Greetings, and welcome to the Pinnacle West Capital Corporation Third Quarter 2019 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.

Thank you, Christine. I would like to thank everyone for participating in this conference call and webcast to review our third quarter 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' President; and Daniel Froetscher, APS' Executive Vice President of Operations 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 our 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 third quarter 2019 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 November 14. I will now turn the call over to Don.

Thank you, Stefanie, and thank you all for joining us today. Our operating performance and financial management remain in line with our expectations for the year. As you know, weather provided significantly below average revenue in the second quarter and was mild in the third quarter. Before Jim discusses the impacts of weather on our expectations for 2019 and details of our third quarter results, I'll provide a few updates on current regulatory and operational developments. The 2019 summer season was successfully completed by focusing on our core priorities, delivering safe, clean, reliable and affordable energy. June began with relatively mild temperatures, which for resource planning meant heavy imports from California renewables and watching for over generation during the midday hours, while July and August had 23 days over 110 degrees. It was the driest summer in the last 20 years, with less than one inch of rain between June and the end of September. The lack of humidity can impact peak demand, which was 7,270 megawatts in 2019, following 200 megawatts short of the 2018 peak. Our evaluation of the McMicken substation battery storage facility equipment failure is ongoing. The fire occurred on one rack containing 14 battery modules. The rack that experienced the fire has been disassembled and was shipped to a forensic lab in Michigan where it's undergoing a series of tests. While we remain committed to our investments in energy storage, it's imperative that we move forward safely. We expect that more specifics on what a safer path forward looks like shouldn't be available by the end of this year or early 2020. Turning to our regulatory updates. We filed a rate case on October 31, 2019. Key components of the filing include a 10.15% return on equity, a 1% return on the fair value increment,…

Thank you, Don, and thank you again, everyone, for joining us today. This morning, we reported our financial results for the third quarter of 2019. We earned $3.77 per share in the third quarter of 2019 compared to $2.80 per share in the third quarter of 2018. A reconciliation of the earnings drivers can be found on Slide 3 of the materials. Given the impact year-to-date from below normal weather, we would not expect to hit the lower end of the $4.75 to $4.95, 2019 guidance range. As illustrated on Slide 26, through the end of the third quarter of 2019, weather decreased gross margin, a total of $24 million or $0.16 per share. October sales are also below expectations due, in part, to another month of mild weather. For the full year 2019, we expect a negative weather impact will be partially offset by lower O&M and the approval of the TEAM 3 refund. As we look ahead to 2020, we will continue to enhance our customer and shareholder value through our cost management discipline. We have a long track record of managing our costs and continuous improvement. The customer affordability effort challenges our employees to find ways to work better and more efficiently challenged bureaucracy and eliminate unnecessary work in our daily operations, all of which are based on lean principles. Just working harder will not get us there. We must find different general rates to get the job done and cost savings will result. Although we are in the early stages of the customer affordability initiative, we have identified $20 million of potential O&M savings that will serve as a positive driver in 2020. We are introducing 2020 guidance of $4.75 to $4.95 per share. Given the rate case outcome is unlikely to materially impact 2020 earnings.…

Thank you. [Operator Instructions] Our first question comes from the line of Michael Weinstein with Credit Suisse. Please proceed with your question.

Good morning.

Good morning, Michael.

When I look at the slides on – I'll continue on the Four Corners SCRs, and I think there's a slide in here that shows about $0.07 of EPS reduction full year 2019 impact from Four Corners. It looks like perhaps the two of those things combined in 2020 would be probably about a $0.15 hit. Is that – would it be fair to say that, that $0.15 would be restored once the rate case is finished in 2021.

That would be the math of the combined two. We can't predict the optimal rate case, obviously, but those are the two big components of our rate ask.

Got you. And do you have kind of any thoughts right now on what kinds of equity issuances you might do for the modest equity that you said you might need going forward? And what the timing of that might be? Is it a 2020 issue or a 2021 issue?

I don’t have any thoughts currently, Michael.

All right. Thank you very much.

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

Thank you. Maybe starting with the economic data that you guys were pointing out, it seems like there is – continues to be a lot of growth in various industries in the commercial/industrial side. Despite that, you – now you’re forecasting the weather-normalized load growth for 2021 to be about 50 basis points lower than your prior forecast? Could you just talk a little bit about the usage trends that you’re seeing in the various customer classes?

