Pinnacle West Capital Corporation — Q3 2013 Form 10-Q
Business and period. Unaudited results for the quarter and nine months ended September 30, 2013, compared with the same 2012 periods. Pinnacle West is a holding company whose principal business is Arizona Public Service Company (APS), a regulated, vertically integrated Arizona electric utility. Figures below are consolidated Pinnacle West unless otherwise noted.
Financial performance and position
| Metric | Q3 2013 | Q3 2012 | Nine months 2013 | Nine months 2012 |
|---|---|---|---|---|
| Operating revenue | $1,152 million | $1,109 million | $2,755 million | $2,609 million |
| Operating income | $416 million | $448 million | $762 million | $750 million |
| Net income attributable to common shareholders | $226 million | $245 million | $382 million | $359 million |
| Diluted EPS | $2.04 | $2.21 | $3.44 | $3.25 |
| Operating margin | 36.1% | 40.4% | 27.7% | 28.8% |
Cash flow and liquidity. Nine-month operating cash flow was $882 million, down from $929 million; investing cash outflow was $572 million, including $582 million of capital expenditures; financing cash outflow was $201 million. Cash rose to $135 million at September 30 from $26 million at year-end 2012. Pinnacle West had no borrowings under its $200 million credit facility; APS had no borrowings under its combined $1 billion of facilities. APS’s $566 million of current long-term debt maturities compares with $123 million at year-end 2012.
Debt and capitalization. Disclosed consolidated long-term debt carrying amount, including current maturities, was $3.387 billion; fair value was $3.663 billion. APS reported a 58% common-equity ratio under the applicable ACC definition and was compliant with its minimum 40% requirement. Debt-to-capitalization covenant ratios were approximately 44% for Pinnacle West and 43% for APS, within the 65% maximum.
Other metrics. Total assets were $13.823 billion, compared with $13.380 billion at December 31, 2012. Pinnacle West declared $1.09 per share of dividends for the first nine months. On October 23, the board declared a quarterly dividend of $0.5675 per share, increasing the indicated annual rate to $2.27.
Material changes and management commentary
- Q3 common-shareholder earnings fell $19 million year over year. Management attributed the decline principally to lower retail sales from conservation, efficiency and distributed generation; higher operations and maintenance, depreciation and property taxes; and lower pretax income. Lower income taxes partly offset these effects.
- Nine-month common-shareholder earnings increased $23 million. Benefits from the 2012 retail rate settlement, higher retail transmission revenue, lower net interest charges and weather were partly offset by higher operating costs, fuel and purchased-power costs, and depreciation.
- Weather-normalized retail electricity sales declined 0.1% year over year for the first nine months, while APS customer growth was 1.3%. Management expected average annual customer growth of about 2% and weather-normalized retail sales growth of less than 1% over 2013–2015.
- Operating cash flow declined despite higher pretax income, primarily reflecting higher pension contributions and a change in cash collateral posted. Capital expenditures were lower than in the prior-year period.
Outlook, significant matters and risks
- Investment and regulation: APS estimated capital expenditures of $1.055 billion in 2013, $909 million in 2014 and $1.110 billion in 2015. Its 2014 renewable-energy plan requested approximately $143 million; ACC staff recommended approval. APS’s next general rate case was generally stayed until after May 31, 2015, with a requested rate increase not to take effect before July 1, 2016.
- Four Corners: APS’s proposed $294 million purchase of SCE’s interests in Units 4 and 5 remained conditional, with a new coal-supply contract a key closing condition. APS planned to close Units 1–3 if the acquisition proceeds. EPA extended the deadline for selecting a regional-haze compliance strategy to December 31, 2013. APS cannot predict whether the transaction will close.
- Transmission agreement: FERC accepted cancellation of an agreement associated with the Four Corners transaction but denied APS’s request to recover a related $40 million payment through rates. APS believes the denial may relieve it of its agreement obligations; negotiations were ongoing, with arbitration possible.
- Environmental exposure: Estimated APS costs include approximately $300 million for Four Corners controls under the assumed acquisition and closure scenario, up to $200 million for Navajo Plant controls under EPA’s proposal, and approximately $200 million for Cholla controls if APS’s challenge fails. Additional environmental requirements could raise costs, impair coal-plant economics or lead to early retirement; recovery through rates is uncertain.
- Other contingencies: APS disclosed a Superfund-related groundwater lawsuit with 24 other defendants for which it could not estimate a reasonably possible loss range; a Clean Air Act case concerning Four Corners; and potential enforcement or claims arising from the 2011 Southwest power outage. APS also reported an approximately $12 million share of a disputed New Mexico coal severance tax assessment.
- Tax and pension items: An anticipated $137 million IRS refund was classified as current and expected within 12 months; it was reduced by about $4 million for the likely outcome of an IRS examination, and uncertain tax positions could decrease by a further approximately $35 million, substantially offset by deferred tax liabilities. Pinnacle West contributed $141 million voluntarily to its pension plan in 2013 and expected contributions of up to approximately $175 million annually in 2014 and 2015.
- Key operating risks: Demand and weather variability, fuel and purchased-power prices, generation or transmission outages, rate recovery, regulation and environmental compliance, nuclear operations, capital-market access, credit ratings, and counterparty performance. Management cautioned that interim results are seasonally affected by weather and may not indicate full-year results.
Important facts for investors to verify
- Whether APS’s retail sales, customer growth and allowed cost recovery support management’s 2013–2015 outlook.
- Progress and final economics of the Four Corners acquisition, coal-supply arrangements, environmental-control choices and the unresolved $40 million transmission payment.
- Final ACC decisions on net metering, energy-efficiency standards, renewable funding and recovery of transmission and other costs.
- Timing and amount of the IRS refund, pension funding needs, and the effect of the substantial current debt maturities on financing plans.
- Developments in the environmental, Superfund, outage-related, Clean Air Act and tax proceedings, including any material loss estimates or rate-recovery outcomes.