Earnings Labs

Pinnacle West Capital Corporation (PNW)

Q4 2019 Earnings Call· Fri, Feb 21, 2020

$102.86

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Transcript

Operator

Operator

Greetings, and welcome to the Pinnacle West Capital Corporation 2019 fourth quarter and full year 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 fourth quarter and full-year 2019 earnings, recent developments and operating performance. Our speakers today will be our Chairman and CEO, Jeff Guldner; and our Chief Administrative Officer, Jim Hatfield. Ted Geisler, CFO; Daniel Froetscher, APS' President and COO; and Barbara Lockwood, Senior Vice President, Public Policy 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 actual results may differ materially from expectations. Our 2019 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 28.I will now turn the call over to Jeff.

Jeff Guldner

Analyst

Thanks, Stefanie, and thank you all for joining us today. Before I review our 2019 achievements and provide operating and regulatory updates, I want to look forward to the future and share more information about our focus areas and priorities. Our strategy is anchored by four concepts that align with industry trends and shape the way we do business. Those concepts can most simply be stated as clean, affordable, reliable and customer-focused.Let me talk briefly about each one. Clean is about decarbonizing our generation mix with our new goal to deliver 100% clean carbon-free energy by 2050. Affordable is planning and operating our business to maintain reasonable electricity prices for the people, businesses and communities we serve. Reliable means serving our customers with dependable power safely and efficiently. And customer-focused is about developing new solutions, products and services to meet the changing needs and expectations of our customers. With these in mind, we created a long-term plan and targets to track our progress along the way.First, we recently announced our goal to deliver 100% clean carbon-free electricity to customers by 2050. This goal includes a near-term target of 65% clean energy with 45% coming from renewables by 2030 and a commitment to exit coal by 2031. Importantly, our plan includes flexibility to ensure that we're able to execute in a way that maintains affordability for customers. As Jim will discuss, we expect this plan will require considerable capital investment. We believe a carbon-free future as possible while keeping customer rates over time at or below the rate of inflation with timely recovery of clean energy investments.To support the affordability of our transition to a carbon-free resource mix, we will have a sharp focus on economic development in Arizona. Growing our customer base, allocates these costs across more customers, which helps…

Jim Hatfield

Analyst

Thank you, Jeff, and thank you again, everyone, for joining us today. This morning, we reported our financial results for the fourth quarter and full-year 2019. Before I review the details of our 2019 results, let me briefly touch on some of the key factors from the quarter, which can be found on Slide 3. For the fourth quarter of 2019, we earned $0.57 per share compared to $0.23 per share in the fourth quarter of 2018. Our results were largely impacted by a one-time tax refund to customers related to the TEAM III refund and lower adjusted O&M expenses.We also experienced another quarter of mild weather. For the full-year 2019, we earned $4.77 per share compared to $4.54 per share in 2018. 2019 earnings reflect our growing infrastructure to support the strong Phoenix economy and 2% customer growth. Other key items for 2019 was negative weather, which decreased gross margin by $37 million or $0.25 per share. The negative impact was more than offset by lower O&M. Year-over-year lower adjusted O&M expense increased earnings $0.52 per share, primarily driven by lower planned outage expenses and lower public outreach costs at the parent level.As I mentioned last quarter, we are committed to enhancing our customer and shareholder value through cost management. The implementation of Lean Sigma will be the mechanism that allows us to improve the customer and employee experience while eliminating waste. As a result of our cost management efforts, we made great strides in reducing O&M in 2019, allowing us to reach the low end of our original guidance range, despite the mildest Metro Phoenix cooling season on 10 years. We expect to continue our cost savings efforts by reducing O&M approximately $20 million in 2020.As Jeff mentioned in his comments, we are on a path to deliver…

Operator

Operator

Thank you. We will now be conducting a question-and-answer session. [Operator Instructions] Thank you.Our first question comes from the line of Michael Weinstein with Credit Suisse. Please proceed with your question.

