10-Q 1 pnw2016063010-q.htm 10-Q Document



 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
 
 

FORM 10-Q
 
(Mark One)
 
ý
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the quarterly period ended June 30, 2016
 
OR
 
o
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the transition period from              to          
 
Commission File
Number
 
Exact Name of Each Registrant as specified in its
charter; State of Incorporation; Address; and
Telephone Number
 
IRS Employer
Identification No.
1-8962
 
PINNACLE WEST CAPITAL CORPORATION
(an Arizona corporation)
400 North Fifth Street, P.O. Box 53999
Phoenix, Arizona  85072-3999
(602) 250-1000
 
86-0512431
1-4473
 
ARIZONA PUBLIC SERVICE COMPANY
(an Arizona corporation)
400 North Fifth Street, P.O. Box 53999
Phoenix, Arizona  85072-3999
(602) 250-1000
 
86-0011170
 
Indicate by check mark whether each registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
 
PINNACLE WEST CAPITAL CORPORATION
Yes  x   No o
ARIZONA PUBLIC SERVICE COMPANY
Yes  x   No o
 
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).
 
PINNACLE WEST CAPITAL CORPORATION
Yes  x   No o
ARIZONA PUBLIC SERVICE COMPANY
Yes  x   No o
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company.  See the definitions of "large accelerated filer," "accelerated filer" and "smaller reporting company" in Rule 12b-2 of the Exchange Act.
 
PINNACLE WEST CAPITAL CORPORATION
 
Large accelerated filer x
Accelerated filer o
Non-accelerated filer o
Smaller reporting company o
 
ARIZONA PUBLIC SERVICE COMPANY
 
Large accelerated filer o
Accelerated filer o
Non-accelerated filer x
Smaller reporting company o
 
Indicate by check mark whether each registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
 
PINNACLE WEST CAPITAL CORPORATION
Yes  o   No x
ARIZONA PUBLIC SERVICE COMPANY
Yes  o   No x
 
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.
 
PINNACLE WEST CAPITAL CORPORATION
Number of shares of common stock, no par value, outstanding as of July 22, 2016: 111,174,772
ARIZONA PUBLIC SERVICE COMPANY
Number of shares of common stock, $2.50 par value, outstanding as of July 22, 2016: 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
 
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 Combined Notes to Condensed Consolidated Financial Statements.


1



FORWARD-LOOKING STATEMENTS
 
This document contains forward-looking statements based on current expectations.  These forward-looking statements are often identified by words such as "estimate," "predict," "may," "believe," "plan," "expect," "require," "intend," "assume" and similar words.  Because actual results may differ materially from expectations, we caution readers not to place undue reliance on these statements.  A number of factors could cause future results to differ materially from historical results, or from outcomes currently expected or sought by Pinnacle West or APS.  In addition to the Risk Factors described in Part I, Item 1A of the Pinnacle West/APS Annual Report on Form 10-K for the fiscal year ended December 31, 2015 ("2015 Form 10-K"), Part II, Item 1A of this report and in Part I, Item 2 — "Management’s Discussion and Analysis of Financial Condition and Results of Operations" of this report, these factors include, but are not limited to:
 
our ability to manage capital expenditures and operations and maintenance costs while maintaining reliability and customer service levels;
variations in demand for electricity, including those due to weather, seasonality, the general economy, customer and sales growth (or decline), and the effects of energy conservation measures and distributed generation;
power plant and transmission system performance and outages;
competition in retail and wholesale power markets;
regulatory and judicial decisions, developments and proceedings;
new legislation, ballot initiatives and regulation, including those relating to environmental requirements, regulatory policy, nuclear plant operations and potential deregulation of retail electric markets;
fuel and water supply availability;
our ability to achieve timely and adequate rate recovery of our costs, including returns on and of debt and equity capital investment;
our ability to meet renewable energy and energy efficiency mandates and recover related costs;
risks inherent in the operation of nuclear facilities, including spent fuel disposal uncertainty;
current and future economic conditions in Arizona, including in real estate markets;
the development of new technologies which may affect electric sales or delivery;
the cost of debt and equity capital and the ability to access capital markets when required;
environmental and other concerns surrounding coal-fired generation, including regulation of greenhouse gas emissions;
volatile fuel and purchased power costs;
the investment performance of the assets of our nuclear decommissioning trust, pension, and other postretirement benefit plans and the resulting impact on future funding requirements;
the liquidity of wholesale power markets and the use of derivative contracts in our business;
potential shortfalls in insurance coverage;
new accounting requirements or new interpretations of existing requirements;
generation, transmission and distribution facility and system conditions and operating costs;
the ability to meet the anticipated future need for additional generation and associated transmission facilities in our region;
the willingness or ability of our counterparties, power plant participants and power plant land owners to meet contractual or other obligations or extend the rights for continued power plant operations; and
restrictions on dividends or other provisions in our credit agreements and Arizona Corporation Commission ("ACC") orders.
 
These and other factors are discussed in the Risk Factors described in Part I, Item 1A of our 2015 Form 10-K and in Part II, Item 1A of this report, which readers should review carefully before placing any reliance on our financial statements or disclosures.  Neither Pinnacle West nor APS assumes any obligation to update these statements, even if our internal estimates change, except as required by law.


2



PART I — FINANCIAL INFORMATION
 
ITEM 1.  FINANCIAL STATEMENTS
 
 INDEX TO FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULES
 
 
Page
 
 
 
 
 
 



3




PINNACLE WEST CAPITAL CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(unaudited)
(dollars and shares in thousands, except per share amounts)
 
 
 
Three Months Ended 
 June 30,
 
Six Months Ended 
 June 30,
 
 
2016
 
2015
 
2016
 
2015
 
 
 
 
 
 
 
 
 
OPERATING REVENUES
 
$
915,394

 
$
890,648

 
$
1,592,561

 
$
1,561,867

 
 
 
 
 
 
 
 
 
OPERATING EXPENSES
 
 

 
 

 
 
 
 
Fuel and purchased power
 
274,848

 
281,477

 
496,133

 
504,714

Operations and maintenance
 
242,279

 
210,965

 
485,474

 
425,909

Depreciation and amortization
 
123,073

 
122,739

 
242,549

 
243,688

Taxes other than income taxes
 
42,117

 
43,032

 
84,618

 
86,248

Other expenses
 
1,329

 
462

 
1,877

 
1,651

Total
 
683,646

 
658,675

 
1,310,651

 
1,262,210

OPERATING INCOME
 
231,748

 
231,973

 
281,910

 
299,657

OTHER INCOME (DEDUCTIONS)
 
 

 
 

 
 
 
 
Allowance for equity funds used during construction
 
10,369

 
9,345

 
20,885

 
18,569

Other income (Note 8)
 
197

 
175

 
314

 
410

Other expense (Note 8)
 
(2,842
)
 
(2,609
)
 
(6,880
)
 
(6,895
)
Total
 
7,724

 
6,911

 
14,319

 
12,084

INTEREST EXPENSE
 
 

 
 

 
 
 
 
Interest charges
 
52,849

 
48,328

 
103,593

 
96,727

Allowance for borrowed funds used during construction
 
(5,301
)
 
(4,322
)
 
(10,528
)
 
