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SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-K

OR

Arizona Public Service Company

Securities registered pursuant to Section 12(b) or 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 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 o No x

     As of March 15, 2004, there were issued and outstanding 71,264,947 shares of the registrant’s common stock, $2.50 par value, all of which were held beneficially and of record by Pinnacle West Capital Corporation.

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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, the Company

APS Energy Services – APS Energy Services Company, Inc., a subsidiary of Pinnacle West

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 – Arizona Public Service Company

DOE – United States Department of Energy

EITF – the FASB’s Emerging Issues Task Force

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 our $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

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

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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, parent company of the Company

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

PRP – potentially responsible parties under Superfund

PWEC Dedicated Assets – the following Pinnacle West Energy power plants, each of which is dedicated to serving our 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 Pinnacle West

Superfund – Comprehensive Environmental Response, Compensation and Liability Act

T&D – transmission and distribution

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

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

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

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PART I

ITEM 1. BUSINESS

CURRENT STATUS

General

     We were incorporated in 1920 under the laws of Arizona and currently have more than 931,500 customers. Pinnacle West owns all of our outstanding common stock. We are 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. Electricity is delivered through a distribution system that we own. We do not distribute any products. During 2003, no single purchaser or user of energy (other than Pinnacle West) accounted for more than 4% of total electric revenues. Through our marketing and trading division, we generate, sell and deliver electricity to wholesale customers in the western United States. The marketing and trading division also sells, in the wholesale market, our and Pinnacle West Energy generation output that is not needed for our Native Load, which includes loads for retail customers and cost-of-service wholesale customers. The marketing and trading division focuses primarily on managing our purchased power and fuel risks in connection with our costs of serving retail customer energy requirements. Additionally, the marketing and trading division, subject to specific parameters, markets, hedges and trades in electricity, fuels and emission allowances and credits.

     At December 31, 2003, we employed approximately 6,000 people, which includes employees at jointly-owned generating facilities for which we serve as the generating facility manager. Our principal executive offices are located at 400 North Fifth Street, Phoenix, Arizona 85004 (telephone 602-250-1000).

Business Segments

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

	•		our regulated electricity segment (95% 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; and
	•		our marketing and trading segment (5% of operating revenues in 2003), which consists of our competitive energy business activities, including wholesale marketing and trading.

     See Note 15 of Notes to Financial Statements in Item 8 for financial information about our business segments.

General Rate Case

     We believe our 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 Financial Statements in Item 8, in this

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rate case we have 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 us as part of the 1999 Settlement Agreement. In its filed testimony, the ACC staff recommended, among other things, that the ACC decrease our rates by approximately 8% (approximately $143 million annually), not allow the PWEC Dedicated Assets to be included in our rate base, and not allow us 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 our rate case requests are supported by, among other things, our demonstrated need for the PWEC Dedicated Assets; our need to attract capital at reasonable rates of return to support the required capital investment to ensure continued customer reliability in our 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.

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 we 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;
	•		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

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			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;
	•		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;
	•		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 our retail electric rates and our issuance of securities. The ACC must also approve any transfer of our property used to provide retail electric service and approve or receive prior notification of certain transactions between us and affiliated parties. See Note 3 of Notes to 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.

     As of January 1, 2001, all of our 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 our customers. As a result, we cannot predict when, and the extent to which, additional competitors will re-enter our 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 Financial Statements in Item 8 for additional information.

     We are 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). We also face 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.

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Wholesale

     General

     The FERC regulates rates for wholesale power sales and transmission services. During 2003, approximately 8% of our electric operating revenues resulted from such sales and services. In early 2003, the marketing and trading division was moved from Pinnacle West to us 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 our generating assets to Pinnacle West Energy (see “Track A Order” in Note 3 of Notes to Financial Statements in Item 8).

     The marketing and trading division focuses primarily on managing our purchased power and fuel risks in connection with our costs of serving retail customer energy requirements. The division also sells, in the wholesale market, our and Pinnacle West Energy generation output that is not needed for our 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 Financial Statements in Item 8 for information regarding an ACC-mandated process by which we 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.

     On October 16, 2001, we 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. We are now participating in a cost/benefit analysis of implementing WestConnect, the results 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. We participated in the creation of the AISA, a not-for-profit entity, and the filing at the FERC for

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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 we should be required to continue funding the AISA.

Purchased Power and Generating Fuel

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

     2003 Energy Mix

     Our 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 us. We purchase 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. We 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, we believe 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 us. We purchase 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 – Net Accredited Capacity” in Item 2 for information about our ownership interests in Cholla, Four Corners and the Navajo Generating Station. See Note 10 of Notes to Financial Statements in Item 8 for information regarding our coal mine reclamation obligations.

