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, 2000 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 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 12, 2000: 84,732,123
Glossary ACC - Arizona Corporation Commission ACC Staff - Staff of the Arizona Corporation Commission APS - Arizona Public Service Company, a Pinnacle West subsidiary APS Energy Services - APS Energy Services Company, Inc., a direct access electricity provider, a Pinnacle West subsidiary Company - Pinnacle West Capital Corporation DOE - United States Department of Energy EITF 97-4 - Emerging Issues Task Force Issue No. 97-4, "Deregulation of the Pricing of Electricity -- Issues Related to the Application 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, a Pinnacle West subsidiary EPA - Environmental Protection Agency FERC - Federal Energy Regulatory Commission Four Corners - Four Corners Power Plant ITC - Investment tax credit MW - Megawatts NGS - Navajo Generating Station 1999 10-K - Pinnacle West Capital Corporation Annual Report on Form 10-K for the fiscal year ended December 31, 1999 Palo Verde - Palo Verde Nuclear Generating Station Pinnacle West - Pinnacle West Capital Corporation Pinnacle West Energy - Pinnacle West Energy Corporation, a Pinnacle West subsidiary SFAS No. 71 - Statement of Financial Accounting Standards No. 71, "Accounting for the Effects of Certain Types of Regulation" 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 SunCor - SunCor Development Company, a Pinnacle West subsidiary
-2- PART I. FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS. PINNACLE WEST CAPITAL CORPORATION CONDENSED CONSOLIDATED STATEMENTS OF INCOME (Unaudited) (In thousands, except per share amounts) Three Months Ended March 31, ----------------------- 2000 1999 --------- --------- Operating Revenues Electric $ 446,228 $ 413,983 Real estate 41,889 24,533 --------- --------- Total 488,117 438,516 --------- --------- Operating Expenses Fuel and purchased power 125,997 100,345 Utility operations and maintenance 110,599 101,942 Real estate operations 32,820 22,235 Depreciation and amortization 97,038 96,910 Taxes other than income taxes 25,392 25,485 --------- --------- Total 391,846 346,917 --------- --------- Operating Income 96,271 91,599 --------- --------- Other Income (Expense) Preferred stock dividend requirements of APS -- (1,016) Net other income and expense 35,543 (2,337) --------- --------- Total 35,543 (3,353) --------- --------- Income Before Interest and Income Taxes 131,814 88,246 --------- --------- Interest Expense Interest charges 40,777 40,769 Capitalized interest (3,849) (4,074) --------- --------- Total 36,928 36,695 --------- --------- Income Before Income Taxes 94,886 51,551 Income Taxes 40,816 20,861 --------- --------- Net Income $ 54,070 $ 30,690 ========= ========= Average Common Shares Outstanding - Basic 84,728 84,670 Average Common Shares Outstanding - Diluted 84,834 85,176 Earnings Per Average Common Share Outstanding Net Income - Basic $ 0.64 $ 0.36 Net Income - Diluted $ 0.64 $ 0.36 Dividends Declared Per Share $ 0.35 $ 0.325 See Notes to Condensed Consolidated Financial Statements.
-3- PINNACLE WEST CAPITAL CORPORATION CONDENSED CONSOLIDATED STATEMENTS OF INCOME (Unaudited) (In thousands, except per share amounts) Twelve Months Ended March 31, ----------------------- 2000 1999 ---------- ---------- Operating Revenues Electric $2,325,429 $2,039,958 Real estate 147,525 114,560 ---------- ---------- Total 2,472,954 2,154,518 ---------- ---------- Operating Expenses Fuel and purchased power 821,761 570,694 Utility operations and maintenance 455,434 422,500 Real estate operations 130,101 107,330 Depreciation and amortization 385,696 383,759 Taxes other than income taxes 96,513 102,345 ---------- ---------- Total 1,889,505 1,586,628 ---------- ---------- Operating Income 583,449 567,890 ---------- ---------- Other Income (Expense) Preferred stock dividend requirements of APS -- (7,841) Net other income and expense 48,673 (6,087) ---------- ---------- Total 48,673 (13,928) ---------- ---------- Income From Continuing Operations Before Interest and Income Taxes 632,122 553,962 ---------- ---------- Interest Expense Interest charges 162,389 166,992 Capitalized interest (11,439) (18,014) ---------- ---------- Total 150,950 148,978 ---------- ---------- Income From Continuing Operations Before Income Taxes 481,172 404,984 Income Taxes 188,020 162,488 ---------- ---------- Income From Continuing Operations 293,152 242,496 Income Tax Benefit From Discontinued Operations 38,000 -- Extraordinary Charge - Net of Income Taxes of $94,115 (139,885) -- ---------- ---------- Net Income $ 191,267 $ 242,496 ========== ========== Average Common Shares Outstanding - Basic 84,732 84,746 Average Common Shares Outstanding - Diluted 84,925 85,352 Earnings Per Average Common Share Outstanding Continuing Operations - Basic $ 3.46 $ 2.86 Net Income - Basic $ 2.26 $ 2.86 Continuing Operations - Diluted $ 3.45 $ 2.84 Net Income - Diluted $ 2.25 $ 2.84 Dividends Declared Per Share $ 1.35 $ 1.25 See Notes to Condensed Consolidated Financial Statements.
