Pinnacle West Capital Corp (PNW) 2011 Q2 法說會逐字稿

Greetings, and welcome to the Pinnacle West Capital Corporation second-quarter 2011 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)

As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Becky Hickman, Director of Investor Relations. Thank you, Ms. Hickman. You may begin.

Thank you, Christine, and thank you, everyone, for participating in this conference call and webcast to review our second-quarter earnings, recent developments, and operating performance. Our speakers today will be our Chairman and CEO, Don Brandt; and our CFO, Jim Hatfield. Don Robinson, who is President and Chief Operating Officer of APS, 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 we refer to today are available on our Investor Relations website, along with our earnings release, supplemental information on our earnings variances and quarterly operating statistics, the webcast, and the Form 8-K filed this morning. 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 advise you that this call 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 of 2011 Form 10-Q was filed this morning. Please refer to that document for the forward-looking statement, as well as the MD&A section, which identifies risks and uncertainties that could cause actual results to differ materially from those contained in our forward-looking statement. A replay of this call will be available on our website for the next 30 days. It will also be available by telephone through August 9.

At this point, I'll turn the call over to Jim.

Thank you, Becky, and good morning, everyone.

The topics I'll discuss today are outlined on Slide 4. First, I will review the consolidated second-quarter results and discuss the main variances from last year's corresponding quarter. Second, I will provide a brief update on the status and outlook for the Arizona economy. Third, I will discuss our 2011 earnings guidance. And lastly, I'll close with brief comments on our credit ratings, liquidity, and financing activities.

Slide 5 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 $87 million, or $0.79 per share, compared with net income of $115 million, or $1.07 per share, for the prior year second quarter. Our ongoing earnings decreased $0.04 per share. For the 2011 second quarter, we had consolidated ongoing earnings of $86 million or $0.78 per share, versus ongoing earnings of $89 million or $0.82 per share for the comparable quarter a year ago.

Slide 6 contains a reconciliation of our second-quarter GAAP earnings per share to our ongoing earnings. The amounts for both quarters exclude results related to our discontinued operations. The discontinued operations amounts relate primarily to APS Energy Services. My remaining comments on the quarter will focus on the ongoing results.

Moving to Slide 7, you see the variances that drove the change in quarterly ongoing earnings per share. First, an increase in our regulated electricity gross -- segment gross margin added $0.01 per share, compared with the prior year second quarter. Several pluses and minuses comprised this net variance, and I will cover those items in more detail on the next slide. Second, lower operations and maintenance expenses improved earnings by $0.03 per share. The decrease largely reflects lower generation costs related to the timing and scope of planned outages at our fossil fuel generating plants. This change in O&M excludes expenses related to the renewable energy standard, or RES, energy efficiency, demand side management, and similar regulatory programs, which are offset by comparable revenue amounts.

Third, higher infrastructure-related costs decreased earnings by $0.07 per share, reflecting increases in property taxes of $0.05 per share and depreciation of $0.02 per share. The property tax increase relates to a higher property tax rate in 2011 versus 2010, as counties raise rates to adjust their lower residential assessed valuations. As Arizona's largest property taxpayer, APS has been significantly impacted by this property tax rate shift. Higher depreciation and amortization related to plant additions decreased earnings by $0.02 per share. And finally, the net impact of all other items decreased earnings by $0.01 per share.

Just a comment on property taxes, since 2008, we have seen assessed real estate values decline by approximately 20%. Therefore, counties increased tax rates to balance their budget. The net result to APS is a double whammy of stable utility-assessed values and higher rates. Also point out that property taxes are an 18- to 24-month lagging indicator and that declining real estate values of 2008 and 2009 are just now being reflected in property tax rates.

Turning to Slide 8 and the composition of net increase in our regulated electricity gross margin, total regulated segment gross margin was up $0.01 per share compared with the 2010 quarter. The components of that increase were as follows. Higher usage by APS's customers increased our quarterly results by $0.02 per share compared with the second quarter a year ago. Total weather-normalized retail kilowatt-hour sales were up 0.7% in the quarterly comparison, after reflecting the effects of our ACC-approved energy efficiency and demand side management programs. The increased retail sales reflect 0.3% customer growth, as well as higher average usage per customer, primarily by residential customers. I'll provide more information on the Arizona economy momentarily.

