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Indicate by check mark whether each registrant (1) has filed all reports required to be filed
by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or
for such shorter period that the registrant was required to file such reports), and (2) has been
subject to such filing requirements for the past 90 days.
PINNACLE WEST CAPITAL CORPORATION
Yes þ
No o
ARIZONA PUBLIC SERVICE COMPANY
Yes þ
No o
Indicate by check mark whether the registrant has submitted electronically and posted on its
corporate Web site, if any, every Interactive Data File required to be submitted and posted
pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period
that the registrant was required to submit and post such files).
PINNACLE WEST CAPITAL CORPORATION
Yes þ
No o
ARIZONA PUBLIC SERVICE COMPANY
Yes o
No o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated
filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large
accelerated filer,”“accelerated filer” and “smaller reporting company” in Rule 12b-2 of the
Exchange Act.
PINNACLE WEST CAPITAL CORPORATION
Large accelerated filer þ
Accelerated filer o
Non-accelerated filer o
Smaller reporting company o
ARIZONA PUBLIC SERVICE COMPANY
Large accelerated filer o
Accelerated filer o
Non-accelerated filer þ
Smaller reporting company o
Indicate by check mark whether each registrant is a shell company (as defined in Exchange Act
Rule 12b-2).
PINNACLE WEST CAPITAL CORPORATION
Yes o
No þ
ARIZONA PUBLIC SERVICE COMPANY
Yes o
No þ
Indicate the number of shares outstanding of each of the issuer’s classes of common stock as
of the latest practicable date.
PINNACLE WEST CAPITAL CORPORATION
Number of shares of common stock, no par
value, outstanding as of July 28, 2010: 108,642,028
ARIZONA PUBLIC SERVICE COMPANY
Number of shares of common stock, $2.50
par value, outstanding as of July 28,2010: 71,264,947
Arizona Public Service Company meets the conditions set forth in General Instruction H(1)(a)
and (b) of Form 10-Q and is therefore filing this form with the reduced disclosure format allowed
under that General Instruction.
This combined Form 10-Q is separately provided by Pinnacle West Capital Corporation
(“Pinnacle West”) and Arizona Public Service Company (“APS”). Any use of the words “Company,”“we,” and “our” refer to Pinnacle West. Each registrant is providing on its own behalf all of the
information contained in this Form 10-Q that relates to such registrant and, where required, its
subsidiaries. Except as stated in the preceding sentence, neither registrant is providing any
information that does not relate to such registrant, and therefore makes no representation as to
any such information. The information required with respect to each company is set forth within
the applicable items. Item 1 of this report includes Condensed Consolidated Financial Statements
of Pinnacle West and Condensed Consolidated Financial Statements of APS. Item 1 also includes
Notes to Pinnacle West’s Condensed Consolidated Financial Statements, the majority of which also
relates to APS, and Supplemental Notes, which only relate to APS’ Condensed Consolidated Financial
Statements. Item 2 of this report is divided into two sections — Pinnacle West Consolidated and
APS. The Pinnacle West Consolidated section describes Pinnacle West and its subsidiaries on a
consolidated basis, including discussions of Pinnacle West’s regulated utility and non-utility
operations.
This document contains forward-looking statements based on current expectations, and neither
Pinnacle West nor APS assumes any obligation to update these statements, even if our internal
estimates change, except as required by applicable law. These forward-looking statements are often
identified by words such as “estimate,”“predict,”“may,”“believe,”“plan,”“expect,”“require,”“intend,”“assume” and similar words. Because actual results may differ materially from
expectations, we caution readers not to place undue reliance on these statements. A number of
factors could cause future results to differ materially from historical results, or from outcomes
currently expected or sought by Pinnacle West or APS. In addition to the Risk Factors described in
Item 1A of the Pinnacle West/APS Annual Report on Form 10-K for the fiscal year ended December 31,2009 (“2009 Form 10-K”) and in Item 2 — Management’s Discussion and Analysis of Financial Condition
and Results of Operations herein, these factors include, but are not limited to:
•
regulatory and judicial decisions, developments and proceedings;
•
our ability to achieve timely and adequate rate recovery of our costs;
•
our ability to reduce capital expenditures and other costs while maintaining reliability
and customer service levels;
•
variations in demand for electricity, including those due to weather, the general economy,
customer and sales growth (or decline), and the effects of energy conservation measures;
•
power plant performance and outages;
•
volatile fuel and purchased power costs;
•
fuel and water supply availability;
•
new legislation or regulation relating to greenhouse gas emissions, renewable energy
mandates and energy efficiency standards;
•
our ability to meet renewable energy requirements and recover related costs, including
returns on debt and equity capital;
•
risks inherent in the operation of nuclear facilities, including spent fuel disposal
uncertainty;
•
competition in retail and wholesale power markets;
•
the duration and severity of the economic decline in Arizona and current credit, financial
and real estate market conditions;
•
the cost of debt and equity capital and the ability to access capital markets when
required;
•
restrictions on dividends or other burdensome provisions in our credit agreements and
Arizona Corporation Commission (“ACC”) orders;
•
our ability, or the ability of our subsidiaries, to meet debt service obligations;
•
changes to our credit ratings;
•
the investment performance of the assets of our nuclear decommissioning trust, pension, and
other postretirement benefit plans and the resulting impact on future funding requirements;
•
the liquidity of wholesale power markets and the use of derivative contracts in our
business;
•
potential shortfalls in insurance coverage;
•
new accounting requirements or new interpretations of existing requirements;
•
transmission and distribution system conditions and operating costs;
•
the ability to meet the anticipated future need for additional baseload generation and
associated transmission facilities in our region;
•
the ability of our counterparties and power plant participants to meet contractual or other
obligations;
•
technological developments in the electric industry; and
•
economic and other conditions affecting SunCor Development Company’s (“SunCor”) ability to
dispose of its remaining assets and satisfy its debt obligations.
These and other factors are discussed in Risk Factors described in Item 1A of our 2009 Form 10-K,
which readers should review carefully before placing any reliance on our financial statements or
disclosures.
PINNACLE WEST CAPITAL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
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 (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 the
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 variable
interest entities (“VIEs”) (see
Note 7). The following tables show
the impacts of the
reclassifications to prior year
(previously reported) amounts
(dollars in
thousands):
PINNACLE WEST CAPITAL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
Reclassifications as a
Amounts reported
result of the adoption of
after adoption of
As previously
the new VIE accounting
amended VIE
reported
guidance
accounting guidance
Statement of Cash Flows for the Six Months Ended June 30, 2009
Cash Flows from Operating Activities
Net loss
$
(102,525
)
$
9,301
$
(93,224
)
Depreciation and amortization
including nuclear fuel
218,939
3,851
222,790
Other current liabilities
(7,977
)
(7,818
)
(15,795
)
Other long-term assets
(8,025
)
2
(8,023
)
Other long-term liabilities
46,898
4,662
51,560
Cash Flows from Financing Activities
Repayment and acquisition of
long-term debt
(195,767
)
(6,605
)
(202,372
)
Noncontrolling interests
—
(3,393
)
(3,393
)
Supplemental Disclosure of Cash Flow
Information
Cash paid for Interest, Net of Amounts
Capitalized
90,847
6,677
97,524
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 June 30, 2010 (dollars in millions):
Consolidated
Consolidated
Year
Pinnacle West
APS
2010
$
271
$
181
2011
632
457
2012
478
478
2013
92
92
2014
503
503
Thereafter
1,816
1,816
Total
$
3,792
$
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 CAPITAL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
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 June 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 June 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 June 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 June 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.
PINNACLE WEST CAPITAL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
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 June 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, 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
will be recognized in the third quarter of 2010.
At June 30, 2010, SunCor had approximately $103 million of assets on its balance sheet
classified as assets held for sale. These assets consisted of the $70 million of assets sold
in July as discussed above, $25 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 June 30, 2010, SunCor had $94 million of debt outstanding under various credit facilities,
all of which was in default. After the sale and debt restructuring discussed above, $6 million
remains outstanding. 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 June 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 common equity divided by the sum of common
equity and long-term debt, including current maturities of long-term debt. At June 30, 2010, APS’
common equity ratio, as defined, was 52%. Its total shareholder equity was approximately $3.6
billion, and total capitalization was approximately $7.0 billion. APS would be prohibited from
paying dividends if the payment would reduce its common equity below approximately $2.8 billion,
assuming APS’ total capitalization remains the same. This restriction does not materially affect
Pinnacle West’s ability to meet its ongoing capital requirements.
PINNACLE WEST CAPITAL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
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;
•
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.
PINNACLE WEST CAPITAL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
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.
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. Third party
developers may also own systems that participate in the pilot. 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 includes two
components to address issues that have arisen in the past year: 1) enhancements to the residential
distributed energy incentive program based on high customer participation; and 2) two programs
offered in response to ACC workshops on “feed-in tariffs,” which provide opportunities for
streamlined development of certain renewable 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 $78.9 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 $74.5 million over a twelve month
period beginning March 1, 2011.
PINNACLE WEST CAPITAL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
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 six-month periods
ended June 30, 2010 and 2009 (dollars in millions):
Deferred fuel and purchased power costs-current period
(65
)
(13
)
Amounts refunded (recovered)
55
(66
)
Ending balance
$
(97
)
$
(71
)
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 June 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.
PINNACLE WEST CAPITAL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
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.
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.
PINNACLE WEST CAPITAL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
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):
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.
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, 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 June 30, 2010 and all of SunCor’s operations have been reclassified to
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.
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 in the period ended June 30, 2010. See Note 14 — Discontinued Operations.
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 six
months ended June 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 $65 million long-term income tax receivable on the Condensed Consolidated Balance Sheets
represents the anticipated refunds related to an APS tax accounting method change approved by the
Internal Revenue Service (“IRS”) in the third quarter of 2009.
PINNACLE WEST CAPITAL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
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 June 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.
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 we are the operating agent for Palo Verde, are obligated to
decommission the leased assets and have 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 six months ended June 30, 2010 of $5 million and of $10 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.
Property plant and equipment, net of accumulated
depreciation
$
142
Long-term debt including current maturities
143
Equity- Noncontrolling interests
89
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 June 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 June 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 $25 million of
assets and $25 million of noncontrolling equity interests relating to these arrangements at June30, 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.
PINNACLE WEST CAPITAL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
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 June 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.
PINNACLE WEST CAPITAL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
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 June 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
16,004,799
megawatt hours
Gas
166,950,111
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 six months ended June 30, 2010 and 2009 (dollars in
thousands):
Three Months Ended
Six Months Ended
Financial Statement
June 30,
June 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
$
(8,588
)
$
5,554
$
(100,255
)
$
(132,994
)
Amount of Loss Reclassified
from AOCI into Income (Effective Portion Realized)
Regulated electricity segment
fuel and purchased power
(29,143
)
(47,964
)
(42,329
)
(73,330
)
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
11,899
(4,900
)
1,432
(3,908
)
(a)
During the three and six months ended June 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 $101 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.
