Paul Mountain - Director, Investor Relations Donald Brandt - Chairman of the Board, President and Chief Executive Officer James Hatfield - Executive Vice President and Chief Financial Officer Jeffrey Guldner - Senior Vice President, Public Policy, Arizona Public Service Company Mark Schiavoni - Executive Vice President and Chief Operating Officer, Arizona Public Service Company.

Greg Gordon - Evercore Julien Dumoulin-Smith - UBS Ali Agha - SunTrust Michael Lapides - Goldman Sachs Charles Fishman - Morningstar Shar Pourreza - Guggenheim Paul Patterson - Glenrock Associates.

Greetings, and welcome to the Pinnacle West Capital Corporation first quarter 2016 earnings conference call. [Operator Instructions] It is now my pleasure to introduce your host, Paul Mountain, Director of Investor Relations. Thank you, sir. You may begin..

Thank you, Christine. I would like to thank everyone for participating in this conference call and webcast to review our first quarter 2016 earnings, recent developments and operating performance. Our speakers today will be our Chairman and CEO, Don Brandt; and our CFO, Jim Hatfield.

Jeff Guldner, APS's Senior Vice President of Public Policy; and Mark Schiavoni, APS's Chief Operating Officer are also here with us. First, we 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 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 first quarter Form 10-Q was filed this morning.

Please refer to that document for forward-looking statements, cautionary language as well as the risk factors and MD&A sections, which identify risks and uncertainties that could cause actual results to differ materially from those contained in our disclosures. A replay of this call will be available shortly on our website for the next 30 days.

It will also be available by telephone through May 6. I will now turn the call over to Don..

Thanks, Paul, and thank you all for joining us today. 2016 has started off with a solid first quarter, very much in line with our expectations and we remain well-positioned to meet our financial commitments this year. We're focused on operational execution in APS's rate case filing plan for June 1.

We have had planned outages at both units at the Four Corner Generating fossil plant and at the Palo Verde Nuclear Generating Station. Jim will discuss the financial impact, but the Four Corners planned outages were the primary headwind in our first quarter results compared to the first quarter of 2015.

The Four Corners Unit 5 major outage began in late January, while Unit 4's outage started in March, with both expected online very soon. Palo Verde's planned Unit 1 refueling outage began on April 10. Palo Verde continues to perform exceptionally well.

The site recently completed a peer evaluation by the World Association of Nuclear Operations or WANO as its known and by the Institute of Nuclear Power Operations or INPO, and received exceptionally positive feedback from this evaluation.

On a related note, Maria Lacal, who has been instrumental in Palo Verde's success, has been promoted to Senior Vice President of Regulatory and Oversight for Palo Verde. Maria, I know you're listening, so thank you for all you've done to make Palo Verde one of the safest and best performing nuclear plants in the nation.

We're making progress on our capital investment program. We're building a 40 megawatt utility scale solar facility known as Red Rock Solar, where our major customers ASU and PayPal have agreed to buy the power, and we'll also receive the renewable energy credits.

We signed an agreement with a data center to construct the microgrid at their location in North Phoenix. This will be the second microgrid, APS is partnering on in our service territory. The first was with the Department of the Navy's Marine Corps Air Station Yuma.

The Red Rock Solar and microgrid projects represent unique opportunities to develop innovative solutions for our customers. Additionally, as part of the APS solar partner program, we are the first utility in the nation to use advanced technology to manage solar generation through the use of advanced inverters.

The inverters APS is using recently received Underwriters Laboratories certification. This is an important milestone, since we require that all equipment on the grid be certified by UL. The advanced inverters allow us full command and control of the devices we own, which includes ramping up or curtailing power and enabling two-way power flows.

Turning to the regulatory calendar. The Arizona Corporation Commission and staff have been managing a full schedule. The UNS rate case hearings took place in March. We were engaged in the residential rate design portion of that docket.

The discussion centered on the deployment of three-part rates, which include an energy component, a demand component and a customer charge. A final decision is expected this summer. We also filed testimony in the value and cost of distributed generation docket. Hearings began on April 18 and are expected to conclude in early May.

There is not a set timetable for a decision. The outcome of this docket is anticipated to outline a statewide methodology of how the cost of service for solar customers will be handled as well as how the value of solar will be determined.

We do not expect to have decisions on these two dockets before our June 1 rate case filing date, but our engagement in each process has provided insight on rate design.

Residential rate design is an area where we will propose changes to better align cost with prices, including proposing three-part rates for most residential customers as well as shifting our time of use periods to later in the day. We'll also request a deferral of cost, related to two large capital projects that we'll be investing in.