(8,538
)
Total
 
47,548

 
44,006

 
93,065

 
88,189

INCOME BEFORE INCOME TAXES
 
191,924

 
194,878

 
203,164

 
223,552

INCOME TAXES
 
65,742

 
67,371

 
67,656

 
75,318

NET INCOME
 
126,182

 
127,507

 
135,508

 
148,234

Less: Net income attributable to noncontrolling interests (Note 5)
 
4,874

 
4,605

 
9,747

 
9,210

NET INCOME ATTRIBUTABLE TO COMMON SHAREHOLDERS
 
$
121,308

 
$
122,902

 
$
125,761

 
$
139,024

 
 
 
 
 
 
 
 
 
WEIGHTED-AVERAGE COMMON SHARES OUTSTANDING — BASIC
 
111,368

 
110,986

 
111,336

 
110,958

WEIGHTED-AVERAGE COMMON SHARES OUTSTANDING — DILUTED
 
112,004

 
111,460

 
111,930

 
111,426

 
 
 
 
 
 
 
 
 
EARNINGS PER WEIGHTED-AVERAGE COMMON SHARE OUTSTANDING
 
 

 
 

 
 
 
 
Net income attributable to common shareholders — basic
 
$
1.09

 
$
1.11

 
$
1.13

 
$
1.25

Net income attributable to common shareholders — diluted
 
$
1.08

 
$
1.10

 
$
1.12

 
$
1.25

 
 
 
 
 
 
 
 
 
DIVIDENDS DECLARED PER SHARE
 
$
1.25

 
$
1.19

 
$
1.25

 
$
1.19

 
The accompanying notes are an integral part of the financial statements.


4



PINNACLE WEST CAPITAL CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(unaudited)
(dollars in thousands)
 
 
Three Months Ended 
 June 30,
 
Six Months Ended 
 June 30,
 
2016
 
2015
 
2016
 
2015
 
 
 
 
 
 
 
 
NET INCOME
$
126,182

 
$
127,507

 
$
135,508

 
$
148,234

 
 
 
 
 
 
 
 
OTHER COMPREHENSIVE INCOME, NET OF TAX
 

 
 

 
 
 
 
Derivative instruments:
 

 
 

 
 
 
 
Net unrealized gain (loss), net of tax expense of $80, $16, $626 and $489 for the respective periods
128

 
25

 
(566
)
 
(775
)
Reclassification of realized loss, net of tax benefit of $392, $556, $191 and $923 for the respective periods
624

 
874

 
1,766

 
2,850

Pension and other postretirement benefits activity, net of tax benefit (expense) of $439, $74, $(206) and $(793) for the respective periods
(701
)
 
(117
)
 
(171
)
 
466

Total other comprehensive income
51

 
782

 
1,029

 
2,541

 
 
 
 
 
 
 
 
COMPREHENSIVE INCOME
126,233

 
128,289

 
136,537

 
150,775

Less: Comprehensive income attributable to noncontrolling interests
4,874

 
4,605

 
9,747

 
9,210

 
 
 
 
 
 
 
 
COMPREHENSIVE INCOME ATTRIBUTABLE TO COMMON SHAREHOLDERS
$
121,359

 
$
123,684

 
$
126,790

 
$
141,565

 
The accompanying notes are an integral part of the financial statements.


5



PINNACLE WEST CAPITAL CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEETS
(unaudited)
(dollars in thousands)
 
 
June 30,
2016
 
December 31,
2015
ASSETS
 

 
 

 
 
 
 
CURRENT ASSETS
 

 
 

Cash and cash equivalents
$
43,040

 
$
39,488

Customer and other receivables
278,900

 
274,691

Accrued unbilled revenues
197,571

 
96,240

Allowance for doubtful accounts
(2,755
)
 
(3,125
)
Materials and supplies (at average cost)
241,612

 
234,234

Fossil fuel (at average cost)
36,768

 
45,697

Income tax receivable

 
589

Assets from risk management activities (Note 6)
16,676

 
15,905

Regulatory assets (Note 3)
108,596

 
149,555

Other current assets
42,979

 
37,242

Total current assets
963,387

 
890,516

INVESTMENTS AND OTHER ASSETS
 

 
 

Assets from risk management activities (Note 6)
5,464

 
12,106

Nuclear decommissioning trust (Note 11)
767,416

 
735,196

Other assets
54,401

 
52,518

Total investments and other assets
827,281

 
799,820

PROPERTY, PLANT AND EQUIPMENT
 

 
 

Plant in service and held for future use
16,663,962

 
16,222,232

Accumulated depreciation and amortization
(5,733,857
)
 
(5,594,094
)
Net
10,930,105

 
10,628,138

Construction work in progress
966,146

 
816,307

Palo Verde sale leaseback, net of accumulated depreciation (Note 5)
115,450

 
117,385

Intangible assets, net of accumulated amortization
108,751

 
123,975

Nuclear fuel, net of accumulated amortization
120,408

 
123,139

Total property, plant and equipment
12,240,860

 
11,808,944

DEFERRED DEBITS
 

 
 

Regulatory assets (Note 3)
1,190,622

 
1,214,146

Assets for other postretirement benefits (Note 4)
186,505

 
185,997

Other
129,910

 
128,835

Total deferred debits
1,507,037

 
1,528,978

 
 
 
 
TOTAL ASSETS
$
15,538,565

 
$
15,028,258

 
The accompanying notes are an integral part of the financial statements.


6



PINNACLE WEST CAPITAL CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEETS
(unaudited)
(dollars in thousands)
 
June 30,
 2016
 
December 31,
2015
LIABILITIES AND EQUITY
 

 
 

 
 
 
 
CURRENT LIABILITIES
 

 
 

Accounts payable
$
316,589

 
$
297,480

Accrued taxes
145,167

 
138,600

Accrued interest
57,927

 
56,305

Common dividends payable
69,484

 
69,363

Short-term borrowings (Note 2)
64,140

 

Current maturities of long-term debt (Note 2)
293,580

 
357,580

Customer deposits
79,136

 
73,073

Liabilities from risk management activities (Note 6)
55,338

 
77,716

Liabilities for asset retirements (Note 14)
15,513

 
28,573

Deferred fuel and purchased power regulatory liability (Note 3)
2,439

 
9,688

Other regulatory liabilities (Note 3)
113,733

 
136,078

Other current liabilities
265,498

 
197,861

Total current liabilities
1,478,544

 
1,442,317

LONG-TERM DEBT LESS CURRENT MATURITIES (Note 2)
3,897,835

 
3,462,391

DEFERRED CREDITS AND OTHER
 

 
 

Deferred income taxes
2,794,741

 
2,723,425

Regulatory liabilities (Note 3)
1,010,821

 
994,152

Liabilities for asset retirements (Note 14)
446,324

 
415,003

Liabilities for pension benefits (Note 4)
440,919

 
480,998

Liabilities from risk management activities (Note 6)
52,212

 
89,973

Customer advances
101,568

 
115,609

Coal mine reclamation
203,623

 
201,984

Deferred investment tax credit
184,998

 
187,080

Unrecognized tax benefits
9,772

 
9,524

Other
198,025

 
186,345

Total deferred credits and other
5,443,003

 
5,404,093

COMMITMENTS AND CONTINGENCIES (SEE NOTE 7)


 


EQUITY
 

 
 

Common stock, no par value; authorized 150,000,000 shares, 111,175,500 and 111,095,402 issued at respective dates
2,549,498

 
2,541,668

Treasury stock at cost; 1,900 and 115,030 shares at respective dates
(130
)
 
(5,806
)
Total common stock
2,549,368

 
2,535,862

Retained earnings
2,079,619

 
2,092,803

Accumulated other comprehensive loss:
 

 
 

Pension and other postretirement benefits
(37,764
)
 
(37,593
)
Derivative instruments
(5,955
)
 
(7,155
)
Total accumulated other comprehensive loss
(43,719
)
 
(44,748
)
Total shareholders’ equity
4,585,268

 
4,583,917

Noncontrolling interests (Note 5)
133,915

 
135,540

Total equity
4,719,183

 
4,719,457

 
 
 
 
TOTAL LIABILITIES AND EQUITY
$
15,538,565

 
$
15,028,258

The accompanying notes are an integral part of the financial statements.