Higher line extension fees recorded as revenues increased gross margin by $0.01 per share. The net effect of other miscellaneous items improved gross margin by $0.01 per share. Milder weather in this year's second quarter decreased earnings by $0.02 per share, compared with the same period a year ago. Although the quarter-over-quarter comparison was minor, it was one of the central issues for our quarterly results, since last year's second quarter reflected $0.15 per share for milder-than-normal weather. Of course, we always provide guidance on a weather-normalized basis, and I will discuss some weather indicators in more detail on the next slide. The last item impacting gross margin was the net effect of lower transmission rates of $0.01 per share, which reflect the impact of the retail transmission cost adjustor rate decrease that became effective August 1 of 2010.

On Slide 9, we have summarized some of the relevant weather indicators for the quarterly comparison. A combination of mild temperatures and dry weather negatively impacted our second-quarter results by $0.17 per share, compared to normal, and thus, as previously stated, reduced our quarterly earnings by $0.02 per share, compared with last year's second quarter. We recorded 375 residential cooling degree days for the 2011 second quarter, which was 27% below normal and about 2% below last year's second quarter. For this year's May and June combined, we had the lowest number of cooling degree days since 1999, with only about half the number of days that normally are above 105 degrees.

In addition, for the second quarter of this year, we had the second-lowest average humidity recorded in the last 20 years, averaging 14%, compared with normal humidity of 18%. This dry period translated into 50% more days than normal with average humidity below 15%. Unlike last year, for July, the mild trend continued, with no real hot stretch of weather in the month, coupled with only half the number of days above 110 degrees versus normal. Therefore, our revised guidance has incorporated the negative impact of July weather, as well. For your reference, we have included a slide in the appendix that contains quarterly pre-tax gross margin effects of weather variances versus normal for the past couple of years.

Turning to Slide 10 and looking at our fundamental growth outlook in the Arizona economy, economic growth in Arizona continued to improve in the second quarter, although modestly. As shown on Slide 10, month-over-month, non-farm job growth has remained choppy but positive, as businesses began adding more temporary help and we saw some expansion in the manufacturing and financial services sectors. Second-quarter job growth in Arizona was 2%, above the national average of 1.4%. Additionally, consumer spending rebounded significantly, reflecting some recovery from the extraordinarily large pullback we observed during 2008 and 2009.

While these trends indicate that the Arizona economy is headed in the right direction, we must remain cognizant of the significant headwinds that continue. Unemployment remains high, and vacancy rates in housing and commercial real estate have only just begun to retreat from their peaks of last year. Despite lagging residential valuations for tax purposes, we've seen fairly stable home price in the metro Phoenix since early 2009 and view it as an indication that new housing supply is in balance with demand, although at very low levels for both. Weak demand for housing is mirrored in the commercial segment as well, where gains in occupancy for retail and office space are marginal at best. We believe that this situation will continue to restrain new construction and higher levels of growth for at least 2 to 3 years.

Over the long term, though, we remain confident in Arizona's fundamentals. We expect customer growth and usage to return to stronger levels as the national and state economic environments improve. Although we experienced growth in both customers and usage per customer in the second quarter, we view these changes as short term in nature and a relaxation from the recession-related conservation of the past 2 years. Looking at the next several years, we currently expect annual customer growth to average about 1.3% from 2011 to 2013, while our average annual weather-normalized retail sales in kilowatt hours will be relatively flat from 2011 to 2013, primarily due to APS's energy efficiency programs, offsetting a modest recovery in the economy.

Now turning to our earnings outlook, I point you to Slide 11. We expect our consolidated ongoing earnings for 2011 will be in the range of $2.75 to $2.90 per share. As previously discussed, this revision to guidance is driven almost entirely by mild weather in the first 7 months of the year. If not for the impact of weather, we would not have revised guidance for 2011 at this time. Our 2011 updated outlook assumes actual weather for the first 7 months and normal weather patterns for the remainder of the year. Also, we updated our expense estimates for higher estimated property taxes, partially offset by lower estimated interest expense. For your reference, an updated list of key assumptions of factors underlying our revised 2011 outlook is included in the appendix of today's slides.

