Earnings Call: Q3 2018

Nov 8, 2018

Greetings, and welcome to the Pinnacle West Capital Corporation Third Quarter 2018 Earnings Conference Call. At this time, all participants are in a listen only mode. A brief question and answer session will follow the formal presentation. As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Stephanie 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 Q3 earnings, recent developments and operating performance. Our speakers today will be our Chairman and CEO, Don Brandt and our CFO, Jim Hatfield Daniel Froetscher, APS' Executive Vice President of Operations and Barbara Lockwood, APS' Vice President of Regulation 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 Q3 2018 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 and A sections, which identify risks and uncertainties that could cause actual results to differ materially from those 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 15. I will now turn the call over to Don. Thank you, Stephanie, and thank you all for joining us today. Throughout this year, our positive customer growth and disciplined cost management continue to support our ability to meet financial commitments. The Pinnacle West Board also displayed confidence in the company's outlook by approving a 6.1 percent dividend increase effective with the December 2018 payment. Before Jim discusses the detail of our Q3 results and guidance, I'll provide several updates on recent operational and regulatory developments including the ballot initiative and certain elections. Our operations team did an excellent job maintaining the generating fleet and electrical grid again this summer. Our workforce quickly restored service to customers after several storms toppled a combined 4 51 poles, which is almost as many as the 2016 2017 summers combined. The Palo Verde generating station also performed well with all three units operating at a combined 97.3% capacity factor. To meet customer demand and increase our clean energy mix, we issued 3 requests for proposals this year. We've received bids on our request for forest, bioenergy solutions, peaking capacity and energy storage. Our energy storage RFP is particularly noteworthy because it will allow customers to use energy from our existing AZ Sun Solar Facilities during the peak period after the sun sets. We are in the process of evaluating the bids and anticipate making our selection for each in the late 2018 or early 2019 timeframe. Our capital investment program continues to be robust supporting investments in clean energy resources and maintaining safe and reliable service for our customers. Approximately 51% of our distribution capital investment from 2018 through 2020 will be driven by customer growth. For generation related investments, the installation of 5 new fast start flexible generating units at the Ocotillo power plant is on track to be completed in the Q2 2019. Turning to our regulatory updates, the hearing for the Four Corners step increase request concluded on September 7. On September 24, the Arizona Corporation Commission staff filed its closing brief which recommended a $58,500,000 step up in revenue compared to our filed request or a $67,500,000 increase. Next, the administrative law judge will issue a recommended opinion and order. The step increase request will then be scheduled for an open meeting and the ACC will issue a decision. APS's installation of pollution controls at the Four Corners power plant is part of our continued investment in a cleaner energy future. We commissioned the selective catalytic reduction equipment earlier this year and now are achieving an 88% reduction in nitrous oxide emissions. In August, APS filed a second request with the Arizona Corporation Commission to return an additional $86,500,000 in tax savings to customers beginning January 1, 2019. If approved, the 2nd wave of savings from tax reform will offset the request to 4 foreigners step increase. The total tax savings for customers when combined with the first reduction implemented in March 2018 would be $205,500,000 Over the last 20 years, our price increases has been below the rate of inflation. With the rate reductions from tax reform and other price reductions, customer rates will be lower at the end of 2018 than they were at the beginning of the year. As required by the 2017 rate review decision, each year the resource comparison proxy must be recalculated to determine the amount new rooftop solar customers will receive for the generation they export back to the grid. Beginning October 1, 2018, the Arizona Corporation Commission approved a rate of $0.116 per kilowatt hour, which is 10% less than the previous rate of $0.129 per kilowatt hour. This reduction continues to move the amount received by solar customers for excess generation closer to our avoided cost and further mitigates the cost shift between solar and non solar customers. Lastly, on October 1, the Arizona