The selective catalytic reduction controls or SCR is as they're known at Four Corners and the fast-ramping natural gas modernization project at our Ocotillo site. These investments total over $900 million over the next few years within service dates of 2018 and 2019, respectively.

And in the case with the SCRs, since the timing of installations will be close to the end of this rate case, we'll also propose a step mechanism to reflect a deferred SCR cost similar to the treatment of the Four Corners acquisition.

Our overall rate filing theme centers on clear energy, sustainability, innovation and technological options for customer. Lastly, I'll comment on a recent development.

Earlier this month, a constitutional ballot initiative supported by SolarCity that was related to distributed generation and rate making was filed with the Arizona Secretary of State in an effort to put the initiative on the November 2016 ballot.

In response, two bills were introduced this week in the Arizona Legislature that would have offered competing referendums for Arizona voters to consider. Very late yesterday, the SolarCity ballot initiative and the two bills were pulled from consideration.

The Arizona utility industry and SolarCity agreed to further dialogue in the future to seek a constructive outcome on net metering. In closing, we're delivering on our commitments and continue to be well-positioned for a solid year in 2016.

We're focused on operational excellence and positioning APS as a sustainable leader through strategic capital investments and a forward-thinking rate filing. I'll now turn the call over to Jim..

Thank you, Don. And thank you, again, everyone, for joining us on the call. This morning we reported our financial results for the first quarter of 2016, which were in line with our expectations.

As you can see, on Slide 3 of the materials, for the first quarter of 2016, we were on $0.04 per share compared to $0.14 per share in the first quarter of 2015. The primary divers were higher gross margin offset by higher operations and maintenance expense.

Several factor contributed to the gross margin in the first quarter, including favorable weather. The net effect of weather variations increased earnings by $0.02 per share.

Although, weather in both 2016 and 2015 first quarters were less favorable than the normal 10-year averages, heating degree days were 57% higher in the first quarter of this year compared to last year. Higher usage by APS's customers compared to the first quarter a year ago added a $0.01 to gross margin.

Weather normalized retail kilowatt hour sales increased 1.3% in the first quarter of 2016 versus 2015. The transmission adjustment mechanism in the Arizona Sun program also added to the first quarter gross margin.

We still expect a loss fixed cost recovery mechanism or LFCR to be a positive driver for the year, that favorability will be more heavily weighted in the second half of the year. Now, turning to O&M.

As Don mentioned earlier, higher O&M was a primary headwind to first quarter 2016 earnings compared to 2015, largely driven by the major plant outage at Four Corners Unit 5 that began in late January. In line with our expectation, the outage cost decreased earnings by about $0.13 quarter-over-quarter.

The Four Corners Unit 4 and 5 planned outages will both conclude in the second quarter, which will provide a headwind similar to the first quarter consistent with guidance. Lastly, a brief note on depreciation and amortization expenses. Lower D&A increased earnings by $0.01 in the first quarter.

This variance includes higher expenses resolving from additional plant service, which were offset by lower depreciation related to the extension of the Palo Verde sale leaseback.

As Arizona's economy continues to be an integral part of our business story, I'll highlight next the trends we are seeing in the local economy, and in particular, the Metro Phoenix area. What you see on Slide 4 is a continuation of a consistent growth trend we have been describing for you over the last couple of years.

Job growth in the first quarter of 2016 in the Metro Phoenix area remained above the national average, as it has for nearly five years. As seen on the upper panel, Metro Phoenix added jobs at a 3.6% year-over-year rate.

This job growth is broad-based with construction, business services, financial services and healthcare, showing strong sectoral strength, adding jobs at a clip above 4% year-over-year. The job growth in Phoenix economy is driving robust population migrations. Of the 15 largest U.S.

metro areas, Phoenix ranks third in the nation in 2015 population growth, behind only Houston and Dallas, which is influencing trends in the Metro Phoenix housing permits, as can be seen in the lower panel of Slide 4.

In 2015, Phoenix housing market record its best year since 2007, for both total permits and the single-family sector by itself, with almost 22,000 permits and 15,000 permits, respectively. This growth trend continued in the first quarter of 2016, as single-family permit grew nearly 35% over last year's first quarter.

We expect the housing market to continue to improve throughout this year with annual total housing permits probably in the range of 25,000 to 32,000. In summary, the Metro Phoenix economy continues to grow steadily and is positioned for stronger growth over the next couple of years.

Additionally, Arizona and Metro Phoenix remain attractive places to live and do business, especially as they are situated relative to the large, but higher cost California market. Reflecting the steady improvement in economic conditions, APS's retail customer base grew 1.3% compared with the first quarter last year.

