Business Context and Reporting Period
This Form 8-K, dated November 25, 2008, is a combined current report filed by Pinnacle West Capital Corporation (Pinnacle West) and its subsidiary, Arizona Public Service Company (APS). The filing serves to reclassify financial statements from the 2007 Form 10-K to align with accounting changes adopted in 2008. Specifically, the report reflects the retrospective application of FASB Staff Position No. FIN 39-1 regarding the netting of derivative instruments and collateral, and the reclassification of certain SunCor Development Company activities to discontinued operations under SFAS 144.
Key Financial Metrics (Fiscal Year 2007)
The following metrics reflect the reclassified 2007 data for Pinnacle West Consolidated:
- Operating Revenues: $3,521 million (Regulated electricity: $2,918 million; Real estate: $213 million; Marketing and trading: $342 million).
- Net Income: $307 million ($3.06 per share basic).
- Income from Continuing Operations: $301 million.
- Discontinued Operations: $6 million net income (primarily from SunCor commercial property sales).
- Total Assets: $11.16 billion.
- Long-Term Debt: $3.13 billion (excluding current maturities).
- Operating Cash Flow: $658 million provided by operating activities.
- Capital Expenditures: $1.06 billion total ($900 million for APS).
Material Changes vs. Prior Period
Compared to 2006, Pinnacle West reported a decrease in consolidated net income from $327 million to $307 million. Key drivers included:
- Regulated Electricity Segment: Income increased by approximately $15 million due to higher retail sales from customer growth, weather effects, and a retail rate increase effective July 1, 2007. These gains were partially offset by higher operations and maintenance expenses (including Palo Verde performance improvements) and a regulatory disallowance of $14 million.
- Real Estate Segment: Income decreased by approximately $36 million due to a slowdown in western U.S. real estate markets, resulting in lower residential property and land parcel sales.
- Accounting Reclassifications: The 8-K adjusts the 2007 presentation to net derivative assets and liabilities against collateral, significantly reducing reported gross asset and liability balances compared to the original 2007 10-K filing.
Guidance, Outlook, and Risks
Outlook and Guidance:
- Customer Growth: Expected to decline to an average of 1% to 2% annually for 2008-2010 due to economic conditions, down from 4.0% in the 2005-2007 period.
- Real Estate: SunCor's 2008 net income is estimated at approximately $20 million, reflecting continued market slowdowns.
- Capital Expenditures: Estimated at $1.18 billion for 2008, primarily for transmission, distribution, and generation upgrades.
- Regulatory: Financial results depend on timely rate recovery from the Arizona Corporation Commission (ACC). A $14 million regulatory disallowance was recorded in 2007 related to Palo Verde outage costs deemed imprudent.
- Environmental: Uncertainty regarding costs for Regional Haze Rules (BART) at Cholla and Four Corners plants, and potential mercury emission controls.
- Legal: Ongoing litigation regarding water rights, Navajo Nation environmental issues, and Superfund liabilities (Motorola 52nd Street site).
- Market Risks: Exposure to commodity price fluctuations (electricity, natural gas) and interest rate changes affecting debt costs and decommissioning trust values.
- FIN 39-1 Adoption: Reclassification of derivative assets/liabilities to a net basis, reducing reported balances by hundreds of millions of dollars.
- Discontinued Operations: Reclassification of SunCor commercial property sales to discontinued operations.
Investor Verification Checklist
- Verify the impact of the FIN 39-1 reclassification on the company's reported leverage ratios and liquidity positions.
- Monitor the outcome of the ACC's prudence audit regarding Palo Verde outage costs and potential future regulatory disallowances.
- Assess the trajectory of the western U.S. real estate market and its effect on SunCor's contribution to consolidated earnings.
- Review the status of pending environmental regulations (BART, Mercury) and their potential capital expenditure implications.
- Confirm the company's ability to maintain its credit ratings (Moody's Baa3/P, S&P BB+/prelim) given the negative outlooks assigned by some agencies.