XNYS:PNW Pinnacle West Capital Quarterly Report 10-Q Filing - 6/30/2012

Effective Date 6/30/2012

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Table of Contents

 

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 


 

FORM 10-Q

 

(Mark One)

 

x  QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the quarterly period ended June 30, 2012

 

OR

 

o   TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the transition period from              to            

 

Commission File
Number

 

Exact Name of Each Registrant as specified in its
charter; State of Incorporation; Address; and
Telephone Number

 

IRS Employer
Identification No.

1-8962

 

PINNACLE WEST CAPITAL CORPORATION

(an Arizona corporation)

400 North Fifth Street, P.O. Box 53999

Phoenix, Arizona 85072-3999

(602) 250-1000

 

86-0512431

1-4473

 

ARIZONA PUBLIC SERVICE COMPANY

(an Arizona corporation)

400 North Fifth Street, P.O. Box 53999

Phoenix, Arizona 85072-3999

(602) 250-1000

 

86-0011170

 

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 x  No o

ARIZONA PUBLIC SERVICE COMPANY

 

Yes x  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 x  No o

ARIZONA PUBLIC SERVICE COMPANY

 

Yes x  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 x

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 x

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 x

ARIZONA PUBLIC SERVICE COMPANY

 

Yes o  No x

 

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 27, 2012: 109,543,792

ARIZONA PUBLIC SERVICE COMPANY

 

Number of shares of common stock, $2.50 par value, outstanding as of July 27, 2012: 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.

 

 

 



Table of Contents

 

TABLE OF CONTENTS

 

 

Page

 

 

Forward-Looking Statements

2

Part I

3

 

Item 1.

Financial Statements

3

 

 

Pinnacle West Capital Corporation

3

 

 

Arizona Public Service Company

43

 

Item 2.

Management’s Discussion and Analysis of Financial Condition and Results of Operations

53

 

Item 3.

Quantitative and Qualitative Disclosures About Market Risk

72

 

Item 4.

Controls and Procedures

72

 

 

 

 

Part II

 

73

 

Item 1.

Legal Proceedings

73

 

Item 1A.

Risk Factors

73

 

Item 5.

Other Information

73

 

Item 6.

Exhibits

78

Signatures

81

 

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 relate to APS, and Supplemental Notes, which only relate to APS’s Condensed Consolidated Financial Statements.

 



Table of Contents

 

FORWARD-LOOKING STATEMENTS

 

This document contains forward-looking statements based on current expectations.  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 Part I, Item 1A of the Pinnacle West/APS Annual Report on Form 10-K for the fiscal year ended December 31, 2011 (“2011 Form 10-K”), Part II, Item 1A of this report and in Part I, Item 2 — “Management’s Discussion and Analysis of Financial Condition and Results of Operations” of this report, these factors include, but are not limited to:

 

·          our ability to manage capital expenditures and operation and maintenance 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 and distributed generation;

·          power plant and transmission system performance and outages;

·          volatile fuel and purchased power costs;

·          fuel and water supply availability;

·          our ability to achieve timely and adequate rate recovery of our costs, including returns on debt and equity capital;

·          regulatory and judicial decisions, developments and proceedings;

·          new legislation or regulation, including those relating to environmental requirements and nuclear plant operations;

·          our ability to meet renewable energy and energy efficiency mandates and recover related costs;

·          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 real estate market conditions;

·          the cost of debt and equity capital and the ability to access capital markets when required;

·          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;

·          generation, transmission and distribution facility and 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 willingness or ability of our counterparties, power plant participants and power plant land owners to meet contractual or other obligations or extend the rights for continued power plant operations;

·          technological developments affecting the electric industry; and

·          restrictions on dividends or other provisions in our credit agreements and Arizona Corporation Commission (“ACC”) orders.

 

These and other factors are discussed in the Risk Factors described in Part I, Item 1A of our 2011 Form 10-K and in Part II, Item 1A of this report, which readers should review carefully before placing any reliance on our financial statements or disclosures.  Neither Pinnacle West nor APS assumes any obligation to update these statements, even if our internal estimates change, except as required by law.

 

2



Table of Contents

 

PART I — FINANCIAL INFORMATION

 

ITEM 1.  FINANCIAL STATEMENTS

 

PINNACLE WEST CAPITAL CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF INCOME

(unaudited)

(dollars and shares in thousands, except per share amounts)

 

 

 

Three Months Ended
June 30,

 

 

 

2012

 

2011

 

 

 

 

 

 

 

OPERATING REVENUES

 

$

878,576

 

$

799,799

 

 

 

 

 

 

 

OPERATING EXPENSES

 

 

 

 

 

Fuel and purchased power

 

264,723

 

244,049

 

Operations and maintenance

 

216,236

 

210,590

 

Depreciation and amortization

 

100,606

 

106,617

 

Taxes other than income taxes

 

41,289

 

40,155

 

Other expenses

 

1,233

 

1,396

 

Total

 

624,087

 

602,807

 

OPERATING INCOME

 

254,489

 

196,992

 

OTHER INCOME (DEDUCTIONS)

 

 

 

 

 

Allowance for equity funds used during construction

 

5,175

 

5,924

 

Other income (Note 11)

 

177

 

557

 

Other expense (Note 11)

 

(2,669

)

(3,186

)

Total

 

2,683

 

3,295

 

INTEREST EXPENSE

 

 

 

 

 

Interest charges

 

53,000

 

60,140

 

Allowance for borrowed funds used during construction

 

(3,447

)

(3,856

)

Total

 

49,553

 

56,284

 

INCOME FROM CONTINUING OPERATIONS BEFORE INCOME TAXES

 

207,619

 

144,003

 

INCOME TAXES

 

76,689

 

50,818

 

INCOME FROM CONTINUING OPERATIONS

 

130,930

 

93,185

 

INCOME (LOSS) FROM DISCONTINUED OPERATIONS

 

 

 

 

 

Net of income tax expense (benefit) of $(535) and $773 (Note 13)

 

(819

)

654

 

NET INCOME

 

130,111

 

93,839

 

Less: Net income attributable to noncontrolling interests (Note 7)

 

7,766

 

7,154

 

NET INCOME ATTRIBUTABLE TO COMMON SHAREHOLDERS

 

$

122,345

 

$

86,685

 

 

 

 

 

 

 

WEIGHTED-AVERAGE COMMON SHARES OUTSTANDING — BASIC

 

109,491

 

109,044

 

WEIGHTED-AVERAGE COMMON SHARES OUTSTANDING — DILUTED

 

110,359

 

109,718

 

 

 

 

 

 

 

EARNINGS PER WEIGHTED-AVERAGE COMMON SHARE OUTSTANDING

 

 

 

 

 

Income from continuing operations attributable to common shareholders — basic

 

$

1.12

 

$

0.79

 

Net income attributable to common shareholders — basic

 

1.12

 

0.80

 

Income from continuing operations attributable to common shareholders — diluted

 

1.12

 

0.78

 

Net income attributable to common shareholders — diluted

 

1.11

 

0.79

 

 

 

 

 

 

 

DIVIDENDS DECLARED PER SHARE

 

$

1.05

 

$

1.05

 

 

 

 

 

 

 

AMOUNTS ATTRIBUTABLE TO COMMON SHAREHOLDERS:

 

 

 

 

 

Income from continuing operations, net of tax

 

$

123,164

 

$

86,001

 

Discontinued operations, net of tax

 

(819

)

684

 

Net income attributable to common shareholders

 

$

122,345

 

$

86,685

 

 

See Notes to Pinnacle West’s Condensed Consolidated Financial Statements.

