Earnings Labs

Pinnacle West Capital Corporation (PNW)

Q2 2020 Earnings Call· Sat, Aug 8, 2020

$102.86

+0.43%

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Transcript

Operator

Operator

Greetings, and welcome to the Pinnacle West Capital Corporation Second Quarter 2020 earnings. [Operator Instructions] As a reminder this conference is being recovered. 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 2020 earnings, recent developments and operating performance. Our speakers today will be our Chairman and CEO, Jeff Guldner; and our CFO, Ted Geisler; Jim Hatfield, Chief Administrative Officer; 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 second quarter 2020 Form 10-Q was filed this morning. Please refer to that document for forward-looking statements, cautionary language, as well as 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 13, 2020. I will now turn the call over to Jeff.

Jeff Guldner

Analyst

Thank you, Stefanie, and thank you all for joining us today. I'd actually like to begin today's call by expressing my immense appreciation to our team. All of us in leadership stand in awe of their incredible strengths and adaptability. We're continually impressed by their compassion for others and their sheer drive to do their very best each day to serve our customers, our stakeholders and our communities. The culture and engagement that we're striving to create throughout the organization is key to our success in navigating the ongoing COVID-19 challenges. Our plants are operating with impressive reliability during a severe Arizona summer. Our crews have kept the lights on, new customers are being served, and our customers are benefiting from an exceptional commitment to service demonstrated by our people. I'm also pleased to report that through the end of the second quarter, we remain in line with our expectations for the year. I'll provide a brief overview of the current status of COVID-19 in Arizona and then some operational and regulatory updates. While weather variations are typical, we experienced an unusually hot second quarter this year that followed a mild second quarter of last year. So Ted will provide more details regarding the impact of weather, given the year-over-year change took us from really one extreme to the other and Ted will then offer a review of our financial performance and our future forecast. As you know, from March 13th through May 12th, many businesses in Arizona were closed and the Governor asked residents to stay home. Governor Ducey's stay home, stay healthy and state connected order expired on May 15th, and in early June, the state began to see an increase in COVID-19 cases. As a result, on June 29th, the Governor paused operations of bars, nightclubs, gyms,…

Ted Geisler

Analyst

Thank you, Jeff, and thank you, everyone, again, for joining us today. Jeff recognized a number of our team's accomplishments, and I'd also like to add to that by mentioning Jeff's receipt of the Smart Electric Power Alliance Individual Power Player of the Year award. This award recognized Jeff for his demonstrated leadership and innovation to advance clean energy and its value as a resource to help meet the future needs of our customers. On behalf of the entire Pinnacle West team, I want to express our congratulations and appreciation for Jeff's leadership.

Jeff Guldner

Analyst

Thanks, Ted.

Ted Geisler

Analyst

This recognition for your support, Jeff, of our clean energy plan is well deserved. Turning now to our earnings update. I'll cover our second quarter results, economic activity, successes in our cost savings initiative and forward-looking expectations. Our performance in the second quarter remained strong despite impacts of COVID earning $1.71 per share compared to $1.28 per share in the second quarter of 2019. Above-average temperatures, continued cost management and higher pension and OPEB non-service credits contributed to the increase in earnings. As we've highlighted before, weather can be a significant factor in our annual earnings. The above-average temperatures from this quarter, combined with the below-average temperatures in the second quarter last year added $0.43 to earnings year-over-year. Compared to normal, weather added $37 million of pretax gross margin or $0.25 per share. We also experienced 2.4% customer growth in the second quarter 2020 compared to the same period last year. These positive drivers were partially offset by a 1.3% reduction in weather-normalized sales for the quarter, including the impacts from COVID. From May 13, when businesses started reopening, through July 28, weather-normalized sales were essentially flat compared to the same period last year. We continue to see a reduction in weather-normalized commercial and industrial sales of 4% offset by an increase in weather-normalized residential sales of 4%. In June, we experienced 2.5% customer growth and 0.8% weather-normalized sales growth, reflecting the growth in our service territory and continued improvement in our economy following the full COVID closure period earlier this quarter. In addition to customer growth, weather has been impactful this year, notably, on July 30, between 5 and 6 p.m., our customers required a new all-time high peak energy demand of 7,660 megawatts. This exceeded the prior peak set in 2017 by nearly 300 megawatts. Our company performed…

Operator

Operator

[Operator Instructions] Our first question comes from the line of Michael Weinstein with Credit Suisse.

Michael Weinstein

Analyst

For the, on the gross margin financial outlook, where, I noticed it's a little bit lower than back in May. Is that all COVID-related? Or is there some other dynamic that's happening there?

