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FORM 10-Q
SECURITIES AND EXCHANGE COMMISSION
| (Mark One) | ||
| þ | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) | |
| OF THE SECURITIES EXCHANGE ACT OF 1934 | ||
| For the quarterly period ended March 31, 2005 |
OR
| o | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 | |
| For the transition period from _________ to _________ |
| Exact Name of Each Registrant as specified in | ||||
| Commission | its charter; State of Incorporation; Address; | IRS Employer | ||
| File Number | and Telephone Number | Identification No. | ||
| 1-8962 | PINNACLE WEST CAPITAL CORPORATION | 86-0512431 | ||
| (an Arizona corporation) | ||||
| 400 North Fifth Street, P.O. Box 53999 | ||||
| Phoenix, Arizona 85072-3999 | ||||
| (602) 250-1000 | ||||
| 1-4473 | ARIZONA PUBLIC SERVICE COMPANY | 86-0011170 | ||
| (an Arizona corporation) | ||||
| 400 North Fifth Street, P.O. Box 53999 | ||||
| Phoenix, Arizona 85072-3999 | ||||
| (602) 250-1000 | ||||
Indicate by check mark whether each 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. Yesþ Noo
Indicate by check mark whether each registrant is an accelerated filer (as defined in Exchange Act Rule 12b-2).
| PINNACLE WEST CAPITAL CORPORATION | Yesþ Noo | |
| ARIZONA PUBLIC SERVICE COMPANY | Yeso Noþ |
Indicate the number of shares outstanding of each of the issuer’s classes of common stock as of the latest practicable date.
| PINNACLE WEST CAPITAL CORPORATION | Number of shares of common stock, no par value, | |
| outstanding as of May 5, 2005:98,350,044 | ||
| ARIZONA PUBLIC SERVICE COMPANY | Number of shares of common stock, $2.50 par value, | |
| outstanding as of May 5, 2005: 71,264,947 | ||
Arizona Public Service Company meets the conditions set forth in General Instruction H(1)(a) and (b) ofForm 10-Q and is therefore filing this form with the reduced disclosure format allowed under that General Instruction.
This combined Form 10-Q is separately filed by Pinnacle West Capital Corporation and Arizona Public Service Company. Each registrant is filing on its own behalf all of the information contained in this Form 10-Q that relates to such registrant. Neither registrant is filing any information that does not relate to such registrant, and therefore makes no representation as to any such information.
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TABLE OF CONTENTS
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| Exhibit 12.1 | ||||||||
| Exhibit 12.2 | ||||||||
| Exhibit 31.1 | ||||||||
| Exhibit 31.2 | ||||||||
| Exhibit 31.3 | ||||||||
| Exhibit 31.4 | ||||||||
| Exhibit 32.1 | ||||||||
| Exhibit 32.2 | ||||||||
| Exhibit 99.1 | ||||||||
| Exhibit 99.2 | ||||||||
| Exhibit 99.3 | ||||||||
| Exhibit 99.4 | ||||||||
| Exhibit 99.5 | ||||||||
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GLOSSARY
ACC — Arizona Corporation Commission
ADEQ — Arizona Department of Environmental Quality
AFUDC — allowance for funds used during construction
ALJ — Administrative Law Judge
APS — Arizona Public Service Company, a subsidiary of the Company
APS Energy Services — APS Energy Services Company, Inc., a subsidiary of the Company
CC&N — Certificate of Convenience and Necessity
Clean Air Act — Clean Air Act, as amended
Company — Pinnacle West Capital Corporation
DOE — United States Department of Energy
EITF — FASB’s Emerging Issues Task Force
El Dorado — El Dorado Investment Company, a subsidiary of the Company
EPA — United States Environmental Protection Agency
ERMC — Energy Risk Management Committee
FASB — Financial Accounting Standards Board
FERC — United States Federal Energy Regulatory Commission
FIN — FASB Interpretation
Financing Order — ACC Order that authorized APS’ $500 million loan to Pinnacle West Energy in May 2003
FSP — FASB Staff Position
GAAP — accounting principles generally accepted in the United States of America
IRS — United States Internal Revenue Service
Moody’s — Moody’s Investors Service
MW — megawatt, one million watts
MWh — megawatt-hours, one million watts per hour
NAC — collectively, NAC Holding Inc. and NAC International Inc., subsidiaries of El Dorado that were sold in November 2004
Native Load — retail and wholesale sales supplied under traditional cost-based rate regulation
1999 Settlement Agreement — comprehensive settlement agreement related to the implementation of retail electric competition
NRC — United States Nuclear Regulatory Commission
Nuclear Waste Act — Nuclear Waste Policy Act of 1982, as amended
OCI — other comprehensive income
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Palo Verde — Palo Verde Nuclear Generating Station, also known as ANPP
Pinnacle West — Pinnacle West Capital Corporation, the Company
Pinnacle West Energy — Pinnacle West Energy Corporation, a subsidiary of the Company
PPL Sundance — PPL Sundance Energy, LLC
PRP — potentially responsible party
PSA — power supply adjuster
PWEC Dedicated Assets — the following Pinnacle West Energy power plants, each of which is dedicated to serving APS’ customers: Redhawk Units 1 and 2, West Phoenix Units 4 and 5 and Saguaro Unit 3
PX — California Power Exchange
RFP — request for proposals
Salt River Project — Salt River Project Agricultural Improvement and Power District
SEC — United States Securities and Exchange Commission
SFAS — Statement of Financial Accounting Standards
SNWA — Southern Nevada Water Authority
Standard & Poor’s — Standard & Poor’s Corporation
SunCor — SunCor Development Company, a subsidiary of the Company
Sundance Plant — PPL Sundance’s 450-megawatt generating facility located approximately 55 miles southeast of Phoenix, Arizona
Superfund — Comprehensive Environmental Response, Compensation and Liability Act
T&D — transmission and distribution
Track A Order — ACC order dated September 10, 2002 regarding generation asset transfers and related issues
Track B Order — ACC order dated March 14, 2003 regarding competitive solicitation requirements for power purchases by Arizona’s investor-owned electric utilities
Trading — energy-related activities entered into with the objective of generating profits on changes in market prices
2004 Settlement Agreement — an agreement proposing terms under which APS’ general rate case would be settled
2004 Form 10-K — Pinnacle West/APS Annual Report on Form 10-K for the fiscal year ended December 31, 2004
VIE — variable interest entity
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INTRODUCTION
Filing Format
This Quarterly Report on Form 10-Q is a combined report being filed by two separate registrants: Pinnacle West and APS. The information required with respect to each company is set forth within the applicable items.
The Management’s Discussion and Analysis of Financial Condition and Results of Operations included under Item 2 of this report is divided into the following two sections:
| • | Pinnacle West Consolidated—This section describes the financial condition and results of operations of Pinnacle West and its subsidiaries on a consolidated basis. It includes discussions of Pinnacle West’s regulated utility and non-utility operations. A substantial part of Pinnacle West’s revenues and earnings is derived from its regulated utility, APS. | |||
| • | APS—This section includes a detailed description of the results of operations and contractual obligations of APS. | |||
Item 1 of this report includes Condensed Consolidated Financial Statements of Pinnacle West and Condensed Financial Statements of APS. Item 1 also includes Notes to Pinnacle West’s Condensed Consolidated Financial Statements, the majority of which also relate to APS, and Supplemental Notes to APS’ Condensed Financial Statements.
Certain Notes to APS’ Condensed Financial Statements are combined with the Notes to Pinnacle West’s Condensed Consolidated Financial Statements. See page 34 of this Report for a list of the Notes to Pinnacle West’s Condensed Consolidated Financial Statements, the majority of which also relate to APS’ Condensed Financial Statements, as well as the Supplemental Notes, which are required disclosures for APS and should be read in conjunction with Pinnacle West’s Condensed Consolidated Notes.
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PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
PINNACLE WEST CAPITAL CORPORATION
| Three Months Ended | ||||||||
| March 31, | ||||||||
| 2005 | 2004 | |||||||
| OPERATING REVENUES | ||||||||
| Regulated electricity segment | $ | 416,030 | $ | 415,464 | ||||
| Marketing and trading segment | 116,866 | 88,383 | ||||||
| Real estate segment | 72,056 | 51,593 | ||||||
| Other revenues | 10,135 | 10,905 | ||||||
| Total | 615,087 | 566,345 | ||||||
| OPERATING EXPENSES | ||||||||
| Regulated electricity segment purchased power and fuel | 78,423 | 88,611 | ||||||
| Marketing and trading segment purchased power and fuel | 100,641 | 67,764 | ||||||
| Operations and maintenance | 156,496 | 137,386 | ||||||
| Real estate operations segment | 56,476 | 47,690 | ||||||
| Depreciation and amortization | 94,231 | 101,616 | ||||||
| Taxes other than income taxes | 35,190 | 30,330 | ||||||
| Other expenses | 8,374 | 8,750 | ||||||
| Total | 529,831 | 482,147 | ||||||
| OPERATING INCOME | 85,256 | 84,198 | ||||||
| OTHER | ||||||||
| Allowance for equity funds used during construction | 2,603 | 2,002 | ||||||
| Other income (Note 15) | 1,744 | 11,412 | ||||||
| Other expense (Note 15) | (5,309 | ) | (5,945 | ) | ||||
| Total | (962 | ) | 7,469 | |||||
| INTEREST EXPENSE | ||||||||
| Interest charges | 49,195 | 50,319 | ||||||
| Capitalized interest | (3,289 | ) | (4,911 | ) | ||||
| Total | 45,906 | 45,408 | ||||||
| INCOME FROM CONTINUING OPERATIONS BEFORE INCOME TAXES | 38,388 | 46,259 | ||||||
| INCOME TAXES | 14,732 | 15,468 | ||||||
| INCOME FROM CONTINUING OPERATIONS | 23,656 | 30,791 | ||||||
| Income from discontinued operations — net of income tax expense of $518 and $411 | 792 | 635 | ||||||
| NET INCOME | $ | 24,448 | $ | 31,426 | ||||
| WEIGHTED-AVERAGE COMMON SHARES OUTSTANDING — BASIC | 91,962 | 91,294 | ||||||
| WEIGHTED-AVERAGE COMMON SHARES OUTSTANDING — DILUTED | 92,045 | 91,376 | ||||||
| EARNINGS PER WEIGHTED — AVERAGE COMMON SHARES OUTSTANDING | ||||||||
| Income from continuing operations — basic | $ | 0.26 | $ | 0.34 | ||||
| Net income — basic | 0.27 | 0.34 | ||||||
| Income from continuing operations — diluted | 0.26 | 0.34 | ||||||
| Net income — diluted | 0.27 | 0.34 | ||||||
| DIVIDENDS DECLARED PER SHARE | $ | 0.95 | $ | 0.90 | ||||
See Notes to Pinnacle West’s Condensed Consolidated Financial Statements.
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PINNACLE WEST CAPITAL CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEETS
(unaudited)
(dollars in thousands)
| March 31, | December 31, | |||||||
| 2005 | 2004 | |||||||
| ASSETS | ||||||||
| CURRENT ASSETS | ||||||||
| Cash and cash equivalents | $ | 172,116 | $ | 163,366 | ||||
| Investment in debt securities | 100,000 | 181,175 | ||||||
| Customer and other receivables | 265,538 | 367,863 | ||||||
| Allowance for doubtful accounts | (4,632 | ) | (4,896 | ) | ||||
| Accrued utility revenues | 78,156 | 93,227 | ||||||
| Materials and supplies (at average cost) | 109,568 | 101,333 | ||||||
| Fossil fuel (at average cost) | 22,244 | 20,512 | ||||||
| Assets from risk management and trading activities (Note 10) | 300,440 | 166,896 | ||||||
| Assets held for sale (Note 18) | 34,393 | — | ||||||
| Other current assets | 57,919 | 47,654 | ||||||
| Total current assets | 1,135,742 | 1,137,130 | ||||||
| INVESTMENTS AND OTHER ASSETS | ||||||||
| Real estate investments — net | 345,809 | 382,398 | ||||||
| Assets from risk management and trading activities-long term (Note 10) | 358,024 | 224,341 | ||||||
| Decommissioning trust accounts | 266,497 | 267,700 | ||||||
| Other assets | 101,857 | 107,212 | ||||||
| Total investments and other assets | 1,072,187 | 981,651 | ||||||
| PROPERTY, PLANT AND EQUIPMENT | ||||||||
| Plant in service and held for future use | 10,544,621 | 10,486,648 | ||||||
| Less accumulated depreciation and amortization | 3,437,733 | 3,365,954 | ||||||
| Total | 7,106,888 | 7,120,694 | ||||||
| Construction work in progress | 269,010 | 258,119 | ||||||
| Intangible assets, net of accumulated amortization | 127,537 | 105,486 | ||||||
| Nuclear fuel, net of accumulated amortization | 58,092 | 51,188 | ||||||
| Net property, plant and equipment | 7,561,527 | 7,535,487 | ||||||
| DEFERRED DEBITS | ||||||||
| Regulatory assets | 138,374 | 135,051 | ||||||
| Other deferred debits | 109,384 | 107,428 | ||||||
| Total deferred debits | 247,758 | 242,479 | ||||||
| TOTAL ASSETS | $ | 10,017,214 | $ | 9,896,747 | ||||
See Notes to Pinnacle West’s Condensed Consolidated Financial Statements.
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PINNACLE WEST CAPITAL CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEETS
(unaudited)
(dollars in thousands)
| March 31, | December 31, | |||||||
| 2005 | 2004 | |||||||
| LIABILITIES AND EQUITY | ||||||||
| CURRENT LIABILITIES | ||||||||
| Accounts payable | $ | 194,540 | $ | 373,526 | ||||
| Accrued taxes | 277,379 | 245,611 | ||||||
| Accrued interest | 48,683 | 38,795 | ||||||
| Dividends payable | 43,751 | — | ||||||
| Short-term borrowings | 63,252 | 71,030 | ||||||
| Current maturities of long-term debt | 517,805 | 617,165 | ||||||
| Customer deposits | 56,693 | 55,558 | ||||||
| Deferred income taxes | 9,057 | 9,057 | ||||||
| Liabilities from risk management and trading activities (Note 10) | 201,476 | 113,406 | ||||||
| Liabilities held for sale (Note 18) | 28,947 | — | ||||||
| Other current liabilities | 145,784 | 101,748 | ||||||
| Total current liabilities | 1,587,367 | 1,625,896 | ||||||
| LONG-TERM DEBT LESS CURRENT MATURITIES | 2,576,360 | 2,584,985 | ||||||
| DEFERRED CREDITS AND OTHER | ||||||||
| Deferred income taxes | 1,283,476 | 1,227,553 | ||||||
| Regulatory liabilities | 513,798 | 506,646 | ||||||
| Liability for asset retirements | 252,926 | 251,612 | ||||||
| Pension liability | 250,328 | 234,445 | ||||||
| Liabilities from risk management and trading activities-long term (Note 10) | 199,648 | 156,262 | ||||||
| Unamortized gain — sale of utility plant | 49,189 | 50,333 | ||||||
| Other | 311,080 | 308,819 | ||||||
| Total deferred credits and other | 2,860,445 | 2,735,670 | ||||||
| COMMITMENTS AND CONTINGENCIES (Notes 5, 12 and 13) | ||||||||
| COMMON STOCK EQUITY | ||||||||
| Common stock, no par value | 1,781,050 | 1,769,047 | ||||||
| Treasury stock | (35 | ) | (428 | ) | ||||
| Total common stock | 1,781,015 | 1,768,619 | ||||||
| Accumulated other comprehensive income (loss): | ||||||||
| Minimum pension liability adjustment | (81,788 | ) | (81,788 | ) | ||||
| Derivative instruments | 152,662 | 59,243 | ||||||
| Total accumulated other comprehensive income (loss) | 70,874 | (22,545 | ) | |||||
| Retained earnings | 1,141,153 | 1,204,122 | ||||||
| Total common stock equity | 2,993,042 | 2,950,196 | ||||||
| TOTAL LIABILITIES AND EQUITY | $ | 10,017,214 | $ | 9,896,747 | ||||
See Notes to Pinnacle West’s Condensed Consolidated Financial Statements.