 

3



Table of Contents

 

PINNACLE WEST CAPITAL CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(unaudited)

(dollars in thousands)

 

 

 

Three Months Ended
June 30,

 

 

 

2012

 

2011

 

 

 

 

 

 

 

NET INCOME

 

$

130,111

 

$

93,839

 

 

 

 

 

 

 

OTHER COMPREHENSIVE INCOME (LOSS), NET OF TAX

 

 

 

 

 

Derivative instruments:

 

 

 

 

 

Net unrealized gain (loss), net of tax benefit (expense) of $(1,781) and $6,448

 

2,728

 

(9,875

)

Reclassification of net realized loss, net of tax benefit of $9,090 and $9,988

 

13,925

 

15,299

 

Pension and other postretirement benefits activity, net of tax expense of $526 and $797

 

806

 

1,222

 

Total other comprehensive income

 

17,459

 

6,646

 

 

 

 

 

 

 

COMPREHENSIVE INCOME

 

147,570

 

100,485

 

Less: Comprehensive income attributable to noncontrolling interests

 

7,766

 

7,154

 

 

 

 

 

 

 

COMPREHENSIVE INCOME ATTRIBUTABLE TO COMMON SHAREHOLDERS

 

$

139,804

 

$

93,331

 

 

See Notes to Pinnacle West’s Condensed Consolidated Financial Statements.

 

4



Table of Contents

 

PINNACLE WEST CAPITAL CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF INCOME

(unaudited)

(dollars and shares in thousands, except per share amounts)

 

 

 

Six Months Ended
June 30,

 

 

 

2012

 

2011

 

 

 

 

 

 

 

OPERATING REVENUES

 

$

1,499,207

 

$

1,448,646

 

 

 

 

 

 

 

OPERATING EXPENSES

 

 

 

 

 

Fuel and purchased power

 

481,032

 

456,056

 

Operations and maintenance

 

426,899

 

465,619

 

Depreciation and amortization

 

200,715

 

213,200

 

Taxes other than income taxes

 

83,764

 

77,779

 

Other expenses

 

4,301

 

3,216

 

Total

 

1,196,711

 

1,215,870

 

OPERATING INCOME

 

302,496

 

232,776

 

OTHER INCOME (DEDUCTIONS)

 

 

 

 

 

Allowance for equity funds used during construction

 

9,931

 

11,319

 

Other income (Note 11)

 

937

 

2,247

 

Other expense (Note 11)

 

(6,737

)

(4,927

)

Total

 

4,131

 

8,639

 

INTEREST EXPENSE

 

 

 

 

 

Interest charges

 

109,967

 

121,217

 

Allowance for borrowed funds used during construction

 

(6,598

)

(7,432

)

Total

 

103,369

 

113,785

 

INCOME FROM CONTINUING OPERATIONS BEFORE INCOME TAXES

 

203,258

 

127,630

 

INCOME TAXES

 

72,044

 

44,813

 

INCOME FROM CONTINUING OPERATIONS

 

131,214

 

82,817

 

INCOME (LOSS) FROM DISCONTINUED OPERATIONS

 

 

 

 

 

Net of income tax expense (benefit) of $(1,040) and $906 (Note 13)

 

(1,584

)

1,348

 

NET INCOME

 

129,630

 

84,165

 

Less: Net income attributable to noncontrolling interests (Note 7)

 

15,542

 

12,615

 

NET INCOME ATTRIBUTABLE TO COMMON SHAREHOLDERS

 

$

114,088

 

$

71,550

 

 

 

 

 

 

 

WEIGHTED-AVERAGE COMMON SHARES OUTSTANDING — BASIC

 

109,395

 

108,939

 

WEIGHTED-AVERAGE COMMON SHARES OUTSTANDING — DILUTED

 

110,183

 

109,540

 

 

 

 

 

 

 

EARNINGS PER WEIGHTED-AVERAGE COMMON SHARE OUTSTANDING

 

 

 

 

 

Income from continuing operations attributable to common shareholders — basic

 

$

1.06

 

$

0.64

 

Net income attributable to common shareholders — basic

 

1.04

 

0.66

 

Income from continuing operations attributable to common shareholders — diluted

 

1.05

 

0.64

 

Net income attributable to common shareholders — diluted

 

1.04

 

0.65

 

 

 

 

 

 

 

DIVIDENDS DECLARED PER SHARE

 

$

1.575

 

$

1.575

 

 

 

 

 

 

 

AMOUNTS ATTRIBUTABLE TO COMMON SHAREHOLDERS:

 

 

 

 

 

Income from continuing operations, net of tax

 

$

115,681

 

$

70,163

 

Discontinued operations, net of tax

 

(1,593

)

1,387

 

Net income attributable to common shareholders

 

$

114,088

 

$

71,550

 

 

See Notes to Pinnacle West’s Condensed Consolidated Financial Statements.

 

5



Table of Contents

 

PINNACLE WEST CAPITAL CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(unaudited)

(dollars in thousands)

 

 

 

Six Months Ended
June 30,

 

 

 

2012

 

2011

 

 

 

 

 

 

 

NET INCOME

 

$

129,630

 

$

84,165

 

 

 

 

 

 

 

OTHER COMPREHENSIVE INCOME (LOSS), NET OF TAX

 

 

 

 

 

Derivative instruments:

 

 

 

 

 

Net unrealized loss, net of tax benefit of $14,770 and $6,058

 

(22,624

)

(9,277

)

Reclassification of net realized loss, net of tax benefit of $14,818 and $15,852

 

22,697

 

24,281

 

Pension and other postretirement benefits activity, net of tax expense of $1,157 and $1,363

 

1,772

 

2,088

 

Total other comprehensive income

 

1,845

 

17,092

 

 

 

 

 

 

 

COMPREHENSIVE INCOME

 

131,475

 

101,257

 

Less: Comprehensive income attributable to noncontrolling interests

 

15,542

 

12,615

 

 

 

 

 

 

 

COMPREHENSIVE INCOME ATTRIBUTABLE TO COMMON SHAREHOLDERS

 

$

115,933

 

$

88,642

 

 

See Notes to Pinnacle West’s Condensed Consolidated Financial Statements.

 

6



Table of Contents

 

PINNACLE WEST CAPITAL CORPORATION

CONDENSED CONSOLIDATED BALANCE SHEETS

(unaudited)

(dollars in thousands)

 

 

 

June 30,
2012

 

December 31,
2011

 

ASSETS

 

 

 

 

 

 

 

 

 

 

 

CURRENT ASSETS

 

 

 

 

 

Cash and cash equivalents

 

$

11,228

 

$

33,583

 

Customer and other receivables

 

316,722

 

284,183

 

Accrued unbilled revenues

 

168,450

 

125,239

 

Allowance for doubtful accounts

 

(3,302

)

(3,748

)

Materials and supplies (at average cost)

 

217,222

 

204,387

 

Fossil fuel (at average cost)

 

30,177

 

22,000

 

Deferred income taxes

 

87,690

 

130,571

 

Income tax receivable (Note 6)

 

885

 

6,466

 

Assets from risk management activities (Note 8)

 

29,991

 

30,264

 

Deferred fuel and purchased power regulatory asset (Note 3)

 

 

27,549

 

Other regulatory assets (Note 3)

 

54,857

 

69,072

 

Other current assets

 

33,496

 

26,904

 

Total current assets

 

947,416

 

956,470

 

 

 

 

 

 

 

INVESTMENTS AND OTHER ASSETS

 

 

 

 

 

Assets from risk management activities (Note 8)

 

43,526

 

49,322

 

Nuclear decommissioning trust (Note 15)

 

544,933

 

513,733

 

Other assets

 

64,800

 

64,588

 

Total investments and other assets

 

653,259

 

627,643

 

 

 

 

 

 

 

PROPERTY, PLANT AND EQUIPMENT

 

 

 

 

 

Plant in service and held for future use

 

14,048,957

 

13,753,971

 

Accumulated depreciation and amortization

 

(4,843,868

)

(4,709,991

)

Net

 

9,205,089

 

9,043,980

 

Construction work in progress

 

458,441

 

496,745

 

Palo Verde sale leaseback, net of accumulated depreciation (Note 7)

 

130,929

 

132,864

 

Intangible assets, net of accumulated amortization

 

163,727

 

170,571

 

Nuclear fuel, net of accumulated amortization

 

159,493

 

118,098

 

Total property, plant and equipment

 

10,117,679

 

9,962,258

 

 

 

 

 

 

 

DEFERRED DEBITS

 

 

 

 

 

Regulatory assets (Note 3)

 

1,283,322

 

1,352,079

 

Income tax receivable (Note 6)

 

69,508

 

68,633

 

Other

 

143,223

 

143,935

 

Total deferred debits

 

1,496,053

 

1,564,647

 

 

 

 

 

 

 

TOTAL ASSETS

 

$

13,214,407

 

$

13,111,018

 

 

See Notes to Pinnacle West’s Condensed Consolidated Financial Statements.