On Slide 12, you see our current credit ratings. On June 24, Standard & Poor's raised its corporate credit ratings on APS and the Parent Company, as well as APS's senior unsecured debt rating to triple B up from triple B-minus. Also, S&P raised its short-term commercial paper ratings for both entities to A2, up from A3, while maintaining its positive outlook. S&P's rating increase was a reflection of several important components -- the Company's improved financial performance, evidenced by stronger credit metrics; the prospect of improving regulatory relationships; our focus on cost control during the rate moratorium; and our setting non-core assets to focus on our regulated operations. We are pleased S&P recognizes the progress we have made to date. However, it is imperative that we continue to execute operationally and financially.

I want to comment on our liquidity and financing. APS ended the second quarter with no short-term debt outstanding and has ample liquidity. Also, the rating improvement provide APS and the Parent Company better access to short-term funding, as well as the debt capital markets. Regarding financings, we have $400 million of APS unsecured notes due October 15 this year. We will look to refinance all or a portion of these notes in the upcoming months.

To close my remarks today, we continue to be comfortable with our ability to fund APS's capital expenditure program, with no new equity needed until 2012 at the earliest. And with that, I'll turn the call over to Don. Don?

Thanks, Jim, and thank you all for taking the time to join us this morning.

Since our last earnings call, we've made distinct progress in key areas and continued our track record of operational excellence. Today, I'll update you on the following topics -- one, Arizona regulatory developments; two, our renewable and other generation investments; and, three, our recent operating performance.

We know Arizona regulation and APS's recently filed retail rate case were top of mind for investors and analysts, so I'll start with those topics. Progress has been made in Arizona's regulatory environment, and we appreciate the opportunity to continue working with the Arizona Corporation Commission and various stakeholders to further enhance the state's regulatory framework, address several regulatory and operational issues, and find solutions that balance the interests of customers, shareholders, and other stakeholders alike. With this goal in mind, we look forward to continuing this dialogue in our ongoing state regulatory proceedings.

On June 1, APS filed a general retail rate case. The key provisions of the case were in line with expectations set for stakeholders through APS's 120-day notice, filed back in February. Today, I'll highlight the key requests of the case and their benefits. For your reference, these items, as well as key underlying assumptions, are summarized in the appendix to today's slide deck.

The rate case provisions contain a number of benefits for our customers, the communities we serve, and our shareholders. The requested regulatory treatment would build upon the constructive regulatory framework established in the 2009 settlement and would provide the financial support APS needs to achieve Arizona's ambitious energy goals. Through the rate application, APS has requested a $95 million net -- excuse me, base rate increase, effective July 1 of 2012.

The proposed rate changes include -- a non-fuel base rate increase of $194 million; a fuel-related base rate decrease of $144 million, attributable to the transfer of lower commodity costs from the power supply adjustor to base rates; and. a $45 million base rate increase, attributable to the transfer of revenues from the renewable energy surcharge to base rates. This change relates primarily to AZ Sun projects that will be placed into service prior to new base rates becoming effective. The next effect of these proposed changes on the average retail customer bill would be an increase of approximately 6.6%.

Slide 17 in the appendix shows the key financial assumptions underpinning the rate request, including updated rate base cost of capital and fuel prices. Other key provisions of the rate case request would continue constructive regulatory treatment and mitigate regulatory lag. Post test-year plant additions would be added to rate base through the date new rates would become effective. These additions totaled $250 million for AZ Sun and other solar projects, and $161 million for all other projects. This 18-month catch up is consistent with the methodology used in the 2009 settlement.

APS also proposes to implement 2 new recovery mechanisms that would modernize the rate-setting process and adjust electricity rates between general base rate applications. The first of these is a decoupling mechanism using a revenue-per-customer method. This mechanism would update APS's rates to address recovery of the Company's fixed costs in an environment of lower energy sales caused by energy efficiency programs and renewable distributed generation. The second mechanism proposed is a generation and environmental infrastructure tracker. This mechanism would update APS's rates for costs associated with environmental compliance investments, as well as generation additions and generation efficiency projects needed to serve APS's customers' expanding energy needs.

APS has requested its power supply adjustor be modified to allow full pass-through of all fuel and purchase power changes, increases, and decreases, instead of the current 90/10 sharing provisions. In addition, APS requested that the second 50 megawatts of the AZ Sun program be recovered through the RES until it's included in base rates. This request is consistent with the 2009 regulatory settlement and was the approved treatment for the first 50 megawatts of the program.

