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 SEPTEMBER 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
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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 November 13, 1998: 71,264,947
GLOSSARY
ACC - Arizona Corporation Commission
ACC Staff - Staff of the Arizona Corporation Commission
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"
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
TEP - Tucson Electric Power Company
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
ARIZONA PUBLIC SERVICE COMPANY
CONDENSED STATEMENTS OF INCOME
------------------------------
(Unaudited)
Three Months
Ended September 30,
-----------------------
1998 1997
--------- ---------
(Thousands of Dollars)
ELECTRIC OPERATING REVENUES .......................... $ 740,734 $ 632,821
--------- ---------
FUEL EXPENSES:
Fuel for electric generation ....................... 74,112 48,379
Purchased power .................................... 178,587 110,151
--------- ---------
Total ........................................... 252,699 158,530
--------- ---------
OPERATING REVENUES LESS FUEL EXPENSES ................ 488,035 474,291
--------- ---------
OTHER OPERATING EXPENSES:
Operations and maintenance excluding
fuel expenses .................................... 110,259 110,102
Depreciation and amortization ...................... 94,284 90,874
Income taxes ....................................... 98,411 92,195
Other taxes ........................................ 30,002 30,228
--------- ---------
Total ........................................... 332,956 323,399
--------- ---------
OPERATING INCOME ..................................... 155,079 150,892
--------- ---------
OTHER INCOME (DEDUCTIONS):
Other - net ........................................ (2,120) 445
Income taxes ....................................... 14,271 14,052
--------- ---------
Total ........................................... 12,151 14,497
--------- ---------
INCOME BEFORE INTEREST DEDUCTIONS .................... 167,230 165,389
--------- ---------
INTEREST DEDUCTIONS:
Interest on long-term debt ......................... 33,906 35,699
Interest on short-term borrowings .................. 2,359 2,163
Debt discount, premium and expense ................. 1,878 1,825
Capitalized interest ............................... (4,106) (3,997)
--------- ---------
Total ........................................... 34,037 35,690
--------- ---------
NET INCOME ........................................... 133,193 129,699
PREFERRED STOCK DIVIDEND REQUIREMENTS ................ 2,347 2,984
--------- ---------
EARNINGS FOR COMMON STOCK ............................ $ 130,846 $ 126,715
========= =========
See Notes to Condensed Financial Statements.
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ARIZONA PUBLIC SERVICE COMPANY
CONDENSED STATEMENTS OF INCOME
------------------------------
(Unaudited)
Nine Months
Ended September 30,
-------------------------
1998 1997
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(Thousands of Dollars)
ELECTRIC OPERATING REVENUES ........................ $1,562,872 $1,470,593
---------- ----------
FUEL EXPENSES:
Fuel for electric generation ..................... 174,874 155,127
Purchased power .................................. 247,327 188,182
---------- ----------
Total ......................................... 422,201 343,309
---------- ----------
OPERATING REVENUES LESS FUEL EXPENSES .............. 1,140,671 1,127,284
---------- ----------
OTHER OPERATING EXPENSES:
Operations and maintenance excluding
fuel expenses................................... 309,388 287,280
Depreciation and amortization .................... 279,097 274,027
Income taxes ..................................... 162,808 164,066
Other taxes ...................................... 89,459 89,874
---------- ----------
Total ......................................... 840,752 815,247
---------- ----------
OPERATING INCOME ................................... 299,919 312,037
---------- ----------
OTHER INCOME (DEDUCTIONS):
Other - net ...................................... (7,035) (2,674)
Income taxes ..................................... 26,214 24,942
---------- ----------
Total ......................................... 19,179 22,268
---------- ----------
INCOME BEFORE INTEREST DEDUCTIONS .................. 319,098 334,305
---------- ----------
INTEREST DEDUCTIONS:
Interest on long-term debt ....................... 103,249 105,390
Interest on short-term borrowings ................ 5,419 7,586
Debt discount, premium and expense ............... 5,745 5,883
Capitalized interest ............................. (12,627) (12,391)
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Total ......................................... 101,786 106,468
---------- ----------
NET INCOME ......................................... 217,312 227,837
PREFERRED STOCK DIVIDEND REQUIREMENTS .............. 7,660 9,805
