ITEM 1. BUSINESS
THE COMPANY
Pinnacle West Capital Corporation (the "Company") was incorporated in 1985 under the laws of the State of Arizona and is engaged in the acquisition and holding of securities of corporations for investment purposes. The principal executive offices of the Company are located at 400 East Van Buren Street, Phoenix, Arizona 85004 (telephone 602-379-2500).
The Company and its subsidiaries employ approximately 7,440 persons. Of these employees, approximately 6,535 are employees of the Company's principal subsidiary, Arizona Public Service Company ("APS"), and employees assigned to joint projects of APS where APS serves as a project manager, and approximately 905 are employees of the Company and its other subsidiaries.
Other subsidiaries of the Company, in addition to APS, include SunCor Development Company ("SunCor") and El Dorado Investment Company ("El Dorado"). SunCor is engaged primarily in the owning, holding, and development of real property. El Dorado is involved in the business of making equity investments in other companies. See "Business of Non-Utility Subsidiaries" in this Item for further information regarding SunCor and El Dorado.
CAPITAL REQUIREMENTS
During the past three years, the Company's primary cash needs were for the payment of interest and the optional and mandatory repayment of principal on its long-term debt. Additional cash needs in 1993 and 1994 were related to the resumption and subsequent growth of common stock dividends. The Company's ability to satisfy its debt service obligations is substantially dependent upon the receipt of common stock dividends from APS. See Note 5 of the Notes to the Consolidated Financial Statements in Item 8 for additional information regarding the Company's and APS' outstanding long-term debt.
The terms and provisions of certain of the Company's financing agreements place severe restrictions on the Company's ability to incur additional debt, to make capital infusions into its subsidiaries (excluding APS), to make other new investments, and to pay cash dividends to its shareholders unless certain conditions are met. While the debt under these financing agreements remains outstanding, the Company has agreed not to incur new debt, except generally (and with certain restrictions) for borrowings to reduce, refinance, or prepay existing debt. The Company's ability to pay cash dividends or to make other corporate distributions is dependent upon the satisfaction of certain financial covenants. As of December 31, 1994, the Company could have declared dividends of approximately $259 million based on these covenants.
In the event of a sale of all or substantially all of the assets or shares of common stock of El Dorado or SunCor, the net cash proceeds must be applied by the Company to reduce its outstanding debt. Until the Company's lenders are fully repaid, (1) any new investments by the Company in its subsidiaries (excluding APS) are generally restricted to $15 million in the aggregate and (2) any other new investments by the Company are generally restricted to $20 million in the aggregate. As of December 31, 1994, the Company had not made any such investments.
As part of the Company's 1990 debt restructuring, the Company granted substantially all of its lenders a security interest in the outstanding common stock of APS pursuant to a Pledge Agreement, dated as of January 31, 1990 (the "Pledge Agreement"). At December 31, 1994, the APS common stock secured approximately $430 million of the Company's outstanding debt. Until the Company and the collateral agent under the Pledge Agreement (the "Collateral Agent") receive notice of the occurrence and continuation of an Event of Default (as defined in the Pledge Agreement), the Company is entitled to exercise or refrain from exercising any and all voting and other consensual rights pertaining to the APS common stock. As to matters other than the election of directors, the Company agreed not to exercise or refrain from exercising any such rights if, in the Collateral Agent's judgment, such action would have a material adverse effect on the value of the APS common stock. After notice of an Event of Default, the Collateral Agent would have the right to vote the APS common stock.
REGULATION
PUBLIC UTILITY HOLDING COMPANY. The Company currently conducts no significant business activities other than investing in its subsidiaries and owns no significant assets other than the common stock of its subsidiaries. The Company and its subsidiaries are currently exempt from registration under the Public Utility Holding Company Act of 1935 (the "1935 Act"); however, the Securities and Exchange Commission (the "SEC") has the authority to revoke or condition an exemption if it appears that any question exists as to whether the exemption may be detrimental to the public interest or the interest of investors or consumers. In May 1990, the Arizona Corporation Commission (the "ACC") filed a petition with the SEC requesting the SEC to revoke or modify the Company's exemption under the 1935 Act. To date, the SEC has not taken any action with respect to the ACC petition. The Company cannot predict what action, if any, the SEC may take with respect to such petition.
ARIZONA CORPORATION COMMISSION AFFILIATED INTEREST RULES. On March 14, 1990 the ACC issued an order adopting certain rules purportedly applicable only to a certain class of public utilities regulated by the ACC, including APS. The rules define the terms "public utility holding company" and "affiliate" with respect to public service corporations regulated by the ACC in such a manner as to include the Company and all of the Company's non-public service corporation subsidiaries. By their terms, the rules, among other things, require public utilities, such as APS, to receive ACC approval prior to (1) obtaining an interest in, or guaranteeing or assuming the liabilities of, any affiliate not regulated by the ACC; (2) lending to any such affiliate (except for short-term loans in an amount less than $100,000); or (3) using utility funds to form a subsidiary or divest itself of any established subsidiary. The rules also would prevent a utility from transacting business with an affiliate unless the affiliate agrees to provide the ACC "access to the books and records of the affiliate to the degree required to fully audit, examine or otherwise investigate transactions between the public utility and the affiliate." In addition, the rules provide that an "affiliate or holding company may not divest itself of, or otherwise relinquish control of, a public utility without thirty (30) days prior written notification to the [ACC]" and would require all public utilities subject to them and all public utility holding companies to annually "provide the [ACC] with a description of diversification plans for the current calendar year that have been approved by the Boards of Directors." The order became effective as to APS on December 1, 1992. The rules have not had, nor does the Company expect the rules to have, a material adverse impact on the business or operations of the Company.
BUSINESS OF ARIZONA PUBLIC SERVICE COMPANY
Following is a discussion of the business of APS, the Company's principal subsidiary.
GENERAL
APS was incorporated in 1920 under the laws of Arizona and is engaged principally in serving electricity in the State of Arizona. The principal executive offices of APS are located at 400 North Fifth Street, Phoenix, Arizona 85004 (telephone 602-250-1000). APS currently employs approximately 6,535 people, which includes employees assigned to joint projects where APS is project manager.
APS serves approximately 681,000 customers in an area that includes all or part of 11 of Arizona's 15 counties. During 1994, no single purchaser or user of energy accounted for more than 3% of total electric revenues.
INDUSTRY AND COMPANY ISSUES
The utility industry continues to experience a number of challenges. Depending on the circumstances of a particular utility, these may include (i) competition in general from numerous sources (see "Competition" below); (ii) difficulties in meeting government imposed environmental requirements; (iii) the necessity to make substantial capital outlays for transmission and distribution facilities; (iv) uncertainty regarding projected electrical demand growth; (v) controversies over electromagnetic fields; (vi) controversies over the safety and use of nuclear power; (vii) issues related to spent fuel and low-level waste (see "Generating Fuel" below); and (viii) increasing costs of wages and materials.
COMPETITION
Certain territory adjacent to or within areas served by APS is served by other investor-owned utilities (notably Tucson Electric Power Company serving electricity in the Tucson area, Southwest Gas Corporation serving gas throughout the state, and Citizens Utilities Company serving electricity and gas in various locations throughout the state) and a number of cooperatives, municipalities, electrical districts, and similar types of governmental organizations (principally the Salt River Project Agricultural Improvement and Power District ("SRP") serving electricity in various areas in and around Phoenix).
Electric utilities have historically operated in a highly-regulated environment that provides limited opportunities for direct competition in providing electric service to their customers. The National Energy Policy Act of 1992 (the "Energy Act") has far-reaching implications for APS by moving utilities toward a more competitive environment. The Energy Act is designed, among other things, to promote competition among utility and non-utility generators by amending the 1935 Act to exempt a new class of independent power producers that are not subject to regulation under the 1935 Act. The Energy Act also amends the Federal Power Act to allow the Federal Energy Regulatory Commission ("FERC") to order electric utilities to transmit, or "wheel," wholesale power for others. The FERC is prohibited under the Energy Act from requiring utilities to provide transmission access to retail customers, and there remains uncertainty about a state's ability to authorize such transmission access to and for retail electric customers.
One of the issues that must be addressed responsibly is the recovery in a more competitive environment of the carrying value of assets (including those referred to in Note 1K of the Notes to the Consolidated Financial Statements in Item 8) acquired or recorded under the existing regulatory environment. Pursuant to a 1994 rate settlement (see Note 2 of Notes to Consolidated Financial Statements in Item 8), APS and the ACC staff will develop certain procedures that are responsive to the competitive forces in larger customer segments, with the objective of making joint recommendations to the ACC in 1995. A separate ACC proceeding on competition was opened in mid-1994 and is expected to continue for some months.
As the forces of competition continue to impact the industry, it will become clearer as to what customer sectors and what regions will be most affected and what strategies are best to deal with those forces. See "Management's Discussion and Analysis of Financial Condition and Results of Operations -- Competition" in Item 7 for a discussion of some of APS' strategies.
CAPITAL STRUCTURE
The capital structure of APS (which, for this purpose, includes short-term borrowings and current maturities of long-term debt) as of December 31, 1994 is tabulated below.
Amount Percentage ---------- ---------- (Thousands of Dollars) Long-Term Debt Less Current Maturities: First mortgage bonds................................ $1,740,071 Other............................................... 441,761 ---------- Total long-term debt less current maturities...... 2,181,832 52.5% ---------- Non-Redeemable Preferred Stock........................ 193,561 4.7 ---------- Redeemable Preferred Stock............................ 75,000 1.8 ---------- Common Stock Equity: Common stock, $2.50 par value, 100,000,000 shares authorized; 71,264,947 shares outstanding......... 178,162 Premiums and expenses............................... 1,039,303 Retained earnings................................... 353,655 ---------- Total common stock equity......................... 1,571,120 37.8 ---------- Total capitalization............................ 4,021,513 Current Maturities of Long-Term Debt.................. 3,428 .1 Short-Term Borrowings................................. 131,500 3.1 ---------- --------
Total........................................... $4,156,441 100.0% ========== ========
See Notes 4, 5 and 6 of Notes to the Consolidated Financial Statements in Item 8.
On January 12, 1995, APS issued $75 million of its 10% junior subordinated deferrable interest debentures, Series A (MIDS), due 2025, and applied the net proceeds to the repayment of short-term borrowings incurred for the redemption of preferred stock in 1994. On March 2, 1995, APS redeemed $49.15 million in aggregate principal amount of APS' First Mortgage Bonds, 10.25% Series due 2000 (the "10.25% Bonds").
So long as any of APS' first mortgage bonds are outstanding, APS is required for each calendar year to deposit with the trustee under its mortgage cash in a formularized amount related to net additions to APS' mortgaged utility plant; however, APS may satisfy all or any part of this "replacement fund" requirement by utilizing redeemed or retired bonds, net property additions, or property retirements. For 1994, the replacement fund requirement amounted to approximately $125 million. Many, though not all, of the bonds issued by APS under its mortgage are redeemable at their par value plus accrued interest with cash deposited by APS in the replacement fund, subject in many cases to a period of time after the original issuance of the bonds during which they may not be so redeemed and/or to other restrictions on any such redemption. The cash deposited with the trustee by APS in partial satisfaction of its 1994 replacement fund requirements was used to redeem the 10.25% Bonds at their principal amount plus accrued interest.
RATES
STATE. The ACC has regulatory authority over APS in matters relating to retail electric rates and the issuance of securities. See Note 2 of the Notes to the Consolidated Financial Statements in Item 8 for a discussion of the 1994 retail rate settlement agreement between APS and the ACC.
FEDERAL. APS' rates for wholesale power sales and transmission services are subject to regulation by the FERC. During 1994, approximately 6% of APS' electric operating revenues resulted from such sales and charges. For most wholesale transactions regulated by the FERC, a fuel adjustment clause results in monthly adjustments for changes in the actual cost of fuel for generation and in the fuel component of purchased power expense.
CONSTRUCTION PROGRAM
Present construction plans exclude any major baseload generating plants. Utility construction expenditures for the years 1995 through 1997 are therefore expected to be primarily for expanding transmission and distribution capabilities to meet customer growth, upgrading existing facilities, and for environmental purposes. Construction expenditures, including expenditures for environmental control facilities, for the years 1995 through 1997 have been estimated as follows:
(MILLIONS OF DOLLARS) BY YEAR BY MAJOR FACILITIES ---------------------------------- ---------------------------------------- 1995 $300 Electric generation $278 1996 257 Electric transmission 59 1997 236 Electric distribution 367 ----- General facilities 89 $793 ---- ===== $793 ====
The amounts for 1995 through 1997 exclude capitalized interest costs and capitalized property taxes. These amounts include about $27 million each year for nuclear fuel expenditures. APS conducts a continuing review of its construction program. This program and the above estimates are subject to periodic revisions based upon changes in projections as to system reliability, system load growth, rates of inflation, the availability and timing of environmental and other regulatory approvals, the availability and costs of outside sources of capital, and changes in project construction schedules. During the years 1992 through 1994, APS incurred approximately $728 million in construction expenditures and approximately $31 million in additional capitalized items.
ENVIRONMENTAL MATTERS
Pursuant to the Clean Air Act, the United States Environmental Protection Agency ("EPA") has adopted regulations, applicable to certain federally-protected areas, that address visibility impairment that can be reasonably attributed to specific sources. In September 1991, the EPA issued a final rule that would limit sulfur dioxide emissions at the Navajo Generating Station ("NGS"). Compliance with the emission limitation becomes applicable to NGS Units 1, 2, and 3 in 1997, 1998, and 1999, respectively. SRP, the NGS operating agent, has estimated a capital cost of $500 million, most of which will be incurred from 1995-1998, and annual operations and maintenance costs of approximately $14 million for all three units, for NGS to meet these requirements. APS will be required to fund 14% of these expenditures.
