Table of Contents

 
FORM 10-Q
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
 
(Mark One)
 	 	 	
þ	 	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934	
For the quarterly period ended June 30, 2006
OR
 	 	 	
o	 	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934	
For the transition period from                      to                     
 	 	 	 	 	
 	 	Exact Name of Each Registrant as specified in	 	 	
Commission	 	its charter; State of Incorporation; Address;	 	IRS Employer	
File Number	 	and Telephone Number	 	Identification No.	
1-8962	 	PINNACLE WEST CAPITAL CORPORATION	 	86-0512431	
 	 	(an Arizona corporation)	 	 	
 	 	400 North Fifth Street, P.O. Box 53999	 	 	
 	 	Phoenix, Arizona 85072-3999	 	 	
 	 	(602) 250-1000	 	 	
1-4473	 	ARIZONA PUBLIC SERVICE COMPANY	 	86-0011170	
 	 	(an Arizona corporation)	 	 	
 	 	400 North Fifth Street, P.O. Box 53999	 	 	
 	 	Phoenix, Arizona 85072-3999	 	 	
 	 	(602) 250-1000	 	 	
     Indicate by check mark whether each registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
PINNACLE WEST CAPITAL CORPORATION              Yes þ       No o
ARIZONA PUBLIC SERVICE COMPANY                     Yes þ       No o
     Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer” and “large accelerated filer” in Rule 12b-2 of the Exchange Act.
PINNACLE WEST CAPITAL CORPORATION
Large accelerated filer þ       Accelerated filer o       Non-accelerated filer o
ARIZONA PUBLIC SERVICE COMPANY
Large accelerated filer o       Accelerated filer o       Non-accelerated filer þ
     Indicate by check mark whether each registrant is a shell company (as defined in Exchange Act Rule 12b-2).
PINNACLE WEST CAPITAL CORPORATION               Yes o       No þ
ARIZONA PUBLIC SERVICE COMPANY                      Yes o       No þ
     Indicate the number of shares outstanding of each of the issuer’s classes of common stock as of the latest practicable date.
 	 	 	
PINNACLE WEST CAPITAL CORPORATION	 	Number of shares of common stock, no par value, outstanding as of August 4, 2006: 99,477,663	
 	 	 	
ARIZONA PUBLIC SERVICE COMPANY	 	Number of shares of common stock, $2.50 par value, outstanding as of August 4, 2006: 71,264,947	
           Arizona Public Service Company meets the conditions set forth in General Instruction H(1)(a) and (b) of Form 10-Q and is therefore filing this form with the reduced disclosure format allowed under that General Instruction.
          This combined Form 10-Q is separately filed by Pinnacle West Capital Corporation and Arizona Public Service Company. Each registrant is filing on its own behalf all of the information contained in this Form 10-Q that relates to such registrant and, where required, its subsidiaries. Except as stated in the preceding sentence, neither registrant is filing any information that does not relate to such registrant, and therefore makes no representation as to any such information.

 

 

TABLE OF CONTENTS
 	 	 	 	 	
 	 	Page	
Glossary	 	 	2	 	
Part I	 	 	4	 	
Item 1. Financial Statements	 	 	4	 	
Pinnacle West Capital Corporation	 	 	4	 	
Arizona Public Service Company	 	 	32	 	
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations	 	 	42	 	
Item 3. Quantitative and Qualitative Disclosures About Market Risk	 	 	68	 	
Item 4. Controls and Procedures	 	 	68	 	
 	 	 	 	 	
Part II	 	 	69	 	
Item 1. Legal Proceedings	 	 	69	 	
Item 1A. Risk Factors	 	 	69	 	
Item 4. Submission of Matters to a Vote of Security Holders	 	 	70	 	
Item 5. Other Information	 	 	70	 	
Item 6. Exhibits	 	 	72	 	
Signatures	 	 	74	 	
  Exhibit 10.1	
  Exhibit 12.1	
  Exhibit 12.2	
  Exibit 12.3	
  Exhibit 31.1	
  Exhibit 31.2	
  Exhibit 31.3	
  Exhibit 31.4	
  Exhibit 32.1	
  Exhibit 32.2	
  Exhibit 99.1	
  Exhibit 99.2	

Table of Contents

GLOSSARY
ACC – Arizona Corporation Commission
ADEQ – Arizona Department of Environmental Quality
ALJ – Administrative Law Judge
APB – Accounting Principles Board
APS – Arizona Public Service Company, a subsidiary of the Company
APS Energy Services – APS Energy Services Company, Inc., a subsidiary of the Company
Clean Air Act – Clean Air Act, as amended
Company – Pinnacle West Capital Corporation
DOE – United States Department of Energy
EITF – FASB’s Emerging Issues Task Force
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
FIP – Federal Implementation Plan
GAAP – accounting principles generally accepted in the United States of America
IRS – United States Internal Revenue Service
kWh – kilowatt-hour
Moody’s – Moody’s Investors Service
MWh – megawatt-hour, one million watts per hour
Native Load – retail and wholesale sales supplied under traditional cost-based rate regulation
NPC – Nevada Power Company
NRC – United States Nuclear Regulatory Commission
OCI – other comprehensive income
Off-System Sales – sales of electricity from generation owned by the Company that is over and above the amount required to serve APS’ retail customers and traditional wholesale contracts
Palo Verde – Palo Verde Nuclear Generating Station
Pinnacle West – Pinnacle West Capital Corporation, the Company
Pinnacle West Energy – Pinnacle West Energy Corporation, a subsidiary of the Company
PRP – potentially responsible party
PSA – power supply adjustor
2

Table of Contents

PWEC Dedicated Assets – the following power plants, each of which was transferred by Pinnacle West Energy to APS on July 29, 2005: Redhawk Units 1 and 2, West Phoenix Units 4 and 5 and Saguaro Unit 3
Salt River Project – Salt River Project Agricultural Improvement and Power District
SEC – United States Securities and Exchange Commission
SFAS – Statement of Financial Accounting Standards
Silverhawk – Silverhawk Power Station, a 570-megawatt, natural gas-fueled, combined-cycle electric generating facility located 20 miles north of Las Vegas, Nevada
Standard & Poor’s – Standard & Poor’s Corporation
SunCor – SunCor Development Company, a subsidiary of the Company
Sundance Plant – 450-megawatt generating facility located approximately 55 miles southeast of Phoenix, Arizona
Superfund – Comprehensive Environmental Response, Compensation and Liability Act
Trading – energy-related activities entered into with the objective of generating profits on changes in market prices
2005 Form 10-K – Pinnacle West/APS Annual Report on Form 10-K for the fiscal year ended December 31, 2005
VIE – variable interest entity
3

Table of Contents
PART I – FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
PINNACLE WEST CAPITAL CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(unaudited)
(dollars and shares in thousands, except per share amounts)
 	 	 	 	 	 	 	 	 	
 	 	Three Months Ended
June 30,	 	
 	 	2006	 	 	2005	 	
OPERATING REVENUES	 	 	 	 	 	 	 	 	
Regulated electricity segment	 	$	712,718	 	 	$	579,652	 	
Marketing and trading segment	 	 	89,925	 	 	 	71,172	 	
Real estate segment	 	 	112,603	 	 	 	84,259	 	
Other revenues	 	 	9,782	 	 	 	20,259	 	
 	 	 	 	 	 	 	
Total	 	 	925,028	 	 	 	755,342	 	
 	 	 	 	 	 	 	
OPERATING EXPENSES	 	 	 	 	 	 	 	 	
Regulated electricity segment fuel and purchased power	 	 	263,944	 	 	 	160,590	 	
Marketing and trading segment fuel and purchased power	 	 	72,716	 	 	 	57,593	 	
Operations and maintenance	 	 	168,332	 	 	 	153,097	 	
Real estate segment operations	 	 	98,412	 	 	 	67,713	 	
Depreciation and amortization	 	 	89,297	 	 	 	85,323	 	
Taxes other than income taxes	 	 	32,700	 	 	 	34,638	 	
Other expenses	 	 	8,430	 	 	 	17,556	 	
 	 	 	 	 	 	 	
Total	 	 	733,831	 	 	 	576,510	 	
 	 	 	 	 	 	 	
OPERATING INCOME	 	 	191,197	 	 	 	178,832	 	
 	 	 	 	 	 	 	
OTHER	 	 	 	 	 	 	 	 	
Allowance for equity funds used during construction	 	 	3,633	 	 	 	2,952	 	
Other income (Note 14)	 	 	12,022	 	 	 	8,684	 	
Other expense (Note 14)	 	 	(5,815	)	 	 	(3,846	)	
 	 	 	 	 	 	 	
Total	 	 	9,840	 	 	 	7,790	 	
 	 	 	 	 	 	 	
INTEREST EXPENSE	 	 	 	 	 	 	 	 	
Interest charges	 	 	45,882	 	 	 	50,077	 	
Capitalized interest	 	 	(4,959	)	 	 	(3,544	)	
 	 	 	 	 	 	 	
Total	 	 	40,923	 	 	 	46,533	 	
 	 	 	 	 	 	 	
INCOME FROM CONTINUING OPERATIONS BEFORE INCOME TAXES	 	 	160,114	 	 	 	140,089	 	
INCOME TAXES	 	 	49,271	 	 	 	54,988	 	
 	 	 	 	 	 	 	
INCOME FROM CONTINUING OPERATIONS	 	 	110,843	 	 	 	85,101	 	
INCOME (LOSS) FROM DISCONTINUED OPERATIONS	 	 	 	 	 	 	 	 	
Net of income tax expense (benefit) of $855 and $(37,673) (Note 17)	 	 	1,311	 	 	 	(58,366	)	
 	 	 	 	 	 	 	
NET INCOME	 	$	112,154	 	 	$	26,735	 	
 	 	 	 	 	 	 	
WEIGHTED-AVERAGE COMMON SHARES OUTSTANDING – BASIC	 	 	99,221	 	 	 	96,192	 	
WEIGHTED-AVERAGE COMMON SHARES OUTSTANDING – DILUTED	 	 	99,640	 	 	 	96,299	 	
 	 	 	 	 	 	 	 	 	
EARNINGS PER WEIGHTED – AVERAGE COMMON SHARE OUTSTANDING	 	 	 	 	 	 	 	 	
Income from continuing operations – basic	 	$	1.12	 	 	$	0.88	 	
Net income – basic	 	 	1.13	 	 	 	0.28	 	
Income from continuing operations – diluted	 	 	1.11	 	 	 	0.88	 	
Net income – diluted	 	 	1.13	 	 	 	0.28	 	
DIVIDENDS DECLARED PER SHARE	 	$	—	 	 	$	—	 	
See Notes to Pinnacle West’s Condensed Consolidated Financial Statements.
4

Table of Contents

PINNACLE WEST CAPITAL CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(unaudited)
(dollars and shares in thousands, except per share amounts)
 	 	 	 	 	 	 	 	 	
 	 	Six Months Ended	 	
 	 	June 30,	 	
 	 	2006	 	 	2005	 	
OPERATING REVENUES	 	 	 	 	 	 	 	 	
Regulated electricity segment	 	$	1,178,844	 	 	$	995,682	 	
Marketing and trading segment	 	 	174,927	 	 	 	160,429	 	
Real estate segment	 	 	220,457	 	 	 	154,195	 	
Other revenues	 	 	21,006	 	 	 	30,394	 	
 	 	 	 	 	 	 	
Total	 	 	1,595,234	 	 	 	1,340,700	 	
 	 	 	 	 	 	 	
OPERATING EXPENSES	 	 	 	 	 	 	 	 	
Regulated electricity segment fuel and purchased power	 	 	421,339	 	 	 	239,013	 	
Marketing and trading segment fuel and purchased power	 	 	146,891	 	 	 	128,402	 	
Operations and maintenance	 	 	346,759	 	 	 	308,181	 	
Real estate segment operations	 	 	169,742	 	 	 	123,047	 	
Depreciation and amortization	 	 	176,918	 	 	 	176,267	 	
Taxes other than income taxes	 	 	68,273	 	 	 	69,203	 	
Other expenses	 	 	16,952	 	 	 	25,930	 	
 	 	 	 	 	 	 	
Total	 	 	1,346,874	 	 	 	1,070,043	 	
 	 	 	 	 	 	 	
OPERATING INCOME	 	 	248,360	 	 	 	270,657	 	
 	 	 	 	 	 	 	
OTHER	 	 	 	 	 	 	 	 	
Allowance for equity funds used during construction	 	 	7,434	 	 	 	5,555	 	
Other income (Note 14)	 	 	17,489	 	 	 	9,487	 	
Other expense (Note 14)	 	 	(10,356	)	 	 	(8,232	)	
 	 	 	 	 	 	 	
Total	 	 	14,567	 	 	 	6,810	 	
 	 	 	 	 	 	 	
INTEREST EXPENSE	 	 	 	 	 	 	 	 	
Interest charges	 	 	93,408	 	 	 	96,042	 	
Capitalized interest	 	 	(8,983	)	 	 	(6,833	)	
 	 	 	 	 	 	 	
Total	 	 	84,425	 	 	 	89,209	 	
 	 	 	 	 	 	 	
INCOME FROM CONTINUING OPERATIONS BEFORE INCOME TAXES	 	 	178,502	 	 	 	188,258	 	
INCOME TAXES	 	 	56,064	 	 	 	73,558	 	
 	 	 	 	 	 	 	
INCOME FROM CONTINUING OPERATIONS	 	 	122,438	 	 	 	114,700	 	
INCOME (LOSS) FROM DISCONTINUED OPERATIONS	 	 	 	 	 	 	 	 	
Net of income tax expense (benefit) of $1,412 and $(40,992) (Note 17)	 	 	2,171	 	 	 	(63,517	)	
 	 	 	 	 	 	 	
NET INCOME	 	$	124,609	 	 	$	51,183	 	
 	 	 	 	 	 	 	
WEIGHTED-AVERAGE COMMON SHARES OUTSTANDING – BASIC	 	 	99,168	 	 	 	94,089	 	
WEIGHTED-AVERAGE COMMON SHARES OUTSTANDING – DILUTED	 	 	99,562	 	 	 	94,189	 	
 	 	 	 	 	 	 	 	 	
EARNINGS PER WEIGHTED – AVERAGE COMMON SHARE OUTSTANDING	 	 	 	 	 	 	 	 	
Income from continuing operations – basic	 	$	1.23	 	 	$	1.22	 	
Net income – basic	 	 	1.26	 	 	 	0.54	 	
Income from continuing operations – diluted	 	 	1.23	 	 	 	1.22	 	
Net income – diluted	 	 	1.25	 	 	 	0.54	 	
DIVIDENDS DECLARED PER SHARE	 	$	1.00	 	 	$	0.95	 	
See Notes to Pinnacle West’s Condensed Consolidated Financial Statements.
5

Table of Contents

PINNACLE WEST CAPITAL CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEETS
(unaudited)
(dollars in thousands)
 	 	 	 	 	 	 	 	 	
 	 	June 30,	 	 	December 31,	 	
 	 	2006	 	 	2005	 	
ASSETS	 	 	 	 	 	 	 	 	
 	 	 	 	 	 	 	 	 	
CURRENT ASSETS	 	 	 	 	 	 	 	 	
Cash and cash equivalents	 	$	15,608	 	 	$	154,003	 	
Customer and other receivables	 	 	510,086	 	 	 	502,681	 	
Allowance for doubtful accounts	 	 	(4,868	)	 	 	(4,979	)	
Materials and supplies (at average cost)	 	 	112,891	 	 	 	109,736	 	
Fossil fuel (at average cost)	 	 	25,210	 	 	 	23,658	 	
Assets from risk management and trading activities (Note 10)	 	 	473,551	 	 	 	827,779	 	
Assets held for sale (Note 17)	 	 	22,568	 	 	 	202,645	 	
Other current assets	 	 	78,607	 	 	 	75,869	 	
 	 	 	 	 	 	 	
Total current assets	 	 	1,233,653	 	 	 	1,891,392	 	

INVESTMENTS AND OTHER ASSETS	 	 	 	 	 	 	 	 	
Real estate investments – net	 	 	453,947	 	 	 	390,702	 	
Assets from long-term risk management and trading activities (Note 10)	 	 	321,131	 	 	 	597,831	 	
Decommissioning trust accounts (Note 18)	 	 	306,981	 	 	 	293,943	 	
Other assets	 	 	118,034	 	 	 	111,931	 	
 	 	 	 	 	 	 	
Total investments and other assets	 	 	1,200,093	 	 	 	1,394,407	 	

PROPERTY, PLANT AND EQUIPMENT	 	 	 	 	 	 	 	 	
Plant in service and held for future use	 	 	10,974,195	 	 	 	10,727,695	 	
Less accumulated depreciation and amortization	 	 	3,725,592	 	 	 	3,622,884	 	
 	 	 	 	 	 	 	
Total	 	 	7,248,603	 	 	 	7,104,811	 	
Construction work in progress	 	 	337,949	 	 	 	327,172	 	
Intangible assets, net of accumulated amortization	 	 	101,293	 	 	 	90,916	 	
Nuclear fuel, net of accumulated amortization	 	 	57,394	 	 	 	54,184	 	
 	 	 	 	 	 	 	
Net property, plant and equipment	 	 	7,745,239	 	 	 	7,577,083	 	

DEFERRED DEBITS	 	 	 	 	 	 	 	 	
Deferred fuel and purchased power regulatory asset (Note 5)	 	 	174,666	 	 	 	172,756	 	
Other regulatory assets	 	 	176,018	 	 	 	151,123	 	
Other deferred debits	 	 	120,030	 	 	 	135,884	 	
 	 	 	 	 	 	 	
Total deferred debits	 	 	470,714	 	 	 	459,763	 	

TOTAL ASSETS	 	$	10,649,699	 	 	$	11,322,645	 	
 	 	 	 	 	 	 	
See Notes to Pinnacle West’s Condensed Consolidated Financial Statements.
6

Table of Contents

PINNACLE WEST CAPITAL CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEETS
(unaudited)
(dollars in thousands)
 	 	 	 	 	 	 	 	 	
 	 	June 30,	 	 	December 31,	 	
 	 	2006	 	 	2005	 	
LIABILITIES AND COMMON STOCK EQUITY	 	 	 	 	 	 	 	 	
 	 	 	 	 	 	 	 	 	
CURRENT LIABILITIES	 	 	 	 	 	 	 	 	
Accounts payable	 	$	293,386	 	 	$	377,107	 	
Accrued taxes	 	 	336,338	 	 	 	289,235	 	
Accrued interest	 	 	26,455	 	 	 	31,774	 	
Short-term borrowings	 	 	174,019	 	 	 	15,673	 	
Current maturities of long-term debt	 	 	85,601	 	 	 	384,947	 	
Customer deposits	 	 	66,952	 	 	 	60,509	 	
Deferred income taxes	 	 	24,845	 	 	 	94,710	 	
Liabilities from risk management and trading activities (Note 10)	 	 	399,368	 	 	 	720,693	 	
Other current liabilities (Note 10)	 	 	153,245	 	 	 	297,425	 	
 	 	 	 	 	 	 	
Total current liabilities	 	 	1,560,209	 	 	 	2,272,073	 	

LONG-TERM DEBT LESS CURRENT MATURITIES	 	 	2,815,665	 	 	 	2,608,455	 	

DEFERRED CREDITS AND OTHER	 	 	 	 	 	 	 	 	
Deferred income taxes	 	 	1,200,030	 	 	 	1,225,253	 	
Regulatory liabilities	 	 	570,697	 	 	 	592,494	 	
Liability for asset retirements	 	 	277,592	 	 	 	269,011	 	
Pension liability	 	 	284,060	 	 	 	264,476	 	
Liabilities from long-term risk management and trading activities (Note 10)	 	 	243,886	 	 	 	256,413	 	
Unamortized gain – sale of utility plant	 	 	43,469	 	 	 	45,757	 	
Other	 	 	369,162	 	 	 	363,749	 	
 	 	 	 	 	 	 	
Total deferred credits and other	 	 	2,988,896	 	 	 	3,017,153	 	

COMMITMENTS AND CONTINGENCIES (Notes 5, 12, 13 and 15)	 	 	 	 	 	 	 	 	
 	 	 	 	 	 	 	 	 	
COMMON STOCK EQUITY	 	 	 	 	 	 	 	 	
Common stock, no par value	 	 	2,079,774	 	 	 	2,067,377	 	
Treasury stock	 	 	(895	)	 	 	(1,245	)	
 	 	 	 	 	 	 	
Total common stock	 	 	2,078,879	 	 	 	2,066,132	 	
 	 	 	 	 	 	 	
Accumulated other comprehensive income (loss) (Note 11):	 	 	 	 	 	 	 	 	
Minimum pension liability adjustment	 	 	(97,277	)	 	 	(97,277	)	
Derivative instruments	 	 	84,233	 	 	 	262,397	 	
 	 	 	 	 	 	 	
Total accumulated other comprehensive income	 	 	(13,044	)	 	 	165,120	 	
 	 	 	 	 	 	 	
Retained earnings	 	 	1,219,094	 	 	 	1,193,712	 	
 	 	 	 	 	 	 	
Total common stock equity	 	 	3,284,929	 	 	 	3,424,964	 	

TOTAL LIABILITIES AND COMMON STOCK EQUITY	 	$	10,649,699	 	 	$	11,322,645	 	
 	 	 	 	 	 	 	
See Notes to Pinnacle West’s Condensed Consolidated Financial Statements.
7

Table of Contents

PINNACLE WEST CAPITAL CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited)
(dollars in thousands)
 	 	 	 	 	 	 	 	 	
 	 	Six Months Ended	 	
 	 	June 30,	 	
 	 	2006	 	 	2005	 	
CASH FLOWS FROM OPERATING ACTIVITIES	 	 	 	 	 	 	 	 	
Net Income	 	$	124,609	 	 	$	51,183	 	
Adjustments to reconcile net income to net cash provided by operating activities:	 	 	 	 	 	 	 	 	
Silverhawk impairment loss	 	 	—	 	 	 	91,057	 	
Depreciation and amortization including nuclear fuel	 	 	188,863	 	 	 	185,613	 	
Deferred fuel and purchased power	 	 	(94,565	)	 	 	(33,785	)	
Deferred fuel and purchased power amortization	 	 	92,656	 	 	 	—	 	
Allowance for equity funds used during construction	 	 	(7,434	)	 	 	(5,555	)	
Deferred income taxes	 	 	16,481	 	 	 	(36,209	)	
Change in mark-to-market valuations	 	 	11,730	 	 	 	(17,436	)	
Changes in current assets and liabilities:	 	 	 	 	 	 	 	 	
Customer and other receivables	 	 	(764	)	 	 	344	 	
Materials, supplies and fossil fuel	 	 	580	 	 	 	(15,773	)	
Other current assets	 	 	3,806	 	 	 	(27,571	)	
Accounts payable	 	 	(91,543	)	 	 	(107,299	)	
Accrued taxes	 	 	50,074	 	 	 	70,268	 	
Other current liabilities	 	 	5,754	 	 	 	16,726	 	
Proceeds from the sale of real estate assets	 	 	15,482	 	 	 	41,259	 	
Real estate investments	 	 	(61,758	)	 	 	(39,968	)	
Change in risk management and trading – assets	 	 	64,893	 	 	 	16,360	 	
Change in risk management and trading – liabilities	 	 	(132,448	)	 	 	5,603	 	
Change in collateral	 	 	(155,354	)	 	 	91,969	 	
Change in other long-term assets	 	 	4,532	 	 	 	6,016	 	
Change in other long-term liabilities	 	 	20,631	 	 	 	41,344	 	
 	 	 	 	 	 	 	
Net cash flow provided by operating activities	 	 	56,225	 	 	 	334,146	 	

CASH FLOWS FROM INVESTING ACTIVITIES	 	 	 	 	 	 	 	 	
Capital expenditures	 	 	(363,795	)	 	 	(302,880	)	
Capitalized interest	 	 	(8,983	)	 	 	(6,833	)	
Purchase of Sundance	 	 	—	 	 	 	(185,046	)	
Proceeds from the sale of Silverhawk	 	 	207,620	 	 	 	—	 	
Purchases of investment securities	 	 	(280,527	)	 	 	(1,579,906	)	
Proceeds from sale of investment securities	 	 	280,527	 	 	 	1,431,348	 	
Proceeds from nuclear decommissioning trust sales	 	 	114,875	 	 	 	82,764	 	
Investment in nuclear decommissioning trust	 	 	(125,246	)	 	 	(90,814	)	
Other	 	 	1,618	 	 	 	2,724	 	
 	 	 	 	 	 	 	
Net cash flow used for investing activities	 	 	(173,911	)	 	 	(648,643	)	

CASH FLOWS FROM FINANCING ACTIVITIES	 	 	 	 	 	 	 	 	
Issuance of long-term debt	 	 	255,984	 	 	 	664,003	 	
Repayment of long-term debt	 	 	(353,549	)	 	 	(430,673	)	
Short-term borrowings and payments — net	 	 	158,336	 	 	 	16,253	 	
Dividends paid on common stock	 	 	(99,227	)	 	 	(90,364	)	
Common stock equity issuance	 	 	8,910	 	 	 	271,069	 	
Other	 	 	8,837	 	 	 	21,246	 	
 	 	 	 	 	 	 	
Net cash flow provided by (used for) financing activities	 	 	(20,709	)	 	 	451,534	 	

NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS	 	 	(138,395	)	 	 	137,037	 	
 	 	 	 	 	 	 	 	 	
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD	 	 	154,003	 	 	 	163,366	 	

CASH AND CASH EQUIVALENTS AT END OF PERIOD	 	$	15,608	 	 	$	300,403	 	

Supplemental disclosure of cash flow information	 	 	 	 	 	 	 	 	
Cash paid during the period for:	 	 	 	 	 	 	 	 	
Income taxes, net of refunds	 	$	251	 	 	$	7,733	 	
Interest, net of amounts capitalized	 	$	87,290	 	 	$	87,617	 	
See Notes to Pinnacle West’s Condensed Consolidated Financial Statements.
8