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     Natural Gas Supply

     See Note 10 of Notes to 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 us. The fuel cycle for Palo Verde is comprised of the following stages:

	•		mining and milling of uranium ore to produce uranium concentrates;
	•		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 10 of Notes to Financial Statements in Item 8 for a discussion of spent nuclear fuel and waste disposal.

Purchased Power Agreements

     In addition to that available from our own generating capacity (see “Properties” in Item 2), we purchase 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 us is based in large part on customer demand within certain areas now served by us pursuant to a related territorial agreement. The generating capacity available to us pursuant to the contract was 343 MW from January through May 2003, and starting in June 2003, it changed to 350 MW. In 2003, we 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. We may also cancel the contract on five years’ notice, given no earlier than December 31, 2006.

     In September 1990, we entered into a thirty-year seasonal capacity exchange agreement with PacifiCorp. Under this agreement, we receive electricity from PacifiCorp during the summer peak season (from May 15 to September 15) and we return electricity to PacifiCorp during the winter season (from October 15 to February 15). Until 2020, we and PacifiCorp each have 480 MW of capacity and a related amount of energy available to us under the agreement for our respective seasons. In 2003, we received approximately 571,392 MWh of energy under the capacity exchange. We must also make additional offers of energy to PacifiCorp each year through October 31, 2020.

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Pursuant to this requirement, during 2003, PacifiCorp received offers of 1,091,450 MWh and purchased about 168,000 MWh.

     In December 2003, we 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 our anticipated retail load. For additional information, see “Request for Proposals” in Note 3 of Notes to Financial Statements in Item 8.

     Consistent with the ACC’s Track B Order, we issued a request for proposals (“RFP”) in March 2003 and, as a result of that RFP, on or before May 6, 2003, we entered into contracts with three parties, including Pinnacle West Energy, to meet a portion of our capacity and energy requirements for the years 2003 through 2006. See “Track B Order” in Note 3 of Notes to Financial Statements in Item 8 for additional information about the contracts and the Track B Order.

Construction Program

     During the years 2001 through 2003, we incurred approximately $1.4 billion in capital expenditures. Our 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. Our capital expenditures were approximately $429 million in 2003. Our 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 our generation (production) assets. We conduct a continuing review of our construction program.

     See “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Capital Needs and Resources” in Item 7 for additional information about our construction program.

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.

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     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, we do not anticipate any new emission reduction requirements for our 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. We are currently assessing the need 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, we do 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. We do not currently expect the FIP to have a material adverse effect on our 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 us that the EPA considers us to be a “potentially responsible party” in the Motorola 52nd Street Superfund Site, Operable Unit 3 (OU3) in Phoenix, Arizona. We have 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 We are currently investigating properties which we now own or which were previously owned by us or our corporate predecessors, that were at one time sites of, or sites associated with, manufactured gas plants. Where appropriate, we conduct clean-up activities for these sites. We do not expect these matters to have a material adverse effect on our financial position, results of operations or liquidity.

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     Arizona Department of Environmental Quality

     ADEQ issued two NOVs to us in 2001 alleging, among other things, the burning of unauthorized materials and storage of hazardous waste without a permit at the Cholla Power Plant. We, 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, we paid a $200,000 penalty to the State of Arizona.

     ADEQ issued an NOV to us in January 2004 alleging, among other things, that the discharge limit for lead was exceeded at the Saguaro Power Plant. We are 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. We are the Four Corners operating agent. We own a 100% interest in Four Corners Units 1, 2 and 3, and a 15% interest in Four Corners Units 4 and 5. We own 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. We 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. We believe that the Clean Air Act does not supersede these pre-existing agreements. We 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.

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Water Supply

     Assured supplies of water are important for our generating plants. At the present time, we have adequate water to meet our 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 our operations have been the subject of inquiries, claims and legal proceedings, which will require a number of years to resolve. We are 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 us 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 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. Our 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, we 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, we seek confirmation of such rights. Three of our other power plants and two of Pinnacle West Energy’s power plants are also located within the geographic area subject to the summons. Our claims dispute the court’s jurisdiction over our groundwater rights with respect to these plants. Alternatively, we seek 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 our water rights claims has been set in this matter.

     We have 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). Our groundwater resource utilized at Cholla is within the geographic area subject to the adjudication and is therefore potentially at issue in the case. Our claims dispute the court’s jurisdiction over our groundwater rights. Alternatively, we seek 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 our water rights claims has been set in this matter.

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     Although the above matters remain subject to further evaluation, we expect that the described litigation will not have a material adverse impact on our 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.

