Table of Contents

FORM 10-Q
Securities and Exchange Commission
Washington, D.C. 20549

		
[X] 	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934	
For the quarterly period ended June 30, 2004
OR

		
[  ] 	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 1-8962
PINNACLE WEST CAPITAL CORPORATION

(Exact name of registrant as specified in its charter)
 	 	 	
Arizona	 	86-0512431	

 	
(State or other jurisdiction of
incorporation or organization)	 	(I.R.S. Employer
Identification No.)	
 	 	 	
400 North Fifth Street, P.O. Box 53999, Phoenix, Arizona	 	85072-3999	

 	
(Address of principal executive offices)	 	(Zip Code)	
Registrant’s telephone number, including area code:           (602) 250-1000

(Former name, former address and former fiscal year, if changed since last report)
Indicate by check mark whether the 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.
Yes x    No o
Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).
Yes x    No o
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.
Number of shares of common stock, no par value,
outstanding as of August 4, 2004   91,318,091

TABLE OF CONTENTS

									
PART I. FINANCIAL INFORMATION	
	ITEM 1. Financial Statements	
		CONDENSED CONSOLIDATED STATEMENTS OF INCOME	
		CONDENSED CONSOLIDATED BALANCE SHEETS	
		CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS	
		NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS	
	Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations	
	Item 3. Market Risks	
	Item 4. Controls and Procedures	
PART II – OTHER INFORMATION	
	Item 2. Changes in Securities, Use of Proceeds and Issuer Purchases of Equity Securities	
	Item 4. Submission of Matters to a Vote of Security-Holders	
	Item 5. Other Information	
	Item 6. Exhibits and Reports on Form 8-K	
SIGNATURES	
Exhibit Index	
EX-3.1	
EX-10.1	
EX-10.2A	
EX-10.3A	
EX-10.4A	
EX-10.5A	
EX-12.1	
EX-31.1	
EX-31.2	
EX-32.1	
EX-99.1	

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Glossary

ACC – Arizona Corporation Commission	
 	
ALJ – administrative law judge	
 	
APS – Arizona Public Service Company, a subsidiary of the Company	
 	
APS Energy Services – APS Energy Services Company, Inc., a subsidiary of the Company	
 	
CC&N – Certificate of Convenience and Necessity	
 	
Company – Pinnacle West Capital Corporation	
 	
CPUC – California Public Utility Commission	
 	
DOE – United States Department of Energy	
 	
El Dorado – El Dorado Investment Company, a subsidiary of the Company	
 	
EPA – United States Environmental Protection Agency	
 	
ERMC – Energy Risk Management Committee	
 	
FASB – Financial Accounting Standards Board	
 	
FERC – United States Federal Energy Regulatory Commission	
 	
FIN – FASB Interpretation	
 	
Financing Order – ACC order that authorized APS’ $500 million loan to Pinnacle West Energy in May 2003	
 	
FSP – FASB Staff Position	
 	
GAAP – accounting principles generally accepted in the United States of America	
 	
IRS – United States Internal Revenue Service	
 	
Moody’s – Moody’s Investors Service	
 	
MW – megawatt, one million watts	
 	
MWh – megawatt-hours, one million watts per hour	
 	
NAC – collectively, NAC Holding Inc. and NAC International Inc., subsidiaries of El Dorado	
 	
Native Load – retail and wholesale sales supplied under traditional cost-based rate regulation	
 	
1999 Settlement Agreement – comprehensive settlement agreement approved by the ACC related to the implementation of retail electric competition	
 	
NRC – United States Nuclear Regulatory Commission	
 	
Nuclear Waste Act – United States Nuclear Waste Policy Act of 1982, as amended	
 	
OCI – other comprehensive income	
 	
Palo Verde – Palo Verde Nuclear Generating Station	
 	
PG&E – PG&E Corp.	
 	
Pinnacle West – Pinnacle West Capital Corporation, the Company	
 	
Pinnacle West Energy – Pinnacle West Energy Corporation, a subsidiary of the Company	
 	
PPL Sundance – PPL Sundance Energy, LLC	
 	
PWEC Dedicated Assets – the following Pinnacle West Energy power plants, each of which is dedicated to serving APS’ customers: Redhawk Units 1 and 2, West Phoenix Units 4 and 5 and Saguaro Unit 3	

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PX – California Power Exchange	
 	
Rules – ACC retail electric competition rules	
 	
SEC – United States Securities and Exchange Commission	
 	
SFAS – Statement of Financial Accounting Standards	
 	
SNWA – Southern Nevada Water Authority	
 	
SPE – special-purpose entity	
 	
Standard & Poor’s – Standard & Poor’s Corporation	
 	
SunCor – SunCor Development Company, a subsidiary of the Company	
 	
Sundance Generating Station – PPL Sundance’s 450 megawatt generating facility approximately 55 miles southeast of Phoenix, Arizona	
 	
Superfund – Comprehensive Environmental Response, Compensation and Liability Act	
 	
T&D – transmission and distribution	
 	
Track A Order – ACC order dated September 10, 2002 regarding generation asset transfers and related issues	
 	
Track B Order –ACC order dated March 14, 2003 regarding competitive solicitation requirements for power purchases by Arizona’s investor-owned electric utilities	
 	
Trading – energy-related activities entered into with the objective of generating profits on changes in wholesale market prices	
 	
2003 Form 10-K – the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2003	
 	
VIE – variable interest entity	
2

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PART I. FINANCIAL INFORMATION 
ITEM 1. Financial Statements. 
PINNACLE WEST CAPITAL CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(unaudited)
(in thousands, except per share amounts)

 	 	Three Months Ended	
 	 	June 30,
	
 	 	2004
	 	2003
	
Operating Revenues	 	 	 	 	 	 	 	 	
Regulated electricity segment	 	$	519,929	 	 	$	498,751	 	
Marketing and trading segment	 	 	115,240	 	 	 	101,175	 	
Real estate segment	 	 	67,300	 	 	 	57,189	 	
Other revenues	 	 	20,217	 	 	 	26,187	 	

 	 	
Total	 	 	722,686	 	 	 	683,302	 	

 	 	
Operating Expenses	 	 	 	 	 	 	 	 	
Regulated electricity segment purchased power and fuel	 	 	151,642	 	 	 	116,227	 	
Marketing and trading segment purchased power and fuel	 	 	94,120	 	 	 	81,398	 	
Operations and maintenance	 	 	140,245	 	 	 	141,519	 	
Real estate segment operations	 	 	62,605	 	 	 	53,942	 	
Depreciation and amortization	 	 	104,241	 	 	 	107,076	 	
Taxes other than income taxes	 	 	32,532	 	 	 	28,149	 	
Other expenses	 	 	16,141	 	 	 	22,509	 	

 	 	
Total	 	 	601,526	 	 	 	550,820	 	

 	 	
Operating Income	 	 	121,160	 	 	 	132,482	 	

 	 	
Other	 	 	 	 	 	 	 	 	
Allowance for equity funds used during construction	 	 	2,184	 	 	 	—	 	
Other income (Notes 15 and 19)	 	 	36,541	 	 	 	2,698	 	
Other expense (Note 15)	 	 	(4,067	)	 	 	(5,157	)	

 	 	
Total	 	 	34,658	 	 	 	(2,459	)	

 	 	
Interest Expense	 	 	 	 	 	 	 	 	
Interest charges	 	 	44,854	 	 	 	51,117	 	
Capitalized interest	 	 	(4,120	)	 	 	(11,231	)	

 	 	
Total	 	 	40,734	 	 	 	39,886	 	

 	 	
Income From Continuing Operations Before Income Taxes	 	 	115,084	 	 	 	90,137	 	
Income Taxes	 	 	44,027	 	 	 	35,248	 	

 	 	
Income From Continuing Operations	 	 	71,057	 	 	 	54,889	 	
Income From Discontinued Operations	 	 	 	 	 	 	 	 	
- Net of Income Tax Expense of $204 and $817	 	 	313	 	 	 	1,253	 	

 	 	
Net Income	 	$	71,370	 	 	$	56,142	 	

 	 	
Weighted-Average Common Shares Outstanding - Basic	 	 	91,315	 	 	 	91,258	 	
Weighted-Average Common Shares Outstanding - Diluted	 	 	91,400	 	 	 	91,450	 	
Earnings Per Weighted-Average Common Share Outstanding (Note 17)	 	 	 	 	 	 	 	 	
Income From Continuing Operations - Basic	 	$	0.78	 	 	$	0.60	 	
Net Income - Basic	 	 	0.78	 	 	 	0.62	 	
Income From Continuing Operations - Diluted	 	 	0.78	 	 	 	0.60	 	
Net Income - Diluted	 	 	0.78	 	 	 	0.61	 	
Dividends Declared Per Share	 	$	0.450	 	 	$	0.425	 	
See Notes to Condensed Consolidated Financial Statements.
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PINNACLE WEST CAPITAL CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(unaudited)
(in thousands, except per share amounts)

 	 	Six Months Ended	
 	 	June 30,
	
 	 	2004
	 	2003
	
Operating Revenues	 	 	 	 	 	 	 	 	
Regulated electricity segment	 	$	935,393	 	 	$	878,429	 	
Marketing and trading segment	 	 	203,623	 	 	 	217,881	 	
Real estate segment	 	 	118,893	 	 	 	97,877	 	
Other revenues	 	 	39,146	 	 	 	41,758	 	

 	 	
Total	 	 	1,297,055	 	 	 	1,235,945	 	

 	 	
Operating Expenses	 	 	 	 	 	 	 	 	
Regulated electricity segment purchased power and fuel	 	 	240,253	 	 	 	185,616	 	
Marketing and trading segment purchased power and fuel	 	 	161,884	 	 	 	179,006	 	
Operations and maintenance	 	 	278,901	 	 	 	274,636	 	
Real estate segment operations	 	 	110,295	 	 	 	94,101	 	
Depreciation and amortization	 	 	205,745	 	 	 	212,474	 	
Taxes other than income taxes	 	 	62,862	 	 	 	56,645	 	
Other expenses	 	 	32,584	 	 	 	31,730	 	

 	 	
Total	 	 	1,092,524	 	 	 	1,034,208	 	

 	 	
Operating Income	 	 	204,531	 	 	 	201,737	 	

 	 	
Other	 	 	 	 	 	 	 	 	
Allowance for equity funds used during construction	 	 	4,186	 	 	 	—	 	
Other income (Notes 15 and 19)	 	 	47,953	 	 	 	8,353	 	
Other expense (Note 15)	 	 	(10,012	)	 	 	(9,288	)	

 	 	
Total	 	 	42,127	 	 	 	(935	)	

 	 	
Interest Expense	 	 	 	 	 	 	 	 	
Interest charges	 	 	95,210	 	 	 	98,968	 	
Capitalized interest	 	 	(9,031	)	 	 	(21,210	)	

 	 	
Total	 	 	86,179	 	 	 	77,758	 	

 	 	
Income From Continuing Operations Before Income Taxes	 	 	160,479	 	 	 	123,044	 	
Income Taxes	 	 	59,654	 	 	 	48,002	 	

 	 	
Income From Continuing Operations	 	 	100,825	 	 	 	75,042	 	
Income From Discontinued Operations	 	 	 	 	 	 	 	 	
- Net of Income Tax Expense of $456 and $4,191	 	 	701	 	 	 	6,398	 	

 	 	
Net Income	 	$	101,526	 	 	$	81,440	 	

 	 	
Weighted-Average Common Shares Outstanding - Basic	 	 	91,304	 	 	 	91,257	 	
Weighted-Average Common Shares Outstanding - Diluted	 	 	91,391	 	 	 	91,402	 	
Earnings Per Weighted-Average Common Share Outstanding (Note 17)	 	 	 	 	 	 	 	 	
Income From Continuing Operations - Basic	 	$	1.10	 	 	$	0.82	 	
Net Income - Basic	 	 	1.11	 	 	 	0.89	 	
Income From Continuing Operations - Diluted	 	 	1.10	 	 	 	0.82	 	
Net Income - Diluted	 	 	1.11	 	 	 	0.89	 	
Dividends Declared Per Share	 	$	0.900	 	 	$	0.850	 	
See Notes to Condensed Consolidated Financial Statements.
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PINNACLE WEST CAPITAL CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEETS
(unaudited)
(dollars in thousands)
ASSETS

 	 	June 30,	 	December 31,	
 	 	2004
	 	2003
	
Current Assets	 	 	 	 	 	 	 	 	
Cash and cash equivalents	 	$	271,816	 	 	$	228,779	 	
Customer and other receivables	 	 	334,856	 	 	 	365,732	 	
Allowance for doubtful accounts	 	 	(4,682	)	 	 	(9,223	)	
Accrued utility revenues	 	 	126,058	 	 	 	88,629	 	
Materials and supplies (at average cost)	 	 	95,728	 	 	 	96,099	 	
Fossil fuel (at average cost)	 	 	25,978	 	 	 	28,367	 	
Assets from risk management and trading activities (Note 10)	 	 	166,528	 	 	 	97,630	 	
Other current assets	 	 	45,938	 	 	 	73,034	 	

 	 	
Total current assets	 	 	1,062,220	 	 	 	969,047	 	

 	 	
Investments and Other Assets	 	 	 	 	 	 	 	 	
Real estate investments-net	 	 	351,659	 	 	 	343,322	 	
Assets from risk management and trading activities - long-term (Note 10)	 	 	206,647	 	 	 	138,946	 	
Decommissioning trust accounts	 	 	253,522	 	 	 	240,645	 	
Other assets	 	 	137,582	 	 	 	88,816	 	

 	 	
Total investments and other assets	 	 	949,410	 	 	 	811,729	 	

 	 	
Property, Plant and Equipment	 	 	 	 	 	 	 	 	
Plant in service and held for future use	 	 	10,351,566	 	 	 	9,925,344	 	
Less accumulated depreciation and amortization	 	 	3,251,782	 	 	 	3,160,675	 	

 	 	
Total	 	 	7,099,784	 	 	 	6,764,669	 	
Construction work in progress	 	 	179,779	 	 	 	554,876	 	
Intangible assets, net of accumulated amortization	 	 	120,366	 	 	 	108,534	 	
Nuclear fuel, net of accumulated amortization	 	 	52,347	 	 	 	52,011	 	

 	 	
Net property, plant and equipment	 	 	7,452,276	 	 	 	7,480,090	 	

 	 	
Deferred Debits	 	 	 	 	 	 	 	 	
Regulatory assets	 	 	167,493	 	 	 	164,804	 	
Other deferred debits	 	 	110,579	 	 	 	110,708	 	

 	 	
Total deferred debits	 	 	278,072	 	 	 	275,512	 	

 	 	
Total Assets	 	$	9,741,978	 	 	$	9,536,378	 	

 	 	
See Notes to Condensed Consolidated Financial Statements.
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PINNACLE WEST CAPITAL CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEETS
(unaudited)
(dollars in thousands)
LIABILITIES AND EQUITY

 	 	June 30,	 	December 31,	
 	 	2004
	 	2003
	
Current Liabilities	 	 	 	 	 	 	 	 	
Accounts payable	 	$	278,006	 	 	$	293,427	 	
Accrued taxes	 	 	88,707	 	 	 	69,769	 	
Accrued interest	 	 	38,383	 	 	 	51,825	 	
Short-term borrowings	 	 	127,802	 	 	 	86,081	 	
Current maturities of long-term debt	 	 	268,211	 	 	 	705,820	 	
Customer deposits	 	 	52,850	 	 	 	49,783	 	
Deferred income taxes	 	 	631	 	 	 	631	 	
Liabilities from risk management and trading activities (Note 10)	 	 	131,841	 	 	 	92,755	 	
Other current liabilities	 	 	100,875	 	 	 	81,223	 	

 	 	
Total current liabilities	 	 	1,087,306	 	 	 	1,431,314	 	

 	 	
Long-Term Debt Less Current Maturities	 	 	2,933,736	 	 	 	2,617,385	 	

 	 	
Deferred Credits and Other	 	 	 	 	 	 	 	 	
Deferred income taxes	 	 	1,388,465	 	 	 	1,329,253	 	
Regulatory liabilities	 	 	523,880	 	 	 	510,423	 	
Pension liability (Note 6)	 	 	217,714	 	 	 	188,041	 	
Liability for asset retirement	 	 	242,687	 	 	 	234,440	 	
Liabilities from risk management and trading activities - long-term (Note 10)	 	 	129,380	 	 	 	82,730	 	
Unamortized gain - sale of utility plant	 	 	52,621	 	 	 	54,909	 	
Other	 	 	271,629	 	 	 	258,104	 	

 	 	
Total deferred credits and other	 	 	2,826,376	 	 	 	2,657,900	 	

 	 	
Commitments and Contingencies (Notes 5, 12 and 13)	 	 	 	 	 	 	 	 	
Common Stock Equity	 	 	 	 	 	 	 	 	
Common stock, no par value	 	 	1,748,580	 	 	 	1,744,354	 	
Treasury stock	 	 	(2,625	)	 	 	(3,273	)	

 	 	
Total common stock	 	 	1,745,955	 	 	 	1,741,081	 	

 	 	
Accumulated other comprehensive income (loss):	 	 	 	 	 	 	 	 	
Minimum pension liability adjustment	 	 	(66,564	)	 	 	(66,564	)	
Derivative instruments	 	 	68,135	 	 	 	27,563	 	

 	 	
Total accumulated other comprehensive income (loss)	 	 	1,571	 	 	 	(39,001	)	

 	 	
Retained earnings	 	 	1,147,034	 	 	 	1,127,699	 	

 	 	
Total common stock equity	 	 	2,894,560	 	 	 	2,829,779	 	

 	 	
Total Liabilities and Equity	 	$	9,741,978	 	 	$	9,536,378	 	

 	 	
See Notes to Condensed Consolidated Financial Statements.
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PINNACLE WEST CAPITAL CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited)
(dollars in thousands)

 	 	Six Months Ended	
 	 	June 30,
	
 	 	2004
	 	2003
	
CASH FLOWS FROM OPERATING ACTIVITIES	 	 	 	 	 	 	 	 	
Net Income	 	$	101,526	 	 	$	81,440	 	
Adjustments to reconcile net income to net cash provided by operating activities:	 	 	 	 	 	 	 	 	
Gain on sale of discontinued operations	 	 	(701	)	 	 	(6,398	)	
Equity earnings in Phoenix Suns partnership	 	 	(34,594	)	 	 	—	 	
Depreciation and amortization	 	 	205,745	 	 	 	212,474	 	
Nuclear fuel amortization	 	 	14,501	 	 	 	14,858	 	
Allowance for equity funds used during construction	 	 	(4,186	)	 	 	—	 	
Deferred income taxes	 	 	23,854	 	 	 	(23,844	)	
Change in mark-to-market valuations	 	 	2,413	 	 	 	(6,986	)	
Changes in current assets and liabilities:	 	 	 	 	 	 	 	 	
Customer and other receivables	 	 	26,335	 	 	 	18,851	 	
Accrued utility revenues	 	 	(37,429	)	 	 	(27,438	)	
Materials, supplies and fossil fuel	 	 	2,760	 	 	 	(4,458	)	
Other current assets	 	 	27,097	 	 	 	23,644	 	
Accounts payable	 	 	(11,041	)	 	 	(14,231	)	
Accrued taxes	 	 	18,938	 	 	 	63,951	 	
Accrued interest	 	 	(13,442	)	 	 	(798	)	
Other current liabilities	 	 	31,839	 	 	 	(19,658	)	
Real estate investments	 	 	(36,518	)	 	 	(27,674	)	
Other real estate activities	 	 	27,379	 	 	 	26,596	 	
Increase in regulatory assets	 	 	(5,342	)	 	 	(4,565	)	
Change in risk management and trading - assets	 	 	12,402	 	 	 	22,098	 	
Change in risk management and trading - liabilities	 	 	1,119	 	 	 	(11,973	)	
Change in pension liability	 	 	29,673	 	 	 	(14,348	)	
Change in other long-term assets	 	 	(20,700	)	 	 	(29,105	)	
Change in other long-term liabilities	 	 	22,425	 	 	 	35,396	 	

 	 	
Net cash flow provided by operating activities	 	 	384,053	 	 	 	307,832	 	

 	 	
CASH FLOWS FROM INVESTING ACTIVITIES	 	 	 	 	 	 	 	 	
Capital expenditures	 	 	(252,904	)	 	 	(343,880	)	
Proceeds from the sale of Silverhawk	 	 	93,378	 	 	 	—	 	
Capitalized interest	 	 	(9,031	)	 	 	(21,210	)	
Trust fund for bond redemption	 	 	—	 	 	 	(54,150	)	
Proceeds from sale of assets from discontinued operations	 	 	117	 	 	 	27,128	 	
Other	 	 	(12,280	)	 	 	(1,066	)	

 	 	
Net cash flow used for investing activities	 	 	(180,720	)	 	 	(393,178	)	

 	 	
CASH FLOWS FROM FINANCING ACTIVITIES	 	 	 	 	 	 	 	 	
Issuance of long-term debt	 	 	476,268	 	 	 	538,154	 	
Short-term borrowings and payments-net	 	 	41,721	 	 	 	(34,135	)	
Dividends paid on common stock	 	 	(82,192	)	 	 	(77,556	)	
Repayment of long-term debt	 	 	(602,831	)	 	 	(327,901	)	
Other	 	 	6,738	 	 	 	3,402	 	

 	 	
Net cash flow (used for) provided by financing activities	 	 	(160,296	)	 	 	101,964	 	

 	 	
Net Increase in Cash and Cash Equivalents	 	 	43,037	 	 	 	16,618	 	
Cash and Cash Equivalents at Beginning of Period	 	 	228,779	 	 	 	77,566	 	

 	 	
Cash and Cash Equivalents at End of Period	 	$	271,816	 	 	$	94,184	 	

 	 	
Supplemental disclosure of cash flow information:	 	 	 	 	 	 	 	 	
Cash paid during the period for:	 	 	 	 	 	 	 	 	
Interest paid, net of amounts capitalized	 	$	119,458	 	 	$	73,333	 	
Income taxes paid	 	$	7,300	 	 	$	—	 	
See Notes to Condensed Consolidated Financial Statements.
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PINNACLE WEST CAPITAL CORPORATION
 NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
1. The condensed consolidated financial statements include the accounts of Pinnacle West and our subsidiaries: APS, Pinnacle West Energy, APS Energy Services, SunCor and El Dorado (principally NAC). All significant intercompany accounts and transactions between the consolidated companies have been eliminated. Our accounting records are maintained in accordance with 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. We have reclassified certain prior year amounts to conform to the current year presentation.
2. Our unaudited condensed consolidated financial statements reflect all adjustments which we believe are necessary for the fair presentation of our financial position and results of operations for the periods presented. These adjustments are of a normal recurring nature. We suggest that these condensed consolidated financial statements and notes to condensed consolidated financial statements be read along with the consolidated financial statements and notes to consolidated financial statements included in our 2003 Form 10-K.
3. Weather conditions cause significant seasonal fluctuations in our revenues. In addition, trading and wholesale marketing activities can have significant impacts on our results for interim periods. For these reasons as well as others, results for interim periods do not necessarily represent results to be expected for the year.
4. Changes in Liquidity
     On February 2, 2004, we used proceeds from the $165 million Floating Rate Notes issued on November 12, 2003 and short-term borrowings to pay down the maturing $215 million 4.5% Senior Notes due 2004.
     On February 15, 2004, $125 million of APS’ 5.875% Notes due 2004 were redeemed at maturity and on March 1, 2004, $80 million of APS First Mortgage Bonds, 6.625% Series due 2004, were redeemed at maturity. APS used cash from operations and short-term debt to redeem the maturing debt.
     On March 31, 2004, Navajo County, Arizona Pollution Control Corporation issued $166 million of variable interest rate pollution control bonds, 2004 Series A-E, due 2034 to refinance $166 million of outstanding pollution control bonds. The 2004 Series A-E bonds are payable solely from revenues obtained from APS pursuant to a loan agreement between APS and Navajo County, Arizona Pollution Control Corporation. These bonds are classified as long-term debt on our Condensed Consolidated Balance Sheets.
     Also on March 31, 2004, Coconino County, Arizona Pollution Control Corporation issued $13 million of variable interest rate pollution control bonds, 2004 Series A, due 2034 to refinance $13 million of outstanding pollution control bonds. These bonds are payable solely from revenues obtained from APS pursuant to a loan agreement between APS and
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Coconino County, Arizona Pollution Control Corporation. The 2004 Series A bonds are classified as long-term debt on our Condensed Consolidated Balance Sheets.
     In May 2004, we renewed our $250 million revolving credit facility, while increasing its size to $325 million and extending its term to three years. The revolver provides liquidity support for APS’ $250 million commercial paper program, as well as an additional $75 million for other liquidity needs and miscellaneous letters of credit.
     On June 29, 2004, APS issued $300 million of 5.80% senior unsecured notes due June 30, 2014. The proceeds from the sale of the notes will be used to redeem all or a portion of $100 million in aggregate principal amount of APS’ 6.25% Notes due January 15, 2005 and/or all or a portion of $300 million in aggregate principal amount of APS’ 7.625% Notes due August 1, 2005.
     At June 30, 2004, APS had $566 million of pollution control bonds under which interest rates are reset on a daily, weekly or annual basis. The holders of $387 million of these bonds have the right to cause APS to purchase their bonds on the applicable reset date if the bonds are not remarketed; therefore, $164 million of such bonds are classified as current maturities of long-term debt. The remaining $223 million of bonds are classified as long-term debt because APS has the intent and ability, as demonstrated by credit agreements in place that extend for more than one year, to refinance any bonds that APS is required to purchase.
     The following is a list of payments due on our total long-term debt and capitalized lease requirements as of June 30, 2004:

 	•	 	$167 million in 2004;	
 	
 	•	 	$619 million in 2005;	
 	
 	•	 	$397 million in 2006;	
 	
 	•	 	$175 million in 2007;	
 	
 	•	 	$6 million in 2008; and	
 	
 	•	 	$1.847 billion thereafter.	
     As of May 2004, SNWA has paid Pinnacle West Energy $93 million for a 25% interest in the 570 MW Silverhawk combined cycle plant.
5. Regulatory Matters
Electric Industry Restructuring
State
      Overview of Pending Rate Case
     On June 27, 2003, APS filed a general rate case with the ACC and requested a $175.1 million, or 9.8%, increase in its annual retail electricity revenues, to become effective July 1, 2004. An ACC ALJ has issued various procedural orders staying the existing schedule until at least August 18, 2004, as the parties continue settlement discussions. Based on these recent procedural orders, hearings could begin no earlier than mid to late September 2004. The
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major components of the request are described under “APS General Rate Case and Retail Rate Adjustment Mechanisms” below.
      1999 Settlement Agreement
     The following are the major provisions of the 1999 Settlement Agreement, as approved by the ACC:

 	•	 	APS has reduced rates for standard-offer service for customers with loads less than three MW in a series of annual retail electricity price reductions of 1.5% on July 1 for each of the years 1999 to 2003 for a total of 7.5%. Based on the price reductions authorized in the 1999 Settlement Agreement, there were retail price decreases of approximately $24 million ($14 million after taxes), effective July 1, 1999; approximately $28 million ($17 million after taxes), effective July 1, 2000; approximately $27 million ($16 million after taxes), effective July 1, 2001; approximately $28 million ($17 million after taxes), effective July 1, 2002; and approximately $29 million ($18 million after taxes), effective July 1, 2003. For customers having loads of three MW or greater, standard-offer rates have been reduced in varying annual increments that total 5% in the years 1999 through 2002.	
 	
 	•	 	Unbundled rates being charged by APS for competitive direct access service (for example, distribution services) became effective upon approval of the 1999 Settlement Agreement, retroactive to July 1, 1999, and also became subject to annual reductions beginning January 1, 2000, that vary by rate class, through January 1, 2004.	
 	
 	•	 	There was a moratorium on retail price changes for standard-offer and unbundled competitive direct access services until July 1, 2004, except for the price reductions described above and certain other limited circumstances. Neither the ACC nor APS was prevented from seeking or authorizing rate changes prior to July 1, 2004 in the event of conditions or circumstances that constituted an emergency, such as an inability to finance on reasonable terms; material changes in APS’ cost of service for ACC-regulated services resulting from federal, tribal, state or local laws; regulatory requirements; or judicial decisions, actions or orders.	
 	
 	•	 	APS is being permitted to defer for later recovery prudent and reasonable costs of complying with the Rules, system benefits costs in excess of the levels included in then-current (1999) rates, and costs associated with the “provider of last resort” and standard-offer obligations for service after July 1, 2004. These costs are to be recovered through an adjustment clause or clauses commencing on July 1, 2004, or when the rate case is decided. See “APS General Rate Case and Retail Rate Adjustment Mechanisms” below.	
 	
 	•	 	APS’ distribution system opened for retail access effective September 24, 1999. Customers were eligible for retail access in accordance with the phase-in adopted by the ACC under the Rules (see “Retail Electric	
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 	 	 	Competition Rules” below), including an additional 140 MW being made available to eligible non-residential customers. APS opened its distribution system to retail access for all customers on January 1, 2001. The regulatory developments and legal challenges to the Rules discussed in this Note have raised considerable uncertainty about the status and pace of electric competition and of electric restructuring in Arizona. Although some very limited retail competition existed in APS’ service area in 1999 and 2000, there are currently no active retail competitors providing unbundled energy or other utility services to APS’ customers. As a result, we cannot predict when, and the extent to which, additional competitors will re-enter APS’ service territory.	
 	
 	•	 	Prior to the 1999 Settlement Agreement, APS was recovering substantially all of its regulatory assets through July 1, 2004, pursuant to a 1996 regulatory agreement. In addition, the 1999 Settlement Agreement states that APS has demonstrated that its allowable stranded costs, after mitigation and exclusive of regulatory assets, are at least $533 million net present value (in 1999 dollars). The 1999 Settlement Agreement also states that APS will not be allowed to recover $183 million net present value (in 1999 dollars) ($234 million pre-tax) of the $533 million. The 1999 Settlement Agreement provides that APS will have the opportunity to recover $350 million net present value (in 1999 dollars) through a competitive transition charge that will remain in effect through December 31, 2004, at which time it will terminate. The costs subject to recovery under the adjustment clause described above will be decreased or increased by any over/under-recovery of the $350 million due to sales volume variances. As discussed below under “APS General Rate Case and Retail Rate Adjustment Mechanisms,” APS is seeking to recover amounts written off by APS as a result of the 1999 Settlement Agreement.	
 	
 	•	 	The 1999 Settlement Agreement required APS to form, or cause to be formed, a separate corporate affiliate or affiliates and transfer to such affiliate(s) its competitive electric assets and services no later than December 31, 2002. The 1999 Settlement Agreement provided that APS would be allowed to defer and later collect, beginning July 1, 2004, 67% of its costs to accomplish the required transfer of generation assets to an affiliate. However, as discussed below, in 2002 the ACC unilaterally modified this aspect of the 1999 Settlement Agreement by issuing the Track A Order, an order preventing APS from transferring its generation assets. APS is seeking to recover all costs incurred by APS in preparation for the previously anticipated transfer of generation assets to Pinnacle West Energy. See “APS General Rate Case and Retail Rate Adjustment Mechanisms” below.	
      Retail Electric Competition Rules
     The Rules approved by the ACC include the following major provisions:

 	•	 	They apply to virtually all Arizona electric utilities regulated by the ACC, including APS.	
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 	•	 	Effective January 1, 2001, retail access became available to all APS retail electricity customers.	
 	
 	•	 	Electric service providers that get CC&N’s from the ACC can supply only competitive services, including electric generation, but not electric transmission and distribution.	
 	
 	•	 	Affected utilities must file ACC tariffs that unbundle rates for noncompetitive services.	
 	
 	•	 	The ACC shall allow a reasonable opportunity for recovery of unmitigated stranded costs.	
 	
 	•	 	Absent an ACC waiver, prior to January 1, 2001, each affected utility (except certain electric cooperatives) must transfer all competitive electric assets and services to an unaffiliated party or parties or to a separate corporate affiliate or affiliates. Under the 1999 Settlement Agreement, APS received a waiver to allow transfer of its competitive electric assets and services to affiliates no later than December 31, 2002. However, as discussed below, in 2002 the ACC reversed its decision, as reflected in the Rules, to require APS to transfer its generation assets.	
     Under the 1999 Settlement Agreement, the Rules are to be interpreted and applied, to the greatest extent possible, in a manner consistent with the 1999 Settlement Agreement. If the two cannot be reconciled, APS must seek, and the other parties to the 1999 Settlement Agreement must support, a waiver of the Rules in favor of the 1999 Settlement Agreement.
     On November 27, 2000, a Maricopa County, Arizona, Superior Court judge issued a final judgment holding that the Rules are unconstitutional and unlawful in their entirety due to failure to establish a fair value rate base for competitive electric service providers and because certain of the Rules were not submitted to the Arizona Attorney General for certification. The judgment also invalidates all ACC orders authorizing competitive electric service providers, including APS Energy Services, to operate in Arizona. We do not believe the ruling affects the 1999 Settlement Agreement. The 1999 Settlement Agreement was not at issue in the consolidated cases before the judge. Further, the ACC made findings related to the fair value of APS’ property in the order approving the 1999 Settlement Agreement. The ACC and other parties aligned with the ACC appealed the ruling to the Arizona Court of Appeals, and in January 2004, the Court invalidated some, but not all, of the Rules as either violative of Arizona’s constitutional requirement that the ACC consider the “fair value” of a utility’s property in setting rates or as being beyond the ACC’s constitutional and statutory powers. Other Rules were set aside for failure to submit such regulations to the Arizona Attorney General for approval as required by statute.
      Provider of Last Resort Obligation
     Although the Rules allow retail customers to have access to competitive providers of energy and energy services, APS is, under the Rules, the “provider of last resort” for
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standard-offer, full-service customers under rates that have been approved by the ACC. At various times, prices in the spot wholesale market have significantly exceeded the amount included in APS’ current retail rates. In the event of shortfalls due to unforeseen increases in load demand or generation or transmission outages, APS may need to purchase additional supplemental power in the wholesale spot market. There can be no assurance that APS would be able to fully recover the costs of this power. See “APS General Rate Case and Retail Rate Adjustment Mechanisms” below for a discussion of retail rate adjustment mechanisms that were the subject of ACC hearings in April 2003.
      Track A Order
     On September 10, 2002, the ACC issued the Track A Order, in which the ACC, among other things:

 	•	 	reversed its decision, as reflected in the Rules, to require APS to transfer its generation assets either to an unrelated third party or to a separate corporate affiliate; and	
 	
 	•	 	unilaterally modified the 1999 Settlement Agreement, which authorized APS’ transfer of its generating assets, and directed APS to cancel its activities to transfer its generation assets to Pinnacle West Energy.	
     On November 15, 2002, APS filed appeals of the Track A Order in the Maricopa County, Arizona Superior Court and in the Arizona Court of Appeals. Arizona Public Service Company vs. Arizona Corporation Commission, CV 2002-0222 32. Arizona Public Service Company vs. Arizona Corporation Commission, 1CA CC 02-0002. On December 13, 2002, APS and the ACC staff agreed to principles for resolving certain issues raised by APS in its appeals of the Track A Order. The major provisions of the principles include, among other things, the following:

 	•	 	APS and the ACC staff agreed that it would be appropriate for the ACC to consider the following matters in APS’ general rate case, which was filed on June 27, 2003:	

 	•	 	the generating assets to be included in APS’ rate base, including the question of whether the PWEC Dedicated Assets should be included in APS’ rate base;	

 	•	 	the appropriate treatment of the $234 million pretax asset write-off agreed to by APS as part of the 1999 Settlement Agreement; and	

 	•	 	the appropriate treatment of costs incurred by APS in preparation for the previously anticipated transfer of generation assets to Pinnacle West Energy.	

 	•	 	Upon the ACC’s issuance of a final decision that is no longer subject to appeal approving APS’ request to provide $500 million of financing or credit support to Pinnacle West Energy or the Company, with appropriate	
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 	 	 	conditions, APS’ appeals of the Track A Order would be limited to the issues described in the preceding bullet points, each of which would be presented to the ACC for consideration prior to any final judicial resolution. As noted below, the ACC issued the Financing Order on April 4, 2003. The Financing Order is final and no longer subject to appeal. As a result, APS’ appeals of the Track A Order are limited to the issues described in the preceding bullet points.	
     On August 27, 2003, APS, Pinnacle West and Pinnacle West Energy filed a lawsuit asserting damage claims relating to the Track A Order. Arizona Public Service Company et al. v. The State of Arizona ex rel., Superior Court of the State of Arizona, County of Maricopa, No. CV2003-016372.
      Track B Order
     On March 14, 2003, the ACC issued the Track B Order, which required APS to solicit bids for certain estimated amounts of capacity and energy for periods beginning July 1, 2003. For 2003, APS was required to solicit competitive bids for about 2,500 MW of capacity and about 4,600 gigawatt-hours of energy, or approximately 20% of APS’ total retail energy requirements. The Track B Order also confirmed that it was “not intended to change the current rate base status of [APS’] existing assets.”
     The order recognized APS’ right to reject any bids that are unreasonable, uneconomical or unreliable. The ACC staff and an independent monitor participated in the Track B procurement process. The Track B Order also contains requirements relating to standards of conduct between APS and any affiliate of APS participating in the competitive solicitation, requires that APS treat bidders in a nondiscriminatory manner and requires APS to file a protocol regarding short-term and emergency procurements. The order permits the provision by APS of corporate oversight, support and governance as long as such activities do not favor Pinnacle West Energy in the procurement process or provide Pinnacle West Energy with confidential APS bidding information that is not available to other bidders. The order directs APS to evaluate bids on cost, reliability and reasonableness. The decision requires bidders to allow the ACC to inspect their plants and requires assurances of appropriate competitive market conduct from senior officers of such bidders. Following the solicitation, the decision requires APS to prepare a report evaluating environmental issues relating to the procurement, and a series of workshops on environmental risk management will be commenced thereafter.
     APS issued requests for proposals in March 2003 and, by May 6, 2003, APS entered into contracts to meet all or a portion of its requirements for the years 2003 through 2006 as follows:

 	(1)	 	Pinnacle West Energy agreed to provide 1,700 MW in July through September of 2003 and in June through September of 2004, 2005 and 2006, by means of a unit contingent contract.	
 	
 	(2)	 	PPL EnergyPlus, LLC agreed to provide 112 MW in July through September of 2003 and 150 MW in June through September of 2004 and 2005, by means of a unit contingent contract.	
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 	(3)	 	Panda Gila River LP agreed to provide 450 MW in October of 2003 and 2004 and May of 2004 and 2005, and 225 MW from November 2003 through April 2004 and from November 2004 through April 2005, by means of firm call options.	
      ACC Financing Order
     On April 4, 2003, the ACC issued the Financing Order authorizing APS to lend up to $500 million to Pinnacle West Energy, guarantee up to $500 million of Pinnacle West Energy debt, or a combination of both, not to exceed $500 million in the aggregate (the “APS Loan”), subject to the following principal conditions:

 	•	 	any debt issued by APS pursuant to the order must be unsecured;	
 	
 	•	 	the APS Loan must be callable and secured by the PWEC Dedicated Assets;	
 	
 	•	 	the APS Loan must bear interest at a rate equal to 264 basis points above the interest rate on APS debt that could be issued and sold on equivalent terms (including, but not limited to, maturity and security);	
 	
 	•	 	the 264 basis points referred to in the previous bullet point will be capitalized as a deferred credit and used to offset retail rates in the future, with the deferred credit balance bearing an interest rate of six percent per annum;	
 	
 	•	 	the APS Loan must have a maturity date of not more than four years, unless otherwise ordered by the ACC;	
 	
 	•	 	any demonstrable increase in APS’ cost of capital as a result of the transaction (such as from a decline in bond rating) will be excluded from future rate cases;	
 	
 	•	 	APS must maintain a common equity ratio of at least forty percent and may not pay common dividends if such payment would reduce its common equity ratio below that threshold, unless otherwise waived by the ACC. The ACC will process any waiver request within sixty days, and for this sixty-day period this condition will be suspended. However, this condition, which will continue indefinitely, will not be permanently waived without an order of the ACC; and	
 	
 	•	 	certain waivers of the ACC’s affiliated interest rules previously granted to APS and its affiliates will be temporarily withdrawn and, during the term of the APS Loan, neither Pinnacle West nor Pinnacle West Energy may reorganize or restructure, acquire or divest assets, or form, buy or sell affiliates (each, a “Covered Transaction”), or pledge or otherwise encumber the Pinnacle West Energy assets without prior ACC approval, except that the foregoing restrictions will not apply to the following categories of Covered Transactions:	
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 	•	 	Covered Transactions less than $100 million, measured on a cumulative basis over the calendar year in which the Covered Transactions are made;	
 	
 	•	 	Covered Transactions by SunCor of less than $300 million through 2005, consistent with SunCor’s anticipated accelerated asset sales activity during those years;	
 	
 	•	 	Covered Transactions related to the payment of ongoing construction costs for Pinnacle West Energy’s (a) West Phoenix Unit 5, located in Phoenix, and (b) Silverhawk plant, located near Las Vegas; and	
 	
 	•	 	Covered Transactions related to the sale of 25% of the Silverhawk plant to SNWA pursuant to an agreement between SNWA and Pinnacle West Energy.	
     The ACC also ordered the ACC staff to conduct an inquiry into our and our affiliates’ compliance with the retail electric competition and related rules and decisions. On June 13, 2003, APS submitted its report on these matters to the ACC staff. The ACC has indicated that the preliminary investigation would be addressed in the pending general rate case (see below).
     On May 12, 2003, APS issued $500 million of debt pursuant to the Financing Order and made a $500 million loan to Pinnacle West Energy. Pinnacle West Energy distributed the net proceeds of that loan to us to fund the repayment of a portion of the debt we incurred to finance the construction of the PWEC Dedicated Assets.
      APS General Rate Case and Retail Rate Adjustment Mechanisms
     As noted above, on June 27, 2003, APS filed a general rate case with the ACC and requested a $175.1 million, or 9.8%, increase in its annual retail electricity revenues, intended to become effective July 1, 2004. In this rate case, APS updated its cost of service and rate design.
      Major Components of the Request The major reasons for the request include:

 	•	 	complying with the provisions of the 1999 Settlement Agreement;	
 	
 	•	 	incorporating significant increases in fuel and purchased power costs, including results of purchases through the ACC’s Track B procurement process;	
 	
 	•	 	recognizing changes in APS’ cost of service, cost allocation and rate design;	
 	
 	•	 	obtaining rate recognition of the PWEC Dedicated Assets;	
 	
 	•	 	recovering $234 million written off by APS as a result of the 1999 Settlement Agreement; and	
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 	•	 	recovering restructuring and compliance costs associated with the Rules.	
      Requested Rate Increase The requested rate increase totals $175.1 million, or 9.8%, and is comprised of the following items (dollars in millions):

  	 	Annual Revenue
	 	Percent
	
Increase in base rates	 	$	166.8	 	 	 	9.3	%	
Rules compliance charge	 	 	8.3	 	 	 	0.5	%	

 	 	
Total increase	 	$	175.1	 	 	 	9.8	%	

 	 	
      Test Year The filing is based on an adjusted historical test year ended December 31, 2002.
      Cost of Capital The proposed weighted average cost of capital for the test year ended December 31, 2002 is 8.67%, including an 11.5% return on equity.
      Rate Base The request is based on a rate base of $4.2 billion, calculated using Original Cost Less Depreciation (“OCLD”) methodology. The OCLD rate base approximates the ACC-jurisdictional portion of the net book value of utility plant, net of accumulated depreciation and deferred taxes, as of December 31, 2002, except as set forth below.
     The requested rate base includes the PWEC Dedicated Assets, with a total combined capacity of approximately 1,800 MW. These assets were included at their then estimated July 1, 2004 net book value. Upon approval of the request, the PWEC Dedicated Assets would be transferred to APS from Pinnacle West Energy.
     The filing also includes calculated amounts for Fair Value Rate Base and Replacement Cost New Depreciated (“RCND”) rate base. The ACC is required by the Arizona Constitution to make a finding of Fair Value Rate Base, which has traditionally been defined by the ACC as the arithmetic average of OCLD rate base and RCND rate base.
      Recovery of Previous $234 Million Write-Off The request includes recovery, over a fifteen year period, of the write-off of $234 million pretax of regulatory assets by APS as a result of the 1999 Settlement Agreement. See “1999 Settlement Agreement” above.
     The general rate case also addresses the implementation of rate adjustment mechanisms that were the subject of ACC hearings in April 2003. The rate adjustment mechanisms, which were authorized as a result of the 1999 Settlement Agreement, would allow APS to recover several types of costs, the most significant of which are power supply costs (fuel and purchased power costs) and costs associated with complying with the Rules.
     On November 4, 2003, the ACC approved the issuance of an order which authorizes a rate adjustment mechanism allowing APS to recover changes in purchased power costs (but not changes in fuel costs) incurred after July 1, 2004. The other rate adjustment mechanisms authorized in the 1999 Settlement Agreement (such as the costs associated
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with complying with the Rules) were also tentatively approved for subsequent implementation in the general rate case. The provisions of this order will not become effective until there is a final order in the general rate case, and the ACC further reserved the right to amend, modify or reconsider, in its entirety, this November 4 order during the rate case.
      Testimony On February 3, 2004, the following parties filed their initial written testimony with the ACC on all issues except cost of service (i.e., cost allocation among customer classes) and rate design:

 	•	 	the ACC “litigation” staff;	
 	
 	•	 	the Arizona Residential Utility Consumers Office (“RUCO”), an office established by the Arizona legislature to represent the interests of residential utility consumers before the ACC; and	
 	
 	•	 	other approved rate case interveners.	
      ACC Staff Recommendations In its filed testimony, the ACC staff recommended, among other things, that the ACC:

 	•	 	decrease APS’ annual retail electricity revenues by at least $142.7 million, which would result in a rate decrease of approximately 8%, based on a 9% return on equity;	
 	
 	•	 	not allow the PWEC Dedicated Assets to be included in APS’ rate base;	
 	
 	•	 	not allow APS to recover any of the $234 million pretax written off as a result of the 1999 Settlement Agreement; and	
 	
 	•	 	not implement any adjustment mechanisms for fuel and purchased power.	
     The ACC staff recommendations, if implemented as proposed, could have a material adverse impact on our results of operations, financial position, liquidity, dividend sustainability, credit ratings and access to capital markets. We believe that APS’ rate case requests are supported by, among other things, APS’ demonstrated need for the PWEC Dedicated Assets; APS’ need to attract capital at reasonable rates of return to support the required capital investment to ensure continued customer reliability in APS’ high-growth service territory; and the conditions in the western energy market. As a result, we believe it is unlikely that the ACC would adopt the ACC staff recommendations in their present form, although we can give no assurances in that regard.
     The ACC staff also submitted testimony indicating that APS and its affiliates had violated the “spirit, if not the letter” of the Rules, the Code of Conduct and the 1999 Settlement Agreement.
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      RUCO Recommendations In its filed testimony, RUCO recommended, among other things, that the ACC:

 	•	 	decrease APS’ annual retail electricity revenues by $53.6 million, which would result in a rate decrease of approximately 2.84%, based on a 9.5% return on equity;	
 	
 	•	 	not allow the PWEC Dedicated Assets to be included in APS’ rate base;	
 	
 	•	 	not allow APS to recover any of the $234 million pretax written off as a result of the 1999 Settlement Agreement; and	
 	
 	•	 	not implement any adjustment mechanisms for fuel and purchased power.	
     APS believes that its rate request is necessary to ensure APS’ continued ability to reliably serve one of the fastest growing regions in the country and views any ultimate decision that would deny recovery of the Company’s investment in the PWEC Dedicated Assets as constituting a regulatory “taking.” APS will vigorously oppose the recommendations of the ACC staff, RUCO, and other parties offering similar recommendations.
      Estimated Timeline APS had asked the ACC to approve the requested rate increase by July 1, 2004. Hearings on the rate case were previously scheduled to begin on May 25, 2004. On April 15, 2004, the ACC ALJ issued a procedural order revising the schedule and timing of the rate case. On April 29, 2004, the ACC ALJ issued an order staying the existing procedural schedule for 30 days while the parties discuss settlement. The ALJ issued subsequent procedural orders continuing the stay through at least August 18, 2004 and indicating that she would schedule a future procedural conference on the status of settlement discussions. Based on these recent procedural orders, hearings could begin no earlier than mid to late September 2004.
      Request for Proposals and Asset Purchase Agreement
     In early December 2003, APS issued a request for proposals (“RFP”) for long-term power supply resources. On June 1, 2004, APS and PPL Sundance, a wholly-owned subsidiary of PPL Corporation, entered into an asset purchase agreement by which APS agreed to purchase the 450 MW Sundance Generating Station. The Sundance Generating Station, which began commercial operation in July 2002, would provide peaking generation support for APS’ system and reduce APS’ growing needs for new generation resources.
     The purchase price for the Sundance Generating Station is $189.5 million. Subject to the receipt of approvals from various regulatory agencies, including the ACC, the FERC, the Department of Justice and the Federal Trade Commission, the transaction is expected to close in the first quarter of 2005. Either party may terminate the agreement if ACC approval is not obtained by December 31, 2004 or the transaction does not close by March 31, 2005.
     On June 1, 2004, APS and PPL Sundance filed a joint application with the ACC requesting approval of the transaction on or before December 31, 2004. APS also
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requested, among other things, that the Sundance Generating Station be included in APS’ rates in APS’ next rate case and that certain operating and capital costs be deferred until that time. APS is not requesting that the Sundance Generating Station be reflected in its current general rate case before the ACC.
     APS does not expect to enter into any additional transactions as a result of the RFP.
Federal
     In July 2002, the FERC adopted a price mitigation plan that constrains the price of electricity in the wholesale spot electricity market in the western United States. The FERC adopted a price cap of $250 per MWh for the period subsequent to October 31, 2002. Sales at prices above the cap must be justified and are subject to potential refund.
     On July 31, 2002, the FERC issued a Notice of Proposed Rulemaking for Standard Market Design for wholesale electric markets. Voluminous comments and reply comments were filed on virtually every aspect of the proposed rule. On April 28, 2003, the FERC Staff issued an additional white paper on the proposed Standard Market Design. The white paper discusses several policy changes to the proposed Standard Market Design, including a greater emphasis on flexibility for regional needs. We cannot currently predict what, if any, impact there may be to the Company if the FERC adopts the proposed rule or any modifications proposed in the comments.
     The FERC has been in the process of auditing numerous utilities regarding compliance with its regulations. Such an audit of APS and its affiliates is currently in process. Certain instances of noncompliance with FERC regulations related to the administration of APS’ transmission tariff have been identified. APS is presently discussing these issues with the FERC staff and expects a public report to be issued later this year. APS currently expects, but cannot provide any assurance, that the resolution of these matters will not have a material adverse effect on its financial position, results of operations or liquidity.
General
     The regulatory developments and legal challenges to the Rules discussed in this Note have raised considerable uncertainty about the status and pace of retail electric competition and of electric restructuring in Arizona. Although some very limited retail competition existed in APS’ service area in 1999 and 2000, there are currently no active retail competitors providing unbundled energy or other utility services to APS’ customers. As a result, we cannot predict when, and the extent to which, additional competitors will re-enter APS’ service territory. As competition in the electric industry continues to evolve, we will continue to evaluate strategies and alternatives that will position us to compete in the new regulatory environment.
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6. Retirement Plans and Other Benefits
     Pinnacle West sponsors a qualified defined benefit pension plan, a nonqualified supplemental excess benefit retirement plan, and other postretirement benefits for the employees of Pinnacle West and our subsidiaries.
     On December 8, 2003, the President signed the “Medicare Prescription Drug, Improvement and Modernization Act of 2003” (the Act). One feature of the Act is a government subsidy for prescription drug costs provided the benefit plan is considered actuarially equivalent to Medicare Part D. We believe that our plan is considered actuarially equivalent to Medicare Part D, and thus would qualify for the federal subsidy.
     The FASB issued FSP 106-2, “Accounting and Disclosure Requirements Related to the Medicare Prescription Drug, Improvement and Modernization Act of 2003,” to address the accounting for the effects of the Act for companies that sponsor postretirement health care benefit plans that provide prescription drug benefits. The guidance allows a retroactive or prospective adoption and is effective July 1, 2004. Although our current financial statements do not reflect any amount for the subsidy, we estimate a reduction in the accumulated postretirement benefit obligation of approximately $65 million. Based upon various assumptions, we estimate an annual after-tax reduction in net periodic postretirement benefit expense of approximately $5 million, excluding amounts capitalized as construction overhead or billed to electric plant participants.
     The following table provides details of the plans’ benefit costs. Also included is the portion of these costs charged to expense, including administrative costs and excluding amounts capitalized as construction overhead or billed to electric plant participants (dollars in millions):

  	 	Pension Benefits
	 	Other Benefits
	
 	 	Three Months	 	Six Months	 	Three Months	 	Six Months	
 	 	Ended June 30,
	 	Ended June 30,
	 	Ended June 30,
	 	Ended June 30,
	
 	 	2004
	 	2003
	 	2004
	 	2003
	 	2004
	 	2003
	 	2004
	 	2003
	
Service cost-benefits earned during the period	 	$	11	 	 	$	9	 	 	$	22	 	 	$	18	 	 	$	5	 	 	$	4	 	 	$	10	 	 	$	8	 	
Interest cost on benefit obligation	 	 	21	 	 	 	19	 	 	 	43	 	 	 	37	 	 	 	8	 	 	 	7	 	 	 	16	 	 	 	15	 	
Expected return on plan assets	 	 	(21	)	 	 	(16	)	 	 	(42	)	 	 	(31	)	 	 	(6	)	 	 	(4	)	 	 	(11	)	 	 	(9	)	
Amortization of:	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
Transition (asset)/obligation	 	 	(1	)	 	 	(1	)	 	 	(2	)	 	 	(2	)	 	 	1	 	 	 	1	 	 	 	1	 	 	 	1	 	
Prior service cost	 	 	1	 	 	 	1	 	 	 	1	 	 	 	1	 	 	 	—	 	 	 	—	 	 	 	—	 	 	 	—	 	
Net actuarial loss	 	 	4	 	 	 	4	 	 	 	9	 	 	 	9	 	 	 	3	 	 	 	2	 	 	 	5	 	 	 	5	 	

 	 	 	 	

 	 	 	 	

 	 	
Net periodic benefit cost	 	$	15	 	 	$	16	 	 	$	31	 	 	$	32	 	 	$	11	 	 	$	10	 	 	$	21	 	 	$	20	 	

 	 	 	 	

 	 	 	 	

 	 	
Portion of cost charged to expense	 	$	7	 	 	$	7	 	 	$	14	 	 	$	14	 	 	$	5	 	 	$	4	 	 	$	9	 	 	$	9	 	

 	 	 	 	

 	 	 	 	

 	 	
Contributions
     The United States Pension Stability Act was signed into law on April 10, 2004. Under this new legislation, our required pension contribution in 2004 is $35 million, which we
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plan to contribute in the third quarter. We have contributed approximately $14 million to our other postretirement benefits plan in 2004 through June.
7. Business Segments
     We have three principal business segments (determined by services and regulatory environment):

 	•	 	our regulated electricity segment, which consists of traditional regulated retail and wholesale electricity businesses and related activities, and includes electricity generation, transmission and distribution;	
 	
 	•	 	our marketing and trading segment, which consists of our competitive energy business activities, including wholesale marketing and trading and APS Energy Services’ commodity-related energy services; and	
 	
 	•	 	our real estate segment, which consists of SunCor’s real estate development and investment activities.	
     The amounts in our other segment include activities principally related to El Dorado’s investment in NAC, as well as the parent company and APS Energy Services’ non-commodity services. Financial data for our business segments follows (dollars in millions):

  	 	Three Months	 	Six Months	
 	 	Ended June 30,
	 	Ended June 30,
	
 	 	2004
	 	2003
	 	2004
	 	2003
	
Operating Revenues:	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
Regulated electricity	 	$	520	 	 	$	499	 	 	$	935	 	 	$	878	 	
Marketing and trading	 	 	115	 	 	 	101	 	 	 	204	 	 	 	218	 	
Real estate	 	 	67	 	 	 	57	 	 	 	119	 	 	 	98	 	
Other	 	 	21	 	 	 	26	 	 	 	39	 	 	 	42	 	

 	 	 	 	

Total	 	$	723	 	 	$	683	 	 	$	1,297	 	 	$	1,236	 	

 	 	 	 	

Net Income:	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
Regulated electricity	 	$	37	 	 	$	44	 	 	$	54	 	 	$	52	 	
Marketing and trading	 	 	7	 	 	 	7	 	 	 	17	 	 	 	14	 	
Real estate (a)	 	 	4	 	 	 	3	 	 	 	6	 	 	 	10	 	
Other (b)	 	 	23	 	 	 	2	 	 	 	25	 	 	 	5	 	

 	 	 	 	

Total	 	$	71	 	 	$	56	 	 	$	102	 	 	$	81	 	

 	 	 	 	

(a)	 	Real estate net income includes income from discontinued operations (net of income taxes) in the following amounts: $0.3 million and $1 million for the three months ended June 30, 2004 and 2003, respectively; and $1 million and $6 million for the six months ended June 30, 2004 and 2003, respectively. See Note 18 for further discussion of our real estate activities.	
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(b)	 	The three and six months ended June 30, 2004 include a $35 million gain ($21 million after tax) related to the sale of El Dorado’s limited partnership interest in the Phoenix Suns (see Note 19).	
 	 	 	 	 	 	 	 	 	
