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Pinnacle West Capital Corporation (NYSE:PNW)

Q1 2012 Earnings Call

May 03, 2012 01:30 pm ET

Executives

Becky Hickman - Director, IR

Jim Hatfield - CFO

Don Brandt Chairman & CEO

Analysts

Shar Pourreza - Citigroup

Kevin Cole - Credit Suisse

Greg Gordon - ISI Group

Ali Agha - SunTrust

Brian Russo - Ladenburg Thalmann

Jim Krapfel - Morningstar

Paul Patterson - Glenrock Associates

Operator

Greetings, and welcome to the Pinnacle West Capital Corporation 2011 first quarter earnings conference call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. (Operator Instructions) As a reminder, this conference is being recorded.

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

Becky Hickman

Thank you, Claudia. I’d like to thank everyone for participating in this conference call and webcast to review our first quarter 2012 earnings, recent developments and operating performance. Our speakers today will be our Chairman and CEO, Don Brandt; and our CFO, Jim Hatfield. Jeff Guldner, who is APS Vice President of Rates and Regulation is also here with us.

Before I turn the call over to our speakers, I need to cover a few details with you. First, the slides to which we refer are available on our Investor Relations website, along with our earnings release and related information. Please note that the slides contain reconciliations of certain non-GAAP financial information. Also, all of our references to per share amounts will be after income taxes and based on diluted shares outstanding.

It is my responsibility to advise you that this call and our slides contain forward-looking statements based on current expectations, and the company assumes no obligation to update these statements. Because the actual results may differ materially from expectations, we caution you not to place undue reliance on these statements.

Our first quarter 2012 Form 10-Q was filed this morning. Please refer to that document for forward-looking statements, cautionary language as well as the MD&A section, which identifies risks and uncertainties that could cause actual results to differ materially from those contained in our forward-looking statements. A replay of this call will be available on our website for the next 30 days. It will also be available by telephone through May 10.

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

Jim Hatfield

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

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

Slide six contains a reconciliation of our first quarter GAAP earnings per share to our ongoing earnings per share. The amount for both quarters exclude results related to our discontinued real estate and energy services businesses. My remaining comments on the quarter will focus on our 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 gross margins added one penny per share compared against the prior year's first-quarter earnings. Several plusses and minuses comprises positive net variance and I will cover those items in more detail on the next slide.

Second lower operations and maintenance expense improved earnings by $0.07 per share. The expense decrease largely reflects lower fossil plant maintenance cost as a result of less work being completed early in the year compared to 2011 as well as the net decrease in other items.

This on end variance excludes expenses related to the Renewable Energy Standard or RAS, energy efficiency, similar regulatory programs as well as the 2011 first quarter settlement of transmission rights, away costs, all of which were essentially offset by comparable revenue amounts. Third, lower infrastructure related costs increased earnings by $0.03 per share reflecting both lower interest charges and lower depreciation and amortization associated with the 20-year license extension granted last year by the NRC for the Palo Verde Nuclear Generating Station.

Those cost reductions were partially offset by higher property tax related to tax rates. Fourth, the net impact of all other items decreased earnings by $0.03 per share. Finally our first-quarter 2012 earnings benefited $0.02 per share because of the Arizona (inaudible) plants that were placed in service last year and earlier this year.

This net variance is reflected in various items on the income statement. Total gross margin was up one penny per share compared to the 2011 first quarter. The main components of that increase were as follows. The Retail Transmission Cost Adjustor rate increase that became effective July 1st of 2011 improved earnings by $0.03 per share. Line extension fees recorded as revenue pursuant to 2009 retail regulatory settlement improved our results by $0.02 per share.

The net effect of other miscellaneous items increased our gross margin by $0.03 per share. Lower usage by APS retail customers compared against last year's first quarter decreased our quarterly results by $0.04 per share. Weather normalized retail kilowatt hour sales were down 0.9% in the quarterly comparison after accounting for the effects of our ACC approved energy efficiency and demand side management programs.

