Stefanie Layton - Director, Investor Relations Don Brandt - Chairman and Chief Executive Officer Jim Hatfield - Chief Financial Officer Jeff Guldner - Executive Vice President, Public Policy and General Counsel Mark Schiavoni - Chief Operating Officer.

Greg Gordon - Evercore Insoo Kim - RBC Michael Lapides - Goldman Sachs Ali Agha - SunTrust Jerimiah Booream - UBS Charles Fishman - Morningstar.

Greetings and welcome to the Pinnacle West Capital Corporation Second Quarter 2017 Earnings Conference Call. [Operator Instructions] As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Stefanie Layton, Director of Investor Relations. Thank you. You may begin..

Thank you, Christine. I would like to thank everyone for participating in this conference call and webcast to review our second quarter 2017 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 Executive Vice President of Public Policy and General Counsel and Mark Schiavoni, APS’s Chief Operating Officer are also here with us. First, I need to cover a few details with you. The slides 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 second 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 August 10. I will now turn the call over to Don..

Thank you, Stefanie and thank you all for joining us today. We continue to demonstrate operational excellence through the second quarter of 2017 and we remain well-positioned for a solid year. Before Jim discusses the details of our second quarter results, I will provide a few updates on our recent regulatory and operational developments.

Two significant milestones in the APS rate review had been completed as we near the conclusion of that process. The hearing ended on May 2 and the administrative law judge issued a recommended order on July 26.

The recommended order supports the settlement agreement without material modification, including the 10% return on equity, a $94.6 million base rate increase, which is the equivalent of an overall 3.3% bill increase, deferrals for the selective catalytic reduction equipment at Four Corners, and the Ocotillo Modernization project, with a step increase in 2019 for the SCRs and moving the time of use window from noon to 7:00 p.m.

to 3:00 p.m. to 8:00 p.m. The administrative law judge also recommended that the new rates go into effect on September 1. APS will file exceptions and clarifications to the recommended order tomorrow on August 4.

The settlement agreement will bring about sustainable solar, a smarter energy infrastructure, a cleaner energy mix and more options for customers. The judge’s recommendation to support the settlement agreement continues to move us in that direction. The final step in the rate review process is for the commission to vote at an upcoming open meeting.

We view the progress to this point, including the judge’s recommendation to approve this settlement as very positive. With the anticipated conclusion of our rate review and the related imminent grandfathering deadline for net metering, we continue to see an increase in residential solar.

In June, we received over 4,500 applications for solar interconnections, which is more than double the recent monthly average. As of July, there have been more than 62,000 residential PV installations in the APS service territory, totaling 483 megawatts.

As you know, APS customers also receive solar power from the large Solana Generating Station and from 10 AZ Sun utility scale solar plants. Turning to our operations, Palo Verde generating station successfully completed a planned refueling outage for Unit 2 in less than 31 days, with no OSHA recordable injuries.

The units operated at 93.1% capacity factor through the first half of the year. At our Four Corners Power Plant, the installation of new selective catalytic reduction equipment is more than 75% complete. The first unit with the new equipment will come online later this year and the second in early 2018.

The 5 new fast-start flexible generating units being installed at our Ocotillo plant are more than 60% complete, and all are expected to be in service by summer 2019. The Navajo Generating Station co-owners and the Navajo Nation agreed that the Navajo plant will remain in operation until December 2019.

On June 26, the Navajo Nation Council approved a replacement lease that will allow the plant to operate through 2019 and sets guidelines for decommissioning activities that will begin after 2019. Certain additional approvals are required, which are expected to occur by late 2017.

Various stakeholders, including regulators, tribal representatives, the plant’s coal supplier and the United States Department of the Interior have been meeting to determine if an alternative solution can be reached that would permit continued operation of the plant beyond 2019.

On June 20, amidst a week long spell of temperatures ranging between 115 and 119 degrees, APS customers set an all-time record peak demand of 7,367 megawatts between the hours of 5:00 and 6:00 p.m. This record demand eclipsed the 11-year-old record of 7,236 megawatts set back in 2006.

Allow me to expand on a few more observations about energy supply on that peak day, June 20. By 8:00 p.m. that evening, the system load was still within 6% of the record peak, demonstrating how energy demand remains very strong even after the sun goes down. Production from private rooftop solar had peaked at 1:00 p.m.

that afternoon and was only producing 30% of its capacity during the 6:00 p.m. hour. Our growing customer demand and the misalignment between when our demand peak occurs and when rooftop solar produces the most energy, further demonstrates the need to continue grid enhancements, while adding peaking resources. Looking to our capital investment program.