7



PINNACLE WEST CAPITAL CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited)
(dollars in thousands)
 
Six Months Ended 
 June 30,
 
2016
 
2015
CASH FLOWS FROM OPERATING ACTIVITIES
 

 
 

Net income
$
135,508

 
$
148,234

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

 
 

Depreciation and amortization including nuclear fuel
282,291

 
282,218

Deferred fuel and purchased power
(21,026
)
 
11,711

Deferred fuel and purchased power amortization
13,778

 
11,424

Allowance for equity funds used during construction
(20,885
)
 
(18,569
)
Deferred income taxes
65,881

 
65,377

Deferred investment tax credit
(2,083
)
 
(2,218
)
Change in derivative instruments fair value
(237
)
 
(225
)
Changes in current assets and liabilities:
 

 
 

Customer and other receivables
(19,898
)
 
(17,402
)
Accrued unbilled revenues
(101,331
)
 
(84,683
)
Materials, supplies and fossil fuel
1,551

 
(18,311
)
Income tax receivable
589

 
3,098

Other current assets
(5,649
)
 
(8,728
)
Accounts payable
47,621

 
36,634

Accrued taxes
6,567

 
15,199

Other current liabilities
53,912

 
(13,138
)
Change in margin and collateral accounts — assets
(34
)
 
(4,552
)
Change in margin and collateral accounts — liabilities
18,010

 
26,853

Change in other long-term assets
(41,101
)
 
(1,616
)
Change in other long-term liabilities
9,011

 
(37,012
)
Net cash flow provided by operating activities
422,475

 
394,294

CASH FLOWS FROM INVESTING ACTIVITIES
 

 
 

Capital expenditures
(731,609
)
 
(531,035
)
Contributions in aid of construction
29,127

 
41,010

Allowance for borrowed funds used during construction
(10,528
)
 
(8,538
)
Proceeds from nuclear decommissioning trust sales
290,594

 
225,779

Investment in nuclear decommissioning trust
(291,734
)
 
(234,651
)
Other
(1,307
)
 
(2,068
)
Net cash flow used for investing activities
(715,457
)
 
(509,503
)
CASH FLOWS FROM FINANCING ACTIVITIES
 

 
 

Issuance of long-term debt
445,933

 
600,000

Repayment of long-term debt
(76,850
)
 
(344,847
)
Short-term borrowing and payments — net
64,140

 
10,100

Dividends paid on common stock
(135,335
)
 
(128,241
)
Common stock equity issuance - net of purchases
10,017

 
12,161

Distributions to noncontrolling interests
(11,372
)
 
(28,012
)
Other
1

 
1

Net cash flow provided by financing activities
296,534

 
121,162

 
 
 
 
NET INCREASE IN CASH AND CASH EQUIVALENTS
3,552

 
5,953

 
 
 
 
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD
39,488

 
7,604

 
 
 
 
CASH AND CASH EQUIVALENTS AT END OF PERIOD
$
43,040

 
$
13,557

The accompanying notes are an integral part of the financial statements.


8



PINNACLE WEST CAPITAL CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN EQUITY
(unaudited)
(dollars in thousands)
 
Common Stock
 
Treasury Stock
 
Retained Earnings
 
Accumulated Other Comprehensive Income (Loss)
 
Noncontrolling Interests
 
Total
 
Shares
 
Amount
 
Shares
 
Amount
 
 
 
 
 
 
 
 
Balance, January 1, 2015
110,649,762

 
$
2,512,970

 
(78,400
)
 
$
(3,401
)
 
$
1,926,065

 
$
(68,141
)
 
$
151,609

 
$
4,519,102

Net income
 
 

 
 
 

 
139,024

 

 
9,210

 
148,234

Other comprehensive income
 
 

 
 
 

 

 
2,541

 

 
2,541

Dividends on common stock
 
 

 
 
 

 
(131,833
)
 

 

 
(131,833
)
Issuance of common stock
215,268

 
13,975

 
 
 

 

 

 

 
13,975

Purchase of treasury stock (a)
 
 

 
(93,280
)
 
(6,096
)
 

 

 

 
(6,096
)
Reissuance of treasury stock for stock-based compensation and other
 
 

 
118,121

 
7,732

 

 

 

 
7,732

Capital activities by noncontrolling interests
 
 

 
 
 

 

 

 
(28,012
)
 
(28,012
)
Balance, June 30, 2015
110,865,030

 
$
2,526,945

 
(53,559
)
 
$
(1,765
)
 
$
1,933,256

 
$
(65,600
)
 
$
132,807

 
$
4,525,643

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Balance, January 1, 2016
111,095,402

 
$
2,541,668

 
(115,030
)
 
$
(5,806
)
 
$
2,092,803

 
$
(44,748
)
 
$
135,540

 
$
4,719,457

Net income
 
 

 
 
 

 
125,761

 

 
9,747

 
135,508

Other comprehensive income
 
 

 
 
 

 

 
1,029

 

 
1,029

Dividends on common stock
 
 

 
 
 

 
(138,947
)
 

 

 
(138,947
)
Issuance of common stock
80,098

 
7,830

 
 
 

 

 

 

 
7,830

Purchase of treasury stock (a)
 
 

 
(71,962
)
 
(4,880
)
 

 

 

 
(4,880
)
Reissuance of treasury stock for stock-based compensation and other
 
 

 
185,092

 
10,556

 
2

 

 

 
10,558

Capital activities by noncontrolling interests
 
 

 
 
 

 

 

 
(11,372
)
 
(11,372
)
Balance, June 30, 2016
111,175,500

 
$
2,549,498

 
(1,900
)
 
$
(130
)
 
$
2,079,619

 
$
(43,719
)
 
$
133,915

 
$
4,719,183

(a)    Primarily represents shares of common stock withheld from certain stock awards for tax purposes.

The accompanying notes are an integral part of the financial statements.



