Pinnacle West Capital Corp (PNW) 2016 Q1 法說會逐字稿

Greetings and welcome to the Pinnacle West Capital Corporation first quarter 2016 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 first quarter 2016 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. First I need to cover a few details with you.

The slides that we 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 first quarter Form 10-Q 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 also will be available by telephone through May 6. I will now turn the call over to Don.

Thanks, Paul, and thank you all for joining us today. 2016 has started off with a solid first quarter, very much in line with our expectations, and we remain well positioned to meet our financial commitments this year. We are focused on operational execution and APS's rate case filing planned for June 1.

We have had planned outages at both units at the Four Corners generating fossil plant and at the Palo Verde nuclear generating station. Jim will discuss the financial impact, but the Four Corners planned outages were the primary headwind in our first quarter results compared to the first quarter of 2015. The Four Corners unit five major outage began in late January while unit four's outage started in March with both expected on-line very soon.

Palo Verde's planned unit 1 refueling outage began on April 10. Palo Verde continues to perform exceptionally well. The site recently completed a peer evaluation by the World Association of Nuclear Operations, or WANO as it's known, and by the Institute of Nuclear Power Operations, or INFO, and received exceptionally positive feedback from this evaluation.

On a related note, Maria Lacal has been instrumental in Palo Verde's success has been promoted to senior vice president of regulatory and oversight for Palo Verde. Maria, I know you're listening, so thank you for all you've done to make Palo Verde one of the safest and best performing nuclear plants in the nation.

We're making progress on our capital investment program. We're building a 40-megawatt utility scale solar facility known as Red Rocks Solar where our major customers, ASU and Paypal, have agreed to buy the power and will also receive the renewable energy credits.

We signed an agreement with a data center to construct a micro grid at their location in north Phoenix. This will be the second micro grid APS is partnering on in our service territory. The first with the department of the Navy's Marine Corps air station Yuma.

The Red Rocks Solar and micro grid projects represent unique opportunities to develop innovative solutions for our customers. Additionally, as part of the APS solar partner program, we are the first utility in the nation to use advanced technology to manage solar generation through the use of advanced inverters. The inverters APS is using recently received underwriters laboratory certification.

This is an important milestone since we require that all equipment on the grid be certified by UL. The advance inverters allow us full command and control of the devices we own, which includes ramping up or curtailing power and enabling two-way power flows.

Turning to the regulatory calendar, the Arizona corporation commission and staff have been managing a full schedule. The UNS rate case hearing took place in March.

We were engaged in the residential rate design portion of that docket. The discussions centered on the deployment of three-part rates, which include an energy component, a demand component, and a customer charge. A final decision is expected this summer.

We also filed testimony in the value and cost of distributed generation docket. Hearings began on April 18 and are expected to conclude in early May. There is not a set timetable for a decision. The outcome of this docket is anticipated to outline a statewide methodology of how the cost of service for solar customers will be handled, as well as how the value of solar will be determined.

We do not expect to have decisions on these two dockets before our June 1 rate case filing date, but our engagement in each process has provided insight on rate design. Residential rate design is an area where we will propose changes to better align costs with prices, including proposing three-part rates for most residential customers as well as shifting our time of use periods to later in the day.

We'll also request a deferral of costs related to two large capital projects that we will be investing in. The selective catalytic reduction controls, or SCRs as they're known, at Four Corners, and the fast ramping natural gas modernization project at our Ocatillo site. These investments total over $900 million over the next few years with in service dates of 2018 and 2019 respectively.

In the case of the SCRs since the timing of installations will be close to the end this rate case, we'll also propose a step mechanism to reflect the deferred SCR cost similar to the treatment of the Four Corners acquisition. Our overall rate filing theme centers on clean energy, sustainability, innovation, and technological options for customers.

Lastly, I will comment on a recent development. Earlier this month, a constitutional ballot initiative supported by Solar City that was related to distributed generation and rate making was filed with the Arizona secretary of state in an effort to put the initiative on the November 2016 ballot. In response, two bills were introduced this week in the Arizona legislature that would have offered competing referendums for Arizona voters to consider.

Very late yesterday, the Solar City ballot initiative and the two bills were pulled from consideration. The Arizona utility industry and Solar City agreed to further dialogue in the future to seek a constructive outcome on net metering.

In closing, we're delivering on our commitments and continue to be well positioned for a solid year in 2016. We're focused on operational excellence and positioning APS as a sustainable leader through strategic capital investments and a forward thinking rate filing. I will now turn the call over to Jim.

