Business Context and Reporting Period
This Form 10-K is a combined annual report for Pinnacle West Capital Corporation (the holding company) and its primary subsidiary, Arizona Public Service Company (APS), for the fiscal year ended December 31, 2007. Pinnacle West is a holding company that owns all outstanding equity of APS, a vertically-integrated electric utility serving most of Arizona. Pinnacle West also owns SunCor, a real estate development subsidiary, and other smaller subsidiaries including APSES (energy services) and El Dorado (investments).
The company operates two primary reportable segments: the Regulated Electricity Segment (83% of 2007 operating revenues) and the Real Estate Segment (6% of 2007 operating revenues). The remainder consists of marketing, trading, and other activities.
Key Financial Metrics (2007)
| Metric | Pinnacle West Consolidated | APS (Utility Subsidiary) |
|---|---|---|
| Total Operating Revenues | $3,523.6 million | $2,936.3 million |
| Net Income | $307.1 million | $283.9 million |
| Income from Continuing Operations | $298.8 million | $283.9 million (Net Income) |
| Earnings Per Share (Diluted) | $3.05 | N/A |
| Total Assets | $11,243.7 million | $10,402.9 million |
| Long-Term Debt (less current) | $3,127.1 million | $2,876.9 million |
| Operating Cash Flow | $657.9 million | $765.8 million |
| Capital Expenditures | $1,064 million | $900 million |
Material Changes vs. Prior Period
- Net Income Decline: Consolidated net income decreased by $20.1 million (6.1%) to $307.1 million in 2007 compared to $327.3 million in 2006. This was primarily driven by a significant decline in the Real Estate segment.
- Real Estate Segment: Income from continuing operations in the Real Estate segment dropped approximately $38 million due to a slowdown in the western U.S. real estate market, resulting in lower sales of residential property and land parcels.
- Regulated Electricity Segment: Income from continuing operations increased by approximately $15 million. This growth was driven by higher retail sales (customer growth and weather effects) and a retail rate increase effective July 1, 2007. These gains were partially offset by higher operations and maintenance expenses (including Palo Verde performance improvements) and a $14 million regulatory disallowance.
- Cash Flow: Net cash provided by operating activities increased significantly to $658 million in 2007 from $394 million in 2006, largely due to a decrease in cash collateral and margin cash returned to counterparties.
Guidance, Outlook, and Risks
- Customer Growth: Management expects customer growth to decline to an average of 1% to 2% per year for 2008–2010, down from 4.0% in the prior three years, due to economic conditions.
- Real Estate Outlook: SunCor's net income is estimated at approximately $20 million for 2008, reflecting the continued slowdown in the real estate market.
- Regulatory Matters: The Arizona Corporation Commission (ACC) approved a retail rate increase in June 2007. The company is also navigating a "prudence audit" regarding 2006 Palo Verde outage costs, which the ACC staff concluded were reasonable and prudent.
- Nuclear Operations: Palo Verde Unit 3 remains under an enhanced Nuclear Regulatory Commission (NRC) inspection regime ("Column 4") due to previous safety findings. Management is implementing an improvement plan to return the site to routine inspection.
- Environmental Risks: The company faces potential costs related to Regional Haze rules (BART) for coal plants (Cholla, Four Corners) and mercury emissions, though the Clean Air Mercury Rule was vacated by the D.C. Circuit Court in early 2008.
- Capital Requirements: Estimated capital expenditures for 2008–2010 range from $1.06 billion to $1.30 billion annually, primarily for transmission, distribution, and generation upgrades.
Investor Verification Checklist
- Real Estate Exposure: Verify the extent of the slowdown in SunCor's residential and land sales and its impact on future earnings guidance.
- Regulatory Recovery: Confirm the status of the Power Supply Adjustor (PSA) and the recovery of deferred fuel costs, as well as the outcome of the ACC's prudence audit on Palo Verde outage costs.
- Nuclear Compliance: Monitor the NRC's progress on the Palo Verde Unit 3 improvement plan and any potential operational impacts or costs associated with the enhanced inspection regime.
- Environmental Costs: Assess the potential financial impact of pending Regional Haze (BART) determinations for Cholla and Four Corners plants.
- Debt Covenants: Review the company's compliance with debt-to-capitalization ratios (currently ~50% for Pinnacle West and ~47% for APS) and interest coverage ratios.