Business Context and Reporting Period
Pinnacle West Capital Corporation (Pinnacle West) filed this unaudited Form 10-Q for the quarter and six months ended June 30, 2013. Its wholly owned subsidiary, Arizona Public Service Company (APS), is a vertically integrated electric utility and accounts for essentially all of Pinnacle West’s revenue and earnings. Results are seasonal and interim performance may not indicate full-year results.
Key Financial Metrics
Amounts below are for Pinnacle West unless otherwise indicated; dollar figures are in millions except per-share amounts.
| Metric | Three months ended June 30 | Six months ended June 30 |
|---|---|---|
| Operating revenue | $915.8; prior year $878.6 | $1,602.5; prior year $1,499.2 |
| Operating income | $259.8; prior year $254.5 | $346.7; prior year $302.5 |
| Net income attributable to common shareholders | $131.2; prior year $122.3 | $155.7; prior year $114.1 |
| Diluted EPS | $1.18; prior year $1.11 | $1.40; prior year $1.04 |
| Operating margin | 28.4%; prior year 29.0% | 21.6%; prior year 20.2% |
- Cash flow: First-half operating cash flow was $454.3 million versus $458.6 million. Capital expenditures were $376.6 million, implying approximately $77.7 million of operating cash flow less capital expenditures. Cash ended the period at $27.8 million.
- Debt and liquidity: Pinnacle West reported $3.42 billion of total debt, including current maturities and Palo Verde sale-leaseback notes, versus $3.32 billion at December 31, 2012. Current liabilities exceeded current assets. Pinnacle West had no commercial paper borrowings or borrowings under its $200 million facility; APS had $30 million of commercial paper outstanding and access to $1 billion of revolving facilities, with no facility borrowings reported.
- Capital and dividends: APS’s defined common equity ratio was 56%, above the ACC-required 40% minimum. Pinnacle West declared dividends of $1.09 per share for the first half, compared with $1.575 in the prior-year period.
- APS results: First-half net income attributable to APS’s common shareholder was $160.0 million, versus $120.8 million. APS operating revenue was $1,600.9 million, versus $1,497.8 million.
Material Changes Versus Prior Period
- First-half Pinnacle West common-shareholder income increased $41.6 million, or about 36%, and diluted EPS rose from $1.04 to $1.40. Management attributed the improvement mainly to the 2012 retail rate settlement, higher retail transmission revenue, increased sales from customer growth and usage patterns, and lower net interest expense.
- Second-quarter common-shareholder income rose about 7%. Higher revenue and retail transmission receipts were partly offset by weather effects, higher fuel and purchased-power costs, increased operations and maintenance, and higher depreciation.
- First-half operating and maintenance expense increased $25.7 million, while depreciation and amortization rose $9.3 million. Net interest expense declined $10.2 million.
- Operating cash flow was broadly stable year over year. Lower capital spending contributed to reduced investing cash outflow; financing cash outflow increased.
Outlook, Commentary, Risks and Unusual Items
- Outlook: No formal earnings guidance is stated. Management expected average annual customer growth of about 2% and weather-adjusted retail electricity sales growth of less than 1% for 2013–2015. Estimated APS capital expenditures were $1.094 billion in 2013, $1.030 billion in 2014 and $1.190 billion in 2015; these estimates assume the Four Corners acquisition closes.
- Regulation and rates: The ACC had approved a settlement effective July 1, 2012, with no net base-rate change and a stay on a general rate case filing before May 31, 2015. APS’s 2013 renewable-energy budget was approved at $103 million. APS sought approval for a proposed net-metering change and a 2014 renewable-energy budget of about $143 million after quarter-end.
- Four Corners: APS’s proposed purchase of SCE’s interests in Units 4 and 5 for an adjusted purchase price originally set at $294 million remained uncertain, with a new coal-supply contract and regulatory considerations outstanding. APS expects to close Units 1–3 if the purchase proceeds. Environmental-control costs and recovery in rates remain important uncertainties.
- Environmental and legal exposure: Potential costs include APS’s estimated shares of approximately $300 million for Four Corners regional-haze controls, up to $158 million for Navajo Generating Station upgrades under EPA’s proposal, and approximately $187 million for Cholla controls if its challenge fails. The filing also describes unresolved Clean Air Act litigation, Superfund matters, and possible enforcement or claims related to the 2011 Southwest outage; potential losses for several matters could not be reasonably estimated.
- Other risks and contingencies: Risks include weather and demand variability, fuel and purchased-power costs, plant reliability, rate recovery, regulatory changes, environmental rules, pension funding, commodity and counterparty exposure, and access to capital. A downgrade below investment grade could require substantial additional collateral under energy contracts. Management reported no material changes to contractual obligations outside the normal course of business.
- Unusual items: Pinnacle West’s 2012 comparative results included losses from discontinued SunCor operations; the filing says SunCor’s bankruptcy plan became effective in March 2013 and released Pinnacle West and affiliates from related claims. After quarter-end, IRS guidance indicated a $71 million tax receivable would be reclassified to short-term in the following quarter.
Important Facts for Investors to Verify
- Whether APS can complete the Four Corners transaction, secure a coal-supply agreement, and recover related purchase and environmental costs through rates.
- How ACC proceedings on retail deregulation, net metering, and energy-efficiency standards may affect APS’s rates, customer economics, and investment plans.
- Whether environmental-control estimates and the planned capital program change as regulatory requirements and plant decisions are finalized.
- Whether customer growth, weather-adjusted sales, fuel costs, and rate mechanisms support management’s stated operating expectations.
- How debt maturities, pension contributions, collateral requirements, and dividend payments affect liquidity and financing needs.