Ted Geisler

Analyst

No, Michael, you're absolutely right. That's just simply reflecting the adjustment in our expected weather-normalized sales for the year given the impacts of COVID.

Michael Weinstein

Analyst

Got it. And then the other numbers are all intending to offset that?

Ted Geisler

Analyst

That's correct.

Michael Weinstein

Analyst

Is it, I think if you add it all up, it comes out to a little bit lower overall expectation than before, although you're maintaining guidance. Are there any other factors that may not be on the page that we -- that would be positive and offsetting?

Ted Geisler

Analyst

No, nothing else there, Michael. We've got ranges listed. We're being conservative with our weather-normalized sales expectations for the balance of the year. As we said through June, we're really at 0.3% negative, but we gave a range of flat to negative 1%. But the other adjustments should offset, but we are confident in our year-end guidance range of $4.75 to $4.95.

Michael Weinstein

Analyst

Got you. And Jeff, with the delay in the procedural schedule a little bit further for the rate case, it looks like the hearings will start after the election. Does this mean that we should wait until after -- into next year probably for any kind of settlement process to take place there? I think we were talking before maybe about a partial settlement in September, but to me, it looks like maybe it all pushed out into next year. Is that the right way to think about it?

Jeff Guldner

Analyst

Yes, Michael, I mean, you kind of flagged the -- one of the issues, which is when the procedural schedule pushes out, it puts the window between staff and intervenor testimonies. We've said before, typically, you can't really begin a real settlement process before you see staff and intervenor testimony and you book in the ranges. I'd point out, too, that in the last response that the commission staff filed, they were pretty clear that they were looking for an indication from the bench if there was settlement. And otherwise, they're proceeding down a litigated case. And so now you've got an added complexity that bench may change. So we're still open for discussions with anybody that wants to talk about issues. There's still ways that you could potentially take issues off the table. I think it's harder to see a comprehensive settlement in a traditional rate case settlement process coming about right now. And if that were to happen, it probably would happen in later -- probably next year. But again, then you're going to be in the middle of the hearings. So we'll have to just watch and see how that develops.

Operator

Operator

Our next question comes from the line of Shahriar Pourreza with Guggenheim. Please proceed with your question.

Shahriar Pourreza

Analyst · Guggenheim. Please proceed with your question.

Let me just follow-up on Michael's question on sort of the settlement here. Are you having discussions right now? And sort of how are discussions forming, right? I mean, is it -- are you gaining a little bit of traction here? And then just does the delay in the schedule shifted push your thinking about the timing of the next rate case, and in turn, your plans to sort of raise equity that you've previously said later in '21 or early '22?

Jeff Guldner

Analyst · Guggenheim. Please proceed with your question.

Yes, Shahriar, on the settlement question, I mean we're -- to the extent you talk to -- you have a customer, for example, who would come in and say, I'm interested in this kind of new program, you can have those conversations at any point in the process. And so we continue -- I think the notion of kind of the traditional comprehensive settlement discussions those aren't happening. And again, I think staff would be looking for a signal from the bench to begin to do that, and that's less likely to happen, I think, now with this commission. But we're open to talking to anybody who wants to talk about taking issues off the table or working through different aspects. And even if you don't get a comprehensive settlement, it helps you work through issues and make the hearing more streamlined. You kind of have to see how the hearing process goes in order to see what timing effects that would have on the next case. So I don't really -- no change in plans right now, but we need to watch how this case proceeds, I think.

Shahriar Pourreza

Analyst · Guggenheim. Please proceed with your question.

And then just, sorry, but I don't know if you addressed the delay in the rate case and how to think about the next rate case in equity?

Ted Geisler

Analyst · Guggenheim. Please proceed with your question.

Yes, Shar, this is Ted. The way I think about that is it really depends on the timing and outcome of the current case we're in. So once this case concludes, we'll evaluate the outcome, and that will really inform the timing of the next case as well as timing of equity needs.

Shahriar Pourreza

Analyst · Guggenheim. Please proceed with your question.

And then just most of the recent renewable clean target proposals in the energy rules docket, i.e., the staffs and Burns and Kennedys seems to follow the goals you guys have already put out. Are there any kind of puts or takes that we should be thinking about as the dialogue continues with interim step targets i.e., every five years, be less desirable than a straightforward endpoint, i.e., neutral 2050? And has there been any more conversations about alternative mechanisms i.e., a writer for solar and storage, so you don't have to be a serial filer? Or is the preference with the ACC and stakeholders just to keep things status quo?

Ted Geisler

Analyst · Guggenheim. Please proceed with your question.

