FORM 10-Q

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

(Mark One)

þ		QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended March 31, 2008

o		TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from                      to                     

		Exact Name of Each Registrant as specified in
Commission		its charter; State of Incorporation; Address;		IRS Employer
File Number		and Telephone Number		Identification No.
1-8962		PINNACLE WEST CAPITAL CORPORATION		86-0512431
		(an Arizona corporation)
		400 North Fifth Street, P.O. Box 53999
		Phoenix, Arizona 85072-3999
		(602) 250-1000
1-4473		ARIZONA PUBLIC SERVICE COMPANY		86-0011170
		(an Arizona corporation)
		400 North Fifth Street, P.O. Box 53999
		Phoenix, Arizona 85072-3999
		(602) 250-1000

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

PINNACLE WEST CAPITAL CORPORATION		Yes þ  No o
ARIZONA PUBLIC SERVICE COMPANY		Yes þ  No o

     Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

PINNACLE WEST CAPITAL CORPORATION

Large accelerated filer þ		Accelerated filer o		Non-accelerated filer o		Smaller reporting company o
				(Do not check if a smaller reporting company)

ARIZONA PUBLIC SERVICE COMPANY

Large accelerated filer o		Accelerated filer o		Non-accelerated filer þ		Smaller reporting company o
				(Do not check if a smaller reporting company)

     Indicate by check mark whether each registrant is a shell company (as defined in Exchange Act Rule 12b-2).

PINNACLE WEST CAPITAL CORPORATION		Yes o  No þ
ARIZONA PUBLIC SERVICE COMPANY		Yes o  No þ

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

PINNACLE WEST CAPITAL CORPORATION		Number of shares of common stock, no par value, outstanding as of May 5, 2008: 100,633,751
ARIZONA PUBLIC SERVICE COMPANY		Number of shares of common stock, $2.50 par value, outstanding as of May 5, 2008: 71,264,947

     Arizona Public Service Company meets the conditions set forth in General Instruction H(1)(a) and (b) of Form 10-Q and is therefore filing this form with the reduced disclosure format allowed under that General Instruction.

     This combined Form 10-Q is separately filed by Pinnacle West Capital Corporation and Arizona Public Service Company. Each registrant is filing on its own behalf all of the information contained in this Form 10-Q that relates to such registrant and, where required, its subsidiaries. Except as stated in the preceding sentence, neither registrant is filing any information that does not relate to such registrant, and therefore makes no representation as to any such information.

 

 

TABLE OF CONTENTS

		Page
Glossary			2
Part I			4
Item 1. Financial Statements			4
Pinnacle West Capital Corporation			4
Arizona Public Service Company			31
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations			40
Item 3. Quantitative and Qualitative Disclosures About Market Risk			57
Item 4. Controls and Procedures			57
Part II			59
Item 1. Legal Proceedings			59
Item 1A. Risk Factors			59
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds			59
Item 5. Other Information			59
Item 6. Exhibits			63
Signatures			65
EX-12.1
EX-12.2
EX-12.3
EX-31.1
EX-31.2
EX-31.3
EX-32.1
EX-32.2

GLOSSARY

ACC — Arizona Corporation Commission

ADEQ — Arizona Department of Environmental Quality

ALJ — Administrative Law Judge

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

APSES — APS Energy Services Company, Inc., a subsidiary of the Company

Base Fuel Rate — the portion of APS’ retail base rates attributable to fuel and purchased power costs

Clean Air Act — Clean Air Act, as amended

Company — Pinnacle West Capital Corporation

DOE — United States Department of Energy

El Dorado — El Dorado Investment Company, a subsidiary of the Company

EPA — United States Environmental Protection Agency

ERMC — Energy Risk Management Committee

FASB — Financial Accounting Standards Board

FERC — United States Federal Energy Regulatory Commission

FIN — FASB Interpretation Number

FIP — Federal Implementation Plan

Fitch — Fitch, Inc.

Four Corners — Four Corners Power Plant

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

IRS — United States Internal Revenue Service

kWh — kilowatt-hour, one thousand watts per hour

Moody’s — Moody’s Investors Service, Inc.

MWh — megawatt-hour, one million watts per hour

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

Note — a Note to Pinnacle West’s Condensed Consolidated Financial Statements in Item 1 of this report

NRC — United States Nuclear Regulatory Commission

OCI — other comprehensive income

Off-System Sales — sales of electricity from generation owned or contracted by the Company that is over and above the amount required to serve APS’ retail customers and traditional wholesale contracts

Palo Verde — Palo Verde Nuclear Generating Station

Pinnacle West — Pinnacle West Capital Corporation, the Company

Pinnacle West Energy — Pinnacle West Energy Corporation, a subsidiary of the Company, dissolved as of August 31, 2006

Pinnacle West Marketing & Trading — Pinnacle West Marketing & Trading Co., LLC, a subsidiary of the Company

PRP — potentially responsible parties under Superfund

PSA — power supply adjustor approved by the ACC to provide for recovery or refund of variations in actual fuel and purchased power costs compared with the Base Fuel Rate

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

SEC — United States Securities and Exchange Commission

SFAS — Statement of Financial Accounting Standards

Standard & Poor’s — Standard & Poor’s Ratings Services

SunCor — SunCor Development Company, a subsidiary of the Company

Superfund — Comprehensive Environmental Response, Compensation and Liability Act

2005 Deferrals — PSA deferrals related to 2005 replacement power costs associated with Palo Verde outages

2007 Form 10-K — Pinnacle West/APS Annual Report on Form 10-K for the fiscal year ended December 31, 2007

VIE — variable interest entity

PART I — FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

PINNACLE WEST CAPITAL CORPORATION

(unaudited)

(dollars and shares in thousands, except per share amounts)

		Three Months Ended
		March 31,
		2008				2007
OPERATING REVENUES
Regulated electricity segment		$	622,801			$	536,051
Real estate segment			47,742				77,132
Marketing and trading			57,458				72,471
Other revenues			8,737				9,363
Total			736,738				695,017
OPERATING EXPENSES
Regulated electricity segment fuel and purchased power			269,378				203,353
Real estate segment operations			48,219				61,336
Marketing and trading fuel and purchased power			51,522				57,944
Operations and maintenance			194,124				171,578
Depreciation and amortization			95,607				89,378
Taxes other than income taxes			33,152				34,719
Other expenses			5,938				8,488
Total			697,940				626,796
OPERATING INCOME			38,798				68,221
OTHER
Allowance for equity funds used during construction			6,124				4,444
Other income (Note 14)			3,848				4,512
Other expense (Note 14)			(4,908	)			(6,353	)
Total			5,064				2,603
INTEREST EXPENSE
Interest charges			54,766				50,126
Capitalized interest			(5,679	)			(4,807	)
Total			49,087				45,319
INCOME (LOSS) FROM CONTINUING OPERATIONS BEFORE INCOME TAXES			(5,225	)			25,505
INCOME TAXES			(557	)			9,041
INCOME (LOSS) FROM CONTINUING OPERATIONS			(4,668	)			16,464
INCOME FROM DISCONTINUED OPERATIONS
Net of income tax expense of $120 and $46 (Note 17)			195				66
NET INCOME (LOSS)		$	(4,473	)		$	16,530
WEIGHTED-AVERAGE COMMON SHARES
OUTSTANDING — BASIC			100,521				100,045
WEIGHTED-AVERAGE COMMON SHARES
OUTSTANDING — DILUTED			100,521				100,622
EARNINGS PER WEIGHTED-AVERAGE COMMON SHARE OUTSTANDING
Income (loss) from continuing operations — basic		$	(0.05	)		$	0.16
Net income (loss) — basic		$	(0.04	)		$	0.17
Income (loss) from continuing operations — diluted		$	(0.05	)		$	0.16
Net income (loss) — diluted		$	(0.04	)		$	0.16
DIVIDENDS DECLARED PER SHARE		$	0.525			$	0.525

See Notes to Pinnacle West’s Condensed Consolidated Financial Statements.

