Pinnacle West Capital Corp (PNW) 2016 Q4 法說會逐字稿

Greetings and welcome to Pinnacle West Capital Corporation's 2016 fourth-quarter and full-year earnings conference call. (Operator Instructions). As a reminder, this conference is being recorded. I would now like to turn the conference over to Mr. Ted Geisler, Director of Investor Relations. Thank you, Mr. Geisler, you may begin.

Thank you, Manny. I would like to thank everyone for participating in this conference call and webcast to review our fourth-quarter and full-year 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 with us.

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 2016 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 March 3. I will now turn the call over to Don.

Thanks, Ted and thank you all for joining us today. Pinnacle West concluded a productive 2016 with earnings in line with our expectations. Palo Verde Nuclear Generating Station had another record year, our employees set a new companywide safety record and we continue making progress on our regulatory initiatives.

Our capital execution program is on track with several noteworthy projects recently placed into service and our balance sheet remains one of the strongest in the industry. Jim will discuss the financial results in a moment. My comments will focus on our 2016 highlights and the year ahead.

Our fleet performed very well in 2016, highlighted by Palo Verde's 25th consecutive year as the nation's largest power producer. Total production reached 32.2 billion kilowatt hours of carbon-free electricity. In fact, the fall refueling outage for unit 3 set a station record for the shortest outage ever and set a nuclear industry record for radiological safety.

Before I continue, I want to recognize Randy Edington for his significant positive impact on our Company as Chief Nuclear Officer. Randy will be retiring from APS in March and I want to thank him for the great service to our Company and the nuclear industry as a whole during his decade of leadership here in Arizona. Because of his skill and experience, as well as his ability to develop strong leaders and sustainable processes, he has left a lasting legacy of excellence at Palo Verde.

In 2016, APS also achieved its safest year with the fewest OSHA-recordable injuries in our history. I consider the safety of our employees a top priority and I also believe safety metrics are good indicators of management's ability to lead an organization. These just aren't statistics, but the result of a continued commitment from all our employees and management team to drive operational excellence.

Turning to the regulatory front, we've had a busy few months with the ongoing progress of our rate review and the conclusion of the value and cost of distributed generation proceeding. I will provide an update on these important items in a moment, but first I want to thank Arizona Corporation Commissioner, Bob Stump, whose term ended in early January this year. We appreciate his commitment to the state over his many years of public service and for driving the dialogue on several complex regulatory issues.

Commissioner Bob Burns, Andy Tobin and Boyd Dunn were sworn in on January 3 to four-year terms. Commissioner Tom Forese was also selected by his fellow commissioners as Chairman succeeding Commissioner Doug Little who led the commission through a challenging period.

I will now provide an update on two important regulatory dockets, the value and cost of distributed generation decision and our 2016 rate review filing.

On December 20, the Corporation Commission completed its proceeding on the value and cost of DG. The commission approved the recommendation to replace a current net metering tariff with a more formula-driven approach. The formula will use inputs from utility scale solar power costs and eventually transition to an avoided cost methodology.

In addition, the ACC made the following determinations. First, banking of energy produced by DG solar systems has been eliminated. Second, customers with DG solar may be considered a separate class of customers for ratemaking purposes. And third, DG Solar customers who have interconnected systems prior to the decision in APS's pending rate review will be grandfathered for a period of 20 years.

This decision marks an important milestone in our commitment to modernize customer rates while minimizing subsidies among customer classes. Although other jurisdictions have attempted to make similar changes, this was among the first to fully litigate the cases in the country and was founded on actual evidence, sworn testimony and a judge's order.

Moreover, the decision was embraced by a wide variety of stakeholders, including local solar installers who share our vision for creating a sustainable energy future for Arizona.

I know APS's rate review is top of mind for many of you and we continue making good progress with this proceeding. Since our last call, the ACC staff and their interveners filed testimony in response to our initial proposal. This provided a foundation for us to engage in meaningful settlement negotiations in January and earlier this month.

