10-Q

FORM 10-Q

Securities and Exchange Commission

Washington, D.C. 20549

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

For the quarterly period ended September 30, 2004

OR

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

For the transition period from                                        to                                       

Commission file number 1-8962

PINNACLE WEST CAPITAL CORPORATION

(Exact name of registrant as specified in its charter)

Arizona	86-0512431
(State or other jurisdiction of incorporation or organization)	(I.R.S. Employer Identification No.)

400 North Fifth Street, P.O. Box 53999, Phoenix, Arizona	85072-3999
(Address of principal executive offices)	(Zip Code)

Registrant’s telephone number, including area code: (602) 250-1000

(Former name, former address and former fiscal year, if changed since last report)

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 [  ]

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

Yes [X] No [  ]

     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, no par value,
outstanding as of November 4, 2004: 91,572,219

TABLE OF CONTENTS

PART I. FINANCIAL INFORMATION
	ITEM 1. Financial Statements.
		CONDENSED CONSOLIDATED STATEMENTS OF INCOME
		CONDENSED CONSOLIDATED BALANCE SHEETS
		CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
		NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
	Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations.
	Item 3. Market Risks
	Item 4. Controls and Procedures
PART II – OTHER INFORMATION
	Item 1. Legal Proceedings
	Item 5. Other Information
	Item 6. Exhibits
SIGNATURES
Exhibit 10.1
Exhibit 10.2
Exhibit 12.1
Exhibit 31.1
Exhibit 31.2
Exhibit 32.1
Exhibit 99.1

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

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

CC&N – Certificate of Convenience and Necessity

Company – Pinnacle West Capital Corporation

CPUC – California Public Utility Commission

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

Financing Order – ACC order that authorized APS’ $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

NAC – collectively, NAC Holding Inc. and NAC International Inc., subsidiaries of El Dorado

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

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

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, the Company

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

PPL Sundance – PPL Sundance Energy, LLC

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

PX – California Power Exchange

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

SunCor – SunCor Development Company, a subsidiary of the Company

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

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

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

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

2004 Settlement Agreement – an agreement proposing terms under which APS’ general rate case would be settled

VIE – variable interest entity

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PART I. FINANCIAL INFORMATION

ITEM 1. Financial Statements.

PINNACLE WEST CAPITAL CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(unaudited)
(in thousands, except per share amounts)

	Three Months Ended
	September 30,
	2004			2003
Operating Revenues
Regulated electricity segment	$	670,559		$	667,400
Marketing and trading segment		128,563			82,558
Real estate segment		75,072			75,009
Other revenues		12,585			6,035
Total		886,779			831,002
Operating Expenses
Regulated electricity segment purchased power and fuel		202,156			208,757
Marketing and trading segment purchased power and fuel		107,377			84,195
Operations and maintenance		160,765			133,852
Real estate segment operations		67,079			63,196
Depreciation and amortization		97,349			110,242
Taxes other than income taxes		31,649			28,206
Other expenses		9,568			5,193
Total		675,943			633,641
Operating Income		210,836			197,361
Other
Allowance for equity funds used during construction		(1,327	)		11,194
Other income (Note 15)		2,836			5,533
Other expense (Note 15)		(4,568	)		(5,791	)
Total		(3,059	)		10,936
Interest Expense
Interest charges		49,497			52,527
Capitalized interest		(4,506	)		(2,851	)
Total		44,991			49,676
Income From Continuing Operations Before Income Taxes		162,786			158,621
Income Taxes		58,900			49,961
Income From Continuing Operations		103,886			108,660
Income From Discontinued Operations
- Net of Income Tax Expense of $1,174 and $899 (Note 18)		1,514			1,388
Net Income	$	105,400		$	110,048
Weighted-Average Common Shares Outstanding — Basic		91,357			91,271
Weighted-Average Common Shares Outstanding — Diluted		91,491			91,467
Earnings Per Weighted-Average Common Share Outstanding (Note 17)
Income From Continuing Operations — Basic	$	1.14		$	1.19
Net Income — Basic		1.15			1.21
Income From Continuing Operations — Diluted		1.14			1.19
Net Income — Diluted		1.15			1.20
Dividends Declared Per Share	$	0.45		$	0.425

See Notes to Condensed Consolidated Financial Statements.

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PINNACLE WEST CAPITAL CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(unaudited)
(in thousands, except per share amounts)

	Nine Months Ended
	September 30,
	2004			2003
Operating Revenues
Regulated electricity segment	$	1,605,952		$	1,545,829
Marketing and trading segment		332,186			300,439
Real estate segment		193,965			172,886
Other revenues		32,904			16,774
Total		2,165,007			2,035,928
Operating Expenses
Regulated electricity segment purchased power and fuel		442,409			394,373
Marketing and trading segment purchased power and fuel		269,261			263,201
Operations and maintenance		437,126			408,488
Real estate segment operations		177,374			157,297
Depreciation and amortization		302,919			321,197
Taxes other than income taxes		94,511			84,851
Other expenses		25,893			12,445
Total		1,749,493			1,641,852
Operating Income		415,514			394,076
Other
Allowance for equity funds used during construction		2,859			11,194
Other income (Notes 15 and 19)		50,653			13,886
Other expense (Note 15)		(14,444	)		(15,079	)
Total		39,068			10,001
Interest Expense
Interest charges		144,645			151,332
Capitalized interest		(13,537	)		(24,061	)
Total		131,108			127,271
Income From Continuing Operations Before Income Taxes		323,474			276,806
Income Taxes		117,574			96,054
Income From Continuing Operations		205,900			180,752
Income From Discontinued Operations
- Net of Income Tax Expense of $2,609 and $7,000 (Note 18)		3,566			10,736
Net Income	$	209,466		$	191,488
Weighted-Average Common Shares Outstanding — Basic		91,322			91,262
Weighted-Average Common Shares Outstanding — Diluted		91,430			91,432
Earnings Per Weighted-Average Common Share Outstanding (Note 17)
Income From Continuing Operations — Basic	$	2.25		$	1.98
Net Income — Basic		2.29			2.10
Income From Continuing Operations — Diluted		2.25			1.98
Net Income — Diluted		2.29			2.09
Dividends Declared Per Share	$	1.35		$	1.28

See Notes to Condensed Consolidated Financial Statements.

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

	September 30,			December 31,
	2004			2003
Current Assets
Cash and cash equivalents	$	373,064		$	222,912
Customer and other receivables		428,947			354,666
Allowance for doubtful accounts		(5,059	)		(9,223	)
Accrued utility revenues		120,532			88,629
Materials and supplies (at average cost)		98,943			96,099
Fossil fuel (at average cost)		22,892			28,367
Assets from risk management and trading activities (Note 10)		164,572			97,630
NAC assets held for sale (Note 18)		13,941			23,065
Other current assets		40,935			72,649
Total current assets		1,258,767			974,794
Investments and Other Assets
Real estate investments—net		381,494			343,322
Assets from risk management and trading activities - long-term (Note 10)		231,657			138,946
Decommissioning trust accounts		253,020			240,645
Other assets		103,728			88,473
Total investments and other assets		969,899			811,386
Property, Plant and Equipment
Plant in service and held for future use		10,397,795			9,904,874
Less accumulated depreciation and amortization		3,303,970			3,145,609
Total		7,093,825			6,759,265
Construction work in progress		193,339			554,876
Intangible assets, net of accumulated amortization		114,690			108,534
Nuclear fuel, net of accumulated amortization		57,936			52,011
Net property, plant and equipment		7,459,790			7,474,686
Deferred Debits
Regulatory assets		169,368			164,804
Other deferred debits		109,755			110,708
Total deferred debits		279,123			275,512
Total Assets	$	9,967,579		$	9,536,378

See Notes to Condensed Consolidated Financial Statements.

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

	September 30,			December 31,
	2004			2003
Current Liabilities
Accounts payable	$	315,319		$	283,021
Accrued taxes		171,409			69,769
Accrued interest		49,647			51,825
Short-term borrowings		94,204			86,081
Current maturities of long-term debt		566,991			704,914
Customer deposits		54,696			49,783
Deferred income taxes		631			631
Liabilities from risk management and trading activities (Note 10)		133,355			92,755
NAC liabilities held for sale (Note 18)		9,971			16,427
Other current liabilities		91,021			77,362
Total current liabilities		1,487,244			1,432,568
Long-Term Debt Less Current Maturities		2,632,062			2,616,585
Deferred Credits and Other
Deferred income taxes		1,402,246			1,329,253
Regulatory liabilities		528,838			510,423
Pension liability (Note 6)		197,039			188,041
Liability for asset retirement		246,774			234,440
Liabilities from risk management and trading activities - long-term (Note 10)		124,703			82,730
Unamortized gain — sale of utility plant		51,477			54,909
Other		320,443			257,650
Total deferred credits and other		2,871,520			2,657,446
Commitments and Contingencies (Notes 5, 12 and 13)
Common Stock Equity
Common stock, no par value		1,753,825			1,744,354
Treasury stock		(490	)		(3,273	)
Total common stock		1,753,335			1,741,081
Accumulated other comprehensive income (loss):
Minimum pension liability adjustment		(66,564	)		(66,564	)
Derivative instruments		76,102			27,563
Total accumulated other comprehensive income (loss)		9,538			(39,001	)
Retained earnings		1,213,880			1,127,699
Total common stock equity		2,976,753			2,829,779
Total Liabilities and Equity	$	9,967,579		$	9,536,378

See Notes to Condensed Consolidated Financial Statements.

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

	Nine Months Ended
	September 30,
	2004			2003
CASH FLOWS FROM OPERATING ACTIVITIES
Net Income	$	209,466		$	191,488
Adjustments to reconcile net income to net cash provided by operating activities:
Income from discontinued operations		(3,566	)		(10,736	)
Equity earnings in Phoenix Suns partnership		(34,594	)		—
Depreciation and amortization		302,919			321,197
Nuclear fuel amortization		23,393			22,781
Allowance for equity funds used during construction		(2,859	)		(11,194	)
Deferred income taxes		32,558			(43,864	)
Change in mark-to-market valuations		(25,563	)		9,522
Changes in current assets and liabilities:
Customer and other receivables		(78,445	)		(49,218	)
Accrued utility revenues		(31,903	)		(33,946	)
Materials, supplies and fossil fuel		2,631			(3,130	)
Other current assets		31,714			4,568
Accounts payable		37,127			(4,332	)
Accrued taxes		101,640			158,589
Accrued interest		(2,178	)		(2,345	)
Other current liabilities		27,623			4,174
Proceeds from the sale of real estate assets		37,259			51,612
Real estate investments		(54,722	)		(44,661	)
Increase in regulatory assets		(5,551	)		(10,681	)
Increase in regulatory liabilities		18,415			612
Change in risk management and trading — assets		7,257			35,747
Change in risk management and trading — liabilities		21,078			(11,489	)
Change in pension liability		8,998			2,616
Change in other long-term assets		(25,451	)		4,103
Change in other long-term liabilities		33,201			35,205
Net cash flow provided by operating activities		630,447			616,618
CASH FLOWS FROM INVESTING ACTIVITIES
Capital expenditures		(356,707	)		(495,825	)
Proceeds from the sale of Silverhawk		90,967			—
Capitalized interest		(13,537	)		(24,061	)
Proceeds from sale of assets from discontinued operations		8,566			24,098
Discontinued operations — NAC		4,129			(14,356	)
Proceeds from sale of the Phoenix Suns partnership		23,101			—
Other		(8,775	)		(3,018	)
Net cash flow used for investing activities		(252,256	)		(513,162	)
CASH FLOWS FROM FINANCING ACTIVITIES
Issuance of long-term debt		476,293			542,154
Short-term borrowings and payments—net		8,123			(9,019	)
Dividends paid on common stock		(123,285	)		(116,346	)
Repayment of long-term debt		(603,286	)		(404,284	)
Other		14,116			6,374
Net cash flow (used for) provided by financing activities		(228,039	)		18,879
Net Increase in Cash and Cash Equivalents		150,152			122,335
Cash and Cash Equivalents at Beginning of Period		222,912			75,089
Cash and Cash Equivalents at End of Period	$	373,064		$	197,424
Supplemental disclosure of cash flow information:
Cash paid during the period for:
Interest paid, net of amounts capitalized	$	146,903		$	120,098
Income taxes paid	$	16,557		$	9,674

See Notes to Condensed Consolidated Financial Statements.

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PINNACLE WEST CAPITAL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

1. The condensed consolidated financial statements include the accounts of Pinnacle West and our subsidiaries: APS, Pinnacle West Energy, APS Energy Services, SunCor and El Dorado (principally NAC). All significant intercompany accounts and transactions between the consolidated companies have been eliminated. Our accounting records are maintained in accordance with GAAP. The preparation of financial statements in accordance with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities at the date of the financial statements and reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. We have reclassified certain prior year amounts to conform to the current year presentation.

2. Our unaudited condensed consolidated 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 consolidated financial statements and notes to condensed consolidated financial statements be read along with the consolidated financial statements and notes to consolidated financial statements included in our 2003 Form 10-K.

3. 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.

4. Changes in Liquidity

     On February 2, 2004, we used proceeds from the $165 million Floating Rate Notes issued on November 12, 2003 and short-term borrowings to pay down the maturing $215 million 4.5% Senior Notes due 2004.

     On February 15, 2004, $125 million of APS’ 5.875% Notes due 2004 were redeemed at maturity and on March 1, 2004, $80 million of APS First Mortgage Bonds, 6.625% Series due 2004, were redeemed at maturity. APS 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 APS pursuant to a loan agreement between APS and Navajo County, Arizona Pollution Control Corporation. These bonds are classified as long-term debt on our Condensed Consolidated Balance Sheets.

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     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 APS pursuant to a loan agreement between APS and Coconino County, Arizona Pollution Control Corporation. The 2004 Series A bonds are classified as long-term debt on our Condensed Consolidated Balance Sheets.

     In May 2004, APS renewed its $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 APS’ $250 million commercial paper program, as well as an additional $75 million for other liquidity needs and miscellaneous letters of credit.

     On June 29, 2004, APS 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 APS’ 6.25% Notes due January 15, 2005 and/or all or a portion of $300 million in aggregate principal amount of APS’ 7.625% Notes due August 1, 2005.

     At September 30, 2004, APS 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 APS to purchase their bonds on the applicable reset date if the bonds are not remarketed. Of these bonds, $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 APS has the intent and ability, as demonstrated by credit agreements in place that extend for more than one year, to refinance any bonds that APS is required to purchase.

     In October 2004, we replaced two separate revolving credit facilities (with collective borrowing capacity of $275 million) with a $300 million revolving credit facility that terminates in October 2007. The revolver provides liquidity support for Pinnacle West’s $250 million commercial paper program, as well as up to $100 million of the facility that can be used for letters of credit.

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

• $1 million in 2004;

• $782 million in 2005;

• $396 million in 2006;

• $175 million in 2007;

• $6 million in 2008; and

• $1.847 billion thereafter.

     In May 2004, SNWA paid Pinnacle West Energy approximately $91 million for a 25% interest in the 570 MW Silverhawk combined cycle plant.

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5. Regulatory Matters

Electric Industry Restructuring

State

     APS General Rate Case; 2004 Settlement Agreement

     On June 27, 2003, APS filed a general rate case with the ACC and requested a $175.1 million, or 9.8%, increase in its annual retail electricity revenues, intended to become effective July 1, 2004. In this rate case, APS updated its cost of service and rate design.

     The general rate case also addresses the implementation of rate adjustment mechanisms that were the subject of ACC hearings in April 2003. The rate adjustment mechanisms, which were authorized as a result of the 1999 Settlement Agreement, would allow APS to recover several types of costs, the most significant of which are power supply costs (fuel and purchased power costs) and costs associated with complying with the Rules.

     On August 18, 2004, a substantial majority of the parties to the rate case, including APS, the ACC staff, the Residential Utility Consumer Office, other customer groups, and merchant power plant intervenors entered into an agreement that proposes terms under which the rate case would be settled (the “2004 Settlement Agreement”). Key financial components of the 2004 Settlement Agreement, which is subject to ACC approval, are as follows:

• APS would receive an annual retail rate increase of approximately $75.5 million, or 4.21%. The increase would consist of an increase in base rates of approximately 3.77% and an increase of approximately 0.44% for recovery over five years of the past costs of compliance with the ACC’s retail electric competition rules.

• APS would acquire the PWEC Dedicated Assets from Pinnacle West Energy and rate base the PWEC Dedicated Assets at a rate base value of $700 million, which would result in a mandatory rate base disallowance of $148 million. As a result, for financial reporting purposes, APS would recognize a one-time, after-tax net plant write-off of approximately $88 million in the period when the plant transfer to APS is completed, and would reduce annual depreciation expense by approximately $5 million.

• To bridge the time between the effective date of the rate increase and the actual date the PWEC Dedicated Assets transfer, APS and Pinnacle West Energy would enter into a cost-based purchase power agreement (the “Bridge PPA”), which would be based on the value of the PWEC Dedicated Assets described in the previous bullet point. The Bridge PPA would remain in effect until the FERC approves the

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transfer of the PWEC Dedicated Assets to APS and the transfer is completed.

• If the FERC were to issue an order denying APS’ request to acquire the PWEC Dedicated Assets, the Bridge PPA would become a 30-year purchased power agreement, with prices reflecting cost-of-service as if APS had acquired and rate-based the PWEC Dedicated Assets at the value described above.

• If the FERC were to issue an order (a) approving APS’ request to transfer the PWEC Dedicated Assets at a value materially less than $700 million, (b) approving the transfer of fewer than all of the PWEC Dedicated Assets, or (c) that was materially inconsistent with the 2004 Settlement Agreement, APS would file an appropriate application with the ACC so that rates could be adjusted. In these circumstances, the Bridge PPA would continue at least until the conclusion of the subsequent proceeding to consider any appropriate adjustment to APS’ rates.

• A power supply adjuster would provide for the recovery of fuel and purchased power costs, subject to specified parameters and procedures.

• APS would not restore and recover in rates the $234 million write-off recorded in 1999 as a result of a 1999 settlement agreement approved by the ACC related to the implementation of retail electric competition in Arizona. As a result, annual amortization expense for financial reporting purposes would be approximately $16 million less than if the $234 million write-off had been restored and amortized over a 15-year period as originally requested.

• APS would adopt longer service lives than originally requested for certain depreciable assets, which would have the effect of reducing annual depreciation expense for financial reporting purposes by approximately $26 million.

     Major changes in revenue requirements under the 2004 Settlement Agreement are as follows (dollars in millions):

Original APS request	$	175
Return on equity to 10.25% versus 11.50%		(36	)
No recovery of $234 million write-off		(32	)
Lengthen asset depreciable lives		(26	)
$148 million rate base disallowance		(22	)
Miscellaneous – net (not specifically identified in 2004 Settlement Agreement)		17
Proposed settlement	$	76

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     Hearings on the 2004 Settlement Agreement are scheduled to begin on November 8, 2004.

     ACC Financing Order

     On May 12, 2003, APS issued $500 million of debt pursuant to the Financing Order and made a $500 million loan to Pinnacle West Energy. Pinnacle West Energy distributed the net proceeds of that loan to us to fund the repayment of a portion of the debt we incurred to finance the construction of the PWEC Dedicated Assets.

     The ACC granted the Financing Order subject to various conditions. One of these conditions is that APS must maintain a common equity ratio of at least forty percent and may not pay common dividends if such payment would reduce its common equity ratio below that threshold, unless otherwise waived by the ACC.

     In addition, the Financing Order required the ACC staff to conduct an inquiry into our and our affiliates’ compliance with the retail electric competition and related rules and decisions. On June 13, 2003, APS submitted its report on these matters to the ACC staff. As part of the 2004 Settlement Agreement, this inquiry would be concluded with no further action by the ACC.

     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 APS.

• Effective January 1, 2001, retail access became available to all APS 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.

• 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, APS received a waiver to allow transfer of its competitive electric assets and services to affiliates no later than December 31,

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2002. However, as discussed below, in 2002 the ACC reversed its decision, as reflected in the Rules, to require APS to transfer its 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, APS 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 affected 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 APS’ 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. A request for the Arizona Supreme Court to review the Court of Appeals decision is still pending.

     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 APS to transfer its generation assets either to an unrelated third party or to a separate corporate affiliate; and

• unilaterally modified the 1999 Settlement Agreement, which authorized APS’ transfer of its generating assets, and directed APS to cancel its activities to transfer its generation assets to Pinnacle West Energy.

     On November 15, 2002, APS 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, APS and the ACC staff agreed to principles for resolving certain issues raised by APS in its appeals of the Track A

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Order. The major provisions of the principles include, among other things, the following:

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

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

• the appropriate treatment of the $234 million pretax asset write-off agreed to by APS as part of the 1999 Settlement Agreement; and

• the appropriate treatment of costs incurred by APS in preparation for the previously anticipated transfer of generation assets to Pinnacle West Energy.

• As a result of the ACC’s issuance of the Financing Order, APS’ appeals of the Track A Order are limited to the issues described in the preceding bullet points.

     On August 27, 2003, APS, Pinnacle West and Pinnacle West Energy filed a lawsuit asserting damage claims relating to the Track A Order. Arizona Public Service Company et al. v. The State of Arizona ex rel., Superior Court of the State of Arizona, County of Maricopa, No. CV2003-016372.

     Upon the ACC’s issuance of a final, non-appealable order approving the 2004 Settlement Agreement, APS, Pinnacle West, and Pinnacle West Energy will dismiss the litigation described under this “Track A” heading.

     Track B Order

     On March 14, 2003, the ACC issued the Track B Order, which required APS to solicit bids for certain estimated amounts of capacity and energy for periods beginning July 1, 2003. For 2003, APS was required to solicit competitive bids for about 2,500 MW of capacity and about 4,600 gigawatt-hours of energy, or approximately 20% of APS’ total retail energy requirements.

     APS issued requests for proposals in March 2003 and, by May 6, 2003, APS entered into contracts to meet all or a portion of its requirements for the years 2003 through 2006 as follows:

(1) Pinnacle West Energy agreed to provide 1,700 MW in July through September of 2003 and in June through September of 2004, 2005 and 2006, by means of a unit contingent contract.

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(2)	PPL EnergyPlus, LLC agreed to provide 112 MW in July through September of 2003 and 150 MW in June through September of 2004 and 2005, by means of a unit contingent contract.
(3)	Panda Gila River LP agreed to provide 450 MW in October of 2003 and 2004 and May of 2004 and 2005, and 225 MW from November 2003 through April 2004 and from November 2004 through April 2005, by means of firm call options.

     Effective upon final ACC approval of the 2004 Settlement Agreement and the closing of the purchase of PPL Sundance, the Track B contracts with Pinnacle West Energy and PPL Energy Plus, LLC will be cancelled.

     Provider of Last Resort Obligation

     Although the Rules allow retail customers to have access to competitive providers of energy and energy services, APS is, under the Rules, the “provider of last resort” for standard-offer, full-service customers under rates that have been approved by the ACC. In the event of shortfalls due to unforeseen increases in load demand or generation or transmission outages, APS may need to purchase additional supplemental power in the wholesale spot market. At various times, prices in the spot wholesale market have significantly exceeded the amount included in APS’ current retail rates. There can be no assurance that APS would be able to fully recover the costs of this power. The proposed settlement of APS’ general rate case, discussed above, would, among other things, allow APS to recover purchased power costs.

     1999 Settlement Agreement

     The following are the major provisions of a settlement agreement entered into in 1999, as approved by the ACC:

• APS has 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 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 APS for competitive direct access service (for example, distribution services) became effective upon approval of the 1999 Settlement Agreement, retroactive to July 1,

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	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.
•	APS is 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 “APS General Rate Case; 2004 Settlement Agreement” above.
•	APS’ 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” above), including an additional 140 MW being made available to eligible non-residential customers. APS opened its distribution system to retail access for all customers on January 1, 2001.
•	Prior to the 1999 Settlement Agreement, APS was recovering substantially all of its regulatory assets through July 1, 2004, pursuant to a 1996 regulatory agreement. In addition, the 1999 Settlement Agreement stated that APS has demonstrated that its 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 stated that APS 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 provided that APS 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 part of its general rate case request, APS sought the recovery of amounts written off by APS as a result of the 1999 Settlement Agreement. That claim would be given up under the terms of the 2004 Settlement Agreement (see above).
•	The 1999 Settlement Agreement required APS to form, or cause to be formed, a separate corporate affiliate or affiliates and transfer to such affiliate(s) its competitive electric assets and services no later than December 31, 2002. The 1999 Settlement Agreement provided that APS would be allowed to defer and later collect, beginning July 1,

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2004, 67% of its costs to accomplish the required transfer of generation assets to an affiliate. However, as discussed above under “Track A Order,” in 2002 the ACC unilaterally modified this aspect of the 1999 Settlement Agreement by issuing an order preventing APS from transferring its generation assets. Under the 2004 Settlement Agreement, APS would recover all costs incurred by APS in preparation for the previously anticipated transfer of generation assets to Pinnacle West Energy. See “APS General Rate Case; 2004 Settlement Agreement” above. Such full recovery of divestiture costs is allowed under the 2004 Settlement Agreement (see above).

     General

     The regulatory developments and legal challenges to the Rules discussed in this Note have raised considerable uncertainty about the status and pace of retail electric competition and of electric restructuring in Arizona. Although some very limited retail competition existed in APS’ service area in 1999 and 2000, there are currently no active retail competitors providing unbundled energy or other utility services to APS’ customers. As a result, we cannot predict when, and the extent to which, additional competitors will re-enter APS’ service territory. As competition in the electric industry continues to evolve, we will continue to evaluate strategies and alternatives that will position us to compete in the new regulatory environment.

     Request for Proposals and Asset Purchase Agreement

     In early December 2003, APS issued a request for proposals (“RFP”) for long-term power supply resources. On June 1, 2004, APS and PPL Sundance, a wholly-owned subsidiary of PPL Corporation, entered into an asset purchase agreement by which APS agreed to purchase the 450 MW Sundance Generating Station. The Sundance Generating Station, which began commercial operation in July 2002, would provide peaking generation support for APS’ system and reduce APS’ growing needs for new generation resources.

     The purchase price for the Sundance Generating Station is $189.5 million. Subject to the receipt of approvals from various regulatory agencies, including the ACC, the FERC, the Department of Justice and the Federal Trade Commission, the transaction is expected to close in the first quarter of 2005. Either party may terminate the agreement if ACC approval is not obtained by December 31, 2004 or the transaction does not close by March 31, 2005.

     On June 1, 2004, APS and PPL Sundance filed a joint application with the ACC requesting approval of the transaction on or before December 31, 2004. APS also requested, among other things, that the Sundance Generating Station be included in APS’ rates in APS’ next rate case and that certain operating and capital costs be deferred until that time. APS is not requesting that the Sundance Generating Station be reflected in its current general rate case before the ACC. A hearing on the application was held in early October, and we expect a decision by the end of the year.

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     APS does not expect to enter into any additional transactions as a result of the RFP.

Federal

     In July 2002, the FERC adopted a price mitigation plan that constrains the price of electricity in the wholesale spot electricity market in the western United States. The FERC adopted a price cap of $250 per MWh for the period subsequent to October 31, 2002. Sales at prices above the cap must be justified and are subject to potential refund.

     On July 31, 2002, the FERC issued a Notice of Proposed Rulemaking for Standard Market Design for wholesale electric markets. Voluminous comments and reply comments were filed on virtually every aspect of the proposed rule. On April 28, 2003, the FERC staff issued an additional white paper on the proposed Standard Market Design. The white paper discusses several policy changes to the proposed Standard Market Design, including a greater emphasis on flexibility for regional needs. We cannot currently predict what, if any, impact there may be to the Company if the FERC adopts the proposed rule or any modifications proposed in the comments.

     The FERC has been in the process of auditing numerous utilities regarding compliance with its regulations. Such an audit of APS and its affiliates is currently in process. Certain instances of noncompliance with FERC regulations related to the administration of APS’ transmission tariff have been identified. APS is presently discussing these issues with the FERC staff and expects a public report to be issued later this year. APS currently expects, but cannot provide any assurance, that the resolution of these matters will not have a material adverse effect on its financial position, results of operations or liquidity.

6. Retirement Plans and Other Benefits

     Pinnacle West sponsors a qualified defined benefit pension plan, a nonqualified supplemental excess benefit retirement plan, and other postretirement benefits for the employees of Pinnacle West and our subsidiaries.

     On December 8, 2003, the President signed the “Medicare Prescription Drug, Improvement and Modernization Act of 2003” (the Act). One feature of the Act is a government subsidy of prescription drug cost. The FASB issued FSP 106-2, “Accounting and Disclosure Requirements Related to the Medicare Prescription Drug, Improvement and Modernization Act of 2003,” to address the accounting for the effects of the Act. During the third quarter of 2004, We retroactively adopted the provisions of FSP 106-2, resulting in the remeasurement of our postretirement benefit plans’ accumulated postretirement benefit obligation (APBO) as of December 31, 2003. The impact of the subsidy is a decrease in the accumulated projected benefit obligation of approximately $65 million and a decrease of approximately $11 million in the net periodic postretirement benefit cost for 2004. The annual after-tax reduction to expense is approximately $5 million,

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excluding amounts capitalized as construction overhead or billed to electric plant participants.

     The following table provides details of the plans’ benefit costs for the three and nine months ended September 30, 2004 and 2003. Also included is the portion of these costs charged to expense, including administrative costs and excluding amounts billed to electric plant participants or amounts capitalized as overhead construction (dollars in millions):

	Pension Benefits												Other Benefits
	Three Months						Nine Months						Three Months						Nine Months
	Ended						Ended						Ended						Ended
	September 30,						September 30,						September 30,						September 30,
	2004			2003			2004			2003			2004			2003			2004(a)			2003
Service cost-benefits earned during the period	$	10		$	10		$	31		$	28		$	4		$	4		$	13		$	12
Interest cost on benefit obligation		21			20			62			57			7			8			22			23
Expected return on plan assets		(20	)		(17	)		(60	)		(48	)		(6	)		(5	)		(18	)		(14	)
Amortization of:
Transition (asset)/obligation		(1	)		(1	)		(2	)		(2	)		1			1			2			2
Prior service cost		1			1			2			2			—			—			—			—
Net actuarial loss		4			4			13			13			2			2			5			7
Net periodic benefit cost	$	15		$	17		$	46		$	50		$	8		$	10		$	24		$	30
Portion of cost charged to expense	$	7		$	8		$	21		$	22		$	4		$	5		$	11		$	13

(a) The nine months ended September 30, 2004 amounts include the reduction in benefit costs for the first and second quarter Medicare Part D subsidy not previously reflected in those periods.

Contributions

     The Pension Stability Act was signed into law on April 10, 2004. Under this new legislation, our required pension contribution in 2004 is $35 million, which we contributed in the third quarter. We have contributed approximately $14 million to our other postretirement benefits plan in 2004 through September.

7. Business Segments

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

• our regulated electricity segment, which consists of traditional regulated retail and wholesale electricity businesses and related activities, and includes electricity generation, transmission and distribution;

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• our marketing and trading segment, which consists of our competitive energy business activities, including wholesale marketing and trading and APS Energy Services’ commodity-related energy services; and

• our real estate segment, which consists of SunCor’s real estate development and investment activities.

     The amounts in our other segment include activities principally related to APS Energy Services’ non-commodity services and to the parent company. Financial data for our business segments follows (dollars in millions):

	Three Months					Nine Months
	Ended					Ended
	September 30,					September 30,
	2004		2003			2004		2003
Operating Revenues:
Regulated electricity	$	671	$	667		$	1,606	$	1,546
Marketing and trading		129		83			332		300
Real estate		75		75			194		173
Other		12		6			33		17
Total	$	887	$	831		$	2,165	$	2,036
Net Income (loss):
Regulated electricity	$	90	$	108		$	146	$	158
Marketing and trading		8		(7	)		25		8
Real estate (a)		5		7			12		17
Other (b) (c)		2		2			26		8
Total	$	105	$	110		$	209	$	191

(a)	Real estate net income includes income from discontinued operations (net of income taxes) in the following amounts: for the three months ended September 30 — $1 million in 2004 and $0.5 million in 2003; and for the nine months ended September 30 — $2 million in 2004 and $6 million in 2003. See Note 18 for further discussion of our real estate activities.
(b)	The nine months ended September 30, 2004 includes a $35 million gain ($21 million after tax) related to the sale of El Dorado’s limited partnership interest in the Phoenix Suns (see Note 19).
(c)	Other net income includes income from discontinued operations (net of income taxes) in the following amounts: for the three months ended September 30 — $0.1 million in 2004 and $1 million in 2003; and for the nine months ended September 30 — $1 million in 2004 and $4 million in 2003. See Note 18 for further discussion of NAC’s discontinued operations.

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	As of		As of
	September 30, 2004		December 31, 2003
Assets:
Regulated electricity	$	8,766	$	8,405
Marketing and trading		729		680
Real estate		438		424
Other		35		27
Total	$	9,968	$	9,536

8. Accounting Matters

     See the following Notes for information about new accounting standards and other accounting matters:

• Note 6 for FSP 106-2 regarding the Medicare Prescription Drug, Improvement and Modernization Act related to retirement plans and other benefits; and

• Note 9 for FIN No. 46R related to variable interest entities.

9. Variable Interest Entities

     In 2003, we adopted FIN No. 46R, “Consolidation of Variable Interest Entities,” as it applies to special-purpose entities. FIN No. 46R requires that we consolidate a VIE if we have a majority of the risk of loss from the VIE’s activities or we are entitled to receive a majority of the VIE’s residual returns or both. A VIE is a corporation, partnership, trust or any other legal structure that either does not have equity investors with voting rights or has equity investors that do not provide sufficient financial resources for the entity to support its activities.

     In 1986, APS entered into agreements with three separate SPE 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. Based on our assessment of FIN No. 46R, we are not required to consolidate the Palo Verde VIEs.

     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 September 30, 2004, APS would have been required to assume approximately $250 million of debt and pay the equity participants approximately $195 million.

     In the first quarter of 2004, we adopted FIN No. 46R for all other contractual arrangements. SunCor has certain land development arrangements that are

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required to be consolidated under FIN No. 46R. The assets and noncontrolling interests reflected in our Condensed Consolidated Balance Sheets related to these arrangements were approximately $17 million at September 30, 2004.

10. Derivative Instruments and Energy Trading Activities

     We are exposed to the impact of market fluctuations in interest rates and in the commodity price and transportation costs of electricity, natural gas, coal and emissions allowances. We manage risks associated with these market fluctuations by utilizing various instruments that qualify as derivatives, including exchange-traded futures and options and over-the-counter forwards, options and swaps. As part of our overall risk management program, we use such instruments to hedge our exposure to changes in interest rates and to hedge purchases and sales of electricity, fuels, and emissions allowances and credits. As of September 30, 2004 we hedge exposures to the price variability of these commodities for a maximum of eight years. The changes in market value of such contracts have a high correlation to price changes in the hedged transactions. In addition, subject to specified risk parameters monitored by the ERMC, we engage in marketing and trading activities intended to profit from market price movements.

Cash Flow Hedges

     The changes in the fair value of our hedged positions included in the Condensed Consolidated Statements of Income for the three and nine months ended September 30, 2004 and 2003 were comprised of the following (dollars in thousands):

	Three Months				Nine Months
	Ended September 30,				Ended September 30,
	2004		2003		2004		2003
Gains on the ineffective portion of derivatives qualifying for hedge accounting	$	138	$	1,069	$	1,610	$	8,176
Gains from the change in options’ time value excluded from measurement of effectiveness		—		—		63		—
Gains from the discontinuance of cash flow hedges		—		—		1,137		—

     During the twelve months ending September 30, 2005, we estimate that a net gain of $56 million before income taxes will be reclassified from accumulated other comprehensive income as an offset to the effect on earnings of market price changes for the related hedged transactions.

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     Our assets and liabilities from risk management and trading activities are presented in two categories, consistent with our business segments:

• Regulated Electricity – non-trading derivative instruments that hedge our purchases and sales of electricity and fuel for APS’ Native Load requirements of our regulated electricity business segment; and

• Marketing and Trading – both non-trading and trading derivative instruments of our competitive business segment.

     The following table summarizes our assets and liabilities from risk management and trading activities at September 30, 2004 and December 31, 2003 (dollars in thousands):

	Current				Current			Other			Net Asset/
	Assets		Investments		Liabilities			Liabilities			(Liability)
September 30, 2004
Regulated Electricity:
Mark-to-market	$	65,886	$	28,268	$	(21,913	)	$	(4,041	)	$	68,200
Options at cost and margin account		7,185		3,138		(19,456	)		—			(9,133	)
Marketing and Trading:
Mark-to-market		91,467		199,319		(75,041	)		(109,355	)		106,390
Emission allowances – at cost		34		932		(16,945	)		(11,307	)		(27,286	)
Total	$	164,572	$	231,657	$	(133,355	)	$	(124,703	)	$	138,171

	Current				Current			Other			Net Asset/
	Assets		Investments		Liabilities			Liabilities			(Liability)
December 31, 2003
Regulated Electricity:
Mark-to-market	$	44,079	$	5,900	$	(47,268	)	$	(3,028	)	$	(317	)
Options		—		12,101		—			—			12,101
Marketing and Trading:
Mark-to-market		53,551		116,363		(37,023	)		(63,398	)		69,493
Emission allowances – at cost		—		4,582		(8,464	)		(16,304	)		(20,186	)
Total	$	97,630	$	138,946	$	(92,755	)	$	(82,730	)	$	61,091

     Cash or other assets may be required to serve as collateral against our open positions on certain energy-related contracts. Collateral provided to counterparties

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was $2 million at September 30, 2004 and $1 million at December 31, 2003, and is included in investments and other assets on the Condensed Consolidated Balance Sheets. Collateral provided to us by counterparties was $23 million at September 30, 2004 and $12 million at December 31, 2003, and is included in other current liabilities on the Condensed Consolidated Balance Sheets.

     Credit Risk

     We are exposed to losses in the event of nonperformance or nonpayment by counterparties. We have risk management and trading contracts with many counterparties, including two counterparties for which a worst case exposure represented approximately 30% of our $396 million of risk management and trading assets as of September 30, 2004. Our risk management process assesses and monitors the financial exposure of these and all other counterparties. Despite the fact that the great majority of trading counterparties are rated as investment grade by the credit rating agencies, including the counterparties noted 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 major energy companies, municipalities, local distribution companies and financial institutions. 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. In many contracts, we employ collateral requirements and standardized agreements that allow for the netting of positive and negative exposures associated with a single counterparty. Valuation adjustments are established representing our estimated credit losses on our overall exposure to counterparties.

Fair Value Hedges

     On January 29, 2004, we entered into two fixed-for-floating interest rate swap transactions on our $300 million 6.4% senior note. The purpose of these hedges is to protect against significant fluctuations in the fair value of our debt. Our interest rate swaps are considered to be fully effective with any resulting gains or losses on the derivative offset by a similar loss or gain amount on the underlying fair value of debt. The fair value of the interest rate swaps was $1.4 million at September 30, 2004 and is included in other assets with the corresponding offset in long-term debt less current maturities on the Condensed Consolidated Balance Sheets.

11. Comprehensive Income

     Components of comprehensive income for the three and nine months ended September 30, 2004 and 2003, are as follows (dollars in thousands):

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	Three Months						Nine Months
	Ended September 30,						Ended September 30,
	2004			2003			2004			2003
Net income	$	105,400		$	110,048		$	209,466		$	191,488
Other comprehensive income:
Unrealized gain (loss) on derivative instruments, net of tax (a)		16,788			(3,704	)		61,295			43,927
Reclassification of realized gain to income, net of tax (b)		(8,821	)		(4,378	)		(12,756	)		(8,219	)
Total other comprehensive income (loss)		7,967			(8,082	)		48,539			35,708
Comprehensive income	$	113,367		$	101,966		$	258,005		$	227,196

(a)	These amounts primarily include unrealized gains and losses on contracts used to hedge our forecasted electricity and gas requirements to serve Native Load.
(b)	These amounts primarily include the reclassification of unrealized gains and losses to realized for contracted commodities delivered during the period.