Table of Contents

PINNACLE WEST CAPITAL CORPORATION
 NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
1. Consolidation and Nature of Operations
     The unaudited condensed consolidated financial statements include the accounts of Pinnacle West and our wholly-owned subsidiaries: APS, Pinnacle West Energy, APS Energy Services, SunCor and El Dorado. 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. Condensed Consolidated Financial Statements
     Our unaudited condensed consolidated financial statements reflect all adjustments which we believe are necessary for the fair presentation of our financial position, results of operations and cash flows for the periods presented. 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 2005 Form 10-K.
3. Quarterly Fluctuations
     Weather conditions cause significant seasonal fluctuations in our revenues. In addition, real estate and trading and wholesale marketing activities can have significant impacts on our results for interim periods. For these reasons, results for interim periods do not necessarily represent results to be expected for the year.
4. Changes in Liquidity
     In January 2006, Pinnacle West infused into APS $210 million of the proceeds from the sale of Silverhawk. See “Equity Infusions” in Note 5 for more information.
     On February 28, 2006, Pinnacle West entered into an Uncommitted Master Shelf Agreement with Prudential Investment Management, Inc. (“Prudential”) and certain of its affiliates. The agreement provides the terms under which Pinnacle West may offer up to $200 million of its senior notes for purchase by Prudential affiliates at any time prior to December 31, 2007. The maturity of notes issued under the agreement cannot exceed five years. Pursuant to the agreement, on February 28, 2006, Pinnacle West issued and sold to Prudential affiliates $175 million of its 5.91% Senior Notes, Series A, due February 28, 2011 (the “Series A Notes”).
     On April 3, 2006, Pinnacle West repaid $300 million of its 6.40% Senior Notes due April 2006. Pinnacle West used the proceeds of the Series A Notes, cash on hand and commercial paper proceeds to repay these notes.
     On August 3, 2006, APS issued $400 million of debt as follows: $250 million of its 6.25% Notes due 2016 and $150 million of its 6.875% Notes due 2036. A portion of the proceeds will be used to pay at
9

Table of Contents

PINNACLE WEST CAPITAL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
maturity approximately $84 million of APS’ 6.75% Senior Notes due November 15, 2006, to fund its construction program and for other general corporate purposes. A portion of the proceeds may also be used to pay any liability determined to be payable as a result of the review by the Internal Revenue Service of a tax refund the Company received in 2002.
     The following table shows principal payments due on Pinnacle West’s and APS’ total long-term debt and capitalized lease requirements (dollars in millions) as of June 30, 2006:
 	 	 	 	 	 	 	 	 	
       Year	 	Pinnacle West	 	APS	
2006	 	$	86	 	 	$	85	 	
2007	 	 	2	 	 	 	1	 	
2008	 	 	130	 	 	 	1	 	
2009	 	 	27	 	 	 	1	 	
2010	 	 	227	 	 	 	224	 	
Thereafter	 	 	2,438	 	 	 	2,261	 	
 	 	 	 	 	
Total	 	$	2,910	 	 	$	2,573	 	
 	 	 	 	 	
5. Regulatory Matters
APS General Rate Case
     On January 31, 2006, APS filed with the ACC updated financial schedules, testimony and other data in the general rate case that APS originally filed on November 4, 2005. As requested by the ACC staff, the updated information uses the twelve months ended September 30, 2005 as the test period instead of the test year ended December 31, 2004 used in APS’ original filing. As a result of the updated filing, APS is requesting a 21.3%, or $453.9 million, increase in its annual retail electricity revenues effective no later than December 31, 2006. The original filing requested a 19.9%, or $409.1 million, retail rate increase.
     The updated requested rate increase is designed to recover the following (dollars in millions):
 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
 	 	Updated Filing	 	 	Original Filing	 	
 	 	(January 31, 2006)	 	 	(November 4, 2005)	 	
 	 	Annual	 	 	 	 	 	 	Annual	 	 	 	 	
 	 	Revenue	 	 	Percentage	 	 	Revenue	 	 	Percentage	 	
 	 	Increase	 	 	Increase	 	 	Increase	 	 	Increase	 	
Increased fuel and purchased power	 	$	299.0	 	 	 	14.0	%	 	$	246.8	 	 	 	12.0	%	
Capital structure update	 	 	98.3	 	 	 	4.6	%	 	 	96.8	 	 	 	4.7	%	
Rate base update, including acquisition of Sundance Plant	 	 	46.2	 	 	 	2.2	%	 	 	42.5	 	 	 	2.1	%	
Pension funding	 	 	41.3	 	 	 	1.9	%	 	 	41.2	 	 	 	2.0	%	
Other items	 	 	(30.9	)	 	 	(1.4	)%	 	 	(18.2	)	 	 	(0.9	)%	

Total increase	 	$	453.9	 	 	 	21.3	%	 	$	409.1	 	 	 	19.9	%	
 	 	 	 	 	 	 	 	 	 	 	 	 	
     The request is based on (a) a rate base of $4.4 billion as of September 30, 2005; (b) a base rate for fuel and purchased power costs of $0.031904 per kilowatt-hour based on estimated 2006
10

Table of Contents

PINNACLE WEST CAPITAL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
prices; and (c) a proposed capital structure of 45% long-term debt and 55% common stock equity, with a weighted-average cost of capital of 8.73% (5.41% for long-term debt and 11.50% for common stock equity). The requested increase in annual retail electricity revenues from the original filing is based solely on increased fuel and purchased power costs, slightly offset by other items (see the above chart). If the ACC approves the requested base rate increase for fuel and purchased power costs (see clause (b) of this paragraph), subsequent PSA rate adjustments and/or PSA surcharges would be reduced because more of such costs would be recovered in base rates.
     The updated request does not include the PSA annual adjustor rate increase of approximately 5% that took effect February 1, 2006, the PSA surcharge increase of approximately 0.7% that took effect May 1, 2006, or APS’ pending application for a 1.9% PSA surcharge rate increase. See “Power Supply Adjustor” below. The interim rate increase described immediately below would, if it becomes permanent, accelerate the recovery of a portion of the fuel and purchased power component of the general rate case request.
Interim Rate Increase
     On January 6, 2006, APS filed with the ACC an application requesting an emergency interim rate increase of $299 million, or approximately 14%, to be effective April 1, 2006. APS later reduced this request to $232 million, or approximately 11%, due to a decline in expected 2006 natural gas and wholesale power prices. The purpose of the emergency interim rate increase was solely to address APS’ under-collection of higher annual fuel and purchased power costs. On May 2, 2006, the ACC approved an order in this matter that, among other things:

 	•	 	authorized an interim PSA adjustor, effective May 1, 2006, that resulted in an interim retail rate increase of approximately 8.3% designed to recover approximately $138 million of fuel and purchased power costs incurred in 2006 (this interim adjustor, combined with the $15 million PSA surcharge approved by the ACC (see “Surcharge for Certain 2005 PSA Deferrals” below), resulted in a rate increase of approximately 9.0% designed to recover approximately $149 million of fuel and purchased power costs during 2006);	
 		
 	•	 	provides that amounts collected through the interim PSA adjustor “remain subject to a prudency review at the appropriate time” and that “all unplanned Palo Verde outage costs for 2006 should undergo a prudence audit by [the ACC] Staff” (see “PSA Deferrals Related to Unplanned Palo Verde Outages” below);	
 		
 	•	 	encourages parties to APS’ general rate case to “propose modifications to the PSA that will address on a permanent basis, the issues with timing of recovery when deferrals are large and growing”;	
 		
 	•	 	affirmed APS’ ability to defer fuel and purchased power costs above the prior annual cap of $776.2 million until the ACC decides the general rate case; and	
 		
 	•	 	encourages APS to diversify its resources “through large scale, sustained energy efficiency programs, [using] low cost renewable energy resources as a hedge against high fossil fuel costs.”	
11

Table of Contents

PINNACLE WEST CAPITAL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
As noted above, the interim PSA adjustor would, if it becomes permanent, accelerate the recovery of a portion of the fuel and purchased power component of APS’ general rate case and is not an additional increase.
Power Supply Adjustor
      PSA Provisions
     The PSA approved by the ACC in April 2005 as part of APS’ 2003 rate case provides for adjustment of retail rates to reflect variations in retail fuel and purchased power costs. On January 25, 2006, the ACC modified the PSA in certain respects. The PSA, as modified, is subject to specified parameters and procedures, including the following:

 	•	 	APS will record deferrals for recovery or refund to the extent actual retail fuel and purchased power costs vary from the base fuel amount (currently $0.020743 per kWh);	
 		
 	•	 	the deferrals are subject to a 90/10 sharing arrangement in which APS must absorb 10% of the retail fuel and purchased power costs above the base fuel amount and may retain 10% of the benefit from the retail fuel and purchased power costs that are below the base fuel amount;	
 		
 	•	 	amounts to be recovered or refunded through the PSA adjustor are limited to a) a cumulative plus or minus $0.004 per kWh from the base fuel amount over the life of the PSA and b) a maximum plus or minus $0.004 change in the adjustor rate in any one year;	
 		
 	•	 	the recoverable amount of annual retail fuel and purchased power costs through current base rates and the PSA was originally capped at $776.2 million; however, the ACC has removed the cap pending the ACC’s final ruling on APS’ pending request in the general rate case to have the cap eliminated or substantially raised;	
 		
 	•	 	the PSA will remain in effect for a minimum five-year period, but the ACC may eliminate the PSA at any time, if appropriate, in the event APS files a rate case before the expiration of the five-year period (which APS did by filing the general rate case noted above) or if APS does not comply with the terms of the PSA; and	
 		
 	•	 	APS is prohibited from requesting PSA surcharges until after the PSA annual adjustor rate has been set each year. The amount available for potential PSA surcharges will be limited to the amount of accumulated deferrals through the prior year-end, which are not expected to be recovered through the annual adjustor or any PSA surcharges previously approved by the ACC.	
      2006 PSA Annual Adjustor The effective date of the PSA’s annual adjustor is February 1, 2006 and the adjustor rate was set at the maximum $0.004 per kilowatt-hour effective February 1, 2006.
12

Table of Contents

PINNACLE WEST CAPITAL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
The change in the adjustor rate represents a retail rate increase of approximately 5% designed to recover $110 million of deferred fuel and purchased power costs over the twelve-month period beginning February 1, 2006.
      Surcharge for Certain 2005 PSA Deferrals On April 12, 2006, the ACC approved APS’ request to recover $15 million of 2005 PSA deferrals over a twelve-month period beginning May 2, 2006, representing a temporary rate increase of approximately 0.7%. Approximately $45 million of 2005 PSA deferrals remain subject to a pending application (see “PSA Deferrals Related to Unplanned Palo Verde Outages” below); the balance of the 2005 PSA deferrals is being recovered under the 2006 PSA annual adjustor described in the preceding paragraph.
      PSA Deferrals Related to Unplanned Palo Verde Outages On February 2, 2006, APS filed with the ACC an application to recover approximately $45 million over a twelve-month period, representing a temporary rate increase of approximately 1.9%, proposed to begin no later than the ACC’s completion of its inquiry regarding the unplanned 2005 Palo Verde outages.
     As noted under “Interim Rate Increase” above, the ACC has directed the ACC staff to conduct a “prudence audit” on unplanned 2006 Palo Verde outage costs. PSA deferrals related to these 2006 outages are estimated to be about $70 million.
      Proposed Modifications to PSA (Requested In General Rate Case)
     In its pending general rate case, APS has requested the following modifications to the PSA:

 	•	 	The cumulative plus or minus $0.004 per kWh limit from the base fuel amount over the life of the PSA would be eliminated, while the maximum plus or minus $0.004 limit to changes in the adjustor rate in any one year would remain in effect;	
 		
 	•	 	The $776.2 million annual limit on the retail fuel and purchased power costs under APS’ current base rates and the PSA would be removed or increased (although APS may defer fuel and purchased power costs above $776.2 million per year pending the ACC’s final ruling on APS’ pending request to have the cap eliminated or substantially raised);	
 		
 	•	 	The current provision that APS is required to file a surcharge application with the ACC after accumulated pretax PSA deferrals equal $50 million and before they equal $100 million would be eliminated, thereby giving APS flexibility in determining when a surcharge filing should be made;	
 		
 	•	 	The costs of renewable energy and capacity costs attributable to purchased power obtained through competitive procurement would be excluded from the existing 90/10 sharing arrangement under which APS absorbs 10% of the retail fuel and purchased power costs above the base fuel amount and retains 10% of the benefit from retail fuel and purchased power costs that are below the base fuel amount; and	
13

Table of Contents

PINNACLE WEST CAPITAL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 	•	 	10% of any realized gains or losses resulting from APS’ hedges of retail fuel and purchased power costs would be retained or absorbed by APS before being subject to the 90/10 sharing provision under the PSA.	
Equity Infusions
     On November 8, 2005, the ACC approved Pinnacle West’s request to infuse more than $450 million of equity into APS during 2005 or 2006. These infusions consist of about $250 million of the proceeds of Pinnacle West’s common equity issuance on May 2, 2005 and about $210 million of the proceeds from the sale of Silverhawk in January 2006 (see Note 17). Pinnacle West has made these equity infusions into APS.
Federal
      Price Mitigation Plan
     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. On February 13, 2006, the FERC increased this price cap to $400 per MWh for prospective sales. Sales at prices above the cap must be justified and are subject to potential refund.
      FERC Order
     On August 11, 2004, Pinnacle West, APS, Pinnacle West Energy, and APS Energy Services (collectively, the “Pinnacle West Companies”) submitted to the FERC an update to its three-year market-based rate review pursuant to the FERC’s order implementing a new generation market power analysis. On December 20, 2004, the FERC issued an order approving the Pinnacle West Companies’ market-based rates for control areas other than those of APS, Public Service Company of New Mexico (“PNM”) and Tucson Electric Power Company (“TEP”). The FERC staff required the Pinnacle West Companies to submit additional data with respect to these control areas, and the Pinnacle West Companies did so.
     On April 17, 2006, the FERC issued an order revoking the Pinnacle West Companies’ market-based rate authority in the APS control area (the “FERC Order”). The FERC found that the Pinnacle West Companies failed to provide the necessary information about the APS control area to allow the FERC to make a determination about the FERC’s generation market power “screens” in the APS control area. The FERC found that the Pinnacle West Companies may charge market-based rates in the PNM and TEP control areas.
     As a result of the FERC Order, the Pinnacle West Companies must charge cost-based rates, rather than market-based rates, in the APS control area for sales occurring after the date of the order, April 17, 2006. The Pinnacle West Companies are required to refund any amounts collected that exceed the default cost-based rates for all market rate sales within the APS control area from February 27, 2005 to April 17, 2006.
     The Pinnacle West Companies filed a rehearing request of the FERC Order on May 17, 2006 and requested a technical conference with the FERC staff to discuss the order. The rehearing request
14

Table of Contents

PINNACLE WEST CAPITAL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
is still pending. The FERC granted the request to hold a technical conference so that FERC staff and the Pinnacle West Companies may discuss how to implement the cost-based mitigation requirements of the FERC Order. The technical conference was held on July 10, 2006, and the Pinnacle West Companies submitted a supplemental compliance filing on July 31, 2006. Based upon an analysis of the FERC Order and preliminary calculations of the refund obligations, at this time, neither Pinnacle West nor APS believes that the FERC Order will have a material adverse effect on its financial position, results of operations or cash flows.
6. Retirement Plans and Other Benefits
     Pinnacle West sponsors a qualified defined benefit and account balance pension plan, a nonqualified supplemental excess benefit retirement plan, and other postretirement benefit plans for the employees of Pinnacle West and our subsidiaries. Pinnacle West uses a December 31 measurement date for its pension and other postretirement benefit plans. The market-related value of our plan assets is their fair value at the measurement date.
     The following table provides details of the plans’ benefit costs for the three and six months ended June 30, 2006 and 2005. Also included is the portion of these costs charged to expense, including administrative costs and excluding amounts billed to electric plant participants or capitalized as overhead construction (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,	 	
 	 	2006	 	 	2005	 	 	2006	 	 	2005	 	 	2006	 	 	2005	 	 	2006	 	 	2005	 	
Service cost-benefits earned during the period	 	$	9	 	 	$	11	 	 	$	24	 	 	$	23	 	 	$	2	 	 	$	5	 	 	$	10	 	 	$	11	 	
Interest cost on benefit obligation	 	 	17	 	 	 	21	 	 	 	46	 	 	 	44	 	 	 	4	 	 	 	9	 	 	 	17	 	 	 	17	 	
Expected return on plan assets	 	 	(18	)	 	 	(21	)	 	 	(48	)	 	 	(44	)	 	 	(4	)	 	 	(8	)	 	 	(18	)	 	 	(16	)	
Amortization of:	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
Transition (asset) obligation	 	 	—	 	 	 	(1	)	 	 	(1	)	 	 	(2	)	 	 	—	 	 	 	1	 	 	 	2	 	 	 	2	 	
Prior service cost	 	 	1	 	 	 	1	 	 	 	1	 	 	 	1	 	 	 	—	 	 	 	—	 	 	 	—	 	 	 	—	 	
Net actuarial loss	 	 	4	 	 	 	4	 	 	 	12	 	 	 	10	 	 	 	1	 	 	 	2	 	 	 	4	 	 	 	5	 	
 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
Net periodic benefit cost	 	$	13	 	 	$	15	 	 	$	34	 	 	$	32	 	 	$	3	 	 	$	9	 	 	$	15	 	 	$	19	 	
 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
Portion of cost charged to expense	 	$	5	 	 	$	6	 	 	$	14	 	 	$	13	 	 	$	1	 	 	$	4	 	 	$	6	 	 	$	8	 	
 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
APS’ share of costs charged to expense	 	$	5	 	 	$	6	 	 	$	13	 	 	$	12	 	 	$	1	 	 	$	3	 	 	$	6	 	 	$	7	 	
 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
Contributions
     The contribution to our pension plan in 2006 is estimated to be approximately $50 million, $29 million of which has been contributed through June 30, 2006. The contribution to our other postretirement benefit plan in 2006 is estimated to be approximately $29 million. APS’ share is approximately 97% of both plans.
15

Table of Contents

PINNACLE WEST CAPITAL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
7. Business Segments
     We have three principal business segments (determined by products, services and the regulatory environment):

 	•	 	our regulated electricity segment, which consists of traditional regulated retail and wholesale electricity businesses (primarily electricity service to Native Load customers) and related activities and includes electricity generation, transmission and distribution;	
 		
 	•	 	our real estate segment, which consists of SunCor’s real estate development and investment activities; and	
 		
 	•	 	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.	
     Financial data for the three and six months ended June 30, 2006 and 2005 and at June 30, 2006 and December 31, 2005 by business segment is provided as follows (dollars in millions):
 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
 	 	Three Months Ended	 	 	Six Months Ended	 	
 	 	June 30,	 	 	June 30,	 	
 	 	2006	 	 	2005	 	 	2006	 	 	2005	 	
Operating Revenues:	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
Regulated electricity	 	$	713	 	 	$	580	 	 	$	1,179	 	 	$	996	 	
Real estate	 	 	113	 	 	 	84	 	 	 	220	 	 	 	154	 	
Marketing and trading	 	 	90	 	 	 	71	 	 	 	175	 	 	 	161	 	
Other	 	 	9	 	 	 	20	 	 	 	21	 	 	 	30	 	
 	 	 	 	 	 	 	 	 	 	 	 	 	
Total	 	$	925	 	 	$	755	 	 	$	1,595	 	 	$	1,341	 	

Net Income (Loss):	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
Regulated electricity	 	$	95	 	 	$	69	 	 	$	82	 	 	$	83	 	
Real estate	 	 	9	 	 	 	12	 	 	 	32	 	 	 	20	 	
Marketing and trading(a)	 	 	7	 	 	 	(55	)	 	 	10	 	 	 	(54	)	
Other	 	 	1	 	 	 	1	 	 	 	1	 	 	 	2	 	
 	 	 	 	 	 	 	 	 	 	 	 	 	
Total	 	$	112	 	 	$	27	 	 	$	125	 	 	$	51	 	

			
(a)	 	The three and six months ended June 30, 2005 include a loss in discontinued operations related to the sale of Silverhawk of $59 million and $65 million, respectively.	
16

Table of Contents

PINNACLE WEST CAPITAL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 	 	 	 	 	 	 	 	 	
 	 	As of	 	 	As of	 	
 	 	June 30, 2006	 	 	December 31, 2005	 	
 	 	 	 	 	 	 	
Assets:	 	 	 	 	 	 	 	 	
Regulated electricity	 	$	9,663	 	 	$	9,732	 	
Real estate	 	 	564	 	 	 	483	 	
Marketing and trading	 	 	391	 	 	 	1,070	 	
Other	 	 	32	 	 	 	38	 	
 	 	 	 	 	 	 	
Total	 	$	10,650	 	 	$	11,323	 	
 	 	 	 	 	 	 	
8. Stock-Based Compensation
     Pinnacle West offers stock-based compensation plans for officers and key employees of Pinnacle West and our subsidiaries.
     The 2002 Long-Term Incentive Plan (“2002 Plan”) allows Pinnacle West to grant performance shares, stock ownership incentive awards and non-qualified and performance-accelerated stock options to key employees. We have reserved 6 million shares of common stock for issuance under the 2002 plan. No more than 1.8 million shares may be issued in relation to performance share awards and stock ownership incentive awards. The plan also provides for the granting of new non-qualified stock options at a price per share not less than the fair market value of the common stock at the time of grant. The stock options vest over three years, unless certain performance criteria are met, which can accelerate the vesting period. The terms of the options cannot be longer than 10 years and the options cannot be repriced.
     Generally, each recipient of performance shares is entitled to receive shares of common stock at the end of a three-year period based upon Pinnacle West’s earnings per share growth rate during that three-year period compared to the earnings per share growth rate of all relevant companies in a specified utilities index. The number of shares of common stock a recipient is entitled to receive is determined by Pinnacle West’s relative percentile ranking during the three-year period.
     The 1994 Long-Term Incentive Plan (“1994 Plan”) includes outstanding options but no new options may be granted under the plan. Options vest one-third of the grant per year beginning one year after the date the option is granted and expire ten years from the date of the grant. The 1994 Plan also provided for the granting of any combination of shares of restricted stock, stock appreciation rights or dividend equivalents.
     In the third quarter of 2002, we began applying the fair value method of accounting for stock-based compensation, as provided for in SFAS No. 123, “Accounting for Stock-Based Compensation.” In accordance with the transition requirements of SFAS No. 123, 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 APB No. 25, “Accounting for Stock Issued to Employees.”
     Effective January 1, 2006, we prospectively adopted SFAS No. 123(R), “Share-Based Payment.” Because the fair value recognition provisions of both SFAS No. 123 and SFAS No. 123(R) are materially consistent with respect to our stock-based compensation plans, the adoption of SFAS No. 123(R) did not have a material impact on our financial statements.
17

Table of Contents

PINNACLE WEST CAPITAL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
     The compensation cost that has been charged against income for share-based compensation plans was $1.3 million and $4.1 million for the three and six months ended June 30, 2006, respectively compared to $1.6 million and $2.2 million for the three and six months ended June 30, 2005, respectively. The total income tax benefit recognized in the condensed consolidated income statement for share-based compensation arrangements was $0.5 million and $1.5 million for the three and six months ended June 30, 2006, respectively, compared to $0.6 million and $0.9 million for the three and six months ended June 30, 2005, respectively.
     The following table is a summary of option activity under our equity incentive plans as of June 30, 2006 and changes during the six months ending on that date:
 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
 	 	 	 	 	 	 	 	 	 	Weighted-	 	 	
 	 	 	 	 	 	 	 	 	 	Average	 	Aggregate	
 	 	 	 	 	 	Weighted-	 	Remaining	 	Intrinsic Value	
 	 	Shares	 	Average Exercise	 	Contractual Term	 	(dollars in	
Options	 	(in thousands)	 	Price	 	(Years)	 	thousands)	
Outstanding at January 1, 2006	 	 	1,696	 	 	$	39.65	 	 	 	 	 	 	 	 	 	
Exercised	 	 	(28	)	 	 	33.00	 	 	 	 	 	 	 	 	 	
Forfeited or expired	 	 	(21	)	 	 	43.92	 	 	 	 	 	 	 	 	 	
 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
Outstanding at June 30, 2006	 	 	1,647	 	 	 	39.70	 	 	 	4.6	 	 	$	3,411	 	
Exercisable at June 30, 2006	 	 	1,641	 	 	 	39.71	 	 	 	4.6	 	 	 	3,400	 	
 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
     There were no options granted during the six months ended June 30, 2006 and 2005. The intrinsic value of options exercised during the three months ended June 30, 2006 and 2005 was $0.2 million and $0.6 million, respectively. The intrinsic value of options exercised during the six months ended June 30, 2006 and 2005 was $0.2 million and $1.1 million, respectively.
     The following table is a summary of the status of stock compensation awards, other than options, as of June 30, 2006 and changes during the six months ending on that date:
 	 	 	 	 	 	 	 	 	
 	 	Shares	 	Weighted-Average Grant-Date	
Nonvested shares	 	(in thousands)	 	Fair Value	
Nonvested at January 1, 2006	 	 	528	 	 	$	38.23	 	
Granted	 	 	274	 	 	 	41.50	 	
Vested	 	 	(13	)	 	 	44.13	 	
Forfeited	 	 	(224	)	 	 	36.10	 	
 	 	 	 	 	 	 	 	 	
Nonvested at June 30, 2006	 	 	565	 	 	 	40.52	 	
 	 	 	 	 	 	 	 	 	
     As of June 30, 2006, there was $8.6 million of total unrecognized compensation cost related to nonvested share-based compensation arrangements granted under the plan. That cost is expected to be recognized over a weighted-average period of 1.8 years. No shares vested during the three months ended June 30, 2006 and 2005. The total fair value of shares vested during the six months ended June 30, 2006 and 2005 was $0.5 million and $2.9 million, respectively.
18

Table of Contents

PINNACLE WEST CAPITAL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
     Cash received from options exercised under our share-based payment arrangements was $0.9 million and $2.1 million for the three months ended June 30, 2006 and 2005, respectively. Cash received from options exercised under our share-based payment arrangements was $0.9 million and $6.1 million for the six months ended June 30, 2006 and 2005, respectively. The actual tax benefit realized for the tax deductions from option exercises of the share-based payment arrangements was immaterial for the three and six months ended June 30, 2006 and 2005.
     Pinnacle West has a current policy of issuing new shares to satisfy share requirements for stock compensation plans and does not expect to repurchase any shares during 2006.
9. Variable-Interest Entities
     In 1986, APS entered into agreements with three separate VIE 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. We are not the primary beneficiary of the Palo Verde VIEs and, accordingly, do not consolidate them.
     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, 2006, APS would have been required to assume approximately $228 million of debt and pay the equity participants approximately $182 million.
10. Derivative and Energy Trading Accounting
     We use derivative instruments (primarily forward purchases and sales, swaps, options and futures) to manage our exposure to the commodity price risk inherent in the purchase and sale of fuel, electricity and emission allowances and credits, as well as interest rate risk associated with long-term debt. As of June 30, 2006, we hedged exposures to the price variability of the power and gas commodities for a maximum of 3.25 years. 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, after consideration of amounts deferred under the PSA, for the three and six months ended June 30, 2006 and 2005 are comprised of the following (dollars in thousands):
19

