Pinnacle West Capital Corp (PNW) 2014 Q2 法說會逐字稿

Greetings and welcome to the Pinnacle West Capital Corporation Second Quarter 2014 Earnings Conference Call. (Operator Instructions) As a reminder, this conference is being recorded. 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 second quarter 2014 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' Senior Vice President of Public Policy, and Mark Schiavoni, APS' Chief Operating Officer, are also here with us.

First, I need to cover a few details with you. The slides that we will be using are available on our Investor Relations website, along with our earnings release and related information. Note that the slides contain reconciliations of certain non-GAAP financial information. Today's comments and our slides contain forward-looking statements based on 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 you 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 7. I will now turn the call over to Don.

Thanks, Paul, and thank you all for joining us today. As Paul mentioned, along with Jim and Jeff Guldner, we have Mark Schiavoni with us here today. Mark was promoted to Chief Operating Officer last month. Mark oversees our non-nuclear operations, while also helping us set the Company strategy. He co-chairs our sustainable cost management initiative with Jim and is one of our most vocal champions on safety issues.

Last quarter, I shared my view that Arizona's regulatory climate is stronger today because APS and the Arizona Corporation Commission were among the first to address the fairness issues associated with distributed generation and did so long before these rate design challenges became a significant financial issue for our customers. I will update you on the regulatory progress, as well as a few operational highlights and then Jim will discuss the second quarter results and update you on our economic and financial outlook.

The Arizona Corporation Commission has conducted two workshops in the value and cost of distributed generation series; the most recent on June 20. On that date, APS, along with Tucson Electric, the Residential Utility Consumer Office, or RUCO, and two Arizona solar trade associations, Arizona Solar Deployment Alliance and the Arizona Solar Energy Industries Association, filed a joint letter in the docket outlining three broad principles of rate design to which all diverse signatories agreed.

These three principles are that rates need to be customer-focused, forward-thinking, and affordable and fair. The workshop was constructive. In the end, all parties agreed that devoting time to address rate design was necessary. Following the workshop, at the ACC's July 22 staff meeting, the ACC voted 4-1 for a limited reopening of the 2013 net metering decision to consider removing the requirement for APS to file a rate case in 2015 to allow for the possibility of developing rate design options in generic proceedings.

The commissioners agreed that Chairman Stump would file a letter in the docket explaining the need for a rate design generic proceeding and providing notice that the Commission would vote on whether to eliminate the requirement for APS to file a rate case in June 2015 at an August open meeting. Commissioner Brenda Burns was the sole dissenter, only because she thought it best to open the matter and vote on the proposed change to the requirement at one time.

The exact process is currently undetermined but we expect rate design discussions to continue into 2015. Rate design changes agreed upon would likely not take effect until the conclusion of APS' next rate case. We applaud the Commission for beginning to take action to deal with rate design, showing that Arizona is a leader in dealing with these complex issues, while providing clarity to stakeholders on the next steps.

We look forward to building on the principles outlined in the joint letter and having a constructive dialogue with all parties. The ACC is taking a forward-looking approach in other areas as well. The innovative technologies workshop series also continues through the summer. The topics covered inform the rate design discussions and educate all stakeholders on new ways to address customer interest. APS is actively participating in these workshops.

Planning what's next for Arizona's energy future is our top priority. We know our customers want more options for receiving energy to power their lives, including rooftop solar. The total number of residential grid-tied solar photovoltaic systems on our system is now about 26,800. There were about 2,000 applications in the second quarter, in line with last year, although we continue to see increasing number of applicants each month this year. Earlier this week, APS presented the ACC with an additional option to complete the final 20 megawatts of our AZ Sun program.

In April, we proposed to continue our successful program of building community-scale solar, with a new plant at our Redhawk facility. On July 28, we presented the Commission with a second option that would be an APS-owned residential rooftop solar program in partnership with local Arizona solar installers. 20 megawatts is the equivalent of about 3,000 home installations. This proposal would provide a new avenue for customers who may not want to or be able to purchase or lease solar panels from third parties, so that they, too, can benefit from rooftop solar installations.