The Clean Air Act Amendments of 1990 (the "Amendments") became effective on November 15, 1990. The Amendments address, among other things, "acid rain," visibility in certain specified areas, toxic air pollutants, and the nonattainment of national ambient air quality standards. With respect to "acid rain," the Amendments establish a system of sulfur dioxide emissions "allowances." Each existing utility unit is granted a certain number of "allowances." On March 5, 1993, the EPA promulgated rules listing allowance allocations applicable to APS-owned plants, which allocations will begin in the year 2000. Based on those allocations, APS will have sufficient allowances to permit continued operation of its plants at current levels without installing additional equipment. In addition, the Amendments require the EPA to set nitrogen oxides emissions limitations which would require certain plants to install additional pollution control equipment. On March 22, 1994, the EPA issued rules for nitrogen oxides emissions limitations; however, on November 29, 1994, the United States Court of Appeals for the District of Columbia Circuit vacated the rules and remanded them to the EPA for further consideration. The EPA has not yet proposed revised rules.
With respect to protection of visibility in certain specified areas, the Amendments require the EPA to complete a study by November 1995 concerning visibility impairment in those areas and identification of sources contributing to such impairment. Interim findings of this study have indicated that any beneficial effect on visibility as a result of the Amendments would be offset by expected population and industry growth. The EPA has established a "Grand Canyon Visibility Transport Commission" to complete a study by November 1995 on visibility impairment in the "Golden Circle of National Parks" in the Colorado Plateau. NGS, the Cholla Power Plant ("Cholla"), and the Four Corners Power Plant ("Four Corners") are located near the "Golden Circle of National Parks." Based on the recommendations of the Commission, the EPA may require additional emissions controls at various sources causing visibility impairment in the "Golden Circle of National Parks" and may limit economic development in several western states. APS cannot currently estimate the capital expenditures, if any, which may be required as a result of the EPA studies and the Commission's recommendations.
With respect to hazardous air pollutants emitted by electric utility steam generating units, the Amendments require two studies. The results of the first study indicated an impact from mercury emissions from such units in certain unspecified areas; however, the EPA has not yet stated whether or not emissions limitations will be imposed. Next, the EPA will complete a general study by November 1995 concerning the necessity of regulating such units under the Amendments. Due to the lack of historical data, and because APS cannot speculate as to the ultimate requirements by the EPA, APS cannot currently estimate the capital expenditures, if any, which may be required as a result of these studies.
Certain aspects of the Amendments may require related expenditures by APS, such as permit fees, none of which APS expects to have a material impact on its financial position.
Other includes oil and hydro generation.
APS believes that Cholla has sufficient reserves of low sulfur coal committed to that plant for the next five years, the term of the existing coal contract. Sufficient reserves of low sulfur coal are available to continue operating Cholla for its useful life. APS also believes that Four Corners and NGS have sufficient reserves of low sulfur coal available for use by those plants to continue operating them for their useful lives. The current sulfur content of coal being used at Four Corners, NGS, and Cholla is approximately 0.8%, 0.6%, and 0.4%, respectively. In 1994, average prices paid for coal supplied from reserves dedicated under the existing contracts were relatively stable, although applicable contract clauses permit escalations under certain conditions. In addition, major price adjustments can occur from time to time as a result of contract renegotiation.
NGS and Four Corners are located on the Navajo Reservation and held under easements granted by the federal government as well as leases from the Navajo Tribe. See "Properties" in Item 2.
ITEM 2. PROPERTIES
APS' present generating facilities have an accredited capacity aggregating 4,022,410 kilowatts (kW), comprised as follows:
Capacity(kW) ------------ Coal: Units 1, 2, and 3 at Four Corners, aggregating........... 560,000 15% owned Units 4 and 5 at Four Corners, representing.... 222,000 Units 1, 2, and 3 at Cholla Plant, aggregating........... 590,000 14% owned Units 1, 2, and 3 at the Navajo Plant, representing........................................... 315,000 ----------- 1,687,000 ===========
Gas or Oil: Two steam units at Ocotillo, two steam units at Saguaro, and one steam unit at Yucca, aggregating............... 468,400(1) Eleven combustion turbine units, aggregating............. 500,600 Three combined cycle units, aggregating.................. 253,500 ----------- 1,222,500 ===========
Nuclear: 29.1% owned or leased Units 1, 2, and 3 at Palo Verde, representing........................................... 1,108,710 =========== Other........................................................ 4,200 =========== ---------- (1) West Phoenix steam units (96,300 kW) are currently mothballed.
--------------
APS' peak one-hour demand on its electric system was recorded on June 29, 1994 at 4,214,000 kW, compared to the 1993 peak of 3,802,300 kW recorded on August 2. Taking into account additional capacity then available to it under purchase power contracts as well as its own generating capacity, APS' capability of meeting system demand on June 29, 1994, computed in accordance with accepted industry practices, amounted to 4,514,300 kW, for an installed reserve margin of 8.1%. The power actually available to APS from its resources fluctuates from time to time due in part to planned outages and technical problems. The available capacity from sources actually operable at the time of the 1994 peak amounted to 4,193,500 kW, for a margin of -0.5%. Firm purchases from neighboring utilities totaling 550 megawatts were in place at the time of the 1994 peak, ensuring the Company's ability to meet the load requirement.
NGS and Four Corners are located on land held under easements from the federal government and also under leases from the Navajo Tribe. The risk with respect to enforcement of these easements and leases is not deemed by APS to be material. APS is dependent, however, in some measure upon the willingness and ability of the Navajo Tribe to honor its commitments. Certain of APS' transmission lines and almost all of its contracted coal sources are also located on Indian reservations. See "Generating Fuel" in Item 1.
On August 18, 1986 and December 19, 1986, APS entered into a total of three sale and leaseback transactions under which it sold and leased back approximately 42% of its 29.1% ownership interest in Palo Verde Unit 2. The leases under each of the sale and leaseback transactions have initial lease terms expiring on December 31, 2015. Each of the leases also allows APS to extend the term of the lease and/or to repurchase the leased Unit 2 interest under certain circumstances at fair market value. The leases in the aggregate require annual payments of approximately $40 million through 1999, approximately $46 million in 2000, and approximately $49 million through 2015 (see Note 9 of the Notes to the Consolidated Financial Statements in Item 8).
See "Water Supply" in Item 1 with respect to matters having possible impact on the operation of certain of APS' power plants, including Palo Verde.
APS' construction plans are susceptible to changes in forecasts of future demand on its electric system and in its ability to finance its construction program. Although its plans are subject to change, present construction plans exclude any major baseload generating plants. Important factors affecting APS' ability to delay the construction of new major generating units are continuing efforts to upgrade and improve the reliability of existing generating stations, system load diversity with other utilities, and continuing efforts in customer demand-side conservation and load management programs.
In addition to that available from its own generating capacity, APS purchases electricity from other utilities under various arrangements. One of the most important of these is a long-term contract with SRP which may be canceled by SRP on three years' notice and which requires SRP to make available, and APS to pay for, certain amounts of electricity that are based in large part on customer demand within certain areas now served by APS pursuant to a related territorial agreement. APS believes that the prices payable by it under the contract are fair to both parties. The generating capacity available to APS pursuant to the contract was 304,000 kW until May 1994, at which time the capacity increased to 313,000 kW. In 1994, APS received approximately 887,650 Megawatt hours (MWh) of energy under the contract and paid approximately $40 million for capacity availability and energy received.
In September 1990, APS and PacifiCorp, an Oregon-based utility company, entered into certain agreements relating principally to sales and purchases of electric power and electric utility assets, and in July 1991, after regulatory approvals, APS sold Cholla Unit 4 to PacifiCorp for approximately $230 million. As part of the transaction, PacifiCorp agreed to make a firm system sale to APS for thirty years during APS' summer peak season in the amount of 175 megawatts for the first five years, increasing thereafter, at APS' option, up to a maximum amount equal to the rated capacity of Cholla Unit 4. After the first five years, all or part of the sale may be converted to a one-for-one seasonal capacity exchange. PacifiCorp has the right to purchase from APS up to 125 average megawatts of energy per year for thirty years. PacifiCorp and APS also entered into a 100 megawatt one-for-one seasonal capacity exchange to be effective upon the latter of January 1, 1996 or the completion of certain new transmission projects. In addition, PacifiCorp agreed to pay APS (i) $20 million upon commercial operation of 150 megawatts of peaking capacity constructed by APS and (ii) $19 million ($9.5 million of which has been paid) in connection with the construction of transmission lines and upgrades that will afford PacifiCorp 150 megawatts of northbound transmission rights. In addition, PacifiCorp secured additional firm transmission capacity of 30 megawatts, for which approximately $0.5 million was paid during 1994. In 1994, APS received 389,110 MWh of energy from PacifiCorp under these transactions and paid approximately $18 million for capacity availability and the energy received, and PacifiCorp paid approximately $0.5 million for approximately 32,000 MWh.
See "El Paso Electric Company Bankruptcy" in Note 11 of the Notes to the Consolidated Financial Statements in Item 8 for a discussion of the filing by El Paso Electric Company ("EPEC") of a voluntary petition to reorganize under Chapter 11 of the Bankruptcy Code. EPEC has a joint ownership interest with APS and others in Palo Verde and Four Corners Units 4 and 5.
Substantially all of APS' utility plant is subject to the lien of APS' mortgage bond indenture. See Note 9 of the Notes to the Consolidated Financial Statements in Item 8 with respect to certain leased property of APS. See "The Company -- Capital Requirements" in Item 1 for information regarding the Pledge Agreement to which the APS common stock owned by the Company is subject.
See "SunCor Development Company" and "El Dorado Investment Company" under the heading "Business of Non-Utility Subsidiaries" in Item 1 for a description of properties held by the non-utility subsidiaries of the Company.
GRAPHIC -------
In accordance with Item 304 of Regulation S-T of the Securities Exchange Act of 1934, APS' Service Territory map contained in this Form 10-K is a map of the state of Arizona showing APS' service area, the location of its major power plants and principal transmission lines, and the location of transmission lines operated by APS for others. The major power plants shown on such map are the Navajo Generating Station located in Coconino County, Arizona; the Four Corners Power Plant located near Farmington, New Mexico; the Cholla Power Plant, located in Navajo County, Arizona; the Yucca Power Plant, located near Yuma, Arizona; and the Palo Verde Nuclear Generating Station, located about 55 miles west of Phoenix, Arizona (each of which plants is reflected on such map as being jointly owned with other utilities), as well as the Ocotillo Power Plant and West Phoenix Power Plant, each located near Phoenix, Arizona, and the Saguaro Power Plant, located near Tucson, Arizona. APS' major transmission lines shown on such map are reflected as running between the power plants named above and certain major cities in the state of Arizona. The transmission lines operated for others shown on such map are reflected as running from the Four Corners Plant through a portion of northern Arizona to the California border.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
APS
On June 29, 1990, a new Arizona state tax law was enacted, effective as of December 31, 1989, which adversely impacted APS' earnings in tax years 1990 through 1994 by an aggregate amount of approximately $21 million per year, before income taxes. On December 20, 1990, the Palo Verde participants, including APS, filed a lawsuit in the Arizona Tax Court, a division of the Maricopa County Superior Court, against the Arizona Department of Revenue, the Treasurer of the State of Arizona, and various Arizona counties, claiming, among other things, that portions of the new tax law are unconstitutional. (Arizona Public Service Company, et al. v. Apache County, et al., No. TX 90-01686 (Consol.), Maricopa County Superior Court). In December 1992, the court granted summary judgment to the taxing authorities, holding that the law is constitutional. APS has appealed this decision to the Arizona Court of Appeals. APS cannot currently predict the ultimate outcome of this matter.
See "Water Supply" and "Palo Verde Nuclear Generating Station" in Item 1 and "El Paso Electric Company Bankruptcy" in Note 11 of the Notes to the Consolidated Financial Statements in Item 8 in regard to other pending or threatened litigation involving APS.
PINNACLE WEST
A lawsuit was filed in the United States District Court for the District of Arizona against the Company, its inside directors and certain of its officers on November 7, 1988 and was amended on December 15, 1988 to add the remaining directors and additional substantive claims. As amended, the complaint alleges violations of federal securities laws and Arizona securities, consumer fraud and other state laws in connection with certain actions of the Company and statements made on its behalf relating to the Company's diversification activities, future business prospects and dividends. The Court certified a class consisting of all purchasers of the Company's common stock between April 1, 1987 and October 7, 1988 (the alleged "Class Period"). The complaint sought unspecified compensatory and punitive damages as well as fees and costs.
On December 20, 1988 a lawsuit was filed in the United States District Court for the District of Arizona against the Company and certain officers and directors, alleging violations of federal securities laws and Arizona securities, consumer fraud and other state laws in connection with certain actions of the Company and statements made on its behalf relating to the Company's diversification activities, future business prospects and dividends. The lawsuit is substantially similar to the lawsuit referenced in the preceding paragraph. The plaintiffs, two individuals who claim to have purchased the Company's common stock between April 1, 1987 and October 7, 1988 (the alleged "Class Period"), requested unspecified compensatory and punitive damages as well as fees and costs. On October 2, 1989, the cases described in this and the preceding paragraph were consolidated.
On December 15, 1989 a shareholder derivative lawsuit was filed in the United States District Court for the District of Arizona naming the Company's directors as defendants and the Company as nominal defendant. The lawsuit alleges breach of fiduciary duties by the directors in connection with the Company's diversification activities, and further alleges violation of federal securities laws by one director in connection with the sale of MeraBank to the Company in 1986. The plaintiffs requested, on the Company's behalf, unspecified compensatory and punitive damages.
On April 22, 1991 a lawsuit was filed in the United States District Court for the District of Arizona by the Resolution Trust Corporation (the "RTC") against certain former officers and directors of MeraBank. The suit sought, among other things, damages in excess of $270 million, and alleged negligence, gross negligence, breach of fiduciary duty, breach of duty of loyalty and breach of contract with respect to the management and operation of MeraBank by the defendants beginning in the early 1980s. Although the Company was not a defendant, the Company agreed to advance reasonable attorneys' fees and expenses, in various amounts, to those defendants who served on the MeraBank Board of Directors at the request of the Company. The Company reserved the right to alter the amount of such advances or to terminate them as the case developed, and has also received undertakings from the persons receiving such advances to repay such amounts in the event that they are ultimately determined not to be entitled to indemnification. The Company has terminated future such advances as to certain of those defendants. In addition, in June and November of 1989 the Company's Board of Directors adopted resolutions whereby the Company agreed to indemnify the non-officer members of the MeraBank Board of Directors against claims brought against such individuals in their capacity as directors of MeraBank, for acts occurring on or after June and November 1989, the effective dates of the indemnification resolutions.