Michael Weinstein

Analyst

Hi, good morning guys. Could you talk about the -- you mentioned that there would be potentially some upside after 2022 in the capital plan as a result of your carbon reduction and greenhouse gas goals trying to achieve that going forward. Is there any way -- maybe we could kind of frame that up and talk about some more of the specific opportunities you see ahead, particularly maybe in battery storage or in generation?

Jeff Guldner

Analyst

Well, on average between now and to hit the interim target at 2030, we're going to need at least 300 megawatts of battery storage and 300 megawatts to 500 megawatts of other resources to meet that goal. And so, ultimately you have some competing plans out there all toward green and clean, but at different dates and want to see exactly how it plays out. But we're being very conservative in how we think about our capex budgets at this point.

Michael Weinstein

Analyst

Got you. And I think maybe I missed this, but did you talk about equity needs going forward? I know it's a little bit early considering the rate case is still pending and everything. But can you talk about the normalized equity need going forward and what -- how that might change depending on the outcome of the case?

Jeff Guldner

Analyst

Well, so we don't expect to issue equity in 2020, Michael. We expect the next offering we have will be in the $300 million to $400 million range. It will be teed up closer to the next rate filing, but a lot of that will be what it shakes out ultimately and the capital expenditures as we move forward PPA versus owned.

Operator

Operator

Does that complete your question?

Michael Weinstein

Analyst

No. Is that block equity or ATM-type equity?

Jeff Guldner

Analyst

We haven't decided the how yet at this point. So we'll have to -- details will follow on that as we get closer.

Michael Weinstein

Analyst

Okay. Got you. Thank you very much.

Operator

Operator

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

Greg Gordon

Analyst · Evercore. Please proceed with your question.

Thanks. Good morning. A couple of questions. So other than the rider that you have for APS Solar Communities, which I believe is for rooftop, which we should be assuming that to move this capital through into rates that -- I think, you've already said this pretty explicitly, you will need to file another rate case post the one that's going to be closing this year too or you'll be in sort of serial filing mode to get these investments into revenues. Is that fair?

Jeff Guldner

Analyst · Evercore. Please proceed with your question.

It may depend a little bit, Greg, on kind of how the -- how this case moves forward. We've got an RES adjustment mechanism. There's some potential for that to come into play. I think what you see is, if you move with a more traditional rate basing process, then, yeah, you would be looking at rate cases that would be filed periodically to reflect the changing capital. But one of the things I think we'd like to have a conversation with the commission about is, are there either mechanisms we have today or other ways that we can look at doing that so that we're not in serial rate-making mode.

Greg Gordon

Analyst · Evercore. Please proceed with your question.

Understood. And then when I look at the 2022 rate base target or aspiration, it's -- it just looks a little bit low to me relative to the increase in capex. Maybe I'm wrong. But should I presume that the CWIP balances would be perhaps a bit larger and the AFUDC portion of your income statement would be a little bit bigger in '22?

Jim Hatfield

Analyst · Evercore. Please proceed with your question.

You know, Greg, this is Jim. I know this slide is 2020 to 2022. That 6% to 7% we think is a long-term outlook and when necessary it just reflects the debt, the period that shown. The math looking at what's shown is more like 8%, but we're looking at into the future.

Greg Gordon

Analyst · Evercore. Please proceed with your question.

No, I understand that. I'm making -- I'm asking a more basic question when I think about the earnings guidance for this year with AFUDC expected to be $35 million plus or minus, that's on Slide 6.

Jim Hatfield

Analyst · Evercore. Please proceed with your question.

Yeah.

Greg Gordon

Analyst · Evercore. Please proceed with your question.

I'm just sort of saying like, maybe I'm stating the obvious, but as your capital expenditures accelerate up that CWIP and therefore the contribution to earnings from AFUDC should grow.

Jim Hatfield

Analyst · Evercore. Please proceed with your question.

That would be correct, Greg.

