FORM 10-Q
Securities and Exchange Commission
Washington, D.C. 20549
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 1998
------------------------
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from to
-------------------- --------------------
Commission file number 1-8962
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PINNACLE WEST CAPITAL CORPORATION
------------------------------------------------------
(Exact name of registrant as specified in its charter)
Arizona 86-0512431
- ------------------------------ -------------------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
400 E. Van Buren St., P.O. Box 52132, Phoenix, Arizona 85072-2132
- ------------------------------------------------------ ----------
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (602) 379-2500
--------------------------------------------------------------------------
(Former name, former address and former fiscal year, if changed since last
report)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes X No
----- -----
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.
Number of shares of common stock, no par value,
outstanding as of May 14, 1998: 84,808,018
<PAGE>
Glossary
--------
ACC - Arizona Corporation Commission
ACC Staff - Staff of the Arizona Corporation Commission
APS - Arizona Public Service Company
Cholla - Cholla Power Plant
Company - Pinnacle West Capital Corporation
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"
El Dorado - El Dorado Investment Company
EPA - United States Environmental Protection Agency
FERC - Federal Energy Regulatory Commission
Four Corners - Four Corners Power Plant
ITC - Investment tax credit
1997 10-K - Pinnacle West Capital Corporation Annual Report on Form 10-K for the
fiscal year ended December 31, 1997
NGS - Navajo Generating Station
Palo Verde - Palo Verde Nuclear Generating Station
Pinnacle West - Pinnacle West Capital Corporation
Power Coordination Agreement - 1955 agreement between the Company and Salt River
Project that provides for certain electric system and power sales
Rules - Rules adopted by the ACC for the introduction of retail electric
competition in Arizona
SFAS No. 71 - Statement of Financial Accounting Standards No. 71, "Accounting
for the Effects of Certain Types of Regulation"
SFAS No. 130 - Statement of Financial Accounting Standards No. 130, "Reporting
Comprehensive Income"
SFAS No. 131 - Statement of Financial Accounting Standards No. 131, "Disclosures
about Segments of an Enterprise and Related Information"
SFAS No. 132 - Statement of Financial Accounting Standards No. 132, "Employers'
Disclosures about Pensions and Other Postretirement Benefits"
Salt River Project - Salt River Project Agricultural Improvement and Power
District
<PAGE>
SunCor - SunCor Development 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
<PAGE>
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PART I. FINANCIAL INFORMATION
-----------------------------
Item 1. Financial Statements.
- -----------------------------
PINNACLE WEST CAPITAL CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
-------------------------------------------
(Unaudited)
(Dollars in thousands, except per share amounts)
Three Months Ended
March 31,
1998 1997
------------ ------------
Operating Revenues
Electric $ 380,423 $ 379,021
Real estate 34,161 19,543
------------ ------------
Total 414,584 398,564
------------ ------------
Fuel Expenses
Fuel for electric generation 50,328 51,122
Purchased power 23,589 34,347
------------ ------------
Total 73,917 85,469
------------ ------------
Operating Expenses
Utility operations and maintenance 96,416 88,016
Real estate operations 30,236 19,762
Depreciation and amortization 92,830 92,602
Taxes other than income taxes 30,348 30,244
------------ ------------
Total 249,830 230,624
------------ ------------
Operating Income 90,837 82,471
------------ ------------
Other Income (Deductions)
Interest on long-term debt (39,710) (39,451)
Other interest (2,707) (4,501)
Capitalized interest 4,151 3,834
Preferred stock dividend requirements of APS (2,878) (3,626)
Other-net 4,359 4,223
------------ ------------
Total (36,785) (39,521)
------------ ------------
Income Before Income Tax 54,052 42,950
Income Tax Expense 22,966 17,568
------------ ------------
Net Income $ 31,086 $ 25,382
============ ============
Average Common Shares Outstanding 84,785,309 87,418,663
Earnings Per Average Common Share Outstanding:
Net income - basic $ 0.37 $ 0.29
============ ============
Net income - diluted $ 0.36 $ 0.29
============ ============
Dividends Declared Per Share $ 0.300 $ 0.275
============ ============
See Notes to Condensed Consolidated Financial Statements.