  	 	As of	 	As of	
 	 	June 30, 2004
	 	December 31, 2003
	
Assets:	 	 	 	 	 	 	 	 	
Regulated electricity	 	$	8,573	 	 	$	8,405	 	
Marketing and trading	 	 	703	 	 	 	680	 	
Real estate	 	 	409	 	 	 	424	 	
Other	 	 	57	 	 	 	27	 	

 	 	
Total	 	$	9,742	 	 	$	9,536	 	

 	 	
8. Accounting Matters
     See the following Notes for information about new accounting standards and other accounting matters:

 	•	 	Note 6 for FSP 106-2 regarding the Medicare Prescription Drug, Improvement and Modernization Act related to retirement plans and other benefits; and	
 	
 	•	 	Note 9 for FIN No. 46R related to variable interest entities.	
9. Variable Interest Entities
     In 2003, we adopted FIN No. 46R, “Consolidation of Variable Interest Entities,” as it applies to special-purpose entities. FIN No. 46R requires that we consolidate a VIE if we have a majority of the risk of loss from the VIE’s activities or we are entitled to receive a majority of the VIE’s residual returns or both. A VIE is a corporation, partnership, trust or any other legal structure that either does not have equity investors with voting rights or has equity investors that do not provide sufficient financial resources for the entity to support its activities.
     In 1986, APS entered into agreements with three separate SPE lessors in order to sell and lease back interests in Palo Verde Unit 2. The leases are accounted for as operating leases in accordance with GAAP. Based on our assessment of FIN No. 46R, we are not required to consolidate the Palo Verde VIEs.
     APS is exposed to losses under the Palo Verde sale-leaseback agreements upon the occurrence of certain events that APS does not consider to be reasonably likely to occur. Under certain circumstances (for example, the NRC issuing specified violation orders with respect to Palo Verde or the occurrence of specified nuclear events), APS would be required to assume the debt associated with the transactions, make specified payments to the equity participants, and take title to the leased Unit 2 interests, which, if appropriate, may be required to be written down in value. If such an event had occurred as of June 30, 2004, APS would have been required to assume approximately $250 million of debt and pay the equity participants approximately $195 million.
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     In the first quarter of 2004, we adopted FIN No. 46R for all other contractual arrangements. There was no impact to our financial statements.
10. Derivative Instruments and Energy Trading Activities
     We are exposed to the impact of market fluctuations in interest rates and in the commodity price and transportation costs of electricity, natural gas, coal and emissions allowances. We manage risks associated with these market fluctuations by utilizing various instruments that qualify as derivatives, including exchange-traded futures and options and over-the-counter forwards, options and swaps. As part of our overall risk management program, we use such instruments to hedge our exposure to changes in interest rates and to hedge purchases and sales of electricity, fuels, and emissions allowances and credits. The changes in market value of such contracts have a high correlation to price changes in the hedged transactions. In addition, subject to specified risk parameters monitored by the ERMC, we engage in marketing and trading activities intended to profit from market price movements. 
Cash Flow Hedges
     The changes in the fair value of our hedged positions included in the Condensed Consolidated Statements of Income for the three and six months ended June 30, 2004 and 2003 were comprised of the following (dollars in thousands):

 	 	Three Months	 	Six Months	
 	 	Ended June 30,
	 	Ended June 30,
	
 	 	2004
	 	2003
	 	2004
	 	2003
	
Gains on the ineffective portion of derivatives qualifying for hedge accounting	 	$	88	 	 	$	4,329	 	 	$	1,472	 	 	$	7,107	 	
Gains (losses) from the change in options’ time value excluded from measurement of effectiveness	 	 	(17	)	 	 	—	 	 	 	63	 	 	 	—	 	
Gains from the discontinuance of cash flow hedges	 	 	—	 	 	 	—	 	 	 	1,137	 	 	 	—	 	
     As of June 30, 2004, the maximum length of time over which we are hedging our exposure to the variability in future cash flows for forecasted transactions was approximately five years. During the twelve months ending June 30, 2005, we estimate that a net gain of $50 million before income taxes will be reclassified from accumulated other comprehensive income as an offset to the effect on earnings of market price changes for the related hedged transactions.
     Our assets and liabilities from risk management and trading activities are presented in two categories, consistent with our business segments:
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 	•	 	Regulated Electricity – non-trading derivative instruments that hedge our purchases and sales of electricity and fuel for APS’ Native Load requirements of our regulated electricity business segment; and	
 	
 	•	 	Marketing and Trading – both non-trading and trading derivative instruments of our competitive business segment.	
     The following table summarizes our assets and liabilities from risk management and trading activities at June 30, 2004 and December 31, 2003 (dollars in thousands):
June 30, 2004

  	 	Current	 	 	 	 	 	Current	 	Other	 	Net Asset/	
 	 	Assets
	 	Investments
	 	Liabilities
	 	Liabilities
	 	(Liability)
	
Regulated Electricity:	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
Mark-to-market	 	$	70,000	 	 	$	24,095	 	 	$	(27,609	)	 	$	(3,417	)	 	$	63,069	 	
Options at cost and margin account	 	 	—	 	 	 	4,898	 	 	 	(27,122	)	 	 	—	 	 	 	(22,224	)	
Marketing and Trading:	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
Mark-to-market	 	 	96,528	 	 	 	178,270	 	 	 	(68,225	)	 	 	(108,961	)	 	 	97,612	 	
Emission allowances – at cost	 	 	—	 	 	 	(616	)	 	 	(8,885	)	 	 	(17,002	)	 	 	(26,503	)	

 	 	 	 	

 	 	
Total	 	$	166,528	 	 	$	206,647	 	 	$	(131,841	)	 	$	(129,380	)	 	$	111,954	 	

 	 	 	 	

 	 	
December 31, 2003

  	 	Current	 	 	 	 	 	Current	 	Other	 	Net Asset/	
 	 	Assets
	 	Investments
	 	Liabilities
	 	Liabilities
	 	(Liability)
	
Regulated Electricity:	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
Mark-to-market	 	$	44,079	 	 	$	5,900	 	 	$	(47,268	)	 	$	(3,028	)	 	$	(317	)	
Options	 	 	—	 	 	 	12,101	 	 	 	—	 	 	 	—	 	 	 	12,101	 	
Marketing and Trading:	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
Mark-to-market	 	 	53,551	 	 	 	116,363	 	 	 	(37,023	)	 	 	(63,398	)	 	 	69,493	 	
Emission allowances – at cost	 	 	—	 	 	 	4,582	 	 	 	(8,464	)	 	 	(16,304	)	 	 	(20,186	)	

 	 	 	 	

 	 	
Total	 	$	97,630	 	 	$	138,946	 	 	$	(92,755	)	 	$	(82,730	)	 	$	61,091	 	

 	 	 	 	

 	 	
     Cash or other assets may be required to serve as collateral against our open positions on certain energy-related contracts. Collateral provided to counterparties was $1 million at June 30, 2004 and $1 million at December 31, 2003, and is included in investments and other assets on the Condensed Consolidated Balance Sheets. Collateral provided to us by counterparties was $43 million at June 30, 2004 and $12 million at
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December 31, 2003, and is included in other current liabilities on the Condensed Consolidated Balance Sheets.
      Credit Risk
     We are exposed to losses in the event of nonperformance or nonpayment by counterparties. We have risk management and trading contracts with many counterparties, including two counterparties for which a worst case exposure represented approximately 26% of our $373 million of risk management and trading assets as of June 30, 2004. Our risk management process assesses and monitors the financial exposure of these and all other counterparties. Despite the fact that the great majority of trading counterparties are rated as investment grade by the credit rating agencies, including the counterparties noted above, 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 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. In many contracts, 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.
Fair Value Hedges
     On January 29, 2004, we entered into two fixed-for-floating interest rate swap transactions on our $300 million 6.4% senior note. The purpose of these hedges is to protect against significant fluctuations in the fair value of our debt. Our interest rate swaps are considered to be fully effective with any resulting gains or losses on the derivative offset by a similar loss or gain amount on the underlying fair value of debt. The fair value of the interest rate swaps was $2.4 million at June 30, 2004 and is included in other assets with the corresponding offset in long-term debt less current maturities on the Condensed Consolidated Balance Sheets.
11. Comprehensive Income
     Components of comprehensive income for the three and six months ended June 30, 2004 and 2003, are as follows (dollars in thousands):
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  	 	Three Months	 	Six Months	
 	 	Ended June 30,
	 	Ended June 30,
	
 	 	2004
	 	2003
	 	2004
	 	2003
	
Net income	 	$	71,370	 	 	$	56,142	 	 	$	101,526	 	 	$	81,440	 	

 	 	 	 	

Other comprehensive income:	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
Minimum pension liability adjustment, net of tax	 	 	—	 	 	 	29	 	 	 	—	 	 	 	60	 	
Unrealized gain on derivative instruments, net of tax (a)	 	 	15,620	 	 	 	31,766	 	 	 	44,507	 	 	 	47,571	 	
Reclassification of realized (gain) loss to income, net of tax (b)	 	 	(3,837	)	 	 	509	 	 	 	(3,935	)	 	 	(3,841	)	

 	 	 	 	

Total other comprehensive income	 	 	11,783	 	 	 	32,304	 	 	 	40,572	 	 	 	43,790	 	

 	 	 	 	

Comprehensive income	 	$	83,153	 	 	$	88,446	 	 	$	142,098	 	 	$	125,230	 	

 	 	 	 	

(a)	 	These amounts primarily include unrealized gains and losses on contracts used to hedge our forecasted electricity and gas requirements to serve Native Load.	

(b)	 	These amounts primarily include the reclassification of unrealized gains and losses to realized for contracted commodities delivered during the period.	
12. Commitments and Contingencies
Palo Verde Nuclear Generating Station — Spent Fuel and Waste Disposal
     Nuclear power plant owners are required to enter into spent fuel disposal contracts with the 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 Act required the DOE to develop a permanent repository for the storage and disposal of spent nuclear fuel by 1998, the DOE has announced that the repository cannot be completed before 2010 and it does not intend to begin accepting spent nuclear fuel prior to that date. 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. Arizona Public Service Company v. United States of America, United States Court of Federal Claims, 03-2832C.
     Based upon current estimates of the amount of spent fuel and the cost of storage, APS currently estimates it will incur $115 million over the life of Palo Verde for its share of the costs related to the on-site interim storage of spent nuclear fuel. As of June 30, 2004, APS had spent $8 million and recorded a liability of $42 million for on-site interim spent nuclear fuel storage costs related to nuclear fuel burned to date. APS has recorded a corresponding regulatory asset of $50 million and is seeking recovery of these costs through future rates (see “APS General Rate Case and Retail Rate Mechanisms” in Note 5).
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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. The FERC is still considering the evidence and refund amounts have not yet been finalized. APS does not anticipate material changes in its exposure and still believes, subject to the finalization of the revised proxy prices, that it will be entitled to a net refund.
     The FERC also ordered an evidentiary proceeding to discuss and evaluate possible refunds for the Pacific Northwest. The FERC affirmed the ALJ’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 has now been appealed to the Court of Appeals (Ninth Circuit). Although the FERC ruling in the Pacific Northwest matter is being appealed and the FERC has not yet calculated the specific refund amounts due in California, we do not expect that the resolution of these issues, as to the amounts alleged in the proceedings, will have a material adverse impact on our financial position, results of operations or liquidity.
     On March 26, 2003, FERC made public a Final Report on Price Manipulation in Western Markets, prepared by its Staff and covering spot markets in the West in 2000 and 2001. The report stated that a significant number of entities who participated in the California markets during the 2000-2001 time period, including APS, may potentially have been involved in arbitrage transactions that allegedly violated certain provisions of the ISO tariff. After reviewing the matter, along with the data supplied by APS, the FERC staff moved to dismiss the claims against APS and to dismiss the proceeding. The motion to dismiss was granted by the FERC on January 22, 2004. Certain parties have sought rehearing of this order, and that request is pending.
     PG&E filed for bankruptcy protection in 2001. In the fourth quarter of 2003, the CPUC and the Bankruptcy Court accepted PG&E’s plan of reorganization. The plan indicated that PG&E would, at the close of bankruptcy proceedings, be able to pay in full all outstanding, undisputed debts. PG&E emerged from bankruptcy protection on April 12, 2004 and settled all outstanding, undisputed debts with us.
      California Energy Market Litigation On March 19, 2002, the State of California filed a complaint with the FERC alleging that wholesale sellers of power and energy, including the Company, failed to properly file rate information at the FERC in connection with sales to California from 2000 to the present. State of California v. British Columbia Power Exchange et al. , Docket No. EL02-71-000. The complaint requests the FERC to require the wholesale sellers to refund any rates that are “found to exceed just and reasonable levels.” This complaint has been dismissed by the FERC and the State of California is now appealing the matter to the Ninth Circuit Court of Appeals. In addition, the State of California and others have filed various claims, which have now been consolidated, against several power suppliers to California alleging antitrust violations. Wholesale Electricity Antitrust Cases I and II , Superior Court in and for the County of San Diego, Proceedings Nos. 4204-00005 and 4204-00006. Two of the suppliers who were named as defendants in those matters, Reliant Energy Services, Inc. (and other Reliant entities) and Duke Energy and Trading, LLP (and other Duke entities), filed cross-claims against various
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other participants in the PX and California independent system operator markets, including APS, attempting to expand those matters to such other participants. APS has not yet filed a responsive pleading in the matter, but APS believes the claims by Reliant and Duke as they relate to APS are without merit.
     APS was also named in a lawsuit regarding wholesale contracts in California, which, after moving to state court, has been removed to the federal court for a second time. James Millar, et al. v. Allegheny Energy Supply, et al. , San Francisco Superior Court, Case No. 407867, U.S. District Court (Northern District) C-04-0519 SBA. The First Amended Complaint alleges basically that the contracts entered into were the result of an unfair and unreasonable market, in violation of California unfair competition laws. The PX has filed a lawsuit against the State of California regarding the seizure of forward contracts and the State has filed a cross complaint against APS and numerous other PX participants. Cal PX v. The State of California , Superior Court in and for the County of Sacramento, JCCP No. 4203. Various motions continue to be filed, and we currently believe these claims will have no material adverse impact on our financial position, results of operations or liquidity.
Natural Gas Supply
     APS and Pinnacle West Energy purchase the majority of their natural gas requirements for their gas-fired plants under contracts with a number of natural gas suppliers. Pursuant to the terms of a comprehensive settlement entered into in 1996 with El Paso Natural Gas Company, the rates charged for transportation are subject to a rate moratorium through December 31, 2005.
     On July 9, 2003 the FERC issued an order that altered the contractual obligations and the rights of parties to the 1996 settlement. In order for APS and Pinnacle West Energy to meet their natural gas supply and capacity requirements, we now expect that the combined increase in costs associated with the natural gas supply and the transportation capacity to result in an overall average increase of approximately $4 million per year in 2004 and 2005. APS and Pinnacle West Energy have sought appellate review of the FERC’s July 9 order and related issues on the grounds that the FERC decision to abrogate the full requirements contracts is arbitrary and capricious and is not supported by substantial evidence. Arizona Public Service Company and Pinnacle West Energy Corporation v. Federal Energy Regulatory Commission , United States Court of Appeals for the District of Columbia Circuit, No. 03-1209. This petition for review was consolidated with a petition filed by the ACC and other full requirements contract holders. Arizona Corporation Commission et al v. Federal Energy Regulatory Commission , United States Court of Appeals for the District of Columbia Circuit, No. 03-1206. We are continuing to analyze the market to determine the most favorable source and method of meeting our natural gas requirements.
     In addition, another party has also sought review of FERC’s July 9 order and is seeking to reallocate the costs associated with the changed contractual obligations in a way that would be less favorable to APS and Pinnacle West Energy than under FERC’s order. Should this party prevail on this point, APS and Pinnacle West Energy’s annual capacity cost could be increased by approximately $3 million per year, from September 2003 through December 2005.
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Environmental Matters — Superfund
     On September 3, 2003, the EPA advised APS and Pinnacle West that the EPA considers APS and Pinnacle West to be a “potentially responsible party” in the Motorola 52nd Street Superfund Site, Operable Unit 3 (OU3) in Phoenix, Arizona. APS has facilities that are within this superfund site. Liability under Superfund is strict, joint and several. The Company and APS are currently negotiating with the EPA regarding the performance of remedial investigation activities of the APS facilities. Because the ultimate remediation requirements are not yet finalized, we cannot currently estimate the expenditures which may be required.
Asset Purchase Agreement
     See Note 5 for a description of an asset purchase agreement between APS and PPL Sundance.
13. Nuclear Insurance
     The Palo Verde participants have insurance for public liability resulting from nuclear energy hazards to the full limit of liability under federal law. The Price Anderson Act currently limits the combined public liability of nuclear reactor owners to $10.76 billion for claims that could arise from a single nuclear incident. The Palo Verde participants purchase the maximum available commercial insurance of $300 million. The balance of the $10.46 billion is provided by an industry-wide retrospective assessment program. If losses at any nuclear power plant covered by the programs 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 $101 million, subject to an annual limit of $10 million per incident. Based on APS’ interest in the three Palo Verde units, APS’ maximum potential assessment per incident for all three units is approximately $88 million, with an annual payment limitation of approximately $9 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 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 estimated maximum amount of retrospective assessments APS could incur under the current NEIL policies totals $16 million. The insurance coverage discussed in this and the previous paragraph is subject to certain policy conditions and exclusions.
14. Stock-Based Compensation
     Pinnacle West offers stock-based compensation plans for officers and key employees of the Company and our subsidiaries. In 2002, we began applying the fair value method of accounting for stock-based compensation, as provided for in SFAS No. 123,
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“Accounting for Stock-Based Compensation.” In accordance with the transition requirements of SFAS No. 123, as amended by SFAS No. 148, “Accounting for Stock-Based Compensation – Transition and Disclosure,” we applied the fair value method prospectively, beginning with 2002 stock grants. In prior years, we recognized stock compensation expense based on the intrinsic value method allowed in Accounting Principles Board Opinion (APB) No. 25, “Accounting for Stock Issued to Employees.”
     The following chart compares our net income, stock compensation expense and earnings per share for the three and six months ended June 30, 2004 and 2003 to what those items would have been if we had recorded stock compensation expense based on the fair value method for all stock grants through June 30, 2004 (dollars in thousands, except per share amounts): 

 	 	Three Months	 	Six Months	
 	 	Ended June 30,
	 	Ended June 30,
	
 	 	2004
	 	2003
	 	2004
	 	2003
	
Net income, as reported	 	$	71,370	 	 	$	56,142	 	 	$	101,526	 	 	$	81,440	 	
Add: Stock compensation expense included in reported net income (net of tax)	 	 	393	 	 	 	375	 	 	 	789	 	 	 	528	 	
Deduct: Total stock compensation expense determined under fair value method (net of tax)	 	 	757	 	 	 	665	 	 	 	1,519	 	 	 	1,118	 	

 	 	 	 	

Pro forma net income	 	$	71,006	 	 	$	55,852	 	 	$	100,796	 	 	$	80,850	 	

 	 	 	 	

Earnings per share – basic:	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
As reported	 	$	0.78	 	 	$	0.62	 	 	$	1.11	 	 	$	0.89	 	
Pro forma	 	$	0.78	 	 	$	0.61	 	 	$	1.10	 	 	$	0.89	 	
Earnings per share – diluted:	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
As reported	 	$	0.78	 	 	$	0.61	 	 	$	1.11	 	 	$	0.89	 	
Pro forma	 	$	0.78	 	 	$	0.61	 	 	$	1.10	 	 	$	0.88	 	
15. Other Income and Other Expense
     The following table provides detail of other income and other expense for the three and six months ended June 30, 2004 and 2003 (dollars in thousands):
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  	 	Three Months	 	Six Months	
 	 	Ended June 30,
	 	Ended June 30,
	
 	 	2004
	 	2003
	 	2004
	 	2003
	
Other income:	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
Investment gains – net (a)	 	$	34,863	 	 	$	—	 	 	$	37,081	 	 	$	1,213	 	
Interest income	 	 	419	 	 	 	1,136	 	 	 	4,220	 	 	 	1,763	 	
SunCor joint venture earnings	 	 	2,006	 	 	 	1,288	 	 	 	3,191	 	 	 	4,532	 	
Asset sales	 	 	(1,189	)	 	 	21	 	 	 	2,462	 	 	 	302	 	
Miscellaneous	 	 	442	 	 	 	253	 	 	 	999	 	 	 	543	 	

 	 	 	 	

Total other income	 	$	36,541	 	 	$	2,698	 	 	$	47,953	 	 	$	8,353	 	

 	 	 	 	

Other expense:	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
Non-operating costs (b)	 	$	(3,831	)	 	$	(4,112	)	 	$	(6,658	)	 	$	(7,784	)	
Asset sales	 	 	1,175	 	 	 	(268	)	 	 	(964	)	 	 	(918	)	
Investment losses – net	 	 	—	 	 	 	(66	)	 	 	—	 	 	 	—	 	
Miscellaneous	 	 	(1,411	)	 	 	(711	)	 	 	(2,390	)	 	 	(586	)	

 	 	 	 	

Total other expense	 	$	(4,067	)	 	$	(5,157	)	 	$	(10,012	)	 	$	(9,288	)	

 	 	 	 	

(a)	 	The three and six months ended June 30, 2004 include a $35 million gain ($21 million after tax) related to the sale of El Dorado’s limited partnership interest in the Phoenix Suns (see Note 19).	

(b)	 	As defined by the FERC, includes below-the-line non-operating utility costs (primarily community relations and other).	
16. Guarantees
     We have issued parental guarantees and letters of credit and obtained surety bonds on behalf of our unregulated subsidiaries. Our parental guarantees related to Pinnacle West Energy consist of equipment and performance guarantees related to our generation construction program, transmission service guarantees for West Phoenix Unit 5 and long-term service agreement guarantees for new power plants. Our credit support instruments enable APS Energy Services to offer commodity energy and energy-related products and enable El Dorado to support the activities of NAC. Non-performance or payment under the original contract by our unregulated 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 guarantees on behalf of its subsidiaries. Our guarantees have no recourse (except NAC) or collateral provisions to allow us to recover amounts paid under the guarantee. The amounts and approximate terms of our guarantees and surety bonds for each subsidiary at June 30, 2004 are as follows (dollars in millions):
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  	 	Guarantees
	 	Surety Bonds
	
 	 	 	 	 	 	Term	 	 	 	 	 	Term	
 	 	Amount
	 	(in years)
	 	Amount
	 	(in years)
	
Parental:	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
Pinnacle West Energy	 	$	45	 	 	 	1 to 2	 	 	$	—	 	 	 	—	 	
APS Energy Services	 	 	20	 	 	 	1 to 2	 	 	 	42	 	 	 	1 to 2	 	
El Dorado (NAC)	 	 	40	 	 	 	1 to 2	 	 	 	—	 	 	 	—	 	

 	 	 	 	 	 	
Total	 	$	105	 	 	 	 	 	 	$	42	 	 	 	 	 	

 	 	 	 	 	 	
     At June 30, 2004, we had entered into approximately $40 million of letters of credit which support various construction agreements. These letters of credit expire in 2004 and 2005. We intend to provide from either existing or new facilities for the extension, renewal or substitution of the letters of credit to the extent required. Pinnacle West has approximately $3 million of letters of credit related to workers’ compensation expiring in 2004.
     APS has entered into various agreements that require letters of credit for financial assurance purposes. At June 30, 2004, approximately $200 million of letters of credit were outstanding to support existing pollution control bonds of approximately $200 million. See Note 4 for more information. The letters of credit are available to fund the payment of principal and interest of such debt obligations. In July 2004, $150 million of these letters of credit were renewed for a three-year term and expire in 2007. The remainder expire in 2005. APS has also entered into approximately $102 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 expire in 2005. Additionally, APS has approximately $5 million of letters of credit related to counterparty collateral requirements expiring in 2004. APS intends to provide from either existing or new facilities for the extension, renewal or substitution of the letters of credit to the extent required.
     We provide indemnifications relating to liabilities arising from or related to certain of our agreements. APS has provided indemnifications to 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 indemnifications and therefore, the overall maximum amount of the obligation under such indemnifications 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 indemnifications is likely and therefore no related liability has been recorded.
17. Earnings Per Share
     The following table presents earnings per weighted average common share outstanding for the three and six months ended June 30, 2004 and 2003:
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  	 	Three Months	 	Six Months	
 	 	Ended June 30,
	 	Ended June 30,
	
 	 	2004
	 	2003
	 	2004
	 	2003
	
Basic earnings per share:	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
Income from continuing operations	 	$	0.78	 	 	$	0.60	 	 	$	1.10	 	 	$	0.82	 	
Income from discontinued operations	 	 	—	 	 	 	0.02	 	 	 	0.01	 	 	 	0.07	 	

 	 	 	 	

Earnings per share – basic	 	$	0.78	 	 	$	0.62	 	 	$	1.11	 	 	$	0.89	 	

 	 	 	 	

Diluted earnings per share:	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
Income from continuing operations	 	$	0.78	 	 	$	0.60	 	 	$	1.10	 	 	$	0.82	 	
Income from discontinued operations	 	 	—	 	 	 	0.01	 	 	 	0.01	 	 	 	0.07	 	

 	 	 	 	

Earnings per share – diluted	 	$	0.78	 	 	$	0.61	 	 	$	1.11	 	 	$	0.89	 	

 	 	 	 	

     The following table reconciles weighted-average common shares outstanding – basic to weighted-average common shares outstanding – diluted that are used in the earnings per share calculation in the Condensed Consolidated Statements of Income for the three and six months ended June 30, 2004 and 2003 (in thousands):

  	 	Three Months	 	Six Months	
 	 	Ended June 30,
	 	Ended June 30,
	
 	 	2004
	 	2003
	 	2004
	 	2003
	
Weighted-average common shares outstanding – basic	 	 	91,315	 	 	 	91,258	 	 	 	91,304	 	 	 	91,257	 	
Dilutive shares	 	 	85	 	 	 	192	 	 	 	87	 	 	 	145	 	

 	 	 	 	

Weighted-average common shares outstanding – diluted	 	 	91,400	 	 	 	91,450	 	 	 	91,391	 	 	 	91,402	 	

 	 	 	 	

     Options to purchase 2,325,165 shares of common stock for the three month period ended June 30, 2004 and 2,355,287 shares of common stock for the six month period ended June 30, 2004 were outstanding but were not included in the computation of earnings per share because the options’ exercise prices were greater than the average market price of the common shares. Options to purchase shares of common stock that were not included in the computation of diluted earnings per share for that same reason were 1,784,168 shares for the three month period ended June 30, 2003 and 2,026,228 shares for the six month period ended June 30, 2003.
     18. Real Estate Activities – Discontinued Operations
     For the three- and six-month periods ended June 30, 2003, SunCor recorded an after tax gain of $1 million ($2 million pretax) and $6 million ($10 million pretax), respectively, as a result of the sale of its water utility company. The amounts of the gain on the sale and operating income of the water utility company in the current and prior periods
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are classified as discontinued operations on our Condensed Consolidated Statements of Income.
19. Sale of Phoenix Suns Partnership Interest
     In June 2004, the Phoenix Suns Limited Partnership, in which El Dorado held a limited partnership interest, sold the partnership’s assets to a new investor group. The transaction resulted in a gain for El Dorado of approximately $35 million pretax ($21 million after income taxes), which is reflected in other income on the Condensed Consolidated Statement of Income. Additionally, $23 million in cash was received in July 2004 and $12 million will be received in 2007.
     20. Subsequent Event – Sale of NAC
     In July 2004, we entered into an agreement to sell our investment in NAC Holding Inc. and NAC International Inc. (NAC). The transaction is expected to close later this year and result in an after-tax gain of approximately $6 million, which will be classified as discontinued operations. The operating income related to NAC in the current and prior periods will also be classified as discontinued operations in our Condensed Consolidated Statements of Income in the third quarter.
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PINNACLE WEST CAPITAL CORPORATION 

Item 2. 	Management’s Discussion and Analysis of Financial Condition and Results of Operations.	
Introduction
     We suggest this section be read along with the 2003 Form 10-K. Throughout this Item, we refer to specific “Notes” in the Notes to Condensed Consolidated Financial Statements in this report. These Notes add further details to the discussion. Operating statistics for the three and six months ended June 30, 2004 and 2003 are available on our website (www.pinnaclewest.com).
Overview
     We own all of the outstanding common stock of APS. APS is a vertically-integrated electric utility that provides either retail or wholesale electric service to most of the state of Arizona. Through its marketing and trading division, APS also generates, sells and delivers electricity to wholesale customers in the western United States. APS’ marketing and trading division also sells, in the wholesale market, Pinnacle West Energy’s generation output that is not needed for APS’ Native Load, which includes loads for retail customers and traditional cost-of-service wholesale customers. The marketing and trading division focuses primarily on managing APS’ purchased power and fuel risks in connection with APS’ costs of serving retail customer energy requirements. APS has historically accounted for a substantial part of our revenues and earnings. Growth in APS’ service territory is about three times the national average and remains a fundamental driver of our revenues and earnings.
     Pinnacle West Energy is our unregulated generation subsidiary. We formed Pinnacle West Energy in 1999 as a result of the ACC’s requirement that APS transfer all of its competitive assets and services to an affiliate or to a third party by the end of 2002. We planned to transfer APS’ generation assets to Pinnacle West Energy. Additionally, Pinnacle West Energy constructed several power plants to meet growing energy needs (1790 MW in Arizona and 570 MW in Nevada). In September 2002, the ACC issued the Track A Order, which prohibited APS from transferring its generation assets to Pinnacle West Energy. As a result of the Track A Order, we are seeking to transfer the plants built by Pinnacle West Energy in Arizona to APS to unite the Arizona generation under one common owner, as originally intended.
     SunCor, our real estate development subsidiary, has been and is expected to be an important source of earnings and cash flow, particularly during the years 2003 through 2005 due to accelerated asset sales activity. Our subsidiary, APS Energy Services, provides competitive commodity-related energy services and energy-related products and services to commercial, industrial and institutional retail customers in the western United States.
     We believe APS’ general rate case pending before the ACC is the key issue affecting our outlook. See Note 5 in Item 1 for a detailed discussion of this rate case. Other factors affecting our past and future financial results include the June 2004 sale of El Dorado’s limited partnership interest in the Phoenix Suns; customer growth; purchased power and fuel costs; operations and maintenance expenses, including those relating to
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plant outages; temporary transmission constraints related to recent substation fires in our Phoenix service territory; weather variations; depreciation and amortization expenses, which are affected by net additions to existing utility plant and other property and changes in regulatory asset amortization; and the expected performance of our subsidiaries, SunCor and El Dorado.
EARNINGS CONTRIBUTIONS BY SUBSIDIARY AND BUSINESS SEGMENT
     We have three principal business segments (determined by services and the regulatory environment):

•	 	our regulated electricity segment, which consists of traditional regulated retail and wholesale electricity businesses and related activities, and includes electricity generation, transmission and distribution;	
 	
•	 	our marketing and trading segment, which consists of our competitive energy business activities, including wholesale marketing and trading and APS Energy Services’ commodity-related energy services; and	
 	
•	 	our real estate segment, which consists of SunCor’s real estate development and investment activities.	
     The following tables summarize net income and segment details for the three and six months ended June 30, 2004 and the comparable prior year period for Pinnacle West and each of our subsidiaries (dollars in millions):

  	 	 	 	 	 	 	 	 	 	Regulated	 	Marketing and	 	 	 	 	
 	 	Total
	 	Electricity
	 	Trading
	 	Real Estate
	 	Other
	
Three months ended June 30,
	 	2004
	 	2003
	 	2004
	 	2003
	 	2004
	 	2003
	 	2004
	 	2003
	 	2004
	 	2003
	
APS (a)	 	$	54	 	 	$	43	 	 	$	55	 	 	$	42	 	 	$	(1	)	 	$	1	 	 	$	—	 	 	$	—	 	 	$	—	 	 	$	—	 	
Pinnacle West Energy (a) (b)	 	 	(12	)	 	 	2	 	 	 	(22	)	 	 	2	 	 	 	10	 	 	 	—	 	 	 	—	 	 	 	—	 	 	 	—	 	 	 	—	 	
APS Energy Services	 	 	1	 	 	 	5	 	 	 	—	 	 	 	—	 	 	 	—	 	 	 	4	 	 	 	—	 	 	 	—	 	 	 	1	 	 	 	1	 	
SunCor	 	 	4	 	 	 	2	 	 	 	—	 	 	 	—	 	 	 	—	 	 	 	—	 	 	 	4	 	 	 	2	 	 	 	—	 	 	 	—	 	
El Dorado (b) (c)	 	 	36	 	 	 	2	 	 	 	—	 	 	 	—	 	 	 	—	 	 	 	—	 	 	 	—	 	 	 	—	 	 	 	36	 	 	 	2	 	
Parent company (b) (c)	 	 	(12	)	 	 	1	 	 	 	4	 	 	 	—	 	 	 	(2	)	 	 	2	 	 	 	—	 	 	 	—	 	 	 	(14	)	 	 	(1	)	

 	 	 	 	

 	 	 	 	

 	 	 	 	

Income from continuing operations	 	 	71	 	 	 	55	 	 	 	37	 	 	 	44	 	 	 	7	 	 	 	7	 	 	 	4	 	 	 	2	 	 	 	23	 	 	 	2	 	
Discontinued operations – net of income tax expense	 	 	—	 	 	 	1	 	 	 	—	 	 	 	—	 	 	 	—	 	 	 	—	 	 	 	—	 	 	 	1	 	 	 	—	 	 	 	—	 	
Net income	 	$	71	 	 	$	56	 	 	$	37	 	 	$	44	 	 	$	7	 	 	$	7	 	 	$	4	 	 	$	3	 	 	$	23	 	 	$	2	 	

 	 	 	 	

 	 	 	 	

 	 	 	 	

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  	 	 	 	 	 	 	 	 	 	Regulated	 	Marketing and	 	 	 	 	
 	 	Total
	 	Electricity
	 	Trading
	 	Real Estate
	 	Other

Six months ended June 30,
	 	2004
	 	2003
	 	2004
	 	2003
	 	2004
	 	2003
	 	2004
	 	2003
	 	2004
	 	2003
	
APS (a)	 	$	87	 	 	$	59	 	 	$	93	 	 	$	56	 	 	$	(6	)	 	$	3	 	 	$	—	 	 	$	—	 	 	$	—	 	 	$	—	 	
Pinnacle West Energy (a) (b)	 	 	(30	)	 	 	8	 	 	 	(50	)	 	 	8	 	 	 	20	 	 	 	—	 	 	 	—	 	 	 	—	 	 	 	—	 	 	 	—	 	
APS Energy Services	 	 	3	 	 	 	13	 	 	 	—	 	 	 	—	 	 	 	1	 	 	 	10	 	 	 	—	 	 	 	—	 	 	 	2	 	 	 	3	 	
SunCor	 	 	5	 	 	 	4	 	 	 	—	 	 	 	—	 	 	 	—	 	 	 	—	 	 	 	5	 	 	 	4	 	 	 	—	 	 	 	—	 	
El Dorado (b) (c)	 	 	36	 	 	 	5	 	 	 	—	 	 	 	—	 	 	 	—	 	 	 	—	 	 	 	—	 	 	 	—	 	 	 	36	 	 	 	5	 	
Parent company (b) (c)	 	 	—	 	 	 	(14	)	 	 	11	 	 	 	(12	)	 	 	2	 	 	 	1	 	 	 	—	 	 	 	—	 	 	 	(13	)	 	 	(3	)	

 	 	 	 	

 	 	 	 	

 	 	 	 	

Income from continuing operations	 	 	101	 	 	 	75	 	 	 	54	 	 	 	52	 	 	 	17	 	 	 	14	 	 	 	5	 	 	 	4	 	 	 	25	 	 	 	5	 	
Discontinued operations – net of income tax expense	 	 	1	 	 	 	6	 	 	 	—	 	 	 	—	 	 	 	—	 	 	 	—	 	 	 	1	 	 	 	6	 	 	 	—	 	 	 	—	 	

 	 	 	 	

 	 	 	 	

 	 	 	 	

Net income	 	$	102	 	 	$	81	 	 	$	54	 	 	$	52	 	 	$	17	 	 	$	14	 	 	$	6	 	 	$	10	 	 	$	25	 	 	$	5	 	

 	 	 	 	

 	 	 	 	

 	 	 	 	

(a)	 	Consistent with APS’ October 2001 ACC filing, APS entered into contracts with its affiliates to buy power through June 2003. The contracts reflected prices based on the fully-dispatchable dedication of the Pinnacle West Energy generating assets to APS’ Native Load customers (customers receiving power under traditional cost-based rate regulation). Beginning July 1, 2003, under the ACC Track B Order, APS was required to solicit bids for certain estimated capacity and energy requirements. Pinnacle West Energy bid on and entered into a contract to supply most of these purchase power requirements in summer months through September 2006. See Note 5.	
 	
(b)	 	Pinnacle West Energy’s net loss in 2004 and El Dorado’s net income in 2003 and 2004 are reported before income taxes. The income tax expense or benefit for these subsidiaries is recorded at the parent company.	
 	
(c)	 	The three and six months ended June 30, 2004 include a $35 million gain ($21 million after-tax) related to the sale of El Dorado’s limited partnership interest in the Phoenix Suns.	
Results of Operations
      General
     Throughout the following explanations of our results of operations, we refer to “gross margin.” With respect to our regulated electricity segment and our marketing and trading segment, gross margin refers to electric operating revenues less purchased power and fuel costs. Our real estate segment gross margin refers to real estate revenues less real estate operations costs of SunCor. Other gross margin refers to other operating revenues less other operating expenses, which primarily includes El Dorado’s investment in NAC and APS Energy Services’ non-commodity services.
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 	 	Operating Results – Three-month period ended June 30, 2004 compared with the three-month period ended June 30, 2003	
     Our consolidated net income for the three months ended June 30, 2004 was $71 million compared with $56 million for the prior year period. The $15 million increase in the period-to-period comparison reflects the following changes in earnings by segment:

•	 	Regulated Electricity Segment – Net income decreased approximately $7 million primarily due to higher costs related to new power plants placed in service in mid 2003 and mid 2004; higher replacement power costs from unplanned plant outages due to higher market prices; and a retail electricity price reduction. These negative factors were partially offset by lower regulatory asset amortization and customer growth.	
 	
•	 	Marketing and Trading Segment – Net income was flat in the period-to-period comparison. Higher prices for wholesale sales of electricity were offset by lower margins in California for APS Energy Services.	
 	
•	 	Other Segment – Net income increased approximately $21 million primarily due to a gain at El Dorado related to the sale of El Dorado’s limited partnership interest in the Phoenix Suns, which resulted in an after-tax gain of $21 million.	
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     Additional details on the major factors that increased (decreased) income from continuing operations and net income are contained in the following table (dollars in millions).

  	 	Increase (Decrease)
	
 	 	Pretax
	 	After Tax
	
Regulated electricity segment gross margin:	 	 	 	 	 	 	 	 	
Higher replacement power costs from unplanned plant outages due to higher market prices	 	$	(8	)	 	$	(5	)	
Retail electricity price reduction effective July 1, 2003	 	 	(7	)	 	 	(4	)	
Increased purchased power and fuel costs due to higher hedged fuel and power prices	 	 	(4	)	 	 	(2	)	
Higher retail sales volumes due to customer growth, excluding weather effects	 	 	11	 	 	 	7	 	
Miscellaneous factors, net	 	 	(6	)	 	 	(4	)	

 	 	
Net decrease in regulated electricity segment gross margin	 	 	(14	)	 	 	(8	)	

 	 	
Marketing and trading segment gross margin:	 	 	 	 	 	 	 	 	
Higher mark-to-market gains for future delivery due to higher forward prices for wholesale electricity	 	 	5	 	 	 	3	 	
Higher realized margins on wholesale sales primarily due to higher prices	 	 	4	 	 	 	2	 	
Lower competitive retail unit margins in California by APS Energy Services	 	 	(8	)	 	 	(5	)	

 	 	
Net increase in marketing and trading segment gross margin	 	 	1	 	 	 	—	 	

 	 	
Net decrease in regulated electricity and marketing and trading segments’ gross margins	 	 	(13	)	 	 	(8	)	
Higher other income net of other expense primarily due to the sale of El Dorado’s limited partnership interest in the Phoenix Suns	 	 	35	 	 	 	21	 	
Depreciation and amortization decreases (increases):	 	 	 	 	 	 	 	 	
Decreased regulatory asset amortization	 	 	13	 	 	 	8	 	
New power plants in service	 	 	(5	)	 	 	(3	)	
Increased delivery and other assets	 	 	(5	)	 	 	(3	)	
Interest expense net decreases (increases):	 	 	 	 	 	 	 	 	
New power plants in service	 	 	(8	)	 	 	(5	)	
Primarily lower debt balances	 	 	9	 	 	 	5	 	
Higher property taxes due to increased property values	 	 	(4	)	 	 	(2	)	
Miscellaneous items, net	 	 	3	 	 	 	3	 	

 	 	
Net increase in income from continuing operations	 	$	25	 	 	 	16	 	

Discontinued operations	 	 	 	 	 	 	(1	)	

Net increase in net income	 	 	 	 	 	$	15	 	

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     The increase in net costs (primarily interest expense, depreciation, and operations and maintenance expense) related to new power plants placed in service in mid 2003 and mid 2004 by Pinnacle West Energy totaled approximately $9 million after income taxes in the three months ended June 30, 2004, compared with the prior-year period.
Regulated Electricity Segment Revenues
     Regulated electricity segment revenues were $21 million higher for the three months ended June 30, 2004 compared with the prior year period, primarily as a result of:

•	 	a $28 million increase in retail revenues related to customer growth and higher average usage, excluding weather effects;	
 	
•	 	a $7 million decrease in retail revenues related to a reduction in retail electricity prices;	
 	
•	 	a $2 million decrease in retail revenues related to weather; and	
 	
•	 	a $2 million increase due to miscellaneous factors.	
Marketing and Trading Segment Revenues
     Marketing and trading segment revenues were $14 million higher for the three months ended June 30, 2004 compared with the prior year period, primarily as a result of:

•	 	a $10 million increase from generation sales other than Native Load primarily due to higher prices and sales volumes;	

•	 	$5 million in higher mark-to-market gains for future-period deliveries primarily as a result of higher forward prices for wholesale electricity;	

•	 	$2 million of higher other realized wholesale revenues primarily due to higher prices; and	

•	 	a $3 million decrease from lower competitive retail sales in California by APS Energy Services.	
Real Estate Segment Revenues
     Real estate segment revenues were $10 million higher for the three months ended June 30, 2004 compared with the prior year period primarily as a result of increased home sales.
Other Revenues
     Other revenues were $6 million lower for the three months ended June 30, 2004 compared with the prior year period primarily due to lower revenues related to an NAC contract settlement in 2003.
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 	 	Operating Results – Six-month period ended June 30, 2004 compared with the six-month period ended June 30, 2003	
     Our consolidated net income for the six months ended June 30, 2004 was $102 million compared with $81 million for the prior year period. The $21 million increase in the period-to-period comparison reflects the following changes in earnings by segment:

•	 	Regulated Electricity Segment – Net income increased approximately $2 million primarily due to customer growth, lower regulatory asset amortization, and favorable weather. These positive factors were partially offset by higher costs related to new power plants placed in service in mid 2003 and mid 2004; higher replacement power costs from plant outages due to higher market prices and more unplanned outages; a retail electricity price reduction; and higher depreciation expense related to increased delivery and other assets.	
 	
•	 	Marketing and Trading Segment – net income increased approximately $3 million primarily due to higher prices for wholesale electricity, largely offset by lower margins in California of APS Energy Services.	
 	
•	 	Real Estate Segment – Net income decreased approximately $4 million primarily due to the 2003 gain on the sale of SunCor’s water utility company, which was reported as discontinued operations.	
 	
•	 	Other Segment – Net income increased approximately $20 million primarily due to a gain at El Dorado related to the sale of El Dorado’s limited partnership interest in the Phoenix Suns, which resulted in an after-tax gain of $21 million.	
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 	 	     Additional details on the major factors that increased (decreased) income from continuing operations and net income are contained in the following table (dollars in millions).	
 	 	 	 	 	 	 	 	 	
  	 	Increase (Decrease)
	
 	 	Pretax
	 	After Tax
	
Regulated electricity segment gross margin:	 	 	 	 	 	 	 	 	
Higher retail sales volumes due to customer growth, excluding weather effects	 	$	24	 	 	$	14	 	
Effects of weather on retail sales	 	 	10	 	 	 	6	 	
Decreased purchased power and fuel costs due to lower hedged gas and power prices	 	 	4	 	 	 	2	 	
Higher replacement power costs from plant outages due to higher market prices and more unplanned outages	 	 	(17	)	 	 	(10	)	
Retail electricity price reduction effective July 1, 2003	 	 	(13	)	 	 	(8	)	
Miscellaneous factors, net	 	 	(6	)	 	 	(3	)	

 	 	
Net increase in regulated electricity segment gross margin	 	 	2	 	 	 	1	 	

 	 	
Marketing and trading segment gross margin:	 	 	 	 	 	 	 	 	
Higher mark-to-market gains for future delivery due to higher forward prices for wholesale electricity	 	 	9	 	 	 	5	 	
Higher realized margins on wholesale sales primarily due to higher prices	 	 	10	 	 	 	6	 	
Lower competitive retail unit margins in California by APS Energy Services	 	 	(16	)	 	 	(9	)	

 	 	
Net increase in marketing and trading segment gross margin	 	 	3	 	 	 	2	 	

 	 	
Net increase in regulated electricity and marketing and trading segments’ gross margins	 	 	5	 	 	 	3	 	
Higher other income net of other expense primarily due to the sale of El Dorado’s limited partnership interest in the Phoenix Suns	 	 	39	 	 	 	23	 	
Higher operations and maintenance expense primarily due to higher customer service costs and new power plants in service	 	 	(4	)	 	 	(2	)	
Interest expense net decreases (increases):	 	 	 	 	 	 	 	 	
New power plants in service	 	 	(12	)	 	 	(7	)	
Primarily lower debt balances	 	 	8	 	 	 	5	 	
Depreciation and amortization decreases (increases):	 	 	 	 	 	 	 	 	
Decreased regulatory asset amortization	 	 	25	 	 	 	15	 	
New power plants in service	 	 	(9	)	 	 	(5	)	
Increased delivery and other assets	 	 	(9	)	 	 	(5	)	
Higher property taxes due to increased property values	 	 	(6	)	 	 	(4	)	
Miscellaneous items, net	 	 	—	 	 	 	3	 	

 	 	
Net increase in income from continuing operations	 	$	37	 	 	 	26	 	

Discontinued operations related to the first quarter of 2003	 	 	 	 	 	 	(5	)	

Net increase in net income	 	 	 	 	 	$	21	 	

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     The increase in net costs (primarily interest expense, depreciation, and operations and maintenance expense) related to new power plants placed in service in mid 2003 and mid 2004 by Pinnacle West Energy totaled approximately $15 million after income taxes in the six months ended June 30, 2004, compared with the prior year period.
Regulated Electricity Segment Revenues
     Regulated electricity segment revenues were $57 million higher for the six months ended June 30, 2004 compared with the prior year period, primarily as a result of:

•	 	a $48 million increase in retail revenues related to customer growth and higher average usage, excluding weather effects;	
 	
•	 	a $16 million increase in retail revenues related to weather;	
 	
•	 	a $13 million decrease in retail revenues related to a reduction in retail electricity prices; and	
 	
•	 	a $6 million increase due to miscellaneous factors.	
Marketing and Trading Segment Revenues
     Marketing and trading segment revenues were $14 million lower for the six months ended June 30, 2004 compared with the prior year period, primarily as a result of:

•	 	a $24 million decrease from generation sales other than Native Load primarily due to lower sales volumes and lower prices;	
 	
•	 	a $5 million decrease from lower competitive retail sales in California by APS Energy Services;	
 	
•	 	$6 million of higher other realized wholesale revenues primarily due to higher prices partially offset by lower volumes; and	
 	
•	 	$9 million in higher mark-to-market gains for future-period deliveries primarily as a result of higher forward prices for wholesale electricity.	
Real Estate Segment Revenues
     Real estate segment revenues were $21 million higher for the six months ended June 30, 2004 compared with the prior year period primarily as a result of increased home sales.
Other Revenues
     Other revenues were $3 million lower for the six months ended June 30, 2004 compared with the prior year period primarily due to lower revenues related to an NAC contract settlement in 2003.
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Liquidity and Capital Resources
      Capital Expenditure Requirements
     The following table summarizes the actual capital expenditures for the six months ended June 30, 2004 and estimated capital expenditures for the next three years (dollars in millions):

 	 	Six Months	 	 	
 	 	Ended June 30,
	 	Estimated
	
 	 	2004
	 	2004
	 	2005
	 	2006
	
APS	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
Delivery	 	$	161	 	 	$	326	 	 	$	390	 	 	$	453	 	
Generation (a) (b)	 	 	54	 	 	 	108	 	 	 	350	 	 	 	202	 	
Other (c)	 	 	9	 	 	 	29	 	 	 	30	 	 	 	18	 	

 	 	 	 	

Subtotal	 	 	224	 	 	 	463	 	 	 	770	 	 	 	673	 	
Pinnacle West Energy (a)	 	 	28	 	 	 	56	 	 	 	15	 	 	 	17	 	
SunCor (d)	 	 	37	 	 	 	83	 	 	 	27	 	 	 	17	 	
Other	 	 	1	 	 	 	1	 	 	 	—	 	 	 	—	 	

 	 	 	 	

Total	 	$	290	 	 	$	603	 	 	$	812	 	 	$	707	 	

 	 	 	 	

(a)	 	As discussed in Note 5 under “APS General Rate Case and Retail Rate Adjustment Mechanisms,” as part of its general rate case, APS has requested rate base treatment of the PWEC Dedicated Assets. Pinnacle West Energy’s actual capital expenditures related to the PWEC Dedicated Assets are estimated to be $15 million in 2004, $14 million in 2005 and $14 million in 2006.	

(b)	 	Estimate for 2005 includes about $190 million for acquisition of the Sundance Generating Station. See Note 5 for a discussion of the asset purchase agreement between APS and PPL Sundance Energy, LLC.	

(c)	 	Primarily information systems and facilities projects.	

(d)	 	Consists primarily of capital expenditures for land development and retail and office building construction reflected in “Change in real estate investments” on the Condensed Consolidated Statements of Cash Flows.	
     Delivery capital expenditures are comprised of T&D infrastructure additions and upgrades, capital replacements, new customer construction and related information systems and facility cost. Examples of the types of projects included in the forecast include T&D lines and substations, line extensions to new residential and commercial developments and upgrades to customer information systems. Major transmission projects are driven by strong regional customer growth. APS will begin major projects each year for the next several years, and expects to spend about $200 million on major transmission projects during the 2004 to 2006 time frame. These amounts are included in “APS-Delivery” in the table above. Completion of these projects will stretch from 2005 through at least 2008.
     Generation capital expenditures are comprised of various improvements to APS’ existing fossil and nuclear plants and the replacement of Palo Verde steam generators.
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Examples of the types of projects included in this category are additions, upgrades and capital replacements of various power plant equipment such as turbines, boilers and environmental equipment. Generation also includes nuclear fuel expenditures of approximately $30 million annually for 2004 to 2006.
     Replacement of the steam generators in Palo Verde Unit 2 was completed during the fall outage of 2003 at a cost to APS of approximately $70 million. The Palo Verde owners have approved the manufacture of two additional sets of steam generators. These generators will be installed in Unit 1 (scheduled completion in 2005) and Unit 3 (scheduled completion in 2007). Our portion of steam generator expenditures for Units 1 and 3 is approximately $140 million, which will be spent through 2008. In 2004 through 2006, approximately $90 million of the Unit 1 and Unit 3 costs are included in the generation capital expenditures table above and will be funded with internally-generated cash or external financings.
      Contractual Obligations
     Our future contractual obligations have not changed materially from the amounts disclosed in Part II, Item 7 of the 2003 Form 10-K with the following exceptions that occurred in the six months ended June 30, 2004:

•	 	Our purchased power and fuel commitments increased approximately $126 million with respect to 2004 payment obligations.	

•	 	See Note 4 for a list of payments due on total long-term debt and capitalized lease requirements.	

•	 	Our purchase obligations for 2005 increased approximately $190 million for our proposed acquisition of the Sundance Generating Station. See Note 5, “Regulatory Matters – Request for Proposals and Asset Purchase Agreement,” for a discussion of the asset purchase agreement between APS and PPL Sundance, including required regulatory approvals.	
      Off-Balance Sheet Arrangements
     In 2003, we adopted FIN No. 46R, “Consolidation of Variable Interest Entities,” as it applies to special-purpose entities. FIN No. 46R requires that we consolidate a VIE if we have a majority of the risk of loss from the VIE’s activities or we are entitled to receive a majority of the VIE’s residual returns or both. A VIE is a corporation, partnership, trust or any other legal structure that either does not have equity investors with voting rights or has equity investors that do not provide sufficient financial resources for the entity to support its activities.
     In 1986, APS entered into agreements with three separate SPE lessors in order to sell and lease back interests in Palo Verde Unit 2. The leases are accounted for as operating leases in accordance with GAAP. Based on our assessment of FIN No. 46R, we are not required to consolidate the Palo Verde VIEs.
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     APS is exposed to losses under the Palo Verde sale leaseback agreements upon the occurrence of certain events that APS does not consider to be reasonably likely to occur. Under certain circumstances (for example, the NRC issuing specified violation orders with respect to Palo Verde or the occurrence of specified nuclear events), APS would be required to assume the debt associated with the transactions, make specified payments to the equity participants, and take title to the leased Unit 2 interests, which, if appropriate, may be required to be written down in value. If such an event had occurred as of June 30, 2004, APS would have been required to assume approximately $250 million of debt and pay the equity participants approximately $195 million.
     In the first quarter of 2004, we adopted FIN No. 46R for all other contractual arrangements. There was no impact to our financial statements.
      Guarantees and Letters of Credit
     We and certain of our subsidiaries have issued guarantees and letters of credit in support of our unregulated businesses. We have also obtained surety bonds on behalf of APS Energy Services. We have not recorded any liability on our Condensed Consolidated Balance Sheets with respect to these obligations. See Note 16 for additional information regarding guarantees and letters of credit.
      Credit Ratings
     The ratings of securities of Pinnacle West and APS as of August 4, 2004 are shown below and are considered to be “investment-grade” ratings. The ratings reflect the respective views of the rating agencies, from which an explanation of the significance of their ratings may be obtained. There is no assurance that these ratings will continue for any given period of time. The ratings may be revised or withdrawn entirely by the rating agencies, if, in their respective judgments, circumstances so warrant. Any downward revision or withdrawal may adversely affect the market price of Pinnacle West’s or APS’ securities and serve to increase those companies’ cost of and access to capital. It may also require additional collateral related to certain derivative instruments (see Note 10). 

