Pinnacle West's (PNW) CEO Don Brandton Q4 2016 Results - Earnings Call Transcript

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Pinnacle West Capital Corporation (NYSE:PNW) Q4 2016 Earnings Conference Call February 24, 2017 11:00 AM ET

Executives

Ted Geisler - IR

Don Brandt - CEO

Jim Hatfield - CFO

Mark Schiavoni - COO

Jeff Guldner - SVP Public Policy

Analysts

Ali Agha - SunTrust

Operator

Greetings and welcome to Pinnacle West Capital Corporation's 2016 Fourth Quarter and Full Year 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.

I would now like to turn the conference over to Mr. Ted Geisler, Director of Investor Relations. Thank you Mr. Geisler, you may begin.

Ted Geisler

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 here 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 our expectations, we caution you not to place undue reliance on these statements.

Our full year 2016 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.

Don Brandt

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 in the 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 an unclear 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's left a lasting legacy of excellence at Palo Verde.

In 2016, APS also achieved the safest year with the fewest reportable injuries in our history. I consider the safety of our employees the 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'll 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 dialog on several complex regulatory issues. Commissioner Bob Burns, Andy Tobin and Boyd Dunn were sworn in on January 3rd to four year terms. Commission Tom Forese was also selected by his fellow commissioners as Chairman succeeding Commissioner Doug Little who lead the commission through a challenging period.

I'll 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 the current net metering tool [ph] with a more formula driven approach. The formula will use inputs from utility scale solar power cost and eventually transition into an avoided cost mythology.

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 maybe considered a separate class of customers for rate making purposes, and third DG solar customers who have interconnected systems prior to the decision in APS's pending rate view 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 of fully litigated cases in the country and was founded on our 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 shared our vision for creating a sustainable energy future for Arizona.

I know APS's rate view is top of mind for many of you and we continue making good progress with this proceeding. Since our last call, the ACC's staff intervene filed testimony in response to our initial proposal. This provided a foundation for us to engage a meaningful settlement negotiations in January and earlier this month. We continue working with parties towards a constructive settlement proposal to be filed no later than March 17th.

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 cost of -- excuse me, value and cost of DG decision. As a result, the time clock was extended by 33 days and the new hearing date is April 24th.

2017 marks a period of unprecedented capital investment of our company as we manage more than 1.3 billion in projects and planned 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're well positioned to be a leader in grid automation and technology integration. The EPS 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 applications of smart inverters to integrating rooftop solar and battery storage on the distribution grid. In addition, we've recently placed into service an industry leading advanced distribution management system.

Next month we'll 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 its whole 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 the 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 3,500 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 Ocotillo project and our recent 565 megawatt power purchase agreement. The remainder will be procured through additional market opportunities, customer conservation and the 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 imbalanced market which produced $6 million in savings for our customers in the fourth quarter 2016 alone. We expect continued savings throughout 2017 which reduces cost 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 in the long-term. We have a clear plan and a strong leadership team in place 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 and 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’ll now turn the call over to Jim.

Jim Hatfield

Thank you John and thank you everyone for joining us on the call. This morning, we’ve reported our financial results for the fourth quarter and full year 2016. As you can see on Slide 3 in 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 of 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 on maintenance expenses in the fourth quarter of 2016 compared to 2015 improved earnings by $0.06 per share largely due to lower employee benefit cost driven by the adoption of a new stock compensation accounting guidance.

Now, I’ll turn 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, translate into an earned consolidated ROE of 9.5 on a weather normalized basis. Gross margin was the fastest 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 flow of our sales [ph] 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 and related pricing by customer class or mix and generated a positive gross margin effect.

Transmission LFCR revenues also continued to add incremental growth in our gross margins as designed contributing $0.17 per share respectively. Looking at the operating expenses, as expected higher operations to maintenance expense in 2016 compared to 2015 was a primary offset to ongoing results. Decrease in earnings by $0.37 per share. With the major planned outages at the four corners units 4 and 5 serving as a largest headwind. Higher transmission, distribution and customer service and higher employee benefit cost also contributed to 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 deprecation due to additional plant and service. Interest expense net of AIPDC was $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 benefitting AIPDC. As a reminder, both the O&M and gross margin variances excluding amounts related to our renewable energy and demand side management programs. Also note that the gross margin and G&A variances exclude operating revenues and expense related to the Palo Verde Unit-2 decommissioning recovered through a system benefit charge. The drivers I discussed 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'll highlight the next trends we are seeing in our local economy and in particularly in the Metro Phoenix area. In 2016 the Metro Phoenix region continues to add 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 is 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 add 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 vacancy office and regional space has been growing steadily since 2010. Vacancy rates in both markets are falling 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 the continuation of business expansion and related job growth in our 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 levels of 2007. This trend is expected to continue in 2017 as housing permits are expected to increase by about 7,000 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 loan prices which have return to levels last seen in early 2008.