PINNACLE WEST CAPITAL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
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 six months ended June 30, 2010 and 2009 (dollars in
thousands):
Three Months Ended
Six Months Ended
Financial Statement
June 30,
June 30,
Commodity Contracts
Location
2010
2009
2010
2009
Amount of Net
Gain Recognized
in Income from Derivative Instruments
Regulated
electricity segment revenue
$
426
$
766
$
595
$
337
Amount of Net
Gain (Loss)
Recognized in Income from Derivative Instruments
Regulated electricity segment fuel and purchased power expense
PINNACLE WEST CAPITAL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
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 June 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
$
10
$
—
$
14
$
70
$
94
Liabilities
(188
)
(1,285
)
(115,010
)
(98,430
)
(214,913
)
Total hedging
instruments
(178
)
(1,285
)
(114,996
)
(98,360
)
(214,819
)
Derivatives not
designated as accounting
hedging instruments:
PINNACLE WEST CAPITAL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
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 one counterparty for which our
exposure represents approximately 34% of Pinnacle West’s $104 million of risk management assets as
of June 30, 2010. This exposure relates to a long-term traditional wholesale contract with a
counterparty that has 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.
PINNACLE WEST CAPITAL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
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 June 30, 2010 was $390
million, for which we had posted collateral of $192 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 triggered on June 30, 2010, after off-setting asset positions
under master netting arrangements we would have been required to post approximately an additional
$90 million of collateral to our counterparties; this amount includes those contracts which 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 also require us to post additional collateral of approximately $200
million if our debt credit ratings were to fall below investment grade.
PINNACLE WEST CAPITAL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
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 six months ended June 30, 2010 and 2009
(dollars in thousands):
Net unrealized losses
on derivative
instruments (a)
(100,255
)
—
(100,255
)
(132,994
)
—
(132,994
)
Net reclassification of
realized losses to
income (b)
42,329
—
42,329
73,330
—
73,330
Reclassification of
pension and other
postretirement benefits
to income
2,755
—
2,755
2,506
—
2,506
Net unrealized losses
related to pension and
other postretirement
benefits
(6,933
)
—
(6,933
)
(4,204
)
—
(4,204
)
Net income tax benefit
related to items of
other comprehensive
income (loss)
24,511
—
24,511
24,157
—
24,157
Total other comprehensive
loss
(37,593
)
—
(37,593
)
(37,205
)
—
(37,205
)
Total comprehensive
income (loss)
71,190
9,886
81,076
(125,368
)
(5,061
)
(130,429
)
Issuance of capital stock
258,160
—
258,160
5,346
—
5,346
Purchase of treasury
stock,
net of reissuances
1,078
—
1,078
(1,546
)
—
(1,546
)
Other (primarily stock
compensation)
142
—
142
(11,527
)
—
(11,527
)
Dividends on common
stock
(167,131
)
—
(167,131
)
(106,079
)
—
(106,079
)
Net capital activities by
noncontrolling interests
—
(8,326
)
(8,326
)
—
(7,252
)
(7,252
)
Ending balance, June 30
$
3,479,548
$
113,455
$
3,593,003
$
3,206,805
$
112,677
$
3,319,482
(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.
PINNACLE WEST CAPITAL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
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’ share of this amount is approximately $9 million. Because
the appeal period for this decision has not yet passed, APS has not recorded this amount on its
financial statements.
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 June 30, 2010, APS had a regulatory liability of $38 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
APS is party to 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 $637 million in 2010; $347 million in 2011; $377 million in 2012; $479 million in
2013; $506 million in 2014; and $6.8 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 due
to increased solar contracts to meet our increasing renewable energy requirements.
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.
PINNACLE WEST CAPITAL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
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 June 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 $69 million which is included
in other deferred debits on the Condensed Consolidated Balance Sheets. This amount will continue
to increase to approximately $94 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.
PINNACLE WEST CAPITAL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
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.
11. Other Income and Other Expense
The following table provides detail of other income and other expense for the three and six
months ended June 30, 2010 and 2009 (dollars in thousands):
PINNACLE WEST CAPITAL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
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 June 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 June 30, 2010 are as follows (dollars in millions):
Guarantees
Surety Bonds
Term
Term
Amount
(in years)
Amount
(in years)
APSES
$
5
1
$
30
1
APS
3
1
9
1
Total
$
8
$
39
APS has entered into various agreements that require letters of credit for financial assurance
purposes. At June 30, 2010, approximately $227 million of letters of credit were outstanding to
support existing pollution control bonds of approximately $223 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 mode and termination of a corresponding letter of credit for
certain pollution control bonds described in Note 2, the letters of credit outstanding have
decreased since June 30, 2010. Currently, there are approximately $194 million of letters of credit
outstanding to support existing pollution control bonds of approximately $190 million. These
letters of credit expire in 2010 and 2011. APS has also entered into approximately $62 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.
Income from continuing
operations attributable to
common shareholders
$
0.84
$
0.76
$
0.93
$
0.51
Income (loss) from
discontinued operations
0.23
(0.08
)
0.11
(1.38
)
Earnings per share — basic
$
1.07
$
0.68
$
1.04
$
(0.87
)
Diluted earnings per share:
Income from continuing
operations attributable to
common shareholders
$
0.83
$
0.75
$
0.92
$
0.51
Income (loss) from discontinued
operations
0.24
(0.07
)
0.12
(1.38
)
Earnings per share — diluted
$
1.07
$
0.68
$
1.04
$
(0.87
)
Dilutive stock options and performance shares (which are contingently issuable) increased
average diluted common shares outstanding by approximately 409,000 shares and 84,000 shares for the
three months ended June 30, 2010 and 2009, respectively, and by approximately 426,000 shares for
the six months ended June 30, 2010. For the six months ended June 30, 2009 the weighted average
common shares outstanding were the same for both basic and diluted shares.
Options to purchase 387,800 shares of common stock for the three-month period ended June 30,2010, and 599,324 shares for the three-month period ended June 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 387,800
shares and 612,424 shares of common stock for the six-month periods ended June 30, 2010 and
June 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.
14. Discontinued Operations
SunCor (real estate segment) — In July, 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 June30, 2010, SunCor had approximately $103 million of assets on its balance sheet classified as assets
held for sale. These assets consist of the $70 million of assets sold in July as discussed
above, $25 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 six months ended June 30, 2010, all of SunCor’s operations have been reclassified to
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.
PINNACLE WEST CAPITAL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
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. Prior period income statement amounts related to this sale and the
associated revenues and costs were reclassified to 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 six months ended June 30, 2010 and 2009 (dollars in
millions):
Includes a tax benefit recognized by the parent company in accordance with an
intercompany tax sharing agreement of $1 million and $5 million for the three months
ended June 30, 2010, and 2009, respectively; $9 million and $93 million for the six
months ended June 30, 2010 and 2009, respectively.
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.
PINNACLE WEST CAPITAL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
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.
PINNACLE WEST CAPITAL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
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
valuations 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.
PINNACLE WEST CAPITAL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
Fair Value Tables
The following table presents the fair value at June 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 &
June 30,
(Level 1)
(Level 2)
(Level 3)
Other (b)
2010
Assets
Risk management activities:
Commodity contracts
$
—
$
97
$
56
$
(49
)
$
104
Nuclear decommissioning
trust:
Equity securities:
U.S. commingled funds
—
136
—
—
136
Fixed income securities:
U.S. Treasury
56
—
—
—
56
Corporate
—
57
—
—
57
Mortgage-backed
—
61
—
—
61
Municipality
—
68
—
—
68
Other
—
57
—
(11
)
46
Total
$
56
$
476
$
56
$
(60
)
$
528
Liabilities
Risk management activities:
Commodity contracts
$
(2
)
$
(319
)
$
(98
)
$
269
$
(150
)
(a)
Primarily consists of long-dated electricity contracts.
(b)
Primarily represents netting under master netting arrangements, including margin
and collateral. See Note 8.
PINNACLE WEST CAPITAL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
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.
PINNACLE WEST CAPITAL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
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 six months ended
June 30, 2010 and 2009 (dollars in millions):
Three Months
Six Months
Ended June 30,
Ended June 30,
Commodity Contracts
2010
2009
2010
2009
Net derivative balance at beginning of period
$
(31
)
$
(23
)
$
(10
)
$
(7
)
Total net gains (losses) realized/unrealized:
Included in earnings
(1
)
—
(2
)
2
Included in OCI
(3
)
—
(9
)
(1
)
Deferred as a regulatory asset
or liability
(12
)
9
(24
)
6
Settlements
3
3
3
3
Transfers into Level 3 from Level 2
8
(7
)
8
(21
)
Transfers from Level 3 into Level 2
(6
)
2
(8
)
2
Net derivative balance at end of period
$
(42
)
$
(16
)
$
(42
)
$
(16
)
Net unrealized gains (losses) included in
earnings related to instruments still held
at end of period
$
—
$
—
$
(1
)
$
2
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 June 30, 2010. Due
to these unobservable inputs, the valuation of real estate assets are considered Level 3
measurements.
As of June 30, 2010, the fair value of our impaired real estate assets that are measured at
fair value on a nonrecurring basis was $68 million, all of which was valued using significant
unobservable inputs (Level 3). Total impairment charges included in net income for the three and
six months ended June 30, 2010 were approximately $2 million and $17 million, respectively. See
Note 16 for additional information.
PINNACLE WEST CAPITAL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
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):
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 June30, 2010 and December 31, 2009 (dollars in millions):
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):
PINNACLE WEST CAPITAL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
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, 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 June 30, 2010. As a result of the discussion above, as of June 30, 2010, all
of SunCor’s operations have been reclassified to discontinued operations. The detail of the
impairment charges are as follows (dollars in millions, and before income taxes):
Allowance for equity funds used during construction
5,504
4,730
Other income (Note S-2)
1,827
4,958
Other expense (Note S-2)
(6,091
)
(4,973
)
Total
2,894
6,147
INTEREST
EXPENSE
Interest on long-term debt
53,220
53,994
Interest on short-term borrowings
2,879
1,293
Debt discount, premium and expense
1,118
1,256
Allowance for borrowed funds used during construction
(3,072
)
(3,217
)
Total
54,145
53,326
NET INCOME
94,998
83,195
Less: Net income attributable to noncontrolling
interests (Note 7)
4,778
4,651
NET INCOME ATTRIBUTABLE TO COMMON SHAREHOLDER
$
90,220
$
78,544
See Notes to Pinnacle West’s Condensed Consolidated Financial Statements and Supplemental Notes to
Arizona Public Service Company’s Condensed Consolidated Financial Statements.