Yes, Shar, I think what's encouraging is directionally, it feels like there's a lot of alignment in terms of the direction we're going. Obviously, the details are important. And you do have to look at, I think, some of the comments that we make and other parties would make is how do you think about interim goals? So we wanted to make sure with ours that we didn't just set a 2050 target and then nothing until 2050. And so we had put a 2030 goal in place. The challenge is it get more granular as it just gets harder on the procurement, so you lose some flexibility. So if you were to have goals every year, every two years, then it's a little bit harder to try to do the procurement and the flexibility that you can get around different technologies with that. And so it's an evolving conversation. I think that just watch the filings and the comments that come into those, to that docket. With respect to tracking mechanisms, I expect there'll be some conversation about that in the current rate case because you're exactly right on the impact of that, if you don't do a tracking mechanism of some sort or some kind of regulatory mechanism, then it just pushes you into a pretty continuous rate case filing stream. And so there's value, we think, in that. But again, that's part of what I expect will be the evidence that will be heard in the rate case that we've got on file right now.

Operator

Operator

Our next question comes from the line of Durgesh Chopra with Evercore.

Durgesh Chopra

Analyst · Evercore.

On the guidance front, the reduction in interest expense, it's partly driven by higher AFUDC, what is driving that? And are you just assuming lower rates now in the updated assumption?

Jeff Guldner

Analyst · Evercore.

Yes. That's exactly right. It's updated with our current financing, the current rate and then higher, net of higher AFUDC than originally projected.

Durgesh Chopra

Analyst · Evercore.

And then just one small one. The CapEx plan did not change, but the rate base is modestly higher, and this may be too much into the reads. I'm looking at your slide where you actually put out rate base and break it into the company and FERC, and it's modestly higher, but the CapEx plan didn't change. What is driving that?

Jeff Guldner

Analyst · Evercore.

Yes. So that's just simply an update in the rate base projection given the CapEx forecast that we previously released. We did not change any of our forward-looking projections in the last quarter. But as you can see this time, we updated most to reflect both impacts of COVID as well as update rate base to be in line with the recently issued CapEx forecast. So it's just getting those 2 in sync.

Durgesh Chopra

Analyst · Evercore.

I get it. So this is basically up-to-date and ties with your most recent CapEx forecast?

Jeff Guldner

Analyst · Evercore.

That's correct.

Durgesh Chopra

Analyst · Evercore.

Okay. Understood. And then just one last question. In terms of the COVID trends and demand trends, you're saying you're pretty conservative in, for the back half of the year, assuming that the trends are as to what you saw in Q2, would that put you in the high end of the guidance range?

Jeff Guldner

Analyst · Evercore.

Well, I think it's too early to project. The COVID situation is still fairly uncertain. But the way I think about it is we're pleased to see that since the reopening in mid-May, we've seen the decline in commercial sales be evenly offset by the increase of residential, and that's an important metric for us. But other than that, we'll just continue to focus on how things normalize for the balance of the year.

Operator

Operator

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

Insoo Kim

Analyst · Goldman Sachs.

My first question, regarding the delayed staff testimony and the filings associated with that. Correct me if I'm wrong, but it seems like it still opened up the possibility of a change in the test year for this rate case. Is that correct? And if that is the case, what is the process? And if it were to get changed, would it be the commission's decision at by a certain day to make that happen?

Ted Geisler

Analyst · Goldman Sachs.

No, I don't think Insoo. It's not a change in the test year. You may change some of the pro formas. I mean, that's something we'd have to look at for the rebuttal case. But the test year was the test year we filed. And again, we make adjustments in post test year plan and other things to that test year.

Insoo Kim

Analyst · Goldman Sachs.

Right. And in terms of the post test year adjustments, would it allow you with is a way to extend the time line for post test year adjustments?

Ted Geisler

Analyst · Goldman Sachs.

I mean, I guess that's possible. I think you'd have to see how the case would evolve.

Insoo Kim

Analyst · Goldman Sachs.

Got it. And then, in terms of the renewable process, kind of following up on a couple of the other questions. I think at this point in Arizona, it's more of an acknowledgment or not acknowledgment process for when you file an IRP. As you weighed into all of the capacity investments in renewables and storage over the next few years, are there any conversations that you're trying to have with the commission to establish more of a soft approval or acknowledgment further for those type of investments?

Ted Geisler

Analyst · Goldman Sachs.