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PINNACLE WEST CAPITAL CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited)
(dollars in thousands)
| Three Months Ended | ||||||||
| March 31, | ||||||||
| 2005 | 2004 | |||||||
| CASH FLOWS FROM OPERATING ACTIVITIES | ||||||||
| Net Income | $ | 24,448 | $ | 31,426 | ||||
| Adjustment to reconcile net income to net cash provided by operating activities: | ||||||||
| Income from discontinued operations, net of tax | (792 | ) | (635 | ) | ||||
| Depreciation and amortization | 94,231 | 101,616 | ||||||
| Nuclear fuel amortization | 2,101 | 7,599 | ||||||
| Allowance for equity funds used during construction | (2,603 | ) | (2,002 | ) | ||||
| Deferred income taxes | (4,281 | ) | 9,060 | |||||
| Change in mark-to-market valuations | (18,557 | ) | (22,920 | ) | ||||
| Changes in current assets and liabilities: | ||||||||
| Customer and other receivables | 102,061 | 70,857 | ||||||
| Accrued utility revenues | 15,071 | (718 | ) | |||||
| Materials, supplies and fossil fuel | (9,967 | ) | 3,668 | |||||
| Other current assets | (10,265 | ) | (505 | ) | ||||
| Accounts payable | (179,467 | ) | (52,208 | ) | ||||
| Accrued taxes | 31,768 | 33,891 | ||||||
| Accrued interest | 9,888 | (4,748 | ) | |||||
| Other current liabilities | 42,982 | 21,552 | ||||||
| Proceeds from the sale of real estate assets | 53,820 | 9,800 | ||||||
| Real estate investments | (13,797 | ) | (10,634 | ) | ||||
| Increase in regulatory assets | (3,323 | ) | (847 | ) | ||||
| Change in risk management and trading activities — assets | (1,198 | ) | 5,875 | |||||
| Change in risk management and trading activities — liabilities | 37,707 | 19,427 | ||||||
| Change in customer advances | 2,189 | 3,070 | ||||||
| Change in pension liability | 15,883 | 14,704 | ||||||
| Change in other long-term assets | 4,871 | (11,106 | ) | |||||
| Change in other long-term liabilities | 3,181 | (994 | ) | |||||
| Net cash flow provided by operating activities | 195,951 | 225,228 | ||||||
| CASH FLOWS FROM INVESTING ACTIVITIES | ||||||||
| Capital expenditures | (121,120 | ) | (116,122 | ) | ||||
| Capitalized interest | (3,289 | ) | (4,911 | ) | ||||
| Discontinued operations — Real Estate | (2,785 | ) | 133 | |||||
| Discontinued operations — NAC | — | 3,555 | ||||||
| Purchases of investment securities | (343,525 | ) | (193,345 | ) | ||||
| Proceeds from sale of investment securities | 424,700 | 285,195 | ||||||
| Other | 6,138 | (4,194 | ) | |||||
| Net cash flow used for investing activities | (39,881 | ) | (29,689 | ) | ||||
| CASH FLOWS FROM FINANCING ACTIVITIES | ||||||||
| Issuance of long-term debt | 163,999 | 179,000 | ||||||
| Short-term borrowings and payments — net | (7,778 | ) | 149,005 | |||||
| Dividends paid on common stock | (43,666 | ) | (41,080 | ) | ||||
| Repayment of long-term debt | (264,805 | ) | (601,427 | ) | ||||
| Common stock equity issuance | 12,649 | — | ||||||
| Other | (7,719 | ) | 2,752 | |||||
| Net cash flow used for financing activities | (147,320 | ) | (311,750 | ) | ||||
| NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS | 8,750 | (116,211 | ) | |||||
| CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD | 163,366 | 131,062 | ||||||
| CASH AND CASH EQUIVALENTS AT END OF PERIOD | $ | 172,116 | $ | 14,851 | ||||
| Supplemental disclosure of cash flow information | ||||||||
| Cash paid during the period for: | ||||||||
| Income taxes paid | $ | 15,230 | $ | 6,767 | ||||
| Interest paid, net of amounts capitalized | $ | 71,327 | $ | 72,367 | ||||
See Notes to Pinnacle West’s Condensed Consolidated Financial Statements.
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PINNACLE WEST CAPITAL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
1. Consolidation and Nature of Operations
The condensed consolidated financial statements include the accounts of Pinnacle West and our wholly-owned subsidiaries: APS, Pinnacle West Energy, APS Energy Services, SunCor and El Dorado. All significant intercompany accounts and transactions between the consolidated companies have been eliminated. Our accounting records are maintained in accordance with GAAP. The preparation of financial statements in accordance with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities at the date of the financial statements and reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. We have reclassified certain prior year amounts to conform to the current year presentation.
2. Condensed Consolidated Financial Statements
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 2004 Form 10-K.
3. Quarterly Fluctuations
Weather conditions cause significant seasonal fluctuations in our revenues. In addition, real estate, trading and wholesale marketing activities can have significant impacts on our results for interim periods. For these reasons as well as others, results for interim periods do not necessarily represent results to be expected for the year.
4. Changes in Liquidity
On January 15, 2005, APS repaid its $100 million 6.25% Notes due 2005. APS used cash on hand to redeem these notes.
On March 1, 2005, Maricopa County, Arizona Pollution Control Corporation issued $164 million of variable interest rate pollution control bonds, 2005 Series A-E, due 2029. The bonds were issued to refinance $164 million of outstanding pollution control bonds. The Series A-E bonds are payable solely from revenues obtained from APS pursuant to a loan agreement between APS and Maricopa County, Arizona Pollution Control Corporation. These bonds are classified as long-term debt on our Condensed Consolidated Balance Sheets.
On April 11, 2005 Pinnacle West Energy issued $500 million of Floating Rate Senior Notes due April 1, 2007. Pinnacle West has unconditionally guaranteed these notes. Pinnacle West Energy used the proceeds of this issuance to repay a $500 million loan from APS. See “ACC Financing Order” in Note 5. APS intends to use the proceeds to pay a portion of the purchase price of the PWEC Dedicated Assets. In the interim, APS intends to invest the proceeds or use them for general corporate purposes. In the event that the FERC does not approve the transfer of the PWEC Dedicated Assets, APS will use the proceeds for general corporate purposes.
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PINNACLE WEST CAPITAL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
On May 2, 2005, Pinnacle West redeemed at par all of its $165 million Floating Rate Senior Notes due November 1, 2005. We used cash on hand to redeem the notes.
On May 2, 2005, Pinnacle West issued 6,095,000 shares of its common stock at an offering price of $42 per share, resulting in net proceeds of approximately $248 million. Pinnacle West anticipates using the net proceeds of the offering for general corporate purposes, including making capital contributions to APS, which will, in turn, use such funds to pay a portion of the approximately $190 million purchase price of its pending acquisition of the Sundance Plant and other capital expenditures expected to be incurred to meet the growing needs of APS’ service territory. See “Request for Proposals and Asset Purchase Agreement” in Note 5 for information regarding APS’ pending acquisition of the Sundance Plant.
APS had $566 million of pollution control bonds outstanding under which interest rates are reset on a daily, weekly or annual basis as of March 31, 2005. The holders of $223 million of these bonds have the right to cause APS to purchase their bonds on the applicable reset date if the bonds are not remarketed. Of these bonds, $50 million of such bonds are classified as current maturities of long-term debt. The remaining $173 million of bonds are classified as long-term debt because APS has the intent and ability, as demonstrated by credit agreements in place that extend for more than one year, to refinance any bonds that APS is required to purchase.
The following is a list of principal payments due on Pinnacle West’s consolidated long-term debt and capitalized lease requirements as of March 31, 2005:
| • | $517 million in 2005; | |||
| • | $395 million in 2006; | |||
| • | $174 million in 2007; | |||
| • | $7 million in 2008; | |||
| • | $1 million in 2009; and | |||
| • | $2.013 billion thereafter. | |||
We have investments in auction rate securities in which interest rates are reset on a short-term basis; however, the underlying contract maturity dates extend beyond three months. We classify the investments in auction rate securities as investments in debt securities on our Condensed Consolidated Balance Sheets. The purchase and sale activities related to these investments have been reclassified on the Consolidated Statement of Cash Flows for the prior-year period.
5. Regulatory Matters
Electric Industry Restructuring
State
APS General Rate Case
On April 7, 2005, the ACC issued an order in the general rate case that APS filed on June 27, 2003. The order became final and non-appealable on April 28, 2005. In its order, the ACC approved the 2004 Settlement Agreement, with certain revisions. Certain key financial components of the order include:
| • | APS received an annual retail rate increase of approximately $75.5 million, or 4.21%, which was effective as of April 1, 2005. This increase does not include the impact of |
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PINNACLE WEST CAPITAL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
| the PSA (discussed below), which is estimated to be 5% in 2006. These increases could be further impacted if the ACC approves additional surcharges. |
| • | The PSA provides for the annual adjustment of rates to reflect variations in fuel and purchased power costs, subject to specified parameters and procedures, including the following: |
| • | APS will record deferrals for recovery or refund to the extent actual fuel and purchased power costs vary from $0.020743 per kWh; | |||
| • | amounts to be recovered or refunded through the PSA are limited to plus or minus $0.004 per kWh over the life of the PSA; | |||
| • | in addition, the ACC order provides for a surcharge mechanism as follows: | |||
| • | each time the accumulated pretax net deferrals reach $50 million, APS must notify the ACC, but prior to the deferral balance exceeding $100 million, APS must file with the ACC to recover or refund such deferral balance through a surcharge; | |||
| • | amounts recovered or refunded through any surcharge are not included in the $0.004 per kWh PSA limit; | |||
| • | the recoverable amount of net fuel and purchased power costs is capped at $776.2 million per year (APS does not expect such costs to exceed $776.2 million in 2005 or 2006); | |||
| • | the PSA will remain in effect for a minimum five-year period, but the ACC may eliminate the PSA at any time, if appropriate, in the event APS files a rate case before the expiration of the five-year period or if APS does not comply with the terms of the PSA; and | |||
| • | the first adjustment of rates under the PSA would occur on April 1, 2006, unless the ACC approves a special surcharge prior to that date. | |||
| • | The 2004 Settlement Agreement included a self-build moratorium for generating plants to be in service prior to January 1, 2015. The ACC order modified that moratorium to include the acquisition of a generating unit, or an interest in a generating unit, from any utility or merchant generator without prior ACC approval. | |||
| • | APS was authorized to acquire Redhawk Units 1 and 2, West Phoenix Units 4 and 5, and Saguaro Unit 3, which are dedicated to serving APS’ customers (the “PWEC Dedicated Assets”) from PWEC, with a net carrying value of approximately $850 million, and to rate base the PWEC Dedicated Assets at a rate base value of $700 million, which will result in a mandatory rate base disallowance of approximately $150 million. As a result, for financial reporting purposes, APS will recognize a one-time, after-tax net plant write-off of approximately $90 million in the period when the assets are recorded on APS’ books. This transfer remains subject to approval of the FERC. | |||
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PINNACLE WEST CAPITAL CORPORATION
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| • | To bridge the time between the effective date of the rate increase and the actual date the PWEC Dedicated Assets transfer, effective April 1, 2005, APS and PWEC entered into a cost-based purchase power agreement (the “Bridge PPA”), which is based on the value of the PWEC Dedicated Assets. When the Bridge PPA became effective, prior power purchase agreements entered into between APS and PWEC were terminated. The Bridge PPA will remain in effect until the FERC approves the transfer of the PWEC Dedicated Assets to APS and the transfer is completed. |
| • | If the FERC were to issue an order denying APS’ request to acquire the PWEC Dedicated Assets, the Bridge PPA would become a 30-year purchase power agreement, with prices reflecting cost-of-service as if APS had acquired and rate-based the PWEC Dedicated Assets at the value described above. | |||
| • | If the FERC were to issue an order (a) approving APS’ request to transfer the PWEC Dedicated Assets at a value materially less than $700 million, (b) approving the transfer of fewer than all of the PWEC Dedicated Assets, or (c) that was materially inconsistent with the ACC order, APS would file an appropriate application with the ACC so that rates could be adjusted. In these circumstances, the Bridge PPA would continue at least until the conclusion of the subsequent proceeding to consider any appropriate adjustment to APS’ rates. | |||
ACC Financing Order
On May 12, 2003, APS issued $500 million of debt pursuant to the Financing Order and made a $500 million loan to Pinnacle West Energy. Pinnacle West Energy distributed the net proceeds of that loan to us to fund the repayment of a portion of the debt we incurred to finance the construction of the PWEC Dedicated Assets. On April 11, 2005, this loan was repaid with the proceeds of a new debt issuance. See “Capital Needs and Resources — By Company — Pinnacle West Energy” in Part I, Item 2 below.
The ACC granted the Financing Order subject to various conditions. One of these conditions is that APS must maintain a common equity ratio of at least 40% and may not pay common dividends if such payment would reduce its common equity ratio below that threshold, unless otherwise waived by the ACC. This condition is an ongoing requirement and was not affected by Pinnacle West Energy’s repayment of APS’ $500 million loan.
In addition, the Financing Order required the ACC staff to conduct an inquiry into our and our affiliates’ compliance with the retail electric competition and related rules and decisions. On June 13, 2003, APS submitted its report on these matters to the ACC staff. As part of the ACC order in APS’ general rate case discussed above, this inquiry was concluded with no further action by the ACC.
Retail Electric Competition Rules
In 1999, the ACC approved rules for the introduction of retail electric competition in Arizona. The rules include the following major provisions:
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| • | They apply to virtually all Arizona electric utilities regulated by the ACC, including APS. | |||
| • | Effective January 1, 2001, retail access became available to all APS retail electricity customers. | |||
| • | Electric service providers that get CC&N’s from the ACC can supply only competitive services, including electric generation, but not electric transmission and distribution. | |||
| • | Affected utilities must file ACC tariffs that unbundle rates for noncompetitive services. | |||
| • | The ACC shall allow a reasonable opportunity for recovery of unmitigated stranded costs. | |||
On November 27, 2000, a Maricopa County, Arizona, Superior Court judge issued a final judgment holding that the rules are unconstitutional and unlawful in their entirety due to failure to establish a fair value rate base for competitive electric service providers and because certain of the rules were not submitted to the Arizona Attorney General for certification. The judgment also invalidates all ACC orders authorizing competitive electric service providers, including APS Energy Services, to operate in Arizona. The ACC and other parties aligned with the ACC appealed the ruling to the Arizona Court of Appeals, and in January 2004, the Court invalidated some, but not all, of the rules as either violative of Arizona’s constitutional requirement that the ACC consider the “fair value” of a utility’s property in setting rates or as being beyond the ACC’s constitutional and statutory powers. Other rules were set aside for failure to submit such regulations to the Arizona Attorney General for certification as required by statute. A request for the Arizona Supreme Court to review the Court of Appeals decision was denied on January 4, 2005. To date, the ACC has taken no action on either the rules or the orders authorizing competitive electric service providers in response to the now final Court of Appeals decision. As a result, at present only limited electric retail competition exists in Arizona and only with certain entities not regulated by the ACC.
Track A Order
On September 10, 2002, the ACC issued the Track A Order, in which the ACC, among other things:
| • | reversed its decision, as reflected in the rules, to require APS to transfer its generation assets either to an unrelated third party or to a separate corporate affiliate; and | |||
| • | unilaterally modified the 1999 Settlement Agreement, which authorized APS’ transfer of its generating assets, and directed APS to cancel its activities to transfer its generation assets to Pinnacle West Energy. | |||
On November 15, 2002, APS filed appeals of the Track A Order in the Maricopa County, Arizona Superior Court and in the Arizona Court of Appeals.Arizona Public Service Company vs. Arizona Corporation Commission, CV 2002-0222 32;Arizona Public Service Company vs. Arizona
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Corporation Commission, 1CA CC 02-0002. On December 13, 2002, APS and the ACC staff agreed to principles for resolving certain issues raised by APS in its appeals of the Track A Order. The major provisions of the principles include, among other things, the following:
| • | APS and the ACC staff agreed that it would be appropriate for the ACC to consider the following matters in APS’ general rate case: |
| • | the generating assets to be included in APS’ rate base, including the question of whether the PWEC Dedicated Assets should be included in APS’ rate base; | |||
| • | the appropriate treatment of the $234 million pretax asset write-off agreed to by APS as part of the 1999 Settlement Agreement; and | |||
| • | the appropriate treatment of costs incurred by APS in preparation for the previously anticipated transfer of generation assets to Pinnacle West Energy. | |||
| • | As a result of the ACC’s issuance of the Financing Order, APS’ appeals of the Track A Order are limited to the issues described in the preceding bullet points. |
On August 27, 2003, APS, Pinnacle West and Pinnacle West Energy filed a lawsuit asserting damage claims relating to the Track A Order.Arizona Public Service Company et al. v. The State of Arizona ex rel., Superior Court of the State of Arizona, County of Maricopa, No. CV2003-016372.
As a result of the ACC’s order in APS’ general rate case discussed above, APS, Pinnacle West, and Pinnacle West Energy are presently in the process of seeking dismissal of the above litigation.
Track B Order
On March 14, 2003, the ACC issued the Track B Order, which required APS to solicit bids for certain estimated amounts of capacity and energy for periods beginning July 1, 2003. For 2003, APS was required to solicit competitive bids for about 2,500 MW of capacity and about 4,600 gigawatt-hours of energy, or approximately 20% of APS’ total retail energy requirements.
APS issued requests for proposals in March 2003 and, by May 6, 2003, APS entered into contracts to meet all or a portion of its requirements for the years 2003 through 2006 as follows:
| (1) | Pinnacle West Energy agreed to provide 1,700 MW in July through September of 2003 and in June through September of 2004, 2005 and 2006, by means of a unit contingent contract. | |||
| (2) | PPL EnergyPlus, LLC agreed to provide 112 MW in July through September of 2003 and 150 MW in June through September of 2004 and 2005, by means of a unit contingent contract. | |||
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| (3) | Panda Gila River LP agreed to provide 450 MW in October of 2003 and 2004 and May of 2004 and 2005, and 225 MW from November 2003 through April 2004 and from November 2004 through April 2005, by means of firm call options. |
With final ACC approval of the 2004 Settlement Agreement, the Track B contract with Pinnacle West Energy was cancelled, effective April 1, 2005 and replaced by the Bridge PPA. The Track B contract with PPL will be cancelled upon closing of the purchase of the Sundance Plant (see below).
