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 June 30, 1998
-----------------------
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from to
Commission file number 1-4473
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 August 14, 1998: 71,264,947
GLOSSARY
ACC - Arizona Corporation Commission
ACC Staff - Staff of the Arizona Corporation Commission
Company - Arizona Public Service Company
DOE - United States Department of Energy
EITF - Emerging Issues Task Force
EITF 97-4 - Emerging Issues Task Force Issue No. 97-4, "Deregulation of the
Pricing of Electricity -- Issues Related to the Applications of FASB Statements
No. 71, Accounting for the Effects of Certain Types of Regulation, and No. 101,
Regulated Enterprises -- Accounting for the Discontinuation of Application of
FASB Statement No. 71"
EPA - United States Environmental Protection Agency
FERC - Federal Energy Regulatory Commission
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
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
SFAS No. 71 - Statement of Financial Accounting Standards No. 71, "Accounting
for the Effects of Certain Types of Regulation"
SFAS No. 131 - Statement of Financial Accounting Standards No. 131, "Disclosures
about Segments of an Enterprise and Related Information"
SFAS No. 133 - Statement of Financial Accounting Standards No. 133, "Accounting
for Derivative Instruments and Hedging Activities"
Salt River Project - Salt River Project Agricultural Improvement and Power
District
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 June 30,
----------------------
1998 1997
--------- ---------
(Thousands of Dollars)
ELECTRIC OPERATING REVENUES .......................... $ 441,715 $ 458,751
--------- ---------
FUEL EXPENSES:
Fuel for electric generation ....................... 50,434 55,626
Purchased power .................................... 45,151 43,684
--------- ---------
Total ........................................... 95,585 99,310
--------- ---------
OPERATING REVENUES LESS FUEL EXPENSES ................ 346,130 359,441
--------- ---------
OTHER OPERATING EXPENSES:
Operations and maintenance excluding fuel expenses . 102,713 89,162
Depreciation and amortization ...................... 92,666 91,138
Income taxes ....................................... 39,933 49,579
Other taxes ........................................ 29,519 29,856
--------- ---------
Total ........................................... 264,831 259,735
--------- ---------
OPERATING INCOME ..................................... 81,299 99,706
--------- ---------
OTHER INCOME (DEDUCTIONS):
Other - net ........................................ (2,519) (910)
Income taxes ....................................... 7,488 6,550
--------- ---------
Total ........................................... 4,969 5,640
--------- ---------
INCOME BEFORE INTEREST DEDUCTIONS .................... 86,268 105,346
--------- ---------
INTEREST DEDUCTIONS:
Interest on long-term debt ......................... 34,160 35,262
Interest on short-term borrowings .................. 2,376 3,095
Debt discount, premium and expense ................. 1,918 2,056
Capitalized interest ............................... (4,370) (4,560)
--------- ---------
Total ........................................... 34,084 35,853
--------- ---------
NET INCOME ........................................... 52,184 69,493
PREFERRED STOCK DIVIDEND REQUIREMENTS ................ 2,435 3,195
--------- ---------
EARNINGS FOR COMMON STOCK ............................ $ 49,749 $ 66,298
========= =========
See Notes to Condensed Financial Statements.
