Business context and reporting period
Pinnacle West Capital Corporation (Pinnacle West) filed this combined Form 10-Q for the quarter ended March 31, 2018. Its principal business is Arizona Public Service Company (APS), a vertically integrated, regulated electric utility serving most of Arizona. Figures below are generally Pinnacle West consolidated and in U.S. dollars; the quarter is seasonally affected by weather and maintenance timing.
Financial performance and position
| Metric | Q1 2018 | Q1 2017 / comparison |
|---|---|---|
| Operating revenue | $692.7 million | $677.7 million; up 2.2% |
| Operating income and margin | $31.3 million; 4.5% | $67.4 million; 10.0% |
| Net income attributable to common shareholders | $3.2 million; diluted EPS $0.03 | $23.3 million; diluted EPS $0.21 |
| Operating cash flow | $166.9 million | $140.1 million |
| Capital expenditures | $361.0 million | $348.8 million |
| Cash and cash equivalents, March 31 | $15.4 million | $13.9 million at December 31, 2017 |
Revenue growth did not offset higher operating costs. Operating and maintenance expense rose $39.6 million, depreciation and amortization increased $17.2 million, and taxes other than income taxes rose $9.8 million. Fuel and purchased power expense fell $15.3 million. Operating margin contracted materially; net margin attributable to common shareholders was approximately 0.5%, versus 3.4% a year earlier.
Pinnacle West reported $5.15 billion of total equity and $17.15 billion of assets at quarter-end. Long-term debt, including current maturities, was $4.87 billion; short-term borrowings were $369.9 million. The $582 million current portion of long-term debt compares with $82 million at year-end, largely reflecting classification as current maturities, not a comparable increase in total long-term debt. Current liabilities exceeded current assets by approximately $917 million. Management said the companies had ample borrowing capacity and access to credit facilities. APS reported a 53% common-equity ratio under the ACC definition, above its 40% minimum requirement.
Operating cash flow exceeded the prior-year quarter, but investment outflows remained substantial. Cash used for investing was $361.1 million, and financing provided $195.8 million, including net short-term borrowing and $75.9 million of common dividends paid. APS operating cash flow was $177.3 million, capital expenditures were $355.0 million, and cash at quarter-end was $14.0 million.
Material changes and drivers
- Common-shareholder earnings fell about $20 million. Management cited customer refunds related to lower federal tax rates, higher planned outage costs, and higher depreciation rates. These were partly offset by the 2017 retail rate settlement, higher transmission revenue, and favorable non-service pension credits and construction allowances.
- Weather reduced the quarter’s revenue less fuel and purchased power by an estimated $14 million. Weather-normalized retail electricity sales declined 0.4%, while APS customer count grew 1.7% year over year.
- Tax reform lowered the federal corporate tax rate to 21%. The ACC approved an annualized $119.1 million retail rate reduction for the remainder of 2018, effective with the first billing cycle in March. The company recorded a substantial regulatory liability for excess deferred taxes; its eventual customer pass-through remains subject to regulatory processes.
- Capital spending remained high. APS estimated capital expenditures of $1.181 billion in 2018, $1.153 billion in 2019, and $1.211 billion in 2020.
Outlook, risks, contingencies and unusual items
No specific earnings guidance was provided. Management projected APS customer growth of 1.5%–2.5% in 2018 and 2%–3% on average over 2018–2020; weather-adjusted retail sales growth of 0.5%–1.5% for both periods. The filing cautions that conservation, efficiency measures, distributed generation, economic conditions, and weather could cause results to differ. Management estimated normal weather variations can change annual net income by up to about $10 million, with extreme variations historically producing impacts above $20 million.
- Rate and regulatory matters: The 2017 rate settlement set an authorized 10.0% return on common equity and rates effective August 19, 2017. Appeals and a customer complaint remain pending; a hearing on the complaint was scheduled for September 2018. APS cannot predict the outcome.
- Generation transition and environmental exposure: Management considered it probable that the Navajo Generating Station would stop operating in December 2019. APS intends to seek recovery of its $95 million remaining book value and closure costs, which may be material; recovery is not assured. APS also reported estimated Four Corners pollution-control costs of about $400 million for its 63% share, plus potential coal ash compliance and other environmental costs.
- Four Corners matters: APS and NTEC had agreed in principle to a $45 million coal-supply dispute settlement, of which APS’s share was about $34 million, subject to final agreements and approvals. APS also paid NTEC about $24 million in March as an advance for coal. NTEC and 4CA agreed in principle to a purchase of 4CA’s 7% Four Corners interest around July 2018, subject to documentation and approvals.
- Policy uncertainty: A proposed Arizona ballot initiative would require 50% renewable energy by 2030; the company cannot predict whether it will qualify for the ballot or its outcome. ACC proposals to change renewable-energy policy and continuing federal environmental rulemaking could affect operating and capital costs.
- Other exposures: Nuclear operations, fuel and power prices, counterparties, pension assets, rate recovery, and access to capital remain risks. Credit downgrades could trigger substantial collateral requirements under energy and insurance arrangements. The company disclosed no material change in contractual obligations outside the normal course of business.
- Accounting and tax items: Adoption of the new revenue standard had no material financial-statement impact. The company early adopted guidance to reclassify tax effects of tax reform from accumulated other comprehensive loss to retained earnings; this did not affect income from continuing operations. New lease accounting is expected to add lease assets and liabilities to the balance sheet beginning in 2019; the impact was still being evaluated.
After quarter-end, the Pinnacle West board declared a $0.695-per-share dividend, payable June 1, 2018. Management also expected $60–$75 million of cash tax benefits over the next two years from bonus depreciation for qualifying projects, subject to interpretation of tax-law transition rules.
Important facts for investors to verify
- Whether APS’s tax-related customer rate reductions and deferred-tax refunds materially affect earnings and cash flow through the year.
- Progress and outcomes in the pending rate-case complaint, appeals, and regulatory approvals, including recovery of environmental and plant-retirement costs.
- Whether Navajo Plant operations cease as expected in December 2019, and the amount and recoverability of associated retirement costs.
- Final terms, approvals, and payment timing for the NTEC coal-supply settlement and proposed Four Corners ownership transfer.
- Funding of APS’s projected capital program, upcoming debt maturities, liquidity capacity, and actual cash generation relative to dividends.
- Actual customer and sales growth versus management’s projections, especially the effects of weather, conservation, and distributed generation.