FORM 10-Q
Securities and Exchange Commission
Washington, D.C. 20549
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the quarterly period ended March 31, 1998
--------------------------
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from to
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Commission file number 1-4473
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ARIZONA PUBLIC SERVICE COMPANY
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(Exact name of registrant as specified in its charter)
Arizona 86-0011170
- ------------------------------ -------------------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
400 North Fifth Street, P.O. Box 53999, Phoenix, Arizona 85072-3999
- -------------------------------------------------------- ----------
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (602) 250-1000
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(Former name, former address and former fiscal year, if changed since last
report)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes X No
----- -----
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.
Number of shares of common stock, $2.50 par value,
outstanding as of May 15, 1998: 71,264,947
Glossary
--------
ACC - Arizona Corporation Commission
ACC Staff - Staff of the Arizona Corporation Commission
Cholla - Cholla Power Plant
Company - Arizona Public Service Company
EITF - Emerging Issues Task Force
EITF 97-4 - Emerging Issues Task Force Issue No. 97-4, "Deregulation of the
Pricing of Electricity --- Issues Related to the Applications of FASB Statements
No. 71, Accounting for the Effects of Certain Types of Regulation, and No. 101,
Regulated Enterprises --- Accounting for the Discontinuation of Application of
FASB Statement No. 71"
EPA - United States Environmental Protection Agency
FERC - Federal Energy Regulatory Commission
Four Corners - Four Corners Power Plant
ITC - Investment tax credit
1997 10-K - Arizona Public Service Company Annual Report on Form 10-K for the
fiscal year ended December 31, 1997
NGS - Navajo Generating Station
Palo Verde - Palo Verde Nuclear Generating Station
Pinnacle West - Pinnacle West Capital Corporation
Power Coordination Agreement - 1955 agreement between the Company and Salt River
Project that provides for certain electric system and power sales
Rules - Rules adopted by the ACC for the introduction of retail electric
competition in Arizona
SFAS No. 71 - Statement of Financial Accounting Standards No. 71, "Accounting
for the Effects of Certain Types of Regulation"
SFAS No. 130 - Statement of Financial Accounting Standards No. 130, "Reporting
Comprehensive Income"
SFAS No. 131 - Statement of Financial Accounting Standards No. 131, "Disclosures
about Segments of an Enterprise and Related Information"
SFAS No. 132 - Statement of Financial Accounting Standards No. 132, "Employers'
Disclosures about Pensions and Other Postretirement Benefits"
Salt River Project - Salt River Project Agricultural Improvement and Power
District
Territorial Agreement - 1955 agreement between the Company and Salt River
Project that has provided exclusive retail service territories in Arizona as
against each other
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PART I - FINANCIAL INFORMATION
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Item 1. Financial Statements
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ARIZONA PUBLIC SERVICE COMPANY
CONDENSED STATEMENTS OF INCOME
------------------------------
(Unaudited)
Three Months
Ended March 31,
----------------------
1998 1997
--------- ---------
(Thousands of Dollars)
ELECTRIC OPERATING REVENUES .......................... $ 380,423 $ 379,021
--------- ---------
FUEL EXPENSES:
Fuel for electric generation ....................... 50,328 51,122
Purchased power .................................... 23,589 34,347
--------- ---------
Total ........................................... 73,917 85,469
--------- ---------
OPERATING REVENUES LESS FUEL EXPENSES ................ 306,506 293,552
--------- ---------
OTHER OPERATING EXPENSES:
Operations and maintenance excluding fuel expenses . 96,416 88,016
Depreciation and amortization ...................... 92,147 92,015
Income taxes ....................................... 24,464 22,292
Other taxes ........................................ 29,938 29,790
--------- ---------
Total ........................................... 242,965 232,113
--------- ---------
OPERATING INCOME ..................................... 63,541 61,439
--------- ---------
OTHER INCOME (DEDUCTIONS):
Other - net ........................................ (2,396) (2,209)
Income taxes ....................................... 4,455 4,340
--------- ---------
Total ........................................... 2,059 2,131
--------- ---------
INCOME BEFORE INTEREST DEDUCTIONS .................... 65,600 63,570
--------- ---------
INTEREST DEDUCTIONS:
Interest on long-term debt ......................... 35,183 34,429
Interest on short-term borrowings .................. 684 2,328
Debt discount, premium and expense ................. 1,949 2,002
Capitalized interest ............................... (4,151) (3,834)
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Total ........................................... 33,665 34,925
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NET INCOME ........................................... 31,935 28,645
PREFERRED STOCK DIVIDEND REQUIREMENTS ................ 2,878 3,626
--------- ---------
EARNINGS FOR COMMON STOCK ............................ $ 29,057 $ 25,019
========= =========
See Notes to Condensed Financial Statements.