9




ARIZONA PUBLIC SERVICE COMPANY
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(unaudited)
(dollars in thousands)
 
 
 
Three Months Ended 
 June 30,
 
Six Months Ended 
 June 30,
 
 
2016
 
2015
 
2016
 
2015
 
 
 
 
 
 
 
 
 
ELECTRIC OPERATING REVENUES
 
$
909,757

 
$
889,723

 
$
1,586,389

 
$
1,560,391

 
 
 
 
 
 
 
 
 
OPERATING EXPENSES
 
 

 
 

 
 
 
 
Fuel and purchased power
 
274,848

 
281,477

 
496,133

 
504,714

Operations and maintenance
 
233,712

 
208,031

 
472,423

 
417,978

Depreciation and amortization
 
123,033

 
122,716

 
242,479

 
243,642

Income taxes
 
70,444

 
71,672

 
76,294

 
83,911

Taxes other than income taxes
 
42,036

 
43,123

 
84,446

 
86,109

Total
 
744,073

 
727,019

 
1,371,775

 
1,336,354

OPERATING INCOME
 
165,684

 
162,704

 
214,614

 
224,037

 
 
 
 
 
 
 
 
 
OTHER INCOME (DEDUCTIONS)
 
 

 
 

 
 
 
 
Income taxes
 
1,721

 
2,980

 
3,536

 
5,131

Allowance for equity funds used during construction
 
10,369

 
9,345

 
20,885

 
18,569

Other income (Note 8)
 
5,747

 
710

 
6,357

 
1,349

Other expense (Note 8)
 
(4,430
)
 
(2,449
)
 
(9,180
)
 
(7,803
)
Total
 
13,407

 
10,586

 
21,598

 
17,246

 
 
 
 
 
 
 
 
 
INTEREST EXPENSE
 
 

 
 

 
 
 
 
Interest on long-term debt
 
48,903

 
44,826

 
95,722

 
90,254

Interest on short-term borrowings
 
1,930

 
1,705

 
4,007

 
2,879

Debt discount, premium and expense
 
1,195

 
1,103

 
2,334

 
2,237

Allowance for borrowed funds used during construction
 
(4,999
)
 
(4,311
)
 
(10,039
)
 
(8,527
)
Total
 
47,029

 
43,323

 
92,024

 
86,843

 
 
 
 
 
 
 
 
 
NET INCOME
 
132,062

 
129,967

 
144,188

 
154,440

 
 
 
 
 
 
 
 
 
Less: Net income attributable to noncontrolling interests (Note 5)
 
4,874

 
4,605

 
9,747

 
9,210

 
 
 
 
 
 
 
 
 
NET INCOME ATTRIBUTABLE TO COMMON SHAREHOLDER
 
$
127,188

 
$
125,362

 
$
134,441

 
$
145,230

 
The accompanying notes are an integral part of the financial statements.

10



ARIZONA PUBLIC SERVICE COMPANY
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(unaudited)
(dollars in thousands)
 
 
Three Months Ended 
 June 30,
 
Six Months Ended 
 June 30,
 
2016
 
2015
 
2016
 
2015
 
 
 
 
 
 
 
 
NET INCOME
$
132,062

 
$
129,967

 
$
144,188

 
$
154,440

 
 
 
 
 
 
 
 
OTHER COMPREHENSIVE INCOME, NET OF TAX
 

 
 

 
 
 
 
Derivative instruments:
 

 
 

 
 
 
 
Net unrealized gain (loss), net of tax expense of $80, $16, $626 and $489 for the respective periods
128

 
25

 
(566
)
 
(775
)
Reclassification of realized loss, net of tax benefit of $392, $556, $191 and $923 for the respective periods
624

 
874

 
1,766

 
2,850

Pension and other postretirement benefits activity, net of tax benefit (expense) of $403, $47, $(156) and $(722) for the respective periods
(642
)
 
(74
)
 
(31
)
 
607

Total other comprehensive income
110

 
825

 
1,169

 
2,682

 
 
 
 
 
 
 
 
COMPREHENSIVE INCOME
132,172

 
130,792

 
145,357

 
157,122

Less: Comprehensive income attributable to noncontrolling interests
4,874

 
4,605

 
9,747

 
9,210

 
 
 
 
 
 
 
 
COMPREHENSIVE INCOME ATTRIBUTABLE TO COMMON SHAREHOLDER
$
127,298

 
$
126,187

 
$
135,610

 
$
147,912

 
The accompanying notes are an integral part of the financial statements.


11



ARIZONA PUBLIC SERVICE COMPANY
CONDENSED CONSOLIDATED BALANCE SHEETS
(unaudited)
(dollars in thousands)
 
 
June 30,
2016
 
December 31,
2015
ASSETS
 

 
 

 
 
 
 
PROPERTY, PLANT AND EQUIPMENT
 

 
 

Plant in service and held for future use
$
16,660,370

 
$
16,218,724

Accumulated depreciation and amortization
(5,730,672
)
 
(5,590,937
)
Net
10,929,698

 
10,627,787

 
 
 
 
Construction work in progress
948,472

 
812,845

Palo Verde sale leaseback, net of accumulated depreciation (Note 5)
115,450

 
117,385

Intangible assets, net of accumulated amortization
108,596

 
123,820

Nuclear fuel, net of accumulated amortization
120,408

 
123,139

Total property, plant and equipment
12,222,624

 
11,804,976

 
 
 
 
INVESTMENTS AND OTHER ASSETS
 

 
 

Nuclear decommissioning trust (Note 11)
767,416

 
735,196

Assets from risk management activities (Note 6)
5,464

 
12,106

Other assets
34,843

 
34,455

Total investments and other assets
807,723

 
781,757

 
 
 
 
CURRENT ASSETS
 

 
 

Cash and cash equivalents
31,207

 
22,056

Customer and other receivables
278,692

 
274,428

Accrued unbilled revenues
197,571

 
96,240

Allowance for doubtful accounts
(2,755
)
 
(3,125
)
Materials and supplies (at average cost)
241,612

 
234,234

Fossil fuel (at average cost)
36,768

 
45,697

Assets from risk management activities (Note 6)
16,676

 
15,905

Regulatory assets (Note 3)
108,596

 
149,555

Other current assets
39,602

 
35,765

Total current assets
947,969

 
870,755

 
 
 
 
DEFERRED DEBITS
 

 
 

Regulatory assets (Note 3)
1,190,622

 
1,214,146

Assets for other postretirement benefits (Note 4)
183,131

 
182,625

Other
128,348

 
127,923

Total deferred debits
1,502,101

 
1,524,694

 
 
 
 
TOTAL ASSETS
$
15,480,417

 
$
14,982,182

 
The accompanying notes are an integral part of the financial statements.


12



ARIZONA PUBLIC SERVICE COMPANY
CONDENSED CONSOLIDATED BALANCE SHEETS
(unaudited)
(dollars in thousands) 
 
June 30,
2016
 
December 31,
2015
LIABILITIES AND EQUITY
 

 
 

 
 
 
 
CAPITALIZATION
 

 
 

Common stock
$
178,162

 
$
178,162

Additional paid-in capital
2,379,696

 
2,379,696

Retained earnings
2,143,934

 
2,148,493

Accumulated other comprehensive (loss):
 

 
 

Pension and other postretirement benefits
(19,973
)
 
(19,942
)
Derivative instruments
(5,955
)
 
(7,155
)
Total shareholder equity
4,675,864

 
4,679,254

Noncontrolling interests (Note 5)
133,915

 
135,540

Total equity
4,809,779

 
4,814,794

Long-term debt less current maturities (Note 2)
3,772,835

 
3,337,391

Total capitalization
8,582,614

 
8,152,185

CURRENT LIABILITIES
 

 
 

Short-term borrowings (Note 2)
64,140

 

