FORM 10-Q

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

(Mark One)

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

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

		Exact Name of Each Registrant as specified in its
Commission File		charter; State of Incorporation; Address; and		IRS Employer
Number		Telephone Number		Identification No.
1-8962		PINNACLE WEST CAPITAL CORPORATION		86-0512431
		(an Arizona corporation)
		400 North Fifth Street, P.O. Box 53999
		Phoenix, Arizona 85072-3999
		(602) 250-1000
1-4473		ARIZONA PUBLIC SERVICE COMPANY		86-0011170
		(an Arizona corporation)
		400 North Fifth Street, P.O. Box 53999
		Phoenix, Arizona 85072-3999
		(602) 250-1000

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 o		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 October 23, 2009: 101,281,436
ARIZONA PUBLIC SERVICE COMPANY		Number of shares of common stock, $2.50 par value, outstanding as of October 23, 2009: 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 and Arizona Public Service Company. 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.

 

 

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			41
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations			49
Item 3. Quantitative and Qualitative Disclosures About Market Risk			75
Item 4. Controls and Procedures			75
Part II			77
Item 1. Legal Proceedings			77
Item 1A. Risk Factors			77
Item 5. Other Information			77
Item 6. Exhibits			81
Signatures			83
Exhibit 12.1
Exhibit 12.2
Exhibit 12.3
Exhibit 31.1
Exhibit 31.2
Exhibit 31.3
Exhibit 31.4
Exhibit 32.1
Exhibit 32.2

FORWARD-LOOKING STATEMENTS

This document contains forward-looking statements based on current expectations, and neither Pinnacle West Capital Corporation (“Pinnacle West”) nor Arizona Public Service Company (“APS”) assumes any obligation to update these statements, 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, 2008 (“2008 Form 10-K”) and in Item 2 — Management’s Discussion and Analysis of Financial Condition and Results of Operation herein, these factors include, but are not limited to:

•

regulatory and judicial decisions, developments and proceedings, including the outcome and timing of APS’ pending retail rate case;

•

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 federal 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;

•

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;

•

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 the real estate and credit markets in SunCor Development Company’s (“SunCor”) market areas, which include Arizona, Idaho, New Mexico and Utah.

PART I — FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

(unaudited)

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

		Three Months Ended
		September 30,
		2009				2008
OPERATING REVENUES
Regulated electricity segment		$	1,083,750			$	1,040,348
Real estate segment			48,474				16,152
Marketing and trading			—				4,663
Other revenues			10,853				8,925
Total			1,143,077				1,070,088
OPERATING EXPENSES
Regulated electricity segment fuel and purchased power			381,543				419,979
Real estate segment operations			26,863				26,129
Real estate impairment charge (Note 21)			36,993				—
Marketing and trading fuel and purchased power			—				1,456
Operations and maintenance			208,769				211,332
Depreciation and amortization			102,273				98,556
Taxes other than income taxes			34,111				28,423
Other expenses			8,014				8,321
Total			798,566				794,196
OPERATING INCOME			344,511				275,892
OTHER
Allowance for equity funds used during construction			2,197				4,673
Other income (Note 14)			4,488				1,786
Other expense (Note 14)			(1,934	)			(7,102	)
Total			4,751				(643	)
INTEREST EXPENSE
Interest charges			60,244				51,165
Capitalized interest			(1,423	)			(3,976	)
Total			58,821				47,189
INCOME FROM CONTINUING OPERATIONS BEFORE INCOME TAXES			290,441				228,060
INCOME TAXES			103,061				76,592
INCOME FROM CONTINUING OPERATIONS			187,380				151,468
INCOME (LOSS) FROM DISCONTINUED OPERATIONS
Net of income tax expense (benefit) of ($848) and $81 (Note 17)			(1,310	)			118
NET INCOME			186,070				151,586
Less: Net loss attributable to noncontrolling interests			(582	)			—
NET INCOME ATTRIBUTABLE TO COMMON SHAREHOLDERS		$	186,652			$	151,586
WEIGHTED-AVERAGE COMMON SHARES OUTSTANDING — BASIC			101,223				100,750
WEIGHTED-AVERAGE COMMON SHARES OUTSTANDING — DILUTED			101,385				101,018
EARNINGS PER WEIGHTED-AVERAGE COMMON SHARE OUTSTANDING
Income from continuing operations attributable to common shareholders — basic		$	1.86			$	1.50
Net income attributable to common shareholders — basic			1.84				1.50
Income from continuing operations attributable to common shareholders — diluted			1.85				1.50
Net income attributable to common shareholders — diluted			1.84				1.50
DIVIDENDS DECLARED PER SHARE		$	0.525			$	0.525
AMOUNTS ATTRIBUTABLE TO COMMON SHAREHOLDERS:
Income from continuing operations, net of tax		$	187,962			$	151,468
Discontinued operations, net of tax			(1,310	)			118
Net income attributable to common shareholders		$	186,652			$	151,586

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

PINNACLE WEST CAPITAL CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(unaudited)
(dollars and shares in thousands, except per share amounts)