In June, the Daisy Mountain Substation came online, helping to provide strong reliability for a growing population north of the Phoenix Metropolitan area. The new system is one of over two prototype substations that incorporate self-correcting technology.

As part of our continuing proactive approach to modernizing the grid, APS has implemented advanced technologies, completed multiple high-voltage transmission projects to further improve reliability and introduced new ways for customers to receive important energy usage information.

This planned investment strategy helps to ensure we are able to meet our customers’ increasing energy requirements. For our future resource needs, APS issued an RFP on April 12, seeking proposals for 400 to 700 megawatts of capacity to meet peak demand requirements beginning in 2021.

This RFP will be used primarily to backfill a 480-megawatt seasonal exchange agreement, which expires in 2020. The RFP required proposals to be submitted by July 14, last month. APS is currently evaluating those proposals, and we expect to have a decision by the end of 2017. In closing, we continue to be well positioned for a very solid 2017.

We’re focused on completing our rate review filing and positioning the company to continue to grow to meet the increasing energy needs of our customers. Now, I will 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 second quarter of 2017. As shown on Slide 3 of the materials, for the second quarter of 2017, we earned $1.49 per share compared to $1.08 per share in the second quarter of 2016.

Slide 4 outlines the variances that drove the change in our quarterly ongoing earnings per share. I’ll highlight a few of the key drivers. Total gross margin was up $0.27 per share compared with the second quarter of 2016, supported by stronger customer usage, favorable weather and higher transmission and loss fixed cost recovery revenues.

Higher net sales in the second quarter of 2017 compared with the second quarter of 2016 increased earnings by $0.10 per share, which we believe reflects the improving economic conditions we are seeing locally and I’ll talk about more on that in a moment, which was supported by 1.8% customer growth as well as higher average usage by our residential customers.

Weather-normalized retail, kilowatt-hour sales were up 2.9% in the quarterly comparison, net of the impact of customer conservation energy efficiency programs and distributed renewable generation.

Although we are pleased with the favorable sales growth we saw in the second quarter, year-to-date, through the end of June, sales were up 0.1% and we still expect that weather-normalized sales growth will fall within the range of about 0% to 1% for the year.

Lower operations and maintenance expense contributed $0.14 per share in the second quarter of 2017, primarily driven by less fossil generation plant outage activity during the current period.

As you recall, we had a large plant outage at the Four Corners Power Plant in both the first and second quarters of 2016 as part of the plant’s routine maintenance schedule. And keep in mind that we expect extended outages at Four Corners in the second half of this year as we prepare for the installation of pollution control equipment.

Also want to note that the quarterly O&M variance includes a charge related to the cancellation of capital projects at the Navajo Generating Station, which has an offsetting adjustment depreciation.

On the topic of depreciation, higher D&A decreased earnings by $0.01 per share in the second quarter, primarily due to increased plant in service, partly offset by the Navajo plant item I just mentioned.

Turning now to the Arizona’s economy, which continues to be an integral part of our investment story, I will highlight the trends we are seeing in our local economy and in particular, the Metro Phoenix area. As seen on the upper panel on Slide 5, the Phoenix Metropolitan area continued to show job growth above the national average.

Through May, employment in the Metro Phoenix area increased 2.4%, compared to 1.6% for the entire U.S. This above-average job growth is driven largely by the financial services sector. The solid job growth continues to have a positive effect on the Metro Phoenix area’s commercial and residential real estate markets.

Vacancy rates in commercial markets continue to fall and at are levels last seen in 2008 or earlier. Additionally, about 2 million-square-foot of new office and retail space was under construction at the end of the quarter.

We expect a continuation of business expansion and related job growth in the Phoenix market, which will, in turn, support continued commercial development. Metro Phoenix has also had growth in its residential real estate market. As you can see in the lower panel on Slide 5, housing construction is expected to continue the upward post-recession trend.

In 2017, housing permits are expected to increase by about 5,000 compared to 2016, driven by single-family permits. In fact, permits for new single-family homes in March through May were at their highest level seen since August of 2007. One factor driving this increase is that Maricopa County was the fastest-growing county in the U.S. in 2016.

That activity in the market is providing meaningful support for home prices, which have returned to levels last seen in 2008.

We believe that solid job growth, low mortgage rates and the opening up of credit to the wave of households who suffered from foreclosures during the recession should allow the Metro Phoenix housing market and the economy more generally to continue to expand at this pace over the next couple of years.

As I previously mentioned, reflecting the steady improvement in economic conditions, APS’s retail customer base grew 1.8% in the second quarter. We expect that this growth rate will continue to gradually accelerate in response to the economic growth trends I just discussed.

Importantly, the long-term fundamentals support future population, job growth, and economic development in Arizona prepared to be in place. Finally, a quick update on our financing and guidance plans.