On December 30, 1993, and as the result of a negotiated settlement, the United States District Court for the District of Arizona entered orders and final judgments (1) dismissing the consolidated shareholder class litigation and shareholder derivative litigation initiated in 1988 and 1989, respectively, and described in the first three paragraphs under this heading and (2) partially dismissing the litigation initiated by the RTC and described in the immediately preceding paragraph. The settlement provides for payments totaling $61.625 million, of which the Company's share is $5.75 million. A litigation reserve previously established by the Company is sufficient to cover the Company's share of the settlement. The balance of the settlement payment will be funded by the Company's insurers. Two non-settling individuals who pursued independent claims against the RTC were not dismissed from the RTC litigation and have appealed the settlement. On March 23, 1995, the appeals court affirmed the judgment entered by the District Court which approved the settlement and dismissed the litigation described above. The non-settling individuals have filed a third-party complaint against the Company in the District Court for the District of Arizona alleging claims for contractual and statutory indemnification in the event that these individuals are found liable on the RTC's claims against them. The third-party complaint, which has not been served on the Company, further alleges that the Company acted in bad faith and wrongfully denied indemnification to these individuals and seeks compensatory and punitive damages in an unspecified amount as well as costs and attorneys' fees. In addition, one of these individuals seeks a judicial determination that the Company is obligated to pay him pension benefits in an unspecified amount in the event that the RTC does not fully pay these benefits. The Company believes that it has no obligation with respect to any such costs or damages.
On January 18, 1991 a lawsuit was filed in the United States District Court, Southern District of Ohio, Western Division, against, among other parties, the Company and certain of its officers and directors, the Office of Thrift Supervision ("OTS"), the RTC and the Federal Deposit Insurance Corporation ("FDIC"). The amended complaint in this lawsuit alleges that the plaintiff purchased MeraBank subordinated debentures with a face amount of $1 million in 1987 in reliance upon a capital maintenance stipulation executed by the Company as a condition to the Company's acquisition of MeraBank. The plaintiff further alleges that the value of such debentures was impaired because of the Company's release from its purported obligations under the stipulation and the actions of the OTS in placing MeraBank in receivership. The amended complaint alleges claims under the federal securities laws, the federal racketeering statutes, and state consumer fraud statutes and seeks damages in the approximate amount of $4.8 million. On August 2, 1991 the Ohio court issued an order dismissing the case with prejudice as to the Company and the officer/director defendants for lack of personal jurisdiction. The court also ordered the case dismissed with prejudice as to the OTS, the RTC and the FDIC. On October 1, 1991 the plaintiff appealed the court's order. On February 17, 1993, the United States Court of Appeals for the Sixth Circuit affirmed the entry of summary judgment in favor of the RTC, OTS, and FDIC, but reversed the district court's dismissal in favor of the Company and certain of its officers and directors. The Court of Appeals remanded the case to the district court for a determination of whether the plaintiff had adequately pled its claims so that the district court could exercise personal jurisdiction. The district court was further instructed to consider whether the Southern District of Ohio was the proper venue for the suit. On June 8, 1993, the Ohio court ordered this case to be transferred to the District of Arizona. On August 17, 1993, the Company was served with a separate complaint filed by the same plaintiff in the District Court for the District of Arizona alleging claims under the Arizona Racketeering Act and the Arizona Consumer Fraud Act seeking compensatory damages in the amount of $1.2 million plus interest, punitive damages, treble damages, interest, attorneys' fees and costs. On September 24, 1993, the plaintiff voluntarily dismissed the Arizona Consumer Fraud Act claims. On March 6, 1995, the court dismissed the Arizona Racketeering Act claims. The federal securities law, federal racketeering and state consumer fraud claims remain pending. The Company and the individual directors and officers believe that the lawsuit is without merit and will vigorously defend themselves.
On May 1, 1991, a lawsuit was filed in the United States District Court for the District of Arizona against the Company by another purchaser of the same issue of MeraBank subordinated debentures referred to in the immediately preceding paragraph. This plaintiff also claims to have purchased the debentures, with a face amount of approximately $12.4 million, in reliance upon the stipulation. The suit further alleges that the Company induced the plaintiff to retain its investment in the debentures by representing to the plaintiff that the Company would keep MeraBank capitalized in accordance with federal regulatory requirements. The suit alleges violations of federal and state securities laws, fraud, negligent representation, racketeering and intentional interference with contractual relations. On October 7, 1994, the court dismissed the plaintiff's federal securities law claims. Motions for reconsideration of the court's ruling are pending. The plaintiff seeks unspecified compensatory and punitive damages and has requested that the compensatory damages be trebled under Arizona's civil racketeering statute. The Company intends to vigorously defend itself in this action.
On December 22, 1993, the Company was served with a complaint filed by other purchasers of MeraBank subordinated debentures with a face amount of approximately $1.5 million alleging claims substantially similar to the claims described in the preceding paragraph. The complaint which was filed in the United States District Court for the District of Arizona, seeks compensatory and punitive damages in an unspecified amount plus attorneys' fees and costs. The Company intends to vigorously defend itself in this action.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matter was submitted to a vote of security holders during the fourth quarter of the fiscal year covered by this report, through the solicitation of proxies or otherwise.
SUPPLEMENTAL ITEM. EXECUTIVE OFFICERS OF THE REGISTRANT
The Company's executive officers are as follows:
AGE AT MARCH 1, 1995 NAME ------------- POSITION(S) AT MARCH 1, 1995 ---- ---------------------------- Michael S. Ash 41 Corporate Counsel Arlyn J. Larson 60 Vice President of Corporate Planning and Development Nancy E. Newquist 43 Vice President and Treasurer Henry B. Sargent 60 Executive Vice President and Chief Financial Officer(1) Richard Snell 64 Chairman of the Board of Directors, President and Chief Executive Officer(1) Faye Widenmann 46 Vice President of Corporate Relations and Administration and Secretary
---------- (1) Member of the Board of Directors.
The executive officers of the Company are elected no less often than annually and may be removed by the Board of Directors at any time. The terms served by the named officers in their current positions and the principal occupations (in addition to those stated in the table) of such officers for the past five years have been as follows:
Mr. Ash was elected Corporate Counsel of the Company in February 1991. He previously held the position of Legal Counsel to the Company from December 1986 to February 1991.
Mr. Larson was elected Vice President, Corporate Planning and Development in July 1986.
Ms. Newquist was elected Treasurer in June 1990 and as a Vice President in February 1994. Ms. Newquist also serves as Treasurer of APS, a position she was elected to in June 1993 after serving as Assistant Treasurer of APS since October 1992. From May 1987 to June 1990, Ms. Newquist served as the Company's Director of Finance.
Mr. Sargent was elected Executive Vice President and Chief Financial Officer of the Company in April 1985. Mr. Sargent was Executive Vice President and Chief Financial Officer of APS from September 1981 until July 1986. He is also a director of Magma Copper Company, Tucson, Arizona; Megafoods Stores, Inc., Phoenix, Arizona and APS.
Mr. Snell was elected Chairman of the Board, President and Chief Executive Officer of the Company effective February 5, 1990. He was also elected Chairman of the Board of APS effective the same date. Previously, he was Chairman of the Board (1989-1992) and Chief Executive Officer (1989-1990) of Aztar Corporation. Mr. Snell remains a director of Aztar Corporation and is also a director of Bank One Arizona Corporation, Phoenix, Arizona.
Ms. Widenmann was elected Secretary of the Company in 1985 and Vice President of Corporate Relations and Administration in November 1986. She was Secretary of APS from June 1983 until April 1987.
PART II
ITEM 5.
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The Company's common stock is publicly held and is traded on the New York and Pacific Stock Exchanges. At the close of business on March 24, 1995, the Company's common stock was held of record by approximately 55,400 shareholders.
The chart below sets forth the common stock price ranges on the composite tape, as reported in the Wall Street Journal for 1994 and 1993. The chart also sets forth the dividends declared and paid per share during each of the four quarters for 1994 and 1993.
COMMON STOCK PRICE RANGES AND DIVIDENDS ------------------------------------------------------------------------------
DIVIDEND 1994 HIGH LOW PER SHARE ------------------------------------------------------------------------------ 1st Quarter 22-7/8 19-1/2 .20 2nd Quarter 21 16 .20 3rd Quarter 18-3/4 16-1/8 .20 4th Quarter 20-1/8 17-1/8 .225 ------------------------------------------------------------------------------ ------------------------------------------------------------------------------ 1st Quarter 21-3/4 19-5/8 2nd Quarter 23-1/2 20-7/8 3rd Quarter 25-1/4 23-1/8 4th Quarter 24-3/8 20-3/8 .20 ------------------------------------------------------------------------------
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion relates to Pinnacle West Capital Corporation (Pinnacle West) and its subsidiaries: Arizona Public Service Company (APS), SunCor Development Company (SunCor) and El Dorado Investment Company (El Dorado). The discussion also relates to the discontinued operations of MeraBank, A Federal Savings Bank (MeraBank).
CAPITAL NEEDS AND RESOURCES
Parent Company
During the past three years, Pinnacle West's primary cash needs were for the payment of interest and the optional and mandatory repayment of principal on its long-term debt (see Note 5 of Notes to Consolidated Financial Statements). Additional cash needs in 1993 and 1994 were related to the resumption and subsequent growth of common stock dividends.
Dividends from APS have been Pinnacle West's primary source of cash. Tax allocations within the consolidated group and net operating loss carryforwards associated primarily with MeraBank have also been sources of cash.
SunCor provided cash in 1994, and SunCor and El Dorado are both expected to contribute to Pinnacle West's cash flow in 1995.
Pinnacle West repaid substantial amounts of its parent-level debt in each of the last three years. Management expects Pinnacle West to have sufficient cash flow to reduce parent company debt to approximately $310 million at the end of 1995 from $430 million at the end of 1994.
APS
APS' capital needs consist primarily of construction expenditures and optional and mandatory repayments or redemptions of long-term debt and preferred stock. The capital resources available to meet these requirements include funds provided by operations and external financings.
Present construction plans do not include any major baseload generating plants. In general, most of the construction expenditures are for expanding transmission and distribution capabilities to meet customer growth, upgrading existing facilities and for environmental purposes. Construction expenditures are anticipated to be approximately $300 million, $257 million and $236 million for 1995, 1996 and 1997, respectively. These amounts include about $27 million each year for nuclear fuel expenditures.
In the period 1992 through 1994, APS funded all of its construction expenditures and capitalized property taxes with funds provided by operations, after the payment of dividends. For the period 1995 through 1997, APS estimates that it will fund substantially all such expenditures in the same manner.
During 1994, APS repurchased or redeemed approximately $587 million of long-term debt and preferred stock, of which approximately $518 million was optional. Refunding obligations for preferred stock, long-term debt, a capitalized lease obligation and certain anticipated early redemptions are expected to total approximately $106 million, $4 million and $164 million for the years 1995, 1996 and 1997, respectively. On March 2, 1995, APS redeemed all of its outstanding first mortgage bonds, 10.25% Series due 2000 (the 10.25% Bonds) for approximately $50 million.
APS currently expects to issue up to $175 million of debt in 1995. Of this amount, on January 12, 1995, APS issued $75 million of 10% junior subordinated deferrable interest debentures (MIDS) due 2025, and applied the net proceeds to the repayment of short-term debt that had been incurred for the redemption of preferred stock in 1994. APS expects that substantially all of the net proceeds of the remaining financing activity in 1995 will be used for the retirement of outstanding debt.
Provisions in APS' mortgage bond indenture and articles of incorporation require certain coverage ratios to be met before APS can issue additional first mortgage bonds or preferred stock. In addition, the bond indenture limits the amount of additional first mortgage bonds which may be issued to a percentage of net property additions, to the amount of certain first mortgage bonds that have been redeemed or retired, and/or to cash deposited with the mortgage bond trustee. After giving proforma effect to the redemption of the 10.25% Bonds as of December 31, 1994, APS estimates that the bond indenture and the articles of incorporation would then have allowed it to issue up to approximately $1.33 billion and $768 million of additional first mortgage bonds and preferred stock, respectively.
The Arizona Corporation Commission (ACC) has authority over APS with respect to the issuance of long-term debt and equity securities. Existing ACC orders allow APS to have up to approximately $2.6 billion in long-term debt and approximately $501 million of preferred stock outstanding at any one time.
Management does not expect any of the foregoing restrictions to limit APS' ability to meet its capital requirements.
As of December 31, 1994, APS had credit commitments from various banks totaling approximately $300 million, which were available either to support the issuance of commercial paper or to be used as bank borrowings. There were no bank borrowings outstanding at the end of 1994. Commercial paper borrowings totaling $131.5 million were then outstanding.
Non-Utility Subsidiaries
During the past three years, the non-utility subsidiaries together funded all of their operations through cash flow from operations and financings that did not involve Pinnacle West. SunCor's capital needs consist primarily of construction expenditures, which, on the basis of projects now under development by it, are expected to approximate $35 million, $31 million and $11 million for 1995, 1996 and 1997, respectively. Capital resources available to meet these requirements include funds provided by SunCor's operations and external financings.
During 1994, SunCor issued $30 million of collateralized mortgage bonds. These bonds are secured by specified parcels of real property. Additionally, SunCor established revolving lines of credit totaling $24.5 million; at December 31, 1994, borrowings of $18.5 million were outstanding thereunder.
RESULTS OF OPERATIONS
1994 Compared with 1993
Pinnacle West reported income from continuing operations of $200.6 million in 1994, which included a non-recurring income tax benefit of $26.8 million. Excluding the non-recurring tax benefit, income from continuing operations in 1994 was $173.8 million compared with $170.0 million in 1993.
