SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-K

(Mark One)

OR

PINNACLE WEST CAPITAL CORPORATION

Securities registered pursuant to Section 12(b) of the Act:

Securities registered pursuant to Section 12(g) of the Act: None.

     Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No o

     Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or in any amendment to this Form 10-K. x

     Indicate by check mark whether the registrant is an accelerated filer (as defined in Exchange Act Rule 12b-2). Yes x No o

     State the aggregate market value of the voting and non-voting common equity held by non-affiliates, computed by reference to the price at which the common equity was last sold, or the average bid and asked price of such common equity, as of the last business day of the registrant’s most recently completed second fiscal quarter: $3,404,788,658 as of June 30, 2003

     The number of shares outstanding of the registrant’s common stock as of March 11, 2004 was 91,297,881.

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the registrant’s definitive Proxy Statement relating to its Annual Meeting of Shareholders to be held on May 19, 2004 are incorporated by reference into Part III hereof.

TABLE OF CONTENTS

 i 

GLOSSARY

ACC – Arizona Corporation Commission

ADEQ – Arizona Department of Environmental Quality

AFUDC – allowance for funds used during construction

AISA – Arizona Independent Scheduling Administrator

ALJ – Administrative Law Judge

ANPP – Arizona Nuclear Power Project, also known as Palo Verde

APS – Arizona Public Service Company, a subsidiary of the Company

APS Energy Services – APS Energy Services Company, Inc., a subsidiary of the Company

CC&N – Certificate of Convenience and Necessity

Cholla – Cholla Power Plant

Citizens – Citizens Communications Company

Clean Air Act – the Clean Air Act, as amended

Company – Pinnacle West Capital Corporation

CPUC – California Public Utility Commission

DOE – United States Department of Energy

EITF – the 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

FIN – FASB Interpretation

Financing Order – ACC Order that authorized APS’ $500 million loan to Pinnacle West Energy in May 2003

FIP – Federal Implementation Plan

Four Corners – Four Corners Power Plant

GAAP – accounting principles generally accepted in the United States of America

IRS – United States Internal Revenue Service

ISO – California Independent System Operator

kW – kilowatt, one thousand watts

kWh – kilowatt-hour, one thousand watts per hour

Moody’s – Moody’s Investors Service

MW – megawatt, one million watts

MWh – megawatt-hours, one million watts per hour

NAC – NAC International Inc., a subsidiary of El Dorado

Native Load – retail and wholesale sales supplied under traditional cost-based rate regulation

1999 Settlement Agreement – comprehensive settlement agreement related to the implementation of retail electric competition

NOV – Notice of Violation

NRC – United States Nuclear Regulatory Commission

Nuclear Waste Act – Nuclear Waste Policy Act of 1982, as amended

OCI – other comprehensive income

Palo Verde – Palo Verde Nuclear Generating Station

PCAOB – Public Company Accounting Oversight Board

PG&E – PG&E Corp.

Pinnacle West – Pinnacle West Capital Corporation, the Company

Pinnacle West Energy – Pinnacle West Energy Corporation, a subsidiary of the Company

PRP – potentially responsible parties under Superfund

PWEC Dedicated Assets – the following Pinnacle West Energy power plants, each of which is dedicated to serving APS’ customers: Redhawk Units 1 and 2, West Phoenix Units 4 and 5 and Saguaro Unit 3

PX – California Power Exchange

RTO – regional transmission organization

Rules – ACC retail electric competition rules

Salt River Project – Salt River Project Agricultural Improvement and Power District

SCE – Southern California Edison Company

SEC – United States Securities and Exchange Commission

SFAS – Statement of Financial Accounting Standards

SNWA – Southern Nevada Water Authority

SPE – special-purpose entity

Standard & Poor’s – Standard & Poor’s Corporation

SunCor – SunCor Development Company, a subsidiary of the Company

Superfund – Comprehensive Environmental Response, Compensation and Liability Act

T&D – transmission and distribution

2

Track A Order – ACC order dated September 10, 2002 regarding generation asset transfers and related issues

Track B Order –ACC order dated March 14, 2003 regarding competitive solicitation requirements for power purchases by Arizona’s investor-owned electric utilities

Trading – energy-related activities entered into with the objective of generating profits on changes in market prices

VIE – variable interest entity

WestConnect – WestConnect RTO, LLC, a proposed RTO to be formed by owners of electric transmission lines in the southwestern United States

3

PART I

ITEM 1. BUSINESS

CURRENT STATUS

General

     We were incorporated in 1985 under the laws of the State of Arizona and own all of the outstanding equity securities of APS, our major subsidiary. APS is a vertically-integrated electric utility that provides either retail or wholesale electric service to substantially all of the state of Arizona, with the major exceptions of the Tucson metropolitan area and about one-half of the Phoenix metropolitan area. Through its marketing and trading division, APS also generates, sells and delivers electricity to wholesale customers in the western United States.

