Seeking Alpha
We cover over 5K calls/quarter
Profile| Send Message| ()  

Executives

Rebecca Hickman – Director, IR

James Hatfield – SVP, CFO and Treasurer

Donald Brandt – Chairman, President and CEO

Jeff Guldner - VP, Rates & Regulation, Arizona Public Service Company

Analysts

Shar Pourreza – Citigroup

Michael Lapides - Goldman Sachs

Scott Senchak - Decade Capital

Pinnacle West Capital Corporation (PNW) Q4 2011 Earnings Call February 24, 2012 11:00 AM ET

Operator

Greetings, and welcome to the Pinnacle West Capital Corporation 2011 Fourth Quarter and Year-End Earnings Conference Call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. (Operator Instructions) As a reminder, this conference is being recorded.

It is now my pleasure to introduce your host, Rebecca Hickman, Director of Investor Relations. Thank you, Ms. Hickman, you may begin.

Rebecca Hickman

Thank you, Christine. I’d like to thank everyone for participating in this conference call and webcast to review our fourth quarter and full year 2011 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, supplemental information on our earnings variances and operating statistics, the webcast and the Form 8-K filed this morning. Please note that 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 2011 Form 10-K 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 March 2.

At this point, I’ll turn the call over to Jim.

James Hatfield

Thank you, Becky. The topics I will discuss today are outlined on slide four. First, I’ll review the consolidated fourth quarter results and discuss the main variances from last year’s corresponding quarter. Second, I will discuss our 2011 full year results provide. Third, I will provide a brief update on the status and outlook for the Arizona economy. And lastly, I will close with brief comments on our liquidity and financing activities.

Slide five summarizes our reported and ongoing earnings for the quarter. On a GAAP basis, for this year’s fourth quarter, we reported consolidated net income attributable to common shareholders of $13 million, or $0.11 per share, compared with net income of $7 million, or $0.07 per share for the prior year’s fourth quarter.

Our ongoing earnings increased $0.06 per share. For the 2011 fourth quarter, we had consolidated ongoing earnings of $12 million, or $0.11 per share, versus ongoing earnings of $5 million, or $0.05 per share for the comparable quarter a year ago.

Slide six contains a reconciliation of our fourth quarter 2011 and 2010 GAAP earnings per share to our ongoing earnings. The amounts for both quarters exclude the results related to our discontinued operations. The discontinued operations amounts relate primarily to APS Energy Services, part of which were sold in mid-2010 and the remainder of which was sold in mid-2011. My remaining comments on the quarter will focus on ongoing results.

Moving to slide seven, you see the variances that drove the change in quarterly ongoing earnings per share. First, an increase in our regulated electricity segment gross margin added $0.05 per share, compared with the prior year’s fourth quarter. Several pluses and minuses comprise this positive net variance and I will cover those items in more detail on the next slide.

Second, lower operations and maintenance expenses improved earnings by $0.06 per share. The decrease largely reflects lower power plant maintenance costs as a result of more work being completed earlier in the year than in

2010, as well as lower employee benefit costs. This O&M variance excludes expenses related to the Renewable Energy Standard, or RES, energy efficiency, and similar regulatory programs, which are offset by comparable revenue amounts.

Third, the impact of all other items increased earnings by $0.01 per share. These favourable variances were partially offset by the absence of tax benefits of $0.06 per share that were recorded in the fourth quarter of 2010.

Turning to slide eight and the composition of the net increase in our regulated electricity gross margin, total regulated electricity gross margin was up $0.05 per share, compared with the 2010 quarter. The main components of that increase were as follows. The retail transmission cost adjustor rate increase that became effective July 1 of 2011 raised revenue by $0.03 per share. Line extension fees recorded as revenues 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 $0.02 per share. Lastly, the non-cash mark-to-market valuation of APS’ fuel and purchase power hedges, net of the related power supply adjustor or PSA deferrals, lowered earnings by $0.02 per share compared with the year ago.

For your reference, our mark-to-market amounts by quarter for the past couple of years are shown in the appendix slide.

