FORM 10-Q

For the quarterly period ended June 30, 2004

OR

For the transition period from _______________________ to _____________

Commission file number 1-4473

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes x No o

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).

Yes o No x

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

Number of shares of common stock, $2.50 par value,
outstanding as of August 6, 2004: 71,264,947

The Registrant meets the conditions set forth in General Instruction H(1)(a) and (b) of Form 10-Q and is therefore filing this form with the reduced disclosure format.

Table of Contents

Glossary

ACC – Arizona Corporation Commission

ALJ – administrative law judge

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

Company – Arizona Public Service Company

CPUC – California Public Utility Commission

DOE – United States Department of Energy

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

FSP – FASB Staff Position

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

IRS – United States Internal Revenue Service

Moody’s – Moody’s Investors Service

MW – megawatt, one million watts

MWh – megawatt-hours, one million watts per hour

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

NRC – United States Nuclear Regulatory Commission

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

OCI – other comprehensive income

Palo Verde – Palo Verde Nuclear Generating Station

PG&E – PG&E Corp.

Pinnacle West – Pinnacle West Capital Corporation, parent company of the Company

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

PPL Sundance – PPL Sundance Energy, LLC

PX – California Power Exchange

Rules – ACC retail electric competition rules

SEC – United States Securities and Exchange Commission

SFAS – Statement of Financial Accounting Standards

SNWA – Southern Nevada Water Authority

SPE – special-purpose entity

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

Sundance Generating Station – PPL Sundance’s 450 megawatt generating facility approximately 55 miles southeast of Phoenix, Arizona

Superfund – Comprehensive Environmental Response, Compensation and Liability Act

T&D – transmission and distribution

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

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

2003 Form 10-K – the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2003

VIE – variable interest entity

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PART I — FINANCIAL INFORMATION

Item 1. Financial Statements

ARIZONA PUBLIC SERVICE COMPANY

See Notes to Condensed Financial Statements.

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ARIZONA PUBLIC SERVICE COMPANY

See Notes to Condensed Financial Statements.

4

ARIZONA PUBLIC SERVICE COMPANY
CONDENSED BALANCE SHEETS
(Unaudited)

ASSETS

See Notes to Condensed Financial Statements.

5

ARIZONA PUBLIC SERVICE COMPANY
CONDENSED BALANCE SHEETS
(Unaudited)

CAPITALIZATION AND LIABILITIES

See Notes to Condensed Financial Statements.

6

ARIZONA PUBLIC SERVICE COMPANY
CONDENSED STATEMENTS OF CASH FLOWS
(Unaudited)

See Notes to Condensed Financial Statements.

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ARIZONA PUBLIC SERVICE COMPANY

1. Our unaudited condensed financial statements reflect all adjustments which we believe are necessary for the fair presentation of our financial position and results of operations for the periods presented. These adjustments are of a normal recurring nature. We suggest that these condensed financial statements and notes to condensed financial statements be read along with the financial statements and notes to financial statements included in our 2003 Form 10-K. Our accounting records are maintained in accordance with GAAP. The preparation of financial statements in accordance with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities at the date of the financial statements and reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. We have reclassified certain prior year amounts to conform to the current year presentation.

2. Weather conditions cause significant seasonal fluctuations in our revenues. In addition, trading and wholesale marketing activities can have significant impacts on our results for interim periods. For these reasons as well as others, results for interim periods do not necessarily represent results to be expected for the year.

3. We are a wholly-owned subsidiary of Pinnacle West.

4. Changes in Liquidity

     On February 15, 2004, $125 million of our 5.875% Notes due 2004 were redeemed at maturity and on March 1, 2004, $80 million of our First Mortgage Bonds, 6.625% Series due 2004, were redeemed at maturity. We used cash from operations and short-term debt to redeem the maturing debt.

     On March 31, 2004, Navajo County, Arizona Pollution Control Corporation issued $166 million of variable interest rate pollution control bonds, 2004 Series A-E, due 2034 to refinance $166 million of outstanding pollution control bonds. The 2004 Series A-E bonds are payable solely from revenues obtained from us pursuant to a loan agreement between us and Navajo County, Arizona Pollution Control Corporation. These bonds are classified as long-term debt on our Condensed Balance Sheets.

     Also on March 31, 2004, Coconino County, Arizona Pollution Control Corporation issued $13 million of variable interest rate pollution control bonds, 2004 Series A, due 2034 to refinance $13 million of outstanding pollution control bonds. These bonds are payable solely from revenues obtained from us pursuant to a loan agreement between us and Coconino County, Arizona Pollution Control Corporation. The 2004 Series A bonds are classified as long-term debt on our Condensed Balance Sheets.

     In May 2004, we renewed our $250 million revolving credit facility, while increasing its size to $325 million and extending its term to three years. The revolver provides liquidity support for our $250 million commercial paper program, as well as an additional $75 million for other liquidity needs and miscellaneous letters of credit.