Table of Contents

PINNACLE WEST CAPITAL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
 	 	Three Months Ended	 	Six Months Ended	
 	 	June 30,	 	June 30,	
 	 	2006	 	2005	 	2006	 	2005	
Gains (losses) on the ineffective portion of derivatives qualifying for hedge accounting	 	$	(2,975	)	 	$	453	 	 	$	(3,154	)	 	$	7,777	 	
Gains (losses) from the change in options’ time value excluded from measurement of effectiveness	 	 	3	 	 	 	(119	)	 	 	(14	)	 	 	739	 	
Gains from the discontinuance of cash flow hedges	 	 	—	 	 	 	—	 	 	 	434	 	 	 	385	 	
     During the next twelve months ending June 30, 2007, we estimate that a net gain of $47 million before income taxes will be reclassified from accumulated OCI as an offset to the effect of market price changes for the related hedged transactions. To the extent the amounts are eligible for inclusion in the PSA, the amounts will be recorded as either a regulatory asset or liability and have no effect on earnings (see Note 5).
     Our assets and liabilities from risk management and trading activities are presented in two categories, consistent with our business segments.
     The following table summarizes our assets and liabilities from risk management and trading activities at June 30, 2006 and December 31, 2005 (dollars in thousands):
June 30, 2006
 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
 	 	 	 	 	 	Investments	 	 	 	 	 	 	Deferred	 	 	 	 	
 	 	Current	 	 	and Other	 	 	Current	 	 	Credits and	 	 	Net Asset	 	
 	 	Assets	 	 	Assets	 	 	Liabilities	 	 	Other	 	 	(Liability)	 	
Regulated electricity:	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
Mark-to-market	 	$	330,793	 	 	$	192,384	 	 	$	(329,666	)	 	$	(161,754	)	 	$	31,757	 	
Margin account and options	 	 	15,632	 	 	 	—	 	 	 	—	 	 	 	(1,114	)	 	 	14,518	 	
Marketing and trading:	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
Mark-to-market	 	 	126,604	 	 	 	128,461	 	 	 	(55,085	)	 	 	(81,018	)	 	 	118,962	 	
Options and emission allowances	 	 	522	 	 	 	286	 	 	 	(14,617	)	 	 	—	 	 	 	(13,809	)	
 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
Total	 	$	473,551	 	 	$	321,131	 	 	$	(399,368	)	 	$	(243,886	)	 	$	151,428	 	
 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
20

Table of Contents

PINNACLE WEST CAPITAL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2005
 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
 	 	 	 	 	 	Investments	 	 	 	 	 	 	Deferred	 	 	 	 	
 	 	Current	 	 	and Other	 	 	Current	 	 	Credits and	 	 	Net Asset	 	
 	 	Assets	 	 	Assets	 	 	Liabilities	 	 	Other	 	 	(Liability)	 	
Regulated electricity:	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
Mark-to-market	 	$	516,399	 	 	$	228,873	 	 	$	(335,801	)	 	$	(74,787	)	 	$	334,684	 	
Margin account and options	 	 	1,814	 	 	 	—	 	 	 	(124,165	)	 	 	—	 	 	 	(122,351	)	
Marketing and trading:	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
Mark-to-market	 	 	307,883	 	 	 	291,122	 	 	 	(236,922	)	 	 	(181,417	)	 	 	180,666	 	
Options and emission allowances	 	 	1,683	 	 	 	77,836	 	 	 	(23,805	)	 	 	(209	)	 	 	55,505	 	
 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
Total	 	$	827,779	 	 	$	597,831	 	 	$	(720,693	)	 	$	(256,413	)	 	$	448,504	 	
 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
     We maintain a margin account with a broker to support our risk management and trading activities. The margin account was an asset of $13 million at June 30, 2006 and a liability of $123 million at December 31, 2005 and is included in the margin account in the table above. Cash is deposited with the broker in this account at the time futures or options contracts are initiated. The change in market value of these contracts (reflected in mark-to-market) requires adjustment of the margin account balance.
     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 $13 million at June 30, 2006 and $6 million at December 31, 2005, and is included in other current assets on the Condensed Consolidated Balance Sheets. Collateral provided to us by counterparties was $67 million at June 30, 2006 and $216 million at December 31, 2005, 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. Our risk management process assesses and monitors the financial exposure of all counterparties. Despite the fact that the great majority of trading counterparties’ securities are rated as investment grade by the credit rating agencies, there is still a possibility that one or more of these companies could default, resulting in a material impact on consolidated earnings for a given period. Counterparties in the portfolio consist principally of financial institutions, major energy companies, municipalities and local distribution companies. We maintain credit policies that we believe minimize overall credit risk to within acceptable limits. Determination of the credit quality of our counterparties is based upon a number of factors, including credit ratings and our evaluation of their financial condition. To manage credit risk, we employ collateral requirements, standardized agreements that allow for the netting of positive and negative exposures associated with a single counterparty and credit default swaps. Valuation adjustments are established representing our estimated credit losses on our overall exposure to counterparties.
21

Table of Contents

PINNACLE WEST CAPITAL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
11. Comprehensive Income (Loss)
     Components of comprehensive income (loss) for the three and six months ended June 30, 2006 and 2005 are as follows (dollars in thousands):
 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
 	 	Three Months	 	 	Six Months	 	
 	 	Ended June 30,	 	 	Ended June 30,	 	
 	 	2006	 	 	2005	 	 	2006	 	 	2005	 	
Net income	 	$	112,154	 	 	$	26,735	 	 	$	124,609	 	 	$	51,183	 	
 	 	 	 	 	 	 	 	 	 	 	 	 	
OCI (loss):	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
Net unrealized gains (losses) on derivative instruments (a)	 	 	(69,124	)	 	 	(24,220	)	 	 	(274,107	)	 	 	135,424	 	
Reclassification of realized gain to income (b)	 	 	(676	)	 	 	(9,769	)	 	 	(18,206	)	 	 	(15,688	)	
Income tax benefit (expense) related to items of OCI	 	 	27,257	 	 	 	13,334	 	 	 	114,149	 	 	 	(46,972	)	

Total OCI (loss)	 	 	(42,543	)	 	 	(20,655	)	 	 	(178,164	)	 	 	72,764	 	
 	 	 	 	 	 	 	 	 	 	 	 	 	
Comprehensive income (loss)	 	$	69,611	 	 	$	6,080	 	 	$	(53,555	)	 	$	123,947	 	

			
(a)	 	These amounts primarily include unrealized gains and losses on contracts used to hedge our forecasted electricity and natural gas requirements to serve Native Load. These changes are primarily due to changes in forward natural gas prices and wholesale electricity prices.	
 		
(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 Nuclear Fuel and Waste Disposal
     Nuclear power plant operators 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 Policy 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.
22

Table of Contents

PINNACLE WEST CAPITAL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
     APS currently estimates it will incur $147 million (in 2005 dollars) over the life of Palo Verde for its share of the costs related to the on-site interim storage of spent nuclear fuel. At June 30, 2006, APS had a regulatory asset of $2 million that represents amounts spent for on-site interim spent fuel storage net of amounts recovered in rates per the ACC rate order that was effective April 1, 2005.
California Energy Market Issues and Refunds in the Pacific Northwest
      FERC
     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. However, on September 6, 2005, the Ninth Circuit issued a decision, concluding that the FERC may not order refunds from entities that are not within the FERC’s jurisdiction. Because a number of the entities owing refunds under the FERC’s calculations are not within the FERC’s jurisdiction, this order may affect the level of recovery of refunds due in this proceeding. In addition, on August 8, 2005, the FERC issued an order allowing sellers in the California markets to demonstrate that its refund methodology results in an overall revenue shortfall for their transactions in the relevant markets over a specified time frame. More than twenty sellers made such cost recovery filings on September 14, 2005. On January 26, 2006, the FERC conditionally accepted thirteen of these filings, reducing the refund liability for these sellers. Correspondingly, this will reduce the recovery of total refunds in the California markets. On August 2, 2006, the Ninth Circuit issued a decision on the appropriate temporal scope and the type of transactions properly subject to the refund orders. In the decision, the Court preserved the scope of the FERC’s existing refund proceedings, but also expanded it potentially to include additional transactions, remanding the orders to the FERC for further proceedings. Petitions for rehearing on this order and due 90 days from the date of issuance. We currently believe the refund claims at FERC will have no material adverse impact on our financial position, results of operations, cash flow or liquidity.
     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 under market-based rates. 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 was dismissed by the FERC and the State of California appealed the matter to the Ninth Circuit Court of Appeals. In an order issued September 9, 2004, the Ninth Circuit upheld the FERC’s authority to permit market-based rates, but rejected the FERC’s claim that it was without authority to consider retroactive refunds when a utility has not strictly adhered to the quarterly reporting requirements of the market-based rate system. On September 9, 2004, the Ninth Circuit remanded the case to the FERC for further proceedings. Several of the intervenors in this appeal filed a petition for rehearing of this decision on October 25, 2004. The petition for rehearing was denied on July 31, 2006. On August 4, 2006, the State of California filed a motion to stay the issuance of the mandate (scheduled to be issued on August 7, 2006), until the end of the period for seeking rehearing in the California refund proceeding before the Ninth Circuit, discussed above. The outcome of the further proceedings cannot be predicted at this time.
     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 Ninth Circuit Court of Appeals. 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
23

Table of Contents

PINNACLE WEST CAPITAL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
the amounts alleged in the proceedings, will have a material adverse impact on our financial position, results of operations or cash flows.
     On March 26, 2003, the 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 Independent System Operator 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.
FERC Order
     See “FERC Order” in Note 5 for a discussion of an order issued by the FERC on April 17, 2006.
Natural Gas Supply
     Pursuant to the terms of a comprehensive settlement entered into in 1996 with El Paso Natural Gas Company, the rates charged for natural gas transportation were subject to a rate moratorium through December 31, 2005.
     On July 9, 2003, the FERC issued an order that altered the capacity rights of parties to the 1996 settlement but maintained the cost responsibility provisions agreed to by parties to that settlement. On December 28, 2004, the D.C. Court of Appeals upheld the FERC’s authority to alter the capacity rights of parties to the settlement. With respect to the FERC’s authority to maintain the cost responsibility provisions of the settlement, a party has sought appellate review and is seeking to reallocate the cost responsibility associated with the changed contractual obligations in a way that would be less favorable to APS and Pinnacle West Energy than under the FERC’s July 9, 2003 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 after income taxes for the period September 2003 through December 2005. This appeal had been stayed pending further consideration by the FERC. On May 26, 2006, the FERC issued an Order on Remand affirming its earlier decision that there is no basis for modifying the settlement rates during the remaining term of the settlement. Despite the May 26 order, the party seeking appellate review is continuing to pursue an appeal of this issue.
     Consistent with its obligations under the 1996 settlement, El Paso filed a new rate case on June 30, 2005, which proposed new rates, terms and conditions and services to become effective on January 1, 2006. These rates are subject to refund pending the outcome of a hearing. The cost impact of this rate case will not have a material adverse effect on APS’ financial position, results of operations, cash flows or liquidity.
Navajo Nation Litigation
     In June 1999, the Navajo Nation served Salt River Project with a lawsuit filed in the United States District Court for the District of Columbia (the “D.C. Lawsuit”) naming Salt River Project, several Peabody Coal Company entities (collectively, “Peabody”), Southern California Edison Company and other defendants, and citing various claims in connection with the renegotiations of the coal royalty and lease agreements under which Peabody mines coal for the Navajo Generating Station and the Mohave Generating Station. APS is a 14% owner of the Navajo Generating Station, which Salt River Project operates. The D.C. Lawsuit alleges, among other things, that the defendants
24

Table of Contents

PINNACLE WEST CAPITAL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
obtained a favorable coal royalty rate by improperly influencing the outcome of a federal administrative process under which the royalty rate was to be adjusted. The suit seeks $600 million in damages, treble damages, punitive damages of not less than $1 billion, and the ejection of defendants “from all possessory interests and Navajo Tribal lands arising out of the [primary coal lease].” In July 2001, the court dismissed all claims against Salt River Project.
     In January 2005, Peabody served APS with a lawsuit filed in the Circuit Court for the City of St. Louis naming APS and the other Navajo Generating Station participants and seeking, among other things, a declaration that the participants “are obligated to reimburse Peabody for any royalty, tax, or other obligation arising out of the D.C. Lawsuit.” Based on APS’ ownership interest, however, in the Navajo Generating Station, APS could be liable for up to 14% of any such obligation. APS believes Peabody's claims are without merit and intends to contest those claims. Because the litigation is in preliminary stages, however, APS cannot currently predict the outcome of this matter.
Superfund
     Superfund establishes liability for the cleanup of hazardous substances found contaminating the soil, water or air. Those who generated, transported or disposed of hazardous substances at a contaminated site are among those who are PRPs. PRPs may be strictly, and often jointly and severally, liable for clean-up. On September 3, 2003, the EPA advised APS that the EPA considers APS to be a PRP in the Motorola 52 nd Street Superfund Site, Operable Unit 3 (OU3) in Phoenix, Arizona. APS has facilities that are within this superfund site. APS and Pinnacle West have agreed with the EPA to perform certain investigative activities of the APS facilities within OU3. Because the investigation has not yet been completed and ultimate remediation requirements are not yet finalized, neither APS nor Pinnacle West can currently estimate the expenditures which may be required.
Income Taxes
     As a result of a change in IRS guidance, we claimed a tax deduction related to an APS tax accounting method change on the 2001 federal consolidated income tax return. The accelerated deduction resulted in a $200 million reduction in the current income tax liability and a corresponding increase in the plant-related deferred tax liability. In 2002, we received an income tax refund of approximately $115 million related to our 2001 federal consolidated income tax return. The 2001 federal consolidated income tax return is currently under examination by the IRS. As part of this ongoing examination, the IRS is reviewing this accounting method change and the resultant deduction. During 2004 and again in 2005, the current income tax liability was increased, with a corresponding decrease to plant-related deferred tax liability, to reflect the expected outcome of this audit. We do not expect the ultimate outcome of this examination to have a material adverse impact on our financial position or results of operations. We expect that it will have a negative impact on cash flows.
25

Table of Contents

PINNACLE WEST CAPITAL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
Litigation
     We are party to various other claims, legal actions and complaints arising in the ordinary course of business, including but not limited to environmental matters related to the Clean Air Act, Navajo Nation issues and EPA and ADEQ issues. In our opinion, the ultimate resolution of these matters will not have a material adverse effect on our financial position, results of operations, cash flows or liquidity.
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. This potential liability is covered by primary liability insurance provided by commercial insurance carriers in the amount of $300 million and the balance 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 $15 million per incident, to be periodically adjusted for inflation. Based on APS’ interest in the three Palo Verde units, APS’ maximum potential assessment per incident for all three units is approximately $88 million, with an annual payment limitation of approximately $13 million.
     The Palo Verde participants maintain “all risk” (including nuclear hazards) insurance for property damage to, and decontamination of, property at Palo Verde in the aggregate amount of $2.75 billion, a substantial portion of which must first be applied to stabilization and decontamination. APS has also secured insurance against portions of any increased cost of generation or purchased power and business interruption resulting from a sudden and unforeseen accidental outage of any of the three units. The property damage, decontamination, and replacement power coverages are provided by Nuclear Electric Insurance Limited (NEIL). APS is subject to retrospective assessments under all NEIL policies if NEIL’s losses in any policy year exceed accumulated funds. The maximum amount of retrospective assessments APS could incur under the current NEIL policies totals $17.8 million. The insurance coverage discussed in this and the previous paragraph is subject to certain policy conditions and exclusions.
14. 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, 2006 and 2005 (dollars in thousands):
26

Table of Contents

PINNACLE WEST CAPITAL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
 	 	Three Months Ended	 	 	Six Months Ended	 	
 	 	June 30,	 	 	June 30,	 	
 	 	2006	 	 	2005	 	 	2006	 	 	2005	 	
Other income:	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
Asset sales	 	$	8,810	 	 	$	142	 	 	$	9,171	 	 	$	383	 	
Interest income	 	 	2,285	 	 	 	3,872	 	 	 	7,190	 	 	 	5,191	 	
SunCor joint venture earnings	 	 	717	 	 	 	2,370	 	 	 	883	 	 	 	2,342	 	
Investment gains – net (a)	 	 	—	 	 	 	923	 	 	 	—	 	 	 	—	 	
Miscellaneous	 	 	210	 	 	 	1,377	 	 	 	245	 	 	 	1,571	 	
 	 	 	 	 	 	 	 	 	 	 	 	 	
Total other income	 	$	12,022	 	 	$	8,684	 	 	$	17,489	 	 	$	9,487	 	

Other expense:	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
Non-operating costs (b)	 	$	(3,828	)	 	$	(3,058	)	 	$	(7,547	)	 	$	(6,156	)	
Investment losses – net (a)	 	 	(1,066	)	 	 	—	 	 	 	(1,097	)	 	 	(326	)	
Miscellaneous	 	 	(921	)	 	 	(788	)	 	 	(1,712	)	 	 	(1,750	)	
 	 	 	 	 	 	 	 	 	 	 	 	 	
Total other expense	 	$	(5,815	)	 	$	(3,846	)	 	$	(10,356	)	 	$	(8,232	)	

			
(a)	 	Includes joint venture and other non-operating income.	
 		
(b)	 	As defined by the FERC, includes below-the-line non-operating utility costs (primarily community relations and other costs excluded from utility rate recovery).	
15. Guarantees
     We have issued parental guarantees and letters of credit and obtained surety bonds on behalf of APS Energy Services. Our credit support instruments enable APS Energy Services to offer commodity energy and energy-related products. Non-performance or non-payment under the original contract by APS Energy Services would require us to perform under the guarantee or surety bond. No liability is currently recorded on the Condensed Consolidated Balance Sheets related to Pinnacle West’s current outstanding guarantees on behalf of its subsidiary. Our guarantees have no recourse or collateral provisions to allow us to recover amounts paid under the guarantees. At June 30, 2006, we had guarantees totaling $21 million and surety bonds totaling $24 million with a term of approximately one year for APS Energy Services.
     At June 30, 2006, Pinnacle West had approximately $4 million of letters of credit related to workers’ compensation expiring in 2007. 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.
     APS has entered into various agreements that require letters of credit for financial assurance purposes. At June 30, 2006, approximately $200 million of letters of credit were outstanding to support existing pollution control bonds of approximately $200 million. The letters of credit are available to fund the payment of principal and interest of such debt obligations and expire in 2010. APS has also entered into approximately $93 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 2010. Additionally, at June 30, 2006 APS had approximately $5 million of letters of credit related to counterparty collateral requirements
27

Table of Contents

PINNACLE WEST CAPITAL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
expiring in 2006. 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 enter into agreements that include indemnification provisions relating to liabilities arising from or related to certain of our agreements. APS has agreed to indemnify the equity participants and other parties in the Palo Verde sale leaseback transactions with respect to certain tax matters. Generally, a maximum obligation is not explicitly stated in the indemnification provisions and, therefore, the overall maximum amount of the obligation under such indemnification provisions cannot be reasonably estimated. Based on historical experience and evaluation of the specific indemnities, we do not believe that any material loss related to such indemnification provisions is likely.
16. Earnings Per Share
     The following table presents earnings per weighted average common share outstanding for the three and six months ended June 30, 2006 and 2005:
 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
 	 	Three Months Ended	 	 	Six Months Ended	 	
 	 	June 30,	 	 	June 30,	 	
 	 	2006	 	 	2005	 	 	2006	 	 	2005	 	
Basic earnings per share:	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
Income from continuing operations	 	$	1.12	 	 	$	0.88	 	 	$	1.23	 	 	$	1.22	 	
Income (loss) from discontinued operations	 	 	0.01	 	 	 	(0.60	)	 	 	0.03	 	 	 	(0.68	)	
 	 	 	 	 	 	 	 	 	 	 	 	 	
Earnings per share – basic	 	$	1.13	 	 	$	0.28	 	 	$	1.26	 	 	$	0.54	 	

Diluted earnings per share:	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
Income from continuing operations	 	$	1.11	 	 	$	0.88	 	 	$	1.23	 	 	$	1.22	 	
Income (loss) from discontinued operations	 	 	0.02	 	 	 	(0.60	)	 	 	0.02	 	 	 	(0.68	)	
 	 	 	 	 	 	 	 	 	 	 	 	 	
Earnings per share – diluted	 	$	1.13	 	 	$	0.28	 	 	$	1.25	 	 	$	0.54	 	
 	 	 	 	 	 	 	 	 	 	 	 	 	
     Dilutive stock options and performance shares increased average common shares outstanding by approximately 419,000 shares and 107,000 shares for the three months ended June 30, 2006 and 2005, respectively, and by approximately 394,000 shares and 100,000 shares for the six months ended June 30, 2006 and 2005, respectively.
     Options to purchase 881,628 shares for the three-month period ended June 30, 2006 and 808,876 shares for the six-month period ended June 30, 2006 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 491,984 shares for the three-month period ended June 30, 2005 and 503,859 shares for the six-month period ended June 30, 2005.
28

Table of Contents

PINNACLE WEST CAPITAL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
17. Discontinued Operations
      Silverhawk (marketing and trading segment) – In June 2005, we entered into an agreement to sell our 75% interest in the Silverhawk Power Station to NPC. The sale was completed on January 10, 2006. As a result of this sale, we recorded a loss from discontinued operations of approximately $56 million ($91 million pretax) in the second quarter of 2005. The marketing and trading segment discontinued operations amounts in the chart below also include the revenues and expenses related to the operations of Silverhawk.
      SunCor (real estate segment) – In 2005 and 2006, SunCor sold commercial properties that are required to be reported as discontinued operations on Pinnacle West’s Condensed Consolidated Statements of Income in accordance with SFAS No. 144.
     The following table provides revenue and income (loss) before income taxes and after income taxes classified as discontinued operations on Pinnacle West’s Condensed Consolidated Statements of Income for the three and six months ended June 30, 2006 and 2005 (dollars in millions):
 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
 	 	Three Months Ended	 	 	Six Months Ended	 	
 	 	June 30,	 	 	June 30,	 	
 	 	2006	 	 	2005	 	 	2006	 	 	2005	 	
Revenue:	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
Silverhawk	 	$	—	 	 	$	15	 	 	$	1	 	 	$	43	 	
SunCor – commercial operations	 	 	2	 	 	 	3	 	 	 	3	 	 	 	7	 	
 	 	 	 	 	 	 	 	 	 	 	 	 	
Total revenue	 	$	2	 	 	$	18	 	 	$	4	 	 	$	50	 	

Income (loss) before income taxes:	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
Silverhawk (a)	 	$	—	 	 	$	(97	)	 	$	1	 	 	$	(107	)	
SunCor – commercial operations	 	 	2	 	 	 	1	 	 	 	3	 	 	 	3	 	
 	 	 	 	 	 	 	 	 	 	 	 	 	
Total income (loss) before income taxes	 	$	2	 	 	$	(96	)	 	$	4	 	 	$	(104	)	

Income (loss) after income taxes:	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
Silverhawk	 	$	—	 	 	$	(59	)	 	$	1	 	 	$	(65	)	
SunCor – commercial operations	 	 	1	 	 	 	1	 	 	 	2	 	 	 	1	 	
 	 	 	 	 	 	 	 	 	 	 	 	 	
Total income (loss) after income taxes	 	$	1	 	 	$	(58	)	 	$	3	 	 	$	(64	)	

			
(a)	 	For the three and six months ended June 30, 2005, income (loss) before income taxes includes an interest expense allocation, net of capitalized costs, of $3 million and $6 million respectively. The allocation was based on Pinnacle West’s weighted-average interest rate applied to the net property, plant and equipment.	
18. Nuclear Decommissioning Trust
     To fund the costs APS expects to incur to decommission Palo Verde, APS established external decommissioning trusts in accordance with NRC regulations. APS invests the trust funds in debt and domestic equity securities. APS applies the provisions of SFAS No. 115, “Accounting for Certain Investments in Debt and Equity Securities,” in accounting for investments in
29

Table of Contents

PINNACLE WEST CAPITAL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
decommissioning trust funds, and classifies these investments as available for sale. As a result, we record the decommissioning trust funds at their fair value on our Condensed Consolidated Balance Sheets. Because of the ability of APS to recover decommissioning costs in rates and in accordance with the regulatory treatment for decommissioning trust funds, APS has recorded the offsetting amount of unrealized gains (losses) on investment securities in other regulatory liabilities/assets . The following table summarizes the fair value of APS’ nuclear decommissioning trust fund assets at June 30, 2006 and December 31, 2005 (dollars in millions):
 	 	 	 	 	 	 	 	 	 	 	 	 	
 	 	 	 	 	 	Total	 	 	Total	 	
 	 	 	 	 	 	Unrealized	 	 	Unrealized	 	
 	 	Fair Value	 	 	Gains	 	 	Losses	 	
June 30, 2006	 	 	 	 	 	 	 	 	 	 	 	 	
Equity securities	 	$	160	 	 	$	53	 	 	$	—	 	
Debt securities	 	 	147	 	 	 	1	 	 	 	2	 	
 	 	 	 	 	 	 	 	 	 	
Total	 	$	307	 	 	$	54	 	 	$	2	 	

December 31, 2005	 	 	 	 	 	 	 	 	 	 	 	 	
Equity securities	 	$	150	 	 	$	50	 	 	$	—	 	
Debt securities	 	 	144	 	 	 	3	 	 	 	1	 	
 	 	 	 	 	 	 	 	 	 	
Total	 	$	294	 	 	$	53	 	 	$	1	 	
 	 	 	 	 	 	 	 	 	 	
     The costs of securities sold are determined on the basis of specific identification. The following table sets forth approximate gains and losses and proceeds from the sale of securities by the nuclear decommissioning trust funds (dollars in millions):
 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
 	 	Three Months Ended June 30,	 	Six Months Ended June 30,	
 	 	2006	 	2005	 	2006	 	2005	
Realized gains	 	$	1	 	 	$	—	 	 	$	1	 	 	$	1	 	
Realized losses	 	 	(1	)	 	 	—	 	 	 	(2	)	 	 	(1	)	
Proceeds from the sale of securities	 	 	49	 	 	 	43	 	 	 	115	 	 	 	83	 	
     The fair value of debt securities, summarized by contractual maturities, at June 30, 2006 is as follows (dollars in millions):
 	 	 	 	 	
 	 	Fair Value	 	
 	 	June 30, 2006	 	
Less than one year	 	$	14	 	
1 year - 5 years	 	 	32	 	
5 years - 10 years	 	 	38	 	
Greater than 10 years	 	 	63	 	
 	 	 	 	