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PINNACLE WEST CAPITAL CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
-------------------------------------------
(Unaudited)
(Dollars in thousands, except per share amounts)
<TABLE>
<CAPTION>
Twelve Months Ended
March 31,
1998 1997
------------ ------------
<S> <C> <C>
Operating Revenues
Electric $ 1,879,955 $ 1,752,032
Real estate 131,091 103,037
------------ ------------
Total 2,011,046 1,855,069
------------ ------------
Fuel Expenses
Fuel for electric generation 200,547 239,181
Purchased power 224,528 115,539
------------ ------------
Total 425,075 354,720
------------ ------------
Operating Expenses
Utility operations and maintenance 407,834 430,987
Real estate operations 122,102 98,300
Depreciation and amortization 368,513 333,174
Taxes other than income taxes 121,650 118,120
------------ ------------
Total 1,020,099 980,581
------------ ------------
Operating Income 565,872 519,768
------------ ------------
Other Income (Deductions)
Allowance for equity funds used during construction -- 3,534
Interest on long-term debt (160,929) (165,000)
Other interest (16,879) (23,419)
Capitalized interest 16,525 10,106
Preferred stock dividend requirements of APS (12,055) (16,241)
Other-net 4,705 (4,192)
------------ ------------
Total (168,633) (195,212)
------------ ------------
Income From Continuing Operations Before Income Tax 397,239 324,556
Income Tax Expense 155,679 122,974
------------ ------------
Income From Continuing Operations 241,560 201,582
Loss from Discontinued Operations, Net of Income Tax of $6,461 -- (9,539)
Extraordinary Charge for Early Retirement of Debt,
Net of Income Tax of $11,341 -- (16,743)
------------ ------------
Net Income $ 241,560 $ 175,300
============ ============
Average Common Shares Outstanding 84,853,589 87,433,676
Earnings (Loss) Per Average Common Share Outstanding:
Continuing Operations - Basic $ 2.85 $ 2.30
Net Income - Basic $ 2.85 $ 2.00
Continuing Operations - Diluted $ 2.83 $ 2.29
Net Income - Diluted $ 2.83 $ 1.99
Dividends Declared Per Share $ 1.150 $ 1.050
============ ============
</TABLE>
See Notes to Condensed Consolidated Financial Statements.
<PAGE>
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PINNACLE WEST CAPITAL CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEETS
-------------------------------------
(Unaudited)
ASSETS
------
(Thousands of Dollars)
<TABLE>
<CAPTION>
March 31, December 31,
1998 1997
------------ ------------
<S> <C> <C>
Current Assets
Cash and cash equivalents $ 22,119 $ 27,484
Customer and other receivables--net 139,615 183,507
Accrued utility revenues 49,531 58,559
Material and supplies 72,902 70,634
Fossil fuel 10,854 9,621
Deferred income taxes 57,888 57,887
Other current assets 44,007 41,408
------------ ------------
Total current assets 396,916 449,100
------------ ------------
Investments and Other Assets
Real estate investments--net 355,857 365,921
Other assets 220,709 215,027
------------ ------------
Total investments and other assets 576,566 580,948
------------ ------------
Utility Plant
Electric plant in service and held for future use 7,024,991 7,009,059
Less accumulated depreciation and
amortization 2,685,184 2,620,607
------------ ------------
Total 4,339,807 4,388,452
Construction work in progress 270,147 237,492
Nuclear fuel, net of amortization 58,737 51,624
------------ ------------
Net utility plant 4,668,691 4,677,568
------------ ------------
Deferred Debits
Regulatory asset for income taxes 444,887 458,369
Rate synchronization cost deferrals 345,068 358,871
Other deferred debits 313,480 325,561
------------ ------------
Total deferred debits 1,103,435 1,142,801
------------ ------------
Total Assets $ 6,745,608 $ 6,850,417
============ ============
</TABLE>
See Notes to Condensed Consolidated Financial Statements.