Allowance for equity funds used during construction
10,893
9,722
Other income (Note S-2)
2,445
4,050
Other expense (Note S-2)
(8,552
)
(8,008
)
Total
7,283
8,378
INTEREST
EXPENSE
Interest on long-term debt
107,972
103,728
Interest on short-term borrowings
3,721
4,268
Debt discount, premium and expense
2,255
2,445
Allowance for borrowed funds used during construction
(6,091
)
(6,941
)
Total
107,857
103,500
NET INCOME
111,110
72,366
Less: Net income attributable to noncontrolling
interests (Note 7)
9,906
9,301
NET INCOME ATTRIBUTABLE TO COMMON SHAREHOLDER
$
101,204
$
63,065
See Notes to Pinnacle West’s Condensed Consolidated Financial Statements and Supplemental Notes to
Arizona Public Service Company’s Condensed Consolidated Financial Statements.
Palo Verde sale leaseback, net of accumulated
depreciation (Note 7)
142,335
146,722
Intangible assets, net of accumulated amortization
168,078
164,183
Nuclear fuel, net of accumulated amortization
136,151
118,243
Total
property, plant and equipment
9,473,786
9,344,244
INVESTMENTS AND OTHER ASSETS
Nuclear decommissioning trust (Note 15)
424,260
414,576
Assets from risk management activities (Note 8)
44,205
28,855
Other assets
67,765
68,839
Total investments and other assets
536,230
512,270
CURRENT ASSETS
Cash and cash equivalents
35,602
120,798
Customer and other receivables
263,201
280,226
Accrued unbilled revenues
162,441
110,971
Allowance for doubtful accounts
(6,223
)
(6,063
)
Materials and supplies (at average cost)
172,091
176,020
Fossil fuel (at average cost)
29,597
39,245
Assets from risk management activities (Note 8)
60,111
50,619
Deferred income taxes
74,134
53,990
Other current assets
41,966
25,724
Total current assets
832,920
851,530
DEFERRED DEBITS
Regulatory assets
850,001
813,161
Income tax receivable (Note 6)
65,498
65,498
Unamortized debt issue costs
19,679
20,959
Other
79,263
73,909
Total deferred debits
1,014,441
973,527
TOTAL ASSETS
$
11,857,377
$
11,681,571
See Notes to Pinnacle West’s Condensed Consolidated Financial Statements and Supplemental
Notes to Arizona Public Service Company’s Condensed Consolidated Financial Statements.
Palo Verde sale leaseback lessor notes (Notes 2 and 7)
113,379
126,000
Total capitalization
7,020,724
6,834,085
CURRENT LIABILITIES
Current maturities of long-term debt (Note 2)
194,082
222,959
Accounts payable
232,537
213,833
Accrued taxes (Note 6)
155,452
158,051
Common dividends payable
56,900
—
Accrued interest
53,215
54,099
Customer deposits
69,088
70,780
Liabilities from risk management activities (Note 8)
63,567
55,908
Other current liabilities
100,241
124,995
Total current liabilities
925,082
900,625
DEFERRED CREDITS AND OTHER
Deferred income taxes
1,677,864
1,582,945
Deferred fuel and purchased power regulatory liability (Note 3)
97,047
87,291
Other regulatory liabilities
651,146
679,072
Liability for asset retirements
317,980
301,783
Liabilities for pension and other postretirement
benefits (Note 4)
688,012
766,378
Customer advances
133,112
136,595
Liabilities from risk management activities (Note 8)
86,580
62,443
Coal mine reclamation
92,557
92,060
Unrecognized tax benefits (Note 6)
75,796
140,638
Other
91,477
97,656
Total deferred credits and other
3,911,571
3,946,861
COMMITMENTS AND CONTINGENCIES (SEE NOTES)
TOTAL LIABILITIES AND EQUITY
$
11,857,377
$
11,681,571
See Notes to Pinnacle West’s Condensed Consolidated Financial Statements and Supplemental Notes to
Arizona Public Service Company’s Condensed Consolidated Financial Statements.
Adjustments to reconcile net income to net cash provided by
operating activities:
Depreciation and amortization including nuclear fuel
228,513
219,815
Deferred fuel and purchased power
65,249
13,144
Deferred fuel and purchased power amortization
(55,494
)
66,163
Allowance for equity funds used during construction
(10,893
)
(9,722
)
Deferred income taxes
58,225
75,096
Change in mark-to-market valuations
2,396
(401
)
Changes in current assets and liabilities:
Customer and other receivables
(4,062
)
23,252
Accrued unbilled revenues
(51,470
)
(44,309
)
Materials, supplies and fossil fuel
13,577
(21,628
)
Other current assets
(16,242
)
(4,687
)
Accounts payable
43,451
(44,577
)
Accrued taxes
(2,599
)
(60,839
)
Other current liabilities
(27,330
)
(16,412
)
Change in margin and collateral accounts — assets
656
(2,856
)
Change in margin and collateral accounts — liabilities
(90,694
)
(91,856
)
Change in unrecognized tax benefits
(62,198
)
14,639
Change in other long-term assets
(7,203
)
(21,693
)
Change in other long-term liabilities
(40,738
)
51,624
Net cash flow provided by operating activities
154,254
217,119
CASH FLOWS FROM INVESTING ACTIVITIES
Trust fund for bond redemptions
—
(163,975
)
Capital expenditures
(378,239
)
(388,526
)
Contributions in aid of construction
15,163
33,371
Allowance
for borrowed funds used during construction
(6,091
)
(6,941
)
Proceeds from nuclear decommissioning trust sales
329,796
244,858
Investment in nuclear decommissioning trust
(342,004
)
(255,754
)
Other
1,074
990
Net cash flow used for investing activities
(380,301
)
(535,977
)
CASH FLOWS FROM FINANCING ACTIVITIES
Issuance of long-term debt
—
837,193
Repayment of long-term debt
(9,296
)
(186,105
)
Short-term
borrowings and payments-net
—
(312,464
)
Equity infusion
252,833
—
Dividends paid on common stock
(99,400
)
(85,000
)
Noncontrolling interests
(3,286
)
(3,393
)
Net cash flow provided by financing activities
140,851
250,231
NET DECREASE IN CASH AND CASH EQUIVALENTS
(85,196
)
(68,627
)
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD
120,798
71,544
CASH AND CASH EQUIVALENTS AT END OF PERIOD
$
35,602
$
2,917
Supplemental disclosure of cash flow information
Cash paid during the period for:
Income
taxes, net of (refunds)
$
65,498
$
13,704
Interest, net of amounts capitalized
$
106,485
$
86,943
See Notes to Pinnacle West’s Condensed Consolidated Financial Statements and Supplemental Notes to
Arizona Public Service Company’s Condensed Consolidated Financial Statements.
Certain notes to APS’ Condensed Consolidated Financial Statements are combined with the Notes
to Pinnacle West’s Condensed Consolidated Financial Statements. Listed below are the Condensed
Consolidated Notes to Pinnacle West’s Condensed Consolidated Financial Statements, the majority of
which also relate to APS’ Condensed Consolidated Financial Statements. In addition, listed below
are the Supplemental Notes that are required disclosures for APS and should be read in conjunction
with Pinnacle West’s Condensed Consolidated Notes.
ARIZONA PUBLIC SERVICE COMPANY
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
C:
Changes In Equity
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 six months ended June 30, 2010 and 2009 (dollars in
thousands):
Net unrealized
losses on derivative
instruments (a)
(100,255
)
—
(100,255
)
(132,994
)
—
(132,994
)
Net reclassification
of realized losses to
income (b)
42,329
—
42,329
73,330
—
73,330
Reclassification of
pension and other
postretirement
benefits to income
2,328
—
2,328
1,993
—
1,993
Net unrealized
losses related to
pension benefits
(6,862
)
—
(6,862
)
(3,774
)
—
(3,774
)
Net income tax
benefit related to
items of other
comprehensive income
(loss)
24,659
—
24,659
24,295
—
24,295
Total other
comprehensive loss
(37,801
)
—
(37,801
)
(37,150
)
—
(37,150
)
Total comprehensive
income
63,403
9,906
73,309
25,915
9,301
35,216
Dividends on common
stock
(156,300
)
—
(156,300
)
(85,000
)
—
(85,000
)
Equity infusion
252,833
—
252,833
4,503
—
4,503
Other
1
(3,286
)
(3,285
)
—
(3,393
)
(3,393
)
Ending balance, June 30
$
3,605,292
$
88,944
$
3,694,236
$
3,284,568
$
83,509
$
3,368,077
(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.
ARIZONA PUBLIC SERVICE COMPANY
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
Other Income And Other Expenses
S-2. Other Income and Other Expense
The following table provides detail of APS’ other income and other expense for the three and
six months ended June 30, 2010 and 2009 (dollars in thousands):
ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
INTRODUCTION
The following discussion should be read in conjunction with Pinnacle West’s Condensed
Consolidated Financial Statements and Arizona Public Service Company’s Condensed Consolidated
Financial Statements and the related Notes that appear in Item 1 of this report. For purposes of
this report, a “Note” refers to a Note to Pinnacle West’s Condensed Consolidated Financial
Statements in Item 1 of this report. For information on the broad factors that may cause our
actual future results to differ from those we currently seek or anticipate, see “Forward-Looking
Statements” at the front of this report and “Risk Factors” in Item 1A of the 2009 Form 10-K.
OVERVIEW
Pinnacle West owns all of the outstanding common stock of APS. APS is a vertically-integrated
electric utility that provides retail and wholesale electric service to most of the state of
Arizona, with the major exceptions of about one-half of the Phoenix metropolitan area, the Tucson
metropolitan area and Mohave County in northwestern Arizona. APS accounts for substantially all of
our revenues and earnings, and is expected to continue to do so.
Areas of Business Focus
Nuclear. APS operates and is a joint-owner of the Palo Verde Nuclear Generating Station.
With a focus on safely and efficiently generating electricity for the long-term, APS applied for
twenty-year renewals of its operating licenses for each of the three Palo Verde units, and is
making preparations to secure necessary resources to operate the plant during this extended period
of time.
Coal and Related Environmental Matters. APS is a joint-owner of three coal-fired power plants
and acts as operating agent for two of the plants. APS is focused on the impacts on its coal fleet
that may result from potential legislation and increased regulation concerning greenhouse gas
emissions. Recent concern over climate change and other emission-related issues could have a
significant impact on APS’ capital expenditures and operating costs in the form of taxes, emissions
allowances or required equipment upgrades for these plants. APS is closely monitoring its long
range capital management plans, understanding that the resulting legislation and regulation could
impact the economic viability of certain plants, as well as the willingness or ability of power
plant participants to fund any such equipment upgrades. In particular, Southern California Edison,
a participant in the Four Corners Power Plant (“Four Corners”), has indicated that certain
California legislation may prohibit it from making emission control expenditures at the plant.