Underlying the small increase were several significant factors. Electric operating revenues increased primarily due to strong customer growth and significantly warmer weather in 1994, partially offset by lower interchange sales and the 1994 rate reduction. Substantially offsetting the earnings effect of the 1994 rate reduction was a one-time depreciation reversal, also occasioned by the 1994 rate settlement. Interest expense declined due primarily to parent company debt repayment and APS' refinancing efforts in 1994 and 1993. APS' effort to refinance high-cost debt, started in 1992, was substantially completed at the end of 1994.
Substantially offsetting these positive factors were the completion in May 1994 of the recording of non-cash income related to a 1991 rate settlement; increased utility operations and maintenance expense due primarily to employee severance costs related to various cost-reduction efforts; and increased nuclear decommissioning costs reflecting the most recent site-specific study.
Fuel and purchased power expenses remained relatively unchanged in 1994 compared with 1993. Higher costs to meet increased retail sales were about offset by lower fuel costs for reduced interchange sales. APS does not have a fuel adjustment clause as part of its retail rate structure; therefore, changes in fuel and purchased power expenses are reflected currently in earnings.
SunCor reported a small profit in 1994 compared with a $4.0 million loss in 1993. Real estate revenues and operating expenses in 1994 increased $27.0 million and $21.6 million, respectively, reflecting increased volumes of residential and commercial property sales.
1993 Compared with 1992
Pinnacle West reported income from continuing operations of $170.0 million in 1993 compared with $150.4 million in 1992. The primary factor that contributed to this increase was lower interest expense due to refinancing debt at lower rates, lower average debt balances and lower interest rates on APS' variable-rate debt. Partially offsetting the lower interest expense were increased taxes and higher utility operating expenses.
Electric operating revenue increased significantly due to customer growth. Offsetting customer growth were the effects of milder weather and increased fuel and purchased power costs due to Palo Verde outages and reduced power levels related to steam generator tube problems (see Note 11 of Notes to Consolidated Financial Statements).
Utility operations and maintenance expense for 1993 increased over 1992 levels primarily due to the implementation of new accounting standards for postemployment benefits and postretirement benefits other than pensions, which added $17.0 million to expense in 1993 (see Note 8 of Notes to Consolidated Financial Statements). Partially offsetting these factors were lower power plant operating costs, lower rent expense and lower costs for an employee cost-saving incentive plan.
Real estate revenues and operating expenses increased $12.3 million and $10.9 million, respectively, in 1993 due primarily to increased sales of residential lots.
Electric Operating Revenues
Electric operating revenues reflect changes in both the volume of units sold and price per kilowatt-hour (kWh) of electric sales. An analysis of the changes in 1994 and 1993 electric operating revenues compared with the prior year follows (in millions of dollars):
1994 1993 ---- ---- Volume variance $86.7 $22.3 1994 rate reduction (27.4) -- Interchange sales (19.5) (7.2) Reversal of refund obligation (12.1) -- Other operating revenues (3.9) (0.3) ----- ----- Total change $23.8 $14.8 ===== =====
The volume increase in 1994 primarily reflects the effects on retail sales of customer growth ($56 million) and warmer weather ($42 million). The volume increase in 1993 was primarily due to customer growth ($41 million), partially offset by milder weather ($20 million reduction). Other factors affecting volumes include changes in usage, unbilled revenue and firm sales for resale for a net total of $11 million reduction in 1994 and $1 million increase in 1993.
Income Tax Issues
See Note 3 of Notes to Consolidated Financial Statements regarding recognition of $26.8 million of income tax benefits in 1994 and a recent accounting standard for income taxes which required the recognition in 1993 of $19.3 million of tax benefits related to net operating loss carryforwards.
Other Income/Rate Settlement Impacts
Net income reflects accounting practices required for regulated public utilities and represents a composite of cash and non-cash items, including Allowance for Funds Used During Construction (AFUDC), accretion income on Palo Verde Unit 3 and the reversal of a refund obligation arising out of the 1991 rate settlement (see Consolidated Statements of Cash Flows and Note 1 of Notes to Consolidated Financial Statements). The accretion and refund reversals, net of income taxes, totaled $25.9 million, $58.2 million and $53.6 million in 1994, 1993 and 1992, respectively. APS has now recorded all of the Palo Verde Unit 3 accretion income and refund obligation reversals related to the 1991 settlement. Also in 1994 was a one-time Palo Verde depreciation reversal of $15 million, net of income tax, which is included in "Other -- net" in the Consolidated Statements of Income (see Note 2 of Notes to Consolidated Financial Statements).
The retail rate settlement which was approved by the ACC in May 1994 did not significantly affect 1994 earnings as previously discussed, and is not expected to significantly affect earnings for the years 1995 through 1999 because the rate reduction will be substantially offset by accelerated amortization of deferred investment tax credits (see Note 2 of Notes to Consolidated Financial Statements).
Competition
A significant challenge for APS will be how well it is able to respond to increasingly competitive conditions in the electric utility industry, while continuing to earn an acceptable return for its shareholders. Strategies emphasize managing costs, stabilizing electric rates, negotiating long-term contracts with large customers and capitalizing on the growth characteristics of APS' service territory.
One of the issues that must be addressed responsibly is the recovery in a more competitive environment of the carrying value of assets (including those referred to in Note 1K of Notes to Consolidated Financial Statements) acquired or recorded under the existing regulatory environment.
Pursuant to the 1994 rate settlement, APS and the ACC staff will develop certain procedures that are responsive to the competitive forces in larger customer segments, with the objective of making joint recommendations to the ACC in 1995. A separate ACC proceeding on competition was opened in mid-1994 and is expected to continue for some months.
As the forces of competition continue to impact the industry, it will become clearer as to what customer sectors and what regions will be most affected and what strategies are best to deal with those forces.
REPORT OF MANAGEMENT
The primary responsibility for the integrity of Pinnacle West's financial information rests with management, which has prepared the accompanying financial statements and related information. Such information was prepared in accordance with generally accepted accounting principles appropriate in the circumstances, based on management's best estimates and judgments and giving due consideration to materiality. These financial statements have been audited by independent auditors and their report is included.
Management maintains and relies upon systems of internal accounting controls. A limiting factor in all systems of internal accounting control is that the cost of the system should not exceed the benefits to be derived. Management believes that Pinnacle West's system provides the appropriate balance between such costs and benefits.
Periodically the internal accounting system is reviewed by both Pinnacle West's internal auditors and its independent auditors to test for compliance. Reports issued by the internal auditors are released to management, and such reports, or summaries thereof, are transmitted to the Audit Committee of the Board of Directors and the independent auditors on a timely basis.
The Audit Committee, composed solely of outside directors, meets periodically with the internal auditors and independent auditors (as well as management) to review the work of each. The internal auditors and independent auditors have free access to the Audit Committee, without management present, to discuss the results of their audit work.
Management believes that Pinnacle West's systems, policies and procedures provide reasonable assurance that operations are conducted in conformity with the law and with management's commitment to a high standard of business conduct.
Richard Snell Henry B. Sargent Chairman & President Executive Vice President & Chief Financial Officer
INDEPENDENT AUDITORS' REPORT
We have audited the accompanying consolidated balance sheets of Pinnacle West Capital Corporation and its subsidiaries as of December 31, 1994 and 1993 and the related consolidated statements of income, retained earnings and cash flows for each of the three years in the period ended December 31, 1994. Our audits also included the financial statement schedule listed in the Index at Item 8. These financial statements and financial statement schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and financial statement schedule based on our audits.
We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of Pinnacle West Capital Corporation and its subsidiaries at December 31, 1994 and 1993 and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1994 in conformity with generally accepted accounting principles. Also, in our opinion, such financial statement schedule, when considered in relation to the basic financial statements taken as a whole, presents fairly in all material respects the information set forth therein.
As discussed in Note 3 of Notes to Consolidated Financial Statements, the Company changed its method of accounting for income taxes effective January 1, 1993 to conform with Statement of Financial Accounting Standards No. 109.
Deloitte & Touche LLP Phoenix, Arizona March 3, 1995
PINNACLE WEST CAPITAL CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. Summary of Significant Accounting Policies
A. Consolidation
The consolidated financial statements include the accounts of Pinnacle West Capital Corporation and its subsidiaries: Arizona Public Service Company, an electric utility; SunCor Development Company, a real estate development company; and El Dorado Investment Company, a venture capital firm.
B. Utility Plant and Depreciation
Utility plant represents the buildings, equipment and other facilities used to provide electric service. The cost of utility plant includes labor, materials, contract services, other related items and an allowance for funds used during construction. The cost of retired depreciable utility plant, plus removal costs less salvage realized, is charged to accumulated depreciation.
Depreciation on utility property is recorded on a straight-line basis. The applicable rates for 1992 through 1994 ranged from 0.84% to 15.00%, which resulted in an annual composite rate of 3.43% for 1994. Depreciation and amortization of non-utility property and equipment are provided over the estimated useful lives of the related assets, ranging from 3 to 33.3 years.
C. Revenues
Electric operating revenues are recognized on the accrual basis and include estimated amounts for service rendered but unbilled at the end of each accounting period.
In 1991 APS recorded a refund obligation of $53.4 million ($32.3 million after tax) as a result of a 1991 rate settlement. The refund obligation was used to reduce the amount of a 1991 rate increase granted rather than require specific customer refunds and was reversed over the thirty months ended May 1994. The after-tax refund obligation reversals that were recorded as electric operating revenues by APS amounted to $5.6 million in 1994 and $12.9 million in each of the years 1993 and 1992.
Consistent with the 1994 presentation, prior years electric operating revenues and other taxes have been restated to exclude sales tax on electric revenue.
D. Allowance for Funds Used During Construction
AFUDC represents the cost of debt and equity funds used to finance construction of utility plant. Plant construction costs, including AFUDC, are recovered in authorized rates through depreciation when completed projects are placed into commercial operation. AFUDC does not represent current cash earnings.
AFUDC has been calculated using composite rates of 7.70% for 1994; 7.20% for 1993; and 10.00% for 1992. APS compounds AFUDC semiannually and ceases to accrue AFUDC when construction work is completed and the property is placed in service.
E. Income Taxes
Pinnacle West and its subsidiaries file a consolidated U.S. income tax return. Provisions for income taxes are made by each subsidiary as if separate income tax returns were filed. The difference, if any, between these provisions and consolidated income tax expense is allocated to Pinnacle West.
Investment tax credits (ITCs) were deferred and are being amortized to other income over the estimated lives of the related assets as directed by the ACC. The 1994 retail rate settlement provides for accelerated amortization of ITCs over five years beginning in 1995 (see Note 2).
F. Reacquired Debt Costs
APS amortizes gains and losses on reacquired debt over the remaining life of the original debt, consistent with ratemaking.
G. Nuclear Fuel and Decommissioning Costs
Nuclear fuel is charged to fuel expense using the unit-of-production method under which the number of units of thermal energy produced in the current period is related to the total thermal units expected to be produced over the remaining life of the fuel.
Under federal law, the United States Department of Energy (DOE) is responsible for the permanent disposal of spent nuclear fuel. The DOE assesses $.001 per kWh of nuclear generation. This amount is charged to nuclear fuel expense and recovered through rates.
In 1994, APS recorded $11.9 million for decommissioning expense. APS estimates it will cost approximately $2.1 billion ($425 million in 1994 dollars), over a thirteen-year period beginning in 2023, to decommission its 29.1% interest in Palo Verde. Decommissioning costs are charged to expense over the respective units operating license term and are included in the accumulated depreciation balance until each Palo Verde unit is fully decommissioned. Nuclear decommissioning costs are currently recovered in rates.
APS is utilizing a 1992 site-specific study for Palo Verde, prepared for APS by an independent consultant, that assumes the prompt removal/dismantlement method of decommissioning. The study is updated every three years.
As required by the ACC, APS has established external trust accounts into which quarterly deposits are made for decommissioning. As of December 31, 1994, APS has deposited a total of $45.0 million. The trust accounts are included in Investments and Other Assets on the Consolidated Balance Sheets at a market value of $55.2 million on December 31, 1994. The trust funds are invested primarily in fixed-income securities and domestic stock and are classified as available for sale. Gains and losses are reflected in accumulated depreciation.
In 1994, the Financial Accounting Standards Board (FASB) added a project to its agenda on accounting for nuclear decommissioning obligations. Only preliminary views have been discussed at this time, however, there is some indication the FASB may require the estimated present value of the cost of decommissioning to be recorded as a liability along with an offsetting plant asset. Pinnacle West is unable to determine what, if any, impact these deliberations may have on its financial position or results of operations.
H. Statements of Cash Flows
Temporary cash investments and marketable securities are considered to be cash equivalents for purposes of the Consolidated Statements of Cash Flows. During 1994, 1993 and 1992 Pinnacle West and its subsidiaries paid interest, net of amounts capitalized, of $231.6 million, $243.9 million and $286.4 million, respectively. Income taxes paid were $56.5 million, $45.3 million and $33.8 million, respectively; and dividends paid on preferred stock of APS were $26.2 million, $30.9 million and $32.6 million, respectively.
I. Palo Verde Cost Deferrals
As authorized by the ACC, APS deferred operating costs (excluding fuel) and financing costs of Palo Verde Units 2 and 3 from the commercial operation date (September 1986 and January 1988, respectively) until the date the units were included in a rate order (April 1988 and December 1991, respectively). The deferrals are being amortized and recovered through rates over thirty-five year periods.
J. Palo Verde Accretion Income
In 1991, APS discounted the carrying value of Palo Verde Unit 3 to reflect the present value of lost cash flows resulting from a 1991 rate settlement agreement deeming a portion of the unit to temporarily be excess capacity. In accordance with generally accepted accounting principles, APS recorded accretion income over a thirty-month period ended May 1994 in the aggregate amount of the original discount. The after-tax accretion income recorded by APS in 1994, 1993 and 1992 was $20.3 million, $45.3 million and $40.7 million, respectively.
K. 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' major regulatory assets are Palo Verde cost deferrals (see Note 1) and deferred taxes (see Note 3). These items, combined with miscellaneous other items and regulatory liabilities, amounted to approximately $1.1 billion at December 31, 1994 and 1993, most of which are included in "Deferred Debits" on the Consolidated Balance Sheets.