Yes, there, I guess, I'd say there is, and I'll ask Barbara to chime in if she's got a different, or some additional information. But the IRP process itself is an acknowledgment process, right? And there's some discussions about what would happen with that under the new energy rules. That's probably a topic of discussion that could come up in the new energy rules debate. When you get into down the individual RFPs, it gets a little more nuanced because there could be things that do require commission approval and there could be things that don't. In a lot of cases, you wouldn't be going through a siting committee approval because these aren't thermal plants, so they're not subject to this state Siting Act. But I think there, it's going to be something we'll watch as the rules evolve as to how the approval process goes for. Do you want to add anything, Barbara?

Barbara Lockwood

Analyst · Goldman Sachs.

Yes, Insoo, this is Barbara Lockwood. I would say the way to think about it is the conversation is evolving to more engagement with the commission and stakeholders through both the IRP process as well as the RFP process and approval or acknowledgment is all in discussion on various components associated with that. But really, the best way to think about it right now is the discussion is how to engage more with the commission through those processes as well as with the stakeholders. Nothing definitive in that regard yet.

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.

Paul, I apologize if I missed this, but the sales growth change over the long term, what caused you to change that?

Ted Geisler

Analyst · Glenrock Associates. Please proceed with your question.

Paul, that's really just reflecting the flat to negative expected weather normalized sales growth we see in 2020. So given it's a 3-year period, including 2020, we just want to make sure that we updated that period to reflect the expected 2020 results and impacts as a result of COVID.

Paul Patterson

Analyst · Glenrock Associates. Please proceed with your question.

So when COVID is over, whenever that is, you guys don't really expect to see sort of a catch-up, so to speak, you see basically just sort of things progressing pretty much as they were before. Is that the right way to think about it? So it's kind of a lost year as opposed to -- not lost year, but if you follow me like COVID will cause a decrease for this year. And then off of that -- then you'll get back to where you were before, your growth rate will be the same, but there won't be some big rebound in terms of catch-up. Is that the right way to think of it?

Ted Geisler

Analyst · Glenrock Associates. Please proceed with your question.

I think that's a fair way to think about it. A couple of data points for you. As I mentioned, the economy remains robust in virtually every measure you look at it. If you look at June, of course, the most recent month in this period, we had 2.5% customer growth. We had 0.8% weather-normalized sales growth and that's during what I would still consider to be a COVID period. We look to the future, difficult to predict, of course. But we want to make sure we reflected updated guidance over the next 3 years that did include the impacts we're seeing in 2020. That said, those numbers do exclude contributions we'd expect from data centers, and so that provides upside as well.

Paul Patterson

Analyst · Glenrock Associates. Please proceed with your question.

Okay. And then you also mentioned, and I apologize if -- I didn't get it completely, but you mentioned something about your peak growth hasn't been changed, I think or I apologize again, I heard it, but I got slightly distracted. Could you just elaborate a little bit more on what you meant by the peak growth and how that -- I guess, it's still driving your -- it doesn't -- in other words, your CapEx is less affected, I guess, by the sales growth at South, but more by the peak growth?

Ted Geisler

Analyst · Glenrock Associates. Please proceed with your question.

Yes, that's exactly right, Paul. One of the key pieces is regardless of annual sales growth, we plan for the long-term to ensure that we're there on the hottest day of the year when our customers need us the most and that's the peak demand day. This year, that peak demand day increased demand by over 300 megawatts compared to the last all-time high, which is significant. And that's really what's driving our resource procurement needs and the integrated resource plan for the long-term is making sure that we've got resource capacity plus reserves to maintain reliable service during peak demand on a forward-looking basis.

Paul Patterson

Analyst · Glenrock Associates. Please proceed with your question.

Okay. And that really hasn't changed -- that really hasn't -- okay. And I think the rest of my questions have been asked and answered. Just on the energy rules, I mean, there does seem to be some sort of an impasse, I guess, at least currently, and I know the commission probably will be changing in November. So any thoughts on that? Or does it have any -- is it sort of just a wait-and-see sort of situation? Or is there any other takeaway from that, do you think?

Barbara Lockwood

Analyst · Glenrock Associates. Please proceed with your question.

Yes. Paul, this is Barbara Lockwood. I think that's true. There's a philosophical alignment on many parts of the energy rules, but the procedure and the process for making policy and getting through to a vote seems to be complicated, and it's just a wait and see right now. They're discussing it again today to see if they can find a process to move forward. But at this point, it really is just a wait and see from a procedural perspective, if they can get anywhere.

Operator

Operator

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

Charles Fishman

Analyst · Morningstar.

You have consistently left data center growth out of your forecast, which certainly makes sense because, I guess, that moves the needle. And I guess my just general question is, with this work-at-home trend going on and potentially benefiting data center growth, are you seeing anything specific to the Phoenix area with respect to the data center growth that you can provide color on?