-4- PINNACLE WEST CAPITAL CORPORATION CONDENSED CONSOLIDATED BALANCE SHEETS ASSETS (Thousands of Dollars) March 31, December 31, 2000 1999 ---------- ---------- (Unaudited) Current Assets Cash and cash equivalents $ 127,304 $ 20,705 Customer and other receivables--net 196,419 244,599 Accrued utility revenues 63,093 72,919 Materials and supplies 73,779 69,977 Fossil fuel 21,260 21,869 Deferred income taxes 9,280 8,163 Other current assets 63,722 60,562 ---------- ---------- Total current assets 554,857 498,794 ---------- ---------- Investments and Other Assets Real estate investments--net 346,682 344,293 Other assets 292,884 267,458 ---------- ---------- Total investments and other assets 639,566 611,751 ---------- ---------- Property, Plant and Equipment Plant in service and held for future use 7,611,330 7,546,314 Less accumulated depreciation and amortization 3,082,764 3,026,194 ---------- ---------- Total 4,528,566 4,520,120 Construction work in progress 214,693 209,281 Nuclear fuel, net of amortization 52,390 49,114 ---------- ---------- Net property, plant and equipment 4,795,649 4,778,515 ---------- ---------- Deferred Debits Regulatory assets 580,158 613,729 Other deferred debits 99,667 105,717 ---------- ---------- Total deferred debits 679,825 719,446 ---------- ---------- Total Assets $6,669,897 $6,608,506 ========== ========== See Notes to Condensed Consolidated Financial Statements.
-5- PINNACLE WEST CAPITAL CORPORATION CONDENSED CONSOLIDATED BALANCE SHEETS LIABILITIES AND EQUITY (Thousands of Dollars) March 31, December 31, 2000 1999 ---------- ---------- (Unaudited) Current Liabilities Accounts payable $ 133,393 $ 186,524 Accrued taxes 133,032 70,510 Accrued interest 19,711 33,253 Short-term borrowings 128,800 38,300 Current maturities of long-term debt 215,261 114,798 Customer deposits 26,753 26,098 Other current liabilities 27,429 26,007 ---------- ---------- Total current liabilities 684,379 495,490 ---------- ---------- Long-Term Debt Less Current Maturities 2,054,581 2,206,052 ---------- ---------- Deferred Credits and Other Deferred income taxes 1,186,102 1,183,855 Unamortized gain - sale of utility plant 72,068 73,212 Other 442,841 444,164 ---------- ---------- Total deferred credits and other 1,701,011 1,701,231 ---------- ---------- Commitments and contingencies (Notes 6, 7, 9 and 10) Common Stock Equity Common stock, no par value 1,537,219 1,537,449 Retained earnings 692,707 668,284 ---------- ---------- Total common stock equity 2,229,926 2,205,733 ---------- ---------- Total Liabilities and Equity $6,669,897 $6,608,506 ========== ========== See Notes to Condensed Consolidated Financial Statements.
-6- PINNACLE WEST CAPITAL CORPORATION CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited) (THOUSANDS OF DOLLARS) Three Months Ended March 31, ---------------------- 2000 1999 --------- --------- CASH FLOWS FROM OPERATING ACTIVITIES Net Income $ 54,070 $ 30,690 Items not requiring cash Depreciation and amortization 97,038 96,910 Nuclear fuel amortization 7,931 8,269 Deferred income taxes--net 12,635 (7,870) Other--net 1,030 (1,126) Changes in current assets and liabilities Customer and other receivables--net 48,180 35,268 Accrued utility revenues 9,826 8,804 Materials, supplies and fossil fuel (3,193) (1,189) Other current assets (3,160) (7,007) Accounts payable (53,023) (52,168) Accrued taxes 62,522 54,715 Accrued interest (13,542) (3,909) Other current liabilities 2,124 8,969 Change in El Dorado partnership investment (32,072) -- Increase in land held (2,097) (1,256) Other--net 5,023 (191) --------- --------- Net Cash Flow Provided By Operating Activities 193,292 168,909 --------- --------- CASH FLOWS FROM INVESTING ACTIVITIES Capital expenditures (89,704) (67,467) Capitalized interest (3,849) (4,074) Other--net (2,461) (9,082) --------- --------- Net Cash Flow Used For Investing Activities (96,014) (80,623) --------- --------- CASH FLOWS FROM FINANCING ACTIVITIES Issuance of long-term debt 49,000 127,928 Short-term borrowings--net 90,500 (66,105) Dividends paid on common stock (29,654) (27,534) Repayment of long-term debt (100,295) (17,575) Redemption of preferred stock -- (96,499) Other--net (230) (3,330) --------- --------- Net Cash Flow Provided by (Used For) Financing Activities 9,321 (83,115) --------- --------- Net Cash Flow 106,599 5,171 Cash and Cash Equivalents at Beginning of Period 20,705 20,538 --------- --------- Cash and Cash Equivalents at End of Period $ 127,304 $ 25,709 ========= ========= Supplemental Disclosure of Cash Flow Information: Cash paid during the period for: Interest, net of amounts capitalized $ 34,618 $ 37,434 Income taxes $ -- $ -- See Notes to Condensed Consolidated Financial Statements.
