PINNACLE WEST CAPITAL CORP, 10-Q filed on 10/28/2010
Quarterly Report
Document and Entity Information
9 Months Ended
Sep. 30, 2010
Oct. 25, 2010
Document and Entity Information [Abstract]
 
 
Entity Registrant Name
PINNACLE WEST CAPITAL CORP 
 
Entity Central Index Key
0000764622 
 
Document Type
10-Q 
 
Document Period End Date
2010-09-30 
 
Amendment Flag
FALSE 
 
Document Fiscal Year Focus
2010 
 
Document Fiscal Period Focus
Q3 
 
Current Fiscal Year End Date
12/31 
 
Entity Well-known Seasoned Issuer
Yes 
 
Entity Voluntary Filers
No 
 
Entity Current Reporting Status
Yes 
 
Entity Filer Category
Large Accelerated Filer 
 
Entity Common Stock, Shares Outstanding
 
108,711,779 
Condensed Consolidated Statements of Income (Unaudited) (USD $)
In Thousands, except Per Share data
3 Months Ended
Sep. 30,
9 Months Ended
Sep. 30,
2010
2009
2010
2009
OPERATING REVENUES
 
 
 
 
Regulated electricity segment
$ 1,116,211 
$ 1,083,750 
$ 2,527,052 
$ 2,498,838 
Other revenues
22,874 
5,286 
52,982 
16,164 
Total
1,139,085 
1,089,036 
2,580,034 
2,515,002 
OPERATING EXPENSES
 
 
 
 
Regulated electricity segment fuel and purchased power
353,904 
381,543 
821,244 
920,630 
Operations and maintenance
221,469 
198,030 
644,415 
610,401 
Depreciation and amortization
104,194 
103,008 
307,864 
304,066 
Taxes other than income taxes
37,528 
34,015 
100,936 
100,788 
Other expenses
18,365 
5,033 
41,009 
15,862 
Total
735,460 
721,629 
1,915,468 
1,951,747 
OPERATING INCOME
403,625 
367,407 
664,566 
563,255 
OTHER INCOME (DEDUCTIONS)
 
 
 
 
Allowance for equity funds used during construction
5,524 
2,197 
16,417 
11,919 
Other income (Note 11)
4,348 
4,386 
3,828 
4,102 
Other expense (Note 11)
(3,855)
(1,934)
(8,650)
(8,887)
Total
6,017 
4,649 
11,595 
7,134 
INTEREST EXPENSE
 
 
 
 
Interest charges
60,491 
60,299 
181,937 
177,447 
Allowance for borrowed funds used during construction
(6,163)
(1,349)
(12,314)
(8,318)
Total
54,328 
58,950 
169,623 
169,129 
INCOME FROM CONTINUING OPERATIONS BEFORE INCOME TAXES
355,314 
313,106 
506,538 
401,260 
INCOME TAXES
123,486 
109,778 
168,143 
137,594 
INCOME FROM CONTINUING OPERATIONS
231,828 
203,328 
338,395 
263,666 
INCOME (LOSS) FROM DISCONTINUED OPERATIONS
 
 
 
 
Net of income tax expense (benefit) of $4,721 and $(7,567) for three months ended and $12,611 and $(97,662) for nine months ended (Note 14)
7,211 
(12,305)
19,313 
(165,867)
Net Income
239,039 
191,023 
357,708 
97,799 
Less: Net income (loss) attributable to noncontrolling interests (Notes 7 and 16)
5,119 
4,371 
15,005 
(690)
NET INCOME ATTRIBUTABLE TO COMMON SHAREHOLDERS
233,920 
186,652 
342,703 
98,489 
WEIGHTED-AVERAGE COMMON SHARES OUTSTANDING - BASIC
108,632 
101,223 
105,846 
101,107 
WEIGHTED-AVERAGE COMMON SHARES OUTSTANDING - DILUTED
109,094 
101,385 
106,318 
101,184 
EARNINGS PER WEIGHTED-AVERAGE COMMON SHARE OUTSTANDING
 
 
 
 
Income from continuing operations attributable to common shareholders - basic
2.09 
1.96 
3.06 
2.47 
Net income attributable to common shareholders - basic
2.15 
1.84 
3.24 
0.97 
Income from continuing operations attributable to common shareholders - diluted
2.08 
1.96 
3.04 
2.46 
Net income attributable to common shareholders - diluted
2.14 
1.84 
3.22 
0.97 
DIVIDENDS DECLARED PER SHARE
0.525 
1.575 
1.575 
AMOUNTS ATTRIBUTABLE TO COMMON SHAREHOLDERS:
 
 
 
 
Income from continuing operations, net of tax
226,700 
198,375 
323,361 
249,412 
Discontinued operations, net of tax
7,220 
(11,723)
19,342 
(150,923)
NET INCOME ATTRIBUTABLE TO COMMON SHAREHOLDERS
$ 233,920 
$ 186,652 
$ 342,703 
$ 98,489 
Condensed Consolidated Statements of Income (Unaudited) (Parenthetical) (USD $)
In Thousands
3 Months Ended
Sep. 30,
9 Months Ended
Sep. 30,
2010
2009
2010
2009
INCOME (LOSS) FROM DISCONTINUED OPERATIONS
 
 
 
 
Income tax expense (benefit) on discontinued operations
$ 4,721 
$ (7,567)
$ 12,611 
$ (97,662)
Condensed Consolidated Balance Sheets (Unaudited) (USD $)
In Thousands
9 Months Ended
Sep. 30, 2010
Year Ended
Dec. 31, 2009
CURRENT ASSETS
 
 
Cash and cash equivalents
$ 195,915 
$ 145,378 
Customer and other receivables
387,435 
301,915 
Accrued unbilled revenues
180,006 
110,971 
Allowance for doubtful accounts
(7,901)
(6,153)
Materials and supplies (at average cost)
174,428 
176,020 
Fossil fuel (at average cost)
21,826 
39,245 
Deferred income taxes
134,012 
53,990 
Income tax receivable (Note 6)
22,840 
26,005 
Assets from risk management activities (Note 8)
68,476 
50,619 
Assets held for sale (Notes 14 and 16)
22,312 
Other current assets
43,983 
30,747 
Total current assets
1,243,332 
928,737 
INVESTMENTS AND OTHER ASSETS
 
 
Real estate investments - net (Note 16)
119,989 
Assets from risk management activities (Note 8)
54,968 
28,855 
Nuclear decommissioning trust (Note 15)
453,963 
414,576 
Other assets
112,797 
110,091 
Total investments and other assets
621,728 
673,511 
PROPERTY, PLANT AND EQUIPMENT
 
 
Plant in service and held for future use
12,987,278 
12,848,138 
Accumulated depreciation and amortization
(4,459,579)
(4,340,645)
Net
8,527,699 
8,507,493 
Construction work in progress
555,137 
467,700 
Palo Verde sale leaseback, net of accumulated depreciation (Note 7)
140,145 
146,722 
Intangible assets, net of accumulated amortization
178,666 
164,380 
Nuclear fuel, net of accumulated amortization
124,101 
118,243 
Total property, plant and equipment
9,525,748 
9,404,538 
DEFERRED DEBITS
 
 
Regulatory assets
879,056 
813,161 
Income tax receivable (Note 6)
65,103 
65,103 
Other
100,520 
101,274 
Total deferred debits
1,044,679 
979,538 
TOTAL ASSETS
12,435,487 
11,986,324 
CURRENT LIABILITIES
 
 
Accounts payable
253,565 
240,637 
Accrued taxes
157,697 
104,011 
Accrued interest
52,384 
54,596 
Short-term borrowings
153,715 
Current maturities of long-term debt (Note 2)
238,513 
303,476 
Customer deposits
68,254 
71,026 
Liabilities from risk management activities (Note 8)
55,847 
55,908 
Other current liabilities
141,547 
125,574 
Total current liabilities
967,807 
1,108,943 
LONG-TERM DEBT LESS CURRENT MATURITIES
 
 
Long-term debt less current maturities (Note 2)
3,349,927 
3,370,524 
Palo Verde sale leaseback lessor notes (Notes 2 and 7)
113,379 
126,000 
Total long-term debt less current maturities
3,463,306 
3,496,524 
DEFERRED CREDITS AND OTHER
 
 
Deferred income taxes
1,868,860 
1,496,095 
Deferred fuel and purchased power regulatory liability (Note 3)
41,385 
87,291 
Other regulatory liabilities
685,908 
679,072 
Liability for asset retirements
323,134 
301,783 
Liabilities for pension and other postretirement benefits (Note 4)
737,644 
811,338 
Liabilities from risk management activities (Note 8)
80,656 
62,443 
Customer advances
127,449 
136,595 
Coal mine reclamation
117,029 
92,060 
Unrecognized tax benefits (Note 6)
66,837 
142,099 
Other
127,243 
144,077 
Total deferred credits and other
4,176,145 
3,952,853 
COMMITMENTS AND CONTINGENCIES (SEE NOTES)
 
 
EQUITY (Note 9)
 
 
Common stock, no par value
2,418,660 
2,153,295 
Treasury stock
(2,157)
(3,812)
Total common stock
2,416,503 
2,149,483 
Retained earnings
1,473,683 
1,298,213 
Accumulated other comprehensive loss:
 
 
Pension and other postretirement benefits
(52,626)
(50,892)
Derivative instruments
(120,634)
(80,695)
Total accumulated other comprehensive loss
(173,260)
(131,587)
Total shareholders' equity
3,716,926 
3,316,109 
Noncontrolling interests (Note 7)
111,303 
111,895 
Total equity
3,828,229 
3,428,004 
TOTAL LIABILITIES AND EQUITY
$ 12,435,487 
$ 11,986,324 
Condensed Consolidated Statements of Cash Flows (Unaudited) (USD $)
In Thousands
9 Months Ended
Sep. 30,
2010
2009
CASH FLOWS FROM OPERATING ACTIVITIES
 
 
Net income
$ 357,708 
$ 97,799 
Adjustments to reconcile net income to net cash provided by operating activities:
 
 
Gain on sale of district cooling business
(41,973)
Depreciation and amortization including nuclear fuel
350,762 
338,311 
Deferred fuel and purchased power
50,020 
(46,743)
Deferred fuel and purchased power amortization
(95,926)
115,214 
Allowance for equity funds used during construction
(16,417)
(11,919)
Real estate impairment charges
16,731 
260,450 
Gain on real estate debt restructuring
(14,403)
Deferred income taxes
281,486 
154,517 
Change in mark-to-market valuations
3,716 
(5,970)
Changes in current assets and liabilities:
 
 
Customer and other receivables
(103,973)
(79,297)
Accrued unbilled revenues
(69,035)
(56,420)
Materials, supplies and fossil fuel
19,011 
(16,781)
Other current assets
(13,236)
26,308 
Accounts payable
36,687 
(35,923)
Accrued taxes and income tax receivable-net
56,851 
(120,878)
Other current liabilities
10,989 
8,789 
Expenditures for real estate investments
(514)
(2,410)
Gains and other changes in real estate assets
1,811 
(10,527)
Change in margin and collateral accounts - assets
(4,336)
1,652 
Change in margin and collateral accounts - liabilities
(143,725)
3,564 
Change in unrecognized tax benefits
(72,649)
92,720 
Change in other regulatory liabilities
40,121 
92,598 
Change in other long-term assets
(51,659)
(49,577)
Change in other long-term liabilities
(28,547)
15,491 
Net cash flow provided by operating activities
569,500 
770,968 
CASH FLOWS FROM INVESTING ACTIVITIES
 
 
Capital expenditures
(552,707)
(558,495)
Contributions in aid of construction
25,258 
17,393 
Allowance for borrowed funds used during construction
(12,553)
(8,568)
Proceeds from sale of district cooling business
100,300 
Proceeds from nuclear decommissioning trust sales
424,255 
370,399 
Investment in nuclear decommissioning trust
(442,567)
(386,743)
Proceeds from sale of commercial real estate investments
71,174 
30,847 
Other
9,621 
(1,404)
Net cash flow used for investing activities
(377,219)
(536,571)
CASH FLOWS FROM FINANCING ACTIVITIES
 
 
Issuance of long-term debt
867,582 
Repayment of long-term debt
(84,529)
(421,079)
Short-term borrowings and payments - net
(153,715)
(528,217)
Dividends paid on common stock
(161,722)
(153,740)
Common stock equity issuance
255,156 
2,623 
Noncontrolling interests
(3,286)
(3,393)
Other
6,352 
(2,594)
Net cash flow used for financing activities
(141,744)
(238,818)
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS
50,537 
(4,421)
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD
145,378 
105,245 
CASH AND CASH EQUIVALENTS AT END OF PERIOD
195,915 
100,824 
Cash paid during the period for:
 
 
Income taxes, net of (refunds)
(22,165)
(34,700)
Interest, net of amounts capitalized
$ 167,576 
$ 163,438 
Consolidation and Nature of Operations
Consolidation and Nature of Operations
1. Consolidation and Nature of Operations
The unaudited condensed consolidated financial statements include the accounts of Pinnacle West and our subsidiaries: APS, SunCor, APS Energy Services Company, Inc. (“APSES”), and El Dorado Investment Company (“El Dorado”). Intercompany accounts and transactions between the consolidated companies have been eliminated. The unaudited condensed consolidated financial statements for APS include the accounts of APS and the Palo Verde sale leaseback variable interest entities (“VIEs”) (see Note 7 for further discussion). Our accounting records are maintained in accordance with accounting principles generally accepted in the United States of America (“GAAP”). The preparation of financial statements in accordance with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities at the date of the financial statements and reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
Weather conditions cause significant seasonal fluctuations in our revenues; therefore, results for interim periods do not necessarily represent results expected for the year.
In preparing the condensed consolidated financial statements, we have evaluated the events that have occurred after December 31, 2009 through the date the financial statements were issued. Our condensed consolidated financial statements reflect all adjustments (consisting only of normal recurring adjustments except as otherwise disclosed in the notes) that we believe are necessary for the fair presentation of our financial position, results of operations and cash flows for the periods presented. The December 31, 2009 condensed consolidated balance sheet data was derived from audited financial statements, but does not include disclosures required by GAAP for audited annual statements. This quarterly report should be reviewed in conjunction with the audited financial statements included in the 2009 Form 10-K. These condensed consolidated financial statements and notes have been prepared consistently with the 2009 Form 10-K with the exception of certain line items that are presented in more detail on the Condensed Consolidated Statements of Cash Flows than were presented in the prior year. The prior year amounts were reclassified to conform to the current year presentation. Change in margin and collateral accounts — assets is presented as a separate line item instead of as a single line item of change in other long-term assets as previously reported. Change in margin and collateral accounts — liabilities is presented as a separate line item instead of as a single line item of change in other long-term liabilities as previously reported. There has also been a reclassification of certain prior-year amounts on our Condensed Consolidated Statements of Income, Condensed Consolidated Balance Sheets and Condensed Consolidated Statements of Cash Flows in accordance with accounting requirements for reporting discontinued operations (see Note 14) and amended accounting guidance on consolidation of VIEs (see Note 7). The following tables show the impacts of the reclassifications to prior year (previously reported) amounts (dollars in thousands):
                                 