Total	 	$	147	 	
 	 	 	 	
30

Table of Contents

PINNACLE WEST CAPITAL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
19. New Accounting Standards
     In June 2006, the FASB issued FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes — an interpretation of FASB Statement No. 109.” This guidance requires us to recognize the tax benefits of an uncertain tax position if it is more likely than not that the benefit will be sustained upon examination by the taxing authority. The Interpretation is effective for fiscal years beginning after December 15, 2006. We are currently evaluating this new guidance and believe it will not have a material impact on our financial statements.
31

Table of Contents

ARIZONA PUBLIC SERVICE COMPANY
CONDENSED STATEMENTS OF INCOME
(unaudited)
(dollars in thousands)
 	 	 	 	 	 	 	 	 	
 	 	Three Months Ended	 	
 	 	June 30,	 	
 	 	2006	 	 	2005	 	
ELECTRIC OPERATING REVENUES	 	 	 	 	 	 	 	 	
Regulated electricity	 	$	714,727	 	 	$	581,757	 	
Marketing and trading	 	 	4,123	 	 	 	7,000	 	
 	 	 	 	 	 	 	
Total	 	 	718,850	 	 	 	588,757	 	

OPERATING EXPENSES	 	 	 	 	 	 	 	 	
Regulated electricity fuel and purchased power	 	 	265,735	 	 	 	201,871	 	
Marketing and trading fuel and purchased power	 	 	1,490	 	 	 	3,349	 	
Operations and maintenance	 	 	164,373	 	 	 	138,314	 	
Depreciation and amortization	 	 	87,969	 	 	 	76,808	 	
Income taxes	 	 	46,650	 	 	 	41,772	 	
Other taxes	 	 	32,666	 	 	 	31,322	 	
 	 	 	 	 	 	 	
Total	 	 	598,883	 	 	 	493,436	 	
 	 	 	 	 	 	 	
OPERATING INCOME	 	 	119,967	 	 	 	95,321	 	

OTHER INCOME (DEDUCTIONS)	 	 	 	 	 	 	 	 	
Income taxes	 	 	953	 	 	 	(1,549	)	
Allowance for equity funds used during construction	 	 	3,633	 	 	 	2,952	 	
Other income (Note S-3)	 	 	10,989	 	 	 	7,005	 	
Other expense (Note S-3)	 	 	(4,558	)	 	 	(2,876	)	
 	 	 	 	 	 	 	
Total	 	 	11,017	 	 	 	5,532	 	

INTEREST DEDUCTIONS	 	 	 	 	 	 	 	 	
Interest on long-term debt	 	 	34,890	 	 	 	35,612	 	
Interest on short-term borrowings	 	 	2,985	 	 	 	2,055	 	
Debt discount, premium and expense	 	 	1,025	 	 	 	1,188	 	
Allowance for borrowed funds used during construction	 	 	(1,673	)	 	 	(2,000	)	
 	 	 	 	 	 	 	
Total	 	 	37,227	 	 	 	36,855	 	

NET INCOME	 	$	93,757	 	 	$	63,998	 	
 	 	 	 	 	 	 	
See Notes to Pinnacle West’s Condensed Consolidated Financial Statements and Supplemental Notes to Arizona Public Service Company’s Condensed Financial Statements.
32

Table of Contents

ARIZONA PUBLIC SERVICE COMPANY
CONDENSED STATEMENTS OF INCOME
(unaudited)
(dollars in thousands)
 	 	 	 	 	 	 	 	 	
 	 	Six Months Ended	 	
 	 	June 30,	 	
 	 	2006	 	 	2005	 	
ELECTRIC OPERATING REVENUES	 	 	 	 	 	 	 	 	
Regulated electricity	 	$	1,181,949	 	 	$	1,000,191	 	
Marketing and trading	 	 	13,770	 	 	 	29,858	 	
 	 	 	 	 	 	 	
Total	 	 	1,195,719	 	 	 	1,030,049	 	

OPERATING EXPENSES	 	 	 	 	 	 	 	 	
Regulated electricity fuel and purchased power	 	 	424,009	 	 	 	283,785	 	
Marketing and trading fuel and purchased power	 	 	2,858	 	 	 	31,651	 	
Operations and maintenance	 	 	337,726	 	 	 	280,608	 	
Depreciation and amortization	 	 	174,280	 	 	 	159,022	 	
Income taxes	 	 	43,621	 	 	 	58,152	 	
Other taxes	 	 	68,214	 	 	 	62,767	 	
 	 	 	 	 	 	 	
Total	 	 	1,050,708	 	 	 	875,985	 	
 	 	 	 	 	 	 	
OPERATING INCOME	 	 	145,011	 	 	 	154,064	 	

OTHER INCOME (DEDUCTIONS)	 	 	 	 	 	 	 	 	
Income taxes	 	 	1,189	 	 	 	(2,386	)	
Allowance for equity funds used during construction	 	 	7,434	 	 	 	5,555	 	
Other income (Note S-3)	 	 	15,085	 	 	 	12,664	 	
Other expense (Note S-3)	 	 	(7,528	)	 	 	(6,234	)	
 	 	 	 	 	 	 	
Total	 	 	16,180	 	 	 	9,599	 	

INTEREST DEDUCTIONS	 	 	 	 	 	 	 	 	
Interest on long-term debt	 	 	69,140	 	 	 	71,129	 	
Interest on short-term borrowings	 	 	5,011	 	 	 	3,246	 	
Debt discount, premium and expense	 	 	2,198	 	 	 	2,192	 	
Allowance for borrowed funds used during construction	 	 	(3,394	)	 	 	(3,947	)	
 	 	 	 	 	 	 	
Total	 	 	72,955	 	 	 	72,620	 	

NET INCOME	 	$	88,236	 	 	$	91,043	 	
 	 	 	 	 	 	 	
See Notes to Pinnacle West’s Condensed Consolidated Financial Statements and Supplemental Notes to Arizona Public Service Company’s Condensed Financial Statements.
33

Table of Contents

ARIZONA PUBLIC SERVICE COMPANY
CONDENSED BALANCE SHEETS
(unaudited)
(dollars in thousands)
 	 	 	 	 	 	 	 	 	
 	 	June 30,	 	 	December 31,	 	
 	 	2006	 	 	2005	 	
ASSETS	 	 	 	 	 	 	 	 	
 	 	 	 	 	 	 	 	 	
UTILITY PLANT	 	 	 	 	 	 	 	 	
Electric plant in service and held for future use	 	$	10,919,272	 	 	$	10,682,999	 	
Less accumulated depreciation and amortization	 	 	3,718,938	 	 	 	3,616,886	 	
 	 	 	 	 	 	 	
Total	 	 	7,200,334	 	 	 	7,066,113	 	
Construction work in progress	 	 	323,975	 	 	 	314,584	 	
Intangible assets, net of accumulated amortization	 	 	100,932	 	 	 	90,327	 	
Nuclear fuel, net of accumulated amortization	 	 	57,394	 	 	 	54,184	 	
 	 	 	 	 	 	 	
Utility plant – net	 	 	7,682,635	 	 	 	7,525,208	 	

INVESTMENTS AND OTHER ASSETS	 	 	 	 	 	 	 	 	
Decommissioning trust accounts (Note 18)	 	 	306,981	 	 	 	293,943	 	
Assets from long-term risk management and trading activities (Note S-1)	 	 	195,319	 	 	 	234,372	 	
Other assets	 	 	64,654	 	 	 	64,128	 	
 	 	 	 	 	 	 	
Total investments and other assets	 	 	566,954	 	 	 	592,443	 	

CURRENT ASSETS	 	 	 	 	 	 	 	 	
Cash and cash equivalents	 	 	—	 	 	 	49,933	 	
Customer and other receivables	 	 	441,811	 	 	 	421,621	 	
Allowance for doubtful accounts	 	 	(3,438	)	 	 	(3,568	)	
Materials and supplies (at average cost)	 	 	112,891	 	 	 	109,736	 	
Fossil fuel (at average cost)	 	 	25,210	 	 	 	23,658	 	
Assets from risk management and trading activities (Note S-1)	 	 	349,657	 	 	 	532,923	 	
Deferred income taxes	 	 	3,364	 	 	 	—	 	
Other current assets	 	 	18,012	 	 	 	14,639	 	
 	 	 	 	 	 	 	
Total current assets	 	 	947,507	 	 	 	1,148,942	 	

DEFERRED DEBITS	 	 	 	 	 	 	 	 	
Deferred fuel and purchased power regulatory asset (Note 5)	 	 	174,666	 	 	 	172,756	 	
Other regulatory assets	 	 	176,018	 	 	 	151,123	 	
Unamortized debt issue costs	 	 	24,153	 	 	 	25,279	 	
Other deferred debits	 	 	79,311	 	 	 	91,690	 	
 	 	 	 	 	 	 	
Total deferred debits	 	 	454,148	 	 	 	440,848	 	

TOTAL ASSETS	 	$	9,651,244	 	 	$	9,707,441	 	
 	 	 	 	 	 	 	
See Notes to Pinnacle West’s Condensed Consolidated Financial Statements and Supplemental Notes to Arizona Public Service Company’s Condensed Financial Statements.
34

Table of Contents

ARIZONA PUBLIC SERVICE COMPANY
CONDENSED BALANCE SHEETS
(unaudited)
(dollars in thousands)
 	 	 	 	 	 	 	 	 	
 	 	June 30,	 	 	December 31,	 	
 	 	2006	 	 	2005	 	
CAPITALIZATION AND LIABILITIES	 	 	 	 	 	 	 	 	
 	 	 	 	 	 	 	 	 	
CAPITALIZATION	 	 	 	 	 	 	 	 	
Common stock	 	$	178,162	 	 	$	178,162	 	
Additional paid-in capital (Note 5)	 	 	2,063,098	 	 	 	1,853,098	 	
Retained earnings	 	 	863,911	 	 	 	860,675	 	
Accumulated other comprehensive income (loss):	 	 	 	 	 	 	 	 	
Minimum pension liability adjustment	 	 	(86,132	)	 	 	(86,132	)	
Derivative instruments	 	 	37,804	 	 	 	179,422	 	
 	 	 	 	 	 	 	
Common stock equity	 	 	3,056,843	 	 	 	2,985,225	 	
Long-term debt less current maturities	 	 	2,479,214	 	 	 	2,479,703	 	
 	 	 	 	 	 	 	
Total capitalization	 	 	5,536,057	 	 	 	5,464,928	 	

CURRENT LIABILITIES	 	 	 	 	 	 	 	 	
Commercial paper	 	 	117,558	 	 	 	—	 	
Current maturities of long-term debt	 	 	84,829	 	 	 	85,620	 	
Accounts payable	 	 	186,510	 	 	 	215,384	 	
Accrued taxes	 	 	396,069	 	 	 	360,737	 	
Accrued interest	 	 	25,657	 	 	 	25,003	 	
Customer deposits	 	 	58,493	 	 	 	55,474	 	
Deferred income taxes	 	 	—	 	 	 	64,210	 	
Liabilities from risk management and trading activities (Note S-1)	 	 	336,372	 	 	 	480,138	 	
Other current liabilities (Note S-1)	 	 	90,428	 	 	 	227,398	 	
 	 	 	 	 	 	 	
Total current liabilities	 	 	1,295,916	 	 	 	1,513,964	 	

DEFERRED CREDITS AND OTHER	 	 	 	 	 	 	 	 	
Deferred income taxes	 	 	1,212,106	 	 	 	1,215,403	 	
Regulatory liabilities	 	 	570,697	 	 	 	592,494	 	
Liability for asset retirements	 	 	277,592	 	 	 	269,011	 	
Pension liability	 	 	251,116	 	 	 	233,342	 	
Customer advances for construction	 	 	63,704	 	 	 	60,287	 	
Unamortized gain – sale of utility plant	 	 	43,469	 	 	 	45,757	 	
Liabilities from long-term risk management and trading activities (Note S-1)	 	 	167,987	 	 	 	83,774	 	
Other	 	 	232,600	 	 	 	228,481	 	
 	 	 	 	 	 	 	
Total deferred credits and other	 	 	2,819,271	 	 	 	2,728,549	 	

COMMITMENTS AND CONTINGENCIES (Notes 5, 12, 13, 15 and S-4)	 	 	 	 	 	 	 	 	
 	 	 	 	 	 	 	 	 	
TOTAL CAPITALIZATION AND LIABILITIES	 	$	9,651,244	 	 	$	9,707,441	 	
 	 	 	 	 	 	 	
See Notes to Pinnacle West’s Condensed Consolidated Financial Statements and Supplemental Notes to Arizona Public Service Company’s Condensed Financial Statements.
35

Table of Contents

ARIZONA PUBLIC SERVICE COMPANY
CONDENSED STATEMENTS OF CASH FLOWS
(unaudited)
(dollars in thousands)
 	 	 	 	 	 	 	 	 	
 	 	Six Months Ended	 	
 	 	June 30,	 	
 	 	2006	 	 	2005	 	
CASH FLOWS FROM OPERATING ACTIVITIES	 	 	 	 	 	 	 	 	
Net income	 	$	88,236	 	 	$	91,043	 	
Adjustments to reconcile net income to net cash provided by operating activities:	 	 	 	 	 	 	 	 	
Depreciation and amortization including nuclear fuel	 	 	186,225	 	 	 	162,641	 	
Deferred fuel and purchased power	 	 	(94,565	)	 	 	(33,785	)	
Deferred fuel and purchased power amortization	 	 	92,655	 	 	 	—	 	
Allowance for equity funds used during construction	 	 	(7,434	)	 	 	(5,555	)	
Deferred income taxes	 	 	16,481	 	 	 	(1,926	)	
Change in mark-to-market valuations	 	 	2,464	 	 	 	(12,191	)	
Changes in current assets and liabilities:	 	 	 	 	 	 	 	 	
Customer and other receivables	 	 	(13,257	)	 	 	(12,223	)	
Materials, supplies and fossil fuel	 	 	(4,707	)	 	 	(10,854	)	
Other current assets	 	 	1,677	 	 	 	2,566	 	
Accounts payable	 	 	(26,765	)	 	 	(61,798	)	
Accrued taxes	 	 	38,303	 	 	 	80,816	 	
Collateral	 	 	(162,310	)	 	 	84,071	 	
Other current liabilities	 	 	25,063	 	 	 	(20,592	)	
Change in risk management and trading activities – liabilities	 	 	(120,505	)	 	 	2,244	 	
Change in other long-term assets	 	 	(5,045	)	 	 	23,726	 	
Change in other long-term liabilities	 	 	21,553	 	 	 	3,201	 	
 	 	 	 	 	 	 	
Net cash flow provided by operating activities	 	 	38,069	 	 	 	291,384	 	
 	 	 	 	 	 	 	
CASH FLOWS FROM INVESTING ACTIVITIES	 	 	 	 	 	 	 	 	
Capital expenditures	 	 	(313,479	)	 	 	(301,098	)	
Allowance for borrowed funds used during construction	 	 	(3,394	)	 	 	(3,947	)	
Purchase of Sundance Plant	 	 	—	 	 	 	(185,046	)	
Purchases of investment securities	 	 	(133,026	)	 	 	(769,166	)	
Proceeds from sale of investment securities	 	 	133,026	 	 	 	677,558	 	
Proceeds from nuclear decommissioning trust sales	 	 	114,875	 	 	 	82,764	 	
Investment in nuclear decommissioning trust	 	 	(125,246	)	 	 	(90,814	)	
Repayment of loan by Pinnacle West Energy	 	 	—	 	 	 	500,000	 	
Other	 	 	(1,626	)	 	 	(3,113	)	
 	 	 	 	 	 	 	
Net cash flow used for investing activities	 	 	(328,870	)	 	 	(92,862	)	
 	 	 	 	 	 	 	
CASH FLOWS FROM FINANCING ACTIVITIES	 	 	 	 	 	 	 	 	
Issuance of long-term debt	 	 	—	 	 	 	163,975	 	
Repayment and reacquisition of long-term debt	 	 	(1,690	)	 	 	(264,975	)	
Short-term borrowings, net	 	 	117,558	 	 	 	—	 	
Equity infusion	 	 	210,000	 	 	 	100,000	 	
Dividends paid on common stock	 	 	(85,000	)	 	 	(42,500	)	
 	 	 	 	 	 	 	
Net cash flow provided by (used for) financing activities	 	 	240,868	 	 	 	(43,500	)	
 	 	 	 	 	 	 	
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS	 	 	(49,933	)	 	 	155,022	 	
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD	 	 	49,933	 	 	 	49,575	 	
 	 	 	 	 	 	 	
CASH AND CASH EQUIVALENTS AT END OF PERIOD	 	$	—	 	 	$	204,597	 	
 	 	 	 	 	 	 	
Supplemental disclosure of cash flow information:	 	 	 	 	 	 	 	 	
Cash paid (received) during the period for:	 	 	 	 	 	 	 	 	
Income taxes, net of refunds	 	$	—	 	 	$	(8,829	)	
Interest, net of amounts capitalized	 	$	70,103	 	 	$	73,656	 	
See Notes to Pinnacle West’s Condensed Consolidated Financial Statements and Supplemental Notes to Arizona Public Service Company’s Condensed Financial Statements.
36

Table of Contents

     Certain notes to APS’ Condensed Financial Statements are combined with the Notes to Pinnacle West’s Condensed Consolidated Financial Statements. Listed below are the Condensed Consolidated Notes to Pinnacle West’s Condensed Consolidated Financial Statements, the majority of which also relate to APS’ Condensed Financial Statements. In addition, listed below are the Supplemental Notes which are required disclosures for APS and should be read in conjunction with Pinnacle West’s Condensed Consolidated Notes.
 	 	 	 	 	 	 	 	 	
 	 	Condensed	 	APS’	
 	 	Consolidated	 	Supplemental	
 	 	Footnote	 	Footnote	
 	 	Reference	 	Reference	
Consolidation and Nature of Operations	 	Note 1	 	 	—	 	
Condensed Consolidated Financial Statements	 	Note 2	 	 	—	 	
Quarterly Fluctuations	 	Note 3	 	 	—	 	
Changes in Liquidity	 	Note 4	 	 	—	 	
Regulatory Matters	 	Note 5	 	 	—	 	
Retirement Plans and Other Benefits	 	Note 6	 	 	—	 	
Business Segments	 	Note 7	 	 	—	 	
Stock-Based Compensation	 	Note 8	 	 	—	 	
Variable Interest Entities	 	Note 9	 	 	—	 	
Derivative and Energy Trading Accounting	 	Note 10	 	Note S-1	
Comprehensive Income	 	Note 11	 	Note S-2	
Commitments and Contingencies	 	Note 12	 	 	—	 	
Nuclear Insurance	 	Note 13	 	 	—	 	
Other Income and Other Expense	 	Note 14	 	Note S-3	
Guarantees	 	Note 15	 	 	—	 	
Earnings Per Share	 	Note 16	 	 	—	 	
Discontinued Operations	 	Note 17	 	 	—	 	
Nuclear Decommissioning Trust	 	Note 18	 	 	—	 	
New Accounting Standards	 	Note 19	 	 	—	 	
Related Party Transactions	 	 	—	 	 	Note S-4	
37

Table of Contents

ARIZONA PUBLIC SERVICE COMPANY
SUPPLEMENTAL NOTES TO THE CONDENSED FINANCIAL STATEMENTS
S-1. Derivative and Energy Trading Accounting
     APS is exposed to the impact of market fluctuations in the commodity price of electricity, natural gas, coal and emissions allowances. As part of its overall risk management program, APS uses various commodity instruments that qualify as derivatives to hedge purchases and sales of electricity, fuels, and emission allowances and credits. As of June 30, 2006, APS hedged exposures to these risks for a maximum of 3.25 years.
Cash Flow Hedges
     The changes in the fair value of APS’ hedged positions included in the APS Condensed Statements of Income, after consideration of amounts deferred under the PSA, for the three and six months ended June 30, 2006 and 2005 were comprised of the following (dollars in thousands):
 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
 	 	Three Months Ended	 	Six Months Ended	
 	 	June 30,	 	June 30,	
 	 	2006	 	2005	 	2006	 	2005	
Gains (losses) on the ineffective portion of derivatives qualifying for hedge accounting	 	$	(2,824	)	 	$	451	 	 	$	(3,260	)	 	$	7,868	 	
Gains (losses) from the change in options’ time value excluded from measurement of effectiveness	 	 	3	 	 	 	(119	)	 	 	(14	)	 	 	739	 	
Gains from the discontinuance of cash flow hedges	 	 	—	 	 	 	—	 	 	 	159	 	 	 	302	 	
     During the next twelve months ending June 30, 2007, APS estimates that a net gain of $15 million before income taxes will be reclassified from accumulated OCI as an offset to the effect of market price changes for the related hedged transactions. To the extent the amounts are eligible for inclusion in the PSA, the amounts will be recorded as either a regulatory asset or liability and have no effect on earnings (see Note 5).
     APS’ assets and liabilities from risk management and trading activities are presented in two categories, consistent with Pinnacle West’s business segments.
     The following table summarizes APS’ assets and liabilities from risk management and trading activities at June 30, 2006 and December 31, 2005 (dollars in thousands):
38

Table of Contents

ARIZONA PUBLIC SERVICE COMPANY
SUPPLEMENTAL NOTES TO THE CONDENSED FINANCIAL STATEMENTS
June 30, 2006
 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
 	 	 	 	 	 	Investments	 	 	 	 	 	 	Deferred	 	 	 	 	
 	 	Current	 	 	and Other	 	 	Current	 	 	Credits and	 	 	Net Asset	 	
 	 	Assets	 	 	Assets	 	 	Liabilities	 	 	Other	 	 	(Liability)	 	
Regulated Electricity:	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
Mark-to-market	 	$	330,793	 	 	$	192,384	 	 	$	(329,666	)	 	$	(161,754	)	 	$	31,757	 	
Margin account and options	 	 	15,632	 	 	 	—	 	 	 	—	 	 	 	(1,114	)	 	 	14,518	 	
Marketing and Trading:	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
Mark-to-market	 	 	3,232	 	 	 	2,935	 	 	 	(3,951	)	 	 	(5,119	)	 	 	(2,903	)	
Options	 	 	—	 	 	 	—	 	 	 	(2,755	)	 	 	—	 	 	 	(2,755	)	
 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
Total	 	$	349,657	 	 	$	195,319	 	 	$	(336,372	)	 	$	(167,987	)	 	$	40,617	 	
 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
December 31, 2005
 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
 	 	 	 	 	 	Investments	 	 	 	 	 	 	Deferred	 	 	 	 	
 	 	Current	 	 	and Other	 	 	Current	 	 	Credits and	 	 	Net Asset	 	
 	 	Assets	 	 	Assets	 	 	Liabilities	 	 	Other	 	 	(Liability)	 	
Regulated Electricity:	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
Mark-to-market	 	$	516,399	 	 	$	228,873	 	 	$	(335,801	)	 	$	(74,787	)	 	$	334,684	 	
Margin account and options	 	 	1,814	 	 	 	—	 	 	 	(124,165	)	 	 	—	 	 	 	(122,351	)	
Marketing and Trading:	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
Mark-to-market	 	 	13,027	 	 	 	5,499	 	 	 	(20,172	)	 	 	(8,778	)	 	 	(10,424	)	
Options	 	 	1,683	 	 	 	—	 	 	 	—	 	 	 	(209	)	 	 	1,474	 	
 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
Total	 	$	532,923	 	 	$	234,372	 	 	$	(480,138	)	 	$	(83,774	)	 	$	203,383	 	
 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
     We maintain a margin account with a broker to support our risk management and trading activities. The margin account was an asset of $13 million at June 30, 2006 and a liability of $123 million at December 31, 2005 and is included in the margin account in the table above. Cash is deposited with the broker in this account at the time futures or options contracts are initiated. The change in market value of these contracts (reflected in mark-to-market) requires adjustment of the margin account balance.
     Cash or other assets may be required to serve as collateral against APS’ open positions on certain energy-related contracts. Collateral provided to counterparties was $4 million at June 30, 2006 and is included in other current assets on the Condensed Balance Sheets. No collateral was provided at December 31, 2005. Collateral provided to us by counterparties was $16 million at June 30, 2006 and $175 million at December 31, 2005, and is included in other current liabilities on the Condensed Balance Sheets.
S-2. Comprehensive Income (Loss)
     Components of APS’ comprehensive income (loss) for the three and six months ended June 30, 2006 and 2005 are as follows (dollars in thousands):
39

Table of Contents

ARIZONA PUBLIC SERVICE COMPANY
SUPPLEMENTAL NOTES TO THE CONDENSED FINANCIAL STATEMENTS
 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
 	 	Three Months Ended	 	 	Six Months Ended	 	
 	 	June 30,	 	 	June 30,	 	
 	 	2006	 	 	2005	 	 	2006	 	 	2005	 	
Net income	 	$	93,757	 	 	$	63,998	 	 	$	88,236	 	 	$	91,043	 	
 	 	 	 	 	 	 	 	 	 	 	 	 	
OCI (loss):	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
Unrealized gains (losses) on derivative instruments (a)	 	 	(62,304	)	 	 	(24,147	)	 	 	(225,196	)	 	 	84,070	 	
Reclassification of realized (gains) losses to income (b)	 	 	2,958	 	 	 	(4,437	)	 	 	(7,157	)	 	 	(5,819	)	
Income tax (expense) benefit related to items of OCI	 	 	23,175	 	 	 	11,253	 	 	 	90,735	 	 	 	(30,807	)	
 	 	 	 	 	 	 	 	 	 	 	 	 	
Total OCI (loss)	 	 	(36,171	)	 	 	(17,331	)	 	 	(141,618	)	 	 	47,444	 	
 	 	 	 	 	 	 	 	 	 	 	 	 	
Comprehensive income (loss)	 	$	57,586	 	 	$	46,667	 	 	$	(53,382	)	 	$	138,487	 	

			
(a)	 	These amounts primarily include unrealized gains and losses on contracts used to hedge our forecasted electricity and natural gas requirements to serve Native Load. These changes are primarily due to changes in forward natural gas prices and wholesale electricity prices.	
 		
