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Executives

Becky Hickman - Director, IR

Don Brandt Chairman & CEO

Jim Hatfield – CFO

Jeff Guldner – SVP, Customers & Regulations

Analysts

Greg Gordon - ISI Group

Neil Mehta – Goldman Sachs

Shar Pourreza – Citigroup

Ali Agha – SunTrust

Brian Russo - Ladenburg Thalmann

Kevin Cole - Credit Suisse

Jim [inaudible] – UBS

Charles Fishman - Morningstar

Paul Patterson - Glenrock Associates

Pinnacle West Capital Corporation (PNW) Q2 2012 Earnings Call August 2, 2012 12:00 PM ET

Operator

Greetings, and welcome to the Pinnacle West Capital Corporation’s 2012 second quarter 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. (Operator Instructions).

It is now my please to introduce your host, Ms. Rebecca Hickman, Director of Investor Relations. Thank you, Ms. Hickman, you may begin.

Becky Hickman

Thank you, LaTonya. I’d like to thank everyone for participating in this conference call and webcast to review our second quarter 2012 earnings, recent developments operating performance.

Our speakers today will be our Chairman and CEO, Don Brandt and our CFO Jim Hatfield. Jeff Guldner, who is our APS Senior Vice President of Customers and Regulations is also here with us.

Before I turn the call over to our speakers, I need to cover a few details with you. First, the slides to which we refer are available on our Investor Relations website along with our earnings release and related information. Please note that the slides contain reconciliations of certain non-GAAP financial information. Also, all of our references to per-share amounts will be after income taxes and based on diluted shares outstanding.

It is my responsibility to advice you that this call and our slides contains forward-looking statements based on current expectations and the company assumes no obligation to update these statements. Because actual results may differ materially from expectations, we caution you not to place undue reliance on these statements. Our second quarter 2012 Form 10-Q was filed this morning. Please refer to that document’s forward-looking statements cautionary language as well as the MDNA section, which identifies risks and uncertainties that could cause actual results to differ materially from those contained in our forward-looking statements. A replay of this call will be available on our website for the next 30 days. It is also available by telephone through August 9th.

At this point, I’ll turn the call over to Don.

Don Brandt

Thank you, Becky, and thank you all for joining us today. Since our last conference call we’ve made progress in a number of key areas as we focus on our core electric utility business. This progress includes demonstrating improvement in the regulatory environment in Arizona, maintaining operational excellence, strengthening our financial profile and positioning ourselves to benefit from economic recovery. Jim and I will provide more information on each of these areas through our remarks today.

The regulatory environment in Arizona took another step forward when APS’s retail rate settlement was approved on May 15th by the Arizona Corporation Commission. The decision came 11 ½ months after the case was filed, the quickest resolution of a major Arizona utility rate case in recent memory. Supported by 22 of the 24 active parties to the case, the settlement shows significant collaboration and cooperation among APS, the Arizona Corporation Commission and other parties as well as a comprehensive commitment to an expedited process.

The settlement contains a number of benefits for our customers, the communities we serve and our shareholders. Details of the agreement, as well as key underlying assumptions are outlined in the appendix to our slides today.

The settlement prevents base rates from increasing for four years, but it is not a rate freeze. Under the agreement, APS may file it’s next general rate case on or after May 31st of 2015 for new base rates to become effective on or after July 1st of 2016. That said, we believe a number of factors will allow us to achieve competitive financial performance during the stay-out period.

Aspects related to that settlement include first APS’s rate adjustment mechanisms. All of APS’s rate adjustment mechanisms will continue to function throughout the stay-out period. These mechanism include, among others, first the preferred formula rates and the related retail transmission costs adjusted, which beginning in 2013 can pass annual changes in the preferred formula rate to APS retail customers without explicit ACC approval because of the settlement.

Next, the renewable energy surcharge, which allows for recovery of AZ Sun plant additions and then the loss fixed cost recovery mechanisms, which was adopted in the settlement to mitigate the loss of certain fixed costs related to energy efficiency programs and distributed generation.

And finally, an enhanced environmental improvement surcharge, which will allow APS to collect up to $5 million annually for certain carrying costs on government-mandated environmental capital projects. Second, a carve out for the proposed Four Corners acquisition. This provision will allow APS to seek rate adjustments as early as mid-2013 if the acquisition is consummated as we currently plan. I will review our progress in the Four Corners plan momentarily.

Third, provisions to mitigate certain cost increases. These features include deferrals of portions of higher property taxes attributable to tax rate increases and 100% pass through of fuel costs through the power supply adjuster.

