-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, WC49R35e1jEQhj0QDwwvA7hy1ypC8JmlTS2ZekMrPuH1KzaDMwLOI9iXzZg9neT7 cd5umL+zYHV+Sc+AIflm9w== 0000950147-99-000510.txt : 19990518 0000950147-99-000510.hdr.sgml : 19990518 ACCESSION NUMBER: 0000950147-99-000510 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 2 CONFORMED PERIOD OF REPORT: 19990331 FILED AS OF DATE: 19990517 FILER: COMPANY DATA: COMPANY CONFORMED NAME: PINNACLE WEST CAPITAL CORP CENTRAL INDEX KEY: 0000764622 STANDARD INDUSTRIAL CLASSIFICATION: ELECTRIC SERVICES [4911] IRS NUMBER: 860512431 STATE OF INCORPORATION: AZ FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-Q SEC ACT: SEC FILE NUMBER: 001-08962 FILM NUMBER: 99627394 BUSINESS ADDRESS: STREET 1: 400 E VAN BUREN ST PO BOX 52132 STREET 2: P O BOX 52132 CITY: PHOENIX STATE: AZ ZIP: 85072-2132 BUSINESS PHONE: 6023792616 MAIL ADDRESS: STREET 1: 400 E VAN BUREN ST STREET 2: PO BOX 52132 CITY: PHOENIX STATE: AZ ZIP: 85072-2132 FORMER COMPANY: FORMER CONFORMED NAME: AZP GROUP INC DATE OF NAME CHANGE: 19870506 10-Q 1 QTRLY REPORT FOR PERIOD ENDING 03-31-99 FORM 10-Q Securities and Exchange Commission Washington, D.C. 20549 [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended March 31, 1999 ------------------------ OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from _____________ to _____________ Commission file number 1-8962 ------------ PINNACLE WEST CAPITAL CORPORATION ------------------------------------------------------ (Exact name of registrant as specified in its charter) Arizona 86-0512431 - ------------------------------- ------------------- (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 400 E. Van Buren St., P.O. Box 52132, Phoenix, Arizona 85072-2132 - ------------------------------------------------------ ------------------- (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code: (602) 379-2500 ------------------- - -------------------------------------------------------------------------------- (Former name, former address and former fiscal year, if changed since last report) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [ ] Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date. Number of shares of common stock, no par value, outstanding as of May 13, 1999: 84,822,997 Glossary ACC - Arizona Corporation Commission ACC Staff - Staff of the Arizona Corporation Commission APS - Arizona Public Service Company APS Energy Services - APS Energy Services Company, Inc. Company - Pinnacle West Capital Corporation DOE - United States Department of Energy EITF - Emerging Issues Task Force EITF 97-4 - Emerging Issues Task Force Issue No. 97-4, "Deregulation of the Pricing of Electricity -- Issues Related to the Applications of FASB Statements No. 71, Accounting for the Effects of Certain Types of Regulation, and No. 101, Regulated Enterprises -- Accounting for the Discontinuation of Application of FASB Statement No. 71" EITF 98-10 - Emerging Issues Task Force Issue No. 98-10, "Accounting for Contracts Involved in Energy Trading and Risk Management Activities" El Dorado - El Dorado Investment Company FERC - Federal Energy Regulatory Commission ITC - Investment tax credit MW - Megawatt, one million watts 1998 10-K - Pinnacle West Capital Corporation Annual Report on Form 10-K for the fiscal year ended December 31, 1998 Palo Verde - Palo Verde Nuclear Generating Station Pinnacle West - Pinnacle West Capital Corporation Power Coordination Agreement - 1955 agreement between APS and Salt River Project that provides for certain electric system and power sales SFAS No. 71 - Statement of Financial Accounting Standards No. 71, "Accounting for the Effects of Certain Types of Regulation" SFAS No. 128 - Statement of Financial Accounting Standards No. 128, "Earnings Per Share" SFAS No. 133 - Statement of Financial Accounting Standards No. 133, "Accounting for Derivative Instruments and Hedging Activities" Salt River Project - Salt River Project Agricultural Improvement and Power District SunCor - SunCor Development Company Territorial Agreement - 1955 agreement between APS and Salt River Project that has provided exclusive retail service territories in Arizona for each party -2- PART I. FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS. PINNACLE WEST CAPITAL CORPORATION CONDENSED CONSOLIDATED STATEMENTS OF INCOME (Unaudited) (Dollars in thousands, except per share amounts) Three Months Ended March 31, 1999 1998 ------------ ------------ Operating Revenues Electric $ 414,154 $ 380,423 Real estate 24,533 34,161 ------------ ------------ Total 438,687 414,584 ------------ ------------ Operating Expenses Fuel and purchased power 99,241 73,917 Utility operations and maintenance 99,084 96,416 Real estate operations 22,235 30,236 Depreciation and amortization 96,910 92,830 Taxes other than income taxes 29,447 30,348 ------------ ------------ Total 346,917 323,747 ------------ ------------ Operating Income 91,770 90,837 ------------ ------------ Other Income (Expense) Preferred stock dividend requirements of APS (1,016) (2,878) Net other income and expense (2,508) 4,359 ------------ ------------ Total (3,524) 1,481 ------------ ------------ Income Before Interest and Income Taxes 88,246 92,318 ------------ ------------ Interest Expense Interest charges 40,769 42,922 Capitalized interest (4,074) (4,656) ------------ ------------ Total 36,695 38,266 ------------ ------------ Income Before Income Tax 51,551 54,052 Income Taxes 20,861 22,966 ------------ ------------ Net Income $ 30,690 $ 31,086 ============ ============ Average Common Shares Outstanding - Basic 84,669,800 84,785,309 Average Common Shares Outstanding - Diluted 85,176,298 85,332,159 Earnings Per Average Common Share Outstanding: Net income - basic $ 0.36 $ 0.37 Net income - diluted $ 0.36 $ 0.36 Dividends Declared Per Share $ 0.325 $ 0.300 ============ ============ See Notes to Condensed Consolidated Financial Statements. -3- PINNACLE WEST CAPITAL CORPORATION CONDENSED CONSOLIDATED STATEMENTS OF INCOME (Unaudited) (Dollars in thousands, except per share amounts) Twelve Months Ended March 31, 1999 1998 ----------- ----------- Operating Revenues Electric $ 2,040,129 $ 1,879,955 Real estate 114,560 131,091 ----------- ----------- Total 2,154,689 2,011,046 ----------- ----------- Operating Expenses Fuel and purchased power 562,825 425,075 Utility operations and maintenance 416,709 407,834 Real estate operations 107,330 122,102 Depreciation and amortization 383,759 368,513 Taxes other than income taxes 116,005 121,650 ----------- ----------- Total 1,586,628 1,445,174 ----------- ----------- Operating Income 568,061 565,872 ----------- ----------- Other Income (Expense) Preferred stock dividend requirements of APS (7,841) (12,055) Net other income and expense (6,258) 4,705 ----------- ----------- Total (14,099) (7,350) ----------- ----------- Income Before Interest and Income