Summary of PINNACLE WEST CAPITAL CORP

ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
INTRODUCTION The following discussion should be read in conjunction with Pinnacle West's Condensed Consolidated Financial Statements and Arizona Public Service Company's Condensed Financial Statements and the related Notes that appear in Item 1 of this report.
OVERVIEW Pinnacle West owns all of the outstanding common stock of APS. APS is a vertically-integrated electric utility that provides retail and wholesale electric service to most of the state of Arizona, with the major exceptions of about one-half of the Phoenix metropolitan area, the Tucson metropolitan area and Mohave County in northwestern Arizona. APS has historically accounted for a substantial part of our revenues and earnings, and is expected to continue to do so.
While customer growth in APS' service territory has been an important driver of our revenues and earnings, it has significantly slowed, reflecting recessionary economic conditions both nationally and in Arizona. Customer growth averaged 3% a year for the three years 2006 through 2008. We currently expect customer growth and retail electricity sales growth (excluding the effects of weather variations) to average about 1% per year during 2009 through 2011. We currently project that our customer growth will begin to accelerate as the economy recovers.
The near-term economic conditions are reflected in the recent volatility and disruption of the credit markets, as discussed in detail under "Pinnacle West Consolidated - Liquidity and Capital Resources" below. Despite these conditions, Pinnacle West and APS currently have ample borrowing capacity under their respective credit facilities and have been able to access these facilities, ensuring adequate liquidity for each company.
Our cash flows and profitability are affected by the electricity rates APS may charge and the timely recovery of costs through those rates. APS' retail rates are regulated by the ACC and its wholesale electric rates (primarily for transmission) are regulated by the FERC. APS' capital expenditure requirements, which are discussed below under "Pinnacle West Consolidated - Liquidity and Capital Resources," are substantial because of increased costs related to environmental compliance and controls and system reliability, as well as continuing, though slowed, customer growth in APS' service territory.
APS needs timely recovery through rates of its capital and operating expenditures to maintain adequate financial health. See "Factors Affecting Our Financial Outlook" below. On March 24, 2008, APS filed a rate case with the ACC, which it updated on June 2, 2008, requesting, among other things, an increase in retail rates to help defray rising infrastructure costs, approval of an impact fee and approval of new conservation rates. On January 30, 2009, APS and the other parties to the rate case began settlement discussions, and on May 4, 2009 they filed a proposed settlement term sheet with the ACC, a copy of which is attached to this Report on Form 10-Q as Exhibit 99.1. See Note 5 for details regarding this rate case, including the ACC's approval of an interim base rate surcharge pending the outcome of the case and a discussion of the proposed settlement term sheet and related timeline.

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As a result of current and anticipated continuing distressed conditions in real estate and credit markets, SunCor, our real estate subsidiary, undertook and has now completed a review of its assets and strategies within its various markets. Based on the results of the review, on March 27, 2009, SunCor's Board of Directors authorized a series of strategic transactions to dispose of SunCor's homebuilding operations, master-planned communities, and golf courses in order to reduce SunCor's outstanding debt. Management plans to dispose of the assets in 2009. As a result of this decision, we recorded pretax impairment charges in the first quarter of $202 million, or $123 million after taxes on a Pinnacle West consolidated basis. SunCor currently plans to retain selected Arizona assets, with a book value of approximately $70 million. See "Liquidity and Capital Resources - Other Subsidiaries - SunCor" below for a discussion of SunCor's outstanding debt and related matters.
Our other principal first tier subsidiaries, El Dorado and APSES, are not expected to have any material impact on our financial results, or to require any material amounts of capital, over the next three years.
We continue to focus on solid operational performance in our electricity generation and delivery activities. In the generation area, the NRC recently completed its inspections of corrective actions taken by Palo Verde to address certain performance deficiencies, and returned all three units of Palo Verde to routine inspection and oversight. See "NRC Inspection" in Part II, Item 5 below. In the delivery area, we focus on superior reliability and customer satisfaction. We plan to expand long-term energy resources and our transmission and distribution systems to meet the electricity needs of our growing retail customer base and to sustain reliability.
See "Factors Affecting Our Financial Outlook" below for a discussion of several factors that could affect our future financial results.
EARNINGS CONTRIBUTION BY BUSINESS SEGMENT
Pinnacle West's two reportable business segments are:
• our regulated electricity segment, which consists of traditional regulated retail and wholesale electricity businesses (primarily electric service to Native Load customers) and related activities and includes electricity generation, transmission and distribution; and