---------- ----------
EARNINGS FOR COMMON STOCK .......................... $ 209,652 $ 218,032
========== ==========
See Notes to Condensed Financial Statements
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ARIZONA PUBLIC SERVICE COMPANY
CONDENSED STATEMENTS OF INCOME
------------------------------
(Unaudited)
Twelve Months
Ended September 30,
-------------------------
1998 1997
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(Thousands of Dollars)
ELECTRIC OPERATING REVENUES ........................ $1,970,832 $1,850,047
---------- ----------
FUEL EXPENSES:
Fuel for electric generation ..................... 221,089 217,654
Purchased power .................................. 294,430 207,115
---------- ----------
Total ......................................... 515,519 424,769
---------- ----------
OPERATING REVENUES LESS FUEL EXPENSES .............. 1,455,313 1,425,278
---------- ----------
OTHER OPERATING EXPENSES:
Operations and maintenance excluding
fuel expenses................................... 421,542 429,569
Depreciation and amortization .................... 370,741 363,625
Income taxes ..................................... 183,479 170,562
Other taxes ...................................... 119,844 117,084
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Total ......................................... 1,095,606 1,080,840
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OPERATING INCOME ................................... 359,707 344,438
---------- ----------
OTHER INCOME (DEDUCTIONS):
AFUDC - equity ................................... -- (411)
Other - net ...................................... (14,188) (13,188)
Income taxes ..................................... 32,685 40,383
---------- ----------
Total ......................................... 18,497 26,784
---------- ----------
INCOME BEFORE INTEREST DEDUCTIONS .................. 378,204 371,222
---------- ----------
INTEREST DEDUCTIONS:
Interest on long-term debt ....................... 138,790 142,196
Interest on short-term borrowings ................ 7,237 8,811
Debt discount, premium and expense ............... 7,653 7,915
Capitalized interest ............................. (16,444) (14,478)
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Total ......................................... 137,236 144,444
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NET INCOME ......................................... 240,968 226,778
PREFERRED STOCK DIVIDEND REQUIREMENTS .............. 10,658 13,941
---------- ----------
EARNINGS FOR COMMON STOCK .......................... $ 230,310 $ 212,837
========== ==========
See Notes to Condensed Financial Statements.
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ARIZONA PUBLIC SERVICE COMPANY
CONDENSED BALANCE SHEETS
------------------------
ASSETS
(Unaudited)
September 30, December 31,
1998 1997
------------ -----------
(Thousands of Dollars)
UTILITY PLANT:
Electric plant in service and held for
future use.................................... $ 7,179,571 $ 7,009,059
Less accumulated depreciation and amortization ... 2,759,425 2,620,607
----------- -----------
Total ......................................... 4,420,146 4,388,452
Construction work in progress .................... 211,758 237,492
Nuclear fuel, net of amortization ................ 55,771 51,624
----------- -----------
Utility plant - net ........................... 4,687,675 4,677,568
----------- -----------
INVESTMENTS AND OTHER ASSETS ..................... 186,342 164,906
----------- -----------
CURRENT ASSETS:
Cash and cash equivalents ........................ 17,687 12,552
Accounts receivable:
Service customers ............................. 238,905 141,022
Other ......................................... 52,349 31,313
Allowance for doubtful accounts ............... (1,414) (1,338)
Accrued utility revenues ......................... 86,153 58,559
Materials and supplies, at average cost .......... 71,896 70,634
Fossil fuel, at average cost ..................... 17,303 9,621
Deferred income taxes ............................ 3,496 3,496
Other ............................................ 27,632 24,529
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Total current assets .......................... 514,007 350,388
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DEFERRED DEBITS:
Regulatory asset for income taxes ................ 414,491 458,369
Rate synchronization cost deferral ............... 317,463 358,871
Unamortized costs of reacquired debt ............. 56,409 63,501
Unamortized debt issue costs ..................... 15,142 15,303
Other ............................................ 260,904 242,236
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Total deferred debits ......................... 1,064,409 1,138,280
----------- -----------
TOTAL ......................................... $ 6,452,433 $ 6,331,142
=========== ===========
See Notes to Condensed Financial Statements.
