PINNACLE WEST CAPITAL CORP quarterly report, Q2 FY2019

Pinnacle West Capital Corporation (PNW) — Q2 2019 Form 10-Q

Reporting period: Quarter and six months ended June 30, 2019. Pinnacle West owns APS, a regulated, vertically integrated electric utility that generates essentially all of Pinnacle West’s revenue and earnings. Figures below are for Pinnacle West unless otherwise noted; dollars are U.S. dollars.

Key financial results

Metric	Q2 2019	Q2 2018	Six months 2019	Six months 2018
Operating revenue	$869.5 million	$974.1 million	$1,610.0 million	$1,666.8 million
Operating income	$196.6 million	$242.2 million	$256.7 million	$273.5 million
Net income attributable to common shareholders	$144.1 million	$166.7 million	$162.1 million	$170.0 million
Diluted EPS	$1.28	$1.48	$1.44	$1.51
Operating margin (operating income / revenue)	22.6%	24.9%	15.9%	16.4%

• For the six months, operating cash flow was $345.9 million, versus $395.8 million a year earlier. Capital expenditures were $541.4 million, down from $679.9 million; operating cash flow less capital expenditures was negative $195.5 million, compared with negative $284.1 million.
• Cash and cash equivalents were $1.6 million at June 30, 2019. Pinnacle West had $432.4 million of short-term borrowings and $5.14 billion of long-term debt including current maturities. APS separately reported $376.9 million of commercial paper outstanding and $4.69 billion of long-term debt including current maturities.
• APS had $1.0 billion of revolving credit facilities, with no facility borrowings or letters of credit drawn at quarter-end; Pinnacle West had a $200 million facility with no borrowings and $10 million of commercial paper. Management said both companies had ample borrowing capacity. Debt-to-capitalization covenant ratios were 52% for Pinnacle West and 47% for APS, below the 65% limit.
• Total assets were $18.17 billion and total equity was $5.36 billion at June 30, 2019. APS’s ACC-defined common equity ratio was 54%, above its 40% minimum.

Changes versus the prior comparable period

• Q2 revenue declined $104.6 million (10.7%); six-month revenue fell $56.8 million (3.4%). Management attributed the Q2 earnings decline mainly to weather, partly offset by lower operations and maintenance costs. Lower customer refunds tied to federal tax savings and lower renewable-energy regulatory surcharges also reduced revenue.
• Q2 net income attributable to common shareholders fell $22.6 million; six-month net income fell $7.9 million. For the six-month period, lower weather-related contribution and lower pension/postretirement non-service credits were partly offset by lower operations and maintenance expense and lower income taxes.
• Operations and maintenance expense decreased $40.9 million in Q2 and $60.9 million over six months. The filing cites lower planned outages and operating costs, lower renewable-program costs, and lower parent-company public outreach costs, among other items.
• APS issued $300 million of 4.25% senior notes due 2049 and repaid $500 million of 8.75% notes at maturity in March 2019. Pinnacle West also entered a $50 million term loan agreement, with $46 million outstanding at quarter-end.
• Adoption of new lease accounting guidance in January 2019 added operating lease right-of-use assets and liabilities to the balance sheet. At June 30, reported operating lease assets were $176.2 million and lease liabilities totaled approximately $113.6 million.

Outlook, management commentary and key risks

• Management projected APS customer growth of 1.5%–2.5% annually for 2019 and on average for 2019–2021. Weather-normalized retail electricity sales were projected to rise 1.0%–2.0% in 2019 and average 1.5%–2.5% growth over 2019–2021. Management noted that weather, economic conditions, conservation, efficiency and distributed generation could affect these estimates.
• Estimated APS capital expenditures were $1.24 billion for 2019, $1.27 billion for 2020 and $1.47 billion for 2021; the company expects to fund spending with operating cash and external financing. Pinnacle West declared a $0.7375-per-share dividend payable September 3, 2019.
• An ACC order requires APS to file a new rate case by October 31, 2019, using a June 30, 2019 test year. The order also requires customer rate-plan education and enrollment measures. APS said the outcome of the rate case and financial effects of other requirements were uncertain.
• APS estimated the residential disconnection moratorium would reduce 2019 operating results by approximately $5 million–$10 million before tax; effects beyond 2019 remain uncertain. Proposed return of additional tax savings to customers under TEAM Phase III had not been approved by the ACC.
• Recovery of Four Corners selective catalytic reduction costs remained pending before the ACC; APS accepted staff’s recommended annual revenue requirement of about $58.5 million. An unfavorable decision could require a charge. The Navajo Generating Station was scheduled to cease operations in December 2019; APS intended to seek rate recovery for its remaining $83 million book investment and other retirement costs, which may be material.
• A battery module failure at APS’s McMicken facility prompted an investigation and review of the timing of planned storage projects. APS had targeted at least 700 MW of additional APS-owned solar-plus-storage and stand-alone storage by summer 2025, but said timing and implementation were under evaluation.
• Environmental compliance, fuel and purchased-power costs, power-plant performance, nuclear operations and waste disposal, regulatory decisions and rate recovery, and potential retail-market restructuring are among the disclosed risks. APS estimated incremental coal-combustion-residual compliance and closure costs, while noting that estimates could change as assessments and regulations proceed.
• For the six months, non-designated commodity derivatives recorded a $41.5 million loss in fuel and purchased power before the effect of PSA regulatory deferrals. APS defers qualifying unrealized and certain realized fuel-cost variations for future rate treatment.

Important facts for investors to verify

• Progress, timing and potential earnings or customer impacts of the ACC-required rate case and related customer-rate measures.
• Whether the ACC approves Four Corners SCR cost recovery and TEAM Phase III, and the allowed recovery of Navajo Plant retirement costs.
• Final customer and cash-flow effects of the disconnection moratorium, including any longer-term rule changes.
• McMicken investigation findings and their implications for battery safety, project timing and planned storage capacity.
• Actual capital spending, financing needs and cash generation relative to the 2019–2021 investment plan and dividend commitments.