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

The following table presents loss from continuing operations for our regulated electricity and real estate segments and reconciles those amounts to our consolidated net income (loss) (dollars in millions):

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                                                                      Three Months Ended
                                                                           March 31,
                                                                     2009              2008
Regulated electricity segment                                     $       (20 )       $    (6 )
Real estate segment (a)                                                  (143 )            (4 )
All other (b)                                                              (5 )             4

Loss from continuing operations                                          (168 )            (6 )
Income (loss) from discontinued operations - net of tax:
Real estate segment (a)                                                    (3 )             3
All other (b)                                                               -              (1 )

Net Loss                                                                 (171 )            (4 )
Less: Net loss attributable to noncontrolling interests -
real estate segment (a) (c)                                               (14 )             -

Net loss attributable to common shareholders                      $      (157 )       $    (4 )

(a) We recorded an after-tax real estate impairment charge in the first quarter of 2009 of $123 million on a Pinnacle West consolidated basis.

(b) Includes activities related to marketing and trading, APSES and El Dorado. None of these segments is a reportable segment.

PINNACLE WEST CONSOLIDATED - RESULTS OF OPERATIONS Operating Results - Three-month period ended March 31, 2009 compared with three-month period ended March 31, 2008
Our consolidated net loss attributable to common shareholders for the three months ended March 31, 2009 was $157 million, compared with a net loss of $4 million for the comparable prior-year period. The major factors that increased or decreased the net loss attributable to common shareholders for the three-month comparison are summarized in the following table (dollars in millions):

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                                                                       Increase (Decrease)
                                                                    Pretax           After Tax
Regulated electricity segment:
Interim retail rate increase effective January 1, 2009            $       13         $        8
Transmission rate increases effective July 1, 2008
(including related retail rates)                                           6                  4
Lower mark-to-market valuations of fuel and purchased power
contracts related to changes in market prices, net of
related PSA deferrals                                                    (19 )              (12 )
Effects of milder weather on retail sales                                (13 )               (8 )
Higher depreciation and amortization primarily due to
increased utility plant in service                                        (4 )               (2 )
Higher interest expense, net of capitalized financing costs,
primarily due to higher debt balances                                     (4 )               (3 )
Miscellaneous items, net                                                  (1 )               (1 )

Increase in regulated electricity segment net loss                       (22 )              (14 )
Real estate segment:
Real estate impairment charge (Note 21)                                 (211 )             (134 )
Higher real estate segment costs primarily related to
employee severance and other disposition costs                            (9 )               (5 )
All other:
Lower marketing and trading contributions primarily due to
lower sales volumes                                                       (7 )               (4 )
Increase in other expense, net of other income, primarily
due to higher investment losses                                           (6 )               (4 )
Other miscellaneous items, net                                            (1 )               (1 )

Increase in loss from continuing operations                       $     (256 )             (162 )

Decrease in discontinued operations primarily related to the
impairment of certain real estate properties (Note 21)                                       (5 )

Increase in net loss                                                                       (167 )
Less: Net loss attributable to real estate noncontrolling
interests primarily due to real estate impairment                                           (14 )

Increase in net loss attributable to common shareholders                             $     (153 )

Regulated Electricity Segment Revenues
Regulated electricity segment revenues were $20 million lower for the three months ended March 31, 2009 compared with the prior-year period primarily because of:
• a $22 million decrease in retail revenues due to the effects of weather;

• a $22 million decrease in retail revenues related to recovery of PSA deferrals, which had no earnings effect because of amortization of the same amount recorded as fuel and purchased power expense (see Note 5);

• a $7 million decrease in retail revenues primarily related to lower average usage per customer, excluding weather effects;

• a $19 million increase in retail revenues due to an interim rate increase effective January 2009 and transmission rate increases in 2008 (including related retail rates);

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• a $16 million increase in renewable energy surcharges, which had no earnings effect because of amortization of the same amount recorded as operations and maintenance expense; and

• a $4 million net decrease due to miscellaneous factors.