                            Amount  
                            reported after  
            Reclassifications             adoption of  
            as a result of the             amended VIE  
            adoption of             accounting  
    As     new VIE     Reclassifications     guidance and  
Statement of Income for the   previously     accounting     for discontinued     discontinued  
Three Months Ended September 30, 2009   reported     guidance     operations     operations  
Operating Revenues
                               
Real estate segment
  $ 47,602     $     $ (47,602 )   $  
Other revenues
    10,853             (5,567 )     5,286  
Operating Expenses
                               
Real estate segment operations
    25,074             (25,074 )      
Real estate impairment charge
    37,051             (37,051 )      
Operations and maintenance
    208,769       (9,916 )     (823 )     198,030  
Depreciation and amortization
    102,246       1,927       (1,165 )     103,008  
Taxes other than income taxes
    34,111             (96 )     34,015  
Other expenses
    8,014             (2,981 )     5,033  
Other
                               
Other income
    4,650             (264 )     4,386  
Interest Expense
                               
Interest charges
    60,161       3,036       (2,898 )     60,299  
Allowance for borrowed funds used during construction
    (1,423 )           74       (1,349 )
Income Taxes
    103,507             6,271       109,778  
Income From Continuing Operations
    188,065       4,953       10,310       203,328  
Loss From Discontinued Operations
    (1,995 )           (10,310 )     (12,305 )
Net Income
    186,070       4,953             191,023  
Net Income (Loss) Attributable To Noncontrolling Interests
    (582 )     4,953             4,371  
 
                               
Statement of Income for the
Nine Months Ended September 30, 2009
                               
Operating Revenues
                               
Real estate segment
  $ 75,122     $     $ (75,122 )   $  
Other revenues
    30,084             (13,920 )     16,164  
Operating Expenses
                               
Real estate segment operations
    71,413             (71,413 )      
Real estate impairment charge
    241,469             (241,469 )      
Operations and maintenance
    642,545       (29,745 )     (2,399 )     610,401  
Depreciation and amortization
    302,166       5,778       (3,878 )     304,066  
Taxes other than income taxes
    101,126             (338 )     100,788  
Other expenses
    22,214             (6,352 )     15,862  
Other
                               
Other income
    4,820             (718 )     4,102  
Interest Expense
                               
Interest charges
    174,720       9,713       (6,986 )     177,447  
Allowance for borrowed funds used during construction
    (8,568 )           250       (8,318 )
Income Taxes
    48,082             89,512       137,594  
Income From Continuing Operations
    96,099       14,254       153,313       263,666  
Loss From Discontinued Operations
    (12,554 )           (153,313 )     (165,867 )
Net Income
    83,545       14,254             97,799  
Net Loss Attributable To Noncontrolling Interests
    (14,944 )     14,254             (690 )
                         
            Reclassifications as a     Amounts reported  
            result of the adoption of     after adoption of  
    As previously     the new VIE accounting     amended VIE  
Balance Sheets — December 31, 2009   reported     guidance     accounting guidance  
Property, Plant and Equipment — Palo Verde sale leaseback, net of accumulated depreciation
  $     $ 146,722     $ 146,722  
Deferred Debits — Regulatory assets
    781,714       31,447       813,161  
Current Liabilities — Current maturities of long-term debt
    277,693       25,783       303,476  
Long-Term Debt Less Current Maturities — Palo Verde sale leaseback lessor notes
          126,000       126,000  
Deferred Credits and Other — Other
    200,015       (55,938 )     144,077  
Equity — Noncontrolling Interests
    29,571       82,324       111,895  
                         
                    Amounts reported  
            Reclassifications as a     after adoption of  
            result of the adoption of     amended VIE  
            the new VIE accounting     accounting guidance  
            guidance and to conform     and to conform to  
Statement of Cash Flows for the   As previously     to current year     current year  
Nine Months Ended September 30, 2009   reported     presentation     presentation  
Cash Flows from Operating Activities
                       
Net income
  $ 83,545     $ 14,254     $ 97,799  
Depreciation and amortization including nuclear fuel
    332,532       5,779       338,311  
Other current liabilities
    25,808       (17,019 )     8,789  
Change in margin and collateral accounts-assets
          1,652       1,652  
Change in margin and collateral accounts-liabilities
          3,564       3,564  
Other long-term assets
    (47,925 )     (1,652 )     (49,577 )
Other long-term liabilities
    12,071       3,420       15,491  
Cash Flows from Financing Activities
                       
Repayment and acquisition of long-term debt
    (414,474 )     (6,605 )     (421,079 )
Noncontrolling interests
          (3,393 )     (3,393 )
Supplemental Disclosure of Cash Flow Information
                       
Cash paid for Interest, Net of Amounts Capitalized
    153,725       9,713       163,438  
Long-term Debt and Liquidity Matters
Long-term Debt and Liquidity Matters
2. Long-term Debt and Liquidity Matters
The following table shows principal payments due on Pinnacle West’s and APS’ total long-term debt and capitalized lease requirements as of September 30, 2010 (dollars in millions):
                 
    Consolidated     Consolidated  
Year   Pinnacle West     APS  
2010
  $ 23     $ 17  
2011
    632       457  
2012
    478       478  
2013
    140       140  
2014
    503       503  
Thereafter
    1,932       1,932  
 
           
Total
  $ 3,708     $ 3,527  
 
           
Credit Facilities, Debt and Equity Issuances
Pinnacle West and APS maintain committed revolving credit facilities in order to enhance liquidity and provide credit support for their commercial paper programs. During the first quarter of 2010, Pinnacle West and APS refinanced existing revolving credit facilities that would have otherwise matured in December 2010. Since March 2010, Pinnacle West and APS have accessed the commercial paper markets, which neither company had utilized since the third quarter of 2008 due to negative market conditions.
Pinnacle West
On February 12, 2010, Pinnacle West refinanced its $283 million revolving credit facility that would have matured in December 2010, and decreased the size of the facility to $200 million. The new facility matures in February 2013. Pinnacle West has the option to increase the amount of the facility up to a maximum of $300 million upon the satisfaction of certain conditions and with the consent of the lenders. Pinnacle West will use the facility for general corporate purposes, commercial paper support and for the issuance of letters of credit. Interest rates are based on Pinnacle West’s senior unsecured debt credit ratings. As a result of the downsized credit facility, the Company also reduced the size of its commercial paper program to $200 million from $250 million.
At September 30, 2010, the $200 million credit facility was available to support the issuance of up to $200 million in commercial paper or for bank borrowings, including issuances of letters of credit up to $100 million. At September 30, 2010, Pinnacle West had no outstanding borrowings under this credit facility, no commercial paper borrowings and no outstanding letters of credit.
In April 2010, Pinnacle West issued 6,900,000 shares of common stock at an offering price of $38.00 per share, resulting in net proceeds of approximately $253 million. Pinnacle West contributed all of the net proceeds from this offering into APS in the form of equity infusions. APS has used these contributions to repay short-term indebtedness, to finance capital expenditures and for other general corporate purposes.
In June 2010, Pinnacle West received approximately $100 million related to the sale of APSES’ district cooling business. The net proceeds were used to repay short-term indebtedness.
APS
On February 12, 2010, APS refinanced its $377 million credit facility that would have matured in December 2010, and increased the size of the facility to $500 million. The new credit facility terminates in February 2013. APS has the option to increase the amount of the facility up to a maximum of $700 million upon the satisfaction of certain conditions and with the consent of the lenders. APS will use the facility for general corporate purposes, commercial paper support and for the issuance of letters of credit. Interest rates are based on APS’ senior unsecured debt credit ratings.
At September 30, 2010, APS had two credit facilities totaling $989 million, including the $500 million credit facility described above and a $489 million facility that terminates in September 2011. These facilities are available either to support the issuance of up to $250 million in commercial paper or for bank borrowings, including issuances of letters of credit up to $739 million. At September 30, 2010, APS had no borrowings outstanding under any of its credit facilities and no outstanding commercial paper. A $20 million letter of credit was issued under APS’ $489 million credit facility in the second quarter of 2010.
On July 13, 2010, APS changed the interest rate mode for the approximately $33 million of Coconino County, Arizona Pollution Control Corporation Pollution Control Revenue Bonds (Arizona Public Service Company Navajo Project) 1994 Series A, due 2029. The rate period for the bonds changed from a daily rate mode, supported by a letter of credit, to a three-year term rate mode that will bear interest at a rate of 3.625% per annum for three years. The letter of credit was terminated in connection with this change, and there is no bank or other third-party credit support for the bonds in the term rate mode.
On August 10, 2010, APS changed the letter of credit supporting the approximately $17 million of Coconino County, Arizona Pollution Control Corporation Pollution Control Revenue Bonds (Arizona Public Service Company Project) Series 1998, due 2033. The bonds were in a daily rate mode supported by a letter of credit and remain in a daily rate mode, supported by a new three-year letter of credit expiring in August 2013.
On October 12, 2010, APS changed the interest rate mode for the approximately $147 million of City of Farmington, New Mexico Pollution Control Revenue Refunding Bonds (Arizona Public Service Company Four Corners Project) 1994 Series A and 1994 Series B, due 2024 and City of Farmington, New Mexico Pollution Control Revenue Bonds (Arizona Public Service Company Four Corners Project) 1994 Series C, due 2024. The rate period for the 1994 Series A bonds and the 1994 Series B bonds changed from a daily rate mode, supported by letters of credit, to a term rate mode to maturity with an optional redemption after year ten that will bear interest at a rate of 4.70% per annum until maturity in 2024 unless the optional redemption is exercised by APS. The rate period for the 1994 Series C bonds changed from a daily rate mode, supported by a letter of credit, to a three-year term rate mode that will bear interest at a rate of 2.875% per annum until October 2013. The letters of credit supporting each of these three series of bonds were terminated in connection with these changes, and there is no bank or other third-party credit support for any of these bonds.
On January 1, 2010, due to the adoption of amended accounting guidance relating to VIEs, APS began consolidating the Palo Verde Lessor Trusts (see Note 7) and, as a result of consolidation of these VIEs, APS has reported the Lessor Trusts’ long-term debt on its Condensed Consolidated Balance Sheets. Interest rates on these debt instruments are 8% and are fixed for the remaining life of the debt. As of September 30, 2010, approximately $30 million was classified as current maturities of long-term debt and $113 million was classified as long-term debt relating to these VIEs. These debt instruments mature on December 30, 2015 and have sinking fund features that are serviced by the lease payments. See Note 7 for additional discussion of the VIEs.
SunCor
In July 2010, SunCor sold land parcels, commercial assets and a master planned home-building community for approximately $70 million, which approximated the carrying value of these assets, resulting in a net gain of zero. In connection with this sale, SunCor negotiated a restructuring of certain of its credit facilities, including its principal loan facility. The debt restructuring resulted in an after-tax gain of approximately $9 million, which was recognized in the third quarter of 2010.
At September 30, 2010, SunCor had approximately $22 million of assets on its balance sheet classified as assets held for sale. These assets consisted of $18 million of consolidated VIEs (see Note 7), master planned home-building communities and golf courses. Because it is expected that SunCor will dispose of these assets within the next 12 months, they are classified as assets held for sale on the balance sheet.
At September 30, 2010, SunCor had $6 million in debt outstanding, a portion of which is in default. Neither Pinnacle West nor any of its other subsidiaries has guaranteed any SunCor indebtedness. A SunCor debt default would not result in a cross-default of any of the debt of Pinnacle West or any of its other subsidiaries. While there can be no assurances as to the ultimate outcome of this matter, Pinnacle West does not believe that SunCor’s inability to repay remaining debt outstanding would have a material adverse impact on Pinnacle West’s cash flows or liquidity.
As of September 30, 2010, SunCor could not transfer any cash dividends to Pinnacle West. This restriction does not affect Pinnacle West’s ability to meet its ongoing capital requirements.
Debt Provisions
An existing ACC order requires APS to maintain a common equity ratio of at least 40%. As defined in the ACC order, the common equity ratio is total shareholder equity divided by the sum of total shareholder equity and long-term debt, including current maturities of long-term debt. At September 30, 2010, APS’ common equity ratio, as defined, was 53%. Its total shareholder equity was approximately $3.8 billion, and total capitalization was approximately $7.2 billion. APS would be prohibited from paying dividends if the payment would reduce its total shareholder equity below approximately $2.9 billion, assuming APS’ total capitalization remains the same. This restriction does not materially affect Pinnacle West’s ability to meet its ongoing capital requirements.
Regulatory Matters
Regulatory Matters
3. Regulatory Matters
2008 General Retail Rate Case Impacts
On December 30, 2009, the ACC issued an order approving a settlement agreement (“Settlement Agreement”) entered into by APS and twenty-one other parties to its general retail rate case, which was originally filed in March 2008. The Settlement Agreement contains on-going requirements, commitments and authorizations, including the following:
    Revenue accounting treatment for line extension payments received for new or upgraded service from January 1, 2010 through year end 2012 (or until new rates are established in APS’ next general rate case, if that is before the end of 2012), which resulted in projected estimates of increased revenues of $23 million, $25 million and $49 million, respectively (as of September 30, 2010, estimates for the 2010 year are expected to be $17 — $21 million);
    An authorized return on common equity of 11%;
    A capital structure comprised of 46.2% debt and 53.8% common equity;
    A commitment from APS to reduce average annual operational expenses by at least $30 million from 2010 through 2014;
    Authorization and requirements of equity infusions into APS of at least $700 million during the period beginning June 1, 2009 through December 31, 2014 ($253 million of which was infused into APS from proceeds of a Pinnacle West equity issuance in the second quarter of 2010 (see Note 2)); and
    Various modifications to the existing energy efficiency, demand-side management and renewable energy programs that require APS to, among other things, expand its conservation and demand-side management programs and its use of renewable energy, as well as allow for concurrent recovery of renewable energy expenses and provide for more concurrent recovery of demand-side management costs and incentives.
The parties also agreed to a rate case filing plan in which APS is prohibited from filing its next two general rate cases until on or after June 1, 2011 and June 1, 2013, respectively, unless certain extraordinary events occur. Subject to the foregoing, APS may not request its next general retail rate increase to be effective prior to July 1, 2012. APS currently expects it will file its next rate case in June 2011. The parties agreed to use good faith efforts to process these subsequent rate cases within twelve months of sufficiency findings from the ACC staff, which generally occur within 30 days after the filing of a rate case.
Cost Recovery Mechanisms
APS has received regulatory decisions that allow for more timely recovery of certain costs through the following recovery mechanisms.
Renewable Energy Standard. In 2006, the ACC approved the Arizona Renewable Energy Standard and Tariff (“RES”). Under the RES, electric utilities that are regulated by the ACC must supply an increasing percentage of their retail electric energy sales from eligible renewable resources, including solar, wind, biomass, biogas and geothermal technologies. In order to achieve these requirements, the ACC allows APS to include a RES surcharge on customer bills to recover the approved amounts for use on renewable energy projects. Each year APS is required to file a five-year implementation plan with the ACC and seek approval for the upcoming year’s RES funding amount.
During 2009, APS filed its annual RES implementation plan, covering the 2010-2014 timeframe and requesting 2010 RES funding approval. The plan provided for the acquisition of renewable generation in compliance with requirements through 2014, and requested RES funding of $86.7 million for 2010, which was later approved by the ACC. APS also sought various other determinations in its plan, including approval of the AZ Sun Program and the Community Power Project in Flagstaff, Arizona described below.
On March 3, 2010, the ACC approved the AZ Sun Program, which contemplates the addition of 100 megawatts (“MW”) of APS-owned solar resources through 2014. Through this program, APS plans to invest up to $500 million in solar photovoltaic projects across Arizona, which APS will acquire through competitive procurement processes. The costs associated with the first 50 MW under this program will be recovered initially through the RES until such time as the costs are recovered in base rates. The costs of the second 50 MW will be recovered through a mechanism to be determined in APS’ next retail rate case. As of September 30, 2010, APS had signed two contracts to develop 33 MW of photovoltaic power for approximately $150 million under the AZ Sun Program.
On April 1, 2010, the ACC approved the Community Power Project, a pilot program in which APS will own, operate and receive energy from approximately 1.5 MW of solar panels on the rooftops of up to 200 residential and business customers located within a certain test area. Costs of the program will be recovered through the RES until such time as the costs are recovered in base rates.
On July 1, 2010, APS filed its annual RES implementation plan, covering the 2011-2015 timeframe and requesting 2011 RES funding of $96.4 million. The 2011 Plan addressed enhancements to the residential distributed energy incentive program based on high customer participation and additional programs offered in response to ACC workshops on “feed in tariffs,” which provide opportunities for streamlined development of certain renewable projects. On October 13, 2010, APS filed an adjusted RES implementation plan to reflect the following items, among others: 1) increased clarity relating to customer project in-service dates and related budget revisions; 2) AZ Sun Program updates; and 3) addition of 10 MW of biomass capacity. In addition, APS lowered its 2011 RES funding request to $92.5 million primarily as a result of an improved understanding of the timing of incentives payable for commercial projects. APS expects the ACC to vote on the 2011 Plan in the fourth quarter of 2010.
Demand-Side Management Adjustor Charge (“DSMAC”). The Settlement Agreement requires APS to submit an annual Energy Efficiency Implementation Plan for review by and approval of the ACC. On July 15, 2009, APS filed its initial Energy Efficiency Implementation Plan, requesting approval by the ACC of programs and program elements for which APS had estimated a budget in the amount of $49.9 million for 2010. APS received ACC approval of all of its proposed programs and implemented the new DSMAC on March 1, 2010. A surcharge was added to customer bills in order to recover these estimated amounts for use on certain demand-side management programs. The surcharge allows for the recovery of energy efficiency expenses and any earned incentives.
The ACC approved recovery of all 2009 program costs plus incentives. The change from program cost recovery on a historical basis to recovery on a concurrent basis, as authorized in the Settlement Agreement, resulted in this one-time need to address two years (2009 and 2010) of cost recovery. As requested by APS, 2009 program cost recovery is to be spread over a three-year period.
On June 1, 2010, APS filed its 2011 Energy Efficiency Implementation Plan. In order to meet the energy efficiency goal for 2011 established by the Settlement Agreement of annual energy savings of 1.25%, expressed as a percent of total energy resources to meet retail load, APS proposed a total budget for 2011 of $79.2 million. If this plan is approved by the ACC as proposed, and when added to the amortization of 2009 costs discussed above less the $10 million already being recovered in general rates, the DSMAC would recover approximately $74.8 million over a twelve month period beginning March 1, 2011. These amounts do not include $1.3 million for an electric vehicle charging station program submitted to the ACC for approval on September 30, 2010.
PSA Mechanism and Balance. The power supply adjustor (“PSA”) provides for the adjustment of retail rates to reflect variations in retail fuel and purchased power costs from the “Base Fuel Rate,” which is currently $0.0376 per kilowatt-hour (“kWh”). The following table shows the changes in the deferred fuel and purchased power regulatory asset (liability) for the nine-month periods ended September 30, 2010 and 2009 (dollars in millions):
                 