Request for Proposals and Asset Purchase Agreement
In early December 2003, APS issued a request for proposals for long-term power supply resources. On June 1, 2004, APS and PPL Sundance, a wholly-owned subsidiary of PPL Corporation, entered into an asset purchase agreement by which APS agreed to purchase the Sundance Plant. The Sundance Plant, which began commercial operation in July 2002, would provide peaking generation support for APS’ system and reduce APS’ growing needs for new generation resources. The purchase price for the Sundance Plant is approximately $190 million.
On June 1, 2004, APS and PPL Sundance filed a joint application with the ACC with respect to APS’ proposed acquisition of the Sundance Plant. On January 20, 2005, the ACC issued an order confirming APS’ authority to “self-build or buy new generation assets for native load” and stated that APS’ acquisition of the Sundance Plant would be a proper purpose under APS’ existing ACC financing authorizations. APS’ filings with the ACC also requested that the ACC allow APS to defer for future recovery certain capital and operating costs (net of fuel and purchased power savings) associated with the Sundance Plant acquisition until rate treatment for the Sundance Plant could be considered in APS’ next general rate case. APS’ filings estimated that the deferrals would be approximately $10 million to $15 million before income taxes on an annualized basis. The order issued by the ACC allows APS to record the deferrals for up to 36 months, subject to a number of conditions. However, if APS has a general rate case pending at the end of the 36-month period, the deferral period could extend until the rate case had been decided. The conditions imposed by the order are expected to substantially limit the amount of deferrals that APS will be able to record.
APS’ acquisition of the Sundance Plant, which was approved by the FERC on May 6, 2005, is subject to customary closing conditions. The transaction is targeted to close in the spring of 2005. Pursuant to the asset purchase agreement, as amended, either party may terminate the agreement if the transaction does not close by May 27, 2005, subject to PPL Sundance’s right to extend the closing date by 60 days. In connection with the FERC proceeding, APS committed to an independent market monitoring plan that provides for an independent expert to monitor APS’ generation dispatch and operation of its transmission system and report to the FERC any potentially anti-competitive conduct. The plan will be effective upon closing of the transaction and will continue in effect until the FERC approves a regional market monitoring plan or five years, whichever is earlier.
General
The regulatory developments and legal challenges to the ACC’s retail electric competition rules discussed in this Note have raised considerable uncertainty about the status and pace of retail electric competition and of electric restructuring in Arizona. Although some very limited retail competition existed in APS’ service area in 1999 and 2000, there are currently no active retail competitors providing unbundled energy or other utility services to APS’ customers. As a result, we cannot predict when, and the extent to which, additional competitors will re-enter APS’ service territory. 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.
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Federal
In July 2002, the FERC adopted a price mitigation plan that constrains the price of electricity in the wholesale spot electricity market in the western United States. The FERC adopted a price cap of $250 per MWh for the period subsequent to October 31, 2002. Sales at prices above the cap must be justified and are subject to potential refund.
On July 31, 2002, the FERC issued a Notice of Proposed Rulemaking for Standard Market Design for wholesale electric markets. Voluminous comments and reply comments were filed on virtually every aspect of the proposed rule. On April 28, 2003, the FERC Staff issued an additional white paper on the proposed Standard Market Design. The white paper discusses several policy changes to the proposed Standard Market Design, including a greater emphasis on flexibility for regional needs. We cannot currently predict what, if any, impact there may be to the Company if the FERC adopts the proposed rule or any modifications proposed in the comments.
On August 11, 2004, Pinnacle West, APS, Pinnacle West Energy, and APS Energy Services (collectively, the “Pinnacle West Companies”) submitted to the FERC an update to its three-year market-based rate review, pursuant to the FERC’s order implementing a new generation market power analysis. On December 20, 2004, the FERC issued an order approving market-based rates for control areas other than those of APS, Public Service Company of New Mexico and Tucson Electric Company. The order required the Pinnacle West Companies to submit additional data with respect to these control areas, and on February 18, 2005, the Pinnacle West Companies submitted such data. On April 11, 2005, APS and a group of APS wholesale electric customers, the Arizona Districts, submitted a settlement that resolved concerns raised by the Arizona Districts in the proceeding. On May 2, 2005, a protest and a motion to intervene were filed by the Yavapai-Apache Energy Office with respect to the settlement between APS and the Arizona Districts. On April 5, 2005, the FERC issued a deficiency letter seeking further information from the Pinnacle West Companies relating to the APS control area and the Pinnacle West Companies filed a response on April 22, 2005. The notice period for filing comments on that filing expired on May 5, 2005, and no additional comments were filed. We cannot currently predict the outcome of this proceeding, but we do not believe that the outcome will have a material adverse effect on our financial position, results of operations or liquidity.
6. Retirement Plans and Other Benefits
Pinnacle West sponsors a qualified defined benefit and account balance pension plan, a nonqualified supplemental excess benefit retirement plan, and other postretirement benefit plans for the employees of Pinnacle West and our subsidiaries.
The following table provides details of the plans’ benefit costs for the three months ended March 31, 2005 and 2004. Also included is the portion of these costs charged to expense, including administrative costs and excluding amounts billed to electric plant participants or amounts capitalized as overhead construction (dollars in millions):
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| Pension Benefits | Other Benefits | |||||||||||||||
| Three Months Ended | Three Months Ended | |||||||||||||||
| March 31, | March 31, | |||||||||||||||
| 2005 | 2004 | 2005 | 2004 | |||||||||||||
| Service cost-benefits earned during the period | $ | 12 | $ | 10 | $ | 6 | $ | 3 | ||||||||
| Interest cost on benefit obligation | 23 | 21 | 9 | 6 | ||||||||||||
| Expected return on plan assets | (24 | ) | (20 | ) | (8 | ) | (4 | ) | ||||||||
| Amortization of: | ||||||||||||||||
| Transition (asset) obligation | (1 | ) | (1 | ) | 1 | 1 | ||||||||||
| Prior service cost | 1 | 1 | — | — | ||||||||||||
| Net actuarial loss | 5 | 4 | 2 | 2 | ||||||||||||
| Net periodic benefit cost | $ | 16 | $ | 15 | $ | 10 | $ | 8 | ||||||||
| Portion of cost charged to expense | $ | 7 | $ | 7 | $ | 4 | $ | 3 | ||||||||
| APS share of costs charged to expense | $ | 6 | $ | 6 | $ | 4 | $ | 3 | ||||||||
Contributions
The minimum required contribution to be made to our pension plan in 2005 is estimated to be approximately $50 million, $13 million of which was contributed on April 15, 2005. The contribution to be made to other postretirement benefit plans in 2005 is estimated to be approximately $40 million. APS’ share is approximately 92% of both plans.
7. Business Segments
We have three principal business segments (determined by products, services and the regulatory environment):
| • | our regulated electricity segment, which consists of traditional regulated retail and wholesale electricity businesses (primarily electricity service to Native Load customers) and related activities and includes electricity generation, transmission and distribution; | |||
| • | our marketing and trading segment, which consists of our competitive energy business activities, including wholesale marketing and trading and APS Energy Services’ commodity-related energy services; and | |||
| • | our real estate segment, which consists of SunCor’s real estate development and investment activities. | |||
Financial data for the three months ended March 31, 2005 and 2004 and at March 31, 2005 and December 31, 2004 by business segment is provided as follows (dollars in millions):
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| Three Months Ended | ||||||||
| March 31, | ||||||||
| 2005 | 2004 | |||||||
| Operating Revenues: | ||||||||
| Regulated electricity | $ | 416 | $ | 415 | ||||
| Marketing and trading | 117 | 88 | ||||||
| Real estate | 72 | 52 | ||||||
| Other | 10 | 11 | ||||||
| Total | $ | 615 | $ | 566 | ||||
| Net Income: | ||||||||
| Regulated electricity | $ | 13 | $ | 18 | ||||
| Marketing and trading | 1 | 10 | ||||||
| Real estate | 9 | 2 | ||||||
| Other | 1 | 1 | ||||||
| Total | $ | 24 | $ | 31 | ||||
| As of | As of | |||||||
| March 31, 2005 | December 31, 2004 | |||||||
| Assets: | ||||||||
| Regulated electricity | $ | 8,670 | $ | 8,674 | ||||
| Marketing and trading | 871 | 746 | ||||||
| Real estate | 452 | 454 | ||||||
| Other | 24 | 23 | ||||||
| Total | $ | 10,017 | $ | 9,897 | ||||
8. New Accounting Standards
In December 2004, the FASB issued SFAS No. 123(R), “Share-Based Payment.” The standard establishes accounting for transactions in which an entity exchanges its equity instruments for goods or services. It also addresses transactions in which an entity incurs liabilities in exchange for goods or services that are based on the fair value of the entity’s equity instruments or that may be settled by the issuance of those equity instruments. SFAS No. 123(R) is effective for us as of January 1, 2006. We are currently evaluating the impacts of this new guidance, but we do not believe it will have a material impact on our financial statements.
In March 2005, the FASB issued FIN No. 47, “Accounting for Conditional Asset Retirement Obligations.” FIN No. 47 clarifies that an entity must record a liability for the fair value of an asset retirement obligation for which the timing and (or) method of settlement are conditional on a future event if the liability’s fair value can be reasonably estimated. FIN No. 47 is effective no later than the end of fiscal years ending after December 15, 2005. We are currently evaluating the new guidance, but do not expect the adoption of this interpretation to have a material impact on our financial statements.
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9. Variable Interest Entities
In 1986, APS entered into agreements with three separate VIE lessors in order to sell and lease back interests in Palo Verde Unit 2. The leases are accounted for as operating leases in accordance with GAAP. We are not the primary beneficiary of the Palo Verde VIEs and, accordingly, do not consolidate them.
APS is exposed to losses under the Palo Verde sale leaseback agreements upon the occurrence of certain events that APS does not consider to be reasonably likely to occur. Under certain circumstances (for example, the NRC issuing specified violation orders with respect to Palo Verde or the occurrence of specified nuclear events), APS would be required to assume the debt associated with the transactions, make specified payments to the equity participants, and take title to the leased Unit 2 interests, which, if appropriate, may be required to be written down in value. If such an event had occurred as of March 31, 2005, APS would have been required to assume approximately $250 million of debt and pay the equity participants approximately $192 million.
10. Derivative and Energy Trading Accounting
We are exposed to the impact of market fluctuations in the commodity price of electricity, natural gas, coal and emissions allowances and in interest rates. We manage risks associated with these market fluctuations by utilizing various instruments that qualify as derivatives, including exchange-traded futures and options and over-the-counter forwards, options and swaps. As part of our overall risk management program, we use such instruments to hedge our exposure to changes in interest rates and to hedge purchases and sales of electricity, fuels, and emissions allowances and credits. As of March 31, 2005, we hedged exposures to the price variability of the commodities for a maximum of eight years. The changes in market value of such contracts have a high correlation to price changes in the hedged transactions. In addition, subject to specified risk parameters monitored by the ERMC, we engage in marketing and trading activities intended to profit from market price movements.
Cash Flow Hedges
The changes in the fair value of our hedged positions included in the Condensed Consolidated Statements of Income for the three months ended March 31, 2005 and 2004 were comprised of the following (dollars in thousands):
| Three Months Ended | ||||||||
| March 31, | ||||||||
| 2005 | 2004 | |||||||
| Gains on the ineffective portion of derivatives qualifying for hedge accounting | $ | 7,324 | $ | 1,384 | ||||
| Gains from the change in options’ time value excluded from measurement of effectiveness | 858 | 80 | ||||||
| Gains from the discontinuance of cash flow hedges | 385 | 1,137 | ||||||
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During the twelve months ending March 31, 2006, we estimate that a net gain of $136 million before income taxes will be reclassified from accumulated other comprehensive income as an offset to the effect on earnings of market price changes for the related hedged transactions.
Our assets and liabilities from risk management and trading activities are presented in two categories, consistent with our business segments:
| • | Regulated Electricity – non-trading derivative instruments that hedge our purchases and sales of electricity and fuel for APS’ Native Load requirements of our regulated electricity business segment; and | |||
| • | Marketing and Trading – both non-trading and trading derivative instruments of our competitive business segment. | |||
The following table summarizes our assets and liabilities from risk management and trading activities at March 31, 2005 and December 31, 2004 (dollars in thousands):
March 31, 2005
| Current | Current | Other | Net Asset | |||||||||||||||||
| Assets | Investments | Liabilities | Liabilities | (Liability) | ||||||||||||||||
| Regulated electricity: | ||||||||||||||||||||
| Mark-to-market | $ | 132,810 | $ | 49,156 | $ | (24,974 | ) | $ | (4,179 | ) | $ | 152,813 | ||||||||
| Options and futures – at cost | 19,334 | — | (44,903 | ) | — | (25,569 | ) | |||||||||||||
| Marketing and trading: | ||||||||||||||||||||
| Mark-to-market | 148,296 | 307,773 | (101,010 | ) | (195,469 | ) | 159,590 | |||||||||||||
| Options and futures and emission allowances – at cost | — | 1,095 | (30,589 | ) | — | (29,494 | ) | |||||||||||||
| Total | $ | 300,440 | $ | 358,024 | $ | (201,476 | ) | $ | (199,648 | ) | $ | 257,340 | ||||||||
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December 31, 2004
| Current | Current | Other | Net Asset | |||||||||||||||||
| Assets | Investments | Liabilities | Liabilities | (Liability) | ||||||||||||||||
| Regulated electricity: | ||||||||||||||||||||
| Mark-to-market | $ | 45,220 | $ | 19,417 | $ | (19,191 | ) | $ | (12,000 | ) | $ | 33,446 | ||||||||
| Options and margin account | 18,821 | 118 | (8,879 | ) | — | 10,060 | ||||||||||||||
| Marketing and trading: | ||||||||||||||||||||
| Mark-to-market | 102,855 | 204,512 | (68,008 | ) | (132,683 | ) | 106,676 | |||||||||||||
| Emission allowances – at cost and margin account | — | 294 | (17,328 | ) | (11,579 | ) | (28,613 | ) | ||||||||||||
| Total | $ | 166,896 | $ | 224,341 | $ | (113,406 | ) | $ | (156,262 | ) | $ | 121,569 | ||||||||
Cash or other assets may be required to serve as collateral against our open positions on certain energy-related contracts. Collateral provided to counterparties was $3 million at March 31, 2005 and $1 million at December 31, 2004, and is included in other current assets on the Condensed Consolidated Balance Sheets. Collateral provided to us by counterparties was $57 million at March 31, 2005 and $24 million at December 31, 2004, and is included in other current liabilities on the Condensed Consolidated Balance Sheets.
Fair Value Hedges
On January 29, 2004, we entered into two fixed-for-floating interest rate swap transactions on our $300 million 6.4% Senior Notes. The purpose of these hedges is to protect against significant fluctuations in the fair value of our debt. Our interest rate swaps are considered to be fully effective with any resulting gains or losses on the derivative offset by a similar loss or gain amount on the underlying fair value of debt. The fair value of the interest rate swaps was a loss of approximately $5 million at March 31, 2005 and is included in deferred credits and other with the corresponding offset in long-term debt less current maturities on the Condensed Consolidated Balance Sheets.
Credit Risk
We are exposed to losses in the event of nonperformance or nonpayment by counterparties. We have risk management and trading contracts with many counterparties, including two counterparties for which a worst case exposure represents approximately 30% of Pinnacle West’s $658 million of risk management and trading assets as of March 31, 2005. Our risk management process assesses and monitors the financial exposure of these and all other counterparties. Despite the fact that the great majority of trading counterparties are rated as investment grade by the credit rating agencies, including the counterparties noted above, there is still a possibility that one or more of these companies could default, resulting in a material impact on consolidated earnings for a given period. Counterparties in the portfolio consist principally of major energy companies, municipalities, local distribution companies and financial institutions. We maintain credit policies that we believe minimize overall credit risk to within acceptable limits. Determination of the credit quality of our counterparties is based upon a number of factors, including credit ratings and our evaluation of their financial condition. In many contracts, we employ collateral requirements and standardized
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agreements that allow for the netting of positive and negative exposures associated with a single counterparty. Valuation adjustments are established representing our estimated credit losses on our overall exposure to counterparties.
| 11. | Comprehensive Income |
Components of comprehensive income for the three months ended March 31, 2005 and 2004, are as follows (dollars in thousands):
| Three Months | ||||||||
| Ended March 31, | ||||||||
| 2005 | 2004 | |||||||
| Net income | $ | 24,448 | $ | 31,426 | ||||
| Other comprehensive income: | ||||||||
| Unrealized gain on derivative instruments, net of tax (a) | 97,016 | 28,886 | ||||||
| Reclassification of realized gain to income, net of tax (b) | (3,597 | ) | (98 | ) | ||||
| Total other comprehensive income | 93,419 | 28,788 | ||||||
| Comprehensive income | $ | 117,867 | $ | 60,214 | ||||
| (a) | These amounts primarily include unrealized gains and losses on contracts used to hedge our forecasted electricity and gas requirements to serve Native Load. | |
| (b) | These amounts primarily include the reclassification of unrealized gains and losses to realized for contracted commodities delivered during the period. |
| 12. | Commitments and Contingencies |
Palo Verde Nuclear Generating Station
Spent Nuclear Fuel and Waste Disposal
Nuclear power plant operators are required to enter into spent fuel disposal contracts with the DOE, and the DOE is required to accept and dispose of all spent nuclear fuel and other high-level radioactive wastes generated by domestic power reactors. Although the Nuclear Waste Act required the DOE to develop a permanent repository for the storage and disposal of spent nuclear fuel by 1998, the DOE has announced that the repository cannot be completed before 2010 and it does not intend to begin accepting spent nuclear fuel prior to that date. In November 1997, the United States Court of Appeals for the District of Columbia Circuit (D.C. Circuit) issued a decision preventing the DOE from excusing its own delay, but refused to order the DOE to begin accepting spent nuclear fuel. Based on this decision and the DOE’s delay, a number of utilities, including APS (on behalf of itself and the other Palo Verde owners), filed damages actions against the DOE in the Court of Federal Claims.Arizona Public Service Company v. United States of America, United States Court of Federal Claims, 03-2832C.
