Business context and reporting period
Pinnacle West Capital Corporation (Pinnacle West) filed this unaudited Form 10-Q for the quarter and nine months ended September 30, 2012. Its principal business is regulated electric utility APS, which generates, transmits and distributes electricity in Arizona and accounts for substantially all Pinnacle West revenue and earnings. Results are seasonal and affected by weather.
Financial results and liquidity
| Metric | Q3 2012 | Q3 2011 | Nine months 2012 | Nine months 2011 |
|---|---|---|---|---|
| Operating revenue | $1,109.5m | $1,124.8m | $2,608.7m | $2,573.5m |
| Operating income | $448.0m | $435.0m | $750.5m | $667.8m |
| Net income attributable to common shareholders | $244.8m | $255.4m | $358.9m | $326.9m |
| Diluted EPS | $2.21 | $2.32 | $3.25 | $2.98 |
| Operating cash flow | Not presented by quarter | $929.5m | $920.5m |
Calculated operating margin was 40.4% in Q3 2012 versus 38.7% in Q3 2011, and 28.8% for the first nine months versus 26.0%. Nine-month continuing-operations income attributable to common shareholders was $360.5m, up from $316.0m; diluted continuing-operations EPS was $3.26 versus $2.88. The 2011 comparison included an approximately $10m after-tax gain from the APSES sale in discontinued operations.
Nine-month capital expenditures were $670.7m. Investing cash use was $653.1m and financing cash use was $230.5m; cash increased by $45.9m to $79.5m. At September 30, Pinnacle West reported approximately $3.43bn of debt, including current maturities and Palo Verde sale-leaseback notes, versus $3.50bn at year-end 2011. Pinnacle West had a $200m revolving facility and APS had $1.0bn of facilities; neither had facility borrowings or commercial paper outstanding. APS’s defined common-equity ratio was 56%, above its 40% minimum; debt-to-capitalization ratios were approximately 45% for Pinnacle West and 44% for APS, below the 65% covenant ceiling.
Material changes versus prior comparable periods
- Q3 revenue declined 1.4%, but operating income increased about 3.0%; common-shareholder net income fell about 4.1%, primarily reflecting the absence of the prior-year APSES sale gain. Regulated-segment earnings were approximately unchanged.
- For the first nine months, revenue increased 1.4% and common-shareholder net income rose about 9.8%. Higher regulated-segment results reflected the 2012 rate settlement, increased retail transmission revenue, lower depreciation following Palo Verde license extensions, and lower net interest costs.
- Lower fuel and purchased-power costs helped results. Q3 benefits were partly offset by milder weather and higher operations and maintenance expense. Nine-month O&M fell, including because 2011 included a $28m transmission right-of-way settlement that was offset by revenue.
- APS issued $325m of 4.50% senior notes due 2042 and used the proceeds with other funds to repay $375m of 6.50% notes due in March 2012. Pinnacle West’s long-term debt carrying amount was broadly lower year over year-end despite the refinancing.
Outlook, management commentary, risks and contingencies
- The ACC approved a retail rate settlement effective July 1, 2012, providing zero net base-rate change: a $116.3m non-fuel increase, a $153.1m fuel-related decrease, and transfer of an estimated $36.8m of renewable-project recovery into base rates. The settlement authorizes a 10.0% return on common equity and generally bars APS from filing its next general rate case before May 31, 2015.
- Management expects average annual customer growth of about 2.0% for 2012–2015, while weather-adjusted retail electricity sales are expected to remain flat on average. These are estimates, not earnings guidance; the filing provides no specific EPS forecast. APS expected an ACC decision around year-end on its 2013 renewable-energy plan.
- Estimated APS capital expenditures are $1.135bn in 2012, $901m in 2013 and $1.185bn in 2014. The 2012 estimate assumes APS completes its proposed $294m purchase of SCE’s Four Corners Units 4 and 5 interests and closes Units 1–3; approvals, a coal-supply agreement and other conditions remained outstanding.
- Environmental rules could require substantial additional investment beyond current estimates: APS’s estimated share of Four Corners controls is approximately $300m under the unit-closure alternative or up to $400m under the other option; proposed Cholla controls could cost about $182m. Final requirements and recovery are uncertain.
- APS sought FERC approval to defer and recover a $40m Four Corners-related transmission termination payment over 29 years; disallowance would result in a charge. Other exposures include Clean Air Act litigation, potential inquiries or claims arising from the 2011 regional outage, Superfund investigation costs, and nuclear insurance assessments. Management could not estimate a reasonably possible loss range for the Four Corners lawsuit.
- Other risks include weather and demand variability, fuel and power-market prices, rate-recovery decisions, plant reliability, environmental and nuclear requirements, counterparty and collateral exposure, and access to capital. A Palo Verde fuel-conversion supplier invoked force majeure; strategic reserves were expected to avoid a short-term supply impact, while APS evaluated longer-term alternatives.
- Management declared a quarterly dividend of $0.545 per share payable December 3, 2012, increasing the indicated annual rate from $2.10 to $2.18. APS had contributed $65m to its pension plan in 2012; future required contributions depend on funding assumptions and investment performance.
Important facts for investors to verify
- Track the timing and outcome of the Four Corners acquisition, related unit closures, coal-supply arrangements, and regulatory recovery of associated costs.
- Confirm final EPA requirements and the resulting capital spending, especially for Four Corners and Cholla, and whether regulators permit recovery.
- Monitor customer growth, weather-adjusted sales, weather effects, and performance of the July 2012 rate settlement and fuel-cost recovery mechanisms.
- Assess the funding of the projected capital program, debt maturities, credit ratings and collateral requirements; verify the timing of the approximately $70m long-term tax refund receivable.
- Follow the outage-related inquiries and environmental and other legal matters for any new estimated losses or material developments.