Jeff Guldner

Analyst · Morningstar.

Yes. Charles, that's an insightful question. The short answer is nothing specific that we can point to. But when we look at technology trends and expected data center demand, we certainly recognize the point you're making, which is, if you have the parallel, keep systems and data up and running, both in corporate network and at home, then there's a potential to increase demand. But I'd say that's hypothesis by many and nothing specific that we can point to at this time. Our focus for the data center growth is really the customers that we know that we're interconnecting, that we are building out capacity for, and it's still early in that process. As you can probably imagine, we plan for their peak capacity, but what they actually use is uncertain until they start to fill out the shell of the data center. And so that's why we exclude it because it's got some long term, very strong demand, but it's just unclear on the trajectory in which they fall to fill up that demand.

Operator

Operator

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

Julien Dumoulin-Smith

Analyst

I want to revisit the subject a little bit here, but I wanted to address it more directly. So you will have a pretty substantive clean energy spend in your outlook for next year and the year after. And you've made an allusion into the course of the call about a potential for some sort of tracking type mechanism to avoid a subsequent case. In the context of the current case, you've talked about recovery. Can you suggest more directly, what would be the sort of ideal avenue for pathway of recovery? And then secondly, to the extent which that this rate case is perhaps protracted and broadly defined, do you anticipate that, or do you have confidence [indiscernible] spend in '21 for the clean energy capital without having the certainty of any specific writers, et cetera? I understand you probably could move ahead and do it, but do you have the specific projects lined up and at least you're organizationally and operationally ready to make those investments without the recovery writers at play?

Jeff Guldner

Analyst

Yes, Julien, you're a little muffled at a couple of times there. I think I got the gist of your question. And so yes, we do plan in the case to talk about how a tracking mechanism could work and what the existing mechanisms are. I think that's going to be a topic of a lot of discussion. And to the point that was raised earlier, if you don't have a tracking mechanism, what happens is, it just increases the pace of which you have to file rate cases. We've got a combination of the clean energy commitment. I think, general alignment on where clean energy is going in the state from a lot of different parties and what you heard in my comments is that we also have a growing capacity need. And so we're going to have to be building out the wind, solar and batteries to meet the capacity needs that we're going to have. And so yes, we'd like to tie it to a tracking mechanism and make sure we have a good discussion around that. See if there are existing mechanisms like the RES or other things that we could potentially use and expect that's going to have a fair amount of discussion in the rate case. But the reliability needs are going to drive some of that spending as well.

Julien Dumoulin-Smith

Analyst

Right. But maybe just to be clear about this, operationally, do you have projects identified for 2021? I know you don't have necessarily the recovery mechanism but do you have the specific projects already sort of teed up for 2021 that you anticipate pursuing? And what's the nature of those projects, if you can speak to them? Just, I know, historically, there's been these competitive processes for larger-scale projects, what's the nature of what you anticipate spending in '21, more specifically, if you can speak to it?

Daniel Froetscher

Analyst

Julien, this is Daniel Froetscher. Prior to our McMicken event, we had a number of solar, solar plus storage projects teed up for progression through '21, '22 and '23. And now post McMicken, we'll be dusting them off and moving them forward, integrating the learnings from our McMicken event from an engineering design and safety standpoint. Jeff has alluded to significant resource roll-offs occurring over the next few years. Ted has alluded to customer growth. So absent any tracker, we still have reliability and service obligations that we plan to meet through the combination of wind, solar and battery and have every intention of doing so, to benefit our customers. We've got a couple of tranches of battery storage to accompany our Arizona sun photovoltaic installations that we built a number of years ago. We've got a couple of PPAs that were teed up, have been placed on the shelf since McMicken that we've been working with those suppliers throughout the course of our McMicken learnings to incorporate again the safety, design and engineering improvements that are needed there. And we have a couple of current RFPs out that Jeff mentioned in his opening remarks, within which we'll be making decisions shortly in either the wind, solar or both spaces as it relates to those RFPs. So there is real work in play.

Ted Geisler

Analyst

Yes. Thanks, Daniel. And Julien, I'd just summarize by saying we're going to execute on that 2021 capital plan, whether it be the RFPs, Daniel mentioned, or projects that we have coming up, we will be executing on that plan.

Julien Dumoulin-Smith

Analyst

Got it. So it sounds like you're pretty confident regardless of the construct of recovery?

Ted Geisler

Analyst

That's correct. Although certainly, recovery is what we've made clear is necessary to be able to execute clean plan in the long term, promote rate gradualism and ensure that you don't have serial rate case filings.

Operator

Operator

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.

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.