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ARIZONA PUBLIC SERVICE COMPANY
CONDENSED STATEMENTS OF INCOME
------------------------------
(Unaudited)
Twelve Months
Ended March 31,
--------------------------
1998 1997
----------- -----------
(Thousands of Dollars)
ELECTRIC OPERATING REVENUES ........................ $ 1,879,955 $ 1,752,032
----------- -----------
FUEL EXPENSES:
Fuel for electric generation ..................... 200,547 239,181
Purchased power .................................. 224,528 115,539
----------- -----------
Total ......................................... 425,075 354,720
----------- -----------
OPERATING REVENUES LESS FUEL EXPENSES .............. 1,454,880 1,397,312
----------- -----------
OTHER OPERATING EXPENSES:
Operations and maintenance excluding fuel expenses 407,834 430,987
Depreciation and amortization .................... 365,803 330,839
Income taxes ..................................... 186,909 169,446
Other taxes ...................................... 120,407 116,915
----------- -----------
Total ......................................... 1,080,953 1,048,187
----------- -----------
OPERATING INCOME ................................... 373,927 349,125
----------- -----------
OTHER INCOME (DEDUCTIONS):
AFUDC - equity ................................... -- 3,534
Other - net ...................................... (10,014) (17,462)
Income taxes ..................................... 31,528 44,242
----------- -----------
Total ......................................... 21,514 30,314
----------- -----------
INCOME BEFORE INTEREST DEDUCTIONS .................. 395,441 379,439
----------- -----------
INTEREST DEDUCTIONS:
Interest on long-term debt ....................... 141,685 144,695
Interest on short-term borrowings ................ 7,760 10,279
Debt discount, premium and expense ............... 7,738 8,061
Capitalized interest ............................. (16,525) (10,106)
----------- -----------
Total ......................................... 140,658 152,929
----------- -----------
NET INCOME ......................................... 254,783 226,510
PREFERRED STOCK DIVIDEND REQUIREMENTS .............. 12,055 16,241
----------- -----------
EARNINGS FOR COMMON STOCK .......................... $ 242,728 $ 210,269
=========== ===========
See Notes to Condensed Financial Statements.
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ARIZONA PUBLIC SERVICE COMPANY
CONDENSED BALANCE SHEETS
------------------------
ASSETS
(Unaudited)
March 31, December 31,
1998 1997
----------- ------------
(Thousands of Dollars)
UTILITY PLANT:
Electric plant in service and held for future use $ 7,024,991 $ 7,009,059
Less accumulated depreciation and amortization ... 2,685,184 2,620,607
----------- -----------
Net ........................................... 4,339,807 4,388,452
Construction work in progress .................... 270,147 237,492
Nuclear fuel, net of amortization ................ 58,737 51,624
----------- -----------
Utility plant - net ........................... 4,668,691 4,677,568
----------- -----------
INVESTMENTS AND OTHER ASSETS ..................... 167,243 164,906
----------- -----------
CURRENT ASSETS:
Cash and cash equivalents ........................ 8,936 12,552
Accounts receivable:
Service customers ............................. 112,208 141,022
Other ......................................... 17,847 31,313
Allowance for doubtful accounts ............... (981) (1,338)
Accrued utility revenues ......................... 49,531 58,559
Materials and supplies, at average cost .......... 72,902 70,634
Fossil fuel, at average cost ..................... 10,854 9,621
Deferred income taxes ............................ 3,496 3,496
Other ............................................ 27,013 24,529
----------- -----------
Total current assets .......................... 301,806 350,388
----------- -----------
DEFERRED DEBITS:
Regulatory asset for income taxes ................ 444,887 458,369
Rate synchronization cost deferral ............... 345,068 358,871
Unamortized costs of reacquired debt ............. 61,592 63,501
Unamortized debt issue costs ..................... 15,576 15,303
Other ............................................ 236,254 242,236
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Total deferred debits ......................... 1,103,377 1,138,280
----------- -----------
TOTAL ......................................... $ 6,241,117 $ 6,331,142
=========== ===========
See Notes to Condensed Financial Statements.
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ARIZONA PUBLIC SERVICE COMPANY
CONDENSED BALANCE SHEETS
------------------------
LIABILITIES
(Unaudited)
March 31, December 31,
1998 1997
------------ ------------
(Thousands of Dollars)
CAPITALIZATION:
Common stock ............................................... $ 178,162 $ 178,162
Premiums and expenses - net ................................ 1,142,499 1,142,364
Retained earnings .......................................... 472,853 528,798
---------- ----------
Common stock equity ..................................... 1,793,514 1,849,324
Non-redeemable preferred stock ............................. 141,317 142,051
Redeemable preferred stock ................................. 19,110 29,110
Long-term debt less current maturities ..................... 2,019,248 1,953,162
---------- ----------
Total capitalization .................................... 3,973,189 3,973,647
---------- ----------
CURRENT LIABILITIES:
Commercial paper ........................................... 81,000 130,750
Current maturities of long-term debt ....................... 4,068 104,068
Accounts payable ........................................... 72,467 107,423
Accrued taxes .............................................. 141,148 85,886
Accrued interest ........................................... 26,247 31,660
Common dividends payable ................................... 42,500 --
Customer deposits .......................................... 28,788 29,116
Other ...................................................... 29,094 19,588
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Total current liabilities ............................... 425,312 508,491
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DEFERRED CREDITS AND OTHER:
Deferred income taxes ...................................... 1,337,255 1,345,177
Deferred investment tax credit ............................. 56,639 60,093
Unamortized gain - sale of utility plant ................... 81,219 82,363
Customer advances for construction ......................... 30,083 29,294
Other ...................................................... 337,420 332,077
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Total deferred credits and other ........................ 1,842,616 1,849,004
---------- ----------
COMMITMENTS AND CONTINGENCIES (Notes 5, 8, and 9)
TOTAL ................................................... $6,241,117 $6,331,142
========== ==========
See Notes to Condensed Financial Statements.