 	 	Moody's	 	Standard & Poor's	
Pinnacle West	 	 	 	 	 	 	
Senior unsecured	 	Baa2	 	BBB-	
Commercial paper	 	P-2	 	 	A-2	 	
Outlook	 	Negative	 	Negative	
 	 	 	 	 	 	 	
APS	 	 	 	 	 	 	
Senior unsecured	 	Baa1	 	BBB	
Secured lease obligation bonds	 	Baa2	 	BBB	
Commercial paper	 	P-2	 	 	A-2	 	
Outlook	 	Negative	 	Negative	
     APS no longer has any senior secured debt. See “APS” below for a discussion of the termination of APS’ mortgage and deed of trust.
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      Debt Provisions
     Pinnacle West’s and APS’ debt covenants related to their respective financing arrangements include a debt-to-total-capitalization ratio and an interest coverage test. Pinnacle West and APS comply with these covenants and each anticipates it will continue to meet these and other significant covenant requirements. The ratio of debt to total capitalization cannot exceed 65% for the Company and for APS. At June 30, 2004, the ratio was approximately 54% for Pinnacle West. At June 30, 2004, the ratio was approximately 54% for APS. The provisions regarding interest coverage require a minimum cash coverage of two times the interest requirements for each of the Company and APS. The coverages were approximately 4 times for the Company and 4 times for the APS bank financing agreements at June 30, 2004. Failure to comply with such covenant levels would result in an event of default which, generally speaking, would require the immediate repayment of the debt subject to the covenants.
     Neither Pinnacle West’s nor APS’ financing agreements contain “ratings triggers” that would result in an acceleration of the required interest and principal payments in the event of a ratings downgrade. However, in the event of a ratings downgrade, Pinnacle West and/or APS may be subject to increased interest costs under certain financing agreements.
     All of Pinnacle West’s bank agreements contain “cross-default” provisions that would result in defaults and the potential acceleration of payment under these loan agreements if Pinnacle West or APS were to default under other agreements. All of APS’ bank agreements contain cross-default provisions that would result in defaults and the potential acceleration of payment under these bank agreements if APS were to default under other agreements. Pinnacle West’s and APS’ credit agreements generally contain provisions under which the lenders could refuse to advance loans in the event of a material adverse change in financial condition or financial prospects, except APS does not have a material adverse change restriction for revolver borrowings equal to outstanding commercial paper amounts.
     See Note 4 for further discussions.
      Capital Needs and Resources by Company
      Pinnacle West (Parent Company)
     Our primary cash needs are for dividends to our shareholders; interest payments and optional and mandatory repayments of principal on our long-term debt and equity infusions into our subsidiaries, primarily Pinnacle West Energy. The level of our common dividends and future dividend growth will be dependent on a number of factors including, but not limited to, payout ratio trends, free cash flow and financial market conditions.
     Our primary sources of cash are dividends from APS, external financings and cash distributions from our other subsidiaries, primarily SunCor. We expect SunCor to make cash distributions to the parent company of $80 to $100 million annually in 2004 and 2005
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due to anticipated accelerated asset sales activity. As discussed in Note 5 under “ACC Financing Orders,” APS must maintain a common equity ratio of at least 40% and may not pay common dividends if the payment would reduce its common equity below that threshold. As defined in the Financing Order, common equity ratio is common equity divided by common equity plus long-term debt, including current maturities of long-term debt. At June 30, 2004, APS’ common equity ratio was approximately 45 %.
     On February 2, 2004, we used proceeds from the $165 million Floating Rate Notes issued on November 12, 2003 and short term borrowings to pay down the maturing $215 million 4.5% Senior Notes due 2004.
     Pinnacle West sponsors a pension plan that covers employees of Pinnacle West and our subsidiaries. We contribute at least the minimum amount required under IRS regulations, but no more than the maximum tax-deductible amount. The minimum required funding takes into consideration the value of the fund assets and our pension obligation. APS and other subsidiaries fund their share of the pension contribution, of which APS represents approximately 89% of the total funding amounts described above. The assets in the plan are comprised of common stocks, bonds and real estate. Future year contribution amounts are dependent on fund performance and fund valuation assumptions. The United States Pension Stability Act was signed into law on April 10, 2004. Under this new legislation, our required pension contribution in 2004 is $35 million, which we plan to contribute in the third quarter. We have contributed approximately $14 million to our other postretirement benefits plan in 2004 through June.
      APS
     APS’ capital requirements consist primarily of capital expenditures and optional and mandatory redemptions of long-term debt. See Note 5 for a discussion of the $500 million financing arrangement between APS and Pinnacle West Energy approved by the ACC in 2003.
     APS pays for its capital requirements with cash from operations and, to the extent necessary, external financings. APS has historically paid for its dividends to Pinnacle West with cash from operations. See “Pinnacle West (Parent Company)” above for a discussion of common equity ratio that APS must maintain in order to pay dividends to Pinnacle West.
     On February 15, 2004, $125 million of APS’ 5.875% Notes due 2004 were redeemed at maturity and on March 1, 2004, $80 million of APS’ First Mortgage Bonds, 6.625% Series due 2004 were redeemed at maturity. APS used cash from operations and short-term debt to redeem the maturing debt.
     On March 31, 2004, Navajo County, Arizona Pollution Control Corporation issued $166 million of variable interest rate pollution control bonds, 2004 Series A-E, due 2034. The bonds were issued to refinance $166 million of outstanding pollution control bonds. The Series A-E bonds are payable solely from revenues obtained from APS pursuant to a loan agreement between APS and Navajo County, Arizona Pollution Control Corporation. These bonds are classified as long-term debt on our Condensed Consolidated Balance Sheets.
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     Also on March 31, 2004, Coconino County, Arizona Pollution Control Corporation issued $13 million of variable interest rate pollution control bonds, 2004 Series A, due 2034. The bonds were issued to refinance $13 million of outstanding pollution control bonds. The Series A bonds are payable solely from revenues obtained from APS pursuant to a loan agreement between APS and Coconino County, Arizona Pollution Control Corporation. These bonds are classified as long-term debt on our Condensed Consolidated Balance Sheets.
     In May 2004, we renewed our $250 million revolving credit facility, while increasing its size to $325 million and extending its term to three years. The revolver provides liquidity support for APS’ $250 million commercial paper program, as well as an additional $75 million for other liquidity needs and miscellaneous letters of credit.
     On June 29, 2004 APS issued $300 million of 5.80% senior unsecured notes due June 30, 2014. The proceeds from the sale of the notes will be used to redeem all or a portion of $100 million in aggregate principal amount of APS’ 6.25% Notes due January 15, 2005 and/or all or a portion of $300 million in aggregate principal amount of APS’ 7.625% Notes due August 1, 2005.
     APS has retired all first mortgage bonds issued by APS under its 1946 mortgage and deed of trust, including the first mortgage bonds securing APS senior notes. On April 30, 2004, APS terminated its mortgage and deed of trust and, as a result, is not able to issue any additional first mortgage bonds under that mortgage.
     Although provisions in APS’ articles of incorporation and ACC financing orders establish maximum amounts of preferred stock and debt that APS may issue, APS does not expect any of these provisions to limit its ability to meet its capital requirements.
      Pinnacle West Energy
     Pinnacle West Energy’s capital requirements consist primarily of capital expenditures. As of May 2004, SNWA has paid Pinnacle West Energy about $93 million for a 25% interest in the 570 MW Silverhawk combined cycle plant. Pinnacle West Energy’s capital requirements are funded through capital infusions from Pinnacle West, which finances those infusions through debt and equity financings and internally-generated cash. See the capital expenditures table above for actual capital expenditures in the six months ended June 30, 2004 and projected capital expenditures for the next three years.
     See Note 5 for a discussion of the $500 million financing arrangement between APS and Pinnacle West Energy authorized by the ACC pursuant to the Financing Order.
      Other Subsidiaries
     During the past three years, SunCor funded its cash requirements with cash from operations and its own external financings. SunCor’s capital needs consist primarily of capital expenditures for land development and retail and office building construction. See the capital expenditures table above for actual capital expenditures in the six months ended June 30, 2004 and projected capital expenditures for the next three years. SunCor expects to fund its capital requirements with cash from operations and external financings.
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     We expect SunCor to make cash distributions to the parent company of $80 to $100 million annually in 2004 and 2005 due to anticipated accelerated asset sales activity.
     El Dorado funded its cash requirements during the past three years, primarily for NAC in 2002, with cash infused by the parent company and with cash from operations. El Dorado expects minimal capital requirements over the next three years and intends to focus on prudently realizing the value of its existing investments.
     APS Energy Services’ cash requirements during the past three years were funded with cash infusions from the parent company and with cash from operations.
      Critical Accounting Policies
     In preparing the financial statements in accordance with GAAP, management must often make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues, expenses and related disclosures at the date of the financial statements and during the reporting period. Some of those judgments can be subjective and complex, and actual results could differ from those estimates. Our most critical accounting policies include the impacts of regulatory accounting and the determination of the appropriate accounting for our pension and other postretirement benefits, derivatives and mark-to-market accounting. There have been no changes to our critical accounting policies since our 2003 Form 10-K except for the impact of recent accounting pronouncements as discussed in Note 8. See “Critical Accounting Policies” in Item 7 of the 2003 Form 10-K for further details about our critical accounting policies.
Business Outlook
      2004 Earnings Outlook
     We confirm our previous guidance that we expect our 2004 earnings will be approximately $2.50 per share, after taxes on a fully-diluted basis. This estimate assumes no contribution from a general rate case decision (see Note 5) and excludes the gains on El Dorado’s sale of its limited partnership interest in the Phoenix Suns (see Note 19) and its pending sale of NAC (see Note 20). Although temporary transmission constraints related to recent substation fires in our Phoenix service territory likely will have a modest negative impact on 2004 earnings, it would be premature to change our guidance at this time. This earnings guidance, which supersedes all previous 2004 earnings guidance provided by the Company, is forward-looking information, and actual results may differ materially from our expectations. See “Forward-Looking Statements” below.
     A number of factors affecting our business outlook are discussed below.
      APS General Rate Case
     We believe APS’ general rate case pending before the ACC is the key issue affecting our outlook. See Note 5 for a detailed discussion of this rate case.
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      Wholesale Power Market Conditions
     The marketing and trading division focuses primarily on managing APS’ purchased power and fuel risks in connection with its costs of serving retail customer demand. We moved this division to APS in early 2003 for future marketing and trading activities (existing wholesale contracts remained at Pinnacle West) as a result of the ACC’s Track A Order prohibiting APS’ transfer of generating assets to Pinnacle West Energy. Additionally, the marketing and trading division, subject to specified parameters, markets, hedges and trades in electricity, fuels and emission allowances and credits. Our future earnings will be affected by the strength or weakness of the wholesale power market. The market has suffered a substantial reduction in overall liquidity because there are fewer creditworthy counterparties and because several key participants have exited the market or scaled back their activities.
      Generation Construction Program
     See “Liquidity and Capital Resources – Pinnacle West Energy” for information regarding Pinnacle West Energy’s generation construction program, which is nearing completion. The additional generation is expected to increase revenues, fuel expenses, operating expenses and financing costs.
      Factors Affecting Operating Revenues
      General Electric operating revenues are derived from sales of electricity in regulated retail markets in Arizona and from competitive retail and wholesale power markets in the western United States. These revenues are expected to be affected by electricity sales volumes related to customer mix, customer growth and average usage per customer as well as electricity prices and variations in weather from period to period. Competitive sales of energy and energy-related products and services are made by APS Energy Services in western states that have opened to competitive supply.
      Customer Growth Customer growth in APS’ service territory averaged about 3.4% a year for the three years 2001 through 2003; we currently expect customer growth to average about 3.6% per year from 2004 to 2006. We currently estimate that total retail electricity sales in kilowatt-hours will grow 4.8 % on average, from 2004 through 2006, before the retail effects of weather variations. The customer and sales growth referred to in this paragraph applies to Native Load customers. Customer growth for the six-month period ended June 30, 2004 compared with the prior year period was 3.6%.
      Retail Rate Changes As part of the 1999 Settlement Agreement, APS agreed to a series of annual retail electricity price reductions of 1.5% on July 1 for each of the years 1999 to 2003 for a total of 7.5%. The final price reduction was implemented July 1, 2003. See “1999 Settlement Agreement” in Note 5 for further information. In addition, the Company has requested a 9.8% retail rate increase to be effective July 1, 2004. See “APS General Rate Case and Retail Rate Adjustment Mechanisms” in Note 5 for further information.
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      Other Factors Affecting Future Financial Results
      Purchased Power and Fuel Costs Purchased power and fuel costs are impacted by our electricity sales volumes, existing contracts for purchased power and generation fuel, our power plant performance, prevailing market prices, new generating plants being placed in service and our hedging program for managing such costs. See “Natural Gas Supply” in Note 12 for more information on fuel costs.
      Operations and Maintenance Expenses Operations and maintenance expenses are impacted by growth, power plant additions and operations, inflation, outages, higher trending pension and other postretirement benefit costs and other factors.
      Depreciation and Amortization Expenses Depreciation and amortization expenses are impacted by net additions to existing utility plant and other property, changes in regulatory asset amortization and our generation construction program. West Phoenix Unit 4 was placed in service in June 2001. Redhawk Units 1 and 2 and the new Saguaro Unit 3 began commercial operations in July 2002. West Phoenix Unit 5 was placed in service in July 2003 and Silverhawk was placed in service in May 2004. The regulatory assets to be recovered through June 30, 2004 under the 1999 Settlement Agreement were amortized as follows (dollars in millions): 

1999
	2000
	2001
	2002
	2003
	2004
	Total
	
 	$	164	 	 	$	158	 	 	$	145	 	 	$	115	 	 	$	86	 	 	$	18	 	 	$	686	 	
      Property Taxes Taxes other than income taxes consist primarily of property taxes, which are affected by tax rates and the value of property in-service and under construction. The average property tax rate for APS, which currently owns the majority of our property, was 9.3% of assessed value for 2003 and 9.7% for 2002. We expect property taxes to increase primarily due to our generation construction program, as the plants phase-in to the property tax base over a five-year period, and our additions to existing facilities.
      Interest Expense Interest expense is affected by the amount of debt outstanding and the interest rates on that debt. The primary factors affecting borrowing levels in the next several years are expected to be our capital requirements and our internally generated cash flow. Capitalized interest offsets a portion of interest expense while capital projects are under construction. We stop accruing capitalized interest on a project when it is placed in commercial operation. As noted above, we placed new power plants in commercial operation in 2001, 2002, 2003 and 2004. Interest expense is also affected by interest rates on variable-rate debt and interest rates on the refinancing of the Company’s future liquidity needs.
      Retail Competition The regulatory developments and legal challenges to the Rules discussed in Note 5 have raised considerable uncertainty about the status and pace of retail electric competition and of electric restructuring in Arizona. Although some very limited retail competition existed in APS’ service area in 1999 and 2000, there are currently no active retail competitors providing unbundled energy or other utility services to APS’ customers. As a result, we cannot predict when, and the extent to which, additional competitors will re-enter APS’ service territory.
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      Subsidiaries In the case of SunCor, efforts to accelerate asset sales activities in 2003 were successful. A portion of these sales have been, and additional amounts may be required to be, reported as discontinued operations on our Condensed Consolidated Statements of Income. See Note 18 for further discussion. The annual earnings contribution from SunCor was $56 million after tax in 2003. We anticipate SunCor’s annual earnings contributions will average $30-$40 million over the years 2004 and 2005.
     The annual earnings contribution from APS Energy Services is expected to be positive over the next several years due primarily to a number of retail electricity contracts in California. APS Energy Services had after tax earnings of $16 million in 2003.
     We expect SunCor and APS Energy Services to have combined earnings of approximately $10 million per year after tax beyond 2005.
     El Dorado’s historical results are not necessarily indicative of future performance. In June 2004, the Phoenix Suns Limited Partnership, in which El Dorado holds limited partnership interests, sold the partnership’s assets to a new investor group. The transaction resulted in a gain for El Dorado of approximately $21 million after income taxes (see Note 19 for further information). See Note 20 for information regarding El Dorado’s pending sale of NAC.
      General Our financial results may be affected by a number of broad factors. See “Forward-Looking Statements” below for further information on such factors, which may cause our actual future results to differ from those we currently seek or anticipate.
Risk Factors
     Exhibit 99.1, which is hereby incorporated by reference, contains a discussion of risk factors affecting the Company.
Forward-Looking Statements
     This document contains forward-looking statements based on current expectations, and we assume no obligation to update these statements or make any further statements on any of these issues, except as required by applicable law. These forward-looking statements are often identified by words such as “predict”, “hope,” “may,” “believe,” “anticipate,” “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 results or outcomes currently expected or sought by us. In addition to the Risk Factors noted above (see Exhibit 99.1), these factors include, but are not limited to:

•	 	state and federal regulatory and legislative decisions and actions, including the outcome of the rate case we filed with the ACC on June 27, 2003 and the wholesale electric price mitigation plan adopted by the FERC;	

•	 	the ongoing restructuring of the electric industry, including the introduction of retail electric competition in Arizona and decisions impacting wholesale competition;	
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•	 	the outcome of regulatory, legislative and judicial proceedings relating to the restructuring;	
 	
•	 	market prices for electricity and natural gas;	
 	
•	 	power plant performance and outages, including transmission outages and constraints;	
 	
•	 	weather variations affecting local and regional customer energy usage;	
 	
•	 	energy usage;	
 	
•	 	regional economic and market conditions, including the results of litigation and other proceedings resulting from the California energy situation, volatile purchased power and fuel costs and the completion of generation and transmission construction in the region, which could affect customer growth and the cost of power supplies;	
 	
•	 	the cost of debt and equity capital and access to capital markets;	
 	
•	 	our ability to compete successfully outside traditional regulated markets (including the wholesale market);	
 	
•	 	the performance of our marketing and trading activities due to volatile market liquidity and deteriorating counterparty credit and the use of derivative contracts in our business (including the interpretation of the subjective and complex accounting rules related to these contracts);	
 	
•	 	changes in accounting principles generally accepted in the United States of America;	
 	
•	 	the performance of the stock market and the changing interest rate environment, which affect the amount of our required contributions to our pension plan and nuclear decommissioning trust funds, as well as our reported costs of providing pension and other postretirement benefits;	
 	
•	 	technological developments in the electric industry;	
 	
•	 	strength of the real estate market in SunCor’s market areas, which include Arizona, Idaho, New Mexico and Utah;	
 	
•	 	conservation programs; and	
 	
•	 	other uncertainties, all of which are difficult to predict and many of which are beyond our control.	
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Item 3. Market Risks
     Our operations include managing market risks related to changes in interest rates, commodity prices and investments held by our nuclear decommissioning trust fund.
      Interest Rate and Equity Risk
     Our major financial market risk exposure is to changing interest rates. Changing interest rates will affect interest paid on variable-rate debt and interest earned by our nuclear decommissioning trust fund. Our policy is to manage interest rates through the use of a combination of fixed-rate and floating-rate debt.
     On January 29, 2004, we entered into two fixed-for-floating interest rate swap transactions on our $300 million 6.4% senior note. These transactions qualify as fair value hedges under SFAS No. 133. See Note 10.
      Commodity Price Risk
     We are exposed to the impact of market fluctuations in interest rates and in the commodity price and transportation costs of electricity, natural gas, coal and emissions allowances. We manage risks associated with these market fluctuations by utilizing various instruments that qualify as derivatives, including exchange-traded futures and options and over-the-counter forwards, options and swaps. Our ERMC, consisting of officers and key management personnel, oversees company-wide energy risk management activities and monitors the results of marketing and trading activities to ensure compliance with our stated energy risk management and trading policies. As part of our risk management program, we use such instruments to hedge our exposure to changes in interest rates and to hedge purchases and sales of electricity, fuels and emissions allowances and credits. The changes in market value of such contracts have a high correlation to price changes in the hedged transactions. In addition, subject to specified risk parameters monitored by the ERMC, we engage in marketing and trading activities intended to profit from market price movements.
     The mark-to-market values of derivative instruments related to our risk management and trading activities are presented in two categories consistent with our business segments:

•	 	Regulated Electricity – non-trading derivative instruments that hedge our purchases and sales of electricity and fuel for APS’ Native Load requirements of our regulated electricity business segment; and	

•	 	Marketing and Trading – non-trading and trading derivative instruments of our competitive business segment.	
     The following tables show the pretax changes in mark-to-market of our regulated electricity and marketing and trading derivative positions for the six months ended June 30, 2004 and 2003 (dollars in millions):
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  	 	Six Months Ended	 	Six Months Ended	
 	 	June 30, 2004
	 	June 30, 2003
	
 	 	 	 	 	 	Marketing	 	 	 	 	 	Marketing	
 	 	Regulated	 	and	 	Regulated	 	and	
 	 	Electricity
	 	Trading
	 	Electricity
	 	Trading
	
Mark-to-market of net positions at beginning of period	 	$	—	 	 	$	69	 	 	$	(49	)	 	$	57	 	
Change in mark-to-market gains/(losses) for future period deliveries	 	 	11	 	 	 	13	 	 	 	6	 	 	 	(5	)	
Changes in cash flow hedges recorded in OCI	 	 	48	 	 	 	25	 	 	 	33	 	 	 	46	 	
Ineffective portion of changes in fair value recorded in earnings	 	 	1	 	 	 	1	 	 	 	6	 	 	 	1	 	
Mark-to-market losses/(gains) realized during the period	 	 	3	 	 	 	(10	)	 	 	7	 	 	 	(14	)	

 	 	 	 	

Mark-to-market of net positions at end of period	 	$	63	 	 	$	98	 	 	$	3	 	 	$	85	 	

 	 	 	 	

     The tables below show the fair value of maturities of our regulated electricity and trading derivative contracts (dollars in millions) at June 30, 2004 by maturities and by the type of valuation that is performed to calculate the fair values. See “Critical Accounting Policies — Mark-to-Market Accounting,” in Item 7 of our 2003 Form 10-K for more discussion on our valuation methods. 
Regulated Electricity

 	 	 	 	 	 	 	 	 	 	 	 	 	 	Total	
 	 	 	 	 	 	 	 	 	 	Years	 	fair	
Source of Fair Value
	 	2004
	 	2005
	 	thereafter
	 	value
	
Prices actively quoted	 	$	19	 	 	$	27	 	 	$	8	 	 	$	54	 	
Prices provided by other external sources	 	 	8	 	 	 	1	 	 	 	—	 	 	 	9	 	
Prices based on models and other valuation methods	 	 	—	 	 	 	—	 	 	 	—	 	 	 	—	 	

 	 	 	 	

Total by maturity	 	$	27	 	 	$	28	 	 	$	8	 	 	$	63	 	

 	 	 	 	

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Marketing and Trading

 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	Total	
 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	Years	 	fair	
Source of Fair Value
	 	2004
	 	2005
	 	2006
	 	2007
	 	2008
	 	thereafter
	 	value
	
Prices actively quoted	 	$	14	 	 	$	—	 	 	$	—	 	 	$	—	 	 	$	—	 	 	$	—	 	 	$	14	 	
Prices provided by other external sources	 	 	—	 	 	 	32	 	 	 	33	 	 	 	38	 	 	 	19	 	 	 	(1	)	 	 	121	 	
Prices based on models and other valuation methods	 	 	—	 	 	 	(3	)	 	 	(13	)	 	 	(15	)	 	 	(5	)	 	 	(1	)	 	 	(37	)	

 	 	 	 	

 	 	 	 	

Total by maturity	 	$	14	 	 	$	29	 	 	$	20	 	 	$	23	 	 	$	14	 	 	$	(2	)	 	$	98	 	

 	 	 	 	

 	 	 	 	

     The table below shows the impact that hypothetical price movements of 10% would have had on the market value of our risk management and trading assets and liabilities included on the Condensed Consolidated Balance Sheets at June 30, 2004 (dollars in millions).

  	 	June 30, 2004	
 	 	Gain (Loss)
	
 	 	Price Up	 	Price Down	
Commodity
	 	10%
	 	10%
	
Mark-to-market changes reported in earnings (a):	 	 	 	 	 	 	 	 	
Electricity	 	$	(2	)	 	$	2	 	
Natural gas	 	 	1	 	 	 	(1	)	
Mark-to-market changes reported in OCI (b):	 	 	 	 	 	 	 	 	
Electricity	 	 	40	 	 	 	(40	)	
Natural gas	 	 	34	 	 	 	(34	)	

 	 	
Total	 	$	73	 	 	$	(73	)	

 	 	

(a)	 	These contracts are primarily structured sales activities hedged with a portfolio of forward purchases that protects the economic value of the sales transactions.	
 	
(b)	 	These contracts are hedges of our forecasted purchases of natural gas and electricity. The impact of these hypothetical price movements would substantially offset the impact that these same price movements would have on the physical exposures being hedged.	
Credit Risk
     We are exposed to losses in the event of nonperformance or nonpayment by counterparties. We have risk management and trading contracts with many counterparties, including two counterparties for which a worst case exposure represented approximately 26% of our $373 million of risk management and trading assets as of June 30, 2004. See “Critical Accounting Policies - Mark-to-Market Accounting,” in Item 7 of our 2003 Form 10-K
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for more discussion on our valuation methods. See Note 10 for further discussion of credit risk. 
Item 4. Controls and Procedures
     (a) Evaluation of Disclosure Controls and Procedures
     The Company’s management, with the participation of the Company’s Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness the Company’s disclosure controls and procedures as of the end of the period covered by this report. Based on that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that the Company’s disclosure controls and procedures as of the end of the period covered by this report have been designed and are functioning effectively to provide reasonable assurance that the information required to be disclosed by the Company in reports filed under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms.
     (b) Change in Internal Control over Financial Reporting
     No change in the Company’s internal control over financial reporting occurred during the Company’s most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.
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PART II – OTHER INFORMATION 

Item 2. 	Changes in Securities, Use of Proceeds and Issuer Purchases of Equity Securities	
     (e) Issuer Purchases of Equity Securities
     The following table contains information about our purchases of our common stock during the second quarter of 2004. 
Issuer Purchases of Equity Securities

 	 	 	 	 	 	 	 	 	 	 	 	 	 	Maximum	
 	 	 	 	 	 	 	 	 	 	 	 	 	 	Number (or	
 	 	 	 	 	 	 	 	 	 	 	 	 	 	Approximate	
 	 	 	 	 	 	 	 	 	 	Total Number	 	Dollar Value) of	
 	 	 	 	 	 	 	 	 	 	of Shares	 	Shares that	
 	 	 	 	 	 	 	 	 	 	Purchased as	 	May Yet Be	
 	 	 	 	 	 	 	 	 	 	Part of Publicly	 	Purchased	
 	 	Total Number	 	 	 	 	 	Announced	 	Under the	
 	 	of Shares	 	Average Price	 	Plans or	 	Plans or	
Period
	 	Purchased (1)
	 	Paid per Share
	 	Programs
	 	Programs
	
April 1 to April 30, 2004	 	 	—	 	 	 	—	 	 	 	—	 	 	 	—	 	
May 1 to May 31, 2004	 	 	80,000	 	 	$	37.3047	 	 	 	—	 	 	 	—	 	
June 1 to June 30, 2004	 	 	—	 	 	 	—	 	 	 	—	 	 	 	—	 	

 	 	 	 	

Total	 	 	80,000	 	 	$	37.3047	 	 	 	—	 	 	 	—	 	

(1)	 	Represents shares purchased on the open market to satisfy common stock requirements under our Savings Plan, 1994 Long-Term Incentive Plan, 2002 Long-Term Incentive Plan, and Investors Advantage Plan. Later this year, we intend to begin satisfying the common stock requirements under these plans through newly-issued common stock.	
Item 4. Submission of Matters to a Vote of Security-Holders
     At our Annual Meeting of Shareholders held on May 19, 2004, the following persons were elected as directors:
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Class I (Term to expire at	 	 	 	 	 	 	 	 	 	Abstentions and	
2007 Annual Meeting)
	 	Votes For
	 	Votes Against
	 	Broker Non-Votes
	
Roy A. Herberger, Jr.	 	 	80,156,572	 	 	 	2,610,463	 	 	N/A	
 		
Humberto S. Lopez	 	 	80,240,013	 	 	 	2,527,022	 	 	N/A	
 		
Kathryn L. Munro	 	 	80,588,683	 	 	 	2,178,353	 	 	N/A	
 		
William L. Stewart	 	 	80,195,369	 	 	 	2,571,666	 	 	N/A	
     At the same meeting, a proposal for the ratification of the selection of Deloitte & Touche LLP as Independent Auditors of the Company was submitted to the shareholders, and the voting was as follows: 

Proposal for the ratification	 	 	 	 	 	 	 	 	 	Abstentions and	
of Deloitte & Touche LLP
	 	Votes For
	 	Votes Against
	 	Broker Non-Votes
	
	 	 	79,191,564	 	 	 	2,516,578	 	 	 	1,058,893	 	
     Also, at the same meeting, the following shareholder proposal was submitted to shareholders: 

Proposal that Pinnacle West	 	 	 	 	 	 	 	 	 	 	
provide shareholders with a	 	 	 	 	 	 	 	 	 	 	
report regarding the interim	 	 	 	 	 	 	 	 	 	 	
storage of irradiated fuel	 	 	 	 	 	 	 	 	 	Abstentions and	
rods at Palo Verde
	 	Votes For
	 	Votes Against
	 	Broker Non-Votes
	
	 	 	4,484,685	 	 	 	57,733,104	 	 	 	10,393,800	 	
Item 5. Other Information
Construction and Financing Programs
     See “Liquidity and Capital Resources” in Part I, Item 2 of this report for a discussion of construction and financing programs of the Company and its subsidiaries.
Regulatory Matters
     See Note 5 of Notes to Condensed Consolidated Financial Statements in Part I, Item 1 of this report for a discussion of regulatory developments.
Environmental Matters
     See “Environmental Matters — Superfund” in Note 12 of Notes to Condensed Consolidated Financial Statements for a discussion of a superfund site.
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Item 6. Exhibits and Reports on Form 8-K
     (a) Exhibits 

Exhibit No.
	 	Description
	
3.1	 	Bylaws, amended as of June 23, 2004	
 	 	 	
10.1	 	Asset Purchase Agreement by and between PPL Sundance Energy, LLC, as Seller, and Arizona Public Service Company, as Purchaser, dated as of June 1, 2004	
 	 	 	
10.2 a	 	Form of Performance Accelerated Stock Option Agreement under Pinnacle West Capital Corporation 2002 Long-Term Incentive Plan	
 	 	 	
10.3 a	 	Form of Performance Share Agreement under Pinnacle West Capital Corporation 2002 Long-Term Incentive Plan	
 	 	 	
10.4 a	 	Form of Stock Ownership Incentive Agreement under Pinnacle West Capital Corporation 2002 Long-Term Incentive Plan	
 	 	 	
10.5 a	 	Form of Restricted Stock Award Agreement under Pinnacle West Capital Corporation 1994 Long-Term Incentive Plan	
 	 	 	
12.1	 	Ratio of Earnings to Fixed Charges	
 	 	 	
31.1	 	Certificate of William J. Post, Chief Executive Officer, pursuant to Rule 13a-14(a) and Rule 15d-14(a) of the Securities Exchange Act, as amended	

a	 	Agreements, substantially identical in all material respects to this Exhibit, have been entered into with officers and key employees of the Company. Although such additional documents may differ in other respects (such as stock amounts and dates of execution), there are no material details in which such agreements differ from this Exhibit.	
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Exhibit No.
	 	Description
	
31.2	 	Certificate of Donald E. Brandt, Chief Financial Officer, pursuant to Rule 13a-14(a) and Rule 15d-14(a) of the Securities Exchange Act, as amended	
 	 	 	
32.1	 	Certification of Chief Executive Officer and Chief Financial Officer, pursuant to 18 U.S.C. Section 1850, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002	
 	 	 	
99.1	 	Pinnacle West Risk Factors	
     In addition, the Company hereby incorporates the following Exhibits pursuant to Exchange Act Rule 12b-32 and Regulation §229.10(d) by reference to the filings set forth below: 

 	 	 	 	Originally Filed	 	 	 	Date	
Exhibit No.
	 	Description
	 	as Exhibit:
	 	File No. a
	 	Effective
	
3.2	 	Articles of Incorporation restated as of July 29, 1988	 	19.1 to the Company’s September 30, 1988 Form 10-Q Report	 	1-8962	 	11-14-88	

a Reports filed under File No. 1-8962 were filed in the office of the Securities and Exchange Commission located in Washington, D.C.
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(b)	 	Reports on Form 8-K	
     During the quarter ended June 30, 2004, and the period from July 1 through August 6, 2004, we filed the following reports on Form 8-K:
     Report dated March 31, 2004, containing exhibits comprised of financial information, earnings variance explanations and an earnings news release (Item 7, Item 9 and Item 12).
     Report dated April 16, 2004, containing a procedural order issued by an ACC ALJ, which revised the procedural schedule and timing of APS’ general rate case (Item 5 and Item 7).
     Report dated May 26, 2004, regarding the Asset Purchase Agreement between APS and PPL Sundance Energy, LLC and the issuance of a procedural order extending the stay of the procedural schedule and discovery in APS’ general rate case (Item 5).
     Report dated June 14, 2004, regarding a shutdown of the Palo Verde units, the issuance by an ACC ALJ of a procedural order extending the stay of the procedural schedule in APS’ general rate case and a FERC audit of APS and its affiliates (Item 5).
     Report dated June 30, 2004, containing exhibits comprised of financial information, earnings variance explanations and an earnings news release (Item 7, Item 9 and Item 12).
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SIGNATURES
     Pursuant to the requirements of the Securities Exchange Act of 1934, the Company has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 	 	PINNACLE WEST CAPITAL CORPORATION
     (Registrant)	
 	 	 	 	 	
Dated: August 6, 2004	 	By:	 	/s/  Donald E. Brandt	

	 	 	 	Donald E. Brandt	
	 	 	 	Executive Vice President and Chief	
	 	 	 	Financial Officer	
	 	 	 	(Principal Financial Officer and Officer Duly Authorized to sign this Report)	
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Exhibit Index 

Exhibit No.
	 	Description
	
3.1	 	Bylaws, amended as of June 23, 2004	
 	 	 	
10.1	 	Asset Purchase Agreement by and between PPL Sundance Energy, LLC, as Seller, and Arizona Public Service Company, as Purchaser, dated as of June 1, 2004	
 	 	 	
10.2 a	 	Form of Performance Accelerated Stock Option Agreement under Pinnacle West Capital Corporation 2002 Long-Term Incentive Plan	
 	 	 	
10.3 a	 	Form of Performance Share Agreement under Pinnacle West Capital Corporation 2002 Long-Term Incentive Plan	
 	 	 	
10.4 a	 	Form of Stock Ownership Incentive Agreement under Pinnacle West Capital Corporation 2002 Long-Term Incentive Plan	
 	 	 	
10.5 a	 	Form of Restricted Stock Award Agreement under Pinnacle West Capital Corporation 1994 Long-Term Incentive Plan	
 	 	 	
12.1	 	Ratio of Earnings to Fixed Charges	
 	 	 	
31.1	 	Certificate of William J. Post, Chief Executive Officer, pursuant to Rule 13a-14(a) and Rule 15d-14(a) of the Securities Exchange Act, as amended	

a	 	Agreements, substantially identical in all material respects to this Exhibit, have been entered into with officers and key employees of the Company. Although such additional documents may differ in other respects (such as stock amounts and dates of execution), there are no material details in which such agreements differ from this Exhibit.	

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Exhibit No.
	 	Description
	
31.2	 	Certificate of Donald E. Brandt, Chief Financial Officer, pursuant to Rule 13a-14(a) and Rule 15d-14(a) of the Securities Exchange Act, as amended	
 	 	 	
32.1	 	Certification of Chief Executive Officer and Chief Financial Officer, pursuant to 18 U.S.C. Section 1850, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002	
 	 	 	
99.1	 	Pinnacle West Risk Factors	
     In addition, the Company hereby incorporates the following Exhibits pursuant to Exchange Act Rule 12b-32 and Regulation §229.10(d) by reference to the filings set forth below: 

 	 	 	 	Originally Filed	 	 	 	Date	
Exhibit No.
	 	Description
	 	as Exhibit:
	 	File No. a
	 	Effective
	
3.2	 	Articles of Incorporation restated as of July 29, 1988	 	19.1 to the Company’s September 30, 1988 Form 10-Q Report	 	1-8962	 	11-14-88	

a	 	Reports filed under File No. 1-8962 were filed in the office of the Securities and Exchange Commission located in Washington, D.C.	

EXHIBIT 3.1
BYLAWS
OF
PINNACLE WEST CAPITAL CORPORATION
 (AMENDED AS OF JUNE 23, 2004)
I. REFERENCES; SENIORITY
1.01. REFERENCES. Any reference herein made to law will be deemed to refer to the law of the State of Arizona, including any applicable provision or provisions of Chapters 1-17 and Chapter 23 of Title 10, Arizona Revised Statutes (or its successor), as at any given time in effect. Any reference herein made to the Articles will be deemed to refer to the applicable provision or provisions of the Articles of Incorporation of the Company, and all amendments thereto, as at any given time on file with the Arizona Corporation Commission (this reference to that Commission being intended to include any successor to the incorporating and related functions being performed by that Commission at the date of the initial adoption of these Bylaws).
1.02. SENIORITY. Except as indicated in Part X of these Bylaws, the law and the Articles (in that order of precedence) will in all respects be considered senior and superior to these Bylaws, with any inconsistency to be resolved in favor of the law and the Articles (in that order of precedence), and with these Bylaws to be deemed automatically amended from time to time to eliminate any such inconsistency which may then exist.
1.03. SHAREHOLDERS OF RECORD. Except as otherwise required by law and subject to any procedure established by the Company pursuant to Arizona Revised Statutes Section 10-723 (or any comparable successor provision), the word "shareholder" as used herein shall mean one who is a holder of record of shares of capital stock in the Company.
II. SHAREHOLDERS MEETINGS
2.01. ANNUAL MEETINGS. An annual meeting of shareholders shall be held for the election of directors at such date, time and place, either within or without the State of Arizona, as may be designated by resolution of the Board of Directors from time to time. Any other proper business may be transacted at the annual meeting. A special meeting may be called and held in lieu of an annual meeting pursuant to the provisions of Section 2.02 below, and the same proceedings (including the election of directors) may be conducted thereat as at a regular meeting. Any director elected at any annual meeting, or special meeting in lieu of an annual meeting, will continue in office until the election of his or her successor, subject to his or her (a) earlier resignation pursuant to Section 6.01 below, (b) removal pursuant to Section 3.13 below, or (c) death or disqualification.

