Pinnacle West Capital Corporation
Q4 2014 Earnings Call Transcript

Published: 20 Feb 2015

[Operator:]

Greetings, and welcome to the Pinnacle West Capital Corporation 2014 Fourth Quarter and Full Year 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, Paul Mountain, Director of Investor Relations. Thank you, sir. You may begin.

[Paul Mountain:]

Thank you, Christine. I would like to thank everyone for participating in this conference call and webcast to review our fourth quarter and full year 2014 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 expectations, we caution you not to place undue reliance on these statements. Our 2014 Form 10-K was filed this morning. Please refer to that document for forward-looking statements, cautionary language, as well as the risk factors and MD&A sections, which identify risks and uncertainties that could cause actual results to differ materially from those contained in our disclosures. A replay of this call will be available shortly on our website for the next 30 days. It will also be available by telephone through February 27. I will now turn the call over to Don.

[Don Brandt:]

Thanks Paul and thank you all for joining us today. The fourth quarter wrapped up a productive year, and set the stage for further progress in the year ahead. Earnings finished the year in the middle of the range after adjusting for below normal weather. APS’s reliability and customer satisfaction remain in the top tier. Safety had another solid year and Palo Verde set a record for power production. In fact Palo Verde Unit No. 3 produced the second highest electricity output of any nuclear unit in the world in 2014 and all three Palo Verde units individually ranked among the top six producers in the United States. Jim will discuss the 2014 financial results but first I’ll update you on the regulatory progress and discuss a few significant projects. In December the Arizona Corporation commission voted on several key issues and we appreciate their commitment to resolve these items before the bench turned over. I’ll provide an update on two key issues in a moment but I’d like to first thank commissioners Brenda Burns and Gary Pierce, whose terms ended in early January. We appreciate their commitment to the state over many years of public service and on driving the dialog on several complex regulatory issues. Commissioners Doug Little and Tom Forese were sworn in on January 5th to four year terms. Commissioner Susan Bitter Smith was selected by her fellow commissioners as the next chair succeeding Commissioner Stump who did a tremendous job leading the Commission through a challenging period. Governor Doug Ducey was also sworn in, leading a group of many new officials at the state level that are bringing a renewed focus to economic development in Arizona. We look forward to working Governor Ducey’s team. I’ll now provide an overview of the key dockets that were voted on in December at the commission. The Four Corners rate tariff was approved with rates in effect as of January 1st of this year. The $57.1 million rate change was $8 million below our request, however it was in line with the commission staffs and administrative law judges recommended order. We were pleased to have a final order in this matter. Separately the commission voted it had no objection for APS to build and own 10 megawatts of residential roof-top solar on approximately 1500 homes. Now titled the APS Solar Partner program, installations will be given a spring. We’ve had a great deal of interest from our customers and initiated the first of three requests for proposals to qualify local Arizona based installers at the end of January. We're in the process of determining the system feeders and customers to target, which will then be matched up with the selected installers who will inspect roofs and install the roof-top systems. Putting this program in perspective, as of the end of 2014 APS has 30,000 residential roof-top installations, equating to about 200 megawatts of installed capacity. In 2014 interconnection application volume was down slightly from the record setting 2013 numbers, but actual installations in 2014 of 7,800 systems was the highest ever showing a 10% increase over 2013. This robust level of growth causes the unfair cost shift to continue increase. In addition the ACC initiated a generic docket in December titled in the matter of the inquiry in the solar DG business models and practices and their impacts on public service corporations and rate payers. Chairman Bitter Smith requested comments by February 13th. So the commission and staff are now reviewing the comments received last week. The next steps in timeline for this docket are expected to be discussed at an upcoming commission meeting. We have included 2015 calendar in our presentation to highlight the key dockets and dates ahead of us this year, including the docket I just mentioned. Let me highlight a few other items. Rate design discussions are surfacing after the initial discussion last fall. We're having discussions with several stakeholders to determine the best path forward. Late last year Salt River project proposed a broad rate restructuring and it is expected this will be voted on at their Board meeting on February 26. SRP's proposal includes several rate design principles that we have been advocating, primarily better alignment of fixed and variable cost and revenue. While each utility may have a different rate structure, it is clear from the national discussion and here in Arizona that appropriately addressing the unfair cost shift and aligning the fixed and variable discrepancy are a top priority. The Ocotillo modernization project has moved a year closer to beginning construction, which is expected in 2016. We've been working on the necessary approvals and outreach to the surrounding community and are pleased with the reception we have received. The certificate of environmental compatibility was approved in November. The last milestone before construction will begin was raised during the commission's integrated resource planning meeting in the fall. While there was clear support for the first two units which replaced the existing steam units, questions were raised on the cost effectiveness of the additional three units. We have maintained the importance of the five units to serve future load growth as well as improve the valley's reliability. However, to address the concerns that were raised we issued an RFP in late January for the incremental capacity equivalent to three of the five units. This process is expected to conclude in the summer. One other item to watch is the Delaney-Colorado River transmission line decision; Trans-Canyon which is joint venture with BAG U.S. Transmission, formerly named Mid-American Transmission submitted its bid to the California ISO on November 19. In January the bidder list was disclosed, six bidders in total. The Cal-ISO is working through its qualification and selection process and we expect a decision this summer. Lastly, I'll comment on a few recent environmental developments. On December 19, U.S. EPA issued its final regulations governing coal ash, which regulates coal combustion residuals as non-hazardous. Our initial estimate, a portion of which is included in our capital forecast is that our incremental cost to comply will be approximately $100 million, mostly at our Cholla plant. We're also working with the corporation commission, the Arizona Department of Environmental Quality known ADEQ and the Arizona Utilities to encourage the EPA to make revisions to Arizona's requirements under the clean power plan. Under the draft clean power plan, Arizona would be the second most impacted state in the nation. While APS's diverse portfolio is a clear advantage, we are concerned about the impact on other utilities in the state, including the need for additional infrastructure and the cost to Arizonans associated with achieving the goals originally established. We support the State's efforts to enact legislation that enables ADEQ to submit a state plan to U.S. EPA. This legislation is necessary to assure EPA does not issue a federal plan for the state of Arizona. Let me conclude by saying I'm very proud of the leadership of our people again this year, ranging from the pursuit of excellence each day across our operations and the safety of our employees and in the discussion on the complex topic rate design. I expect our team to again lead on these efforts in 2015 and that we will deliver on our commitments this year. I'll now turn the call over to Jim.