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ARIZONA PUBLIC SERVICE COMPANY
CONDENSED BALANCE SHEETS
------------------------
LIABILITIES
(Unaudited)
September 30, December 31,
1998 1997
----------- -----------
(Thousands of Dollars)
CAPITALIZATION:
Common stock .................................... $ 178,162 $ 178,162
Additional paid-in capital ...................... 1,143,617 1,142,364
Retained earnings ............................... 610,535 528,798
----------- -----------
Common stock equity .......................... 1,932,314 1,849,324
Non-redeemable preferred stock .................. 123,795 142,051
Redeemable preferred stock ...................... 9,401 29,110
Long-term debt less current maturities .......... 1,871,949 1,953,162
----------- -----------
Total capitalization ......................... 3,937,459 3,973,647
----------- -----------
CURRENT LIABILITIES:
Commercial paper ................................ 115,350 130,750
Current maturities of long-term debt ............ 154,220 104,068
Accounts payable ................................ 170,202 107,423
Accrued taxes ................................... 208,595 85,886
Accrued interest ................................ 26,489 31,660
Customer deposits ............................... 28,841 29,116
Other ........................................... 36,394 19,588
----------- -----------
Total current liabilities .................... 740,091 508,491
----------- -----------
DEFERRED CREDITS AND OTHER:
Deferred income taxes ........................... 1,291,258 1,345,177
Deferred investment tax credit .................. 36,724 60,093
Unamortized gain - sale of utility plant ........ 78,931 82,363
Customer advances for construction .............. 29,489 29,294
Other ........................................... 338,481 332,077
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Total deferred credits and other ............. 1,774,883 1,849,004
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COMMITMENTS AND CONTINGENCIES (Notes 5 and 8)
TOTAL ........................................ $ 6,452,433 $ 6,331,142
=========== ===========
See Notes to Condensed Financial Statements.
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ARIZONA PUBLIC SERVICE COMPANY
CONDENSED STATEMENTS OF CASH FLOWS
----------------------------------
(Unaudited)
Nine Months
Ended September 30,
----------------------
1998 1997
--------- ---------
(Thousands of Dollars)
Cash Flows from Operating Activities:
Net Income ......................................... $ 217,312 $ 227,837
Items not requiring cash:
Depreciation and amortization .................... 279,097 274,027
Nuclear fuel amortization ........................ 24,991 24,077
Deferred income taxes - net ...................... (47,749) (58,675)
Deferred investment tax credit - net ............. (23,369) (24,091)
Changes in certain current assets and liabilities:
Accounts receivable - net ........................ (118,843) (84,769)
Accrued utility revenues ......................... (27,594) (26,597)
Materials, supplies and fossil fuel .............. (8,944) 2,077
Other current assets ............................. (3,103) (4,541)
Accounts payable ................................. 61,611 23,270
Accrued taxes .................................... 122,709 93,215
Accrued interest ................................. (5,171) (13,279)
Other current liabilities ........................ 16,799 12,171
Other - net ........................................ (20,778) 32,244
--------- ---------
Net cash flow provided by operating activities ....... 466,968 476,966
--------- ---------
Cash Flows from Investing Activities:
Capital expenditures ............................... (221,904) (229,608)
Capitalized interest ............................... (12,627) (12,391)
Other .............................................. (5,872) (16,798)
--------- ---------
Net cash flow used for investing activities .......... (240,403) (258,797)
--------- ---------
Cash Flows from Financing Activities:
Long-term debt ..................................... 109,375 109,906
Short-term borrowings - net ........................ (15,400) 100,850
Dividends paid on common stock ..................... (127,500) (127,500)
Dividends paid on preferred stock .................. (8,070) (10,334)
Repayment of preferred stock ....................... (37,585) (46,511)
Repayment and reacquisition of long-term debt ...... (142,250) (222,725)
--------- ---------
Net cash flow used for financing activities .... (221,430) (196,314)
--------- ---------
Net increase in cash and cash equivalents ............ 5,135 21,855
Cash and cash equivalents at beginning of period ..... 12,552 12,521
--------- ---------
Cash and cash equivalents at end of period ........... $ 17,687 $ 34,376
========= =========
Supplemental Disclosure of Cash Flow Information:
Cash paid during the period for:
Interest (excluding capitalized interest) ........ $ 100,929 $ 114,070
Income taxes ..................................... $ 115,585 $ 161,228
See Notes to Condensed Financial Statements.