2.02. SPECIAL MEETINGS. Except as otherwise required by law, special meetings of the shareholders may be held whenever and wherever called by the Chairman of the Board, the President, or a majority of the Board of Directors, but such special meetings may not be called by any other person or persons. Business transacted at any special meeting of shareholders shall be limited to the purposes stated in the notice.
2.03. NOTICE. Notice of any meeting of the shareholders will be given as provided by law to each shareholder entitled to vote at such meeting and, if required by law, to each other shareholder of the Company. Any such notice may be waived as provided by law.
2.04. RIGHT TO VOTE. For each meeting of the shareholders, the Board of Directors will fix in advance a record date as contemplated by law, and the shares of stock and the shareholders "entitled to vote" (as that or any similar term is herein used) at any meeting of the shareholders will be determined as of the applicable record date. The Secretary (or in his or her absence an Assistant Secretary) will see to the making and production of any record of shareholders entitled to vote or otherwise entitled to notice of shareholders meetings, in either case which is required by law. Any voting entitlement may be exercised through proxy, or in such other manner as specifically provided by law, in accordance with the applicable law. In the event of contest, the burden of proving the validity of any undated or irrevocable proxy will rest with the person seeking to exercise the same. A telegram, cablegram, or facsimile appearing to have been transmitted by a shareholder (or by his or her duly authorized attorney-in-fact) or other means of voting by telephone or electronic transmission may be accepted as a sufficiently written and executed proxy if otherwise permitted by law.
2.05. NOTICE OF SHAREHOLDER BUSINESS AND NOMINATIONS.
(a) Annual Meetings of Shareholders. (1) Nominations of persons for election to the Board of Directors of the Company and the proposal of business to be considered by the shareholders may be made at an annual meeting of shareholders only (a) pursuant to the Company's notice of meeting (or any supplement thereto), (b) by or at the direction of the Board of Directors or (c) by any shareholder of the Company who was a shareholder at the time the notice provided for in this Section 2.05 is delivered to the Secretary of the Company, who is entitled to vote at the meeting and who complies with the notice procedures set forth in this Section 2.05.
(2) For nominations or other business to be properly brought before an annual meeting by a shareholder pursuant to clause (c) of paragraph (a)(1) of this Section 2.05, the shareholder must have given timely notice thereof in writing to the Secretary of the Company and any such proposed business other than the nominations of persons for election to the Board of Directors must constitute a proper matter for shareholder action. To be timely, a shareholder notice shall
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be delivered to the Secretary at the principal executive offices of the Company not later than the close of business (a) with respect to business to be brought before the meeting, on the ninetieth (90th) day nor earlier than the close of business on the one hundred twentieth (120th) day prior to the first anniversary of the preceding year's annual meeting (provided, however, that in the event that the date of the annual meeting is changed by more than thirty (30) days from such anniversary date, notice by the shareholder must be so delivered not earlier than the close of business on the one hundred twentieth
(120th) day prior to such annual meeting and not later than the close of business on the later of the ninetieth (90th) day prior to such annual meeting or the tenth (10th) day following the day on which public announcement of the date of such meeting is first made by the Company), and (b) with respect to nominations of persons to be elected to the Board of Directors, the one-hundred eightieth (180th) day prior to the date of the meeting at which the election is to occur. In no event shall the public announcement of an adjournment or postponement of an annual meeting commence a new time period (or extend any time period) for the giving of a shareholder's notice as described above.
(3) In addition to meeting the timely notice requirements of paragraph (a)(2) of this
Section 2.05, in order for nominations or other business to be properly brought before an annual meeting by a shareholder pursuant to clause (c) of paragraph (a)(1) of this
Section 2.05, such shareholder's notice shall set forth: (a) as to each person whom the shareholder proposes to nominate for election as a director, (i) all information relating to such person that is required to be disclosed in solicitations of proxies for election of directors in an election contest, or is otherwise required, in each case pursuant to and in accordance with Regulation 14A under the Securities Exchange Act of 1934, as amended (the "Exchange Act"), and (ii) and such person's written consent to being named in the proxy statement as a nominee and to serving as a director if elected; (b) as to any other business that the shareholder proposes to bring before the meeting, a brief description of the business desired to be brought before the meeting, the text of the proposal or business (including the text of any resolutions proposed for consideration and, in the event that such business includes a proposal to amend the Bylaws of the Company, the language for the proposed amendment), the reasons for conducting such business at the meeting, and any material
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interest in such business of such shareholder and the beneficial owner, if any, on whose behalf the proposal is made; and (c) as to the shareholder giving the notice and the beneficial owner, if any, on whose behalf the nomination or proposal is made, (i) the name and address of such shareholder, as they appear on the Company's books, and of such beneficial owner, (ii) the class and number of shares of capital stock of the Company that are owned beneficially and of record by such shareholder and such beneficial owner, (iii) a representation that the shareholder is a holder of record of stock of the Company entitled to vote at such meeting and intends to appear in person or by proxy at the meeting to propose such business or nomination, and (iv) a representation whether the shareholder or the beneficial owner, if any, intends or is part of a group that intends (A) to deliver a proxy statement and/or form of proxy to holders of at least the percentage of the Company's outstanding capital stock required to approve or adopt the proposal or elect the nominee and/or (B) otherwise to solicit proxies from shareholders in support of such proposal or nomination. The foregoing notice requirements of clauses (b) and (c) of paragraph (a)(3) of this Section 2.05 shall be deemed satisfied by a shareholder if the shareholder has notified the Company of his or her intention to present a proposal at an annual meeting in compliance with Rule 14a-8 (or any successor thereof) promulgated under the Exchange Act and such shareholder's proposal has been included in a proxy statement that has been prepared by the Company to solicit proxies for such annual meeting. The Company may require any proposed nominee to furnish such other information as it may reasonably require to determine the eligibility of such proposed nominee to serve as a director of the Company.
(b) Special Meetings of Shareholders. Only such business shall be conducted at a special meeting of shareholders as shall have been brought before the meeting pursuant to the Company's notice of meeting.
(c) General. (1) Only such persons who are nominated in accordance with the procedures set forth in this
Section 2.05 shall be eligible to be elected at an annual or special meeting of shareholders of the Company to serve as directors and only such business shall be conducted at a meeting of shareholders as shall have been brought before the meeting in accordance with the procedures set forth in this
Section 2.05. Except as otherwise provided by law, the Chairman of the meeting shall have the power and duty (a) to determine whether a nomination or any business proposed to be
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brought before the meeting was made or proposed, as the case may be, in accordance with the procedures set forth in this Section 2.05 (including whether the shareholder or beneficial owner, if any, on whose behalf the nomination or proposal is made solicited (or is part of a group that solicited) or did not so solicit, as the case may be, proxies in support of such shareholder's nominee or proposal in compliance with such shareholder's representation as required by clause (a)(2)(c)(iv) of this Section 2.05) and (b) if any proposed nomination or business was not made or proposed in compliance with this Section 2.05, to declare that such nomination shall be disregarded or that such proposed business shall not be transacted. Notwithstanding the foregoing provisions of this
Section 2.05, if the shareholder (or a qualified representative of the shareholder) does not appear at the annual meeting of shareholders of the Company to present a nomination or business, such nomination shall be disregarded and such business shall not be transacted, notwithstanding that proxies in respect of such vote may have been received by the Company. For purposes of this Section 2.05, to be considered a qualified representative of the shareholder, a person must be authorized by a writing executed by such shareholder or an electronic transmission delivered by such shareholder to act for such shareholder as proxy at the meeting of shareholders and such person must produce such writing or electronic transmission, or a reliable reproduction of the writing or electronic transmission, at the meeting of shareholders.
(2) For purposes of this Section 2.05, "public announcement" shall mean disclosure in a press release reported by the Dow Jones News Service, Associated Press or comparable national news service or in a document publicly filed by the Company with the Securities and Exchange Commission pursuant to
Section 13, 14 or 15(d) of the Exchange Act.
(3) Notwithstanding the foregoing provisions of this
Section 2.05, a shareholder shall also comply with all applicable requirements of the Exchange Act and the rules and regulations thereunder with respect to the matters set forth in this Section 2.05. Nothing in this Section 2.05 shall be deemed to affect any rights (a) of shareholders to request inclusion of proposals in the Company's proxy statement pursuant to Rule 14a-8 of the Exchange Act or (b) of the holders of any series of Preferred Stock to elect directors pursuant to any applicable provisions of the Articles.
2.06. RIGHT TO ATTEND. Except only to the extent of persons designated by the Board of Directors or the Chairman of the meeting to assist in the conduct of the meeting (as referred to in Sections 2.08 and 2.09 below) and except as otherwise permitted by the Board or such Chairman, the persons entitled to attend any meeting of
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shareholders may be confined to (i) shareholders entitled to vote thereat and other shareholders entitled to notice of the meeting and (ii) the persons upon whom proxies valid for purposes of the meeting have been conferred or their duly appointed substitutes (if the related proxies confer a power of substitution); provided, however, that the Board of Directors or the Chairman of the meeting may establish rules limiting the number of persons referred to in clause (ii) as being entitled to attend on behalf of any shareholder so as to preclude such an excessively large representation of such shareholder at the meeting as, in the judgment of the Board or such Chairman, would be unfair to other shareholders represented at the meeting or be unduly disruptive of the orderly conduct of business at such meeting (whether such representation would result from fragmentation of the aggregate number of shares held by such shareholder for the purpose of conferring proxies, from the naming of an excessively large proxy delegation by such shareholder or from employment of any other device). A person otherwise entitled to attend any such meeting will cease to be so entitled if, in the judgment of the Chairman of the meeting, such person engages thereat in disorderly conduct impeding the proper conduct of the meeting in the interests of all shareholders as a group.
2.07. QUORUM. Except as otherwise provided by law, the Articles or these Bylaws, at each meeting of shareholders the presence in person or by proxy of the holders of a majority in voting power of the outstanding shares of stock entitled to vote at the meeting shall be necessary and sufficient to constitute a quorum.
2.08. ELECTION INSPECTORS. The Board of Directors, in advance of any shareholders meeting may appoint an election inspector or inspectors to act at such meeting (and any adjournment thereof). If an election inspector or inspectors are not so appointed, the Chairman of the meeting may or, upon the request of any person entitled to vote at the meeting will, make such appointment. If any person appointed as an inspector fails to appear or to act, a substitute may be appointed by the Chairman of the meeting. If appointed, the election inspector or inspectors (acting through a majority of them if there be more than one) will determine the number of shares outstanding, the authenticity, validity and effect of proxies, the credentials of persons purporting to be shareholders or persons named or referred to in proxies, and the number of shares represented at the meeting in person and by proxy; they will receive and count votes, ballots and consents and announce the results thereof; they will hear and determine all challenges and questions pertaining to proxies and voting; and, in general, they will perform such acts as may be proper to conduct elections and voting with complete fairness to all shareholders. No such election inspector need be a shareholder of the Company.
2.09. ORGANIZATION AND CONDUCT OF MEETINGS. Each shareholders meeting will be called to order and thereafter chaired by the Chairman of the Board if there then is one; or, if not, or if the Chairman of the Board is absent or so requests, then by the President; or if both the Chairman of the Board and the President are unavailable, then by such other officer of the Company or such shareholder as may be appointed by the Board of Directors. The Secretary (or in his or her absence an Assistant Secretary) of the Company will act as secretary of each shareholders meeting; if neither the Secretary nor an Assistant Secretary is in attendance, the Chairman of the meeting may
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appoint any person (whether a shareholder or not) to act as secretary thereat. After calling a meeting to order, the Chairman thereof may require the registration of all shareholders intending to vote in person, and the filing of all proxies, with the election inspector or inspectors, if one or more have been appointed (or, if not, with the secretary of the meeting). After the announced time for such filing of proxies has ended, no further proxies or changes, substitutions or revocations of proxies will be accepted. If directors are to be elected, a tabulation of the proxies so filed will, if any person entitled to vote in such election so requests, be announced at the meeting (or adjournment thereof) prior to the closing of the election polls.
Absent a showing of bad faith on his or her part, the Chairman of a meeting will, among other things, have absolute authority to determine the order of business to be conducted at such meeting and to establish rules for, and appoint personnel to assist in, preserving the orderly conduct of the business of the meeting (including any informal, or question and answer, portions thereof). Rules, regulations or procedures regarding the conduct of the business of a meeting, whether adopted by the Board of Directors or prescribed by the Chairman of the meeting, may include, without limitation, the following: (i) the establishment of an agenda or order of business for the meeting; (ii) rules and procedures for maintaining order at the meeting and the safety of those present;
(iii) limitations on attendance at or participation in the meeting to shareholders of record of the Company, their duly authorized and constituted proxies (subject to Section 2.06) or such other persons as the Chairman of the meeting shall determine; (iv) restrictions on entry to the meeting after the time fixed for the commencement thereof; and (v) limitations on the time allotted to questions or comments by participants. Unless and to the extent determined by the Board of Directors or the Chairman of the meeting, meetings of shareholders shall not be required to be held in accordance with the rules of parliamentary procedure. Any informational or other informal session of shareholders conducted under the auspices of the Company after the conclusion of or otherwise in conjunction with any formal business meeting of the shareholders will be chaired by the same person who chairs the formal meeting, and the foregoing authority on his or her part will extend to the conduct of such informal session.
2.10. VOTING. The number of shares voted on any matter submitted to the shareholders which is required to constitute their action thereon or approval thereof will be determined in accordance with applicable law, the Articles, and these Bylaws, if applicable. No ballot or change of vote will be accepted after the polls have been declared closed following the ending of the announced time for voting.
2.11. SHAREHOLDER APPROVAL OR RATIFICATION. The Board of Directors may submit any contract or act for approval or ratification at any duly constituted meeting of the shareholders, the notice of which either includes mention of the proposed submittal or is waived as provided in Section 2.03 above. Except as otherwise required by law (e.g., Arizona Revised Statutes Section 10-863), if any contract or act so submitted is approved or ratified by a majority of the votes cast thereon at such meeting, the same will be valid and as binding upon the Company and all of its shareholders as it would be if approved and ratified by each and every shareholder of the Company.
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2.12. CONTROL SHARE ACT. The provisions of Section 10-2721 through and including Section 10-2727 of the Arizona Revised Statutes shall not apply to the Company.
2.13. ADJOURNMENTS. Any meeting of shareholders, annual or special, may adjourn from time to time to reconvene at the same or some other place, and notice need not be given of any such adjourned meeting if the time and place thereof are announced at the meeting at which the adjournment is taken. At the adjourned meeting the Company may transact any business that might have been transacted at the original meeting. If the adjournment is for more than one hundred and twenty days, or if after the adjournment a new record date is fixed for the adjourned meeting, notice of the adjourned meeting shall be given to each shareholder of record entitled to vote at the meeting.
III. BOARD OF DIRECTORS
3.01. MEMBERSHIP. The Board of Directors of the corporation shall consist of not less then nine (9) nor more than twenty-one (21) shareholders of the Company or of any parent corporation thereof (except that it shall not be a requirement that any member of the initial Board of Directors be a shareholder of the Company or of any parent corporation thereof), and shall be divided into three classes in the manner provided in the Articles (Art. Fifth). The Board will have the exclusive power to increase or decrease its size within such limits. Any vacancy occurring in the Board, whether by reason of death, resignation, disqualification or otherwise, may be filled by the directors as contemplated by law and as provided in the Articles (Art. Fifth). Any such increase in the size of the Board, and the filling of any vacancy created thereby, will require action by a majority of the whole membership of the Board as comprised immediately before such increase.
3.02. QUALIFICATIONS. In order to qualify as a director, a person must be the owner of one or more shares of the capital stock of the Company or of any parent corporation thereof at the time of assuming office (except as may otherwise be provided in these Bylaws or in the Articles) and for so long thereafter as such person remains in office. A person will cease to qualify as a director if he or she (i) is in good faith determined by a majority of the other directors then in office to be physically or mentally incapable of competent performance as a director for a period, starting with inception of the incapacity, that has extended or is likely to extend for more than six months or
(ii) has failed to attend six successive regular meetings of the Board (as determined in accordance with Section 3.03 below) unless and to the extent such failure is waived by a majority of the other directors then in office; however, disqualification pursuant to clause (i) or (ii) of this sentence will not preclude the subsequent election or appointment of such person as a director by the shareholders or the Board if a majority of the directors in office immediately prior to the submission of such person for election or appointment shall determine that his or her prior incapacity or principal reason for prior non-attendance no longer exists. A person will not qualify for election or appointment as a director, whether initially or on re-election and whether by the shareholders at their annual meeting or by the Board of Directors as contemplated in
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Section 3.01 above, if such person's 72nd birthday occurs on or has occurred before the date of such election, appointment or re-election. A person who has been a full-time employee of the Company within twelve months prior to the date of any election will not qualify for election as a director on that date unless he or she then remains a full-time employee of the Company or unless the Board of Directors specifically authorizes the election of such person (but it is not intended that any such authorization will extend a person's service on the Board beyond the age limitation set out in the preceding sentence). A person who has qualified by age or employment status for his or her most recent election as a director may serve throughout the term for which such person was elected, notwithstanding the occurrence of his or her 72nd birthday or cessation of full-time employment by the Company between the date of such election and the end of such term, subject, however, to his or her otherwise remaining qualified for such office.
3.03. REGULAR MEETINGS. A regular annual meeting of the directors is to be held as soon as practicable after the adjournment of each annual shareholders meeting either at the place of the shareholders meeting or at such other place as the directors elected at the shareholders meeting may have been informed of at or before the time of their election. Regular meetings, other than the annual ones, may be held at such intervals at such places and at such times as the Board of Directors may provide.
3.04. SPECIAL MEETINGS. Special meetings of the Board of Directors may be held whenever and wherever called for by the Chairman of the Board, the President or the number of directors which would be required to constitute a quorum.
3.05. NOTICE. No notice need be given of regular meetings of the Board of Directors. Notice of the time and place (but not necessarily the purpose or all of the purposes) of any special meeting will be given to each director in person or by telephone, or via mail, telegram, facsimile, or other electronic transmission addressed in the manner appearing on the Company's records. Notice to any director of any such special meeting will be deemed given sufficiently in advance when (i) if given by mail, the same is deposited in the United States mail at least four days before the meeting date, with postage thereon prepaid,
(ii) if given by telegram, the same is delivered to the telegraph office for fast transmittal at least 48 hours prior to the convening of the meeting, (iii) if given by facsimile or other electronic transmission, the same is received by the director or an adult member of his or her office staff or household, at least 24 hours prior to the convening of the meeting, or (iv) if personally delivered or given by telephone, the same is handed, or the substance thereof is communicated over the telephone to the director or to an adult member of his or her office staff or household, at least 24 hours prior to the convening of the meeting. Any such notice may be waived as provided by law. No call or notice of a meeting of directors will be necessary if each of them waives the same in writing or by attendance. Any meeting, once properly called and noticed (or as to which call and notice have been waived as aforesaid) and at which a quorum is formed, may be adjourned to another time and place by a majority of those in attendance.
3.06. QUORUM; VOTING. A quorum for the transaction of business at any meeting or adjourned meeting of the directors will consist of a majority of those then in
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office. Any matter submitted to a meeting of the directors will be resolved by a majority of the votes cast thereon, except as otherwise required by these Bylaws (Section Section 3.01 and 3.02 above and Section 3.07 below), by law or by any applicable Article. Where action by a majority of the whole membership is required, such requirement will be deemed to relate to a majority of the directors in office at the time the action is taken. In computing any such majority, whether for purposes of determining the presence of a quorum or the adequacy of the vote on any proposed action, any unfilled vacancies at the time existing in the membership of the Board will be excluded from the computation.
3.07. EXECUTIVE COMMITTEE. The Board of Directors may, by resolution adopted by a majority of the whole Board, name three or more of its members as an Executive Committee. Such Executive Committee will have and may exercise the powers of the Board of Directors in the management of the business and affairs of the Company while the Board is not in session, except only as precluded by law or where action other than by a majority of the votes cast is required by these Bylaws, or the law (all as referred to in Section 3.06 above), and subject to such limitations as may be included in any applicable resolution passed by a majority of the whole membership of the Board. A majority of those named to the Executive Committee will constitute a quorum.
3.08. OTHER COMMITTEES. The Board of Directors may designate one or more additional committees, each committee to consist of one or more of the directors of the Company. The Board of Directors may designate one or more directors as alternate members of any committee, who may replace any absent or disqualified member at any meeting of the committee. Any such committee, to the extent permitted by law and to the extent provided in the resolution of the Board of Directors, shall have and may exercise all the powers and authority of the Board of Directors in the management of the business and affairs of the Company, and may authorize the seal of the Company to be affixed to all papers that may require it.
3.09. COMMITTEE FUNCTIONING. Notice requirements and related waiver provisions for meetings of the Executive Committee and other committees of the Board will be the same as those set forth in Section 3.05 above for meetings of the Board of Directors. Except as provided in the next two succeeding sentences, a majority of those named to the Executive Committee or any other committee of the Board will constitute a quorum at any meeting thereof (with the effect of departure of committee members from a meeting and the computation of a majority of committee members to be in accordance with the applicable policies of Section 3.06 above), and any matter submitted to a meeting of any such committee will be resolved by a majority of the votes cast thereon. No distinction will be made among ex-officio or other members of any such committee for quorum, voting or other purposes, except that the membership of any committee (including the Executive Committee), in performing any function vested in it as herein contemplated, may be deemed to exclude any officer or employee of the Company, in either case, or other person having a direct or indirect personal interest in any proposed exercise of such function, whose exclusion for that purpose is deemed appropriate by a majority of the other members of such committee proposing to perform such function. All committees are to keep regular minutes of the transactions of their meetings.
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3.10. ACTION BY TELEPHONE OR CONSENT. Any meeting of the Board or any committee thereof may be held by conference telephone or similar communications equipment as permitted by law, in which case any required notice of such meeting may generally describe the arrangements (rather than the place) for the holding thereof, and all other provisions herein contained or referred to will apply to such meeting as though it were physically held at a single place. Action may also be taken by the Board or any committee thereof without a meeting if the members thereof consent in writing thereto as contemplated by law.
3.11. PRESUMPTION OF ASSENT. A director of the Company who is present at a meeting of the Board of Directors, or of any committee when corporate action is taken is deemed to have assented to the action taken unless either (i) the director objects at the beginning of the meeting or promptly on the director's arrival to holding it or transacting business at the meeting; (ii) the director's dissent or abstention from the action taken is entered in the minutes of the meeting; or (iii) the director delivers written notice of the director's dissent or abstention to the presiding officer of the meeting before its adjournment or to the Company before 5:00 P.M. on the next business day after the meeting. The right of dissent or abstention is not available to a director who votes in favor of the action taken.
3.12. COMPENSATION. By resolution of the Board, the directors may be paid their expenses, if any, of attendance at each meeting of the Board of Directors, or of any committee, and may be paid a fixed sum for attendance at each such meeting and/or a stated salary as a director or committee member. No such payment will preclude any director from serving the Company in any other capacity and receiving compensation therefor.
3.13. REMOVAL. Any director or the entire Board of Directors may be removed, with or without cause, only at a special meeting of shareholders called for that purpose, if the votes cast in favor of such removal exceed the votes cast against such removal, except that if less than the entire Board of Directors is to be removed, no one of the directors may be removed if the votes cast against the director's removal would be sufficient to elect the director if then cumulatively voted at an election for the class of directors of which the director is a part.
IV. OFFICERS - GENERAL
4.01. ELECTIONS AND APPOINTMENTS. The directors may elect or appoint one or more of the officers of the Company contemplated in Part V below. Any such election or appointment will regularly take place at the annual meeting of the directors, but elections of officers may be held at any other meeting of the Board. A person elected or appointed to any office will continue to hold that office until the election or appointment of his or her successor, subject to action earlier taken pursuant to Section 4.04 or 6.01 below. Any person may hold more than one office.
4.02. ADDITIONAL APPOINTMENTS. In addition to the officers contemplated in Part V below, the Board of Directors may create other corporate positions, and appoint
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persons thereto, with such authority to perform such duties as may be prescribed from time to time by the Board of Directors, by the President or by the superior officer of any person so appointed. Notwithstanding such additional appointments, only those persons whose offices are described in Part V are to be considered an officer of the Company unless the resolution or other Board action appointing such person expressly states that such person is to be considered an officer of the Company. Each of such persons (in the order designated by the Board or the superior officer of such person) will be vested with all of the powers and charged with all of the duties of his or her superior officer in the event of such superior officer's absence or disability.
4.03. BONDS AND OTHER REQUIREMENTS. The Board of Directors may require any officer or other appointee to give bond to the Company (with sufficient surety, and conditioned upon the faithful performance of the duties of his or her office or position) and to comply with such other conditions as may from time to time be required of him or her by the Board.
4.04. REMOVAL OR DELEGATION. Provided that a majority of the whole membership thereof concurs therein, the Board of Directors may remove any officer of the Company as provided by law and declare his or her office or offices vacant or abolished or, in the case of the absence or disability of any officer or for any other reason considered sufficient, may temporarily delegate his or her powers and duties to any other officer or to any director. Similar action may be taken by the Board of Directors in regard to appointees designated pursuant to Section 4.02 above.
4.05. SALARIES. Officer salaries may from time to time be fixed by the Board of Directors or (except as to his or her own) be left to the discretion of the Chief Executive Officer or the President. No officer will be prevented from receiving a salary by reason of the fact that he or she is also a director of the Company.
V. SPECIFIC OFFICERS, FUNCTIONS AND POWERS
5.01. CHAIRMAN OF THE BOARD. The Board of Directors may elect a Chairman to serve as a general executive officer of the Company and, if specifically designated as such by the Board, as the Chief Executive Officer of the Company. If elected, the Chairman will preside at all meetings of the directors and be vested with such other powers and duties as the Board may from time to time delegate to him or her.
5.02. CHIEF EXECUTIVE OFFICER. Subject to the control of the Board of Directors exercised as hereinafter provided, the Chief Executive Officer of the Company will supervise its business and affairs and the performance of their respective duties by all other officers, by appointees designated pursuant to
Section 4.02 above, and by such additional appointees to such additional positions (corporate, divisional or otherwise) as the Chief Executive Officer may designate, with authority on his or her part to delegate the foregoing duty of supervision to such extent and to such person or persons as may be determined by the Chief Executive Officer. Except as otherwise indicated from time to time by resolution of the Board of Directors, its management of the business and
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affairs of the Company will be implemented through the office of the Chief Executive Officer.
5.03. PRESIDENT AND VICE PRESIDENTS. Unless specified to the contrary by resolution of the Board of Directors, the President will be the Chief Executive Officer of the Company. In addition to the supervisory functions above set forth on the part of the Chief Executive Officer or in lieu thereof if a contrary specification is made by the Board relative to the Chief Executive Officer, the President will be vested with such powers and duties as the Board may from time to time designate. Vice Presidents may be elected by the Board of Directors to perform such duties as may be designated by the Board or be assigned or delegated to them by their respective superior officers. The Board may identify (i) one or more Vice Presidents as "Executive" or "Senior" Vice Presidents and (ii) the President or any Vice President as "General Manager" of the Company and the title of any Vice President may include words indicative of his or her particular area of responsibility and authority. Vice Presidents will succeed to the responsibilities and authority of the President, in the event of his or her absence or disability, in the order consistent with their respective titles or regular duties or as specifically designated by the Board of Directors.
5.04. TREASURER AND SECRETARY. The Treasurer and Secretary each will perform all such duties normally associated with his or her office (including, in the case of the Secretary, the giving of notice and the preparation and retention of minutes of corporate proceedings and the custody of corporate records and the seal of the Company) as are not assigned to a Vice President of the Company, along with such other duties as may be designated by the Board or be assigned or delegated to them by their respective superior officers. The Board may appoint one or more Assistant Treasurers or Assistant Secretaries, each of whom (in the order designated by the Board or their respective superior officers) will be vested with all of the powers and charged with all of the duties of the Treasurer or the Secretary (as the case may be) in the event of his or her absence or disability.
5.05. SPECIFIC POWERS. Except as may otherwise be specifically provided in a resolution of the Board of Directors, any of the officers referred to in this Part V will be a proper officer to authenticate records of the Company and to sign on behalf of the Company any deed, bill of sale, assignment, option, mortgage, pledge, note, bond, debenture, evidence of indebtedness, application, consent (to service of process or otherwise), agreement, indenture or other instrument of importance to the Company. Any such officer may represent the Company at any meeting of the shareholders or members of any corporation, association, partnership, joint venture or other entity in which this Company then has an interest, and may vote such interest in person or by proxy appointed by him or her, provided that the Board of Directors may from time to time confer the foregoing authority upon any other person or persons.
VI. RESIGNATIONS AND VACANCIES
6.01. RESIGNATIONS. Any director, committee member or officer may resign from his or her office at any time by written notice as specified in accordance with
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Arizona Revised Statutes Sections 10-807 and 10-843. The acceptance of a resignation will not be required to make it effective.
6.02. VACANCIES. If the office of any director, committee member or officer becomes vacant by reason of his or her death, resignation, disqualification, removal or otherwise, the Board of Directors may choose a successor to hold office for the unexpired term.
VII. INDEMNIFICATION AND RATIFICATION
7.01. INDEMNIFICATION. In order to induce qualified persons to serve the Company (and any other corporation, joint venture, partnership, trust or other enterprise at the request of the Company) as directors and officers, the Company shall indemnify any and all of its directors and officers, or former directors and officers to the fullest extent permitted by applicable law as it presently exists or may hereafter be amended.
7.02. RATIFICATION; SPECIAL COMMITTEE. Any transaction involving the Company, any of its subsidiary corporations or any of its directors, officers, employees or agents which at any time is questioned in any manner or context (including a shareholders derivative suit), on the ground of lack of authority, conflict of interest, misleading or omitted statement of fact or law, nondisclosure, miscomputation, improper principles or practices of accounting, inadequate records, defective or irregular execution or any similar ground, may be investigated and/or ratified (before or after judgment), or an election may be made not to institute or pursue a claim or legal proceedings on account thereof or to accept or approve a negotiated settlement with respect thereto (before or after the institution of legal proceedings), by the Board of Directors or by a special committee thereof comprised of one or more disinterested directors (that is, a director or directors who did not participate in the questioned transaction with actual knowledge of the questioned aspect or aspects thereof). Such a special committee may be validly formed and fully empowered to act, in accordance with the purposes and duties assigned thereto, by resolution or resolutions of the Board of Directors, notwithstanding (i) the inclusion of Board members who are not disinterested as aforesaid among those who form a quorum at the meeting or meetings at which one or more members of such special committee are elected or appointed to the Board or to such special committee or at which such committee is formed or empowered, or their inclusion among the directors who vote upon or otherwise participate in taking any of the foregoing actions, or (ii) the taking of any of such actions by the disinterested members of the Board (or a majority of such members) whose number is not sufficient to constitute a quorum or a majority of the membership of the full Board. Any such special committee so comprised will, to the full extent consistent with its purposes and duties as expressed in such resolution or resolutions, have all of the authority and powers of the full Board and its Executive Committee (the same as though it were the full Board and/or its Executive Committee in carrying out such purposes and duties) and will function in accordance with Section 3.09 above. No other provisions of these Bylaws which may at any time appear to conflict with any provisions of this Section 7.02, and no defect or irregularity in the formation, empowering or functioning of any such special committee, will serve to impede, impair or bring into
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question any action taken or purported to be taken by such committee or the validity of any such action. Any ratification of a transaction pursuant to this
Section 7.02 will have the same force and effect as if the transaction has been duly authorized originally. Any such ratification, and any election made pursuant to this Section 7.02 with respect to claims, legal proceedings or settlements, will be binding upon the Company and its shareholders and will constitute a bar to any claim or the execution of any judgment in respect of the transaction involved in such ratification or election.
VIII. SEAL
8.01. FORM THEREOF. The seal of the Company will have inscribed thereon the name of the Company, the state and year of its incorporation and the words "SEAL".
IX. STOCK CERTIFICATES
9.01. FORM THEREOF. Each certificate representing stock of the Company will be in such form conforming to law as may from time to time be approved by the Board of Directors, and will bear the manual facsimile signatures and seal of the Company as required or permitted by law.
9.02. OWNERSHIP. The Company will be entitled to treat the registered owner of any share as the absolute owner thereof and accordingly, will not be bound to recognize any beneficial, equitable or other claim to, or interest in, such share on the part of any other person, whether or not it has notice thereof, except as may expressly be provided by Chapter 8 of Title 47, Arizona Revised Statutes (or its successor), as at the time in effect, or other applicable law.
9.03. TRANSFERS. Transfer of stock will be made on the books of the Company only upon surrender of the certificate therefor, duly endorsed by an appropriate person, with such assurance of the genuineness and effectiveness of the endorsement as the Company may require, all as contemplated by Chapter 8 of Title 47, Arizona Revised Statutes (or its successor), as at the time in effect, and/or upon submission of any affidavit, other document or notice which the Company considers necessary.
9.04. LOST CERTIFICATES. In the event of the loss, theft or destruction of any certificate representing capital stock of this Company, the Company may issue (or, in the case of any such stock as to which a transfer agent and/or registrar have been appointed, may direct such transfer agent and/or registrar to countersign, register and issue) a replacement certificate in lieu of that alleged to be lost, stolen or destroyed, and cause the same to be delivered to the owner of the stock represented thereby, provided that the owner shall have submitted such evidence showing the circumstances of the alleged loss, theft or destruction, and his or her ownership of the certificate as the Company considers satisfactory, together with any other factors which the Company considers pertinent, and further provided that an indemnity agreement and/or indemnity bond shall have been provided in form and amount satisfactory to the Company and to its transfer agent and/or registrar, if applicable.
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X. EMERGENCY BYLAWS
10.01. EMERGENCY CONDITIONS. The emergency Bylaws provided in this Part X will be as effective in the event of an emergency as prescribed in Arizona Revised Statutes Section 10-207.D. To the extent not inconsistent with the provisions of this Part X, these Bylaws will remain in effect during such emergency and upon its termination these emergency Bylaws will cease to be operative.
10.02. BOARD MEETINGS. During any such emergency, a meeting of the Board of Directors or any of its committees may be called by any officer or director of the Company. Notice of the time and place of the meeting will be given by the person calling the same to those of the directors whom it may be feasible to reach by any available means of communication. Such notice will be given so much in advance of the meeting as circumstances permit in the judgment of the person calling the same. At any Board or committee meeting held during any such emergency, a quorum will consist of a majority of those who could reasonably be expected to attend the meeting if they were willing to do so, but in no event more than a majority of those to whom notice of such meeting is required to have been given as above provided.
10.03. CERTAIN ACTIONS. The Board of Directors, either before or during any such emergency, may provide and from time to time modify lines of succession in the event that during such an emergency any or all officers, appointees, employees or agents of the Company are for any reason rendered incapable of discharging their duties. The Board, either before or during any such emergency, may, effective in the emergency, change the head office or designate several alternative head offices of the Company, or authorize the officers to do so.
10.04. LIABILITY. No director, officer, appointee, employee or agent acting in accordance with these emergency Bylaws will be liable except for willful misconduct.
10.05. MODIFICATIONS. These emergency Bylaws will be subject to repeal or change by further action of the Board of Directors, but no such repeal or change will modify the provisions of Section 10.04 with respect to action taken prior to the time of such repeal or change. Any amendment of these emergency Bylaws may make any further or different provisions that may be practical and necessary for the circumstances of the emergency.
XI. DIVIDENDS
11.01. DECLARATION. Subject to such restrictions or requirements as may be imposed by law or the Company's Articles or as may otherwise be binding upon the Company, the Board of Directors may from time to time declare dividends on stock of the Company outstanding on the dates of record fixed by the Board, to be paid in cash, in property or in shares of the Company's stock on or as of such payment or distribution dates as the Board may prescribe.
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XII. BUSINESS COMBINATIONS
12.01. DEFINITIONS. In these Bylaws, the following definitions shall apply:
1. "Affiliate" means a person that directly or indirectly controls, is controlled by, or is under common control with a specified person.
2. "Announcement date," when used in reference to any business combination, means the date of the first public announcement of the final, definitive proposal for the business combination.
3. "Associate," when used to indicate a relationship with any person, means any of the following:
(a) Any corporation or organization of which the person is an officer, director, or partnership or is, directly or indirectly, the beneficial owner of ten percent (10%) or more of any class or series of shares entitled to vote or other equity interest;
(b) Any trust or estate in which the person has a substantial beneficial interest or as to which the person serves as trustee or personal representative or in a similar fiduciary capacity; or
(c) Any relative or spouse of the person, or any relative of the spouse, residing in the home of the person.
4. "Beneficial owner," when used with respect to shares or other securities, includes any person who, directly or indirectly through any agreement, arrangement, relationship, understanding, or otherwise, whether or not in writing, has or shares the power to vote, or direct the voting of the shares or securities or has or shares the power to dispose of or direct the disposition of the shares or securities, except that:
(a) A person is not deemed the beneficial owner of shares or securities tendered pursuant to a tender or exchange offer made by the person or any of the person's affiliates or associates until the tendered shares or securities are accepted for purchase or exchange; and
(b) A person is not deemed the beneficial owner of shares or securities with respect to which the person has the power to vote or direct the voting arising solely from a revocable proxy given in response to a proxy solicitation required to be made and made in accordance with the applicable rules and regulations under the Securities Exchange Act of 1934, as
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amended, and is not then reportable under that act on a Schedule 13D or comparable report.
5. "Beneficial ownership" includes the right to acquire shares or securities through the exercise of options, warrants, or rights, the conversion of convertible securities, or otherwise. The shares or securities subject to the options, warrants, rights, or conversion privileges held by a person are deemed to be outstanding for the purpose of computing the percentage of outstanding shares or securities of the class or series owned by the person but are not deemed to be outstanding for the purpose of computing the percentage of the class or series owned by any other person. A person is deemed the beneficial owner of shares and securities beneficially owned by the spouse of the person or any relative of the spouse residing in the home of the person, any trust or estate in which the person owns ten percent (10%) or more of the total beneficial interest or serves as trustee or personal representative, any corporation or entity in which the person owns ten percent (10%) or more of the equity and any affiliate of the person.
6. "Business combination," when used in reference to the Company and any interested shareholder of the Company, means any of the following:
(a) Any merger or consolidation of the Company or any subsidiary of the Company with either:
(i) The interested shareholder; or
(ii) Any other domestic or foreign corporation, whether or not itself an interested shareholder of the Company, that is, or after the merger would be, an affiliate or associate of the interested shareholder, except that the foregoing does not include the merger of a wholly-owned subsidiary of the Company into the Company or the merger of two or more wholly-owned subsidiaries of the Company.
(b) Any exchange, pursuant to a plan of exchange under the laws of the State of Arizona or a comparable statute of any other state or jurisdiction, of shares of the Company or any subsidiary of the Company for shares of either:
(i) The interested shareholder; or
(ii) Any other domestic or foreign corporation, whether or not itself an interested shareholder of the Company,
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that is, or after the exchange would be, an affiliate or associate of the interested shareholder.
(c) Any sale, lease, exchange, mortgage, pledge, transfer, or other disposition, in a single transaction or a series of transactions, to or with the interested shareholder or any affiliate or associate of the interested shareholder, of assets of the Company or any subsidiary of the Company to which any of the following applies:
(i) Has an aggregate market value equal to ten percent (10%) or more of the aggregate market value of all the assets, determined on a consolidated basis, of the Company.
(ii) Has an aggregate market value equal to ten percent (10%) or more of the aggregate market value of all the outstanding shares of the Company.
(iii) Represents ten percent (10%) or more of the earning power or net income, determined on a consolidated basis, of the Company.
(d) The issuance or transfer by the Company or any subsidiary of the Company, in a single transaction or a series of transactions, of any shares of the Company or any subsidiary of the Company that have an aggregate market value equal to five percent (5%) or more of the aggregate market value of all the outstanding shares of the Company to the interested shareholder or any affiliate or associate of the interested shareholder, except pursuant to the exercise of warrants or rights to purchase shares offered or a dividend or distribution paid or made pro rata to all shareholders of the Company.
(e) The adoption of any plan or proposal for the liquidation or dissolution of the Company, or any reincorporation of the Company in another state or jurisdiction, proposed by, on behalf of, or pursuant to any agreement, arrangement, or understanding, whether or not in writing, with the interested shareholder or any affiliate or associate of the interested shareholder.
(f) Any reclassification of securities, including any share dividend or split, reverse share split, or other distribution of shares in respect of shares, recapitalization of the Company, merger or consolidation of the Company with any subsidiary
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of the Company exchange of shares of the Company with any subsidiary of the Company or other transaction, whether or not with or into or otherwise involving the interested shareholder, proposed by, on behalf of, or pursuant to any agreement, arrangement, or understanding, whether or not in writing, with the interested shareholder or any affiliate or associate of the interested shareholder that has the effect, directly or indirectly, of increasing the proportionate share of the outstanding shares of any class or series of shares entitled to vote, or securities that are exchangeable for or convertible into or that carry a right to acquire shares entitled to vote, of the Company or any subsidiary of the Company that is, directly or indirectly, owned by the interested shareholder or any affiliate or associate of the interested shareholder, except as a result of immaterial changes due to fractional share adjustments.
(g) Any receipt by the interested shareholder or any affiliate or associate of the interested shareholder of the benefit, directly or indirectly, except proportionately as a shareholder of the Company, of any loans, advances, guarantees, pledges, or other financial assistance or any tax credits or other tax advantages provided by or through the Company or any subsidiary of the Company (other than expense account advances made in the ordinary course of business).
7. "Consummation date," with respect to any business combination, means the date of consummation of the business combination or, in the case of a business combination as to which a shareholder vote is taken, the later of:
(i) The business day before the vote; or
(ii) Twenty (20) days before the date of consummation of the business combination.
8. "Control," "controlling," "controlled by" or "under common control with" means the possession, directly or indirectly, of the power to direct or cause the direction of the management and policies of a person, whether through the ownership of voting securities, by contract, or otherwise. A person's beneficial ownership of ten percent (10%) or more of the voting power of the Company's outstanding shares entitled to vote in the election of directors creates a presumption that the person has control of the Company. A person is not considered to have control of the Company if the person holds voting power, in good faith and not for the purpose of avoiding any provision of law as an agent, bank, broker, nominee,
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custodian, or trustee for one or more beneficial owners who do not individually or as a group have control of the Company.
9. "Interested shareholder," when used in reference to the Company means any person, other than the Company or any subsidiary of the Company, that is either:
(a) The beneficial owner, directly or indirectly, of ten percent (10%) or more of the voting power of the outstanding shares entitled to vote of the Company; or
(b) An affiliate or associate of the Company who at any time within the three (3) year period immediately before the date in question was the beneficial owner of ten percent (10%) or more of the voting power of the then outstanding shares entitled to vote of the Company.
10. "Market value," when used in reference to shares or property of the Company, means the following:
(a) In the case of shares, the highest closing sale price during the thirty (30) day period immediately preceding the date in question of a share on the composite tape for New York Stock Exchange listed shares or, if the shares are not quoted on the composite tape or not listed on the New York Stock Exchange, on the principal United States securities exchange registered under the Securities Exchange Act of 1934, as amended, on which the share are listed or, if the shares are not listed on any such exchange, on the National Association of Securities Dealers, Inc. Automated Quotations National Market System or, if the shares are not quoted on the National Association of Securities Dealers, Inc. Automated Quotations National Market System, the highest closing bid quotation during the thirty (30) day period preceding the date in question of a share on the National Association of Securities Dealers, Inc. Automated Quotations System or any system then in use or, if no such quotation is available, the fair market value on the date in question of a share as determined in good faith by the Board of the Company.
(b) In the case of property other than cash or shares, the fair market value of the property on the date in question as determined in good faith by the Board of the Company.
11. "Person" means any natural person, partnership, corporation, group, association, venture, firm, or other entity (other than the
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Company, any subsidiary of the Company, or a trustee or fiduciary holding stock for the benefit of the employees of the Company or its subsidiaries or any one of its subsidiaries, pursuant to one or more employee benefit plans). If two or more persons act as a partnership, limited partnership, syndicate, or other group pursuant to any agreement, arrangement, relationship, understanding, or otherwise, whether or not in writing, for the purposes of acquiring, owning, or voting shares of the Company, all members of the partnership, syndicate, or other group shall be deemed a person. Person does not include a licensed broker, dealer, or underwriter that purchases shares of the Company solely for purposes of resale to the public that is not acting in concert with an interested shareholder.
12. "Share acquisition date," with respect to any person and the Company, means the date that the person first becomes an interested shareholder of the Company.
12.02. BUSINESS COMBINATION WITH INTERESTED SHAREHOLDERS; APPROVED BY DIRECTORS.
1. Except as set forth in these Bylaws, the Company may not engage in any business combination or vote, consent or otherwise act to authorize a subsidiary of the Company to engage in any business combination with respect to, proposed by, or on behalf of, or pursuant to any agreement, arrangement or understanding, whether or not in writing, with any interested shareholder of the Company or any affiliate or associate of the interested shareholder for a period of three (3) years after the interested shareholder's share acquisition date, unless the business combination or the acquisition of shares made by the interested shareholder on the interested shareholder's share acquisition date is approved by a committee of the Board of Directors of the Company before the interested shareholder's share acquisition date. The committee shall be formed in accordance with subsection 4 of this Section 12.02.
2. If a good faith definitive proposal regarding a business combination is made in writing to the Board of Directors of the Company, a committee of the Board formed in accordance with subsection 4 of this
Section 12.02 shall consider and take action on the proposal. Unless the committee responds affirmatively in writing within forty-five (45) days after receipt of the proposal by the Company, the committee shall be considered to have disapproved the business combination.
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3. If a good faith definitive proposal to acquire shares is made in writing to the Board of Directors of the Company, a committee of the Board of Directors formed in accordance with subsection 4 of this Section 12.02 shall consider and take action on the proposal. Unless the committee responds affirmatively in writing within forty-five (45) days after receipt of the proposal by the Company, the committee shall be considered to have disapproved the share acquisition.
4. When a business combination or acquisition of shares is proposed pursuant to this Section 12.02, the Board of Directors shall promptly form a committee composed of all of the Board's disinterested Directors. The committee shall take action on the proposal by the affirmative vote of a simple majority of the committee members. The committee is not subject to any direction or control by the Board with respect to the committee's consideration of or any action concerning a business combination or acquisition of shares pursuant to this Section 12.02. A committee formed pursuant to this subsection shall be composed of one or more members. Only disinterested Directors may be members of a committee formed pursuant to this subsection. However, if the Board of Directors has no disinterested Directors, the Board shall select three or more disinterested persons to be committee members. For purposes of this subsection, a Director or person is disinterested if the Director or person is not an interested shareholder or an affiliate thereof or a present or former officer or employee of the Company or an affiliate or associate of the Company or of the interested shareholder or of any affiliate or associate of the interested shareholder.
12.03. Requirements after Three Years. Except for the provisions of Sections 12.02 and 12.04, the Company may not engage at any time in any business combination or vote, consent, or otherwise act to authorize a subsidiary of the Company to engage in any business combination with respect to, proposed by, on behalf of, or pursuant to any agreement, arrangement, or understanding, whether or not in writing, with an interested shareholder of the Company or any affiliate or associate of the interested shareholder other than a business combination meeting all the requirements of this Article XII, the Articles, and the requirements specified in any of the following:
1. A business combination with respect to which the consummation date is no less than three years after the share acquisition date, approved by the Board of Directors of the Company before the interested shareholder's share acquisition date, or as to which the acquisition of shares made by the interested shareholder on the interested shareholder's acquisition date had been approved by the Board of Directors before the interested shareholder's share acquisition date.
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2. A business combination approved by the affirmative vote of the holders of a majority of the outstanding shares entitled to vote not beneficially owned by the interested shareholder proposing the business combination or any affiliate or associate of the interested shareholder proposing the business combination at a meeting called for that purpose no earlier than three years after the interested shareholder's share acquisition date.
3. A business combination, with respect to which the consummation date is no earlier than three years after the interested shareholder's share acquisition date, that meets all of the following conditions:
(a) The aggregate amount of the cash and the market value as of the consummation date of consideration other than cash to be received per share by holders of outstanding common shares of the Company in the business combination is at least equal to the higher of the following:
(i) The highest per share price paid by the interested shareholder, at a time when the interested shareholder was the beneficial owner, directly or indirectly, of five percent (5%) or more of the outstanding shares entitled to vote of the Company, for any common shares of the same class or series acquired by it within the three (3) year period immediately before the announcement date with respect to the business combination or within the three (3) year period immediately before, or in, the transaction in which the interested shareholder became an interested shareholder, whichever is higher, plus, in either case, interest compounded annually from the earliest date on which the highest per share acquisition price was paid through the consummation date at the rate for one year United States treasury obligations from time to time in effect less the aggregate amount of any cash dividends paid, and the market value of any dividends paid other than in cash, per common share since the earliest date, up to the amount of the interest.
(ii) The market value per common share on the announcement date with respect to the business combination or on the interested shareholder's share acquisition date, whichever is higher, plus interest compounded annually from that date through the consummation date at the rate for one year United States treasury obligations from time to time in effect
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less the aggregate amount of any cash dividends paid and the market value of any dividends paid other than in cash, per common share since that date, up to the amount of the interest.
(b) The aggregate amount of the cash and the market value as of the consummation date of consideration other than cash to be received per share by holders of outstanding shares of any class or series of shares, other than common shares, of the Company in the business combination is at least equal to the highest of the following, whether or not the interested shareholder has previously acquired any shares of the class or series:
(i) The highest per share price paid by the interested shareholder, at a time when the interested shareholder was the beneficial owner, directly or indirectly, of five percent (5%) or more of the outstanding shares entitled to vote of the Company, for any shares of the class or series acquired by it within the three (3) year period immediately before the announcement date with respect to the business combination or within the three (3) year period immediately before, or in, the transaction in which the interested shareholder became an interested shareholder, whichever is higher, plus, in either case, interest compounded annually from the earliest date on which the highest per share acquisition price was paid through the consummation date at the rate for one year United States treasury obligations from time to time in effect less the aggregate amount of any cash dividends paid and the market value of any dividends paid other than in cash, per share of the class or series since such earliest date, up to the amount of the interest.
(ii) The highest preferential amount per share to which the holders of shares of the class or series are entitled in the event of any voluntary liquidation, dissolution, or winding up of the Company, plus the aggregate amount of any unpaid dividends declared or due as to which the holders are entitled before payment of
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dividends on some other class or series of shares, unless the aggregate amount of the dividends is included in the preferential amount.
(iii) The market value per share of the class or series on the announcement date with respect to the business combination or on the interested shareholder's share acquisition date, whichever is higher, plus interest compounded annually from that date through the consummation date at the rate for one year United States treasury obligations from time to time in effect less the aggregate amount of any cash dividends paid and the market value of any dividends paid other than in cash, per share of the class or series since that date, up to the amount of the interest.
(c) The consideration to be received by holders of a particular class or series of outstanding shares, including common shares, of the Company in the business combination is in cash or in the same form as the interested shareholder has used to acquire the largest number of shares of the class or series of shares previously acquired by it and the consideration is distributed promptly.
(d) The holders of all outstanding shares of the Company not beneficially owned by the interested shareholder immediately before the consummation date with respect to the business combination are entitled to receive in the business combination cash or other consideration for the shares in compliance with subdivisions (a),
(b) and (c).
(e) After the interested shareholder's share acquisition date and before the consummation date with respect to the business combination, the interested shareholder has not become the beneficial owner of any additional shares entitled to vote of the Company except:
(i) As part of the transaction that resulted in the interested shareholder becoming an interested shareholder;
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(ii) By virtue of proportionate share splits, share dividends, or other distributions of shares in respect of shares not constituting a business combination;
(iii) Through a business combination meeting all of the conditions of Section 12.02 and this paragraph; or
(iv) Through purchase by the interested shareholder at any price that, if the price had been paid in an otherwise permissible business combination the announcement date and consummation date of which were the date of the purchase, would have satisfied the requirements of subdivisions (a), (b) and (c) of this Section.
12.04. APPLICATION. This Article XII does not apply to any business combination of the Company with an interested shareholder of the Company who became an interested shareholder inadvertently, if the interested shareholder both:
1. As soon as practicable, divests itself of a sufficient amount of the shares entitled to vote of the Company so that it no longer is the beneficial owner, directly or indirectly, of ten percent (10%) or more of the outstanding shares entitled to vote of the Company.
2. Would not at any time within the three (3) year period preceding the announcement date with respect to the business combination have been an interested shareholder except for the inadvertent acquisition.
XIII. LIMITATION ON SHARE REPURCHASES
13.01. LIMITATION ON SHARE REPURCHASES. The Company shall not, directly or indirectly, purchase or agree to purchase any shares entitled to vote from a person who beneficially owns more than five per cent (5%) of the voting stock of the Company for more than the "average market price" of the shares if the shares have been beneficially owned by the person or persons for less than three (3) years, unless either (i) the purchase or agreement to purchase is approved at a meeting of shareholders by the affirmative vote of the holders of a majority of the voting stock entitled to vote excluding shares beneficially owned by such person, by any of such person's affiliates or associates, or by any officer or director of the Company or (ii) the Company makes an offer, of at least equal value per share, to all holders of shares of such class or series and to all holders of any class or series into which the shares may be converted.
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13.02. DEFINITIONS. For the purposes of this Article, "average market price" means the average closing sale price during the thirty trading days immediately preceding the purchase of the shares in question, or if the person or persons have commenced a tender offer or have announced an intention to seek control of the Company, during the thirty trading days preceding the earlier of the commencement of the tender offer or the making of the announcement, of a share on the composite tape for New York Stock Exchange listed shares or, if the shares are not quoted on the composite tape or not listed on the New York Stock Exchange, on the principal United States securities exchange registered under the Securities Exchange Act of 1934, as amended, on which the shares are listed or, if the shares are not listed on any such exchange, on the National Association of Securities Dealers, Inc. Automated Quotations National Market System or, if the shares are not quoted on the National Association of Securities Dealers, Inc. Automated Quotations National Market System, the average closing bid quotation, during the thirty trading days preceding the purchase of the shares in questions of a share on the National Association of Securities Dealers, Inc. Automated Quotations System or any system then in use, or if the person or persons have commenced a tender offer or have announced an intention to seek control of the issuing public corporation, during the thirty trading days preceding the earlier of the commencement of the tender offer or the making of the announcement, except that if no quotation is available the average market price is the fair market value on the date of purchase of the shares in question of a share as determined in good faith by the Board of Directors of the Company.
XIV. AMENDMENTS
14.01. AMENDMENT OF BYLAWS. These Bylaws may be altered, amended, supplemented, repealed, or temporarily or permanently suspended, in whole or in part, or replacement Bylaw provisions adopted by: (i) the affirmative vote of a majority of the directors then in office; or (ii) the affirmative vote of a majority of the votes cast on such matter(s) at a meeting of shareholders.
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CERTIFICATE
I, NANCY C. LOFTIN, Vice President, General Counsel and Secretary of Pinnacle West Capital Corporation, an Arizona corporation, do HEREBY CERTIFY that the foregoing is a true and correct copy of the Company's Bylaws, as amended, and that they are in full force and effect as of the date hereof.
IN WITNESS WHEREOF, I have hereunto set my hand and affixed the seal of the corporation this 23rd day of June, 2004.

/s/ Nancy C. Loftin
------------------------------
NANCY C. LOFTIN
Vice President, General Counsel, and
Secretary	

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EXHIBIT 10.1
ASSET PURCHASE AGREEMENT
BY AND BETWEEN
PPL SUNDANCE ENERGY, LLC
AS SELLER
AND
ARIZONA PUBLIC SERVICE COMPANY
AS PURCHASER
DATED AS OF JUNE 1, 2004

TABLE OF CONTENTS

ARTICLE I            DEFINITIONS; CONSTRUCTION...................................................................     1

Section 1.1          Definitions.................................................................................     1

Section 1.2          Construction................................................................................     1

ARTICLE II           PURCHASE AND SALE...........................................................................     2

Section 2.1          Purchase and Sale...........................................................................     2

Section 2.2          Excluded Assets.............................................................................     3

Section 2.3          Assumed Liabilities.........................................................................     3

Section 2.4          Excluded Liabilities........................................................................     4

ARTICLE III          PURCHASE PRICE; CLOSING.....................................................................     5

Section 3.1          Purchase Price..............................................................................     5

Section 3.2          Proration...................................................................................     5

Section 3.3          Closing.....................................................................................     7

Section 3.4          Closing Deliveries by Seller to Purchaser...................................................     7

Section 3.5          Closing Deliveries by Purchaser to Seller...................................................     8

Section 3.6          Allocation of Purchase Price................................................................     9

Section 3.7          Minimum Inventory Amount Adjustment.........................................................    10

Section 3.8          Adjustment Disputes.........................................................................    10

Section 3.9          Change in Name..............................................................................    11

ARTICLE IV           REPRESENTATIONS AND WARRANTIES OF SELLER....................................................    11

Section 4.1          Organization, Standing and Power............................................................    11

Section 4.2          Authority...................................................................................    12

Section 4.3          No Conflicts................................................................................    12

Section 4.4          Business....................................................................................    13

Section 4.5          Subsidiaries................................................................................    13

Section 4.6          Legal Proceedings...........................................................................    13

Section 4.7          Compliance with Laws and Orders.............................................................    13

Section 4.8          Liabilities.................................................................................    14

Section 4.9          Absence of Certain Changes or Events........................................................    14

Section 4.10         Taxes ......................................................................................    14

Section 4.11         Regulatory Status...........................................................................    14	

TABLE OF CONTENTS

Section 4.12         Contracts...................................................................................    15

Section 4.13         Real Property...............................................................................    17

Section 4.14         Personal Property...........................................................................    20

Section 4.15         Permits.....................................................................................    21

Section 4.16         Environmental Matters.......................................................................    21

Section 4.17         Insurance...................................................................................    22

Section 4.18         Intellectual Property.......................................................................    22

Section 4.19         Related Persons.............................................................................    22

Section 4.20         Brokers.....................................................................................    22

Section 4.21         Employees...................................................................................    23

Section 4.22         Employee Benefits...........................................................................    23

Section 4.23         Improvements................................................................................    23

ARTICLE V            REPRESENTATIONS AND WARRANTIES OF PURCHASER.................................................    24

Section 5.1          Corporate Existence.........................................................................    24

Section 5.2          Authority...................................................................................    24

Section 5.3          No Conflicts................................................................................    24

Section 5.4          Legal Proceedings...........................................................................    25

Section 5.5          Compliance with Laws and Orders.............................................................    25

Section 5.6          Brokers.....................................................................................    25

Section 5.7          Financial Resources.........................................................................    25

ARTICLE VI           COVENANTS...................................................................................    25

Section 6.1          Regulatory and Other Approvals..............................................................    25

Section 6.2          Access of Purchaser.........................................................................    27

Section 6.3          Certain Restrictions........................................................................    28

Section 6.4          Further Assurances..........................................................................    29

Section 6.5          Employee and Employee Benefit Matters.......................................................    29

Section 6.6          Insurance...................................................................................    31

Section 6.7          Seller's Covenants and Closing Conditions...................................................    31

Section 6.8          Purchaser's Covenants and Closing Conditions................................................    32

Section 6.9          Exclusivity.................................................................................    32	

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TABLE OF CONTENTS

Section 6.10         Risk of Loss................................................................................    32

Section 6.11         Current Evidence of Title...................................................................    34

Section 6.12         Transition Plan.............................................................................    36

Section 6.13         Updating....................................................................................    37

Section 6.14         Records.....................................................................................    38

Section 6.15         Synthetic Lease Transaction.................................................................    39

ARTICLE VII          TAX MATTERS.................................................................................    40

Section 7.1          Proration...................................................................................    40

Section 7.2          Cooperation.................................................................................    40

Section 7.3          Transfer Taxes..............................................................................    41

ARTICLE VIII         PURCHASER'S CONDITIONS TO CLOSING...........................................................    41

Section 8.1          Representations and Warranties..............................................................    41

Section 8.2          Performance.................................................................................    41

Section 8.3          Deliveries..................................................................................    41

Section 8.4          Orders and Laws.............................................................................    41

Section 8.5          Consents and Approvals......................................................................    42

Section 8.6          Seller Material Adverse Effect..............................................................    42

Section 8.7          Approvals of Governmental Authorities.......................................................    42

Section 8.8          Transferred Permits.........................................................................    43

Section 8.9          Title Insurance.............................................................................    43

Section 8.10         Environmental Diligence.....................................................................    43

Section 8.11         Legal Opinion...............................................................................    43

ARTICLE IX           SELLER'S CONDITIONS TO CLOSING..............................................................    44

Section 9.1          Representations and Warranties..............................................................    44

Section 9.2          Performance.................................................................................    45

Section 9.3          Deliveries..................................................................................    45

Section 9.4          Orders and Laws.............................................................................    45

Section 9.5          Consents and Approvals......................................................................    45

Section 9.6          Purchaser Material Adverse Effect...........................................................    45

Section 9.7          Approvals of Governmental Authorities.......................................................    45	

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TABLE OF CONTENTS

Section 9.8          Legal Opinion...............................................................................    45

ARTICLE X            TERMINATION.................................................................................    46

Section 10.1         Termination.................................................................................    46

Section 10.2         Effect of Termination.......................................................................    48

ARTICLE XI           INDEMNIFICATION, LIMITATIONS OF LIABILITY, WAIVERS AND ARBITRATION..........................    48

Section 11.1         Indemnification.............................................................................    48

Section 11.2         Waiver of Remedies..........................................................................    51

Section 11.3         Survival and Time Limitation................................................................    52

Section 11.4         Waiver of Other Representations; Limitations of Liability...................................    52

Section 11.5         Procedure for Indemnification - Third-Party Claims..........................................    53

Section 11.6         Arbitration.................................................................................    54

ARTICLE XII          MISCELLANEOUS...............................................................................    56

Section 12.1         Notices.....................................................................................    56

Section 12.2         Entire Agreement............................................................................    57

Section 12.3         Expenses....................................................................................    57

Section 12.4         Public Announcements........................................................................    57

Section 12.5         Confidential Information....................................................................    58

Section 12.6         Disclosure..................................................................................    59

Section 12.7         Waiver; Remedies Cumulative.................................................................    60

Section 12.8         Amendment...................................................................................    60

Section 12.9         No Third Party Beneficiary..................................................................    60

Section 12.10        Assignment; Binding Effect..................................................................    60

Section 12.11        Headings....................................................................................    60

Section 12.12        Invalid Provisions..........................................................................    60

Section 12.13        Counterparts; Facsimile.....................................................................    60

Section 12.14        Governing Law; Venue; and Jurisdiction......................................................    61

Section 12.15        Attorneys' Fees.............................................................................    61	

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TABLE OF CONTENTS

APPENDIX I           DEFINITIONS.................................................................................     1

EXHIBIT A            FORM OF ASSUMPTION OF CERTAIN LIABILITIES...................................................     1

EXHIBIT B            FORM OF AFFIDAVIT OF PROPERTY VALUE.........................................................     1

EXHIBIT C            FORM OF SPECIAL WARRANTY DEED...............................................................     1

EXHIBIT D            FORM OF BILL OF SALE AND ASSIGNMENT OF CONTRACT RIGHTS......................................     1

EXHIBIT E            FORM OF CERTIFICATION OF NON-FOREIGN STATUS.................................................     1

EXHIBIT F            FORM OF GUARANTY AGREEMENT..................................................................     1	

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ASSET PURCHASE AGREEMENT
THIS ASSET PURCHASE AGREEMENT (this "AGREEMENT") dated as of June 1, 2004 (the "AGREEMENT DATE") is made and entered into by and between PPL SUNDANCE ENERGY, LLC, a Delaware limited liability company ("SELLER"), and ARIZONA PUBLIC SERVICE COMPANY, an Arizona corporation ("PURCHASER").
RECITALS
Seller owns a generating plant in Pinal County, Arizona, having a nominal generating capacity of 450 megawatts.
Seller desires to sell and assign to Purchaser, and Purchaser desires to purchase and assume from Seller, the Purchased Assets and the Assumed Liabilities (each as hereinafter defined) on the terms and subject to the conditions set forth herein.
STATEMENT OF AGREEMENT
Now, therefore, in consideration of the premises and the mutual representations, warranties, covenants and agreements set forth in this Agreement, and for other good and valuable consideration, the receipt and sufficiency of which are hereby acknowledged, the Parties agree as follows:
ARTICLE I
DEFINITIONS; CONSTRUCTION
1.1 DEFINITIONS. Capitalized terms used in this Agreement have the meanings given to them in Appendix I to this Agreement.
1.2 CONSTRUCTION.
(a) In this Agreement, unless expressly provided otherwise:
(i) Unless otherwise specified, all article, section, subsection, schedule, exhibit and appendix references used in this Agreement are to articles, sections, subsections, schedules, exhibits and appendices to this Agreement. The exhibits, schedules and appendices attached to this Agreement constitute a part of this Agreement and are incorporated herein for all purposes.
(ii) If a term is defined as one part of speech (such as a noun), it shall have a corresponding meaning when used as another part of speech (such as a verb). Unless the context of this Agreement clearly requires otherwise the singular shall include the plural and the plural shall include the singular wherever and as often as may be appropriate, and words importing the masculine gender shall include the feminine and neutral genders and vice versa. The words "includes" or "including" shall mean "including without limitation," the words "hereof," "hereby," "herein," "hereunder" and similar terms in this Agreement

