Earnings Labs

Pinnacle West Capital Corporation (PNW)

Q2 2017 Earnings Call· Sun, Aug 6, 2017

$102.86

+0.43%

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Transcript

Operator

Operator

Greetings and welcome to the Pinnacle West Capital Corporation Second Quarter 2017 Earnings Conference Call. [Operator Instructions] As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Stefanie Layton, Director of Investor Relations. Thank you. You may begin.

Stefanie Layton

Analyst

Thank you, Christine. I would like to thank everyone for participating in this conference call and webcast to review our second quarter 2017 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 Executive Vice President of Public Policy and General Counsel 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 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 second quarter Form 10-Q 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 August 10. I will now turn the call over to Don.

Don Brandt

Analyst

Thank you, Stefanie and thank you all for joining us today. We continue to demonstrate operational excellence through the second quarter of 2017 and we remain well-positioned for a solid year. Before Jim discusses the details of our second quarter results, I will provide a few updates on our recent regulatory and operational developments. Two significant milestones in the APS rate review had been completed as we near the conclusion of that process. The hearing ended on May 2 and the administrative law judge issued a recommended order on July 26. The recommended order supports the settlement agreement without material modification, including the 10% return on equity, a $94.6 million base rate increase, which is the equivalent of an overall 3.3% bill increase, deferrals for the selective catalytic reduction equipment at Four Corners, and the Ocotillo Modernization project, with a step increase in 2019 for the SCRs and moving the time of use window from noon to 7:00 p.m. to 3:00 p.m. to 8:00 p.m. The administrative law judge also recommended that the new rates go into effect on September 1. APS will file exceptions and clarifications to the recommended order tomorrow on August 4. The settlement agreement will bring about sustainable solar, a smarter energy infrastructure, a cleaner energy mix and more options for customers. The judge’s recommendation to support the settlement agreement continues to move us in that direction. The final step in the rate review process is for the commission to vote at an upcoming open meeting. We view the progress to this point, including the judge’s recommendation to approve this settlement as very positive. With the anticipated conclusion of our rate review and the related imminent grandfathering deadline for net metering, we continue to see an increase in residential solar. In June, we received over 4,500…

Jim Hatfield

Analyst

Thank you, Don and thank you again everyone for joining us on the call. This morning, we reported our financial results for the second quarter of 2017. As shown on Slide 3 of the materials, for the second quarter of 2017, we earned $1.49 per share compared to $1.08 per share in the second quarter of 2016. Slide 4 outlines the variances that drove the change in our quarterly ongoing earnings per share. I’ll highlight a few of the key drivers. Total gross margin was up $0.27 per share compared with the second quarter of 2016, supported by stronger customer usage, favorable weather and higher transmission and loss fixed cost recovery revenues. Higher net sales in the second quarter of 2017 compared with the second quarter of 2016 increased earnings by $0.10 per share, which we believe reflects the improving economic conditions we are seeing locally and I’ll talk about more on that in a moment, which was supported by 1.8% customer growth as well as higher average usage by our residential customers. Weather-normalized retail, kilowatt-hour sales were up 2.9% in the quarterly comparison, net of the impact of customer conservation energy efficiency programs and distributed renewable generation. Although we are pleased with the favorable sales growth we saw in the second quarter, year-to-date, through the end of June, sales were up 0.1% and we still expect that weather-normalized sales growth will fall within the range of about 0% to 1% for the year. Lower operations and maintenance expense contributed $0.14 per share in the second quarter of 2017, primarily driven by less fossil generation plant outage activity during the current period. As you recall, we had a large plant outage at the Four Corners Power Plant in both the first and second quarters of 2016 as part of the…

Operator

Operator

Thank you. [Operator Instructions] Thank you. Our first question comes from the line of Greg Gordon with Evercore. Please proceed with your question.

Greg Gordon

Analyst

Thanks. Good afternoon, guys. How are you?

Don Brandt

Analyst

Hi, Greg.