    Nine Months Ended  
    September 30,  
    2010     2009  
Beginning balance
  $ (87 )   $ 8  
Deferred fuel and purchased power costs-current period
    (50 )     47  
Amounts refunded (recovered)
    96       (115 )
 
           
Ending balance
  $ (41 )   $ (60 )
 
           
The PSA rate for the current PSA year is ($0.0045) per kWh. Since the 2010 PSA adjustment was a reduction of the PSA rate, the ACC accelerated the 2010 adjustment from the standard PSA year start date of February 1st to January 1st to coincide with the increase in retail rates resulting from the ACC’s decision in the general retail rate case, causing a minimal net impact on residential bills. This accelerated 2010 adjustment will remain in effect until February 1, 2011. The regulatory liability at September 30, 2010 reflects lower average prices and the seasonal nature of fuel and purchased power costs. Any uncollected (overcollected) deferrals during the 2010 PSA year will be included in the historical component of the PSA rate for the PSA year beginning February 1, 2011.
The PSA rate for the PSA year that began February 1, 2009 was $0.0053 per kWh. The PSA rate may not be increased or decreased more than $0.004 per kWh in a year without permission of the ACC.
Transmission Rates and Transmission Cost Adjustor. In July 2008, the United States Federal Energy Regulatory Commission (“FERC”) approved an Open Access Transmission Tariff for APS to move from fixed rates to a formula rate-setting methodology in order to more accurately reflect and recover the costs that APS incurs in providing transmission services. A large portion of the rate represents charges for transmission services to serve APS’ retail customers (“Retail Transmission Charges”). In order to recover the Retail Transmission Charges, APS must file an application with, and obtain approval from, the ACC under the transmission cost adjustor (“TCA”) mechanism, by which changes in Retail Transmission Charges can be reflected in APS’ retail rates.
The formula rate is updated each year effective June 1 on the basis of APS’ actual cost of service, as disclosed in APS’ FERC Form 1 report for the previous fiscal year. Items to be updated include actual capital expenditures made as compared with previous projections, transmission revenue credits and other items. The resolution of proposed adjustments can result in significant volatility in the revenues to be collected. APS reviews the proposed formula rate filing amounts with the ACC staff. Any items or adjustments which are not agreed to by APS and the ACC staff can remain in dispute until settled or litigated at FERC. Settlement or litigated resolution of disputed issues could require an extended period of time and have a significant effect on the Retail Transmission Charge because any adjustment, though applied prospectively, may be calculated to account for previously over-collected amounts.
Effective June 1, 2010, APS’ annual wholesale transmission rates for all users of its transmission system were reduced by approximately $12 million in accordance with the FERC-approved formula as a result of lower costs reflected in the formula. Approximately $10 million of this revenue reduction relates to transmission services used for APS’ retail customers. On May 20, 2010, APS filed with the ACC an application for the related reduction of its TCA rate. The ACC approved the TCA reduction on July 27, 2010.
Decoupling. On October 18, 2010, the Chairman of the ACC issued a draft decoupling policy statement. Decoupling refers to a ratemaking design which reduces or removes the linkage between sales and utility revenues and/or profits, reducing utility disincentives to the adoption of programs that benefit customers by saving energy. Mechanically, decoupling compares actual versus authorized revenues or revenue per customer over a period and either credits or collects any differences from customers in a subsequent period. The draft policy is supportive of decoupling using a revenue-per-customer methodology, which is the mechanism APS and a number of other parties support because it recognizes increased costs associated with additional customers. The draft policy would allow a utility to file a decoupling plan in its next general rate case. Subsequent steps by the ACC prior to approving any policy statement will likely depend on the nature and extent of the comments received from various stakeholders.
Retirement Plans and Other Benefits
Retirement Plans and Other Benefits
4. Retirement Plans and Other Benefits
Pinnacle West sponsors a qualified defined benefit and account balance pension plan, a non-qualified supplemental excess benefit retirement plan, and other postretirement benefit plans for the employees of Pinnacle West and our subsidiaries. Pinnacle West uses a December 31 measurement date for its pension and other postretirement benefit plans. The market-related value of our plan assets is their fair value at the measurement date.
On March 23, 2010, the President signed into law comprehensive health care reform legislation under the Patient Protection and Affordable Care Act (the “Act”). One feature of the Act is the elimination of the tax deduction for prescription drug costs that are reimbursed as part of the Medicare Part D subsidy. Although this tax increase does not take effect until 2013, we are required to recognize the full accounting impact in our financial statements in the period in which the Act is signed. In accordance with accounting for regulated companies, the loss of this deduction is substantially offset by a regulatory asset that will be recovered through future electric revenues. In the first quarter of 2010, Pinnacle West charged regulatory assets and liabilities for a total of $42 million, with a corresponding increase in accumulated deferred income tax liabilities, to reflect the impact of this change in tax law.
The following table provides details of the plans’ net periodic benefit costs and the portion of these costs charged to expense (including administrative costs and excluding amounts capitalized as overhead construction or billed to electric plant participants) (dollars in millions):
                                                                 
    Pension Benefits     Other Benefits  
    Three Months     Nine Months     Three Months     Nine Months  
    Ended     Ended     Ended     Ended  
    September 30,     September 30,     September 30,     September 30,  
    2010     2009     2010     2009     2010     2009     2010     2009  
Service cost — benefits earned during the period
  $ 14     $ 13     $ 42     $ 40     $ 4     $ 4     $ 14     $ 14  
Interest cost on benefit obligation
    31       29       92       88       11       10       32       29  
Expected return on plan assets
    (31 )     (29 )     (93 )     (87 )     (9 )     (9 )     (29 )     (26 )
Amortization of:
                                                               
Transition obligation
                                  1             2  
Prior service cost
          1       1       2                          
Net actuarial loss
    5       4       15       11       2       3       7       8  
 
                                               
Net periodic benefit cost
  $ 19     $ 18     $ 57     $ 54     $ 8     $ 9     $ 24     $ 27  
 
                                               
Portion of cost charged to expense
  $ 10     $ 9     $ 29     $ 26     $ 4     $ 4     $ 12     $ 13  
 
                                               
APS’ share of cost charged to expense
  $ 9     $ 8     $ 28     $ 25     $ 4     $ 4     $ 12     $ 12  
 
                                               
Contributions
The required minimum contribution to our pension plan is zero in 2010. During the first quarter of 2010, we made a voluntary contribution of $100 million to our pension plan. The contribution to our other postretirement benefit plans in 2010 is estimated to be approximately $15 million. APS and other subsidiaries fund their share of the contributions. APS’ share is approximately 98% of both plans.
Business Segments
Business Segments
5. Business Segments
Pinnacle West’s two reportable business segments are:
    our regulated electricity segment, which consists of traditional regulated retail and wholesale electricity businesses (primarily retail and wholesale sales supplied to traditional cost-based rate regulation (“Native Load”) customers) and related activities and includes electricity generation, transmission and distribution; and
    our real estate segment, which consists of SunCor’s real estate development and investment activities.
In July 2010, SunCor sold land parcels, commercial assets and a master planned home-building community. It is expected that SunCor will dispose of its remaining assets within the next 12 months. As a result, they are classified as assets held for sale on the balance sheet at September 30, 2010 and all of SunCor’s operations are reflected in discontinued operations. While segment reporting is not required for discontinued operations, Pinnacle West continues to provide the information below, due to the significant impacts of real estate impairments in 2009. See Note 14 — Discontinued Operations.
Financial data for the three and nine months ended September 30, 2010 and 2009 and at September 30, 2010 and December 31, 2009 is provided as follows (dollars in millions):
                                 
    Three Months Ended     Nine Months Ended  
    September 30,     September 30,  
    2010     2009     2010     2009  
Operating revenues:
                               
Regulated electricity segment
  $ 1,116     $ 1,084     $ 2,527     $ 2,499  
All other (a)
    23       5       53       16  
 
                       
Total
  $ 1,139     $ 1,089     $ 2,580     $ 2,515  
 
                       
 
                               
Net income (loss) attributable to common shareholders:
                               
Regulated electricity segment
  $ 225     $ 200     $ 320     $ 257  
Real estate segment
    8       (12 )     (6 )     (153 )
All other (a)
    1       (1 )     29       (6 )
 
                       
Total
  $ 234     $ 187     $ 343     $ 98  
 
                       
                 
    As of     As of  
    September 30, 2010     December 31, 2009  
Assets:
               
Regulated electricity segment
  $ 12,324     $ 11,691  
Real estate segment
    41       161  
All other (a)
    70       134  
 
           
Total
  $ 12,435     $ 11,986  
 
           
     
