Business context and reporting period
Pinnacle West Capital Corporation (Pinnacle West) filed this unaudited Form 10-Q for the quarter ended March 31, 2017. Its Arizona Public Service Company (APS) subsidiary is a vertically integrated regulated electric utility and accounts for essentially all of Pinnacle West’s revenue and earnings. Comparisons below are with the three months ended March 31, 2016 unless noted.
First-quarter results are seasonal and may not indicate full-year performance; electricity demand, weather and generating-plant maintenance affect interim results.
Financial performance
| Metric | Pinnacle West consolidated | Comparison / detail |
|---|---|---|
| Operating revenue | $677.7 million | Up $0.6 million from $677.2 million |
| Operating income | $73.5 million | Up from $50.2 million |
| Operating margin | 10.8% | 7.4% in 2016 |
| Net income | $28.2 million | Up from $9.3 million; includes $4.9 million attributable to noncontrolling interests |
| Net income attributable to common shareholders | $23.3 million; diluted EPS $0.21 | $4.5 million; diluted EPS $0.04 |
| Net margin attributable to common shareholders | 3.4% | 0.7% in 2016 |
| Operating cash flow | $140.1 million | Down from $144.2 million |
| Capital expenditures | $348.8 million | Down from $378.5 million |
| Cash and cash equivalents | $3.0 million at March 31 | $8.9 million at December 31, 2016 |
Operating cash flow less capital expenditures was negative approximately $208.8 million. Investing cash use was $348.7 million and financing provided $202.8 million, leaving cash down $5.9 million during the quarter.
APS reported electric operating revenue of $676.9 million, operating income of $65.5 million and net income attributable to its common shareholder of $23.2 million, versus $676.6 million, $48.9 million and $7.3 million, respectively, a year earlier.
Debt and liquidity
- Pinnacle West had $4.27 billion of long-term debt less current maturities, $125 million of current maturities and $207.3 million of short-term borrowings at quarter-end. APS reported $4.27 billion of long-term debt less current maturities and $116.5 million of commercial paper outstanding.
- APS issued $250 million par value of 4.35% senior notes due November 2045 in March. Proceeds were used to refinance commercial paper and replenish cash used for capital expenditures.
- APS had $1 billion of revolving credit facilities, with no facility borrowings or letters of credit outstanding. Pinnacle West reported $42.8 million of commercial paper and $48 million drawn under a separate $75 million facility. Management described borrowing capacity as ample.
- APS’s common equity ratio, as defined by its regulatory order, was 52%, above the required 40% minimum. Pinnacle West and APS were in compliance with their 65% debt-to-capitalization covenant; reported ratios were approximately 49% and 48%, respectively.
Material changes and management commentary
- Common-shareholder earnings increased by about $18.9 million. Management attributed the improvement primarily to lower operations and maintenance costs, higher lost fixed-cost recovery and favorable weather effects, partly offset by lower retail sales and usage-related pricing.
- Operations and maintenance expense fell $23.2 million, primarily due to $18 million less fossil-generation expense from reduced planned outages and $7 million lower employee-benefit costs. Depreciation and amortization rose $8.2 million, mainly from increased plant in service.
- Weather-adjusted retail electricity sales declined 3.3%, despite 1.4% customer growth. The company cited conservation, energy efficiency, distributed generation, customer usage patterns and one fewer sales day than in leap-year 2016.
- Fuel and purchased-power expense decreased to $212.4 million from $221.3 million. Pinnacle West’s derivative disclosures report a $52.9 million first-quarter net loss recognized in income before power-supply-adjustor deferrals; regulated recovery mechanisms defer eligible amounts for future rate treatment.
Outlook, regulation and risks
- Rate case: APS and supporting stakeholders filed a proposed settlement on March 27, 2017. It provides for a net annual base-rate increase of $94.6 million, subject to ACC approval, and includes a 10.0% authorized return on common equity. Hearings began April 24; the company expected a moderate delay beyond the originally anticipated July 1 effective date. On April 27, Commissioner Burns requested suspension of proceedings and an investigation concerning commissioner disqualification. APS said the approval and timing remained uncertain.
- Business outlook: Management projected 2017 customer growth of 1.5%–2.5% and weather-adjusted retail sales growth of 0%–1.0%; for 2017–2019 it projected average annual customer growth of 2.0%–3.0% and sales growth of 0.5%–1.5%. These are estimates, not guarantees. Typical weather variation may change annual net income by up to $10 million; extreme variations have historically caused impacts exceeding $20 million.
- Investment: APS estimated capital expenditures of $1.337 billion in 2017, $1.139 billion in 2018 and $1.009 billion in 2019. Management expects funding from operating cash flow and external financing. A $0.655 per-share dividend was declared for payment June 1, 2017.
- Generation transition: Navajo Generating Station co-owners voted not to pursue operation beyond December 2019, absent an acceptable alternative. APS’s remaining investment was $106 million; recovery of that investment and potentially material retirement costs is uncertain. APS’s $114 million Cholla Unit 2 regulatory asset also depends on continued rate recovery. Planned Four Corners pollution controls were estimated to cost APS approximately $400 million for its 63% share.
- Other material uncertainties: Environmental compliance costs, potential coal-plant retirements and asset impairments, fuel and power prices, plant and transmission reliability, customer demand, and timely regulatory recovery pose risks. Legal and regulatory matters include the ACC rate case and subpoena dispute, challenges related to Four Corners, and environmental proceedings. Westinghouse’s Chapter 11 filing was not expected by management to have a material financial impact, though the outcome was uncertain.
- Other items: Fuel and purchased-power commitments declined approximately $600 million in the quarter, primarily from updated renewable-purchase estimates, mostly for 2022 and later. Pinnacle West made $60 million of voluntary pension contributions year-to-date and expected up to $300 million in voluntary contributions over 2017–2019.
Important facts for investors to verify
- Whether the ACC approves the proposed rate settlement, its effective date and any changes to its $94.6 million annual net increase.
- Whether APS can recover its Navajo Plant and Cholla investments and retirement-related costs, and the timing and cost of the Navajo transition.
- Actual 2017 sales, customer growth, weather effects and expense trends versus management’s projections.
- Capital spending, financing needs, debt levels and access to liquidity as APS executes its investment program.
- Whether environmental requirements, litigation, or fuel and purchased-power market movements materially change costs or rate recovery.