Transmission and Delivery. APS’ 2010 transmission plan projects that it will invest
approximately $520 million in new transmission over the next ten years, which includes 270 miles of
new lines. APS is working closely with regulators to identify and plan for transmission needs
resulting from the current focus on renewable energy. APS is also working to establish and expand
smart grid technology throughout its service territory designed to provide a variety of benefits
both to APS and its customers. This technology is designed to allow customers to better monitor
their energy use and needs, minimize system outage durations and the number of customers that
experience outages, and facilitate cost savings to APS through improved reliability and the
automation of certain distribution functions, including remote meter reading and remote connects
and disconnects.
Renewable Energy. APS is committed to increasing the amount of energy produced by renewable
energy resources. The ACC adopted a renewable energy standard several years ago, recognizing the
importance of renewable energy to our state. In the Settlement Agreement for the 2008 general
retail rate case, APS agreed to exceed these standards, committing that approximately 10% of APS’
energy will come from renewable resources by the year 2015. A variety of other provisions in the
Settlement Agreement reinforce APS’ dedication to renewable energy through initiatives such as
building photovoltaic solar plants, installing solar rooftop panels on schools and government
buildings and seeking an Arizona wind generation project.
On March 3, 2010, the ACC approved the AZ Sun Program, under which APS plans to own 100 MW of
photovoltaic power plants across Arizona by investing up to $500 million through 2014. APS expects
to acquire these resources through competitive procurement processes, with projects being placed
into service in the 2011 to 2014 timeframe. The ultimate timing depends on the outcome of current
and future procurement processes. See Note 3 for additional details of this program, including the
related cost recovery.
In the first half of 2010, APS issued three requests for proposals (“RFPs”) for renewable
resources. These RFPs are part of the process for procuring the additional renewable resources
required under the rate case settlement. The first RFP is for wind projects between 15 and 100 MW
to be located within Arizona. As a result of this RFP, on July 22, 2010, APS signed a long-term
power purchase agreement for all of the energy from a 99 MW wind farm to be located near Williams,
Arizona. This energy will help APS meet the ACC-mandated Renewable Energy Standard, as well as the
Arizona-based wind provision included in APS’ rate case settlement. The agreement is subject to
various conditions, including ACC approval of the agreement and successful siting, permitting and
interconnection of the project to the state’s electric grid. If these conditions are met,
commercial operation is expected in late 2011 or 2012.
The second RFP is for utility-scale solar photovoltaic projects between 15 and 50 MW. This
RFP serves as the first procurement step for implementing the AZ Sun Program. APS is currently
in formal negotiations regarding this RFP. The third RFP, the 2010 Small Generation RFP, serves as
the first in a series of solicitations that will define APS’ Small Generation Program. This
program will focus on renewable projects between 2 and 15 MW.
Energy Efficiency. Arizona regulators are placing an increased focus on energy efficiency and
demand side management programs to encourage customers to conserve energy, while incentivizing
utilities to aid in these efforts that ultimately reduce the demand for energy. In December 2009,
the ACC initiated Energy Efficiency rulemaking, with a proposed Energy Efficiency Standard of 22%
annual energy savings by 2020. The 22% figure represents the cumulative reduction in future energy
usage through 2020 attributable to energy efficiency initiatives. On
July 27, 2010, the proposed
Energy Efficiency Standard was approved by the ACC subject to review and approval by the Arizona
Attorney General, which should be completed before the end of 2010. An ambitious standard, such as
that approved by the ACC, will increase participation by APS customers in these conservation and
energy efficiency programs, which in turn will impact Arizona’s future energy resource needs.
Rate Matters. APS needs timely recovery through rates of its capital and operating
expenditures to maintain adequate financial health. APS’ retail rates are regulated by the ACC and
its wholesale electric rates (primarily for transmission) are regulated by the FERC. At the end of
2009, the ACC approved a settlement agreement entered into by APS and twenty-one of the
twenty-three other parties to APS’ general retail rate case, with modifications that did not
materially affect the overall economic terms of the agreement. The rate case settlement should
strengthen APS’ financial condition by allowing for rate
stability and a greater level of cost recovery and return on investment. It also authorizes
and requires equity infusions into APS of at least $700 million prior to the end of 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)). The settlement demonstrates cooperation among APS, the ACC
staff, the Residential Utility Consumer Office and other intervenors to the rate case, and
establishes a future rate case filing plan that allows APS the opportunity to help shape Arizona’s
energy future outside of continual rate cases. See Note 3 for a discussion of the Settlement
Agreement terms and information on APS’ FERC rates.
APS has several recovery mechanisms in place that provide more timely recovery to APS of its
fuel and transmission costs, and costs associated with the promotion and implementation of its
energy efficiency, demand-side management and renewable energy efforts and customer programs.
These mechanisms are described more fully in Note 3.
Financial Strength and Flexibility. Pinnacle West and APS currently have ample borrowing
capacity under their respective credit facilities and have been able to access these facilities as
well as the commercial paper market, ensuring adequate liquidity for each company. In early
February 2010, APS entered into a $500 million revolving credit facility, replacing its $377
million facility that would have otherwise terminated in December 2010. At that same time,
Pinnacle West entered into a $200 million revolving credit facility that replaced its $283 million
facility that also would have otherwise terminated 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.
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 capital contributions to repay short-term indebtedness, to finance
capital expenditures and for other general corporate purposes.
SunCor Real Estate Operations. As a result of the distressed conditions in the real estate
markets, during 2009 SunCor undertook a program to dispose of its homebuilding operations,
master-planned communities, land parcels, commercial assets and golf courses in order to reduce its
outstanding debt. In July, 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 will be recognized in the third quarter of
2010. At June 30, 2010, SunCor had approximately $103 million of assets on its balance sheet classified as assets held for sale.
These assets consisted of the $70 million of assets sold in July as discussed above, $25 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. See
“Pinnacle West Consolidated —
Liquidity and Capital Resources — Other Subsidiaries — SunCor” below for a discussion of SunCor’s
outstanding debt and related matters and Note 16 for a discussion of related impairment charges.
District Cooling Business Sale. 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. The sale resulted in an after-tax gain of approximately $25 million.
Following this sale, APSES plans to focus on its core business of energy conservation and renewable
energy contracting services.
Other Subsidiary Matters. The operations of APSES and our other first tier subsidiary, El
Dorado, are not expected to have any material impact on our financial results, or to require any
material amounts of capital, over the next three years.
Key Financial Drivers
In addition to the continuing impact of the matters described above, many factors influence
our financial results and our future financial outlook, including those listed below. We closely
monitor these factors to plan for the Company’s current needs, and to adjust our expectations,
financial budgets and forecasts appropriately.
Regulated Electricity Segment Revenues. For the years 2007 through 2009, retail electric
revenues comprised approximately 94% of our total electric operating revenues. Our electric
operating revenues are affected by customer growth, variations in weather from period to period,
customer mix, average usage per customer and the impacts of energy efficiency programs, electricity
rates and tariffs, the recovery of PSA deferrals and the operation of other recovery mechanisms.
Off-system sales of excess generation output, purchased power and natural gas are included in
regulated electricity segment revenues and related fuel and purchased power because they are
credited to APS’ retail customers through the PSA. These revenue transactions are affected by the
availability of excess generation or other energy resources and wholesale market conditions,
including competition, demand and prices.
Customer and Sales Growth. Customer growth in APS’ service territory for the six-month period
ended June 30, 2010 was 0.6% compared with the prior year period. For the three years 2007 through
2009, APS’ customer growth averaged 1.8% per year. We currently expect annual customer growth to
average about 1% for 2010 through 2012 due to economic conditions both nationally and in Arizona.
Retail sales in kilowatt-hours, adjusted to exclude the effects of weather variations, for the
six-month period ended June 30, 2010 declined 0.4% compared to the same period in the prior year,
reflecting the poor economic conditions and the effects of our energy efficiency programs. For the
three years 2007 through 2009, APS’ actual retail electricity sales in kilowatt-hours, adjusted to
exclude the effects of weather variations, grew at an average annual rate of 0.2%. We currently
estimate that total annual retail electricity sales in kilowatt-hours will remain flat on average
during 2010 through 2012, including the effects of APS’ energy efficiency programs, but excluding
the effects of weather variations. A continuation of the economic downturn, or the failure of the
Arizona economy to rebound in the near future, could further impact these estimates. The customer
and sales growth referred to in this paragraph apply to Native Load customers.
Actual sales growth, excluding weather-related variations, may differ from our projections as
a result of numerous factors, such as economic conditions, customer growth, usage patterns, impacts
of energy efficiency programs and responses to retail price changes. Our experience indicates that
a reasonable range of variation in our kilowatt-hour sales projection attributable to such economic
factors under normal business conditions can result in increases or decreases in annual net income
of up to $10 million.
Weather. In forecasting the retail sales growth numbers provided above, we assume normal
weather patterns based on historical data. Historical extreme weather variations have resulted in
annual variations in net income in excess of $20 million. However, our experience indicates that
the more typical variations from normal weather can result in increases or decreases in annual net
income of up to $10 million.
Fuel and Purchased Power Costs. Fuel and purchased power costs included on our Condensed
Consolidated Statements of Income are impacted by our electricity sales volumes, existing contracts
for purchased power and generation fuel, our power plant performance, transmission availability or
constraints, prevailing market prices, new generating plants being placed in service in our market
areas, our hedging program for managing such costs and PSA deferrals and the related amortization.
Operations and Maintenance Expenses. Operations and maintenance expenses are impacted by
growth, power plant operations, maintenance of utility plant (including generation, transmission,
and distribution facilities), inflation, outages, higher-trending pension and other postretirement
benefit costs, renewable energy and demand side management related expenses (which are offset by
the same amount of regulated electricity segment operating revenues) and other factors. In its
retail rate case settlement, APS committed to operational expense reductions from 2010 through 2014
and received approval to defer certain pension and other postretirement benefit cost increases to
be incurred in 2011 and 2012.
Depreciation and Amortization Expenses. Depreciation and amortization expenses are impacted
by net additions to utility plant and other property (such as new generation, transmission, and
distribution facilities), and changes in depreciation and amortization rates. The “Capital
Expenditures” section below provides information regarding the planned additions to our facilities.
We have also applied to the NRC for renewed operating licenses for each of the Palo Verde units.
If the NRC grants the extension, we estimate that our annual pretax depreciation expense will
decrease by approximately $34 million at the later of the license extension date or January 1,2012.
Property Taxes. Taxes other than income taxes consist primarily of property taxes, which are
affected by the value of property in-service and under construction, assessment ratios, and tax
rates. The average property tax rate for APS, which currently owns the majority of our property,
was 7.5% of the assessed value for 2009 and 7.8% of the assessed value for 2008. We expect
property taxes to increase as we add new utility plant (including new generation, transmission and
distribution facilities described below under “Capital Additions”) and as we improve our existing
facilities.