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     On June 29, 2004, we issued $300 million of 5.80% senior unsecured notes due June 30, 2014. The proceeds from the sale of the notes will be used to redeem all or a portion of $100 million in aggregate principal amount of our 6.25% Notes due January 15, 2005 and/or all or a portion of $300 million in aggregate principal amount of our 7.625% Notes due August 1, 2005.

     At June 30, 2004, we had $566 million of pollution control bonds under which interest rates are reset on a daily, weekly or annual basis. The holders of $387 million of these bonds have the right to cause us to purchase their bonds on the applicable reset date if the bonds are not remarketed; therefore, $164 million of such bonds are classified as current maturities of long-term debt. The remaining $223 million of bonds are classified as long-term debt because we have the intent and ability, as demonstrated by credit agreements in place that extend for more than one year, to refinance any bonds that we are required to purchase.

     The following is a list of payments due on total long-term debt and capitalized lease requirements as of June 30, 2004:

•		$166 million in 2004;
•		$459 million in 2005;
•		$84 million in 2006;
•		$174 million in 2007;
•		$0 million in 2008; and
•		$1.843 billion thereafter.

5. Regulatory Matters

Electric Industry Restructuring

State

     Overview of Pending Rate Case

     On June 27, 2003, we filed a general rate case with the ACC and requested a $175.1 million, or 9.8%, increase in our annual retail electricity revenues, to become effective July 1, 2004. An ACC ALJ has issued various procedural orders staying the existing schedule until at least August 18, 2004, as the parties continue settlement discussions. Based on these recent procedural orders, hearings could begin no earlier than mid to late September 2004. The major components of the request are described under “General Rate Case and Retail Rate Adjustment Mechanisms” below.

1999 Settlement Agreement

     The following are the major provisions of the 1999 Settlement Agreement, as approved by the ACC:

•

We have reduced rates for standard-offer service for customers with loads less than three MW in a series of annual retail electricity price reductions of 1.5% on July 1 for each of the years 1999 to 2003 for a total of 7.5%. Based on the price reductions authorized in the 1999 Settlement Agreement, there

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		were retail price decreases of approximately $24 million ($14 million after taxes), effective July 1, 1999; approximately $28 million ($17 million after taxes), effective July 1, 2000; approximately $27 million ($16 million after taxes), effective July 1, 2001; approximately $28 million ($17 million after taxes), effective July 1, 2002; and approximately $29 million ($18 million after taxes), effective July 1, 2003. For customers having loads of three MW or greater, standard-offer rates have been reduced in varying annual increments that total 5% in the years 1999 through 2002.
•		Unbundled rates being charged by us for competitive direct access service (for example, distribution services) became effective upon approval of the 1999 Settlement Agreement, retroactive to July 1, 1999, and also became subject to annual reductions beginning January 1, 2000, that vary by rate class, through January 1, 2004.
•		There was a moratorium on retail price changes for standard-offer and unbundled competitive direct access services until July 1, 2004, except for the price reductions described above and certain other limited circumstances. Neither the ACC nor us was prevented from seeking or authorizing rate changes prior to July 1, 2004 in the event of conditions or circumstances that constituted an emergency, such as an inability to finance on reasonable terms; material changes in our cost of service for ACC-regulated services resulting from federal, tribal, state or local laws; regulatory requirements; or judicial decisions, actions or orders.
•		We are being permitted to defer for later recovery prudent and reasonable costs of complying with the Rules, system benefits costs in excess of the levels included in then-current (1999) rates, and costs associated with the “provider of last resort” and standard-offer obligations for service after July 1, 2004. These costs are to be recovered through an adjustment clause or clauses commencing on July 1, 2004, or when the rate case is decided. See “General Rate Case and Retail Rate Adjustment Mechanisms” below.
•		Our distribution system opened for retail access effective September 24, 1999. Customers were eligible for retail access in accordance with the phase-in adopted by the ACC under the Rules (see “Retail Electric Competition Rules” below), including an additional 140 MW being made available to eligible non-residential customers. We opened our distribution system to retail access for all customers on January 1, 2001. The regulatory developments and legal challenges to the Rules discussed in this Note have raised considerable uncertainty about the status and pace of electric competition and of electric restructuring in Arizona. Although some very limited retail competition existed in our service area in 1999 and 2000, there are currently no active retail competitors providing 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.

