Business Context and Reporting Period
This Form 10-Q covers the quarterly period ended June 30, 2007, for Pinnacle West Capital Corporation (the Company) and its principal subsidiary, Arizona Public Service Company (APS). Pinnacle West is a holding company owning all outstanding common stock of APS, a vertically-integrated electric utility serving most of Arizona. The Company also operates a real estate segment (SunCor) and a marketing and trading subsidiary (Pinnacle West Marketing & Trading), which began operations in February 2007.
Key Financial Metrics (Six Months Ended June 30, 2007)
| Metric | 2007 (in millions) | 2006 (in millions) |
|---|---|---|
| Total Operating Revenues | $1,558.6 | $1,595.2 |
| Net Income | $95.5 | $124.6 |
| Net Income from Continuing Operations | $94.3 | $122.4 |
| Diluted EPS (Continuing Ops) | $0.94 | $1.23 |
| Operating Cash Flow | $290.3 | $56.2 |
| Capital Expenditures | $437.8 | $363.8 |
| Total Debt (Long-term + Current) | $3,339.3 | $3,269.9 |
| Cash and Cash Equivalents | $23.5 | $87.2 |
Note: Debt figures include current maturities of long-term debt and short-term borrowings. Cash flow figures are for the six-month period.
Material Changes vs. Prior Period
- Net Income Decline: Consolidated net income decreased by $29.1 million (23%) compared to the prior year. This was driven primarily by a $22 million decrease in the real estate segment due to a slowdown in residential property sales and a $8 million decrease in the regulated electricity segment.
- Regulatory Disallowance: The Arizona Corporation Commission (ACC) disallowed approximately $14 million of 2005 fuel cost deferrals related to Palo Verde outages, citing imprudence. This resulted in an $8 million after-tax charge.
- Real Estate Segment: Revenues dropped $95 million year-over-year, largely due to a $76 million decrease in residential property sales.
- Regulated Electricity: Revenues increased $68 million, primarily due to the recovery of Power Supply Adjustor (PSA) deferrals ($48 million) and customer growth ($26 million), offset by lower off-system sales prices.
- Interest Expense: Increased due to higher debt balances and interest rates, partially offset by capitalized interest.
Guidance, Outlook, and Risks
- Rate Case Outcome: On June 28, 2007, the ACC issued an order increasing APS's annual retail base revenues by approximately $322 million (15.1% fuel-related increase), effective July 1, 2007. This includes a temporary surcharge to recover approved 2005 deferrals.
- Prudence Audit: The ACC has directed a prudence audit of 2006 Palo Verde outage costs (approx. $79 million). APS believes these costs are recoverable, but the audit is pending.
- Capital Expenditures: Estimated capital expenditures for 2007 are $1.093 billion, with significant spending on distribution, transmission, and generation (including Palo Verde steam generator replacements).
- Real Estate Outlook: SunCor's 2007 net income is estimated at $30 million, reflecting a continued slowdown in western U.S. residential real estate markets.
- Key Risks:
- Regulatory decisions regarding rate recovery and fuel cost prudence.
- Volatility in wholesale electricity and natural gas prices.
- Power plant performance and outages (specifically Palo Verde).
- Counterparty credit risk in marketing and trading activities.
- Environmental compliance costs (e.g., Federal Implementation Plan for Four Corners).
Investor Verification Checklist
- PSA Deferral Recovery: Verify the timeline and mechanism for recovering the $137 million in accumulated PSA deferrals and the outcome of the 2006 prudence audit.
- Real Estate Exposure: Assess the impact of the ongoing residential real estate slowdown on SunCor's future earnings and asset valuations.
- Debt Covenants: Confirm compliance with debt-to-capitalization ratios (currently ~50% for Pinnacle West, ~46% for APS) and interest coverage ratios.
- Derivative Positions: Review the mark-to-market valuation of risk management and trading assets ($311 million total) and potential exposure to counterparty defaults.
- Capital Funding: Monitor the ability to fund the $1.1 billion+ annual capital program through internal cash flow and external financing, given the recent cash balance decline.