We've asked the ACC to review the proposal within two months in order to maintain compliance by the end of 2015. AZ Sun added 32 megawatts to our operations when the Gila Bend site came online in June as expected. The 10 megawatt sites in the city of Phoenix and at Luke Air Force Base are making progress and are expected to come online in 2015. Closely related to our planning for the future of the grid is our modernization plan for Ocotillo generating station, which will be an important component in managing intermittent generation, which includes renewable and distributed generation.

The certificate of environmental compatibility application will be filed with the ACC this week and hearings are expected this fall. Turning to the rest of our operations, the Palo Verde Nuclear Generating Station had another great quarter. Unit 2's planned refueling outage in April was completed in record time for the site: 28 days and 22 hours. The site capacity factor was in line with the second quarter of last year, as each quarter included one planned outage.

In May, the nuclear industry held a grand opening on Phoenix's west side for the first of two nuclear response centers and the second facility opened this month in Memphis, Tennessee. These reserve facilities are part of the industry's response to the 2011 Fukushima Daiichi incident in Japan and provide standardized equipment that can be shipped to any nuclear site in the United States in 24 hours or less. Arizona was selected as one of the sites because of the low probability of natural disasters here.

On June 2, the EPA released the Clean Power Plan which proposes state-specific goals to achieve reductions in carbon dioxide emissions measured from a 2012 baseline. As proposed, states would be required to submit their plans to EPA by June 2016, although states may be eligible for one or two year extensions. For sources on Native American tribal lands, including Four Corners and the Navajo Plant, EPA is expected to finalize a plan by June 2015.

We're working with regulators and other utilities to determine what the EPA's plan means for Arizona. We've already made significant progress in reducing greenhouse gas emissions, including permanently shutting down three units at Four Corners. E PA also issued its final Cooling Water Intake Structures rule in May under Section 316-B of the Clean Water Act. We have not determined the exact cost to comply; however, we don't expect the cost to be material.

Those of you who have followed Pinnacle West in recent years know the emphasis this management team has placed on running our core electricity business well. By sticking to our knitting, we've achieved strong operational and financial results. Looking forward, we see an opportunity to leverage our operational expertise and pursue growth through carefully selected opportunities that are close to our core business.

In an example of the kind of close to core opportunity that we intend to explore, the California ISO Board of Governors recently voted to move forward with the Delaney to Colorado River transmission line. The 500 kilovolt line would be approximately 130 miles long, 90% of which would be located in Arizona. To enable our exploration of this opportunity, we formed a new subsidiary of Pinnacle West called Bright Canyon Energy Corporation.

Bright Canyon, in turn, has formed a 50/50 joint venture to pursue transmission projects in the Western United States with the Berkshire Hathaway Subsidiary MidAmerican Transmission. This joint venture plans to participate in the bidding for the DCR line. The competitive solicitation process is expected to begin in August and culminate in 2015. It is expected that the DCR line will take three years to permit and two years to construct.

At this point, we expect the line would be in service by 2020. Given the competitive process and this time frame, we do not currently reflect any CapEx in our forecast for this line. Jim will discuss the latest economic data in his remarks, but let me provide some context. We have spent significant time with home builders in our area in recent weeks to calibrate our outlook and understand what they see and expect to see in the Phoenix housing market.

While they agree that the very near term trends are difficult to predict from quarter-to-quarter, they also agree that Phoenix is a great place to live and grow a business and the fundamentals for growth remain solidly intact looking ahead into 2015 and 2016. Let me conclude my remarks by thanking the crews and volunteers who helped limit the damage caused by the nearly 22,000-acre Slide Rock Fire in late May of this year.

Slide Rock is in the canyon directly adjacent to Sedona, Arizona, a very popular destination north of Phoenix and recognizable by its fantastic red rock formations. The terrain in this area is extremely difficult to navigate and required our crews to fly in poles and other equipment necessary to restore service to area customers. Because of the difficulty in reaching this location, much of this work was done the old-fashioned way, by hiking in on foot and using hand tools to dig holes to replace poles damaged by the fire.

Just as important, our crews performed this challenging work safely and without any recordable injuries. This is also one example of what helped APS to be recognized as industry leading in customer satisfaction. To that point, APS maintained top decile performance among large investor-owned utilities in overall customer satisfaction, ranking fifth in that category as measured by the JD Power and Associates Residential Customer Survey that was released earlier this month. I'll now turn the call over to Jim.