[James Hatfield:]

Thank you Don. The topics I will cover today are outlined on Slide 3 and include a discussion of our 2014 financial results and update on the Arizona economy, a look at our financing activity and a review of earnings guidance. Slide 4 summarizes our GAAP net income and ongoing earnings for the quarter and the full year. For the fourth quarter of 2014, we reported consolidated ongoing earnings of $5.4 million or $0.05 per share compared with ongoing earnings of $24.3 million or $0.22 per share for the fourth quarter of 2013. For the full year 2014, we reported consolidated net income attributable to common shareholders of $398 million or $3.58 per share compared to net income of $406 million or $3.66 per share for 2013. Weather-normalized our earnings for 2014 would have been $3.68 in the middle of our guidance range at $3.60 to $3.75, translating earned consolidated earning of greater than 9.5%. Slide 5 outlines the full year earnings per share drivers compared to 2013. Primary favorable variances include higher gross margin supported by the various revenue adjustments and lower interest expense driven by our financing activities and the lower cost of longer term debt. The effect of adverse weather decreased earnings by $0.16 per share. To put the unfavorable weather effect in perspective, in terms of its impact on megawatt hours, 2014 was the second modest year in 15 years including the first quarter of 2014 which was the modest first quarter in 40 years. There was not much variance in the other drivers including operating and maintenance expenses. Starting on Slide 6 let me walk through the variances that drove the change in quarterly ongoing earnings per share. An increasing gross margin improved earnings by $0.07 per share. I’ll cover the drivers of our gross margin variance on the next slide. Lower depreciation and amortization expenses increased earnings by $0.01 per share, in part due to the Palo Verde Unit 2 lease extension we announced in July, offset by additional plant in service. Lower interest expense, net of AFUDC, benefited earnings by $0.04 per share. The decrease largely reflects reduced interest charges, resulting from refinancing long-term debt at a lower rate. Higher operations and maintenance expenses decreased earnings by $0.18 per share, largely due to more fossil generation planned outages. A higher effective tax rate reduced earnings by $0.06 per share including a prior year tax benefit and the extension of bonus deprecation. The net impact of our other items decreased earnings by $0.05 per share. Turning to Slide 7, and the components of the net increase of $0.07 in our gross margin. The main components of this were as follows

[Operator:]

Thank you. [Operator Instructions] Thank you. Our first question comes from the line of Dan Eggers with Credit Suisse. Please proceed with your question. Mr. Eggers your line is live, perhaps you have yourself on mute.

[Don Brandt:]

We can go to the next question, Dan can get back in the queue.

[Operator:]

Our next question comes from the line of Ali Agha with SunTrust. Please proceed with your question.