-7- 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, El Dorado, APS Energy Services, and Pinnacle West Energy. All significant intercompany balances have been eliminated. We have reclassified certain prior year amounts to conform to the current year presentation. 2. Our unaudited condensed consolidated financial statements reflect all adjustments which we believe are necessary for the fair presentation of our financial position and results of operations for the periods presented. These adjustments are of a normal recurring nature with the exception of the extraordinary item and the tax benefit from discontinued operations. We suggest that these condensed consolidated financial statements and notes to condensed consolidated financial statements be read along with the consolidated financial statements and notes to consolidated financial statements included in our 1999 10-K. 3. Weather conditions can have a significant impact on APS' results for interim periods. El Dorado's earnings are subject to stock market volatility (see Note 12). For these and other reasons, results for interim periods do not necessarily represent results to be expected for the 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, 2000. 5. Regulatory Accounting For regulated operations, APS prepares its financial statements in accordance with 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. During 1997, the Emerging Issues Task Force (EITF) of the Financial Accounting Standards Board (FASB) issued EITF 97-4. EITF 97-4 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.
-8- In September 1999, APS' Settlement Agreement (Settlement Agreement) was approved by the ACC (see Note 6 for a discussion of the agreement). APS has discontinued the application of SFAS No. 71 for its generation operations. This means that the generation assets were tested for impairment and the portion of regulatory assets deemed to be unrecoverable through ongoing regulated cash flows was eliminated. APS determined that the generation assets were not impaired. A regulatory disallowance removed $234 million pretax ($183 million net present value) from ongoing regulatory cash flows and was recorded as a net reduction of regulatory assets. This reduction ($140 million after income taxes) was reported as an extraordinary charge on the income statement during the third quarter of 1999. Prior to the Settlement Agreement, under the 1996 regulatory agreement (see Note 6), the ACC accelerated the amortization of substantially all of APS' regulatory assets to an eight-year period that would have ended June 30, 2004. The regulatory assets to be recovered under the 1999 Settlement Agreement are now being amortized as follows (millions of dollars): 1/1 - 6/30 1999 2000 2001 2002 2003 2004 Total ---- ---- ---- ---- ---- ---- ----- $164 $158 $145 $115 $86 $18 $686 The majority of APS' regulatory assets relate to deferred income taxes and rate synchronization cost deferrals. The condensed balance sheets include the amounts listed below for generation assets not subject to SFAS No. 71 (thousands of dollars): March 31, December 31, 2000 1999 ----------- ----------- Electric plant in service & held for future use $ 3,767,769 $ 3,770,234 Accumulated depreciation and amortization (1,845,080) (1,817,589) Construction work in progress 76,248 87,819 Nuclear fuel, net of amortization 52,390 49,114 6. Regulatory Matters -- Electric Industry Restructuring STATE SETTLEMENT AGREEMENT. On May 14, 1999, APS entered into a comprehensive Settlement Agreement with various parties, including representatives of major consumer groups, related to the implementation of retail electric competition. On September 23, 1999, the ACC voted to approve the Settlement Agreement, with some
-9- modifications. On December 13, 1999, two parties filed lawsuits challenging the ACC's approval of the Settlement Agreement. One of the parties questioned the authority of the ACC to approve the Settlement Agreement and both parties challenged several specific provisions of the Settlement Agreement. The following are the major provisions of the Settlement Agreement, as approved: * APS will reduce rates for standard offer service for customers with loads less than 3 megawatts in a series of annual retail electric price reductions of 1.5% beginning July 1, 1999 through July 1, 2003, for a total of 7.5%. The first reduction of approximately $24 million ($14 million after income taxes) included the July 1, 1999 retail price decrease of approximately $11 million annually ($7 million after income taxes) related to the 1996 regulatory agreement. See "1996 Regulatory Agreement" below. For customers having loads 3 megawatts or greater, standard offer rates will be reduced in annual increments that total 5% through 2002. * Unbundled rates being charged by APS for competitive direct access service (for example, distribution services) became effective upon approval of the Settlement Agreement, retroactive to July 1, 1999, and also will be subject to annual reductions beginning January 1, 2000, that vary by rate class, through January 1, 2004. * There will be a moratorium on retail price changes for standard offer and unbundled competitive direct access services until July 1, 2004, except for the price reductions described above and certain other limited circumstances. Neither the ACC nor APS will be prevented from seeking or authorizing rate changes prior to July 1, 2004 in the event of conditions or circumstances that constitute an emergency, such as an inability to finance on reasonable terms, or material changes in APS' cost of service for ACC-regulated services resulting from federal, tribal, state or local laws, regulatory requirements, judicial decisions, actions or orders. * APS will be permitted to defer for later recovery prudent and reasonable costs of complying with the ACC electric competition rules, system benefits costs in excess of the levels included in current rates, and costs associated with APS' "provider of last resort" and standard offer obligations for service after July 1, 2004. These costs are to be recovered through an adjustment clause or clauses commencing on July 1, 2004. * APS' distribution system opened for retail access effective September 24, 1999. Customers will be eligible for retail access in accordance with the phase-in adopted by the ACC under the electric competition rules (see "Retail Electric Competition Rules" below), with an additional 140 megawatts being made available to eligible non-residential customers. Unless subject to judicial or