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ARIZONA PUBLIC SERVICE COMPANY
CONDENSED STATEMENTS OF INCOME
------------------------------
(Unaudited)
Six Months
Ended June 30,
----------------------
1998 1997
--------- ---------
(Thousands of Dollars)
ELECTRIC OPERATING REVENUES .......................... $ 822,138 $ 837,772
--------- ---------
FUEL EXPENSES:
Fuel for electric generation ....................... 100,762 106,748
Purchased power .................................... 68,740 78,031
--------- ---------
Total ........................................... 169,502 184,779
--------- ---------
OPERATING REVENUES LESS FUEL EXPENSES ................ 652,636 652,993
--------- ---------
OTHER OPERATING EXPENSES:
Operations and maintenance excluding fuel expenses . 199,129 177,178
Depreciation and amortization ...................... 184,813 183,153
Income taxes ....................................... 64,397 71,871
Other taxes ........................................ 59,457 59,646
--------- ---------
Total ........................................... 507,796 491,848
--------- ---------
OPERATING INCOME ..................................... 144,840 161,145
--------- ---------
OTHER INCOME (DEDUCTIONS):
Other - net ........................................ (4,915) (3,119)
Income taxes ....................................... 11,943 10,890
--------- ---------
Total ........................................... 7,028 7,771
--------- ---------
INCOME BEFORE INTEREST DEDUCTIONS .................... 151,868 168,916
--------- ---------
INTEREST DEDUCTIONS:
Interest on long-term debt ......................... 69,343 69,691
Interest on short-term borrowings .................. 3,060 5,423
Debt discount, premium and expense ................. 3,867 4,058
Capitalized interest ............................... (8,521) (8,394)
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Total ........................................... 67,749 70,778
--------- ---------
NET INCOME ........................................... 84,119 98,138
PREFERRED STOCK DIVIDEND REQUIREMENTS ................ 5,313 6,821
--------- ---------
EARNINGS FOR COMMON STOCK ............................ $ 78,806 $ 91,317
========= =========
See Notes to Condensed Financial Statements
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ARIZONA PUBLIC SERVICE COMPANY
CONDENSED STATEMENTS OF INCOME
------------------------------
(Unaudited)
Twelve Months
Ended June 30,
--------------------------
1998 1997
----------- -----------
(Thousands of Dollars)
ELECTRIC OPERATING REVENUES ..................... $ 1,862,919 $ 1,784,125
----------- -----------
FUEL EXPENSES:
Fuel for electric generation .................. 195,355 237,518
Purchased power ............................... 225,995 136,757
----------- -----------
Total ...................................... 421,350 374,275
----------- -----------
OPERATING REVENUES LESS FUEL EXPENSES ........... 1,441,569 1,409,850
----------- -----------
OTHER OPERATING EXPENSES:
Operations and maintenance excluding
fuel expenses............................... 421,385 419,853
Depreciation and amortization ................. 367,331 363,182
Income taxes .................................. 177,263 169,361
Other taxes ................................... 120,070 111,601
----------- -----------
Total ...................................... 1,086,049 1,063,997
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OPERATING INCOME ................................ 355,520 345,853
----------- -----------
OTHER INCOME (DEDUCTIONS):
AFUDC - equity ................................ -- 1,531
Other - net ................................... (11,623) (15,621)
Income taxes .................................. 32,466 41,253
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Total ...................................... 20,843 27,163
----------- -----------
INCOME BEFORE INTEREST DEDUCTIONS ............... 376,363 373,016
----------- -----------
INTEREST DEDUCTIONS:
Interest on long-term debt .................... 140,583 142,597
Interest on short-term borrowings ............. 7,041 9,245
Debt discount, premium and expense ............ 7,600 8,113
Capitalized interest .......................... (16,335) (12,502)
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Total ...................................... 138,889 147,453
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NET INCOME ...................................... 237,474 225,563
PREFERRED STOCK DIVIDEND REQUIREMENTS ........... 11,295 15,110
----------- -----------
EARNINGS FOR COMMON STOCK ....................... $ 226,179 $ 210,453
=========== ===========
See Notes to Condensed Financial Statements.