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APS currently estimates it will incur $115 million (in 2004 dollars) over the life of Palo Verde for its share of the costs related to the on-site interim storage of spent nuclear fuel. As of March 31, 2005, APS had spent $12 million for on-site interim spent nuclear fuel storage. APS has recorded a regulatory asset of $12 million for the costs.
California Energy Market Issues and Refunds in the Pacific Northwest
FERC
In July 2001, the FERC ordered an expedited fact-finding hearing to calculate refunds for spot market transactions in California during a specified time frame. APS was a seller and a purchaser in the California markets at issue, and to the extent that refunds are ordered, APS should be a recipient as well as a payor of such amounts. The FERC is still considering the evidence and refund amounts have not yet been finalized. APS does not anticipate material changes in its exposure and still believes, subject to the finalization of the revised proxy prices, that it will be entitled to a net refund.
On March 19, 2002, the State of California filed a complaint with the FERC alleging that wholesale sellers of power and energy, including the Company, failed to properly file rate information at the FERC in connection with sales to California from 2000 to the present under market-based rates.State of California v. British Columbia Power Exchange et al., Docket No. EL02-71-000. The complaint requests the FERC to require the wholesale sellers to refund any rates that are “found to exceed just and reasonable levels.” This complaint was dismissed by the FERC and the State of California appealed the matter to the Ninth Circuit Court of Appeals. In an order issued September 9, 2004, the Ninth Circuit upheld the FERC’s authority to permit market-based rates, but rejected the FERC’s claim that it was without authority to consider retroactive refunds when a utility has not strictly adhered to the quarterly reporting requirements of the market-based rate system. On September 9, 2004, the Ninth Circuit remanded the case to the FERC for further proceedings.State of California ex rel. Bill Lockyer, Attorney General v. FERC, No. 02-73093. Several of the intervenors in this appeal filed a petition for rehearing of this decision on October 25, 2004. The petition for rehearing has not been acted upon, and the outcome of the further proceedings cannot be predicted at this time.
The FERC also ordered an evidentiary proceeding to discuss and evaluate possible refunds for the Pacific Northwest. The FERC affirmed the ALJ’s conclusion that the prices in the Pacific Northwest were not unreasonable or unjust and refunds should not be ordered in this proceeding. This decision has now been appealed to the Ninth Circuit Court of Appeals. Although the FERC ruling in the Pacific Northwest matter is being appealed and the FERC has not yet calculated the specific refund amounts due in California, we do not expect that the resolution of these issues, as to the amounts alleged in the proceedings, will have a material adverse impact on our financial position, results of operations or liquidity.
On March 26, 2003, FERC made public a Final Report on Price Manipulation in Western Markets, prepared by its staff and covering spot markets in the West in 2000 and 2001. The report stated that a significant number of entities who participated in the California markets during the 2000-2001 time period, including APS, may potentially have been involved in arbitrage transactions that allegedly violated certain provisions of the ISO tariff. After reviewing the matter, along with the data supplied by APS, the FERC staff moved to dismiss the claims against APS and to dismiss the
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proceeding. The motion to dismiss was granted by the FERC on January 22, 2004. Certain parties have sought rehearing of this order, and that request is pending.
California Civil Energy Market Litigation
The State of California and others have filed various claims, which have now been consolidated, against several power suppliers to California alleging antitrust violations.Wholesale Electricity Antitrust Cases I and II, Superior Court in and for the County of San Diego, Proceedings Nos. 4204-00005 and 4204-00006. Two of the suppliers who were named as defendants in those matters, Reliant Energy Services, Inc. (and other Reliant entities) and Duke Energy and Trading, LLP (and other Duke entities), filed cross-claims against various other participants in the PX and California independent system operator markets, including APS, attempting to expand those matters to such other participants. APS has not yet filed a responsive pleading in the matter, but APS believes the claims by Reliant and Duke as they relate to APS are without merit.
APS was also named in a lawsuit regarding wholesale contracts in California, which, after moving to state court, has been removed to the federal court for a second time.James Millar, et al. v. Allegheny Energy Supply, et al., San Francisco Superior Court, Case No. 407867, U.S. District Court (Northern District) C-04-0519 SBA. The First Amended Complaint alleges basically that the contracts entered into were the result of an unfair and unreasonable market, in violation of California unfair competition laws. The PX has filed a lawsuit against the State of California regarding the seizure of forward contracts and the State has filed a cross complaint against APS and numerous other PX participants.Cal PX v. The State of California, Superior Court in and for the County of Sacramento, JCCP No. 4203. Various motions continue to be filed, and we currently believe these claims will have no material adverse impact on our financial position, results of operations or liquidity.
Natural Gas Supply
Pursuant to the terms of a comprehensive settlement entered into in 1996 with El Paso Natural Gas Company, the rates charged for natural gas transportation are subject to a rate moratorium through December 31, 2005.
On July 9, 2003 the FERC issued an order that altered the capacity rights of parties to the 1996 settlement but maintained the cost responsibility provisions agreed to by parties to that settlement. On December 28, 2004, the D.C. Court of Appeals upheld the FERC’s authority to alter the capacity rights of parties to the settlement. With respect to the FERC’s authority to maintain the cost responsibility provisions of the settlement, a party has sought appellate review and is seeking to reallocate the costs responsibility associated with the changed contractual obligations in a way that would be less favorable to APS and Pinnacle West Energy than under the FERC’s July 9, 2003 order. Should this party prevail on this point, APS and Pinnacle West Energy’s annual capacity cost could be increased by approximately $3 million per year, from September 2003 through December 2005.
El Paso is required under the terms of the 1996 settlement to file a new rate case by July 1, 2005, with new rates to become effective on January 1, 2006. APS cannot currently assess the financial impact that El Paso’s filing could have on rates.
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Navajo Nation Litigation
In June 1999, the Navajo Nation served Salt River Project with a lawsuit naming Salt River Project, several Peabody Coal Company entities (collectively, “Peabody”), Southern California Edison Company and other defendants, and citing various claims in connection with the renegotiations of the coal royalty and lease agreements under which Peabody mines coal for the Navajo Generating Station and the Mohave Generating Station.The Navajo Nation v. Peabody Holding Company, Inc., et al., United States District Court for the District of Columbia, CA-99-0469-EGS (the “D.C. Lawsuit”). APS is a 14% owner of the Navajo Generating Station, which Salt River Project operates. The D.C. Lawsuit alleges, among other things, that the defendants obtained a favorable coal royalty rate by improperly influencing the outcome of a federal administrative process under which the royalty rate was to be adjusted. The suit seeks $600 million in damages, treble damages, punitive damages of not less than $1 billion, and the ejection of defendants “from all possessory interests and Navajo Tribal lands arising out of the [primary coal lease]”. In July 2001, the court dismissed all claims against Salt River Project.
In January, 2005, Peabody served APS with a lawsuit naming APS and the other Navajo Generating Station participants and seeking, among other things, a declaration that the participants “are obligated to reimburse Peabody for any royalty, tax, or other obligation arising out of the D.C. Lawsuit”.Peabody Western Coal Company v. Salt River Project Agricultural Improvement and Power District, et al., Circuit Court for the City of St. Louis, Division No. 1, Cause No. 042-08561. Based on APS’ ownership interest in the Navajo Generating Station, APS could be liable for up to 14% of any such obligation. Because the litigation is in preliminary stages, APS cannot currently predict the outcome of this matter.
Environmental Matters
Superfund Superfund establishes liability for the cleanup of hazardous substances found contaminating the soil, water or air. Those who generated, transported or disposed of hazardous substances at a contaminated site are among those who are PRPs. PRPs may be strictly, and often jointly and severally, liable for clean-up. On September 3, 2003, the EPA advised APS that the EPA considers APS to be a PRP in the Motorola 52nd Street Superfund Site, Operable Unit 3 (OU3) in Phoenix, Arizona. APS has facilities that are within this Superfund site. APS and Pinnacle West have agreed with the EPA to perform certain investigative activities of the APS facilities within OU3. Because the investigation has not yet been completed and ultimate remediation requirements are not yet finalized, neither APS nor Pinnacle West can currently estimate the expenditures which may be required.
Litigation
We are party to various other claims, legal actions and complaints arising in the ordinary course of business, including but not limited to environmental matters related to the Clean Air Act, Navajo Nation issues and EPA and ADEQ issues. In our opinion, the ultimate resolution of these matters will not have a material adverse effect on our financial position, results of operations or liquidity.
| 13. | Nuclear Insurance |
The Palo Verde participants have insurance for public liability 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 $300 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 $101 million, subject to an annual limit of $10 million per incident. Based on APS’ interest in the three Palo Verde units, APS’ maximum potential assessment per incident for all three units is approximately $88 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
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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
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.
| 14. | Stock-Based Compensation |
Pinnacle West offers stock-based compensation plans for officers and key employees of the Company and our subsidiaries. Beginning with our 2002 stock option grants we began applying the fair value method of accounting for stock-based compensation as provided for in SFAS No. 123, “Accounting for Stock-Based Compensation.” In prior years, we recognized stock compensation expense based on the intrinsic value method allowed in Accounting Principles Board Opinion (APB) No. 25, “Accounting for Stock Issued to Employees.” For the three months ended March 31, 2005 and 2004, the reported compensation expense, net income and earnings per share were not materially different from pro forma amounts for both Pinnacle West and APS.
| 15. | Other Income and Other Expense |
The following table provides detail of other income and other expense for the three months ended March 31, 2005 and 2004 (dollars in thousands):
| Three Months Ended | ||||||||
| March 31, | ||||||||
| 2005 | 2004 | |||||||
| Other income: | ||||||||
| Investment gains – net | $ | — | $ | 2,218 | ||||
| Interest income | 1,338 | 3,802 | ||||||
| SunCor joint venture earnings (loss) | (28 | ) | 1,185 | |||||
| Asset sales | 241 | 3,651 | ||||||
| Miscellaneous | 193 | 556 | ||||||
| Total other income | $ | 1,744 | $ | 11,412 | ||||
| Other expense: | ||||||||
| Non-operating costs (a) | $ | (3,098 | ) | $ | (2,802 | ) | ||
| Asset sales | (64 | ) | (2,139 | ) | ||||
| Investment losses – net | (1,249 | ) | — | |||||
| Miscellaneous | (898 | ) | (1,004 | ) | ||||
| Total other expense | $ | (5,309 | ) | $ | (5,945 | ) | ||
| (a) | As defined by the FERC, includes below-the-line non-operating utility costs (primarily community relations and other costs excluded from utility rate recovery). |
| 16. | Guarantees |
We have issued parental guarantees and letters of credit and obtained surety bonds on behalf of our unregulated subsidiaries. Our parental guarantees related to Pinnacle West Energy consist of equipment and performance guarantees related to our generation construction program, and long-
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term service agreement guarantees for new power plants. Our credit support instruments enable APS Energy Services to offer commodity energy and energy-related products. Non-performance or payment under the original contract by our unregulated subsidiaries would require us to perform under the guarantee or surety bond. No liability is currently recorded on the Condensed Consolidated Balance Sheets related to Pinnacle West’s guarantees on behalf of its subsidiaries. Our guarantees have no recourse or collateral provisions to allow us to recover amounts paid under the guarantee. The amounts and approximate terms of our guarantees and surety bonds for each subsidiary at March 31, 2005 are as follows (dollars in millions):
| Guarantees | Surety Bonds | |||||||||||||||
| Term | Term | |||||||||||||||
| Amount | (in years) | Amount | (in years) | |||||||||||||
| Parental: | ||||||||||||||||
| Pinnacle West Energy | $ | 17 | 1 | $ | — | — | ||||||||||
| APS Energy Services | 26 | 1 | 61 | 1 | ||||||||||||
| Total | $ | 43 | $ | 61 | ||||||||||||
At March 31, 2005, we had entered into approximately $41 million of letters of credit which support various transmission and construction agreements. These letters of credit expire in 2005 and 2006. We intend to provide from either existing or new facilities for the extension, renewal or substitution of the letters of credit to the extent required. At March 31, 2005, Pinnacle West had approximately $4 million of letters of credit related to workers’ compensation expiring in 2006.
APS has entered into various agreements that require letters of credit for financial assurance purposes. At March 31, 2005, approximately $200 million of letters of credit were outstanding to support existing pollution control bonds of approximately $200 million. The letters of credit are available to fund the payment of principal and interest of such debt obligations. In July 2004, $150 million of these letters of credit were renewed for a three-year term and expire in 2007. The remainder expire in 2005. APS has also entered into approximately $100 million of letters of credit to support certain equity lessors in the Palo Verde sale leaseback transactions (see Note 9 for further details on the Palo Verde sale leaseback transactions). These letters of credit expire in 2005. Additionally, APS has approximately $5 million of letters of credit related to counterparty collateral requirements expiring in 2006. APS intends to provide from either existing or new facilities for the extension, renewal or substitution of the letters of credit to the extent required.
We enter into agreements that include indemnification provisions relating to liabilities arising from or related to certain of our agreements. APS has agreed to indemnify the equity participants and other parties in the Palo Verde sale leaseback transactions with respect to certain tax matters. Generally, a maximum obligation is not explicitly stated in the indemnification provisions and therefore, the overall maximum amount of the obligation under such indemnification provisions cannot be reasonably estimated. Based on historical experience and evaluation of the specific indemnities, we do not believe that any material loss related to such indemnification provisions is likely.
See Note 4 for information regarding Pinnacle West’s guarantee of $500 million of Pinnacle West Energy’s debt obligations.
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| 17. | Earnings Per Share |
The following table presents earnings per weighted average common share outstanding for the three months ended March 31, 2005 and 2004:
| Three Months Ended | ||||||||
| March 31, | ||||||||
| 2005 | 2004 | |||||||
| Basic earnings per share: | ||||||||
| Income from continuing operations | $ | 0.26 | $ | 0.34 | ||||
| Income from discontinued operations | 0.01 | — | ||||||
| Earnings per share – basic | $ | 0.27 | $ | 0.34 | ||||
| Diluted earnings per share: | ||||||||
| Income from continuing operations | $ | 0.26 | $ | 0.34 | ||||
| Income from discontinued operations | 0.01 | — | ||||||
| Earnings per share – diluted | $ | 0.27 | $ | 0.34 | ||||
Dilutive stock options increased average common shares outstanding by approximately 83,000 shares for the three months ended March 31, 2005 and 82,000 shares for the three months ended March 31, 2004.
Options to purchase 868,934 shares for the three-month period ended March 31, 2005 were outstanding but were not included in the computation of earnings per share because the options’ exercise prices were greater than the average market price of the common shares. Options to purchase shares of common stock that were not included in the computation of diluted earnings per share for that same reason were 2,381,699 shares for the three-month period ended March 31, 2004.
| 18. | Discontinued Operations |
Due to pending sales of certain SunCor commercial properties in 2005, the related assets and liabilities have been reclassified to assets and liabilities held for sale on the Condensed Consolidated Balance Sheets at March 31, 2005. The assets held for sale at March 31, 2005 relate to property in the amount of $34 million, and the liabilities held for sale relate to current maturities of long-term debt in the amount of $29 million. Operating revenues and expenses related to these commercial properties for the prior-year periods are immaterial and therefore have not been reclassified on the Condensed Consolidated Statements of Income.
| 19. | Silverhawk Power Station |
Pinnacle West Energy has a 75% ownership in the Silverhawk Power Station. As of March 31, 2005 we concluded that there was no impairment of this asset under SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets,” (“SFAS 144”).
Recently, we have received proposals from several parties that have expressed interest in purchasing this ownership interest. If an agreement is reached with a party and approved by the Board of Directors, we anticipate that the asset at that point would be classified as held for sale and, accordingly, an impairment loss would be recognized using the fair value method required by SFAS 144. Management’s best estimate of this impairment would result in a loss in the range of $50 million to $60 million after income taxes. If such a transaction were to occur, we would plan to invest the net sale proceeds, estimated to be in the range of $200 million to $215 million, into APS. No assurance can be given that a transaction will occur.