PINNACLE WEST CAPITAL CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEETS
(unaudited)
(dollars in thousands)

		March 31,				December 31,
		2008				2007
ASSETS
CURRENT ASSETS
Cash and cash equivalents		$	17,533			$	56,321
Customer and other receivables			392,784				456,007
Allowance for doubtful accounts			(4,219	)			(4,782	)
Materials and supplies (at average cost)			164,003				149,759
Fossil fuel (at average cost)			24,966				27,792
Deferred income taxes			—				31,510
Assets from risk management and trading activities (Note 10)			133,000				57,605
Home inventory			94,693				98,729
Assets held for sale (Note 17)			51,090				7,139
Other current assets			31,678				26,849
Total current assets			905,528				906,929
INVESTMENTS AND OTHER ASSETS
Real estate investments — net			480,604				532,600
Assets from long-term risk management and trading activities (Note 10)			108,702				48,928
Nuclear decommissioning trust (Note 18)			371,500				379,347
Other assets			113,891				117,941
Total investments and other assets			1,074,697				1,078,816
PROPERTY, PLANT AND EQUIPMENT
Plant in service and held for future use			11,764,798				11,640,739
Less accumulated depreciation and amortization			4,016,182				4,004,944
Net			7,748,616				7,635,795
Construction work in progress			597,132				625,577
Intangible assets, net of accumulated amortization			103,067				105,746
Nuclear fuel, net of accumulated amortization			94,311				69,271
Total property, plant and equipment			8,543,126				8,436,389
DEFERRED DEBITS
Deferred fuel and purchased power regulatory asset			50,497				110,928
Other regulatory assets			502,803				514,353
Other deferred debits			120,926				114,794
Total deferred debits			674,226				740,075
TOTAL ASSETS		$	11,197,577			$	11,162,209

See Notes to Pinnacle West’s Condensed Consolidated Financial Statements.

PINNACLE WEST CAPITAL CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEETS
(unaudited)
(dollars in thousands)

		March 31,				December 31,
		2008				2007
LIABILITIES AND COMMON STOCK EQUITY
CURRENT LIABILITIES
Accounts payable		$	218,596			$	323,346
Accrued taxes (Note 8)			325,771				269,628
Accrued interest			41,746				39,836
Short-term borrowings			342,626				340,661
Current maturities of long-term debt (Note 4)			192,893				163,773
Customer deposits			78,560				80,010
Deferred income taxes			33,206				—
Liabilities from risk management and trading activities (Note 10)			22,916				24,510
Other current liabilities			85,257				102,685
Total current liabilities			1,341,571				1,344,449
LONG-TERM DEBT LESS CURRENT MATURITIES (NOTE 4)			3,114,579				3,127,125
DEFERRED CREDITS AND OTHER
Deferred income taxes			1,178,679				1,243,743
Regulatory liabilities			728,308				642,564
Liability for asset retirements			263,653				281,903
Liabilities for pension and other postretirement benefits (Note 6)			514,545				504,603
Liabilities from long-term risk management and trading activities (Note 10)			11,121				4,701
Unamortized gain — sale of utility plant			35,462				36,606
Other			465,458				444,904
Total deferred credits and other			3,197,226				3,159,024
COMMITMENTS AND CONTINGENCIES (SEE NOTES)
COMMON STOCK EQUITY
Common stock, no par value			2,134,904				2,135,787
Treasury stock			(3,398	)			(2,054	)
Total common stock			2,131,506				2,133,733
Accumulated other comprehensive income (loss) (Note 11):
Pension and other postretirement benefits			(38,667	)			(39,336	)
Derivative instruments			95,107				23,473
Total accumulated other comprehensive income (loss)			56,440				(15,863	)
Retained earnings			1,356,255				1,413,741
Total common stock equity			3,544,201				3,531,611
TOTAL LIABILITIES AND COMMON STOCK EQUITY		$	11,197,577			$	11,162,209

See Notes to Pinnacle West’s Condensed Consolidated Financial Statements.

PINNACLE WEST CAPITAL CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited)
(dollars in thousands)

		Three Months Ended
		March 31,
		2008				2007
CASH FLOWS FROM OPERATING ACTIVITIES
Net Income (Loss)		$	(4,473	)		$	16,530
Adjustments to reconcile net income (loss) to net cash provided by operating activities:
Depreciation and amortization including nuclear fuel			104,418				98,476
Deferred fuel and purchased power			9,722				(26,293	)
Deferred fuel and purchased power amortization			50,709				68,766
Allowance for equity funds used during construction			(6,124	)			(4,444	)
Deferred income taxes			(44,781	)			(12,752	)
Change in mark-to-market valuations			(14,709	)			(5,494	)
Changes in current assets and liabilities:
Customer and other receivables			63,285				149,097
Materials, supplies and fossil fuel			(11,418	)			(14,438	)
Other current assets			(511	)			4,525
Accounts payable			(84,556	)			(124,785	)
Other current liabilities			30,057				21,242
Proceeds from the sale of real estate assets			23,678				16,824
Real estate investments			(10,967	)			(24,374	)
Change in risk management and trading — assets			93,449				19,715
Change in risk management and trading — liabilities			6,647				34,191
Change in unrecognized tax benefits			13,223				—
Change in other long-term assets			16,145				(11,900	)
Change in other long-term liabilities			11,738				9,695
Net cash flow provided by operating activities			245,532				214,581
CASH FLOWS FROM INVESTING ACTIVITIES
Capital expenditures			(248,264	)			(210,174	)
Contributions in aid of construction			10,040				4,091
Capitalized interest			(5,679	)			(4,807	)
Proceeds from sale of investment securities			—				69,225
Purchases of investment securities			—				(36,525	)
Proceeds from nuclear decommissioning trust sales			67,177				63,490
Investment in nuclear decommissioning trust			(72,362	)			(68,675	)
Other			970				(626	)
Net cash flow used for investing activities			(248,118	)			(184,001	)
CASH FLOWS FROM FINANCING ACTIVITIES
Issuance of long-term debt			43,690				53,257
Repayment of long-term debt			(29,295	)			(39,305	)
Short-term borrowings and payments — net			1,965				35,300
Dividends paid on common stock			(52,759	)			(52,495	)
Common stock equity issuance			2,815				7,613
Other			(2,618	)			(907	)
Net cash flow (used for) provided by financing activities			(36,202	)			3,463
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS			(38,788	)			34,043
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD			56,321				87,210
CASH AND CASH EQUIVALENTS AT END OF PERIOD		$	17,533			$	121,253
Supplemental disclosure of cash flow information
Cash paid during the period for:
Income taxes, net of refunds		$	9,860			$	38,980
Interest, net of amounts capitalized		$	45,949			$	50,703

See Notes to Pinnacle West’s Condensed Consolidated Financial Statements.

PINNACLE WEST CAPITAL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

1. Consolidation and Nature of Operations

     The unaudited condensed consolidated financial statements include the accounts of Pinnacle West and our subsidiaries: APS, SunCor, APSES, El Dorado and Pinnacle West Marketing & Trading. Intercompany accounts and transactions between the consolidated companies have been eliminated. Our accounting records are maintained in accordance with GAAP. The preparation of financial statements in accordance with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities at the date of the financial statements and reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.

2. Condensed Consolidated Financial Statements

     Our unaudited condensed consolidated financial statements reflect all adjustments that we believe are necessary for the fair presentation of our financial position, results of operations and cash flows for the periods presented. We suggest that these condensed consolidated financial statements and notes be read along with the consolidated financial statements and notes to consolidated financial statements included in our 2007 Form 10-K, except to the extent of the following items: (1) we have reclassified certain prior year real estate segment revenues and expenses to discontinued operations on our Condensed Consolidated Statements of Income in accordance with SFAS No. 144; (2) we have netted certain prior year amounts on our Condensed Consolidated Balance Sheets and Statements of Cash Flows to reflect the adoption of FASB Staff Position No. FIN 39-1 (see Note 10); and (3) reclassifications as “contributions in aid of construction” of amounts previously reported as part of “capital expenditures” on the Condensed Consolidated Statements of Cash Flows.

3. Quarterly Fluctuations

     Weather conditions cause significant seasonal fluctuations in our revenues. In addition, real estate activities can have significant impacts on our results for interim periods. For these reasons, results for interim periods do not necessarily represent results expected for the year.