-10- regulatory restraint, APS will open its distribution system to retail access for all customers on January 1, 2001. * Prior to the Settlement Agreement, APS was recovering substantially all of its regulatory assets through July 1, 2004, pursuant to the 1996 regulatory agreement. In addition, the Settlement Agreement states that APS has demonstrated that its allowable stranded costs, after mitigation and exclusive of regulatory assets, are at least $533 million net present value. APS will not be allowed to recover $183 million net present value of the above amounts. The Settlement Agreement provides that APS will have the opportunity to recover $350 million net present value through a competitive transition charge (CTC) that will remain in effect through December 31, 2004, at which time it will terminate. Any over/under-recovery will be credited/debited against the costs subject to recovery under the adjustment clause described above. * APS will form a separate corporate affiliate or affiliates and transfer to that affiliate(s) its generating assets and competitive services at book value as of the date of transfer, which transfer shall take place no later than December 31, 2002. APS will be allowed to defer and later collect, beginning July 1, 2004, sixty-seven percent of its costs to accomplish the required transfer of generation assets to an affiliate. * When the Settlement Agreement approved by the ACC is no longer subject to judicial review, APS will move to dismiss all of its litigation pending against the ACC as of the date it entered into the Settlement Agreement. To protect APS' rights, it has several lawsuits pending on ACC orders relating to stranded cost recovery and the adoption and amendment of the ACC's electric competition rules, which would be voluntarily dismissed at the appropriate time under this provision. As discussed in Note 5 above, APS has discontinued the application of SFAS No. 71 for its generation operations. RETAIL ELECTRIC COMPETITION RULES. On September 21, 1999, the ACC voted to approve the rules that provide a framework for the introduction of retail electric competition in Arizona (Rules). If any of the Rules conflict with the Settlement Agreement, the terms of the Settlement Agreement govern. On December 8, 1999, APS filed a lawsuit to protect its legal rights regarding the Rules. This lawsuit is pending, along with several other lawsuits on ACC orders relating to stranded cost recovery and the adoption or amendment of the Rules, but two related cases filed by other utilities have been partially decided in a manner adverse to those utilities' positions. On January 14, 2000, a special action was filed requesting the Arizona Supreme Court to enjoin implementation of the Rules and decide whether the ACC can allow the competitive marketplace, rather than the ACC, to set just and reasonable rates under the Arizona Constitution. The issue of competitively set rates has been
-11- decided by lower Arizona courts in favor of the ACC in four separate lawsuits, two of which relate to telecommunications companies. The Supreme Court denied to hear the case as a special action on March 17, 2000. The lower court litigation will continue. The Rules approved by the ACC include the following major provisions: * They apply to virtually all Arizona electric utilities regulated by the ACC, including APS. * The Rules require each affected utility, including APS, to make available at least 20% of its 1995 system retail peak demand for competitive generation supply beginning when the ACC makes a final decision on each utility's stranded costs and unbundled rates (Final Decision Date) or January 1, 2001, whichever is earlier, and 100% beginning January 1, 2001. Under the Settlement Agreement, APS will provide retail access to customers representing the minimum 20% required by the ACC and an additional 140 megawatts of non-residential load in 1999, and to all customers as of January 1, 2001, or such other dates as approved by the ACC. * Subject to the 20% requirement, all utility customers with single premise loads of one megawatt or greater will be eligible for competitive electric services on the Final Decision Date, which for APS' customers was the approval of the Settlement Agreement. Customers may also aggregate smaller loads to meet this one megawatt requirement. * When effective, residential customers will be phased in at 1.25% per quarter calculated beginning on January 1, 1999, subject to the 20% requirement above. * Electric service providers that get Certificates of Convenience and Necessity (CC&Ns) from the ACC can supply only competitive services, including electric generation, but not electric transmission and distribution. * Affected utilities must file ACC tariffs that unbundle rates for non-competitive services. * The ACC shall allow a reasonable opportunity for recovery of unmitigated stranded costs. * Absent an ACC waiver, prior to January 1, 2001, each affected utility (except certain electric cooperatives) must transfer all competitive generation assets and services either to an unaffiliated party or to a separate corporate affiliate. Under the Settlement Agreement, APS received a waiver to allow transfer of its competitive generation assets and services to affiliates no later than December 31, 2002.
-12- 1996 REGULATORY AGREEMENT. In April 1996, the ACC approved a regulatory agreement between the ACC Staff and APS. Based on the price reduction formula authorized in the agreement, the ACC approved retail price decreases of approximately $49 million ($29 million after income taxes), or 3.4%, effective July 1, 1996; approximately $18 million ($11 million after income taxes), or 1.2%, effective July 1, 1997; approximately $17 million ($10 million after income taxes), or 1.1%, effective July 1, 1998; and approximately $11 million ($7 million after income taxes), or 0.7%, effective as of July 1, 1999. The July 1, 1999 rate decrease was included in the first rate reduction under the Settlement Agreement discussed above. The regulatory agreement also required the parent company to infuse $200 million of common equity into APS in annual payments of $50 million from 1996 through 1999. All of these equity infusions were made by December 31, 1999. LEGISLATION. In May 1998, a law was enacted to facilitate implementation of retail electric competition in Arizona. The law includes the following major provisions: * Arizona's largest government-operated electric utility (Salt River Project) and, at their option, smaller municipal electric systems must (i) make at least 20% of their 1995 retail peak demand available to electric service providers 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 comparable to those already applicable to public service corporations for establishing the terms, conditions, and pricing of electric services as well as certain other decisions affecting retail electric competition; * describes the factors which form the basis of consideration by Salt River Project in determining stranded costs; and * metering and meter reading services must 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. GENERAL APS 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, APS will continue to evaluate strategies and alternatives that will position itself to compete in the new regulatory environment.