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ARIZONA PUBLIC SERVICE COMPANY
CONDENSED STATEMENTS OF CASH FLOWS
----------------------------------
(Unaudited)
Three Months
Ended March 31,
----------------------
1998 1997
--------- ---------
(Thousands of Dollars)
Cash Flows from Operating Activities:
Net income ......................................... $ 31,935 $ 28,645
Items not requiring cash:
Depreciation and amortization .................... 92,147 92,015
Nuclear fuel amortization ........................ 8,417 7,523
Deferred income taxes - net ...................... (7,010) (8,948)
Deferred investment tax credit - net ............. (3,454) (3,380)
Changes in certain current assets and liabilities:
Accounts receivable - net ........................ 41,923 24,589
Accrued utility revenues ......................... 9,028 6,244
Materials, supplies and fossil fuel .............. (3,501) 2,196
Other current assets ............................. (2,484) (2,024)
Accounts payable ................................. (33,020) (48,355)
Accrued taxes .................................... 55,262 47,992
Accrued interest ................................. (5,413) (14,482)
Other current liabilities ........................ 7,528 4,313
Other - net ........................................ 13,730 28,385
--------- ---------
Net cash flow provided by operating activities ....... 205,088 164,713
--------- ---------
Cash Flows from Investing Activities:
Capital expenditures ............................... (60,848) (77,129)
Capitalized interest ............................... (4,151) (3,834)
Other .............................................. (2,533) (4,046)
--------- ---------
Net cash flow used for investing activities .... (67,532) (85,009)
--------- ---------
Cash Flows from Financing Activities:
Long-term debt ..................................... 99,375 --
Short-term borrowings - net ........................ (49,750) 199,400
Dividends paid on common stock ..................... (42,500) (42,500)
Dividends paid on preferred stock .................. (2,964) (3,897)
Repayment of preferred stock ....................... (10,599) (25,980)
Repayment and reacquisition of long-term debt ...... (134,734) (193,056)
--------- ---------
Net cash flow used for financing activities .... (141,172) (66,033)
--------- ---------
Net increase (decrease) in cash and cash equivalents . (3,616) 13,671
Cash and cash equivalents at beginning of period ..... 12,552 12,521
--------- ---------
Cash and cash equivalents at end of period ........... $ 8,936 $ 26,192
========= =========
Supplemental Disclosure of Cash Flow Information:
Cash paid during the period for:
Interest (excluding capitalized interest) ........ $ 37,072 $ 48,051
Income taxes ..................................... $ 1,250 $ 9,814
See Notes to Condensed Financial Statements.
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ARIZONA PUBLIC SERVICE COMPANY
NOTES TO CONDENSED FINANCIAL STATEMENTS
1. In the opinion of the Company, the accompanying unaudited condensed financial
statements contain all adjustments (consisting of normal recurring accruals)
necessary to present fairly the financial position of the Company as of March
31, 1998, the results of operations for the three months and twelve months ended
March 31, 1998 and 1997, and the cash flows for the three months ended March 31,
1998 and 1997. It is suggested that these condensed financial statements and
notes to condensed financial statements be read in conjunction with the
financial statements and notes to financial statements included in the 1997
10-K.
2. The Company's operations are subject to seasonal fluctuations, with
variations in energy usage by customers occurring from season to season and from
month to month within a season, primarily as a result of changing weather
conditions. For this and other reasons, the results of operations for interim
periods are not necessarily indicative of the results to be expected for the
full year.
3. All the outstanding shares of common stock of the Company are owned by
Pinnacle West.
4. See "Liquidity and Capital Resources" in Part I, Item 2 of this report for
changes in capitalization for the three months ended March 31, 1998.
5. Regulatory Matters --- Electric Industry Restructuring
State
ACC Rules. The ACC has been conducting an ongoing investigation into the
restructuring of the Arizona electric industry. In December 1996, the ACC
adopted rules that provide a framework for the introduction of retail electric
competition. The ACC framework rules include the following major provisions:
o The rules are intended to apply to virtually all of the Arizona electric
utilities regulated by the ACC, including the Company.
o Each affected utility would be required to make available at least 20% of
its 1995 system retail peak demand for competitive generation supply to all
customer classes not later than January 1, 1999; at least 50% not later
than January 1, 2001; and all of its retail demand not later than January
1, 2003.
o Electric service providers that obtain Certificates of Convenience and
Necessity (CC&Ns) from the ACC would be allowed to supply, market, and/or
broker specified electric services at retail. These services would include
electric generation, but exclude electric transmission and distribution.