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ARIZONA PUBLIC SERVICE COMPANY
CONDENSED BALANCE SHEETS
------------------------
ASSETS
(Unaudited)
June 30, December 31,
1998 1997
----------- -----------
(Thousands of Dollars)
UTILITY PLANT:
Electric plant in service and held for future use $ 7,057,168 $ 7,009,059
Less accumulated depreciation and amortization ... 2,720,762 2,620,607
----------- -----------
Total ......................................... 4,336,406 4,388,452
Construction work in progress .................... 294,978 237,492
Nuclear fuel, net of amortization ................ 51,165 51,624
----------- -----------
Utility plant - net ........................... 4,682,549 4,677,568
----------- -----------
INVESTMENTS AND OTHER ASSETS ..................... 180,393 164,906
----------- -----------
CURRENT ASSETS:
Cash and cash equivalents ........................ 14,192 12,552
Accounts receivable:
Service customers ............................. 130,568 141,022
Other ......................................... 31,494 31,313
Allowance for doubtful accounts ............... (1,012) (1,338)
Accrued utility revenues ......................... 66,922 58,559
Materials and supplies, at average cost .......... 71,207 70,634
Fossil fuel, at average cost ..................... 17,960 9,621
Deferred income taxes ............................ 3,496 3,496
Other ............................................ 29,824 24,529
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Total current assets .......................... 364,651 350,388
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DEFERRED DEBITS:
Regulatory asset for income taxes ................ 430,601 458,369
Rate synchronization cost deferral ............... 331,265 358,871
Unamortized costs of reacquired debt ............. 59,088 63,501
Unamortized debt issue costs ..................... 15,294 15,303
Other ............................................ 231,163 242,236
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Total deferred debits ......................... 1,067,411 1,138,280
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TOTAL ......................................... $ 6,295,004 $ 6,331,142
=========== ===========
See Notes to Condensed Financial Statements.
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ARIZONA PUBLIC SERVICE COMPANY
CONDENSED BALANCE SHEETS
------------------------
LIABILITIES
(Unaudited)
June 30, December 31,
1998 1997
------------ ------------
(Thousands of Dollars)
CAPITALIZATION:
Common stock .................................... $ 178,162 $ 178,162
Additional paid-in capital ...................... 1,143,586 1,142,364
Retained earnings ............................... 479,690 528,798
------------ ------------
Common stock equity .......................... 1,801,438 1,849,324
Non-redeemable preferred stock .................. 124,034 142,051
Redeemable preferred stock ...................... 15,377 29,110
Long-term debt less current maturities .......... 1,861,783 1,953,162
------------ ------------
Total capitalization ......................... 3,802,632 3,973,647
------------ ------------
CURRENT LIABILITIES:
Commercial paper ................................ 213,485 130,750
Current maturities of long-term debt ............ 154,220 104,068
Accounts payable ................................ 98,480 107,423
Accrued taxes ................................... 78,451 85,886
Accrued interest ................................ 31,743 31,660
Common dividends payable ........................ 42,500 --
Customer deposits ............................... 29,298 29,116
Other ........................................... 23,657 19,588
------------ ------------
Total current liabilities .................... 671,834 508,491
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DEFERRED CREDITS AND OTHER:
Deferred income taxes ........................... 1,324,121 1,345,177
Deferred investment tax credit .................. 50,142 60,093
Unamortized gain - sale of utility plant ........ 80,075 82,363
Customer advances for construction .............. 29,920 29,294
Other ........................................... 336,280 332,077
------------ ------------
Total deferred credits and other ............. 1,820,538 1,849,004
------------ ------------
COMMITMENTS AND CONTINGENCIES (Notes 5, 8, and 9)
TOTAL ........................................ $ 6,295,004 $ 6,331,142
============ ============
See Notes to Condensed Financial Statements.