Real Estate Segment Revenues
Real estate segment revenues were $8 million lower for the three months ended March 31, 2009 compared with the prior-year period primarily because of lower residential property sales as a result of the distressed real estate markets. All Other Revenues
Other revenues were $31 million lower for the three months ended March 31, 2009 compared with the prior-year period because of planned reductions of marketing and trading activities.

          PINNACLE WEST CONSOLIDATED - LIQUIDITY AND CAPITAL RESOURCES
Cash Flows
   The following table presents net cash provided by (used for) operating,
investing and financing activities for the three months ended March 31, 2009 and
2008 (dollars in millions):

                                                                 Three Months Ended
                                                                     March 31,
                                                                  2009          2008
  Net cash flow provided by (used for) operating activities    $    (56 )     $  246
  Net cash flow used for investing activities                      (182 )       (248 )
  Net cash flow provided by (used for) financing activities         166          (37 )

The increase of approximately $302 million in net cash used for operating activities is primarily due to increased collateral and margin cash provided as a result of changes in commodity prices.
The decrease of approximately $66 million in net cash used for investing activities is primarily due to lower levels of capital expenditures (see table and discussion below).
The increase of approximately $203 million in net cash provided by financing activities is primarily due to APS' issuance of $500 million of unsecured senior notes. A portion of these proceeds were used to repay short-term borrowings.

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                              CAPITAL EXPENDITURES
                             (dollars in millions)

                           Three Months Ended             Estimated for the Year Ended
                                March 31,                         December 31,
                          2008            2009          2009            2010          2011
       APS
       Distribution     $      88       $      60     $     276       $     266       $ 356
       Generation (a)          89              70           288             274         319
       Transmission            37              31           275              99         185
       Other (b)                4               5            44              37          50

       Subtotal               218             166           883             676         910
       Other                   20               6            12               8           8

       Total            $     238       $     172     $     895       $     684       $ 918

(a) Generation includes nuclear fuel expenditures of approximately $60 million to $80 million per year for 2009, 2010 and 2011.

(b) Primarily information systems and facilities projects.

Distribution and transmission capital expenditures are comprised of infrastructure additions and upgrades, capital replacements, new customer construction and related information systems and facility costs. Examples of the types of projects included in the forecast include power lines, substations, line extensions to new residential and commercial developments and upgrades to customer information systems, partially offset by contributions in aid of construction in accordance with APS' line extension policy.
Generation capital expenditures are comprised of various improvements to APS' existing fossil and nuclear plants. 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. Environmental expenditures differ for each of the years 2009, 2010 and 2011, with the lowest year estimated at approximately $25 million, and the highest year estimated at approximately $80 million. We are also monitoring the status of certain environmental matters, which, depending on their final outcome, could require modification to our environmental expenditures. (See "Business of Arizona Public Service Company - Environmental Matters - EPA Environmental Regulation - Regional Haze Rules" in Item 1 of the 2008 Form 10-K and "Environmental Matters - EPA Environmental Regulation - Mercury" in Part II, Item 5 below.)
In early 2008, we announced and began implementing a cost reduction effort that included the elimination of approximately $200 million of capital expenditures for the years 2008 - 2012. These capital expenditure reductions are reflected in the estimates provided above. Due primarily to our reduced customer growth outlook as well as the deferral of upgrades and other capital projects, we have identified additional capital expenditure reductions of over $500 million at APS (net of the change in amounts collected for projected line extensions) over the years 2009 - 2011. These reductions are across all areas - distribution, generation, transmission and general plant, and are reflected in the estimates provided above. (See "Pinnacle West Consolidated - Factors Affecting Our Financial Outlook - Customer and Sales Growth" below for additional information on our growth outlook.)