12. Commitments and Contingencies

Palo Verde Nuclear Generating Station

     Spent Fuel and Waste Disposal

     Nuclear power plant owners 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 Act required the DOE to develop a permanent repository for the storage and disposal of spent nuclear fuel by 1998, the DOE has announced that the repository cannot be completed before 2010 and it does not intend to begin accepting spent nuclear fuel prior to that date. In November 1997, the United States Court of Appeals for the District of Columbia Circuit (D.C. Circuit) issued a decision preventing the DOE from excusing its own delay, but refused to order the DOE to begin accepting spent nuclear fuel. Based on this decision and the DOE’s delay, a number of utilities, including APS (on behalf of itself and the other Palo Verde owners), filed damages actions against the DOE in the Court of Federal Claims. Arizona Public Service Company v. United States of America, United States Court of Federal Claims, 03-2832C.

     Based upon current estimates of the amount of spent fuel and the cost of storage, APS currently estimates it will incur $115 million over the life of Palo Verde for its share of the costs related to the on-site interim storage of spent nuclear fuel. As of September 30, 2004, APS had spent $10 million and recorded a liability of $41

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million for on-site interim spent nuclear fuel storage costs related to nuclear fuel burned to date. APS has recorded a corresponding regulatory asset of $51 million and is seeking recovery of these costs through future rates (see “APS General Rate Case; 2004 Settlement Agreement” in Note 5).

California Energy Market Issues and Refunds in the Pacific Northwest

     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. APS does not anticipate material changes in its exposure and still believes, subject to the finalization of the revised proxy prices, that it will be entitled to a net refund.

     The FERC also ordered an evidentiary proceeding to discuss and evaluate possible refunds for the Pacific Northwest. The FERC affirmed the ALJ’s conclusion that the prices in the Pacific Northwest were not unreasonable or unjust and refunds should not be ordered in this proceeding. This decision has now been appealed to the Court of Appeals (Ninth Circuit). Although the FERC ruling in the Pacific Northwest matter is being appealed and the FERC has not yet calculated the specific refund amounts due in California, we do not expect that the resolution of these issues, as to the amounts alleged in the proceedings, will have a material adverse impact on our financial position, results of operations or liquidity.

     On March 26, 2003, 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 ISO 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.

     PG&E filed for bankruptcy protection in 2001. In the fourth quarter of 2003, the CPUC and the Bankruptcy Court accepted PG&E’s plan of reorganization. The plan indicated that PG&E would, at the close of bankruptcy proceedings, be able to pay in full all outstanding, undisputed debts. PG&E emerged from bankruptcy protection on April 12, 2004 and settled all outstanding, undisputed debts with us.

     California Energy Market Litigation On March 19, 2002, the State of California filed a complaint with the FERC alleging that wholesale sellers of power and energy, including the Company, failed to properly file rate information at the FERC in connection with sales to California from 2000 to the present under market-based rates. State of California v. British Columbia Power Exchange et al., Docket No. EL02-71-000. The complaint requests the FERC to require the wholesale

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sellers to refund any rates that are “found to exceed just and reasonable levels.” This complaint was dismissed by the FERC and the State of California appealed the matter to the Ninth Circuit Court of Appeals. In an order issued September 9, 2004, the Ninth Circuit upheld the FERC’s authority to permit market-based rates, but rejected the FERC’s claim that it was without authority to consider retroactive refunds when a utility has not strictly adhered to the quarterly reporting requirements of the market-based rate system. On September 9, 2004, the Ninth Circuit remanded the case to the FERC for further proceedings. State of California ex rel. Bill Lockyer, Attorney General v. FERC, No. 02-73093. Several of the intervenors in this appeal filed a petition for rehearing of this decision on October 25, 2004. The outcome of the further proceedings cannot be predicted at this time.

     In addition, the State of California and others have filed various claims, which have now been consolidated, against several power suppliers to California alleging antitrust violations. Wholesale Electricity Antitrust Cases I and II, Superior Court in and for the County of San Diego, Proceedings Nos. 4204-00005 and 4204-00006. Two of the suppliers who were named as defendants in those matters, Reliant Energy Services, Inc. (and other Reliant entities) and Duke Energy and Trading, LLP (and other Duke entities), filed cross-claims against various other participants in the PX and California independent system operator markets, including APS, attempting to expand those matters to such other participants. APS has not yet filed a responsive pleading in the matter, but APS believes the claims by Reliant and Duke as they relate to APS are without merit.

     APS was also named in a lawsuit regarding wholesale contracts in California, which, after moving to state court, has been removed to the federal court for a second time. James Millar, et al. v. Allegheny Energy Supply, et al., San Francisco Superior Court, Case No. 407867, U.S. District Court (Northern District) C-04-0519 SBA. The First Amended Complaint alleges basically that the contracts entered into were the result of an unfair and unreasonable market, in violation of California unfair competition laws. The PX has filed a lawsuit against the State of California regarding the seizure of forward contracts and the State has filed a cross complaint against APS and numerous other PX participants. Cal PX v. The State of California, Superior Court in and for the County of Sacramento, JCCP No. 4203. Various motions continue to be filed, and we currently believe these claims will have no material adverse impact on our financial position, results of operations or liquidity.

Natural Gas Supply

     APS and Pinnacle West Energy purchase the majority of their natural gas requirements for their gas-fired plants under contracts with a number of natural gas suppliers. Pursuant to the terms of a comprehensive settlement entered into in 1996 with El Paso Natural Gas Company, the rates charged for transportation are subject to a rate moratorium through December 31, 2005.

     On July 9, 2003 the FERC issued an order that altered the contractual obligations and the rights of parties to the 1996 settlement. In order for APS and Pinnacle West Energy to meet their natural gas supply and capacity requirements, we now expect that the combined increase in costs associated with the natural gas

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supply and the transportation capacity to result in an overall average increase of approximately $4 million per year in 2004 and 2005. APS and Pinnacle West Energy have sought appellate review of the FERC’s July 9 order and related issues on the grounds that the FERC decision to abrogate the full requirements contracts is arbitrary and capricious and is not supported by substantial evidence. Arizona Public Service Company and Pinnacle West Energy Corporation v. Federal Energy Regulatory Commission, United States Court of Appeals for the District of Columbia Circuit, No. 03-1209. This petition for review was consolidated with a petition filed by the ACC and other full requirements contract holders. Arizona Corporation Commission et al v. Federal Energy Regulatory Commission, United States Court of Appeals for the District of Columbia Circuit, No. 03-1206. We are continuing to analyze the market to determine the most favorable source and method of meeting our natural gas requirements.

     In addition, another party has also sought review of FERC’s July 9 order and is seeking to reallocate the costs associated with the changed contractual obligations in a way that would be less favorable to APS and Pinnacle West Energy than under FERC’s order. Should this party prevail on this point, APS and Pinnacle West Energy’s annual capacity cost could be increased by approximately $3 million per year, from September 2003 through December 2005, in addition to the $4 million discussed above.

Environmental Matters — Superfund

     On September 3, 2003, the EPA advised APS and Pinnacle West that the EPA considers APS and Pinnacle West to be a “potentially responsible party” in the Motorola 52nd Street Superfund Site, Operable Unit 3 (OU3) in Phoenix, Arizona. APS has facilities that are within this superfund site. Liability under Superfund is strict, joint and several. The Company and APS have agreed with the EPA to perform certain investigation activities of the APS facilities within OU3. Because the investigation has not yet been completed and the ultimate remediation requirements are not yet finalized, we cannot currently estimate the expenditures which may be required.

Asset Purchase Agreement

     See “Request for Proposals and Asset Purchase Agreement” in Note 5 for a description of an asset purchase agreement between APS and PPL Sundance.

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. The Price Anderson Act currently limits the combined public liability of nuclear reactor owners to $10.76 billion for claims that could arise from a single nuclear incident. The Palo Verde participants purchase the maximum available commercial insurance of $300 million. The balance of the $10.46 billion is provided by an industry-wide retrospective assessment program. If losses at any nuclear power plant covered by the programs exceed the accumulated funds, APS could be assessed retrospective premium adjustments. The maximum assessment per reactor under the program for

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each nuclear incident is approximately $101 million, subject to an annual limit of $10 million per incident. 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 $9 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 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 estimated maximum amount of retrospective assessments APS could incur under the current NEIL policies totals $16 million. The insurance coverage discussed in this and the previous paragraph is subject to certain policy conditions and exclusions.

14. Stock-Based Compensation

     Pinnacle West offers stock-based compensation plans for officers and key employees of the Company and our subsidiaries. In 2002, we began applying the fair value method of accounting for stock-based compensation, as provided for in SFAS No. 123, “Accounting for Stock-Based Compensation.” In accordance with the transition requirements of SFAS No. 123, as amended by SFAS No. 148, “Accounting for Stock-Based Compensation – Transition and Disclosure,” we applied the fair value method prospectively, beginning with 2002 stock grants. In prior years, we recognized stock compensation expense based on the intrinsic value method allowed in Accounting Principles Board Opinion (APB) No. 25, “Accounting for Stock Issued to Employees.”

     The following chart compares our net income, stock compensation expense and earnings per share for the three and nine months ended September 30, 2004 and 2003 to what those items would have been if we had recorded stock compensation expense based on the fair value method for all stock grants through September 30, 2004 (dollars in thousands, except per share amounts):

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	Three Months				Nine Months
	Ended				Ended
	September 30,				September 30,
	2004		2003		2004		2003
Net income, as reported	$	105,400	$	110,048	$	209,466	$	191,488
Add: Stock compensation expense included in reported net income (net of tax)		1,296		1,063		3,517		2,409
Deduct: Total stock compensation expense determined under fair value method (net of tax)		1,449		1,505		4,034		3,736
Pro forma net income	$	105,247	$	109,606	$	208,949	$	190,161
Earnings per share – basic:
As reported	$	1.15	$	1.21	$	2.29	$	2.10
Pro forma	$	1.15	$	1.20	$	2.29	$	2.08
Earnings per share – diluted:
As reported	$	1.15	$	1.20	$	2.29	$	2.09
Pro forma	$	1.15	$	1.20	$	2.28	$	2.08

15. Other Income and Other Expense

     The following table provides detail of other income and other expense for the three and nine months ended September 30, 2004 and 2003 (dollars in thousands):

	Three Months						Nine Months
	Ended September 30,						Ended September 30,
	2004			2003			2004			2003
Other income:
Investment gains – net (a)	$	—		$	2,248		$	36,945		$	3,617
Interest income		1,369			1,809			5,321			3,572
SunCor joint venture earnings		838			331			4,029			4,863
Asset sales		33			—			2,495			—
Miscellaneous		596			1,145			1,863			1,834
Total other income	$	2,836		$	5,533		$	50,653		$	13,886
Other expense:
Non-operating costs (b)	$	(3,642	)	$	(4,539	)	$	(10,302	)	$	(12,284	)
Asset sales		(123	)		(452	)		(391	)		(1,370	)
Investment losses – net		(136	)		—			—			—
Miscellaneous		(667	)		(800	)		(3,751	)		(1,425	)
Total other expense	$	(4,568	)	$	(5,791	)	$	(14,444	)	$	(15,079	)

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(a)	The nine-month period ended September 30, 2004 includes a $35 million gain ($21 million after tax) related to the sale of El Dorado’s limited partnership interest in the Phoenix Suns (see Note 19).
(b)	As defined by the FERC, includes below-the-line non-operating utility costs (primarily community relations and other costs excluded from utility rate recovery).

16. Guarantees

     We have issued parental guarantees and letters of credit and obtained surety bonds on behalf of our unregulated subsidiaries. Our parental guarantees related to Pinnacle West Energy consist of equipment and performance guarantees related to our generation construction program and long-term service agreement guarantees for new power plants. Our credit support instruments enable APS Energy Services to offer commodity energy and energy-related products and enable El Dorado to support the activities of NAC. Non-performance or payment under the original contract by our unregulated subsidiaries would require us to perform under the guarantee or surety bond. No liability is currently recorded on the Condensed Consolidated Balance Sheets related to Pinnacle West’s guarantees on behalf of its subsidiaries. Our guarantees have no recourse (except NAC) or collateral provisions to allow us to recover amounts paid under the guarantee. The amounts and approximate terms of our guarantees and surety bonds for each subsidiary at September 30, 2004 are as follows (dollars in millions):

	Guarantees				Surety Bonds
			Term				Term
	Amount		(in years)		Amount		(in years)
Parental:
Pinnacle West Energy	$	26		1 to 2	$	—		—
APS Energy Services		29		1 to 2		42		1 to 2
El Dorado (NAC)		40		1 to 2		—		—
Total	$	95			$	42

     At September 30, 2004, we had entered into approximately $39 million of letters of credit, which support various construction agreements. At September 30, 2004, the terms of these letters of credit expired in 2004 and 2005; however, during October 2004, the terms of these letters of credit were extended to 2005 and 2006. 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. Pinnacle West has approximately $3 million of letters of credit related to workers’ compensation expiring in 2004.

     APS has entered into various agreements that require letters of credit for financial assurance purposes. At September 30, 2004, approximately $200 million of letters of credit were outstanding to support existing pollution control bonds of approximately $200 million. See Note 4 for more information. In July 2004, $150 million of these letters of credit were renewed for a three-year term and expire in

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2007. The remainder expire in 2005. APS has also entered into approximately $102 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 2005. Additionally, APS has approximately $5 million of letters of credit related to counterparty collateral requirements expiring in 2005. 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 provide indemnifications relating to liabilities arising from or related to certain of our agreements. APS has provided indemnifications to 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 indemnifications and therefore, the overall maximum amount of the obligation under such indemnifications 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 indemnifications is likely and therefore no related liability has been recorded.

17. Earnings Per Share

     The following table presents earnings per weighted average common share outstanding for the three and nine months ended September 30, 2004 and 2003:

	Three Months				Nine Months
	Ended				Ended
	September 30,				September 30,
	2004		2003		2004		2003
Basic earnings per share:
Income from continuing operations	$	1.14	$	1.19	$	2.25	$	1.98
Income from discontinued operations		0.01		0.02		0.04		0.12
Earnings per share – basic	$	1.15	$	1.21	$	2.29	$	2.10
Diluted earnings per share:
Income from continuing operations	$	1.14	$	1.19	$	2.25	$	1.98
Income from discontinued operations		0.01		0.01		0.04		0.11
Earnings per share – diluted	$	1.15	$	1.20	$	2.29	$	2.09

     The following table reconciles weighted-average common shares outstanding – basic to weighted-average common shares outstanding – diluted that are used in the earnings per share calculation in the Condensed Consolidated Statements of Income for the three and nine months ended September 30, 2004 and 2003 (in thousands):

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	Three Months				Nine Months
	Ended September 30,				Ended September 30,
	2004		2003		2004		2003
Weighted-average common shares outstanding – basic		91,357		91,271		91,322		91,262
Dilutive shares		134		196		108		170
Weighted-average common shares outstanding – diluted		91,491		91,467		91,430		91,432

     Options to purchase 985,469 shares for the three-month period ended September 30, 2004 and 1,088,378 shares for the nine-month period ended September 30, 2004 were outstanding but were not included in the computation of earnings per share because the options’ exercise prices were greater than the average market price of the common shares. Options to purchase shares of common stock that were not included in the computation of diluted earnings per share for that same reason were 1,784,168 shares for the three-month period ended September 30, 2003 and 2,021,928 shares for the nine-month period ended September 30, 2003.

18. Discontinued Operations – SunCor and NAC

     The following chart provides a summary of SunCor and NAC income from discontinued operations (after income taxes) for the three and nine months ended September 30, 2004 and the comparable prior periods (dollars in millions):

	Three Months Ended				Nine Months Ended
	September 30,				September 30,
	2004		2003		2004		2003
SunCor	$	1	$	—	$	2	$	6
NAC		—		1		1		4
Total income from discontinued operations	$	1	$	1	$	3	$	10

Real Estate Activities

     The following table provides the revenue and income before taxes for properties owned by SunCor that were classified as discontinued operations for the three and nine months ended September 30, 2004 and the comparable prior periods (dollars in millions):

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	Three Months Ended				Nine Months Ended
	September 30,				September 30,
	2004		2003		2004		2003
Revenue	$	1	$	2	$	2	$	4
Income before taxes	$	—	$	1	$	2	$	2

NAC

     In July 2004, we entered into an agreement to sell our investment in NAC Holding Inc. and NAC International Inc. (NAC). The transaction is expected to close later this year and result in an after-tax gain of up to approximately $6 million, which will be classified as discontinued operations. Due to the pending sale of NAC, all revenues and expenses for NAC have been reclassified to discontinued operations for the three months and nine months ended September 30, 2004 and 2003 on our Condensed Consolidated Statements of Income.

     The following table provides the revenue and income before taxes for El Dorado’s investment in NAC that was classified as discontinued operations for the three and nine months ended September 30, 2004 and the comparable prior periods (dollars in millions):

	Three Months Ended				Nine Months Ended
	September 30,				September 30,
	2004		2003		2004		2003
Revenue	$	6	$	17	$	25	$	48
Income before taxes	$	—	$	1	$	2	$	6

     Due to the pending sale of NAC, all amounts related to assets and liabilities of discontinued operations have been reclassified to assets and liabilities held for sale on the Condensed Consolidated Balance Sheets.

19. Sale of Phoenix Suns Partnership Interest

     In June 2004, the Phoenix Suns Limited Partnership, in which El Dorado held a limited partnership interest, sold the partnership’s assets to a new investor group. The transaction resulted in a gain for El Dorado of approximately $35 million pretax ($21 million after income taxes), which is reflected in other income on the Condensed Consolidated Statements of Income. Additionally, $23 million in cash was received in July 2004 and $12 million will be received in 2007.

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PINNACLE WEST CAPITAL CORPORATION

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations.

Introduction

     We suggest this section be read along with the 2003 Form 10-K. Throughout this Item, we refer to specific “Notes” in the Notes to Condensed Consolidated Financial Statements in this report. These Notes add further details to the discussion. Operating statistics for the three and nine months ended September 30, 2004 and 2003 are available on our website (www.pinnaclewest.com).

Overview

     We own all of the outstanding common stock of APS. APS is a vertically-integrated electric utility that provides either retail or wholesale electric service to most of the state of Arizona. Through its marketing and trading division, APS also generates, sells and delivers electricity to wholesale customers in the western United States. APS’ marketing and trading division also sells, in the wholesale market, Pinnacle West Energy’s generation output that is not needed for APS’ Native Load, which includes loads for retail customers and traditional cost-of-service wholesale customers. The marketing and trading division focuses primarily on managing APS’ purchased power and fuel risks in connection with APS’ costs of serving retail customer energy requirements. APS has historically accounted for a substantial part of our revenues and earnings. Growth in APS’ service territory is about three times the national average and remains a fundamental driver of our revenues and earnings.

     Pinnacle West Energy is our unregulated generation subsidiary. We formed Pinnacle West Energy in 1999 as a result of the ACC’s requirement that APS transfer all of its competitive assets and services to an affiliate or to a third party by the end of 2002. We planned to transfer APS’ generation assets to Pinnacle West Energy. Additionally, Pinnacle West Energy constructed several power plants to meet growing energy needs (1790 MW in Arizona and 570 MW in Nevada). In September 2002, the ACC issued the Track A Order, which prohibited APS from transferring its generation assets to Pinnacle West Energy. As a result of the Track A Order, we are seeking to transfer the plants built by Pinnacle West Energy in Arizona to APS to unite the Arizona generation under one common owner, as originally intended. The 2004 Settlement Agreement would provide for that transfer.

     SunCor, our real estate development subsidiary, has been and is expected to be an important source of earnings and cash flow, particularly during the years 2003 through 2005 due to accelerated asset sales activity. Our subsidiary, APS Energy Services, provides competitive commodity-related energy services and energy-related products and services to commercial, industrial and institutional retail customers in the western United States.

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     We believe APS’ general rate case, including the proposed settlement, pending before the ACC is the key issue affecting our outlook. See Note 5 in Item 1 for a detailed discussion of this rate case and proposed settlement. Other factors affecting our past and future financial results include the June 2004 sale of El Dorado’s limited partnership interest in the Phoenix Suns; customer growth; purchased power and fuel costs; operations and maintenance expenses, including those relating to plant outages; weather variations; depreciation and amortization expenses, which are affected by net additions to existing utility plant and other property and changes in regulatory asset amortization; and the expected performance of our subsidiaries, SunCor and El Dorado.

EARNINGS CONTRIBUTION BY BUSINESS SEGMENT

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

• our regulated electricity segment, which consists of traditional regulated retail and wholesale electricity businesses and related activities, and includes electricity generation, transmission and distribution;

• our marketing and trading segment, which consists of our competitive energy business activities, including wholesale marketing and trading and APS Energy Services’ commodity-related energy services; and

• our real estate segment, which consists of SunCor’s real estate development and investment activities.

     The following table summarizes net income (loss) by segment for the three and nine months ended September 30, 2004 and the comparable prior-year periods (dollars in millions):

	Three Months Ended					Nine Months Ended
	September 30					September 30
	2004		2003			2004		2003
Regulated electricity	$	90	$	108		$	146	$	158
Marketing and trading		8		(7	)		25		8
Real estate		4		7			10		10
Other (a)		2		1			25		5
Income from continuing operations		104		109			206		181
Discontinued operations – net of tax (See Note 18)		1		1			3		10
Net income	$	105	$	110		$	209	$	191

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(a) The nine months ended September 30, 2004 includes a $35 million gain ($21 million after-tax) related to the sale of El Dorado’s limited partnership interest in the Phoenix Suns.

General

     Throughout the following explanations of our results of operations, we refer to “gross margin.” With respect to our regulated electricity segment and our marketing and trading segment, gross margin refers to electric operating revenues less purchased power and fuel costs. Our real estate segment gross margin refers to real estate revenues less real estate operations costs of SunCor. In addition, we have reclassified certain prior period amounts to conform to our current period presentation.

     In accordance with the 1999 Settlement Agreement, we completed amortizing substantially all of our regulatory assets related to the 1999 Settlement Agreement as of June 30, 2004.

Operating Results – Three-month period ended September 30, 2004 compared with the three-month period ended September 30, 2003

     Our consolidated net income for the three months ended September 30, 2004 was $105 million compared with $110 million for the prior-year period. The $5 million decrease in the period-to-period comparison reflects the following changes in earnings by segment:

• Regulated Electricity Segment – Net income decreased approximately $18 million primarily due to increased operations and maintenance costs related to customer service and personnel costs, the effects of weather on retail sales, increased purchased power and fuel costs due to higher fuel and power prices, and increased costs related to new power plants placed in service in mid-2003 and mid-2004. These negative factors were partially offset by lower replacement power costs due to fewer unplanned outages, the absence of regulatory asset amortization, and the benefit of customer growth.

• Marketing and Trading Segment – Net income increased approximately $15 million primarily due to higher forward and realized prices for wholesale sales of electricity.

     Additional details on the major factors that increased (decreased) net income are contained in the following table (dollars in millions):

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	Increase (Decrease)
	Pretax			After Tax
Regulated electricity segment gross margin:
Lower replacement power costs due to fewer unplanned outages, partially offset by higher prices for replacement power	$	24		$	14
Higher retail sales volumes due to customer growth, excluding weather effects		17			10
Effects of weather on retail sales		(20	)		(12	)
Increased purchased power and fuel costs due to higher fuel and power prices		(11	)		(6	)
Net increase in regulated electricity segment gross margin		10			6
Marketing and trading segment gross margin:
Higher mark-to-market gains on contracts for future delivery due to higher forward prices for wholesale electricity		11			7
Higher realized margins on energy trading primarily due to higher electricity prices		9			5
Increase in generation sales other than Native Load due to higher sales volumes and higher unit margins, including sales from new power plants in service		5			3
Lower unit margins and lower competitive retail sales in California by APS Energy Services		(2	)		(1	)
Net increase in marketing and trading segment gross margin		23			14
Net increase in regulated electricity and marketing and trading segments’ gross margins		33			20
Higher operations and maintenance expense primarily related to higher customer service costs, new power plants in service and personnel costs		(27	)		(16	)
Lower real estate margins due to decreased land sales		(4	)		(2	)
Depreciation and amortization decreases (increases):
Absence of regulatory asset amortization		21			13
New power plants in service		(4	)		(2	)
Increased delivery and other assets		(4	)		(2	)
Lower income resulting from APS’ return to the AFUDC method of capitalizing construction finance costs in the third quarter of 2003		(5	)		(8	)
Interest expense net decreases (increases):
New power plants in service		(6	)		(4	)
Lower other debt balances		3			2
Higher property taxes due to increased plant in service		(3	)		(2	)
Lower income tax credits		—			(4	)
Net increase (decrease) in net income	$	4		$	(5	)

     The increase in net costs (primarily interest expense, depreciation and operations and maintenance expense, net of gross margin contributions) related to new power plants placed in service in mid-2003 and mid-2004 by Pinnacle West Energy totaled approximately $6 million after income taxes in the three months ended September 30, 2004, compared with the prior-year period.

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Regulated Electricity Segment Revenues

     Regulated electricity segment revenues were $3 million higher for the three months ended September 30, 2004 compared with the prior-year period, primarily as a result of:

• a $38 million increase in retail sales volumes related to customer growth and higher average usage, excluding weather effects;

• a $44 million decrease in retail revenues related to weather; and

• a $9 million increase due to miscellaneous factors.

Marketing and Trading Segment Revenues

     Marketing and trading segment revenues were $46 million higher for the three months ended September 30, 2004 compared with the prior-year period, primarily as a result of:

• a $31 million increase from generation sales other than Native Load primarily due to sales volumes and higher wholesale market prices;

• $13 million of higher realized energy trading revenues primarily due to higher electricity prices;

• $11 million in higher mark-to-market gains for future-period deliveries primarily as a result of higher forward prices for wholesale electricity; and

• a $9 million decrease from lower competitive retail sales in California by APS Energy Services.

Other Revenues

     Other revenues were $7 million higher for the three months ended September 30, 2004 compared with the prior year period primarily due to higher non-commodity revenues at APS Energy Services.

Operating Results – Nine-month period ended September 30, 2004 compared with the nine-month period ended September 30, 2003

     Our consolidated net income for the nine months ended September 30, 2004 was $209 million compared with $191 million for the prior-year period. The $18 million increase in the period-to-period comparison reflects the following changes in earnings by segment:

• Regulated Electricity Segment – Net income decreased approximately $12 million primarily due to higher costs related to new power plants placed in service in mid-2003 and mid-2004, increased operations and

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maintenance costs related to customer service and personnel costs, higher depreciation, property taxes and interest expense related to increased delivery and other assets, a retail electricity price reduction, the effects of weather on retail sales, and increased fuel and purchased power costs due to higher fuel and power prices. These negative factors were partially offset by lower regulatory asset amortization, the benefit of customer growth, lower interest expense due to lower balances and rates, and lower replacement power costs due to fewer unplanned outages.

• Marketing and Trading Segment – net income increased approximately $17 million primarily due to higher forward and realized prices for wholesale electricity, partially offset by lower margins in California of APS Energy Services.

• Real Estate Segment – Net income decreased approximately $5 million primarily due to the 2003 gain on the sale of SunCor’s water utility company, which was reported as discontinued operations.

• Other Segment – Net income increased approximately $18 million primarily due to a gain at El Dorado related to the sale of El Dorado’s limited partnership interest in the Phoenix Suns, which resulted in an after-tax gain of $21 million.

     Additional details on the major factors that increased (decreased) income from continuing operations and net income are contained in the following table (dollars in millions).

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	Increase (Decrease)
	Pretax			After Tax
Regulated electricity segment gross margin:
Higher retail sales volumes due to customer growth, excluding weather effects	$	41		$	25
Lower replacement power costs due to fewer unplanned outages		7			4
Retail electricity price reduction effective July 1, 2003		(13	)		(8	)
Effects of weather on retail sales		(10	)		(6	)
Increased purchased power and fuel costs due to higher fuel and power prices		(10	)		(6	)
Miscellaneous factors, net		(3	)		(2	)
Net increase in regulated electricity segment gross margin		12			7
Marketing and trading segment gross margin:
Higher mark-to-market gains on contracts for future delivery due to higher forward prices for wholesale electricity		22			13
Higher realized margins on energy trading primarily due to higher electricity prices		17			10
Increase in generation sales other than Native Load due to higher sales volumes and higher unit margins, including sales from new power plants in service		6			4
Lower unit margins and lower competitive retail sales in California by APS Energy Services		(19	)		(11	)
Net increase in marketing and trading segment gross margin		26			16
Net increase in regulated electricity and marketing and trading segments’ gross margins		38			23
Higher other income net of other expense primarily due to the sale of El Dorado’s limited partnership interest in the Phoenix Suns (Notes 15 and 19)		37			22
Higher operations and maintenance expense primarily related to customer service costs, new power plants in service and personnel costs		(29	)		(17	)
Interest expense net decreases (increases):
New power plants in service		(19	)		(11	)
Increased delivery and other assets		(7	)		(6	)
Lower other debt balances and rates		14			8
Depreciation and amortization decreases (increases):
Decreased regulatory asset amortization		47			28
New power plants in service		(14	)		(8	)
Increased delivery and other assets		(15	)		(9	)
Higher property taxes due to increased plant in service		(10	)		(6	)
Lower income tax credits		—			(2	)
Miscellaneous items, net		5			3
Net increase in income from continuing operations	$	47			25
Discontinued operations					(7	)
Net increase in net income				$	18

     The increase in net costs (primarily interest expense, depreciation and operations and maintenance expense, net of gross margin contributions) related to new power plants placed in service in mid-2003 and mid-2004 by Pinnacle West Energy totaled approximately $21 million after income taxes in the nine months ended September 30, 2004, compared with the prior-year period.

Regulated Electricity Segment Revenues

     Regulated electricity segment revenues were $60 million higher for the nine months ended September 30, 2004 compared with the prior-year period, primarily as a result of:

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• an $86 million increase in retail revenues related to customer growth and higher average usage, excluding weather effects;

• a $27 million decrease in retail revenues related to weather;

• a $13 million decrease in retail revenues related to a reduction in retail electricity prices; and

• a $14 million increase due to miscellaneous factors.

Marketing and Trading Segment Revenues

     Marketing and trading segment revenues were $31 million higher for the nine months ended September 30, 2004 compared with the prior-year period, primarily as a result of:

• $22 million in higher mark-to-market gains for future-period deliveries primarily as a result of higher forward prices for wholesale electricity;

• $17 million of higher energy trading revenues primarily due to higher electricity prices;

• a $7 million increase from generation sales other than Native Load primarily due to higher wholesale market prices; and

• a $15 million decrease from lower competitive retail sales in California by APS Energy Services.

Real Estate Segment Revenues

     Real estate segment revenues were $21 million higher for the nine months ended September 30, 2004 compared with the prior year period primarily as a result of increased home and commercial property sales partially offset by decreased land sales.

Other Revenues

     Other revenues were $16 million higher for the nine months ended September 30, 2004 compared with the prior year period primarily due to higher non-commodity revenues at APS Energy Services.

Liquidity and Capital Resources

        Capital Expenditure Requirements

     The following table summarizes the actual capital expenditures for the nine months ended September 30, 2004 and estimated capital expenditures for the next three years (dollars in millions):

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	Nine Months				Estimate for the
	Ended				Year Ended
	September 30,				December 31,
	2004		2004		2005		2006
APS
Delivery	$	246	$	326	$	390	$	453
Generation (a) (b)		69		108		350		202
Other (c)		16		29		30		18
Subtotal		331		463		770		673
Pinnacle West Energy (a)		30		56		15		17
SunCor (d)		55		83		27		17
Other		1		1		—		—
Total	$	417	$	603	$	812	$	707

(a) As discussed in Note 5 under “APS General Rate Case; 2004 Settlement Agreement,” as part of its general rate case, APS has requested rate base treatment of the PWEC Dedicated Assets. Pinnacle West Energy’s actual capital expenditures related to the PWEC Dedicated Assets are estimated to be $15 million in 2004, $14 million in 2005 and $14 million in 2006.

(b) Estimate for 2005 includes about $190 million for acquisition of the Sundance Generating Station. See Note 5 for a discussion of the asset purchase agreement between APS and PPL Sundance.

(c) Primarily information systems and facilities projects.

(d) Consists primarily of capital expenditures for land development and retail and office building construction reflected in “Change in real estate investments” on the Condensed Consolidated Statements of Cash Flows.

     Delivery capital expenditures are comprised of T&D infrastructure additions and upgrades, capital replacements, new customer construction and related information systems and facility cost. Examples of the types of projects included in the forecast include T&D lines and substations, line extensions to new residential and commercial developments and upgrades to customer information systems. Major transmission projects are driven by strong regional customer growth. APS will begin major projects each year for the next several years, and expects to spend about $200 million on major transmission projects during the 2004 to 2006 time frame. These amounts are included in “APS-Delivery” in the table above. Completion of these projects will stretch from 2005 through at least 2008.

     Generation capital expenditures are comprised of various improvements to APS’ existing fossil and nuclear plants and the replacement of Palo Verde steam generators. Examples of the types of projects included in this category are additions, upgrades and capital replacements of various power plant equipment such as turbines, boilers and environmental equipment. Generation also includes nuclear fuel expenditures of approximately $30 million annually for 2004 to 2006.

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     Replacement of the steam generators in Palo Verde Unit 2 was completed during the fall outage of 2003 at a cost to APS of approximately $70 million. The Palo Verde owners have approved the manufacture of two additional sets of steam generators. These generators will be installed in Unit 1 (scheduled completion in 2005) and Unit 3 (scheduled completion in 2007). Our portion of steam generator expenditures for Units 1 and 3 is approximately $140 million, which will be spent through 2008. In 2004 through 2006, approximately $90 million of the Unit 1 and Unit 3 costs are included in the generation capital expenditures table above and will be funded with internally-generated cash or external financings.

     Contractual Obligations

     Our future contractual obligations have not changed materially from the amounts disclosed in Part II, Item 7 of the 2003 Form 10-K with the following exceptions that occurred in the nine months ended September 30, 2004:

• Our purchased power and fuel commitments increased approximately $45 million to $254 million primarily related to fourth quarter 2004 obligations.

• See Note 4 for a list of payments due on total long-term debt and capitalized lease requirements.

• Our purchase obligations for 2005 increased approximately $190 million for our proposed acquisition of the Sundance Generating Station. See Note 5, “Regulatory Matters – Request for Proposals and Asset Purchase Agreement,” for a discussion of the asset purchase agreement between APS and PPL Sundance, including required regulatory approvals.

     Off-Balance Sheet Arrangements

     In 2003, we adopted FIN No. 46R, “Consolidation of Variable Interest Entities,” as it applies to special-purpose entities. FIN No. 46R requires that we consolidate a VIE if we have a majority of the risk of loss from the VIE’s activities or we are entitled to receive a majority of the VIE’s residual returns or both. A VIE is a corporation, partnership, trust or any other legal structure that either does not have equity investors with voting rights or has equity investors that do not provide sufficient financial resources for the entity to support its activities.

     In 1986, APS entered into agreements with three separate SPE 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. Based on our assessment of FIN No. 46R, we are not required to consolidate the Palo Verde VIEs.

     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

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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 September 30, 2004, APS would have been required to assume approximately $250 million of debt and pay the equity participants approximately $195 million.

     In the first quarter of 2004, we adopted FIN No. 46R for all other contractual arrangements. SunCor has certain land development arrangements that are required to be consolidated under FIN No. 46R. The assets and noncontrolling interests reflected in our Condensed Consolidated Balance Sheets related to these arrangements were approximately $17 million at September 30, 2004.

     Guarantees and Letters of Credit

     We and certain of our subsidiaries have issued guarantees and letters of credit in support of our unregulated businesses. We have also obtained surety bonds on behalf of APS Energy Services. We generally provide indemnifications relating to liabilities arising from or related to certain of our agreements, except with limited exceptions depending on the particular agreement. We have not recorded any liability on our Condensed Consolidated Balance Sheets with respect to these obligations. See Note 16 for additional information regarding guarantees and letters of credit.

     Credit Ratings

     The ratings of securities of Pinnacle West and APS as of November 5, 2004 are shown below and are considered to be “investment-grade” ratings. The ratings reflect the respective views of the rating agencies, from which an explanation of the significance of their ratings may be obtained. There is no assurance that these ratings will continue for any given period of time. The ratings may be revised or withdrawn entirely by the rating agencies, if, in their respective judgments, circumstances so warrant. Any downward revision or withdrawal may adversely affect the market price of Pinnacle West’s or APS’ securities and serve to increase those companies’ cost of and access to capital. It may also require additional collateral related to certain derivative instruments (see Note 10).

	Moody’s	Standard & Poor’s
Pinnacle West
Senior unsecured	Baa2	BBB-
Commercial paper	P-2	A-2
Outlook	Negative	Negative
APS
Senior unsecured	Baa1	BBB
Secured lease obligation bonds	Baa2	BBB
Commercial paper	P-2	A-2
Outlook	Negative	Negative

     APS no longer has any senior secured debt. See “APS” below for a discussion of the termination of APS’ mortgage and deed of trust.

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     Debt Provisions

     Pinnacle West’s and APS’ debt covenants related to their respective bank financing arrangements include a debt-to-total-capitalization ratio and an interest coverage test. Pinnacle West and APS comply with these covenants and each anticipates it will continue to meet these and other significant covenant requirements. The ratio of debt to total capitalization cannot exceed 65% for the Company and for APS. At September 30, 2004, the ratio was approximately 53% for Pinnacle West. At September 30, 2004, the ratio was approximately 53% for APS. The provisions regarding interest coverage require a minimum cash coverage of two times the interest requirements for each of the Company and APS. The coverages were approximately 4 times for the Company and 4 times for APS at September 30, 2004. Failure to comply with such covenant levels would result in an event of default which, generally speaking, would require the immediate repayment of the debt subject to the covenants.

     Neither Pinnacle West’s nor APS’ financing agreements contain “ratings triggers” that would result in an acceleration of the required interest and principal payments in the event of a ratings downgrade. However, in the event of a ratings downgrade, Pinnacle West and/or APS may be subject to increased interest costs under certain financing agreements.

     All of Pinnacle West’s bank agreements contain “cross-default” provisions that would result in defaults and the potential acceleration of payment under these loan agreements if Pinnacle West or APS were to default under other agreements. All of APS’ bank agreements contain cross-default provisions that would result in defaults and the potential acceleration of payment under these bank agreements if APS were to default under other agreements. Pinnacle West’s and APS’ credit agreements generally contain provisions under which the lenders could refuse to advance loans in the event of a material adverse change in financial condition or financial prospects, except Pinnacle West and APS do not have a material adverse change restriction for revolver borrowings equal to outstanding commercial paper amounts.

     See Note 4 for further discussions.

     Capital Needs and Resources by Company

     Pinnacle West (Parent Company)

     Our primary cash needs are for dividends to our shareholders; interest payments and optional and mandatory repayments of principal on our long-term debt. The level of our common dividends and future dividend growth will be dependent on a number of factors including, but not limited to, payout ratio trends, free cash flow and financial market conditions.

     Our primary sources of cash are dividends from APS, external financings and cash distributions from our other subsidiaries, primarily SunCor. We expect SunCor to make cash distributions to the parent company of $80 to $100 million annually in 2004 and 2005 due to anticipated accelerated asset sales activity. As discussed in Note 5 under “ACC

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Financing Order,” APS must maintain a common equity ratio of at least 40% and may not pay common dividends if the payment would reduce its common equity below that threshold. As defined in the Financing Order, common equity ratio is common equity divided by common equity plus long-term debt, including current maturities of long-term debt. At September 30, 2004, APS’ common equity ratio was approximately 46%.

     On February 2, 2004, we used proceeds from the $165 million Floating Rate Notes issued on November 12, 2003 and short term borrowings to pay down the maturing $215 million 4.5% Senior Notes due 2004.