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ARIZONA PUBLIC SERVICE COMPANY
CONDENSED STATEMENTS OF CASH FLOWS
----------------------------------
(Unaudited)
Six Months
Ended June 30,
----------------------
1998 1997
--------- ---------
(Thousands of Dollars)
Cash Flows from Operating Activities:
Net income ......................................... $ 84,119 $ 98,138
Items not requiring cash:
Depreciation and amortization .................... 184,813 183,153
Nuclear fuel amortization ........................ 16,580 16,186
Deferred income taxes - net ...................... (18,428) (25,107)
Deferred investment tax credit - net ............. (9,951) (9,926)
Changes in certain current assets and liabilities:
Accounts receivable - net ........................ 9,947 (6,092)
Accrued utility revenues ......................... (8,363) (14,047)
Materials, supplies and fossil fuel .............. (8,912) 1,153
Other current assets ............................. (5,295) (6,964)
Accounts payable ................................. (10,279) (37,099)
Accrued taxes .................................... (7,435) 8,163
Accrued interest ................................. 83 (6,898)
Other current liabilities ........................ 2,922 2,826
Other - net ........................................ 10,267 34,120
--------- ---------
Net cash flow provided by operating activities ....... 240,068 237,606
--------- ---------
Cash Flows from Investing Activities:
Capital expenditures ............................... (144,580) (145,203)
Capitalized interest ............................... (8,521) (8,394)
Other .............................................. (3,347) (12,577)
--------- ---------
Net cash flow used for investing activities .... (156,448) (166,174)
--------- ---------
Cash Flows from Financing Activities:
Long-term debt ..................................... 99,375 99,875
Short-term borrowings - net ........................ 82,735 181,100
Dividends paid on common stock ..................... (85,000) (85,000)
Dividends paid on preferred stock .................. (5,631) (7,345)
Repayment of preferred stock ....................... (31,209) (46,044)
Repayment and reacquisition of long-term debt ...... (142,250) (219,192)
--------- ---------
Net cash flow used for financing activities .... (81,980) (76,606)
--------- ---------
Net increase (decrease) in cash and cash equivalents . 1,640 (5,174)
Cash and cash equivalents at beginning of period ..... 12,552 12,521
--------- ---------
Cash and cash equivalents at end of period ........... $ 14,192 $ 7,347
========= =========
Supplemental Disclosure of Cash Flow Information:
Cash paid during the period for:
Interest (excluding capitalized interest) ........ $ 63,960 $ 74,291
Income taxes ..................................... $ 86,397 $ 84,432
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 June 30,
1998, the results of operations for the three months, six months and twelve
months ended June 30, 1998 and 1997, and the cash flows for the six months ended
June 30, 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. Certain prior year balances have been restated to conform to the
current year presentation.
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 six months ended June 30, 1998.
5. Regulatory Matters -- Electric Industry Restructuring
State
ACC Rules. In December 1996, the ACC adopted rules that provide a framework for
the introduction of retail electric competition in Arizona. On August 5, 1998,
the ACC adopted amendments to the rules. The ACC rules, as amended, include the
following major provisions:
+ The rules apply to virtually all of the Arizona electric utilities
regulated by the ACC, including the Company.
+ The rules require each affected utility, including the Company, to
make available at least 20% of its 1995 system retail peak demand for
competitive generation supply to all customer classes beginning
January 1, 1999, and 100% beginning January 1, 2001.
+ All affected utility customers with single premise loads of one
megawatt or greater will be eligible for competitive electric services
beginning January 1, 1999, until the 20% level described in the
preceding paragraph is met. Until the
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20% level is met, affected utility customers with single premise loads
of forty kilowatts or greater will be able to aggregate into a
combined load of one megawatt or greater to be eligible for
competitive electric services beginning January 1, 1999.
+ Prior to January 1, 2001, residential customers will have access to
competitive services through a quarterly phase-in of one-half percent
of residential customers per quarter beginning January 1, 1999.
+ Electric service providers that obtain Certificates of Convenience and
Necessity (CC&Ns) from the ACC will be allowed to supply, market,
and/or broker specified electric services at retail. These services
include electric generation, but exclude electric transmission and
distribution.
+ As required by the rules, in February 1998 the Company filed with the
ACC proposed tariffs for unbundled service (electric service elements
provided and priced separately). The ACC has not issued a decision in
this matter.
+ The rules establish that the ACC shall allow a reasonable opportunity
for the recovery of unmitigated stranded costs. See "Stranded Costs"
below. Affected utilities are expected to take reasonable,
cost-effective steps to mitigate stranded costs.
+ Absent a waiver from the ACC, each affected utility must separate
itself from all competitive generation assets and services prior to
January 1, 2001. The separation must be either to an unaffiliated
party or to a separate corporate affiliate or affiliates.
+ Beginning January 1, 1999, each affected utility will be prohibited
from providing certain competitive electric services, except through a
separate affiliate.