 

7



Table of Contents

 

PINNACLE WEST CAPITAL CORPORATION

CONDENSED CONSOLIDATED BALANCE SHEETS

(unaudited)

(dollars in thousands)

 

 

 

June 30,
2012

 

December 31,
2011

 

LIABILITIES AND EQUITY

 

 

 

 

 

 

 

 

 

 

 

CURRENT LIABILITIES

 

 

 

 

 

Accounts payable

 

$

316,329

 

$

326,987

 

Accrued taxes (Note 6)

 

133,766

 

120,289

 

Accrued interest

 

61,451

 

54,872

 

Common dividends payable

 

57,479

 

 

Short-term borrowings

 

109,000

 

 

Current maturities of long-term debt

 

57,962

 

477,435

 

Customer deposits

 

74,575

 

72,176

 

Liabilities from risk management activities (Note 8)

 

64,442

 

53,968

 

Deferred fuel and purchased power regulatory liability (Note 3)

 

325

 

 

Other regulatory liabilities (Note 3)

 

89,433

 

88,362

 

Other current liabilities

 

139,561

 

148,616

 

Total current liabilities

 

1,104,323

 

1,342,705

 

 

 

 

 

 

 

LONG-TERM DEBT LESS CURRENT MATURITIES

 

 

 

 

 

Long-term debt less current maturities

 

3,313,992

 

2,953,507

 

Palo Verde sale leaseback lessor notes less current maturities (Note 7)

 

57,420

 

65,547

 

Total long-term debt less current maturities

 

3,371,412

 

3,019,054

 

 

 

 

 

 

 

DEFERRED CREDITS AND OTHER

 

 

 

 

 

Deferred income taxes

 

1,946,540

 

1,925,388

 

Regulatory liabilities (Note 3)

 

738,693

 

737,332

 

Liability for asset retirements

 

289,641

 

279,643

 

Liabilities for pension and other postretirement benefits (Note 4)

 

1,243,256

 

1,268,910

 

Liabilities from risk management activities (Note 8)

 

108,554

 

82,495

 

Customer advances

 

111,655

 

116,805

 

Coal mine reclamation

 

118,374

 

117,896

 

Unrecognized tax benefits (Note 6)

 

72,977

 

72,270

 

Other

 

209,645

 

217,934

 

Total deferred credits and other

 

4,839,335

 

4,818,673

 

 

 

 

 

 

 

COMMITMENTS AND CONTINGENCIES (SEE NOTES)

 

 

 

 

 

 

 

 

 

 

 

EQUITY (Note 9)

 

 

 

 

 

Common stock, no par value

 

2,453,453

 

2,444,247

 

Treasury stock

 

(1,359

)

(4,717

)

Total common stock

 

2,452,094

 

2,439,530

 

Retained earnings

 

1,476,259

 

1,534,483

 

Accumulated other comprehensive loss:

 

 

 

 

 

Pension and other postretirement benefits

 

(63,675

)

(65,447

)

Derivative instruments

 

(86,643

)

(86,716

)

Total accumulated other comprehensive loss

 

(150,318

)

(152,163

)

Total shareholders’ equity

 

3,778,035

 

3,821,850

 

Noncontrolling interests (Note 7)

 

121,302

 

108,736

 

Total equity

 

3,899,337

 

3,930,586

 

 

 

 

 

 

 

TOTAL LIABILITIES AND EQUITY

 

$

13,214,407

 

$

13,111,018

 

 

See Notes to Pinnacle West’s Condensed Consolidated Financial Statements.

 

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PINNACLE WEST CAPITAL CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(unaudited)

(dollars in thousands)

 

 

 

Six Months Ended
June 30,

 

 

 

2012

 

2011

 

CASH FLOWS FROM OPERATING ACTIVITIES

 

 

 

 

 

Net income

 

$

129,630

 

$

84,165

 

Adjustments to reconcile net income to net cash provided by operating activities:

 

 

 

 

 

Depreciation and amortization including nuclear fuel

 

239,743

 

245,700

 

Deferred fuel and purchased power

 

82,261

 

64,679

 

Deferred fuel and purchased power amortization

 

(54,388

)

(68,762

)

Allowance for equity funds used during construction

 

(9,931

)

(11,319

)

Deferred income taxes

 

66,142

 

11,945

 

Change in derivative instruments fair value

 

(2,618

)

(279

)

Changes in current assets and liabilities:

 

 

 

 

 

Customer and other receivables

 

(21,424

)

43,271

 

Accrued unbilled revenues

 

(43,211

)

(60,390

)

Materials, supplies and fossil fuel

 

(21,012

)

(18,226

)

Other current assets

 

(9,407

)

(37,053

)

Accounts payable

 

9,199

 

37,817

 

Accrued taxes and income tax receivable — net

 

19,775

 

29,530

 

Other current liabilities

 

807

 

3,967

 

Change in margin and collateral accounts — assets

 

124

 

21,185

 

Change in margin and collateral accounts — liabilities

 

69,602

 

39,567

 

Change in unrecognized tax benefits

 

 

18,959

 

Change in other long-term assets

 

(1,692

)

(26,225

)

Change in other long-term liabilities

 

5,035

 

57,748

 

Net cash flow provided by operating activities

 

458,635

 

436,279

 

 

 

 

 

 

 

CASH FLOWS FROM INVESTING ACTIVITIES

 

 

 

 

 

Capital expenditures

 

(424,775

)

(387,272

)

Contributions in aid of construction

 

25,800

 

21,905

 

Allowance for borrowed funds used during construction

 

(6,598

)

(7,432

)

Proceeds from nuclear decommissioning trust sales

 

211,138

 

299,600

 

Investment in nuclear decommissioning trust

 

(219,762

)

(308,222

)

Proceeds from sale of life insurance policies

 

 

55,444

 

Other

 

(525

)

(2,352

)

Net cash flow used for investing activities

 

(414,722

)

(328,329

)

 

 

 

 

 

 

CASH FLOWS FROM FINANCING ACTIVITIES

 

 

 

 

 

Issuance of long-term debt

 

351,081

 

175,000

 

Repayment of long-term debt

 

(421,451

)

(187,962

)

Short-term borrowings and payments — net

 

109,000

 

(9,300

)

Dividends paid on common stock

 

(111,297

)

(112,537

)

Common stock equity issuance

 

8,869

 

14,520

 

Distributions to noncontrolling interests

 

(2,630

)

(2,610

)

Other

 

160

 

(2,975

)

Net cash flow used for financing activities

 

(66,268

)

(125,864

)

 

 

 

 

 

 

NET DECREASE IN CASH AND CASH EQUIVALENTS

 

(22,355

)

(17,914

)

 

 

 

 

 

 

CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD

 

33,583

 

110,188

 

 

 

 

 

 

 

CASH AND CASH EQUIVALENTS AT END OF PERIOD

 

$

11,228

 

$

92,274

 

Supplemental disclosure of cash flow information

 

 

 

 

 

Cash paid during the period for:

 

 

 

 

 

Income taxes, net of (refunds)

 

$

(649

)

$

 

Interest, net of amounts capitalized

 

$

94,680

 

$

110,659

 

 

See Notes to Pinnacle West’s Condensed Consolidated Financial Statements.