<PAGE>
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PINNACLE WEST CAPITAL CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEETS
-------------------------------------
(Unaudited)
LIABILITIES AND EQUITY
----------------------
(Thousands of Dollars)
March 31, December 31,
1998 1997
------------ ------------
Current Liabilities
Accounts payable $ 80,038 $ 117,429
Accrued taxes 138,328 84,610
Accrued interest 28,465 32,974
Short-term borrowings 81,000 130,750
Current maturities of long-term debt 8,313 108,695
Customer deposits 30,924 30,672
Other current liabilities 27,962 18,534
------------ ------------
Total current liabilities 395,030 523,664
------------ ------------
Long-Term Debt Less Current Maturities 2,283,235 2,244,248
------------ ------------
Deferred Credits and Other
Deferred income taxes 1,350,797 1,363,461
Deferred investment tax credit 48,435 50,861
Unamortized gain - sale of utility plant 81,219 82,363
Other 393,697 387,223
------------ ------------
Total deferred credits and other 1,874,148 1,883,908
------------ ------------
Commitments and Contingencies (Notes 5, 8 and 9)
Minority Interests
Non-redeemable preferred stock of APS 141,317 142,051
------------ ------------
Redeemable preferred stock of APS 19,110 29,110
------------ ------------
Common Stock Equity
Common stock, no par value 1,553,453 1,553,771
Retained earnings 479,315 473,665
------------ ------------
Total common stock equity 2,032,768 2,027,436
------------ ------------
Total Liabilities and Equity $ 6,745,608 $ 6,850,417
============ ============
See Notes to Condensed Consolidated Financial Statements.
<PAGE>
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PINNACLE WEST CAPITAL CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
-----------------------------------------------
(Unaudited)
(THOUSANDS OF DOLLARS)
Three Months Ended
March 31,
1998 1997
--------- ---------
CASH FLOWS FROM OPERATING ACTIVITIES
Net Income $ 31,086 $ 25,382
Items not requiring cash
Depreciation and amortization 101,443 100,322
Deferred income taxes--net (11,419) (8,816)
Deferred investment tax credit (2,426) (2,352)
Other--net 1,325 (5,661)
Changes in current assets and liabilities
Customer and other receivables--net 44,468 24,718
Accrued utility revenues 9,028 6,244
Materials, supplies and fossil fuel (3,501) 2,196
Other current assets (2,585) (1,133)
Accounts payable (37,749) (51,383)
Accrued taxes 53,384 51,438
Accrued interest (4,509) (10,900)
Other current liabilities 10,679 (11,916)
Decrease in land held 11,051 1,673
Other--net 8,527 28,286
--------- ---------
Net Cash Flow Provided By Operating Activities 208,802 148,098
--------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES
Capital expenditures (60,848) (77,129)
Capitalized interest (4,151) (3,834)
Other--net (89) 1,797
--------- ---------
Net Cash Flow Used For Investing Activities (65,088) (79,166)
--------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES
Issuance of long-term debt 99,375 2,507
Short-term borrowings--net (49,750) 199,400
Dividends paid on common stock (25,436) (24,042)
Repayment of long-term debt (162,216) (194,098)
Redemption of preferred stock (10,599) (25,980)
Other--net (453) (813)
--------- ---------
Net Cash Flow Used For Financing Activities (149,079) (43,026)
--------- ---------
Net Cash Flow (5,365) 25,906
Cash and Cash Equivalents at Beginning of Period 27,484 26,686
--------- ---------
Cash and Cash Equivalents at End of Period $ 22,119 $ 52,592
========= =========
Supplemental Disclosure of Cash Flow Information:
Cash paid during the period for:
Interest, net of amounts capitalized $ 40,942 $ 50,096
Income taxes $ 4,600 $ 4,001
See Notes to Condensed Consolidated Financial Statements.
<PAGE>
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PINNACLE WEST CAPITAL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
1. The condensed consolidated financial statements include the accounts of
Pinnacle West and its subsidiaries: APS, SunCor and El Dorado. All significant
intercompany balances have been eliminated. Certain prior year balances have
been restated to conform to the current year presentation.
2. In the opinion of the Company, the accompanying unaudited condensed
consolidated financial statements contain all adjustments (consisting of normal
recurring accruals) necessary to present fairly the financial position of
Pinnacle West and its subsidiaries as of March 31, 1998, the results of
operations for the three months and twelve months ended March 31, 1998 and 1997,
and the cash flows for the three months ended March 31, 1998 and 1997. It is
suggested that these condensed consolidated financial statements and notes to
condensed consolidated financial statements be read in conjunction with the
consolidated financial statements and notes to consolidated financial statements
included in the 1997 10-K.
3. The operations of APS 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.
4. See "Liquidity and Capital Resources" in Part I, Item 2 of this report for
changes in capitalization for the three months ended March 31, 1998.