The Commission administrative law judge has set a procedural schedule for the rate case proceedings. In short, the schedule provides 2 possible tracks for processing the request. Under both tracks, the ACC staff and intervenors would file their direct testimony on November 18 on all matters except cost of service and rate design, and then on December 2, on those technical topics. And the hearing would begin on January 16. However, the details of the tracks are different.

One track assumes APS and the Commission staff and other parties pursue settlement discussions and settle the case. Under this schedule, the parties would enter into settlement discussions November 30, with the goal of filing a settlement agreement with the Commission by late December. Testimony supporting or opposing the settlement would be filed on January 11. The other track assumes that no settlement is reached and the parties proceed to litigation. Under that scenario, APS would file rebuttal testimony on December 23.

The schedules are noteworthy in that they demonstrate support for collaboration among the parties and improve streamlining and efficiency of the regulatory process. They also are noteworthy in that they are designed to allow for a final ACC decision by July 1 of 2012, consistent with APS's 2009 regulatory settlement. In a separate application filed with the Commission on May 20, APS requested changes to its line extension policy to allow new customers an opportunity to avoid certain new construction costs. As requested, the policy change would be effective with the decision on the general retail rate case. A procedural schedule for ACC consideration of this request has yet to be established.

As I discussed during our last conference call in April, we made our 2011 filings for rate changes related to transmission services. The total adjustment to our annual transmission rates, effective this year, is a $44 million increase, calculated pursuant to the formula rate-making procedures previously approved by the Federal Energy Regulatory Commission. Of this amount, $6 million relates to wholesale transactions with other utilities, and that became effective June 1. On June 21, the Arizona Commission approved our request to allow the $38 million balance of the adjustment related to transmission services for APS's retail customers to pass through the Company's transmission cost adjustor, effective July 1.

Turning to renewable resources and our AZ Sun development activities, we're on track with plans to significantly increase the amount of renewable energy APS provides. Investing in these resources makes sense for our customers, our communities, the environment, and our shareholders. We place strong emphasis on solar power because Arizona has some of the best solar conditions in the world. Solid progress continues on APS's AZ Sun program, the Company's plan to develop and own utility-scale photovoltaic plants in Arizona. We now propose that there will be 2 phases to this program -- the first 100-megawatt phase, which was approved in 2010 by the Commission, and a second 100-megawatt phase, which was proposed as part of the APS's 2012 RES implementation plan that was filed with the Arizona Commission on July 1.

I'll provide an update on Phase I. Then I'll outline what we have proposed for Phase II. For your reference, the appendix to our slides today contain summaries of both phases of the AZ Sun program.

For Phase I, to date we've announced projects with a total capacity of 83 megawatts and an estimated capital investment of $384 million. Construction and other development activities are progressing as planned, and we expect to place the first 45 megawatts of the AZ Sun program in service for customers later this year. One of the plants has begun delivering energy to the grid as portions of the plant are wired and tested, and a second facility has nearly all the solar modules in place as crews continue to wire the collection system. Procurement initiatives are underway to fill out the last 17 megawatts of Phase I. Now, we expect projects for the remainder of Phase I to come on line in 2012 and 2013.

Based on our success to date with the first 100 megawatts of AZ Sun, APS has requested that the Commission approve Phase II of AZ Sun as part of the Company's 2012 RES implementation plan. Phase II includes an additional 100 megawatts of utility-scale photovoltaic plants, representing a potential capital investment of up to $475 million. We estimate the facilities would be placed in service in the 2013 through 2015 timeframe. Further, we have requested regulatory treatment for the facilities through the renewable energy surcharge until the plants are recovered through base rates. This approach is consistent with the first 50 megawatts of Phase I.

Assuming the ACC's consideration follows the timing of previous years' RES implementation plans, we expect a decision from the Commission on the 2012 plan around the end of this year. We're excited about the AZ Sun program and our other renewable energy initiatives. They're important steps toward advancing Arizona's sustainable energy future.

Now, turning to the status of our Four Corners plan, during our last 2 conference calls, we discussed our multi-part plan to address several challenges facing our Four Corners coal-fired plant in northwestern New Mexico. The plan presents a creative solution to address new environmental regulations and maintains our well-balanced resource portfolio. A summary of the plan is included in the appendix to our slides. To recap the plan, APS has agreed to buy Southern California Edison's 739-megawatt interest in Units 4 and 5 for $294 million. The parties target closing the transaction in late 2012.