     Our other significant subsidiaries are Pinnacle West Energy, which owns and operates generating plants; APS Energy Services, which provides competitive energy services and products in the western United States; and SunCor, which is engaged in real estate development activities. We discuss each of these subsidiaries in greater detail below. See “Business of Pinnacle West Energy Corporation,” “Business of APS Energy Services Company, Inc.” and “Business of SunCor Development Company” in this Item 1.

Business Segments

     We have three principal business segments (determined by products, services and the regulatory environment):

•		our regulated electricity segment (70% of operating revenues in 2003), which consists of traditional regulated retail and wholesale electricity businesses and related activities, and includes electricity generation, transmission and distribution;
•		our marketing and trading segment (14% of operating revenues in 2003), which consists of our competitive energy business activities, including wholesale marketing and trading and APS Energy Services’ commodity-related energy services; and
•		our real estate segment (13% of operating revenues in 2003), which consists of SunCor’s real estate development and investment activities.

     See Note 17 of Notes to Consolidated Financial Statements in Item 8 for financial information about our business segments.

APS General Rate Case

     We believe APS’ general rate case pending before the ACC is the key issue affecting our outlook. As discussed in greater detail in Note 3 of Notes to Consolidated Financial Statements in Item 8, in this rate case APS has requested, among other things, a 9.8% retail rate increase (approximately $175 million annually), rate treatment for the PWEC Dedicated Assets and the recovery of $234 million written off by APS as part of the 1999 Settlement Agreement. In its filed

4

testimony, the ACC staff recommended, among other things, that the ACC decrease APS’ rates by approximately 8% (approximately $143 million annually), not allow the PWEC Dedicated Assets to be included in APS’ rate base, and not allow APS to recover any of the $234 million written off as a result of the 1999 Settlement Agreement. The ACC staff recommendations, if implemented as proposed, could have a material adverse impact on our results of operations, financial position, liquidity, dividend sustainability, credit ratings and access to capital markets. We believe that APS’ rate case requests are supported by, among other things, APS’ demonstrated need for the PWEC Dedicated Assets; APS’ need to attract capital at reasonable rates of return to support the required capital investment to ensure continued customer reliability in APS’ high-growth service territory; and the conditions in the western energy market. As a result, we believe it is unlikely that the ACC would adopt the ACC staff recommendations in their present form, although we can give no assurances in that regard. The hearing on the rate case is scheduled to begin on May 25, 2004. We believe the ACC will be able to make a decision by the end of 2004.

Employees

     At December 31, 2003, we employed about 7,200 people, including the employees of our subsidiaries. Of these employees, about 6,000 were employees of APS, including employees at jointly-owned generating facilities for which APS serves as the generating facility manager. About 1,200 people were employed by Pinnacle West and our other subsidiaries. Our principal executive offices are located at 400 North Fifth Street, Phoenix, Arizona 85004 (telephone 602-250-1000).

Available Information

     We make available free of charge on or through our Internet Website (www.pinnaclewest.com) the following filings as soon as reasonably practicable after they are electronically filed with, or furnished to, the SEC: our Annual Report on Form 10-K, our Quarterly Reports on Form 10-Q, our Current Reports on Form 8-K and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934. The information on our Website is not part of this report.

Forward-Looking Statements

     This document contains forward-looking statements based on current expectations, and we assume no obligation to update these statements or make any further statements on any of these issues, except as required by applicable law. These forward-looking statements are often identified by words such as “predict,” “hope,” “may,” “believe,” “anticipate,” “plan,” “expect,” “require,” “intend,” “assume” and similar words. Because actual results may differ materially from expectations, we caution readers not to place undue reliance on these statements. A number of factors could cause future results to differ materially from historical results, or from results or outcomes currently expected or sought by us. These factors include, but are not limited to:

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

5

•		the ongoing restructuring of the electric industry, including the introduction of retail electric competition in Arizona and decisions impacting wholesale competition;
•		market prices for electricity and natural gas;
•		power plant performance and outages;
•		weather variations affecting local and regional customer energy usage;
•		energy usage;
•		regional economic and market conditions, including the results of litigation and other proceedings resulting from the California energy situation, volatile purchased power and fuel costs and the completion of generation and transmission construction in the region, which could affect customer growth and the cost of power supplies;
•		the cost of debt and equity capital and access to capital markets;
•		our ability to compete successfully outside traditional regulated markets (including the wholesale market);
•		the performance of our marketing and trading activities due to volatile market liquidity and deteriorating counterparty credit and the use of derivative contracts in our business (including the interpretation of the subjective and complex accounting rules related to these contracts);
•		changes in accounting principles generally accepted in the United States of America;
•		the successful completion of our generation construction program;
•		regulatory issues associated with generation construction, such as permitting and licensing;
•		the performance of the stock market and the changing interest rate environment, which affect the amount of our required contributions to our pension plan and nuclear decommissioning trust funds, as well as our reported costs of providing pension and other postretirement benefits;
•		technological developments in the electric industry;
•		the strength of the real estate market in SunCor’s market areas, which include Arizona, Idaho, New Mexico and Utah;
•		conservation programs; and
•		other uncertainties, all of which are difficult to predict and many of which are beyond our control.