5. Regulatory Matters --- Electric Industry Restructuring
State
ACC Rules. The ACC has been conducting an ongoing investigation into the
restructuring of the Arizona electric industry. In December 1996, the ACC
adopted rules that provide a framework for the introduction of retail electric
competition. The ACC framework rules include the following major provisions:
o The rules are intended to apply to virtually all of the Arizona
electric utilities regulated by the ACC, including APS.
o Each affected utility would be required to make available at least 20%
of its 1995 system retail peak demand for competitive generation supply
to all customer classes not later than January 1, 1999; at least 50%
not later than January 1, 2001; and all of its retail demand not later
than January 1, 2003.
o Electric service providers that obtain Certificates of Convenience and
Necessity (CC&Ns) from the ACC would be allowed to supply, market,
and/or broker
<PAGE>
-7-
specified electric services at retail. These services would include
electric generation, but exclude electric transmission and
distribution.
o On or before December 31, 1997, each affected utility was required to
file with the ACC proposed tariffs for bundled service, if different
than current tariffs, and unbundled service. Bundled service means
electric service elements (i.e., generation, transmission,
distribution, and ancillary services) provided as a package to
consumers within an affected utility's current service area. Unbundled
service means electric service elements provided and priced separately.
o The rules indicate that the ACC will allow recovery of unmitigated
stranded costs. Stranded costs are the costs of generating plants,
other assets and contract commitments that were prudently incurred to
serve power customers that could go unrecovered if these customers are
allowed to use open access to move to another supplier. Each affected
utility would be required to file with the ACC its estimates of
unmitigated stranded costs. The ACC would then, after hearing and
consideration of various factors, determine the magnitude of stranded
costs and appropriate stranded cost recovery mechanisms and charges.
The ACC ordered in the rules that numerous issues (including reliability;
stranded cost measurement and recovery; the phase-in process, bundled, unbundled
and metering services; legal issues; and independent system operator and spot
market development) require additional consideration prior to implementation of
retail electric competition. During 1997, the ACC conducted workshops to gather
input from various constituencies with respect to those issues. In 1998, the ACC
has continued conducting workshops on certain of the issues.
In February 1998, the ACC completed a formal, generic hearing on stranded cost
determination and recovery. Based on various assumptions, estimates and
methodologies, APS currently estimates that its stranded costs to be recovered
(excluding regulatory assets which have already been addressed by the ACC) will
be less than $500 million. APS is seeking full recovery of stranded costs during
a transition period proposed to go through 2006. On May 6, 1998, an ACC Hearing
Officer issued a Recommended Decision in the above proceeding that, although
recommending an opportunity for full recovery of APS' stranded costs, would
impose certain conditions and restrictions on stranded cost recovery. However,
final decisions by the ACC have not yet been made with respect to this issue.
The Company believes that certain provisions of the ACC framework rules are
deficient. In February 1997, a lawsuit was filed by APS to protect its legal
rights regarding those rules. That lawsuit is pending but two related cases
filed by other utilities have been partially decided in a manner adverse to
those utilities' positions.
Legislative Initiatives. An Arizona joint legislative committee studied electric
utility industry restructuring issues in 1996 and 1997. In conjunction with that
study, Arizona legislative counsel prepared memoranda in late 1997 related to
the legal authority of
<PAGE>
-8-
the ACC to deregulate the Arizona electric utility industry. The memoranda raise
a question as to the degree to which the ACC may, under the Arizona
Constitution, deregulate any portion of the electric utility industry and allow
rates to be determined by market forces. This latter issue (the ability of the
ACC to set rates based on the competitive market) was decided in favor of the
ACC in the related lawsuits referenced in the preceding paragraph.
In May 1998, the final version of a bill to facilitate implementation of retail
electric competition in the state was approved by the House/Senate conference
committee of the Arizona legislature. The bill includes the following major
provisions: (a) requirements that Arizona's largest government-operated electric
utility (Salt River Project) and, at their option, smaller city electric systems
(i) open their service territories to electric service providers to implement
retail electric generation competition for 20% of each utility's 1995 retail
peak demand by December 31, 1998 and for all retail customers by December 31,
2000; (ii) decrease rates by at least 10% over a ten-year period beginning as
early as January 1, 1991; (iii) implement procedures and public processes,
including judicial review at the request of either an interested party or the
Arizona Attorney General, for establishing the terms, conditions and pricing of
electric services as well as certain other decisions affecting retail electric
competition, which procedures and processes are comparable to those already
applicable to public service corporations; (b) a description of the factors
which form the basis of consideration by Salt River Project in determining
stranded costs; and (c) a requirement, both for public power entities and public
service corporations (including APS), that billing, collection, metering and
meter reading services be provided on a competitive basis during the first two
years of competition only for customers having demands in excess of one megawatt
(and that are eligible for competitive generation services), and thereafter for
all customers receiving competitive electric generation.