Greg Gordon

Analyst · Evercore. Please proceed with your question.

Okay. Final question guys. I think there was some work -- the PUC -- sorry the ACC outside of the Tucson case and outside of the -- your pending case has been workshopping several different issues, including making a policy decision on how to deal with fair value adjustment, how to deal with post test year adjustments in rate cases. And I think there was one other item, which, frankly I'm embarrassed, I can't remember, but I think you -- hopefully, you are knowledgeable about to what I'm referencing. And could you give us an update on that where those stand on those two or three items?

Barbara Lockwood

Analyst · Evercore. Please proceed with your question.

Yes. Greg, this is Barbara Lockwood. There has been some conversation about taking a look at those outside of rate cases. Frankly, there hasn't been much activity on that recently. They've been focused on some other topics.

Greg Gordon

Analyst · Evercore. Please proceed with your question.

Okay. So there's no sort of formal process for coming up with policy statements on those would like a date certain?

Barbara Lockwood

Analyst · Evercore. Please proceed with your question.

No, there's not. Not at this time.

Greg Gordon

Analyst · Evercore. Please proceed with your question.

Okay. Thank you very much. Take care.

Operator

Operator

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

Insoo Kim

Analyst · Goldman Sachs. Please proceed with your question.

Thank you. First question, could you maybe give a little bit of an update on your thoughts on the telecom petition docket and couple of the proposal that were made? And just your thoughts on the feasibility of that and what potential impact that could have on the system and on APS as well?

Jeff Guldner

Analyst · Goldman Sachs. Please proceed with your question.

Yeah. Insoo, it's Jeff. The process, there has been some draft rule proposals that were put out. And if we want to go into any more detail, let Barbara talk about it. But one of the major challenges we have here in Arizona is that we're not in an organized market. And to make the retail competition effective, I think, you've really got to be in an RTO and have that underlying framework, and you've also got to have a fair amount of infrastructure around resource adequacy.We're in a time, if you go back to the original competition discussion back in the early 2000s, there was a lot more capacity, there was an overbuild of capacity. And so, capacity was not as tight. We're in a much tighter capacity markets, so it would be really risky to move forward without strong resource adequacy frameworks. And this is a pretty lean commission. And so how you would put in place the infrastructure that would ensure resource adequacy, how would you deal with the market structure that moves beyond scheduling -- independent scheduling administrator, which is what we had in the last go around, into an actual RTO type of Independent system operator. And then how would you actually address the arbitrage, the gaming that could happen around the trading and prices and customer-facing situation.So it's just really difficult for me to see how you put all those in place to make this effective. But obviously, this is early in the discussion on where those rules are. And so we'll engage and share that perspective with the commission.

Insoo Kim

Analyst · Goldman Sachs. Please proceed with your question.

Got it. Thank you for the insight. And the second question, just going back to the storage and other clean energy investments. I think the 300 of storage and the 300 megawatts to 500 megawatts of other resources, what time frame was that for? And I heard a 2030 timeframe and I didn't know what the overall opportunity set you may have spoken about in this next 10-year period.

Jeff Guldner

Analyst · Goldman Sachs. Please proceed with your question.

Yeah. Insoo, I was referencing the sort of interim 45% renewables target in 2030. And over that timeframe from now to 2030, our need is about 300 megawatts a year of battery storage and 300 megawatts to 500 megawatts of renewable generation a year in that timeframe.

Insoo Kim

Analyst · Goldman Sachs. Please proceed with your question.

Got it. When I was just looking at the clean energy investments in 2021 and 2022, it seems like the dollar amounts, if you do some rough math, would imply pretty high hundreds of megawatts. I don't know if it's what you're talking about already been captured in this next couple of years or am I doing the math wrong?

Jeff Guldner

Analyst · Goldman Sachs. Please proceed with your question.

No, it's been captured. Remember, it's an average over the timeframe. But yeah, we see significant opportunity in storage and renewables.

