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 May 3, 2010: 108,447,282
ARIZONA PUBLIC SERVICE COMPANY		Number of shares of common stock, $2.50 par value, outstanding as of May 3, 2010: 71,264,947

Arizona Public Service Company meets the conditions set forth in General Instruction H(1)(a) and (b) of Form 10-Q and is therefore filing this form with the reduced disclosure format allowed under that General Instruction.

 

 

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			40
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations			47
Item 3. Quantitative and Qualitative Disclosures About Market Risk			67
Item 4. Controls and Procedures			67
Part II			68
Item 1. Legal Proceedings			68
Item 1A. Risk Factors			68
Item 5. Other Information			68
Item 6. Exhibits			72
Signatures			75
Exhibit 10.1
Exhibit 10.2
Exhibit 10.3
Exhibit 10.4
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

This combined Form 10-Q is separately provided by Pinnacle West Capital Corporation (“Pinnacle West”) and Arizona Public Service Company (“APS”). Any use of the words “Company,” “we,” and “our” refer to Pinnacle West. Each registrant is providing on its own behalf all of the information contained in this Form 10-Q that relates to such registrant and, where required, its subsidiaries. Except as stated in the preceding sentence, neither registrant is providing any information that does not relate to such registrant, and therefore makes no representation as to any such information. The information required with respect to each company is set forth within the applicable items. Item 1 of this report includes Condensed Consolidated Financial Statements of Pinnacle West and Condensed Consolidated Financial Statements of APS. Item 1 also includes Notes to Pinnacle West’s Condensed Consolidated Financial Statements, the majority of which also relates to APS, and Supplemental Notes, which only relate to APS’ Condensed Consolidated Financial Statements. Item 2 of this report is divided into two sections — Pinnacle West Consolidated and APS. The Pinnacle West Consolidated section describes Pinnacle West and its subsidiaries on a consolidated basis, including discussions of Pinnacle West’s regulated utility and non-utility operations.

FORWARD-LOOKING STATEMENTS

This document contains forward-looking statements based on current expectations, and neither Pinnacle West nor APS assumes any obligation to update these statements, even if our internal estimates change, except as required by applicable law. These forward-looking statements are often identified by words such as “estimate,” “predict,” “may,” “believe,” “plan,” “expect,” “require,” “intend,” “assume” and similar words. Because actual results may differ materially from expectations, we caution readers not to place undue reliance on these statements. A number of factors could cause future results to differ materially from historical results, or from outcomes currently expected or sought by Pinnacle West or APS. In addition to the Risk Factors described in Item 1A of the Pinnacle West/APS Annual Report on Form 10-K for the fiscal year ended December 31, 2009 (“2009 Form 10-K”) and in Item 2 — Management’s Discussion and Analysis of Financial Condition and Results of Operation herein, these factors include, but are not limited to:

•		regulatory and judicial decisions, developments and proceedings;
•		our ability to achieve timely and adequate rate recovery of our costs;
•		our ability to reduce capital expenditures and other costs while maintaining reliability and customer service levels;
•		variations in demand for electricity, including those due to weather, the general economy, customer and sales growth (or decline), and the effects of energy conservation measures;
•		power plant performance and outages;
•		volatile fuel and purchased power costs;
•		fuel and water supply availability;
•		new legislation or regulation relating to greenhouse gas emissions, renewable energy mandates and energy efficiency standards;
•		our ability to meet renewable energy requirements and recover related costs;
•		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 market in SunCor Development Company’s (“SunCor”) market areas.

These and other factors are discussed in Risk Factors described in Item 1A of our 2009 Form 10-K, which readers should review carefully before placing any reliance on our financial statements or disclosures.

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
		March 31,
		2010				2009
OPERATING REVENUES
Regulated electricity segment		$	611,425			$	602,578
Real estate segment			9,416				14,840
Other revenues			12,750				8,449
Total			633,591				625,867
OPERATING EXPENSES
Regulated electricity segment fuel and purchased power			215,540				247,388
Real estate segment operations			13,890				26,910
Real estate impairment charge (Note 20)			15,112				208,480
Operations and maintenance			209,991				197,616
Depreciation and amortization			101,536				101,812
Taxes other than income taxes			31,827				34,128
Other expenses			8,061				6,467
Total			595,957				822,801
OPERATING INCOME (LOSS)			37,634				(196,934	)
OTHER
Allowance for equity funds used during construction			5,389				4,992
Other income (Note 14)			2,395				537
Other expense (Note 14)			(2,696	)			(9,741	)
Total			5,088				(4,212	)
INTEREST EXPENSE
Interest charges			62,054				59,035
Capitalized interest			(3,080	)			(3,834	)
Total			58,974				55,201
LOSS FROM CONTINUING OPERATIONS BEFORE INCOME TAXES			(16,252	)			(256,347	)
INCOME TAXES			(15,480	)			(95,004	)
LOSS FROM CONTINUING OPERATIONS			(772	)			(161,343	)
LOSS FROM DISCONTINUED OPERATIONS
Net of income tax benefit of $81 and $3,063 (Note 17)			(125	)			(4,727	)
NET LOSS			(897	)			(166,070	)
Less: Net income (loss) attributable to noncontrolling interests (Notes 9 and 20)			5,117				(9,560	)
NET LOSS ATTRIBUTABLE TO COMMON SHAREHOLDERS		$	(6,014	)		$	(156,510	)
WEIGHTED-AVERAGE COMMON SHARES OUTSTANDING — BASIC			101,474				100,986
WEIGHTED-AVERAGE COMMON SHARES OUTSTANDING — DILUTED			101,474				100,986
EARNINGS PER WEIGHTED-AVERAGE COMMON SHARE OUTSTANDING
Loss from continuing operations attributable to common shareholders — basic		$	(0.06	)		$	(1.50	)
Net loss attributable to common shareholders — basic		$	(0.06	)		$	(1.55	)
Loss from continuing operations attributable to common shareholders — diluted		$	(0.06	)		$	(1.50	)
Net loss attributable to common shareholders — diluted		$	(0.06	)		$	(1.55	)
DIVIDENDS DECLARED PER SHARE		$	0.525			$	0.525
AMOUNTS ATTRIBUTABLE TO COMMON SHAREHOLDERS:
Loss from continuing operations, net of tax		$	(5,889	)		$	(151,783	)
Discontinued operations, net of tax			(125	)			(4,727	)
Net loss attributable to common shareholders		$	(6,014	)		$	(156,510	)

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

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

		March 31,				December 31,
		2010				2009
ASSETS
CURRENT ASSETS
Cash and cash equivalents		$	3,528			$	145,378
Customer and other receivables			215,062				301,915
Accrued unbilled revenues			86,466				110,971
Allowance for doubtful accounts			(5,892	)			(6,153	)
Materials and supplies (at average cost)			171,118				176,020
Fossil fuel (at average cost)			37,907				39,245
Deferred income taxes			77,915				53,990
Income tax receivable (Note 8)			19,503				26,005
Assets from risk management activities (Note 10)			75,421				50,619
Other current assets			39,583				30,747
Total current assets			720,611				928,737
INVESTMENTS AND OTHER ASSETS
Real estate investments — net (Note 20)			104,177				119,989
Assets from risk management activities (Note 10)			40,763				28,855
Nuclear decommissioning trust (Note 18)			433,399				414,576
Other assets			112,571				110,091
Total investments and other assets			690,910				673,511
PROPERTY, PLANT AND EQUIPMENT
Plant in service and held for future use			12,849,716				12,848,138
Less accumulated depreciation and amortization			(4,349,437	)			(4,340,645	)
Net			8,500,279				8,507,493
Construction work in progress			528,940				467,700
Palo Verde sale leaseback, net of accumulated depreciation (Note 9)			144,528				146,722
Intangible assets, net of accumulated amortization			169,912				164,380
Nuclear fuel, net of accumulated amortization			142,254				118,243
Total property, plant and equipment			9,485,913				9,404,538
DEFERRED DEBITS
Regulatory assets			863,233				813,161
Income tax receivable (Note 8)			65,103				65,103
Other			109,149				101,274
Total deferred debits			1,037,485				979,538
TOTAL ASSETS		$	11,934,919			$	11,986,324