And finally, without a time-sensitive base rate case litigation process in the next few years, we can focus fully on operational excellence, efficiency and discipline cost management.

This settlement builds upon a constructive framework established in the 2009 settlement and provides financial support for APS that will help us achieve Arizona’s energy goals over the next four years.

In a related manner, on July 18th, the Arizona Commission approved the 2012 retail transmission cost adjuster increase. The rate change, which became effective August 1st will increase annual revenues $18 million. As I mentioned earlier, beginning next year, any future changes can automatically go into effect June 1st of each year without separate Arizona Commission action.

We appreciate the opportunity to continue to work with the Arizona Corporate Commission and various stakeholders to further influence the state’s regulatory framework and define solutions that balance the interest of customers, shareholders and other stakeholders.

Our selective capital investments position us well to reliably serve the needs of APS’s electricity customers while meeting goals for Arizona’s sustainable energy future and environmental compliance.

I’ll update you on two major components of our capital expenditures program; the AZ Sun program and the planned Four Corners acquisition. Our renewable energy initiatives, particularly the AZ Sun program are important measured steps towards advancing Arizona’s sustainable energy future. Through AZ Sun, APS plans to develop and own up to 200 megawatts of utility scale photoable take solar plants in Arizona within service dates from 2011 through 2015.

A summary of the program is included in the appendix to today’s slides. This program is progressing on target. To date, we have placed in commercial operation three plants with a total of 50 megawatts of solar capacity. Construction and other development activities are currently underway at two sites for another 54 megawatts. We plan to place 19 megawatts into service late this year and the remainder into operation in 2013.

Additional planning and procurement activities are in various stages for the balance of the AZ Sun program.

We are continuing to make progress on our plan to acquire Southern California Edison’s interest in the Four Corners coal-fired plant in Northwestern New Mexico. A summary of that plan is included in the appendix to today’s slides. The plan has substantial merits, economically, environmentally and socially. The acquisition requires approvals from Arizona, California and Federal regulators and other government agencies, most of which have been obtained. Noteworthy conditions that remain to be met prior to closing the transaction include negotiation of a new coal supply contract reasonably acceptable to APS and approval by the Federal Energy Regulatory Commission. We continue to target closing of the acquisition late this year.

In addition to strategic capital investments, excellence in day-to-day execution remains a top priority. In the second quarter, our operating results reflected that priority. Palo Verde operated at a 93% capacity factor, reflecting a portion of the planned refueling outage at Unit 3, which was completed on April 17th in 32 days. The facility’s second shortest refueling outage to date.

On the customer service side of our business, JD Power and Associates released the results of this year’s residential customer survey last month. I am pleased that APS was ranked third best among 55 large investor-owned electric utilities, continuing the recognition of our excellence and overall customer satisfaction.

More specific to our region, we were ranked second among the ten investor-owned utilities in the West.

Looking to the future, in late June I announced APS’s organizational changes and promotions to strengthen our leadership team and further enhance our operations. First, APS President, Don Robinson will continue as a Senior Advisor and join me in the newly-created Office of Procurement while handing off his day-to-day operational responsibilities.

Second, Mark Schiavoni has been named Executive Vice President of Operations. In his new role, Mark has responsibility of r operations except for nuclear generation and customer service. Mark joined APS in 2009 ,bringing strong experience running Exelon’s Fossil Fleet and also at nuclear operations at two other utilities.

Third, Jeff Guldner was named Senior Vice President of Customers and Regulation. This move combines our customer service organization and APS’s interactions with Arizona and federal utility regulators under Jeff’s guidance. To date, Jeff has successfully headed our rate regulation efforts including leading the team that negotiated the 2009 and 2012 retail rate settlements.

Fourth, the Information Technology organization now reports to Jim Hatfield who will focus that important group on increased efficiency and effectiveness that will benefit our entire company. In addition, we have hired a new Senior Executive in IT who brings impressive experience in this regard from a major financial services company.

Finally, there were several senior manager promotions that will realign some of our operational areas under proven leaders. I believe these changes to the senior management team support our company-wide focus on best practices and continuous improvement.

Over the past several years we have often spoke about cost management. Following the theme of continuous improvement, we will continue to look for ways to improve our cost while maintaining safety and operational excellence.

We have cross-functional management initiatives underway, co-headed by Jiim Hatfield and Mark Schiavoni. Jim will discuss those initiatives momentarily.