Income Taxes. Income taxes are affected by the amount of pre-tax book income, income tax
rates, and certain non-taxable items, such as the allowance for equity funds used during
construction. In addition, income taxes may also be affected by the settlement of issues with
taxing authorities.
Interest Expense. Interest expense is affected by the amount of debt outstanding and the
interest rates on that debt (see Note 2.) The primary factors affecting borrowing levels are
expected to be our capital expenditures, long-term debt maturities, and internally generated cash
flow. An allowance for borrowed funds offsets a portion of interest expense while capital projects
are under construction. We stop accruing the allowance for borrowed funds on a project when it is
placed in commercial operation.
PINNACLE WEST CONSOLIDATED — RESULTS OF OPERATIONS
Our results of operations, provided below, are based upon our two reportable business
segments:
•
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. As of June 30, 2010, all of SunCor’s operations have been
reclassified to discontinued operations (see Notes 5 and 14). The real estate segment
activities are presented separately in the period-over-period discussions that follow.
Operating Results — Three-month period ended June 30, 2010 compared with three-month period ended
June 30, 2009
Our consolidated net income attributable to common shareholders for the three months ended
June 30, 2010 was $115 million, compared with net income of $68 million for the comparable
prior-year period. The improved results reflect an increase of approximately $10 million in
regulated electricity segment net income primarily due to increased revenues related to APS’ retail
rate increases and other factors, partially offset by milder weather in 2010.
In addition, our consolidated results for 2010 include a gain of $25 million after income
taxes related to the sale of APSES’ district cooling business.
The following table presents net income attributable to common shareholders by business
segment compared with the prior-year period:
Increase
(Decrease)
in Net Income
Three Months Ended
Attributable
June 30,
to Common
2010
2009
Shareholders
(dollars in millions)
Regulated Electricity Segment:
Operating revenues less fuel and
purchased power expenses
$
548
$
521
$
27
Operations and maintenance
(213
)
(213
)
—
Depreciation and amortization
(103
)
(101
)
(2
)
Taxes other than income taxes
(32
)
(33
)
1
Other income (expenses), net
(3
)
3
(6
)
Interest charges, net of capitalized
financing costs
(53
)
(52
)
(1
)
Income taxes
(51
)
(42
)
(9
)
Noncontrolling interests (Note 7)
(5
)
(5
)
—
Regulated electricity segment net
income
88
78
10
All Other (a)
2
(2
)
4
Income from Continuing Operations
Attributable to Common Shareholders
90
76
14
Real Estate Segment:
Real estate impairment charges (Note 16)
(2
)
(6
)
4
Other real estate operations
—
(9
)
9
Income taxes
1
6
(5
)
Real estate segment net loss
(1
)
(9
)
8
All other (a)
26
1
25
Income (Loss) from Discontinued Operations
Attributable to Common Shareholders
25
(8
)
33
Net Income Attributable to Common
Shareholders
$
115
$
68
$
47
(a)
Includes activities related to APSES and El Dorado. None of the activities of
either of these companies constitutes a reportable segment. Income from discontinued
operations for the period ended June 30, 2010 includes a gain of $25 million after
income taxes related to the sale of APSES’ district cooling business.
This section includes a discussion of major variances in income and expense amounts for the
regulated electricity segment.
Operating revenues less fuel and purchased power expenses
Regulated electricity segment operating revenues less fuel and purchased power expenses were
$27 million higher for the three months ended June 30, 2010 compared with the prior-year period.
The following table describes the major components of this change:
Higher demand-side management and renewable
energy surcharges (substantially offset in
operations and maintenance expense)
8
8
Lower retail revenues related to recovery of PSA
deferrals, substantially offset by lower
amortization of fuel and purchased power expense
(67
)
(68
)
1
Effects of weather on retail sales, primarily due
to milder weather in 2010
(39
)
(12
)
(27
)
Miscellaneous items, net
8
9
(1
)
Total
$
(13
)
$
(40
)
$
27
Operations and maintenance Operations and maintenance expense variances for the three months
ended June 30, 2010 compared with the prior-year period include:
•
An increase of $7 million related to demand-side management and renewable energy
programs, which are primarily offset in operating revenues; and
•
A decrease of $7 million due to miscellaneous adjustments related primarily to employee
benefits.
Other income (expenses), net Other income (expenses), net, decreased earnings by $7 million
for the three months ended June 30, 2010 compared with the prior-year period primarily due to net
investment losses related to certain nonqualified employee benefit plans. Other income (expenses),
net, is comprised of the regulated electricity segment portions of the line items other income and
other expense from the Condensed Consolidated Statements of Income.
Income taxes Income taxes were $9 million higher for the three months ended June 30, 2010
compared with the prior-year period primarily because of higher pretax income in the current-year
period.
Real estate segment
As of June 30, 2010, all of SunCor’s operations have been reclassified to discontinued
operations. The real estate segment net loss attributable to common shareholders was $8 million
lower for the three months ended June 30, 2010 compared with the prior-year period primarily
because of:
•
A decrease in real estate impairment charges of $4 million;
•
A decrease in the loss from other real estate operations of $9 million; and
•
A decrease in income tax benefits of $5 million primarily because of a lower net
loss for the 2010 period.
All Other
All other earnings from discontinued operations were $25 million higher for the three months
ended June 30, 2010 compared to the prior-year period primarily because of a gain of $25 million
after income taxes related to the sale of APSES’ district cooling business in 2010.
Operating Results — Six-month period ended June 30, 2010 compared with six-month period ended June30, 2009
Our consolidated net income attributable to common shareholders for the six months ended June30, 2010 was $109 million, compared with a net loss of $88 million for the comparable prior-year
period. The improved results were primarily due to lower real estate impairment charges recorded
in 2010 compared with the prior-year period by SunCor, the Company’s real estate subsidiary.
In addition, regulated electricity segment net income increased approximately $37 million from
the prior-year period primarily due to increased revenues related to APS’ retail rate increases and
other factors, partially offset by milder weather in 2010. Our consolidated results for 2010 also
include a gain of $25 million after income taxes related to the sale of APSES’ district cooling
business.
The following table presents net income (loss) attributable to common shareholders by business
segment compared with the prior-year period:
Increase
(Decrease)
in Net Income
Six Months Ended
Attributable
June 30,
to Common
2010
2009
Shareholders
(dollars in millions)
Regulated Electricity Segment:
Operating revenues less fuel and
purchased power expenses
$
944
$
876
$
68
Operations and maintenance
(420
)
(408
)
(12
)
Depreciation and amortization
(204
)
(201
)
(3
)
Taxes other than income taxes
(63
)
(67
)
4
Other income (expenses), net
(5
)
(1
)
(4
)
Interest charges, net of capitalized
financing costs
(104
)
(100
)
(4
)
Income taxes
(43
)
(32
)
(11
)
Noncontrolling interests (Note 7)
(10
)
(9
)
(1
)
Regulated electricity segment net
income
95
58
37
All Other (a)
2
(7
)
9
Income from Continuing Operations
Attributable to Common Shareholders
97
51
46
Real Estate Segment:
Real estate impairment charges (Note 16)
(17
)
(208
)
191
Other real estate operations
(7
)
(23
)
16
Income taxes
9
91
(82
)
Real estate segment net loss
(15
)
(140
)
125
All other (a)
27
1
26
Income from Discontinued Operations
Attributable to Common Shareholders
12
(139
)
151
Net Income (Loss) Attributable to
Common Shareholders
$
109
$
(88
)
$
197
(a)
Includes activities related to APSES and El Dorado. None of the activities of either of these
companies constitutes a reportable segment. Income from discontinued operations for the period
ended June 30, 2010 includes a gain of $25 million after income taxes related to the sale of APSES’
district cooling business.
This section includes a discussion of major variances in income and expense amounts for the
regulated electricity segment.
Operating revenues less fuel and purchased power expenses
Regulated electricity segment operating revenues less fuel and purchased power expenses were
$68 million higher for the six months ended June 30, 2010 compared with the prior-year period. The
following table describes the major components of this change:
Higher demand-side management and renewable
energy surcharges (substantially offset in
operations and maintenance expense)
15
15
Lower retail revenues related to recovery of PSA
deferrals, substantially offset by lower
amortization of fuel and purchased power
expense
(122
)
(125
)
3
Effects of weather on retail sales, primarily due
to milder weather in the second quarter 2010
(33
)
(10
)
(23
)
Miscellaneous items, net
—
6
(6
)
Total
$
(4
)
$
(72
)
$
68
Operations and maintenance Operations and maintenance expenses increased $12 million for the
six months ended June 30, 2010 compared with the prior-year period primarily because of:
•
An increase of $13 million related to demand-side management and renewable energy
programs, which are primarily offset in operating revenues;
•
An increase of $7 million related to customer service and other costs; and
•
A decrease of $8 million in generation costs, including timing of fossil-plant
planned maintenance.
Income taxes Income taxes were $11 million higher for the six months ended June 30, 2010
compared with the prior-year period primarily because of higher pretax income in the current-year
period, partially offset by $9 million related to a reduction in the Company’s 2010 effective
income tax rate. See Note 6.
All other earnings from continuing operations were $9 million higher for the six months ended
June 30, 2010 compared to the prior-year period primarily because of improved margins from APSES’
products and services business and investment losses at El Dorado in 2009.
Real estate segment
During the first quarter of 2009, SunCor’s Board of Directors authorized a series of strategic
transactions to dispose of SunCor’s assets. This decision resulted in
impairment charges of approximately $208 million pretax in the first six months of 2009. As of
June 30, 2010, all of SunCor’s operations have been reclassified to discontinued operations (see
Note 2). The real estate segment net loss attributable to common shareholders was $125 million
lower for the six months ended June 30, 2010 compared with the prior-year period primarily because
of:
•
A decrease in real estate impairment charges of $191 million;
•
A decrease in the loss from other real estate operations of $16 million; and
•
A decrease in income tax benefits of $82 million primarily because of a lower net
loss for the 2010 period.
All Other
All other earnings from discontinued operations were $26 million higher for the six months
ended June 30, 2010 compared to the prior-year period primarily because of a gain of $25 million
after income taxes related to the sale of APSES’ district cooling business in 2010.
PINNACLE WEST CONSOLIDATED — LIQUIDITY AND CAPITAL RESOURCES
Cash Flows
The following table presents net cash provided by (used for) operating, investing and
financing activities for the six months ended June 30, 2010 and 2009 (dollars in millions):
Net cash flow provided by (used for)
financing activities
(18
)
251
The
decrease of approximately $1 million in net cash provided by operating activities is
primarily due to a voluntary pension contribution
in 2010 of approximately $100 million partially offset by
changes in working capital.