Greg Gordon

Analyst

Good. So, several questions. First on, you indicated that your – you can file exceptions to the rule by August 4. I mean, there weren’t very many material modifications to the settlement. So, should we expect that you will have material issues with the rule or would they be limited to perhaps the fact that the recommendation bifurcates the AMI opt out, because other than that, I didn’t see any major changes?

Don Brandt

Analyst

I think it will be mostly categorized as tweaking, Greg.

Greg Gordon

Analyst

Okay, that’s great. Thanks. My second question is the weather normal sales growth as you calculated it this quarter was really quite impressive. Now, I know if I look in the appendix on Page 20 that the first – the 6 months ended weather-normal is just 0.1%, because the Q1 number looked weak, I remember asking about it at the time. Is this a number – this 2.9%, I mean, is this a number off of which you think you can build momentum or do you think it ebbs back down to a lower number, but still one that sort of drives you towards the type of customer growth targets that we have been waiting to see, which are finally showing up? I am just asking for a little bit more color and characterization of like why did it go from such a low number in Q1, such a huge number in Q2 and how...

Don Brandt

Analyst

So I might ask Jim to comment on the comparison of the two quarters, Greg. But I will say – I mean we are still looking at, as we pointed out in the press release, 0% to 1% for the year. And for the first 6 months, we are up only up net-net 0.1%, but for a longer term, and by that, I mean the next 2 to 3 years, the balance of the year, some of the things Jim cited, but I mean the growth here, number one in the nation, the housing permits or the house since 2007 and if you saw the number driving around the entire metropolitan area, there is apartment buildings – huge apartment buildings going up almost everywhere you look. Different magazines and realtor.com projects Phoenix to be the number one housing market this year and next. There is a lot going on here that I think is going to continue to sustain our growth for the next few years. And Jim, I don’t know if...

Jim Hatfield

Analyst

Yes. I would just say, Greg, it’s a great question as one quarter we come up pretty flat to negative. We do know that consumer confidence at the residential level increased in the second quarter. And I think that’s consistent with the surge in housing permits in the second quarter. That said we will see some consumer elasticity as they get their bills in July from the warm June. So right now, we are continuing to be led here today by the commercial sector with the things we mentioned before, State Farm completing its build-out last year, but still continuing to increase forecast as we move forward. So, I think I would answer that by saying I think the third quarter is going to tell us a lot as well.

Greg Gordon

Analyst

Okay. Move on to my last question, obviously, the quarter-over-quarter earnings comparison was incredibly punchy, $1.49 versus $1.08. But you did point to the fact that you are going to have some plant outages in the second half. Can you quantify, just – if we were to just isolate O&M, we are just going to isolate O&M in the second half sort of second half ‘17 versus second half ‘16, what that delta looks like as a function of those planned expenses?

Jim Hatfield

Analyst

So we knew our O&M was going to be back end loaded this year. I think I would look to the first quarter of ‘16 when we did similar type outages at Four Corners. That’s the guide in terms of the magnitude of that spend, Greg.

Greg Gordon

Analyst

Okay, thank you very much, guys. Have a great day.

Jim Hatfield

Analyst

Thank you.

Don Brandt

Analyst

Thanks, Greg.

Operator

Operator

Our next question comes from the line of Insoo Kim with RBC. Please proceed with your question.

Insoo Kim

Analyst · RBC. Please proceed with your question.

Good morning, everyone.

Don Brandt

Analyst · RBC. Please proceed with your question.

Good morning, Insoo.

Insoo Kim

Analyst · RBC. Please proceed with your question.

After the rate case decision when you guys do provide your ‘17 guidance, have you guys made a decision on whether to potentially provide longer term growth forecast, whether it be rate base or earnings growth CAGRs?

Jim Hatfield

Analyst · RBC. Please proceed with your question.

No, we will provide ‘18 guidance. And then as our normal practice at the end of the third quarter – I am sorry, ‘17 guidance and at the end of the third quarter, we will do ‘18 guidance. But at this time, we have no plans to go out any further than what we normally do.