Insoo Kim

Analyst · Goldman Sachs. Please proceed with your question.

Got it. Okay. I'll follow up. Thank you.

Jeff Guldner

Analyst · Goldman Sachs. Please proceed with your question.

Thanks.

Operator

Operator

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

Julien Dumoulin-Smith

Analyst

Hey, good morning team. Can you hear me?

Jeff Guldner

Analyst

Hey Julien.

Julien Dumoulin-Smith

Analyst

Hey. Howdy. Just to follow up and clarify the early equity commentary, when you talk about that $300 million to $400 million, it seems as if that you're basically saying 2021 upon rate case resolution. Just also want to clarify, does that include 2022 or these contemplate no equity in '22 as you true up your capital structure in '21, given that you've now provide a capex in '22? So sorry for all that detail, but I wanted to clarify that.

Jeff Guldner

Analyst

Yeah, no...

Julien Dumoulin-Smith

Analyst

Yeah. Go forward.

Jeff Guldner

Analyst

I would just say, Julien, if I imply that was going to be in 2021, that wasn't what I was trying to imply. I was just trying to imply as we look out, we see our capex, we'll need to issue equity to support the capital structure into the next rate case. I’ve made no assumption on when that rate case would be filed.

Julien Dumoulin-Smith

Analyst

Okay. And just to clarify that, that is reflective of the capex at least through '22 as it says they're not necessarily indicative of, like perhaps equity subsequently post '22 right?

Jeff Guldner

Analyst

Yeah. This is just -- the next time we go to market, I expect it to be in a $300 million to $400 million range, and that will be refined based on what we ultimately do on the capex front and so on.

Julien Dumoulin-Smith

Analyst

Got it. Excellent. Thank you. And then the second question. Coming back to the rate case dynamics, obviously it's a little bit more protracted here. How do you think about settlement and the timing of having those settlement conversations, just given how long of a process it? And then just to what -- well, I'll leave easy.

Jeff Guldner

Analyst

Yeah. The -- originally, if you remember, Julien, that there was a lot of discussion. This was a case that we were directed to file by the commission. And I think that the assumption was that this would be a fully litigated rate case. Obviously, we would, I think, like to talk about settlement. I think there is a lot of benefits of settling cases, particularly in the sense that you can come up with solutions that both sides you can have a win-win kind of an outcome and often in litigated cases you're much more in a binary outcome where it's kind of one or the other.And so I think there's value in settlement. It's probably too early. We haven't even got in it. If staffer has been our testimony, yeah, that's going to come in May likely. And so it's early yet to see if there is a dynamic that could come into play there. But just to be realistic, the commission has said that this is a case that they want to see fully litigated. So if that changes or if the opportunity presents itself, I think we'd certainly be interested in doing that, but that's not the path that we're on right now.

Julien Dumoulin-Smith

Analyst

Got it. And just to clarify that, that has not changed in recent months there? At least your understanding on this case?

Jeff Guldner

Analyst

Yeah. And again, Julien, this is also kind of early in the process, where it too haven't really done anything, because normally that's going to come after you see staff and intervenor testimony come in.

Operator

Operator

Our next question comes from the line of Paul Patterson with Glenrock Associates. Please proceed with your question.

Paul Patterson

Analyst · Glenrock Associates. Please proceed with your question.

Hey, good morning. So first question sort of on the renewable energy, sort of outlook and potential cost impacts. You guys are putting more effort in renewable energy. Costs have come way down. I'm just wondering how you -- when you look at your rate base and your capex projections and everything, obviously there's going to be lots of variables. But what are you guys thinking about what the potential rate impact might be with this outlook?

Jeff Guldner

Analyst · Glenrock Associates. Please proceed with your question.