The legislature will also review and make recommendations for the 1999 Arizona
legislature on certain issues, including: whether public power entities excluded
from the current bill should be included; taxation issues associated with
electric competition; regulation of public power entities outside their service
territory; constitutional issues relating to facilitating electric competition;
system priority, capacity, capability and reliability; antitrust issues; and
public power entities compliance with the code of conduct and affiliate issues
between competitive and noncompetitive service electricity providers. The bill
now goes to the Arizona House and Senate for a final vote and, if passed, to the
Governor for consideration.
Federal
The Energy Policy Act of 1992 and recent rulemakings by FERC have promoted
increased competition in the wholesale electric power markets. The Company does
not expect these rules to have a material impact on its financial statements.
Several electric utility reform bills have been introduced during recent
congressional sessions, which as currently written, would allow consumers to
choose their electricity suppliers by 2000 or 2003. These bills, other bills
that are expected to be introduced, and ongoing discussions at the federal level
suggest a wide range of opinion that will need to be narrowed before any
substantial restructuring of the electric utility industry can occur.
Regulatory Accounting
APS prepares its financial statements in accordance with 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. APS' existing
<PAGE>
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regulatory orders and current regulatory environment support its accounting
practices related to regulatory assets, which amounted to approximately $0.9
billion at March 31, 1998. In accordance with the 1996 regulatory agreement, the
ACC accelerated the amortization of substantially all of APS' 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. APS 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, APS would be required
to write off the remaining balance as an extraordinary charge to expense.
General
The Company believes that further ACC decisions, legislation at the Arizona and
federal levels and perhaps amendments to the Arizona Constitution (which
amendments would require a vote of the people) will ultimately be required
before significant implementation of retail electric competition can lawfully
occur in Arizona. Until the manner of implementation of competition, including
addressing stranded costs, is determined, the Company cannot accurately predict
the impact of full retail competition on its financial position, cash flows or
results of operation. As competition in the electric industry continues to
evolve, the Company will continue to evaluate strategies and alternatives that
will position the Company to compete in the new regulatory environment.
6. Regulatory Matters --- 1996 Regulatory Agreement
In April 1996, the ACC approved a regulatory agreement between APS 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 APS' 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).
<PAGE>
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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 APS by the parent
company, 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, APS 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, APS and Salt River Project entered into a Memorandum of
Agreement in anticipation of, and to facilitate, the opening of the Arizona
electric industry. The Agreement contains the following major components (some
of which are subject to approval of their respective Boards of Directors):
o APS 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 APS and Salt River Project would amend the Power Coordination Agreement
to lower the price that APS will pay Salt River Project for purchased
power by approximately $17 million (pretax) in 1999 and by lesser
annual amounts through 2006.
o APS and Salt River Project agreed on certain legislative positions
regarding electric utility restructuring at the state and federal
level.
An ACC docket has been established so that the ACC may review certain provisions
of the Agreement. The ACC Staff has requested the ACC Hearing Division to issue
a procedural order to govern the proceedings before the ACC on this matter. In
its request, the ACC Staff identified certain issues that it believes the ACC
should consider, including whether (a) the Territorial Agreement remains in the
public interest,
(b) the Agreement is a contract in restraint of trade, and (c) the Agreement
will materially lessen the potential for retail electric competition in Arizona.
APS cannot predict what action, if any, will result from any ACC hearings that
may be held with respect to the Agreement.
<PAGE>
-11-
The Antitrust Unit of the Arizona Attorney General's Office, which has been
involved in the ongoing regulatory and legislative proceedings regarding the
restructuring of the Arizona electric industry, has requested clarification of
the operation of certain of the Agreement's provisions. APS is currently engaged
in discussions with the Arizona Attorney General's Office regarding this matter.