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

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

		March 31,				December 31,
		2010				2009
LIABILITIES AND EQUITY
CURRENT LIABILITIES
Accounts payable		$	219,888			$	240,637
Accrued taxes			127,513				104,011
Accrued interest			53,336				54,596
Short-term borrowings			289,616				153,715
Current maturities of long-term debt (Note 4)			489,626				303,476
Customer deposits			70,484				71,026
Liabilities from risk management activities (Note 10)			52,469				55,908
Other current liabilities			90,794				125,574
Total current liabilities			1,393,726				1,108,943
LONG-TERM DEBT LESS CURRENT MATURITIES
Long-term debt (Note 4)			3,180,476				3,370,524
Palo Verde sale leaseback lessor notes (Notes 4 and 9)			126,000				126,000
Total long-term debt less current maturities			3,306,476				3,496,524
DEFERRED CREDITS AND OTHER
Deferred income taxes			1,582,660				1,496,095
Deferred fuel and purchased power regulatory liability (Note 5)			105,378				87,291
Other regulatory liabilities			670,023				679,072
Liability for asset retirements			306,868				301,783
Liabilities for pension and other postretirement benefits (Note 6)			723,959				811,338
Liabilities from risk management activities (Note 10)			79,194				62,443
Customer advances			134,030				136,595
Coal mine reclamation			92,303				92,060
Unrecognized tax benefits (Note 8)			76,632				142,099
Other			133,670				144,077
Total deferred credits and other			3,904,717				3,952,853
COMMITMENTS AND CONTINGENCIES (SEE NOTES)
EQUITY (Note 11)
Common stock, no par value			2,155,977				2,153,295
Treasury stock			(2,734	)			(3,812	)
Total common stock			2,153,243				2,149,483
Retained earnings			1,238,940				1,298,213
Accumulated other comprehensive loss:
Pension and other postretirement benefits			(50,048	)			(50,892	)
Derivative instruments			(128,202	)			(80,695	)
Total accumulated other comprehensive loss			(178,250	)			(131,587	)
Total Pinnacle West shareholders’ equity			3,213,933				3,316,109
Noncontrolling interests (Note 9)			116,067				111,895
Total equity			3,330,000				3,428,004
TOTAL LIABILITIES AND EQUITY		$	11,934,919			$	11,986,324

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

PINNACLE WEST CAPITAL CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited)
(dollars in thousands)

		Three Months Ended
		March 31,
		2010				2009
CASH FLOWS FROM OPERATING ACTIVITIES
Net loss		$	(897	)		$	(166,070	)
Adjustments to reconcile net loss to net cash used for operating activities:
Depreciation and amortization including nuclear fuel			114,122				112,000
Deferred fuel and purchased power			44,040				28,238
Deferred fuel and purchased power amortization			(25,953	)			28,961
Allowance for equity funds used during construction			(5,389	)			(4,992	)
Real estate impairment charge			15,112				215,869
Deferred income taxes			50,845				(3,901	)
Change in mark-to-market valuations			1,842				3,822
Changes in current assets and liabilities:
Customer and other receivables			60,244				76,390
Accrued unbilled revenues			24,505				15,365
Materials, supplies and fossil fuel			6,240				(11,796	)
Other current assets			(8,836	)			(711	)
Accounts payable			(23,334	)			(78,090	)
Accrued taxes and income tax receivable-net			30,004				(81,846	)
Other current liabilities			(36,582	)			(29,658	)
Expenditures for real estate investments			(443	)			(1,459	)
Gains and other changes in real estate assets			4,095				(264	)
Change in margin and collateral accounts — assets			(11,280	)			(23,476	)
Change in margin and collateral accounts — liabilities			(124,495	)			(162,013	)
Change in unrecognized tax benefits			(62,062	)			(1,050	)
Change in other long-term assets			(25,903	)			8,897
Change in other long-term liabilities			(39,550	)			19,618
Net cash flow used for operating activities			(13,675	)			(56,166	)
CASH FLOWS FROM INVESTING ACTIVITIES
Capital expenditures			(202,554	)			(193,014	)
Contributions in aid of construction			2,949				18,762
Capitalized interest			(3,080	)			(3,834	)
Proceeds from nuclear decommissioning trust sales			158,448				129,816
Investment in nuclear decommissioning trust			(164,552	)			(135,264	)
Other			(1,639	)			1,501
Net cash flow used for investing activities			(210,428	)			(182,033	)
CASH FLOWS FROM FINANCING ACTIVITIES
Issuance of long-term debt			—				499,683
Repayment and reacquisition of long-term debt			(4,150	)			(16,386	)
Short-term borrowings and payments — net			135,901				(263,464	)
Dividends paid on common stock			(51,421	)			(51,196	)
Common stock equity issuance			844				815
Other			1,079				(3,694	)
Net cash flow provided by financing activities			82,253				165,758
NET DECREASE IN CASH AND CASH EQUIVALENTS			(141,850	)			(72,441	)
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD			145,378				105,245
CASH AND CASH EQUIVALENTS AT END OF PERIOD		$	3,528			$	32,804
Supplemental disclosure of cash flow information
Cash paid during the period for:
Income taxes, net of (refunds)		$	(5,547	)		$	17,602
Interest, net of amounts capitalized		$	58,679			$	46,040

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”), and El Dorado Investment Company (“El Dorado”). Intercompany accounts and transactions between the consolidated companies have been eliminated. The unaudited condensed consolidated financial statements for APS include the accounts of APS and the Palo Verde sale leaseback variable interest entities (see Note 9 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.

2. Condensed Consolidated Financial Statements

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 exception of the reclassification of certain prior year amounts on our Condensed Consolidated Statements of Income, Condensed Consolidated Balance Sheets and Condensed Consolidated Statements of Cash Flows in accordance with accounting requirements for reporting discontinued operations (see Note 17) and amended accounting guidance on consolidation of variable interest entities (see Note 9).

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 and 2010 (see Note 20), 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. Long-term Debt and Liquidity Matters

The following table shows principal payments due on Pinnacle West’s and APS’ total long-term debt and capitalized lease requirements as of March 31, 2010 (dollars in millions):

		Consolidated
Year		Pinnacle West				APS
2010		$	315			$	223
2011			632				457
2012			478				478
2013			59				59
2014			503				503
Thereafter			1,816				1,816
Total		$	3,803			$	3,536

PINNACLE WEST CAPITAL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

Credit Facilities and Debt Issuances

Pinnacle West and APS maintain credit facilities in order to enhance liquidity and provide credit support. During the first quarter of 2010, Pinnacle West and APS refinanced existing revolving credit facilities that would have matured in December 2010. In addition, Pinnacle West and APS accessed the commercial paper market, which neither company had utilized since the third quarter of 2008 due to negative market conditions.

Pinnacle West

On February 12, 2010, Pinnacle West refinanced its $283 million revolving credit facility that would have matured in December 2010, and decreased the size of the facility to $200 million. The new facility matures February 2013. Pinnacle West has the option to increase the amount of the facility up to a maximum of $300 million upon the satisfaction of certain conditions and with the consent of the lenders. Pinnacle West will use the facility for general corporate purposes, repayment of long-term debt, commercial paper support and for the issuance of letters of credit. Interest rates are based on Pinnacle West’s senior unsecured debt credit ratings. As a result of the downsized revolving credit facility, the Company also reduced the size of its commercial paper program to $200 million from $250 million.

At March 31, 2010, the $200 million revolver was available to support the issuance of up to $200 million in commercial paper or to be used as bank borrowings, including issuances of letters of credit up to $100 million. At March 31, 2010 the Company had outstanding $10 million of borrowings under its revolving credit facility and no letters of credit. In addition, Pinnacle West had commercial paper borrowings of $80 million at March 31, 2010.