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(unaudited)
(dollars in thousands)
| Three Months Ended | ||||||||
| March 31, | ||||||||
| 2005 | 2004 | |||||||
| ELECTRIC OPERATING REVENUES | ||||||||
| Regulated electricity | $ | 418,434 | $ | 420,299 | ||||
| Marketing and trading | 22,858 | 20,803 | ||||||
| Total | 441,292 | 441,102 | ||||||
| OPERATING EXPENSES | ||||||||
| Regulated electricity purchased power and fuel | 81,914 | 88,592 | ||||||
| Marketing and trading purchased power and fuel | 28,302 | 25,758 | ||||||
| Operations and maintenance | 142,294 | 125,912 | ||||||
| Depreciation and amortization | 82,214 | 88,848 | ||||||
| Income taxes | 16,380 | 17,362 | ||||||
| Other taxes | 31,445 | 27,580 | ||||||
| Total | 382,549 | 374,052 | ||||||
| OPERATING INCOME | 58,743 | 67,050 | ||||||
| OTHER INCOME (DEDUCTIONS) | ||||||||
| Income taxes | (837 | ) | (2,469 | ) | ||||
| Allowance for equity funds used during construction | 2,603 | 2,002 | ||||||
| Other income (Note S-4) | 6,161 | 11,235 | ||||||
| Other expense (Note S-4) | (3,860 | ) | (4,904 | ) | ||||
| Total | 4,067 | 5,864 | ||||||
| INTEREST DEDUCTIONS | ||||||||
| Interest on long-term debt | 35,517 | 35,646 | ||||||
| Interest on short-term borrowings | 1,191 | 2,501 | ||||||
| Debt discount, premium and expense | 1,004 | 1,195 | ||||||
| Capitalized interest | (1,947 | ) | (857 | ) | ||||
| Total | 35,765 | 38,485 | ||||||
| NET INCOME | $ | 27,045 | $ | 34,429 | ||||
See Notes to Pinnacle West’s Condensed Consolidated Financial Statements and Supplemental Notes to Arizona Public Service Company’s Condensed Financial Statements.
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ARIZONA PUBLIC SERVICE COMPANY
CONDENSED BALANCE SHEETS
(unaudited)
(dollars in thousands)
| March 31, | December 31, | |||||||
| 2005 | 2004 | |||||||
| ASSETS | ||||||||
| UTILITY PLANT | ||||||||
| Electric plant in service and held for future use | $ | 9,203,579 | $ | 9,120,407 | ||||
| Less accumulated depreciation and amortization | 3,328,892 | 3,266,181 | ||||||
| Total | 5,874,687 | 5,854,226 | ||||||
| Construction work in progress | 262,097 | 249,243 | ||||||
| Intangible assets, net of accumulated amortization | 102,218 | 103,701 | ||||||
| Nuclear fuel, net of accumulated amortization | 58,092 | 51,188 | ||||||
| Utility plant-net | 6,297,094 | 6,258,358 | ||||||
| INVESTMENTS AND OTHER ASSETS | ||||||||
| Note receivable from Pinnacle West Energy (Notes 5 and S-5) | 498,646 | 498,489 | ||||||
| Decommissioning trust accounts | 266,497 | 267,700 | ||||||
| Assets from risk management and trading activities long term (Note S-2) | 57,990 | 20,123 | ||||||
| Other assets | 60,302 | 61,364 | ||||||
| Total investments and other assets | 883,435 | 847,676 | ||||||
| CURRENT ASSETS | ||||||||
| Cash and cash equivalents | 101,816 | 49,575 | ||||||
| Investment in debt securities | — | 181,175 | ||||||
| Accounts receivable: | ||||||||
| Service customers | 124,521 | 214,487 | ||||||
| Other | 89,391 | 63,131 | ||||||
| Allowance for doubtful accounts | (3,107 | ) | (3,444 | ) | ||||
| Accrued utility revenues | 69,030 | 76,154 | ||||||
| Materials and supplies (at average cost) | 87,470 | 83,893 | ||||||
| Fossil fuel (at average cost) | 22,238 | 20,506 | ||||||
| Assets from risk management and trading activities (Note S-2) | 173,787 | 70,430 | ||||||
| Other current assets | 8,068 | 10,187 | ||||||
| Total current assets | 673,214 | 766,094 | ||||||
| DEFERRED DEBITS | ||||||||
| Regulatory assets | 138,374 | 135,051 | ||||||
| Unamortized debt issue costs | 24,401 | 21,832 | ||||||
| Other deferred debits | 72,884 | 69,541 | ||||||
| Total deferred debits | 235,659 | 226,424 | ||||||
| TOTAL ASSETS | $ | 8,089,402 | $ | 8,098,552 | ||||
See Notes to Pinnacle West’s Condensed Consolidated Financial Statements and Supplemental Notes to Arizona Public Service Company’s Condensed Financial Statements.
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ARIZONA PUBLIC SERVICE COMPANY
CONDENSED BALANCE SHEETS
(unaudited)
(dollars in thousands)
| March 31, | December 31, | |||||||
| 2005 | 2004 | |||||||
| CAPITALIZATION AND LIABILITIES | ||||||||
| CAPITALIZATION | ||||||||
| Common stock | $ | 178,162 | $ | 178,162 | ||||
| Additional paid-in capital | 1,246,804 | 1,246,804 | ||||||
| Retained earnings | 844,740 | 860,196 | ||||||
| Accumulated other comprehensive income (loss): | ||||||||
| Minimum pension liability adjustment | (71,087 | ) | (71,087 | ) | ||||
| Derivative instruments | 83,102 | 18,327 | ||||||
| Common stock equity | 2,281,721 | 2,232,402 | ||||||
| Long-term debt less current maturities | 2,266,700 | 2,267,094 | ||||||
| Total capitalization | 4,548,421 | 4,499,496 | ||||||
| CURRENT LIABILITIES | ||||||||
| Current maturities of long-term debt | 351,393 | 451,247 | ||||||
| Accounts payable | 92,097 | 215,076 | ||||||
| Accrued taxes | 340,360 | 292,521 | ||||||
| Accrued interest | 37,944 | 33,332 | ||||||
| Customer deposits | 52,825 | 51,804 | ||||||
| Deferred income taxes | 9,057 | 9,057 | ||||||
| Liabilities from risk management and trading activities (Note S-2) | 90,890 | 34,292 | ||||||
| Other current liabilities | 87,315 | 91,441 | ||||||
| Total current liabilities | 1,061,881 | 1,178,770 | ||||||
| DEFERRED CREDITS AND OTHER | ||||||||
| Deferred income taxes | 1,149,522 | 1,108,571 | ||||||
| Regulatory liabilities | 513,798 | 506,646 | ||||||
| Liability for asset retirements | 252,926 | 251,612 | ||||||
| Pension liability | 217,961 | 203,668 | ||||||
| Customer advances for construction | 61,374 | 59,185 | ||||||
| Unamortized gain — sale of utility plant | 49,189 | 50,333 | ||||||
| Liabilities from risk management and trading activities - long term (Note S-2) | 18,490 | 13,124 | ||||||
| Other | 215,840 | 227,147 | ||||||
| Total deferred credits and other | 2,479,100 | 2,420,286 | ||||||
| COMMITMENTS AND CONTINGENCIES (Notes 5, 12, 13 and S-5) | ||||||||
| TOTAL LIABILITIES AND EQUITY | $ | 8,089,402 | $ | 8,098,552 | ||||
See Notes to Pinnacle West’s Condensed Consolidated Financial Statements and Supplemental Notes to Arizona Public Service Company’s Condensed Financial Statements.
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CONDENSED STATEMENTS OF CASH FLOWS
(unaudited)
(dollars in thousands)
| Three Months Ended | ||||||||
| March 31, | ||||||||
| 2005 | 2004 | |||||||
| CASH FLOWS FROM OPERATING ACTIVITIES | ||||||||
| Net income | $ | 27,045 | $ | 34,429 | ||||
| Items not requiring cash: | ||||||||
| Depreciation and amortization | 82,214 | 88,848 | ||||||
| Nuclear fuel amortization | 2,101 | 7,599 | ||||||
| Allowance for equity funds used during construction | (2,603 | ) | (2,002 | ) | ||||
| Deferred income taxes | (1,009 | ) | 2,714 | |||||
| Change in mark-to-market valuations | (8,234 | ) | (19,582 | ) | ||||
| Changes in current assets and liabilities: | ||||||||
| Accounts receivable | 63,369 | 34,880 | ||||||
| Accrued utility revenues | 7,124 | (2,111 | ) | |||||
| Materials, supplies and fossil fuel | (5,309 | ) | 3,757 | |||||
| Other current assets | 3,089 | 1,557 | ||||||
| Accounts payable | (123,460 | ) | (6,333 | ) | ||||
| Accrued taxes | 47,839 | 49,109 | ||||||
| Accrued interest | 4,612 | (5,950 | ) | |||||
| Other current liabilities | (3,105 | ) | 11,203 | |||||
| Increase in regulatory assets | (3,323 | ) | (1,248 | ) | ||||
| Change in risk management and trading activities — assets | (395 | ) | 2,562 | |||||
| Change in risk management and trading activities - liabilities | 36,204 | 18,856 | ||||||
| Change in customer advances | 2,189 | 3,070 | ||||||
| Change in pension liability | 14,293 | 13,074 | ||||||
| Change in other long-term assets | (4,879 | ) | (5,383 | ) | ||||
| Change in other long-term liabilities | (10,314 | ) | (12,237 | ) | ||||
| Net cash flow provided by operating activities | 127,448 | 216,812 | ||||||
| CASH FLOWS FROM INVESTING ACTIVITIES | ||||||||
| Capital expenditures | (117,501 | ) | (99,684 | ) | ||||
| Capitalized interest | (1,947 | ) | (857 | ) | ||||
| Purchases of investment securities | (67,450 | ) | (24,200 | ) | ||||
| Proceeds from sale of investment securities | 248,625 | 94,050 | ||||||
| Other | 6,073 | (5,412 | ) | |||||
| Net cash flow provided by (used for) investing activities | 67,800 | (36,103 | ) | |||||
| CASH FLOWS FROM FINANCING ACTIVITIES | ||||||||
| Issuance of long-term debt | 163,975 | 179,000 | ||||||
| Short-term borrowings | — | 25,200 | ||||||
| Dividends paid on common stock | (42,500 | ) | (42,500 | ) | ||||
| Repayment and reacquisition of long-term debt | (264,482 | ) | (384,561 | ) | ||||
| Net cash flow used for financing activities | (143,007 | ) | (222,861 | ) | ||||
| NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS | 52,241 | (42,152 | ) | |||||
| CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD | 49,575 | 42,152 | ||||||
| CASH AND CASH EQUIVALENTS AT END OF PERIOD | $ | 101,816 | $ | — | ||||
| Supplemental disclosure of cash flow information: | ||||||||
| Cash paid during the year for: | ||||||||
| Income taxes paid | $ | 9 | $ | — | ||||
| Interest, net of amounts capitalized | $ | 30,149 | $ | 42,228 | ||||
See Notes to Pinnacle West’s Condensed Consolidated Financial Statements and Supplemental Notes to Arizona Public Service Company’s Condensed Financial Statements.
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Certain notes to APS’ Condensed Financial Statements are combined with the Notes to Pinnacle West’s Condensed Consolidated Financial Statements. Listed below are the Condensed Consolidated Notes to Pinnacle West’s Condensed Consolidated Financial Statements, the majority of which also relate to APS’ Condensed Financial Statements. In addition, listed below are the Supplemental Notes which are required disclosures for APS and should be read in conjunction with Pinnacle West‘s Condensed Consolidated Notes.
| Condensed | APS' | |||
| Consolidated | Supplemental | |||
| Footnote | Footnote | |||
| Reference | Reference | |||
| Consolidation and Nature of Operations | Note 1 | — | ||
| Condensed Consolidated Financial Statements | Note 2 | — | ||
| Quarterly Fluctuations | Note 3 | — | ||
| Changes in Liquidity | Note 4 | Note S-1 | ||
| Regulatory Matters | Note 5 | — | ||
| Retirement Plans and Other Benefits | Note 6 | — | ||
| Business Segments | Note 7 | — | ||
| New Accounting Standards | Note 8 | — | ||
| Variable Interest Entities | Note 9 | — | ||
| Derivative and Energy Trading Accounting | Note 10 | Note S-2 | ||
| Comprehensive Income | Note 11 | Note S-3 | ||
| Commitments and Contingencies | Note 12 | — | ||
| Nuclear Insurance | Note 13 | — | ||
| Stock-Based Compensation | Note 14 | — | ||
| Other Income and Other Expense | Note 15 | Note S-4 | ||
| Guarantees | Note 16 | — | ||
| Earnings Per Share | Note 17 | — | ||
| Discontinued Operations | Note 18 | — | ||
| Silverhawk Power Station | Note 19 | — | ||
| Related Party Transactions | — | Note S-5 |
S-1. Changes in Liquidity
The following is a list of principal payments due on APS’ total long-term debt and capitalized lease requirements:
| • | $351 million in 2005; | |||
| • | $86 million in 2006; | |||
| • | $174 million in 2007; | |||
| • | $1 million in 2008; | |||
| • | $1 million in 2009; and | |||
| • | $2.013 billion, thereafter. | |||
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SUPPLEMENTAL NOTES TO THE CONDENSED FINANCIAL STATEMENTS
| S-2. Derivative and Energy Trading Accounting |
APS is exposed to the impact of market fluctuations in the commodity price of electricity, natural gas and coal. As part of its overall risk management program, APS uses various commodity instruments that qualify as derivatives to hedge purchases and sales of electricity and fuels. As of March 31, 2005, APS hedged exposures to these risks for a maximum of three years.
Cash Flow Hedges
The changes in the fair value of APS’ hedged positions included in the APS Condensed Statements of Income for the three months ended March 31, 2005 and 2004 were comprised of the following (dollars in thousands):
| Three Months Ended | ||||||||
| March 31, | ||||||||
| 2005 | 2004 | |||||||
| Gains on the ineffective portion of derivatives qualifying for hedge accounting | $ | 7,417 | $ | 1,411 | ||||
| Gains from the change in options’ time value excluded from measurement of effectiveness | 858 | 80 | ||||||
| Gains from the discontinuance of cash flow hedges | 302 | 575 | ||||||
During the twelve months ending March 31, 2006, we estimate that a net gain of $95 million before income taxes will be reclassified from accumulated other comprehensive income as an offset to the effect on earnings of market price changes for the related hedged transactions.
APS’ assets and liabilities from risk management and trading activities are presented in two categories, consistent with our business segments:
| • | Regulated Electricity — non-trading derivative instruments that hedge APS’ purchases and sales of electricity and fuel for its Native Load requirements; and | |||
| • | Marketing and Trading — both non-trading and trading derivative instruments. | |||
The following table summarizes APS’ assets and liabilities from risk management and trading activities at March 31, 2005 and December 31, 2004 (dollars in thousands):
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ARIZONA PUBLIC SERVICE COMPANY
SUPPLEMENTAL NOTES TO THE CONDENSED FINANCIAL STATEMENTS
| March 31, 2005 | ||||||||||||||||||||
| Current | Current | Other | Net Asset | |||||||||||||||||
| Assets | Investments | Liabilities | Liabilities | (Liability) | ||||||||||||||||
| Regulated Electricity: | ||||||||||||||||||||
| Mark-to-market | $ | 132,809 | $ | 49,157 | $ | (24,974 | ) | $ | (4,179 | ) | $ | 152,813 | ||||||||
| Options and futures-at cost | 19,334 | — | (44,903 | ) | — | (25,569 | ) | |||||||||||||
| Marketing and Trading: | ||||||||||||||||||||
| Mark-to-market | 21,644 | 8,828 | (20,834 | ) | (14,311 | ) | (4,673 | ) | ||||||||||||
| Options and futures and other-at cost | — | 5 | (179 | ) | — | (174 | ) | |||||||||||||
| Total | $ | 173,787 | $ | 57,990 | $ | (90,890 | ) | $ | (18,490 | ) | $ | 122,397 | ||||||||
| December 31, 2004 | ||||||||||||||||||||
| Current | Current | Other | Net Asset | |||||||||||||||||
| Assets | Investments | Liabilities | Liabilities | (Liability) | ||||||||||||||||
| Regulated Electricity: | ||||||||||||||||||||
| Mark-to-market | $ | 45,220 | $ | 19,417 | $ | (19,191 | ) | $ | (12,000 | ) | $ | 33,446 | ||||||||
| Options and futures-at cost | 18,821 | 118 | (8,879 | ) | — | 10,060 | ||||||||||||||
| Marketing and Trading: | ||||||||||||||||||||
| Mark-to-market | 6,389 | 581 | (6,222 | ) | (1,124 | ) | (376 | ) | ||||||||||||
| Other-at cost | — | 7 | — | — | 7 | |||||||||||||||
| Total | $ | 70,430 | $ | 20,123 | $ | (34,292 | ) | $ | (13,124 | ) | $ | 43,137 | ||||||||
Cash or other assets may be required to serve as collateral against APS’ open positions on certain energy-related contracts. No collateral was provided to counterparties at March 31, 2005 or December 31, 2004. Collateral provided to us by counterparties was $37 million at March 31, 2005 and $6 million at December 31, 2004, and is included in other current liabilities on the Condensed Balance Sheets.
