Stock-Based Compensation

Pinnacle West has incentive compensation plans under which stock-based compensation is granted to officers, key-employees, and non-officer members of the Board of Directors. Awards granted under the 2012 Long-Term Incentive Plan (“2012 Plan”) may be in the form of stock grants, restricted stock units, stock units, performance shares, restricted stock, dividend equivalents, performance share units, performance cash, incentive and non-qualified stock options, and stock appreciation rights. The 2012 Plan authorizes up to 4.6 million common shares to be available for grant. As of December 31, 2017, 2.2 million common shares were available for issuance under the 2012 Plan. During 2017, 2016, and 2015, the Company granted awards in the form of restricted stock units, stock units, stock grants, and performance shares. Awards granted from 2007 to 2011 were issued under the 2007 Long-Term Incentive Plan (“2007 Plan”), and no new awards may be granted under the 2007 Plan.

Stock-Based Compensation Expense and Activity

During the fourth quarter of 2016, we adopted new stock-based compensation accounting guidance prescribed by ASU 2016-09. Prior to the adoption of this guidance we had certain awards that were accounted for as liability awards due to the ability of the employee to withhold taxes beyond the minimum statutory tax withholding rate. Under the new standard, the tax withholding terms of our awards no longer trigger liability treatment. Accordingly, effective January 1, 2016 certain awards that were previously classified as liability awards are now accounted for as equity awards. The impacts of this accounting change relating to prior years have been applied using a modified retrospective approach, resulting in a $6 million cumulative-effect adjustment, net of income tax expense of $3 million, to increase Retained Earnings as of January 1, 2016. The impacts of this accounting change relating to 2016 resulted in a pre-tax $12 million adjustment to decrease operations and maintenance expense that was recognized during the fourth quarter of 2016. The following amounts related to years ended 2017 and 2016 expense and activity include the effects of adopting this new accounting standard; however, expense and activities relating to 2015 reflect the historical accounting treatment. The new standard also requires excess income tax benefits and deficiencies arising from stock based compensation to now be recognized in the period incurred, simplifies accounting for forfeitures, and clarifies certain cash flow presentation matters. These other provisions of the standard did not have a material impact on our consolidated financial statements.

Compensation cost included in net income for stock-based compensation plans was $21 million in 2017, $19 million in 2016, and $19 million in 2015. The compensation cost capitalized is immaterial for all years. Income tax benefits related to stock-based compensation arrangements were $15 million in 2017, $10 million in 2016, and $7 million in 2015.

As of December 31, 2017, there were approximately $12 million of unrecognized compensation costs related to nonvested stock-based compensation arrangements. We expect to recognize these costs over a weighted-average period of 2 years.

The total fair value of shares vested was $22 million in 2017, $22 million in 2016 and $21 million in 2015.

The following table is a summary of awards granted and the weighted-average grant date fair value for the three years ended 2017, 2016 and 2015.



	Restricted Stock Units, Stock Grants, and Stock Units (a)						Performance Shares (b)
	2017		2016		2015		2017		2016		2015
Units granted	161,963		141,811		152,651		147,706		166,666		151,430
Weighted-average grant date fair value	$	72.60	$	67.34	$	64.12	$	78.99	$	66.60	$	64.97


(a)	Units granted includes awards that will be cash settled of 67,599 in 2017, 43,952 in 2016, and 45,104 in 2015.


(b)	Reflects the target payout level.

The following table is a summary of the status of non-vested awards as of December 31, 2017 and changes during the year.



	Restricted Stock Units, Stock Grants, and Stock Units					Performance Shares
	Shares			Weighted-Average Grant Date Fair Value		Shares (b)		Weighted-Average Grant Date Fair Value
Nonvested at January 1, 2017	335,259			$	62.04	312,724		$	65.32
Granted	161,963			72.60		147,706		78.99
Change in performance factor	—			—		18,266		64.97
Vested	(202,327	)		59.19		(164,396	)	63.87
Forfeited (c)	(3,607	)		69.58		(4,798	)	69.77
Nonvested at December 31, 2017	291,288		(a)	69.78		309,502		72.46
Vested Awards Outstanding at December 31, 2017	89,928					164,396


(a)	Includes 133,373 of awards that will be cash settled.