Customer growth of 0.8% over a year ago levels helped offset the decline in kilowatt hour sales. The effects of weather variations decreased earnings by $0.03 per share. This year's first quarter was warmer than normal with residential heating degree days lower than normal by 17%.

Turning to slide nine and looking at our fundamental growth outlook in the Arizona economy. Economic growth in Arizona continues to improve in the first quarter although modestly. As shown on slide nine growth in non-farm jobs and consumer spending are both slightly ahead of the prior year's levels.

In particular the rate of overall job growth has set up well for almost a year and virtually all of the major industrial sectors are experiencing some growth. Other indicators like income growth and the unemployment rate also shows steady improvement although the patterns remain uneven.

Additionally APS' customer base grew 0.8% in the first quarter which is the strongest growth we have seen in three years. All-in-all these trends indicate that the Arizona economy is headed in the right direction even though we have significant headwinds to contend with.

Unemployment remains too high and vacancy rates in housing and commercial real estate only marginally lower in their peaks of 2010. One bright spot has begun to emerge in the demand for industrial space in the Metro Phoenix region with vacancy rates down some 20% from their peak but other sectors are seeing only slow absorption of excess space. We believe that this situation will continue to restrain new construction and higher levels of growth for at least two to three years.

Over the long term though, we remain confident in Arizona’s fundamentals. We expect customer growth in [inaudible] to return to stronger levels as the national and state economic environments improve.

Looking at the next several years, we currently expect annual customer growth to average about 1.6% for 2012 to 2014. Additionally, we expect our average annual weather normalized retail sales in kilowatt hours to be relatively flat from 2012 through 2014 primarily due to APS’ energy efficiency programs offsetting a modest recovery in the economy.

Finally I want to comment on our liquidity and financing plans. At the end of the first quarter, the parent company had no short-term debt outstanding. APS had $217 million of short-term borrowings and both have ample liquidity. Our higher credit ratings have provided APS and the parent company improved access to short-term funding as well as lower cost funding through the debt capital markets.

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

Additionally if the constructed element in the pending retail rate case is approved by the Arizona Corporation Commission. We would be comfortable with our ability to fund APS’ capital expenditure program with no new equity needed until 2013 at the earliest.

And with that I will turn the call over to Don. Don?

Don Brandt

Thanks Jim. And thank you all for joining us today. I will update you on developments in the following areas. Arizona regulation and APS’ pending retail rates supplement, our investments in generations including renewable resources and our overall operating performance. I will start with APS’ pending rate settlement. On January 6, we filed a proposed settlement of APS’ pending retail rate case which was signed by 22 of the 24 active parties to the proceedings. Very late yesterday, the Arizona Corporation Commission’s Chief Administrative Law Judge issued her recommendation that the settlement be improved without material modifications.

Collectively, the settlement terms would produce a net $0 change to existing change to existing base rates 2012, an important benefit for APS customers. In addition to the base rate change is a settlement contained a number of key financial provisions which we discussed during last quarter’s conference call.

Details of the settlement as well as key underlying assumptions are outlined on slides 13 to 17 in the appendix to your slide space. The settlement contains a number of benefits for our customers, the communities we serve and our shareholders. Notably the requested regulatory treatment would build upon the constructive framework established in the 2009 settlement and provide financial support for APS will help us achieve Arizona’s energy goals over the next four years. The settlement also includes a four year stay out for the next general retail rate case. Under this provision, APS’ may file its next general rate case on or after May 31, 2015 for based rate to become effective not earlier than July 1, 2016.

We believe several factors will support us financially during the stay out period. These factors include first APS’ rate adjustment mechanisms such as the power supply adjustor and the transmission cost adjustor. Second, provision to allow APS to seek rate adjustments related the Four Corners acquisition if it is can’t submitted and I’ll review the Four Corners progress momentarily.

Third, certain features of settlements such as the lost fixed cost recovery mechanism and the property tax deferrals. And finally our continuing focus on cost management and operational excellence.

Looking at key procedural dates, the parties to the case have until May 11 to file any exceptions to the ALJ’s recommended order. Thereafter, the Commissioner will consider a settlement at an open meeting which has not been yet schedule.