Taxes 553,962 558,522 ----------- ----------- Interest Expense Interest charges 166,992 180,971 Capitalized interest (18,014) (19,688) ----------- ----------- Total 148,978 161,283 ----------- ----------- Income Before Income Taxes 404,984 397,239 Income Taxes 162,488 155,679 ----------- ----------- Net Income $ 242,496 $ 241,560 =========== =========== Average Common Shares Outstanding - Basic 84,745,736 84,853,589 Average Common Shares Outstanding - Diluted 85,351,957 85,383,767 Earnings Per Average Common Share Outstanding: Net income - basic $ 2.86 $ 2.85 Net income - diluted $ 2.84 $ 2.83 Dividends Declared Per Share $ 1.250 $ 1.150 =========== =========== See Notes to Condensed Consolidated Financial Statements. -4- PINNACLE WEST CAPITAL CORPORATION CONDENSED CONSOLIDATED BALANCE SHEETS (Unaudited) ASSETS (Thousands of Dollars) March 31, December 31, 1999 1998 ---------- ------------ Current Assets Cash and cash equivalents $ 25,709 $ 20,538 Customer and other receivables--net 198,608 233,876 Accrued utility revenues 58,936 67,740 Materials and supplies 71,232 69,074 Fossil fuel 13,009 13,978 Deferred income taxes 4,052 3,999 Other current assets 54,601 47,594 ---------- ---------- Total current assets 426,147 456,799 ---------- ---------- Investments and Other Assets Real estate investments--net 332,454 331,021 Other assets 255,285 236,562 ---------- ---------- Total investments and other assets 587,739 567,583 ---------- ---------- Utility Plant Electric plant in service and held for future use 7,299,849 7,265,604 Less accumulated depreciation and amortization 2,886,117 2,814,762 ---------- ---------- Total 4,413,732 4,450,842 Construction work in progress 242,084 228,643 Nuclear fuel, net of amortization 57,386 51,078 ---------- ---------- Net utility plant 4,713,202 4,730,563 ---------- ---------- Deferred Debits Regulatory asset for income taxes 387,616 400,795 Rate synchronization cost deferral 289,857 303,660 Other deferred debits 367,397 365,146 ---------- ---------- Total deferred debits 1,044,870 1,069,601 ---------- ---------- Total Assets $6,771,958 $6,824,546 ========== ========== See Notes to Condensed Consolidated Financial Statements. -5- PINNACLE WEST CAPITAL CORPORATION CONDENSED CONSOLIDATED BALANCE SHEETS (Unaudited) LIABILITIES AND EQUITY (Thousands of Dollars) March 31, December 31, 1999 1998 ---------- ------------ Current Liabilities Accounts payable $ 104,628 $ 155,800 Accrued taxes 117,235 62,520 Accrued interest 27,957 31,866 Short-term borrowings 112,725 178,830 Current maturities of long-term debt 157,646 168,045 Customer deposits 28,348 28,510 Other current liabilities 23,013 14,632 ---------- ---------- Total current liabilities 571,552 640,203 ---------- ---------- Long-Term Debt Less Current Maturities 2,170,640 2,048,961 ---------- ---------- Deferred Credits and Other Deferred income taxes 1,334,840 1,343,536 Deferred investment tax credit 25,293 27,345 Unamortized gain - sale of utility plant 76,643 77,787 Other 431,076 428,122 ---------- ---------- Total deferred credits and other 1,867,852 1,876,790 ---------- ---------- Commitments and contingencies (Notes 5, 8, 9, and 11) Minority Interests Non-redeemable preferred stock of APS -- 85,840 ---------- ---------- Redeemable preferred stock of APS -- 9,401 ---------- ---------- Common Stock Equity Common stock, no par value 1,546,055 1,550,643 Retained earnings 615,859 612,708 ---------- ---------- Total common stock equity 2,161,914 2,163,351 ---------- ---------- Total Liabilities and Equity $6,771,958 $6,824,546 ========== ========== See Notes to Condensed Consolidated Financial Statements. -6- PINNACLE WEST CAPITAL CORPORATION CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited) (THOUSANDS OF DOLLARS) Three Months Ended March 31, 1999 1998 --------- --------- CASH FLOWS FROM OPERATING ACTIVITIES Net Income $ 30,690 $ 31,086 Items not requiring cash Depreciation and amortization 96,910 92,830 Nuclear fuel amortization 8,269 8,417 Deferred income taxes--net (7,870) (11,419) Deferred investment tax credit (2,052) (2,426) Other--net 926 1,521 Changes in current assets and liabilities Customer and other receivables--net 35,268 44,468 Accrued utility revenues 8,804 9,028 Materials, supplies and fossil fuel (1,189) (3,501) Other current assets (7,007) (2,585) Accounts payable (52,168) (37,749) Accrued taxes 54,715 53,384 Accrued interest (3,909) (4,509) Other current liabilities 8,969 10,679 Decrease (increase) in land held (1,256) 11,556 Other--net (191) 6,113 --------- --------- Net Cash Flow Provided By Operating Activities 168,909 206,893 --------- --------- CASH FLOWS FROM INVESTING ACTIVITIES Capital expenditures (67,467) (60,848) Capitalized interest (4,074) (4,656) Other--net (9,082) 2,325 --------- --------- Net Cash Flow Used For Investing Activities (80,623) (63,179) --------- --------- CASH FLOWS FROM FINANCING ACTIVITIES Issuance of long-term debt 127,928 99,375 Short-term borrowings--net (66,105) (49,750) Dividends paid on common stock (27,534) (25,436) Repayment of long-term debt (17,575) (162,216) Redemption of preferred stock (96,499) (10,599) Other--net (3,330) (453) --------- --------- Net Cash Flow Used For Financing Activities (83,115) (149,079) --------- --------- Net Cash Flow 5,171 (5,365) Cash and Cash Equivalents at Beginning of Period 20,538 27,484 --------- --------- Cash and Cash Equivalents at End of Period $ 25,709 $ 22,119 ========= ========= Supplemental Disclosure of Cash Flow Information: Cash paid during the period for: Interest, net of amounts capitalized $ 37,434 $ 40,942 Income taxes $ -- $ 4,600 See Notes to Condensed Consolidated Financial Statements. -7- PINNACLE WEST CAPITAL CORPORATION NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS 1. The condensed consolidated financial statements include the accounts of Pinnacle West and its subsidiaries: APS, SunCor, El Dorado and APS Energy Services. All significant intercompany balances have been eliminated. We have reclassified certain prior year amounts to conform to the current year presentation. 2. Our unaudited condensed consolidated financial statements reflect all adjustments which we believe are necessary for the fair presentation of our financial position and results of operations for the periods presented. These adjustments are of a normal recurring nature. We suggest that these condensed consolidated financial statements and notes to condensed consolidated financial statements be read along with the consolidated financial statements and notes to consolidated financial statements included in our 1998 10-K. 3. Weather conditions can have a significant impact on APS' results for interim periods. For this and other reasons, results for interim periods do not necessarily represent results to be expected for the year. 4. See "Liquidity and Capital Resources" in Part I, Item 2 of this report for changes in capitalization for the three months ended March 31, 1999. 