To close my remarks, I’m very please where our company is today and very optimistic about our future. With the retail rate settlement behind us, we will continue achieving top-tier performance through focus on excellence and execution and continuous improvement, something our talented leadership team and workforce do exceptionally well.

Now, Jim will review our second quarter results, credit rating upgrades and financing plans, the outlook for this Arizona economy, our cost management initiatives and our guidance for 2012 earnings and our financial outlook through the stay-out period. Jim?

Jim Hatfield

Thank you, Don. As Don said, we continue making progress strengthening our financial profile. Today I will discuss the following topics. First, I will discuss our second quarter results, including earnings and the primary variances from last year’s corresponding quarter. Second, I will review recent upgrades of our credit ratings and our financing plans. Third, I’ll provide an update on the status outlook for the Arizona economy. Fourth, I will describe our cost management initiatives to which Don referred. And finally, I will discuss our guidance for 2012 earnings and our financials during the stay-out.

Slide 6 summarizes our reported and ongoing earnings for the quarter. On a GAAP basis for this year’s second quarter, we reported consolidated net income attributable to common shareholders of 122 million, or $1.11 per share compared with net income of 87 million or $0.79 per share for last year’s second quarter. Our ongoing earnings increased $0.34 per share. For this year’s second quarter, we had consolidated ongoing earnings of 123 million or $1.12 per share versus ongoing earnings of 86 million or $0.78 per share for the comparable quarter a year ago.

Slide 7 contains a reconciliation of our second quarter GAAP earnings per share to our ongoing earnings per share. The amount for both quarters exclude results related to our discontinued real estate and our energy services businesses. My remaining comments on the quarter will focus on ongoing results.

Slide 8, this displays the variances that grow the change in quarterly ongoing earnings per share. First, an increase in our gross margin added $0.35 per share compared with the prior year’s second quarter earnings. Several pluses and minuses comprise of positive net variance and I will cover those items in more detail on the next slide.

Second, lower infrastructure-related costs improved earnings by $0.06 per share, reflecting both lower interest charges and lower depreciation and amortization associated with the 20-year license extension granted last year by the U.S. Nuclear Regulatory Commission for the Palo Verde Nuclear Generating Station. These costs reductions were partially offset by higher property taxes related to tax-rate increased.

Third, higher operations and maintenance expense reduced earnings by $0.05 per share. The expense increase was largely due to stock compensation costs resulting from improvements in the company’s stock price. This O&M variance excludes expenses related to the renewable energy standard, or RES, energy efficiency and similar regulator programs all of which were essentially offset by comparable revenue amounts under the adjustment mechanisms.

Fourth, the net impact of miscellaneous other items decreased earnings by $0.02 per share. Our second quarter 2012 earnings benefited $0.03 per share because of the Arizona Sun program and plans that were placed in service late last year and early this year. This net variance is reflected in various line items on the income statement.

Turning to Slide 9, and the components of the net increase in our gross margins, total gross margin increased $0.35 per share compared with last year’s second quarter. The main components of that increase were as follows: The effect of weather variations improved earnings by $0.23 per share. This year’s second quarter was hotter than normal while the 2011 second quarter was abnormally mild. This year, residents of cooling degree days were 14% higher than normal and 51% over the comparable quarter a year ago. The retail transmission cost adjusted rate increase that became effective July 1st of 2011 improved earnings by $0.05 per share. Lower fuel and purchased power costs and higher mark-to-market valuations of APS’s fuel hedges net of related PCA deferrals improved earnings by $0.04.

The net effect of miscellaneous items improved our gross margin by $0.04 per share. Lower weather normalized retail kilowatt hours sales decreased our earnings by $0.01 per share. This variance reflects the effects of customer conservation and energy efficiency and distributed renewable generation initiatives, which were essentially offset by customer growth of 0.9% over year-ago levels.

Slide 10 displays our investment-grade credit ratings. In May after approval of the retail rate settlement, both Moody’s and Fitch rate Pinnacle West and APS long-term credit ratings up one notch including an upgrade of APS’s senior unsecured debt to Baa1 and BBB+ respectively. We are pleased the rating industry recognizes constructive conservatory outcome and are improving financial performance.

Regarding our planned financing activity, we expect to issue debt upon the acquisition of SoCal Edison’s interest in Four Corners later this year if the transaction is consummated. With respect to potential equity issuances, [inaudible] successful completion of the retail rate settlement, we currently project that we will not need to raise additional common equity capital until 2014 at the earliest. The timing of any amount – the timing and amount of any issuance would facilitate balancing of APS’s capital structure and provide support for the company’s credit metrics.