shall refer to this Agreement as a whole and not any particular section or article in which such words appear and any reference to a Law shall include any amendment thereof or any consolidation, amendment, reenactment, extension, replacement or successor thereto and any rules and regulations promulgated thereunder. References to "or" shall be deemed to be disjunctive but not necessarily exclusive (i.e., unless the context dictates otherwise, "or" shall be interpreted to mean "and/or" rather than "either/or"). Currency amounts referenced herein, unless otherwise specified, are in U.S. Dollars.
(iii) A reference to (A) a day (other than a Business Day) is a reference to a calendar day, (B) a month is a reference to a calendar month and (C) a year is a reference to a calendar year. A reference to a time is a reference to the time in effect in Phoenix, Arizona on the relevant date. When a period of time is specified to run from or after a given day or the day of an act or event, it is to be calculated exclusive of such day; and where a period of time is specified as commencing on a given day or the day of an act or event, it is to be calculated inclusive of such day. Whenever this Agreement refers to a number of days, such number shall refer to calendar days unless Business Days are specified. Whenever any action must be taken hereunder on or by a day that is not a Business Day, then such action may be validly taken on or by the next day that is a Business Day. A reference to a day (other than a Business Day) is a reference to a period of time commencing at midnight Phoenix time and ending the following midnight Phoenix time. A reference to a Business Day is a reference to a period of time commencing at 9:00 a.m. Phoenix time on a Business Day and ending at 5:00 p.m. Phoenix time on the same Business Day.
(iv) All accounting terms used herein and not expressly defined herein shall have the meanings given to them under GAAP.
(b) Time is of the essence in this Agreement.
(c) Each Party acknowledges that it and its attorneys have been given an equal opportunity to negotiate the terms and conditions of this Agreement and that any rule of construction to the effect that ambiguities are to be resolved against the drafting Party or any similar rule operating against the drafter of an agreement shall not be applicable to the construction or interpretation of this Agreement.
ARTICLE II
PURCHASE AND SALE
2.1 PURCHASE AND SALE. On the terms and subject to the conditions set forth in this Agreement, at the Closing, Seller shall sell, assign, convey, transfer and deliver to Purchaser, and Purchaser shall purchase and acquire from Seller, free and clear of all Liens (except for Permitted Liens, including the Permitted Liens set forth on Schedule 2.1), all of Seller's right, title and interest in, to and under the real and personal property, tangible or intangible, constituting the Purchased Assets.
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2.2 EXCLUDED ASSETS. Notwithstanding any provision herein to the contrary, the Purchased Assets shall not include the following (collectively, the "EXCLUDED ASSETS"):
(a) except for Prepayments, any cash, cash equivalents, certificates of deposit, bank deposits, commercial paper, securities, rights to payment, accounts receivable, rights to refunds, credits, offsets, in-kind or exchange arrangements, income, sales, payroll or other tax receivables, and any similar rights arising from or relating to the ownership or operation of the Business or the Project with respect to any period of time prior to the Closing;
(b) all claims, causes of action, rights of recovery, rights of set-off, rights to refunds and similar rights of any kind in favor of Seller or any other Person arising from or relating to the ownership or operation of the Business or the Project with respect to any period of time prior to the Closing, including any refund of Taxes paid prior to the Closing (including refunds of Taxes received after the Closing) and described in SECTION 2.2(d) below, except for (i) any of the foregoing that relate to Assumed Liabilities and (ii) the Warranty Rights;
(c) any rights of Seller or any other Person in the names "PPL" and "PPL Sundance Energy" or any other trade names, trademarks, service marks or logos;
(d) any refund, credit penalty payment, adjustment or reconciliation (i) related to real property taxes, personal property taxes or other Taxes paid prior to the Closing Date in respect of the Purchased Assets or relating to the Business or the Project, whether such refund, adjustment or reconciliation is received as a payment or as a credit against future Taxes payable, or (ii) arising under the Transferred Contracts and relating to any period before the Closing Date;
(e) the rights under any insurance policy arising out of and relating to events or periods prior to the Closing or which is not related to the Business or the Project, except to the extent such policy insures for events or occurrences that are included in the Assumed Liabilities;
(f) the contracts, leases and other agreements set forth on Schedule 2.2(f) and any other contracts, leases or other agreements of Seller or any other Person not used or useful in, or related primarily to or necessary for, the Business or the Project (the "EXCLUDED CONTRACTS");
(g) all books and records of Seller or any other Person other than the Books and Records;
(h) the rights and assets described in Schedule 2.2(h) as not part of the Purchased Assets (the "EXCLUDED ITEMS"); and
(i) the rights of Seller under this Agreement and the Ancillary Agreements.
2.3 ASSUMED LIABILITIES. On the Closing Date, Purchaser shall execute and deliver in favor of Seller the Assumption Agreement, pursuant to which Purchaser shall assume and agree to pay, perform and discharge when due the following Liabilities of Seller, whether direct or indirect, known or unknown (except as otherwise provided in SECTION 11.1(c) of this Agreement with respect to Environmental Liabilities and Tort Liabilities), absolute or contingent, accrued, fixed or otherwise, or whether due or to become due, solely to the extent such Liabilities accrue
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or arise from and after the Closing (except as otherwise specifically provided in SECTION 11.1(c) of this Agreement with respect to Environmental Liabilities and Tort Liabilities), other than Excluded Liabilities (as defined below), in accordance with the respective terms and subject to the respective conditions thereof (collectively, but excluding the Excluded Liabilities, the "ASSUMED LIABILITIES"):
(a) all Liabilities of Seller under the Transferred Contracts, the Transferred Permits and the Transferred Intellectual Property, in each case in accordance with the terms thereof, except to the extent that such Liabilities, but for a breach or default by Seller, would have been paid, performed or otherwise discharged on or prior to the Closing Date or to the extent the same arise out of any such breach or default or out of any event which after the giving of notice would constitute a default by Seller;
(b) any and all Liabilities associated with Continued Employees, to the extent provided in SECTION 6.5;
(c) any Liability of Seller described on Schedule 2.3(c);
(d) any Liability for Real Property and other Taxes attributable to the Purchased Assets, except to the extent of the proration provided for in SECTION 3.2;
(e) subject to SECTION 11.1(c), any and all Environmental Liabilities, except for the Excluded Environmental Liabilities; and
(f) subject to SECTION 11.1(c), any and all Tort Liabilities, except for the Excluded Tort Liabilities.
2.4 EXCLUDED LIABILITIES. Except for the Assumed Liabilities, Purchaser shall not assume by virtue of this Agreement, the Assumption Agreement or any other Ancillary Agreement, or the transactions contemplated hereby or thereby, or otherwise, and shall have no liability for, any Liabilities of Seller (the "EXCLUDED LIABILITIES"), including any of the following Liabilities:
(a) any Liabilities of Seller in respect of any Excluded Assets or other assets of Seller that are not Purchased Assets;
(b) any Liabilities in respect of Taxes attributable to the Purchased Assets for taxable periods ending on or before the Closing Date, except to the extent of the proration provided for in SECTION 3.2;
(c) any Liabilities of Seller (i) arising from the violation, breach or default by Seller, prior to the Closing Date, of any Transferred Contract, Transferred Permit or Transferred Intellectual Property or (ii) in respect of any other contract, agreement, personal property lease, permit, license or other arrangement or instrument entered into by Seller;
(d) subject to SECTION 3.2, any payment obligations of Seller, including accounts or notes payable, accruing or arising prior to the Closing Date;
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(e) any fines and penalties imposed by any Governmental Authority resulting from any act or omission by Seller or its Affiliates that occurred prior to the Closing Date;
(f) any income Taxes attributable to income received by Seller;
(g) any Liability of Seller arising as a result of its execution and delivery of this Agreement or any Ancillary Agreement, the performance of its obligations hereunder or thereunder, or the consummation by Seller of the transactions contemplated hereby or thereby;
(h) any Liability of Seller based on Seller's acts or omissions after the Closing;
(i) any and all Environmental Liabilities to the extent accruing, arising or occurring during the period of Seller's (or any of its Affiliates') ownership of the Real Property or operation of the Project, and any and all other Environmental Liabilities to the extent accruing, arising or occurring prior to the Closing and within Seller's Knowledge prior to the Closing (the "EXCLUDED ENVIRONMENTAL LIABILITIES"); and
(j) any and all Tort Liabilities to the extent accruing, arising or occurring during the period of Seller's (or any of its Affiliates') ownership of the Real Property or operation of the Project, and any and all other Tort Liabilities to the extent accruing, arising or occurring prior to the Closing and within Seller's Knowledge prior to the Closing (the "EXCLUDED TORT LIABILITIES").
ARTICLE III
PURCHASE PRICE; CLOSING
3.1 PURCHASE PRICE. At the Closing, Purchaser agrees to pay to Seller the sum of One Hundred Eighty-Nine Million Five Hundred Thousand and No/100 Dollars ($189,500,000.00), subject to adjustment pursuant to SECTION 3.7 and
SECTION 10.1(g) (the "PURCHASE PRICE").
3.2 PRORATION.
(a) Purchaser and Seller agree that, except as otherwise set forth in this Agreement, all of the items normally prorated, including those listed below, relating to the Business and the Purchased Assets shall be prorated as of the effective time of the Closing on the Closing Date, with Seller liable to the extent such items relate to any time period through the effective time of the Closing on the Closing Date, and Purchaser liable to the extent such items relate to any time period subsequent to the effective time of the Closing on the Closing Date:
(i) any rent, Taxes and other items payable by or to Seller under any of the Transferred Contracts to be assigned to and assumed by Purchaser hereunder;
(ii) any permit, license or registration fees with respect to any Transferred Permit; and
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(iii) charges for water, telephone, electricity and other utilities.
(b) Purchaser and Seller agree that Property Taxes with respect to the Business or the ownership and the operations of the Purchased Assets or the Project shall be prorated as follows:
(i) Seller shall be liable for and shall pay when due all Property Taxes having a lien date in the year before the calendar year of the Closing Date.
(ii) Seller shall be liable for and shall pay when due all Property Taxes having a lien date in the same calendar year as the Closing Date; and
(iii) Property Taxes having a lien date in the calendar year following the year of the Closing Date shall be paid by Purchaser; however, such Property Taxes shall be prorated with (A) Seller being liable for that portion of the Property Taxes calculated by multiplying (1) the final determined Property Tax liability by (2) the number of days beginning with January 1 in the year of Closing up to and including the Closing Date divided by three hundred sixty-five
(365) days, and (B) Purchaser being liable for that portion of the Property Taxes calculated by multiplying (1) the final determined Property Tax liability by (2) the number of days after the Closing Date up to and including December 31 in the year of Closing divided by three hundred sixty-five (365) days. Schedule 3.2(b) illustrates the operation of this
SECTION 3.2(b). After each payment of Property Taxes referred to in this SECTION 3.2(b)(iii) by Purchaser, Purchaser shall notify Seller in writing of the total amount of Property Taxes paid and, as to that payment, the prorated amount for which Seller is liable. Seller shall reimburse Purchaser such prorated amount within fifteen (15) days after receipt of the notice from Purchaser.
(c) In the event that actual figures are not available at the Closing Date, prorations required by SECTION 3.2(a) shall be calculated as follows:
(i) Such proration shall be based upon the actual fee, cost or amount of the specific item for the most recent preceding year (or appropriate period) for which an actual fee, cost or amount paid is available.
(ii) Upon the request of either Seller or Purchaser, made within sixty (60) days of the date that any actual amount previously estimated in accordance with SECTION 3.2(c)(i) becomes available (the "REQUEST DATE"), the Parties shall (A) calculate the prorated amounts using the actual available amounts (the "ACTUAL PRORATED AMOUNTS"), (B) calculate the difference between the originally estimated prorations (the "ESTIMATED PRORATED AMOUNTS") and the Actual Prorated Amounts (the "PRORATED DIFFERENCE"), and (C) the Party that at Closing paid less than the Actual Prorated Amount due from such Party based upon the Estimated Prorated Amounts shall pay the Prorated Difference to the other Party within sixty (60) days of the Request Date.
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3.3 CLOSING. The Closing shall take place in Phoenix at the offices of Moyes Storey at 10:00 A.M. Phoenix time, on the third Business Day after the conditions to Closing set forth in ARTICLES VIII and IX (other than actions to be taken or items to be delivered at Closing) have been either satisfied or waived by the Party entitled to waive such conditions, or on such other date and at such other time and place as Purchaser and Seller mutually agree in writing. All actions scheduled in this Agreement for the Closing Date shall be deemed to occur simultaneously at the Closing. Subject to the provisions of ARTICLE X, failure to consummate the purchase and sale provided for in this Agreement on the date determined pursuant to this SECTION 3.3 will not result in the termination of this Agreement and will not relieve any Party of any obligation under this Agreement. The Closing shall be effective for all purposes as of 11:59:59 P.M. Phoenix time on the Closing Date.
3.4 CLOSING DELIVERIES BY SELLER TO PURCHASER. At the Closing (or, in the case of clause (j) below, simultaneously with the execution and delivery hereof), Seller shall deliver, or shall cause to be delivered, to Purchaser the following:
(a) the Deed, duly executed by and acknowledged on behalf of Seller and in recordable form;
(b) the Bill of Sale and Assignment of Rights, duly executed by Seller;
(c) the Affidavit of Property Value, duly executed by and acknowledged on behalf of Seller;
(d) the FIRPTA Affidavit, duly executed by and acknowledged on behalf of Seller;
(e) a certificate of an officer of Seller, dated as of the Closing Date, setting forth and attesting to (i) the resolutions of the board of directors of the sole member of Seller authorizing the execution, delivery and performance of this Agreement and the Ancillary Agreements and the consummation of the transactions contemplated hereby and thereby, (ii) the incumbency and signature of the officer(s) of Seller executing this Agreement and the Ancillary Agreements and (iii) the Original Cost and the Accumulated Provision for Depreciation and Amortization for the Purchased Assets as of the Closing Date;
(f) a certificate of an officer of Seller, dated as of the Closing Date, as to the matters set forth in SECTIONS 8.1 and 8.2;
(g) a complete copy of the certificate of formation (and all amendments thereto) of Seller, certified by the Secretary of State of Delaware as of a date not more than five (5) Business Days prior to the Closing Date, and a complete copy of the Charter Documents (and all amendments thereto) of Seller as in effect on the Closing Date, certified by an officer of Seller;
(h) certificates from appropriate Governmental Authorities, dated no earlier than five (5) Business Days prior to the Closing Date, as to the good standing and legal existence of Seller in the State of Delaware and as to the good standing and qualification to do business by Seller in the State of Arizona;
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(i) the consents, waivers, authorizations and approvals set forth on Schedules 4.3(b) and 4.3(c), in form and substance reasonably satisfactory to Purchaser;
(j) a duly executed unconditional guaranty of Seller's obligations under ARTICLE X, ARTICLE XI and SECTION 12.15 in the form attached hereto as Exhibit F (the "GUARANTY AGREEMENT") from PPL Energy Supply;
(k) a tax clearance certificate from the Arizona Department of Revenue, dated no earlier than five (5) Business Days prior to the Closing Date, with respect to Seller; and
(l) such other documents as Purchaser may reasonably request to carry out the purposes of this Agreement.
3.5 CLOSING DELIVERIES BY PURCHASER TO SELLER. At the Closing, Purchaser shall deliver to Seller the following:
(a) a wire transfer of immediately available funds (to such account as Seller shall have notified Purchaser of at least two (2) Business Days prior to the Closing Date) in the amount equal to the Purchase Price (plus or minus any prorated amounts calculated pursuant to SECTION 3.2(c));
(b) the Affidavit of Property Value, duly executed by and acknowledged on behalf of Purchaser;
(c) an assumption agreement (the "ASSUMPTION AGREEMENT"), in the form attached hereto as Exhibit A, evidencing the assumption by Purchaser of the Assumed Liabilities, duly executed by Purchaser;
(d) a certificate of an officer of Purchaser, dated as of the Closing Date, setting forth and attesting to (i) the resolutions of the board of directors of Purchaser authorizing the execution, delivery and performance of this Agreement and the Ancillary Agreements to which it is a party and the consummation of the transactions contemplated hereby and thereby, and (ii) the incumbency and signature of each officer of Purchaser executing this Agreement and the Ancillary Agreements to which it is a party;
(e) a certificate of an officer of Purchaser, dated as of the Closing Date, as to the matters set forth in SECTIONS 9.1 and 9.2;
(f) a complete copy of Purchaser's articles of incorporation (and all amendments thereto), certified by the ACC as of a date not more than five (5) Business Days prior to the Closing Date, and a complete copy of the bylaws (and all amendments thereto) of Purchaser, certified by an officer of Purchaser;
(g) a certificate from the ACC, dated no earlier than five (5) Business Days prior to the Closing Date, as to the good standing and legal existence of Purchaser in Arizona; and
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(h) such other documents as Seller may reasonably request to carry out the purposes of this Agreement.
3.6 ALLOCATION OF PURCHASE PRICE.
(a) Seller and Purchaser agree that prior to the Closing, the Purchase Price shall be allocated among the Purchased Assets in accordance with an allocation schedule (the "PURCHASE PRICE ALLOCATION SCHEDULE") agreed upon by Purchaser and Seller, which shall be prepared in a manner required by Section 1060 of the Code and any other applicable Law and delivered by Purchaser to Seller prior to the Closing. Seller and Purchaser each shall prepare a mutually acceptable and substantially identical IRS Form 8594 "Asset Acquisition Statements Under Section 1060" consistent with the Purchase Price Allocation Schedule which the Parties shall use to report the transactions contemplated by this Agreement to the applicable Taxing Authorities. Each of Seller and Purchaser agrees to provide the other promptly with any other information required to complete IRS Form 8594. Each Party agrees that it shall not, without the consent of the other Party, take a position on any Tax Return, or before any Taxing Authority in connection with the examination of any Tax Return or in any subsequent judicial proceeding, that is in any manner inconsistent with the terms of the Purchase Price Allocation Schedule. In recognition of Seller's status as a disregarded entity for U.S. federal and Arizona income tax purposes, Purchaser agrees that Seller's responsibilities and obligations under this
SECTION 3.6(a) shall be satisfied by Seller cooperating with its sole member with respect to such responsibilities and obligations.
(b) If Purchaser and Seller are unable to agree upon the Purchase Price Allocation Schedule within fifteen (15) days prior to the scheduled Closing Date, Purchaser and Seller shall refer the matter to Independent Accountants, which shall determine the Purchase Price Allocation Schedule (including any valuations) in accordance with the provisions set forth in this SECTION 3.6(b). The Independent Accountants shall be instructed to deliver to Purchaser and Seller a written determination of the Purchase Price Allocation Schedule within ten (10) days from the date of referral thereof to the Independent Accountants. For purposes of this SECTION 3.6(b) and whenever the Independent Accountants are retained to resolve a dispute between the Parties under this Agreement, the Independent Accountants may determine the issues in dispute following such procedures, consistent with the provisions of this Agreement, as they deem appropriate in the circumstances and with reference to the amounts in issue. The Parties do not intend to impose any particular procedures upon the Independent Accountants, it being the desire of the Parties that any such disagreement shall be resolved as expeditiously and inexpensively as reasonably practicable. The Independent Accountants shall have no liability to the Parties in connection with such services except for acts of bad faith, willful misconduct or gross negligence, and the Parties shall provide such indemnities to the Independent Accountants as they may reasonably request. Except in the case of fraud or manifest error, the finding of the Independent Accountants shall be final and binding on the Parties. Purchaser and Seller shall share equally the fees and disbursements of the Independent Accountants in connection with resolving the dispute.
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3.7 MINIMUM INVENTORY AMOUNT ADJUSTMENT.
(a) The Purchase Price will be increased on a dollar-for-dollar basis to the extent that the Post-Closing Inventory Amount Determination (as defined below) is greater than the Minimum Inventory Amount (provided that such increase shall in no event exceed $100,000) and decreased on a dollar-for-dollar basis to the extent that the Post-Closing Inventory Amount Determination is less than the Minimum Inventory Amount.
(b) At least five (5) Business Days prior to the execution and delivery hereof, Seller shall have provided Purchaser with a certificate containing a description, part number, quantity on hand, average unit cost and extended value (quantity times average unit cost) with respect to each class of inventory as of the last day of each calendar month between January 1, 2003 and December 31, 2003. During the Interim Period, Purchaser will be entitled to conduct onsite test counts of the spare parts inventory in accordance with
SECTION 6.2.
(c) Within sixty (60) days after the Closing Date, Purchaser will deliver to Seller written notice (the "INVENTORY ADJUSTMENT NOTICE") of Purchaser's post-Closing determination of the spare parts in inventory as of the Closing Date (the "POST-CLOSING INVENTORY AMOUNT DETERMINATION"), as derived from Purchaser's physical review of the spare parts in inventory, the records (financial and otherwise) relating to such spare parts, and the Transferred Contracts. The Inventory Adjustment Notice will contain reasonable detail as to how the Post-Closing Inventory Amount Determination was determined by Purchaser. Within twenty (20) days after Seller's receipt of the Inventory Adjustment Notice, Seller will notify Purchaser in writing of Seller's acceptance or rejection of the Post-Closing Inventory Amount Determination as set forth in the Inventory Adjustment Notice. Any notice of rejection by Seller must include the reasons for such rejection and, if appropriate, Seller's proposed calculation of the Post-Closing Inventory Amount Determination. If (i) by written notice to Purchaser, Seller accepts the Post-Closing Inventory Amount Determination as set forth in the Inventory Adjustment Notice, or (ii) Seller fails to deliver any notice of acceptance or rejection of the Post-Closing Inventory Amount Determination within the prescribed twenty (20)-day period (which failure will result in Seller being deemed to have irrevocably accepted and agreed with the Post-Closing Inventory Amount Determination), the Post-Closing Inventory Amount Determination as set forth in the Inventory Adjustment Notice will be final and binding on the Parties.
3.8 ADJUSTMENT DISPUTES.
(a) If Seller delivers written notice to Purchaser under
SECTION 3.7(c) of rejection of the Post-Closing Inventory Amount Determination as set forth in the Inventory Adjustment Notice, Seller and Purchaser will promptly (and in any event within ten (10) Business Days after the date of delivery of Seller's notice of rejection to Purchaser) cause their respective representatives to confer with each other with a view to resolving any such matter. If such Parties' representatives are unable to resolve any such matter within thirty (30) days after the date of delivery of Seller's notice of rejection to Purchaser, Seller and Purchaser will refer the dispute to Independent Accountants for review and final determination of the Post-Closing Inventory Amount Determination. The Independent Accountants shall be instructed to deliver to Purchaser and Seller a written determination of the Post-Closing Inventory Amount Determination within ten (10) Business Days from the date of referral thereof to the Independent
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Accountants. The Independent Accountants may request of Seller or Purchaser such documents and information as may be necessary or appropriate for proper determination of any such matter, and such Parties will cooperate to promptly satisfy any such request. Except in the case of fraud or manifest error ,the determination by the Independent Accountants of the Post-Closing Inventory Amount Determination will be final and binding on the Parties. Seller and Purchaser will equally share the fees and disbursements of the Independent Accountants in undertaking such review and determination.
(b) Within five (5) Business Days after the final agreement of Seller and Purchaser, the final determination by the Independent Accountants or the deemed acceptance by Seller (as the case may be) of the Post-Closing Inventory Amount Determination, either:
(i) Purchaser will pay to Seller, by wire transfer of immediately available funds, the amount (if any) by which the Post-Closing Inventory Amount Determination exceeds the Minimum Inventory Amount (provided that such adjustment shall in no event exceed $100,000), or
(ii) Seller will pay to Purchaser, by wire transfer of immediately available funds, the amount (if any) by which the Post-Closing Inventory Amount Determination is less than the Minimum Inventory Amount.
3.9 CHANGE IN NAME. Not more than ten (10) Business Days after the Closing Date, Purchaser shall remove all signs or other indications of ownership at the Project or on the Purchased Assets that reference Seller.
ARTICLE IV
REPRESENTATIONS AND WARRANTIES OF SELLER
The representations and warranties contained in this ARTICLE IV are qualified by the disclosure made with respect to such representations and warranties in the Schedules attached hereto, to the extent that such disclosure specifically identifies, or that it is reasonably apparent that such disclosure relates to, the subsections that it qualifies. This ARTICLE IV and the Schedules shall be read together as an integrated provision. Subject to the foregoing, effective as of the Agreement Date and the Closing Date, Seller hereby represents and warrants to Purchaser that, except as disclosed in the Schedules:
4.1 ORGANIZATION, STANDING AND POWER. Seller is a limited liability company duly formed, validly existing and in good standing under the Laws of Delaware and has all requisite power and authority to conduct its business as it is now being conducted and to own, lease and operate the Business and the Purchased Assets. Seller is duly qualified or licensed to do business in each jurisdiction in which the ownership or operation of the Purchased Assets or the nature of the business conducted by it make such qualification or licensing necessary, except in those jurisdictions where the failure to be so qualified or licensed would not reasonably be expected to result in a material adverse effect on Seller's ability to perform its obligations hereunder. Seller has made available to Purchaser true, correct and complete copies of Seller's Charter Documents.
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4.2 AUTHORITY. Seller has all requisite limited liability company power and authority to execute and deliver this Agreement and each of the Ancillary Agreements to which it is a party, to perform its obligations hereunder and thereunder and to consummate the transactions contemplated hereby and thereby. The execution and delivery by Seller of this Agreement and each Ancillary Agreement to which Seller is a party, and the performance by Seller of its obligations hereunder and thereunder, have been duly and validly authorized by all necessary limited liability company action. This Agreement and each of the Ancillary Agreements to which Seller is a party have been duly and validly executed and delivered by Seller and constitute the legal, valid and binding obligation of Seller enforceable against Seller in accordance with their respective terms, except that the enforcement hereof and thereof may be limited by bankruptcy, insolvency, reorganization, arrangement, moratorium or other similar Laws relating to or affecting the rights of creditors generally, or by general equitable principles.
4.3 NO CONFLICTS. The execution, delivery and performance by Seller of this Agreement and each of the Ancillary Agreements to which Seller is a party and the completion of the transactions contemplated hereby and thereby do not and will not:
(a) conflict with or result in a violation or breach of any of the terms, conditions or provisions of the Charter Documents of Seller;
(b) assuming the notices, consents and waivers set forth on Schedule 4.3(b) (the "SELLER CONSENTS") have been made or obtained:
(i) violate, result in a breach of, constitute (with due notice or lapse of time or both) a default or cause any obligation, penalty, premium or right of termination, cancellation or acceleration to arise or accrue under, any Contract to which Seller is a party or by which it or any of the Purchased Assets may be bound, except for any such defaults or consents (or rights of termination, cancellation or acceleration) as to which requisite waivers or consents have been obtained or which would not, individually or in the aggregate, reasonably be expected to have a Seller Material Adverse Effect;
(ii) result in the creation or imposition of any Lien upon any of the Purchased Assets;
(iii) result in the cancellation, modification (except as contemplated by this Agreement), revocation or suspension of any Transferred Contract, Transferred Permit or Transferred Intellectual Property;
(iv) require the consent, approval, or notification of, or registration or filing with, any third party; or
(v) cause Purchaser, any of its Affiliates, or any of the Purchased Assets to become subject to, or liable for the payment of, any Tax relating to the operation of Seller, the Purchased Assets or the Business for any period ending or deemed to end on or before the Closing Date; and
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(c) assuming all required filings, approvals, consents, authorizations and notices set forth on Schedule 4.3(c) (collectively, the "SELLER APPROVALS") have been made, obtained or given, (i) conflict with or result in a violation or breach of any term or provision of any Law or writ, judgment, order or decree applicable to Seller or its Assets, or (ii) require the consent, approval, or notification of, or registration or filing with, any Governmental Authority under any applicable Law.
4.4 BUSINESS. The Business is the only business operation carried on by Seller. Except for the Excluded Items, the Purchased Assets are sufficient to operate the Business as currently operated and constitute all the assets and rights that are used by Seller or any of its Affiliates in connection with the operation of the Business. All equipment included in the Purchased Assets (other than spare parts and other equipment not currently in service) and all buildings, structures and fixtures constituting part of the Project have been maintained by Seller in accordance with Good Operating Practices, except for ordinary wear and tear. There are no pending or, to Seller's Knowledge, threatened proceedings or governmental actions to condemn or take by power of eminent domain all or any part of the Purchased Assets. For purposes of this Agreement, "SELLER'S KNOWLEDGE" means the actual knowledge of the individuals named on Schedule 4.4, who Seller represents to be the persons generally responsible for the subject matters to which such knowledge is pertinent.
4.5 SUBSIDIARIES. Seller does not have any subsidiaries or own equity interests in any Person.
4.6 LEGAL PROCEEDINGS.
(a) Neither Seller nor any of its Affiliates has been served with notice of any Claim, and, to Seller's Knowledge, none has been threatened against any such Person, that (i) affects Seller or the Purchased Assets and would, individually or in the aggregate, if pursued or resulting in a judgment against Seller, reasonably be expected to have a Seller Material Adverse Effect or (ii) seeks a writ, judgment, order or decree restraining, enjoining or otherwise prohibiting or making illegal any of the transactions contemplated by this Agreement. Seller does not have any Knowledge of any facts that would reasonably be expected to form the basis for any such Claim, writ, judgment, order or decree.
(b) Schedule 4.6(b) lists all of the currently pending legal proceedings before any Governmental Authority relating to the Project or the Business (but not, however, including any such legal proceedings that apply generically to the electric power industry or any segment thereof, or to participants within such industry or any such segment). To Seller's Knowledge, all currently effective filings relating to the Project or the Business heretofore made by Seller with any Governmental Authority were made in compliance with the Laws then applicable thereto and the information contained therein was true and correct in all material respects as of the respective dates of such filings.
4.7 COMPLIANCE WITH LAWS AND ORDERS. Seller is in compliance with all Laws and orders applicable to it, except where any such non-compliance would not, in the aggregate, reasonably be expected to have a Seller Material Adverse Effect; provided that this SECTION 4.7
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does not address (a) Real Property, which is exclusively addressed by SECTION 4.13, or (b) Environmental Laws, which are exclusively addressed by SECTIONS 4.15 and 4.16.
4.8 LIABILITIES. Except as disclosed on Schedule 4.8, Seller has no Liabilities that individually or in the aggregate exceed $100,000, excluding (i) Liabilities under the Transferred Contracts and Excluded Contracts, (ii) Liabilities under this Agreement, (iii) Liabilities under Seller's Permits listed on Schedule 4.15, (iv) Liabilities under this Agreement for which Seller is responsible, and (v) Liabilities incurred after the date hereof in accordance with the provisions contained in ARTICLE VI.
4.9 ABSENCE OF CERTAIN CHANGES OR EVENTS. Except as set forth in Schedule 4.9, and except as otherwise contemplated by this Agreement, between December 31, 2003, and the Agreement Date, there has not been: (i) any Seller Material Adverse Effect; (ii) any damage, destruction or casualty loss, whether covered by insurance or not, which has had a Seller Material Adverse Effect; or
(iii) any entry into any agreement, commitment or transaction (including any borrowing, capital expenditure or capital financing) by Seller or any of its Affiliates, which is material to the Business or operations of the Purchased Assets, except agreements, commitments or transactions in the ordinary course of business or as contemplated herein.
4.10 TAXES. All Tax Returns that are required to be filed on or before the Closing Date by, on behalf of or relating to Seller or its financial results have been or will be duly and timely filed or are the subject of a timely filed and valid extension. All Taxes that are shown to be due on such Tax Returns with respect to the Business have been or will be timely paid in full. All Property Taxes with respect to the Purchased Assets having a lien date in the year before the calendar year of the Closing Date have been or will be paid in full by Seller no later than the respective due dates for such Property Taxes. All Property Taxes with respect to the Purchased Assets having a lien date in the same year as the Closing Date have been or will be paid in full by Seller no later than the respective due dates for such Property Taxes. All Property Tax Returns with respect to the Purchased Assets have been or will be duly and timely filed by Seller for certain time periods, as set forth in SECTION 7.1(b). All withholding Tax requirements imposed on Seller have been satisfied in full in all respects. Seller does not have in force any waiver of any statute of limitations in respect of Taxes or any extension of time with respect to a Tax assessment or deficiency. There are no pending or active audits or, to Seller's Knowledge, threatened audits or proposed deficiencies or other claims for unpaid Taxes of Seller.
4.11 REGULATORY STATUS.
(a) Seller is qualified as an "exempt wholesale generator" and the Project is an "eligible facility," each within the meaning of Section 32(a) of the Public Utility Holding Company Act of 1935. Except as set forth on Schedule 4.11(a), Seller is not subject to regulation as a public utility or public service company (or similar designation) by the United States, any State of the United States, any foreign country or any municipality or any political subdivision of the foregoing.
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(b) Seller is not an "investment company," a company "controlled" by an "investment company" or an "investment advisor" within the meaning of the Investment Company Act of 1940.
4.12 CONTRACTS.
(a) Schedule 4.12(a) sets forth a complete and accurate list as of the Agreement Date of all of the following Transferred Contracts to which Seller or an Affiliate of Seller is a party relating to the Project or the Business or by which the Purchased Assets may be bound (collectively, "MATERIAL CONTRACTS" and individually a "MATERIAL CONTRACT"):
(i) Contracts for the future purchase, exchange or sale of gas;
(ii) Contracts for the future purchase, exchange or sale of power or ancillary services;
(iii) Contracts for the future purchase, exchange, or sale of steam;
(iv) Contracts for the future transportation or transmission of gas or electric power;
(v) interconnection Contracts;
(vi) Contracts (A) for the sale of any Asset or (B) that grant a right or option to purchase any Asset, other than Contracts entered into in the ordinary course of business relating to Assets with a value of less than $50,000 individually or $100,000 in the aggregate;
(vii) Contracts (other than Contracts identified pursuant to SECTIONS 4.12(a)(i) THROUGH (vi)) for the future provision of goods or services and requiring payments by Seller in excess of $50,000 for each individual Contract;
(viii) Contracts under which Seller has created, incurred, assumed or guaranteed any outstanding indebtedness for borrowed money or any capitalized lease obligation, or under which Seller has imposed a security interest on any of its Assets, tangible or intangible, which security interest secures outstanding indebtedness for borrowed money;
(ix) outstanding agreements of guaranty, surety or indemnification, direct or indirect, by Seller, or by any Affiliate of Seller for the benefit of Seller;
(x) Contracts between Seller and any Affiliate of Seller relating to the future provision of goods or services by Seller to such Affiliate of Seller, or by such Affiliate of Seller to Seller;
(xi) Any contract for consulting that provides for annual compensation by Seller in an amount in excess of $50,000 and which is not cancelable by Seller on ninety (90) days or less advance notice;
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(xii) outstanding futures, swap, collar, put, call, floor, cap, option or other Contracts that are intended to benefit from or reduce or eliminate the risk of fluctuations in the price of commodities, including electric power, gas or securities;
(xiii) Contracts that purport to limit Seller's freedom to compete in any line of business or in any geographic area;
(xiv) partnership, joint venture or limited liability company agreements; and
(xv) Contracts conveying, granting, leasing or assigning to or by Seller an interest in real property.
(b) Seller has provided Purchaser with, or access to, true and complete copies of all Material Contracts.
(c) Each of the Material Contracts is in full force and effect in all material respects and constitutes a valid and binding obligation of Seller (or, if applicable, an Affiliate of Seller) and, to Seller's Knowledge, of the other parties thereto, and, except as disclosed in Schedule 4.12(c), each Transferred Contract may be transferred to Purchaser pursuant to this Agreement without the consent of the other parties thereto and without breaching any material terms thereof or resulting in the forfeiture or impairment of any rights thereunder.
(d) Except as set forth in Schedule 4.12(d), there is not under any Material Contract any material default or event which, with notice or lapse of time or both, (i) would constitute a material default by Seller (or by any Affiliate of Seller which is a party thereto) or, to Seller's Knowledge, any other party thereto, (ii) would constitute a default by Seller (or by any Affiliate of Seller which is a party thereto) or, to Seller's Knowledge, any other party thereto which would give rise to an automatic termination, or the right of discretionary termination thereof, or (iii) would cause the acceleration of any of Seller's (or any of its Affiliates') obligations thereunder or result in the creation of any Lien (other than any Permitted Lien) on any of the Purchased Assets. There are no claims, actions, proceedings or investigations pending or, to Seller's Knowledge, threatened against Seller (or by any Affiliate of Seller which is a party thereto) or, to Seller's Knowledge, any other party to any Material Contract before any Governmental Authority acting in an adjudicative capacity, in each case relating in any way to any Material Contract or the subject matter thereof. Seller has no Knowledge of any defense, offset or counterclaim arising under any Material Contract.
(e) Schedule 4.12(e) details all warranties by any vendor, materialman, supplier, contractor or subcontractor relating to the Purchased Assets or any component thereof and specifies the following information with respect to each such warranty: (i) the item of equipment or other item of the Purchased Assets to which the warranty is applicable, but only to the extent such item has a value of $50,000 or more, (ii) the contract or agreement pursuant to which the warranty was given or made (a true and complete copy of each such contract or agreement has been provided to Purchaser); (iii) a description of any warranty work done under the applicable warranty, the date thereof and the applicable warranty period for the warranty
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work; and (iv) whether such warranty is transferable to Purchaser. Except as disclosed on Schedule 4.12(e), Seller has complied with all storage, installation, operation, maintenance and other requirements with respect to each item of equipment or other item of the Purchased Assets to which each warranty relates and each other condition to the continued effectiveness of each such warranty, and there are no events that have occurred or conditions applicable that constitute or may constitute a defense to the continuing effectiveness of each such warranty.
4.13 REAL PROPERTY.
(a) Transferred Real Property. Schedule 4.13(a) contains a true and complete list of all Real Property of Seller that is part of the Purchased Assets (including all rights of Seller relating to any rights of way, encumbrances or other such rights). Based solely upon the Existing Title Policies, Seller owns or leases (as tenant or lessee) all Real Property listed on Schedule 4.13(a), in each case free and clear of all Liens (except for Permitted Liens that do not affect the use or marketability of such Real Property) created by, through or under Seller, except as otherwise noted on Schedule 4.13(a) or as disclosed or listed in the Existing Title Policies, true and complete copies of which title policies have been made available for due diligence review by Purchaser.
(b) Encumbrances and Improvements. Schedule 4.13(b) includes a description of all encumbrances, easements, licenses or rights of way of record (or, if not of record, of which Seller has Knowledge) granted on or appurtenant to or otherwise affecting the Real Property, and all plants, buildings, structures or other Improvements located thereon. All Liens, easements or rights of way that are not of public record, if any, would not reasonably be expected to have a Seller Material Adverse Effect. There are now in full force and effect duly issued certificates of occupancy permitting the Real Property and Improvements located thereon to be legally used and occupied as the same are now constituted. To Seller's Knowledge, and except for any items listed in the Existing Title Policies or the survey prepared by Superior Surveying Services, Inc., dated July 29, 2002 under Job #220649 (the "EXISTING SURVEY"): (i) no fact or condition exists which would prohibit or adversely affect the ordinary rights of access to and from the Real Property from and to the existing highways and roads; (ii) there is no pending or threatened restriction or denial, governmental or otherwise, upon such ingress and egress; (iii) there is not (A) any claim of adverse possession or prescriptive rights involving any of the Real Property, (B) any structure located on any Real Property which encroaches on or over the boundaries of neighboring or adjacent properties or (C) any structure of any other party which encroaches on or over the boundaries of any such Real Property; and (iv) no public improvements have been commenced and none are planned which in either case may result in special assessments or otherwise would, individually or in the aggregate, reasonably be expected to have a Seller Material Adverse Effect.
(c) Real Property Leases. Except as set forth in Schedule 4.13(c), there are no real property leases, recorded or unrecorded (the "REAL PROPERTY LEASES"), relating to the Purchased Assets under which Seller is a lessee, lessor or under which Seller has any interest.
(d) Approval. No state, municipal, or other governmental approval regarding the division, platting, or mapping of real estate is required as a prerequisite to the conveyance by
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Seller to Purchaser (or as a prerequisite to the recording of any conveyance document) of any Real Property pursuant to the terms hereof.
(e) Governmental Restrictions; Condemnation. Seller has not received, and does not have Knowledge of, any notifications, restrictions, or stipulations from the United States of America, the State of Arizona, the County of Pinal, or any other Governmental Authority requiring any work to be done on the Real Property or threatening the use of the Real Property. There are no pending or, to Seller's Knowledge, threatened taking or condemnation proceedings affecting any portion of the Real Property. Seller is not subject to, and, to Seller's Knowledge, no basis exists for, any order, judgment, decree or governmental restriction that would adversely affect the transactions contemplated by this Agreement, the Real Property or the use of the Real Property in the manner presently being used by Seller. Seller has no Knowledge of any plan, study, litigation, action, proceeding or effort by any Governmental Authority or private party which in any way challenges, affects or would challenge or affect the continuation of the present use of the Real Property specifically.
(f) Title and Access. Based solely upon the Existing Title Policies, fee simple title to the Real Property is currently vested in Seller. Permanent, legal access as presently existing is available to the Real Property from a dedicated public right-of-way.
(g) Knowledge of Adverse Title Matters. Except as set forth on Schedule 4.13(g), Seller has no Knowledge of any title defect, Lien, encumbrance, adverse claim, or other matter relating to the title to the Real Property or to the title insurance coverage for the Real Property which is not shown by the public records, the Existing Title Policies or the Existing Survey.
(h) Absence of Liens. No Liens against the Real Property are pending, or to Seller's Knowledge, are threatened or have arisen or exist under federal or state Tax Law, any Environmental Law, or other applicable federal or state Law, other than Permitted Liens.
(i) Utilities. All water, sewer, telephone, gas and electrical facilities that are presently installed to the Real Property line, are, to Seller's Knowledge, available and in good working order, and, to Seller's Knowledge, are in compliance with all applicable Laws of all Governmental Authorities having jurisdiction and with the rules and regulations of the relevant public utilities.
(j) Zoning. The Real Property is zoned in part Industrial
(CI-2), subject to an Industrial Use Permit for a natural gas electrical peaking power generation facility (including the stipulations listed in such permit), and in part General Rural Zone (GR).
(k) Condition of Property. To Seller's Knowledge, except as set forth on Schedule 4.13(k), all of the improvements, buildings and fixtures on or part of the Real Property were constructed in a good and workmanlike manner, are structurally sound, and, for purposes of their use in the Business as currently conducted, are in good and proper working condition and repair, normal wear and tear excepted.
(l) Insurance. Seller has not received any written (or, to Seller's Knowledge, any oral) notice from any insurance company of any defects or any inadequacies in the Real
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Property or any part thereof that would adversely affect the insurability of the Real Property. To Seller's Knowledge, the Real Property is in compliance with the material requirements of all insurance carriers currently providing insurance for the Real Property.
(m) Compliance. Seller has complied, in all material respects, with all Laws, and all requirements and orders of Governmental Authorities, with respect to the Real Property and the operations presently being conducted by Seller upon the Real Property. Neither the Real Property, nor any improvement or building upon the Real Property, nor the continued maintenance or use of any portion of the Real Property for the Business, nor the current operations being conducted by Seller on the Real Property, violates, in any material respect, any such Laws, requirements and orders, including zoning or building Laws, ordinances, orders or regulations. Seller has obtained all material Permits currently required for the conduct of the current operations on the Real Property, all such Permits are in full force and effect, and Seller is, in all material respects, in compliance therewith. Notwithstanding any of the foregoing, this SECTION 4.13 does not address Environmental Laws, which are exclusively addressed by SECTIONS 4.15 and 4.16.
(n) Archeological Artifacts and Endangered Species. To Seller's Knowledge, there are no historical or archeological materials or artifacts of any kind or any Indian ruins of any kind located on the Real Property. To Seller's Knowledge, no part of the Real Property is "critical habitat" as defined in the Federal Endangered Species Act, 16 U.S.C. Sections 1531 et seq., or in regulations promulgated thereunder, nor are any "endangered species" or "threatened species" located on the Real Property, as defined therein.
(o) Americans with Disabilities Act. Seller has not received any written (or to Seller's Knowledge, any oral) notice of violation of, and the Real Property is in compliance in all material respects with, the Americans with Disabilities Act of 1990.
(p) Special Districts. To Seller's Knowledge, except as set forth in Schedule 4.13(p), the Real Property is not located within any water conservation, irrigation, soil conservation, weed or insect abatement, or other similar district, or any special improvement district. To Seller's Knowledge, except as shown on the Survey, the Real Property is not within a flood plain, flood way or flood control district.
(q) Taxes. To Seller's Knowledge, Seller does not have any liability for any Taxes, or any interest or penalty in respect thereof, of any nature that may be assessed against Purchaser or that are or may become a Lien against the Real Property, other than the lien for current real property Taxes not yet due and payable.
(r) Mechanics' Liens. Except as described in Schedule 4.13(r), no work has been performed on or about the Real Property within six (6) months prior to the Agreement Date that would legally entitle any Person to file or record any mechanics' or materialmen's Liens.
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(s) Water Rights.
(i) Seller holds all water rights appurtenant to the Property, including those certificated rights identified on Schedule 4.13(s)(i) attached hereto (collectively, the "WATER RIGHTS").
(ii) Seller owns the wells ("WELLS") and well sites further identified on Schedule 4.13(s)(ii).
(iii) To Seller's Knowledge, the Water Rights remain appurtenant to the Real Property, and no Water Rights have been severed from that portion of the Real Property to which they are appurtenant.
(iv) To Seller's Knowledge, to the extent that either Seller or Marcus D. Martin Farms, pursuant to that certain Lease Agreement by and between Marcus D. Martin d/b/a Marcus D. Martin Farms and Seller dated December 12, 2001 (the "MARTIN FARMS LEASE"), has used any groundwater at or for the Real Property, all such groundwater has been pumped pursuant to a Certificate of Grandfathered Groundwater Right (a "WATER RIGHTS CERTIFICATE") issued by the Arizona Department of Water Resources (the "DWR") solely for the purposes permitted by applicable Law pursuant to such Certificate in such a manner that the Water Rights are not subject to claims of abandonment or forfeiture.
(v) All filings, registrations and assessments for the Water Rights appurtenant to the Real Property have been made and are current with all appropriate Governmental Authorities, including the DWR. As used herein, the phrase, "filings, registrations and assessments" includes registrations of Wells and all notifications of change of ownership forms necessary to assign, transfer or otherwise convey the reported ownership of the Water Rights and Wells from any previous owner to the Seller.
(vi) To Seller's Knowledge, as of the date hereof, there are no charges, pump Taxes, groundwater withdrawal and use fees or assessments due or owing to any state agency including DWR for the Water Rights.
(vii) As of the date hereof, there are no enforcement actions by DWR threatened or pending against Seller relating to the Water Rights, and to Seller's Knowledge, Seller is in material compliance with all water conservation rules, regulations and requirements as set forth in the applicable management plans for the Pinal County active management area.
(viii) Seller has caused Annual Groundwater Withdrawal and Use Reports to be prepared and filed annually with DWR for each Water Right, pursuant to the rules and regulations promulgated by DWR.
4.14 PERSONAL PROPERTY. Seller has good title to (or, with respect to those items of tangible personal property held pursuant to a lease, a good and valid leasehold interest in) all of its tangible personal property, including the tangible personal property listed on Schedule 4.14,
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free and clear of all Liens, except for Permitted Liens. The foregoing shall not apply with respect to any item of Intellectual Property, which is governed exclusively by SECTION 4.18. Seller has good title, free and clear of Liens (other than Permitted Liens), to the spare parts in inventory listed or disclosed on Schedule 4.14.
4.15 PERMITS.
(a) Seller has obtained all material Permits required for the ownership and operation of the Project by Seller in the manner in which it is currently owned and operated. All such Permits are set forth on Schedule 4.15, are in full force and effect, and have not been amended except as set forth on Schedule 4.15 or for extensions in the ordinary course of business.
(b) Seller is in compliance, in all material respects, with all Permits set forth on Schedule 4.15, and, except as set forth on Schedules 4.6(b) and 4.16(b), Seller has not received any written notification from any Governmental Authority alleging that it is in violation of any such Permits.
4.16 ENVIRONMENTAL MATTERS.
(a) Seller has made available to Purchaser, on a confidential basis in accordance with the terms and conditions of SECTION 12.5, true and complete copies of all environmental site assessment reports, studies and related documents in the possession of, or available to, Seller or its Affiliates and that relate to environmental matters in connection with the operation of the Project or the Real Property.
(b) Except as set forth on Schedule 4.16(b):
(i) Seller has not been served with notice of any Environmental Claims and, to Seller's Knowledge, no Environmental Claims are threatened against Seller by any Governmental Authority or other Person (including any private citizen's group) under any Environmental Laws;
(ii) there has been no event or occurrence at the Project that has caused or reasonably would be expected to cause Seller to fail to comply with any applicable Environmental Laws in any material respect;
(iii) there has been no Release of any Hazardous Material at or from the Project that could reasonably be expected to result in an Environmental Claim;
(iv) there are not outstanding, nor have there been issued, any judgments, decrees or judicial orders relating to the Purchased Assets regarding (A) compliance with any Environmental Law or (B) the investigation or cleanup of Hazardous Materials under any Environmental Law;
(v) Seller is, and at all times has been, in compliance with, in all material respects, and has not been and is not in violation of or liable in any
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material respect under, any Environmental Law in connection with the Business or the Purchased Assets;
(vi) to Seller's Knowledge, there are no Environmental Liabilities associated with the Purchased Assets that would, individually or in the aggregate, reasonably be expected to have a Seller Material Adverse Effect; and
(vii) Seller is and at all times has been in full compliance with all terms and conditions of the Certificate of Environmental Compatibility.
(c) Seller makes no representation or warranty regarding any environmental matters except as expressly set forth in SECTIONS 4.15 and 4.16.
4.17 INSURANCE. The Project and its tangible Assets are covered by insurance policies in such amounts and against such risks and losses as are consistent with Seller's historical practices. To Seller's Knowledge, except as set forth in Schedule 4.17, all such policies purchased or held by and insuring the Business or the Purchased Assets are in full force and effect, and all premiums with respect thereto covering all periods up to and including the date as of which this representation is being made have been paid. Seller has not received any written (or to Seller's Knowledge, any oral) notice of cancellation or termination with respect to any such policy which was not replaced on substantially similar terms prior to the date of such cancellation. Seller has provided to Purchaser a summary of the loss experience under each insurance policy insuring the Business or the Purchased Assets. Except as described in Schedule 4.17, Seller has not been refused any insurance with respect to the Business or the Purchased Assets nor, to Seller's Knowledge, has Seller's coverage been limited by any insurance carrier to which it has applied for any such insurance or with which it has carried insurance during the twelve (12) month period immediately preceding the Agreement Date.
4.18 INTELLECTUAL PROPERTY. Except for the Excluded Items:
(a) Schedule 4.18 lists all issued patents and registered trademarks owned by Seller and currently used in the United States in the Business as currently conducted. As described on Schedule 4.18, Seller owns, or has the license or right to use for the Business, all material Intellectual Property currently used in the Business. The Parties acknowledge and agree that Purchaser shall not acquire in or in connection with the transactions contemplated by this Agreement or any of the Ancillary Agreements any trademarks or trade names using "PPL."
(b) Seller has not received from any third party a claim in writing that Seller is infringing the Intellectual Property of such third party. To Seller's Knowledge, no third party is infringing any Intellectual Property owned or exclusively licensed by Seller.
4.19 RELATED PERSONS. Except as set forth on Schedule 4.19, no Affiliate of Seller has any interest in any of the Purchased Assets, and no Affiliate of Seller is a party to any Contract with Seller with respect to the Purchased Assets.
4.20 BROKERS. Seller does not have any liability or obligation to pay fees or commissions to any broker, finder or agent with respect to the transactions contemplated by this Agreement for which Purchaser could become liable or obligated.
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4.21 EMPLOYEES.
(a) Each of the employees at the Project (each, a "PROJECT EMPLOYEE") is employed by PPL Montana. Schedule 4.21(a) sets forth, with respect to each Project Employee (including any Project Employee who is on a leave of absence or on layoff status): (i) the name and title of such Project Employee;
(ii) the aggregate dollar amounts of the compensation (including wages, salary, commissions, fringe benefits, bonuses, profit-sharing payments and other payments or benefits of any type) received by such Project Employee from PPL Montana; (iii) such Project Employee's annualized compensation as of the Agreement Date; (iv) the number of hours of sick-time which such Project Employee has accrued as of the date hereof and the aggregate dollar amount thereof; and (v) the number of hours of vacation time which such Project Employee has accrued as of the date hereof and the aggregate dollar amount thereof.
(b) Except as set forth on Schedule 4.21(b), neither PPL Montana nor Seller is a party to or bound by, or has ever been a party to or bound by, any employment contract or any union contract, collective bargaining agreement or similar contract with respect to the Project. The employment of the Project Employees is terminable by Seller at will and no employee is entitled to severance pay or other benefits following termination or resignation, except as otherwise provided by Law.
(c) Seller has delivered to Purchaser accurate and complete copies of all employee manuals and handbooks, policy statements and other documents in Seller's possession relating to the terms and conditions of employment of the current Project Employees.
(d) Schedule 4.21(d) sets forth the name of, and a general description of the services performed by, each independent contractor to whom Seller has made any payment in excess of $50,000 in the aggregate since January 1, 2003 for services rendered in respect of the Project.
4.22 EMPLOYEE BENEFITS. Set forth on Schedule 4.22 is a complete and correct list of all Benefit Plans currently in effect with respect to the Project Employees. With respect to any "employee benefit plan," within the meaning of Section 3(3) of ERISA, that is sponsored, maintained or contributed to, or has been sponsored, maintained or contributed to within six (6) years prior to the Agreement Date, by any ERISA Affiliate, (a) no withdrawal liability, within the meaning of Section 4201 of ERISA, has been incurred, which withdrawal liability has not been satisfied, (b) no liability to the Pension Benefit Guaranty Corporation has been incurred by any such entity, which liability has not been satisfied, (c) no accumulated funding deficiency, whether or not waived, within the meaning of Section 302 of ERISA or Section 412 of the Code has been incurred, and (d) all contributions (including installments) to such plan required by Section 302 of ERISA and Section 412 of the Code have been timely made.
4.23 IMPROVEMENTS. Except as set forth in Schedule 4.23, Seller has not received any written notices from any Governmental Authority stating or alleging that any Improvements with respect to the Purchased Assets have not been constructed in compliance with applicable Law. Except as set forth in Schedule 4.23, no written notice has been received by Seller from any Governmental Authority requiring or advising as to the need for any repair, alteration, restoration or improvement of the Purchased Assets.
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ARTICLE V
REPRESENTATIONS AND WARRANTIES OF PURCHASER
Effective as of the Agreement Date and the Closing Date, Purchaser hereby represents and warrants to Seller that:
5.1 CORPORATE EXISTENCE. Purchaser is a corporation duly organized, validly existing and in good standing under the Laws of the State of Arizona and has all requisite corporate power and authority to enter into this Agreement and each of the Ancillary Agreements to which it is a party, to perform its obligations hereunder and thereunder and to consummate the transactions contemplated hereby and thereby. Purchaser is duly qualified or licensed to do business in each other jurisdiction where the nature of its business or the actions required to be performed by it hereunder makes such qualification or licensing necessary, except in those jurisdictions where the failure to be so qualified or licensed would not reasonably be expected to result in a material adverse effect on Purchaser's ability to perform its obligations hereunder. Purchaser has made available to Seller true, correct and complete copies of Purchaser's Charter Documents.
5.2 AUTHORITY. Purchaser has all requisite corporate power and authority to execute and deliver this Agreement and each of the Ancillary Agreements to which it is a party, to perform its obligations hereunder and thereunder and to consummate the transactions contemplated hereby and thereby. The execution and delivery by Purchaser of this Agreement and each of the Ancillary Agreements to which Purchaser is a party and the performance by Purchaser of its obligations hereunder and thereunder have been duly and validly authorized by all corporate action on behalf of Purchaser. This Agreement and each of the Ancillary Agreements to which Purchaser is a party have been duly and validly executed and delivered by Purchaser and constitute the legal, valid and binding obligation of Purchaser enforceable against Purchaser in accordance with their respective terms except that the enforcement hereof and thereof may be limited by bankruptcy, insolvency, reorganization, arrangement, moratorium or other similar Laws relating to or affecting the rights of creditors generally, or by general equitable principles.
5.3 NO CONFLICTS. The execution, delivery, and performance by Purchaser of this Agreement and each of the Ancillary Agreements to which Purchaser is a party and the completion of the transactions contemplated hereby and thereby do not and will not:
(a) conflict with or result in a violation or breach of any of the terms, conditions or provisions of Purchaser's Charter Documents;
(b) violate, result in a breach of, constitute (with due notice or lapse of time or both) a default or cause any obligation, penalty, premium or right of termination, cancellation or acceleration to arise or accrue under, any Contract to which Purchaser is a party or by which it or any of its Assets may be bound, except for any such defaults or consents (or rights of termination, cancellation or acceleration) as to which requisite waivers or consents have been obtained or which would not, individually or in the aggregate, reasonably be expected to have a Purchaser Material Adverse Effect; or
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(c) assuming all required filings, approvals, consents, authorizations and notices set forth in Schedule 5.3(c) (collectively, the "PURCHASER APPROVALS") have been made, obtained or given, (i) conflict with or result in a material violation or breach of any term or provision of any Law or writ, judgment, order or decree applicable to Purchaser or its Assets, or (ii) require the consent, approval, or notification of, or registration or filing with, any Governmental Authority under any applicable Law, except for any such consents, approvals, notifications, registrations or filings which would not, individually or in the aggregate, reasonably be expected to have a Purchaser Material Adverse Effect.
5.4 LEGAL PROCEEDINGS. Neither Purchaser nor any of its Affiliates has been served with notice of any Claim, and, to Purchaser's Knowledge, none has been threatened against any such Person, that (a) affects Purchaser or its Assets and would, individually or in the aggregate, if pursued or resulting in a judgment against Purchaser, reasonably be expected to have a Purchaser Material Adverse Effect or (b) seeks a writ, judgment, order or decree restraining, enjoining or otherwise prohibiting or making illegal any of the transactions contemplated by this Agreement. Purchaser does not have any Knowledge of any facts that would reasonably be expected to form the basis for any such Claim, writ, judgment, order or decree. For purposes of this Agreement, "PURCHASER'S KNOWLEDGE" means the actual knowledge of the individuals named on Schedule 5.4, who Purchaser represents to be the persons generally responsible for the subject matters to which such knowledge is pertinent.
5.5 COMPLIANCE WITH LAWS AND ORDERS. Purchaser is in compliance with all Laws and orders applicable to Purchaser or its Assets, except where any non-compliance would not, in the aggregate, reasonably be expected to have a Purchaser Material Adverse Effect.
5.6 BROKERS. Purchaser does not have any liability or obligation to pay fees or commissions to any broker, finder or agent with respect to the transactions contemplated by this Agreement for which Seller could become liable or obligated.
5.7 FINANCIAL RESOURCES. Subject to Purchaser's receipt of the ACC Order, Purchaser has cash or credit available, and will have cash available at the Closing, to enable it to purchase the Purchased Assets on the terms hereof.
ARTICLE VI
COVENANTS
6.1 REGULATORY AND OTHER APPROVALS.
(a) Seller covenants that, from the date hereof until the earlier of the Closing or termination of this Agreement in accordance with its terms (the "INTERIM PERIOD"), Seller will, in order to consummate the transactions contemplated hereby (including the transfer of the Transferred Permits to Purchaser), take such reasonable steps as are necessary or desirable, and proceed diligently and in good faith and use all reasonable efforts to expedite and obtain the Seller Approvals and Seller Consents, and to make all filings with, and to give all notices to, Governmental Authorities, and provide such other information and communications to such Governmental Authorities or other Persons, as such Governmental Authorities or other Persons
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may reasonably request in connection therewith. Purchaser covenants that, during the Interim Period, Purchaser will, in order to consummate the transactions contemplated hereby (including the transfer of the Transferred Permits to Purchaser), take such reasonable steps as are necessary or desirable, and proceed diligently and in good faith and use all reasonable efforts to expedite and obtain the Purchaser Approvals, and to make all filings with, and to give all notices to, Governmental Authorities, and provide such other information and communications to such Governmental Authorities or other Persons, as such Governmental Authorities or other Persons may reasonably request in connection therewith. Without limiting the generality of the foregoing, each Party shall provide, and cause its respective Affiliates to provide, true and accurate information in a timely manner with respect to all filings with and notices to Governmental Authorities. Nothing in this SECTION 6.1(a) shall be construed to require (i) Purchaser to take any action with respect to filings with or notices to Governmental Authorities that in Purchaser's discretion could materially adversely affect any other proceeding with such Governmental Authorities or (ii) Seller to take any action that would result in the transfer of a Permit to Purchaser prior to Closing. Each Party will cooperate fully in good faith with the other Party with respect to all filings that are required by Law or that such other Party elects to make in connection with the transactions contemplated under this Agreement. Each Party will also cooperate fully in good faith with the other in obtaining all material consents and approvals required under this Agreement.
(b) Each Party will provide the other Party with a reasonable opportunity to review and provide prior comment upon any notices, filings or other submissions that the Party plans to deliver or submit to any Governmental Authority, and will promptly provide to such other Party a copy of any such notices or filings. Notwithstanding the foregoing, the Parties recognize that as a result of the short time frames available for the preparation and filing of many documents required to be filed in the proceedings seeking the ACC Order, each Party may be able to afford the other Party only a very brief opportunity for prior review of or comment on filings in such proceedings. Each Party will provide prompt notification to the other Party when any approval referred to in
SECTION 6.1(a) is obtained, taken, made or given, as applicable, and will advise the other Party of any material communications with any Governmental Authority from which such approval is required regarding any pending application or request for approval by such Governmental Authority of any of the transactions contemplated by this Agreement.
(c) Each Party shall prepare, as soon as is reasonably practicable following the execution of this Agreement, all necessary filings in connection with the transactions contemplated by this Agreement that may be required to be made by such Party at FERC or under the HSR Act. Each Party shall submit such filings as soon as practicable, but, in the case of filings under the HSR Act, in no event later than thirty (30) days after the date that the Parties file their application with FERC, under Section 203 of the Federal Power Act of 1935, and Part 33 of the FERC Regulations (18 CFR Part 33), for the approval of the transactions contemplated by this Agreement. Unless the Parties agree otherwise at the time of filing, the Parties shall request expedited treatment of filings at FERC and early termination of the waiting period under the HSR Act. The Parties shall promptly make any appropriate or necessary subsequent or supplemental filings and shall cooperate in the preparation of such filings as is reasonably necessary and appropriate.
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(d) To the extent that any Transferred Contract or Transferred Permit is not assignable without the consent of another party, then this Agreement shall not constitute an assignment or attempted assignment thereof if such assignment or attempted transfer thereof would constitute a breach thereof or a default thereunder. Without limiting the provisions of SECTION 6.1(a), if any such consent shall not be obtained, or if any attempted assignment of a Transferred Contract or Transferred Permit would be ineffective or would impair Purchaser's rights and obligations such that Purchaser would not in effect acquire the benefit of substantially all of such rights and obligations, Seller shall cooperate with Purchaser in any reasonable arrangement, to the extent legally permissible, designed to provide for Purchaser the benefits intended to be assigned to Purchaser under the Transferred Contract or Transferred Permit, including enforcement at the cost and for the account of Purchaser of any and all rights of Seller against the other party thereto arising out of the breach or cancellation thereof by such party or otherwise. If and to the extent that such arrangement is not made in a manner reasonably satisfactory to Purchaser, Purchaser shall have no obligation pursuant to SECTION 2.3 or otherwise with respect to such Transferred Contract or Transferred Permit. The provisions of this SECTION 6.1(d) shall not affect the right of Purchaser not to consummate the transactions contemplated by this Agreement if the conditions to Purchaser's obligations set forth in SECTION 8.5 have not been fulfilled.
6.2 ACCESS OF PURCHASER. Seller covenants that, during the Interim Period, Seller will provide Purchaser and its Representatives with reasonable access, upon reasonable prior notice and during normal business hours, to the Project, all Contracts to which Seller is a party related to the Project or the Business or by which the Purchased Assets are bound, all Books and Records, including all environmental records, permits, and compliance audits relating to the Business or the Project, and the officers and employees of Seller or its Affiliates who have significant responsibility for Seller, but only to the extent that such access does not unreasonably interfere with the Business of Seller and that such access is reasonably related to the Purchaser's obligations and rights hereunder; provided that Seller shall have the right to (i) have a Representative of Seller present for any communication with employees or officers of Seller or its Affiliates and (ii) impose reasonable restrictions and requirements upon Purchaser and its Representatives for safety purposes. Purchaser shall be entitled, at its sole cost and expense, to have the Real Property surveyed and to conduct physical inspections (including invasive testing procedures) of the Real Property. Purchaser shall provide Seller with not less than five (5) Business Days prior written notice of the date and time on which any such entry upon the Real Property is proposed to occur. Promptly upon completion of any such entry, Purchaser shall, at its sole cost and expense, repair any and all damage caused by such entry and restore any affected Real Property and any other affected property to its original condition. Purchaser hereby agrees to indemnify, defend and hold harmless Seller and its Representatives and Affiliates from and against any and all Losses, whether or not involving a third-party Claim, resulting from or arising out of or in connection with any entry upon the Real Property by Purchaser or any of its Affiliates or any of its or their respective Representatives, agents, contractors or subcontractors pursuant to this SECTION 6.2. The provisions of this SECTION 6.2 shall apply to the access and inspection by Purchaser of any and all portions of the Real Property leased by Seller to Marcus D. Martin d/b/a Marcus D. Martin Farms under the Martin Farms Lease. In addition to complying with the notice, repair and other provisions of this Section, Purchaser shall comply with any and all additional requirements set forth in the Martin Farms Lease, and any access and inspection by Purchaser to the portions of the Real Property leased
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under the Martin Farms Lease shall be subject to the rights of the tenant under such lease. Without limiting the foregoing, Seller shall take all actions that are reasonably necessary and appropriate to assist Purchaser in gaining access to and inspecting such portions of the Real Property in accordance with the terms and conditions of this Section.
6.3 CERTAIN RESTRICTIONS. Seller covenants that, except as set forth in Schedule 6.3, during the Interim Period, Seller will operate and maintain the Business and the Purchased Assets in the usual and ordinary course consistent with Good Operating Practices. Without limiting the foregoing, during the Interim Period, Seller will not, without the prior consent of Purchaser, which consent shall not be unreasonably withheld or delayed:
(a) permit, allow, or suffer to exist any Lien (other than a Permitted Lien) against any of the Purchased Assets;
(b) grant any waiver of any material term under, or give any material consent with respect to, any Material Contract;
(c) sell, lease (as lessor), transfer, convey or otherwise dispose of any Purchased Assets (including by way of merger, liquidation or dissolution) having an aggregate value in excess of $50,000, other than Purchased Assets used, consumed or replaced in the ordinary course of business consistent with Good Operating Practices or Purchased Assets which are replaced prior to the Closing;
(d) other than trade payables incurred in the ordinary course of business or accounts payable pursuant to any Contract, incur, create, assume or otherwise become liable for indebtedness or issue any debt securities or assume or guarantee the obligations of any other Person;
(e) change any accounting method or practice in a manner that is inconsistent with past practice except as may be required to meet the requirements of applicable Law or GAAP, in a way that would adversely affect the Business or Seller;
(f) fail to maintain its limited liability company existence or consolidate with any other Person or acquire all or substantially all of the Assets of any other Person;
(g) issue or sell any limited liability company membership interests;
(h) liquidate, dissolve, recapitalize, reorganize, or otherwise wind up its business or operations;
(i) purchase any securities of any Person, except for short-term investments made in the ordinary course of business;
(j) enter into, terminate, extend or amend any Contract involving total consideration throughout its term in excess of $100,000 (other than Contracts entered into in the ordinary course which will be fully performed prior to Closing);
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(k) cancel any debts or waive any claims or rights with respect to the Purchased Assets having a value, individually or in the aggregate, in excess of $100,000;
(l) enter into any collective bargaining or labor agreement;
(m) make any material election with respect to Taxes;
(n) amend or modify its Charter Documents;
(o) make any material change in the operations of the Purchased Assets including the levels of inventory and materials and supplies customarily maintained by Seller;
(p) enter into, terminate, extend or amend any real or personal property Tax agreement, treaty or settlement, except as required by applicable Law;
(q) execute, enter into, terminate, extend or amend any agreement, order, decree or judgment relating to any material Permit, except as required by applicable Law or (in any case other than termination) except in the ordinary course of business consistent with past practices;
(r) prohibit payment of or delay payment of or prohibit or delay discharge of any Liability that will be an Assumed Liability; or
(s) agree or commit to do any of the foregoing.
Notwithstanding the foregoing, Seller may take commercially reasonable actions with respect to emergency situations so long as Seller shall, upon receipt of notice of any such actions, promptly inform Purchaser of any such emergency actions taken outside the ordinary course of business.
6.4 FURTHER ASSURANCES. Subject to the terms and conditions of this Agreement, each Party shall, upon request by the other Party at any time, or from time to time, after the Closing, and without further consideration, execute and deliver to such other Party such other instruments of sale, transfer, conveyance, assignment and confirmation, provide such materials and information and take such other actions as such other Party may reasonably request in order to consummate the transactions contemplated by this Agreement.
6.5 EMPLOYEE AND EMPLOYEE BENEFIT MATTERS.
(a) Schedule 6.5(a) sets forth a list of Project Employees that Seller and such Affiliates will make available to Purchaser at least thirty
(30) Business Days before the Closing Date (the "AVAILABLE EMPLOYEES") for the purpose of discussing potential employment with Purchaser (which discussions the Parties agree shall not violate SECTION 12.5), together with each such Available Employee's name, current annual base compensation, job title, work location, hire date, vacation balance and sick leave balance, as of the date hereof. Prior to the Closing Date, Purchaser may make an offer of employment to any Available Employee, and each such offer shall include terms and provisions determined by Purchaser that are consistent with the provisions of this SECTION 6.5; provided, that subject to the following provisions of this SECTION 6.5, the foregoing shall not be construed to prevent Purchaser from changing the terms
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and conditions of employment of any Continued Employee (as hereinafter defined) following the Closing Date. Seller shall be responsible for, and shall indemnify and hold Purchaser harmless from and against, (i) all severance benefits payable under Seller's applicable severance policies to any Available Employees (or any other employee of Seller or its Affiliates) who do not accept or are not provided with an offer of employment with Purchaser or its Affiliates prior to or at Closing, and (ii) any accrued salary or incentive compensation or outstanding vacation or sick pay balance as of the Closing owing to any employee of Seller or its Affiliates, whether or not any such employee is provided with or accepts an offer of employment with Purchaser or its Affiliates. Purchaser shall be responsible for, and shall indemnify and hold Seller harmless from and against, any Losses caused by or resulting from any failure by Purchaser to offer employment to any Available Employee on any basis prohibited by applicable Law.
(b) On or before five (5) Business Days prior to the Closing Date, Purchaser shall deliver to Seller a Schedule 6.5(b) that sets forth the names of the Available Employees who have agreed to accept employment with Purchaser effective as of the Closing Date (each, a "CONTINUED EMPLOYEE"); provided, that to be a Continued Employee, such employee must (i) accept Purchaser's offer to transfer employment to Purchaser under the terms provided in Purchaser's offer, and (ii) on the Closing Date, be actively at work, on wellness or sickness leave, short-term disability or an approved leave of absence.
(c) Effective as of the Closing Date, the Continued Employees shall cease to participate in all "employee benefit plans" (within the meaning of Section 3(3) of ERISA) of Seller or its Affiliates (the "SELLER PLANS"). Purchaser shall not assume any of the Seller Plans.
(d) From and after the Closing Date, Purchaser shall cause each Continued Employee to be provided with compensation and benefits on a basis substantially similar to those provided to similarly situated employees of Purchaser and its Affiliates. Purchaser shall cause each Continued Employee and his or her "eligible dependents" (as defined by the applicable group health plan of Purchaser or its Affiliates) to be covered under a group health plan maintained by Purchaser or an Affiliate of Purchaser that (i) provides medical benefits to the Continued Employee and such eligible dependents effective immediately upon the Closing Date and (ii) credits such Continued Employee and such eligible dependents, for the year during which such coverage under such group health plan begins, with any deductibles and co-payments already incurred during such year under a group health plan maintained by Seller or an Affiliate of Seller (provided, that for purposes of applying this clause (ii) with respect to any Continued Employee or eligible dependent, the Continued Employee or eligible dependent, as applicable, shall be responsible for providing the necessary information to Purchaser based on explanation of benefit forms received by the Continued Employee or the eligible dependent from the group health plan maintained by Seller or an Affiliate of Seller). Purchaser shall cause the employee benefit plans and programs maintained after the Closing by Purchaser and the Affiliates of Purchaser to recognize each Continued Employee's years of service and level of seniority prior to the Closing Date with Seller and the Affiliates of Seller for purposes of terms of employment and eligibility and vesting under such plans and programs (other than benefit accruals under any defined benefit pension plan). Purchaser shall cause each employee welfare benefit plan or program sponsored by Purchaser or an Affiliate of Purchaser in which the Continued Employees may be eligible to participate on or after the Closing Date to waive any preexisting condition
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exclusion with respect to participation and coverage requirements applicable to Continued Employees and their eligible dependents.
(e) Claims of Continued Employees and their eligible beneficiaries and dependents for medical, dental, prescription drug, life insurance, or other welfare benefits ("WELFARE BENEFITS") (other than disability benefits) that are incurred before the Closing Date shall be the responsibility solely of Seller and the Seller Plans. Claims of Continued Employees and their eligible beneficiaries and dependents for Welfare Benefits (other than disability benefits) that are incurred from and after the Closing Date shall be the responsibility solely of Purchaser and its Affiliates. For purposes of this paragraph, a medical/dental claim shall be considered incurred on the date when the medical/dental services are rendered or medical/dental supplies are provided, and not when the condition arose or when the course of treatment began. Claims of individuals receiving long-term disability benefits under a Seller Plan as of the Closing Date shall be the responsibility solely of Seller and the Seller Plans. Except as provided in the preceding sentence, claims of Continued Employees and their eligible beneficiaries and dependents for short-term or long-term disability benefits from and after the Closing Date shall be the responsibility solely of Purchaser and its Affiliates (without regard to whether the circumstances giving rise to such claim occurred before, on or after the Closing Date).
(f) All claims for health care and dependent care flexible spending account benefits submitted on or after the Closing Date for expenses incurred prior to the Closing Date by Continued Employees shall be paid by Seller's or its Affiliates' health care and dependent care flexible spending account plan to the extent permitted in accordance with the terms of such plan.
(g) Claims for workers' compensation benefits arising out of occurrences prior to the Closing Date shall be the responsibility of Seller. Claims for workers' compensation benefits for Continued Employees arising out of occurrences on or after the Closing Date shall be the responsibility of Purchaser.
6.6 INSURANCE. Seller shall maintain or cause to be maintained the insurance policies (or reasonably equivalent renewals or replacements thereof) covering the Project until the Closing. Neither Seller nor any of its Affiliates shall have any liability for any claims made or reported under such insurance policies after the Closing.
6.7 SELLER'S COVENANTS AND CLOSING CONDITIONS. Except as contemplated by this Agreement or with the prior written consent of Purchaser, during the Interim Period Seller shall use commercially reasonable efforts to:
(a) take all actions that are reasonably necessary or appropriate to ensure that the representations and warranties in ARTICLE IV hereof remain true and correct in all respects at the Closing;
(b) promptly advise Purchaser of any facts of which Seller has Knowledge that would cause any of Seller's representations and warranties to be untrue or would make the satisfaction of the conditions in ARTICLE VIII impossible or unlikely; and
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(c) bring about, as soon as practical after the date hereof, the satisfaction of all the conditions set forth in ARTICLE VIII.
6.8 PURCHASER'S COVENANTS AND CLOSING CONDITIONS. Except as contemplated by this Agreement or with the prior written consent of Seller, during the Interim Period Purchaser shall use commercially reasonable efforts to:
(a) take all actions that are reasonably necessary or appropriate to ensure that the representations and warranties in ARTICLE V remain true and correct in all material respects at the Closing;
(b) promptly advise Seller of any facts of which Purchaser has Knowledge that would cause any of Purchaser's representations and warranties to be untrue or would make the satisfaction of the conditions in ARTICLE IX impossible or unlikely; and
(c) bring about, as soon as practical after the date hereof, the satisfaction of all the conditions set forth in ARTICLE IX.
6.9 EXCLUSIVITY. Seller covenants that it will not, and will not cause or permit its Affiliates or any of their respective Representatives to, directly or indirectly, (a) discuss, negotiate, undertake, authorize, recommend, propose or enter into, either as the proposed surviving, merged, acquiring or acquired entity, any transaction involving a merger, consolidation, business combination, purchase or disposition of any of the Purchased Assets or any equity interest in Seller other than the transactions contemplated by this Agreement and the Ancillary Agreements (an "ACQUISITION TRANSACTION"), (b) facilitate, encourage, solicit or initiate discussions, negotiations or submissions of proposals or offers in respect of an Acquisition Transaction, (c) furnish or cause to be furnished, to any Person, any information concerning the business, operations, properties or Assets of Seller in connection with an Acquisition Transaction, or