(a)   Includes activities related to APSES and El Dorado. None of the activities of either of these companies constitutes a reportable segment. All other also includes the sale of APSES’ district cooling business, which resulted in an after-tax gain of $25 million for the nine months ended September 30, 2010. See Note 14 — Discontinued Operations.
Income Taxes
Income Taxes
6. Income Taxes
Pinnacle West expects to receive approximately $132 million of cash tax benefits related to SunCor’s strategic asset sales (see Note 16), which will not be fully realized until all of the asset sales are completed. Approximately $7 million of these benefits were recorded in the nine months ended September 30, 2010 as reductions to income tax expense related to the current impairment charges. The additional $125 million of tax benefits were recorded as reductions to income tax expense related to SunCor impairment charges recorded on or before December 31, 2009.
The $88 million income tax receivables on the Condensed Consolidated Balance Sheets represent the anticipated refunds related to an APS tax accounting method change approved by the Internal Revenue Service (“IRS”) in the third quarter of 2009 and the current year tax benefits related to the SunCor strategic asset sales that closed in 2010.
During the first quarter of 2010, the Company reached a settlement with the IRS with regard to the examination of tax returns for the years ended December 31, 2005 through 2007. As a result of this settlement, net uncertain tax positions decreased $62 million, including approximately $3.5 million which decreased our effective tax rate. Additionally, the settlement resulted in the recognition of net interest benefits of approximately $3 million through the effective tax rate.
As of September 30, 2010, the tax year ended December 31, 2008 and all subsequent tax years remain subject to examination by the IRS. With few exceptions, we are no longer subject to state income tax examinations by tax authorities for years before 1999.
Variable Interest Entities
Variable Interest Entities
7. Variable Interest Entities
On January 1, 2010 we adopted amended accounting guidance relating to VIEs. This amended guidance significantly changed the consolidation model for VIEs. Under the prior guidance the consolidation model considered risk absorption using a quantitative approach when determining the primary beneficiary. The consolidation model under the new guidance requires a qualitative assessment and focuses on the power to direct activities of the VIE when determining the primary beneficiary. As a result of applying this qualitative assessment, we have determined that APS is the primary beneficiary of certain VIEs, and is therefore required to consolidate these VIEs. Prior to adopting this new guidance, APS was not considered the primary beneficiary of these VIEs and did not consolidate these entities. We have adopted this guidance using retrospective application and have adjusted prior periods presented to reflect consolidation of the VIEs in those periods. Further discussion follows regarding the impact of the consolidation.
APS VIEs
In 1986, APS entered into agreements with three separate VIE lessor trusts in order to sell and lease back interests in Palo Verde Nuclear Generating Station (“Palo Verde”) Unit 2 and related common facilities. The VIE lessor trusts are single-asset leasing entities. APS will pay approximately $49 million per year for the years 2010 to 2015 related to these leases. The leases do not contain fixed price purchase options or residual value guarantees. However, the lease agreements include fixed rate renewal periods which may have a significant impact on the VIEs’ economic performance. We have concluded that these fixed rate renewal periods may give APS the ability to utilize the asset for a significant portion of the asset’s economic life, and therefore provide APS with the power to direct activities of the VIEs that most significantly impact the VIEs’ economic performance. In addition to the fixed rate renewal periods, our primary beneficiary analysis also considered that APS is the operating agent for Palo Verde, is obligated to decommission the leased assets and has fair value purchase options.
Under the previous quantitative VIE consolidation model, APS was not considered the primary beneficiary of the lessor trusts, as APS did not absorb the majority of the entities’ expected losses or did not receive a majority of the residual returns. The arrangements were previously accounted for as operating leases.
Consolidation of these VIEs eliminates the lease accounting we previously reported and results in changes in our consolidated assets, debt, equity, and net income. Assets of the VIEs are restricted and may only be used to settle the VIEs’ debt obligations and for payment to the noncontrolling interest holders. The creditors of the VIEs have no recourse to the assets of APS or Pinnacle West. As a result of consolidation we have eliminated rent expense, and have recognized depreciation and interest expense, resulting in an increase in net income for the three and nine months ended September 30, 2010 of $5 million and of $15 million, respectively, entirely attributable to the noncontrolling interests. Income attributable to Pinnacle West shareholders remains the same. Consolidation of these VIEs also results in changes to our Condensed Consolidated Statements of Cash Flows, but does not impact net cash flows.
Our Condensed Consolidated Balance Sheets at September 30, 2010 include the following amounts relating to the VIEs (in millions):
         
    September 30,  
    2010  
Property plant and equipment, net of accumulated depreciation
  $ 140  
Long-term debt including current maturities
    143  
Equity- Noncontrolling interests
    94  
For regulatory ratemaking purposes the leases continue to be treated as operating leases, and as a result we have recorded a regulatory asset of $32 million as of September 30, 2010.
APS is exposed to losses relating to these lessor trust VIEs upon the occurrence of certain events that APS does not consider to be reasonably likely to occur. Under certain circumstances (for example, the Nuclear Regulatory Commission (“NRC”) issuing specified violation orders with respect to Palo Verde or the occurrence of specified nuclear events), APS would be required to make specified payments to the VIEs’ noncontrolling equity participants, assume the VIEs’ debt, and take title to the leased Unit 2 interests, which, if appropriate, may be required to be written down in value. If such an event had occurred as of September 30, 2010, APS would have been required to pay the noncontrolling equity participants approximately $152 million and assume $143 million of debt. Since APS now consolidates the VIEs, the debt APS would be required to assume is already reflected in our Condensed Consolidated Balance Sheets.
We also have certain long-term purchased power agreements to purchase substantially all of an entity’s output from a specified facility for a specified period. We have evaluated these arrangements under the VIE accounting guidance and have determined that these agreements do not represent variable interests. If these agreements had been deemed variable interests, we would not be considered the primary beneficiary, as we do not have the power to direct the entities’ activities in a manner that would significantly impact their economic performance and, therefore, would not consolidate the entities. The adoption of the amended accounting guidance has not changed how we account for these arrangements.
SunCor VIEs
SunCor is the primary beneficiary of certain land development trust arrangements and, accordingly, consolidates these VIEs. We have determined that SunCor is the primary beneficiary of these VIEs because SunCor controls the activities related to the development of the land held in the trusts. Our adoption of amended VIE accounting guidance has not changed our accounting treatment of the SunCor VIEs. Our Condensed Consolidated Balance Sheets reflect $18 million of assets and $18 million of noncontrolling equity interests relating to these arrangements at September 30, 2010. Our Condensed Consolidated Balance Sheets reflect $29 million of assets and $29 million of noncontrolling equity interests related to these arrangements at December 31, 2009. The assets relating to these VIEs consist strictly of land, all of which is restricted and may only be used for payment to the noncontrolling interests. We have not provided, and are not required to provide, financing or other financial support to these entities.
Derivative and Energy Trading Accounting
Derivative and Energy Trading Accounting
8. Derivative and Energy Trading Accounting
We are exposed to the impact of market fluctuations in the commodity price and transportation costs of electricity, natural gas, coal, emissions allowances and in interest rates. We manage risks associated with these market fluctuations by utilizing various derivative instruments, including futures, forwards, options and swaps. As part of our overall risk management program, we may use such instruments to hedge purchases and sales of electricity, fuels, and emissions allowances and credits. Derivative instruments that are designated as cash flow hedges are used to limit our exposure to cash flow variability on forecasted transactions. The changes in market value of such contracts have a high correlation to price changes in the hedged transactions.
Our derivative instruments are accounted for at fair value and are presented on the Condensed Consolidated Balance Sheets as “Assets/Liabilities from Risk Management Activities” (see Note 15 for a discussion of fair value measurements). Derivative instruments for the physical delivery of purchase and sale quantities transacted in the normal course of business qualify for the normal purchase and sales scope exception and are accounted for under the accrual method of accounting. Due to the scope exception, these derivative instruments are excluded from our derivative instrument discussion and disclosures below.
We enter into derivative instruments for economic hedging purposes. While we believe the economic hedges mitigate exposure to fluctuations in commodity prices, some of these instruments may not meet the specific hedge accounting requirements and are not designated as accounting hedges. Economic hedges not designated as accounting hedges are recorded at fair value on our balance sheet with changes in fair value recognized in the statement of income as incurred. These instruments are included in the “non-designated hedges” discussion and disclosure below.
Hedge effectiveness is the degree to which the derivative instrument contract and the hedged item are correlated and is measured based on the relative changes in fair value between the derivative instrument contract and the hedged item over time. We assess hedge effectiveness both at inception and on a continuing basis. These assessments exclude the time value of certain options. For accounting hedges that are deemed an effective hedge, the effective portion of the gain or loss on the derivative instrument is reported as a component of accumulated other comprehensive income (“AOCI”) and reclassified into earnings in the same period during which the hedged transaction affects earnings. We recognize in current earnings the gains and losses representing hedge ineffectiveness, and the gains and losses on any hedge components which are excluded from our effectiveness assessment. As of September 30, 2010, we hedged the majority of certain exposures to the price variability of commodities for a maximum of 39 months.
In the electricity business, some contracts to purchase energy are netted against other contracts to sell energy. This is called “book-out” and usually occurs in contracts that have the same terms (quantities and delivery points) and for which power does not flow. We net these book-outs, which reduces both revenues and fuel and purchased power costs in our Condensed Consolidated Statements of Income, but this does not impact our financial condition, net income or cash flows.
For its regulated operations, APS defers for future rate treatment approximately 90% of unrealized gains and losses on certain derivatives pursuant to the PSA mechanism that would otherwise be recognized in income. Realized gains and losses on derivatives are deferred in accordance with the PSA to the extent the amounts are above or below the portion of APS’ retail base rates attributable to fuel and purchased power costs (“Base Fuel Rate”), which is currently $0.0376 per kWh (see Note 3). Gains and losses from derivatives in the following tables represent the amounts reflected in income before the effect of PSA deferrals.
As of September 30, 2010, we had the following outstanding gross notional amount of derivatives, which represent both purchases and sales (does not reflect net position):
             
Commodity   Quantity
Power
    14,149,591     megawatt hours
Gas
    149,026,687     MMBTU (a)
     
(a)   “MMBTU” is one million British thermal units.
Derivative Instruments in Designated Accounting Hedging Relationships
The following table provides information about gains and losses from derivative instruments in designated accounting hedging relationships and their impact on our Condensed Consolidated Statements of Income during the three and nine months ended September 30, 2010 and 2009 (dollars in thousands):
                                     
        Three Months Ended     Nine Months Ended  
    Financial Statement   September 30,     September 30,  
Commodity Contracts   Location   2010     2009     2010     2009  
 
Amount of Gain (Loss) Recognized in AOCI on Derivative Instruments (Effective Portion)
 
Accumulated other comprehensive loss-derivative instruments
  $ (67,856 )   $ 4,959     $ (168,110 )   $ (128,035 )
Amount of Loss Reclassified from AOCI into Income (Effective Portion Realized)
 
Regulated electricity segment fuel and purchased power
    (59,801 )     (81,660 )     (102,130 )     (154,990 )
Amount of Gain (Loss) Recognized in Income from Derivative Instruments (Ineffective Portion and Amount Excluded from Effectiveness Testing) (a)
 
Regulated electricity segment fuel and purchased power
    (68 )     (9,085 )     1,364       (12,993 )
     
(a)   During the three and nine months ended September 30, 2010 and 2009, we had no amounts reclassified from AOCI to earnings related to discontinued cash flow hedges.
During the next twelve months, we estimate that a net loss of $119 million before income taxes will be reclassified from AOCI as an offset to the effect of market price changes for the related hedged transactions. Approximately 90% of the amounts related to derivatives subject to the PSA will be recorded as either a regulatory asset or liability and have no effect on earnings.
Derivative Instruments Not Designated as Accounting Hedges
The following table provides information about gains and losses from derivative instruments not designated as accounting hedging instruments and their impact on our Condensed Consolidated Statements of Income during the three and nine months ended September 30, 2010 and 2009 (dollars in thousands):
                                     
        Three Months Ended     Nine Months Ended  
    Financial Statement   September 30,     September 30,  
Commodity Contracts   Location   2010     2009     2010     2009  
 
                                   
Amount of Net Gain Recognized in Income from Derivative Instruments
 
Regulated electricity segment revenue
  $ 1,721     $ 126     $ 2,316     $ 464  
 
                                   
Amount of Net Gain (Loss) Recognized in Income from Derivative Instruments
 
Regulated electricity segment fuel and purchased power expense
    (41,044 )     23,463       (105,272 )     (18,259 )
 
                           
Total
      $ (39,323 )   $ 23,589     $ (102,956 )   $ (17,795 )
 
                           
Fair Values of Derivative Instruments in the Condensed Consolidated Balance Sheets
The following table provides information about the fair value of our derivative instruments, margin account and cash collateral reported on a gross basis. Transactions with counterparties that have master netting arrangements are reported net on the balance sheet. These amounts are located in the assets and liabilities from risk management activities lines of our Condensed Consolidated Balance Sheets. Amounts are as of September 30, 2010 (dollars in thousands):
                                         
            Investments     Current     Deferred Credits     Total Assets  
Commodity Contracts   Current Assets     and Other Assets     Liabilities     and Other     (Liabilities)  
Derivatives designated as accounting hedging instruments:
                                       
Assets
  $ 2     $     $     $     $ 2  
Liabilities
    (1,311 )     (2,159 )     (123,351 )     (86,043 )     (212,864 )
 
                             
Total hedging instruments
    (1,309 )     (2,159 )     (123,351 )     (86,043 )     (212,862 )
 
                             
 
                                       
Derivatives not designated as accounting hedging instruments:
                                       
Assets
    40,078       57,154       45,700       30,659       173,591  
Liabilities
    (1,257 )     (27 )     (124,165 )     (126,066 )     (251,515 )
 
                             
Total non-hedging instruments
    38,821       57,127       (78,465 )     (95,407 )     (77,924 )
 
                             
 
                                       
Total derivatives
    37,512       54,968       (201,816 )     (181,450 )     (290,786 )
 
                                       
Margin account
    23,822             2,068             25,890  
Collateral provided to counterparties
    12,701             145,230       100,794       258,725  
Collateral provided from counterparties
    (6,750 )           (1,250 )           (8,000 )
Prepaid option premiums and other
    1,191             (79 )           1,112  
 
                             
Balance Sheet Total
  $ 68,476     $ 54,968     $ (55,847 )   $ (80,656 )   $ (13,059 )
 
                             
The following table provides information about the fair value of our derivative instruments, margin account and cash collateral reported on a gross basis at December 31, 2009 (dollars in thousands):
                                         
            Investments     Current     Deferred Credits     Total Assets  
Commodity Contracts   Current Assets     and Other Assets     Liabilities     and Other     (Liabilities)  
Derivatives designated as accounting hedging instruments:
                                       
Assets
  $ 329     $     $ 3,242     $ 75     $ 3,646  
Liabilities
    (3,436 )     (256 )     (72,899 )     (77,953 )     (154,544 )
 
                             
Total hedging instruments
    (3,107 )     (256 )     (69,657 )     (77,878 )     (150,898 )
 
                             
 
                                       
Derivatives not designated as accounting hedging instruments:
                                       
Assets
    31,220       29,807       34,645       44,631       140,303  
Liabilities
    (4,123 )     (696 )     (81,722 )     (71,408 )     (157,949 )
 
                             
Total non-hedging instruments
    27,097       29,111       (47,077 )     (26,777 )     (17,646 )
 
                             
 
                                       
Total derivatives
    23,990       28,855       (116,734 )     (104,655 )     (168,544 )
 