4. Liquidity Matters

     The following table shows principal payments due on Pinnacle West’s and APS’ total long-term debt and capitalized lease requirements as of March 31, 2008 (dollars in millions):

		Consolidated
Year		Pinnacle West				APS
2008		$	192			$	—
2009			58				1
2010			226				224
2011			578				401
2012			376				376
Thereafter			1,886				1,884
Total		$	3,316			$	2,886

PINNACLE WEST CAPITAL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

     Recent sub-prime mortgage issues have adversely affected the overall financial markets. Certain bond insurers have had actual or potential downgrades of their “AAA” credit ratings due to their insuring certain mortgage-backed securities and collateralized debt obligations. The interest rates on eleven issues of APS’ pollution control bonds, in the aggregate amount of approximately $343 million, are reset every seven days through auction processes. These bonds are supported by bond insurance policies provided by Ambac Assurance Corporation, and the interest rates on the bonds can be directly affected by the rating of the bond insurer. Downgrades of bond insurers also increase the possibility of a “failed auction,” which results in higher interest rates during the failed auction periods. During the first quarter of 2008, we had seven failed auctions, which represented about 5% of all of our auctions for the quarter. When the auctions failed, the bondholders received the maximum 14% annual interest rate for the week of the failed auction. The bonds were successfully re-auctioned the following week. We continue to monitor this market and are evaluating our options to eliminate our exposure to the auction rate market. We do not expect, however, that our auction rate interest exposure will have a material adverse impact on our financial position, results of operations, cash flows or liquidity.

     An existing ACC order requires APS to maintain a common equity ratio of at least 40%. As defined in the ACC order, the common equity ratio is common equity divided by the sum of common equity and long-term debt, including current maturities of long-term debt. At March 31, 2008, APS’ common equity ratio, as defined, was 54%, its total common equity was approximately $3.4 billion, and total capitalization was approximately $6.2 billion. APS would be prohibited from paying dividends if its common equity falls below approximately $2.5 billion, assuming APS’ total capitalization remains the same.

     SunCor has a $150 million loan facility secured primarily by an interest in land, commercial properties, land contracts and homes under construction. The loan facility requires compliance with certain loan covenants pertaining to debt to net worth, debt service, liquidity, cash flow coverage and restrictions on debt. As of March 31, 2008, the amount of SunCor’s net assets that could not be transferred to Pinnacle West in the form of cash dividends as a result of these covenants was approximately $217 million.

     As a result of the restrictions in the preceding two paragraphs, as of March 31, 2008, the restricted net assets of our subsidiaries exceeded 25% of our consolidated net assets (at March 31, 2008, our consolidated net assets were approximately $3.5 billion). These restrictions do not materially affect Pinnacle West’s ability to meet its ongoing capital requirements.

5. Regulatory Matters

     2008 General Rate Case

     On March 24, 2008, APS filed a request with the ACC for a net rate increase of $266 million for retail customers effective no later than July 1, 2009 (the “March Rate Request”) based on a test year ended September 30, 2007, adjusted as described below. The ACC staff requested that APS update financial schedules, testimony and other data contained in the March Rate Request to reflect a test year ended December 31, 2007. Although APS concluded that the March Rate Request complied with applicable ACC test year requirements, to prevent further delays in processing the rate request, APS agreed to file the updated information with the ACC on or before June 3, 2008. The ACC staff has agreed to complete its review of the updated information no later than 30 days after APS makes its revised submission. Thereafter, we expect the ACC to issue a procedural schedule detailing the timeline for addressing the request.

PINNACLE WEST CAPITAL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

     The key financial provisions of the March Rate Request included:

	•		an average rate increase of 8.1% for existing customers plus the establishment of a new growth-related impact fee charged to new connections;
	•		an increase of $253 million in non-fuel base rates and a net increase of $13 million for fuel and purchased power costs reflected in base rates, and recovery of up to $53 million of such increases through the impact fee;
	•		a rate base of $5.3 billion, which approximates the ACC-jurisdictional portion of the book value of utility assets, net of accumulated depreciation and other credits, as of September 30, 2007, subject to certain adjustments, such as the inclusion of Units 5 and 6 of the Yucca Power Plant (near Yuma in southwestern Arizona), the steam generator replacements at Palo Verde Unit 3, environmental upgrades to APS coal plants, and other plant additions under construction at the end of the test year that are currently in service or expected to go into service before the proposed rates are requested to become effective;
	•		the following proposed capital structure and costs of capital:

		Capital				Cost of
		Structure				Capital
Long-term debt			45.9	%			5.77	%
Common stock equity			54.1	%			11.50	%
Weighted-average cost of capital							8.87	%

	•		a Base Fuel Rate of $0.0366 per kWh based on estimated 2009 prices (an increase from the current Base Fuel Rate of $0.0325 per kWh, including the reclassification of $106 million of fuel and purchased power revenues from the PSA to base rates);
	•		an $87 million attrition adjustment to address erosion in APS’ earnings and return on equity between the end of the test year and 2010; and
	•		a new super-peak residential time-of-use rate and a commercial and industrial critical peak pricing proposal to allow eligible customers additional options to manage their electric bills, as well as other conservation-related rate design proposals.

     In addition, APS requested various modifications to the Environmental Improvement Surcharge and the Demand Side Management Adjustment Clause that will allow APS to expand its conservation and demand-side management programs and support environmental upgrades to APS facilities in response to and in anticipation of future environmental requirements.

     2007 Retail Rate Order

     As previously disclosed, in June 2007 the ACC issued an order (the “Retail Rate Order”) in a general retail rate case that APS filed in late 2005. The Retail Rate Order approved a $322 million increase in APS’ annual retail base revenues, effective July 1, 2007, which included a $315 million fuel-related increase and a $7 million non-fuel related increase. The Retail Rate Order also authorized APS’ recovery of approximately $34 million of 2005 Deferrals through a temporary PSA surcharge over a twelve-month period beginning July 1, 2007, modified the PSA in various respects and increased the Base Fuel Rate. In addition, the Retail Rate Order provides that the PSA adjustor that took effect on February 1, 2007 ($0.004 per kWh), and that was scheduled to expire on January 31, 2008, will remain in effect as long as necessary to allow APS to collect $46 million of

PINNACLE WEST CAPITAL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

2007 fuel and purchased power costs deferred as a result of the mid-2007 implementation of the new Base Fuel Rate. We anticipate that this adjustor will remain in effect through mid-2008.

     PSA Balance

     The following table shows the changes in the deferred fuel and purchased power regulatory asset for the three months ended March 31, 2008 and 2007 (dollars in millions):

		Three Months Ended
		March 31,
		2008				2007
Beginning balance		$	111			$	160
Deferred fuel and purchased power costs-current period			(11	)			25
Interest on deferred fuel and purchased power			1				2
Amounts recovered through revenues			(51	)			(69	)
Ending balance		$	50			$	118

     The PSA rate for the PSA Year (February 1 through January 1) beginning February 1, 2008 was set at the maximum $0.004 per kWh. Any uncollected deferrals during the 2008 PSA Year resulting from this limit will be included in the historical component of the PSA rate for the PSA Year beginning February 1, 2009.

     Rate Requests for Transmission and Ancillary Services

     On July 10, 2007, APS submitted a revised Open Access Transmission Tariff filing with the FERC to move from a fixed rate to a formula rate in order to more accurately reflect the costs that APS incurs in providing transmission and ancillary services. The requested formula rate would have resulted in an estimated $37 million increase in annual transmission revenues, effective October 1, 2007. The proposed formula rate would be updated each year effective June 1 on the basis of APS’ actual cost of service, as disclosed in APS’ FERC Form 1 report for the previous fiscal year, and projected capital expenditures. Approximately $30 million of the requested increase represents charges for transmission services to serve APS’ retail customers (“Retail Transmission Charges”).

     On September 21, 2007, the FERC issued an order on these proposed revisions to APS’ transmission rates in which it accepted APS’ proposed formula rates and ordered settlement judge procedures, which are underway. The proposed rates became effective March 1, 2008, subject to refund based upon the ultimate outcome of proceedings at the FERC on this matter.

     On December 31, 2007, APS filed with the ACC an application to increase annual pretax retail revenues by approximately $30 million, effective March 1, 2008, to cover the Retail Transmission Charges authorized by the FERC. This retail rate increase implements an ACC-approved mechanism, the transmission cost adjustor (“TCA”), by which changes in Retail Transmission Charges can be reflected in APS’ retail rates. On February 13, 2008, the ACC voted to approve APS’ request, subject to refund pending final outcome of FERC proceedings on this matter.