		Nine Months Ended
		September 30,
		2009				2008
OPERATING REVENUES
Regulated electricity segment		$	2,498,838			$	2,492,627
Real estate segment			80,333				62,165
Marketing and trading			—				57,623
Other revenues			30,084				26,824
Total			2,609,255				2,639,239
OPERATING EXPENSES
Regulated electricity segment fuel and purchased power			920,630				1,016,918
Real estate segment operations			76,893				83,822
Real estate impairment charge (Note 21)			247,509				—
Marketing and trading fuel and purchased power			—				44,129
Operations and maintenance			642,545				598,055
Depreciation and amortization			302,255				291,915
Taxes other than income taxes			101,126				94,826
Other expenses			22,214				21,081
Total			2,313,172				2,150,746
OPERATING INCOME			296,083				488,493
OTHER
Allowance for equity funds used during construction			11,919				16,211
Other income (Note 14)			4,452				9,489
Other expense (Note 14)			(8,887	)			(22,053	)
Total			7,484				3,647
INTEREST EXPENSE
Interest charges			174,985				157,371
Capitalized interest			(8,568	)			(14,593	)
Total			166,417				142,778
INCOME FROM CONTINUING OPERATIONS BEFORE INCOME TAXES			137,150				349,362
INCOME TAXES			45,307				91,154
INCOME FROM CONTINUING OPERATIONS			91,843				258,208
INCOME (LOSS) FROM DISCONTINUED OPERATIONS
Net of income tax expense (benefit) of ($5,371) and $14,766 (Note 17)			(8,298	)			22,767
NET INCOME			83,545				280,975
Less: Net loss attributable to noncontrolling interests			(14,944	)			—
NET INCOME ATTRIBUTABLE TO COMMON SHAREHOLDERS		$	98,489			$	280,975
WEIGHTED-AVERAGE COMMON SHARES OUTSTANDING — BASIC			101,107				100,642
WEIGHTED-AVERAGE COMMON SHARES OUTSTANDING — DILUTED			101,184				100,911
EARNINGS PER WEIGHTED-AVERAGE COMMON SHARE OUTSTANDING
Income from continuing operations attributable to common shareholders — basic		$	1.06			$	2.57
Net income attributable to common shareholders — basic			0.97				2.79
Income from continuing operations attributable to common shareholders — diluted			1.06				2.56
Net income attributable to common shareholders — diluted			0.97				2.78
DIVIDENDS DECLARED PER SHARE		$	1.575			$	1.575
AMOUNTS ATTRIBUTABLE TO COMMON SHAREHOLDERS:
Income from continuing operations, net of tax		$	106,787			$	258,208
Discontinued operations, net of tax			(8,298	)			22,767
Net income attributable to common shareholders		$	98,489			$	280,975

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

(unaudited)
(dollars in thousands)

		September 30,				December 31,
		2009				2008
ASSETS
CURRENT ASSETS
Cash and cash equivalents		$	100,824			$	105,245
Customer and other receivables			383,694				292,682
Accrued utility revenues			156,509				100,089
Allowance for doubtful accounts			(3,955	)			(3,383	)
Materials and supplies (at average cost)			180,144				173,252
Fossil fuel (at average cost)			39,641				29,752
Deferred income taxes			58,640				79,729
Income tax receivable (Note 8)			167,747				—
Home inventory (Note 21)			7,881				50,688
Assets held for sale (Note 17)			6,273				—
Assets from risk management and trading activities (Note 10)			32,220				32,581
Other current assets			21,205				21,847
Total current assets			1,150,823				882,482
INVESTMENTS AND OTHER ASSETS
Real estate investments — net (Note 21)			150,253				415,296
Assets from risk management and trading activities (Note 10)			22,167				33,675
Nuclear decommissioning trust (Note 18)			399,808				343,052
Other assets			106,560				117,935
Total investments and other assets			678,788				909,958
PROPERTY, PLANT AND EQUIPMENT
Plant in service and held for future use			12,636,322				12,264,805
Less accumulated depreciation and amortization			4,296,823				4,141,546
Net			8,339,499				8,123,259
Construction work in progress			540,991				572,354
Intangible assets, net of accumulated amortization			154,450				131,722
Nuclear fuel, net of accumulated amortization			126,767				89,323
Total property, plant and equipment			9,161,707				8,916,658
DEFERRED DEBITS
Deferred fuel and purchased power regulatory asset (Note 5)			—				7,984
Other regulatory assets			726,883				787,506
Other deferred debits			113,022				115,505
Total deferred debits			839,905				910,995
TOTAL ASSETS		$	11,831,223			$	11,620,093

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

PINNACLE WEST CAPITAL CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEETS
(unaudited)
(dollars in thousands)

		September 30,				December 31,
		2009				2008
LIABILITIES AND EQUITY
CURRENT LIABILITIES
Accounts payable		$	208,134			$	261,029
Accrued taxes			156,667				109,798
Accrued interest			49,389				40,741
Short-term borrowings			142,252				670,469
Current maturities of long-term debt (Note 4)			148,677				177,646
Customer deposits			74,128				78,745
Liabilities from risk management and trading activities (Note 10)			50,976				69,585
Other current liabilities			124,213				97,915
Total current liabilities			954,436				1,505,928
LONG-TERM DEBT LESS CURRENT MATURITIES (NOTE 4)			3,519,934				3,031,603
DEFERRED CREDITS AND OTHER
Deferred income taxes			1,542,402				1,403,318
Deferred fuel and purchased power regulatory liability (Note 5)			60,488				—
Other regulatory liabilities			668,567				587,586
Liability for asset retirements			289,921				275,970
Liabilities for pension and other postretirement benefits (Note 6)			726,756				675,788
Liabilities from risk management and trading activities (Note 10)			46,498				126,532
Customer advances			131,512				132,023
Coal mine reclamation			91,847				91,201
Unrecognized tax benefits			162,717				68,904
Other			210,982				227,872
Total deferred credits and other			3,931,690				3,589,194
COMMITMENTS AND CONTINGENCIES (SEE NOTES)
EQUITY (Note 11)
Common stock, no par value			2,149,465				2,151,323
Treasury stock			(3,811	)			(2,854	)
Total common stock			2,145,654				2,148,469
Retained earnings			1,381,547				1,444,208
Accumulated other comprehensive loss:
Pension and other postretirement benefits			(47,753	)			(47,547	)
Derivative instruments			(82,786	)			(99,151	)
Total accumulated other comprehensive loss			(130,539	)			(146,698	)
Total Pinnacle West shareholders’ equity			3,396,662				3,445,979
Noncontrolling real estate interests			28,501				47,389
Total equity			3,425,163				3,493,368
TOTAL LIABILITIES AND EQUITY		$	11,831,223			$	11,620,093