     In October 2004, we replaced two separate revolving credit facilities (with collective borrowing capacity of $275 million) with a $300 million revolving credit facility that terminates in October 2007. The revolver provides liquidity support for Pinnacle West’s $250 million commercial paper program, as well as up to $100 million of the facility that can be used for letters of credit.

     Pinnacle West sponsors a pension plan that covers employees of Pinnacle West and our subsidiaries. We contribute at least the minimum amount required under IRS regulations, but no more than the maximum tax-deductible amount. The minimum required funding takes into consideration the value of the fund assets and our pension obligation. APS and other subsidiaries fund their share of the pension contribution, of which APS represents approximately 89% of the total funding amounts described above. The assets in the plan are comprised of common stocks, bonds and real estate. Future year contribution amounts are dependent on fund performance and fund valuation assumptions. The United States Pension Stability Act was signed into law on April 10, 2004. Under this new legislation, our required pension contribution in 2004 is $35 million, which we contributed in the third quarter. We have contributed approximately $14 million to our other postretirement benefits plan in 2004 through September.

     APS

     APS’ capital requirements consist primarily of capital expenditures and optional and mandatory redemptions of long-term debt. See Note 5 for a discussion of the $500 million financing arrangement between APS and Pinnacle West Energy approved by the ACC in 2003.

     APS pays for its capital requirements with cash from operations and, to the extent necessary, external financings. APS has historically paid for its dividends to Pinnacle West with cash from operations. See “Pinnacle West (Parent Company)” above for a discussion of common equity ratio that APS must maintain in order to pay dividends to Pinnacle West.

     On February 15, 2004, $125 million of APS’ 5.875% Notes due 2004 were redeemed at maturity and on March 1, 2004, $80 million of APS’ First Mortgage Bonds, 6.625% Series due 2004 were redeemed at maturity. APS 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. The bonds were issued to refinance $166 million of outstanding pollution control bonds.

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The Series A-E bonds are payable solely from revenues obtained from APS pursuant to a loan agreement between APS and Navajo County, Arizona Pollution Control Corporation. These bonds are classified as long-term debt on our Condensed Consolidated 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. The bonds were issued to refinance $13 million of outstanding pollution control bonds. The Series A bonds are payable solely from revenues obtained from APS pursuant to a loan agreement between APS and Coconino County, Arizona Pollution Control Corporation. These bonds are classified as long-term debt on our Condensed Consolidated Balance Sheets.

     In May 2004, APS renewed its $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 APS’ $250 million commercial paper program, as well as an additional $75 million for other liquidity needs and miscellaneous letters of credit.

     On June 29, 2004 APS 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 APS’ 6.25% Notes due January 15, 2005 and/or all or a portion of $300 million in aggregate principal amount of APS’ 7.625% Notes due August 1, 2005.

     APS has retired all first mortgage bonds issued by APS under its 1946 mortgage and deed of trust, including the first mortgage bonds securing APS senior notes. On April 30, 2004, APS terminated its mortgage and deed of trust and, as a result, is not able to issue any additional first mortgage bonds under that mortgage.

     Although provisions in APS’ articles of incorporation and ACC financing orders establish maximum amounts of preferred stock and debt that APS may issue, APS does not expect any of these provisions to limit its ability to meet its capital requirements.

     Pinnacle West Energy

     Pinnacle West Energy’s capital requirements consist primarily of capital expenditures. In May 2004, SNWA paid Pinnacle West Energy approximately $91 million for a 25% interest in the 570 MW Silverhawk combined cycle plant. Pinnacle West Energy’s capital requirements are funded through capital infusions from Pinnacle West, which finances those infusions through debt and equity financings and internally-generated cash. See the capital expenditures table above for actual capital expenditures in the nine months ended September 30, 2004 and projected capital expenditures for the next three years.

     See Note 5 for a discussion of the $500 million financing arrangement between APS and Pinnacle West Energy authorized by the ACC pursuant to the Financing Order.

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     Other Subsidiaries

     During the past three years, SunCor funded its cash requirements with cash from operations and its own external financings. SunCor’s capital needs consist primarily of capital expenditures for land development and retail and office building construction. See the capital expenditures table above for actual capital expenditures in the nine months ended September 30, 2004 and projected capital expenditures for the next three years. SunCor expects to fund its capital requirements with cash from operations and external financings.

     We expect SunCor to make cash distributions to the parent company of $80 to $100 million annually in 2004 and 2005 due to anticipated accelerated asset sales activity.

     El Dorado funded its cash requirements during the past three years, primarily for NAC in 2002, with cash infused by the parent company and with cash from operations. El Dorado expects minimal capital requirements over the next three years and intends to focus on prudently realizing the value of its existing investments. For information on the pending sale of NAC, see Note 18.

     APS Energy Services’ cash requirements during the past three years were funded with cash infusions from the parent company and with cash from operations.

     Critical Accounting Policies

     In preparing the financial statements in accordance with GAAP, management must often make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues, expenses and related disclosures at the date of the financial statements and during the reporting period. Some of those judgments can be subjective and complex, and actual results could differ from those estimates. Our most critical accounting policies include the impacts of regulatory accounting and the determination of the appropriate accounting for our pension and other postretirement benefits, derivatives and mark-to-market accounting. There have been no changes to our critical accounting policies since our 2003 Form 10-K except for the impact of recent accounting pronouncements as discussed in Note 8. See “Critical Accounting Policies” in Item 7 of the 2003 Form 10-K for further details about our critical accounting policies.

Business Outlook

     2004 Earnings Outlook

     We confirm our previous guidance that we expect our 2004 earnings will be approximately $2.50 per share, after taxes on a fully-diluted basis. This estimate assumes no contribution from a general rate case decision (see Note 5) and excludes the gain on El Dorado’s sale of its limited partnership interest in the Phoenix Suns (see Note 19). This earnings guidance, which supersedes all previous 2004 earnings guidance provided by the Company, is forward-looking information, and actual results may differ materially from our expectations. See “Forward-Looking Statements” below.

     A number of factors affecting our business outlook are discussed below.

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     APS General Rate Case

     We believe APS’ general rate case, including the proposed settlement, pending before the ACC is the key issue affecting our outlook. See Note 5 for a detailed discussion of this rate case and proposed settlement.

     Wholesale Power Market Conditions

     The marketing and trading division focuses primarily on managing APS’ purchased power and fuel risks in connection with its costs of serving retail customer demand. We moved this division to APS in early 2003 for future marketing and trading activities (existing wholesale contracts remained at Pinnacle West) as a result of the ACC’s Track A Order prohibiting APS’ transfer of generating assets to Pinnacle West Energy. Additionally, the marketing and trading division, subject to specified parameters, markets, hedges and trades in electricity, fuels and emission allowances and credits. Our future earnings will be affected by the strength or weakness of the wholesale power market. The market has suffered a substantial reduction in overall liquidity because there are fewer creditworthy counterparties and because several key participants have exited the market or scaled back their activities.

     Factors Affecting Operating Revenues

     General Electric operating revenues are derived from sales of electricity in regulated retail markets in Arizona and from competitive retail and wholesale power markets in the western United States. These revenues are expected to be affected by electricity sales volumes related to customer mix, customer growth and average usage per customer as well as electricity prices and variations in weather from period to period. Competitive sales of energy and energy-related products and services are made by APS Energy Services in western states that have opened to competitive supply.

     Customer Growth Customer growth in APS’ service territory averaged about 3.4% a year for the three years 2001 through 2003; we currently expect customer growth to average about 3.8% per year from 2004 to 2006. We currently estimate that total retail electricity sales in kilowatt-hours will grow 4.6% on average, from 2004 through 2006, before the retail effects of weather variations. The customer and sales growth referred to in this paragraph applies to Native Load customers. Customer growth for the nine-month period ended September 30, 2004 compared with the prior year period was 3.7%.

     Retail Rate Changes As part of the 1999 Settlement Agreement, APS agreed to 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%. The final price reduction was implemented July 1, 2003. See “1999 Settlement Agreement” in Note 5 for further information. In addition, the Company has requested a 9.8% retail rate increase to be effective July 1, 2004. See “APS General Rate Case; 2004 Settlement Agreement” in Note 5 for further information.

     Other Factors Affecting Future Financial Results

     Purchased Power and Fuel Costs Purchased power and fuel costs are impacted by our electricity sales volumes, existing contracts for purchased power and generation fuel,

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our power plant performance, prevailing market prices, new generating plants being placed in service and our hedging program for managing such costs. See “Natural Gas Supply” in Note 12 for more information on fuel costs.

     Operations and Maintenance Expenses Operations and maintenance expenses are impacted by growth, power plant additions and operations, inflation, outages, higher trending pension and other postretirement benefit costs and other factors.

     Depreciation and Amortization Expenses Depreciation and amortization expenses are impacted by net additions to existing utility plant and other property, changes in regulatory asset amortization and our generation construction program. West Phoenix Unit 4 was placed in service in June 2001. Redhawk Units 1 and 2 and the new Saguaro Unit 3 began commercial operations in July 2002. West Phoenix Unit 5 was placed in service in July 2003 and Silverhawk was placed in service in May 2004. The regulatory assets to be recovered through June 30, 2004 under the 1999 Settlement Agreement were amortized as follows (dollars in millions):

1999	2000		2001		2002		2003		2004		Total
$164	$	158	$	145	$	115	$	86	$	18	$	686

     Property Taxes Taxes other than income taxes consist primarily of property taxes, which are affected by tax rates and the value of property in-service and under construction. The average property tax rate for APS, which currently owns the majority of our property, was 9.3% of assessed value for 2003 and 9.7% for 2002. We expect property taxes to increase primarily due to our generation construction program, as the plants phase-in to the property tax base over a five-year period, and our additions to existing facilities.

     Interest Expense Interest expense is affected by the amount of debt outstanding and the interest rates on that debt. The primary factors affecting borrowing levels in the next several years are expected to be our capital requirements and our internally generated cash flow. Capitalized interest offsets a portion of interest expense while capital projects are under construction. We stop accruing capitalized interest on a project when it is placed in commercial operation. As noted above, we placed new power plants in commercial operation in 2001, 2002, 2003 and 2004. Interest expense is also affected by interest rates on variable-rate debt and interest rates on the refinancing of the Company’s future liquidity needs.

     Retail Competition The regulatory developments and legal challenges to the Rules discussed in Note 5 have raised considerable uncertainty about the status and pace of retail electric competition and of electric restructuring in Arizona. Although some very limited retail competition existed in APS’ service area in 1999 and 2000, there are currently no active retail competitors providing unbundled energy or other utility services to APS’ customers. As a result, we cannot predict when, and the extent to which, additional competitors will re-enter APS’ service territory.

     Subsidiaries In the case of SunCor, efforts to accelerate asset sales activities in 2003 were successful. A portion of these sales have been, and additional amounts may be required to be, reported as discontinued operations on our Condensed Consolidated Statements of Income. See Note 18 for further discussion. The annual earnings

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contribution from SunCor was $56 million after tax in 2003. We anticipate SunCor’s annual earnings contributions will average $30-$40 million over the years 2004 and 2005.

     The annual earnings contribution from APS Energy Services is expected to be positive over the next several years due primarily to a number of retail electricity contracts in California. APS Energy Services had after tax earnings of $16 million in 2003.

     We expect SunCor and APS Energy Services to have combined earnings of approximately $10 million per year after tax beyond 2005.

     El Dorado’s historical results are not necessarily indicative of future performance. In June 2004, the Phoenix Suns Limited Partnership, in which El Dorado holds limited partnership interests, sold the partnership’s assets to a new investor group. The transaction resulted in a gain for El Dorado of approximately $21 million after income taxes (see Note 19 for further information). See Note 18 for information regarding El Dorado’s pending sale of NAC.

     General Our financial results may be affected by a number of broad factors. See “Forward-Looking Statements” below for further information on such factors, which may cause our actual future results to differ from those we currently seek or anticipate.

Risk Factors

     Exhibit 99.1, which is hereby incorporated by reference, contains a discussion of risk factors affecting the Company.

Forward-Looking Statements

     This document contains forward-looking statements based on current expectations, and we assume no obligation to update these statements or make any further statements on any of these issues, except as required by applicable law. These forward-looking statements are often identified by words such as “predict”, “hope,” “may,” “believe,” “anticipate,” “plan,” “expect,” “require,” “intend,” “assume” and similar words. Because actual results may differ materially from expectations, we caution readers not to place undue reliance on these statements. A number of factors could cause future results to differ materially from historical results, or from results or outcomes currently expected or sought by us. In addition to the Risk Factors noted above (see Exhibit 99.1), these factors include, but are not limited to:

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

• the ongoing restructuring of the electric industry, including the introduction of retail electric competition in Arizona and decisions impacting wholesale competition;

• the outcome of regulatory, legislative and judicial proceedings relating to the restructuring;

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• market prices for electricity and natural gas;

• power plant performance and outages, including transmission outages and constraints;

• weather variations affecting local and regional customer energy usage;

• customer growth and energy usage;

• regional economic and market conditions, including the results of litigation and other proceedings resulting from the California energy situation, volatile purchased power and fuel costs and the completion of generation and transmission construction in the region, which could affect customer growth and the cost of power supplies;

• the cost of debt and equity capital and access to capital markets;

• the uncertainty that current credit ratings will remain in effect for any given period of time;

• our ability to compete successfully outside traditional regulated markets (including the wholesale market);

• the performance of our marketing and trading activities due to volatile market liquidity and any deteriorating counterparty credit and the use of derivative contracts in our business (including the interpretation of the subjective and complex accounting rules related to these contracts);

• changes in accounting principles generally accepted in the United States of America and the interpretation of those principles;

• the performance of the stock market and the changing interest rate environment, which affect the amount of our required contributions to our pension plan and nuclear decommissioning trust funds, as well as our reported costs of providing pension and other postretirement benefits;

• technological developments in the electric industry;

• the strength of the real estate market in SunCor’s market areas, which include Arizona, Idaho, New Mexico and Utah;

• conservation programs; and

• other uncertainties, all of which are difficult to predict and many of which are beyond our control.

Item 3. Market Risks

     Our operations include managing market risks related to changes in interest rates, commodity prices and investments held by our nuclear decommissioning trust fund.

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     Interest Rate and Equity Risk

     Our major financial market risk exposure is to changing interest rates. Changing interest rates will affect interest paid on variable-rate debt and interest earned by our nuclear decommissioning trust fund. Our policy is to manage interest rates through the use of a combination of fixed-rate and floating-rate debt.

     On January 29, 2004, we entered into two fixed-for-floating interest rate swap transactions on our $300 million 6.4% senior note. These transactions qualify as fair value hedges under SFAS No. 133. See Note 10.

     Commodity Price Risk

     We are exposed to the impact of market fluctuations in interest rates and in the commodity price and transportation costs of electricity, natural gas, coal and emissions allowances. We manage risks associated with these market fluctuations by utilizing various instruments that qualify as derivatives, including exchange-traded futures and options and over-the-counter forwards, options and swaps. Our ERMC, consisting of officers and key management personnel, oversees company-wide energy risk management activities and monitors the results of marketing and trading activities to ensure compliance with our stated energy risk management and trading policies. As part of our risk management program, we use such instruments to hedge our exposure to changes in interest rates and to hedge purchases and sales of electricity, fuels and emissions allowances and credits. The changes in market value of such contracts have a high correlation to price changes in the hedged transactions. In addition, subject to specified risk parameters monitored by the ERMC, we engage in marketing and trading activities intended to profit from market price movements.

     The mark-to-market values of derivative instruments related to our risk management and trading activities are presented in two categories consistent with our business segments:

• Regulated Electricity – non-trading derivative instruments that hedge our purchases and sales of electricity and fuel for APS’ Native Load requirements of our regulated electricity business segment; and

• Marketing and Trading – non-trading and trading derivative instruments of our competitive business segment.

     The following tables show the pretax changes in mark-to-market of our regulated electricity and marketing and trading derivative positions for the nine months ended September 30, 2004 and 2003 (dollars in millions):

54

	Nine Months Ended						Nine Months Ended
	September 30, 2004						September 30, 2003
				Marketing						Marketing
	Regulated			and			Regulated			and
	Electricity			Trading			Electricity			Trading
Mark-to-market of net positions at beginning of period	$	—		$	69		$	(49	)	$	57
Change in mark-to-market gains/(losses) for future period deliveries		10			19			(6	)		(5	)
Changes in cash flow hedges recorded in OCI		68			32			29			44
Ineffective portion of changes in fair value recorded in earnings		1			1			8			—
Mark-to-market gains realized during the period		(11	)		(17	)		—			(20	)
Change in valuation techniques		—			2			—			—
Mark-to-market of net positions at end of period	$	68		$	106		$	(18	)	$	76

     The tables below show the fair value of maturities of our regulated electricity and trading derivative contracts (dollars in millions) at September 30, 2004 by maturities and by the type of valuation that is performed to calculate the fair values. See “Critical Accounting Policies — Mark-to-Market Accounting,” in Item 7 of our 2003 Form 10-K for more discussion on our valuation methods.

Regulated Electricity

									Total
							Years		fair
Source of Fair Value	2004			2005			thereafter		value
Prices actively quoted	$	7		$	49		$	14	$	70
Prices provided by other external sources		—			1			—		1
Prices based on models and other valuation methods		(2	)		(1	)		—		(3	)
Total by maturity	$	5		$	49		$	14	$	68

55

Marketing and Trading

																			Total
																Years			fair
Source of Fair Value	2004			2005			2006			2007			2008			thereafter			value
Prices actively quoted	$	8		$	7		$	—		$	—		$	—		$	—		$	15
Prices provided by other external sources		—			34			39			43			24			(1	)		139
Prices based on models and other valuation methods		(2	)		(5	)		(16	)		(16	)		(8	)		(1	)		(48	)
Total by maturity	$	6		$	36		$	23		$	27		$	16		$	(2	)	$	106

     The table below shows the impact that hypothetical price movements of 10% would have had on the market value of our risk management and trading assets and liabilities included on the Condensed Consolidated Balance Sheets at September 30, 2004 (dollars in millions).

	September 30, 2004
	Gain (Loss)
	Price Up			Price Down
Commodity	10%			10%
Mark-to-market changes reported in earnings (a):
Electricity	$	(6	)	$	6
Natural gas		5			(5	)
Mark-to-market changes reported in OCI (b):
Electricity		39			(39	)
Natural gas		31			(31	)
Total	$	69		$	(69	)

(a)	These contracts are primarily structured sales activities hedged with a portfolio of forward purchases that protects the economic value of the sales transactions.
(b)	These contracts are hedges of our forecasted purchases of natural gas and electricity. The impact of these hypothetical price movements would substantially offset the impact that these same price movements would have on the physical exposures being hedged.

Credit Risk

     We are exposed to losses in the event of nonperformance or nonpayment by counterparties. We have risk management and trading contracts with many counterparties, including two counterparties for which a worst case exposure represented approximately 30% of our $396 million of risk management and trading assets as of September 30, 2004. See “Critical Accounting Policies - Mark-to-Market Accounting,” in Item 7 of our 2003 Form

56

10-K for more discussion on our valuation methods. See Note 10 for further discussion of credit risk.

Item 4. Controls and Procedures

     (a) Evaluation of Disclosure Controls and Procedures

     The Company’s management, with the participation of the Company’s Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness the Company’s disclosure controls and procedures as of the end of the period covered by this report. Based on that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that the Company’s disclosure controls and procedures as of the end of the period covered by this report have been designed and are functioning effectively to provide reasonable assurance that the information required to be disclosed by the Company in reports filed under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms.

     (b) Change in Internal Control over Financial Reporting

     No change in the Company’s internal control over financial reporting occurred during the Company’s most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.

57

PART II – OTHER INFORMATION

Item 1. Legal Proceedings

     See Note 12 of Notes to Condensed Consolidated Financial Statements in regard to pending or threatened litigation or other disputes.

Item 5. Other Information

Construction and Financing Programs

     See “Liquidity and Capital Resources” in Part I, Item 2 of this report for a discussion of construction and financing programs of the Company and its subsidiaries.

Regulatory Matters

     See Note 5 of Notes to Condensed Consolidated Financial Statements in Part I, Item 1 of this report for a discussion of regulatory developments.

Environmental Matters

     ADEQ issued a Notice of Violation to APS in January 2004 alleging that, among other things, the discharge limit for lead was exceeded at the Saguaro Power Plant. See “Environmental Matters – Arizona Department of Environmental Quality” in Part I, Item 1 of the 2003 10-K. In August 2004, ADEQ closed the Notice of Violation without issuing any penalty.

     See “Environmental Matters — Superfund” in Note 12 of Notes to Condensed Consolidated Financial Statements for a discussion of a superfund site.

58

Item 6. Exhibits

     (a) Exhibits

Exhibit No.		Description
	10.1	Credit Agreement dated as of October 19, 2004 among Pinnacle West, other lenders, and JPMorgan Chase Bank, as Administrative Agent
	10.2	Amendment to Agreement between APS and James M. Levine
	12.1	Ratio of Earnings to Fixed Charges
	31.1	Certificate of William J. Post, Chief Executive Officer, pursuant to Rule 13a-14(a) and Rule 15d-14(a) of the Securities Exchange Act, as amended
	31.2	Certificate of Donald E. Brandt, Chief Financial Officer, pursuant to Rule 13a-14(a) and Rule 15d-14(a) of the Securities Exchange Act, as amended
	32.1	Certification of Chief Executive Officer and Chief Financial Officer, pursuant to 18 U.S.C. Section 1850, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
	99.1	Pinnacle West Risk Factors

     In addition, the Company hereby incorporates the following Exhibits pursuant to Exchange Act Rule 12b-32 and Regulation §229.10(d) by reference to the filings set forth below:

		Originally Filed		Date
Exhibit No.	Description	as Exhibit:	File No.a	Effective
3.1	Articles of Incorporation, restated as of July 29, 1988	19.1 to the Company’s September 30, 1988 Form 10-Q Report	1-8962	11-14-88
3.2	Bylaws, amended as of June 23, 2004	3.1 to the Company’s June 30, 2004 Form 10-Q Report	1-8962	8-9-04

^a Reports filed under File No. 1-8962 were filed in the office of the Securities and Exchange Commission located in Washington, D.C.

59

SIGNATURES

     Pursuant to the requirements of the Securities Exchange Act of 1934, the Company has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

	PINNACLE WEST CAPITAL CORPORATION
		(Registrant)
Dated: November 8, 2004	By:	/s/ Donald E. Brandt
		Donald E. Brandt
		Executive Vice President and Chief Financial Officer
		(Principal Financial Officer and Officer Duly Authorized to sign this Report)

60

EX-10.1

                                                                  EXECUTION COPY

                                CREDIT AGREEMENT

                          DATED AS OF OCTOBER 19, 2004

                                      AMONG

                       PINNACLE WEST CAPITAL CORPORATION,

                  THE LENDERS FROM TIME TO TIME PARTIES HERETO,

                              JPMORGAN CHASE BANK,
                             AS ADMINISTRATIVE AGENT

                         UNION BANK OF CALIFORNIA, N.A.,
                              AS SYNDICATION AGENT

                                       AND

                   BANK OF AMERICA, N.A., THE BANK OF NEW YORK
                        AND MIZUHO CORPORATE BANK, LTD.,
                           AS CO-DOCUMENTATION AGENTS

================================================================================

                         J.P. MORGAN SECURITIES INC. AND
                         UNION BANK OF CALIFORNIA, N.A.
                    AS CO-LEAD ARRANGERS AND CO-BOOK RUNNERS

================================================================================



                                TABLE OF CONTENTS

                                                                                                              
ARTICLE I              DEFINITIONS........................................................................        1

          1.1.   Definitions..............................................................................        1
          1.2.   Plural Forms.............................................................................       12

ARTICLE II             THE CREDITS........................................................................       12

          2.1.   Commitment...............................................................................       12
          2.2.   Required Payments; Termination...........................................................       12
          2.3.   Ratable Loans............................................................................       13
          2.4.   Types of Advances........................................................................       13
          2.5.   Facility Fee; Utilization Margin; LC Fee; Reductions in Aggregate Commitment.............       13
          2.6.   Minimum Amount of Each Advance...........................................................       14
          2.7.   Optional Principal Payments..............................................................       14
          2.8.   Method of Selecting Types and Interest Periods for New Advances..........................       14
          2.9.   Conversion and Continuation of Outstanding Advances......................................       15
          2.10.  Changes in Interest Rate, etc. ..........................................................       15
          2.11.  Rates Applicable After Default...........................................................       16
          2.12.  Method of Payment........................................................................       16
          2.13.  Noteless Agreement; Evidence of Indebtedness.............................................       16
          2.14.  Telephonic Notices.......................................................................       17
          2.15.  Interest Payment Dates; Interest and Fee Basis; Regulation D Compensation................       17
          2.16.  Notification of Advances, Interest Rates, Prepayments and Commitment Reductions..........       18
          2.17.  Lending Installations....................................................................       18
          2.18.  Non-Receipt of Funds by the Agent........................................................       19
          2.19.  Replacement of Lender....................................................................       19
          2.20   Replacement of Lender....................................................................       19
          2.20.  Letters of Credit........................................................................       20

ARTICLE III            YIELD PROTECTION; TAXES............................................................       24

          3.1.   Yield Protection.........................................................................       24
          3.2.   Changes in Capital Adequacy Regulations..................................................       25
          3.3.   Availability of Types of Advances........................................................       26
          3.4.   Funding Indemnification..................................................................       26
          3.5.   Taxes....................................................................................       26
          3.6.   Lender Statements; Survival of Indemnity.................................................       28

ARTICLE IV             CONDITIONS PRECEDENT...............................................................       29

          4.1.   Effectiveness of Agreement...............................................................       29
          4.2.   Each Credit Extension....................................................................       30

ARTICLE V              REPRESENTATIONS AND WARRANTIES.....................................................       30





                                                                                                              
          5.1.   Existence and Standing...................................................................       30
          5.2.   Corporate and Governmental Authorization; No Contravention...............................       31
          5.3.   Binding Effect...........................................................................       31
          5.4.   Financial Information....................................................................       31
          5.5.   Litigation...............................................................................       32
          5.6.   Compliance with ERISA....................................................................       32
          5.7.   Environmental Matters....................................................................       32
          5.8.   Taxes....................................................................................       32
          5.9.   Material Subsidiaries....................................................................       32
          5.10.  Not an Investment Company................................................................       33
          5.11.  Public Utility Holding Company Act, Etc. ................................................       33
          5.12.  Full Disclosure..........................................................................       33

ARTICLE VI             COVENANTS..........................................................................       33

          6.1.   Information..............................................................................       33
          6.2.   Maintenance of Property; Insurance.......................................................       35
          6.3.   Conduct of Business and Maintenance of Existence.........................................       36
          6.4.   Compliance with Laws.....................................................................       36
          6.5.   Pari Passu...............................................................................       37
          6.6.   Ownership of APS.........................................................................       37
          6.7.   Consolidations, Mergers and Sales of Assets..............................................       37
          6.8.   Use of Proceeds..........................................................................       37
          6.9.   Interest Coverage Ratio..................................................................       38
          6.10.  Indebtedness.............................................................................       38
          6.11.  Inspection of Property, Books and Records................................................       38

ARTICLE VII            DEFAULTS...........................................................................       38

ARTICLE VIII           ACCELERATION, WAIVERS, AMENDMENTS AND REMEDIES.....................................       40

          8.1.   Acceleration.............................................................................       40
          8.2.   Amendments...............................................................................       40
          8.3.   Preservation of Rights...................................................................       41

ARTICLE IX             GENERAL PROVISIONS.................................................................       41

          9.1.   Survival of Representations..............................................................       41
          9.2.   Governmental Regulation..................................................................       41
          9.3.   Headings.................................................................................       41
          9.4.   Entire Agreement.........................................................................       41
          9.5.   Several Obligations; Benefits of this Agreement..........................................       42
          9.6.   Expenses; Indemnification................................................................       42
          9.7.   Numbers of Documents.....................................................................       43
          9.8.   Accounting Terms and Determinations......................................................       43
          9.9.   Severability of Provisions...............................................................       43
          9.10.  Nonliability of Lenders..................................................................       43



                                       iii



                                                                                                              
          9.11.  Confidentiality..........................................................................       43
          9.12.  Nonreliance..............................................................................       44
          9.13.  Disclosure...............................................................................       44
          9.14.  USA Patriot Act Notification.............................................................       44
          9.15.  Relations Among Lenders..................................................................       44
          9.16.  Notice of Termination of Existing Agreements.............................................       45

ARTICLE X              THE AGENT..........................................................................       45

          10.1.  Appointment; Nature of Relationship......................................................       45
          10.2.  Powers...................................................................................       45
          10.3.  General Immunity.........................................................................       46
          10.4.  No Responsibility for Loans, Recitals, etc. .............................................       46
          10.5.  Action on Instructions of Lenders........................................................       46
          10.6.  Employment of Agents and Counsel.........................................................       46
          10.7.  Reliance on Documents; Counsel...........................................................       47
          10.8.  Agent's Reimbursement and Indemnification................................................       47
          10.9.  Notice of Default........................................................................       47
          10.10. Rights as a Lender.......................................................................       47
          10.11. Lender Credit Decision...................................................................       48
          10.12. Successor Agent..........................................................................       48
          10.13. Agent and Arranger Fees..................................................................       48
          10.14. Delegation to Affiliates.................................................................       49
          10.15. Co-Agents, Managing Agent, Documentation Agent, Syndication Agent, etc. .................       49

ARTICLE XI             SETOFF; RATABLE PAYMENTS...........................................................       49

          11.1.  Setoff...................................................................................       49
          11.2.  Ratable Payments.........................................................................       49

ARTICLE XII            BENEFIT OF AGREEMENT; ASSIGNMENTS; PARTICIPATIONS..................................       49

          12.1.  Successors and Assigns...................................................................       49
          12.2.  Participations...........................................................................       50
          12.3.  Assignments..............................................................................       51
          12.4.  Dissemination of Information.............................................................       52
          12.5.  Tax Treatment............................................................................       52

ARTICLE XIII           NOTICES............................................................................       53

          13.1.  Notices; Effectiveness; Electronic Communication.........................................       53

ARTICLE XIV            COUNTERPARTS; INTEGRATION; EFFECTIVENESS; ELECTRONIC EXECUTION.....................       54

          14.1.  Counterparts; Effectiveness..............................................................       54
          14.2.  Electronic Execution of Assignments......................................................       54



                                       iv



                                                                                                              
ARTICLE XV             CHOICE OF LAW; CONSENT TO JURISDICTION; WAIVER OF JURY TRIAL.......................       54

          15.1.  CHOICE OF LAW............................................................................       54
          15.2.  CONSENT TO JURISDICTION..................................................................       54
          15.3.  WAIVER OF JURY TRIAL.....................................................................       55



                                        v



                             SCHEDULES AND EXHIBITS

PRICING SCHEDULE
COMMITMENT SCHEDULE

SCHEDULE 2.20  EXISTING LETTERS OF CREDIT

EXHIBIT A      ASSIGNMENT AND ASSUMPTION AGREEMENT
EXHIBIT B      NOTE

                                       vi



                                CREDIT AGREEMENT

      This Agreement, dated as of October 19, 2004, is among Pinnacle West
Capital Corporation, as Borrower, the Lenders and JPMorgan Chase Bank, as Agent.
The parties hereto agree as follows:

                                    ARTICLE I

                                   DEFINITIONS

      1.1. Definitions. As used in this Agreement:

      "Advance" means a borrowing hereunder consisting of the aggregate amount
of several Loans, (i) made by the Lenders on the same Borrowing Date, or (ii)
converted or continued by the Lenders on the same date of conversion or
continuation, consisting, in either case, of the aggregate amount of the several
Loans of the same Type and, in the case of Eurodollar Loans, for the same
Interest Period.

      "Affiliate" of any Person means any other Person directly or indirectly
controlling, controlled by or under common control with such Person. A Person
shall be deemed to control another Person if the controlling Person possesses,
directly or indirectly, the power to direct or cause the direction of the
management or policies of the controlled Person, whether through ownership of
voting securities, by contract or otherwise.

      "Agent" means JPMCB in its capacity as contractual representative of the
Lenders pursuant to Article X, and not in its individual capacity as a Lender,
and any successor Agent appointed pursuant to Article X.

      "Aggregate Commitment" means the aggregate of the Commitments of all the
Lenders, as reduced from time to time pursuant to the terms hereof.

      "Aggregate Outstanding Credit Exposure" means, at any time, the aggregate
of the Outstanding Credit Exposure of all the Lenders.

      "Agreement" means this credit agreement, as it may be amended, restated,
supplemented or modified and in effect from time to time.

      "Alternate Base Rate" means, for any day, a fluctuating rate of interest
per annum equal to the higher of (i) the Prime Rate for such day and (ii) the
sum of (a) the Federal Funds Effective Rate for such day plus (b) 1/2% per
annum.

      "Annual Interest Requirements" means an amount equal to:

      (i)   interest on long-term debt for such period as reported in the
            consolidated income statement for such period, plus

      (ii)  interest on short-term debt for such period as reported in the
            consolidated income statement for such period, plus

                                       1



      (iii) imputed interest on the Sale Leaseback Obligation Bonds for such
            period, such amount being equal to the product of (A) the principal
            amount of Sale Leaseback Obligation Bonds outstanding during such
            period and (B) the rate of interest applicable to such Sale
            Leaseback Obligation Bonds during such period, plus

      (iv)  all rental payments in respect of operating leases (excluding any
            portion of such rental payments attributable to operating expenses
            and excluding any payments in respect of Sale Leaseback Obligation
            Bonds) with respect to which the payment obligations of the Borrower
            or a Consolidated Subsidiary of the Borrower have a present value of
            at least $25,000,000.

      "Applicable Facility Fee Rate" means, at any time, the percentage rate per
annum as set forth in the Pricing Schedule.

      "Applicable Margin" means, with respect to Advances of any Type at any
time, the percentage rate per annum which is applicable at such time with
respect to Advances of such Type as set forth in the Pricing Schedule.

      "Applicable Percentage" means, with respect to any Lender, the percentage
of the total Commitments represented by such Lender's Commitment. If the
Commitments have terminated or expired, the Applicable Percentages shall be
determined based upon the Commitments most recently in effect, giving effect to
any assignments.

      "Applicable Utilization Margin" means, at any time, the percentage rate
per annum at which utilization margins are accruing on the Aggregate Outstanding
Credit Exposure at such time as set forth in the Pricing Schedule.

      "Approved Fund" means any Fund that is administered or managed by (i) a
Lender, (ii) an Affiliate of a Lender or (iii) an entity or an Affiliate of an
entity that administers or manages a Lender.

      "APS" means the Arizona Public Service Company, an Arizona corporation,
and its successors.

      "Arrangers" means, collectively, J.P. Morgan Securities Inc., and its
successors, and Union Bank of California, N.A., and its successors, in their
capacity as Co-Lead Arrangers and Co-Book Runner.

      "Article" means an article of this Agreement unless another document is
specifically referenced.

      "Authorized Officer" means the Chairman of the Board, Chief Executive
Officer, Chief Financial Officer, President, Treasurer, Controller, Chief
Operating Officer, any Vice President or any Assistant Treasurer of the
Borrower.

      "Benefit Arrangement" means at any time an employee benefit plan within
the meaning of Section 3(3) of ERISA which is not a Plan or a Multiemployer Plan
and which is maintained or otherwise contributed to by any member of the ERISA
Group.

                                       2



      "Borrower" means Pinnacle West Capital Corporation, an Arizona
corporation, and its permitted successors and assigns (including, without
limitation, a debtor in possession on its behalf).

      "Borrower's 2003 Form 10-K" means the Borrower's annual report on Form
10-K for the fiscal year ended December 31, 2003, as filed with the Securities
and Exchange Commission pursuant to the Securities Exchange Act of 1934.

      "Borrower's Latest Form 10-Q" means the Borrower's quarterly report on
Form 10-Q for the quarter ended June 30, 2004, as filed with the Securities and
Exchange Commission pursuant to the Securities Exchange Act of 1934.

      "Borrower's SEC Reports" means the Borrower's 2003 Form 10-K; the
Borrower's quarterly reports on Form 10-Q for the quarters ended March 31, 2004
and June 30, 2004; and the Borrower's current reports on Form 8-K as filed with
the Securities and Exchange Commission on January 9, January 28, January 29,
February 2, February 4, April 21, May 7, June 2, June 23, July 29, August 9, and
August 18, 2004.

      "Borrowing Date" means a date on which an Advance is made hereunder.

      "Borrowing Notice" is defined in Section 2.8.

      "Business Day" means (i) with respect to any borrowing, payment or rate
selection of Eurodollar Advances, a day (other than a Saturday or Sunday) on
which banks generally are open in New York City and Phoenix, Arizona for the
conduct of substantially all of their commercial lending activities, interbank
wire transfers can be made on the Fedwire system and dealings in United States
dollars are carried on in the London interbank market and (ii) for all other
purposes, a day (other than a Saturday or Sunday) on which banks generally are
open in New York City and Phoenix for the conduct of substantially all of their
commercial lending activities and interbank wire transfers can be made on the
Fedwire system.

      "Capital Lease Obligations" means as to any Person, the obligations of
such Person to pay rent or other amounts under a lease of (or other agreement
conveying the right to use) real and/or personal property, which obligations are
required to be classified and accounted for as a capital lease on the balance
sheet of such Person under generally accepted accounting principles and, for the
purposes of this Agreement, the amount of such obligations shall be the
capitalized amount thereof, determined in accordance with generally accepted
accounting principles.

      "Change in Control" means (i) the acquisition by any Person, or two or
more Persons acting in concert, of beneficial ownership (within the meaning of
Rule 13d-3 of the Securities and Exchange Commission under the Securities
Exchange Act of 1934) of thirty percent (30%) or more of the aggregate ordinary
voting power represented by the issued and outstanding capital stock of the
Borrower; or (ii) the majority of the board of directors of the Borrower fails
to consist of Continuing Directors (other than due to death or disability).

      "Closing Date" means October 19, 2004.

                                       3



      "Commitment" means, for each Lender, the obligation of such Lender to make
Loans to, and participate in Letters of Credit issued upon the application of,
the Borrower in an aggregate amount not exceeding the amount set forth opposite
its name on the Commitment Schedule, as it may be modified as a result of any
assignment that has become effective pursuant to Section 12.3.3 or as otherwise
modified from time to time pursuant to the terms hereof.

      "Commitment Schedule" means the Schedule identifying each Lender's
Commitment attached hereto and identified as such, which Schedule may be
modified from time to time after the Closing Date by the Agent (and the parties
hereto hereby authorize the Agent to make such modifications) to reflect any
assignment that has become effective pursuant to Section 12.3.3 or as otherwise
modified from time to time pursuant to the terms hereof.

      "Confidential Information" means information that the Borrower furnishes
to any party hereto in writing designated as confidential or that any such party
obtains pursuant to its rights under Section 6.1.9 or 6.11, but does not include
any such information that (a) is or becomes generally available to the public
other than as a result of a breach by any party hereto of its obligations
hereunder, (b) was available to such party on a nonconfidential basis prior to
its disclosure to such party by the Borrower or any of its Affiliates or (c) is
or becomes available to such party from a source other than the Borrower or any
of its Affiliates that is not, to the knowledge of such party after inquiry,
acting in violation of a confidentiality agreement with the Borrower or any
other Person.

      "Consolidated Capitalization" means the sum of (i) Consolidated Debt and
(ii) Consolidated Net Worth.

      "Consolidated Debt" means at any date the Debt of the Borrower and its
Consolidated Subsidiaries determined on a consolidated basis as of such date.