-13- FEDERAL The Energy Policy Act of 1992 and recent rulemakings by FERC have promoted increased competition in the wholesale electric power markets. APS does not expect these rules to have a material impact on its financial statements. Several electric utility industry restructuring bills have been introduced during the 106th Congress. Several of these bills are written to allow consumers to choose their electricity suppliers beginning in 2000 and beyond. 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 comprehensive restructuring of the electric utility industry can occur. 7. Nuclear Insurance 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 $88 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 $77 million, with an annual payment limitation of approximately $9 million. The Palo Verde participants maintain "all risk" (including nuclear hazards) insurance for property damage to, and decontamination of, property at Palo Verde in the aggregate amount of $2.75 billion, a substantial portion of which must first be applied to stabilization and decontamination. 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. 8. Business Segments We have two principal business segments (determined by products, services and regulatory environment) which consist of the generation of electricity (generation business segment) and the transmission and distribution of electricity (delivery business segment). Eliminations primarily relate to intersegment sales of electricity. The other amounts include activity relating to the parent company and other subsidiaries including SunCor, El Dorado, and APS Energy Services. Segment
-14- information for the three and twelve months ended March 31, 2000, and 1999 is as follows (millions of dollars): 3 Months Ended 12 Months Ended March 31, March 31, ------------------- ------------------- 2000 1999 2000 1999 ------- ------- ------- ------- Operating Revenues: Generation $ 181 $ 178 $ 858 $ 856 Delivery 446 414 2,325 2,040 Other 42 25 148 115 Eliminations (181) (178) (858) (856) ------- ------- ------- ------- Total $ 488 $ 439 $ 2,473 $ 2,155 ======= ======= ======= ======= Income from Continuing Operations: Generation $ 8 $ 11 $ 118 $ 113 Delivery 25 22 149 136 Other 21 (2) 26 (7) ------- ------- ------- ------- Total $ 54 $ 31 $ 293 $ 242 ======= ======= ======= ======= As of March 31, As of December 31, 2000 1999 ------- ------- Assets: Generation $ 2,310 $ 2,342 Delivery 3,845 3,796 Other 515 471 ------- ------- Total $ 6,670 $ 6,609 ======= ======= 9. Accounting Matters In June 1998, the Financial Accounting Standards Board issued SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities," which is effective for us in 2001. SFAS No. 133 requires that entities recognize all derivatives as either assets or liabilities on the balance sheet and measure those instruments at fair value. The standard also provides specific guidance for accounting for derivatives designated as hedging instruments. We are currently evaluating what impact this standard will have on our financial statements. 10. Generation Expansion Pinnacle West Energy is currently planning a 650-megawatt expansion of the West Phoenix Power Plant and the construction of a natural gas-fired electric generating station of up to 2,120 megawatts near Palo Verde, called Redhawk. Assuming all
-15- approvals are granted, Pinnacle West Energy expects to begin construction at West Phoenix in the second quarter of 2000, with commercial operation of the first unit expected in the fall of 2001. Pinnacle West Energy also expects that construction will begin on the first two units of Redhawk in the third quarter of 2000, with commercial operation scheduled in the summer of 2002. Pinnacle West Energy has signed a joint development agreement with Reliant Energy Power Generation, Inc. (Reliant) covering construction and operations of three new merchant plants. Pinnacle West Energy plans to jointly develop the first two units (1,060 megawatts) of the Redhawk project as part of the venture. Reliant plans to jointly develop two new natural gas-fired projects (1,500 megawatts) in Nevada as part of the venture. Projected capital expenditures for the above expansion plans are estimated to be $152 million in 2000, $252 million in 2001, and $347 million in 2002. On April 27, 2000, Pinnacle West Energy entered into two agreements with Southern California Edison Company (SCE) to purchase SCE's 15.8% ownership interest in Palo Verde and its 48% ownership interest in Units 4 and 5 of the Four Corners Power Plant (Four Corners). The purchase price is $550 million in cash to be paid at closing, subject to certain adjustments. The interests to be acquired represent 1,310 MW of generating capacity (600 MW associated with SCE's Palo Verde interest, and 710 MW associated with SCE's Four Corners interest). The transactions are expected to close in mid-2001, subject to the approval of various governmental authorities, including the California Public Utility Commission (CPUC), the FERC, the Nuclear Regulatory Commission, the Internal Revenue Service, and the Navajo Nation. The agreements between Pinnacle West Energy and SCE include the following additional terms: * Prior to and up to 90 days following SCE's filing with the CPUC seeking approval of the transactions, SCE may solicit offers for, or indications of interest in, (a) its Four Corners interest or (b) its Four Corners interest and its Palo Verde interest. Subject to CPUC approval, Pinnacle West Energy has the right to match any offer or indication of interest that SCE receives during this period. SCE's sale of its interest in Four Corners is also subject to a right of first refusal on the part of the other Four Corners participants, including APS. SCE has advised Pinnacle West Energy that it intends to make its CPUC filing on or before May 15, 2000. * Pinnacle West Energy is not obligated to purchase SCE's Four Corners interest unless SCE also sells its Palo Verde interest to Pinnacle West Energy. SCE is not obligated to sell its Palo Verde interest to Pinnacle West Energy unless Pinnacle West Energy (or some other third party) purchases SCE's Four Corners interest.