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•		Prior to the 1999 Settlement Agreement, we were recovering substantially all of our regulatory assets through July 1, 2004, pursuant to a 1996 regulatory agreement. In addition, the 1999 Settlement Agreement states that we have demonstrated that our allowable stranded costs, after mitigation and exclusive of regulatory assets, are at least $533 million net present value (in 1999 dollars). The 1999 Settlement Agreement also states that we will not be allowed to recover $183 million net present value (in 1999 dollars) ($234 million pre-tax) of the $533 million. The 1999 Settlement Agreement provides that we will have the opportunity to recover $350 million net present value (in 1999 dollars) through a competitive transition charge that will remain in effect through December 31, 2004, at which time it will terminate. The costs subject to recovery under the adjustment clause described above will be decreased or increased by any over/under-recovery of the $350 million due to sales volume variances. As discussed below under “General Rate Case and Retail Rate Adjustment Mechanisms,” we are seeking to recover amounts written off by us as a result of the 1999 Settlement Agreement.
•		The 1999 Settlement Agreement required us to form, or cause to be formed, a separate corporate affiliate or affiliates and transfer to such affiliate(s) our competitive electric assets and services no later than December 31, 2002. The 1999 Settlement Agreement provided that we would be allowed to defer and later collect, beginning July 1, 2004, 67% of our costs to accomplish the required transfer of generation assets to an affiliate. However, as discussed below, in 2002 the ACC unilaterally modified this aspect of the 1999 Settlement Agreement by issuing the Track A Order, an order preventing us from transferring our generation assets. We are seeking to recover all costs incurred by us in preparation for the previously anticipated transfer of generation assets to Pinnacle West Energy. See “General Rate Case and Retail Rate Adjustment Mechanisms” below.

Retail Electric Competition Rules

The Rules approved by the ACC include the following major provisions:

•		They apply to virtually all Arizona electric utilities regulated by the ACC, including us.
•		Effective January 1, 2001, retail access became available to all of our retail electricity customers.
•		Electric service providers that get CC&N’s from the ACC can supply only competitive services, including electric generation, but not electric transmission and distribution.
•		Affected utilities must file ACC tariffs that unbundle rates for noncompetitive services.

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•		The ACC shall allow a reasonable opportunity for recovery of unmitigated stranded costs.
•		Absent an ACC waiver, prior to January 1, 2001, each affected utility (except certain electric cooperatives) must transfer all competitive electric assets and services to an unaffiliated party or parties or to a separate corporate affiliate or affiliates. Under the 1999 Settlement Agreement, we received a waiver to allow transfer of our competitive electric assets and services to affiliates no later than December 31, 2002. However, as discussed below, in 2002 the ACC reversed its decision, as reflected in the Rules, to require us to transfer our generation assets.

     Under the 1999 Settlement Agreement, the Rules are to be interpreted and applied, to the greatest extent possible, in a manner consistent with the 1999 Settlement Agreement. If the two cannot be reconciled, we must seek, and the other parties to the 1999 Settlement Agreement must support, a waiver of the Rules in favor of the 1999 Settlement Agreement.

     On November 27, 2000, a Maricopa County, Arizona, Superior Court judge issued a final judgment holding that the Rules are unconstitutional and unlawful in their entirety due to failure to establish a fair value rate base for competitive electric service providers and because certain of the Rules were not submitted to the Arizona Attorney General for certification. The judgment also invalidates all ACC orders authorizing competitive electric service providers, including APS Energy Services, to operate in Arizona. We do not believe the ruling affects the 1999 Settlement Agreement. The 1999 Settlement Agreement was not at issue in the consolidated cases before the judge. Further, the ACC made findings related to the fair value of our property in the order approving the 1999 Settlement Agreement. The ACC and other parties aligned with the ACC appealed the ruling to the Arizona Court of Appeals, and in January 2004, the Court invalidated some, but not all, of the Rules as either violative of Arizona’s constitutional requirement that the ACC consider the “fair value” of a utility’s property in setting rates or as being beyond the ACC’s constitutional and statutory powers. Other Rules were set aside for failure to submit such regulations to the Arizona Attorney General for approval as required by statute.

Provider of Last Resort Obligation

     Although the Rules allow retail customers to have access to competitive providers of energy and energy services, we are, under the Rules, the “provider of last resort” for standard-offer, full-service customers under rates that have been approved by the ACC. At various times, prices in the spot wholesale market have significantly exceeded the amount included in our current retail rates. In the event of shortfalls due to unforeseen increases in load demand or generation or transmission outages, we may need to purchase additional supplemental power in the wholesale spot market. There can be no assurance that we would be able to fully recover the costs of this power. See “General Rate Case and Retail Rate Adjustment Mechanisms” below for a discussion of retail rate adjustment mechanisms that were the subject of ACC hearings in April 2003.

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     Track A Order

     On September 10, 2002, the ACC issued the Track A Order, in which the ACC, among other things:

•		reversed its decision, as reflected in the Rules, to require us to transfer our generation assets either to an unrelated third party or to a separate corporate affiliate; and
•		unilaterally modified the 1999 Settlement Agreement, which authorized the transfer of our generating assets, and directed us to cancel our activities to transfer our generation assets to Pinnacle West Energy.

     On November 15, 2002, we filed appeals of the Track A Order in the Maricopa County, Arizona Superior Court and in the Arizona Court of Appeals. Arizona Public Service Company vs. Arizona Corporation Commission, CV 2002-0222 32. Arizona Public Service Company vs. Arizona Corporation Commission, 1CA CC 02-0002. On December 13, 2002, we and the ACC staff agreed to principles for resolving certain issues raised by us in our appeals of the Track A Order. The major provisions of the principles include, among other things, the following:

•

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

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