S-3. Comprehensive Income
Components of APS’ comprehensive income for the three months ended March 31, 2005 and 2004, are as follows (dollars in thousands):
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ARIZONA PUBLIC SERVICE COMPANY
SUPPLEMENTAL NOTES TO THE CONDENSED FINANCIAL STATEMENTS
| Three Months Ended | ||||||||
| March 31, | ||||||||
| 2005 | 2004 | |||||||
| Net income | $ | 27,045 | $ | 34,429 | ||||
| Other comprehensive income: | ||||||||
| Unrealized gains on derivative instruments, net of tax (a) | 65,612 | 18,315 | ||||||
| Reclassification of realized gain to income, net of tax (b) | (837 | ) | (1,130 | ) | ||||
| Total other comprehensive income | 64,775 | 17,185 | ||||||
| Comprehensive income | $ | 91,820 | $ | 51,614 | ||||
| (a) | These amounts primarily include unrealized gains and losses on contracts used to hedge our forecasted electricity and gas requirements to serve Native Load. | |||
| (b) | These amounts primarily include the reclassification of unrealized gains and losses to realized for contracted commodities delivered during the period. | |||
S-4. Other Income and Other Expense
The following table provides detail of APS’ other income and other expense for the three months ended March 31, 2005 and 2004 (dollars in thousands):
| Three Months Ended | ||||||||
| March 31, | ||||||||
| 2005 | 2004 | |||||||
| Other income: | ||||||||
| Interest income | $ | 5,423 | $ | 5,038 | ||||
| Asset sales | 241 | 3,651 | ||||||
| Investment gains-net | — | 2,047 | ||||||
| Miscellaneous | 497 | 499 | ||||||
| Total other income | $ | 6,161 | $ | 11,235 | ||||
| Other expense: | ||||||||
| Non-operating costs(a) | $ | (2,628 | ) | $ | (2,232 | ) | ||
| Asset sales | (64 | ) | (2,139 | ) | ||||
| Investment losses-net | (502 | ) | — | |||||
| Miscellaneous | (666 | ) | (533 | ) | ||||
| Total other expense | $ | (3,860 | ) | $ | (4,904 | ) | ||
| (a) | As defined by the FERC, includes below-the-line non-operating utility costs (primarily community relations and other). | |
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ARIZONA PUBLIC SERVICE COMPANY
SUPPLEMENTAL NOTES TO THE CONDENSED FINANCIAL STATEMENTS
S-5. Related Party Transactions
From time to time, APS enters into transactions with Pinnacle West or Pinnacle West’s subsidiaries. The following table summarizes the amounts included in the APS Condensed Statements of Income and Condensed Balance Sheets related to transactions with affiliated companies (dollars in millions):
| Three Months Ended | ||||||||
| March 31, | ||||||||
| 2005 | 2004 | |||||||
| Electric operating revenues: | ||||||||
| Pinnacle West — marketing and trading | $ | 1 | $ | 4 | ||||
| Pinnacle West Energy | 1 | 1 | ||||||
| Total | $ | 2 | $ | 5 | ||||
| Purchased power and fuel costs: | ||||||||
| Pinnacle West Energy | $ | 8 | $ | 10 | ||||
| Total | $ | 8 | $ | 10 | ||||
| Other: | ||||||||
| Pinnacle West Energy interest income | $ | 5 | $ | 5 | ||||
| Total | $ | 5 | $ | 5 | ||||
| As of | As of | |||||||
| March 31, 2005 | December 31, 2004 | |||||||
| Net intercompany receivables (payables): | ||||||||
| Pinnacle West Energy | $ | 484 | $ | 467 | ||||
| Pinnacle West — marketing and trading | 17 | 19 | ||||||
| APS Energy Services | 7 | 9 | ||||||
| Pinnacle West | 23 | (5 | ) | |||||
| Total | $ | 531 | $ | 490 | ||||
Electric revenues include sales of electricity to affiliated companies at contract prices. Purchased power includes purchases of electricity from affiliated companies at contract prices. The Company purchases electricity from and sells electricity to APS Energy Services; however, these transactions are settled net and reported net in accordance with EITF 03-11, “Reporting Realized Gains and Losses on Derivative Instruments That Are Subject to FASB Statement No. 133 and Not ‘Held for Trading Purposes’ As Defined in Issue No. 2-3.” Intercompany receivables primarily include the amounts related to the loan APS made to Pinnacle West Energy and intercompany sales of electricity. Intercompany payables primarily include amounts related to the intercompany purchases of electricity. Intercompany receivables and payables are generally settled on a current basis in cash.
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ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
INTRODUCTION
The following discussion should be read in conjunction with Pinnacle West’s Condensed Consolidated Financial Statements and Arizona Public Service Company’s Condensed Financial Statements and the related Notes that appear in Item 1 of this report.
OVERVIEW
Pinnacle West owns all of the outstanding common stock of APS. APS is a vertically-integrated electric utility that provides retail and wholesale electric service to most of the state of Arizona, with the major exceptions of about one-half of the Phoenix metropolitan area, the Tucson metropolitan area and Mohave County in northwestern Arizona. Through its marketing and trading division, APS also generates, sells and delivers electricity to wholesale customers in the western United States. APS has historically accounted for a substantial part of our revenues and earnings. Customer growth in APS’ service territory is about three times the national average and remains a fundamental driver of our revenues and earnings.
Pinnacle West Energy is our unregulated generation subsidiary. The ACC’s order in APS’ general rate case authorized Pinnacle West Energy to transfer the PWEC Dedicated Assets to APS. This transfer remains subject to FERC approval. See “APS General Rate Case” in Note 5. Following the transfer, Pinnacle West Energy’s remaining generating plant will be the Silverhawk Power Station, a 570 MW combined cycle plant located north of Las Vegas, Nevada. See Note 19 of Notes to Condensed Consolidated Financial Statements for a discussion of proposals to purchase our 75% ownership interest in the Silverhawk Power Station.
SunCor, our real estate development subsidiary, has been and is expected to be an important source of earnings and cash flow, particularly during the years 2003 through 2005 due to accelerated asset sales activity.
Our subsidiary, APS Energy Services, provides competitive commodity-related energy services and energy-related products and services to commercial and industrial retail customers in the western United States.
El Dorado, our investment subsidiary, owns minority interests in several energy-related investments and Arizona community-based ventures.
We continue to focus on solid operational performance in our electricity generation and delivery activities. In the generation area, 2004 represented the thirteenth consecutive year Palo Verde was the largest power producer in the United States. In the delivery area, we focus on superior reliability and customer satisfaction while expanding our transmission and distribution system to
meet growth and sustain reliability. We plan to expand long-term resources to meet our retail customers’ growing electricity needs.
See “Pinnacle West Consolidated — Factors Affecting Our Financial Outlook” below for a discussion of several factors that could affect our future financial results.
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EARNINGS CONTRIBUTION BY BUSINESS SEGMENT
We have three principal business segments (determined by products, services and the regulatory environment):
| • | our regulated electricity segment, which consists of traditional regulated retail and wholesale electricity businesses (primarily electric service to “Native Load” customers) and related activities and includes electricity generation, transmission and distribution; | |||
| • | our marketing and trading segment, which consists of our competitive energy business activities, including wholesale marketing and trading and APS Energy Services’ commodity-related energy services; and | |||
| • | our real estate segment, which consists of SunCor’s real estate development and investment activities. | |||
The following table summarizes net income for the three months ended March 31, 2005 and 2004 (dollars in millions):
| Three Months Ended | ||||||||
| March 31 | ||||||||
| 2005 | 2004 | |||||||
| Regulated electricity | $ | 13 | $ | 18 | ||||
| Marketing and trading | 1 | 10 | ||||||
| Real estate | 9 | 2 | ||||||
| Other | 1 | 1 | ||||||
| Net income | $ | 24 | $ | 31 | ||||
General
Throughout the following explanations of our results of operations, we refer to “gross margin.” With respect to our regulated electricity segment and our marketing and trading segment, gross margin refers to electric operating revenues less purchased power and fuel costs. “Gross margin” is a “non-GAAP financial measure,” as defined in accordance with SEC rules. Exhibit 99.3 reconciles this non-GAAP financial measure to operating income, which is the most directly comparable financial measure calculated and presented in accordance with GAAP. We view gross margin as an important performance measure of the core profitability of our operations. This measure is a key component of our internal financial reporting and is used by our management in analyzing our business segments. We believe that investors benefit from having access to the same financial measures that our management uses. In addition, we have reclassified certain prior period amounts to conform to our current period presentation.
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Operating Results — Three-month period ended March 31, 2005 compared with the three-month period ended March 31, 2004
Our consolidated net income for the three months ended March 31, 2005 was $24 million compared with $31 million for the prior-year period. The $7 million decrease in the period-to-period comparison reflected the following changes in earnings by segment:
| • | Regulated Electricity Segment — Net income decreased approximately $5 million primarily due to higher operations and maintenance costs primarily related to customer service, generation and benefit costs; lower other income, net of other expense, primarily due to gains on asset sales in the prior year period; increased property taxes due to increased plant in service; and the effects of milder weather on retail sales. These negative factors were partially offset by the absence of regulatory asset amortization; higher retail sales volumes due to customer growth and usage; decreased purchased power and fuel costs due to lower hedged gas and power prices; and lower replacement power costs due to fewer unplanned outages. | |||
| • | Marketing and Trading Segment — Net income decreased approximately $9 million primarily due to increased costs related to the Silverhawk Power Station, which was placed in service in mid-2004 and lower margins on competitive retail sales in California by APS Energy Services. | |||
| • | Real Estate Segment — Net income increased approximately $7 million primarily due to increased land sales. | |||
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Additional details on the major factors that increased (decreased) net income are contained in the following table (dollars in millions).
| Increase (Decrease) | ||||||||
| Pretax | After Tax | |||||||
| Regulated electricity segment gross margin: | ||||||||
| Higher retail sales volumes due to customer growth, excluding weather effects | $ | 7 | $ | 4 | ||||
| Decreased purchased power and fuel costs due to lower hedged gas and power prices | 5 | 3 | ||||||
| Lower replacement power costs due to fewer unplanned outages | 4 | 3 | ||||||
| Effects of weather on retail sales | (5 | ) | (3 | ) | ||||
| Net increase in regulated electricity segment gross margin | 11 | 7 | ||||||
| Marketing and trading segment gross margin: | ||||||||
| Lower competitive retail unit margins in California by APS Energy Services | (6 | ) | (4 | ) | ||||
| Lower realized margins on wholesale sales primarily due to lower unit margins | (1 | ) | (1 | ) | ||||
| Increase in generation sales other than Native Load due to higher sales volumes | 3 | 2 | ||||||
| Net decrease in marketing and trading segment gross margin | (4 | ) | (3 | ) | ||||
| Net increase in gross margin for regulated electricity and marketing and trading segments | 7 | 4 | ||||||
| Higher real estate segment contribution primarily related to increased land sales | 12 | 7 | ||||||
| Higher operations and maintenance expense primarily related to customer service, generation and benefit costs | (19 | ) | (11 | ) | ||||
| Depreciation and amortization decreases (increases): | ||||||||
| Absence of regulatory asset amortization | 9 | 5 | ||||||
| Increased delivery and other assets | (2 | ) | (1 | ) | ||||
| Higher property taxes due to increased plant in service | (5 | ) | (3 | ) | ||||
| Lower other income net of other expense primarily due to gain on asset sales and higher interest income in prior-year period | (9 | ) | (5 | ) | ||||
| Miscellaneous items, net | (1 | ) | (3 | ) | ||||
| Net decrease in net income | $ | (8 | ) | $ | (7 | ) | ||
The increase in net costs (primarily depreciation, interest expense, property taxes and operations and maintenance expense, net of gross margin contributions) related to the Silverhawk Power Station, which was placed in service in mid-2004 by Pinnacle West Energy totaled approximately $4 million after income taxes in the three months ended March 31, 2005 compared with the prior-year period.
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Regulated Electricity Segment Revenues
Regulated electricity segment revenues were $1 million higher for the three months ended March 31, 2005 compared with the prior-year period primarily as a result of:
| • | a $13 million increase in retail revenues related to customer growth, excluding weather effects; | |||
| • | a $13 million decrease in retail revenues related to milder weather; and | |||
| • | a $1 million increase due to miscellaneous factors. | |||
Marketing and Trading Segment Revenues
Marketing and trading segment revenues were $29 million higher for the three months ended March 31, 2005 compared with the prior-year period primarily as a result of:
| • | a $36 million increase from generation sales other than Native Load primarily due to higher sales volumes, including sales from the Silverhawk Power Station, and higher wholesale market prices; | |||
| • | $1 million of higher energy trading revenues on realized sales of electricity primarily due to higher electricity prices; and | |||
| • | an $8 million decrease from lower competitive retail sales and prices in California by APS Energy Services. | |||
Real Estate Revenues
Real estate revenues were $20 million higher for the three months ended March 31, 2005 compared with the prior-year period primarily due to higher land and home sales.
LIQUIDITY AND CAPITAL RESOURCES
Capital Needs and Resources — Pinnacle West Consolidated
Capital Expenditure Requirements
The following table summarizes the actual capital expenditures for the three months ended March 31, 2005 and estimated capital expenditures for the next three years.
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CAPITAL EXPENDITURES
(dollars in millions)
| Three Months Ended | Estimated for the Year Ended | |||||||||||||||
| March 31, | December 31, | |||||||||||||||
| 2005 | 2005 | 2006 | 2007 | |||||||||||||
| APS | ||||||||||||||||
| Delivery | $ | 84 | $ | 390 | $ | 395 | $ | 440 | ||||||||
| Generation (a) (b) | 26 | 352 | 158 | 195 | ||||||||||||
| Other (c) | 9 | 30 | 7 | 6 | ||||||||||||
| Subtotal | 119 | 772 | 560 | 641 | ||||||||||||
| Pinnacle West Energy (a) | — | 7 | 5 | 2 | ||||||||||||
| SunCor (d) | 19 | 114 | 61 | 63 | ||||||||||||
| Other | 1 | 8 | 7 | 4 | ||||||||||||
| Total | $ | 139 | $ | 901 | $ | 633 | $ | 710 | ||||||||
| (a) | As discussed in Note 5 under “APS General Rate Case,” as part of the ACC’s order in APS’ general rate case, APS received rate base treatment of the PWEC Dedicated Assets. The estimated capital expenditures related to the PWEC Dedicated Assets are reflected in APS for the years 2005, 2006 and 2007. | |||
| (b) | The estimate for 2005 includes about $190 million for acquisition of the Sundance Plant. See “Request for Proposals and Asset Purchase Agreement” in Note 5 for a discussion of the asset purchase agreement between APS and PPL Sundance. | |||
| (c) | Primarily information systems and facilities projects. | |||
| (d) | Consists primarily of capital expenditures for land development and retail and office building construction reflected in “Real estate investments” on the Condensed Consolidated Statements of Cash Flows. | |||
Delivery capital expenditures are comprised of T&D infrastructure additions and upgrades, capital replacements, new customer construction and related information systems and facility costs. Examples of the types of projects included in the forecast include T&D lines and substations, line extensions to new residential and commercial developments and upgrades to customer information systems. Major transmission projects are driven by strong regional customer growth. APS will begin major projects each year for the next several years, and expects to spend about $200 million on major transmission projects during the 2005 to 2007 time frame. These amounts are included in “APS-Delivery” in the table above. Completion of these projects is expected by at least 2008.
Generation capital expenditures are comprised of various improvements to APS’ existing fossil and nuclear plants, the acquisition of the Sundance Plant and the replacement of Palo Verde steam generators (see below). Examples of the types of projects included in this category are additions, upgrades and capital replacements of various power plant equipment such as turbines, boilers and environmental equipment. Generation also includes nuclear fuel expenditures of approximately $30 million annually for 2005 through 2007.
Replacement of the steam generators in Palo Verde Unit 2 was completed during the fall outage of 2003 at a cost to APS of approximately $70 million. The Palo Verde owners have approved the manufacture of two additional sets of steam generators. These generators will be
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installed in Unit 1 (scheduled completion in the fall of 2005) and Unit 3 (scheduled completion in the fall of 2007). Our portion of steam generator expenditures for Units 1 and 3 is approximately $140 million, which will be spent through 2008. In 2005 through 2007, approximately $95 million of the costs for steam generator replacements at Units 1 and 3 are included in the generation capital expenditures table above and will be funded with internally-generated cash or external financings.
Contractual Obligations
Our future contractual obligations have not changed materially from the amounts disclosed in Part II, Item 7 of the 2004 Form 10-K, with the exception of our aggregate purchased power and fuel commitments, which increased approximately $46 million for the years 2005 through 2007 to $901 million.
See Note 4 for a list of payments due on total long-term debt and capitalized lease requirements.
Off-Balance Sheet Arrangements
In 1986, APS entered into agreements with three separate VIE lessors in order to sell and lease back interests in Palo Verde Unit 2. The leases are accounted for as operating leases in accordance with GAAP. We are not the primary beneficiary of the Palo Verde VIEs and, accordingly, do not consolidate them.
APS is exposed to losses under the Palo Verde sale leaseback agreements upon the occurrence of certain events that APS does not consider to be reasonably likely to occur. Under certain circumstances (for example, the NRC issuing specified violation orders with respect to Palo Verde or the occurrence of specified nuclear events), APS would be required to assume the debt associated with the transactions, make specified payments to the equity participants, and take title to the leased Unit 2 interests, which, if appropriate, may be required to be written down in value. If such an event had occurred as of March 31, 2005, APS would have been required to assume approximately $250 million of debt and pay the equity participants approximately $192 million.
Guarantees and Letters of Credit
We and certain of our subsidiaries have issued guarantees and letters of credit in support of our unregulated businesses. We have also obtained surety bonds on behalf of APS Energy Services. We have not recorded any liability on our Condensed Consolidated Balance Sheets with respect to these obligations. We generally agree to indemnification provisions related to liabilities arising from or related to certain of our agreements, with limited exceptions depending on the particular agreement. See Note 16 for additional information regarding guarantees and letters of credit.
See “Pinnacle West Energy” below for information regarding Pinnacle West’s guarantee of $500 million of Pinnacle West Energy’s debt obligations.