REGULATION AND COMPETITION

Retail

     The ACC regulates APS’ retail electric rates and its issuance of securities. The ACC must also approve any transfer of APS’ property used to provide retail electric service and approve or receive prior notification of certain transactions between Pinnacle West, APS and their respective affiliates. See Note 3 of Notes to Consolidated Financial Statements in Item 8 for a discussion of the status of electric industry restructuring in Arizona.

     The electric utility industry has undergone significant regulatory change in the last few years designed to encourage competition in the sale of electricity and related services. However, the experience in California with deregulation has caused many states, including Arizona, to reexamine retail electric competition.

6

     As of January 1, 2001, all of APS’ retail customers were eligible to choose an alternate energy supplier. However, there are currently no active retail competitors offering unbundled energy or other utility services to APS’ customers. As a result, we cannot predict when, and the extent to which, additional competitors will re-enter APS’ service territory. Also, regulatory developments and legal challenges to the ACC’s electric competition rules have raised considerable uncertainty about the status and pace of retail electric competition and of electric restructuring in Arizona. See “Retail Electric Competition Rules” in Note 3 of Notes to Consolidated Financial Statements in Item 8 for additional information.

     APS is subject to varying degrees of competition from other investor-owned utilities in Arizona (such as Tucson Electric Power Company and Southwest Gas Corporation) as well as cooperatives, municipalities, electrical districts and similar types of governmental or non-profit organizations (principally Salt River Project). APS also faces competition from low-cost, hydroelectric power and parties that have access to low-priced preferential, federal power and other governmental subsidies. In addition, some customers, particularly industrial and large commercial customers, may own and operate generation facilities to meet their own energy requirements.

Wholesale

     General

     The FERC regulates rates for wholesale power sales and transmission services. During 2003, approximately 19% of our electric operating revenues resulted from such sales and services. In early 2003, we moved our marketing and trading division from Pinnacle West to APS for all future marketing and trading activities (existing wholesale contracts remained at Pinnacle West) as a result of the ACC’s Track A Order prohibiting the previously required transfer of APS’ generating assets to Pinnacle West Energy (see “Track A Order” in Note 3 of Notes to Consolidated Financial Statements in Item 8).

     The marketing and trading division focuses primarily on managing APS’ purchased power and fuel risks in connection with its costs of serving retail customer energy requirements. The division also sells, in the wholesale market, APS and Pinnacle West Energy generation output that is not needed for APS’ Native Load and, in doing so, competes with other utilities, power marketers and independent power producers. See “Track B Order” in Note 3 of Notes to Consolidated Financial Statements in Item 8 for information regarding an ACC-mandated process by which APS must competitively procure energy. Additionally, the marketing and trading division, subject to specified parameters, markets, hedges and trades in electricity, fuels and emissions allowances and credits.

     Regional Transmission Organizations

     Federal In a December 1999 order, the FERC established characteristics and functions that must be met by utilities in forming and operating RTOs. The characteristics for an acceptable RTO include independence from market participants, operational control over a region large enough to support efficient and nondiscriminatory markets and exclusive authority to maintain short-term reliability. Additionally, in a pending notice of proposed rulemaking, the FERC is considering implementing a standard market design for wholesale markets.

7

     On October 16, 2001, APS and other owners of electric transmission lines in the Southwest filed with the FERC a request for a declaratory order confirming that their proposal to form WestConnect RTO, LLC would satisfy the FERC’s requirements for the formation of an RTO. On October 10, 2002, the FERC issued an order finding that the WestConnect proposal, if modified to address specified issues, could meet the FERC’s RTO requirements and provide the basic framework for a standard market design for the Southwest. On September 15, 2003, the FERC issued an order granting clarification and rehearing, in part, of its prior orders. In particular, this order approved the use of a physical congestion management scheme, which is used to allocate transmission rights on congested lines, for WestConnect for an initial phase-in period. The FERC indicated that the WestConnect utilities and the appropriate regional state advisory committee should develop a market-based congestion management scheme for subsequent implementation. APS is now participating in a cost/benefit analysis of implementing WestConnect, the results of which are expected to be completed in 2004.

     State The Rules also required the formation and implementation of an Arizona Independent Scheduling Administrator. The purpose of the AISA is to oversee the application of operating protocols to ensure statewide consistency for transmission access. The AISA is anticipated to be a temporary organization until the implementation of an independent system operator or RTO. APS participated in the creation of the AISA, a not-for-profit entity, and the filing at the FERC for approval of its operating protocols. The operating protocols were partially rejected and the remainder are currently under review. In its Track B Order, the ACC directed that a hearing be held on whether or not APS should be required to continue funding the AISA.

BUSINESS OF ARIZONA PUBLIC SERVICE COMPANY

General

     APS was incorporated in 1920 under the laws of Arizona and currently has more than 931,500 customers. APS does not distribute any products. During 2003, no single purchaser or user of energy (other than Pinnacle West) accounted for more than 4% of consolidated electric revenues. See “Current Status – General” and “Regulation and Competition” above for additional background information about APS’ business, including its marketing and trading division.

