Pinnacle West Capital Corporation — Q2 2017 Form 10-Q
Business context and reporting period. The filing covers the quarter and six months ended June 30, 2017. Pinnacle West is a holding company whose results are driven primarily by its regulated Arizona utility, APS. Amounts below are Pinnacle West consolidated unless noted; financial statements are unaudited.
Key financial metrics
| Metric | Q2 2017 | Q2 2016 | Six months 2017 | Six months 2016 |
|---|---|---|---|---|
| Operating revenue | $944.6 million | $915.4 million | $1,622.3 million | $1,592.6 million |
| Operating income | $304.2 million | $231.7 million | $377.7 million | $281.9 million |
| Net income attributable to common shareholders | $167.4 million | $121.3 million | $190.8 million | $125.8 million |
| Diluted EPS | $1.49 | $1.08 | $1.70 | $1.12 |
| Operating cash flow | Not presented quarterly | Not presented quarterly | $290.6 million | $422.5 million |
- Q2 revenue increased about 3% year over year; common-shareholder net income rose about 38%. For the first half, revenue increased about 2% and common-shareholder net income about 52%.
- Operating margin was approximately 32.2% in Q2 versus 25.3% in Q2 2016, and 23.3% for the first half versus 17.7%. Improvement primarily reflected lower operating and maintenance costs and higher transmission and retail revenues.
- Six-month capital expenditures were $693.6 million, versus $731.6 million in 2016. Operating cash flow fell by $131.9 million year over year, leaving cash flow after capital expenditures negative at approximately $403 million before financing.
- Cash and equivalents were $5.0 million at June 30, 2017, versus $8.9 million at year-end 2016. Current assets were $1.07 billion and current liabilities $1.64 billion.
- At June 30, Pinnacle West had $4.19 billion of long-term debt, $207 million of current maturities and $482 million of short-term borrowings. APS separately reported $4.19 billion of long-term debt, $82 million of current maturities and $385.7 million of commercial paper. APS reported a 53% common-equity ratio under the ACC definition and was in compliance with its 40% minimum.
- APS issued $250 million of 4.35% notes due 2045 during the period and had $1 billion of revolving credit facilities, with no facility borrowings or letters of credit outstanding at quarter-end. Pinnacle West had $39.3 million of commercial paper outstanding and $57 million outstanding under its 364-day facility.
Material changes and management commentary
- Management attributed the earnings improvement mainly to reduced operations and maintenance costs—particularly lower fossil-generation, employee-benefit and Palo Verde costs—along with higher transmission revenues, customer growth, usage patterns and lost-fixed-cost recovery. Higher income taxes and depreciation partly offset gains.
- APS reported weather-adjusted retail sales up 0.1% for the first half and customer growth of 1.6%. 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%–3% and sales growth of 0.5%–1.5%.
- Estimated APS capital expenditures are $1.337 billion in 2017, $1.139 billion in 2018 and $1.009 billion in 2019. Funding is expected from operating cash and external financing.
- Six-month fuel and purchased-power commitments decreased approximately $670 million, mainly due to updated renewable-energy purchase estimates, largely for 2022 and later.
Outlook, regulation, risks and unusual items
- Rate case: A multi-party settlement provides for a $94.6 million annual net base-rate increase, a 10.0% authorized return on equity and other rate-design and cost-recovery provisions. On July 26, 2017, after quarter-end, the administrative law judge recommended approval without material changes and rates effective September 1. The ACC had not issued its final decision as of the filing; approval and timing remained uncertain.
- Generation and recovery risks: APS considered it probable that the Navajo Generating Station would cease operations in December 2019. It reclassified its $102 million remaining investment to a regulatory asset and intends to seek rate recovery, including retirement costs that were still being assessed and could be material. Cholla Unit 2 had a $112 million remaining net book value; recovery depends on regulatory treatment. Failure to recover these balances could adversely affect earnings, cash flow and financial position.
- Environmental obligations: APS estimated its share of required Four Corners pollution controls at about $400 million and potential Navajo Plant upgrades at up to about $200 million. CCR compliance estimates were about $22 million for Four Corners, $20 million for Cholla and $1 million for Navajo, excluding corrective-action costs that could not yet be estimated. The effects of changing environmental requirements remain uncertain.
- Contingencies: NTEC sought arbitration over alleged coal-purchase shortfalls of about $27 million, of which APS’s share was about $17 million; the company did not expect a material financial impact. Other unresolved matters include environmental litigation, regulatory proceedings, and a dispute over Commissioner Burns’s subpoenas; outcomes were not predictable.
- Liquidity and market risks: Management described borrowing capacity as ample, but low cash, substantial capital spending and reduced operating cash flow make funding needs and access to capital important. Commodity-price, counterparty, interest-rate and credit-rating changes may affect collateral needs; a below-investment-grade downgrade could require additional collateral under certain contracts.
- Other developments: Pinnacle West amended its 364-day revolving facility on July 31, 2017, increasing capacity from $75 million to $125 million and extending maturity to July 30, 2018. The filing also identifies cybersecurity threats and unresolved APS union negotiations; neither was expected to have a material impact at that time.
Investor verification priorities
- Confirm the ACC’s final ruling, effective date and realized customer-rate and earnings effects of the APS rate-case settlement.
- Assess whether earnings gains from lower maintenance costs, transmission revenues and regulatory recovery persist, and monitor the divergence between earnings growth and lower operating cash flow.
- Track capital spending, short-term borrowing, debt maturities, liquidity availability and APS compliance with equity and debt covenants.
- Verify the timing and cost of Navajo Plant retirement, environmental compliance projects, and recovery of the Navajo and Cholla regulatory assets.
- Monitor coal-supply arbitration, environmental and regulatory proceedings, cybersecurity exposure, and potential collateral or insurance requirements.