If the purchase transaction moves forward as planned, we intend to shut down Four Corners Units 1, 2, and 3, which total 560 megawatts in size and are wholly owned by APS. These units are smaller and less efficient than Units 4 and 5 and are not as well situated as the 2 larger units to bear the compliance costs associated with new regulations issued by the US EPA. The net result of the anticipated acquisition and closure is a 179-megawatt increase in the APS's share of Four Corners. We estimate APS's capital expenditures for environmental compliance for our revised share of the plant would be about $300 million. These expenditures would be far less than the estimated $620 million APS would need to spend if, instead, it were to bring our existing interests in all 5 plants' units into compliance with the proposed EPA rules.

The acquisition requires approval by Arizona, California, and federal regulators, and other government agencies. It also is contingent upon extensions of the land lease with the Navajo Nation and of the coal supply contract. We've made progress on our plan on several fronts. First, the land lease extension through 2041 has been approved by the Navajo Nation. Second, the Arizona Corporation Commission began a hearing on the matter on July 14 and 15, and the hearing will resume on August 8. Third, coal contract negotiations are underway.

We believe our plan has substantial merits, economically, environmentally, and socially. Our proposal clearly provides significant savings, given that the combined purchase price and environmental compliance cost for APS's revised share would be less than environmental compliance costs for APS's existing ownership in the plant. Our plan has substantial benefits in other important areas as well. We remain optimistic that APS and Southern California Edison will obtain the requisite approvals in a timely manner.

Now, turning to our power plant performance for a few moments, our base load coal and nuclear fleet continues to perform well. Our coal-fired plants continued their top-tier performance. In the second quarter, our coal fleet posted a capacity factor of 78%, which is well above the most recently available industry average of 68%. During the second quarter, our Palo Verde nuclear facility operated at an 87% capacity factor, reflecting the planned Unit 2 refueling outage during that time frame, which was completed in 35 days, as planned. We have another refueling outage scheduled for this fall in Unit 1, which we expect to be completed in about the same amount of time. These refueling outage durations reflect sound planning and execution, the benefits of our work over the past couple of years improving outage management and installing rapid refueling packages and replacing reactor vessel heads in each of the plant's 3 units.

Now, turning to the quality of our customer service, last month, J.D. Power and Associates released the results of its 2011 residential customer survey. I am pleased that APS continues its record of excellent performance in overall customer satisfaction. In 8 of the last 9 years, APS has been ranked by residential or business customers in the top 10 nationally among all large-segment utilities in overall customer satisfaction. In the most recent results, APS ranked fourth nationally among 55 large investor-owned electric utilities. More specific to our region, we were rated third among the 10 investor-owned utilities in the West. In addition to the overall customer satisfaction index, APS ranked in the top 10 nationally on 5 of the 6 components of customer satisfaction, as defined by J.D. Power.

Finally, regarding our non-utility operations, we continue to focus on our core utility operations and streamlining the Company. Toward that end, Pinnacle West is negotiating the potential sale of our competitive energy services subsidiary, APS Energy Services. As a result, APS Energy Services was classified as a discontinued operation as of June 30.

In summary, our Company's goal is to achieve top-tier performance, and we constantly work toward that objective in every facet of our business. Going forward, we are committed to maintaining operational excellence and achieving superior financial results by concentrating on our core electric utility business. This concludes our prepared remarks.

Operator, at this time we would be pleased to take any questions.

Thank you. We will now be conducting a question-and-answer session. (Operator Instructions). Thank you.

Our first question is from Greg Gordon with ISI Group. Please proceed with your question.

Gentlemen, good afternoon.

Hi, Greg.

The phase two Arizona Sun, so this is the first -- this is your first disclosure of this opportunity, correct? So this is incremental to Four Corners and others, rate-based growth drivers, should be it approved, that we should think about post-2012, is that fair?

That's right, Greg. We filed this annual filing on July 1 of this year. So this would be the first cycle where we would be talking about it publicly.

Okay, so should you be permitted to make these investments, it would obviously wrap into your assessment of your capital needs. But would it change the statement you made earlier that you would need equity no sooner than '12 at the earliest?