Putting this all in context for earnings, let’s look at our full year comparison on slide nine. On a GAAP basis, for the year 2011 as a whole, we reported consolidated net income attributable to common shareholders of $339 million or $3.09 per share compared with net income of $350 million or $3.27 per share for 2010. Our ongoing earnings for 2011 were $2.99 per share compared with $3.03 per share in 2010.

Our 2011 earnings exceeded our earnings guidance. We had projected ongoing earnings would be near the top of our guidance range of $2.75 to $2.90. The actual results were due in part to lower O&M costs than previously projected and colder than normal fourth quarter weather. Our cost management efforts companywide continued to control our O&M and other costs. Our guidance was based on normal weather, so the colder weather increased retail sales above our previous projections.

As we previously indicated, we do not intend to issue earnings guidance for 2012 until after the final decision has been rendered in APS’ pending rate case. However, to assess with your estimates, a list of key drivers that may affect 2012 ongoing earnings is included in the appendix to today’s slides.

We understand pensions are an important topic for the financial community at this time. To address that concern, I will give you a few of our pension statistics. Our pre-tax pension cost towards the O&M was $29 million in 2011, net of the deferral under the 2009 retail rate settlement. We expect our annual pension expense to increase only about $5 million a year over the next couple of years.

Also, in spite of market conditions, our pension plan earned 9.4% in 2011. Looking at our pension funding status, we estimate that our plan is 85% funded as calculated under the RES requirements. We did not make a contribution to the plan in 2011, and we currently anticipate contributing $65 million in 2012. All in all, we feel good about our pension expense and the funding outlook and status of the plan.

Turning to slide 10 and looking at our fundamental growth outlook in the Arizona economy. Economic growth in Arizona continued to improve in the fourth quarter although modestly. As shown on the slide 10, growth in non-farm jobs and consumer spending are both solidly ahead of the prior year’s level. The rate of growth has moderated slightly from earlier in this in the year but the trend remains positive.

Other indicators like income growth and the unemployment rate also showed steady improvement although the patterns remain uneven. All in all, these trends indicate that the Arizona economy is headed in the right direction even though we have significant headwinds to contain with. Unemployment remains too high and the vacancy rates in housing and commercial real estate are only marginally lower than our pace in 2010.

One bright spot has begun to emerge in the demand trend for industrial space in metro Phoenix region with vacancy rates down some 20% from our peak but other sectors are seen only slow absorption of excess space. We believe the situation will continue restrain new construction and higher levels of growth for at least two to three years.

APS’ customer base grew 0.4% in 2011 while retail sales increased 0.6% after reflecting the effects of the company synergy efficiency programs but excluding weather variations. 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 1.6% for 2012 through 2014 as growth accelerates during that timeframe. Additionally, we expect our average annual weather normalized retail sales in kilowatt hours to be relatively flat from 2012 to 2014, primarily due to APS’ energy efficiency programs offsetting a modest recovery in the economy.

Lastly, I want to comment on our liquidity and financing. APS ended the fourth quarter with no short-term debt outstanding and has ample liquidity. Our higher credit ratings have provided APS and the parent company improved access to short-term funding as well as to the debt capital markets.

Last month, APS issued $325 million of 30 years senior unsecured notes at 4.5%. To date, we believe this is the lowest interest rate on record ever for an S&P BBB rated corporate issuance in the utilities space. I believe the record interest rate and a strong demand for the notes speak highly to the progress we have made over the last three years. Net proceeds from the sale of those notes along with cash on hand will be used to repay $375 million of APS’ outstanding 6.5% unsecured senior notes that mature on March 1.

With that, I will turn the call over to Don.

Donald Brandt

Thanks, Jim, and thank you all for joining us this morning. Today I will update you on three areas: first, APS’ pending retail rate settlement; two, our investments in renewable resources and other generation, and three, our operating performance in 2011.

We know Arizona regulation and APS’ recently filed rate settlement are top of mind for investors. So I will start with those topics.