Current maturities of long-term debt (Note 2)
293,580

 
357,580

Accounts payable
311,655

 
291,574

Accrued taxes
161,629

 
144,488

Accrued interest
57,627

 
56,003

Common dividends payable
69,500

 
69,400

Customer deposits
79,136

 
73,073

Liabilities from risk management activities (Note 6)
55,338

 
77,716

Liabilities for asset retirements (Note 14)
15,513

 
28,573

Deferred fuel and purchased power regulatory liability (Note 3)
2,439

 
9,688

Other regulatory liabilities (Note 3)
113,733

 
136,078

Other current liabilities
239,926

 
180,535

Total current liabilities
1,464,216

 
1,424,708

DEFERRED CREDITS AND OTHER
 

 
 

Deferred income taxes
2,830,006

 
2,764,489

Regulatory liabilities (Note 3)
1,010,821

 
994,152

Liabilities for asset retirements (Note 14)
446,324

 
415,003

Liabilities for pension benefits (Note 4)
419,545

 
459,065

Liabilities from risk management activities (Note 6)
52,212

 
89,973

Customer advances
101,568

 
115,609

Coal mine reclamation
203,623

 
201,984

Deferred investment tax credit
184,998

 
187,080

Unrecognized tax benefits
35,497

 
35,251

Other
148,993

 
142,683

Total deferred credits and other
5,433,587

 
5,405,289

COMMITMENTS AND CONTINGENCIES (SEE NOTE 7)


 


 
 
 
 
TOTAL LIABILITIES AND EQUITY
$
15,480,417

 
$
14,982,182


The accompanying notes are an integral part of the financial statements.


13



ARIZONA PUBLIC SERVICE COMPANY
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited)
(dollars in thousands)
 
Six Months Ended 
 June 30,
 
2016
 
2015
CASH FLOWS FROM OPERATING ACTIVITIES
 

 
 

Net income
$
144,188

 
$
154,440

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

 
 

Depreciation and amortization including nuclear fuel
282,221

 
282,172

Deferred fuel and purchased power
(21,026
)
 
11,711

Deferred fuel and purchased power amortization
13,778

 
11,424

Allowance for equity funds used during construction
(20,885
)
 
(18,569
)
Deferred income taxes
60,131

 
24,442

Deferred investment tax credit
(2,083
)
 
(2,218
)
Change in derivative instruments fair value
(237
)
 
(225
)
Changes in current assets and liabilities:
 

 
 

Customer and other receivables
(19,809
)
 
(9,250
)
Accrued unbilled revenues
(101,331
)
 
(84,683
)
Materials, supplies and fossil fuel
1,551

 
(18,311
)
Other current assets
(3,749
)
 
(8,193
)
Accounts payable
48,593

 
37,656

Accrued taxes
17,141

 
68,382

Other current liabilities
44,711

 
(31,408
)
Change in margin and collateral accounts — assets
(34
)
 
(4,552
)
Change in margin and collateral accounts — liabilities
18,010

 
26,853

Change in other long-term assets
(38,780
)
 
(3,564
)
Change in other long-term liabilities
3,979

 
(30,337
)
Net cash flow provided by operating activities
426,369

 
405,770

CASH FLOWS FROM INVESTING ACTIVITIES
 

 
 

Capital expenditures
(717,729
)
 
(530,850
)
Contributions in aid of construction
29,127

 
41,010

Allowance for borrowed funds used during construction
(10,039
)
 
(8,527
)
Proceeds from nuclear decommissioning trust sales
290,594

 
225,779

Investment in nuclear decommissioning trust
(291,734
)
 
(234,651
)
Other
(388
)
 
(614
)
Net cash flow used for investing activities
(700,169
)
 
(507,853
)
CASH FLOWS FROM FINANCING ACTIVITIES
 

 
 

Issuance of long-term debt
445,933

 
600,000

Short-term borrowings and payments — net
64,140

 
10,100

Repayment of long-term debt
(76,850
)
 
(344,847
)
Dividends paid on common stock
(138,900
)
 
(131,700
)
Distributions to noncontrolling interests
(11,372
)
 
(28,012
)
Net cash flow provided by financing activities
282,951

 
105,541

NET INCREASE IN CASH AND CASH EQUIVALENTS
9,151

 
3,458

CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD
22,056

 
4,515

CASH AND CASH EQUIVALENTS AT END OF PERIOD
$
31,207

 
$
7,973

Supplemental disclosure of cash flow information
 

 
 

Cash paid during the period for:
 

 
 

Income taxes, net of refunds
$
8,772

 
$
184

Interest, net of amounts capitalized
$
88,066

 
$
82,651

Significant non-cash investing and financing activities:
 

 
 

Accrued capital expenditures
$
55,286

 
$
38,985

Dividends declared but not yet paid
$
69,500

 
$
65,900

 
The accompanying notes are an integral part of the financial statements.


14




ARIZONA PUBLIC SERVICE COMPANY
CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN EQUITY
(unaudited)
(dollars in thousands)
 
Common Stock
 
 
 
Additional Paid-In Capital
 
Retained Earnings
 
Accumulated Other Comprehensive Income (Loss)
 
Noncontrolling Interests
 
Total
 
Shares
 
Amount
 
 
 
 
 
 
 
 
 
 
Balance, January 1, 2015
71,264,947

 
$
178,162

 
$
2,379,696

 
$
1,968,718

 
$
(48,333
)
 
$
151,609

 
$
4,629,852

Net income
 
 

 

 
145,230

 

 
9,210

 
154,440

Other comprehensive income
 
 

 

 

 
2,682

 

 
2,682

Dividends on common stock
 
 

 

 
(131,800
)
 

 

 
(131,800
)
Other
 
 

 

 
2

 

 

 
2

Net capital activities by noncontrolling interests
 
 

 

 

 

 
(28,012
)
 
(28,012
)
Balance, June 30, 2015
71,264,947

 
$
178,162

 
$
2,379,696

 
$
1,982,150

 
$
(45,651
)
 
$
132,807

 
$
4,627,164

 
 
 
 
 
 
 
 
 
 
 
 
 
 
Balance, January 1, 2016
71,264,947

 
$
178,162

 
$
2,379,696

 
$
2,148,493

 
$
(27,097
)
 
$
135,540

 
$
4,814,794

Net income
 
 

 

 
134,441

 

 
9,747

 
144,188

Other comprehensive income
 
 

 

 

 
1,169

 

 
1,169

Dividends on common stock
 
 

 

 
(139,000
)
 

 

 
(139,000
)
Net capital activities by noncontrolling interests
 
 

 

 

 

 
(11,372
)
 
(11,372
)
Balance, June 30, 2016
71,264,947

 
$
178,162

 
$
2,379,696

 
$
2,143,934

 
$
(25,928
)
 
$
133,915

 
$
4,809,779


The accompanying notes are an integral part of the financial statements.



15



COMBINED 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, Bright Canyon Energy Corporation ("BCE") 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 Nuclear Generating Station ("Palo Verde") sale leaseback variable interest entities ("VIEs") (see Note 5 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.
 
Amounts reported in our interim Condensed Consolidated Statements of Income are not necessarily indicative of amounts expected for the respective annual periods, due to the effects of seasonal temperature variations on energy consumption, timing of maintenance on electric generating units, and other factors.
 
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. Certain information and footnote disclosures normally included in financial statements prepared in conformity with GAAP have been condensed or omitted pursuant to such regulations, although we believe that the disclosures provided are adequate to make the interim information presented not misleading. The accompanying condensed consolidated financial statements and these notes should be read in conjunction with the audited consolidated financial statements and notes included in our 2015 Form 10-K.
 