The
decrease of approximately $263 million in net cash used for investing activities is
primarily due to the timing of APS’ $164 million of pollution control auction rate securities
redemptions in 2009 (related to a corresponding amount in the financing activities’ section) and
approximately $100 million of proceeds from the sale of the district cooling business in June 2010.
The decrease of approximately $269 million in net cash provided by financing activities is
primarily due to APS’ issuance of $500 million of unsecured senior notes in 2009 and APS’ issuance
of $343 million of pollution control bonds in 2009 (a portion of which was used to redeem $179
million of APS’ existing pollution control bonds, with the remainder deposited in a restricted
trust fund for redemption of auction rate securities in 2009, as noted above). This was partially
offset by proceeds of approximately $253 million from the issuance of equity in April 2010 and
lower levels of repayment of short-term borrowings in 2010.
Liquidity
Capital Expenditure Requirements
The following table summarizes the actual capital expenditures for the six months ended June30, 2009 and 2010 and the estimated capital expenditures for the next three years:
Estimated 2010 capital expenditures are lower than the estimate in the 2009
Form 10-K, primarily due to the timing of renewable expenditures.
(b)
Primarily information systems and facilities projects.
Generation capital expenditures are comprised of various improvements to APS’ existing fossil
and nuclear plants. Examples of the types of projects included in this category are additions,
upgrades and capital replacements of various power plant equipment, such as turbines, boilers and
environmental equipment. We are also monitoring the status of certain environmental matters,
which, depending on their
final outcome, could require modification to our environmental expenditures. (See “Business of
Arizona Public Service Company — Environmental Matters — EPA Environmental Regulation — Regional
Haze Rules in Item 1 of the 2009 Form 10-K and “Environmental Matters — Mercury and Other Hazardous
Air Pollutants” in Part II, Item 5 below.)
Distribution and transmission capital expenditures are comprised of infrastructure additions
and upgrades, capital replacements, new customer construction, related information systems and
facility costs. Examples of the types of projects included in the forecast include power lines,
substations, line extensions to new residential and commercial developments and upgrades to
customer information systems.
Capital expenditures will be funded with internally generated cash and external financings,
which may include issuances of long-term debt and Pinnacle West common stock.
Pinnacle West (Parent Company)
Our primary cash needs are for dividends to our shareholders and principal and interest
payments on our short-term and long-term debt. The level of our common stock dividends and future
dividend growth will be dependent on a number of factors including, but not limited to, payout
ratio trends, free cash flow and financial market conditions.
On June 22, 2010, the Pinnacle West Board of Directors declared a quarterly dividend of $0.525
per share of common stock, payable on September 1, 2010, to shareholders of record on August 2,2010.
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 common equity divided by the sum of common
equity and long-term debt, including current maturities of long-term debt. At June 30, 2010, APS’
common equity ratio, as defined, was 52%. Its total common equity was approximately $3.6 billion,
and total capitalization was approximately $7.0 billion. APS would be prohibited from paying
dividends if the payment would reduce its common equity below approximately $2.8 billion, assuming
APS’ total capitalization remains the same.
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 credit facilities that would have otherwise
matured in December 2010.
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 June 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 June 30, 2010, Pinnacle West had no outstanding borrowings under its
revolving 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. Pinnacle West intends to issue equity to
provide most of the funds for the equity infusions into APS required by the retail rate case
settlement. Such equity issuances may occur at any time in the period through 2014, in Pinnacle
West’s discretion. See Note 3.
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.
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 six
months ended June 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 $65 million long-term income tax receivable on the Condensed Consolidated Balance Sheets
represents the anticipated refunds related to an APS tax accounting method change approved by the
IRS in the third quarter of 2009.
Pinnacle West sponsors a qualified defined benefit and account balance pension plan and a
non-qualified supplemental excess benefit retirement plan for the employees of Pinnacle West and
our subsidiaries. IRS regulations require us to contribute a minimum amount to the qualified plan.
We contribute at least the minimum amount required under IRS regulations, but no more than the
maximum tax-deductible amount. The minimum required funding takes into consideration the value of
plan assets and our pension obligation. The assets in the plan are comprised of fixed-income,
equity and short-term investments. Future year contribution amounts are dependent on plan asset
performance and plan actuarial assumptions. We made no contribution to our pension plan in 2009.
We currently estimate that our pension contributions could average around $100 million for several
years, assuming the discount rate remains at approximately current levels. During the first
quarter of 2010, we made a voluntary contribution of approximately $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.
APS
APS’ capital requirements consist primarily of capital expenditures and maturities of
long-term debt. APS funds its capital requirements with cash from operations and, to the extent
necessary, equity infusions from Pinnacle West and external financings. See “Pinnacle West (Parent
Company)” above for a discussion of the common equity ratio that APS must maintain in order to pay
dividends to Pinnacle West.
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 June 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 June 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 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 June 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.
Other Financing Matters — See Note 3 for information regarding the PSA approved by the ACC.
Although APS defers actual retail fuel and purchased power costs on a current basis, APS’ recovery
of the deferrals from its ratepayers is subject to annual and, if necessary, periodic PSA
adjustments.
See Note 3 for information regarding the retail rate case settlement, which includes ACC
authorization and requires equity infusions into APS of at least $700 million by December 31, 2014.
See Note 8 for information related to the change in our margin accounts.
Other Subsidiaries
SunCor — In July, 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
will be recognized in the third quarter of 2010.
At June 30, 2010, SunCor had approximately $103 million of assets on its balance sheet
classified as assets held for sale. These assets consist of the $70 million of assets sold in July
as discussed above, $25 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 June 30, 2010, SunCor had $94 million outstanding debt under various credit facilities, all
of which was in default. After the sale discussed above, $6 million remains outstanding. 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 June 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.
El Dorado — El Dorado expects minimal capital requirements over the next three years and
intends to focus on prudently realizing the value of its existing investments.
APSES — APSES expects minimal capital expenditures over the next three years.
Debt Provisions
Pinnacle West’s and APS’ debt covenants related to their respective bank financing
arrangements include maximum debt to capitalization ratios. Certain of APS’ bank financing
arrangements also include an interest coverage test. Pinnacle West and APS comply with these
covenants and each anticipates it will continue to meet these and other significant covenant
requirements. For both Pinnacle West and APS, these covenants require that the ratio of
consolidated debt to total consolidated capitalization not exceed 65%. At June 30, 2010, the ratio
was approximately 51% for Pinnacle West and 50% for APS. The provisions regarding interest
coverage require minimum cash coverage of two times the interest requirements. The
interest coverage was approximately 4.4 times as of June 30,2010. Failure to comply with such covenant levels would result in an event of default which,
generally speaking, would require the immediate repayment of the debt subject to the covenants and
could cross-default other debt. See further discussion of “cross-default” provisions below.
Neither Pinnacle West’s nor APS’ financing agreements contain “rating triggers” that would
result in an acceleration of the required interest and principal payments in the event of a rating
downgrade. However, our bank financial agreements contain a pricing grid in which the interest
costs we pay for borrowings thereafter are determined by our current credit ratings.
All of Pinnacle West’s loan agreements contain “cross-default” provisions that would result in
defaults and the potential acceleration of payment under these loan agreements if Pinnacle West or
APS were to default under certain other material agreements. All of APS’ bank agreements contain
cross-default provisions that would result in defaults and the potential acceleration of payment
under these bank agreements if APS were to default under certain other material agreements.
Pinnacle West and APS do not have a material adverse change restriction for credit facility
borrowings.
See Note 2 for further discussions of liquidity matters.
The
ratings of securities of Pinnacle West and APS as of August 2, 2010 are shown below.
The ratings reflect the respective views of the rating agencies, from which an explanation of the
significance of their ratings may be obtained. There is no assurance that these ratings will
continue for any given period of
time. The ratings may be revised or withdrawn entirely by the rating agencies if, in their
respective judgments, circumstances so warrant. Any downward revision or withdrawal may adversely
affect the market price of Pinnacle West’s or APS’ securities and serve to increase the cost of and
limit access to capital. It may also require substantial additional cash or other collateral
requirements related to certain derivative instruments, insurance policies, natural gas
transportation, fuel supply, and other energy-related contracts. At this time, we believe we have
sufficient liquidity to cover a downward revision to our credit ratings.
Moody’s
Standard & Poor’s
Fitch
Pinnacle West
Senior unsecured (a)
Baa3 (P)
BB+ (prelim)
N/A
Commercial paper
P-3
A-3
F3
Outlook
Stable
Positive
Stable
APS
Senior unsecured
Baa2
BBB-
BBB
Secured lease
obligation bonds
Baa2
BBB-
BBB
Commercial paper
P-2
A-3
F3
Outlook
Stable
Positive
Stable
(a)
Pinnacle West has a shelf registration under SEC Rule 415. Pinnacle West
currently has no outstanding, rated senior unsecured securities. However, Moody’s
assigned a provisional (P) rating and Standard & Poor’s assigned a preliminary (prelim)
rating to the senior unsecured securities that can be issued under such shelf
registration.
Off-Balance Sheet Arrangements
On January 1, 2010 we adopted amended accounting guidance relating to VIEs and, as a result,
we have consolidated certain entities which were previously not consolidated. The consolidation of
these entities has impacted our consolidated financial statement results. See Note 7 for a
discussion of these impacts.
Guarantees and Letters of Credit
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 June 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. We generally agree to indemnification provisions related to liabilities arising from or related to
certain of our agreements, with limited exceptions depending on the particular agreement. See Note
12 for additional information regarding guarantees and letters of credit.
Our future contractual obligations, including contingent obligations, related to purchased
power and fuel contracts, have increased from approximately $8.4 billion at December 31, 2009 to
$9.1 billion at June 30, 2010 as follows (dollars in billions):
2010
2011-2012
2013-2014
Thereafter
Total
$
0.6
$
0.7
$
1.0
$
6.8
$
9.1
These amounts have increased since the 2009 Form 10-K primarily due to increased solar
contracts associated with meeting the Renewable Energy Standards.
See Note 2 for a list of payments due on total long-term debt and capitalized lease
requirements.
CRITICAL ACCOUNTING POLICIES
In preparing the financial statements in accordance with GAAP, management must often make
estimates and assumptions that affect the reported amounts of assets, liabilities, revenues,
expenses and related disclosures at the date of the financial statements and during the reporting
period. Some of those judgments can be subjective and complex, and actual results could differ
from those estimates. There have been no changes to our critical accounting policies since our
2009 Form 10-K. See “Critical Accounting Policies” in Item 7 of the 2009 Form 10-K for further
details about our critical accounting policies.