-8-
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
September 30, 1998, the results of operations for the three months, nine months
and twelve months ended September 30, 1998 and 1997, and the cash flows for the
nine months ended September 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 nine months ended September 30, 1998.
5. Regulatory Matters ___ Electric Industry Restructuring
STATE
The following is a description of regulatory and legislative developments
related to implementation of retail electric competition beginning with the ACC
rules adopted in December 1996 through the proposed settlement agreement in
November 1998.
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:
o The rules apply to virtually all of the Arizona electric utilities
regulated by the ACC, including the Company.
o 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.
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o 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 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.
o 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.
o 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.
o 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.
o 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.
o 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.
o Beginning January 1, 1999, each affected utility will be prohibited
from providing certain competitive electric services, except through a
separate affiliate.
o 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.
In accordance with the rules, on September 15, 1998, the Company filed a report
detailing possible mechanisms to provide certain non-rate benefits and a
possible extension of the 1996 regulatory agreement to all standard offer
customers and a proposed plan for phase-in implementation of 3,500 residential
customers per quarter
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on a first come, first served basis.
The amended rules became effective on an emergency basis upon their filing with
the Secretary of State on August 10, 1998. The ACC held hearings on the amended
rules in October 1998 and must complete the process of adopting the amended
rules on a permanent basis within 180 days of the Secretary of State filing. The
Company anticipates the completion of this process by year-end 1998 or early
1999.
The Company believes that certain provisions of the 1996 ACC rules and the
amended rules are deficient. In February 1997, a lawsuit was filed by the
Company to protect its legal rights regarding the 1996 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. In October 1998, the
Company also filed a lawsuit to protect its legal rights regarding the amended
rules.
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
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." In accordance with the order, on August 21, 1998 the Company
filed with the ACC the Transition Revenues Methodology as its choice of options
for stranded cost recovery and a related implementation plan relating to its
chosen option. The Company does not intend to divest its generating assets
except to an affiliated party. The Company believes that certain provisions of
the stranded cost order are deficient and in August 1998 the Company filed two
lawsuits to protect its legal rights relating to the order. Based on various
assumptions, estimates and methodologies, the Company estimates its recoverable
stranded costs (excluding regulatory assets which have already been addressed in
the 1996 regulatory agreement with the ACC) to be $533 million, assuming a
measurement period 1999 through 2004. The Company cannot accurately predict the
outcome of this matter.