Thank you, Don, and welcome, everybody, to the second quarter call. The topics I will discuss today are outlined on slide 4. I'll begin with a review of our second quarter results, including earnings and the primary variances from last year's second quarter. I'll follow with an update on the Arizona economy and I'll conclude with a review of our financial outlook.

Slide 5 summarizes our GAAP net income and ongoing earnings, which are the same this quarter. As usual, my comments will refer to ongoing earnings. For the second quarter of 2014, we reported consolidated ongoing earnings of $132 million or $1.19 per share compared with ongoing earnings of $131 million or $1.18 per share for the second quarter 2013. Slide 6 outlines the variances that drove the change in quarterly ongoing earnings per share.

Lower operations and maintenance expenses added $0.03 per share, largely driven by lower employee benefit costs, including the favorable impact on lower pension and post-retirement expense that is expected to positively impact each quarter this year. Lower interest expense, net of AFUDC, added $0.02 per share, primarily driven by tax credits related to our renewable facilities and a slightly lower statutory state tax rate. The net impact of other items increased earnings by $0.02 per share.

A decrease in gross margin reduced earnings by $0.06 per share compared with the prior year's second quarter. I will cover the drivers of our gross margin variance on the next slide. Higher depreciation and amortization expenses decreased earnings by $0.01 per share, primarily due to additional plant in-service. Higher taxes, other than income tax, also reduced earnings by $0.01 per share.

As a reminder, both the gross margin and O&M variances exclude expenses related to the renewable energy standard, energy efficiency, and similar regulatory programs; all of which are essentially offset by comparable revenue amounts under adjustment mechanisms. Also, the deferrals associated with the Four Corners transaction are treated in a similar manner. The drivers I discussed exclude these deferrals as there was no net impact on second quarter 2014 results.

Turning to slide 7 and the components of our net decrease of $0.06 in our gross margin, the main components of this were as follows. The lost fixed cost recovery mechanism improved earnings by $0.02 per share, which as designed, offset some of the impact from energy efficiency programs and distributed energy. The impact of the Arizona Sun was a primary driver of the other $0.01 per share. The effects of weather variation decreased earnings by $0.03 per share.

This year's second quarter was more favorable than normal, although milder than the second quarter of 2013. Cooling degree days were 10% above normal, but 9% lower than the comparable quarter a year ago. On this topic, APS hit a peak load for the year of 7,020 megawatts on July 23 during a week-long heat wave and also surpassed last year's peak. Lower usage by APS customers compared with the second quarter a year ago decreased quarterly results by $0.04 per share.

Weather-normalized retail kilowatt hour sales after the effects of energy efficiency programs, customer conservation, and distributed generation were down 2% in the second quarter of 2014 versus 2013. Lower transmission revenue decreased earnings by $0.02 per share due to the annual update in May related to the formula rate filing and the updated estimate for the current year. We continue to expect transmission revenue to be relatively flat on a full year basis compared to 2013.

Beginning on slide 8 is a look at the Arizona economy and our fundamental growth outlook. Economic growth in Arizona generally continued its overall improvement in the second quarter of 2014, consistent with the prior four quarters, although growth remains modest. Vacant housing in metro Phoenix has fallen by more than half since its peak in early 2010 and is at its lowest level in almost six years. Housing prices have responded.

On the upper left hand side, you can see that prices on existing home sales are 10% higher than they were a year ago and up 45% from the bottom of the market in mid-2011. As for commercial buildings, vacant space continues to be absorbed in the office and retail sectors yielding steadily declining vacancy rates. As shown in the upper right, vacancy rates for industrial space reflected some sizable new developments which have just recently come online.

Both trends are indicative of the steady job growth the metro Phoenix area and Arizona have been experiencing for the last three years. Arizona has added jobs year-over-year at around a very steady 2% since the end of 2011, as seen on the lower right hand side. Business services, tourism, healthcare, wholesale trade, manufacturing, and financial services have all been sources of growth in recent quarters and highlight the sources for continued occupancy gains in the available commercial floor stock.