OTHER ACCOUNTING MATTERS
On January 1, 2010 we adopted amended accounting guidance relating to VIEs, and as a result we
have consolidated certain entities which were previously not consolidated. The consolidation of
these entities has impacted our consolidated financial statement results. See Notes 1 and 7 for a
discussion of these impacts.
MARKET AND CREDIT RISKS
Market Risks
Our operations include managing market risks related to changes in interest rates, commodity
prices and investments held by our nuclear decommissioning trust fund.
Interest Rate and Equity Risk
We have exposure to changing interest rates. Changing interest rates will affect interest
paid on variable-rate debt and the market value of fixed income securities held by our nuclear
decommissioning trust fund (see Note 15). The nuclear decommissioning trust fund also has risks
associated with the changing market value of its investments. Nuclear decommissioning costs are
recovered in regulated electricity prices.
We are exposed to the impact of market fluctuations in the commodity price and transportation
costs of electricity and natural gas. Our risk management committee, consisting of officers and
key management personnel, oversees company-wide energy risk management activities to ensure
compliance with our stated energy risk management policies. We manage risks associated with these
market fluctuations by utilizing various commodity instruments that qualify as derivatives,
including exchange-traded futures and options and over-the-counter forwards, options and swaps. As
part of our risk management program, we use such instruments to hedge purchases and sales of
electricity and fuels. The changes in market value of such contracts have a high correlation to
price changes in the hedged commodities.
The following table shows the net pretax changes in mark-to-market of our derivative positions
for the six months ended June 30, 2010 and 2009 (dollars in millions):
Mark-to-market of net positions at beginning of
period
$
(169
)
$
(282
)
Recognized in earnings:
Change in mark-to-market losses for future
period deliveries
(4
)
(4
)
Mark-to-market losses realized including
ineffectiveness during the period
2
5
Increase in regulatory asset
(37
)
—
Recognized in other comprehensive income (OCI):
Change in mark-to-market losses for future
period deliveries (a)
(100
)
(133
)
Mark-to-market losses realized during the
period
42
73
Change in valuation techniques
—
—
Mark-to-market of net positions at end of period
$
(266
)
$
(341
)
(a)
The changes in mark-to-market recorded in OCI are due primarily to changes in
forward natural gas prices.
The table below shows the fair value of maturities of our derivative contracts (dollars in
millions) at June 30, 2010 by maturities and by the type of valuation that is performed to
calculate the fair values. See Note 1, “Derivative Accounting” and “Fair Value Measurements,” in
Item 8 of our 2009 Form 10-K and Note 15 for more discussion of our valuation methods.
Total
Years
fair
Source of Fair Value
2010
2011
2012
2013
2014
thereafter
value
Prices actively quoted
$
(1
)
$
(1
)
$
—
$
—
$
—
$
—
$
(2
)
Prices provided by
other external sources
(89
)
(100
)
(27
)
(6
)
—
—
(222
)
Prices based on models
and other valuation
methods
The table below shows the impact that hypothetical price movements of 10% would have on the
market value of our risk management assets and liabilities included on Pinnacle West’s Condensed
Consolidated Balance Sheets at June 30, 2010 and December 31, 2009 (dollars in millions):
These contracts are hedges of our forecasted purchases of natural gas and
electricity. The impact of these hypothetical price movements would substantially
offset the impact that these same price movements would have on the physical exposures
being hedged. To the extent the amounts are eligible for inclusion in the PSA, the
amounts are recorded as either a regulatory asset or liability.
Credit Risk
We are exposed to losses in the event of non-performance or non-payment by counterparties.
See Note 15 — “Fair Value Measurements” for a discussion of our credit valuation adjustment policy.
See Note 8 for a further discussion of credit risk.
ARIZONA PUBLIC SERVICE COMPANY — RESULTS OF OPERATIONS
Operating Results — Three-month period ended June 30, 2010 compared with three-month period ended
June 30, 2009
APS’ consolidated net income attributable to common shareholder for the three months ended
June 30, 2010 was $90 million, compared with net income of $79 million for the comparable
prior-year period. Net income increased approximately $11 million from the prior-year period
primarily due to increased revenues related to APS’ retail rate increases and other factors,
partially offset by milder weather in 2010.
Operating revenues less fuel and purchased power expenses
Electric operating revenues less fuel and purchased power expenses were $27 million higher for
the three months ended June 30, 2010 compared with the prior-year period. The following table
describes the major components of this change:
Higher demand-side management and renewable
energy surcharges (substantially offset in
operations and maintenance expense)
8
8
Lower retail revenues related to recovery of PSA
deferrals, substantially offset by lower
amortization of fuel and purchased power
expense
(67
)
(68
)
1
Effects of weather on retail sales, primarily due
to milder weather in 2010
(39
)
(12
)
(27
)
Miscellaneous items, net
8
9
(1
)
Total
$
(13
)
$
(40
)
$
27
Operations and maintenance Operations and maintenance variances for the three months ended
June 30, 2010 compared with the prior-year period primarily include:
•
An increase of $7 million related to demand-side management and renewable energy
programs, which are primarily offset in operating revenues; and
•
A decrease of $7 million due to miscellaneous adjustments related primarily to employee
benefits.
Other income (expenses), net Other income (expenses), net, decreased earnings by $4 million
for the three months ended June 30, 2010 compared with the prior-year period primarily due to net
investment losses related to certain nonqualified employee benefit plans. Other income (expenses),
net, is comprised of the line items other income and other expense from the Condensed Consolidated
Statements of Income.
Income taxes Income taxes were $10 million higher for the three months ended June 30, 2010
compared with the prior-year period primarily because of higher pretax income in the current-year
period.
Operating Results — Six-month period ended June 30, 2010 compared with six-month period ended June30, 2009
APS’ consolidated net income attributable to common shareholder for the six months ended June30, 2010 was $101 million, compared with a net income of $63 million for the comparable prior-year
period.
Net income increased approximately $38 million from the prior-year period primarily due to
increased revenues related to APS’ retail rate increases and other factors, partially offset by
milder weather in 2010.
The following table presents net income attributable to common shareholder compared with the
prior-year period:
Increase
(Decrease)
in Net Income
Six Months Ended
Attributable
June 30,
to Common
2010
2009
Shareholder
(dollars in millions)
Operating revenues less fuel and
purchased power expenses
$
944
$
876
$
68
Operations and maintenance
(415
)
(402
)
(13
)
Depreciation and amortization
(204
)
(201
)
(3
)
Taxes other than income taxes
(63
)
(66
)
3
Other income (expenses), net
(6
)
(4
)
(2
)
Interest charges, net of capitalized
financing costs
Operating revenues less fuel and purchased power expenses
Electric operating revenues less fuel and purchased power expenses were $68 million higher for
the six months ended June 30, 2010 compared with the prior-year period. The following table
describes the major components of this change:
Higher demand-side management and renewable
energy surcharges (substantially offset in
operations and maintenance expense)
15
15
Lower retail revenues related to recovery of PSA
deferrals, substantially offset by lower
amortization of fuel and purchased power
expense
(122
)
(125
)
3
Effects of weather on retail sales, primarily due
to milder weather in the second quarter 2010
(33
)
(10
)
(23
)
Miscellaneous items, net
—
6
(6
)
Total
$
(4
)
$
(72
)
$
68
Operations and maintenance Operations and maintenance expenses increased $13 million for the
six months ended June 30, 2010 compared with the prior-year period primarily because of:
•
An increase of $13 million related to demand-side management and renewable energy
programs, which are primarily offset in operating revenues;
•
An increase of $8 million related to customer service and other costs; and
•
A decrease of $8 million in generation costs, including timing of fossil-plant
planned maintenance.
Income taxes Income taxes were $11 million higher for the six months ended June 30, 2010
compared with the prior-year period primarily because of higher pretax income in the current-year
period, partially offset by $9 million related to a reduction in the Company’s 2010 effective
income tax rate. See Note 6.
ARIZONA PUBLIC SERVICE COMPANY — LIQUIDITY AND CAPITAL RESOURCES
Cash Flows
The following table presents net cash provided by (used for) operating, investing and
financing activities for the six months ended June 30, 2010 and 2009 (dollars in millions):
The decrease of approximately $63 million in net cash provided by operating activities is
primarily due to the payment of income taxes in 2010 and a voluntary pension contribution in 2010
of approximately $100 million, partially offset by other changes in working capital.
The decrease of approximately $156 million in net cash used for investing activities is
primarily due to APS’ timing of $164 million of pollution control auction rate securities
redemptions in 2009 (related to a corresponding amount in the financing activities’ section).
The decrease of approximately $109 million in net cash provided by financing activities is
primarily due to APS’ issuance of $500 million of unsecured senior notes in 2009 and APS’ issuance
of $343 million of pollution control bonds in 2009 (a portion of which was used to redeem $179
million of APS’ existing pollution control bonds, with the remainder deposited in a restricted
trust fund for bond redemption of auction rate securities in 2009, as noted above). This was
partially offset by the reduction of short-term borrowings in 2009 and proceeds of approximately
$253 million from the infusion of equity from Pinnacle West in 2010.
Contractual Obligations
APS’ future contractual obligations, including contingent obligations, related to purchased
power and fuel contracts have increased from approximately $8.4 billion at December 31, 2009 to
$9.1 billion at June 30, 2010 as follows (dollars in billions):
2010
2011-2012
2013-2014
Thereafter
Total
$
0.6
$
0.7
$
1.0
$
6.8
$
9.1
These amounts have increased since the 2009 Form 10-K primarily due to increased solar
contracts associated with meeting the Renewable Energy Standard.
See Note 2 for a list of payments due on total long-term debt and capitalized lease
requirements.
Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
See “Key Financial Drivers” and “Market and Credit Risks” in Item 2 above for a discussion of
quantitative and qualitative disclosures about market risks.
Item 4. CONTROLS AND PROCEDURES
(a) Disclosure Controls and Procedures
The term “disclosure controls and procedures” means controls and other procedures of a company
that are designed to ensure that information required to be disclosed by a company in the reports
that it files or submits under the Securities Exchange Act of 1934, as amended (the “Exchange Act”)
(15 U.S.C. 78a et seq.), is recorded, processed, summarized and reported, within the time periods
specified in the SEC’s rules and forms. Disclosure controls and procedures include, without
limitation, controls and procedures designed to ensure that information required to be disclosed by
a company in the reports that it files or submits under the Exchange Act is accumulated and
communicated to a company’s management, including its principal executive and principal financial
officers, or persons performing similar functions, as appropriate to allow timely decisions
regarding required disclosure.
Pinnacle West’s management, with the participation of Pinnacle West’s Chief Executive Officer
and Chief Financial Officer, have evaluated the effectiveness of Pinnacle West’s disclosure
controls and procedures as of June 30, 2010. Based on that evaluation, Pinnacle West’s Chief
Executive Officer and Chief Financial Officer have concluded that, as of that date, Pinnacle West’s
disclosure controls and procedures were effective.