+ The rules contain affiliate transaction rules generally prohibiting an
affected utility and its competitive electric affiliates from sharing
personnel, office space, equipment, services, and systems, except to
the extent appropriate to perform certain permissible shared corporate
support functions. No later than December 31, 1998, each affected
utility must file a compliance plan with the ACC demonstrating its
compliance with the affiliate transaction rules.
+ By September 15, 1998, each affected utility must file a report
detailing possible mechanisms to provide benefits, such as rate
reductions of 3% to 5%, to all standard offer customers and a proposed
plan for residential phase-in implementation.
The amended rules, a copy of which has been filed as an exhibit to this Report
on Form 10-Q, became effective on an emergency basis upon their filing with the
Secretary of State on August 10, 1998; however, the ACC must complete a public
process to adopt
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the rules on a permanent basis within 180 days. The Company anticipates the
completion of this process by year-end 1998 or early 1999.
The Company believes that certain provisions of the ACC 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.
Stranded Costs. In February 1998, the ACC completed a formal, generic hearing on
stranded cost determination and recovery. On June 22, 1998, the ACC issued an
order in this matter. The order allows an affected utility, such as the Company,
to choose between two options for the recovery of its stranded costs. Under the
first option, an affected utility that chooses to divest its generating assets
to an unaffiliated party must file a divestiture plan for ACC approval no later
than October 1, 1998, and such divestiture must be completed by January 1, 2001,
after which the affected utility would be permitted to collect 100 percent of
its stranded costs, including a return on the unamortized balance, over a
ten-year period. Under the second option (referred to by the ACC as the
"Transition Revenues Methodology"), an affected utility would be provided
sufficient revenues necessary to maintain financial integrity for a period of
ten years or the ACC would "otherwise provide an allocation of stranded cost
responsibilities and risks between ratepayers and shareholders as is determined
to be in the public interest." The order also states an intent that the various
recovery options "will provide the affected utilities sufficient revenues to
enable them to recover appropriate regulatory assets." The order requires each
affected utility to file with the ACC, on or before August 21, 1998, its choice
of options for stranded cost recovery as well as an implementation plan relating
to its chosen option, including its estimated stranded costs separated out into
regulatory assets and other generation related assets. Stranded costs estimates
vary depending on various assumptions, estimates, methodologies and measurement
periods. Based on various assumptions, estimates and methodologies, the Company
has previously estimated that its recoverable stranded costs (excluding
regulatory assets which have already been addressed in the 1996 regulatory
agreement with the ACC) would be less than $500 million, assuming a measurement
period 2001 through 2006.
The Company intends to use the Transition Revenues Methodology and does not
intend to divest its generating assets to an unaffiliated party. The Company
cannot accurately predict the outcome of this matter.
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 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) has been
subsequently decided in favor of the ACC in one
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unrelated and two related lawsuits.
In May 1998, a bill was enacted to facilitate implementation of retail electric
competition in the state. 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 that 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. In addition, the Arizona legislature
will review and make recommendations for the 1999 legislature on certain
competitive issues.
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, 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 June 30, 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.
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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
Changes in ACC decisions, Arizona and federal legislation, and possible
amendments to the Arizona Constitution may impact the implementation of retail
electric competition in Arizona. Until the details of implementation of
competition, including addressing stranded costs, are 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.
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:
+ An annual rate reduction of approximately $48.5 million ($29 million
after income taxes), or 3.4% on average for all customers except
certain contract customers, effective July 1, 1996.
+ Recovery of substantially all of 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).
+ A formula for sharing future cost savings between customers and
shareholders (price reduction formula) referencing a return on equity
(as defined) of 11.25%.
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+ A moratorium on filing for permanent rate changes prior to July 2,
1999, except under the price reduction formula and under certain other
limited circumstances.
+ Infusion of $200 million of common equity into 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:
+ 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.
+ 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.
+ The Company and Salt River Project agreed on certain legislative
positions regarding electric utility restructuring at the state and
federal level.