5. Regulatory Matters -- Electric Industry Restructuring STATE PROPOSED RETAIL ELECTRIC COMPETITION RULES In December 1996, the ACC adopted rules that provide a framework for the introduction of retail electric competition in Arizona. The rules, as amended, became effective on August 10, 1998, and on December 10, 1998, the ACC adopted the amended rules without any modifications that would have a significant impact on APS. We believe that certain provisions of the 1996 ACC rules and the amended rules are deficient and APS has filed lawsuits to protect its legal rights regarding the 1996 rules and the amended rules. These lawsuits are pending but two related cases filed by other utilities have been partially decided in a manner adverse to those utilities' positions. On January 11, 1999, the ACC issued an order which stayed the amended rules, granted reconsideration of the decision to make the rules permanent, and directed the hearing division of the ACC to establish a procedural order for further action on these rules. The order also granted waivers from compliance with the rules for APS, and all affected utilities. On February 5, 1999, the ACC Hearing Division issued recommendations for changes to the amended rules. The recommended changes to the amended rules were further modified by a Procedural Order of the ACC Hearing Division dated March 12, 1999. On April 14, 1999, the ACC voted to notice, for further rulemaking, the Hearing Division's -8- recommended changes, with certain exceptions. The proposed rules approved by the ACC for further rulemaking consideration include the following major provisions: * They would apply to virtually all Arizona electric utilities regulated by the ACC, including APS. * The rules require each affected utility, including APS, to make available at least 20% of its 1995 system retail peak demand for competitive generation supply beginning when the ACC makes a final decision on each utility's stranded costs and unbundled rates (Final Decision Date) or January 1, 2001, whichever is earlier, and 100% beginning January 1, 2001. * Subject to the 20% requirement, all utility customers with single premise loads of one megawatt or greater will be eligible for competitive electric services on the Final Decision Date. Customers with single premise loads of 40 kilowatts or greater may aggregate loads to meet this one megawatt requirement. * When effective, residential customers will be phased in at 1 1/4% per quarter calculated beginning on January 1, 1999, subject to the 20% requirement above. * Electric service providers that get Certificates of Convenience and Necessity (CC&Ns) from the ACC can supply only competitive services, including electric generation, but not electric transmission and distribution. * Affected utilities must file ACC tariffs with separate pricing for electric services provided for noncompetitive services. * ACC shall allow a reasonable opportunity for recovery of unmitigated stranded costs (see "Stranded Costs" below). * Absent an ACC waiver, prior to January 1, 2001, each affected utility must transfer all competitive generation assets and services either to an unaffiliated party or to a separate corporate affiliate. The proposed rules approved on April 14, 1999 will not become final and effective until approved by the ACC following formal rulemaking proceedings under Arizona law. In compliance with statutory procedural requirements, ACC oral proceedings on the matter are scheduled for June 14 and June 17, 1999. We cannot currently predict when or if the amended rules will be further modified, when the stay of the amended rules will be lifted, or when retail electric competition will be introduced in Arizona. STRANDED COSTS On June 22, 1998, the ACC issued an Order on stranded cost determination and recovery. APS believes that certain provisions of the stranded cost order -9- are deficient and in August 1998, APS filed two lawsuits to protect its legal rights relating to the order. On February 5, 1999, the ACC Hearing Division issued recommended changes to the June 1998 stranded cost order. These recommended changes were further amended by an ACC Procedural Order dated March 12, 1999. On April 14, 1999, the ACC voted to adopt the Hearing Division's changes to the June 1998 stranded cost order. The amended stranded cost order became effective on April 27, 1999, and allows each affected utility to choose from any one of five options for the recovery of stranded costs: * Net Revenues Lost Methodology is the difference between generation revenues under traditional regulation and generation revenues under competition. This option provides for declining recovery percentages for stranded costs over a five-year recovery period. Regulatory assets are to be fully recovered under their presently authorized amortization schedule. In accordance with a 1996 regulatory agreement, the ACC accelerated the amortization of substantially all of APS' regulatory assets to an eight-year period that ends June 30, 2004. * Divestiture/Auction Methodology allows a utility to divest all or substantially all of its generating assets, including regulatory assets associated with generation, in order to collect 100 percent of the difference between net sales price and book value of generating assets divested over a ten-year period, with no return on the unamortized balance. * Financial Integrity Methodology allows a utility "sufficient revenues to meet minimum financial ratios" for a period of ten years. * Settlement Methodology allows a settlement to be agreed upon by the ACC and a utility. * Any combination of the above if shown to be in the best interests of all affected parties. LEGISLATIVE INITIATIVES An Arizona joint legislative committee studied electric utility industry restructuring issues in 1996 and 1997. In conjunction with that study, the Arizona legislative counsel prepared memoranda in late 1997 related to the legal authority of the ACC to deregulate the Arizona electric utility industry. The memoranda raise a question as to the degree to which the ACC may, under the Arizona Constitution, deregulate any portion of the electric utility industry and allow rates to be determined by market forces. This latter issue has been subsequently decided by lower courts in favor of the ACC in four separate lawsuits, two of which are unrelated. In May 1998, a law was enacted to facilitate implementation of retail electric competition in Arizona. The law includes the following major provisions: * Arizona's largest government-operated electric utility (Salt River Project) and, at their option, smaller municipal electric systems must (i) make at least 20% of their 1995 retail peak demand available to electric service providers by December 31, 1998 and for all retail customers by December 