Business context and reporting period
Pinnacle West Capital Corporation (Pinnacle West) is the parent of Arizona Public Service Company (APS), a vertically integrated regulated electric utility that accounts for essentially all Pinnacle West revenue and earnings. This unaudited Form 10-Q covers the quarter and nine months ended September 30, 2015; comparisons are with the same 2014 periods.
Key financial metrics
Amounts are in millions of dollars except per-share data. Pinnacle West consolidated results:
| Metric | Q3 2015 | Q3 2014 | Nine months 2015 | Nine months 2014 |
|---|---|---|---|---|
| Operating revenue | $1,199 | $1,173 | $2,761 | $2,765 |
| Operating income | $445 | $422 | $745 | $751 |
| Net income attributable to common shareholders | $257 | $244 | $396 | $392 |
| Diluted earnings per share | $2.30 | $2.20 | $3.55 | $3.53 |
| Operating margin | 37.1% | 36.0% | 27.0% | 27.2% |
For the first nine months, operating cash flow was $821 million versus $887 million; capital expenditures were $779 million versus $619 million. Cash and cash equivalents were $13 million at September 30. Long-term debt, including current maturities, was $3.669 billion; short-term borrowings were $57 million. APS had $1 billion of revolving credit facilities, with no facility borrowings or letters of credit outstanding; it had $57 million of commercial paper outstanding. Pinnacle West had a $200 million revolving facility with no borrowings or commercial paper outstanding.
APS’s shareholder equity was approximately $4.8 billion and its ACC-defined common equity ratio was 56%, above the 40% minimum. APS’s estimated capital expenditures are $1.056 billion for 2015, $1.111 billion for 2016, and $1.285 billion for 2017. Pinnacle West declared dividends of $1.19 per share for the first nine months, compared with $1.14 in 2014. On October 21, 2015, it declared a $0.625 quarterly dividend, raising the indicated annual rate from $2.38 to $2.50 per share.
Material changes versus prior comparable periods
- Q3 revenue rose about 2% and diluted EPS increased from $2.20 to $2.30. Management attributed the earnings improvement mainly to the Four Corners rate change, higher retail sales from customer growth and usage, and weather effects; higher depreciation partly offset these benefits.
- Nine-month revenue was nearly flat, while common-shareholder net income rose about 1% and diluted EPS increased from $3.53 to $3.55. The Four Corners rate change and retail sales growth helped results; higher depreciation and amortization were a substantial offset.
- Depreciation and amortization increased $22 million in Q3 and $59 million year to date, principally reflecting plant additions and Four Corners-related items. Nine-month operating cash flow declined partly because 2014 included a $135 million income-tax refund; investing cash use increased with higher capital expenditures.
- APS issued $550 million of senior notes during 2015, refinanced short-term borrowings, and replaced a $500 million revolving facility with a facility maturing in 2020.
Outlook, management commentary, risks and unusual items
- Management expects APS customer growth to average 2.0%–3.0% annually and weather-adjusted retail electricity sales growth to average 0.5%–1.5% annually over 2015–2017. These are projections, not earnings guidance; results remain sensitive to Arizona economic conditions, weather, conservation, distributed generation and usage patterns.
- APS closed Cholla Unit 2 on October 1, 2015. Its remaining net book value was $124 million at September 30 and is recorded as a regulatory asset; failure to obtain full rate recovery could require a write-off. Plans to cease coal burning at Cholla Units 1 and 3 by the mid-2020s depend on regulatory approvals.
- Environmental rules and compliance investments could materially affect costs and the economics of coal plants. Estimated APS shares of regional-haze control costs include approximately $400 million for Four Corners Units 4 and 5, up to $200 million for the Navajo Plant, and approximately $100 million for Cholla, excluding Unit 2. Further costs, timing and rate recovery remain uncertain.
- Regulatory proceedings pose risks to cost recovery. An Arizona Court of Appeals decision concerning utility “fair value” findings could affect certain APS rate adjustors if upheld. The ACC dismissed APS’s proposed increase to the rooftop-solar grid charge and will hold a broader proceeding on distributed generation. An appeal also challenges Four Corners-related rate adjustments.
- APS and SCE continue to address a disputed $40 million payment under a transmission termination agreement; an unsuccessful arbitration could result in a charge. Superfund and outage litigation, environmental matters, and the appeal of a New Mexico tax ruling remain unresolved; management did not expect certain identified matters to materially affect results, but outcomes are uncertain.
- Energy derivatives produced a reported nine-month net loss of approximately $85 million before Power Supply Adjustor deferrals. Management states that most relevant unrealized and realized fuel-cost effects are deferred for future rate treatment and therefore generally do not immediately affect earnings.
- APS had $72 million of Four Corners acquisition and closure cost deferrals at September 30, amortized in rates over 10 years. The filing also reports increased asset-retirement obligations, including a $39 million Cholla obligation associated with coal-combustion-residual rules.
Important facts for investors to verify
- Whether APS’s regulatory recovery mechanisms and rate adjustors remain available, including the effect of the Arizona fair-value litigation and ACC proceedings.
- Whether APS receives full recovery of Cholla Unit 2’s $124 million remaining book value and of future environmental and retirement costs.
- The realized cost, schedule and financing needs for planned capital expenditures, Four Corners controls, Ocotillo gas generation, and other environmental obligations.
- How weather, customer growth, sales per customer, conservation and rooftop solar affect the reported growth outlook and earnings.
- Developments in the transmission termination dispute, Four Corners rate appeal, and other material legal or environmental contingencies.
- Liquidity, debt maturities, collateral requirements and credit ratings; a downgrade could increase borrowing costs or trigger additional collateral demands.