Business Context and Reporting Period
This Form 10-Q covers the quarterly period ended March 31, 2007, filed by Pinnacle West Capital Corporation (the parent company) and its subsidiary, Arizona Public Service Company (APS). Pinnacle West is a holding company with two primary segments: regulated electricity (primarily through APS) and real estate (through SunCor). APS is a vertically integrated electric utility serving most of Arizona. The filing notes that Pinnacle West transferred its market-based rate tariff to a new subsidiary, Pinnacle West Marketing & Trading, in February 2007, removing the parent from FERC jurisdiction regarding securities issuance.
Key Financial Metrics
| Metric (in millions) | Q1 2007 | Q1 2006 |
|---|---|---|
| Total Operating Revenues | $695.1 | $670.2 |
| Net Income | $16.5 | $12.5 |
| Earnings Per Share (Diluted) | $0.16 | $0.13 |
| Operating Cash Flow | $214.6 | $3.1 |
| Capital Expenditures | $206.1 | $167.4 |
| Total Assets | $11,009.0 | $11,455.9 |
| Long-Term Debt | $3,187.0 | $3,232.6 |
| Cash and Equivalents | $121.3 | $87.2 |
Note: Segment results show Regulated Electricity net income of $4 million (vs. a $12 million loss in Q1 2006) and Real Estate net income of $9 million (vs. $22 million in Q1 2006).
Material Changes vs. Prior Period
- Revenue Growth: Total revenues increased $24.9 million (3.7%) year-over-year. The Regulated Electricity segment saw a $70 million revenue increase, driven by cooler weather, customer growth, and the recovery of deferred fuel costs via the Power Supply Adjustor (PSA). Conversely, Real Estate revenues declined $30.6 million due to a slowdown in the western U.S. residential market and the absence of a significant land parcel sale that occurred in 2006.
- Profitability: Net income rose $4.1 million. The Regulated Electricity segment improved significantly due to lower operations and maintenance expenses (fewer plant outages) and favorable weather, offsetting higher fuel costs. The Real Estate segment's contribution dropped $13 million due to lower property sales.
- Cash Flow: Operating cash flow surged to $214.6 million from $3.1 million in the prior year, largely due to changes in working capital and the timing of fuel cost deferrals.
- Balance Sheet: Total assets decreased by approximately $447 million, primarily due to a reduction in assets from risk management and trading activities (mark-to-market adjustments) and a decrease in receivables.
Guidance, Outlook, and Risks
Regulatory Proceedings (Critical)
The primary factor affecting financial outlook is the resolution of APS's retail rate proceedings before the Arizona Corporation Commission (ACC):
- General Rate Case: APS requested a 20.4% ($434.6 million) revenue increase. An Administrative Law Judge (ALJ) recommended a 13.5% ($286 million) increase, effective June 1, 2007. APS plans to file exceptions to this recommendation.
- PSA Deferrals: Approximately $118 million in fuel costs remain deferred. The ALJ recommended disallowing approximately $14 million of deferrals related to 2005 Palo Verde outages. A prudence review of 2006 outage costs ($79 million) is ongoing.
Outlook and Guidance
- Customer Growth: Expected to average 4.0% annually from 2007 to 2009.
- SunCor Earnings: Estimated net income for 2007 is between $30 million and $35 million, reflecting a slowdown in the real estate market.
- Capital Expenditures: Estimated at $1.093 billion for 2007, $1.068 billion for 2008, and $1.232 billion for 2009. Major projects include Palo Verde steam generator replacements.
Risks and Contingencies
- Regulatory Risk: Uncertainty regarding the final outcome of the rate case and the recovery of deferred fuel costs.
- Operational Risk: Potential for unplanned outages at the Palo Verde Nuclear Generating Station, which could impact costs and regulatory recovery.
- Market Risk: Exposure to commodity price fluctuations (natural gas, electricity) managed through hedging; credit risk from trading counterparties.
- Environmental/Legal: Ongoing litigation regarding Navajo Nation coal royalties, Superfund site remediation, and EPA Federal Implementation Plans (FIP) for air quality.
Investor Verification Checklist
- Rate Case Outcome: Monitor the final ACC decision on the general rate case and the specific treatment of the $14 million disallowed deferral recommendation.
- Real Estate Market: Verify SunCor's ability to meet the $30-$35 million earnings guidance given the slowdown in western residential markets.
- PSA Deferral Recovery: Track the status of the prudence review for 2006 Palo Verde outage costs ($79 million) and the timing of future PSA adjustor filings.
- Capital Expenditure Funding: Confirm the mix of internal cash flow versus external financing required to meet the ~$1.1 billion 2007 capex plan.
- Derivative Valuations: Review the impact of mark-to-market adjustments on trading assets and liabilities, which fluctuated significantly between Q4 2006 and Q1 2007.