      "Consolidated Net Worth" means the sum of (i) the par value (or value
stated on the books of the Borrower) of all classes of capital stock of the
Borrower and its Subsidiaries, excluding the Borrower's capital stock owned by
the Borrower and/or its Subsidiaries, plus (or minus in the case of a surplus
deficit) (ii) the amount of the consolidated surplus, whether capital or earned,
of the Borrower, determined in accordance with generally accepted accounting
principles as of the end of the most recent calendar month (excluding (x)
cumulative charges of up to $300 million to consolidated surplus resulting from,
or in anticipation of, discontinuation of FASB 71, accounting for all or part of
the business and (y) the effect on the Borrower's accumulated other
comprehensive income/loss of the ongoing application of FASB 133).

      "Consolidated Subsidiary" means at any date any Subsidiary or other entity
the accounts of which would be consolidated with those of the Borrower in its
consolidated financial statements if such statements were prepared as of such
date.

      "Continuing Director" means, with respect to any Person as of any date of
determination, any member of the board of directors of such Person who (i) was a
member of such board of directors on the date of this Agreement, or (ii) was
nominated for election or elected to such board of directors with the approval
of a majority of the Continuing Directors who were members of such board at the
time of such nomination or election.

                                       4



      "Conversion/Continuation Notice" is defined in Section 2.9.

      "Credit Extension" means the making of an Advance or the issuance of a
Letter of Credit hereunder.

      "Credit Extension Date" means the Borrowing Date for an Advance or the
issuance date for a Letter of Credit.

      "Debt" means as to any Person at any date (without duplication): (i)
indebtedness created, issued, incurred or assumed by such Person for borrowed
money or evidenced by bonds, debentures, notes or similar instruments; (ii) all
obligations of such Person to pay the deferred purchase price of property or
services, excluding, however, trade accounts payable (other than for borrowed
money) arising in, and accrued expenses incurred in, the ordinary course of
business of such Person so long as such trade accounts payable are paid within
180 days of the date incurred; (iii) all Debt secured by a lien on any asset of
such Person, to the extent such Debt has been assumed by, or is a recourse
obligation of, such Person; (iv) all Guarantees by such Person; (v) all Capital
Lease Obligations of such Person; and (vi) the amount of all reimbursement
obligations of such Person (whether contingent or otherwise) in respect of
letters of credit, bankers' acceptances, surety or other bonds and similar
instruments in support of Debt.

      "Default" means an event described in Article VII.

      "Derivative Obligations" of any Person means all obligations of such
Person in respect of any rate swap transaction, basis swap, forward rate
transaction, commodity swap, commodity option, equity or equity index swap,
equity or equity index option, bond option, interest rate option, foreign
exchange transaction, cap transaction, floor transaction, collar transaction,
currency swap transaction, cross-currency rate swap transaction, currency option
or any other similar transaction (including any option with respect to any of
the foregoing transactions) or any combination of the foregoing transactions.

      "Environmental Laws" means any and all federal, state, local and foreign
statutes, laws, judicial decisions, regulations, ordinances, rules, judgments,
orders, decrees, plans, injunctions, permits, concessions, grants, franchises,
licenses, agreements and other governmental restrictions relating to the
environment, the effect of the environment on human health or to emissions,
discharges or releases of pollutants, contaminants, Hazardous Substances or
wastes into the environment including, without limitation, ambient air, surface
water, ground water, or land, or otherwise relating to the manufacture,
processing, distribution, use, treatment, storage, disposal, transport or
handling of pollutants, contaminants, Hazardous Substances or wastes or the
clean-up or other remediation thereof.

      "ERISA" means the Employee Retirement Income Security Act of 1974, as
amended, or any successor statute and any rule or regulation issued thereunder.

      "ERISA Group" means the Borrower, any Subsidiary and all members of a
controlled group of corporations and all trades or businesses (whether or not
incorporated) under common control which, together with the Borrower or any
Subsidiary are treated as a single employer under Section 414 of the Internal
Revenue Code.

                                       5



      "Eurodollar Advance" means an Advance which, except as otherwise provided
in Section 2.11, bears interest at the applicable Eurodollar Rate.

      "Eurodollar Loan" means a Loan which, except as otherwise provided in
Section 2.11, bears interest at the applicable Eurodollar Rate.

      "Eurodollar Rate" means, with respect to a Eurodollar Advance for the
relevant Interest Period, the sum of (i) the LIBO Rate applicable to such
Interest Period, plus (ii) the then Applicable Margin, changing as and when the
Applicable Margin changes.

      "Excluded Taxes" means, in the case of each Lender, each Issuing Bank or
applicable Lending Installation and the Agent, (A) taxes imposed on its overall
net income, and franchise taxes imposed on it, by (i) the United States, (ii)
any jurisdiction under the laws of which such Lender, such Issuing Bank or the
Agent is incorporated or organized or (iii) any jurisdiction in which the
Agent's, such Issuing Bank's or such Lender's principal executive office or such
Lender's or Issuing Bank's applicable Lending Installation is located and (B) in
the case of each Lender and Issuing Bank, any United States withholding tax
imposed with respect to any payment by the Borrower pursuant to this Agreement,
but only up to the rate (if any) at which United States withholding tax would
apply to such payments to such Lender or Issuing Bank, or applicable Lending
Installation, at the time such Lender or Issuing Bank, as applicable, first
becomes a party to this Agreement.

      "Exhibit" refers to an exhibit to this Agreement, unless another document
is specifically referenced.

      "Existing Credit Agreements" means, collectively, (i) that certain Credit
Agreement, dated as of December 18, 2003, by and among the Borrower, the lenders
parties thereto and Bank One, NA, as administrative agent, and (ii) that certain
Credit Agreement, dated as of November 30, 2001, by and among the Borrower, the
lenders parties thereto, and JPMorgan Chase Bank, as administrative agent, in
each case, as the same has been amended, restated, supplemented or otherwise
modified from time to time.

      "Facility Termination Date" means October 19, 2007, or any earlier date on
which the Aggregate Commitment is reduced to zero or otherwise terminated
pursuant to the terms hereof.

      "Federal Funds Effective Rate" means, for any day, the weighted average
(rounded upwards, if necessary, to the next 1/100 of 1%) of the rates on
overnight Federal funds transactions with members of the Federal Reserve System
arranged by Federal funds brokers, as published on the next succeeding Business
Day by the Federal Reserve Bank of New York, or, if such rate is not so
published for any day that is a Business Day, the average (rounded upwards, if
necessary, to the next 1/100 of 1%) of the quotations for such day for such
transactions received by the Agent from three Federal funds brokers of
recognized standing selected by it.

      "Floating Rate" means, for any day, a rate per annum equal to (i) the
Alternate Base Rate for such day plus (ii) the Applicable Margin, in each case
changing when and as the Alternate Base Rate changes.

                                       6



      "Floating Rate Advance" means an Advance which, except as otherwise
provided in Section 2.11, bears interest at the Floating Rate.

      "Floating Rate Loan" means a Loan which, except as otherwise provided in
Section 2.11, bears interest at the Floating Rate.

      "Fund" means any Person (other than a natural person) that is (or will be)
engaged in making, purchasing, holding or otherwise investing in commercial
loans and similar extensions of credit in the ordinary course of its business.

      "Guarantee" means as to any Person, any obligation, contingent or
otherwise, of such Person directly or indirectly guaranteeing any Debt of any
other Person or in any manner providing for the payment of any Debt of any other
Person or otherwise protecting the holder of such Debt against loss (whether by
virtue of partnership arrangements, agreements to keep well, to purchase assets,
goods, securities or services, or to take-or-pay or otherwise), provided that
the term "Guarantee" shall not include endorsements for collection or deposit in
the ordinary course of business. The term "Guarantee" used as a verb has a
corresponding meaning.

      "Hazardous Substances" means (i) any toxic, radioactive, caustic or
otherwise hazardous substance, as defined by any applicable Environmental Law;
(ii) petroleum, its derivatives, by-products and other hydrocarbons; or (iii)
any substance having any constituent elements displaying any of the foregoing
characteristics, as defined by any applicable Environmental Law.

      "Income Available for Debt Service" means an amount equal to:

      (i)     consolidated net income of the Borrower and its Consolidated
              Subsidiaries for such period, plus

      (ii)    all material non-recurring items which decreased said net income
              for such period, minus

      (iii)   all material non-recurring items which increased said net income
              for such period, plus

      (iv)    income taxes deducted in determining said net income for such
              period, plus

      (v)     total Annual Interest Requirements of the Borrower and its
              Consolidated Subsidiaries for such period, plus

      (vi)    depreciation and amortization, and nuclear fuel amortization for
              such period, minus

      (vii)   allowance for equity and borrowed funds used during construction
              for such period, minus

      (viii)  deferrals as described in Financial Accounting Standards Board
              Statement No. 71 for such period, plus or minus

                                       7



      (ix)    other significant noncash items for such period as may be
              specified under Financial Accounting Standards Board Statements or
              other accounting guidelines.

      "Interest Coverage Ratio" means, with respect to the Borrower and its
Consolidated Subsidiaries, for each twelve-month period ending on the last day
of each fiscal quarter (determined as of the last day of such fiscal quarter),
the ratio of Income Available for Debt Service to, without duplication of any
item, Annual Interest Requirements.

      "Interest Period" means, with respect to a Eurodollar Advance, a period of
one, two, three or six months commencing on a Business Day selected by the
Borrower pursuant to this Agreement. Such Interest Period shall end on the day
which corresponds numerically to such date one, two, three or six months
thereafter, provided, however, that if there is no such numerically
corresponding day in such next, second, third or sixth succeeding month, such
Interest Period shall end on the last Business Day of such next, second, third
or sixth succeeding month. If an Interest Period would otherwise end on a day
which is not a Business Day, such Interest Period shall end on the next
succeeding Business Day, provided, however, that if said next succeeding
Business Day falls in a new calendar month, such Interest Period shall end on
the immediately preceding Business Day.

      "Internal Revenue Code" means the Internal Revenue Code of 1986, as
amended, or any successor statute.

      "Issuing Bank" means JPMCB or any other Lender (with such Lender's
consent) satisfactory to the Agent and the Borrower in its capacity as issuer of
Letters of Credit hereunder.

      "JPMCB" means JPMorgan Chase Bank, in its individual capacity, and its
successors.

      "LC Disbursement" means a payment made by an Issuing Bank pursuant to a
Letter of Credit.

      "LC Exposure" means, at any time, the sum of (i) the aggregate undrawn
amount of all outstanding Letters of Credit at such time plus (ii) the aggregate
unpaid amount of all Reimbursement Obligations at such time. The LC Exposure of
any Lender at any time shall be its Applicable Percentage of the total LC
Exposure at such time.

      "LC Fee" is defined in Section 2.5.3.

      "Lenders" means the lending institutions listed on the signature pages of
this Agreement and their respective permitted successors and assigns.

      "Lending Installation" means, with respect to a Lender, an Issuing Bank or
the Agent, the office, branch, subsidiary or affiliate of such Lender, Issuing
Bank or the Agent listed on the administrative information sheets provided to
the Agent in connection herewith or on the signature pages hereof or on a
Schedule or otherwise selected by such Lender, Issuing Bank or the Agent
pursuant to Section 2.17.

                                       8



      "Letter of Credit" means any letter of credit issued pursuant to this
Agreement, including, without limitation, each Letter of Credit deemed issued by
JPMCB, as Issuing Bank, hereunder pursuant to Section 2.20.1(ii).

      "Letter of Credit Application" is defined in Section 2.20.1(i).

      "Letter of Credit Collateral Account" is defined in Section 2.20.10.

      "LIBO Rate" means, with respect to any Eurodollar Advance for any Interest
Period, the rate appearing on Page 3750 of the Dow Jones Market Service (or on
any successor or substitute page of such Service, or any successor to or
substitute for such Service, providing rate quotations comparable to those
currently provided on such page of such Service, as determined by the Agent from
time to time for purposes of providing quotations of interest rates applicable
to dollar deposits in the London interbank market) at approximately 11:00 a.m.,
London time, two Business Days prior to the commencement of such Interest
Period, as the rate for dollar deposits with a maturity comparable to such
Interest Period. In the event that such rate is not available at such time for
any reason, then the "LIBO Rate" with respect to such Eurodollar Advance for
such Interest Period shall be the rate at which dollar deposits of $5,000,000
and for a maturity comparable to such Interest Period are offered by the
principal London office of the Agent in immediately available funds in the
London interbank market at approximately 11:00 a.m., London time, two Business
Days prior to the commencement of such Interest Period.

      "Lien" means, with respect to any asset, any mortgage, lien, pledge,
charge, security interest or encumbrance of any kind, or any other type of
preferential arrangement that has the practical effect of creating a security
interest, in respect of such asset. For the purposes of this Agreement, the
Borrower or any Subsidiary shall be deemed to own subject to a Lien any asset
which it has acquired or holds subject to the interest of a vendor or lessor
under any conditional sale agreement, capital lease or other title retention
agreement relating to such asset.

      "Loan" means, with respect to a Lender, such Lender's loan made pursuant
to Article II (or any conversion or continuation thereof).

      "Loan Documents" means this Agreement and any Notes issued pursuant to
Section 2.13.

      "Material Debt" means Debt (other than the Credit Extensions) of the
Borrower and/or one or more of its Material Subsidiaries in an aggregate
principal amount exceeding $25,000,000.

      "Material Derivative Obligations" means Derivative Obligations of the
Borrower and/or one or more of its Material Subsidiaries with an aggregate
mark-to-market termination amount exceeding $25,000,000.

      "Material Plan" means at any time a Plan or Plans having aggregate
Unfunded Liabilities in excess of $25,000,000.

      "Material Subsidiary" means APS and each other Subsidiary of the Borrower
(other than SunCor Development Company and any of its Subsidiaries) whose
consolidated assets exceed 10% of the consolidated assets of the Borrower and
its Consolidated Subsidiaries.

                                       9



      "Modify" and "Modification" are defined in Section 2.20.1(i).

      "Moody's" means Moody's Investors Service, Inc., and any successor
thereto.

      "Multiemployer Plan" means, at any time, an employee pension benefit plan
within the meaning of Section 4001(a)(3) of ERISA to which any member of the
ERISA Group is then making or accruing an obligation to make contributions or
has within the preceding five plan years made contributions, including for these
purposes any Person which ceased to be a member of the ERISA Group during such
five year period.

      "Non-U.S. Lender" is defined in Section 3.5(iv).

      "Note" is defined in Section 2.13.

      "Obligations" means all unpaid principal of and accrued and unpaid
interest on the Loans, all Reimbursement Obligations, all accrued and unpaid
fees and all expenses, reimbursements, indemnities and other obligations of the
Borrower to the Lenders or to any Lender, any Issuing Bank, the Agent or any
indemnified party arising under the Loan Documents.

      "Other Taxes" is defined in Section 3.5(ii).

      "Outstanding Credit Exposure" means, as to any Lender at any time, the sum
of (i) the aggregate principal amount of its Loans outstanding at such time,
plus (ii) an amount equal to its Applicable Percentage of the LC Exposure at
such time.

      "Participants" is defined in Section 12.2.1.

      "Payment Date" means the last day of each of March, June, September and
December and the Facility Termination Date.

      "PBGC" means the Pension Benefit Guaranty Corporation or any entity
succeeding to any or all of its functions under ERISA.

      "Person" means an individual, a corporation, a limited liability company,
a partnership, an association, a trust or any other entity or organization,
including a government or political subdivision or an agency or instrumentality
thereof.

      "Plan" means, at any time, an employee pension benefit plan (other than a
Multiemployer Plan) which is covered by Title IV of ERISA or subject to the
minimum funding standards under Section 412 of the Internal Revenue Code and
either (i) is maintained, or contributed to, by any member of the ERISA Group
for employees of any member of the ERISA Group or (ii) has at any time within
the preceding five years been maintained, or contributed to, by any Person which
was at such time a member of the ERISA Group for employees of any Person which
was at such time a member of the ERISA Group.

      "Pricing Schedule" means the Schedule attached hereto identified as such.

                                       10



      "Prime Rate" means the rate of interest per annum publicly announced from
time to time by JPMCB as its prime rate in effect at its principal office in New
York City; each change in the Prime Rate shall be effective from and including
the date such change is publicly announced as being effective.

      "Purchasers" is defined in Section 12.3.1.

      "PWEC" means Pinnacle West Energy Corporation, an Arizona corporation, and
its successors.

      "Regulation U" means Regulation U of the Board of Governors of the Federal
Reserve System as in effect from time to time and any successor or other
regulation or official interpretation of said Board of Governors relating to the
extension of credit by banks, non-banks and non-broker lenders for the purpose
of purchasing or carrying margin stocks applicable to member banks of the
Federal Reserve System.

      "Reimbursement Obligations" means, at any time, the aggregate of all LC
Disbursements and all other obligations of the Borrower then outstanding under
Section 2.20 to reimburse the applicable Issuing Bank for amounts paid by such
Issuing Bank in respect of any one or more drawings under Letters of Credit
issued by it.

      "Required Lenders" means Lenders in the aggregate having more than 50% of
the Aggregate Commitment at such time or, if the Aggregate Commitment has been
terminated, Lenders in the aggregate holding more than 50% of the Aggregate
Outstanding Credit Exposure at such time.

      "S&P" means Standard and Poor's Ratings Group, a division of The
McGraw-Hill Companies, Inc., and any successor thereto.

      "Sale Leaseback Obligation Bonds" means PVNGS II Funding Corp.'s (i) 7.39%
Secured Lease Obligation Bond, Series 1993, due 2005; (ii) 8.00% Secured Lease
Obligation Bonds, Series 1993, due 2015; (iii) any other bonds issued by the
Borrower in connection with a sale/leaseback transaction; and (iv) any
refinancing or refunding of the obligations specified in subclauses (i) through
(iii) above.

      "Schedule" refers to a specific schedule to this Agreement, unless another
document is specifically referenced.

      "Section" means a numbered section of this Agreement, unless another
document is specifically referenced.

      "Subsidiary" means, as to any Person, any corporation or other entity of
which securities or other ownership interests having ordinary voting power to
elect a majority of the board of directors or other persons performing similar
functions are at the time directly or indirectly owned by such Person. Unless
otherwise specified, "Subsidiary" means a Subsidiary of the Borrower.

                                       11



      "Syndication Agent" means Union Bank of California, N.A. and its
successors and assigns.

      "Taxes" means any and all present or future taxes, duties, levies,
imposts, deductions, charges or withholdings, and any and all liabilities with
respect to the foregoing, but excluding Excluded Taxes and Other Taxes.

      "Transferee" is defined in Section 12.4.

      "Type" means, with respect to any Advance, its nature as a Floating Rate
Advance or a Eurodollar Advance and with respect to any Loan, its nature as a
Floating Rate Loan or a Eurodollar Loan.

      "Unfunded Liabilities" means, with respect to any Plan at any time, the
amount (if any) by which (i) the value of all benefit liabilities under such
Plan, determined on a plan termination basis using the assumptions prescribed by
the PBGC for purposes of Section 4044 of ERISA, exceeds (ii) the fair market
value of all Plan assets allocable to such liabilities under Title IV of ERISA
(excluding any accrued but unpaid contributions), all determined as of the then
most recent valuation date for such Plan, but only to the extent that such
excess represents a potential liability of a member of the ERISA Group to the
PBGC or any other Person under Title IV of ERISA.

      "Unmatured Default" means an event which but for the lapse of time or the
giving of notice, or both, would constitute a Default.

      1.2. Plural Forms. The foregoing definitions shall be equally applicable
to both the singular and plural forms of the defined terms.

                                   ARTICLE II

                                   THE CREDITS

      2.1. Commitment. From and including the date of this Agreement and prior
to the Facility Termination Date, each Lender severally agrees, on the terms and
conditions set forth in this Agreement, to (i) make Loans to the Borrower and
(ii) participate in Letters of Credit issued upon the request of the Borrower,
provided that, after giving effect to the making of each such Loan and the
issuance of each such Letter of Credit, such Lender's Outstanding Credit
Exposure shall not exceed its Commitment. Subject to the terms of this
Agreement, the Borrower may borrow, repay and reborrow at any time prior to the
Facility Termination Date. The Commitments to extend credit hereunder shall
expire on the Facility Termination Date. The Issuing Banks will issue Letters of
Credit hereunder on the terms and conditions set forth in Section 2.20.

      2.2. Required Payments; Termination. The Aggregate Outstanding Credit
Exposure and all other unpaid Obligations (other than contingent indemnity
obligations and other expense reimbursement obligations not then due and
payable) shall be payable on the Facility Termination Date.

                                       12



      2.3. Ratable Loans. Each Advance hereunder shall consist of Loans made
from the several Lenders ratably in proportion to their Applicable Percentages.

      2.4. Types of Advances. The Advances may be Floating Rate Advances or
Eurodollar Advances, or a combination thereof, selected by the Borrower in
accordance with Sections 2.8 and 2.9.

      2.5. Facility Fee; Utilization Margin; LC Fee; Reductions in Aggregate
Commitment.

            2.5.1 The Borrower agrees to pay to the Agent for the account of
      each Lender a facility fee at a per annum rate equal to the Applicable
      Facility Fee Rate on such Lender's Commitment (whether used or unused)
      from the date hereof to and including the Facility Termination Date,
      payable in arrears on each Payment Date hereafter, provided that, if any
      Lender continues to have Outstanding Credit Exposure outstanding hereunder
      after the termination of its Commitment (including, without limitation,
      during any period when Outstanding Credit Exposure may be outstanding but
      new Credit Extensions may not be made hereunder), then such facility fee
      shall continue to accrue on the Outstanding Credit Exposure owed to such
      Lender until such Outstanding Credit Exposure is repaid in full.

            2.5.2 For each day from and after the date hereof to but not
      including the Facility Termination Date on which the Aggregate Outstanding
      Credit Exposure exceeds fifty percent (50%) of the Aggregate Commitment,
      the interest rate otherwise applicable to the Advances and the LC Fee,
      respectively, shall be increased by an amount equal to a utilization
      margin at a rate per annum equal to the Applicable Utilization Margin in
      effect from time to time, payable from the date hereof until the date on
      which this Agreement is terminated in full and the Aggregate Outstanding
      Credit Exposure has been paid in full pursuant to Section 2.2. Such
      utilization margin shall be payable in arrears on each Payment Date
      hereafter and on the date on which this Agreement is terminated in full
      and the Aggregate Outstanding Credit Exposure hereunder has been paid in
      full pursuant to Section 2.2.

            2.5.3 The Borrower agrees to pay (i) to the Agent for the account of
      each Lender a participation fee with respect to its participations in
      Letters of Credit (the "LC Fee"), which shall accrue at the same
      Applicable Margin used to determine the interest rate applicable to
      Eurodollar Loans on the average daily amount of such Lender's LC Exposure
      (excluding any portion thereof attributable to unreimbursed LC
      Disbursements) during the period from and including the Closing Date to
      but excluding the later of the date on which such Lender's Commitment
      terminates and the date on which such Lender ceases to have any LC
      Exposure, and (ii) to each Issuing Bank a fronting fee, which shall accrue
      at a per annum rate agreed upon between the Borrower and the applicable
      Issuing Bank on the average daily amount of the LC Exposure (excluding any
      portion thereof attributable to unreimbursed LC Disbursements) related to
      Letters of Credit issued by it during the period from and including the
      Closing Date to but excluding the later of the date of termination of the
      Commitments and the date on which there ceases to be any LC Exposure, as
      well as such Issuing Bank's standard fees with respect to the issuance or
      Modification of any Letter of Credit issued by it or processing of
      drawings thereunder. Participation fees and fronting fees accrued through
      and including the last day of March,

                                       13



      June, September and December of each year shall be payable on or before
      the third Business Day following such last day, commencing on the first
      such date to occur after the Closing Date; provided that all such accrued
      and unpaid fees shall be payable on the date on which the Commitments
      terminate and any such fees accruing after the date on which the
      Commitments terminate shall be payable either on demand, if such
      termination is due to a Default arising under Section 7.1, 7.6 or 7.7, or
      otherwise within 3 days after demand. Any other fees payable to the
      Issuing Banks pursuant to this Section 2.5.3 shall be payable within 10
      days after demand. All participation fees and fronting fees shall be
      computed on the basis of a year of 360 days and shall be payable for the
      actual number of days elapsed (including the first day but excluding the
      last day).

            2.5.4 The Borrower may permanently reduce the Aggregate Commitment
      in whole, or in part ratably among the Lenders in integral multiples of
      $1,000,000, upon at least three Business Days' prior written notice to the
      Agent, which notice shall specify the amount of any such reduction,
      provided, however, that the amount of the Aggregate Commitment may not be
      reduced below the Aggregate Outstanding Credit Exposure. All accrued
      facility fees and utilization margin shall be payable on the effective
      date of any termination of the obligations of the Lenders to make Credit
      Extensions hereunder and on the final date upon which the Aggregate
      Outstanding Credit Exposure is repaid hereunder.

      2.6. Minimum Amount of Each Advance. Each Eurodollar Advance shall be in
the minimum amount of $5,000,000 (and in multiples of $1,000,000 if in excess
thereof), and, except as provided in Section 2.20.5, each Floating Rate Advance
shall be in the minimum amount of $5,000,000 (and in multiples of $1,000,000 if
in excess thereof), provided, however, that any Floating Rate Advance may be in
the amount of the unused Aggregate Commitment.

      2.7. Optional Principal Payments. The Borrower may from time to time pay,
without penalty or premium, all outstanding Floating Rate Advances, or, in a
minimum aggregate amount of $1,000,000 or any integral multiple of $1,000,000 in
excess thereof, any portion of the outstanding Floating Rate Advances upon one
Business Day's prior notice to the Agent. The Borrower may from time to time
pay, subject to the payment of any funding indemnification amounts required by
Section 3.4 but without penalty or premium, all outstanding Eurodollar Advances,
or, in a minimum aggregate amount of $5,000,000 or any integral multiple of
$1,000,000 in excess thereof, any portion of the outstanding Eurodollar Advances
upon three Business Days' prior notice to the Agent.

      2.8. Method of Selecting Types and Interest Periods for New Advances. The
Borrower shall select the Type of Advance and, in the case of each Eurodollar
Advance, the Interest Period applicable thereto from time to time. The Borrower
shall give the Agent irrevocable notice (a "Borrowing Notice") not later than
1:30 p.m. (New York time) on the Borrowing Date of each Floating Rate Advance
and three Business Days before the Borrowing Date for each Eurodollar Advance,
specifying:

      (i)   the Borrowing Date, which shall be a Business Day, of such Advance,

      (ii)  the aggregate amount of such Advance,

                                       14



      (iii) the Type of Advance selected, and

      (iv)  in the case of each Eurodollar Advance, the Interest Period
            applicable thereto.

The Agent will promptly send each Borrowing Notice to the Lenders. Not later
than 3:30 p.m. (New York time) on each Borrowing Date, each Lender shall make
available its Loan or Loans in funds immediately available in New York to the
Agent at its address specified pursuant to Article XIII. The Agent will make the
funds so received from the Lenders available to the Borrower at the Agent's
aforesaid address or as otherwise provided in such Borrowing Notice.

      2.9. Conversion and Continuation of Outstanding Advances. Floating Rate
Advances shall continue as Floating Rate Advances unless and until such Floating
Rate Advances are converted into Eurodollar Advances pursuant to this Section
2.9 or are repaid in accordance with Section 2.7. Each Eurodollar Advance shall
continue as a Eurodollar Advance until the end of the then applicable Interest
Period therefor, at which time such Eurodollar Advance shall be automatically
converted into a Floating Rate Advance unless (x) such Eurodollar Advance is or
was repaid in accordance with Section 2.7 or (y) the Borrower shall have given
the Agent a Conversion/Continuation Notice (as defined below) requesting that,
at the end of such Interest Period, such Eurodollar Advance continue as a
Eurodollar Advance for the same or another Interest Period. Subject to the terms
of Section 2.6, the Borrower may elect from time to time to convert all or any
part of a Floating Rate Advance into a Eurodollar Advance. The Borrower shall
give the Agent irrevocable notice (a "Conversion/Continuation Notice") of each
conversion of a Floating Rate Advance into a Eurodollar Advance or continuation
of a Eurodollar Advance not later than 11:00 a.m. (New York time) at least three
Business Days prior to the date of the requested conversion or continuation,
specifying:

      (i)   the requested date, which shall be a Business Day, of such
            conversion or continuation,

      (ii)  the aggregate amount and Type of the Advance which is to be
            converted or continued, and

      (iii) in connection with the conversion or continuation of an Advance as a
            Eurodollar Advance, (a) the amount of such Advance which is to be
            converted or continued and (b) the duration of the Interest Period
            applicable thereto.

      2.10. Changes in Interest Rate, etc. Each Floating Rate Advance shall bear
interest on the outstanding principal amount thereof, for each day from and
including the date such Advance is made or is automatically converted from a
Eurodollar Advance into a Floating Rate Advance pursuant to Section 2.9, to but
excluding the date it is paid or is converted into a Eurodollar Advance pursuant
to Section 2.9 hereof, at a rate per annum equal to the Floating Rate for such
day. Changes in the rate of interest on that portion of any Advance maintained
as a Floating Rate Advance will take effect simultaneously with each change in
the Alternate Base Rate. Each Eurodollar Advance shall bear interest on the
outstanding principal amount thereof from and including the first day of the
Interest Period applicable thereto to (but not including) the last day of such
Interest Period at the interest rate determined by the Agent as applicable to
such Eurodollar Advance based upon the Borrower's selections under Sections 2.8
and 2.9 and

                                       15



otherwise in accordance with the terms hereof. No Interest Period may end after
the Facility Termination Date. The Borrower shall select Interest Periods so
that it is not necessary to repay any portion of a Eurodollar Advance prior to
the last day of the applicable Interest Period in order to make a mandatory
repayment required pursuant to Section 2.2.

      2.11. Rates Applicable After Default. Notwithstanding anything to the
contrary contained in Section 2.8, 2.9 or 2.10, during the continuance of a
Default or Unmatured Default the Required Lenders may, at their option, by
notice to the Borrower (which notice may be revoked at the option of the
Required Lenders notwithstanding any provision of Section 8.2 requiring
unanimous consent of the Lenders to changes in interest rates), declare that no
Advance may be made as, converted into or continued as a Eurodollar Advance.
During the continuance of a Default under Section 7.1, 7.6 (relating to the
Borrower) or 7.7 (relating to the Borrower) and without any election or action
on the part of the Agent or any Lender, (i) each Eurodollar Advance shall bear
interest for the remainder of the applicable Interest Period at the rate
otherwise applicable to such Interest Period plus 2% per annum, (ii) each
Floating Rate Advance shall bear interest at a rate per annum equal to the
Floating Rate in effect from time to time plus 2% per annum and (iii) the LC Fee
shall be increased to a rate per annum equal to the Applicable Margin used to
determine the interest applicable to Eurodollar Loans in effect from time to
time plus 2% per annum, provided that the Required Lenders may, at their option
revoke such increase notwithstanding any provision of Section 8.2 requiring
unanimous consent of the Lenders to changes in interest rates or the LC Fee.

      2.12. Method of Payment. All payments of the Obligations hereunder shall
be made, without setoff, deduction, or counterclaim, in immediately available
funds to the Agent at the Agent's address specified pursuant to Article XIII, or
at any other Lending Installation of the Agent specified in writing by the Agent
to the Borrower, by 1:00 p.m. (New York time) on the date when due and shall be
applied ratably by the Agent among the Lenders in accordance with amounts then
owing to such Lenders. Each payment delivered to the Agent for the account of
any Lender shall be delivered promptly by the Agent to such Lender in the same
type of funds that the Agent received at its address specified pursuant to
Article XIII or at any Lending Installation specified in a notice received by
the Agent from such Lender. Each reference to the Agent in this Section 2.12
shall also be deemed to refer, and shall apply equally, to the Issuing Banks, in
the case of payments required to be made by the Borrower to the Issuing Banks
pursuant to Section 2.20.5.

      2.13. Noteless Agreement; Evidence of Indebtedness. (i) Each Lender shall
maintain in accordance with its usual practice an account or accounts evidencing
the indebtedness of the Borrower to such Lender resulting from each Credit
Extension made by such Lender from time to time, including the amounts of
principal and interest payable and paid to such Lender from time to time
hereunder.

      (ii)  The Agent shall also maintain accounts in which it will record (a)
            the amount of each Loan made hereunder, the Type thereof and the
            Interest Period with respect thereto, (b) the amount of any
            principal or interest due and payable or to become due and payable
            from the Borrower to each Lender hereunder, (c) the original stated
            amount of each Letter of Credit and the amount of LC Exposure

                                       16



            outstanding at any time and (d) the amount of any sum received by
            the Agent hereunder from the Borrower and each Lender's share
            thereof.

      (iii) The entries maintained in the accounts maintained pursuant to
            paragraphs (i) and (ii) above shall be prima facie evidence of the
            existence and amounts of the Obligations therein recorded; provided,
            however, that the failure of the Agent or any Lender to maintain
            such accounts or any error therein shall not in any manner affect
            the obligation of the Borrower to repay the Obligations in
            accordance with their terms.

      (iv)  Any Lender may request that its Loans be evidenced by a promissory
            note in substantially the form of Exhibit C (a "Note"). In such
            event, the Borrower shall prepare, execute and deliver to such
            Lender such Note payable to the order of such Lender or its
            registered assigns. Thereafter, the Loans evidenced by such Note and
            interest thereon shall at all times (prior to any assignment
            pursuant to Section 12.3) be represented by one or more Notes
            payable to the order of the payee named therein, except to the
            extent that any such Lender subsequently returns any such Note for
            cancellation and requests that such Loans once again be evidenced as
            described in paragraphs (i) and (ii) above.

      2.14. Telephonic Notices. The Borrower hereby authorizes the Lenders and
the Agent to extend, convert or continue Advances, effect selections of Types of
Advances and to transfer funds based on telephonic notices made by any person or
persons the Agent or any Lender in good faith believes to be acting on behalf of
the Borrower, it being understood that the foregoing authorization is
specifically intended to allow Borrowing Notices and Conversion/Continuation
Notices to be given telephonically. The Borrower agrees to deliver promptly to
the Agent a written confirmation, if such confirmation is requested by the Agent
or any Lender, of each telephonic notice signed by an Authorized Officer. If the
written confirmation differs in any material respect from the action taken by
the Agent and the Lenders, the records of the Agent and the Lenders shall govern
absent manifest error.

      2.15. Interest Payment Dates; Interest and Fee Basis; Regulation D
Compensation.

            2.15.1 Interest accrued on each Floating Rate Advance shall be
      payable on each Payment Date, commencing with the first such date to occur
      after the date hereof, on any date on which the Floating Rate Advance is
      prepaid, whether due to acceleration or otherwise, and at maturity.
      Interest accrued on that portion of the outstanding principal amount of
      any Floating Rate Advance converted into a Eurodollar Advance on a day
      other than a Payment Date shall be payable on the date of conversion.
      Interest accrued on each Eurodollar Advance shall be payable on the last
      day of its applicable Interest Period, on any date on which the Eurodollar
      Advance is prepaid, whether by acceleration or otherwise, and at maturity.
      Interest accrued on each Eurodollar Advance having an Interest Period
      longer than three months shall also be payable on the last day of each
      three-month interval during such Interest Period. Interest on Eurodollar
      Advances and fees shall be calculated for actual days elapsed on the basis
      of a 360-day year. Interest on Floating Rate Advances shall be calculated
      for actual days elapsed on the basis of a 365-/366-day year. Interest
      shall be payable for the day an Advance is made but not for the

                                       17



      day of any payment on the amount paid if payment is received prior to 1:00
      p.m. (New York time) at the place of payment. If any payment of principal
      of or interest on an Advance, any fees or any other amounts payable to the
      Agent or any Lender hereunder shall become due on a day which is not a
      Business Day, such payment shall be made on the next succeeding Business
      Day and, in the case of a principal payment, such extension of time shall
      be included in computing interest, fees and commissions in connection with
      such payment.

            2.15.2 Each Lender may require the Borrower to pay,
      contemporaneously with each payment of interest on such Lender's
      Eurodollar Loans, additional interest on the such Lender's Eurodollar Loan
      at a rate per annum determined by such Lender up to but not exceeding the
      excess of (i) (A) the applicable LIBO Rate divided by (B) one minus the
      "Eurodollar Reserve Percentage" (as defined below) over (ii) the
      applicable LIBO Rate. Any Lender wishing to require payment of such
      additional interest (x) shall so notify the Borrower and the Agent, in
      which case such additional interest on such Lender's Eurodollar Loans
      shall be payable to such Lender at the place indicated in such notice with
      respect to each Interest Period commencing at least three Business Days
      after the giving of such notice and (y) shall notify the Borrower at least
      five Business Days prior to each date on which interest is payable on the
      Eurodollar Loans of the amount then due it under this Section 2.15.2.
      "Eurodollar Reserve Percentage" means for any day that percentage
      (expressed as a decimal) which is in effect on such day, as prescribed by
      the Board of Governors of the Federal Reserve System (or any successor)
      for determining the maximum reserve requirement for a member bank of the
      Federal Reserve System in New York City with deposits exceeding five
      billion dollars in respect of "Eurocurrency liabilities" (or in respect of
      any other category of liabilities which includes deposits by reference to
      which the interest rate on Eurodollar Advances is determined or any
      category of extensions of credit or other assets which includes loans by a
      non-United States office of any Lender to United States residents).

      2.16. Notification of Advances, Interest Rates, Prepayments and Commitment
Reductions. Promptly after receipt thereof, the Agent will notify each Lender of
the contents of each Aggregate Commitment reduction notice, Borrowing Notice,
Conversion/Continuation Notice, and repayment notice received by it hereunder.
The Agent will notify each Lender of the interest rate applicable to each
Eurodollar Advance promptly upon determination of such interest rate and will
give each Lender prompt notice of each change in the Alternate Base Rate.

      2.17. Lending Installations. Each Lender may book its Loans and its
participation in any LC Exposure and the Issuing Banks may book the Letters of
Credit issued by it at any Lending Installation selected by such Lender or
Issuing Bank, as the case may be, and may change its Lending Installation from
time to time. All terms of this Agreement shall apply to any such Lending
Installation and the Loans, Letters of Credit, participations in LC Exposure and
any Notes issued hereunder shall be deemed held by each Lender or Issuing Bank,
as the case may be, for the benefit of any such Lending Installation. Each
Lender or Issuing Bank, as the case may be, may, by written notice to the Agent
and the Borrower in accordance with Article XIII, designate replacement or
additional Lending Installations through which Loans will be made by it or
Letters of Credit will be issued by it and for whose account Loan payments or
payments with respect to Letters of Credit are to be made.

                                       18



      2.18. Non-Receipt of Funds by the Agent. Unless the Borrower or a Lender,
as the case may be, notifies the Agent prior to 1:00 p.m. (New York time) on the
date on which it is scheduled to make payment to the Agent of (i) in the case of
a Lender, the proceeds of a Loan or (ii) in the case of the Borrower, a payment
of principal, interest or fees to the Agent for the account of the Lenders, that
it does not intend to make such payment, the Agent may assume that such payment
has been made. The Agent may, but shall not be obligated to, make the amount of
such payment available to the intended recipient in reliance upon such
assumption. If such Lender or the Borrower, as the case may be, has not in fact
made such payment to the Agent, the recipient of such payment shall, on or
before the fifth Business Day after demand by the Agent, repay to the Agent the
amount so made available together with interest thereon in respect of each day
during the period commencing on the date such amount was so made available by
the Agent until the date the Agent recovers such amount at a rate per annum
equal to (x) in the case of payment by a Lender, the Federal Funds Effective
Rate for such day for the first three days and, thereafter, the interest rate
applicable to the relevant Loan or (y) in the case of payment by the Borrower,
the interest rate applicable to the relevant Loan.