     At December 31, 2003, APS employed approximately 6,000 people, including employees at jointly-owned generating facilities for which APS serves as the generating facility manager. APS’ principal executive offices are located at 400 North Fifth Street, P.O. Box 53999, Phoenix, Arizona 85072-3999 (telephone 602-250-1000).

Purchased Power and Generating Fuel

     See “Properties – Capacity” in Item 2 for information about our power plants by fuel types.

     2003 Energy Mix

     Our consolidated sources of energy during 2003 were: purchased power – 54.4% (approximately 90.0% of which was for wholesale power operations); coal – 20.1%; nuclear – 14.7%; gas – 10.7%; and other (includes oil, hydro and solar) – 0.1%.

8

     APS’ sources of energy during 2003 were: purchased power – 55.3% (approximately 75.0% of which was for wholesale power operations); coal – 24.5%; nuclear – 17.9%; gas – 2.2%; and other (includes oil, hydro and solar) – 0.1%.

     Coal Supply

     Cholla Cholla is a coal-fired power plant located in northeastern Arizona. It is a jointly-owned facility operated by APS. APS purchases most of Cholla’s coal requirements from a coal supplier that mines all of the coal under a long-term lease of coal reserves owned by the Navajo Nation, the federal government and private landholders. Cholla has sufficient coal under current contracts to ensure a reliable fuel supply through 2007. This includes our expected requirements for low sulfur coal, which is required for limited operating conditions; however, if necessary, low sulfur coal may be purchased on the open market. APS may purchase a portion of Cholla’s coal requirements on the spot market to take advantage of competitive pricing options. Following expiration of current contracts, APS believes that numerous competitive fuel supply options will exist to ensure the continued operation of Cholla for its useful life.

     Four Corners Four Corners is a coal-fired power plant located in the northwestern corner of New Mexico. It is a jointly-owned facility operated by APS. APS purchases all of Four Corners’ coal requirements from a supplier with a long-term lease of coal reserves owned by the Navajo Nation. The Four Corners coal contract runs through July 2016, with options to extend the contract for five to fifteen additional years beyond the plant site lease expiration in 2017.

     Navajo Generating Station The Navajo Generating Station is a coal-fired power plant located in northern Arizona. It is a jointly-owned facility operated by Salt River Project. The Navajo Generating Station’s coal requirements are purchased from a supplier with long-term leases from the Navajo Nation and the Hopi Tribe. The Navajo Generating Station is under contract with its coal supplier through 2011, with options to extend through the plant site lease expiration in 2019. The Navajo Generating Station lease waives certain taxes through the lease expiration in 2019. The lease provides for the potential to renegotiate the coal royalty in 2007 and 2017 and a five-year price review, each of which may impact the fuel price.

     See “Properties – Capacity” in Item 2 for information about APS’ ownership interests in Cholla, Four Corners and the Navajo Generating Station. See Note 11 of Notes to Consolidated Financial Statements in Item 8 for information regarding our coal mine reclamation obligations.

     Natural Gas Supply

     See Note 11 of Notes to Consolidated Financial Statements in Item 8 for a discussion of our natural gas requirements.

     Nuclear Fuel Supply

     Palo Verde Fuel Cycle Palo Verde is a nuclear power plant located about 50 miles west of Phoenix, Arizona. It is a jointly-owned facility operated by APS. The fuel cycle for Palo Verde is comprised of the following stages:

•

mining and milling of uranium ore to produce uranium concentrates;

9

•		conversion of uranium concentrates to uranium hexafluoride;
•		enrichment of uranium hexafluoride;
•		fabrication of fuel assemblies;
•		utilization of fuel assemblies in reactors; and
•		storage and disposal of spent nuclear fuel.

     The Palo Verde participants have contracted for all of Palo Verde’s requirements for uranium concentrates and conversion services through 2008. The Palo Verde participants have also contracted for all of Palo Verde’s enrichment services through 2010 and fuel assembly fabrication services until at least 2015.

     Spent Nuclear Fuel and Waste Disposal See “Palo Verde Nuclear Generating Station” in Note 11 of Notes to Consolidated Financial Statements in Item 8 for a discussion of spent nuclear fuel and waste disposal.

Purchased Power Agreements

     In addition to its own available generating capacity (see “Properties” in Item 2), APS purchases electricity under various arrangements. One of the most important of these is a long-term contract with Salt River Project. The amount of electricity available to APS is based in large part on customer demand within certain areas now served by APS pursuant to a related territorial agreement. The generating capacity available to APS pursuant to the contract was 343 MW from January through May 2003, and starting in June 2003, it changed to 350 MW. In 2003, APS received approximately 952,146 MWh of energy under the contract and paid about $64.4 million for capacity availability and energy received. This contract may be canceled by Salt River Project on three years’ notice, given no earlier than December 31, 2003. To date, Salt River Project has not given any notice to cancel. APS may also cancel the contract on five years’ notice, given no earlier than December 31, 2006.