                                       
Margin account
    8,643             12,464       104       21,211  
Collateral provided to counterparties
    17,986             49,412       42,108       109,506  
Collateral provided from counterparties
                (1,050 )           (1,050 )
 
                             
Balance Sheet Total
  $ 50,619     $ 28,855     $ (55,908 )   $ (62,443 )   $ (38,877 )
 
                             
Credit Risk and Credit-Related Contingent Features
We are exposed to losses in the event of nonperformance or nonpayment by counterparties. We have risk management contracts with many counterparties, including two counterparties for which our exposure represents approximately 51% of Pinnacle West’s $123 million of risk management assets as of September 30, 2010. This exposure relates to long-term traditional wholesale contracts with counterparties that have very high credit quality. Our risk management process assesses and monitors the financial exposure of all counterparties. Despite the fact that the great majority of our trading counterparties’ debt is rated as investment grade by the credit rating agencies, there is still a possibility that one or more of these companies could default, resulting in a material impact on consolidated earnings for a given period. Counterparties in the portfolio consist principally of financial institutions, major energy companies, municipalities and local distribution companies. We maintain credit policies that we believe minimize overall credit risk to within acceptable limits. Determination of the credit quality of our counterparties is based upon a number of factors, including credit ratings and our evaluation of their financial condition. To manage credit risk, we employ collateral requirements and standardized agreements that allow for the netting of positive and negative exposures associated with a single counterparty. Valuation adjustments are established representing our estimated credit losses on our overall exposure to counterparties.
Certain of our derivative instrument contracts contain credit-risk-related contingent features including, among other things, investment grade credit rating provisions, credit-related cross default provisions, and adequate assurance provisions. Adequate assurance provisions allow a counterparty with reasonable grounds for uncertainty to demand additional collateral based on subjective events and/or conditions. The aggregate fair value of all derivative instruments with credit-risk-related contingent features that were in a liability position on September 30, 2010 was $430 million, for which we had posted collateral of $247 million in the normal course of business.
For those derivative instruments in a net liability position, with investment grade credit contingencies, the counterparties could demand additional collateral if our debt credit rating were to fall below investment grade (below BBB- for Standard & Poor’s Ratings Services (“Standard & Poor’s”) or Fitch, Inc. (“Fitch”) or Baa3 for Moody’s Investors Service, Inc. (“Moody’s”)), which would be a violation of the credit rating provisions. If the investment grade contingent features underlying these agreements had been fully triggered on September 30, 2010, after off-setting asset positions under master netting arrangements we would have been required to post approximately an additional $111 million of collateral to our counterparties; this amount includes those contracts that qualify for scope exceptions, which are excluded from the derivative details in the above footnote. We also have energy related non-derivative instrument contracts with investment grade credit-related contingent features which could require us to post additional collateral of approximately $204 million if our debt credit ratings were to fall below investment grade.
Changes in Equity
Changes in Equity
9. Changes in Equity
The following tables show Pinnacle West’s changes in shareholders’ equity and changes in equity of noncontrolling interests for the three and nine months ended September 30, 2010 and 2009 (dollars in thousands):
                                                 
    Three Months Ended September 30, 2010     Three Months Ended September 30, 2009  
    Common     Noncontrolling             Common     Noncontrolling        
    Shareholders     Interests     Total     Shareholders     Interests     Total  
 
                                               
Beginning balance, July 1
  $ 3,479,548     $ 113,455     $ 3,593,003     $ 3,206,805     $ 112,677     $ 3,319,482  
 
                                               
Net income
    233,920       5,119       239,039       186,652       4,371       191,023  
 
                                   
Other comprehensive income (loss):
                                               
Net unrealized gains (losses) on derivative instruments (a)
    (67,856 )           (67,856 )     4,959             4,959  
Net reclassification of realized losses to income (b)
    59,801             59,801       81,660             81,660  
Reclassification of pension and other postretirement benefits to income
    1,314             1,314       1,240             1,240  
Net income tax benefit (expense) related to items of other comprehensive income (loss)
    2,660             2,660       (34,495 )           (34,495 )
 
                                   
Total other comprehensive income (loss)
    (4,081 )           (4,081 )     53,364             53,364  
 
                                   
Total comprehensive income
    229,839       5,119       234,958       240,016       4,371       244,387  
 
                                   
 
                                               
Issuance of capital stock
    2,506             2,506       2,756             2,756  
Purchase of treasury stock, net of reissuances
    577             577       589             589  
Other (primarily stock compensation)
    4,456             4,456       (372 )           (372 )
Dividends on common stock
                      (53,132 )           (53,132 )
Net capital activities by noncontrolling interests
          (7,271 )     (7,271 )           (93 )     (93 )
 
                                   
Ending balance, September 30
  $ 3,716,926     $ 111,303     $ 3,828,229     $ 3,396,662     $ 116,955     $ 3,513,617  
 
                                   
                                                 
    Nine Months Ended September 30, 2010     Nine Months Ended September 30, 2009  
    Common     Noncontrolling             Common     Noncontrolling        
    Shareholders     Interests     Total     Shareholders     Interests     Total  
 
                                               
Beginning balance, January 1
  $ 3,316,109     $ 111,895     $ 3,428,004     $ 3,445,979     $ 124,990     $ 3,570,969  
 
                                               
Net income (loss)
    342,703       15,005       357,708       98,489       (690 )     97,799  
 
                                   
Other comprehensive income (loss):
                                               
Net unrealized losses on derivative instruments (a)
    (168,110 )           (168,110 )     (128,035 )           (128,035 )
Net reclassification of realized losses to income (b)
    102,130             102,130       154,990             154,990  
Reclassification of pension and other postretirement benefits to income
    4,069             4,069       3,745             3,745  
Net unrealized losses related to pension and other postretirement benefits
    (6,933 )           (6,933 )     (4,204 )           (4,204 )
Net income tax benefit (expense) related to items of other comprehensive income (loss)
    27,171             27,171       (10,337 )           (10,337 )
 
                                   
Total other comprehensive income (loss)
    (41,673 )           (41,673 )     16,159             16,159  
 
                                   
Total comprehensive income (loss)
    301,030       15,005       316,035       114,648       (690 )     113,958  
 
                                   
 
                                               
Issuance of capital stock
    260,665             260,665       8,102             8,102  
Purchase of treasury stock, net of reissuances
    1,655             1,655       (957 )           (957 )
Other (primarily stock compensation)
    4,598             4,598       (11,899 )           (11,899 )
Dividends on common stock
    (167,131 )           (167,131 )     (159,211 )           (159,211 )
Net capital activities by noncontrolling interests
          (15,597 )     (15,597 )           (7,345 )     (7,345 )
 
                                   
Ending balance, September 30
  $ 3,716,926     $ 111,303     $ 3,828,229     $ 3,396,662     $ 116,955     $ 3,513,617  
 
                                   
     
(a)   These amounts primarily include unrealized gains and losses on contracts used to hedge our forecasted electricity and natural gas requirements to serve Native Load. These changes are primarily due to changes in forward natural gas prices and wholesale electricity prices.
 
(b)   These amounts primarily include the reclassification of unrealized gains and losses to realized gains and losses for contracted commodities delivered during the period.
Commitments and Contingencies
Commitments and Contingencies
10. Commitments and Contingencies
Palo Verde Nuclear Generating Station
Spent Nuclear Fuel and Waste Disposal
Nuclear power plant operators are required to enter into spent fuel disposal contracts with the United States Department of Energy (“DOE”), and the DOE is required to accept and dispose of all spent nuclear fuel and other high-level radioactive wastes generated by domestic power reactors. Although the Nuclear Waste Policy Act required the DOE to develop a permanent repository for the storage and disposal of spent nuclear fuel by 1998, the DOE announced that it would not be able to open the repository by 1998 and sought to excuse its performance under the contract. In November 1997, the United States Court of Appeals for the District of Columbia Circuit (D.C. Circuit) issued a decision preventing the DOE from excusing its own delay, but refused to order the DOE to begin accepting spent nuclear fuel.
Based on this decision and the DOE’s delay, a number of utilities, including APS (on behalf of itself and the other Palo Verde owners), filed damages actions against the DOE in the Court of Federal Claims. APS pursued a damages claim for costs incurred through December 2006 in a trial that began on January 28, 2009. On June 18, 2010, the court awarded APS and the other Palo Verde owners approximately $30 million. APS received its share of this amount in October 2010, which is approximately $9 million.
APS currently estimates it will incur $132 million (in 2010 dollars) over the current life of Palo Verde for its share of the costs related to the on-site interim storage of spent nuclear fuel. At September 30, 2010, APS had a regulatory liability of $46 million that represents amounts recovered in retail rates in excess of amounts spent for on-site interim spent fuel storage.
Fuel and Purchased Power Commitments and Purchase Obligations
APS is party to purchase obligations and various fuel and purchased power contracts with terms expiring between 2010 and 2042 that include required purchase provisions. APS estimates the contract requirements to be approximately $727 million in 2010; $527 million in 2011; $435 million in 2012; $515 million in 2013; $550 million in 2014; and $7.6 billion thereafter. However, these amounts may vary significantly pursuant to certain provisions in such contracts that permit us to decrease required purchases under certain circumstances. These amounts have increased since the 2009 Form 10-K primarily due to increased commitments for fuel and purchased power and contracts associated with meeting our renewable energy requirements.
Coal Mine Reclamation Obligations
APS is obligated to reimburse certain coal providers for amounts incurred for coal mine reclamation. APS’ coal mine reclamation obligation recorded on the Condensed Consolidated Balance Sheets was estimated to be $117 million at September 30, 2010 and $92 million at December 31, 2009.
FERC Market Issues
APS reached a settlement on previously disputed matters resulting from its involvement in the California energy market during specified time frames in the early 2000s. The settlement was approved by the FERC in an order issued on June 30, 2008. The resolution of the claims related to the parties involved in this settlement had no material adverse impact on APS’ financial position, results of operations or cash flows.
On July 25, 2001, the FERC ordered an evidentiary proceeding to discuss and evaluate possible refunds for wholesale sales in the Pacific Northwest. The FERC affirmed the administrative law judge’s conclusion that the prices in the Pacific Northwest were not unreasonable or unjust and refunds should not be ordered in this proceeding. This decision was appealed to the U.S. Court of Appeals for the Ninth Circuit. On August 24, 2007, the Ninth Circuit issued an opinion that remanded the proceeding to the FERC for further consideration. Although the FERC has not yet determined whether any refunds will ultimately be required, we do not expect that the resolution of these issues will have a material adverse impact on our financial position, results of operations or cash flows.
Superfund
The Comprehensive Environmental Response, Compensation and Liability Act (“Superfund”) establishes liability for the cleanup of hazardous substances found contaminating the soil, water or air. Those who generated, transported or disposed of hazardous substances at a contaminated site are among those who are potentially responsible parties under Superfund (“PRPs”). PRPs may be strictly, and often are jointly and severally, liable for clean-up. On September 3, 2003, the United States Environmental Protection Agency (“EPA”) advised APS that the EPA considers APS to be a PRP in the Motorola 52nd Street Superfund Site, Operable Unit 3 (“OU3”) in Phoenix, Arizona. APS has facilities that are within this Superfund site. APS and Pinnacle West have agreed with the EPA to perform certain investigative activities of the APS facilities within OU3. In addition, on September 23, 2009, APS agreed with the EPA and one other PRP to voluntarily assist with the funding and management of the site-wide groundwater remedial investigation and feasibility study work plan. We estimate that our costs related to this investigation and study will be approximately $1.2 million, which is reserved as a liability on our financial statements. We anticipate incurring additional expenditures in the future, but because the overall investigation is not complete and ultimate remediation requirements are not yet finalized, at the present time we cannot accurately estimate our total expenditures.
Landlord Bankruptcy
On April 16, 2009, the landlord for our corporate headquarters building announced that it is seeking relief under Chapter 11 of the United States Bankruptcy Code. At September 30, 2010, we have several assets on our books related to our landlord, the most significant of which is an asset related to levelized rent payments for the building of approximately $70 million which is included in other deferred debits on the Condensed Consolidated Balance Sheets. This amount will continue to increase to approximately $93 million as a result of the lease terms until 2015, when this amount will begin to decrease over the remaining life of the lease. We are monitoring this matter and, while there can be no assurances as to the ultimate outcome of the matter due to the complexity of the bankruptcy proceedings, we currently do not expect that it will have a material adverse effect on our financial position, results of operations, or cash flows.
Nuclear Insurance
The Palo Verde participants are insured against public liability for a nuclear incident up to $12.6 billion per occurrence. As required by the Price Anderson Nuclear Industries Indemnity Act, Palo Verde maintains the maximum available nuclear liability insurance in the amount of $375 million, which is provided by commercial insurance carriers. The remaining balance of $12.2 billion is provided through a mandatory industry wide retrospective assessment program. If losses at any nuclear power plant covered by the program exceed the accumulated funds, APS could be assessed retrospective premium adjustments. The maximum assessment per reactor under the program for each nuclear incident is approximately $118 million, subject to an annual limit of $18 million per incident, to be periodically adjusted for inflation. Based on APS’ interest in the three Palo Verde units, APS’ maximum potential assessment per incident for all three units is approximately $103 million, with an annual payment limitation of approximately $15 million.
The Palo Verde participants maintain “all risk” (including nuclear hazards) insurance for property damage to, and decontamination of, property at Palo Verde in the aggregate amount of $2.75 billion, a substantial portion of which must first be applied to stabilization and decontamination. APS has also secured insurance against portions of any increased cost of generation or purchased power and business interruption resulting from a sudden and unforeseen accidental outage of any of the three units. The property damage, decontamination, and replacement power coverages are provided by Nuclear Electric Insurance Limited (“NEIL”). APS is subject to retrospective assessments under all NEIL policies if NEIL’s losses in any policy year exceed accumulated funds. The maximum amount APS could incur under the current NEIL policies totals approximately $16 million for each retrospective assessment declared by NEIL’s Board of Directors due to losses. In addition, NEIL policies contain rating triggers that would result in APS providing approximately $44 million of collateral assurance within 20 business days of a rating downgrade to non-investment grade. The insurance coverage discussed in this and the previous paragraph is subject to certain policy conditions and exclusions.
Other Income and Other Expense
Other Income and Other Expense
11. Other Income and Other Expense
The following table provides detail of other income and other expense for the three and nine months ended September 30, 2010 and 2009 (dollars in thousands):
                                 
    Three Months Ended     Nine Months Ended  
    September 30,     September 30,  
    2010     2009     2010     2009  
Other income:
                               
Interest income
  $ 943     $ 543     $ 2,597     $ 1,185  
Investment gains — net
    3,390       3,696       1,051       120  
Miscellaneous
    15       147       180       2,797  
 