Credit Ratings
The ratings of securities of Pinnacle West and APS as of May 9, 2005 are shown below and are considered to be “investment-grade” ratings. The ratings reflect the respective views of the rating
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agencies, from which an explanation of the significance of their ratings may be obtained. There is no assurance that these ratings will continue for any given period of time. The ratings may be revised or withdrawn entirely by the rating agencies, if, in their respective judgments, circumstances so warrant. Any downward revision or withdrawal may adversely affect the market price of Pinnacle West’s or APS’ securities and serve to increase those companies’ cost of and access to capital. It may also require additional collateral related to certain derivative instruments (see Note 10).
| Moody’s | Standard & Poor’s | |||
Pinnacle West | ||||
| Senior unsecured Commercial paper Outlook | Baa2 P-2 Stable | BBB- A-2 Stable | ||
APS | ||||
| Senior unsecured Secured lease obligation bonds Commercial paper Outlook | Baa1 Baa1 P-2 Stable | BBB BBB A-2 Stable |
Debt Provisions
Pinnacle West’s and APS’ debt covenants related to their respective bank financing arrangements include a debt-to-total-capitalization ratio and an interest coverage test. Pinnacle West and APS comply with these covenants and each anticipates it will continue to meet these and other significant covenant requirements. These covenants require that the ratio of debt to total capitalization cannot exceed 65% for the Company and for APS. At March 31, 2005, the ratio was approximately 52% for Pinnacle West and 53% for APS. The provisions regarding interest coverage require a minimum cash coverage of two times the interest requirements for each of the Company and APS. The interest coverage is approximately 4 times under the Company’s and APS’ bank financing agreements. Failure to comply with such covenant levels would result in an event of default which, generally speaking, would require the immediate repayment of the debt subject to the covenants.
Neither Pinnacle West’s nor APS’ financing agreements contain “ratings triggers” that would result in an acceleration of the required interest and principal payments in the event of a ratings downgrade. However, in the event of a ratings downgrade, Pinnacle West and/or APS may be subject to increased interest costs under certain financing agreements.
All of Pinnacle West’s bank agreements contain “cross-default” provisions that would result in defaults and the potential acceleration of payment under these loan agreements if Pinnacle West or APS were to default under other agreements. All of APS’ bank agreements contain cross-default provisions that would result in defaults and the potential acceleration of payment under these bank agreements if APS were to default under other agreements. Pinnacle West’s and APS’ credit agreements generally contain provisions under which the lenders could refuse to advance loans in the event of a material adverse change in financial condition or financial prospects, except that Pinnacle
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West and APS do not have a material adverse change restriction for revolver borrowings equal to outstanding commercial paper amounts.
See Note 4 for further discussions.
Capital Needs and Resources — By Company
Pinnacle West (Parent Company)
Our primary cash needs are for dividends to our shareholders; interest payments and optional and mandatory repayments of principal on our long-term debt. The level of our common dividends and future dividend growth will be dependent on a number of factors including, but not limited to, payout ratio trends, free cash flow and financial market conditions.
Our primary sources of cash are dividends from APS, external financings and cash distributions from our other subsidiaries, primarily SunCor. We expect SunCor to make cash distributions to the parent company of approximately $80 to $100 million in 2005 based on anticipated asset sales activities. As discussed in Note 5 under “ACC Financing Order,” APS must maintain a common equity ratio of at least 40% and may not pay common dividends if the payment would reduce its common equity below that threshold. As defined in the Financing Order, common equity ratio is common equity divided by common equity plus long-term debt, including current maturities of long-term debt. At March 31, 2005, APS’ common equity ratio as defined was approximately 47%.
Pinnacle West sponsors a qualified pension plan for the employees of Pinnacle West and our subsidiaries. We contribute at least the minimum amount required under IRS regulations, but no more than the maximum tax-deductible amount. The minimum required funding takes into consideration the value of the fund assets and our pension obligation. We contributed $35 million in 2004. APS and other subsidiaries fund their share of the pension contribution, of which APS represents approximately 92% of the total funding amounts described above. The assets in the plan are comprised of common stocks, bonds and real estate. Future year contribution amounts are dependent on fund performance and fund valuation assumptions. The minimum required contribution to be made to our pension plan in 2005 is estimated to be approximately $50 million, $13 million of which was contributed on April 15, 2005. The expected contribution to our other postretirement benefit plans in 2005 is estimated to be approximately $40 million. We have not yet made any 2005 contributions to our other postretirement benefit plans.
On May 2, 2005, Pinnacle West redeemed at par all of its $165 million Floating Rate Senior Notes due November 1, 2005. The Company used cash on hand to redeem the notes.
On May 2, 2005, Pinnacle West issued 6,095,000 shares of its common stock at an offering price of $42 per share, resulting in net proceeds of approximately $248 million. Pinnacle West anticipates using the net proceeds of the offering for general corporate purposes, including making capital contributions to APS, which will, in turn, use such funds to pay a portion of the approximately $190 million purchase price of its pending acquisition of the Sundance Plant and other capital expenditures expected to be incurred to meet the growing needs of APS’ service territory. See “Request for Proposals and Asset Purchase Agreement” in Note 5 for information regarding APS’ pending acquisition of the Sundance Plant.
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APS
APS’ capital requirements consist primarily of capital expenditures and optional and mandatory redemptions of long-term debt. See “ACC Financing Order” in Note 5 for a discussion of the $500 million loan from APS to Pinnacle West Energy authorized by the ACC pursuant to the Financing Order. This loan was repaid on April 11, 2005.
APS pays for its capital requirements with cash from operations and, to the extent necessary, external financings. APS has historically paid for its dividends to Pinnacle West with cash from operations. See “Pinnacle West (Parent Company)” above for a discussion of the common equity ratio that APS must maintain in order to pay dividends to Pinnacle West.
On January 15, 2005, APS repaid its $100 million 6.25% Notes due 2005. APS used cash on hand to redeem these notes.
On March 1, 2005, Maricopa County, Arizona Pollution Control Corporation issued $164 million of variable interest rate pollution control bonds, 2005 Series A-E, due 2029. The bonds were issued to refinance $164 million of outstanding pollution control bonds. The Series A-E bonds are payable solely from revenues obtained from APS pursuant to a loan agreement between APS and Maricopa County, Arizona Pollution Control Corporation. These bonds are classified as long-term debt on our Condensed Consolidated Balance Sheets.
Although provisions in APS’ articles of incorporation and ACC financing orders establish maximum amounts of preferred stock and debt that APS may issue, APS does not expect any of these provisions to limit its ability to meet its capital requirements.
Pinnacle West Energy
Pinnacle West Energy’s capital requirements consist primarily of capital expenditures. See the capital expenditures table above for actual capital expenditures during the three months ended March 31, 2005 and projected capital expenditures for the next three years (the estimated capital expenditures related to the PWEC Dedicated Assets are reflected in APS). Pinnacle West Energy’s sources of cash will be cash infusions from the parent and cash from operations.
See “ACC Financing Order” in Note 5 for a discussion of the $500 million loan from APS to Pinnacle West Energy authorized by the ACC pursuant to the Financing Order. On April 11, 2005 Pinnacle West Energy issued $500 million Floating Rate Senior Notes due April 1, 2007. Pinnacle West has unconditionally guaranteed these notes. Pinnacle West Energy used the proceeds of this issuance to repay the APS loan.
See Note 19 of Notes to Condensed Consolidated Financial Statements above for a discussion of proposals to purchase our 75% ownership interest in the Silverhawk Power Station.
Other Subsidiaries
During the past three years, SunCor funded its cash requirements with cash from operations and its own external financings. SunCor’s capital needs consist primarily of capital expenditures for land development and retail and office building construction. See the capital expenditures table above for actual capital expenditures during the three months ended March 31, 2005 and projected
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capital expenditures for the next three years. SunCor expects to fund its capital requirements with cash from operations and external financings.
We expect SunCor to make cash distributions to the parent company of approximately $80 to $100 million in 2005 based on anticipated asset sales activities.
El Dorado expects minimal capital requirements over the next three years and intends to focus on prudently realizing the value of its existing investments.
APS Energy Services expects minimal capital expenditures over the next three years.
CRITICAL ACCOUNTING POLICIES
In preparing the financial statements in accordance with GAAP, management must often make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues, expenses and related disclosures at the date of the financial statements and during the reporting period. Some of those judgments can be subjective and complex, and actual results could differ from those estimates. Our most critical accounting policies include the impacts of regulatory accounting and the determination of the appropriate accounting for our pension and other postretirement benefits and derivatives accounting. There have been no changes to our critical accounting policies since our 2004 Form 10-K except for the impact of recent accounting pronouncements as discussed in Note 8. See “Critical Accounting Policies” in Item 7 of the 2004 Form 10-K for further details about our critical accounting policies.
PINNACLE WEST CONSOLIDATED – FACTORS AFFECTING
OUR FINANCIAL OUTLOOK
Factors Affecting Operating Revenues, Purchased Power and Fuel Costs
GeneralElectric operating revenues are derived from sales of electricity in regulated retail markets in Arizona and from competitive retail and wholesale power markets in the western United States. These revenues are affected by electricity sales volumes related to customer mix, customer growth and average usage per customer as well as electricity prices and variations in weather from period to period. Competitive sales of energy and energy-related products and services are made by APS Energy Services in western states that have opened to competition.
Customer and Sales GrowthThe customer and sales growth referred to in this paragraph applies to Native Load customers and sales to them. Customer growth in APS’ service territory averaged about 3.4% a year for the three years 2002 through 2004; we currently expect customer growth to average about 3.8% per year from 2005 to 2007. We currently estimate that total retail electricity sales in kilowatt-hours will grow 5.0% on average, from 2005 through 2007, before the effects of weather variations. Customer growth for the three-month period ended March 31, 2005 compared with the prior year period was 4.0%.
Actual sales growth, excluding weather-related variations, may differ from our projections as a result of numerous factors, such as economic conditions, customer growth and usage patterns. Our experience indicates that a reasonable range of variation in our kilowatt-hour sales projection
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attributable to such economic factors can result in increases or decreases in annual net income of up to $10 million.
�� Retail Rate ChangesSee “APS General Rate Case” in Note 5 for a discussion of the ACC’s order in APS’ general rate case. APS expects to file another general rate case in late 2005.
WeatherIn forecasting retail sales growth, we assume normal weather patterns based on historical data. Historical extreme weather variations have resulted in annual variations in net income in excess of $20 million. However, our experience indicates that the more typical variations from normal weather can result in increases or decreases in annual net income of up to $10 million.
Purchased Power and Fuel CostsPurchased power and fuel costs are impacted by our electricity sales volumes, existing contracts for purchased power and generation fuel, our power plant performance, transmission availability or constraints, prevailing market prices, new generating plants being placed in service and our hedging program for managing such costs. See “Natural Gas Supply” in Note 12 for more information on fuel costs. See “APS General Rate Case” in Note 5 for information regarding the PSA approved by the ACC in APS’ general rate case.
Wholesale Power Market ConditionsThe marketing and trading division focuses primarily on managing APS’ purchased power and fuel risks in connection with its costs of serving retail customer demand. The marketing and trading division, subject to specified parameters, markets, hedges and trades in electricity, fuels and emission allowances and credits. Our future earnings will be affected by the strength or weakness of the wholesale power market.
Other Factors Affecting Financial Results
Operations and Maintenance ExpensesOperations and maintenance expenses are impacted by growth, power plant additions and operations, inflation, outages, higher trending pension and other postretirement benefit costs and other factors.
Depreciation and Amortization ExpensesDepreciation and amortization expenses are impacted by net additions to utility plant and other property, which includes generation construction or acquisition, and changes in regulatory asset amortization. See Note 19 for information on the potential sale of the Silverhawk Power Station. APS plans to acquire the Sundance Plant in 2005 and to issue requests for proposals to acquire additional long-term resources in 2006 and 2007.
Property TaxesTaxes other than income taxes consist primarily of property taxes, which are affected by tax rates and the value of property in-service and under construction. The average property tax rate for APS, which currently owns the majority of our property, was 9.2% of assessed value for 2004 and 9.3% for 2003. We expect property taxes to increase as new power plants, the planned acquisition of the Sundance Plant and our additions to transmission and distribution facilities phase-in to the property tax base.
Interest ExpenseInterest expense is affected by the amount of debt outstanding and the interest rates on that debt. The primary factors affecting borrowing levels in the next several years are expected to be our capital requirements and our internally generated cash flow. Capitalized interest offsets a portion of interest expense while capital projects are under construction. We stop accruing capitalized interest on a project when it is placed in commercial operation. We placed new power plants in commercial operation in 2001, 2002, 2003 and 2004. Interest expense is also
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affected by interest rates on variable-rate debt and interest rates on the refinancing of the Company’s future liquidity needs.
Retail CompetitionThe regulatory developments and legal challenges to the ACC’s retail electric competition rules discussed in Note 5 have raised considerable uncertainty about the status and pace of retail electric competition and of electric restructuring in Arizona. Although some very limited retail competition existed in APS’ service area in 1999 and 2000, there are currently no active retail competitors providing unbundled energy or other utility services to APS’ customers. As a result, we cannot predict when, and the extent to which, additional competitors will re-enter APS’ service territory.
SubsidiariesIn the case of SunCor, efforts to accelerate asset sales activities in 2004 were successful. A portion of these sales have been, and additional amounts may be required to be, reported as discontinued operations on our Condensed Consolidated Statements of Income. SunCor’s net income was $45 million in 2004. See Note 18 for further discussion. We anticipate SunCor’s earnings contributions in 2005 to be approximately $50 million after income taxes.
El Dorado’s historical results are not indicative of future performance.
GeneralOur financial results may be affected by a number of broad factors. See “Forward-Looking Statements” for further information on such factors, which may cause our actual future results to differ from those we currently seek or anticipate.
Market Risks
Our operations include managing market risks related to changes in interest rates, commodity prices and investments held by our nuclear decommissioning trust fund.
Interest Rate and Equity Risk
Our major financial market risk exposure is to changing interest rates. Changing interest rates will affect interest paid on variable-rate debt and interest earned by our nuclear decommissioning trust fund. Our policy is to manage interest rates through the use of a combination of fixed-rate and floating-rate debt.
Commodity Price Risk
We are exposed to the impact of market fluctuations in the commodity price and transportation costs of electricity, natural gas, coal and emissions allowances. We manage risks associated with these market fluctuations by utilizing various commodity instruments that qualify as derivatives, including exchange-traded futures and options and over-the-counter forwards, options and swaps. Our ERMC, consisting of officers and key management personnel, oversees company-wide energy risk management activities and monitors the results of marketing and trading activities to ensure compliance with our stated energy risk management and trading policies. As part of our risk management program, we use such instruments to hedge purchases and sales of electricity, fuels and emissions allowances and credits. The changes in market value of such contracts have a high correlation to price changes in the hedged commodities. In addition, subject to specified risk parameters monitored by the ERMC, we engage in marketing and trading activities intended to profit from market price movements.
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The mark-to-market value of derivative instruments related to our risk management and trading activities are presented in two categories consistent with our business segments:
| • | Regulated Electricity – non-trading derivative instruments that hedge our purchases and sales of electricity and fuel for APS’ Native Load requirements of our regulated electricity business segment; and | |||
| • | Marketing and Trading – non-trading and trading derivative instruments of our competitive business segment. | |||
The following tables show the pretax changes in mark-to-market of our non-trading and trading derivative positions for the three months ended March 31, 2005 and 2004 (dollars in millions):
| Three Months Ended | Three Months Ended | |||||||||||||||
| March 31, 2005 | March 31, 2004 | |||||||||||||||
| Regulated | Marketing | Regulated | Marketing | |||||||||||||
| Electricity | and Trading | Electricity | and Trading | |||||||||||||
| Mark-to-market of net positions at beginning of period | $ | 34 | $ | 107 | $ | — | $ | 69 | ||||||||
| Change in mark-to-market gains (losses) for future period deliveries | 4 | 8 | 10 | 8 | ||||||||||||
| Changes in cash flow hedges recorded in OCI | 108 | (4 | ) | 30 | 17 | |||||||||||
| Ineffective portion of changes in fair value recorded in earnings | 8 | — | 1 | 1 | ||||||||||||
| Mark-to-market losses (gains) realized during the period | (1 | ) | 49 | 6 | (2 | ) | ||||||||||
| Mark-to-market of net positions at end of period | $ | 153 | $ | 160 | $ | 47 | $ | 93 | ||||||||
The tables below show the fair value of maturities of our non-trading and trading derivative contracts (dollars in millions) at March 31, 2005 by maturities and by the type of valuation that is performed to calculate the fair values. See Note 1, “Derivative Accounting,” in Item 8 of our 2004 Form 10-K for more discussion of our valuation methods.