     In September 1990, APS entered into a thirty-year seasonal capacity exchange agreement with PacifiCorp. Under this agreement, APS receives electricity from PacifiCorp during the summer peak season (from May 15 to September 15) and APS returns electricity to PacifiCorp during the winter season (from October 15 to February 15). Until 2020, APS and PacifiCorp each has 480 MW of capacity and a related amount of energy available to it under the agreement for its respective seasons. In 2003, APS received approximately 571,392 MWh of energy under the capacity exchange. APS must also make additional offers of energy to PacifiCorp each year through October 31, 2020. Pursuant to this requirement, during 2003, PacifiCorp received offers of 1,091,450 MWh and purchased about 168,000 MWh.

     In December 2003, APS issued a request for proposals for the purchase of at least 500 MW of long-term power supply resources for delivery beginning June 1, 2007 to be used for APS’ anticipated retail load. For additional information, see “Request for Proposals” in Note 3 of Notes to Consolidated Financial Statements in Item 8.

     Consistent with the ACC’s Track B Order, APS issued a request for proposals (“RFP”) in March 2003 and, as a result of that RFP, on or before May 6, 2003, APS entered into contracts with three parties, including Pinnacle West Energy, to meet a portion of APS’ capacity and energy requirements for the years 2003 through 2006. See “Track B Order” in Note 3 of Notes to

10

Consolidated Financial Statements in Item 8 for additional information about the contracts and the Track B Order.

Construction Program

     During the years 2001 through 2003, APS incurred approximately $1.4 billion in capital expenditures. APS’ capital expenditures for the years 2004 through 2006 are expected to be primarily for expanding transmission and distribution capabilities to meet growing customer needs, for upgrading existing utility property and for environmental purposes. APS’ capital expenditures were approximately $429 million in 2003. APS’ capital expenditures, including expenditures for environmental control facilities, for the years 2004 through 2006 have been estimated as follows:

(dollars in millions)

     The above amounts exclude capitalized interest costs and include capitalized property taxes and approximately $30 million per year for nuclear fuel. These amounts include only APS’ generation (production) assets. APS conducts a continuing review of its construction program.

     See “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Capital Needs and Resources by Company” in Item 7 for additional information about APS’ and Pinnacle West Energy’s construction programs.

Environmental Matters

     EPA Environmental Regulation

     Regional Haze Rules On April 22, 1999, the EPA announced final regional haze rules. These new regulations require states to submit, by 2008, implementation plans to eliminate all man-made emissions causing visibility impairment in certain specified areas, including Class I Areas in the Colorado Plateau, and to consider and potentially apply the best available retrofit technology for major stationary sources.

     The rules allow nine western states and tribes to follow an alternate implementation plan and schedule for the Class I Areas. Five western states, including Arizona, have submitted proposed State Implementation Plans (SIPs) to the EPA to implement this alternative plan. If the EPA approves Arizona’s SIP, APS does not anticipate any new emission reduction requirements for its Arizona plants through 2013.

     With respect to hazardous air pollutants emitted by electric utility steam generating units, the EPA determined in 2000 that mercury emissions and other hazardous air pollutants from coal and oil-fired power plants should be regulated. The EPA recently proposed two alternatives to regulate mercury emissions from these plants. Under the first alternative, the EPA would promulgate a Maximum Achievable Control Technology (MACT) standard establishing mercury emission limitations for coal- and oil-fired power plants, effective 2008. APS is currently assessing the need

11

for additional controls to meet this proposed alternative. Under the second alternative, the EPA would rescind its 2000 finding requiring the establishment of a MACT standard for such plants, and would instead establish a two-phased mercury emissions trading program under the Clean Air Act’s new source performance standards provisions. If this second alternative is adopted, APS does not anticipate any emission reduction requirements under the first phase of the program (from 2010 through 2018). Because the ultimate requirements that the EPA may impose are not yet known, we cannot currently estimate the capital expenditures, if any, which may be required.

     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 Four Corners. The FIP is similar to current Arizona regulation of the Navajo Generating Station and New Mexico regulation of Four Corners, with minor modifications. APS does not currently expect the FIP to have a material adverse effect on its financial position, results of operations or liquidity.

     Superfund The Comprehensive Environmental Response, Compensation, and Liability Act (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 “potentially responsible party” in the Motorola 52^nd Street Superfund Site, Operable Unit 3 (OU3) in Phoenix, Arizona. APS has facilities that are within this superfund site. The EPA has only recently begun to study the OU3 site. Because the ultimate remediation requirements the EPA may require are not yet known, we cannot currently estimate the expenditures, if any, which may be required.

     Manufactured Gas Plant Sites APS is currently investigating properties which it now owns or which were previously owned by it or its corporate predecessors, that were at one time sites of, or sites associated with, manufactured gas plants. Where appropriate, APS conducts clean-up activities for these sites. APS does not expect these matters to have a material adverse effect on its financial position, results of operations or liquidity.