31, 2000; (ii) decrease rates by at least 10% over a ten-year period beginning as early as January 1, 1991; (iii) implement procedures and public processes comparable to -10- those already applicable to public service corporations for establishing the terms, conditions, and pricing of electric services as well as certain other decisions affecting retail electric competition; * describes the factors which form the basis of consideration by Salt River Project in determining stranded costs; and * metering and meter reading services must be provided on a competitive basis during the first two years of competition only for customers having demands in excess of one megawatt (and that are eligible for competitive generation services), and thereafter for all customers receiving competitive electric generation. In addition, the Arizona legislature will review and make recommendations for the 1999 legislative session on certain competitive issues. GENERAL We believe that further ACC decisions, legislation at the Arizona and federal levels, and perhaps amendments to the Arizona Constitution (which would require a vote of the people) will ultimately be required before significant implementation of retail electric competition can lawfully occur in Arizona. Until the manner of implementation of competition, including addressing stranded costs, is determined, we cannot accurately predict the impact of full retail competition on our financial position, cash flows, or results of operation. As competition in the electric industry continues to evolve, we will continue to evaluate strategies and alternatives that will position us to compete in the new regulatory environment. FEDERAL The Energy Policy Act of 1992 and recent rulemakings by FERC have promoted increased competition in the wholesale electric power markets. APS does not expect these rules to have a material impact on its financial statements. Several electric utility reform bills have been introduced during recent congressional sessions, which as currently written would allow consumers to choose their electricity suppliers by 2000 or 2003. These bills, other bills that are expected to be introduced, and ongoing discussions at the federal level suggest a wide range of opinion that will need to be narrowed before any substantial restructuring of the electric utility industry can occur. REGULATORY ACCOUNTING APS prepares its financial statements in accordance with Statement of Financial Accounting Standards (SFAS) No. 71, "Accounting for the Effects of Certain Types of Regulation." SFAS No. 71 requires a cost-based, rate-regulated enterprise to reflect the impact of regulatory decisions in its financial statements. APS' existing regulatory orders and the current regulatory environment support its accounting practices related to regulatory assets, which amounted to about $900 million at March 31, 1999. Under the 1996 regulatory agreement (see Note 6), the ACC accelerated the amortization of substantially all of APS' regulatory assets to an eight-year period that will end June 30, 2004. During 1997, the Emerging Issues Task Force (EITF) of the Financial Accounting Standards Board (FASB) issued EITF 97-4. EITF 97-4 requires that SFAS No. 71 be discontinued no later than when legislation is passed or a rate order is issued that contains sufficient detail to determine its effect on the portion of the business being deregulated, which could result in write-downs or write-offs of physical and/or regulatory assets. Additionally, the EITF determined that regulatory assets should not be written off if they are to be recovered from a portion of the entity which continues to apply SFAS No. 71. Although rules have been proposed for transitioning generation services to competition, there are many unresolved issues. APS continues to apply SFAS No. 71 to its -11- generation operations. If rate recovery of regulatory assets is no longer probable, whether due to competition or regulatory action, APS would be required to write off the remaining balance as an extraordinary charge to expense. 6. 1996 Regulatory Agreement In April 1996, the ACC approved a regulatory agreement between the ACC Staff and APS. The major provisions of this agreement are: * An annual rate reduction of approximately $48.5 million ($29 million after income taxes), or 3.4% on average for all customers except certain contract customers, effective July 1, 1996. * Recovery of substantially all of APS' present regulatory assets through accelerated amortization over an eight-year period that will end June 30, 2004, increasing annual amortization by approximately $120 million ($72 million after income taxes). * A formula for sharing future cost savings between customers and shareholders (price reduction formula), referencing a return on equity (as defined) of 11.25%. * A moratorium on filing for permanent rate changes prior to July 2, 1999, except under the price reduction formula and under certain other limited circumstances. * Infusion of $200 million of common equity into APS by the parent company, in annual payments of $50 million starting in 1996. Based on the price reduction formula, the ACC approved retail price decreases of approximately $17.6 million ($10.5 million after income taxes), or 1.2%, effective July 1, 1997, and approximately $17 million ($10 million after income taxes), or 1.1%, effective July 1, 1998. APS expects to file with the ACC for another retail price decrease of approximately $10.8 million annually ($6.5 million after income taxes) to become effective July 1, 1999. The amount and timing of the price decrease are subject to ACC approval. This will be the last price decrease under the 1996 regulatory agreement. -12- 7. Agreement with Salt River Project On April 25, 1998, APS entered into a Memorandum of Agreement with Salt River Project in anticipation of, and to facilitate, the opening of the Arizona electric industry. The Agreement contains the following major components: * Both parties would amend the Territorial Agreement to remove any barriers to the provision of competitive electricity supply and non-distribution services. * Both parties would amend the Power Coordination Agreement to lower the price that APS will pay Salt River Project for purchased power by approximately $17 million (pretax) during the first full year that the Agreement is effective and by lesser annual amounts during the next seven years. * Both parties agreed on certain legislative positions regarding electric utility restructuring at the state and federal level. Certain provisions of the Agreement (including those relating to the amendments of the Territorial Agreement and the Power Coordination Agreement) are affected by the timing of the introduction of competition. See Note 5. On February 18, 1999, the ACC approved the Agreement. 