We continue working with parties toward a constructive settlement proposal to be filed no later than March 17. Last month, the administrative law judge revised the procedural schedule for this case in order to provide staff with sufficient time to incorporate the recent value and cost of DG decision. As a result, the time clock was extended by 33 days and the new hearing date is April 24.

2017 marks a period of unprecedented capital investment for our Company as we manage more than $1.3 billion in projects and plan to spend more than $3.4 billion in capital over the next three years. Our focus continues to be modernizing the distribution grid, investing in flexible generation and advancing our customer experience.

We are well-positioned to be a leader in grid automation and technology integration. The APS solar partner program recently won the award for Renewable Integration Project of the Year at the annual DistribuTECH conference. Through this program, our employees are studying the application of smart inverters to integrate rooftop solar and battery storage on the distribution grid.

In addition, we recently placed into service an industry-leading advanced distribution management system. Next month, we will launch a new state-of-the-art customer information system. Both systems are innovative, forward-thinking and bring greater value to our customers while preparing for the future.

These investments drive operating efficiencies through leveraging technology on the grid, which results in continued cost management and improved reliability for our customers.

We also remain committed to upgrading our generation portfolio with more flexible gas generation as the Ocotillo Modernization Project hits full stride this year. Finally, our traditional generation and transmission business continues to drive meaningful investments as we further expand our high-voltage transmission system and install environmental control technology at the Four Corners Power Plant.

Recently, the owners of Navajo Generating Station announced a decision to retire the plant by 2019 in which APS has a 315 megawatt stake. This generation shortfall is in addition to the existing shortfall of 3500 megawatts by 2022 as outlined in our 2017 preliminary integrated resource plan, which I described for you last quarter.

Although a portion of this resource gap will be filled by the Ocotillo Project and our recent 565 megawatt power purchase agreement, the remainder will be procured through additional market opportunities, customer conservation and distributed generation.

In addition to our changing energy mix, we continue to embrace the growing Western marketplace for wholesale power. In October, we joined the Western Energy Imbalance Market, which produced $6 million in savings for our customers in the fourth quarter of 2016 alone. We expect continued savings throughout 2017, which reduces costs for customers and improves the competitiveness of our retail rates.

In summary, we delivered on our commitments in 2016 and are well-positioned for 2017 and the long term. We have a clear plan and a strong leadership team in place to deliver on the plan. The priorities we have for the year ahead, in particular completing the rate review and executing on our capital investments, are laying the foundation for APS to be a sustainable leader in an evolving industry. We remain focused on creating value through our core business while delivering on our financial and operational commitments. I will now turn the call over to Jim.

Thank you, Don and thank you, everyone, for joining us on the call. This morning, we reported our financial results for the fourth quarter and full-year 2016. As you can see on slide 3 of the materials, we had a good year and ended on a strong note.

Before I review the details of our 2016 results, let me touch on a couple highlights from the quarter. For the fourth quarter of 2016, we earned $0.47 per share compared to $0.37 per share in the fourth quarter of 2015. Slide 4 outlines the variances which drove the increase in our quarterly earnings per share.

Gross margin was flat, including lower sales, which were offset by higher LFCR revenues. Lower operations and maintenance expenses in the fourth quarter of 2016 compared to 2015 improved earnings by $0.06 per share largely due to lower employee benefit costs driven by the adoption of the new stock compensation accounting guidance.

Now turning to slide 5, let's review some of the details of our full-year results. 2016 results were in line with our expectations, earning $3.95 per share compared to $3.92 per share in 2015 translating to an earned consolidated ROE of 9.5% on a weather-normalized basis. Gross margin was a positive driver for the year, contributing $0.33 per share, including favorable year-over-year weather.

Sales in 2016 compared to 2015 added $0.05 to gross margin. Weather-normalized retail kilowatt hour sales after the effects of energy efficiency program and distributed generation were flat year-over-year, but similar to the pattern we saw throughout 2016, the usage trends or related pricing by customer class were mixed and generated a positive gross margin effect.

Transmission and LFCR revenues also continued to add incremental growth to our gross margin as designed contributing $0.17 per share collectively.

