Business Context and Reporting Period
Company: Pinnacle West Capital Corporation (Pinnacle West)
Filing Type: Form 10-Q (Quarterly Report)
Period Ended: September 30, 2004
Business Overview: Pinnacle West is a holding company owning Arizona Public Service Company (APS), a vertically-integrated electric utility, and Pinnacle West Energy, an unregulated generation subsidiary. The company also operates real estate (SunCor) and energy marketing/trading segments. The reporting period is heavily influenced by regulatory proceedings regarding APS's general rate case and the proposed transfer of generation assets.
Key Financial Metrics (Nine Months Ended Sept 30, 2004)
| Metric | 2004 (9 Months) | 2003 (9 Months) | Change |
|---|---|---|---|
| Total Operating Revenues | $2,165.0 million | $2,035.9 million | +6.3% |
| Net Income | $209.5 million | $191.5 million | +9.4% |
| Earnings Per Share (Diluted) | $2.29 | $2.09 | +9.6% |
| Operating Income | $415.5 million | $394.1 million | +5.4% |
| Net Cash from Operating Activities | $630.4 million | $616.6 million | +2.2% |
| Cash and Cash Equivalents (End of Period) | $373.1 million | $197.4 million | +88.9% |
| Total Debt (Current + Long-Term) | $3.20 billion | $3.32 billion | -3.6% |
Note: Debt figures derived from Balance Sheet current maturities ($567M) and long-term debt ($2.63B) for 2004 vs. 2003 ($705M + $2.62B).
Material Changes vs. Prior Period
- Revenue Growth: Driven by a $60 million increase in regulated electricity revenues (due to customer growth) and a $31 million increase in marketing and trading revenues (due to higher wholesale prices and mark-to-market gains).
- Profitability: Net income increased $18 million year-over-year. The "Other" segment contributed significantly due to a $35 million pre-tax gain ($21 million after-tax) from the sale of El Dorado's interest in the Phoenix Suns partnership.
- Segment Performance:
- Regulated Electricity: Net income decreased $12 million due to higher costs for new power plants, increased O&M expenses, and weather impacts, partially offset by lower regulatory asset amortization.
- Marketing & Trading: Net income increased $17 million driven by higher forward and realized prices for wholesale electricity.
- Real Estate: Net income decreased $5 million, primarily due to the absence of a 2003 gain on the sale of a water utility (classified as discontinued operations).
- Capital Expenditures: Actual capital expenditures for the nine months were $417 million, with a significant portion allocated to delivery infrastructure and generation improvements.
Guidance, Outlook, and Risks
Management Guidance
Pinnacle West confirms its 2004 earnings guidance of approximately $2.50 per share (fully diluted, after-tax). This estimate excludes the gain from the Phoenix Suns sale and assumes no contribution from the pending general rate case decision.
Key Outlook Factors
- APS General Rate Case: A proposed settlement (2004 Settlement Agreement) is pending ACC approval. It proposes a $75.5 million annual rate increase (4.21%) and the transfer of Pinnacle West Energy's dedicated assets to APS. Approval is expected to impact future depreciation and rate base.
- Asset Acquisition: APS has agreed to purchase the 450 MW Sundance Generating Station from PPL Sundance for $189.5 million, expected to close in Q1 2005 subject to regulatory approval.
- Customer Growth: Expected to average 3.8% annually from 2004 to 2006, with total retail sales growing 4.6% annually excluding weather effects.
Risks and Contingencies
- Regulatory Uncertainty: Ongoing legal challenges regarding retail electric competition rules in Arizona and the outcome of the rate case.
- Market Risks: Exposure to volatility in wholesale electricity and natural gas prices; credit risk from counterparties in trading activities.
- Environmental/Litigation: Pending FERC audits regarding transmission tariffs; potential Superfund liabilities at the Motorola 52nd Street site; California energy market litigation.
- Debt Covenants: Debt-to-total-capitalization ratio is currently ~53% (limit 65%); interest coverage is ~4x (minimum 2x).
Investor Verification Checklist
- Rate Case Approval: Verify the status of the ACC's approval of the 2004 Settlement Agreement, which is critical for the proposed asset transfer and rate increases.
- Sundance Acquisition: Monitor regulatory approvals (ACC, FERC, DOJ, FTC) required for the $189.5 million purchase of the Sundance Generating Station.
- Phoenix Suns Gain: Confirm the non-recurring nature of the $21 million after-tax gain from the Phoenix Suns sale when evaluating core operating performance.
- Regulatory Asset Amortization: Note that regulatory asset amortization related to the 1999 Settlement Agreement was substantially completed by June 30, 2004, impacting future expense baselines.
- Debt Refinancing: Review the schedule of debt maturities, particularly the $782 million due in 2005, and the company's ability to refinance at favorable rates given the "Negative" outlook from rating agencies.