In April 2010, Pinnacle West issued 6,900,000 shares of common stock at an offering price of $38.00 per share, resulting in net proceeds of approximately $253 million. Pinnacle West contributed all of the proceeds from this offering to APS. APS anticipates using these capital contributions to repay short-term indebtedness, to finance capital expenditures and for other general corporate purposes.

APS

On February 12, 2010, APS refinanced its $377 million revolving credit facility that would have matured in December 2010, and increased the size of the facility to $500 million. The new revolving credit facility terminates in February 2013. APS has the option to increase the amount of the facility up to a maximum of $700 million upon the satisfaction of certain conditions and with the consent of the lenders. APS will use the facility for general corporate purposes, commercial paper support and for the issuance of letters of credit. Interest rates are based on APS’ senior unsecured debt credit ratings.

At March 31, 2010 APS had two committed revolving credit facilities totaling $989 million, including the $500 million credit facility described above and a $489 million facility that 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 $739 million. At March 31, 2010, APS had borrowings of $70 million under its $489 million credit facility and no letters of credit under its revolving credit facilities. APS had commercial paper borrowings of $125 million at March 31, 2010.

PINNACLE WEST CAPITAL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

On January 1, 2010, due to the adoption of amended accounting guidance relating to variable interest entities (“VIEs”), APS began consolidating the Palo Verde Lessor Trusts (see Note 9) and, as a result of consolidation of these VIEs, we have reported the Lessor Trusts’ long-term debt on our Condensed Consolidated Balance Sheets. Interest rates on these debt instruments are 8% and are fixed for the remaining life. As of March 31, 2010, approximately $26 million was classified as current maturities of long-term debt and $126 million was classified as long-term debt relating to these VIEs. These debt instruments mature on December 30, 2015 and have sinking fund features that are serviced by the lease payments. See Note 9 for additional discussion of the VIEs.

SunCor

SunCor’s principal loan facility (the “SunCor Secured Revolver”) is secured primarily by an interest in land, commercial properties and land contracts. At March 31, 2010, SunCor had outstanding borrowings of approximately $54 million under the SunCor Secured Revolver, which matured on January 30, 2010. SunCor and the lenders under the SunCor Secured Revolver have signed a forbearance agreement under which the lenders have agreed not to exercise any remedies prior to June 30, 2010 to allow time for SunCor to continue discussions concerning the potential sale of additional properties. In addition to the SunCor Secured Revolver, at March 31, 2010, SunCor had approximately $42 million of outstanding debt under other credit facilities ($26 million of which has matured and remains outstanding). To date, the lenders under these credit facilities have taken no enforcement action. At March 31, 2010, $92 million was classified as current maturities of long-term debt and $4 million was classified as short-term borrowings on our Condensed Consolidated Balance Sheets.

If SunCor is unable to obtain extensions or renewals of the SunCor Secured Revolver or its other matured debt, or if it is unable to comply with the mandatory repayment and other provisions of any new or modified credit agreements, SunCor could be required to immediately repay its outstanding indebtedness under all of its credit facilities as a result of cross-default provisions. Such an immediate repayment obligation would have a material adverse impact on SunCor’s business and financial position and impair its ongoing viability.

SunCor cannot predict the outcome of negotiations with its lenders or its ability to sell assets for sufficient proceeds to repay its outstanding debt (see Note 20). SunCor’s ability to generate sufficient cash from operations while it pursues lender negotiations and further asset sales is uncertain.

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 extensions or renewals from SunCor’s lenders would have a material adverse impact on Pinnacle West’s cash flows or liquidity.

As of March 31, 2010, SunCor could not transfer any cash dividends to Pinnacle West as a result of the covenants mentioned above. The restriction does not affect Pinnacle West’s ability to meet its ongoing capital requirements.

PINNACLE WEST CAPITAL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

Debt Provisions

An existing ACC order requires APS to maintain a common equity ratio of at least 40%. As defined in the ACC order, the common equity ratio is common equity divided by the sum of common equity and long-term debt, including current maturities of long-term debt. At March 31, 2010, APS’ common equity ratio, as defined, was 50%. Its total common equity was approximately $3.4 billion, and total capitalization was approximately $6.7 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.

5. Regulatory Matters

2008 General Retail Rate Case Impacts

On December 30, 2009, the ACC issued an order approving a settlement agreement (“Settlement Agreement”) entered into by APS and twenty-one other parties to its general retail rate case, which was originally filed in March 2008. The Settlement Agreement contains on-going requirements, commitments and authorizations, including the following:

	•		Revenue accounting treatment for line extension payments received for new or upgraded service from January 1, 2010 through year end 2012 (or until new rates are established in APS’ next general rate case, if that is before the end of 2012), 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;
	•		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 as of May 6, 2010 from proceeds of a Pinnacle West equity issuance (see Note 4)); and
	•		Various modifications to the existing energy efficiency, demand-side management and renewable energy programs that require APS to, among other things, expand its conservation and demand-side management programs and its use of renewable energy, as well as allow for concurrent recovery of renewable energy expenses and provide for more concurrent recovery of demand-side management costs and incentives.

The parties also agreed to a rate case filing plan in which APS is prohibited from filing its next two general rate cases until on or after June 1, 2011 and June 1, 2013, respectively, unless certain extraordinary events occur. Subject to the foregoing, APS may not request its next general retail rate increase to be effective prior to July 1, 2012. APS currently expects it will file its next rate case in June 2011. The parties agreed to use good faith efforts to process these subsequent rate cases within twelve months of sufficiency findings from the ACC staff, which generally occur within 30 days after the filing of a rate case.

PINNACLE WEST CAPITAL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

Cost Recovery Mechanisms

APS has received supportive regulatory decisions that allow for more timely recovery of certain costs through the following recovery mechanisms.

Renewable Energy Standard. In 2006, the ACC approved the Arizona Renewable Energy Standard and Tariff (“RES”). Under the RES, electric utilities that are regulated by the ACC must supply an increasing percentage of their retail electric energy sales from eligible renewable resources, including solar, wind, biomass, biogas and geothermal technologies. In order to achieve these requirements, the ACC allows APS to include a RES surcharge on customer bills to recover the approved amounts for use on renewable energy projects. Each year APS is required to file a five-year implementation plan with the ACC and seek approval for the upcoming year’s RES funding amount.

During 2009, APS filed its annual RES implementation plan, covering the 2010-2014 timeframe and requesting 2010 RES funding approval. The plan provides for the acquisition of renewable generation in compliance with requirements through 2014, and requests RES funding of $86.7 million for 2010. APS also sought various other determinations in its plan, including approval of the AZ Sun program and the Community Power Project in Flagstaff, Arizona. At its December 2009 open meeting, the ACC approved APS’ 2010 RES funding request.

On March 3, 2010, the ACC approved the AZ Sun program, which contemplates the addition of 100 megawatts (“MW”) of utility-owned solar resources through 2014. Through the expected life of the program, APS plans to invest up to $500 million for turn-key photovoltaic power plants across Arizona. Developers will be selected through competitive procurement processes to build the plants, which APS will own. The costs associated with the first 50 MW under this program will be recovered initially through the RES until such time as the costs are recovered in base rates. The costs of the second 50 MW will be recovered through a mechanism to be determined in APS’s next retail rate case.

On April 1, 2010 the ACC approved the Community Power Project, a pilot program in which APS will own, operate and receive energy from solar panels on the rooftops of up to 200 residential and business customers located within a certain test area. Third party developers may also own systems that participate in the pilot. Costs of the program will be recovered through the RES until such time as the costs are recovered in base rates.