Corporation Commission concluded its hearing regarding a customer complaint alleging the average residential bill increase is higher than the average approved in the 2017 rate review order. We're confident that the rate increase was implemented appropriately and is consistent with the rate review order. Final briefs in this matter are due on November 16 and a recommended opinion and order will subsequently be issued by the administrative law judge. We anticipate the commissioners will issue a decision in this matter in 2019. As you are aware, Arizona held its midterm elections on November 6. While the Corporation Commission race has not been officially declared, as of this morning, Commissioner Olson and Republican Rodney Glassman are ahead of the Democratic candidates. Commissioners Dunn, Tobin and Burns will continue serving through the remainder of their terms ending in January 2021. Importantly, the residents of Arizona voted overwhelmingly to defeat Proposition 127, ensuring that energy policy in Arizona will continue to evolve in a thoughtful and constructive manner. With Proposition 127 behind us, we can now work with stakeholders to establish forward thinking energy policies that move towards an increasingly clean energy mix. Arizona is number 3 nationally in solar energy installed and our APS energy mix is already 50% clean. We're on the cutting edge of advanced battery storage technology. Arizona is uniquely positioned to achieve a cleaner energy mix with our abundant solar resource, leadership in advanced technologies and Palo Verde generating station, the largest clean energy generator in the nation. Additional infrastructure investments will not only support our clean energy focus, they are also necessary to support our robust customer growth. Maricopa County was the fastest growing in the United States the last 2 years in a row. We estimate that 340,000 new customers will move into the APS service territory by 2,030 and our customers' energy needs are expected to increase by more than 30% over that same period. Significant investments in new resources including grid infrastructure, cleaner power generation and advanced energy technologies will be required to support Arizona's growing economy. Let me conclude by saying that I'm proud of our team's commitment to our customers and our community. We not only supported the effort to protect Arizonans, but we also remain focused on our operational performance and delivering on our commitments. Our capital investment opportunities and emphasis on cost management continue to create value for our shareholders. I'll now turn the call over to Jim. Thank you, Don, thank you again everyone for joining us today. This morning, we reported our financial results for the Q3 of 2018. I'll discuss the details of our financial results, provide an update on the Arizona economy and introduce 2019 guidance. As shown on Slide 3 of the materials, for the Q3 of 2018, we earned $2.80 per share compared to $2.46 per share in the Q3 of 2017. Slide 4 outlines the variances that drove the change in our quarterly earnings per share. I'll highlight a few of the key drivers. Adjusted gross margin was up $0.04 per share compared with the Q3 in 2017, supported by favorable weather, the price increase from the 2017 rate review, higher sales and transmission revenue, Sales, net of energy efficiency and distributed generation, were up 1.2% in the quarter, driven by strong commercial sales growth and robust residential customer growth. The strong commercial sales growth reflects the positive economic trends we have seen in the Metro Phoenix area. Offsetting drivers include the refund to customers resulting from the federal tax reform and a shift in the seasonality of revenue resulting from the residential rate design changes approved in the 2017 rate order review. As previously discussed, the 2017 rate review order established new rate options for customers. The new rate shifted a portion of the revenue previously collected during the summer to non summer months, better aligning revenue collection with the cost to serve. Looking now to our operating expenses, Higher adjusted operating and maintenance expense decreased earnings by $0.12 per share due to higher costs at APS for transmission, distribution, customer service and information technology and at the parent company level for public outreach costs primarily associated with Prop 127. Depreciation and amortization expenses were higher in the Q3 of 2018 compared to the Q3 of 2017, reducing earnings by $0.08 per share. The increase was primarily related to higher depreciation rates approved in the 2017 rate review order and plan additions. Pension and other postretirement benefits non service credits increased pretax income by approximately $6,000,000 or $0.04 per share in the 3rd quarter. The increase was primarily related to higher market returns and the adoption of the new pension and OPEB accounting