Pinnacle West Capital Corporation — Q2 2014 Form 10-Q
Period: Quarter and six months ended June 30, 2014; unaudited. Pinnacle West is a holding company whose results are generated primarily by its regulated Arizona utility, Arizona Public Service Company (APS). Comparisons below are against 2013.
Financial performance
| Metric | Q2 2014 | Q2 2013 | Six months 2014 | Six months 2013 |
|---|---|---|---|---|
| Operating revenue | $906.3m | $915.8m | $1,592.5m | $1,602.5m |
| Operating income | $254.1m | $259.8m | $329.3m | $346.7m |
| Net income attributable to common shareholders | $132.5m | $131.2m | $148.2m | $155.7m |
| Diluted EPS | $1.19 | $1.18 | $1.34 | $1.40 |
| Operating margin (operating income/revenue) | 28.0% | 28.4% | 20.7% | 21.6% |
Q2 operating revenue fell about 1.0% and operating income about 2.2%, while common-shareholder net income rose about 1.0%. For the first half, revenue declined about 0.6%, operating income about 5.0%, and common-shareholder net income about 4.8%. The first-half decline reflected adverse weather, lower retail transmission revenue and higher property taxes; lower operations and maintenance costs, higher other income and lower income taxes partly offset the pressure. Q2 benefited from lower operations and maintenance costs and higher other income, partly offset by weather and weaker retail sales. First-half diluted EPS was $1.34, versus $1.40.
- Cash flow: First-half operating cash flow was $465.1m, versus $454.3m; capital expenditures were $388.8m, versus $376.6m. Investing cash outflow was $393.0m and financing cash outflow $72.5m. Ending cash was $9.2m. The $135m IRS refund received in Q1 materially supported operating cash flow; higher pension contributions, collateral changes, fuel and purchased-power costs, and working capital partly offset it.
- Debt and liquidity: Pinnacle West reported $3.00bn of long-term debt excluding current maturities, $368.8m of current maturities and $176.7m of short-term borrowings. Its debt-to-capitalization covenant ratio was about 46%; APS’s was about 45%, both below the 65% limit. APS’s ACC-required common-equity ratio was 58%, above its 40% minimum. Pinnacle West had a $200m revolver and $4m commercial paper outstanding; APS had $1bn of revolvers and $173m of commercial paper outstanding, with no revolver borrowings. Both companies said borrowing capacity was ample.
- Dividend: Pinnacle West declared $0.5675 per share payable September 2, 2014; dividends declared were $1.14 per share for the first half, compared with $1.09 in 2013.
Material changes and business developments
- APS’s weather-adjusted retail electricity sales declined 0.8% year over year in the first half, despite 1.3% customer growth. Management attributed the sales decline to conservation, efficiency programs and distributed generation, partly offset by economic improvement and customer growth.
- APS completed its acquisition of SCE’s 48% interest in Four Corners Units 4 and 5 in December 2013 for about $182m; Units 1–3 were retired. APS’s request for pre-rate-case recovery related to the transaction could produce an estimated 2% average residential-bill impact if approved. A hearing was scheduled for August 2014; the outcome remained uncertain.
- APS issued $250m of 4.70% senior notes due 2044 and $250m of 3.35% notes due 2024. Proceeds helped fund the Four Corners transaction and refinance maturing debt, including $300m of 5.80% notes.
- APS replaced its $500m revolver, and Pinnacle West replaced its $200m revolver, with facilities maturing in May 2019. First-half capital spending increased year over year.
Outlook, risks and unusual items
- Management expected customer growth to average about 2.5% annually and weather-adjusted retail sales growth about 1% annually over 2014–2016. It cautioned that economic conditions, weather, usage, conservation and distributed generation could change these estimates. Typical weather or economic variations could affect annual net income by up to about $10m; extreme weather variations had historically caused impacts exceeding $20m.
- Estimated APS capital expenditures were $931m for 2014, $1.026bn for 2015 and $1.263bn for 2016, funded through operating cash flow and external financing. Planned investment includes generation, distribution, transmission and environmental work.
- EPA’s proposed Clean Power Plan could shift Arizona generation from coal toward natural gas and renewables, potentially requiring additional investment and increasing operating costs. Environmental compliance estimates include APS’s share of about $350m for Four Corners controls and potentially up to $200m for Navajo; Cholla controls could cost about $200m if APS’s challenge is unsuccessful. APS said cost recovery through rates was uncertain.
- APS’s Four Corners transmission-termination arrangements with SCE remained subject to FERC proceedings and possible arbitration. FERC had denied rate recovery of $40m associated with the termination; an unsuccessful outcome could result in a charge to earnings.
- On July 7, 2014, APS agreed to exercise fixed-rate lease renewal options for Palo Verde sale-leaseback assets, with annual payments of about $23m for 2016–2023 and $16m for 2024–2033. Separately, FERC approved a $3.25m civil penalty resolving the 2011 Southwest power-outage reliability investigation; APS neither admitted nor denied four alleged violations.
- Other contingencies include Superfund and environmental matters, a New Mexico coal-tax dispute, a pending spent-fuel claim against the Department of Energy, and an appeal related to the 2011 regional outage. The filing says potential losses could not be reasonably estimated in certain matters.
- APS expects voluntary pension contributions of up to $175m in 2014; $140m had been contributed through July 2014. Management cautioned that plan funding needs depend on asset performance and actuarial assumptions.
Investor verification priorities
- Track the ACC’s decision on Four Corners cost recovery and the related proposed residential rate impact.
- Verify developments in EPA greenhouse-gas and plant-specific environmental requirements, expected compliance costs, and recoverability in rates.
- Follow the FERC/SCE transmission dispute, including possible arbitration and any earnings charge.
- Assess whether the $135m tax refund masks underlying operating cash-flow needs, particularly capital spending and pension funding.
- Monitor weather-adjusted sales, customer growth, and the effects of conservation and rooftop solar on revenue and margins.
- Review the status and potential exposure of the disclosed environmental, outage, tax and nuclear-related contingencies.