Pinnacle West Capital Corporation — 2018 Form 10-K Summary
Reporting period: Fiscal year ended December 31, 2018. The filing also reports fourth-quarter results. Pinnacle West is a holding company whose revenues and earnings are derived essentially entirely from its regulated utility subsidiary, Arizona Public Service Company (APS), which serves approximately 1.2 million customers in Arizona.
Financial performance and key metrics
| Metric | 2018 | 2017 | Change |
|---|---|---|---|
| Pinnacle West operating revenues | $3.691 billion | $3.565 billion | +3.5% |
| Operating income | $774 million | $910 million | −15.0% |
| Net income attributable to common shareholders | $511 million | $488 million | +4.6% |
| Diluted EPS | $4.54 | $4.35 | +4.4% |
| Net cash from operating activities | $1.277 billion | $1.118 billion | +$159 million |
| Capital expenditures | $1.178 billion | $1.409 billion | −$231 million |
Operating margin was approximately 21.0%, down from 25.5%; net margin was approximately 13.8%, compared with 13.7%. The increase in common net income despite lower operating income primarily reflected substantially lower income tax expense following federal tax reform and higher non-service pension and postretirement credits. Higher operating and maintenance, depreciation and property-tax expenses weighed on operating income.
APS reported 2018 operating revenues of $3.688 billion, operating income of $830 million and net income attributable to its common shareholder of $570 million, versus $3.558 billion, $925 million and $504 million, respectively, in 2017.
Fourth quarter: Pinnacle West revenue was $756 million versus $760 million in fourth-quarter 2017; common-shareholder net income was $26 million versus $22 million, and diluted EPS was $0.23 versus $0.19.
Debt and liquidity: At year-end, Pinnacle West had $4.638 billion of long-term debt excluding current maturities, $500 million of current maturities and approximately $76 million of short-term borrowings. Its debt-to-capitalization ratio was approximately 50%, below the 65% covenant limit. Pinnacle West and APS had $1.274 billion of available committed credit facilities combined. Cash and cash equivalents were approximately $6 million. APS’s ACC-defined common equity ratio was 54%, above its 40% minimum.
Dividends: Pinnacle West declared $2.87 per share for 2018 and paid approximately $309 million in common dividends. Its indicated annual dividend increased to $2.95 per share during 2018. Cash from operations less capital expenditures was approximately $99 million, below dividends paid.
Material changes versus the prior comparable period
- Common net income rose $23 million, while operating income fell $136 million. The filing attributes the earnings increase principally to reduced income taxes, partly offset by higher operating costs, depreciation, property taxes and interest.
- The 2017 retail rate-case settlement contributed higher base-rate and transmission revenues. Federal tax reform also led APS to reduce customer rates: the ACC approved an annualized $119.1 million rate reduction, effective with the first billing cycle in March 2018. Management describes the tax mechanism as earnings-neutral over time, though quarterly timing can differ.
- Operating cash flow increased, while capital spending and investing cash outflow declined. Net cash used for financing was $92 million in 2018, versus $316 million provided in 2017.
- APS completed the sale of 4CA’s 7% Four Corners interest to NTEC for approximately $70 million, payable over four years under a secured note. Pinnacle West guaranteed certain obligations of NTEC to the other plant owners.
Outlook, commentary and material risks
- Operating outlook: Management projected APS customer growth of 1.5%–2.5% annually in 2019 and on average through 2021. Weather-adjusted retail electricity sales were projected to grow 1.0%–2.0% in 2019 and average 1.5%–2.5% growth through 2021. These are operating projections, not earnings guidance. No clear 2019 EPS guidance is provided in the supplied filing text.
- Investment plans: Estimated APS capital expenditures are $1.226 billion in 2019, $1.203 billion in 2020 and $1.484 billion in 2021. The Ocotillo modernization project was expected to add 510 MW by mid-2019. APS planned at least 660 MW of additional APS-owned solar-plus-storage and stand-alone storage by summer 2025; several storage contracts and procurement plans were announced after year-end.
- Generation transition: APS and other Navajo Generating Station owners expected the plant to cease operations in December 2019, although alternatives were under discussion. APS had an $88 million remaining investment recorded as a regulatory asset and intended to seek rate recovery, along with recovery of retirement and closure costs that could be material. Cholla Unit 2 had already retired; APS planned to cease coal burning at Units 1 and 3 by the mid-2020s.
- Regulatory exposure: The ACC opened a 2018 test-year review of APS rates, with a staff report requested by May 3, 2019; the commission could take further action, potentially including reopening the 2017 rate decision. A separate customer complaint proceeding remained unresolved. APS’s requested Four Corners SCR recovery was reduced from $67.5 million to a recommended annual revenue requirement of approximately $58.5 million, pending ACC action.
- Environmental and legal matters: CCR monitoring identified Cholla and Four Corners units requiring corrective action and closure by October 2020. APS estimated about $5 million in additional corrective-action, closure and replacement-capacity costs for those sites, beyond previously estimated compliance costs; estimates could change. Other uncertainties include environmental regulation and permits, Four Corners litigation and wastewater permitting, coal-plant economics, water rights and supply, and Navajo Plant closure obligations.
- Other notable items: Pinnacle West disclosed grand jury subpoenas connected principally with Arizona’s 2014 statewide elections and stated it was cooperating with the U.S. Attorney’s Office. Commissioner Burns appealed a trial-court dismissal related to subpoenas seeking company expenditure records. Management states it cannot predict outcomes.
- Additional risks: Earnings and cash flows are sensitive to weather, customer usage, fuel and purchased-power costs, regulatory cost recovery, plant outages, cybersecurity, wildfire exposure, interest rates, pension assets and liabilities, and access to capital. APS expects approximately $1.23 billion of capital expenditures in 2019 and identified a $500 million 2019 debt maturity.
Most important facts for investors to verify
- Whether the ACC rate review or customer complaint changes the economics of the 2017 rate settlement or APS’s authorized returns.
- The final timing and rate recovery of the Four Corners SCR investment, and the recoverability of APS’s Navajo Plant investment and closure costs.
- Actual CCR corrective-action and closure requirements, final costs, and any material changes to environmental permitting or compliance obligations.
- Delivery, cost and regulatory treatment of planned capital expenditures, Ocotillo capacity additions and battery-storage projects.
- Funding of capital spending, the 2019 debt maturity and dividends, given 2018 capital expenditures exceeded cash generated after capital spending.
- Developments in the Four Corners-related legal matters, the Burns appeal and the U.S. Attorney’s investigation.
Controls and audit: Deloitte & Touche issued unqualified opinions on the financial statements and internal control over financial reporting; management reported effective controls as of December 31, 2018.