment to resolve these items before the bench turned over.

I will provide an update on two key issues in a moment, but I would like to first thank Commissioners Brenda Burns and Gary Pierce, whose terms ended in early January. We appreciate their commitment to the state over many years of public service and on driving the dialogue on several complex regulatory issues.

Commissioners Doug Little and Tom Forese were sworn in on January 5 to four-year terms. Commissioner Susan Bitter Smith was also selected by her fellow commissioners as the next chair, succeeding Commissioner Stump, who did a tremendous job leading the commission through a challenging period.

Governor Doug Ducey was also sworn in, leading a group of many new officials at the state level that are bringing a renewed focus to economic development in Arizona. We look forward to working with Governor Ducey's team.

I will now provide an overview of the key dockets that were voted on in December at the commission. The Four Corners rate tariff was approved with rates in effect as of January 1 of this year. The $57.1 million rate change was $8 million below our request; however, it was in line with the commission's staffs and the administrative law judges' recommended order. We were pleased to have a final order in this matter.

Separately, the commission voted it had no objection for APS to build and own 10 megawatts of residential rooftop solar on approximately 1,500 homes. Now titled the APS Solar Partner Program, installations will begin in the spring. We have had a great deal of interest from our customers and initiated the first of three requests for proposals to qualified local Arizona-based installers at the end of January. We are in the process of determining the system feeders and customers to target, which will then be matched up with the selected installers who will inspect the roofs and install the rooftop systems.

Putting this program in perspective, as of the end of 2014, APS has 30,000 residential rooftop installations equating to about 200 megawatts of installed capacity. In 2014, interconnection application volume was down slightly from the record-setting 2013 numbers, but actual installations in 2014 of 7,800 systems was the highest ever, showing a 10% increase over 2013. This robust level of growth causes the unfair cost shift to continue to increase.

In addition, the ACC initiated a generic docket in December titled, "In the Matter of the Inquiry into Solar DG Business Models and Practices and Their Impacts on Public Service Corporations and Ratepayers." Chairman Bitter Smith requested comments by February 13, so the commission and staff are now reviewing the comments received last week.

The next steps and timeline for this docket are expected to be discussed at an upcoming commission meeting. We have included a 2015 calendar in our presentation to highlight the key dockets and dates ahead of us this year, including the docket I just mentioned.

Let me highlight a few other items. Rate design discussions are surfacing after the initial discussion last fall. We are having discussions with several stakeholders to determine the best path forward.

Late last year, Salt River Project proposed a broad rate restructuring and it is expected this will be voted on at their board meeting on February 26. SRP's proposal includes several rate design principles that we have been advocating, primarily better alignment of fixed and variable costs and revenue. While each utility may have a different rate structure, it is clear from the national discussion and here in Arizona that appropriately addressing the unfair cost shift and aligning the fixed and variable discrepancy are a top priority.

The Ocotillo modernization project has moved a year closer to beginning construction, which is expected in 2016. We have been working on the necessary approvals and outreach to the surrounding community and are pleased with the reception we have received. The certificate of environmental of compatibility was approved in November.

The last milestone before construction will begin was raised during the commission's integrated resource planning meeting in the fall. While there was clear support for the first two units, which replaced the existing steam units, questions were raised on the cost effectiveness of the additional three units. We have maintained the importance of the five units to serve future load growth, as well as improve the valley's reliability.

However, to address the concerns that were raised, we issued an RFP in late January for the incremental capacity equivalent to three of the five units. This process is expected to conclude in the summer.

One other item to watch is the Delaney Colorado River transmission line decision. TransCanyon, which is our joint venture with BHE US Transmission, formerly named Mid-American Transmission, submitted its bid to the California ISO on November 19. In January the bidder list was disclosed; six bidders in total. The CAL ISO is working through its qualification and selection process and we expect a decision this summer.

Lastly, I will comment on a few recent environmental developments. On December 19, US EPA issued its final regulations governing coal ash, which regulates coal combustion residuals as nonhazardous. Our initial estimate, a portion of which is included in our capital forecast, is that our incremental cost to comply will be approximately $100 million, mostly at our Cholla plant.