(b)	 	These amounts primarily include the reclassification of unrealized gains and losses to realized gains and losses for contracted commodities delivered during the period.	
S-3. Other Income and Other Expense
     The following table provides detail of APS’ other income and other expense for the three and six months ended June 30, 2006 and 2005 (dollars in thousands):
 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
 	 	Three Months Ended	 	 	Six Months Ended	 	
 	 	June 30,	 	 	June 30,	 	
 	 	2006	 	 	2005	 	 	2006	 	 	2005	 	
Other income:	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
Asset sales	 	$	8,810	 	 	$	142	 	 	$	9,171	 	 	$	383	 	
Interest income	 	 	1,970	 	 	 	4,177	 	 	 	5,504	 	 	 	9,600	 	
Investment gains – net	 	 	—	 	 	 	981	 	 	 	165	 	 	 	479	 	
Miscellaneous	 	 	209	 	 	 	1,705	 	 	 	245	 	 	 	2,202	 	
 	 	 	 	 	 	 	 	 	 	 	 	 	
Total other income	 	$	10,989	 	 	$	7,005	 	 	$	15,085	 	 	$	12,664	 	

Other expense:	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
Non-operating costs(a)	 	$	(3,311	)	 	$	(2,708	)	 	$	(6,527	)	 	$	(5,335	)	
Investment losses – net	 	 	(710	)	 	 	—	 	 	 	—	 	 	 	—	 	
Miscellaneous	 	 	(537	)	 	 	(168	)	 	 	(1,001	)	 	 	(899	)	
 	 	 	 	 	 	 	 	 	 	 	 	 	
Total other expense	 	$	(4,558	)	 	$	(2,876	)	 	$	(7,528	)	 	$	(6,234	)	

			
(a)	 	As defined by the FERC, includes below-the-line non-operating utility costs (primarily community relations and other costs excluded from utility rate recovery).	
40

Table of Contents

ARIZONA PUBLIC SERVICE COMPANY
SUPPLEMENTAL NOTES TO THE CONDENSED FINANCIAL STATEMENTS
S-4. Related Party Transactions
     From time to time, APS enters into transactions with Pinnacle West or Pinnacle West’s other subsidiaries. The following table summarizes the amounts included in the APS Condensed Statements of Income and Condensed Balance Sheets related to transactions with affiliated companies (dollars in millions):
 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
 	 	Three Months	 	 	Six Months	 	
 	 	Ended	 	 	Ended	 	
 	 	June 30,	 	 	June 30,	 	
 	 	2006	 	 	2005	 	 	2006	 	 	2005	 	
Electric operating revenues:	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
Pinnacle West – marketing and trading	 	$	2	 	 	$	2	 	 	$	3	 	 	$	3	 	
Pinnacle West Energy	 	 	—	 	 	 	1	 	 	 	—	 	 	 	2	 	
 	 	 	 	 	 	 	 	 	 	 	 	 	
Total	 	$	2	 	 	$	3	 	 	$	3	 	 	$	5	 	

Fuel and purchased power costs:	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
Pinnacle West Energy	 	$	—	 	 	$	39	 	 	$	—	 	 	$	47	 	
Other:	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
Pinnacle West Energy interest income	 	$	—	 	 	$	—	 	 	$	—	 	 	$	5	 	
 	 	 	 	 	 	 	 	 	
 	 	As of	 	 	As of	 	
 	 	June 30, 2006	 	 	December 31, 2005	 	
Net intercompany receivables (payables):	 	 	 	 	 	 	 	 	
Pinnacle West – marketing and trading	 	$	13	 	 	$	82	 	
APS Energy Services	 	 	1	 	 	 	2	 	
Pinnacle West	 	 	(19	)	 	 	(2	)	
 	 	 	 	 	 	 	
Total	 	$	(5	)	 	$	82	 	
 	 	 	 	 	 	 	
     Electric revenues include sales of electricity to affiliated companies at contract prices. Purchased power includes purchases of electricity from affiliated companies at contract prices. APS purchases electricity from and sells electricity to APS Energy Services; however, these transactions are settled net and reported net in accordance with EITF 03-11, “Reporting Realized Gains and Losses on Derivative Instruments That Are Subject to FASB Statement No. 133 and Not ‘Held for Trading Purposes’ As Defined in EITF Issue No. 02-3.”
     Intercompany receivables primarily include amounts related to the intercompany sales of electricity. Intercompany payables primarily include amounts related to the intercompany purchases of electricity. Intercompany receivables and payables are generally settled on a current basis in cash.
41

Table of Contents
ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
INTRODUCTION
     The following discussion should be read in conjunction with Pinnacle West’s Condensed Consolidated Financial Statements and Arizona Public Service Company’s Condensed Financial Statements and the related Notes that appear in Item 1 of this report.
OVERVIEW
     Pinnacle West owns all of the outstanding common stock of APS. APS is a vertically-integrated electric utility that provides retail and wholesale electric service to most of the state of Arizona, with the major exceptions of about one-half of the Phoenix metropolitan area, the Tucson metropolitan area and Mohave County in northwestern Arizona. APS has historically accounted for a substantial part of our revenues and earnings, and is expected to continue to do so. Customer growth in APS’ service territory is about three times the national average and remains a fundamental driver of our revenues and earnings.
     The ACC regulates APS’ retail electric rates. The key issue affecting Pinnacle West’s and APS’ financial outlook is the satisfactory resolution of APS’ retail rate proceedings pending before the ACC. As discussed in greater detail in Note 5, these proceedings consist of:

 	•	 	a general retail rate case pursuant to which APS is requesting a 21.3%, or $453.9 million, increase in its annual retail electricity revenues effective no later than December 31, 2006;	
 		
 	•	 	an application for a temporary rate increase of approximately 1.9%, through a PSA surcharge, to recover $45 million in retail fuel and purchased power costs relating to Palo Verde’s 2005 unplanned outages that were deferred by APS in 2005 under the PSA and are subject to the ACC’s completion of an inquiry regarding the outages; and	
 		
 	•	 	the ACC’s prudency review of amounts collected through the May 2, 2006 interim PSA adjustor (see “Interim Rate Increase” in Note 5) related to unplanned 2006 Palo Verde outages. The related PSA deferrals were approximately $70 million for the six months ended June 30, 2006.	
     SunCor, our real estate development subsidiary, has been and is expected to be an important source of earnings and cash flow. Our subsidiary, APS Energy Services, provides competitive commodity-related energy services and energy-related products and services to commercial and industrial retail customers in the western United States. El Dorado, our investment subsidiary, owns minority interests in several energy-related investments and Arizona community-based ventures.
     Pinnacle West Energy is our subsidiary that previously owned and operated unregulated generating plants. Pursuant to the ACC’s April 7, 2005 order in APS’ 2003 rate case, on July 29, 2005, Pinnacle West Energy transferred the PWEC Dedicated Assets to APS. See “APS 2003 Rate Case” in Note 5. Pinnacle West Energy sold its 75% interest in Silverhawk to NPC on January 10, 2006. See Note 17 for discussion of discontinued operations. As a result, Pinnacle West Energy no longer owns any generating plants and has ceased operations.
42

Table of Contents

     We continue to focus on solid operational performance in our electricity generation and delivery activities. In the delivery area, we focus on superior reliability and customer satisfaction. We plan to expand long-term resources and our transmission and distribution systems to meet the electricity needs of our growing retail customers and sustain reliability.
     See “Pinnacle West Consolidated – Factors Affecting Our Financial Outlook” below for a discussion of several factors that could affect our future financial results.
EARNINGS CONTRIBUTION BY BUSINESS SEGMENT
     Pinnacle West has three principal business segments (determined by products, services and the regulatory environment):

 	•	 	our regulated electricity segment, which consists of traditional regulated retail and wholesale electricity businesses (primarily electric service to Native Load customers) and related activities and includes electricity generation, transmission and distribution;	
 		
 	•	 	our real estate segment, which consists of SunCor’s real estate development and investment activities; and	
 		
 	•	 	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.	
     The following table summarizes net income by segment for the three months and six months ended June 30, 2006 and 2005 (dollars in millions):
 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
 	 	Three Months Ended	 	 	Six Months Ended	 	
 	 	June 30,	 	 	June 30,	 	
 	 	2006	 	 	2005	 	 	2006	 	 	2005	 	
Regulated electricity	 	$	95	 	 	$	69	 	 	$	82	 	 	$	83	 	
Real estate	 	 	8	 	 	 	11	 	 	 	30	 	 	 	19	 	
Marketing and trading	 	 	7	 	 	 	4	 	 	 	9	 	 	 	11	 	
Other	 	 	1	 	 	 	1	 	 	 	1	 	 	 	2	 	
 	 	 	 	 	 	 	 	 	 	 	 	 	
Income from continuing operations	 	 	111	 	 	 	85	 	 	 	122	 	 	 	115	 	
Discontinued operations – net of tax:	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
Real estate (a)	 	 	1	 	 	 	1	 	 	 	2	 	 	 	1	 	
Marketing and trading (b)	 	 	—	 	 	 	(59	)	 	 	1	 	 	 	(65	)	
 	 	 	 	 	 	 	 	 	 	 	 	 	
Net income	 	$	112	 	 	$	27	 	 	$	125	 	 	$	51	 	

			
(a)	 	Primarily relates to sales of commercial properties.	
 		
(b)	 	Relates to the loss on the sale of Silverhawk in June 2005 and the operations of Silverhawk.	
43

Table of Contents

PINNACLE WEST CONSOLIDATED – 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 operating revenues less fuel and purchased power costs. “Gross margin” is a “non-GAAP financial measure,” as defined in accordance with SEC rules. Exhibit 99.1 reconciles this non-GAAP financial measure to operating income, which is the most directly comparable financial measure calculated and presented in accordance with accounting principles generally accepted in the United States (GAAP). We view gross margin as an important performance measure of the core profitability of our operations. This measure is a key component of our internal financial reporting and is used by our management in analyzing our business segments. We believe that investors benefit from having access to the same financial measures that our management uses. In addition, we have reclassified certain prior-period amounts to conform to our current-period presentation.
Deferred Fuel and Purchased Power Costs
     APS’ retail rate settlement became effective April 1, 2005. As part of the settlement, the ACC approved the PSA, which permits APS to defer for recovery or refund fluctuations in retail fuel and purchased power costs, subject to specified parameters. In accordance with the PSA, APS defers for future rate recovery 90% of the difference between actual retail fuel and purchased power costs and the amount of such costs currently included in base rates. APS’ recovery of PSA deferrals from its customers is subject to the ACC’s approval of annual PSA adjustments and periodic surcharge applications. See “Power Supply Adjustor” in Note 5.
     Since the inception of the PSA, APS has incurred substantially higher fuel and purchased power prices than those authorized in APS’ current base rates and has deferred those cost differences in accordance with the PSA. The balance of APS’ PSA deferrals at June 30, 2006 was $175 million. APS estimates that its PSA deferral balance at December 31, 2006 will be approximately $155 million to $175 million, based on APS’ hedged positions for fuel and purchased power at June 30, 2006 and recent forward market prices for natural gas and purchased power (which are subject to change). The recovery of PSA deferrals through ACC approved adjustors and surcharges recorded as revenue is offset dollar-for-dollar by the amortization of those deferred expenses.
     APS operated Palo Verde Unit 1 at reduced power levels from December 25, 2005 until March 18, 2006 due to vibration levels in one of the Unit’s shutdown cooling lines. During an outage at Unit 1 from March 18, 2006 to July 7, 2006, APS performed the necessary work and modifications to remedy the situation. APS estimates that incremental replacement power costs resulting from Palo Verde’s outages and reduced power levels were approximately $78 million during the six months ended June 30, 2006. The related PSA deferrals were approximately $70 million in that period. The Palo Verde replacement power costs were partially offset by $30 million of lower than expected replacement power costs related to APS’ fossil-fueled generating units during the six months ended June 30, 2006. As a result, the corresponding deferrals were reduced in that six-month period by $27 million.
     The PSA deferral balance at June 30, 2006 and estimated balance as of December 31, 2006 each includes (a) $45 million related to replacement power costs associated with unplanned 2005
44

Table of Contents

Palo Verde outages and (b) $70 million related to replacement power costs associated with unplanned 2006 outages or reduced power operations at Palo Verde. The PSA deferrals associated with these unplanned Palo Verde outages and reduced power operations are the subject of ACC prudence reviews. See “PSA Deferrals Related to Unplanned Palo Verde Outages” in Note 5.
Operating Results – Three-month period ended June 30, 2006 compared with three-month period ended June 30, 2005
     Our consolidated net income for the three months ended June 30, 2006 was $112 million compared with $27 million for the comparable prior-year period. The three months ended June 30, 2005 included a net loss from discontinued operations of $58 million, substantially all of which was related to the sale and operations of Silverhawk. Income from continuing operations increased $26 million in the period-to-period comparison, reflecting the following changes in earnings by segment:

 	•	 	Regulated Electricity Segment – Income from continuing operations increased approximately $26 million primarily due to higher retail sales volumes related to customer growth; effects of warmer weather on retail sales; income tax credits related to prior years resolved in 2006; and lower interest expense. These positive factors were partially offset by higher operations and maintenance expense related to generation and customer service. Higher fuel and purchased power costs (as discussed above) were substantially offset by the deferral of those costs in accordance with the PSA.	
 		
 	•	 	Real Estate Segment – Income from continuing operations decreased approximately $3 million primarily due to decreased margins on parcel sales, partially offset by increased margins on residential sales.	
 		
 	•	 	Marketing and Trading Segment – Income from continuing operations increased approximately $3 million primarily due to higher unit margins on wholesale sales.	
45

Table of Contents

     Additional details on the major factors that increased (decreased) net income are contained in the following table (dollars in millions):
 	 	 	 	 	 	 	 	 	
 	 	Increase (Decrease)	 	
 	 	Pretax	 	 	After Tax	 	
Regulated electricity segment gross margin:	 	 	 	 	 	 	 	 	
Higher fuel and purchased power costs	 	$	(43	)	 	$	(26	)	
Increased deferred fuel and purchased power costs	 	 	40	 	 	 	24	 	
Higher retail sales volumes due to customer growth, excluding weather effects	 	 	26	 	 	 	16	 	
Effects of warmer weather on retail sales	 	 	16	 	 	 	10	 	
Miscellaneous items, net	 	 	(9	)	 	 	(6	)	
 	 	 	 	 	 	 	
Net increase in regulated electricity segment gross margin	 	 	30	 	 	 	18	 	
Higher marketing and trading segment gross margin primarily due to higher unit margins on wholesale sales	 	 	3	 	 	 	2	 	
Lower real estate segment contribution primarily related to decreased margins on parcel sales, partially offset by increased margins on residential sales	 	 	(5	)	 	 	(3	)	
Operations and maintenance increases primarily due to:	 	 	 	 	 	 	 	 	
Generation costs, including maintenance and overhauls	 	 	(6	)	 	 	(4	)	
Customer service costs, including regulatory demand-side management programs and planned maintenance	 	 	(4	)	 	 	(2	)	
Miscellaneous items, net	 	 	(5	)	 	 	(3	)	
Lower interest expense, net of capitalized financing costs, primarily due to lower debt balances, partially offset by higher rates	 	 	6	 	 	 	4	 	
Income tax credits related to prior years resolved in 2006	 	 	—	 	 	 	10	 	
Miscellaneous items, net	 	 	1	 	 	 	4	 	
 	 	 	 	 	 	 	
Net increase in income from continuing operations	 	$	20	 	 	 	26	 	
 	 	 	 	 	 	 	 	
Discontinued operations related to the sale of Silverhawk	 	 	 	 	 	 	59	 	
 	 	 	 	 	 	 	 	
Net increase in net income	 	 	 	 	 	$	85	 	
 	 	 	 	 	 	 	 	
Regulated Electricity Segment Revenues
     Regulated electricity segment revenues were $133 million higher for the three months ended June 30, 2006 compared with the prior-year period primarily as a result of:

 	•	 	a $75 million increase in revenues related to recovery of PSA deferrals, which had no earnings effect because of amortization of the same amount recorded as fuel and purchased power expense (see “Deferred Fuel and Purchased Power Costs” above);	
 		
 	•	 	a $36 million increase in retail revenues related to customer growth, excluding weather effects;	
 		
 	•	 	a $22 million increase in retail revenues related to warmer weather;	
 		
 	•	 	a $10 million increase in Off-System Sales due to higher prices; and	
 		
 	•	 	a $10 million decrease due to miscellaneous factors.	
46

Table of Contents

Real Estate Segment Revenues
     Real estate segment revenues were $28 million higher for the three months ended June 30, 2006 compared with the prior-year period primarily as a result of:

 	•	 	a $32 million increase from residential sales due to higher prices and volumes;	
 		
 	•	 	an $11 million decrease from parcel sales due to timing; and	
 		
 	•	 	a $7 million increase due to miscellaneous sales.	
Marketing and Trading Segment Revenues
     Marketing and trading segment revenues were $19 million higher for the three months ended June 30, 2006 compared with the prior-year period primarily as a result of:

 	•	 	a $12 million increase due to higher power prices on delivered wholesale electricity sales;	
 		
 	•	 	a $10 million increase from higher prices on competitive retail sales in California; and	
 		
 	•	 	a $3 million decrease in mark-to-market gains on contracts for future delivery due to changes in forward prices.	
47

Table of Contents

Operating Results – Six-month period ended June 30, 2006 compared with six-month period ended June 30, 2005
     Our consolidated net income for the six months ended June 30, 2006 was $125 million compared with $51 million for the comparable prior-year period. The six months ended June 30, 2005 included a net loss from discontinued operations of $64 million, substantially all of which was related to the sale and operations of Silverhawk. Income from continuing operations increased $7 million in the period-to-period comparison, reflecting the following changes in earnings by segment:

 	•	 	Regulated Electricity Segment – Income from continuing operations decreased approximately $1 million primarily due to higher fuel and purchased power costs (as discussed above); and higher operations and maintenance expense related to generation and customer service. These negative factors were partially offset by deferred fuel and purchased power costs; higher retail sales volumes due to customer growth; income tax credits related to prior years resolved in 2006; effects of weather on retail sales; a retail price increase effective April 1, 2005; lower interest expense; and higher interest income.	
 		
 	•	 	Real Estate Segment – Income from continuing operations increased approximately $11 million primarily due to increased margins on residential and parcel sales.	
 		
 	•	 	Marketing and Trading Segment – Income from continuing operations decreased approximately $2 million primarily due to lower mark-to-market gains on contracts for future delivery, partially offset by higher unit margins on wholesale sales.	
48

Table of Contents

Additional details on the major factors that increased (decreased) net income are contained in the following table (dollars in millions):
 	 	 	 	 	 	 	 	 	
 	 	Increase (Decrease)	 	
 	 	Pretax	 	 	After Tax	 	
 	 	 	 	 	 	 	
Regulated electricity segment gross margin:	 	 	 	 	 	 	 	 	
Higher fuel and purchased power costs	 	$	(98	)	 	$	(60	)	
Increased deferred fuel and purchased power costs (deferrals began April 1, 2005)	 	 	53	 	 	 	32	 	
Higher retail sales volumes due to customer growth, excluding weather effects	 	 	39	 	 	 	24	 	
Effects of weather on retail sales	 	 	13	 	 	 	8	 	
Retail price increase effective April 1, 2005	 	 	7	 	 	 	4	 	
Miscellaneous items, net	 	 	(13	)	 	 	(7	)	
 	 	 	 	 	 	 	
Net increase in regulated electricity segment gross margin	 	 	1	 	 	 	1	 	
Lower marketing and trading segment gross margin primarily related to lower mark-to-market gains, partially offset by higher unit margins on wholesale sales	 	 	(4	)	 	 	(2	)	
Higher real estate segment contribution primarily related to increased margins on residential and parcel sales	 	 	18	 	 	 	11	 	
Operations and maintenance increases primarily due to:	 	 	 	 	 	 	 	 	
Generation costs, including maintenance and overhauls	 	 	(28	)	 	 	(17	)	
Customer service costs, including regulatory demand-side management programs and planned maintenance	 	 	(11	)	 	 	(7	)	
Lower interest expense, net of capitalized financing costs, primarily due to lower debt balances, partially offset by higher rates	 	 	7	 	 	 	4	 	
Higher other income, net of expense, primarily due to miscellaneous asset sales and increased interest income	 	 	6	 	 	 	4	 	
Income tax credits related to prior years resolved in 2006	 	 	—	 	 	 	10	 	
Miscellaneous items, net	 	 	1	 	 	 	3	 	
 	 	 	 	 	 	 	
Net increase (decrease) in income from continuing operations	 	$	(10	)	 	 	7	 	
 	 	 	 	 	 	 	 	
Discontinued operations related to the sale of Silverhawk and sales of real estate assets	 	 	 	 	 	 	67	 	
 	 	 	 	 	 	 	 	
Net increase in net income	 	 	 	 	 	$	74	 	
 	 	 	 	 	 	 	 	
Regulated Electricity Segment Revenues
     Regulated electricity segment revenues were $183 million higher for the six months ended June 30, 2006 compared with the prior-year period primarily as a result of:

 	•	 	a $93 million increase in revenues related to recovery of PSA deferrals, which had no earnings effect because of amortization of the same amount recorded as fuel and purchased power expense (see “Deferred Fuel and Purchased Power Costs” above);	
 		
 	•	 	a $54 million increase in retail revenues related to customer growth, excluding weather effects;	
49

Table of Contents

 	•	 	an $18 million increase in retail revenues related to weather;	
 		
 	•	 	a $12 million increase in Off-System Sales primarily resulting from sales previously reported in the trading segment that were classified beginning in April 2005 as sales in the regulated electricity segment in accordance with the APS retail rate case settlement;	
 		
 	•	 	a $10 million increase in Off-System Sales due to higher prices;	
 		
 	•	 	a $7 million increase in retail revenues due to a price increase effective April 1, 2005; and	
 		
 	•	 	an $11 million decrease due to miscellaneous factors.	
Real Estate Segment Revenues
     Real estate segment revenues were $66 million higher for the six months ended June 30, 2006 compared with the prior-year period primarily as a result of:

 	•	 	a $48 million increase from residential sales due to higher prices and volumes;	
 		
 	•	 	a $9 million increase from parcel sales due to timing; and	
 		
 	•	 	a $9 million increase due to miscellaneous sales.	
Marketing and Trading Segment Revenues
     Marketing and trading segment revenues were $15 million higher for the six months ended June 30, 2006 compared with the prior-year period primarily as a result of:

 	•	 	a $32 million increase from higher prices on competitive retail sales in California;	
 		
 	•	 	a $12 million decrease in off-system sales due to the absence of sales previously reported in the marketing and trading segment that were classified beginning in April 2005 as sales in the regulated electricity segment in accordance with the APS retail rate case settlement;	
 		
 	•	 	a $7 million decrease in mark-to-market gains on contracts for future delivery due to changes in forward prices; and	
 		
 	•	 	a $2 million increase due to miscellaneous factors.	
50

Table of Contents

LIQUIDITY AND CAPITAL RESOURCES
Capital Needs and Resources – Pinnacle West Consolidated
      Capital Expenditure Requirements
     The following table summarizes the actual capital expenditures for the six months ended June 30, 2006 and estimated capital expenditures for the next three years:
CAPITAL EXPENDITURES
(dollars in millions)
 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
 	 	Six Months Ended	 	 	Estimated for the Year Ended	 	
 	 	June 30,	 	 	December 31,	 	
 	 	2006	 	 	2006	 	 	2007	 	 	2008	 	
APS	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
Distribution	 	$	184	 	 	$	322	 	 	$	323	 	 	$	362	 	
Transmission	 	 	55	 	 	 	120	 	 	 	169	 	 	 	203	 	
Generation	 	 	73	 	 	 	184	 	 	 	207	 	 	 	279	 	
Other (a)	 	 	10	 	 	 	23	 	 	 	16	 	 	 	13	 	
 	 	 	 	 	 	 	 	 	 	 	 	 	
Subtotal	 	 	322	 	 	 	649	 	 	 	715	 	 	 	857	 	
SunCor (b)	 	 	100	 	 	 	232	 	 	 	142	 	 	 	119	 	
Other	 	 	5	 	 	 	6	 	 	 	2	 	 	 	6	 	
 	 	 	 	 	 	 	 	 	 	 	 	 	
Total	 	$	427	 	 	$	887	 	 	$	859	 	 	$	982	 	

			
(a)	 	Primarily information systems and facilities projects.	
 		