-8-
o On or before December 31, 1997, each affected utility was required to file
with the ACC proposed tariffs for bundled service, if different than
current tariffs, and unbundled service. Bundled service means electric
service elements (i.e., generation, transmission, distribution, and
ancillary services) provided as a package to consumers within an affected
utility's current service area. Unbundled service means electric service
elements provided and priced separately.
o The rules indicate that the ACC will allow recovery of unmitigated stranded
costs. Stranded costs are the costs of generating plants, other assets and
contract commitments that were prudently incurred to serve power customers
that could go unrecovered if these customers are allowed to use open access
to move to another supplier. Each affected utility would be required to
file with the ACC its estimates of unmitigated stranded costs. The ACC
would then, after hearing and consideration of various factors, determine
the magnitude of stranded costs and appropriate stranded cost recovery
mechanisms and charges.
The ACC ordered in the rules that numerous issues (including reliability;
stranded cost measurement and recovery; the phase-in process, bundled, unbundled
and metering services; legal issues; and independent system operator and spot
market development) require additional consideration prior to implementation of
retail electric competition. During 1997, the ACC conducted workshops to gather
input from various constituencies with respect to those issues. In 1998, the ACC
has continued conducting workshops on certain of the issues.
In February 1998, the ACC completed a formal, generic hearing on stranded cost
determination and recovery. Based on various assumptions, estimates and
methodologies, the Company currently estimates that its stranded costs to be
recovered (excluding regulatory assets which have already been addressed by the
ACC) will be less than $500 million. The Company is seeking full recovery of
stranded costs during a transition period proposed to go through 2006. On May 6,
1998, an ACC Hearing Officer issued a Recommended Decision in the above
proceeding that, although recommending an opportunity for full recovery of the
Company's stranded costs, would impose certain conditions and restrictions on
stranded cost recovery. However, final decisions by the ACC have not yet been
made with respect to this issue.
The Company believes that certain provisions of the ACC framework rules are
deficient. In February 1997, a lawsuit was filed by the Company to protect its
legal rights regarding those rules. That lawsuit is pending but two related
cases filed by other utilities have been partially decided in a manner adverse
to those utilities' positions.
Legislative Initiatives. An Arizona joint legislative committee studied electric
utility industry restructuring issues in 1996 and 1997. In conjunction with that
study, Arizona legislative counsel prepared memoranda in late 1997 related to
the legal authority of
-9-
the ACC to deregulate the Arizona electric utility industry. The memoranda raise
a question as to the degree to which the ACC may, under the Arizona
Constitution, deregulate any portion of the electric utility industry and allow
rates to be determined by market forces. This latter issue (the ability of the
ACC to set rates based on the competitive market) was decided in favor of the
ACC in the related lawsuits referenced in the preceding paragraph.
In May 1998, the final version of a bill to facilitate implementation of retail
electric competition in the state was approved by the House/Senate conference
committee of the Arizona legislature. The bill includes the following major
provisions: (a) requirements that Arizona's largest government-operated electric
utility (Salt River Project) and, at their option, smaller city electric systems
(i) open their service territories to electric service providers to implement
retail electric generation competition for 20% of each utility's 1995 retail
peak demand by December 31, 1998 and for all retail customers by December 31,
2000; (ii) decrease rates by at least 10% over a ten-year period beginning as
early as January 1, 1991; (iii) implement procedures and public processes,
including judicial review at the request of either an interested party or the
Arizona Attorney General, for establishing the terms, conditions and pricing of
electric services as well as certain other decisions affecting retail electric
competition, which procedures and processes are comparable to those already
applicable to public service corporations; (b) a description of the factors
which form the basis of consideration by Salt River Project in determining
stranded costs; and (c) a requirement, both for public power entities and public
service corporations (including the Company), that billing, collection, metering
and meter reading services be provided on a competitive basis during the first
two years of competition only for customers having demands in excess of one
megawatt (and that are eligible for competitive generation services), and
thereafter for all customers receiving competitive electric generation.
The legislature will also review and make recommendations for the 1999 Arizona
legislature on certain issues, including: whether public power entities excluded
from the current bill should be included; taxation issues associated with
electric competition; regulation of public power entities outside their service
territory; constitutional issues relating to facilitating electric competition;
system priority, capacity, capability and reliability; antitrust issues; and
public power entities compliance with the code of conduct and affiliate issues
between competitive and noncompetitive service electricity providers. The bill
now goes to the Arizona House and Senate for a final vote and, if passed, to the
Governor for consideration.
Federal
The Energy Policy Act of 1992 and recent rulemakings by FERC have promoted
increased competition in the wholesale electric power markets. The Company does
not expect these rules to have a material impact on its financial statements.
Several electric utility reform bills have been introduced during recent
congressional sessions, which as currently written, would allow consumers to
choose their electricity suppliers by 2000 or 2003. These bills, other bills
that are expected to be introduced,
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and ongoing discussions at the federal level suggest a wide range of opinion
that will need to be narrowed before any substantial restructuring of the
electric utility industry can occur.