2. Regulatory Matters
In May 1994, the ACC approved a retail rate settlement agreement which was jointly proposed by APS and the ACC staff. The major provisions of the settlement include:
o A net annual rate reduction of approximately $32.3 million ($19 million after tax), or 2.2% on average effective June 1, 1994.
o A moratorium on filing for permanent rate changes, except under certain circumstances, prior to the end of 1996 for both APS and the ACC staff.
o A joint APS-ACC study to develop rate principles allowing APS greater flexibility to deal with market conditions and increasing competition in the electric industry.
o All of Palo Verde Unit 3 included in rate base.
o An incentive rewarding reduction in fuel and operating and maintenance cost per kWh below established targets.
As part of the settlement, APS reversed approximately $20 million of depreciation ($15 million after tax) related to a 1991 Palo Verde write-off. The 1994 settlement also provided for the accelerated amortization of substantially all deferred ITCs over a five-year period beginning in 1995. Overall, the settlement is not expected to materially affect APS results of operations for the years 1995-1999.
3. Income Tax Expense
Non-recurring Income Tax Benefit
The recognition of $26.8 million of non-recurring income tax benefits in 1994 relates to a change in tax law.
Change in Accounting for Income Taxes
Effective January 1, 1993, Pinnacle West adopted SFAS No. 109, "Accounting for Income Taxes," which requires the use of the liability method of accounting for income taxes. The cumulative effect on prior years of this change in accounting principle resulted in an increase in 1993 net income of $19.3 million, due primarily to the recognition of deferred tax benefits relating to state net operating loss (NOL) carryforwards of Pinnacle West.
As a result of adopting SFAS No. 109, APS recorded additional deferred income taxes related to the equity component of AFUDC; the debt component of AFUDC recorded net-of-tax; and other temporary differences for which deferred income taxes had not been provided. Deferred tax balances were also adjusted for changes in tax rates. The adoption of SFAS No. 109 increased net deferred income tax liabilities by $585.3 million at December 31, 1993. Historically, the Federal Energy Regulatory Commission and the ACC have allowed revenues sufficient to pay for these deferred tax liabilities and, in accordance with SFAS No. 109, a regulatory asset was established in a corresponding amount.
At December 31, 1994, Pinnacle West had federal NOL carryforwards of approximately $80 million which may be used through 2005 and state NOL carryforwards of approximately $490 million which expire in 1995. Pinnacle West also had ITC carryforwards of approximately $18 million which expire in 2000 through 2005.
4. Lines of Credit
APS had committed lines of credit with various banks of $300 million at December 31, 1994, and $302 million at December 31, 1993, which were available either to support the issuance of commercial paper or to be used for bank borrowings. The commitment fees on these lines were 0.25% per annum through June 30, 1994, 0.20% per annum on $200 million and 0.15% per annum on $100 million thereafter, through December 31, 1994. APS had commercial paper borrowings outstanding of $131.5 million at December 31, 1994, and $148.0 million at December 31, 1993. The weighted average interest rate on commercial paper borrowings was 6.25% on December 31, 1994, and 3.48% on December 31, 1993. By Arizona statute, APS short-term borrowings cannot exceed 7% of its total capitalization without the consent of the ACC.
SunCor had revolving lines of credit totaling $24.5 million at December 31, 1994, and none at December 31, 1993. Any borrowings are collateralized by certain real property and would bear interest based on the prime rate or on London Interbank Offered Rate (LIBOR). The commitment fees on these lines were 0.5% per annum on $15.0 million and 0.2% per annum on $9.5 million. SunCor had $18.5 million outstanding under these lines at December 31, 1994.
5. Long-Term Debt
Aggregate annual principal payments due on total long-term debt and for sinking fund requirements through 1999 are as follows: 1995, $78.5 million; 1996, $50.7 million; 1997, $166.9 million; 1998, $113.4 million; and 1999, $112.8 million. See Note 6 for redemption and sinking fund requirements of redeemable preferred stock of APS.
On January 12, 1995, APS issued $75 million of 10% junior subordinated deferrable interest debentures (MIDS) due 2025.
If there were to be any arrearage in dividends on any of its preferred stock or in the sinking fund requirements applicable to any of its redeemable preferred stock, APS could not pay dividends on its common stock or acquire any shares thereof for consideration. The redemption requirements for the above issues for the next five years are: $0 in 1995 and 1996, and $10.0 million in each of the years 1997 through 1999.
Redeemable preferred stock transactions of APS during each of the three years in the period ended December 31, 1994, are as follows:
Number Par of Value Shares Amount --------- ----------- (Dollars in Thousands)
Balance, December 31, 1991 ............... 2,272,782 $ 227,278 Issuance $7.875 Series V .................. 250,000 25,000 Retirements $10.00 Series H .................. (8,677) (868) $8.80 Series K ................... (4,725) (472) $12.90 Series N .................. (213,280) (21,328) $11.50 Series R .................. (39,750) (3,975) --------- ----------- Balance, December 31, 1992 ............... 2,256,350 225,635 Retirements $8.80 Series K ................... (45,000) (4,500) $11.50 Series R .................. (35,250) (3,525) $8.48 Series S ................... (200,000) (20,000) --------- ----------- Balance, December 31, 1993 ............... 1,976,100 197,610 Retirements $8.80 Series K ................... (142,100) (14,210) $11.50 Series R .................. (284,000) (28,400) $8.48 Series S ................... (300,000) (30,000) $8.50 Series T ................... (500,000) (50,000) --------- ----------- Balance, December 31, 1994 ............... 750,000 $ 75,000 ========= ===========
7. Common Stock
Pinnacle West's common stock issued during each of the three years in the period ended December 31, 1994, is as follows:
Number of Shares Amount(a) ---------- ------------ (Dollars in Thousands)
Balance, December 31, 1991 .............. 87,009,974 $ 1,646,889 Common stock issued ............. 151,898 (117) ---------- ------------ Balance, December 31, 1992 .............. 87,161,872 1,646,772 Common stock issued ............. 261,945 (3,989) ---------- ------------ Balance, December 31, 1993 .............. 87,423,817 1,642,783 Common stock issued ............. 5,825 (1,587) ---------- ------------ Balance, December 31, 1994 .............. 87,429,642 $ 1,641,196 ========== ============ ------------ (a) Including premiums and expenses of preferred stock issues of APS.
The Pinnacle West Stock Purchase and Dividend Reinvestment Plan (renamed the Investors Advantage Plan in 1995) provides that any participant may purchase shares of its common stock directly from Pinnacle West.
Both Pinnacle West and APS have employee savings plans under which contributions by participating employees and contributions by employers could involve the issuance of new shares of Pinnacle West common stock. Contributions made by Pinnacle West and APS to their respective employee retirement plans may also involve one or more such issuances of common stock. However, Pinnacle West plans to continue making market purchases of its outstanding stock to meet its needs related to the Stock Purchase and Dividend Reinvestment Plan, the employee savings plans and the employee retirement plans.
Pinnacle West has incentive plans under which it may grant non-qualified stock options (NQSOs), incentive stock options (ISOs) and restricted stock awards to officers and key employees of Pinnacle West and its subsidiaries up to an aggregate of 6.5 million shares of Pinnacle West common stock. The plans also provide for the granting of any combination of stock appreciation rights or dividend equivalents. As of December 31, 1994, approximately 1,917,500 NQSOs, 9,000 ISOs, 287,000 restricted shares and 35,000 dividend equivalent shares were outstanding. A plan for Pinnacle West's directors under which an additional 150,500 NQSOs were outstanding at December 31, 1994, was replaced in 1994 by a plan that provides for the granting of stock to directors as part of their annual retainers up to an aggregate amount of 50,000 shares.
8. Pension Plans and Other Benefits
Pension Plans
Pinnacle West and its subsidiaries sponsor defined benefit pension plans covering substantially all employees. Benefits are based on years of service and compensation utilizing a final average pay benefit formula. The plans are funded on a current basis to the extent deductible under existing tax regulations. Plan assets consist primarily of domestic and international common stocks and bonds and real estate. Pension cost, including administrative cost, for 1994, 1993 and 1992 was approximately $25.8 million, $14.3 million and $14.4 million, respectively, of which approximately $12.3 million, $6.8 million and $4.3 million, respectively, was charged to expense. The remainder was either capitalized or billed to others.
In addition to the defined benefit pension plans described above, Pinnacle West and its subsidiaries also sponsor qualified defined contribution plans. Collectively, these plans cover substantially all employees. The plans provide for employee contributions and partial employer matching contributions after certain eligibility requirements are met. The cost of these plans for 1994, 1993 and 1992 was $7.0 million, $6.4 million and $5.4 million, respectively, of which $3.3 million, $3.1 million and $2.6 million, respectively, was charged to expense.
Postretirement Plans
Pinnacle West and its subsidiaries provide medical and life insurance benefits to their retired employees. Employees may become eligible for these retirement benefits based on years of service and age. The retiree medical insurance plans are contributory; the retiree life insurance plans are noncontributory. In accordance with the governing plan documents, the companies retain the right to change or eliminate these benefits.
During 1993, Pinnacle West adopted SFAS No. 106, "Employers' Accounting for Postretirement Benefits Other Than Pensions," which requires the cost of postretirement benefits be accrued during the years employees render service. Prior to 1993, the costs of retiree benefits were recognized as expense when claims were paid. This change had the effect of increasing 1994 and 1993 retiree benefits costs from approximately $6 million in each year to $28 million and $35 million, respectively. The amount charged to expense for 1994 increased from about $3 million to $14 million, and for 1993 increased from about $2 million to $17 million. The balance was either capitalized or billed to others. The above amounts include the amortization (over 20 years) of the initial postretirement benefit obligation estimated at January 1, 1993, to be $184 million. Funding is based upon actuarially determined contributions that take tax consequences into account. Plan assets consist primarily of domestic stocks and bonds.
Assuming a one percent increase in the health care cost trend rate, the 1994 cost of postretirement benefits other than pensions would increase by approximately $5 million and the accumulated benefit obligation as of December 31, 1994, would increase by approximately $31 million.
In 1993, Pinnacle West adopted SFAS No. 112, "Employers' Accounting for Postemployment Benefits". The standard required a change from a cash method to an accrual method in accounting for benefits (such as long-term disability) provided to former or inactive employees after employment but before retirement. The adoption of this standard resulted in an increase in 1993 postemployment benefit expense of approximately $2 million.
9. Leases
In 1986, APS entered into sale and leaseback transactions under which it sold approximately 42% of its share of Palo Verde Unit 2 and certain common facilities. The gain of approximately $140.2 million has been deferred and is being amortized to operations expense over the original lease term. The leases are being accounted for as operating leases. The amounts paid each year approximate $40.1 million through December 1999, $46.3 million through December 2000, and $49.0 million through December 2015. Options to renew for two additional years and to purchase the property at fair market value at the end of the lease terms are also included. Consistent with the ratemaking treatment, an amount equal to the annual lease payments is included in rent expense. A regulatory asset (totaling approximately $52.8 million at December 31, 1994) has been established for the difference between lease payments and rent expense calculated on a straight-line basis. Lease expense for 1994, 1993 and 1992 was $42.2 million, $41.8 million and $45.8 million, respectively.
APS has a capital lease on a combined cycle plant which it sold and leased back. The lease requires semiannual payments of $2.6 million through June 2001, and includes renewal and purchase options based on fair market value. This plant is included in plant in service at its original cost of $54.4 million; accumulated amortization at December 31, 1994, was $40.3 million.
In addition, Pinnacle West and its subsidiaries lease certain land, buildings, equipment and miscellaneous other items through operating rental agreements with varying terms, provisions and expiration dates. Rent expense for 1994, 1993 and 1992 was approximately $21.3 million, $21.5 million and $26.1 million, respectively. Annual future minimum rental commitments, excluding the Palo Verde and combined cycle leases, through 1999 are as follows: 1995, $17.6 million; 1996, $14.6 million; 1997, $14.5 million; 1998, $14.6 million; and 1999, $14.7 million. Total rental commitments after 1999 are estimated at $189 million.
11. Commitments and Contingencies
Litigation
Pinnacle West and its subsidiaries are parties to various claims, legal actions and complaints arising in the ordinary course of business. In the opinion of management, the ultimate resolution of these matters will not have a material adverse effect on the operations or financial position of Pinnacle West.
Palo Verde Nuclear Generating Station
APS has encountered tube cracking in steam generators and has taken, and will continue to take, remedial actions that it believes have slowed further tube problems to manageable levels. APS believes that the Palo Verde steam generators are capable of operating for their designed life of 40 years, although at some point, long-term economic considerations may make steam generator replacement desirable. All of the Palo Verde units were operating at full power at December 31, 1994.
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. The maximum assessment per reactor under the retrospective rating 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 for all three units 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 $2.78 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.
El Paso Electric Company Bankruptcy
El Paso Electric Company (EPEC), one of the joint owners of the Palo Verde and Four Corners facilities, has been operating under Chapter 11 of the Bankruptcy Code since 1992. A plan whereby EPEC would become a wholly-owned subsidiary of Central and South West Corporation (CSW) has been confirmed by the bankruptcy court, but cannot become fully effective until several other approvals are obtained. Under the plan, certain issues, including EPEC allegations regarding the 1989-90 Palo Verde outages, would be resolved, and EPEC would assume the joint facilities operating agreements. CSW has stated that several matters have arisen which may impede completion of the merger. If the plan is not approved, Pinnacle West does not expect that there would be a material adverse effect on its operations or financial position.
Construction Program
Total construction expenditures in 1995 are estimated at $335 million, excluding capitalized property taxes and capitalized interest.
Fuel and Purchased Power Commitments
APS is a party to various fuel and purchased power contracts with terms expiring from 1995 through 2020. APS estimates its 1995 contract requirements to be approximately $127 million. However, this amount may vary significantly pursuant to certain provisions in such contracts which permit APS to decrease its required purchases under certain circumstances.
13. Fair Value of Financial Instruments
Pinnacle West estimates that carrying amounts of its cash equivalents and commercial paper are reasonable estimates of their fair values at December 31, 1994 and 1993 due to their short maturities.