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

(unaudited)
(dollars in thousands)

		Nine Months Ended
		September 30,
		2009				2008
CASH FLOWS FROM OPERATING ACTIVITIES
Net income		$	83,545			$	280,975
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization including nuclear fuel			332,532				317,366
Deferred fuel and purchased power			(46,743	)			(104,774	)
Deferred fuel and purchased power amortization			115,214				157,999
Allowance for equity funds used during construction			(11,919	)			(16,211	)
Real estate impairment charge			260,450				—
Deferred income taxes			154,517				228,567
Change in mark-to-market valuations			(5,970	)			1,411
Changes in current assets and liabilities:
Customer and other receivables			(79,297	)			(40,195	)
Accrued utility revenues			(56,420	)			(50,843	)
Materials, supplies and fossil fuel			(16,781	)			(13,527	)
Other current assets			26,308				25,906
Accounts payable			(35,923	)			(10,571	)
Accrued taxes and income tax receivable-net			(120,878	)			22,136
Other current liabilities			25,808				44,153
Expenditures for real estate investments			(2,410	)			(17,397	)
Gains and other changes in real estate assets			(10,527	)			34,875
Change in unrecognized tax benefits			92,720				(107,069	)
Change in other regulatory liabilities			92,598				(4,397	)
Change in other long-term assets			(47,925	)			30,662
Change in other long-term liabilities			12,071				4,875
Net cash flow provided by operating activities			760,970				783,941
CASH FLOWS FROM INVESTING ACTIVITIES
Capital expenditures			(558,495	)			(707,685	)
Contributions in aid of construction			17,393				40,950
Capitalized interest			(8,568	)			(14,593	)
Proceeds from nuclear decommissioning trust sales			370,399				255,706
Investment in nuclear decommissioning trust			(386,743	)			(271,263	)
Proceeds from sale of commercial real estate investments			30,847				94,171
Other			(1,404	)			5,628
Net cash flow used for investing activities			(536,571	)			(597,086	)
CASH FLOWS FROM FINANCING ACTIVITIES
Issuance of long-term debt			867,582				88,550
Repayment and reacquisition of long-term debt			(414,474	)			(179,796	)
Short-term borrowings and payments — net			(528,217	)			100,886
Dividends paid on common stock			(153,740	)			(158,477	)
Common stock equity issuance			2,623				8,165
Other			(2,594	)			2,024
Net cash flow used for financing activities			(228,820	)			(138,648	)
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS			(4,421	)			48,207
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD			105,245				56,321
CASH AND CASH EQUIVALENTS AT END OF PERIOD		$	100,824			$	104,528
Supplemental disclosure of cash flow information
Cash paid during the period for:
Income taxes, net of (refunds)		$	(34,700	)		$	202
Interest, net of amounts capitalized		$	153,725			$	136,996

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

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”), El Dorado Investment Company (“El Dorado”) and Pinnacle West Marketing & Trading Co., LLC. By the end of 2008, substantially all of Pinnacle West Marketing & Trading Co., LLC’s contracts were transferred to APS or expired. Intercompany accounts and transactions between the consolidated companies have been eliminated. 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. In preparing the accompanying unaudited condensed consolidated financial statements, we have evaluated subsequent events that have occurred after September 30, 2009 through the date the financial statements were issued on October 29, 2009.

2. Condensed Consolidated Financial Statements

Our unaudited 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 should be read in conjunction with the consolidated financial statements and related notes included in our 2008 Form 10-K. These condensed consolidated financial statements and notes have been prepared consistently with the 2008 Form 10-K with the exception of the reclassification of certain prior year amounts on our Condensed Consolidated Statement of Income and Condensed Consolidated Balance Sheets in accordance with accounting requirements for reporting discontinued operations (see Note 17), and amended accounting guidance on reporting noncontrolling interests in consolidated financial statements (see Note 19). We have also presented certain line items in more detail in the Condensed Consolidated Balance Sheets than was presented at December 31, 2008. The prior year amounts were reclassified to conform to the current year presentation. Customer advances for construction, coal mine reclamation and unrecognized tax benefits are presented as separate line items instead of the previously reported single line item of other deferred credits.

Certain line items are presented in more detail on the Condensed Consolidated Statement of Cash Flows than was presented in the prior year. Other line items are more condensed than the previous presentation. The prior year amounts were reclassified to conform to the current year presentation. Customer and other receivables and accrued utility revenues are presented as separate line items instead of the previously reported single line item of customer and other receivables. Accrued taxes and income tax receivable-net and other current liabilities are presented as separate line items instead of the previously reported single line item of other current liabilities. Change in other regulatory liabilities is reported separately from change in other long-term liabilities. The change in collateral and margin account — assets and the change in other long-term assets are presented as a single line item of changes in other long-term assets. These reclassifications had no impact on total net cash flow provided by operating activities.

PINNACLE WEST CAPITAL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

3. Quarterly Fluctuations

Weather conditions cause significant seasonal fluctuations in our revenues. In addition, real estate activities, such as the real estate impairment charges recorded in 2009 (see Note 21), can have significant impacts on our results for interim periods. For these reasons, results for interim periods do not necessarily represent results expected for the year.

4. Liquidity Matters

The following table shows principal payments due on Pinnacle West’s and APS’ total long-term debt and capitalized lease requirements as of September 30, 2009 (dollars in millions):

		Consolidated
Year		Pinnacle West				APS
2009		$	11			$	—
2010			285				197
2011			618				428
2012			446				446
2013			34				32
Thereafter			2,282				2,282
Total		$	3,676			$	3,385

Credit Facilities and Debt Issuances

The credit and liquidity markets experienced significant stress beginning the third quarter of 2008. Since the fourth quarter of 2008, Pinnacle West and APS have not accessed the commercial paper market due to negative market conditions. They have both been able to access existing credit facilities, ensuring adequate liquidity.