(d) otherwise cooperate in any way with, or assist or participate in, facilitate or encourage, any effort or attempt by any other Person to do or seek any of the foregoing; provided, however, that Affiliates of the Seller may engage in discussions or negotiations with, or furnish information concerning the Seller and its properties, assets and business to, any person which makes, or indicates in writing an intention to make, a proposal for an Acquisition Transaction if the Board of Directors of such Affiliate shall conclude in good faith on the basis of the advice of its outside counsel that the failure to take such action would violate the fiduciary obligations of such Board of Directors under applicable Law. Seller will inform Purchaser in writing immediately following the receipt by Seller, its Affiliates or any Representative of any substantial written proposal in respect of any Acquisition Transaction. Notwithstanding the foregoing, and without limiting the provisions of SECTION 6.3, Seller shall be entitled from time to time and at any time prior to the Closing, without obligation of or liability to Purchaser, to market, sell and deliver capacity and energy products and services from the Project and any portion thereof for a term or terms ending not later than the Closing.
6.10 RISK OF LOSS.
(a) From the date hereof until the Closing, all risk of loss or damage to the property included in the Purchased Assets shall be borne by Seller.
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(b) If, before the Closing any or all of the Purchased Assets are taken by eminent domain, or are the subject of a pending or, to Seller's Knowledge, contemplated taking or condemnation which has not been consummated, Seller shall notify Purchaser promptly in writing of such fact.
(i) If such taking would reasonably be expected to have a Seller Material Adverse Effect, Purchaser and Seller shall negotiate in good faith to settle the loss resulting from such taking or condemnation (including by making a fair and equitable adjustment to the Purchase Price) and, upon such settlement, consummate the transactions contemplated by this Agreement pursuant to the terms of this Agreement. If no such settlement is reached within sixty (60) days after Seller has notified Purchaser of such taking or condemnation, then Purchaser or Seller may, if such taking relates to the Purchased Assets, terminate this Agreement pursuant to SECTION 10.1(h) hereof.
(ii) If such taking or condemnation would not reasonably be expected to have a Seller Material Adverse Effect, Purchaser and Seller shall negotiate in good faith to settle the loss resulting from such taking or condemnation (including by making a fair and equitable adjustment to the Purchase Price or by transferring certain rights to the condemnation award, if any, to Purchaser) and, upon such settlement, consummate the transactions contemplated by this Agreement pursuant to the terms of this Agreement.
(c) If, before the Closing, all or any material portion of the Purchased Assets are damaged or destroyed by fire or other casualty, Seller shall notify Purchaser promptly in writing of such fact.
(i) If such damage or destruction would reasonably be expected to have a Seller Material Adverse Effect and Seller has not notified Purchaser of its intention to cure such damage or destruction within thirty (30) days after the occurrence of such damage or destruction, Purchaser and Seller shall negotiate in good faith to settle the loss resulting from such casualty (including by making a fair and equitable adjustment to the Purchase Price) and, upon such settlement, consummate the transactions contemplated by this Agreement pursuant to the terms of this Agreement. If no such settlement is reached within sixty (60) days after Seller has notified Purchaser of such casualty, then Purchaser or Seller may terminate this Agreement pursuant to SECTION 10.1(h) hereof.
(ii) If such damage or destruction would not reasonably be expected to have a Seller Material Adverse Effect and Seller has not notified Purchaser of its intention to cure such damage or destruction within thirty (30) days after the occurrence of such damage or destruction, Purchaser and Seller shall negotiate in good faith to settle the loss resulting from such casualty (including by making a fair and equitable adjustment to the Purchase Price or by transferring certain rights to insurance proceeds, if any, to Purchaser) and, upon such settlement, consummate the transactions contemplated by this Agreement pursuant to the terms of this Agreement.
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(d) If the Parties fail to reach a settlement contemplated by
SECTION 6.10(b)(ii) or SECTION 6.10(c)(ii) hereof, as applicable, within thirty
(30) days after Seller has notified Purchaser of such taking or casualty, as the case may be, then the Purchase Price shall be adjusted downward by the amount of the fair market value of the portion of the Purchased Assets subject to the taking, condemnation or casualty loss, as determined by Independent Accountants for review and final determination of such fair market value. The Independent Accountants may request of Seller or Purchaser such documents and information as may be necessary or appropriate for proper determination of any such matter, and such Parties will cooperate to promptly satisfy any such request. The Independent Accountants shall be instructed to deliver to Purchaser and Seller a written determination of the fair market value within thirty (30) days from the date of referral thereof to the Independent Accountants. Except in the case of fraud or manifest error, the determination by the Independent Accountants of such fair market value will be final and binding on the Parties. Seller and Purchaser will equally share the fees and disbursements of the Independent Accountants in undertaking such review and determination.
6.11 CURRENT EVIDENCE OF TITLE.
(a) As soon as is reasonably possible after the Agreement Date, and in no event later than thirty (30) Business Days after the Agreement Date, Seller shall furnish to Purchaser, for each parcel, tract or subdivided land lot of Real Property set forth on Schedule 4.13(a):
(i) from Stewart Title Guaranty Company (the "TITLE
INSURER"):
(A) title commitments issued by the Title Insurer to insure title to all Real Property and Improvements in the amount of that portion of the Purchase Price allocated to the Real Property, covering such Real Property, naming Purchaser as the proposed insured and having an effective date after the Agreement Date, wherein the Title Insurer shall agree to issue, an ALTA 1992 form owner's extended coverage policy of title insurance (each a "TITLE COMMITMENT"); and
(B) complete and legible copies of all documents listed or disclosed in Schedule B to the Title Commitment (the "TITLE EXCEPTION DOCUMENTS"); and
(ii) at Purchaser's cost and expense, a survey of the Real Property made after the Agreement Date by a land surveyor licensed by the State of Arizona and bearing a certificate, signed and sealed by the surveyor, certifying to Seller, Purchaser and the Title Insurer that:
(A) such survey was made (1) in accordance with "MINIMUM STANDARD DETAIL REQUIREMENTS FOR ALTA/ACSM LAND TITLE SURVEYS," jointly established and adopted by ALTA and ACSM in 1992, and includes Items 1-4, 6,
7(a), 7(b)(1), 7(c), 8-11 and 13 of Table A thereof, and (2) pursuant to the Accuracy Standards (as
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adopted by ALTA and ACSM and in effect on the date of said certificate) of an "Urban" survey; and
(B) such survey reflects the locations of all building lines, easements and areas affected by any Title Exception Documents affecting such Real Property as disclosed in the Title Commitment (identified by issuer, commitment number, and an effective date after the date hereof) as well as any encroachments onto the Real Property or by the Improvements onto any easement area or adjoining property (each a "SURVEY"); and
(iii) The Title Commitment shall include the Title Insurer's standard requirements for issuing its title policy, which requirements, to the extent applicable to Seller, shall be met by Seller on or before the Closing Date (including those requirements that must be met by releasing or satisfying monetary Liens, but excluding requirements that are to be met solely by Purchaser).
(iv) Seller shall pay the premium for a standard form owner's policy. Purchaser shall be responsible for the difference in premium between standard and extended coverage and for other endorsements and any other costs and expenses of such policy of title insurance.
(b) If any of the following shall occur:
(i) any Title Commitment or other evidence of title or search of the appropriate real estate records discloses that any party other than Seller has title to the insured estate covered by the Title Commitment;
(ii) any title exception is disclosed in Schedule B to the Title Commitment that (A) is not one of the Permitted Liens and (B) Purchaser reasonably believes could have a material adverse effect on Purchaser's use and enjoyment of the Real Property described therein; or
(iii) any Survey discloses any matter that Purchaser reasonably believes could have a material adverse effect on Purchaser's use and enjoyment of the Real Property described therein;
then Purchaser shall notify Seller in writing ("PURCHASER'S NOTICE") of such matters (any such matter of which Purchaser so provides Purchaser's Notice to Seller, a "TITLE OBJECTION") within thirty (30) Business Days after receiving all of the Title Commitment, Survey and copies of Title Exception Documents for the Real Property covered thereby. Any such matter of which Purchaser fails to provide Purchaser's Notice to Seller within such period shall not constitute a Title Objection and shall be deemed to be acceptable to Purchaser and constitute a Permitted Lien for purposes of this Agreement.
(c) Seller shall have ten (10) Business Days after receipt of Purchaser's Notice to notify Purchaser that either (i) Seller has elected to remove any Title Objection(s) from
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the title and provide Purchaser with evidence reasonably satisfactory to Purchaser of such removal, or provide Purchaser with evidence reasonably satisfactory to Purchaser that said exceptions will be removed on or before the Closing, or (ii) Seller has elected not to remove such Title Objections. Notwithstanding the provisions to the contrary contained in this SECTION 6.11(c), Seller shall remove all liens, mortgages, deeds of trust or other monetary liens and encumbrances (other than non-delinquent real estate taxes for the current year or special assessments or local improvement district assessments payable in installments which shall be paid or prorated to the Closing Date as provided in SECTION 3.2) prior to or upon Closing. If Seller gives Purchaser notice under the foregoing clause (ii), Purchaser shall have ten
(10) Business Days to elect to proceed with the purchase and take the Real Property subject to such Title Objections (which exceptions shall then constitute Permitted Liens), or to terminate this Agreement. If Purchaser shall fail to give Seller written notice of such election within said ten (10) Business Days, Purchaser shall be deemed to have waived any and all such Title Objections. If Seller shall give notice pursuant to the foregoing clause (i), Seller shall use commercially reasonable efforts to cure each Title Objection which is the subject of such notice prior to the Closing and take all steps required by the Title Insurer to eliminate each Title Objection as an exception to the Title Commitment. In the event that Seller shall thereafter fail to remove any such Title Objections from title prior to the Closing Date, and Purchaser is unwilling to take title subject thereto, Purchaser may elect to terminate this Agreement, and in the event of any such termination, Seller shall be liable for payment of all title cancellation charges. Any Title Objection that the Title Company is willing to insure over on terms acceptable to Seller and Purchaser is herein referred to as an "INSURED EXCEPTION." The Insured Exceptions, together with any title exception or matters disclosed by the Survey not objected to by Purchaser in the manner aforesaid, shall be deemed to be acceptable to Purchaser and shall constitute a Permitted Lien for purposes of this Agreement.
(d) Nothing herein waives Purchaser's right to claim a breach of SECTION 4.13 or to claim a right to indemnification as provided in ARTICLE XI if Purchaser suffers Losses as a result of a misrepresentation with respect to the condition of title to the Real Property.
6.12 TRANSITION PLAN. Within ten (10) Business Days after the Agreement Date, Purchaser shall deliver to Seller a list of its proposed representatives to a joint transition team. Seller will add its representatives to such team within five (5) Business Days after receipt of Purchaser's list. Such team will be responsible for preparing as soon as reasonably practicable after the Agreement Date, and timely implementing, a transition plan which will identify and describe substantially all of the various transition activities that the Parties will cause to occur before and after the Closing and any other transfer of control matters that any Party reasonably believes should be addressed in such transition plan. If requested by either Party, the terms and conditions governing such transition activities will be more fully set forth in a transition agreement reasonably satisfactory to the Parties. Purchaser and Seller shall use commercially reasonable efforts to cause their representatives on such transition team to cooperate in good faith and take all reasonable steps necessary to develop a mutually acceptable transition plan by no later than sixty (60) days after the Agreement Date.
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6.13 UPDATING.
(a) Each Party shall, from time to time prior to the Closing by written notice to the other Party, supplement or amend the Schedules to this Agreement to correct any matter that constitutes a breach of any representation or warranty made by such Party in ARTICLE IV or ARTICLE V, as the case may be, as of the Agreement Date. In the event that at any time either Party supplements or amends any Schedule pursuant to this SECTION 6.13(a), such Party shall: (i) concurrently with a notice provided to the other Party containing such supplement or amendment, specifically identify and provide a detailed description (including any supporting information, materials and data) of the breach such supplement or amendment is proposed to cure reasonably sufficient to enable the other Party to make an informed decision with respect to the consequences of such breach and (ii) promptly, and in any event within two (2) Business Days of the request of the other Party, provide the other Party with any additional information, materials and data relating to such breach as may be reasonably requested by the other Party. Provided that the foregoing shall have been complied with, any such supplement or amendment shall, unless the other Party objects thereto in writing within a period of fifteen (15) Business Days after notice of such supplement or amendment, be deemed to cure, effective as of the Agreement Date, any applicable inaccuracy in such representation or warranty to the extent (and only to the extent) such inaccuracy has been specifically detailed as provided above, and to constitute a waiver by such other Party of any applicable breach of or default under this Agreement. Notwithstanding the foregoing, any such waiver shall not apply to the conditions set forth in
SECTION 8.6 or SECTION 9.6 and no retroactive effect shall be given to any such supplement or amendment for purposes of any determination as to the magnitude of, as the case may be, (1) any change in the Purchased Assets after the Agreement Date that, individually or in the aggregate with other such changes, has, or could reasonably be expected to have, a Seller Material Adverse Effect, or (2) any change in the business, assets, operations, property, performance or condition (financial or otherwise) of Purchaser after the Agreement Date which, individually or in the aggregate with other such changes, has, or could reasonably be expected to have, a Purchaser Material Adverse Effect. In the event that the other Party does so object in writing, the applicable Schedule supplement or amendment made pursuant to this SECTION 6.13(a) shall not be deemed to cure any inaccuracy of any representation or warranty made in this Agreement by the Party supplementing or amending such Schedule, and shall not be considered to constitute or give rise to a waiver by the other Party of any condition or obligation set forth in this Agreement.
(b) Each Party shall, from time to time prior to the Closing by written notice to the other Party, supplement or amend the Schedules to this Agreement with respect to any matter arising after the Agreement Date that, if existing at, or occurring on, the Agreement Date, would have been required to be set forth or described on any such Schedule. In the event that at any time either Party supplements or amends any Schedule pursuant to this SECTION 6.13(b), such Party shall: (i) concurrently with a notice provided to the other Party containing such supplement or amendment, specifically identify and provide a detailed description (including any supporting information, materials and data) of the breach such supplement or amendment is proposed to cure reasonably sufficient to enable the other Party to make an informed decision with respect to the consequences of such breach and (ii) promptly, and in any event within two (2) Business Days of the request of the other Party, provide the other Party with any additional information, materials and data relating to such breach as may be reasonably requested by the
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other Party. Any such supplement or amendment shall, effective immediately upon notice thereof to the other Party, be deemed to cure any applicable inaccuracy in such representation or warranty to the extent (and only to the extent) such inaccuracy has been specifically detailed as provided above, and any applicable breach of or default under this Agreement shall be deemed waived; provided that notwithstanding the foregoing, the foregoing waiver shall not apply to the conditions set forth in SECTION 8.6 or SECTION 9.6 and no retroactive effect shall be given to any such supplement or amendment for purposes of any determination as to the magnitude of, as the case may be, (1) any change in the Purchased Assets after the Agreement Date that, individually or in the aggregate with other such changes, has, or could reasonably be expected to have, a Seller Material Adverse Effect, or (2) any change in the business, assets, operations, property, performance or condition (financial or otherwise) of Purchaser after the Agreement Date which, individually or in the aggregate with other such changes, has, or could reasonably be expected to have, a Purchaser Material Adverse Effect. In the event that any Schedule to this Agreement is supplemented or amended pursuant to this SECTION 6.13(b), and the matter with respect to which such Schedule is supplemented or amended causes or results in an expense, fee or other type of cost to either Party, the Parties shall negotiate in good faith to determine how such expense, fee or other costs should fairly and reasonably be apportioned between the Parties. If the Parties are unable reasonably promptly to agree upon such apportionment of such expense, fee or other costs, the Parties' dispute with respect to such apportionment shall be resolved in accordance with the arbitration provisions of SECTION 11.6; provided, however, that if the Parties are unable reasonably promptly to agree upon such apportionment of such expense, fee or other costs, and such expense, fee or other costs must be paid prior to the Closing, the Parties shall, pending the Closing, share such expense, fee or other costs equally so as not to delay or prevent the Closing, subject to reimbursement of any overpayment following resolution of the Parties dispute in accordance with the arbitration provisions of SECTION 11.6.
(c) Each Party shall notify the other Party promptly after becoming aware of any inaccuracy in or breach of any representation or warranty of such other Party under this Agreement.
(d) Without limiting the generality of the foregoing, (i) Seller shall notify Purchaser promptly of the occurrence of any event which, to Seller's Knowledge, could reasonably be expected to result in a Seller Material Adverse Effect, and (ii) Purchaser shall notify Seller promptly of the occurrence of any event which, to Purchaser's Knowledge, could reasonably be expected to result in a Purchaser Material Adverse Effect.
6.14 RECORDS.
(a) On the Closing Date or as soon as practicable thereafter, Seller shall deliver or cause to be delivered to Purchaser all original agreements, documents, Books and Records and files, including records and files stored in electronic form (collectively, "RECORDS"), if any, in the possession of Seller relating to the Business to the extent not then in the possession of Purchaser, provided that (i) Purchaser recognizes that certain Records may contain incidental information relating to Affiliates of Seller, and that Seller may retain such Records and shall provide copies of the relevant portions thereof to Purchaser and (ii) Records shall not include (A) documents or files relating to employees who are not Continued Employees or (B) employee
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documents or files afforded confidential treatment under any applicable Laws, except to the extent the affected employee consents in writing to the disclosure of the same to Purchaser.
(b) Following the Closing, Purchaser shall permit Seller and its Representatives, during normal business hours and upon reasonable notice, to have reasonable access to personnel of Purchaser, and to examine and make copies of, all Records, in each case relating to transactions or events occurring prior to the Closing ("PRE-CLOSING TRANSACTIONS") or transactions or events occurring subsequent to the Closing that are related to or arising out of Pre-Closing Transactions, to the extent such Pre-Closing Transactions relate to Excluded Liabilities or Excluded Assets or to the extent necessary to comply with applicable financial reporting obligations. Purchaser agrees that it shall retain all such Records for a period of seven (7) years following the Closing, or for such longer period following the Closing as may be required by applicable Law.
6.15 SYNTHETIC LEASE TRANSACTION. Seller represents and warrants that, pursuant to the terms of an Amended and Restated Participation Agreement dated as of July 17, 2001 by and among PPL Large Scale Distributed Generation II, LLC, as Lessee and Supervisory Agent, Large Scale Distributed Generation II Statutory Trust, a Connecticut statutory trust, as Lessor, State Street Bank and Trust Company of Connecticut, National Association, as Trustee, First Union National Bank, as Administrative Agent, certain financial institutions, as Certificate Holders, and certain financial institutions, as Lenders, and various other related agreements, Seller and certain of its Affiliates entered into a synthetic lease arrangement (the "SYNTHETIC LEASE TRANSACTION") for purposes of financing the acquisition and construction of the Project. The Synthetic Lease Transaction subjects the Purchased Assets to various Liens and leases. Seller covenants and agrees that: (a) prior to the Closing, all right, title and interest in, to and under the Purchased Assets that are the subject of the Synthetic Lease Transaction shall be transferred to Seller; and (b) promptly following such transfer, Seller shall (i) provide notice thereof to Purchaser and (ii) update the Schedules as necessary and appropriate to reflect such transfer. Without limiting the provisions of SECTION 2.1, Seller covenants and agrees that, on the terms and subject to the conditions set forth in this Agreement, Seller shall, at the Closing, sell, assign, convey, transfer and deliver to Purchaser all of Seller's right, title and interest in the Purchased Assets free and clear of any and all Liens and leases (other than Permitted Liens) resulting from or arising out of or in connection with the Synthetic Lease Transaction. The Parties acknowledge and agree that Seller's representations and warranties in this Agreement with respect to the Purchased Assets that are the subject of the Synthetic Lease Transaction contemplate, and are cast as of the time period commencing immediately following, the transfer to Seller of all right, title and interest in, to and under the Purchased Assets that are the subject of the Synthetic Lease Transaction, which transfer shall in any event be effective no later than the Closing.
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ARTICLE VII
TAX MATTERS
7.1 PRORATION.
(a) With respect to Taxes to be prorated in accordance with
SECTION 3.2(a) hereof only, Purchaser shall prepare and timely file all Tax Returns, if any, required to be filed with respect to the Purchased Assets, and shall duly and timely pay all such Taxes shown to be due on such Tax Returns; provided, however, that Seller shall file all of its federal and state income tax returns (including those reporting prorated income) and shall not be required to permit Purchaser to review or comment on any such income tax returns; provided, further, that any income Tax Returns that report Seller's income shall be prepared in accordance with SECTION 3.6 hereof. Purchaser shall make such Tax Returns that it prepares under this SECTION 7.1 available for Seller's review and comment no later than sixty (60) days prior to the due date for filing each such Tax Return, and shall not unreasonably refuse to accept any such comments or proposed changes. Within ten (10) days after receipt of such Tax Return, Seller shall pay to Purchaser Seller's proportionate share of the amount shown as due on such Tax Return as determined in accordance with SECTION 3.2 hereof.
(b) With respect to Property Taxes to be prorated in accordance with SECTION 3.2(b) hereof only, (i) for all such Property Taxes having a lien date in the year before the calendar year of the Closing Date, Seller shall prepare and timely file all related Property Tax Returns required to be filed with respect to the Purchased Assets and Seller shall duly and timely pay all such Property Taxes; (ii) for all such Property Taxes having a lien date in the same calendar year of the Closing Date, Seller shall prepare and timely file all related Property Tax Returns required to be filed with respect to the Purchased Assets and Seller shall duly and timely pay all such Property Taxes; and (iii) for all such Property Taxes having a lien date in the year after the calendar year of the Closing Date, Seller shall prepare and file when due all related Property Tax Returns required to be filed with respect to the Purchased Assets, except that, if such Property Tax Returns are not due before the Closing Date, Seller shall prepare and file such Property Tax Returns on or before the Closing Date, and in either case Purchaser shall duly and timely pay all such Property Taxes, and shall be reimbursed for a portion thereof in accordance with SECTION 3.2(b)(iii). Seller shall, in good faith, prepare and timely file any such Property Tax Returns, including any affirmative claims for adjustments, reasonably and in good faith defend the values and adjustments filed, and preserve any and all appeal rights related to such returns. The Parties hereby acknowledge that, without regard to any other provision of this Agreement, all Property Tax Returns, documentation and supporting workpapers relating to any Property Taxes of Seller shall be proprietary to Seller and have not and will not be disclosed to Purchaser; provided, however, that (i) Seller shall, upon request of Purchaser, provide an estimate of Property Taxes to be paid, and (ii) the Party receiving the actual Property Tax bills or statements from the Taxing Authorities shall, upon request from the other Party, provide copies of such Property Tax bills or statements to the requesting Party.
7.2 COOPERATION. Except as limited by SECTION 7.1(b), Seller and Purchaser shall provide each other with such assistance as may reasonably be requested by the other Party in connection with the preparation of any Tax Return, any audit or other examination by any
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Taxing Authority, or any judicial or administrative proceedings relating to liability for Taxes, and upon any such request the requested Party shall retain and provide the requesting Party with any records or information which may be relevant to such return, audit or examination, proceedings or determination. Except as required by applicable Law, any information obtained pursuant to this
SECTION 7.2 or pursuant to any other Section hereof providing for the sharing of information or review of any Tax Return or other schedule relating to Taxes shall be kept confidential by the Parties in accordance with SECTION 12.5.
7.3 TRANSFER TAXES. Notwithstanding any other provision of this Agreement, responsibility for payment of any and all Transfer Taxes incurred in connection with this Agreement and the transactions contemplated hereby shall be borne by Seller. Seller shall, at its own expense, file, to the extent required by Law, all necessary Tax Returns and other documentation with respect to all such Transfer Taxes, and Purchaser will be entitled to review such return in advance and, if required by applicable Law, Purchaser shall join in the execution of any such Tax Returns or other required documentation.
ARTICLE VIII
PURCHASER'S CONDITIONS TO CLOSING
The obligation of Purchaser to purchase the Purchased Assets under this Agreement is subject to the fulfillment, at or before the Closing, of each of the following conditions (except to the extent waived in writing by Purchaser in its sole discretion):
8.1 REPRESENTATIONS AND WARRANTIES. The representations and warranties made by Seller in ARTICLE IV of this Agreement shall be true and correct in all material respects (except for representations and warranties that contain a qualification as to materiality, which shall have been true and correct in all respects) as of the Agreement Date and shall be true and correct in all material respects (except for representations and warranties that contain a qualification as to materiality, which shall have been true and correct in all respects) as of the Closing Date as if made on the Closing Date or, in the case of representations and warranties made as of a specified date earlier than the Closing Date, on and as of such earlier date (after giving effect to any Schedule supplements or amendments delivered by Seller pursuant to SECTION 6.13 to the extent (and only to the extent) such Schedule supplements or amendments are expressly permitted to be taken into account in determining the accuracy of Seller's representations and warranties following compliance by the Parties with the terms and conditions set forth in SECTION 6.13).
8.2 PERFORMANCE. Seller shall have performed and complied, in all material respects, with the agreements, covenants and obligations required by this Agreement to be so performed or complied with by Seller at or before the Closing.
8.3 DELIVERIES. Seller shall have made all deliveries required of it under SECTION 3.4 hereof.
8.4 ORDERS AND LAWS. There shall not be any litigation or proceedings (filed by a Person other than Purchaser or its Affiliates) or Law or order restraining, enjoining or otherwise prohibiting or making illegal or threatening to restrain, enjoin or otherwise prohibit or make
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illegal the consummation of any of the transactions contemplated by this Agreement or the Ancillary Agreements; provided, however, that this SECTION 8.4 is not intended to expand the scope of the conditions described in SECTION 8.7(b).
8.5 CONSENTS AND APPROVALS. The consents and approvals listed on Schedule 8.5 shall have been duly obtained, made or given and shall be in full force and effect.
8.6 SELLER MATERIAL ADVERSE EFFECT. There shall not have occurred and be continuing any change in the business, Assets, operations, property, performance or condition (financial or otherwise) of Seller after the Agreement Date which, individually or in the aggregate with other such changes, has, or could reasonably be expected to have, a Seller Material Adverse Effect.
8.7 APPROVALS OF GOVERNMENTAL AUTHORITIES.
(a) All consents and approvals of Governmental Authorities required for the consummation of the transactions contemplated hereby or by the Ancillary Agreements, including the Seller Approvals and the Purchaser Approvals, shall have become Final Orders (other than the ACC Order, which must meet the conditions of SECTION 8.7(b) rather than becoming a Final Order, and approval under the HSR Act, which may be obtained by the expiration or early termination of the initial waiting period and shall not be required to be or become a Final Order) with such terms and conditions as shall have been imposed by the Governmental Authority issuing such Final Order, and such terms or conditions in the aggregate, could not reasonably be expected to have a material adverse effect on the Business, the Purchased Assets, or the business, assets, operations or condition (financial or otherwise) of Purchaser; provided, however, that this SECTION 8.7(a) is not intended to expand the scope of the conditions described in SECTION 8.7(b).
(b) Without limiting the provisions of SECTION 8.7(a), the ACC shall have issued one or more orders (collectively, the "ACC ORDER"), each of which orders shall (as determined by Purchaser in the reasonable exercise of its discretion) be substantially the same in form and substance as the orders requested by Purchaser in its applicable filings with the ACC, (i) approving the transactions contemplated hereby and by the Ancillary Documents and the regulatory treatment of the Purchased Assets, including, (A) to the extent Purchaser, in its sole discretion, determines such approval is necessary, Purchaser's financing of all or a portion of the Purchase Price, (B) authorization for the inclusion in Purchaser's rate base of the Purchased Assets at the Purchase Price plus the deferred costs described in clause (D) of this
SECTION 8.7(b) without any direct or indirect disallowance, with such inclusion to be effective in Purchaser's next rate case, (C) authorization for the timely recovery in Purchaser's retail rates of all reasonable costs of owning and operating the Purchased Assets, including the deferred costs described in clause (D) of this SECTION 8.7(b), with such recovery to be effective no later than Purchaser's next rate case, (D) an order authorizing deferral for future recovery in the Purchaser's next general rate proceeding of all capital and operating costs associated with the Purchased Assets, net of any savings produced by the Purchased Assets, and (E) a declaration that the Certificate of Environmental Compatibility is in full force and effect and a modification to Condition 16 of the Certificate of Environmental Compatibility to eliminate the self-executing nature of such Condition; and (ii) the ACC shall not have rescinded, altered or amended the ACC Order nor shall the ACC have taken or be in the process of taking any action that could result in
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the rescission, alteration or amendment of such ACC Order. The ACC Order shall not be required to be or become a Final Order.
8.8 TRANSFERRED PERMITS. Purchaser shall be satisfied that all Transferred Permits will be transferred to Purchaser or obtained by Purchaser effective as of or promptly after the Closing.
8.9 TITLE INSURANCE. Purchaser shall have received an unconditional and binding commitment to issue the policy of title insurance consistent with
SECTION 6.11, dated the Closing Date, in an aggregate amount equal to the amount of the Purchase Price allocated to the Real Property, acknowledging the satisfaction of all requirements listed in ALTA Schedule B-1, amending the effective date to the date and time of recordation of the Deed conveying title to the Real Property to Purchaser with no exception for the gap between Closing and recordation, deleting or insuring over Title Objections as required pursuant to SECTION 6.11, attaching all reasonable endorsements available from the title company required by Purchaser in order to ensure provision of all coverage required pursuant to SECTION 6.11 and otherwise in form satisfactory to Purchaser insuring Purchaser's interest in each parcel of Real Property or interest therein to the extent required by SECTION 6.11.
8.10 ENVIRONMENTAL DILIGENCE. Purchaser shall, within ninety (90) days following the Agreement Date, have completed, at its sole cost and expense, an environmental investigation of the Real Property (which may, in Purchaser's discretion, include environmental audits or any other similar invasive or non-invasive procedures, subject to SECTION 6.2), and shall have determined, in its sole discretion, that the results of such investigation are satisfactory to Purchaser. Purchaser shall provide written notice to Seller, not later than fifteen (15) days following the completion of such investigation but in any event not less than thirty (30) days prior to Closing, whether Purchaser has determined that it is satisfied with respect to the results of such investigation. No such investigation or assessment shall in any manner be deemed to relieve Seller of any obligations with respect to any warranties, representations, covenants or other undertakings made hereunder or to qualify any such warranties, representations or covenants, except to the extent that Purchaser has failed to comply with its obligations under SECTION 6.13(c) or
6.13(d). Purchaser shall have the right to extend the ninety (90)-day deadline set forth above upon a showing of good cause and with the consent of Seller (which consent shall not be unreasonably withheld).
8.11 LEGAL OPINION. Purchaser shall have received opinions from Preston Gates & Ellis LLP and Moyes Storey, dated the Closing Date and satisfactory in form and substance to Purchaser and its counsel, substantially to the effect that, when taken together:
(a) Seller is a limited liability company duly formed, existing and in good standing under the Laws of the State of Delaware and has the requisite power and authority to execute and deliver this Agreement and the Ancillary Agreements and to consummate the transactions contemplated hereby and thereby; and the execution and delivery of this Agreement and the Ancillary Agreements and the consummation of the transactions contemplated hereby and thereby have been duly authorized by requisite action taken on the part of Seller;
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(b) This Agreement and the Ancillary Agreements have been executed and delivered by Seller and (assuming that the required approvals of Governmental Authorities are obtained) are valid and binding obligations of Seller, enforceable against it in accordance with their respective terms, except that such enforcement thereof may be limited by (i) bankruptcy, insolvency, reorganization, moratorium or other similar Laws affecting creditors' rights generally, and (ii) general principles of equity (regardless of whether enforceability is considered in a proceeding at law or in equity) and except to the extent that the right to indemnification and contribution contained therein may be limited by state or federal securities Laws or the public policy underlying such Laws;
(c) The execution, delivery and performance of this Agreement and the Ancillary Agreements by Seller do not (i) constitute a violation of the Charter Documents of Seller or, (ii) to such counsel's knowledge, constitute a violation of or default under the Material Contracts; and
(d) No declaration, filing or registration with, or notice to, or authorization, consent or approval of any Governmental Authority is necessary for the consummation by Seller of the transactions contemplated by this Agreement and the Ancillary Agreements to which it is a party other than (i) those that have been obtained and are in full force and effect with such terms and conditions as shall have been imposed by any applicable Governmental Authority, (ii) such declarations, filings or registrations, or notices, or authorizations, consents or approvals relating to Permits and (iii) such declarations, filings or registrations, or notices, or authorizations, consents or approvals which, if not obtained or made, would not, in the aggregate, reasonably be expected to have a Seller Material Adverse Effect. Any opinions relied upon by such counsel shall be delivered together with the opinion of such counsel. Such opinion may expressly rely as to matters of fact upon certificates furnished by Seller and by public officials.
ARTICLE IX
SELLER'S CONDITIONS TO CLOSING
The obligation of Seller to sell the Purchased Assets under this Agreement is subject to the fulfillment, at or before the Closing, of each of the following conditions (except to the extent waived in writing by Seller in its sole discretion):
9.1 REPRESENTATIONS AND WARRANTIES. The representations and warranties made by Purchaser in ARTICLE V of this Agreement shall be true and correct in all material respects (except for representations and warranties that contain a qualification as to materiality, which shall have been true and correct in all respects) as of the Agreement Date and shall be true and correct in all material respects (except for representations and warranties that contain a qualification as to materiality, which shall have been true and correct in all respects) as of the Closing Date as if made on the Closing Date or, in the case of representations and warranties made as of a specified date earlier than the Closing Date, on and as of such earlier date (after giving effect to any Schedule supplements or amendments delivered by Purchaser pursuant to SECTION 6.13 to the extent (and only to the extent) such Schedule supplements or amendments are expressly permitted to be taken into account in determining the accuracy of Purchaser's representations
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and warranties following compliance by the Parties with the terms and conditions set forth in SECTION 6.13).
9.2 PERFORMANCE. Purchaser shall have performed and complied, in all material respects, with the agreements, covenants and obligations required by this Agreement so to be performed or complied with by Purchaser at or before the Closing.
9.3 DELIVERIES. Purchaser shall have taken all actions and made all deliveries required of it under SECTIONS 3.5.
9.4 ORDERS AND LAWS. There shall not be any litigation or proceedings (filed by a Person other than Seller or its Affiliates) or Law or order restraining, enjoining or otherwise prohibiting or making illegal or threatening to restrain, enjoin or otherwise prohibit or make illegal the consummation of any of the transactions contemplated by this Agreement or the Ancillary Agreements.
9.5 CONSENTS AND APPROVALS. The consents and approvals listed on Schedule 9.5 shall have been duly obtained, made or given and shall be in full force and effect.
9.6 PURCHASER MATERIAL ADVERSE EFFECT. There shall not have occurred and be continuing any change in the business, Assets, operations, property, performance or condition (financial or otherwise) of Purchaser after the Agreement Date which, individually or in the aggregate with other such changes, has, or could reasonably be expected to have, a Purchaser Material Adverse Effect.
9.7 APPROVALS OF GOVERNMENTAL AUTHORITIES. All consents and approvals of Governmental Authorities required for the consummation of the transactions contemplated hereby or by the Ancillary Agreements, including the Seller Approvals and the Purchaser Approvals, shall have become Final Orders (other than the ACC Order, which must meet the conditions of SECTION 8.7(b) rather than becoming a Final Order, and approval under the HSR Act, which may be obtained by the expiration or early termination of the initial waiting period and shall not be required to be or become a Final Order) with such terms and conditions as shall have been imposed by the Governmental Authority issuing such order, and such terms or conditions, in the aggregate, could not reasonably be expected to have a material adverse effect on the Business, the Purchased Assets, or the business, assets, operations or condition (financial or otherwise) of Seller.
9.8 LEGAL OPINION. Seller shall have received an opinion from Snell & Wilmer L.L.P., dated the Closing Date and satisfactory in form and substance to Seller and its counsel, substantially to the effect that:
(a) Purchaser is a corporation duly formed, existing and in good standing under the Laws of the State of Arizona and has the requisite power and authority to execute and deliver this Agreement and the Ancillary Agreements and to consummate the transactions contemplated hereby and thereby; and the execution and delivery of this Agreement and the Ancillary Agreements and the consummation of the transactions contemplated hereby and thereby have been duly authorized by requisite action taken on the part of Purchaser;
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(b) This Agreement and the Ancillary Agreements have been executed and delivered by Purchaser and (assuming that the required approvals of Governmental Authorities are obtained) are valid and binding obligations of Purchaser, enforceable against it in accordance with their respective terms, except that such enforcement thereof may be limited by (i) bankruptcy, insolvency, reorganization, moratorium or other similar Laws affecting creditors' rights generally, and (ii) general principles of equity (regardless of whether enforceability is considered in a proceeding at law or in equity) and except to the extent that the right to indemnification and contribution contained therein may be limited by state or federal securities Laws or the public policy underlying such Laws;
(c) The execution, delivery and performance of this Agreement and the Ancillary Agreements by Purchaser do not (i) constitute a violation of the Charter Documents of Purchaser or, (ii) to such counsel's knowledge, constitute a violation of or default under Purchaser's Applicable Contracts. "PURCHASER'S APPLICABLE CONTRACTS" means those agreements or instruments set forth on a schedule attached to such counsel's opinion and which have been identified by Purchaser to such counsel as all of the agreements and instruments which are material to the business or financial condition of Purchaser; and
(d) No declaration, filing or registration with, or notice to, or authorization, consent or approval of any Governmental Authority is necessary for the consummation by Purchaser of the transactions contemplated by this Agreement and the Ancillary Agreements to which it is party other than (i) those that have been obtained and are in full force and effect with such terms and conditions as shall have been imposed by any applicable Governmental Authority,
(ii) such declarations, filings or registrations, or notices, or authorizations, consents or approvals relating to Permits and (iii) such declarations, filings or registrations, or notices, or authorizations, consents or approvals which, if not obtained or made, would not, in the aggregate, reasonably be expected to have a Purchaser Material Adverse Effect. Any opinions relied upon by such counsel shall be delivered together with the opinion of such counsel. Such opinion may expressly rely as to matters of fact upon certificates furnished by Purchaser and by public officials.
ARTICLE X
TERMINATION
10.1 TERMINATION. This Agreement may be terminated, and the transactions contemplated hereby may be abandoned, as follows:
(a) at any time before the Closing, by mutual consent of Seller and Purchaser;
(b) at any time before the Closing, by either Party effective upon notice to the other Party, in the event that any Law or order of any Governmental Authority becomes effective and continues in effect for sixty (60) days restraining, enjoining or otherwise prohibiting or making illegal the consummation of the transactions contemplated by this Agreement or the Ancillary Agreements;
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(c) by Purchaser, effective upon notice to Seller, if there has been a material violation or breach by Seller of any covenant, representation, or warranty contained in this Agreement which has rendered the satisfaction of any condition to the obligations of Purchaser to effect the Closing impossible and such violation or breach is not cured by the date which is thirty (30) days after receipt by Seller of notice specifying particularly such violation or breach, and such violation or breach has not been waived by Purchaser, provided that Purchaser may not terminate this Agreement if Purchaser is also at the time in such material violation or breach of any covenant, representation or warranty contained in this Agreement;
(d) by Seller, effective upon notice to Purchaser, if there has been a material violation or breach by Purchaser of any covenant, representation, or warranty contained in this Agreement which has rendered the satisfaction of any condition to the obligations of Seller to effect the Closing impossible and such violation or breach (other than a breach by Purchaser of its obligation to pay the Purchase Price in accordance with the terms of ARTICLE
III) is not cured by the date thirty (30) days after receipt by Purchaser of notice specifying particularly such violation or breach and such violation or breach has not been waived by Seller, provided that Seller may not terminate this Agreement if Seller is also at the time in such material violation or breach of any covenant, representation or warranty contained in this Agreement;
(e) by Purchaser, effective upon notice to Seller, if any of the Purchaser Approvals shall have been denied (and a petition for rehearing or refiling of any application initially denied without prejudice shall also have been denied) and such denial was not caused by a breach of this Agreement by Purchaser;
(f) by Seller, effective upon notice to Purchaser, if any of the Seller Approvals shall have been denied or refused (and a petition for rehearing or refiling of any application initially denied without prejudice shall also have been denied) and such denial or refusal was not caused by a breach of this Agreement by Seller;
(g) (i) by either Party that is not in breach of this Agreement, by notice to the other Party on or before the close of business on January 10, 2005, if the conditions described in SECTION 8.7(b) have not been satisfied on or prior to the close of business on December 31, 2004, or (ii) automatically and without action by either Party, at the close of business on March 31, 2005 (the "TERMINATION DATE"), if the Closing shall not have occurred on or prior thereto, unless Seller, in its sole and absolute discretion, notifies Purchaser prior thereto that Seller has elected to extend the Termination Date for a period of 60 days; provided, however, that in the event of any such extension by Seller, the Purchase Price shall increase by the amount of Fifty Thousand and No/100 Dollars ($50,000.00) per day for each day from March 31, 2005 up to and including the Closing Date; provided, further, that, notwithstanding the foregoing, the right to terminate this Agreement under this
SECTION 10.1(g) shall not be available to any Party whose failure to fulfill any obligation under this Agreement has been the cause of, or resulted in, the failure of the Closing Date to occur on or before such date; or
(h) by either Party pursuant to SECTION 6.10, effective upon notice to the other Party.
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10.2 EFFECT OF TERMINATION.
(a) If this Agreement is validly terminated pursuant to
SECTION 10.1, then:
(i) the obligations of the Parties to consummate the transactions contemplated by this Agreement and the Ancillary Agreements shall terminate;
(ii) all filings, applications and other submissions made to any Governmental Authority shall, to the extent reasonably practicable, be withdrawn from the Governmental Authority to which they were made by the Party making them; and
(iii) Purchaser shall return all documents, work papers and other materials (and all copies thereof) obtained from Seller relating to the transactions contemplated by this Agreement and the Ancillary Agreements, whether so obtained before or after execution of this Agreement, and Purchaser shall ensure that all Seller Information received by Purchaser shall be treated in accordance with the requirements of
SECTION 12.5.
(b) If this Agreement is validly terminated pursuant to
SECTION 10.1, then except as set forth in SECTION 10.2(c), there will be no liability or obligation on the part of Seller or Purchaser (or any of their respective Representatives or Affiliates). Without limiting the foregoing,
SECTION 1.2 (Construction), SECTIONS 4.20 and 5.6 (Brokers), SECTION 6.2 (Access of Purchaser), SECTION 11.2(b) (Non-reimbursable Damages), SECTION 11.2(c) (No Personal Liability), SECTION 11.6 (Arbitration), SECTION 12.3 (Expenses),
SECTION 12.4 (Public Announcements), SECTION 12.5 (Confidential Information),
SECTION 12.14 (Governing Law; Venue; and Jurisdiction) and SECTION 12.15 (Attorneys' Fees) will survive any such termination.
(c) Notwithstanding any other provision of this Agreement to the contrary, if this Agreement is validly terminated by Purchaser pursuant to
SECTION 10.1(c) or by Seller pursuant to SECTION 10.1(d), the terminating Party shall be entitled to all rights and remedies available to it, except that no Party shall have any liability for a breach of a representation or warranty if such Party used commercially reasonable efforts to cure such breach prior to the date of termination.
ARTICLE XI
INDEMNIFICATION, LIMITATIONS OF LIABILITY, WAIVERS AND ARBITRATION
11.1 INDEMNIFICATION.
(a) Subject to the limitations set forth in SECTION 11.1(c) and elsewhere in this ARTICLE XI, from and after the Closing, Seller hereby agrees to indemnify, defend and hold harmless Purchaser and its Representatives and Affiliates (collectively, the "PURCHASER INDEMNIFIED PARTIES") from and against any and all Losses, whether or not involving a third-party Claim, resulting from or arising out of or in connection with:
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(i) any breach of a representation or warranty made by Seller in this Agreement;
(ii) the breach by Seller of, or default in the performance by Seller of, any covenant, agreement or obligation to be performed by Seller pursuant to this Agreement or in any other certificate, document, writing or instrument delivered by Seller pursuant to this Agreement;
(iii) any Benefit Plan established or maintained by Seller; and
(iv) any Excluded Liability.
(b) Subject to the limitations set forth in SECTION 11.1(c) and elsewhere in this ARTICLE XI, from and after the Closing Purchaser hereby agrees to indemnify, defend and hold harmless Seller and its Representatives and Affiliates (collectively, the "SELLER INDEMNIFIED PARTIES") from and against any and all Losses, whether or not involving a third-party Claim, resulting from or arising out of or in connection with:
(i) any breach of a representation or warranty made by Purchaser in this Agreement;
(ii) the breach by Purchaser of, or default in the performance by Purchaser of, any covenant, agreement or obligation to be performed by Purchaser pursuant to this Agreement or in any other certificate, document, writing or instrument delivered by Purchaser pursuant to this Agreement;
(iii) any Assumed Liability; and
(iv) any entry upon the Real Property by Purchaser or any of its Affiliates or any of its or their respective Representatives, agents, contractors or subcontractors pursuant to SECTION 6.2.
(c) Notwithstanding anything to the contrary contained in this Agreement, any and all Environmental Liabilities and Tort Liabilities (other than the Excluded Environmental Liabilities and the Excluded Tort Liabilities) shall be deemed to constitute Assumed Liabilities for all purposes of this Agreement (including for purposes of SECTIONS 11.1(b)(iii), 11.4(b) and 11.4(C)); provided, however, that Seller agrees to indemnify, defend and hold harmless the Purchaser Indemnified Parties from and against any and all Losses, whether or not involving a third-party Claim, resulting from or arising out of or in connection with any such Environmental Liabilities or Tort Liabilities that accrue, arise or occur prior to the Closing ("PRE-CLOSING ENVIRONMENTAL LIABILITIES/TORT LIABILITIES"); provided, further, that in no event shall Seller's aggregate liability arising out of its indemnification obligations for or with respect to any such Pre-Closing Environmental Liabilities/Tort Liabilities exceed the amount of $3,500,000 in the aggregate; and provided, further, that Seller's indemnification obligations shall extend only to such Pre-Closing Environmental Liabilities/Tort Liabilities as are attributable to conditions existing at or prior to Closing, and Seller shall not be required to indemnify Purchaser for Losses to the extent attributable to acts or omissions of Purchaser resulting in any increase or aggravation of such Environmental Liabilities or Tort Liabilities, whether arising from a change
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in use of the Purchased Assets or otherwise. Notwithstanding anything to the contrary contained in SECTION 11.3 or any other provision of this Agreement, after the Closing, any assertion by Purchaser or any Purchaser Indemnified Party that Seller is liable to Purchaser or any Purchaser Indemnified Party for indemnification with respect to Losses for or with respect to any Pre-Closing Environmental Liabilities/Tort Liabilities must be made in writing and must be given to Seller (or not at all) on or prior to the earlier of the fifth anniversary of the Closing Date or the date on which the applicable statute of limitations expires with respect to the matters covered thereby.
(d) The Parties acknowledge that Section 5 of the Martin Farms Lease provides as follows (with all capitalized terms used in the following paragraph having the meaning assigned thereto in the Martin Farms Lease):
Lessee, as a material part of the consideration for this Lease, hereby agrees to indemnify and hold Lessor entirely free and harmless from all liability, responsibility and obligations for any crop loss or damage or other loss, damage or injury to any person or property (whether arising during or after the lease term) that may arise from (a) Lessee's use of the Premises or from the acts or omissions of Lessee or its agents, employees, invitees or contractors, or from (b) Lessor's delivery to the Premises and Lessee's use of reuse water from the Power Plant or, as to claims brought by, through or on behalf of Lessee or persons or entities financing Lessee, any other act or omission of Lessor or Lessor's affiliated entities or persons arising from or related to the operation of the Power Plant and/or its water supply, treatment, storage, disposal and/or reuse systems and operations. The forgoing indemnity shall also apply to any and all damages, claims, losses, costs and expenses arising from or related to the acts or omissions set forth in this paragraph, including without limitation any attorneys' fees incurred by Lessor in defending against any such liability.
The Parties further acknowledge that Section 8.3 of the Martin Farms Lease provides as follows (with all capitalized terms used in the following paragraph having the meaning assigned thereto in the Martin Farms Lease):
Lessee agrees to indemnify and hold Lessor harmless from any and all claims, damages, fines, judgments, penalties, costs, liabilities or losses (including, without limitation, any and all sums paid for settlement of claims, attorneys' fees, consultant and expert fees) arising during or after the term of this Lease from or in connection with the presence of hazardous substances and/or contaminants in or on the Premises as the result of Lessee's actions or inactions, or those of its agents, invitees, employees or assigns, unless the hazardous substances are present solely as a result of the negligence, willful misconduct or other wrongful acts of the Lessor's agents, employees, contractors or invitees. This indemnification shall specifically include any and all costs due to hazardous substances that flow, diffuse, migrate or percolate into, onto or under the Premises after the Lease terminates. As used herein, "hazardous substance" means any substance that is toxic, ignitable, reactive or corrosive, or is defined and/or
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regulated as "hazardous waste," "extremely hazardous waste," or "hazardous substance" pursuant to state, federal or local governmental law.
(The indemnity obligations set forth above in this SECTION 11.1(d) are hereinafter referred to collectively as the "MARTIN FARMS INDEMNITY OBLIGATIONS"). Without limiting any other provision of this ARTICLE XI, Purchaser agrees that, in the event that (i) the Martin Farms Lease is, in accordance with the intent of the Parties, included among the Transferred Contracts sold, assigned, conveyed, transferred and delivered by Seller to Purchaser pursuant to SECTION 2.1 of this Agreement, and (ii) at any time from and after the Closing Seller incurs any Claim by or Loss to Purchaser under ARTICLE XI of this Agreement for or in respect of any Losses that, in Seller's reasonable determination, fall within the scope of the Martin Farms Indemnity Obligations, Purchaser shall, promptly upon any request by Seller, assign, transfer and convey to Seller all right, title and interest of Purchaser for and with respect to any rights, claims and causes of action available under the Martin Farms Indemnity Obligations. In the event that Purchaser is not reasonably capable of effecting any such assignment, transfer and conveyance, or in the event that any such assignment, transfer or conveyance does not, in Seller's reasonable determination, provide Seller with a complete and effective remedy and right of action against the lessee under the Martin Farms Lease for or in respect of the Martin Farms Indemnity Obligations, Purchaser shall, upon any request by Seller and at Seller's sole cost and expense, actively and diligently pursue against the lessee under the Martin Farms Lease, for and on behalf of Seller, any and all Claims that are reasonably available to Purchaser under the Martin Farms Indemnity Obligations for or in respect of any such Losses. The legal counsel employed in any such action shall be selected by Seller in its sole discretion, and the fees and expenses of such counsel shall be paid exclusively by Seller. Purchaser shall cooperate fully with Seller and such counsel in the defense or compromise of such Claim, and in such event that Purchaser provides such cooperation no compromise or settlement of such Claims may be effected by Seller without Purchaser's consent unless there is not in connection therewith any finding or admission of any violation of Law or any violation of the rights of any Person by Purchaser. Purchaser covenants and agrees that it will not, without the prior consent of Seller, permit or agree to any amendment of the Martin Farms Lease that eliminates or in any way reduces the benefits and protections afforded by the Martin Farms Indemnity Obligations to the lessor under the Martin Farms Lease.
11.2 WAIVER OF REMEDIES.
(a) The Parties hereby agree to limit their recourse for all matters, and not make any Claim for any Loss or other matter, under, relating to or arising out of this Agreement or any other document, agreement, certificate or other matter delivered pursuant hereto, whether based on contract, tort, strict liability, other Laws or otherwise, except (i) for Claims for indemnification pursuant to this ARTICLE XI , (ii) as permitted in ARTICLE X, or
(iii) as permitted under SECTION 12.15 (Attorneys' Fees). From and after the Closing, the indemnification provisions of this ARTICLE XI shall be the sole and exclusive remedy of each Party (including the Seller Indemnified Parties and Purchaser Indemnified Parties) (i) for any breach of the other Party's representations, warranties or covenants contained in this Agreement or (ii) otherwise with respect to this Agreement or the transactions contemplated hereby.
(b) NOTWITHSTANDING ANYTHING TO THE CONTRARY CONTAINED IN THIS AGREEMENT, UNDER NO CIRCUMSTANCES SHALL ANY
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PARTY BE LIABLE UNDER OR IN CONNECTION WITH THIS AGREEMENT FOR SPECIAL, PUNITIVE, EXEMPLARY, INCIDENTAL, CONSEQUENTIAL OR INDIRECT DAMAGES, OR LOST PROFITS, WHETHER BASED ON CONTRACT, TORT, STRICT LIABILITY, OTHER LAW OR OTHERWISE AND WHETHER OR NOT ARISING FROM SUCH PARTY'S SOLE, JOINT OR CONCURRENT NEGLIGENCE, STRICT LIABILITY OR OTHER FAULT ("NON-REIMBURSABLE DAMAGES").
(c) Notwithstanding anything to the contrary contained in this Agreement, no Representative of Seller, Affiliate of Seller or Representative of any such Affiliate shall, except as provided in the Guaranty Agreement, have any personal liability to Purchaser or any other Person as a result of the breach of any representation, warranty, covenant or agreement of Seller contained herein and no Representative of Purchaser, Affiliate of Purchaser or Representative of any such Affiliate shall have any personal liability to Seller or any other Person as a result of the breach of any representation, warranty, covenant or agreement of Purchaser contained herein.
11.3 SURVIVAL AND TIME LIMITATION. The terms and provisions of this Agreement shall survive the Closing. Notwithstanding the foregoing, after the Closing, any assertion by Purchaser or any Purchaser Indemnified Party that Seller is liable to Purchaser or any Purchaser Indemnified Party for indemnification under the terms of this Agreement or otherwise in connection with the transactions contemplated in this Agreement must be made in writing and must be given to Seller (or not at all) on or prior to the date that is twenty-four (24) months after the Closing Date, except for (i) indemnification for breach of Seller's representations and covenants in SECTIONS 4.10, 4.13(a), 4.14, 4.21, 6.5, 6.15 and 7.1, which shall survive for the limitations period provided under applicable Law, and (ii) indemnification for matters addressed in
SECTION 11.1(a)(iii) or (iv), which must be made in writing and must be given to Seller (or not at all) on or prior to the date that is ninety (90) days after the date on which the applicable statute of limitations expires with respect to the matters covered thereby.
11.4 WAIVER OF OTHER REPRESENTATIONS; LIMITATIONS OF LIABILITY.
(a) NOTWITHSTANDING ANYTHING TO THE CONTRARY CONTAINED IN THIS AGREEMENT, IT IS THE EXPRESS INTENT OF EACH PARTY HERETO THAT NEITHER PARTY IS MAKING ANY REPRESENTATION OR WARRANTY WHATSOEVER, EXPRESS OR IMPLIED, EXCEPT FOR THOSE REPRESENTATIONS AND WARRANTIES CONTAINED IN ARTICLE IV AND ARTICLE V, RESPECTIVELY, AND THAT, EXCEPT FOR SUCH EXPRESS REPRESENTATIONS AND WARRANTIES, PURCHASER IS ACQUIRING THE PURCHASED ASSETS "AS IS" AND "WHERE IS." WITHOUT LIMITING THE GENERALITY OF THE FOREGOING, SELLER HEREBY EXPRESSLY DISCLAIMS ANY OTHER REPRESENTATION OR WARRANTY OF ANY KIND, INCLUDING ANY IMPLIED REPRESENTATION OR WARRANTY AS TO CONDITION, MERCHANTABILITY OR SUITABILITY FOR ANY PARTICULAR PURPOSE AS TO ANY OF THE PURCHASED ASSETS AND SELLER MAKES NO REPRESENTATION OR WARRANTY TO PURCHASER WITH RESPECT TO ANY FINANCIAL PROJECTION OR FORECAST RELATING TO THE PURCHASED ASSETS. WITH RESPECT TO ANY SUCH PROJECTION OR FORECAST DELIVERED BY OR ON BEHALF OF SELLER TO PURCHASER, PURCHASER ACKNOWLEDGES THAT (I) THERE ARE UNCERTAINTIES INHERENT IN ATTEMPTING TO MAKE SUCH
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PROJECTIONS AND FORECASTS, (II) IT IS FAMILIAR WITH SUCH UNCERTAINTIES, AND
(III) IT HAS MADE ITS OWN EVALUATION OF THE ADEQUACY AND ACCURACY OF ALL SUCH PROJECTIONS AND FORECASTS FURNISHED TO IT.
(b) Notwithstanding anything to the contrary contained in this Agreement, (i) Seller shall have no liability for its indemnification obligations under SECTION 11.1(a)(i) or SECTION 11.1(a)(ii) until the aggregate amount of all Losses incurred by the Purchaser Indemnified Parties equals or exceeds $1,000,000 (the "THRESHOLD AMOUNT"), in which event Seller shall be liable for all such Losses from dollar one; it being understood and agreed that the foregoing Threshold Amount shall not apply to (A) claims for indemnification relating to Excluded Liabilities, and (B) claims for indemnifications relating to SECTIONS 3.2, 4.10, 4.13(a), 4.14, 4.21, 6.5, 6.15 and 7.1, in each case for which Seller shall be responsible from dollar one, whether or not the Threshold Amount has been reached and (ii) Purchaser shall have no liability for its indemnification obligations under SECTION 11.1(b)(i) or SECTION 11.1(b)(ii) until the aggregate amount of all Losses incurred by the Seller Indemnified Parties equals or exceeds the Threshold Amount, in which event Purchaser shall be liable for all such Losses from dollar one; it being understood and agreed that the foregoing Threshold Amount shall not apply to (A) claims for indemnification relating to Assumed Liabilities, and (B) claims for indemnification relating to SECTIONS 3.2, 6.5 and 7.1, in each case for which Purchaser shall be responsible from dollar one, whether or not the Threshold Amount has been reached; and
(c) In no event shall (i) Seller's aggregate liability arising out of its indemnification obligations under SECTION 11.1(a)(i) and SECTION 11.1(a)(ii) exceed 50% of the Purchase Price; it being understood and agreed that the foregoing limitation shall not apply to claims for indemnification relating to Excluded Liabilities and any indemnifiable Losses related to such Excluded Liabilities shall not be deemed to count against or otherwise reduce such limitation on Seller's aggregate liability and (ii) Purchaser's aggregate liability arising out of its indemnification obligations under SECTION 11.1(b)(i) and SECTION 11.1(b)(ii) exceed 50% of the Purchase Price; it being understood and agreed that the foregoing limitation shall not apply to claims for indemnification relating to Assumed Liabilities and any indemnifiable Losses related to such Assumed Liabilities shall not be deemed to count against or otherwise reduce such limitation on Purchaser's aggregate liability.
11.5 PROCEDURE FOR INDEMNIFICATION - THIRD-PARTY CLAIMS.
(a) If any Party shall claim indemnification hereunder arising from any Claim of a third party, the Party seeking indemnification (the "INDEMNIFIED PARTY") shall notify in writing the Party from which indemnification is sought (the "INDEMNIFYING PARTY") of the basis for such Claim, setting forth the nature of the Claim in reasonable detail. The failure of the Indemnified Party to so notify the Indemnifying Party shall not relieve the Indemnifying Party of any indemnification obligation hereunder except to the extent that the defense of such Claim is materially prejudiced by the failure to give such notice.
(b) If any proceeding is brought by a third party against an Indemnified Party and the Indemnified Party gives notice to the Indemnifying Party pursuant to SECTION 11.5(a), the Indemnifying Party shall be entitled to participate in such proceeding and, to the extent that it wishes, to assume the defense of such proceeding, if (i) the Indemnifying Party provides written
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notice to the Indemnified Party that the Indemnifying Party intends to undertake such defense, (ii) the Indemnifying Party conducts the defense of the third-party Claim actively and diligently with counsel reasonably satisfactory to the Indemnified Party and (iii) if the Indemnifying Party is a party to the proceeding, the Indemnifying Party has not determined in good faith that joint representation would be inappropriate because of a conflict in interest. The Indemnified Party shall, in its sole discretion, have the right to employ separate counsel (who may be selected by the Indemnified Party in its sole discretion) in any such action and to participate in the defense thereof, and the fees and expenses of such counsel shall be paid by such Indemnified Party. The Indemnified Party shall fully cooperate with the Indemnifying Party and its counsel in the defense or compromise of such Claim. If the Indemnifying Party assumes the defense of a proceeding, no compromise or settlement of such Claims may be effected by the Indemnifying Party without the Indemnified Party's consent unless (A) there is no finding or admission of any violation of Law or any violation of the rights of any Person and no effect on any other Claims that may be made against the Indemnified Party and (B) the sole relief provided is monetary damages that are paid in full by the Indemnifying Party.
(c) If (i) the Indemnified Party gives notice to the Indemnifying Party of the commencement of any third-party legal proceeding and the Indemnifying Party does not, within ten (10) days after the Indemnified Party's notice is given, give notice to the Indemnified Party of the Indemnifying Party's election to assume the defense of such legal proceeding,
(ii) any of the conditions set forth in clauses (i) through (iii) of SECTION 11.5(b) above become unsatisfied or (iii) an Indemnified Party determines in good faith that there is a reasonable probability that a legal proceeding may adversely affect it other than as a result of monetary damages for which it would be entitled to indemnification from the Indemnifying Party under this Agreement, the Indemnified Party shall (upon notice to the Indemnifying Party) have the right to undertake the defense, compromise or settlement of such claim; provided that the Indemnifying Party shall reimburse the Indemnified Party for the Indemnified Party's costs of defending against the third-party claim (including reasonable attorneys' fees and expenses) and the Indemnifying Party shall remain responsible for any indemnifiable amounts arising from or related to such third-party claim to the fullest extent provided in this ARTICLE XI. The Indemnifying Party may elect to participate in such legal proceedings, negotiations or defense at any time at its own expense.
11.6 ARBITRATION.
(a) Any and all disputes between the Parties arising out of or relating to this Agreement (a "DISPUTE") must be resolved through the use of binding arbitration using three (3) arbitrators, selected in accordance with the Commercial Arbitration Rules of the American Arbitration Association ("AAA") as then in effect, as supplemented to the extent necessary to determine any procedural appeal questions by the Federal Arbitration Act (Title 9 of the United States Code), and shall be administered by AAA. If there is any inconsistency between this SECTION 11.6 and the Commercial Arbitration Rules or the Federal Arbitration Act, the terms of this SECTION 11.6 will control the rights and obligations of the Parties. If there is more than one (1) Arbitrable Dispute that involves the same facts and parties as the facts and parties with respect to which an arbitration has been initiated pursuant to this Agreement, such disputes shall be consolidated into the first arbitration initiated pursuant to this Agreement. No other arbitration shall be consolidated with any arbitration initiated pursuant to this Agreement without
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the agreement of the Parties or parties thereto. The Party initiating any Dispute must promptly notify AAA in writing of any such action.
(b) Arbitration must be initiated within the applicable time limits set forth in this Agreement and not thereafter or if no time limit is given, within the time period allowed by the applicable statute of limitations. Arbitration may be initiated by either Seller or Purchaser ("CLAIMANT") serving written notice on Purchaser or Seller, respectively ("RESPONDENT") that Claimant elects to refer the Dispute to binding arbitration (the "ARBITRABLE DISPUTE").
(c) Claimant's notice initiating binding arbitration must describe in reasonable detail the nature of the Arbitrable Dispute and the facts and circumstances relating thereto and identify the arbitrator Claimant has appointed. Respondent shall respond to Claimant within sixty (60) days after receipt of Claimant's notice, identifying the arbitrator Respondent has appointed. If Respondent fails for any reason to name an arbitrator within such sixty (60) day period, Claimant may upon notice to the AAA and the Respondent, request that the AAA office in Phoenix, Arizona select the Respondent's arbitrator, with the AAA giving due regard to the selection criteria set forth below and input from the Respondent in making such selection. The two (2) arbitrators so chosen shall select a third arbitrator within thirty (30) days after the second arbitrator has been appointed. If the two (2) arbitrators are unable to agree on a third arbitrator within such thirty (30) day selection period, then either Party may, upon notice to the AAA and the other Party, request that the AAA office in Phoenix, Arizona select the third arbitrator, with the AAA giving due regard to the selection criteria set forth below and input from the Parties and other arbitrators in making such selection.
(d) The AAA shall select the third arbitrator not later than thirty (30) days from the notice of request sent to the AAA in accordance with
SECTION 11.6(c) above. In the event the AAA should fail to select the third arbitrator within such thirty (30) day period, then either Party may petition the Chief United States District Judge for the State of Arizona to select the third arbitrator. The Party making such petition shall provide a copy thereof to the other Party. The Chief Judge shall give due regard to the selection criteria set forth below and input from the Parties and other arbitrators in making such selection.
(e) Subject to the arbitrators' award of costs to the prevailing party, Claimant shall pay the compensation and expenses of the arbitrator named by or for it, Respondent shall pay the compensation and expenses of the arbitrator named by or for it, and Claimant and Respondent shall each pay one-half (-1/2) of the compensation and expenses of the third arbitrator. All arbitrators must be neutral parties who have never been officers, directors or employees of the Parties or any of their Affiliates. Each of the three (3) arbitrators must have not less than seven (7) years experience as an attorney or accountant handling complex business transactions and have formal training in dispute resolution.
(f) The hearing will be conducted in Phoenix, Arizona, and commence within sixty (60) days after the selection of the third arbitrator. The Parties and the arbitrators should proceed diligently and in good faith in order that the award may be made as promptly as possible. The arbitrators shall determine the Arbitrable Disputes of the Parties and render a final award in accordance with the choice of Law set forth in this Agreement. The arbitrators shall render their decision within sixty (60) days following completion of the hearing. The arbitrators'
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decision shall be in writing and set forth the reasons for the award and shall include an award of costs to the prevailing Party (or an allocation of such costs between the Parties based upon the extent to which each prevails), including reasonable attorneys' fees and disbursements and the fees and expenses of the arbitrators. All statutes of limitations and defenses based upon passage of time applicable to any Arbitrable Dispute (including any counterclaim or setoff) shall be interrupted by the filing of the arbitration and suspended while the arbitration is pending. The terms of this SECTION 11.6 shall not create nor limit any obligations of a Party hereunder to defend, indemnify or hold harmless the other Party against Claims or Losses. In order to prevent irreparable harm, the arbitrators shall have the power to grant temporary or permanent injunctive or other equitable relief. A Party may, notwithstanding any other provision of this Agreement, seek temporary injunctive relief or other interim, provisional or interlocutory relief or any order in aid of arbitration from any court of competent jurisdiction; provided, that the Party seeking such relief shall (if arbitration has not already been commenced) simultaneously commence arbitration. Such court-ordered relief shall not continue more than ten (10) days after the appointment of the third arbitrator and in no event for longer than sixty (60) days. Except as provided in the Federal Arbitration Act, the decision of the arbitrators will be binding on and non-appealable by the Parties. Each Party agrees that any arbitration award against it may be enforced in any court of competent jurisdiction and that any Party may authorize any such court to enter judgment on the arbitrators' decisions. The arbitrators may not grant or award Non-reimbursable Damages.
ARTICLE XII
MISCELLANEOUS
12.1 NOTICES.
(a) Unless this Agreement specifically requires otherwise, any notice, demand or request provided for in this Agreement, or served, given or made in connection with it, shall be in writing and shall be deemed properly served, given or made if delivered in person or sent by facsimile equipment providing confirmation of successful transmission or sent by registered or certified mail, postage prepaid, or by a nationally recognized overnight courier service that provides a receipt of delivery, in each case, to the applicable Party at the applicable address or number specified below:
If to Purchaser, to:
Arizona Public Service Company
P.O. Box 53999
Phoenix, Arizona 85072
Facsimile No.: (602) 250-3002
Attn: Corporate Secretary
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With a copy to:
Snell & Wilmer L.L.P.
One Arizona Center
Phoenix, Arizona 85004
Facsimile No.: (602) 382-6070
Attn: Matthew P. Feeney
If to Seller to:
PPL Sundance Energy, LLC
303 North Broadway, Suite 400
Billings, Montana 59101
Facsimile No.: (406) 237-6930
Attn: David B. Kinnard
With a copy to:
PPL Services Corporation
Two North Ninth Street
Allentown, Pennsylvania 18101
Facsimile No.: (610) 774-6726
Attn: Eric W. Hurlocker
(b) Notice given by personal delivery, mail or overnight courier pursuant to this SECTION 12.1 shall be effective upon physical receipt. Notice given by facsimile pursuant to this SECTION 12.1 shall be effective as of the date of confirmed delivery if delivered before 5:00 p.m. Phoenix time on any Business Day or on the next succeeding Business Day if confirmed delivery is after 5:00 p.m. Phoenix time on any Business Day or during any non-Business Day.
12.2 ENTIRE AGREEMENT. This Agreement and the Ancillary Agreements supersede all prior discussions, agreements and understandings between the Parties with respect to the subject matter hereof and thereof and contain the sole and entire agreement between the Parties with respect to the subject matter hereof and thereof. As of the execution of this Agreement by the Parties, the Confidentiality Agreement between Purchaser and PPL EnergyPlus dated as of February 10, 2004 shall be deemed fully replaced, merged in and superseded by this Agreement and the Ancillary Agreements as of the Agreement Date for all periods after the Agreement Date; provided, however, such Confidentiality Agreement shall remain in full force and effect with respect to any event or circumstance that is within the subject matter of such agreement and that occurred prior to the Agreement Date.
12.3 EXPENSES. Except as otherwise expressly provided in this Agreement, whether or not the transactions contemplated hereby are consummated, each Party will be responsible for, and will pay, its own costs and expenses incurred in anticipation of, relating to and in connection with the negotiation and execution of this Agreement and the transactions contemplated hereby.
12.4 PUBLIC ANNOUNCEMENTS. Except as may be required by Law or any applicable stock exchange rules, neither Party will issue or make any press releases or other public
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disclosures concerning this Agreement or the transactions contemplated hereby without first obtaining consent from the other Party, which consent shall not be unreasonably withheld, conditioned or delayed.
12.5 CONFIDENTIAL INFORMATION.
(a) For a period of two (2) years from and after the Closing, Seller shall cause any data or information received at any time by Seller or its Affiliates or its or their Representatives from Purchaser, any data or information regarding Purchaser or its businesses, operations, financial conditions or prospects, and any data or information regarding the Purchase Price and other key financial terms of the transactions contemplated hereby and the discussions among the Parties relating thereto (any of the foregoing, "PURCHASER INFORMATION"), to be maintained by Seller, its Affiliates and their respective Representatives in confidence, not to be utilized for any purpose (except, pending Closing, to prepare therefor) and not to be disclosed for any purpose. Without limiting the generality of the foregoing, Seller and Purchaser acknowledge that, during the Interim Period, Purchaser may conduct one or more solicitations or requests for proposals from third parties and that the foregoing restrictions concerning the Purchase Price and other financial terms are necessary in order to protect Purchaser's interest in the integrity of its acquisition activities.
(b) From the Agreement Date until the Closing (or, if this Agreement is earlier terminated, then until two (2) years after the date of such termination, and in any event, in the case of any Seller Information not contained in the Purchased Assets, from the Agreement Date until a period two
(2) years from and after the Closing), Purchaser shall cause any such data or information received at any time by Purchaser, its Affiliates or their respective Representatives from Seller, its Affiliates or their respective Representatives and any such data or information regarding Seller or its businesses, operations, financial conditions or prospects, and any data or information regarding the Purchase Price and other key financial terms of the transactions contemplated hereby and the discussions among the Parties relating thereto (any of the foregoing, "SELLER INFORMATION"), to be maintained by Purchaser, its Affiliates and their respective Representatives in confidence, not to be utilized for any purposes (except pending Closing, to prepare therefor) and not to be disclosed for any purpose.
(c) Purchaser and Seller acknowledge that the approvals of the Governmental Authorities that are required by this Agreement will likely necessitate the provision of Confidential Information to third parties in proceedings to obtain such approvals. Where a filing is made with any Governmental Authority for approval of this Agreement, the Party responsible for the filing shall request that the Governmental Authority approve a reasonable confidentiality agreement or protective order that will provide appropriate protections for any Confidential Information of the other Party.
(d) Other than as provided in SECTION 12.5(c) and with respect to the obligations under SECTIONS 12.5(a) and 12.5(b), in the event that the Party receiving Confidential Information (the "RECEIVING PARTY") is requested by any Governmental Authority to disclose any Confidential Information of the other Party (the "DISCLOSING PARTY"), the Receiving Party shall give the Disclosing Party prompt written notice of such requirement and shall not disclose any such Confidential Information without reasonable assurances from such Governmental Authority
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that such Confidential Information will be afforded reasonable confidentiality protections by such Governmental Authority. In the event that the Receiving Party becomes legally compelled (by deposition, interrogatory, request for documents, subpoena, civil investigative demand or similar process) to disclose any Confidential Information (or, in the case of any such disclosure to the ACC, the Receiving Party is required or requested to make such disclosure as a condition to the approval by the ACC contemplated by SECTION 8.7(b)), the Receiving Party shall give the Disclosing Party prompt written notice of such requirement so that the Disclosing Party may attempt to seek a protective order or other assurance that confidential treatment will be accorded to any such portion of such Confidential Information as may be required to be disclosed (and the Receiving Party shall cooperate reasonably with any such efforts by the Disclosing Party) or waive compliance with the terms of this SECTION 12.5. In the event that such protective order or other remedy is not timely obtained, the Receiving Party agrees to give the Disclosing Party written notice of the Confidential Information to be disclosed as far in advance of such disclosure as is reasonably practicable, and shall furnish only that portion of the Confidential Information for which the Disclosing Party has waived compliance with the relevant provisions of this SECTION 12.5, or which is in the opinion of the Receiving Party's legal counsel required to be disclosed in order to avoid a contempt order or other civil or criminal sanction or penalty.
(e) Notwithstanding the foregoing, the confidentiality obligations set forth in this SECTION 12.5 shall not apply to any disclosure of information:
(i) which at the time of disclosure is already in the public domain through no fault of the applicable Parties, their Affiliates or their respective Representatives;
(ii) which after disclosure becomes part of the public domain through no act or fault of the applicable Parties or their Affiliates or their respective Representatives;
(iii) if such information subsequently becomes known to the applicable Parties or their Affiliates through no breach of their obligations hereunder;
(iv) which is independently developed by the applicable Parties or their Affiliates through no breach of their obligations hereunder; or
(v) required by Law or stock exchange rules; provided that the applicable Parties shall use, and shall cause their applicable Affiliates, if any, to use, commercially reasonable efforts to give the other Parties prior notice of such disclosure in sufficient time to enable such other Parties to protect any such information.
12.6 DISCLOSURE. Seller may, at its option, include in the Schedules items that are not material in order to avoid any misunderstanding, and any such inclusion, or any references to dollar amounts, shall not be deemed to be an acknowledgment or representation that such items are material, to establish any standard of materiality or to define further the meaning of such terms for purposes of this Agreement.
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12.7 WAIVER; REMEDIES CUMULATIVE. Any term or condition of this Agreement may be waived at any time by the Party that is entitled to the benefit thereof, but no such waiver shall be effective unless set forth in a written instrument duly executed by or on behalf of the Party waiving such term or condition. No waiver by any Party of any term or condition of this Agreement, in any one or more instances, shall be deemed to be or construed as a waiver of the same or any other term or condition of this Agreement on any future occasion. The failure of any Party to assert any of its rights under this Agreement shall not constitute a waiver of such rights. All remedies, either under this Agreement or by Law or otherwise afforded, will be cumulative and not alternative.
12.8 AMENDMENT. This Agreement may be amended, supplemented or modified only by a written instrument duly executed by or on behalf of each Party, which written instrument indicates that such writing is intended to amend the terms of this Agreement.
12.9 NO THIRD PARTY BENEFICIARY. The terms and provisions of this Agreement are intended solely for the benefit of the Parties and their respective successors or permitted assigns, and it is not the intention of the Parties to confer third-party beneficiary or similar rights upon any other Person.
12.10 ASSIGNMENT; BINDING EFFECT. Purchaser may assign its rights and obligations hereunder to an Affiliate; provided, however, that no such assignment shall release Purchaser from its obligations hereunder. Except as provided in the preceding sentence, neither this Agreement nor any right, interest or obligation hereunder may be assigned by either Party without the prior written consent of the other Party, and any attempt to do so will be null and void. Subject to this SECTION 12.10, this Agreement is binding upon, inures to the benefit of and is enforceable by the Parties and their respective successors and permitted assigns.
12.11 HEADINGS. The headings used in this Agreement have been inserted for convenience of reference only and do not define or limit the provisions hereof.
12.12 INVALID PROVISIONS. If any provision of this Agreement is held to be illegal, invalid or unenforceable under any present or future Law, and if the rights or obligations of any Party under this Agreement will not be materially and adversely affected thereby, such provision will be fully severable, this Agreement will be construed and enforced as if such illegal, invalid or unenforceable provision had never comprised a part hereof, the remaining provisions of this Agreement will remain in full force and effect and will not be affected by the illegal, invalid or unenforceable provision or by its severance herefrom and in lieu of such illegal, invalid or unenforceable provision, there will be added automatically as a part of this Agreement a legal, valid and enforceable provision as similar in terms to such illegal, invalid or unenforceable provision as may be possible.
12.13 COUNTERPARTS; FACSIMILE. This Agreement may be executed in any number of counterparts, each of which will be deemed an original, but all of which together shall constitute one and the same instrument. Any facsimile copies hereof or signature hereon shall, for all purposes, be deemed originals.
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12.14 GOVERNING LAW; VENUE; AND JURISDICTION.
(a) This Agreement shall be governed by and construed in accordance with the Laws of the State of Arizona, without giving effect to any conflict or choice of law provision that would result in the imposition of another state's Law.
(b) WITH RESPECT TO THE ENFORCEMENT OF ANY ARBITRATION AWARD PURSUANT TO SECTION 11.6, THE PARTIES HEREBY IRREVOCABLY SUBMIT TO THE NON-EXCLUSIVE JURISDICTION OF ANY STATE OR FEDERAL COURT IN PHOENIX, ARIZONA.
(c) WITH RESPECT TO THE ENFORCEMENT OF ANY ARBITRATION AWARD PURSUANT TO SECTION 11.6, EACH PARTY HEREBY WAIVES, TO THE FULLEST EXTENT PERMITTED BY LAW, ANY AND ALL RIGHT TO TRIAL BY JURY IN ANY LEGAL PROCEEDING ARISING OUT OF OR RELATING TO THIS AGREEMENT OR ANY OF THE TRANSACTIONS CONTEMPLATED HEREBY.
12.15 ATTORNEYS' FEES. If either of the Parties shall bring an action to enforce the provisions of this Agreement, the prevailing Party shall be entitled to recover its reasonable attorneys' fees and expenses incurred in such action from the non-prevailing Party.
[SIGNATURE PAGE FOLLOWS]
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IN WITNESS WHEREOF, this Agreement has been duly executed and delivered by the duly authorized officer of each Party as of the date first above written.
SELLER:
PPL SUNDANCE ENERGY, LLC