The December 31, 1994 and 1993 fair values of debt and equity investments, determined by using quoted market values or by discounting cash flows at rates equal to Pinnacle West's cost of capital, approximate their carrying amounts. It was not practical to estimate the fair values of several investments in joint ventures and untraded equity securities because costs to do so would be excessive. The carrying value of these investments totaled $40.6 million and $45.6 million at year-end 1994 and 1993, respectively. Investments in debt and equity securities are held for purposes other than trading.
On December 31, 1994, the carrying amount of long-term debt (excluding $26 million of capital lease obligations) was $2.64 billion and its estimated fair value was approximately $2.49 billion. On December 31, 1993, the carrying amount of long-term debt (excluding $30 million of capital lease obligations) was $2.68 billion and its estimated fair value was approximately $2.91 billion. The fair value estimates were determined by independent sources using quoted market rates where available. Where market prices were not available, the fair values were based on market values of comparable instruments.
PINNACLE WEST CAPITAL CORPORATION
SCHEDULE II -- VALUATION AND QUALIFYING ACCOUNTS
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Reference is hereby made to "Election of Directors" and "Section 16 Requirements" in the Company's Proxy Statement relating to the annual meeting of shareholders to be held on May 17, 1995 (the "1995 Proxy Statement") and to the Supplemental Item -- "Executive Officers of the Company" in Part I of this report.
ITEM 11. EXECUTIVE COMPENSATION
Reference is hereby made to the last two paragraphs under the heading "The Board and its Committees," and to "Executive Compensation" in the 1995 Proxy Statement.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Reference is hereby made to "Certain Securities Ownership" in the 1995 Proxy Statement.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
None.
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENTS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULES
See the Index to Financial Statements and Financial Statement Schedule in Part II, Item 8.
EXHIBITS FILED
EXHIBIT NO. DESCRIPTION ----------- ----------- 10.1a -- Summary of the Pinnacle West Capital Corporation 1995 Bonus Plan
22 -- Subsidiaries of the Company
23.1 -- Consent of Deloitte & Touche LLP
27.1 -- Financial Data Schedule
REPORTS ON FORM 8-K
During the quarter ended December 31, 1994, and the period ended March 30, 1995, the Company did not file any Reports on Form 8-K.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
PINNACLE WEST CAPITAL CORPORATION (Registrant)
Date: March 30, 1995 RICHARD SNELL ---------------------------------------------------- (Richard Snell, Chairman of the Board of Directors, President and Chief Executive Officer)
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
Signature Title Date --------- ----- ----
RICHARD SNELL Principal Executive March 30, 1995 ---------------------------------------- Officer and Director (Richard Snell, Chairman of the Board of Directors, President and Chief Executive Officer)
H. B. SARGENT Principal Financial March 30, 1995 ---------------------------------------- Officer, Principal (H. B. Sargent, Executive Vice President Accounting Officer and Chief Financial Officer) and Director
O. MARK DEMICHELE Director March 30, 1995 ---------------------------------------- (O. Mark DeMichele)
PAMELA GRANT Director March 30, 1995 ---------------------------------------- (Pamela Grant)
ROY A. HERBERGER, JR. Director March 30, 1995 ---------------------------------------- (Roy A. Herberger, Jr.)
MARTHA O. HESSE Director March 30, 1995 ---------------------------------------- (Martha O. Hesse)
WILLIAM S. JAMIESON, JR. Director March 30, 1995 ---------------------------------------- (William S. Jamieson, Jr.)
JOHN R. NORTON, III Director March 30, 1995 ---------------------------------------- (John R. Norton, III)
DONALD N. SOLDWEDEL Director March 30, 1995 ---------------------------------------- (Donald N. Soldwedel)
DOUGLAS J. WALL Director March 30, 1995 ---------------------------------------- (Douglas J. Wall)
COMMISSION FILE NUMBER 1-8962 ------ ================================================================================
SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 -------------- EXHIBITS TO FORM 10-K ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE FISCAL YEAR ENDED DECEMBER 31, 1994 -------------- PINNACLE WEST CAPITAL CORPORATION (EXACT NAME OF REGISTRANT AS SPECIFIED IN CHARTER)
================================================================================
INDEX TO EXHIBITS
EXHIBIT NO. DESCRIPTION ----------- ----------- 10.1a -- Summary of the Pinnacle West Capital Corporation 1995 Bonus Plan
22 -- Subsidiaries of the Company
23.1 -- Consent of Deloitte & Touche LLP
27.1 -- Financial Data Schedule ----------
(a) Management contract or compensatory plan or arrangement required to be filed as an exhibit pursuant to Item 14(c) of Form 10-K.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion relates to Pinnacle West Capital Corporation (Pinnacle West) and its subsidiaries: Arizona Public Service Company (APS), SunCor Development Company (SunCor) and El Dorado Investment Company (El Dorado). The discussion also relates to the discontinued operations of MeraBank, A Federal Savings Bank (MeraBank).
CAPITAL NEEDS AND RESOURCES
Parent Company
During the past three years, Pinnacle West's primary cash needs were for the payment of interest and the optional and mandatory repayment of principal on its long-term debt (see Note 5 of Notes to Consolidated Financial Statements). Additional cash needs in 1993 and 1994 were related to the resumption and subsequent growth of common stock dividends.
Dividends from APS have been Pinnacle West's primary source of cash. Tax allocations within the consolidated group and net operating loss carryforwards associated primarily with MeraBank have also been sources of cash.
SunCor provided cash in 1994, and SunCor and El Dorado are both expected to contribute to Pinnacle West's cash flow in 1995.
Pinnacle West repaid substantial amounts of its parent-level debt in each of the last three years. Management expects Pinnacle West to have sufficient cash flow to reduce parent company debt to approximately $310 million at the end of 1995 from $430 million at the end of 1994.
APS
APS' capital needs consist primarily of construction expenditures and optional and mandatory repayments or redemptions of long-term debt and preferred stock. The capital resources available to meet these requirements include funds provided by operations and external financings.
Present construction plans do not include any major baseload generating plants. In general, most of the construction expenditures are for expanding transmission and distribution capabilities to meet customer growth, upgrading existing facilities and for environmental purposes. Construction expenditures are anticipated to be approximately $300 million, $257 million and $236 million for 1995, 1996 and 1997, respectively. These amounts include about $27 million each year for nuclear fuel expenditures.
In the period 1992 through 1994, APS funded all of its construction expenditures and capitalized property taxes with funds provided by operations, after the payment of dividends. For the period 1995 through 1997, APS estimates that it will fund substantially all such expenditures in the same manner.
During 1994, APS repurchased or redeemed approximately $587 million of long-term debt and preferred stock, of which approximately $518 million was optional. Refunding obligations for preferred stock, long-term debt, a capitalized lease obligation and certain anticipated early redemptions are expected to total approximately $106 million, $4 million and $164 million for the years 1995, 1996 and 1997, respectively. On March 2, 1995, APS redeemed all of its outstanding first mortgage bonds, 10.25% Series due 2000 (the 10.25% Bonds) for approximately $50 million.
APS currently expects to issue up to $175 million of debt in 1995. Of this amount, on January 12, 1995, APS issued $75 million of 10% junior subordinated deferrable interest debentures (MIDS) due 2025, and applied the net proceeds to the repayment of short-term debt that had been incurred for the redemption of preferred stock in 1994. APS expects that substantially all of the net proceeds of the remaining financing activity in 1995 will be used for the retirement of outstanding debt.
Provisions in APS' mortgage bond indenture and articles of incorporation require certain coverage ratios to be met before APS can issue additional first mortgage bonds or preferred stock. In addition, the bond indenture limits the amount of additional first mortgage bonds which may be issued to a percentage of net property additions, to the amount of certain first mortgage bonds that have been redeemed or retired, and/or to cash deposited with the mortgage bond trustee. After giving proforma effect to the redemption of the 10.25% Bonds as of December 31, 1994, APS estimates that the bond indenture and the articles of incorporation would then have allowed it to issue up to approximately $1.33 billion and $768 million of additional first mortgage bonds and preferred stock, respectively.
The Arizona Corporation Commission (ACC) has authority over APS with respect to the issuance of long-term debt and equity securities. Existing ACC orders allow APS to have up to approximately $2.6 billion in long-term debt and approximately $501 million of preferred stock outstanding at any one time.
Management does not expect any of the foregoing restrictions to limit APS' ability to meet its capital requirements.
As of December 31, 1994, APS had credit commitments from various banks totaling approximately $300 million, which were available either to support the issuance of commercial paper or to be used as bank borrowings. There were no bank borrowings outstanding at the end of 1994. Commercial paper borrowings totaling $131.5 million were then outstanding.
Non-Utility Subsidiaries
During the past three years, the non-utility subsidiaries together funded all of their operations through cash flow from operations and financings that did not involve Pinnacle West. SunCor's capital needs consist primarily of construction expenditures, which, on the basis of projects now under development by it, are expected to approximate $35 million, $31 million and $11 million for 1995, 1996 and 1997, respectively. Capital resources available to meet these requirements include funds provided by SunCor's operations and external financings.
During 1994, SunCor issued $30 million of collateralized mortgage bonds. These bonds are secured by specified parcels of real property. Additionally, SunCor established revolving lines of credit totaling $24.5 million; at December 31, 1994, borrowings of $18.5 million were outstanding thereunder.
RESULTS OF OPERATIONS
1994 Compared with 1993
Pinnacle West reported income from continuing operations of $200.6 million in 1994, which included a non-recurring income tax benefit of $26.8 million. Excluding the non-recurring tax benefit, income from continuing operations in 1994 was $173.8 million compared with $170.0 million in 1993.
Underlying the small increase were several significant factors. Electric operating revenues increased primarily due to strong customer growth and significantly warmer weather in 1994, partially offset by lower interchange sales and the 1994 rate reduction. Substantially offsetting the earnings effect of the 1994 rate reduction was a one-time depreciation reversal, also occasioned by the 1994 rate settlement. Interest expense declined due primarily to parent company debt repayment and APS' refinancing efforts in 1994 and 1993. APS' effort to refinance high-cost debt, started in 1992, was substantially completed at the end of 1994.
Substantially offsetting these positive factors were the completion in May 1994 of the recording of non-cash income related to a 1991 rate settlement; increased utility operations and maintenance expense due primarily to employee severance costs related to various cost-reduction efforts; and increased nuclear decommissioning costs reflecting the most recent site-specific study.
Fuel and purchased power expenses remained relatively unchanged in 1994 compared with 1993. Higher costs to meet increased retail sales were about offset by lower fuel costs for reduced interchange sales. APS does not have a fuel adjustment clause as part of its retail rate structure; therefore, changes in fuel and purchased power expenses are reflected currently in earnings.
SunCor reported a small profit in 1994 compared with a $4.0 million loss in 1993. Real estate revenues and operating expenses in 1994 increased $27.0 million and $21.6 million, respectively, reflecting increased volumes of residential and commercial property sales.
1993 Compared with 1992
Pinnacle West reported income from continuing operations of $170.0 million in 1993 compared with $150.4 million in 1992. The primary factor that contributed to this increase was lower interest expense due to refinancing debt at lower rates, lower average debt balances and lower interest rates on APS' variable-rate debt. Partially offsetting the lower interest expense were increased taxes and higher utility operating expenses.
Electric operating revenue increased significantly due to customer growth. Offsetting customer growth were the effects of milder weather and increased fuel and purchased power costs due to Palo Verde outages and reduced power levels related to steam generator tube problems (see Note 11 of Notes to Consolidated Financial Statements).
Utility operations and maintenance expense for 1993 increased over 1992 levels primarily due to the implementation of new accounting standards for postemployment benefits and postretirement benefits other than pensions, which added $17.0 million to expense in 1993 (see Note 8 of Notes to Consolidated Financial Statements). Partially offsetting these factors were lower power plant operating costs, lower rent expense and lower costs for an employee cost-saving incentive plan.
Real estate revenues and operating expenses increased $12.3 million and $10.9 million, respectively, in 1993 due primarily to increased sales of residential lots.
Electric Operating Revenues
Electric operating revenues reflect changes in both the volume of units sold and price per kilowatt-hour (kWh) of electric sales. An analysis of the changes in 1994 and 1993 electric operating revenues compared with the prior year follows (in millions of dollars):
1994 1993 ---- ---- Volume variance $86.7 $22.3 1994 rate reduction (27.4) -- Interchange sales (19.5) (7.2) Reversal of refund obligation (12.1) -- Other operating revenues (3.9) (0.3) ----- ----- Total change $23.8 $14.8 ===== =====
The volume increase in 1994 primarily reflects the effects on retail sales of customer growth ($56 million) and warmer weather ($42 million). The volume increase in 1993 was primarily due to customer growth ($41 million), partially offset by milder weather ($20 million reduction). Other factors affecting volumes include changes in usage, unbilled revenue and firm sales for resale for a net total of $11 million reduction in 1994 and $1 million increase in 1993.
Income Tax Issues
See Note 3 of Notes to Consolidated Financial Statements regarding recognition of $26.8 million of income tax benefits in 1994 and a recent accounting standard for income taxes which required the recognition in 1993 of $19.3 million of tax benefits related to net operating loss carryforwards.
Other Income/Rate Settlement Impacts
Net income reflects accounting practices required for regulated public utilities and represents a composite of cash and non-cash items, including Allowance for Funds Used During Construction (AFUDC), accretion income on Palo Verde Unit 3 and the reversal of a refund obligation arising out of the 1991 rate settlement (see Consolidated Statements of Cash Flows and Note 1 of Notes to Consolidated Financial Statements). The accretion and refund reversals, net of income taxes, totaled $25.9 million, $58.2 million and $53.6 million in 1994, 1993 and 1992, respectively. APS has now recorded all of the Palo Verde Unit 3 accretion income and refund obligation reversals related to the 1991 settlement. Also in 1994 was a one-time Palo Verde depreciation reversal of $15 million, net of income tax, which is included in "Other -- net" in the Consolidated Statements of Income (see Note 2 of Notes to Consolidated Financial Statements).
The retail rate settlement which was approved by the ACC in May 1994 did not significantly affect 1994 earnings as previously discussed, and is not expected to significantly affect earnings for the years 1995 through 1999 because the rate reduction will be substantially offset by accelerated amortization of deferred investment tax credits (see Note 2 of Notes to Consolidated Financial Statements).
