Business context and reporting period
Pinnacle West Capital Corporation (Pinnacle West) filed this combined Form 10-Q with its principal subsidiary, Arizona Public Service Company (APS), for the three months ended March 31, 2019. APS is a vertically integrated, regulated electric utility and accounts for essentially all of Pinnacle West’s revenue and earnings. Amounts below are in U.S. dollars; financial statement figures are in millions unless noted.
Financial results and position
| Metric | Pinnacle West Q1 2019 | Q1 2018 |
|---|---|---|
| Operating revenue | $740.5 | $692.7 |
| Operating income | $60.1 | $31.3 |
| Net income attributable to common shareholders | $17.9 | $3.2 |
| Diluted earnings per share | $0.16 | $0.03 |
| Cash from operations | $173.4 | $166.9 |
| Capital expenditures | $259.8 | $361.0 |
- Revenue increased 6.9%; operating income rose to $60.1 million from $31.3 million. Operating margin was approximately 8.1%, compared with 4.5%.
- Results improved primarily with weather, residential rate design and seasonal rates, and lower fossil-generation planned outage costs. Higher fuel and purchased-power costs, depreciation, and lower pension and postretirement non-service credits partly offset the improvement.
- APS reported revenue of $740.5 million, operating income of $65.4 million, and net income attributable to its common shareholder of $28.3 million, versus $692.0 million, $37.9 million, and $9.6 million, respectively, in Q1 2018.
- Pinnacle West total assets were $17.85 billion at March 31, 2019. Cash was $6.1 million; current liabilities were $1.59 billion. Operating cash flow exceeded investing outflows, but cash was supplemented by financing.
- Pinnacle West’s cash from financing was $81.4 million. APS’s was $72.1 million. Pinnacle West paid $80.9 million in common dividends during the quarter; the board later declared a $0.7375-per-share dividend payable June 3, 2019.
Material changes versus the prior comparable period
- Pinnacle West common-shareholder income increased by $14.7 million. Revenue less fuel and purchased-power expense increased $20 million; operations and maintenance expense declined $20.0 million, while depreciation and amortization increased $3.9 million.
- Operating cash flow increased modestly, while capital expenditures fell by $101.2 million. Pinnacle West’s investing cash outflow declined to $254.5 million from $361.1 million.
- APS issued $300 million of 4.25% senior notes due 2049 and entered a $200 million term loan; together with available funds, these were used to refinance debt. APS repaid $500 million of 8.75% notes at maturity.
- Operating lease right-of-use assets and liabilities were recorded on adoption of the new lease standard on January 1, 2019; adoption added approximately $194 million of assets and $119 million of liabilities.
Debt, liquidity and outlook
- At March 31, Pinnacle West had $4.89 billion of long-term debt excluding current maturities, $250 million of current maturities, and $244 million of short-term borrowings. Its debt-to-capitalization ratio under bank covenants was approximately 51%.
- APS had $4.44 billion of long-term debt excluding current maturities, $250 million of current maturities, and $157.5 million of commercial paper outstanding. Its covenant debt-to-capitalization ratio was approximately 46%. APS had $1 billion of revolving credit facilities, with no revolver borrowings outstanding; Pinnacle West also reported ample borrowing capacity.
- Management projected APS customer growth of 1.5%–2.5% in 2019 and on average through 2021; weather-adjusted retail electricity sales growth was projected at 1.0%–2.0% in 2019 and 1.5%–2.5% on average through 2021. These are estimates, not guarantees.
- Estimated APS capital expenditures were $1.237 billion in 2019, $1.266 billion in 2020, and $1.472 billion in 2021. Management expects to fund investment with operating cash and external financing as needed.
- Management cited weather, economic conditions, customer usage, conservation, distributed generation, plant performance, fuel and purchased-power prices, regulation, environmental requirements, and access to capital as important factors affecting results. Typical weather variation may change annual net income by up to about $10 million; extreme variations have historically caused changes exceeding $20 million.
Regulatory matters, contingencies and unusual items
- APS faced an ACC review of whether its 2017 rate-case outcome produced earnings above authorized levels. APS said it did not expect the review to materially affect current results, but the ACC could take further action, including potentially reopening the rate decision. A related administrative law judge recommended dismissing a customer complaint, with a proposed amendment that could require a $5 million customer credit; outcomes remained unresolved.
- The ACC had not decided APS’s requested Four Corners selective catalytic reduction cost recovery. The administrative law judge recommended an annual revenue requirement of approximately $58.5 million; APS warned an unfavorable decision could result in a charge.
- APS’s 2019 Lost Fixed Cost Recovery request would reduce annual recovery to $36.2 million from $60.7 million; ACC approval was pending. The ACC approved a separate $86.5 million tax-savings refund mechanism effective April 2019. A further proposed tax refund was not yet approved.
- The Navajo Generating Station was scheduled to cease operations in December 2019. APS reported an $85 million remaining investment and intended to seek continued rate recovery, along with recovery of retirement and closure costs that were still being assessed and could be material.
- Coal ash rules and corrective-action requirements remained subject to regulatory uncertainty. APS estimated approximately $5 million of additional corrective-action, closure, and replacement-disposal costs for Cholla and Four Corners, subject to change as assessments proceed.
- Other exposures include nuclear plant operating and insurance risks, environmental and Superfund matters, potential plant impairment or retirement, fuel and purchased-power commitments (up approximately $180 million from the 2018 Form 10-K, largely for 2024 and later), and counterparty or collateral risks. The filing generally states that outcomes of pending matters cannot be predicted.
Most important facts for investors to verify
- Whether the ACC rate review or related complaint results in rate changes, customer credits, or other action.
- Whether APS receives approval for Four Corners SCR cost recovery and the requested 2019 recovery mechanisms.
- Whether APS recovers the Navajo Plant’s remaining investment and closure costs after the planned 2019 shutdown.
- Actual operating cash generation, capital spending, borrowing needs, and refinancing costs against management’s projections.
- Whether customer growth and electricity sales meet forecasts given weather, conservation, and distributed generation trends.