8. The Palo Verde participants have insurance for public liability payments resulting from nuclear energy hazards to the full limit of liability under federal law. This potential liability is covered by primary liability insurance provided by commercial insurance carriers in the amount of $200 million and the balance by an industry-wide retrospective assessment program. If losses at any nuclear power plant covered by the programs exceed the accumulated funds, APS could be assessed retrospective premium adjustments. The maximum assessment per reactor under the program for each nuclear incident is approximately $88 million, subject to an annual limit of $10 million per incident. Based upon APS' 29.1% interest in the three Palo Verde units, APS' maximum potential assessment per incident is approximately $77 million, with an annual payment limitation of approximately $9 million. The Palo Verde participants maintain "all risk" (including nuclear hazards) insurance for property damage to, and decontamination of, property at Palo Verde in the aggregate amount of $2.75 billion, a substantial portion of which must first be applied to stabilization and decontamination. APS has also secured insurance against portions of any increased cost of generation or purchased power and business interruption resulting from a sudden and unforeseen outage of any of the three units. The insurance coverage discussed in this and the previous paragraph is subject to certain policy conditions and exclusions. 9. In the first quarter of 1999 we adopted EITF 98-10, "Accounting for Contracts Involved in Energy Trading and Risk Management Activities." EITF 98-10 requires energy trading contracts to be measured at fair value as of the balance sheet date with the gains and losses included in earnings and separately disclosed in the financial statements or footnotes. The effects of adopting EITF 98-10 were not material to our financial statements. -13- In June 1998 the Financial Accounting Standards Board issued SFAS No. 133 "Accounting for Derivative Instruments and Hedging Activities," which is effective for us in 2000. SFAS No. 133 requires that entities recognize all derivatives as either assets or liabilities on the balance sheet and measure those instruments at fair value. The standard also provides specific guidance for accounting for derivatives designated as hedging instruments. We are currently evaluating what impact this standard will have on our financial statements. 10. SFAS No. 128, "Earnings Per Share" requires the presentation of both basic and diluted earnings per share on the consolidated financial statements. Dilutive stock options increased average common shares outstanding by 506,498 and 546,850 for the three-month period ended March 31, 1999 and 1998, respectively; and 606,221 and 530,178 for the twelve-month period ended March 31, 1999 and 1998, respectively, but had no effect on net income. Total average common shares outstanding for the purposes of calculating diluted earnings per share were 85,176,298 and 85,332,159 for the three-month period ended March 31, 1999 and 1998, respectively; and 85,351,957 and 85,383,767 for the twelve-month period ended March 31, 1999 and 1998, respectively. 11. On April 23, 1999, we entered into a memorandum of understanding with Calpine Corporation, an independent power producer located in San Jose, California, for a potential $220 million, 500 MW expansion at the site of APS' West Phoenix Power Plant. The joint project is the second phase of a potential 750 MW expansion at West Phoenix. The first phase includes a $60 million repowering of an existing unit to create a 130 MW combined cycle unit. The remainder of the expansion involves repowering other existing units at the West Phoenix site. Assuming approvals are granted, construction is scheduled to begin in mid-2000, with commercial operation of the first phase in mid-2001 and of the second phase in late 2001. -14- PINNACLE WEST CAPITAL CORPORATION ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS. In this section, we explain our results of operations, general financial condition, and outlook for Pinnacle West and our subsidiaries: APS, SunCor, El Dorado, and APS Energy Services, including: * the changes in our earnings for the periods presented * the factors impacting our business, including competition and electric industry restructuring * the effects of regulatory agreements on our results * our capital needs and resources and * Year 2000 technology issues. We suggest this section be read along with the 1998 10-K. Throughout this Management's Discussion and Analysis of Financial Condition and Results of Operations, we refer to specific "Notes" in the Notes to Condensed Consolidated Financial Statements. These Notes add further details to the discussion. OPERATING RESULTS OPERATING RESULTS - THREE-MONTH PERIOD ENDED MARCH 31, 1999 COMPARED WITH THREE-MONTH PERIOD ENDED MARCH 31, 1998 Consolidated net income for the three months ended March 31, 1999 was $30.7 million compared with $31.1 million for the same period in the prior year. Net income decreased slightly in the three-month comparison because higher earnings at APS and lower financing costs at the parent company were more than offset by lower earnings at the other subsidiaries. APS earnings for the first quarter of 1999 were $32.8 million compared with $29.1 million for the same period in the prior year. APS earnings increased in the three-month comparison primarily because of an increase in customers and increased contributions from power marketing and trading activities, partially offset by milder weather, a retail price reduction, and higher depreciation and amortization expense. See Note 6 for information on the price reduction. Electric operating revenues increased $34 million because of: * increased power marketing and trading revenues ($34 million) * increases in the number of customers ($12 million) and * miscellaneous factors ($3 million). -15- As mentioned above, these positive factors were partially offset by the effects of milder weather ($11 million) and reductions in retail prices ($4 million). Power marketing and trading activities are predominantly short-term opportunity wholesale sales. The increase in power marketing revenues resulted from increased activity in Western bulk power markets. The increase in power marketing and trading revenues was accompanied by related increases in purchased power expenses. Depreciation and amortization expense increased $4 million because APS had more plant in service. Parent company financing costs decreased $2 million because we paid down debt. SunCor's earnings decreased $2 million in the three-month period primarily because of a decrease in net land sales. El Dorado's earnings decreased $3 million because of investment sales in 1998. OPERATING RESULTS - TWELVE-MONTH PERIOD ENDED MARCH 31, 1999 COMPARED WITH TWELVE-MONTH PERIOD ENDED