 

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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 and El Dorado Investment Company (“El Dorado”) and formerly SunCor Development Company (“SunCor”) and APS Energy Services Company, Inc. (“APSES”).  See Note 13 for discussion of the bankruptcy filing of SunCor and the sale of APSES.  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 Nuclear Generating Station (“Palo Verde”) sale leaseback variable interest entities (“VIEs”) (see Note 7 for further discussion).  Our accounting records are maintained in accordance with accounting principles generally accepted in the United States of America (“GAAP”).  The preparation of financial statements in accordance with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities at the date of the financial statements and reported amounts of revenues and expenses during the reporting period.  Actual results could differ from those estimates.

 

Weather conditions cause significant seasonal fluctuations in our revenues; therefore, results for interim periods do not necessarily represent results expected for the year.

 

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.  These condensed consolidated financial statements and notes have been prepared consistently with the 2011 Form 10-K with the exception of the reclassification of certain prior year amounts on our Condensed Consolidated Statements of Income and Condensed Consolidated Statements of Cash Flows to conform to the current year presentation.

 

See Note 16 for discussion of amended guidance on the presentation of comprehensive income.

 

The following tables show the impact of the reclassifications to prior year (previously reported) amounts (dollars in thousands):

 

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PINNACLE WEST CAPITAL CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 

Statement of Income for the Three
Months Ended June 30, 2011

 

As
previously
reported

 

Reclassifications
to conform to
current year
presentation

 

Amount
reported after
reclassification
to conform to
current year
presentation

 

Operating Revenues

 

 

 

 

 

 

 

Regulated electricity segment

 

$

798,669

 

$

(798,669

)

$

 

Other revenues

 

1,130

 

(1,130

)

 

Operating revenues

 

 

799,799

 

799,799

 

 

Statement of Income for the Six
Months Ended June 30, 2011

 

As
previously
reported

 

Reclassifications
to conform to
current year
presentation

 

Amount
reported after
reclassification
to conform to
current year
presentation

 

Operating Revenues

 

 

 

 

 

 

 

Regulated electricity segment

 

$

1,446,643

 

$

(1,446,643

)

$

 

Other revenues

 

2,003

 

(2,003

)

 

Operating revenues

 

 

1,448,646

 

1,448,646

 

 

Statement of Cash Flows for the Six
Months Ended June 30, 2011

 

As
previously
reported

 

Reclassifications
to conform to
current year
presentation

 

Amount
reported after
reclassification
to conform to
current year
presentation

 

Cash Flows from Operating Activities

 

 

 

 

 

 

 

Expenditures for real estate investments

 

$

(40

)

$

40

 

$

 

Change in other long-term assets

 

(26,185

)

(40

)

(26,225

)

 

2.             Long-Term Debt and Liquidity Matters

 

Pinnacle West and APS maintain committed revolving credit facilities in order to enhance liquidity and provide credit support for their commercial paper programs.

 

Pinnacle West

 

At June 30, 2012, Pinnacle West’s $200 million credit facility, which matures in November 2016, was available to refinance indebtedness of the Company and for other general corporate purposes, including credit support for its $200 million commercial paper program.  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.  At June 30, 2012, Pinnacle West had no outstanding borrowings under its credit facility, no letters of credit outstanding and no commercial paper borrowings.

 

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PINNACLE WEST CAPITAL CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 

APS

 

On January 13, 2012, APS issued $325 million of 4.50% unsecured senior notes that mature on April 1, 2042.  The net proceeds from the sale were used along with other funds to repay at maturity APS’s $375 million aggregate principal amount of 6.50% senior notes on March 1, 2012.

 

On May 1, 2012, pursuant to the mandatory tender provision, APS purchased all $32 million of the Maricopa County, Arizona Pollution Control Corporation Pollution Control Revenue Refunding Bonds (Arizona Public Service Company Palo Verde Project), 2009 Series B, due 2029.  On June 1, 2012 we remarketed these bonds.  Currently, the interest rate on these bonds is reset daily by a remarketing agent.  The daily rate at June 30, 2012 was 0.17%.  Additionally, the bonds are supported by a letter of credit.  These bonds are classified as long-term debt on our Condensed Consolidated Balance Sheets at June 30, 2012 and were classified as current maturities of long-term debt on our Condensed Consolidated Balance Sheets at December 31, 2011.

 

On June 1, 2012, pursuant to the mandatory tender provision, APS changed the interest rate mode for the approximately $38 million of Navajo County, Arizona Pollution Control Corporation Pollution Control Revenue Refunding Bonds (Arizona Public Service Company Cholla Project), 2009 Series A.  The new term rate period for these bonds commenced on June 1, 2012, and ends, subject to a mandatory tender, on May 29, 2014.  During this time, the bonds will bear interest at a rate of 1.25% per annum.  These bonds are classified as long-term debt on our Condensed Consolidated Balance Sheets at June 30, 2012 and were classified as current maturities of long-term debt on our Condensed Consolidated Balance Sheets at December 31, 2011.

 

At June 30, 2012, APS had two credit facilities totaling $1 billion, including a $500 million credit facility that matures in February 2015, and a $500 million facility that matures in November 2016.  APS may increase the amount of each facility up to a maximum of $700 million upon the satisfaction of certain conditions and with the consent of the lenders.  APS will use these facilities to refinance indebtedness and for other general corporate purposes.  Interest rates are based on APS’s senior unsecured debt credit ratings.

 

The facilities described above are available to support APS’s $250 million commercial paper program, for bank borrowings or for issuances of letters of credit.  At June 30, 2012, APS had commercial paper borrowings of $109 million, and no outstanding borrowings or letters of credit under these facilities.

 

See “Financial Assurances” in Note 10 for discussion of APS’s separate outstanding letters of credit.

 

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PINNACLE WEST CAPITAL CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 

Debt Fair Value

 

Our long-term debt fair value estimates are based on quoted market prices for the same or similar issues, and are classified within Level 2 of the fair value hierarchy.  See Note 14 for discussion of the fair value hierarchy.  The following table represents the estimated fair value of our long-term debt, including current maturities (dollars in millions):

 

 

 

As of
June 30, 2012

 

As of
December 31, 2011

 

 

 

Carrying
Amount

 

Fair Value

 

Carrying
Amount

 

Fair Value

 

 

 

 

 

 

 

 

 

 

 

Pinnacle West

 

$

125

 

$

123

 

$

125

 

$

123

 

APS

 

3,304

 

3,794

 

3,371

 

3,803

 

Total

 

$

3,429

 

$

3,917

 

$

3,496

 

$

3,926

 

 

Debt Provisions

 

An ACC order requires APS to maintain a common equity ratio of at least 40%.  As defined in the ACC order, the common equity ratio is total shareholder equity divided by the sum of total shareholder equity and long-term debt, including current maturities of long-term debt.  At June 30, 2012, APS was in compliance with this common equity ratio requirement.  Its total shareholder equity was approximately $3.9 billion, and total capitalization was approximately $7.1 billion.  APS would be prohibited from paying dividends if such payment would reduce its total shareholder equity below approximately $2.8 billion, assuming APS’s total capitalization remains the same.  Since APS was in compliance with this common equity ratio requirement, this restriction does not materially affect Pinnacle West’s ability to meet its ongoing cash needs or ability to pay dividends to shareholders.

 

3.             Regulatory Matters

 

Retail Rate Case Filing with the Arizona Corporation Commission

 

On June 1, 2011, APS filed an application with the ACC for a net retail base rate increase of $95.5 million.  APS requested that the increase become effective July 1, 2012.  The request would have increased the average retail customer bill approximately 6.6%.  On January 6, 2012, APS and other parties to APS’s pending general retail rate case entered into an agreement (the “Settlement Agreement”) detailing the terms upon which the parties have agreed to settle the rate case.  On May 15, 2012, the ACC approved the Settlement Agreement without material modifications.

