Pinnacle West Capital Corporation
Q4 2011 Earnings Call Transcript

Published: 24 Feb 2012

[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

[Operator:]

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

[Shar Pourreza:]

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:]

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:]

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:]

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:]

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:]

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:]

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:]

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.