Pinnacle West Capital Corporation — Q2 2015 Form 10-Q
Reporting period: Three and six months ended June 30, 2015; unaudited. Pinnacle West is the parent of Arizona Public Service Company (APS), a vertically integrated Arizona electric utility that accounts for essentially all of Pinnacle West’s revenue and earnings. Results are seasonal and interim results may not indicate full-year performance. Dollar amounts below are in millions unless otherwise stated.
Financial performance
| Metric | Q2 2015 | Q2 2014 | First half 2015 | First half 2014 |
|---|---|---|---|---|
| Operating revenue | $890.6 | $906.3 | $1,561.9 | $1,592.5 |
| Operating income | $232.0 | $254.1 | $299.7 | $329.3 |
| Net income | $127.5 | $141.4 | $148.2 | $166.1 |
| Net income attributable to common shareholders | $122.9 | $132.5 | $139.0 | $148.2 |
| Diluted EPS | $1.10 | $1.19 | $1.25 | $1.34 |
| Dividends declared per share | $1.19 | $1.14 | $1.19 | $1.14 |
- Operating margin was approximately 26.0% in Q2 versus 28.0% a year earlier; first-half operating margin was approximately 19.2% versus 20.7%.
- APS reported Q2 electric revenue of $889.7 million and net income attributable to its common shareholder of $125.4 million; first-half amounts were $1,560.4 million and $145.2 million, respectively.
- First-half operating cash flow was $394.3 million, down from $465.1 million. Capital expenditures were $531.0 million, compared with $388.8 million; investing cash use was $509.5 million. Financing provided $121.2 million, versus $72.5 million used in the prior-year period. Cash ended the period at $13.6 million.
- At June 30, total debt, including current maturities, was approximately $3.67 billion; short-term borrowings were $157.5 million. Pinnacle West had $4.53 billion of equity. APS reported $3.54 billion of debt and $4.49 billion of shareholder equity.
- Liquidity includes Pinnacle West’s $200 million revolving facility, with no borrowings or commercial paper outstanding, and APS’s $1 billion of revolving facilities, with $158 million of commercial paper outstanding and no facility borrowings. APS met its ACC minimum common-equity-ratio requirement; its reported ratio was 55%. Debt-to-capitalization covenant ratios were 48% for Pinnacle West and 46% for APS.
Changes versus the prior-year period
- Common-shareholder earnings declined $9.6 million in Q2 and $9.2 million for the first half; diluted EPS fell $0.09 and $0.09, respectively. Revenue declined 1.7% in Q2 and 1.9% for the first half.
- Management attributed the Q2 earnings decline mainly to higher depreciation and amortization, weather effects and lower transmission revenue, partly offset by the Four Corners rate adjustment and lower interest charges. For the first half, higher depreciation and amortization was partly offset by the Four Corners rate adjustment and lower interest charges.
- Depreciation and amortization rose $17.6 million in Q2 and $36.8 million in the first half. Lower first-half fuel and purchased-power expense partly offset reduced revenue. First-half cash from operations also fell partly because the prior-year period included a $135 million income-tax refund.
- APS issued $250 million of 2.20% notes due 2020 and $300 million of 3.15% notes due 2025, and entered a $50 million term loan due 2018. Proceeds primarily refinanced short-term debt and funded capital needs.
Outlook, risks and unusual items
- Management estimated average annual customer growth of 2.0%–3.0% and weather-adjusted retail electricity sales growth of 0.5%–1.5% for 2015–2017. It noted that conservation, efficiency and distributed generation weigh on usage, while a weaker Arizona recovery could reduce growth. Typical weather variation can change annual net income by up to $10 million; extreme weather has historically caused larger swings.
- APS estimated capital expenditures of $1.06 billion in 2015, $1.11 billion in 2016 and $1.29 billion in 2017. Capital needs are expected to be funded through operating cash flow and external financing. Gas-generation project purchase obligations increased about $170 million, with scheduled payments through 2018.
- Environmental compliance and coal-plant economics remain significant uncertainties. APS plans to retire Cholla Unit 2 by April 2016 and cease coal burning at Units 1 and 3 by the mid-2020s, subject to regulatory approvals. The remaining book value of Unit 2 was $125 million; recovery depends on future ACC rate treatment. Estimated environmental costs include approximately $400 million for APS’s 63% share of Four Corners controls, up to $200 million for Navajo Plant upgrades, and estimated CCR-rule costs of $85 million for Cholla and $15 million for Four Corners. These estimates and recovery prospects may change.
- APS’s proposed increase in the rooftop-solar grid access charge—from $0.70 to $3.00 per kilowatt—was pending before the ACC; outcome was uncertain. A court appeal also challenged the Four Corners rate adjustment. APS disclosed a potential arbitration and possible charge relating to its transmission-termination arrangement with SCE.
- The proposed Four Corners Clean Air Act settlement contemplated a $1.5 million penalty and $6.2 million in mitigation spending across co-owners; APS’s 15% share was not expected to be material. A New Mexico court ruled the coal severance tax assessment invalid and ordered refunds, but the state indicated it intended to appeal.
- Counterparty, commodity-price and credit risks remain. The filing states that a downgrade below investment grade could trigger approximately $89 million of additional collateral for derivative contracts and approximately $161 million for certain energy-related non-derivative contracts. Nuclear insurance, spent-fuel disposal, environmental proceedings and potential rate-recovery disallowances are additional contingencies.
- No formal earnings guidance was provided. Management said it could not determine the eventual impacts of proposed environmental rules, regulatory decisions or certain contested matters.
Important facts for investors to verify
- Whether earnings pressure from rising depreciation, plant investment and lower transmission revenue persists, and how weather and customer usage affect sales.
- Progress and final ACC treatment for Cholla retirement costs, Four Corners rate recovery and the proposed solar grid charge.
- Actual capital spending, funding needs and debt levels against the 2015–2017 investment plan.
- Environmental-rule outcomes, required coal-plant expenditures and the extent to which costs are recoverable in rates.
- Potential cash or earnings effects from the SCE transmission dispute, pending appeals and other contingencies, and any changes in collateral requirements or credit ratings.