     Arizona Department of Environmental Quality

     ADEQ issued two NOVs to APS in 2001 alleging, among other things, the burning of unauthorized materials and storage of hazardous waste without a permit at the Cholla Power Plant. APS, the Attorney General for the State of Arizona and ADEQ have reached an agreement (in the form of a Consent Judgment) to settle this matter. The Consent Judgment (No. CV2004-000731) was entered on January 26, 2004, and on February 2, 2004, pursuant to its terms, APS paid a $200,000 penalty to the State of Arizona.

     ADEQ issued an NOV to APS in January 2004 alleging that, among other things, the discharge limit for lead was exceeded at the Saguaro Power Plant. APS is in the process of investigating this matter.

     Navajo Nation Environmental Issues

     Four Corners and the Navajo Generating Station are located on the Navajo Reservation and are held under easements granted by the federal government as well as leases from the Navajo Nation. APS is the Four Corners operating agent. APS owns a 100% interest in Four Corners Units

12

1, 2 and 3, and a 15% interest in Four Corners Units 4 and 5. APS owns a 14% interest in Navajo Generating Station Units 1, 2 and 3.

     In July 1995, the Navajo Nation enacted the Navajo Nation Air Pollution Prevention and Control Act, the Navajo Nation Safe Drinking Water Act and the Navajo Nation Pesticide Act (collectively, the Navajo Acts). The Navajo Acts purport to give the Navajo Nation Environmental Protection Agency authority to promulgate regulations covering air quality, drinking water and pesticide activities, including those activities that occur at Four Corners and the Navajo Generating Station. On October 17, 1995, the Four Corners participants and the Navajo Generating Station participants each filed a lawsuit in the District Court of the Navajo Nation, Window Rock District, challenging the applicability of the Navajo Nation as to Four Corners and Navajo Generating Station. The Court has stayed these proceedings pursuant to a request by the parties, and the parties are seeking to negotiate a settlement. APS cannot currently predict the outcome of this matter.

     In February 1998, the EPA issued regulations identifying those Clean Air Act provisions for which it is appropriate to treat Indian tribes in the same manner as states. The EPA has announced that it has not yet determined whether the Clean Air Act would supersede pre-existing binding agreements between the Navajo Nation and the Four Corners participants and the Navajo Generating Station participants that could limit the Navajo Nation’s environmental regulatory authority over the Navajo Generating Station and Four Corners. APS believes that the Clean Air Act does not supersede these pre-existing agreements. APS cannot currently predict the outcome of this matter.

     In April 2000, the Navajo Tribal Council approved operating permit regulations under the Navajo Nation Air Pollution Prevention and Control Act. We believe the regulations fail to recognize that the Navajo Nation did not intend to assert jurisdiction over Four Corners and the Navajo Generating Station. On July 12, 2000, the Four Corners participants and the Navajo Generating Station participants each filed a petition with the Navajo Supreme Court for review of the operating permit regulations. Those proceedings have been stayed, pending the settlement negotiations mentioned above. We cannot currently predict the outcome of this matter.

Water Supply

     Assured supplies of water are important for our generating plants. At the present time, APS has adequate water to meet its needs. However, conflicting claims to limited amounts of water in the southwestern United States have resulted in numerous court actions.

     Both groundwater and surface water in areas important to APS’ operations have been the subject of inquiries, claims and legal proceedings, which will require a number of years to resolve. APS is one of a number of parties in a proceeding before a state court in New Mexico to adjudicate rights to a stream system from which water for Four Corners is derived. (State of New Mexico, in the relation of S.E. Reynolds, State Engineer vs. United States of America, City of Farmington, Utah International, Inc., et al., San Juan County, New Mexico, District Court No. 75-184). An agreement reached with the Navajo Nation in 1985, however, provides that if Four Corners loses a portion of its rights in the adjudication, the Navajo Nation will provide, for a then-agreed upon cost, sufficient water from its allocation to offset the loss.

     A summons served on APS in early 1986 required all water claimants in the Lower Gila River Watershed in Arizona to assert any claims to water on or before January 20, 1987, in an action pending in Maricopa County, Arizona, Superior Court. (In re The General Adjudication of All

13

Rights to Use Water in the Gila River System and Source, Supreme Court Nos. WC-79-0001 through WC 79-0004 (Consolidated) [WC-1, WC-2, WC-3 and WC-4 (Consolidated)], Maricopa County Nos. W-1, W-2, W-3 and W-4 (Consolidated)). Palo Verde is located within the geographic area subject to the summons. APS’ rights and the rights of the Palo Verde participants to the use of groundwater and effluent at Palo Verde are potentially at issue in this action. As project manager of Palo Verde, APS filed claims that dispute the court’s jurisdiction over the Palo Verde participants’ groundwater rights and their contractual rights to effluent relating to Palo Verde. Alternatively, APS seeks confirmation of such rights. Three of APS’ other power plants and two of Pinnacle West Energy’s power plants are also located within the geographic area subject to the summons. APS’ claims dispute the court’s jurisdiction over its groundwater rights with respect to these plants. Alternatively, APS seeks confirmation of such rights. In November 1999, the Arizona Supreme Court issued a decision confirming that certain groundwater rights may be available to the federal government and Indian tribes. In addition, in September 2000, the Arizona Supreme Court issued a decision affirming the lower court’s criteria for resolving groundwater claims. Litigation on both of these issues will continue in the trial court. No trial date concerning APS’ water rights claims has been set in this matter.