Supplemental Cash Flow Information
 
The following table summarizes supplemental Pinnacle West cash flow information (dollars in thousands):
 
Six Months Ended 
 June 30,
 
2016
 
2015
Cash paid during the period for:
 
 
 
Income taxes, net of refunds
$
2,503

 
$
1,834

Interest, net of amounts capitalized
89,109

 
84,008

Significant non-cash investing and financing activities:
 
 
 
Accrued capital expenditures
$
55,286

 
$
38,985

Dividends accrued but not yet paid
69,484

 
65,933

 
2.
Long-Term Debt and Liquidity Matters

Pinnacle West and APS maintain committed revolving credit facilities in order to enhance liquidity and provide credit support for their commercial paper programs, to refinance indebtedness, and for other general corporate purposes.
 

16


COMBINED NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

Pinnacle West
 
On May 13, 2016, Pinnacle West replaced its $200 million revolving credit facility that would have matured in May 2019, with a new $200 million facility that matures in May 2021. Pinnacle West has the option to increase the amount of the facility up to a maximum of $300 million upon the satisfaction of certain conditions and with the consent of the lenders.  At June 30, 2016, Pinnacle West had no outstanding borrowings under its credit facility, no letters of credit outstanding and no commercial paper borrowings.
 
APS

During the first quarter of 2016, APS increased its commercial paper program from $250 million to $500 million.

On April 22, 2016, APS entered into a $100 million term loan facility that matures April 22, 2019. Interest rates are based on APS's senior unsecured debt credit ratings. APS used the proceeds to repay and refinance existing short-term indebtedness.

On May 6, 2016, APS issued $350 million of 3.75% unsecured senior notes that mature on May 15, 2046. The net proceeds from the sale were used to redeem and cancel pollution control bonds (see details below), and to repay commercial paper borrowings and replenish cash temporarily used to fund capital expenditures.

On May 13, 2016, APS replaced its $500 million revolving credit facility that would have matured in May 2019, with a new $500 million facility that matures in May 2021.

On June 1, 2016, APS redeemed at par and canceled all $64 million of the Navajo County, Arizona Pollution Control Corporation Revenue Refunding Bonds (Arizona Public Service Company Cholla Project), 2009 Series D and E.

On June 1, 2016, APS redeemed at par and canceled all $13 million of the Coconino County, Arizona Pollution Control Corporation Revenue Refunding Bonds (Arizona Public Service Company Navajo Project), 2009 Series A.

On August 1, 2016, APS repaid at maturity APS’s $250 million aggregate principal amount of 6.25% senior notes due August 1, 2016.

At June 30, 2016, APS had two revolving credit facilities totaling $1 billion, including a $500 million credit facility that matures in September 2020 and the $500 million facility that matures in May 2021.  APS may increase the amount of each facility up to a maximum of $700 million, for a total of $1.4 billion, upon the satisfaction of certain conditions and with the consent of the lenders.  Interest rates are based on APS’s senior unsecured debt credit ratings. These facilities are available to support APS’s $500 million commercial paper program, for bank borrowings or for issuances of letters of credit.  At June 30, 2016, APS had $64 million of commercial paper outstanding and no outstanding borrowings or letters of credit under its revolving credit facilities.
 
See "Financial Assurances" in Note 7 for a discussion of APS’s separate outstanding letters of credit.
 

17


COMBINED NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

Debt Fair Value
 
Our long-term debt fair value estimates are based on quoted market prices for the same or similar issues, and are classified within Level 2 of the fair value hierarchy.  Certain of our debt instruments contain third-party credit enhancements and, in accordance with GAAP, we do not consider the effect of these credit enhancements when determining fair value.  The following table presents the estimated fair value of our long-term debt, including current maturities (dollars in thousands):

 
As of June 30, 2016
 
As of December 31, 2015
 
Carrying
Amount
 
Fair Value
 
Carrying
Amount
 
Fair Value
Pinnacle West
$
125,000

 
$
125,000

 
$
125,000

 
$
125,000

APS
4,066,415

 
4,658,591

 
3,694,971

 
3,981,367

Total
$
4,191,415

 
$
4,783,591

 
$
3,819,971

 
$
4,106,367

 
Debt Provisions
 
An existing ACC order requires APS to maintain a common equity ratio of at least 40%.  As defined in the ACC order, the common equity ratio is total shareholder equity divided by the sum of total shareholder equity and long-term debt, including current maturities of long-term debt.  At June 30, 2016, APS was in compliance with this common equity ratio requirement.  Its total shareholder equity was approximately $4.7 billion, and total capitalization was approximately $8.9 billion.  APS would be prohibited from paying dividends if the payment would reduce its total shareholder equity below approximately $3.6 billion, assuming APS’s total capitalization remains the same.

3.
Regulatory Matters
 
Retail Rate Case Filing with the Arizona Corporation Commission
 
On June 1, 2016, APS filed an application with the ACC for an annual increase in retail base rates of $165.9 million. This amount excludes amounts that are currently collected on customer bills through adjustor mechanisms. The application requests that some of the balances in these adjustor accounts (aggregating to approximately $267.6 million as of December 31, 2015) be transferred into base rates through the ratemaking process. This transfer would not have an incremental effect on customer bills. The average annual customer bill impact of APS’s request is an increase of 5.74% (the average annual bill impact for a typical APS residential customer is 7.96%).

The principal provisions of the application are:

a test year ended December 31, 2015, adjusted as described below;
         
an original cost rate base of $6.8 billion, which approximates the ACC-jurisdictional portion of the book value of utility assets, net of accumulated depreciation and other credits, as of December 31, 2015;


18


COMBINED NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

the following proposed capital structure and costs of capital:
 
 
 
Capital Structure
 
Cost of Capital
 
Long-term debt
 
44.2
%
5.13
%
Common stock equity
 
55.8
%
10.50
%
Weighted-average cost of capital
 
 
 
8.13
%
 
a 1% return on the increment of fair value rate base above APS’s original cost rate base, as provided for by Arizona law;

a base rate for fuel and purchased power costs of $0.029882 per kilowatt-hour (“kWh”) based on estimated 2017 prices (a decrease from the current base fuel rate of $0.03207 per kWh);

authorization to defer for potential future recovery its share of the construction costs associated with installing selective catalytic reduction equipment at the Four Corners Power Plant (estimated at approximately $400 million in direct costs). APS proposes that the rates established in this rate case be increased through a step mechanism beginning in 2019 to reflect these deferred costs;

authorization to defer for potential future recovery in the Company’s next general rate case the construction costs APS incurs for its Ocotillo power plant modernization project, once the project reaches commercial operation. APS estimates the direct construction costs at approximately $500 million and that the new facility will be fully in service by early 2019;

authorization to defer until the Company’s next general rate case the increase or decrease in its Arizona property taxes attributable to tax rate changes after the date the rate application is adjudicated;

updates and modifications to four of APS’s adjustor mechanisms - the Power Supply Adjustor (“PSA”), the Lost Fixed Cost Recovery Mechanism (“LFCR”), the Transmission Cost Adjustor (“TCA”) and the Environmental Improvement Surcharge (“EIS”);

a number of proposed rate design changes for residential customers, including:
change the on-peak time of use period from 12 p.m. - 7 p.m. to 3 p.m. - 8 p.m. Monday through Friday, excluding holidays;
reduce the difference in the on- and off-peak energy price and lower all energy charges;
offer four rate plan options, three of which have demand charges and a fourth that is available to non-partial requirements customers using less than 600 kWh on average per month; and
modify the current net metering tariff to provide for a credit at the retail rate for the portion of generation by rooftop solar customers that offsets their own load, and for a credit for excess energy delivered to the grid at an export rate.

proposed rate design changes for commercial customers, including an aggregation rider that allows certain large customers to qualify for a reduced rate, an extra-high load factor rate schedule for certain customers, and an economic development rate offering for new loads meeting certain criteria.