The lower left hand side shows that permits for new single family homes increased 8% in 2013 over 2012 and more than 75% from the low point in 2011. While single family housing permit activity this year has been softer than we initially expected, multifamily permit activity has been robust and is contributing to an overall increase in housing investment. As apartment rents and existing home prices continue to rise, we expect activity levels in both sectors to continue to expand.

As Don mentioned, we have engaged with local home builders in recent weeks to validate our view of the fundamental growth prospects for Phoenix and Arizona. Slide 9 displays selected public statements by four different homebuilding executives, giving support to the idea that Phoenix remains a very desirable city in which to work and raise a family. The sentiments expressed here are very much in line with our own.

In our conversations with the home builders, they have not wavered from these opinions. They do acknowledge that the market today is less robust than they, and, frankly, than we expected, but they are collectively quite confident that the impediments facing the housing market today are largely related to the hangover from the extreme business cycle we just went through. In particular, the spread between new home and existing home prices, while much narrower than several years ago, remains too high and buyer confidence is rising only slowly.

These factors, along with other market dynamics, have led to subdued builder confidence at the moment. Although this situation may slow the momentum for single family home construction in the near term, it has created an opportunity for multifamily market to expand at its best rate in six years, as I mentioned earlier. On balance, we see signs of sustained improvement in our economic environment and a gradually steady recovery.

As in past recoveries, it is likely that each successive year in the near term will be stronger as we go forward. Key in this pattern is a steady absorption of vacant housing, which provides additional price support to existing homes and by extension, the new home market. Reflecting this steady improvement and economic condition, APS's customer base grew 1.4% compared with the second quarter last year.

We expect that this growth rate will gradually accelerate in response to the economic growth trends I just discussed. It is easy to draw conclusions on long-term growth each quarter; however, we are planning and running our business for the long term. Nothing we see changes our view that the long-term fundamental supporting future population and job growth in Arizona appear to be firmly in place.

Finally, I will review our recent financings and the financial outlook. Referring to slide 10 in terms of our recent financings, on June 18, APS issued $250 million of new 10-year, 3.35% senior unsecured notes. The proceeds from the sale were used, along with other funds, to refinance a $300 million, 5.8% maturity on June 30. We expect to need up to $350 million of additional long-term debt later this year.

During the second quarter, APS temporarily purchased five series of pollution control revenue bonds totaling $166 million on their mandatory tender dates and we expect to remarket or refinance the bonds within the next 12 months. APS also remarketed two other series of pollution control bonds totaling $49 million during the quarter. Overall, liquidity remains very strong.

At the end of the second quarter, we had total available liquidity of over $1 billion, with a total of $177 million of commercial paper outstanding, principally at APS. On May 9, we refinanced the Pinnacle West $200 million and the APS $500 million revolving credit facilities that would have matured on November 16. These new facilities mature in 2019. As we head into the important third quarter, we continue to expect that Pinnacle West consolidated ongoing earnings for 2014 will be in the range of $3.60 to $3.75 per share.

A complete list of factors and assumptions underlying our 2014 guidance is included on slide 11. I will conclude with a brief update on the Four Corners rate rider proceedings. Testimony recently concluded and hearings will begin next week. The consensus from most intervenors is that the transaction is a good investment for APS and its customers. The focus on the testimony and the hearing center on the determination of fair value rate of return.

APS believes that its interpretation is the most consistent with prior orders as asserted in our testimony. This concludes our prepared remarks. Operator, we will now take questions.

(Operator Instructions) Our first question comes from the line of Dan Eggers with Credit Suisse.

Good morning, guys.

Good morning, Dan.

On the housing outlook, you said it was maybe a little bit slower right now than you had anticipated, but more optimism out of the home builders. Can you just maybe convert how we should think about that optimism really being real versus home builders being optimistic, because by nature they tend to be.

Sure. I had some of Jim's team do a little research and I personally called a few of the CEOs I know to get a good perspective. I've got several pages of notes. I'm not going to read them all, but let me hit a couple of high points. Virtually all were bullish on the Phoenix area, as you say, no surprise there. It's their job to be bullish. Some of the observations, one, they still see the labor markets being constrained and that's a negative, but it's sort of a temporary six month to 15 month phenomenon.