Regulatory Accounting
The Company prepares its financial statements in accordance with the provisions
of Statement of Financial Accounting Standards (SFAS) No. 71, "Accounting for
the Effects of Certain Types of Regulation." SFAS No. 71 requires a cost-based,
rate-regulated enterprise to reflect the impact of regulatory decisions in its
financial statements. The Company's existing regulatory orders and current
regulatory environment support its accounting practices related to regulatory
assets, which amounted to approximately $0.9 billion at March 31, 1998. In
accordance with the 1996 regulatory agreement, the ACC accelerated the
amortization of substantially all of the Company's regulatory assets to an
eight-year period that began July 1, 1996.
During 1997, the Emerging Issues Task Force (EITF) of the Financial Accounting
Standards Board (FASB) issued EITF 97-4, which requires that SFAS No. 71 be
discontinued no later than when legislation is passed or a rate order is issued
that contains sufficient detail to determine its effect on the portion of the
business being deregulated, which could result in write-downs or write-offs of
physical and/or regulatory assets. Additionally, the EITF determined that
regulatory assets should not be written off if they are to be recovered from a
portion of the entity which continues to apply SFAS No. 71.
Although the ACC has issued rules for transitioning generation services to
competition, there are many unresolved issues. The Company continues to apply
SFAS No. 71 to all of its operations. If rate recovery of regulatory assets is
no longer probable, whether due to competition or regulatory action, the Company
would be required to write off the remaining balance as an extraordinary charge
to expense.
General
The Company believes that further ACC decisions, legislation at the Arizona and
federal levels and perhaps amendments to the Arizona Constitution (which
amendments would require a vote of the people) will ultimately be required
before significant implementation of retail electric competition can lawfully
occur in Arizona. Until the manner of implementation of competition, including
addressing stranded costs, is determined, the Company cannot accurately predict
the impact of full retail competition on its financial position, cash flows or
results of operation. As competition in the electric industry continues to
evolve, the Company will continue to evaluate strategies and alternatives that
will position the Company to compete in the new regulatory environment.
-11-
6. Regulatory Matters --- 1996 Regulatory Agreement
In April 1996, the ACC approved a regulatory agreement between the Company and
the ACC Staff. The major provisions of this agreement are:
o An annual rate reduction of approximately $48.5 million ($29 million after
income taxes), or 3.4% on average for all customers except certain contract
customers, effective July 1, 1996.
o Recovery of substantially all of the Company's present regulatory assets
through accelerated amortization over an eight-year period that began July
1, 1996, increasing annual amortization by approximately $120 million ($72
million after income taxes).
o A formula for sharing future cost savings between customers and
shareholders (price reduction formula) referencing a return on equity (as
defined) of 11.25%.
o A moratorium on filing for permanent rate changes prior to July 2, 1999,
except under the price reduction formula and under certain other limited
circumstances.
o Infusion of $200 million of common equity into the Company by Pinnacle
West, in annual payments of $50 million starting in 1996.
Pursuant to the price reduction formula, in May 1997, the ACC approved a retail
price decrease of approximately $17.6 million ($10.5 million after income
taxes), or 1.2%, effective July 1, 1997. In March 1998, the Company filed with
the ACC its calculation of an annual price reduction of approximately $17
million ($10 million after income taxes), or 1.1%, to become effective July 1,
1998. The amount and timing of the price decrease are subject to ACC approval.
7. Agreement with Salt River Project
On April 25, 1998, the Company and Salt River Project entered into a Memorandum
of Agreement in anticipation of, and to facilitate, the opening of the Arizona
electric industry. The Agreement contains the following major components (some
of which are subject to approval of their respective Boards of Directors):
o The Company and Salt River Project would amend the Territorial Agreement to
remove any barriers to the provision of competitive electricity supply and
non-distribution services.
o The Company and Salt River Project would amend the Power Coordination
Agreement to lower the price that the Company will pay Salt River Project
for purchased power by approximately $17 million (pretax) in 1999 and by
lesser annual amounts through 2006.
-12-
o The Company and Salt River Project agreed on certain legislative positions
regarding electric utility restructuring at the state and federal level.
An ACC docket has been established so that the ACC may review certain provisions
of the Agreement. The ACC Staff has requested the ACC Hearing Devision to issue
a procedural order to govern the proceedings before the ACC on this matter. In
its request, the ACC Staff identified certain issues that it believes the ACC
should consider, including whether (a) the Territorial Agreement remains in the
public interest, (b) the Agreement is a restraint of trade, and (c) the
Agreement will materially lessen the potential for retail electric competition
in Arizona. The Company cannot predict what action, if any, will result from any
ACC hearings that may be held with respect to the Agreement.
The Antitrust Unit of the Arizona Attorney General's Office, which has been
involved in the ongoing regulatory and legislative proceedings regarding the
restructuring of the Arizona electric industry, has requested clarification of
the operation of certain of the Agreement's provisions. The Company is currently
engaged in discussions with the Arizona Attorney General's Office regarding this
matter.