Competition
A significant challenge for APS will be how well it is able to respond to increasingly competitive conditions in the electric utility industry, while continuing to earn an acceptable return for its shareholders. Strategies emphasize managing costs, stabilizing electric rates, negotiating long-term contracts with large customers and capitalizing on the growth characteristics of APS' service territory.
One of the issues that must be addressed responsibly is the recovery in a more competitive environment of the carrying value of assets (including those referred to in Note 1K of Notes to Consolidated Financial Statements) acquired or recorded under the existing regulatory environment.
Pursuant to the 1994 rate settlement, APS and the ACC staff will develop certain procedures that are responsive to the competitive forces in larger customer segments, with the objective of making joint recommendations to the ACC in 1995. A separate ACC proceeding on competition was opened in mid-1994 and is expected to continue for some months.
As the forces of competition continue to impact the industry, it will become clearer as to what customer sectors and what regions will be most affected and what strategies are best to deal with those forces.
REPORT OF MANAGEMENT
The primary responsibility for the integrity of Pinnacle West's financial information rests with management, which has prepared the accompanying financial statements and related information. Such information was prepared in accordance with generally accepted accounting principles appropriate in the circumstances, based on management's best estimates and judgments and giving due consideration to materiality. These financial statements have been audited by independent auditors and their report is included.
Management maintains and relies upon systems of internal accounting controls. A limiting factor in all systems of internal accounting control is that the cost of the system should not exceed the benefits to be derived. Management believes that Pinnacle West's system provides the appropriate balance between such costs and benefits.
Periodically the internal accounting system is reviewed by both Pinnacle West's internal auditors and its independent auditors to test for compliance. Reports issued by the internal auditors are released to management, and such reports, or summaries thereof, are transmitted to the Audit Committee of the Board of Directors and the independent auditors on a timely basis.
The Audit Committee, composed solely of outside directors, meets periodically with the internal auditors and independent auditors (as well as management) to review the work of each. The internal auditors and independent auditors have free access to the Audit Committee, without management present, to discuss the results of their audit work.
Management believes that Pinnacle West's systems, policies and procedures provide reasonable assurance that operations are conducted in conformity with the law and with management's commitment to a high standard of business conduct.
Richard Snell Henry B. Sargent Chairman & President Executive Vice President & Chief Financial Officer
INDEPENDENT AUDITORS' REPORT
We have audited the accompanying consolidated balance sheets of Pinnacle West Capital Corporation and its subsidiaries as of December 31, 1994 and 1993 and the related consolidated statements of income, retained earnings and cash flows for each of the three years in the period ended December 31, 1994. Our audits also included the financial statement schedule listed in the Index at Item 8.
Item 8. These financial statements and financial statement schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and financial statement schedule based on our audits.
We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of Pinnacle West Capital Corporation and its subsidiaries at December 31, 1994 and 1993 and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1994 in conformity with generally accepted accounting principles. Also, in our opinion, such financial statement schedule, when considered in relation to the basic financial statements taken as a whole, presents fairly in all material respects the information set forth therein.
As discussed in Note 3 of Notes to Consolidated Financial Statements, the Company changed its method of accounting for income taxes effective January 1, 1993 to conform with Statement of Financial Accounting Standards No. 109.
Deloitte & Touche LLP Phoenix, Arizona March 3, 1995
PINNACLE WEST CAPITAL CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. Summary of Significant Accounting Policies
A. Consolidation
The consolidated financial statements include the accounts of Pinnacle West Capital Corporation and its subsidiaries: Arizona Public Service Company, an electric utility; SunCor Development Company, a real estate development company; and El Dorado Investment Company, a venture capital firm.
B. Utility Plant and Depreciation
Utility plant represents the buildings, equipment and other facilities used to provide electric service. The cost of utility plant includes labor, materials, contract services, other related items and an allowance for funds used during construction. The cost of retired depreciable utility plant, plus removal costs less salvage realized, is charged to accumulated depreciation.
Depreciation on utility property is recorded on a straight-line basis. The applicable rates for 1992 through 1994 ranged from 0.84% to 15.00%, which resulted in an annual composite rate of 3.43% for 1994. Depreciation and amortization of non-utility property and equipment are provided over the estimated useful lives of the related assets, ranging from 3 to 33.3 years.
C. Revenues
Electric operating revenues are recognized on the accrual basis and include estimated amounts for service rendered but unbilled at the end of each accounting period.
In 1991 APS recorded a refund obligation of $53.4 million ($32.3 million after tax) as a result of a 1991 rate settlement. The refund obligation was used to reduce the amount of a 1991 rate increase granted rather than require specific customer refunds and was reversed over the thirty months ended May 1994. The after-tax refund obligation reversals that were recorded as electric operating revenues by APS amounted to $5.6 million in 1994 and $12.9 million in each of the years 1993 and 1992.
Consistent with the 1994 presentation, prior years electric operating revenues and other taxes have been restated to exclude sales tax on electric revenue.
D. Allowance for Funds Used During Construction
AFUDC represents the cost of debt and equity funds used to finance construction of utility plant. Plant construction costs, including AFUDC, are recovered in authorized rates through depreciation when completed projects are placed into commercial operation. AFUDC does not represent current cash earnings.
AFUDC has been calculated using composite rates of 7.70% for 1994; 7.20% for 1993; and 10.00% for 1992. APS compounds AFUDC semiannually and ceases to accrue AFUDC when construction work is completed and the property is placed in service.
E. Income Taxes
Pinnacle West and its subsidiaries file a consolidated U.S. income tax return. Provisions for income taxes are made by each subsidiary as if separate income tax returns were filed. The difference, if any, between these provisions and consolidated income tax expense is allocated to Pinnacle West.
Investment tax credits (ITCs) were deferred and are being amortized to other income over the estimated lives of the related assets as directed by the ACC. The 1994 retail rate settlement provides for accelerated amortization of ITCs over five years beginning in 1995 (see Note 2).
F. Reacquired Debt Costs
APS amortizes gains and losses on reacquired debt over the remaining life of the original debt, consistent with ratemaking.
G. Nuclear Fuel and Decommissioning Costs
Nuclear fuel is charged to fuel expense using the unit-of-production method under which the number of units of thermal energy produced in the current period is related to the total thermal units expected to be produced over the remaining life of the fuel.
Under federal law, the United States Department of Energy (DOE) is responsible for the permanent disposal of spent nuclear fuel. The DOE assesses $.001 per kWh of nuclear generation. This amount is charged to nuclear fuel expense and recovered through rates.
In 1994, APS recorded $11.9 million for decommissioning expense. APS estimates it will cost approximately $2.1 billion ($425 million in 1994 dollars), over a thirteen-year period beginning in 2023, to decommission its 29.1% interest in Palo Verde. Decommissioning costs are charged to expense over the respective units operating license term and are included in the accumulated depreciation balance until each Palo Verde unit is fully decommissioned. Nuclear decommissioning costs are currently recovered in rates.
APS is utilizing a 1992 site-specific study for Palo Verde, prepared for APS by an independent consultant, that assumes the prompt removal/dismantlement method of decommissioning. The study is updated every three years.
As required by the ACC, APS has established external trust accounts into which quarterly deposits are made for decommissioning. As of December 31, 1994, APS has deposited a total of $45.0 million. The trust accounts are included in Investments and Other Assets on the Consolidated Balance Sheets at a market value of $55.2 million on December 31, 1994. The trust funds are invested primarily in fixed-income securities and domestic stock and are classified as available for sale. Gains and losses are reflected in accumulated depreciation.
In 1994, the Financial Accounting Standards Board (FASB) added a project to its agenda on accounting for nuclear decommissioning obligations. Only preliminary views have been discussed at this time, however, there is some indication the FASB may require the estimated present value of the cost of decommissioning to be recorded as a liability along with an offsetting plant asset. Pinnacle West is unable to determine what, if any, impact these deliberations may have on its financial position or results of operations.
H. Statements of Cash Flows
Temporary cash investments and marketable securities are considered to be cash equivalents for purposes of the Consolidated Statements of Cash Flows. During 1994, 1993 and 1992 Pinnacle West and its subsidiaries paid interest, net of amounts capitalized, of $231.6 million, $243.9 million and $286.4 million, respectively. Income taxes paid were $56.5 million, $45.3 million and $33.8 million, respectively; and dividends paid on preferred stock of APS were $26.2 million, $30.9 million and $32.6 million, respectively.
I. Palo Verde Cost Deferrals
As authorized by the ACC, APS deferred operating costs (excluding fuel) and financing costs of Palo Verde Units 2 and 3 from the commercial operation date (September 1986 and January 1988, respectively) until the date the units were included in a rate order (April 1988 and December 1991, respectively). The deferrals are being amortized and recovered through rates over thirty-five year periods.
J. Palo Verde Accretion Income
In 1991, APS discounted the carrying value of Palo Verde Unit 3 to reflect the present value of lost cash flows resulting from a 1991 rate settlement agreement deeming a portion of the unit to temporarily be excess capacity. In accordance with generally accepted accounting principles, APS recorded accretion income over a thirty-month period ended May 1994 in the aggregate amount of the original discount. The after-tax accretion income recorded by APS in 1994, 1993 and 1992 was $20.3 million, $45.3 million and $40.7 million, respectively.
K. 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' major regulatory assets are Palo Verde cost deferrals (see Note 1) and deferred taxes (see Note 3). These items, combined with miscellaneous other items and regulatory liabilities, amounted to approximately $1.1 billion at December 31, 1994 and 1993, most of which are included in "Deferred Debits" on the Consolidated Balance Sheets.
2. Regulatory Matters
In May 1994, the ACC approved a retail rate settlement agreement which was jointly proposed by APS and the ACC staff. The major provisions of the settlement include:
o A net annual rate reduction of approximately $32.3 million ($19 million after tax), or 2.2% on average effective June 1, 1994.
o A moratorium on filing for permanent rate changes, except under certain circumstances, prior to the end of 1996 for both APS and the ACC staff.
o A joint APS-ACC study to develop rate principles allowing APS greater flexibility to deal with market conditions and increasing competition in the electric industry.
o All of Palo Verde Unit 3 included in rate base.
o An incentive rewarding reduction in fuel and operating and maintenance cost per kWh below established targets.
As part of the settlement, APS reversed approximately $20 million of depreciation ($15 million after tax) related to a 1991 Palo Verde write-off. The 1994 settlement also provided for the accelerated amortization of substantially all deferred ITCs over a five-year period beginning in 1995. Overall, the settlement is not expected to materially affect APS results of operations for the years 1995-1999.
3. Income Tax Expense
Non-recurring Income Tax Benefit
The recognition of $26.8 million of non-recurring income tax benefits in 1994 relates to a change in tax law.
Change in Accounting for Income Taxes
Effective January 1, 1993, Pinnacle West adopted SFAS No. 109, "Accounting for Income Taxes," which requires the use of the liability method of accounting for income taxes. The cumulative effect on prior years of this change in accounting principle resulted in an increase in 1993 net income of $19.3 million, due primarily to the recognition of deferred tax benefits relating to state net operating loss (NOL) carryforwards of Pinnacle West.
As a result of adopting SFAS No. 109, APS recorded additional deferred income taxes related to the equity component of AFUDC; the debt component of AFUDC recorded net-of-tax; and other temporary differences for which deferred income taxes had not been provided. Deferred tax balances were also adjusted for changes in tax rates. The adoption of SFAS No. 109 increased net deferred income tax liabilities by $585.3 million at December 31, 1993. Historically, the Federal Energy Regulatory Commission and the ACC have allowed revenues sufficient to pay for these deferred tax liabilities and, in accordance with SFAS No. 109, a regulatory asset was established in a corresponding amount.
At December 31, 1994, Pinnacle West had federal NOL carryforwards of approximately $80 million which may be used through 2005 and state NOL carryforwards of approximately $490 million which expire in 1995. Pinnacle West also had ITC carryforwards of approximately $18 million which expire in 2000 through 2005.
4. Lines of Credit
APS had committed lines of credit with various banks of $300 million at December 31, 1994, and $302 million at December 31, 1993, which were available either to support the issuance of commercial paper or to be used for bank borrowings. The commitment fees on these lines were 0.25% per annum through June 30, 1994, 0.20% per annum on $200 million and 0.15% per annum on $100 million thereafter, through December 31, 1994. APS had commercial paper borrowings outstanding of $131.5 million at December 31, 1994, and $148.0 million at December 31, 1993. The weighted average interest rate on commercial paper borrowings was 6.25% on December 31, 1994, and 3.48% on December 31, 1993. By Arizona statute, APS short-term borrowings cannot exceed 7% of its total capitalization without the consent of the ACC.
SunCor had revolving lines of credit totaling $24.5 million at December 31, 1994, and none at December 31, 1993. Any borrowings are collateralized by certain real property and would bear interest based on the prime rate or on London Interbank Offered Rate (LIBOR). The commitment fees on these lines were 0.5% per annum on $15.0 million and 0.2% per annum on $9.5 million. SunCor had $18.5 million outstanding under these lines at December 31, 1994.
5. Long-Term Debt
Aggregate annual principal payments due on total long-term debt and for sinking fund requirements through 1999 are as follows: 1995, $78.5 million; 1996, $50.7 million; 1997, $166.9 million; 1998, $113.4 million; and 1999, $112.8 million. See Note 6 for redemption and sinking fund requirements of redeemable preferred stock of APS.
On January 12, 1995, APS issued $75 million of 10% junior subordinated deferrable interest debentures (MIDS) due 2025.
If there were to be any arrearage in dividends on any of its preferred stock or in the sinking fund requirements applicable to any of its redeemable preferred stock, APS could not pay dividends on its common stock or acquire any shares thereof for consideration. The redemption requirements for the above issues for the next five years are: $0 in 1995 and 1996, and $10.0 million in each of the years 1997 through 1999.