Most of them cited 12 consecutive quarters of job increases and lower unemployment rates, personal income growth, a high jobs to permit, meaning building permit ratio, and favorable long-term outlook with respect to both population and job growth. Statistic that surprised me, but actually when we dug into it was validated by what we're seeing with their contacts to our folks that reach out to us about 12 to 18 months before they actually break ground to get the electric set up, but over the last 12 months, the number of builder communities in the area, and they range in different size, but in absolute number, they've increased from 300 to 400.

So we've seen a 33% increase in the number of communities. Also, one specifically, heard this reaction from several, is they're not going to give these homes away. They see this bow wave of demand coming and one pointed to me that his average sale price increased 35% in the last 12 months. So that's just some of the commentary we saw. Also, there's a tremendous increase in multifamily construction and the builders see that as where potential buyers are staging themselves now and they still talk about the amount of traffic at their display homes that's up substantially.

But the sales are not tracking the demand there and they attribute much of that to consumer confidence and concerns over job security. Hope that helps, Dan.

Yes, thank you for that. If I look at slide 17 where you show the PV applications, the residential level, those numbers are relatively consistent year on year, so not a lot of additional upside. Can you just talk about where you're seeing those permits placed? Are you seeing changes in demographics? Are you seeing more of a bias between existing homes and new homes or any kind of trends we can draw from that data?

No real changes in the demographics that we've seen 2014 compared to 2013.

Okay, so it looks the same? The last question, just because maybe I didn't pay enough attention to it is on 111-D as relates to Four Corners and the different treatment for the tribal lands. What are the considerations the EPA is taking up relative to a full national perspective and how do you see that prospectively affecting this investment?

This is Mark Schiavoni. Quite frankly, we don't see any differences in the way they're going to treat it, but we, quite frankly, don't know much more of what they're going to do with the tribal lands. We'll know this fall. That's when we expect to get feedback for what will take place on tribal lands.

Okay. Thank you guys.

Our next question comes from the line of Greg Gordon with ISI Group.

Thanks. Jim, I want to believe that your longer term growth expectations are ultimately going to come to fruition and that they're just sort of trailing behind because of a slow start to the recovery. But you are, year-to-date, sales are tracking 200 basis points behind customer growth, not the 150 that you articulated you see as being the long-term average. Am I just focusing in on too small of a dataset and should we be waiting for a longer term trend, look through the third quarter, the fourth quarter, before we see how things play out?

As I said in my remarks, Greg, I think it's easy to look at a quarter and extrapolate something. Last year, if I look at three and six month trends, we were up. So there's a lot of volatility in these numbers today and I would -- the third quarter is always big for us and the fourth quarter in terms of momentum into 2015. So I'm not putting -- I'm not worried about our long-term growth trend. As I said, we believe in the fundamentals in Arizona and Phoenix.

If you look at what is driving the delta between customer growth and sales growth, the impact of DG is still probably the smallest piece of that?

Yes, we see a little usage per customer and that really relates to the consumer confidence in EE. DG continues to be about 0.5% with really the EE and consumer confidence, which is driven by job security or other things going on in their life being a bigger part of that.

How's July been in terms of underlying demand trends?

It's been good. Weather's going to come in pretty much close to normal and we've seen usage demand pretty much according to expectations.

Okay. Don, you made a pretty innovative filing with the Commission to ask to participate in rooftop solar market in a pretty significant way. It would be 10% of the installs, if you were approved on a prospective basis. That would be in rate base. What makes you think that the thought process of the ACC's evolved to the point where they think that the utility should be one of the service providers for rooftop solar, because historically, that has not been the case.

Well, it hasn't except for we did the, a couple years ago, the pilot project the Commission approved up in Flagstaff, the community power project, and we learned a lot from that experience. In this case, when we're doing rooftop solar, first, there's no cost shift from, let's say, lower creditworthy customers to higher creditworthy customers, as there is under the current, I'll call it, the lease structure that some solar companies are using, because credit score's not an issue.

It's basically a structurally sound roof and a customer is good to go. There's no upfront investment. We handle the maintenance. We'll use reputable Arizona-based installers, so it's jobs in Arizona. The customers are guaranteed a $30 a month bill credit for 20 years from a Company that's been around for 127 years and has a AA credit rating and most of the others can't claim that.