APS and other settling parties have requested that the settlement become effective to July 1 of this year and that’s supported by the judges recommended.

We view the settlement agreement as a further sign or progress in Arizona regulatory environment. With its broad based support, the settlement demonstrates significant collaborations and cooperation among APS, the ACC staff and the variety of other parties.

We appreciate the opportunity to continue to work with Arizona Corporation Commission and the various stakeholders to enhance the state’s regulatory framework and to find solutions of balance of the interested customers, shareholders and other stakeholders.

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

The acquisition requires approval by Arizona, California and federal regulators and other government agencies. Noteworthy progress has been made in this regard. On April 18, the Arizona Corporation Commission authorized APS to proceed with the acquisition and to defer certain transaction related cost until the acquired generation is played in to retail rates with a condition that the transaction may not close prior to December 1st of this year.

The commission established a closing date parameter to reduce the cost impacts of the transaction on customers. Separately, as I have already mentioned, APS suspending retail rate settlement contains a proposal that would permit APS to seek to reflect the Four Corners transaction in retail rates on or after July 1 of 2013, if it is [inaudible] submitted.

In addition, the California Public Utilities Commission approved the transaction for Southern California Edison on March 29. Other conditions that must be met prior to closing the transaction include negotiation of the new coal supply contract, approval by the Federal Energy regulatory Commission, expiration of the Hart-Scott-Rodino waiting period and other typical closing conditions.

We remain optimistic about our pending remaining approvals and completing the related required activities to allow the completion of our Four Corners plant in a timely manner.

Turning to renewable resources and our AZ Sun development activities; we were on track with plans to increase the amount of renewable energy APS provides for our retail customers. Under the AZ Sun program, APS plans develop and own up to 200 megawatts of utility scale portable take solar plants in Arizona.

The projects that we placed in service in 2011 through 2015 and the Arizona Corporation Commission has approved the program with a constructive rate recovery mechanism. To-date, we have announced AZ Sun projects that have a total production capacity of 104 megawatts at an estimated capital investment of $451 million. A summary of the program is included on slide 19.

In late 2011 and earlier this year, we placed three new AZ Sun plants into commercial operation adding a total of 50 megawatts of solar capacity to APS’ generation mix.

Construction and other development activities are currently underway at two sites for another 54 megawatts and we anticipate these facilities will be placed in service in late 2012 and in 2013. Additional planning and procurement activities are in various stages for the balance of the capacity needed to complete the AZ Sun program.

Our renewable energy initiatives particularly AZ Sun are important measured steps toward advancing Arizona’s sustainable energy future. These projects also support our economy. New solar and wind plants to serve APS customers have created more than 2400 design, engineering and construction jobs for our state. We are pleased that APS’ accomplishments installing and promoting solar power have been recognized by a number of independent third parties.

For example in April, APS was named one of the top 10 Solar Electric Utilities in the United States by the Solar Electric Power Association.

Looking at our operating performance, our base load nuclear and coal fleet continues to perform well. During the first quarter, our Palo Verde nuclear facility operated at a 94% capacity factor. This capacity factor reflects the fact that Unit 3’s refueling outage began during the quarter on March 17th and that 32 day outage was successfully completed on April 17th making it the second charters to refueling outage in the Palo Verde site’s history.

The chartered duration demonstrates Palo Verde’s commitment to reducing its average refueling outage time, while maintaining its commitment to safely and efficiently generate electricity for the long term. The site’s next refueling outage will be Unit 2 this fall.

Our coal-fired plants also continued their run of solid performance.

Turning to the quality of our customer service, in February of this year JD Power & Associates released the results of its most recent Business Customer Survey. I am pleased that APS continues its record of performance excellence in overall customer satisfaction.

In the most recent results APS ranked fourth nationally among 47 large investor owned electric utilities. More specific to our region, we were rated second among 10 investor owned utilities in the West. In addition, for the third consecutive year APS was awarded the environmental protection agencies highest honor for continuing leadership and protecting the environment through energy efficiency programs.