Demand-Side Management Adjustor Charge (“DSMAC”). The Settlement Agreement requires APS to submit an annual Energy Efficiency Implementation Plan for review by and approval of the ACC. On July 15, 2009, APS filed its initial Energy Efficiency Implementation Plan, requesting approval by the ACC of programs and program elements for which APS has estimated a budget in the amount of $49.9 million for 2010. 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. APS received ACC approval of all of its proposed programs and implemented the new DSMAC on March 1, 2010.

PINNACLE WEST CAPITAL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

The ACC approved recovery of the 2010 Energy Efficiency budget less some $1.0 million, which reflected a recalculation of the incentive payment due to APS under the Energy Efficiency Implementation Plan and not a reduction in allowed program costs. The ACC also approved recovery of all 2009 program costs plus incentives. The change from program cost recovery on a historical basis to recovery on a concurrent basis, as authorized in the Settlement Agreement, resulted in this one-time need to address two years (2009 and 2010) of cost recovery. As requested by APS, 2009 program cost recovery is to be spread over a three-year period.

PSA Mechanism and Balance. The power supply adjustor (“PSA”) provides for the adjustment of retail rates to reflect variations in retail fuel and purchased power costs. The following table shows the changes in the deferred fuel and purchased power regulatory asset (liability) for the three-month periods ended March 31, 2010 and 2009 (dollars in millions):

		Three Months Ended
		March 31,
		2010				2009
Beginning balance		$	(87	)		$	8
Deferred fuel and purchased power costs-current period			(44	)			(28	)
Amounts refunded (recovered)			26				(29	)
Ending balance		$	(105	)		$	(49	)

The PSA rate for the current PSA Year is ($0.0045) per kilowatt hour (“kWh”). Since the 2010 PSA adjustment was a reduction of the PSA rate, the ACC accelerated the 2010 adjustment from the standard PSA year start date of February 1^st to January 1^st to coincide with the increase in retail rates resulting from the ACC’s decision in the general retail rate case, causing a minimal net impact on residential bills. This accelerated 2010 adjustment will remain in effect until February 1, 2011. The $105 million regulatory liability at March 31, 2010 reflects lower average prices and the seasonal nature of fuel and purchased power costs. Any uncollected (overcollected) deferrals during the 2010 PSA Year will be included in the historical component of the PSA rate for the PSA Year beginning February 1, 2011.

The PSA rate for the PSA Year that began February 1, 2009 was $0.0053 per kWh. The PSA rate may not be increased or decreased more than $0.004 per kWh in a year without permission of the ACC.

Transmission Rates and Transmission Cost Adjustor. In July 2008, the United States Federal Energy Regulatory Commission (“FERC”) approved an Open Access Transmission Tariff for APS to move from fixed rates to a formula rate-setting methodology in order to more accurately reflect the costs that APS incurs in providing transmission services. A large portion of the rate represents charges for transmission services to serve APS’ retail customers (“Retail Transmission Charges”). In order to recover the Retail Transmission Charges, APS must file an application with, and obtain approval from, the ACC under the transmission cost adjustor (“TCA”) mechanism, by which changes in Retail Transmission Charges can be reflected in APS’ retail rates.

The formula rate is updated, or “trued-up”, each year effective June 1 on the basis of APS’ actual cost of service, as disclosed in APS’ FERC Form 1 report for the previous fiscal year. Items to be updated include actual capital expenditures made as compared with previous projections, transmission revenue credits and other items. The resolution of proposed adjustments can result in significant volatility in the revenues to be collected. APS reviews the proposed formula rate filing amounts with the ACC staff. Any items or adjustments which are not agreed to by APS and the ACC staff can remain in dispute until settled or litigated at FERC. Settlement or litigated resolution of disputed issues could require an extended period of time and have a significant effect on the Retail Transmission Charge because any adjustment, though applied prospectively, may be calculated to account for previously over-collected amounts.

PINNACLE WEST CAPITAL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

In 2009, APS was authorized to implement an increase 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. The 2010 TCA will be filed with the ACC in mid-May.

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.

On March 23, 2010, the President signed into law comprehensive health care reform legislation under the Patient Protection and Affordable Care Act (the “Act”). One feature of the Act is the elimination of the tax deduction for prescription drug costs that are reimbursed as part of the Medicare Part D subsidy. Although this tax increase does not take effect until 2013, we are required to recognize the full accounting impact in our financial statements in the period in which the Act is signed. In accordance with accounting for regulated companies, the loss of this deduction is substantially offset by a regulatory asset that will be recovered through future electric revenues. In the first quarter of 2010, Pinnacle West charged regulatory assets and liabilities for a total of $42 million, with a corresponding increase in accumulated deferred income tax liabilities, to reflect the impact of this change in tax law.

The following table provides details of the plans’ net periodic benefit costs and the portion of these costs charged to expense (including administrative costs and excluding amounts capitalized as overhead construction or billed to electric plant participants) (dollars in millions):

		Pension Benefits								Other Benefits
		Three Months								Three Months
		Ended March 31,								Ended March 31,
		2010				2009				2010				2009
Service cost — benefits earned during the period		$	15			$	14			$	5			$	5
Interest cost on benefit obligation			31				29				11				10
Expected return on plan assets			(31	)			(29	)			(10	)			(9	)
Amortization of:
Transition obligation			—				—				1				1
Prior service cost			1				1				—				—
Net actuarial loss			6				3				3				3
Net periodic benefit cost		$	22			$	18			$	10			$	10
Portion of cost charged to expense		$	11			$	8			$	5			$	5
APS’ share of cost charged to expense		$	10			$	8			$	5			$	5

PINNACLE WEST CAPITAL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

Contributions

The required minimum contribution to our pension plan is zero in 2010. During the first quarter of 2010 we made a voluntary contribution of $100 million to our pension plan. The contribution to our other postretirement benefit plans in 2010 is estimated to be approximately $15 million. APS and other subsidiaries fund their share of the contributions. APS’ share is approximately 97% of both 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 retail and wholesale sales supplied to traditional cost-based rate regulation (“Native Load”) customers) and related activities and includes electricity generation, transmission and distribution; and
	•		our real estate segment, which consists of SunCor’s real estate development and investment activities

Financial data for the three months ended March 31, 2010 and 2009 and at March 31, 2010 and December 31, 2009 is provided as follows (dollars in millions):

		Three Months Ended
		March 31,
		2010				2009
Operating revenues:
Regulated electricity segment		$	611			$	603
Real estate segment (a)			10				15
All other (b)			13				8
Total		$	634			$	626
Net income (loss) attributable to common shareholders:
Regulated electricity segment		$	7			$	(20	)
Real estate segment (a)			(13	)			(132	)
All other (b)			—				(5	)
Total		$	(6	)		$	(157	)

PINNACLE WEST CAPITAL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

		As of				As of
		March 31, 2010				December 31, 2009
Assets:
Regulated electricity segment		$	11,686			$	11,691
Real estate segment (a)			133				161
All other (b)			116				134
Total		$	11,935			$	11,986

8. Income Taxes

Pinnacle West expects to recognize approximately $131 million of cash tax benefits related to SunCor’s strategic asset sales (see Note 20), which will not be fully realized until all the asset sale transactions are completed. Approximately $6 million of these benefits were recorded in the three months ended March 31, 2010 as reductions to income tax expense related to the current impairment charges. The additional $125 million of tax benefits were recorded as reductions to income tax expense related to SunCor impairment charges recorded on or before December 31, 2009.

The $85 million 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 and the current year tax benefits related to the SunCor strategic asset sales that closed prior to March 31, 2010.

During the first quarter of 2010, the Company reached a settlement with the IRS with regard to the examination of tax returns for the years ended December 31, 2005 through 2007. As a result of this settlement, net uncertain tax positions have decreased by $62 million through March 31, 2010, including approximately $3.5 million which decreased our effective tax rate. Additionally, the settlement resulted in the recognition of net interest benefits of approximately $3 million through the effective tax rate.