One final question. Jim, as you look at the financial model for the Company and you look at the aspiration to earn at least 9.5% on ROE on the capital investment. With the capital investment growing, if we're looking at least a short period where sales growth is stagnant, do you have a revenue model through the rate adjustors that you currently receive and your ability to control costs that still allows you to hit your earnings targets in lieu of --

Greg, I think it's important to remember while we're in a base rate stay-out, we have mechanisms, Four Corners in 2015, we have AZ Sun, we have the TCA, LFCR. So the top line is not stagnant from that perspective.

Greg, this is Don. We are very confident we'll make our numbers.

Thank you, guys. Have a good afternoon.

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

Good morning. So first, just picking up on Greg's last question if you don't mind. On the solar rooftop program, if you will, how do you ensure that you'll be competitive or how do you just think about competitiveness versus the broader marketplace, if you can elaborate a little bit.

Well, because our program will apply to the broad market, whereas the current programs are effectively discriminate against low income customers. A Credit score to qualify for a lease arrangement or to purchase the solar, come outright and purchase it, basically skews that market to higher end customers, whereas this, there is no credit score requirement, just a structurally sound roof. It's across the whole system and there's no subsidization from one credit category of customer to another.

Julien, this is Jeff Guldner. One thing to keep in mind, too, this is meant as an option, so it doesn't displace the current folks that are out there. This is simply saying that we extend a program that's modeled like our Arizona Sun program around utility ownership to a broader set of customers than probably could get it today.

Got you. Could you expand a little bit about where and how big this program could get? I know it's a little early, but obviously this is the growth subject.

As it's filed right now, this is a compliance program. We've got a compliance requirement in our Arizona Sun settlement commitment for 20 megawatts of generation. If you convert that 20 megawatts, it's either a 20 megawatt utility scale project or it's 3,000 smaller solar rooftops. That's how we're thinking about this program.

Got you. All right. Excellent. Moving on, you talked here about creating a new transco, 50/50, it was also in the context of a broader Western exploration from what I could tell, right?

That's correct.

In that vein, what other opportunities are you exploring outside of what you specifically called out?

Well, we're looking with our partner on several opportunities in the west. None are as far along as DCR, which is front and center right now.

Got you. Could you just elaborate a little bit more on the weather norm sales growth trends? How much of what we saw in the quarter is energy efficiency versus, as you said, consumer confidence, what have you?

Well, energy efficiency, DE, consumer confidence, roughly $0.06 a share offset by customer growth of $0.04 and then slightly lower usage, about $0.03. So all together, about $0.06.

Excellent. Thank you very much.

Thanks, Julien.

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

Thank you. Good morning.

Good morning.

Jim, can you remind us in your forecast for weather normalized sales, what the assumptions are? If I recall correctly, for 2014, you'd assume about 0.5% and going forward about 2% a year, is that right?

0.5% this year, looking through 2016, on average 1%.

Okay. How sensitive are your plans for the next rate case filing around where these sales numbers do come out? If you don't hit those targets and let's say we are flat to even down, how much capacity do you have in terms of staying away from the rate case filing?

We're confident, even stressing sales under the model that we will hit above 9.5% in the.

Okay. Just to give us some cushion around that, would that be even a negative sales scenario or flattish sales scenario?

I really think since 2008, we've had negative sales every year, including since the stay-out went to effect and we haven't wavered from our commitment.

Separately, on the filing for the solar rooftop option, does that sort of signal to us that you guys sort of -- the feedback you were getting from the Commission would suggest that they were perhaps not that supportive of the utility scale kind of model and so this kind of gives them another option to look at? Or do you think the early scale 20 megawatts Redhawk is still a viable option in front of the Commission?

Ali, this is Jeff. This is simply filed as an option. What the Commission will do is as they're considering the application that we've made, they'll consider both the 20 megawatt utility scale one and then this distributed alternative as an option.

Ali, I'll add, it was an issue of feedback from the Commission. It was listening to our customers. There's a significant segment of our customers, as a matter of fact, a majority, that were locked out of the solar, rooftop solar market because of either lack of credit standing or lack of upfront cash to invest in.