Thank you, Don. And thank you again, everyone, for joining us on the call.

This morning we reported our financial results for the first quarter of 2016 which were in line with our expectations. As you can see on slide 3 of the materials, for the first quarter of 2016, we earned $0.04 per share compared to $0.14 per share in the first quarter of 2015.

The primary drivers were a higher gross margin, offset by a higher operations and maintenance expense. Several factors contributed to the gross margin in the first quarter, including favorable weather. The net effect of weather variations increased earnings by $0.02 per share.

Although weather in both 2016 and 2015 first quarters were less favorable than the normal 10-year averages, heating degree days were 57% higher in the first quarter of this year compared to last year. Higher usage by APS's customers compared to the first quarter a year ago added a penny to gross margin. Weather normalized retail kilowatt hour sales increased 1.3% in the first quarter of 2016 versus 2015.

The transmission adjustment mechanism and the Arizona sun program also added to the first quarter gross margin. We still expect the lost fix cost recovery mechanism or LFCR, to be a positive driver for the year, but favorability will be more heavily weighted in the second half of the year.

Now turning to O&M, as Don mentioned earlier, higher O&M was a primary headwind to first quarter 2016 earnings compared to 2015, largely driven by the major planned outage at Four Corners unit five that began in late January. In line with our expectations, the outage costs decreased earnings by about $0.13 quarter-over-quarter.

The Four Corners unit four and five planned outages were both concluded in the second quarter which will provide a headwind similar to the first quarter consistent with guidance.

Lastly, a brief note on depreciation and amortization expenses. Lower D&A increased earnings by a penny in the first quarter.

This variance includes higher expenses resulting from additional plant and service which were offset by lower depreciation related to the extension of the Palo Verde sale lease-back. As Arizona's economy continues to be an integral part of our business story, I will highlight next the trends we are seeing in the local economy and in particular the metro Phoenix area.

What you see on slide 4 is a continuation of the consistent growth trend we have been describing for you the last couple of years. Job growth in the first quarter of 2016 in the metro Phoenix area remained above the national average as it has for nearly five years. As seen on the upper panel, Metro Phoenix added jobs at a 3.6% year-over-year rate.

This job growth is broad based with construction, business services, financial services, and healthcare showing strong sectorial strength adding jobs at a clip above 4% year-over-year. The job growth in Phoenix economy is driven -- is driving robust population migration. Of the 15 largest US metro areas, Phoenix ranks third in the nation in 2015 population growth, behind only Houston and Dallas, which is influencing trends in the metro Phoenix housing permits as can be seen in the lower panel of slide 4.

In 2015, Phoenix saw the housing market record its best year since 2007 for both total permits and the single-family sector by itself with almost 22,000 permits and 15,000 permits respectively. This growth trend continued in the first quarter of 2016 as single-family permits grew nearly 35% over last year's first quarter. We expect the housing market to continue to improve throughout this year with annual total housing permits falling in the range of 25,000 to 32,000.

In summary, the metro Phoenix economy continues to grow steadily and is positioned for stronger growth over the next couple of years. Additionally Arizona and metro Phoenix remain attractive places to live and do business, especially as they are situated relative to the large but higher cost California market.

Reflecting the steady improvement in economic conditions, APS's retail customer base grew 1.3% compared with the first quarter last year. 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 population, job growth, and economic development in Arizona appear to be in place.

In closing, I will review our earnings guidance and financial outlook. We continue to expect Pinnacle West consolidated ongoing earnings for 2016 will be in the range of $3.90 to $4.10 per share. The adjustment mechanisms, particularly transmission and the LFCR, along with modest sales growth and normal weather remain the key gross margin drivers. You will you find a complete list of factors and assumptions underlying our guidance included on slide 5 which are unchanged from last year.

Looking ahead to 2016 financing, we plan to refinance a $250 million August maturity and anticipate issuing up to $400 million of additional long-term debt.

Overall, our balance sheet and liquidity remain very strong. During the first quarter APS increased its commercial paper program from $250 million to $500 million. At the end of the quarter Pinnacle West had no short-term borrowing, and APS had $262 million of commercial paper outstanding.

Finally, our rate base growth outlook remains 6% to 7% through 2018, and our forecast does not include the need for additional equity. This concludes our prepared remarks. I will now turn the call back over to the operator for questions.

Thank you.

(Operator Instructions)

Our first question comes from the line of Greg Gordon with Evercore. Please proceed.