APS’ management, with the participation of APS’ Chief Executive Officer and Chief Financial
Officer, have evaluated the effectiveness of APS’ disclosure controls and procedures as of June 30,2010. Based on that evaluation, APS’ Chief Executive Officer and Chief Financial Officer have
concluded that, as of that date, APS’ disclosure controls and procedures were effective.
(b) Changes in Internal Control Over Financial Reporting
The term “internal control over financial reporting” (defined in SEC Rule 13a-15(f)) refers to
the process of a company that is designed to provide reasonable assurance regarding the reliability
of financial reporting and the preparation of financial statements for external purposes in
accordance with GAAP.
No change in Pinnacle West’s or APS’ internal control over financial reporting occurred during
the fiscal quarter ended June 30, 2010 that materially affected, or is reasonably likely to
materially affect, Pinnacle West’s or APS’ internal control over financial reporting.
See “Environmental Matters” in Item 5 below and in Part II, Item 5 of the Pinnacle West/APS
Quarterly Report on Form 10-Q for the quarter ended March 31, 2010 (“First Quarter 10-Q”) and
“Business of Arizona Public Service Company — Environmental Matters” in Item 1 of the 2009 Form
10-K in regard to pending or threatened litigation or other disputes.
See Note 10 with regard to a lawsuit brought by APS on behalf of itself and the other Palo
Verde owners against the DOE, for information relating to FERC proceedings on California and
Pacific Northwest energy market issues and for information regarding bankruptcy proceedings
involving the landlord for our corporate headquarters building.
Item 1A. RISK FACTORS
In addition to the other information set forth in this report, you should carefully consider
the factors discussed in Part I, Item 1A. — Risk Factors in the 2009 Form 10-K, which could
materially affect the business, financial condition, cash flows or future results of Pinnacle West
and APS. The risks described in the 2009 Form 10-K are not the only risks facing Pinnacle West and
APS. Additional risks and uncertainties not currently known to us or that we currently deem to be
immaterial also may materially adversely affect the business, financial condition, cash flows
and/or operating results of Pinnacle West and APS.
Item 5. OTHER INFORMATION
Environmental Matters
Superfund
See “Superfund” in Note 10 for a discussion of a Superfund site.
Climate Change
See “Environmental Matters — Climate Change” in Part II, Item 5 of the First Quarter 10-Q for
a discussion of recent climate change matters, including legislative and regulatory initiatives,
regional initiatives, and the Company’s response to climate change initiatives. Updates to certain
regulatory matters and climate change related lawsuits are discussed below.
Regulatory Initiative — EPA Endangerment Finding and Tailoring Rule. In December 2009, the
EPA determined that greenhouse gas emissions endanger public health and welfare. This
determination was made in response to a 2007 United States Supreme Court ruling that greenhouse
gases fit within the Clean Air Act’s broad definition of “air pollutant” and, as a result, the EPA
has the authority to regulate greenhouse gas emissions of new motor vehicles under the Clean Air
Act. As a result of the endangerment finding, the EPA determined that
the Clean Air Act required new regulatory requirements for new and modified major greenhouse gas emitting sources,
including power plants. On June 3, 2010, the EPA issued a rule under the Clean Air Act, known as
the “tailoring rule,” establishing new greenhouse gas emissions thresholds that determine when
sources, including power plants, must obtain air operating permits or New Source Review permits.
The tailoring rule became effective on August 2, 2010 and will
apply to power plants starting January 1, 2011. Several groups have filed lawsuits
challenging the EPA’s endangerment finding and the tailoring rule.
APS does not expect the tailoring rule to have a significant impact on its current operations.
The rule will require APS to consider the impact of greenhouse gas emissions as part of its
traditional New Source Review analysis for new sources and major modifications to existing plants.
At the present time, APS cannot predict what other rules or regulations may ultimately result from
the EPA’s endangerment finding, whether the parties challenging the endangerment finding or the
tailoring rule will be successful, and what impact other potential rules or regulations will have
on APS’ operations.
Climate Change Lawsuits. In February 2008, the Native Village of Kivalina and the City of
Kivalina, Alaska filed a lawsuit in federal court in the Northern District of California against
nine oil companies, fourteen power companies (including Pinnacle West), and a coal company,
alleging that the defendants’ emissions of carbon dioxide contribute to global warming and
constitute a public and private nuisance. The plaintiffs also allege that the effects of global
warming will require the relocation of the village and they are seeking an unspecified amount of
monetary damages. In June 2008, the defendants filed motions to dismiss the action, which were
granted. The plaintiffs filed an appeal with the court in November 2009 and Pinnacle West filed
its reply on June 30, 2010. We believe the action is without merit and intend to continue to
defend against the claims.
A similar nuisance lawsuit is currently pending in the 2nd Circuit and another such lawsuit
was recently dismissed by the 5th Circuit on procedural grounds. These climate change lawsuits
raise political and legal considerations, including whether the courts can or should be making
climate change policy decisions. We are not a party to either of these two lawsuits, but will
monitor these developments and their potential industry impacts.
Mercury and Other Hazardous Air Pollutants
In early 2008, the U.S. Court of Appeals for the D.C. Circuit vacated the Clean Air Mercury
Rule (“CAMR”), which was adopted by the EPA to regulate mercury emissions from coal fired power
plants. As a result, the law in effect prior to the adoption of the CAMR became the applicable
law, and the EPA is now required to adopt final maximum achievable control technology emissions
(“MACT”) standards. Under a consent decree that was finalized on April 15, 2010, the EPA has
agreed to issue final MACT standards for mercury and other hazardous air pollutants by November
2011. Under the terms of the consent decree, APS will have three years after the EPA issues its
final rule to achieve compliance, which would likely require APS to install additional pollution
control equipment.
APS has installed, and continues to install, certain of the equipment necessary to meet the
anticipated standards. The estimated costs expected to be incurred over the next three years for
such equipment are included in our environmental expenditure estimates (see “Management’s
Discussion and Analysis of Financial Condition and Results of Operations — Pinnacle West
Consolidated — Liquidity and Capital Resources — Capital Expenditure Requirements” in Item 2).
In September 1999, the EPA proposed FIPs to set air quality standards at certain power plants,
including Four Corners and the Navajo Plant, which it later revised in 2006. The FIP for Four
Corners was finalized in 2009 and the FIP for the Navajo Plant was finalized in April 2010. We do
not believe compliance with the required limits established in either FIP will have a material
adverse impact on our financial position, results of operations or cash flows.
Coal Combustion Waste
On June 21, 2010, the EPA released its proposed regulations governing the handling and
disposal of coal combustion residuals (“CCRs”), such as fly ash and bottom ash. APS currently
disposes of CCRs in ash ponds and dry storage areas at Cholla and Four Corners, and also sells a
portion of its fly ash for beneficial reuse as a constituent in concrete production. The EPA
proposes regulating CCRs as either non-hazardous waste or hazardous waste and is seeking comment on
three different alternatives. The hazardous waste proposal would phase out the use of ash ponds
for disposal of CCRs. The other two proposals regulate CCRs as non-hazardous waste and impose
performance standards for ash disposal. One of these proposals would require retrofitting or
closure of currently unlined ash ponds, while the other proposal would not require the installation
of liners or pond closures. The EPA has not yet indicated a preference for any of the alternatives.
APS intends to file comments on the proposed rule during a 90-day comment period. We do not
know when the EPA will issue a final rule, including required compliance dates. We cannot currently
predict the outcome of the EPA’s actions or whether such actions will have a material adverse
impact on our financial position, results of operations or cash flows.
Notice of Intent to Sue
As disclosed in the 2009 Form 10-K, on April 6, 2009, APS received a request from the EPA under Section 114
of the Clean Air Act for information regarding projects at and operations of Four Corners. This request was part of an
EPA enforcement initiative under the New Source Review provisions of
the Clean Air Act. APS responded to the request in August 2009.
On May 7, 2010, APS received a Notice of Intent to Sue from Earthjustice, on behalf of several
environmental organizations, related to alleged violations of the Clean Air Act at Four Corners
(the “Notice”). The Notice alleges New Source Review-related violations and New Source Performance
Standard violations. Under the Clean Air Act, a citizens group is required to provide 60 days
advance notice of its intent to file a lawsuit. Within that 60-day time period, the EPA may step
in and file a lawsuit regarding the allegations. If the EPA does so, the citizens group is
precluded from filing its own lawsuit, but it may still intervene in the EPA’s lawsuit, if it so
desires. The 60-day period lapsed in early July, and the EPA did not take any action. At this
time, we cannot predict whether or when Earthjustice might file a lawsuit.
Pinnacle West Capital Corporation Bylaws,
amended as of May 19, 2010
10.1
Pinnacle West
Form of Performance Share Agreement under
the Pinnacle West Capital Corporation 2007
Long-Term Incentive Plan
10.2
Pinnacle West
Form of Restricted Stock Unit Agreement
under the Pinnacle West Capital Corporation
2007 Long-Term Incentive Plan
12.1
Pinnacle West
Ratio of Earnings to Fixed Charges
12.2
APS
Ratio of Earnings to Fixed Charges
12.3
Pinnacle West
Ratio of Earnings to Combined Fixed Charges
and Preferred Stock Dividend Requirements
31.1
Pinnacle West
Certificate of Donald E. Brandt, Chief
Executive Officer, pursuant to Rule
13a-14(a) and Rule 15d-14(a) of the
Securities Exchange Act, as amended
31.2
Pinnacle West
Certificate of James R. Hatfield, Senior
Vice President and Chief Financial Officer,
pursuant to Rule 13a-14(a) and Rule
15d-14(a) of the Securities Exchange Act,
as amended
31.3
APS
Certificate of Donald E. Brandt, Chief
Executive Officer, pursuant to Rule
13a-14(a) and Rule 15d-14(a) of the
Securities Exchange Act, as amended
31.4
APS
Certificate of James R. Hatfield, Senior
Vice President and Chief Financial Officer,
pursuant to Rule 13a-14(a) and Rule
15d-14(a) of the Securities Exchange Act,
as amended
32.1
*
Pinnacle West
Certification of Chief Executive Officer
and Chief Financial Officer, pursuant to 18
U.S.C. Section 1350, as adopted pursuant to
Section 906 of the Sarbanes-Oxley Act of
2002
Certification of Chief Executive Officer
and Chief Financial Officer, pursuant to 18
U.S.C. Section 1350, as adopted pursuant to
Section 906 of the Sarbanes-Oxley Act of
2002
In addition, Pinnacle West hereby incorporates the following Exhibits pursuant to Exchange Act
Rule 12b-32 and Regulation §229.10(d) by reference to the filings set forth below:
Pursuant to the requirements of the Securities Exchange Act of 1934, each registrant has duly
caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