Insoo Kim

Analyst · RBC. Please proceed with your question.

Understood. And my only other question was with the latest update in the suit by Commissioner Burns and on June, the ACC denied the motion to compel it. Is it pretty safe to assume that any other further consideration by the court near term shouldn’t delay the upcoming rate case decision?

Jeff Guldner

Analyst · RBC. Please proceed with your question.

Insoo, this is Jeff. The Superior Court judge just heard arguments on amending the complaint that was asked at the four commissioners and the commission. I expect him to rule on that in the next week or so. And so we have got an open meeting that’s coming up in – next open meeting, the rate case could go on would be August 15 and 16. So, I think the rate case is probably going to go before anything happens in Superior Court.

Insoo Kim

Analyst · RBC. Please proceed with your question.

Got it. Thank you very much.

Operator

Operator

Our next question comes from the line of Michael Lapides with Goldman Sachs. Please proceed with your question.

Michael Lapides

Analyst · Goldman Sachs. Please proceed with your question.

Hey, guys. Don, a question for you. I know the rate case lays out some of the boundaries for this, but given kind of what you have seen for the last 6 or 9 months or even longer term and what you expect going forward, how are you thinking about your generation capacity and energy needs and whether post Ocotillo, there is need in the early 2020s for new gas-fired generation in your portfolio?

Don Brandt

Analyst · Goldman Sachs. Please proceed with your question.

Most likely, we would be looking at simple cycle peaking needs at that period of time.

Michael Lapides

Analyst · Goldman Sachs. Please proceed with your question.

Got it. And can you remind me – or as part of this rate case agreement, are you allowed to actually own and operate the simple cycle? The agreement, I think doesn’t let you go into construction for some types of gas plants, but others it does?

Don Brandt

Analyst · Goldman Sachs. Please proceed with your question.

Yes, that’s correct.

Michael Lapides

Analyst · Goldman Sachs. Please proceed with your question.

Got it. Thanks, Don. Much appreciated.

Operator

Operator

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

Ali Agha

Analyst · SunTrust. Please proceed with your question.

Thank you. Good morning.

Don Brandt

Analyst · SunTrust. Please proceed with your question.

Good morning, Ali.

Ali Agha

Analyst · SunTrust. Please proceed with your question.

Good morning. First question, Jim or Don, assuming the rate case settlement is approved and it looks like it will be, given that your ROE stays as it was but your equity ratio goes up somewhat, does that cause the earnings power of the company to increase as well?

Jim Hatfield

Analyst · SunTrust. Please proceed with your question.

No. I would expect actually our equity ratio to sort of fall as we issue fixed income securities over the next couple of years.

Ali Agha

Analyst · SunTrust. Please proceed with your question.

So, ultimately you think that would kind of remain where it has been?

Jim Hatfield

Analyst · SunTrust. Please proceed with your question.

Yes. The equity ratio and the ROE were just placed in there as parameters for us, the rate case for the black box, so the extra equity in this case, it doesn’t lead to earnings power.

Ali Agha

Analyst · SunTrust. Please proceed with your question.

I see. Okay. And then separately, when you look at the deferrals and the step up increase in ‘19, again, as part of the settlement, I recall in the past, you have talked about, I think rate base growth has been 6% to 7%, dividend growth 5%, and you have talked about earnings growth somewhere in the middle of the two. One, did I get that, right? Have you...

Jim Hatfield

Analyst · SunTrust. Please proceed with your question.

That’s correct.

Ali Agha

Analyst · SunTrust. Please proceed with your question.

Okay. But do you see that the trajectory, given the step up etcetera, won’t be smooth? Should we think about some peaks and troughs as we think about that earnings trajectory because of the timing of the step up?

Jim Hatfield

Analyst · SunTrust. Please proceed with your question.