Looking next at operating expenses. As expected, higher operations and maintenance expense in 2016 compared to 2015 was the primary offset to ongoing results, decreasing earnings by $0.30 per share, with the major planned outages at Four Corners Units 4 and 5 serving as the largest headwind. Higher transmission, distribution and customer service costs and higher employee benefit costs also contributed to the year-over-year increase in O&M.

Our depreciation and amortization expense in 2016 versus 2015 reduced earnings by $0.03 per share, including higher depreciation due to additional plant and service. Interest expense net of AFUDC was a $0.02 per share benefit to earnings in 2016 compared to 2015. The net reduction included higher interest charges resulting from higher debt balances, which were more than offset by higher construction work in progress benefiting AFUDC.

As a reminder, both the O&M and gross margin variances exclude amounts related to our renewable energy and demand side management programs. Also note that the gross margin and D&A variances exclude operating revenues and expense related to the Palo Verde Unit 2 decommissioning recovered through a system benefits charge. The drivers I discuss exclude these items as there was no net impact on full-year results.

As you know, Arizona's economy continues to be an integral part of our investment story. I will highlight next the trends we are seeing in our local economy and in particular the Metro Phoenix area.

In 2016, the Metro Phoenix region continued to have job growth above the national average. For the full year, employment in Metro Phoenix increased 2.7% compared to 1.7% for the entire United States. This above-average job growth was seen in virtually every major industry sector; although the most significant performance gains are seen in the construction and financial services sector. This solid job growth continues to have a positive effect on the Metro Phoenix area's commercial and residential real estate markets.

As seen on the upper panel of slide 6, the net absorption of vacant office and retail space has been growing steadily since 2010. Vacancy rates in both markets have fallen to levels last seen in 2008 or earlier and almost 3 million square feet of new office and retail space was under construction at the end of the quarter.

We expect a continuation of business expansion and related job growth in the Phoenix market, which will in turn support continued commercial development. Metro Phoenix has also growth in the real estate market. As you can see in the lower panels of slide 6, housing construction in 2016 was at its highest level since 2007. This trend is expected to continue in 2017 as housing permits are expected to increase by about 7000 driven largely by single-family permits.

Several factors are driving this increase. Vacant housing in Phoenix is solidly back to pre-recession levels. Record low apartment vacancies and absorption of available single-family homes is providing meaningful support to home prices, which have returned to levels last seen in early 2008.

We believe that solid job growth, low mortgage rates and the opening up of credit to households, who suffered from foreclosures during the recession, should allow the Metro Phoenix housing market and the economy more generally to expand over the next couple of years.

Reflecting the steady improvement in economic conditions, APS's retail customer base grew 1.4% in 2016. We expect that this growth rate will continue to 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 appears to be in place.

In closing, I will review our financial outlook and financing plan. As previously indicated, we will not be issuing 2017 earnings-per-share guidance at this time, but will continue to evaluate the appropriate time to do so as our rate case progresses. In the meantime, to assist with your estimates, a list of key drivers that may affect 2017 ongoing earnings is included in the appendix to today's slides.

One item worth noting, we expect planned outage spend in 2017 to be comparable to 2016 in part driven by preparation for the SCR's installation at Four Corners.

In terms of capital expenditures, we anticipate APS's spend to average around $1.1 billion annually from 2017 to 2019, which will be primarily funded through internally generated cash flow. We continue to expect our rate base to grow at an average annual rate of 6% to 7% through 2019.

Turning to 2017 financing, we expect to issue up to $850 million of long-term debt, including the refinance of Pinnacle's $125 million term loan. Overall, our balance sheet and liquidity continues to remain very strong.

A quick note on pension. Our funded status remains steady at 88% as of year-end 2016. The continued implementation of our liability-driven investment strategy has helped keep costs down. There is a slide in the appendix with additional details on our pension outlook.

Lastly, I will share a few thoughts on proposed tax reform. We are actively assessing tax reform scenarios and are working closely with our EEI peers. Overall, we view the proposed changes as beneficial to customers with the potential to relieve some rate pressure. We generally view the potential company impact as mild, especially given Pinnacle's minimal parent-level debt, but with so much uncertainty at this point, it's difficult to speculate with any degree of certainty. We will continue to monitor discussions closely as they develop.

