Business Context and Reporting Period
This Form 10-Q covers the quarterly period ended June 30, 2006, for Pinnacle West Capital Corporation (Pinnacle West) and its primary subsidiary, Arizona Public Service Company (APS). Pinnacle West is a holding company owning APS, a vertically integrated electric utility serving most of Arizona, as well as subsidiaries involved in real estate (SunCor), energy marketing (APS Energy Services), and investments (El Dorado). The filing includes unaudited condensed consolidated financial statements.
Key Financial Metrics
Consolidated Results (Pinnacle West) for the Six Months Ended June 30, 2006:
- Total Operating Revenues: $1,595.2 million (up from $1,340.7 million in 2005).
- Net Income: $124.6 million (up from $51.2 million in 2005).
- Income from Continuing Operations: $122.4 million (up from $114.7 million in 2005).
- Earnings Per Share (Diluted): $1.25 (up from $0.54 in 2005).
- Operating Cash Flow: $56.2 million provided by operating activities.
- Capital Expenditures: $363.8 million (including $8.9 million capitalized interest).
- Debt: Total long-term debt less current maturities was $2.82 billion. Current maturities of long-term debt were $85.6 million.
- Liquidity: Cash and cash equivalents decreased to $15.6 million from $154.0 million at year-end 2005.
Segment Performance (Six Months 2006):
- Regulated Electricity: Net income of $82 million.
- Real Estate: Net income of $32 million.
- Marketing and Trading: Net income of $10 million.
Material Changes Versus Prior Period
The significant increase in consolidated net income compared to the prior year is primarily driven by the absence of a $58 million loss from discontinued operations in the second quarter of 2005, which was related to the sale of the Silverhawk Power Station. The sale was completed in January 2006.
Key operational changes include:
- Revenue Growth: Regulated electricity revenues increased due to customer growth, warmer weather, and the recovery of deferred fuel costs via the Power Supply Adjustor (PSA).
- Fuel Costs: Higher fuel and purchased power costs were largely offset by regulatory deferrals under the PSA mechanism.
- Real Estate: Income increased due to higher margins on residential and parcel sales.
- Interest Expense: Decreased due to lower debt balances, partially offset by higher interest rates.
Guidance, Outlook, Risks, and Contingencies
Regulatory Proceedings (APS):
- General Rate Case: APS is requesting a 21.3% ($453.9 million) increase in annual retail electricity revenues, effective no later than December 31, 2006. This request is based on increased fuel costs, capital structure updates, and the acquisition of the Sundance Plant.
- Interim Rate Increase: An interim PSA adjustor effective May 1, 2006, resulted in an ~8.3% rate increase to recover fuel costs. A surcharge for 2005 deferrals (~0.7%) was also approved.
- Prudence Review: The Arizona Corporation Commission (ACC) is conducting a prudence audit on approximately $70 million of PSA deferrals related to unplanned 2006 Palo Verde outages and $45 million related to 2005 outages.
FERC Order: On April 17, 2006, the FERC revoked Pinnacle West's market-based rate authority in the APS control area, requiring cost-based rates and potential refunds for sales between February 2005 and April 2006. Management does not currently believe this will have a material adverse effect.
Capital Needs: Estimated capital expenditures for 2006 are $887 million, driven by distribution, transmission, and generation projects, including Palo Verde steam generator replacements.
Risks: Key risks include the outcome of rate proceedings, volatility in natural gas and electricity prices, power plant performance (specifically Palo Verde outages), and credit rating downgrades which could increase borrowing costs.
Investor Verification Checklist
- Verify the status and outcome of the APS General Rate Case and the ACC's prudence review of Palo Verde outage costs.
- Monitor the FERC Order regarding market-based rates and the potential magnitude of required refunds.
- Review the Power Supply Adjustor (PSA) deferral balance (approx. $175 million) and the timeline for recovery through rate adjustments.
- Assess the impact of fuel price volatility on future margins, given the 90/10 sharing arrangement under the PSA.
- Track capital expenditure execution, particularly the Palo Verde Unit 3 steam generator replacement project.
- Confirm credit ratings (Moody's Baa3/P, S&P BB+/prelim for Pinnacle West; Baa2/BBB- for APS) and any potential rating triggers in debt covenants.