Earnings always goes in peaks and troughs. And keep in mind, when we do the step increase, we still have $0.5 billion of Ocotillo that’s being deferred, but not being earned on. So that would create a drag until it ultimately gets some rates hopefully in 2020.

Ali Agha

Analyst · SunTrust. Please proceed with your question.

I see, okay. And then more near-term, I know you talked about the planned outages and how the O&M will move over time. But excluding that, when you look at how second quarter came out and how first half has come out, has it come out pretty much as expected on plan or how would you categorize the first half of the year?

Jim Hatfield

Analyst · SunTrust. Please proceed with your question.

Yes. I think we are pleased with where we are compared to our plan this year. And beyond that, we haven’t really given any guidance and we will talk about that when we get guidance out here soon.

Ali Agha

Analyst · SunTrust. Please proceed with your question.

Okay, thank you.

Operator

Operator

Our next question comes from the line of Jerimiah Booream with Bank of America Merrill Lynch [sic] [UBS].

Jerimiah Booream

Analyst

Hi, good afternoon.

Don Brandt

Analyst

Good afternoon.

Jerimiah Booream

Analyst

I just wanted to go back to the customer growth question. And specifically, could you just remind us what percentage offset you have seen from solar installations? And specifically, could you see that affecting how you are thinking about customer growth as the grandfathering period ends later this year?

Jim Hatfield

Analyst

Yes. So I would say that we get probably as much impact of energy efficiency as we do rooftop, but we probably will have by the time rate goes into effect and installations that are valid we have received before that, we will probably end with 70,000 or so rooftop solar and that will be about 6% of our residential customer base will be with rooftop solar. After that, remains to be seen in terms of continued growth. We get about a 1.5% or so offset typically from the EE and DE.

Jerimiah Booream

Analyst

Got it. That makes sense. And then just a quick clarification, if the Navajo operators reach an agreement to extend operations beyond 2019, would you be obligated to basically maintain your ownership or will you have the option or how are you thinking about that?

Mark Schiavoni

Analyst

Well, this is Mark Schiavoni, Jerimiah. Right now, the expectation with Navajo Generating Station, the current ownership structure would not remain in place through efforts of the Navajo Nation, Department of Interior, they are looking for alternative ownership in the future of Navajo Generating Station.

Jerimiah Booream

Analyst

Okay. Yes, that’s fine. Thank you.

Operator

Operator

Our next question comes from the line of Charles Fishman with Morningstar. Please proceed with your question.

Charles Fishman

Analyst · Morningstar. Please proceed with your question.

Thanks. Hey, the only question I have was on Slide 9. There was a third bullet point under the rule about the battery storage. And just to make that clear, it’s an incentive program for the customer to install this battery storage, correct?

Jeff Guldner

Analyst · Morningstar. Please proceed with your question.

Yes, Charles, it’s Jeff. It was a response to specific issue in the case that was not included in the settlement. And there were a couple of proposals out, but this is an incentive program for the customer. It’s funded through the DSM adjustment mechanism.

Charles Fishman

Analyst · Morningstar. Please proceed with your question.

So I know we have seen some battery storage – utility scale storage in Southern California, for instance. Was there any thought about going in that direction, because obviously the situation in your system almost lends itself to that.

Mark Schiavoni

Analyst · Morningstar. Please proceed with your question.

Charles, this is Mark. We have installed a couple 2-megawatt batteries into our system and quite frankly, we are using that as part of the solution set. So with the way we look at storage or any technology, if it doesn’t provide the right solution at the right cost or a system reliability so it could be a capacitor, it could be storage, it could be transformer, it doesn’t matter in the technology. So we are pretty agnostic when it comes to that.

Charles Fishman

Analyst · Morningstar. Please proceed with your question.

Okay, that’s all I have. Thank you.

Operator

Operator

Thank you. We have no further questions at this time. I would now like to turn the floor back over to management for closing comments.

Stefanie Layton

Analyst

Thank you for joining us today. This concludes our call.