     APS has also filed claims to water in the Little Colorado River Watershed in Arizona in an action pending in the Apache County, Arizona, Superior Court. (In re The General Adjudication of All Rights to Use Water in the Little Colorado River System and Source, Supreme Court No. WC-79-0006 WC-6, Apache County No. 6417). APS’ groundwater resource utilized at Cholla is within the geographic area subject to the adjudication and is therefore potentially at issue in the case. APS’ claims dispute the court’s jurisdiction over its groundwater rights. Alternatively, APS seeks confirmation of such rights. A number of parties are in the process of settlement negotiations with respect to certain claims in this matter. Other claims have been identified as ready for litigation in motions filed with the court. No trial date concerning APS’ water rights claims has been set in this matter.

     Although the above matters remain subject to further evaluation, APS expects that the described litigation will not have a material adverse impact on its financial position, results of operations or liquidity.

     The Four Corners region, in which Four Corners is located, has been experiencing drought conditions that may affect the water supply for the plants in 2004, as well as later years if adequate moisture is not received in the watershed that supplies the area. We are negotiating agreements with various parties to provide backup supplies of water for 2004, if required, and are continuing to work with area stakeholders to implement additional agreements to minimize the effect, if any, on operations of the plant for 2005 and later years. The effect of the drought cannot be fully assessed at this time, and we cannot predict the ultimate outcome, if any, of the drought or whether the drought will adversely affect the amount of power available, or the price thereof, from Four Corners.

BUSINESS OF PINNACLE WEST ENERGY CORPORATION

     Pinnacle West Energy was incorporated in 1999 under the laws of the State of Arizona and is engaged principally in the operation of generating plants. Pinnacle West Energy had approximately 100 employees as of December 31, 2003. Pinnacle West Energy’s principal offices are located at 400 North Fifth Street, Phoenix, Arizona 85004 (telephone (602) 250-4145).

14

     See “Liquidity and Capital Resources” in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in Item 7 for a discussion of Pinnacle West Energy’s capital expenditures.

     Pinnacle West Energy’s Arizona plants were built as a result of what we believed was a regulatory restriction against APS’ construction of additional plants and based on the requirement in the 1999 Settlement Agreement that APS transfer its generation assets. As discussed under “APS General Rate Case and Retail Rate Adjustment Mechanisms” in Note 3 of Notes to Consolidated Financial Statements in Item 8, as part of its general rate case, APS is seeking rate base treatment of the PWEC Dedicated Assets.

     At December 31, 2003, Pinnacle West Energy had total assets of $1.4 billion. Pinnacle West Energy had a net loss of $1 million in 2003, a net loss of $19 million in 2002 and net income of $18 million in 2001. See footnote (c) in “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Earnings Contributions by Subsidiary and Business Segments” in Item 7 for a discussion of Pinnacle West Energy’s contract to supply purchase power requirements in summer months through September 2006.

BUSINESS OF APS ENERGY SERVICES COMPANY, INC.

     APS Energy Services was incorporated in 1998 under the laws of the State of Arizona and provides competitive commodity-related energy services (such as direct access commodity contracts, energy procurement and energy supply consultation) and energy-related products and services (such as energy master planning, energy use consultation and facility audits, cogeneration analysis and installation and project management) to commercial, industrial and institutional retail customers in the western United States. APS Energy Services had approximately 100 employees as of December 31, 2003. APS Energy Services’ principal offices are located at 400 East Van Buren Street, Phoenix, Arizona 85004 (telephone (602) 250-5000).

     APS Energy Services had net income of $16 million in 2003, pretax income of $28 million in 2002, and a pretax loss of $10 million in 2001. Income taxes related to APS Energy Services were recorded by the parent company prior to 2003. At December 31, 2003, APS Energy Services had total assets of $90 million.

BUSINESS OF SUNCOR DEVELOPMENT COMPANY

     SunCor was incorporated in 1965 under the laws of the State of Arizona and is a developer of residential, commercial and industrial real estate projects in Arizona, Idaho, New Mexico and Utah. The principal executive offices of SunCor are located at 80 East Rio Salado Parkway, Suite 410, Tempe, Arizona 85281 (telephone (480) 317-6800). SunCor and its subsidiaries had approximately 800 full- and part-time employees at December 31, 2003.

     At December 31, 2003, SunCor had total assets of about $439 million. SunCor’s assets consist primarily of land with improvements, commercial buildings, golf courses and other real estate investments. SunCor intends to continue its focus on real estate development of master-planned communities, mixed-use residential, commercial, office and industrial projects.

     SunCor projects under development include seven master-planned communities and several commercial projects. The commercial projects and four of the master-planned communities are in

15

Arizona. Other master-planned communities are located near St. George, Utah, Boise, Idaho and Santa Fe, New Mexico.