      2.19. Replacement of Lender. If the Borrower is required pursuant to
Section 3.1, 3.2 or 3.5 to make any additional payment to any Lender or if any
Lender's obligation to make or continue, or to convert Floating Rate Advances
into, Eurodollar Advances shall be suspended pursuant to Section 3.3 (any Lender
so affected an "Affected Lender"), the Borrower may elect to terminate or
replace the Commitment and Outstanding Credit Exposure of such Affected Lender,
provided that no Default shall have occurred and be continuing at the time of
such termination or replacement, and provided further that, concurrently with
such termination or replacement, (i) if the Affected Lender is being replaced,
another bank or other entity which is reasonably satisfactory to the Borrower
and the Agent shall agree, as of such date, to purchase for cash the Outstanding
Credit Exposure and other Obligations then due to the Affected Lender pursuant
to an assignment substantially in the form of Exhibit B and to become a Lender
for all purposes under this Agreement and to assume all obligations of the
Affected Lender to be terminated as of such date and to comply with the
requirements of Section 12.3 applicable to assignments, (ii) the Borrower shall
pay to such Affected Lender in same day funds on the day of such replacement (A)
all interest, fees and other amounts then accrued but unpaid to such Affected
Lender by the Borrower hereunder to and including the date of termination,
including without limitation payments due to such Affected Lender under Sections
3.1, 3.2 and 3.5, and (B) an amount, if any, equal to the payment which would
have been due to such Lender on the day of such replacement under Section 3.4
had the Outstanding Credit Exposure of such Affected Lender been prepaid on such
date rather than sold to the replacement Lender, in each case to the extent not
paid by the purchasing Lender and (iii) if the Affected Lender is being
terminated, the Borrower shall pay to such Affected Lender all Obligations then
due and payable to such Affected Lender (including the amounts described in the
immediately preceding clauses (i) and (ii) plus such Affected Lender's
Outstanding Credit Exposure) and (iv) concurrently with the effectiveness of
such release or termination, such Affected Lender shall be released with respect
to its Commitments and such Commitments shall be terminated, and, in the case of
replacement, Outstanding Credit Exposure assigned by such Affected Lender, and
shall cease to be a Lender hereunder but shall continue to be entitled to the
benefits of, and subject to, those provisions of this Agreement and the other
Loan Documents which survive payment of the Obligations and termination of the
applicable agreement.

                                       19



      2.20. Letters of Credit.

            2.20.1 General; Existing Letters of Credit. (i) Subject to the terms
      and conditions set forth herein, the Borrower may request the issuance of
      Letters of Credit for its own account, in a form reasonably acceptable to
      the Agent and the applicable Issuing Bank, and to renew, extend, increase,
      decrease or otherwise modify each Letter of Credit ("Modify," and each
      such action a "Modification"), from time to time from and including the
      date of this Agreement and prior to the date that is five Business Days
      prior to the Facility Termination Date. In the event of any inconsistency
      between the terms and conditions of this Agreement and the terms and
      conditions of any form of letter of credit application or other agreement
      submitted by the Borrower to, or entered into by the Borrower with, the
      applicable Issuing Bank relating to any Letter of Credit (a "Letter of
      Credit Application"), the terms and conditions of this Agreement shall
      control. Without limitation of the immediately preceding sentence, no such
      Letter of Credit Application may impose any additional conditions on the
      issuance of a Letter of Credit nor obligations of the Borrower to the
      Issuing Bank or any Lender, other than as expressly stated in this
      Agreement.

      (ii)  Schedule 2.20 contains a schedule of certain letters of credit
            issued for the account of the Borrower prior to the Closing Date.
            Subject to the satisfaction of the conditions contained in Sections
            4.1 and 4.2, from and after the Closing Date such letters of credit
            shall be deemed to be Letters of Credit issued pursuant to this
            Section 2.20.

            2.20.2 Notice of Issuance, Amendment, Renewal, Extension; Certain
      Conditions. To request the issuance of a Letter of Credit (or the
      Modification of an outstanding Letter of Credit), the Borrower shall hand
      deliver or telecopy (or transmit by electronic communication, if
      arrangements for doing so have been approved by the applicable Issuing
      Bank) to the applicable Issuing Bank and the Agent (reasonably in advance
      of the requested date of issuance, amendment, renewal or extension) a
      notice requesting the issuance of a Letter of Credit, or identifying the
      Letter of Credit to be Modified, and specifying the date of issuance or
      Modification (which shall be a Business Day), the date on which such
      Letter of Credit is to expire (which shall comply with Section 2.20.3),
      the amount of such Letter of Credit, the name and address of the
      beneficiary thereof and such other information as shall be necessary to
      prepare or Modify such Letter of Credit. If requested by the applicable
      Issuing Bank, but subject to Section 2.20.1(i) hereof, the Borrower also
      shall submit a Letter of Credit Application on such Issuing Bank's
      standard form in connection with any request for a Letter of Credit. A
      Letter of Credit shall be issued or Modified only if (A) after giving
      effect to such issuance or Modification (and upon such issuance or
      Modification the Borrower shall be deemed to represent and warrant that)
      (i) the LC Exposure shall not exceed $100,000,000 and (ii) the Aggregate
      Outstanding Credit Exposure shall not exceed the Aggregate Commitment and
      (B) the Issuing Bank has not received written notice from the Agent, the
      Required Lenders or the Borrower, at least one Business Day prior to the
      requested date of issuance or Modification of the applicable Letter of
      Credit, that one or more applicable conditions contained in Section 4.2
      shall not be satisfied.

                                       20



            2.20.3 Expiration Date. Each Letter of Credit shall expire at or
      prior to the close of business on the earlier of (i) the date eighteen
      months after the date of the issuance or any renewal or extension of such
      Letter of Credit and (ii) the date that is five Business Days prior to the
      Facility Termination Date. A Letter of Credit may contain a provision
      pursuant to which it is deemed to be extended on an annual basis unless
      notice of termination is given by the Issuing Bank subject to clause (ii)
      in the immediately preceding sentence.

            2.20.4 Participations. On the Closing Date with respect to the
      Letters of Credit identified on Schedule 2.20, and for all other Letters
      of Credit by the issuance of such Letter of Credit, or a Modification to a
      Letter of Credit increasing the amount thereof, and without any further
      action on the part of the Issuing Bank issuing such Letter of Credit or
      the Lenders, such Issuing Bank hereby grants to each Lender, and each
      Lender hereby acquires from such Issuing Bank, a participation in such
      Letter of Credit equal to such Lender's Applicable Percentage of the
      aggregate amount available to be drawn under such Letter of Credit. In
      consideration and in furtherance of the foregoing, each Lender hereby
      absolutely and unconditionally agrees to pay to the Agent, for the account
      of the applicable Issuing Bank, such Lender's Applicable Percentage of
      each LC Disbursement made by the Issuing Bank and not reimbursed by the
      Borrower on the date due as provided in Section 2.20.5, or of any
      reimbursement payment required to be refunded to the Borrower for any
      reason. Each Lender acknowledges and agrees that its obligation to acquire
      participations pursuant to this Section 2.20.4 in respect of Letters of
      Credit is absolute and unconditional and shall not be affected by any
      circumstance whatsoever, including any amendment, renewal or extension of
      any Letter of Credit or the occurrence and continuance of a Default or
      Unmatured Default or reduction or termination of the Commitments, and that
      each such payment shall be made without any offset, abatement, withholding
      or reduction whatsoever.

            2.20.5 Reimbursement. If any Issuing Bank shall make any LC
      Disbursement in respect of a Letter of Credit, the Borrower shall
      reimburse such LC Disbursement by paying to the Agent an amount equal to
      such LC Disbursement not later than 2:30 p.m., New York City time, on the
      date that such LC Disbursement is made, if the Borrower shall have
      received notice of such LC Disbursement prior to 1:00 p.m., New York City
      time, on such date, or, if such notice has not been received by the
      Borrower prior to such time on such date, then not later than 2:30 p.m.,
      New York City time, on (i) the Business Day that the Borrower receives
      such notice, if such notice is received prior to 1:00 p.m., New York City
      time, on the day of receipt, or (ii) the Business Day immediately
      following the day that the Borrower receives such notice, if such notice
      is not received prior to such time on the day of receipt; provided that,
      if such LC Disbursement is not less than $1,000,000, the Borrower may
      request in accordance with Section 2.8 that such payment be financed with
      a Floating Rate Advance in an equivalent amount and, to the extent so
      financed, the Borrower's obligation to make such payment shall be
      discharged and replaced by the resulting Floating Rate Advance. If the
      Borrower fails to make such payment when due, the Agent shall notify each
      Lender of the applicable LC Disbursement, the payment then due from the
      Borrower in respect thereof and such Lender's Applicable Percentage
      thereof. Promptly following receipt of such notice, each Lender shall pay
      to the Agent its Applicable Percentage of the payment then due from the

                                       21



      Borrower, in the same manner as provided in Section 2.12 with respect to
      Loans made by such Lender (and Section 2.12 shall apply, mutatis mutandis,
      to the payment obligations of the Lenders), and the Agent shall promptly
      pay to the applicable Issuing Bank the amounts so received by it from the
      Lenders. Promptly following receipt by the Agent of any payment from the
      Borrower pursuant to this paragraph, the Agent shall distribute such
      payment to the applicable Issuing Bank or, to the extent that Lenders have
      made payments pursuant to this paragraph to reimburse such Issuing Bank,
      then to such Lenders and the applicable Issuing Bank as their interests
      may appear. Any payment made by a Lender pursuant to this paragraph to
      reimburse any Issuing Bank for any LC Disbursement (other than the funding
      of Floating Rate Advances as contemplated above) shall not constitute a
      Loan and shall not relieve the Borrower of its obligation to reimburse
      such LC Disbursement.

            2.20.6 Obligations Absolute. The Borrower's obligation to reimburse
      LC Disbursements as provided in Section 2.20.5 shall be absolute,
      unconditional and irrevocable, and shall be performed strictly in
      accordance with the terms of this Agreement under any and all
      circumstances whatsoever and irrespective of (i) any lack of validity or
      enforceability of any Letter of Credit or this Agreement, or any term or
      provision therein, (ii) any draft or other document presented under a
      Letter of Credit proving to be forged, fraudulent or invalid in any
      respect or any statement therein being untrue or inaccurate in any
      respect, (iii) payment by any Issuing Bank under a Letter of Credit issued
      by it against presentation of a draft or other document that does not
      comply with the terms of such Letter of Credit, or (iv) any other event or
      circumstance whatsoever, whether or not similar to any of the foregoing,
      that might, but for the provisions of this Section, constitute a legal or
      equitable discharge of, or provide a right of setoff against, the
      Borrower's obligations hereunder. Neither the Agent, the Lenders nor any
      Issuing Bank, nor any of their Affiliates, shall have any liability or
      responsibility by reason of or in connection with the issuance or transfer
      of any Letter of Credit or any payment or failure to make any payment
      thereunder (irrespective of any of the circumstances referred to in the
      preceding sentence), or any error, omission, interruption, loss or delay
      in transmission or delivery of any draft, notice or other communication
      under or relating to any Letter of Credit (including any document required
      to make a drawing thereunder), any error in interpretation of technical
      terms or any consequence arising from causes beyond the control of the
      Issuing Bank issuing such Letter of Credit; provided that the foregoing
      shall not be construed to excuse such Issuing Bank from liability to the
      Borrower to the extent of any direct damages (as opposed to consequential
      damages, claims in respect of which are hereby waived by the Borrower to
      the extent permitted by applicable law) suffered by the Borrower that are
      caused by such Issuing Bank's failure to exercise care when determining
      whether drafts and other documents presented under a Letter of Credit
      issued by it comply with the terms thereof or such Issuing Bank's willful
      failure to make lawful payment under a Letter of Credit after the
      presentation to it of a draft and certificates strictly complying with the
      terms and conditions of the Letter of Credit. The parties hereto expressly
      agree that, in the absence of gross negligence or willful misconduct on
      the part of an Issuing Bank (as finally determined by a court of competent
      jurisdiction), such Issuing Bank shall be deemed to have exercised care in
      each such determination. In furtherance of the foregoing and without
      limiting the generality thereof, the parties agree that, with respect to
      documents

                                       22



      presented which appear on their face to be in substantial compliance with
      the terms of a Letter of Credit, the applicable Issuing Bank may, in its
      sole discretion, either accept and make payment upon such documents
      without responsibility for further investigation, regardless of any notice
      or information to the contrary, or refuse to accept and make payment upon
      such documents if such documents are not in strict compliance with the
      terms of such Letter of Credit.

            2.20.7 Disbursement Procedures. Each Issuing Bank shall, promptly
      following its receipt thereof, examine all documents purporting to
      represent a demand for payment under a Letter of Credit issued by it. Each
      Issuing Bank shall promptly notify the Agent and the Borrower by telephone
      (confirmed by telecopy) of such demand for payment and whether such
      Issuing Bank has made or will make an LC Disbursement thereunder; provided
      that any failure to give or delay in giving such notice shall not relieve
      the Borrower of its obligation to reimburse such Issuing Bank and the
      Lenders with respect to any such LC Disbursement.

            2.20.8 Interim Interest. If any Issuing Bank shall make any LC
      Disbursement, then, unless the Borrower shall reimburse such LC
      Disbursement in full on the date such LC Disbursement is made, the unpaid
      amount thereof shall bear interest, for each day from and including the
      date such LC Disbursement is made to but excluding the date that the
      Borrower reimburses such LC Disbursement, at the rate per annum then
      applicable to Floating Rate Advances; provided that, if the Borrower fails
      to reimburse such LC Disbursement when due pursuant to Section 2.20.5,
      then Section 2.11 shall apply. Interest accrued pursuant to this Section
      2.20.8 shall be for the account of the applicable Issuing Bank, except
      that interest accrued on and after the date of payment by any Lender
      pursuant to Section 2.20.5 to reimburse the applicable Issuing Bank shall
      be for the account of such Lender to the extent of such payment.

            2.20.9 Replacement of any Issuing Bank. An Issuing Bank may be
      replaced at any time by written agreement among the Borrower, the Agent,
      the replaced Issuing Bank and the successor Issuing Bank. The Agent shall
      notify the Lenders of any such replacement of an Issuing Bank. At the time
      any such replacement shall become effective, the Borrower shall pay all
      unpaid fees accrued for the account of the replaced Issuing Bank pursuant
      to Section 2.5.3. From and after the effective date of any such
      replacement, (i) the successor Issuing Bank shall have all the rights and
      obligations of the replaced Issuing Bank under this Agreement with respect
      to Letters of Credit to be issued by it thereafter and (ii) references
      herein to the term "Issuing Bank" shall be deemed to refer to such
      successor or to any previous Issuing Bank, or to such successor and all
      previous Issuing Banks, as the context shall require. After the
      replacement of an Issuing Bank hereunder, the replaced Issuing Bank shall
      remain a party hereto and shall continue to have all the rights and
      obligations of an Issuing Bank under this Agreement with respect to
      Letters of Credit issued by it prior to such replacement, but shall not be
      required to issue additional Letters of Credit.

            2.20.10 Cash Collateralization. If any Default shall occur and be
      continuing, on the Business Day that the Borrower receives notice from the
      Agent or the Required Lenders (or, if the maturity of the Loans has been
      accelerated, Lenders with LC Exposure

                                       23



      representing greater than 50% of the total LC Exposure) demanding the
      deposit of cash collateral pursuant to this Section 2.20.10, the Borrower
      shall deposit in an account with the Agent, in the name of the Agent and
      for the benefit of the Lenders (the "Letter of Credit Collateral
      Account"), an amount in cash which is free and clear of all rights and
      claims of third parties equal to the aggregate undrawn amount of all
      outstanding Letters of Credit as of such date plus any accrued and unpaid
      LC Fees thereon; provided that the obligation to deposit such cash
      collateral shall become effective immediately, and such deposit shall
      become immediately due and payable, without demand or other notice of any
      kind, upon the occurrence of any Default with respect to the Borrower
      described in Section 7.6 or 7.7. If at any time while any Default is
      continuing, the Agent determines that the amount on deposit in the Letter
      of Credit Collateral Account shall be less than the aggregate undrawn
      amount of all outstanding Letters of Credit as of such date plus any
      accrued and unpaid LC Fees thereon, the Agent may make demand on the
      Borrower to pay, and the Borrower will, forthwith upon such demand and
      without any further notice or act, pay to the Agent an amount equal to
      such deficiency, which funds shall be deposited in the Letter of Credit
      Collateral Account. All deposits maintained in the Letter of Credit
      Collateral Account shall be held by the Agent as collateral for the
      payment and performance of the Reimbursement Obligations of the Borrower
      with respect to such undrawn amounts and as otherwise expressly set forth
      in this Section 2.20.10. The Agent shall have exclusive dominion and
      control, including the exclusive right of withdrawal, over such Letter of
      Credit Collateral Account. Other than any interest earned on the
      investment of such deposits, which investments shall be made at the option
      and sole discretion of the Agent and at the Borrower's risk and expense,
      such deposits shall not bear interest. Interest or profits, if any, on
      such investments shall accumulate in such account. Moneys in such Letter
      of Credit Collateral Account shall be applied by the Agent to reimburse
      each Issuing Bank for LC Disbursements with respect to such undrawn
      amounts for which it has not otherwise been reimbursed and, to the extent
      not so applied, shall be held for the satisfaction of additional
      Reimbursement Obligations arising in respect of undrawn amounts of
      outstanding Letters of Credit or, if the maturity of the Loans has been
      accelerated (but subject to the consent of Lenders with LC Exposure
      representing greater than 50% of the total LC Exposure), be applied to
      satisfy other obligations of the Borrower under this Agreement. If the
      Borrower is required to provide an amount of cash collateral hereunder as
      a result of the occurrence of a Default, such amount (to the extent not
      applied as aforesaid) shall be returned to the Borrower within three
      Business Days after all Defaults have been cured or waived.

                                   ARTICLE III

                             YIELD PROTECTION; TAXES

      3.1. Yield Protection. If, on or after the date of this Agreement, the
adoption of any law or any governmental or quasi-governmental rule, regulation,
policy, guideline or directive, or any change in the interpretation or
administration thereof by any governmental or quasi-governmental authority,
central bank or comparable agency charged with the interpretation or
administration thereof, or compliance by any Lender or applicable Lending
Installation or Issuing Bank with any request or directive (whether or not
having the force of law) of any such authority, central bank or comparable
agency:

                                       24



      (i)   imposes or increases or deems applicable any reserve, assessment,
            insurance charge, special deposit or similar requirement against
            assets of, deposits with or for the account of, or credit extended
            by, any Lender or any applicable Lending Installation or any Issuing
            Bank (including, without limitation, any such requirement imposed by
            the Board of Governors of the Federal Reserve System but excluding
            with respect to any Eurodollar Loans any such requirement with
            respect to which such Lender is entitled to compensation for the
            relevant Interest Period under Section 2.15.2), or

      (ii)  imposes any other condition the result of which is to increase the
            cost to any Lender, Issuing Bank or any applicable Lending
            Installation of making, funding or maintaining its Eurodollar Loans
            or Commitment, or of issuing or participating in any Letter of
            Credit, or reduces any amount receivable by any Lender, Issuing Bank
            or any applicable Lending Installation in connection with its
            Eurodollar Loans, Commitment, Letters of Credit or participations
            therein, by an amount deemed material by such Lender or Issuing
            Bank,

and the result of any of the foregoing is to increase the cost to such Lender,
Issuing Bank or applicable Lending Installation of making or maintaining its
Eurodollar Loans or Commitment or of issuing or participating in Letters of
Credit or to reduce the return received by such Lender, Issuing Bank or
applicable Lending Installation in connection with such Eurodollar Loans,
Commitment, Letters of Credit or participations therein, then, within 30 days of
demand by such Lender or Issuing Bank, the Borrower shall pay such Lender or
Issuing Bank, as applicable, such additional amount or amounts as will
compensate such Lender or Issuing Bank, as applicable, for such increased cost
or reduction in amount received.

      3.2. Changes in Capital Adequacy Regulations. If a Lender or Issuing Bank
determines the amount of capital required or expected to be maintained by such
Lender or Issuing Bank, any Lending Installation of such Lender or Issuing Bank
or any corporation controlling such Lender or Issuing Bank is increased as a
result of a Change, then, within 30 days of demand by such Lender or Issuing
Bank, the Borrower shall pay such Lender or Issuing Bank, as applicable, the
amount necessary to compensate for any shortfall in the rate of return on the
portion of such increased capital which such Lender or Issuing Bank reasonably
determines is attributable to this Agreement, its Outstanding Credit Exposure or
its Commitment to make Loans, or issue or participate in Letters of Credit,
hereunder (after taking into account such Lender or Issuing Bank's policies as
to capital adequacy). "Change" means (i) any change after the date of this
Agreement in the Risk-Based Capital Guidelines or (ii) any adoption of, or
change in, or change in the interpretation or administration of, any other law,
governmental or quasi-governmental rule, regulation, policy, guideline,
interpretation, or directive (whether or not having the force of law) after the
date of this Agreement which affects the amount of capital required or expected
to be maintained by any Lender, Issuing Bank or any Lending Installation or any
corporation controlling any Lender or Issuing Bank. "Risk-Based Capital
Guidelines" means (i) the risk-based capital guidelines in effect in the United
States on the date of this Agreement, including transition rules, and (ii) the
corresponding capital regulations promulgated by regulatory authorities outside
the United States implementing the July 1988 report of the Basle Committee on
Banking Regulation and Supervisory Practices Entitled "International

                                       25



Convergence of Capital Measurements and Capital Standards," including transition
rules, and any amendments to such regulations adopted prior to the date of this
Agreement.

      3.3. Availability of Types of Advances. If (i) any Lender determines that
maintenance of its Eurodollar Loans at a suitable Lending Installation would
violate any applicable law, rule, regulation, or directive, whether or not
having the force of law, or (ii) the Required Lenders determine that (a)
deposits of a type and maturity appropriate to match fund Eurodollar Advances
are not available, (b) the interest rate applicable to Eurodollar Advances does
not accurately reflect the cost of making or maintaining Eurodollar Advances or
(c) no reasonable basis exists for determining the LIBO Rate, then the Agent
shall suspend the availability of Eurodollar Advances of each affected Lender
and, on the date of such suspension in the case of an event described in clauses
(i) above or on the last day of the then current Interest Period applicable
thereto in the case of an event described in clause (ii) above, require any
affected Eurodollar Advances either to be repaid or, at the election of the
Borrower, converted to Floating Rate Advances (on which interest and principal
shall be payable contemporaneously with the related Eurodollar Loans of the
other Lenders), subject to the payment of any funding indemnification amounts
required by Section 3.4. If the applicable Lender in the case of clause (i)
above, or the Required Lenders in the case of clause (ii) above, notify the
Borrower that the circumstances giving rise to such suspension no longer apply,
the principal amount of each such Floating Rate Advances shall be converted into
Eurodollar Advances on the first day of the next such Interest Period applicable
to the related Eurodollar Loan of the other Lenders.

      3.4. Funding Indemnification. If any payment of a Eurodollar Advance
occurs on a date which is not the last day of the applicable Interest Period,
whether because of acceleration, prepayment or otherwise, or a Eurodollar
Advance is not made or continued, or a Floating Rate Advance is not converted
into a Eurodollar Advance, on the date specified by the Borrower for any reason
other than default by the Lenders or any Lender, or a Eurodollar Advance is not
prepaid on the date specified by the Borrower for any reason, the Borrower will
indemnify each Lender for any loss or cost (excluding loss of anticipated
profits) incurred by it resulting therefrom, including, without limitation, any
loss or cost in liquidating or employing deposits acquired to fund or maintain
such Eurodollar Advance.

      3.5. Taxes. (i) All payments by the Borrower to or for the account of any
Lender, Issuing Bank or the Agent hereunder or under any Note or Letter of
Credit Application shall be made free and clear of and without deduction for any
and all Taxes. If the Borrower shall be required by law to deduct any Taxes from
or in respect of any sum payable hereunder to any Lender, Issuing Bank or the
Agent, (a) the sum payable shall be increased as necessary so that after making
all required deductions (including deductions applicable to additional sums
payable under this Section 3.5) such Lender, Issuing Bank or the Agent (as the
case may be) receives an amount equal to the sum it would have received had no
such deductions been made, (b) the Borrower shall make such deductions, (c) the
Borrower shall pay the full amount deducted to the relevant authority in
accordance with applicable law and (d) the Borrower shall furnish to the Agent
the original copy of a receipt evidencing payment thereof within 30 days after
such payment is made.

      (ii)  In addition, the Borrower hereby agrees to pay any present or future
            stamp or documentary taxes and any other excise or property taxes,
            charges or similar

                                       26



            levies which arise from any payment made hereunder or under any Note
            or Letter of Credit Application or from the execution or delivery
            of, or otherwise with respect to, this Agreement or any Note or any
            Letter of Credit Application ("Other Taxes").

      (iii) The Borrower hereby agrees to indemnify the Agent, each Issuing Bank
            and each Lender for the full amount of Taxes or Other Taxes
            (including, without limitation, any Taxes or Other Taxes imposed on
            amounts payable under this Section 3.5) paid by the Agent, such
            Issuing Bank or such Lender as a result of its Commitment, any
            Credit Extensions made by it hereunder, any Letter of Credit issued
            or participated in by it hereunder, or otherwise in connection with
            its participation in this Agreement and any liability (including
            penalties, interest and expenses) arising therefrom or with respect
            thereto. Payments due under this indemnification shall be made
            within 30 days of the date the Agent, such Issuing Bank or such
            Lender makes demand therefor pursuant to Section 3.6.

      (iv)  Each Lender that is not incorporated under the laws of the United
            States of America or a state thereof (each a "Non-U.S. Lender")
            agrees that it will, not more than ten Business Days after the date
            on which it becomes a party to this Agreement (but in any event
            before a payment is due to it hereunder), (i) deliver to the Agent
            two duly completed copies of United States Internal Revenue Service
            Form W-8BEN or W-8ECI or successor forms, certifying in either case
            that such Lender is entitled to receive payments under this
            Agreement without deduction or withholding of any United States
            federal income taxes, or (ii) deliver to the Agent a United States
            Internal Revenue Service Form W-8IMY or successor form together with
            the applicable accompanying duly completed copies of United States
            Internal Revenue Service applicable Forms W-8 or W-9 or successor
            forms, as the case may be, and certify that it is entitled to an
            exemption from United States backup withholding tax. Each Non-U.S.
            Lender further undertakes to deliver to each of the Borrower and the
            Agent renewals or additional copies of such form (or any amendment
            thereto or successor form) (x) on or before the date that such form
            expires or becomes obsolete, (y) after the occurrence of any event
            requiring a change in the most recent forms so delivered by it and
            (z) from time to time upon reasonable request by the Borrower or the
            Agent. All forms or amendments described in the preceding sentence
            shall certify that such Lender is entitled to receive payments under
            this Agreement without deduction or withholding of any United States
            federal income taxes, unless an event (including without limitation
            any change in treaty, law or regulation) has occurred prior to the
            date on which any such delivery would otherwise be required which
            renders all such forms inapplicable or which would prevent such
            Lender from duly completing and delivering any such form or
            amendment with respect to it and such Lender advises the Borrower
            and the Agent that it is not capable of receiving payments without
            any deduction or withholding of United States federal income tax.

      (v)   For any period during which a Non-U.S. Lender has failed to provide
            the Borrower with an appropriate form pursuant to clause (iv) above
            (unless such

                                       27



            failure is due to a change in treaty, law or regulation, or any
            change in the interpretation or administration thereof by any
            governmental authority, occurring subsequent to the date on which a
            form originally was required to be provided), the Borrower shall not
            gross up the payments as provided under Section 3.5 with respect to
            such Non-U.S. Lender, and such Non-U.S. Lender shall not be entitled
            to indemnification under this Section 3.5 with respect to Taxes
            imposed by the United States; provided that, should a Non-U.S.
            Lender which is otherwise exempt from or subject to a reduced rate
            of withholding tax become subject to Taxes because of its failure to
            deliver a form required under clause (iv) above, the Borrower shall
            take such steps as such Non-U.S. Lender shall reasonably request to
            assist such Non-U.S. Lender to recover such Taxes.

      (vi)  Any Lender or Issuing Bank that is entitled to an exemption from or
            reduction of withholding tax with respect to payments under this
            Agreement or any Note pursuant to the law of any relevant
            jurisdiction or any treaty shall deliver to the Borrower (with a
            copy to the Agent), at the time or times prescribed by applicable
            law, such properly completed and executed documentation prescribed
            by applicable law as will permit such payments to be made without
            withholding or at a reduced rate.

      (vii) If the U.S. Internal Revenue Service or any other governmental
            authority of the United States or any other country or any political
            subdivision thereof asserts a claim that the Agent did not properly
            withhold tax from amounts paid to or for the account of any Lender
            or any Issuing Bank (because the appropriate form was not delivered
            or properly completed, because such Lender or Issuing Bank failed to
            notify the Agent of a change in circumstances which rendered its
            exemption from withholding ineffective, or for any other reason),
            such Lender or Issuing Bank, as applicable, shall indemnify the
            Agent fully for all amounts paid, directly or indirectly, by the
            Agent as tax, withholding therefor, or otherwise, including
            penalties and interest, and including taxes imposed by any
            jurisdiction on amounts payable to the Agent under this subsection,
            together with all costs and expenses related thereto (including
            attorneys fees for the Agent, which attorneys may be employees of
            the Agent). The obligations of the Lenders and Issuing Banks under
            this Section 3.5(vii) shall survive the payment of the Obligations
            and termination of this Agreement.

      3.6. Lender Statements; Survival of Indemnity. To the extent reasonably
possible, each Lender shall designate an alternate Lending Installation with
respect to its Eurodollar Loans and issuance or participation in Letters of
Credit to reduce any liability of the Borrower to such Lender under Sections
3.1, 3.2 and 3.5 or to avoid the unavailability of Eurodollar Advances under
Section 3.3, so long as such designation is not, in the judgment of such Lender,
disadvantageous to such Lender. The Borrower shall not be required to compensate
a Lender pursuant to Section 3.1, 3.2 or 3.5 for any amounts incurred or arising
thereunder more than 90 days prior to the date that such Lender notifies the
Borrower of the event(s) giving rise to such amounts and of such Lender's
intention to claim compensation therefor; provided that, if the adoption or
change described in Section 3.1 or Change described in 3.2 or adoption or
modification of any applicable law under Section 3.5 giving rise to such request
for

                                       28



compensation is retroactive, then the 90 day period referred to above shall be
extended to include the period of retroactive effect thereof. Each Lender shall
deliver a written statement of such Lender to the Borrower (with a copy to the
Agent) as to the amount due, if any, under Section 3.1, 3.2, 3.4 or 3.5. Such
written statement shall set forth in reasonable detail the calculations upon
which such Lender determined such amount and shall be final, conclusive and
binding on the Borrower in the absence of manifest error. Determination of
amounts payable under Sections 3.1, 3.2 or 3.4 in connection with a Eurodollar
Loan shall be calculated as though each Lender funded its Eurodollar Loan
through the purchase of a deposit of the type and maturity corresponding to the
deposit used as a reference in determining the Eurodollar Rate applicable to
such Loan, whether in fact that is the case or not. Unless otherwise provided
herein, the amount specified in the written statement of any Lender shall be
payable within 30 days after receipt by the Borrower of such written statement.
The obligations of the Borrower under Sections 3.1, 3.2, 3.4 and 3.5 shall
survive payment of the Obligations and termination of this Agreement.

                                   ARTICLE IV

                              CONDITIONS PRECEDENT

      4.1. Effectiveness of Agreement. This Agreement shall become effective as
of the Closing Date, provided that on or prior to the Closing Date the Borrower
has furnished to the Agent with sufficient copies for the Lenders:

            4.1.1 Copies of the articles of incorporation of the Borrower,
      together with all amendments, and a certificate of good standing, each
      certified by the appropriate governmental officer in its jurisdiction of
      incorporation, as well as any other information required by Section 326 of
      the USA Patriot Act or necessary for the Agent or any Lender to verify the
      identity of the Borrower as required by Section 326 of the USA Patriot
      Act.

            4.1.2 Copies, certified by the Secretary, Assistant Secretary or an
      Associate Secretary of the Borrower, of its by-laws and of its Board of
      Directors' resolutions and of resolutions or actions of any other body
      authorizing the execution of the Loan Documents to which the Borrower is a
      party.

            4.1.3 An incumbency certificate, executed by the Secretary,
      Assistant Secretary or an Associate Secretary of the Borrower, which shall
      identify by name and title and bear the signatures of the Authorized
      Officers and any other officers of the Borrower authorized to sign the
      Loan Documents to which the Borrower is a party, upon which certificate
      the Agent and the Lenders shall be entitled to rely until informed of any
      change in writing by the Borrower.

            4.1.4 A certificate, signed by the chief financial officer or
      treasurer of the Borrower, stating that on the Closing Date no Default or
      Unmatured Default has occurred and is continuing.

            4.1.5 Written opinion letters of the Borrower's counsel, addressed
      to the Lenders in form and substance reasonably acceptable to the Agent.

                                       29



            4.1.6 Written opinion of Sidley Austin Brown & Wood, LLP, counsel
      for the Agent, addressed to the Agent and the Lenders, with respect to the
      enforceability of this Agreement and the Notes issued on the Closing Date,
      in form and substance reasonably acceptable to the Agent.

            4.1.7 Any Notes requested by a Lender pursuant to Section 2.13
      payable to the order of each such requesting Lender.

            4.1.8 Evidence satisfactory to the Agent that the Existing Credit
      Agreements shall have been or shall simultaneously on the Closing Date be
      terminated (except for those provisions that expressly survive the
      termination thereof), all loans outstanding and other amounts owed to the
      lenders or agents thereunder shall have been, or shall simultaneously with
      the Closing Date, be paid in full, and all liens and security interests,
      if any, granted in connection therewith shall have been or shall
      simultaneously on the Closing Date be terminated.

      4.2. Each Credit Extension. The Lenders shall not be required to make (i)
the initial Credit Extension hereunder unless all of the conditions in Section
4.1 shall have been satisfied as of the Closing Date, and (ii) any Credit
Extension (other than (x) a conversion or continuation of an outstanding Advance
pursuant to Section 2.9 or (y) the financing of any payment under a Letter of
Credit with a Floating Rate Advance made pursuant to Section 2.20.5) unless on
the applicable Credit Extension Date:

            4.2.1 There exists no Default or Unmatured Default.

            4.2.2 The representations and warranties contained in Article V are
      true and correct in all material respects as of such Credit Extension Date
      except to the extent any such representation or warranty is stated to
      relate solely to an earlier date, in which case such representation or
      warranty shall have been true and correct in all material respects on and
      as of such earlier date; provided that this requirement shall not apply to
      the representations and warranties set forth in Sections 5.4.3, 5.5 and
      5.7 with respect to any Loan if the proceeds of such Loan will be used
      exclusively to repay the Borrower's commercial paper.

      Each Borrowing Notice or request for issuance or Modification of a Letter
of Credit with respect to each such Credit Extension shall constitute a
representation and warranty by the Borrower that the conditions contained in
Sections 4.2.1 and 4.2.2 have been satisfied.

                                    ARTICLE V

                         REPRESENTATIONS AND WARRANTIES

      The Borrower represents and warrants to the Lenders that:

      5.1. Existence and Standing. The Borrower is a corporation duly
incorporated, validly existing and in good standing under the laws of Arizona,
and has all corporate powers and all material governmental licenses,
authorizations, consents and approvals required to carry on its business as now
conducted, unless the failure to have any such license, authorization, consent
or

                                       30



approval would not have a material adverse effect on the financial condition or
financial prospects of the Borrower and its Consolidated Subsidiaries taken as a
whole.

      5.2. Corporate and Governmental Authorization; No Contravention. The
execution, delivery and performance by the Borrower of this Agreement and the
Notes are within the Borrower's corporate powers, have been duly authorized by
all necessary corporate action, require no action by or in respect of, or filing
with, any governmental body, agency or official and do not contravene, or
constitute a default under, any provision of applicable law or regulation or of
the certificate of incorporation or by-laws of the Borrower or of any agreement,
judgment, injunction, order, decree or other instrument binding upon the
Borrower or any Material Subsidiary or result in the creation or imposition of
any Lien on any asset of the Borrower or any Material Subsidiary except as
otherwise permitted hereunder.

      5.3. Binding Effect. This Agreement constitutes a valid and binding
agreement of the Borrower and each Note, when executed and delivered in
accordance with this Agreement, will constitute a valid and binding obligation
of the Borrower, in each case enforceable in accordance with its terms; subject,
however, to the application by a court of general principles of equity and to
the effect of any applicable bankruptcy, insolvency, reorganization, moratorium
or similar laws affecting creditors' rights generally.

      5.4. Financial Information.

            5.4.1 The consolidated balance sheet of the Borrower and its
      Consolidated Subsidiaries as of December 31, 2003 and the related
      consolidated statements of income and of cash flow for the fiscal year
      then ended, reported on by Deloitte & Touche LLP and set forth in the
      Borrower's 2003 Form 10-K, fairly present in all material respects, in
      conformity with generally accepted accounting principles (except as
      disclosed therein and except for the application of Statement of Financial
      Accounting Standards No. 144 "Accounting for the Impairment or Disposal of
      Long-Lived Assets"; among other guidance, SFAS 144 prescribes accounting
      for discontinued operations and defines certain activities as discontinued
      operations; SFAS 144 requires the current and prior year operations of NAC
      Holding Inc and NAC International Inc (collectively, "NAC") effective in
      the third quarter of 2004 to be reclassified as discontinued operations),
      the consolidated financial position of the Borrower and its Consolidated
      Subsidiaries as of such date and their consolidated results of operations
      and cash flows for such fiscal year.

            5.4.2 The unaudited consolidated balance sheet of the Borrower and
      its Consolidated Subsidiaries as of June 30, 2004 and the related
      unaudited consolidated statements of income and of cash flows for the six
      months then ended, set forth in the Borrower's Latest Form 10-Q, fairly
      present in all material respects, in conformity with generally accepted
      accounting principles applied on a basis consistent with the financial
      statements referred to in Section 5.4.1 (except as disclosed therein and
      except for the application of SFAS 144 as it relates to the operations of
      NAC being reclassified as discontinued operations), the consolidated
      financial position of the Borrower and its Consolidated Subsidiaries as of
      such date and their consolidated results of operations and cash flows for
      such six month period (subject to normal year-end adjustments).

                                       31



            5.4.3 Except as disclosed in the Borrower's SEC Reports, since
      December 31, 2003 there has been no material adverse change in the
      financial condition or financial prospects of the Borrower and its
      Consolidated Subsidiaries, considered as a whole.

      5.5. Litigation. Except as disclosed in the Borrower's SEC Reports, there
is no action, suit or proceeding pending against, or to the knowledge of the
Borrower threatened against or affecting, the Borrower or any of its
Subsidiaries before any court or arbitrator or any governmental body, agency or
official in which there is a reasonable possibility of an adverse decision which
could materially adversely affect the financial condition or financial prospects
of the Borrower and its Consolidated Subsidiaries, considered as a whole, or
which in any manner draws into question the validity of this Agreement or the
Notes.

      5.6. Compliance with ERISA. Each member of the ERISA Group has fulfilled
its obligations under the minimum funding standards of ERISA and the Internal
Revenue Code with respect to each Plan and is in compliance in all material
respects with the presently applicable provisions of ERISA and the Internal
Revenue Code with respect to each Plan. No member of the ERISA Group has (i)
sought a waiver of the minimum funding standard under Section 412 of the
Internal Revenue Code in respect of any Plan, (ii) failed to make any
contribution or payment to any Plan or Multiemployer Plan or in respect of any
Benefit Arrangement, or made any amendment to any Plan or Benefit Arrangement,
which has resulted or could result in the imposition of a Lien or the posting of
a bond or other security under ERISA or the Internal Revenue Code or (iii)
incurred any liability under Title IV of ERISA other than a liability to the
PBGC for premiums under Section 4007 of ERISA.

      5.7. Environmental Matters. Except as disclosed in the Borrower's SEC
Reports, the operations and properties of the Borrower and its Material
Subsidiaries comply in all material respects with all Environmental Laws, except
where (i) the necessity of compliance therewith is being contested in good faith
by appropriate proceedings or (ii) the noncompliance with which would not have a
material adverse effect on the financial condition or financial prospects of the
Borrower and its Consolidated Subsidiaries taken as a whole.