We are also working with the Corporation Commission, the Arizona Department of Environmental Quality, known as ADEQ, and the Arizona utilities to encourage the EPA to make revisions to Arizona's requirements under the Clean Power Plan. Under the draft Clean Power Plan, Arizona would be the second-most impacted state in the nation. While APS's diverse portfolio is a clear advantage, we are concerned about the impact on other utilities in the state, including the need for additional infrastructure, and the cost to Arizonans associated with achieving the goals originally established.

We support the state's efforts to enact legislation that enables ADEQ to submit a state plan to US EPA. This legislation is necessary to assure EPA does not issue a federal plan for the state of Arizona.

Let me conclude by saying I'm very proud of the leadership of our people again this year, ranging from the pursuit of excellence each day across our operations and the safety of our employees and a discussion on the complex topic of rate design. I expect our team to again lead on these efforts in 2015 and that we will deliver on our commitments this year.

I will now turn the call over to Jim.

Thank you, Don. The topics I will cover today are outlined on slide 3 and include a discussion of our 2014 financial results, an update on the Arizona economy, a look at our financing activity, and a review of our earnings guidance.

Slide 4 summarizes our GAAP net income and ongoing earnings for the quarter and the full year. For the fourth quarter of 2014 we reported consolidated ongoing earnings of $5.4 million, or $0.05 per share, compared with ongoing earnings of $24.3 million, or $0.22 per share, for the fourth quarter of 2013.

For the full year 2014, we reported consolidated net income attributable to common shareholders of $398 million, or $3.58 per share, compared to net income of $406 million, or $3.66 per share, for 2013. Weather-normalized, our earnings for 2014 would have been $3.68, in the middle of our guidance range of $3.60 to $3.75, translating into an earned consolidated ROE of greater than 9.5%.

Slide 5 outlines the full-year earnings per share drivers compared to 2013. Primary favorable variances include: higher gross margin supported by the various revenue adjusters and lower interest expense driven by our financing activities and the lower costs of long-term debt.

The effects of adverse weather decreased earnings by $0.16 per share. To put the unfavorable weather effect in perspective, in terms of its impact on megawatt hours, 2014 was the second mildest year in 15 years including the first quarter of 2014, which was the mildest first quarter in 40 years. There was not much variance in the other drivers, including operation and maintenance expenses.

Starting on slide 6 let me walk through the variances that drove the change in quarterly ongoing earnings per share.

An increase in gross margin improved earnings by $0.07 per share. I will cover the drivers of our gross margin variance on the next slide. Lower depreciation and amortization expenses increased earnings by $0.01 per share, in part due to the Palo Verde Unit 2 lease extension we announced in July offset by additional plant service.

Lower interest expense, net of AFUDC, benefited earnings by $0.04 per share. The decrease largely reflects reduced interest charges resulting from refinancing long-term debt at a lower rate. Higher operations and maintenance expenses decreased earnings by $0.18 per share, largely due to more fossil generation planned outages.

A higher effective tax rate reduced earnings by $0.06 per share, including a prior-year tax benefit and the extension of bonus depreciation. The net impact of other items decreased earnings by $0.05 per share.

Turning to slide 7 and the components of the net increase of $0.07 in our gross margin, the main components of this were as follows. The loss fixed cost recovery mechanism improved earnings by $0.01 per share, which as designed offset some of the impact from energy efficiency programs and distributed energy. The Arizona Sun program benefited earnings by $0.01 per share, primarily driven by the 32 megawatts Gila Bend solar project that went into service.

The effect of weather variations increased earnings by $0.03 per share. Although weather in both the 2014 and 2013 fourth quarters was less favorable than normal, fourth-quarter 2014 benefited from a warmer October compared to the same month 2013.

Higher usage by APS's customers compared with the fourth quarter a year ago increased quarterly results by $0.01 per share. Weather-normalized retail kilowatt hour sales after the effects of energy efficiency programs, customer conservation, and distributed generation were up 1.9% in the fourth quarter of 2014 versus 2013. The favorable variance is partly due to the low usage we saw in the fourth quarter in 2013 and was in line with our expectations of where we would in the year.

The net impact of other miscellaneous items added $0.01 per share. As a reminder, both the gross margin and O&M variances exclude expenses related to the renewable energy standard, energy efficiency, and similar regulatory programs, all of which are essentially offset by comparable revenue amounts under adjustment mechanisms.