Turing to Slide 11 and looking at our fundamental growth outlook in the Arizona economy. Economic growth in Arizona continues to improve in the second quarter although the growth remains modest as has been the case for the last several quarters.

As shown on Slide 11, growth in non-farm jobs continue to show modest gains. In particular, the rate of overall job growth was – has held up well for over a year and virtually all the major industrial sectors are experiencing some growth. The sustained growth in jobs has been helpful in supporting gradual growth and incomes and consumer spending and has pushed the unemployment rate down parallel with national trends. However, as I have discussed on previous calls, significant headwinds remain to be overcome before we can expect the Arizona economy to begin growing robustly. While consumer spending is above last year’s levels, the rate of growth has declined I recent months, unemployment remains persistently high and the amount of unoccupied housing continues to restrain the new home construction market.

On Slide 11, you can see our estimates of the amount of excess housing that presently exists in our service territory and metro Phoenix. The good news is that the Phoenix economy has absorbed about 10,000 vacant homes and apartments since the peak of [inaudible] in 2009. We believe we are on a page to further reduce those vacancies by the end of next year to a level of our existing home resale price will be more supportive of new home construction.

On Slide 12, you can see the recent trends in Metro Phoenix home prices as reflected in [inaudible] repeat sales index. In recent months we have seen a slight rebound in pricing as the number of foreclosure sales have declined. While we view this as a positive trend, we also recognize that the single-family retail pricing has just recently returned to levels that we saw in early 2010, just past the peak of the recession. More importantly, these price levels are consist with the market for homes at the end of 2001 or 11 years ago.

This slide also shows that similar conditions are present in the commercial real estate market. As you can see on the slide, vacant rates for office and retail space have begun to fall from their peak levels but remain quite high. Again, we view this as a positive trend but believe that to the extent of vacant space in these markets means that the recovery for new office and retail construction will likely lag that for new homes.

Reflecting this modest steady improvement in economic conditions, APS’s customer base grew 0.9% in this year’s second quarter compared with the same quarter a year ago and represents the strongest growth we’ve seen in three years.

Over the long term, we believe the fundamentals that have been important to Arizona’s growth are still here and that our growth rate and customers will return to more typical levels. Looking at the next several years, we see current – we currently expect the annual customer growth to average about 2% for 2012 to 2015 with growth rates higher at the end of the period than in the near term for reasons I just discussed.

Additionally, we expect our average annual weather normalized retail sales in kilowatt hours to be relatively flat in 2012 to 2015 primarily due to customer conservation and energy efficiency and distributed renewable generation initiatives offsetting the modest recovery in the economy.

Turing to Slide 13 and our cost management initiatives. We are building on the cost management foundation with solid achievements in recent years. As this slide shows, we have been able to hold O&M essentially flat since 2008. In preparation for the recently settled rate case, we reduced capital and operational spending by more than 30 million per year through several efforts such as our enterprise-wide supply chain initiative. However, we are cognizant that we cannot let cost escalate unchecked as customer growth and sales improve. Our goal is to keep O&M growth in line with retail sales growth. However, we will not sacrifice safety or operational excellence in order to do so.

To achieve continuous improvement, we’re challenging employees throughout the company to find ways to be more efficient and effective in their jobs. Additionally, we have a number of corporate initiatives. A company-wide cross-functional initiative underway to benchmark and evaluate various activities. Recently we have identified and eliminated some duplication of efforts. For example, we have combined financial business analyst groups in my organization by consolidating previously these centralized functions, we were able to create significant synergies. Further, progress is being made on cross-functional processes which will also create significant synergies.

Workforce attrition will provide opportunity to capitalize on efficiencies without the need for large layoffs. We estimate that more than 220 will leave the company in each of the next 10 years due in large part to retirements as the baby boomers transition to the next phase of their lives. Through process improvements, we believe that we will be able to avoid replacing a significant number of those employees. To minimize a loss of key knowledge as our workforce changes, we are implementing programs to enhance knowledge transfer and ensure consistency and documentation of processes.

Finally, I will discuss our earnings guidance and financial outlook. As shown on Slide 14, we currently expect Pinnacle West consolidated ongoing earnings for 2012 will be in the range of 3.35 to 3.50 per share. Using the middle of the range, this reflects an improvement of approximately 15% over 2011 ongoing in earnings per share.

The key factors and assumptions that underpin our guidance are listed on Slide 16 in the appendix to today’s slide.