Pinnacle West

Pinnacle West (parent company) has a $283 million revolving credit facility that terminates in December 2010. The revolver is available to support the issuance of up to $250 million in commercial paper or to be used as bank borrowings, including issuances of letters of credit of up to $94 million. At September 30, 2009, the parent company had outstanding $138 million of borrowings under its revolving credit facility and no letters of credit.

APS

On February 26, 2009, APS issued $500 million of 8.75% unsecured senior notes that mature on March 1, 2019. Net proceeds from the sale of the notes were used to repay short-term borrowings under two committed revolving lines of credit incurred to fund capital expenditures and for general corporate purposes.

APS has two committed revolving credit facilities totaling $866 million, of which $377 million terminates in December 2010 and $489 million terminates in September 2011. The revolvers are available either to support the issuance of up to $250 million in commercial paper or to be used for bank borrowings, including issuances of letters of credit up to $583 million. At September 30, 2009, APS had no borrowings and no letters of credit under its revolving lines of credit.

PINNACLE WEST CAPITAL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

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 September 30, 2009, APS’ common equity ratio, as defined, was 51%. Its total common equity was approximately $3.5 billion, and total capitalization was approximately $6.9 billion. APS would be prohibited from paying dividends if the payment would reduce its common equity below approximately $2.7 billion, assuming APS’ total capitalization remains the same. This restriction does not materially affect Pinnacle West’s ability to meet its ongoing capital requirements.

SunCor

SunCor’s principal loan facility (the “SunCor Secured Revolver”) matures in January 2010 and requires SunCor to reduce its outstanding borrowings by specified amounts over the term of the facility. As of September 30, 2009, approximately $72 million of borrowings were outstanding under the SunCor Secured Revolver and approximately $49 million of debt was outstanding under other SunCor credit facilities. SunCor intends to apply the proceeds of planned asset sales (see Note 21) to the repayment of the SunCor Secured Revolver and SunCor’s other outstanding debt. The impairment charges discussed in Note 21 resulted in violations of certain covenants contained in the SunCor Secured Revolver and SunCor’s other credit facilities. The lenders have taken no enforcement action related to the covenant defaults, and SunCor is current on all of its debt payment obligations under the SunCor Secured Revolver and its other credit facilities. SunCor remains in discussions with its lenders to modify or replace the SunCor Secured Revolver to resolve the covenant defaults and extend the principal repayment provisions and the January 2010 maturity date. If SunCor is unable to obtain additional extensions, modifications, waivers or similar relief from its lenders, or is unable to comply with the provisions of any new or modified agreements, SunCor could be required to repay its outstanding indebtedness under the SunCor Secured Revolver and its other credit facilities. Such debt acceleration would have a material adverse impact on SunCor’s business and its financial position. 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 obtain waivers or similar relief from SunCor’s lenders would have a material adverse impact on Pinnacle West’s cash flows or liquidity.

As of September 30, 2009, SunCor could not transfer any cash dividends to Pinnacle West as a result of the covenants mentioned above. The 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

Pollution Control Bonds

During 2009, APS refinanced approximately $343 million of its $566 million variable rate pollution control bonds. As a result of these refinancings, which are described in the following table, APS no longer has any outstanding debt securities in auction rate mode. Each series of bonds, described below, is payable solely from revenues obtained from APS pursuant to a loan agreement between APS and the respective pollution control corporation. We will be required to purchase the bonds at the applicable interest reset dates and have the opportunity to remarket the bonds at that time. These bonds are classified as long-term debt on our Condensed Consolidated Balance Sheets.

		Navajo County, AZ		Coconino County, AZ		Maricopa County, AZ
		Pollution Control		Pollution Control		Pollution Control
Issuer		Corporation (1)		Corporation (2)		Corporation (3)
Issuance Date		May 28, 2009		May 28, 2009		June 26, 2009
Due Date		June 1, 2034		June 1, 2034		May 1, 2029
Bond series details (series, fixed interest rate, amount, reset date)		Series A — 5.00% $38 million June 1, 2012		Series A — 5.50% $13 million June 1, 2014		Series A — 6.00% $36 million May 1, 2014
		Series B — 5.50% $32 million June 1, 2014				Series B — 5.50% $32 million May 1, 2012
		Series C — 5.50% $32 million June 1, 2014				Series C — 5.75% $32 million May 1, 2013
		Series D — 5.75% $32 million June 1, 2016				Series D — 6.00% $32 million May 1, 2014
		Series E — 5.75%, $32 million June 1, 2016				Series E — 6.00% $32 million May 1, 2014
Total		$166 million		$13 million		$164 million

On September 11, 2008, APS purchased all of the approximately $27 million of the Coconino County, Arizona Pollution Control Corporation (“Coconino”) Pollution Control Revenue Bonds, Series 1996A and Series 1999 due December 2031 and April 2034 and held them as treasury bonds. On September 22, 2009, Coconino issued approximately $27 million of Coconino Pollution Control Revenue Refunding Bonds, 2009 Series B due April 2038 to redeem the existing bonds. APS used the funds received from the issuance to repay certain existing indebtedness under a revolving line of credit drawn upon by APS to fund its purchase of the 1996A and 1999 Series Bonds in 2008. The 2009 Series B Bonds are payable solely from revenues obtained from APS pursuant to a loan agreement between APS and Coconino. According to the indenture of the bonds, the interest rate of the 2009 Series B Bonds could be reset daily, weekly, monthly, or at other time intervals. The initial rate period selected for the 2009 Series B Bonds is a daily rate period. At September 30, 2009, the daily interest rate was 0.35%. The daily rates are variable rates set by a remarketing agent. Concurrently with the issuance of the 2009 Series B Bonds, the Company entered into a two year letter of credit and reimbursement agreement to provide credit support for the 2009 Series B Bonds.

