16. Stock-Based Compensation

Pinnacle West grants long-term incentive awards under the 2012 long-term incentive plan (“2012 Plan”) in the form of Stock Grants, Restricted Stock Units and Performance Shares and may grant restricted stock, stock units, dividend equivalents, performance share units, performance cash, incentive and non-qualified stock options, and stock appreciation rights. The 2012 Plan, effective May 16, 2012, provides 4,595,500 common shares to be available for grant to eligible employees and members of the Board of Directors. Awards made in 2012 were issued under the 2012 Plan, prior awards from 2007 to 2011 were issued under the 2007 long-term incentive plan (“2007 Plan”).

Restricted Stock Unit Awards and Stock Grants

Stock grants issued to non-officer members of the Board of Directors (“Directors”) in 2012, 2011 and 2010, provided Directors the option to elect to receive a stock grant, or to defer receipt until a later date and receive restricted stock units in lieu of the stock grant. Directors who elect to defer may elect to receive payment in either stock, or 50% in cash and 50% in stock. The Director may elect to receive payments either as of the last business day of the month following the month in which they separate from service on the Board, or as of a specified date, which must be after December 31 of the year in which the grant was received. The deferred restricted stock units accrue dividend rights equal to the amount of dividends the Director would have received had they directly owned stock equal to the number of vested restricted stock units from the date of grant to the date of payment plus interest compounded quarterly. The dividends and interest are paid, based on the Director’s election, in either stock, or 50% in cash and 50% in stock.

Restricted stock units were granted to officers and key employees in each year since 2007. From 2007 through 2009, officers and key employees elected to receive payment in either cash or in fully transferable shares of stock, in exchange for each restricted stock unit on pre-established valuation dates. In 2010, 2011 and 2012, officers and key employees elected to receive payment in either stock, or 50% cash and 50% stock.

Restricted stock unit awards vest and settle over a four-year period. In addition, officers and key employees accrue dividend rights on the vested restricted stock units, equal to the amount of dividends that they would have received had they directly owned stock equal to the number of vested restricted stock units from the date of grant to the date of payment plus interest compounded quarterly. The dividends and interest for the 2007 through 2009 awards are paid in cash. The dividends and interest for the 2010, 2011 and 2012 awards are paid in the same form as the restricted stock unit payment election. Restricted stock unit awards are accounted for as a liability award, with compensation cost initially calculated on the date of grant using the Company’s closing stock price, and remeasured at each balance sheet date. Compensation expense for retirement eligible participants is recognized immediately.

On December 19, 2012, the Company granted a retention award of 50,617 restricted stock units to the Chairman of the Board, President, and Chief Executive Officer of Pinnacle West. The award will vest and will be paid in shares of common stock on December 31, 2016 provided that he remains employed with the Company until the vesting date. The award can be increased up to an additional 33,745 restricted stock units payable in stock if certain performance requirements are met.

A grant of restricted stock unit awards was made to officers of the company on February 15, 2011, payable solely in shares of common stock upon the officer’s retirement or other separation of employment. This award will vest 50% on February 15, 2013, 25% on February 15, 2014 and 25% on February 15, 2015, provided that the officer remains employed on such date. The officers will also accrue notional dividends equal to the amount of dividends that an officer would have received if the officer had directly owned one share of Pinnacle West common stock for each restricted stock unit held by the officer from the grant date to each dividend payment date. Each additional restricted stock unit will proportionally vest on the same remaining vesting schedule that applies to the original restricted stock unit.

The following table is a summary of granted restricted stock units and stock grants and the weighted-average fair value for the three years ended 2012, 2011 and 2010:

	2012		2011		2010
Units granted	202,278		292,242		202,341
Grant date fair value (a)	$	49.31	$	41.98	$	37.47

(a) Weighted-average grant date fair value

The following table is a summary of the status of restricted stock units and stock grants, as of December 31, 2012 and changes during the year. This table represents only the stock portion of restricted stock units, per the election on payment discussed in the paragraph above:

Nonvested shares	Shares	Weighted-Average Grant-Date Fair Value
Nonvested at January 1, 2012	416,231	$	39.61
Granted	202,278	49.31
Vested	126,959	39.76
Forfeited	10,797	42.63
Nonvested at December 31, 2012	480,753	43.58

The amount of cash required to settle the payments on restricted stock units is (dollars in millions):

Year	2012		2011		2010
2007 Grant	$	—	$	1.0	$	0.9
2008 Grant	1.9		1.6		1.5
2009 Grant	1.7		1.5		1.4
2010 Grant	0.6		0.6		—
2011 Grant	0.7		—		—

Performance Share Awards

Performance share awards were granted to officers and key employees under the 2012 Plan in 2012 and under the 2007 Plan from 2008 to 2011. Performance share awards contain two performance element criteria that affect the number of shares received after the end of a three-year performance period if performance criteria conditions are met.