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ITEM 2. PROPERTIES

Net Accredited Capacity

     Our present generating facilities have net accredited capacities as follows:

Reserve Margin

     Our 2003 peak one-hour demand on our 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 us under long-term purchase power contracts as well as our and Pinnacle West Energy’s generating capacity, our 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 us from our 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 “Purchased Power Agreements” in Item 1 for information about certain of our long-term power agreements. See "Request for Proposals" in Note 3 of Notes to Financial Statements in Item 8 for information regarding a request for proposals issued by us in December 2003 for the purchase of at least 500 MW of long-term power supply resources for delivery beginning June 1, 2007.

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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 us, 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” other than us, the customer will still have to pay this charge as part of the customer’s electric bill.

     Other mechanisms are prescribed, including prepayment, if the requirements for exclusive reliance on the external sinking fund mechanism are not met. We currently rely on the external sinking fund mechanism to meet the NRC financial assurance requirements for our interests in Palo Verde Units 1, 2 and 3. The decommissioning costs of Palo Verde Units 1, 2 and 3 are currently included in our ACC jurisdictional rates. The Rules provide that decommissioning costs would be recovered through a non-bypassable “system benefits” charge, which would allow us to maintain our external sinking fund mechanism. See Note 11 of Notes to Financial Statements in Item 8 for additional information about our nuclear decommissioning costs.

     Palo Verde Liability and Insurance Matters

     See “Palo Verde Nuclear Generating Station” in Note 10 of Notes to Financial Statements in Item 8 for a discussion of the insurance maintained by the Palo Verde participants, including us, for Palo Verde.

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Property Not Held in Fee or Subject to Encumbrances

     Jointly-Owned Facilities

     We share ownership of some of our generating and transmission facilities with other companies. The following table shows our interest in those jointly-owned facilities recorded on the Balance Sheets at December 31, 2003:

(a)		PacifiCorp owns Cholla Unit 4 and we operate the unit for PacifiCorp. The common facilities at the Cholla Plant are jointly-owned.
(b)		Weighted average of interests.

     Palo Verde Leases

     In 1986, we sold about 42% of our share of Palo Verde Unit 2 and certain common facilities in three separate sale-leaseback transactions. We account for these leases as operating leases. The leases, which have terms of 29.5 years, contain options to renew the leases for two additional years and to purchase the property for fair market value at the end of the lease terms. See Notes 8 and 18 of Notes to Financial Statements in Item 8 for additional information regarding the Palo Verde Unit 2 sale-leaseback transactions.

     First Mortgage Lien

     Our first mortgage bondholders share a lien on substantially all utility plant assets (other than nuclear fuel and transportation equipment and other excluded assets). See Note 6 of Notes to Financial Statements in Item 8 for information regarding our outstanding first mortgage bonds.

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Transmission Access

     Our transmission facilities consist of approximately 5,000 pole miles of overhead lines and approximately 35 miles of underground lines, all of which are located within the State of Arizona. Our distribution facilities consist of approximately 12,000 pole miles of overhead lines and approximately 13,000 miles of underground lines, all of which are located within the State of Arizona. In June 2003 we energized a new 37-mile 500-kilovolt transmission line that runs from Palo Verde to the Phoenix area. See also “Regional Transmission Organizations” in Item 1.

Other Information Regarding Our Properties

     See “Environmental Matters” and “Water Supply” in Item 1 with respect to matters having a possible impact on the operation of certain of our power plants.

     See “Construction Program” in Item 1 and “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Liquidity and Capital Resources” in Item 7 for a discussion of our construction program.

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ITEM 3. LEGAL PROCEEDINGS

     See “Environmental Matters” and “Water Supply” in Item 1 in regard to pending or threatened litigation and other disputes. See Note 3 of Notes to Financial Statements in Item 8 for a discussion of the ACC retail electric competition Rules, the Track A Order and related litigation.

     See Note 10 of Notes to Financial Statements in Item 8 for information relating to the FERC proceedings on California energy market issues and a claim by Citizens that we overcharged Citizens under a power service agreement.

ITEM 4. SUBMISSION OF MATTERS TO A
VOTE OF SECURITY HOLDERS

     Not applicable.

PART II

ITEM 5. MARKET FOR REGISTRANT’S COMMON
STOCK AND RELATED STOCKHOLDER MATTERS

     Our common stock is wholly-owned by Pinnacle West and is not listed for trading on any stock exchange. As a result, there is no established public trading market for our common stock.

     The chart below sets forth the dividends declared on the Company’s common stock for each of the four quarters for 2003 and 2002.

Common Stock Dividends
(Dollars in Thousands)

     After payment or setting aside for payment of cumulative dividends and mandatory sinking fund requirements, where applicable, on all outstanding issues of preferred stock, the holders of common stock are entitled to dividends when and as declared out of funds legally available therefor. As of December 31, 2003, we did not have any outstanding preferred stock.

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ITEM 6. SELECTED FINANCIAL DATA