                       
Total other income
  $ 4,348     $ 4,386     $ 3,828     $ 4,102  
 
                       
 
                               
Other expense:
                               
Non-operating costs
  $ (2,894 )   $ (1,643 )   $ (5,917 )   $ (6,498 )
Miscellaneous
    (961 )     (291 )     (2,733 )     (2,389 )
 
                       
Total other expense
  $ (3,855 )   $ (1,934 )   $ (8,650 )   $ (8,887 )
 
                       
Guarantees
Guarantees
12. Guarantees
We have issued parental guarantees and obtained surety bonds on behalf of our subsidiaries including credit support instruments enabling APSES to offer energy-related products and surety bonds at APS, principally related to self-insured workers’ compensation. Non-performance or non-payment under the underlying contract by our subsidiaries would result in a payment liability on our part under the guarantee or surety bond. No liability is currently recorded on the Condensed Consolidated Balance Sheets related to Pinnacle West’s current outstanding guarantees and surety bonds on behalf of our subsidiaries. At September 30, 2010, we had no outstanding claims for payment under any of these guarantees. Our guarantees and surety bonds have no recourse or collateral provisions to allow us to recover amounts paid under the guarantees or surety bonds from our subsidiaries. The amounts and approximate terms of our guarantees and surety bonds for each subsidiary at September 30, 2010 are as follows (dollars in millions):
                                 
    Guarantees     Surety Bonds  
            Term             Term  
    Amount     (in years)     Amount     (in years)  
APSES
  $ 5       1     $ 42       1  
APS
    3       1       9       1  
 
                           
Total
  $ 8             $ 51          
 
                       
APS has entered into various agreements that require letters of credit for financial assurance purposes. At September 30, 2010, approximately $194 million of letters of credit were outstanding to support existing pollution control bonds of approximately $190 million. The letters of credit are available to fund the payment of principal and interest of such debt obligations. In connection with the change of interest rate modes and termination of corresponding letters of credit for certain pollution control bonds described in Note 2, the letters of credit outstanding have decreased since September 30, 2010. Currently, there are approximately $44 million of letters of credit outstanding to support existing pollution control bonds of approximately $44 million. These letters of credit expire in 2011 and 2013. APS has also entered into approximately $61 million of letters of credit to support certain equity lessors in the Palo Verde sale leaseback transactions (see Note 7 for further details on the Palo Verde sale leaseback transactions). These letters of credit were amended and extended in April 2010, and will expire in 2013.
We enter into agreements that include indemnification provisions relating to liabilities arising from or related to certain of our agreements; most significantly, APS has agreed to indemnify the equity participants and other parties in the Palo Verde sale leaseback transactions with respect to certain tax matters. Generally, a maximum obligation is not explicitly stated in the indemnification provisions and, therefore, the overall maximum amount of the obligation under such indemnification provisions cannot be reasonably estimated. Based on historical experience and evaluation of the specific indemnities, we do not believe that any material loss related to such indemnification provisions is likely.
Earnings Per Share
Earnings Per Share
13. Earnings Per Share
The following table presents earnings per weighted average common share outstanding for the three and nine months ended September 30, 2010 and 2009:
                                 
    Three Months Ended     Nine Months Ended  
    September 30,     September 30,  
    2010     2009     2010     2009  
Basic earnings per share:
                               
Income from continuing operations attributable to common shareholders
  $ 2.09     $ 1.96     $ 3.06     $ 2.47  
Income (loss) from discontinued operations
    0.06       (0.12 )     0.18       (1.50 )
 
                       
Earnings per share — basic
  $ 2.15     $ 1.84     $ 3.24     $ 0.97  
 
                       
 
                               
Diluted earnings per share:
                               
Income from continuing operations attributable to common shareholders
  $ 2.08     $ 1.96     $ 3.04     $ 2.46  
Income (loss) from discontinued operations
    0.06       (0.12 )     0.18       (1.49 )
 
                       
Earnings per share — diluted
  $ 2.14     $ 1.84     $ 3.22     $ 0.97  
 
                       
Dilutive stock options and performance shares (which are contingently issuable) increased average diluted common shares outstanding by approximately 462,000 shares and 162,000 shares for the three months ended September 30, 2010 and 2009, respectively, and by approximately 472,000 and 77,000 shares for the nine months ended September 30, 2010 and 2009, respectively.
Options to purchase 175,333 shares of common stock for the three-month period ended September 30, 2010, and 561,157 shares for the three-month period ended September 30, 2009 were outstanding but were excluded from the computation of diluted earnings per share because the options’ exercise prices were greater than the average market price of the common shares. Options to purchase 322,333 shares and 595,335 shares of common stock for the nine-month periods ended September 30, 2010 and September 30, 2009, respectively, were outstanding but were excluded from the computation of diluted earnings per share because the options’ exercise prices were greater than the average market price of the common shares.
Discontinued Operations
Discontinued Operations
14. Discontinued Operations
SunCor (real estate segment) In July 2010, SunCor sold land parcels, commercial assets and a master planned home-building community for approximately $70 million, which approximated the carrying value of these assets, resulting in a net gain of zero. At September 30, 2010, SunCor had approximately $22 million of assets on its balance sheet classified as assets held for sale. These assets consist of $18 million of consolidated VIEs (see Note 7), master planned home-building communities and golf courses. Because it is expected that SunCor will dispose of these assets within the next 12 months, they are classified as assets held for sale on the balance sheet. As a result, for the three and nine months ended September 30, 2010, all of SunCor’s operations are reflected in discontinued operations. Prior comparative period income statement amounts related to these properties were reclassified from continuing operations to discontinued operations. In addition, see Note 16 — Real Estate Impairment Charge.
APSES (other) On June 22, 2010, our subsidiary, APSES, sold its district cooling business consisting of operations in downtown Phoenix, Tucson, and on certain Arizona State University campuses. As a result of the sale, we recorded an after-tax gain from discontinued operations of approximately $25 million in June 2010. Prior period income statement amounts related to this sale and the associated revenues and costs are reflected in discontinued operations in 2010 and 2009.
The following table provides revenue, income (loss) before income taxes and income (loss) after taxes classified as discontinued operations in Pinnacle West’s Condensed Consolidated Statements of Income for the three and nine months ended September 30, 2010 and 2009 (dollars in millions):
                                 
    Three Months Ended     Nine Months Ended  
    September 30,     September 30,  
    2010     2009     2010     2009  
Revenue:
                               
SunCor
  $ 4     $ 49     $ 25     $ 85  
APSES
          5       7       14  
 
                       
Total revenue
  $ 4     $ 54     $ 32     $ 99  
 
                       
 
                               
Income (loss) before taxes:
                               
SunCor
  $ 14     $ (20 )   $ (10 )   $ (252 )
APSES
    (2 )     1       42       3  
 
                       
Total income (loss) before taxes
  $ 12     $ (19 )     32     $ (249 )
 
                       
 
                               
Income (loss) after taxes:
                               
SunCor (a)
  $ 8     $ (12 )   $ (6 )   $ (153 )
APSES
    (1 )     1       26       2  
 
                       
Total income (loss) after taxes
  $ 7     $ (11 )   $ 20     $ (151 )
 
                       
(a)   Includes a tax (expense) benefit recognized by the parent company in accordance with an intercompany tax sharing agreement of ($6) million and $8 million for the three months ended September 30, 2010, and 2009, respectively; and $4 million and $99 million for the nine months ended September 30, 2010 and 2009, respectively.
Fair Value Measurements
Fair Value Measurements
15. Fair Value Measurements
We disclose the fair value of certain assets and liabilities according to a fair value hierarchy. This hierarchy ranks the quality and reliability of the inputs used to determine fair values, which are then classified and disclosed in one of three categories. The three levels of the fair value hierarchy are:
    Level 1 — Quoted prices in active markets for identical assets or liabilities. Active markets are those in which transactions for the asset or liability occur in sufficient frequency and volume to provide information on an ongoing basis. This category includes derivative instruments that are exchange-traded such as futures, cash equivalents invested in exchange-traded money market funds, exchange-traded equities, and investments in Treasury securities.
    Level 2 — Quoted prices in active markets for similar assets or liabilities; quoted prices in markets that are not active; and model-derived valuations whose inputs are observable. This category includes nonexchange-traded derivative instruments such as forwards, options, and swaps. This category also includes investments in common and commingled funds that are redeemable and valued based on the funds’ net asset values.
    Level 3 — Model-derived valuations with significant unobservable inputs that are supported by little or no market activity. Instruments in this category include long-dated derivative transactions where models are required due to the length of the transaction, certain options, transactions in locations where observable market data does not exist, and common and collective trusts with significant restrictions on our ability to transact in the fund. The valuation models we employ utilize spot prices, forward prices, historical market data and other factors to forecast future prices. The primary valuation technique we use to calculate the fair value of contracts where price quotes are not available is based on the extrapolation of forward pricing curves using observable market data for more liquid delivery points in the same region and actual transactions at the more illiquid delivery points.
Assets and liabilities are classified in their entirety based on the lowest level of input that is significant to the fair value measurement. We maximize the use of observable inputs and minimize the use of unobservable inputs. If market data is not readily available, inputs may reflect our own assumptions about the inputs market participants would use. Our assessment of the significance of a particular input to the fair value measurement requires judgment, and may affect the valuation of fair value assets and liabilities and their placement within the fair value hierarchy levels. Thus, a valuation may be classified in Level 3 even though the valuation may include significant inputs that are readily observable. We assess whether a market is active by obtaining observable broker quotes, reviewing actual market transactions, and assessing the volume of transactions. We consider broker quotes observable inputs when the quote is binding on the broker, we can validate the quote with market transactions, or we can determine that the inputs the broker used to arrive at the quoted price are observable.
Recurring Fair Value Measurements
We apply recurring fair value measurements to derivative instruments, nuclear decommissioning trusts, certain cash equivalents and plan assets held in our retirement and other benefit plans.
Cash Equivalents
Cash equivalents represent short-term investments in exchange-traded money market funds that are valued using quoted prices in active markets.
Risk Management Activities
Exchange-traded contracts are valued using quoted prices in active markets. For non-exchange traded contracts, we calculate fair market value based on the average of the bid and offer price, discounted to reflect net present value. We maintain certain valuation adjustments for a number of risks associated with the valuation of future commitments. These include valuation adjustments for liquidity and credit risks based on the financial condition of counterparties. The liquidity valuation adjustment represents the cost that would be incurred if all unmatched positions were closed-out or hedged.
The credit valuation adjustment represents estimated credit losses on our overall exposure to counterparties, taking into account netting arrangements, expected default experience for the credit rating of the counterparties and the overall diversification of the portfolio. Counterparties in the portfolio consist principally of major energy companies, municipalities, local distribution companies and financial institutions. We maintain credit policies that management believes minimize overall credit risk. Determination of the credit quality of counterparties is based upon a number of factors, including credit ratings, financial condition, project economics and collateral requirements. When applicable, we employ standardized agreements that allow for the netting of positive and negative exposures associated with a single counterparty.
Some of our derivative instrument transactions are valued based on unobservable inputs due to the long-term nature of contracts or the unique location of the transactions. Our long-dated energy transactions consist of observable valuations for the near-term portion and unobservable inputs for the long-term portions of the transaction. When the unobservable portion is significant to the overall valuation of the transaction, the entire transaction is classified as Level 3. Our classification of instruments as Level 3 is primarily reflective of the long-term nature of our energy transactions, and is not reflective of material inactive markets.
Nuclear Decommissioning Trust
The nuclear decommissioning trust invests in fixed income securities directly and equity securities indirectly through commingled funds. The commingled equity funds are valued based on the fund’s net asset value and are classified within Level 2. We may transact in the fund on a semi-monthly basis. Our trustee provides valuation of our nuclear decommissioning trust assets by using pricing services to determine fair market value. We assess these valuations and verify that pricing can be supported by actual recent market transactions. The trust fund investments have been established to satisfy APS’ nuclear decommissioning obligations.
Fair Value Tables
The following table presents the fair value at September 30, 2010 of our assets and liabilities that are measured at fair value on a recurring basis (dollars in millions):
                                         
    Quoted Prices     Significant                    
    in Active     Other     Significant              
    Markets for     Observable     Unobservable     Counterparty     Balance at  
    Identical Assets     Inputs     Inputs (a)     Netting &     September 30,  
    (Level 1)     (Level 2)     (Level 3)     Other (b)     2010  
Assets
                                       
Cash equivalents
  $ 122     $     $     $     $ 122  
Risk management activities:
                                       
Commodity contracts
          98       76       (51 )     123  
Nuclear decommissioning trust:
                                       
Equity securities:
                                       
U.S. commingled funds
          151                   151  
Fixed income securities:
                                       
U.S. Treasury
    67                         67  
Corporate
          63                   63  
Mortgage-backed
          61                   61  
Municipality
          71                   71  
Other
          54             (13 )     41  
 
                             
Total
  $ 189     $ 498     $ 76     $ (64 )   $ 699  
 
                             
 
                                       
Liabilities
                                       
Risk management activities:
                                       
Commodity contracts
  $ (2 )   $ (338 )   $ (125 )   $ 328     $ (137 )
 
                             
(a)   Primarily consists of long-dated electricity contracts.
 
(b)   Primarily represents netting under master netting arrangements, including margin and collateral. See Note 8.
The following table presents the fair value at December 31, 2009 of our assets and liabilities that are measured at fair value on a recurring basis (dollars in millions):
                                         
    Quoted Prices     Significant                    
    in Active     Other     Significant              
    Markets for     Observable     Unobservable     Counterparty     Balance at  
    Identical Assets     Inputs     Inputs (a)     Netting &     December 31,  
    (Level 1)     (Level 2)     (Level 3)     Other (b)     2009  
Assets
                                       
Cash equivalents
  $ 97     $     $     $     $ 97  
Risk management activities:
                                       
Commodity contracts
    1       100       42       (64 )     79  
Nuclear decommissioning trust:
                                       
Equity securities:
                                       
U.S. commingled funds
          167                   167  
Fixed income securities:
                                       
U.S. Treasury
    55                         55  
Corporate
          62                   62  
Mortgage-backed
          60                   60  
Municipality
          49                   49  
Other
          21             1       22  
 
                             
Total
  $ 153     $ 459     $ 42     $ (63 )   $ 591  
 
                             
 
                                       
Liabilities
                                       
Risk management activities:
                                       
Commodity contracts
  $ (14 )   $ (246 )   $ (52 )   $ 194     $ (118 )
 
                             
(a)   Primarily consists of long-dated electricity contracts.
 