Redeemable preferred stock transactions of APS during each of the three years in the period ended December 31, 1994, are as follows:
Number Par of Value Shares Amount --------- ----------- (Dollars in Thousands)
Balance, December 31, 1991 ............... 2,272,782 $ 227,278 Issuance $7.875 Series V .................. 250,000 25,000 Retirements $10.00 Series H .................. (8,677) (868) $8.80 Series K ................... (4,725) (472) $12.90 Series N .................. (213,280) (21,328) $11.50 Series R .................. (39,750) (3,975) --------- ----------- Balance, December 31, 1992 ............... 2,256,350 225,635 Retirements $8.80 Series K ................... (45,000) (4,500) $11.50 Series R .................. (35,250) (3,525) $8.48 Series S ................... (200,000) (20,000) --------- ----------- Balance, December 31, 1993 ............... 1,976,100 197,610 Retirements $8.80 Series K ................... (142,100) (14,210) $11.50 Series R .................. (284,000) (28,400) $8.48 Series S ................... (300,000) (30,000) $8.50 Series T ................... (500,000) (50,000) --------- ----------- Balance, December 31, 1994 ............... 750,000 $ 75,000 ========= ===========
7. Common Stock
Pinnacle West's common stock issued during each of the three years in the period ended December 31, 1994, is as follows:
Number of Shares Amount(a) ---------- ------------ (Dollars in Thousands)
Balance, December 31, 1991 .............. 87,009,974 $ 1,646,889 Common stock issued ............. 151,898 (117) ---------- ------------ Balance, December 31, 1992 .............. 87,161,872 1,646,772 Common stock issued ............. 261,945 (3,989) ---------- ------------ Balance, December 31, 1993 .............. 87,423,817 1,642,783 Common stock issued ............. 5,825 (1,587) ---------- ------------ Balance, December 31, 1994 .............. 87,429,642 $ 1,641,196 ========== ============ ------------ (a) Including premiums and expenses of preferred stock issues of APS.
The Pinnacle West Stock Purchase and Dividend Reinvestment Plan (renamed the Investors Advantage Plan in 1995) provides that any participant may purchase shares of its common stock directly from Pinnacle West.
Both Pinnacle West and APS have employee savings plans under which contributions by participating employees and contributions by employers could involve the issuance of new shares of Pinnacle West common stock. Contributions made by Pinnacle West and APS to their respective employee retirement plans may also involve one or more such issuances of common stock. However, Pinnacle West plans to continue making market purchases of its outstanding stock to meet its needs related to the Stock Purchase and Dividend Reinvestment Plan, the employee savings plans and the employee retirement plans.
Pinnacle West has incentive plans under which it may grant non-qualified stock options (NQSOs), incentive stock options (ISOs) and restricted stock awards to officers and key employees of Pinnacle West and its subsidiaries up to an aggregate of 6.5 million shares of Pinnacle West common stock. The plans also provide for the granting of any combination of stock appreciation rights or dividend equivalents. As of December 31, 1994, approximately 1,917,500 NQSOs, 9,000 ISOs, 287,000 restricted shares and 35,000 dividend equivalent shares were outstanding. A plan for Pinnacle West's directors under which an additional 150,500 NQSOs were outstanding at December 31, 1994, was replaced in 1994 by a plan that provides for the granting of stock to directors as part of their annual retainers up to an aggregate amount of 50,000 shares.
8. Pension Plans and Other Benefits
Pension Plans
Pinnacle West and its subsidiaries sponsor defined benefit pension plans covering substantially all employees. Benefits are based on years of service and compensation utilizing a final average pay benefit formula. The plans are funded on a current basis to the extent deductible under existing tax regulations. Plan assets consist primarily of domestic and international common stocks and bonds and real estate. Pension cost, including administrative cost, for 1994, 1993 and 1992 was approximately $25.8 million, $14.3 million and $14.4 million, respectively, of which approximately $12.3 million, $6.8 million and $4.3 million, respectively, was charged to expense. The remainder was either capitalized or billed to others.
In addition to the defined benefit pension plans described above, Pinnacle West and its subsidiaries also sponsor qualified defined contribution plans. Collectively, these plans cover substantially all employees. The plans provide for employee contributions and partial employer matching contributions after certain eligibility requirements are met. The cost of these plans for 1994, 1993 and 1992 was $7.0 million, $6.4 million and $5.4 million, respectively, of which $3.3 million, $3.1 million and $2.6 million, respectively, was charged to expense.
Postretirement Plans
Pinnacle West and its subsidiaries provide medical and life insurance benefits to their retired employees. Employees may become eligible for these retirement benefits based on years of service and age. The retiree medical insurance plans are contributory; the retiree life insurance plans are noncontributory. In accordance with the governing plan documents, the companies retain the right to change or eliminate these benefits.
During 1993, Pinnacle West adopted SFAS No. 106, "Employers' Accounting for Postretirement Benefits Other Than Pensions," which requires the cost of postretirement benefits be accrued during the years employees render service. Prior to 1993, the costs of retiree benefits were recognized as expense when claims were paid. This change had the effect of increasing 1994 and 1993 retiree benefits costs from approximately $6 million in each year to $28 million and $35 million, respectively. The amount charged to expense for 1994 increased from about $3 million to $14 million, and for 1993 increased from about $2 million to $17 million. The balance was either capitalized or billed to others. The above amounts include the amortization (over 20 years) of the initial postretirement benefit obligation estimated at January 1, 1993, to be $184 million. Funding is based upon actuarially determined contributions that take tax consequences into account. Plan assets consist primarily of domestic stocks and bonds.
Assuming a one percent increase in the health care cost trend rate, the 1994 cost of postretirement benefits other than pensions would increase by approximately $5 million and the accumulated benefit obligation as of December 31, 1994, would increase by approximately $31 million.
In 1993, Pinnacle West adopted SFAS No. 112, "Employers' Accounting for Postemployment Benefits". The standard required a change from a cash method to an accrual method in accounting for benefits (such as long-term disability) provided to former or inactive employees after employment but before retirement. The adoption of this standard resulted in an increase in 1993 postemployment benefit expense of approximately $2 million.
9. Leases
In 1986, APS entered into sale and leaseback transactions under which it sold approximately 42% of its share of Palo Verde Unit 2 and certain common facilities. The gain of approximately $140.2 million has been deferred and is being amortized to operations expense over the original lease term. The leases are being accounted for as operating leases. The amounts paid each year approximate $40.1 million through December 1999, $46.3 million through December 2000, and $49.0 million through December 2015. Options to renew for two additional years and to purchase the property at fair market value at the end of the lease terms are also included. Consistent with the ratemaking treatment, an amount equal to the annual lease payments is included in rent expense. A regulatory asset (totaling approximately $52.8 million at December 31, 1994) has been established for the difference between lease payments and rent expense calculated on a straight-line basis. Lease expense for 1994, 1993 and 1992 was $42.2 million, $41.8 million and $45.8 million, respectively.
APS has a capital lease on a combined cycle plant which it sold and leased back. The lease requires semiannual payments of $2.6 million through June 2001, and includes renewal and purchase options based on fair market value. This plant is included in plant in service at its original cost of $54.4 million; accumulated amortization at December 31, 1994, was $40.3 million.
In addition, Pinnacle West and its subsidiaries lease certain land, buildings, equipment and miscellaneous other items through operating rental agreements with varying terms, provisions and expiration dates. Rent expense for 1994, 1993 and 1992 was approximately $21.3 million, $21.5 million and $26.1 million, respectively. Annual future minimum rental commitments, excluding the Palo Verde and combined cycle leases, through 1999 are as follows: 1995, $17.6 million; 1996, $14.6 million; 1997, $14.5 million; 1998, $14.6 million; and 1999, $14.7 million. Total rental commitments after 1999 are estimated at $189 million.
11. Commitments and Contingencies
Litigation
Pinnacle West and its subsidiaries are parties to various claims, legal actions and complaints arising in the ordinary course of business. In the opinion of management, the ultimate resolution of these matters will not have a material adverse effect on the operations or financial position of Pinnacle West.
Palo Verde Nuclear Generating Station
APS has encountered tube cracking in steam generators and has taken, and will continue to take, remedial actions that it believes have slowed further tube problems to manageable levels. APS believes that the Palo Verde steam generators are capable of operating for their designed life of 40 years, although at some point, long-term economic considerations may make steam generator replacement desirable. All of the Palo Verde units were operating at full power at December 31, 1994.
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. The maximum assessment per reactor under the retrospective rating 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 for all three units 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 $2.78 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.
El Paso Electric Company Bankruptcy
El Paso Electric Company (EPEC), one of the joint owners of the Palo Verde and Four Corners facilities, has been operating under Chapter 11 of the Bankruptcy Code since 1992. A plan whereby EPEC would become a wholly-owned subsidiary of Central and South West Corporation (CSW) has been confirmed by the bankruptcy court, but cannot become fully effective until several other approvals are obtained. Under the plan, certain issues, including EPEC allegations regarding the 1989-90 Palo Verde outages, would be resolved, and EPEC would assume the joint facilities operating agreements. CSW has stated that several matters have arisen which may impede completion of the merger. If the plan is not approved, Pinnacle West does not expect that there would be a material adverse effect on its operations or financial position.
Construction Program
Total construction expenditures in 1995 are estimated at $335 million, excluding capitalized property taxes and capitalized interest.
Fuel and Purchased Power Commitments
APS is a party to various fuel and purchased power contracts with terms expiring from 1995 through 2020. APS estimates its 1995 contract requirements to be approximately $127 million. However, this amount may vary significantly pursuant to certain provisions in such contracts which permit APS to decrease its required purchases under certain circumstances.
13. Fair Value of Financial Instruments
Pinnacle West estimates that carrying amounts of its cash equivalents and commercial paper are reasonable estimates of their fair values at December 31, 1994 and 1993 due to their short maturities.
The December 31, 1994 and 1993 fair values of debt and equity investments, determined by using quoted market values or by discounting cash flows at rates equal to Pinnacle West's cost of capital, approximate their carrying amounts. It was not practical to estimate the fair values of several investments in joint ventures and untraded equity securities because costs to do so would be excessive. The carrying value of these investments totaled $40.6 million and $45.6 million at year-end 1994 and 1993, respectively. Investments in debt and equity securities are held for purposes other than trading.
On December 31, 1994, the carrying amount of long-term debt (excluding $26 million of capital lease obligations) was $2.64 billion and its estimated fair value was approximately $2.49 billion. On December 31, 1993, the carrying amount of long-term debt (excluding $30 million of capital lease obligations) was $2.68 billion and its estimated fair value was approximately $2.91 billion. The fair value estimates were determined by independent sources using quoted market rates where available. Where market prices were not available, the fair values were based on market values of comparable instruments.
PINNACLE WEST CAPITAL CORPORATION
SCHEDULE II -- VALUATION AND QUALIFYING ACCOUNTS
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None.
PART III
ITEM 10.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Reference is hereby made to "Election of Directors" and "Section 16 Requirements" in the Company's Proxy Statement relating to the annual meeting of shareholders to be held on May 17, 1995 (the "1995 Proxy Statement") and to the Supplemental Item -- "Executive Officers of the Company" in Part I of this report.
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION
Reference is hereby made to the last two paragraphs under the heading "The Board and its Committees," and to "Executive Compensation" in the 1995 Proxy Statement.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Reference is hereby made to "Certain Securities Ownership" in the 1995 Proxy Statement.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
None.
PART IV
ITEM 14.
ITEM 14. EXHIBITS, FINANCIAL STATEMENTS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULES
See the Index to Financial Statements and Financial Statement Schedule in Part II, Item 8.
EXHIBITS FILED
EXHIBIT NO. DESCRIPTION ----------- ----------- 10.1a -- Summary of the Pinnacle West Capital Corporation 1995 Bonus Plan
22 -- Subsidiaries of the Company
23.1 -- Consent of Deloitte & Touche LLP
27.1 -- Financial Data Schedule
REPORTS ON FORM 8-K
During the quarter ended December 31, 1994, and the period ended March 30, 1995, the Company did not file any Reports on Form 8-K.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
PINNACLE WEST CAPITAL CORPORATION (Registrant)
Date: March 30, 1995 RICHARD SNELL ---------------------------------------------------- (Richard Snell, Chairman of the Board of Directors, President and Chief Executive Officer)
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
Signature Title Date --------- ----- ----
RICHARD SNELL Principal Executive March 30, 1995 ---------------------------------------- Officer and Director (Richard Snell, Chairman of the Board of Directors, President and Chief Executive Officer)
H. B. SARGENT Principal Financial March 30, 1995 ---------------------------------------- Officer, Principal (H. B. Sargent, Executive Vice President Accounting Officer and Chief Financial Officer) and Director
O. MARK DEMICHELE Director March 30, 1995 ---------------------------------------- (O. Mark DeMichele)
PAMELA GRANT Director March 30, 1995 ---------------------------------------- (Pamela Grant)
ROY A. HERBERGER, JR. Director March 30, 1995 ---------------------------------------- (Roy A. Herberger, Jr.)
MARTHA O. HESSE Director March 30, 1995 ---------------------------------------- (Martha O. Hesse)
WILLIAM S. JAMIESON, JR. Director March 30, 1995 ---------------------------------------- (William S. Jamieson, Jr.)
JOHN R. NORTON, III Director March 30, 1995 ---------------------------------------- (John R. Norton, III)
DONALD N. SOLDWEDEL Director March 30, 1995 ---------------------------------------- (Donald N. Soldwedel)
DOUGLAS J. WALL Director March 30, 1995 ---------------------------------------- (Douglas J. Wall)
COMMISSION FILE NUMBER 1-8962 ------ ================================================================================
SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 -------------- EXHIBITS TO FORM 10-K ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE FISCAL YEAR ENDED DECEMBER 31, 1994 -------------- PINNACLE WEST CAPITAL CORPORATION (EXACT NAME OF REGISTRANT AS SPECIFIED IN CHARTER)
================================================================================
INDEX TO EXHIBITS
EXHIBIT NO. DESCRIPTION ----------- ----------- 10.1a -- Summary of the Pinnacle West Capital Corporation 1995 Bonus Plan
22 -- Subsidiaries of the Company
23.1 -- Consent of Deloitte & Touche LLP
27.1 -- Financial Data Schedule ----------
(a) Management contract or compensatory plan or arrangement required to be filed as an exhibit pursuant to Item 14(c) of Form 10-K.