Yes. So if I look at the – residential continues to be strong. The economy is doing very well overall, virtually all sectors. For stronger growth in the C&I customer base is being dominated by warehousing and logistics. Currently, retail stores and malls still appear to be weak, which is in line with national trends. So from an energy-use perspective, the rapid growth in warehousing and logistics sector appears to be reducing average use per customer in the C&I area, still showing growth but a little weaker than we expected.

Understood. And then maybe switching to the rate case. I think in the past couple of months, there’s been conversations about the treatment of the fair value increment of the rate base. And I just – I’m not as familiar with that in terms of – is that a PSC statute, is that a legislative item? Or is that just something that the ACC has discretion on whether to approve an increment or not?

Hey, Insoo, it’s Jeff. That’s actually part of the Arizona constitution and so the state is adopted in the constitution in 1912, a fair value requirement. So it’s somewhat unique to Arizona. And over the years, it’s been addressed in a variety of different rate cases, not all of them, ours. And it really started to have more of a role, probably five or six years ago, a lot of rate case context. And so the commission has been applying it and discussing how to apply the fair value standard since that time. This was a workshop on it a few weeks ago. And so there’s some moving parts on it. I don’t know exactly how that’s going to play out.

Okay. But the constitution would state that the PSC would apply some sort of fair value increment to rates?

Yes.

Okay. Thank you very much.

Our next question comes from the line of Julien Dumoulin-Smith with Bank of America Merrill Lynch. Please proceed with your question.

Hey, good morning, team. So obviously, continue to cut costs in the 2020 versus 2019. Can you talk a little bit about how you think about earned returns and narrowing the gap versus authorized? And I’m really trying to get at how you think about sort of a post rate case outcome, and continuing to focus on narrowing that gap, especially in the eventuality of any change in authorized returns here. And then maybe if I could follow-up on Insoo’s question just in brief. How do you think about the delta in ask here on the fair value piece just given some of the commentary in other cases between staff?

So Julien, I think in terms of narrow on the regulatory lag, we have some mechanisms now that work well from a rate gradualism perspective. Obviously, as an alternative in the case, we proposed formula rates would just be an annual filing, much like we do at FERC, which we would need adjusters. And those will be the sort of two things we’d look at in terms of getting faster recovery in terms of the fair value.

Yes. Obviously, on the fair value, Julian, each case is a little bit different. So if you watch right now in the Tucson Electric case, they had requested a 1.25% fair value increment and the staff testimony at fall was a little less than 0.5% increment. There’ve been other cases before where the company – water company didn’t get a fair value increment. But again, that’s going to be in the context of that specific case. And so it is an area that’s – the policy is evolving or at least being discussed. But it’s just a part of the Arizona regulatory framework.

All right. Fair enough. But with respect to earned returns, I mean, obviously, O&M coming down. I mean the broad framework, I think you guys have historically talked about is about a 9.5% earned return or better. I suppose, still broadly, even in going to the future, sticking to that mantra, is there no ability to kind of narrow that range?

Well, I mean based on where we are now, obviously, beyond the right case outcome, we can’t really focus or really say what that is because we don’t – we can’t predict the outcome.

But we do try to get the delta between – you’re always going to have some structural disallowances, right? And so you do try to narrow the delta between the earned and the authorized return. And so that obviously will continue to be a focus for us.

Got it. Excellent. And then CapEx wise. I know it’s a small bump in 2020. But how do you think about any potential to shift that around, obviously, I suppose it was earlier here, you made a more meaningful shift. Given the pendency of the case, we shouldn’t be expecting anything more meaningful until the termination of that case, right? Or resolution, rather?

Yes, I think as we’re now almost on 2020, that’s – we have a good plan for 2020 and 2021, and I wouldn’t expect any big changes currently.

All right. Fair enough, guys. I leave it there. Thank you.

Our next question comes from the line of Greg Gordon with Evercore ISI. Please proceed with your question.

Thanks, First, hey Don, congratulations on the retirement. You’ve served the customers of your utility in Arizona very, very well over your tenure and also put up good returns for shareholders, so well deserved.

Thanks, Greg. I appreciate it, especially coming from you.