(b)   Primarily represents netting under master netting arrangements, including margin and collateral. See Note 8.
The following table shows the changes in fair value for assets and liabilities that are measured at fair value on a recurring basis using Level 3 inputs for the three and nine months ended September 30, 2010 and 2009 (dollars in millions):
                                 
    Three Months Ended     Nine Months Ended  
    September 30,     September 30,  
Commodity Contracts   2010     2009     2010     2009  
Net derivative balance at beginning of period
  $ (42 )   $ (16 )   $ (10 )   $ (7 )
Total net gains (losses) realized/unrealized:
                               
Included in earnings
    1       1       (1 )     3  
Included in OCI
    (11 )     (2 )     (20 )     (3 )
Deferred as a regulatory asset or liability
    (15 )     6       (39 )     12  
Settlements
    12       (4 )     15       (1 )
Transfers into Level 3 from Level 2
    (2 )     (2 )     6       (23 )
Transfers from Level 3 into Level 2
    8       4             6  
 
                       
Net derivative balance at end of period
  $ (49 )   $ (13 )   $ (49 )   $ (13 )
 
                       
 
                               
Net unrealized gains (losses) included in earnings related to instruments still held at end of period
  $ 1     $ 1     $     $ 3  
Amounts included in earnings are recorded in either regulated electricity segment revenue or regulated electricity segment fuel and purchased power depending on the nature of the underlying contract.
Transfers reflect the fair market value at the beginning of the period and are triggered by a change in the lowest significant input as of the end of the period. We had no significant Level 1 transfers to or from any other hierarchy level. Transfers in or out of Level 3 are typically related to our long-dated energy transactions that extend beyond available quoted periods.
Nonrecurring Fair Value Measurements
We may be required to record other assets at fair value on a nonrecurring basis. These nonrecurring fair value measurements typically involve write-downs of individual assets due to impairment.
We apply nonrecurring fair value measurements to certain real estate assets. These adjustments to fair value are the result of write-downs of individual assets due to impairment. Our real estate assets have been impaired due to the distressed real estate market. The majority of our real estate assets reflect the expected sales price less cost to sell at September 30, 2010. Due to these unobservable inputs, the valuation of real estate assets are considered Level 3 measurements.
Financial Instruments Not Carried at Fair Value
The carrying value of our net accounts receivable, accounts payable and short-term borrowings approximate fair value. Our long-term debt fair value estimates are based on quoted market prices of the same or similar issues. Certain of our debt instruments contain third-party credit enhancements and, in accordance with GAAP, we do not consider the effect of these credit enhancements when determining fair value.
The following table represents the carrying amount and estimated fair value of our long-term debt, including current maturities (dollars in millions):
                                 
    As of     As of  
    September 30, 2010     December 31, 2009  
    Carrying             Carrying        
    Amount     Fair Value     Amount     Fair Value  
 
 
Pinnacle West
  $ 175     $ 178     $ 175     $ 180  
APS
    3,521       3,919       3,530       3,667  
SunCor (a)
    6       6       95       95  
 
                       
Total
  $ 3,702     $ 4,103     $ 3,800     $ 3,942  
 
                       
(a)   See Note 2 for further discussion related to SunCor’s debt and liquidity matters.
Nuclear Decommissioning Trust
To fund the costs APS expects to incur to decommission Palo Verde, APS established external decommissioning trusts in accordance with NRC regulations. Third-party investment managers are authorized to buy and sell securities per their stated investment guidelines. The trust funds are invested in a tax efficient manner in fixed income securities and domestic equity securities. APS classifies investments in decommissioning trust funds as available for sale, and therefore, we record the decommissioning trust funds at their fair value on our Condensed Consolidated Balance Sheets. Because of the ability of APS to recover decommissioning costs in rates and in accordance with the regulatory treatment for decommissioning trust funds, we have recorded the offsetting amount of gains or losses on investment securities in other regulatory liabilities or assets. The following table summarizes the fair value of APS’ nuclear decommissioning trust fund assets at September 30, 2010 and December 31, 2009 (dollars in millions):
                         
            Total     Total  
            Unrealized     Unrealized  
    Fair Value     Gains     Losses  
September 30, 2010
                       
Equity securities
  $ 151     $ 31     $ (4 )
Fixed income securities
    316       20        
Net payables (a)
    (13 )            
 
                 
Total
  $ 454     $ 51     $ (4 )
 
                 
(a)   Net payables relate to pending securities sales and purchases.
                         
            Total     Total  
            Unrealized     Unrealized  
    Fair Value     Gains     Losses  
December 31, 2009
                       
Equity securities
  $ 167     $ 37     $ (6 )
Fixed income securities
    247       11       (1 )
Net receivables (a)
    1              
 
                 
Total
  $ 415     $ 48     $ (7 )
 
                 
(a)   Net receivables relate to pending securities sales and purchases.
The costs of securities sold are determined on the basis of specific identification. The following table sets forth approximate realized gains and losses and proceeds from the sale of securities by the nuclear decommissioning trust funds (dollars in millions):
                                 
    Three Months Ended     Nine Months Ended  
    September 30,     September 30,  
    2010     2009     2010     2009  
Realized gains
  $ 1     $ 3     $ 15     $ 8  
Realized losses
          (1 )     (3 )     (6 )
Proceeds from the sale of securities (a)
    94       126       424       370  
(a)   Proceeds are reinvested in the trust.
The fair value of fixed income securities, summarized by contractual maturities, at September 30, 2010 is as follows (dollars in millions):
         
    Fair Value  
Less than one year
  $ 26  
1 year - 5 years
    74  
5 years - 10 years
    93  
Greater than 10 years
    123  
 
     
Total
  $ 316  
 
     
Real Estate Impairment Charge
Real Estate Impairment Charge
16. Real Estate Impairment Charge
In 2009, SunCor undertook and completed a review of its assets and strategies within its various markets as a result of the distressed conditions in real estate and credit markets. Based on the results of the review, on March 27, 2009, SunCor’s Board of Directors authorized a series of strategic transactions to dispose of SunCor’s homebuilding operations, master-planned communities, land parcels, commercial assets and golf courses in order to reduce SunCor’s outstanding debt. In July 2010, SunCor sold land parcels, commercial assets and a master planned home-building community for approximately $70 million, which approximated the carrying value of these assets, resulting in a net gain of zero. It is expected that SunCor will dispose of its other assets within the next 12 months. As a result, they are classified as assets held for sale on the balance sheet at September 30, 2010 and all of SunCor’s operations are reflected in discontinued operations. The detail of the impairment charges are as follows (dollars in millions, and before income taxes):
                                 
    Three Months Ended     Nine Months Ended  
    September 30,     September 30,  
    2010     2009     2010     2009  
Discontinued Operations:
                               
Homebuilding and master-planned communities
  $     $ 10     $ 1     $ 160  
Land parcels and commercial assets
          27       11       81  
Golf courses
          1       1       19  
Other
                4        
 
                       
Subtotal
          38       17       260  
Less noncontrolling interests
                      (14 )
 
                       
Total
  $     $ 38     $ 17     $ 246  
 
                       
See Note 2 for a discussion of SunCor’s debt and liquidity matters.
Condensed Consolidated Statements of Income (APSC) (Unaudited) (USD $)
In Thousands
3 Months Ended
Sep. 30,
9 Months Ended
Sep. 30,
2010
2009
2010
2009
ELECTRIC OPERATING REVENUES
$ 1,116,211 
$ 1,083,750 
$ 2,527,052 
$ 2,498,838 
OPERATING EXPENSES
 
 
 
 
Fuel and purchased power
353,904 
381,543 
821,244 
920,630 
Operations and maintenance
221,469 
198,030 
644,415 
610,401 
Depreciation and amortization
104,194 
103,008 
307,864 
304,066 
Taxes other than income taxes
37,528 
34,015 
100,936 
100,788 
Other expenses
18,365 
5,033 
41,009 
15,862 
Total
735,460 
721,629 
1,915,468 
1,951,747 
OPERATING INCOME
403,625 
367,407 
664,566 
563,255 
OTHER INCOME (DEDUCTIONS)
 
 
 
 
Allowance for equity funds used during construction
5,524 
2,197 
16,417 
11,919 
Other income (Note S-2)
4,348 
4,386 
3,828 
4,102 
Other expense (Note S-2)
(3,855)
(1,934)
(8,650)
(8,887)
Total
6,017 
4,649 
11,595 
7,134 
INTEREST EXPENSE
 
 
 
 
Allowance for borrowed funds used during construction
(6,163)
(1,349)
(12,314)
(8,318)
Total
54,328 
58,950 
169,623 
169,129 
NET INCOME
239,039 
191,023 
357,708 
97,799 
Less: Net income (loss) attributable to noncontrolling interests (Notes 7 and 16)
5,119 
4,371 
15,005 
(690)
NET INCOME ATTRIBUTABLE TO COMMON SHAREHOLDERS
233,920 
186,652 
342,703 
98,489 
ARIZONA PUBLIC SERVICE COMPANY
 
 
 
 
ELECTRIC OPERATING REVENUES
1,116,220 
1,083,825 
2,527,163 
2,499,072 
OPERATING EXPENSES
 
 
 
 
Fuel and purchased power
353,904 
381,543 
821,244 
920,630 
Operations and maintenance
217,044 
193,530 
632,235 
595,929 
Depreciation and amortization
104,152 
102,954 
307,731 
303,814 
Income taxes
126,841 
118,923 
177,089 
158,041 
Taxes other than income taxes
37,270 
33,782 
100,171 
100,077 
Total
839,211 
830,732 
2,038,470 
2,078,491 
OPERATING INCOME
277,009 
253,093 
488,693 
420,581 
OTHER INCOME (DEDUCTIONS)
 
 
 
 
Income taxes
1,272 
1,070 
3,769 
3,684 
Allowance for equity funds used during construction
5,524 
2,197 
16,417 
11,919 
Other income (Note S-2)
2,962 
3,530 
3,872 
7,580 
Other expense (Note S-2)
(4,074)
(2,790)
(11,091)
(10,798)
Total
5,684 
4,007 
12,967 
12,385 
INTEREST EXPENSE
 
 
 
 
Interest on long-term debt
53,946 
54,252 
161,918 
157,980 
Interest on short-term borrowings
2,013 
1,058 
5,734 
5,326 
Debt discount, premium and expense
1,121 
1,115 
3,376 
3,560 
Allowance for borrowed funds used during construction
(6,163)
(1,343)
(12,254)
(8,284)
Total
50,917 
55,082 
158,774 
158,582 
NET INCOME
231,776 
202,018 
342,886 
274,384 
Less: Net income (loss) attributable to noncontrolling interests (Notes 7 and 16)
5,128 
4,953 
15,034 
14,254 
NET INCOME ATTRIBUTABLE TO COMMON SHAREHOLDERS
$ 226,648 
$ 197,065 
$ 327,852 
$ 260,130 
Condensed Consolidated Balance Sheets (APSC) (Unaudited) (USD $)
In Thousands
9 Months Ended
Sep. 30, 2010
Year Ended
Dec. 31, 2009
PROPERTY, PLANT AND EQUIPMENT
 
 
Plant in service and held for future use
$ 12,987,278 
$ 12,848,138 
Accumulated depreciation and amortization
(4,459,579)
(4,340,645)
Net
8,527,699 
8,507,493 
Construction work in progress
555,137 
467,700 
Palo Verde sale leaseback, net of accumulated depreciation (Note 7)
140,145 
146,722 
Intangible assets, net of accumulated amortization
178,666 
164,380 
Nuclear fuel, net of accumulated amortization
124,101 
118,243 
Total property, plant and equipment
9,525,748 
9,404,538 
INVESTMENTS AND OTHER ASSETS
 
 
Nuclear decommissioning trust (Note 15)
453,963 
414,576 
Assets from risk management activities (Note 8)
54,968 
28,855 
Other assets
112,797 
110,091 
Total investments and other assets
621,728 
673,511 
CURRENT ASSETS
 
 
Cash and cash equivalents
195,915 
145,378 
Customer and other receivables
387,435 
301,915 
Accrued unbilled revenues
180,006 
110,971 
Allowance for doubtful accounts
(7,901)
(6,153)
Materials and supplies (at average cost)
174,428 
176,020 
Fossil fuel (at average cost)
21,826 
39,245 
Assets from risk management activities (Note 8)
68,476 
50,619 
Deferred income taxes
134,012 
53,990 
Other current assets
43,983 
30,747 
Total current assets
1,243,332 
928,737 
DEFERRED DEBITS
 
 
Regulatory assets
879,056 
813,161 
Income tax receivable (Note 6)
65,103 
65,103 
Other
100,520 
101,274 
Total deferred debits
1,044,679 
979,538 
TOTAL ASSETS
12,435,487 
11,986,324 
CAPITALIZATION
 
 
Common stock
2,416,503 
2,149,483 
Retained earnings
1,473,683 
1,298,213 
Accumulated other comprehensive loss:
 
 
Pension and other postretirement benefits
(52,626)
(50,892)
Derivative instruments
(120,634)
(80,695)
Total shareholder equity
3,716,926 
3,316,109 
Noncontrolling interests (Note 7)
111,303 
111,895 
Total equity
3,828,229 
3,428,004 
Long-term debt less current maturities (Note 2)
3,349,927 
3,370,524 
Palo Verde sale leaseback lessor notes (Notes 2 and 7)
113,379 
126,000 
CURRENT LIABILITIES
 
 
Current maturities of long-term debt (Note 2)
238,513 
303,476 
Accounts payable
253,565 
240,637 
Accrued taxes
157,697 
104,011 
Accrued interest
52,384 
54,596 
Customer deposits
68,254 
71,026 
Liabilities from risk management activities (Note 8)
55,847 
55,908 
Other current liabilities
141,547 
125,574 
Total current liabilities
967,807 
1,108,943 
DEFERRED CREDITS AND OTHER
 
 
Deferred income taxes
1,868,860 
1,496,095 
Deferred fuel and purchased power regulatory liability (Note 3)
41,385 
87,291 
Other regulatory liabilities
685,908 
679,072 
Liability for asset retirements
323,134 
301,783 
Liabilities for pension and other postretirement benefits (Note 4)
737,644 
811,338 
Liabilities from risk management activities (Note 8)
80,656 
62,443 
Customer advances
127,449 
136,595 
Coal mine reclamation
117,029 
92,060 
Unrecognized tax benefits (Note 6)
66,837 
142,099 
Other
127,243 
144,077 
Total deferred credits and other
4,176,145 
3,952,853 
COMMITMENTS AND CONTINGENCIES (SEE NOTES)
 