Also, the deferrals associated with the Four Corners transaction and the impacts to our non-controlling interest for the Palo Verde lease extensions are treated in a similar manner. The drivers I discuss exclude these items as there was no net impact in 2014 results.

Slide 8 presents a look at the Arizona economy and our fundamental growth outlook. Arizona's economy continued its steady improvement in the fourth quarter of 2014. Job growth in Arizona and the Phoenix metro area picked up modestly at the end of the year and for the quarter. Arizona added jobs at a 2.6% rate, as seen on the lower right-hand side of slide 8.

Business services, healthcare, tourism, and consumer services are each adding jobs in excess of 4% on a year-over-year basis and most other sectors continue to grow at more modest rates. The job growth we are seeing reflects the attractiveness of metro Phoenix and Arizona as a great place to do business, with excellent access to California and other markets, but with a much lower cost structure.

This continued job growth is providing a stable pace of absorption in commercial, office, and retail space, yielding a continual decline in vacancy rates in those sectors. As these markets tighten up, we expect to see construction activity regain steam. As an example, the Phoenix metro area currently has 2.9 million square feet of office space currently under construction, most of which will be delivered this year. This is the highest amount of office construction since 2009.

Although the retail sector remains quiet, industrial space continues to be in high demand with 4 million square feet under construction, primarily in our West Valley territory. We were also seeing continual increases in the Metro Phoenix housing demand, although the increase in demand is present being met largely with multifamily development. Total housing permits and multifamily permits both set cycle highs in 2014, providing their best year since 2007 as you can see in the panel at lower left.

We expect 2015 to be better than 2014 in terms of job growth, income growth, consumer spending, and absorption of residential and commercial vacancies and believe that these trends will translate into higher overall housing activity. The future market share for apartments versus single-family homes remains a question and is largely dependent on the degree of strength in the existing single-family home market. As you can see in the panel at the upper left, existing home prices have recovered substantially from their recession lows and continue to increase year-on-year.

The recovery in prices reflects the continual absorption of vacant homes and apartments in Metro Phoenix and the normalization of foreclosure sales activity. While existing home prices may not have recovered enough yet to spur new single-family home construction, the apartment markets is enjoying the lowest vacancy rate it has seen in 15 years and we believe it is only a matter of time before new single-family market moves more decidedly in the upward direction.

On balance, we see signs of sustained improvement in the economic environment and a gradually steady recovery. As in past recoveries, it is likely that each successive year in the near term will be stronger as we go forward. Reflecting this steady improvement in economic conditions, APS's customer base grew 1.4% compared with the fourth quarter last year, in line with our forecasts.

We expect that this growth rate will gradually accelerate in response to the economic growth trends I just discussed. Importantly, the long-term fundamentals supporting future populations and job growth in Arizona appear to be in place.

Slide 9 outlines our financing activities. On January 12 APS issued $250 million of 5-year 2.20% senior unsecured notes. The proceeds from the sale were used to repay commercial paper borrowings and to replenish cash temporarily used to fund capital expenditures. We plan to refinance a $300 million maturity in 2015 and raise up to $275 million of additional long-term debt as assumed in our guidance.

Overall, liquidity remains strong. At the end of the fourth quarter the parent company had no short-term debt outstanding and APS had $147 million of commercial paper outstanding.

A quick note on pension. Our funded status remained strong at 90% as of year-end 2014, in line with year-end 2013. This is due largely to the continued implementation of our liability-driven investment strategy. Our higher funded status translates to lower long-term funding requirements.

Also in October, the Society of Actuaries issued its final report on mortality tables. We have incorporated a modified version of the mortality assumptions in our pension calculation, which we believe better reflects our employees' demographics. Additional detail, as shown on the slide, included in the appendix of today's presentation.

Finally, I will review our earnings guidance and the financial outlook on slide 10. We continue to expect Pinnacle West's consolidated ongoing earnings for 2015 will be in the range of $3.75 to $3.95 per share. The rate adjusters in cost management remain important drivers. A complete list of the factors and assumptions underlying our guidance is included in the appendix to our slides, which are unchanged.

This concludes our prepared remarks. Operator, we will now take questions.

(Operator Instructions) Dan Eggers, Credit Suisse.

We can go to the next question and Dan can get back in the queue.

Ali Agha, SunTrust.