PINNACLE WEST CAPITAL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

     On June 1, 2008, our FERC transmission rates will automatically adjust based on the formula mechanism described above. In addition, APS will file a new request with the ACC to implement the TCA allowing APS to reflect the resulting increased Retail Transmission Charges in its retail rates.

     Equity Infusion Notice

     On May 2, 2008, Pinnacle West filed a Notice with the ACC that would allow Pinnacle West to infuse up to $400 million of equity into APS during 2008 in the event Pinnacle West deems it appropriate to do so. Under Arizona law and implementing regulatory decisions, Pinnacle West is required to give such notice at least 120 days prior to such an equity infusion into APS. The ACC may, but need not, take action on this Notice. If the ACC takes no action within the 120 day notice period, Pinnacle West may thereafter make any such infusions at the Company’s discretion.

Federal

     FERC Order

     On August 11, 2004, Pinnacle West, APS, Pinnacle West Energy, and APSES (collectively, the “Pinnacle West Companies”) submitted to the FERC an update to their three-year market-based rate review pursuant to the FERC’s order implementing a new generation market power analysis. On December 20, 2004, the FERC issued an order approving the Pinnacle West Companies’ market-based rates for control areas other than those of APS, Public Service Company of New Mexico (“PNM”) and Tucson Electric Power Company (“TEP”). The FERC staff required the Pinnacle West Companies to submit additional data with respect to these control areas, and the Pinnacle West Companies did so.

     On April 17, 2006, the FERC issued an order revoking the Pinnacle West Companies’ authority to make sales at market-based rates in the APS control area (the “April 17 Order”). The FERC found that the Pinnacle West Companies failed to provide the necessary information about the calculation of transmission imports into the APS control area to allow the FERC to make a determination regarding FERC’s generation market power “screens” in the APS control area. The FERC found that the Pinnacle West Companies may charge market-based rates in the PNM and TEP control areas.

     On August 13, 2007, the FERC issued an order on rehearing, reinstating the authority of the Pinnacle West Companies to make sales at market-based rates in all seasons for sales outside of the Phoenix Valley, and in all seasons except the summer for sales within the Phoenix Valley. The Pinnacle West Companies submitted a compliance filing implementing this order to the FERC on October 12, 2007. This compliance filing was accepted conditionally by FERC in an order issued January 17, 2008. In compliance with the January 17, 2008 order, the Pinnacle West Companies filed a revised mitigation plan to implement cost-based rates for sales in the Phoenix Valley during the summer months. The first summer period under this cost-based mitigation will begin on June 1, 2008. We are awaiting a response from the FERC regarding the approval of our proposed mitigation plan.

     Based upon an analysis of this matter, at this time neither Pinnacle West nor APS believes that this proceeding will have a material adverse effect on its financial position, results of operations or cash flows.

PINNACLE WEST CAPITAL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

6. Retirement Plans and Other Benefits

     Pinnacle West sponsors a qualified defined benefit and account balance pension plan, a nonqualified supplemental excess benefit retirement plan (“SEBRP”), and other postretirement benefit plans for the employees of Pinnacle West and our subsidiaries. Pinnacle West uses a December 31 measurement date for its pension and other postretirement benefit plans. The market-related value of our plan assets is their fair value at the measurement date.

     The following table provides details of the plans’ benefit costs for the three months ended March 31, 2008 and 2007. Also included is the portion of these costs charged to expense, including administrative costs and excluding amounts billed to electric plant participants or capitalized as overhead construction (dollars in millions):

		Pension Benefits								Other Benefits
		Three Months								Three Months
		Ended March 31,								Ended March 31,
		2008				2007				2008				2007
Service cost-benefits earned during the period		$	13			$	14			$	5			$	6
Interest cost on benefit obligation			27				27				10				10
Expected return on plan assets			(29	)			(29	)			(11	)			(12	)
Amortization of:
Transition obligation			—				—				1				1
Prior service cost			1				1				—				—
Net actuarial loss			4				4				1				2
Net periodic benefit cost		$	16			$	17			$	6			$	7
Portion of cost charged to expense		$	7			$	8			$	3			$	3
APS’ share of costs charged to expense		$	7			$	7			$	3			$	3

Contributions

     The contribution to our pension plan in 2008 is estimated to be approximately $50 million. The contribution to our other postretirement benefit plans in 2008 is estimated to be approximately $20 million. APS and other subsidiaries fund their share of the contributions. APS’ share is approximately 96% of the plans.

7. Business Segments

     Pinnacle West’s two reportable business segments are:

•

our regulated electricity segment, which consists of traditional regulated retail and wholesale electricity businesses (primarily electricity service to Native Load

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

			customers) and related activities and includes electricity generation, transmission and distribution; and
	•		our real estate segment, which consists of SunCor’s real estate development and investment activities.

     Financial data for the three months ended March 31, 2008 and 2007 and at March 31, 2008 and December 31, 2007 is provided as follows (dollars in millions):

		Three Months Ended
		March 31,
		2008				2007
Operating Revenues:
Regulated electricity segment		$	623			$	536
Real estate segment			48				77
All other (a)			66				82
Total		$	737			$	695
Net Income (Loss):
Regulated electricity segment		$	(6	)		$	4
Real estate segment			(1	)			9
All other (a)			3				4
Total		$	(4	)		$	17

		As of				As of
		March 31, 2008				December 31, 2007
Assets:
Regulated electricity segment		$	10,399			$	10,356
Real estate segment			658				661
All other (a)			141				145
Total		$	11,198			$	11,162

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

8. Income Taxes

     As a result of a change in IRS guidance, we claimed a tax deduction related to an APS tax accounting method change on our 2001 federal consolidated income tax return. The accelerated deduction resulted in a $200 million reduction in the current income tax liability and a corresponding increase in the plant-related deferred tax liability. Our 2001 federal consolidated income tax return is currently under examination by the IRS. As part of its ongoing examination, the IRS is reviewing this accounting method change and the resultant deduction. Within the next three months, we expect that the IRS will finalize its examination of the 2001 return, which will include a settlement on the tax accounting method change. Although the ultimate outcome of this matter cannot currently be predicted, as a result of the current status of the examination, we have increased by approximately $13 million our estimate of the amounts of unrecognized tax benefits included in accrued taxes and other deferred credits on the Condensed Consolidated Balance Sheets at March 31, 2008. We do not expect the ultimate outcome of this examination to have a material adverse impact on our financial position or results of operations. We expect that it will have a negative impact on cash flows, but do not believe it will materially affect our ability to meet our on-going capital requirements. We do not expect that there will be any other significant increases or decreases in our unrecognized tax benefits within the next 12 months.

9. Variable-Interest Entities

     In 1986, APS entered into agreements with three separate VIE lessors in order to sell and lease back interests in Palo Verde Unit 2. The leases are accounted for as operating leases in accordance with GAAP. We are not the primary beneficiary of the Palo Verde VIEs and, accordingly, do not consolidate them.

     APS is exposed to losses under the Palo Verde sale leaseback agreements upon the occurrence of certain events that APS does not consider to be reasonably likely to occur. Under certain circumstances (for example, the NRC issuing specified violation orders with respect to Palo Verde or the occurrence of specified nuclear events), APS would be required to assume the debt associated with the transactions, make specified payments to the equity participants, and take title to the leased Unit 2 interests, which, if appropriate, may be required to be written down in value. If such an event had occurred as of March 31, 2008, APS would have been required to assume approximately $194 million of debt and pay the equity participants approximately $170 million.

10. Derivative and Energy Trading Accounting

     We use derivative instruments (primarily forward purchases and sales, swaps, options and futures) to manage our exposure to the commodity price risk inherent in the purchase and sale of fuel, electricity and emission allowances and credits. As of March 31, 2008, we hedged exposures to the price variability of the power and gas commodities for a maximum of 39 months. The changes in market value of such contracts have a high correlation to price changes in the hedged transactions.

