Business context and reporting period
Pinnacle West Capital Corporation’s Form 10-K covers the fiscal year ended December 31, 2015; it is an annual filing, not a standalone fourth-quarter report. Pinnacle West is a holding company whose results are driven primarily by wholly owned Arizona Public Service Company (APS), a regulated electric utility serving approximately 1.2 million customers in Arizona. The filing also provides unaudited fourth-quarter results.
Financial performance and position
| Metric | FY 2015 | FY 2014 | Change |
|---|---|---|---|
| Operating revenue | $3.495 billion | $3.492 billion | Up 0.1% |
| Operating income | $854.6 million | $811.2 million | Up 5.3% |
| Net income attributable to common shareholders | $437.3 million | $397.6 million | Up 10.0% |
| Diluted EPS | $3.92 | $3.58 | Up 9.5% |
| Operating cash flow | $1.094 billion | $1.100 billion | Down $5.3 million |
| Capital expenditures | $1.076 billion | $910.6 million | Up $165.5 million |
- Approximate operating margin was 24.5%, versus 23.2% in 2014; net income attributable to common shareholders was approximately 12.5% of revenue, versus 11.4%.
- Operating cash flow less capital expenditures was negative approximately $18 million. Cash and cash equivalents ended the year at $39.5 million.
- Long-term debt, including current maturities, was approximately $3.82 billion, compared with $3.39 billion at year-end 2014. The reported debt-to-capitalization covenant ratios were 47% for Pinnacle West and 46% for APS, below the 65% limit.
- Pinnacle West and APS had $1.2 billion of revolving credit facilities available, with no facility borrowings outstanding at year-end. APS’s regulatory common-equity ratio was 55%, above its 40% minimum.
- Pinnacle West declared $2.44 per share in dividends for 2015 and paid $260 million in common dividends. Its indicated annual dividend was increased to $2.50 per share.
In the fourth quarter, Pinnacle West reported revenue of $734.4 million and net income attributable to common shareholders of $41.1 million, or diluted EPS of $0.37. For Q4 2014, the corresponding figures were $726.5 million, $5.4 million, and $0.05.
Material changes versus the prior comparable period
Full-year common-shareholder earnings improved by $39.7 million. Management attributed the improvement chiefly to the Four Corners rate change, lower operations and maintenance expense, and increased retail sales from customer growth and usage patterns. These benefits were partly offset by higher depreciation and amortization. APS’s Four Corners-related rate adjustment added $57.1 million of annual revenue; the increase was appealed and remains subject to legal proceedings.
APS fuel and purchased-power expense fell to $1.101 billion from $1.180 billion, while operations and maintenance expense declined about $40 million. Depreciation and amortization rose about $77 million. Pinnacle West’s operating cash flow was broadly flat year over year; 2014 included a $135 million income-tax refund, while 2015 investing cash use increased primarily because of higher capital expenditures.
Outlook, management commentary, risks, and unusual items
- Demand and resources: Management projected average annual customer growth of 2.0%–3.0% and weather-adjusted retail sales growth of 0.5%–1.5% for 2016–2018. APS reported a 28% reserve margin at its 2015 peak, or 21% excluding certain short-notice contractual capacity, and anticipated a 24% margin in 2016. It expected additional resources would be needed by 2017 to meet its 15% planning reserve criterion.
- Rates and recovery: APS gave notice of a planned June 2016 rate-case filing, with proposed pricing changes targeted for July 2017; the requested amount was still being developed. Recovery of costs through regulated rates is central to results. The Cholla Unit 2 retirement left $122 million of net book value in a regulatory asset; disallowance of recovery could require a write-off. A pending Arizona Supreme Court review of the SIB rate-adjustor decision could affect recovery between rate cases.
- Capital program: APS estimated capital expenditures of $1.205 billion in 2016, $1.285 billion in 2017, and $1.124 billion in 2018. Major planned spending includes environmental compliance, generation, distribution, and transmission projects. The Ocotillo modernization project was expected to increase site capacity from 330 MW to 620 MW by summer 2019, subject to permitting.
- Environmental and generation exposure: APS estimated its share of Four Corners regional-haze controls at approximately $400 million and potential Navajo Plant upgrades at up to $200 million. It estimated incremental coal-combustion-residuals compliance costs of approximately $85 million for Cholla, $15 million for Four Corners, and $1 million for the Navajo Plant. The proposed Clean Power Plan’s compliance cost remained uncertain; management said a mass-based plan could entail material annual costs. A Supreme Court stay of the plan was granted on February 9, 2016, after year-end.
- Other contingencies: An ACC commissioner opened an investigation into APS ratepayer-funded political, lobbying, or charitable spending and the relationship between APS and Pinnacle West. Environmental claims, water availability and drought, coal supply and mine reclamation, nuclear operations and spent-fuel disposal, and regulatory or litigation outcomes are additional risks. Management stated that certain identified matters were not expected to have a material impact, but several outcomes and potential costs could not be predicted.
- Tax and accounting: Legislation extending bonus depreciation was expected to produce $375–$425 million of cash-tax benefits over three years, primarily by accelerating deductions. Early adoption of balance-sheet presentation standards for deferred taxes and debt issuance costs did not affect earnings or cash flows.
Important facts for investors to verify
- Track the APS rate-case request, the SIB appeal, and whether the Four Corners rate adjustment remains recoverable.
- Assess regulatory recovery of the $122 million Cholla Unit 2 asset and the timing and final cost of coal-plant environmental requirements.
- Compare projected capital spending and resource additions with operating cash flow, financing needs, debt maturities, and dividend commitments.
- Monitor Clean Power Plan litigation and state or federal compliance approaches, particularly potential mass-based costs and effects on Navajo Nation facilities.
- Review the ACC investigation, Four Corners-related litigation, and other material contingencies for developments that could affect rates, earnings, or cash flows.