MARCH 31, 1998 Net income for the twelve months ended March 31, 1999 was $242.5 million compared with $241.6 million for the same period in the prior year. Net income increased slightly because of increased earnings at APS and lower financing costs at the parent company, partially offset by lower contributions from other subsidiaries. APS earnings were $249.3 million for the twelve months ended March 31, 1999 compared with $242.7 million for the twelve months ended March 31, 1998. APS earnings increased primarily because of an increase in customers, increased contributions from power marketing and trading activities, and lower financing costs. In the comparison, these positive factors more than offset the effects of milder weather, two fuel-related settlements recorded in the third quarter of 1997, retail price reductions that became effective July 1, 1997 and 1998, and higher depreciation and amortization expense. See Note 6 for additional information about the price reductions. Electric operating revenues increased $160 million primarily because of: * increased power marketing and trading revenues ($138 million) * increases in the number of customers and the amount of electricity used by customers ($80 million) and * miscellaneous factors ($7 million). As mentioned above, these positive factors were partially offset by the effects of milder weather ($47 million) and reductions in retail prices ($18 million). -16- Power marketing and trading activities are predominantly short-term opportunity wholesale sales. The increase in power marketing revenues resulted from increased activity in Western bulk power markets, higher prices, and increased sales to large customers in California. The increase in power marketing and trading revenues was accompanied by related increases in purchased power expenses. The two fuel-related settlements increased pretax earnings in the twelve months ended March 31, 1998 by approximately $21 million. The income statement reflects these settlements as reductions in fuel expense and as other income. Depreciation and amortization expense increased $15 million because APS had more plant in service. APS decreased its financing costs by $9 million primarily because of lower amounts of outstanding debt and preferred stock and lower interest rates. Parent company financing costs decreased $9 million as we paid down debt and took advantage of lower interest rates. El Dorado's earnings decreased $7 million in the twelve-month period because of investment sales in 1998 and 1997. INVESTMENT TAX CREDIT AMORTIZATION As part of a 1994 rate settlement with the ACC, APS accelerated amortization of substantially all deferred ITCs over a five-year period that ends on December 31, 1999. The amortization of ITCs decreases annual consolidated income tax expense by approximately $24 million. Beginning in 2000, no further benefits will be reflected in income tax expense. LIQUIDITY AND CAPITAL RESOURCES PARENT COMPANY The parent company's cash requirements and its ability to fund those requirements are discussed under "Capital Needs and Resources" in Management's Discussion and Analysis of Financial Condition and Results of Operation in Part II, Item 7 of the 1998 10-K. During the three-months ended March 31, 1999, the parent company redeemed approximately $7 million of its long-term debt with cash from operations and short-term borrowings. -17- As a result of the 1996 regulatory agreement (see Note 6), the parent company has invested $50 million in APS in 1996, 1997, and 1998 and will invest a similar amount in 1999. On April 23, 1999, we entered into a memorandum of understanding with Calpine Corporation, an independent power producer located in San Jose, California, for a potential $220 million, 500 MW expansion at the site of APS' West Phoenix Power Plant. The joint project is the second phase of a potential 750 MW expansion at West Phoenix. The first phase includes a $60 million repowering of an existing unit to create a 130 MW combined cycle unit. The remainder of the expansion involves repowering other existing units at the West Phoenix site. Assuming approvals are granted, construction is scheduled to begin in mid-2000, with commercial operation of the first phase in mid-2001 and of the second phase in late 2001. We are also considering additional expansion over the next several years, which may result in additional expenditures. We currently believe that there will be additional opportunities to expand our investment in generating assets in the next five years. It is expected that these and other generating assets would be organized in a non-regulated subsidiary under the parent company. The Board declared a quarterly dividend of 32.5 cents per share of common stock, payable June 1, 1999 to shareholders of record on May 3, 1999, totaling approximately $27.6 million. APS For the three months ended March 31, 1999, APS incurred approximately $68 million in capital expenditures, which is approximately 21% of the most recently estimated 1999 capital expenditures. APS' projected capital expenditures for the next three years are: 1999, $328 million; 2000, $317 million; and 2001, $300 million. These amounts include about $30 - $35 million each year for nuclear fuel expenditures. APS' long-term debt and preferred stock redemption requirements and payment obligations on a capitalized lease for the next three years are: 1999, $285 million; 2000, $115 million; and 2001, $2 million. During the three months ended March 31, 1999, APS redeemed approximately $10 million of long-term debt and all $96 million (including premiums) of its preferred stock with cash from operations and long-term and short-term debt. In February 1999 APS issued $125 million of unsecured long-term debt. As a result of the 1996 regulatory agreement (see Note 6), Pinnacle West invested $50 million in APS in 1996, 1997 and 1998 and will invest a similar amount in 1999. Although provisions in APS' first mortgage bond indenture, articles of incorporation, and ACC financing orders establish maximum amounts of additional first mortgage bonds that APS may issue, APS does not expect any of these provisions to limit its ability to meet its capital requirements. -18- YEAR 2000 READINESS DISCLOSURE OVERVIEW As the year 2000 approaches, many companies face problems because many computer systems and equipment will not properly recognize calendar dates beginning with the year 2000. We are addressing the Year 2000 issue as described below. APS initiated a comprehensive company-wide Year 2000 program during 1997 to review and resolve all Year 2000 issues in mission critical systems (systems and equipment that are key to the power production and delivery function, health, and safety) in a timely manner to ensure the reliability of electric service to our customers. This included a company-wide awareness program of the Year 