A couple questions. First on all the activity in the capital around the net metering, the legislation, is it your expectation that you are going to be able to settle -- substantively settle issues around net metering in the context of your rate case, or do you think that whatever happens in the Unisource case is going to be precedential, some combination of both? Is it your expectation that will you be able to effectively bury the hatchet with the solar leasing guys and figure out a scenario that makes everybody happy?

Thanks, Greg. And thanks for being on the call. Our expectations at this point is to sit down and we and the rest of the utility industry in Arizona and have good faith discussions with representatives of the leasing -- the solar leasing industry. And see where that takes us.

Do you expect those conversations would happen soon enough to affect the outcome of the Unisource case, or will the commission just make a move to change the tariffs in the way --

Jeff is sitting here. I will let him chime in on the UNS case.

The UNS case is moving into settlement discussions so they're through hearing, so I expect that's going to continue on the path that it's on, and then our case is teed up to file on June 1. Right now there's a bunch of different paths that are moving. We'll just to have see how they intersect.

Okay. I've got a bunch of other questions, but I'll go to the back of the queue. Thanks, guys.

Our next question comes from the line of Julien Dumoulin-Smith with UBS securities.

Good morning.

Hey, Julien.

Wanted to follow up a little bit on that solar question. I'd be curious, what exactly is the mediation that's talked about here as dar as the deal with Solar City and the rest of the crowd here? What could that ultimately come out of that? What is the scope of that perhaps is the most precise question.

It's Jeff. So the scope is, sit down and look at certainly there have been some things that have happened elsewhere and look at what we can talk about in Arizona. So, it need to have an Arizona focus. We're different than other parts of the country, but we certainly are open to sitting down and having good faith discussions with folks on the rooftop solar side.

So ala what happened in New York?

Yes, there are different things with framers but New York is obviously a different situation, and those talks were broader and also involved some community solar aspects. So I think the important thing is understanding Arizona has got a different setting, if you will, but still there's certainly room for discussion.

And just to clarify, what's the timeline on that? Just as it relates to sort of Greg's question here with the Tucson case being precedential or your own case, et cetera?

We're working to schedule the discussions right now, but how they intersect it's that early to say.

Got it. Fair enough. Moving back to the transmission side, the TransCanyon JV of sorts, I would be curious what are you guys looking at now that PG&E is in the mix, how widespread is this? Is there anything specific you can speak in to terms of FERC 1,000 processes that you're looking at?

No, the PG&E partnership we believe at TransCanyon will give us more opportunity sets, if you will. I think the scope of TransCanyon has not changed. It's still focused in the [wec] region, and we'll continue to be active where we can on a transmission project.

Right. And just to clarify here, given some of the bankruptcies in the sector is there any opportunity to revisit certain transmission lines?

I don't think so.

Okay. Great. I will leave it there. I will get back in the queue.

Our next question comes from the line of Ali Agha with SunTrust. Please proceed with your question.

Thank you. Good morning.

Good morning, Ali.

First, Jim, wanted to clarify, I believe if I heard you correctly you were saying the outage at Four Corners impacted the first quarter by $0.13, and that you expect is similar in second quarter as well, $0.13? Is that the way we should think about?

No. As we said on the fourth quarter call, the headwind would be $0.13 in the first quarter, and it was. I think Four Corners 5 is on-line now, and so we're having a little bleed into the second quarter, but certainly the majority of the impact is first quarter driven.

I see. So more like a couple of pennies in the second quarter.

Yes.

Okay. Secondly, just to get a sense, a lot of moving parts around the solar issue. Do you still have that value and cost of solar process going on as well, and so is that still the key sort of part, sort of the critical part, if you will, to finally the commission reaching some conclusion on would they want to do with solar, or are these other discussions taking precedence? Can you just line it up for us, like what is the key critical part item to clarify the solar situation?

So, Ali, this is Jeff, you've got -- so the value and cost of solar docket which is a generic docket is moving through hearings right now. That will go into briefings and provide the commission with information, but it's another separate track.

So the challenge right now is there's multiple separate tracks that are moving forward, and we don't know how those are going to intersect. And so if the value in solar -- value and cost of solar docket results in findings and conclusions, then presumably those get factored into rate cases or other things.

Okay.

But it's unclear where that's going right now. It's still in hearing.

I see. So when you file your rate case June 1, assuming all of this is still out there, will you basically lay out what you assume makes sense and then put that as part of the rate case filing, or would you leave it blank? Conceptually how should we think about that?