8. The Palo Verde participants have insurance for public liability payments
resulting from nuclear energy hazards to the full limit of liability under
federal law. This potential liability is covered by primary liability insurance
provided by commercial insurance carriers in the amount of $200 million and the
balance by an industry-wide retrospective assessment program. If losses at any
nuclear power plant covered by the programs exceed the accumulated funds, APS
could be assessed retrospective premium adjustments. The maximum assessment per
reactor under the program for each nuclear incident is approximately $79
million, subject to an annual limit of $10 million per incident. Based upon APS'
29.1% interest in the three Palo Verde units, APS' maximum potential assessment
per incident is approximately $69 million, with an annual payment limitation of
approximately $9 million.
The Palo Verde participants maintain "all risk" (including nuclear hazards)
insurance for property damage to, and decontamination of, property at Palo Verde
in the aggregate amount of $2.75 billion, a substantial portion of which must
first be applied to stabilization and decontamination. APS has also secured
insurance against portions of any increased cost of generation or purchased
power and business interruption resulting from a sudden and unforeseen outage of
any of the three units. The insurance coverage discussed in this and the
previous paragraph is subject to certain policy conditions and exclusions.
9. APS 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 APS to replace the Unit 2 steam generators between
2003 and 2008. APS estimates that its share of the replacement costs (in 1998
dollars and including installation and replacement power costs) will be
approximately $50 million, most of which will be incurred after the year 2000.
During the fourth quarter of 1997, the Palo Verde participants, including APS,
entered into a contract for the fabrication of two replacement steam generators.
The cost to APS 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. APS'
share of installation costs is approximately $24 million. Based on the latest
available data, APS estimates that the Unit 1 and Unit 3 steam generators should
operate for the license periods (until 2025 and 2027, respectively), although
APS will continue its normal periodic assessment of these steam generators.
10. In the first quarter of 1998 the Company adopted SFAS No. 130, "Reporting
Comprehensive Income." This standard changed the reporting of certain items
previously reported in the common stock equity section of the balance sheet. The
effects of
<PAGE>
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adopting SFAS No. 130 were not material to the Company's consolidated financial
statements.
The Financial Accounting Standards Board issued SFAS No. 131 on "Disclosures
about Segments of an Enterprise and Related Information" and SFAS No. 132,
"Employers' Disclosures about Pensions and Other Postretirement Benefits," both
of which are effective for fiscal years beginning after December 15, 1997. SFAS
No. 131 requires that public companies report certain information about
operating segments in their financial statements. It also establishes related
disclosures about products and services, geographic areas, and major customers.
The Company is currently evaluating what impact this standard will have on its
disclosures. SFAS No. 132 standardizes the disclosure requirements for pensions
and other postretirement benefits. It is not expected to have a material effect
on the Company's financial statement disclosures.
<PAGE>
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PINNACLE WEST CAPITAL CORPORATION
Item 2. Management's Discussion and Analysis of Financial Condition and Results
-----------------------------------------------------------------------
of Operations.
- --------------
Operating Results
- -----------------
The following table shows the income and/or loss of Pinnacle West and
its subsidiaries for the three-month and twelve-month periods ended March 31,
1998 and 1997:
Income (Loss)
(Unaudited)
(Thousands of Dollars)
Three Months Ended Twelve Months Ended
March 31, March 31,
1998 1997 1998 1997
--------- --------- --------- ---------
APS $ 29,057 $ 25,019 $ 242,728 $ 210,269
SunCor 3,239 1,088 7,485 6,452
El Dorado 3,169 3,270 8,089 3,777
Pinnacle West (1) (4,379) (3,995) (16,742) (45,198)
--------- --------- --------- ---------
NET INCOME $ 31,086 $ 25,382 $ 241,560 $ 175,300
========= ========= ========= =========
(1) Includes Pinnacle West's interest expense, extraordinary charge for
early retirement of debt, discontinued operations and operating
expenses, net of income tax benefits. Income tax benefits (expenses)
are as follows (in thousands): $(921) and $386 for the three months
ended March 31, 1998 and 1997, respectively; and $1,443 and $20,033 for
the twelve months ended March 31, 1998 and 1997 respectively.
APS
---
Operating Results - Three-month period ended March 31, 1998 compared
-----------------------------------------------------------------------
with three-month period ended March 31, 1997
--------------------------------------------
Earnings increased $4 million in the three-month comparison primarily
because of strong customer growth, partially offset by increased operations and
maintenance expenses.