We expect to issue about $650 million of additional long-term debt this year, one transaction at Pinnacle, including the refinancing of the $125 million term loan and one at APS. Overall, our balance sheet and liquidity remain very strong.

We plan to issue earnings guidance for 2017 after the final approval of APS’s pending rate review through a separate communication. However, to assist you with estimates, a list of key drivers that may affect 2017 ongoing earnings is included in the Appendix to today’s slides.

We also plan to release 2018 ongoing guidance on our third quarter call consistent with our standard practice. This concludes our prepared remarks. I will now turn the call back over to the operator for questions..

Thank you. [Operator Instructions] Thank you. Our first question comes from the line of Greg Gordon with Evercore. Please proceed with your question..

Thanks. Good afternoon, guys.

How are you?.

Hi, Greg..

Good. So, several questions. First on, you indicated that your – you can file exceptions to the rule by August 4. I mean, there weren’t very many material modifications to the settlement.

So, should we expect that you will have material issues with the rule or would they be limited to perhaps the fact that the recommendation bifurcates the AMI opt out, because other than that, I didn’t see any major changes?.

I think it will be mostly categorized as tweaking, Greg..

Okay, that’s great. Thanks. My second question is the weather normal sales growth as you calculated it this quarter was really quite impressive. Now, I know if I look in the appendix on Page 20 that the first – the 6 months ended weather-normal is just 0.1%, because the Q1 number looked weak, I remember asking about it at the time.

Is this a number – this 2.9%, I mean, is this a number off of which you think you can build momentum or do you think it ebbs back down to a lower number, but still one that sort of drives you towards the type of customer growth targets that we have been waiting to see, which are finally showing up? I am just asking for a little bit more color and characterization of like why did it go from such a low number in Q1, such a huge number in Q2 and how....

So I might ask Jim to comment on the comparison of the two quarters, Greg. But I will say – I mean we are still looking at, as we pointed out in the press release, 0% to 1% for the year.

And for the first 6 months, we are up only up net-net 0.1%, but for a longer term, and by that, I mean the next 2 to 3 years, the balance of the year, some of the things Jim cited, but I mean the growth here, number one in the nation, the housing permits or the house since 2007 and if you saw the number driving around the entire metropolitan area, there is apartment buildings – huge apartment buildings going up almost everywhere you look.

Different magazines and realtor.com projects Phoenix to be the number one housing market this year and next. There is a lot going on here that I think is going to continue to sustain our growth for the next few years. And Jim, I don’t know if....

Yes. I would just say, Greg, it’s a great question as one quarter we come up pretty flat to negative. We do know that consumer confidence at the residential level increased in the second quarter. And I think that’s consistent with the surge in housing permits in the second quarter.

That said we will see some consumer elasticity as they get their bills in July from the warm June. So right now, we are continuing to be led here today by the commercial sector with the things we mentioned before, State Farm completing its build-out last year, but still continuing to increase forecast as we move forward.

So, I think I would answer that by saying I think the third quarter is going to tell us a lot as well..

Okay. Move on to my last question, obviously, the quarter-over-quarter earnings comparison was incredibly punchy, $1.49 versus $1.08. But you did point to the fact that you are going to have some plant outages in the second half.

Can you quantify, just – if we were to just isolate O&M, we are just going to isolate O&M in the second half sort of second half ‘17 versus second half ‘16, what that delta looks like as a function of those planned expenses?.

So we knew our O&M was going to be back end loaded this year. I think I would look to the first quarter of ‘16 when we did similar type outages at Four Corners. That’s the guide in terms of the magnitude of that spend, Greg..

Okay, thank you very much, guys. Have a great day..

Thank you..

Thanks, Greg..

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

Good morning, everyone..

Good morning, Insoo..

After the rate case decision when you guys do provide your ‘17 guidance, have you guys made a decision on whether to potentially provide longer term growth forecast, whether it be rate base or earnings growth CAGRs?.

No, we will provide ‘18 guidance. And then as our normal practice at the end of the third quarter – I am sorry, ‘17 guidance and at the end of the third quarter, we will do ‘18 guidance. But at this time, we have no plans to go out any further than what we normally do..

Understood. And my only other question was with the latest update in the suit by Commissioner Burns and on June, the ACC denied the motion to compel it.

Is it pretty safe to assume that any other further consideration by the court near term shouldn’t delay the upcoming rate case decision?.

Insoo, this is Jeff. The Superior Court judge just heard arguments on amending the complaint that was asked at the four commissioners and the commission. I expect him to rule on that in the next week or so. And so we have got an open meeting that’s coming up in – next open meeting, the rate case could go on would be August 15 and 16.