On January 6, we filed a proposed settlement of APS’s pending retail rate case. 22 of the 24 active parties to the proceedings signed the settlement agreement. Such broad-based support demonstrates significant collaboration and cooperation among APS, the commission staff and other parties. Details of the settlement as well as key underlying assumptions are outlined in the appendix to our slides today.

The settlement contains a number of benefits for our customers, the communities we serve and our shareholders. Slide 14 highlights the benefits from an investor’s perspective. Notably, the requested regulatory treatment would build upon the constructive framework established in the 2009 settlement and provide a financial support structure for APS that will help us achieve Arizona’s energy goals over the next four years.

Slide 15 shows the settlement’s proposed base rate changes which include: first, a non-fuel base rate increase of $116.3 million, reflecting, among other things, 15 months of post-test year plant additions in rate base. Second, a fuel related rate base decrease of $153.1 million attributable to lower commodity costs, and finally, a $36.8 million base rate increase to transfer revenues from the renewable energy surcharge to base rates. Those revenues relate primarily to the AZ Sun projects that will have been placed in service by March 31 of this year.

Collectively, these terms would produce a net zero dollar change to existing base rates in 2012, which is an important benefit to APS customers. In addition, the average retail customer bill would decrease slightly when the rates proposed are first implemented.

In addition to the base rate changes, the settlement contains a number of key financial provisions. I will provide a brief overview of these proposals which are shown on slide 16. Several newer modified rate adjustment mechanisms would further support timely cost recovery. These include: first, the adoption of a new lost fixed cost recovery rate mechanism or LFCR, to address ratemaking effects of energy efficiency and distributed renewable energy. Second, changes to APS’ power supply adjustor to allow 100% recovery of fuel and purchase power costs, thus eliminating the current 90:10 sharing.

Third, procedural changes related to the retail transmission cost adjustor to streamline the passthrough of future FERC rate changes. And fourth, modification of the environmental improvement surcharge to allow a timely recovery of certain carrying costs for government mandated environmental capital expenditures.

The settlement would permit APS to seek rate adjustments in 2013 for the Four Corners transaction after it’s consummated. I will provide an update on Four Corners plant momentarily. The settlement also would allow certain property tax expense variances caused by future changes to Arizona property tax rates to be deferred for future rate treatment. And finally, the settlement includes a four-year stay-out for the next general retail rate case filing. Under this provision, APS may file its next general rate case on or after May 31 of 2015 for 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 include certain features of the settlement, such as the property tax deferrals and the lost fixed cost recovery mechanism, rate adjustments related to the Four Corners acquisition and APS’ other tracking mechanisms and our continuing focus on cost management and operational excellence.

Key financial assumptions that underpin the settlement, including updated rate base, a 10% allowed return on equity, capital structure and fuel prices can be found on slide 17.

Looking ahead, key procedural dates are shown on slide 18. Of recent note, the hearing in the matter was conducted January 26 through February 3. The next steps in the process are post-hearing briefs which are due February 29 and then again March 14. After that, the case will be in the hands of the commission’s chief administrative law judge for preparation of her recommended order on the matter. APS and the other settling parties have requested that the settlement become effective July 1 of this year, which appears very reasonable under the current schedule.

We view the settlement agreement as a further sign of progress in Arizona’s regulatory environment. We appreciate the opportunity to continue working with the commission and various stakeholders to enhance the state’s regulatory framework and to find solutions that balance the interests of customers, shareholders and other stakeholders.

Now turning to renewable resources and our AZ Sun development activities, we are on track with plans to increase the amount of renewable energy APS provides for our retail customers. Our plans place strong emphasis on solar power because Arizona has some of the best solar conditions in the world. Our most noteworthy progress related to renewable energy has been APS’ AZ Sun program.

The Arizona Corporation Commission has approved the program and its related constructive rate recovery. Under the program, which has been expanded since our last call, APS now 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. The program was expanded last December when the Arizona commission approved the second 100 megawatts phase.

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 our generation mix. The facilities are located at the Paloma and Cotton Center plants, both of which are in Gila Bend, Arizona, a town southwest of Phoenix, and at the Hyder facility located in South-western Arizona.