PROPOSED SETTLEMENT AGREEMENT. On November 4, 1998, the Company and the ACC
Staff entered into a proposed settlement agreement related to the implementation
of retail electric competition. In connection with the settlement agreement, the
Company and TEP entered into a memorandum of understanding for the exchange of
certain
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assets. The following are the major provisions of each agreement, both of which
are attached as exhibits to this Form 10-Q and incorporated herein by reference:
PROPOSED SETTLEMENT AGREEMENT WITH ACC STAFF
o The Company will reduce its prices by a total of at least 4% in the
years 1999 through 2002. Price reductions in 2001 and 2002 will apply
only to the Company's residential customers who purchase all their
electric services from the Company.
o There will be a moratorium on filing for retail rate changes before
January 1, 2003, except for the price reductions described above and
certain other limited circumstances.
o In addition to the cost-saving incentive mechanism, the rate filing
moratorium and full recovery of regulatory assets, certain other
aspects of the 1996 regulatory settlement are extended through 2002.
See Note 6 below for additional information on the 1996 regulatory
agreement.
o The Company will be permitted to defer for later recovery prudent and
reasonable costs of complying with the amended ACC rules, systems
benefits costs and solar power costs in excess of the levels included
in current rates.
o The Company will have the ability to recover stranded costs in exchange
for the divestiture of its 345 kV and 500 kV transmission assets to
TEP.
o The Company and TEP entered into a memorandum of understanding for the
exchange of certain assets.
o Upon final adoption and approval of the settlement agreement by the
ACC, the Company will move to dismiss all of its litigation currently
pending against the ACC.
o The Company will establish a separate corporate affiliate for marketing
generation and other competitive electric services before year-end
1998.
o The Company will form a separate corporate affiliate and transfer to it
generating assets by year-end 2002.
MEMORANDUM OF UNDERSTANDING WITH TEP
o The Company and TEP have entered into a memorandum of understanding to
negotiate in good faith to reach a definitive agreement on the exchange
of certain transmission and generation assets.
o The Company would acquire from TEP up to 273 MW of generating capacity
in exchange for the Company's 500 kV and 345 kV transmission lines. The
assets
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will be exchanged at the transmission current book value, which is
approximately $162 million as of July, 1998. If TEP is unable to
transfer 273 MW of generating capacity, the deficiency is to be made up
by a cash payment from TEP to the Company.
o The transaction is expected to close by December 31, 2000.
o The generating assets are TEP's interest in the Navajo Generating
Station and Four Corners Generating Plant.
A hearing date for the ACC's consideration or approval of the settlement
agreement has not yet been set. The memorandum of understanding provides that a
definitive agreement must be entered into within sixty days of a final order on
the settlement agreement by the ACC.
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 by lower courts in favor of the ACC in two 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.
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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 September 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.
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.
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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:
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 1997 and in 1998, the ACC approved
retail price decreases of approximately $17.6 million ($10.5 million after
income taxes), or 1.2%, effective July 1, 1997, and approximately $17 million
($10 million after income taxes), or 1.1%, effective July 1, 1998, respectively.
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:
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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.
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 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 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
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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 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 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, nine-month and twelve-month periods ended September 30, 1998
and 1997:
Periods ended September 30
(Unaudited)
(Thousands of Dollars)
Three Months Nine Months Twelve Months
----------------------- ----------------------- -----------------------
1998 1997 1998 1997 1998 1997
---------- ---------- ---------- ---------- ---------- ----------
Operating
Revenues $ 740,734 $ 632,821 $1,562,872 $1,470,593 $1,970,832 $1,850,047
Earnings for
Common
Stock $ 130,846 $ 126,715 $ 209,652 $ 218,032 $ 230,310 $ 212,837
OPERATING RESULTS - THREE-MONTH PERIOD ENDED SEPTEMBER 30, 1998
COMPARED WITH THREE-MONTH PERIOD ENDED SEPTEMBER 30, 1997
Earnings increased $4 million in the three-month comparison primarily
because of customer growth, weather effects, and higher profitability from power
marketing activities, partially offset by higher fuel expenses and a retail
price reduction. See Note 6 of Notes to Condensed Financial Statements for
information on the price reduction.