PINNACLE WEST CAPITAL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

5. Regulatory Matters

2008 General Retail Rate Case

Summary of APS Request and Interim Rate Surcharge — On June 2, 2008, APS filed with the ACC updated financial statements, testimony and other data in the general rate case originally filed on March 24, 2008. In its filing, APS requested a net retail rate increase of $278.2 million effective no later than October 1, 2009, which represents a base rate increase of $448.2 million less the reclassification of $170 million of fuel and purchased power revenues from the existing power supply adjustor (“PSA”) to base rates.

On December 18, 2008, the ACC approved an emergency interim base rate surcharge for APS. This surcharge became effective for retail customer bills issued after December 31, 2008 and will continue in effect until a decision in the general rate case becomes effective. This surcharge increased annual pretax retail revenues by approximately $65.2 million, and is subject to refund with interest pending the final outcome of APS’ general retail rate case.

Proposed Settlement Agreement and Related Hearing — APS and other parties to the rate case began settlement discussions on January 30, 2009. On June 12, 2009, they entered into an agreement (the “Settlement Agreement”) detailing the terms upon which the parties have agreed to settle the rate case and which requires ACC approval. The ACC conducted an evidentiary hearing on the matter which concluded September 18, 2009 and the parties filed reply briefs in mid-October. Following the Administrative Law Judge’s (“ALJ”) issuance of a recommended order, the ACC will hold an open meeting, which is currently scheduled for December 7-11, in order to reach a final decision on this matter. These dates are subject to change by the ACC. If the Settlement Agreement is approved by the ACC, APS expects that its provisions, including the new rates, would become effective on or about January 1, 2010. At this time, APS cannot predict whether the ACC will approve the Settlement Agreement or, if approved, what conditions or changes to the agreement the ACC may require.

The Settlement Agreement includes a net retail rate increase of $207.5 million, which represents a base rate increase of $344.7 million less the reclassification of $137.2 million of fuel and purchased power revenues from the existing PSA to base rates.

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. 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.

PINNACLE WEST CAPITAL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

Other key provisions of the Settlement Agreement include the following:

•

A non-fuel base rate increase in annual pretax revenues of $196.3 million, which would replace the $65.2 million interim base rate surcharge described above;

•

A net increase in annual pretax revenues of $11.2 million for fuel and purchased power costs reflected in base rates that would not otherwise have been recoverable under the PSA;

•

A Base Fuel Rate (the portion of APS’ retail base rates attributable to fuel and purchased power costs) of $0.0376 per kilowatt-hour (“kWh”) (compared to the current Base Fuel Rate of $0.0325 per kWh);

•

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), resulting in present estimates of increased revenues of $23 million, $25 million and $49 million, respectively;

•

An authorized return on common equity of 11.0%;

•

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 (an increase of $10 million above the $20 million required reductions for 2009 ordered by the ACC in its interim rate decision in this matter);

•

Equity infusions into APS of at least $700 million during the period beginning June 1, 2009 through December 31, 2014; and

•

Various modifications to the existing energy efficiency, demand-side management and renewable energy programs that would 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.

Energy Efficiency, Demand-Side Management and Renewable Energy Programs

In 2006, the ACC approved the Arizona Renewable Energy Standard and Tariff (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 an RES surcharge on customer bills to recover the approved amounts for use on renewable energy projects. On July 1, 2009, APS filed its annual RES implementation plan with the ACC, which covers the 2010-2014 timeframe and requests approval for RES funding of $85.5 million for 2010. We filed a revised RES implementation plan on October 16, 2009, increasing our total requested RES funding to $86.7 million for 2010. We expect to receive a determination from the ACC on this matter by the end of 2009.

PINNACLE WEST CAPITAL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

On July 15, 2009, APS filed its initial Energy Efficiency Implementation Plan in compliance with certain provisions of the Settlement Agreement. APS is requesting approval by the ACC of programs and program elements for which APS has estimated a budget in the amount of $49.9 million for 2010. The Plan is also contingent upon ACC approval of the Settlement Agreement. In order to recover these estimated amounts for use on certain demand-side management programs, a surcharge would be added to customer bills similar to that described above under the RES. The surcharge will offset energy efficiency expenses and allow for the recovery of any earned incentives. We expect to receive a determination from the ACC on this matter simultaneously with its decision on the Settlement Agreement.

PSA Balance

The following table shows the changes in the deferred fuel and purchased power regulatory asset (liability) for the nine-month period ended September 30, 2009 and 2008 (dollars in millions):

		Nine Months Ended
		September 30,
		2009				2008
Beginning balance		$	8			$	111
Deferred fuel and purchased power costs-current period			47				103
Interest on deferred fuel and purchased power			—				2
Amounts recovered through revenues			(115	)			(158	)
Ending balance		$	(60	)		$	58

The PSA is the power supply adjustor approved by the ACC to provide for recovery or refund of variations in actual fuel and purchased power costs compared with the Base Fuel Rate. The PSA annual adjustor rate is reset for a “PSA Year” effective for a twelve-month period beginning February 1 each year. The PSA rate for the PSA Year that began February 1, 2008 was set at $0.004 per kWh. The PSA rate for the PSA Year that began February 1, 2009 was set at $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. The $60 million regulatory liability at September 30, 2009 reflects lower average prices and the seasonal nature of fuel and purchased power costs. We expect to have overcollected fuel cost deferrals during the 2009 PSA Year that will be refunded through the historical component of the PSA rate for the PSA Year beginning February 1, 2010. If the proposed Settlement Agreement is approved, APS anticipates this reset would occur January 1, 2010.

Formula Transmission Tariff

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 the costs that APS incurs in providing transmission services. 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, and projected capital expenditures. 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.

PINNACLE WEST CAPITAL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

In 2009, APS was authorized to implement increases in its annual transmission revenues based on calculations filed with the FERC using data for its 2008 fiscal year. Increases in APS’ annual transmission revenues of $22.8 million became effective June 1, 2009. Of this amount, $21 million represents an increase in Retail Transmission Charges, which was approved by the ACC on July 29, 2009 and allows APS to reflect the related increased Retail Transmission Charges in its retail rates through the TCA effective August 1, 2009.