Thank you, good morning. First question, I understood you guys talked about the weather impact in 2014 on the earnings, but you know, as recently as the end of the Q3 results or around EEI time we were still looking at a $3.60 to $3.75 guidance range for the year. So when we look at the $3.58 that you reported, what were the big factors relative to your own assumptions in the fourth quarter that caused us to miss the lower end of guidance for the year?

Well, we had negative weather in the fourth quarter, as we talked about. We also had the extension of bonus depreciation, which pushed out our ability to use production tax credits, which had a negative impact of about $0.03 on the quarter as well.

Got it, okay. Then secondly, looking at the dynamic between weather-normalized sales growth and customer growth, I know quarterly numbers tend to get skewed, but your customer growth has been fairly steady, 1.4%, and yet we saw the 1.9% weather-normalized sales number in the quarter. Again, anything to extrapolate from that? And just remind us what the expectations are for customer growth and weather-normalized growth for 2015.

Well, for customer growth we are looking 1.5% to 2.5% for 2015. We had 1.4% fourth quarter of this year. Weather-normalized sales sort of flat to 1% range.

I think it's important in the fourth quarter of 2013 we had I think a negative 2% sales growth. And then I would not look at any -- I would not look at the quarter in and of itself. I would really look over the course of the year where we really had sort of flat sales and the 1.4% customer growth.

Got it. My last question, Jim, with regards to the current thinking in terms of the timing of the next rate case and the earliest need for equity, can you just remind us again where you stand today on both of those factors?

No change really. We are looking at not filing until at the earliest mid-2016. And equity, again, no earlier than 2016.

Okay, got it. Thank you.

(Operator Instructions) Paul Ridzon, KeyBanc.

Just real quickly, do you have any sizable maturities coming up and how are you thinking about the opportunities on the interest line?

Well, we have $300 million of debt maturing later this year, which we will refinance. We also have maturities in 2016 and then our big maturity is in 2019. So we will look at all factors when we look at that in today's interest rate environment.

We chose in January to take advantage of the short end of the curve due to demand, but we still have historically low interest rates across the board and see that those refinancings as really an opportunity to incrementally provide some interest savings.

Thank you very much.

Michael Weinstein, UBS.

Good morning. I was wondering if you could characterize how the discussions at the commission have been going with regard to rate design. In terms of -- I understand comments were just taken; is the process moving forward at a quick pace, a regular pace? Has it stalled recently?

And what kinds of initiatives -- what's the involvement of the Company in those discussions?

Michael, this is Jeff Guldner. I think the discussions are moving forward at a normal pace, and so what you are seeing right now is comments from the parties here in Arizona. Obviously, folks are also paying attention to what's happening on the national scene. There's a lot of discussions that are happening nationally and we are engaged in both of those. So we are engaged at the state level; we are also participating in the national debate.

Right, have you -- would you say that things are moving along at the pace that you expected?

I think what you will see -- so you've got two new commissioners that have just taken their seats and so I think you will see the discussions continue to accelerate here in the next few months.

And do you still expect that -- or I guess do you have any expectation that rate design, metering, those types of issues to be dealt with separately outside of the rate case or whether they will be rolled into the rate case?

Well, it's a statewide issue, so remember there's going to be a discussion on just what it means from a state perspective. How the implementation happens is part of that discussion.

And so we have got a mechanism right now that is the LFCR DG adjuster. That is a component or that's one method of addressing really the cost shift issue. But structurally how you do the rate design changes, we know a lot of that is going to happen in the rate case.

Okay. I guess maybe the thrust of the question is more like when do these -- when does action have to be taken by the commission on this docket? How early does it have to happen?

What is the latest it could happen before -- so that a separate process could occur? Or at some point I guess it's just too late and you have to roll it into the rate case because the filing is coming in mid-2016.

There's no time clock on the discussion. The discussion -- I can't tell you when the discussion is going to -- how it is going to specifically unfold. But from a process standpoint, I mean some rate design changes are going to have to happen in a rate case. It is helpful to have the discussion of what that process should look like and what some of the issues are ahead of the rate case filing.

Okay, all right. Well, thank you very much.

It appears we have no further questions at this time. I would now like to turn the floor back over to management for closing comments.

All right. Thanks, everyone. As you look at the 10-K and the materials, please give us a call if you have any questions and we will talk with you soon. Thank you.

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