Business Context and Reporting Period
Company: Pinnacle West Capital Corporation (PINNACLE WEST CAPITAL CORP)
Filing Type: Form 10-K (Annual Report)
Period Ended: December 31, 2003
Headquarters: Phoenix, Arizona
Pinnacle West Capital Corporation is a holding company that owns all outstanding equity securities of Arizona Public Service Company (APS), a vertically-integrated electric utility serving most of Arizona. The company operates through three principal segments: Regulated Electricity (70% of 2003 revenues), Marketing and Trading (14%), and Real Estate (13%, primarily via subsidiary SunCor). The company is currently navigating significant regulatory uncertainty regarding the restructuring of the Arizona electric industry and a pending general rate case before the Arizona Corporation Commission (ACC).
Key Financial Metrics (2003)
| Metric | 2003 Value | 2002 Value |
|---|---|---|
| Total Operating Revenues | $2,817.9 million | $2,440.3 million |
| Net Income | $240.6 million | $149.4 million |
| Income from Continuing Operations | $230.6 million | $206.2 million |
| Earnings Per Share (Basic) | $2.64 | $1.76 |
| Total Assets | $9,536.4 million | $9,139.2 million |
| Long-Term Debt (less current) | $2,897.7 million | $2,743.7 million |
| Common Stock Equity | $2,829.8 million | $2,686.2 million |
| Net Cash Provided by Operating Activities | $901.8 million | $841.2 million |
Material Changes vs. Prior Period
- Net Income Increase: Net income rose 61% to $240.6 million from $149.4 million in 2002. This increase is largely attributable to the absence of a $66 million after-tax charge recorded in 2002 for the cumulative effect of a change in accounting for trading activities (EITF 02-3).
- Segment Performance:
- Regulated Electricity: Net income was relatively flat year-over-year. Higher retail sales volumes and customer growth were offset by increased purchased power and fuel costs, higher replacement power costs due to plant outages, and retail price reductions.
- Marketing and Trading: Income from continuing operations decreased approximately $49 million due to lower market liquidity and deteriorating counterparty credit in wholesale power markets.
- Real Estate: Net income improved approximately $36 million, driven by increased asset, land, and home sales by SunCor.
- Capital Expenditures: Total capital expenditures were $767 million in 2003, down from $984 million in 2002. APS expenditures were $429 million, while Pinnacle West Energy spent $250 million.
Guidance, Outlook, and Risks
APS General Rate Case (Critical Issue)
The outcome of the APS general rate case filed with the ACC on June 27, 2003, is the primary factor affecting the company's outlook. APS requested a 9.8% retail rate increase (approx. $175 million annually) to recover costs, including $234 million written off under a 1999 Settlement Agreement and rate base treatment for Pinnacle West Energy Dedicated Assets. The ACC staff recommended an 8% rate decrease and denied recovery of the written-off assets. Management believes the staff's recommendations are unlikely to be adopted in full but acknowledges the risk of a material adverse impact on operations, liquidity, and credit ratings if implemented.
Outlook and Guidance
- Trading Activities: Contributions from marketing and trading activities are expected to be negligible for 2004 and approximately $10 million (pretax) annually thereafter due to market erosion.
- Real Estate: SunCor expects net income of $30–$40 million annually for 2004 and 2005 due to an accelerated asset sales program, with cash distributions to the parent of $80–$100 million annually.
- Customer Growth: Expected to average 3.5% per year from 2004 to 2006.
Risks and Contingencies
- Regulatory Risk: Uncertainty regarding retail electric competition rules and the final decision on the general rate case.
- Market Risk: Exposure to fluctuations in electricity, natural gas, and coal prices; credit risk from counterparties in the wholesale market.
- Environmental/Litigation: Ongoing proceedings regarding water rights, nuclear waste disposal, and potential Superfund liabilities (e.g., Motorola 52nd Street site).
- Off-Balance Sheet: Potential exposure of approximately $268 million in debt and $200 million in payments to equity participants under Palo Verde Unit 2 sale-leaseback agreements if specific nuclear events or regulatory violations occur.
Investor Verification Checklist
- Rate Case Outcome: Monitor the ACC's final decision on the APS general rate case (expected by end of 2004) regarding the 9.8% rate increase request and the $234 million asset write-off recovery.
- Trading Segment Viability: Verify the sustainability of the Marketing and Trading segment given the management's expectation of negligible earnings in 2004.
- SunCor Asset Sales: Confirm the execution of SunCor's accelerated asset sales program and the realization of projected $80–$100 million annual cash distributions.
- Debt Covenants: Review compliance with debt-to-total-capitalization ratios (currently ~53-54%) and interest coverage ratios (currently ~4x) to ensure no covenant breaches.
- Regulatory Assets: Assess the recoverability of $165 million in regulatory assets, particularly those related to the 1999 Settlement Agreement and restructuring costs.