We expect that this growth rate will gradually accelerate in response to the economic growth trends, I just discussed. Importantly, the long-term fundamentals supporting future population, job growth and the economic development in Arizona appear to be in place. In closing, I will review our earnings guidance and financial outlook.

We continue to expect Pinnacle West consolidated ongoing earnings for 2016 will be in the range of $3.19 to $4.10 per share. The adjustment mechanisms, particularly transmission and the LFCR, along with modest sales growth and normal weather, remain the key gross margin drivers.

You will a t complete list of factors and assumptions underlying our guidance included on Slide 5, which are unchanged from last year. Looking ahead to 2016 financing, we plan to refinance a $250 million August maturity and anticipate issuing up $400 million of additional long-term debt. Overall, our balance sheet liquidity remained very strong.

During the first quarter, APS increased its commercial paper program from $250 million to $500 million. At the end of the quarter, Pinnacle West had no short-term borrowings and APS had $262 million of commercial paper outstanding.

Finally, our rate base growth outlook remains 6% to 7% through 2018 and our forecast does not include the need for additional equity. This concludes our prepared remarks. I will now turn the call back over to the operator for questions..

[Operator Instructions] Our first question comes from the line of Greg Gordon with Evercore..

Don, a couple of questions. First, on the all the activity in the capital around the net metering, the legislation.

Is it your expectation that you're going to be able to substantively settle issues around net metering in the context of your rate case or do you think that whatever happens in the UniSource case is going to be presidential, some combination of both? Is your expectation that you'll be able to effectively bury the hatchet with the solar leasing guys and figure out a scenario that makes everybody happy?.

Our expectations at this point is to sit down, and we and the rest of the utility industry in Arizona, and have good faith discussions with representatives of the solar leasing industry and see where that takes us..

But do you expect that those conversations would happen soon enough to affect the outcome of the UniSource case or will the commission just make a move to change the tariffs in a way --.

Jeff is sitting here. I'll let him chime in on the UNS case..

The UNS case is moving into settlement discussion, so they're through hearing. And so I expect that's going to just continue on the path that it's on. And then our case is teed up to file on June 1, so right now there is a bunch of different paths that are moving and we'll just have to see how they intersect..

Our next question comes from the line of Julien Dumoulin-Smith with UBS..

So wanted to follow-up a little bit on that solar question. I'd be curious, what exactly is the mediation that's talked about here as far as the deal with the SolarCity and the rest of the solar crowd here.

What could that ultimately come out of that? What is the scope of that perhaps, is the most precise question?.

So the scope is sit down and look at -- certainly there have been some things that have happened elsewhere and look at what we can talk about in Arizona. And so it needs to have an Arizona focus.

We're different than other parts of the country, but we certainly are open to sitting down and having good faith discussions with folks on the rooftop solar side..

So what happened in New York; is that what you're saying?.

Yes, and also there are different things with framers, but New York is obviously at different situation. And those talks were broader and also involved some community solar aspects. And so I think the important thing is understanding Arizona has got a different setting, if you will, but still there is certainly room for discussions..

And just to clarify, what's the timeline on that, just as it relates to sort of Craig's question here with the Tucson being presidential or your own case, et cetera?.

So we're working on schedule the discussions right now, but how they intersect, it's too early to say..

And then moving back to the transition side, the TransCanyon JV of sorts, I'd be curious what are you guys looking at now that PG&E in the mix.

I mean, how wide spread is this? Is there anything specific you can speak to in terms of FERC 1000 processes, et cetera, that you're looking out?.

No. The PG&E partnership, we believe at TransCanyon will give us more opportunity sets if you will. I think the scope of TransCanyon has not changed. It's still focused in the WECC region. And we'll continue to be active where we can on earth for transmission project..

And just to clarify here, given some of the bankruptcies in the sector, is there any opportunity to revisit certain transition line?.

I don't think so..

Our next question comes from the line of Ali Agha with SunTrust..

First, Jim, wanted to clarify, I believe I heard you correctly, you were saying the outage at Four Corners impacted the first quarter by $0.13 and that you expected a similar hit in second quarter as well, $0.13, is that the way we should think about it?.

No. As we said on the fourth quarter call, the headwind would be $0.13 in the first quarter and it was. I think Four Corners 5 is online now, and so we're having a little bleed into the second quarter, but certainly the majority of the impact is first quarter driven..

So more like a couple of pennies in the second quarter?.

Yes..

And then, secondly, just to get a sense. A lot of moving parts around the solar issue, but do you still have that value and cost of solar process going on as well.