 

Settlement Agreement

 

The Settlement Agreement provides for a zero net change in base rates, consisting of:  (1) a non-fuel base rate increase of $116.3 million; (2) a fuel-related base rate decrease of $153.1 million (to be implemented by a change in the base fuel rate for purchased power costs (“Base Fuel Rate”)) from $0.03757 to $0.03207 per kilowatt-hour (“kWh”); and (3) the transfer of cost recovery for certain renewable energy projects from the Arizona Renewable Energy Standard and Tariff (“RES”) surcharge to base rates in an estimated amount of $36.8 million.

 

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PINNACLE WEST CAPITAL CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 

APS also agreed not to file its next general rate case before May 31, 2015, and not to request that its next general retail rate increase be effective prior to July 1, 2016.  The Settlement Agreement allows APS to request a change to its base rates during the stay-out period in the event of an extraordinary event that, in the ACC’s judgment, requires base rate relief in order to protect the public interest.  Nor is APS precluded from seeking rate relief, or any other party to the Settlement Agreement precluded from petitioning the ACC to examine the reasonableness of APS’s rates, in the event of significant regulatory developments that materially impact the financial results expected under the terms of the Settlement Agreement.

 

Other key provisions of the Settlement Agreement include the following:

 

·              An authorized return on common equity of 10.0%;

 

·              A capital structure comprised of 46.1% debt and 53.9% common equity;

 

·              A test year ended December 31, 2010, adjusted to include plant that is in service as of March 31, 2012;

 

·              Deferral for future recovery or refund of property taxes above or below a specified 2010 test year level caused by changes to the Arizona property tax rate as follows:

 

·              Deferral of 25% in 2012, 50% in 2013 and 75% for 2014 and subsequent years if Arizona property tax rates increase; and

 

·              Deferral of 100% in all years if Arizona property tax rates decrease;

 

·              A procedure to allow APS to request rate adjustments prior to its next general rate case related to APS’s proposed acquisition (should it be consummated) of additional interests in Units 4 and 5 and the related closure of Units 1-3 of the Four Corners Power Plant (“Four Corners”);

 

·              Implementation of a “Lost Fixed Cost Recovery” rate mechanism to support energy efficiency and distributed renewable generation;

 

·              Modifications to the Environmental Improvement Surcharge (“EIS”) to allow for the recovery of carrying costs for capital expenditures associated with government-mandated environmental controls, subject to an existing cents per kWh cap on cost recovery that could produce up to approximately $5 million in revenues annually;

 

·              Modifications to the Power Supply Adjustor (“PSA”), including the elimination of the current 90/10 sharing provision;

 

·              A limitation on the use of the RES surcharge and the Demand Side Management Adjustor Charge (“DSMAC”) to recoup capital expenditures not required under the terms of the 2008 rate case settlement agreement discussed below.

 

·              Allowing a negative credit that currently exists in the PSA to continue until February 2013, rather than being reset on the anticipated July 1, 2012 rate effective date;

 

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 

·              Modification of the transmission cost adjustor (“TCA”) to streamline the process for future transmission-related rate changes; and

 

·              Implementation of various changes to rate schedules, including the adoption of an experimental “buy-through” rate that could allow certain large commercial and industrial customers to select alternative sources of generation to be supplied by APS.

 

The Settlement Agreement was approved by the ACC on May 15, 2012, with new rates effective on July 1, 2012.  This accomplished a goal set by the parties to the 2008 rate case settlement to process 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.

 

2008 General Retail Rate Case On-Going Impacts

 

On December 30, 2009, the ACC issued an order approving a settlement agreement entered into by APS and twenty-one other parties in APS’s prior general retail rate case, which was originally filed in March 2008.  The settlement agreement contains certain on-going requirements, commitments and authorizations that will survive the 2012 Settlement Agreement, including the following:

 

·              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); 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 through 2012 and its use of renewable energy through 2015, as well as allow for concurrent recovery of renewable energy expenses and provide for more concurrent recovery of demand side management costs and incentives.

 

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 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 as part of 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 funding the upcoming year’s RES budget.

 

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PINNACLE WEST CAPITAL CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 

On July 1, 2011, APS filed its annual RES implementation plan, covering the 2012-2016 timeframe and requesting 2012 RES funding of $129 million to $152 million.  On December 14, 2011, the ACC voted to approve APS’s 2012 RES Plan and authorized a total 2012 RES budget of $110 million.  Within that budget, the ACC authorized APS to, among other items, (i) own an additional 100 megawatts (“MW”) under the AZ Sun Program, for a total of 200 MW; (ii) recover revenue requirements for the second 100 MW as APS did for the first 100 MW of the AZ Sun Program; (iii) expand APS’s School and Government Program by another 6.25 MW of utility owned distributed generation; and (iv) own another 25 MW of renewable generation to be described later and installed in 2014 and 2015.  In addition, the ACC ordered an initial up front incentive of $0.75 per watt for residential distributed energy and incentive level step downs throughout 2012 based upon the volume and timing of residential incentive applications.  Under the ACC’s order, residential incentives could fall to $0.20 or $0.10 per watt by the end of 2012 depending on demand.

 

On June 29, 2012, APS filed its annual RES implementation plan, covering the 2013-2017 timeframe and requesting 2013 RES funding of $92.8 million to $102.4 million.  The budget range stems from options related to distributed energy; if the ACC decides to promote more distributed energy by selecting the higher budget, APS requested that the 2013 incentives for photovoltaic distributed energy begin at $0.20 and step down gradually based upon market participation.  APS’s filing also proposed a system of establishing compliance with distributed energy requirements that depends upon tracking and recording distributed energy, rather than acquiring and retiring renewable energy credits.  Further, APS described its Community Solar program, a utility-owned 25 MW program that will be split into 3 to 7 separate projects throughout communities in APS’s service territory (this is the 25 MW program described in clause (iv) of the preceding paragraph).  APS expects a decision from the ACC around year end.

 

Demand Side Management Adjustor Charge.  The ACC Electric Energy Efficiency Standards require APS to submit a Demand Side Management Implementation Plan for review by and approval of the ACC.  In 2010, the DSMAC was modified to recover estimated amounts for use on certain demand side management programs over the current year.  Previously, the DSMAC allowed for such recovery only on a historical or after-the-fact basis.  The surcharge allows for the recovery of energy efficiency program expenses and any earned incentives.

 

The ACC previously 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 2008 retail rate case 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 amortized over a three-year period, which ends in 2012.

 

On June 1, 2011, APS filed its 2012 Demand Side Management Implementation Plan consistent with the ACC’s Electric Energy Efficiency Standards, which became effective January 1, 2011.  The 2012 requirement under such standards is for cumulative energy efficiency savings of 3% of APS retail sales for the prior year.  This energy savings requirement is slightly higher than the goal established by the 2008 retail rate case settlement agreement (2.75% of total energy resources for the same two-year period).  The ACC issued an order on April 4, 2012 approving recovery of approximately $72 million over a twelve-month period beginning March 1, 2012.  This amount does not include $10 million already being recovered in general retail base rates.

 

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 

On June 1, 2012, APS filed its 2013 Demand Side Management Implementation Plan.  In 2013, the standards will require APS to achieve cumulative energy savings equal to 5% of its 2012 retail energy sales.  Later this year, APS intends to file a supplement to its plan that will include a proposed budget for 2013.

 

PSA Mechanism and Balance.  The PSA provides for the adjustment of retail rates to reflect variations in retail fuel and purchased power costs.

