Pinnacle West Capital Corporation — Q1 2011 Form 10-Q
Business context and reporting period. The filing covers the three months ended March 31, 2011, compared with Q1 2010. Pinnacle West owns Arizona Public Service Company (APS), a vertically integrated regulated electric utility serving much of Arizona; APS generates substantially all Pinnacle West’s revenue and earnings. Interim results are seasonal and may not indicate full-year performance. Amounts below are in U.S. dollars; financial figures are generally in millions unless stated otherwise.
Financial results and liquidity
| Metric | Q1 2011 | Q1 2010 |
|---|---|---|
| Operating revenue | $659.6 | $620.4 |
| Operating income | $37.1 | $57.7 |
| Net income (loss) attributable to common shareholders | $(15.1) | $(6.0) |
| Basic and diluted EPS | $(0.14) | $(0.06) |
| Operating cash flow | $243.5 | $(13.7) |
| Capital expenditures, cash-flow statement | $191.6 | $202.6 |
| Dividends declared per share | $0.525 | $0.525 |
- Revenue rose about 6%, but operating income fell about 36%. The operating margin was approximately 5.6%, compared with 9.3% a year earlier.
- Continuing-operations loss attributable to common shareholders was $14.8 million, versus income of $6.9 million in Q1 2010. Total net loss also includes discontinued operations; the prior-year comparative was reclassified for discontinued operations.
- Operations and maintenance expense increased $48.6 million to $256.5 million. The company attributed much of the increase to planned maintenance at two gas-fired combined-cycle plants; $28 million of transmission-rights-of-way settlement expense was offset by related revenue and did not affect net income. Fuel and purchased-power expense declined slightly.
- Operating cash flow improved by $257 million year over year, principally due to returned margin and collateral cash, the absence of a voluntary $100 million pension contribution made in 2010, and working-capital changes. Investing cash outflow was $192.8 million; financing cash outflow was $46.7 million.
- At March 31, cash was $114.2 million and current assets were $958.0 million, against current liabilities of $1.674 billion. Consolidated debt, including current maturities and Palo Verde sale-leaseback lessor notes, was approximately $3.68 billion; short-term borrowings were $17.3 million. Current maturities of long-term debt were $832.3 million.
- Pinnacle West reported $200 million of committed revolving credit capacity and $17 million of commercial paper outstanding. APS had $1 billion of credit facilities, no facility borrowings or commercial paper outstanding, and a $20 million letter of credit. APS reported a 53% common-equity ratio under the ACC definition and was above its 40% minimum requirement.
Material changes, outlook, and management commentary
- Operating performance: Management attributed the $22 million year-over-year decline in regulated-segment net income primarily to planned timing and level of maintenance at two gas-fired plants. Weather, higher retail usage, and regulatory surcharges affected revenue comparisons.
- Demand and customer outlook: Weather-adjusted retail kilowatt-hour sales rose 1.2% year over year in Q1, while customer growth was 0.4%. Management estimated average annual customer growth of about 1.7% and flat average retail sales for 2011–2013, excluding weather effects; economic weakness could reduce these outcomes.
- Capital spending: Estimated capital expenditures were $952 million in 2011, $1.340 billion in 2012, and $962 million in 2013. The 2012 estimate includes $294 million for the planned purchase of SCE’s Four Corners Units 4 and 5 interests. The purchase and related plant changes remain subject to regulatory and other conditions.
- Rates and regulation: APS filed notice that it intended to submit its next general rate case on June 1, 2011, and expected to propose decoupling and other cost-recovery mechanisms. APS’s settlement requires at least $700 million of equity infusions through 2014. A FERC formula-rate increase of about $44.3 million annually was scheduled to take effect June 1, 2011; about $38.2 million relates to APS retail transmission service, and the related ACC cost-adjustor application was pending.