[Ali Agha:]

First question, I know you guys talked about the weather impact in 2014 on the earnings but as recently at the end of the Q3 results, or around EEI time, we were still looking at the 360 to 375 guidance range for the year. So when we look at the 358 that you reported, what were the big factors relative to your own assumptions in the fourth quarter that caused us to miss the lower end of guidance for the year?

[James Hatfield:]

Well, we had negative weather in the fourth quarter as we talked about. We also had the extension of bonus depreciation which pushed out our ability to use production tax credits which had a negative impact of about $0.03 on the quarter as well.

[Ali Agha:]

Got it, okay. And then secondly, looking at the dynamic between weather-normalized sales growth and customer growth, I know, quarterly numbers tend to gets queued, but your customer growth has been fairly steady, 1% and yet we saw the 1.9% weather-normalized sales number in the quarter. Again anything to extrapolate from that and just remind us what the expectations are for customer growth and weather-normalized growth for 2015?

[Don Brandt:]

Well, for customer growth we’re looking 1.5% to 2.5% for ‘15 with 1.4% fourth quarter of this year. Weather-normalized sales sort of flat to 1% range. I think it’s important in the fourth quarter of 2013 we had, I think a negative 2% sales growth and I would not look at the quarter in and of itself. I would really look over the course of the year where we really had sort of flat sales and 1.4% customer growth.

[Ali Agha:]

Got it. And my last question Jim, with regards to the current thinking in terms of the timing of the next rate case and the earliest need for equity, just remind us again where you stand today on both of those factors.

[James Hatfield:]

No change really, we’re looking at not filling until at the earliest mid-16 at equity again no earlier than 2016 at the earliest.

[Operator:]

[Operator Instructions] Our next question comes from the line of Paul Ridzon with Keybanc. Please proceed with your question.

[Paul Ridzon:]

Just real quickly, do you have any sizable maturities coming up and kind of how you’re thinking about the opportunities on the interest lend?

[Don Brandt:]

While we have 300 million of debt maturing earlier this year -- later this year which we'll refinance. We also have maturities in 2016 and then our big maturity is on 2019. So we’ll look at all factors when we look at that in today’s interest rate environment. We chose January to take advantage the short end of the curve due to demand but we still have historically low interest rates across the board and see that those refinancing got really an opportunity to incrementally provide some interest savings.

[Operator:]

Our next question comes from the line of Michael Weinstein with UBS. Please proceed with your question.

[Michael Weinstein:]

I was wondering if you can characterize how the discussions at the commission have been going with regard to rate design. I understand comments were was taken and is the process moving forward at a quick pace, regular place? Has it installed recently, and what kind of initiatives, what’s the involvement of the Company in those discussions.

[Jeffrey Guldner:]

Michael, this is Jeff Guldner. So I think those discussions are moving forward at a normal pace and so what you’re seeing right now is comments from the parties here in Arizona, obviously folks are also paying attention on what’s happening on the national scene and there's a lot of discussions that are happening nationally and we're engaged in both of those. So we're engaged at a state level. We're also participating in the national debate.

[Michael Weinstein:]

Right and would you say that the things are moving along at the pace you expected?

[Jeffrey Guldner:]

Yes, I think what you'll see -- so you've got two new commissioners that have just taken their seats and so I think you'll see the discussions continue to accelerate here in the next few months.

[Michael Weinstein:]

And do you still expect that or -- do you have any expectation that rate design and metering, those types of issues be dealt with separately outside of the rate case or whether they'll be rolled into a rate case?

[Jeffrey Guldner:]

Well, it's a state wide issue. So remember there's going to be a discussion on this, what it means from a state perspective, how the implementation happens as part of that discussion. And so we've got a mechanism right now that is the LFCR DG adjuster. That's a component or that's one method of addressing really the cost shift issue, but structurally how do you the rate design changes. We know a lot of that's going to happen in a rate case.

[Michael Weinstein:]

Okay, I guess maybe the crux of the question is more like when do these, when does action have to be taken by the commission on this docket? How early does it have to happen? What's the latest that could happen before so that a separate process could occur or at some point I guess it's just too late, you've to roll it in into the rate case because the file is coming in mid '16?

[Jeffrey Guldner:]

So, there is no time clock on the discussion. So the discussion -- I can't tell you when the discussion is going to -- how it's going to specifically unfold, but from a process standpoint, some rate design changes are going to have to happen in a rate case. It's helpful to have the discussion of what that process should look like and what some of the issues are ahead of the rate case filing.

[Operator:]

It appears we've no further questions at this time. I'd now like to turn the floor back over to management for closing comments.

[Don Brandt:]

All right, well, thanks everyone. I mean as you look at the 10-K and then materials please give us a call if you have any questions and we'll talk with you soon. Thank you.

[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.