Looking ahead through the base rate stay-out period, the company’s goal is to achieve an annual consolidated rate of return, average common equity of at least 9.5% on average through 2015 as shown on Slide 14. This represents another step change in returns, demonstrating the benefit to shareholders from our rate settlement. This expectation reflects the financial support provided by the retail rate settlement and other factors and assumptions outlined in Slide 17 and 18.

In terms of capital expenditures, we anticipate spend to average around $1.1 billion through 2015. However, approximately 45% will be addressed by the rate mechanisms Don alluded to and approximately 35% will be covered by depreciation cash flow. This leaves minimal annual spend exposed to regulatory lag.

In closing, we are confident in achieving our financial objectives through the stay-out period. The gross margin mechanisms contained in the retail rate settlement coupled with our demonstrated cost management ability give us this confidence.

Additionally, but not assumed in our outlook, an accelerated return to our economic growth provide outside out outlook.

This concludes our prepared remarks. Operator, we would be pleased to take questions.

Question-and-Answer Session

Operator

Thank you. (Operator instructions). Our first question comes from Greg Gordon with ISI Group, please proceed with your question.

Bill Episelli - ISI Group

Hi, good morning, it’s actually Bill Episelli.

Don Brandt

Hey, Bill.

Bill Episelli - ISI Group

Hey, just a question on the, you know, the outlook going out to ’15, I know you guys have given the guidance here of rate base growth, from about 6% and off of an 11 base, and you know, you’re targeting the average ROE of 9.5% - I mean, thinking not earning is how they relate to those metrics, and I know that you’re good about talking about, you know, issuing equity in ’14, so, there will it be some impact from that, but I was just wondering if you could give additional thoughts on how the key pieces of earnings as it relates to base rate growth, and then the – you know, other pieces that you – you mentioned there at the end about the acceleration in the economy, all the things that could drive the 9.5% higher off of the targeted base.

Jim Hatfield

Well, you know, again, and that 6% rate base [inaudible] – you do have equity in ’14, you do have a little bit of regulatory lag, all though a lot of that has been mitigated, and we’re assuming, you know, cost control. If all those things come true, and the economy recovers, about a 1% customer increase equals 10 million in after tax earnings on average. Since we’re assuming no sales growth over the 2015, we don’t think there is a lot of downside in the growth number, and so that sort of gives you a [inaudible] of [inaudible] what may happen if we do see some acceleration.

Bill Episelli - ISI Group

Okay, great, and then on the sales growth outlook, you know, could you maybe desegregate the 2.5% in terms of how it’s getting offset through just to regeneration in energy efficiency?

Jim Hatfield

No, but since they break down we do – we assume compliance on energy efficiency which goes up every year, and then – and then we have the renewable energy standard by ’15 and we do know that from a deployment perspective, we’re slightly ahead of target – we can track those pretty good. And so, we feel that we have those two, and we do have just some customer conservation in there due to continued lack of direction of the long term economy.

Bill Episelli - ISI Group

Okay, and then just lastly – so, if we think about growth, if it were to say they hit 3% or 3.5% at some point over the life of the deal, is that – so, that’s netting out the 2.5% that you’re targeting, so that’s how you get your sort of 1% of additional growth, is that how we think about it?

Jim Hatfield

No, my one percent of additional growth is just the same as additional 1% - customers came out of the system, normally you see to have gained about 10 million after tax earning.

Bill Episelli - ISI Group

Oh, okay. Thank you.

Operator

Our next question comes from Neil Mehta with Goldman and Sachs, please proceed with your question.

Neil Mehta – Goldman Sachs

Hi, thank you – so, now that we’re through the rate case here, as you said Jim, cost control is so key, so, do you believe that you can keep going them flat throughout the stay out period assuming that retail sales are flat, or is that more of an aspirational target?

Jim Hatfield

It’s both aspirational, but I have highly great confidence in our ability to do that. We – you know, the good news for me from a cost perspective, is – you know, what we’re trying to accomplish from the cost side is not just coming from the CFO – I have a good partner and [inaudible] loaning from the off side, and together we are pretty aligned, and pretty much seeing the same path going forward. So, I’m pretty confident now.

Neil Mehta – Goldman Sachs

Got it, [inaudible], and also with a rate base – your rate base behind us, dividend growth comes into focus, you had that dividend around $2.10 for a long time, how are you think about the potential for dividend growth now?

Jim Hatfield

You know, Neil, now that I think we have a runway out through ’15, I would expect, you know, the board will look at the dividend policy later this year.