So, I think the rate case is probably going to go before anything happens in Superior Court..

Got it. Thank you very much..

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

Hey, guys. Don, a question for you.

I know the rate case lays out some of the boundaries for this, but given kind of what you have seen for the last 6 or 9 months or even longer term and what you expect going forward, how are you thinking about your generation capacity and energy needs and whether post Ocotillo, there is need in the early 2020s for new gas-fired generation in your portfolio?.

Most likely, we would be looking at simple cycle peaking needs at that period of time..

Got it.

And can you remind me – or as part of this rate case agreement, are you allowed to actually own and operate the simple cycle? The agreement, I think doesn’t let you go into construction for some types of gas plants, but others it does?.

Yes, that’s correct..

Got it. Thanks, Don. Much appreciated..

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

Thank you. Good morning..

Good morning, Ali..

Good morning.

First question, Jim or Don, assuming the rate case settlement is approved and it looks like it will be, given that your ROE stays as it was but your equity ratio goes up somewhat, does that cause the earnings power of the company to increase as well?.

No. I would expect actually our equity ratio to sort of fall as we issue fixed income securities over the next couple of years..

So, ultimately you think that would kind of remain where it has been?.

Yes. The equity ratio and the ROE were just placed in there as parameters for us, the rate case for the black box, so the extra equity in this case, it doesn’t lead to earnings power..

I see. Okay. And then separately, when you look at the deferrals and the step up increase in ‘19, again, as part of the settlement, I recall in the past, you have talked about, I think rate base growth has been 6% to 7%, dividend growth 5%, and you have talked about earnings growth somewhere in the middle of the two.

One, did I get that, right? Have you....

That’s correct..

Okay.

But do you see that the trajectory, given the step up etcetera, won’t be smooth? Should we think about some peaks and troughs as we think about that earnings trajectory because of the timing of the step up?.

Earnings always goes in peaks and troughs. And keep in mind, when we do the step increase, we still have $0.5 billion of Ocotillo that’s being deferred, but not being earned on. So that would create a drag until it ultimately gets some rates hopefully in 2020..

I see, okay. And then more near-term, I know you talked about the planned outages and how the O&M will move over time.

But excluding that, when you look at how second quarter came out and how first half has come out, has it come out pretty much as expected on plan or how would you categorize the first half of the year?.

Yes. I think we are pleased with where we are compared to our plan this year. And beyond that, we haven’t really given any guidance and we will talk about that when we get guidance out here soon..

Okay, thank you..

Our next question comes from the line of Jerimiah Booream with Bank of America Merrill Lynch [sic] [UBS]..

Hi, good afternoon..

Good afternoon..

I just wanted to go back to the customer growth question.

And specifically, could you just remind us what percentage offset you have seen from solar installations? And specifically, could you see that affecting how you are thinking about customer growth as the grandfathering period ends later this year?.

Yes.

So I would say that we get probably as much impact of energy efficiency as we do rooftop, but we probably will have by the time rate goes into effect and installations that are valid we have received before that, we will probably end with 70,000 or so rooftop solar and that will be about 6% of our residential customer base will be with rooftop solar.

After that, remains to be seen in terms of continued growth. We get about a 1.5% or so offset typically from the EE and DE..

Got it. That makes sense.

And then just a quick clarification, if the Navajo operators reach an agreement to extend operations beyond 2019, would you be obligated to basically maintain your ownership or will you have the option or how are you thinking about that?.

Well, this is Mark Schiavoni, Jerimiah. Right now, the expectation with Navajo Generating Station, the current ownership structure would not remain in place through efforts of the Navajo Nation, Department of Interior, they are looking for alternative ownership in the future of Navajo Generating Station..

Okay. Yes, that’s fine. Thank you..

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

Thanks. Hey, the only question I have was on Slide 9. There was a third bullet point under the rule about the battery storage.

And just to make that clear, it’s an incentive program for the customer to install this battery storage, correct?.

Yes, Charles, it’s Jeff. It was a response to specific issue in the case that was not included in the settlement. And there were a couple of proposals out, but this is an incentive program for the customer. It’s funded through the DSM adjustment mechanism..

So I know we have seen some battery storage – utility scale storage in Southern California, for instance. Was there any thought about going in that direction, because obviously the situation in your system almost lends itself to that..

Charles, this is Mark. We have installed a couple 2-megawatt batteries into our system and quite frankly, we are using that as part of the solution set.

So with the way we look at storage or any technology, if it doesn’t provide the right solution at the right cost or a system reliability so it could be a capacitor, it could be storage, it could be transformer, it doesn’t matter in the technology. So we are pretty agnostic when it comes to that..

Okay, that’s all I have. Thank you..

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 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..