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

Cash Flow Hedges

     The changes in the fair value of our hedged positions included in the Condensed Consolidated Statements of Income, after consideration of amounts deferred under the PSA, for the three months ended March 31, 2008 and 2007 are comprised of the following (dollars in thousands):

		Three Months Ended
		March 31,
		2008				2007
Gains on the ineffective portion of derivatives qualifying for hedge accounting		$	1,090			$	911
Gains from the discontinuance of cash flow hedges			—				314

     During the next twelve months ending March 31, 2009, we estimate that a net gain of $101 million before income taxes will be reclassified from accumulated other comprehensive income as an offset to the effect of market price changes for the related hedged transactions. To the extent the amounts are eligible for inclusion in the PSA, the amounts will be recorded as either a regulatory asset or liability and have no effect on earnings.

FIN 39-1

     We adopted FASB Staff Position No. FIN 39-1, “Amendment of FASB Interpretation No. 39, Offsetting of Amounts Related to Certain Contracts” (FIN 39-1) on January 1, 2008. In accordance with this guidance, we elected to offset the fair value amounts for derivative instruments, including collateral, executed with the same counterparty under a master netting arrangement. Collateral was previously reported in other current assets or other current liabilities on our Condensed Consolidated Balance Sheets. This guidance required retrospective application for all prior periods presented. As a result, our Condensed Consolidated Balance Sheet and Statement of Cash Flows line items changed by the following amounts (dollars in thousands):

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

		As originally				Reclassifications
		reported in the				as a result of the
		2007				adoption of				After adoption
Balance Sheet - December 31, 2007		Form 10-K				FIN 39-1				of FIN 39-1
Current Assets — Assets from risk management and trading activities		$	97,373			$	(39,768	)		$	57,605
Current Assets — Other current assets			34,738				(750	)			33,988	(a)
Investments and Other Assets — Assets from long-term risk management and trading activities			89,913				(40,985	)			48,928
Current Liabilities — Liabilities from risk management and trading activities			65,028				(40,518	)			24,510
Deferred Credits and Other - Liabilities from long-term risk management and trading activities			45,686				(40,985	)			4,701

(a)	This balance also includes $7 million of “Assets held for sale” presented separately in this filing.

		As originally				Reclassifications
		reported in the				as a result of the
Statement of Cash Flows —		March 31, 2007				adoption of				After adoption
Three months ended March 31, 2007		Form 10-Q				FIN 39-1				of FIN 39-1
Change in risk management and trading — assets		$	54,689			$	(34,974	)		$	19,715
Change in risk management and trading — liabilities			(480	)			34,671				34,191
Collateral			(303	)			303				—

     The following tables summarize our assets and liabilities from risk management and trading activities presented net in accordance with FIN 39-1 (dollars in thousands):

						Investments								Deferred
		Current				and Other				Current				Credits and				Net Asset
March 31, 2008		Assets				Assets				Liabilities				Other				(Liability)
Mark-to-market		$	195,049			$	108,702			$	(22,416	)		$	(11,121	)		$	270,214
Margin account liability			(62,049	)			—				(500	)			—				(62,549	)
Collateral provided to counterparties			—				—				—				—				—
Collateral provided from counterparties			—				—				—				—				—
Total		$	133,000			$	108,702			$	(22,916	)		$	(11,121	)		$	207,665

PINNACLE WEST CAPITAL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

						Investments								Deferred
		Current				and Other				Current				Credits and
December 31, 2007		Assets				Assets				Liabilities				Other				Net Asset
Mark-to-market		$	26,333			$	48,928			$	(30,786	)		$	(4,701	)		$	39,774
Margin account			30,650				—				6,148				—				36,798
Collateral provided to counterparties			622				—				128				—				750
Collateral provided from counterparties			—				—				—				—				—
Total		$	57,605			$	48,928			$	(24,510	)		$	(4,701	)		$	77,322

     We maintain a margin account with a broker to support our risk management and trading activities. The margin account was a liability of $56 million at March 31, 2008 and an asset of $31 million at December 31, 2007 and is included in the margin account in the table above. Cash is deposited with the broker in this account at the time futures or options contracts are initiated. The change in market value of these contracts (reflected in mark-to-market) requires adjustment of the margin account balance.

     See Note 20 for a discussion of SFAS No. 157, “Fair Value Measurements,” which we adopted January 1, 2008.

Credit Risk

     We are exposed to losses in the event of nonperformance or nonpayment by counterparties. We have risk management and trading contracts with many counterparties, including one counterparty for which a worst case exposure represents approximately 19% of Pinnacle West’s $242 million of risk management and trading assets as of March 31, 2008. Our risk management process assesses and monitors the financial exposure of this and all other counterparties. Despite the fact that the great majority of trading counterparties’ securities are rated as investment grade by the credit rating agencies, including the counterparty discussed above, there is still a possibility that one or more of these companies could default, resulting in a material impact on consolidated earnings for a given period. Counterparties in the portfolio consist principally of financial institutions, major energy companies, municipalities and local distribution companies. We maintain credit policies that we believe minimize overall credit risk to within acceptable limits. Determination of the credit quality of our counterparties is based upon a number of factors, including credit ratings and our evaluation of their financial condition. To manage credit risk, we employ collateral requirements, standardized agreements that allow for the netting of positive and negative exposures associated with a single counterparty and credit default swaps. Valuation adjustments are established representing our estimated credit losses on our overall exposure to counterparties.

11. Comprehensive Income

     Components of comprehensive income for the three months ended March 31, 2008 and 2007 are as follows (dollars in thousands):

PINNACLE WEST CAPITAL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

		Three Months
		Ended March 31,
		2008				2007
Net income (loss)		$	(4,473	)		$	16,530
Other comprehensive income (loss):
Net unrealized gains on derivative instruments (a)			119,806				62,560
Net reclassification of realized gains on derivative instruments to income (b)			(2,065	)			(5,013	)
Reclassification of pension and other postretirement benefits to income			1,043				251
Net income tax expense related to items of other comprehensive income			(46,481	)			(22,570	)
Total other comprehensive income			72,303				35,228
Comprehensive income		$	67,830			$	51,758

12. Commitments and Contingencies

Palo Verde Nuclear Generating Station

     Spent Nuclear Fuel and Waste Disposal

     Nuclear power plant operators are required to enter into spent fuel disposal contracts with the DOE, and the DOE is required to accept and dispose of all spent nuclear fuel and other high-level radioactive wastes generated by domestic power reactors. Although the Nuclear Waste Policy Act required the DOE to develop a permanent repository for the storage and disposal of spent nuclear fuel by 1998, the DOE has announced that the repository cannot be completed before at least 2017. In November 1997, the United States Court of Appeals for the District of Columbia Circuit (D.C. Circuit) issued a decision preventing the DOE from excusing its own delay, but refused to order the DOE to begin accepting spent nuclear fuel. Based on this decision and the DOE’s delay, a number of utilities, including APS (on behalf of itself and the other Palo Verde owners), filed damages actions against the DOE in the Court of Federal Claims. APS is currently pursuing that damages claim and trial is expected to occur in 2009.

PINNACLE WEST CAPITAL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

     APS currently estimates it will incur $132 million (in 2008 dollars) over the life of Palo Verde for its share of the costs related to the on-site interim storage of spent nuclear fuel. At March 31, 2008, APS had a regulatory liability of $15 million that represents amounts recovered in retail rates in excess of amounts spent for on-site interim spent fuel storage.