The EPA’s ENERGY STAR Sustained Excellence Award recognized two APS program for promoting energy efficiency and reducing Greenhouse gas emissions.

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

Operator, this concludes our prepared remarks and we would be pleased to take questions at this time.

Question-and-Answer Session

Operator

Thank you. (Operator Instructions) Our first question is coming from the line of Shar Pourreza with Citigroup. Please state your question.

Shar Pourreza - Citigroup

Just a quick question, Jim I know you mention that you would look to issue 2012 APS guidance following a final order in the GFC and then Don did a great a job presenting some growth drivers outside of base rates during his prepared remarks.

Given that you could be in a multi-year duration under the settlement, could you also issue some kind of EPS growth trajectory during the stay-out period when you begin to issue guidance again? Thank.

Jim Hatfield

A great question Shar and the answer to that is, yes. And if you remember our last settlement, we issued guidance over a couple of year period and we would look to do some sort of EPS growth looking over the settlement period again to give investor’s comfort of our ability to manage through that.

Operator

Our next question is coming from the line of Kevin Cole with Credit Suisse. Please state your question.

Kevin Cole - Credit Suisse

Yeah, I was just checking whether for AGA it will mid 90 so we can, is it still too early to have any really cooling driven weather at all or how does that….

Don Brandt

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

Kevin Cole - Credit Suisse

And so I guess with the Four Corners approval a couple of weeks ago, does this impulsively approve the $300 million of environmental CapEx then also treatment of Units 1, 2, 3?

Jim Hatfield

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

Kevin Cole - Credit Suisse

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

Jim Hatfield

Well, assuming we close, we will put our CapEx plan pain upon when that’s needed to be in service 2016. The 2018 will be in design and engineering work for the plant which is consistent with what was filed in our IRP back on March 30th?

Kevin Cole - Credit Suisse

And then with the $700 million of equity, I think you guys kind of agreed to in the last settlement, I guess from my chair it doesn’t look like you need that much and from an expensive form of financing. With this new settlement are you able to rebase that number or does it kind of nullify the previous number?

Jim Hatfield

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

Operator

Our next question is coming from the line of the (inaudible) with Goldman Sachs. Please state your question.

Unidentified Analyst

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

Jim Hatfield

Well obviously assuming the settlement is approved and the ability really to have a sort of runway now to the next filing I would expect a dialog with the board on the appropriate dividend level for Pinnacle West going forward?

Unidentified Analyst

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

Jim Hatfield

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

Unidentified Analyst

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

Jim Hatfield

No

Unidentified Analyst

And then the last question I had, has there been any update in terms of what happened with the Southwest utilities outage last year, there's been some headlines that's been coming across our screens here?

Don Brandt

The report out at this point that's all we know is the report’s out.

Operator

The next question is coming from the line of Greg Gordon with ISI Group.

Greg Gordon - ISI Group

So one of the things that jumped out from the release was while you are seeing some signs of pick up in economic growth you also had significant impact of energy efficient, from energy efficiency and demand side management in the quarter?

Don Brandt

That's correct.

Greg Gordon - ISI Group

So, can you refresh our memories on how the recovery writer prospectively will work to sort of incentivize you to continue to sue those and/or compensate you for continuing to pursue those types of savings?

Don Brandt

Sure the mechanism of loss fixed costs recovery mechanism envisions that we will file the first recovery in March of 2013 and it recovers that distribution fixed costs associated with lost cells through those mechanisms.

Greg Gordon - ISI Group

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

Jim Hatfield

That's correct. I would not characterize it as a one that will offset but you do get a partial revenue pick up from what's lost through the programs.

Greg Gordon - ISI Group

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

Jim Hatfield

Correct.

Greg Gordon - ISI Group

Okay. Second question with regard to financing plans, you said 2013 at the earliest for equity but when I just think about regulated utility model the fact, that filing a rate case till 2014 for at the earliest 2014, for rates in ’15 and that you have an historic test period what are the factors that are going to go into the timing of the equity issuance, it would seemed to me that it would be reviewed sort of try time it more concurrently with when you would need to update your capital structure for the next rate review which is some time away.