      5.8. Taxes. The Borrower and its Material Subsidiaries have filed all
United States Federal income tax returns and all other material tax returns
which are required to be filed by them and have paid all taxes due pursuant to
such returns or pursuant to any assessment received by them, except to the
extent that such taxes are being contested in good faith and by appropriate
proceedings and that appropriate reserves for the payment thereof have been
maintained by the Borrower or its Material Subsidiaries in accordance with
generally accepted accounting principles. The charges, accruals and reserves on
the books of the Borrower in respect of taxes or other governmental charges are,
in the opinion of the Borrower, adequate.

      5.9. Material Subsidiaries. Each Material Subsidiary is duly organized,
validly existing and in good standing under the laws of its jurisdiction of
organization, and, except as disclosed in the Borrower's SEC Reports, has all
corporate and other legal powers and all material governmental licenses,
authorizations, consents and approvals required to carry on its business as now
conducted, except where the failure to have any such license, authorization,
consent or approval would not have a material adverse effect on the financial
condition or financial prospects of the Borrower and its Consolidated
Subsidiaries taken as a whole, and as to

                                       32



APS, except that (i) APS from time to time may make minor extensions of its
lines, plants, services or systems prior to the time a related franchise,
certificate of convenience and necessity, license or permit is procured, (ii)
from time to time communities served by APS may become incorporated and
considerable time may elapse before such a franchise is procured, (iii) certain
such franchises may have expired prior to the renegotiation thereof, (iv)
certain minor defects and exceptions may exist which, individually and in the
aggregate, are not material and (v) certain franchises, certificates, licenses
and permits may not be specific as to their geographical scope.

      5.10. Not an Investment Company. The Borrower is not an "investment
company" within the meaning of the Investment Company Act of 1940, as amended.

      5.11. Public Utility Holding Company Act, Etc. The Borrower is a "holding
company" within the meaning of the Public Utility Holding Company Act of 1935,
as amended; however, pursuant to Section 3(a)(1) of such Act and Rule 2
promulgated thereunder, the Borrower is exempt from all provisions of such Act
other than Section 9(a)(2) thereof. The Borrower is a "public utility", as such
term is defined in the Federal Power Act, as amended, which has obtained blanket
authority from the Federal Energy Regulatory Commission to issue securities and
assume liabilities.

      5.12. Full Disclosure. All information (other than financial projections)
heretofore furnished by the Borrower in writing to the Agent, any Issuing Bank
or any Lender for purposes of or in connection with this Agreement or any
transaction contemplated hereby is, and all such information (other than
financial projections) hereafter furnished by the Borrower to the Agent, any
Issuing Bank or any Lender in connection with this Agreement will be, true and
accurate in all material respects on the date as of which such information is
furnished. The financial projections that have been or will be furnished by the
Borrower to the Agent or any Issuing Bank or any Lender for purposes of or in
connection with this Agreement or any transaction contemplated hereby were or
will be prepared in good faith based upon reasonable assumptions. The Borrower
has disclosed to the Lenders in writing (including through the Borrower's SEC
Reports) any and all facts which materially and adversely affect or may
materially and adversely affect (to the extent the Borrower can now reasonably
foresee), the financial condition or financial prospects of the Borrower and its
Consolidated Subsidiaries, taken as a whole, or the ability of the Borrower to
perform its obligations under this Agreement.

                                   ARTICLE VI

                                    COVENANTS

      During the term of this Agreement, unless the Required Lenders shall
otherwise consent in writing:

      6.1. Information. The Borrower will deliver to each of the Lenders:

            6.1.1 As soon as available and in any event within 120 days after
      the end of each fiscal year of the Borrower, a consolidated balance sheet
      of the Borrower and its Consolidated Subsidiaries as of the end of such
      fiscal year and the related consolidated

                                       33



      statements of income and cash flow for such fiscal year, setting forth in
      each case in comparative form the figures for the previous fiscal year,
      accompanied by an opinion thereon of independent certified public
      accountants of nationally recognized public standing, which opinion shall
      state that said financial statements fairly present in all material
      respects the financial position and results of operations of the Borrower
      and its Consolidated Subsidiaries as at the end of, and for, such fiscal
      year, in conformity with generally accepted accounting principles (except
      as disclosed therein);

            6.1.2 As soon as available and in any event within 60 days after the
      end of each of the first three quarters of each fiscal year of the
      Borrower, a consolidated balance sheet of the Borrower and its
      Consolidated Subsidiaries as of the end of such quarter and the related
      consolidated statements of income and cash flow for such quarter and for
      the portion of the Borrower's fiscal year ended at the end of such
      quarter, setting forth in the case of such statements of income and of
      cash flow in comparative form the figures for the corresponding quarter
      and the corresponding portion of the Borrower's previous fiscal year,
      accompanied by a certificate of an Authorized Officer, which certificate
      shall state that said financial statements fairly present in all material
      respects the financial condition and results of operations of the Borrower
      and its Consolidated Subsidiaries in accordance with generally accepted
      accounting principles, consistently applied (except as disclosed therein),
      as at the end of, and for, such period (subject to normal year-end audit
      adjustments);

            6.1.3 Simultaneously with the delivery of each set of financial
      statements referred to in clauses (a) and (b) above, a certificate of an
      Authorized Officer of the Borrower (i) setting forth in reasonable detail
      the calculations required to establish whether the Borrower was in
      compliance with the requirements of Sections 6.6, 6.9 and 6.10 on the date
      of such financial statements and (ii) stating whether any Default or
      Unmatured Default exists on the date of such certificate and, if any
      Default or Unmatured Default then exists, setting forth the details
      thereof and the action which the Borrower is taking or proposes to take
      with respect thereto;

            6.1.4 As soon as possible and in any event within five Business Days
      after an Authorized Officer obtains knowledge of any Default or Unmatured
      Default, if such Default or Unmatured Default is then continuing, a
      certificate of an Authorized Officer setting forth the details thereof and
      the action which the Borrower is taking or proposes to take with respect
      thereto;

            6.1.5 Promptly upon the mailing thereof to the shareholders of the
      Borrower generally, copies of all financial statements, reports and proxy
      statements so mailed;

            6.1.6 Promptly upon the filing thereof, copies of all registration
      statements (other than the exhibits thereto and any registration
      statements on Form S-8 or its equivalent) and reports on Forms 10-K, 10-Q
      and 8-K (or their equivalents) which the Borrower shall have filed with
      the Securities and Exchange Commission;

            6.1.7 If and when any member of the ERISA Group (i) gives or is
      required to give notice to the PBGC of any "reportable event" (as defined
      in Section 4043 of ERISA)

                                       34



      with respect to any Plan which might constitute grounds for a termination
      of such Plan under Title IV of ERISA, or knows that the plan administrator
      of any Plan has given or is required to give notice of any such reportable
      event, a copy of the notice of such reportable event given or required to
      be given to the PBGC; (ii) receives notice of complete or partial
      withdrawal liability under Title IV of ERISA or notice that any
      Multiemployer Plan is in reorganization, is insolvent or has been
      terminated, a copy of such notice; (iii) receives notice from the PBGC
      under Title IV of ERISA of an intent to terminate, impose liability (other
      than for premiums under Section 4007 of ERISA) in respect of, or appoint a
      trustee to administer any Plan, a copy of such notice; (iv) applies for a
      waiver of the minimum funding standard under Section 412 of the Internal
      Revenue Code, a copy of such application; (v) gives notice of intent to
      terminate any Plan under Section 4041(c) of ERISA, a copy of such notice
      and other information filed with the PBGC; (vi) gives notice of withdrawal
      from any Plan pursuant to Section 4063 of ERISA, a copy of such notice; or
      (vii) fails to make any payment or contribution to any Plan or
      Multiemployer Plan or in respect of any Benefit Arrangement or makes any
      amendment to any Plan or Benefit Arrangement which has resulted or could
      result in the imposition of a Lien or the posting of a bond or other
      security under ERISA and the Internal Revenue Code, a certificate of an
      Authorized Officer setting forth details as to such occurrence and action,
      if any, which the Borrower or applicable member of the ERISA Group is
      required or proposes to take; and

            6.1.8 Promptly after an Authorized Officer becomes aware of the
      occurrence thereof, notice of any change by Moody's or S&P of their
      respective ratings referenced in the Pricing Schedule or of the cessation
      (or subsequent commencement) by Moody's or S&P of publication of their
      respective ratings referenced in the Pricing Schedule; and

            6.1.9 From time to time such additional information regarding the
      financial position or business of the Borrower and its Subsidiaries as the
      Agent, at the request of any Lender, may reasonably request.

Information required to be delivered pursuant to Sections 6.1.1, 6.1.2, 6.1.5 or
6.1.6 above shall be deemed to have been delivered on the date on which the
Borrower provides notice to the Lenders that such information has been posted on
the Borrower's website on the Internet at the website address listed on the
signature pages hereof, at sec.gov/edaux/searches.htm or at another website
identified in such notice and accessible by the Lenders without charge; provided
that (i) such notice may be included in a certificate delivered pursuant to
Section 6.1.3 and (ii) the Borrower shall deliver paper copies of the
information referred to in Sections 6.1.1, 6.1.2, 6.1.5 or 6.1.6 to any Lender
which requests such delivery.

      6.2. Maintenance of Property; Insurance.

            6.2.1 The Borrower will keep, and will cause each Material
      Subsidiary to keep, all property useful and necessary in its business in
      good working order and condition, ordinary wear and tear excepted, unless
      the failure to do so would not have a material adverse effect on the
      financial condition or financial prospects of the Borrower and its
      Consolidated Subsidiaries, considered as a whole, it being understood that
      this covenant

                                       35



      relates only to the working order and condition of such properties and
      shall not be construed as a covenant not to dispose of properties.

            6.2.2 The Borrower will maintain, and cause each Material Subsidiary
      to maintain, insurance with responsible and reputable insurance companies
      or associations in such amounts and covering such risks as is usually
      carried by companies engaged in similar businesses and owning similar
      properties in the same general areas in which the Borrower or such
      Material Subsidiary operates: provided, however, that the Borrower and
      each Material Subsidiary may self-insure to the same extent as other
      companies engaged in similar businesses and owning similar properties in
      the same general areas in which the Borrower or such Material Subsidiary
      operates.

      6.3. Conduct of Business and Maintenance of Existence.

            6.3.1 The Borrower (a) will preserve and maintain, and, except to
      the extent permitted under Section 6.7, will cause each Material
      Subsidiary to preserve and maintain, (i) its corporate existence and (ii)
      all rights and privileges (other than, in the case of APS, "franchises" as
      described in Arizona Revised Statutes, Section 40-283 or any successor
      provision) reasonably necessary in the normal conduct of its business,
      unless the failure to maintain such rights or privileges would not have a
      material adverse effect on the financial condition or financial prospects
      of the Borrower and its Consolidated Subsidiaries, considered as a whole,
      and (b) will cause APS to use its best efforts to preserve and maintain
      such franchises reasonably necessary in the normal conduct of its
      business, except that, in the case of clause (b) above, (i) APS from time
      to time may make minor extensions of its lines, plants, services or
      systems prior to the time a related franchise, certificate of convenience
      and necessity, license or permit is procured, (ii) from time to time
      communities served by APS may become incorporated and considerable time
      may elapse before such a franchise is procured, (iii) certain such
      franchises may have expired prior to the renegotiation thereof, (iv)
      certain minor defects and exceptions may exist which, individually and in
      the aggregate, are not material and (v) certain franchises, certificates,
      licenses and permits may not be specific as to their geographical scope.

            6.3.2 The Borrower will continue to conduct, directly or through its
      Subsidiaries, the same general type of business conducted by the Borrower
      and its Material Subsidiaries on the date hereof.

      6.4. Compliance with Laws. The Borrower will comply, and cause each
Material Subsidiary to comply, in all material respects with all applicable
laws, ordinances, rules, regulations, and requirements of governmental
authorities (including, without limitation, Environmental Laws and ERISA and the
rules and regulations thereunder) except where (i) the necessity of compliance
therewith is contested in good faith by appropriate proceedings or (ii) the
noncompliance with which would not have a material adverse effect on the
financial condition or financial prospects of the Borrower and its Consolidated
Subsidiaries, considered as a whole.

                                       36



      6.5. Pari Passu. The Borrower will not create, assume or suffer to exist
any Lien on any of the capital stock of any Material Subsidiary owned by the
Borrower or on any Debt of a Material Subsidiary owed to the Borrower unless the
Lenders are also granted a Lien thereon on a pari passu basis securing all of
the Borrower's obligations under this Agreement and the Notes.

      6.6. Ownership of APS. Except to the extent permitted under Section 6.7,
the Borrower will at all times continue to own directly at least 80% of the
outstanding capital stock of APS and PWEC for so long as PWEC is a Material
Subsidiary.

      6.7. Consolidations, Mergers and Sales of Assets.

            6.7.1 The Borrower will not, nor will it permit any Material
      Subsidiary to, merge or consolidate with or into any other Person, except
      (i) any Material Subsidiary may merge or consolidate with the Borrower if
      the Borrower is the corporation surviving such merger, (ii) any Material
      Subsidiary may merge or consolidate with any other Subsidiary, provided
      that the Borrower's aggregate direct and indirect ownership interest in
      the survivor thereof shall not be less than the greater of the Borrower's
      direct and indirect ownership interest in such Subsidiaries prior to such
      merger, and (iii) the Borrower or any Material Subsidiary may merge or
      consolidate with any other Person if (a) such Person was organized under
      the laws of the United States of America or one of its States and (b) the
      Borrower or such Material Subsidiary is the corporation surviving such
      merger; provided that, in each case, after giving effect thereto, no
      Default or Unmatured Default will be in existence.

            6.7.2 The Borrower will not sell, lease, transfer, assign or
      otherwise dispose of all or substantially all of its assets, or permit any
      of its Material Subsidiaries to sell, lease, transfer, assign or otherwise
      dispose of all or substantially all of its assets, except for sales,
      leases, transfers, assignments, and other dispositions of all or
      substantially all of the Borrower's or any such Material Subsidiary's
      assets to the Borrower or any other Subsidiary of the Borrower, provided
      in each case that no Unmatured Default or Default shall have occurred and
      be continuing after giving effect thereto and provided further that (i) in
      no case will the sale, lease, transfer, assignment or other disposition by
      PWEC of the Silverhawk Power Plant or any interest therein be governed or
      prohibited by this Section 6.7.2, and (ii) this Section 6.7.2 will not
      govern or prohibit pledges or the grant of security interests, mortgages
      or other Liens on any assets.

      6.8. Use of Proceeds. The proceeds of the Loans made under this Agreement
will be used by the Borrower to refinance indebtedness from time to time and for
general corporate purposes. All Letters of Credit issued under this Agreement
will be used for general corporate purposes. None of such proceeds will be used,
directly or indirectly, for the purpose, whether immediate, incidental, or
ultimate, of buying or carrying any "margin stock" within the meaning of
Regulation U; provided, however, that the Borrower may use the proceeds of the
Loans made under this Agreement for the purpose of repurchasing shares of the
Borrower's common stock so long as such repurchases do not subject any of the
Lenders to the requirements of Regulation U in respect of this Agreement. In
accordance with applicable Federal Energy Regulatory Commission orders and
precedent, each Credit Extension will be for some lawful object within

                                       37



the corporate purposes of the Borrower, compatible with the public interest, and
reasonably necessary or appropriate for such purposes.

      6.9. Interest Coverage Ratio. The Borrower will maintain for each
twelve-month period ending on the last day of each fiscal quarter (determined as
of the last day of such fiscal quarter) an Interest Coverage Ratio of no less
than 2:1.

      6.10. Indebtedness. Consolidated Debt will not exceed at any time an
amount equal to 65% of Consolidated Capitalization.

      6.11. Inspection of Property, Books and Records. The Borrower will keep,
and will cause each Material Subsidiary to keep, proper books of record and
account in which full, true and correct entries shall be made of all dealings
and transactions in relation to its business and activities; and will permit,
and will cause each Material Subsidiary to permit, representatives of any Lender
at such Lender's expense to visit and inspect any of their respective
properties, to examine and make abstracts from any of their respective books and
records and to discuss their respective affairs, finances and accounts with
their respective officers, employees and independent public accountants, all at
such reasonable times and as often as may reasonably be desired; provided,
however, that the Borrower and its Material Subsidiaries reserve the right to
restrict access to any of its properties in accordance with reasonably adopted
policies relating to safety and security.

                                   ARTICLE VII

                                    DEFAULTS

      The occurrence of any one or more of the following events shall constitute
a Default:

      7.1. The Borrower shall fail to pay (i) when due, any principal of any
Loan, (ii) any Reimbursement Obligation within one Business Day after the same
becomes due or (iii) within three Business Days of the date when due, interest
on any Loan, or any fees (including any LC Fee) payable hereunder.

      7.2. The Borrower shall fail to observe or perform any covenant contained
in Sections 6.1.4, 6.3.1(a)(i) (solely with respect to the Borrower) and 6.5 to
6.10, inclusive.

      7.3. The Borrower shall fail to observe or perform any covenant or
agreement contained in this Agreement (other than those covered by Section 7.1
or Section 7.2 above) for 30 days after notice thereof has been given to the
Borrower by the Agent at the request of any Lender.

      7.4. Any representation, warranty, certification or statement made by the
Borrower in this Agreement or in any certificate, financial statement or other
document delivered pursuant to this Agreement shall prove to have been incorrect
in any material respect when made (or deemed made).

      7.5. The Borrower or any Material Subsidiary shall fail to pay any
principal of or premium or interest on any Material Debt or Material Derivative
Obligation, when the same

                                       38



becomes due and payable (whether by scheduled maturity, required prepayment,
acceleration, demand or otherwise), and such failure shall continue after the
applicable grace period, if any, specified in the agreement or instrument
relating to such Material Debt or Material Derivative Obligation; or the
Borrower or any Material Subsidiary shall fail to perform or comply with any
other term or covenant in any agreement or instrument relating to such Material
Debt or Material Derivative Obligation and such failure shall continue after the
applicable grace period, if any, specified in such agreement or instrument, if
the effect of such failure is to accelerate, or to permit the acceleration of,
the maturity of such Material Debt or Material Derivative Obligation.

      7.6. The Borrower or any Material Subsidiary shall commence a voluntary
case or other proceeding seeking liquidation, reorganization or other relief
with respect to itself or its debts under any bankruptcy, insolvency or other
similar law now or hereafter in effect or seeking the appointment of a trustee,
receiver, liquidator, custodian or other similar official of it or any
substantial part of its property, or shall consent to any such relief or to the
appointment of or taking possession by any such official in an involuntary case
or other proceeding commenced against it, or shall make a general assignment for
the benefit of creditors, or shall fail generally to pay its debts as they
become due, or shall take any corporate action to authorize any of the
foregoing.

      7.7. An involuntary case or other proceeding shall be commenced against
the Borrower or any Material Subsidiary seeking liquidation, reorganization or
other relief with respect to it or its debts under any bankruptcy, insolvency or
other similar law now or hereafter in effect or seeking the appointment of a
trustee, receiver, liquidator, custodian or other similar official of it or any
substantial part of its property, and such involuntary case or other proceeding
shall remain undismissed or unstayed for a period of 60 days; or an order for
relief shall be entered against the Borrower or any Material Subsidiary under
the federal bankruptcy laws as now or hereafter in effect.

      7.8. Any member of the ERISA Group shall fail to pay when due an amount or
amounts aggregating in excess of $25,000,000 which it shall have become liable
to pay under Title IV of ERISA; or notice of intent to terminate a Material Plan
shall be filed under Title IV of ERISA by any member of the ERISA Group, any
plan administrator or any combination of the foregoing; or the PBGC shall
institute proceedings under Title IV of ERISA to terminate, to impose liability
(other than for premiums under Section 4007 of ERISA) in respect of, or to cause
a trustee to be appointed to administer any Material Plan; or a condition shall
exist by reason of which the PBGC would be entitled to obtain a decree
adjudicating that any Material Plan must be terminated; or there shall occur a
complete or partial withdrawal from, or a default, within the meaning of Section
4219(c)(5) of ERISA, with respect to, one or more Multiemployer Plans which
could cause one or more members of the ERISA Group to incur a current payment
obligation in excess of $25,000,000.

      7.9. Judgments or orders for the payment of money that exceeds any
applicable insurance coverage by more than $25,000,000 in the aggregate shall be
rendered against the Borrower or any Material Subsidiary and such judgments or
orders shall continue unsatisfied or unstayed for a period of 45 days.

      7.10. Any Change in Control shall occur.

                                       39



                                  ARTICLE VIII

                 ACCELERATION, WAIVERS, AMENDMENTS AND REMEDIES

      8.1. Acceleration. (i) If any Default described in Section 7.6 or 7.7
occurs with respect to the Borrower, the obligations of the Lenders to make
Loans hereunder and the obligation and power of the Issuing Banks to issue
Letters of Credit shall automatically terminate and the Obligations shall
immediately become due and payable without any election or action on the part of
the Agent, any Issuing Bank or any Lender. If any other Default occurs, the
Required Lenders (or the Agent with the consent of the Required Lenders) may
terminate or suspend the obligations of the Lenders to make Loans hereunder and
the obligation and power of the Issuing Banks to issue Letters of Credit, or
declare the Obligations to be due and payable, or both, whereupon the
Obligations shall become immediately due and payable, without presentment,
demand, protest or notice of any kind, all of which the Borrower hereby
expressly waives.

      (ii) If, within 30 days after acceleration of the maturity of the
Obligations or termination of the obligations of the Lenders to make Loans and
the obligation and power of the Issuing Banks to issue Letters of Credit
hereunder as a result of any Default (other than any Default as described in
Section 7.6 or 7.7 with respect to the Borrower) and before any judgment or
decree for the payment of the Obligations due shall have been obtained or
entered, the Required Lenders (in their sole discretion) shall so direct, the
Agent shall, by notice to the Borrower, rescind and annul such acceleration
and/or termination.

      8.2. Amendments. Subject to the provisions of this Section 8.2, the
Required Lenders (or the Agent with the consent in writing of the Required
Lenders) and the Borrower may enter into agreements supplemental hereto for the
purpose of adding or modifying any provisions to the Loan Documents or changing
in any manner the rights of the Lenders or the Borrower hereunder or waiving any
Default hereunder; provided, however, that no such supplemental agreement shall,
without the consent of each Lender adversely affected thereby:

            8.2.1 Extend the final maturity of any Loan, or extend the expiry
      date of any Letter of Credit to a date after the Facility Termination Date
      or forgive all or any portion of the principal amount thereof or any
      Reimbursement Obligation related thereto, or reduce the rate or extend the
      time of payment of interest or fees thereon or any Reimbursement
      Obligation related thereto.

            8.2.2 Reduce the percentage specified in the definition of Required
      Lenders.

            8.2.3 Extend the Facility Termination Date, or reduce the amount or
      extend the payment date for, the mandatory payments required under Section
      2.2, or increase the amount of the Commitment of any Lender hereunder or
      the commitment to issue Letters of Credit, or permit the Borrower to
      assign its rights under this Agreement.

            8.2.4 Amend the definition of "Applicable Percentage", this Section
      8.2 or any other provision of this Agreement regarding the percentage of
      Lenders required to effect an action under the Loan Documents.

                                       40



            8.2.5 Amend Section 11.2 of this Agreement in a manner that would
      alter the pro rata sharing of payments required thereby.

No amendment of any provision of this Agreement relating to the Agent shall be
effective without the written consent of the Agent, and no amendment of any
provision relating to any Issuing Bank shall be effective without the written
consent of such Issuing Bank. The Agent may waive payment of the fee required
under Section 12.3.3 without obtaining the consent of any other party to this
Agreement.

      8.3. Preservation of Rights. No delay or omission of the Lenders, any
Issuing Bank or the Agent to exercise any right under the Loan Documents shall
impair such right or be construed to be a waiver of any Default or an
acquiescence therein, and the making of a Credit Extension notwithstanding the
existence of a Default or the inability of the Borrower to satisfy the
conditions precedent to such Credit Extension shall not constitute any waiver or
acquiescence. Any single or partial exercise of any such right shall not
preclude other or further exercise thereof or the exercise of any other right,
and no waiver, amendment or other variation of the terms, conditions or
provisions of the Loan Documents whatsoever shall be valid unless in writing
signed by, or by the Agent with the consent of, the requisite number of Lenders
required pursuant to Section 8.2, and then only to the extent in such writing
specifically set forth. All remedies contained in the Loan Documents or by law
afforded shall be cumulative and all shall be available to the Agent, the
Issuing Banks and the Lenders until the Obligations have been paid in full.

                                   ARTICLE IX

                               GENERAL PROVISIONS

      9.1. Survival of Representations. All representations and warranties of
the Borrower contained in this Agreement shall survive the making of the Credit
Extensions herein contemplated.

      9.2. Governmental Regulation. Anything contained in this Agreement to the
contrary notwithstanding, no Lender or Issuing Bank shall be obligated to extend
credit to the Borrower in violation of any limitation or prohibition provided by
any applicable statute or regulation.

      9.3. Headings. Section headings in the Loan Documents are for convenience
of reference only, and shall not govern the interpretation of any of the
provisions of the Loan Documents.

      9.4. Entire Agreement. The Loan Documents and the Letter of Credit
Applications embody the entire agreement and understanding among the Borrower,
the Agent, the Issuing Banks and the Lenders and supersede all prior agreements
and understandings among the Borrower, the Agent, the Issuing Banks and the
Lenders relating to the subject matter thereof other than those contained in the
fee letter and, to the extent expressly set forth therein, the commitment
letter, described in Section 10.13 which shall survive and remain in full force
and effect during the term of this Agreement.

                                       41



      9.5. Several Obligations; Benefits of this Agreement. The respective
obligations of the Lenders hereunder are several and not joint and no Lender
shall be the partner, co-venturer or agent of any other (except to the extent to
which the Agent is authorized to act as such). The failure of any Lender to
perform any of its obligations hereunder shall not relieve any other Lender from
any of its obligations hereunder. This Agreement shall not be construed so as to
confer any right or benefit upon any Person other than the parties to this
Agreement and their respective successors and assigns and as otherwise expressly
stated herein.

      9.6. Expenses; Indemnification. (i) The Borrower shall reimburse the Agent
and the Arrangers for any reasonable out-of-pocket costs and expenses (including
reasonable attorneys' and paralegals' fees for one firm of attorneys for the
Agent and Arrangers, and which attorneys may be employees of the Agent or either
Arranger and expenses of and fees for other advisors and professionals engaged
by the Agent or the Arrangers in consultation with the Borrower) paid or
incurred by the Agent or the Arrangers in connection with the preparation,
investigation, negotiation, documentation, execution, delivery, syndication,
distribution (including, without limitation, via the internet), review,
amendment, modification, and administration of the Loan Documents and incurred
after the Closing Date. The Borrower also agrees to reimburse the Agent, the
Arrangers, the Issuing Banks and the Lenders for any reasonable out-of-pocket
costs and expenses (including reasonable attorneys' and paralegals' fees and
out-of-pocket expenses of attorneys for the Agent, the Arrangers, the Issuing
Banks and the Lenders, which attorneys may be employees of the Agent, the
Arrangers, the Issuing Banks or the Lenders) paid or incurred by the Agent, the
Arrangers, the Issuing Banks or any Lender in connection with the collection and
enforcement of the Loan Documents.

      (ii)  The Borrower hereby further agrees to indemnify the Agent, each
            Arranger, each Issuing Bank, each Lender, their respective
            affiliates, and their respective directors, officers, employees and
            agents (each, an "Indemnified Party") against all losses, claims,
            damages, penalties, judgments, liabilities and expenses (including,
            without limitation, all expenses of litigation or preparation
            therefor whether or not such Indemnified Party is a party thereto,
            and all reasonable outside attorneys' and paralegals' fees and
            expenses of outside attorneys and paralegals of the Indemnified
            Party) which any of them may pay or incur arising out of or relating
            to this Agreement, the other Loan Documents, the transactions
            contemplated hereby or the direct or indirect application or
            proposed application of the proceeds of any Credit Extension
            hereunder except to the extent that they are expressly stated in
            this Agreement to be payable by the Indemnified Party or one of its
            Affiliates, including, but not limited to, expenses payable under
            Sections 3.5(vii) and 6.11, or are determined in a final
            non-appealable judgment by a court of competent jurisdiction to have
            resulted from the gross negligence or willful misconduct of such
            Indemnified Party or any of its Affiliates, in which case any fees
            and expenses previously paid or advanced by the Borrower to such
            Indemnified Party in respect of such indemnified obligation will be
            returned by such Indemnified Party. In the case of an investigation,
            litigation or other proceeding to which the indemnity in this
            Section 9.6(ii) applies, such indemnity shall be effective whether
            or not such investigation, litigation or proceeding is brought by
            the Borrower, its directors, equityholders or creditors or an
            Indemnified Party or any other Person, whether or not any
            Indemnified Party is

                                       42



            otherwise a party thereto, unless such litigation or proceeding is
            brought by or against the Borrower and the Borrower prevails in a
            final, non-appealable judgment, in which case any fees or expenses
            previously paid or advanced by the Borrower to such Indemnified
            Party in respect of such indemnified obligation will be returned by
            such Indemnified Party, and whether or not the transactions
            contemplated hereby are consummated. The obligations of the Borrower
            under this Section 9.6 shall survive the termination of this
            Agreement.

      9.7. Numbers of Documents. All statements, notices, closing documents, and
requests hereunder shall be furnished to the Agent with sufficient counterparts
so that the Agent may furnish one to each of the Lenders.

      9.8. Accounting Terms and Determinations. Unless otherwise specified
herein, all accounting terms used herein shall be interpreted, all accounting
determinations hereunder shall be made, and all financial statements required to
be delivered hereunder shall be prepared, in accordance with generally accepted
accounting principles as in effect from time to time, applied on a basis
consistent (except for changes concurred in by the Borrower's independent public
accountants) with the most recent audited consolidated financial statements of
the Borrower delivered to the Agent; provided that, if the Borrower notifies the
Agent that the Borrower wishes to amend any covenant in Article VI to eliminate
the effect of any change in generally accepted accounting principles on the
operation of such covenant (or if the Agent notifies the Borrower that the
Required Lenders wish to amend Article VI for such purpose), then the Borrower's
compliance with such covenant shall be applied on the basis of generally
accepted accounting principles in effect immediately before the relevant change
in generally accepted accounting principles became effective, until either such
notice is withdrawn or such covenant is amended in a manner satisfactory to the
Borrower and the Required Lenders.

      9.9. Severability of Provisions. Any provision in any Loan Document that
is held to be inoperative, unenforceable, or invalid in any jurisdiction shall,
as to that jurisdiction, be inoperative, unenforceable, or invalid without
affecting the remaining provisions in that jurisdiction or the operation,
enforceability, or validity of that provision in any other jurisdiction, and to
this end the provisions of all Loan Documents are declared to be severable.

      9.10. Nonliability of Lenders. The relationship between the Borrower on
the one hand and the Lenders, the Issuing Banks and the Agent on the other hand
shall be solely that of borrower and lender. Neither the Agent, any Arranger,
any Issuing Bank nor any Lender shall have any fiduciary responsibilities to the
Borrower. Neither the Agent, any Arranger, any Issuing Bank nor any Lender
undertakes any responsibility to the Borrower to review or inform the Borrower
of any matter in connection with any phase of the Borrower's business or
operations. Neither the Agent, any Arranger, any Issuing Bank nor any Lender
shall have any liability with respect to, and the Borrower hereby waives,
releases and agrees not to sue for, any special, indirect, consequential or
punitive damages suffered by the Borrower in connection with, arising out of, or
in any way related to the Loan Documents or the transactions contemplated
thereby.

      9.11. Confidentiality. Each Lender, each Issuing Bank and the Agent shall
exercise the same degree of care that it exercises with respect to its own
proprietary information of the same

                                       43



types to maintain the confidentiality of any Confidential Information received
pursuant to this Agreement except that disclosure of such Confidential
Information may be made (i) to the agents, employees, subsidiaries or affiliates
of such Person in connection with its present or prospective business relations
with the Borrower arising out of this Agreement, provided that such Person will
cause such agents, employees, subsidiaries or affiliates to comply with the
provisions of this Section 9.11 with respect to such Confidential Information,
(ii) to prospective transferees or purchasers of any interest in the Outstanding
Credit Exposure (including any Participant), provided that they have agreed to
be bound by the provision of this Section 9.11, (iii) as required by law,
regulations, rule, request or order, subpoena, judicial order or similar order
and in connection with any litigation, (iv) as may be required in connection
with the examination, audit or similar investigation of such Person, (v) to its
direct or indirect contractual counterparties in swap agreements or to legal
counsel, accountants and other professional advisors to such counterparties,
provided that such counterparties, legal counsel, accountants and other
professional advisors shall agree to comply with the provisions of this Section
9.11 with respect to such Confidential Information, and (vi) to rating agencies
if requested or required by such agencies in connection with a rating relating
to the Credit Extensions hereunder. Without limiting Section 9.4, the Borrower
agrees that the terms of this Section 9.11 shall set forth the entire agreement
between the Borrower and each Lender (including the Issuing Banks and the Agent)
with respect to any confidential information previously or hereafter received by
such Lender in connection with this Agreement, and this Section 9.11 shall
supersede any and all prior confidentiality agreements entered into by such
Lender with respect to such confidential information.

      9.12. Nonreliance. Each Lender hereby represents that it is not relying on
or looking to any margin stock (as defined in Regulation U of the Board of
Governors of the Federal Reserve System) for the repayment of the Credit
Extensions provided for herein.

      9.13. Disclosure. The Borrower and each Lender hereby acknowledge and
agree that JPMCB and/or its Affiliates from time to time may hold investments
in, make other loans to or have other relationships with the Borrower and its
Affiliates.

      9.14. USA Patriot Act Notification. The following notification is provided
to the Borrower pursuant to Section 326 of the USA Patriot Act of 2001, 31
U.S.C. Section 5318:

IMPORTANT INFORMATION ABOUT PROCEDURES FOR OPENING A NEW ACCOUNT. To help the
government fight the funding of terrorism and money laundering activities,
Federal law requires all financial institutions to obtain, verify, and record
information that identifies each person or entity that opens an account,
including any deposit account, treasury management account, loan, other
extension of credit, or other financial services product. What this means for
the Borrower: When the Borrower opens an account, the Agent and the Lenders will
ask for the Borrower's name, tax identification number, business address, and
other information that will allow the Agent and the Lenders to identify the
Borrower. The Agent and the Lenders may also ask to see the Borrower's legal
organizational documents or other identifying documents.

      9.15. Relations Among Lenders.

                                       44



            9.15.1 No Action Without Consent. Except with respect to the
      exercise of setoff rights of any Lender, in accordance with Section 11.1,
      the proceeds of which are applied in accordance with this Agreement, each
      Lender and each Issuing Bank agrees that it will not take any action, nor
      institute any actions or proceedings, against the Borrower or with respect
      to any Loan Document, without the prior written consent of the Required
      Lenders or, as may be provided in this Agreement or the other Loan
      Documents, with the consent of the Agent.

            9.15.2 No Liability. The Agent shall have the exclusive right on
      behalf of the Lenders to enforce the payment of the principal of and
      interest on, or LC Exposure in respect of, any Credit Extension after the
      date such principal or interest has become due and payable pursuant to the
      terms of this Agreement.

      9.16. Notice of Termination of Existing Agreements. The Borrower, the
Lenders and the Agent agree that, upon (i) the execution and delivery of this
Agreement by each of the parties hereto and (ii) the satisfaction (or waiver by
the aforementioned parties) of the conditions precedent set forth in Sections
4.1 and 4.2, the Existing Credit Agreements shall be and hereby are terminated.
To the extent any such termination shall require prior written notice be
received within a specified period of days prior to such termination pursuant to
the terms of the Existing Credit Agreements, any such requirements are hereby
waived.

                                    ARTICLE X

                                    THE AGENT

      10.1. Appointment; Nature of Relationship. JPMorgan Chase Bank is hereby
appointed by each of the Lenders and Issuing Banks as its contractual
representative (herein referred to as the "Agent") hereunder and under each
other Loan Document, and each of the Lenders and Issuing Banks irrevocably
authorizes the Agent to act as the contractual representative of such Lender and
Issuing Banks with the rights and duties expressly set forth herein and in the
other Loan Documents. The Agent agrees to act as such contractual representative
upon the express conditions contained in this Article X. Notwithstanding the use
of the defined term "Agent," it is expressly understood and agreed that the
Agent shall not have any fiduciary responsibilities to any Lender or any Issuing
Bank by reason of this Agreement or any other Loan Document and that the Agent
is merely acting as the contractual representative of the Lenders and the
Issuing Banks with only those duties as are expressly set forth in this
Agreement and the other Loan Documents. In its capacity as the Lenders' and
Issuing Banks' contractual representative, the Agent (i) does not hereby assume
any fiduciary duties to any of the Lenders or any Issuing Bank and (ii) is
acting as an independent contractor, the rights and duties of which are limited
to those expressly set forth in this Agreement and the other Loan Documents.
Each of the Lenders and the Issuing Banks, for itself and each of its
Affiliates, hereby agrees to assert no claim against the Agent on any agency
theory or any other theory of liability for breach of fiduciary duty, all of
which claims each Lender, each Issuing Bank and each Affiliate of each Lender
and each Issuing Bank hereby waives.

      10.2. Powers. The Agent shall have and may exercise such powers under the
Loan Documents as are specifically delegated to the Agent by the terms of each
thereof, together with

                                       45



such powers as are reasonably incidental thereto. The Agent shall have no
implied duties to the Lenders, or any obligation to the Lenders to take any
action thereunder except any action specifically provided by the Loan Documents
to be taken by the Agent.

      10.3. General Immunity. Neither the Agent nor any of its directors,
officers, agents or employees shall be liable to any Lender for any action taken
or omitted to be taken by it or them hereunder or under any other Loan Document
or in connection herewith or therewith except to the extent such action or
inaction is determined in a final non-appealable judgment by a court of
competent jurisdiction to have arisen from the gross negligence or willful
misconduct of such Person.

      10.4. No Responsibility for Loans, Recitals, etc. Neither the Agent nor
any of its directors, officers, agents or employees shall be responsible for or
have any duty to ascertain, inquire into, or verify (a) any statement, warranty
or representation made in connection with any Loan Document or any borrowing
hereunder; (b) the performance or observance of any of the covenants or
agreements of any obligor under any Loan Document, including, without
limitation, any agreement by an obligor to furnish information directly to each
Lender; (c) the satisfaction of any condition specified in Article IV, except
receipt of items required to be delivered solely to the Agent; (d) the existence
or possible existence of any Default or Unmatured Default; (e) the validity,
enforceability, effectiveness, sufficiency or genuineness of any Loan Document
or any other instrument or writing furnished in connection therewith; or (f) the
financial condition of the Borrower or of any of the Borrower's Subsidiaries.
The Agent shall have no duty to disclose to the Lenders information that is not
required to be furnished by the Borrower to the Agent at the time so furnished,
but is voluntarily furnished by the Borrower to the Agent (either in its
capacity as Agent or in its individual capacity).

      10.5. Action on Instructions of Lenders. The Agent shall in all cases be
fully protected in acting, or in refraining from acting, hereunder and under any
other Loan Document in accordance with written instructions signed by the
Required Lenders (or all of the Lenders in the event that and to the extent that
this Agreement expressly requires such approval), and such instructions and any
action taken or failure to act pursuant thereto shall be binding on all of the
Lenders. The Lenders hereby acknowledge that the Agent shall be under no duty to
take any discretionary action permitted to be taken by it pursuant to the
provisions of this Agreement or any other Loan Document unless it shall be
requested in writing to do so by the Required Lenders (or all of the Lenders in
the event that and to the extent that this Agreement expressly requires such
approval). The Agent shall be fully justified in failing or refusing to take any
action hereunder and under any other Loan Document unless it shall first be
indemnified to its satisfaction by the Lenders pro rata against any and all
liability, cost and expense that it may incur by reason of taking or continuing
to take any such action.

