Business Context and Reporting Period
This Form 10-Q covers the quarterly period ended March 31, 2008, for Pinnacle West Capital Corporation (the Company) 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 through its subsidiary, SunCor, and engages in energy marketing and trading.
Key Financial Metrics
| Metric | Q1 2008 | Q1 2007 |
|---|---|---|
| Total Operating Revenues | $736.7 million | $695.0 million |
| Net Income (Loss) | $(4.5) million | $16.5 million |
| Operating Income | $38.8 million | $68.2 million |
| Operating Cash Flow | $245.5 million | $214.6 million |
| Capital Expenditures | $248.3 million | $210.2 million |
| Total Debt (Long-term + Current) | $3.3 billion | $3.3 billion |
| Cash and Equivalents | $17.5 million | $56.3 million |
Note: Figures are in millions unless otherwise noted. Net loss for Q1 2008 includes a loss from continuing operations of $4.7 million.
Material Changes vs. Prior Period
- Profitability Decline: The Company reported a net loss of $4.5 million in Q1 2008, a decrease of $21 million compared to the $16.5 million net income in Q1 2007.
- Regulated Electricity Segment: Net income decreased by approximately $10 million due to higher operations and maintenance expenses (generation costs, planned overhauls) and increased depreciation, partially offset by higher retail sales from customer growth.
- Real Estate Segment: Net income decreased by approximately $10 million, driven by lower land parcel sales resulting from a weak real estate market.
- Revenue Growth: Total operating revenues increased by $41.7 million (6.0%). The regulated electricity segment saw an $86.8 million increase, primarily due to a rate increase effective July 1, 2007, and higher off-system sales. Conversely, real estate revenues dropped $29.4 million.
- Cash Flow: Operating cash flow increased by $30.9 million to $245.5 million, largely due to changes in margin cash collected from counterparties related to commodity price fluctuations. Investing cash outflows increased by $64.1 million due to higher capital expenditures.
Guidance, Outlook, and Risks
- Rate Case: On March 24, 2008, APS filed a request with the Arizona Corporation Commission (ACC) for a net rate increase of $266 million for retail customers, effective no later than July 1, 2009. This includes an average rate increase of 8.1% and a new growth-related impact fee.
- Capital Expenditures: Estimated capital expenditures for 2008 are $1.1 billion, with significant portions allocated to generation ($380 million) and distribution ($380 million). Funding will come from internal cash flows and external financing.
- Regulatory Risks:
- FERC Proceedings: APS is involved in proceedings regarding market-based rates in the Phoenix Valley and refund claims related to California and Pacific Northwest energy markets. Management does not currently expect a material adverse impact.
- Environmental: The EPA has identified APS as a potentially responsible party (PRP) at the Gila River Indian Reservation Superfund Site. Additionally, the Clean Air Mercury Rule was vacated by the D.C. Circuit Court, creating uncertainty regarding future mercury emission standards.
- Market Risks: The Company faces exposure to commodity price fluctuations (natural gas, electricity) and interest rate changes. Credit ratings for Pinnacle West and APS are currently investment grade but carry negative or stable outlooks depending on the agency.
- Liquidity: APS maintains a common equity ratio of 54%, well above the 40% regulatory minimum required to pay dividends to Pinnacle West.
Investor Verification Checklist
- Rate Case Outcome: Monitor the ACC's decision on the $266 million rate increase request filed in March 2008, as this is critical for future revenue recovery.
- Real Estate Exposure: Verify the extent of SunCor's exposure to the weak real estate market and its impact on future earnings contributions.
- Regulatory Liabilities: Review the status of FERC refund proceedings and the Gila River Superfund site investigation for potential unexpected costs.
- Capital Funding: Assess the Company's ability to fund the $1.1 billion capital expenditure plan through internal cash flows and debt markets given current liquidity conditions.
- Derivative Valuations: Examine the mark-to-market adjustments on risk management and trading activities, which significantly impacted comprehensive income.