Operating revenues increased $108 million because of increased power
marketing revenues ($71 million), customer growth ($28 million), and weather
effects ($18 million), partially offset by the price reduction ($6 million) and
other ($3 million). The increase in power marketing revenues was a result of
higher market prices and increased activity. The increase in power marketing
revenues was accompanied by related increases in purchased power.
Fuel expenses increased $94 million primarily because of higher
purchased power prices, increased wholesale and retail sales volumes, and the
effects of two fuel-related settlements in the third quarter of 1997. The
settlements contributed approximately $21 million to 1997 pretax earnings and
are reflected on the income statement as reductions in fuel expense and as other
income.
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OPERATING RESULTS - NINE-MONTH PERIOD ENDED SEPTEMBER 30, 1998 COMPARED
WITH NINE-MONTH PERIOD ENDED SEPTEMBER 30, 1997
Earnings decreased $8 million in the nine-month comparison primarily
because of two fuel-related settlements recorded in 1997, increased operations
and maintenance expenses, the effects of weather, and two retail price
reductions, partially offset by customer growth and higher profitability from
power marketing activities. See Note 6 of Notes to Condensed Financial
Statements for additional information about the price reduction.
The two fuel-related settlements increased the Company's 1997 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 $22 million related to
impending competition and growth, outages at power plants and other
miscellaneous factors.
Operating revenues increased $92 million because of increased power
marketing revenues ($69 million) and customer growth ($58 million). These
factors were partially offset by the effects of weather ($20 million) and the
price reductions ($15 million). The increase in power marketing revenues was a
result of higher prices and increased activity. The increase in power marketing
revenues was accompanied by related increases in purchased power.
OPERATING RESULTS - TWELVE-MONTH PERIOD ENDED SEPTEMBER 30, 1998
COMPARED WITH TWELVE-MONTH PERIOD ENDED SEPTEMBER 30, 1997
Earnings increased $17 million in the twelve-month comparison primarily
because of customer growth and higher profitability from power marketing
activities. These positive factors more than offset two retail price reductions
and the effects of weather. See Note 6 of Notes to Condensed Financial
Statements for additional information about the price reductions. The period
ended September 30, 1997 also benefited from two fuel-related settlements and
the recognition of $8 million of income tax benefits associated with capital
loss carryforwards.
Operating revenues increased $121 million because of increased power
marketing revenues ($85 million) and customer growth ($69 million), partially
offset by the price reductions ($18 million), the effects of weather ($10
million), and other ($5 million). The increase in power marketing revenues was a
result of higher prices and increased activity. The increase in power marketing
revenues was accompanied by related increases in purchased power.
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The two fuel-related settlements increased the Company's 1997 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 decreased $8 million because of a
$32 million pretax charge for a voluntary severance program recorded in 1996 and
related savings in 1997, partially offset by higher expenses related to
impending competition and growth, outages at power plants and other
miscellaneous factors.
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 nine months ended September 30, 1998, the Company incurred
approximately $221 million in capital expenditures, which is approximately 68%
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, $221 million; 1999, $174 million; and 2000, $104 million.
During the nine months ended September 30, 1998, the Company redeemed
approximately $142 million of its long-term debt and approximately $38 million
of its preferred stock with cash from operations and long-term and short-term
debt. On December 1, 1998 the Company will redeem all $37.5 million of its
$1.8125 Cumulative Preferred Stock, Series W. 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
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not expect any of these restrictions to limit the Company's ability to meet its
capital requirements.
YEAR 2000 READINESS DISCLOSURE
As the year 2000 approaches many companies face problems because most
software application and operational programs will not properly recognize
calendar dates beginning with the year 2000. The Company initiated a
comprehensive 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 to avoid impacting the reliability of electric service to its customers.
This included a Company-wide awareness program of the Year 2000 issue.
