Business Context and Reporting Period
This Form 10-Q covers the quarterly period ended September 30, 2008, for Pinnacle West Capital Corporation (Pinnacle West) and its primary 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 energy marketing/trading activities. The filing reflects the impact of the 2008 financial market stress, a weak real estate market, and ongoing regulatory proceedings regarding rate increases.
Key Financial Metrics (Nine Months Ended Sept 30, 2008)
| Metric | 2008 (9 Months) | 2007 (9 Months) |
|---|---|---|
| Total Operating Revenues | $2,742.9 million | $2,763.2 million |
| Net Income | $281.0 million | $304.2 million |
| Net Income (Continuing Ops) | $260.3 million | $297.4 million |
| Diluted EPS (Net Income) | $2.78 | $3.02 |
| Operating Cash Flow | $783.9 million | $477.5 million |
| Capital Expenditures | $707.7 million | $734.8 million |
| Total Assets | $11,452.9 million | $11,162.2 million |
| Long-Term Debt (excl. current) | $3,047.4 million | $3,127.1 million |
| Cash and Cash Equivalents | $104.5 million | $56.3 million |
Material Changes vs. Prior Period
- Net Income Decline: Consolidated net income decreased by approximately $23 million (7.6%) compared to the prior year. This was driven by lower earnings from the real estate segment due to the weak housing market, higher operations and maintenance expenses, and weather-related variations in retail sales.
- Segment Performance:
- Regulated Electricity: Revenues increased $202 million year-over-year, primarily due to a rate increase effective July 2007 and higher transmission rates. However, net income for this segment decreased slightly due to higher O&M costs and weather impacts.
- Real Estate (SunCor): Revenues dropped $68 million and income from continuing operations fell significantly due to reduced land parcel and home sales.
- Marketing & Trading: Revenues decreased $144 million due to planned reductions in retail commodity-related energy services.
- Cash Flow Improvement: Operating cash flow increased by $306 million, largely due to lower real estate investments, increased collateral/margin cash collected from commodity price changes, and higher retail revenues from Base Fuel Rate adjustments.
- Debt and Liquidity: The company accessed credit facilities to maintain liquidity amidst market stress. Pinnacle West and APS repurchased $27 million of pollution control bonds. Auction rate securities experienced failed auctions, though management does not expect a material adverse impact.
Guidance, Outlook, and Risks
- Rate Proceedings: APS filed a general rate case with the Arizona Corporation Commission (ACC) requesting a net rate increase of $278.2 million (approx. 8.5% for existing customers) effective no later than October 1, 2009. An interim rate surcharge motion is pending to address credit metrics and cost recovery.
- Capital Expenditures: Estimated capital expenditures for the full year 2008 are $1.01 billion. The company announced a cost reduction effort eliminating approximately $200 million of capital expenditures for 2008-2012, with further reductions of over $500 million anticipated for 2009-2011 due to reduced customer growth outlooks.
- Customer Growth: Customer growth is expected to slow to an average of 1% per year for 2008-2010, down from 4.0% in previous years, reflecting national and local economic conditions.
- Key Risks:
- Regulatory: Timing and outcome of rate cases and environmental regulations (e.g., mercury emissions, climate change).
- Market: Volatility in fuel and purchased power costs; credit market disruptions affecting auction rate securities.
- Real Estate: Continued weakness in the housing market impacting SunCor earnings.
- Legal: Ongoing litigation regarding California energy market refunds and Navajo Nation coal royalty disputes.
Investor Verification Checklist
- Verify the status and potential outcome of the APS General Rate Case and the interim surcharge motion with the ACC.
- Monitor the failed auction rate securities and the associated interest rate exposure (currently averaging 9.8% on affected bonds).
- Review the real estate market trends in Arizona and their specific impact on SunCor's future revenue and capital needs.
- Assess the impact of environmental regulations (specifically mercury and greenhouse gas emissions) on future capital expenditure requirements.
- Confirm the company's ability to maintain its common equity ratio above the 40% threshold required by the ACC to pay dividends to the parent company.