Yeah. Paul, what we've really been focused on is trying to manage through this plan with essentially real prices remaining flat. So keep the rate pressure at or below the rate of inflation. And obviously, part of what you can look at with that is as you put more storage resources into the system, you're able to trade out some fuel expense. And so I think we're probably $1 billion or so of fuel expense right now in what we've seen.So if you can do a little fuel for steel, you're able to translate that fuel expense into, you had rate base growth, but importantly it takes the rate pressure off customers so that you're able to make that trade out and get the capital investment, but also mitigate the rate impacts. And really important other component to this plan is the work that we've been doing, you see it reflected in. And I think some of the earnings that we're able to announce this quarter is the work around Lean Six Sigma transformation where we're trying to really look at doing work differently and eliminate waste and streamline processes and that's going to be important, because we've got to keep the O&M flat or lower. So, as you're making these capital investments, you're not just putting the rate increases through to consumers.And so it's going to have to be a combination of that looking at how you can do some fuel for steel and save on fuel expense, and then how you can find the O&M savings. And then just a third component, which is different from the internal pieces, but is just driving growth in the state. And so when you see the large high-load factor customers come in like the data centers, they pick up a significant amount of the fixed costs and so you're able to more efficiently use the system. And so it's really tying those three things together that we think can help mitigate rate pressures on us.

Paul Patterson

Analyst · Glenrock Associates. Please proceed with your question.

Okay. Great. And then, I guess, sort of on the other element that you mentioned at the beginning of the call, this rate design issue. And as you know, this -- it seems to me at least from watching all of this that the rate design issue that was implemented in the last rate cases caused or really actually probably caused a lot of the regulatory issues that we're now encountering.And I know that you guys are trying to do customer education and what have you. But coming from -- sort of from more of a consumer perspective like technology and stuff, when you have to educate the consumer, that sometimes has seen in of itself is being kind of a drawback. And I'm wondering whether or not there is an effort of maybe thinking about and I don't really see it, I guess, in the current rate case, and it's there, I apologize. But the idea of maybe just simplifying the whole thing because I'm not -- I guess, what I'm wondering is customers may not want to be educated. I'm saying in other words, they might want simplicity.And so I'm just wondering, I know you guys are doing a stakeholder thing and discussing it with stakeholders and what have you. But I'm wondering if there is any plan potentially of sort of making it so that you don't have what we, I guess, sort of have come up with in which you have people sort of having a really difficult time with. We've just sort of dealing -- outside of rates, just the complexity of what at least some of these customers seem to be dealing with.

Jeff Guldner

Analyst · Glenrock Associates. Please proceed with your question.

Yeah. Paul, a couple of points to that. First is, we are absolutely looking at those issues. We've got a proposal in the case for essentially a flat bill. So similar to what you see cellphone companies offer which is, here's what your monthly plan would be, it's fixed, we don't do a true up at the end, there is a nuance to that that actually says if you tie it to allowing us to put a smart thermostat in the house, you've get a lower risk rate on that. But what's really important you're -- I think you're going to see this still continue across commission's around the country.As you move into this advanced energy economies, since we're making this transition, there is absolutely a role for customers, not just commercial and industrial, and we're working a lot with some of our commercial and industrial customers who are asking for demand side options so that they can manage around the prices that we see at the wholesale level, the duck curve issue that we've got, which is causing wholesale prices to be very low or negative in the middle of the day, and then the need to shift load off into the evening hours when you've got no solar production coming onto the grid.And so the commercial/industrial customers are absolutely taking advantage of that. A lot of the rate design pieces are simply to align rates that we've had for decades. We've had time of use in demand rates in our service territory for decades, so the rate concepts aren't new. The issue was that if you have a 12 to seven peak period and you've got negative prices occurring at noon, that is a crazy price signal to send customers. There's no way you can long-term operate a…

Paul Patterson

Analyst · Glenrock Associates. Please proceed with your question.

I appreciate it. Thanks a lot.

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.

Hi. The only thing I had left is the disconnect policy that you brought up last quarter. I see it's still on the bullet points on your 2020 drivers. Did that get resolved between the $20 million and $30 million?