The Company has been actively implementing and replacing new systems
and technology since 1995 for reasons unrelated to the year 2000, and these
actions have resulted in substantially all of its major information technology
(IT) systems becoming Year 2000 compliant. 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 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 and assessed all IT and non-IT systems and any
renovation, validation and implementation of these systems will be completed by
mid-1999, except for those items that can only be completed during maintenance
outages at Palo Verde, which will be completed for the last unit during the last
half of 1999. The Company has also designated an internal audit/quality review
team that is periodically reviewing the individual Year 2000 projects and their
Year 2000 readiness.
The Company is 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
of systems, services and materials in order to assess whether their schedules
for analysis and remediation of Year 2000 issues are timely and to assess their
ability to continue to supply required services and materials. The Company is
also working with the North American Electric Reliability Council (NERC) through
the Western Systems Coordinating Council (WSCC) to develop operational plans for
stable grid operation that will be utilized by the Company and other utilities
in the western United States. However, the Company cannot currently predict the
effect on the Company if the systems of these other companies are not Year 2000
compliant.
The Company currently estimates that it will spend approximately $5
million relating to Year 2000 issues, about half of which has been spent to
date. This does not include expenditures incurred since 1995 to implement and
replace systems for
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reasons unrelated to the Year 2000, as discussed above. Costs incurred to
address the Year 2000 issue are charged to operating expenses as incurred and
are expected to be funded by available cash balances and cash provided by
operations.
The Company currently expects that its most reasonably likely worst
case Year 2000 scenario would be intermittent loss of power, similar to an
outage during a severe weather disturbance. In this situation the Company would
restore power as soon as possible by, among other things, re-routing power
flows. The Company does not currently expect that this scenario would have a
material effect on its financial position, cash flows or results of operations.
The Company is working to develop its own contingency plans to handle
Year 2000 issues, and expects these plans to be completed by mid-1999. As
discussed above, the Company is also working with NERC and WSCC to develop
contingency plans related to grid operation.
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.
RATE MATTERS
See Note 6 of Notes to Condensed Financial Statements in Part I, Item 1
of this report for a discussion of a price reduction, which became effective on
July 1, 1998.
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.
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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.
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PART II - OTHER INFORMATION
---------------------------
ITEM 5. OTHER INFORMATION
CONSTRUCTION AND FINANCING PROGRAMS
See "Liquidity and Capital Resources" in Part I, Item 2 of this report
for a discussion of 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 and
October 16, 1998, lawsuits were filed by the Company to protect its legal rights
regarding the rules and the amended rules, respectively, and in each 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. ARIZONA PUBLIC SERVICE COMPANY v. ARIZONA CORPORATION
COMMISSION, CV 97-03753 (consolidated under CV 97-03748.) ARIZONA PUBLIC SERVICE
COMPANY v. ARIZONA CORPORATION COMMISSION, CV 98-18896. On August 28, 1998, the
Company filed two lawsuits to protect its legal rights under the stranded cost
order and in its complaints the Company asked the Court to vacate and set aside
the order. ARIZONA PUBLIC SERVICE COMPANY v. ARIZONA CORPORATION COMMISSION, CV
98-15728. ARIZONA PUBLIC SERVICE COMPANY v. ARIZONA CORPORATION COMMISSION,
1-CA-CC-98-0008. See "State-Proposed Settlement Agreement" in Note 5 of Notes to
Condensed Financial Statements in this Report regarding the possible dismissal
of the lawsuits described in this paragraph.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
EXHIBIT NO. DESCRIPTION
- ----------- -----------
27.1 Financial Data Schedule
99.1 Settlement Agreement with the ACC dated November 4, 1998, which
includes a Memorandum of Understanding with TEP
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:
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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
(b) Reports on Form 8-K
During the quarter ended September 30, 1998, and the period from
October 1 through November 13, 1998, the Company filed the following reports on
Form 8-K:
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.
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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: November 13, 1998 By: George A. Schreiber, Jr.
--------------------------------------
George A. Schreiber, Jr.
Executive Vice President and
Chief Financial Officer
(Principal Financial Officer
and Officer Duly Authorized
to sign this Report)