An ACC docket had previously been established and the ACC held a hearing on
August 6, 1998 so that the ACC could review certain provisions of the Memorandum
of Agreement, as amended, including, whether: (a) the Territorial Agreement
remains in the public interest, (b) the Agreement is a contract in restraint of
trade, and (c) the Agreement will materially lessen the potential for retail
electric competition in Arizona.
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, requested clarification of the
operation of certain of the Agreement's provisions. Pursuant to an Addendum to
Memorandum of Agreement, dated as of May 19, 1998 (the "Addendum"), the Company
and Salt River Project amended and clarified certain provisions of the
Memorandum of Agreement in response to certain issues raised by the Antitrust
Unit. By letter dated May 19, 1998, the Antitrust Unit advised the Company and
Salt River Project that, upon their execution of the Addendum, it would take no
action regarding the language of the
-14-
Memorandum of Agreement, although it reserved the right to take action in the
future if new information justified doing so.
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 $88 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 $77
million, with an annual payment limitation of approximately $9 million.
The Palo Verde participants maintain "all risk" (including nuclear hazards)
insurance for property damage to, and decontamination of, property at Palo Verde
in the aggregate amount of $2.75 billion, a substantial portion of which must
first be applied to stabilization and decontamination. 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 estimates that its share of the replacement
costs (in 1998 dollars) 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. The Financial Accounting Standards Board issued SFAS No. 131 on "Disclosures
about Segments of an Enterprise and Related Information" which is 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
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major customers. The Company is currently evaluating what impact this standard
will have on its disclosures.
In June 1998 the Financial Accounting Standards Board issued SFAS No. 133
"Accounting for Derivative Instruments and Hedging Activities," which is
effective for the Company in 2000. SFAS No. 133 requires that an entity
recognize all derivatives as either assets or liabilities in the balance sheet
and measure those instruments at fair value. The standard also provides specific
guidance for accounting for derivatives designated as hedging instruments. The
Company is currently evaluating what impact this standard will have on its
financial statements.
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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, six-month and twelve-month periods ended June 30, 1998 and
1997:
Periods ended June 30
(Unaudited)
(Thousands of Dollars)
Three Months Six Months Twelve Months
------------------- ------------------ -----------------------
1998 1997 1998 1997 1998 1997
Operating Revenues $441,715 $458,751 $822,138 $837,772 $1,862,919 $1,784,125
Earnings for
Common Stock $ 49,749 $ 66,298 $ 78,806 $ 91,317 $ 226,179 $ 210,453
Operating Results - Three-month period ended June 30, 1998 compared
with three-month period ended June 30, 1997
Earnings decreased $17 million in the three-month comparison primarily
because of the effects of weather, increased operations and maintenance
expenses, and a retail price reduction, partially offset by customer growth and
lower fuel expenses. See Note 6 of Notes to Condensed Financial Statements for
information on the price reduction.
Operating revenues decreased $17 million because of weather effects
($41 million) and the price reduction ($4 million), partially offset by the
effects of customer growth ($17 million), increased sales for resale ($8
million) and other ($3 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 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.
Operations and maintenance expenses increased $14 million as a result
of the timing of scheduled outages at power plants and other miscellaneous
expenses.
Fuel expenses decreased $4 million primarily because of lower fuel
prices and lower retail sales, partially offset by higher sales for resale.
-17-
Operating Results - Six-month period ended June 30, 1998 compared with
six-month period ended June 30, 1997
Earnings decreased $13 million in the six-month comparison primarily
because of the effects of weather, increased operations and maintenance
expenses, and a retail price reduction, partially offset by customer growth and
lower fuel expenses. See Note 6 of Notes to Condensed Financial Statements for
additional information about the price reduction.
Operating revenues decreased $16 million because of weather effects
($38 million) and the price reduction ($8 million), partially offset by the
effects of customer growth ($29 million). Operations and maintenance expenses
increased $22 million as a result of growth and increased expenses due to
impending competition, the timing of scheduled outages at power plants and other
miscellaneous factors.