The Company requested that the increase become effective July 1, 2017.  On July 22, 2016, the administrative law judge set a procedural schedule for the rate proceedings. The ACC staff and interveners will begin filing their direct testimony on December 21, and the hearing will commence on March 22, 2017. The

19


COMBINED NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

Commission staff supports completing the case within 12 months. APS cannot predict the outcome of its request.

Prior Rate Case Filing
 
On June 1, 2011, APS filed an application with the ACC for a net retail base rate increase of $95.5 million.  APS requested that the increase become effective July 1, 2012.  The request would have increased the average retail customer bill by approximately 6.6%.  On January 6, 2012, APS and other parties to the general retail rate case entered into an agreement (the "2012 Settlement Agreement") detailing the terms upon which the parties agreed to settle the rate case.  On May 15, 2012, the ACC approved the 2012 Settlement Agreement without material modifications.
 
Settlement Agreement
 
The 2012 Settlement Agreement provides for a zero net change in base rates, consisting of:  (1) a non-fuel base rate increase of $116.3 million; (2) a fuel-related base rate decrease of $153.1 million (to be implemented by a change in the base fuel rate for fuel and purchased power costs ("Base Fuel Rate") from $0.03757 to $0.03207 per kilowatt hour ("kWh"); and (3) the transfer of cost recovery for certain renewable energy projects from the Arizona Renewable Energy Standard and Tariff ("RES") surcharge to base rates in an estimated amount of $36.8 million.
  
Other key provisions of the 2012 Settlement Agreement include the following:
 
An authorized return on common equity of 10.0%;

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

A test year ended December 31, 2010, adjusted to include plant that is in service as of March 31, 2012;
 
Deferral for future recovery or refund of property taxes above or below a specified 2010 test year level caused by changes to the Arizona property tax rate as follows:
 
Deferral of increases in property taxes of 25% in 2012, 50% in 2013 and 75% for 2014 and subsequent years if Arizona property tax rates increase; and

Deferral of 100% in all years if Arizona property tax rates decrease;
 
A procedure to allow APS to request rate adjustments prior to its next general rate case related to APS’s acquisition of additional interests in Units 4 and 5 and the related closure of Units 1-3 of the Four Corners Power Plant ("Four Corners") (APS made its filing under this provision on December 30, 2013, see "Four Corners" below);
 
Implementation of a Lost Fixed Cost Recovery ("LFCR") rate mechanism to support energy efficiency and distributed renewable generation;
 
Modifications to the Environmental Improvement Surcharge ("EIS") to allow for the recovery of carrying costs for capital expenditures associated with government-mandated environmental

20


COMBINED NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

controls, subject to an existing cents per kWh cap on cost recovery that could produce up to approximately $5 million in revenues annually;
 
Modifications to the Power Supply Adjustor ("PSA"), including the elimination of the 90/10 sharing provision;
 
A limitation on the use of the RES surcharge and the Demand Side Management Adjustor Charge ("DSMAC") to recoup capital expenditures not required under the terms of APS’s 2009 retail rate case settlement agreement (the "2009 Settlement Agreement");
  
Modification of the Transmission Cost Adjustor ("TCA") to streamline the process for future transmission-related rate changes; and
 
Implementation of various changes to rate schedules, including the adoption of an experimental "buy-through" rate that could allow certain large commercial and industrial customers to select alternative sources of generation to be supplied by APS.
 
The 2012 Settlement Agreement was approved by the ACC on May 15, 2012, with new rates effective on July 1, 2012.  This accomplished a goal set by the parties to the 2009 Settlement Agreement to process subsequent rate cases within twelve months of sufficiency findings from the ACC staff, which generally occurs within 30 days after the filing of a rate case.
 
Cost Recovery Mechanisms
 
APS has received regulatory decisions that allow for more timely recovery of certain costs through the following recovery mechanisms.
 
Renewable Energy Standard.  In 2006, the ACC approved the RES.  Under the RES, electric utilities that are regulated by the ACC must supply an increasing percentage of their retail electric energy sales from eligible renewable resources, including solar, wind, biomass, biogas and geothermal technologies.  In order to achieve these requirements, the ACC allows APS to include a RES surcharge as part of customer bills to recover the approved amounts for use on renewable energy projects.  Each year APS is required to file a five-year implementation plan with the ACC and seek approval for funding the upcoming year’s RES budget.
  
In accordance with the ACC's decision on APS's 2014 RES plan, on April 15, 2014, APS filed an application with the ACC requesting permission to build an additional 20 megawatts ("MW") of APS-owned grid scale solar under the AZ Sun Program. In a subsequent filing, APS also offered an alternative proposal to replace the 20 MW of grid scale solar with 10 MW (approximately 1,500 customers) of APS-owned residential solar that will not be under the AZ Sun Program. On December 19, 2014, the ACC voted that it had no objection to APS implementing its residential rooftop solar program. The first stage of the residential rooftop solar program, called the "Solar Partner Program," is to be 8 MW followed by a 2 MW second stage that will only be deployed if coupled with distributed storage. The program will target specific distribution feeders in an effort to maximize potential system benefits, as well as make systems available to limited-income customers who cannot easily install solar through transactions with third parties. The ACC expressly reserved that any determination of prudency of the residential rooftop solar program for rate making purposes shall not be made until the project is fully in service and APS requests cost recovery in a future rate case.
 
On July 1, 2015, APS filed its 2016 RES Implementation Plan and proposed a RES budget of approximately $148 million. On January 12, 2016, the ACC approved APS’s plan and requested budget.

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COMBINED NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS


On July 1, 2016, APS filed its 2017 RES Implementation Plan and proposed a budget of approximately $150 million. APS’s budget request included additional funding to process the high volume of residential rooftop solar interconnection requests and also requested a permanent waiver of the residential distributed energy requirement for 2017 contained in the RES rules.
 
Demand Side Management Adjustor Charge.  The ACC Electric Energy Efficiency Standards require APS to submit a Demand Side Management Implementation Plan ("DSM Plan") for review by and approval of the ACC. In March 2014, the ACC approved a Resource Savings Initiative that allows APS to count towards compliance with the ACC Electric Energy Efficiency Standards, savings from improvements to APS’s transmission and delivery system, generation and facilities that have been approved through a DSM Plan. 

On March 20, 2015, APS filed an application with the ACC requesting a budget of $68.9 million for 2015 and minor modifications to its DSM portfolio going forward, including for the first time three resource savings projects which reflect energy savings on APS's system. The ACC approved APS’s 2015 DSM budget on November 25, 2015. In its decision, the ACC also approved that verified energy savings from APS's resource savings projects could be counted toward compliance with the Electric Energy Efficiency Standard, however, the ACC ruled that APS was not allowed to count savings from systems savings projects toward determination of its achievement tier level for its performance incentive, nor may APS include savings from conservation voltage reduction in the calculation of its LFCR mechanism.