guidance for 2018. Lastly, the refund to customers resulting from federal tax reform was possibly offset by a lower effective tax rate. The net impact of federal corporate tax cuts in the quarter was a $0.14 per share benefit to net income. Turning now to Arizona's economy, customer growth and sales growth. Metro Phoenix continues to show strong job growth and has consistently been above the national average as shown in the top panel of Slide 5. Through August, employment in the Metro Phoenix area increased 3.1% compared to 1.6% for the entire U. S. Job growth is particularly strong in the construction sector, a sign of strength in the area's commercial and residential real estate markets. Construction employment has increased by 10.4% versus 2017. We expect a continuation of business expansion and the related job growth to continue to support commercial development. The Metro Phoenix residential real estate market has also continued its upward post recession trend as shown in the lower panel of Slide 5. In 2018, we expect a total of 30,000 housing permits, an increase of about 4,200 compared to 2017 driven by single family permits. We believe that solid job and income growth and relatively low mortgage rates should allow the Metro Phoenix housing market and economy more generally to continue to expand faster than the national average. Reflecting this steady improvement in economic conditions, APS' retail customer base grew 1.6% in the Q3 of 2018. We expect this growth rate will continue to accelerate in response to the economic growth trends I just discussed. Importantly, the long term fundamentals supporting future population, job growth and economic development in Arizona appear to be in place and we believe Phoenix should remain one of the country's fastest growing large metropolitan areas. As I mentioned earlier, net sales were up 1.2% in the quarter. Marshall and Industrial sales increased 2.3% over the Q3 of 2017, reflecting the positive economic growth trends we have seen in the region. Finally, I will review our financing activity, earnings guidance and financial outlook. On August 9, 2018, APS issued $300,000,000 of 30 year 4.20 percent unsecured senior notes. The proceeds were used to repay commercial paper borrowings. Overall, our balance sheet and liquidity remained strong. At the end of the quarter, Pinnacle West had approximately $128,000,000 of short term debt outstanding. Later this year, we expect to infuse up to $150,000,000 of equity capital from Pinnacle West into APS. Turning to guidance, as shown on Slide 6, we continue to expect Pinnacle West consolidated earnings for 2018 will be in the range of $4.35 to $4.55 per share. While we benefited from a hot September, we also had a very mild October. We expect October weather will negatively impact the full year 2018 earnings by approximately $0.10 to $0.15 per share. Offsetting updates to our 2018 guidance can be found in the appendix to our slides. Before I introduce 2019 guidance, I would like to confirm that we do not intend to file a rate review request in 2019. As a reminder, the 2017 rate review order prohibited APS from filing a new general rate review before June 1, 2019. After reviewing our financial expectations, we have determined that filing a rate review in mid-twenty 20 will meet our financial objectives. In preparation for this filing, we expect to keep our capital structure similar to the level approved in our last rate review. Continuing with guidance, we're introducing 2019 guidance of $4.75 to $4.95 per share. Positive drivers for 2019 include the anticipated Four Corners SCR revenue increase, higher weather normalized sales, higher transmission revenue, flat to lower interest expense and lower operating and maintenance expenses primarily due to lower planned outages and our continued cost management. We expect these drivers to be partially offset by higher D and A related to more plant in service, higher property taxes and lower AFUDC. The estimated effective tax rate of 10% for 2019 reflects the amortization of $71,000,000 of excess deferred taxes associated with the 2nd team filing. The decrease in the effective tax rate is offset by the proposed 86.5 $1,000,000 refund to customers, which is also part of the 2nd team filing. Our 2019 capital expenditure forecast remains at 1 point $15,000,000,000 We will provide updates to our capitalized forecast and rate base on our Q4 call. A complete list of key factors and assumptions underlying our 2018 2019 guidance is in the appendix to our slides. Our rate based growth outlook remains at 6% to 7% through 2020 and we still expect to achieve a weather normalized annual consolidated earned return on average common equity of more than 9.5% over the same period. As we have said, our earnings are not linear and will fluctuate from year to year. However, over the long term, the opportunity to lead Arizona to a cleaner energy future positions us well to