By: /s/ James H. Miller
   ----------------------------------------
Name: James H. Miller
   ----------------------------------------
Title: President
   ----------------------------------------	

PURCHASER:
ARIZONA PUBLIC SERVICE COMPANY

By: /s/ Jack E. Davis
   ----------------------------------------
Name: Jack E. Davis
   ----------------------------------------
Title: CEO and President
   ----------------------------------------	

SIGNATURE PAGE
PURCHASE AGREEMENT

APPENDIX I
DEFINITIONS
"AAA" has the meaning given to it in SECTION 11.6(a).
"ACC" means the Arizona Corporation Commission or any successor agency with jurisdiction over the rates and charges of Purchaser.
"ACC ORDER" has the meaning given to it in SECTION 8.7(b).
"ACCUMULATED PROVISION FOR DEPRECIATION AND AMORTIZATION" means the net accumulated credit balance arising from provisions for depreciation or amortization of assets. The net balance reflects current and prior credits less charges.
"ACQUISITION TRANSACTION" has the meaning given to it in SECTION 6.9.
"ACSM" means the American Congress on Surveying and Mapping, or its successor.
"ACTUAL PRORATED AMOUNTS" has the meaning given to it in SECTION 3.2(c)(ii).
"AFFIDAVIT OF PROPERTY VALUE" means the form of Affidavit of Property Value attached hereto as Exhibit B.
"AFFILIATE" means any Person that directly, or indirectly through one or more intermediaries, controls, is controlled by or is under common control with the Person specified. For purposes of this definition, control of a Person means the power, directly or indirectly, to direct or cause the direction of the management and policies of such Person whether through ownership of voting securities or ownership interests, by contract or otherwise, and specifically with respect to a corporation, partnership or limited liability company, means direct or indirect ownership of more than 50% of the voting securities in such corporation or of the voting interests in a partnership or limited liability company.
"AGREEMENT" has the meaning given to it in the recitals.
"AGREEMENT DATE" has the meaning given to it in the introduction to this Agreement.
"ALTA" means the American Land Title Association, or its successor.
"ANCILLARY AGREEMENTS" means the Assumption Agreement, the Affidavit of Property Value, the Deed, the Bill of Sale and Assignment of Rights, the Form of Certification of Non-Foreign Status, the Guaranty Agreement and such other documents, instruments, certificates or agreements as may be executed and delivered in connection with this Agreement or the foregoing.
"ARBITRABLE DISPUTE" has the meaning given to it in SECTION 11.6(b).
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"ASSETS" of any Person means all assets and properties of every kind, nature, character and description (whether real, personal or mixed, whether tangible or intangible and wherever situated), including the goodwill related thereto, operated, owned or leased by such Person.
"ASSUMED LIABILITIES" has the meaning given to it in SECTION 2.3.
"ASSUMPTION AGREEMENT" has the meaning given to it in SECTION 3.5(c).
"AVAILABLE EMPLOYEES" has the meaning given to it in SECTION 6.5(a).
"BENEFIT PLANS" means (a) each "employee benefit plan," as such term is defined in Section 3(3) of ERISA, (b) each plan that would be an "employee benefit plan", as such term is defined in Section 3(3) of ERISA, if it was subject to ERISA, such as foreign plans and plans for directors, (c) each stock bonus, stock ownership, stock option, stock purchase stock appreciation rights, phantom stock, or other stock plan (whether qualified or nonqualified), and (d) each bonus or incentive compensation plan.
"BILL OF SALE AND ASSIGNMENT OF RIGHTS" means the form of Bill of Sale and Assignment of Rights from Seller to Purchaser attached hereto as Exhibit D.
"BOOKS AND RECORDS" means all books, operating records, operating, safety and maintenance manuals, engineering design plans, blueprints and as-built plans, specifications, procedures and similar items relating specifically to the Purchased Assets.
"BUSINESS" means the ownership and operation of the Project, including the generation and sale of electricity and capacity at or from the Project and the conduct of other activities related or incidental to the foregoing.
"BUSINESS DAY" means a day other than Saturday, Sunday or any day on which banks located in the State of Arizona are authorized or obligated to close.
"CERTIFICATE OF ENVIRONMENTAL COMPATIBILITY" means the Decision of the Arizona Power Plant and Transmission Line Siting Committee and Certificate of Environmental Compatibility issued on April 11, 2001, and revised nunc pro tunc on June 25, 2001, by the Arizona Power Plant and Transmission Line Siting Committee in Case No. 107, Docket No. L-00000W-00-0107 (Decision No. 63863), as affirmed and approved on July 9, 2001 by the Arizona Corporation Commission, with respect to the Project.
"CHARTER DOCUMENTS" means with respect to any Person, the articles of incorporation or organization and by-laws, the limited partnership agreement, the partnership agreement or the limited liability company agreement, or such other organizational documents of such Person, including those that are required to be registered or kept in the place of incorporation, organization or formation of such Person and which establish the existence of such Person as a legal entity.
"CLAIM" means any demand, claim, action, investigation, legal proceeding (whether at law or in equity) or arbitration.
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"CLAIMANT" has the meaning set forth in SECTION 11.6(b).
"CLOSING" means the closing of the transactions contemplated by this Agreement, as provided for in SECTION 3.3.
"CLOSING DATE" means the date on which Closing occurs.
"CODE" means the Internal Revenue Code of 1986, as amended.
"CONFIDENTIAL INFORMATION" means Seller Information or Purchaser Information, individually or collectively as the context may require.
"CONTINUED EMPLOYEE" has the meaning set forth in SECTION 6.5(b).
"CONTRACT" means any written contract, lease, license, evidence of indebtedness, mortgage, indenture, purchase order, binding bid, letter of credit, security agreement or other legally binding arrangement.
"CREDIT RATING" means (i) with respect to any entity other than a financial institution, the current (A) rating issued or maintained by S&P or Moody's with respect to such entity's senior, unsecured debt securities or (B) corporate credit rating or long-term issuer rating issued or maintained with respect to such entity by S&P or Moody's, or (ii) if such entity is a financial institution, the ratings issued or maintained by S&P or Moody's with respect to such entity's long-term, unsecured, unsubordinated deposits.
"DEED" means the form of Special Warranty Deed from Seller to Purchaser attached hereto as Exhibit C.
"DISCLOSING PARTY" has the meaning given to it in SECTION 12.5(d).
"DISPUTE" has the meaning given to it in SECTION 11.6(a).
"DWR" has the meaning given to it in SECTION 4.13(s)(iv).
"ENVIRONMENTAL CLAIM" means any Claim arising out of or related to any violation of Environmental Law, or in respect of any Environmental Conditions or Hazardous Materials.
"ENVIRONMENTAL CONDITION" means the presence or Release to the environment, whether at the Real Property or otherwise, of Hazardous Materials, including any migration of Hazardous Materials through air, soil or groundwater at, to or from the Real Property or at, to or from any Off-Site Location, regardless of when such presence or Release occurred or is discovered.
"ENVIRONMENTAL LAW" means any Law relating to (i) facility siting, land use and environmental matters, (ii) the control of any pollutant, or protection of the air, water, or land, (iii) solid, gaseous or liquid waste generation, handling, treatment, storage, disposal or transportation, (iv) exposure to hazardous, toxic or other harmful substances, and (v) the protection and enhancement of the environment. Environmental Laws shall include the Comprehensive Environmental Response, Compensation and Liability Act, 42 U.S.C.
Section 9601 et
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seq.; the Resource Conservation and Recovery Act, 42 U.S.C. Section 6901 et seq.; the Federal Water Pollution Control Act, 33 U.S.C. Section 1251 et seq.; the Clean Air Act, 42 U.S.C. Section 7401 et seq.; the Hazardous Materials Transportation Act, 49 U.S.C. Section 1471 et seq.; the Toxic Substances Control Act, 15 U.S.C. Sections 2601 through 2629; the Oil Pollution Act, 33 U.S.C. Section 2701 et seq.; the Emergency Planning and Community Right-to-Know Act, 42 U.S.C. Section 11001 et seq.; the Safe Drinking Water Act, 42 U.S.C. Sections 300f through 300j; Endangered Species Act, 16 U.S.C. Sections 1531 et seq.; Federal Insecticide, Fungicide and Rodenticide Act, 7 U.S.C. Sections 136 et seq.; Occupational Safety and Health Act; National Environmental Policy Act; Comprehensive Air Quality Act, A.R.S. Sections 49-401 et seq.; Arizona Emergency Planning and Community Right-to-Know Act, A.R.S. Sections 26-341 et seq.; Water Quality Control, A.R.S. Sections 49-201 to 391; Solid Waste Management, A.R.S. Sections 49-701 to 881; Hazardous Waste Disposal, A.R.S. Sections 49-901 to 971; Underground Storage Tank Act, A.R.S. Sections 49-1001 to 1073; Groundwater Management Act, A.R.S. Sections 45-401 to 704 and all similar Laws of any Governmental Authority having jurisdiction over the assets in question addressing pollution or protection of the environment and all amendments to such Laws and all regulations implementing any of the foregoing.
"ENVIRONMENTAL LIABILITIES" means all Liabilities with respect to the Purchased Assets or the Business arising under or relating to Environmental Laws or relating to any Environmental Claim, including settlements, judgments, costs and expenses, including reasonable attorneys fees, whether based on common law or Environmental Laws.
"ERISA" means the Employee Retirement Income Security Act of 1974, as amended.
"ERISA AFFILIATE" means any entity, trade or business that is a member of a group described in Section 414(b), (c), (m) or (o) of the Code or Section 4001(b)(1) of ERISA that includes Seller, or that is a member of the same "controlled group" as Seller pursuant to Section 4001(a)(14) of ERISA; provided, that Seller shall not be considered to be an ERISA Affiliate from and after the Closing Date.
"ESTIMATED PRORATED AMOUNTS" has the meaning given to it in SECTION 3.2(c)(ii).
"EXCLUDED ASSETS" has the meaning given to it in SECTION 2.2.
"EXCLUDED CONTRACTS" has the meaning given to it in SECTION 2.2(f).
"EXCLUDED ENVIRONMENTAL LIABILITIES" has the meaning given to it in
SECTION 2.4(i).
"EXCLUDED ITEMS" has the meaning given to it in SECTION 2.2(h).
"EXCLUDED LIABILITIES" has the meaning given to it in SECTION 2.4.
"EXCLUDED TORT LIABILITIES" has the meaning given to it in SECTION 2.4(j).
"EXISTING SURVEY" has the meaning given to it in SECTION 4.13(b).
"EXISTING TITLE POLICIES" means (a) Title Insurance Policy No. O-993-2374088, dated September 21, 2001, by Stewart Title and Trust of Phoenix, Inc. insuring PPL Sundance Energy,
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LLC, and (b) Title Insurance Policy No. 0-9993-2407891, dated November 19, 2001, by Stewart Title and Trust of Phoenix, Inc. insuring PPL Sundance Energy, LLC.
"FERC" means the Federal Energy Regulatory Commission, or its successor.
"FINAL ORDER" means an action by a Governmental Authority as to which: (a) no request for stay of the action is pending, no such stay is in effect and if any time period is permitted by applicable Law for filing any request for such stay, such time period has expired; (b) no petition for rehearing, reconsideration or application for review of the action is pending and the time for filing any such petition or application has expired; (c) such Governmental Authority does not have the action under reconsideration or subject to rehearing on its own motion or otherwise and the time in which such reconsideration or rehearing is permitted has expired; and (d) no appeal to a court, or a request for stay by a court of the Governmental Authority's action is pending or in effect and the deadline for filing any such appeal or request has expired. For purposes of determining the consent and approval of Governmental Authorities under the HSR Act, a "Final Order" shall include the signing of any stipulation between the Governmental Authority and the Parties allowing consummation of the transactions contemplated hereby and by the Ancillary Documents.
"FIRPTA AFFIDAVIT" means an affidavit, signed by and acknowledged on behalf of Seller under penalties of perjury, certifying that Seller is not a nonresident alien, foreign corporation, foreign partnership, foreign trust, foreign estate, or other foreign person within the meaning of Section 1445 and 7701 of the Internal Revenue Code of 1986, as amended, and the associated Treasury Regulations.
"GAAP" means generally accepted accounting principles in the United States of America applied on a consistent basis.
"GOOD OPERATING PRACTICES" means, with respect to the Project or the Purchased Assets, the practices, methods and acts generally engaged in or approved by a significant portion of the independent electric power industry in the WECC for similarly situated facilities in the WECC during a particular time period, or any of such practices, methods, and acts, which, in the exercise of reasonable judgment in light of the facts known or that reasonably should be known at the time a decision is made, would be expected to accomplish the desired result in a manner consistent with applicable Law, reliability, safety, environmental protection, economy and expedition, and taking into consideration the requirements of this Agreement, the Material Contracts and the other Contracts affecting the operation of the Project. Good Operating Practices are not intended to be limited to the optimum practices, methods or acts, to the exclusion of all others, but rather to include a spectrum of possible practices, methods or acts generally acceptable in the region during the relevant period in light of the circumstances.
"GOVERNMENTAL AUTHORITY" means any court, tribunal, authority, agency, commission, official or other instrumentality of the United States, or any domestic state, province, county, city or other political subdivision or similar governing entity, and including any governmental, quasi-governmental or non-governmental body administering, regulating or having general oversight over gas, electricity, power or other markets.
I-5

"GUARANTY AGREEMENT" has the meaning given to it in SECTION 3.4(j).
"HAZARDOUS MATERIAL" means any chemicals, materials, substances, or items in any form, whether solid, liquid, gaseous, semisolid, or any combination thereof, whether waste materials, raw materials, chemicals, finished products, by-products, or any other materials or articles, which are listed or regulated as hazardous, toxic or dangerous or as waste or a contaminant, or are otherwise listed or regulated, or for which liability or standards of care are imposed, under any Environmental Law, including petroleum products, asbestos, PCBs, coal combustion by-products, urea formaldehyde foam insulation, lead-containing paints or coatings, and any substances included in the definition of "hazardous debris," "hazardous substances," "hazardous materials," "hazardous wastes," "toxic substances," "pollutants," "contaminants" or words of similar import, under any Environmental Law.
"HSR ACT" means the Hart-Scott-Rodino Antitrust Improvements Act of 1976 and the rules and regulations thereunder.
"IMPROVEMENTS" means all buildings, structures, fixtures and improvements located on the Real Property or included in the Purchased Assets, including those under construction as of the Closing Date.
"INDEMNIFIED PARTY" has the meaning given to it in SECTION 11.5(a).
"INDEMNIFYING PARTY" has the meaning given to it in SECTION 11.5(a).
"INDEPENDENT ACCOUNTANTS" means a nationally recognized firm of independent certified public accountants that is mutually acceptable to Seller and Purchaser.
"INSURED EXCEPTION" has the meaning given to it in SECTION 6.11(c).
"INTELLECTUAL PROPERTY" means the following intellectual property rights, both statutory and common law rights, if applicable: (a) copyrights, and registrations and applications for registration thereof, (b) trademarks, trademark rights, service marks, service mark rights, trade names, trade name rights, slogans, domain names, logos and trade dress, and registrations and applications for registrations thereof, (c) patents, as well as any reissued and reexamined patents and extensions corresponding to the patents, and any patent rights and patent applications, as well as any related continuation, continuation in part and divisional applications and patents issuing therefrom and (d) trade secrets and confidential information, including ideas, designs, concepts, inventions, compilations of information, methods, techniques, procedures, processes and other know-how, whether or not patentable.
"INTERIM PERIOD" has the meaning given to it in SECTION 6.1.
"INVENTORY ADJUSTMENT NOTICE" has the meaning given to it in SECTION 3.7(c).
"INVESTMENT GRADE ENTITY" means an entity having a Credit Rating of BBB- or above from S&P and Baa3 or above from Moody's.
I-6

"KNOWLEDGE" when used in a particular representation or otherwise herein
(a) with respect to Seller, means Seller's Knowledge, and (b) with respect to Purchaser, means Purchaser's Knowledge.
"LAWS" means all laws, statutes, rules, regulations, ordinances, judgments, orders, decrees and other pronouncements having the effect of law of any Governmental Authority.
"LIABILITY" with respect to any Person, any liability, indebtedness or obligation of such Person of any kind, character or description, whether known or unknown, absolute or contingent, accrued or unaccrued, disputed or undisputed, liquidated or unliquidated, secured or unsecured, joint or several, due or to become due, vested or unvested, executory, determined, determinable or otherwise, and whether or not the same is required to be accrued on the financial statements of such Person.
"LIEN" means any mortgage; deed of trust; pledge; security interest; adverse possessory right; mechanic's, materialmen's or other lien; covenant, condition or restriction; charge or assessment; lease; easement; license; purchase option; right of first refusal; or any other matter affecting title of any nature whatsoever.
"LOSS" means any and all judgments, losses, Liabilities, amounts paid in settlement, damages, fines, penalties, deficiencies, losses and expenses (including interest, court costs, reasonable fees and expenses of attorneys, accountants and other experts or other reasonable expenses of litigation or other proceedings or of any claim, default or assessment). For all purposes in this Agreement the term "LOSSES" does not include any Non-reimbursable Damages.
"MARTIN FARMS INDEMNITY OBLIGATIONS" has the meaning given to it in
SECTION 11.1(d).
"MARTIN FARMS LEASE" has the meaning given to it in SECTION 4.13(s)(iv).
"MATERIAL CONTRACT" or "MATERIAL CONTRACTS" has the meaning given to it in
SECTION 4.12(a).
"MINIMUM INVENTORY AMOUNT" means one million fifty thousand dollars ($1,050,000).
"MOODY'S" means Moody's Investor Services, Inc., or any successor thereto.
"NON-REIMBURSABLE DAMAGES" has the meaning given to it in SECTION 11.2(b).
"OFF-SITE LOCATION" means any real property other than the Real Property.
"ORIGINAL COST" means the cost of utility property at the time such property was brought into service.
"PARTICIPATION AGREEMENT" has the meaning given to it in SECTION 6.15.
"PARTY" means each of Purchaser and Seller, individually; and "PARTIES" means Purchaser and Seller, collectively.
I-7

"PERMITS" means all licenses, permits, certificates of authority, authorizations, approvals, franchises, exemptions, variances, consents, orders, judgments or decrees granted by, or any notices to, declarations of, or filings or registrations with, any Governmental Authority under any provision of any applicable Laws.
"PERMITTED LIEN" means (a) any Lien for Taxes not yet due or delinquent;
(b) imperfections or irregularities of title and other Liens that would not, individually or in the aggregate, reasonably be expected to have a Seller Material Adverse Effect; (c) zoning, planning, entitlement, conservation restriction and other similar governmental limitations and restrictions; (d) any Lien to be released on or prior to Closing; (e) any statutory Lien (other than mechanics' or materialmen's Liens) arising in the ordinary course of business by operation of Law with respect to a Liability that is not yet due or delinquent; and (f) each item set forth on Schedule 2.1; provided, however, that Permitted Liens shall include (i) any Lien for Taxes and (ii) any statutory Lien, to the extent not otherwise included in clauses (a) and (e) above, but only if such are being contested in good faith by appropriate proceedings for which adequate reserves have been established in accordance with GAAP.
"PERSON" means any natural person, corporation, general partnership, limited partnership, limited liability company, proprietorship, other business organization, trust, union, joint venture, association, whether or not a legal entity, and any Governmental Authority.
"PLANT ACQUISITION ADJUSTMENT" means the difference between the cost to the utility of plant acquired as an operating unit or system by purchase, merger, consolidation, liquidation or otherwise, and the Original Cost of such plant less the amount(s) credited at the time of acquisition to Accumulated Provision for Depreciation and Amortization.
"POST-CLOSING INVENTORY AMOUNT DETERMINATION" has the meaning given to it 
in SECTION 3.7(c).
"PPL ENERGY SUPPLY" means PPL Energy Supply, LLC, a Delaware limited liability company and Affiliate of Seller.
"PPL ENERGYPLUS" means PPL EnergyPlus, LLC, a Pennsylvania limited liability company and Affiliate of Seller.
"PPL MONTANA" means PPL Montana, LLC, a Delaware limited liability company and Affiliate of Seller.
"PRE-CLOSING ENVIRONMENTAL LIABILITIES/TORT LIABILITIES" has the meaning
given to it in SECTION 11.1(c).
"PRE-CLOSING TRANSACTIONS" has the meaning given to it in SECTION 6.14(b).
"PREPAYMENTS" means all advance payments, including but not limited to any advance payments made in connection with the Master Power Purchase and Sale Agreement Confirmation Letter, for a term beginning June 1, 2003, by and between Tucson Electric Power and PPL EnergyPlus, LLC, as amended by Amendment dated May 6, 2003, prepaid expenses, progress payments and deposits of Seller, rights to receive prepaid expenses, deposits or progress
I-8

payments relating to the ownership, operation and maintenance of the Purchased Assets, but not including any prepaid expenses or deposits attributable to Excluded Assets.
"PROJECT" means the 450 MW generating plant located on a site owned by Seller in Pinal County, Arizona, together with all auxiliary equipment, ancillary and associated facilities and equipment, electrical transformers, pipeline and electrical interconnection and metering facilities (whether owned or leased) that are located at such site, together with all other improvements that are located at such site.
"PROJECT EMPLOYEE" has the meaning given to it in SECTION 4.21(a).
"PROPERTY TAX RETURN" means any returns, declarations, reports, bills, claims for refund, information returns or other documents (including any related or supporting schedules, statements or information) filed or required to be filed in connection with the determination, assessment or collection of any Property Taxes or in connection with the administration of any statutes, laws, rules, regulations, orders or awards of any Governmental Authorities relating to any Property Taxes.
"PROPERTY TAXES" means any tax, imposition or assessment resulting from and relating to the assessment of real or personal property by any Governmental Authority.
"PRORATED DIFFERENCE" has the meaning given to it in SECTION 3.2(c)(ii).
"PURCHASE PRICE" has the meaning given to it in SECTION 3.1.
"PURCHASE PRICE ALLOCATION SCHEDULE" has the meaning given to it in
SECTION 3.6.
"PURCHASED ASSETS" means, subject to the Permitted Liens, all of the right, title and interest in, to and under the real and personal property, tangible or intangible, constituting the Project or used principally for generation purposes in connection with the Project including the following assets owned by Seller: (i) the Real Property described on Schedule 4.13(a) as associated with the Project, together with all easements, rights of way and privileges (including water rights) relating to the Project; (ii) all inventories of fuels, supplies, materials and spares located on or in transit to the Real Property on the Closing Date or otherwise held for use principally in connection with the Project on the Closing Date; (iii) the machinery, equipment, vehicles, furniture and other personal property located on the Real Property or held for use principally in connection with the Project on the Closing Date, including the items of personal property included in Schedule 4.14 as being associated with the Project, and all Warranty Rights; (iv) the Transferred Contracts; (v) the Transferred Permits; (vi) the Transferred Intellectual Property; (vii) all Books and Records; (viii) all financial records relating primarily to the Purchased Assets, and plant in service, construction work in process, fuel inventory, spares and materials and supplies in inventory records;
(ix) any emission reduction credits paid for or obtained for the Purchased Assets; (x) Prepayments; and (xi) all rights, privileges, claims, causes of action and options against any third parties (including indemnification, contribution and insurance claims) relating to any Purchased Assets or Assumed Liabilities.
"PURCHASER" has the meaning given to it in the introduction to this Agreement.
I-9

"PURCHASER APPROVALS" has the meaning given to it in SECTION 5.3(c).
"PURCHASER INDEMNIFIED PARTIES" has the meaning given to it in SECTION 11.1(a).
"PURCHASER INFORMATION" has the meaning given to it in SECTION 12.5(a).
"PURCHASER MATERIAL ADVERSE EFFECT" means a material adverse effect on (i) the ability of Purchaser to perform its obligations under this Agreement, (ii) the validity or enforceability of this Agreement or any of the Ancillary Agreements, or (iii) the rights or remedies of Seller hereunder or thereunder.
"PURCHASER'S APPLICABLE CONTRACTS" has the meaning given to it in SECTION 9.8(c).
"PURCHASER'S KNOWLEDGE" has the meaning given to it in SECTION 5.4.
"PURCHASER'S NOTICE" has the meaning given to it in SECTION 6.11(b).
"REAL PROPERTY" means the real property of which any of the Project is a part or on which the Project is located, together with all rights, privileges, easements and rights-of-way appurtenant thereto and Improvements thereon, as described in Schedule 4.13(a).
"REAL PROPERTY LEASES" has the meaning given to it in SECTION 4.13(c).
"RECEIVING PARTY" has the meaning given to it in SECTION 12.5(d).
"RECORDS" has the meaning given to it in SECTION 6.14(a).
"RELEASE" means any actual or threatened release, spill, emission, migration, leaking, pumping, injection, deposit, disposal or discharge of any Hazardous Materials into the environment, to the extent prohibited under applicable Environmental Laws.
"REPRESENTATIVES" means, with respect to any Person, such Person's officers, directors, employees, counsel, accountants, financial advisers, consultants and other advisers.
"REQUEST DATE" has the meaning given to it in SECTION 3.2(c)(ii).
"RESPONDENT" has the meaning given to it in SECTION 11.6(b).
"S&P" means the Standard & Poor's Rating Group, a division of The McGraw-Hill Companies, Inc., or any successor thereto.
"SCHEDULES" means the disclosure schedules prepared by Seller and attached to this Agreement.
"SELLER" has the meaning given to it in the introduction to this Agreement.
"SELLER APPROVALS" has the meaning given to it in SECTION 4.3(c).
"SELLER CONSENTS" has the meaning given to it in SECTION 4.3(b).
I-10

"SELLER INDEMNIFIED PARTIES" has the meaning given to it in SECTION 11.1(b).
"SELLER INFORMATION" has the meaning given to it in SECTION 12.5(b).
"SELLER MATERIAL ADVERSE EFFECT" means an effect caused by any event, circumstance, condition, development, or occurrence, individually or in the aggregate, that is or is reasonably likely to be materially adverse to the Business, Purchased Assets or operations, performance or condition (financial or otherwise) of Seller or the Project, taken as a whole; provided that the following shall not be considered when determining whether a Seller Material Adverse Effect has occurred: any effect resulting from (i) any change resulting from changes in the international, national, regional or local wholesale or retail markets for electricity; (ii) any change resulting from changes in the international, national, regional or local markets for any fuel used at the Project; (iii) any change resulting from changes in the North American, national, regional or local electricity or gas transmission systems; (iv) any change in the financial condition or results of operations of Seller caused by the pending sale of the Purchased Assets to Purchaser; or (v) any actions to be taken pursuant to or in accordance with this Agreement, excluding any actions taken by Seller pursuant to the "emergency situations" provision in the last paragraph of SECTION 6.3.
"SELLER PLANS" has the meaning given to it in SECTION 6.5(c).
"SELLER'S KNOWLEDGE" has the meaning given to it in SECTION 4.4.
"SURVEY" has the meaning given to it in SECTION 6.11(a)(ii)(b).
"SYNTHETIC LEASE TRANSACTION" has the meaning given to it in SECTION 6.15.
"TAX" or "TAXES" means any federal, state, local or foreign income, gross receipts, ad valorem, sales, transaction privilege or use, employment, social security, disability, occupation, rent, property, severance, value added, transfer, capital stock, excise or other taxes, charges, fees, levies or other assessments imposed by or on behalf of any Taxing Authority, including any interest or penalty thereon, or any addition thereto.
"TAX RETURN" means any returns, declarations, reports, bills, claims for refund, information returns (including where permitted or required, any consolidated, combined or unitary returns) or other documents (including any related or supporting schedules, statements or information) filed or required to be filed in connection with the determination, assessment or collection of any Taxes or in connection with the administration of any statutes, laws, rules, regulations, orders or awards of any Governmental Authorities relating to any Taxes.
"TAXING AUTHORITY" means, with respect to any Tax, the Governmental Authority that imposes such Tax, and the Governmental Authority (if any) charged with the collection of such Tax for the Governmental Authority that imposes such Tax.
"TERMINATION DATE" has the meaning given to it in SECTION 10.1(g).
"THRESHOLD AMOUNT" has the meaning given to it in SECTION 11.4(b).
I-11

"TITLE COMMITMENT" has the meaning given to it in SECTION 6.11(a)(i)(A).
"TITLE EXCEPTION DOCUMENTS" has the meaning given to it in SECTION 6.11(a)(i)(B).
"TITLE INSURER" has the meaning given to it in SECTION 6.11(a)(i).
"TITLE OBJECTION" has the meaning given to it in SECTION 6.11(b).
"TORT LIABILITIES" means all Liabilities (other than Environmental Liabilities) to third parties for personal injury or tort, or similar causes of action arising out of the Business or the ownership, lease, maintenance or operation of the Purchased Assets.
"TRANSFER TAXES" means all transfer, sales, transaction privilege, use, goods and services, value added, documentary, stamp duty, gross receipts, excise, transfer and conveyance Taxes and other similar Taxes, duties, fees or charges.
"TRANSFERRED CONTRACTS" means all Contracts to which Seller (or any Affiliate of Seller) is a party and relating to the Business or by which the Purchased Assets may be bound (including the Material Contracts but excluding the Excluded Contracts), subject to receipt of necessary consents and approvals.
"TRANSFERRED INTELLECTUAL PROPERTY" means the Intellectual Property identified on Schedule 4.18 as "Transferred Intellectual Property," subject to receipt of necessary consents and approvals, and any plant drawings, equipment performance data, design criteria or maintenance records collected by the Seller's data collection or other information technology systems or software and relating to the Project, whether or not identified on Schedule 4.18 as "Transferred Intellectual Property."
"TRANSFERRED PERMITS" means the Permits identified on Schedule 4.15 as "Transferred Permits," subject to receipt of necessary consents and approvals.
"WARRANTY RIGHTS" means warranties against manufacturers or vendors relating to the Purchased Assets, to the extent that such warranties relate specifically to the Project, are unexpired as of the Closing and are transferable, including those warranties set forth on Schedule 4.12(e).
"WATER RIGHTS" has the meaning given to it in SECTION 4.13(s)(i).
"WATER RIGHTS CERTIFICATE" has the meaning given to it in SECTION 4.13(s)(iv).
"WECC" means the Western Electricity Coordinating Council, or its successor.
"WELFARE BENEFITS" has the meaning given to it in SECTION 6.5(e).
"WELLS" has the meaning given to it in SECTION 4.13(s)(ii).
I-12

Exhibit 10.2
PERFORMANCE ACCELERATED STOCK OPTION AGREEMENT
UNDER
PINNACLE WEST CAPITAL CORPORATION 2002
LONG-TERM INCENTIVE PLAN
      THIS AWARD AGREEMENT is made and entered into as of                       (the “Date of Grant”), by and between Pinnacle West Capital Corporation (the “Company”), and «Name» (“Employee”).
BACKGROUND

A.	 	The Board of Directors of the Company (the “Board of Directors”) has adopted, and the Company’s shareholders have approved, the Pinnacle West Capital Corporation 2002 Long-Term Incentive Plan (the “Plan”), pursuant to which options to purchase             shares of the common stock of the Company may be granted to employees of the Company and its subsidiaries and to certain other individuals.	
 	
B.	 	The Company desires to grant to Employee the option to purchase certain shares of its stock under the terms of the Plan.	
 	
C.	 	Pursuant to the Plan, the Company and Employee agree as follows:	
AGREEMENT

1.	 	Grant of Option. Pursuant to action of the Committee, which was taken on the Date of Grant, the Company grants to Employee the option (the “Option”) to purchase all or any part of «Shares» shares of the Company’s Common Stock. This Option is not intended as, nor will it be treated as, an incentive stock option under Section 422 of the Code.	
 	
2.	 	Grant Subject to Plan. This Option is granted under and is expressly subject to, all the terms and provisions of the Plan, which terms are incorporated herein by reference, and this Award Agreement. The Committee referred to in Section 4 of the Plan (“Committee”) has been appointed by the Board of Directors, and designated by it, as the Committee to make grants of options.	
 	
3.	 	Purchase Price. The price at which Employee will be entitled to purchase the Common Stock covered by the Option will be $           per share.	
 	
4.	 	Vesting of Option . The Option will vest and become exercisable as follows:	

(a)	 	On or after the first anniversary of the Date of Grant, or                      , Employee may purchase up to one-third (1/3) of the total number of shares of Common Stock subject to this Option.	
 	
(b)	 	On or after the second anniversary of the Date of Grant, or                      , Employee may purchase up to an additional one-third (1/3) of the total number of shares of Common Stock subject to this Option; provided, however, that if the Company has achieved the “First Year Target” (as defined in Section 5(a) below), Employee may purchase the shares of Common Stock described in this Section 4(b) on or after the date which is eighteen months after the Date of Grant, or                      .	
 	
(c)	 	On or after the third anniversary of the Date of Grant, or                      , Employee may purchase up to an additional one-third (1/3) of the total number of shares of Common Stock subject to this Option; provided, however, that:	

 

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Performance Accelerated Stock Option

(i)	 	If the Company has achieved the First Year Target or the “Second Year Target” (as defined in Section 5(b) below), Employee may purchase the shares of Common Stock described in this Section 4(c) on or after the date which is thirty months after the Date of Grant, or                      ; and	
 	
(ii)	 	If the Company has achieved the First Year Target and the Second Year Target, Employee may purchase the shares of Common Stock described in this Section 4(c) on or after the second anniversary of the Date of Grant, or                      .	