Jim Hatfield

Analyst · Morningstar. Please proceed with your question.

So that $20 million and $30 million was our projection going into 2020. Keep in mind, you're just now having people come off the sort of form of payment plan. And so a lot of this is, we'll see later this year what that impact will be. We did increase our bad debt reserve last year in June. So we are picking some of that in just our reserve, but where that shakes out remains to be seen. We will ultimately adjust that reserve once we have an annualized pattern that we feel good that that's the right amount.

Jeff Guldner

Analyst · Morningstar. Please proceed with your question.

Okay. But, Charles, the rulemaking -- still the rulemaking is still under way at the commission. So they've not landed on final rules for that yet.

Operator

Operator

Our next question comes from the line of David Peters with Wolfe Research. Please proceed with your question.

David Peters

Analyst · Wolfe Research. Please proceed with your question.

Yeah. Hey, good morning guys. I would be curious just to kind of get your guys view of the legislation that's been proposed to potentially move the ACC to an appointed commission. Do you sense there is a level of support for this at the legislature and from voters? Or should we expect to kind of see a similar result that we saw in the past?

Jeff Guldner

Analyst · Wolfe Research. Please proceed with your question.

Yeah. I think, David, the -- it didn't get out through a committee. There is a committee that it failed out of, and that was exactly the comment that was made is that the committee members that they believed it was important to allow the voters to have the right to elect the commission. And so it's working its way through the process right now. Just again, to be clear, this was not something that we proposed or that we were trying to move forward with. And just to give you a flavor on that, I think if it were, and so it's still unclear as to whether it would ultimately get out of the house, but are out of legislature to the ballot, it would then have to go to the ballot.So then you'd have to actually have voters decide to do this. And as you know, I made the commitment that we weren't going to participate in commission elections. I think within the spirit of that commitment, we would not be participating in something like an independent expenditure to try to promote this, because I just think that would be too close to violating the spirit of what we are committed to do with the commission. So legislature will do what they're doing, but -- and I think we said we'd work with commissioners, obviously, whether appointed or elected, but if this will be a long road.

David Peters

Analyst · Wolfe Research. Please proceed with your question.

Great. And then just quickly on the Bright Canyon business as you kind of think about it today, do you expect or is the intention to ever get to the scale of where it's kind of a material earnings driver for you guys?

Jeff Guldner

Analyst · Wolfe Research. Please proceed with your question.

Yeah. It's a little early in that, but I think when you look at the adjacency opportunities, that's what I try to emphasize in the prepared remarks, is that we're not trying to go out far beyond what we believe is really core expertise. So we've got expertise and working with the -- with wind and solar. We're working on more expertise around battery storage. We've got -- we had phenomenal performance at our microgrid. We had an event in Yuma with the microgrid that we had installed for the Marine Corps Air Station, where they actually lost the substation. And in eight seconds that microgrid kicked in and picked up the entire load of the base from a black start, held the load until the substation was repaired and then was able to seamlessly transition the base back into service.So for what the military is looking for in their base resiliency work, those kind of projects are good. We've got great expertise, I think, in doing those. And so a little early to see how much is really there, but I don't want to leave that expertise untapped. And so we are looking at how we can expand Bright Canyon into more opportunities like that. But it's a competitive environment, we're not going to do something that doesn't make sense, obviously, for our investors. But we do think there is some opportunity there.

David Peters

Analyst · Wolfe Research. Please proceed with your question.

Great. Thank you.

Operator

Operator

Our next question is a follow-up question from Michael Weinstein with Credit Suisse. Please proceed with your question.

Michael Weinstein

Analyst

Hey, guys. Just a quick one. How much equity is usually issued through the employee plans every year? And how much can that absorb of the future $300 million to $400 million?

Jim Hatfield

Analyst

So, we don't have an employee plan, we have a DRIP. And I think the revenue through the DRIP is $11 million, $12 million a year. It's not significant.

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.

Operator

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.