And so is that still be the key sort of path sort of the critical path, if you will, to finally the commission reaching some conclusion on what they want to do with solar or are these other discussions taking precedence? Can you just line it up for us like what is the key critical path item here to clarify the solar situation?.

So the value and cost of solar docket, which is a generic docket is moving through hearings right now. And then that will go into briefings and provide the commission with information, but it's another separate track.

And so the challenge right now -- and so there multiple separate tracks that are moving forward and we don't know how those are going to intersect. And so if the value and cost of solar docket results in findings and conclusions, then presumably those get factored into rate cases and other things. It's unclear where that's going right now.

It's still in hearing..

So when you file your rate case June 1 assuming all of this is still out there, will you basically lay out what you assume makes sense and then put that as part of the rate case filing or would you leave it blank or conceptually how should we think about that?.

Now, we've got a plan. Our plan in the rate case filing continues to be around making changes to the residential rate design and moving to the three part rate structure. And that's what s you'll see proposed in our case.

Now, what the commission does with that and how they overlay some of these other dockets, that's something that something will be discussed. But that's the change here in Arizona, as a lot of the focus has moved into the rate design portion of these rate cases. And in the past, it's been much more around the revenue requirement side.

So we're seeing a lot of interest and a lot of desire to talk about rate design. And these other dockets are helping to feed into that discussion..

Last question. Don, in the recent past and even the last couple of years, there has been clearly a trend towards consolidation in the sector.

Just from an industry observer point of view, wanted to get your sense of how you're looking at that changing landscape? And given valuations as they are, does that kind of make sense as far as the ongoing consolidation trend that we're seeing in this overall utility sector?.

I think the best way to respond to that is we're focused on running an exceptional utility in one of the fastest growing territories in the Untied States..

Our next question comes from the line of Michael Lapides with Goldman Sachs..

Real quick on the rate case process. I want to make sure I'm thinking about this that you're thinking that the rate case would end with the step up that probably comes mid-2017 and then another step up to reflect the SCRs like at the end of '18, beginning of '19 timeframe, am I thinking about that right? That's the first question.

And then the second question is a little more nuanced.

In your 2016 guidance, what do you assume for the revenue step up related to both transmission and the LFCR?.

Let me just talk on the rate case side and then Jim can follow-up on a second part of your question. So similar to Four Corners, we're looking at a combination of -- we're asking in this case for the commission to consider combination and mechanism that would go and replace after the case has concluded, one of them would be a step increase.

So if the case was concluded and rates went into effect in mid-2017 that would be the outcome of just the rate case result, and then a step increase later would be factored into that. And so that's similar.

If you want to go look at what happened in the Four Corners decision in our last rate case, and it just reflects the fact that the timing of some of these plan additions occurred after they are too far out. And if we don't address it with some kind of a step mechanism, then you come right back in on another rate case pretty quickly.

Jim can talk about the --.

Yes. So Michael, we haven't really disclosed individually transmission LFCR, other than to say that those two together are large part of the gross margin increase. But keep in mind one thing about transmission. Last year we have the one-time decrease at transmission revenues reflecting our filing, so we don't expect to have that this year..

Just coming back to the rate case and the incremental step up piece, is the step up just for the SCRs? Is there a chance you could potentially get a step up in late '18 or early '19 for the SCRs and maybe even get Ocotillo win too? Just trying to think, you've got two really big CapEx projects underway, just trying to think about how you get rate recovery for both?.

Yes, so one would be at deferral mechanisms, so deferral mechanisms around SCRs isn't a step for Ocotillo..

You wouldn't be putting in the SCR cost into rates at the same time you would try to do Ocotillo.

You would defer the SCR cost until like a future case?.

No, the deferral would go on to the future case..

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

Don, you mentioned that the discussions in the three-part design.

I assume both you and Unisource right now have a two part design, just energy and fixed, is that correct?.

No, we've actually have had demand rates for, what Jeff, for almost 200,000 customers?.

Yes, again, got north of 100,000 customers right now on three part residential rate design that has the demand and energy and fixed component, and so that's I think where the largest utility or line of customer base with the demand rates today in the U.S..

And really what allows you to do that is the smart meters there were installed, correct?.

Actually, no, we've had demand rates well before we've had smart meters. The smart meters provide some additional accessory functionality for customers. And so you can do more things with them and get more information, but we were doing demand rates before we had AMI meters..

Our next question comes from the line of Shar Pourreza with Guggenheim..

I thought prior discussions in the past, including our own conversations with the ACC seem to point that they were looking to solve the at least the generic solar proceedings by the May timeframe prior to your rate case fine. It seemed like they were pretty confident on that.