California Energy Market Issues and Refunds in the Pacific Northwest

     FERC

     In July 2001, the FERC ordered an expedited fact-finding hearing to calculate refunds for spot market transactions in California during a specified time frame. APS was a seller and a purchaser in the California markets at issue and, to the extent that refunds are ordered, APS should be a recipient as well as a payor of such amounts. The FERC is still considering the evidence and refund amounts have not yet been finalized. However, on September 6, 2005, the Ninth Circuit issued a decision, concluding that the FERC may not order refunds from entities that are not within the FERC’s jurisdiction. Because a number of the entities owing refunds under the FERC’s calculations are not within the FERC’s jurisdiction, this order may affect the level of recovery of refunds due in this proceeding. In addition, on August 8, 2005, the FERC issued an order allowing sellers in the California markets to demonstrate that its refund methodology results in an overall revenue shortfall for their transactions in the relevant markets over a specified time frame. More than twenty sellers made such cost recovery filings on September 14, 2005. On January 26, 2006, the FERC conditionally accepted thirteen of these filings, reducing the refund liability for these sellers. Correspondingly, this will reduce the recovery of total refunds in the California markets. On August 2, 2006, the Ninth Circuit issued a decision on the appropriate temporal scope and the type of transactions that are properly subject to the refund orders. In the decision, the Court preserved the scope of the FERC’s existing refund proceedings, but also expanded it potentially to include additional transactions, remanding the orders to the FERC for further proceedings. Various parties filed petitions for rehearing on this order. In addition, on December 19, 2006, the Ninth Circuit issued a decision on the appropriate standard of review at the FERC on wholesale power contracts in the refund proceedings, specifically addressing the application of the so-called “just and reasonable” standard as opposed to the “public interest” standard. In so doing, the Ninth Circuit remanded the matter back to the FERC with the requirement that the FERC review the refund matter using the appropriate standard of review. Several parties sought rehearing of this decision at the Ninth Circuit. Like the August 2, 2006 Ninth Circuit decision, the December 19, 2006 decision has the potential to expand the existing FERC refund proceedings. A settlement, resolving APS’ issues with certain California parties for the current refund period, was filed with the FERC on May 2, 2008, which will be followed by a sixty-day comment period at the FERC. We currently believe the refund claims at the FERC related to the parties not involved in this settlement, as well as the claims related to the parties involved in the settlement, will have no material adverse impact on our financial position, results of operations or cash flows.

     On March 19, 2002, the State of California filed a complaint with the FERC alleging that wholesale sellers of power and energy, including APS, failed to properly file rate information at the FERC in connection with sales to California from 2000 to the present under market-based rates. The complaint requests the FERC to require the wholesale sellers to refund any rates that are “found to exceed just and reasonable levels.” This complaint was dismissed by the FERC, and the State of California appealed the matter to the Ninth Circuit Court of Appeals. In an

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

order issued September 9, 2004, the Ninth Circuit upheld the FERC’s authority to permit market-based rates, but rejected the FERC’s claim that it was without authority to consider retroactive refunds when a utility has not strictly adhered to the quarterly reporting requirements of the market-based rate system. On September 9, 2004, the Ninth Circuit remanded the case to the FERC for further proceedings. Following several years of procedural activity, on March 20, 2008, the FERC re-opened its proceedings. We believe that, once the settlement mentioned above is approved by the FERC, this matter also will be dismissed as to APS. Accordingly, we currently believe that the outcome of these further proceedings will have no material adverse impact on our financial position, results of operations or cash flows.

     On March 26, 2003, the FERC made public a Final Report on Price Manipulation in Western Markets, prepared by its staff and covering spot markets in the West in 2000 and 2001. The report stated that a significant number of entities who participated in the California markets during the 2000-2001 time period, including APS, may potentially have been involved in arbitrage transactions that allegedly violated certain provisions of the Independent System Operator tariff. After reviewing the matter, along with the data supplied by APS, the FERC staff moved to dismiss the claims against APS and to dismiss the proceeding. The motion to dismiss was granted by the FERC on January 22, 2004. Certain parties have sought rehearing of this order, and that request is pending. Under the pending settlement agreement mentioned above, filed with the FERC on May 2, 2008, these parties will withdraw their request for rehearing once the settlement is approved by the FERC.

     On July 25, 2001, the FERC also ordered an evidentiary proceeding to discuss and evaluate possible refunds for wholesale sales in the Pacific Northwest. The FERC affirmed the ALJ’s conclusion that the prices in the Pacific Northwest were not unreasonable or unjust and refunds should not be ordered in this proceeding. This decision was appealed to the U.S. Court of Appeals for the Ninth Circuit. On August 24, 2007, the Ninth Circuit issued an opinion that remanded the proceeding to the FERC for further consideration. Petitions for rehearing of this opinion were filed on December 17, 2007. Although the FERC ruling in this matter is being appealed and the FERC has not yet calculated the specific refund amounts at issue, we do not expect that the resolution of these issues will have a material adverse impact on our financial position, results of operations or cash flows.

Navajo Nation Litigation

     In June 1999, the Navajo Nation served Salt River Project with a lawsuit filed in the United States District Court for the District of Columbia (the “D.C. Lawsuit”) naming Salt River Project, several Peabody Coal Company entities (collectively, “Peabody”), Southern California Edison Company and other defendants, and citing various claims in connection with the renegotiations of the coal royalty and lease agreements under which Peabody mines coal for the Navajo Generating Station and the Mohave Generating Station. APS is a 14% owner of the Navajo Generating Station, which Salt River Project operates. The D.C. Lawsuit alleges, among other things, that the defendants obtained a favorable coal royalty rate by improperly influencing the outcome of a federal administrative process under which the royalty rate was to be adjusted. The suit seeks $600 million in damages, treble damages, punitive damages of not less than $1 billion, and the ejection of defendants “from all possessory interests and Navajo Tribal lands arising out of the [primary coal lease].” In July 2001, the court dismissed all claims against Salt River Project.

PINNACLE WEST CAPITAL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

     In January 2005, Peabody served APS with a lawsuit filed in the Circuit Court for the City of St. Louis naming APS and the other Navajo Generating Station participants and seeking, among other things, a declaration that the participants “are obligated to reimburse Peabody for any royalty, tax, or other obligation arising out of the D.C. Lawsuit.” Based on APS’ ownership interest in the Navajo Generating Station, APS could be liable for up to 14% of any such obligation. APS cannot currently predict the outcome of this matter.

Superfund

     Superfund establishes liability for the cleanup of hazardous substances found contaminating the soil, water or air. Those who generated, transported or disposed of hazardous substances at a contaminated site are among those who are PRPs. PRPs may be strictly, and often jointly and severally, liable for clean-up. On September 3, 2003, the EPA advised APS that the EPA considers APS to be a PRP in the Motorola 52^nd Street Superfund Site, Operable Unit 3 (OU3) in Phoenix, Arizona. APS has facilities that are within this Superfund site. APS and Pinnacle West have agreed with the EPA to perform certain investigative activities of the APS facilities within OU3. Because the investigation has not yet been completed and ultimate remediation requirements are not yet finalized, at the present time neither APS nor Pinnacle West can accurately estimate the expenditures that may be required.

Salt River Project

     Salt River Project has notified APS that Salt River Project allegedly failed to bill APS for (a) energy losses under certain service schedules of a power contract between the parties and (b) certain other charges under the contract. Salt River Project asserts that certain of these failures to bill APS for such losses and charges may extend back to 1996 and, as a result, claims that APS owes it approximately $29 million. APS disputes that it is required to pay these amounts. No lawsuit or litigation has been initiated in the matter at this time. We do not expect that resolution of this matter will have a material adverse impact on our financial position, results of operations, or cash flows.

Litigation

     We are party to various other claims, legal actions and complaints arising in the ordinary course of business, including but not limited to environmental matters related to the Clean Air Act, Navajo Nation issues and EPA and ADEQ issues. In our opinion, the ultimate resolution of these matters will not have a material adverse effect on our financial position, results of operations or cash flows.

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

13. Nuclear Insurance

     The Palo Verde participants have insurance for public liability resulting from nuclear energy hazards to the full limit of liability under federal law. This potential liability is covered by primary liability insurance provided by commercial insurance carriers in the amount of $300 million and the balance by an industry-wide retrospective assessment program. If losses at any nuclear power plant covered by the program exceed the accumulated funds, APS could be assessed retrospective premium adjustments. The maximum assessment per reactor under the program for each nuclear incident is approximately $101 million, subject to an annual limit of $15 million per incident, to be periodically adjusted for inflation. Based on APS’ interest in the three Palo Verde units, APS’ maximum potential assessment per incident for all three units is approximately $88 million, with an annual payment limitation of approximately $13 million.

     The Palo Verde participants maintain “all risk” (including nuclear hazards) insurance for property damage to, and decontamination of, property at Palo Verde in the aggregate amount of $2.75 billion, a substantial portion of which must first be applied to stabilization and decontamination. APS has also secured insurance against portions of any increased cost of generation or purchased power and business interruption resulting from a sudden and unforeseen accidental outage of any of the three units. The property damage, decontamination, and replacement power coverages are provided by Nuclear Electric Insurance Limited (NEIL). APS is subject to retrospective assessments under all NEIL policies if NEIL’s losses in any policy year exceed accumulated funds. The maximum amount of retrospective assessments APS could incur under the current NEIL policies totals $21.1 million. The insurance coverage discussed in this and the previous paragraph is subject to certain policy conditions and exclusions.

