Pinnacle West Capital Corporation — Q2 2011 Form 10-Q
Business context and reporting period. This combined, unaudited filing covers the quarter and six months ended June 30, 2011. Pinnacle West owns Arizona Public Service Company (APS), a vertically integrated electric utility that generates most of the group’s revenue and earnings. Comparisons below are with the corresponding 2010 periods unless noted.
Financial performance and position
| Metric | Q2 2011 | Q2 2010 | Six months 2011 | Six months 2010 |
|---|---|---|---|---|
| Operating revenue | $799.8 million | $802.8 million | $1,448.6 million | $1,415.1 million |
| Operating income | $197.0 million | $201.4 million | $232.8 million | $258.4 million |
| Income from continuing operations attributable to common shareholders | $86.0 million | $88.5 million | $70.2 million | $95.1 million |
| Net income attributable to common shareholders | $86.7 million | $114.8 million | $71.6 million | $108.8 million |
| Basic EPS | $0.80 | $1.07 | $0.66 | $1.04 |
| Operating margin (operating income / operating revenue) | 24.6% | 25.1% | 16.1% | 18.3% |
Cash flow and capital spending. For the first half, operating cash flow was $436.3 million, investing cash outflow was $328.3 million, and financing cash outflow was $125.9 million. Cash capital expenditures were $387.3 million; operating cash flow less capital expenditures was approximately $49.0 million. Ending cash was $92.3 million, down from $110.2 million at year-end 2010. Management attributed much of the operating cash flow improvement over 2010 to returns of collateral and margin cash; the prior-year period also included a voluntary pension contribution and income-tax payments.
Debt and liquidity. At June 30, Pinnacle West reported $3.665 billion of long-term debt, including current maturities, at carrying value; fair value was $3.957 billion. The company reported a roughly 50% debt-to-capitalization ratio and APS roughly 47%, both below the 65% covenant ceiling. Pinnacle West had $7 million of commercial paper outstanding and no borrowings under its $200 million revolving facility. APS had no credit-facility borrowings or commercial paper outstanding and had $1 billion of revolving facilities available. Current liabilities exceeded current assets; the filing does not present a current ratio as a measure of liquidity.
Dividends. Pinnacle West declared $1.05 per share for Q2 and $1.575 per share for the first half. The board declared a quarterly dividend of $0.525 per share payable September 1, 2011.
Changes versus the prior comparable period
- Q2 revenue was nearly flat, while operating income declined 2.2%. Q2 continuing income attributable to common shareholders declined about 2.9%; total common-shareholder net income fell about 24%.
- First-half revenue rose about 2.4%, but operating income declined about 9.9% and continuing income attributable to common shareholders fell about 26%.
- The first-half continuing-earnings decline primarily reflected higher operations and maintenance expense, including the timing and level of maintenance at two gas-fired combined-cycle plants, and higher property taxes. Increased retail usage partly offset these costs. First-half O&M also included a $28 million transmission rights-of-way settlement, offset by related revenue and not affecting net income.
- Total net income comparisons were affected by prior-year discontinued-operation gains: Q2 2010 included an after-tax $25 million gain from the sale of APSES’s district cooling business. For the first half, the comparison also reflects prior-year real-estate impairment charges.
Outlook, management commentary, risks and contingencies
- Rate case: APS filed for a net $95.5 million retail base-rate increase, requested effective July 1, 2012, estimated to raise the average retail customer bill about 6.6%. The request is pending before the Arizona Corporation Commission (ACC); APS expected a hearing in early 2012 and could not predict the outcome. APS also proposed changes to fuel-cost recovery and new annual recovery mechanisms.
- Demand and investment: Management expected customer growth to average about 1.3% annually in 2011–2013 and weather-adjusted retail sales to remain flat on average, including energy-efficiency effects. These estimates depend on economic conditions, weather, customer usage and regulatory outcomes.
- Capital expenditure estimates: APS estimated capital expenditures of $887 million in 2011, $1.316 billion in 2012 and $1.137 billion in 2013. The forecast includes renewable projects subject to ACC approval and assumes APS’s proposed acquisition of SCE’s Four Corners Units 4 and 5 for $294 million, also subject to approvals. Closing was expected in the second half of 2012; APS proposed closing Units 1–3 if the purchase proceeds.
- Generation and regulation: The NRC approved 20-year license extensions for all three Palo Verde units. Management estimated pretax depreciation expense would decline about $34 million annually beginning January 1, 2012. The filing identifies potential additional nuclear safety requirements following Fukushima as a risk, with possible significant operational or financial impacts that were not yet known.
- Other material risks: Results may be affected by weather, economic and sales conditions, fuel and purchased-power prices, plant availability, timely rate recovery, environmental and renewable-energy requirements, water availability, regulatory decisions, and access to capital. If investment-grade credit-rating triggers were fully activated at June 30, the company estimated additional collateral needs of about $106 million for certain derivatives and $194 million for certain energy-related non-derivative contracts.
- Contingencies and commitments: Contractual obligations increased about $0.5 billion from year-end 2010, primarily due to transmission rights-of-way, a solar construction contract, fuel and purchased-power commitments, and renewable-energy credits. The company reported approximately $9.5 billion of fuel and purchased-power commitments, largely due after 2015. APS estimated $1 million of costs for an ongoing Superfund investigation; ultimate remediation costs were not yet estimable. The filing said the described water-rights litigation or settlement was not expected to have a material adverse impact.
- Portfolio changes: Pinnacle West was negotiating a potential sale of APSES and classified it as discontinued operations and held for sale. If completed, management expected an after-tax gain, but provided no clear amount or closing date. SunCor continued its real-estate asset disposition program.
Most important facts for investors to verify
- Progress and final ACC decisions on APS’s rate case, proposed cost-recovery mechanisms, and renewable-energy funding.
- Whether the Four Corners acquisition and related plant closures receive required approvals, and the resulting capital, operating and environmental costs.
- Whether the improvement in operating cash flow is sustained after the reported collateral movements and other timing effects; also track capital spending against the forecast.
- Changes in maintenance, property-tax and other operating costs, and whether customer growth and usage meet management’s estimates.
- Any NRC actions following Fukushima, environmental compliance requirements, and resulting impacts on Palo Verde or coal-fired facilities.
- Completion and proceeds of the proposed APSES sale, and potential collateral requirements if credit ratings decline.