Fuel expenses decreased $15 million primarily because of lower prices
and a more favorable mix.
Operating Results - Twelve-month period ended June 30, 1998 compared
with twelve-month period ended June 30, 1997
Earnings increased $16 million in the twelve-month comparison primarily
because of customer growth; two fuel-related settlements in the third quarter of
1997; and lower fuel prices. These positive factors more than offset the effects
of weather and a retail price reduction. See Note 6 of Notes to Condensed
Financial Statements for additional information about the price reduction. In
the period ended June 30, 1997, the Company also recognized $8 million of income
tax benefits associated with capital loss carryforwards.
Operating revenues increased $79 million primarily because of increases
in sales for resale ($80 million) and customer growth ($57 million), partially
offset by the effects of weather ($37 million) and the price reduction ($18
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 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.
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 increased $2 million because higher
expenses related to growth and impending competition, the timing of scheduled
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outages at power plants and other miscellaneous factors more than offset the
effects of a charge for a voluntary severance program recorded in 1996 and
related savings in 1997.
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.
Liquidity and Capital Resources
For the six months ended June 30, 1998, the Company incurred
approximately $145 million in capital expenditures, which is approximately 45%
of the most recently estimated 1998 capital expenditures. The Company's
projected capital expenditures for the next three years are: 1998, $323 million;
1999, $322 million; and 2000, $317 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, $176 million; 1999, $174 million; and 2000, $109 million.
During the six months ended June 30, 1998, the Company redeemed approximately
$142 million of its long-term debt and approximately $31 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.
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 Issue
As the year 2000 approaches many companies face problems because many
software application and operational programs will not properly recognize
calendar dates beginning with the year 2000. The Company initiated a
comprehensive
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Company-wide Year 2000 program over a year ago to review and resolve all Year
2000 issues in critical systems and equipment in a timely manner in an effort to
ensure the reliability of electric service to its customers. This included a
Company-wide awareness program of the Year 2000 issue.
The Company believes that substantially all of its major information
technology (IT) systems are Year 2000 compliant. The Company has made, and will
continue to make, certain modifications to its computer hardware and software
systems and applications in an effort to ensure they are capable of handling
changing business needs, including dates in the year 2000 and thereafter. In
addition, other IT systems and non-IT systems, including embedded technology and
real-time process control systems, are being analyzed for potential
modifications. To date, the Company has inventoried essentially all critical IT
and non-IT systems and the assessment of these systems is ongoing. The analysis
of the IT and non-IT systems should be complete in late 1998 and any renovation,
validation, and implementation to be made will be completed by mid-1999 for all
critical systems that affect operations, except for those items that can only be
completed during maintenance outages at Palo Verde, which will be completed
during the last half of 1999. The Company has also designated an internal
audit/quality review team that is reviewing the individual Year 2000 projects
and their Year 2000 readiness on a quarterly basis. The cost to the Company of
Year 2000 remediation has not had, and is not expected to have, a material
adverse effect on the Company's financial position, cash flows, or results of
operations.
The Company is in the process of communicating with its significant
suppliers, business partners, other utilities, 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. The Company has been
interfacing with suppliers for systems, services, and materials in order to
assess whether their schedules for analysis and remediation of Year 2000 issues
are timely and to assess their ability to continue to supply services and
materials required by the Company. However, the Company cannot currently predict
the effect on the Company if the systems of these other companies are not Year
2000 compliant.
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 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.
-20-
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; technological developments in the electric
industry; and Year 2000 issues.
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.