8. The Palo Verde participants have insurance for public liability payments
resulting from nuclear energy hazards to the full limit of liability under
federal law. This potential liability is covered by primary liability insurance
provided by commercial insurance carriers in the amount of $200 million and the
balance by an industry-wide retrospective assessment program. If losses at any
nuclear power plant covered by the programs exceed the accumulated funds, the
Company could be assessed retrospective premium adjustments. The maximum
assessment per reactor under the program for each nuclear incident is
approximately $79 million, subject to an annual limit of $10 million per
incident. Based upon the Company's 29.1% interest in the three Palo Verde units,
the Company's maximum potential assessment per incident is approximately $69
million, with an annual payment limitation of approximately $9 million.
The Palo Verde participants maintain "all risk" (including nuclear hazards)
insurance for property damage to, and decontamination of, property at Palo Verde
in the aggregate amount of $2.75 billion, a substantial portion of which must
first be applied to stabilization and decontamination. The Company has also
secured insurance against portions of any increased cost of generation or
purchased power and business interruption resulting from a sudden and unforeseen
outage of any of the three units. The insurance coverage discussed in this and
the previous paragraph is subject to certain policy conditions and exclusions.
9. The Company has encountered tube cracking in the Palo Verde steam generators
and has taken, and will continue to take, remedial actions that it believes have
slowed the rate of tube degradation. The projected service life of the steam
generators is reassessed periodically and these analyses indicate that it will
be economically desirable for the Company to replace the Unit 2 steam generators
between 2003 and 2008. The Company
-13-
estimates that its share of the replacement costs (in 1998 dollars and including
installation and replacement power costs) will be approximately $50 million,
most of which will be incurred after the year 2000. During the fourth quarter of
1997, the Palo Verde participants, including the Company, entered into a
contract for the fabrication of two replacement steam generators. The cost to
the Company is estimated at approximately $26 million. These generators will be
used as replacements if performance of existing generators deteriorates to less
than acceptable levels. The generators are expected on site in 2002. The
Company's share of installation costs is approximately $24 million. Based on the
latest available data, the Company estimates that the Unit 1 and Unit 3 steam
generators should operate for the license periods (until 2025 and 2027,
respectively), although the Company will continue its normal periodic assessment
of these steam generators.
10. In the first quarter of 1998 the Company adopted SFAS No. 130, "Reporting
Comprehensive Income." This standard changed the reporting of certain items
previously reported in the common stock equity section of the balance sheet. The
effects of adopting SFAS No. 130 were not material to the Company's financial
statements.
The Financial Accounting Standards Board issued SFAS No. 131 on "Disclosures
about Segments of an Enterprise and Related Information" and SFAS No. 132,
"Employers' Disclosures about Pensions and Other Postretirement Benefits," both
of which are effective for fiscal years beginning after December 15, 1997. SFAS
No. 131 requires that public companies report certain information about
operating segments in their financial statements. It also establishes related
disclosures about products and services, geographic areas, and major customers.
The Company is currently evaluating what impact this standard will have on its
disclosures. SFAS No. 132 standardizes the disclosure requirements for pensions
and other postretirement benefits. It is not expected to have a material effect
on the Company's financial statement disclosures.
-14-
ARIZONA PUBLIC SERVICE COMPANY
Item 2. Management's Discussion and Analysis of Financial Condition and Results
------------------------------------------------------------------------
of Operations.
- --------------
Operating Results
- -----------------
The following table summarizes the Company's revenues and earnings for
the three-month and twelve-month periods ended March 31, 1998 and 1997:
Periods ended March 31
(Thousands of Dollars)
Three Months Twelve Months
------------------------ ------------------------
1998 1997 1998 1997
------------------------ ------------------------
Operating Revenues $ 380,423 $ 379,021 $1,879,955 $1,752,032
Earnings for
Common stock $ 29,057 $ 25,019 $ 242,728 $ 210,269
Operating Results - Three-month period ended March 31, 1998 compared
-----------------------------------------------------------------------
with three-month period ended March 31, 1997
--------------------------------------------
Earnings increased $4 million in the three-month comparison primarily
because of strong customer growth, partially offset by increased operations and
maintenance expenses.
Operating revenues increased $1 million because the effects of customer
growth ($13 million) and weather ($3 million) offset a decrease in sales for
resale ($10 million) and a price reduction ($4 million). See Note 6 of Notes to
Condensed Financial Statements for information on the price reduction. Sales for
resale are wholesale electricity sales to third parties who resell the
electricity to their customers. The decrease in sales for resale was a result of
changes in power marketing activity, which can vary from period to period
without corresponding effects on earnings because of related fluctuations in
purchased power costs.
Operation and maintenance expenses increased $8 million as a result of
growth and increased expenses due to impending competition, increased outages at
coal plants and other miscellaneous factors, partially offset by savings
resulting from a 1996 voluntary severance program.