On the first point, yes. This would be incremental capital. And I think it's reflected -- '12 is reflected in our queue. The Arizona Sun, too. But it's not going to change our statement on equity before '12.

Great. Second question.

You obviously had a relatively mild second quarter last year. I think street consensus presumed it would get better. It actually got a little bit worse. But in terms of what you would -- we should think about in terms of the revenue requirement that you've asked for in the rate case, that does presume normal weather next year, is that right?

Yes. Correct.

Yes, it does, Greg.

Then on the tax rate, if I'm doing the math correctly, your -- are you -- did these new tax rates just into effect in the second quarter? Is that the first -- is this the first -- as I look back at your comments on what drivers were in Q1, you didn't mention higher tax rates then. So --

You mean property tax?

Yes.

Yes. I think when we came into the year, obviously we had a significant increase last year, we planned for significant increase this year, as well, as we went to the budget process. We're beginning to get looks at the bills and we are seeing rates that are higher than we thought.

Okay. So you're getting the bills for the full year, but you are getting them now.

Yes.

I got you. Just like my co-op here in New York.

And it looks like the run rate, am I right, is that the tax run rate looks like it's $30 million to $40 million higher pre-tax, just grossing up the $0.05 on an annualized basis, or is that not a fair assessment?

That's not a fair assessment.

It is or it is not?

It is not, Greg.

Can you tell us what you think or is this sort of a work in progress?

No, no, no. If you look at what we did with the ranges, we increased operating expenses by approximately $10 million to reflect the increased property tax at this point.

Got you.

And we reduced interest expense by about $5 million -- keep in mind, these are ranges -- to reflect lower interest expense for the year.

That lower interest expense is partly reflective of the borrowing cost savings you'll be getting from being able to access the commercial paper market?

Yes, it's less need to borrow. Cheaper rates because of the change to A2, or P2, in this case.

Great. Final question.

To the extent that these property taxes are running higher, are you going to be able to make post-period adjustments to your rate case to reflect that?

You know, we always try to make post test year adjustments, and we'll certainly look at any operating spent that's not immeasurable and try to account for that.

Okay. So we should assume that, under normal course of business, these are recoverable expenses, then?

They are recoverable expenses.

Thank you.

Our next question comes from Daniel Eggers with Credit Suisse. Please proceed with your question.

Hi, guys. Just real quick on the rate case process, you guys still feel comfortable with the schedule formally out that you can get this done by July, worst case scenario?

Yes, very much so, Dan.

Then from a settlement discussion perspective, nothing's going to open up until after Thanksgiving, and there's effectively a month-long window, basically, to get something resolved?

Yes.

Okay.

Then weather, have you guys seen any turnabout in -- as July has moved on, if you look at the forecast, as far as August is concerned, such that the reduction for the third quarter is already captured in the books, or have you guys put more cushion in for weather?

We've taken account of weather kind of like right up to yesterday. And there's -- we're seeing a little bit of a rebound. I think for today and tomorrow, we're supposed to hit 110 or 111 but then we'll start cooling down after this week. It's anybody's guess.

And Dan, I'll say that you keep in mind that May, June, July, all big summer months for us. We're sort of down and not a lot of time left to offset this.

Okay. And then I guess on Four Corners, I read something about the Department of Interior, you know, had a preempting EPA action and the need for investment. Do you see that changing prospectively the demands at Navajo, or are these upgrades ultimately going to be required?

Oh, I think it's premature to talk about Navajo. We and the other partners are still in discussions, early stage of discussions with EPA and other parties.

Okay, thank you.

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

Yes, hello.

Hi, Brian.

Just a followup on the revised 2011 guidance. It looks like the gross margin is down about $40 million. And I would imagine that's almost entirely related to weather.

Correct.

Then it looks like for the first half of 2011, the weather impact was negative $27 million versus normal, which I assume your guidance was based on.

Correct.

Given that -- and since the revision is for the first seven months, does that imply that July mild weather impacted margins by negative $13 million?

Well, I don't think you can -- just try to add the two together and get exactly the seven-month impact. But the implication of it is July was below normal. I don't have the stats yet. But we do get daily weather statistics -- sorry, sale statistics that we know we're under from what would be normal weather.

Okay.

And phase two of the Arizona, AZ Sun program that you laid out, is that needed to get to your RPS standard by 2015, or is some of that incremental?