(b)	 	Consists primarily of capital expenditures for land development and retail and office building construction reflected in “Real estate investments” and “Capital expenditures” on the Condensed Consolidated Statements of Cash Flows.	
     Distribution and transmission capital expenditures are comprised of infrastructure additions and upgrades, capital replacements, new customer construction and related information systems and facility costs. Examples of the types of projects included in the forecast include lines, 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.
     Generation capital expenditures are comprised of various improvements to APS’ existing fossil and nuclear plants and the replacement of Palo Verde steam generators (see below). 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 $35 million annually for 2006 through 2008.
     The Palo Verde owners have approved the manufacture of one additional set of steam generators. These generators will be installed in Unit 3 and are scheduled for completion in the fall of 2007 at an approximate cost of $75 million (APS’ share). Approximately $25 million of the Unit
51

Table of Contents

3 steam generator costs have been incurred through June 30, 2006, with the remaining $50 million included in the capital expenditures table above. Capital expenditures will be funded with internally generated cash and/or external financings.
Contractual Obligations
     Our future contractual obligations have not changed materially from the amounts disclosed in Part II, Item 7 of the 2005 Form 10-K, with the exception of our aggregate:

 	•	 	fuel and purchased power commitments, which increased from approximately $1.9 billion at December 31, 2005 to $2.9 billion at June 30, 2006 as follows (in billions):	
 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
2006	 	2007-2008	 	2009-2010	 	Thereafter	 	Total	
$0.5	 	$	0.6	 	 	$	0.4	 	 	$	1.4	 	 	$	2.9	 	
     See Note 4 for a list of payments due on total long-term debt and capitalized lease requirements.
      Off-Balance Sheet Arrangements
     In 1986, APS entered into agreements with three separate VIE 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. We are not the primary beneficiary of the Palo Verde VIEs and, accordingly, do not consolidate them.
     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, 2006, APS would have been required to assume approximately $228 million of debt and pay the equity participants approximately $182 million.
      Guarantees and Letters of Credit
     We 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. We generally agree to indemnification provisions related to liabilities arising from or related to certain of our agreements, with limited exceptions depending on the particular agreement. See Note 15 for additional information regarding guarantees and letters of credit.
      Credit Ratings
     The ratings of securities of Pinnacle West and APS as of August 7, 2006 are shown below. 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
52

Table of Contents

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 the 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 (a)	 	Baa3 (P)	 	BB+ (prelim)	
Commercial paper	 	P	-3	 	 	 	A-3	 	
Outlook	 	Negative	 	Stable	
 	 	 	 	 	 	 	 	 	
APS	 	 	 	 	 	 	 	 	
Senior unsecured	 	Baa2	 	BBB-	
Secured lease obligation bonds	 	Baa2	 	BBB-	
Commercial paper	 	P	-2	 	 	 	A-3	 	
Outlook	 	Negative	 	Stable	

(a)	 	Pinnacle West has a combined shelf registration under SEC Rule 415. Moody’s assigns a provisional (P) rating and Standard & Poor’s assigns a preliminary (prelim) rating to such shelf registrations. Pinnacle West currently has no outstanding, rated senior unsecured securities.	
      Debt Provisions
     Pinnacle West’s and APS’ debt covenants related to their respective bank financing arrangements include a debt to capitalization ratio. Certain of APS’ bank financing arrangements also include 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. For each of Pinnacle West and APS, these covenants require that the ratio of consolidated debt to total consolidated capitalization cannot exceed 65%. At June 30, 2006, the ratio was approximately 48% for Pinnacle West and 46% for APS. The provisions regarding interest coverage require a minimum cash coverage of two times the interest requirements for APS. The interest coverage was approximately 4 times under APS’ bank financing agreements as of June 30, 2006. 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 and could cross-default other debt.
     Neither Pinnacle West’s nor APS’ financing agreements contain “rating triggers” that would result in an acceleration of the required interest and principal payments in the event of a rating downgrade. However, in the event of a further rating 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 certain other material 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 certain other material agreements. Pinnacle West and APS do not have a material adverse change restriction for revolver borrowings.
53

Table of Contents

     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 and principal and interest payments on our long-term debt. The level of our common stock 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. An existing ACC order requires APS to maintain a common equity ratio of at least 40% and prohibits APS from paying common stock dividends if the payment would reduce its common equity below that threshold. As defined in the ACC order, the common equity ratio is common equity divided by the sum of common equity and long-term debt, including current maturities of long-term debt. At June 30, 2006, APS’ common equity ratio, as defined, was approximately 54%.
     Pinnacle West sponsors a qualified defined benefit and account balance pension plan for the 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 plan assets and our pension obligation. The assets in the plan are comprised of common stocks, bonds, common and collective trusts and short-term investments. Future year contribution amounts are dependent on fund performance and valuation assumptions of plan assets. We contributed $53 million in 2005. The contribution to our pension plan in 2006 is estimated to be approximately $50 million, $29 million of which has been contributed through June 30, 2006. The contribution to our other postretirement benefit plan in 2006 is estimated to be approximately $29 million. APS and other subsidiaries fund their share of the contributions. APS’ share is approximately 97% of both plans.
     In January 2006, Pinnacle West infused into APS $210 million of the proceeds from the sale of Silverhawk. See “Equity Infusions” in Note 5 for more information.
     On February 28, 2006, Pinnacle West entered into an Uncommitted Master Shelf Agreement with Prudential Investment Management, Inc. (“Prudential”) and certain of its affiliates. The agreement provides the terms under which Pinnacle West may offer up to $200 million of its senior notes for purchase by Prudential affiliates at any time prior to December 31, 2007. The maturity of notes issued under the agreement cannot exceed five years. Pursuant to the agreement, on February 28, 2006, Pinnacle West issued and sold to Prudential affiliates $175 million of its 5.91% Senior Notes, Series A, due February 28, 2011 (the “Series A Notes”).
     On April 3, 2006, Pinnacle West repaid $300 million of its 6.40% Senior Notes due April, 2006. Pinnacle West used the proceeds of the Series A Notes, cash on hand and commercial paper proceeds to repay these notes.
54

Table of Contents

     On July 19, 2006, the Pinnacle West Board of Directors declared a quarterly dividend of $0.50 per share of common stock, payable on September 1, 2006, to shareholders of record on August 1, 2006.
     In connection with the FERC Order discussed under “Federal” in Note 5, the FERC revoked a previous FERC order allowing Pinnacle West to issue securities or incur long-term debt without FERC approval. On May 3, 2006, the FERC issued an order approving Pinnacle West’s application to issue a broad range of debt and equity securities through June 30, 2008. Pinnacle West does not expect this FERC order to limit its ability to meet its capital requirements.
      APS
     APS’ capital requirements consist primarily of capital expenditures and optional and mandatory redemptions of long-term debt. APS pays for its capital requirements with cash from operations and, to the extent necessary, external financings. APS has historically paid its dividends to Pinnacle West with cash from operations. See “Pinnacle West (Parent Company)” above for a discussion of the common equity ratio that APS must maintain in order to pay dividends to Pinnacle West.
     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.
     On August 3, 2006, APS issued $400 million of debt as follows: $250 million of its 6.25% Notes due 2016 and $150 million of its 6.875% Notes due 2036. A portion of the proceeds will be used to pay at maturity approximately $84 million of APS’ 6.75% Senior Notes due November 15, 2006, to fund its construction program and for other general corporate purposes. A portion of the proceeds may also be used to pay any liability determined to be payable as a result of the review by the Internal Revenue Service of a tax refund the Company received in 2002.
     See “Deferred Fuel and Purchased Power Costs” above and “Power Supply Adjustor” in Note 5 for information regarding the PSA approved by the ACC. Although APS defers actual retail fuel and purchased power costs on a current basis, APS’ recovery of the deferrals from its ratepayers is subject to the ACC’s approval of annual PSA adjustments and periodic surcharge applications. During the six months ended June 30, 2006, APS recovered approximately $93 million of PSA deferrals, which had no effect on earnings because of amortization of the same amount recorded as fuel and purchased power expense.
     See “Cash Flow Hedges” in Note 10 for information related to collateral provided to us by counterparties.
      Pinnacle West Energy
     See Note 17 of Notes to Condensed Consolidated Financial Statements above for a discussion of the sale of our 75% ownership interest in Silverhawk.
55

Table of Contents

      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 during the six months ended June 30, 2006 and projected capital expenditures for the next three years. SunCor expects to fund its future capital requirements with cash from operations and external financings.
     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 expects minimal capital expenditures over the next three years.
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, the determination of the appropriate accounting for our pension and other postretirement benefits and derivatives accounting. There have been no changes to our critical accounting policies since our 2005 Form 10-K. See “Critical Accounting Policies” in Item 7 of the 2005 Form 10-K for further details about our critical accounting policies.
OTHER ACCOUNTING MATTERS
     In June 2006, the FASB issued FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes — an interpretation of FASB Statement No. 109.” This guidance requires us to recognize the tax benefits of an uncertain tax position if it is more likely than not that the benefit will be sustained upon examination by the taxing authority. The Interpretation is effective for fiscal years beginning after December 15, 2006. We are currently evaluating this new guidance and believe it will not have a material impact on our financial statements.
PINNACLE WEST CONSOLIDATED – FACTORS AFFECTING
OUR FINANCIAL OUTLOOK
Factors Affecting Operating Revenues, Fuel and Purchased Power Costs
      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 affected by electricity sales volumes related to customer mix, customer growth and average usage per customer as well as electricity rates and tariffs 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 certain western states that have opened to competition.
56

Table of Contents

      Retail Rate Proceedings The key issue affecting Pinnacle West’s and APS’ financial outlook is the satisfactory resolution of APS’ retail rate proceedings pending before the ACC. As discussed in greater detail in Note 5, these proceedings consist of a general rate case request; an application for a 1.9% temporary rate increase that is subject to the ACC’s completion of an inquiry regarding unplanned 2005 Palo Verde outages; and a “prudency review” of amounts collected through the May 2, 2006 interim PSA adjustor, including a “prudence audit” of unplanned 2006 Palo Verde outages to be conducted by the ACC staff.
      Fuel and Purchased Power Costs Fuel and purchased power costs are impacted by our electricity sales volumes, existing contracts for purchased power and generation fuel, our power plant performance, transmission availability or constraints, prevailing market prices, new generating plants being placed in service, variances in deferrals and amortization of fuel and purchased power since April 1, 2005 and our hedging program for managing such costs. See “Power Supply Adjustor” in Note 5 for information regarding the PSA, including PSA deferrals related to unplanned Palo Verde outages and reduced power operations that are the subject of ACC prudence reviews. See “Natural Gas Supply” in Note 12 for more information on fuel costs. APS’ recovery of PSA deferrals from its ratepayers is subject to the ACC’s approval of annual PSA adjustments and periodic surcharge applications.
      Customer and Sales Growth The customer and sales growth referred to in this paragraph applies to Native Load customers and sales to them. Customer growth in APS’ service territory averaged about 3.8% a year for the three years 2003 through 2005; we currently expect customer growth to average about 4.2% per year from 2006 to 2008. We currently estimate that total retail electricity sales in kilowatt-hours will grow 3.7% on average, from 2006 through 2008, before the effects of weather variations. Customer growth was 4.5% higher for the six-month period ended June 30, 2006 when compared with the prior-year period.
     Actual sales growth, excluding weather-related variations, may differ from our projections as a result of numerous factors, such as economic conditions, customer growth, usage patterns and responses to retail price changes. Our experience indicates that a reasonable range of variation in our kilowatt-hour sales projection attributable to such economic factors can result in increases or decreases in annual net income of up to $10 million.
      Weather In forecasting retail sales growth, we assume normal weather patterns based on historical data. Historical extreme weather variations have resulted in annual variations in net income in excess of $20 million. However, our experience indicates that the more typical variations from normal weather can result in increases or decreases in annual net income of up to $10 million.
      Wholesale Power Market Conditions The marketing and trading division focuses primarily on managing APS’ risks relating to fuel and purchased power costs in connection with its costs of serving Native Load customer demand. The marketing and trading division, subject to specified parameters, markets, hedges and trades in electricity, fuels and emission allowances and credits.
Other Factors Affecting Financial Results
      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.
57

Table of Contents

      Depreciation and Amortization Expenses Depreciation and amortization expenses are impacted by net additions to utility plant and other property, which include generation construction, acquisition, the sale of generation (see discussion of the sale of Silverhawk – Note 17), changes in depreciation and amortization rates, and changes in regulatory asset amortization.
      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 9.2% of assessed value for 2005 and 2004. We expect property taxes to increase as new power plants, the acquisition of the Sundance Plant in 2005 and our additions to transmission and distribution facilities are included in the property tax base.
      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.
      Retail Competition Although some very limited retail competition existed in Arizona in 1999 and 2000, there are currently no active retail competitors providing unbundled energy or other utility services to APS’ customers. We cannot predict when, and the extent to which, additional competitors will re-enter APS’ service territory.
      Subsidiaries SunCor’s net income was $56 million in 2003, $45 million in 2004 and $56 million in 2005.
     APS Energy Services’ and El Dorado’s historical results are not indicative of future performance.
      General Our financial results may be affected by a number of broad factors. See “Forward-Looking Statements” for further information on such factors, which may cause our actual future results to differ from those we currently seek or anticipate.
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.
58

Table of Contents

      Interest Rate and Equity Risk
     We have exposure to changing interest rates. Changing interest rates will affect interest paid on variable-rate debt and the market value of debt securities held by our nuclear decommissioning trust fund. The nuclear decommissioning trust fund also has risk associated with the changing market value of its investments. Nuclear decommissioning costs are recovered in regulated electricity prices.
      Commodity Price Risk
     We are exposed to the impact of market fluctuations 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 commodity 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 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 commodities. 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 value 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 non-trading and trading derivative positions for the six months ended June 30, 2006 and 2005 (dollars in millions):
59

Table of Contents

 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
 	 	Six Months Ended	 	 	Six Months Ended	 	
 	 	June 30, 2006	 	 	June 30, 2005	 	
 	 	Regulated	 	 	Marketing	 	 	Regulated	 	 	Marketing	 	
 	 	Electricity	 	 	and Trading	 	 	Electricity	 	 	and Trading	 	
Mark-to-market of net positions at beginning of period	 	$	335	 	 	$	181	 	 	$	33	 	 	$	107	 	
Recognized in earnings:	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
Change in mark-to-market for future period deliveries – gains (losses)	 	 	(6	)	 	 	(3	)	 	 	12	 	 	 	12	 	
Mark-to-market gains (losses) realized including ineffectiveness during the period	 	 	(4	)	 	 	1	 	 	 	(1	)	 	 	(10	)	
Deferred as a regulatory (asset) liability	 	 	(61	)	 	 	—	 	 	 	4	 	 	 	—	 	
Recognized in OCI:	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
Change in mark-to-market for future period deliveries – gains (losses) (a)	 	 	(225	)	 	 	(49	)	 	 	84	 	 	 	52	 	
Mark-to-market gains realized during the period	 	 	(7	)	 	 	(11	)	 	 	(6	)	 	 	(10	)	
 	 	 	 	 	 	 	 	 	 	 	 	 	
Mark-to-market of net positions at end of period	 	$	32	 	 	$	119	 	 	$	126	 	 	$	151	 	

			
(a)	 	The gains (losses) in regulated mark-to-market recorded in OCI are due primarily to increases (decreases) in forward natural gas prices.	
     The tables below show the fair value of maturities of our non-trading and trading derivative contracts (dollars in millions) at June 30, 2006 by maturities and by the source for calculating the fair values. See Note 1, “Derivative Accounting,” in Item 8 of our 2005 Form 10-K for more discussion of our valuation methods.
Regulated Electricity
 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	Total	 	
 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	Years	 	 	fair	 	
Source of Fair Value	 	2006	 	 	2007	 	 	2008	 	 	2009	 	 	2010	 	 	thereafter	 	 	value	 	
Prices actively quoted	 	$	(20	)	 	$	63	 	 	$	20	 	 	$	(1	)	 	$	—	 	 	$	—	 	 	$	62	 	
Prices provided by other external sources	 	 	(2	)	 	 	4	 	 	 	(1	)	 	 	(1	)	 	 	—	 	 	 	—	 	 	 	—	 	
Prices based on models and other valuation methods	 	 	(4	)	 	 	(4	)	 	 	(4	)	 	 	—	 	 	 	(4	)	 	 	(14	)	 	 	(30	)	
 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
Total by maturity	 	$	(26	)	 	$	63	 	 	$	15	 	 	$	(2	)	 	$	(4	)	 	$	(14	)	 	$	32	 	
 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
60

Table of Contents

Marketing and Trading
 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	Total	 	
 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	Years	 	 	fair	 	
Source of Fair Value	 	2006	 	 	2007	 	 	2008	 	 	2009	 	 	2010	 	 	thereafter	 	 	value	 	
Prices actively quoted	 	$	9	 	 	$	—	 	 	$	—	 	 	$	—	 	 	$	—	 	 	$	—	 	 	$	9	 	
Prices provided by other external sources	 	 	—	 	 	 	66	 	 	 	19	 	 	 	—	 	 	 	—	 	 	 	—	 	 	 	85	 	
Prices based on models and other valuation methods	 	 	11	 	 	 	(2	)	 	 	16	 	 	 	(1	)	 	 	(1	)	 	 	2	 	 	 	25	 	
 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
Total by maturity	 	$	20	 	 	$	64	 	 	$	35	 	 	$	(1	)	 	$	(1	)	 	$	2	 	 	$	119	 	
 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
     The table below shows the impact that hypothetical price movements of 10% would have on the market value of our risk management and trading assets and liabilities included on Pinnacle West’s Condensed Consolidated Balance Sheets at June 30, 2006 and December 31, 2005 (dollars in millions).
 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
 	 	June 30, 2006	 	 	December 31, 2005	 	
 	 	Gain (Loss)	 	 	Gain (Loss)	 	
 	 	Price Up	 	 	Price Down	 	 	Price Up	 	 	Price Down	 	
Commodity	 	10%	 	 	10%	 	 	10%	 	 	10%	 	
Mark-to-market changes reported in earnings (a):	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
Electricity	 	$	1	 	 	$	(1	)	 	$	—	 	 	$	—	 	
Mark-to-market changes reported in OCI (b):	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
Electricity	 	 	85	 	 	 	(85	)	 	 	66	 	 	 	(66	)	
Natural gas	 	 	88	 	 	 	(88	)	 	 	103	 	 	 	(103	)	

Total	 	$	174	 	 	$	(174	)	 	$	169	 	 	$	(169	)	

			
(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 non-performance or non-payment by counterparties. See Note 1, “Derivative Accounting” in Item 8 of our 2005 Form 10-K for a discussion of our credit valuation adjustment policy. See Note 10 for further discussion of credit risk.
61

Table of Contents

ARIZONA PUBLIC SERVICE COMPANY – RESULTS OF OPERATIONS
General
     Throughout the following explanations of our results of operations, we refer to “gross margin.” Gross margin refers to electric operating revenues less fuel and purchased power costs. Gross margin is a “non-GAAP financial measure,” as defined in accordance with SEC rules. Exhibit 99.2 reconciles this non-GAAP financial measure to operating income, which is the most directly comparable financial measure calculated and presented in accordance with GAAP. We view gross margin as an important performance measure of the core profitability of our operations. This measure is a key component of our internal financial reporting and is used by our management in analyzing our business. We believe that investors benefit from having access to the same financial measures that our management uses. In addition, we have reclassified certain prior-period amounts to conform to our current-period presentation.
Deferred Fuel and Purchased Power Costs
     APS’ retail rate settlement became effective April 1, 2005. As part of the settlement, the ACC approved the PSA, which permits APS to defer for recovery or refund fluctuations in retail fuel and purchased power costs, subject to specified parameters. In accordance with the PSA, APS defers for future rate recovery 90% of the difference between actual retail fuel and purchased power costs and the amount of such costs currently included in base rates. APS’ recovery of PSA deferrals from its customers is subject to the ACC’s approval of annual PSA adjustments and periodic surcharge applications. See “Power Supply Adjustor” in Note 5.
     Since the inception of the PSA, APS has incurred substantially higher fuel and purchased power prices than those authorized in APS’ current base rates and has deferred those cost differences in accordance with the PSA. The balance of APS’ PSA deferrals at June 30, 2006 was $175 million. APS estimates that its PSA deferral balance at December 31, 2006 will be approximately $155 million to $175 million, based on APS’ hedged positions for fuel and purchased power at June 30, 2006 and recent forward market prices for natural gas and purchased power (which are subject to change). The recovery of PSA deferrals through ACC approved adjustors and surcharges recorded as revenue is offset dollar-for-dollar by the amortization of those deferred expenses.
     APS operated Palo Verde Unit 1 at reduced power levels from December 25, 2005 until March 18, 2006 due to vibration levels in one of the Unit’s shutdown cooling lines. During an outage at Unit 1 from March 18, 2006 to July 7, 2006, APS performed the necessary work and modifications to remedy the situation. APS estimates that incremental replacement power costs resulting from Palo Verde’s outages and reduced power levels were approximately $78 million during the six months ended June 30, 2006. The related PSA deferrals were approximately $70 million in that period. The Palo Verde replacement power costs were partially offset by $30 million of lower than expected replacement power costs related to APS’ fossil-fueled generating units during the six months ended June 30, 2006. As a result, the corresponding deferrals were reduced in that six-month period by $27 million.
     The PSA deferral balance at June 30, 2006 and estimated balance as of December 31, 2006 each includes (a) $45 million related to replacement power costs associated with unplanned 2005
62

Table of Contents

Palo Verde outages and (b) $70 million related to replacement power costs associated with unplanned 2006 outages or reduced power operations at Palo Verde. The PSA deferrals associated with these unplanned Palo Verde outages and reduced power operations are the subject of ACC prudence reviews. See “PSA Deferrals Related to Unplanned Palo Verde Outages” in Note 5.
     See “Power Supply Adjustor” in Note 5 for further information regarding the PSA.
Operating Results – Three-month period ended June 30, 2006 compared with three-month period ended June 30, 2005
     APS’ net income for the three months ended June 30, 2006 was $94 million compared with $64 million for the comparable prior-year period. The $30 million increase was primarily due to the higher retail sales volumes due to customer growth; effects of warmer weather on retail sales; and income tax credits related to prior years resolved in 2006. These positive factors were partially offset by higher operations and maintenance expense related to generation and customer service costs and higher depreciation and amortization related to increased depreciable assets. In addition, the increase also related to the absence of a prior year cost-based contract for PWEC Dedicated Assets which was partially offset by increased operations and maintenance expense and depreciation of those units. Higher fuel and purchased power costs (as discussed above) were substantially offset by the deferral of those costs in accordance with the PSA.
     Additional details on the major factors that increased (decreased) net income are contained in the following table (dollars in millions):
 	 	 	 	 	 	 	 	 	
 	 	Increase (Decrease)	 	
 	 	Pretax	 	 	After Tax	 	
Gross margin:	 	 	 	 	 	 	 	 	
Higher fuel and purchased power costs	 	$	(43	)	 	$	(26	)	
Deferred fuel and purchased power costs	 	 	40	 	 	 	24	 	
Absence of prior year cost-based contract for PWEC Dedicated Assets	 	 	40	 	 	 	24	 	
Higher retail sales volumes due to customer growth, excluding weather effects	 	 	26	 	 	 	16	 	
Effects of warmer weather on retail sales	 	 	16	 	 	 	10	 	
Miscellaneous items, net	 	 	(11	)	 	 	(6	)	
 	 	 	 	 	 	 	
Net increase in gross margin	 	 	68	 	 	 	42	 	
Operations and maintenance increases primarily due to:	 	 	 	 	 	 	 	 	
Costs of PWEC Dedicated Assets not included in prior year period	 	 	(8	)	 	 	(5	)	
Generation costs, including maintenance and overhauls	 	 	(6	)	 	 	(4	)	
Customer service costs, including regulatory demand-side management programs and planned maintenance	 	 	(6	)	 	 	(4	)	
Miscellaneous items, net	 	 	(6	)	 	 	(4	)	
Depreciation and amortization increases primarily due to:	 	 	 	 	 	 	 	 	
Higher depreciable assets due to transfer of PWEC Dedicated Assets	 	 	(6	)	 	 	(4	)	
Higher other depreciable assets partially offset by lower depreciation rates	 	 	(5	)	 	 	(3	)	
Income tax credits related to prior years resolved in 2006	 	 	—	 	 	 	7	 	
Miscellaneous items, net	 	 	1	 	 	 	5	 	
 	 	 	 	 	 	 	
Net increase in net income	 	$	32	 	 	$	30	 	
 	 	 	 	 	 	 	
63

Table of Contents

Regulated Electricity Revenues
     Regulated electricity revenues were $133 million higher for the three months ended June 30, 2006 compared with the prior-year period primarily as a result of:

 	•	 	a $75 million increase in revenues related to recovery of PSA deferrals, which had no earnings effect because of amortization of the same amount recorded as fuel and purchased power expense (see “Deferred Fuel and Purchased Power Costs” above);	
 		
 	•	 	a $36 million increase in retail revenues related to customer growth, excluding weather effects;	
 		
 	•	 	a $22 million increase in retail revenues related to warmer weather;	
 		
 	•	 	a $10 million increase in Off-System Sales due to higher prices; and	
 		
 	•	 	a $10 million decrease due to miscellaneous factors.	
Operating Results – Six-month period ended June 30, 2006 compared with six-month period ended June 30, 2005
     APS’ net income for the six months ended June 30, 2006 was $88 million compared with $91 million for the comparable prior-year period. The $3 million decrease was primarily due to higher fuel and purchased power costs (as discussed above); higher operations and maintenance expense related to generation and customer service costs; and higher depreciation and amortization related to increased depreciable assets. These negative factors were partially offset by deferred fuel and purchased power costs; higher retail sales volumes due to customer growth; effects of weather on retail sales; income tax credits related to prior years resolved in 2006; and a retail price increase effective April 1, 2005. In addition, the increase also related to the absence of a prior year cost-based contract for PWEC Dedicated Assets which was partially offset by increased operations and maintenance expense and depreciation of those units.
64

Table of Contents

Additional details on the major factors that increased (decreased) net income are contained in the following table (dollars in millions):
 	 	 	 	 	 	 	 	 	
 	 	Increase (Decrease)	 	
 	 	Pretax	 	 	After Tax	 	
 	 	 	 	 	 	 	
Gross margin:	 	 	 	 	 	 	 	 	
Higher fuel and purchased power costs	 	$	(98	)	 	$	(60	)	
Deferred fuel and purchased power costs (deferrals began April 1, 2005)	 	 	53	 	 	 	32	 	
Absence of prior year cost-based contract for PWEC Dedicated Assets	 	 	42	 	 	 	26	 	
Higher retail sales volumes due to customer growth, excluding weather effects	 	 	39	 	 	 	24	 	
Effects of weather on retail sales	 	 	13	 	 	 	8	 	
Higher marketing and trading gross margin primarily related to higher mark-to-market gains	 	 	13	 	 	 	8	 	
Retail price increase effective April 1, 2005	 	 	7	 	 	 	4	 	
Miscellaneous items, net	 	 	(15	)	 	 	(9	)	
 	 	 	 	 	 	 	
Net increase in gross margin	 	 	54	 	 	 	33	 	
Operations and maintenance increases primarily due to:	 	 	 	 	 	 	 	 	
Generation costs, including maintenance and overhauls	 	 	(25	)	 	 	(15	)	
Costs of PWEC Dedicated Assets not included in prior year period	 	 	(15	)	 	 	(9	)	
Customer service costs, including regulatory demand-side management programs and planned maintenance	 	 	(12	)	 	 	(7	)	
Miscellaneous items, net	 	 	(5	)	 	 	(3	)	
Depreciation and amortization increases primarily due to:	 	 	 	 	 	 	 	 	
Higher depreciable assets due to transfer of PWEC Dedicated Assets	 	 	(12	)	 	 	(7	)	
Higher other depreciable assets partially offset by lower depreciation rates	 	 	(3	)	 	 	(2	)	
Higher property taxes due to increased plant in service	 	 	(5	)	 	 	(3	)	
Income tax credits related to prior years resolved in 2006	 	 	—	 	 	 	7	 	
Miscellaneous items, net	 	 	2	 	 	 	3	 	
 	 	 	 	 	 	 	
Net decrease in net income	 	$	(21	)	 	$	(3	)	
 	 	 	 	 	 	 	
Regulated Electricity Revenues
     Regulated electricity revenues were $182 million higher for the six months ended June 30, 2006 compared with the prior-year period primarily as a result of:

 	•	 	a $93 million increase in revenues related to recovery of PSA deferrals, which had no earnings effect because of amortization of the same amount recorded as fuel and purchased power expense (see “Deferred Fuel and Purchased Power Costs” above);	
 		
 	•	 	a $54 million increase in retail revenues related to customer growth, excluding weather effects;	
 		
 	•	 	an $18 million increase in retail revenues related to weather;	
65

Table of Contents

 	•	 	a $12 million increase in Off-System Sales primarily resulting from sales previously reported in marketing and trading that were classified beginning in April 2005 as sales in regulated electricity in accordance with the APS retail rate case settlement;	
 		
 	•	 	a $10 million increase in Off-System Sales due to higher prices;	
 		
 	•	 	a $7 million increase in retail revenues due to a price increase effective April 1, 2005; and	
 		
 	•	 	a $12 million decrease due to miscellaneous factors.	
Marketing and Trading Revenues
     Marketing and trading revenues were $16 million lower for the six months ended June 30, 2006 compared with the prior-year period primarily as a result of:

 	•	 	a $15 million decrease in energy trading revenues on realized sales of electricity primarily due to lower delivered electricity prices and lower volumes;	
 		