As of March 31, 2010, the tax year ended December 31, 2008 and all subsequent tax years remain subject to examination by the IRS. With few exceptions, we are no longer subject to state income tax examinations by tax authorities for years before 1999.

9. Variable Interest Entities

On January 1, 2010 we adopted amended accounting guidance relating to VIEs. This amended guidance significantly changed the consolidation model for VIEs. Under the prior guidance the consolidation model considered risk absorption using a quantitative approach when determining the primary beneficiary. The consolidation model under the new guidance requires a qualitative assessment and focuses on the powers to direct activities of the VIE when determining the primary beneficiary. As a result of applying this qualitative assessment we have determined that APS is the primary beneficiary of certain VIEs, and is therefore required to consolidate these VIEs. Prior to adopting this new guidance APS was not considered the primary beneficiary of these VIEs and did not consolidate these entities. We have adopted this guidance using retrospective application and have adjusted prior periods presented to reflect consolidation of the VIEs in those periods. Further discussion follows regarding the impact of the consolidation.

PINNACLE WEST CAPITAL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

APS VIEs

In 1986, APS entered into agreements with three separate VIE lessor trusts in order to sell and lease back interests in Palo Verde Nuclear Generating Station (“Palo Verde”) Unit 2 and related common facilities. The VIE lessor trusts are single-asset leasing entities. APS will pay approximately $49 million per year for the years 2010 to 2015 related to these leases. The leases do not contain fixed price purchase options or residual value guarantees. However, the lease agreements include fixed-rate renewal periods which may have a significant impact on the VIEs’ economic performance. We have concluded that these fixed rate renewal periods may give APS the ability to utilize the asset for a significant portion of the asset’s economic life, and therefore provide APS with the power to direct activities of the VIEs that most significantly impact the VIEs’ economic performance. In addition to the fixed rate renewal periods, our primary beneficiary analysis also considered that we are the operating agent for Palo Verde, are obligated to decommission the leased assets and have fair value purchase options.

Under the previous quantitative VIE consolidation model, APS was not considered the primary beneficiary of the lessor trusts as APS did not absorb the majority of the entities’ expected losses or did not receive a majority of the residual returns. The arrangements were previously accounted for as operating leases.

Consolidation of these VIEs eliminates the lease accounting we previously reported and results in changes in our consolidated assets, debt, equity, and net income. Assets of the VIEs are restricted and may only be used to settle the VIEs’ debt and for payment to the noncontrolling interest holders. The creditors of the VIEs have no recourse to the general credit of APS or Pinnacle West. As a result of consolidation we have eliminated rent expense, and have recognized depreciation and interest expense, resulting in an increase in net income of $5 million 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 March 31, 2010 include the following amounts relating to the VIEs (in millions):

		March 31,
		2010
Property plant and equipment, net of accumulated depreciation		$	145
Long-term debt including current maturities			152
Equity- Noncontrolling interests			87

For regulatory ratemaking purposes the leases continue to be treated as operating leases, and as a result we have recorded a regulatory asset of $32 million as of March 31, 2010.

PINNACLE WEST CAPITAL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

APS is exposed to losses relating to these lessor trust VIEs upon the occurrence of certain events that APS does not consider to be reasonably likely to occur. Under certain circumstances (for example, the 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 March 31, 2010, APS would have been required to pay the noncontrolling equity participants approximately $153 million and assume $152 million of debt. Since APS now consolidates the VIEs, the debt APS would be required to assume is already reflected in our Condensed Consolidated Balance Sheets.

We also have certain long-term purchased power agreements to purchase substantially all of an entity’s output from a specified facility for a specified period. We have evaluated these arrangements under the VIE accounting guidance and have determined that these agreements do not represent variable interests. If these agreements had been deemed variable interests in these entities, we would not be considered the primary beneficiary of these entities, as we do not have the power to direct activities of these entities in a manner that would significantly impact their economic performance and therefore would not consolidate the entities. The adoption of the amended accounting guidance has not changed how we account for these arrangements.

PINNACLE WEST CAPITAL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

Prior-Year Periods

We have elected to apply the amended guidance retrospectively for all prior periods presented on Pinnacle West’s Condensed Consolidated Statements of Income, Balance Sheets, and Statements of Cash Flows. The following table presents the financial statement line item changes (dollars in thousands):

						Reclassifications as a				Amount reported
						result of the adoption of				after adoption of
		As previously				new VIE accounting				amended VIE
		reported				guidance				accounting guidance
Statement of Income for the three months ended March 31, 2009
Operating Expenses — Operations and maintenance		$	207,531			$	(9,915	)		$	197,616
Operating Expenses — Depreciation and amortization			99,886				1,926				101,812
Interest Expense — Interest Charges			55,696				3,339				59,035
Loss from Continuing Operations			(165,993	)			4,650				(161,343	)
Net Loss			(170,720	)			4,650				(166,070	)
Net income (loss) attributable to noncontrolling interests			(14,210	)			4,650				(9,560	)
Balance Sheets — December 31, 2009
Property, Plant and Equipment — Palo Verde sale leaseback, net of accumulated depreciation		$	—			$	146,722			$	146,722
Deferred Debits — Regulatory assets			781,714				31,447				813,161
Current Liabilities — Current maturities of long-term debt			277,693				25,783				303,476
Long-Term Debt Less Current Maturities — Palo Verde sale leaseback lessor notes			—				126,000				126,000
Deferred Credits and Other — Other			200,015				(55,938	)			144,077
Equity — Noncontrolling Interests			29,571				82,324				111,895
Statement of Cash Flows for the three months ended March 31, 2009
Cash Flows from Operating Activities — Net loss		$	(170,720	)		$	4,650			$	(166,070	)
Cash Flows from Operating Activities — Depreciation and amortization including nuclear fuel			110,073				1,927				112,000
Cash Flows from Operating Activities — Change in other current liabilities			(20,744	)			(8,914	)			(29,658	)
Cash Flows from Operating Activities — Change in other long-term liabilities			17,281				2,337				19,618

PINNACLE WEST CAPITAL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

SunCor VIEs

SunCor is the primary beneficiary of certain land development trust arrangements and, accordingly, consolidates these VIEs. We have determined that SunCor is the primary beneficiary of these VIEs because SunCor controls the activities related to the development of the land held in the trusts. Our adoption of amended VIE accounting guidance has not changed our accounting treatment of the SunCor VIEs. Our Condensed Consolidated Balance Sheets reflect $29 million of assets and $29 million of noncontrolling equity interests relating to these arrangements at March 31, 2010 and December 31, 2009. The assets relating to these VIEs consist strictly of land, all of which is restricted and may only be used for payment to the noncontrolling interests. We have not provided, and are not required to provide, financing or other financial support to these entities.

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.

Our derivative instruments are accounted for at fair value and are presented on the Condensed Consolidated Balance Sheets as “Assets/Liabilities from Risk Management Activities” (see Note 19 for a discussion of fair value measurements). Derivative instruments for the physical delivery of purchase and sale quantities transacted in the normal course of business qualify for the normal purchase and sales scope exception and are accounted for under the accrual method of accounting. Due to the scope exception, these derivative instruments are excluded from our derivative instrument discussion and disclosures below.

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

Hedge effectiveness is the degree to which the derivative instrument contract and the hedged item are correlated and is measured based on the relative changes in fair value between the derivative instrument contract and the hedged item over time. We assess hedge effectiveness both at inception and on a continuing basis. These assessments exclude the time value of certain options. For accounting hedges that are deemed an effective hedge, the effective portion of the gain or loss on the derivative instrument is reported as a component of accumulated other comprehensive income (“AOCI”) and reclassified into earnings in the same period during which the hedged transaction affects earnings. We recognize in current earnings the gains and losses representing hedge ineffectiveness, and the gains and losses on any hedge components which are excluded from our effectiveness assessment. As of March 31, 2010, we hedged the majority of certain exposures to the price variability of commodities for a maximum of 39 months.

