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, 2008. Pinnacle West operates two principal segments: a regulated electricity segment (93% of 2008 revenues) and a real estate segment (4% of 2008 revenues) conducted through its subsidiary SunCor. The company serves most of Arizona, excluding parts of the Phoenix and Tucson metropolitan areas.
Key Financial Metrics (2008)
| Metric | Pinnacle West Consolidated | APS (Utility Subsidiary) |
|---|---|---|
| Total Operating Revenues | $3,367 million | $3,133 million |
| Net Income | $242 million | $262 million |
| Income from Continuing Operations | $214 million | $262 million |
| Earnings Per Share (Basic) | $2.40 | N/A |
| Total Assets | $11.62 billion | $10.96 billion |
| Long-Term Debt (less current) | $3.03 billion | $2.85 billion |
| Common Stock Equity | $3.45 billion | $3.34 billion |
| Operating Cash Flow | $814 million | $785 million |
Material Changes vs. Prior Period
- Net Income Decline: Consolidated net income decreased by approximately $65 million (21%) to $242 million in 2008 from $307 million in 2007.
- Real Estate Segment Loss: The real estate segment (SunCor) reported a net loss of $26 million in 2008, compared to net income of $24 million in 2007. This was driven by a $53 million pre-tax real estate impairment charge and lower sales volumes due to the weak housing market.
- Regulated Segment Performance: The regulated electricity segment's income from continuing operations decreased by $18 million. While retail revenues increased due to rate hikes effective July 2007, this was offset by higher operating costs, increased depreciation, and unfavorable weather effects on retail sales.
- Discontinued Operations: Income from discontinued operations increased to $29 million in 2008 (from $8 million in 2007), primarily due to commercial property sales by SunCor and the resolution of tax issues related to the 2005 sale of Silverhawk.
Guidance, Outlook, and Risks
- Rate Case Status: APS filed a general rate case in 2008 requesting a net retail rate increase of $278.2 million. In December 2008, the Arizona Corporation Commission (ACC) approved an interim base rate surcharge expected to increase annual pretax retail revenues by approximately $65.2 million pending the final outcome of the case.
- Customer Growth Outlook: Management expects customer growth to decline to an average of 1% per year for 2009–2011, down from a 3% average in 2006–2008, due to national and local economic conditions.
- Capital Expenditures: Total capital expenditures were $904 million in 2008. Estimates for 2009–2011 range from $749 million to $1,088 million annually. Management has identified over $500 million in capital expenditure reductions at APS for 2009–2011 due to reduced growth outlooks.
- Liquidity and Credit Markets: The company has been unable to access commercial paper markets since September 2008 due to credit market stress but maintains adequate liquidity through existing bank credit facilities. APS has $900 million in committed revolving credit facilities.
- Key Risks:
- SunCor Debt Covenants: SunCor has approximately $188 million in outstanding debt, with a significant portion due in 2009. Failure to meet financial covenants could trigger cross-default provisions, though Pinnacle West does not guarantee this debt.
- Regulatory Risk: Outcomes of the pending rate case and potential disallowances of costs could materially impact financial results.
- Environmental Compliance: Potential costs related to regional haze rules, mercury emissions, and climate change legislation remain uncertain.
- Nuclear Operations: Palo Verde Unit 3 is subject to an enhanced NRC inspection regime, though the facility is operating safely.
Investor Verification Checklist
- Rate Case Resolution: Monitor the final outcome of the 2008 General Rate Case before the ACC to confirm the magnitude of approved rate increases and any cost disallowances.
- SunCor Debt Refinancing: Verify SunCor's ability to renegotiate or refinance its debt facilities maturing in 2009 and its compliance with financial covenants to avoid acceleration of debt.
- Real Estate Impairments: Assess whether further real estate impairment charges are necessary if the housing market continues to deteriorate.
- Auction Rate Securities: Review the status of APS's auction rate pollution control bonds ($343 million) and the company's plan to refund and reissue them, noting the recent spike in interest rates during failed auctions.
- Customer Growth Trends: Track actual customer growth rates in 2009 against the revised 1% forecast to gauge the impact of the economic downturn on utility revenues.