continue our track record of success. This concludes our prepared remarks. I'll now turn the call over to the operator for questions. Thank you. We will now be conducting a question and answer session. Thank you. Our first question comes from the line of Michael Weinstein with Credit Suisse. Hi. Good morning, guys. Hi, Michael. Hi. Maybe we could just start and talk a little bit about the process going forward now that Prop 127 is deceded. What can we expect to see going into next year or maybe even later this year in terms of kind of a collaborative process or some kind of stakeholder review of options going forward? Well, I think, Michael, it remains to be seen exactly what that process looks like. As you know, and we talked about Commissioner Tobin has a docket open on the 80% clean by 2,050. A lot of things are also been attached to that docket. And so the exact way forward is sort of unknown at the moment. It would be our intent to participate in that docket and all of those factors. But we'll have to wait and see where it ultimately goes from a timing and outcome perspective. Do you expect to have something, I guess solidified by the time you file your next draft IRP? Draft IRP is in April. So not sure we would be able to go fully through a process at that point. I think our remains to be seen exactly how the IRP unfolds. That's one of the sections in a moderate 80 by 50 is reviewing how we go forward on the IRP. So again, remains to be seen. Yes, Jim, it's Daniel. I think the timing of the informal docket on the energy modernization plan is a little bit ambiguous. And therefore, as it relates to flanging up with the preliminary IRP, we can't make that call. I think Don put out a test release here a couple of days ago, Post 127 though indicating that we're going to build on the coalition network on Prop 127 in terms of trying to shape and formulate what a cleaner energy future looks like for Arizona. So we will continue to engage in that space. Great. Hey, just one final question. I'll let other people get on. The weather normalized retail electric sales volume that you're assuming for 2019 guidance is still the 0% to 1% range. Now for the 3 year period, it's a little higher than that. I'm just wondering at what point does that 3 year forecast kind of roll into those 1 year forecasts? Well, I think what we're seeing is a continual gradual improvement in the overall economy and exactly when over the 3 year period it rolls into the higher remains to be seen. But I think we saw this quarter sort of the example of the improved economy and we have a site to a pipeline of a lot of projects in West Phoenix as well, which will continue to build that momentum. Okay. Thanks a lot. Nice job on guidance and congratulations on winning your argument against Prop 127. Thank you. Thanks, Michael. Our next question comes from the line of Insoo Kim with Goldman Sachs. Please proceed with your question. Hey, good morning guys. Good morning, Insoo. As you prepare for the 2020 rate case, would any potential equity issuance to boost the equity layer likely be done sometime in 2020 in the early half of the year? And have you also considered whether potentially a forward sale is an option given where your stock is trading at the current moment? So last year, we injected $150,000,000 from Pinnacle and APS. We expect to do similar to 2019. Any additional equity that we'll need can be handled through a DRIP type of program, and we're not contemplating a forward sale at the moment. It certainly won't be a lot of additional equity. We'll need to raise through a dividend reinvestment. Understood. And turning to the renewable discussions going forward, given the uncertain timelines to when the final RPS standards or the IRP will take place. Do you not see any meaningful uptick in renewable investments until maybe 2021 at the earliest? Or could you see some meaningful amounts in 2020, especially to take advantage of some tax benefits? Well, we're obviously cognizant of the ITC and the timetable there. I think from a renewable right now, nothing planned. Don referred to the battery IRP, which depend on how the prices shake out and we're in discussions now that will be attached to our utility scale solar and be able to when we have the negative pricing, feed the batteries to be able to provide peaking power later in the day. I think we have to see how this conversation unfolds over the near term before we think about any large scale renewable bill. At this time, that obviously continues to change as we talk to customers and other things. Got it. Thank you very much. Our next question comes from the line of Paul Ridzon with KeyBanc. Please proceed with your question. You touched on it earlier, but if you look at Tobin's proposal of 80x50, is that workable? Or do we get into cost pressures under that plan? Paul, the Prop 127 was a constitutional amendment that was just a rigid and it was irrespective of cost. I