-16- * SCE will transfer its Palo Verde decommissioning fund to Pinnacle West Energy, and Pinnacle West Energy will assume SCE's Palo Verde decommissioning obligations. * Pinnacle West Energy will assume SCE's obligations and liabilities associated with ownership of its interests in Palo Verde and Four Corners, subject to specified exceptions. * We guaranteed Pinnacle West Energy's obligations under each of the agreements, including Pinnacle West Energy's purchase price obligations. Pinnacle West Energy is also considering additional expansion over the next several years, which may result in additional expenditures. Pinnacle West Energy's expenditures are expected to be funded through capital infusions from the parent company from internally generated cash and debt proceeds, as well as debt issued directly by Pinnacle West Energy. 11. Income Tax Benefit In September 1999, we recorded a tax benefit of $38 million, or $0.45 per basic or diluted share, which stemmed from the resolution of income tax matters related to a former subsidiary, MeraBank. This amount is reflected as a tax benefit from discontinued operations in the income statement. 12. El Dorado Partnership Investment Income Net other income includes El Dorado's share in the earnings of a venture capital partnership. El Dorado recognizes these earnings as the partnership adjusts the value of its investment to estimated market values. The value of El Dorado's investment in the partnership is determined by factors beyond our control, including equity market conditions. Most of the partnership's investments are in technology-related companies whose share prices are highly volatile. The book value of El Dorado's investment in the partnership at March 31, 2000 was approximately $47 million.
-17- PINNACLE WEST CAPITAL CORPORATION ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS. In this section, we explain our results of operations, general financial condition, and outlook for Pinnacle West and our subsidiaries: APS, SunCor, El Dorado, APS Energy Services, and Pinnacle West Energy, including: * the changes in our earnings for the periods presented * the factors impacting our business, including competition * the effects of regulatory agreements on our results and outlook * our capital needs and resources - for APS and our other operations, and * our management of market risks. APS, our major subsidiary and Arizona's largest electric utility, provides wholesale and retail electric service to the entire state with the exception of Tucson and about one-half of the Phoenix area. APS also generates, sells, and delivers electricity and energy-related products and services to wholesale and retail customers in the western United States. SunCor is a developer of residential, commercial, and industrial projects in Arizona, New Mexico, and Utah. El Dorado is primarily a venture capital firm. APS Energy Services was formed in 1998 and sells energy and energy-related products and services in competitive retail markets in the western United States. Pinnacle West Energy, which was formed in 1999, is the subsidiary through which we intend to conduct our future unregulated generation operations. The following table summarizes net income for the three-month and twelve-month periods ended March 31, 2000 and the comparable prior-year periods for Pinnacle West and each of its subsidiaries:
-18- 3 Months Ended 12 Months Ended March 31, March 31, ------------------ ------------------ (Millions of Dollars) 2000 1999 2000 1999(a) ------ ------ ------ ------ APS $ 33 $ 33 $ 267 $ 249 APS Energy Services (2) (2) (9) (2) SunCor 5 1 10 6 El Dorado 19 -- 31 1 Parent Company (1) (1) (6) (12) ------ ------ ------ ------ Income From Continuing Operations 54 31 293 242 Income Tax Benefit From Discontinued Operations -- -- 38 -- Extraordinary Charge - Net of Income Taxes of $94 -- -- (140) -- ------ ------ ------ ------ Net Income $ 54 $ 31 $ 191 $ 242 ====== ====== ====== ====== (a) SunCor's 1999 earnings have been restated here to exclude a $37 million deferred tax benefit. In accordance with our intercompany tax sharing agreement, the offset resides with the parent company. There is no consolidated earnings effect as these tax benefits had already been reflected on a consolidated basis. We suggest this section be read along with the 1999 10-K. Throughout this Management's Discussion and Analysis of Financial Condition and Results of Operations, we refer to specific "Notes" in the Notes to Condensed Consolidated Financial Statements. These Notes add further details to the discussion. OPERATING RESULTS OPERATING RESULTS - THREE-MONTH PERIOD ENDED MARCH 31, 2000 COMPARED WITH THREE-MONTH PERIOD ENDED MARCH 31, 1999 Consolidated net income for the three months ended March 31, 2000 was $54 million compared with $31 million for the same period in the prior year. Consolidated net income increased for the three-month period primarily because of an increase in El Dorado's earnings and increased revenue related to customer growth. These positive factors were partially offset by higher utility operations and maintenance expenses; a reduction in retail electricity prices; and the completion of the amortization of investment tax credits in 1999. See Note 6 for information on the price reduction. See "Income Taxes" for a discussion of the investment tax credit amortization. Electric operating revenues increased $32 million because of: * increased power marketing and trading revenues ($23 million) and * increases in the number of customers ($15 million).
-19- As mentioned above, these positive factors were partially offset by the effect of a reduction in retail electricity prices ($5 million) and miscellaneous factors ($1 million). The increase in power marketing revenues resulted from higher prices and increased activity in the western U.S. bulk power markets. The revenues were accompanied by an increase in purchased power and fuel expenses. Although these activities contributed positively to earnings in both periods, the contribution in 2000 was modestly lower than in 1999. Utility operations and maintenance expense increased primarily due to the timing of customer related expenses. Net other income increased $38 million primarily because of El Dorado's quarterly adjustment of the value of its investment in a technology-related venture capital partnership. See Note 12. OPERATING RESULTS - TWELVE-MONTH PERIOD ENDED MARCH 31, 2000 COMPARED WITH TWELVE-MONTH PERIOD ENDED MARCH 31, 1999 Consolidated net income for the twelve months ended March 31, 2000 was $191 million compared with $242 million for the same period in the prior year. The decrease primarily relates to an extraordinary charge recorded in the third quarter of 1999, partially offset by higher income from continuing operations and an income tax benefit from discontinued operations also recorded in the third quarter of 1999. The extraordinary charge related to a regulatory disallowance that resulted from APS' comprehensive Settlement Agreement that was approved by the ACC in September 1999. See Notes 5 and 6 for additional information about the regulatory disallowance and the Settlement Agreement. The income tax benefit from discontinued operations resulted from the resolution of income tax matters related to a former subsidiary, MeraBank, A Federal Savings Bank. See Note 11. Income from continuing operations increased $51 million over the comparable period primarily because of an increase in El Dorado's earnings; increases in the number of customers and in the average amount of electricity used by customers; and favorable weather impacts. These positive factors more than offset higher utility operations and maintenance expense, a reduction in retail electricity prices, and the completion of the amortization of investment tax credits in 1999. See Note 6 for information on the price reduction. See "Income Taxes" below for a discussion of the investment tax credit amortization.