No, we've got a plan. Our plan in the rate case filing continues to be around making changes to the residential rate design and moving to a three-part rate structure. That's what you will see proposed in our case. What the commission does with that and how they overlay some of these other dockets, that's something that will be discussed but that's the change here in Arizona is a lot of the focus has moved into the rate design portion of these rate cases, and in the past it's been much more around the revenue requirement side. So we're seeing a lot of interest and a lot of desire to talk about rate design, and these other dockets are helping to feed into that discussion.

I see. Last question. In the recent past and even the last couple of years, there's been clearly a trend towards consolidation in the sector. Just from an industry observer point of view, I wanted to get your sense of how you're looking at that, changing landscape, and given valuations as they are, does that kind of make sense as far as the ongoing consolidation trend that we're seeing in this overall utility sector?

Ali, I think the best way is to respond to that is we're focused on running an exceptional utility and one of the fastest growing territories in the United States.

Okay. Thank you.

Our next question comes from the line of Michael Lapides with Goldman Sachs.

Real quick on the rate case process, I want to make sure I'm thinking about this, that you're thinking that the rate case would end with a step-up that probably comes mid-2017, and then another step-up to reflect the SCRs like at the end 2018, beginning of 2019 time frame? Am I thinking about that right?

That's the first question. The second question is a little more nuanced. In your 2016 guidance what do you assume for the revenue step-up related to both transmission and the LFCR?

Michael this is Jeff. Let me just talk about on the rate case side, then Jim can follow up on the second part of your question. So similar to Four Corners, we're looking at a combination of -- we're asking this case for the commission to consider a combination of mechanisms that would affect -- that would go into place after the case is concluded. One of them would be a step increase.

So if the case was concluded and rates went into effect in mid-2017 that would be the outcome with the rate case result. And then a step increase later would be factored into that. And so that's similar.

If you want to go look at what happened in the Four Corners decision in our last rate case, it just reflects the timing of some of these plant additions occur after they're too far out, and if we don't address it with some kind of a step mechanism, then you come right back in on another rate case pretty quickly. Jim can talk about the --

Yes, so, Michael, we haven't really disclosed individually transmission LFCR, other than to say that those two together are a large part of the gross margin increase. But keep in mind one thing about transmission. Last year we had the -- we had the one-time decrease of transmission revenues reflecting our filing. So we don't expect to have that this year.

Got it. Just coming back to the rate case and the incremental step-up piece, is the step-up just for the SCRs? Is there a chance you could potentially get a step-up in late 2018, early 2019 for the SCR and maybe even get Ocatillo in, too? Just trying to think -- you've got two really big CapEx projects underway. Just trying to think about how you get rate recovery for those.

One would be a deferral mechanism. Deferral mechanism around SCR isn't a step for Ocotillo.

Got it. But you wouldn't be putting in the deferral, the SCR costs into rates at the same time would you try to do Ocotillo? You would defer the SCR call until a future case?

The deferral would go into a future case.

Charles Fishman with Morningstar. Please proceed.

Don, you mentioned that the discussion on the three-part rate design, I assume both you and Unisource right now after two-part design, just energy and fixed. Is that correct?

No, we've actually have had demand rates for what, Jeff, almost 200,000 customers.

North of 100,000 customers right now on three-part residential rate design that has a demand in energy and a fixed component. And so that's -- I think we're the utility -- or largest customer base with demand rates today in the US.

And really what allows you to do that is the smart meters that were installed, correct?

Actually, no. We've had demand rates well before we've had smart meters. The smart meters provide some additional essentially functionality for customers. And so you can do more things with them and get more information. But we were doing demand rates before we had AMI meters.

Okay. That's all I had. Thanks for the clarification.

Our next question comes from the line of Shahriar Pourreza with Guggenheim. Please proceed with your question.

I thought prior discussions in the past, including our own conversations with the ACC, seem to point that they were looking to solve the at least the generic solar proceedings by the May time frame prior to your rate case filing. They seem like they were pretty confident on that. Is this sort of a change, or what sort of a delay, or if there wasn't a delay and we were mistaken?

So the hearings go through next week, May 6. Then we would expect the ALJ to have a recommended order out July time frame, and then we expect the commissioners to hear it in an open meeting sometime after that.

So the generic document would occur before the decision in the -- in our rate case. It's more of a challenge for the UNS given the timing of their rate case.