On June 1, 2015, APS filed its 2016 DSM Plan requesting a budget of $68.9 million and minor modifications to its DSM portfolio to increase energy savings and cost effectiveness of the programs. On April 1, 2016, APS filed an amended 2016 DSM Plan that sought minor modifications to its existing DSM Plan and requested to continue the current DSMAC and current budget of $68.9 million. On July 12, 2016, the ACC approved APS’s amended DSM Plan and directed APS to spend up to an additional $4 million on a new residential demand response or load management program that facilitates energy storage technology.
 
Electric Energy Efficiency. On June 27, 2013, the ACC voted to open a new docket investigating whether the Electric Energy Efficiency Standards should be modified.  The ACC held a series of three workshops in March and April 2014 to investigate methodologies used to determine cost effective energy efficiency programs, cost recovery mechanisms, incentives, and potential changes to the Electric Energy Efficiency and Resource Planning Rules.

On November 4, 2014, the ACC staff issued a request for informal comment on a draft of possible amendments to Arizona’s Electric Energy Efficiency Standards. The draft proposed substantial changes to the rules and energy efficiency standards. The ACC accepted written comments and took public comment regarding the possible amendments on December 19, 2014. A formal rulemaking has not been initiated and there has been no additional action on the draft to date. On July 12, 2016, the ACC ordered that ACC staff convene a workshop within 120 days to discuss a number of issues related to the Electric Energy Efficiency Standards, including the process of determining the cost effectiveness of DSM programs and the treatment of peak demand and capacity reductions, among others.
 

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COMBINED NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

PSA Mechanism and Balance.  The PSA provides for the adjustment of retail rates to reflect variations in retail fuel and purchased power costs.  The following table shows the changes in the deferred fuel and purchased power regulatory asset (liability) for 2016 and 2015 (dollars in thousands):
 
 
Six Months Ended 
 June 30,
 
2016
 
2015
Beginning balance
$
(9,688
)
 
$
6,925

Deferred fuel and purchased power costs — current period
21,027

 
(11,710
)
Amounts charged to customers
(13,778
)
 
(11,424
)
Ending balance
$
(2,439
)
 
$
(16,209
)
 
The PSA rate for the PSA year beginning February 1, 2016 is $0.001678 per kWh, as compared to $0.000887 per kWh for the prior year.  This new rate is comprised of a forward component of $0.001975 per kWh and a historical component of $(0.000297) per kWh.  On October 15, 2015, APS notified the ACC that it was initiating a PSA transition component of $(0.004936) per kWh for the months of November 2015, December 2015, and January 2016. The PSA transition component is a mid-year adjustment to the PSA rate that may be established when conditions change sufficiently to cause high balances to accrue in the PSA balancing account. The transition component expired on February 1, 2016. Any uncollected (overcollected) deferrals during the PSA year, after accounting for the transition component, will be included in the calculation of the PSA rate for the PSA year beginning February 1, 2017.
 
Transmission Rates, Transmission Cost Adjustor and Other Transmission Matters In July 2008, the United States Federal Energy Regulatory Commission ("FERC") approved an Open Access Transmission Tariff for APS to move from fixed rates to a formula rate-setting methodology in order to more accurately reflect and recover the costs that APS incurs in providing transmission services.  A large portion of the rate represents charges for transmission services to serve APS's retail customers ("Retail Transmission Charges").  In order to recover the Retail Transmission Charges, APS was previously required to file an application with, and obtain approval from, the ACC to reflect changes in Retail Transmission Charges through the TCA.  Under the terms of the 2012 Settlement Agreement, however, an adjustment to rates to recover the Retail Transmission Charges will be made annually each June 1 and will go into effect automatically unless suspended by the ACC.
 
The formula rate is updated each year effective June 1 on the basis of APS's actual cost of service, as disclosed in APS's FERC Form 1 report for the previous fiscal year.  Items to be updated include actual capital expenditures made as compared with previous projections, transmission revenue credits and other items.  The resolution of proposed adjustments can result in significant volatility in the revenues to be collected.  APS reviews the proposed formula rate filing amounts with the ACC staff.  Any items or adjustments which are not agreed to by APS and the ACC staff can remain in dispute until settled or litigated at FERC.  Settlement or litigated resolution of disputed issues could require an extended period of time and could have a significant effect on the Retail Transmission Charges because any adjustment, though applied prospectively, may be calculated to account for previously over- or under-collected amounts.
 
Effective June 1, 2015, APS’s annual wholesale transmission rates for all users of its transmission system decreased by approximately $17.6 million for the twelve-month period beginning June 1, 2015 in accordance with the FERC-approved formula.  An adjustment to APS’s retail rates to recover FERC-approved transmission charges went into effect automatically on June 1, 2015.

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COMBINED NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS


Effective June 1, 2016, APS's annual wholesale transmission rates for all users of its transmission system increased by approximately $24.9 million in accordance with the FERC-approved formula.  An adjustment to APS’s retail rates to recover FERC approved transmission charges went into effect automatically on June 1, 2016.

APS's formula rate protocols have been in effect since 2008. Recent FERC orders suggest that FERC is examining the structure of formula rate protocols and may require companies such as APS to make changes to their protocols in the future.
 
Lost Fixed Cost Recovery Mechanism.  The LFCR mechanism permits APS to recover on an after-the-fact basis a portion of its fixed costs that would otherwise have been collected by APS in the kWh sales lost due to APS energy efficiency programs and to distributed generation such as rooftop solar arrays.  The fixed costs recoverable by the LFCR mechanism were established in the 2012 Settlement Agreement and amount to approximately 3.1 cents per residential kWh lost and 2.3 cents per non-residential kWh lost.  The LFCR adjustment has a year-over-year cap of 1% of retail revenues.  Any amounts left unrecovered in a particular year because of this cap can be carried over for recovery in a future year.  The kWh’s lost from energy efficiency are based on a third-party evaluation of APS’s energy efficiency programs.  Distributed generation sales losses are determined from the metered output from the distributed generation units.
 
APS files for a LFCR adjustment every January. APS filed its 2014 annual LFCR adjustment on January 15, 2014, requesting a LFCR adjustment of $25.3 million, effective March 1, 2014.  The ACC approved APS’s LFCR adjustment without change on March 11, 2014, which became effective April 1, 2014. APS filed its 2015 annual LFCR adjustment on January 15, 2015, requesting an LFCR adjustment of $38.5 million, which was approved on March 2, 2015, effective for the first billing cycle of March. APS filed its 2016 annual LFCR adjustment on January 15, 2016, requesting an LFCR adjustment of $46.4 million (a $7.9 million annual increase), to be effective for the first billing cycle of March 2016. In April 2016, the ACC approved the 2016 annual LFCR to be effective in April 2016. Because the LFCR mechanism has a balancing account that trues up any under or over recoveries, the one month delay in implementation will not have an adverse effect on APS.

Net Metering

On July 12, 2013, APS filed an application with the ACC proposing a solution to address the cost shift brought by the current net metering rules.  On December 3, 2013, the ACC issued its order on APS's net metering proposal. The ACC instituted a charge on customers who install rooftop solar panels after December 31, 2013. The charge of $0.70 per kilowatt became effective on January 1, 2014, and is estimated to collect $4.90 per month from a typical future rooftop solar customer to help pay for their use of the electric grid. The fixed charge does not increase APS's revenue be