     SunCor has implemented an accelerated asset sales program for 2004 and 2005. As a result of this program, SunCor expects to have net income of approximately $30 – 40 million a year in this period. SunCor also expects to make cash distributions of $80 – 100 million annually to the parent in this time frame.

     For the past three years, SunCor’s operating revenues were approximately: $362 million in 2003; $201 million in 2002; and $169 million in 2001. For those same periods, SunCor’s net income was approximately $56 million in 2003; $19 million in 2002; and $3 million in 2001.

     See Note 6 of Notes to Consolidated Financial Statements in Item 8 for information regarding SunCor’s long-term debt and “Liquidity and Capital Resources” in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in Item 7 for a discussion of SunCor’s capital expenditures.

BUSINESS OF EL DORADO INVESTMENT COMPANY

     El Dorado was incorporated in 1983 under the laws of the State of Arizona. El Dorado’s largest holding is a majority interest in NAC, a company specializing in spent nuclear fuel technology. El Dorado also owns minority interests in several energy-related investments and Arizona community-based ventures. El Dorado’s short-term goal is to prudently realize the value of its existing investments. On a long-term basis, we may use El Dorado, when appropriate, as our subsidiary for investments that are strategic to our principal business of generating, distributing and marketing electricity. El Dorado’s offices are located at 400 North Fifth Street, Phoenix, Arizona 85004 (telephone (602) 250-3517). El Dorado had approximately 100 employees (all NAC) at December 31, 2003.

     El Dorado had pretax income of $7 million in 2003, a pretax loss of $55 million in 2002 and net income of $0.2 million in 2001. The parent company recorded income taxes related to El Dorado in 2003 and 2002. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in Item 7 for information regarding El Dorado’s 2002 losses. At December 31, 2003, El Dorado had total assets of $27 million.

16

ITEM 2. PROPERTIES

Capacity

     Our generating facilities are described below. For APS’ plants, the “net accredited capacities” are reported, consistent with industry practice for regulated utilities. For Pinnacle West Energy, the “permitted capacities” are reported, consistent with industry practice for unregulated plants.

APS – Net Accredited Capacity

     APS’ present generating facilities have net accredited capacities as follows:

Pinnacle West Energy – Permitted Capacities

     Pinnacle West Energy’s present generating facilities have permitted capacities as follows:

17

Reserve Margin

     APS’ 2003 peak one-hour demand on its electric system was recorded on July 14, 2003 at 6,332,400 kW, compared to the 2002 peak of 5,802,900 kW recorded on July 9, 2002. Firm purchases totaling 4,198,000 kW, including short-term seasonal purchases and unit contingent purchases, were in place at the time of the peak, ensuring the ability to meet the load requirement, with an actual reserve margin of 12.1%. Taking into account additional capacity then available to APS under long-term purchase power contracts as well as APS’ and Pinnacle West Energy’s generating capacity, APS’ capability of meeting system demand on July 14, 2003 amounted to 6,371,600 kW, for an installed reserve margin of 1.0%. The power actually available to APS from its resources fluctuates from time to time due in part to outages, both planned and unplanned, and technical problems. The available capacity from sources actually operable at the time of the 2003 peak amounted to 3,736,500 kW, for a margin of negative 50.4%.

     See “Business of Arizona Public Service Company – Purchased Power Agreements” in Item 1 for information about certain of APS’ long-term power agreements. See “Request for Proposals” in Note 3 of Notes to Consolidated Financial Statements in Item 8 for information regarding a request for proposals issued by APS in December 2003 for the purchase of at least 500 MW of long-term power supply resources for delivery beginning June 1, 2007.

Plant Sites Leased from Navajo Nation

     The Navajo Generating Station and Four Corners are located on land held under easements from the federal government and also under leases from the Navajo Nation. These are long-term agreements with options to extend, and we do not believe that the risk with respect to enforcement of these easements and leases is material. The majority of coal contracted for use in these plants and certain associated transmission lines are also located on Indian reservations. See “Purchased Power and Generating Fuel – Coal Supply” in Item 1.

Palo Verde Nuclear Generating Station

     Regulatory

     Operation of each of the three Palo Verde units requires an operating license from the NRC. The NRC issued full power operating licenses for Unit 1 in June 1985, Unit 2 in April 1986 and Unit 3 in November 1987. The full power operating licenses, each valid for a period of approximately 40 years, authorize APS, as operating agent for Palo Verde, to operate the three Palo Verde units at full power.

     Nuclear Decommissioning Costs

     The NRC rules on financial assurance requirements for the decommissioning of nuclear power plants provide that a licensee may use a trust as the exclusive financial assurance mechanism if the licensee recovers estimated total decommissioning costs through cost of service rates or through a “non-bypassable charge.” The “non-bypassable systems benefits” charge is the charge that the ACC has approved to recover certain types of ACC-approved costs, including costs for low income programs, demand side management, consumer education, environmental, renewables, etc. “Non-bypassable” means that if a customer chooses to take energy from an “energy service provider”

18