Pinnacle West Capital Corporation — Q3 2011 Form 10-Q
Reporting period: Three and nine months ended September 30, 2011. Pinnacle West is the parent of Arizona Public Service Company (APS), a regulated electric utility that accounts for substantially all of Pinnacle West’s revenue and earnings. Unless otherwise noted, financial amounts below are in millions of dollars.
Financial results and position
- Third quarter: Operating revenue was $1,124.8, up 0.7% from $1,116.7. Operating income was $435.0, up from $400.3; operating margin was approximately 38.7%, compared with 35.8%. Net income attributable to common shareholders was $255.4, versus $233.9, and diluted EPS was $2.32, versus $2.14.
- First nine months: Operating revenue was $2,573.5, up 1.6%. Operating income was $667.8, versus $658.6. Net income attributable to common shareholders was $326.9, down from $342.7; diluted EPS was $2.98, versus $3.22. Continuing-operations income attributable to common shareholders was $316.0, versus $319.5.
- Cash flow: Nine-month operating cash flow was $920.5, compared with $569.5. Capital expenditures were $643.3, versus $552.7; operating cash flow less capital expenditures was approximately $277.2, versus $16.8. Cash and cash equivalents ended the period at $564.7, up from $110.2 at December 31, 2010. Management attributed much of the operating cash flow improvement to changes in collateral and margin accounts and the absence of a $100 million voluntary pension contribution made in 2010.
- Debt and liquidity: Reported current maturities of long-term debt were $876.4 and long-term debt, including Palo Verde sale-leaseback lessor notes, was $3,046.6 at September 30. Pinnacle West had no borrowings or commercial paper outstanding under its $200 million credit facility. APS had $1 billion in credit facilities, no facility borrowings or commercial paper outstanding, and a $20 million letter of credit under one facility. APS issued $300 million of 5.05% senior notes due 2041 and used the proceeds with cash on hand to repay $400 million of 6.375% notes at maturity.
- Equity and dividends: Pinnacle West declared dividends of $1.575 per share in the first nine months, the same as in 2010. After quarter-end, the board declared a $0.525-per-share quarterly dividend payable December 1, 2011.
- APS results: Third-quarter net income attributable to APS’s common shareholder was $246.3, up from $226.6. Nine-month net income was $322.0, down from $327.9.
Changes versus the comparable period
- Third-quarter continuing-operations results improved by about $21 million, primarily from warmer-weather-related revenue and lower operations and maintenance expense. Lower fuel and purchased-power expense also supported results; higher retail transmission charges contributed to revenue.
- For the first nine months, regulated-segment income declined about $3 million. Higher weather-related revenue and retail usage were offset by higher operations and maintenance, depreciation, property taxes, and income taxes. The prior-year period also included larger gains from discontinued operations: 2011 included an approximately $10 million after-tax gain from the APSES sale, while 2010 included an approximately $25 million after-tax gain from the sale of APSES’s district-cooling business.
- APS’s customer growth was 0.4% for the nine-month period; weather-adjusted retail electricity sales increased 0.5% year over year. Pinnacle West sold its investment in APSES on August 19, 2011.
Outlook, regulatory matters, risks and unusual items
- Rate case: APS requested a $95.5 million net retail base-rate increase, proposed to take effect July 1, 2012, which it estimated would raise the average retail customer bill about 6.6%. The ACC hearing was scheduled to begin January 19, 2012. APS also proposed changes to fuel-cost recovery and new mechanisms for fixed-cost and generation-investment recovery; outcomes were uncertain.
- Capital spending: Estimated capital expenditures were $868 million for 2011 and $1,185 million for 2012. The 2012 estimate includes $294 million for the proposed purchase of SCE’s interests in Four Corners Units 4 and 5, subject to regulatory and other approvals. APS expects to close Units 1–3 if the purchase proceeds. The filing’s forecasts also depend on regulatory approval of renewable-energy plans.
- Operating outlook: Management expected average customer growth of about 1% annually in 2011–2013 and weather-adjusted retail electricity sales to remain flat on average over that period. APS estimated that Palo Verde license extensions would reduce pretax depreciation expense by about $34 million annually beginning January 1, 2012. APS expected federal bonus depreciation to generate approximately $425–$475 million of cash-tax benefits through 2013, mostly in 2012 and 2013.
- Major event and potential exposure: The September 8, 2011 Southwest outage affected approximately 69,700 APS customers and was part of wider outages affecting about 2.8 million customers across the region. FERC and NERC inquiries and other reviews were underway; APS could not predict their outcome or potential impact. The filing notes FERC’s authority to impose fines of up to $1 million per violation per day if reliability violations are found.
- Legal and environmental matters: Environmental organizations sued APS and other Four Corners participants over alleged Clean Air Act violations, seeking, among other remedies, an injunction and civil penalties. APS could not predict the outcome. Other uncertainties include potential regional-haze requirements, coal-plant environmental costs, nuclear regulation, and Superfund investigation costs that the company could not yet estimate fully.
- Other risks: The filing highlights rate-recovery risk, weather and demand variability, fuel and purchased-power prices, plant and transmission reliability, regulatory decisions, Arizona economic conditions, capital-market access, counterparty and collateral exposure, and cybersecurity. A downgrade below investment grade could trigger additional collateral requirements under certain contracts; disclosed potential requirements include $136 million for derivative contracts and approximately $194 million for certain energy-related non-derivative contracts.
- Contractual obligations increased approximately $0.75 billion from year-end 2010. APS was in compliance with the ACC requirement to maintain a common-equity ratio of at least 40%; its reported ratio was 52% at September 30.
Important facts for investors to verify
- Track the ACC’s decision on APS’s rate case and whether the proposed recovery mechanisms and requested rate increase are approved.
- Confirm the status, final cost, approvals, and timing of the proposed Four Corners acquisition and related unit closures.
- Monitor findings and any claims, penalties, or remediation arising from the September 8 outage and the Four Corners Clean Air Act litigation.
- Assess whether operating cash flow remains strong after accounting for collateral movements, capital spending, debt maturities, and pension funding.
- Review the assumptions behind APS’s renewable-energy and efficiency spending plans, projected flat sales, and expected depreciation and tax benefits.