(b)	The nonvested performance shares are reflected at target payout level. The performance metric component 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.


(c)	We account for forfeitures as they occur.

Share-based liabilities paid relating to restricted stock units were $4 million, $3 million and $10 million in 2017, 2016 and 2015, respectively. This includes cash used to settle restricted stock units of $4 million, $3 million and $3 million in 2017, 2016 and 2015, respectively. Restricted stock units that are cash settled are classified as liability awards. Share-based liabilities paid relating to performance shares were $16 million in 2015. In 2017 and 2016, performance shares were classified as equity awards.

Restricted Stock Units, Stock Grants, and Stock Units

Restricted stock units are granted to officers and key employees. Restricted stock units typically vest and settle in equal annual installments over a 4-year period after the grant date. Vesting is typically dependent upon continuous service during the vesting period; however, awards granted to retirement-eligible employees will vest upon the employee's retirement. Awardees elect to receive payment in either 100% stock, 100% cash, or 50% in cash and 50% in stock. Restricted stock unit awards typically include a dividend equivalent feature. This feature allows each award to accrue dividend rights equal to the dividends they would have received had they directly owned the stock. Interest on dividend rights compounds quarterly. If the award is forfeited the employee is not entitled to the dividends on those shares.

In December 2012, the Company granted a retention award of 50,617 performance-linked restricted stock units to the Chairman of the Board and Chief Executive Officer of Pinnacle West. This award vested on December 31, 2016, because he remained employed with the Company through that date. The Board did increase the number of awards that vested by 33,745 restricted stock units, payable in stock because certain performance requirements were met. In February 2017, 84,362 restricted stock units were released.

Compensation cost for restricted stock unit awards is based on the fair value of the award, with the fair value being the market price of our stock on the measurement date. Restricted stock unit awards that will be settled in cash 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. Restricted stock unit awards that will be settled in shares are accounted for as equity awards, with compensation cost calculated using the Company's closing stock price on the date of grant. Compensation cost is recognized over the requisite service period based on the fair value of the award.

Stock grants are issued to non-officer members of the Board of Directors. They may elect to receive the stock grant, or to defer receipt until a later date and receive stock units in lieu of the stock grant. The members of the Board of Directors who elect to defer may elect to receive payment in either 100% stock, or 50% in cash and 50% in stock. Each stock unit is convertible to one share of stock. The stock units accrue dividend rights, equal to the amount of dividends the Directors would have received had they directly owned stock equal to the number of vested restricted stock units or 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.

Performance Share Awards

Performance share awards are granted to officers and key employees. The awards contain two separate performance criteria that affect the number of shares that may be received if after the end of a 3-year performance period the performance criteria are met. For the first criteria, the number of shares that will vest is based on non-financial performance metrics (i.e., the metric component). The other criteria is based upon Pinnacle West's total shareholder return ('TSR') in relation to the TSR of other companies in a specified utility index (i.e., the TSR component). 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 recipients 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. If the award is forfeited or if the performance criteria are not achieved, the employee is not entitled to the dividends on those shares.

Performance share awards are accounted for as equity awards, with compensation cost based on the fair value of the award on the grant date. Compensation cost relating to the metric component of the award is based on the Company’s closing stock price on the date of grant, with compensation cost recognized over the requisite service period based on the number of shares expected to vest. Management evaluates the probability of meeting the metric component at each balance sheet date. If the metric component criteria are not ultimately achieved, no compensation cost is recognized relating to the metric component, and any previously recognized compensation cost is reversed. Compensation cost relating to the TSR component of the award is determined using a Monte Carlo simulation valuation model, with compensation cost recognized ratably over the requisite service period, regardless of the number of shares that actually vest.