Business Context and Reporting Period
This Form 10-Q covers the quarterly period ended September 30, 2009, for Pinnacle West Capital Corporation (Pinnacle West) and its primary subsidiary, Arizona Public Service Company (APS). Pinnacle West is a holding company whose principal subsidiary, APS, is a vertically integrated electric utility serving most of Arizona. The company operates two primary reportable segments: Regulated Electricity and Real Estate (SunCor Development Company).
Key Financial Metrics
For the Nine Months Ended September 30, 2009 (in millions, except per share):
- Total Operating Revenues: $2,609.3 million (Decreased from $2,639.2 million in 2008).
- Net Income Attributable to Common Shareholders: $98.5 million (Decreased significantly from $281.0 million in 2008).
- Earnings Per Share (Diluted): $0.97 (Decreased from $2.78 in 2008).
- Operating Cash Flow: $761.0 million provided by operating activities.
- Capital Expenditures: $558.5 million (Net of contributions in aid of construction).
- Debt and Liquidity:
- Total Long-Term Debt (less current maturities): $3,519.9 million.
- Short-term borrowings: $142.3 million.
- Cash and cash equivalents: $100.8 million.
- Available Credit Facilities: Pinnacle West has a $283 million revolver; APS has $866 million in committed revolving facilities.
Material Changes vs. Prior Period
The significant decline in consolidated net income for the nine months ended September 30, 2009, compared to the prior year, was primarily driven by the Real Estate Segment.
- Real Estate Impairment Charges: SunCor recorded total pretax impairment charges of approximately $246 million for the nine-month period due to distressed real estate and credit market conditions. This included charges for homebuilding operations, master-planned communities, land parcels, commercial assets, and golf courses.
- Regulated Electricity Segment: Net income for this segment decreased by approximately $16 million compared to the prior year. This was due to lower retail sales (driven by lower usage per customer and economic conditions), higher interest charges, and higher depreciation. These factors were partially offset by increased revenues from an interim rate increase effective January 1, 2009, and transmission rate increases.
- Discontinued Operations: The company recorded a loss of $8.3 million from discontinued operations, compared to income of $22.8 million in the prior year, largely due to the restructuring of SunCor.
Guidance, Outlook, and Risks
Regulatory Matters:
- Rate Case: APS and other parties entered into a proposed Settlement Agreement regarding the 2008 general retail rate case. If approved by the Arizona Corporation Commission (ACC), new rates would become effective approximately January 1, 2010. The settlement includes a net retail rate increase of $207.5 million and requires APS to reduce operational expenses by at least $30 million annually from 2010 through 2014.
- Equity Infusion: Under the proposed settlement, APS would be authorized to obtain equity infusions of up to $700 million between June 1, 2009, and December 31, 2014.
- Sales Growth: Customer growth is expected to average about 1% per year for 2009 through 2011. Retail electricity sales (weather-adjusted) are estimated to remain flat on average per year during this period.
- Capital Expenditures: Estimated total capital expenditures for the full year 2009 are $895 million, with $707 million projected for 2010 and $943 million for 2011.
- SunCor Liquidity: SunCor's impairment charges resulted in violations of certain debt covenants. While lenders have not taken enforcement action, SunCor is in discussions to modify or replace its credit facilities. Failure to obtain waivers could require immediate repayment of outstanding indebtedness.
- Environmental Regulations: Potential costs related to EPA Regional Haze Rules (BART) for the Four Corners and Navajo plants could range from $56 million to over $500 million depending on the final determination. Climate change legislation remains a significant uncertainty.
- Market Risks: The company is exposed to commodity price fluctuations (natural gas, electricity) and interest rate risks, managed through derivative instruments.
Investor Verification Checklist
- SunCor Covenant Status: Verify the outcome of SunCor's discussions with lenders regarding covenant waivers and the potential for debt acceleration.
- Rate Case Approval: Monitor the ACC's final decision on the proposed Settlement Agreement and the effective date of new rates.
- Real Estate Asset Sales: Track the progress of SunCor's strategic asset sales, which are critical for debt reduction and realizing tax benefits.
- Environmental Compliance Costs: Review final EPA determinations on Regional Haze Rules to assess potential capital expenditure impacts on the Four Corners and Navajo plants.
- Derivative Exposure: Assess the impact of potential credit rating downgrades on collateral requirements for derivative instruments (estimated additional collateral of $80 million if investment grade is lost).