PINNACLE WEST CAPITAL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

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

For its regulated operations, APS defers for future rate treatment approximately 90% of unrealized gains and losses on certain derivatives pursuant to the PSA mechanism that would otherwise be recognized in income. Realized gains and losses on derivatives are deferred in accordance with the PSA to the extent the amounts are above or below the portion of APS’ retail base rates attributable to fuel and purchased power costs (“Base Fuel Rate”), which is currently $0.0376 per kWh (see Note 5). Gains and losses from derivatives in the following tables represent the amounts reflected in income before the effect of PSA deferrals.

As of March 31, 2010, we had the following outstanding gross notional amount of derivatives, which represent both purchases and sales (does not reflect net position):

Commodity		Quantity
Power			15,928,321			megawatt hours
Gas			157,264,840			MMBTU (a)

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 months ended March 31, 2010 and 2009 (dollars in thousands):

				Three Months Ended
		Financial Statement		March 31,
Commodity Contracts		Location		2010				2009
Amount of Loss Recognized in AOCI on Derivative Instruments (Effective Portion)		Accumulated other comprehensive loss-derivative instruments		$	(91,667	)		$	(138,548	)
Amount of Loss Reclassified from AOCI into Income (Effective Portion Realized)		Regulated electricity segment fuel and purchased power			(13,185	)			(25,365	)
Amount of Gain (Loss) Recognized in Income from Derivative Instruments (Ineffective Portion and Amount Excluded from Effectiveness Testing) (a)		Regulated electricity segment fuel and purchased power			(10,467	)			992

PINNACLE WEST CAPITAL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

During the next twelve months, we estimate that a net loss of $118 million before income taxes will be reclassified from AOCI as an offset to the effect of market price changes for the related hedged transactions. Approximately 90% of the amounts related to derivatives subject to the PSA will be recorded as either a regulatory asset or liability and have no effect on earnings.

Derivative Instruments Not Designated as Accounting Hedges

The following table provides information about gains and losses from derivative instruments not designated as accounting hedging instruments and their impact on our Condensed Consolidated Statements of Income during the three months ended March 31, 2010 and 2009 (dollars in thousands):

				Three Months Ended
		Financial Statement		March 31,
Commodity Contracts		Location		2010				2009
Amount of Net Gain (Loss) Recognized in Income from Derivative Instruments		Regulated electricity segment revenue		$	170			$	(429	)
Amount of Net Loss Recognized in Income from Derivative Instruments		Regulated electricity segment fuel and purchased power expense			(34,969	)			(63,964	)
Total				$	(34,799	)		$	(64,393	)

PINNACLE WEST CAPITAL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

Fair Values of Derivative Instruments in the Condensed Consolidated Balance Sheets

The following table provides information about the fair value of our derivative instruments, margin account and cash collateral reported on a gross basis. Transactions with counterparties that have master netting arrangements are reported net on the balance sheet. These amounts are located in the assets and liabilities from risk management activities lines of our Condensed Consolidated Balance Sheets. Amounts are as of March 31, 2010 (dollars in thousands):

						Investments				Current				Deferred Credits				Total Assets
Commodity Contracts		Current Assets				and Other Assets				Liabilities				and Other				(Liabilities)
Derivatives designated as accounting hedging instruments:
Assets		$	—			$	—			$	—			$	18			$	18
Liabilities			(1,381	)			—				(132,258	)			(112,704	)			(246,343	)
Total hedging instruments			(1,381	)			—				(132,258	)			(112,686	)			(246,325	)
Derivatives not designated as accounting hedging instruments:
Assets			41,278				40,780				59,403				47,986				189,447
Liabilities			(2,384	)			(17	)			(117,972	)			(103,669	)			(224,042	)
Total non-hedging instruments			38,894				40,763				(58,569	)			(55,683	)			(34,595	)
Total derivatives			37,513				40,763				(190,827	)			(168,369	)			(280,920	)
Margin account			20,402				—				9,336				258				29,996
Collateral provided to counterparties			23,256				—				130,072				88,917				242,245
Collateral provided from counterparties			(5,750	)			—				(1,050	)			—				(6,800	)
Balance Sheet Total		$	75,421			$	40,763			$	(52,469	)		$	(79,194	)		$	(15,479	)

PINNACLE WEST CAPITAL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

The following table provides information about the fair value of our derivative instruments, margin account and cash collateral reported on a gross basis at December 31, 2009 (dollars in thousands):

						Investments				Current				Deferred Credits				Total Assets
Commodity Contracts		Current Assets				and Other Assets				Liabilities				and Other				(Liabilities)
Derivatives designated as accounting hedging instruments:
Assets		$	329			$	—			$	3,242			$	75			$	3,646
Liabilities			(3,436	)			(256	)			(72,899	)			(77,953	)			(154,544	)
Total hedging instruments			(3,107	)			(256	)			(69,657	)			(77,878	)			(150,898	)
Derivatives not designated as accounting hedging instruments:
Assets			31,220				29,807				34,645				44,631				140,303
Liabilities			(4,123	)			(696	)			(81,722	)			(71,408	)			(157,949	)
Total non-hedging instruments			27,097				29,111				(47,077	)			(26,777	)			(17,646	)
Total derivatives			23,990				28,855				(116,734	)			(104,655	)			(168,544	)
Margin account			8,643				—				12,464				104				21,211
Collateral provided to counterparties			17,986				—				49,412				42,108				109,506
Collateral provided from counterparties			—				—				(1,050	)			—				(1,050	)
Balance Sheet Total		$	50,619			$	28,855			$	(55,908	)		$	(62,443	)		$	(38,877	)

Credit Risk and Credit Related Contingent Features

We are exposed to losses in the event of nonperformance or nonpayment by counterparties. We have risk management contracts with many counterparties, including one counterparty for which our exposure represents approximately 31% of Pinnacle West’s $116 million of risk management assets as of March 31, 2010. This exposure relates to a long-term traditional wholesale contract with a counterparty that has very high credit quality. Our risk management process assesses and monitors the financial exposure of all counterparties. Despite the fact that the great majority of trading counterparties’ debt is rated as investment grade by the credit rating agencies, there is still a possibility that one or more of these companies could default, resulting in a material impact on consolidated earnings for a given period. Counterparties in the portfolio consist principally of financial institutions, major energy companies, municipalities and local distribution companies. We maintain credit policies that we believe minimize overall credit risk to within acceptable limits. Determination of the credit quality of our counterparties is based upon a number of factors, including credit ratings and our evaluation of their financial condition. To manage credit risk, we employ collateral requirements and standardized agreements that allow for the netting of positive and negative exposures associated with a single counterparty. Valuation adjustments are established representing our estimated credit losses on our overall exposure to counterparties.

PINNACLE WEST CAPITAL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

Certain of our derivative instrument contracts contain credit-risk-related contingent features including, among other things, investment grade credit rating provisions, credit-related cross default provisions, and adequate assurance provisions. Adequate assurance provisions allow a counterparty with reasonable grounds for uncertainty to demand additional collateral based on subjective events and/or conditions. The aggregate fair value of all derivative instruments with credit-risk-related contingent features that were in a liability position on March 31, 2010 was $425 million, for which we had posted collateral of $222 million in the normal course of business.