Okay. Last question, as you look at your sales comparisons going forward, you're going to run into some easier comparisons. You had negative numbers reported in the third and fourth quarter last year, weather normalized. Can you just remind us what were the factors there that perhaps don't get repeated this year as we look at the second half numbers for sales growth?

Ali, there's several trends that did into that. For example, last year we had a very cold first quarter, so customers got high bills. We had a very warm second quarter, so they got high bills. And that leads to lower levels of usage. We think a lot of the last half of 2013 was really the impact of a very strong first half of the year as it relates to sales and the impact of weather.

Okay. Fair enough. Thank you.

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

Hey, guys. I'm just trying to think a little bit longer term about kind of where rate base is going. You obviously give your CapEx forecast in the appendices but also, things that could provide upside to that level. Could you just kind of summarize and it may be kind of a short list, what are things that could provide incremental upside to rate base or even capital spending levels that aren't necessarily in your current CapEx forecast through about 2018 or so?

Well, the upside would be certainly outside of rate base, transmission, which currently isn't in our forecast. AZ Sun's not in our forecast at this point because it's just a proposal. I think we're reflecting customer growth in the base infrastructure in T&D. So that's sort of the two things I can point to with some visibility.

Got it. Is Ocotillo currently in the forecast? I know it's not due online until 2017/2018 time frame.

It is. The build will start in 2016 and 2017 for the most part, the same with the SCRs at Four Corners is really a 2016/2017 CapEx period.

Got it. Thanks, guys. Much appreciated.

Our next question comes from the line of Kit Konolige with BGC.

Good morning.

Hi, Kit.

Just had a question about the political situation, I believe there's a primary on, I think it's, August 26. Can you give us a sense of how that team of Parker and Mason is doing in the Republican primary?

The voting doesn't start until, I guess, the end of this week, the early voting and you're right, the election, the primary is August 26.

Do you guys have any -- I don't know if there is any polling on an ACC race or do you guys have any sense of who's ahead? Maybe you can also give us a little background on how much of an issue DG has become in that race or solar in particular?

There's no good polling available. Kit, I'd suggest, each of the candidates, their websites will kind of give you an inclination of their issues.

Okay. Fair enough. Thanks a lot, Don.

Thanks, Kit.

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

Does the DCR transmission line project, has FERC set the allowed ROE on that or is that also part of the competitive bid process?

It's part of the competitive bid process and like Don said in his remarks, if we're selected, we won't know until early 2015. It's a 2020 in-service date. We have a lot ahead of before we even count on DCR at this point.

Got it. That's the only question I had. Thank you.

Thank you.

Our next question comes from the line of Paul Ridzon with KeyBanc Capital Markets.

Your O&M is tracking very well year-over-year. What should we look for the back half of the year to show?

We do know that, from an overall perspective, we have more fall outages than we have in prior years, so that's probably going to put a little stress on O&M. But overall, I would say that the things Mark and I and the rest of the leadership team are doing around the sustainable cost is providing dividends now. As we're implementing enterprise process improvement, we think we'll be able to keep that going for at least a couple years. At some point, we're going to get into wage inflation and that's just the way it's going to be, but right now, we're still working at fairly flat O&M.

Any favor on the 790 to 810 range?

We'll look at that as we get into third quarter and we plan our outages and we see how the summer goes. Remember, we have storms and we have stress in equipment and the third quarter's key in terms of where we'll be. We'll update that at the end of the third quarter.

What's the status of the discussion around the tax position of leased solar?

The position now, by the Department of Revenue, is they are subject to property tax. They have been sending out assessments to be paid in 2015. Nothing's changed on the ruling at this point for the Department of Revenue.

Okay. Thank you.

Our next question comes from the line of Jim von Riesemann with CRT Capital.

I want to just touch base on the solar topic a little bit. Is there anything you unique in your proposal that's different than, say, what the competitors are doing right now? I know one of the big hang-ups is the lien that gets attached by the competitors. Are you going to do something where you're absorbing that cost so if somebody tries to sell their house, there's no $30,000 lien or so attached to the home? Are you guys doing something different?

That's correct. There is no lien on the home. Basically, we're renting, for 20 years, the roof space and the customers are eligible to cancel at any point in time. So when they sell the home, if the new homeowner doesn't want solar on his rooftop, his or her rooftop for whatever reason, we'll remove it and put the roof back in the shape it was before the equipment was up there.