Neil Mehta – Goldman Sachs

Got it, and guidance…

Jim Hatfield

Let me add to that, traditionally, our board’s a little bit the dividend level – the annualize dividend level at their October meeting, and I think this year would be consistent with that, the board will take a look at it, and we’ve accomplished a lot in the last few years in rebuilding our balance sheet, and getting our earnings up to a competitive level, and I think those are all positive aspects going into the fall, and the dividend decision.

Neil Mehta – Goldman Sachs

Okay, and then when do you intend to issue 2013 guidance?

Jim Hatfield

Right now we’re attentatively planning to do it on our analyst day, November 9th.

Neil Mehta – Goldman Sachs

Perfect, thank you, thank you very much.

Jim Hatfield

You’re welcome, thanks.

Operator

Your next question comes from Shar Pourreza with Citigroup, please proceed with your question.

Shar Pourreza – Citigroup

Good morning everyone.

Jim Hatfield

Good morning, Shar.

har Pourreza – Citigroup

Can you just remind us with the current regional haze rules that’s coming about if your cap x outlook includes a state plan, or a federal implemented plan?

Jim Hatfield

Currently, in terms of us, the regional haze rule advise to all [inaudible] four corners, Navaho, and [inaudible] three and four. The state proposed [inaudible] would be to install low nox burners in over fired air. All thought the EPA recently rejected that, and calling for more stringent, expensive FCRs, and what [inaudible] determined schedule for November of this year. The EPA proposed to burn it for [inaudible] be the insulation on FCRs on units four and five, it’s been in the transaction close and we don’t have a bared ruling from the EPA on Navaho at this time.

Shar Pourreza – Citigroup

Is there a status on how much your cap x can increase assuming that the federal implemented plan gets inacted?

Jim Hatfield

Excuse me?

Shar Pourreza – Citigroup

Is there a status on how much you cap x could increase assuming a federal implemented plan gets inacted?

Jim Hatfield

Yes, really it effects [inaudible] at this point, and we don’t have – we have the state plan in there, I think, it’s about 182 million if we had to implement the rest of the EPA.

Don Brandt

Yes, FCRs on units two and three at [inaudible] would cost us about 182 million in additional CapEx.

Shar Pourreza – Citigroup

Okay, perfect, thank you.

Operator

Our next question comes from Ali Agha with SunTrust, please proceed with your question.

Ali Agha – SunTrust

Thank you, good morning.

Jim Hatfield

Hey, Ali.

Ali Agha – SunTrust

To be clear, to be guidance that you have for 2012 range, the 9.5% [inaudible], should we assume that associate with the midpoint of that guidance, or do you think about [inaudible] for 2012?

Jim Hatfield

I think that the 9.5 really relates to ’13 through ’15, if you think about how we have that rate increase in the second half of the year, and we have the mechanisms from the nine settlement in the first half of the year, but – so, I would suspect slightly to exceed the 9.5 in 2012 with a sort of a hybrid year.

Ali Agha – SunTrust

I see, okay. And secondly, also, to be clear, if I had [inaudible] the cap x that you have planned to have right now, if I use [inaudible] does that translate into a 5% annual rate based growth? Is it 5 or 6?

Jim Hatfield

Well, [inaudible] is from 2011.

Ali Agha – SunTrust

Right, so, it would be…

Jim Hatfield

I have – I even calculated from ’12.

Ali Agha – SunTrust

Okay, I thought in one of your slides that I may have seen 5%, and I may be wrong there.

Jim Hatfield

It would decelerate because you have four corners in 2012, which is a large piece of that component in ’12.

Ali Agha – SunTrust

Right, right. Okay, and thirdly on the equity issue that said that you don’t see before 2014, should we think of it really, you know, timing issue you needed for your next rate case, or should we think of end of ’14, or maybe not there, and from a size perspective for the last couple of [inaudible] actions, be a good proxy of the size that we should be thinking about?

Jim Hatfield

No proxy for size at this point, and you know, it wouldn’t be until ’14 at the earliest and we would have to get to ’14 to make a decision as to what we are going to do at that point.

Ali Agha – SunTrust

Understood, thank you.

Operator

Our next question comes from Brian Russo – Ladenburg Thalmann. Please proceed with your questions.

Brian Russo – Ladenburg Thalmann

You mentioned the ongoing coal contract at Four Corners as the acquisition will be contingent on that. Could you just update us on the timeline there and what are the major items of discussion?