2000 issue. APS has an internal audit/quality review team that is periodically reviewing the individual Year 2000 projects and their Year 2000 readiness. The following chart shows Year 2000 readiness of our mission critical systems as of April 30, 1999: Inventory Assessment Remediation & Testing --------- ---------- --------------------- APS 100% 100% 90%(1) - --- --- --- --- Pinnacle West and other subsidiaries (excluding APS) 100% 100% 85%(2) (1) Estimated to be at 100% by June 30, 1999, except as discussed below. (2) Estimated to be at 100% by September 30, 1999. DISCUSSION APS has been actively implementing and replacing systems and technology since 1995 for general business reasons unrelated to the Year 2000, and these actions have resulted in substantially all of its major information technology (IT) systems becoming Year 2000 ready. The major IT systems that were, and are being, implemented and replaced include the following: * Work Management * Materials Management * Energy Management System * Payroll * Financial * Human Resources * Trouble Call Management System * Computer and Communications Network Upgrades * Geographic Information System * Customer Information System and * Palo Verde Site Work Management System. -19- We and our subsidiaries have made, and will continue to make, certain modifications to computer hardware and software systems and applications, including IT and non-IT systems, in an effort to ensure they are capable of handling changing business needs, including dates in the year 2000 and thereafter. In addition, other APS IT systems and non-IT systems, including embedded technology and real-time process control systems, are being analyzed for potential modifications. Pinnacle West and its subsidiaries have inventoried and assessed essentially all mission critical IT and non-IT systems and equipment. APS is 90% complete and Pinnacle West and its other subsidiaries are 85% complete with the remediation and testing of these systems. Remediation and testing is expected to be completed by June 30, 1999 for all mission critical systems, except for (i) those items that can only be completed during maintenance outages at Palo Verde, which will be completed for the last unit, which is substantially identical to the other two units, during the last half of 1999, and (ii) the continuous emissions monitoring systems for APS' five fossil plants, which will also be completed during the last half of 1999. APS currently estimates that it will spend approximately $5 million relating to Year 2000 issues, about $3 million of which has been spent to date. This includes an estimated allocation of payroll costs for APS employees working on Year 2000 issues, and costs for consultants, hardware, and software. We do not separately track other internal costs. This does not include any expenditures incurred since 1995 to implement and replace systems for reasons unrelated to the Year 2000, as discussed above. Our cost to address the Year 2000 issue is charged to operating expenses as incurred and has not had, and is not expected to have, a material adverse effect on our financial position, cash flows, or results of operations. We expect to fund this cost with available cash balances and cash provided by operations. Pinnacle West and its subsidiaries are communicating with their significant suppliers, business partners, other utilities, and large customers to determine the extent to which they may be affected by these third parties' plans to remediate their own Year 2000 issues in a timely manner. These companies have been interfacing with suppliers of systems, services, and materials in order to assess whether their schedules for analysis and remediation of Year 2000 issues are timely and to assess their ability to continue to supply required services and materials. APS is also working with the North American Electric Reliability Council (NERC) through the Western Systems Coordinating Council (WSCC) to develop operational plans for stable grid operation that will be utilized by APS and other utilities in the western United States. APS' operational plans are complete. However, APS cannot currently predict the effect on APS if the systems of these other companies are not Year 2000 ready. -20- We currently expect that our most reasonably likely worst case Year 2000 scenario would be intermittent loss of power to APS customers, similar to an outage during a severe weather disturbance. In this situation, APS would restore power as soon as possible by, among other things, re-routing power flows. We do not currently expect that this scenario would have a material adverse effect on our financial position, cash flows, or results of operations. We are working to develop our own contingency plans to handle Year 2000 issues, including the most reasonably likely worst case scenario discussed above, and we expect these plans to be completed by June 30, 1999. As discussed above, APS has also been working with NERC and WSCC to develop contingency plans related to grid operation. COMPETITION AND ELECTRIC INDUSTRY RESTRUCTURING See Note 5 for discussions of competitive developments and regulatory accounting. See Note 7 for a discussion of a proposed amendment to a Power Coordination Agreement with Salt River Project that APS estimates would reduce its pretax costs for purchased power by approximately $17 million during the first full year that the amendment is effective and by lesser annual amounts during the next seven years. RATE MATTERS See Note 6 for a discussion of a proposed price reduction that would be effective July 1, 1999. FORWARD-LOOKING STATEMENTS The above discussion contains forward-looking statements that involve risks and uncertainties. Words such as "estimates," "expects," "anticipates," "plans," "believes," "projects," and similar expressions identify forward-looking statements. These risks and uncertainties include, but are not limited to, the ongoing restructuring of the electric industry; the outcome of the regulatory proceedings relating to the restructuring; regulatory, tax, and environmental legislation; the ability of APS to successfully compete outside its traditional regulated markets; regional economic conditions, which could affect customer growth; the cost of debt and equity capital; weather variations affecting customer usage; technological developments in the electric industry; Year 2000 issues; the successful completion of a large-scale construction project; and the strength of the real estate market. These factors and the other matters discussed above may cause future results to differ materially from historical results, or from results or outcomes we currently expect or seek. -21- ITEM 3. MARKET RISKS Our operations include managing market risks related to changes in interest rates, commodity prices, and investments held by the nuclear decommissioning trust