That sounds like a unique proposition that could actually improve the penetration rates pretty high, maybe nullify --

We think it's very customer friendly.

And then they get a creditworthy counterpart and somebody who will answer the phone calls, right?

Exactly. We stand behind it.

Second thing is, I know we've talked a lot about the housing market and some of the disconnects there but can you talk about what's going on in, call it, wage or income growth in Arizona. Is that flat or is it kind of rising?

No, in terms of wages, we've seen wages grow 3.1% year-over-year, so we're having strong wage growth. Personal incomes are up almost 3%. So it's really a lot around a couple things that Don mentioned. Certainly, credit's tighter today. You need a bigger down payment and just confidence in the economy is still not where it was, I don't think. I think all these things are impacting.

Okay. I forgot to ask the second part of my question on the solar thing, so I apologize for jumping around. With this solar proposal that you're doing, is that going to go into rate base or is that going to go outside of the utility?

If it's approved by the Commission, it would be a rate-based item.

Okay. What would be your initial investment out of all this?

We think it's $60 million to $65 million, roughly. A lot that will depend on the size of the installation, the number and so on.

Great. Sounds good. That's all I need, guys. Thank you.

Thanks.

Our next question comes from the line of Rajeev Lalwani with Morgan Stanley.

Hi, thanks for taking my question. I wanted to come back to just the confidence in hitting some of your targets and numbers going forward. Can you talk more about the specific leverage you have, be it O&M, CapEx, equity that will help you hit the numbers? Second, relating to that, to the extent that you can hit your numbers for whatever reason, couldn't you then just go ahead and file a rate case? Obviously, this is all assuming that the Commission approves your request.

Leverage we have, we don't plan on issuing equity until 2016 at the earliest. You saw in the numbers flat O&M with benefits down. That continues to be a lever. I would say overall cost control is a focus of this Company and we're managing costs well and we have the mechanisms I talked about.

We've said we didn't want to file in 2015, so we'll see how that goes. We have large CapEx going in 2016, 2017, in-service 2018. So moving the rate case back, certainly lines up better with our CapEx spend. As Don said, we're highly confident that we're going to hit our numbers during this period.

Okay. And then are you envisioning or does your request for the Commission to have some sort of stay-out period or would they just potentially remove the requirement to file a rate case and you can come in at any time?

Remember under the settlement, we could not file until May 31, 2015 and then that metering day ordered us to sort of come in on that date. If they remove that, it's open ended after May 31, we could file any time. We could file in last half of 2015, 2016, 2017. There's no requirement at that point.

Great. That was it. Thank you, sir.

Our next question is a follow-up question from Julien Dumoulin-Smith with UBS.

I just wanted to get some clarity, if you wouldn't mind, about when you would expect to see new solar tariffs in place coming out of both these workshops and revisiting the broader subject of solar tariffs? Secondly, just to be very clear about it, when would you expect to file another rate case, given your commitment to continue earnings your ROE irrespective?

So on the first subject, we have not asked nor do we expect any change in the $5 tariff at this point. Remember, that tariff goes to offset the LFCR, so there's no income impact to APS. Second of all, we wouldn't file until at least 2016, at the earliest, and that would be dependent upon earnings and allowed ROEs around the country and some of the other things.

Just to be clear, in theory, when would that $5 tariff at least be revisited, just procedurally speaking.

Julien, it's Jeff. That would be, if you do a rate design change or a change like that, that would happen in the next rate case.

Got you. In some sense, you would be revisiting that here in the near term, subsequently implementing whatever changes came out of that at the conclusion of a rate case in 2016?

Conceptually, the Commission right now is talking about doing some generic rate design discussions that would benefit from having our rate case come after those discussions have occurred, which is part of the desire to move that out to 2016. Once you get you through those discussions, then you could begin to implement those in that subsequent rate case.

And there would be no requirement, even in 2016, for you to file, right? That's just your -- that would be subject to your decision.

The proposal right now that they're talking about is to lift the requirement that we file in 2015 that was in the net metering decision. If you lift that back, you would go back to the underlying settlement, which had a no earlier than requirement.

Right, great. 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.

That concludes our call. Thanks, everybody.

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.