Okay, got it. And then just one last, a little bit more of an obscure question. On TransCanyon, is there sort of -- with the EIM being launched is there an opportunity to go beyond that real time day ahead sort of balancing to something that could lead to something more on the resource adequacy longer term, ie, can there be more infrastructure spending around the region, especially if you get Mexico to join the EIM, which I think that's preliminary discussions?

So I think you need to separate TransCanyon from EIM. They're separate decisions. EIM is not to solve resource adequacy capacity. It's really a -- more of a real-time intermittency type mechanism, so no connection between the two.

And you don't see that expanding to regional transmission planning.

Not the way the west is configured today, no.

Great, thanks so much.

Our next question comes from the line of Paul Patterson with Glenrock Associates. Please proceed with your question.

Good morning. Just to circle back on the negotiations with Solar City and what have you, I'm just wondering, what caused the change in heart? I mean, you guys were battling, and now it looks like peace is breaking out. I'm just wondering if you can give us a little sense as to what changed on the ground and whether or not there's -- what you see the risk of potentially unraveling. I just was wondering if you could give us any flavor.

Paul, this is Jeff. We started in 2012 we reached out and said let's have a dialog of how we address net metering and move to a more sustainable model for the rooftop solar compensation in Arizona. And as I think you know that was met with very aggressive political campaign that has continued to date, and what happened earlier this month is about proposition was launched by Solar City that would put in the constitution very detailed provisions around net metering, interconnection rules and things like that.

That prompted a response by the Arizona legislature that proposed -- was proposing and hearing a separate ballot proposition, two separate ballot propositions, one around the resolution of net metering issues, and the second one that would have ensured that solar rooftop companies were treated as public service corporations. That obviously escalated everything up to where we had three ballot propositions that were on the constitution.

And we think it's probably more constructive to have dialogue with that without ballot propositions hanging over everyone.

That makes sense, but it doesn't sound like your position changed all that much. I mean, so I guess what I'm wondering, is there anything to point to other than the ballot initiatives in the legislature that were going pretty quickly this week? Is that what was the crux? Is that the pivot point from, in terms of Solar City and what have you? Is that the right way to think about?

I think the ballot propositions coming down is what's allowing the discussions to move forward.

Okay. Fair enough. My other questions have been answered. Thanks so much. Have a great weekend.

Thank you.

Thanks, Paul.

Our next question is a follow-up question from Greg Gordon with Evercore. Please proceed with your question.

Yes, I guess as I'm thinking about the deferral mechanism that you are going ask for, for the SCRs that would be -- have the effect, if I'm thinking about it correctly, of sort of immunizing you guys from the earnings impact of the costs associated with running SCRs until you could get rate recovery, but that would be a drag on the cash flow of the Company, because the SCRs would actually be in place.

So I guess I'm asking you, Jim, you must be pretty confident on the underlying cash flow profile of the core business to be able to offer to the customer a deferral mechanism that would smooth the rate impact in that manner. Is that a fair way of thinking about it?

Greg, that's absolutely correct. I mean, we modeled this in our model that we've given to the agencies, as Don alluded to on the fourth quarter call, we have one of the best balance sheets in the industry. So we can really carry those from a cash perspective without recovery until we get the -- in the rate base.

Greg, it's Jeff. I misspoke earlier. I think I transposed them. The step is for the SCRs. The deferral is for Ocatillo.

Either way --

Either way, Greg, we're good with that.

And we're still looking at 6% to 7% rate base growth with no equity needs through -- what year have you put out on the table as the sort of outside date where you're confident you don't need equity?

It's really through our planning [horizes].

And is that indefinite?

It's not indefinite.

I'm kidding. I'm just wondering how far out you guys generally plan for. Three, five, eight, ten years.

we plan for five years. We have a five-year forecast.

Okay. So if rate base is growing at 6% to 7%, Don, and you can craft up rate settlement that allows you a stable return on equity construct, at a 5% dividend growth aspiration you would actually after declining payout ratio. So at would point do you reassess that, especially given how the fortress balance sheet that you guys have put together?

I think your analysis is correct, Greg. We take a good hard look at it usually in the fall of each year as you know, and discuss it with our board and take what we think are the appropriate long-term actions at that point in time.

Okay. Thanks, guys. Have a great afternoon.

Thanks, Greg.

Mr. Mountain, we have no further questions at this time. I would to you like to turn the floor back over to you for closing comments.

Thank you, Christine, and thank you, everybody. That concludes our call. Talk to you soon.

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