fund. Our major financial market risk exposure is changing interest rates. Changing interest rates will affect interest paid on variable rate debt and interest earned by the nuclear decommissioning trust fund. Our policy is to manage interest rates through the use of a combination of fixed and floating rate debt. The nuclear decommissioning fund also has risks associated with changing market values of equity investments. Nuclear decommissioning costs are recovered in rates. APS utilizes a variety of derivative instruments including exchange-traded futures, options, and swaps as part of its overall risk management strategies and for trading purposes. In order to reduce the risk of adverse price fluctuations in the electricity and natural gas markets, APS enters into futures and/or option transactions to hedge certain natural gas held in storage as well as certain expected purchases and sales of natural gas and electricity. APS is exposed to credit losses in the event of non-performance or non-payment by counterparties. APS uses a credit management process to assess and monitor the financial viability of counterparties. Our exposure to market risks, including those of APS, has not changed materially from December 31, 1998 to March 31, 1999. -22- PART II - OTHER INFORMATION ITEM 5. OTHER INFORMATION CONSTRUCTION AND FINANCING PROGRAMS See "Liquidity and Capital Resources" in Part I, Item 2 of this report for a discussion of APS' construction and financing programs. COMPETITION AND ELECTRIC INDUSTRY RESTRUCTURING See Note 5 of Notes to Condensed Consolidated Financial Statements in Part I, Item 1 of this report for a discussion of competition and the rules regarding the introduction of retail electric competition in Arizona. SPENT NUCLEAR FUEL AND WASTE DISPOSAL As previously reported, on July 24, 1998, APS filed a Petition for Review regarding DOE's obligation to begin accepting spent nuclear fuel. See "Generating Fuel and Purchased Power - Nuclear Fuel Supply - Spent Nuclear Fuel and Waste Disposal" in Part I, Item 1 of the 1998 10-K. On April 16, 1999, the court dismissed APS' petition, holding that APS is bound by the court's previous ruling in another case. That court held that DOE has an obligation to accept spent nuclear fuel as of January 31, 1998, but did not order DOE to do so. Instead, the court held that APS must follow the provisions of its standard contract for relief. ENVIRONMENTAL MATTERS PURPORTED NAVAJO ENVIRONMENTAL REGULATION As previously reported, on February 19, 1999, the EPA promulgated regulations setting forth the EPA's approach to issuing Federal permits to covered stationary sources on Indian reservations, pursuant to the Clean Air Act Amendments of 1990. See "Environmental Matters - Purported Navajo Environmental Regulation" in Part I, Item 1 of our 1998 10-K. On April 15, 1999, APS filed a Petition for Review in the United States Court of Appeals for the District of Columbia. ARIZONA PUBLIC SERVICE COMPANY V. UNITED STATES ENVIRONMENTAL PROTECTION AGENCY, No. 99-1146. EPA ENVIRONMENTAL REGULATION On April 22, 1999, the EPA announced final regional haze rules. See "Environmental Matters - EPA Environmental Regulation - Clean Air Act" in our 1998 10-K. These new regulations require states to submit, by 2008, implementation plans containing requirements to eliminate all man-made emissions causing visibility impairment in certain specified areas, including the Golden Circle of National Parks in the Colorado Plateau. The 2008 implementation plans must also include consideration and potential application of best available retrofit technology ("BART") for major stationary sources which came into operation between August 1962 -23- and August 1977, such as the Navajo Generating Station, Cholla Power Plant and Four Corners Power Plant. The nine western states and tribes that participated in the Grand Canyon Visibility Transport Commission process will have the option to follow an alternate implementation plan and schedule for areas considered by the Commission. Under this option, those states and tribes would submit implementation plans by 2003, which would incorporate the emission reduction scheme adopted in the Commission's recommendations. Any states and tribes that implement this option will also have to submit revised implementation plans in 2008 to address visibility in certain specified areas that were not considered by the Commission. Because Arizona has the discretion to choose between the national or Commission options and a variety of pollution controls to meet the requirements of the regional haze rules, the actual impact on APS cannot be determined at this time. ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibits Exhibit No. Description ----------- ----------- 27.1 Financial Data Schedule In addition to those Exhibits shown above, the Company hereby incorporates the following Exhibits pursuant to Exchange Act Rule 12b-32 and Regulation ss.229.10(d) by reference to the filings set forth below:
EXHIBIT NO. DESCRIPTION ORIGINALLY FILED AS EXHIBIT: FILE NO.(a) DATE EFFECTIVE - ----------- ----------- ---------------------------- ---------- -------------- 10.1 Articles of Incorporation 19.1 to the Company's 1-8962 11-14-88 restated as of July 29, 1988 September 30, 1988 Form 10-Q Report 10.2 Bylaws, amended as of 3.1 to the Company's 1995 1-8962 4-1-96 February 21, 1996 Form 10-K Report
- -------- (a) Reports filed under File No. 1-4473 were filed in the office of the Securities and Exchange Commission located in Washington, D.C. -24- (b) Reports on Form 8-K During the quarter ended March 31, 1999, and the period from April 1 through May 17, 1999, we filed the following reports on Form 8-K: Report dated January 11, 1999 relating to (i) the ACC hearing officers' recommended changes to the amended rules regarding the introduction of retail electric competition in Arizona and to the June 1998 stranded cost order and (ii) action by the Arizona Supreme Court vacating its order staying ACC hearings on the proposed settlement agreement and dismissing the Attorney General's action. -25- SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the Company has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. PINNACLE WEST CAPITAL CORPORATION (Registrant) Dated: May 17, 1999 By: George A. Schreiber, Jr. ----------------------------- George A. Schreiber, Jr. President and Chief Financial Officer (Principal Financial Officer and Officer Duly Authorized to sign this Report) EX-27.1 2 FINANCIAL DATA SCHEDULE
UT 1,000 3-MOS DEC-31-1999 JAN-01-1999 MAR-31-1999 PER-BOOK 4,713,202 587,739 426,147 1,044,870 0 6,771,958 1,546,055 0 615,859 2,161,914 0 0 2,170,640 0 0 112,725 157,646 0 0 0 2,169,033 6,771,958 438,687 20,861 247,676 346,917 91,770 (3,524) 0 36,695 30,690 0 30,690 27,534 27,761 168,909 0.36 0.36
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