Don Brandt

Yeah, Greg I think you are exactly right there that it would be certainly no sooner than we needed and the driving force would be rebalancing our capital structure going into that test year.

Operator

Our next question is coming from the line of Ali Agha with SunTrust.

Ali Agha - SunTrust

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

Jim Hatfield

That's correct Ali.

Ali Agha - SunTrust

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

Jim Hatfield

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

Ali Agha - SunTrust

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

Jim Hatfield

That’s correct and back to Don's earlier comments. We’re not going to issue equity any sooner than we needed, but I think the factors that go into that are obviously liquidity which we have ample liquidity. So I am not necessarily worried about that, but we do have to watch our credit ratios as well which will be part of the equation. And that’s going to be driven obviously by fund some operation CapEx going forward.

I mean I think there is a balance there between try to maintain ratings and not pile on too much debt but it's going to be the latest long as possible.

Operator

Our next question is coming from the line of Brian Russo with Ladenburg Thalmann. Please state your question.

Brian Russo - Ladenburg Thalmann

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

Jim Hatfield

Sure, from a regulatory ROE, our regulatory equity layer, our last case was 539 which was our actual capital structure, long before that was 538. So it's in that range and at sort of a consolidated level it's 50-50. What we also have to monitor is imputed debt and the other factors that S&P puts into the rating.

Brian Russo - Ladenburg Thalmann

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

Jim Hatfield

Well, we get to defer the cost associated with four and five. We get a debt return. So the real lag from an earnings perspective is just the offset of the equity return. It’s more of a cash flow issue than it’s going to be a book issue during that timeframe.

Brian Russo - Ladenburg Thalmann

And then lastly, just could you remind us how the property tracker works, is there any sort of cap and inherent risk of under recovering those taxes?

Jim Hatfield

Well, so the deferral started 25% in 2012 and ramps up to 75%. So yeah, there is a risk there obviously of property taxes. The assessment rates continue to go up. Property tax assessment rates typically are about 18 month lag to values. So it’s really depend upon what happens in and around in property values in Arizona between now and the next decade.

Operator

(Operator Instructions) Our next question is coming from Jim Krapfel with Morningstar. Please state your question.

Jim Krapfel - Morningstar

Hi, recent net migration from Mexico has recently turned negative for the US; (inaudible) is going to have impact on the growth opportunities?

Don Brandt

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

Operator

Our next question is coming from Paul Patterson with Glenrock Associates. Please repeat your question.

Paul Patterson - Glenrock Associates

Just on a touch basis you guys on sales growth, you guys are projecting flat sales growth growing forward and that’s because of customer growth being offset by energy efficiency; correct?

Don Brandt

That’s correct Paul

Paul Patterson - Glenrock Associates

And what would it be without energy -- what is the energy efficiency impact and is this completely APS’ efforts or is it just stuff that we are seeing as well in other parts or others efforts that might be going on underway?

Don Brandt

Well, that’s pretty hard to track exactly Paul, but I would say, I know we have energy efficiency standard and a distributor generation standard. We can track pretty much what we’re doing; customers are also doing things as well. But primarily, I would say yes, it’s the ACC compliance program that’s involved.

Paul Patterson - Glenrock Associates

And what is that versus what the -- what would the growth rate be with out your efforts I guess?

Don Brandt

Well over this time frame probably slightly less than 2%

Paul Patterson - Glenrock Associates

Little over 2% growth, correct?

Don Brandt

Correct.

Paul Patterson - Glenrock Associates

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

Jim Hatfield

That’s correct.

Paul Patterson - Glenrock Associates

And does that include leap year?

Jim Hatfield

Yeah, it would.

Paul Patterson - Glenrock Associates

So it would even be lower; I mean is there anything in particular with this quarter that would still be causing that or is that something that…?

Jim Hatfield

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

Operator

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

Becky Hickman

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

Operator

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

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