 

The following table shows the changes in the deferred fuel and purchased power regulatory asset (liability) for 2012 and 2011 (dollars in millions):

 

 

 

Six Months Ended
June 30,

 

 

 

2012

 

2011

 

Beginning balance

 

$

28

 

$

(58

)

Deferred fuel and purchased power costs — current period

 

(82

)

(65

)

Amounts refunded through revenues

 

54

 

69

 

Ending balance

 

$

 

$

(54

)

 

The PSA rate for the PSA year beginning February 1, 2012 is negative $0.0042 per kWh as compared to negative $0.0057 per kWh for the prior year.  Any uncollected (overcollected) deferrals during the 2012 PSA year will be included in the calculation of the PSA rate for the PSA year beginning February 1, 2013.

 

Transmission Rates and Transmission Cost AdjustorIn 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’s retail customers (“Retail Transmission Charges”).  In order to recover the Retail Transmission Charges, APS was previously required to file an application with, and obtain approval from, the ACC to reflect changes in Retail Transmission Charges through the TCA.  Under the terms of the Settlement Agreement (discussed above), however, an adjustment to rates to recover the Retail Transmission Charges will be made annually each June 1 beginning in 2013 and will go into effect automatically unless suspended by the ACC.

 

The formula rate is updated each year effective June 1 on the basis of APS’s actual cost of service, as disclosed in APS’s 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 could have a significant effect on the Retail Transmission Charge because any adjustment, though applied prospectively, may be calculated to account for previously over-collected amounts.

 

Effective June 1, 2011, APS’s annual wholesale transmission rates for all users of its transmission system increased by approximately $44 million for the twelve-month period beginning

 

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 

June 1, 2011 in accordance with the FERC-approved formula as a result of higher costs and lower revenues reflected in the formula.  Approximately $38 million of this revenue increase relates to Retail Transmission Charges.  The ACC approved the related increase of APS’s TCA rate on June 21, 2011 and it became effective on July 1, 2011.

 

Effective June 1, 2012, APS’s annual wholesale transmission rates for all users of its transmission system increased by approximately $16 million for the twelve-month period beginning June 1, 2012 in accordance with the FERC-approved formula.  Because of higher relative system demand by APS’s retail customers, the approximately $16 million increase roughly reflects a $2 million decrease for wholesale customers and an $18 million increase for APS retail customers.

 

On May 14, 2012, APS filed an application with the ACC to implement the FERC-approved transmission rates for retail customers.  On July 18, 2012, the ACC approved the application authorizing the implementation of the FERC-approved transmission rates for retail customers to be effective beginning in August 2012.

 

Regulatory Assets and Liabilities

 

The detail of regulatory assets is as follows (dollars in millions):

 

 

 

June 30, 2012

 

December 31, 2011

 

 

 

Current

 

Non-Current

 

Current

 

Non-Current

 

Pension and other postretirement benefits

 

$

 

$

954

 

$

 

$

1,023

 

Income taxes — allowance for funds used during construction (“AFUDC”) equity

 

3

 

85

 

3

 

81

 

Deferred fuel and purchased power — mark-to-market (Note 8)

 

18

 

35

 

43

 

34

 

Transmission vegetation management

 

9

 

27

 

9

 

32

 

Coal reclamation

 

8

 

28

 

2

 

35

 

Palo Verde VIEs (Note 7)

 

 

37

 

 

35

 

Deferred compensation

 

 

34

 

 

33

 

Deferred fuel and purchased power (a)

 

 

 

28

 

 

Tax expense of Medicare subsidy

 

2

 

18

 

2

 

18

 

Loss on reacquired debt

 

1

 

19

 

1

 

19

 

Income taxes — investment tax credit basis adjustment

 

1

 

16

 

 

15

 

Pension and other postretirement benefits deferral

 

8

 

17

 

 

12

 

Demand side management (a)

 

4

 

 

7

 

1

 

Other

 

1

 

13

 

2

 

14

 

Total regulatory assets (b)

 

$

55

 

$

1,283

 

$

97

 

$

1,352

 

 


(a)           See “Cost Recovery Mechanisms” discussion above.

(b)           There are no regulatory assets for which the ACC has allowed recovery of costs but not allowed a return by exclusion from rate base.  FERC rates are set using a formula rate as described in “Transmission Rates and Transmission Cost Adjustor.”

 

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 

The detail of regulatory liabilities is as follows (dollars in millions):

 

 

 

June 30, 2012

 

December 31, 2011

 

 

 

Current

 

Non-Current

 

Current

 

Non-Current

 

Removal costs (a)

 

$

25

 

$

340

 

$

22

 

$

349

 

Asset retirement obligations

 

 

240

 

 

225

 

Renewable energy standard (b)

 

46

 

 

54

 

 

Income taxes — change in rates

 

 

60

 

 

59

 

Spent nuclear fuel

 

9

 

38

 

5

 

44

 

Deferred gains on utility property

 

3

 

13

 

2

 

14

 

Income taxes- deferred investment tax credit

 

1

 

33

 

1

 

30

 

Other

 

6

 

15

 

4

 

16

 

Total regulatory liabilities

 

$

90

 

$

739

 

$

88

 

$

737

 

 


(a)           In accordance with regulatory accounting guidance, APS accrues for removal costs for its regulated assets, even if there is no legal obligation for removal.

(b)           See “Cost Recovery Mechanisms” discussion above.

 

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.

 

Certain pension and other postretirement benefit costs in excess of amounts recovered in electric retail rates are deferred as a regulatory asset for future recovery, pursuant to an ACC regulatory order.  We deferred pension and other postretirement benefit costs of approximately $5 million and $3 million for the three months ended June 30, 2012 and 2011, respectively, and approximately $14 million and $6 million for the six months ended June 30, 2012 and 2011, respectively.  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, billed to electric plant participants or charged to the regulatory asset) (dollars in millions):

 

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 

 

 

Pension Benefits

 

Other Benefits

 

 

 

Three Months
Ended June 30,

 

Six Months
Ended June 30,

 

Three Months
Ended June 30,

 

Six Months
Ended June 30,

 

 

 

2012

 

2011

 

2012

 

2011

 

2012

 

2011

 

2012

 

2011

 

Service cost - benefits earned during the period

 

$

15

 

$

13

 

$

32

 

$

29

 

$

6

 

$

5

 

$

14

 

$

11

 

Interest cost on benefit obligation

 

30

 

31

 

60

 

62

 

11

 

12

 

23

 

23

 

Expected return on plan assets

 

(35

)

(33

)

(71

)

(67

)

(11

)

(11

)

(23

)

(21

)

Amortization of:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Prior service cost

 

 

 

1

 

1

 

 

 

 

 

Net actuarial loss

 

12

 

7

 

22

 

13

 

4

 

4

 

10

 

8

 

Net periodic benefit cost

 

$

22

 

$

18

 

$

44

 

$

38

 

$

10

 

$

10

 

$

24

 

$

21

 

Portion of cost charged to expense

 

$

8

 

$

7

 

$

13

 

$

15

 

$

3

 

$

4

 

$

6

 

$

8

 

 

Contributions

 

We expect to contribute to our pension plan approximately $65 million in 2012 (of which $15 million was contributed in July 2012), approximately $150 million in 2013 and approximately $160 million in 2014.  The contributions to our other postretirement benefit plans for 2012, 2013 and 2014 are expected to be approximately $20 million each year.

 

5.                                      Business Segments

 

Pinnacle West’s only reportable business segment is 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.

 

Financial data for the three and six months ended June 30, 2012 and 2011 and at June 30, 2012 and December 31, 2011 is provided as follows (dollars in millions):

 

 

 

Three Months Ended
June 30,

 

Six Months Ended
June 30,

 

 

 

2012

 

2011

 

2012

 

2011

 

Operating revenues:

 

 

 

 

 

 

 

 

 

Regulated electricity segment

 

$

878

 

$

799

 

$

1,498

 

$

1,447

 

All other

 

1

 

1

 

1

 

2

 

Total

 

$

879

 

$

800

 

$

1,499

 

$

1,449

 

 

 

 

 

 

 

 

 

 

 

Net income attributable to common shareholders:

 

 

 

 

 

 

 

 

 

Regulated electricity segment

 

$

123

 

$

86

 

$

117

 

$

71

 

All other (a)

 

(1

)

1

 

(3

)

1

 

Total

 

$

122

 

$

87

 

$

114

 

$

72

 

 

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PINNACLE WEST CAPITAL CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 

 

 

As of
June 30, 2012

 

As of
December 31, 2011

 

Assets:

 

 

 

 

 

Regulated electricity segment

 

$

13,178

 

$

13,068

 

All other (a)

 

36

 

43

 

Total

 

$

13,214

 

$

13,111

 

 


(a)                                  All other activities relate to APSES, SunCor, Pinnacle West and El Dorado.  See Note 13 for discussion of discontinued operations.