This concludes our prepared remarks. I will now turn the call over to the operator for questions.

Thank you. (Operator Instructions). Julien Dumoulin-Smith, UBS.

Good morning. It's Jerimiah Booream. I guess, first off, on the Navajo plant, it's been a fluid situation and I guess, one, is there any chance to think that it wouldn't shut down at this point, or is that pretty clear? And two, could you just clarify what exactly that might be backfilled with? As I understand, the shutdown is not included in your IRP.

NGS, as far as your first question about shutdown, the owners, led by SRP, who is the operating agent, has made a decision at 2019, which is the current expiration of the existing lease. Either we renew the lease and move forward beyond 2019 with the current owner structure or a changed owner structure. A couple owners have made it clear they do not want to operate beyond 2019.

In the meantime, the Department of Interior and our ACC, as well as others, have pulled all the parties together and are looking for some sort of resolution post 2019 in order to continue to operate the facility. The economics of the facility as it stands today would not warrant continued operation without some significant changes. So that is an ongoing issue still to be resolved.

As far as the impact of the generation, we will update our RFP as we go forward, but the current expectation is we have the resource until at least 2019, potentially longer and we will put it into our future plans and what we do from an RFP or some other position with regards to Navajo Generating Station.

Okay. Just to clarify that. Would that be traditional generation or something more along the lines of storage or even solar since you guys I believe just passed the 1 gigawatt mark on solar, or is that TBD?

It can be any of the above at this point.

Okay. And then just one other question on tax reform. If we had a lower tax rate and obviously, that's a pass-through, would you expect that to be changed in the rate case following the tax reform or would there be any chance of that happening sooner?

Well, I think a lower overall corporate tax rate would be passed on to customers. I don't think it will necessarily wait till the next rate case. I think that the tricky part about it is there may be some things that hurt the Company, so you would want to put it all together and do it all at once, but we will just have to wait and see.

There is at least two proposals out there. The Treasury Secretary spoke yesterday. I think the issue is further clouded and we will just have to wait and see ultimately what happens.

Okay. Thank you.

Ali Agha, SunTrust.

First question, it looks like the weather-normalized electric sales for the year at flat were below what you had been projecting for the year, if I recall correctly. What do you think was causing that and any further visibility for the terms of the growth on customers and sales that you are projecting looking over the next three years given where we've been running the last four, five, six quarters? Anything you can point to to give us that more optimism. I know you talked about the economic indicators, but why did 2016 come in below what you had been expecting?

First of all, no question we had a weak fourth quarter. At the end of the fourth quarter, we had positive sales, so don't know that that's necessarily a trend and I'm not going to look to the first and fourth quarters to look at a trend with us being weighted to second and third quarter.

But I will say we have a lot of -- business sales were up last year. For example, State Farm started filling their buildings in 2015. That wasn't complete until October of this year, so you'll have a full-year impact of that and we just see a lot of construction, especially multifamily homes, going on in downtown Phoenix.

So all the signs are pointing toward modest sales growth in 2017. We are projecting between 0% to 1%. So we will ultimately see what happens.

Second, over this next three-year cycle, 2017 through 2019, do you have an earned ROE goal, Jim, like you've had in the last cycle, minimum was (inaudible) and 9.5% and you were higher? Should we think about similar goals or different goals over this cycle period?

I think I will defer that until we talk about 2017 guidance.

Okay. And then on the rate case itself, I guess, is the confidence level still pretty high on reaching a settlement on or before March 17 and what remains in your mind the most contentious issues at this stage?

We continue engaging with the parties in constructive settlement discussions and generally speaking, we believe the parties are motivated to settle. It's really difficult to go into any detail at this point.

Okay. But, Don, is it fair to say the usual ROEs, etc. all would be up for negotiation, I guess?

Everything is up for negotiation.

Thank you.

Thank you. We have no further questions at this time. I would like to turn the conference back over to Mr. Geisler for closing remarks.

Thanks, Manny. This concludes our call. Thank you all for joining us today.

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