-21-
PART II - OTHER INFORMATION
ITEM 4. Submission Of Matters to a Vote of Security Holders
At the Annual Meeting of Shareholders held on May 19, 1998, the
shareholders elected all of the directors of the Company, each of whom will
serve for the ensuing year or until his or her successor is elected or
qualified, as follows:
Votes Against Broker
Director Votes For and Withheld Abstentions Non-votes
-------- --------- ------------ ----------- ---------
O. Mark De Michele 74,335,487 12,620 N/A N/A
Michael L. Gallagher 74,334,952 13,120 N/A N/A
Martha O. Hesse 74,335,702 12,420 N/A N/A
Marianne M. Jennings 74,332,821 15,109 N/A N/A
Robert E. Keever 74,334,952 13,120 N/A N/A
Robert G. Matlock 74,335,702 12,420 N/A N/A
Bruce J. Nordstrom 74,335,702 12,420 N/A N/A
John R. Norton III 74,335,103 12,979 N/A N/A
William J. Post 74,335,166 12,920 N/A N/A
Donald M. Riley 74,334,952 13,120 N/A N/A
George A. Schreiber, Jr. 74,335,166 12,920 N/A N/A
Quentin P. Smith, Jr. 74,334,952 13,120 N/A N/A
Richard Snell 74,333,387 14,580 N/A N/A
Dianne C. Walker 74,334,952 13,120 N/A N/A
Ben F. Williams, Jr. 74,335,434 12,670 N/A N/A
ITEM 5. Other Information
EPA Environmental Regulation
As previously reported, the EPA has been considering the Grand Canyon
Visability Transport Commission's recommendations prior to promulgating final
regulations on a regional haze regulatory program and final regulations were
expected by June 1998. See "Environmental Matters - EPA Environmental
Regulation" in Part I, Item 1 of the 1997 10-K. These final regulations are now
expected by December 1998. The Company cannot currently estimate the capital
expenditures, if any, which may be required as a result of the EPA studies and
the Commission's recommendations.
As previously reported, in July 1997, the EPA promulgated final National
Ambient Air Quality Standards for ozone and particulate matter. See
"Environmental Matters - EPA Environmental Regulation" in Part I, Item 1 of the
1997 10-K. Congress recently
-22-
enacted legislation that could delay the implementation of the regional haze
requirements and particulate matter ambient standard.
Spent Nuclear Fuel and Waste Disposal
As previously reported, in November 1997, the D.C. Circuit issued a
Writ of Mandamus precluding DOE from excusing its delay in accepting spent
nuclear fuel by January 31, 1998. See "Generating Fuel and Purchased Power -
Nuclear Fuel Supply - Spent Nuclear Fuel and Waste Disposal" in Part I, Item 1
of the 1997 10-K. On May 5, 1998, the D.C. Circuit issued a ruling refusing to
order DOE to begin moving spent nuclear fuel. On July 24, 1998, the Company
filed a Petition for Review with the D.C. Circuit regarding DOE's obligation to
begin accepting spent nuclear fuel. Arizona Public Service Company v. Department
--------------------------------------------
of Energy and United States of America, No. 98-1346 (D.C. Cir.).
- ---------------------------------------
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 Retail Electric Competition Rules
27.1 Financial Data Schedule
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In addition to those Exhibits shown above, the Company hereby incorporates
the following Exhibits pursuant to Exchange Act Rule 12b-32 and Regulation
section 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 means of September 24,
Series A through V of the 1993 Form 8-K Report
Company's 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
10.2 Arizona Corporation 99.1 to 1996 Form 10-K 1-4473 3-28-97
Commission Order, Decision Report
No. 59943, dated December
26, 1996, including the
rules regarding the
introduction of retail
competition in Arizona
(b) Reports on Form 8-K
During the quarter ended June 30, 1998, and the period from July 1
through August 14, 1998, the Company filed the following reports on Form 8-K:
Report dated May 19, 1998 regarding the stranded cost hearing at the
ACC, ACC Staff's Statement of Position related to retail competition and the
Company's agreement with Salt River Project.
Report dated August 5, 1998 regarding the ACC rules related to retail
competition.
- ----------
a Reports filed under File No. 1-4473 were filed in the office of the Securities
and Exchange Commission located in Washington, D.C.
-24-
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: August 14, 1998 By: George A. Schreiber
--------------------------------
George A. Schreiber, Jr.
Executive Vice President and
Chief Financial Officer
(Principal Financial Officer
and Officer Duly Authorized to
sign this Report)