 

6.                                      Income Taxes

 

The $70 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.  This amount is classified as long-term, as there remains uncertainty regarding the timing of this cash receipt.  Further clarification of the timing is expected from the IRS within the next twelve months.

 

Net Income associated with the Palo Verde sale leaseback variable interest entities is not subject to tax (see Note 7).  As a result, there is no income tax expense associated with the VIEs recorded on the Condensed Consolidated Statements of Income.

 

It is reasonably possible that within the next twelve months the IRS will finalize the examination of tax returns for the years ended December 31, 2008 and 2009.  At this time, a reasonable estimate of the range of possible change in the uncertain tax position cannot be made.  However, we do not expect the ultimate outcome of this examination to have a material adverse impact on our financial position or results of operations.

 

On February 17, 2011, Arizona enacted legislation (H.B. 2001) that included a four year phase-in of corporate income tax rate reductions beginning in 2014.  As a result of these tax rate reductions, Pinnacle West has revised the tax rate applicable to reversing temporary items in Arizona.  In accordance with accounting for regulated companies, the benefit of this rate reduction is substantially offset by a regulatory liability.

 

As of June 30, 2012, 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 2007.

 

7.                                      Palo Verde Sale Leaseback Variable Interest Entities

 

In 1986, APS entered into agreements with three separate VIE lessor trusts in order to sell and lease back interests in Palo Verde Unit 2 and related common facilities.  APS will pay approximately $49 million per year for the years 2012 to 2015 related to these leases.  The lease agreements include fixed rate renewal periods, which gives 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.  Predominately due to the fixed rate renewal periods, APS has been deemed the primary beneficiary of these VIEs and therefore consolidates the VIEs.

 

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 

As a result of consolidation we eliminate rent expense and recognize depreciation and interest expense, resulting in an increase in net income for the three and six months ended June 30, 2012 of $8 million and $16 million, respectively, entirely attributable to the noncontrolling interests.  Income attributable to Pinnacle West shareholders remains the same.  Consolidation of these VIEs also results in changes to our Condensed Consolidated Statements of Cash Flows, but does not impact net cash flows.

 

Our Condensed Consolidated Balance Sheets at June 30, 2012 and December 31, 2011 include the following amounts relating to the VIEs (in millions):

 

 

 

June 30,
2012

 

December 31,
2011

 

Palo Verde sale leaseback property plant and equipment, net of accumulated depreciation

 

$

131

 

$

133

 

Current maturities of long-term debt

 

26

 

31

 

Palo Verde sale leaseback lessor notes long-term debt excluding current maturities

 

57

 

66

 

Equity — Noncontrolling interests

 

121

 

108

 

 

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.  Other than the VIEs’ assets reported on our consolidated financial statements, the creditors of the VIEs have no other recourse to the assets of APS or Pinnacle West, except in certain circumstances such as a default by APS under the lease.

 

APS is exposed to losses relating to these VIEs upon the occurrence of certain events that APS does not consider to be reasonably likely to occur.  Under certain circumstances (for example, the United States 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, 2012, APS would have been required to pay the noncontrolling equity participants approximately $142 million and assume $83 million of debt.  Since APS consolidates these VIEs, the debt APS would be required to assume is already reflected in our Condensed Consolidated Balance Sheets.

 

For regulatory ratemaking purposes the leases continue to be treated as operating leases and, as a result, we have recorded a regulatory asset relating to the arrangements.

 

8.                                      Derivative 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 market volatility by utilizing various physical and financial derivative instruments, including futures, forwards, options and swaps.  As part of our overall risk management program, we may use derivative instruments to hedge purchases and sales of electricity and fuels.  Derivative instruments that meet certain hedge accounting criteria may be designated as cash flow hedges and are used to limit our exposure to cash flow variability on forecasted transactions.  The changes in market value of such instruments have a high correlation to price changes in the hedged transactions.  We also

 

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 

enter into derivative instruments for economic hedging purposes.  While we believe the economic hedges mitigate exposure to fluctuations in commodity prices, these instruments have not been designated as accounting hedges.  Contracts that have the same terms (quantities, delivery points and delivery periods) and for which power does not flow are netted, which reduces both revenues and fuel and purchased power costs in our Condensed Consolidated Statements of Income, but does not impact our financial condition, net income or cash flows.

 

On June 1, 2012, we elected to discontinue cash flow hedge accounting treatment for the significant majority of our contracts that had previously been designated as accounting hedges.  This discontinuation is due to changes in PSA recovery (see Note 3), which now allows for 100% deferral of the unrealized gains and losses relating to these contracts.  For those contracts that were de-designated, all changes in fair value after May 31, 2012 are no longer recorded through other comprehensive income (“OCI”), but are deferred through the PSA.  The amounts previously recorded in accumulated OCI relating to these instruments will remain in accumulated OCI, and will transfer to earnings in the same period or periods during which the hedged transaction affects earnings or sooner if we determine that the forecasted transaction is no longer probable of occurring.  Cash flow hedge accounting treatment will continue for a limited number of contracts that are not subject to PSA recovery.

 

Our derivative instruments, excluding those qualifying for a scope exception, are recorded on the balance sheet as an asset or liability and are measured at fair value; see Note 14 for a discussion of fair value measurements.  Derivative instruments may qualify for the normal purchases and normal sales scope exception if they require physical delivery and the quantities represent those transacted in the normal course of business.  Derivative instruments qualifying for the normal purchases and sales scope exception are accounted for under the accrual method of accounting and excluded from our derivative instrument discussion and disclosures 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 of 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 OCI and reclassified into earnings in the same period during which the hedged transaction affects earnings.  We recognize in current earnings, subject to the PSA, the gains and losses representing hedge ineffectiveness, and the gains and losses on any hedge components which are excluded from our effectiveness assessment.  As cash flow hedge accounting has been discontinued for the significant majority of our contracts, after May 31, 2012, effectiveness testing is no longer being performed for these contracts.

 

Prior to the recent Settlement Agreement, for its regulated operations, APS deferred 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.  Due to the recent Settlement Agreement, for its regulated operations, APS now defers for future rate treatment 100% of the unrealized gains and losses for delivery periods after June 30, 2012 on 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 Base Fuel Rate (see Note 3).  Gains and losses from derivatives in the following tables represent the amounts reflected in income before the effect of PSA deferrals.

 

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PINNACLE WEST CAPITAL CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 

As of June 30, 2012, we had the following outstanding gross notional volume of derivatives, which represent both purchases and sales (does not reflect net position):

 

Commodity

 

Quantity

 

Power

 

9,914

 

gigawatt hours

 

Gas

 

178

 

Bcfs (a)

 

 


(a)                                  “Bcf” is Billion Cubic Feet.