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Capital expenditures will be funded with internally generated cash and/or external financings, which may include issuances of long-term debt and Pinnacle West common stock.
Pinnacle West (Parent Company)
Our primary cash needs are for dividends to our shareholders and principal and interest payments on our long-term debt. The level of our common stock 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.
On April 22, 2009, the Pinnacle West Board of Directors declared a quarterly dividend of $0.525 per share of common stock, payable on June 1, 2009, to shareholders of record on May 1, 2009.
Our primary sources of cash are dividends from APS, external debt and equity financings and cash distributions from our other subsidiaries. In addition, Pinnacle West expects to recognize approximately $100 million of cash tax benefits related to SunCor's strategic asset sales which will not be realized until the asset sale transactions are completed. Approximately $80 million of these benefits were recorded in the first quarter of 2009 as reductions to income tax expense related to the current impairment charges. The additional $20 million of tax benefits were recorded as reductions in income tax expense related to the impairment charge recorded in the fourth quarter of 2008.
An existing ACC order requires APS to maintain a common equity ratio of at least 40% and prohibits APS from paying common stock dividends if the payment would reduce its common equity below that threshold. As defined in the ACC order, the common equity ratio is common equity divided by the sum of common equity and long-term debt, including current maturities of long-term debt. At March 31, 2009, APS' common equity ratio, as defined, was approximately 49%.
The credit and liquidity markets experienced significant stress beginning the week of September 15, 2008. While Pinnacle West's and APS' ability to issue commercial paper has been negatively impacted by the market stress, they have both been able to access existing credit facilities, ensuring adequate liquidity. Cash on hand is being invested in money market funds consisting of U.S. Treasury and government agency securities and repurchase agreements collateralized fully by U.S. Treasury and government agency securities.
Pinnacle West (parent company) has a $283 million revolving credit facility that terminates in December 2010. The revolver is available to support the issuance of up to $250 million in commercial paper (see discussion above) or to be used as bank borrowings, including issuances of letters of credit of up to $94 million. At March 31, 2009, the parent company had outstanding $166 million of borrowings under its revolving credit facility and approximately $7 million of letters of credit. It also had no commercial paper outstanding at March 31, 2009. At March 31, 2009, the parent company had remaining capacity available under its revolver of approximately $110 million and had cash and investments of approximately $3 million.
Pinnacle West sponsors a qualified defined benefit and account balance pension plan and a non-qualified supplemental excess benefit retirement plan for the employees of Pinnacle West and our subsidiaries. IRS regulations require us to contribute a minimum amount to the qualified plan. We contribute at least the minimum amount required under IRS regulations, but no more than the maximum

