Pinnacle West Capital Corporation — Q2 2010 Form 10-Q
Business context and reporting period
For the quarter and six months ended June 30, 2010. Pinnacle West is the parent of Arizona Public Service Company (APS), an Arizona electric utility that generates, transmits and distributes power and accounts for substantially all of Pinnacle West’s revenue and earnings. Results are seasonal and interim performance may not represent the full year.
Financial performance and liquidity
| Metric | Q2 2010 | Q2 2009 | Six months 2010 | Six months 2009 |
|---|---|---|---|---|
| Operating revenue | $820.6 million | $818.6 million | $1,440.9 million | $1,426.0 million |
| Operating income | $203.3 million | $171.9 million | $260.9 million | $195.8 million |
| Income from continuing operations attributable to common shareholders | $89.8 million | $76.4 million | $96.7 million | $51.0 million |
| Net income (loss) attributable to common shareholders | $114.8 million | $68.3 million | $108.8 million | $(88.2) million |
| Diluted EPS | $1.07 | $0.68 | $1.04 | $(0.87) |
- Operating margin, calculated as operating income divided by revenue, was approximately 24.8% in Q2 2010 versus 21.0% in Q2 2009; for the first half, approximately 18.1% versus 13.7%.
- Fuel and purchased-power costs were $251.8 million in Q2 and $467.3 million for the first half, down from $291.7 million and $539.1 million, respectively. Revenue less these costs increased to $548 million for Q2 and $944 million for the first half.
- First-half operating cash flow was $201.4 million, versus $202.4 million a year earlier. Investing used $277.9 million, including $378.6 million of capital expenditures; financing used $18.4 million. Cash declined $94.9 million to $50.5 million at June 30.
- At June 30, current assets were $1.087 billion and current liabilities $1.227 billion (current ratio approximately 0.89). Long-term debt, including current maturities and Palo Verde lessor notes, had a carrying amount of approximately $3.785 billion; short-term borrowings were $4.6 million. Consolidated debt-to-capitalization was approximately 51% for Pinnacle West and 50% for APS.
- Pinnacle West had an undrawn $200 million revolving facility; APS had $989 million of facilities and no outstanding facility borrowings or commercial paper. APS’s regulatory common-equity ratio was 52%, above its 40% minimum.
Material changes and unusual items
- First-half common-shareholder net income improved by $197 million from the prior-year loss, mainly because SunCor’s real-estate impairment charges fell to $17 million from $208 million. APS’s regulated-electricity earnings also improved, supported by rate increases and lower fuel costs.
- Q2 and first-half results include an approximately $25 million after-tax gain from APSES’s June sale of its district-cooling business. The sale generated about $100 million in proceeds, used to repay short-term debt.
- In April, Pinnacle West issued 6.9 million shares at $38 per share, raising approximately $253 million net, which was contributed to APS. This increased common shares outstanding and supports APS’s rate-case-required equity infusions.
- Adoption of amended variable-interest-entity accounting brought Palo Verde lessor trusts onto APS’s balance sheet, including approximately $143 million of debt. The accounting change did not affect cash flows or Pinnacle West shareholder income.
- SunCor reported $94 million of debt outstanding at June 30, all in default; after a July asset sale and debt restructuring, $6 million remained. The filing says the debt is not guaranteed by Pinnacle West or other subsidiaries and does not create a cross-default. SunCor could not transfer cash dividends to Pinnacle West at quarter-end.
Outlook, management commentary and risks
- No company-wide earnings guidance is provided. Management estimated APS customer growth averaging about 1% annually and weather-adjusted retail electricity sales remaining flat on average for 2010–2012, citing weak economic conditions and efficiency programs.
- APS expects to file its next general rate case in June 2011; under the settlement, a rate increase generally cannot become effective before July 1, 2012. The settlement authorizes an 11% return on equity, requires at least $700 million of APS equity infusions through 2014 (including $253 million already contributed), and commits APS to reduce average annual operating expenses by at least $30 million over 2010–2014.
- Planned APS capital expenditures are $758 million in 2010, $999 million in 2011 and $1.088 billion in 2012. APS’s approved AZ Sun program contemplates up to $500 million of investment for 100 MW of solar capacity through 2014. A proposed 99 MW wind-farm power purchase agreement remains subject to approvals and project conditions.
- Key uncertainties include weather and demand, rate recovery and regulatory decisions, fuel and purchased-power prices, generation outages and fuel availability, environmental requirements and related capital costs, nuclear operations and spent-fuel disposal, access to capital and credit ratings, and counterparty performance. APS’s fuel and purchased-power contractual obligations rose to approximately $9.1 billion, primarily due to renewable-energy contracts.
- Environmental and legal matters include pending challenges to EPA greenhouse-gas rules, prospective mercury and hazardous-air-pollutant standards, proposed coal-combustion-waste regulation, and a notice of intent to sue concerning alleged Clean Air Act violations at Four Corners. The filing says outcomes and potential financial effects are uncertain; APS did not expect the greenhouse-gas “tailoring rule” to materially affect current operations.
Important facts for investors to verify
- Separate recurring regulated-utility earnings from the district-cooling gain and the substantially lower SunCor impairments when assessing year-over-year profit growth.
- Confirm APS’s rate recovery, the timing and terms of its next rate case, and progress toward required equity infusions and expense reductions.
- Track cash generation against the substantial planned capital program, debt maturities and dividend requirements; confirm continued access to credit facilities and commercial-paper markets.
- Monitor SunCor’s remaining asset sales and debt restructuring, including whether the remaining defaulted debt is repaid without affecting the parent or utility.
- Assess potential costs and schedule impacts from environmental rules, renewable commitments, nuclear obligations, and any additional collateral demands tied to credit ratings or derivative contracts.