Business Context and Reporting Period
This Form 10-Q covers the quarterly period ended March 31, 2006, filed by Pinnacle West Capital Corporation (Pinnacle West) and its primary subsidiary, Arizona Public Service Company (APS). Pinnacle West is a holding company with three principal segments: regulated electricity (APS), real estate (SunCor), and marketing and trading. APS is a vertically integrated electric utility serving most of Arizona. The filing includes unaudited condensed consolidated financial statements.
Key Financial Metrics
| Metric | Q1 2006 | Q1 2005 |
|---|---|---|
| Total Operating Revenues | $670.2 million | $585.4 million |
| Net Income | $12.5 million | $24.4 million |
| Income from Continuing Operations | $11.6 million | $29.6 million |
| Earnings Per Share (Diluted) | $0.13 | $0.27 |
| Operating Cash Flow | $3.1 million | $162.4 million |
| Cash and Cash Equivalents (End of Period) | $314.9 million | $172.1 million |
| Total Assets | $10.76 billion | $11.32 billion |
| Long-Term Debt (Less Current) | $2.78 billion | $2.61 billion |
| Debt to Capitalization Ratio | ~50% | N/A |
Note: Segment results show a loss of $12 million in the regulated electricity segment, offset by $21 million in the real estate segment and $2 million in marketing and trading.
Material Changes vs. Prior Period
- Revenue Growth: Total revenues increased by $84.8 million (14.5%) year-over-year, driven primarily by a $37.9 million increase in the real estate segment and a $50.1 million increase in the regulated electricity segment due to customer growth and rate adjustments.
- Profit Decline: Net income decreased by $12.0 million (49%). Income from continuing operations dropped $18.0 million. The decline was primarily due to higher fuel and purchased power costs in the regulated segment and lower mark-to-market gains in the marketing and trading segment.
- Segment Performance:
- Regulated Electricity: Income decreased $26 million due to higher fuel costs ($55 million pretax impact) and higher operations and maintenance expenses, partially offset by deferred fuel costs and higher sales volumes.
- Real Estate: Income increased $13 million due to increased parcel and home sales by SunCor.
- Marketing and Trading: Income decreased $5 million due to lower mark-to-market gains and the reclassification of Off-System Sales to the regulated segment.
- Cash Flow: Operating cash flow dropped significantly to $3.1 million from $162.4 million, largely due to changes in collateral requirements for risk management activities and timing of working capital items.
Guidance, Outlook, and Risks
- Regulatory Proceedings: The key financial outlook driver is the resolution of APS's retail rate proceedings before the Arizona Corporation Commission (ACC). APS is requesting a 21.3% ($453.9 million) increase in annual retail revenues effective no later than December 31, 2006. An interim rate increase of approximately 8.3% was approved effective May 1, 2006.
- Fuel Cost Deferrals: APS has a deferred fuel and purchased power regulatory asset of $169 million as of March 31, 2006. This includes $45 million related to unplanned 2005 Palo Verde outages. Recovery is subject to ACC approval of annual adjustments and surcharges.
- Palo Verde Outages: Palo Verde Unit 1 operated at reduced power levels and underwent a planned outage in Q1 2006 to remedy vibration issues. Incremental replacement power costs were approximately $36 million for the quarter. The ACC has directed a prudence audit of unplanned 2006 outage costs.
- FERC Order: On April 17, 2006, the FERC revoked Pinnacle West's market-based rate authority in the APS control area, requiring a return to cost-based rates effective February 27, 2005. The company is seeking rehearing and does not currently believe this will have a material adverse effect.
- Capital Expenditures: Estimated capital expenditures for 2006 are $887 million, with significant portions allocated to distribution, transmission, and generation upgrades, including steam generator replacements at Palo Verde.
- Discontinued Operations: The company sold its 75% interest in the Silverhawk Power Station in January 2006. Results from Silverhawk and certain real estate sales are reported as discontinued operations.
Investor Verification Checklist
- Rate Case Outcome: Verify the final decision and timing of the ACC's ruling on the 21.3% general rate increase request.
- Fuel Cost Recovery: Monitor the status of the PSA surcharge application to recover the $45 million in deferred costs from 2005 Palo Verde outages.
- Palo Verde Unit 1 Status: Confirm the return to full power of Palo Verde Unit 1 (expected June 2006) and the results of the ACC's prudence audit on 2006 outage costs.
- FERC Rehearing: Track the outcome of the rehearing request regarding the revocation of market-based rate authority in the APS control area.
- Real Estate Market: Assess the sustainability of SunCor's earnings growth given the cyclical nature of the real estate market.
- Debt Covenants: Confirm continued compliance with debt covenants, specifically the 65% debt-to-capitalization ratio (currently ~50%) and interest coverage ratios.