For those derivative instruments in a net liability position, with investment grade credit contingencies, the counterparties could demand additional collateral if our debt credit rating were to fall below investment grade (below BBB- for Standard & Poor’s Ratings Services (“Standard & Poor’s”) or Fitch, Inc. (“Fitch”) or Baa3 for Moody’s Investors Service, Inc. (“Moody’s”)), which would be a violation of the credit rating provisions. If the investment grade contingent features underlying these agreements had been triggered on March 31, 2010, 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 credit ratings 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 shareholders’ equity and changes in equity of noncontrolling interests for the three months ended March 31, 2010 and 2009 (dollars in thousands):

		Three Months Ended March 31, 2010												Three Months Ended March 31, 2009
		Shareholders’				Noncontrolling								Shareholders’				Noncontrolling
		Equity				Interests				Total				Equity				Interests				Total
Beginning balance, January 1		$	3,316,109			$	111,895			$	3,428,004			$	3,445,979			$	124,990			$	3,570,969
Net income (loss)			(6,014	)			5,117				(897	)			(156,510	)			(9,560	)			(166,070	)
Other comprehensive loss:
Net unrealized losses on derivative instruments (a)			(91,667	)			—				(91,667	)			(138,548	)			—				(138,548	)
Net reclassification of realized losses to income (b)			13,185				—				13,185				25,365				—				25,365
Reclassification of pension and other postretirement benefits to income			1,393				—				1,393				1,252				—				1,252
Income tax benefit related to items of other comprehensive income			30,426				—				30,426				44,003				—				44,003
Total other comprehensive loss			(46,663	)			—				(46,663	)			(67,928	)			—				(67,928	)
Total comprehensive income (loss)			(52,677	)			5,117				(47,560	)			(224,438	)			(9,560	)			(233,998	)
Issuance of capital stock			2,680				—				2,680				2,629				—				2,629
Purchase of treasury stock, net of reissuances			1,078				—				1,078				(1,551	)			—				(1,551	)
Other			2				(22	)			(20	)			(6,707	)			(129	)			(6,836	)
Common stock dividends			(53,259	)			—				(53,259	)			(53,010	)			—				(53,010	)
Net capital activities by noncontrolling interests			—				(923	)			(923	)			—				1,316				1,316
Ending balance, March 31		$	3,213,933			$	116,067			$	3,330,000			$	3,162,902			$	116,617			$	3,279,519

PINNACLE WEST CAPITAL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

12. Commitments and Contingencies

Palo Verde Nuclear Generating Station

Spent Nuclear Fuel and Waste Disposal

Nuclear power plant operators are required to enter into spent fuel disposal contracts with the United States Department of Energy (“DOE”), and the DOE is required to accept and dispose of all spent nuclear fuel and other high-level radioactive wastes generated by domestic power reactors. Although the Nuclear Waste Policy Act required the DOE to develop a permanent repository for the storage and disposal of spent nuclear fuel by 1998, the DOE announced that it would not be able to open the repository by 1998 and sought to excuse its performance under the contract. In November 1997, the United States Court of Appeals for the District of Columbia Circuit (D.C. Circuit) issued a decision preventing the DOE from excusing its own delay, but refused to order the DOE to begin accepting spent nuclear fuel.

Based on this decision and the DOE’s delay, a number of utilities, including APS (on behalf of itself and the other Palo Verde owners), filed damages actions against the DOE in the Court of Federal Claims. APS is currently pursuing that damages claim. The trial in the APS matter began on January 28, 2009, and closing arguments were heard in late May 2009. The court has not indicated when it will reach its decision in the matter. In January 2010, on appeal of another utility’s damages case in which the DOE successfully raised the unavoidable delays defense, the Court of Appeals for the Federal Circuit reversed the lower court’s decision and concluded that the Court of Federal Claims, the court handling the APS matter, is bound by the November 1997 D.C. Circuit decision that prevents the DOE from excusing its delay in performance.

APS currently estimates it will incur $132 million (in 2010 dollars) over the current life of Palo Verde for its share of the costs related to the on-site interim storage of spent nuclear fuel. At March 31, 2010, APS had a regulatory liability of $37 million that represents amounts recovered in retail rates in excess of amounts spent for on-site interim spent fuel storage.

Fuel and Purchased Power Commitments

APS is party to various fuel and purchased power contracts with terms expiring between 2010 and 2042 that include required purchase provisions. APS estimates the contract requirements to be approximately $469 million in 2010; $341 million in 2011; $360 million in 2012; $466 million in 2013; $498 million in 2014; and $6.7 billion thereafter. However, these amounts may vary significantly pursuant to certain provisions in such contracts that permit us to decrease required purchases under certain circumstances. These amounts have increased since the 2009 Form 10-K due to increased solar contracts to meet our increasing requirements.

Renewable Energy Credits

In 2010, APS entered into additional contracts to purchase renewable energy credits to comply with the RES. APS estimates the new level of contract requirements at March 31, 2010 to be approximately $33 million in 2010; $19 million in 2011; $19 million in 2012; $19 million in 2013; $19 million in 2014; and $209 million thereafter.

PINNACLE WEST CAPITAL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

California Energy Market Issues and Refunds in the Pacific Northwest

In July 2001, the FERC ordered an expedited fact-finding hearing to calculate refunds for spot market transactions in California during a specified time frame. APS was a seller and a purchaser in the California markets at issue and, to the extent that refunds are ordered, APS should be a recipient as well as a payor of such amounts. In addition, on March 19, 2002, the State of California filed a complaint with the FERC alleging that wholesale sellers of power and energy, including APS, failed to properly file rate information at the FERC in connection with sales to California from 2000 to March 2002 under market-based rates. Since 2004, the Ninth Circuit and the FERC have issued various decisions and orders involving the aforementioned issues, including decisions related to: entities subject to FERC jurisdiction and, therefore, potentially owing refunds; applicable refund methodologies; the temporal scope and types of transactions that are properly subject to the refund orders; and the appropriate standard of review at the FERC on wholesale power contracts in the refund proceedings. A settlement, resolving APS’ issues with certain California parties for the current refund period, was approved by the FERC in an order issued on June 30, 2008. The resolution of the claims related to the parties involved in this settlement had no material adverse impact on our financial position, results of operations or cash flows. We currently believe the refund claims at the FERC related to the parties not involved in this settlement will have no material adverse impact on our financial position, results of operations or cash flows.

On July 25, 2001, the FERC also ordered an evidentiary proceeding to discuss and evaluate possible refunds for wholesale sales in the Pacific Northwest. The FERC affirmed the administrative law judge’s conclusion that the prices in the Pacific Northwest were not unreasonable or unjust and refunds should not be ordered in this proceeding. This decision was appealed to the U.S. Court of Appeals for the Ninth Circuit. On August 24, 2007, the Ninth Circuit issued an opinion that remanded the proceeding to the FERC for further consideration. Although the FERC has not yet determined whether any refunds will ultimately be required, we do not expect that the resolution of these issues will have a material adverse impact on our financial position, results of operations or cash flows.

Superfund

The Comprehensive Environmental Response, Compensation and Liability Act (“Superfund”) establishes liability for the cleanup of hazardous substances found contaminating the soil, water or air. Those who generated, transported or disposed of hazardous substances at a contaminated site are among those who are potentially responsible parties under Superfund (“PRPs”). PRPs may be strictly, and often are jointly and severally, liable for clean-up. On September 3, 2003, the United States Environmental Protection Agency (“EPA”) advised APS that the EPA considers APS to be a PRP in the Motorola 52^nd Street Superfund Site, Operable Unit 3 (OU3) in Phoenix, Arizona. APS has facilities that are within this Superfund site. APS and Pinnacle West have agreed with the EPA to perform certain investigative activities of the APS facilities within OU3. In addition, on September 23, 2009, APS agreed with the EPA and one other PRP to voluntarily assist with the funding and management of the site-wide groundwater remedial investigation and feasibility study work plan. We estimate that our costs related to this investigation and study will be approximately $1.2 million, which is reserved as a liability on our financial statements. We anticipate incurring additional expenditures in the future, but because the overall investigation is not complete and ultimate remediation requirements are not yet finalized, at the present time we cannot accurately estimate our total expenditures.

PINNACLE WEST CAPITAL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

Landlord Bankruptcy

On April 16, 2009, the landlord for our corporate headquarters building announced that it is seeking relief under Chapter 11 of the United States Bankruptcy Code. At March 31, 2010, we have several assets on our books related to our landlord, the most significant of which is an asset related to levelized rent payments for the building of approximately $67 million which is included in other deferred debits on the Condensed Consolidated Balance Sheets. This amount will continue to increase to approximately $94 million as a result of the lease terms until 2015, when this amount will begin to decrease over the remaining life of the lease. We are monitoring this matter and, while there can be no assurances as to the ultimate outcome of the matter due to the complexity of the bankruptcy proceedings, we currently do not expect that it will have a material adverse effect on our financial position, results of operations, or cash flows.