The Arizona Sun II is a piece of the incremental renewable power we need to meet the standard we agreed to in '15.

Okay. Thank you very much.

Our next question comes from Paul Ridzon with KeyBanc Capital Markets. Please proceed with your question.

I had a follow-up on the property tax question.

Sure.

Jim, you talked about a lag effect. How should we think about that being a form of lag? In 2012, once you've got new rates, is this going to happen every year for a couple of years as these counties try to stay whole?

You know, I can't predict what counties are going to do in 2012. I think the implication is what we're now seeing is a steep drop in '08 and '09 work its way through assessment ratios. The housing slide we showed shows it's been fairly flat over the last 12 to 18 months. And if that -- if that relationships hold, I would think property taxes would be fairly flat next year.

Okay. So if you can capture this in post test year, you should be through the woods.

Well, we'll have captured a 20% reduction, which is pretty significant. I can't imagine we're missing another big piece of property tax.

And just in 2011, where are line extension revenues tracking, relative to the plan?

They're tracking pretty much on plan through the first six months of the year. Keep in mind, those things are very volatile, just because they're based on builders' schedules. So, I mean, we still expect to be where we thought we'd be. We'll see what happens the rest of the year.

Then the two post test year plant additions, are those captured in your -- I think it's $198 million ask, or is that going to be incremental?

No, that's captured in our ask.

Great. Thank you very much.

Thanks, Paul.

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

Thank you. Jim, could you remind us, in your revised guidance, what is the assumed utility earned OTM, and just remind us, what was the actual for '10?

The actual for OTM was 9.3, and we assume high eights in guidance.

Okay.

And secondly, also to clarify the rate case proceeding, is it fair to assume if you were to go the settlement route and that would play out to the end, would the new rates still going to affect July 1, or could they change based on the settlement?

No, the assumption of all the parties with the 12-month cycle is they would be effective July 1, 2012.

Okay, regardless of which part ultimately plays out.

That's correct, and it's also consistent with our settlement, which said rates in effect no earlier than July 1, '12.

Right, right.

And the AZ Sun II program, also just to be clear on that, I think I heard you on this, but just to be clear. So that CapEx that you would spend, which you have not, I guess, budgeted today, would not offset some other spending? This would all be incremental and could be absorbed, based on your liquidity and cash flows, etcetera?

Ali, let's clarify. We do have the '12 portion in our 10-Q updated in CapEx. But keep in mind, this will probably be a late '11 approval, which means it's hard to get a whole lot started in '12. It will probably be '13 and later loaded. It would be incremental, the way we see it today. But I'm very confident of our liquidity and the ability to fund these projects.

Okay.

And Jim, as you've said in the past, from the equity issuance point of view, the key there still remains the timing of the future rate case filing and the test year that goes with that, as opposed to the CapEx needs for the business. Is that still a fair way to think about it?

Yes.

Got it. Thank you.

(Operator Instructions).

Our next question is from Neil Mehta with Goldman Sachs. Please proceed with your question.

Good afternoon.

Hi, Neil.

So, Southwest Gas, an interveners followed a settlement in Arizona last week in their base rate case. It looked good. There was some partialty coupling, a more expedient timeline. What readover, if any, is there to the pending APS case?

I've said in the past it's hard to look at a gas settlement and relate that to electric utility, just like it's hard to look at an electric utility settlement and relate it to another company. I think, from that perspective -- again, I think not being involved shows parties wanting to come together and settle cases and dialogue around decoupling, and that's really my only read on that.

Yes. And retail usage per customer increased again this quarter. We saw it last quarter, as well. How does that impact the way you think about decoupling, because you'd be giving up any upside from higher customer usage?

Well, I would say two things. One is, we're seeing a rebound from absolute declines. And so we don't think that this big increase in customer usage is an ongoing pattern. We think it's just that rebound effect. Going forward, with flat sales being taken with decoupling and energy efficiency, decoupling is very important for us to have as a mechanism.

All right.

And final question on transmission projects. Any new developments or key projects we should be keeping our eyes on?

No. Not at this time.

Okay. Great. Thanks, guys.

Ms. Hickman, there are no further questions at this time. I would now like to turn the floor back over to you for closing comments.

Christine, thank you. Thank you again for joining us today. As always, if you need further information about our earnings or other information about our Company, please contact me or Geoff Wendt. This concludes our call.

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