14. Other Income and Other Expense

     The following table provides detail of other income and other expense for the three months ended March 31, 2008 and 2007 (dollars in thousands):

		Three Months Ended March 31,
		2008				2007
Other income:
Interest income		$	2,243			$	3,413
SunCor other income (a)			1,596				579
Miscellaneous			9				520
Total other income		$	3,848			$	4,512
Other expense:
Non-operating costs		$	(1,930	)		$	(3,311	)
Investment losses — net			(2,668	)			(1,739	)
Miscellaneous			(310	)			(1,303	)
Total other expense		$	(4,908	)		$	(6,353	)

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

15. Guarantees

     We have issued parental guarantees and letters of credit and obtained surety bonds on behalf of our subsidiaries. Our parental guarantees for Pinnacle West Marketing & Trading and APS relate to commodity energy products. Our credit support instruments enable APSES to offer energy-related products and commodity energy. Non-performance or non-payment under the original contract by our subsidiaries would require performance under the guarantee or surety bond. No liability is currently recorded on the Condensed Consolidated Balance Sheets related to Pinnacle West’s current outstanding guarantees on behalf of our subsidiaries. Our guarantees have no recourse or collateral provisions to allow us to recover amounts paid under the guarantees. The amounts and approximate terms of our guarantees and surety bonds for each subsidiary at March 31, 2008 are as follows (dollars in millions):

		Guarantees								Surety Bonds
						Term								Term
		Amount				(in years)				Amount				(in years)
Parental:
Pinnacle West Marketing & Trading		$	19				1			$	—				—
APSES			18				1				17				1
APS			4				1				—				—
Total		$	41							$	17

     At March 31, 2008, Pinnacle West had approximately $7 million of letters of credit related to workers’ compensation expiring in 2009. We intend to provide from either existing or new facilities for the extension, renewal or substitution of the letters of credit to the extent required.

     APS has entered into various agreements that require letters of credit for financial assurance purposes. At March 31, 2008, approximately $200 million of letters of credit were outstanding to support existing pollution control bonds of approximately $200 million. The letters of credit are available to fund the payment of principal and interest of such debt obligations and expire in 2010. APS has also entered into approximately $79 million of letters of credit to support certain equity lessors in the Palo Verde sale leaseback transactions (see Note 9 for further details on the Palo Verde sale leaseback transactions). These letters of credit expire in 2010. Additionally, at March 31, 2008, APS had approximately $4 million of letters of credit related to counterparty collateral requirements expiring in 2008. APS intends to provide from either existing or new facilities for the extension, renewal or substitution of the letters of credit to the extent required.

     We enter into agreements that include indemnification provisions relating to liabilities arising from or related to certain of our agreements; most significantly, APS has agreed to indemnify the equity participants and other parties in the Palo Verde sale leaseback transactions with respect to certain tax matters. Generally, a maximum obligation is not explicitly stated in the indemnification provisions and, therefore, the overall maximum amount of the obligation under such indemnification provisions cannot be reasonably estimated. Based on historical experience and evaluation of the specific indemnities, we do not believe that any material loss related to such indemnification provisions is likely.

PINNACLE WEST CAPITAL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

16. Earnings Per Share

     The following table presents earnings per weighted average common share outstanding for the three months ended March 31, 2008 and 2007:

		Three Months Ended
		March 31,
		2008				2007
Basic earnings per share:
Income (loss) from continuing operations		$	(0.05	)		$	0.16
Income from discontinued operations			0.01				0.01
Earnings per share — basic		$	(0.04	)		$	0.17
Diluted earnings per share:
Income (loss) from continuing operations		$	(0.05	)		$	0.16
Income from discontinued operations			0.01				—
Earnings per share — diluted		$	(0.04	)		$	0.16

     For the three months ended March 31, 2008, the weighted average common shares outstanding were the same for both basic and diluted shares. There were 703,875 outstanding options to purchase shares of common stock that were excluded from the computation of diluted earnings per share because the impact of including those options would be antidilutive.

     Dilutive stock options and performance shares (which are contingently issuable) increased average common shares outstanding by approximately 577,000 shares for the three months ended March 31, 2007. All the outstanding options to purchase shares of common stock were included in the computation of diluted earnings per share because the options’ exercise prices were less than the average market price of the common shares for the three-month period ended March 31, 2007.

17. Discontinued Operations

     SunCor (real estate segment) - In 2008 and 2007, SunCor sold or expects to sell commercial properties that are required to be reported as discontinued operations on Pinnacle West’s Condensed Consolidated Statements of Income in accordance with SFAS No. 144. Assets held for sale relate to commercial properties in the amount of $51 million at March 31, 2008 and $7 million at December 31, 2007. Total revenues related to discontinued operations included in Pinnacle West’s Condensed Consolidated Statements of Income for the three months ended March 31, 2008 and 2007 were immaterial.

18. Nuclear Decommissioning Trust

     To fund the costs APS expects to incur to decommission Palo Verde, APS established external decommissioning trusts in accordance with NRC regulations. APS invests the trust funds in fixed income securities and domestic equity securities. APS applies the provisions of SFAS No. 115, “Accounting for Certain Investments in Debt and Equity Securities,” in accounting for investments in

PINNACLE WEST CAPITAL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

decommissioning trust funds, and classifies these investments as available for sale. As a result, we record the decommissioning trust funds at their fair value on our Condensed Consolidated Balance Sheets. Because of the ability of APS to recover decommissioning costs in rates and in accordance with the regulatory treatment for decommissioning trust funds, we have recorded the offsetting amount of gains (losses) on investment securities in other regulatory liabilities or assets. The following table summarizes the fair value of APS’ nuclear decommissioning trust fund assets at March 31, 2008 and December 31, 2007 (dollars in millions):

		Trust Fund				Total Unrealized
		Assets				Gains
March 31, 2008
Equity securities — fair value		$	159			$	51
Fixed income securities — fair value			218				7
Net payables(a)			(5	)			—
Total		$	372			$	58
(a)  Net payables relate to pending securities sales and purchases.
December 31, 2007
Equity securities — fair value		$	175			$	68
Fixed income securities — fair value			204				5
Total		$	379			$	73

     The costs of securities sold are determined on the basis of specific identification. The following table sets forth approximate gains and losses and proceeds from the sale of securities by the nuclear decommissioning trust funds (dollars in millions):

		Three Months Ended
		March 31,
		2008				2007
Realized gains		$	1			$	1
Realized losses			(1	)			(1	)
Proceeds from the sale of securities			67				63

     The fair value of fixed income securities, summarized by contractual maturities, at March 31, 2008 is as follows (dollars in millions):

Fair Value		March 31, 2008
Less than one year		$	24
1 year – 5 years			41
5 years – 10 years			36
Greater than 10 years			117
Total		$	218

     See Note 20 for a discussion of SFAS No. 157, “Fair Value Measurements,” which we adopted January 1, 2008.

PINNACLE WEST CAPITAL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

19. New Accounting Standards

     See Note 20 for a discussion of SFAS No. 157, “Fair Value Measurements,” which we adopted January 1, 2008.

     See Notes 10 and S-1 for a discussion of FASB Staff Position No. FIN 39-1, “Amendment of FASB Interpretation No. 39, Offsetting of Amounts Related to Certain Contracts” (FIN 39-1), which we adopted January 1, 2008.

     SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities” was effective for us on January 1, 2008. This guidance provides companies with an option to report selected financial assets and liabilities at fair value. We did not elect the fair value option for any of our financial assets or liabilities therefore, SFAS No. 159 did not have an impact on our financial statements.

     In March 2008, the FASB issued SFAS No. 161, “Disclosures about Derivative Instruments and Hedging Activities.” This guidance requires enhanced disclosures about derivative instruments and hedging activities. The Statement is effective for us on January 1, 2009. We are currently evaluating this new guidance but do not expect it to have a material impact on our financial statements.