The 2012, 2011 and 2010 performance share grant criteria is based 50% upon the percentile ranking of Pinnacle West’s total shareholder return at the end of the three-year performance period as compared with the total shareholder return of all relevant companies in a specified utility index and the other 50% based upon six non-financial separate performance metrics. The exact number of shares issued will vary from 0% to 200% of the target award. Shares received include dividend rights paid in stock equal to the amount of dividends that they would have received had they directly owned stock equal to the number of vested performance shares from the date of grant to the date of payment plus interest compounded quarterly.

Performance share awards are accounted for as liability awards, with compensation cost initially calculated on the date of grant using the Company’s closing stock price, and remeasured at each balance sheet date. Compensation expense for retirement eligible participants is recognized immediately. Management also evaluates the probability of meeting the performance criteria at each balance sheet date. If the performance criteria are not achieved, no compensation cost is recognized and any previously recognized compensation cost is reversed.

The following table is a summary of the performance shares granted and the weighted-average fair value for the three years ended 2012, 2011 and 2010:

	2012		2011		2010
Units granted (a)	185,878		175,072		178,722
Grant date fair value (b)	$	47.40	$	41.71	$	37.57

(a) Reflects the target payout level.

(b) Weighted-average grant date fair value.

The following table is a summary of the status of performance shares, as of December 31, 2012 and changes during the year:

Nonvested shares (a)	Shares	Weighted-Average Grant-Date Fair Value
Nonvested at January 1, 2012	347,946	$	39.64
Granted	185,878	47.40
Increase in performance factor	87,037	37.57
Vested	257,127	37.57
Forfeited	16,044	42.53
Nonvested at December 31, 2012	347,690	44.67

(a) Nonvested shares are reflected at the target payout level. The increase or decrease in the number of shares from the target level to the estimated actual payout level is included in the increase for performance factor amounts in the year the award vests.

Retention Units

The retention unit awards have fully vested and settled on January 4, 2010; for any employee that was eligible to retire before that date, the employee’s retention units vested by retirement date and the compensation expense was recognized by retirement eligibility. Retention unit awards were granted to key employees in 2006 and 2007. Each retention unit award represented the right to receive a cash payment equal to the fair market value of one share of Pinnacle West’s common stock, determined on pre-established valuation dates. Each retention unit award vested and settled in equal annual installments over a four-year period. In addition, the employee received a cash payment equal to the amount of dividends that the employee would have received if the employee had owned the stock from the date of grant to the date of payment plus interest. As this award was accounted for as a liability award, compensation costs, initially measured based on the Company’s stock price on the grant date, were remeasured at each balance sheet date, using Pinnacle West’s closing stock price.

The amount of cash to settle the payment on the first business day of 2010 was $1.3 million.

Stock Options

The Company has not granted stock options since 2004. Outstanding stock option grant terms cannot be longer than 10 years and options cannot be repriced during their terms.

The following table summarizes the option activity under prior equity incentive plans for the year ended December 31, 2012:

Options	Shares	Weighted- Average Exercise Price		Weighted- Average Remaining Contractual Term (Years)	Aggregate Intrinsic Value (dollars in thousands)
Outstanding at January 1, 2012	22,958	$	34.75
Exercised	15,033	36.05
Forfeited or expired	—	—
Outstanding at December 31, 2012	7,925	32.29		.21	$	148
Exercisable at December 31, 2012	7,925	32.29		.21	$	148

Cash received from options exercised under our share-based payment arrangements was $0.5 million for 2012, $1.8 million for 2011, and $4.6 million for 2010. The tax benefit realized for the tax deductions from option exercises of the share-based payment arrangements were immaterial for all years.

The intrinsic value of options exercised was immaterial for all years.

As of December 31, 2012, there was $17 million of total unrecognized compensation cost related to nonvested share-based compensation arrangements granted under the plans. That cost is expected to be recognized over a weighted-average period of 2.0 years. The total fair value of shares vested during 2012 was $19 million, 2011 was $14 million, and 2010 was $11 million.

The compensation cost that has been charged against Pinnacle West’s income for share-based compensation plans was $32 million in 2012, $23 million in 2011, and $15 million in 2010. The compensation cost that Pinnacle West has capitalized is immaterial for all years. Pinnacle West’s total income tax benefit recognized in the Consolidated Statements of Income for share-based compensation arrangements was $13 million in 2012, $9 million in 2011, and $6 million in 2010. APS’s share of compensation cost that has been charged against income was $32 million in 2012, $22 million in 2011, and $15 million in 2010.

Pinnacle West’s current policy is to issue new shares to satisfy share requirements for stock compensation plans and it does not expect to repurchase any shares except to satisfy tax withholding obligations upon the vesting of restricted stock units and performance shares.