We believe that solid job growth, low mortgage rates and the opening up of credit to households to separate from closures during recession and 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 plans. As previously indicated we will not be issuing 2017 earnings per share guidance at this time, but we'll continue to evaluate appropriate time to do so as our rate case progresses. In the meantime, to assist with your estimate, a list of the key drives that may affect 2017's ongoing earnings is included in the appendix to the today's slides. One item worth nothing, we expect plant outage spend in 2017 to be comparable to 2016 and part driven by preparation for the LFCRs installation of four corners. In terms of capital expenditures, we anticipate APSs spend to average of our 1.1 billion annually from 2017 and 2019 which will be primarily funded through internally generated cash flow. We continue expanding our rate base to grow at an average of annual rate of 6% or 7% through 2019.

Turning to 2017 financing, we expect to issue up to 850 million of long-term debt including the refinance with Pinnacle's 125 million term loan. Overall our balance sheet and liquidity continues to remain very strong. A quick note on pension [ph], our funded status remains steady at as of yearend 2016. The continued implementation of our liability driven investment strategy has helped to keep cost down. There is a slide in the appendix with additional details on our outlook.

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

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

Question-and-Answer Session

Operator

Thank you. We will now be conducting a Question-And-Answer Session. [Operator Instruction] our first question is from Julien Dumoulin-Smith of UBS. Please go ahead.

Unidentified Analyst

It's Jeremy [indiscernible] on. Just on the first off on the Navajo plant it's been kind of a fluid situation and I guess one, is there any sense to think that it wouldn’t shut down at this point or is that pretty clear and two, can you just clarify what exactly that might be backfilled with, as I understand it not -- the shutdown is not included in your IRP?

Mark Schiavoni

This is Mark Schiavoni, and yes, as far as your first quarter about shutdown. The owners led by SRP who is the operating agent has made decision at 2019 which is a current exploitation of the existing lease either as a year to lease [ph] and move forward beyond 2019 with the current owners structure or a changed owner structure. Couple of owners have made it clear they do not want to operate beyond 2019. But in the meantime, department has interior and our ACC as well as others that pull all the party together and are looking forward some sort of resolution post 2019 in order to continue the operating of the facility.

The economics or the facility as it stands today would not warrant continued operation without some significant changes. So that’s an ongoing issue still to be resolved. As far as the impact of the generation we will update our [indiscernible] as we go forward. But the current expectation is, we have the resources until at least 2019 potentially longer, and we will put it into our future finance and what we do from an RP [ph] or some more other positions with regards to Navajo generating station.

Unidentified Analyst

Okay. And just to clarify that, will 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 in solar or it [technical difficulty].

Don Brandt

It would be any amount at this point, so.

Unidentified Analyst

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?

Mark Schiavoni

Well I think lower overall corporate tax rate will be passed on to customers. I don't think it never going to wait till the next rate case. I think the [indiscernible] maybe something that hurt the company, so you want to put it all together and do it all at once. But we'll 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'll just have to wait and see ultimately what happens

Unidentified Analyst

Okay thank you.

Operator

Thank you. the next question is from Ali Agha of SunTrust. Please go ahead.

Ali Agha

First question it looks like the weather normalized electric sales for the year at flat or below of what you'd been projecting for the year, if I recall correctly. What do you think was causing that and any further visibility both in terms of the growth on customers and sales that you're projecting looking over the next three years given where we've been running last four or five, six quarters? Anything it is important to give us that more optimism. I know you've talked about the economic indicators. But why did '16 coming below what you had been expecting?

Mark Schiavoni

Well I think well first of all. No question we had a weak fourth quarter, heading into fourth quarter we had positive sales. So don't know that that's necessarily a trend and I'm not going to the to the first and fourth quarters to look at the trend with us being waited till second, third quarter. But I will say we have a lot of business sales were up last year for example State Farm [ph] 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 multi-family homes going on into Downtown Phoenix. So all the signs are pointing towards modest sales growth in 2017, we're projecting between of 0% and 1%. So we will ultimately see what happens.

Ali Agha

Okay. And then second over this next three-year cycle '17 through '19, do you have a sort of an earn ROE goal given like you had in the last cycle minimal was 9.5% and you got higher. I mean should we think about similar goals or different goals over this cycle period?

Mark Schiavoni

I think I'll defer that until we talk about ’17 guidance.

Ali Agha

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

Don Brandt

Ali, this is Don here and we continue engaging with the parties in a constructive settlement discussions and in generally speaking, we believe that parties are motivated to settle. It’s really difficult to go in any detail at this point.

Ali Agha

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

Don Brandt

Everything is up for negotiation.

Ali Agha

Yeah, thank you.

Operator

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.

Ted Geisler

Thank you Manny, this concludes our call. Thank you all for joining today.

Operator

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.

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