-20- Electric operating revenues increased $285 million because of: * increased power marketing and trading revenues ($209 million) * increases in the number of customers and the average amount of electricity used by customers ($82 million) * favorable weather impacts ($10 million) and * miscellaneous factors ($8 million). As mentioned above, these positive factors were partially offset by the effect of a reduction in retail prices ($24 million). The increase in power marketing revenues resulted primarily from increased activity in western bulk power markets and higher prices. The revenues were accompanied by increases in purchased power and fuel expenses. Although these activities contributed positively to earnings in both periods, the contribution in the current period was modestly lower than the prior period. Fuel expenses were also higher because of increased fuel prices and higher retail sales volumes. Utility operations and maintenance expenses increased primarily because of $19 million of non-recurring items recorded in the current period, including a provision for certain environmental costs. Other increases primarily related to customer growth, power marketing costs, and technology related costs. Net other income increased $55 million primarily because of El Dorado's quarterly adjustment of the value of its investment in a technology-related venture capital partnership. See Note 12. INCOME TAXES As part of a 1994 rate settlement with the ACC, APS accelerated amortization of substantially all deferred ITCs over a five-year period that ended on December 31, 1999. It decreased annual income tax expense by approximately $24 million. Beginning in 2000, no further benefits from these deferred ITCs will be reflected in income tax expense.
-21- LIQUIDITY AND CAPITAL RESOURCES CAPITAL EXPENDITURE REQUIREMENTS The following table summarizes the actual capital expenditures as of the three-month period ended March 31, 2000 and estimated capital expenditures for the next three years: CAPITAL EXPENDITURES (millions of dollars) ------------------------------------------- 3 months ended 12 months ended March 31, December 31, (actual) (estimated) -------------- -------------------------- 2000 2000 2001 2002 ------ ------ ------ ------ APS (a) $ 81 $ 384 $ 342 $ 334 Pinnacle West Energy 8 152 252 347 SunCor 29 53 43 51 ------ ------ ------ ------ Total $ 118 $ 589 $ 637 $ 732 ====== ====== ====== ====== (a) APS amounts include about $30 - $35 million each year for nuclear fuel expenditures. CAPITAL RESOURCES AND DEBT FINANCING PINNACLE WEST 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 1999 10-K. During the three-months ended March 31, 2000, the parent company increased long-term borrowings by about $40 million. APS APS' long-term debt redemption requirements, optional repayments on long-term debt, and payment obligations on a capitalized lease for the next three years are: $304 million in 2000; $252 million in 2001; and $125 million in 2002. During the three months ended March 31, 2000, APS redeemed approximately $89 million of its long-term debt with cash from operations and long-
-22- and short-term debt. On May 15, 2000, APS will redeem approximately $100 million of its First Mortgage Bonds, 10.25% Series due 2020. Although provisions in APS' first mortgage bond indenture, articles of incorporation, and ACC financing orders establish maximum amounts of additional first mortgage bonds and preferred stock that APS may issue, APS does not expect any of these provisions to limit its ability to meet its capital requirements. PINNACLE WEST ENERGY Pinnacle West Energy is currently planning a 650-megawatt expansion of the West Phoenix Power Plant and the construction of a natural gas-fired electric generating station of up to 2,120 megawatts near Palo Verde, called Redhawk. Assuming all approvals are granted, Pinnacle West Energy expects to begin construction at West Phoenix in the second quarter of 2000, with commercial operation of the first unit expected in the fall of 2001. Pinnacle West Energy also expects that construction will begin on the first two units of Redhawk in the third quarter of 2000, with commercial operation scheduled in the summer of 2002. Pinnacle West Energy has signed a joint development agreement with Reliant Energy Power Generation, Inc. (Reliant) covering construction and operations of three new merchant plants. Pinnacle West Energy plans to jointly develop the first two units (1,060 megawatts) of the Redhawk project as part of the venture. Reliant plans to jointly develop two new natural gas-fired projects (1,500 megawatts) in Nevada as part of the venture. See the above table for expected capital expenditures for these expansions. Pinnacle West Energy has signed agreements with Southern California Edison (SCE) to acquire SCE's interest in the Palo Verde Nuclear Generating Station west of Phoenix and the Four Corners Power Plant near Farmington New Mexico. Pursuant to the agreements, Pinnacle West Energy will acquire SCE's 15.8 percent interest in the three unit Palo Verde plant and SCE's 48 percent interest in Four Corners Units 4 and 5, for a total of approximately 1,300 megawatts at both plants. The total price will be $550 million, subject to certain adjustments. The transactions are expected to close in mid-2001 following the approval of various governmental authorities, including the California Public Utilities Commission, the FERC, the Nuclear Regulatory Commission, the Internal Revenue Service, and the Navajo Nation. For additional information about the transactions, see Note 10. Pinnacle West Energy is also considering additional expansion over the next several years, which may result in additional expenditures. Pinnacle West Energy's expenditures are expected to be funded through capital infusions from the parent company from internally generated cash and debt proceeds, as well as debt issued directly by Pinnacle West Energy.