The – I’ve been multitasking here. So I appreciate and apologize if I missed this, but when looking at the adjusted gross margin targets for 2019 and 2020, obviously, they came down a lot for 2019 and the 2020 adjusted gross margin target is actually below where you thought you were initially going to come in, in 2019. Your expectations for weather-normalized retail electric sales volume are lower for this year, but the same for next year. Can you just go through what you’ve recalibrated there? And whether it’s just a 2019 issue or there’s also some uncertainty around where you think you’ll end in 2020 versus initial expectations in 2019?

Well, in a response to an earlier question, we talked about how in the C&I sector due to the customer mix that we’re – we have now versus historically, we’re seeing less huge per customer, that’s really around warehousing logistics. And going forward, we have a slide with some of the other data centers and other things, which are highly uncertain in terms of timing and exact amounts. So I think we’re just recalibrating to what we’re seeing actually in the marketplace.

Okay. And then back on Michael Weinstein’s question. You did – thank you for putting a slide in the appendix on the impact this year of not getting the step increase. I think you annualized that at $0.07. Is it – will it annualize at a larger number in 2020 before it all gets worked out in the rate case, is that right?

No, that’s really the delta between – you’re having it in as rates and earning an equity return versus just a debt return. And that project will continue to be deferred. There’s a – they’re concurrent ALJ rule out there for that, and that’s not going to change. The impact will be – it’s a non-cash return. So you’re always – you’re not getting your cash return, but it’s fairly minimal over a one-year time frame.

Okay. Thank you, guys. Have a great afternoon.

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

Thank you, good morning. First question, just to clarify, I think you mentioned that you’re going to be below the low end of your guidance for this year, can you give us some calibration of how much lower we should be thinking about just as we think about finishing this year off?

We’ll be below $475 million. That’s about as a finest point I can put on at the moment.

Okay, Jim. I mean can you – I know you manage all your target towards the 9.5% or higher earned return. Any range or numbers we should think about for 2019, when the dust settles?

No.

Okay. Then my second question, I think in your comments, you mentioned in 2020, these revised disconnect policies will hurt you by about $20 million to $30 million. One, I wanted to confirm I heard that right? And two, does that impact continue in future years as well?

Well, you heard it correctly, the impact based on various assumptions. The reality is we don’t have a policy at this point going forward. So anything beyond the assumption of the number would be a pure guess at this point. And at some point in the future, those will ultimately be reflected in rates whenever we end up.

I see. So there is some truing up that will happen in this rate case that’s currently pending?

We did do a couple of pro formas in the case to try to increase our uncollectible expense based on the increase we’re seeing now.

Ali, longer term, it’ll depend on what the final rules are. So they’re in a rule-making process now on the disconnect policy, and we’re participating in that. And ultimately, it’ll be reflected in what those rules come out with.

I see. But just from, I guess, a big picture point of view, would we expect that there would be some headwinds from this? Or – I mean theoretically, the rules would be such that this would not be an issue going forward?

There’ll be headwinds until ultimately you get it reflected in rates, whether that’s what we ask for in this case or down the road based on the final rules, which we don’t have yet.

I got you. And then lastly, Jim, I just wanted to confirm, you mentioned the need for some equity or small equity going forward. But you don’t need that for this rate case, right? That 54.7%, that’s based on your actual capital structure? Or does – is there some equity needed to calibrate to that level as well?

No. Our capital structure is 54.7% as of June 30, that’s what we filed in the case.

Right. Okay. Thank you.

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

Thank you. Don, I think I first met you over 20 years ago and sort of followed you around and the – or the Board at Pinnacle West certainly made a great decision when they took you out of St. Louis.

Thanks, Charles.

The only question I have is effective tax rate, 14% that you’re using in your key factors for next year. Can you give a little more color on that, Jim? Or – and what will likely – I mean, I assume that will rise as we go forward here in the next decade.

Well, what it is, is it’s really a reflection of the deferred tax flowback through TEAM 3, which really will be reflected in effective tax rate for the foreseeable future. But based on the fact that we’re giving it back over 27.5 years, roughly.

Okay. So we can – it will stay at around this level over the next few years?

All things equal.

Okay. Got it. That’s the only thing I had. Thank you.

Thank you. We have reached the end of the question-and-answer session. I would now like to turn the floor back over to management for closing comments.

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

Ladies and gentlemen, this concludes today’s teleconference. You may disconnect your lines at this time. Thank you for your participation, and have a wonderful day.