Construction and other development activities are currently underway for two sites for another 33 megawatts. These facilities would be in service in late 2012 and then again in 2013. To date, our announced projects and service and under development have a total capacity of 83 megawatts with an estimated capital investment of $375 million. A project summary is included on slide 19. Additional planning and procurement activities are in various stages for the balance of the capacity needed to complete the AZ Sun program.

These renewable energy initiatives, particularly AZ Sun are important measured steps toward advancing Arizona’s sustainable energy future. These projects also support Arizona’s economy. New solar and wind plants to serve APS customers have created more than 2400 design engineering and construction jobs for our state.

Turning to the status of the Four Corners plant, as you know, late in 2010 we announced our plan to acquire Southern California Edison’s interest in the Four Corners coal-fired plant in North-western New Mexico. The plant addresses new environmental regulations while maintaining our well balanced resource portfolio. Our plant has substantial merits, economically, environmentally and socially. A summary of the plant is included on slide 20.

The acquisition requires approval by Arizona, California and Federal regulators and other government agencies. In Arizona, the corporation commission completed a hearing on the matter last fall and we are awaiting a recommendation from the administrative law judge before the matter is brought before the commission for a vote.

Last week, the California public utilities commission issued a proposed decision, approving the sale by Southern California Edison, and a final decision from the CPUC is expected in March. We will remain optimistic that both APS and Southern California Edison will obtain the requisite favorable rulings from the respective commissions in a timely manner.

Our acquisition also was conditioned upon the execution of a new coal supply contract as well as approval by the Federal Energy Regulatory Commission, expiration of the Hart-Scott-Rodino waiting period and other typical closing conditions.

Looking at our operating performance, our baseload, nuclear and coal fleet continues to perform well. For the full year 2011, Palo Verde nuclear facility operated at a site average capacity factor of 91%. Palo Verde had its best production year ever, generating more than 31 million megawatt hours, topping at site record from 2010. Palo Verde is the only U.S. generating facility of any kind to ever exceed 30 million megawatt hours in a single year and it did so last year for the seventh time. Additionally, Palo Verde was the top U.S. power producer of any kind again in 2011.

Our coal-fired plants continued their run of strong performance as well. For the year 2011, our coal fleet posted a capacity factor of 80%, which is well above the most recently available industry average of 67%.

Before I close, I will take just another minute or two to highlight a few additional achievements that reflect on our overall solid performance in 2011.

Pinnacle West stock outperformed both our industry and the broad market. We are pleased that our total shareholder return, which is comprised of stock price appreciation plus dividends, was 22% which compares favorably with the U.S. electric utility average of 21% and the S&P 500 index return of only 2%.

Early last summer, Standard & Poor’s upgraded both APS’ and the parent company’s crediting ratings to BBB from BBB minus, thus improving our borrowing costs and more importantly, further securing our access to the capital markets. After more than two years of review and scrutiny, the U.S. nuclear regulatory commission approved 20-year license extensions for all of three Palo Verde units, assuring that Palo Verde will continue to power the South-western United States until the middle of this century.

Our industrial safety record is at the top of our list of accomplishments. I am proud to report that in 2011, we had the lowest number of recordable injuries in our company’s history. However, I and every other member of our team will continue to drive safety performance towards our goal of zero injuries.

Regarding system reliability, APS’ average outage time per customer continued to be in the best quartile of our industry and set a new company record in 2011. Record setting reliability and other customer focused efforts allowed APS to continue achieving best of class customer satisfaction as evidenced by the company being ranked fourth highest nationally among large investor-owned electric utilities by JD Power and Associates.

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, we’re committed to achieving superior operational and financial results by concentrating on our core electric utility business.

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

Question-and-Answer Session

Operator

(Operator Instructions) Our first question is from Shar Pourreza with Citigroup. Please proceed with your question.

Shar Pourreza – Citigroup

Just one question. With the current docket in the GRC remaining open for Four Corners, what kind of like a recovery lag are we looking at as you spend on the environmental retrofits?

James Hatfield

On the environmental piece specifically?

Shar Pourreza – Citigroup

Yep.