      10.6. Employment of Agents and Counsel. The Agent may execute any of its
duties as Agent hereunder and under any other Loan Document by or through
employees, agents, and attorneys-in-fact and shall not be answerable to the
Lenders, except as to money or securities received by it or its authorized
agents, for the default or misconduct of any such agents or attorneys-in-fact
selected by it with reasonable care. The Agent shall be entitled to advice of
counsel concerning the contractual arrangement between the Agent and the Lenders
and all matters pertaining to the Agent's duties hereunder and under any other
Loan Document.

                                       46


      10.7. Reliance on Documents; Counsel. The Agent shall be entitled to rely
upon any Note, notice, consent, certificate, affidavit, letter, telegram,
facsimile, telex, electronic mail message, statement, paper or document
reasonably (but without any requirement of any additional diligence by the Agent
with respect thereto) believed by it to be genuine and correct and to have been
signed or sent by the proper person or persons, and, in respect to legal
matters, upon the opinion of counsel selected by the Agent, which counsel may be
employees of the Agent. For purposes of determining compliance with the
conditions specified in Sections 4.1 and 4.2, each Lender that has signed this
Agreement (or otherwise become party hereto pursuant to an assignment under
Section 12.3) shall be deemed to have consented to, approved or accepted or to
be satisfied with, each document or other matter required thereunder to be
consented to or approved by or acceptable or satisfactory to a Lender unless the
Agent shall have received notice from such Lender prior to the applicable date
specifying its objection thereto.

      10.8. Agent's Reimbursement and Indemnification. The Lenders agree to
reimburse and indemnify the Agent ratably in proportion to the Lenders'
respective Applicable Percentages of the Aggregate Commitment (or, if the
Aggregate Commitment has been terminated, of the Aggregate Outstanding Credit
Exposure) to the extent not reimbursed by or on behalf of the Borrower and
without limiting any obligation of the Borrower to do so (i) for any amounts not
reimbursed by the Borrower for which the Agent is entitled to reimbursement by
the Borrower under the Loan Documents, (ii) for any other expenses incurred by
the Agent on behalf of the Lenders, in connection with the preparation,
execution, delivery, administration and enforcement of the Loan Documents
(including, without limitation, for any expenses incurred by the Agent in
connection with any dispute between the Agent and any Lender or between two or
more of the Lenders) and (iii) for any liabilities, obligations, losses,
damages, penalties, actions, judgments, suits, costs, expenses or disbursements
of any kind and nature whatsoever which may be imposed on, incurred by or
asserted against the Agent in any way relating to or arising out of the Loan
Documents or any other document delivered in connection therewith or the
transactions contemplated thereby (including, without limitation, for any such
amounts incurred by or asserted against the Agent in connection with any dispute
between the Agent and any Lender or between two or more of the Lenders), or the
enforcement of any of the terms of the Loan Documents or of any such other
documents, provided that (i) no Lender shall be liable for any of the foregoing
to the extent any of the foregoing is found in a final non-appealable judgment
by a court of competent jurisdiction to have resulted from the gross negligence
or willful misconduct of the Agent and (ii) any indemnification required
pursuant to Section 3.5(vii) shall, notwithstanding the provisions of this
Section 10.8, be paid by the relevant Lender in accordance with the provisions
thereof. The obligations of the Lenders under this Section 10.8 shall survive
payment of the Obligations and termination of this Agreement.

      10.9. Notice of Default. The Agent shall not be deemed to have knowledge
or notice of the occurrence of any Default or Unmatured Default hereunder unless
the Agent has received written notice from a Lender or the Borrower referring to
this Agreement describing such Default or Unmatured Default and stating that
such notice is a "notice of default". In the event that the Agent receives such
a notice, the Agent shall give prompt notice thereof to the Lenders.

      10.10. Rights as a Lender. In the event the Agent is a Lender, the Agent
shall have the same rights and powers hereunder and under any other Loan
Document with respect to its Commitment and its Outstanding Credit Exposure as
any Lender and may exercise the same as

                                       47



though it were not the Agent, and the term "Lender" or "Lenders" shall, at any
time when the Agent is a Lender, unless the context otherwise indicates, include
the Agent in its individual capacity. The Agent and its Affiliates may accept
deposits from, lend money to, and generally engage in any kind of trust, debt,
equity or other transaction, in addition to those contemplated by this Agreement
or any other Loan Document, with the Borrower or any of its Subsidiaries.

      10.11. Lender Credit Decision. Each Lender acknowledges that it has,
independently and without reliance upon the Agent, any Arranger or any other
Lender and based on the financial statements prepared by the Borrower and such
other documents and information as it has deemed appropriate, made its own
credit analysis and decision to enter into this Agreement and the other Loan
Documents. Each Lender also acknowledges that it will, independently and without
reliance upon the Agent, any Arranger or any other Lender and based on such
documents and information as it shall deem appropriate at the time, continue to
make its own credit decisions in taking or not taking action under this
Agreement and the other Loan Documents.

      10.12. Successor Agent. The Agent may resign at any time by giving written
notice thereof to the Lenders and the Borrower, such resignation to be effective
upon the appointment of a successor Agent or, if no successor Agent has been
appointed, forty-five days after the retiring Agent gives notice of its
intention to resign. Upon any such resignation, the Required Lenders shall, with
the prior written approval of the Borrower (which approval will not be
unreasonably withheld or delayed and which shall be required only so long as no
Default shall be continuing), have the right to appoint, on behalf of the
Borrower and the Lenders, a successor Agent. If no successor Agent shall have
been so appointed by the Required Lenders within thirty days after the resigning
Agent's giving notice of its intention to resign, then the resigning Agent may
appoint, on behalf of the Borrower and the Lenders, a successor Agent.
Notwithstanding the previous sentence, the Agent may at any time without the
consent of the Borrower or any Lender, appoint any of its Affiliates which is a
commercial bank as a successor Agent hereunder. If the Agent has resigned and no
successor Agent has been appointed, the Lenders may perform all the duties of
the Agent hereunder and the Borrower shall make all payments in respect of the
Obligations to the applicable Lender and for all other purposes shall deal
directly with the Lenders. No successor Agent shall be deemed to be appointed
hereunder until such successor Agent has accepted the appointment. Any such
successor Agent shall be a commercial bank having capital and retained earnings
of at least $100,000,000. Upon the acceptance of any appointment as Agent
hereunder by a successor Agent, such successor Agent shall thereupon succeed to
and become vested with all the rights, powers, privileges and duties of the
resigning Agent. Upon the effectiveness of the resignation of the Agent, the
resigning Agent shall be discharged from its duties and obligations hereunder
and under the Loan Documents. After the effectiveness of the resignation of an
Agent, the provisions of this Article X shall continue in effect for the benefit
of such Agent in respect of any actions taken or omitted to be taken by it while
it was acting as the Agent hereunder and under the other Loan Documents. In the
event that there is a successor to the Agent by merger, or the Agent assigns its
duties and obligations to an Affiliate or pursuant to this Section 10.12, then
the term "Prime Rate" as used in this Agreement shall mean the prime rate, base
rate or other analogous rate of the new Agent.

      10.13. Agent and Arranger Fees. The Borrower agrees to pay to the Agent
and the Arrangers, for their respective accounts, the fees agreed to by the
Borrower, the Agent, the Syndication Agent and the Arrangers pursuant to that
certain fee letter agreement dated

                                       48



September 14, 2004 entered into in connection with that certain commitment
letter dated as of September 14, 2004 by and among the Agent, the Syndication
Agent, the Arrangers and the Borrower, or as otherwise agreed from time to time.

      10.14. Delegation to Affiliates. The Borrower and the Lenders agree that
the Agent may delegate any of its duties under this Agreement to any of its
Affiliates; provided that the Agent shall remain solely responsible to the other
parties hereto for the performance of such duties. Any such Affiliate (and such
Affiliate's directors, officers, agents and employees) which performs duties in
connection with this Agreement shall be entitled to the same benefits of the
indemnification, waiver and other protective provisions to which the Agent is
entitled under Articles IX and X.

      10.15. Co-Agents, Managing Agent, Documentation Agent, Syndication Agent,
etc. None of the Lenders identified in this Agreement as a "Co-Agent", "Managing
Agent", "Documentation Agent" or the Syndication Agent shall have any right,
power, obligation, liability, responsibility or duty under this Agreement other
than those applicable to all Lenders as such. Without limiting the foregoing,
none of such Lenders shall have or be deemed to have a fiduciary relationship
with any Lender. Each Lender hereby makes the same acknowledgments with respect
to such Lenders as it makes with respect to the Agent in Section 10.11.

                                   ARTICLE XI

                            SETOFF; RATABLE PAYMENTS

      11.1. Setoff. In addition to, and without limitation of, any rights of the
Lenders under applicable law, if any Default occurs, any and all deposits of the
Borrower (including all account balances, whether provisional or final and
whether or not collected or available) and any other Debt at any time held or
owing by any Lender to or for the credit or account of the Borrower may be
offset and applied toward the payment of the Obligations owing to such Lender,
whether or not the Obligations, or any part thereof, shall then be due, and each
Lender shall endeavor to give notice of any such set-off to the Borrower,
provided that the failure of any Lender to give such notice shall not in any way
limit any Lender's rights under this Section 11.1.

      11.2. Ratable Payments. If any Lender, whether by setoff or otherwise, has
payment made to it upon its Outstanding Credit Exposure (other than payments
received pursuant to Section 3.1, 3.2, 3.4 or 3.5) in a greater proportion than
that received by any other Lender, such Lender agrees, promptly upon demand, to
purchase a portion of the Aggregate Outstanding Credit Exposure held by the
other Lenders so that after such purchase each Lender will hold its Applicable
Percentage of the Aggregate Outstanding Credit Exposure. In case any such
payment is disturbed by legal process, or otherwise, appropriate further
adjustments shall be made.

                                   ARTICLE XII

                BENEFIT OF AGREEMENT; ASSIGNMENTS; PARTICIPATIONS

      12.1. Successors and Assigns. The terms and provisions of the Loan
Documents shall be binding upon and inure to the benefit of the Borrower and the
Lenders and their respective

                                       49



successors and assigns permitted hereby, except that (i) the Borrower shall not
have the right to assign its rights or obligations under the Loan Documents
without the prior written consent of each Lender, (ii) any assignment by any
Lender must be made in compliance with Section 12.3, and (iii) any transfer by
participation must be made in compliance with Section 12.2. Any attempted
assignment or transfer by any party not made in compliance with this Section
12.1 shall be null and void, unless such attempted assignment or transfer is
treated as a participation in accordance with Section 12.3.3. The parties to
this Agreement acknowledge that clause (ii) of this Section 12.1 relates only to
absolute assignments and this Section 12.1 does not prohibit assignments
creating security interests, including, without limitation, (x) any pledge or
assignment by any Lender of all or any portion of its rights under this
Agreement and any Note to a Federal Reserve Bank or (y) in the case of a Lender
which is a Fund, any pledge or assignment of all or any portion of its rights
under this Agreement and any Note to its trustee in support of its obligations
to its trustee; provided, however, that no such pledge or assignment shall
release the transferor Lender from its obligations hereunder unless and until
the parties thereto have complied with the provisions of Section 12.3. The Agent
may treat the Person which made any Credit Extension or which holds any Note as
the owner thereof for all purposes hereof unless and until such Person complies
with Section 12.3; provided, however, that the Agent may in its discretion (but
shall not be required to) follow instructions from the Person which made any
Credit Extension or which holds any Note to direct payments relating to such
Credit Extension or Note to another Person. Any assignee of the rights to any
Outstanding Credit Exposure or any Note agrees by acceptance of such assignment
to be bound by all the terms and provisions of the Loan Documents. Any request,
authority or consent of any Person, who at the time of making such request or
giving such authority or consent is the owner of the rights to any Outstanding
Credit Exposure (whether or not a Note has been issued in evidence thereof),
shall be conclusive and binding on any subsequent holder or assignee of the
rights to such Outstanding Credit Exposure.

      12.2. Participations.

            12.2.1 Permitted Participants; Effect. Any Lender may at any time
      sell to one or more banks or other entities ("Participants") participating
      interests in any Outstanding Credit Exposure owing to such Lender, any
      Note held by such Lender, any Commitment of such Lender or any other
      interest or obligation of such Lender under the Loan Documents. In the
      event of any such sale by a Lender of participating interests or
      obligations to a Participant, such Lender's obligations under the Loan
      Documents shall remain unchanged, such Lender shall remain solely
      responsible to the other parties hereto for the performance of such
      obligations, such Lender shall remain the owner of its Outstanding Credit
      Exposure and the holder of any Note issued to it in evidence thereof for
      all purposes under the Loan Documents, all amounts payable by the Borrower
      under this Agreement shall be determined as if such Lender had not sold
      such participating interests, and the Borrower and the Agent shall
      continue to deal solely and directly with such Lender in connection with
      such Lender's rights and obligations under the Loan Documents.

            12.2.2 Voting Rights. Each Lender shall retain the sole right to
      approve, without the consent of any Participant, any amendment,
      modification or waiver of any provision of the Loan Documents other than
      any amendment, modification or waiver with respect

                                       50



      to any Outstanding Credit Exposure or Commitment in which such Participant
      has an interest which would require consent of all of the Lenders pursuant
      to the terms of Section 8.2 or of any other Loan Document.

            12.2.3 Benefit of Certain Provisions. The Borrower agrees that each
      Participant shall be entitled to the benefits of Sections 3.1, 3.2, 3.4
      and 3.5 to the same extent as if it were a Lender and had acquired its
      interest by assignment pursuant to Section 12.3, provided that (i) a
      Participant shall not be entitled to receive any greater payment under
      Section 3.1, 3.2 or 3.5 than the Lender who sold the participating
      interest to such Participant would have received had it retained such
      interest for its own account, unless the sale of such interest to such
      Participant is made with the prior written consent of the Borrower, and
      (ii) any Participant not incorporated under the laws of the United States
      of America or any State thereof agrees to comply with the provisions of
      Section 3.5 to the same extent as if it were a Lender.

      12.3. Assignments.

            12.3.1 Permitted Assignments. Any Lender may at any time assign to
      one or more banks or other entities ("Purchasers") all or any part of its
      rights and obligations under the Loan Documents. Such assignment shall be
      substantially in the form of Exhibit B or in such other form as may be
      agreed to by the parties thereto. Each such assignment with respect to a
      Purchaser which is not a Lender or an Affiliate of a Lender or an Approved
      Fund shall either be in an amount equal to the entire applicable
      Commitment and Outstanding Credit Exposure of the assigning Lender or
      (unless each of the Borrower and the Agent otherwise consents) be in an
      aggregate amount not less than $5,000,000. The amount of the assignment
      shall be based on the Commitment or Outstanding Credit Exposure (if the
      Commitment has been terminated) subject to the assignment, determined as
      of the date of such assignment or as of the "Trade Date," if the "Trade
      Date" is specified in the assignment.

            12.3.2 Consents. The consent of the Borrower shall be required prior
      to an assignment becoming effective unless the Purchaser is a Lender, an
      Affiliate of a Lender or an Approved Fund, provided that the consent of
      the Borrower shall not be required if a Default has occurred and is
      continuing. The consent of the Agent shall be required prior to an
      assignment becoming effective unless the Purchaser is a Lender. The
      consent of each Issuing Bank shall be required prior to any assignment
      becoming effective. Any consent required under this Section 12.3.2 shall
      not be unreasonably withheld or delayed.

            12.3.3 Effect; Effective Date. Upon (i) delivery to the Agent of an
      assignment, together with any consents required by Sections 12.3.1 and
      12.3.2, and (ii) payment of a $3,500 fee by the transferor Lender or the
      Purchaser to the Agent for processing such assignment (unless such fee is
      waived by the Agent), such assignment shall become effective on the
      effective date specified in such assignment. The assignment shall contain
      a representation by the Purchaser to the effect that none of the
      consideration used to make the purchase of the Commitment and Outstanding
      Credit Exposure under the applicable assignment agreement constitutes
      "plan assets" as defined under ERISA and that the rights and interests of
      the Purchaser in and under the Loan Documents will not be "plan

                                       51



      assets" under ERISA. On and after the effective date of such assignment,
      such Purchaser shall for all purposes be a Lender party to this Agreement
      and any other Loan Document executed by or on behalf of the Lenders and
      shall have all the rights and obligations of a Lender under the Loan
      Documents, to the same extent as if it were an original party thereto, and
      the transferor Lender shall be released with respect to the Commitment and
      Outstanding Credit Exposure assigned to such Purchaser without any further
      consent or action by the Borrower, the Lenders, the Agent or the Issuing
      Banks. In the case of an assignment covering all of the assigning Lender's
      rights and obligations under this Agreement, such Lender shall cease to be
      a Lender hereunder but shall continue to be entitled to the benefits of,
      and subject to, those provisions of this Agreement and the other Loan
      Documents which survive payment of the Obligations and termination of the
      applicable agreement. Any assignment or transfer by a Lender of rights or
      obligations under this Agreement that does not comply with this Section
      12.3 shall be treated for purposes of this Agreement as a sale by such
      Lender of a participation in such rights and obligations in accordance
      with Section 12.2. Upon the consummation of any assignment to a Purchaser
      pursuant to this Section 12.3.3, the transferor Lender, the Agent and the
      Borrower shall, if the transferor Lender or the Purchaser desires that its
      Loans be evidenced by Notes, make appropriate arrangements so that new
      Notes or, as appropriate, replacement Notes are issued to such transferor
      Lender and new Notes or, as appropriate, replacement Notes, are issued to
      such Purchaser, in each case in principal amounts reflecting their
      respective Commitments, as adjusted pursuant to such assignment.

            12.3.4 Register. The Agent, acting solely for this purpose as an
      agent of the Borrower, shall maintain at one of its offices in New York,
      New York a copy of each Assignment and Assumption delivered to it and a
      register for the recordation of the names and addresses of the Lenders,
      and the Commitments of, and principal amounts of the Loans owing to, and
      participations in Letters of Credit by, each Lender pursuant to the terms
      hereof from time to time (the "Register"). The entries in the Register
      shall be conclusive, absent manifest error, and the Borrower, the Agent
      and the Lenders may treat each Person whose name is recorded in the
      Register pursuant to the terms hereof as a Lender hereunder for all
      purposes of this Agreement, notwithstanding notice to the contrary. The
      Register shall be available for inspection by the Borrower at any
      reasonable time and from time to time upon reasonable prior notice.

      12.4. Dissemination of Information. The Borrower authorizes each Lender to
disclose to any Participant or Purchaser or any other Person acquiring an
interest in the Loan Documents by operation of law (each a "Transferee") and any
prospective Transferee any and all information in such Lender's possession
concerning the Borrower and its Subsidiaries; provided that each Transferee and
prospective Transferee agrees to be bound by Section 9.11 of this Agreement.

      12.5. Tax Treatment. If any interest in any Loan Document is transferred
to any Transferee which is not incorporated under the laws of the United States
or any State thereof, the transferor Lender shall cause such Transferee,
concurrently with the effectiveness of such transfer, to comply with the
provisions of Section 3.5(iv).

                                       52



                                  ARTICLE XIII

                                     NOTICES

      13.1. Notices; Effectiveness; Electronic Communication.

            (a) Notices Generally. Except in the case of notices and other
      communications expressly permitted to be given by telephone (and except as
      provided in paragraph (b) below), all notices and other communications
      provided for herein shall be in writing and shall be delivered by hand or
      overnight courier service, mailed by certified or registered mail or sent
      by telecopier as follows:

      (i)   if to the Borrower, at its address or telecopier number set forth on
            the signature page hereof;

      (ii)  if to the Agent or if the applicable Issuing Bank is JPMCB, at its
            address or telecopier number set forth on the signature page hereof;

      (iii) if to a Lender or to any Issuing Bank other than JPMCB, to it at its
            address (or telecopier number) set forth in its administrative
            questionnaire delivered to the Agent.

Notices sent by hand or overnight courier service, or mailed by certified or
registered mail, shall be deemed to have been given when received; notices sent
by telecopier shall be deemed to have been given when sent (except that, if not
given during normal business hours for the recipient, shall be deemed to have
been given at the opening of business on the next Business Day for the
recipient). Notices delivered through electronic communications to the extent
provided in paragraph (b) below, shall be effective as provided in said
paragraph (b).

            (b) Electronic Communications. Notices and other communications to
      the Lenders may be delivered or furnished by electronic communication
      (including e-mail and internet or intranet websites) pursuant to
      procedures approved by the Agent or as otherwise determined by the Agent
      and notified to the Lenders and the Borrower, provided that the foregoing
      shall not apply to notices to any Lender pursuant to Article II if such
      Lender has notified the Agent that it is incapable of receiving notices
      under such Article by electronic communication. The Agent or the Borrower
      may, in its respective discretion, agree to accept notices and other
      communications to it hereunder by electronic communications pursuant to
      procedures approved by it or as it otherwise determines and notified to
      the other parties, provided that such determination or approval may be
      limited to particular notices or communications.

      Unless the Agent otherwise prescribes, (i) notices and other
communications sent to an e-mail address shall be deemed received upon the
sender's receipt of an acknowledgement from the intended recipient (such as by
the "return receipt requested" function, as available, return e-mail or other
written acknowledgement), provided that if such notice or other communication is
not given during the normal business hours of the recipient, such notice or
communication shall be deemed to have been given at the opening of business on
the next Business Day for the recipient, and (ii) notices or communications
posted to an Internet or intranet website shall be

                                       53



deemed received upon the deemed receipt by the intended recipient at its e-mail
address as described in the foregoing clause (i) of notification that such
notice or communication is available and identifying the website address
therefor.

            (c) Change of Address, Etc. Any party hereto may change its address
      or telecopier number for notices and other communications hereunder by
      notice to the other parties hereto.

                                   ARTICLE XIV

         COUNTERPARTS; INTEGRATION; EFFECTIVENESS; ELECTRONIC EXECUTION

      14.1. Counterparts; Effectiveness. This Agreement may be executed in
counterparts (and by different parties hereto in different counterparts), each
of which shall constitute an original, but all of which when taken together
shall constitute a single contract. Except as provided in Article IV, this
Agreement shall become effective when it shall have been executed by the Agent
and when the Agent shall have received counterparts hereof which, when taken
together, bear the signatures of each of the parties hereto, and thereafter
shall be binding upon and inure to the benefit of the parties hereto and their
respective successors and assigns. Delivery of an executed counterpart of a
signature page of this Agreement by telecopy shall be effective as delivery of a
manually executed counterpart of this Agreement.

      14.2. Electronic Execution of Assignments. The words "execution,"
"signed," "signature," and words of like import in any assignment and assumption
agreement shall be deemed to include electronic signatures or the keeping of
records in electronic form, each of which shall be of the same legal effect,
validity or enforceability as a manually executed signature or the use of a
paper-based recordkeeping system, as the case may be, to the extent and as
provided for in any applicable law, including the Federal Electronic Signatures
in Global and National Commerce Act, or any other state laws based on the
Uniform Electronic Transactions Act.

                                   ARTICLE XV

          CHOICE OF LAW; CONSENT TO JURISDICTION; WAIVER OF JURY TRIAL

      15.1. CHOICE OF LAW. THE LOAN DOCUMENTS SHALL BE CONSTRUED IN ACCORDANCE
WITH THE INTERNAL LAWS OF THE STATE OF NEW YORK, BUT GIVING EFFECT TO FEDERAL
LAWS APPLICABLE TO BANKS.

      15.2. CONSENT TO JURISDICTION. EACH OF THE PARTIES HERETO HEREBY
IRREVOCABLY AND UNCONDITIONALLY SUBMITS, FOR ITSELF AND ITS PROPERTY, TO THE
NONEXCLUSIVE JURISDICTION OF THE SUPREME COURT OF THE STATE OF NEW YORK SITTING
IN NEW YORK COUNTY AND OF THE UNITED STATES DISTRICT COURT OF THE SOUTHERN
DISTRICT OF NEW YORK, AND ANY APPELLATE COURT FROM ANY THEREOF, IN ANY ACTION OR
PROCEEDING ARISING OUT OF OR RELATING TO THIS AGREEMENT, OR FOR RECOGNITION OR
ENFORCEMENT OF ANY JUDGMENT, AND EACH OF

                                       54



THE PARTIES HERETO HEREBY TO THE FULLEST EXTENT ALLOWED BY LAW IRREVOCABLY AND
UNCONDITIONALLY AGREES THAT ALL CLAIMS IN RESPECT OF ANY SUCH ACTION OR
PROCEEDING MAY BE HEARD AND DETERMINED IN SUCH NEW YORK STATE OR, TO THE EXTENT
PERMITTED BY LAW, IN SUCH FEDERAL COURT. EACH OF THE PARTIES HERETO AGREES THAT
A FINAL JUDGMENT IN ANY SUCH ACTION OR PROCEEDING SHALL BE CONCLUSIVE AND MAY BE
ENFORCED IN OTHER JURISDICTIONS BY SUIT ON THE JUDGMENT OR IN ANY OTHER MANNER
PROVIDED BY LAW. NOTHING IN THIS AGREEMENT SHALL AFFECT ANY RIGHT THAT ANY PARTY
MAY OTHERWISE HAVE TO BRING ANY ACTION OR PROCEEDING RELATING TO THIS AGREEMENT
IN THE COURTS OF ANY JURISDICTION.

      EACH OF THE PARTIES HERETO HEREBY IRREVOCABLY AND UNCONDITIONALLY WAIVES,
TO THE FULLEST EXTENT IT MAY LEGALLY AND EFFECTIVELY DO SO, ANY OBJECTION WHICH
IT MAY NOW OR HEREAFTER HAVE TO THE LAYING OF VENUE OF ANY SUIT, ACTION OR
PROCEEDING ARISING OUT OF OR RELATING TO THIS AGREEMENT IN ANY COURT REFERRED TO
IN THE IMMEDIATELY PRECEDING PARAGRAPH. EACH OF THE PARTIES HERETO HEREBY
IRREVOCABLY WAIVES, TO THE FULLEST EXTENT PERMITTED BY LAW, THE DEFENSE OF AN
INCONVENIENT FORUM TO THE MAINTENANCE OF SUCH ACTION OR PROCEEDING IN ANY SUCH
COURT.

      15.3. WAIVER OF JURY TRIAL. THE BORROWER, THE AGENT AND EACH LENDER HEREBY
WAIVE TRIAL BY JURY IN ANY JUDICIAL PROCEEDING INVOLVING, DIRECTLY OR
INDIRECTLY, ANY MATTER (WHETHER SOUNDING IN TORT, CONTRACT OR OTHERWISE) IN ANY
WAY ARISING OUT OF, RELATED TO, OR CONNECTED WITH ANY LOAN DOCUMENT OR THE
RELATIONSHIP ESTABLISHED THEREUNDER.

                     [REMAINDER OF PAGE INTENTIONALLY BLANK]

                                       55



      IN WITNESS WHEREOF, the Borrower, the Lenders and the Agent have executed
this Agreement as of the date first above written.

                                    PINNACLE WEST CAPITAL CORPORATION

                                    By:    /s/ Barbara M. Gomez
                                           -----------------------------------
                                    Title: Vice President and Treasurer
                                           400 N. 5th Street
                                           Phoenix AZ, 85004

                                    Attention: Ms. Barbara Gomez
                                               Telephone: (602) 250-5677
                                               FAX:       (602) 250-5640
                                    Website: www.pinnaclewest.com
                                    FEIN: 86-0512431

SIGNATURE PAGE TO CREDIT AGREEMENT



                                    JPMORGAN CHASE BANK,
                                    Individually, as an Issuing Bank and as
                                    Administrative Agent

                                    By:    /s/ Peter M. Ling
                                           -------------------------------
                                    Title: Managing Director

                                           JPM Loan & Agency Services
                                           1111 Fannin St 10th FL
                                           Houston TX, 77002
                                           Ph#:  713-750-2510
                                           Fx#:  713-432-6307
                                           email:  sylvia.gutierrez@jpmorgan

                                           with a copy to:

                                           JPMorgan Corporate Banking
                                           NA Power & Utilities
                                           270 Park Ave 15 FL
                                           New York, NY 10017
                                           Ph# 212-270-5801
                                           Fx# 212-270-4392
                                           email: maj.sayegh@jpmorgan.com

                                           For Letters of Credit:

                                           JPMorganChase LOC Tampa
                                           10420 Highland Manor Dr-BL 2, FL 2
                                           Tampa, FL 33610
                                           Ph#:  813-432-6339
                                           Fx#:   813-432-5161
                                           email:  james.alonzo@chase.com

                                           with a copy to:

                                           Global Trade Services
                                           1 Chase Manhattan Plaza 9 FL
                                           New York, NY 10081
                                           Ph# 212-552-4475
                                           Fx# 212-552-7819
                                           email: olivera.mladenovic@chase.com

SIGNATURE PAGE TO CREDIT AGREEMENT



                                    UNION BANK OF CALIFORNIA, N.A.
                                    Individually and as Syndication Agent

                                    By:   /s/ Efrain Soto
                                          -------------------------------------
                                    Name: Efrain Soto
                                    Title: Assistant Vice President

                                             Energy Capital Services
                                             445 S. Figueroa, 15th Floor
                                             Los Angeles, CA 90071
                                             Attention: Efrain Soto
                                             Phone: (213) 236-5779
                                             Fax: (213) 236-4096
                                             E-mail: efrain.soto@uboc.com

SIGNATURE PAGE TO CREDIT AGREEMENT



                                    THE BANK OF NEW YORK,
                                    Individually and as Co-Documentation Agent

                                    By:   /s/ Peter Keller
                                           ------------------------------------
                                    Name: Peter Keller
                                    Title: Vice President

                                             One Wall Street, 19th Floor
                                             New York, NY 10286
                                             Attention: Nathan S. Howard
                                             Phone: (212) 635-7916
                                             Fax: (212) 635-7923
                                             E-mail: nhoward@bankofny.com

SIGNATURE PAGE TO CREDIT AGREEMENT



                                    BANK OF AMERICA, N.A.,
                                    Individually and as Co-Documentation Agent

                                    By:    /s/ Daryl Patterson
                                           ------------------------------------
                                    Name:  Daryl Patterson
                                    Title: Managing Director

                                           100 N. Tryon St. NC1-007-13-13
                                           Charlotte, NC 28255
                                           Attention: Daryl Patterson
                                           Phone: (704) 388-4945
                                           Fax: (704) 386-1319
                                           E-mail: daryl.patterson
                                           @bankofamerica.com

SIGNATURE PAGE TO CREDIT AGREEMENT



                                    MIZUHO CORPORATE BANK, LTD.,
                                    Individually and as Co-Documentation Agent

                                    By:    /s/ Raymond Ventura
                                           ------------------------------------
                                    Name:  Raymond Ventura
                                    Title: Senior Vice President

                                           1251 Avenue of the Americas
                                           32nd Floor
                                           New York, NY 10020
                                           Attention: Mr. Nelson Chang
                                           Phone: (212) 282-3465
                                           Fax: (212) 282-4488
                                           E-mail: nelson.chang@mizuhocbus.com

SIGNATURE PAGE TO CREDIT AGREEMENT



                                 CITIBANK, N.A.,
                                 Individually and as Managing Agent

                                 By:    /s/ Robert J. Harrity, Jr.
                                        ------------------------------------
                                 Name:  Robert J. Harrity, Jr.
                                 Title: Managing Director

                                        Two Penns Way, Suite 110
                                        New Castle, DE 19720
                                        Attention: Nick Perazza
                                        Phone: (302) 894-6110
                                        Fax: (212) 994-0847
                                        E-mail: nicholas.j.perazz@citigroup.com

SIGNATURE PAGE TO CREDIT AGREEMENT



                                 BARCLAYS BANK PLC,
                                 Individually and as Managing Agent

                                 By:    /s/ Peter Harrington
                                        --------------------------------------
                                 Name:  Peter Harrington
                                 Title: Director

                                            200 Park Avenue
                                            New York, NY 10166
                                            Attention: Sydney G. Dennis
                                            Phone: (212) 412-2470
                                            Fax: (212) 412-6709
                                            E-mail: sydney.dennis@barcap.com

SIGNATURE PAGE TO CREDIT AGREEMENT



                                CREDIT SUISSE FIRST BOSTON,
                                ACTING THROUGH ITS CAYMAN ISLANDS BRANCH,
                                Individually and as Managing Agent

                                By:    /s/ Sarah Wu
                                       -----------------------------------------
                                Name:  Sarah Wu
                                Title: Vice President

                                By:    /s/ Denise Alvarez
                                       -----------------------------------------
                                Name:  Denise Alvarez
                                Title: Associate

                                           11 Madison Avenue
                                           New York, NY 10010
                                           Attention: Sarah Wu
                                           Phone: (212) 325-5813
                                           Fax: (212) 743-1804
                                           E-mail: sarah.wu@csfb.com

SIGNATURE PAGE TO CREDIT AGREEMENT



                                KEYBANK NATIONAL ASSOCIATION,
                                Individually and as Managing Agent

                                By:    /s/ Keven D. Smith
                                       ----------------------------------------
                                Name:  Keven D. Smith
                                Title: Vice President

                                           127 Public Square
                                           Cleveland, OH 44114
                                           OH-01-27-0847
                                           Attention: Yvett M. Dyson-Owen
                                           Phone: (216) 689-4358
                                           Fax: (216) 689-5962
                                           E-mail:
                                           yvette_dyson-owens@keybank.com

SIGNATURE PAGE TO CREDIT AGREEMENT



                                 UBS LOAN FINANCE LLC,
                                 Individually and as Managing Agent

                                 By:    /s/ Wilfred V. Saint
                                        ---------------------------------------
                                 Name:  Wilfred V. Saint
                                 Title: Director
                                        Banking Products Services, US

                                 By:    /s/ Joselin Fernandes
                                        ---------------------------------------
                                 Name:  Joselin Fernandes
                                 Title: Associate Director
                                        Banking Products Services, US

                                        677 Washington Boulevard
                                        Sixth Floor Tower
                                        Stamford, Connecticut 06912

                                        Attention: Winslowe Ogbourne
                                        Phone: 203-719-3587
                                        Fax: 203-719-3888
                                        E-mail: Winslowe.Ogbourne@ubs.com

SIGNATURE PAGE TO CREDIT AGREEMENT



                                  UFJ BANK LIMITED,
                                  as a Lender

                                  By:    /s/ Toshiko Boyd
                                         --------------------------------------
                                  Name:  Toshiko Boyd
                                  Title: Vice President

                                             Los Angeles Branch
                                             601 S. Figueroa St.
                                             Los Angeles, CA 90017
                                             Attention: Toshiko Boyd
                                             Phone: (213) 533-7407
                                             Fax: (213) 533-7495
                                             E-mail: toshiko_boyd@ufjbank.co.jp

SIGNATURE PAGE TO CREDIT AGREEMENT



                                   KBC BANK NV,
                                   as a Lender

                                   By:    /s/ Eric Raskin
                                          --------------------------------------
                                   Name:  Eric Raskin
                                   Title: Vice President

                                   By:    /s/ Robert Snauffer
                                          --------------------------------------
                                   Name:  Robert Snauffer
                                   Title: First Vice President

                                          125 West 55th Street, 10th Floor
                                          New York, NY 10019
                                          Attention: Loan Administration
                                          Phone: (212) 541-0657
                                          Fax: (212) 956-5581
                                          E-mail:

SIGNATURE PAGE TO CREDIT AGREEMENT



                                   BANCA DI ROMA,
                                   as a Lender

                                   By:    /s/ Susan Aguilar
                                          --------------------------------------
                                   Name:  Susan Aguilar (#976417)
                                   Title: Assistant Vice President

                                   By:    /s/ Thomas C. Woodruff
                                          --------------------------------------
                                   Name:  Thomas C. Woodruff (#97969)
                                   Title: Vice President

                                              One Market Steuart Tower
                                              Suite 1000
                                              San Francisco, CA 94105
                                              Attention: T. Woodruff
                                              Phone: (415) 977-7308
                                              Fax: (415) 357-9869
                                              E-mail: bdrsf@sbcglobal.net

SIGNATURE PAGE TO CREDIT AGREEMENT



                               COMMITMENT SCHEDULE

                                   COMMITMENTS



Lender                                            Amount of Commitment                         % of Aggregate Commitment
- ------                                            --------------------                         -------------------------
                                                                                         
JPMorgan Chase Bank                                   $    32,500,000                                    10.83%

Union Bank of California, N.A.                        $    32,500,000                                    10.83%

The Bank of New York                                  $    26,000,000                                     8.67%

Bank of America, N.A.                                 $    26,000,000                                     8.67%

Mizuho Corporate Bank, Ltd.                           $    26,000,000                                     8.67%

Citibank, N.A.                                        $    22,500,000                                     7.50%

Barclays Bank PLC                                     $    22,500,000                                     7.50%

Credit Suisse First Boston,                           $    22,500,000                                     7.50%
Acting Through Its Cayman
Islands Branch

KeyBank National                                      $    22,500,000                                     7.50%
Association

UBS Loan Finance LLC                                  $    22,500,000                                     7.50%

UFJ Bank Limited                                      $    19,500,000                                     6.50%

KBC Bank NV                                           $    15,000,000                                     5.00%

Banca di Roma                                         $    10,000,000                                     3.33%

TOTAL                                                 $300,000,000.00                                      100%




                                PRICING SCHEDULE



  APPLICABLE                LEVEL I      LEVEL II     LEVEL III      LEVEL IV       LEVEL V
    MARGIN                  STATUS        STATUS        STATUS        STATUS        STATUS
    ------                  ------        ------        ------        ------        ------
                                                                     
Eurodollar Rate              0.50%         0.60%         0.70%         0.925%        1.20%
Floating Rate                 0.0%          0.0%          0.0%           0.0%        0.25%




  APPLICABLE                LEVEL I      LEVEL II     LEVEL III      LEVEL IV       LEVEL V
   FEE RATE                 STATUS        STATUS        STATUS        STATUS        STATUS
   --- ----                 ------        ------        ------        ------        ------
                                                                     
Facility Fee Rate           0.125%        0.150%        0.175%        0.200%         0.300%
Utilization Margin          0.125%        0.125%        0.125%        0.125%         0.250%


            For the purposes of this Schedule, the following terms have the
following meanings, subject to the final paragraph of this Schedule:

            "Level I Status" exists at any date if, on such date, the Borrower's
Moody's Rating is A3 or better or the Borrower's S&P Rating is A- or better.

            "Level II Status" exists at any date if, on such date, (i) the
Borrower has not qualified for Level I Status and (ii) the Borrower's Moody's
Rating is Baa1 or better or the Borrower's S&P Rating is BBB+ or better.

            "Level III Status" exists at any date if, on such date, (i) the
Borrower has not qualified for Level I Status or Level II Status and (ii) the
Borrower's Moody's Rating is Baa2 or better or the Borrower's S&P Rating is BBB
or better.

            "Level IV Status" exists at any date if, on such date, (i) the
Borrower has not qualified for Level I Status or Level II Status or Level III
Status and (ii) the Borrower's Moody's Rating is Baa3 or better or the
Borrower's S&P Rating is BBB- or better.

            "Level V Status" exists at any date if, on such date, the Borrower
has not qualified for Level I Status, Level II Status, Level III Status, or
Level IV Status.

            "Moody's Rating" means, at any time, the Rating issued by Moody's
and then in effect.

            "Rating" means the credit ratings assigned to the senior unsecured
long-term debt securities of the Borrower without third-party credit enhancement
by the applicable rating agencies. If there is no Rating assigned to debt
securities, the corporate credit rating of the Borrower will be used. Any Rating
assigned to any other debt security of the Borrower shall be




disregarded. The Rating in effect at any date is that in effect at the close of
business on such date.

            "S&P Rating" means, at any time, the Rating issued by S&P and then
in effect.

            "Status" means Level I Status, Level II Status, Level III Status,
Level IV Status or Level V Status.