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Regulated Electricity
| Total | ||||||||||||||||
| fair | ||||||||||||||||
| Source of Fair Value | 2005 | 2006 | 2007 | value | ||||||||||||
| Prices actively quoted | $ | 93 | $ | 42 | $ | 13 | $ | 148 | ||||||||
| Prices provided by other external sources | — | 5 | 1 | 6 | ||||||||||||
| Prices based on models and other valuation methods | (1 | ) | — | — | (1 | ) | ||||||||||
| Total by maturity | $ | 92 | $ | 47 | $ | 14 | $ | 153 | ||||||||
Marketing and Trading
| Total | ||||||||||||||||||||||||||||
| Years | fair | |||||||||||||||||||||||||||
| Source of Fair Value | 2005 | 2006 | 2007 | 2008 | 2009 | thereafter | value | |||||||||||||||||||||
| Prices actively quoted | $ | 55 | $ | — | $ | — | $ | — | $ | — | $ | — | $ | 55 | ||||||||||||||
| Prices provided by other external sources | — | 64 | 74 | 33 | (1 | ) | (1 | ) | 169 | |||||||||||||||||||
| Prices based on models and other valuation methods | (8 | ) | (21 | ) | (27 | ) | (8 | ) | — | — | (64 | ) | ||||||||||||||||
| Total by maturity | $ | 47 | $ | 43 | $ | 47 | $ | 25 | $ | (1 | ) | $ | (1 | ) | $ | 160 | ||||||||||||
The table below shows the impact that hypothetical price movements of 10% would have on the market value of our risk management and trading assets and liabilities included on Pinnacle West’s Condensed Consolidated Balance Sheets at March 31, 2005 and December 31, 2004 (dollars in millions).
| March 31, 2005 | December 31, 2004 | |||||||||||||||
| Gain (Loss) | Gain (Loss) | |||||||||||||||
| Price Up | Price Down | Price Up | Price Down | |||||||||||||
| Commodity | 10% | 10% | 10% | 10% | ||||||||||||
| Mark-to-market changes reported in earnings (a): | ||||||||||||||||
| Electricity | $ | (4 | ) | $ | 4 | $ | (4 | ) | $ | 4 | ||||||
| Natural gas | 2 | (2 | ) | 2 | (2 | ) | ||||||||||
| Other | 1 | (1 | ) | 1 | (1 | ) | ||||||||||
| Mark-to-market changes reported in OCI (b): | ||||||||||||||||
| Electricity | 47 | (45 | ) | 35 | (35 | ) | ||||||||||
| Natural gas | 62 | (62 | ) | 43 | (43 | ) | ||||||||||
| Total | $ | 108 | $ | (106 | ) | $ | 77 | $ | (77 | ) | ||||||
| (a) | These contracts are primarily structured sales activities hedged with a portfolio of forward purchases that protects the economic value of the sales transactions. | |
| (b) | These contracts are hedges of our forecasted purchases of natural gas and electricity. The impact of these hypothetical price movements would substantially offset the |
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| impact that these same price movements would have on the physical exposures being hedged. |
Credit Risk
We are exposed to losses in the event of nonperformance or nonpayment by counterparties. We have risk management and trading contracts with many counterparties, including two counterparties for which a worst case exposure represents approximately 30% of Pinnacle West’s $658 million of risk management and trading assets as of March 31, 2005. See Note 1, “Derivative Accounting” in Item 8 of our 2004 Form 10-K for a discussion of our credit valuation adjustment policy. See Note 10 for further discussion of credit risk.
ARIZONA PUBLIC SERVICE COMPANY – RESULTS OF OPERATIONS
General
Throughout the following explanations of APS’ results of operations, we refer to “gross margin.” Gross margin refers to electric operating revenues less purchased power and fuel costs. “Gross margin” is a “non-GAAP financial measure,” as defined in accordance with SEC rules. Exhibit 99.4 reconciles this non-GAAP financial measure to operating income, which is the most directly comparable financial measure calculated and presented in accordance with GAAP. We view gross margin as an important performance measure of the core profitability of our operations. This measure is a key component of our internal financial reporting and is used by our management in analyzing our business segments. We believe that investors benefit from having access to the same financial measures that our management uses. In addition, we have reclassified certain prior period amounts to conform to our current period presentation.
Operating Results – Three-month period ended March 31, 2005 compared with the three-month period ended March 31, 2004
APS’ net income for the three months ended March 31, 2005 was $27 million compared with $34 million for the prior-year period. The $7 million decrease in the period-to-period comparison reflects higher operations and maintenance costs primarily related to customer service, generation and benefit costs; the effects of milder weather on retail sales; lower other income, net of other expense, primarily due to gains on asset sales in the prior year period; and increased purchased power and fuel costs due to higher fuel and power prices. These negative factors were partially offset by the absence of regulatory asset amortization; higher retail sales volumes due to customer growth and usage; and lower replacement power costs due to fewer unplanned outages.
Additional details on the major factors that increased (decreased) net income are contained in the following table (dollars in millions).
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| Increase (Decrease) | ||||||||
| Pretax | After Tax | |||||||
| Gross margin: | ||||||||
| Higher retail sales volumes due to customer growth, excluding weather effects | $ | 7 | $ | 4 | ||||
| Lower replacement power costs due to fewer unplanned outages | 4 | 2 | ||||||
| Effects of weather on retail sales | (5 | ) | (3 | ) | ||||
| Increased purchased power and fuel costs due to higher fuel and power prices | (2 | ) | (1 | ) | ||||
| Net increase in gross margin | 4 | 2 | ||||||
| Higher operations and maintenance expense primarily related to customer service, generation and benefit costs | (16 | ) | (10 | ) | ||||
| Depreciation and amortization decreases (increases): | ||||||||
| Absence of regulatory asset amortization | 9 | 5 | ||||||
| Increased delivery and other assets | (2 | ) | (1 | ) | ||||
| Lower other income net of other expense primarily due to gain on asset sales in the prior-year period | (4 | ) | (2 | ) | ||||
| Miscellaneous items, net | (1 | ) | (1 | ) | ||||
| Net decrease in net income | $ | (10 | ) | $ | (7 | ) | ||
Regulated Electricity Revenues
Regulated electricity revenues were $2 million lower for the three months ended March 31, 2005 compared with the prior-year period primarily as a result of:
| • | a $13 million increase in retail revenues related to customer growth, excluding weather effects; | |||
| • | a $13 million decrease in retail revenues related to milder weather; and | |||
| • | a $2 million decrease due to miscellaneous factors. | |||
Marketing and Trading Revenues
Marketing and trading revenues were $2 million higher for the three months ended March 31, 2005 compared with the prior-year period primarily as a result of:
| • | a $7 million increase from generation sales other than Native Load primarily due to higher wholesale market prices and higher sales volumes; and | |||
| • | $5 million of lower mark-to-market gains for future delivery due to higher prices. | |||
LIQUIDITY AND CAPITAL RESOURCES – ARIZONA PUBLIC SERVICE COMPANY
Contractual Obligations
APS’ future contractual obligations have not changed materially from the amounts disclosed in Part II, Item 7 of the 2004 Form 10-K. See Note S-1 for a list of APS’ payments due on total long-term debt and capitalized lease requirements.
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RISK FACTORS
Exhibit 99.1 and Exhibit 99.2, which are hereby incorporated by reference, contain a discussion of risk factors affecting Pinnacle West and APS, respectively.
FORWARD-LOOKING STATEMENTS
This document contains forward-looking statements based on current expectations, and neither Pinnacle West nor APS assumes any obligation to update these statements or make any further statements on any of these issues, except as required by applicable law. These forward-looking statements are often identified by words such as “estimate,” “predict,” “hope,” “may,” “believe,” “anticipate,” “plan,” “expect,” “require,” “intend,” “assume” and similar words. Because actual results may differ materially from expectations, we caution readers not to place undue reliance on these statements. A number of factors could cause future results to differ materially from historical results, or from results or outcomes currently expected or sought by Pinnacle West or APS. In addition to the “Risk Factors” described in Exhibits 99.1 and 99.2 to this report, these factors include, but are not limited to:
| • | state and federal regulatory and legislative decisions and actions, including by the FERC; | |||
| • | the ongoing restructuring of the electric industry, including the introduction of retail electric competition in Arizona and decisions impacting wholesale competition; | |||
| • | the outcome of regulatory, legislative and judicial proceedings relating to the restructuring; | |||
| • | market prices for electricity and natural gas; | |||
| • | power plant performance and outages; | |||
| • | transmission outages and constraints; | |||
| • | weather variations affecting local and regional customer energy usage; | |||
| • | customer growth and energy usage; | |||
| • | regional economic and market conditions, including the results of litigation and other proceedings resulting from the California energy situation, volatile purchased power and fuel costs and the completion of generation and transmission construction in the region, which could affect customer growth and the cost of power supplies; | |||
| • | the cost of debt and equity capital and access to capital markets; | |||
| • | the uncertainty that current credit ratings will remain in effect for any given period of time; | |||
| • | our ability to compete successfully outside traditional regulated markets (including the wholesale market); | |||
| • | the performance of our marketing and trading activities due to volatile market liquidity and any deteriorating counterparty credit and the use of derivative contracts in our business (including the interpretation of the subjective and complex accounting rules related to these contracts); | |||
| • | changes in accounting principles generally accepted in the United States of America and the interpretation of those principles; | |||
| • | the performance of the stock market and the changing interest rate environment, which affect the amount of required contributions to Pinnacle West’s pension plan and APS’ nuclear decommissioning trust funds, as well as the reported costs of providing pension and other postretirement benefits; | |||
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| • | technological developments in the electric industry; | |||
| • | the strength of the real estate market in SunCor’s market areas, which include Arizona, Idaho, New Mexico and Utah; and | |||
| • | other uncertainties, all of which are difficult to predict and many of which are beyond the control of Pinnacle West and APS. | |||
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Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
See “Pinnacle West Consolidated – Factors Affecting Our Financial Outlook” in Item 2 above for a discussion of quantitative and qualitative disclosures about market risks.
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ITEM 4. CONTROLS AND PROCEDURES
(a) Disclosure Controls and Procedures
The term “disclosure controls and procedures” means controls and other procedures of a company that are designed to ensure that information required to be disclosed by a company in the reports that it files or submits under the Securities Exchange Act of 1934 (the “Exchange Act”) (15 U.S.C. 78aet seq.) is recorded, processed, summarized and reported, within the time periods specified in the SEC’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by a company in the reports that it files or submits under the Exchange Act is accumulated and communicated to a company’s management, including its principal executive and principal financial officers, or persons performing similar functions, as appropriate to allow timely decisions regarding required disclosure.
Pinnacle West’s management, with the participation of Pinnacle West’s Chief Executive Officer and Chief Financial Officer, have evaluated the effectiveness of Pinnacle West’s disclosure controls and procedures as of March 31, 2005. Based on that evaluation, Pinnacle West’s Chief Executive Officer and Chief Financial Officer have concluded that, as of that date, Pinnacle West’s disclosure controls and procedures were effective.
APS’ management, with the participation of APS’ Chief Executive Officer and Chief Financial Officer, have evaluated the effectiveness of APS’ disclosure controls and procedures as of March 31, 2005. Based on that evaluation, APS’ Chief Executive Officer and Chief Financial Officer have concluded that, as of that date, APS’ disclosure controls and procedures were effective.
(b) Changes In Internal Control Over Financial Reporting
The term “internal control over financial reporting” (defined in SEC Rule 13a-15(f)) refers to the process of a company that is designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with GAAP.
No change in Pinnacle West’s or APS’ internal control over financial reporting occurred during the fiscal quarter ended March 31, 2005 that materially affected, or is reasonably likely to materially affect, Pinnacle West’s or APS’ internal control over financial reporting.
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Part II — OTHER INFORMATION
Item 1. LEGAL PROCEEDINGS
See Note 12 of Notes to Condensed Consolidated Financial Statements in regard to pending or threatened litigation or other disputes.
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 construction and financing programs of the Company and its subsidiaries.
Regulatory Matters
See Note 5 of Notes to Condensed Consolidated Financial Statements in Part I, Item 1 of this report for a discussion of regulatory developments.
Environmental Matters
See “Environmental Matters — Superfund” in Note 12 of Notes to Condensed Consolidated Financial Statements for a discussion of a Superfund site.
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Item 6. EXHIBITS
(a) Exhibits
| Exhibit No. | Registrant(s) | Description | ||
| 12.1 | Pinnacle West | Ratio of Earnings to Fixed Charges | ||
| 12.2 | APS | Ratio of Earnings to Fixed Charges | ||
| 31.1 | Pinnacle West | Certificate of William J. Post, Chief Executive Officer, pursuant to Rule 13a-14(a) and Rule 15d-14(a) of the Securities Exchange Act, as amended | ||
| 31.2 | Pinnacle West | Certificate of Donald E. Brandt, Chief Financial Officer, pursuant to Rule 13a-14(a) and Rule 15d-14(a) of the Securities Exchange Act, as amended | ||
| 31.3 | APS | Certificate of Jack E. Davis, Chief Executive Officer, pursuant to Rule 13a-14(a) and Rule 15d-14(a) of the Securities Exchange Act, as amended | ||
| 31.4 | APS | Certificate of Donald E. Brandt, Chief Financial Officer, pursuant to Rule 13a-14(a) and Rule 15d-14(a) of the Securities Exchange Act, as amended | ||
| 32.1 | Pinnacle West | Certification of Chief Executive Officer and Chief Financial Officer, pursuant to 18 U.S.C. Section 1850, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 | ||
| 32.2 | APS | Certification of Chief Executive Officer and Chief Financial Officer, pursuant to 18 U.S.C. Section 1850, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 | ||
| 99.1 | Pinnacle West | Pinnacle West Risk Factors | ||
| 99.2 | APS | APS Risk Factors | ||
| 99.3 | Pinnacle West | Reconciliation of Operating Income to Gross Margin |
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| Exhibit No. | Registrant(s) | Description | ||
| 99.4 | APS | Reconciliation of Operating Income to Gross Margin | ||
| 99.5 | Pinnacle West/APS | Opinion and Order, ACC Decision No. 67744 dated April 7, 2005 (see Exhibit No. 99.6 below for Attachment A to the Opinion and Order, the 2004 Settlement Agreement) |
In addition, the Company hereby incorporates the following Exhibits pursuant to Exchange Act Rule 12b-32 and Regulation §229.10(d) by reference to the filings set forth below:
| Exhibit | Date | |||||||
| No. | Registrant(s) | Description | Previously Filed as Exhibit 1 | Effective | ||||
| 3.1 | Pinnacle West | Articles of Incorporation, restated as of July 29, 1988 | 19.1 to Pinnacle West’s September 1988 Form 10-Q Report, File No. 1-8962 | 11-14-88 | ||||
| 3.2 | Pinnacle West | Pinnacle West Capital Corporation Bylaws, amended as of June 23, 2004 | 3.1 to Pinnacle West’s June 30, 2004 Form 10-Q Report, File No. 1-8962 | 8-9-04 | ||||
| 3.3 | APS | Articles of Incorporation, restated as of May 25, 1988 | 4.2 to APS’ Form S-3 Registration Nos. 33-33910 and 33-55248 by means of September 24, 1993 Form 8-K Report, File No. 1-4473 | 9-29-93 | ||||
| 3.4 | APS | Arizona Public Service Company Bylaws, amended as of June 23, 2004 | 3.1 to APS’ June 30, 2004 Form 10-Q Report, File No. 1-4473 | 8-9-04 | ||||
| 99.6 | Pinnacle West APS | 2004 Settlement Agreement dated August 18, 2004 | 99.1 to Pinnacle West’s August 18, 2004 Form 8-K Report, File No. 1-8962 | 8-18-04 |
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, each registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
| PINNACLE WEST CAPITAL CORPORATION (Registrant) | ||||||
| Dated: May 9, 2004 | By: | /s/ Donald E. Brandt | ||||
| Donald E. Brandt | ||||||
| Executive Vice President and Chief | ||||||
| Financial Officer | ||||||
| (Principal Financial Officer | ||||||
| and Officer Duly Authorized to sign this Report) | ||||||
| ARIZONA PUBLIC SERVICE COMPANY (Registrant) | ||||||
| Dated: May 9, 2004 | By: | /s/ Donald E. Brandt | ||||
| Donald E. Brandt | ||||||
| Executive Vice President and Chief | ||||||
| Financial Officer | ||||||
| (Principal Financial Officer | ||||||
| and Officer Duly Authorized to sign this Report) |
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Exhibit Index
| Exhibit No. | Registrant(s) | Description | ||
| 12.1 | Pinnacle West | Ratio of Earnings to Fixed Charges | ||
| 12.2 | APS | Ratio of Earnings to Fixed Charges | ||
| 31.1 | Pinnacle West | Certificate of William J. Post, Chief Executive Officer, pursuant to Rule 13a-14(a) and Rule 15d-14(a) of the Securities Exchange Act, as amended | ||
| 31.2 | Pinnacle West | Certificate of Donald E. Brandt, Chief Financial Officer, pursuant to Rule 13a-14(a) and Rule 15d-14(a) of the Securities Exchange Act, as amended | ||
| 31.3 | APS | Certificate of Jack E. Davis, Chief Executive Officer, pursuant to Rule 13a-14(a) and Rule 15d-14(a) of the Securities Exchange Act, as amended | ||
| 31.4 | APS | Certificate of Donald E. Brandt, Chief Financial Officer, pursuant to Rule 13a-14(a) and Rule 15d-14(a) of the Securities Exchange Act, as amended | ||
| 32.1 | Pinnacle West | Certification of Chief Executive Officer and Chief Financial Officer, pursuant to 18 U.S.C. Section 1850, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 | ||
| 32.2 | APS | Certification of Chief Executive Officer and Chief Financial Officer, pursuant to 18 U.S.C. Section 1850, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 | ||
| 99.1 | Pinnacle West | Pinnacle West Risk Factors | ||
| 99.2 | APS | APS Risk Factors | ||
| 99.3 | Pinnacle West | Reconciliation of Operating Income to Gross Margin | ||
| 99.4 | APS | Reconciliation of Operating Income to Gross Margin | ||
| 99.5 | Pinnacle West/APS | Opinion and Order, ACC Decision No. 67744 dated April 7, 2005 |
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