Equity Infusion Approval

On May 2, 2008, Pinnacle West filed a notice with the ACC that would allow Pinnacle West to infuse up to $400 million of equity into APS in the event Pinnacle West deems it appropriate to do so to strengthen or maintain APS’ financial integrity. Under Arizona law and implementing regulatory decisions, Pinnacle West is required to give such notice at least 120 days prior to an equity infusion into APS that exceeds $150 million in a single calendar year. On August 6, 2008, the ACC issued an order permitting the infusion to occur on or before December 31, 2009. Pursuant to the terms of the Settlement Agreement, APS would be authorized and obligated to obtain equity infusions of up to $700 million during the period beginning June 1, 2009 through December 31, 2014, and such authorization would replace the $400 million authorization described in this paragraph.

6. 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.

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):

		Pension Benefits																Other Benefits
		Three Months Ended								Nine Months Ended								Three Months Ended								Nine Months Ended
		September 30,								September 30,								September 30,								September 30,
		2009				2008				2009				2008				2009				2008				2009				2008
Service cost — benefits earned during the period		$	13			$	13			$	40			$	39			$	4			$	4			$	14			$	13
Interest cost on benefit obligation			29				27				88				83				10				8				29				28
Expected return on plan assets			(29	)			(30	)			(87	)			(89	)			(9	)			(10	)			(26	)			(32	)
Amortization of:
Transition obligation			—				—				—				—				1				1				2				2
Prior service cost			1				1				2				2				—				—				—				—
Net actuarial loss			4				3				11				8				3				1				8				2
Net periodic benefit cost		$	18			$	14			$	54			$	43			$	9			$	4			$	27			$	13
Portion of cost charged to expense		$	9			$	6			$	26			$	19			$	4			$	2			$	13			$	6
APS’ share of cost charged to expense		$	8			$	6			$	25			$	18			$	4			$	2			$	12			$	5

Contributions

In the first quarter of 2009, United States Internal Revenue Service (“IRS”) regulations were modified to allow alternative measurement dates to determine the interest rate used to value the year-end 2008 pension liability for funding purposes. As a result of this change, we estimate our 2009 minimum pension contribution to be zero. The expected contribution to our other postretirement benefit plans in 2009 is estimated to be approximately $15 million. APS and other subsidiaries fund their share of the contributions. APS’ share is approximately 97% of the qualified defined benefit and account balance pension plan and other postretirement benefit plans.

7. 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 electric service to retail and wholesale customers supplied under traditional cost-based rate regulation (“Native Load”)) 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.

PINNACLE WEST CAPITAL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

Financial data for the three and nine months ended September 30, 2009 and 2008 and at September 30, 2009 and December 31, 2008 is provided as follows (dollars in millions):

		Three Months Ended								Nine Months Ended
		September 30,								September 30,
		2009				2008				2009				2008
Operating revenues:
Regulated electricity segment		$	1,084			$	1,040			$	2,499			$	2,493
Real estate segment			48				16				80				62
All other (a)			11				14				30				84
Total		$	1,143			$	1,070			$	2,609			$	2,639
Net income (loss) attributable to common shareholders:
Regulated electricity segment		$	200			$	158			$	257			$	273
Real estate segment			(12	)			(6	)			(153	)			8
All other (a)			(1	)			—				(6	)			—
Total		$	187			$	152			$	98			$	281

		As of				As of
		September 30, 2009				December 31, 2008
Assets:
Regulated electricity segment		$	11,509			$	10,951
Real estate segment			189				523
All other (a)			133				146
Total		$	11,831			$	11,620

8. Income Taxes

Pinnacle West expects to recognize approximately $117 million of cash tax benefits related to SunCor’s strategic asset sales (see Note 21), which will not be realized until the asset sale transactions are completed. Approximately $97 million of these benefits were recorded in the nine months ended September 30, 2009 as reductions to income tax expense related to the current impairment charges. The additional $20 million of tax benefits were recorded as reductions to income tax expense related to the SunCor impairment charge recorded in the fourth quarter of 2008.

The $168 million income tax receivable on the Condensed Consolidated Balance Sheets represents the anticipated cash refunds related to an APS tax accounting method change approved by the IRS in the third quarter of 2009 and the expected tax benefits related to the SunCor strategic asset sales that closed in 2009.

As of September 30, 2009, the tax year ended December 31, 2005 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.

For the nine months ended September 30, 2009, unrecognized tax benefits increased $94 million as a result of tax positions taken in prior periods.

PINNACLE WEST CAPITAL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

9. Variable-Interest Entities

In 1986, APS entered into agreements with three separate variable-interest entity (“VIE”) lessors in order to sell and lease back interests in Palo Verde Nuclear Generating Station (“Palo Verde”) Unit 2. The leases are accounted for as operating leases. We are not the primary beneficiary of the Palo Verde VIEs and, accordingly, do not consolidate them.

APS is exposed to losses under the Palo Verde sale leaseback agreements 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 assume the debt associated with the transactions, make specified payments to the equity participants, and take title to the leased Unit 2 interests, which, if appropriate, may be required to be written down in value. If such an event had occurred as of September 30, 2009, APS would have been required to assume approximately $167 million of debt and pay the equity participants approximately $161 million. See Note 15 for a discussion of letters of credit that support certain lessors in the Palo Verde sale leaseback transactions.

SunCor is the primary beneficiary of certain land development arrangements and, accordingly, consolidates the variable interest entities. The assets and non-controlling interests reflected in our Condensed Consolidated Balance Sheets related to these arrangements were approximately $29 million at September 30, 2009 and December 31, 2008.

In addition, see Note 19 for a discussion of the pending adoption of amended accounting guidance relating to VIEs.