think the value of a commission driven process is you think about claim, you think about reliability, but you also think about affordability. And so that will be a key gating factor as we move forward will be what can customers afford. And we're very cognizant of that from a as we think about CapEx and other things, it's always how much is this going to cost customers and we're very mindful of that. So this proposal would have some off ramps? Well, yes, the thing about it is you sort of build as you go forward and sort of come up with a trip to plan today that says, this is what we're going to do and that's the value of a more of a commission driven process. And Jim, just a clarification that the inter quarter tax items will be net neutral for the calendar year? Correct. Okay. And we have a slide in the appendix that sort of shows how that's been laid out over the course of the year. Great. Thank you. Thanks, Paul. Our next question comes from the line of Andrew Levi with ExodusPoint. Please proceed with your question. Hey, good morning guys. Good morning, Andrew. Great job on lots of different things last quarter, so happy with that. Just two questions. 1, just on the CapEx post 2020. This $1,200,000,000 level that you kind of been averaging, should we just assume, even though you haven't given guidance yet on that, that's kind of like your sweet spot CapEx level? And then anything that would occur on the renewable side as far as any type of new initiatives would be incremental? Well, certainly, as we look out over our CapEx forecast, I can't I won't comment specifically about 2021 beyond. But as we look at things, for example, battery storage, 100 and 6 megawatts will not be something that's in our base CapEx plan. And so it depends on how that takes out, that could be incremental, renewables could be incremental, electric vehicle infrastructure could be incremental. We filed for a pilot in the 2018 DSM plan and we're waiting to get that from the commission. So how it plays out and when it's sort of TBD, but we feel good about our fundamental ability to continue to grow rate base and keep it cost affordable to customers. That sounds good. And then when do we get a refresh on the CapEx? We'll do rate base and CapEx in our year end call, and it'll be 2021 CapEx will be in the 10 ks. Got it. And then one last question, just on the 2019 guidance, because I think there was a little confusion, but I think if I heard you correctly, there's an offset. So the lower tax rate is offset by a customer credit. Is that what you were saying? Yes. Okay. Yes. That's why you have a lower tax rate, I guess, right? Correct. Okay, perfect. Thank you, guys. Thank you. 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 guys. Hey, Julien. Hey. So I just wanted to follow-up a little bit on the composition of the CapEx here quarter over quarter, roughly the same magnitude of capital here, but just shifting around the buckets. Can you talk a little bit about the 2 buckets, the traditional gen and the clean gen, and what's shifting that around? I suppose why perhaps to start with it, why the downtick in traditional gen? Well, go ahead. Excuse me. Julian, it's Daniel. So the downtick in the traditional gen is reflective of the completion of the SCR projects and a different outage plan for 2019 going forward in terms of number of majors and minors, so on and so forth. The uptick in CleanGen is a reflection of Palo Verde generating station fuel, the clean battery technologies that Jim mentioned that won't be determined, if you will, until we settle and make our decisions relative to the 3 RFPs that are out there. But we certainly anticipate some level of investment in that space. And we've got a segment with our residential low and moderate income customer base, a program called community solar within which we are installing and rate basing residential distributed generation rooftop solar on customer rooftops. That's a multiyear program. Got it. And maybe to clarify that, the traditional gen, is this probably a new lower level on a consistent basis or for the 2019 2020 this 100,000,000 ish type number, is that probably just a transient based on outages, etcetera? No. Major outages at our power plants are cyclical in nature. Certain work is every 3 to 4 years, certain work is every 6 to 8 years. So this is just a reflection of the normal cyclical nature, if you will, of our major and minor outs. Got it. Excellent. And just to clarify on the capital recovery piece for the CleanGen uptick, is that fairly straightforward in the context of the next case? Well, we're recovering the residential to the res surcharge currently. The rest will be just included for recovery on an X-ray case. All right, great. Thank you all very much. All the best. Thanks. 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. Thank you all for joining us today. This concludes our call. 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.