 	•	 	an $11 million increase in mark-to-market gains on contracts for future delivery due to changes in forward prices; and	
 		
 	•	 	a $12 million decrease in Off-System Sales due to the absence of sales previously reported in marketing and trading that were classified beginning in April 2005 as sales in regulated electricity in accordance with the APS retail rate case settlement.	
ARIZONA PUBLIC SERVICE COMPANY – LIQUIDITY AND CAPITAL RESOURCES
      Contractual Obligations
     APS’ future contractual obligations have not changed materially from the amounts disclosed in Part II, Item 7 of the 2005 Form 10-K, with the exception of our aggregate:

 	•	 	fuel and purchased power commitments, which increased from approximately $1.7 billion at December 31, 2005 to $2.7 billion at June 30, 2006 as follows (in billions):	
 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
2006	 	2007-2008	 	2009-2010	 	Thereafter	 	Total	
$	0.4	 	 	$	0.5	 	 	$	0.4	 	 	$	1.4	 	 	$	2.7	 	
     See Note 4 for a list of APS’ payments due on total long-term debt and capitalized lease requirements.
66

Table of Contents

FORWARD-LOOKING STATEMENTS
     This document contains forward-looking statements based on current expectations, and neither Pinnacle West nor APS assumes any obligation to update these statements 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 “estimate,” “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 Pinnacle West or APS. In addition to the Risk Factors described in Item 1A of the 2005 Form 10-K, these factors include, but are not limited to:

 	•	 	state and federal regulatory and legislative decisions and actions, including the outcome and timing of APS’ retail rate proceedings pending before the ACC;	
 		
 	•	 	the timely recovery of PSA deferrals, including approximately $115 million of deferrals at June 30, 2006 associated with unplanned Palo Verde outages and reduced power operations that are the subject of ACC prudence reviews;	
 		
 	•	 	the ongoing restructuring of the electric industry, including the introduction of retail electric competition in Arizona and decisions impacting wholesale competition;	
 		
 	•	 	the outcome of regulatory, legislative and judicial proceedings, both current and future, relating to the restructuring;	
 		
 	•	 	market prices for electricity and natural gas;	
 		
 	•	 	power plant performance and outages;	
 		
 	•	 	transmission outages and constraints;	
 		
 	•	 	weather variations affecting local and regional customer energy usage;	
 		
 	•	 	customer growth and energy usage;	
 		
 	•	 	regional economic and market conditions, including the results of litigation and other proceedings resulting from the California energy situation, volatile fuel and purchased power 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;	
 		
 	•	 	current credit ratings remaining in effect for any given period of time;	
 		
 	•	 	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 any 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 and the interpretation of those principles;	
 		
 	•	 	the performance of the stock market and the changing interest rate environment, which affect the amount of required contributions to Pinnacle West’s pension plan and APS’ nuclear decommissioning trust funds, as well as the reported costs of providing pension and other postretirement benefits;	
 		
 	•	 	technological developments in the electric industry;	
67

Table of Contents

 	•	 	the strength of the real estate market in SunCor’s market areas, which include Arizona, Idaho, New Mexico and Utah; and	
 		
 	•	 	other uncertainties, all of which are difficult to predict and many of which are beyond the control of Pinnacle West and APS.	
68

Table of Contents

Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
     See “Pinnacle West Consolidated – Factors Affecting Our Financial Outlook — Market Risks” in Item 2 above for a discussion of quantitative and qualitative disclosures about market risks.
Item 4. CONTROLS AND PROCEDURES
     (a) Disclosure Controls and Procedures
     The term “disclosure controls and procedures” means controls and other procedures of a company that are designed to ensure that information required to be disclosed by a company in the reports that it files or submits under the Securities Exchange Act of 1934 (the “Exchange Act”) (15 U.S.C. 78a et seq .) is recorded, processed, summarized and reported, within the time periods specified in the SEC’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by a company in the reports that it files or submits under the Exchange Act is accumulated and communicated to a company’s management, including its principal executive and principal financial officers, or persons performing similar functions, as appropriate to allow timely decisions regarding required disclosure.
     Pinnacle West’s management, with the participation of Pinnacle West’s Chief Executive Officer and Chief Financial Officer, have evaluated the effectiveness of Pinnacle West’s disclosure controls and procedures as of June 30, 2006. Based on that evaluation, Pinnacle West’s Chief Executive Officer and Chief Financial Officer have concluded that, as of that date, Pinnacle West’s disclosure controls and procedures were effective.
     APS’ management, with the participation of APS’ Chief Executive Officer and Chief Financial Officer, have evaluated the effectiveness of APS’ disclosure controls and procedures as of June 30, 2006. Based on that evaluation, APS’ Chief Executive Officer and Chief Financial Officer have concluded that, as of that date, APS’ disclosure controls and procedures were effective.
     (b) Changes In Internal Control Over Financial Reporting
     The term “internal control over financial reporting” (defined in SEC Rule 13a-15(f)) refers to the process of a company that is designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with GAAP.
     No change in Pinnacle West’s or APS’ internal control over financial reporting occurred during the fiscal quarter ended June 30, 2006 that materially affected, or is reasonably likely to materially affect, Pinnacle West’s or APS’ internal control over financial reporting.
69

Table of Contents
Part II — OTHER INFORMATION
Item 1. LEGAL PROCEEDINGS
     See Note 12 of Notes to Condensed Consolidated Financial Statements in Part I, Item 1 of this report in regard to pending or threatened litigation or other disputes.
Item 1A. RISK FACTORS
     In addition to the other information set forth in this report, you should carefully consider the factors discussed in Part I, “Item 1A. Risk Factors” in the 2005 Form 10-K, which could materially affect the business, financial condition or future results of APS and Pinnacle West. The risks described in this report and the 2005 Form 10-K are not the only risks facing APS and Pinnacle West. Additional risks and uncertainties not currently known to us or that we currently deem to be immaterial also may materially adversely affect the business, financial condition and/or operating results of APS and Pinnacle West.
Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Proposal 1 – Election of Directors
     At our Annual Meeting of Shareholders held on May 17, 2006, the following persons were elected as directors:
 	 	 	 	 	 	 	 	 	 	 	 	 	
Class III (Term to expire at	 	 	 	 	 	 	 	 	 	Abstentions and	
2009 Annual Meeting)	 	Votes For	 	Votes Withheld	 	Broker Non-Votes	
Jack E. Davis	 	 	86,958,623	 	 	 	1,821,065	 	 	 	N/A	 	
Pamela Grant	 	 	86,967,924	 	 	 	1,811,764	 	 	 	N/A	 	
Martha O. Hesse	 	 	86,924,165	 	 	 	1,855,523	 	 	 	N/A	 	
William S. Jamieson, Jr.	 	 	86,990,842	 	 	 	1,788,846	 	 	 	N/A	 	
Continuing Directors
     The terms of Roy A. Herberger, Jr., Humberto S. Lopez, Kathryn L. Munro, and William L. Stewart will expire in 2007. The terms of Edward N. Basha, Jr., Michael L. Gallagher, Bruce J. Nordstrom and William J. Post will expire in 2008.
Proposal 2 — Independent Auditors
     At the same meeting, a proposal for the ratification of the selection of Deloitte & Touche LLP as independent Auditors of the Company for fiscal year ending 2006 was submitted to the shareholders, and the voting was as follows:
70

Table of Contents

 	 	 	 	 	 	 	 	 	 	 	 	 	
Proposal for the ratification	 	 	 	 	 	 	 	 	 	 	
of the selection of Deloitte &	 	 	 	 	 	 	 	 	 	 	
Touche LLP for fiscal year ending	 	 	 	 	 	 	 	 	 	Abstentions and	
2006	 	Votes For	 	Votes Against	 	Broker Non-Votes	
 	 	 	87,880,830	 	 	 	234,347	 	 	 	664,511	 	
Proposal 3 – Shareholder Proposal
     Also at this annual meeting, a shareholder proposal requesting that the Board of Directors take action to allow for the annual election of directors was submitted to the shareholders, and the voting was as follows:
 	 	 	 	 	 	 	 	 	 	 	 	 	
Proposal to elect each director	 	 	 	 	 	 	 	 	 	Abstentions and	 	
annually	 	Votes For	 	 	Votes Against	 	 	Broker Non-Votes	 	
 	 	 	61,797,460	 	 	 	12,834,465	 	 	 	14,147,763	 	
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 in Part I, Item 1 of this report for a discussion of a Superfund site.
      Mercury. By November 2006, the Arizona Department of Environmental Quality will submit a State Implementation Plan to the EPA to implement the Clean Air Mercury Rule or an alternate mercury program, as authorized by the EPA. See “Environmental Matters — Mercury” in Part 1, Item 1 of the 2005 Form 10-K. ADEQ issued a proposed mercury rule on July 25, 2006. The proposed rule generally incorporates EPA’s model cap-and-trade program, but requires sources to acquire two allowances for every one allowance needed for compliance. The proposed rule also requires coal-fired power plants to achieve a 90% mercury removal efficiency or to achieve certain emission limits. APS is still evaluating the potential impacts of the proposed rule and cannot currently estimate the expenditures which may be required.
71

Table of Contents

      Federal Implementation Plan. In September 1999, the EPA proposed a FIP to set air quality standards at certain power plants, including the Navajo Generating Station and the Four Corners Power Plant. See “Environmental Matters – Federal Implementation Plan” in Part I, Item 1 of the 2005 Form 10-K. On July 26, 2006, the Sierra Club sued the EPA to compel the EPA to issue a final FIP for Four Corners Power Plant. APS does not currently expect the FIP to have a material adverse effect on its financial position, results of operations, cash flows or liquidity.
72

Table of Contents
Item 6. EXHIBITS
     (a) Exhibits
 	 	 	 	 	
Exhibit No.	 	Registrant(s)	 	Description	
 		
10.1	 	Pinnacle West	 	First Amendment to Amended and Restated Credit Agreement, dated as of May 15, 2006, supplementing and amending the Amended and Restated Credit Agreement, dated as of December 9, 2005, among Pinnacle West Capital Corporation, as Borrower, JPMorgan Chase Bank, N.A., as Agent and the other parties thereto	
 	 	 	 	 	
12.1	 	Pinnacle West	 	Ratio of Earnings to Fixed Charges	
 	 	 	 	 	
12.2	 	APS	 	Ratio of Earnings to Fixed Charges	
 	 	 	 	 	
12.3	 	Pinnacle West	 	Ratio of Earnings to Combined Fixed Charges and Preferred Stock Dividend Requirements	
 	 	 	 	 	
31.1	 	Pinnacle West	 	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	
 	 	 	 	 	
31.2	 	Pinnacle West	 	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	
 	 	 	 	 	
31.3	 	APS	 	Certificate of Jack E. Davis, Chief Executive Officer, pursuant to Rule 13a-14(a) and Rule 15d-14(a) of the Securities Exchange Act, as amended	
 	 	 	 	 	
31.4	 	APS	 	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	 	Pinnacle West	 	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	
73

Table of Contents

 	 	 	 	 	
Exhibit No.	 	Registrant(s)	 	Description	
 		
32.2	 	APS	 	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	 	Reconciliation of Operating Income to Gross Margin	
 	 	 	 	 	
99.2	 	APS	 	Reconciliation of Operating Income to Gross Margin	
     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:
 	 	 	 	 	 	 	 	 	
 	 	 	 	 	 	 	 	Date	
Exhibit No.	 	Registrant(s)	 	Description	 	Previously Filed as Exhibit a	 	Effective	
 		
3.1	 	Pinnacle West	 	Articles of Incorporation, restated as of July 29, 1988	 	19.1 to Pinnacle West’s September 1988 Form 10-Q Report, File No. 1-8962	 	11-14-88	
 	 	 	 	 	 	 	 	 	
3.2	 	Pinnacle West	 	Pinnacle West Capital Corporation Bylaws, amended as of December 14, 2005	 	3.1 to Pinnacle West/APS December 9, 2005 Form 8-K Report, File Nos. 1-8962 and 1-4473	 	12-15-05	
 	 	 	 	 	 	 	 	 	
3.3	 	APS	 	Articles of Incorporation, restated as of May 25, 1988	 	4.2 to APS’ Form S-3 Registration Nos. 33-33910 and 33-55248 by means of September 24, 1993 Form 8-K Report, File No. 1-4473	 	9-29-93	
 	 	 	 	 	 	 	 	 	
3.4	 	APS	 	Arizona Public Service Company Bylaws, amended as of June 23, 2004	 	3.1 to APS’ June 30, 2004 Form 10-Q Report, File No. 1-4473	 	8-9-04	

a	 	Reports filed under File Nos. 1-4473 and 1-8962 were filed in the office of the Securities and Exchange Commission located in Washington, D.C.	
74

Table of Contents
SIGNATURES
     Pursuant to the requirements of the Securities Exchange Act of 1934, each registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
 	 	 	 	 	
 	PINNACLE WEST CAPITAL CORPORATION
   (Registrant)
 	 	
Dated: August 8, 2006 	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) 	 	
 	
 	ARIZONA PUBLIC SERVICE COMPANY
    (Registrant)
 	 	
Dated: August 8, 2006  	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) 	 	
 	
75

Table of Contents
EXHIBIT INDEX
 	 	 	 	 	
Exhibit No.	 	Registrant(s)	 	Description	
 		
10.1	 	PinnacleWest	 	First Amendment to Amended and Restated Credit Agreement, dated as of May 15, 2006, supplementing and amending the Amended and Restated Credit Agreement, dated as of December 9, 2005, among Pinnacle West Capital Corporation, as Borrower, JPMorgan Chase Bank, N.A., as Agent and the other parties thereto	
 	 	 	 	 	
12.1	 	Pinnacle West	 	Ratio of Earnings to Fixed Charges	
 	 	 	 	 	
12.2	 	APS	 	Ratio of Earnings to Fixed Charges	
 	 	 	 	 	
12.3	 	Pinnacle West	 	Ratio of Earnings to Combined Fixed Charges and Preferred Stock Dividend Requirements	
 	 	 	 	 	
31.1	 	Pinnacle West	 	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	
 	 	 	 	 	
31.2	 	Pinnacle West	 	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	
 	 	 	 	 	
31.3	 	APS	 	Certificate of Jack E. Davis, Chief Executive Officer, pursuant to Rule 13a-14(a) and Rule 15d-14(a) of the Securities Exchange Act, as amended	
 	 	 	 	 	
31.4	 	APS	 	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	 	Pinnacle West	 	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	
 		
32.2	 	APS	 	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	 	Reconciliation of Operating Income to Gross Margin	
 	 	 	 	 	
99.2	 	APS	 	Reconciliation of Operating Income to Gross Margin	

 

Exhibit 10.1
EXECUTION COPY
FIRST AMENDMENT TO
AMENDED AND RESTATED CREDIT AGREEMENT
     This First Amendment, dated as of May 15, 2006 (this “Amendment”), supplements and amends the Amended and Restated Credit Agreement, dated as of December 9, 2005 (as amended, restated, supplemented or otherwise modified from time to time, the “Credit Agreement”), among Pinnacle West Capital Corporation, as Borrower, the Lenders from time to time party thereto, JPMorgan Chase Bank, National Association, as Agent, and the other agents party thereto. Capitalized terms used herein and not otherwise defined shall have the meanings given to them in the Credit Agreement.
     WHEREAS, on April 17, 2006, the Federal Energy Regulatory Commission (“FERC”) issued an Order on Updated Market Power Analysis and Revoking Market-Based Rate Authority in Pinnacle West Capital Corp., et al., 115 FERC ¶61,055 (2006), revoking the Borrower’s market-based rate authority under the Federal Power Act (the “FPA”) in the APS control area and prior waivers and authorizations granted in connection with that market-based rate authority;
     WHEREAS, the applicable waivers and authorizations previously granted to the Borrower and so revoked include blanket authorization for issuances of securities or assumptions of liability under the FPA;
     WHEREAS, on April 20, 2006, the Borrower filed with the FERC an Application for Authorization to Issue Securities, Waivers, and Expedited Consideration under Section 204 of the FPA, seeking authorization for borrowings under the Credit Agreement and for the issuance of certain other securities and on May 3, 2006, the FERC issued an order under Section 204 of the FPA, 115 FERC ¶62,134 (2006), granting conditional authorization for borrowings under the Credit Agreement through June 30, 2008 and for the issuance of certain other securities; and
     WHEREAS, as a result of these events, the Borrower has requested the Lenders to amend certain of the representations and warranties of the Borrower under the Credit Agreement.
     WHEREAS, the Lenders executing this Amendment and the Agent are willing to amend the Credit Agreement on the terms and conditions set forth herein.
     NOW, THEREFORE, in consideration of the foregoing, the terms and conditions set forth herein and the undertakings herein set forth and intending to be legally bound, the parties hereto agree as follows:
          1. Amendments to the Credit Agreement . Effective as of the date first above written, and subject to the satisfaction of the conditions to effectiveness set forth in Section 3 below, the Credit Agreement is hereby amended as follows:

 	1.1.	 	Amendments to Section 1.1 of the Credit Agreement . New definitions are hereby added to Section 1.1 of the Credit Agreement in the appropriate alphabetical order to read as follows:	

 

      “FERC” means the Federal Energy Regulatory Commission or any successor agency under the FPA.
      “FPA” means the Federal Power Act, as amended, or any successor statute thereto.
      “May 2006 Letter Order” means that certain letter order issued by the FERC under Section 204 of the FPA on May 3, 2006, Pinnacle West Capital Corporation, 115 FERC ¶62,134 (2006).
      “Section 204 Authorization Expiration Date” shall mean the date on which FERC authorization under Section 204 of the FPA for the Borrower to issue securities and assume liabilities under the Credit Agreement shall expire. The Section 204 Authorization Expiration Date as established in the May 2006 Letter Order is June 30, 2008, but the Section 204 Authorization Expiration Date shall be such later date as the FERC may establish in a subsequent order under Section 204 of the FPA authorizing the Borrower to issue securities and assume liabilities under the Credit Agreement, a copy of which the Borrower shall provide to the Agent, together with such opinion letters of counsel and other information as the Agent shall reasonably request.
      “Section  204(e) Power” means the right of a public utility under Section 204(e) of the FPA to issue or renew the issuance of short-term debt securities or assume liabilities with respect to short-term debt securities without FERC approval under Section 204(a) of the FPA.

 	1.2.	 	Amendment to Section 2.2 of the Credit Agreement . The following language is hereby added to the end of Section 2.2 of the Credit Agreement:	
      Notwithstanding anything to the contrary in this Article II or in any Note, unless (i) the Borrower shall not be subject to FERC regulation under Section 204 of the FPA, or (ii) all necessary approvals of the FERC under Section 204 of the FPA for the Borrower to issue securities and assume liabilities under the Credit Agreement from and after the Section 204 Authorization Expiration Date have been obtained and provided to the Agent, together with such opinion letters of counsel and other information as the Agent shall reasonably request, (a) after the Section 204 Authorization Expiration Date, the Borrower shall not request, nor shall any Lender be required to make, any Credit Extension in respect of which FERC authorization under Section 204 of the FPA would be required, and (b) for the period commencing on the day after the Section 204 Authorization Expiration Date and thereafter, if and to the extent that any Credit Extension is made in reliance on the Section 204(e) Power as provided in the last sentence of Section 5.11 hereof, for a period of at least one Business Day during any 364-day period, the principal amount of all outstanding Advances hereunder shall be zero.

 	1.3.	 	Amendment to Section 5.2 of the Credit Agreement . The following language is hereby added to the end of Section 5.2 of the Credit Agreement:	
2

 

      It is acknowledged that pursuant to the May 2006 Letter Order the Borrower shall be required to make filings with the FERC as required under 18 C.F.R. § 34.10 and § 131.43.

 	1.4.	 	Amendments to Section 5.11 of the Credit Agreement . (i) The phrase “the Federal Energy Regulatory Commission (“ FERC ”)” now appearing in the third sentence of Section 5.11 of the Credit Agreement is deleted and the following is substituted therefor: “FERC”; and (ii) the last two sentences of Section 5.11 of the Credit Agreement are hereby amended in their entirety to read as follows:	
The Borrower is a “public utility” within the meaning of the FPA, and is subject to FERC regulation under the FPA, provided that upon the delivery to the Agent and the Lenders of a certificate of an Authorized Officer of the Borrower stating that the Borrower is no longer a “public utility” under the FPA, the foregoing representation shall no longer be operative. Except as provided in the next sentence below, to the extent required under the FPA, the Borrower has obtained authority from the FERC under Section 204 of the FPA to issue securities and assume liabilities under the Credit Agreement, and such authorization remains in full force and effect. After the Section 204 Authorization Expiration Date, to the extent that the Borrower remains subject to regulation under Section 204 of the FPA and all necessary approvals of the FERC under Section 204 of the FPA to issue securities and assume liabilities under the Credit Agreement from and after the Section 204 Authorization Expiration Date, have not then been obtained and provided to the Agent, together with such opinion letters of counsel and other information as the Agent shall reasonably request, Credit Extensions may be made under this Agreement solely pursuant to the Section 204(e) Power to the extent the Section 204(e) Power shall be applicable to the Borrower.

 	1.5.	 	Amendments to Section 6.1 of the Credit Agreement . (i) The following new subsections 6.1.10 and 6.1.11 to the Credit Agreement shall be inserted immediately following subsection 6.1.9 now appearing therein:	
      6.1.10. Promptly, and in any event within five (5) Business Days after the occurrence thereof, notice of (i) any change to or revocation of any applicable waiver or authorization previously granted to the Borrower under Section 204 of the FPA to issue securities and assume liabilities under the Credit Agreement, (ii) the issuance of any applicable waiver or authorization granted to the Borrower under Section 204 of the FPA to issue securities and assume liabilities under the Credit Agreement, and (iii) the Borrower not being subject to FERC regulation under the FPA.
      6.1.11. Promptly, and in any event within five (5) Business Days after an Authorized Officer obtains knowledge thereof, notice of any breach of the Borrower’s obligations under the May 2006 Letter Order or any other applicable waiver or authorization granted to the Borrower under Section 204 of the FPA to issue securities and assume liabilities under the Credit Agreement.
and (ii) the following language is hereby added to the end of the last paragraph of Section 6.1 of the Credit Agreement:
3

 

      So long as the Borrower remains subject to the reporting requirements of the Securities Exchange Act of 1934, as amended, the Borrower may provide, (i) in satisfaction of the requirement to provide financial statements under Section 6.1.1, its report on Form 10-K for the applicable fiscal year, and (ii) in satisfaction of the requirement to provide financial statements under Section 6.1.2, its Report on Form 10-Q for the applicable fiscal quarter.
          2. Representations and Warranties . The Borrower hereby represents and warrants that:

 	2.1.	 	After giving effect to this Amendment, the representations and warranties made by the Borrower in the Credit Agreement are true and correct on and as of the date of this Amendment, except to the extent such representations and warranties expressly relate to an earlier date, in which case such representations and warranties shall have been true and correct in all material respects on and as of such earlier date.	
 		
 	2.2.	 	This Amendment has been duly authorized by all requisite action on behalf of the Borrower and constitutes the legal, valid and binding obligation of the Borrower, enforceable against the Borrower in accordance with its terms, except to the extent the enforceability thereof may be limited by applicable bankruptcy, insolvency or other laws affecting the rights of creditors generally and by the application of general principles of equity.	
 		
 	2.3.	 	Upon the effectiveness of this Amendment, no Default or Unmatured Default exists under the terms of the Credit Agreement.	
          3. Conditions Precedent . This Amendment shall become effective and be deemed effective as of the date hereof, if, and only if, the Agent shall have received (i) executed copies of this Amendment from the Borrower and the Required Lenders and (ii) a duly executed opinion letter of counsel to the Borrower, addressed to the Lenders and the Agent, in substantially the form of Exhibit A hereto.
          4. Counterparts . This Amendment may be executed in one or more counterparts, each of which shall constitute an original Amendment and all of which together shall constitute one and the same Amendment.
          5. Governing Law . This shall be governed by, and construed in accordance with, the laws of the State of New York.
          6. Effect .

 	6.1.	 	Upon the effectiveness of this Amendment, on and after the date hereof, each reference in the Credit Agreement to “this Agreement,” “hereunder,” “hereof,” “herein” or words of like import shall mean and be a reference to the Credit Agreement, as amended and modified hereby.	
4

 

 	6.2.	 	Except as specifically amended and modified above, the Credit Agreement and all other documents, instruments and agreements executed and/or delivered in connection therewith shall remain in full force and effect, and are hereby ratified and confirmed.	
 		
 	6.3.	 	The execution, delivery and effectiveness of this Amendment shall neither, except as expressly provided herein, operate as a waiver of any right, power or remedy of the Lenders or the Agent, nor constitute a waiver of any provision of the Credit Agreement or any other Loan Document. The Agent and the Lenders expressly reserve all of their rights and remedies, including the right to institute enforcement actions in consequence of any existing Defaults or Unmatured Defaults not waived hereunder or otherwise at any time without further notice, under the Credit Agreement and the other Loan Documents and applicable law.	
[REMAINDER OF PAGE INTENTIONALLY BLANK]
5

 

          IN WITNESS WHEREOF, the parties hereto have caused this Amendment to be duly executed and delivered by their respective officers hereunto duly authorized as of the date first written above.
 	 	 	 	 	