-15-
Operating Results - Twelve-month period ended March 31, 1998 compared
-----------------------------------------------------------------------
with twelve-month period ended March 31, 1997
---------------------------------------------
Earnings increased $32 million in the twelve-month comparison ended
March 31, 1998 primarily because of customer growth; a $32 million pretax charge
in 1996 for a voluntary severance program; two fuel-related settlements in the
third quarter of 1997; and lower financing costs. These positive factors more
than offset the effects of the 1996 regulatory agreement with the ACC, which, in
the twelve-month comparison, resulted in $27 million of additional regulatory
asset amortization and a $28 million revenue decrease caused by two retail price
reductions. See Note 6 of Notes to Condensed Financial Statements for additional
information about the regulatory agreement. In the period ended March 31, 1997,
the Company also recognized $11 million of income tax benefits associated with
capital loss carryforwards.
Operating revenues increased $128 million primarily because of
increases in sales for resale ($95 million); customer growth ($59 million) and
weather effects ($12 million). As mentioned above, these positive factors were
partially offset by the $28 million revenue decrease caused by retail price
reductions and by various other factors ($10 million). Sales for resale are
wholesale electricity sales to third parties who resell the electricity to their
customers. The increase in sales for resale was a result of increased activity
in competitive bulk power markets. The increase in sales for resale did not
significantly affect earnings because it was substantially offset by higher
power purchases.
The two fuel-related settlements increased the Company's pretax
earnings by approximately $21 million. The Company's income statement reflects
these settlements as reductions in fuel expense and as other income.
Operations and maintenance expenses were lower because of the charge
for the voluntary severance program recorded in 1996 and related savings in
1997. These savings were partially offset by increased expenses as a result of
growth and competition, and other miscellaneous factors.
Financing costs decreased $10 million because of lower amounts of
outstanding debt and preferred stock.
Other Income
------------
As part of a 1994 rate settlement with the ACC, the Company accelerated
amortization of substantially all deferred ITCs over a five-year period that
ends on December 31, 1999. The amortization of ITCs is shown on the Company's
income statement as Other Income --- Income Taxes and decreases annual income
tax expense by approximately $28 million.
-16-
Liquidity and Capital Resources
- -------------------------------
For the three months ended March 31, 1998, the Company incurred
approximately $60 million in capital expenditures, which is approximately 19% of
the most recently estimated 1998 capital expenditures. The Company's projected
capital expenditures for the next three years are: 1998, $323 million; 1999,
$313 million; and 2000, $306 million, respectively. These amounts include about
$30 - $35 million each year for nuclear fuel expenditures. In addition, the
Company is considering expanding certain of its businesses over the next several
years, which may result in increased expenditures.
The Company's long-term debt and preferred stock redemption
requirements and payment obligations on a capitalized lease for the next three
years are: 1998, $165 million; 1999, $174 million; and 2000, $109 million.
During the three months ended March 31, 1998, the Company redeemed approximately
$135 million of its long-term debt and approximately $11 million of its
preferred stock with cash from operations and long-term and short-term debt. As
a result of the 1996 regulatory agreement (see Note 6 of Notes to Condensed
Financial Statements), Pinnacle West invested $50 million in the Company in 1996
and 1997 and will invest similar amounts annually in 1998 and 1999. During the
three months ended March 31, 1998, the Company issued $100 million of its
unsecured debt.
Although provisions in the Company's bond indenture, articles of
incorporation, and financing orders from the ACC establish maximum amounts of
additional first mortgage bonds and preferred stock that the Company may issue,
management does not expect any of these restrictions to limit the Company's
ability to meet its capital requirements.
Year 2000 Technology Issues
- ---------------------------
The Company has made, and will continue to make, certain modifications
to its computer hardware and software systems and applications to ensure they
are capable of handling dates in the year 2000 and thereafter. The Company's
major computer systems have been updated and other systems are being analyzed
for potential modifications. The financial impact on the Company is not
anticipated to be material to its financial position, cash flows or results of
operations. The Company is in the process of formal communications with its
significant suppliers, business partners, and large customers to determine the
extent to which it may be affected by these third parties' plans to remediate
their own year 2000 issues in a timely manner.
Competition and Electric Industry Restructuring
- -----------------------------------------------
See Note 5 of Notes to Condensed Financial Statements in Part I, Item 1
of this report for discussions of competitive developments and regulatory
accounting. See Note 7 of Notes to Condensed Financial Statements in Part I,
Item 1 of this report for a
-17-
discussion of a proposed amendment to a Power Coordination Agreement with Salt
River Project that the Company estimates would reduce its pretax costs for
purchased power by approximately $17 million in 1999 and by lesser annual
amounts through 2006.
Rate Matters
- ------------
See Note 6 of Notes to Condensed Financial Statements in Part I, Item 1
of this report for a discussion of a proposed price reduction.