10. 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. We may also invest in derivative instruments for trading purposes; however, for the nine months ended September 30, 2009, there was no material trading activity.

Our derivative instruments are accounted for at fair value; see Note 20 for a discussion of fair value measurements. On January 1, 2009, we adopted amended accounting guidance that required enhanced disclosures about derivative instruments and hedging activities. The adoption of this guidance did not have a material impact on our financial statements.

PINNACLE WEST CAPITAL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

Derivative instruments for the physical delivery of purchase and sale quantities transacted in the normal course of business qualify for the normal purchase and sales scope exception and are accounted for under the accrual method of accounting. Due to the scope exception, these derivative instruments are excluded from our derivative instrument discussion and disclosures below.

We enter into derivative instruments for economic hedging purposes. While we believe the economic hedges mitigate exposure to fluctuations in commodity prices, some of these instruments may not meet the specific hedge accounting requirements and are not designated as accounting hedges. Economic hedges not designated as accounting hedges are recorded at fair value on our balance sheet with changes in fair value recognized in the statement of income as incurred. These instruments are included in the “non-designated hedges” discussion and disclosure below.

Hedge effectiveness is the degree to which the derivative instrument contract and the hedged item are correlated and is measured based on the relative changes in fair value between the derivative instrument contract and the hedged item over time. We assess hedge effectiveness both at inception and on a continuing basis. These assessments exclude the time value of certain options. For accounting hedges that are deemed an effective hedge, the effective portion of the gain or loss on the derivative instrument is reported as a component of accumulated other comprehensive income (“AOCI”) and reclassified into earnings in the same period during which the hedged transaction affects earnings. We recognize in current earnings the gains and losses representing hedge ineffectiveness, and the gains and losses on any hedge components which are excluded from our effectiveness assessment. As of September 30, 2009, we hedged the majority of certain exposures to the price variability of commodities for a maximum of 39 months.

In the electricity business, some contracts to purchase energy are netted against other contracts to sell energy. This is called “book-out” and usually occurs in contracts that have the same terms (quantities and delivery points) and for which power does not flow. We net these book-outs, which reduces both revenues and fuel and purchased power costs in our Condensed Consolidated Statements of Income, but this does not impact our financial condition, net income or cash flows.

For its regulated operations, APS defers for future rate treatment approximately 90% of unrealized gains and losses on certain derivatives pursuant to the PSA mechanism that would otherwise be recognized in income. Realized gains and losses on derivatives are deferred in accordance with the PSA to the extent the amounts are above or below the Base Fuel Rate. Gains and losses from derivatives in the following tables represent the amounts reflected in income before the effect of PSA deferrals.

As of September 30, 2009, we had the following outstanding gross notional amount of derivatives, which represent both purchases and sales (does not reflect net position):

Commodity				Quantity
Power				13,113,421 megawatt hours
Gas				174,919,500 MMBTU (a)

PINNACLE WEST CAPITAL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

Derivative Instruments in Designated Accounting Hedging Relationships

The following table provides information about gains and losses from derivative instruments in designated accounting hedging relationships and their impact on our Condensed Consolidated Statements of Income during the three and nine months ended September 30, 2009 (dollars in thousands):

		Financial Statement				Three Months Ended				Nine Months Ended
Commodity Contracts		Location				September 30, 2009				September 30, 2009
Amount of Gain (Loss) Recognized in AOCI on Derivative Instruments (Effective Portion)		Accumulated other comprehensive loss-derivative instruments				$	4,959			$	(128,035	)
Amount of Loss Reclassified from AOCI into Income (Effective Portion Realized)		Regulated electricity segment fuel and purchased power					(81,660	)			(154,990	)
Amount of Loss Recognized in Income from Derivative Instruments (Ineffective Portion and Amount Excluded from Effectiveness Testing) (a)		Regulated electricity segment fuel and purchased power					(9,085	)			(12,993	)

During the next twelve months, we estimate that a net loss of $76 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, certain of these amounts 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 nine months ended September 30, 2009 (dollars in thousands):

						Three Months Ended				Nine Months Ended
Commodity Contracts		Financial Statement Location				September 30, 2009				September 30, 2009
Amount of Gain Recognized in Income from Derivative Instruments		Regulated electricity segment revenue				$	126			$	464
Amount of Gain (Loss) Recognized in Income from Derivative Instruments		Regulated electricity segment fuel and purchased power expense					23,463				(18,259	)
Total						$	23,589			$	(17,795	)

Fair Values of Derivative Instruments in the Condensed Consolidated Balance Sheets

The following table provides information about the fair value of our derivative instruments. These amounts are located in the asset or liability from risk management and trading activities lines of our Condensed Consolidated Balance Sheets. Amounts are as of September 30, 2009 (dollars in thousands):

						Investments								Deferred Credits				Total Assets
Commodity Contracts		Current Assets				and Other Assets				Current Liabilities				and Other				(Liabilities)
Derivatives designated as accounting hedging instruments:
Assets		$	373			$	—			$	8,849			$	1,138			$	10,360
Liabilities			(3,783	)			(573	)			(76,925	)			(64,460	)			(145,741	)
Total hedging instruments			(3,410	)			(573	)			(68,076	)			(63,322	)			(135,381	)
Derivatives not designated as accounting hedging instruments:
Assets			26,983				22,892				40,806				39,617				130,298
Liabilities			(3,525	)			(152	)			(111,265	)			(70,362	)			(185,304	)
Total non-hedging instruments			23,458				22,740				(70,459	)			(30,745	)			(55,006	)
Total derivatives			20,048				22,167				(138,535	)			(94,067	)			(190,387	)
Margin account			8,798				—				23,466				547				32,811
Collateral provided to counterparties			3,587				—				64,901				47,022				115,510
Collateral provided from counterparties			—				—				(750	)			—				(750	)
Prepaid option premiums			(213	)			—				(58	)			—				(271	)
Balance Sheet Total		$	32,220			$	22,167			$	(50,976	)		$	(46,498	)		$	(43,087	)

PINNACLE WEST CAPITAL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

Derivative instrument assets and liabilities in the table are reported on a gross basis and exclude cash collateral and margin accounts. Transactions with counterparties that have master netting arrangements are reported net on the balance sheet, including cash collateral and margin.