PINNACLE WEST CAPITAL CORPORATION	 	 	
 	 	 	 	 	
By:	 	/s/ Barbara M. Gomez	 	 	
 	 	 	 	 	
Name:	 	Barbara M. Gomez	 	 	
 	 	 	 	 	
Title:	 	Vice President and Treasurer	 	 	

JPMORGAN CHASE BANK, NATIONAL ASSOCIATION,	
as a Lender, as an Issuing Bank and as	 	 	
Administrative Agent	 	 	
 	 	 	 	 	
By:	 	/s/ Nancy R. Barwig	 	 	
 	 	 	 	 	
Name:	 	Nancy R. Barwig	 	 	
Title:	 	Vice President	 	 	
 	 	 	 	 	
SIGNATURE PAGE TO FIRST AMENDMENT TO AMENDED AND RESTATED CREDIT AGREEMENT

 

 	 	 	 	 	
UNION BANK OF CALIFORNIA, N.A.,	 	 	
as a Lender and as Syndication Agent	 	 	
 	 	 	 	 	
By:	 	/s/ Efrain Soto	 	 	
 	 	 	 	 	
Name:	 	Efrain Soto	 	 	
Title:	 	Vice President	 	 	
 	 	 	 	 	
SIGNATURE PAGE TO FIRST AMENDMENT TO AMENDED AND RESTATED CREDIT AGREEMENT

 

 	 	 	 	 	
CITIBANK, N.A.,	 	 	
as a Lender and as Co-Documentation Agent	 	 	
 	 	 	 	 	
By:	 	/s/ Oscar Cragwell	 	 	
 	 	 	 	 	
Name:	 	Oscar Cragwell	 	 	
Title:	 	Vice President	 	 	
 	 	 	 	 	
SIGNATURE PAGE TO FIRST AMENDMENT TO AMENDED AND RESTATED CREDIT AGREEMENT

 

 	 	 	 	 	
KEYBANK NATIONAL ASSOCIATION,	 	 	
as a Lender and as Co-Documentation Agent	 	 	
 	 	 	 	 	
By:	 	/s/ Keven D. Smith	 	 	
 	 	 	 	 	
Name:	 	Keven D. Smith	 	 	
Title:	 	Senior Vice President	 	 	
 	 	 	 	 	
SIGNATURE PAGE TO FIRST AMENDMENT TO AMENDED AND RESTATED CREDIT AGREEMENT

 

 	 	 	 	 	
MIZUHO CORPORATE BANK, LTD.,	 	 	
as a Lender and as Co-Documentation Agent	 	 	
 	 	 	 	 	
By:	 	/s/ Raymond Ventura	 	 	
 	 	 	 	 	
Name:	 	Raymond Ventura	 	 	
Title:	 	Deputy General Manager	 	 	
 	 	 	 	 	
SIGNATURE PAGE TO FIRST AMENDMENT TO AMENDED AND RESTATED CREDIT AGREEMENT

 

 	 	 	 	 	
BANK OF AMERICA, N.A.,	 	 	
as a Lender	 	 	
 	 	 	 	 	
By:	 	/s/ Gabriela Millhorn	 	 	
 	 	 	 	 	
Name:	 	Gabriela Millhorn	 	 	
Title:	 	Senior Vice President	 	 	
 	 	 	 	 	
SIGNATURE PAGE TO FIRST AMENDMENT TO AMENDED AND RESTATED CREDIT AGREEMENT

 

 	 	 	 	 	
THE BANK OF NEW YORK,	 	 	
as a Lender	 	 	
 	 	 	 	 	
By:	 	/s/ John-Paul Marotta	 	 	
 	 	 	 	 	
Name:	 	John-Paul Marotta	 	 	
Title:	 	Managing Director	 	 	
 	 	 	 	 	
SIGNATURE PAGE TO FIRST AMENDMENT TO AMENDED AND RESTATED CREDIT AGREEMENT

 

 	 	 	 	 	
BARCLAYS BANK PLC,	 	 	
as a Lender	 	 	
 	 	 	 	 	
By:	 	/s/ Alison M c Guigan	 	 	
 	 	 	 	 	
Name:	 	Alison M c Guigan	 	 	
Title:	 	Associate Director	 	 	
 	 	 	 	 	
SIGNATURE PAGE TO FIRST AMENDMENT TO AMENDED AND RESTATED CREDIT AGREEMENT

 

 	 	 	 	 	
CREDIT SUISSE, Cayman Islands Branch,	 	 	
as a Lender	 	 	
 	 	 	 	 	
By:	 	/s/ Sarah Wu	 	 	
 	 	 	 	 	
Name:	 	Sarah Wu	 	 	
Title:	 	Director	 	 	

By:	 	/s/ Nupur Kumar	 	 	
 	 	 	 	 	
Name:	 	Nupur Kumar	 	 	
Title:	 	Associate	 	 	
 	 	 	 	 	
SIGNATURE PAGE TO FIRST AMENDMENT TO AMENDED AND RESTATED CREDIT AGREEMENT

 

 	 	 	 	 	
WELLS FARGO BANK, N.A.,	 	 	
as a Lender	 	 	
 	 	 	 	 	
By:	 	/s/ Ling Li	 	 	
 	 	 	 	 	
Name:	 	Ling Li	 	 	
Title:	 	Vice President	 	 	
 	 	 	 	 	
SIGNATURE PAGE TO FIRST AMENDMENT TO AMENDED AND RESTATED CREDIT AGREEMENT

 

 	 	 	 	 	
LEHMAN BROTHERS COMMERCIAL BANK,	 	 	
as a Lender	 	 	
 	 	 	 	 	
By:	 	/s/ George Janes	 	 	
 	 	 	 	 	
Name:	 	George Janes	 	 	
Title:	 	Chief Credit Officer	 	 	
 	 	 	 	 	
SIGNATURE PAGE TO FIRST AMENDMENT TO AMENDED AND RESTATED CREDIT AGREEMENT

 

 	 	 	 	 	
UBS LOAN FINANCE LLC,	 	 	
as a Lender	 	 	
 	 	 	 	 	
By:	 	/s/ Richard L. Tavrow	 	 	
 	 	 	 	 	
Name:	 	Richard L. Tavrow	 	 	
Title:	 	Director	 	 	

By:	 	/s/ Irja R. Otsa	 	 	
 	 	 	 	 	
Name:	 	Irja R. Otsa	 	 	
Title:	 	Associate Director	 	 	
SIGNATURE PAGE TO FIRST AMENDMENT TO AMENDED AND RESTATED CREDIT AGREEMENT

 

 	 	 	 	 	
U.S. BANK NATIONAL ASSOCIATION,	 	 	
as a Lender	 	 	
 	 	 	 	 	
By:	 	/s/ Scott J. Bell	 	 	
 	 	 	 	 	
Name:	 	Scott J. Bell	 	 	
Title:	 	Senior Vice President	 	 	
 	 	 	 	 	
SIGNATURE PAGE TO FIRST AMENDMENT TO AMENDED AND RESTATED CREDIT AGREEMENT

 

 	 	 	 	 	
MELLON BANK, N.A.,	 	 	
as a Lender	 	 	
 	 	 	 	 	
By:	 	/s/ Mark W. Rogers	 	 	
 	 	 	 	 	
Name:	 	Mark W. Rogers	 	 	
Title:	 	Vice President	 	 	
 	 	 	 	 	
SIGNATURE PAGE TO FIRST AMENDMENT TO AMENDED AND RESTATED CREDIT AGREEMENT

 

 	 	 	 	 	
THE NORTHERN TRUST COMPANY,	 	 	
as a Lender	 	 	
 	 	 	 	 	
By:	 	/s/ John P. Brazzale	 	 	
 	 	 	 	 	
Name:	 	John P. Brazzale	 	 	
Title:	 	Vice President	 	 	
 	 	 	 	 	
SIGNATURE PAGE TO FIRST AMENDMENT TO AMENDED AND RESTATED CREDIT AGREEMENT

 

THE BANK OF TOKYO-MITSUBISHI UFJ, LTD., CHICAGO BRANCH, (formerly
known as UFJ BANK LIMITED), as a Lender
 	 	 	 	 	
By:	 	/s/ Chi-Cheng Chen	 	 	
 	 	 	 	 	
Name:	 	Chi-Cheng Chen	 	 	
 	 	 	 	 	
Title:	 	Authorized Signatory
Vice President	 	 	
 	 	 	 	 	
SIGNATURE PAGE TO FIRST AMENDMENT TO AMENDED AND RESTATED CREDIT AGREEMENT

 

EXHIBIT A
Form of Opinion Letter of Counsel to the Borrower
Attached.

 
EXHIBIT 12.1
Pinnacle West Capital Corporation
Computation of Earnings to Fixed Charges
($000’s)
 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
 	 	Six	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
 	 	Months	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
 	 	Ended	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
 	 	6/30/2006	 	 	2005	 	 	2004	 	 	2003	 	 	2002	 	 	2001	 	
Earnings:	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
Income From Continuing Operations	 	$	122,438	 	 	$	223,163	 	 	$	246,590	 	 	$	225,384	 	 	$	236,563	 	 	$	327,367	 	
Income Taxes	 	 	56,064	 	 	 	126,892	 	 	 	136,142	 	 	 	102,202	 	 	 	152,145	 	 	 	213,535	 	
Fixed Charges	 	 	107,698	 	 	 	214,430	 	 	 	214,803	 	 	 	225,041	 	 	 	219,178	 	 	 	211,958	 	
 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
Total Earnings	 	$	286,200	 	 	$	564,485	 	 	$	597,535	 	 	$	552,627	 	 	$	607,886	 	 	$	752,860	 	

Fixed Charges:	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
Interest Expense	 	$	93,408	 	 	$	185,087	 	 	$	183,527	 	 	$	193,973	 	 	$	187,039	 	 	$	175,822	 	
Estimated Interest Portion of Annual Rents	 	 	14,290	 	 	 	29,343	 	 	 	31,276	 	 	 	31,068	 	 	 	32,139	 	 	 	36,136	 	
 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
Total Fixed Charges	 	$	107,698	 	 	$	214,430	 	 	$	214,803	 	 	$	225,041	 	 	$	219,178	 	 	$	211,958	 	

Ratio of Earnings to Fixed Charges (rounded down)	 	 	2.65	 	 	 	2.63	 	 	 	2.78	 	 	 	2.45	 	 	 	2.77	 	 	 	3.55	 	

  
 
EXHIBIT 12.2
Arizona Public Service Company
Computation of Earnings to Fixed Charges
($000’s)
 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
 	 	Six Months Ended	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
 	 	6/30/2006	 	 	2005	 	 	2004	 	 	2003	 	 	2002	 	 	2001	 	
Earnings:	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
Net Income	 	$	88,236	 	 	$	170,479	 	 	$	199,627	 	 	$	180,937	 	 	$	199,343	 	 	$	280,688	 	
Income Taxes	 	 	42,432	 	 	 	98,010	 	 	 	120,030	 	 	 	86,854	 	 	 	126,805	 	 	 	183,136	 	
Fixed Charges	 	 	90,511	 	 	 	178,437	 	 	 	181,372	 	 	 	181,793	 	 	 	168,985	 	 	 	166,939	 	
 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
Total Earnings	 	$	221,179	 	 	$	446,926	 	 	$	501,029	 	 	$	449,584	 	 	$	495,133	 	 	$	630,763	 	

Fixed Charges:	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
Interest Charges	 	$	74,151	 	 	$	145,502	 	 	$	146,983	 	 	$	147,610	 	 	$	133,878	 	 	$	130,525	 	
Amortization of Debt Discount	 	 	2,198	 	 	 	4,085	 	 	 	4,854	 	 	 	3,337	 	 	 	2,888	 	 	 	2,650	 	
Estimated Interest Portion of Annual Rents	 	 	14,162	 	 	 	28,850	 	 	 	29,535	 	 	 	30,846	 	 	 	32,219	 	 	 	33,764	 	
 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
Total Fixed Charges	 	$	90,511	 	 	$	178,437	 	 	$	181,372	 	 	$	181,793	 	 	$	168,985	 	 	$	166,939	 	

Ratio of Earnings to Fixed Charges (rounded down)	 	 	2.44	 	 	 	2.50	 	 	 	2.76	 	 	 	2.47	 	 	 	2.93	 	 	 	3.77	 	

  
 
Exhibit 12.3
PINNACLE WEST CAPITAL CORPORATION
COMPUTATION OF EARNINGS TO COMBINED FIXED CHARGES
AND PREFERRED STOCK DIVIDEND REQUIREMENTS
(dollars in thousands)
 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
 	 	Six Months	 	 	 	 	
 	 	Ended	 	 	 	 	
 	 	June 30,	 	 	Twelve Months Ended December 31,	 	
 	 	2006	 	 	2005	 	 	2004	 	 	2003	 	 	2002	 	 	2001	 	
Earnings:	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
Income from continuing operations	 	$	122,438	 	 	$	223,163	 	 	$	246,590	 	 	$	225,384	 	 	$	236,563	 	 	$	327,367	 	
Income taxes	 	 	56,064	 	 	 	126,892	 	 	 	136,142	 	 	 	102,202	 	 	 	152,145	 	 	 	213,535	 	
Fixed charges	 	 	107,698	 	 	 	214,430	 	 	 	214,803	 	 	 	225,041	 	 	 	219,178	 	 	 	211,958	 	
 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
Total	 	$	286,200	 	 	$	564,485	 	 	$	597,535	 	 	$	552,627	 	 	$	607,886	 	 	$	752,860	 	

Fixed Charges:	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
Interest expense	 	$	93,408	 	 	$	185,087	 	 	$	183,527	 	 	$	193,973	 	 	$	187,039	 	 	$	175,822	 	
Estimated interest portion of annual rents	 	 	14,290	 	 	 	29,343	 	 	 	31,276	 	 	 	31,068	 	 	 	32,139	 	 	 	36,136	 	
 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
Total	 	$	107,698	 	 	$	214,430	 	 	$	214,803	 	 	$	225,041	 	 	$	219,178	 	 	$	211,958	 	

Preferred Stock Dividend Requirements:	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
Income before income taxes	 	$	178,502	 	 	$	350,055	 	 	$	382,732	 	 	$	327,586	 	 	$	388,708	 	 	$	540,902	 	
Net income from continuing operations	 	 	122,438	 	 	 	223,163	 	 	 	246,590	 	 	 	225,384	 	 	 	236,563	 	 	 	327,367	 	
 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
Ratio of income before income taxes to net income	 	 	1.458	 	 	 	1.569	 	 	 	1.552	 	 	 	1.453	 	 	 	1.643	 	 	 	1.652	 	
Preferred stock dividends	 	 	—	 	 	 	—	 	 	 	—	 	 	 	—	 	 	 	—	 	 	 	—	 	

Preferred stock dividend requirements — ratio (above) times preferred stock dividends	 	$	—	 	 	$	—	 	 	$	—	 	 	$	—	 	 	$	—	 	 	$	—	 	

Fixed Charges and Preferred Stock Dividend Requirements:	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
Fixed charges	 	$	107,698	 	 	$	214,430	 	 	$	214,803	 	 	$	225,041	 	 	$	219,178	 	 	$	211,958	 	
Preferred stock dividend requirements	 	 	—	 	 	 	—	 	 	 	—	 	 	 	—	 	 	 	—	 	 	 	—	 	
 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
Total	 	$	107,698	 	 	$	214,430	 	 	$	214,803	 	 	$	225,041	 	 	$	219,178	 	 	$	211,958	 	

Ratio of Earnings to Combined Fixed Charges and Preferred Stock Dividend Requirements (rounded down)	 	 	2.65	 	 	 	2.63	 	 	 	2.78	 	 	 	2.45	 	 	 	2.77	 	 	 	3.55	 	

  

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)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) 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)	 	designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;	
 		
 	c)	 	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	
 		
 	d)	 	disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent 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 8, 2006.
 	 	 	 	 	
 	 	/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)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) 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)	 	designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;	
 		
 	c)	 	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	
 		
 	d)	 	disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent 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 8, 2006.
 	 	 	 	 	
 	 	/s/ Donald E. Brandt	 	 	
 	 	 	 	 	
 	 	Donald E. Brandt	 	 	
 	 	Executive Vice President &	 	 	
 	 	Chief Financial Officer	 	 	

 

Exhibit 31.3
CERTIFICATION
I, Jack E. Davis, certify that:

1.	 	I have reviewed this Quarterly Report on Form 10-Q of Arizona Public Service Company;	
 		
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)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) 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)	 	designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;	
 		
 	c)	 	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	
 		
 	d)	 	disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent 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 8, 2006.
 	 	 	 	 	
 	 	/s/ Jack E. Davis	 	 	
 	 	 	 	 	
 	 	Jack E. Davis	 	 	
 	 	President and Chief Executive Officer	 	 	
2

Exhibit 31.4
CERTIFICATION
I, Donald E. Brandt, certify that:

1.	 	I have reviewed this Quarterly Report on Form 10-Q of Arizona Public Service Company;	
 		
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)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) 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)	 	designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;	
 		
 	c)	 	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	
 		
 	d)	 	disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent 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 8, 2006.
 	 	 	 	 	
 	 	/s/ Donald E. Brandt	 	 	
 	 	 	 	 	
 	 	Donald E. Brandt	 	 	
 	 	Executive Vice President &	 	 	
 	 	Chief Financial Officer	 	 	

 

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, 2006, 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 8, 2006.
 	 	 	 	 	
 	 	/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, 2006 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 8, 2006.
 	 	 	 	 	
 	 	/s/ Donald E. Brandt	 	 	
 	 	 	 	 	
 	 	Donald E. Brandt	 	 	
 	 	Executive Vice President and	 	 	
 	 	Chief Financial Officer	 	 	

 

Exhibit 32.2
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, Jack E. Davis, 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 Arizona Public Service Company for the fiscal quarter ended June 30, 2006 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 Arizona Public Service Company.
Date: August 8, 2006.
 	 	 	 	 	
 	 	/s/ Jack E. Davis	 	 	
 	 	 	 	 	
 	 	Jack E. Davis	 	 	
 	 	President 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 Arizona Public Service Company for the fiscal quarter ended June 30, 2006 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 Arizona Public Service Company.
Date: August 8, 2006.
 	 	 	 	 	
 	 	/s/ Donald E. Brandt	 	 	
 	 	 	 	 	
 	 	Donald E. Brandt	 	 	
 	 	Executive Vice President and	 	 	
 	 	Chief Financial Officer	 	 	

 

Exhibit 99.1
PINNACLE WEST CAPITAL CORPORATION
NON-GAAP FINANCIAL MEASURE RECONCILIATION — OPERATING INCOME
(GAAP MEASURE) TO GROSS MARGIN (NON-GAAP FINANCIAL MEASURE)
(in thousands)
 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
 	 	THREE MONTHS ENDED	 	 	 	 	
 	 	JUNE 30,	 	 	Increase (Decrease)	 	
 	 	2006	 	 	2005	 	 	Pretax	 	 	After Tax	 	
RECONCILIATION OF REGULATED ELECTRICITY SEGMENT GROSS MARGIN	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
Operating Income (closest GAAP measure)	 	$	191,197	 	 	$	178,832	 	 	$	12,365	 	 	$	7,536	 	
Plus:	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
Operations and maintenance	 	 	168,332	 	 	 	153,097	 	 	 	15,235	 	 	 	9,286	 	
Real estate segment operations	 	 	98,412	 	 	 	67,713	 	 	 	30,699	 	 	 	18,711	 	
Depreciation and amortization	 	 	89,297	 	 	 	85,323	 	 	 	3,974	 	 	 	2,422	 	
Taxes other than income taxes	 	 	32,700	 	 	 	34,638	 	 	 	(1,938	)	 	 	(1,181	)	
Other expenses	 	 	8,430	 	 	 	17,556	 	 	 	(9,126	)	 	 	(5,562	)	
Marketing and trading segment fuel and purchased power	 	 	72,716	 	 	 	57,593	 	 	 	15,123	 	 	 	9,217	 	
Less:	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
Real estate segment revenues	 	 	112,603	 	 	 	84,259	 	 	 	28,344	 	 	 	17,276	 	
Other revenues	 	 	9,782	 	 	 	20,259	 	 	 	(10,477	)	 	 	(6,386	)	
Marketing and trading segment revenues	 	 	89,925	 	 	 	71,172	 	 	 	18,753	 	 	 	11,430	 	

Regulated electricity segment gross margin	 	$	448,774	 	 	$	419,062	 	 	$	29,712	 	 	$	18,109	 	

RECONCILIATION OF MARKETING AND TRADING SEGMENT GROSS MARGIN	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
Operating Income (closest GAAP measure)	 	$	191,197	 	 	$	178,832	 	 	$	12,365	 	 	$	7,536	 	
Plus:	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
Operations and maintenance	 	 	168,332	 	 	 	153,097	 	 	 	15,235	 	 	 	9,286	 	
Real estate segment operations	 	 	98,412	 	 	 	67,713	 	 	 	30,699	 	 	 	18,711	 	
Depreciation and amortization	 	 	89,297	 	 	 	85,323	 	 	 	3,974	 	 	 	2,422	 	
Taxes other than income taxes	 	 	32,700	 	 	 	34,638	 	 	 	(1,938	)	 	 	(1,181	)	
Other expenses	 	 	8,430	 	 	 	17,556	 	 	 	(9,126	)	 	 	(5,562	)	
Regulated electricity segment fuel and purchased power	 	 	263,944	 	 	 	160,590	 	 	 	103,354	 	 	 	62,994	 	
Less:	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
Real estate segment revenues	 	 	112,603	 	 	 	84,259	 	 	 	28,344	 	 	 	17,276	 	
Other revenues	 	 	9,782	 	 	 	20,259	 	 	 	(10,477	)	 	 	(6,386	)	
Regulated electricity segment revenues	 	 	712,718	 	 	 	579,652	 	 	 	133,066	 	 	 	81,104	 	

Marketing and trading segment gross margin	 	$	17,209	 	 	$	13,579	 	 	$	3,630	 	 	$	2,212	 	

 

PINNACLE WEST CAPITAL CORPORATION
NON-GAAP FINANCIAL MEASURE RECONCILIATION — OPERATING INCOME
(GAAP MEASURE) TO GROSS MARGIN (NON-GAAP FINANCIAL MEASURE)
(in thousands)
 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
 	 	SIX MONTHS ENDED	 	 	 	 	
 	 	JUNE 30,	 	 	Increase (Decrease)	 	
 	 	2006	 	 	2005	 	 	Pretax	 	 	After Tax	 	
RECONCILIATION OF REGULATED ELECTRICITY SEGMENT GROSS MARGIN	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
Operating Income (closest GAAP measure)	 	$	248,360	 	 	$	270,657	 	 	$	(22,297	)	 	$	(13,590	)	
Plus:	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
Operations and maintenance	 	 	346,759	 	 	 	308,181	 	 	 	38,578	 	 	 	23,513	 	
Real estate segment operations	 	 	169,742	 	 	 	123,047	 	 	 	46,695	 	 	 	28,461	 	
Depreciation and amortization	 	 	176,918	 	 	 	176,267	 	 	 	651	 	 	 	397	 	
Taxes other than income taxes	 	 	68,273	 	 	 	69,203	 	 	 	(930	)	 	 	(567	)	
Other expenses	 	 	16,952	 	 	 	25,930	 	 	 	(8,978	)	 	 	(5,472	)	
Marketing and trading segment fuel and purchased power	 	 	146,891	 	 	 	128,402	 	 	 	18,489	 	 	 	11,269	 	
Less:	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
Real estate segment revenues	 	 	220,457	 	 	 	154,195	 	 	 	66,262	 	 	 	40,387	 	
Other revenues	 	 	21,006	 	 	 	30,394	 	 	 	(9,388	)	 	 	(5,722	)	
Marketing and trading segment revenues	 	 	174,927	 	 	 	160,429	 	 	 	14,498	 	 	 	8,837	 	

Regulated electricity segment gross margin	 	$	757,505	 	 	$	756,669	 	 	$	836	 	 	$	509	 	

RECONCILIATION OF MARKETING AND TRADING SEGMENT GROSS MARGIN	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
Operating Income (closest GAAP measure)	 	$	248,360	 	 	$	270,657	 	 	$	(22,297	)	 	$	(13,590	)	
Plus:	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
Operations and maintenance	 	 	346,759	 	 	 	308,181	 	 	 	38,578	 	 	 	23,513	 	
Real estate segment operations	 	 	169,742	 	 	 	123,047	 	 	 	46,695	 	 	 	28,461	 	
Depreciation and amortization	 	 	176,918	 	 	 	176,267	 	 	 	651	 	 	 	397	 	
Taxes other than income taxes	 	 	68,273	 	 	 	69,203	 	 	 	(930	)	 	 	(567	)	
Other expenses	 	 	16,952	 	 	 	25,930	 	 	 	(8,978	)	 	 	(5,472	)	
Regulated electricity segment fuel and purchased power	 	 	421,339	 	 	 	239,013	 	 	 	182,326	 	 	 	111,128	 	
Less:	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
Real estate segment revenues	 	 	220,457	 	 	 	154,195	 	 	 	66,262	 	 	 	40,387	 	
Other revenues	 	 	21,006	 	 	 	30,394	 	 	 	(9,388	)	 	 	(5,722	)	
Regulated electricity segment revenues	 	 	1,178,844	 	 	 	995,682	 	 	 	183,162	 	 	 	111,637	 	

Marketing and trading segment gross margin	 	$	28,036	 	 	$	32,027	 	 	$	(3,991	)	 	$	(2,432	)	

  
 
Exhibit 99.2
ARIZONA PUBLIC SERVICE COMPANY
NON-GAAP FINANCIAL MEASURE RECONCILIATION — OPERATING INCOME
(GAAP MEASURE) TO GROSS MARGIN (NON-GAAP FINANCIAL MEASURE)
(in thousands)
 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
 	 	THREE MONTHS ENDED	 	 	 	 	
 	 	JUNE 30,	 	 	Increase (Decrease)	 	
 	 	2006	 	 	2005	 	 	Pretax	 	 	After Tax	 	
RECONCILIATION OF GROSS MARGIN	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
Operating Income (closest GAAP measure)	 	$	119,967	 	 	$	95,321	 	 	$	24,646	 	 	$	15,022	 	
Plus:	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
Operations and maintenance	 	 	164,373	 	 	 	138,314	 	 	 	26,059	 	 	 	15,883	 	
Depreciation and amortization	 	 	87,969	 	 	 	76,808	 	 	 	11,161	 	 	 	6,803	 	
Income taxes	 	 	46,650	 	 	 	41,772	 	 	 	4,878	 	 	 	2,973	 	
Other taxes	 	 	32,666	 	 	 	31,322	 	 	 	1,344	 	 	 	819	 	

Gross margin	 	$	451,625	 	 	$	383,537	 	 	$	68,088	 	 	$	41,500	 	

 
ARIZONA PUBLIC SERVICE COMPANY
NON-GAAP FINANCIAL MEASURE RECONCILIATION — OPERATING INCOME
(GAAP MEASURE) TO GROSS MARGIN (NON-GAAP FINANCIAL MEASURE)
(in thousands)
 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
 	 	SIX MONTHS ENDED	 	 	 	 	
 	 	JUNE 30,	 	 	Increase (Decrease)	 	
 	 	2006	 	 	2005	 	 	Pretax	 	 	After Tax	 	
RECONCILIATION OF GROSS MARGIN	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
Operating Income (closest GAAP measure)	 	$	145,011	 	 	$	154,064	 	 	$	(9,053	)	 	$	(5,518	)	
Plus:	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
Operations and maintenance	 	 	337,726	 	 	 	280,608	 	 	 	57,118	 	 	 	34,813	 	
Depreciation and amortization	 	 	174,280	 	 	 	159,022	 	 	 	15,258	 	 	 	9,300	 	
Income taxes	 	 	43,621	 	 	 	58,152	 	 	 	(14,531	)	 	 	(8,857	)	
Other taxes	 	 	68,214	 	 	 	62,767	 	 	 	5,447	 	 	 	3,320	 	

Gross margin	 	$	768,852	 	 	$	714,613	 	 	$	54,239	 	 	$	33,058