Business Context and Reporting Period
Pinnacle West Capital Corporation filed this combined Form 10-K for the fiscal year ended December 31, 2012. Pinnacle West is a holding company whose results are driven principally by its wholly owned, vertically integrated Arizona utility, Arizona Public Service Company (APS), serving approximately 1.1 million customers. References below distinguish Pinnacle West consolidated results from APS where useful; figures are in U.S. dollars.
The filing is annual, not a standalone quarterly report. For the fourth quarter of 2012, Pinnacle West reported revenue of $693 million and net income attributable to common shareholders of $22.6 million, versus $668 million and $12.6 million, respectively, in fourth-quarter 2011.
Financial Results and Position
| Metric | 2012 | 2011 |
|---|---|---|
| Pinnacle West operating revenue | $3.302 billion | $3.241 billion |
| Operating income | $851.8 million | $746.5 million |
| Income from continuing operations | $419.0 million | $355.6 million |
| Net income attributable to common shareholders | $381.5 million | $339.5 million |
| Diluted EPS | $3.45 | $3.09 |
| Cash from operating activities | $1.171 billion | $1.126 billion |
| Capital expenditures | $889.6 million | $884.4 million |
Operating margin was approximately 25.8% of revenue, compared with 23.0% in 2011; net income attributable to common shareholders was approximately 11.6% of revenue. APS reported electric operating revenue of $3.293 billion, operating income of $605.5 million, and net income attributable to its common shareholder of $395.5 million.
- Profit drivers: Pinnacle West attributed the $43 million year-over-year increase in common-shareholder net income mainly to stronger regulated utility results. The regulated electricity segment gained approximately $59 million, reflecting the July 2012 rate settlement, higher retail transmission revenues, reduced depreciation following Palo Verde license extensions, and lower net interest charges.
- Cash flow and liquidity: Consolidated cash declined to $26.2 million from $33.6 million. Pinnacle West had $3.199 billion of long-term debt, excluding current maturities, and $122.8 million of current maturities; consolidated short-term borrowings were $92.2 million. Committed revolving facilities totaled $1.2 billion, with $1.108 billion unused at year-end. APS had $92 million of commercial paper outstanding.
- Leverage: Debt-to-capitalization covenant ratios were approximately 46% for Pinnacle West and 45% for APS, below the 65% maximum. APS’s regulatory common-equity ratio was 57%, above its 40% minimum.
- Other balance-sheet measures: Total assets were $13.380 billion and total equity was $4.102 billion, compared with $13.111 billion and $3.931 billion, respectively, in 2011. Regulatory assets were approximately $1.2 billion and regulatory liabilities $847 million.
Material Changes Versus the Prior Comparable Period
- Revenue rose about 1.9%, while operating income increased about 14.1% and common-shareholder net income increased about 12.4% year over year.
- Fuel and purchased-power costs declined to $994.8 million from $1.009 billion. Operations and maintenance expense fell to $884.8 million from $904.3 million; depreciation and amortization fell to $404.3 million from $427.1 million. Interest expense, net of construction allowances, declined to $199.6 million from $223.6 million.
- Discontinued operations shifted to a $5.8 million loss from $11.3 million of income, primarily reflecting an expected contribution to SunCor’s bankruptcy estate and the absence of the prior-year gain on the APSES sale.
- Cash from operations increased $46 million, while cash used for investing increased to $873 million from $782 million. Cash used for financing decreased to $306 million from $420 million.
- The ACC-approved retail rate settlement took effect July 1, 2012. It provided for zero net change in base rates through offsetting non-fuel and fuel-related adjustments, authorized a 10.0% return on common equity, and barred APS from filing its next general rate case before May 31, 2015, absent specified circumstances.
Guidance, Outlook, Risks and Unusual Items
- Demand and resources: Management expected annual customer growth to average about 2% in 2013–2015, while weather-adjusted retail electricity sales were expected to remain roughly flat. The 2012 peak demand was 7,207 MW; reserve margin was 22%, or 12% excluding certain short-notice contractual capacity. APS expected 2013 reserve margins of approximately 28%, or 19% on the same excluded-capacity basis, and anticipated needing additional conventional resources around 2017.
- Investment plans: Estimated APS capital expenditures were $1.121 billion in 2013, $1.033 billion in 2014, and $1.188 billion in 2015. These estimates assume completion of the Four Corners acquisition and closure of Units 1–3, and exclude certain potential environmental costs.
- Four Corners transaction: APS proposed purchasing SCE’s 48% interests in Units 4 and 5 for an adjusted purchase price based on $294 million. Regulatory approvals had largely been obtained, but a new coal-supply agreement remained a key closing condition. If completed, APS planned to close Units 1–3; the timing, final terms, and cost recovery remained uncertain.
- Environmental exposure: Potential APS costs include approximately $187 million for Cholla nitrogen-oxide controls, subject to a legal challenge; approximately $300 million for APS’s assumed share of Four Corners controls under the planned transaction scenario; up to approximately $158 million for proposed Navajo Plant controls; and approximately $124 million for remaining Cholla mercury and air-toxics equipment. These amounts involve different facilities and assumptions and should not be treated as a single committed expenditure total. Future rules and litigation could add costs, affect plant economics, or prompt retirement; recovery through rates is not assured.
- Other contingencies and unusual items: APS filed a second lawsuit against the DOE seeking recovery for failure to accept Palo Verde spent fuel. A Clean Air Act case concerning Four Corners remained pending, and APS could not estimate a reasonably possible loss range. The filing also describes uncertain spent-fuel disposal, water availability and rights-of-way, coal-supply and plant-operation risks, and possible enforcement or claims arising from the 2011 regional power outage. SunCor filed for bankruptcy in February 2012 and had no assets at year-end; management did not expect a material impact on Pinnacle West.
- Tax and pension cash flows: Management expected accelerated depreciation to generate $400–$500 million of APS cash tax benefits through 2013, primarily realized by year-end 2012; this accelerates tax benefits otherwise expected over many years. Pinnacle West expected voluntary pension contributions of $140 million in 2013 and up to approximately $175 million in each of 2014 and 2015.
- Management commentary: Palo Verde achieved a 92.3% capacity factor and record generation of more than 31 million MWh in 2012. Coal-plant capacity factors were lower than in prior years, which management attributed primarily to lower gas prices and increased gas generation.
Most Important Facts for Investors to Verify
- Whether APS completed the Four Corners acquisition, secured the coal contract, and obtained required lease and rights-of-way approvals—and how final costs compare with assumptions in the capital plan.
- What environmental-control requirements ultimately apply at Cholla, Four Corners, and the Navajo Plant; the resulting capital and operating costs; and the extent and timing of rate recovery.
- Whether projected customer growth, flat sales, reserve margins, and the expected need for new conventional resources are borne out.
- Whether APS maintains ample liquidity and covenant headroom while funding forecast capital spending, debt maturities, pension contributions, and dividends.
- Whether significant regulatory assets—especially the pension and postretirement benefit balance—and environmental or legal contingencies remain recoverable or otherwise avoid material charges.