 
TOTAL LIABILITIES AND EQUITY
12,435,487 
11,986,324 
ARIZONA PUBLIC SERVICE COMPANY
 
 
PROPERTY, PLANT AND EQUIPMENT
 
 
Plant in service and held for future use
12,982,572 
12,781,256 
Accumulated depreciation and amortization
(4,456,017)
(4,326,908)
Net
8,526,555 
8,454,348 
Construction work in progress
555,137 
460,748 
Palo Verde sale leaseback, net of accumulated depreciation (Note 7)
140,145 
146,722 
Intangible assets, net of accumulated amortization
178,479 
164,183 
Nuclear fuel, net of accumulated amortization
124,101 
118,243 
Total property, plant and equipment
9,524,417 
9,344,244 
INVESTMENTS AND OTHER ASSETS
 
 
Nuclear decommissioning trust (Note 15)
453,963 
414,576 
Assets from risk management activities (Note 8)
54,968 
28,855 
Other assets
70,383 
68,839 
Total investments and other assets
579,314 
512,270 
CURRENT ASSETS
 
 
Cash and cash equivalents
162,272 
120,798 
Customer and other receivables
359,053 
280,226 
Accrued unbilled revenues
180,006 
110,971 
Allowance for doubtful accounts
(7,660)
(6,063)
Materials and supplies (at average cost)
174,428 
176,020 
Fossil fuel (at average cost)
21,826 
39,245 
Assets from risk management activities (Note 8)
68,476 
50,619 
Deferred income taxes
81,719 
53,990 
Other current assets
42,901 
25,724 
Total current assets
1,083,021 
851,530 
DEFERRED DEBITS
 
 
Regulatory assets
879,056 
813,161 
Income tax receivable (Note 6)
65,498 
65,498 
Unamortized debt issue costs
19,719 
20,959 
Other
77,448 
73,909 
Total deferred debits
1,041,721 
973,527 
TOTAL ASSETS
12,228,473 
11,681,571 
CAPITALIZATION
 
 
Common stock
178,162 
178,162 
Additional paid-in capital
2,379,696 
2,126,863 
Retained earnings
1,421,679 
1,250,126 
Accumulated other comprehensive loss:
 
 
Pension and other postretirement benefits
(31,149)
(29,114)
Derivative instruments
(120,614)
(80,682)
Total shareholder equity
3,827,774 
3,445,355 
Noncontrolling interests (Note 7)
94,073 
82,324 
Total equity
3,921,847 
3,527,679 
Long-term debt less current maturities (Note 2)
3,349,924 
3,180,406 
Palo Verde sale leaseback lessor notes (Notes 2 and 7)
113,379 
126,000 
Total capitalization
7,385,150 
6,834,085 
CURRENT LIABILITIES
 
 
Current maturities of long-term debt (Note 2)
57,275 
222,959 
Accounts payable
227,224 
213,833 
Accrued taxes
174,192 
158,051 
Accrued interest
52,112 
54,099 
Customer deposits
68,206 
70,780 
Liabilities from risk management activities (Note 8)
55,847 
55,908 
Other current liabilities
135,931 
124,995 
Total current liabilities
770,787 
900,625 
DEFERRED CREDITS AND OTHER
 
 
Deferred income taxes
1,840,300 
1,582,945 
Deferred fuel and purchased power regulatory liability (Note 3)
41,385 
87,291 
Other regulatory liabilities
685,908 
679,072 
Liability for asset retirements
323,134 
301,783 
Liabilities for pension and other postretirement benefits (Note 4)
697,686 
766,378 
Liabilities from risk management activities (Note 8)
80,656 
62,443 
Customer advances
127,449 
136,595 
Coal mine reclamation
117,029 
92,060 
Unrecognized tax benefits (Note 6)
65,863 
140,638 
Other
93,126 
97,656 
Total deferred credits and other
4,072,536 
3,946,861 
COMMITMENTS AND CONTINGENCIES (SEE NOTES)
 
 
TOTAL LIABILITIES AND EQUITY
$ 12,228,473 
$ 11,681,571 
Condensed Consolidated Statements of Cash Flows (APSC) (Unaudited) (USD $)
In Thousands
9 Months Ended
Sep. 30,
2010
2009
CASH FLOWS FROM OPERATING ACTIVITIES
 
 
Net Income
$ 357,708 
$ 97,799 
Adjustments to reconcile net income to net cash provided by operating activities:
 
 
Depreciation and amortization including nuclear fuel
350,762 
338,311 
Deferred fuel and purchased power
50,020 
(46,743)
Deferred fuel and purchased power amortization
(95,926)
115,214 
Allowance for equity funds used during construction
(16,417)
(11,919)
Deferred income taxes
281,486 
154,517 
Change in mark-to-market valuations
3,716 
(5,970)
Changes in current assets and liabilities:
 
 
Customer and other receivables
(103,973)
(79,297)
Accrued unbilled revenues
(69,035)
(56,420)
Materials, supplies and fossil fuel
19,011 
(16,781)
Other current assets
(13,236)
26,308 
Accounts payable
36,687 
(35,923)
Accrued taxes
56,851 
(120,878)
Other current liabilities
10,989 
8,789 
Change in margin and collateral accounts - assets
(4,336)
1,652 
Change in margin and collateral accounts - liabilities
(143,725)
3,564 
Change in regulatory liabilities
40,121 
92,598 
Change in unrecognized tax benefits
(72,649)
92,720 
Change in other long-term assets
(51,659)
(49,577)
Change in other long-term liabilities
(28,547)
15,491 
Net cash flow provided by operating activities
569,500 
770,968 
CASH FLOWS FROM INVESTING ACTIVITIES
 
 
Capital expenditures
(552,707)
(558,495)
Contributions in aid of construction
25,258 
17,393 
Allowance for borrowed funds used during construction
(12,553)
(8,568)
Proceeds from nuclear decommissioning trust sales
424,255 
370,399 
Investment in nuclear decommissioning trust
(442,567)
(386,743)
Other
9,621 
(1,404)
Net cash flow used for investing activities
(377,219)
(536,571)
CASH FLOWS FROM FINANCING ACTIVITIES
 
 
Issuance of long-term debt
867,582 
Repayment of long-term debt
(84,529)
(421,079)
Short-term borrowings and payments - net
(153,715)
(528,217)
Dividends paid on common stock
(161,722)
(153,740)
Noncontrolling interests
(3,286)
(3,393)
Net cash flow used for financing activities
(141,744)
(238,818)
NET INCREASE IN CASH AND CASH EQUIVALENTS
50,537 
(4,421)
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD
145,378 
105,245 
CASH AND CASH EQUIVALENTS AT END OF PERIOD
195,915 
100,824 
Cash paid during the period for:
 
 
Income taxes, net of (refunds)
(22,165)
(34,700)
Interest, net of amounts capitalized
167,576 
163,438 
ARIZONA PUBLIC SERVICE COMPANY
 
 
CASH FLOWS FROM OPERATING ACTIVITIES
 
 
Net Income
342,886 
274,384 
Adjustments to reconcile net income to net cash provided by operating activities:
 
 
Depreciation and amortization including nuclear fuel
349,267 
334,092 
Deferred fuel and purchased power
50,020 
(46,743)
Deferred fuel and purchased power amortization
(95,926)
115,214 
Allowance for equity funds used during construction
(16,417)
(11,919)
Deferred income taxes
218,575 
252,282 
Change in mark-to-market valuations
3,716 
(5,970)
Changes in current assets and liabilities:
 
 
Customer and other receivables
(93,394)
(92,535)
Accrued unbilled revenues
(69,035)
(56,420)
Materials, supplies and fossil fuel
19,011 
(16,781)
Other current assets
(17,177)
(2,473)
Accounts payable
37,150 
(28,018)
Accrued taxes
16,141 
(149,990)
Other current liabilities
6,375 
(740)
Change in margin and collateral accounts - assets
(4,336)
1,251 
Change in margin and collateral accounts - liabilities
(143,725)
3,564 
Change in regulatory liabilities
40,121 
92,598 
Change in unrecognized tax benefits
(72,217)
92,973 
Change in other long-term assets
(53,566)
(54,781)
Change in other long-term liabilities
(11,686)
13,473 
Net cash flow provided by operating activities
505,783 
713,461 
CASH FLOWS FROM INVESTING ACTIVITIES
 
 
Capital expenditures
(552,331)
(551,042)
Contributions in aid of construction
25,258 
17,393 
Allowance for borrowed funds used during construction
(12,254)
(8,284)
Proceeds from nuclear decommissioning trust sales
424,255 
370,399 
Investment in nuclear decommissioning trust
(442,567)
(386,743)
Other
9,621 
(1,404)
Net cash flow used for investing activities
(548,018)
(559,681)
CASH FLOWS FROM FINANCING ACTIVITIES
 
 
Issuance of long-term debt
863,903 
Repayment of long-term debt
(9,538)
(350,312)
Short-term borrowings and payments - net
(521,684)
Equity infusion
252,833 
Dividends paid on common stock
(156,300)
(127,500)
Noncontrolling interests
(3,286)
(3,393)
Net cash flow used for financing activities
83,709 
(138,986)
NET INCREASE IN CASH AND CASH EQUIVALENTS
41,474 
14,794 
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD
120,798 
71,544 
CASH AND CASH EQUIVALENTS AT END OF PERIOD
162,272 
86,338 
Cash paid during the period for:
 
 
Income taxes, net of (refunds)
76,364 
13,555 
Interest, net of amounts capitalized
$ 157,385 
$ 146,062 
S-1. Changes in Equity (APSC)
9 Months Ended
Sep. 30, 2010
S-1. Changes in Equity
ARIZONA PUBLIC SERVICE COMPANY
 
S-1. Changes in Equity
9. Changes in Equity
The following tables show Pinnacle West’s changes in shareholders’ equity and changes in equity of noncontrolling interests for the three and nine months ended September 30, 2010 and 2009 (dollars in thousands):
                                                 
    Three Months Ended September 30, 2010     Three Months Ended September 30, 2009  
    Common     Noncontrolling             Common     Noncontrolling        
    Shareholders     Interests     Total     Shareholders     Interests     Total  
 
                                               
Beginning balance, July 1
  $ 3,479,548     $ 113,455     $ 3,593,003     $ 3,206,805     $ 112,677     $ 3,319,482  
 
                                               
Net income
    233,920       5,119       239,039       186,652       4,371       191,023  
 
                                   
Other comprehensive income (loss):
                                               
Net unrealized gains (losses) on derivative instruments (a)
    (67,856 )           (67,856 )     4,959             4,959  
Net reclassification of realized losses to income (b)
    59,801             59,801       81,660             81,660  
Reclassification of pension and other postretirement benefits to income
    1,314             1,314       1,240             1,240  
Net income tax benefit (expense) related to items of other comprehensive income (loss)
    2,660             2,660       (34,495 )           (34,495 )
 
                                   
Total other comprehensive income (loss)
    (4,081 )           (4,081 )     53,364             53,364  
 
                                   
Total comprehensive income
    229,839       5,119       234,958       240,016       4,371       244,387  
 
                                   
 
                                               
Issuance of capital stock
    2,506             2,506       2,756             2,756  
Purchase of treasury stock, net of reissuances
    577             577       589             589  
Other (primarily stock compensation)
    4,456             4,456       (372 )           (372 )
Dividends on common stock
                      (53,132 )           (53,132 )
Net capital activities by noncontrolling interests
          (7,271 )     (7,271 )           (93 )     (93 )
 
                                   
Ending balance, September 30
  $ 3,716,926     $ 111,303     $ 3,828,229     $ 3,396,662     $ 116,955     $ 3,513,617  
 
                                   
                                                 
    Nine Months Ended September 30, 2010     Nine Months Ended September 30, 2009  
    Common     Noncontrolling             Common     Noncontrolling        
    Shareholders     Interests     Total     Shareholders     Interests     Total  
 
                                               
Beginning balance, January 1
  $ 3,316,109     $ 111,895     $ 3,428,004     $ 3,445,979     $ 124,990     $ 3,570,969  
 
                                               
Net income (loss)
    342,703       15,005       357,708       98,489       (690 )     97,799  
 
                                   
Other comprehensive income (loss):
                                               
Net unrealized losses on derivative instruments (a)
    (168,110 )           (168,110 )     (128,035 )           (128,035 )
Net reclassification of realized losses to income (b)
    102,130             102,130       154,990             154,990  
Reclassification of pension and other postretirement benefits to income
    4,069             4,069       3,745             3,745  
Net unrealized losses related to pension and other postretirement benefits
    (6,933 )           (6,933 )     (4,204 )           (4,204 )
Net income tax benefit (expense) related to items of other comprehensive income (loss)
    27,171             27,171       (10,337 )           (10,337 )
 
                                   
Total other comprehensive income (loss)
    (41,673 )           (41,673 )     16,159             16,159  
 
                                   
Total comprehensive income (loss)
    301,030       15,005       316,035       114,648       (690 )     113,958  
 
                                   
 
                                               
Issuance of capital stock
    260,665             260,665       8,102             8,102  
Purchase of treasury stock, net of reissuances
    1,655             1,655       (957 )           (957 )
Other (primarily stock compensation)
    4,598             4,598       (11,899 )           (11,899 )
Dividends on common stock
    (167,131 )           (167,131 )     (159,211 )           (159,211 )
Net capital activities by noncontrolling interests
          (15,597 )     (15,597 )           (7,345 )     (7,345 )
 
                                   
Ending balance, September 30
  $ 3,716,926     $ 111,303     $ 3,828,229     $ 3,396,662     $ 116,955     $ 3,513,617  
 
                                   
     
(a)   These amounts primarily include unrealized gains and losses on contracts used to hedge our forecasted electricity and natural gas requirements to serve Native Load. These changes are primarily due to changes in forward natural gas prices and wholesale electricity prices.
 
(b)   These amounts primarily include the reclassification of unrealized gains and losses to realized gains and losses for contracted commodities delivered during the period.
S-1. Changes in Equity
The following tables show APS’ changes in shareholder equity and changes in equity of noncontrolling interests for the three and nine months ended September 30, 2010 and 2009 (dollars in thousands):
                                                 
    Three Months Ended September 30, 2010     Three Months Ended September 30, 2009  
    Shareholder     Noncontrolling             Shareholder     Noncontrolling        
    Equity     Interests     Total     Equity     Interests     Total  
 
                                               
Beginning balance, July 1
  $ 3,605,292     $ 88,944     $ 3,694,236     $ 3,284,568     $ 83,509     $ 3,368,077  
 
                                               
Net income
    226,648       5,128       231,776       197,065       4,953       202,018  
 
                                   
Other comprehensive income (loss):