Forward-Looking Statements
- --------------------------
The above discussion contains forward-looking statements that involve
risks and uncertainties. Words such as "estimates," "expects," "anticipates,"
"plans," "believes," "projects," and similar expressions identify
forward-looking statements. These risks and uncertainties include, but are not
limited to, the ongoing restructuring of the electric industry; the outcome of
the regulatory proceedings relating to the restructuring; regulatory, tax and
environmental legislation; the ability of the Company to successfully compete
outside its traditional regulated markets; regional economic conditions, which
could affect customer growth; the cost of debt and equity capital; weather
variations affecting customer usage; and technological developments in the
electric industry.
These factors and the other matters discussed above may cause future
results to differ materially from historical results, or from results or
outcomes currently expected or sought by the Company.
-18-
PART II - OTHER INFORMATION
---------------------------
ITEM 5. Other Information
- ------------------------------
Purported Navajo Environmental Regulation
- -----------------------------------------
As previously reported, in February 1998, the EPA promulgated
regulations specifying those provisions of the Clean Air Act for which it is
appropriate to treat Indian tribes in the same manner as states, and the Company
reviewed the regulations to determine what effect they may have on Four Corners
and NGS. See "Environmental Matters --- Purported Navajo Environmental
Regulation" in Part I, Item 1 of the 1997 10-K. On April 10, 1998, the Company
filed a Petition for Review in the United States Court of Appeals for the
District of Columbia. Arizona Public Service Company v. United States
Environmental Protection Agency, No. 98-1196.
Palo Verde Nuclear Generating Station
-------------------------------------
See Note 9 of Notes to Condensed Financial Statements in Part I, Item 1
of this report for a discussion of issues regarding the Palo Verde steam
generators.
Construction and Financing Programs
-----------------------------------
See "Liquidity and Capital Resources" in Part I, Item 2 of this report
for a discussion of the Company's construction and financing programs.
Competition and Electric Industry Restructuring
-----------------------------------------------
See Note 5 of Notes to Condensed Financial Statements in Part I, Item 1
of this report for a discussion of competition and the Rules regarding the
introduction of retail electric competition in Arizona. On February 28, 1997, a
lawsuit was filed by the Company to protect its legal rights regarding the Rules
and in its complaint the Company asked the Court for (i) a judgment vacating the
retail electric competition rules, (ii) a declaratory judgment that the Rules
are unlawful because, among other things, they were entered into without proper
legal authorization, and (iii) a permanent injunction barring the ACC from
enforcing or implementing the Rules and from promulgating any other regulations
without lawful authority.
ITEM 6. Exhibits and Reports on Form 8-K
- -----------------------------------------
(a) Exhibits
Exhibit No. Description
- ----------- -----------
10.1 Territorial Agreement
10.2 Power Coordination Agreement
10.3 Memorandum of Agreement between the Company and Salt River Project
27.1 Financial Data Schedule
-19-
In addition to those Exhibits shown above, the Company hereby incorporates
the following Exhibits pursuant to Exchange Act Rule 12b-32 and Regulation
ss.229.10(d) by reference to the filings set forth below:
Exhibit No. Description Originally Filed as Exhibit: File No.(a) Date Effective
- ----------- ----------- ---------------------------- --------- --------------
3.1 Bylaws, amended as of 3.1 to 1995 Form 10-K 1-4473 3-29-96
February 20, 1996 Report
3.2 Resolution of Board of 3.2 to 1994 Form 10-K 1-4473 3-30-95
Directors temporarily Report
suspending Bylaws in part
3.3 Articles of Incorporation, 4.2 to Form S-3 1-4473 9-29-93
restated as of May 25, 1988 Registration Nos.
33-33910 and 33-55248 by
means of September 24,
1993 Form 8-K Report
3.4 Certificates pursuant to 4.3 to Form S-3 1-4473 9-29-93
Sections 10-152.01 and Registration Nos.
10-016, Arizona Revised 33-33910 and 33-55248 by
Statutes, establishing Series A means of September 24,
through V of the Company's 1993 Form 8-K Report
Serial Preferred Stock
3.5 Certificate pursuant to 4.4 to Form S-3 1-4473 9-29-93
Section 10-016, Arizona Registration Nos.
Revised Statutes, establishing 33-33910 and 33-55248 by
Series W of the Company's means of September 24,
Serial Preferred Stock 1993 Form 8-K Report
- ---------------------------
(a)Reports filed under File No. 1-4473 were filed in the office of the
Securities and Exchange Commission located in Washington, D.C.
(b) Reports on Form 8-K
During the quarter ended March 31, 1998, and the period from April 1
through May 15, 1998, the Company filed the following reports on Form 8-K:
Report dated January 13, 1998 comprised of Exhibits to the Company's
Registration Statements (Registration Nos. 333-15379 and 333-27551) relating to
the Company's offering of $100 million of Notes.
-20-
SIGNATURES
----------
Pursuant to the requirements of the Securities Exchange Act of 1934,
the Company has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
ARIZONA PUBLIC SERVICE COMPANY
(Registrant)
Dated: May 15, 1998 By: George A. Schreiber, Jr.
---------------------------------
George A. Schreiber, Jr.
Executive Vice President and
Chief Financial Officer
(Principal Financial Officer
and Officer Duly Authorized
sign this Report)