(d)	 	Notwithstanding the foregoing, upon a Change of Control (as herein after defined) Employee may purchase 100% of the number of shares subject to this Option.	
 	
(e)	 	If any Option vesting date is not a business day on which the New York Stock Exchange (“NYSE”) is open, such vesting date will be deemed to be the next succeeding business day on which the NYSE is open. In no event will this Option be re-priced, or deemed to be re-priced, as a result of any acceleration of vesting periods, as described in this Section 4.	
 	
(f)	 	Attachment A provides generic examples of the operation of a performance accelerated stock option.	

5.	 	Targets .	

(a)	 	First Year Target. For purposes of this Award Agreement, the Company will have achieved the “First Year Target” if its “Earnings Per Share Growth” (as defined in Section 5(c)) equals or exceeds the Earnings Per Share Growth of the S&P Electric Utilities Index for the fiscal year which includes the Date of Grant, or 200   .	
 	
(b)	 	Second Year Target. For purposes of this Award Agreement, the Company will have achieved the “Second Year Target” if its Earnings Per Share Growth equals or exceeds the Earnings Per Share Growth of the S&P Electric Utilities Index for the fiscal year immediately following the fiscal year which includes the Date of Grant, or 200   .	
 	
(c)	 	Earnings Per Share Growth.	

(i)	 	“Earnings Per Share Growth” for a given fiscal year is the percentage increase, if any, of the Company’s earnings per share from continuing operations, on a fully-diluted basis, as of the end of the relevant fiscal year, over the earnings per share from continuing operations, on a fully-diluted basis, as of the end of the immediately preceding fiscal year. For purposes of calculating “Earnings Per Share Growth,” SunCor Development Company’s earnings from discontinued operations will be considered earnings from continuing operations for each fiscal year.	
 	
(ii)	 	The “Earnings Per Share Growth of the S&P Electric Utilities Index” for a given Fiscal Year is the percentage increase, if any, of the S&P Electric Utilities Index earnings per share, as of the end of the relevant fiscal year, over the earnings per share as of the end of the immediately preceding fiscal year. The Earnings Per Share Growth of the S&P Electric Utilities Index will be determined using the S&P Compustat system. The S&P Electric Utilities Index earnings per share is a weighted average number provided in the S&P Compustat system. If the S&P Compustat system is no longer in use, the Committee will replace it with the most comparable third party data system then in use. If the S&P Electric Utilities Index is discontinued, the S&P comparable replacement index for the sector will be used for computing Earnings Per Share Growth of the S&P Electric Utilities Index. If S&P no longer computes an index for the electric utility sector, the Committee shall	

 

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Performance Accelerated Stock Option
select the most comparable index then in use for the sector comparison. In addition, if the sector comparison is no longer representative of the Company’s industry or business, the Committee shall replace the index with the most representative index then in use.

(iii)	 	All results will be verified by the Company’s independent auditors using generally accepted accounting principles, consistently applied.	

6.	 	Term of Option. This Option will be in full force and effect for a period of ten (10) years from the Date of Grant, through and including the close of business of the Company on                      ; however, this Option will terminate earlier upon the occurrence of the events described in this Section 6, with no continuation of vesting.	

(a)	 	Termination-General. Any vested Option will terminate and be of no further force and effect ninety (90) days after the date that Employee is no longer actively employed by the Company or any of its subsidiaries (the “Termination Date”) unless:	

(i)	 	The Termination Date results from Employee’s Retirement, in which case this Option will terminate at the time described in Section 6(b) below;	
 	
(ii)	 	The Termination Date results from Employee’s Disability, in which case this Option will terminate at the time described in Section 6(c) below; or	
 	
(iii)	 	The Termination Date results from Employee’s death, in which case this Option will terminate at the time described in Section 6(d) below.	

(b)	 	Retirement of Employee. If the Termination Date results from Employee’s “Retirement” (as hereinafter defined), any vested Option will terminate fifteen (15) months after the Termination Date. Any options that have not vested will expire upon Retirement. If Employee’s Retirement occurs on or after Employee’s 60th birthday, this Option will also become fully vested, to the extent not already fully vested.	
 	
(c)	 	Disability of Employee. If the Termination Date results from Employee’s “Disability” (as hereinafter defined), any vested Option will terminate fifteen (15) months after the Termination Date. If the Termination Date results from Employee’s Disability, and Employee dies within one (1) year of the Termination Date, this Option may be exercised, to the extent that Employee was entitled to exercise it at the date of Employee’s death, by a legatee or legatees of Employee under Employee’s last will, or by Employee’s personal representatives or distributees (or by a transferee under Section 9), at any time within a period of fifteen (15) months after Employee’s date of death.	
 	
(d)	 	Death of Employee. If the Termination Date results from Employee’s death, any vested Option may be exercised, to the extent that Employee was entitled to exercise it at the date of Employee’s death, by a legatee or legatees of Employee under Employee’s last will, or by Employee’s personal representatives or distributees (or by a transferee under Section 9), at any time within a period of fifteen (15) months after the Termination Date. If Employee dies within ninety (90) days of Employee’s Termination Date, this Option may be exercised, to the extent that Employee was entitled to exercise it at the date of Employee’s death, by a legatee or legatees of Employee under Employee’s last will, or by Employee’s personal representatives or distributees (or by a transferee under Section 9), at any time within a period of fifteen (15) months after Employee’s date of death.	

 

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Performance Accelerated Stock Option

(e)	 	Notwithstanding the foregoing, (i) except as otherwise provided in Section 6(b) above, this Option will cease vesting as of the Termination Date and (ii) in no event may this Option be exercised after the tenth (10th) anniversary of the Date of Grant.	

7.	 	Option Exercise.	

(a)	 	Notice to Company of Option Exercise. Employee may exercise this Option, in whole or in part, by providing written notice to the Company, accompanied by payment of the Option purchase price, as set forth below.	
 	
(b)	 	Payment of Option Purchase Price. The price at which shares of Common Stock may be purchased under this Option will be paid in full in cash at the time of exercise or, if permitted by the Committee, by means of tendering Common Stock or surrendering another Award (as defined in the Plan), or any combination thereof, on such terms and conditions as the Committee deems appropriate. In addition, Employee may effect a “cashless exercise” of this Option in which all or a portion of the shares subject to this Option are sold through a broker and a portion of the proceeds to cover the exercise price is paid to the Company.	

8.	 	Tax Withholding . Employee must pay, or make arrangements acceptable to the Company for the payment of, any and all federal, state, and local tax withholding that in the opinion of the Company is required by law. Unless Employee satisfies any such tax withholding obligation by paying the amount in cash or by check, the Company will withhold shares of Common Stock having a Fair Market Value on the date of withholding equal to the tax withholding obligation.	
 	
9.	 	Non-Transferability. Neither this Option nor any rights under this Award Agreement may be assigned, transferred or in any manner encumbered except by will or the laws of descent and distribution, and any attempted assignment, transfer, mortgage, pledge or encumbrance, except as herein authorized, will be void and of no effect. This Option may be exercised during Employee’s lifetime only by Employee. Notwithstanding the foregoing, this Option may be transferred by gift or otherwise to a member of Employee’s immediate family and/or trusts whose beneficiaries are members of Employee’s immediate family, or to such other persons or entities as may be approved by the Committee.	
 	
10.	 	Definitions: Copy of Plan and Plan Prospectus.	
 	
 	 	For the purposes of this Award Agreement, the following terms shall have the following meanings:	

(a)	 	“Change of Control” shall mean a Change of Control as defined in the KEESA.	
 	
(b)	 	“Disability” shall mean a period of disability during which Employee qualifies for benefits under Employee’s employer’s long-term disability plan, or, if Employee does not participate in such a plan, a period of disability during which Employee would have qualified for benefits under such a plan, as determined by the Committee, had Employee been a participant in such a plan. The Committee may require such medical or other evidence, as it deems necessary to judge the nature of Employee’s condition.	
 	
(c)	 	“KEESA” means the Key Executive Employment and Severance Agreement, as the same may be amended from time to time.	

 

Page 5
Performance Accelerated Stock Option

(d)	 	“Retirement” means a termination of employment under which Employee is immediately eligible to receive payments under the Company’s qualified pension plan.	
 	
 	 	To the extent not specifically defined in this Award Agreement, all capitalized terms used in this Award Agreement will have the same meanings ascribed to them in the Plan. By signing this Award Agreement, Employee acknowledges receipt of a copy of the Plan and the related Plan Prospectus.	

11.	 	Choice of Law. This Award Agreement will be governed by the laws of the State of Arizona, excluding any conflicts or choice of law rule or principle that might otherwise refer construction or interpretation of this Agreement to another jurisdiction.	
An authorized representative of the Company has signed this Award Agreement, and Employee has signed this Award Agreement to evidence Employee’s acceptance of the Option on the terms specified in this Award Agreement, all as of the Date of Grant.

	 	PINNACLE WEST CAPITAL CORPORATION	
 	 	 	
	 	By:                                        	
 	 	 	
	 	Its: Vice President and Treasurer	

	 	Employee	

 

Page 6
Performance Accelerated Stock Option
Attachment A
Generic Example
(Performance Accelerated Stock Option)
Assumption:
On February 17, 2004, Employee is granted an Option to purchase 750 shares of Common Stock. Unless accelerated, the option will vest in 1/3 increments over 3 separate 12-month periods:

•	 	250 shares will vest on February 17, 2005;	
 	
•	 	250 shares will vest on February 17, 2006; and	
 	
•	 	250 shares will vest on February 17, 2007.	
Scenario #1:

•	 	The Company’s Earnings Per Share Growth for fiscal year 2004 is greater than the Earnings Per Share Growth of the S&P Electric Utilities Index for fiscal year 2004. (The First Year Target is met.)	
 	 	 	
•	 	The Company’s Earnings Per Share Growth for fiscal year 2005 is greater than the Earnings Per Share Growth of the S&P Electric Utilities Index for fiscal year 2005. (The Second Year Target is met.)	
     Vesting of Options under Scenario # 1:

•	 	1/3 of the Option (250 shares) vests on February 17, 2005.	
 	
•	 	Based on the achievement of the First Year Target, the remaining Options vest on August 17, 2005 and August 17, 2006 (the achievement of the First Year Target accelerates the standard vesting period by 6 months).	
 	
•	 	Based on the achievement of the Second Year Target, the remaining Options vest on February 17, 2006 (the achievement of the Second Year Target accelerates the vesting period by another 6 months).	
Scenario #2:

•	 	The Company’s Earnings Per Share Growth for fiscal year 2004 is greater than the Earnings Per Share Growth of the S&P Electric Utilities Index for fiscal year 2004. (The First Year Target is met.)	
 	
•	 	The Company’s Earnings Per Share Growth for Fiscal Year 2005 is less than the Earnings Per Share Growth of the S&P Electric Utilities Index for fiscal year 2005. (The Second Year Target is not met.)	
     Vesting of Options Under Scenario #2:

•	 	1/3 of the Option (250 shares) vests on February 17, 2005.	
 	
•	 	Based on the achievement of the First Year Target, the remaining Options vest on August 17, 2005 and August 17, 2006 (the achievement of the First Year Target accelerates the standard vesting period by 6 months.)	
 	
•	 	Based on the failure to achieve the Second Year Target, the remaining Options vest on August 17, 2006 (the failure to achieve the Second Year Target results in the remaining standard vesting period for the final 250 shares.)	

 

Page 7
Performance Accelerated Stock Option
Scenario #3:

•	 	The Company’s Earnings Per Share Growth for fiscal year 2004 is less than the Earnings Per Share Growth of the S&P Electric Utilities Index for fiscal year 2004. (The First Year Target is not met.)	
 	
•	 	The Company’s Earnings Per Share Growth for fiscal year 2005 is greater than the Earnings Per Share Growth of the S&P Electric Utilities Index for fiscal year 2005. (The Second Year Target is met.)	
Vesting of Options Under Scenario #3:

•	 	1/3 of the Option (250 shares) vests on February 17, 2005.	
 	
•	 	Based on the failure to achieve the First Year Target, the remaining Options vests on February 17, 2006 and February 17, 2007 (the failure to achieve the First Year Target results in a standard vesting period).	
 	
•	 	Based on the achievement of the Second Year Target, the remaining Options (the final 250 shares) vest on August 17, 2006 (the achievement of the Second Year Target accelerates the standard vesting period and February 17, 2007 vesting date by 6 months).	

 

Exhibit 10.3
PERFORMANCE SHARE AGREEMENT
UNDER THE
PINNACLE WEST CAPITAL CORPORATION 2002
LONG-TERM INCENTIVE PLAN
      THIS AWARD AGREEMENT is made and entered into as of                      (the “Date of Grant”), by and between Pinnacle West Capital Corporation (the “Company”), and «Name» (“Employee”).
BACKGROUND

 	A.	 	The Board of Directors of the Company (the “Board of Directors”) has adopted, and the Company’s shareholders have approved, the Pinnacle West Capital Corporation 2002 Long-Term Incentive Plan (the “Plan”), pursuant to which performance share incentive awards may be granted to employees of the Company and its subsidiaries and certain other individuals.	
 	
 	B.	 	The Company desires to grant to Employee a performance share award under the terms of the Plan.	
 	
 	C.	 	Pursuant to the Plan, the Company and Employee agree as follows:	
AGREEMENT

 	1.	 	Grant of Award. The Company grants to Employee «Shares» performance shares (“Performance Shares”), subject to the terms, conditions, and adjustments set forth in this Award Agreement. The Performance Shares granted under this Section 1 are referred to in this Award Agreement as the “Base Grant.”	
 	
 	2.	 	Award Subject to Plan. This award is granted under and is expressly subject to, all the terms and provisions of the Plan, which terms are incorporated herein by reference, and this Award Agreement. The Committee referred to in Section 4 of the Plan (“Committee”) has been appointed by the Board of Directors, and designated by it, as the Committee to make awards.	
 	
 	3.	 	Performance Period . The performance period for this award is the three (3) year period beginning                              , and ending                                 (the “Performance Period”).	
 	
 	4.	 	Payment.	

 	(a)	 	Performance Shares Payable In Common Stock. Subject to early termination of this Award Agreement pursuant to Section 7 below, as soon as practicable following the end of the Performance Period and the determination of the Company’s Earnings Per Share Growth Rate as compared to the Earnings Per Share Growth Rate of the S&P Electric Utilities Index over such Performance Period, the Company will deliver to Employee one (1) share of the Company’s Common Stock for each then-outstanding Performance Share under this Award Agreement.	
 	
 	(b)	 	Dividend Equivalents. At the time of the Company’s delivery of Common Stock to Employee pursuant to Section 4(a) above, the Company will also deliver to Employee a cash payment equal to the amount of dividends that Employee would have received if Employee had directly owned all of such Common Stock during the Performance Period, plus interest on such amount at the rate of         percent, compounded quarterly.	

 

Page 2
Performance Share Agreement

 	(c)	 	Maximum Award. Employee may not receive more than 120,000 shares of Common Stock under this Award Agreement.	

 	5.	 	Performance Criteria and Adjustments.	
 	
 	 	 	Adjustment of Base Grant. The number of Performance Shares in the Base Grant will increase or decrease based upon the Company’s “Earnings Per Share Growth Rate” (as defined in Section 6 below) as compared to the Earnings Per Share Growth Rate of the S&P Electric Utilities Index during the Performance Period, as follows:	
 	 	 	
If the Company’s Earnings Per Share	 	 	
Compound Growth Rate Over The Performance	 	 	
Period As Compared to S&P Electric Utilities	 	The Number of	
Index is:
	 	Performance Shares will be:
	
90 th Percentile or Greater	 	2 X Base Grant	
75 th Percentile to 89.9 th Percentile	 	1.5 X Base Grant	
50 th Percentile to 74.9 th Percentile	 	Base Grant	
25 th Percentile to 49.9 th Percentile	 	0.5 X Base Grant	
Less than 25 th Percentile	 	None	
     If intermediate percentiles are achieved, the number of Performance Shares will be prorated (partial shares will be rounded down to the nearest whole share when applicable) . For example, if the Company’s Earnings Per Share Growth Rate during the Performance Period places the Company’s performance in the 80th percentile, then the number of Performance Shares would be increased to 1.667 multiplied by the Base Grant. In no event will Employee be entitled to receive a number of Performance Shares greater than two times the Base Grant, even if the Company’s Earnings Per Share Growth Rate during the Performance Period places the Company’s performance higher than the 90th percentile. Attachment A provides a generic example of the operation of a performance share incentive award.

 	6.	 	Earnings Per Share Growth Rate. “ Earnings Per Share Growth Rate” for the Performance Period is the compounded annual-growth rate (CAGR) of a company’s earnings per share from continuing operations, on a fully diluted basis, during the Performance Period; provided, however, that for calculating the Company’s Earnings Per Share Growth Rate, SunCor Development Company’s earnings from discontinued operations will be considered earnings from continuing operations for each fiscal year during the performance period. Only those companies which were in the S&P Electric Utility Index at both the beginning and the ending of the Performance Period will be considered. The Earnings Per Share Growth Rate of the companies in the S&P Electric Utilities Index will be determined using the S&P Compustat system. If the S&P Compustat system is no longer in use, the Committee shall replace it with the most comparable third party data system then in use. If the S&P Electric Utilities Index is discontinued, the S&P comparable replacement index for the sector will be used for computing Earnings Per Share Growth Rate . If S&P no longer computes an index for the electric utility sector, the Committee shall select the most comparable index then in use for the sector comparison. In addition, if the sector comparison is no longer representative of the Company’s industry or business, the Committee shall replace the index with the most representative index then in use. Once the CAGR of the Company and all relevant companies in the S&P Electric Utility Index have been determined, the member companies will be ranked from greatest to least CAGR. Percentiles will be calculated based on a company’s relative ranking. For example, company 1 out of 26 companies is given a percentile of 96.2% (1.0 – 1/26). Percentiles will be carried out to one (1) decimal place. If the Company is not in the S&P Electric Utility Index, then its percentile will be interpolated between the companies listed in the relative ranking. These calculations will be verified by the Company’s independent auditors.	
 	
 	7.	 	Termination of Award. This Award Agreement will terminate and be of no further force or effect on the date that Employee is no longer actively employed by the Company or any of	

 

Page 3
Performance Share Agreement

 	 	 	its subsidiaries, whether due to voluntary or involuntary termination, death, retirement, disability, or otherwise. Employee will, however, be entitled to receive any Common Stock and dividend equivalents payable under Section 4 of this Award Agreement if Employee’s employment terminates after the Performance Period but before Employee’s receipt of such Common Stock and dividend equivalents.	
 	
 	8.	 	Tax Withholding. Employee must pay, or make arrangements acceptable to the Company for the payment of any and all federal, state, and local tax withholding that in the opinion of the Company is required by law. Unless Employee satisfies any such tax withholding obligation by paying the amount in cash or by check, the Company will withhold shares of Common Stock having a Fair Market Value on the date of withholding equal to the tax withholding obligation.	
 	
 	9.	 	Non-Transferability. Neither this award nor any rights under this Award Agreement may be assigned, transferred, or in any manner encumbered except by will or the laws of descent and distribution, and any attempted assignment, transfer, mortgage, pledge or encumbrance except as herein authorized, will be void and of no effect.	
 	
 	10.	 	Definitions: Copy of Plan and Plan Prospectus. To the extent not specifically defined in this Award Agreement, all capitalized terms used in this Award Agreement will have the same meanings ascribed to them in the Plan. By signing this Award Agreement, Employee acknowledges receipt of a copy of the Plan and the related Plan Prospectus.	
 	
 	11.	 	Choice of Law. This Agreement will be governed by the laws of the State of Arizona, excluding any conflicts or choice of law rule or principle that might otherwise refer construction or interpretation of this Agreement to another jurisdiction.	
     An authorized representative of the Company has signed this Award Agreement, and Employee has signed this Award Agreement to evidence Employee’s acceptance of the award on the terms specified in this Award Agreement, all as of the Date of Grant.

 	PINNACLE WEST CAPITAL CORPORATION
 	 	
 	By:  	 	 	
 	
Its: Treasurer 	 	

Employee 	 	

 

Page 3
Performance Share Agreement
Attachment A
Generic Example
Assumptions :

 	•	 	Employee is granted 500 Performance Shares, which constitutes Employee’s “Base Grant”.	
 	
 	•	 	During the Performance Period, the Company’s Earnings Per Share Growth Rate is in the 88.3 percentile compared to the S&P Electric Utilities Index.	
Calculation of Employee’s Common Stock Payment:

 	•	 	Based on the Company’s achievement of the 88.3 Percentile during the Performance Period, in April of the fiscal year immediately following the end of the Performance Period, Employee will receive 971 shares of Common Stock, calculated as follows:	

 	•	 	750 shares of Common Stock as a result of the Company’s Earnings Per Share Growth Rate meeting at least the 75 th Percentile ( 1.5 X Base Grant) plus	
 	
 	•	 	221 shares of Common Stock as a result of the Company’s Earnings Per Share Growth Rate achieving 13.3/15 of the Percentile increase between the 75 th and 90 th Percentiles (13.3/15 X 250 shares, with the 250 shares representing the Common Stock opportunity between the 75 th and 90 th Percentiles). (Note: 13.3/15 x 250 shares = 221.67 shares and must be rounded down to 221 shares.)	

 

Exhibit 10.4
STOCK OWNERSHIP INCENTIVE AGREEMENT
UNDER
PINNACLE WEST CAPITAL CORPORATION
2002 LONG-TERM INCENTIVE PLAN
      THIS AWARD AGREEMENT is made and entered into as of                                 (the “Date of Grant”), by and between Pinnacle West Capital Corporation (the “Company”), and «Name» (“Employee”).
BACKGROUND

 	A.	 	The Board of Directors of the Company (the “Board of Directors”) has adopted, and the Company’s shareholders have approved, the Pinnacle West Capital Corporation 2002 Long-Term Incentive Plan (the “Plan”), pursuant to which stock ownership incentive awards may be granted to employees of the Company and its subsidiaries and to certain other individuals.	
 	
 	B.	 	The Company desires to grant to Employee a stock ownership incentive award under the terms of the Plan.	
 	
 	C.	 	Pursuant to the Plan, the Company and Employee agree as follows:	
AGREEMENT

 	1.	 	Definitions. For purposes of this Award Agreement, the following terms have the meanings specified in this Section 1:	

 	(a)	 	“Award Period” means the period beginning                         and ending                         .	
 	
 	(b)	 	“Average Number of Shares Owned” means (i) the sum of the number of shares of Common Stock owned by Employee at the end of each month during the Award Period divided by (ii) twelve (12), rounded down to the next whole share.	
 	
 	(c)	 	“Average Share Price” means the average daily closing price of the Common Stock on the New York Stock Exchange during the Award Period.	
 	
 	(d)	 	“Base Salary” means the base salary earned by Employee during the Award Period.	
 	
 	(e)	 	“Common Stock” means the common stock of the Company.	
 	
 	(f)	 	“Ownership Level” means the Stock Ownership Value divided by Employee’s Base Salary, expressed as a ratio, carried out to two decimal places and rounded down.	
 	
 	(g)	 	“Stock Ownership Value” means the Average Number of Shares Owned multiplied by the Average Share Price.	

 	2.	 	Grant of Award. Pursuant to action of the Committee, which was taken on the Date of Grant, the Company grants to Employee the stock ownership incentive award described in this Award Agreement.	
 	
 	3.	 	Award Subject to Plan. This award is granted under and is expressly subject to, all the terms and provisions of the Plan, which terms are incorporated herein by reference, and	

 

Page 2
Performance Share Agreement

 	 	 	this Award Agreement. The Committee referred to in Section 4 of the Plan (“Committee”) has been appointed by the Board of Directors, and designated by it, as the Committee to make awards.	
 	
 	4.	 	Stock Ownership Incentive Award.	

 	(a)	 	General. Upon satisfaction of the “Threshold Performance Goal” described in Section 4(b) below and the Ownership Level described in Section 4(c) below, the Company will deliver to Employee, as soon as practicable after the end of the Award Period, a number of shares of Common Stock equal to four percent (4%) of Employee’s Average Number of Shares Owned. Partial shares will be rounded down to the nearest whole share, when applicable. Attachment A provides a generic example of the operation of a Stock Ownership Incentive Award.	
 	
 	(b)	 	Threshold Performance Goal. For purposes of this Award Agreement, the threshold performance goal for the Award Period will have been met if, during the Award Period, the Company’s earnings from continuing operations plus SunCor Development Company’s earnings from discontinued operations are at least $       million.	
 	
 	(c)	 	Ownership Level . For purposes of this Agreement, the Common Stock ownership requirement will have been met if Employee’s Ownership Level is at least «Shares» times.	
 	
 	(d)	 	Maximum Award. If Employee’s Ownership Level exceeds five (5), the number of shares of Common Stock awarded to Employee will be four percent (4%) of the number of shares represented by an Ownership Level of five (5) or 15,000 shares maximum.	

 	5.	 	Evidence of Ownership.	

 	(a)	 	Shares Held In Company Plans. Employee is not required to provide ownership evidence of shares of Common Stock owned by Employee and held in any Company-sponsored stock-based plan, such as the Pinnacle West Capital Corporation Investors Advantage Plan or the Pinnacle West Capital Corporation Savings Plan.	
 	
 	(b)	 	Shares Held Outside Company Plans. Shares of Common Stock owned by Employee outside of Company-sponsored stock-based plans (for example, shares held in a brokerage account) will be included in Employee’s Average Number of Shares Owned only if Employee provides the Company with written evidence of such ownership (for example, a copy of a brokerage account statement). Employee must provide the Company with evidence of such ownership no later than thirty (30) days following the end of the Award Period.	

 	6.	 	Termination of Award. This Award Agreement will terminate and be of no further force or effect as of the date during the Award Period that Employee is no longer employed by the Company or any of its subsidiaries, unless the termination of active employment is due to Employee’s death or Disability. In the case of Employee’s death or Disability, Employee will be deemed to have been employed by the Company through the end of the Award Period. No adjustment will be made to Employee’s “Base Salary” calculation as a result of Employee’s death or Disability (e.g., the base salary earned by Employee to the date of Employee’s death or Disability will not be annualized over the Award Period).	

 

Page 3
Performance Share Agreement

 	 	 	“Disability” shall mean a period of disability during which Employee qualifies for benefits under Employee’s employer’s long-term disability plan, or, if Employee does not participate in such a plan, a period of disability during which Employee would have qualified for benefits under such a plan, as determined by the Committee, had Employee been a participant in such a plan. The Committee may require such medical or other evidence, as it deems necessary to judge the nature of Employee’s condition.	
 	
 	7.	 	Tax Withholding. Employee must pay, or make arrangements acceptable to the Company for the payment of, any and all federal, state, and local tax withholding that in the opinion of the Company is required by law. Unless Employee satisfies any such tax withholding obligation by paying the amount in cash or by check , the Company will withhold shares of Common Stock having a Fair Market Value on the date of withholding equal to the tax withholding obligation.	
 	
 	8.	 	Non-Transferability. Neither this award nor any rights under this Award Agreement may be assigned, transferred or in any manner encumbered except by will or the laws of descent and distribution, and any attempted assignment, transfer, mortgage, pledge or encumbrance except as herein authorized, will be void and of no effect.	
 	
 	9.	 	Definitions; Copy of Plan and Plan Prospectus. To the extent not specifically defined in this Award Agreement, all capitalized terms used in this Award Agreement will have the same meanings ascribed to them in the Plan. By signing this Award Agreement, Employee acknowledges receipt of a copy of the Plan and the related Plan Prospectus.	
 	
 	10.	 	Choice of Law. This Award Agreement will be governed by the laws of the State of Arizona excluding any conflicts or choice of law rule or principle that might otherwise refer construction or interpretation of this Agreement to another jurisdiction.	
     An authorized representative of the Company has signed this Award Agreement, and Employee has signed this Award Agreement to evidence Employee’s acceptance of the award on the terms specified in this Award Agreement, all as of the Date of Grant.

 	PINNACLE WEST CAPITAL CORPORATION
 	 	
 	By:  	 	 	
 	
Its: Treasurer 	 	

Employee	 	

 

 	 	 	 	 	
Page 4
Performance Share Agreement
Attachment A
Generic Example

 	 	 	Assumptions:	
 	
 	•	 	Earnings threshold is met.	
 	
 	•	 	Employee’s Base Salary is $100,000.	
 	
 	•	 	Employee’s Ownership Level must be at least two (2) (Employee’s Ownership Level is based on Employee’s title).	
 	
 	•	 	Employee owns 5,800 shares of Common Stock at the end of each month during 2004, resulting in the Average Number of Shares Owned equaling 5,800.	
 	
 	•	 	The Average Share Price for 2004 is $35.00 per share.	
 	
 	•	 	Employee’s Stock Ownership Value is $203,000 (5,800 shares X $35.00 per share)	
 	
 	•	 	Employee’s Ownership Level is $203,000 / $100,000, or 2.03.	
 	
 	•	 	Employee meets the required Ownership Level of at least 2.	
Delivery of Common Stock to Employee:

 	•	 	Employee would receive 232 shares of Common Stock (4% of 5,800 shares, rounded down, which represents Employee’s Average Number of Shares Owned)	
      Application of the maximum:

 	•	 	Same assumptions, except Average Number of Shares Owned equals 15,000.	
 	
 	•	 	Employee’s Stock Ownership Value is $525,000 (15,000 shares X $35.00 per share)	
 	
 	•	 	Employee’s Ownership Level is 525,000 / 100,000, or 5.25.	
 	
 	•	 	Shares are not awarded for Ownership Levels above 5, so five times Base Salary is $500,000 Stock Ownership Value, resulting in 14,285 shares ($500,000 / $35 per share). The 4% award would be based on 14,285 shares; as a result, Employee would receive 571 shares.	

 

Exhibit 10.5
PINNACLE WEST CAPITAL CORPORATION
RESTRICTED STOCK AWARD AGREEMENT
     This Award Agreement is made and entered into by and between PINNACLE WEST CAPITAL CORPORATION, an Arizona corporation (the “Company”) and     (“Employee”), as of the    day of    ,   (the “Date of Grant”).
W I T N E S S E T H:
     The Board of Directors of the Company has adopted the Pinnacle West Capital Corporation 1994 Long-Term Incentive Plan (the “Plan”) to encourage ownership in the Company by key employees of the Company and its subsidiaries, to enhance the ability of the Company and its subsidiaries to attract and retain employees whose services are considered unusually valuable, and to provide those individuals with a further incentive to work for the best interests of the Company and its shareholders. Pursuant to the Plan, the Company and the Employee agree as follows.

 	1.	 	Restricted Stock	
               (a) Grant of Shares. Subject to the terms and provisions of this Award Agreement and the Plan, the Company hereby grants     (   ) shares of the Stock to the Employee. The Employee shall be the beneficial owner of said Stock as of the Date of Grant and the Stock shall be transferred of record to the Employee and a certificate or certificates representing said Stock shall be issued in the name of the Employee immediately upon the execution of this Award Agreement. The Employee shall not be entitled to delivery of a stock certificate for any of such shares; however, until the restrictions noted in paragraph 1(c) have lapsed with respect to said shares.
               (b) Rights of Employee. Upon the execution of this Award Agreement, the Employee shall become a shareholder with respect to all of the shares awarded pursuant to paragraph 1(a) and shall have the rights of a shareholder with respect to all such shares, including the right to vote such shares and to receive all dividends and other distributions paid with respect to such shares, provided, however, that such shares shall be subject to the restrictions hereinafter described.
     Notwithstanding the preceding paragraph, the Company will withhold any cash or stock dividends paid on such shares, with such cash or stock dividends to be distributed to the Employee upon the expiration of the restrictions noted herein. Interest will be paid on the amount of cash dividends withheld, including cash dividends on stock dividends, at a rate and subject to such terms and conditions as shall be determined by the Committee.

 

               (c) Restrictions. The restrictions set forth in this Award Agreement shall exist for the period (“Restriction Period”) beginning on the Date of Grant and ending on the last to occur of:

 	(i)	 	immediately exercisable as of the Date of Grant,	
 	
 	(ii)	 	with no matching restrictions.	
     If by virtue of paragraph 1(c)(ii) (the requirements of paragraph 1(c)(i) having then been satisfied), the Restriction Period would end.
               (d) Price. Pricing will be determined by averaging the high and low price of the Stock on the New York Stock Exchange on the date of vesting. If the exchange is closed, it will occur on the first business day thereafter.
               (e) Tax Withholding. The Plan permits the Company to withhold, or require the Employee to remit to the Company, an amount sufficient to satisfy United States Federal, state and local taxes required by law to be withheld with respect to any taxable event arising in connection with the Restricted Stock Award. The Employee may satisfy any such tax withholding obligation by (i) paying the amount in cash or by check or (ii) providing written notice to the Company to withhold shares of Stock having a Fair Market Value on the date of withholding equal to the tax withholding obligation.
     2. Incorporation of Plan. The Plan is incorporated into this Agreement as if set forth fully herein and this Agreement is, at all times, subject to the terms and conditions of the Plan, as amended from time to time.
     3. Definitions; Copy of Plan. To the extent not specifically provided herein, all capitalized terms used in this Award Agreement will have the same meanings ascribed to them in the Plan. By the execution of this Award Agreement, the Employee acknowledges receipt of a copy of the Plan.
     4. Continuation of Employment. This Award Agreement shall not be construed to confer upon the Employee any right to continue in the employ of the Company or its subsidiaries and shall not limit the right of the Company or its subsidiaries, in its sole discretion, to terminate the employment of the Employee at any time.
     5. Governing Law. This Award Agreement shall be interpreted and administered under the laws of the State of Arizona.
     6. Amendments. This Award Agreement may be amended only by a written agreement executed by the Company and the Employee, provided that the Company may amend this Award Agreement without the consent of the
-2-

 

Employee to the extent that such amendment is required by applicable federal or state securities laws.
     IN WITNESS WHEREOF, the Company and the Employee have executed this Award Agreement effective as of the day and year first above written.

 	PINNACLE WEST CAPITAL CORPORATION
 	 	
 	 	By 	 	 	
 	 	
Its Vice President and Treasurer 	 	

Employee 	 	
 	
-3-

Exhibit 12.1
PINNACLE WEST CAPITAL CORPORATION
COMPUTATION OF EARNINGS TO FIXED CHARGES
(Thousands of Dollars)

 	 	Six Months Ended	 	Twelve Months Ended	
 	 	June 30,
	 	December 31,
	
 	 	2004
	 	2003
	 	2002
	 	2001
	 	2000
	 	1999
	
Earnings:	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
Income from continuing Operations	 	$	100,825	 	 	$	230,576	 	 	$	206,198	 	 	$	327,367	 	 	$	302,332	 	 	$	269,772	 	
Income Taxes	 	 	59,654	 	 	 	105,560	 	 	 	132,228	 	 	 	213,535	 	 	 	194,200	 	 	 	141,592	 	
Fixed Charges	 	 	111,317	 	 	 	235,658	 	 	 	219,651	 	 	 	211,958	 	 	 	202,804	 	 	 	194,070	 	

 	 	 	 	

 	 	 	 	
 	 	
Total	 	$	271,796	 	 	$	571,794	 	 	$	558,077	 	 	$	752,860	 	 	$	699,336	 	 	$	605,434	 	

 	 	 	 	

 	 	 	 	
 	 	
Fixed Charges:	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
Interest Expense	 	 	95,210	 	 	 	204,590	 	 	 	187,512	 	 	 	175,822	 	 	 	166,447	 	 	 	157,142	 	
Estimated Interest Portion of Annual Rents	 	 	16,107	 	 	 	31,068	 	 	 	32,139	 	 	 	36,136	 	 	 	36,357	 	 	 	36,928	 	

 	 	 	 	

 	 	 	 	
 	 	
Total Fixed Charges	 	$	111,317	 	 	$	235,658	 	 	$	219,651	 	 	$	211,958	 	 	$	202,804	 	 	$	194,070	 	

 	 	 	 	

 	 	 	 	
 	 	
Ratio of Earnings to Fixed Charges (rounded down)	 	 	2.44	 	 	 	2.42	 	 	 	2.54	 	 	 	3.55	 	 	 	3.44	 	 	 	3.11	 	

 	 	 	 	

 	 	 	 	

 

EXHIBIT 31.1 
CERTIFICATION
I, William J. Post, certify that:

1.	 	I have reviewed this Quarterly Report on Form 10-Q of Pinnacle West Capital Corporation;	
 	
2.	 	Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;	
 	
3.	 	Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;	
 	
4.	 	The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have:	

a)	 	designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;	
 	
b)	 	evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and	
 	
c)	 	disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s second fiscal quarter that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and	

5.	 	The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):	

a)	 	all significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and	

 

b)	 	any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.	
Date: August 6, 2004.

	 	/s/ William J. Post
	
	 	William J. Post	
	 	Chairman and Chief Executive Officer	
2

EXHIBIT 31.2 
CERTIFICATION
I, Donald E. Brandt, certify that:

1.	 	I have reviewed this Quarterly Report on Form 10-Q of Pinnacle West Capital Corporation;	
 	
2.	 	Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;	
 	
3.	 	Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;	
 	
4.	 	The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have:	

 	a)	 	designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;	
 	
 	b)	 	evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and	
 	
 	c)	 	disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s second fiscal quarter that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and	

5.	 	The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):	

 	a)	 	all significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and	

 

 	b)	 	any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.	
 	 	 	
Date: August 6, 2004.	 	 	
 	 	 	
 	 	/s/ Donald E. Brandt
	
	 	Donald E. Brandt	
	 	Executive Vice President &	
	 	Chief Financial Officer	
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EXHIBIT 32.1 
CERTIFICATION
OF
CHIEF EXECUTIVE OFFICER
AND
CHIEF FINANCIAL OFFICER
PURSUANT TO 18 U.S.C. 1350,
AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
     I, William J. Post, certify, pursuant to 18 U.S.C. 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that the Quarterly Report on Form 10-Q of Pinnacle West Capital Corporation for the fiscal quarter ended June 30, 2004 fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934 and that information contained in such Quarterly Report on Form 10-Q fairly presents, in all material respects, the financial condition and results of operations of Pinnacle West Capital Corporation.
Date: August 6, 2004.

 	 	/s/ William J. Post
	
	 	William J. Post	
	 	Chairman and Chief Executive Officer	
     I, Donald E. Brandt, certify, pursuant to 18 U.S.C. 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that the Quarterly Report on Form 10-Q of Pinnacle West Capital Corporation for the fiscal quarter ended June 30, 2004 fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934 and that information contained in such Quarterly Report on Form 10-Q fairly presents, in all material respects, the financial condition and results of operations of Pinnacle West Capital Corporation.
Date: August 6, 2004.

 	 	/s/ Donald E. Brandt
	
	 	Donald E. Brandt	
	 	Executive Vice President and	
	 	Chief Financial Officer	

 

Exhibit 99.1
PINNACLE WEST RISK FACTORS
(Report on Form 10-Q for the Fiscal Quarter ending June 30, 2004)
     Set forth below and in other documents we file with the Securities and Exchange Commission are risks and uncertainties that could affect our financial results.
      We cannot predict the outcome of APS’ general rate case pending before the Arizona Corporation Commission (the “ACC”).
     As required by a 1999 settlement agreement among Arizona Public Service Company (“APS”) and various parties (the “1999 Settlement Agreement”), on June 27, 2003, APS filed a general rate case with the ACC. APS requested a $175.1 million, or 9.8%, increase in its annual retail electricity revenues, to become effective July 1, 2004. The major reasons for the request include:

 	•	 	complying with the provisions of the 1999 Settlement Agreement;	
 	
 	•	 	incorporating significant increases in fuel and purchased power costs, including results of purchases through the ACC’s “Track B” procurement process;	
 	
 	•	 	recognizing changes in APS’ cost of service, cost allocation and rate design;	
 	
 	•	 	obtaining rate base recognition of the generating plants built in Arizona by Pinnacle West Energy Corporation (“Pinnacle West Energy”) since 1999 to serve APS’ retail electricity customers, specifically, Redhawk Units 1 and 2, West Phoenix Units 4 and 5 and Saguaro Unit 3 (the “PWEC Dedicated Assets”);	
 	
 	•	 	recovering $234 million written off by APS as a result of the 1999 Settlement Agreement; and	
 	
 	•	 	recovering restructuring and compliance costs associated with the ACC’s electric competition rules (the “Rules”).	
     The general rate case will also address the implementation of rate adjustment mechanisms that were the subject of ACC hearings in April 2003. The rate adjustment mechanisms, which were authorized in the 1999 Settlement Agreement, would allow APS to recover several types of costs, the most significant of which are power supply costs (fuel and purchased power costs) and costs associated with complying with the Rules. If APS does not have a rate adjustment mechanism that allows it to fully recover its power supply costs, then changes in these costs may harm our financial performance. On November 4, 2003, the ACC approved the issuance of an order which authorizes a rate adjustment mechanism allowing APS to recover changes in purchased power costs (but not changes in fuel costs) incurred after July 1, 2004. The other rate adjustment mechanisms authorized in the 1999 Settlement Agreement (such as the costs associated with complying with the Rules) were also tentatively approved for subsequent implementation in the general rate case. The purchased power rate adjustment mechanism will not become effective until there is a final order in the general rate case, and the ACC further reserved the right to amend or modify, in all respects, this November 4 order during the rate case.
     In its filed testimony in the rate case, the ACC staff recommended, among other things, that the ACC decrease APS’ rates by approximately 8% (approximately $143 million annually), not allow the PWEC Dedicated Assets to be included in APS’ rate base, and not allow APS to recover any of the $234 million written off as a result of the 1999 Settlement Agreement. The ACC staff recommendations, if implemented as proposed, could have a material adverse impact on our results of operations, financial position, liquidity, dividend sustainability, credit ratings, and access to capital markets. We cannot predict the outcome of the rate case and the resulting levels of regulated revenues.

 

 	 	Our cash flow largely depends on the performance of our subsidiaries.	
     We conduct our operations primarily through subsidiaries. Substantially all of our consolidated assets are held by such subsidiaries. Accordingly, our cash flow is dependent upon the earnings and cash flows of these subsidiaries and their distributions to us. The subsidiaries are separate and distinct legal entities and have no obligation to make distributions to us.
     The debt agreements of some of our subsidiaries may restrict their ability to pay dividends, make distributions or otherwise transfer funds to us. As part of the ACC’s approval of a $500 million financing arrangement between APS and Pinnacle West Energy, APS must maintain a common equity ratio of at least 40% and may not pay common dividends if the payment would reduce its common equity below that threshold. As defined in the ACC financing order approving the arrangement, common equity ratio is common equity divided by common equity plus long-term debt, including current maturities of long-term debt. At June 30, 2004, APS’ common equity ratio was approximately [48]%.

 	 	We are subject to complex government regulation which may have a negative impact on our business and our results of operations.	
     We are, directly and through our subsidiaries, subject to governmental regulation that may have a negative impact on our business and results of operations. We are a “holding company” within the meaning of the Public Utility Holding Company Act (“PUHCA”); however, we are exempt from the provisions of PUHCA by virtue of our filing of an annual exemption statement with the SEC.
     APS is subject to comprehensive regulation by several federal, state and local regulatory agencies, which significantly influence its operating environment and may affect its ability to recover costs from utility customers. APS is required to have numerous permits, approvals and certificates from the agencies that regulate APS’ business. The Federal Energy Regulatory Commission (“FERC”), the Nuclear Regulatory Commission (“NRC”), the Environmental Protection Agency (“EPA”), and the ACC regulate many aspects of our utility operations, including siting and construction of facilities, customer service and the rates that APS can charge customers. We believe the necessary permits, approvals and certificates have been obtained for APS’ existing operations. However, changes in regulations or the imposition of additional regulations could have an adverse impact on our results of operations. We are also unable to predict the impact on our business and operating results from the future regulatory activities of any of these agencies. For example, in connection with an audit of APS and its affiliates by the FERC, certain instances of noncompliance with FERC regulations related to the administration of our transmission tariff have been identified. We currently expect, but cannot provide any assurance, that the resolution of these matters will not have a material adverse effect on our financial position, results of operations or liquidity.

 	 	The procurement of wholesale power by APS without the ability to adjust retail rates could have an adverse impact on our business and financial results.	
     Although the Rules allow retail customers to have access to competitive providers of energy and energy services, under the Rules, APS is the “provider of last resort” for standard-offer, full-service customers under rates that have been approved by the ACC. At various times, prices in the spot wholesale market have significantly exceeded the amount included in APS’ current retail rates. In the event of shortfalls due to unforeseen increases in load demand or generation or transmission outages, APS may need to purchase additional supplemental power in the wholesale spot market. There can be no assurance that APS would be able to fully recover the costs of this power. In addition, APS filed a general rate case with the ACC on June 27, 2003 (see discussion above). Among other things, the rate case will address the implementation of rate adjustment mechanisms, which would allow APS to recover several types of costs, the most significant of which are power supply costs (fuel and purchased power costs) and costs associated with complying with the Rules.

 	 	If we are not able to access capital at competitive rates, our ability to implement our financial strategy will be adversely affected.	
     We rely on access to short-term money markets, longer-term capital markets and the bank markets as a significant source of liquidity and for capital requirements not satisfied by the cash flow from our operations. We
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believe that we will maintain sufficient access to these financial markets based upon current credit ratings. However, certain market disruptions or a downgrade of our credit rating may increase our cost of borrowing or adversely affect our ability to access one or more financial markets. Such disruptions could include:

 	•	 	an economic downturn;	
 	
 	•	 	capital market conditions generally;	
 	
 	•	 	the bankruptcy of an unrelated energy company;	
 	
 	•	 	market prices for electricity and gas;	
 	
 	•	 	terrorist attacks or threatened attacks on our facilities or those of unrelated energy companies; or	
 	
 	•	 	the overall health of the utility industry.	
     Changes in economic conditions could result in higher interest rates, which would increase our interest expense on our debt and reduce funds available to us for our current plans. Additionally, an increase in our leverage could adversely affect us by:

 	•	 	increasing the cost of future debt financing;	
 	
 	•	 	increasing our vulnerability to adverse economic and industry conditions;	
 	
 	•	 	requiring us to dedicate a substantial portion of our cash flow from operations to payments on our debt, which would reduce funds available to us for operations, future business opportunities or other purposes; and	
 	
 	•	 	placing us at a competitive disadvantage compared to our competitors that have less debt.	

 	 	A significant reduction in our credit ratings could materially and adversely affect our business, financial condition and results of operations.	
     We cannot be sure that any of our current ratings will remain in effect for any given period of time or that a rating will not be lowered or withdrawn entirely by a rating agency if, in its judgment, circumstances in the future so warrant. Any downgrade could increase our borrowing costs, which would diminish our financial results. We would likely be required to pay a higher interest rate in future financings, and our potential pool of investors and funding sources could decrease. In addition, borrowing costs under certain of our existing credit facilities depend on our credit ratings. A downgrade could also require us to provide additional support in the form of letters of credit or cash or other collateral to various counterparties. If our short-term ratings were to be lowered, it could limit our access to the commercial paper market. We note that the ratings from rating agencies are not recommendations to buy, sell or hold our securities and that each rating should be evaluated independently of any other rating.

 	 	Deregulation or restructuring of the electric industry may result in increased competition, which could have a significant adverse impact on our business and our financial results.	
     Retail competition could have a significant adverse financial impact on us due to an impairment of assets, a loss of retail customers, lower profit margins or increased costs of capital. Under the Rules, as modified by the 1999 Settlement Agreement, APS was required to transfer all of its competitive electric assets and services to an unaffiliated party or parties or to a separate corporate affiliate or affiliates no later than December 31, 2002. To satisfy this requirement APS had planned to transfer its generation assets to Pinnacle West Energy. Pursuant to an ACC order dated September 10, 2002, the ACC unilaterally modified the 1999 Settlement Agreement and directed APS to cancel any plans to divest interests in any of its generating assets. The ACC further established a requirement that APS solicit bids for certain estimated amounts of capacity and energy for periods beginning July 1, 2003. Pinnacle West Energy bid on and entered into contracts to supply most of APS’ requirements in the summer months through September 2006. These regulatory developments and legal challenges to the Rules have raised considerable uncertainty about the status and pace of retail electric competition and of electric restructuring in
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Arizona. Although some very limited retail competition existed in APS’ service area in 1999 and 2000, there are currently no active retail competitors offering unbundled energy or other utility services to APS’ customers. As a result, we cannot predict when, and the extent to which, additional competitors will re-enter APS’ service territory.
     As a result of changes in federal law and regulatory policy, competition in the wholesale electricity market has greatly increased due to a greater participation by traditional electricity suppliers, non-utility generators, independent power producers, and wholesale power marketers and brokers. This increased competition could affect our load forecasts, plans for power supply and wholesale energy sales and related revenues. As a result of the changing regulatory environment and the relatively low barriers to entry, we expect wholesale competition to increase. As competition continues to increase, our financial position and results of operations could be adversely affected.

 	 	Recent events in the energy markets that are beyond our control may have negative impacts on our business.	
     As a result of the energy crisis in California during the summer of 2001, the recent volatility of natural gas prices in North America, the filing of bankruptcy by the Enron Corporation, and investigations by governmental authorities into energy trading activities, companies generally in the regulated and unregulated utility businesses have been under an increased amount of public and regulatory scrutiny. The capital markets and rating agencies also have increased their level of scrutiny. We believe that we are complying with all applicable laws, but it is difficult or impossible to predict or control what effect these or related issues may have on our business or our access to the capital markets.

 	 	Our results of operations can be adversely affected by milder weather.	
     Weather conditions directly influence the demand for electricity and affect the price of energy commodities. Electric power demand is generally a seasonal business. In Arizona, demand for power peaks during the hot summer months, with market prices also peaking at that time. As a result, our overall operating results fluctuate substantially on a seasonal basis. In addition, we have historically sold less power, and consequently earned less income, when weather conditions are milder. As a result, unusually mild weather could diminish our results of operations and harm our financial condition.

 	 	There are inherent risks in the operation of nuclear facilities, such as environmental, health and financial risks and the risk of terrorist attack.	
     Through APS, we have an ownership interest in and operate, on behalf of a group of owners, the Palo Verde Nuclear Generating Station (“Palo Verde”), which is the largest nuclear electric generating facility in the United States. Palo Verde is subject to environmental, health and financial risks such as the ability to dispose of spent nuclear fuel, the ability to maintain adequate reserves for decommissioning, potential liabilities arising out of the operation of these facilities, and the costs of securing the facilities against possible terrorist attacks and unscheduled outages due to equipment and other problems. We maintain nuclear decommissioning trust funds and external insurance coverage to minimize our financial exposure to some of these risks; however, it is possible that damages could exceed the amount of insurance coverage.
     The NRC has broad authority under federal law to impose licensing and safety-related requirements for the operation of nuclear generation facilities. In the event of noncompliance, the NRC has the authority to impose fines or shut down a unit, or both, depending upon its assessment of the severity of the situation, until compliance is achieved. In addition, although we have no reason to anticipate a serious nuclear incident at Palo Verde, if an incident did occur, it could materially and adversely affect our results of operations or financial condition. A major incident at a nuclear facility anywhere in the world could cause the NRC to limit or prohibit the operation or licensing of any domestic nuclear unit.
     The operation of Palo Verde requires licenses that need to be periodically renewed and/or extended. We do not anticipate any problems renewing these licenses. However, as a result of potential terrorist threats and increased public scrutiny of utilities, the licensing process could result in increased licensing or compliance costs that are difficult or impossible to predict.
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 	 	The use of derivative contracts in the normal course of our business and changing interest rates and market conditions could result in financial losses that negatively impact our results of operations.	
     Our operations include managing market risks related to commodity prices and, subject to specified risk parameters, engaging in marketing and trading activities intended to profit from market price movements. We are exposed to the impact of market fluctuations in the price and transportation costs of electricity, natural gas, coal, and emissions allowances and credits. We have established procedures to manage risks associated with these market fluctuations by utilizing various commodity derivatives, including exchange-traded futures and options and over-the-counter forwards, options, and swaps. As part of our overall risk management program, we enter into derivative transactions to hedge purchases and sales of electricity, fuels, and emissions allowances and credits. The changes in market value of such contracts have a high correlation to price changes in the hedged commodity.
     We are exposed to losses in the event of nonperformance or nonpayment by counterparties. We use a risk management process to assess and monitor the financial exposure of all counterparties. Despite the fact that the majority of trading counterparties are rated as investment grade by the rating agencies, there is still a possibility that one or more of these companies could default, resulting in a material adverse impact on our earnings for a given period.
     Changing interest rates will affect interest paid on variable-rate debt and interest earned by our pension plan and nuclear decommissioning trust funds. Our policy is to manage interest rates through the use of a combination of fixed-rate and floating-rate debt. The pension plan is also impacted by the discount rate, which is the interest rate used to discount future pension obligations. Continuation of recent decreases in the discount rate would result in increases in pension costs, cash contributions, and charges to other comprehensive income. The pension plan and nuclear decommissioning trust funds also have risks associated with changing market values of equity investments. A significant portion of the pension costs and all of the nuclear decommissioning costs are recovered in regulated electricity prices.

 	 	The uncertain outcome regarding the creation of regional transmission organizations, or RTOs, and implementation of the FERC’s standard market design may materially impact our operations, cash flows or financial position.	
     In a December 1999 order, the FERC established characteristics and functions that must be met by utilities in forming and operating RTOs. The characteristics for an acceptable RTO include independence from market participants, operational control over a region large enough to support efficient and nondiscriminatory markets and exclusive authority to maintain short-term reliability. Additionally, in a pending notice of proposed rulemaking, the FERC is considering implementing a standard market design for wholesale markets. On October 16, 2001, APS and other owners of electric transmission lines in the Southwest filed with the FERC a request for a declaratory order confirming that their proposal to form WestConnect RTO, LLC would satisfy the FERC’s requirements for the formation of an RTO. On October 10, 2002, the FERC issued an order finding that the WestConnect proposal, if modified to address specified issues, could meet the FERC’s RTO requirements and provide the basic framework for a standard market design for the Southwest. On September 15, 2003, the FERC issued an order granting clarification and rehearing, in part, of its prior orders. In particular, this order approved the use of a physical congestion management scheme, which is used to allocate transmission rights on congested lines, for WestConnect for an initial phase-in period. FERC indicated that the WestConnect utilities and the appropriate regional state advisory committee should develop a market-based congestion management scheme for subsequent implementation. APS is now participating in a cost/benefit analysis of implementing WestConnect, the results of which are expected to be completed in 2004.
     If APS ultimately joins an RTO, APS could incur increased transmission-related costs and reduced transmission service revenues; APS may be required to expand its transmission system according to decisions made by the RTO rather than its internal planning process; and APS may experience other impacts on its operations, cash flows or financial position that will not be quantifiable until the final tariffs and other material terms of the RTO are known.
5

 

 	 	We are subject to numerous environmental laws and regulations that may increase our cost of operations, impact our business plans, or expose us to environmental liabilities.	
     We are subject to numerous environmental regulations affecting many aspects of our present and future operations, including air emissions, water quality, wastewater discharges, solid waste, and hazardous waste. These laws and regulations can result in increased capital, operating, and other costs, particularly with regard to enforcement efforts focused on power plant emissions obligations. These laws and regulations generally require us to obtain and comply with a wide variety of environmental licenses, permits, inspections and other approvals. Both public officials and private individuals may seek to enforce applicable environmental laws and regulations. We cannot predict the outcome (financial or operational) of any related litigation that may arise.
     In addition, we may be a responsible party for environmental clean up at sites identified by a regulatory body. We cannot predict with certainty the amount and timing of all future expenditures related to environmental matters because of the difficulty of estimating clean-up costs. There is also uncertainty in quantifying liabilities under environmental laws that impose joint and several liability on all potentially responsible parties.
     We cannot be sure that existing environmental regulations will not be revised or that new regulations seeking to protect the environment will not be adopted or become applicable to us. Revised or additional regulations that result in increased compliance costs or additional operating restrictions, particularly if those costs are not fully recoverable from APS’ customers, could have a material adverse effect on our results of operations.

 	 	Actual results could differ from estimates used to prepare our financial statements.	
     In preparing the financial statements in accordance with accounting principles generally accepted in the United States of America, management must often make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues, expenses and related disclosures at the date of the financial statements and during the reporting period. Some of those judgments can be subjective and complex, and actual results could differ from those estimates. We consider the following accounting policies to be our most critical because of the uncertainties, judgments and complexities of the underlying accounting standards and operations involved.

 	•	 	Regulatory Accounting — Regulatory accounting allows for the actions of regulators, such as the ACC and the FERC, to be reflected in the financial statements. Their actions may cause us to capitalize costs that would otherwise be included as an expense in the current period by unregulated companies. If future recovery of costs ceases to be probable, the assets would be written off as a charge in current period earnings. We had $167 million of regulatory assets on our balance sheet at June 30, 2004.	
 	
 	•	 	Pensions and Other Postretirement Benefit Accounting — Changes in our actuarial assumptions used in calculating our pension and other postretirement benefit liability and expense can have a significant impact on our earnings, plan funding requirements and financial position. The most relevant actuarial assumptions are the discount rate used to measure our liability and net periodic cost, the expected long-term rate of return on plan assets used to estimate earnings on invested funds over the long-term, and the assumed healthcare cost trend rates. We review these assumptions on an annual basis and adjust them as necessary.	
 	
 	•	 	Derivative Accounting — Derivative accounting requires evaluation of rules that are complex and subject to varying interpretations. Our evaluation of these rules, as they apply to our contracts, will determine whether we use accrual accounting or fair value (mark-to-market) accounting. Mark-to-market accounting requires that changes in fair value be recorded in earnings or, if certain hedge accounting criteria are met, in common stock equity (as a component of other comprehensive income (loss)).	
 	
 	•	 	Mark-to-Market Accounting — The market value of our derivative contracts is not always readily determinable. In some cases, we use models and other valuation techniques to determine fair value. The use of these models and valuation techniques sometimes requires subjective and	
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 	 	 	complex judgment. Actual results could differ from the results estimated through application of these methods. Our marketing and trading portfolio consists of structured activities hedged with a portfolio of forward purchases that protects the economic value of the sales transactions.	
7