Don Brandt

We expect to get the transaction closed by the end of the year, say around the first of December, and we’re in active negotiations on the coal supply contract. Like with most contracts it involves price.

Brian Russo – Ladenburg Thalmann

Okay, and then just to clarify on the 9.5% target ROE. Is that utility earned ROE, or is that the consolidated ROE, which would include the $0.05 of parent track.

Don Brandt

Consolidated.

Brian Russo – Ladenburg Thalmann

Okay, thank you.

Operator

Our next question comes from Kevin Cole – Credit Suisse. Please proceed with your question.

Kevin Cole – Credit Suisse

Hi, Good Morning guys. Congratulations on the very constructive rate outcome and change in (inaudible)

Don Brandt

Thank you.

Kevin Cole – Credit Suisse

I guess I have a little bit more, just kind of I guess on the (inaudible) drivers. So I guess the base approach that I should use is that, given that you expect 6% annual rate based growth, and a flat 9.5% earned ROE, that your base EPS growth should be 6%, and then that will likely be a little bit bigger in 2012, ‘13’ and ’14 due to the rate increase in the four quarters, and that it could be, it could start to taper off towards the backend a little bit due to the equity delusion in 2014 sometime?

Jim Hatfield

Brian, with 6% rate based growth, it would be hard for me to see a path of 6% range growth, whether normalized. Because you do have the delusion at some point assumed throughout to stay out, and you do, and we’ll continue to have some regulatory lag. So, I would say it’s going to be south of that.

Kevin Cole – Credit Suisse

Okay, should it follow the path of it being EPS growth being a little bit stronger in ’12, ’13 and ’14? And then kind of I guess taper off towards the backend due to that equity delusion?

Jim Hatfield

If you assume equity delusion in the backend, yes that would be the case due to the delusion.

Kevin Cole – Credit Suisse

Okay. And then Jim, does your 2014 equity comment preclude you from doing like a forward sale or something like that on the back of the project (inaudible) later this year?

Jim Hatfield

We would not be precluded from doing anything at this point, so.

Kevin Cole – Credit Suisse

Okay. Lastly I guess, can you put some collar around your dividend policy going forward during the four year rate sale?

Don Brandt

Well, Kevin I think where we’re at now is pretty close to the conclusion of rebuilding (1) the company’s balance sheet. Significantly adding some consistency, to the Arizona Regulatory Environment, both consistency and creditability with the expeditious resolution of the last settlement and the settlement before that, that laid really the ground work going forward. You just talked to Jim about earnings growth, and earning at a minimum 9.5% ROE going forward, and that kind of lays the groundwork. (2) The next step is we have had the dividend frozen for a number of years at the current level. That’s something again that the board is going to address at our October board meeting in all likelihood. And I think you’ll see a dividend path forward coming out this fall.

Kevin Cole – Credit Suisse

Great, thank you. That’s very helpful. Again, congrats.

Don Brandt

Thank you.

Operator

Our next question comes from Jim (von Reesman) – UBS. Please proceed with your question.

Jim (von Reesman) – UBS

Good Morning Arizona.

Don Brandt

Hey, Jim how are you?

Jim (von Reesman) – UBS

Good, yourself

Don Brandt

Great.

Jim (von Reesman) – UBS

Hey, a couple of questions. You know this transportation highway bill, whatever you want to call it, that Congress passed. Does that have any cash flow impact for you guys?

Don Brandt

Well it could. Our minimum funding requirements would drop under the highway bill, as we understand the perimeters right now. The result of dropping our funding, Jim going forward, is it drives our expense up. And so at this point with the liquidity we have, and a plan in place, we’re still planning on funding at pre-highway bill levels, which is somewhere in the $150 -$160 area ’13 through ’15.

Jim (von Reesman) – UBS

Okay, just kind of keeping along this whole cash flow things for a second. Can you talk a little bit about, or broadly speaking ’13 to’15, what your coverage metrics, what you want them to look like, or your capital structure targets. And then maybe what the impacts of the absence of bonus depreciation starting next year is going to have cash flow?

Don Brandt

Well a couple of thing on the Jim, obviously are, when we try to reach that at test year we’re very happy with our 53 -54 equity ratio, for making purposes that obviously will fluctuate throughout the time frame, just based on the fact that we’re not in a test year.

Our coverage metrics are fine. We will realize that a lot of the bonus depreciation for tax purposes next year as well, because we have a tax law set, you know, we have to carry forward.

So, we’re very pleased with cash flow, liquidity, and our balance sheet at this point. And it’s not going to deteriorate throughout the sale period.