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tax-deductible amount. The minimum required funding takes into consideration the value of plan assets and our pension obligation. The assets in the plan are comprised of fixed-income, equity, real estate and short-term investments. Future year contribution amounts are dependent on plan asset performance and plan actuarial assumptions. We contributed $35 million to our pension plan in 2008. At December 31, 2008, we estimated the minimum contribution to our pension plan to be approximately $36 million in 2009 and approximately $25 million in 2010. A recent change in IRS regulations allows alternative measurement dates to determine the interest rate used to value pension liabilities for funding purposes. As a result of this change, we now estimate our minimum pension contribution to be zero in both 2009 and 2010. The expected contribution to our other postretirement benefit plans in 2009 is estimated to be approximately $15 million. APS and other subsidiaries fund their share of the contributions. APS' share is approximately 96% of both plans.
See Note 5 for information regarding Pinnacle West's approval from the ACC regarding a potential equity infusion into APS of up to $400 million. In addition, see Note 5 for details regarding terms of the proposed retail rate case settlement under which APS would have authorization to obtain additional equity infusions.
APS
APS' capital requirements consist primarily of capital expenditures and mandatory redemptions of long-term debt. APS pays for its capital requirements with cash from operations and, to the extent necessary, equity infusions from Pinnacle West and external financings. APS has historically paid its dividends to Pinnacle West with cash from operations. See "Pinnacle West (Parent Company)" above for a discussion of the common equity ratio that APS must maintain in order to pay dividends to Pinnacle West.
On February 26, 2009, APS issued $500 million of 8.75% unsecured senior notes that mature on March 1, 2019. Net proceeds from the sale of the notes were used to repay short-term borrowings under two committed revolving lines of credit incurred to fund capital expenditures and for general corporate purposes.
APS has two committed revolving credit facilities totaling $866 million, of which $377 million terminates in December 2010 and $489 million terminates in September 2011. The revolvers are available either to support the issuance of up to $250 million in commercial paper (see discussion above) or to be used for bank borrowings, including issuances of letters of credit up to $583 million. At March 31, 2009, APS had borrowings of approximately $236 million and no letters of credit under its revolving lines of credit. APS had no commercial paper outstanding at March 31, 2009. At March 31, 2009, APS had remaining capacity available under its revolvers of $630 million and had cash and investments of approximately $18 million.
Other Financing Matters - See Note 5 for information regarding the PSA approved by the ACC. Although APS defers actual retail fuel and purchased power costs on a current basis, APS' recovery of the deferrals from its ratepayers is subject to annual and, if necessary, periodic PSA adjustments.
See Note 5 for information regarding an ACC order permitting Pinnacle West to infuse up to $400 million of equity into APS, on or before December 31, 2009, if Pinnacle West deems it appropriate to do so to strengthen or maintain APS' financial integrity. In addition, see Note 5 for details regarding terms of the proposed retail rate case settlement under which APS would have authorization to obtain additional equity infusions.
See Note 10 for information related to the change in our margin account.

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Other Subsidiaries
SunCor - As a result of current and anticipated continuing distressed conditions in real estate and credit markets, SunCor, our real estate subsidiary, undertook and has now completed a review of its assets and strategies within its various markets. Based on the results of the review, on March 27, 2009, SunCor's Board of Directors authorized a series of strategic transactions to dispose of SunCor's homebuilding operations, master-planned communities, and golf courses in order to reduce SunCor's outstanding debt. SunCor currently plans to retain selected Arizona assets, including land parcels and commercial assets associated with SunCor's Hayden Ferry Lakeside project in Tempe, Arizona, and approximately 2,000 acres of commercial land associated with its Palm Valley project located west of Phoenix, Arizona. SunCor's book value of the retained assets will be approximately $70 million.
Management plans to dispose of the assets in 2009. As a result of this decision, we recorded pretax impairment charges in the first quarter of $202 million, or $123 million after taxes on a Pinnacle West consolidated basis. SunCor also recorded in the first quarter approximately $8 million of pretax severance and other charges relating to these actions. SunCor expects to reclassify most of the affected properties to discontinued operations beginning in the second quarter of 2009, as marketing of the assets commences and other criteria are met. Pinnacle West does not expect that any of the impairment charges will result in future cash expenditures, other than immaterial disposition costs.
The SunCor Secured Revolver was recently extended for a twelve-month period to January 2010 and requires SunCor to reduce its outstanding borrowings by specified amounts over the term of the facility. As of March 31, 2009, approximately $108 million of borrowings were outstanding under the SunCor Secured Revolver and approximately $67 million of debt was outstanding under other SunCor credit facilities. SunCor intends to apply the proceeds of the asset sales described above to the accelerated repayment of the SunCor Secured Revolver and SunCor's other outstanding debt, including several project loans totaling approximately $24 million which recently matured. The impairment charges discussed above and the maturity and non-payment of the project loans resulted in violations of certain covenants contained in the SunCor Secured Revolver and SunCor's other credit facilities. If SunCor is unable to obtain waivers or similar relief from its lenders, which it is currently seeking, . . .