- Generation and renewables: The NRC approved 20-year license extensions for all three Palo Verde units on April 21, 2011. Management estimated annual pretax depreciation expense would decrease by about $34 million beginning January 1, 2012. APS reported 901 MW of renewable resources in operation, under contract, or under development. Its approved 2011 renewable-energy budget was $96 million, with ACC reconsideration changing certain program terms.
- Four Corners and environmental spending: APS’s proposed purchase of SCE’s 48% interests in Units 4 and 5 for $294 million is expected, if completed, to be followed by closure of Units 1–3. The transaction depends on approvals and other conditions, including federal review of Navajo Nation lease and rights-of-way matters. Proposed federal hazardous-air-pollutant standards could require estimated control equipment spending of $220 million at Four Corners Units 1–3 and $89 million at Cholla Units 1–3; the Four Corners estimate was excluded from current forecasts based on the assumed plant closures.
- Tax and retirement items: Federal bonus-depreciation provisions were expected to generate $425–475 million of APS cash tax benefits through 2013, primarily in 2012–2013, representing accelerated rather than new lifetime tax benefits. The minimum pension contribution was zero for 2011 and approximately $85 million for 2012; other postretirement contributions were estimated at $20 million annually for 2011 and 2012.
- Unusual balance-sheet item: Updated Palo Verde decommissioning estimates, reflecting the license extensions, reduced the asset-retirement liability by $90 million, reduced plant in service by $78 million, and increased regulatory liabilities by $12 million.
Risks, contingencies, and unusual exposures
- Results depend on timely and adequate rate recovery, electricity demand and weather, fuel and purchased-power prices, plant availability, capital costs, and regulatory decisions. Management noted that typical weather or economic variations may change annual net income by up to about $10 million; extreme weather has previously caused variations exceeding $20 million.
- Derivative contracts expose the company to commodity-price, counterparty, valuation, and collateral risks. If investment-grade credit-rating triggers were fully activated at quarter-end, Pinnacle West estimated it could need to post about $122 million of additional derivative collateral and about $196 million under other energy-related contracts.
- Future contractual purchase obligations increased to $699 million from approximately $456 million at year-end 2010, principally due to a transmission rights-of-way amendment and a solar-facility construction contract.
- APS estimated its share of Palo Verde on-site spent-fuel storage costs over the plant’s current life at $122 million in 2011 dollars. Nuclear insurance is subject to policy conditions, exclusions, and potential retrospective assessments.
- APS estimated approximately $1 million of currently reserved costs for the Motorola 52nd Street Superfund investigation; total future remediation costs could not yet be estimated. The filing also discusses pending climate-change litigation and proposed cooling-water rules whose ultimate financial impacts were not determined.
- Following the Fukushima Daiichi accident, the NRC began a review of U.S. nuclear plant safety. The company stated it could not predict whether any resulting actions would affect Palo Verde or APS.
- SunCor’s real-estate operations were reported as discontinued operations. The Q1 2010 comparison included $15 million of real-estate impairment charges; SunCor had approximately $16 million of remaining assets and no debt at March 31, 2011.
Important facts for investors to verify
- Whether the June 2011 APS rate-case filing and proposed decoupling or cost-recovery measures produce timely, adequate rate relief.
- Whether the Four Corners purchase closes, whether Units 1–3 are retired as assumed, and how regulatory approvals and environmental requirements affect the $294 million purchase and projected spending.
- Whether forecast capital expenditures, renewable commitments, and environmental projects remain within budget and can be financed without pressure on credit metrics or dividends.
- Whether operating cash flow remains strong after the quarter’s favorable collateral, tax, pension, and working-capital comparisons with 2010.
- How proposed emissions, cooling-water, and post-Fukushima nuclear requirements affect Palo Verde, coal-plant operations, capital costs, and recoverability through rates.
- Whether derivative collateral requirements, credit ratings, and debt maturities affect liquidity; confirm the $832 million current-maturity balance and available committed facilities.