Jim (von Reesman) – UBS

Okay, no worries, thanks.

Operator

Once again ladies and gentleman, to ask a question please press Star 1 on your telephone keypad.

Our next question comes from Charles Fishman – Morningstar. Please proceed with your question.

Charles Fishman – Morningstar

All right, thank you. Assuming the Four Corners acquisition is consummated, would the FCR installation for those two units come under the EIS, or do you have to wait till the next rate case?

Don Brandt

They would come under the EIS once we started putting them into on the units, and of course you’d like to try a time load, so you can maximize that. I’ll just point out that that EIS is capped about a roughly a $5 million revenue requirement on an annual basis. So, it won’t be one for one recovery, but of course every little bit helps.

Charles Fishman – Morningstar

Okay, that was it, thank you.

Operator

Our next question comes from Paul Patterson – Glenrock Associates. Please proceed with your question.

Paul Patterson – Glenrock Associates

Good morning and congratulations on the continuance improvements.

Don Brandt

Good Morning Paul.

Paul Patterson – Glenrock Associates

Just to revisit customer growth, and I apologize if I missed this. One percent customer growth in 2012 projected to double through the 2015 timeframe. I’m just wondering what actually draws that? Is it the economy, and if it is, what sort of the economic forecast that you guys have in that?

Don Brandt

Yes, you’re right, it sort of accelerates throughout through ’15. What really drives that Paul, is we don’t see the absorption of available homes are getting to a level until around the end of next year, early ’14 where you’ll see the construction side will start again. And of course, when construction cycles starts, that leads to retail sales which leads to other jobs, which you know has a sort of snowballing affect. So, it’s just the natural digging out of the inventory that we have in Phoenix.

Paul Patterson – Glenrock Associates

So, there’s still a lot of migration into Arizona, it’s just right now absorbing the home building is being delayed as a result. Is that how we should think about it?

Don Brandt

Yes. I mean we had at the peak somewhere around 35,000 available homes and apartments, and we’ve absorbed about 10,000 roughly of those. And until you get the construction cycle moving, that will be the driver, and it’s going to take some time.

Paul Patterson – Glenrock Associates

Okay. And then just in terms of that growth rate which seems to accelerate, looks like you guys still, you know, the APS energy efficiency advantage here, I mean, you guys are still, you know, projection that you are going to be able to keep it flat throughout that period. Or should we think that that’s going to be accelerating as well, that growth rate. I mean, it’s impressive how you guys have been able to keep sales growth flat with the energy efficiency efforts. I’m just wondering how we should think about that over time?

Jim Hatfield

I think Paul, we have increasing standards each year going forward, so you’re going to see acceleration of those programs. And we believe it’s going to offset the increase in customer growth through that timeframe.

Paul Patterson – Glenrock Associates

Very impressive, thank you.

Operator

Our next question comes from Eli (inaudible) - Please proceed with your question.

Chris Shelton –

Good Morning guys, it’s Chris Shelton, how are you?

Jim Hatfield

Hey, Chris.

Chris Shelton –

Quick clarification, I just want to see the, so the 6% rate base growth is off of 2011. I know the rate base that you filed for has put some tax as far…

The question would be, what’s the best for 2011 rate is?

Jim Hatfield

2011 rate base was, let see, it was ACCE total was 5.7 at the end of ’11.

Chris Shelton –

Okay, and that excludes any of the construction work in progress, or any of the…

Don Brandt

Yes, it would be your normal rate base for rate making purposes.

Chris Shelton –

Okay, great. And then I know you used to have a slide – prior to this you had a slide that had rate base growth of 5% through ’14? Is that slide still approximately right for the (inaudible) or is the extra growth kind of coming from the ’15 timeframe.

Don Brandt

The slide that we have had previously is still pretty much intact from a rate based perspective, and obviously as we move to ’15, we’re starting to get into some environmental and some more growth type of projections.

Chris Shelton –

Got it, great. Final question. I know the equity layer at the utility will king of vary as we go through the years and (inaudible) you know, in time for the next case. What equity layer rage I guess do you see over the period?

Jim Hatfield

You know Chris, it stays above 50% throughout that timeframe. It gets down to, you know, maybe 51 ½% but we have healthy credit metrics throughout the stale period.

Chris Shelton –

Okay great. Thanks a lot guys.

Operator

There are no further questions in queue at this time. I would like to turn the call back over to management for closing comments.

Becky Hickman

Thank you again for joining us today. As always, if you have further questions or need other information, please contact me, and this concludes our call.

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