Pinnacle West Capital Corporation — Q3 2014 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2014. The filing presents consolidated results for Pinnacle West, whose principal operating subsidiary is Arizona Public Service Company (APS), a regulated electric utility serving most of Arizona. Figures below are Pinnacle West consolidated unless otherwise noted; dollar amounts are rounded to millions.
Financial performance
| Metric | Q3 2014 | Q3 2013 | Nine months 2014 | Nine months 2013 |
|---|---|---|---|---|
| Operating revenue | $1,173 | $1,152 | $2,765 | $2,755 |
| Operating income | $422 | $416 | $751 | $762 |
| Net income attributable to common shareholders | $244 | $226 | $392 | $382 |
| Diluted earnings per share | $2.20 | $2.04 | $3.53 | $3.44 |
| Operating margin (calculated) | 36.0% | 36.1% | 27.2% | 27.7% |
Q3 revenue increased about 1.8% and common net income rose about 7.9% year over year. For the nine-month period, revenue was nearly flat, operating income declined about 1.5%, and common net income increased about 2.7%. Management attributed earnings improvement chiefly to lower employee benefit costs, with offsets including fossil-generation costs and weather-related sales effects. Nine-month dividends declared were $1.14 per share.
Cash flow: Nine-month operating cash flow was $887 million, compared with $882 million a year earlier. Capital expenditures were $619 million, up from $582 million. Investing cash use was $634 million; financing cash use was $252 million. Cash at September 30 was $10 million. Operating cash flow benefited from a $135 million IRS refund, partly offset by higher fuel and purchased-power costs, pension contributions, collateral changes, and working capital movements.
Debt and liquidity: Long-term debt, including current maturities, was approximately $3.407 billion at September 30, versus $3.337 billion at year-end 2013; short-term borrowings were $19 million. Current assets of $1.041 billion were below current liabilities of $1.449 billion. APS had $1 billion of revolving credit facilities, with $19 million of commercial paper outstanding and no borrowings under the facilities; Pinnacle West had a $200 million facility and no commercial paper borrowings. Reported debt-to-capitalization ratios were approximately 43% for APS and 44% for Pinnacle West. APS complied with its ACC-required minimum common-equity ratio.
Material changes and operating developments
- Q3 operating income increased modestly, but nine-month operating income fell. Nine-month operating revenue less fuel and purchased-power expense declined $53 million, principally reflecting weather, lower retail transmission revenue, and lower sales from customer usage patterns; this was partly offset by cost recovery and other items.
- Operations and maintenance expense decreased $10 million in Q3 and $38 million over nine months, primarily due to lower employee benefit costs. Higher fossil generation costs and property taxes were offsets in the year-to-date comparison.
- APS purchased Southern California Edison’s 48% interests in Four Corners Units 4 and 5 for approximately $182 million in December 2013. A rate-adjustment request remains pending; APS estimated an approximately 2% average residential bill impact if approved.
- On September 30, Pinnacle West announced changes to its other postretirement benefit plan. The interim remeasurement reduced the benefit obligation by $316 million, offset by related regulatory and accumulated other comprehensive income items. Management expected a $10 million reduction in 2014 periodic benefit costs, including $5 million reducing expense, to be recognized in Q4.
Outlook, risks, and contingencies
- Operating outlook: 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. These estimates depend on Arizona economic conditions, customer usage, conservation, efficiency programs, and distributed generation. The filing does not provide a clear full-year 2014 earnings guidance figure.
- Investment plans: APS estimated capital expenditures of $864 million in 2014, $1.091 billion in 2015, and $1.248 billion in 2016. Planned spending includes generation, transmission, distribution, renewables, and environmental projects. Purchase obligations increased about $230 million during the quarter, primarily for gas-generation projects.
- Cholla and environmental regulation: APS determined retirement of Cholla Unit 2 in April 2016 was probable and reclassified its $130 million remaining net book value to a regulatory asset. Recovery depends on regulatory approval; disallowance could require a write-off and adversely affect earnings, cash flow, and financial position. APS’s proposed compromise also contemplates ending coal burning at Units 1 and 3 by the mid-2020s, subject to approvals. Environmental rules may require material spending or prompt further plant retirements.
- Regulatory recovery: APS’s Four Corners recovery case remained unresolved at quarter-end, with staff and consumer representatives proposing lower returns than APS sought. A separate FERC-related dispute with SCE could proceed to arbitration; if APS is unsuccessful, a charge may be required. APS also faces uncertainty over future rate design, net metering, renewable-energy requirements, and timely recovery of costs.
- Other contingencies: APS agreed to a $3.25 million civil penalty and reliability enhancements to resolve FERC/NERC matters concerning the 2011 Southwest power outage; it neither admitted nor denied the alleged violations. A DOE settlement paid Palo Verde owners $57.4 million for specified spent-fuel costs; APS’s $16.7 million share was recorded as a regulatory liability, with no current-income impact. Environmental litigation, Superfund matters, nuclear operating and insurance exposures, and spent-fuel disposal uncertainty remain relevant risks.
- Management’s principal risk themes: Weather and demand, power-plant and transmission reliability, fuel and purchased-power costs, rate recovery and regulatory decisions, environmental compliance, capital-market access, pension investment performance, nuclear risks, and counterparty performance. Management noted that normal weather variations can affect annual net income by up to $10 million; extreme weather has historically caused larger fluctuations.
- Dividend: On October 23, 2014, the Board declared a $0.595-per-share dividend payable December 1, increasing the indicated annual dividend from $2.27 to $2.38 per share.
Important facts for investors to verify
- Whether the ACC approves APS’s requested Four Corners cost recovery and the resulting customer-rate impact.
- Whether APS’s Cholla retirement and environmental-compliance proposals receive required approvals, and whether regulators permit recovery of the $130 million Unit 2 regulatory asset.
- The outcome and potential financial exposure of the SCE transmission termination dispute and related arbitration risk.
- Whether projected customer and sales growth, capital spending, and cost recovery develop as management expects, particularly given weather, conservation, and distributed solar.
- APS’s liquidity, debt maturities and refinancing progress, and the effect of planned capital investment and dividend growth on funding needs.
- Developments in environmental rules and litigation, nuclear obligations, pension assumptions, and other contingencies that could materially change costs or reported results.