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 and trading contracts with many counterparties, including one counterparty for which our exposure represents approximately 41% of Pinnacle West’s $54 million of risk management and trading assets as of September 30, 2009. 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 trading counterparties’ debt is rated as investment grade by the credit rating agencies, there is still a possibility that one or more of these companies could default, resulting in a material impact on consolidated earnings for a given period. Counterparties in the portfolio consist principally of financial institutions, major energy companies, municipalities and local distribution companies. We maintain credit policies that we believe minimize overall credit risk to within acceptable limits. Determination of the credit quality of our counterparties is based upon a number of factors, including credit ratings and our evaluation of their financial condition. To manage credit risk, we employ collateral requirements and standardized agreements that allow for the netting of positive and negative exposures associated with a single counterparty. Valuation adjustments are established representing our estimated credit losses on our overall exposure to counterparties.

Certain of our derivative instrument contracts contain credit-risk-related contingent features including, among other things, investment grade credit rating provisions, credit-related cross default provisions, and adequate assurance provisions. Adequate assurance provisions allow a counterparty with reasonable grounds for uncertainty to demand additional collateral based on subjective events and/or conditions. The aggregate fair value of all derivative instruments with credit-risk-related contingent features that were in a liability position on September 30, 2009 was $290 million for which we had posted collateral of $116 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 were to fall below investment grade (below BBB- for Standard & Poor’s Ratings Services (“S&P”) or Fitch, Inc. (“Fitch”) or Baa3 for Moody’s Investors Services, 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 September 30, 2009, after off-setting asset positions under master netting arrangements we would have been required to post approximately an additional $80 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 were to fall below investment grade.

PINNACLE WEST CAPITAL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

11. Changes in Equity

The following tables show Pinnacle West’s changes in common stock equity and changes in equity of noncontrolling interests for the three and nine months ended September 30, 2009 and 2008 (dollars in thousands):

		Three Months Ended September 30, 2009												Three Months Ended September 30, 2008
		Common				Noncontrolling								Common				Noncontrolling
		Shareholders				Interests				Total				Shareholders				Interests				Total
Beginning balance, June 30		$	3,206,805			$	29,168			$	3,235,973			$	3,747,813			$	53,865			$	3,801,678
Net income (loss)			186,652				(582	)			186,070				151,586				—				151,586
Other comprehensive income (loss):
Net unrealized gains (losses) on derivative instruments (a)			4,959				—				4,959				(348,207	)			—				(348,207	)
Net reclassification of realized (gains) losses to income (b)			81,660				—				81,660				(43,718	)			—				(43,718	)
Reclassification of pension and other postretirement benefits to income			1,240				—				1,240				1,175				—				1,175
Income tax (expense) benefit related to items of other comprehensive income			(34,495	)			—				(34,495	)			153,043				—				153,043
Total other comprehensive income (loss)			53,364				—				53,364				(237,707	)			—				(237,707	)
Total comprehensive income (loss)			240,016				(582	)			239,434				(86,121	)			—				(86,121	)
Issuance of capital stock			2,756				—				2,756				2,603				—				2,603
Purchase of treasury stock, net of reissuances			589				—				589				545				—				545
Other (primarily stock compensation)			(372	)			(85	)			(457	)			1,030				(186	)			844
Common stock dividends			(53,132	)			—				(53,132	)			(52,885	)			—				(52,885	)
Net capital activities by noncontrolling interests			—				—				—				—				(8,006	)			(8,006	)
Ending balance, September 30		$	3,396,662			$	28,501			$	3,425,163			$	3,612,985			$	45,673			$	3,658,658

PINNACLE WEST CAPITAL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

		Nine Months Ended September 30, 2009												Nine Months Ended September 30, 2008
		Common				Noncontrolling								Common				Noncontrolling
		Shareholders				Interests				Total				Shareholders				Interests				Total
Beginning balance, January 1		$	3,445,979			$	47,389			$	3,493,368			$	3,531,611			$	54,569			$	3,586,180
Net income (loss)			98,489				(14,944	)			83,545				280,975				—				280,975
Other comprehensive income (loss):
Net unrealized gains (losses) on derivative instruments (a)			(128,035	)			—				(128,035	)			12,584				—				12,584
Net reclassification of realized (gains) losses to income (b)			154,990				—				154,990				(82,488	)			—				(82,488	)
Reclassification of pension and other postretirement benefits to income			3,745				—				3,745				3,522				—				3,522
Net unrealized losses related to pension and other postretirement benefits			(4,204	)			—				(4,204	)			(10,595	)			—				(10,595	)
Income tax (expense) benefit related to items of other comprehensive income			(10,337	)			—				(10,337	)			30,218				—				30,218
Total other comprehensive income (loss)			16,159				—				16,159				(46,759	)			—				(46,759	)
Total comprehensive income (loss)			114,648				(14,944	)			99,704				234,216				—				234,216
Issuance of capital stock			8,102				—				8,102				8,165				—				8,165
Purchase of treasury stock, net of reissuances			(957	)			—				(957	)			(800	)			—				(800	)
Other (primarily stock compensation)			(11,899	)			(255	)			(12,154	)			(1,730	)			(890	)			(2,620	)
Common stock dividends			(159,211	)			—				(159,211	)			(158,477	)			—				(158,477	)
Net capital activities by noncontrolling interests			—				(3,689	)			(3,689	)			—				(8,006	)			(8,006	)
Ending balance, September 30		$	3,396,662			$	28,501			$	3,425,163			$	3,612,985			$	45,673			$	3,658,658