 

Gains and Losses from Derivative Instruments

 

The following table provides information about gains and losses from derivative instruments in designated cash flow accounting hedging relationships during the three and six months ended June 30, 2012 and 2011 (dollars in thousands).  As cash flow hedge accounting treatment was discontinued for the significant majority of our contracts on June 1, 2012, the table below reflects activity occurring prior to that date:

 

 

 

 

 

Three Months Ended

 

Six Months Ended

 

 

 

Financial Statement

 

June 30,

 

June 30,

 

Commodity Contracts

 

Location

 

2012

 

2011

 

2012

 

2011

 

 

 

 

 

 

 

 

 

 

 

 

 

Gain (Loss) Recognized in OCI on Derivative Instruments (Effective Portion)

 

Other comprehensive income (loss) - derivative instruments

 

$

4,509

 

$

(16,323

)

$

(37,394

)

$

(15,335

)

Loss Reclassified from Accumulated Other Comprehensive Income into Income (Effective Portion Realized) (a)

 

Fuel and purchased power

 

(23,015

)

(25,287

)

(37,515

)

(40,133

)

Gain (Loss) Recognized in Income (Ineffective Portion and Amount Excluded from Effectiveness Testing)

 

Fuel and purchased power

 

32

 

(176

)

117

 

(164

)

 


(a)                                  During the three and six months ended June 30, 2012, we had $1.8 million of losses reclassified from accumulated other comprehensive income to earnings related to discontinued cash flow hedges.

 

During the next twelve months, we estimate that a net loss of $77 million before income taxes will be reclassified from accumulated other comprehensive income as an offset to the effect of market price changes for the related hedged transactions.  In accordance with the PSA, substantially all of these amounts will be recorded as either a regulatory asset or liability and have no immediate effect on earnings.

 

The following table provides information about gains and losses from derivative instruments not designated as accounting hedging instruments during the three and six months ended June 30, 2012 and 2011 (dollars in thousands):

 

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 

 

 

 

 

Three Months Ended

 

Six Months Ended

 

 

 

Financial Statement

 

June 30,

 

June 30,

 

Commodity Contracts

 

Location

 

2012

 

2011

 

2012

 

2011

 

 

 

 

 

 

 

 

 

 

 

 

 

Net Gain (Loss) Recognized in Income

 

Operating revenues

 

$

87

 

$

(503

)

$

(239

)

$

1,004

 

 

 

 

 

 

 

 

 

 

 

 

 

Net Gain (Loss) Recognized in Income

 

Fuel and purchased power

 

26,042

 

(2,892

)

990

 

(11,919

)

Total

 

 

 

$

26,129

 

$

(3,395

)

$

751

 

$

(10,915

)

 

Fair Values of Derivative Instruments in the Condensed Consolidated Balance Sheets

 

The following table provides information about the fair value of our risk management activities reported on a gross basis.  Transactions with counterparties that have master netting arrangements are reported net on the Condensed Consolidated Balance Sheets.  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, 2012 (dollars in thousands):

 

Commodity Contracts

 

Designated
as Hedging
Instruments

 

Not
Designated
as Hedging
Instruments

 

Margin and
Collateral
Provided to
Counterparties

 

Collateral
Provided from
Counterparties

 

Other (b)

 

Total

 

Current Assets

 

$

 

$

66,712

 

$

390

 

$

 

$

(37,111

)

$

29,991

 

Investments and Other Assets

 

 

51,690

 

 

 

(8,164

)

43,526

 

Total Assets

 

 

118,402

 

390

 

 

(45,275

)

73,517

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Current Liabilities

 

(1,185

)

(173,495

)

83,234

 

(11,145

)(a)

38,149

 

(64,442

)

Deferred Credits and Other

 

(4,594

)

(133,720

)

20,086

 

 

9,674

 

(108,554

)

Total Liabilities

 

(5,779

)

(307,215

)

103,320

 

(11,145

)

47,823

 

(172,996

)

Total

 

$

(5,779

)

$

(188,813

)

$

103,710

 

$

(11,145

)

$

2,548

 

$

(99,479

)

 


(a)                                  Collateral relates to non-derivative instruments or derivative instruments that qualify for a scope exception.

(b)                                 Other represents derivative instrument netting, options, and other risk management contracts.

 

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PINNACLE WEST CAPITAL CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 

The following table provides information about the fair value of our risk management activities reported on a gross basis at December 31, 2011 (dollars in thousands):

 

Commodity Contracts

 

Designated
as Hedging
Instruments

 

Not
Designated
as Hedging
Instruments

 

Margin and
Collateral
Provided to
Counterparties

 

Collateral
Provided from
Counterparties

 

Other (b)

 

Total

 

Current Assets

 

$

7,287

 

$

76,162

 

$

1,630

 

$

 

$

(54,815

)

$

30,264

 

Investments and Other Assets

 

3,804

 

58,273

 

 

 

(12,755

)

49,322

 

Total Assets

 

11,091

 

134,435

 

1,630

 

 

(67,570

)

79,586

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Current Liabilities

 

(82,195

)

(124,028

)

107,228

 

(11,145

)(a)

56,172

 

(53,968

)

Deferred Credits and Other

 

(68,137

)

(92,880

)

65,768

 

 

12,754

 

(82,495

)

Total Liabilities

 

(150,332

)

(216,908

)

172,996

 

(11,145

)

68,926

 

(136,463

)

Total Derivative Instruments

 

$

(139,241

)

$

(82,473

)

$

174,626

 

$

(11,145

)

$

1,356

 

$

(56,877

)

 


(a)                                  Collateral relates to non-derivative instruments or derivative instruments that qualify for a scope exception.

(b)                                 Other represents derivative instrument netting, options, and other risk management contracts.

 

Credit Risk and Credit Related Contingent Features

 

We are exposed to losses in the event of nonperformance or nonpayment by counterparties.  We have risk management contracts with many counterparties, including two counterparties for which our exposure represents approximately 83% of Pinnacle West’s $74 million of risk management assets as of June 30, 2012.  This exposure relates to long-term traditional wholesale contracts with counterparties that have high credit quality.  Our risk management process assesses and monitors the financial exposure of all counterparties.  Despite the fact that the great majority of trading counterparties’ debt is rated as investment grade by the credit rating agencies, there is still a possibility that one or more of these companies could default, resulting in a material impact on consolidated earnings for a given period.  Counterparties in the portfolio consist principally of financial institutions, major energy companies, municipalities and local distribution companies.  We maintain credit policies that we believe minimize overall credit risk to within acceptable limits.  Determination of the credit quality of our counterparties is based upon a number of factors, including credit ratings and our evaluation of their financial condition.  To manage credit risk, we employ collateral requirements and standardized agreements that allow for the netting of positive and negative exposures associated with a single counterparty.  Valuation adjustments are established representing our estimated credit losses on our overall exposure to counterparties.

 

Certain of our derivative instrument contracts contain credit-risk-related contingent features including, among other things, investment grade credit rating provisions, credit-related cross default provisions, and adequate assurance provisions.  Adequate assurance provisions allow a counterparty with reasonable grounds for uncertainty to demand additional collateral based on subjective events and/or conditions.  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

 

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PINNACLE WEST CAPITAL CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 

were to fall below investment grade (below BBB- for Standard & Poor’s or Fitch or Baa3 for Moody’s).

 

The following table provides information about our derivative instruments that have credit-risk-related contingent features at June 30, 2012 (dollars in millions):

 

 

 

June 30,
2012

 

Aggregate Fair Value of Derivative Instruments in a Net Liability Position

 

$

306

 

Cash Collateral Posted

 

96

 

Additional Cash Collateral in the Event Credit-Risk Related Contingent Features were Fully Triggered (a)

 

136

 

 


(a)          This amount is after counterparty netting and includes those contracts which qualify for scope exceptions, which are excluded from the derivative details above.

 

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 $184 million if our debt credit ratings were to fall below investment grade.

 

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, 2012 and 2011 (dollars in thousands):

 

 

 

Three Months Ended June 30, 2012

 

Three Months Ended June 30, 2011

 

 

 

Common
Shareholders

 

Noncontrolling
Interests

 

Total

 

Common
Shareholders

 

Noncontrolling
Interests

 

Total

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Beginning balance, April 1

 

$

3,744,917

 

$

116,512

 

$

3,861,429

 

$

3,631,411

 

$

97,360

 

$

3,728,771

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net income

 

122,345

 

7,766

 

130,111