13. Nuclear Insurance

The Palo Verde participants are insured against public liability for a nuclear incident up to $12.6 billion per occurrence. As required by the Price Anderson Nuclear Industries Indemnity Act, Palo Verde maintains the maximum available nuclear liability insurance in the amount of $375 million, which is provided by commercial insurance carriers. The remaining balance of $12.2 billion is provided through a mandatory industry wide retrospective assessment program. If losses at any nuclear power plant covered by the program exceed the accumulated funds, APS could be assessed retrospective premium adjustments. The maximum assessment per reactor under the program for each nuclear incident is approximately $118 million, subject to an annual limit of $18 million per incident, to be periodically adjusted for inflation. Based on APS’ interest in the three Palo Verde units, APS’ maximum potential assessment per incident for all three units is approximately $103 million, with an annual payment limitation of approximately $15 million.

The Palo Verde participants maintain “all risk” (including nuclear hazards) insurance for property damage to, and decontamination of, property at Palo Verde in the aggregate amount of $2.75 billion, a substantial portion of which must first be applied to stabilization and decontamination. APS has also secured insurance against portions of any increased cost of generation or purchased power and business interruption resulting from a sudden and unforeseen accidental outage of any of the three units. The property damage, decontamination, and replacement power coverages are provided by Nuclear Electric Insurance Limited (“NEIL”). APS is subject to retrospective assessments under all NEIL policies if NEIL’s losses in any policy year exceed accumulated funds. The maximum amount APS could incur under the current NEIL policies totals approximately $16 million for each retrospective assessment declared by NEIL’s Board of Directors due to losses. In addition, NEIL policies contain rating triggers that would result in APS providing approximately $44 million of collateral assurance within 20 business days of a rating downgrade to non-investment grade. The insurance coverage discussed in this and the previous paragraph is subject to certain policy conditions and exclusions.

PINNACLE WEST CAPITAL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

14. Other Income and Other Expense

The following table provides detail of other income and other expense for the three months ended March 31, 2010 and 2009 (dollars in thousands):

		Three Months Ended
		March 31,
		2010				2009
Other income:
Interest income		$	875			$	261
SunCor other income (a)			286				93
Investment gains — net			1,222				—
Miscellaneous			12				183
Total other income		$	2,395			$	537
Other expense:
Non-operating costs		$	(1,794	)		$	(1,608	)
Investment losses — net			—				(7,230	)
Miscellaneous			(902	)			(903	)
Total other expense		$	(2,696	)		$	(9,741	)

We have issued parental guarantees and letters of credit and obtained surety bonds on behalf of our subsidiaries.

Our parental guarantees for APS relate to commodity energy products. In addition, Pinnacle West has obtained approximately $9 million of surety bonds related to APS’ operations, which primarily relate to self-insured workers’ compensation. Our credit support instruments enable APSES to offer energy-related products. Non-performance or non-payment under the original contract by our subsidiaries would require us to perform under the guarantee or surety bond. No liability is currently recorded on the Condensed Consolidated Balance Sheets related to Pinnacle West’s current outstanding guarantees on behalf of our subsidiaries. At March 31, 2010, we had no guarantees that were in default. Our guarantees have no recourse or collateral provisions to allow us to recover amounts paid under the guarantees. The amounts and approximate terms of our guarantees and surety bonds for each subsidiary at March 31, 2010 are as follows (dollars in millions):

		Guarantees								Surety Bonds
						Term								Term
		Amount				(in years)				Amount				(in years)
APSES		$	9				1			$	28				1
APS			3				1				9				1
Total		$	12							$	37

APS has entered into various agreements that require letters of credit for financial assurance purposes. At March 31, 2010, approximately $227 million of letters of credit were outstanding to support existing pollution control bonds of approximately $224 million. The letters of credit are available to fund the payment of principal and interest of such debt obligations and expire in 2010. APS has also entered into approximately $62 million of letters of credit to support certain equity lessors in the Palo Verde sale leaseback transactions (see Note 9 for further details on the Palo Verde sale leaseback transactions). These letters of credit were amended and extended in April 2010, and will expire in 2013.

PINNACLE WEST CAPITAL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

We enter into agreements that include indemnification provisions relating to liabilities arising from or related to certain of our agreements; most significantly, APS has agreed to indemnify the equity participants and other parties in the Palo Verde sale leaseback transactions with respect to certain tax matters. Generally, a maximum obligation is not explicitly stated in the indemnification provisions and, therefore, the overall maximum amount of the obligation under such indemnification provisions cannot be reasonably estimated. Based on historical experience and evaluation of the specific indemnities, we do not believe that any material loss related to such indemnification provisions is likely.

16. Earnings Per Share

The following table presents earnings per weighted average common share outstanding for the three months ended March 31, 2010 and 2009:

		Three Months Ended
		March 31,
		2010				2009
Basic earnings per share:
Loss from continuing operations attributable to common shareholders		$	(0.06	)		$	(1.50	)
Loss from discontinued operations			—				(0.05	)
Loss per share — basic		$	(0.06	)		$	(1.55	)
Diluted earnings per share:
Loss from continuing operations attributable to common shareholders		$	(0.06	)		$	(1.50	)
Loss from discontinued operations			—				(0.05	)
Loss per share — diluted		$	(0.06	)		$	(1.55	)

For the three months ended March 31, 2010 and 2009 the weighted average common shares outstanding were the same for both basic and diluted shares. Options to purchase 387,800 shares of common stock for the three-month period ended March 31, 2010 and 625,524 shares for the three-month period ended March 31, 2009 were outstanding but were excluded from the computation of diluted earnings per share because the options’ exercise prices were greater than the average market price of the common shares.

17. Discontinued Operations

SunCor (real estate segment) — In 2009, SunCor sold properties that are required to be reported as discontinued operations on Pinnacle West’s Condensed Consolidated Statements of Income. Prior year income statement amounts related to these properties were reclassified from operations to discontinued operations. In addition, see Note 20 — Real Estate Impairment Charge.

PINNACLE WEST CAPITAL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

The following table contains SunCor’s revenue, loss before income taxes and loss after taxes classified as discontinued operations in Pinnacle West’s Condensed Consolidated Statements of Income for the three months ended March 31, 2010 and 2009 (dollars in millions):

		Three Months Ended
		March 31,
		2010				2009
Revenue		$	—			$	4
Loss before income taxes			—				(8	)
Loss after taxes (a)			—				(5	)

18. Nuclear Decommissioning Trust

To fund the costs APS expects to incur to decommission Palo Verde, APS established external decommissioning trusts in accordance with Nuclear Regulatory Commission (“NRC”) regulations. Third-party investment managers are authorized to buy and sell securities per their stated investment guidelines. The trust funds are invested in a tax efficient manner in fixed income securities and domestic equity securities. APS classifies investments in decommissioning trust funds as available for sale. As a result, we record the decommissioning trust funds at their fair value on our Condensed Consolidated Balance Sheets. Because of the ability of APS to recover decommissioning costs in rates and in accordance with the regulatory treatment for decommissioning trust funds, we have recorded the offsetting amount of gains or losses on investment securities in other regulatory liabilities or assets. The following table summarizes the fair value of APS’ nuclear decommissioning trust fund assets at March 31, 2010 and December 31, 2009 (dollars in millions):

						Total				Total
						Unrealized				Unrealized
		Fair Value				Gains				Losses
March 31, 2010
Equity securities		$	150			$	34			$	(3	)
Fixed income securities			298				11				(1	)
Net payables (a)			(15	)			—				—
Total		$	433			$	45			$	(4	)