But is it sort of a change or what's sort of the delay or if there wasn't delay and we were mistaken it?.

So the hearings go through next week, May 5, and then we would expect the ALJ to have a recommended order out July timeframe. And then we expect the commissioners to hear an open meeting sometimes after that..

So the generic docket would occur before the decision in our rate case, it's more of a challenge for the UNS given the timing of their rate case..

And then just one last, a little bit more of an obscure question is on TransCanyon. Is there sort of, I mean with the EIM kind of being launched, is there sort of an opportunity to go sort of beyond that real-time day ahead sort of balancing to something that could lead to something more on the resource, adequacy, longer-term i.e.

can there'd be more infrastructure spending around that region, especially if you get Mexico to join the EIM, which I think that's preliminary discussions..

So I think you need to separate TransCanyon from EIM. They're separate decisions. And EIM is not to solve resource adequacy capacity. It's really a more of a real-time intermittency type mechanism, so no connection between the two..

And you don't see that sort of expanding to regional transmission planning?.

Not the way the west is configured today, no..

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

Just to circle back on the negotiations with SolarCity and what have you. I'm just wondering what caused the change in heart, I mean you guys were battling and now it looks like pieces breaking out.

And I just was wondering if you can give us maybe a little fence as to what changed on the ground and whether or not there is -- what you see the risk of potentially unraveling.

Just was wondering, can you give us any flavor?.

So we started in 2012, we reached out and said, let's have a dialogue on how we address net metering and moved to a more sustainable model for the rooftop solar compensation in Arizona. And as I think you know that was met with a very aggressive political campaign that has continued to date.

And what happened earlier this month is a value proposition was launched by SolarCity that would put in the constitution very detailed provisions around net metering, interconnection rules, and things like that that prompted I think a response by the Arizona Legislature that was proposing and hearing two separate ballot propositions; one, around the resolution in net metering issues.

And the second one that would have ensured that solar rooftop companies were treated as public service corporation. That obviously escalated everything up to where we had three ballot propositions that were on a constitution. And we think it's probably more constructive to have dialog without ballot proposition hanging over everyone..

And that make sense, but it didn't sound like your position changed all that much.

So I guess what I'm wondering is, is there anything to point to other than the ballot initiatives in the legislature that were going pretty quickly this week? I mean, is that what was the crux? I guess, is that the pivot point in terms of SolarCity and what have you? Is that the right way to think about it maybe?.

I think the ballot proposition is coming down is what's allowing the discussions to move forward..

Our next question is a follow-up question from Greg Gordon with Evercore..

I guess, as I'm thinking about the deferral mechanism that you're going ask for, for the SCRs, that would have the effect, if I'm thinking about it correctly, of sort of immunizing you guys from the earnings impact of the costs associated with running the SCRs until you could get rate recovery.

But that would be a drag on the cash flow of the company, because the SCRs would actually be in place. So I guess I'm asking you, Jim, you must be pretty confident on the underlying cash flow profile of the core business to be able to offer to the customer a deferral mechanism that would smooth the rate impact in that manner.

Is that a fair way of thinking about it?.

Greg, that's absolutely correct. I mean, we model this in our model that we've given to the agencies. As Don alluded to on the fourth quarter call, we have one of the best balance sheets in the industry. So we can really carry those from a cash perspective without recovery, until we get in the rate base..

I misspoke earlier. I think I transposed them. The step is for the SCRs. The deferral is for Ocotillo. Either way, Greg, we're good with that so..

And we're still looking at 6% to 7% rate base growth with no equity needs through -- what year have you put out on the table as the sort of outside date where you're confident you don't need equity?.

It's really to our planning horizon..

And is that indefinite?.

It's not indefinite..

I'm just wondering how far out you guys generally plan for, three, five, eight, ten years?.

Well, we plan for five years. I mean, we have a five-year forecast..

So if rate base is growing at 6% to 7%, Don, and you can craft up rate settlement that allows you a stable return on equity construct, at a 5% dividend growth aspiration you'd actually have a declining payout ratio.

So at would point do you reassess that, especially given how the fortress balance sheet that you guys have put together?.

I think your analysis is correct, Greg. And we take a good hard look at it, usually in the fall of each year, as you know, and discuss it with our Board and take what we think are the appropriate long-term actions at that point in time..

Mr. Mountain, we have no further questions at this time. I would now like to turn the floor back over to you for closing comments. End of Q&A.

Thank you, Christine. And thank you everybody. That concludes our call. Talk to you soon..

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..