20. Fair Value Measurements

     We adopted SFAS No. 157, “Fair Value Measurements,” on January 1, 2008. This new standard defines fair value, establishes a framework for measuring fair value, and expands disclosures about fair value measurements. We apply fair value measurements to derivative instruments and nuclear decommissioning trust assets. The adoption of SFAS No. 157 did not have a material impact on our financial statements.

     SFAS No. 157 requires companies to disclose the fair value of certain assets and liabilities according to a fair value hierarchy. This hierarchy ranks the quality and reliability of the inputs used to determine fair values, which are then classified and disclosed in one of three categories. The three levels of the fair value hierarchy are:

	•		Level 1 — quoted prices in active markets for identical assets or liabilities.
	•		Level 2 — quoted prices in active markets for similar assets or liabilities; quoted prices in markets that are not active; and model-derived valuations whose inputs are observable.
	•		Level 3 — model-derived valuations with unobservable inputs that are supported by little or no market activity.

     As required by SFAS No. 157, assets and liabilities are classified based on the lowest level of input that is significant to the fair value measurement. The Company’s assessment of the significance of a particular input to the fair value measurement requires judgment, and may affect the valuation of fair value assets and liabilities and their placement within the fair value hierarchy levels. The following table presents the fair value at March 31, 2008 of our assets and liabilities that are measured at fair value on a recurring basis for both Pinnacle West Consolidated and APS (dollars in millions):

PINNACLE WEST CAPITAL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

		Quoted Prices
		in Active				Significant
		Markets for				Other				Significant
		Identical				Observable				Unobservable								Balance at
		Assets				Inputs				Inputs				Counterparty				March 31,
		(Level 1)				(Level 2)				(Level 3)				Netting				2008
Pinnacle West:
Assets
Risk management and trading activities (a)		$	125			$	216			$	50			$	(87	)		$	304
Nuclear decommissioning trust (b)			38				339				—				—				377
Total		$	163			$	555			$	50			$	(87	)		$	681
Liabilities
Risk management and trading activities		$	(26	)		$	(52	)		$	(43	)		$	87			$	(34	)
APS:
Assets
Risk management and trading activities (a)		$	125			$	181			$	40			$	(82	)		$	264
Nuclear decommissioning trust (b)			38				339				—				—				377
Total		$	163			$	520			$	40			$	(82	)		$	641
Liabilities
Risk management and trading activities		$	(26	)		$	(44	)		$	(40	)		$	82			$	(28	)

     The following table shows the changes in fair value for assets and liabilities that are measured at fair value on a recurring basis using Level 3 inputs for the three months ended March 31, 2008 for both Pinnacle West Consolidated and APS (dollars in millions):

PINNACLE WEST CAPITAL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

		Pinnacle West’s				APS’
		Net Derivative				Net Derivative
		Asset (Liability)				Asset (Liability)
Balance at December 31, 2007		$	8			$	1
Total net gains (losses) realized/ unrealized:
Included in earnings			(2	)			(2	)
Included in OCI			2				2
Deferred as a regulatory asset or liability			(3	)			(3	)
Purchases, issuances, and settlements			—				—
Transfers in and/or out of Level 3			2				2
Balance at March 31, 2008		$	7			$	—
Net unrealized losses included in earnings related to instruments still held as of March 31, 2008		$	2			$	3

     We did not have any non-recurring fair value measurements during the quarter that required disclosure.

ARIZONA PUBLIC SERVICE COMPANY

(unaudited)

(dollars in thousands)

		Three Months Ended
		March 31,
		2008				2007
ELECTRIC OPERATING REVENUES		$	625,576			$	538,260
OPERATING EXPENSES
Fuel and purchased power			272,053				206,196
Operations and maintenance			188,135				165,934
Depreciation and amortization			93,885				87,876
Income taxes			5,157				3,143
Other taxes			32,718				34,522
Total			591,948				497,671
OPERATING INCOME			33,628				40,589
OTHER INCOME (DEDUCTIONS)
Income taxes			1,115				754
Allowance for equity funds used during construction			6,124				4,444
Other income (Note S-3)			2,064				4,433
Other expense (Note S-3)			(5,888	)			(4,904	)
Total			3,415				4,727
INTEREST DEDUCTIONS
Interest on long-term debt			42,173				40,075
Interest on short-term borrowings			3,849				1,981
Debt discount, premium and expense			1,160				1,156
Allowance for borrowed funds used during construction			(3,775	)			(2,213	)
Total			43,407				40,999
NET INCOME (LOSS)		$	(6,364	)		$	4,317

See Notes to Pinnacle West’s Condensed Consolidated Financial Statements and Supplemental Notes to Arizona Public Service Company’s Condensed Financial Statements.

ARIZONA PUBLIC SERVICE COMPANY
CONDENSED BALANCE SHEETS
(unaudited)
(dollars in thousands)

		March 31,				December 31,
		2008				2007
ASSETS
UTILITY PLANT
Electric plant in service and held for future use		$	11,706,623			$	11,582,862
Less accumulated depreciation and amortization			4,006,235				3,994,777
Net			7,700,388				7,588,085
Construction work in progress			590,880				622,693
Intangible assets, net of accumulated amortization			102,500				105,225
Nuclear fuel, net of accumulated amortization			94,311				69,271
Total utility plant			8,488,079				8,385,274
INVESTMENTS AND OTHER ASSETS
Nuclear decommissioning trust (Note 18)			371,500				379,347
Assets from long-term risk management and trading activities (Note S-1)			101,032				41,603
Other assets			68,600				69,570
Total investments and other assets			541,132				490,520
CURRENT ASSETS
Cash and cash equivalents			7,737				52,151
Customer and other receivables			345,669				402,244
Allowance for doubtful accounts			(3,677	)			(4,265	)
Materials and supplies (at average cost)			164,003				149,759
Fossil fuel (at average cost)			24,966				27,792
Assets from risk management and trading activities (Note S-1)			100,825				34,087
Deferred income taxes			—				38,707
Other current assets			18,841				16,545
Total current assets			658,364				717,020
DEFERRED DEBITS
Deferred fuel and purchased power regulatory asset			50,497				110,928
Other regulatory assets			502,803				514,353
Unamortized debt issue costs			23,864				24,373
Other deferred debits			85,370				78,934
Total deferred debits			662,534				728,588
TOTAL ASSETS		$	10,350,109			$	10,321,402

See Notes to Pinnacle West’s Condensed Consolidated Financial Statements and Supplemental Notes to Arizona Public Service Company’s Condensed Financial Statements.

ARIZONA PUBLIC SERVICE COMPANY
CONDENSED BALANCE SHEETS
(unaudited)
(dollars in thousands)

		March 31,				December 31,
		2008				2007
LIABILITIES AND EQUITY
CAPITALIZATION
Common stock		$	178,162			$	178,162
Additional paid-in capital			2,105,466				2,105,466
Retained earnings			1,027,693				1,076,557
Accumulated other comprehensive income (loss) (Note S-2):
Pension and other postretirement benefits			(21,300	)			(21,782	)
Derivative instruments			79,945				13,038
Common stock equity			3,369,966				3,351,441
Long-term debt less current maturities (Note 4)			2,876,862				2,876,881
Total capitalization			6,246,828				6,228,322
CURRENT LIABILITIES
Short-term debt			100,000				218,000
Commercial paper			90,944				—
Current maturities of long-term debt (Note 4)			995				978
Accounts payable			155,841				239,923
Accrued taxes			433,076				374,444
Accrued interest			40,563				38,262
Customer deposits			73,696				71,376
Liabilities from risk management and trading activities (Note S-1)			17,567				19,921
Deferred income taxes			25,244				—
Other current liabilities			83,636				92,802
Total current liabilities			1,021,562				1,055,706
DEFERRED CREDITS AND OTHER
Deferred income taxes			1,193,140				1,250,028
Regulatory liabilities			728,308				642,564
Liability for asset retirements			263,653				281,903
Pension and other postretirement liabilities (Note 6)			478,843				469,945
Customer advances for construction			110,720				94,801
Unamortized gain — sale of utility plant			35,462				36,606
Liabilities from long-term risk management and trading activities (Note S-1)			10,993				4,573
Other			260,600				256,954
Total deferred credits and other			3,081,719				3,037,374
COMMITMENTS AND CONTINGENCIES (SEE NOTES)
TOTAL LIABILITIES AND EQUITY		$	10,350,109			$	10,321,402