Pinnacle West Capital Corporation — FY 2017 Form 10-K
Reporting period: Fiscal year ended December 31, 2017. This is an annual filing, not a standalone fourth-quarter report. Pinnacle West is a holding company whose results are driven primarily by its regulated Arizona Public Service Company (APS), serving approximately 1.2 million customers.
Key financial results
| Metric | 2017 | 2016 | Change |
|---|---|---|---|
| Pinnacle West revenue | $3.565 billion | $3.499 billion | +1.9% |
| Net income attributable to common shareholders | $488.5 million | $442.0 million | +10.5% |
| Diluted EPS | $4.35 | $3.95 | +10.1% |
| Operating income | $934.4 million | $856.0 million | +9.2% |
| Operating cash flow | $1.118 billion | $1.023 billion | +$95 million |
| Capital expenditures | $1.409 billion | $1.275 billion | +$133 million |
Calculated operating margin was approximately 26.2% versus 24.5% in 2016; net margin attributable to common shareholders was approximately 13.7% versus 12.6%. Cash flow from operations less capital expenditures was negative approximately $291 million, before financing and other investing items.
APS reported 2017 electric operating revenue of $3.554 billion, operating income of $679.6 million, and net income attributable to its common shareholder of $504.3 million, compared with $3.490 billion, $618.0 million, and $462.1 million, respectively, in 2016. APS fuel and purchased-power costs declined to $992.7 million from $1.083 billion.
Balance sheet and liquidity: Pinnacle West had total assets of $17.019 billion, equity of $5.136 billion, long-term debt less current maturities of $4.790 billion, $82 million of current debt maturities, and $95.4 million of short-term borrowings at year-end. Debt-to-capitalization was approximately 50% for Pinnacle West and 47% for APS, below the 65% covenant ceiling. Of $1.325 billion in committed credit facilities, $1.230 billion was available. Pinnacle West operating cash was $13.9 million.
APS operating cash flow was $1.162 billion and capital expenditures were $1.382 billion. APS had $4.491 billion of long-term debt less current maturities and $82 million of current maturities, with no short-term borrowings at year-end. Its regulatory-order common equity ratio was 53%, versus a 40% minimum.
Fourth-quarter reference: Pinnacle West reported revenue of $759.7 million and common-shareholder net income of $21.6 million ($0.19 diluted EPS) in Q4 2017, versus $739.2 million, $53.2 million, and $0.48 in Q4 2016. Interim results are seasonal and do not necessarily indicate full-year performance.
Material changes and management commentary
- Common-shareholder net income increased $46 million year over year. Management attributed the improvement mainly to the retail rate settlement effective August 19, 2017, higher transmission revenue, customer growth, and customer usage/pricing effects. Higher depreciation, property taxes, interest, and income taxes partly offset the gains.
- The ACC approved a retail-rate settlement providing a net annual base-rate increase of $94.6 million; typical residential customer annual bill impact was estimated at 4.54%. The settlement authorized a 10.0% return on common equity and generally bars APS from filing another general rate case before June 1, 2019.
- The Tax Cuts and Jobs Act reduced the federal corporate rate to 21% beginning in 2018. APS recorded a $1.52 billion regulatory liability and a $377 million deferred tax asset related to the tax-rate change. After year-end, the ACC approved an annual $119.1 million customer rate reduction, effective March 1, 2018; APS planned a later filing on amortizing excess deferred taxes.
- Management projects APS customer growth of 1.5%–2.5% in 2018 and an average 2%–3% annually over 2018–2020. Weather-adjusted retail electricity sales are projected to rise 0.5%–1.5% annually in both 2018 and the 2018–2020 period. These estimates are exposed to economic conditions, conservation, energy efficiency, and distributed generation.
- Estimated APS capital expenditures are $1.181 billion in 2018, $1.153 billion in 2019, and $1.211 billion in 2020. Major projects include distribution and transmission investment, environmental compliance, and the Ocotillo gas-plant modernization, targeted for completion by summer 2019.
- APS expects the Navajo Generating Station to cease operations in December 2019. Its remaining investment was $99 million at year-end; APS will seek rate recovery and a return, while retirement and closure costs are still being assessed and may be material. APS stated that it believes recovery will be allowed, but a disallowance could reduce earnings, cash flow, and financial position.
Risks, contingencies, and unusual items
- Coal fleet and environmental costs: APS estimates its share of required Four Corners pollution controls at approximately $400 million and planned to seek a specific rate rider, with recovery requested no later than January 1, 2019. Estimated incremental coal-combustion-residual compliance costs are approximately $22 million for Four Corners, $20 million for Cholla, and $1 million for Navajo; additional groundwater remediation costs are not yet estimable.
- Four Corners/NTEC: Arbitration concerns an alleged initial-year coal-purchase shortfall of approximately $30 million, of which APS’s share is about $17 million; the outcome is uncertain. NTEC also owes 4CA approximately $20 million under an alternate payment formula, due at year-end 2018. NTEC’s planned purchase of 4CA’s 7% plant interest did not occur on the originally contemplated timetable.
- Regulatory and legal uncertainty: The Clean Power Plan repeal/replacement process, renewable-energy policy proposals, rate-case appeals, and a pending FERC-related appeal could affect costs or recovery. A proposed Arizona ballot initiative would require 50% renewable energy by 2030 if qualified and approved; its outcome is uncertain.
- Other proceedings: Pinnacle West reported grand jury subpoenas concerning Arizona’s 2014 statewide election races and stated it was cooperating. The company also disclosed Superfund-related litigation and investigation; it does not expect the RID litigation to materially affect financial position, results, or cash flows. A Four Corners environmental lawsuit dismissal was appealed.
- Key operating and financial risks: Weather-driven demand, plant outages, fuel and purchased-power prices, water availability, nuclear operations and spent-fuel disposal, cybersecurity, pension and decommissioning-trust performance, timely regulatory cost recovery, and access to capital markets. Pinnacle West also relies heavily on APS distributions to fund parent-company needs.
Important facts for investors to verify
- Whether earnings and rate-base growth continue to offset rising depreciation, operating costs, and debt service.
- Actual timing and cost recovery for Four Corners controls, the Ocotillo project, and Navajo plant retirement and closure.
- Outcomes of the NTEC coal-supply arbitration and 4CA payment/ownership discussions, including the approximately $20 million due in 2018.
- Implementation and customer effects of the $119.1 million annual tax-related rate reduction and the treatment of excess deferred taxes.
- Progress against APS’s sales and customer-growth projections, and effects of conservation and distributed solar on volumes and fixed-cost recovery.
- Environmental compliance and remediation developments, rate-case or policy appeals, and any change in the company’s assessment of contingent costs.
- Capital spending, borrowing needs, available liquidity, and the company’s ability to sustain dividends; the 2017 dividend declared was $2.70 per share.