<PAGE>
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Operating revenues increased $1 million because the effects of customer
growth ($13 million) and weather ($3 million) offset a decrease in sales for
resale ($10 million) and a price reduction ($4 million). See Note 6 of Notes to
Condensed Consolidated Financial Statements for information on the price
reduction. Sales for resale are wholesale electricity sales to third parties who
resell the electricity to their customers. The decrease in sales for resale was
a result of changes in power marketing activity, which can vary from period to
period without corresponding effects on earnings because of related fluctuations
in purchased power costs.
Operation and maintenance expenses increased $8 million as a result of
growth and increased expenses due to impending competition, increased outages at
coal plants and other miscellaneous factors, partially offset by savings
resulting from a 1996 voluntary severance program.
Operating Results - Twelve-month period ended March 31, 1998 compared
------------------------------- ---------------------------------------
with twelve-month period ended March 31, 1997
---------------------------------------------
Earnings increased $32 million in the twelve-month comparison ended
March 31, 1998 primarily because of customer growth; a $32 million pretax charge
in 1996 for a voluntary severance program; two fuel-related settlements in the
third quarter of 1997; and lower financing costs. These positive factors more
than offset the effects of the 1996 regulatory agreement with the ACC, which, in
the twelve-month comparison, resulted in $27 million of additional regulatory
asset amortization and a $28 million revenue decrease caused by two retail price
reductions. See Note 6 of Notes to Condensed Consolidated Financial Statements
for additional information about the regulatory agreement. In the period ended
March 31, 1997, APS also recognized $11 million of income tax benefits
associated with capital loss carryforwards.
Operating revenues increased $128 million primarily because of
increases in sales for resale ($95 million); customer growth ($59 million) and
weather effects ($12 million). As mentioned above, these positive factors were
partially offset by the $28 million revenue decrease caused by retail price
reductions and by various other factors ($10 million). Sales for resale are
wholesale electricity sales to third parties who resell the electricity to their
customers. The increase in sales for resale was a result of increased activity
in competitive bulk power markets. The increase in sales for resale did not
significantly affect earnings because it was substantially offset by higher
power puchases.
The two fuel-related settlements increased APS' pretax earnings by
approximately $21 million. APS' income statement reflects these settlements as
reductions in fuel expense and as other income.
Operations and maintenance expenses were lower because of the charge
for the voluntary severance program recorded in 1996 and related savings in
1997. These savings were partially offset by increased expenses as a result of
growth and competition, and other miscellaneous factors.
<PAGE>
-15-
Financing costs decreased $10 million because of lower amounts of
outstanding debt and preferred stock.
Non-Utility Operations
----------------------
The parent company's losses decreased in the twelve-month period due to
lower interest expense resulting from debt reduction. The twelve-month period
ended March 1997 included extraordinary charges related to the early retirement
of debt and a loss from discontinued operations on a legal matter related to
MeraBank, A Federal Savings Bank (a former subsidiary).
SunCor's earnings increased in both the three-month and twelve-month
periods due primarily to an increase in net land and home sales.
El Dorado's increase in earnings in the twelve-month period was the
result of investment sales.
Other Income
------------
As part of a 1994 rate settlement with the ACC, APS accelerated
amortization of substantially all deferred ITCs over a five-year period that
ends on December 31, 1999. The amortization of ITCs decreases annual
consolidated income tax expense by approximately $24 million.
Liquidity and Capital Resources
- -------------------------------
Parent Company
--------------
The parent company's cash requirements and its ability to fund those
requirements are discussed under "Capital Needs and Resources" in Management's
Discussion and Analysis of Financial Condition and Results of Operation in Part
II, Item 7 of the 1997 10-K.
As a result of the 1996 regulatory agreement (see Note 6 of Notes to
Condensed Consolidated Financial Statements in Part I, Item 1 of this report),
the parent company has invested $50 million in APS in 1996 and 1997 and will
invest similar amounts annually in 1998 and 1999.
The Board declared a quarterly dividend of 30 cents per share of common
stock, payable June 1, 1998 to shareholders of record on May 1, 1998, totaling
approximately $ 25.4 million.