-23- SUNCOR SunCor's capital needs consist primarily of capital expenditures for land development, retail and office building construction, and home construction. Capital resources to meet these requirements include funds from operations and SunCor's own external financings. COMPETITION AND ELECTRIC INDUSTRY RESTRUCTURING See Note 5 for a discussion of regulatory accounting. See Note 6 for a discussion of a Settlement Agreement related to the implementation of retail electric competition. RATE MATTERS See Note 6 for a discussion of a price reduction effective as of July 1, 1999, and for a discussion of a Settlement Agreement that will, among other things, result in five price reductions over a four-year period ending July 1, 2003. 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; our ability to successfully compete outside 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; the successful completion of large-scale construction projects; the value of El Dorado's investment in a technology-related venture capital partnership; and, the strength of the real estate market. These factors and the other matters discussed above may cause future results to differ materially from historical results, or from results or outcomes we currently expect or seek. ITEM 3. MARKET RISKS Our operations include managing market risks related to changes in interest rates, commodity prices, and investments held by the nuclear decommissioning trust fund. Our major financial market risk exposure is changing interest rates. Changing interest rates will affect interest paid on variable-rate debt and interest earned by the nuclear decommissioning trust fund. Our policy is to manage interest rates through the use of a combination of fixed-rate and floating-rate debt. The nuclear decommissioning fund
-24- also has risks associated with changing market values of equity investments. Nuclear decommissioning costs are recovered in regulated electricity prices. We are exposed to the impact of market fluctuations in the price and distribution costs of electricity, natural gas, coal, and emissions allowances. We employ established procedures to manage our risks associated with these market fluctuations by utilizing various commodity derivatives, including exchange-traded futures and options and over-the-counter forwards, options, and swaps. As part of our overall risk management program, we enter into these derivative transactions for trading and to hedge certain natural gas in storage as well as purchases and sales of electricity, fuels, and emissions allowances/credits. As of March 31, 2000, a hypothetical adverse price movement of 10% in the market price of our commodity derivative portfolio would decrease the fair market value of these contracts by approximately $17 million. This analysis does not include the favorable impact this same hypothetical price move would have on the underlying positions being hedged with the commodity derivative portfolio. We are exposed to credit losses in the event of non-performance or non-payment by counterparties. We use a credit management process to assess and monitor the financial exposure of counterparties. We do not expect counterparty defaults to materially impact our financial condition, results of operations or net cash flow.
-25- 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 construction and financing programs of the Company and its subsidiaries. COMPETITION AND ELECTRIC INDUSTRY RESTRUCTURING See Note 6 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 and a settlement agreement with the ACC. ENVIRONMENTAL MATTERS As previously reported, in April 1998 APS filed a Petition for Review regarding EPA's regulations specifying those provisions of the Clean Air Act for which it is appropriate to treat Indian Tribes in the same manner as states. See "Environmental Matters - Purported Navajo Environmental Regulation" in Part I, Item 1 of our 1999 Form 10-K. Partly in response to the litigation, EPA indicated it had not determined whether the Clean Air Act would supersede pre-existing binding agreements involving Four Corners and NGS. On May 5, 2000, the United States Court of Appeals for the District of Columbia upheld EPA's regulations on treatment of Indian Tribes in the same manner as states. However, the Court determined that the impact of this ruling on the pre-existing binding agreements involving Four Corners and NGS was not ripe for adjudication because EPA had not made a determination that the Clean Air Act superseded those agreements. APS cannot currently predict the outcome of this matter.
-26- ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibits Exhibit No. Description - ----------- ----------- 27.1 Financial Data Schedule 99.1 Purchase and Sale Agreement for Palo Verde Nuclear Generating Station by and between Southern California Edison Company and Pinnacle West Energy Corporation, dated as of April 27, 2000 99.2 Purchase and Sale Agreement for Four Corners Power Plant by and between Southern California Edison Company and Pinnacle West Energy Corporation, dated as of April 27, 2000 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: <TABLE> <CAPTION> Exhibit No. Description Originally Filed as Exhibit: File No.(a) Date Effective - ----------- ----------- ---------------------------- -------- -------------- <S> <C> <C> <C> <C> 10.1 Articles of Incorporation 19.1 to the Company's 1-8962 11-14-88 restated as of July 29, 1988 September 30, 1988 Form 10-Q Report 10.2 Bylaws, amended as of 3.1 to the Company's 1995 1-8962 4-1-96 February 21, 1996 Form 10-K Report </TABLE> (b) Reports on Form 8-K During the quarter ended March 31, 2000, and the period from April 1 through May 15, 2000, we did not file any reports on Form 8-K. - ---------- (a) Reports filed under File Nos. 1-4473 and 1-8962 were filed in the office of the Securities and Exchange Commission located in Washington, D.C.
-27- 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, 2000 By: Chris N. Froggatt ------------------------------------ Chris N. Froggatt Vice President and Controller (Principal Accounting Officer and Officer Duly Authorized to sign this Report)