            The Applicable Margin and the Applicable Facility Fee Rate and the
Applicable Utilization Margin shall be determined in accordance with the
foregoing table based on the Borrower's Status as determined from its
then-current Ratings. If at any time the Borrower has no Moody's Rating or no
S&P Rating, Level V Status shall exist.

            In the case of split Ratings from S&P or Moody's, the Rating to be
used to determine which Status applies is the higher of the two (e.g., BBB+/Baa2
results in Level II Status); provided that if the split is more than one full
rating category, the rating category immediately above the lower of the two
rating categories will be used (e.g., BBB+/Baa3 results in Level III Status, as
does A-/Baa3).



                                  SCHEDULE 2.20
                           EXISTING LETTERS OF CREDIT



LETTER OF CREDIT NO.            AMOUNT
- --------------------        -------------
                         
No. P-240053                $  320,000.00

No. P-226706                $4,373,467.00

No. P-243249                $3,263,657.00

No. P-230876                $2,036,250.00

No. P-236181                $3,160,620.00




                                    EXHIBIT A

                       ASSIGNMENT AND ASSUMPTION AGREEMENT

      This Assignment and Assumption Agreement (the "Assignment and Assumption")
is dated as of the Effective Date set forth below and is entered into by and
between [Insert name of Assignor] (the "Assignor") and [Insert name of Assignee]
(the "Assignee"). Capitalized terms used but not defined herein shall have the
meanings given to them in the Credit Agreement identified below (as amended, the
"Credit Agreement"), receipt of a copy of which is hereby acknowledged by the
Assignee. The Terms and Conditions set forth in Annex 1 attached hereto are
hereby agreed to and incorporated herein by reference and made a part of this
Assignment and Assumption as if set forth herein in full.

      For an agreed consideration, the Assignor hereby irrevocably sells and
assigns to the Assignee, and the Assignee hereby irrevocably purchases and
assumes from the Assignor, subject to and in accordance with the Terms and
Conditions and the Credit Agreement, as of the Effective Date inserted by the
Agent as contemplated below, the interest in and to all of the Assignor's rights
and obligations in its capacity as a Lender under the Credit Agreement and any
other documents or instruments delivered pursuant thereto that represents the
amount and percentage interest identified below of all of the Assignor's
outstanding rights and obligations under the respective facilities identified
below (including without limitation any guaranties included in such facilities
and, to the extent permitted to be assigned under applicable law, all claims
(including without limitation contract claims, tort claims, malpractice claims,
statutory claims and all other claims at law or in equity), suits, causes of
action and any other right of the Assignor against any Person whether known or
unknown arising under or in connection with the Credit Agreement, any other
documents or instruments delivered pursuant thereto or the loan transactions
governed thereby) (the "Assigned Interest"). Such sale and assignment is without
recourse to the Assignor and, except as expressly provided in this Assignment
and Assumption, without representation or warranty by the Assignor.

1.       Assignor:   _________________________

2.       Assignee:   _________________________  [and is an Affiliate/Approved
                     Fund of [identify Lender](1)

3.       Borrower:   Pinnacle West Capital
                     Corporation

4.       Agent:      JPMorgan Chase Bank, as agent
                     under the Credit Agreement

- -------------------------------

(1) Select as applicable.



5.       Assignee:   ________________________

6.       Credit Agreement:    The Credit Agreement dated as of October
                              19, 2004 among Pinnacle West Capital
                              Corporation, the Lenders party thereto,
                              JPMorgan Chase Bank, as Agent, and the
                              other agents party thereto.

7.       Assigned Interest:



                                Aggregate Amount of
                                    Commitment/                  Amount of             Percentage Assigned of
                                 Outstanding Credit             Commitment/                 Commitment /
                                  Exposure for all           Outstanding Credit        Aggregate Outstanding
Facility Assigned                    Lenders*                Exposure Assigned*          Credit Exposure(2)
- -------- --------                    --------                ------------------          ------------------
                                                                              
Revolving Credit                    $                          $                               _______%
Facility


8.       Trade Date:     _______________________________(3)

Effective Date: ____________________, 20__ [TO BE INSERTED BY AGENT AND WHICH
SHALL BE THE EFFECTIVE DATE OF RECORDATION OF TRANSFER BY THE AGENT.]

      The terms set forth in this Assignment and Assumption are hereby agreed
to:

                                     ASSIGNOR
                                     [NAME OF ASSIGNOR]

                                     By: _______________________________________
                                            Title:

                                     ASSIGNEE
                                     [NAME OF ASSIGNEE]

                                     By: ______________________________________

- ----------------------

* Amount to be adjusted by the counterparties to take into account any payments
or prepayments made between the Trade Date and the Effective Date.

(2) Set forth, to at least 9 decimals, as a percentage of the Commitment/Loans
of all Lenders thereunder.

(3) Insert if satisfaction of minimum amounts is to be determined as of the
Trade Date.



                                     Title:

[Consented to and](4) Accepted:

JPMORGAN CHASE BANK, as Agent

By:__________________________________
Title:
[Consented to:](5)

PINNACLE WEST CAPITAL CORPORATION

By:__________________________________
Title:

- -------------------------

(4) To be added only if the consent of the Agent is required by the Credit
Agreement.

(5) To be added only if the consent of the Borrower is required by the terms of
the Credit Agreement.



                                     ANNEX 1
                            TERMS AND CONDITIONS FOR
                            ASSIGNMENT AND ASSUMPTION

      1. Representations and Warranties.

            1.1 Assignor. The Assignor represents and warrants that (i) it is
the legal and beneficial owner of the Assigned Interest, (ii) the Assigned
Interest is free and clear of any lien, encumbrance or other adverse claim and
(iii) it has full power and authority, and has taken all action necessary, to
execute and deliver this Assignment and Assumption and to consummate the
transactions contemplated hereby. Neither the Assignor nor any of its officers,
directors, employees, agents or attorneys shall be responsible for (i) any
statements, warranties or representations made in or in connection with the
Credit Agreement or any other Loan Document, (ii) the execution, legality,
validity, enforceability, genuineness, sufficiency, perfection, priority,
collectibility, or value of the Loan Documents or any collateral thereunder,
(iii) the financial condition of the Borrower, any of its Subsidiaries or
Affiliates or any other Person obligated in respect of any Loan Document, (iv)
the performance or observance by the Borrower, any of its Subsidiaries or
Affiliates or any other Person of any of their respective obligations under any
Loan Documents, (v) inspecting any of the property, books or records of the
Borrower, or any guarantor, or (vi) any mistake, error of judgment, or action
taken or omitted to be taken in connection with the Credit Extensions or the
Loan Documents.

            1.2. Assignee. The Assignee (a) represents and warrants that (i) it
has full power and authority, and has taken all action necessary, to execute and
deliver this Assignment and Assumption and to consummate the transactions
contemplated hereby and to become a Lender under the Credit Agreement, (ii) from
and after the Effective Date, it shall be bound by the provisions of the Credit
Agreement as a Lender thereunder and, to the extent of the Assigned Interest,
shall have the obligations of a Lender thereunder, (iii) agrees that its payment
instructions and notice instructions are as set forth in Schedule 1 to this
Assignment and Assumption, (iv) confirms that none of the funds, monies, assets
or other consideration being used to make the purchase and assumption hereunder
are "plan assets" as defined under ERISA and that its rights, benefits and
interests in and under the Loan Documents will not be "plan assets" under ERISA,
(v) agrees to indemnify and hold the Assignor harmless against all losses, costs
and expenses (including, without limitation, reasonable attorneys' fees) and
liabilities incurred by the Assignor in connection with or arising in any manner
from the Assignee's non-performance of the obligations assumed under this
Assignment and Assumption, (vi) it has received a copy of the Credit Agreement,
together with copies of financial statements and such other documents and
information as it has deemed appropriate to make its own credit analysis and
decision to enter into this Assignment and Assumption and to purchase the
Assigned Interest on the basis of which it has made such analysis and decision
independently and without reliance on the Agent or any other Lender, and (vii)
attached as Schedule 1 to this Assignment and Assumption is any documentation
required to be delivered by the Assignee with respect to its tax status pursuant
to the terms of the Credit Agreement, duly completed and executed by the
Assignee and (b) agrees that (i) it will, independently and without reliance on
the Agent, the Assignor or any other Lender, and based on such documents and
information as it shall deem appropriate at the time, continue to make its own
credit decisions in taking or not taking action



under the Loan Documents, and (ii) it will perform in accordance with their
terms all of the obligations which by the terms of the Loan Documents are
required to be performed by it as a Lender.

      2. Payments. The Assignee shall pay the Assignor, on the Effective Date,
the amount agreed to by the Assignor and the Assignee. From and after the
Effective Date, the Agent shall make all payments in respect of the Assigned
Interest (including payments of principal, interest, fees and other amounts) to
the Assignor for amounts which have accrued to but excluding the Effective Date
and to the Assignee for amounts which have accrued from and after the Effective
Date.

      3. General Provisions. This Assignment and Assumption shall be binding
upon, and inure to the benefit of, the parties hereto and their respective
successors and assigns. This Assignment and Assumption may be executed in any
number of counterparts, which together shall constitute one instrument. Delivery
of an executed counterpart of a signature page of this Assignment and Assumption
by telecopy shall be effective as delivery of a manually executed counterpart of
this Assignment and Assumption. This Assignment and Assumption shall be governed
by, and construed in accordance with, the law of the State of New York.



                          ADMINISTRATIVE QUESTIONNAIRE



              US AND NON-US TAX INFORMATION REPORTING REQUIREMENTS



                                    EXHIBIT B
                                      NOTE

                                                                          [Date]

      PINNACLE WEST CAPITAL CORPORATION, an Arizona corporation (the
"Borrower"), promises to pay to the order of _____________________________ (the
"Lender") the aggregate unpaid principal amount of all Loans made by the Lender
to the Borrower pursuant to Article II of the Agreement (as hereinafter
defined), in immediately available funds at the address of JPMorgan Chase Bank
in New York, New York, as Agent, specified pursuant to Section 2.12 of the
Agreement, together with interest on the unpaid principal amount hereof at the
rates and on the dates set forth in the Agreement. The Borrower shall pay the
principal of and accrued and unpaid interest on the Loans in full on the
Facility Termination Date, and the Borrower and shall make such mandatory
payments as are required to be made under the terms of Article II of the
Agreement.

      The Lender shall, and is hereby authorized to, record on the schedule
attached hereto, or to otherwise record in accordance with its usual practice,
the date and amount of each Loan and the date and amount of each principal
payment hereunder.

      This Note is one of the Notes issued pursuant to, and is entitled to the
benefits of, the Credit Agreement dated as of October 19, 2004 (which, as it may
be amended or modified and in effect from time to time, is herein called the
"Agreement"), among the Borrower, the lenders party thereto, including the
Lender, and JPMorgan Chase Bank, as Administrative Agent, to which Agreement
reference is hereby made for a statement of the terms and conditions governing
this Note, including the terms and conditions under which this Note may be
prepaid or its maturity date accelerated. Capitalized terms used herein and not
otherwise defined herein are used with the meanings attributed to them in the
Agreement.

                                         PINNACLE WEST CAPITAL CORPORATION

                                         By: __________________________________
                                         Print Name: __________________________
                                         Title: _______________________________



                   SCHEDULE OF LOANS AND PAYMENTS OF PRINCIPAL
                                       TO

                     NOTE OF ______________________________,
                          DATED ______________________,



              Principal       Maturity        Principal
               Amount        of Interest        Amount           Unpaid
Date           of Loan         Period            Paid            Balance
- ----          ---------      -----------      ---------          -------
                                                     

EX-10.2

EXHIBIT 10.2

AMENDMENT TO AGREEMENT

     THIS AMENDMENT is made and entered into by and between Arizona Public Service Company (“APS”) and James M. Levine (“Employee”).

WITNESSETH:

     WHEREAS, APS and Employee entered into an Employment Agreement dated October 11, 2002 (“Agreement”); and

     WHEREAS, the parties desire to correct an error in the original Agreement by amending the Agreement to revise Employee’s allocation of additional shares of restricted stock.

     NOW, THEREFORE, effective as of October 11, 2002, the Agreement is amended as follows:

     1. Section 4(c) is deleted in its entirety and the following new Section 4(c) is inserted in lieu thereof:

(c) Additional Restricted Shares. In addition to (b) above, the Company agrees to annually, for the term of this Agreement, request the Human Resources Committee to grant Employee 2000 shares of restricted stock under the 1994 Long-Term Incentive Plan (the “1994 Plan”) without any vesting requirement, all in accordance with the terms of the 1994 Plan and as previously agreed upon by the parties.

     2. Except as otherwise set forth herein, the terms and conditions in the original Agreement remain in full force and effect.

		ARIZONA PUBLIC SERVICE COMPANY
Date:	11-2-04	By:	/s/ Jack Davis
			Jack Davis
			President and Chief Executive Officer
Date:	11-4-04		/s/ James M. Levine
			James M. Levine

H:\employ\Levine\LevineAmendment

EX-12.1

EXHIBIT 12.1

Pinnacle West Capital Corporation
Computation of Earnings to Fixed Charges
($000’s)

	Nine
	Months
	Ended
	9/30/2004		2003		2002		2001		2000		1999		1998
Earnings:
Income From Continuing Operations	$	205,900	$	225,803	$	241,998	$	327,367	$	302,332	$	269,772	$	242,892
Income Taxes		117,574		102,473		155,710		213,535		194,200		141,592		138,589
Fixed Charges		168,291		235,407		219,178		211,958		202,804		194,070		201,184
Total Earnings	$	491,765	$	563,683	$	616,886	$	752,860	$	699,336	$	605,434	$	582,665
Fixed Charges:
Interest Expense	$	144,645	$	204,339	$	187,039	$	175,822	$	166,447	$	157,142	$	163,975
Estimated Interest Portion of Annual Rents		23,646		31,068		32,139		36,136		36,357		36,928		37,209
Total Fixed Charges	$	168,291	$	235,407	$	219,178	$	211,958	$	202,804	$	194,070	$	201,184
Ratio of Earnings to Fixed Charges (rounded down)		2.92		2.39		2.81		3.55		3.44		3.11		2.89

EX-31.1

EXHIBIT 31.1

CERTIFICATION

I, William J. Post, certify that:

1.	I have reviewed this Quarterly Report on Form 10-Q of Pinnacle West Capital Corporation;
2.	Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;
3.	Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;
4.	The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have:

a)	designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;
b)	evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and
c)	disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s third fiscal quarter that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

5. The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):

a) all significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

Date: November 8, 2004.

/s/ William J. Post

William J. Post
Chairman and Chief Executive Officer

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EX-31.2

EXHIBIT 31.2

CERTIFICATION

I, Donald E. Brandt, certify that:

1.	I have reviewed this Quarterly Report on Form 10-Q of Pinnacle West Capital Corporation;
2.	Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;
3.	Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;
4.	The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have:

a)	designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;
b)	evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and
c)	disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s third fiscal quarter that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

5. The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):

a) all significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

Date: November 8, 2004.

/s/ Donald E. Brandt

Donald E. Brandt
Executive Vice President & Chief Financial Officer

2

EX-32.1

EXHIBIT 32.1

CERTIFICATION
OF
CHIEF EXECUTIVE OFFICER
AND
CHIEF FINANCIAL OFFICER
PURSUANT TO 18 U.S.C. 1350,
AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002

     I, William J. Post, certify, pursuant to 18 U.S.C. 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that the Quarterly Report on Form 10-Q of Pinnacle West Capital Corporation for the fiscal quarter ended September 30, 2004 fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934 and that information contained in such Quarterly Report on Form 10-Q fairly presents, in all material respects, the financial condition and results of operations of Pinnacle West Capital Corporation.

Date: November 8, 2004.

/s/ William J. Post

William J. Post
Chairman and Chief Executive Officer

     I, Donald E. Brandt, certify, pursuant to 18 U.S.C. 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that the Quarterly Report on Form 10-Q of Pinnacle West Capital Corporation for the fiscal quarter ended September 30, 2004 fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934 and that information contained in such Quarterly Report on Form 10-Q fairly presents, in all material respects, the financial condition and results of operations of Pinnacle West Capital Corporation.

Date: November 8, 2004.

/s/ Donald E. Brandt

Donald E. Brandt
Executive Vice President and Chief Financial Officer

EX-99.1

EXHIBIT 99.1

PINNACLE WEST RISK FACTORS
(Report on Form 10-Q for the Fiscal Quarter Ending September 30, 2004)

     Set forth below and in other documents we file with the Securities and Exchange Commission are risks and uncertainties that could affect our financial results.

     We cannot predict the outcome of the general rate case of Arizona Public Service Company (“APS”), our principal subsidiary, pending before the Arizona Corporation Commission (the “ACC”).

     On June 27, 2003, APS filed a request with the ACC to increase its annual retail electricity revenues by approximately $175.1 million, or 9.8%, effective July 1, 2004. On August 18, 2004, a substantial majority of the parties to the rate case, including APS, the ACC staff, the Residential Utility Consumer Office, other customer groups, and merchant power plant intervenors entered into an agreement that proposes terms under which the rate case would be settled (the “Agreement”). The Agreement is subject to ACC approval. Key financial components of the Agreement are as follows:

• APS would receive an annual retail rate increase of approximately $75.5 million, or 4.21%. The increase would consist of an increase in base rates of approximately 3.77% and an increase of approximately 0.44% for recovery over five years of the past costs of APS’ compliance with the ACC’s retail electric competition rules (the “Rules”).

• APS would acquire from Pinnacle West Energy Corporation (“Pinnacle West Energy”) Redhawk Combined Cycle Units 1 and 2, West Phoenix Combined Cycle Units 4 and 5, and Saguaro Combustion Turbine Unit 3 (collectively, the “Dedicated Assets”) and rate base the Dedicated Assets at a rate base value of $700 million, which would result in a regulatory rate base disallowance of $148 million. As a result, for financial reporting purposes, we would recognize a one-time, after-tax net plant write-off of approximately $88 million in the period when the plant transfer to APS is completed, and would reduce annual depreciation expense by approximately $5 million.

• To bridge the time between the effective date of the rate increase and the actual date the Dedicated Assets transfer, APS and Pinnacle West Energy would enter into a cost-based purchase power agreement (the “Bridge PPA”), which would be based on the value of the Dedicated Assets described in the previous bullet point. The Bridge PPA would remain in effect until the Federal Energy Regulatory Commission (the “FERC”) approves the transfer of the Dedicated Assets to APS and the transfer is completed.

• If the FERC were to issue an order denying APS’ request to acquire the Dedicated Assets, the Bridge PPA would become a 30-year purchased power agreement, with prices reflecting cost-of-service as if APS had acquired and rate-based the Dedicated Assets at the value described above.

• If the FERC were to issue an order (a) approving APS’ request to transfer the Dedicated Assets at a value materially less than $700 million, (b) approving the transfer of fewer than all of the Dedicated Assets, or (c) that was materially inconsistent with the Agreement, APS would file an appropriate application with the ACC so that rates could be adjusted. In these circumstances, the Bridge

PPA would continue at least until the conclusion of the subsequent proceeding to consider any appropriate adjustment to APS’ rates.

• A power supply adjuster would provide for the recovery of fuel and purchased power costs, subject to specified parameters and procedures.

• APS would not restore and recover in rates the $234 million write-off recorded in 1999 as a result of a 1999 settlement agreement approved by the ACC related to the implementation of retail electric competition in Arizona (the “1999 Settlement Agreement”).

• APS would adopt longer service lives than originally requested for certain depreciable assets.

     This general rate case, including the proposed settlement, is the key issue affecting our financial outlook. ACC hearings on the Agreement are scheduled to begin on November 8, 2004. We cannot predict the outcome of this matter.

     The procurement of wholesale power by APS without the ability to adjust retail rates could have an adverse impact on our business and financial results.

     Although the Rules allow retail customers to have access to competitive providers of energy and energy services, under the Rules, APS is the “provider of last resort” for standard-offer, full-service customers under rates that have been approved by the ACC. In the event of shortfalls of electricity due to unforeseen increases in load demand or generation or transmission outages, APS may need to purchase additional supplemental power in the wholesale spot market. At various times, prices in the spot wholesale market have significantly exceeded the amount included in APS’ current retail rates. There can be no assurance that APS would be able to fully recover the costs of this power. Although the proposed settlement of APS’ general rate case would, among other things, allow APS to recover purchased power costs, there can be no assurance that the settlement agreement will be approved by the ACC as proposed.

2

     Deregulation or restructuring of the electric industry may result in increased competition, which could have a significant adverse impact on our business and our financial results.

     Retail competition could have a significant adverse financial impact on us due to an impairment of assets, a loss of retail customers, lower profit margins or increased costs of capital. Under the Rules, as modified by the 1999 Settlement Agreement, APS was required to transfer all of its competitive electric assets and services to an unaffiliated party or parties or to a separate corporate affiliate or affiliates no later than December 31, 2002. To satisfy this requirement, APS had planned to transfer its generation assets to Pinnacle West Energy. Pursuant to an ACC order dated September 10, 2002, the ACC unilaterally modified the 1999 Settlement Agreement and directed APS to cancel any plans to divest interests in any of its generating assets. The ACC further established a requirement that APS solicit bids for certain estimated amounts of capacity and energy for periods beginning July 1, 2003. Pinnacle West Energy bid on and entered into contracts to supply most of APS’ requirements in the summer months through September 2006. In addition, as discussed above, a proposed settlement of APS’ general rate case would result in Pinnacle West Energy transferring a significant amount of generation assets to APS. These regulatory developments and legal challenges to the Rules have raised considerable uncertainty about the status and pace of retail electric competition and of electric restructuring in Arizona. Although some very limited retail competition existed in APS’ service area in 1999 and 2000, there are currently no active retail competitors offering unbundled energy or other utility services to APS’ customers. As a result, we cannot predict when, and the extent to which, additional competitors will re-enter APS’ service territory.

     As a result of changes in federal law and regulatory policy, competition in the wholesale electricity market has greatly increased due to a greater participation by traditional electricity suppliers, non-utility generators, independent power producers, and wholesale power marketers and brokers. This increased competition could affect our load forecasts, plans for power supply and wholesale energy sales and related revenues. As a result of the changing regulatory environment and the relatively low barriers to entry, we expect wholesale competition to increase. As competition continues to increase, our financial position and results of operations could be adversely affected.

     We are subject to complex government regulation that may have a negative impact on our business and our results of operations.

     We are, directly and through our subsidiaries, subject to governmental regulation that may have a negative impact on our business and results of operations. We are a “holding company” within the meaning of the Public Utility Holding Company Act of 1935 (“PUHCA”); however, we are exempt from the provisions of PUHCA (except Section 9(a)(2) thereof) by virtue of our filing of an annual exemption statement with the Securities and Exchange Commission (the “SEC”).

     APS is subject to comprehensive regulation by several federal, state and local regulatory agencies, which significantly influence its operating environment and may affect its ability to recover costs from utility customers. APS is required to have numerous permits, approvals and certificates from the agencies that regulate APS’ business. The FERC, the Nuclear Regulatory Commission (“NRC”), the Environmental Protection Agency (“EPA”), and the ACC regulate many aspects of our utility operations, including siting and construction of facilities, customer service and the rates that APS can charge customers. We believe the necessary permits, approvals and certificates have been obtained for APS’ existing operations. However, changes in regulations or the imposition of additional regulations could have an adverse impact on our results of operations. We are also unable to predict the impact on our business and operating results from pending or future regulatory activities of any of these agencies. For example, in connection with an audit of APS and its affiliates by the FERC, certain instances of noncompliance with FERC regulations related to the administration of APS’ transmission tariff have been identified. We currently

3

expect, but cannot provide any assurance, that the resolution of these matters will not have a material adverse effect on our financial position, results of operations or liquidity.

     We are subject to numerous environmental laws and regulations that may increase our cost of operations, impact our business plans, or expose us to environmental liabilities.

     We are subject to numerous environmental laws and regulations affecting many aspects of our present and future operations, including air emissions, water quality, wastewater discharges, solid waste, and hazardous waste. These laws and regulations can result in increased capital, operating, and other costs, particularly with regard to enforcement efforts focused on power plant emissions obligations. These laws and regulations generally require us to obtain and comply with a wide variety of environmental licenses, permits, inspections and other approvals. Both public officials and private individuals may seek to enforce applicable environmental laws and regulations. We cannot predict the outcome (financial or operational) of any related litigation that may arise.

     In addition, we may be a responsible party for environmental clean up at sites identified by a regulatory body. We cannot predict with certainty the amount and timing of all future expenditures related to environmental matters because of the difficulty of estimating clean-up costs. There is also uncertainty in quantifying liabilities under environmental laws that impose joint and several liability on all potentially responsible parties.

     We cannot be sure that existing environmental regulations will not be revised or that new regulations seeking to protect the environment will not be adopted or become applicable to us. Revised or additional regulations that result in increased compliance costs or additional operating restrictions, particularly if those costs are not fully recoverable from APS’ customers, could have a material adverse effect on our results of operations.

     There are inherent risks in the operation of nuclear facilities, such as environmental, health and financial risks and the risk of terrorist attack.

     Through APS, we have an ownership interest in and operate, on behalf of a group of owners, the Palo Verde Nuclear Generating Station (“Palo Verde”), which is the largest nuclear electric generating facility in the United States. Palo Verde is subject to environmental, health and financial risks such as the ability to dispose of spent nuclear fuel, the ability to maintain adequate reserves for decommissioning, potential liabilities arising out of the operation of these facilities, and the costs of securing the facilities against possible terrorist attacks and unscheduled outages due to equipment and other problems. We maintain nuclear decommissioning trust funds and external insurance coverage to minimize our financial exposure to some of these risks; however, it is possible that damages could exceed the amount of insurance coverage.

     The NRC has broad authority under federal law to impose licensing and safety-related requirements for the operation of nuclear generation facilities. In the event of noncompliance, the NRC has the authority to impose fines or shut down a unit, or both, depending upon its assessment of the severity of the situation, until compliance is achieved. In addition, although we have no reason to anticipate a serious nuclear incident at Palo Verde, if an incident did occur, it could materially and adversely affect our results of operations or financial condition. A major incident at a nuclear facility anywhere in the world could cause the NRC to limit or prohibit the operation or licensing of any domestic nuclear unit.

     The operation of Palo Verde requires licenses that need to be periodically renewed and/or extended. We do not anticipate any problems renewing these licenses. However, as a result of potential terrorist threats and increased public scrutiny of utilities, the licensing process could result in increased licensing or compliance costs that are difficult or impossible to predict.

     The uncertain outcome regarding the creation of regional transmission organizations, or RTOs, and implementation of the FERC’s standard market design may materially impact our operations, cash flows or financial position.

     In a December 1999 order, the FERC established characteristics and functions that must be met by utilities in forming and operating RTOs. The characteristics for an acceptable RTO include independence from market participants, operational control over a region large enough to support efficient and nondiscriminatory markets and exclusive authority to maintain short-term reliability. Additionally, in a pending notice of proposed rulemaking, the FERC is considering implementing a standard market design for wholesale markets. On October 16, 2001, APS and other owners of electric transmission lines in the Southwest filed with the FERC a request for a declaratory order confirming that their proposal to form WestConnect RTO, LLC would satisfy the FERC’s requirements for the formation of an RTO. On October 10, 2002, the FERC issued an order finding that the WestConnect proposal, if modified to address specified issues, could meet the FERC’s RTO requirements and provide the basic framework for a standard market design for the Southwest. On September 15, 2003, the FERC issued an order granting clarification and rehearing, in part, of its prior orders. In particular, this order approved the use of a physical congestion management scheme, which is used to allocate transmission rights on congested lines, for WestConnect for an initial phase-in period. The FERC indicated that the WestConnect utilities and the appropriate regional state advisory committee should develop a market-based congestion management scheme for subsequent implementation. APS is now participating in a cost/benefit analysis of implementing WestConnect, the results of which are expected to be completed in 2005.

     If APS ultimately joins an RTO, APS could incur increased transmission-related costs and receive reduced transmission service revenues; APS may be required to expand its transmission system according to decisions made by the RTO rather than its internal planning process; and APS may

4

experience other impacts on its operations, cash flows or financial position that will not be quantifiable until the final tariffs and other material terms of the RTO are known.

     Recent events in the energy markets that are beyond our control may have negative impacts on our business.

     As a result of the energy crisis in California during the summer of 2001, the recent volatility of natural gas prices in North America, the filing of bankruptcy by the Enron Corporation, and investigations by governmental authorities into energy trading activities, companies generally in the regulated and unregulated utility businesses have been under an increased amount of public and regulatory scrutiny. The capital markets and rating agencies also have increased their level of scrutiny. We believe that we are in material compliance with all applicable laws, but it is difficult or impossible to predict or control what effect these or related issues may have on our business or our access to the capital markets.

     Our results of operations can be adversely affected by milder weather.

     Weather conditions directly influence the demand for electricity and affect the price of energy commodities. Electric power demand is generally a seasonal business. In Arizona, demand for power peaks during the hot summer months, with market prices also peaking at that time. As a result, our overall operating results fluctuate substantially on a seasonal basis. In addition, we have historically sold less power, and consequently earned less income, when weather conditions are milder. As a result, unusually mild weather could diminish our results of operations and harm our financial condition.

     Our cash flow largely depends on the performance of our subsidiaries.

5

     We conduct our operations primarily through subsidiaries. Substantially all of our consolidated assets are held by such subsidiaries. Accordingly, our cash flow is dependent upon the earnings and cash flows of these subsidiaries and their distributions to us. The subsidiaries are separate and distinct legal entities and have no obligation to make distributions to us.

     The debt agreements of some of our subsidiaries may restrict their ability to pay dividends, make distributions or otherwise transfer funds to us. As part of the ACC’s approval of a $500 million financing arrangement between APS and Pinnacle West Energy, an ACC order requires APS to maintain a common equity ratio of at least 40% and does not allow APS to pay common dividends if the payment would reduce its common equity below that threshold. As defined in the ACC financing order approving the arrangement, common equity ratio is common equity divided by common equity plus long-term debt, including current maturities of long-term debt. At September 30, 2004, APS’ common equity ratio was approximately 46%.

     The debt securities will be structurally subordinated to the debt securities and other obligations of our subsidiaries.

     Because we are structured as a holding company, all existing and future debt and other liabilities of our subsidiaries will be effectively senior in right of payment to our debt securities. None of the indentures under which we or our subsidiaries may issue debt securities limits our ability or the ability of our subsidiaries to incur additional debt in the future. The assets and cash flows of our subsidiaries will be available, in the first instance, to service their own debt and other obligations. Our ability to have the benefit of their assets and cash flows, particularly in the case of any insolvency or financial distress affecting our subsidiaries, would arise only through our equity ownership interests in our subsidiaries and only after their creditors have been satisfied.

     If we are not able to access capital at competitive rates, our ability to implement our financial strategy will be adversely affected.

     We rely on access to short-term money markets, longer-term capital markets and the bank markets as a significant source of liquidity and for capital requirements not satisfied by the cash flow from our operations. We believe that we will maintain sufficient access to these financial markets based upon current credit ratings. However, certain market disruptions or a downgrade of our credit ratings may increase our cost of borrowing or adversely affect our ability to access one or more financial markets. Such disruptions could include:

• an economic downturn;

• capital market conditions generally;

• the bankruptcy of an unrelated energy company;

• increased market prices for electricity and gas;

• terrorist attacks or threatened attacks on our facilities or those of unrelated energy companies; or

• the overall health of the utility industry.

     Changes in economic conditions could result in higher interest rates, which would increase our interest expense on our debt and reduce funds available to us for our current plans. Additionally, an increase in our leverage could adversely affect us by:

• increasing the cost of future debt financing;

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• increasing our vulnerability to adverse economic and industry conditions;

• requiring us to dedicate a substantial portion of our cash flow from operations to payments on our debt, which would reduce funds available to us for operations, future business opportunities or other purposes; and

• placing us at a competitive disadvantage compared to our competitors that have less debt.

     A significant reduction in our credit ratings could materially and adversely affect our business, financial condition and results of operations.

     We cannot be sure that any of our current ratings will remain in effect for any given period of time or that a rating will not be lowered or withdrawn entirely by a rating agency if, in its judgment, circumstances in the future so warrant. Any downgrade could increase our borrowing costs, which would diminish our financial results. We would likely be required to pay a higher interest rate in future financings, and our potential pool of investors and funding sources could decrease. In addition, borrowing costs under certain of our existing credit facilities depend on our credit ratings. A downgrade could also require us to provide additional support in the form of letters of credit or cash or other collateral to various counterparties. If our short-term ratings were to be lowered, it could limit our access to the commercial paper market. We note that the ratings from rating agencies are not recommendations to buy, sell or hold our securities and that each rating should be evaluated independently of any other rating.

     The use of derivative contracts in the normal course of our business and changing interest rates and market conditions could result in financial losses that negatively impact our results of operations.

     Our operations include managing market risks related to commodity prices and, subject to specified risk parameters, engaging in marketing and trading activities intended to profit from market price movements. We are exposed to the impact of market fluctuations in the price and transportation costs of electricity, natural gas, coal, and emissions allowances and credits. We have established procedures to manage risks associated with these market fluctuations by utilizing various commodity derivatives, including exchange-traded futures and options and over-the-counter forwards, options, and swaps. As part of our overall risk management program, we enter into derivative transactions to hedge purchases and sales of electricity, fuels, and emissions allowances and credits. The changes in market value of such contracts have a high correlation to price changes in the hedged commodity.

     We are exposed to losses in the event of nonperformance or nonpayment by counterparties. We use a risk management process to assess and monitor the financial exposure of all counterparties. Despite the fact that the majority of trading counterparties are rated as investment grade by the rating agencies, there is still a possibility that one or more of these companies could default, resulting in a material adverse impact on our earnings for a given period.

     Changing interest rates will affect interest paid on variable-rate debt and interest earned by our pension plan and nuclear decommissioning trust funds. Our policy is to manage interest rates through the use of a combination of fixed-rate and floating-rate debt. The pension plan is also impacted by the discount rate, which is the interest rate used to discount future pension obligations. Continuation of recent decreases in the discount rate would result in increases in pension costs, cash contributions, and charges to other comprehensive income. The pension plan and nuclear decommissioning trust funds also have risks associated with changing market values of equity investments. A significant portion of the pension costs and all of the nuclear decommissioning costs are recovered in regulated electricity prices.

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     Actual results could differ from estimates used to prepare our financial statements.

     In preparing our financial statements in accordance with accounting principles generally accepted in the United States of America, management must often make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues, expenses and related disclosures at the date of the financial statements and during the reporting period. Some of those judgments can be subjective and complex, and actual results could differ from those estimates. We consider the following accounting policies to be our most critical because of the uncertainties, judgments and complexities of the underlying accounting standards and operations involved.

• Regulatory Accounting — Regulatory accounting allows for the actions of regulators, such as the ACC and the FERC, to be reflected in the financial statements. Their actions may cause us to capitalize costs that would otherwise be included as an expense in the current period by unregulated companies. If future recovery of costs ceases to be probable, the assets would be written off as a charge in current period earnings. We had $169 million of regulatory assets on our balance sheet at September 30, 2004.

• Pensions and Other Postretirement Benefit Accounting - Changes in our actuarial assumptions used in calculating our pension and other postretirement benefit liability and expense can have a significant impact on our earnings, plan funding requirements and financial position. The most relevant actuarial assumptions are the discount rate used to measure our liability and net periodic cost, the expected long-term rate of return on plan assets used to estimate earnings on invested funds over the long-term, and the assumed healthcare cost trend rates. We review these assumptions on an annual basis and adjust them as necessary.

• Derivative Accounting — Derivative accounting requires evaluation of rules that are complex and subject to varying interpretations. Our evaluation of these rules, as they apply to our contracts, will determine whether we use accrual accounting or fair value (mark-to-market) accounting. Mark-to-market accounting requires that changes in fair value be recorded in earnings or, if certain hedge accounting criteria are met, in common stock equity (as a component of other comprehensive income (loss)).

• Mark-to-Market Accounting — The market value of our derivative contracts is not always readily determinable. In some cases, we use models and other valuation techniques to determine fair value. The use of these models and valuation techniques sometimes requires subjective and complex judgment. Actual results could differ from the results estimated through application of these methods. Our

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marketing and trading portfolio consists of structured activities hedged with a portfolio of forward purchases that protects the economic value of the sales transactions.

     The market price of our common stock may be volatile.

     The market price of our common stock could be subject to significant fluctuations in response to factors such as the following, some of which are beyond our control:

• variations in our quarterly operating results;

• operating results that vary from the expectations of management, securities analysts and investors;

• changes in expectations as to our future financial performance, including financial estimates by securities analysts and investors;

• developments generally affecting industries in which we operate, particularly the energy distribution and energy generation industries;

• announcements by us or our competitors of significant contracts, acquisitions, joint marketing relationships, joint ventures or capital commitments;

• announcements by third parties of significant claims or proceedings against us;

• favorable or adverse regulatory developments;

• our dividend policy;

• future sales of our equity or equity-linked securities; and

• general domestic and international economic conditions.

     In addition, the stock market in general has experienced volatility that has often been unrelated to the operating performance of a particular company. These broad market fluctuations may adversely affect the market price of our common stock.

     Our common stock price could be affected because a substantial number of our shares could be available for sale in the future.

     Sales in the public market of a substantial number of shares of common stock could depress the market price of the common stock and could impair our ability to raise capital through the sale of additional equity securities. Because of the number of shares of our common stock that we are authorized to issue under our articles of incorporation, a substantial number of shares of our common stock could be available for future sale.

     We may enter into credit and other agreements from time to time that restrict our ability to pay dividends.

     Payment of dividends on our common stock may be restricted by credit and other agreements entered into by us from time to time. At September 30, 2004, there were no material restrictions on our ability to pay dividends under any such agreement.

     Certain provisions of our articles of incorporation and bylaws and of Arizona law make it more difficult for shareholders to change the composition of our board and may discourage takeover attempts that could be beneficial to us and our shareholders.

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     Certain provisions of our articles of incorporation and bylaws and of Arizona law make it more difficult for shareholders to change the composition of our board and may discourage unsolicited attempts to acquire us, which could preclude our shareholders from receiving a change of control premium. These provisions include the following:

• provisions of our bylaws and Arizona law that restrict our ability to engage in a wide range of “business combination” transactions with an “interested shareholder” (generally, any person who owns 10% or more of our outstanding voting power or any of our affiliates or associates) or any affiliate or associate of an interested shareholder, unless specific conditions are met;

• anti-greenmail provisions of Arizona law and our bylaws that prohibit us from purchasing shares of our voting stock from beneficial owners of more than 5% of our outstanding shares unless specified conditions are satisfied;

• provisions of our bylaws and Arizona law that provide that shareholder action may be taken only at an annual or special meeting or by unanimous written consent, and provisions of our bylaws that provide that a special meeting of shareholders may only be called by a majority of our Board of Directors, the Chairman of our Board of Directors, or our President;

• advance notice procedures for nominating candidates to our Board of Directors or presenting matters at shareholder meetings;

• provisions of our articles and bylaws that provide for a staggered Board of Directors;

• provisions of our bylaws that provide that shareholders may only remove a director with or without cause if the votes cast in favor of such removal exceed the votes cast against such removal (with special requirements, based on cumulative voting rights, if less than the entire board is to be removed); and

• the ability of our Board of Directors to issue additional shares of common stock and shares of preferred stock and to determine the price and, with respect to preferred stock, the other terms, including preferences and voting rights, of those shares without shareholder approval.

     In addition, we have adopted a shareholder rights plan that may have the effect of discouraging unsolicited takeover proposals, including takeover proposals that could result in a premium over the market price of our common stock.

     While these provisions have the effect of encouraging persons seeking to acquire control of us to negotiate with our Board of Directors, they could enable the board to hinder or frustrate a transaction that some, or a majority, of our shareholders might believe to be in their best interests and, in that case, may prevent or discourage attempts to remove and replace incumbent directors.

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