APS
---
<PAGE>
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For the three months ended March 31, 1998, APS incurred approximately
$60 million in capital expenditures, which is approximately 19% of the most
recently estimated 1998 capital expenditures. APS' projected capital
expenditures for the next three years are: 1998, $323 million; 1999, $313
million; and 2000, $306 million, respectively. These amounts include about $30 -
$35 million each year for nuclear fuel expenditures. In addition, APS is
considering expanding certain of its businesses over the next several years,
which may result in increased expenditures.
APS' long-term debt and preferred stock redemption requirements and
payment obligations on a capitalized lease for the next three years are: 1998,
$165 million; 1999, $174 million; and 2000, $109 million. During the three
months ended March 31, 1998, APS redeemed approximately $135 million of its
long-term debt and approximately $11 million of its preferred stock with cash
from operations and long-term and short-term debt. As a result of the 1996
regulatory agreement (see Note 6 of Notes to Condensed Consolidated Financial
Statements), the parent company invested $50 million in APS in 1996 and 1997 and
will invest similar amounts annually in 1998 and 1999. During the three months
ended March 31, 1998, APS issued $100 million of its unsecured debt.
Although provisions in APS' bond indenture, articles of incorporation,
and financing orders from the ACC establish maximum amounts of additional first
mortgage bonds and preferred stock that APS may issue, management does not
expect any of these restrictions to limit APS' ability to meet its capital
requirements.
Year 2000 Technology Issues
- ---------------------------
The Company has made, and will continue to make, certain modifications
to its computer hardware and software systems and applications to ensure they
are capable of handling dates in the year 2000 and thereafter. The Company's
major computer systems have been updated and other systems are being analyzed
for potential modifications. The financial impact on the Company is not
anticipated to be material to its financial position, cash flows or results of
operations. The Company is in the process of formal communications with its
significant suppliers, business partners, and large customers to determine the
extent to which it may be affected by these third parties' plans to remediate
their own year 2000 issues in a timely manner.
Competition and Electric Industry Restructuring
- -----------------------------------------------
See Note 5 of Notes to Condensed Consolidated 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 Consolidated 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 APS
estimates would reduce its pretax costs for purchased power by approximately $17
million in 1999 and by lesser annual amounts through 2006.
<PAGE>
-17-
Rate Matters
- ------------
See Note 5 of Notes to Condensed Consolidated 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 APS to successfully compete outside
its traditional regulated markets; regional economic conditions, which could
affect customer growth; the cost of debt and equity capital; weather variations
affecting customer usage; and technological developments in the electric
industry.
These factors and the other matters discussed above may cause future
results to differ materially from historical results, or from results or
outcomes currently expected or sought by the Company.
<PAGE>
-18-
PART II - OTHER INFORMATION
---------------------------
The following information relates primarily to Pinnacle West and its
principal subsidiary, APS.
ITEM 5. Other Information
- ------------------------------
Purported Navajo Environmental Regulation
- -----------------------------------------
As previously reported, in February 1998, the EPA promulgated
regulations specifying those provisions of the Clean Air Act for which it is
appropriate to treat Indian tribes in the same manner as states, and APS
reviewed the regulations to determine what effect they may have on Four Corners
and NGS. See "Environmental Matters --- Purported Navajo Environmental
Regulation" in Part I, Item 1 of the 1997 10-K. On April 10, 1998, APS filed a
Petition for Review in the United States Court of Appeals for the District of
Columbia. Arizona Public Service Company v. United States Environmental
Protection Agency, No. 98-1196.
Palo Verde Nuclear Generating Station
-------------------------------------
See Note 9 of Notes to Condensed Consolidated 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 Consolidated Financial Statements in
Part I, Item 1 of this report for a discussion of competition and the Rules
regarding the introduction of retail electric competition in Arizona. On
February 28, 1997, a lawsuit was filed by APS to protect its legal rights
regarding the Rules and in its complaint APS 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.
<PAGE>
-19-
ITEM 6. Exhibits and Reports on Form 8-K
- -----------------------------------------
(a) Exhibits
Exhibit No. Description
- ----------- -----------
27.1 Financial Data Schedule
(b) Reports on Form 8-K
During the quarter ended March 31, 1998, and the period from April 1
through May 14, 1998, the Company filed no reports on Form 8-K.
<PAGE>
-20-
SIGNATURES
----------
Pursuant to the requirements of the Securities Exchange Act of 1934,
the Company has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
PINNACLE WEST CAPITAL CORPORATION
(Registrant)
Dated: May 15, 1998 By: /s/ 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)
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