Business Context and Reporting Period
This Form 10-Q covers the quarterly period ended March 31, 2009, for Pinnacle West Capital Corporation (Pinnacle West) and its principal subsidiary, Arizona Public Service Company (APS). Pinnacle West is a holding company whose primary business is the regulated electricity segment operated by APS, a vertically-integrated electric utility serving most of Arizona. The company also operates a real estate segment through its subsidiary, SunCor.
Key Financial Metrics
| Metric | Q1 2009 | Q1 2008 |
|---|---|---|
| Total Operating Revenues | $629.4 million | $688.3 million |
| Net Loss (Consolidated) | $(170.7) million | $(4.5) million |
| Net Loss Attributable to Common Shareholders | $(156.5) million | $(4.5) million |
| Loss Per Share (Basic & Diluted) | $(1.55) | $(0.04) |
| Operating Cash Flow | $(56.2) million | $245.9 million |
| Cash and Cash Equivalents (Ending) | $32.8 million | $17.5 million |
| Total Debt (Long-term + Current) | $3.70 billion | $3.21 billion |
| Dividends Declared Per Share | $0.525 | $0.525 |
Material Changes vs. Prior Period
- Real Estate Impairment: The primary driver of the increased net loss was a $211.3 million pretax impairment charge (approximately $123 million after-tax) recorded in the real estate segment (SunCor). This resulted from distressed conditions in real estate and credit markets, leading to a strategic decision to dispose of homebuilding operations, master-planned communities, and golf courses.
- Revenue Decline: Total operating revenues decreased by $58.9 million (8.5%). The regulated electricity segment saw a $20.2 million decrease due to milder weather reducing retail sales and lower average usage per customer, partially offset by an interim rate increase effective January 2009. The real estate segment revenues dropped $7.9 million due to lower residential property sales.
- Operating Cash Flow: Operating cash flow turned negative, decreasing by approximately $302 million compared to the prior year. This was primarily due to increased collateral and margin cash provided as a result of changes in commodity prices.
- Debt Issuance: On February 26, 2009, APS issued $500 million of 8.75% unsecured senior notes maturing in 2019. Proceeds were used to repay short-term borrowings.
Guidance, Outlook, and Risks
- Rate Case Settlement: APS and other parties filed a proposed settlement term sheet with the Arizona Corporation Commission (ACC) on May 4, 2009. Key terms include a non-fuel base rate increase of $196.3 million effective January 1, 2010, and an authorized return on common equity of 11%. The settlement also requires equity infusions of at least $700 million into APS through 2014.
- Customer Growth Outlook: Management expects customer growth and retail electricity sales growth to average about 1% per year during 2009 through 2011, a significant slowdown from the 3% average seen from 2006 to 2008, reflecting recessionary economic conditions.
- Capital Expenditures: Due to reduced customer growth and deferred projects, Pinnacle West identified additional capital expenditure reductions of over $500 million at APS for the years 2009–2011. Estimated total capital expenditures for 2009 are $895 million.
- SunCor Liquidity Risk: SunCor has violated covenants in its credit facilities due to impairment charges and loan maturities. It is seeking waivers from lenders. While Pinnacle West does not guarantee SunCor's debt and does not expect a material adverse impact on its own liquidity, SunCor could be required to immediately repay outstanding indebtedness if waivers are not obtained.
- Regulatory and Environmental Risks: Risks include the outcome of the pending rate case, volatile fuel costs, and potential costs associated with climate change regulations (e.g., mercury emissions, greenhouse gases). The EPA has proposed findings that greenhouse gas emissions endanger public health, which could lead to new regulatory requirements.
Investor Verification Checklist
- SunCor Covenant Waivers: Verify whether SunCor has successfully obtained waivers from lenders to avoid immediate debt acceleration.
- Rate Case Approval: Monitor the ACC's approval of the proposed rate case settlement term sheet filed in May 2009.
- Asset Disposition Progress: Track the execution of SunCor's strategic asset sales to reduce debt and the timing of cash proceeds.
- Commodity Hedging: Review the impact of mark-to-market valuations on derivative instruments, which significantly affected operating cash flow.
- Environmental Compliance Costs: Assess the final scope and cost of compliance with mercury emission rules and potential future greenhouse gas regulations.