James Hatfield

Well, we do have in this case the EIS, which is a surcharge, is capped at $5 million. So we will be recovering some of those on a next-year basis. So we are looking at less than 12 months on some of the environmental for Four Corners.

Operator

Our next question is from Michael Lapides with Goldman Sachs. Please proceed with your question.

Michael Lapides - Goldman Sachs

Hey guys. Stepping in for Neil a little bit here. Just real quick one, want to follow on Four Corners question. First of all, what’s the lag -- from the time you acquired it, what’s the lag between when you acquired it and when the infrastructure rider would let you actually start earnings on the acquisition? And then when you start the environmental CapEx, if the cap is only $5 million, what do you do – just accrue AFUDC for the unrecovered on the non-cash piece until you file your next TRC?

James Hatfield

That’s correct, Michael. On the last one, we would recover some real-time in the EIS and the other would be AFUDC. On the first question, to keep the docket open, so assuming we acquire their SCE’s piece in the early fourth quarter, potentially as early as mid-year 2013, we would begin actual recovery of the acquisition.

Michael Lapides - Goldman Sachs

So I want to make sure I follow that. So if the transaction closes at year end 2012, what’s the earliest you would see – and what’s the most likely timeframe you would actually see a revenue uplift from it?

Donald Brandt

We’re just assuming mid-year ’13.

Michael Lapides - Goldman Sachs

Got it. And how do you think about financing the actual acquisition?

James Hatfield

Well, I think it’s incremental to sort of our capital build that we would issue incremental debt and equity, just to support the balance sheet.

Michael Lapides - Goldman Sachs

Got it. Last thing, with the multi-year stay-out, how do you think about your O&M cost reduction opportunities, because I mean, that’s generally the primary benefit of the multi-year stay-out? And second, whether kind of the capital structure ratios during the stay-out versus as you get closer to the end of the rate freeze, or not rate freeze but rate case hiatus?

James Hatfield

Well, I think on the O&M side, I look at this year ex-RES, O&M was essentially flat to 2010. As I have said before, as we go forward with the two-thirds of our O&M expense being employee costs, we don’t have a lot of levers to pull. At some point, we are going to become focusing on payroll creep to the O&M. That said, we’re going to continue – I mean, our levers to pull on during the stay-out is the focus on CapEx and O&M. And that’s what we are going to continue to do, and I think our track record over the last three years has proven that we are very much focused on costs.

From a cap structure perspective, obviously ’14 is designed to be the test year. And we’ll try to get our capital structure consistent with where we are now by 2014. In the interim, it will be based on financing needs and credit metrics and those sort of things. So it could vary from the 53.9%.

Operator

(Operator Instructions) Our next question is from the line of Scott Senchak with Decade Capital. Please proceed with your question.

Scott Senchak - Decade Capital

Just a question on the CapEx you guys provided in the K. How does it treat Arizona’s Sun part two? I know you haven’t announced the projects yet but I was just wondering if there was some estimate in there for that or not?

James Hatfield

The estimate for Arizona Sun part two is in the renewables line. It’s really sort of ‘13 to ‘15 even though it only goes to ‘14.

Scott Senchak - Decade Capital

Got you. Okay, great. And then on the O&M side, how should we think about the growth of that? Is there some kind of metrics that you try to taking along with sales growth, or is it customer growth, or is it just something else we could look at?

James Hatfield

Well, obviously as we’ve said before, I mean we try to focus O&M growth at equal to or less than the rate of growth of (indiscernible) sales just as a way to allow sales growth to fall to the bottom line. Like I said, we’ve been fairly flat since 2008 and at some point, we’re going to hit the pressures of just the payroll creep, so.

Operator

Ms. Hickman, it appears we have no further questions at this time. I would now like to turn the floor back over to you for closing comments.

Rebecca Hickman

Thank you, Christine. We appreciate all of you being on the call today. We know it’s a very busy time for you. As always, if you have any questions, please contact me or Geoff Wendt. Thank you very much.

Operator

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.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!

Source: Pinnacle West Capital's CEO Discusses Q4 2011 Results - Earnings Call Transcript
This Transcript
All Transcripts